Business Context and Reporting Period
Cincinnati Financial Corporation filed its Form 10-Q for the quarterly period ended September 30, 2009. The company operates primarily in property casualty insurance (commercial and personal lines), life insurance, and investment operations. The filing includes unaudited condensed consolidated financial statements and management's discussion and analysis (MD&A).
Key Financial Metrics
| Metric (in millions, except per share) | Three Months Ended Sept 30, 2009 | Nine Months Ended Sept 30, 2009 |
|---|---|---|
| Total Revenues | $1,007 | $2,770 |
| Net Income | $171 | $187 |
| Diluted EPS | $1.05 | $1.15 |
| Total Assets | $14,226 | $14,226 |
| Total Liabilities | $9,600 | $9,600 |
| Shareholders' Equity | $4,626 | $4,626 |
| Book Value Per Share | $28.44 | $28.44 |
| Debt-to-Capital Ratio | 15.3% | 15.3% |
| Cash and Cash Equivalents | $448 | $448 |
| Net Cash Provided by Operating Activities (9mo) | $362 |
Material Changes vs. Prior Comparable Period
- Net Income Decline: Net income decreased 31.0% for the quarter and 30.1% for the nine-month period compared to 2008. This was primarily driven by lower realized investment gains and weaker underwriting results in the first nine months.
- Investment Performance: Realized investment gains dropped significantly in the quarter (from $272M to $110M) due to fewer sales and impairment charges. However, for the nine-month period, realized gains increased to $90M from $28M in 2008, driven by sales of equity securities (including ExxonMobil and Procter & Gamble) offset by other-than-temporary impairment (OTTI) charges of $113M.
- Underwriting Results:
- Commercial Lines: Generated an underwriting profit of $42M for the quarter, improving from a $31M profit in 2008. However, the nine-month period showed a loss of $31M compared to a $59M profit in 2008, largely due to adverse reserve development in workers' compensation.
- Personal Lines: Reported an underwriting loss of $4M for the quarter, a significant improvement from a $38M loss in 2008, driven by lower catastrophe losses. The nine-month loss widened to $96M from $82M in 2008 due to higher catastrophe and other losses.
- Combined Ratio: The consolidated property casualty combined ratio was 95.1% for the quarter (profitable) but 106.4% for the nine months (loss), compared to 101.3% and 101.1% respectively in 2008.
- Balance Sheet: Total assets increased to $14.2 billion from $13.4 billion at year-end 2008, largely due to increased market values of the investment portfolio. Shareholders' equity increased approximately 10%.
Guidance, Outlook, Risks, and Unusual Items
- Accounting Change (ASC 320): The company adopted new accounting standards for other-than-temporary impairments (ASC 320) on April 1, 2009. This resulted in a cumulative effect adjustment of $106 million (net of tax) reclassifying non-credit components of impairments from accumulated other comprehensive income to retained earnings. This change makes current period results not directly comparable to prior periods.
- Dividend Increase: The Board of Directors increased the quarterly cash dividend to $0.395 per share in August 2009, marking the 49th consecutive year of dividend increases.
- Strategic Initiatives: Management highlighted progress in technology projects (predictive modeling, policy administration systems) and geographic expansion (new agencies in Texas, Colorado, Wyoming) to drive premium growth and improve profitability.
- Risks and Contingencies:
- Investment Risk: Exposure to market volatility, credit spreads, and interest rate changes. The company holds 18 securities trading below 70% of book value, primarily in financial and real estate sectors.
- Underwriting Risk: Adverse development in workers' compensation reserves and potential for high catastrophe losses remain key risks.
- Regulatory Risk: Potential changes in state or federal insurance regulation and rating agency actions (Fitch lowered ratings in August 2009).
- Outlook: Management expects to achieve a 12% to 15% average value creation ratio (book value growth + dividend yield) between 2010 and 2014. They anticipate continued weak pricing in the commercial lines market until 2010.
Important Facts for Investor Verification
- Workers' Compensation Reserves: Verify the sustainability of the $45 million unfavorable reserve development recognized in the first nine months of 2009 for workers' compensation prior accident years.
- Investment Portfolio Quality: Monitor the 18 securities trading below 70% of book value and the potential for additional OTTI charges if market conditions deteriorate.
- Combined Ratio Trends: Track the personal lines combined ratio, which remains above 100% for the year-to-date period, and the impact of rate increases implemented in late 2009.
- Dividend Sustainability: Confirm that the 49th consecutive dividend increase is supported by the company's strong capital position and cash flow, despite the current earnings decline.
- ASC 320 Impact: Understand how the new impairment accounting standard affects the comparability of current earnings and equity to prior periods.