Cincinnati Financial Corporation

2008 Second-quarter Letter to Shareholders

prev

next

Cincinnati Financial Reports Second-quarter 2008 Profit

• Net income at $63 million, or 38 cents per share in the second quarter of 2008, compared with net income of $351 million, or $2.02 per share, in the second quarter of 2007. A return to profitability in the second quarter after the first quarter loss brought six-month net income per share to 13 cents compared with $3.13 last year. Realized capital losses were significantly lower in the second quarter compared with first-quarter 2008.
• Operating income* at $69 million, or 42 cents per share, in the second quarter of 2008, compared with $164 million, or 94 cents per share, in the comparable 2007 period. Record catastrophe losses reduced second-quarter operating income by 45 cents per share compared with 4 cents per share in last year's second quarter. Six-month operating income at $1.08 per share included a 62 cent impact from catastrophe losses compared with $1.82 per share including a 5 cent impact.
• Atypically high catastrophe losses of $113 million resulted in a consolidated property casualty underwriting loss of $27 million in this year's second quarter.

*	Our Definitions of Non-GAAP Information and Reconciliation to Comparable GAAP Measures appears on our Web site, www.cinfin.com/investors, and defines and reconciles measures presented in this release that are not based on Generally Accepted Accounting Principles or Statutory Accounting Principles.

• 103.5 percent second-quarter 2008 property casualty combined ratio, compared with 88.6 percent for the 2007 second-quarter. The most significant reason for the increase was the 13.5 percentage point rise in the catastrophe loss contribution.
• Decrease in property casualty net written premiums narrowed to 2.5 percent in the second quarter from 8.3 percent in the first quarter, benefiting from $100 million of new business, with new commercial lines business up 21.2 percent and new personal lines business up 7.7 percent. Pricing remains competitive in both commercial and personal lines. Recently launched excess and surplus lines operations contributed $4 million of new business since January 1.
• 6 cents per share contribution from life insurance operations to second-quarter operating income, up from 5 cents.

• $130 million of second-quarter pretax investment income compared with $150 million for the same period last year.
• Book value of $28.99 per share compared with $35.70 at year-end 2007. Invested assets and book value declined primarily on lower market values of financial sector and other equity holdings.

• Property casualty net written premium target unchanged. Competitive pricing could lead to full-year 2008 premiums declining as much as 5 percent.
• Combined ratio could rise above 100 percent due to high catastrophe losses, as recently announced.
• Expected lower investment income now estimated to be as much as 10 percent below the 2007 level due to lower anticipated dividends from common stocks and the lower number of Fifth Third Bancorp (NASDAQ:FITB) shares held after recent sale. Portfolio strategies, including reinvestment of proceeds from Fifth Third sale, continue to focus on balancing near-term income generation with long-term book value growth potential.

Kenneth W. Stecher, president and chief executive officer, stated, "Volatile weather patterns and financial markets hampered our results for the first half of 2008. Our strong business relationships and solid financial foundation allowed us to respond confidently and flexibly to these challenges while acting on our promise of prompt and fair claims service.

"Our financial position remains solid, having absorbed costs associated with the severe storms and with declining valuations of holdings in our equity investment portfolio. Independent agents continue to find that our policies are the best match for their better accounts, appreciating the value of our financial strength and our standout service. Over recent months, we repositioned our investment portfolio, improving our risk profile and adding to our long-term prospects for investment income growth and capital appreciation.

"Also looking to the long-term future, we added depth in our next generation of leadership. The executive transitions we announced in June will broaden and round out the experience of our managers. As a team, we are focused on serving our agent customers and achieving continued growth in earnings and book value over the long term. Our capital position and cash flow continue to support our current cash dividend payout and the board's intention to continue our 48-year tradition of annually increasing cash dividends to our shareholders."

Stecher said, "Our second-quarter results were driven by weather-related events that were largely responsible for the rise in our combined ratio over the same quarter last year. Catastrophe losses totaled $113 million, as we tracked seven events that each contributed $5 million or more to our loss and loss expenses. These storms caused primarily wind, hail and flood damage to our policyholders across 21 states. Our local claims representatives, assisted by four full teams of volunteer representatives from around the country, have already closed approximately 70 percent of the 3,565 reported claims as of July 31. Agents tell us that this prompt and personal claims service is a source of new business referrals.

"Our agents continued to bring the company quality business that allowed us to underwrite insurance near breakeven levels for the first six months of 2008 despite the high catastrophe losses. Agents and underwriters are working together to select and retain appropriately priced accounts, taking the case-by-case approach that has served us so well through all market and pricing cycles.

"As expected, our net written premiums declined 2.5 percent in the second quarter and a little more than 5 percent during the first half, reflecting competitive industry pricing and disciplined company underwriting. Agents continue to market Cincinnati's advantages to their value-oriented clients, leveraging our customized, multi-year commercial coverage packages, superior claims service and high financial strength ratings."

