Cincinnati Financial Corporation — Q3 2010 Form 10-Q
Reporting period: Three and nine months ended September 30, 2010. The company operates property-casualty and life insurance businesses, alongside investment operations. Financial statements are unaudited and presented in millions of dollars except per-share data.
Key financial results
| Metric | Q3 2010 | Q3 2009 | Nine months 2010 | Nine months 2009 |
|---|---|---|---|---|
| Total revenue | $1,071 | $1,007 | $2,836 | $2,770 |
| Net income | $156 | $171 | $251 | $187 |
| Diluted EPS | $0.95 | $1.05 | $1.53 | $1.15 |
| Earned premiums | $784 | $766 | $2,299 | $2,301 |
| Net investment income | $128 | $127 | $388 | $370 |
| Net realized investment gains | $155 | $110 | $140 | $90 |
Q3 revenue rose 6%, but net income fell 9%, principally because property-casualty underwriting results weakened. For the nine-month period, revenue rose 2% and net income rose 34%; the filing cautions that 2010 and 2009 nine-month results are not fully comparable because the 2009 adoption of revised OTTI accounting was not applied retrospectively.
Underwriting: The consolidated property-casualty combined ratio was 103.9% in Q3 versus 95.1% a year earlier, and 104.7% for nine months versus 106.4%. Ratios above 100% indicate underwriting losses. Nine-month results included 7.2 percentage points of current-year catastrophe losses and 7.9 points of favorable prior-year reserve development. Property-casualty underwriting loss was $29 million for Q3 and $103 million year to date. Commercial lines’ Q3 combined ratio was 103.4%; personal lines’ was 103.4%. Nine-month ratios were 102.4% and 109.8%, respectively.
Cash flow and balance sheet: Nine-month operating cash flow was $417 million, compared with $362 million in 2009; investing cash flow was negative $402 million and financing cash flow was negative $127 million. Cash and equivalents were $445 million at September 30, down from $557 million at year-end 2009. Total assets were $15.070 billion, shareholders’ equity $5.010 billion and book value per share $30.80, up from $29.25 at year-end. Debt totaled $839 million ($790 million long term and $49 million short term); the debt-to-total-capital ratio was 14.3%, versus 15.0% at year-end. The company reported $11.305 billion in total investments on its balance sheet.
Material changes and notable items
- Q3 net realized gains included a $128 million pretax gain from selling the remaining Verisk Analytics shares. Investment gains can be timing-dependent and materially affect quarterly earnings.
- Q3 catastrophe losses were $28 million net of reinsurance; nine-month catastrophe losses were $142 million. Favorable prior-year reserve development was $61 million in Q3 and $174 million for nine months, primarily reflecting lower-than-expected exposures, especially in workers’ compensation and umbrella.
- Commercial lines premiums weakened: nine-month earned premiums declined 4%, amid lower insured exposures, price competition and the company’s decision to avoid business it considered underpriced. Personal lines earned premiums increased 4%; new business premiums rose 22% year to date.
- Investment impairment charges totaled $36 million for nine months, down from $113 million in the comparable 2009 period. Unrealized investment gains increased shareholders’ equity; the filing attributes much of the increase in book value to investment gains.
- Standard & Poor’s lowered insurer financial-strength ratings to A from A+ in July 2010 and lowered the parent company’s counterparty credit rating to BBB from BBB+. The insurer ratings outlook was raised to stable; other cited agencies affirmed ratings with stable outlooks.
- The company paid $189 million in dividends during the first nine months and repurchased 0.4 million shares for $10 million; no shares were repurchased in Q3. The board raised the quarterly dividend to $0.40 per share, resulting in a 50th consecutive year of dividend increases.
Outlook, risks and contingencies
Management set a long-term average value-creation-ratio target of 12%–15% annually for 2010–2014; the ratio was 9.4% for the first nine months of 2010, versus 15.0% in 2009. Management said 2010 performance could be below long-term targets. It reported continued investment in pricing models, technology, expense efficiency, agency appointments and geographic expansion; approximately 80 new agency appointments were expected for full-year 2010. Management did not provide a clear full-year earnings forecast in the supplied filing text.
Management highlighted weak market pricing and economic conditions, catastrophe exposure, claims frequency and severity, reserve-estimation uncertainty, low interest rates and reinvestment risk, investment-market declines and potential further impairments, competition, reinsurance availability and counterparty risk, regulation, litigation, and technology and data-security risks. It noted that a 100-basis-point interest-rate move would change fixed-maturity portfolio fair value by approximately 5% under its sensitivity analysis; this is not a forecast.
The company reported ordinary-course insurance litigation and other legal actions, including putative class actions. It considered recorded accruals reasonable and the overall effect not material, but stated that an adverse judgment or settlement substantially above accruals could materially affect results or cash flows. It expected the IRS to conclude its 2007–2008 audit within three months and reported no liability for unrecognized tax benefits. No material changes to estimated contractual obligations were reported.
Most important facts for investors to verify
- Whether underwriting performance improves, particularly commercial workers’ compensation and personal homeowners, and how much future results depend on favorable reserve development.
- The impact of catastrophe losses, reinsurance recoveries and reserve-estimation changes on combined ratios and cash flows.
- How much earnings depend on realized investment gains, including the one-time Verisk sale, versus recurring underwriting and investment income.
- Investment portfolio credit quality, valuation, concentration and sensitivity to interest rates; verify that unrealized gains and impairment assumptions remain supportable.
- Effect of the S&P rating actions on agency relationships, capital flexibility and financing, despite the company’s reported ample liquidity and 14.3% debt-to-capital ratio.
- Progress against management’s long-term value-creation target and the absence of a clear full-year earnings forecast in the filing text.