An uncommon vision: how a small monoline company saw demand for its only line of business fading away, but used the underwriting lessons it learned to expand into a niche property/casualty player that regularly outperforms industry giants.

RLI Corp. was started "in the cockpit of an airplane," said Jerry Stephens, who founded the company four decades ago.

Stephens wore contact lenses, which were expensive in the early days. When he couldn't find anyone to sell him contact lens replacement insurance, he got into the business himself, launching Replacement Lens Inc., a contact lens insurance agency, in 1961.

That wasn't easy.

Stephens, who was working for his father's independent insurance agency, H.O. Stephens & Son, in Peoria, Ill., remembers approaching one eye doctor who manufactured contact lenses. "I kept bringing him proposals for group insurance for his patients. He kept turning me down. About every other month, I brought a new proposal. This went on for two years. Finally, he agreed, and we installed the program in his office, and he had about 30 doctors' accounts that he made contacts for," Stephens said.

Initially, the agency wrote the coverage on paper from a fronting company, but Stephens, who had long dreamed of owning his own property/casualty company, had a vision: "This was my excuse to get into the company business," Stephens said.

Stephens, who also happened to be a licensed pilot, got RLI off the ground by flying in his plane all over the United States to talk to eye doctors about contact lens insurance. "If we could get five doctors together, I'd be there," Stephens said. The company's headquarters in Peoria was built next to a small airstrip where Stephens could come and go easily.

The agency was successful by 1965, garnering $100,000 in premium volume, selling policies for $15 each, Stephens said. At that time, Stephens decided to get out of the agency business and into the underwriting business. By issuing $300,000 of stock to the 30 original doctors, he raised enough money to buy a dormant mutual insurance company. "It had $75,000 in assets, and we paid $100,000 for it," Stephens said. "We used the other $200,000 on a nationwide advertising campaign in Life and McCalls, and sent the tear sheets to every eye doctor in the country."

It was a risky move, but it paid off.

"We were broke at the end of the year," Stephens said. "But the campaign worked and got us off the ground."

By 1966, the fledgling company had $600,000 in premium volume, growing to $1.2 million in premiums by 1967 and $1.4 million in 1968. It became the largest writer of contact lens insurance.

Forced to Evolve

Business was profitable. The monoline insurer ran its business with a combined ratio of 82, meaning for every $1 of premium coming in, RLI was paying out only 82 cents in claims and expenses--the rest was profit. That's not too shabby, considering the entire property/casualty industry was turning a combined ratio of 100.3 in 1970.

Business was also booming--until soft contacts came onto the market in 1972. They became popular, and the price dropped so they were much cheaper than hard lenses. The demand for replacement lens insurance began to fade.

As demand for contact lens insurance waned, RLI could have gone the way of 8-track players, but the leaders at RLI are not near-sighted. "We learned a lot as a monoline company and decided to go into other lines of coverage," Stephens said.

"We reinvented the company," said Jon Michael, president and chief executive officer of RLI. "If you don't change, you're dead."

The company had an unusual approach to expanding. It would either identify specific talent--a specific underwriter--hire him or her and start writing that line of business, or the company would identify a specific niche where it wanted to write business, then find a specific talent to do it.

Unlike companies that expect underwriters to handle more than one product, RLI underwriters are limited to writing their specific niche product. If a customer wants to buy another type of insurance, an underwriter who handles that line writes the business.

"We brought them in and limited them to that one line of coverage. We have stuck religiously to that ever since," Stephens said.

So, beginning in 1977, the company expanded into other areas to acquire an eclectic mix of property/casualty business. It writes homeowners only in Hawaii, where it entered the market after Hurricane Iniki in 1992. It's the largest single writer of stand-alone personal umbrella coverage. It writes commercial earthquake insurance, and various kinds of liability coverage.

"We'd find an underwriter, and set up an office around them. We didn't care where they were," said Michael. Offices were added around the country. Today, about 20 offices provide speciality products to customers.

The company also takes the burden of administering policies away from underwriters, moving those operations to the home office.

Finally, in 1994, RLI dropped contact lens coverage, the product that started the company. It had fully transformed itself into a niche writer offering coverage that larger multiline writers avoid.

Today, about 26% of RLI's business is general liability, and the rest of its business lines are each less than 13% of its total gross premiums written.

"We are not in the business to have a large market share," Michael said. "We like to say we graze. We provide products that customers need and provide service they need."

Underwriting Culture

No matter what product line it entered, RLI stressed the importance of profitable underwriting. Its combined ratio went north of 100 just four times in its history: two years related to the Northridge earthquake and two years when the contact lens industry converted from hard to soft lenses.

"We would tell managers that it didn't matter how much premium you write, you have to make an underwriting profit," Michael said.

Stephens, who served as president of the Society of Chartered Property Casualty Underwriters, said a combined ratio of under 100 is essential.

"We're a bit fanatic about it," Stephens said.

