Cincinnati Financial Corporation — Q3 2014 Form 10-Q
Reporting period: Three and nine months ended September 30, 2014. Cincinnati Financial is an insurer operating in commercial, personal, excess and surplus property-casualty insurance, life insurance and investments. Financial amounts below are in millions unless noted.
Financial performance
| Metric | Q3 2014 | Q3 2013 | Nine months 2014 | Nine months 2013 |
|---|---|---|---|---|
| Total revenue | $1,280 | $1,152 | $3,683 | $3,359 |
| Net income | $183 | $131 | $358 | $395 |
| Diluted EPS | $1.11 | $0.79 | $2.17 | $2.39 |
| Property-casualty underwriting profit | $94 | $61 | $86 | $173 |
| Property-casualty combined ratio | 91.0% | 93.7% | 97.3% | 93.8% |
| Net investment income | $138 | $133 | $409 | $392 |
| Realized investment gains | $65 | $22 | $101 | $77 |
| Operating cash flow | — | — | $633 | $538 |
Earned premiums increased 8% in Q3 and 10% for the nine-month period. For the nine months, current-year catastrophe losses were $233, up from $165; favorable prior-year reserve development was $120, versus $140 in 2013. The company reported a nine-month statutory combined ratio of 96.3%, including 7.7 percentage points of current-year catastrophe losses and a 3.9-point benefit from favorable prior-year development.
Balance sheet, debt and liquidity
- At September 30, total assets were $18.474 billion, investments $14.255 billion, cash and cash equivalents $412, and shareholders’ equity $6.376 billion. Book value per share was $39.01, up from $37.21 at year-end 2013.
- Total debt was $839: $790 of long-term debt and $49 on the revolving line, down from $894 at year-end. The debt-to-total-capital ratio declined to 11.6% from 12.8%.
- Nine-month cash flows were $633 provided by operations, $331 used in investing and $323 used in financing. Cash dividends paid were $208. The quarterly dividend was 44 cents per share.
- Insurance subsidiaries declared $300 in dividends to the parent in the first nine months. Approximately $433 could be paid by the lead insurance subsidiary to the parent during 2014 without regulatory approval.
Material changes and segment trends
- Q3 net income rose 40%, helped by $27 of lower catastrophe losses and $28 more in after-tax realized investment gains than a year earlier. Nine-month net income declined 9%, primarily reflecting lower property-casualty underwriting income, including $47 after tax from higher catastrophe losses.
- Commercial lines earned premiums rose 9% over nine months, but underwriting profit fell to $97 from $135; the combined ratio increased to 95.6% from 93.2%. Commercial auto and specialty packages were noted as key profitability challenges.
- Personal lines earned premiums rose 9%, but the segment recorded a $33 underwriting loss versus $33 profit in 2013; its combined ratio worsened to 104.5% from 95.5%. Management cited higher catastrophe and noncatastrophe weather losses and less favorable reserve development.
- Excess and surplus lines earned premiums rose 28%; underwriting profit increased to $22 from $5, and the combined ratio improved to 79.9% from 94.2%, aided by favorable reserve development.
- Life insurance reported a $5 segment loss for the first nine months, compared with $10 profit a year earlier, largely due to less favorable mortality experience. The life business’s net in-force face amount reached $49.834 billion.
Outlook, commentary and risks
- Management’s stated long-term targets include a 95%–100% GAAP property-casualty combined ratio over any five-year period and an average annual value creation ratio of 10%–13% for 2013–2017. The nine-month value creation ratio was 8.4%, versus 9.8% a year earlier.
- The company continued pricing and underwriting initiatives, including personal-auto rate changes, property inspections and expanded analytics. It planned approximately 130,000 property inspections during 2014 and targeted $5 billion in consolidated annual direct written premiums by year-end 2015. These are targets, not a specific quarterly earnings forecast.
- Management highlighted low interest rates as a constraint on reinvestment yields: the portfolio’s nine-month pretax yield was 3.95%, down from 4.15%. About 14.9% of fixed maturities were expected to mature from October 2014 through December 2016, with an average pretax yield-to-amortized cost of 4.4%.
- Key risks include catastrophe and other claims volatility, reserve estimation uncertainty, market and interest-rate movements, investment impairment, competition, reinsurance availability and collectability, regulatory changes, cyber or technology disruption, and litigation. The company said its risk factors had not materially changed since its 2013 Form 10-K.
- Ordinary-course litigation was considered immaterial; the company stated that a judgment or settlement substantially above accruals could nevertheless materially affect results or cash flows. The estimated exposure for other matters where loss was more than remote but not probable was less than $1.
- The filing reported no material changes in internal controls and no material change in contractual-obligation estimates. Management did not anticipate a material increase in debt during the remainder of 2014.
Important facts for investors to verify
- Whether premium rate increases and underwriting actions improve the elevated personal-lines and commercial-auto loss experience.
- How catastrophe losses, noncatastrophe weather losses and reserve development affect future combined ratios; favorable reserve releases contributed $120 to nine-month results.
- Whether realized investment gains recur: these were $101 for the first nine months, including $93 from sales of common and preferred stocks.
- Investment portfolio sensitivity to interest rates and equity-market declines; unrealized investment gains were $2.603 billion before tax at September 30.
- Cash generation, debt levels, subsidiary dividend capacity and the sustainability of dividends and repurchases.