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Section 1: 10-K (10-K)

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UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

FORM 10-K

 

 

 

ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

 

For the fiscal year ended December 31, 2017

 

or

 

 

 

TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

 

For the transition period from                          to                          

 

Commission File Number 001-09463

 

RLI CORP.

(Exact name of registrant as specified in its charter)

 

 

 

 

Illinois

 

37-0889946

(State or other jurisdiction of incorporation or organization)

 

(I.R.S. Employer Identification No.)

 

 

 

9025 North Lindbergh Drive, Peoria, Illinois

 

61615

(Address of principal executive offices)

 

(Zip Code)

 

Registrant’s telephone number, including area code (309) 692-1000

 

Securities registered pursuant to Section 12(b) of the Act:

 

 

 

 

Title of each class

 

Name of each exchange on which registered

Common Stock $1.00 par value

 

New York Stock Exchange

 

Securities registered pursuant to Section 12(g) of the Act: NONE

 

Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act. Yes ☒ No ☐

 

Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Exchange Act. Yes ☐ No ☒

 

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes ☒ No ☐

 

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes ☒ No ☐

 

Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. ☐

 

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.

 

 

 

 

 

 

 

 

Large accelerated filer ☒

 

Accelerated filer ☐

 

Non-accelerated filer ☐

 

Smaller reporting company ☐

 

 

 

 

(Do not check if a smaller
reporting company)

 

 

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes ☐ No ☒ 

 

The aggregate market value of the registrant’s common stock held by non-affiliates of the Registrant as of June 30, 2017, based upon the closing sale price of the Common Stock on June 30, 2017 as reported on the New York Stock Exchange, was $2,125,028,624. Shares of Common Stock held directly or indirectly by each reporting officer and director along with shares held by the Company ESOP have been excluded in that such persons may be deemed to be affiliates. This determination of affiliate status is not necessarily a conclusive determination for other purposes.

 

The number of shares outstanding of the Registrant’s Common Stock, $1.00 par value, on February 7, 2018 was 44,237,951.

 

 

 

 

 


 

Table of Contents

DOCUMENTS INCORPORATED BY REFERENCE.

 

Portions of the Registrant’s definitive Proxy Statement for the 2018 annual meeting of shareholders to be held May 3, 2018, are incorporated herein by reference into Part III of this document, including:  “Share Ownership of Certain Beneficial Owners,” “Board Meetings and Compensation,” “Compensation Discussion & Analysis,” “Executive Compensation,” “Equity Compensation Plan Information,” “Executive Management,” “Corporate Governance and Board Matters,” “Audit Committee Report” and “Proposal four:  Ratification of Selection of Independent Registered Public Accounting Firm.”

 

Exhibit index is located on pages 122-123 of this document, which lists documents filed as exhibits or incorporated by reference herein.

 

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Table of Contents

RLI Corp.

Index to Annual Report on Form 10-K

 

 

 

 

 

 

 

 

Page

Part I 

 

 

 

Item 1.

Business

4

 

Item 1A.

Risk Factors

23

 

Item 1B.

Unresolved Staff Comments

30

 

Item 2.

Properties

30

 

Item 3.

Legal Proceedings

30

 

Item 4.

Mine Safety Disclosures

30

 

 

 

 

Part II 

 

 

 

Item 5.

Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities

30

 

Item 6.

Selected Financial Data

32

 

Item 7.

Management’s Discussion and Analysis of Financial Condition and Results of Operations

33

 

Item 7A.

Quantitative and Qualitative Disclosures About Market Risk

61

 

Item 8.

Financial Statements and Supplementary Data

63

 

Item 9.

Changes in and Disagreements with Accountants on Accounting and Financial Disclosure

111

 

Item 9A.

Controls and Procedures

111

 

Item 9B.

Other Information

111

 

 

 

 

Part III 

 

 

 

Items 10-14.

111

 

 

 

 

Part IV 

 

 

 

Item 15.

Exhibits and Financial Statement Schedules

111

 

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Table of Contents

PART I

Item 1.    Business

 

RLI Corp. is an Illinois corporation that was organized in 1965. We underwrite selected property and casualty insurance through major subsidiaries collectively known as RLI Insurance Group (the Group). We conduct operations principally through three insurance companies. RLI Insurance Company (RLI Ins.), a subsidiary of RLI Corp. and our principal insurance subsidiary, writes multiple lines of insurance on an admitted basis in all 50 states, the District of Columbia, Puerto Rico, the Virgin Islands and Guam. Mt. Hawley Insurance Company (Mt. Hawley), a subsidiary of RLI Ins., writes excess and surplus lines insurance on a non-admitted basis in all 50 states, the District of Columbia, Puerto Rico, the Virgin Islands and Guam. Contractors Bonding and Insurance Company (CBIC), a subsidiary of RLI Ins., writes multiple lines of insurance on an admitted basis in all 50 states and the District of Columbia. Each of our insurance companies is domiciled in Illinois. We have no material foreign operations.

 

As a specialty insurance company with a niche focus, we offer insurance coverages in both the specialty admitted and excess and surplus markets. We distribute our property and casualty insurance through our branch offices that market to wholesale and retail producers. We offer limited coverages on a direct basis to select insureds, as well as various reinsurance coverages. In addition, from time to time, we produce a limited amount of business under agreements with managing general agents under the direction of our product vice presidents.

 

We maintain a website at http://www.rlicorp.com. We make available free of charge on our website our annual report on Form 10-K, our quarterly reports on Form 10-Q, current reports on Form 8-K and amendments to those reports filed with or furnished to the Securities and Exchange Commission (SEC) as soon as reasonably practicable after such materials are filed or furnished. Information contained on our website is not intended to be incorporated by reference in this annual report and you should not consider that information a part of this annual report.

