Cincinnati Financial Corporation — Third-Quarter 2011 Form 10-Q
Reporting period: Quarter and nine months ended September 30, 2011; financial statements are unaudited. The company operates property-casualty and life insurance businesses and an investment portfolio, principally through independent agencies.
Key financial metrics
| Metric | Third quarter 2011 | Nine months 2011 | Prior comparable period |
|---|---|---|---|
| Earned premiums | $812 million | $2.367 billion | $784 million and $2.299 billion |
| Net investment income | $130 million | $393 million | $128 million and $388 million |
| Net realized investment gains (losses) | $(2) million | $77 million | $155 million and $140 million |
| Total revenue | $944 million | $2.848 billion | $1.071 billion and $2.836 billion |
| Net income | $19 million; $0.12 diluted EPS | $32 million; $0.20 diluted EPS | $156 million and $251 million; $0.95 and $1.53 diluted EPS |
| Operating cash flow | $148 million for nine months | $417 million | |
| Property-casualty combined ratio | 110.6% | 116.8% | 103.9% and 104.7% |
Balance sheet at September 30, 2011: Total assets were $15.412 billion, including $11.529 billion of investments and $308 million of cash and cash equivalents. Total liabilities were $10.626 billion and shareholders’ equity was $4.786 billion. Short-term debt was $104 million and long-term debt was $790 million; total debt of $894 million compared with $839 million at year-end 2010. Book value per share was $29.54 versus $30.91 at year-end, and debt-to-total-capital was 15.7% versus 14.3%.
Material changes versus the prior period
- Third-quarter net income fell 88% and nine-month net income fell 87%. The main drivers were sharply lower realized investment gains and weaker property-casualty underwriting.
- Property-casualty earned premiums increased 3% in both the quarter and nine-month period. Net written premiums rose 7% in the quarter and 4% year to date.
- Catastrophe losses were substantially higher. Nine-month catastrophe losses were $424 million net of reinsurance, versus $142 million in the prior-year period; gross 2011 catastrophe losses were estimated at $682 million. The nine-month combined ratio increased to 116.8%, including 18.8 percentage points from current-year catastrophe losses and a 9.8-point benefit from favorable prior-year reserve development.
- Underwriting results remained pressured outside excess and surplus lines. Nine-month segment underwriting results were losses of $193 million in commercial lines and $182 million in personal lines; excess and surplus lines reported $1 million of profit.
- Investment income grew modestly, but the quarter’s net realized investment result shifted from a $155 million gain to a $2 million loss. Nine-month 2011 net realized gains included $33 million of other-than-temporary impairment charges, including approximately $30 million related to AllianceBernstein common stock.
- Operating cash flow declined to $148 million from $417 million, with increased claims payments and changes in premiums and reinsurance receivables among the reported factors. Cash and cash equivalents fell by $77 million from year-end.
Outlook, management commentary and risks
- Management reiterated long-term objectives, not a specific full-year 2011 earnings forecast: a 95%–100% GAAP combined ratio over five years and a 12%–15% average annual value creation ratio for 2010–2014. The nine-month 2011 value creation ratio was negative 0.5%.
- Management cited pricing analytics, expense/process improvements and premium growth through agency relationships as strategic initiatives. It reported 4% nine-month property-casualty net written premium growth and said it continued to emphasize disciplined underwriting amid competitive pricing.
- Management said it did not anticipate a material increase in debt during the remainder of 2011. The $55 million third-quarter increase in short-term borrowing was primarily used to fund share repurchases. It declared a fourth-quarter dividend of $0.4025 per share, bringing the indicated annual rate to $1.61.
- The company expects continued pressure on investment income from low interest rates and noted that maturing bonds may be reinvested at lower yields. A hypothetical 100-basis-point parallel rate increase would reduce fixed-maturity portfolio fair value by approximately 4.7%, based on the filing’s sensitivity analysis.
- Catastrophe severity, claims frequency, reserve-estimate uncertainty, competition, reinsurance availability and recoverability, market declines, low interest rates, regulation and litigation are identified risks. Moody’s affirmed its ratings but changed its outlook to negative in October 2011, citing expectations of weak underwriting profitability and high weather-related losses; other cited rating outlooks were stable.
- Ordinary-course litigation was described as not material based on current assessments. For certain other matters at an early stage, the company said it could not reasonably estimate potential loss or a range of loss; a significantly adverse judgment or settlement could be material.
- A pending accounting update on insurance acquisition costs may affect capitalization. Of the $512 million deferred acquisition cost asset, approximately $100 million was subject to further analysis; management estimated $35 million–$65 million may qualify for capitalization under the new guidance.
Most important facts for investors to verify
- Whether catastrophe losses, reinsurance recoveries and reinstatement premiums develop as estimated, and how they affect future combined ratios.
- Whether favorable prior-year reserve development persists, particularly in commercial casualty, and whether workers’ compensation and homeowner loss trends improve.
- The quality and sensitivity of the investment portfolio, including equity exposure, impairment assessments, unrealized losses and reinvestment yields.
- Liquidity and capital flexibility after lower operating cash flow, dividends, repurchases and increased short-term borrowing; also monitor restrictions on insurance-subsidiary dividends.
- The eventual impact of the acquisition-cost accounting update and any developments in early-stage legal matters or insurer financial-strength ratings.