That message is well understood by all company employees, who are also owners of the company. RLI was one of the first companies to jump into the Employee Stock Ownership Program in 1975. A number of long-time RLI employees, including receptionists and accountants, have been able to retire as millionaires thanks to the program. About 15% of the company's stock is held by company insiders.

Also, if RLI meets its underwriting goals, employees receive a bonus. An annual bonus party is held for the entire company.

"We act like owners," Michael said. "We go out and hire the most talented underwriters we can find. Across the board, we hire the best people, pay them well, provide them with incentives that allow us to achieve our goals."

Joe Dondanville, chief financial officer of RLI, said the company rewards its people well. "It causes our expense ratio to be higher than our peers, but our loss ratio is lower. It's the people that drive the success--not some magic underlying formula. We don't think that exists."

Stephens said if you run an insurance company properly, you can make money in three ways: first, from the underwriting; secondly from using other people's money for investment income--invested loss reserves and premium reserves; plus unrealized gains on common stock portfolios.

"The insurance industry is a fantastic business to be in, if you really understand what you are doing and you have the talent," Stephens said. "We've not had 100% success in everything we've done; we've had our failures. But we've had an awful lot of success as well."

Growing Pains

Kim Hensey, vice president and corporate secretary, has been with RLI 36 years. Her first task was to get the company licensed to operate in 51 jurisdictions, a difficult process that took about five years. Since Stephens officially retired as CEO in 2005, Hensey can now boast the longest tenure as a company employee.

"No one had ever heard of contact lens insurance, and they'd never heard of us," she recalled. "We didn't use agents. They didn't believe we weren't shysters. In some states, we had to hire attorneys to fight the insurance departments."

Hensey had to travel to about 20 insurance departments in person. Part of the difficulty was regulators didn't know where to place contact lens insurance. The product ended up being in the catch-all category of inland marine.

Then, once the company decided to branch out into other lines of business, Kim had to return to those 51 jurisdictions to get additional licenses to write multiple lines.

The company has made missteps along the way.

From 1979 to 1985, "we did write some reinsurance and found we weren't very good at it," Michael said. "So we thought we should leave that to other people."

The company struggled in the mid-1980s, when it was relying too heavily on reinsurance companies, and lost its strong A.M. Best rating, Michael said.

"We did very well in the contraction of the market in '85 and '86," Stephens said. "We opened our doors, and business came in. But we had no experience. Our rating went down to B for a while."

The company regained its A+ in 2004. The company's combined ratio has averaged in the low 90s for the past 10 years, Stephens said.

One secret to RLI's success is its underwriters have gotten good at saying "No." The company has only quoted about 6% of commercial insurance applications submitted for review in 2005, the company said.

"RLI's ability to sustain its favorable underwriting results continues to stem from its focus on underwriting profitability and incentive compensation plan that rewards management based on underwriting results," said Stacy Canavan, a financial analyst at A.M. Best Co. "This strategy has led RLI to report higher expense ratios than the competition; however, it has contributed to RLI's low loss ratios and consistent underwriting gains. The group also benefits from its high risk/reward strategy, its diverse product offerings, specialty focus and adherence to rate adequacy."

Play in Peoria

Stephens and Michael are both quick to credit the success of RLI to the employees.

"The fact that we have talent, a lot of talent, and we restrict the talent to writing one product line has paid off well for us," Stephens said. "No one runs a company like we do."

He joked that the company has never hired anyone who wasn't smarter than he is.

"The insurance industry is a highly technical field. The ability to survive in this field depends on how fast and well you change. A lot of companies take 60 or 120 days to issue a complex policy. Our standard is 15 days. We issue a lot of policies the same day the application comes in," Stephens said.

"Any change requires learning, but once you understand it, you can make another change. Like a convoy in the war, we are limited by our slowest learner," he said. The company likes to hire people who maintained at least a 3.0 grade point average in school. "We like to have people who have demonstrated at least once in their lives that they were good students and have the ability to learn."

The company emphasizes fun in the workplace. While the Peoria headquarters is fitted with standard-sized cubicles for most workers, RLI and its managers host several parties and celebrations throughout the year, such as an annual recognition banquet and annual bonus day. Quarterly meetings allow employees to take the afternoon off to meet with management and ask questions. Managers cook for employees at an annual cook-out, and employees and their families are treated to an annual air show.

Each department also celebrates off the company clock, including holding cook-outs, pizza parties and bowling.

Creativity is often encouraged.

For instance, many employees look forward to the company's annual pumpkin decorating contest in the fall, and its Christmas decorating contest in December. This past February, the Information Technology Department hosted a winter Olympics, including a biathlon race. Instead of using skis and rifles, employees strapped cardboard "skis" onto their feet to travel the halls, then fired a dart gun at targets--which were pictures of the bosses' faces posted to a cubicle wall.

"We don't like to take ourselves too seriously," Michael said. "Work should be a place to come to and have fun."

Hensey said employees like working for RLI. In her department, the newest employee has been there 10 years. "They treat us like they really care. This is the greatest company I've ever worked for," Hensey said. Stephens said, "Why shouldn't work be fun? We are probably more lax on personal things like death in the family, the family need to take time off to do something. We think family comes first, always. We want to have a pleasant work environment for people."