 

For the year ended December 31, 2017, the following table provides the geographic distribution of our risks insured as represented by direct premiums earned for all coverages:

 

 

 

 

 

 

 

 

 

State

    

Direct Premiums Earned

    

Percent of Total

 

 

 

(in thousands)

 

 

 

California

 

$

130,517

 

15.6

%  

New York

    

 

121,975

 

14.6

%  

Florida

 

 

82,122

 

9.8

%  

Texas

 

 

65,794

 

7.9

%  

Washington

 

 

31,166

 

3.7

%  

New Jersey

 

 

26,077

 

3.1

%  

Illinois

 

 

26,042

 

3.1

%  

Arizona

 

 

25,544

 

3.1

%  

Pennsylvania

 

 

21,677

 

2.6

%  

Louisiana

 

 

20,980

 

2.5

%  

Hawaii

 

 

17,432

 

2.1

%  

Ohio

 

 

16,765

 

2.0

%  

All Other

 

 

249,027

 

29.9

%  

Total direct premiums earned

 

$

835,118

 

100.0

%  

 

In the ordinary course of business, we rely on other insurance companies to share risks through reinsurance. A large portion of the reinsurance is put into effect under contracts known as treaties and, in some instances, by negotiation on each individual risk (known as facultative reinsurance). We have quota share, excess of loss and catastrophe (CAT) reinsurance contracts that protect against losses over stipulated amounts arising from any one occurrence or event. These arrangements allow us to pursue greater diversification of business and serve to limit the maximum net loss on catastrophes and large risks. Reinsurance is subject to certain risks, specifically market risk, which affects the cost of and the ability to secure these contracts, and credit risk, which is the risk that our reinsurers may not pay on losses in a timely fashion or at all. The following table illustrates the degree to which we have utilized reinsurance during the past three years. For an expanded discussion of the impact of reinsurance on our operations, see note 5 to the consolidated financial statements within Item 8, Financial Statements and Supplementary Data.

 

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Year Ended December 31,

 

(in thousands)

    

2017

    

2016

    

2015

 

PREMIUMS WRITTEN

 

 

 

 

 

 

 

 

 

 

Direct & Assumed

 

$

885,312

 

$

874,864

 

$

853,586

 

Reinsurance ceded

 

 

(135,458)

 

 

(133,912)

 

 

(131,615)

 

Net

 

$

749,854

 

$

740,952

 

$

721,971

 

PREMIUMS EARNED

 

 

 

 

 

 

 

 

 

 

Direct & Assumed

 

$

867,639

 

$

863,180

 

$

832,904

 

Reinsurance ceded

 

 

(129,702)

 

 

(134,572)

 

 

(132,743)

 

Net

 

$

737,937

 

$

728,608

 

$

700,161

 

 

SPECIALTY INSURANCE MARKET OVERVIEW

 

The specialty insurance market differs significantly from the standard market. In the standard market, products and coverage are largely uniform with relatively predictable exposures and companies tend to compete for customers on the basis of price. In contrast, the specialty market provides coverage for risks that do not fit the underwriting criteria of the standard carriers. Competition tends to focus less on price and more on availability, coverage, service and other value-based considerations. While specialty market exposures may have higher insurance risks than their standard admitted market counterparts, we manage these risks to achieve higher financial returns. To reach our financial and operational goals, we must have extensive knowledge of, and expertise in, our markets. Many of our risks are underwritten on an individual basis and tailored coverages are employed in order to respond to distinctive risk characteristics. We operate in the specialty admitted insurance market, the excess and surplus insurance market and the specialty property and casualty reinsurance markets.

 

SPECIALTY ADMITTED INSURANCE MARKET

 

We write business in the specialty admitted market. Most of these risks are unique and hard to place in the standard admitted market, but for marketing and regulatory reasons, they must remain with an admitted insurance company. The specialty admitted market is subject to greater state regulation than the excess and surplus market, particularly with regard to rate and form filing requirements, restrictions on the ability to exit lines of business, premium tax payments and membership in various state associations, such as state guaranty funds and assigned risk plans. For 2017, our specialty admitted operations produced gross premiums written of $572.2 million, representing approximately 64 percent of our total gross premiums for the year.

 

EXCESS AND SURPLUS INSURANCE MARKET

 

The excess and surplus market focuses on hard-to-place risks. Participating in this market allows us to underwrite non-standard risks with more flexible policy forms and unregulated premium rates. This typically results in coverages that are more restrictive and more expensive than in the standard admitted market. The excess and surplus lines regulatory environment and production model also effectively filter submission flow and match market opportunities to our expertise and appetite. According to the 2017 edition of A.M. Best Aggregate & Averages – Property/Casualty, United States & Canada, the excess and surplus market represented approximately $27 billion, or 4 percent, of the entire $613 billion domestic property and casualty industry in 2017, as measured by direct premiums written. Our excess and surplus operations wrote gross premiums of $280.1 million, or 32 percent, of our total gross premiums written in 2017.

 

SPECIALTY PROPERTY AND CASUALTY REINSURANCE MARKETS

 

We write business in the specialty property and casualty reinsurance markets. This business can be written on an individual risk (facultative) basis or on a portfolio (treaty) basis. We write contracts on an excess of loss and a proportional basis. Contract provisions are written and agreed upon between the company and its reinsurance clients. The business is typically more volatile as a result of unique underlying exposures and excess and aggregate attachments. This business requires specialized underwriting and technical modeling. For 2017, our specialty property and casualty reinsurance operations wrote gross premiums of $33.0 million, representing approximately 4 percent of our total gross premiums written for the year.

 

BUSINESS SEGMENT OVERVIEW

 

The segments of our insurance operations are casualty, property and surety. For additional information, see note 11 to the consolidated financial statements within Item 8, Financial Statements and Supplementary Data.

