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Cincinnati Financial Corporation
The Cincinnati Insurance Companies
The Cincinnati Insurance Companies
|
Cincinnati Financial Corporation The Cincinnati Insurance Companies |
Cincinnati Financial Corporation 2008 Annual Report on Form 10-K March 11, 2009
In addition, you will find information about your company's strategies and initiatives in the Letter from the Chairman and the Chief
Executive Officer and our quarterly letters to shareholders, as they become available. Together with the detailed analysis of the 2008
Annual Report on Form 10-K, these documents comprise a package of information similar to what appeared in our previous annual reports.
 Part I
Item 1. Business
Cincinnati Financial Corporation – Introduction
We are an Ohio corporation formed in 1968. Our lead subsidiary, The Cincinnati Insurance
Company, was founded in 1950. Our main business is marketing property casualty insurance.
Our headquarters is in Fairfield, Ohio. At year-end 2008, we had 4,179 associates, with
2,984 headquarters associates providing support to 1,195 field associates.
At year-end 2008, Cincinnati Financial Corporation owned 100 percent of four subsidiaries:
The Cincinnati Insurance Company, CSU Producer Resources Inc., CFC Investment Company and
CinFin Capital Management Company. In addition, the parent company has an investment
portfolio, owns the headquarters building and is responsible for corporate borrowings and
shareholder dividends. The Cincinnati Insurance Company owns 100 percent of our four other
insurance subsidiaries.
In addition to The Cincinnati Insurance Company, our standard market property casualty
insurance group includes two of those subsidiaries – The Cincinnati Casualty Company and The
Cincinnati Indemnity Company. This group markets a broad range of business, homeowner and
auto policies in 35 states. Other subsidiaries of The Cincinnati Insurance Company include
The Cincinnati Life Insurance Company, which markets life insurance, disability income
policies and annuities, and The Cincinnati Specialty Underwriters Insurance Company, which
began offering surplus lines insurance products in January 2008.
The three other subsidiaries of Cincinnati Financial are CSU Producer Resources, which
offers insurance brokerage services to our independent agencies so their clients can access
our surplus lines insurance products; CFC Investment Company, which offers commercial
leasing and financing services to our agents, their clients and other customers; and CinFin
Capital Management Company, which provided asset management services to internal and
third-party clients. CinFin Capital Management will cease operations effective February 28,
2009.
Our filings with the Securities and Exchange Commission are available, free of charge, on
our Web site, www.cinfin.com, as soon as possible after they have been filed with the SEC.
These filings include our annual reports on Form 10-K, our quarterly reports on Form 10-Q,
current reports on Form 8-K, and amendments to those reports filed or furnished pursuant to
Section 13(a) or 15(d) of the Securities Exchange Act of 1934. In the following pages we
reference various Web sites. These Web sites, including our own, are not incorporated by
reference in this Annual Report on Form 10-K.
Periodically, we refer to estimated industry data so that we can give information about our
performance versus the overall insurance industry. Unless otherwise noted, the industry data
is prepared by A.M. Best Co., a leading insurance industry statistical, analytical and
insurer financial strength and credit rating organization. Information from A.M. Best is
presented on a statutory basis. When we provide our results on a comparable statutory basis,
we label it as such; all other company data is presented in accordance with accounting
principles generally accepted in the United States of America (GAAP).
Our Business And Our Strategy
Introduction
The Cincinnati Insurance Company was founded almost 60 years ago by independent insurance
agents. They established the mission that continues to guide all of the companies in the
Cincinnati Financial family – to grow profitably and enhance the ability of local
independent insurance agents to deliver quality financial protection to the people and
businesses they serve by:
A select group of agencies in 35 states actively markets our property casualty insurance
within their communities. Standard market commercial lines policies are available in all of
those states, while personal lines policies are available in 27 and surplus commercial lines
policies are available in 33 of the same 35 states. Within this select group, we also seek
to become the life insurance carrier of choice and to help agents and their clients – our
policyholders – by offering leasing and financing services.
Three hallmarks distinguish this company, positioning us to build value and long-term
success:
Cincinnati Financial Corporation — 2008 Annual Report on 10-K — Page 1
Independent Insurance Agency Marketplace
The U.S. property casualty insurance industry is a highly competitive marketplace with over
2,000 stock and mutual companies operating independently or in groups. No single company or
group dominates across all product lines and states. Standard market insurance companies
(carriers) can market a broad array of products nationally or:
Standard market property casualty insurers generally offer insurance products through one or
more distribution channels:
For the most part, we compete with standard market insurance companies that market through
independent insurance agents.
We are committed to this channel. The independent agencies that we choose to market our
standard lines insurance products share our philosophies. They do business person to person;
offer broad, value-added services; maintain sound balance sheets; and manage their agencies
professionally. We develop our relationships with agencies that are active in their local
communities, providing important knowledge of local market trends, opportunities and
challenges.
In addition to the standard market for property casualty insurance, the surplus lines market
exists due to a regulatory distinction. Generally, surplus lines insurance carriers provide
insurance that is unavailable in the standard market due to market conditions or due to
characteristics of the insured person or organization that are caused by nature, the
insured’s claim history or the characteristics of their business. Insurers operating in the
surplus lines market are generally small specialty insurers or specialized divisions of
larger insurance organizations. Each markets through surplus lines insurance brokers.
We opened our own surplus line insurance brokerage firm so that we could offer surplus lines
products exclusively to the independent agents who market our other property casualty
insurance products. We also market life insurance products through the agencies that market
our property casualty products.
At year-end 2008, our 1,133 agency relationships had 1,387 reporting locations marketing our
standard market insurance products. An increasing number of agencies have multiple,
separately identifiable locations, reflecting their growth and consolidation of ownership
within the independent agency marketplace. The number of reporting agency locations
indicates our agents’ regional scope and the extent of our presence within our 35 active
states. At year-end 2007, our 1,092 agency relationships had 1,327 reporting locations. At
year-end 2006, our 1,066 agency relationships had 1,289 reporting locations.
On average, we have a 12.4 percent share of the property casualty insurance purchased
through our reporting agency locations. Our share is 18.1 percent in reporting agency
locations that have represented us for more than 10 years; 7.4 percent in agencies that have
represented us for five to 10 years; 4.4 percent in agencies that have represented us for
one to five years; and 0.6 percent in agencies that have represented us for less than one
year.
Our largest single agency relationship accounted for approximately 1.3 percent of our total
property casualty agency earned premiums in 2008. No aggregate of locations under a single
ownership structure accounted for more than 2.3 percent of our total agency earned premiums
in 2008.
Over the next decade, industry analysts predict successful agencies will have opportunities
to increase their size on average almost three-fold. Agencies are expected to continue to
pursue consolidation opportunities, buying or merging with other agencies to create stronger
organizations and expand service. In addition to the growing networks of agency locations
owned by banks and brokers, other agencies are addressing the consolidation by forming
voluntary associations that may share back office and other functions to enhance economies,
while maintaining their individual ownership structures.
Cincinnati Financial Corporation — 2008 Annual Report on 10-K — Page 2 Financial Strength
We believe that our financial strength and strong surplus position, reflected in our insurer
financial strength ratings, are clear, competitive advantages in the segment of the
insurance marketplace that we serve. This strength supports the consistent, predictable
performance that our policyholders, agents, associates and shareholders have always expected
and received, and helps us withstand significant challenges.
While the prospect exists for volatility due to our exposures to potential catastrophes or
significant capital market losses, the ratings agencies consistently have asserted that we
have built appropriate financial strength and flexibility to manage that volatility. We
remain committed to strategies that emphasize being a consistent, stable market for our
agents’ business over short-term benefits that might accrue by quick reaction to changes in
market conditions.
At year-end 2008 and 2007, risk-based capital (RBC) for our standard and surplus lines
property casualty operations and life operations was exceptionally strong, far exceeding
regulatory requirements.
The consolidated property casualty insurance group’s ratio of investments in common stock to
statutory surplus at 53.4 percent at year-end 2008 compared with 84.5 percent at year-end
2007. The life insurance company’s ratio was 39.2 percent compared with 70.6 percent a year
ago.
Our parent company’s senior debt is rated by four independent ratings firms. In addition,
the ratings firms award our property casualty and life operations insurer financial strength
ratings based on their quantitative and qualitative analyses. These ratings assess an
insurer’s ability to meet financial obligations to policyholders and do not necessarily
address all of the matters that may be important to shareholders. Ratings may be subject to
revision or withdrawal at any time by the rating agency, and each rating should be evaluated
independently of any other rating.
All of our insurance subsidiaries continue to be highly rated. Each of the four
organizations that rate our companies placed the ratings of our standard market property
casualty and life companies on watch or review in June and July 2008 and subsequently
lowered them. These actions followed our June announcement of significant catastrophe losses
and declines in value of our investment assets.
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As of February 26, 2009, our credit and financial strength ratings were:
Our debt ratings are discussed in Item 7, Additional Sources of Liquidity,
Page 71.
Operating Structure
We offer our broad array of insurance products through the independent agency channel. We
recognize that locally based independent agencies have relationships in their communities
that can lead to policyholder satisfaction, loyalty and profitable business. We seek to be a
consistent and predictable property casualty carrier that agencies can rely on to serve
their clients. For our standard market business, field and headquarters underwriters make
risk-specific decisions about both new business and renewals.
In our 10 highest volume states for consolidated property casualty premiums, 910 reporting
agency locations wrote 68.7 percent of our 2008 consolidated property casualty earned
premium volume compared with 69.1 percent in 2007.
Cincinnati Financial Corporation — 2008 Annual Report on 10-K — Page 4 Property Casualty Insurance Earned Premiums by State
Field Focus
We rely on our field associates to provide service and be accountable to our agencies for
decisions we make at the local level. These associates live in the communities they serve
and work from offices in their homes, providing 24/7 availability to our agents.
Headquarters associates also provide agencies with underwriting, accounting and technology
assistance and training. Company executives, headquarters underwriters and special teams
regularly travel to visit agencies, strengthening the personal relationships we have with
these organizations. Agents have opportunities for direct, personal
conversations with our senior management team, and headquarters associates have
opportunities to refresh their knowledge of marketplace conditions and field activities.
The field team is coordinated by field marketing representatives responsible for new
commercial lines business underwriting. They are joined by field representatives
specializing in claims, loss control, personal lines, machinery and equipment, bond, premium
audit, life insurance and leasing. The field team provides many services for agencies and
policyholders; for example, our field machinery and equipment and loss control
representatives perform inspections and recommend specific actions to improve the safety of
the policyholder’s operations and the quality of the agent’s account.
Agents work with us to carefully select risks and assure pricing adequacy. They appreciate
the time our associates invest in creating solutions for their clients while protecting
profitability, whether that means working on an individual case or customizing policy terms
and conditions that preserve flexibility, choice and other sales advantages. We seek to
develop long-term relationships by understanding the unique needs of their customers, our
policyholders.
We also are responsive to agent needs for well designed property casualty products. Our
commercial lines products are structured to allow flexible combinations of property and
liability coverages in a single package with a single expiration date. This approach brings
policyholders convenience, discounts and a reduced risk of coverage gaps or disputes. At the
same time, it increases account retention and saves time and expense for the agency and our
company.
We seek to employ technology solutions and business process improvements that:
Agencies access our systems and other electronic services via their agency management
systems or CinciLink®, our secure agency-only Web site. CinciLink provides an array of
Web-based services and content
Cincinnati Financial Corporation — 2008 Annual Report on 10-K — Page 5 that make it easier to do business with us, such as
commercial and personal lines rating and processing systems, policy loss information, sales
and marketing materials, educational courses on our products and services, accounting
services, and electronic libraries for property and casualty coverage forms and state rating
manuals.
Superior Claims Service
Our claims philosophy reflects our belief that we will prosper as a company by responding to
claims person to person, paying covered claims promptly, preventing false claims from
unfairly adding to overall premiums and building financial strength to meet future
obligations.
Our 748 locally based field claims representatives work from their homes, assigned to
specific agencies. They respond personally to policyholders and claimants, typically within
24 hours of receiving an agency’s claim report. We believe we have a competitive advantage
because of the person-to-person approach and the resulting high level of service that our
field claims representatives provide. We also help our agencies provide prompt service to
policyholders by giving agencies authority to immediately pay most first-party claims under
standard market policies up to $2,500. We believe this same local approach to handling
claims is a competitive advantage for our agents providing surplus lines coverage in their
communities. Our field claims representatives handle these claims under the guidance of
headquarters-based surplus lines claims managers.
Our property casualty claims operation uses CMS, a claims management system, to streamline
processes and achieve operational efficiencies. CMS allows field and headquarters claims
associates to collaborate on reported claims through a virtual claim file. Our field claims
representatives use tablet computers to view and enter information into CMS from any
location, including an insured’s home or agent’s office, and to print claim checks using
portable printers. Agencies now can access selected CMS information such as activity notes
on workers’ compensation claims. Later in 2009, activity notes for other business lines will
be available to the agencies.
Catastrophe response teams are comprised of volunteers from our experienced field claims
staff. We take pride in giving our field personnel the tools and authority they need to do
their jobs. In times of widespread loss, our field claims representatives confidently and
quickly resolve claims, often writing checks on the same day they inspect the loss. CMS
introduced new efficiencies that are especially evident during catastrophes. Electronic
claim files allow for fast initial contact of policyholders and easy sharing of information
and data between rotating storm teams, headquarters and local field claims representatives.
When hurricanes or other weather events are predicted, we can choose to have catastrophe
response team members travel to strategic locations near the expected impact area. This puts
them in position to quickly get to the affected area, set up temporary offices and start
calling on policyholders.
Our claims associates work to control costs where appropriate. They use vendor resources
that provide negotiated pricing to our insureds and claimants. Our field claims
representatives also are educated continuously on new techniques and
repair trends. They can leverage their local knowledge and experience with area body shops,
which helps them negotiate the right price with any facility the policyholder chooses.
We staff a Special Investigations Unit with former law enforcement and claims professionals
whose qualifications make them uniquely suited to gathering facts to uncover potential
fraud. While we believe it’s our job to pay what is due under each policy, we also want to
prevent false claims from unfairly increasing overall premiums. Our SIU also operates a
computer forensic lab, using sophisticated software to recover data and mitigate the cost of
computer-related claims for business interruption and loss of records.
Loss and Loss Expense Reserves
When claims are made by or against policyholders, any amounts that our property casualty
operations pay or expect to pay for covered claims are losses. The costs we incur in
investigating, resolving and processing these claims are loss expenses. Our consolidated
financial statements include property casualty loss and loss expense reserves that estimate
the costs of not-yet-paid claims incurred through December 31 of each year. The reserves
include estimates for claims that have been reported to us plus our estimates for claims
that have been incurred but not yet reported (IBNR), along with our estimate for loss
expenses associated with processing and settling those claims. We develop the various
estimates based on individual claim evaluations and statistical projections. We reduce the
loss reserves by an estimate for the amount of salvage and subrogation we expect to recover.
Our annual review has led us to add to earnings in each of the past 20 years savings from
favorable development of loss reserves on prior accident years.
We encourage you to review several sections of the Management’s Discussion and Analysis
where we discuss our loss reserves in greater depth. In Item 7, Critical Accounting
Estimates, Property Casualty Insurance Loss and Loss Expense Reserves,
Page 41, we discuss
our process for analyzing potential losses and establishing reserves. In Item 7, Property
Casualty Loss and Loss Expense Obligations and Reserves,
Page 74, and Life Insurance
Policyholder Obligations and Reserves,
Page 80, we review reserve levels, including 10 year
development of our property casualty loss reserves.
Cincinnati Financial Corporation — 2008 Annual Report on 10-K — Page 6 Insurance Products
We actively market property casualty insurance in 35 states through a select group of
independent insurance agencies. Our standard market commercial lines products are marketed
in all of those states while our standard market personal lines are marketed in 27. We
discuss our commercial lines and personal lines insurance operations and products in
Commercial Lines Property Casualty Insurance Segment,
Page 11, and Personal Lines Property
Casualty Insurance Segment,
Page 14. At year-end 2008, CSU Producer Resources marketed our
surplus lines products to agencies in 33 states that represent Cincinnati Insurance.
The Cincinnati Specialty Underwriters Insurance Company was formed in 2007. The company was
capitalized with $200 million from its parent company, The Cincinnati Insurance Company. It
began offering surplus lines insurance products in January 2008. We structured this
operation to exclusively serve the needs of the independent agencies that currently market
our standard market insurance policies. When all or a portion of a current or potential
client’s insurance program requires surplus lines coverages, those agencies now can write
the whole account with Cincinnati, gaining benefits not often found in the broader surplus
lines market. Agencies have access to The Cincinnati Specialty Underwriters Insurance
Company’s product line through CSU Producer Resources, the wholly owned insurance brokerage
subsidiary of parent-company Cincinnati Financial Corporation.
Cincinnati Specialty Underwriters and CSU Producer Resources employ a Web-based policy
administration system to quote, bind, issue and deliver policies electronically to agents.
This system also provides integration to existing document management and data management
systems, allowing for straight-through processing of policies and billing.
We also support the independent agencies affiliated with our property casualty operations in
their programs to sell life insurance. The products offered by our life insurance subsidiary
round out and protect accounts and improve account persistency. At the same time, our life
operation increases diversification of revenue and profitability sources for both the agency
and our company.
Our property casualty agencies make up the main distribution system for our life insurance
products. To help build scale, we also develop life business from other independent life
insurance agencies in geographic markets not served through our property casualty agencies.
We are careful to solicit business from these other agencies in a manner that does not
conflict with or compete with the marketing and sales efforts of our property casualty
agencies. We emphasize up-to-date products, responsive underwriting, high quality service
and competitive pricing.
Other Services to Agencies
We complement the insurance operations by providing products and services that help attract
and retain high-quality independent insurance agencies. When we appoint agencies, we look
for organizations with knowledgeable, professional staffs. In turn, we make an exceptionally
strong commitment to assist them in keeping their knowledge up to date and educating new
people they bring on board as they grow. Numerous activities fulfill this commitment at our
headquarters, in regional and agency locations, and online.
Except travel-related expenses for courses held at our headquarters, most programs are
offered at no cost to our agencies. While that approach may be extraordinary in our industry
today, the result is quality service for our policyholders and increased success for our
independent agencies.
In addition to broad education and training support, we make non-insurance financial
services available through CFC Investment Company. CFC Investment Company offers equipment
and vehicle leases and loans for independent insurance agencies, their commercial clients
and other businesses. It also provides commercial real estate loans to help agencies operate
and expand their businesses. We believe that providing these services enhances agency
relationships with their clients, increasing loyalty while diversifying the agency’s
revenues.
Strategic Initiatives
Management has worked with the board of directors to identify the strategies that can
position us for long-term success. We broadly group these strategies into three areas of
focus – preserving capital, improving insurance profitability and driving premium growth –
correlating with the primary ways we measure our progress toward our long-term financial
objectives. Our strategies are intended to position us to compete successfully in the
markets we have targeted while minimizing risk. We believe successful implementation of the
initiatives that support our strategies will help us better serve our agent customers,
reduce volatility in our financial results and weather difficult economic, market or pricing
cycles. We describe our expectations for the results of these initiatives in Item 7,
Executive Summary of the Management’s Discussion and Analysis,
Page 37.
Cincinnati Financial Corporation — 2008 Annual Report on 10-K — Page 7 Preserve Capital
Our first strategy is to preserve capital. Implementation of the initiatives below that
support this strategy is intended to preserve our capital and liquidity so that we can
successfully grow our insurance business. A strong capital position provides the capacity to
support premium growth and provides the liquidity to sustain our investment in the people
and infrastructure needed to implement our other strategic initiatives.
The four primary capital preservation initiatives are:
We measure the overall success of our strategy to preserve capital primarily by growing
investment income and by achieving over any five-year period a total return on our equity
investment portfolio that exceeds the Standard & Poor’s 500’s return. We also monitor other
measures. One of the most significant is our ratio of property casualty net written premiums
to statutory surplus, which was 0.9-to-1 at year-end 2008 compared with 0.7-to-1 at year-end
2007 and 2006. This ratio is a common measure of operating leverage used in the property
casualty industry; the lower the ratio the more capacity a company has for premium growth.
The estimated property casualty industry net written premium to statutory surplus ratio also
was 0.9-to-1 at year-end 2008, 0.8-to-1 at year-end 2007 and 0.9-to-1 at year-end 2006.
Our second means of verifying our capital preservation strategy is our financial strength
ratings as discussed in Our Business and Our Strategy,
Page 1. All of our insurance
subsidiaries continue to be highly rated. A third means is measurement of our risk-based
capital ratios, which currently indicate that our insurance subsidiaries are operating with
a level of capital far exceeding regulatory requirements.
Improve Insurance Profitability
Our second strategy is to improve insurance profitability. Implementation of the operational
initiatives below is intended to support improved cash flow and profitable growth for the
agencies that represent us and for our company. These initiatives primarily seek to
strengthen our relationships with agents, allowing them to serve clients faster and manage
expenses better. Others may streamline our internal processes so we can devote more time to
agent service.
Cincinnati Financial Corporation — 2008 Annual Report on 10-K — Page 8 The three primary initiatives to improve insurance profitability are:
We measure the overall success of our strategy to improve insurance profitability primarily
through our GAAP combined ratio, which we believe can be consistently below 100 percent over
any five-year period.
In addition, we expect these initiatives to contribute to our rank as the No. 1 or No. 2
carrier based on premium volume in agencies that have represented us for at least five
years. In 2008, we again earned that rank in more than 75 percent of the agencies that have
represented Cincinnati Insurance for more than five years. We are working to improve that
rank again in 2009 and in each of the years that follow.
Cincinnati Financial Corporation — 2008 Annual Report on 10-K — Page 9 Drive Premium Growth
Our third strategy is to drive premium growth. Implementation of the operational initiatives
below is intended to expand our geographic footprint and diversify our premium sources to
obtain profitable growth without significant infrastructure expense. Diversified growth also
may reduce our catastrophe exposure risk and temper negative changes that may occur in the
economic, judicial or regulatory environments in the territories we serve.
The four primary initiatives to drive premium growth are:
We measure the overall success of this strategy to drive premium growth primarily through
changes in net written premiums, which we believe can grow faster than the industry average
over any five-year period.
Cincinnati Financial Corporation — 2008 Annual Report on 10-K — Page 10 Notably, many of our growth initiatives have been under way for a
year or more and helped us achieve 13 percent new business growth for 2008 although total
written premiums were down on weak market pricing, economic pressures and a reinsurance
restatement premium.
Our Segments
Consolidated financial results primarily reflect the results of our four reporting segments.
These segments are defined based on financial information we use to evaluate performance and
to determine the allocation of assets.
We also evaluate results for our consolidated property casualty operations, which is the
total of our commercial lines, personal lines and surplus lines results.
Revenues, income before income taxes, and identifiable assets for each segment are shown in
a table in Item 8, Note 18 of the Consolidated Financial Statements,
Page 119. Some of that
information also is discussed in this section of this report, where we explain the business
operations of each segment. The financial performance of each segment is discussed in the
Item 7, Management’s Discussion and Analysis of Financial Condition and Results of
Operations, which begins on
Page 37.
Commercial Lines Property Casualty Insurance Segment
The commercial lines property casualty insurance segment contributed net earned premiums of
$2.316 billion to total revenues, or 60.6 percent of that total, and $70 million to income
before income taxes in 2008. Commercial lines net earned premiums declined 3.9 percent in
2008 after growing 0.4 percent in 2007 and 6.6 percent in 2006.
Approximately 95 percent of our commercial lines premiums are written to provide accounts
with coverages from more than one of our business lines. As a result, we believe that our
commercial lines business is best measured and evaluated on a segment basis. However, we
provide line of business data to summarize growth and profitability trends separately for
our business lines. The seven commercial business lines are:
Cincinnati Financial Corporation — 2008 Annual Report on 10-K — Page 11
Our emphasis is on products that agents can market to small- to mid-size businesses in their
communities. Of our 1,387 reporting agency locations, eight market only our surety and
executive risk products and four market only our personal lines products. The remaining
1,375 locations, located in all states in which we actively market, offer some or all of our
standard market commercial insurance products.
In 2008, our 10 highest volume commercial lines states generated 65.9 percent of our earned
premiums compared with 66.7 percent in the prior year. Earned premiums in the 10 highest
volume states decreased 4.4 percent in 2008 and decreased 3.1 percent in the remaining 25
states. The number of reporting agency locations in our 10 highest volume states increased
to 905 in 2008 from 878 in 2007.
Commercial Lines Earned Premiums by State
For new commercial lines business, case-by-case underwriting and pricing is coordinated by
our locally based field marketing representatives. Our agents and our field marketing,
claims, loss control, premium audit, bond and machinery and equipment representatives get to
know the people and businesses in their communities and can make informed decisions about
each risk. These field marketing representatives also are responsible for selecting new
independent agencies, coordinating field teams of specialized company representatives and
promoting all of the company’s products within the agencies they serve.
Commercial lines policy renewals are managed by headquarters underwriters who are assigned
to specific agencies and consult with local field staff as needed. As part of our team
approach, the headquarters underwriter also helps oversee agency growth and profitability.
They are responsible for formal issuance of all new business and renewal policies as well as
policy endorsements. Further, the headquarters underwriters provide day-to-day customer
service to agencies and marketing representatives by providing product training, answering
underwriting questions, helping to determine underwriting eligibility and assisting with the
mechanics of premium determination.
Cincinnati Financial Corporation — 2008 Annual Report on 10-K — Page 12 Our commercial lines packages are typically offered on a three-year policy term for most
insurance coverages, a key competitive advantage. Although we offer three-year policy terms,
premiums for some coverages within those policies are adjustable at anniversary for the next
annual period, and policies may be cancelled at any time at the discretion of the
policyholder. Contract terms often provide that rates for property, general liability,
inland marine and crime coverages, as well as policy terms and conditions, are fixed for the
term of the policy. The general liability exposure basis may be audited annually. Commercial
auto, workers’ compensation, professional liability and most umbrella liability coverages
within multi-year packages are rated at each of the policy’s annual anniversaries for the
next one-year period. The annual pricing could incorporate rate changes approved by state
insurance regulatory authorities between the date the policy was written and its annual
anniversary date, as well as changes in risk exposures and premium credits or debits
relating to loss experience and other underwriting judgment factors. We estimate that
approximately 75 percent of 2008 commercial premiums were subject to annual rating or were
written on a one-year policy term.
In our experience, multi-year packages are somewhat less price sensitive for the
quality-conscious insurance buyers who we believe are typical clients of our independent
agents. Customized insurance programs on a three-year term complement the long-term
relationships these policyholders typically have with their agents and with the company. By
reducing annual administrative efforts, multi-year policies lower expenses for our company
and for our agents. The commitment we make to policyholders encourages long-term
relationships and reduces their need to annually re-evaluate their insurance carrier or
agency. We believe that the advantages of three-year policies in terms of improved
policyholder convenience, increased account retention and reduced administrative costs
outweigh the potential disadvantage of these policies, even in periods of rising rates.
Staying abreast of evolving market conditions is a critical function, accomplished in both
an informal and a formal manner. Informally, our field marketing representatives and
underwriters are in constant receipt of market intelligence from the
agencies with which they work. Formally, our commercial lines product management group and
field marketing associates conduct periodic surveys to obtain competitive intelligence. This
market information helps identify the top competitors by line of business or specialty
program and also identifies our market strengths and weaknesses. The analysis encompasses
pricing, breadth of coverage and underwriting/eligibility issues.
In addition to reviewing our competitive position, our product management group and our
underwriting audit group review compliance with our underwriting standards as well as the
pricing adequacy of our commercial insurance programs and coverages. Further, our research
and development department analyzes opportunities and develops new products, new coverage
options and improvements to existing insurance products.
At year-end 2008, we supported our commercial lines operations with a variety of technology
tools. WinCPP® is our commercial lines premium quoting system. WinCPP is available in all of
our agency locations in which we actively market commercial lines insurance and provides
quoting capabilities for nearly 100 percent of our new and renewal commercial lines
business. WinCPP works with our real-time agency interface, CinciBridge™, which allows
automated movement of key underwriting data from an agency’s management system to WinCPP,
reducing agents’ data entry and allowing seamless quoting and rating capabilities.
Many small business accounts written as Businessowners Policies (BOP) and Dentist’s Package
Policies (DBOP) are eligible to be issued at our agency locations through our Web-based
e-CLAS® policy processing system. (A businessowners policy combines property, liability and
business interruption coverages for small businesses.) e-CLAS provides full policy lifecycle
transactions, including quoting, issuance, policy changes, renewal processing and policy
printing at the agency location. These features make it easy and efficient for our agencies
to issue and service these policies. At year-end 2008, e-CLAS for BOP and DBOP was in use in
30 states representing 98 percent of our premiums for these products, which are included in
the specialty packages commercial line of business. e-CLAS also uses CinciBridge to provide
real-time data transfer with agency management systems.
We have been streamlining internal processes and achieving operational efficiencies in our
headquarters commercial lines operations through deployment of iView™, a policy imaging and
workflow system. This system provides online access to electronic copies of policy files,
enabling our underwriters to respond to agent requests and inquiries more quickly and
efficiently. iView also automates internal workflows through electronic routing of
underwriting and processing work tasks. At year-end 2008, more than 92 percent of in-force
non-workers’ compensation commercial lines policy files were administered and stored
electronically in iView. Workers’ compensation policies are to be added to iView in 2009.
Commercial Lines Insurance Marketplace
Our competition for the types and sizes of commercial accounts we typically write in the
standard market predominantly consists of those companies that also distribute through
independent agencies. The independent agencies that market our commercial lines products
typically represent six to 12 standard
Cincinnati Financial Corporation — 2008 Annual Report on 10-K — Page 13 market insurance carriers, including both national
and regional carriers, some of which may be mutual companies.
Overall, the softening commercial lines marketplace of the past several years continued to
intensify in 2008. Over this period, anecdotal reports of very aggressive pricing have grown
in frequency. Over the course of 2008, we saw many situations where underwriting discipline
appeared to slip as carriers sought to capture market share. Many carriers continued to
manage the soft market conditions by working aggressively to protect their renewal
portfolios. Renewal decreases in the mid-single digits were still prevalent in the fourth
quarter of 2008; however, we have worked to retain our best renewal business while
continuing to write new business and maintain underwriting discipline. In late 2008 and
early 2009, we have begun to see preliminary indications leading us to believe that market
pricing may be starting to level.
Personal Lines Property Casualty Insurance Segment
The personal lines property casualty insurance segment contributed net earned premiums of
$689 million to total revenues, or 18.0 percent of the total, and reported a loss before
income taxes of $82 million in 2008. Personal lines net earned premiums declined 3.4 percent
in 2008, 6.3 percent in 2007 and 5.3 percent in 2006.
We prefer to write personal lines coverage in accounts that include both auto and homeowner
coverages as well as coverages that are part of our other personal business line. As a
result, we believe that our personal lines business is best measured and evaluated on a
segment basis. However, we provide line of business data to summarize growth and
profitability trends separately for three business lines:
At year-end, we marketed personal lines insurance products through 954 of our 1,387
reporting agency locations in 27 of the 35 states in which we offer standard market
commercial lines insurance. The remaining 433 locations primarily are in states where we do
not yet actively market these products; some are in locations where we have determined, in
conjunction with agency management, that our personal lines products were not appropriate
for their agencies at this time. As discussed in Strategic Initiatives,
Page 7, introducing
personal lines to these agencies is one of the ways we intend to grow profitably in the next
several years. The number of reporting agency locations in our 10 highest volume states
increased to 627 in 2008 from 604 in 2007.