Key Points

* RLI Corp. started as a monoline insurer writing replacement contact lens coverage.

* The company branched out into other property/casualty areas beginning in 1977, eventually exiting the contact lens business.

* RLI has made an underwriting profit in 36 of its 41 years in business.

Top of Their Game

RLI Corp.'s devotion to underwriting profit has helped it to regularly outperform industry competitors, even much larger companies. While RLrs financial incentives to management based on underwriting results leads to higher than average expense ratios, its success in profitable underwriting keeps its combined ratio lower, and its return on revenue higher than its competitors.

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The Founding Father

Upon entering RLI Corp's world headquarters, just off a quiet street in Peoria, Ill., visitors are greeted by a painted portrait of founder Jerry Stephens. You cannot speak to company employees without Stephens' name coming up repeatedly, and with good reason. Even though he has officially handed over the operating reins of the company to Jon Michael, president and chief executive officer, Stephens remains chairman, and as founder of the company four decades ago, his presence still looms large.

Stephens is the son of Homer O. Stephens, a farm boy from Taylorville, Ill. Homer had been impressed by a field man with the Union Auto Indemnity Association of Bloomington, Ill., who had come to have dinner with his aunt and uncle, an independent agent in Hannibal, Mo., around 1921.

That field man, George J. Mecherle, made such an impression on Homer that years later Homer reported to work at Union Auto. The company sent him to Peoria to open his agency. Years later, at an event in his honor, Union Auto officials said they had little confidence in his success because "nobody could sell auto insurance in Peoria." Homer had become their largest-producing agent. And Mecherle, who believed strongly in exclusive agents vs. independent agents, ended up founding State Farm Insurance in 1922.

Perhaps Mecherle's experience helped inspire Stephens to become a leader, also. In addition to his duties in running RLI, Stephens served as president of the CPCU Society from 1988 to 1989, and helped establish an international earthquake conference.

Jerry Stephens did more than just believe in professionalism and apply the experience, ethics and education standards of the CPCU designation, said James R. Marks, executive vice president of the CPCU Society. "Many people looked up to and admired Jerry for his efficient, caring and participative leadership. That kind of commitment from a busy CEO is rare today," Marks said.

RLI in a Nutshell

* Headquarters: Peoria, III.

* Regional offices: 23

* Employees: 695 total--470 in Peoria and 225 in branch offices.

* Operating Units: RLI Insurance Co. (admitted in all states); Mt. Hawley Insurance Co (surplus lines in all states); and RLI Indemnity Co. (admitted in most states)

* 2005 Net Premiums Written: $494.6 million

* 2005 Total Admitted Assets: $1.88 billion

* 2005 Policyholder Surplus: $690.2 million

* 2005 Combined Ratio: 86.8 (Industry composite combined ratio 103.5)

RLI Timeline

1939: Contact lenses first made from plastic.

1945: The American Optometric Association formally recognizes the contact lens field.

* 1961: Jerry Stephens launches a contact lens insurance agency, Replacement Lens Inc.

1965: Stephens forms private holding company and acquires United Founders Insurance Co. (formerly Main Mutual Insurance Co., a shell). Eye doctor clients buy $300,000 in company stock. The company begins to underwrite insurance. 1069: Private holding company renamed RLI Corp. First public shares are issued at 26 cents a share.

* 1971: Soft contacts are introduced. RLI joins the NASDAQ; issues $2.25 million in common stock at 58 cents a share (split adjusted).

1973; United Founders renamed RLI Insurance Co.

1975: RLI becomes Peoria's first employee stock ownership company.

1977: RLI begins to diversify by writing specialty commercial property and casualty coverages.

1985: Issues $13.6 million in common stock at $1.95 a share.

* 1987: RLI lists on the NYSE; opens commercial casualty division.

1992: Establishes surety division.

1994: Retires contact lens insurance, the company's founding product; incurs $44 million in after-taxes losses from Northridge earthquake.

* 2001: Jon Michael named president and CEO of RLI Corp.

2004: Market cap reaches $1 billion.

2005: Opens marine division.

Source: RLI Corp.; Contact Lens Council

RLI's Business

RLI writes a diverse book of business,
with no bringing in more than 26%
of it's gross premiums written.

($ Millions)

Casualty

General liability        $203.9
Commercial &
personal umbrella          98.6
Transportation             79.4
Exec. Products             60.4
Programs                   38.6
Other                      38.2
Total                    $519.1

Property

Commercial fire           $84.9
Earthquake/DIC             53.8
Construction               14.2
Marine                     12.5
Other                      10.8
Total                    $176.2

Surety

Miscellaneous             $19.8
Energy                     15.4
Commercial                 13.5
Contract                   11.0
Other                       1.0
Total                     $60.7

Source: RLI Corp. 2005 annual report

Note: Table made from pie chart.

Learn More

RLI Group A.M. Best Company # 03883 Distribution: Retail agent/broker, wholesale broker, general agency

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