Cincinnati Financial Corporation — Q3 2017 Form 10-Q
Business context and reporting period. Unaudited results for the three and nine months ended September 30, 2017, compared with the same periods of 2016. The company operates property-casualty and life insurance businesses and invests its insurance assets; it distributes insurance primarily through independent agencies.
Financial results and key metrics
Dollar amounts are in millions except per-share data and ratios.
| Metric | Q3 2017 | Q3 2016 | Nine months 2017 | Nine months 2016 |
|---|---|---|---|---|
| Total revenues | $1,412 | $1,402 | $4,321 | $4,137 |
| Earned premiums | $1,247 | $1,191 | $3,696 | $3,518 |
| Net income | $102 | $180 | $403 | $491 |
| Diluted EPS | $0.61 | $1.08 | $2.42 | $2.95 |
| Net investment income | $153 | $148 | $453 | $442 |
| Net realized investment gains | $7 | $56 | $156 | $161 |
| Property-casualty underwriting profit | $11 | $90 | $40 | $196 |
| Property-casualty combined ratio | 99.3% | 92.4% | 99.1% | 94.4% |
- Profit drivers and margins: Lower net income reflected weaker property-casualty underwriting and lower realized gains, partly offset by growth in premiums and investment income. Q3 and nine-month P&C catastrophe losses were $114 million and $349 million, respectively; catastrophe losses contributed 9.6 and 9.9 percentage points to the respective combined ratios. Prior-year reserve development was favorable by $20 million in Q3 and $96 million for the nine months, less than the prior-year comparable favorable development of $40 million and $151 million.
- Segment mix: Nine-month earned premiums grew 7% in personal lines and 13% in excess and surplus lines, while commercial lines grew 3%. Personal lines recorded a $48 million underwriting loss for the first nine months and a 105.6% combined ratio; commercial lines earned $61 million of underwriting profit and had a 97.6% combined ratio. Excess and surplus lines earned $50 million of underwriting profit.
- Cash flow: Operating cash flow was $746 million for the first nine months, versus $835 million in 2016. Investing activities used $459 million and financing activities used $390 million. Cash and cash equivalents declined to $674 million from $777 million at year-end 2016.
- Balance sheet and liquidity: At September 30, total assets were $21.592 billion, investments $16.664 billion, and shareholders’ equity $7.523 billion. Book value per share was $45.86, up from $42.95 at year-end 2016. Total debt was $804 million and the debt-to-total-capital ratio was 9.7%, compared with 10.3% at year-end. The company reported $208 million available on its revolving credit line and stated it did not anticipate a material increase in debt for the remainder of 2017.
- Investment portfolio: Fair value was $16.565 billion, including $6.025 billion of equity securities. Net unrealized investment gains were $3.231 billion before tax. Management noted exposure to equity-market declines, interest-rate changes, credit risk and reinvestment at lower yields.
Material changes and management commentary
- Revenue rose 1% in Q3 and 4% year to date, while net income fell 43% and 18%, respectively. Management attributed the Q3 net-income decline mainly to a $51 million after-tax decrease in P&C underwriting income and a $32 million decline in after-tax realized investment gains. For the nine months, the main contributor was a $101 million after-tax decrease in P&C underwriting income.
- Management cited higher catastrophe losses, larger current-year losses and reduced favorable prior-year reserve development as key pressures. It said pricing increases, underwriting initiatives and improved pricing precision are expected to support future P&C profitability. Commercial auto and personal auto pricing actions continued; management gave no specific earnings or full-year financial guidance in the provided filing text.
- The company declared quarterly dividends of $0.50 per share in January, May and August 2017, and reported a 57th consecutive annual dividend increase. It repurchased $70 million of shares during the first nine months; no repurchases occurred in Q3.
- Management reported that the 2017 catastrophe-bond arrangement could provide recovery if covered aggregate losses, after an $8 million per-occurrence deductible, exceeded $190 million. Covered severe-convective-storm losses through September 30 totaled $135 million after the deductible.
- Unpaid property-casualty loss reserves are a significant estimate and actual claim costs could differ materially. The company reported $96 million of favorable prior-year reserve development year to date, alongside adverse development in commercial auto and commercial casualty. Ordinary-course claims litigation was considered immaterial after reserves; other legal matters could have a material effect if outcomes exceed accruals.
- Adoption of ASU 2016-01, not yet effective at the reporting date, will cause changes in equity-security fair values to be reported in net income rather than other comprehensive income. If adopted at September 30, 2017, $1.795 billion of after-tax unrealized equity gains would have been reclassified from accumulated other comprehensive income to retained earnings; future fair-value changes will affect reported earnings.
Important facts for investors to verify
- Whether catastrophe frequency and severity, including losses from 2017 events, continue to pressure underwriting results and whether reinsurance recoveries develop as expected.
- Whether favorable reserve development persists and whether commercial auto, commercial casualty and personal lines claims trends require reserve strengthening.
- Whether pricing actions and underwriting initiatives improve personal-lines and auto profitability without materially weakening premium growth or retention.
- The sensitivity of reported book value and future earnings to equity-market declines, interest-rate movements and the accounting change for equity securities.
- The adequacy of liquidity and capital resources in light of claims payments, dividends, debt obligations and the company’s continued investment in growth.