In 2008, our 10 highest volume personal lines states generated 85.1 percent of our earned
premiums compared with 84.9 percent in the prior year. Earned premiums in the 10 highest
volume states declined 3.0 percent in 2008 and declined 6.4 percent in the remaining states.
Cincinnati Financial Corporation — 2008 Annual Report on 10-K — Page 14 Personal Lines Earned Premiums by State
New and renewal personal lines business reflects our risk-specific underwriting philosophy.
Each agency selects personal lines business primarily from within the geographic territory
that it serves, based on the agent’s knowledge of the risks in those communities or
familiarity with the policyholder. Personal lines activities are supported by headquarters
associates assigned to individual agencies. We now have five full-time personal lines
marketing representatives, two headquarters based and three living in the field, and plan to
add two more in 2009. These marketing representatives have underwriting authority and visit
agencies on a regular basis. They reinforce the advantages of our personal lines products
and offer training in the use of our processing system.
Competitive advantages of our personal lines coverages include our claims service, credit
structure and customizable endorsements for both the personal auto and homeowner policies.
Most of our personal lines products are processed through Diamond, our real-time personal
lines policy processing system, which supports and allows once-and-done processing. Diamond
incorporates features frequently requested by our agencies such as direct bill and monthly
payment plans, local and headquarters policy printing options, data transfer to and from
popular agency management systems and real-time integration with third-party data such as
insurance scores, motor vehicle reports and address verification. At year-end 2008, Diamond
was in use in 24 states representing approximately 99 percent of our personal lines premium
volume, all of which is on a one-year term.
In 2006, we introduced PL-efiles, a policy imaging system, to our personal lines operations.
Through year-end 2008, we had transitioned information on current Diamond personal lines
policies to PL-efiles and continue to work on imaging necessary older information. The
transition replaces paper format with electronic copies of policy documents. PL-efiles
complements the Diamond system by giving personal lines underwriters and support staff
online access to policy documents and data, enabling them to respond to agent requests and
inquiries quickly and efficiently.
Personal Lines Insurance Marketplace
The independent agencies that market our personal lines products typically represent four to
six standard personal lines carriers. In addition to carriers that market through
independent agents, our personal lines competition also includes carriers that market
through captive agents and direct writers, which our agencies’ clients may investigate
independently.
Over the past several years, we have seen increased competition in the personal lines
marketplace, driven by industrywide improvement in results and favorable frequency and
severity trends. The increased competition in the past several years also reflected
implementation of tiered rating systems by a growing number of carriers. Carriers that have
adopted these systems rely on increasingly more data, including credit-based information, to
identify multiple relevant variables to segment the market.
We expect the overall market to remain competitive, with small pricing increases in personal
lines over the next 12 to 24 months. Carriers will continue to increase the sophistication
of their pricing to attract more
Cincinnati Financial Corporation — 2008 Annual Report on 10-K — Page 15 preferred customers and gain market share. Industry results
should continue to improve if catastrophe losses return to a normalized level.
Life Insurance Segment
The life insurance segment contributed $126 million, or 3.3 percent, of net earned premiums
and $4 million of income before income taxes in 2008. Life insurance segment profitability
is discussed in detail in Item 7, Life Insurance Results of Operations,
Page 64. Life
insurance net earned premiums grew 0.8 percent in 2008, 9.0 percent in 2007 and 7.9 percent
in 2006.
The overall mission of our company is supported by The Cincinnati Life Insurance Company.
Cincinnati Life helps meet the needs of our agencies, including increasing and diversifying
agency revenues. We primarily focus on life products that produce revenue growth through a
steady stream of premium payments. By diversifying revenue and profitability for both the
agency and our company, this strategy enhances the already strong relationship built by the
combination of the property casualty and life companies.
Cincinnati Life seeks to become the life insurance carrier of choice for the independent
agencies that work with our property casualty operations. We emphasize up-to-date products,
responsive underwriting and high quality service as well as competitive commissions. At
year-end 2008, almost 75 percent of our 1,387 property casualty reporting agency locations
offered Cincinnati Life’s products to their clients. We also develop life business from
approximately 500 other independent life insurance agencies. We are careful to solicit
business from these other agencies in a manner that does not conflict with or compete with
the marketing and sales efforts of our property casualty agencies.
Life Insurance Business Lines
Four lines of business – term insurance, universal life insurance, worksite products and
whole life insurance – account for approximately 83.7 percent of the life insurance
segment’s revenues:
In addition, Cincinnati Life markets:
Cincinnati Financial Corporation — 2008 Annual Report on 10-K — Page 16 Life Insurance Marketplace
Our property casualty agencies comprise the main distribution system for our life insurance
segment. While other life insurance carriers continue to expand the use of nontraditional
distribution channels, such as banks or direct sales as alternatives to the agency channel,
we intend to market solely through independent agencies, with an emphasis on enhancing
relationships with agencies affiliated with our property casualty insurance operations.
When marketing through our property casualty agencies, we have specific competitive
advantages:
We continue to emphasize the cross-serving opportunities of our life insurance, including
term and worksite products, for the property casualty agency’s personal and commercial
accounts. In both the property casualty and independent life agency distribution systems, we
enjoy the advantages of offering competitive, up-to-date products, providing close personal
attention in combination with financial strength and stability.
Because of our strong capital position, we can offer a competitive product portfolio
including guaranteed products, giving our agents a marketing edge. Our life insurance
company maintains strong insurer financial strength ratings: A.M. Best – A (Excellent),
Fitch – AA- (Very Strong) and Standard & Poor’s – A+ (Strong), as discussed in Financial
Strength,
Page 3. Our life insurance company has not chosen to establish a Moody’s rating.
Current statutory laws and regulations require life insurance companies to hold redundant
reserves, particularly for preferred risk underwriting classes. While these redundant
reserves have no effect on GAAP results, they depress statutory earnings and require a large
commitment of capital. Redundant reserves are a significant issue, not just for our life
insurance operations, but for all writers of term insurance and universal life with
secondary guarantees.
The National Association of Insurance Commissioners recognizes the problems caused by
redundant reserves and is considering a principles-based reserving system rather than the
current formulaic system. While still capturing all material risks, a principles-based
system would allow a company to use its own experience, subject to credibility standards and
appropriate margins for uncertainty. Also, under the proposed principles-based system, the
insurer would fully document and disclose all its assumptions and methods to regulatory
officials.
Investments Segment
The investment segment contributed $675 million, or 17.6 percent, of our total revenues in
2008, primarily from net investment income and from realized investment gains and losses
from investment portfolios managed for the holding company and each of the operating
subsidiaries. After deducting $63 million in interest credited to contract holders of the
life insurance segment, the investments segment contributed $612 million of income before
income taxes, or more than 100 percent of our 2008 total income before income taxes.
During 2008, our board and investment department adopted internal guidelines to place
additional parameters around our portfolio. These parameters address, among other issues,
the overall mix of the portfolio as well as security and sector concentrations. The
parameters came out of our risk management program, with the goal of more specifically
defining our risk tolerances, aligning our operating plan accordingly and improving
management’s ability to identify and respond to changing conditions. Going forward, we will
evaluate all of our fixed-maturity and equity investments using our investment parameters,
as appropriate.
Cincinnati Financial Corporation — 2008 Annual Report on 10-K — Page 17 The fair value (market value) of our investment portfolio was $8.807 billion and $12.198
billion at year-end 2008 and 2007, respectively. Despite the market turmoil of 2008 and our
decision to realize $1.024 billion in gains on security sales during the year, the overall
portfolio remained in an unrealized gain position at year-end.
The cash we generate from insurance operations historically has been invested in three broad
categories of investments:
We actively determine the portion of new cash flow to be invested in fixed-maturity and
equity securities at the parent and insurance subsidiary levels. We consider internal
measures, as well as insurance department regulations and ratings agency guidance. We
monitor a variety of metrics, including after-tax yields, the ratio of investments in common
stocks to statutory surplus for the property casualty and life insurance operations and the
parent company’s ratio of investment assets to total assets.
At year-end 2008, 1.6 percent of the value of our investment portfolio was made up of
securities that do not actively trade on a public market and require management’s judgment
to develop pricing or valuation techniques (Level 3 assets). We obtain at least two outside
valuations for these assets and generally use the more conservative calculation. These
investments include private placements, small issues and various thinly traded securities.
See Item 7, Fair Value Measurements,
Page 45, and Item 8, Note 3 of the Consolidated
Financial Statements
Page 106, for additional discussion of our valuation techniques.
In addition to securities held in our investment portfolio, at year-end 2008, other invested
assets included $37 million of life policy loans, $32 million of venture capital fund
investments, $8 million of private equity investments and $6 million of investment in real
estate.
Fixed-maturity and Short-term Investments
By maintaining a well diversified fixed-maturity portfolio, we attempt to reduce overall
risk. We invest new money in the bond market on a continuous basis, targeting what we
believe to be optimal risk-adjusted after-tax yields. Risk, in this context, includes
interest rate, call, reinvestment rate, credit and liquidity risk. We do not make a
concerted effort to alter duration on a portfolio basis in response to anticipated movements
in interest rates. By continuously investing in the bond market, we build a broad,
diversified portfolio that we believe mitigates the impact of adverse economic factors.
We place a strong emphasis on purchasing current income-producing securities for the
insurance companies’ portfolios. Within the fixed-maturity portfolio, we invest in a blend
of taxable and tax-exempt securities with an eye toward maximizing credit adjusted after-tax
yields.
During the third quarter of 2008, we terminated a securities lending program under which
certain fixed maturities from our investment portfolio were loaned to other institutions for
short periods of time. As a result, no securities were on loan at year-end 2008 compared
with $745 million at year-end 2007. We discuss the program in Item 8, Note 2 of the
Consolidated Financial Statements,
Page 104.
In conjunction with the program termination, we returned the collateral but chose to retain
a small portfolio of collateralized mortgage obligations (CMOs) rather than sell them at
what we felt were distressed prices in an illiquid market. The CMOs were an investment made
by one of the short-duration funds, which subsequently dissolved and distributed the assets
to its investors. All $30 million of the CMOs in the portfolio are collateralized by Alt-A mortgages that
originated between 2004 and 2006. Consequently, at December 31, 2008, we owned
investment-grade CMOs with a fair value and book value of $27 million and $39 million,
respectively. Of the $27 million investment-grade CMOs, $21 million were rated AAA by
Standard & Poor’s. We also owned non-investment grade CMOs that had a fair value and book
value of $3 million and $4 million, respectively. We do not intend to make additional
investments in this asset category.
Cincinnati Financial Corporation — 2008 Annual Report on 10-K — Page 18 Fixed-maturity and Short-term Portfolio Ratings
As of year-end 2008, the portfolio was trading at 96.2 percent of its book value, in line
with general market conditions. The general level of interest rates decreased over the
course of 2008; however, credit spreads widened considerably due to a continued flight to
quality.
The downward shift in the higher portfolio ratings during 2008 primarily was driven by
significant calls of government sponsored entities (GSE) bonds, as well as rating
withdrawals that occurred in response to the difficulties experienced by certain municipal
bond insurers. The majority of our non-rated securities are tax-exempt municipal bonds from
smaller municipalities that chose not to pursue a credit rating. Credit ratings as of
December 31 for the fixed-maturity and short-term portfolio were:
We discuss the maturity of our fixed-maturity portfolio in Item 8, Note 2 of the
Consolidated Financial Statements,
Page 104. Attributes of the fixed-maturity portfolio
include:
Taxable Fixed Maturities
Our taxable fixed-maturity portfolio (at fair value) at year-end 2008 included:
Our strategy typically is to buy and hold fixed-maturity investments to maturity, but we
monitor credit profiles and market value movements when determining holding periods for
individual securities. With the exception of U.S. agency paper (government-sponsored
entities), no individual issuer’s securities accounted for more than 1.7 percent of the
taxable fixed-maturity portfolio at year-end 2008.
The investment-grade corporate bond portfolio is most heavily concentrated in the
financial-related sectors, including banks, brokerage, finance and investment and insurance
companies. The financial sectors represented 34.2 percent of fair value of this portfolio at
year-end 2008, compared with 42.1 percent, at year-end 2007. Although the financial-related
sectors make up our largest group of investment-grade corporate bonds, we believe our
concentration is below the average for the corporate bond market as a whole. Utilities are
the only other sector that exceeds 10 percent of our investment-grade corporate bond
portfolio, at 11.6 percent of fair value at year-end 2008.
Tax-exempt Fixed Maturities
We traditionally have purchased municipal bonds focusing on general obligation and essential
services bonds, such as sewer, water or others. While no single municipal issuer accounted
for more than 0.6 percent of the tax-exempt municipal bond portfolio at year-end 2008, there
are higher concentrations within individual states. Holdings in Texas and Indiana accounted
for a total of 35.0 percent of the municipal bond portfolio at year-end 2008.
In recent years, we have purchased insured municipal bonds because of their excellent
credit-adjusted after-tax yields. At year-end 2008, bonds representing $2.290 billion, or
83.8 percent, of the fair value of our municipal portfolio were insured with an average
rating of AAA. Because of our emphasis on general obligation and essential services bonds,
over 90 percent of the insured municipal bonds have an underlying rating of at least A3 or
A-.
Cincinnati Financial Corporation — 2008 Annual Report on 10-K — Page 19 Short-term Investments
Our short-term investments consist primarily of commercial paper, demand notes or bonds
purchased within one year of maturity. We make short-term investments primarily with funds
to be used to make upcoming cash payments, such as taxes. At year-end 2008, we had $84
million of short-term investments compared with $101 million at year-end 2007.
Equity Investments
After covering both our intermediate and long-range insurance obligations with
fixed-maturity investments, we historically used available cash flow to invest in equity
securities. Investment in equity securities has played an important role in achieving our
portfolio objectives and has contributed to portfolio appreciation. We remain committed to
our long-term equity focus, which we believe is key to our company’s long-term growth and
stability.
Common Stocks
Our common stock investments generally are dividend-paying securities. In this market, we
are seeking to maximize our potential return while minimizing dividend income risk by
selecting securities from a variety of dividend scenarios, including those with the
potential for dividend growth from a below-market current yield. Other criteria we evaluate
include increasing sales and earnings, proven management and a favorable outlook. We believe
our equity investment style is an appropriate long-term strategy after we have purchased
fixed maturity investments to cover our insurance reserves.
In mid-2008, we began applying new investment guidelines that increased portfolio
diversification, reducing single issue and sector concentrations. Our year-end 2008
portfolio has been positioned for reduced volatility going forward. As a result, despite
economic and market disruptions that led to unprecedented value declines, our equity
portfolio suffered less than the broader indices during 2008.
We view our diversifying actions to be consistent with our view of prudent risk management.
At year-end 2008, our financial sector holdings were 12.4 percent of our $2.7 billion
publicly traded common stock portfolio, below the Standard & Poor’s 500 weighting, and
significantly lower than our 56.2 percent financial sector weighting at year-end 2007. Among
other changes, we reduced our Fifth Third Bancorp (NASDAQ:FITB) holding to approximately 12
million shares at year-end 2008. Following Fifth Third’s further reduction of its dividend
payout in December 2008, we sold the remainder of our holding in January 2009 for an
additional capital gain. We expect to continue to make changes to the portfolio, as deemed
appropriate.
Proceeds of sales are being reinvested in both fixed income and equity securities with
yields that we believe are likely to be more secure. This may slow the return to growth in
investment income although we believe year-over-year comparisons may turn positive in the
second half of 2009.
Common Stock Portfolio Industry Sector Distribution
At year-end 2008, 29.7 percent of our common stock holdings (measured by fair value) were
held at the parent company level.
Until June 2008, we had held more than 10 percent of Fifth Third’s common stock for many
years. We continue to hold more than 5 percent of Piedmont Natural Gas Company (NYSE:PNY).
At year-end 2008, there were 12 holdings with a fair value equal to or greater than 2
percent of our publicly traded common stock portfolio compared with 15 similar holdings at
year-end 2007. No single issue accounted for more than 14.5 percent at year-end 2008.
Cincinnati Financial Corporation — 2008 Annual Report on 10-K — Page 20 Nonredeemable Preferred Stocks
We evaluate preferred stocks in a manner similar to the evaluation we make for
fixed-maturity investments, seeking attractive relative yields. We generally focus on
investment-grade preferred stocks issued by companies that have a strong history of paying
common dividends, providing us with another layer of protection. We believe that careful
application of this strategy continues to have merit, although events of 2008 indicated that
preferred stocks will not receive preferential treatment in a government-sponsored
restructuring. When possible, we seek out preferred stocks that offer a dividend received
deduction for income tax purposes.
Additional information regarding the composition of investments is included in Item 8, Note
2 of the Consolidated Financial Statements,
Page 104.
Other
We report as “Other” the other income of our standard market property casualty insurance
subsidiary, as well as non-investment operations of the parent company and its subsidiaries,
CFC Investment Company and CinFin Capital Management Company (excluding client investment
activities). In 2008, we also included results of our surplus lines operations, The
Cincinnati Specialty Underwriters Insurance Company and CSU Producer Resources.
CFC Investment Company
CFC Investment Company offers commercial leasing and financing services to our agents, their
clients and other customers. As of year-end 2008, CFC Investment Company had 2,197 accounts
and $71 million in receivables, compared with 2,590 accounts and $92 million in receivables
at year-end 2007.
CinFin Capital Management
CinFin Capital Management provided asset management services to internal and third-party
clients. CinFin Capital advised clients in December 2008 that it would close on February 28,
2009. During the recent financial market downturn, this business performed satisfactorily
relative to the appropriate benchmarks, and it was profitable over its 10 years in
operation. We determined that sufficient future growth through agency referrals or other
routes would have required a substantial increase in resources even as we are seeking to
increase our focus on our core insurance business with new initiatives. Many of our agencies
did not see referrals for investment management services within the scope of their offerings
to their clients.
As of year-end 2008, CinFin Capital had 44 institutional, corporate and individual clients.
Assets under management were $817 million. We have given our unaffiliated clients ample
opportunity to arrange for another financial adviser and respond to any market changes in a
timely manner. We will continue to manage internally our pension plan and Cincinnati Life’s
separate accounts.
Surplus Lines Property Casualty Insurance
Agencies have access to The Cincinnati Specialty Underwriters Insurance Company’s product
line through CSU Producer Resources, the wholly owned insurance brokerage subsidiary of
parent-company Cincinnati Financial Corporation. CSU Producer Resources has binding
authority on all classes of business written through CSU and maintains appropriate agent and
surplus lines licenses to process non-admitted business.
Producers can submit risks to CSU Producer Resources, reflecting the mix of accounts
Cincinnati agencies currently write in their non-admitted surplus lines markets. CSU
Producer Resources currently markets and underwrites commercial general liability, property
and miscellaneous errors and omissions coverages in 33 states. It will continue to add lines
of business and coverages.
Agency producers have direct access through CSU Producer Resources to our dedicated surplus
lines underwriters, and they also can tap into their agencies’ broader Cincinnati
relationships to bring their policyholders services such as experienced and responsive loss
control and claims handling. Our new surplus lines policy administration system delivers
electronic copies of policies to producers within minutes of underwriting approval and
policy issue. CSU Producer Resources gives extra support to our producers by remitting
surplus lines taxes and stamping fees and retaining admitted market affadavits, where
required.
Cincinnati Financial Corporation — 2008 Annual Report on 10-K — Page 21 Regulation
State Regulation
The business of insurance primarily is regulated by state law. All of our insurance company
subsidiaries are domiciled in the State of Ohio, except The Cincinnati Specialty
Underwriters Insurance Company, which is domiciled in the State of Delaware. Each insurance
subsidiary is governed by the insurance laws and regulations in its respective state of
domicile. We also are subject to state regulatory authorities of all states in which we
write insurance. The state laws and regulations that have the most significant effect on our
insurance operations and financial reporting are discussed below.
Cincinnati Financial Corporation — 2008 Annual Report on 10-K — Page 22
Federal Regulation
Although the federal government and its regulatory agencies generally do not directly
regulate the business of insurance, federal initiatives often have an impact. Some of the
current and proposed federal measures that may significantly affect our business are
discussed below.
Cincinnati Financial Corporation — 2008 Annual Report on 10-K — Page 23
Cincinnati Financial Corporation — 2008 Annual Report on 10-K — Page 24 Item 1A. Risk Factors
Our business involves various risks and uncertainties that may affect achievement of our
business objectives. Many of the risks could have ramifications across our organization. For
example, while risks related to setting insurance rates and establishing and adjusting loss
reserves are insurance activities, errors in these areas could have an impact on our
investment activities, growth and overall results. The following discussion should be viewed
as a starting point for understanding the significant risks we face. It is not a definitive
summary of their potential impacts or of our strategies to manage and control the risks.
Please see Item 7, Management’s Discussion and Analysis of Financial Condition and Results
of Operations,
Page 37, for a discussion of those strategies.
The risks and uncertainties discussed below are not the only ones we face. There are
additional risks and uncertainties that we currently do not believe are material at this
time. There also may be risks and uncertainties of which we are not aware. If any risks or
uncertainties discussed here develop into actual events, they could have a material adverse
effect on our business, financial condition or results of operations. In that case, the
market price of our common stock could decline materially.
Readers should carefully consider this information together with the other information we
have provided in this report and in other reports and materials we file periodically with
the Securities and Exchange Commission as well as news releases and other information we
disseminate publicly.
We rely exclusively on independent insurance agents to distribute our products.
We market our products through independent, non-exclusive insurance agents. These agents are
not obligated to promote our products and can and do sell our competitors’ products. We must
offer insurance products that meet the needs of these agencies and their clients. We need to
maintain good relationships with the agencies that market our products. If we do not, these
agencies may market our competitors’ products instead of ours, which may lead to us having a
less desirable mix of business and could affect our results of operations.
Events or conditions that could diminish our agents’ desire to produce business for us and
the competitive advantage that our independent agencies enjoy:
A reduction in the number of independent agencies marketing our products, the failure of
agencies to successfully market our products or the choice of agencies to reduce their
writings of our products could affect our results of operations if we are unable to replace
them with agencies that produce adequate and profitable premiums. We could lose premium if
a bank that owns appointed agencies changes its strategies.
Further, policyholders may choose a competitor’s product rather than our own because of real
or perceived differences in price, terms and conditions, coverage or service. If the quality
of the independent agencies with which we do business were to decline, that also might cause
policyholders to purchase their insurance through different agencies or channels. Consumers,
especially in the personal insurance segments, may increasingly choose to purchase insurance
from distribution channels other than independent insurance agents, such as direct
marketers.
We could experience an unusually high level of losses due to catastrophic, pandemic or
terrorism events or risk concentrations.
In the normal course of our business, we provide coverage against perils for which estimates
of losses are highly uncertain, in particular catastrophic and terrorism events.
Catastrophes can be caused by a number of
events, including hurricanes, tornadoes, windstorms, earthquakes, hailstorms, explosions,
severe winter weather and fires. Due to the nature of these events, we are unable to predict
precisely the frequency or
Cincinnati Financial Corporation — 2008 Annual Report on 10-K — Page 25 potential cost of catastrophe occurrences. The extent of losses from a catastrophe is a
function of both the total amount of insured exposure in the area affected by the event and
the severity of the event. Our ability to appropriately manage catastrophe risk depends
partially on catastrophe models, the accuracy of which may be impacted by inaccurate or
incomplete data, the uncertainty of the frequency and severity of future events and the
uncertain impact of climate change.
The geographic regions in which we market insurance are exposed to numerous natural
catastrophes, such as:
The occurrence of terrorist attacks in the geographic areas we serve could result in
substantially higher claims under our insurance policies than we have anticipated. While we
do insure terrorism risk in all areas we serve, we have identified our major terrorism
exposure as general commercial risks in the metropolitan Chicago area as well as small co-op
utilities, small shopping malls and small colleges throughout our 35 active states.
Additionally, our life insurance subsidiary could be adversely affected in the event of a
terrorist event or an epidemic such as the avian flu, particularly if the epidemic were to
affect a broad range of the population beyond just the very young or the very old. Our
associate health plan is self-funded and could similarly be affected.
Our results of operations would be adversely affected if the level of losses we experience
over a period of time exceeds our actuarially determined expectations. In addition, our
financial condition would be adversely affected if we were required to sell securities prior
to maturity or at unfavorable prices to pay an unusually high level of loss and loss
expenses. Securities pricing might be even less favorable if a number of insurance companies
needed to sell securities during a short period of time because of unusually high losses
from catastrophic events.
Our geographic concentration ties our performance to business, economic, environmental and
regulatory conditions in certain states. We market our property casualty insurance products
in 35 states, but our business is concentrated in the Midwest and Southeast. We also have
exposure in states where we do not actively market insurance when clients of our independent
agencies have businesses or properties in multiple states.
The Cincinnati Insurance Company also participates in three assumed reinsurance treaties
with two reinsurers that spread the risk of very high catastrophe losses among many
insurers. In 2009, we have exposure of up to $7 million of assumed losses in three layers,
from $1.0 billion to $1.7 billion, from a single event under an assumed reinsurance treaty
for Munich Re Group. The other two assumed reinsurance treaties are immaterial.
In the event of a severe catastrophic event or terrorist attack elsewhere in the world, our
insurance losses may be immaterial. However, the companies in which we invest might be
severely affected, which could affect our financial condition and results of operations. Our
reinsurers might experience significant losses, potentially jeopardizing their ability to
pay losses we cede to them. We also may be exposed to state guaranty fund assessments if
other carriers in a state cannot meet their obligations to policyholders. A catastrophe or
epidemic event also could affect our operations by damaging our headquarters facility,
injuring associates and visitors at our Fairfield, Ohio, headquarters or disrupting our
associates’ ability to perform their assigned tasks.
Our ability to achieve our performance objectives could be affected by changes in the
financial, credit and capital markets or the general economy.
We invest premiums received from policyholders and other available cash to generate
investment income and capital appreciation, maintaining sufficient liquidity to pay covered
claims and operating expenses, service our debt obligations and pay dividends.
Investment income is an important component of our revenues and net income. The ability to
increase investment income and generate longer-term growth in book value is affected by
factors that are beyond our control, such as inflation, economic growth, interest rates,
world political conditions, terrorism attacks or threats, adverse events affecting other
companies in our industry or the industries in which we invest, market events leading to
credit constriction and other widespread unpredictable events. These events may adversely
affect the economy generally and could cause our investment income or the value of
securities we own to decrease. A significant decline in our investment income could have an
adverse effect on our net income, and thereby on our shareholders’ equity and our
policyholders’ surplus. For more detailed discussion of risks associated with our
investments, please refer to Item 7A, Qualitative and Quantitative Disclosures About Market
Risk,
Page 85.
Cincinnati Financial Corporation — 2008 Annual Report on 10-K — Page 26 We issue
life contracts with guaranteed minimum returns, referred to as bank-owned life
insurance contracts (BOLIs). BOLI investment assets must meet certain criteria established
by the regulatory authorities in which jurisdiction the group contract holder is subject.
Therefore, sales of investments may be mandated to maintain compliance with these
regulations, possibly requiring gains or losses to be recorded. We could experience losses
if the assets in the accounts are less than liabilities at the time of maturity or
termination. We discuss other risks associated with our separate account BOLIs in Item 7,
Critical Accounting Estimates, Separate Accounts,
Page 47.
Further deterioration in the banking sector or in banks with which we have relationships
could affect our results of operations. Our ability to maintain or obtain short-term lines
of credit could be affected if the banks from which we obtain these lines are purchased,
fail or are otherwise negatively affected. The value of corporate bonds and common equities
we hold in the banking sector could further deteriorate. We may lose
premium if a bank that owns appointed agencies changes its strategies. We could experience increased
losses in our directors and officers liability line of business if claims are made against
insured financial institutions.
Our investment performance also could suffer because of the types or concentrations of
investments, industry groups and/or individual securities in which we choose to invest.
Market value changes related to these choices could cause a material change in our financial
condition or results of operations.
At year-end 2008, common stock holdings made up 30.6 percent of our invested assets. Adverse
news or events affecting the global or U.S. economy or the equity markets could affect our
net income, book value and overall results as well as our ability to pay our common stock
dividend. See Item 7, Investments Results of Operations,
Page 66, and Item 7A, Qualitative
and Quantitative Disclosures About Market Risk,
Page 85, for discussion of our investment
activities.
Deteriorating credit and market conditions could also impair our ability to access credit
markets and could affect existing or future lending arrangements.
Our overall results could be affected if a significant portion of our commercial lines
policyholders, including those purchasing surety bonds, are adversely affected by marked or
prolonged economic downturns and events such as a downturn in construction and related
sectors, tightening credit markets and higher fuel costs. Such events could make it more
difficult for policyholders to finance new projects, complete projects or expand their
businesses, leading to lower premiums from reduced payrolls and sales and lower purchases of
equipment and vehicles. These events could also cause claims, including surety claims, to
increase due to a policyholder’s inability to secure necessary financing to complete
projects or to collect on underlying lines of credit in the claims process. Such economic
downturns and events could have a greater impact in the construction sector where we have a
concentration of risks and in geographic areas that are hardest hit by economic downturns.
Deteriorating economic conditions could also increase the degree of credit risk associated
with amounts due from independent agents who collect premiums for payment to us and could
hamper our ability to recover amounts due from reinsurers.
Our ability to properly underwrite and price risks and increased competition could adversely
affect our results.
Our financial condition, cash flow and results of operations depend on our ability to
underwrite and set rates accurately for a full spectrum of risks. We establish our pricing
based on assumptions about the level of losses that may occur within classes of business,
geographic regions and other criteria.
To properly price our products, we must collect and properly analyze data; the data must be
sufficient, reliable and accessible; we need to develop appropriate rating methodologies and
formulae; and we may need to identify and respond to trends quickly. If rates are not
accurate, we may not generate enough premiums to offset losses and expenses or we may not be
competitive in the marketplace.
Setting appropriate rates could be hampered if a state or states where we write business
refuses to allow rate increases that we believe are necessary to cover the risks insured. At
least one state requires us to purchase reinsurance from a mandatory reinsurance fund. Such
reinsurance funds can create a credit risk for insurers if not adequately funded by the
state and, in some cases, the existence of a reinsurance fund could affect the prices
charged for our policies. The effect of these and similar arrangements could reduce our
profitability in any given period or limit our ability to grow our business.
The insurance industry is cyclical and intensely competitive. From time to time, the
insurance industry goes through prolonged periods of intense competition during which it is
more difficult to attract new business, retain existing business and maintain profitability.
Competition in our insurance business is based on many factors, including:
Cincinnati Financial Corporation — 2008 Annual Report on 10-K — Page 27
If our pricing is incorrect or we are unable to compete effectively because of one or more
of these factors, our premium writings could decline and our results of operations and
financial condition could be materially adversely affected.
Please see the discussion of our Commercial Lines, Personal Lines and Life Insurance
Segments in Item 1,
Page 11,
Page 14 and
Page 16, for a discussion of our competitive
position in the insurance marketplace.
Our loss reserves, our largest liability, are based on estimates and could be inadequate to
cover our actual losses.
