1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

A. BASIS OF PRESENTATION

The unaudited condensed consolidated interim financial statements have been prepared in accordance with generally accepted accounting principles in the United States of America (GAAP) for interim financial reporting and with the instructions to Form 10-Q and Regulation S-X. Accordingly, they do not include all of the disclosures required by GAAP for complete financial statements. As such, these unaudited condensed consolidated interim financial statements should be read in conjunction with our 2013 Annual Report on Form 10-K. Management believes that the disclosures are adequate to make the information presented not misleading, and all normal and recurring adjustments necessary to present fairly the financial position at June 30, 2014 and the results of operations of RLI Corp. and subsidiaries for all periods presented have been made. The results of operations for any interim period are not necessarily indicative of the operating results for a full year.

The preparation of the unaudited condensed consolidated interim financial statements requires management to make estimates and assumptions relating to the reported amounts of assets and liabilities, the disclosure of contingent assets and liabilities at the date of the unaudited condensed consolidated interim financial statements, and the reported amounts of revenue and expenses during the period. These estimates are inherently subject to change and actual results could differ significantly from these estimates.

B. ADOPTED ACCOUNTING STANDARDS

We have not adopted any new accounting standards as there have been no accounting standard updates which would impact our financial statements.

C. PROSPECTIVE ACCOUNTING STANDARDS

There are no prospective accounting standards which would impact our financial statements as of June 30, 2014.

D. INTANGIBLE ASSETS

In accordance with GAAP guidelines, the amortization of goodwill and indefinite-lived intangible assets is not permitted. Goodwill and indefinite-lived intangible assets remain on the balance sheet and are tested for impairment on an annual basis, or earlier if there is reason to suspect that their values may have been diminished or impaired. Goodwill and intangibles totaled $74.4 million at June 30, 2014.

Goodwill resulting from acquisitions completed prior to 2011 totaled $26.2 million and is attributable to our surety segment. Goodwill and intangible assets resulting from the Contractors Bonding and Insurance Company (CBIC) acquisition in April 2011 totaled $32.2 million. The CBIC-related assets include goodwill attributable to our casualty and surety segments of $5.3 million and $15.1 million, respectively, and an indefinite-lived intangible asset in the amount of $8.8 million. Annual impairment testing was performed on each of these goodwill and indefinite-lived intangible assets during the second quarter of 2014. Based upon these reviews, none of the assets were impaired. In addition, as of June 30, 2014, there were no triggering events that occurred that would suggest an updated review was necessary. Definite-lived intangible assets related to the CBIC acquisition totaled $3.0 million, net of amortization, as of June 30, 2014.

The remaining $16.0 million of goodwill and intangibles relates to our purchase of Rockbridge Underwriting Agency (Rockbridge) in November 2012. Of this amount, $12.4 million is recorded as goodwill attributable to our casualty segment. The remaining $3.6 million relates to definite-lived intangible assets, net of amortization, as of June 30, 2014. Annual impairment testing was performed on this goodwill asset in the fourth quarter of 2013. Based upon this review, the asset was not impaired. In addition, as of June 30, 2014, there were no triggering events that occurred that would suggest an updated review was necessary.

The aforementioned definite-lived intangible assets are amortized against future operating results based on their estimated useful lives. Amortization of intangible assets resulting from the acquisitions of CBIC and Rockbridge was $0.3 for the second quarter of 2014, and $0.5 million for the six months ended June 30, 2014.

E. EARNINGS PER SHARE

Basic earnings per share (EPS) excludes dilution and is computed by dividing income available to common shareholders by the weighted-average number of common shares outstanding for the period. Diluted EPS reflects the dilution that could occur if securities or other contracts to issue common stock or common stock equivalents were exercised or converted into common stock. When inclusion of common stock equivalents increases the earnings per share or reduces the loss per share, the effect on earnings is anti-dilutive. Under these circumstances, the diluted net earnings or net loss per share is computed excluding the common stock equivalents.

The following represents a reconciliation of the numerator and denominator of the basic and diluted EPS computations contained in the unaudited condensed consolidated interim financial statements.

	For the Three-Month Period					For the Three-Month Period
	Ended June 30, 2014					Ended June 30, 2013
(in thousands, except	Income		Shares	Per Share		Income		Shares	Per Share
per share data)	(Numerator)		(Denominator)	Amount		(Numerator)		(Denominator)	Amount

Basic EPS
Income available to common shareholders	$	35,725	43,001	$	0.83	$	29,902	42,628	$	0.70
Effect of Dilutive Securities
Stock options	—		687			—		713

Diluted EPS
Income available to common shareholders	$	35,725	43,688	$	0.82	$	29,902	43,341	$	0.69

	For the Six-Month Period					For the Six-Month Period
	Ended June 30, 2014					Ended June 30, 2013
(in thousands, except	Income		Shares	Per Share		Income		Shares	Per Share
per share data)	(Numerator)		(Denominator)	Amount		(Numerator)		(Denominator)	Amount

Basic EPS
Income available to common shareholders	$	64,694	42,993	$	1.50	$	54,749	42,587	$	1.29
Effect of Dilutive Securities
Stock options	—		676			—		681

Diluted EPS
Income available to common shareholders	$	64,694	43,669	$	1.48	$	54,749	43,268	$	1.27

F. COMPREHENSIVE EARNINGS

Our comprehensive earnings include net earnings plus unrealized gains/losses on our available-for-sale investment securities, net of tax. In reporting comprehensive earnings on a net basis in the statement of earnings, we used the federal statutory tax rate of 35 percent. The following table illustrates the changes in the balance of each component of accumulated other comprehensive earnings for each period presented in the unaudited condensed consolidated interim financial statements.

	For the Three-Month Periods Ended June 30,						For the Six - Month Periods Ended June 30,
(in thousands)	2014			2013			2014			2013
Unrealized Gains/Losses on Available-for-Sale Securities
Beginning balance	$	153,764		$	160,723		$	136,027		$	143,170
Other comprehensive earnings before reclassifications	26,714			(30,824		)	48,674			(10,557		)
Amounts reclassified from accumulated other comprehensive earnings	(6,780		)	(2,657		)	(11,003		)	(5,371		)
Net current-period other comprehensive earnings	$	19,934		$	(33,481	)	$	37,671		$	(15,928	)
Ending balance	$	173,698		$	127,242		$	173,698		$	127,242

The sale or other-than-temporary impairment of an available-for-sale security results in amounts being reclassified from accumulated other comprehensive earnings to current period net earnings. The effects of reclassifications out of accumulated other comprehensive earnings by the respective line items of net earnings are presented in the following table.

	Amount Reclassified from Accumulated Other Comprehensive Earnings
(in thousands) Component of Accumulated	For the Three-Month Periods Ended June 30,						For the Six-Month Periods Ended June 30,						Affected line item in the
Other Comprehensive Earnings	2014			2013			2014			2013			Statement of Earnings

Unrealized gains and losses on available-for-sale securities	$	10,431		$	4,087		$	16,928		$	8,263		Net realized investment gains
	—			—			—			—			Other-than-temporary impairment (OTTI) losses on investments
	$	10,431		$	4,087		$	16,928		$	8,263		Earnings before income taxes
	(3,651		)	(1,430		)	(5,925		)	(2,892		)	Income tax expense
	$	6,780		$	2,657		$	11,003		$	5,371		Net earnings