Cincinnati Financial Corporation — Q1 2017 Form 10-Q
Business context and period. Cincinnati Financial is an insurance holding company operating primarily in property-casualty and life insurance, with investments as a major earnings source. This unaudited report covers the three months ended March 31, 2017; comparisons are with Q1 2016 unless otherwise noted. Interim results are not necessarily indicative of full-year results.
Financial performance
| Metric | Q1 2017 | Q1 2016 / comparison |
|---|---|---|
| Total revenue | $1.523 billion | $1.364 billion; up 12% |
| Earned premiums | $1.208 billion | $1.154 billion; up 5% |
| Net investment income | $149 million | $145 million; up 3% |
| Net realized investment gains | $160 million | $61 million |
| Net income / diluted EPS | $201 million / $1.21 | $188 million / $1.13 |
| Comprehensive income | $288 million | $375 million |
| Operating cash flow | $136 million | $265 million |
| Property-casualty combined ratio | 99.7% | 91.4% |
Net income increased 7%, primarily because after-tax realized investment gains rose $63 million, offsetting a $59 million after-tax decline in property-casualty underwriting income. The gains included $149 million from sales of common and preferred stocks. The lower comprehensive income reflected smaller investment-related other comprehensive income than in Q1 2016.
Property-casualty earned premiums increased 5% and net written premiums grew 7%. Underwriting profit was $6 million, down from $96 million. Catastrophe losses were a key factor: current-year catastrophe losses were $117 million versus $41 million, and catastrophe impacts added 6.5 percentage points to the combined ratio year over year. Favorable prior-year reserve development was $38 million, compared with $62 million a year earlier.
- Commercial lines: $2 million underwriting loss; combined ratio 100.4%, versus 93.6%.
- Personal lines: $15 million underwriting loss; combined ratio 105.5%, versus 90.1%.
- Excess and surplus lines: $18 million underwriting profit; combined ratio 62.3%, versus 61.1%.
- Life insurance segment reported approximately break-even results, compared with a $1 million loss.
Cash and cash equivalents were $543 million at March 31, down from $777 million at year-end 2016. Operating cash flow was $136 million; investing activities used $246 million and financing activities used $124 million. Shareholders’ equity was $7.256 billion, up from $7.060 billion; book value per share was $44.07, up from $42.95. Total investments were $16.067 billion. The fair value of the fixed-maturity and equity securities portfolio was $15.977 billion.
Debt-to-total-capital was 10.0%, compared with 10.3% at year-end. Management reported $787 million of long-term debt and $17 million of short-term borrowing, with $208 million available on the revolving line. The balance sheet separately reports $825 million of long-term debt and capital lease obligations. The company said it did not anticipate a material increase in debt during the remainder of 2017.
Material changes, outlook and risks
- Investment gains materially supported reported earnings; they depend in part on discretionary investment-sale timing and may vary between periods.
- Management cited higher weather-related catastrophe losses as the principal driver of weaker property-casualty underwriting results. Q1 catastrophe losses included significant Midwest, Northeast and Southern storms.
- Management’s long-term performance aims include property-casualty premium growth above the industry over a five-year period and a GAAP combined ratio of 95%–100% over a five-year period. These are long-term objectives, not specific full-year 2017 guidance. Management said pricing and underwriting initiatives are intended to support future profitability.
- Renewal pricing increases were reported in commercial auto and personal auto; management also noted continued work on rate adequacy and pricing precision. It cautioned that performance during 2017 could be below long-term targets.
- The company highlighted a prolonged low-interest-rate environment as a constraint on reinvestment yields. The average yield on fixed maturities acquired in Q1 was 3.93%, below the portfolio’s 4.54% year-end 2016 average yield. Market, credit-spread and equity-price changes may affect investment values and shareholders’ equity.
- Loss reserves are a significant estimate and actual claim payments may differ. Commercial casualty and commercial auto had unfavorable prior-year development, while reserve increases included higher estimates for unsettled claims. Management also identified catastrophe, claim severity, reinsurance availability, competition, regulation, litigation, technology and cybersecurity among relevant risks.
- Legal proceedings were described as ordinary-course matters; management said probable and estimable accruals were reasonable and not material, while an adverse judgment or settlement above accruals could materially affect results or cash flows.
- Adoption of share-based-payment accounting guidance reduced the current tax provision by $6 million. The reported effective tax rate was 27.2%, versus 29.1%.
The company declared a quarterly dividend of $0.50 per share, up from $0.48, and reported a January increase intended to begin its 57th consecutive year of annual dividend increases. It repurchased 200,000 shares during March for $15 million; 3,342,065 shares remained authorized for repurchase at quarter-end.
Important facts for investors to verify
- Whether catastrophe losses and large claims persist, and how they affect combined ratios and future underwriting profitability.
- Whether the $38 million favorable prior-year reserve development proves sustainable; monitor reserve estimates, especially commercial casualty and commercial auto.
- How much earnings growth is attributable to realized investment gains versus recurring underwriting and investment income.
- Whether premium growth and renewal rate increases translate into improved underwriting results, particularly in personal auto and commercial auto.
- How low interest rates, changing yields, equity-market movements and credit spreads affect investment income, portfolio values and book value.
- Liquidity, debt and capital reporting: reconcile the MD&A debt figures with the balance-sheet amount that includes capital lease obligations, and monitor available revolving credit and regulated subsidiary-dividend capacity.
- Potential legal or regulatory outcomes, reinsurance recoveries and other contingent exposures; the filing does not quantify a material probable loss.