Our consolidated financial statements are prepared using GAAP. These principles require us
to make estimates and assumptions that affect the amounts reported in the Consolidated
Financial Statements and accompanying Notes. Actual results could differ materially from
those estimates. For a discussion of the significant accounting policies we use to prepare
our financial statements and the material implications of uncertainties associated with the
methods, assumptions and estimates underlying our critical accounting policies, please refer
to Item 8, Note 1 of the Consolidated Financial Statements,
Page 98, and Item 7, Critical
Accounting Estimates, Property Casualty Insurance Loss and Loss Expense Reserves and Life
Insurance Policy Reserves,
Page 41 and
Page 44. Our most critical accounting estimate is loss reserves. Loss reserves are the amounts we
expect to pay for covered claims and expenses we incur to settle those claims. The loss
reserves we establish in our financial statements represent an estimate of amounts needed to
pay and administer claims arising from insured events that have already occurred, including
events that have not yet been reported to us. Loss reserves are estimates and are inherently
uncertain; they do not and cannot represent an exact measure of liability. Accordingly, our
loss reserves for past periods could prove to be inadequate to cover our actual losses and
related expenses. Any changes in these estimates are reflected in our results of operations
during the period in which the changes are made. An increase in our loss reserves would
decrease earnings, while a decrease in our loss reserves would increase earnings.
The estimation process for unpaid loss and loss expense obligations involves uncertainty by
its very nature. We continually review the estimates and adjust the reserves as facts about
individual claims develop, additional losses are reported and new information becomes known.
Adjustments due to loss development on prior periods are reflected in the calendar year in
which they are identified. The process used to determine our loss reserves is discussed in
Item 7, Critical Accounting Estimates, Property Casualty Insurance Loss and Loss Expense
Reserves and Life Insurance Policy Reserves,
Page 41 and
Page 44.
Unforeseen losses, the type and magnitude of which we cannot predict, may emerge in the
future. These additional losses could arise from changes in the legal environment, laws and
regulations, climate change, catastrophic events, increases in loss severity or frequency,
or other causes. Such future losses could be substantial.
Our ability to obtain or collect on our reinsurance protection could affect our business,
financial condition, results of operations and cash flows.
We buy property casualty and life reinsurance coverage to mitigate the liquidity risk of an
unexpected rise in claims severity or frequency from catastrophic events or a single large
loss. The availability, amount and cost of reinsurance depend on market conditions and may
vary significantly. If we are unable to obtain reinsurance on acceptable terms and in
appropriate amounts, our business and financial condition may be adversely affected.
In addition, we are subject to credit risk with respect to our reinsurers. Although we
purchase reinsurance to manage our risks and exposures to losses, this reinsurance does not
discharge our direct obligations under the policies we write. We would remain liable to our
policyholders even if we were unable to recover what we
Cincinnati Financial Corporation — 2008 Annual Report on 10-K — Page 28 believe we are entitled to receive under our reinsurance contracts. Reinsurers might refuse
or fail to pay losses that we cede to them, or they might delay payment. For long-tail
claims, the creditworthiness of our reinsurers may change before we can recover amounts to
which we are entitled. A reinsurer’s insolvency, inability or unwillingness to make payments
under the terms of its reinsurance agreement with our insurance subsidiaries could have a
material adverse effect on our financial position, results of operations and cash flows.
Prior to 2003, we participated in USAIG, a joint underwriting association of individual
insurance companies that collectively functions as a worldwide insurance market for all
types of aviation and aerospace accounts. At year-end 2008, 28.6 percent, or $217 million,
of our total reinsurance receivables were related to USAIG, primarily for September 11,
2001, events, offset by $226 million of amounts ceded to other pool
participants and reinsurers. If the pool participants and reinsurers are unable to fulfill
their financial obligations and all security collateral that supports the participants’
obligations becomes worthless, we could be liable for an additional pool liability of
$283 million and our financial position and results of operations could be materially
affected. Currently all pool participants and reinsurers are financially solvent.
We no longer participate in new business generated by USAIG and its members. Please see Item
7, 2009 Reinsurance Programs,
Page 81, for a discussion of our reinsurance treaties.
Our business depends on the uninterrupted operation of our facilities, systems and business
functions.
Our business depends on our associate’s ability to perform necessary business functions,
such as processing new and renewal policies and claims. We increasingly rely on technology
and systems to accomplish these business functions in an efficient and uninterrupted
fashion. Our inability to access our headquarters facilities or a failure of technology,
telecommunications or other systems could significantly impair our ability to perform such
functions on a timely basis or affect the accuracy of transactions. If sustained or
repeated, such a business interruption or system failure could result in a deterioration of
our ability to write and process new and renewal business, serve our agents and
policyholders, pay claims in a timely manner, collect receivables or perform other necessary
business functions. If our disaster recovery and business continuity plans did not
sufficiently consider, address or reverse the circumstances of an interruption or failure,
this could result in a materially adverse effect on our operating results and financial
condition. This risk is exacerbated because approximately 70 percent of our associates work
at our Fairfield, Ohio, headquarters.
The effects of changes in industry practices and regulations on our business are uncertain.
As industry practices and legal, judicial, legislative, regulatory, political, social and
other environmental conditions change, unexpected and unintended issues related to insurance
pricing, claims, and coverage, may emerge. These issues may adversely affect our business by
impeding our ability to obtain adequate rates for covered risks, extending coverage beyond
our underwriting intent or by increasing the number or size of claims. In some instances,
unforeseeable emerging and latent claim and coverage issues may not become apparent until
some time after we have issued the insurance policies that could be affected by the changes.
As a result, the full extent of liability under our insurance contracts may not be known for
many years after a policy is issued.
Further, the National Association of Insurance Commissioners (NAIC), state insurance
regulators and state legislators are continually reexamining existing laws and regulations
governing insurance companies and insurance holding companies, specifically focusing on
modifications to statutory accounting principles, interpretations of existing laws and the
development of new laws and regulations that affect a variety of financial and nonfinancial
components of our business. Any proposed or future legislation, regulation or NAIC
initiatives, if adopted, may be more restrictive on our ability to conduct business than
current regulatory requirements or may result in higher costs.
Additionally, laws and regulations may be enacted in the wake of the current financial and
credit crises that have adverse affects on our business, potentially including a change from
a state-based system of regulation to a system of federal regulation. While we do not
participate or intend to seek to participate in the Troubled Asset Relief Program, the
effect of it or any similar legislation on our industry and the economy in general is
uncertain.
The effects of such changes could adversely affect our results of operations. Please see
Item 7, Critical Accounting Estimates, Property Casualty Insurance Loss and Loss Expense
Reserves and Life Insurance Policy Reserves,
Page 41 and
Page 44, for a discussion of our
reserving practices.
Managing technology initiatives and meeting new data security requirements are significant
challenges.
While technology can streamline many business processes and ultimately reduce the cost of
operations, technology initiatives present short-term cost, implementation and operational
risks. In addition, we may have inaccurate expense projections, implementation schedules or
expectations regarding the efficacy of the
Cincinnati Financial Corporation — 2008 Annual Report on 10-K — Page 29 end product. These issues could escalate over time. If we are unable to find and retain
employees with key technical knowledge, our ability to develop and deploy key technology
solutions could be hampered.
We necessarily collect, use and hold data concerning individuals and businesses with whom we
have a relationship. Threats to data security rapidly emerge and change, exposing us to
rising costs and competing time constraints to secure our data in accordance with customer
expectations and statutory and regulatory requirements. A breach of our security that
results in unauthorized access to our data could expose us to data loss, litigation,
damages, fines and penalties, significant increases in compliance costs and reputational
damage.
Please see Item 1, Strategic Initiatives,
Page 7 for a discussion of our technology
initiatives.
Our status as an insurance holding company with no direct operations could affect our
ability to pay dividends in the future.
Cincinnati Financial Corporation is a holding company that transacts substantially all of
its business through its subsidiaries. Our primary assets are the stock in our operating
subsidiaries and our investments. Consequently, our cash flow to pay cash dividends and
interest on our long-term debt depends on dividends we receive from our operating
subsidiaries and income earned on investments held at the parent-company level.
Dividends paid to our parent company by our insurance subsidiary are restricted by the
insurance laws of Ohio, its domiciliary state. These laws establish minimum solvency and
liquidity thresholds and limits. Currently, the maximum dividend that may be paid without
prior regulatory approval is limited to the greater of 10 percent of statutory surplus or
100 percent of statutory net income for the prior calendar year, up to the amount of
statutory unassigned surplus as of the end of the prior calendar year. Dividends exceeding
these limitations may be paid only with prior approval of the Ohio Department of Insurance.
Consequently, at times, we might not be able to receive dividends from our insurance
subsidiary, or we might not receive dividends in the amounts necessary to meet our debt
obligations or to pay dividends on our common stock. This could affect our financial
position.
Please see Item 1, Regulation,
Page 22, and Item 8, Note 9 of the Consolidated Financial
Statements,
Page 110, for discussion of insurance holding company dividend regulations.
Item 1B. Unresolved Staff Comments
None
Cincinnati Financial Corporation — 2008 Annual Report on 10-K — Page 30 Item 2. Properties
Cincinnati Financial Corporation owns our headquarters building located on 100 acres of land
in Fairfield, Ohio. This building has approximately 1,508,200 total square feet of available
space. In 2008, we completed construction of a 425,400 square foot third office tower and
276,800 square foot underground garage. We expect this expansion to accommodate our business
needs for the foreseeable future. The property, including land, is carried in our financial
statements at $159 million as of December 31, 2008, and is classified as land, building and
equipment, net, for company use. John J. & Thomas R. Schiff & Co. Inc., a related party,
occupies approximately 6,750 square feet (less than 1 percent).
Cincinnati Financial Corporation also owns the Fairfield Executive Center, which is located on
the northwest corner of our headquarters property. This four-story office building has
approximately 124,000 square feet of available space. The property is carried in the
financial statements at $6 million as of December 31, 2008, and is classified as an other
invested asset. Unaffiliated tenants occupy approximately 8 percent. All unoccupied space is
currently available for lease.
The Cincinnati Insurance Company owns an unoccupied building on 16 acres of land in
Springfield Township, Ohio, approximately six miles from our headquarters. We plan to
renovate the 48,000 square foot building to serve as a business continuity center.
The property, including land, is carried on our financial statements at $6 million as of
December 31, 2008, and is classified as land, building and equipment, net, for company use.
Item 3. Legal Proceedings
Neither the company nor any of our subsidiaries is involved in any material litigation other
than ordinary, routine litigation incidental to the nature of its business.
Item 4. Submission of Matters to a Vote of Security Holders
No matters were submitted to a vote of security holders of Cincinnati Financial during the
fourth quarter of 2008.
Part II
Item 5. Market for the Registrant’s Common Equity, Related Stockholder Matters and
Issuer Purchases of Equity Securities
Cincinnati Financial Corporation had approximately 12,000 shareholders of record and
approximately 37,000 beneficial shareholders as of December 31, 2008. Many of our
independent agent representatives and most of the 4,179 associates of our subsidiaries own
the company’s common stock. We are unable to quantify those holdings because many are
beneficially held.
Our common shares are traded under the symbol CINF on the Nasdaq Global Select Market.
We discuss the factors that affect our ability to pay cash dividends and repurchase shares
in Item 7, Liquidity and Capital Resources,
Page 70. One factor we address is regulatory
restrictions on the dividends our insurance subsidiary can pay to the parent company, which
also is discussed in Item 8, Note 9 of the Consolidated Financial Statements,
Page 110.
The following summarizes securities authorized for issuance under our equity compensation
plans as of December 31, 2008:
The number of securities remaining available for future issuance includes: 7,304,065 shares
available for issuance under the Cincinnati Financial Corporation 2006 Stock Compensation
Plan, which can be issued as stock options, service-based, or performance-based restricted
stock units, stock appreciation rights or other equity-based grants; 25,394 shares available
for issuance of full share grants under the Cincinnati Financial Corporation 2003
Non-Employee Directors’ Stock Plan; and 4,186 shares of stock options available for issuance
under the Cincinnati Financial Corporation Stock Option Plan VII. Additional information
about stock-based associate compensation granted under our equity compensation plans is
available in Item 8, Note 17 of the Consolidated Financial Statements,
Page 117.
Cincinnati Financial Corporation — 2008 Annual Report on 10-K — Page 32 We did not sell any shares that were not registered under the Securities Act during 2008.
The board of directors has authorized share repurchases since 1996. In 2008, we repurchased
a total of 3.8 million shares. In January 2008, we acquired 71,003 shares to settle the
accelerated share repurchase program authorized in October 2007, when the board of directors
expanded an existing repurchase authorization to approximately 13 million shares. Purchases
are expected to be made generally through open market transactions. The board gives
management discretion to purchase shares at reasonable prices in light of circumstances at
the time of purchase, pursuant to SEC regulations.
The prior repurchase program for 10 million shares was announced in 2005, replacing a
program that had been in effect since 1999. No repurchase program has expired during the
period covered by the above table. All of the publicly announced plan repurchases in the
table above were made under the expansion announced in October 2007 of our 2005 program.
Neither the 2005 nor 1999 program had an expiration date, but no further repurchases will
occur under the 1999 program.
Cumulative Total Return
As depicted in the graph below, the five–year total return on a $100 investment made
December 31, 2003, assuming the reinvestment of all dividends, was a negative 9.0 percent
for Cincinnati Financial Corporation’s common stock compared with a negative 2.1 percent for
the Standard & Poor’s Composite 1500 Property & Casualty Insurance Index and a negative 10.5
percent for the Standard & Poor’s 500 Index.
The Standard & Poor’s Composite 1500 Property & Casualty Insurance Index includes 23
companies: Allstate Corporation, Berkley (W R) Corporation, Chubb Corporation, Cincinnati
Financial Corporation, Fidelity National Financial Inc., First American Corporation, Hanover
Insurance Group Inc., Infinity Property & Casualty Corporation, MBIA Inc., Mercury General
Corporation, Navigators Group Inc., Old Republic International Corporation, Proassurance
Corporation, Progressive Corporation, RLI Corporation, Safety Insurance Group Inc.,
Selective Insurance Group Inc., Stewart Information Services, Tower Group Inc., Travelers
Companies Inc., United Fire & Casualty Company, XL Capital Ltd. and Zenith National
Insurance Corporation.
The Standard & Poor’s 500 Index includes a representative sample of 500 leading companies in
a cross section of industries of the U.S. economy. Although this index focuses on the large
capitalization segment of the market, it is widely viewed as a proxy for the total market.
Cincinnati Financial Corporation — 2008 Annual Report on 10-K — Page 33 Item 6. Selected Financial Data
Per share data adjusted to reflect all stock splits and dividends prior to December 31,
2008.
One-time Charges or Adjustments:
2008 — We changed the form of retirement benefit we offer certain associates to a 401(k)
plan with company match from a qualified defined benefit pension plan. We incurred a pretax
expense of $27 million to recognize a settlement loss associated with the partial
termination of the qualified pension plan. The expense reduced net income by $17 million, or
11 cents per share, and raised the combined ratio by 0.8 percentage points.
2003 — As the result of a settlement negotiated with a vendor, pretax results included the
recovery of $23 million of the $39 million one-time, pretax charge incurred in 2000.
2000 — We recorded a one-time charge of $39 million, pretax, to write down
previously capitalized costs related to the development of software to process property
casualty policies. We earned $5 million in interest in the first quarter from a
$303 million single-premium bank-owned life insurance (BOLI) policy booked at the end of
1999 that was segregated as a separate account effective April 1, 2000. Investment income
and realized investment gains and losses from separate accounts generally accrue directly to
the contract holder and, therefore, are not included in the company’s consolidated
financials.
Cincinnati Financial Corporation — 2008 Annual Report on 10-K — Page 34
Cincinnati Financial Corporation — 2008 Annual Report on 10-K — Page 35 [This page intentionally blank]
Cincinnati Financial Corporation — 2008 Annual Report on 10-K — Page 36 Item 7. Management’s Discussion and Analysis of Financial Condition and Results of
Operations
Introduction
The purpose of Management’s Discussion and Analysis is to provide an understanding of
Cincinnati Financial Corporation’s consolidated results of operations and financial
condition. Our Management’s Discussion and Analysis should be read in conjunction with Item
6, Selected Financial Data,
Page 34 and
Page 35, and Item 8, Consolidated Financial Statements
and related Notes, beginning on
Page 91. We present per share data on a diluted basis unless
otherwise noted, adjusting those amounts for all stock splits and stock dividends.
We begin with an executive summary of our results of operations and outlook, as well as
details on critical accounting policies and estimates. Periodically, we refer to estimated
industry data so that we can give information on our performance within the context of the
overall insurance industry. Unless otherwise noted, the industry data is prepared by A.M.
Best, a leading insurance industry statistical, analytical and financial strength rating
organization. Information from A.M. Best is presented on a statutory basis. When we provide
our results on a comparable statutory basis, we label it as such; all other company data is
presented in accordance with accounting principles generally accepted in the United States
of America (GAAP).
Executive Summary
Through The Cincinnati Insurance Company, Cincinnati Financial Corporation is one of the 25
largest property casualty insurers in the nation, based on written premium volume for
approximately 2,000 U.S. stock and mutual insurer groups. We market our insurance products
through a select group of independent insurance agencies in 35 states as discussed in Item
1, Our Business and Our Strategy,
Page 1.
Although 2008 was a difficult year for our economy, our industry and our company, our
long-term perspective lets us address the immediate challenges while focusing on the major
decisions that best position the company for success through all market cycles. We believe
that this forward-looking view has consistently benefited our policyholders, agents,
shareholders and associates.
To measure our progress, we have defined a measure of value creation that we believe
captures the contribution of our insurance operations, the success of our investment
strategy and the importance we place on paying cash dividends to shareholders. Between 2010
and 2014, we expect the total of 1) our rate of growth in book value per share plus 2) the
ratio of dividends declared per share to beginning book value per
share to average 12 percent to 15
percent. With the current economic and market uncertainty, we believe this ratio is an
appropriate way to measure our long-term progress in creating value.
When looking at our longer-term objectives, we see three performance drivers:
The board of directors is committed to rewarding shareholders directly through cash
dividends and through share repurchase authorization. The board also has periodically
declared stock dividends and splits. Through
Cincinnati Financial Corporation — 2008 Annual Report on 10-K — Page 37 2008, the company has increased the indicated annual cash dividend rate for 48 consecutive
years, a record we believe is matched by only 11 other publicly traded companies. While
seeing merit in continuing that record, in February 2009, our board indicated its first
priority was assuring continued financial strength for the company and that its intention
was to consider the potential for a 49th year of increase over the course of
2009. We discuss our financial position in more detail in Liquidity and Capital Resources,
Page 70.
Strategic Initiatives Highlights
Management has worked with the board of directors to identify the strategies that can lead
to long-term success. Our strategies are intended to position us to compete successfully in
the markets we have targeted while minimizing risk. We believe successful implementation of
the initiatives that support our strategies will help us better serve our agent customers,
reduce volatility in our financial results and weather difficult economic, market or pricing
cycles.
We discuss each of these strategies, along with the metrics we use to assess their progress,
in Item 1, Strategic Initiatives,
Page 7.
Factors Influencing Our Future Performance
In January and February of 2009, storms affecting our policyholders largely in the Midwest
currently are estimated to have resulted in about $30 million of reported claims, which
will be included in first-quarter pretax catastrophe losses. This estimate does not take
into account development of these catastrophes, any further catastrophe activity that may
occur in the remainder of the first quarter of 2009 or potential development from events in
prior periods.
In 2008, the rate of growth in book value plus the rate of dividend contribution was below
our target, as discussed in the review of our financial highlights below. In 2009, we
believe our value creation ratio may also be below our long-term target for several reasons.
Our view of the value we can create over the next five years relies on two assumptions about
the external environment. First, we’re anticipating some firming of commercial insurance
pricing during 2009. Second, we believe that the economy and financial markets can resume a
growth track by the end of 2010. If those assumptions prove to be inaccurate, we may not be
able to achieve our performance targets even if we accomplish our strategic objectives.
Cincinnati Financial Corporation — 2008 Annual Report on 10-K — Page 38 Other factors that could influence our ability to achieve our targets include:
We discuss in our Item 1A, Risk Factors,
Page 25, many potential risks to our business and
our ability to achieve our qualitative and quantitative objectives. These are real risks,
but their probability of occurring may not be high. We also believe that our risk management
programs generally can mitigate their potential effects, in the event they do occur.
We have formal risk management programs overseen by a senior officer and supported by a team
of representatives from business areas. The team reports to our chairman, our president and
chief executive officer and our board of directors, as appropriate, on detailed and summary
risk assessments, risk metrics and risk plans. Our use of operational audits, strategic
plans and departmental business plans, as well as our culture of open communications and our
fundamental respect for our code of conduct, continue to help us manage risks on an ongoing
basis.
Below we review highlights of our financial results for the past three years. Detailed
discussion of these topics appears in Results of Operations,
Page 48, and Liquidity and
Capital Resources,
Page 70.
Corporate Financial Highlights
The value creation ratio discussed in the Executive Summary,
Page 37, was a negative 23.5
percent in 2008, a negative 5.7 percent in 2007 and a positive 16.7 percent in 2006. In both
2008 and 2007, a decline in unrealized gains on our investment portfolio was the most
significant factor in the decline in book value as discussed below. In 2008, net income also
was significantly below the level of the prior two years.
Cash dividends declared per share rose 9.9 percent in 2008, 6.0 percent in 2007 and 11.2
percent in 2006.
Balance Sheet Data and Performance Measures
Invested
assets declined because of lower fair values for portfolio investments, largely
due to economic factors. The downturn in the economy had a particularly adverse effect on
our financial sector equity holdings, which made up a significant portion of the portfolio
prior to mid-2008. By year-end 2008, the portfolio was substantially more diversified and
generally better positioned to withstand short-term fluctuations. We discuss our investment
strategy in Item 1, Investments Segment,
Page 17, and results for the segment in Investments
Results of Operations,
Page 66.
Our ratio of debt to total capital (debt plus shareholders’ equity) rose over the three
years due to the effect on shareholders’ equity of the declining value of our invested
assets. Long-term debt was unchanged over the period.
Cincinnati Financial Corporation — 2008 Annual Report on 10-K — Page 39 Income Statement and Per Share Data
Net income declined in 2008 from the higher levels of the prior two years because of a
three-year decline in realized investment gains, a first-ever decline in investment income
and a lower aggregate contribution from our insurance segments. The pension plan settlement
reduced 2008 net income by $17 million, or 11 cents per share. The transition from a defined
benefit pension plan reduces company risk while providing flexible, company-sponsored 401(k)
benefit to associates.
Weighted average shares outstanding may fluctuate from period to period because we
repurchase shares under board authorizations and we issue shares when associates exercise
stock options. Weighted average shares outstanding on a diluted basis declined 9 million in
2008, 3 million in 2007 and 2 million in 2006.
As discussed in Investments Results of Operation,
Page 66, security sales led to realized
investment gains in all three years, although 2008 gains were tempered by $510 million in
other-than-temporary impairment charges. Realized investment gains and losses are integral
to our financial results over the long term. We have substantial discretion in the timing of
investment sales and, therefore, the gains or losses that are recognized in any period. That
discretion generally is independent of the insurance underwriting process. Also, applicable
accounting standards require us to recognize gains and losses from certain changes in fair
values of securities and for securities with embedded derivatives without actual realization
of those gains and losses.
Lower income from dividends led to an 11.6 percent decline in net investment income in 2008,
the first decline in this measure in company history. The primary reason for the decline was
dividend reductions by common and preferred holdings, including reductions during the year
on positions subsequently sold or reduced.
Contribution from Insurance Segments
The trend in overall written premium growth reflected the competitive and market factors
discussed in Item 1, Commercial Lines and Personal Lines Property Casualty Insurance
Segment,
Page 11 and
Page 14.
In 2008, our property casualty insurance operations reported an underwriting loss after
achieving record profitability in 2007. Underwriting profitability can be measured by the
combined ratio. (The combined ratio is the percentage of each earned premium dollar spent on
claims plus all expenses — the lower the ratio, the better the performance.) In 2008 and
2007, higher savings from favorable development on prior period reserves helped offset other
loss and loss expenses. Catastrophe losses fluctuated dramatically over the three-year
period, making an unusually high contribution of 6.8 percentage points to the combined ratio
in 2008 after an unusually low 0.8 points in 2007. The pension plan settlement increased the
2008 combined ratio by 0.8 percentage points.
Our new surplus lines operation contributed $14 million to net written premiums and $5
million to earned premiums, but had an immaterial effect on net income. The business
achieved its first-year strategic plan objectives.
Cincinnati Financial Corporation — 2008 Annual Report on 10-K — Page 40 Our life insurance segment continued to provide a consistent source of profit. We discuss results for the segment in Life Insurance Results of
Operations,
Page 64. Income and gains from the life insurance investment portfolio are
included in Investment segment results.
Critical Accounting Estimates
Cincinnati Financial Corporation’s financial statements are prepared using GAAP. These
principles require management to make estimates and assumptions that affect the amounts
reported in the Consolidated Financial Statements and accompanying Notes. Actual results
could differ materially from those estimates.
The significant accounting policies used in the preparation of the financial statements are
discussed in Item 8, Note 1 of the Consolidated Financial Statements,
Page 98. In
conjunction with that discussion, material implications of uncertainties associated with the
methods, assumptions and estimates underlying the company’s critical accounting policies are
discussed below. The audit committee of the board of directors reviews the annual financial
statements with management and the independent registered public accounting firm. These
discussions cover the quality of earnings, review of reserves and accruals, reconsideration
of the suitability of accounting principles, review of highly judgmental areas including
critical accounting policies, audit adjustments and such other inquiries as may be
appropriate.
Property Casualty Insurance Loss And Loss Expense Reserves
Overview
We establish loss and loss expense reserves for our property casualty insurance business as
balance sheet liabilities. These reserves account for unpaid loss and loss expenses as of a
financial statement date. Unpaid loss and loss expenses are the estimated amounts necessary
to pay for and settle all outstanding insured claims, including incurred but not reported
(IBNR) claims, as of that date.
For some lines of business that we write, a considerable and uncertain amount of time can
elapse between the occurrence, reporting and payment of insured claims. The amount we will
actually have to pay for such claims also can be highly uncertain. This uncertainty,
together with the size of our reserves, makes the loss and loss expense reserves our most
significant estimate. Gross loss and loss expense reserves were $4.040 billion at year-end
2008 compared with $3.925 billion at year-end 2007.
How Reserves Are Established
Our field claims representatives establish case reserves when claims are reported to the
company to provide for our unpaid loss and loss expense obligation associated with these
claims. Experienced headquarters claims supervisors review individual case reserves greater
than $35,000 that were established by field claims representatives. Headquarters claims
managers also review case reserves greater than $100,000.
Our claims representatives base their case reserve estimates primarily upon case-by-case
evaluations that consider:
Case reserves of all sizes are subject to review on a 90-day cycle, or more frequently if
new information about a loss becomes available. As part of the review process, we monitor
industry trends, cost trends, relevant court cases, legislative activity and other current
events in an effort to ascertain new or additional loss exposures.
We also establish incurred but not reported (IBNR) reserves to provide for all unpaid loss
and loss expenses not accounted for by case reserves:
Cincinnati Financial Corporation — 2008 Annual Report on 10-K — Page 41
Our actuarial staff applies significant judgment in selecting models and estimating model
parameters when preparing reserve analyses. In addition, unpaid loss and loss expenses are
inherently uncertain as to timing and amount. Uncertainties relating to model
appropriateness, parameter estimates and actual loss and loss expense amounts are referred
to as model, parameter and process uncertainty, respectively. Our management and actuarial
staff control for these uncertainties in the reserving process in a variety of ways.
Our actuarial staff bases its IBNR reserve estimates for these losses primarily on the
indications of methods and models that analyze accident year data. Accident year is the year
in which an insured claim, loss, or loss expense occurred. The specific methods and models
that our actuaries have used for the past several years are:
Our actuarial staff uses diagnostics provided by stochastic reserving software to evaluate
the appropriateness of the models and methods listed above. The software’s diagnostics have
indicated that the appropriateness of these models and methods for estimating IBNR reserves
for our lines of business tends to depend on a line’s tail. Tail refers to the time interval
between a typical claim’s occurrence and its settlement. For our long-tail lines such as
workers’ compensation and commercial casualty, models from the probabilistic trend family
tend to provide superior fits and to validate well compared with models underlying the loss
development and Bornhuetter-Ferguson methods. The loss development and Bornhuetter-Ferguson
methods, particularly the reported loss variations, tend to produce the more appropriate
IBNR reserve estimates for our short-tail lines such as homeowner and commercial property.
For our mid-tail lines such as personal and commercial auto liability, all models and
methods provide useful insights.
Our actuarial staff also devotes significant time and effort to the estimation of model and
method parameters. The loss development and Bornhuetter-Ferguson methods require the
estimation of numerous loss development factors. The Bornhuetter-Ferguson methods also
involve the estimation of numerous ultimate loss ratios by accident year. Models from the
probabilistic trend family require the estimation of development trends, calendar year
inflation trends and exposure levels. Consequently, our actuarial staff monitors a number of
trends and measures to gain key business insights necessary for exercising appropriate
judgment when estimating the parameters mentioned.
These trends and measures include:
These trends and measures also support the estimation of ultimate accident year loss ratios
needed for applying the Bornhuetter-Ferguson methods and for assessing the reasonability of
all IBNR reserve estimates computed. Our actuarial staff reviews these trends and measures
quarterly and updates them as necessary.
Quarterly, our actuarial staff summarizes its reserve analysis by preparing an actuarial
best estimate and a range of reasonable IBNR reserves intended to reflect the uncertainty of
the estimate. An inter-departmental committee that includes our actuarial management team
reviews the results of each quarterly reserve analysis. The committee establishes
management’s best estimate of IBNR reserves, which is the amount that is included in each
period’s financial statements. In addition to the information provided by actuarial staff,
the committee also considers factors such as the following:
Cincinnati Financial Corporation — 2008 Annual Report on 10-K — Page 42
The determination of management’s best estimate, like the preparation of the reserve
analysis that supports it, involves considerable judgment. Changes in reserving data or the
trends and factors that influence reserving data may signal fundamental shifts or may simply
reflect single-period anomalies. Even if a change reflects a fundamental shift, the full
extent of the change may not become evident until years later. Moreover, since our methods
and models do not explicitly relate many of the factors we consider directly to reserve
levels, we typically cannot quantify the precise impact of such factors on the adequacy of
reserves prospectively or retrospectively.
Due to the uncertainties described above, our ultimate loss experience could prove better or
worse than our carried reserves reflect. To the extent that reserves are inadequate and
increased, the amount of the increase is a charge in the period that the deficiency is
recognized, raising our loss and loss expense ratio and reducing earnings. To the extent
that reserves are redundant and released, the amount of the release is a credit in the
period that the redundancy is recognized, reducing our loss and loss expense ratio and
increasing earnings.
Key Assumptions — Loss Reserving
Our actuarial staff makes a number of key assumptions when using their methods and models to
derive IBNR reserve estimates. Appropriate reliance on these key assumptions essentially
entails determinations of the likelihood that statistically significant patterns in
historical data may extend into the future. The four most significant of the key assumptions
used by our actuarial staff and approved by management are:
These key assumptions have not changed since 2005, when our actuarial staff began using
probabilistic trend family models to estimate IBNR reserves.
