Cincinnati Financial Corporation — 2013 Form 10-K Summary
Reporting period: Fiscal year ended December 31, 2013. This is an annual report, not a quarterly filing; the filing also provides unaudited fourth-quarter results. Cincinnati Financial is an Ohio-based insurer whose principal business is property-casualty coverage sold through independent agencies in 39 states, alongside life insurance, investments and commercial financing.
Key financial results
| Metric | 2013 | 2012 |
|---|---|---|
| Total revenues | $4.531 billion | $4.111 billion |
| Net income | $517 million | $421 million |
| Diluted earnings per share | $3.12 | $2.57 |
| Earned premiums | $3.902 billion | $3.522 billion |
| Net investment income, pretax | $529 million | $531 million |
| Net realized investment gains | $83 million | $42 million |
| Operating cash flow | $796 million | $638 million |
| Shareholders’ equity | $6.070 billion | $5.453 billion |
| Book value per share | $37.21 | $33.48 |
| Cash dividends declared per share | $1.655 | $1.62 |
Property-casualty net written premiums grew 12% and earned premiums 11%. The GAAP combined ratio improved to 93.8% from 96.1%; below 100% indicates an underwriting profit. Underwriting profit was $233 million, versus $137 million in 2012. Natural-catastrophe losses fell by $162 million, a major contributor to the improvement. Favorable development on prior-year reserves was $147 million, down from $396 million in 2012.
Segment pretax results were: commercial lines $186 million (2012: $181 million); personal lines $33 million (2012: loss of $43 million); excess and surplus lines $14 million (2012: loss of $1 million); life insurance $9 million (2012: loss of $3 million); investments $532 million (2012: $491 million). Commercial, personal and excess/surplus earned premiums grew 11%, 11% and 25%, respectively; life premiums rose 6%.
For fourth-quarter 2013, revenue was $1.172 billion, pretax income $167 million, net income $122 million and diluted EPS $0.74. In fourth-quarter 2012, the corresponding figures were $1.070 billion, $273 million, $192 million and $1.17. Thus, despite higher quarterly revenue, fourth-quarter earnings declined year over year.
Balance sheet, investments and liquidity
- Total assets were $17.662 billion, compared with $16.548 billion at year-end 2012. Investments on the balance sheet were $13.564 billion; the fair value of the investment portfolio was $13.496 billion.
- Cash and cash equivalents were $433 million. The parent company reported $1.532 billion of cash and marketable securities.
- Long-term debt was $790 million and short-term borrowings were $104 million; debt-to-total-capital was 12.8%, down from 14.1%. The revolving credit facility had $225 million of capacity and expires in May 2017.
- Fixed maturities had a fair value of $9.121 billion; equities had a fair value of $4.375 billion. The fixed-maturity portfolio’s fair value declined relative to amortized cost as interest rates rose, while equity-market gains increased portfolio value.
- Gross property-casualty loss and loss-expense reserves were $4.311 billion; gross life policy reserves were $2.390 billion. Management’s estimated reasonable range for net property-casualty reserves was $3.727 billion to $4.078 billion, against $3.942 billion carried.
- Statutory capital and surplus of the principal standard-market property-casualty subsidiary was $4.326 billion. The company reported strong risk-based capital and investment-grade debt ratings.
Material changes and management commentary
- Net income increased 23%, supported primarily by improved property-casualty underwriting and higher realized investment gains. Investment income edged down less than 1% as lower interest income largely offset higher dividends.
- Personal-lines underwriting returned to profit, with a 96.8% combined ratio versus 105.3% in 2012. Commercial lines remained profitable, though its ratio increased slightly to 93.0% from 92.5%.
- Book value rose 11%. The 2013 value creation ratio was 16.1%, versus 12.6% in 2012, benefiting from higher equity valuations and operating results; declining fixed-maturity valuations partly offset those gains.
- The company began nonrenewing Florida personal-lines policies, citing exposure levels inconsistent with its risk-management objectives. Homeowner and dwelling-fire nonrenewals were to begin in June 2014, with other personal policies generally to follow in the second half of 2015. Commercial lines in Florida were to continue.
- Management’s longer-term goals include a GAAP combined ratio averaging 95%–100% over any five-year period and $5 billion in annual direct written premiums across property-casualty and life insurance by year-end 2015. 2013 direct written premiums were $4.337 billion. Management cautioned that the 2014 value creation ratio could be below its long-term target.
Outlook, risks and unusual items
- Management expected competitive conditions to persist in 2014. Its outlook assumed commercial and personal pricing increases would exceed loss-cost trends, the economy would continue growing, and market valuations would vary within typical ranges. It noted that failure of these assumptions could hinder performance objectives.
- For 2014, management planned further predictive pricing and underwriting work, property inspections, expanded use of deductibles, technology and process investments, and agency growth. It expected personal-lines growth to exceed the industry projection, while emphasizing that pricing must keep pace with losses.
- Catastrophe exposure, geographic concentration, reserve-estimate uncertainty, inflation in claims costs, investment-market and interest-rate volatility, reinsurance availability and collectability, competition, agency-channel reliance, regulatory constraints and cybersecurity or business interruption are key disclosed risks.
- Rising rates reduced fixed-maturity valuations; a 100-basis-point rate increase was estimated to reduce their fair value by approximately 4.6%. Common equities represented a substantial share of invested assets, exposing book value and earnings to market declines.
- Favorable prior-year reserve development contributed to reported earnings, but was substantially smaller than in 2012. Asbestos and environmental reserves were $77 million net, and mold reserves were $51 million at year-end 2013.
- The company reported no material litigation beyond ordinary-course matters. It stated that other legal matters with more than remote loss risk were estimated below $500,000 individually; an adverse judgment or settlement materially above accrued amounts could still affect results or cash flows.
- The independent auditor issued an unqualified opinion on the financial statements and internal control over financial reporting. Management also concluded internal controls were effective as of year-end.
Investor verification priorities
- Check whether underwriting improvement persists after the unusually lower catastrophe losses and the reduced contribution from favorable reserve development.
- Track reserve development, particularly long-tail commercial casualty and workers’ compensation claims, and compare actual outcomes with the disclosed reserve range.
- Assess whether premium growth and rate increases remain adequate relative to claims inflation, especially in personal auto and property-related lines.
- Monitor the Florida personal-lines runoff, catastrophe exposure and the cost and effectiveness of reinsurance protection.
- Evaluate sensitivity of book value and investment income to equity-market changes and interest rates, and confirm parent-company liquidity and regulated subsidiary dividend capacity.
- Compare progress toward the $5 billion direct-written-premium goal with underwriting discipline and the combined-ratio target.