Cincinnati Financial Corporation — Q2 2010 Form 10-Q
Reporting period: Three and six months ended June 30, 2010. The company operates property-casualty and life insurance businesses and an investment portfolio, distributing insurance primarily through independent agencies. Amounts below are in millions unless otherwise stated.
Financial performance
| Metric | Q2 2010 | Q2 2009 | First half 2010 | First half 2009 |
|---|---|---|---|---|
| Total revenue | $878 | $874 | $1,765 | $1,764 |
| Earned premiums | $768 | $770 | $1,515 | $1,535 |
| Investment income, net of expenses | $130 | $119 | $260 | $243 |
| Net realized investment losses | $(23) | $(18) | $(15) | $(20) |
| Net income (loss) | $27 | $(19) | $95 | $17 |
| Diluted earnings per share | $0.17 | $(0.12) | $0.58 | $0.10 |
| Operating cash flow | — | — | $253 | $157 |
Improved property-casualty underwriting was the principal reason net income increased. Higher investment income also helped, partly offset by realized investment losses. The company cautions that first-half 2010 and 2009 results are not fully comparable: adoption of the 2009 other-than-temporary impairment accounting standard resulted in a $106 million after-tax reclassification in 2009, and the standard was not applied retrospectively.
Underwriting and business trends
- Consolidated property-casualty earned premiums declined 1% in Q2 and 2% in the first half. The combined ratio improved to 107.6% for Q2 and 105.2% for the first half, but remained above 100%, indicating underwriting losses. The first-half ratio included 8.8 percentage points of current-year catastrophe losses and was helped by 7.8 points of favorable prior-year reserve development.
- Commercial lines premiums fell 5% year over year in the first half; the segment combined ratio was 101.9%. Workers’ compensation remained a concern, with a 90.6% loss ratio before other combined-ratio components and weak premium trends.
- Personal lines premiums rose 3% in the first half, but the combined ratio was 113.1%. Homeowner catastrophe losses remained a significant profitability challenge, despite improvement from the prior-year period.
- Life insurance earned premiums grew 13% in the first half to $79 million; reported segment profit was $2 million.
- Prior-year property-casualty reserve releases were substantial: $113 million for the first half, chiefly reflecting reduced modeled exposures, particularly in workers’ compensation and umbrella. Reserve estimates remain uncertain.
Financial position, liquidity and capital
- At June 30, total assets were $14.607 billion, shareholders’ equity $4.737 billion, and book value per share $29.13, down from $29.25 at year-end 2009.
- Investments totaled $11.032 billion; cash and cash equivalents were $325 million, down from $557 million at year-end. First-half operating cash flow was $253 million; investing activities used $415 million and financing activities used $70 million.
- Total debt was $839 million: $790 million long-term debt and $49 million short-term borrowings. Debt-to-capital was 15.0%, unchanged from year-end; management said it did not anticipate a material increase in debt during 2010.
- The company paid $126 million in shareholder dividends and repurchased approximately 378,000 shares for $10 million in the first half. The indicated annual dividend rate was $1.58 per share.
- The fixed-maturity portfolio’s fair value was $8.339 billion, with an average rating of A2/A. It exceeded insurance reserves by about 36%. Investment portfolio fair value was $10.950 billion, including $32 million of Level 3 assets.
Outlook, risks and notable items
- Management’s 2010–2014 target is an average annual value creation ratio of 12%–15%. It emphasized disciplined underwriting, pricing improvements, expense efficiency, agency expansion and investment income growth, while noting weak market pricing and economic conditions.
- Management planned personal-lines rate increases beginning in Q4 2010 and continued development of predictive pricing models. It targeted entry into Connecticut and Oregon in the second half of 2010 and expected to contribute $25 million to the qualified pension plan in Q3.
- Management cited a low-interest-rate environment as a constraint on replacing maturing bonds at current yields. A 100-basis-point rate increase was estimated to reduce fixed-maturity fair value by approximately 5%.
- First-half catastrophe losses remained material. Key disclosed risks include severe weather, claims frequency and severity, reserve-estimate uncertainty, weak demand or payment conditions, investment declines or further impairments, competition, reinsurance availability and regulatory or litigation outcomes.
- Standard & Poor’s lowered insurer financial-strength ratings to A from A+ and the parent’s counterparty credit rating to BBB from BBB+ on July 19, 2010, citing earnings and underwriting deterioration; outlook was stable. A.M. Best affirmed its ratings with a stable outlook in February.
- The company reported ordinary-course legal claims and certain other lawsuits, including putative class actions. It considered accrued amounts reasonable and not material, but an adverse judgment or settlement materially above accruals could affect results or cash flows.
Important facts for investors to verify
- Whether underwriting improvement can persist without relying heavily on catastrophe experience or favorable prior-year reserve releases.
- Workers’ compensation and homeowner pricing, loss trends, and progress toward combined ratios below 100%.
- The sustainability and composition of investment income, portfolio concentration and impairment exposure, and sensitivity to interest rates and equity markets.
- Capital and liquidity after dividends, share repurchases, subsidiary dividends, and the planned pension contribution; also monitor the effect of the S&P downgrade.
- Developments in material litigation and the adequacy of property-casualty reserve estimates.