 

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CASUALTY SEGMENT

 

Commercial and Personal Umbrella

 

Our commercial umbrella coverage is written in excess of primary liability insurance provided by other carriers and in excess of primary liability written by us. The personal umbrella coverage is written in excess of homeowners’ and automobile liability coverage provided by other carriers, except in Hawaii, where some underlying homeowners’ coverage is written by us. Net premiums earned from this business totaled $115.5 million, $111.1 million and $104.6 million, or 16 percent, 15 percent and 15 percent of total net premiums earned for 2017, 2016 and 2015, respectively.

 

General Liability

 

Our general liability business consists primarily of coverage for third-party liability of commercial insureds including manufacturers, contractors, apartments, real estate investment trusts (REITs) and mercantile. We also offer coverages for security guards and in the specialized areas of onshore energy-related businesses and environmental liability for underground storage tanks, contractors and asbestos and environmental remediation specialists. Net premiums earned from our general liability business totaled $90.3 million, $86.9 million and $84.2 million, or 12 percent of total net premiums earned for 2017, 2016 and 2015, respectively.

 

Professional Services

 

We offer professional liability coverages focused on providing errors and omission coverage to small to medium-sized design, technical, computer and miscellaneous professionals. Our product suite for these customers also includes a full array of multi-peril package products including general liability, property, automobile, excess liability and workers’ compensation coverages. This business primarily markets its products through specialty retail agents nationwide. Net premiums earned from the professional services group totaled $78.5 million, $75.9 million and $71.0 million, or 11 percent, 10 percent and 10 percent of total net premiums earned for 2017, 2016 and 2015, respectively.

 

Commercial Transportation

 

Our transportation insurance provides commercial automobile liability and physical damage insurance to local, intermediate and long haul truckers, public transportation entities and equipment dealers, along with other types of specialty commercial automobile risks. We also offer incidental, related insurance coverages including general liability, excess liability and motor truck cargo. Our highly experienced transportation underwriters produce business through independent agents and brokers nationwide. Net premiums earned from this business totaled $78.1 million, $81.4 million and $65.6 million, or 11 percent, 11 percent and 9 percent of total net premiums earned for 2017, 2016 and 2015, respectively.

 

Small Commercial

 

Our small commercial business offers property and casualty insurance coverages to small contractors and other small to medium-sized retail businesses. The coverages included in these packages are predominantly general liability, but also have some inland marine coverages as well as commercial automobile, property and umbrella coverage. These products are primarily marketed through retail agents. Net premiums earned from the small commercial business totaled $49.6 million, $45.7 million and $40.4 million, or 7 percent, 6 percent and 6 percent of total net premiums earned for 2017, 2016 and 2015, respectively.

 

Executive Products

 

We provide a suite of management liability coverages, such as directors and officers (D&O) liability insurance, fiduciary liability and fidelity coverages, for a variety of low to moderate classes of risks, including both public and private businesses. Our publicly traded D&O appetite generally focuses on offering excess “Side A” D&O coverage (where corporations cannot indemnify the individual directors and officers) as well as excess full coverage D&O. Additionally, we offer representations and warranties coverage for companies involved in mergers and acquisitions and cyber liability coverage to medium to large size public and private businesses. Net premiums earned from the executive products business totaled $18.1 million, $18.8 million and $17.9 million, or 2 percent, 3 percent and 3 percent of total net premiums earned for 2017, 2016 and 2015, respectively.

 

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Medical Professional Liability

 

We provide healthcare liability coverage that is focused on long-term care and hospital liability. We also offer medical professional liability insurance specializing in hard-to-place individuals and group physicians. This business is marketed through wholesale brokers and retail agents. Net premiums earned from the medical professional liability business totaled $17.1 million, $17.4 million and $12.3 million, or 2 percent of total net premiums earned for 2017, 2016 and 2015, respectively.

 

Other Casualty

 

We offer a variety of other smaller products in our casualty segment, including home business insurance, which provides limited liability and property coverage, on and off-site, for a variety of small business owners who work from their own home. We have a quota share reinsurance agreement with Prime Insurance Company and Prime Property and Casualty Insurance Inc., the two insurance subsidiaries of Prime Holdings Insurance Services, Inc. (Prime). We assume general liability, excess, commercial auto, property and professional liability coverages on hard-to-place risks that are primarily written in the excess and surplus insurance market, as well as certain coverages written on an admitted basis. Additionally, we write mortgage reinsurance, which provides credit risk transfer on pools of mortgages, and offer general liability coverage through a general binding authority group. Net premiums earned from these lines totaled $31.4 million, $17.8 million and $16.3 million, or 4 percent, 2 percent and 2 percent of total net premiums earned for 2017, 2016 and 2015, respectively.

 

PROPERTY SEGMENT

 

Commercial Property

 

Our commercial property coverage consists primarily of excess and surplus lines and specialty insurance such as fire, earthquake and difference in conditions (DIC), which can include earthquake, wind, flood and collapse coverages. We provide insurance for a wide range of commercial and industrial risks, such as office buildings, apartments, condominiums, builders’ risks and certain industrial and mercantile structures. Net premiums earned from the commercial property business totaled $63.1 million, $68.2 million and $75.7 million, or 9 percent, 9 percent and 11 percent of total net premiums earned for 2017, 2016 and 2015, respectively.

 

Marine

 

Our marine coverages include cargo, hull, protection and indemnity (P&I), marine liability, as well as inland marine coverages including builders’ risks and contractors’ equipment. Although the predominant exposures are located within the United States, there is some incidental international exposure written within these coverages. Net premiums earned from the marine business totaled $50.9 million, $48.3 million and $47.0 million, or 7 percent of total net premiums earned for 2017, 2016 and 2015, respectively.