Paid losses, reported losses and paid allocated loss expenses are subject to random as well
as systematic influences. As a result, actual paid losses, reported losses and paid
allocated loss expenses are virtually certain to differ from projections. Such differences
are consistent with what specific models for our business lines predict and with the related
patterns in the historical data used to develop these models. As a result, management does
not closely monitor statistically insignificant differences between actual and projected
data.
Reserve Estimate Variability
Management believes that the standard error of a reserve estimate, a measure of the
estimate’s variability, provides the most appropriate measure of the estimate’s sensitivity.
The reserves we establish depend on the models we use and the related parameters we estimate
in the course of conducting reserve analyses.
Cincinnati Financial Corporation — 2008 Annual Report on 10-K — Page 43 However, the actual amount required to settle
all outstanding insured claims, including IBNR claims, as of a financial statement date
depends on stochastic, or random, elements as well as the systematic elements captured by
our models and estimated model parameters. For the lines of business we write, process
uncertainty — the inherent variability of loss and loss expense payments — typically
contributes more to the imprecision of a reserve estimate than parameter uncertainty.
Consequently, a sensitivity measure that ignores process uncertainty would provide an
incomplete picture of the reserve estimate’s sensitivity. Since a reserve estimate’s
standard error accounts for both process and parameter uncertainty, it reflects the
estimate’s full sensitivity to a range of reasonably likely scenarios.
The table below provides standard errors and reserve ranges for lines of business that
account for 90.6 percent of our 2008 loss and loss expense reserves as well as the potential
effects on our net income, assuming a 35 percent federal tax rate. Standard errors and
reserve ranges for assorted groupings of these lines of business cannot be computed by
simply adding the standard errors and reserve ranges of the component lines of business,
since such an approach would ignore the effects of product diversification. See Range of
Reasonable Reserves,
Page 74, for a total reserve range. While the table reflects our
assessment of the most likely range within which each line’s actual unpaid loss and loss
expenses may fall, one or more lines’ actual unpaid loss and loss expenses could nonetheless
fall outside of the indicated ranges.
If actual unpaid loss and loss expenses fall within these ranges, our cash flow and fixed
maturity investments should provide sufficient liquidity to make the subsequent payments. To
date, our cash flow has covered our loss and loss expense payments, and we have never had to
sell investments to make these payments. If this were to become necessary, however, our
fixed maturity investments should provide us with ample liquidity. At year-end 2008,
consolidated fixed maturity investments exceeded total insurance reserves (including life
policy reserves) by more than $190 million.
Life Insurance Policy Reserves
We establish the reserves for traditional life insurance policies based on expected
expenses, mortality, morbidity, withdrawal rates and investment yields, including a
provision for uncertainty. Once these
assumptions are established, they generally are maintained throughout the lives of the
contracts. We use both our own experience and industry experience adjusted for historical
trends in arriving at our assumptions for expected mortality, morbidity and withdrawal
rates. We use our own experience and historical trends for setting our assumptions for
expected expenses. We base our assumptions for expected investment income on our own
experience adjusted for current economic conditions.
We establish reserves for our universal life, deferred annuity and investment contracts
equal to the cumulative account balances, which include premium deposits plus credited
interest less charges and withdrawals. Some of our universal life insurance policies contain
no-lapse guarantee provisions. For these policies, we establish a reserve in addition to the
account balance based on expected no-lapse guarantee benefits and expected policy
assessments.
Cincinnati Financial Corporation — 2008 Annual Report on 10-K — Page 44 Asset Impairment
Our fixed-maturity and equity investment portfolios are our largest assets. The company’s
asset impairment committee continually monitors the holdings in these portfolios and all
other assets for signs of other-than-temporary or permanent impairment. The committee
monitors significant decreases in the fair value of invested assets, changes in legal
factors or in the business climate, an accumulation of costs in excess of the amount
originally expected to acquire or construct an asset, uncollectability of all receivable
assets, or other factors such as bankruptcy, deterioration of creditworthiness, failure to
pay interest or dividends or signs indicating that the carrying amount may not be
recoverable.
The application of our impairment policy resulted in other-than-temporary impairment charges
that reduced our income before income taxes by $510 million in 2008, $16 million in 2007 and
$1 million in 2006. Impairment charges are recorded for other-than-temporary declines in
value, if, in the asset impairment committee’s judgment, there is little expectation that
the value may be recouped within a designated recovery period. Other than-temporary
impairment losses represent non-cash charges to income.
Our portfolio managers monitor their assigned portfolios. If a security is trading below
book value, the portfolio managers undertake additional reviews. Such declines often occur
in conjunction with events taking place in the overall economy and market, combined with
events specific to the industry or operations of the issuing organization. Management
reviews quantitative measurements such as a declining trend in fair value, the extent of the
fair value decline and the length of time the value of the security has been depressed, as
well as qualitative measures such as pending events, credit ratings and issuer liquidity. We
are even more proactive when these declines in valuation are greater than might be
anticipated when viewed in the context of overall economic and market conditions. We provide
information about valuation of our invested assets in Item 8, Note 2 of the Consolidated
Financial Statements,
Page 104.
All securities valued below 100 percent of book value are reported to the asset impairment
committee for evaluation. A security valued between 95 percent and 100 percent of book value
is not monitored separately by the committee. These assets generally are at this value
because of interest rate-driven factors.
When evaluating for other-than-temporary impairments, the committee considers the company’s
intent and ability to retain a security for a period adequate to recover its cost. Because
of the company’s financial strength, management may not impair certain securities even when
they are trading below cost.
For fixed-maturity investments, we can make that determination based on our ability to hold
until their scheduled redemption securities that are meeting their debt obligations and have
the potential to recover value. For equity investments, we can make that determination based
on a thorough assessment of the potential for recovery over a longer-term horizon. In
addition to evaluating the security’s current valuation, the impairment committee reviews
objective evidence that indicates the potential for a recovery in value. Information is
evaluated regarding the security, such as financial performance, near-term prospects and the
financial condition of the region and industry in which the issuer operates.
Securities that have previously been impaired are evaluated based on their adjusted book
value and written down further, if deemed appropriate. We provide detailed information about
securities trading in a continuous loss position at year-end 2008 in Item 7A, Application of
Asset Impairment Policy,
Page 87. An other-than-temporary decline in the fair value of a
security is recognized in net income as realized investment losses.
Other-than-temporary impairment charges are distinct from the ordinary fluctuations seen in
the value of a security when considered in the context of overall economic and market
conditions. Securities considered to have a temporary decline would be expected to recover
their fair value, which may be at maturity. Under the same accounting
treatment as fair value gains, temporary declines (changes in the fair value of these securities) are
reflected in shareholders’ equity on our balance sheet in accumulated other comprehensive
income, net of tax, and have no impact on reported net income.
Fair Value Measurements
Valuation of Financial Instruments
Valuation of financial instruments, primarily securities held in our investment portfolio,
is a critical component of our interim financial statement preparation. We account for our
investment portfolio at fair value and apply fair value measurements as defined by SFAS No.
157, Fair Value Measurements, to financial instruments. Fair value is applicable to SFAS No.
115, Accounting for Certain Investments in Debt and Equity Securities, SFAS No. 133,
Accounting for Derivative Instruments and Hedging Activities, SFAS No. 155, Accounting for
Certain Hybrid Financial Instruments, and SFAS No. 107, Disclosures about Fair Value of
Financial Instruments.
We adopted the provisions of SFAS No. 157 on January 1, 2008. SFAS No. 157 defines fair
value as the exit price or the amount that would be 1) received to sell an asset or 2) paid
to transfer a liability in an orderly transaction between marketplace participants at the
measurement date. When determining an exit price, we
Cincinnati Financial Corporation — 2008 Annual Report on 10-K — Page 45 must, whenever possible, rely upon observable market data. Prior to the adoption of SFAS No.
157, we considered various factors such as liquidity and volatility but primarily obtained
pricing from various external services, including broker quotes.
The SFAS No. 157 exit price notion requires our valuation also to consider what a
marketplace participant would pay to buy an asset or receive to assume a liability.
Therefore, while we can consider pricing data from outside services, we ultimately determine
whether the data or inputs used by these outside services are observable or unobservable.
In accordance with SFAS No. 157, we have categorized our financial instruments, based on the
priority of the inputs to the valuation technique, into a three-level fair value hierarchy.
The fair value hierarchy gives the highest priority to quoted prices in active markets for
identical assets or liabilities (Level 1) and the lowest priority to unobservable inputs
(Level 3). If the inputs used to measure the financial instruments fall within different
levels of the hierarchy, the categorization is based on the lowest level that is significant
to the fair value measurement of the instrument.
Financial assets and liabilities recorded on the Consolidated Balance Sheets are categorized
based on the inputs to the valuation techniques as described in Item 8, Note 3 of the
Consolidated Financial Statements,
Page 106.
Level 1 and Level 2 Valuation Techniques
Over 98 percent of our $8.8 billion invested assets measured at fair value are classified as
Level 1 or Level 2. Financial assets that fall within Level 1 and Level 2 are priced
according to observable data from identical or similar securities that have traded in the
marketplace. Also within Level 2 are securities that are valued by outside services or
brokers where we have evaluated the pricing methodology and determined that the inputs are
observable.
Included in the Level 2 hierarchy are a small portfolio of collateralized mortgage
obligations that represented less than 1 percent of the fair value of our investment
portfolio at December 31, 2008. We obtained the CMOs as part of the termination of our
securities lending program during 2008. The CMOs were an investment made by one of the
short-duration funds, which subsequently dissolved and distributed the assets to its
investors. When we terminated the securities lending program, we chose to retain the CMOs
rather than sell them at what we felt were distressed prices in an illiquid market.
All $30 million of the CMOs in our portfolio are collateralized by Alt-A mortgages that
originated between 2004 and 2006. We owned investment grade CMOs with a fair value and
book value of $27 million and $39 million, respectively, at December 31, 2008. Of the $27
million investment-grade CMOs, $21 million were rated AAA by Standard & Poor’s. We also
owned non-investment grade CMOs that had a fair value and book value of $3 million and $4
million, respectively. We do not intend to make additional investments in this asset
category.
Level 3 Valuation Techniques
Financial assets that fall within the Level 3 hierarchy are valued based upon unobservable
market inputs, normally because they are not actively traded on a public market. Level 3
taxable fixed maturities securities include certain private placements, small issues,
general corporate bonds and medium-term notes. Level 3 tax-exempt fixed maturities
securities include various thinly traded municipal bonds. Level 3 common equities include
private equity securities. Level 3 preferred equities include private and thinly traded
preferred securities.
Pricing for each Level 3 security is based upon inputs that are market driven, including
third-party reviews provided to the issuer or broker quotes. However, we placed in the Level
3 hierarchy securities for which we were unable to obtain the pricing methodology or we
could not consider the price provided as binding. Management ultimately determined the
pricing for each Level 3 security that we considered to be the best exit price valuation. As
of December 31, 2008, total Level 3 assets were 1.6 percent of our investment portfolio
measured at fair value, which was relatively stable throughout 2008. Broker
quotes are obtained for thinly traded securities that subsequently fall within the Level 3
hierarchy. We obtained two non-binding quotes from brokers and used the more conservative
price for fair value. At December 31, 2008, total fair value of assets priced by broker
quotes for the SFAS No. 157 disclosure was $83 million and consisted mostly of taxable fixed
maturities.
Cincinnati Financial Corporation — 2008 Annual Report on 10-K — Page 46 Employee Benefit Pension Plan
As discussed in Item 8, Note 13 of the Consolidated Financial Statements,
Page 113, we
modified our qualified defined benefit pension during 2008, terminating participation in the
plan for certain participants in a transition to a sponsored 401(k) with company matching of
associate contributions. Contributions and pension costs are developed from annual actuarial
valuations. These valuations involve key assumptions including discount rates and expected
return on plan assets, which are updated each year. Any adjustments to these assumptions are
based on considerations of current market conditions. Therefore, changes in the related
pension costs or credits may occur in the future due to changes in assumptions.
Key assumptions used in developing the 2008 net pension obligation were a 6.00 percent
discount rate and rates of compensation increases ranging from 4 percent to 6 percent. Key
assumptions used in developing the 2008 net pension expense were a 6.25 percent discount
rate, an 8 percent expected return on plan assets and rates of compensation increases
ranging from 4 percent to 6 percent. See Note 13 for additional information on assumptions.
In 2008, the net pension expense was $47 million, including one-time charges of $27 million
for settlement and $3 million for curtailment related to the modifications to the qualified
pension plan. In 2009, we expect a net pension expense of $11 million.
Holding all other assumptions constant, a 0.5 percentage point decline in the discount rate
would lower our 2009 net income before income taxes by $1 million. Likewise, a 0.5
percentage point decline in the expected return on plan assets would lower our 2009 income
before income taxes by $1 million.
The fair value of the plan assets was $52 million less than the accumulated benefit
obligation at year end 2008 and $4 million greater than the accumulated benefit obligation
at year-end 2007. The fair value of the plan assets was $88 million less than the projected
plan benefit obligation at year-end 2008 and $60 million less at year-end 2007. Market
conditions and interest rates significantly affect future assets and liabilities of the
pension plan. In 2009, we expect to contribute approximately $33 million to our qualified
plan.
Deferred Acquisition Costs
We establish a deferred asset for costs that vary with, and are primarily related to,
acquiring property casualty and life insurance business. These costs are principally agent
commissions, premium taxes and certain underwriting costs, which are deferred and amortized
into income as premiums are earned. Deferred acquisition costs track with the change in
premiums. Underlying assumptions are updated periodically to reflect actual experience.
Changes in the amounts or timing of estimated future profits could result in adjustments to
the accumulated amortization of these costs.
For property casualty policies, deferred acquisition costs are amortized over the terms of
the policies. For life policies, acquisition costs are amortized into income either over the
premium-paying period of the policies or the life of the policy, depending on the policy
type.
Contingent Commission Accrual
Another significant estimate relates to our accrual for property casualty contingent
(profit-sharing) commissions. We base the contingent commission accrual estimates on
property casualty underwriting results and on supplemental information. Contingent
commissions are paid to agencies using a formula that takes into account agency
profitability, premium volume and other factors, such as prompt monthly payment of amounts
due to the company. Due to the complexity of the calculation and the variety of factors that
can affect contingent commissions for an individual agency, the amount accrued can differ
from the actual contingent commissions paid. The contingent commission accrual of $75
million in 2008 contributed 2.5 percentage points to the property casualty combined ratio.
If contingent commissions paid were to vary from that amount by 5 percent, it would affect
2009 net income by $2 million (after tax), or 1 cent per share, and the combined ratio by
approximately 0.1 percentage points.
Separate Accounts
We issue life contracts, referred to as bank-owned life insurance policies (BOLI). Based on
the specific contract provisions, the assets and liabilities for some BOLIs are legally
segregated and recorded as assets and liabilities of the separate accounts. Other BOLIs are
included in the general account. For separate account BOLIs, minimum investment returns and
account values are guaranteed by the company and also include death benefits to
beneficiaries of the contract holders.
Separate account assets are carried at fair value. Separate account liabilities primarily
represent the contract holders’ claims to the related assets and are carried at an amount
equal to the contract holders account value. Generally, investment income and realized
investment gains and losses of the separate accounts accrue directly to the contract holders
and, therefore, are not included in our Consolidated Statements of Income. However, each
separate account contract includes a negotiated realized gain and loss sharing arrangement
with the company. This share is transferred from the separate account to our general account
Cincinnati Financial Corporation — 2008 Annual Report on 10-K — Page 47 and is recognized as revenue or expense. In the event that the asset value of contract
holders’ accounts is projected below the value guaranteed by the company, a liability is
established through a charge to our earnings.
For our most significant separate account, written in 1999, realized gains and losses are
retained in the separate account and are deferred and amortized to the contract holder over
a five-year period, subject to certain limitations. Upon termination or maturity of this
separate account contract, any unamortized deferred gains and/or losses will revert to the
general account. In the event this separate account holder were to exchange the contract for
the policy of another carrier in 2009, the account holder would pay a surrender charge equal
to 1 percent of the contract’s account value. The surrender charge falls to zero in 2010 and
beyond.
At year-end 2008, net unamortized realized losses amounted to $12 million. In accordance
with this separate account agreement, the investment assets must meet certain criteria
established by the regulatory authorities to whose jurisdiction the group contract holder is
subject. Therefore, sales of investments may be mandated to maintain compliance with these
regulations, possibly requiring gains or losses to be recorded, and charged to the general
account. Potentially, losses could be material; however, unrealized losses are approximately
$36 million before tax in the separate account portfolio, which had a book value of $521
million at year-end 2008.
Recent Accounting Pronouncements
Information about recent accounting pronouncements is provided in Item 8, Note 1 of the
Consolidated Financial Statements,
Page 98. We have determined that recent accounting
pronouncements have not had nor are they expected to have any material impact on our
consolidated financial statements.
Results Of Operations
Consolidated financial results primarily reflect the results of our four reporting segments.
These segments are defined based on financial information we use to evaluate performance and
to determine the allocation of assets.
We report as “Other” the non-investment operations of the parent company and its
subsidiaries CFC Investment Company and CinFin Capital Management Company (excluding client
investment activities), as well as other income of our standard market property casualty
insurance operations. CinFin Capital Management will terminate all operations effective
February 28, 2009. Beginning in 2008, we also include in Other the results of The Cincinnati
Specialty Underwriters Insurance Company and CSU Producer Resources.
We measure profit or loss for our commercial lines and personal lines property casualty and
life insurance segments based upon underwriting results (profit or loss), which represent
net earned premium less loss and loss expenses and underwriting expenses on a pretax basis.
We also frequently evaluate results for our consolidated property casualty insurance
operations, which is the total of our commercial, personal and surplus insurance results.
Underwriting results and segment pretax operating income are not substitutes for net income
determined in accordance with GAAP.
For our consolidated property casualty insurance operations as well as the insurance
segments, statutory accounting data and ratios are key performance indicators that we use to
assess business trends and to make comparisons to industry results, since GAAP-based
industry data generally is not as readily available.
Investments held by the parent company and the investment portfolios for the insurance
subsidiaries are managed and reported as the investments segment, separate from the
underwriting businesses. Net investment income and net realized investment gains and losses
for our investment portfolios are discussed in the Investments Results of Operations.
The calculations of segment data are described in more detail in Item 8, Note 18 of the
Consolidated Financial Statements,
Page 119. The following sections review results of
operations for each of the four segments. Commercial Lines Insurance Results of Operations
begins on
Page 51, Personal Lines Insurance Results of Operations begins on
Page 59, Life
Insurance Results of Operations begins on
Page 64, and Investments Results of Operations
begins on
Page 66. We begin with an overview of our consolidated property casualty
operations, which is the total of our commercial lines, personal lines and surplus lines
results.
Cincinnati Financial Corporation — 2008 Annual Report on 10-K — Page 48 Consolidated Property Casualty Insurance Results Of Operations
In addition to the factors discussed in Commercial Lines and Personal Lines Insurance
Results of Operations,
Page 51 and
Page 59, growth and profitability for our consolidated
property casualty insurance operations were affected by a number of common factors.
Changes in written and earned premiums over the past three years reflected growing price
competition partially offset by consistently high retention rates of renewal business. New
business written directly by agencies rose in 2008 after declining in 2007. The resurgence
in new business was largely due to the contribution of agencies appointed the past five
years, the contribution of our surplus lines business and more competitive personal lines
pricing. Other written premium is largely ceded reinsurance premiums.
Our combined ratio before catastrophe losses and savings from favorable prior period reserve
development rose substantially in 2008 due to lower pricing prompted by soft market
conditions and also due to normal loss cost inflation, a higher level of larger commercial
lines losses and the pension plan settlement cost. The pension plan settlement increased the
2008 combined ratio by 0.8 percentage points. Our 2007 combined ratio before catastrophe
losses and savings from favorable prior period reserve development rose largely due to the
effects of lower pricing, normal loss cost inflation and a higher level of larger commercial
lines losses.
Catastrophe losses contributed 6.8 percentage points to the combined ratio in 2008, the
highest catastrophe loss ratio for our company since 1991. In 2007, catastrophe losses added
just 0.8 percentage points, the lowest ratio over the same period. The following table shows
catastrophe losses incurred, net of reinsurance, for the past three years, as well as the
effect of loss development on prior period catastrophe reserves.
Hurricane Ike, which reached the Gulf Coast on September 12, 2008, moved into the Midwest on
September 14, causing unusually high winds in Ohio, Indiana and Kentucky. At December 31,
2008, our gross losses from Hurricane Ike were estimated at $129 million, making it the
single largest catastrophe in the company’s history. Net of reinsurance, the loss was
estimated at $58 million. Virtually all of the losses reported by our policyholders occurred
in the Midwest.
Cincinnati Financial Corporation — 2008 Annual Report on 10-K — Page 49 Catastrophe Losses Incurred
The three-year rise in total underwriting expenses largely was due to the rise in
non-commission underwriting expenses, reflecting our continued investment in the people and
systems necessary for our future growth. The change in our pension plan added 0.8 percentage
points to the overall combined ratio, including a 0.5 percentage point addition to the
non-commission expense ratio.
The discussions of our property casualty insurance segments provide additional detail about these factors.
Commercial Lines Insurance Results Of Operations
Overview — Three-year Highlights
Performance highlights for the commercial lines segment include:
Commercial Lines Insurance Premiums
As commercial lines markets have grown more competitive over the past several years, we have
focused on leveraging our local relationships as well as the efforts of our agents and the
teams that work with them. In this environment, we have been careful to maintain appropriate
pricing discipline for both new and renewal
Cincinnati Financial Corporation — 2008 Annual Report on 10-K — Page 51 business as we emphasize the importance of
assessing account quality to our agencies and underwriters. We continue to make case-by-case
decisions not to write or renew certain business. We continue to use rate credits to retain
renewals of quality business and earn new business. Our experience remains that the larger
the account, the higher the credits, with variations by geographic region and class of
business. Agency emphasis on larger accounts, convenience and technology considerations were
the primary reasons for a slight decline in the number of our smaller policies.
Over the past three years, we continued to focus on seeking and maintaining adequate premium
per exposure as well as pursuing non-pricing means of enhancing longer-term profitability.
Non-pricing means have included deliberate reviews of each risk, terms and conditions and
limits of insurance. We continue to adhere to our underwriting guidelines, to re-underwrite
books of business with selected agencies and to update policy terms and conditions. In
addition, we continue to leverage our strong local presence. Our field marketing
representatives meet with local agencies to reaffirm agreements on the extent of frontline
renewal underwriting agents will perform. Loss control, machinery and equipment and field
claims representatives continue to conduct on-site inspections. To assist underwriters,
field claims representatives prepare full reports on risks of concern.
Both renewal and new business reflected the effects of the economic slowdown in many
regions, as exposures declined and policyholders became increasingly focused on reducing
expenses. For commercial accounts, we typically calculate general liability premiums based
on sales or payroll volume while we calculate workers’ compensation premiums based on
payroll volume. A change in sales or payroll volume generally indicates a change in demand
for a business’s goods or services, as well as a change in its exposure to risk.
Policyholders who experience sales or payroll volume changes due to economic factors may be
purchasers of other types of insurance, such as commercial auto or commercial property, in
addition to general liability and workers’ compensation. Premium levels for these other
types of policies generally are not linked directly to sales or payroll volumes.
In 2008, we estimated that policyholders with a contractor-related ISO general liability
code accounted for approximately 38 percent of our general liability premiums, which are
included in the commercial casualty line of business, and that policyholders with a
contractor-related NCCI workers’ compensation code accounted for approximately 47 percent of
our workers’ compensation premiums. The contractor market has been one of the more adversely
affected by the economic slowdown.
The decline in 2008 agency renewal written premiums was largely driven by the pricing and
exposure declines while policy retention rates remained relatively steady. For renewal
business, our headquarters underwriters talk regularly with agents. Our field teams are
available to assist headquarters underwriters by conducting inspections and holding renewal
review meetings with agency staff. These activities can help verify that a commercial
account retains the characteristics that caused us to write the business initially. For
renewal business, the typical pricing decline has moved into the mid-single-digits, although
higher declines occur. In addition to pricing pressures, premiums confirmed by audits of
policyholder sales and payrolls declined for 2008.
For new business, our field associates are in our agents’ offices helping to judge the
quality of each account, emphasizing the Cincinnati value proposition, calling on sales
prospects with those agents, carefully evaluating risk exposure and working up their best
quotes. In 2008, new business premium growth largely was driven by agencies appointed in the
past five years with relatively stable contributions from the remaining agencies. At
year-end 2008, our field marketing representatives reported pricing down about 5 percent to
10 percent on average to write the same piece of quality new business we would have quoted
in 2007, the third consecutive year of significant declines in our new business pricing.
Pricing on new business remains competitive as many carriers appear to be managing the soft
market by working aggressively to protect their renewal portfolios.
In 2007 and 2008, other written premiums lowered net written premiums more than 2006. Higher
ceded reinsurance costs were the primary driver in both 2007 and 2008, including the reinsurance
reinstatement premium incurred in 2008.
Commercial Lines Insurance Loss and Loss Expenses
Loss and loss expenses include both net paid losses and reserve changes for unpaid losses as
well as the associated loss expenses.
For our larger business lines, the trend in the current accident year loss and loss expense
ratio before catastrophe losses over the past three years reflected normal loss cost
inflation as well as competitive
Cincinnati Financial Corporation — 2008 Annual Report on 10-K — Page 52 market conditions and softer pricing that began in 2005 and
continued through 2008, as discussed above. In 2008, we saw a higher level of larger losses
from director and officer liability coverages, as discussed below. The increase in larger losses in
2007 was primarily seen in general liability, commercial auto and workers’ compensation.
Catastrophe losses were highly volatile over the three year period as discussed in
Consolidated Property Casualty Insurance Results of Operations,
Page 49. Savings from prior
period reserve development continued to trend favorably in 2008 as discussed in Commercial
Lines Insurance Segment Reserves,
Page 77.
Commercial Lines Insurance Losses by Size
The rise in the loss and loss expense ratio reflected a growing contribution from new losses
and case reserve increases greater than $250,000. In total, commercial lines new losses and
reserve increases greater than $250,000 rose to 26.3 percent of earned premiums from 23.3
percent in 2007 and 21.3 percent in 2006. Our analysis indicated no unexpected concentration
of these losses and reserve increases by geographic region, policy inception, agency or
field marketing territory. We believe the increase was due to a number of factors, including
a larger number of director and officer liability claims, changes in retention levels for
our per risk reinsurance programs, changes in case reserving practices for our workers’
compensation business line, natural volatility and general inflationary trends in loss
costs, which we continue to monitor. In 2006 and 2007, our retention for our property and
casualty working treaties was $4 million. In 2008, we raised the casualty retention to $5
million.
Commercial Lines Insurance Underwriting Expenses
Commercial lines commission expense as a percent of earned premium declined in 2008 from the
relatively stable level of the prior two years. The change in the ratio reflected both the
decline in earned premiums and a lower level of contingent commissions in 2008. Commission
expenses include our profit-sharing, or contingent, commissions, which are calculated on the
profitability of an agency’s aggregate property casualty book of Cincinnati business, taking
into account longer-term profit and premium volume, with a percentage for prompt payment of
premiums and other criteria, to reward the agency’s effort. These profit-based commissions
generally fluctuate with our loss and loss expense ratio. Our 2008 contingent commission
Cincinnati Financial Corporation — 2008 Annual Report on 10-K — Page 53 accrual reflected our estimate of the profit-sharing commissions to be paid to our agencies
in early 2009, based largely on each agency’s performance in 2008.
In both 2007 and 2008, non-commission expenses rose on flat or declining earned premiums,
which also led to unfavorable deferred acquisition expense comparisons. Further, in 2008,
the salary cost contribution rose by approximately 0.8 percentage points and the change in
our pension plan contributed 0.5 percentage points to the ratio. In 2007, our surplus lines
start-up activities contributed slightly to higher staffing and technology expenses. Surplus
lines expenses were included in Other in 2008. Refinements in the allocation of expenses
between our commercial lines and personal lines segments also contributed to minor variations in the non-commission underwriting expenses.
Commercial Lines Insurance Outlook
Industrywide commercial lines written premiums are expected to decline approximately 1.4
percent in 2009 with the industry combined ratio estimated at 105.1 percent. As discussed in
Item 1, Commercial Lines Insurance Marketplace,
Page 13, over the past several years,
renewal and new business pricing has come under steadily increasing pressure, reinforcing
the need for more flexibility and careful risk selection. We expect commercial lines price
declines to slow in 2009.
We intend to continue marketing our products to a broad range of business classes, pricing
our products appropriately and taking a package approach. We intend to maintain our
underwriting selectivity and carefully manage our rate levels as well as our programs that
seek to accurately match exposures with appropriate premiums. We will continue to evaluate
each risk individually and to make decisions about rates, the use of three-year commercial
policies and other policy conditions on a case-by-case basis, even in lines and classes of
business that are under competitive pressure. Nonetheless, we expect
commercial lines profitability to remain under pressure in 2009.
In Item 1, Strategic Initiatives,
Page 7, we discuss the initiatives we are implementing to
achieve our corporate performance objectives. We discuss our overall outlook for our
property casualty insurance operations in the Executive Summary,
Page 37.
Commercial Lines of Business Analysis
Approximately 95 percent of our commercial lines premiums relate to accounts with coverages
from more than one of our business lines. As a result, we believe that the commercial lines
segment is best measured and evaluated on a segment basis. However, we provide line of
business data to summarize growth and profitability trends separately for each line. The
accident year loss data provides current estimates of incurred loss and loss expenses and
corresponding ratios over the most recent three accident years. Accident year data
classifies losses according to the year in which the corresponding loss events occur,
regardless of when the losses are actually reported, recorded or paid.
Commercial Casualty
Accident year loss and loss expenses incurred and ratios to earned premiums:
Commercial casualty is our largest business line. The decline in commercial casualty net
written premiums reflected the intensifying competition in the casualty market. In addition,
premiums for this business line can reflect economic trends, including changes in underlying
exposures.
The calendar year loss and loss expense ratio improved in 2008 and 2007, largely because of
higher savings from favorable development on prior period reserves. Factors contributing to
the higher savings included
Cincinnati Financial Corporation — 2008 Annual Report on 10-K — Page 54 refinements to our IBNR reserve allocation, quarter-to-quarter
reductions in actuarial reserve estimates, the introduction of an additional umbrella
reserving model, sooner-than-expected moderation in the inflation trend of allocated loss
expenses and unusual deviations from predictions of reserving methods and models.
These factors are discussed in Commercial Lines Insurance Segment Reserves,
Page 77. The
level of new losses and case reserve increases greater than $250,000 was slightly lower than
in 2007.
The current accident year loss and loss expense ratio before catastrophe losses deteriorated
over the three-year period, primarily because of lower pricing per exposure and normal loss
cost inflation. Further, the commercial casualty business line includes some of our longest
tail exposures, making initial estimates of accident year loss and loss expenses incurred
more uncertain, as we discuss in Critical Accounting Estimates, Property Casualty Insurance
Loss and Loss Expense Reserves,
Page 41.
