Cincinnati Financial Corporation — 2017 Form 10-K
Reporting period: Fiscal year ended December 31, 2017. The company is an insurance holding company whose main business is property and casualty insurance distributed through independent agencies in 42 states; it also writes life, excess and surplus lines, and assumed reinsurance.
Financial performance and position
| Metric | 2017 | 2016 |
|---|---|---|
| Total revenue | $5.732 billion | $5.449 billion |
| Net income | $1.045 billion | $591 million |
| Diluted earnings per share | $6.29 | $3.55 |
| Net operating cash flow | $1.052 billion | $1.115 billion |
| Total assets | $21.843 billion | $20.386 billion |
| Shareholders’ equity | $8.243 billion | $7.060 billion |
| Book value per share | $50.29 | $42.95 |
| Total investments | $17.051 billion | $15.500 billion |
| Cash and cash equivalents | $657 million | $777 million |
| Long-term debt, book value | $787 million | $787 million |
| Debt-to-total-capital ratio | 9.0% | 10.3% |
- Earned premiums rose 5% to $4.954 billion; net written premiums increased 6% to $5.118 billion. Net investment income rose 2% to $609 million and realized investment gains were $148 million.
- Consolidated property-casualty underwriting profit was $128 million, down from $242 million. The GAAP combined ratio rose to 97.5% from 94.8%; below 100% still indicates an underwriting profit. Catastrophe losses and less favorable prior-year reserve development pressured results.
- Segment results: commercial lines earned premiums were $3.165 billion and pretax underwriting profit $119 million; personal lines premiums were $1.241 billion and recorded a $32 million pretax loss; excess and surplus lines premiums were $209 million and profit $61 million; life premiums were $232 million and the segment recorded a $1 million loss.
- Operating cash flow was positive, though lower year over year. Property-casualty operations generated $943 million of operating cash flow, compared with $985 million in 2016.
- The investment portfolio’s fair value was $16.948 billion, including $10.699 billion of fixed maturities and $6.249 billion of equity securities. Net unrealized investment gains were $3.540 billion. The pretax total investment return was 10.5%.
Material changes versus 2016
- Net income increased 77%, but included a one-time, noncash $495 million tax benefit from remeasuring deferred taxes following enactment of the Tax Cuts and Jobs Act. The reported effective tax rate was negative 43.2%; management estimated an approximately 16% overall effective rate for 2018, assuming similar pretax income and portfolio mix.
- Fourth-quarter net income was $642 million, compared with $100 million in fourth-quarter 2016, largely reflecting the tax benefit. The filing does not provide a clear recurring fourth-quarter earnings measure excluding this item.
- Property-casualty underwriting profit fell 47%, and the combined ratio worsened 2.7 percentage points. Current-year losses before catastrophes increased, while favorable prior-year reserve development declined to $119 million from $168 million.
- Commercial casualty and commercial auto claims developed less favorably than expected, prompting higher reserve estimates. Personal lines remained unprofitable as catastrophe and large losses weighed on results.
- Total investments rose 10% on a fair-value basis; shareholders’ equity and book value per share each grew 17%, supported by investment market appreciation and the tax-related accounting benefit.
- Cash dividends declared per share were $2.50, including a $0.50 special dividend, versus $1.92 in 2016. The company reported 57 consecutive years of regular dividend increases through 2017.
Outlook, commentary, and risks
- Management targets a five-year average value creation ratio of 10%–13% and a five-year average GAAP combined ratio of 95%–100%. The 2017 value creation ratio was 22.9%, elevated in part by the tax benefit and investment gains.
- Management expects property-casualty premium growth to exceed industry growth over a five-year period, assuming pricing keeps pace with or exceeds loss-cost trends, the economy maintains long-term growth, and investment valuations fluctuate within typical ranges. These are objectives and assumptions, not firm forecasts.
- For 2018, the company planned approximately 100 appointments of agencies offering most or all property-casualty products and approximately 100 personal-lines-only agency appointments, with emphasis on high-net-worth clients. It also planned continued selective expansion of Cincinnati Re.
- Management identified commercial auto and personal auto rate adequacy, underwriting selection, pricing analytics, claims and loss-control practices, and expense efficiency as priorities. It noted competitive pricing pressure and the possibility of soft market conditions.
- Key risks include catastrophe frequency and severity, reserve estimation uncertainty, adverse loss-cost trends, concentrated exposure to construction-related business and Midwest/Southeast states, market and interest-rate changes, equity-price volatility, and dependence on reinsurer recoveries and independent agents. A modeled single hurricane loss, net of reinsurance and taxes, was $173 million for a 1-in-100-year event and $413 million for a 1-in-250-year event.
- Parent-company liquidity included $2.511 billion in cash and marketable securities. The insurer could declare approximately $509 million in dividends to the parent in 2018 without regulatory approval. Long-term debt principal was $793 million; the $225 million revolving credit facility had $24 million drawn and expires in May 2019.
- The company reported no material litigation beyond ordinary-course matters. Deloitte & Touche issued unqualified opinions on the financial statements and internal control over financial reporting.
Important facts for investors to verify
- How much of the 2017 earnings increase is repeatable after excluding the $495 million tax remeasurement benefit and considering realized investment gains.
- Whether commercial casualty, commercial auto, and personal auto loss trends stabilize, and whether rate actions improve segment profitability.
- Whether loss reserves remain adequate, especially given reserve estimate uncertainty and the lower level of favorable prior-year development.
- How catastrophe exposure, reinsurance terms and recoverables, and agency-state concentrations affect potential losses and liquidity.
- How equity-market movements, interest rates, and the 2018 accounting change for equity-security fair-value gains and losses affect reported earnings and book value.
- Whether insurance-subsidiary dividend capacity and parent liquidity continue to support debt service, regular dividends, special dividends, and repurchases.