Cincinnati Financial Corporation — Q1 2013 Form 10-Q
Reporting period: Three months ended March 31, 2013; comparative period is Q1 2012 unless otherwise noted. The filing presents unaudited interim results. Cincinnati Financial operates property-casualty and life insurance businesses, alongside investment operations, and distributes insurance through independent agencies.
Financial performance
| Metric | Q1 2013 | Q1 2012 | Change |
|---|---|---|---|
| Total revenue | $1.103 billion | $986 million | 12% |
| Earned premiums | $931 million | $839 million | 11% |
| Investment income, net | $128 million | $131 million | (2%) |
| Net realized investment gains | $41 million | $13 million | +$28 million |
| Income before taxes | $217 million | $112 million | +$105 million |
| Net income | $154 million | $86 million | 79% |
| Diluted earnings per share | $0.94 | $0.53 | 77% |
| Comprehensive income | $387 million | $232 million | 67% |
Profit growth reflected stronger property-casualty underwriting and higher realized investment gains. Realized gains included $37 million from sales of common and preferred stocks; the timing of investment sales can affect quarterly earnings. Net investment income declined as lower fixed-maturity interest income more than offset higher dividends. Pretax investment yield was 4.14%, versus 4.48% a year earlier. The effective tax rate rose to 29.0% from 23.2%.
Property-casualty underwriting: Earned premiums were $889 million, up 11%; net written premiums were $970 million, up 15%. Underwriting profit was $78 million versus $9 million, and the combined ratio improved to 91.2% from 99.1%. Catastrophe losses contributed 1.2 percentage points to the ratio, compared with 11.1 points in Q1 2012. Favorable prior-year reserve development was $10 million, compared with $116 million, including catastrophe reserve development of $7 million versus $22 million.
Commercial lines earned premiums rose 11% and underwriting profit was $58 million, up from $34 million; its combined ratio was 90.8%. Personal lines premiums rose 11%, and the segment moved to a $20 million underwriting profit from a $22 million loss; its combined ratio improved to 91.6% from 110.9%. Excess and surplus lines premiums increased 29%; underwriting results were approximately breakeven versus a $3 million loss, with a 98.0% combined ratio. Life segment profit was $7 million versus a $3 million loss, mainly reflecting lower operating expenses.
Cash flow and balance sheet: Operating cash flow was $57 million, down from $148 million; investing cash flow was a $102 million outflow and financing cash flow was a $62 million outflow. Cash and equivalents ended the quarter at $380 million, versus $487 million at year-end 2012. Total assets were $17.037 billion; shareholders’ equity was $5.785 billion, up from $5.453 billion. Book value per share increased to $35.41 from $33.48. Total debt was $894 million ($104 million short-term and $790 million long-term); debt-to-total-capital was 13.4%, down from 14.1%.
The investment portfolio had a fair value of $12.970 billion, with $2.237 billion of pretax unrealized gains and $6 million of unrealized losses. Q1 other comprehensive income was $233 million, primarily reflecting higher unrealized investment gains. The filing reports $1.344 billion of cash and invested assets at the parent-company level; 84.1% was invested in common stocks.
Material changes and management commentary
- Property-casualty premium growth and improved current-accident-year loss ratios supported underwriting results, while much lower catastrophe losses were a major year-over-year benefit. Management cautions that catastrophe losses vary substantially between periods.
- Management reported higher pricing and continued to expand pricing analytics, property inspections, deductibles and underwriting actions. Standard commercial lines renewal pricing increases averaged in the mid-single-digit range; personal auto rate changes were planned in most states, generally in the low-single-digit range.
- Management’s long-term targets include a property-casualty GAAP combined ratio of 95%–100% over a five-year period and an annual value creation ratio of 10%–13% on average for 2013–2017. Q1 value creation ratio was 7.0%, versus 4.2% a year earlier. Management also noted that 2013 performance could be below long-term targets; the filing does not provide a specific full-year earnings forecast.
- The board declared a quarterly dividend of $0.4075 per share, equivalent to an indicated annual rate of $1.63. The company said it did not anticipate a material increase in debt during the rest of 2013.
- Investment risks include low interest rates pressuring reinvestment income and potential valuation declines if rates rise. A hypothetical 100-basis-point parallel rate increase was estimated to reduce fixed-maturity fair value by approximately 4.3%; this is a sensitivity, not a forecast. The company held no European sovereign debt.
Risks, contingencies and unusual items
Management identifies property-casualty loss reserves as its most significant estimate; actual claim payments may differ materially from actuarial estimates. The quarter included $10 million of favorable prior-year reserve development, but development was less favorable than in Q1 2012. Surety and executive risk included unfavorable prior-year development, including director-and-officer liability claims involving financial institutions; personal auto also had unfavorable reserve development.
Other stated risks include severe catastrophe losses, changes in claim frequency or severity, competition and pricing, reinsurance availability and collectability, prolonged low rates, equity-market declines, regulatory changes, litigation, and technology or data-security incidents. The company said ordinary-course claims litigation was provided for through reserves and was not expected to be material. For other matters with more than remote loss risk, management’s estimate was less than $500,000; a significantly adverse judgment or settlement could nevertheless affect results or cash flows. No material changes to previously disclosed risk factors were reported.
Five securities were impaired during Q1, resulting in $2 million of pretax noncash impairment charges, versus $16 million in Q1 2012. The company adopted ASU 2013-02 on accumulated other comprehensive income; it had no material financial impact.
Important facts for investors to verify
- How much of the earnings increase is sustainable underwriting improvement versus lower catastrophe losses, reserve development and realized investment gains?
- Whether current pricing and underwriting initiatives continue to offset loss-cost inflation and support profitable premium growth, particularly in commercial auto, personal auto, and surety and executive risk.
- Future reserve development and catastrophe experience, given the uncertainty inherent in claims estimates and the comparatively low Q1 catastrophe losses.
- Investment-income trends as bonds mature in a low-rate environment, and the effect of interest-rate and equity-market movements on income, unrealized gains and book value.
- Cash generation and liquidity, including the quarter’s lower operating cash flow, parent-company resources, debt levels and capacity to sustain dividends.