Cincinnati Financial Corporation — Q3 2012 Form 10-Q
Business context and period. The filing reports unaudited results for the quarter and nine months ended September 30, 2012, for an insurer focused on property-casualty insurance, with life insurance and investment operations. Comparisons are with the corresponding 2011 periods; balance-sheet comparisons are with December 31, 2011. Amounts below are in millions except per-share data and ratios.
Financial performance and position
| Metric | Q3 2012 | Q3 2011 | Nine months 2012 | Nine months 2011 |
|---|---|---|---|---|
| Total revenues | $1,035 | $944 | $3,041 | $2,848 |
| Earned premiums | $889 | $812 | $2,605 | $2,367 |
| Net investment income, pretax | $132 | $130 | $395 | $393 |
| Net realized investment gains | $10 | $(2) | $29 | $77 |
| Net income | $111 | $19 | $229 | $30 |
| Diluted earnings per share | $0.68 | $0.12 | $1.40 | $0.19 |
| Property-casualty combined ratio | 94.8% | 110.6% | 101.1% | 117.0% |
- Underwriting and margins: Property-casualty underwriting generated a $45 profit in Q3, versus an $80 loss, but recorded a $23 loss for the first nine months, improved from a $377 loss. The nine-month GAAP combined ratio remained above 100%, indicating an underwriting loss before investment income.
- Cash flow: Net cash from operating activities was $433 for the first nine months, versus $148 in 2011. Investing activities used $257 and financing activities used $198. Cash and cash equivalents ended the period at $416, compared with $438 at year-end 2011.
- Balance sheet and debt: Total assets were $16.479 billion and shareholders’ equity was $5.359 billion, up from $15.635 billion and $5.033 billion, respectively. Book value per share rose to $32.95 from $31.03. Total debt was $894 ($790 long-term and $104 short-term); debt-to-total-capital was 14.3%, versus 15.1% at year-end.
- Investments: Total investments were $12.533 billion on the balance sheet; the disclosed fair value of the securities portfolio was $12.465 billion. Pretax unrealized investment gains were $1.923 billion, primarily reflecting equity appreciation and low interest rates. Other comprehensive income was $270 for the nine months, versus a $66 loss in 2011.
- Shareholder returns: Cash dividends paid in the first nine months were $191. The quarterly dividend was raised to $0.4075 per share, producing an indicated annual rate of $1.63. The company repurchased 174,550 shares from associates for $7 during the period.
Material changes and management commentary
- Revenue increased 10% in Q3 and 7% for the nine months, led by premium growth. Property-casualty net written premiums rose 14% and 13%, respectively.
- Management attributed improved underwriting primarily to better pricing relative to loss costs, lower catastrophe losses, and underwriting initiatives. Catastrophe losses were $62 in Q3 and $295 year to date, compared with $90 and $419 in 2011.
- Favorable development on prior accident-year reserves was $86 in Q3 and $287 year to date. It improved the nine-month combined ratio by 11.6 percentage points. Management cautions that reserve estimates are uncertain, particularly for long-tailed lines.
- Results varied by business: commercial lines produced a $60 Q3 underwriting profit and a $74 nine-month profit; personal lines remained loss-making ($12 Q3 and $89 year to date); excess and surplus lines recorded losses of $3 and $8. The corresponding nine-month combined ratios were 95.9%, 114.2%, and 111.9%.
- Investment income was nearly flat year over year as lower interest income was offset by higher dividends. Management cited the low-rate environment as a challenge to replacing maturing bonds at current yields. The average pretax investment yield was 4.46% for the first nine months, compared with 4.65% in 2011.
- For 2012, management’s stated long-term targets are a GAAP combined ratio of 95%–100% over any five-year period and an average value creation ratio of 12%–15% for 2010–2014. The nine-month value creation ratio was 10.1%. The supplied filing text does not provide a clear full-year 2012 earnings or combined-ratio forecast.
Outlook, risks and unusual items
- Management reported homeowner rate changes taking effect in late 2012 and personal-auto rate changes targeted to begin in the first half of 2013. It expects pricing improvements to support future profitability, while acknowledging normal loss-cost inflation.
- Key risks include catastrophe frequency and severity, regional concentration, claims trends and reserve-estimation uncertainty, reinsurance availability and recoverability, competition, regulatory or litigation outcomes, cybersecurity, market declines, and prolonged low interest rates. A 100-basis-point parallel rate increase would theoretically reduce fixed-maturity fair value by about 4.3%, based on the portfolio’s 4.3-year duration; this is a sensitivity illustration, not a forecast.
- Investment impairment charges were $32 for the nine months, nearly all related to 11 common stocks. The company reported no securities trading below 70% of cost or amortized cost at September 30, but said further declines or a stalled recovery could lead to additional impairment charges.
- Ordinary-course insurance litigation was described as immaterial after recorded provisions. For other matters with more-than-remote loss risk, the company said potential losses could not be reasonably estimated; a materially adverse judgment or settlement could affect results or cash flows.
- On October 19, 2012, the company entered a separation agreement with former executive Thomas A. Joseph. It provides salary-equivalent severance of approximately $1.188 million over 24 months, subject to stated conditions, as well as potential incentive compensation and accelerated vesting provisions.
- The company said disclosure controls were effective and reported no material change in internal control over financial reporting during the quarter. It reported no material change in risk factors from its 2011 Form 10-K.
Important facts for investors to verify
- How much of the earnings and combined-ratio improvement is repeatable without substantial favorable reserve development or unusually lower catastrophe losses.
- Whether personal-lines and excess-and-surplus underwriting performance improves, and whether commercial property risk actions and rate changes are effective.
- The sensitivity of investment income, unrealized gains, and impairment charges to low rates, market declines, and portfolio concentrations.
- Remaining catastrophe reinsurance protection: the filing says the first layer had $17 of coverage remaining for fourth-quarter 2012 events, with company participation of 51.7% for applicable losses.
- Potential financial effects of unresolved legal matters and the executive separation agreement, including performance-dependent compensation and award vesting.