 

Specialty Personal

 

We offer specialized homeowners’ insurance in select locations, including homeowners’ and dwelling fire insurance through retail agents in Hawaii and a limited amount of homeowners’ insurance in Massachusetts and North Carolina. We also offered recreational vehicle insurance, which we began phasing out towards the end of 2016. Net premiums earned from specialty personal coverages totaled $20.8 million, $25.0 million and $26.4 million, or 3 percent, 3 percent and 4 percent of total net premiums earned for 2017, 2016 and 2015, respectively.

 

Other Property

 

Our other property coverages consist of newer product offerings, such as general binding authority, and lines which we have recently exited, including property and crop reinsurance. Net premiums earned from these lines totaled $3.5 million, $10.7 million and $21.8 million, or less than 1 percent, 1 percent and 3 percent of total net premiums earned for 2017, 2016 and 2015, respectively.

 

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SURETY SEGMENT

 

Miscellaneous

 

Our miscellaneous surety coverage includes small bonds for businesses and individuals written through independent insurance agencies throughout the United States. Examples of these types of bonds are license and permit, notary and court bonds. These bonds are usually individually underwritten and utilize extensive automation tools for the underwriting and bond delivery to our agents. Net premiums earned from miscellaneous surety coverages totaled $47.2 million, $46.2 million and $42.4 million, or 6 percent, 7 percent and 6 percent of total net premiums earned for 2017, 2016 and 2015, respectively.

 

Contract

 

We offer bonds for small to medium-sized contractors throughout the United States, underwritten on an account basis. Typically, these are performance and payment bonds for individual construction contracts. These bonds are marketed through a select number of insurance agencies that have surety and construction expertise. We also offer bonds for small and emerging contractors that are reinsured through the Federal Small Business Administration. Net premiums earned from contract surety coverages totaled $28.6 million, $28.2 million and $28.3 million, or 4 percent of total net premiums earned for 2017, 2016 and 2015, respectively.

 

Commercial

 

We offer a large variety of commercial surety bonds for medium to large-sized businesses across a broad spectrum of industries. These risks are underwritten on an account basis and coverage is marketed through a select number of regional and national brokers with surety expertise. Net premiums earned from commercial surety coverages totaled $27.6 million, $29.1 million and $29.5 million, or 4 percent of total net premiums earned for 2017, 2016 and 2015, respectively.

 

Energy

 

Our energy surety coverages provide commercial surety bonds for the energy, petrochemical and refining industries both on and off shore. These risks are primarily underwritten on an account basis and are primarily marketed through insurance producers with expertise in these industries. Net premiums earned from energy coverages totaled $17.6 million, $18.0 million and $16.8 million, or 2 percent of total net premiums earned for 2017, 2016 and 2015, respectively.

 

MARKETING AND DISTRIBUTION

 

We distribute our coverages primarily through branch offices throughout the country that market to wholesale and retail brokers and through independent agents.

 

BROKERS

 

The largest volume of broker-generated premium is in our commercial property, general liability, commercial surety, commercial umbrella, commercial transportation and medical professional liability coverages. This business is produced through independent wholesale and retail brokers.

 

INDEPENDENT AGENTS

 

We target classes of insurance, such as homeowners’ and dwelling fire, home business, surety and personal umbrella, through independent agents. Several of these products involve detailed eligibility criteria, which are incorporated into strict underwriting guidelines and prequalification of each risk using a system accessible by the independent agent. The independent agent cannot bind the risk unless they receive approval from our underwriters or through our automated systems.

 

UNDERWRITING AGENTS

 

We contract with certain underwriting agencies, which have limited authority to bind or underwrite business on our behalf. The underwriting agreements involve strict underwriting guidelines and the agents are subject to audits upon request. These agencies may receive some compensation through contingent profit commission.

 

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ONLINE AND DIRECT

 

We are utilizing online efforts to produce and efficiently process and service business including home businesses, high performance drivers, small commercial and personal umbrella risks and surety bonding. On a direct basis, we also assume premium on various reinsurance treaties.

 

COMPETITION

 

Our specialty property and casualty insurance subsidiaries are part of a very competitive industry that is cyclical and historically characterized by periods of high premium rates and shortages of underwriting capacity followed by periods of severe competition and excess underwriting capacity. Within the United States alone, approximately 2,600 companies actively market property and casualty coverages. Our primary competitors in the casualty segment include Arch, Aspen, Baldwin & Lyons, Chubb, CNA, Endurance, Great American, Great West, Hartford, Lancer, Markel, Navigators, RSUI, USLI, Travelers and Zurich. Primary competitors in the property segment include Arch, Aspen, Chubb, CNA, Crum & Forster, Endurance, Great American, Lexington and Travelers. Primary competitors in the surety segment are AIG, Arch, Chubb, CNA, Endurance, Great American, HCC, Navigators, Travelers and XL. The combination of coverages, service, pricing and other methods of competition vary from line to line. Our principal methods of meeting this competition are innovative coverages, marketing structure and quality service to the agents and policyholders at a fair price. We compete favorably, in part, because of our sound financial base and reputation, as well as our broad, geographic footprint in all 50 states, the District of Columbia, Puerto Rico, the Virgin Islands and Guam. In the casualty, property and surety areas, we have experienced underwriting specialists in our branch and home offices. We continue to maintain our underwriting and marketing standards by not seeking market share at the expense of earnings. We have a track record of withdrawing from markets when conditions become overly adverse, and we offer new coverages and programs where the opportunity exists to provide needed insurance coverage with exceptional service on a profitable basis.