Commercial Property
Accident year loss and loss expenses incurred and ratios to earned premiums:
Commercial property is our second largest business line. The decline in commercial property
net written premiums over the three-year period reflected pricing declines exacerbated by
higher reinsurance premiums, including the premium reinstatement premium in 2008.
The calendar year loss and loss expense ratio deteriorated substantially in 2008 after
improving in 2007, primarily due to fluctuations in catastrophe losses. New losses and case
reserve increases greater than $250,000 added 3.4 percentage points to the 2008 ratio.
Development on prior period reserves was relatively stable over the period.
The current accident year loss and loss expense ratio before catastrophe losses deteriorated
over the three-year period. A portion of the increase was due to a higher loss expense
allocation because of the level of catastrophe and weather-related losses. In addition, the
refinement in the allocation of IBNR reserves by accident year artificially accentuated the
difference between the 2007 and 2008 ratios by approximately 2 percentage points.
Cincinnati Financial Corporation — 2008 Annual Report on 10-K — Page 55 Commercial Auto
Accident year loss and loss expenses incurred and ratios to earned premiums:
The decline in commercial auto written premiums over the three-year period reflected the
downward pressure exerted by the market on the pricing of commercial accounts. Commercial auto
is one of the business lines that we renew and price annually, so market trends may be reflected
here more quickly than in other lines. Commercial auto also experiences pricing pressure because
it often represents the largest portion of insurance costs for many commercial policyholders.
The calendar year loss and loss expense ratios moved above the range we consider appropriate in
2008 due to ongoing pricing pressures and normal loss cost inflation. We believe volatility in
the number of commercial auto losses greater than $1 million reflected natural volatility and
general inflationary trends in loss costs. Savings from development on prior period reserves was
lower in 2008 than 2007 and 2006 as commercial auto paid and reported loss development trends
were relatively stable.
Pricing and normal loss cost inflation were the primary drivers of the deterioration in the
accident year loss and loss expense ratio before catastrophe losses over the past three years.
Workers’ Compensation
Accident year loss and loss expenses incurred and ratios to earned premiums:
Workers’ compensation written premiums have been relatively flat over the past three years.
Although we have seen rising policy counts, these gains have been offset by reductions in
payroll levels due to the troubled economy as well as rate decreases and the use of credits in a
majority of our territories. We have had initiatives in place to judiciously expand our workers’
compensation business in selected states that
Cincinnati Financial Corporation — 2008 Annual Report on 10-K — Page 56 traditionally have been profitable markets for us and to enter states, such as Arizona and West
Virginia, where we previously were not actively writing the line. We cannot offer workers’
compensation coverage in Ohio, our highest total property casualty premium volume state, because
it is provided solely by the state instead of private insurers.
Since we pay a lower commission rate on workers’ compensation business, this line has a higher
calendar year loss and loss expense breakeven point than our other commercial business lines.
Nonetheless, the ratio remained above our target levels over the three-year period. Management
is actively pursuing programs to improve financial performance for this line. For example, in
2009, we are putting in place a predictive modeling program to improve our pricing accuracy, and
we are accelerating our delivery of loss control services to help manage our workers’
compensation profitability.
In addition, the workers’ compensation business line includes our longest tail exposures, making
initial estimates of accident year loss and loss expenses incurred more uncertain. Due to the
lengthy payout period of workers’ compensation claims, small shifts in medical cost inflation
and payout periods could have a significant effect on our potential future liability compared
with our current projections.
Specialty Packages
Accident year loss and loss expenses incurred and ratios to earned premiums:
Specialty packages net written premiums were relatively flat over the three-year period. Our
commercial lines policy processing system for Businessowners Policies, which are included in
this business line, is helping us meet changing agency needs and address pricing, technology
and service innovations that other carriers have introduced for similar products in recent
years.
The calendar year loss and loss expense ratio reflected the volatility in catastrophe losses
over the three-year period. In addition, the current accident year loss and loss expense ratio
before catastrophe losses has risen over the period because of pricing reductions and normal
loss cost inflation.
Cincinnati Financial Corporation — 2008 Annual Report on 10-K — Page 57 Surety and Executive Risk
Accident year loss and loss expenses incurred and ratios to earned premiums:
Surety and executive risk net written premiums rose over the three-year period as we enhanced
our marketing of these products.
Director and officer liability coverage accounted for 58.9 percent of surety and executive
risk premiums in 2008 compared with 62.3 percent in 2007 and 60.5 percent in 2006. We actively
manage the potentially high risk of writing director and officer liability by:
The calendar year and current accident year loss and loss expense ratios rose substantially in
2008, driven by additional director and officer new losses and case reserve increases greater
than $250,000. During 2008, 38 of the new director and officer losses and case reserve
increases added approximately $43 million to loss and loss expenses compared with 20 adding
about $9 million in 2007 and 16 adding about $16 million in 2006. The higher level in 2008 was
largely due to six new losses and five case reserve increases greater than $1 million on
claims made in 2007. Eight of these 11 items were related to lending practices at financial
institutions. To address the potential risk of this portion of our surety and executive risk
business line moving forward, we are working with our agents to limit the number of new
director and officer policies for financial institutions. At renewal, we are carefully
re-underwriting each account based on credit rating and other metrics.
Cincinnati Financial Corporation — 2008 Annual Report on 10-K — Page 58 Machinery and Equipment
Accident year loss and loss expenses incurred and ratios to earned premiums:
Machinery and equipment net written premiums rose in 2008 after a relatively flat 2007.
Because of the relatively small size of this business line, the calendar year and accident
year loss and loss expense ratios can fluctuate substantially.
Personal Lines Insurance Results Of Operations
Overview — Three-year Highlights
Performance highlights for the personal lines segment include:
Cincinnati Financial Corporation — 2008 Annual Report on 10-K — Page 59
Personal lines insurance is a strategic component of our overall relationship with many of our
agencies and an important component of our agencies’ relationships with their clients. We
believe agents recommend Cincinnati personal insurance products for their value-oriented
clients who seek to balance quality and price and who are attracted by our superior claims
service and the benefits of our package approach.
Our personal lines policyholder retention and new business levels have remained at higher
levels following our July 2006 introduction of a limited program of policy credits for
personal auto and homeowner pricing in most of the states in which our Diamond system is in
use. The program provided credits for eligible new and renewal policyholders identified as
above-average risks.
The rate of decline in our personal lines agency renewal written premiums further slowed in
2008, as the benefits of additional tiers to our pricing structure were seen in many states.
These tiers are intended to improve our ability to compete for our agents’ highest quality
personal lines accounts, increasing opportunities for our agents to market the advantages of
our personal lines products and services to their clients.
The number of in-force homeowner and personal auto policies has declined steadily, but the
year-over-year rate of decline slowed to 2.3 percent as of year-end 2008 compared with 3.1
percent at year-end 2007. Additional pricing and credit changes were implemented in early
2009, with introductions in additional states planned for subsequent months. This round of
changes further improves pricing for the best accounts, which should help us retain and
attract even more of our agents’ preferred business.
Our personal lines new business written by our agencies rose for the third consecutive year in
2008 as the number of agency locations writing our personal lines rose by over 130, or 14.0
percent, in 2008. We set the stage to improve our geographic diversification by opening
Arizona and Utah to personal lines. We also expanded our activity in Maryland and North
Carolina by introducing personal auto and appointing additional locations from our existing
agency network. However, the increased new business did not fully offset the impact of lost
business and lower rates on above-average quality renewal business.
In 2007 and 2008, other written premiums lowered net written premiums more than 2006. Higher
ceded reinsurance costs were the primary driver in both years, including the reinsurance
reinstatement premium incurred in 2008.
Personal Lines Insurance Loss and Loss Expenses
Loss and loss expenses include both net paid losses and reserve changes for unpaid losses as
well as the associated loss expenses. The increase in the current accident year loss and loss
expense ratio before catastrophe losses over the past three years was due to the pricing
factors discussed above, normal loss cost inflation, refinements made to the allocation of
IBNR reserves by accident year and higher non-catastrophe weather-related losses. Larger
personal lines losses were a smaller percentage of earned premiums in 2008.
Catastrophe losses were highly volatile over the three-year period as discussed in
Consolidated Property Casualty Insurance Results of Operations,
Page 49. Savings from prior
period reserve development continued to trend favorably in 2008 as discussed in Personal Lines
Insurance Segment Reserves,
Page 79.
Cincinnati Financial Corporation — 2008 Annual Report on 10-K — Page 60 Personal Lines Insurance Losses by Size
The effect on the loss and loss expense ratio from new losses and case reserve increases
greater than $250,000 was lower in 2008 than it was in 2007. Our analysis indicated no
unexpected concentration of these losses and reserve increases by risk category, geographic
region, policy inception, agency or field marketing territory. We believe the increase in 2007
largely was due to general inflationary trends in loss costs, which we continue to monitor, as
well as natural volatility.
Personal Lines Insurance Underwriting Expenses
Personal lines commission expense as a percent of earned premium declined in 2008 after rising
slightly in 2007. The 2008 decline in the ratio reflected both the decline in earned premiums
and a lower level of contingent commissions. Commission expenses include our profit-sharing,
or contingent, commissions, which are calculated on the profitability of an agency’s aggregate
property casualty book of Cincinnati business, taking into account longer-term profit and
premium volume, with a percentage for prompt payment of premiums and other criteria, to reward
the agency’s effort. These profit-based commissions generally fluctuate with our loss and loss
expense ratio. Our 2008 contingent commission accrual reflected our estimate of the
profit-sharing commissions to be paid to our agencies in early 2009 based largely on each
agency’s performance in 2008.
Non-commission underwriting expenses were relatively stable over the three-year period. The
modest increase in 2008 was due to the pension charge. Refinements in the allocation of
expenses between our commercial lines and personal lines segments also contributed to minor
variations in the non-commission underwriting expenses.
Personal Lines Insurance Outlook
Industry analysts currently anticipate industrywide personal lines written premiums may rise
approximately 2.5 percent in 2009, with the combined ratio estimated at 97.6 percent. While
the improvement in our new business levels and policy retention rates over the past several
years are positive indications for our personal lines business, we expect our growth rate to
be below that of the industry as we continue to address our pricing. In Item 1, Strategic
Initiatives,
Page 7, we discuss the initiatives we are implementing to address the
unsatisfactory performance of our personal lines segment, in particular the homeowner line of
business.
Cincinnati Financial Corporation — 2008 Annual Report on 10-K — Page 61 We describe steps that will enhance our response to the changing marketplace. We are
aware that our personal lines pricing and loss activity are at levels that could put
achievement of our corporate financial objectives at risk if those trends continue. We discuss
our overall outlook for our property casualty insurance operations in the Executive Summary,
Page 37.
Personal Lines of Business Analysis
We prefer to write personal lines coverage on an account basis that includes both auto and
homeowner coverages as well as coverages from the other personal business line. As a result,
we believe that the personal lines segment is best measured and evaluated on a segment basis.
However, we provide line of business data to summarize growth and profitability trends
separately for each line. The accident year loss data provides current estimates of incurred
loss and loss expenses and corresponding ratios over the most recent three accident years.
Accident year data classifies losses according to the year in which the corresponding loss
events occur, regardless of when the losses are actually reported, recorded or paid.
Personal Auto
Accident year loss and loss expenses incurred and ratios to earned premiums:
The decline in written and earned premiums slowed over the past three years as we continued to
modify pricing, improving retention and attracting new policyholders. New business activity is
nearing a level that would allow us to replace premiums lost due to price reductions and
normal attrition. We continue to monitor and modify selected rates and credits to address our
competitive position.
The calendar year loss and loss expense ratio rose slightly over the three-year period. In
recent years, we have seen generally higher costs for liability claims, including severe
injuries, and we have sought rate increases for liability coverages that partially offset
price decreases for physical damage coverages.
Pricing decreases and normal loss cost inflation also were primary drivers in the rise in the
accident year loss and loss expense ratio before catastrophe losses over the past three years.
In addition, the 2008 accident year loss and loss expense ratio rose by approximately 4
percentage points because of the refinements made to our IBNR reserve allocation by accident
year.
Cincinnati Financial Corporation — 2008 Annual Report on 10-K — Page 62 Homeowner
Accident year loss and loss expenses incurred and ratios to earned premiums:
Written and earned premium trends in 2008 and 2007 reflected improved new business levels
offset by higher reinsurance premiums in both years. Reinsurance premiums, including a
reinstatement premium of $8 million in 2008, were $33 million in 2008, $21 million in 2007
and $16 million in 2006. The pricing changes of the past several years have had a positive
effect on policyholder retention and new business activity. We continue to monitor and
modify selected rates and credits to address our competitive position.
The calendar year loss and loss expense ratio over the past three years fluctuated with
catastrophe losses. Catastrophe losses have been above our expected range in recent years,
averaging 24.7 percent of homeowner earned premium from 2006 to 2008, compared with a
five-year average of 20.9 percent.
The current accident year loss and loss expense ratio before catastrophe losses rose
significantly in 2008, in part because of the decline in earned premiums, which largely
reflected rate changes we made to keep our retention rate and new business at acceptable
levels. Non-catastrophe weather-related losses contributed about 5 percentage points to the
2008 ratio. In addition, the refinements made to our IBNR reserve allocation by accident
year and a lower estimate of salvage and subrogation reserves raised the ratio by about 2
percentage points.
Cincinnati Financial Corporation — 2008 Annual Report on 10-K — Page 63 Other Personal
Accident year loss and loss expenses incurred and ratios to earned premiums:
Other personal written premiums were essentially unchanged over the three-year period. The
decline in the number of homeowner and personal auto policies over the past several years
hindered growth in this business line since most of our other personal coverages are
endorsed to homeowner or auto policies.
The calendar year loss and loss expense ratio for other personal deteriorated in 2008 after
improving in 2007. Variations in catastrophe losses and favorable development on prior
period reserves accounted for this result. Savings from favorable development on prior
period reserves is high for this business line because personal umbrella losses, which are a
major component of other personal losses, can fluctuate significantly.
Life Insurance Results Of Operations
Overview — Three-year Highlights
Performance highlights for the life insurance segment include:
Cincinnati Financial Corporation — 2008 Annual Report on 10-K — Page 64 Life Insurance Results
Life Insurance Growth
We market term, whole and universal life products, fixed annuities and disability income
products. In addition, we offer term, whole and universal life and disability insurance to
employees at their worksite. These products provide our property casualty agency force with
excellent cross-serving opportunities for both commercial and personal accounts.
Earned premiums increased slightly in 2008 largely because of growth in our term insurance
business. Total statutory life insurance net written premiums rose in 2008 to $185 million,
compared with $167 million and $161 million in 2007 and 2006. Total statutory written
premiums for life insurance operations for all periods include life insurance, annuity and
accident and health premiums. The increase in total statutory life insurance written
premiums primarily was due to sales of term life insurance and annuity products.
Earned premiums for universal life products declined because fee income decreased 21 percent
in 2008, principally reflecting an increase in our liability for unearned front-end loads,
an actuarial adjustment.
Separate account investment management fee income contributed $2 million to total revenue in
2008, compared with a $4 million contribution in 2007 and $3 million in 2006. These fees
declined primarily because of a net realized capital loss sharing agreement between the
separate account and the general account.
Over the past several years, we have worked to maintain a portfolio of simple, yet
competitive products, primarily under the LifeHorizons banner. Our product development
efforts emphasize death benefit protection and guarantees. Distribution expansion within our
property casualty insurance agencies remains a high priority. In the past several years, we
have added life field marketing representatives for the western, southeastern and
northeastern states. Our 30 life field marketing representatives work in partnership with
our more than 100 property casualty field marketing representatives. Approximately 71
percent of our term and other life insurance product premiums were generated through our
property casualty insurance agency relationships.
Life Insurance Profitability
Life segment expenses consist principally of:
Life segment profitability depends largely on premium levels, the adequacy of product
pricing, underwriting skill and operating efficiencies. Life segment results include only
investment interest credited to contract holders (interest assumed in life insurance policy
reserve calculations). The remaining investment income is reported in the investment segment
results. The life investment
portfolio is managed to earn target spreads between earned investment rates on general
account assets and rates credited to policyholders. We consider the value of assets under
management and investment income for the life investment portfolio as key performance
indicators for the life insurance segment.
We seek to maintain a competitive advantage with respect to benefits paid and reserve
increases by consistently achieving better than average claims experience due to skilled
underwriting. Commissions paid by the life insurance operation are on par with industry
averages.
During the past several years, we have invested in imaging and workflow technology and have
significantly improved application processing. We have achieved process efficiencies while
improving our service. These
Cincinnati Financial Corporation — 2008 Annual Report on 10-K — Page 65 efficiencies have played a significant role in cost containment
and in our ability to increase total premiums and policy count over the past 10 years with
minimal headcount additions.
Life Insurance Outlook
The life insurance industry faced a difficult year as broad and deep dislocations in the
financial markets led to investment losses. While our investments also suffered, Cincinnati
Life finished 2008 with very strong statutory capital and surplus and risk based capital
ratios.
The difficulties have been most acute for writers of variable and equity-indexed products.
In addition to losing significant amounts of fee income, such writers must draw down on
capital to establish additional reserves for product guarantees and they must pay a higher
cost for hedging programs as the markets have declined and become more volatile. We have not
entered the variable or equity-indexed market, so we are not subject to the severe costs
associated with these products.
Companies writing competitively priced term life insurance also must deal with very
conservative statutory reserves and the associated heavy capital requirements. Many term
life writers have used capital market solutions to move redundant reserves off their balance
sheets. The increased cost of these solutions has decreased their viability as a method for
relieving reserve strain. Because of our financial strength, we have not had to employ these
solutions, and their unavailability is not curtailing our ability to continue offering
competitively priced term life insurance.
Some life companies are adopting new rules and/or requesting permitted practices from their
domiciliary state that allow them to strengthen their statutory balance sheets by reducing
their reserve and/or capital requirements. In view of our strong capital, we have elected
not to follow such a course of action. Even in the current difficult business and economic
environment, we believe that we are in a good position to grow at reasonable and profitable
levels in 2009.
Investments Results Of Operations
Overview — Three-year Highlights
The investment segment contributes investment income and realized gains and losses to
results of operations. Investments provide our primary source of pretax and after-tax
profits.
Investment Results
Investment Income
The primary drivers of investment income were:
Cincinnati Financial Corporation — 2008 Annual Report on 10-K — Page 66
We are investing available cash flow in both fixed income and equity securities with yields
that we believe are likely to be more secure. This may slow the return to growth in
investment income although we believe year-over-year comparisons may turn positive in the
second half of 2009.
Net Realized Investment Gains and Losses
Net realized investment gains and losses are made up of realized investment gains and losses
on the sale of securities, changes in the valuation of embedded derivatives within certain
convertible securities and other-than-temporary impairment charges. These three areas are
discussed below.
Investment gains or losses are recognized upon the sales of investments or as otherwise
required under GAAP. The timing of realized gains or losses from sales can have a material
effect on results in any quarter. However, such gains or losses usually have little, if any,
effect on total shareholders’ equity because most equity and fixed maturity investments are
carried at fair value, with the unrealized gain or loss included as a component of other
comprehensive income. Impairment charges are recorded for other-than-temporary declines in
value if, in the asset impairment committee’s
judgment, there is little expectation that the value may be recouped within a designated
recovery period. Other-than-temporary impairment losses represent non-cash charges to
income.
Realized Investment Gains and Losses
As appropriate, we buy, hold or sell both fixed-maturity and equity securities on an ongoing
basis to help achieve our portfolio objectives.
Pretax realized investment gains in the past three years largely were due to the sale of
equity holdings. In 2008, most of the gain was due to sales of holdings of common and
preferred stocks of financial services issuers, reflecting our historical weighting in
financial sector securities. The majority of these holdings were sold following reductions
or elimination of their cash dividends to shareholders. Because of our low cost basis, we
were able to record gains on many of these sales despite the decline in overall stock market
values during 2008. Realized gains were lower in 2007, although we chose to take gains from
partial sales of selected holdings and to sell other holdings because of general credit
concerns that began in the subprime mortgage market and spread to other areas in the
homebuilding and related industries over the course of 2007. The gain in 2006 largely was
due to the sale of our entire Alltel common stock holding.
During the past three years, fixed maturity securities were divested as a result of calls or
as outright sales executed to either improve yield prospects or in response to adverse
credit concerns. Although we prefer to hold fixed-maturity investments until they mature, a
decision to sell reflects our perception of a change in the underlying fundamentals of the
security and preference to allocate those funds to investments that more closely meet our
established parameters for long-term stability and growth. Our opinion that a security
fundamentally no longer meets our investment parameters may reflect a loss of confidence in
the issuer’s management, a change in underlying risk factors (such as political risk,
regulatory risk, sector risk or credit risk), or a strategic shift in business strategy that
is not consistent with our long-term outlook.
Change in the Valuation of Securities with Embedded Derivatives
We have a small portfolio of convertible preferred stocks and bonds, which have an embedded
derivative component under GAAP accounting rules. In 2008 and 2007, we recorded $38 million
and $11 million in fair value declines compared with $7 million in fair value increases in
2006. In 2008 and 2007, these changes in fair value were due to the application of SFAS No.
155, which allows us to account for the entire hybrid financial instrument at fair value,
with changes recognized in realized investment gains and losses. In 2006, these changes in
fair value were due to the application of SFAS No. 133, which required measurement of the
fluctuations in the value of the embedded derivative features in selected convertible
securities. The changes in fair values are recognized in net income in the period they
occur. See the discussion of Derivative Financial Instruments and Hedging Activities in Item
8, Note 1 of the Consolidated Financial Statements,
Page 98, for details on the accounting
for convertible security embedded options.
Other-than-temporary Impairment Charges
In 2008, we recorded $510 million in write-downs of 126 securities that we deemed had
experienced an other-than-temporary decline in fair value versus $16 million in 2007 and
$1 million in 2006. The factors we consider when evaluating impairments are discussed in
Critical Accounting Estimates, Asset Impairment,
Page 45. The other-than-temporary
impairment charges in 2008 represented 5.7 percent of our total invested assets at year-end.
Other-than-temporary impairment charges also include unrealized losses of holdings that we
had identified for sale but not yet completed a transaction.
Cincinnati Financial Corporation — 2008 Annual Report on 10-K — Page 67 Other-than-temporary impairment charges from the investment portfolio by the asset class we
described in Item 1, Investments Segment, Page 17, are summarized below:
Other-than-temporary impairment charges from the investment portfolio by industry are
summarized as follows:
The increase in other-than-temporary impairment charges in 2008 was largely due to
writedowns of holdings of bonds and common and preferred stocks of financial services
issuers, reflecting our historical weighting in this sector and the decline in overall stock
market values during 2008. Impairment charges rose slightly in 2007 on the initial concerns
regarding the real estate market. While we own only $30 million of
Cincinnati Financial Corporation — 2008 Annual Report on 10-K — Page 68 mortgage-backed securities in our investment portfolio, we do own investments in industries directly
affected by this credit environment.
Investments Outlook
We continue to focus on portfolio strategies to balance near-term income generation and
long-term book value growth. In 2009, we expect to continue to allocate a portion of cash
available for investment to equity securities, taking into consideration corporate liquidity
and income requirements, as well as insurance department regulations and ratings agency
comments. We discuss our portfolio strategies in Item 1, Investments Segment,
Page 17.
We believe a continuation of the current credit environment, if exacerbated by recessionary
economic conditions, could lead to further declines in portfolio values and additional
other-than-temporary impairment charges. All but 83 securities of the 2,223 securities in
the portfolio were trading at or above 70 percent of book value at year-end 2008. Our asset
impairment committee continues to monitor the investment portfolio. The current asset
impairment policy is described in Critical Accounting Estimates, Asset Impairment,
Page 45.
Other
Revenues were relatively stable over the three years for our Other business. This includes
the other income of our standard market insurance subsidiary, as well as non-investment
operations of the parent company and its subsidiaries, CFC Investment Company and CinFin
Capital Management Company (excluding client investment activities). In 2008, we also
include results of our surplus lines operations, The Cincinnati Specialty Underwriters
Insurance Company and CSU Producer Resources.
Losses before income taxes for our Other business were largely driven by interest expense
from debt of the parent company. In 2008, the loss also reflected expenses related to the
surplus lines operation.
Taxes
We had $111 million of income tax expense in 2008 compared with $337 million in 2007 and
$399 million in 2006. The effective tax rate for 2008 was 20.7 percent compared with 28.3
percent in 2007 and 30.0 percent in 2006.
The primary reason for the change in the effective tax rate was the level and timing of
realized gains as discussed in Investments Results of Operations,
Page 66. In 2008, we had
pretax realized gains of $138 million compared with pretax gains of $382 million in 2007 and
$684 million in 2006. Growth in the tax-exempt municipal bond portfolio, lower investment
income from dividends and changes in operating earnings over the periods also contributed to
the change in the effective tax rate for 2008.
We pursue a strategy of investing some portion of cash flow in tax-advantaged fixed-maturity
and equity securities to minimize our overall tax liability and maximize after-tax earnings.
For our insurance subsidiaries, approximately 85 percent of income from tax-advantaged
fixed-maturity investments is exempt from federal tax. Our non-insurance companies own no
tax-advantaged fixed-maturity investments. For our insurance subsidiaries, the dividend
received deduction, after the dividend proration of the 1986 Tax Reform Act, exempts
approximately 60 percent of dividends from qualified equities from federal tax. For our
non-insurance subsidiaries, the dividend received deduction exempts 70 percent of dividends
from qualified equities. Details about our effective tax rate are found in Item 8, Note 11
of the Consolidated Financial Statements,
Page 111.
Cincinnati Financial Corporation — 2008 Annual Report on 10-K — Page 69 Liquidity And Capital Resources
Liquidity and capital resources represent the overall financial strength of our company and
our ability to generate cash flows to meet the short- and long-term cash requirements of
business obligations and growth needs. We seek to maintain prudent levels of liquidity and
financial strength for the protection of our policyholders, creditors and shareholders. We
manage liquidity at two levels. The first is the liquidity of the parent company. The second
is the liquidity of our insurance subsidiary. The management of liquidity at both levels is
essential because each has different funding needs and sources and each is subject to
certain regulatory guidelines and requirements.
Parent Company Liquidity
The parent company’s primary means of meeting liquidity requirements are dividends from our
insurance subsidiary, investment income and after-tax sale proceeds from investments held at
the parent company level. The parent company’s primary contractual obligations are interest
and principal payments on long- and short-term debt as described under Contractual
Obligations,
Page 73. Other uses of parent company cash include general operating expenses
described under Other Commitments,
Page 73, as well as dividends to shareholders and common
stock repurchases.
This table shows a summary of the major sources and uses of liquidity by the parent company:
At the discretion of the board of directors, the company can return cash directly to
shareholders:
Insurance Subsidiary Liquidity
Our insurance subsidiary’s primary means of meeting liquidity requirements are investment
income and after-tax sale proceeds from investments held at the subsidiary level and
collection of insurance premiums. Property casualty insurance premiums generally are
received before losses are paid under the policies purchased with those premiums. While
first-year life insurance expenses normally exceed first-year
Cincinnati Financial Corporation — 2008 Annual Report on 10-K — Page 70 premiums, subsequent premiums
are used to generate investment income until the policy benefits are paid or the policy term
expires.
Our
insurance subsidiary’s primary contractual obligations are
property casualty loss and loss expenses and life policyholder
obligations as well as certain ongoing operating expenses as shown
under Contractual Obligations,
Page 73. Other uses of insurance subsidiary cash include
payments of dividends to the parent company and other operating expenses as discussed under
Other Commitments,
Page 73.
This table shows a summary of operating cash flow of the insurance subsidiary (direct
method):
Over the past three years, cash receipts from property casualty and life insurance premiums,
along with investment income, have been more than sufficient to pay claims, operating
expenses and dividends to the parent company. We discuss the factors that affected insurance
operations in Commercial Lines and Personal Lines Insurance Results of Operations,
Page 51
and
Page 59.
Additional Sources of Liquidity
Investing is a primary source of liquidity for both the parent company and insurance
subsidiary. At both the parent company and insurance subsidiary, cash in excess of operating
requirements is invested in fixed-maturity and equity securities. Equity securities provide
the potential for future increases in dividend income and for appreciation. In Item 1,
Investments Segment,
Page 17, we discuss our investment strategy, portfolio allocation and
quality.
Income from our investments is the most important investment contribution to cash flow.
After-tax proceeds of call or maturities also can provide liquidity. Although we have never
sold investments to make claims payments, the sale of investments could provide an
additional source of liquidity at either the parent company or insurance subsidiary level,
if required, although we follow a buy-and-hold investment philosophy seeking to compound
cash flows over the long-term. At year-end 2008, total unrealized gains in the investment
portfolio, before deferred income taxes, were $588 million, down from $3.339 billion at
year-end 2007, because of investment sales and market value declines of our equity holdings.
Further, financial resources of the parent company also could be made available to our
insurance subsidiary, if circumstances required. This would include our ability to access
the capital markets and short-term bank borrowings.
One way we seek to maintain a solid financial position and provide capital flexibility is by
keeping our ratio of debt to total capital low. We now are targeting a ratio below
20 percent. At year-end 2008, the ratio was 16.7 percent compared with 12.7 percent at
year-end 2007. The change was due entirely to the lower level of shareholders’ equity at
year-end 2008. Based on our present capital requirements, we do not believe we will need to
materially increase debt levels during 2009. As a result, we believe that changes in our
debt-to-capital ratio will again be a function of changes in shareholders’ equity.
We had $791 million of long-term debt and $49 million in borrowings on our short-term lines
of credit at year-end 2008. We generally have minimized our reliance on debt financing
although we may use lines of credit to fund short-term cash needs.
Long-term Debt
We provide details of our three long-term notes in Item 8, Note 8 of the Consolidated
Financial Statements,
Page 109. None of the notes are encumbered by rating triggers:
On December 22, 2008, A.M. Best removed our ratings from under review with negative
implications, raised the outlook to stable and lowered Cincinnati Financial Corporation’s
issuer credit rating and senior debt ratings to a from aa-; the issuer credit ratings of our
standard market property casualty insurance group and member companies to aa from aa+; and
the issuer credit ratings of our life insurance subsidiary to a+ from aa-.
Cincinnati Financial Corporation — 2008 Annual Report on 10-K — Page 71 On February 13, 2009, Fitch Ratings affirmed the ratings it had assigned on July 17, 2008,
when it lowered the issuer default rating of Cincinnati Financial Corporation to A from AA-
and its senior debt ratings to A- from A+, with a negative outlook.
Moody’s Investors Service removed our ratings from review on September 25, 2008, lowering
the senior debt rating of Cincinnati Financial Corporation to A3 from A2 with a stable
outlook. Moody’s maintained a two-notch spread between the debt rating and insurance
financial strength ratings due to significant financial flexibility and liquidity afforded
by the holding company’s large investment portfolio representing over 100 percent of its
outstanding debt.
Standard & Poor’s Ratings Services removed our counterparty credit ratings from credit watch
on June 30, 2008, lowering Cincinnati Financial Corporation to BBB+ and our standard market
property casualty insurance companies and our life insurance subsidiary to A+ with a
negative outlook.
Short-term Debt
At year-end 2008, we had two lines of credit with commercial banks amounting to $225 million
with $49 million outstanding.
