Cincinnati Financial Corporation — 2012 Form 10-K
Business context and reporting period
The filing covers the fiscal year ended December 31, 2012; the filing’s fourth-quarter figures are unaudited. Cincinnati Financial is an Ohio insurance holding company whose principal business is property-casualty insurance sold through independent agencies in 39 states. Its operations also include life insurance, excess and surplus lines, investments, and commercial leasing and financing.
Financial and operating performance
- Revenue and earnings: Full-year revenue was $4.111 billion, up 8% from 2011. Net income was $421 million, or $2.57 per diluted share, versus $164 million, or $1.01 per share, in 2011. Pretax income was $566 million. The improvement principally reflected stronger property-casualty underwriting.
- Fourth quarter: Unaudited Q4 revenue was $1.070 billion and net income was $192 million, or $1.17 per diluted share; Q4 2011 was $955 million, $134 million, and $0.82, respectively.
- Premiums and underwriting: Earned premiums were $3.522 billion, up 10%; property-casualty net written premiums rose 12% to $3.482 billion. The consolidated property-casualty combined ratio improved to 96.1% from 109.3%, producing a $137 million underwriting gain versus a $278 million loss. Commercial lines earned premiums increased 8% and had a 92.5% combined ratio; personal lines increased 14% but remained unprofitable, with a 105.3% ratio; excess and surplus lines increased 33% and had a 101.0% ratio.
- Investment performance: Net investment income was $531 million, up 1%. Net realized investment gains were $42 million, down from $70 million. Total investment return before tax was 8.0%, compared with 7.2% in 2011. The portfolio’s fair value was $12.466 billion, including $9.093 billion of fixed maturities and $3.373 billion of equities; consolidated total investments, including other invested assets, were $12.534 billion.
- Cash flow: Operating cash flow was $638 million, compared with $247 million in 2011. Investing activities used $304 million and financing activities used $285 million. Cash and cash equivalents ended the year at $487 million.
- Balance sheet and capital: Total assets were $16.548 billion, shareholders’ equity $5.453 billion, and book value $33.48 per share. Long-term debt was $790 million and short-term borrowings were $104 million; debt to total capital was 14.1%, down from 15.1%. Parent-company cash and marketable securities were $1.151 billion. The company declared dividends of $1.62 per share for the year.
- Reserves and liquidity: Gross property-casualty loss and loss-expense reserves were $4.230 billion on the balance sheet; gross claims obligations in the reserve-payment analysis were $4.169 billion. Management’s net reserve estimate was $3.813 billion, within its stated reasonable range of $3.598 billion to $3.918 billion.
Material changes versus 2011
- Net income rose $257 million. Property-casualty underwriting results improved by $415 million, from a loss to a gain; catastrophe losses decreased, while higher premiums and improved results before catastrophe losses also contributed.
- Favorable development of prior-year property-casualty reserves was $396 million, versus $285 million in 2011. This materially benefited 2012 earnings and remains sensitive to future claims emergence and estimates.
- Invested assets at fair value increased, and shareholders’ equity rose 8%. Investment gains recognized in earnings declined, while unrealized investment gains increased other comprehensive income.
- The company retrospectively adopted ASU 2010-26 on insurance acquisition costs. Prior periods were restated; adoption reduced 2011 book value per share by $0.13 compared with the originally reported amount.
Outlook, management commentary, and risks
- Long-term targets include a GAAP property-casualty combined ratio consistently between 95% and 100% over any five-year period, and $5 billion of annual direct written premiums for property-casualty and life insurance by the end of 2015. Direct written premiums were $3.909 billion in 2012.
- Management’s 2013 assumptions include continued firming in insurance pricing and ongoing economic growth. It cautioned that the 2013 value creation ratio may fall below its 10%–13% annual-average target for 2013–2017, in part because recent investment-market gains may not recur.
- Management expected low interest rates to continue pressuring investment income. It anticipated continued premium growth, but identified personal-lines profitability—particularly homeowners—as an area needing improvement. Planned actions included further rate adjustments, more precise risk pricing, deductibles and underwriting changes, and geographic diversification.
- Key risks include catastrophe and weather losses, geographic concentration, competitive pricing, loss-reserve uncertainty and inflation, investment-market and interest-rate movements, and the availability and collectability of reinsurance. Reinsurance does not release the company from its obligations to policyholders; reinsurance recoverables were $615 million at year-end.
- Other exposures include dependence on independent agencies, regulatory limits on subsidiary dividends, technology and cybersecurity disruption, and the possibility that actual claims or investment outcomes differ from estimates. The filing reports no material litigation beyond ordinary-course matters; it notes that a substantially adverse outcome in certain other proceedings could affect results or cash flows.
- Deloitte & Touche issued an unqualified opinion on the financial statements and internal control over financial reporting; management reported effective internal control as of year-end.
Important facts for investors to verify
- Whether the 2012 underwriting improvement is sustainable without unusually favorable prior-year reserve development or lower catastrophe losses.
- Homeowners and other personal-lines loss trends, pricing adequacy, and the progress of planned underwriting and geographic-diversification measures.
- Reserve adequacy and the continued emergence of favorable development, particularly in long-tail commercial casualty and workers’ compensation claims.
- Investment portfolio sensitivity to interest rates, equity markets, credit conditions, and the reduction in investment income from reinvesting maturing bonds.
- Reinsurance protection, counterparty credit quality, and the effect of a severe catastrophe on claims, liquidity, and capital.
- The assumptions underlying management’s 2013 outlook and long-term premium-growth and combined-ratio targets.