 

FINANCIAL STRENGTH RATINGS

 

A.M. Best financial strength ratings for the industry range from ‘‘A++’’ (Superior) to ‘‘F’’ (In liquidation) with some companies not being rated. Standard & Poor’s financial strength ratings for the industry range from ‘‘AAA’’ (Extremely strong) to ‘‘R’’ (Regulatory action). Moody’s financial strength ratings for the industry range from “Aaa” (Exceptional) to “C” (Lowest). The following table illustrates the range of ratings assigned by each of the three major rating companies that has issued a financial strength rating on our insurance companies:

 

 

 

 

 

 

 

 

 

 

 

 

A.M. Best

 

Standard & Poor’s

 

Moody’s

SECURE

 

SECURE

 

STRONG

A++, A+ 

    

Superior

    

AAA 

    

Extremely strong

    

Aaa

    

Exceptional

A, A-

 

Excellent

 

AA

 

Very strong

 

Aa

 

Excellent

B++, B+

 

Very good

 

A  

 

Strong

 

A

 

Good

 

 

 

 

BBB

 

Good

 

Baa

 

Adequate

 

 

 

 

 

 

 

 

 

 

 

 

 

VULNERABLE

 

VULNERABLE

 

WEAK

B, B-

 

Fair 

    

BB 

 

Marginal 

    

Ba 

 

Questionable 

C++, C+

 

Marginal

 

B  

 

Weak

 

B  

 

Poor

C, C-

 

Weak

 

CCC

 

Very weak

 

Caa

 

Very poor

D  

 

Poor

 

CC

 

Extremely weak

 

Ca

 

Extremely poor

E  

 

Under regulatory supervision

 

R  

 

Regulatory action

 

C  

 

Lowest

F  

 

In liquidation

 

 

 

 

 

 

 

 

S  

 

Rating suspended

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Within-category modifiers

 

+,-

 

 

 

1,2,3 (1 high, 3 low)

 

Publications of A.M. Best, Standard & Poor’s and Moody’s indicate that ‘‘A’’ and ‘‘A+’’ ratings are assigned to those companies that, in their opinion, have achieved exceptional overall performance compared to the standards they have established and have a strong ability to meet their obligations to policyholders over a long period of time. In evaluating a company’s financial and operating performance, each of the firms review the company’s profitability, leverage and liquidity, as well as the company’s spread of risk, the quality and appropriateness of its reinsurance, the quality and diversification of its

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assets, the adequacy of its policy and loss reserves, the adequacy of its surplus, its capital structure, its risk management practices and the experience and objectives of its management. These ratings are based on factors relevant to policyholders, agents, insurance brokers and intermediaries and are not specifically related to securities issued by the company.

 

At December 31, 2017, the following ratings were assigned to our insurance companies:

 

 

 

 

A.M. Best

    

 

 

RLI Ins., Mt. Hawley and CBIC* (group-rated)

 

A+, Superior

 

 

 

 

 

Standard & Poor’s

 

 

 

RLI Ins. and Mt. Hawley

 

A+, Strong

 

 

 

 

 

Moody’s

 

 

 

RLI Ins. and Mt. Hawley

 

A2, Good

 


*CBIC is only rated by A.M. Best

 

For A.M. Best, Standard & Poor’s and Moody’s, the financial strength ratings represented above are affirmations of previously assigned ratings. A.M. Best, in addition to assigning a financial strength rating, also assigns financial size categories. In September 2017, RLI Ins., Mt. Hawley and CBIC, which are collectively rated as a group, were assigned a financial size category of “XI” (adjusted policyholders’ surplus of between $750 million and $1 billion). As of December 31, 2017, the policyholders’ statutory surplus of RLI Insurance Group totaled $864.6 million, which continues to result in A.M. Best’s financial size category “XI”.

 

REINSURANCE

 

We reinsure a portion of our insurance exposure, paying or ceding to the reinsurer a portion of the premiums received on such policies. Earned premiums ceded to non-affiliated reinsurers totaled $129.7 million, $134.6 million and $132.7 million in 2017, 2016 and 2015, respectively. Insurance is ceded principally to reduce net liability on individual risks and to protect against catastrophic losses. We use reinsurance as an alternative to using our own capital to take risks and reduce volatility. Retention levels are evaluated each year to maintain a balance between the growth in surplus and the cost of reinsurance. Although reinsurance does not legally discharge an insurer from its primary liability for the full amount of the policies, it does make the assuming reinsurer liable to the insurer to the extent of the insurance ceded.

 

Reinsurance is subject to certain risks, specifically market risk (which affects the cost and ability to secure reinsurance contracts) and credit risk (which relates to the ability to collect from the reinsurer on our claims). We purchase reinsurance from financially strong reinsurers. We evaluate reinsurers’ ability to pay based on their financial results, level of surplus, financial strength ratings and other risk characteristics. A reinsurance committee, comprised of senior management, reviews and approves our security guidelines and reinsurer usage. More than 94 percent of our reinsurance recoverables are due from companies with financial strength ratings of “A” or better by A.M. Best and Standard & Poor’s rating services. For more information regarding our largest reinsurers, see note 5 to the consolidated financial statements within Item 8, Financial Statements and Supplementary Data.

 

We utilize both treaty and facultative reinsurance coverage for our risks. Treaty coverage refers to a reinsurance contract under which the company agrees to cede all risks within a defined class of business to the reinsurer, who agrees to provide coverage on all risks ceded without individual underwriting. Facultative coverage is applied to individual risks at the company’s discretion and is subject to underwriting by the reinsurer. It is used for a variety of reasons, including supplementing the limits provided by the treaty coverage or covering risks or perils excluded from treaty reinsurance.

 

Much of our reinsurance is purchased on an excess of loss basis. Under an excess of loss arrangement, we retain losses on a risk up to a specified amount and the reinsurers assume any losses above that amount. We may choose to participate in the reinsurance layers purchased by retaining a percentage of the layer. It is common to find conditions in excess of loss covers such as occurrence limits, aggregate limits and reinstatement premium charges. Occurrence limits cap our recovery for multiple losses caused by the same event. Aggregate limits cap our recovery for all losses ceded during the contract term. We may be required to pay additional premium to reinstate or have access to use the reinsurance limits for potential future recoveries during the same contract year. Some property and surety treaties include reinstatement provisions which require us, in certain circumstances, to pay reinstatement premiums after a loss has occurred in order to preserve coverage.