Our $75 million unsecured line of credit with PNC Bank, N.A. was established more than five
years ago and was renewed effective June 30, 2008 for a one-year term to expire on June 30,
2009. The line has no financial covenants, and we currently believe we may be able to renew
it under terms and conditions that are essentially unchanged. CFC Investment Company, a
subsidiary of Cincinnati Financial Corporation, also is a borrower under this line of
credit. At year-end 2008, there was $49 million outstanding on this line of credit at a rate
of LIBOR plus 50 basis points. PNC Bank is a subsidiary of PNC Financial Services Group,
Inc. (NYSE:PNC)
The second line of credit is an unsecured $150 million revolving line of credit administered
by The Huntington National Bank. It was established in 2007 and will mature in 2012. The
line contains customary financial covenants that we presently meet. It is to be used for
general corporate purposes. We borrowed $20 million against the line in 2007, which was
repaid during 2008.
The line of credit includes a swing line sub-facility for same-day borrowing in the amount
of $35 million. The credit agreement provides alternative interest charges based on the type
of borrowing and our debt rating. The interest rate charged for an advancement is adjusted
LIBOR plus the applicable margin. Based on our debt ratings at year-end 2008, interest for
Eurodollar rate advances is adjusted LIBOR plus 33 basis points, and for floating rate
advances is adjusted LIBOR. Utilization and commitment fees based on Cincinnati Financial
Corporation’s current debt rating are 5 basis points and 8 basis points, respectively. CFC
Investment Company, a subsidiary of Cincinnati Financial Corporation, is a co-borrower under
the agreement.
The Huntington National Bank, a subsidiary of Huntington Bancshares Inc. (NASDAQ:HBAN), is
the lead participant with a $75 million share. U.S. Bancorp (NYSE:USB), Bank of America
(NYSE:BAC) and Northern Trust Corporation (NASDAQ: NTRS) also participate, each providing
$25 million of capacity.
Liquidity and Capital Resources Outlook
A long-term perspective governs all of our major decisions, with the goal of benefiting our
policyholders, agents, shareholders and associates over time. Exacerbating the effect of our
weaker insurance results, the ongoing instability of the financial markets in 2008
highlighted the value of building a cushion of financial strength over a period of years. In
responding to current economic pressures, we are confident in the steps we have taken to
protect our capital. We also are confident in our strategies to return our insurance
operations to growth and profitability.
Our consistent cash flows and prudent cash balances continue to create exceptional
liquidity. We enter 2009 with slightly more than $1 billion in cash and cash equivalents on
hand, in part due to an unusual level of investment sales and bond calls in the second half
of 2008, as well as unusual challenges in making new investments due to economic and market
conditions. That high cash level gives us the flexibility to meet current obligations while
building value by prudently investing where we see potential for both current income and
long-term return.
In any year, we consider the most likely source of pressure on liquidity would be an
unusually high level of catastrophe losses in a short period of time. This could create
additional obligations for our insurance operations by increasing the severity or frequency
of claims. To address the risk of unusual insurance loss
obligations including catastrophe events, we maintain property casualty reinsurance
contracts with highly rated reinsurers, as discussed under 2009 Reinsurance Programs,
Page 81. We also monitor the financial condition of our reinsurers because an insolvency could place in jeopardy a portion of our $759 million in outstanding reinsurance recoverables as
of December 31, 2008.
Continued economic weakness also has the potential to affect our liquidity and capital
resources in a number of different ways, including: delinquent payments from agencies,
defaults on interest payments by fixed-maturity holdings in our portfolio, dividend
reductions by holdings in our equity portfolio or declines in the market value of holdings
in our portfolio.
Cincinnati Financial Corporation — 2008 Annual Report on 10-K — Page 72 Further, parent company liquidity could be constrained by State of Ohio regulatory
requirements that restrict the dividends insurance subsidiaries can pay. During 2009, total
dividends that our insurance subsidiary can pay to our parent company without regulatory
approval are approximately $336 million.
Off-balance Sheet Arrangements
We do not use any special-purpose financing vehicles or have any undisclosed off-balance
sheet arrangements (as that term is defined in applicable SEC rules) that are reasonably
likely to have a current or future material effect on the company’s financial condition,
results of operation, liquidity, capital expenditures or capital resources. Similarly, the
company holds no fair-value contracts for which a lack of marketplace quotations would
necessitate the use of fair-value techniques.
Obligations
We pay obligations to customers, suppliers and associates in the normal course of our
business operations. Some are contractual obligations that define the amount, circumstances
and/or timing of payments. We have other commitments for business expenditures, however, the
amount, circumstances and/or timing of our other commitments are not dictated by contractual
arrangements.
Other Commitments
As of December 31, 2008, we believe our most significant other commitments are:
Contractual Obligations
As of December 31, 2008, we estimate our future contractual obligations as follows:
Cincinnati Financial Corporation — 2008 Annual Report on 10-K — Page 73 Our most significant contractual obligations are discussed in conjunction with related
insurance reserves in Gross Property Casualty Loss and Loss Expense Payments and Gross Life
Insurance Policyholder Obligations on
Page 74 and
Page 80, respectively. Other future
contractual obligations include:
Property Casualty Loss and Loss Expense Obligations and Reserves
Gross Property Casualty Loss and Loss Expense Payments
Our estimate of future gross property casualty loss and loss expense payments of $4.040
billion is lower than loss and loss expense reserves of $4.086 billion as of year-end 2008.
The $46 million difference is due to life and health loss
reserves, as discussed in Item 8, Note 5
of the Consolidated Financial Statements,
Page 108.
While we believe that historical performance of property casualty and life loss payment
patterns is a reasonable source for projecting future claims payments, there is inherent
uncertainty in this estimate of contractual obligations. We believe that we could meet our
obligations under a significant and unexpected change in the timing of these payments
because of the liquidity of our invested assets, strong financial position and access to
lines of credit.
Our estimates of gross property casualty loss and loss expense payments also do not include
reinsurance receivables or ceded losses. As discussed in 2009 Reinsurance Programs,
Page 81,
we purchase reinsurance to mitigate our property casualty risk exposure. Ceded property
casualty reinsurance receivables of $542 million at year-end 2008 are an offset to our gross
property casualty loss and loss expense obligations. Our reinsurance program mitigates the
liquidity risk of a single large loss or an unexpected rise in claims severity or frequency
due to a catastrophic event. Reinsurance does not relieve us of our obligation to pay
covered claims. The financial strength of our reinsurers is important because our ability to
recover for losses under one of our reinsurance agreements depends on the financial
viability of the reinsurer.
We direct our associates and agencies to settle claims and pay losses as quickly as is
practical and made $1.955 billion in net claim payments during 2008. At year-end 2008, net
property casualty reserves reflected $2.009 billion in unpaid amounts on reported claims
(case reserves), $802 million in loss expense reserves and $687 million in estimates of
claims that were incurred but had not yet been reported (IBNR). The specific amounts and
timing of obligations related to case reserves and associated loss expenses are not set
contractually. The amounts and timing of obligations for IBNR claims and related loss
expenses are unknown. We discuss our methods to establish loss and loss expense reserves and
our belief that reserves are adequate in Critical Accounting Estimates, Property Casualty
Insurance Loss and Loss Expense Reserves,
Page 41.
The historical pattern of using premium receipts for the payment of loss and loss expenses
has enabled us to extend slightly the maturities of our investment portfolio beyond the
estimated settlement date of the loss reserves. The effective duration of our fixed-maturity
portfolio was 5.4 years at year-end 2008. By contrast, the duration of our loss and loss
expense reserves was 3.0 years, and the duration of all insurance operation liabilities was
3.3 years. We believe this difference in duration does not affect our ability to meet
current obligations because cash flow from operations is sufficient to meet these
obligations. In addition, investment holdings could be liquidated, if necessary, to meet
higher than anticipated loss and loss expenses.
Range of Reasonable Reserves
The company established a reasonably likely range for net loss and loss expense reserves of
$3.256 billion to $3.592 billion at year-end 2008, with the
company carrying net reserves of $3.498 billion.
The likely range was $3.132 billion to $3.427 billion at year-end 2007, with the company
carrying net reserves of $3.397 billion. Our loss and loss expense reserves are not
discounted for the time-value of money, but we have reduced the reserves by an estimate of
the amount of salvage and subrogation payments we expect to recover. We provide a
reconciliation of the property casualty reserves with the loss and loss expense reserve as
shown on the balance sheet in Item 8, Note 5 of the Consolidated
Financial Statements, Page 108.
Cincinnati Financial Corporation — 2008 Annual Report on 10-K — Page 74 The low point of each year’s range corresponds to approximately one standard error below
each year’s mean reserve estimate, while the high point corresponds to approximately one
standard error above each year’s mean reserve estimate. We discussed management’s reasons
for basing reasonably likely reserve ranges on standard errors in Critical Accounting
Estimates, Reserve Estimate Variability,
Page 43.
The ranges reflect our assessment of the most likely unpaid loss and loss expenses at
year-end 2008 and 2007. However, actual unpaid loss and loss expenses could nonetheless fall
outside of the indicated ranges.
Management’s best estimate of total loss reserves as of year-end 2008 was consistent with
the corresponding actuarial best estimate. Management’s best estimate of total loss reserves
as of year-end 2007 also was consistent with the corresponding actuarial best estimate.
Development of Loss and Loss Expenses
We reconcile the beginning and ending balances of our reserves for loss and loss expenses at
December 31, 2008, 2007 and 2006, in Item 8, Note 5 of the Consolidated Financial
Statements,
Page 108. The reconciliation of our year-end 2007 reserve balance to net
incurred losses one year later recognizes approximately $323 million of redundant reserves.
The table on the following page shows the development of estimated reserves for loss and
loss expenses the past 10 years.
In evaluating the development of our estimated reserves for loss and loss expenses for the
past 10 years, note that each amount includes the effects of all changes in amounts for
prior periods. For example, payments or reserve adjustments related to losses settled in
2008 but incurred in 2002 are included in the cumulative deficiency or redundancy amount for
2002 and each subsequent year. In addition, this table presents calendar year data, not
accident or policy year development data, which readers may be more accustomed to analyzing.
Conditions and trends that affected development of the reserves in the past may not
necessarily occur in the future. Accordingly, it may not be appropriate to extrapolate
future redundancies or deficiencies based on this data.
Differences between the property casualty reserves reported in the accompanying consolidated
balance sheets (prepared in accordance with GAAP) and those same reserves reported in the
annual statements (filed with state insurance departments in accordance with statutory
accounting practices — SAP), relate principally to the reporting of reinsurance
recoverables, which are recognized as receivables for GAAP and as an offset to reserves for
SAP.
Cincinnati Financial Corporation — 2008 Annual Report on 10-K — Page 75 Development of Estimated Reserves for Loss and Loss Expenses
Asbestos and Environmental Reserves
We carried $114 million of net loss and loss expense reserves for asbestos and environmental
claims as of year-end 2008, compared with $123 million for such claims as of year-end 2007.
These amounts constitute 2.8 percent and 3.1 percent of total loss and loss expense reserves
as of these year-end dates.
We believe our exposure to asbestos and environmental claims is limited, largely because our
reinsurance retention was $500,000 or below prior to 1987. We also predominantly were a
personal lines company in the 1960s and 1970s when asbestos and pollution exclusions were
not widely used. During the 1980s and early 1990s, commercial lines grew as a percentage of
our overall business and our exposure to asbestos and environmental claims grew accordingly.
Over that period, we endorsed to or included in most policies an asbestos and environmental
exclusion.
Additionally, since 2002, we have revised policy terms where permitted by state regulation
to limit our exposure to mold claims prospectively and further reduce our exposure to other
environmental claims generally. Finally, we have not engaged in any mergers or acquisitions
through which such a liability could
have been assumed. We continue to monitor our claims for evidence of material exposure to
other mass tort classes such as silicosis, but we have found no such credible evidence to
date.
Reserving data for asbestos and environmental claims has characteristics that limit the
usefulness of the methods and models used to analyze loss and loss expense reserves for
other claims. Specifically, asbestos and environmental loss and loss expenses for different
accident years do not emerge independently of one another as loss development and
Bornhuetter-Ferguson methods assume. In addition, asbestos and
Cincinnati Financial Corporation — 2008 Annual Report on 10-K — Page 76 environmental loss and loss
expense data available to date does not reflect a well-defined tail, greatly complicating
the identification of an appropriate probabilistic trend family model.
Commercial Lines Insurance Segment Reserves
For the business lines in the commercial lines insurance segment, the following table shows
the breakout of gross reserves among case, IBNR and loss expense reserves. The rise in total
gross reserves for our commercial business lines is partially due to normal loss cost
inflation and exposure growth in our workers’ compensation business line, the higher level
of catastrophe losses in 2008 and an increase in larger surety and executive risk losses, as
discussed in Commercial Lines Insurance Results of Operations,
Page 51.
Cincinnati Financial Corporation — 2008 Annual Report on 10-K — Page 77 The following table shows net reserve changes at year-end 2008, 2007 and 2006 by commercial
line of business and accident year:
Overall favorable development for commercial lines reserves of $274 million in 2008
illustrated the potential for revisions inherent in estimating reserves, especially for
long-tail lines such as commercial casualty. Favorable reserve development for the
commercial casualty line accounted for 94.2 percent of the segment total in 2008. Five
factors, accounting for $182 million of favorable reserve development for the commercial
casualty line of business as discussed below, were atypical.
Cincinnati Financial Corporation — 2008 Annual Report on 10-K — Page 78 approximately $43 million lower. The release in 2008 of $43 million of commercial
casualty reserves on prior accident years added to the line’s favorable reserve
development.
Factors contributing to the remaining $76 million of commercial casualty favorable reserve
development were not unusual or unexpected. As noted in Critical Accounting Estimates, Key
Assumptions — Loss Reserving,
Page 43, our models predict that actual loss and loss expense
emergence will differ from projections, and we do not attempt to monitor or identify such
normal variations.
Personal Lines Insurance Segment Reserves
For the business lines in the personal lines insurance segment, the following table shows
the breakout of gross reserves among case, IBNR and loss expense reserves. Total gross
reserves were down slightly from year-end 2007 due to the decline in premiums and exposures
for this segment. However, gross reserves for the homeowner line of business rose slightly
on a higher level of catastrophe losses in 2008, as we discussed in Personal Lines Insurance
Results of Operations,
Page 59.
Cincinnati Financial Corporation — 2008 Annual Report on 10-K — Page 79 The following table shows net reserve changes at year-end 2008, 2007 and 2006 by personal
line of business and accident year:
Favorable development for personal lines segment reserves illustrates the potential for
revisions inherent in estimating reserves. As discussed in Commercial Lines Insurance
Segment Reserves,
Page 77, several atypical factors contributed to commercial lines
favorable reserve development in 2008, two of which also contributed to personal lines
favorable reserve development. First, during 2008, we refined our allocation of IBNR
reserves by accident year. The new allocation placed approximately $20 million more reserves
in the latest accident year, accident year 2008, than would have occurred using the prior
allocation method. Accordingly, favorable reserve development increased by the same amount
for calendar year 2008. Also during 2008, we began using blended trends from two separate
reserving models to estimate required personal umbrella reserves as of year-end 2008. This
added approximately $14 million of savings from development on prior accident years to the
other personal business line.
Life Insurance Policyholder Obligations and Reserves
Gross Life Insurance Policyholder Obligations
Our estimates of life, annuity and disability policyholder obligations reflect future
estimated cash payments to be made to policyholders for future policy benefits,
policyholders’ account balances and separate account liabilities. These estimates include
death and disability claims, policy surrenders, policy maturities, annuity payments, minimum
guarantees on separate account products, commissions and premium taxes offset by expected
future deposits and premiums on in-force contracts.
Our estimates of gross life, annuity and disability obligations do not reflect net
recoveries from reinsurance agreements. Ceded life reinsurance receivables were $206 million
at year-end 2008. As discussed in 2009 Reinsurance Programs,
Page 81, we purchase
reinsurance to mitigate or life insurance risk exposure. At year-end 2008, ceded death
benefits represented approximately 51.2 percent of our total policy face amounts in force.
Cincinnati Financial Corporation — 2008 Annual Report on 10-K — Page 80 These estimated cash outflows are undiscounted with respect to interest. As a result, the
sum of the cash outflows for all years of $3.513 billion (total of life insurance
obligations) exceeds the liabilities recorded in life policy reserves and separate accounts
for future policy benefits and claims of $2.144 billion (total of life insurance policy
reserves and separate account policy reserves). Separate account policy reserves make up all
but $1 million of separate accounts liabilities.
We have made significant assumptions to determine the estimated undiscounted cash flows of
these policies and contracts that include mortality, morbidity, future lapse rates and
interest crediting rates. Due to the significance of the assumptions used, the amounts
presented could materially differ from actual results.
Life Insurance Reserves
Gross life policy reserves were $1.551 billion at year-end 2008, compared with $1.478
billion at year-end 2007. We establish reserves for traditional life insurance policies
based on expected expenses, mortality, morbidity, withdrawal rates and investment yields,
including a provision for uncertainty. Once these assumptions are established, they
generally are maintained throughout the lives of the contracts. We use both our own
experience and industry experience adjusted for historical trends in arriving at our
assumptions for expected mortality, morbidity and withdrawal rates. We use our own
experience and historical trends for setting our assumptions for expected expenses. We base
our assumptions for expected investment income on our own experience adjusted for current
economic conditions.
We establish reserves for our universal life, deferred annuity and investment contracts
equal to the cumulative account balances, which include premium deposits plus credited
interest less charges and withdrawals. Some of our universal life insurance policies contain
no-lapse guarantee provisions. For these policies, we establish a reserve in addition to the
account balance based on expected no-lapse guarantee benefits and expected policy
assessments.
We regularly review our life insurance business to ensure that any deferred acquisition cost
associated with the business is recoverable and that our actuarial liabilities (life
insurance segment reserves) make sufficient provision for future benefits and related
expenses.
2009 Reinsurance Programs
A single large loss or an unexpected rise in claims severity or frequency due to a
catastrophic event could present us with a liquidity risk. In an effort to control such
losses, we forego marketing property casualty insurance in specific geographic areas,
monitor our exposure in certain coastal regions, review aggregate exposures to huge
disasters and purchase reinsurance. We use the Risk Management Solutions (RMS) and Applied
Insurance Research (AIR) models to evaluate exposures to a once-in-a-100 year and a
once-in-a-250 year event to help determine appropriate reinsurance coverage programs. In
conjunction with these activities, we also continue to evaluate information provided by our
reinsurance broker. These various sources explore and analyze credible scientific evidence,
including the impact of global climate change, which may affect our exposure under insurance
policies.
Reinsurance mitigates the risk of highly uncertain exposures and limits the maximum net loss
that can arise from large risks or risks concentrated in areas of exposure. Management’s
decisions about the appropriate level of risk retention are affected by various factors,
including changes in our underwriting practices, capacity to retain risks and reinsurance
market conditions. Reinsurance does not relieve us of our obligation to pay covered claims.
The financial strength of our reinsurers is important because our ability to recover for
losses covered under any reinsurance agreement depends on the financial viability of the
reinsurer.
Currently participating on our standard market property and casualty per-risk and
per-occurrence programs are Hannover Reinsurance Company, Munich Reinsurance America,
Partner Reinsurance Company of the U.S. and Swiss Reinsurance America Corporation, all of
which have A.M. Best insurer financial strength ratings of A (Excellent) or A+ (Superior).
Our property catastrophe program is subscribed through a broker by reinsurers from the
United States, Bermuda, London and the European markets.
Primary components of the 2009 property and casualty reinsurance program include:
Cincinnati Financial Corporation — 2008 Annual Report on 10-K — Page 81 reinsured at 100 percent. The ceded premium is estimated at $40 million in
2009, compared with $43 million in 2008 and $50 million in 2007.
Individual risks with insured values in excess of $25 million, as identified in the policy,
are handled through a different reinsurance mechanism. We typically reinsure property
coverage for individual risks with insured values between $25 million and $65 million under
an automatic facultative treaty. For risks with property values exceeding $65 million, we
negotiate the purchase of facultative coverage on an individual certificate basis. For
casualty coverage on individual risks with limits exceeding $25 million, facultative
reinsurance coverage is placed on an individual certificate basis.
Terrorism coverage at various levels has been secured in most of our reinsurance agreements.
The broadest coverage for this peril is found in the property and casualty working treaties,
which provide coverage for commercial and personal risks. Our property catastrophe treaty
provides coverage for personal
risks, and the majority of its reinsurers provide limited coverage for commercial risks with
total insured values of $10 million or less. For insured values between $10 million and $25
million, there also may be coverage in the property working treaty.
Reinsurance protection for the company’s surety business is covered under separate treaties
with many of the same reinsurers that write the property casualty working treaties.
CSU, the company’s newly formed surplus lines subsidiary, has purchased a property and
casualty reinsurance treaty for 2009 through Swiss Reinsurance America Corporation. Primary
components of the treaty include:
For property or casualty risks with limits exceeding $5 million, underwriters place
facultative reinsurance coverage on an individual certificate basis. The combined property
and casualty treaty provides protection on
Cincinnati Financial Corporation — 2008 Annual Report on 10-K — Page 82 a participating basis for extra contractual
obligations, as well as exposure to losses in excess of policy limits. The limit is $5
million for both property and casualty.
Cincinnati Life, our life insurance business, purchases reinsurance under separate treaties
with many of the same reinsurers that write the property casualty working treaties. In 2005,
we modified our reinsurance protection for our term life insurance business due to changes
in the marketplace that affected the cost and availability of reinsurance for term life
insurance. We are retaining no more than a $500,000 exposure, ceding the balance using
excess over retention mortality coverage, and retaining the policy reserve. Retaining the
policy reserve has no direct impact on GAAP results. However, because of the conservative
nature of statutory reserving principles, retaining the policy reserve unduly depresses our
statutory earnings and requires a large commitment of our capital. We also have catastrophe
reinsurance coverage on our life insurance operations that reimburses us up to $50 million
for covered net losses in excess of $10 million. The treaty contains a reinstatement
provision, provided the covered losses are not due to terrorism, and contains protection for
extra-contractual liability coverage losses. For term life insurance business written prior
to 2005, we retain 10 percent to 25 percent of each term policy, not to exceed $500,000,
ceding the balance of mortality risk and policy reserve.
The NAIC recently rejected a package of industry proposals to relax certain statutory
reserve and capital requirements. Due to our strong capital position, we do not intend to
seek permission from the Ohio Department of Insurance to use these proposals as permitted
practices. We continue to monitor the marketplace for attractive alternatives to finance the
redundant statutory reserve strain associated with our term life insurance products.
Safe Harbor Statement
This is our “Safe Harbor” statement under the Private Securities Litigation Reform Act of
1995. Our business is subject to certain risks and uncertainties that may cause actual
results to differ materially from those suggested by the forward-looking statements in this
report. Some of those risks and uncertainties are discussed in our Item 1A, Risk Factors, Page 25. Although we often review or update our forward-looking statements when events warrant, we caution our readers that we undertake no obligation to do so.
Factors that could cause or contribute to such differences include, but are not limited to:
Cincinnati Financial Corporation — 2008 Annual Report on 10-K — Page 83
Further, the company’s insurance businesses are subject to the effects of changing social,
economic and regulatory environments. Public and regulatory initiatives have included
efforts to adversely influence and restrict premium rates, restrict the ability to cancel
policies, impose underwriting standards and expand overall regulation. The company also is
subject to public and regulatory initiatives that can affect the market value for its common
stock, such as recent measures affecting corporate financial reporting and governance. The
ultimate changes and eventual effects, if any, of these initiatives are uncertain.
Cincinnati Financial Corporation — 2008 Annual Report on 10-K — Page 84
Introduction
Market risk is the potential for a decrease in securities value resulting from broad yet
uncontrollable forces such as: inflation, economic growth, interest rates, world political
conditions or other widespread unpredictable events. It is comprised of many individual
risks that, when combined, create a macroeconomic impact. The company accepts and manages
risks in the investment portfolio as part of the means of achieving portfolio objectives.
Some of the risks are:
The investment committee of the board of directors monitors the investment risk management
process primarily through its executive oversight of our investment activities. We take an
active approach to managing market and other investment risks, including the
accountabilities and controls over these activities. Actively managing these market risks is
integral to our operations and could require us to change the character of future
investments purchased or sold or require us to shift the existing asset portfolios to manage
exposure to market risk within acceptable ranges.
Sector risk is the potential for a negative impact on a particular industry due to its
sensitivity to factors that make up market risk. Market risk affects general supply/demand
factors for an industry and will affect companies within that industry to varying degrees.
Risks associated with the five asset classes described in Item 1, Investments Segment,
Page 17, can be summarized as follows (H — high, A — average, L — low):
Fixed-maturity Investments
For investment-grade corporate bonds, the inverse relationship between interest rates and
bond prices leads to falling bond values during periods of increasing interest rates.
Although the potential for a worsening financial condition, and ultimately default, does
exist with investment-grade corporate bonds, their higher-quality financial profiles make
credit risk less of a concern than for lower-quality investments. We address this risk by
consistently investing within a particular maturity range. Over the years, this approach has
provided the portfolio with a laddered maturity schedule, which we believe is less subject
to large swings in
Cincinnati Financial Corporation — 2008 Annual Report on 10-K — Page 85 value due to interest rate changes. While a single maturity range may see
values drop due to general interest rate levels, other maturity ranges would typically be
less affected by those changes. Additionally, purchases are spread across a wide spectrum of
industries and companies, diversifying our holdings and minimizing the impact of specific
industries or companies with greater sensitivities to interest rate fluctuations.
The primary risk related to high-yield corporate bonds is credit risk or the potential for a
deteriorating financial structure. A weak financial profile can lead to rating downgrades
from the credit rating agencies, which can put further downward pressure on bond prices.
Interest rate risk, while significant, is less of a factor with high-yield corporate bonds,
as valuation is related more directly to underlying operating performance than to general
interest rates. This puts more emphasis on the financial results achieved by the issuer
rather than on general economic trends or statistics within the marketplace. We address this
concern by analyzing issuer- and industry-specific financial results and by closely
monitoring holdings within this asset class.
The primary risks related to tax-exempt bonds are interest rate risk and political risk
associated with the specific economic environment within the political boundaries of the
issuing municipal entity. We address these concerns by focusing on municipalities’
general-obligation debt and on essential-service bonds. Essential-service bonds derive a
revenue stream from municipal services that are vital to the people living in the area
(water service, sewer service, etc.). Another risk related to tax-exempt bonds is regulatory
risk or the potential for legislative changes that would negate the benefit of owning
tax-exempt bonds. We monitor regulatory activity for situations that may negatively affect
current holdings and our ongoing strategy for investing in these securities.
The final, less significant risk is our exposure to credit risk for a portion of the
tax-exempt portfolio that has support from corporate entities. Examples are bonds insured by
corporate bond insurers or bonds with interest payments made by a corporate entity through a
municipal conduit/authority. Our decisions regarding these investments primarily consider
the underlying municipal situation. The existence of third-party insurance is intended to
reduce risk in the event of default. In circumstances in which the municipality is unable to
meet its obligations, risk would be increased if the insuring entity were experiencing
financial duress. Because of our diverse exposure and selection of higher-rated entities
with strong financial profiles, we do not believe this is a material concern as we discuss
in Item 1, Investments Segment,
Page 17.
Interest Rate Sensitivity Analysis
Because of our strong surplus, long-term investment horizon and ability to hold most
fixed-maturity investments to maturity, we believe the company is well positioned if
interest rates were to rise. A higher rate environment would provide the opportunity to
invest cash flow in higher-yielding securities, while reducing the likelihood of untimely
redemptions of currently callable securities. While higher interest rates would be expected
to continue to increase the number of fixed-maturity holdings trading below 100 percent of
book value, we believe lower fixed-maturity security values due solely to interest rate
changes would not signal a decline in credit quality.
Our dynamic financial planning model uses analytical tools to assess market risks. As part
of this model, the effective duration of the fixed-maturity portfolio is continually
monitored by our investment department to evaluate the theoretical impact of interest rate
movements.
The table below summarizes the effect of hypothetical changes in interest rates on the
fixed-maturity portfolio:
The effective duration of the fixed maturity portfolio was 5.4 years at year-end 2008,
compared with 4.8 years at year-end 2007. A 100 basis point movement in interest rates would
result in an approximately 5.4 percent change in the fair value of the fixed maturity
portfolio. Generally speaking, the higher a bond is rated, the more directly correlated
movements in its market value are to changes in the general level of interest rates,
exclusive of call features. The market values of average- to lower-rated corporate bonds are
additionally influenced by the expansion or contraction of credit spreads.
In the dynamic financial planning model, the selected interest rate change of 100 basis
points represents our views of a shift in rates that is quite possible over a one-year
period. The rates modeled should not be considered a prediction of future events as interest
rates may be much more volatile in the future. The analysis is not intended to provide a
precise forecast of the effect of changes in rates on our results or financial condition,
nor does it take into account any actions that we might take to reduce exposure to such
risks.
Cincinnati Financial Corporation — 2008 Annual Report on 10-K — Page 86 Short-Term Investments
Our short-term investments consist primarily of commercial paper, demand notes or bonds
purchased within one year of maturity. We make short-term investments primarily with funds
to be used to make upcoming cash payments, such as taxes. At year-end 2008, short-term
investments included $16 million that were frozen in The Reserve’s Primary Fund. Between mid-September
and year-end 2008, the fund had returned approximately $71 million to us in its liquidation
process. In February 2009, the fund returned $6 million of
the year-end balance and we
expect to receive the remainder during 2009.
Equity Investments
Common stocks are subject to a variety of risk factors encompassed under the umbrella of
market risk. General economic swings influence the performance of the underlying industries
and companies within those industries. As we saw in 2008, a downturn in the economy can have
a negative effect on an equity portfolio. Industry- and company-specific risks also have the
potential to substantially affect the value of our portfolio. We implemented new investment
guidelines in 2008 to help address these risks by diversifying the portfolio and
establishing parameters to help manage exposures.
Our equity holdings represented $2.896 billion in fair value and contributed all of the
unrealized appreciation of the portfolio at year-end 2008. See Item 1, Investments Segment,
Page 17, for additional details on our holdings.
The primary risks related to preferred stocks are similar to those related to investment
grade corporate bonds. Falling interest rates adversely affect market values due to the
normal inverse relationship between rates and yields. Credit risk exists due to the
subordinate position of preferred stocks in the capital structure. We minimize this risk by
primarily purchasing investment grade preferred stocks of issuers with a strong history of
paying a common stock dividend. Events of 2008 indicated that the risk related to preferred
stocks is greater because they would not receive preferential treatment in a
government-sponsored restructuring.
Application of Asset Impairment Policy
As discussed in Item 7, Critical Accounting Estimates, Asset Impairment,
Page 45, our
fixed-maturity and equity investment portfolios are our largest assets. The company’s asset
impairment committee monitors a number of significant factors for indications that the value
of investments trading below the carrying amount may not be recoverable. The application of
our impairment policy resulted in other-than-temporary impairment charges that reduced our
income before income taxes by $510 million in 2008, $16 million in 2007 and $1 million in
2006. Impairments are discussed in Item 7, Investment Results of Operations, Page 66.
We expect the number of securities trading below 100 percent of book value to fluctuate as
interest rates rise or fall and credit spreads expand or contract due to prevailing economic
conditions. Further, book values for some securities have been revised due to impairment
charges recognized in prior periods. At year-end 2008, 944 of the 2,233 securities we owned
were trading below 100 percent of book value compared with 373 of the 2,053 securities we
owned at year-end 2007 and 679 of the 1,973 securities we owned at year-end 2006.
