Cincinnati Financial Corporation — Q3 2016 Form 10-Q
Business context and period. Cincinnati Financial is an insurer operating primarily through commercial, personal, excess and surplus property-casualty, life insurance and investment businesses. This unaudited filing covers the quarter and nine months ended September 30, 2016; comparisons are with the same 2015 periods unless noted.
Financial performance
| Metric | Q3 2016 | Nine months 2016 | Comparable 2015 |
|---|---|---|---|
| Total revenue | $1.402 billion | $4.137 billion | $1.278 billion; $3.879 billion |
| Net income | $180 million | $491 million | $174 million; $478 million |
| Diluted EPS | $1.08 | $2.95 | $1.05; $2.89 |
| Net realized investment gains | $56 million | $161 million | $3 million; $110 million |
| Property-casualty combined ratio | 92.4% | 94.4% | 87.8%; 92.5% |
| Operating cash flow | Not separately stated in the summarized cash-flow statement | $824 million | $755 million |
Quarterly and nine-month revenue increased 10% and 7%, respectively, while net income rose 3% in each period. Higher earned premiums and investment income contributed, but realized investment gains were a substantial earnings driver. Net income growth also came despite weaker property-casualty underwriting results.
Earned premiums were $1.191 billion for Q3 and $3.518 billion for nine months, up 6% in each period. Nine-month property-casualty net written premiums grew 6%. The nine-month combined ratio rose 1.9 percentage points year over year: catastrophe losses added 7.8 points, partly offset by 4.6 points of favorable prior-year reserve development. Underwriting remained profitable overall, with a $196 million nine-month property-casualty underwriting profit, down from $243 million.
- Segment trends: Commercial lines earned premiums rose 3% for nine months, but underwriting profit fell to $148 million from $244 million; its combined ratio increased to 93.7% from 89.2%. Personal lines premiums grew 6%; its nine-month combined ratio improved to 100.4% from 103.8%, though Q3 was 103.4%. Excess and surplus lines premiums grew 10%, and its combined ratio improved to 69.9% from 77.9%.
- Investment income: Net investment income increased 5% to $442 million for nine months. The average pretax yield on invested assets and cash was 3.88%, versus 3.91% a year earlier. Management noted that reinvestment of maturing bonds at current rates may pressure future yields.
- Comprehensive income and equity: Nine-month comprehensive income was $899 million versus $14 million, reflecting $408 million of other comprehensive income, primarily investment valuation changes. Shareholders’ equity increased to $7.121 billion from $6.427 billion at year-end 2015; book value per share rose to $43.24 from $39.20.
Balance sheet, liquidity and capital
At September 30, 2016, total assets were $20.455 billion, including $15.642 billion of investments and $700 million of cash and cash equivalents. Total liabilities were $13.334 billion. Management reported $806 million of total debt ($786 million long-term debt and $20 million drawn on the short-term line); the debt-to-total-capital ratio was 10.2%, down from 11.3% at year-end 2015. The line had $205 million available. Nine-month operating, investing and financing cash flows were $824 million, negative $386 million and negative $282 million, respectively.
The company paid $229 million in cash dividends in the first nine months. Quarterly dividends were raised to $0.48 per share, or an indicated annual rate of $1.92. The lead insurance subsidiary declared $300 million of dividends to the parent in the period; approximately $534 million could be paid during 2016 without regulatory approval. Management did not anticipate a material increase in debt during the remainder of 2016.
Outlook, commentary and risks
- No specific consolidated earnings or revenue guidance for full-year 2016 is provided in the supplied filing text. Management said pricing actions and underwriting initiatives are intended to improve future results. Average renewal price increases were in the mid-single-digit range for commercial auto and near the high end of that range for personal auto.
- Management cited elevated weather-related catastrophe losses: $260 million for the first nine months, compared with $161 million in 2015. It also reported $151 million of favorable prior-accident-year reserve development, versus $140 million in 2015. Reserves are estimates and may change as claims develop; recent loss-cost effects led to adverse development in commercial and personal auto.
- Investment portfolio fair value was $15.561 billion, up $1.205 billion from year-end 2015, largely reflecting higher market values and lower interest rates. A hypothetical 100-basis-point rate increase was estimated to reduce fixed-maturity fair value by about 4.9%. Equity-market declines, interest-rate changes, credit spreads and potential impairments are material risks.
- Other stated risks include catastrophe severity and frequency, claim inflation and reserve estimation, low interest rates, market or economic deterioration, reinsurance availability and collectability, competition, technology and cybersecurity, regulation, and litigation. Management reported no material change in risk factors since the 2015 Form 10-K.
- Ordinary-course insurance litigation was considered immaterial after reserves. Other legal and regulatory matters are periodically reviewed; management said accruals were reasonable, while noting that an adverse outcome significantly above accruals could materially affect results or cash flows. No material litigation was identified in Part II.
- There were no material changes to internal control over financial reporting during the quarter; management concluded disclosure controls were effective. No share repurchases were made under the authorization in Q3; 4.06 million shares remained available at September 30.
Important facts for investors to verify
- How much of earnings growth depends on realized investment gains, and whether such gains recur.
- Whether catastrophe losses, commercial/personal auto loss trends and reserve development improve or worsen; review subsequent reserve disclosures.
- Whether premium rate increases and underwriting actions restore sustained profitability in auto lines, particularly given the personal-lines Q3 combined ratio above 100%.
- How lower reinvestment yields, interest-rate movements and equity valuations affect investment income, accumulated unrealized gains and book value.
- Availability of subsidiary dividends, reinsurance protection and liquidity under adverse claims or market scenarios.