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Excluding CAT reinsurance, the table below summarizes the reinsurance treaty coverage currently in effect. We may purchase facultative coverage in excess of the per risk limits shown.

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

(in millions)

 

 

    

 

    

 

    

 

 

    

Per Risk

    

 

 

 

 

 

 

 

Renewal

 

First-Dollar

 

Limit

 

Maximum

 

Product Line(s) Covered

 

Contract Type

 

Date

 

Retention

 

Purchased

 

Retention

*

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

General liability

 

Excess of Loss

 

1/1

 

$

1.0

 

$

9.0

 

$

1.9

 

Commercial umbrella and excess

    

Excess of Loss

    

1/1

 

 

1.0

 

 

9.0

 

 

1.9

 

Personal umbrella and eXS

 

Excess of Loss

 

1/1

 

 

1.0

 

 

9.0

 

 

1.9

 

Commercial transportation

 

Excess of Loss

 

1/1

 

 

0.5

 

 

4.5

 

 

1.1

 

Package - liability and workers' comp

 

Excess of Loss

 

1/1

 

 

1.0

 

 

10.0

 

 

1.9

 

Workers' compensation catastrophe

 

Excess of Loss

 

1/1

 

 

11.0

 

 

14.0

 

 

11.0

 

Medical professional liability

 

Excess of Loss

 

1/1

 

 

1.0

 

 

9.0

 

 

1.9

 

Professional services - professional liability

 

Excess of Loss

 

4/1

 

 

1.0

 

 

9.0

 

 

3.3

 

Executive products

 

Quota Share

 

7/1

 

 

N/A

 

 

25.0

 

 

8.8

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Property - risk cover

 

Excess of Loss

 

1/1

 

 

1.0

 

 

24.0

 

 

1.2

 

Marine

 

Excess of Loss

 

6/1

 

 

2.0

 

 

28.0

 

 

2.0

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Surety

 

Excess of Loss

 

4/1

 

 

2.0

 

 

73.0

 

 

9.7

**


*Maximum retention includes first-dollar retention plus any co-participation we retain through the reinsurance tower.

**A limited number of commercial and energy surety accounts are permitted to exceed the $75.0 million limit. These accounts are subject to additional levels of review and are monitored on a monthly basis.

 

At each renewal, we consider any plans to change the underlying insurance coverage we offer, as well as updated loss activity, the level of RLI Insurance Group’s surplus, changes in our risk appetite and the cost and availability of reinsurance treaties. In the last renewal cycle, we maintained similar retentions on most lines of business.

 

PROPERTY REINSURANCE — CATASTROPHE COVERAGE

 

Our property CAT reinsurance reduces the financial impact of a CAT event involving multiple claims and policyholders. Reinsurance limits purchased fluctuate due to changes in the amount of exposure we insure, reinsurance costs, insurance company surplus levels and our risk appetite. In addition, we monitor the expected rate of return for each of our CAT lines of business. At high rates of return, we grow the book of business and may purchase additional reinsurance to increase our capacity. As the rate of return decreases, we shrink the book and may purchase less reinsurance as this capacity becomes unnecessary. Our reinsurance coverage for the last three years and for 2018 are shown in the following table:

 

Catastrophe Coverages

(in millions)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

2018

 

2017

 

2016

 

2015

 

 

  

First- Dollar
Retention

  

Limit

  

First- Dollar
Retention

  

Limit

  

First- Dollar
Retention

  

Limit

  

First- Dollar
Retention

  

Limit

 

California Earthquake

 

$

25

 

300

 

$

25

 

300

 

$

25

 

300

 

$

25

 

300

 

Non-California Earthquake

 

 

25

 

325

 

 

25

 

325

 

 

25

 

325

 

 

25

 

325

 

Other Perils

 

 

25

 

225

 

 

25

 

225

 

 

25

 

225

 

 

25

 

225

 

 

These CAT limits are in addition to the per-occurrence coverage provided by facultative and other treaty coverages. We have participated in the CAT layers purchased by retaining a percentage of each layer throughout this period. Our participation has varied based on price and the amount of risk transferred by each layer. Since 2014, all layers of the treaty have included one prepaid reinstatement.

 

Our property CAT program continues to be applied on an excess of loss basis. It attaches after all other reinsurance has been considered. Although covered in one program, limits and attachment points differ for California earthquakes and all other perils. The following charts use information from our CAT modeling software to illustrate our pre-tax net retention resulting from particular events that would generate the gross losses.

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Catastrophe - California Earthquake

(in millions)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

2018

 

2017

 

2016

 

Projected

    

Ceded

    

Net

    

Ceded

    

Net

    

Ceded

    

Net

 

Gross Loss

 

Losses

 

Losses

 

Losses

 

Losses

 

Losses

 

Losses

 

$

50

 

$

29

 

$

21

 

$

29

 

$

21

 

$

29

 

$

21

 

 

100

 

 

72

 

 

28

 

 

73

 

 

27

 

 

73

 

 

27

 

 

200

 

 

163

 

 

37

 

 

163

 

 

37

 

 

163

 

 

37

 

 

350

 

 

302

 

 

48

 

 

302

 

 

48

 

 

302

 

 

48

 

 

Catastrophe - Other (Earthquake outside of California, Wind, Other)

(in millions)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

2018

 

2017

 

2016

 

Projected

    

Ceded

    

Net

    

Ceded

    

Net

    

Ceded

    

Net

 

Gross Loss

 

Losses

 

Losses

 

Losses

 

Losses

 

Losses

 

Losses

 

$

25

 

$

 6

 

$

19

 

$

 5

 

$

20

 

$

 6

 

$

19

 

 

50

 

 

24

 

 

26

 

 

20

 

 

30

 

 

22

 

 

28

 

 

100

 

 

64

 

 

36

 

 

59

 

 

41

 

 

63

 

 

37

 

 

250

 

 

182

 

 

68

 

 

191

 

 

59

 

 

198

 

 

52

 

 

In the above table, projected losses for 2018 were estimated based on our exposure as of December 31, 2017, utilizing the treaty structure in place as of January 1, 2018. All previous years were estimated similarly by utilizing the treaty structure in place at the start of the listed year and the exposure at the end of the previous year.