When evaluating the potential for future other-than-temporary impairments, we consider our
intent and ability to retain a security for a period adequate to recover its cost. Because
of our investment philosophy and strong capitalization, we can hold securities that might
otherwise be deemed impaired until their scheduled redemption as we evaluate their potential
for recovery based on economic, industry or company factors.
The 944 holdings trading below book value at year-end 2008 represented 40.3 percent of
invested assets and $596 million in unrealized losses. We deem the risk related to
securities trading between 70 percent and 100 percent of book value to be relatively minor
and at least partially offset by the earned income potential of these investments.
Cincinnati Financial Corporation — 2008 Annual Report on 10-K — Page 87
The following table summarizes the length of time securities
in the investment portfolio
have been in a continuous unrealized gain or loss position.
Cincinnati Financial Corporation — 2008 Annual Report on 10-K — Page 88 The following table summarizes the investment portfolio:
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Cincinnati Financial Corporation — 2008 Annual Report on 10-K — Page 90 Item 8. Financial Statements and Supplementary Data
Responsibility For Financial Statements
We have prepared the consolidated financial statements of Cincinnati Financial Corporation
and our subsidiaries for the year ended December 31, 2008, in accordance with accounting
principles generally accepted in the United States of America (GAAP).
We are responsible for the integrity and objectivity of these financial statements. The
amounts, presented on an accrual basis, reflect our best estimates and judgment. These
statements are consistent in all material aspects with other financial information in the
Annual Report on Form 10-K. Our accounting system and related internal controls are designed
to assure that our books and records accurately reflect the company’s transactions in
accordance with established policies and procedures as implemented by qualified personnel.
Our board of directors has established an audit committee of independent outside directors.
We believe these directors are free from any relationships that could interfere with their
independent judgment as audit committee members.
The audit committee meets periodically with management, our independent registered public
accounting firm and our internal auditors to discuss how each is handling responsibilities.
The audit committee reports their findings to the board of directors. The audit committee
recommends to the board the annual appointment of the independent registered public
accounting firm. The audit committee reviews with this firm the scope of the audit
assignment and the adequacy of internal controls and procedures.
Deloitte & Touche LLP, our independent registered public accounting firm, audited the
consolidated financial statements of Cincinnati Financial Corporation and subsidiaries for
the year ended December 31, 2008. Their report is on
Page 93. Deloitte’s auditors met with
our audit committee to discuss the results of their examination. They have the opportunity
to discuss the adequacy of internal controls and the quality of financial reporting without
management present.
Cincinnati Financial Corporation — 2008 Annual Report on 10-K — Page 91 Management’s Annual Report On Internal Control Over Financial Reporting
The management of Cincinnati Financial Corporation and its subsidiaries is responsible for
establishing and maintaining adequate internal controls, designed to provide reasonable
assurance regarding the reliability of financial reporting and the preparation of financial
statements for external purposes in accordance with accounting principles generally accepted
in the United States of America (GAAP). The company’s internal control over financial
reporting includes those policies and procedures that:
All internal control systems, no matter how well designed, have inherent limitations,
including the possibility of human error and the circumvention of overriding controls.
Accordingly, even effective internal control can provide only reasonable assurance with
respect to financial statement preparation and presentation. Further, because of changes in
conditions, the effectiveness of internal control may vary over time.
The company’s management assessed the effectiveness of the company’s internal control over
financial reporting as of December 31, 2008, as required by Section 404 of the Sarbanes
Oxley Act of 2002. Management’s assessment is based on the criteria established in the
Internal Control — Integrated Framework issued by the Committee of Sponsoring Organizations
of the Treadway Commission and was designed to provide reasonable assurance that the company
maintained effective internal control over financial reporting as of December 31, 2008. The
assessment led management to conclude that, as of December 31, 2008, the company’s internal
control over financial reporting was effective based on those criteria.
The company’s independent registered public accounting firm has issued an audit report on
our internal control over financial reporting as of December 31, 2008. This report appears
on
Page 93.
February 27, 2009
Cincinnati Financial Corporation — 2008 Annual Report on 10-K — Page 92 Report Of Independent Registered Public Accounting Firm
To the Shareholders and Board of Directors of Cincinnati Financial Corporation
Fairfield, Ohio We have audited the accompanying consolidated balance sheets of Cincinnati Financial
Corporation and subsidiaries (the company) as of December 31, 2008 and 2007, and the related
consolidated statements of income, shareholders’ equity, and cash flows for each of the
three years in the period ended December 31, 2008. Our audits also included the financial
statement schedules listed in the Index at Item 15(c). We also have audited the company’s
internal control over financial reporting as of December 31, 2008, based on criteria
established in the Internal Control — Integrated Framework issued by the Committee of
Sponsoring Organizations of the Treadway Commission. The company’s management is responsible
for these financial statements and financial schedules, for maintaining effective internal
control over financial reporting, and for its assessment of the effectiveness of internal
control over financial reporting, included in Management’s Annual Report on Internal Control
Over Financial Reporting report. Our responsibility is to express an opinion on these
financial statements and financial statement schedules and an opinion on the company’s
internal control over financial reporting based on our audits.
We conducted our audits in accordance with the standards of the Public Company Accounting
Oversight Board (United States). Those standards require that we plan and perform the audit
to obtain reasonable assurance about whether the financial statements are free of material
misstatement and whether effective internal control over financial reporting was maintained
in all material respects. Our audit of financial statements included examining, on a test
basis, evidence supporting the amounts and disclosures in the financial statements,
assessing the accounting principles used and significant estimates made by management, and
evaluating the overall financial statement presentation. Our audit of internal control over
financial reporting included obtaining an understanding of internal control over financial
reporting, assessing the risk that a material weakness exists, testing and evaluating the
design and operating effectiveness of internal control, and performing such other procedures
as we considered necessary in the circumstances. We believe that our audits provide a
reasonable basis for our opinions.
A company’s internal control over financial reporting is a process designed by, or under the
supervision of, the company’s principal executive and principal financial officers, or
persons performing similar functions, and effected by the company’s board of directors,
management, and other personnel to provide reasonable assurance regarding the reliability of
financial reporting and the preparation of financial statements for external purposes in
accordance with generally accepted accounting principles. A company’s internal control over
financial reporting includes those policies and procedures that: (1) pertain to the
maintenance of records that, in reasonable detail, accurately and fairly reflect the
transactions and dispositions of the assets of the company; (2) provide reasonable assurance
that transactions are recorded as necessary to permit preparation of financial statements in
accordance with generally accepted accounting principles and that receipts and expenditures
of the company are being made only in accordance with authorizations of management and
directors of the company; and (3) provide reasonable assurance regarding prevention or
timely detection of unauthorized acquisition, use, or disposition of the company’s assets
that could have a material effect on the financial statements.
Because of the inherent limitations of internal control over financial reporting, including
the possibility of collusion or improper management override of controls, material
misstatements due to error or fraud may not be prevented or detected on a timely basis.
Also, projections of any evaluation of the effectiveness of the internal control over
financial reporting to future periods are subject to the risk that the controls may become
inadequate because of changes in conditions, or that the degree of compliance with the
policies or procedures may deteriorate.
In our opinion, the consolidated financial statements referred to above present fairly, in
all material respects, the financial position of the company as of December 31, 2008 and
2007, and the results of its operations and its cash flows for each of the three years in
the period ended December 31, 2008, in conformity with accounting principles generally
accepted in the United States of America. Also, in our opinion, such financial statement
schedules, when considered in relation to the basic consolidated financial statements taken
as a whole, present fairly, in all material respects, the information set forth therein.
Also, in our opinion, the company maintained, in all material respects, effective internal
control over financial reporting as of December 31, 2008, based on the criteria established
in Internal Control — Integrated Framework issued by the Committee of Sponsoring
Organizations of the Treadway Commission.
Cincinnati Financial Corporation — 2008 Annual Report on 10-K — Page 93 CINCINNATI FINANCIAL CORPORATION AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
Accompanying notes are an integral part of these statements.
CINCINNATI FINANCIAL CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF INCOME
Accompanying notes are an integral part of these statements.
CINCINNATI FINANCIAL CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF SHAREHOLDERS’ EQUITY
Accompanying notes are an integral part of these statements.
CINCINNATI FINANCIAL CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
Accompanying notes are an integral part of these statements.
Notes To Consolidated Financial Statements
1. Summary Of Significant Accounting Policies
Nature of Operations
Cincinnati Financial operates through our insurance group and three complementary subsidiary
companies:
The Cincinnati Insurance Company leads our standard market property casualty insurance group
that also includes two subsidiaries: The Cincinnati Casualty Company and The Cincinnati
Indemnity Company. This group markets a broad range of standard market business, homeowner
and auto policies in 35 states. The group provides quality customer service to our select
group of 1,113 local insurance agencies with 1,387 reporting locations. Other subsidiaries
of The Cincinnati Insurance Company include The Cincinnati Life Insurance Company, which
markets life insurance policies, disability income policies and annuities, and The
Cincinnati Specialty Underwriters Insurance Company, which began offering excess and surplus
lines insurance products in 2008.
The three complementary subsidiaries are CSU Producer Resources Inc., which offers insurance
brokerage services to our independent agencies so their clients can access our excess and
surplus lines insurance products; CFC Investment Company, which offers commercial leasing
and financing services to our agents, their clients and other customers; and CinFin Capital
Management Company, which provides asset management services to institutions, corporations
and individuals. CinFin Capital Management will cease operations effective February 28,
2009.
Basis of Presentation
Our consolidated financial statements include the accounts of the parent company and our
wholly owned subsidiaries. We present our statements in accordance with accounting
principles generally accepted in the United States of America (GAAP). In consolidating our
accounts, we have eliminated intercompany balances and transactions.
In accordance with GAAP, we have made estimates and assumptions that affect the amounts we
report and discuss in the consolidated financial statements and accompanying notes. Actual
results could differ from our estimates.
Earnings per Share
Net income per common share is based on the weighted average number of common shares
outstanding during each of the respective years. We calculate net income per common share
(diluted) assuming the exercise of stock-based awards. We have adjusted shares and earnings
per share to reflect all stock splits and dividends prior to December 31, 2008.
Share-based Compensation
We grant qualified and non-qualified share-based compensation under authorized plans. Until
2007, all stock-based awards were in the form of stock options that had an exercise price
equal to the market value of the underlying common stock on the date of grant. The options
vest ratably over three years following the date of grant and are exercisable over 10 year
periods.
The 2006 Stock Compensation Plan provides the compensation committee of the board of
directors flexibility in the types of available stock-based awards including stock options,
restricted stock, restricted stock units, stock appreciation rights and other stock-based
awards. The 2006 Stock Compensation Plan also provides for the grant of performance-based
awards.
In 2008, the committee approved a mix of stock options and restricted stock units for
stock-based awards. Stock options granted had similar terms but generally were awarded for
fewer shares compared with previous years to accommodate new awards of service based and
performance-based restricted stock units, while keeping the overall estimated cost of
stock-based compensation in line with previous years.
Effective January 1, 2006, we adopted the fair value recognition provisions of Statement of
Financial Accounting Standards (SFAS) No. 123(R), “Share-Based Payment,” using the modified
prospective transition method. We elected to use the alternative method for determining the
beginning balance of the additional paid-in capital pool, as described in the Financial
Accounting Standards Board (FASB) Staff Position 123(R)-3. Refer to Note 17, Stock-based
Associate Compensation Plans,
Page 117 for more information regarding our share-based
compensation.
Employee Benefit Pension Plan
We sponsor a defined benefit pension plan that was modified during 2008. We froze entry into
the pension plan and only participants 40 years of age or older could elect to remain in the
plan. Our pension expense is based on certain actuarial assumptions and also is composed of
several components that are determined using the projected unit credit actuarial cost
method. Refer to Note 13, Employee Retirement Benefits,
Page 113 for more information
regarding our defined benefit pension plan.
Cincinnati Financial Corporation — 2008 Annual Report on 10-K — Page 98 Property Casualty Insurance
Property casualty policy written premiums are deferred and recorded as earned premiums on a
pro rata basis over the terms of the policies. We record as unearned premium the portion of
written premiums that apply to unexpired policy terms. The expenses associated with issuing
insurance policies — primarily commissions, premium taxes and underwriting costs — are
deferred and amortized over the terms of the policies. We update our acquisition cost
assumptions periodically to reflect actual experience, and we evaluate our deferred
acquisition cost for recoverability.
Certain property casualty policies are not booked before the effective date. An actuarial
estimate is made to determine the amount of unbooked written premiums. The majority of the
estimate is unearned and does not have a material impact on earned premium.
We establish reserves to cover the expected cost of claims — or losses — and our expenses
related to investigating, processing and resolving claims. Although determining the
appropriate amount of reserves is inherently uncertain, we base our decisions on past
experience and current facts. Reserves are based on claims reported prior to the end of the
year and estimates of unreported claims. We take into account the fact that we may recover
some of our costs through salvage and subrogation. We regularly review and update reserves
using the most current information available. Any resulting adjustments are reflected in
current year insurance losses and policyholder benefits.
The Cincinnati Insurance Companies actively write standard market property casualty
insurance policies in 35 states. Our 10 largest states generated 68.7 percent and 69.1
percent of total property casualty premiums in 2008 and 2007. Ohio, our largest state,
accounted for 20.9 percent and 21.2 percent of total earned premiums in 2008 and 2007.
Agencies in Georgia, Illinois, Indiana, Michigan, North Carolina, Pennsylvania and Virginia
each contributed between 4 percent and 9 percent of premium volume in 2008. The largest
single agency relationship accounted for approximately 1.3 percent of the company’s total
agency direct earned premiums in 2008.
Policyholder Dividends
Certain workers’ compensation policies include the possibility of an insured earning a
return of a portion of their premium in the form of a policyholder dividend. The dividend
generally is calculated by determining the profitability of a policy year along with the
associated premium. We reserve for all probable future policyholder dividend payments.
Life and Health Insurance
We offer several types of life and health insurance and we account for each according to the
duration of the contract. Short-duration contracts are written to cover claims that arise
during a short, fixed term of coverage. We generally have the right to change the amount of
premium charged or cancel the coverage at the end of each contract term. Group life
insurance is an example. We record premiums for short-duration contracts similarly to
property casualty contracts.
Long-duration contracts are written to provide coverage for an extended period of time.
Traditional long-duration contracts require policyholders to pay scheduled gross premiums,
generally not less frequently than annually, over the term of the coverage. Premiums for
these contracts are recognized as revenue when due. Whole life insurance and disability
income insurance are examples. Some traditional long-duration contracts have premium payment
periods shorter than the period over which coverage is provided. For these contracts, the
excess of premium over the amount required to pay expenses and benefits is recognized over
the term of the coverage rather than over the premium payment period. Ten-pay whole life
insurance is an example.
We establish a liability for traditional long-duration contracts as we receive premiums. The
amount of this liability is the present value of future expenses and benefits less the
present value of future net premiums. Net premium is the portion of gross premium required
to provide for all expenses and benefits. We estimate future expenses and benefits and net
premium using assumptions for expected expenses, mortality, morbidity, withdrawal rates and
investment income. We include a provision for adverse deviation, meaning we allow for some
uncertainty in making our assumptions. We establish our assumptions when the contract is
issued and we generally maintain those assumptions for the life of the contract. We use both
our own experience and industry experience, adjusted for historical trends, in arriving at
our assumptions for expected mortality, morbidity and withdrawal rates. We use our own
experience and historical trends for setting our assumption for expected expenses. We base
our assumption for expected investment income on our own experience, adjusted for current
economic conditions.
When we issue a traditional long-duration contract, we capitalize acquisition costs.
Acquisition costs are costs which vary with, and are primarily related to, the production of
new business. We then charge these deferred policy acquisition costs to expenses over the
premium paying period of the contract and we use the same assumptions that we use when we
establish the liability for the contract. We update our acquisition cost assumptions
periodically to reflect actual experience and we evaluate our deferred acquisition cost for
recoverability.
Cincinnati Financial Corporation — 2008 Annual Report on 10-K — Page 99 Universal life contracts are long-duration contracts for which contractual provisions are
not fixed, unlike whole life insurance. Universal life contracts allow policyholders to vary
the amount of premium, within limits, without our consent. However we may vary the mortality
and expense charges, within limits, and the interest crediting rate used to accumulate
policy values. We do not record universal life premiums as revenue. Instead we recognize as
revenue the mortality charges, administration charges and surrender charges when received.
Some of our universal life contracts assess administration charges in the early years of the
contract that are compensation for services we will provide in the later years of the
contract. These administration charges are deferred and are recognized over the period when
we provide those future services.
For universal life long-duration contracts we maintain a liability equal to the policyholder
account value. There is no provision for adverse deviation. Some of our universal life
policies contain no-lapse guarantee provisions. For these policies, we establish a reserve
in addition to the account balance, based on expected no-lapse guarantee benefits and
expected policy assessments.
When we issue a universal life long-duration contract we capitalize acquisition costs. We
then charge these capitalized costs to expenses over the term of coverage of the contract.
When we charge deferred policy acquisition costs to expenses, we use assumptions based on
our best estimates of long-term experience. We review and modify these assumptions on a
regular basis.
Separate Accounts
We issue life contracts with guaranteed minimum returns, referred to as bank-owned life
insurance contracts (BOLIs). We legally segregate and record as separate accounts the assets
and liabilities for some of our BOLIs, based on the specific contract provisions. We
guarantee minimum investment returns, account values and death benefits for our separate
account BOLIs. Our other BOLIs are general account products.
We carry the assets of separate account BOLIs at fair value. The liabilities on separate
account BOLIs primarily are the contract holders’ claims to the related assets and are
carried at an amount equal to the contract holders account value. At December 31, 2008, the
contract holders account value exceeded the current fair value of the BOLI invested assets
and cash by approximately $40 million. If the BOLI projected fair value is below the value
we guaranteed, a liability would be established by a charge to the company’s earnings.
Generally, investment income and realized investment gains and losses of the separate
accounts accrue directly to the contract holder and we do not include them in the
Consolidated Statements of Income. Revenues and expenses related to separate accounts
consist of contractual fees and mortality, surrender and expense risk charges. Also, each
separate account BOLI includes a negotiated gain and loss sharing arrangement with the
company. A percentage of each separate account’s realized gain and loss representing
contract fees and assessments accrues to us and is transferred from the separate account to
our general account and is recognized as revenue or expense.
Reinsurance
We reduce risk and uncertainty by buying property casualty and life reinsurance. Reinsurance
contracts do not relieve us from our duty to policyholders, but rather help protect our
financial strength to perform that duty. All of our reinsurance contracts transfer the
economic risk of loss.
We also serve in a limited way as a reinsurer for other insurance companies, reinsurers and
involuntary state pools. We record our transactions for such assumed reinsurance based on
reports provided to us by the ceding reinsurer.
Reinsurance assumed and ceded premiums are deferred and recorded as earned premiums on a pro
rata basis over the terms of the contract. We estimate loss amounts recoverable from our
reinsurers based on the reinsurance policy terms. Historically, our claims with reinsurers
have been paid. We do not have an allowance for uncollectible reinsurance.
Cash and Cash Equivalents
Cash and cash equivalents include commercial paper, money market funds, invested cash and
other overnight investments purchased with original maturities of less than three months,
which are carried at fair value.
Investments
Our portfolio investments are primarily in publicly traded fixed-maturity, equity and
short-term investments, classified as available for sale at fair value in the consolidated
financial statements. Fixed-maturity investments (taxable bonds, tax-exempt bonds,
redeemable preferred stocks and collateralized mortgage obligations) and equity investments
(common and non-redeemable preferred stocks) are classified as available for sale and
recorded at fair value in the consolidated financial statements. The number of
fixed-maturity securities trading below 100 percent of book value can be expected to
fluctuate as interest rates rise or fall. Because of our strong surplus and long-term
investment horizon, our intent is to hold fixed-maturity investments until maturity,
regardless of short-term fluctuations in fair values.
Cincinnati Financial Corporation — 2008 Annual Report on 10-K — Page 100 Included within our other invested assets are life policy loans, venture capital fund
investments, private equity investments and investment in real estate. Life policy loans are
carried at the receivable value which approximates fair value. We use the equity method of
accounting for venture capital fund investments. The venture capital funds provide their
financial statements to us and generally report investments on their balance sheets at fair
value. Our private equity investments within our invested assets are accounted for under the
cost method. Investment real estate consists of one office building that is carried at cost
less accumulated depreciation.
We include unrealized gains and losses on investments, net of taxes, in shareholders’ equity
as accumulated other comprehensive income. Realized gains and losses on investments are
recognized in net income on a specific identification basis.
Investment income consists mainly of interest and dividends. We record interest on an
accrual basis and record dividends at the ex-dividend date. We amortize premiums and
discounts on fixed-maturity securities using the effective interest method over the expected
life of the security.
Facts and circumstances sometimes warrant investment write-downs. We record such
other-than-temporary declines as realized investment losses. When evaluating for
other-than-temporary impairments, the asset impairment committee considers the company’s
intent and ability to retain a security for a period adequate to recover its cost.
Fair Value Disclosures
We account for our investment portfolio at fair value and apply fair value measurements as
defined by SFAS No. 157, “Fair Value Measurements,” to financial instruments. Fair value is
applicable to SFAS No. 115, “Accounting for Certain Investments in Debt and Equity
Securities,” SFAS No. 133, “Accounting for Derivative Instruments and Hedging Activities,”
SFAS No. 155, “Accounting for Certain Hybrid Financial Instruments,” and SFAS No. 107,
“Disclosures about Fair Value of Financial Instruments.”
We adopted the provisions of SFAS No. 157 on January 1, 2008. SFAS No. 157 defines fair
value as the exit price or the amount that would be 1) received to sell an asset or 2) paid
to transfer a liability in an orderly transaction between marketplace participants at the
measurement date. When determining an exit price we must, whenever possible, rely upon
observable market data. Prior to the adoption of SFAS No. 157, we considered various factors
such as liquidity and volatility but primarily obtained pricing from various external
services, including broker quotes. We primarily base fair value for investments in equity
and fixed-maturity securities (including redeemable preferred stock and assets held in
separate accounts) on quoted market prices or on prices from FT Interactive Data, an outside
resource that supplies global securities pricing, dividend, corporate action and descriptive
information to support fund pricing, securities operations, research and portfolio
management. When a price is not available from these sources, as in the case of securities
that are not publicly traded, we determine the fair value using various inputs including
quotes from independent brokers. The fair value of investments not priced by FT Interactive
Data is less than 1 percent of the fair value of our total investment portfolio.
For the purpose of SFAS No. 107 disclosure, we estimate the fair value for liabilities of
investment contracts and annuities. We also estimate the fair value for assets arising from
policyholder loans on insurance contracts. These estimates are developed using discounted
cash flow calculations across a wide range of economic interest rate scenarios with a
provision for our own credit risk. We base fair value for long-term senior notes and notes
payable on the quoted market prices for such notes.
Derivative Financial Instruments and Hedging Activities
We account for derivative financial instruments as defined by SFAS No. 133, “Accounting for
Derivative Instruments and Hedging Activities,” as amended by SFAS No. 137, “Deferral of the
Effective Date of FASB Statement No. 133” and SFAS No. 138, “Accounting for Certain
Derivative Instruments and Certain Hedging Activities” (collectively referred to as SFAS No.
133).
The hedging definitions included in SFAS No. 133 guide our recognition of the changes in the
fair value of derivative financial instruments as realized gains or losses in the
consolidated statements of income or as a component of accumulated other comprehensive
income in shareholder’s equity in the period for which they occur.
In 2006, CFC Investment Company (CFC-I) replaced $49 million of intercompany debt owed to
CFC with a short-term line of credit issued by PNC Bank. CFC-I entered into an interest-rate
swap contract to hedge against fluctuations of interest payments for certain variable-rate
debt obligations ($49 million notional amount) that expires
August 29, 2009. In October 2006, we completed necessary requirements for the interest-rate swap to
qualify for hedge accounting treatment under the provisions of SFAS No. 133. At December 31,
2008 and 2007, the fair value of the interest rate swap was $1.3 million and $1.2 million,
respectively. We do not expect any significant reclassification into consolidated net income
for the year ending December 31, 2009.
Cincinnati Financial Corporation — 2008 Annual Report on 10-K — Page 101 Securities Lending Program
In 2007, we participated in a securities lending program under which certain fixed-maturity
securities from our investment portfolio were loaned to other institutions for short periods
of time. We required cash collateral in excess of the market value of the loaned securities.
During the third quarter of 2008, we terminated the program.
Lease/Finance
Our CFC Investment Company subsidiary provides auto and equipment direct financing (leases
and loans) to commercial and individual clients. We generally transfer ownership of the
property to the client as the terms of the leases expire. Our lease contracts contain
bargain purchase options. We record income over the financing term using the effective
interest method.
We capitalize and amortize lease or loan origination costs over the life of the financing
using the effective interest method. These costs may include, but are not limited to: finder
fees, broker fees, filing fees and the cost of credit reports. We account for these leases
and loans as direct financing-type leases.
Asset Management
Our CinFin Capital Management subsidiary generated revenue from management fees. We set
those fees based on the market value of assets under management, and we recorded our revenue
as it was earned. CinFin Capital Management will cease operations effective February 28,
2009.
Land, Building and Equipment
We record building and equipment at cost less accumulated depreciation. Certain equipment
held under capital leases also is classified as property and equipment with the related
lease obligations recorded as liabilities. Our depreciation is based on estimated useful
lives (ranging from three years to 391/2 years) using straight-line and accelerated methods.
Depreciation expense was $35 million in 2008 and $38 million in both 2007 and 2006. We
monitor land, building and equipment for potential impairments. Potential impairments may
include a significant decrease in the market values of the assets, considerable cost
overruns on projects or a change in legal factors or business climate, or other factors that
indicate that the carrying amount may not be recoverable. There were no recorded land,
building and equipment impairments for 2006 through 2008.
We capitalize and amortize costs for internally developed computer software during the
application development stage. These costs generally consist of external consulting, payroll
and payroll-related costs.
Income Taxes
We calculate deferred income tax liabilities and assets using tax rates in effect for the
time when temporary differences in book and taxable income are estimated to reverse. We
recognize deferred income taxes for numerous temporary differences between our taxable
income and book-basis income and other changes in shareholders’ equity. Such temporary
differences relate primarily to unrealized gains and losses on investments and differences
in the recognition of deferred acquisition costs and insurance reserves. We charge deferred
income taxes associated with unrealized appreciation and depreciation (except the amounts
related to the effect of income tax rate changes) to shareholders’ equity in accumulated
other comprehensive income. We charge deferred taxes associated with other differences to
income.
There are no amounts in our FIN 48 liability that would change the effective tax rate if
recognized. Although no penalties currently are accrued, if incurred, they would be
recognized as a component of income tax expense. Accrued interest expense is recognized as
other operating expense in the consolidated statements of income.
Pending Accounting Standards
Cincinnati Financial Corporation — 2008 Annual Report on 10-K — Page 102
Adopted Accounting Standards
Cincinnati Financial Corporation — 2008 Annual Report on 10-K — Page 103 2. Investments
The following table analyzes investment income, realized investment gains and losses and the
change in unrealized investment gains and losses:
At December 31, 2008, contractual maturity dates for fixed-maturity and short-term investments were:
Actual maturities may differ from contractual maturities when there is a right to call or
prepay obligations with or without call or prepayment penalties.
At December 31, 2008, investments with book value of $80 million and fair value of $81
million were on deposit with various states in compliance with regulatory requirements.
Cincinnati Financial Corporation — 2008 Annual Report on 10-K — Page 104 The following table analyzes cost or amortized cost, gross unrealized gains, gross
unrealized losses and fair value for our investments:
At year-end 2008, no investment accounted for more than 10 percent of shareholders’ equity.
At year-end 2007, our Fifth Third Bancorp common stock holding, with fair value of $1.691
billion and a cost of $185 million, was our only investment for which the fair value
exceeded 10 percent of shareholders’ equity. We sold 55.4 million shares of our holdings of
Fifth Third common stock in 2008, 5.5 million shares in 2007,
and the remaining 12 million shares sold in January 2009.
This table reviews unrealized losses and fair values by investment category and by the
duration of the securities’ continuous unrealized loss position:
When evaluating for other-than-temporary impairments, our asset impairment committee
considers the company’s intent and ability to retain a security for a period adequate to
recover its cost.
During 2008, we impaired 126 securities. As a result, at December 31, 2008, 142
fixed-maturity investments with a total unrealized loss of $78 million had been in an
unrealized loss position for 12 months or more. Of that total, there were no fixed maturity
investments trading below 70 percent of book value.
At December 31, 2007, 184 fixed-maturity investments with a total unrealized loss of $20
million had been in an unrealized loss position for 12 months or more. Of that total, three
securities were trading below 70 percent of book value with a total unrealized loss of $6
million. The remainder were trading between 70 percent to less than 100 percent of book
value.
Cincinnati Financial Corporation — 2008 Annual Report on 10-K — Page 105 Securities Lending Program
During the third quarter of 2008, we terminated a securities lending program that we
initiated in 2006. As a result, no securities were on loan at year-end 2008 compared with
$745 million at year-end 2007. In conjunction with the program termination, we chose to
retain a small portfolio of collateralized mortgage obligations rather than sell them at
what we felt were distressed prices in an illiquid market. The CMOs were an investment made
by one of the short-duration funds, which subsequently dissolved and distributed the assets
to its investors.
All $30 million of the CMOs in the portfolio are collateralized by Alt-A mortgages that originated between 2004
and 2006. As of December 31, 2008, we owned investment grade CMOs with a fair value and
book value of $27 million and $39 million, respectively. Of this $27 million
investment-grade fair value, $21 million were rated AAA by Standard & Poor’s. Our
non-investment grade CMOs had a fair value and book value of $3 million and $4 million,
respectively. We do not intend to make additional investments in this asset category.
3. Fair Value Measurements
We adopted SFAS No. 157 in the first quarter of 2008. Our investment portfolio is subject to
SFAS No. 157 disclosure requirements for interim and year-end reporting.
Fair Value Hierarchy
In accordance with SFAS No. 157, we categorized our financial instruments, based on the
priority of the observable and market-based data for each valuation technique, into a
three-level fair value hierarchy. The fair value hierarchy gives the highest priority to
quoted prices with readily available independent data in active markets for identical assets
or liabilities (Level 1) and the lowest priority to unobservable market inputs (Level 3).
When various inputs for measurement fall within different levels of the fair value
hierarchy, the lowest observable input that has a significant impact on fair value
measurement is used.
Financial instruments are categorized based upon the following characteristics or inputs to
the valuation techniques:
We conduct a thorough review of fair value hierarchy classifications on a quarterly basis.
Reclassification of certain financial instruments may occur when input observability
changes. As noted below in the Level 3 disclosure table, reclassifications are reported as
transfers in/out of the Level 3 category as of the beginning of the quarter in which the
reclassification occurred.
