Cincinnati Financial Corporation — 2015 Form 10-K
Reporting period: Fiscal year ended December 31, 2015. Although the request identifies 2015 Q4, this filing is an annual report; it also provides unaudited fourth-quarter results. Cincinnati Financial is an insurance holding company whose principal business is property and casualty insurance distributed through independent agencies in 39 states, alongside life insurance, excess and surplus lines, investments, and newly expanded assumed reinsurance operations.
Financial performance and position
- Annual results: Total revenue was $5.142 billion, up 4% from $4.945 billion in 2014. Net income rose 21% to $634 million from $525 million; diluted EPS was $3.83 versus $3.18. Income before tax was $881 million, compared with $721 million.
- Fourth quarter: Revenue was $1.263 billion versus $1.262 billion in Q4 2014. Net income was $156 million versus $167 million, and diluted EPS was $0.94 versus $1.02.
- Premiums and underwriting: Earned premiums increased 6% to $4.480 billion. Consolidated property-casualty earned premiums rose 6% to $4.271 billion, and underwriting profit increased to $386 million from $186 million. The GAAP combined ratio improved to 91.1% from 95.6%; below 100% indicates an underwriting profit.
- Segment results: Commercial lines earned premiums were $2.996 billion, with $345 million pretax underwriting profit. Personal lines earned premiums were $1.097 billion, but produced a $12 million loss and a 101.3% combined ratio. Excess and surplus lines earned premiums were $168 million, with $51 million profit and a 70.0% combined ratio. Life earned premiums were $209 million and reported a $2 million segment loss.
- Investment results: Net investment income was $572 million, up 4%. Net realized investment gains were $70 million, down from $133 million; these included $52 million of other-than-temporary impairment charges. Total investment return before tax was 0.1%, versus 7.8% in 2014, reflecting a $625 million decline in unrealized investment gains and losses.
- Cash flow: Net cash from operating activities was $1.064 billion, versus $873 million in 2014. Cash and cash equivalents ended the year at $544 million, down from $591 million. Property-casualty operations generated $1.103 billion of operating cash flow, compared with $866 million.
- Capital, debt and liquidity: Total assets were $18.888 billion and shareholders’ equity was $6.427 billion, down from $6.573 billion. Book value per share declined to $39.20 from $40.14. Debt-to-total-capital was 11.3%, unchanged and below the company’s 20% target ceiling. Year-end debt included $786 million of long-term debt book value, $793 million principal, and $35 million drawn on the credit line. The parent company reported $1.747 billion in cash and marketable securities.
- Shareholder returns: Dividends declared were $2.30 per share, including a $0.46 special dividend, versus $1.76 in 2014. The company repurchased 1.0 million shares for $53 million. Its value creation ratio was 3.4%, below its 2013–2017 annual target range of 10%–13%, mainly because of declines in investment valuations.
Material changes versus 2014
- Net income and underwriting profit improved substantially, helped by lower catastrophe losses (a $43 million favorable effect) and lower noncatastrophe weather losses (a $31 million favorable effect), as well as pricing and underwriting initiatives.
- Property-casualty catastrophe losses were $161 million, down from $204 million. Favorable prior-year reserve development increased to $184 million from $98 million, benefiting reported earnings; the company cautions that reserve estimates are uncertain.
- Auto loss trends worsened: the company increased its estimates of ultimate losses for commercial and personal auto. Prior-year commercial auto reserves developed unfavorably by $31 million and personal auto by $15 million.
- Investment gains and book value weakened: realized gains fell to $70 million from $133 million, comprehensive income fell to $234 million from $765 million, and equity declined. Net unrealized investment gains fell to $2.094 billion from $2.719 billion.
- Personal lines underwriting deteriorated from a $10 million profit in 2014 to a $12 million loss, with the combined ratio rising from 99.2% to 101.3%. Commercial lines improved to a $345 million profit from $146 million.
- The company began reporting Cincinnati Re, its expanded assumed reinsurance operation; 2015 net written premiums were $33 million and earned premiums were $10 million.
Outlook, risks and unusual items
- Management’s long-term value creation target was an average annual 10%–13% for 2013–2017. It reiterated a focus on profitable premium growth and a five-year average GAAP combined ratio of 95%–100%; no specific consolidated 2016 earnings or EPS guidance is provided.
- Management anticipated continued competition and softer commercial pricing in 2016. It planned approximately 100 new agency appointments, targeted about $25 million of high-net-worth personal-lines new business, and planned commercial auto base-rate increases in 16 states, including double-digit increases in seven states. Personal-lines growth was expected to exceed the industry projection, but improved pricing relative to loss trends is needed to restore profitability.
- Management expected low bond yields to continue pressuring investment-income growth and planned to keep investing a portion of available cash in equities, subject to liquidity, regulatory and rating-agency considerations. It also described a new life term product planned for the latter half of 2016.
- Key risks include catastrophe, weather and terrorism losses; geographic and contractor-related business concentrations; auto claim severity and reserve uncertainty; reinsurance recoverability; interest-rate and equity-market fluctuations; low investment yields; competition and agency-channel changes; cybersecurity and business interruption; and regulatory limits on rates and subsidiary dividends.
- Insurance reserves are a significant estimate. Net property-casualty reserves were $4.379 billion, with a stated reasonably likely range of $4.125 billion to $4.507 billion. The range is an estimate, and actual outcomes could fall outside it. The company also reported $84 million of net asbestos and environmental reserves and $45 million of mold reserves.
- The expanded assumed-reinsurance treaties include catastrophe and terrorism exposure; the largest treaty exposure has an aggregate catastrophe limit of up to $95 million per year. The company also identified a $542 million reinsurance recoverable asset, subject to reinsurer credit risk.
- The filing reports ordinary-course litigation and other legal matters; management considered accrued amounts reasonable and estimated exposure for other matters with more-than-remote loss risk at less than $1 million. It stated that no material litigation was pending. Deloitte issued unqualified opinions on the financial statements and internal control over financial reporting.
Important facts for investors to verify
- Review whether favorable reserve development of $184 million is sustainable, particularly in long-tail commercial casualty and workers’ compensation, and track adverse commercial and personal auto development.
- Assess personal-lines remediation: rate adequacy, claims trends, expense growth, and whether the segment can return to underwriting profitability.
- Separate recurring underwriting and investment income from discretionary realized gains, impairment charges and market-driven unrealized valuation changes when assessing earnings and book value.
- Check catastrophe exposure and reinsurance protection, including modeled loss assumptions, treaty terms, collateral and reinsurer credit quality.
- Monitor parent-company liquidity and the ability of insurance subsidiaries to pay dividends, given regulatory restrictions and shareholder dividend commitments.
- Confirm quarterly and annual figures in the audited statements and notes; the filing’s quarterly supplementary data is unaudited.