Cincinnati Financial Corporation — Q3 2015 Form 10-Q
Business context and period. This unaudited quarterly filing covers the three and nine months ended September 30, 2015. Cincinnati Financial is primarily a property-casualty and life insurer, distributing products through independent agencies, with a substantial investment portfolio.
Financial results and position
| Metric | Q3 2015 | Q3 2014 | Nine months 2015 | Nine months 2014 |
|---|---|---|---|---|
| Total revenue | $1.278 billion | $1.280 billion | $3.879 billion | $3.683 billion |
| Net income | $174 million | $183 million | $478 million | $358 million |
| Diluted EPS | $1.05 | $1.11 | $2.89 | $2.17 |
| Earned premiums | $1.127 billion | $1.071 billion | $3.332 billion | $3.157 billion |
| Net investment income | $143 million | $138 million | $422 million | $409 million |
| Net realized investment gains | $3 million | $65 million | $110 million | $101 million |
- Underwriting: Consolidated property-casualty underwriting profit was $133 million for Q3 and $243 million year to date. Combined ratios were 87.8% and 92.5%, respectively, versus 91.0% and 97.3% in the comparable 2014 periods. Ratios benefited from favorable prior-year reserve development of $48 million in Q3 and $140 million year to date; catastrophe losses were higher year over year in Q3 but lower year to date.
- Segment differences: Commercial lines earned a $121 million Q3 underwriting profit (combined ratio 84.0%); excess and surplus lines earned $14 million (69.9%). Personal lines recorded a $2 million Q3 underwriting loss (100.9% combined ratio), including increased catastrophe losses. Personal lines remained loss-making year to date, with a $30 million underwriting loss and 103.8% combined ratio.
- Cash flow: Operating cash flow was $755 million for the first nine months, versus $633 million in 2014. Investing activities used $620 million and financing activities used $307 million. Cash and equivalents fell to $419 million from $591 million at year-end 2014.
- Balance sheet and capital: Total assets were $18.751 billion, broadly unchanged from year-end 2014. Shareholders’ equity was $6.350 billion, down from $6.573 billion; book value per share was $38.77, down from $40.14. The decline included a $464 million after-tax other comprehensive loss, primarily from investment valuation changes. Debt was $826 million ($791 million long-term and $35 million short-term); debt-to-total-capital was 11.5%, versus 11.3% at year-end. The company reported $190 million available on its revolving credit line.
- Margins and portfolio: The property-casualty combined ratio was below 100% overall, indicating underwriting profit, but personal lines exceeded 100%. The investment portfolio’s fair value was $14.357 billion; net unrealized investment gains were $1.992 billion. The filing attributes declining unrealized gains principally to market movements, including rising interest rates and wider corporate-bond credit spreads.
Material changes and management commentary
- Q3 net income declined 5% despite premium and investment-income growth, chiefly because after-tax realized investment gains were $41 million lower than a year earlier; improved property-casualty underwriting partly offset the reduction. Nine-month net income rose 34%, driven mainly by stronger property-casualty underwriting and lower catastrophe losses.
- Property-casualty earned premiums increased 5% in Q3 and 6% year to date. Management cited renewal pricing, exposure growth, and agency initiatives. The company said it expected to fall slightly short of its target of $5 billion in annual direct written premiums by year-end 2015, emphasizing profitable growth.
- Management identified rising paid-loss trends in commercial and personal auto and increased its estimates of ultimate loss ratios. Auto reserves were $85 million higher than year-end 2014, including a $53 million increase in IBNR. Commercial auto was a notable profitability concern; pricing and underwriting actions were underway.
- Management’s stated long-term targets include a 95%–100% GAAP combined ratio over a five-year period and a 10%–13% average annual value creation ratio for 2013–2017. The nine-month combined ratio was 92.5%; the reported value creation ratio was 0.0% for the period. These are long-term targets, not a specific full-year 2015 earnings forecast.
- Management reported a low-interest-rate environment as a challenge to reinvesting maturing bonds at comparable yields. Fixed maturities acquired in the first nine months yielded an average 4.02%, below the portfolio’s 4.76% year-end 2014 yield. Management also warned that investment values, investment income, and impairment charges could be affected by markets and economic conditions.
Outlook, risks, contingencies and unusual items
- No specific full-year earnings or revenue guidance is provided in the supplied filing text. Management expected no material increase in debt during the remainder of 2015 and no further qualified pension contribution in 2015.
- Key risks include catastrophe severity and frequency, adverse claims development and reserve-estimation uncertainty, auto loss-cost trends, equity-market declines, interest-rate and credit-spread changes, prolonged low rates, reinsurance availability and collectability, competition, regulation, litigation, and technology or cybersecurity disruption.
- The company recorded $8 million of Q3 and $12 million of nine-month pretax other-than-temporary investment impairment charges. Q3 total revenue was affected by the sharp year-over-year decline in realized investment gains.
- Ordinary-course insurance litigation was considered immaterial after reserves. The company said other legal accruals were reasonable and not material, while noting that outcomes materially above accruals could affect results or cash flows; estimated loss for matters not considered probable but more than remote was less than $1 million.
- Management reported effective disclosure controls and no material change in internal control over financial reporting during the quarter. Risk factors were stated to be unchanged materially from the 2014 Form 10-K.
Most important facts for investors to verify
- Whether favorable reserve development continues, particularly in commercial lines, and whether the adverse commercial and personal auto loss trends stabilize.
- Whether premium growth translates into durable underwriting profit after catastrophe losses, reserve changes, and increased underwriting expenses.
- How much future earnings depend on realized investment gains, and how changing rates, equity prices, and credit spreads affect portfolio values, income, and capital.
- Whether the company achieves its long-term combined-ratio and value-creation objectives; the filing provides no specific full-year 2015 earnings guidance.
- Liquidity and capital developments, including subsidiary dividend capacity, debt usage, shareholder dividends and repurchases, and the effect of investment-related OCI on book value.