Cincinnati Financial Corporation — 2008 Annual Report on 10-K — Page 106 The following table illustrates the fair value hierarchy for those assets measured at fair
value on a recurring basis as of December 31, 2008. We do not have any material liabilities
carried at fair value.
Level 3 Assets
Each financial instrument deemed to have significant unobservable inputs when determining
valuation is identified in the table below by security type with a summary of changes in
fair value for the year ended December 31, 2008.
Included within earnings for the Level 3 securities for the year ended December 31, 2008,
was approximately $19 million of impairment charges. Of the $19 million, approximately $16
million was for impairment of preferred equities.
Unrealized gains or losses on Level 3 securities were included in accumulated other
comprehensive income and were not included in net realized investment gains or losses for
the year ended December 31, 2008. We transferred approximately $26 million out of Level 3
taxable fixed maturity securities and $19 million into Level 3 taxable fixed maturity
securities throughout the year. We also transferred approximately $16 million out of Level 3
preferred equity securities and $7 million into Level 3 preferred equity securities
throughout the year.
4. Deferred Acquisition Costs
This table summarizes components of our deferred policy acquisition costs asset:
Cincinnati Financial Corporation — 2008 Annual Report on 10-K — Page 107 5. Property Casualty Loss And Loss Expenses
This table summarizes activity loss and loss expense reserves:
We use actuarial methods, models, and judgment to estimate, as of a financial statement
date, the property casualty loss and loss expense reserves required to pay for and settle
all outstanding insured claims, including incurred but not reported (IBNR) claims, as of
that date. The actuarial estimate is subject to review and adjustment by an
inter-departmental committee that includes actuarial management and is familiar with
relevant company and industry business, claims, and underwriting trends, as well as general
economic and legal trends, that could affect future loss and loss expense payments.
Because of changes in estimates of insured events in prior years, we reduced loss and loss
expenses by $323 million, $244 million and $116 million in calendar years 2008, 2007 and
2006. These decreases are partly due to the effects of settling reported (case) and
unreported (IBNR) reserves established in prior years for amounts less than expected. The
reserve for loss and loss expenses in the consolidated balance sheets also includes $46
million, $42 million and $36 million at December 31, 2008, 2007 and 2006, respectively, for
certain life and health losses.
6. Life Policy Reserves
We establish the reserves for traditional life insurance policies based on expected
expenses, mortality, morbidity, withdrawal rates and investment yields, including a
provision for uncertainty. Once these assumptions are established, they generally are
maintained throughout the lives of the contracts. We use both our own experience and
industry experience, adjusted for historical trends, in arriving at our assumptions for
expected mortality, morbidity and withdrawal rates as well as for expected expenses. We base
our assumptions for expected investment income on our own experience adjusted for current
economic conditions.
We establish reserves for the company’s universal life, deferred annuity and investment
contracts equal to the cumulative account balances, which include premium deposits plus
credited interest less charges and withdrawals. Some of our universal life policies contain
no-lapse guarantee provisions. For these policies, we establish a reserve in addition to the
account balance, based on expected no-lapse guarantee benefits and expected policy
assessments.
Here is a summary of our life policy reserves:
We provide an updated definition of fair value under SFAS No. 157 in Note 1, Summary of Significant Accounting Policies,
Page 98. At December 31, 2008, fair value for annuities and investment contracts
was approximately $460 million, using the updated definition. At December 31, 2007, fair value
for annuities and investment contracts was approximately $564 million.
Cincinnati Financial Corporation — 2008 Annual Report on 10-K — Page 108 7. Notes Payable
At December 31, 2008 and 2007, we had two lines of credit with commercial banks with an
aggregate borrowing capacity of $225 million. Our note payable balance was $49 million at
year-end 2008, down from $69 million at year-end 2007. We had no compensating balance
requirements on short-term debt for either 2008 or 2007. Interest rates charged on
borrowings ranged from 2.99 percent to 6.11 percent during 2008.
In 2006, our subsidiary, CFC Investment Company, entered into an interest-rate swap
agreement that expires August 29, 2009. The purpose of the interest-rate swap contract was
to hedge against fluctuations of interest payments for certain variable-rate debt
obligations ($49 million notional amount). This swap is reflected at fair
value in the consolidated balance sheets as a component of shareholders’ equity in
accumulated other comprehensive income. The unrealized loss, net of tax, was $640,000 at
year-end 2008 compared with $594,000 at year-end 2007. Management does not expect any
significant amounts to be reclassified into earnings as a result of interest rate changes in
the next 12 months.
8. Senior Debt
This table summarizes the principal amounts of our long-term debt excluding unamortized
discounts:
The fair value of our senior debt approximated $595 million at year-end 2008 compared with
$802 million at year-end 2007. Fair value for 2008 was determined under SFAS No. 157 based
on market pricing of these or similar debt instruments that are actively trading. Fair value
can vary with macro economic concerns. Regardless of the fluctuations in fair value, the
outstanding principal amount of our long-term debt remained unchanged from year-end 2007.
None of the notes are encumbered by rating triggers.
Cincinnati Financial Corporation — 2008 Annual Report on 10-K — Page 109 9. Shareholders’ Equity And Dividend Restrictions
Our insurance subsidiary declared dividends to the parent company of $160 million in 2008,
$420 million in 2007 and $275 million in 2006. State regulatory requirements restrict the
dividends insurance subsidiaries can pay. Generally, the most our insurance subsidiaries can
pay without prior regulatory approval is the greater of 10 percent of policyholder surplus
or 100 percent of statutory net income for the prior calendar year. Dividends exceeding
these limitations may be paid only with approval of the insurance department of the
domiciliary state. During 2009, the total dividends that our lead insurance subsidiary may
pay to our parent company without regulatory approval will be approximately $336 million.
As of December 31, 2008, 7.3 million shares of common stock were available for future equity
award grants.
Declared cash dividends per share were $1.56, $1.42 and $1.34 for the years ended December
31, 2008, 2007 and 2006, respectively.
Accumulated Other Comprehensive Income
The change in unrealized gains and losses on investments, pension obligations and
derivatives included:
Cincinnati Financial Corporation — 2008 Annual Report on 10-K — Page 110 10. Reinsurance
Our statements of income include earned consolidated property casualty insurance premiums on
assumed and ceded business:
Our statements of income include incurred consolidated property casualty insurance loss and
loss expenses on assumed and ceded business:
Our statements of income include earned life insurance premiums on assumed and ceded
business:
Our statements of income include life insurance contract holder benefits incurred on assumed
and ceded business:
11. Income Taxes
Deferred tax assets and liabilities reflect temporary differences between the carrying
amounts of assets and liabilities for financial reporting purposes and the amount recognized
for tax purposes. The significant components of deferred tax assets and liabilities included
in the balance sheets at December 31 were as follows:
We believe it is more likely than not that our deferred tax assets will be realized.
Significant factors we considered in determining the probability of realizing the deferred
tax benefits include our historical operating results, the amount of our loss carryback
potentials and the expectations of future earnings. The likelihood of realizing our deferred
tax asset will be reviewed periodically; any adjustments required to the valuation allowance
will be made in the period in which the developments they are based become known.
The provision for federal income taxes is based upon filing a consolidated income tax return
for the company and subsidiaries. As of December 31, 2008, we had no operating or capital
loss carry forwards.
The differences between the 35 percent statutory income tax rate and our effective income
tax rate were as follows:
Interpretation No. 48, Accounting for Uncertainty in Income Taxes, an Interpretation of
SFAS No. 109
On January 1, 2007, we adopted the provisions of FIN 48. As of December 31, 2008, we had
gross unrecognized tax benefits (FIN 48 liability) of $2.1 million.
Below is the unrecognized tax benefit for December 31, 2008, and December 31, 2007:
The FIN 48 liability is carried in other liabilities in the consolidated balance sheets as
of December 31, 2008. There are no amounts in our FIN 48 liability that would change the
effective tax rate if recognized. Although no penalties currently are accrued, if incurred,
they would be recognized as a component of income tax expense. Accrued interest expense is
recognized as other operating expense in the consolidated statements of income. The accrued
interest liability was $1.8 million as of December 31, 2007 with an accrued interest
receivable of $800,000 at December 31, 2008. The consolidated statements of income for the
current year reflect an immaterial amount of net IRS interest expense compared to net
interest income of $1.5 million in 2007 from a reduction in the accrued interest liability
and interest received on refund claims.
In May 2008, the IRS concluded the examination phase of its audit of our 2005 and 2006 tax
years and presented us with adjustments primarily related to the valuation of our loss
reserves. In October 2008, we reached agreement with the IRS settling all issues related to
the 2005 and 2006 tax years. As a result of the IRS agreement for tax years 2005 and 2006,
management refined certain assumptions used to calculate the unrecognized tax benefits
associated with loss reserves, resulting in a revised measurement of the unrecognized tax
benefits for both the current and prior year.
Although we have not been notified by the IRS of the date of our next audit, it is
reasonable to expect that it will begin the audit of tax years 2007 and 2008 in the next 12
months. As a result, it is reasonably possible that a change in the unrecognized tax
benefits may occur once the examination phase of this next audit has concluded. At this
time, we can neither estimate the settlement date of, nor quantify an estimated range for
any potential change to, the unrecognized tax benefits relating to these years.
In addition to our Internal Revenue Service filings, we file income tax returns in various
state jurisdictions. Material amounts of income tax are paid to Ohio, Illinois and Florida.
Although no state audits are currently under way nor are we aware of any pending audits, tax
years 2005 and forward remain open for examination.
Cincinnati Financial Corporation — 2008 Annual Report on 10-K — Page 112 12. Net Income Per Common Share
Basic earnings per share are computed based on the weighted average number of shares
outstanding. Diluted earnings per share are computed based on the weighted average number of
common and dilutive potential common shares outstanding. We have adjusted shares and
earnings per share to reflect all stock splits and dividends prior to December 31, 2008.
Here are calculations for basic and diluted earnings per share:
The current sources of dilution of our common shares are certain equity-based awards as
discussed in Note 17 Stock-Based Associated Compensation Plans,
Page 117. The above table
shows the number of anti-dilutive options shares at year-end 2008, 2007 and 2006. We did not
include these options in the computation of net income per common share (diluted) because
their exercise would have an anti-dilutive effect.
13. Employee Retirement Benefits
We sponsor a defined benefit pension plan and a defined contribution plan (401(k) savings
plan). During 2008, we changed the form of retirement benefit we offer some associates to a
company match on contribution to the 401(k) plan from the defined benefit pension plan.
Effective June 30, 2008, we froze entry into the pension plan for new associates. Only
participants 40 years of age or older could elect to continue to participate. For
participants remaining in the pension plan, we will continue to contribute to fund future
benefit obligations. Benefits for the defined benefit pension plan are based on years of
credited service and compensation level. Contributions are based on the prescribed method
defined in the Pension Protection Act. Our pension expense is based on certain actuarial
assumptions and also is composed of several components that are determined using the
projected unit credit actuarial cost method.
We also maintain a supplemental executive retirement plan (SERP) with liabilities of
approximately $6 million at both year-end 2008 and 2007. The SERP is included in the
obligation and expense amounts in the tables below. The company also makes available to a
select group of associates the Cincinnati Financial Corporation Top Hat Savings Plan, a
non-qualified deferred compensation plan.
For any participant who left the pension plan, benefit accruals were frozen effective August
31, 2008. We transferred $60 million of the pension plan’s accumulated benefit obligation to
an intermediary spin-off plan to facilitate the partial curtailment and settlement for these
participants. For SERP participants who chose to leave the defined benefit pension plan,
benefit accruals were frozen in the SERP as of December 31, 2008. During 2009, the frozen
accrued benefit for those participants, collectively amounting to approximately $1 million,
will transfer to the Top Hat Savings Plan. Beginning in 2009, for these associates, the
company has begun matching deferrals to the Top Hat Savings Plan up to the first 6 percent
of an associate’s compensation that exceeds the compensation limit specified by the Internal
Revenue Code of 1986, as amended.
Pursuant to SFAS No. 88, “Employers’ Accounting for Settlements and Curtailments of Defined
Benefit Pension Plans and for Termination Benefits,” we recognized expense of $3 million in
the consolidated statement of income associated with the partial termination of the
qualified pension plan. In addition, we recognized $27 million in the consolidated statement
of income for a settlement loss associated with the payout to the participants who left the
pension plan of the obligation held in their behalf. Included in the charge is the
contribution of $24 million to complete funding of benefits that were distributed in 2008 to
participants leaving the pension plan.
Cincinnati Financial Corporation — 2008 Annual Report on 10-K — Page 113 We began making matching contributions to our sponsored 401(k) plan during 2008,
contributing $3 million during the year. Associates who are not accruing benefits under the
pension plan are eligible to receive the company match of up to 6 percent of cash
compensation. We also pay all operating expenses for the 401(k) plan. Participants vest in
the company match for the 401(k) plan and Top Hat Savings plan after three years of eligible
service.
Defined Benefit Pension Plan Assumptions
Key assumptions used in developing the 2008 net pension obligation were a 6.00 percent
discount rate and rates of compensation increases ranging from 4 percent to 6 percent. To
determine the discount rate, the plan’s particular liability characteristics — the amounts,
timing and interest sensitivity of expected benefit payments — were evaluated and then
matched to a yield curve based on actual high-quality corporate bonds across a full maturity
spectrum. Once the plan’s projected cash flows matched the yield curve, a present value was
developed, which was then calibrated to a single-equivalent discount rate. That discount
rate, when applied to a single sum, would generate the necessary cash flows to pay benefits
when due. We decreased the rate by 0.25 percentage points in 2008 due to market interest
rate conditions. We based the rates of compensation increase on the company’s historical
data. Due to the curtailment, we re-measured the net pension obligation of our qualified
plan on September 1, 2008, using a 6.75 percent discount rate.
Key assumptions used in developing the 2008 net pension expense were a 6.25 percent discount
rate, an 8 percent expected return on plan assets and rates of compensation increases
ranging from 4 percent to 6 percent. The 8 percent return on plan assets assumption was used
for both the qualified plan and the intermediary spin-off plan that was created on September
1, 2008, and is based partially on the fact that substantially all of the investments held
by the pension plan are common stocks that pay dividends. We believe this rate is
representative of the expected long-term rate of return on these assets. These assumptions
were consistent with the prior year, except that the discount rate was increased by 0.50
percentage points due to market interest rate conditions. Due to the plan changes described
above, we re-measured the net pension expense at September 1, 2008, using a 6.75 percent
discount rate.
Benefit obligation activity using an actuarial measurement date for our qualified and SERP
plans at December 31 follows:
The accumulated benefit obligation was $170 million and $206 million at December 31, 2008
and 2007, respectively.
Cincinnati Financial Corporation — 2008 Annual Report on 10-K — Page 114 A reconciliation follows of the funded status for our qualified and SERP plans at the end of
the measurement period to the amounts recognized in the balance sheet at December 31, 2008:
The weighted-average assumptions used to determine benefit obligations for our qualified and
SERP plans at December 31 follows:
We evaluate our pension plan assumptions annually and update them as necessary. The discount
rate assumptions for our benefit obligation track with high grade corporate bond yield and
yearly adjustments reflect any changes to those bond yields. Compensation increase
assumptions reflect historical calendar year compensation increases.
Here are the components of our net periodic benefit cost for our qualified and SERP pension
plans at December 31:
Our pension plan asset allocations by category are:
The pension plan assets are managed to maximize total return over the long term while
providing sufficient liquidity and current return to satisfy the cash flow requirements of
the plan. Reflecting the long-term time horizon of pension obligations, we currently
allocate 80 percent to 85 percent of the pension portfolio to equity investments, which are
priced from highly observable and actively traded markets. The remainder of the portfolio is
allocated to fixed-maturity investments and cash.
Our pension plan assets included 642,113 shares of the company’s common stock, which had a
fair value of $19 million and $25 million at December 31, 2008 and 2007, respectively. The
defined benefit pension plan did not purchase or sell any shares of our common stock during
2008 and 2007. The company paid $1 million in cash dividends on our common stock to the
pension plan in both 2008 and 2007.
In 2009, we expect to contribute approximately $33 million to our qualified plan. We expect
to make the following benefit payments for our qualified and SERP plans, which reflect
expected future service:
The estimated costs to be amortized from accumulated other comprehensive income into net
periodic benefit cost over the next year for our plans are a $1 million actuarial gain and a
$1 million prior service cost.
Cincinnati Financial Corporation — 2008 Annual Report on 10-K — Page 115 14. Statutory Accounting Information (Unaudited)
Insurance companies use statutory accounting practices (SAP) as prescribed by regulatory
authorities. The three primary differences between SAP and GAAP are:
Statutory net income and capital and surplus as determined in accordance with SAP prescribed
or permitted by insurance regulatory authorities for four legal entities, our insurance
subsidiary and its three insurance subsidiaries, are as follows:
Statutory capital and surplus for our insurance subsidiary, The Cincinnati Insurance
Company, includes capital and surplus of its four insurance subsidiaries.
15. Transactions With Affiliated Parties
We paid certain officers and directors, or insurance agencies of which they are
shareholders, commissions of approximately $6 million, $7 million and $7 million on premium
volume of approximately $38 million, $37 million and $40 million for 2008, 2007 and 2006,
respectively.
16. Commitments And Contingent Liabilities
In the ordinary course of conducting business, the company and its subsidiaries are named as
defendants in various legal proceedings. Most of these proceedings are claims litigation
involving the company’s insurance subsidiaries in which the company is either defending or
providing indemnity for third-party claims brought against insureds who are litigating
first-party coverage claims. The company accounts for such activity through the
establishment of unpaid loss and loss adjustment expense reserves. We believe that the
ultimate liability, if any, with respect to such ordinary-course claims litigation, after
consideration of provisions made for potential losses and costs of defense, will be
immaterial to our consolidated financial condition, results of operations and cash flows.
The company and its subsidiaries also are occasionally involved in other legal actions, some
of which assert claims for substantial amounts. These actions include, among others,
putative state class actions seeking certification of a state or national class. Such
putative class actions have alleged, for example, improper reimbursement of medical
providers paid under workers’ compensation insurance policies. The company’s insurance subsidiaries also
are occasionally parties to individual actions in which extra-contractual damages, punitive
damage, or penalties are sought, such as claims alleging bad faith in the handling of
insurance claims.
On a quarterly basis, we review the outstanding lawsuits seeking such recourse. Based on our
year-end review, we believe we have valid defenses to each. As a result, we believe the
ultimate liability, if any, with respect to these lawsuits, after consideration of
provisions made for estimated losses, will be immaterial to our consolidated financial
position.
Nonetheless, given the potential for large awards in certain of these actions and the
inherent unpredictability of litigation, an adverse outcome could have a material adverse
effect on the company’s consolidated results of operations or cash flows in particular
quarterly or annual periods.
Cincinnati Financial Corporation — 2008 Annual Report on 10-K — Page 116 17. Stock-Based Associate Compensation Plans
We currently have four equity compensation plans that together permit us to grant various
types of equity awards. The Cincinnati Financial Corporation 2006 Stock Compensation Plan
gives us the flexibility to make grants to associates of any type of stock-based awards,
subject to performance-based criteria, to directly link compensation to performance. We
currently grant incentive stock options, non-qualified stock options, service-based
restricted stock units and performance-based restricted stock units under our plans. We also
have a Holiday Stock Plan that permits annual awards of one share of common stock to each
full time associate for each year of service up to a maximum of 10 shares. One of our equity
compensation plans permits us to grant common stock to our outside directors.
We use the modified-prospective-transition method under which we recognize:
Our pretax and after-tax share-based compensation costs are summarized below:
The total intrinsic value of options exercised during the years ended December 31, 2008,
2007 and 2006, was $1 million, $8 million and $22 million, respectively. (Intrinsic value is
the market price less the exercise price.) Options vested during the years ended December
31, 2008 and 2007, had no intrinsic value. The intrinsic value of options vested during the
year ended December 31, 2006 was $10 million.
As of December 31, 2008, we had $22 million of unrecognized total compensation cost related
to non-vested stock options and restricted stock unit awards. That cost will be recognized
over a weighted-average period of 2.2 years.
Stock options are granted to associates at an exercise price that is equal to the fair
market value as reported on the NASDAQ Global Select Market for the grant date and are
exercisable over 10 year periods. The stock options generally vest ratably over a three-year
period. In determining the share-based compensation amounts for 2008, 2007 and 2006, the
fair value of each option granted in those years was estimated on the date of grant using
the binomial option-pricing model. We make assumptions in four areas to develop the binomial
option-pricing model:
The following weighted average assumptions were used for grants in determining fair value of
share-based compensation:
Cincinnati Financial Corporation — 2008 Annual Report on 10-K — Page 117 Here is a summary of options information:
Cash received from the exercise of options was $4 million, $19 million and $27 million for
the years ended December 31, 2008, 2007 and 2006, respectively. SFAS No. 123(R) also
requires us to classify certain tax benefits related to share-based compensation deductions
as cash from financing activities. We did not realize a tax benefit on options exercised for
the year ended December 31, 2008. We realized a $2 million tax benefit on options exercised
for the year ended December 31, 2007, and a $3 million benefit for the year ended December
31, 2006.
Options outstanding and exercisable consisted of the following at December 31, 2008:
The weighted-average remaining contractual life for exercisable awards as of December 31,
2008, was 3.9 years. As of December 31, 2008, 7.3 million shares of common stock were
available for future equity award grants. We currently issue new shares for option
exercises.
Restricted Stock Units
Service-based and performance-based restricted stock units are granted to associates at fair
market value on the date of grant. Service-based restricted stock units vest as a unit three
years after the date of grant.
If certain performance targets are attained, performance-based restricted stock units vest
on the first day of March after a three-calendar year performance period. Quarterly,
management reviews and determines the likelihood that the company will achieve the
performance targets for the outstanding groups of service-based restricted stock units.
As of December 31, 2008, management assumed that performance targets used for restricted
stock unit awards granted during November 2008 would be met and we recognized related
compensation cost. Management concluded that the company would not meet performance targets
for all other restricted stock unit awards and did not recognize related compensation costs
except for certain awards to retirement eligible associates. For the 2007 performance-based
restricted stock awards, we recognize compensation cost during the performance period for
retirement-eligible associates. We recognize that cost regardless of whether the performance
criteria has been met. The fair value of the restricted stock unit awards was determined
based on the fair value on the date of grant less the present value of the dividends that
holders of restricted stock units will not receive on the shares underlying the restricted
stock units during the vesting period.
Here is a summary of restricted stock unit information for 2008:
Cincinnati Financial Corporation — 2008 Annual Report on 10-K — Page 118 18. Segment Information
We operate primarily in two industries, property casualty insurance and life insurance. We
regularly review four different reporting segments to make decisions about allocating
resources and assessing performance:
We report as “Other” the non-investment operations of the parent company and its
subsidiaries CFC Investment Company and CinFin Capital Management Company (excluding client
investment activities), as well as other income of our standard market property casualty
insurance operations and consolidated eliminations. Beginning in 2008, we also are including
results of The Cincinnati Specialty Underwriters Insurance Company and CSU Producer
Resources in Other. In 2007, an immaterial level of expenses from The Cincinnati Specialty
Underwriters Insurance Company was included in the commercial lines property casualty
insurance segment while an immaterial level of expenses for CSU Producer Resources was
included in Other.
Revenues come primarily from unaffiliated customers:
Income or loss before income taxes for each segment is reported based on the nature of that
business area’s operations:
Identifiable assets are used by each segment in its operations. We do not separately report
the identifiable assets for the commercial or personal lines segments because we do not use
that measure to analyze the segments. We include all investment assets, regardless of
ownership, in the investment operations segment.
Cincinnati Financial Corporation — 2008 Annual Report on 10-K — Page 119 This table summarizes segment information:
Cincinnati Financial Corporation — 2008 Annual Report on 10-K — Page 120 19. Quarterly Supplementary Data (Unaudited)
This table includes unaudited quarterly financial information for the years ended December
31, 2008 and 2007:
We had no disagreements with the independent registered public accounting firm on accounting
and financial disclosure during the last two fiscal years.
Evaluation of Disclosure Controls and Procedures – The company maintains disclosure controls
and procedures (as that term is defined in Rules 13a-15(e) and 15d-15(e) under the
Securities Exchange Act of 1934, as amended (Exchange Act)).
Any controls and procedures, no matter how well designed and operated, can provide only
reasonable assurance of achieving the desired control objectives. The company’s management,
with the participation of the company’s chief executive officer and chief financial officer,
has evaluated the effectiveness of the design and operation of the company’s disclosure
controls and procedures as of December 31, 2008. Based upon that evaluation, the company’s
chief executive officer and chief financial officer concluded that the design and operation
of the company’s disclosure controls and procedures provided reasonable assurance that the
disclosure controls and procedures are effective to ensure that:
Changes in Internal Control over Financial Reporting – During the three months ended
December 31, 2008, there were no changes in our internal controls over financial reporting
that have materially affected, or are reasonably likely to materially affect, our internal
control over financial reporting. Management’s Annual Report on Internal Control Over
Financial Reporting and the Audit Report of the Independent Registered Public Accounting
Firm are set forth in Item 8,
Pages 92 and 93.
None
Cincinnati Financial Corporation — 2008 Annual Report on 10-K — Page 122 Part III
Our Proxy Statement will be filed with the SEC in preparation for the 2009 Annual Meeting of
Shareholders no later than April 3, 2009. As permitted in Paragraph G(3) of the General
Instructions for Form 10-K, we are incorporating by reference to that statement portions of
the information required by Part III as noted in Item 10 through Item 14 below.
Information on executive compensation appears in the Proxy Statement under “Compensation of
Named Executive Officers and Directors,” which includes the “Report of the Compensation
Committee” and the “Compensation Discussion and Analysis.”
Information about certain relationships and related transactions appears in the Proxy
Statement under “Certain Relationships and Transactions” and “Compensation Committee
Interlocks and Insider Participation.”
Information about independent registered public accounting firm fees and services and audit
committee pre-approval policies and procedures appears in the Proxy Statement under
“Audit-related Matters,” which includes the “Report of the Audit Committee,” “Fees Billed by
the Independent Registered Public Accounting Firm” and “Services Provided by the Independent
Registered Public Accounting Firm.”
Cincinnati Financial Corporation — 2008 Annual Report on 10-K — Page 123 Part IV
Cincinnati Financial Corporation — 2008 Annual Report on 10-K — Page 124 SCHEDULE I
Cincinnati Financial Corporation and Subsidiaries
Summary of Investments — Other than Investments in Related Parties
Cincinnati Financial Corporation — 2008 Annual Report on 10-K — Page 125 SCHEDULE I (CONTINUED)
Cincinnati Financial Corporation and Subsidiaries
Summary of Investments — Other than Investments in Related Parties
Cincinnati Financial Corporation — 2008 Annual Report on 10-K — Page 126 SCHEDULE II
Cincinnati Financial Corporation (parent company only)
Condensed Balance Sheets
This condensed financial information should be read in conjunction with the Consolidated Financial
Statements and Notes included in Part II, Item 8,
Page 91.
Cincinnati Financial Corporation — 2008 Annual Report on 10-K — Page 127 SCHEDULE II (CONTINUED)
Cincinnati Financial Corporation (parent company only)
Condensed Statements of Income
This condensed financial information should be read in conjunction with the Consolidated Financial
Statements and Notes included in Part II, Item 8,
Page 91.
Cincinnati Financial Corporation — 2008 Annual Report on 10-K — Page 128 SCHEDULE II (CONTINUED)
Cincinnati Financial Corporation (parent company only)
Condensed Statements of Cash Flows
This condensed financial information should be read in conjunction with the Consolidated
Financial Statements and Notes included in Part II, Item 8,
Page 91.
Cincinnati Financial Corporation — 2008 Annual Report on 10-K — Page 129 SCHEDULE III
Cincinnati Financial Corporation and Subsidiaries
Supplementary Insurance Information
Cincinnati Financial Corporation — 2008 Annual Report on 10-K — Page 130 SCHEDULE III (CONTINUED)
Cincinnati Financial Corporation and Subsidiaries
Supplementary Insurance Information
SCHEDULE IV
Cincinnati Financial Corporation and Subsidiaries
Reinsurance
Cincinnati Financial Corporation — 2008 Annual Report on 10-K — Page 132 SCHEDULE V
Cincinnati Financial Corporation and Subsidiaries
Valuation and Qualifying Accounts
Cincinnati Financial Corporation — 2008 Annual Report on 10-K — Page 133 SCHEDULE VI
Cincinnati Financial Corporation and Subsidiaries
Supplementary Information Concerning Property Casualty Insurance Operations
SIGNATURES
Pursuant to the requirements of Section 13 or 15 (d) of the Securities Exchange Act of 1934,
the registrant has duly caused this report to be signed on its behalf by the undersigned,
thereunto duly authorized.
Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been
duly signed below by the following persons on behalf of the registrant and in the capacities
and on the dates indicated.
Cincinnati Financial Corporation — 2008 Annual Report on 10-K — Page 135 INDEX OF EXHIBITS
Cincinnati Financial Corporation — 2008 Annual Report on 10-K — Page 136
Cincinnati Financial Corporation — 2008 Annual Report on 10-K — Page 137
Cincinnati Financial Corporation — 2008 Annual Report on 10-K — Page 138 United States Securities and Exchange Commission
Washington, D.C. 20549
Form 10-K
For the fiscal year ended December 31, 2008.
For the transition period from
to
.
Commission file number 0-4604
Cincinnati Financial Corporation
(Exact name of registrant as specified in its charter)
6200 S. Gilmore Road
Fairfield, Ohio 45014-5141 (Address of principal executive offices) (Zip Code) (513) 870-2000
(Registrant’s telephone number, including area code) Securities registered pursuant to Section 12(b) of the Act:
None Securities registered pursuant to Section 12(g) of the Act:
$2.00 par, common stock (Title of Class) 6.125% Senior Notes due 2034 (Title of Class) 6.9% Senior Debentures due 2028 (Title of Class) 6.92% Senior Debentures due 2028 (Title of Class) Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of
the Securities Act. Yes þ No o
Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or
Section 15(d) of the Act. Yes o No þ
Indicate by check mark whether the registrant: (1) has filed all reports required to be filed by
Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for
such shorter period that the registrant was required to file such reports) and (2) has been subject
to such filing requirements for the past 90 days. Yes þ No o
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is
not contained herein, and will not be contained, to the best of registrant’s knowledge, in
definitive proxy or information statements incorporated by reference in Part III of this Form 10-K
or any amendment to this Form 10-K. o
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated
filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large
accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the
Exchange Act.
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the
Exchange Act).
Yes o No þ The aggregate market value of voting stock held by nonaffiliates of the Registrant was
$3,708,499,771 as of June 30, 2008.
As of February 19, 2009, there were 162,502,547 shares of common stock outstanding.
Document Incorporated by Reference
Portions of the definitive Proxy Statement for Cincinnati Financial Corporation’s Annual Meeting of
Shareholders to be held on May 2, 2009, are incorporated by reference into Parts II and III of this
Form 10-K.
Cincinnati Financial Corporation (as of February 27, 2009)
This report contains forward-looking statements that involve potential risks and uncertainties. For factors that
could cause results to differ materially from those discussed, please see the most recent edition of our safe
harbor statement under the Private Securities Litigation Reform Act of 1995. To view or print the edition in
effect as of this report's initial publication date, please view this document as a printable PDF.
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