Cincinnati Financial Corporation — 2018 Form 10-K
Business context and reporting period. This annual report covers the fiscal year ended December 31, 2018; it is not a standalone fourth-quarter filing. Cincinnati Financial is an Ohio-based insurance holding company whose principal business is property and casualty insurance distributed through independent agencies in 42 states. It also operates life, excess and surplus lines, reinsurance, investment and leasing businesses. Dollar amounts below are U.S. dollars.
Financial performance and condition
| Metric | 2018 | 2017 |
|---|---|---|
| Total revenue | $5.407 billion | $5.732 billion |
| Net income | $287 million | $1.045 billion |
| Diluted EPS | $1.75 | $6.29 |
| Earned premiums | $5.170 billion | $4.954 billion |
| Net investment income | $619 million | $609 million |
| Net investment gains/(losses) | $(402) million | $148 million |
| Property-casualty underwriting profit | $186 million | $128 million |
| GAAP combined ratio | 96.4% | 97.5% |
| Net cash from operating activities | $1.181 billion | $1.052 billion |
| Shareholders’ equity | $7.833 billion | $8.243 billion |
| Book value per share | $48.10 | $50.29 |
- Premium growth was broad-based: consolidated property-casualty net written premiums grew 4%; personal lines earned premiums rose 8%, excess and surplus lines 12%, commercial lines 2%, and life premiums 8%.
- Profitability differed by segment: commercial lines earned $151 million pretax, excess and surplus lines $63 million, life insurance $8 million, and personal lines recorded a $20 million underwriting loss.
- Cash and cash equivalents were $784 million at year-end, compared with $657 million. Total investments were $16.732 billion, down from $17.051 billion. The parent company held $2.478 billion in cash and marketable securities.
- Debt was modest relative to capital: $788 million of long-term debt and $32 million drawn on the short-term credit line; debt-to-total-capital was 9.5%, versus 9.0% in 2017. The company reported total assets of $21.935 billion.
- The board declared $2.12 per share in ordinary dividends in 2018; the 2017 total of $2.50 included a special dividend. The regular dividend had increased for 58 consecutive years through 2018.
Material changes versus the prior period
- Net income fell 73% and revenue declined 6%, chiefly reflecting a $550 million pretax year-over-year swing in investment gains and losses. The 2018 investment loss primarily included $404 million of unrealized losses on equity securities still held.
- Accounting adoption materially changed earnings presentation: ASU 2016-01 moved changes in equity-security fair values into net income rather than other comprehensive income. At adoption, $2.503 billion of after-tax unrealized equity gains was reclassified from accumulated other comprehensive income to retained earnings; prior periods were not restated.
- 2017 earnings also benefited from a one-time $495 million tax benefit from remeasuring deferred taxes after U.S. tax reform. In 2018, the company recorded a $50 million tax benefit from IRS-approved tax accounting method changes, primarily involving tax-basis unpaid-loss valuation.
- Despite a higher loss ratio, underwriting improved: the combined ratio declined to 96.4% from 97.5%, and property-casualty underwriting profit increased by $58 million. Favorable development of prior-year reserves was $167 million in 2018, compared with $119 million in 2017.
- Comprehensive income was $24 million, down from $1.648 billion, reflecting investment-market losses and the accounting and market effects described above. Book value per share decreased 4%.
- In the unaudited fourth-quarter supplement, the company reported revenue of $710 million, a pretax loss of $581 million, a net loss of $452 million and diluted EPS of $(2.78). The filing’s annual discussion identifies investment valuation volatility and the new equity-security accounting treatment as important factors, but does not provide a clear quarterly attribution of the entire fourth-quarter loss.
Outlook, commentary, risks and unusual items
- Management’s five-year value-creation ratio target is an annual average of 10%–13%; the 2018 ratio was negative 0.1%. Its underwriting target is a five-year average GAAP combined ratio of 95%–100%; the 2014–2018 average was 95.1%.
- Management expected competitive pressure to persist. It planned continued underwriting selectivity, pricing refinement and growth initiatives, including approximately 100 appointments of agencies marketing most or all property-casualty products and approximately 80 personal-lines-only agency appointments in 2019.
- Management expected personal-lines premium growth to exceed its industry projection for 2019. For commercial lines, it expected pricing conditions to remain competitive but anticipated profitable growth; commercial auto and personal auto remained areas requiring pricing and profitability improvement.
- The company agreed to acquire MSP Underwriting Limited for £102 million, approximately $134 million at the cited exchange rate, subject to approvals and other closing conditions. Closing was expected in the first quarter of 2019. Risks include completion, integration, international regulation, currency and political/economic exposure, and Brexit-related uncertainty.
- Insurance risks include catastrophe severity and frequency, concentrated geographic exposures, reserve-estimation uncertainty, inflation and claims-cost trends, and reliance on reinsurance recoveries. Net property-casualty reserves were $5.408 billion; management’s reasonably likely range was $5.037 billion–$5.481 billion. The company reported $484 million of reinsurance recoverables.
- Investment risks include equity-market declines and interest-rate/credit-spread effects on fixed maturities. A 100-basis-point rate increase was estimated to reduce fixed-maturity fair value by approximately 5.3%. Management also cited competition, independent-agent relationships, cyber and operational disruption, regulation, and potential constraints on subsidiary dividends.
- Liquidity was supported by operating cash flow and a $300 million revolving credit facility amended in February 2019, with an accordion feature permitting an additional $300 million and an extended maturity to February 2024. The company stated it was in compliance with credit covenants.
- Auditors issued unqualified opinions on the consolidated financial statements and internal control over financial reporting. Management also concluded internal control was effective at year-end 2018. The filing reports no material litigation beyond ordinary-course matters.
Most important facts for investors to verify
- How much of the 2018 earnings decline reflects market-driven unrealized equity losses and accounting presentation, versus underlying insurance and investment-income trends.
- Whether favorable prior-year reserve development continues, especially in long-tail commercial casualty and workers’ compensation, and whether adverse development in personal homeowner and auto lines persists.
- Whether auto rate actions and underwriting changes improve segment profitability; personal lines remained loss-making, with a 101.9% combined ratio.
- Whether catastrophe exposure, reinsurance terms and recoverability remain consistent with modeled estimates and the company’s stated liquidity capacity.
- Whether the MSP acquisition closed on expected terms and delivers the anticipated growth and returns, including amid international and Brexit-related uncertainty.
- How dividend payments, share repurchases, equity-market performance and statutory restrictions affect parent-company liquidity and book value.