CINCINNATI FINANCIAL CORP annual report, FY2019

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Cincinnati Financial Corporation — 2019 Form 10-K

Business context and reporting period. This annual report covers the fiscal year ended December 31, 2019; it is not a standalone fourth-quarter filing. Cincinnati Financial is an Ohio-based insurance holding company, with property-casualty insurance marketed primarily through independent agencies in 45 states, alongside life insurance, reinsurance, specialty underwriting and investment operations. Cincinnati Global was acquired on February 28, 2019, and its results are included from that date.

Financial performance and position

  • Revenue and earnings: Total revenue was $7.924 billion, up 47% from $5.407 billion in 2018. Net income was $1.997 billion, or $12.10 diluted per share, versus $287 million, or $1.75 per share. The increase was principally driven by net investment gains, including $1.626 billion of unrealized gains on equity securities still held. Accordingly, the year-over-year earnings increase should not be read as equivalent growth in recurring operating earnings.
  • Premiums and underwriting: Earned premiums rose 8% to $5.604 billion; property-casualty net written premiums grew 10% to $5.516 billion. Property-casualty underwriting profit increased to $341 million from $186 million. The GAAP combined ratio improved to 93.8% from 96.4%; below 100% indicates an underwriting profit. The improvement reflected lower catastrophe losses, stronger prior-year reserve development and improved current-year experience.
  • Segment results: Commercial lines earned premiums were $3.319 billion and pretax underwriting profit was $241 million, with a 92.9% combined ratio. Personal lines premiums were $1.404 billion and profit was $8 million, with a 99.8% ratio. Excess and surplus lines premiums were $278 million and profit was $53 million, although its combined ratio rose to 81.5% from 73.5%. Life insurance premiums were $270 million and segment profit was $1 million.
  • Investment results and margins: Net investment income, after expenses, increased 4% to $646 million; pretax yield on average invested assets was 3.46%, compared with 3.56%. Net investment gains were $1.650 billion, versus a $402 million loss in 2018. Investment gains and losses include market-value changes on equity securities under the accounting standard adopted in 2018. Property-casualty underwriting expense ratio was 31.0%; the combined ratio is the filing’s key underwriting-margin measure.
  • Cash flow: Consolidated operating cash flow was $1.208 billion, compared with $1.181 billion in 2018. Investing activities used $679 million and financing activities used $546 million. Property-casualty operations generated $1.047 billion in operating cash flow. Year-end cash and cash equivalents were $767 million.
  • Balance sheet, investments and liquidity: Total assets were $25.408 billion and shareholders’ equity was $9.864 billion, up 16% and 26%, respectively. Book value per share increased 26% to $60.55. Total investments were $19.746 billion, including $11.698 billion of fixed maturities and $7.752 billion of equity securities. Parent-company cash and marketable securities totaled $3.315 billion. Management reported strong insurance-subsidiary capital and risk-based capital well above regulatory requirements.
  • Debt and capital returns: Long-term debt was $788 million at carrying value; short-term borrowings were $39 million. Debt-to-total-capital was 7.7%, down from 9.5%. The company paid $355 million in shareholder dividends and repurchased $67 million of shares in 2019. The regular dividend declared was $2.24 per share.

Material changes versus 2018

  • Net income rebounded from $287 million to $1.997 billion, largely because 2019 equity-market appreciation flowed through earnings while 2018 included substantial unrealized equity losses. Net income also benefited from higher property-casualty underwriting profit and investment income.
  • Property-casualty premiums and underwriting profit increased, and the combined ratio improved 2.6 percentage points. Favorable development of prior-year reserves was $248 million in 2019, versus $167 million in 2018; this significant estimate-driven benefit contributed to underwriting results.
  • Total investments increased from $16.732 billion to $19.746 billion, reflecting portfolio purchases and higher market values. Shareholders’ equity rose from $7.833 billion to $9.864 billion.
  • The Cincinnati Global acquisition added $140 million in net written premiums from acquisition through year-end and expanded international specialty and catastrophe exposure. The filing reports $30 million of goodwill and $50 million of identifiable intangible assets associated with the acquisition.

Outlook, management commentary and risks

  • Management targets a five-year average value creation ratio of 10%–13%; the 2019 ratio was 30.5%. Its long-term underwriting objective is a five-year average GAAP combined ratio of 95%–100%; the 2015–2019 average was 94.7%. These are objectives, not specific 2020 earnings guidance.
  • For 2020, management planned approximately 125 appointments of agencies marketing most or all property-casualty products and approximately 35 appointments focused on personal lines, primarily high-net-worth clients. It intended to continue pricing and risk-selection initiatives, expand Cincinnati Re selectively, and pursue growth in Cincinnati Global. The filing does not provide a clear numerical full-year earnings or revenue forecast.
  • Management identified commercial auto and homeowner pricing adequacy as continuing priorities. It noted competitive pressure in commercial lines, continued catastrophe exposure, and the challenge of growing investment income in a low-interest-rate environment. Life insurance also faces low-rate pressure, though management cited its term-life emphasis as less rate-sensitive.
  • Principal risks include catastrophe frequency and severity, climate-related uncertainty, geographic concentration, competition and rate regulation, reserve-estimation uncertainty, investment-market declines and interest-rate changes, reinsurance recovery and counterparty risk, and cyber or operational disruption. The property-casualty reserve estimate was a critical audit matter; net reserves carried were $5.746 billion against a stated reasonably likely range of $5.418–$5.862 billion.
  • The 2020 property-catastrophe reinsurance program increased the stated coverage limit to $800 million from $600 million for 2019, with different retention by coverage layer. Management estimated a maximum net exposure of $249 million for an $800 million covered catastrophe loss under the 2020 program. Reinsurance does not remove the company’s obligation to policyholders, and recoveries depend on reinsurer performance.
  • The independent auditor issued unqualified opinions on the financial statements and internal control over financial reporting. Cincinnati Global was excluded from management’s internal-control assessment for its acquisition year; it represented approximately 2% of consolidated assets and revenue.

Most important facts for investors to verify

  • How much of earnings and book-value growth is attributable to recurring underwriting and investment income versus equity-market gains, including the accounting treatment of unrealized equity changes.
  • Whether reserve releases remain favorable and whether the carried loss reserves adequately reflect long-tail claims, inflation, litigation trends and commercial-auto experience.
  • Whether rate increases and underwriting actions improve profitability in commercial auto and homeowners, and whether premium growth is achieved without weakening risk selection.
  • How Cincinnati Global and Cincinnati Re perform, including acquisition integration, catastrophe accumulations, Lloyd’s capital requirements and reinsurance recoveries.
  • Whether investment income can be sustained as yields on new and reinvested fixed maturities decline, and how equity-market or interest-rate movements affect reported earnings, equity and book value.
  • Parent-company liquidity and dividend capacity, including regulatory limits on subsidiary dividends, debt obligations and the continued affordability of shareholder distributions.