Cincinnati Financial Corporation — Second-Quarter 2012 Form 10-Q
Business context and reporting period. The unaudited filing covers the quarter and six months ended June 30, 2012, for a U.S. insurer operating in commercial, personal and excess-and-surplus property-casualty insurance, life insurance and investments. Unless stated otherwise, dollar amounts below are in millions.
Financial performance and position
| Metric | Q2 2012 | Q2 2011 | Six months 2012 | Six months 2011 |
|---|---|---|---|---|
| Total revenue | $1,020 | $975 | $2,006 | $1,904 |
| Earned premiums | $877 | $773 | $1,716 | $1,555 |
| Net investment income | $132 | $132 | $263 | $263 |
| Net realized investment gains | $6 | $67 | $19 | $79 |
| Net income (loss) | $32 | $(50) | $118 | $11 |
| Diluted earnings per share | $0.20 | $(0.31) | $0.72 | $0.07 |
| Property-casualty combined ratio | 109.5% | 136.7% | 104.4% | 120.2% |
| Operating cash flow | — | $265 | $4 |
Property-casualty underwriting remained loss-making overall: the underwriting loss was $77 million in Q2 and $68 million for the half, compared with losses of $267 million and $297 million in 2011. The combined ratio improved substantially but remained above the 100% underwriting break-even level, both for Q2 and year to date. Before catastrophe losses and prior-year reserve development, the combined ratio was 101.5% for Q2 and 100.6% for the half.
At June 30, total assets were $16.089 billion, investments $12.231 billion, cash and equivalents $263 million, and shareholders’ equity $5.144 billion. Book value per share was $31.66, versus $31.03 at year-end 2011. The debt-to-total-capital ratio was 14.8%, down from 15.1%. Management reported $894 million of total debt, comprising $790 million of long-term debt and $104 million of short-term borrowings. The balance sheet separately reports $831 million of long-term debt and capital-lease obligations.
For the first half, investing activities used $304 million and financing activities used $136 million; cash declined $175 million from year-end. Dividends paid were $128 million. The quarterly dividend declared was $0.4025 per share. The company reported $1.025 billion of parent-company cash and invested assets, including $23 million in cash and equivalents.
Material changes versus the prior period
- Revenue growth was driven principally by premiums: earned premiums rose 13% in Q2 and 10% for the first half. Property-casualty net written premiums increased 18% and 13%, respectively.
- Improved underwriting results reflected lower catastrophe losses than in 2011 and better current accident-year loss performance before catastrophes. Catastrophe losses contributed 17.8 percentage points to the Q2 combined ratio and 14.6 points for the half.
- Prior accident-year reserve development was favorable by $85 million in Q2 and $201 million for the first half. This supported reported results; reserve estimates remain uncertain.
- Net realized investment gains fell sharply year over year. The first half included $30 million of other-than-temporary impairment charges, nearly all related to four common stocks; Q2 charges were $14 million.
- Commercial lines produced a $14 million underwriting profit for the first half, while personal lines recorded a $77 million underwriting loss. The personal-lines combined ratio improved to 118.6% from 139.4%, but remained above break-even.
Outlook, management commentary and risks
The filing provides no specific full-year earnings forecast. Management reiterated a long-term target of a 95%–100% property-casualty GAAP combined ratio over a five-year period and an annual value creation ratio of 12%–15% on average for 2010–2014. The first-half value creation ratio was 4.6%, versus 2.9% a year earlier. Management reported 13% growth in property-casualty net written premiums for the half and cited an A.M. Best industry growth projection of 4% for full-year 2012.
Management described continued work on pricing analytics, underwriting processes and agency growth. Planned actions included deploying an updated workers’ compensation pricing model in Q3, filing homeowner rate changes with Q4 2012 effective dates, and filing personal-auto rate changes with early-2013 effective dates. Management also noted that low interest rates constrain reinvestment yields: approximately 18% of fixed maturities were due to mature or be called from July 2012 through December 2014, with a 4.9% average pretax yield to amortized cost.
- Insurance and reserve risk: catastrophe frequency and severity, large claims, loss-cost inflation, and changes in estimates for long-tailed prior-year claims can materially affect results.
- Investment and market risk: the portfolio is exposed to interest rates, credit spreads and equity-market declines. Gross unrealized investment gains were $1.673 billion at quarter-end; low rates may pressure future investment income. Management estimated a 100-basis-point parallel rate increase could reduce fixed-maturity fair value by about 4.4%.
- Other risks: the filing cites competition, reinsurance availability and collectability, regulatory changes, technology and data-security issues, and litigation. Management considered ordinary claims litigation immaterial to consolidated financial condition, but said certain other matters’ potential losses could not be reasonably estimated; a significantly adverse judgment or settlement could affect results or cash flows.
- Other items: the company adopted new insurance acquisition-cost guidance retrospectively in 2012, reducing adjusted year-end 2011 equity by $22 million and book value per share by $0.13. It also executed a new five-year $225 million credit facility in May, replacing prior facilities of the same total amount, and anticipated a $14 million pension contribution in Q3.
Important facts for investors to verify
- Whether premium pricing and underwriting improvements persist, especially as catastrophe experience normalizes and the combined ratio remains above 100%.
- How much earnings depend on favorable prior-year reserve development, and whether future claims emergence supports current reserve assumptions.
- The impact of low reinvestment yields, realized investment gains and further impairment charges on investment income and earnings.
- Progress on personal-lines profitability, rate filings and stated underwriting and value-creation targets.
- Liquidity and capital resources, including subsidiary dividend capacity, short-term borrowing and the distinction between debt and balance-sheet capital-lease amounts.