Stecher continued, "We're seeing a steady flow of new business submissions from agents, some resulting from our rollover initiatives that help agents lower expenses by reducing the number of carriers they represent. We see substantial growth opportunities in our newer states, and we're planning to appoint our first agencies in Texas before year-end. Plus, we've already appointed 37 new agencies this year in our 34 active states. Historically, in several of those 34 states we marketed commercial policies, but not personal insurance. Now, more of our agencies in more states are able to bring our personal lines products to their valued clients, thanks to technology advances that make our processes easier and more efficient.

"In addition, we expect premium growth to continue benefiting from expansion of our capabilities in excess and surplus lines. During the second quarter, we added property excess and surplus coverages in the five initial states where we already marketed general liability, entered five more states to market general liability and continued planning for marketing in the total of 33 states by year-end. These new capabilities allow us to provide both admitted and non-admitted coverage solutions to our agents and their business insurance clients, attracting new standard market property casualty business as agents and businesses that require excess and surplus solutions also look to Cincinnati to provide the complete insurance program.

"At the same time these activities generate growth, they also further diversify our book of business, geographically and by product line, helping us manage risk to improve the stability of our underwriting results and add to our overall financial strength."

Steven J. Johnston, chief financial officer, commented, "Our updated guidance for full-year 2008 results reflects current market trends and our actual six-month catastrophe loss experience. Unusually high industrywide storm activity through the first half of 2008 may lead to a full-year 2008 combined ratio above 100 percent."

Key assumptions for full-year 2008 combined ratio guidance include:

• Current accident year loss and loss expense ratio excluding catastrophe losses – Will reflect the same market trends that contributed to an increase in this ratio in 2007 and are further pressuring the 2008 ratio. Year-to-date accident year loss ratio excluding catastrophe losses was 66.0 percent compared with 60.9 percent in the first half of 2007. The average accident year loss ratio excluding catastrophe losses was 61.4 percent from 2004 to 2007.
• Catastrophe loss ratio – May contribute up to 9 percentage points to the full-year 2008 combined ratio. Catastrophes are unpredictable for any given year, contributing 10.3 percentage points in the first half of 2008. These losses have contributed on average 3.7 percentage points to the company's combined ratio in the past 10 years, ranging from 2007's low of 0.8 points to 1998's high of 6.1 points.
• Savings from favorable development on prior period reserves – May benefit the full-year 2008 combined ratio by approximately 4 percentage points based on current trends. Net savings from favorable development on prior period reserves improved the 2008 first half combined ratio by 6.6 percentage points, compared with 4.7 points for the same period in 2007.

Even as market conditions soften, management will continue to rely on actual loss experience over the next six months and on sound actuarial estimation techniques in determining loss and loss expense reserves. Historically, management has targeted loss and loss expense reserves in the upper half of the actuarially established range.

Johnston also said, "Our expectations for premium volume have not changed. Competitive pricing could result in our full-year 2008 net written premiums declining by as much as 5 percent. We continue to maintain our underwriting standards, declining inadequately priced new business and non-renewing selected accounts. Our agents help us target accounts with manageable risk characteristics that support the lower prevailing prices.

"We have updated our investment income guidance based on changes in the equity portfolio in the past 12 months, the reduced level of dividend income anticipated from equity holdings, the investment of insurance operations cash flow and the current portfolio attributes. We now believe that full-year 2008 investment income may decline as much as 10 percent from the 2007 level. This expectation considers Fifth Third's 66 percent reduction in its quarterly cash dividend in June 2008 and our sale of 35 million shares of Fifth Third in July 2008."

Stecher added, "Investment income declined during the second quarter of 2008 as we received lower cash dividends from several of the financial institution stocks in our equity portfolio, including $20 million less from Fifth Third. We are working to return to previous levels of investment income by systematically identifying secure sources of interest income as well as common stocks of companies with the potential for growth in earnings and dividends. Our investment income philosophy stands – to balance near-term income generation with the potential for long-term book value growth.

"Our bond portfolio has held up well in the current challenging environment. As of June 30, the bond portfolio was trading at more than 98 percent of its stated par value. It is a diverse mix of taxable and tax-exempt securities, covering a wide range of sectors, industries and maturities. The fixed income portfolio exceeds by a comfortable margin the $5.7 billion we currently estimate we will need to pay claims, including those not yet reported to us, that occurred through the end of the second quarter. Looking back over the past 15 years, our property casualty reserve estimate has proven consistently adequate. A prudent view of a continuation of the current economic and credit trends could be expected to lead to further declines in bond portfolio values and potentially to related other-than-temporary impairment charges. Nonetheless, the bond portfolio and our strong record of reserve adequacy are pillars of our financial strength and our high financial strength ratings.