 

The previous tables were generated using theoretical probabilities of events occurring in areas where our portfolio of currently in-force policies could generate the level of loss illustrated. Actual results could vary significantly from these tables as the actual nature or severity of a particular event cannot be predicted with any reasonable degree of accuracy. Reinsurance limits are purchased based on the anticipated losses from large events. The largest losses shown above are possible, but have a low probability of actually occurring. However, there is a remote chance that a larger event could occur. If the actual event losses are larger than anticipated, we could retain additional losses above the limit of our CAT reinsurance.

 

We continuously monitor and quantify our exposure to catastrophes including earthquakes, hurricanes, floods, convective storms, terrorist acts and other aggregating events. In the normal course of business, we manage our concentrations of exposures to catastrophic events, primarily by limiting concentrations of locations insured to acceptable levels and by purchasing reinsurance. Exposure and coverage detail is recorded for each risk location. We quantify and monitor the total policy limit insured in each geographical region. In addition, we use third-party CAT exposure models and an internally developed analysis to assess each risk to ensure we include an appropriate charge for assumed CAT risks. CAT exposure modeling is inherently uncertain due to the model’s reliance on an infrequent observation of actual events and exposure data, increasing the importance of capturing accurate policy coverage data. The model results are used both in the underwriting analysis of individual risks and at a corporate level for the aggregate book of CAT-exposed business. From both perspectives, we consider the potential loss produced by individual events that represent moderate-to-high loss potential at varying probabilities and magnitudes. In calculating potential losses, we select appropriate assumptions including, but not limited to, loss amplification and loss adjustment expense. We establish risk tolerances at the portfolio level based on market conditions, the level of reinsurance available, changes to the assumptions in the CAT models, rating agency capital constraints, underwriting guidelines and coverages and internal preferences. Our risk tolerances for each type of CAT, and for all perils in aggregate, change over time as these internal and external conditions change. We are required to report to the rating agencies estimated loss to a single event that could include all potential earthquakes and hurricanes contemplated by the CAT modeling software. This reported loss includes the impact of insured losses based on the estimated frequency and severity of potential events, loss adjustment expense, reinstatements paid after the loss, reinsurance recoveries and taxes. Based on the CAT reinsurance treaty purchased on January 1, 2018, there is a 99.6 percent likelihood that the loss will be less than 14.2 percent of policyholders’ surplus as of December 31, 2017. The exposure levels are within our tolerances for this risk.

 

LOSSES AND SETTLEMENT EXPENSES

 

OVERVIEW

 

Loss and loss adjustment expense (LAE) reserves represent our best estimate of ultimate payments for losses and related settlement expenses from claims that have been reported but not paid and losses that have been incurred but not yet reported to

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us (IBNR). Loss reserves do not represent an exact calculation of liability, but instead represent our estimates, generally utilizing individual claim estimates, actuarial expertise and estimation techniques at a given accounting date. The loss reserve estimates are expectations of what ultimate settlement and administration of claims will cost upon final resolution. These estimates are based on facts and circumstances then known to us, review of historical settlement patterns, estimates of trends in claims frequency and severity, projections of loss costs, expected interpretations of legal theories of liability and many other factors. In establishing reserves, we also take into account estimated recoveries from reinsurance, salvage and subrogation. The reserves are reviewed regularly by a team of actuaries we employ.

 

Net loss and loss adjustment reserves by product line at year-end 2017 and 2016 are illustrated in the following table. LAE is classified in the table as either allocated loss adjustment expense (ALAE) or unallocated loss adjustment expense (ULAE). ALAE refers to estimates of claim settlement expenses that can be identified with a specific claim or case, while ULAE cannot be identified with a specific claim. For a detailed discussion of loss reserves, refer to our critical accounting policy in Item 7, Management’s Discussion and Analysis of Financial Condition and Results of Operations.

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

(as of December 31, in thousands)

 

2017

 

2016

 

Product Line

    

Case

    

IBNR

    

Total

    

Case

    

IBNR

    

Total

 

Casualty segment net loss and ALAE reserves

    

 

        

    

 

        

    

 

        

    

 

        

    

 

         

    

 

        

 

Commercial umbrella

 

$

9,724

 

$

99,745

 

$

109,469

 

$

8,181

 

$

82,472

 

$

90,653

 

Personal umbrella

 

 

21,452

 

 

39,395

 

 

60,847

 

 

18,339

 

 

35,027

 

 

53,366

 

General liability

 

 

78,360

 

 

149,102

 

 

227,462

 

 

81,720

 

 

135,024

 

 

216,744

 

Professional services

 

 

28,543

 

 

81,558

 

 

110,101

 

 

23,501

 

 

73,970

 

 

97,471

 

Commercial transportation

 

 

81,543

 

 

38,161

 

 

119,704

 

 

67,693

 

 

30,901

 

 

98,594

 

Small commercial

 

 

12,075

 

 

34,344

 

 

46,419

 

 

13,143

 

 

27,507

 

 

40,650

 

Executive products

 

 

11,327

 

 

44,484

 

 

55,811

 

 

6,943

 

 

45,664

 

 

52,607

 

Medical professional liability

 

 

16,621

 

 

10,526

 

 

27,147

 

 

12,008

 

 

8,013

 

 

20,021

 

Other casualty

 

 

6,595

 

 

31,302

 

 

37,897

 

 

4,725

 

 

