Cincinnati Financial Corporation — Second-Quarter 2014 Form 10-Q
Business context and reporting period. Cincinnati Financial is an insurance holding company with property-casualty, life insurance and investment operations, distributing primarily through independent agencies. This unaudited filing covers the quarter and six months ended June 30, 2014; balance-sheet comparisons are with December 31, 2013. Dollar amounts below are in millions unless stated otherwise.
Key financial results
| Metric | Q2 2014 | Q2 2013 | Six months 2014 | Six months 2013 |
|---|---|---|---|---|
| Total revenues | $1,214 | $1,104 | $2,403 | $2,207 |
| Net income | $84 | $110 | $175 | $264 |
| Diluted EPS | $0.51 | $0.66 | $1.06 | $1.60 |
| Investment income, net | $136 | $131 | $271 | $259 |
| Realized investment gains, net | $14 | $14 | $36 | $55 |
| Property-casualty combined ratio | 100.9% | 96.4% | 100.6% | 93.9% |
Earned premiums increased 11% in both the quarter and first half. Net income declined 24% in Q2 and 34% in the first half. Property-casualty underwriting produced a $7 million loss in Q2 and an $8 million loss for the first half, versus profits of $34 million and $112 million in the comparable 2013 periods.
Balance sheet, cash flow and capital
- At June 30, total assets were $18.335 billion, investments were $14.060 billion, cash and cash equivalents were $462 million, and shareholders’ equity was $6.343 billion.
- Book value per share was $38.77, up from $37.21 at year-end 2013. The increase included higher unrealized investment gains; accumulated other comprehensive income rose to $1.732 billion from $1.504 billion.
- Total debt was $839 million: $790 million long-term debt and $49 million short-term borrowing, down from $894 million at year-end. Debt-to-total-capital was 11.7%, compared with 12.8%.
- For the first six months, operating cash flow was $351 million, investing cash flow was $(97) million and financing cash flow was $(225) million. Cash increased $29 million to $462 million. Cash dividends paid were $138 million.
- The company reported $176 million of remaining availability on its revolving credit line. It did not anticipate a material increase in debt during the remainder of 2014.
Material changes and operating drivers
- Catastrophe losses pressured underwriting. Management attributed the year-over-year decline in property-casualty underwriting income primarily to higher weather-related catastrophe losses: $39 million more in Q2 and $115 million more in the first half than in 2013. Noncatastrophe weather losses were also higher.
- Personal lines weakened most. The personal-lines combined ratio rose to 115.8% for Q2 and 109.4% for the first half, versus 100.4% and 96.1%. The commercial-lines ratios were 96.3% and 98.1%; excess and surplus lines reported 85.0% and 85.9%.
- Reserve releases supported results. Favorable development on prior accident years was $66 million in Q2 and $95 million in the first half. The first-half release reduced the property-casualty combined ratio by 4.8 percentage points. Reserve estimates remain uncertain.
- Premium growth continued. Property-casualty net written premiums grew 10% in Q2 and 8% in the first half. Renewal premiums increased, while new-business premiums declined 4% and 7%, respectively. Life premiums grew 20% in Q2 and 17% in the first half.
- Investment performance and valuation. Net investment income grew 4% in Q2 and 5% in the first half, while the average pretax portfolio yield was lower year over year. The fair value of investments was $13.988 billion, including $4.605 billion in equity securities; portfolio unrealized gains were substantial and market-sensitive.
Outlook, risks and contingencies
Management’s long-term objectives include a 95%–100% GAAP combined ratio over any five-year period and an average annual value creation ratio of 10%–13% for 2013–2017. The company also cited a year-end 2015 target of $5 billion in annual direct written premiums. These are longer-term objectives, not a specific full-year 2014 earnings forecast. The filing notes that 2014 performance may fall below long-term targets.
Management described continued rate and underwriting initiatives, including personal-auto increases effective in most states during Q2, predictive pricing tools, property inspections and tighter property terms. The board declared quarterly dividends of $0.44 per share, an indicated annual rate of $1.76; the filing cited a 54th consecutive year of dividend increases.
Key risks include catastrophe severity and frequency, reserve-estimation uncertainty, low interest rates and market-value declines, insurance pricing and competition, reinsurance availability and collectability, regulatory changes, technology and cybersecurity, and adverse litigation. The company stated that its risk factors had not changed materially since its 2013 Form 10-K. Ordinary-course claims litigation was considered immaterial after reserves; other legal matters could have a material effect if outcomes exceed accruals. The company estimated exposure for other matters where loss was more than remote but not probable at less than $1 million.
Other notable items: the company repaid $55 million on its revolving short-term line of credit in Q2. It recorded $1 million of investment impairment charges in the first half. New accounting updates discussed in the filing were not expected to have a material impact.
Important facts for investors to verify
- Whether catastrophe and noncatastrophe weather losses moderate, particularly in personal lines, and how current pricing actions affect future combined ratios.
- How much future earnings benefit from favorable prior-year reserve development, and whether reserve assumptions remain adequate as claims emerge.
- Whether premium growth and agency initiatives translate into profitable new business, given lower new-business premiums and weak results in selected lines.
- Investment portfolio sensitivity to interest rates and equity-market movements, including the effect of unrealized gains on reported book value.
- Dividend capacity, insurer subsidiary dividend limits, revolving-credit availability and the company’s stated debt outlook.