"In recent quarters, we have chosen to sell some or all of our positions in common stocks with reduced dividend growth prospects, including some financial services holdings. In July, we sold 35 million shares, or slightly more than half, of our Fifth Third holding. This decision reflected our recent efforts to better diversify the portfolio, a part of managing our enterprise risk. We anticipate applying to our portfolio of common stocks a set of enhanced investment parameters that our board and investment department currently are considering for adoption. These new parameters would align our investment strategy with specific risk tolerances, thereby improving our ability to identify and respond to changing conditions," Stecher said.

Consolidated Property Casualty Insurance Operations

• 2.5 percent and 5.4 percent declines in second-quarter and six-month 2008 property-casualty net written premiums, reflecting softer pricing and disciplined underwriting.
• $100 million in second-quarter 2008 new business written directly by agencies, up 22.8 percent from $81 million in last year's second quarter.
• $4 million in first-half net written premiums from excess and surplus lines operations launched in January 2008.
• 1,110 agency relationships with 1,354 reporting locations marketed property casualty insurance products at June 30, 2008, up from 1,092 agency relationships with 1,327 reporting locations at year-end 2007.
• 103.5 percent second-quarter and 101.1 percent six-month 2008 GAAP combined ratios. Increase in both periods primarily due to higher catastrophe losses.
• Second-quarter 2008 combined ratio increased 14.9 percentage points from the 2007 second quarter. The increase reflected a 13.5 percentage point higher contribution from catastrophe losses and a 4.6 percentage point higher contribution from losses and case reserve increases greater than $250,000 as well as the effect of softer pricing and normal loss cost inflation. These increased losses were partially offset by an 11.4 percentage point higher savings from favorable development on prior period reserves.
• $113 million in second-quarter 2008 catastrophe losses, due primarily to wind, hail and flood damage from storms in the South and Midwest.

Insurance Segment Highlights

• 2.7 percent and 6.5 percent declines in second-quarter and six-month 2008 commercial lines net written premiums, primarily a result of market competition.
• $87 million in second-quarter 2008 new commercial lines business written directly by agencies, up 21.2 percent from $71 million in last year's second quarter. Six-month new business rose 6.4 percent to $152 million from $143 million.
• 14.7 percentage point rise in second-quarter 2008 combined ratio largely due to higher loss and loss expense ratio. Lower commission expense offset a slight rise in other underwriting expenses.
• 14.4 percentage point rise in second-quarter 2008 loss and loss expense ratio due to higher catastrophe losses and higher losses and case reserve increases greater than $250,000, as well as the effect of softer pricing and normal loss cost inflation. Those increases were somewhat offset by a higher level of savings from favorable development on prior period reserves.
• $38 million increase in second-quarter losses and case reserve increases greater than $250,000. The increase largely reflected the normal fluctuations of loss patterns, normal variability in the large case reserves for our workers' compensation claims, several unusually large losses related to non-catastrophe weather and a higher number of executive risk losses between $250,000 and $1 million.
• 12.6 percentage point improvement in combined ratio due to savings from favorable development on prior period reserves for the second quarter of 2008, compared with 7.1 percentage points of savings for the same 2007 period. 7.6 percentage point improvement in the combined ratio due to savings from favorable development for the first half of 2008 compared with 4.8 percentage points in same 2007 period.

• 3.0 percent and 2.6 percent declines in second-quarter and six-month 2008 personal lines net written premiums due to lower policy counts and pricing changes that reduced premiums per policy. Higher new personal lines business and premium increases related to rising insured values partially offset those factors.
• $10 million in second-quarter 2008 personal lines new business written directly by agencies, up 7.7 percent. Six-month new business rose 3.9 percent to $19 million from $18 million.
• 15.4 percentage point rise in second-quarter 2008 combined ratio largely due to higher catastrophe losses. The higher catastrophe losses were partially offset by improvements in the loss and loss expense ratio excluding catastrophe losses and by lower commission and other underwriting expenses.
• 4.8 percentage point improvement in the second-quarter 2008 loss and loss expense ratio excluding catastrophe losses, primarily due to fluctuations in prior period reserve development on a year-over-year basis.
• Savings from favorable development of prior period reserves reduced the loss and loss expense ratio by 7.2 and 3.3 percentage points in the first quarter and first half of 2008. Savings reduced the segment ratio by 0.3 and 4.7 percentage points in the same 2007 periods. Fluctuations in prior period reserve development for the personal lines segment largely are due to quarterly fluctuations in savings for the other personal line of business, which includes personal umbrella coverages.