21,184

 

 

25,909

 

Property segment net loss and ALAE reserves

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Commercial property

 

 

21,375

 

 

10,615

 

 

31,990

 

 

6,488

 

 

5,812

 

 

12,300

 

Marine

 

 

11,512

 

 

18,095

 

 

29,607

 

 

9,344

 

 

16,271

 

 

25,615

 

Specialty personal

 

 

1,989

 

 

3,525

 

 

5,514

 

 

2,472

 

 

3,566

 

 

6,038

 

Other property

 

 

3,348

 

 

6,682

 

 

10,030

 

 

4,753

 

 

8,930

 

 

13,683

 

Surety segment net loss and ALAE reserves

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Miscellaneous

 

 

2,550

 

 

5,035

 

 

7,585

 

 

2,321

 

 

4,919

 

 

7,240

 

Contract and commercial

 

 

(253)

 

 

13,914

 

 

13,661

 

 

1,727

 

 

13,044

 

 

14,771

 

Energy

 

 

2,843

 

 

2,254

 

 

5,097

 

 

2,671

 

 

2,666

 

 

5,337

 

Latent liability net loss and ALAE reserves

 

 

6,532

 

 

15,795

 

 

22,327

 

 

6,273

 

 

17,555

 

 

23,828

 

Total net loss and ALAE reserves

 

$

316,136

 

$

604,532

 

$

920,668

 

$

272,302

 

$

532,525

 

$

804,827

 

ULAE reserves

 

 

 —

 

 

48,844

 

 

48,844

 

 

 —

 

 

46,286

 

 

46,286

 

Total net loss and LAE reserves

 

$

316,136

 

$

653,376

 

$

969,512

 

$

272,302

 

$

578,811

 

$

851,113

 

 

Following is a table of significant risk factors involved in estimating losses grouped by major product line. We distinguish between loss ratio risk and reserve estimation risk. Loss ratio risk refers to the possible dispersion of loss ratios from year to year due to inherent volatility in the business, such as high severity or aggregating exposures. Reserve estimation risk recognizes the difficulty in estimating a given year’s ultimate loss liability. As an example, our property CAT business (included below in “other property”) has significant variance in year-over-year results; however, its reserving estimation risk is relatively moderate.

 

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Table of Contents

Significant Risk Factors

 

 

 

 

 

 

 

 

 

 

 

 

 

   

 

   

Emergence

   

 

   

Expected loss

   

Reserve

 

 

Length of

 

patterns relied

 

 

 

ratio

 

estimation

Product line

 

Reserve Tail

 

upon

 

Other risk factors

 

variability

 

variability

Commercial umbrella

 

Long

 

Internal

 

Low frequency

 

High

 

High

 

 

 

 

 

 

High severity

 

 

 

 

 

 

 

 

 

 

Loss trend volatility

 

 

 

 

 

 

 

 

 

 

Rapid growth

 

 

 

 

 

 

 

 

 

 

Unforeseen tort potential

 

 

 

 

 

 

 

 

 

 

Exposure changes/mix

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Personal umbrella

 

Medium

 

Internal

 

Low frequency

 

Medium

 

Medium

 

 

 

 

 

 

High severity

 

 

 

 

 

 

 

 

 

 

Loss trend volatility

 

 

 

 

 

 

 

 

 

 

Unforeseen tort potential

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

General liability

 

Long

 

Internal

 

Exposure growth/mix

 

Medium

 

High

 

 

 

 

 

 

Unforeseen tort potential

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Medical professional liability

 

Long

 

External

 

High severity

 

High

 

High

 

 

 

 

 

 

Exposure changes/mix

 

 

 

 

 

 

 

 

 

 

Unforeseen tort potential

 

 

 

 

 

 

 

 

 

 

Small volume

 

 

 

 

 

 

 

 

 

 

Loss trend volatility

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Commercial transportation

 

Medium

 

Internal

 

High severity

 

Medium

 

Medium

 

 

 

 

 

 

Exposure growth/mix

 

 

 

 

 

 

 

 

 

 

Loss trend volatility

 

 

 

 

 

 

 

 

 

 

Unforeseen tort potential

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Executive products

 

Long

 

Internal & significant external

 

Low frequency

 

High

 

High

 

 

 

 

 

 

High severity

 

 

 

 

 

 

 

 

 

 

Loss trend volatility

 

 

 

 

 

 

 

 

 

 

Economic volatility

 

 

 

 

 

 

 

 

 

 

Unforeseen tort potential

 

 

 

 

 

 

 

 

 

 

Small volume

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Professional services

 

Medium

 

Internal & external

 

Exposure growth

 

High

 

Medium

 

 

 

 

 

 

Highly varied exposures

 

 

 

 

 

 

 

 

 

 

Loss trend volatility

 

 

 

 

 

 

 

 

 

 

Unforeseen tort potential

 

 

 

 

 

 

 

 

 

 

Small volume

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Small commercial

 

Long

 

Internal

 

Exposure growth/mix

 

Medium

 

High

 

 

 

 

 

 

Unforeseen tort potential

 

 

 

 

 

 

 

 

 

 

Small volume

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Other casualty

 

Medium

 

Internal & external

 

Small volume

 

Medium

 

Medium

 

 

 

 

 

 

 

 

 

 

 

Marine

 

Medium

 

Internal & external

 

Exposure changes/mix

 

High

 

High

 

 

 

 

 

 

 

 

 

 

 

Other property

 

Short

 

Internal

 

CAT aggregation exposure

 

High

 

Medium

 

 

 

 

 

 

Low frequency

 

 

 

 

 

 

 

 

 

 

High severity

 

 

 

 

 

 

 

 

 

 

Reporting delay

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Surety

 

Medium

 

Internal

 

Economic volatility

 

Medium

 

Medium

 

 

 

 

 

 

Uniqueness of exposure