Cincinnati Financial Corporation — 2016 Form 10-K
Reporting period: Fiscal year ended December 31, 2016. The filing also reports unaudited fourth-quarter results. Cincinnati Financial is an Ohio-based insurer operating mainly through independent agencies in 41 states, with commercial and personal property-casualty insurance, excess and surplus lines, life insurance, investments and reinsurance operations.
Financial performance and position
| Metric | 2016 | 2015 | Change |
|---|---|---|---|
| Total revenue | $5.449 billion | $5.142 billion | Up 6% |
| Net income | $591 million | $634 million | Down 7% |
| Diluted EPS | $3.55 | $3.83 | Down 7% |
| Earned premiums | $4.710 billion | $4.480 billion | Up 5% |
| Net investment income | $595 million | $572 million | Up 4% |
| Net realized investment gains | $124 million | $70 million | Up 77% |
| Operating cash flow | $1.103 billion | $1.064 billion | Up 4% |
| Shareholders’ equity | $7.060 billion | $6.427 billion | Up 10% |
| Book value per share | $42.95 | $39.20 | Up 10% |
- Underwriting: Property-casualty earned premiums were $4.482 billion, up 5%. The GAAP combined ratio was 94.8%, versus 91.1% in 2015; below 100% indicates an underwriting profit. Underwriting profit fell to $242 million from $386 million.
- Segment results: Commercial lines earned premiums were $3.089 billion and pretax underwriting profit was $184 million (down from $345 million). Personal lines premiums were $1.161 billion and recorded a $12 million pretax loss. Excess and surplus lines premiums were $183 million and profit was $62 million. Life premiums were $228 million and segment profit was $1 million.
- Investments: Total investments were $15.500 billion, including $10.085 billion of fixed maturities and $5.334 billion of equity securities. Total investment return was 8.5%, versus 0.1% in 2015, substantially helped by market appreciation in equities.
- Liquidity and debt: Cash and cash equivalents were $777 million. Long-term debt was $787 million and short-term borrowings were $20 million; debt-to-total-capital was 10.3%, compared with 11.3% a year earlier. The $225 million revolving credit facility had $20 million drawn and expires in May 2019.
- Dividends: The 2016 declared regular dividend was $1.92 per share. The filing reports a 56-year record of annual dividend increases; the board raised the dividend again in January 2017.
- Fourth quarter: Revenue was $1.312 billion, net income $100 million and diluted EPS $0.60, compared with $1.263 billion, $156 million and $0.94, respectively, in fourth-quarter 2015.
Material changes versus the prior year
- Net income declined despite higher revenue and investment income, principally because property-casualty underwriting income fell by $94 million after tax. Higher catastrophe losses reduced underwriting results by $114 million after tax; catastrophe losses were $336 million net of reinsurance in 2016, versus $161 million in 2015.
- The combined ratio rose 3.7 percentage points. Catastrophe losses added 7.7 percentage points to the 2016 ratio, compared with 4.1 points in 2015. The underlying current-accident-year loss ratio before catastrophes improved modestly.
- Management recognized $168 million of favorable prior-year reserve development, down from $184 million in 2015. However, paid-loss trends prompted increased estimates in commercial casualty, commercial auto and personal auto; commercial auto and personal auto had unfavorable prior-year development of $31 million and $18 million, respectively.
- Net unrealized investment gains increased to $2.625 billion from $2.094 billion, primarily reflecting equity-market gains. This contributed to comprehensive income of $940 million, versus $234 million in 2015.
- Net written premiums grew 5% to $4.580 billion. Cincinnati Re expanded, with $71 million of net written premiums in 2016 versus $33 million in 2015.
Outlook, commentary and risks
- Management’s 2013–2017 target is an average annual value creation ratio of 10%–13%; the 2016 ratio was 14.5%. Its long-term underwriting objective is a five-year average GAAP combined ratio of 95%–100%; the 2012–2016 average was 94.3%.
- For 2017, management expects commercial-market pricing to soften and competition to remain intense, but aims to grow commercial premiums faster than the industry through selective underwriting and improved pricing. It expects personal-lines growth above the industry projection, while noting that rates must outpace loss costs to improve profitability. No consolidated earnings or EPS guidance is provided.
- Management expects investment-income growth to remain pressured by low yields and lower yields on new fixed-maturity purchases. It plans to continue allocating some investable cash to equities, subject to liquidity, regulation and capital needs.
- Key exposures include severe weather and catastrophe losses, geographic concentration in the Midwest and Southeast, loss-reserve uncertainty and rising auto claim costs, investment-market and interest-rate movements, competition and agency relationships, reinsurance recoverability, cyber and business interruption risks, and regulatory or tax changes.
- Property-casualty net loss reserves were $4.737 billion; management’s reasonably likely range was $4.449 billion to $4.894 billion. Actual claim outcomes may fall outside the range. The company reported $85 million of net asbestos and environmental reserves and $45 million of mold reserves.
- The company reported no material litigation beyond ordinary-course matters. Deloitte issued an unqualified opinion on the financial statements and internal controls; management also concluded internal control over financial reporting was effective.
Important facts for investors to verify
- Whether catastrophe frequency and severity, especially weather losses, remain elevated and how reinsurance limits the net impact.
- Whether commercial casualty and auto loss trends validate the higher reserve estimates, and whether favorable prior-year development persists.
- Whether pricing and underwriting actions restore profitability in personal lines and commercial auto, both areas of concern in 2016.
- How much future earnings and book value depend on equity-market gains, discretionary investment sales and unrealized portfolio appreciation.
- Whether parent-company liquidity, regulated subsidiary dividends and reinsurer recoverables remain sufficient to support claims, debt service and shareholder distributions.