Cincinnati Financial Corporation — Q2 2011 Form 10-Q
Reporting period: Quarter and six months ended June 30, 2011. Unaudited consolidated results; dollar amounts are in millions unless noted.
Business context and financial performance
The company operates property-casualty and life insurance businesses and an investment portfolio. Results this quarter were sharply affected by severe weather catastrophes, partly offset by stronger realized investment gains.
- Q2 revenue: $975, up 11% from $878; earned premiums were $773, up 1%, and net investment income was $132, up 2%. Net realized investment gains were $67, versus losses of $23 a year earlier.
- Q2 earnings: Net loss of $49, or $0.30 per diluted share, compared with net income of $27, or $0.17 per diluted share. The pretax loss was $97; an income tax benefit of $48 partly offset it.
- First-half revenue and earnings: Revenue of $1,904, up 8%; earned premiums of $1,555, up 3%; net investment income of $263, up 1%; realized gains of $79 versus losses of $15. Net income was $13, or $0.08 per diluted share, down from $95, or $0.58 per diluted share.
- Underwriting and margins: Property-casualty underwriting loss was $265 for Q2 and $294 for the first half. The combined ratio was 136.6% for Q2 and 120.1% year to date, compared with 107.6% and 105.2%, respectively, in 2010. Excluding catastrophe losses and prior-year reserve development, the ratios were still above break-even: 109.8% for Q2 and 107.9% for the first half.
- Cash flow: First-half operating cash flow was $4, versus $253 in 2010. Investing activities provided $26, versus $415 used; financing activities used $102. Cash and cash equivalents ended at $313, down from $385 at year-end 2010.
- Balance sheet and debt: Total assets were $15.702 billion, shareholders’ equity $5.057 billion, and book value per share $31.01 at June 30. Total debt was $839 ($790 long-term and $49 short-term); debt-to-total-capital was 14.2%, versus 14.3% at year-end.
- Liquidity and investments: Investments totaled $11.757 billion, including $8.717 billion of fixed maturities and $2.971 billion of equities. The fair value of the investment portfolio was $11.688 billion; unrealized gains were $1.485 billion and unrealized losses $30.
Material changes versus comparable periods
- Q2 property-casualty catastrophe losses were $290, versus $104 in Q2 2010; first-half catastrophe losses were $332, versus $126. The company attributed most of the increased underwriting loss to weather events.
- The April 22–28 tornado outbreak and May 20–27 storms generated estimated gross losses of $194 and $192, respectively, before reinsurance. Total gross catastrophe losses for Q2 were estimated at $512.
- First-half property-casualty premiums grew 3% to $1.475 billion, while underwriting losses increased substantially. Favorable development on prior-year reserves provided $155 of net benefit for the first half, compared with $113 in 2010.
- Investment operations profit increased to $179 for Q2 from $87 and to $302 for the first half from $206, reflecting higher realized gains. First-half results included $30 of other-than-temporary impairment charges, mainly related to AllianceBernstein Holding L.P. equity.
- Book value per share rose modestly from $30.91 at year-end. Other comprehensive income was $134 for the first half, principally reflecting investment valuation changes.
Outlook, management commentary, risks and contingencies
- Management reiterated long-term objectives: an average annual value-creation ratio of 12%–15% for 2010–2014; a GAAP combined ratio below 100% over a five-year period; and property-casualty premium growth above the industry over five years. These are targets, not near-term earnings guidance.
- Management reported first-half property-casualty net written premium growth of 3%, but a 120.1% GAAP combined ratio. It cited pricing pressure, higher current-year loss costs and catastrophe experience, while continuing predictive-pricing, agency-growth and operating-efficiency initiatives.
- The company purchased reinstated catastrophe reinsurance coverage after events used treaty layers. Ceded reinstatement premiums reduced Q2 earned premiums by $38. Management expected total Q3 and Q4 treaty ceded premiums to be about 50% above the original $12 quarterly average, assuming no further reinstatement premiums.
- Management said it did not anticipate a material increase in debt during the remainder of 2011. After quarter-end, the parent borrowed an additional $55 under its revolving credit line to increase liquidity following the absence of an insurance-subsidiary dividend in Q2.
- Key risks include further severe weather or catastrophe losses; reserve-estimation uncertainty; competitive pricing; reinsurance availability and counterparty performance; low interest rates and reinvestment yields; market declines or additional investment impairments; and regulatory or litigation outcomes. Some legal matters were too early-stage for the company to estimate a potential loss range; management said accrued probable and estimable losses were not material.
- The company declared quarterly dividends of $0.40 per share in February and May. First-half cash dividends paid were $127. Management reported effective disclosure controls and no material change in internal control over financial reporting during the quarter.
Most important facts for investors to verify
- Whether catastrophe claims estimates, reinsurance recoveries and reinstatement costs develop as expected, particularly for the major 2011 storms.
- Whether underlying loss trends and pricing improve enough to reduce combined ratios that remained above 100% even excluding catastrophe losses and prior-year reserve development.
- Whether favorable prior-year reserve development persists and whether reserve estimates remain adequate.
- Whether investment income can withstand low reinvestment yields, and whether further realized losses or impairments occur in the investment portfolio.
- How parent-company liquidity, the post-quarter $55 borrowing, subsidiary dividend capacity and the stated dividend policy evolve.