Cincinnati Financial Corporation — Q2 2013 Form 10-Q
Reporting period: Three and six months ended June 30, 2013. Unaudited consolidated results; dollar amounts are in millions except per-share data.
Business context and financial performance
The company operates property and casualty insurance, life insurance and investment businesses, distributing insurance mainly through independent agencies. Its five reportable segments are commercial lines, personal lines, excess and surplus lines, life insurance and investments.
| Metric | Q2 2013 | Q2 2012 | Six months 2013 | Six months 2012 |
|---|---|---|---|---|
| Total revenue | $1,104 | $1,020 | $2,207 | $2,006 |
| Net income | $110 | $32 | $264 | $118 |
| Diluted EPS | $0.66 | $0.20 | $1.60 | $0.72 |
| Net investment income | $131 | $132 | $259 | $263 |
| Net realized investment gains | $14 | $6 | $55 | $19 |
| Property-casualty earned premiums | $910 | $826 | $1,799 | $1,624 |
| Property-casualty combined ratio | 96.4% | 109.5% | 93.9% | 104.4% |
Material changes and operating drivers
- Revenue increased 8% in Q2 and 10% for the first half, primarily on premium growth. Property-casualty net written premiums rose 9% and 12%, respectively.
- Net income rose $78 in Q2 and $146 for the first half. Management attributed the improvement principally to stronger property-casualty underwriting, including lower catastrophe losses; higher realized investment gains also contributed.
- Property-casualty catastrophe losses contributed 8.3 percentage points to the Q2 combined ratio and 4.8 points for the first half, versus 17.8 and 14.6 points in the prior-year periods. Current-year catastrophe losses were $84 for the first half versus $263 a year earlier.
- Favorable prior-year reserve development was $92 in Q2 and $102 for the first half. This reduced the first-half combined ratio by 5.6 percentage points, compared with a 12.4-point reduction in the prior-year period. Management notes that reserve estimates are inherently uncertain.
- Segment underwriting improved: first-half commercial lines had a 92.9% combined ratio, personal lines 96.1%, and excess and surplus lines 98.4%. Personal auto remained a profitability challenge, and management cited unfavorable first-half prior-year development in surety and executive risk.
- Life segment revenue declined 4% for the first half, while segment profit improved to $10 from a $1 loss, primarily reflecting favorable mortality and lower operating expenses. Lower universal-life earned premiums were partly associated with interest-rate assumption unlocking.
Cash flow, balance sheet and liquidity
- Six-month operating cash flow was $251, compared with $265 in 2012. Investing activities used $230 and financing activities used $126. Cash and cash equivalents ended June at $382, down from $487 at year-end 2012.
- At June 30, total assets were $17.034 billion and shareholders’ equity was $5.699 billion, versus $16.548 billion and $5.453 billion at year-end. Book value per share was $34.83, up from $33.48 at year-end, but down from $35.41 at March 31.
- Total debt was $894: $790 of long-term debt and $104 of short-term borrowing. The debt-to-total-capital ratio was 13.6%, down from 14.1% at year-end. Management did not anticipate a material increase in debt during the remainder of 2013.
- Cash dividends paid were $130 in the first half. The declared quarterly dividend was $0.4075 per share; the indicated annual rate was $1.63. The parent company held $1.369 billion in cash and invested assets, including $1.196 billion in common stocks.
Investments, outlook and risks
- The investment portfolio had a fair value of $12.867 billion, including $8.992 billion in fixed maturities and $3.875 billion in equities. Rising interest rates reduced the fixed-maturity portfolio’s net unrealized gain position; the portfolio was valued at 106.7% of amortized cost, versus 110.6% at year-end.
- Comprehensive income was a loss of $31 in Q2, despite $110 of net income, primarily reflecting after-tax investment-related other comprehensive losses of $159. For the first half, comprehensive income was $356.
- Investment income remained pressured by low interest rates: pretax investment income declined 1% in Q2 and 2% for the first half. Management said maturing bonds would be challenging to replace at current yields and identified a prolonged low-rate environment as a risk.
- Management’s stated 2013–2017 primary performance target is an average annual value creation ratio of 10%–13%. Its long-term property-casualty objective is a GAAP combined ratio of 95%–100% over any five-year period. These are targets, not quarterly earnings guidance. First-half 2013 value creation ratio was 6.4%.
- Management described ongoing pricing, underwriting, analytics and agency-growth initiatives. It targeted approximately 65 new agency appointments for 2013, later indicating it expected to exceed that target by about 15; 63 agencies had been appointed in the first half.
- Key risks include catastrophe severity and frequency, claims inflation and reserve-estimation uncertainty, investment and interest-rate volatility, competition, reinsurance availability and counterparty risk, regulation, litigation, and technology or cybersecurity disruptions. The filing says risk factors had not materially changed from the 2012 Form 10-K.
- Ordinary-course claims litigation was considered immaterial after reserves. Other legal matters were reviewed quarterly; management considered recorded accruals reasonable, but an adverse judgment or settlement above accruals could materially affect results or cash flows. Estimated exposure for matters that were more than remote but not probable was less than $2.
Most important facts for investors to verify
- How much of the underwriting improvement persists after lower catastrophe losses and favorable reserve development are separated from current-year underlying performance.
- Whether pricing and underwriting actions improve challenged lines, particularly personal auto, specialty packages, and surety and executive risk.
- How rising rates, equity-market changes and the sizeable equity portfolio affect investment income, unrealized gains, book value and capital.
- Whether premium growth and agency expansion can be sustained without weakening underwriting discipline or increasing catastrophe concentration.
- Subsequent reserve development, catastrophe claims and any material change in litigation, reinsurance recoverables or liquidity needs.