• $90 million in total six-month 2008 life insurance segment net written premiums. Written premiums include life insurance, annuity and accident and health premiums.
• 3.2 percent increase to $73 million in six-month 2008 written premiums for life insurance products in total.
• 8.2 percent rise to $39 million in six-month 2008 term life insurance written premiums, reflecting marketing advantages of competitive, up-to-date products, providing personal attention and offering policies backed by financial strength and stability.
• 3.3 percent rise in face amount of life policies in force to $63.945 billion at June 30, 2008, from $61.875 billion at year-end 2007.
• $3.8 million decrease in six-month 2008 operating profit, primarily due to less favorable mortality experience.
• 2008 plans include redesign of all life term insurance products. In addition to the worksite term product, updates are planned for the full worksite life portfolio. These improvements support opportunities to cross-sell life insurance products to clients of the independent agencies that sell Cincinnati's property casualty insurance policies.

Investment and Balance Sheet Highlights

• 13.4 percent and 5.5 percent declines in second-quarter and six-month 2008 net investment income, primarily due to dividend reductions of financial institution stocks.
• $11 million realized investment loss in second-quarter 2008 compared with realized investment gain of $293 million in second-quarter 2007. $244 million realized investment loss in 2008 six-month period compared with realized investment gain of $355 million in the same 2007 period.
• Second-quarter pretax realized investment loss reflected $65 million in non-cash charges for other-than-temporary impairments, which included the recognition of the significant market value decline of one large pharmaceutical holding.

• $10.460 billion in investment assets at June 30, 2008, compared with $12.261 billion at year-end 2007. The decrease in investment assets was largely due to lower market valuations of equity holdings, primarily in the financial sector, reflecting broad concerns across the marketplace about credit quality, liquidity and the general health of the economy.
• Shareholders' equity declined to $4.707 billion, or $28.99 per share, at June 30, 2008, down from $5.929 billion, or $35.70, at year-end 2007, largely due to lower market values for investment assets.
• $5.926 billion Aa3/A+-rated bond portfolio at June 30, 2008, containing a diverse mix of taxable and tax-exempt securities.
• $4.453 billion equity portfolio includes $1.888 billion in pretax unrealized gains.
• $3.650 billion in statutory surplus for the property casualty insurance group at June 30, 2008, compared with $4.307 billion at year-end 2007. The ratio of common stock to statutory surplus for the property casualty insurance group portfolio was 71.6 percent at June 30, 2008, compared with 86.0 percent at year-end 2007.
• 23.0 percent ratio of investment securities held at the holding-company level to total holding-company-only assets at June 30, 2008, comfortably within management's below-40 percent target.
• Repurchases of the company's common stock totaled 821,003 shares at a cost of $29 million in the second quarter. Approximately 8.5 million shares remain authorized for repurchase.

Additional information is available on our Web site, www.cinfin.com/investors, including an audio replay of the August 6th conference call webcast.

(Dollars in millions)		June 30,				December 31,
		2008				2007
Assets
Investments		$	10,460			$	12,261
Cash and cash equivalents			333				226
Premiums receivable			1,150				1,107
Reinsurance receivable			777				754
Other assets			2,091				2,289
Total assets		$	14,811			$	16,637
Liabilities
Insurance reserves		$	5,659			$	5,445
Unearned premiums			1,609				1,564
Deferred income tax			380				977
6.125% senior notes due 2034			371				371
6.9% senior debentures due 2028			28				28
6.92% senior debentures due 2028			392				392
Other liabilities			1,665				1,931
Total liabilities			10,104				10,708
Shareholders' Equity
Common stock and paid-in capital			1,452				1,442
Retained earnings			3,298				3,404
Accumulated other comprehensive income			1,163				2,151
Treasury stock			(1,206)				(1,068)
Total shareholders' equity			4,707				5,929
Total liabilities and shareholders' equity		$	14,811			$	16,637

(Dollars in millions except per share data)		Three months ended June 30,								Six months ended June 30,
		2008				2007				2008				2007
Revenues
Earned premiums		$	794			$	822			$	1,575			$	1,637
Investment income, net of expenses			130				150				282				298
Realized investment gains and losses			(11)				293				(244)				355
Other income			4				5				8				11
Total revenues			917				1,270				1,621				2,301
Benefits and Expenses
Insurance losses and policyholder benefits			595				490				1,131				974
Commissions			148				160				298				330
Other operating expenses			110				112				228				218
Total benefits and expenses			853				762				1,657				1,522
Income (Loss) Before Income Taxes			64				508				(36)				779
Provision for Income Taxes			1				157				(57)				234
Net Income		$	63			$	351			$	21			$	545
Per Common Share:
Net income–basic		$	0.38			$	2.04			$	0.13			$	3.16
Net income–diluted		$	0.38			$	2.02			$	0.13			$	3.13

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.

prev

back to top

next