Attached files
file | filename |
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EX-32 - CINCINNATI FINANCIAL CORP | v182149_ex32.htm |
EX-31.B - CINCINNATI FINANCIAL CORP | v182149_ex31b.htm |
EX-11 - CINCINNATI FINANCIAL CORP | v182149_ex-11.htm |
EX-31.A - CINCINNATI FINANCIAL CORP | v182149_ex31a.htm |
UNITED
STATES
|
SECURITIES
AND EXCHANGE COMMISSION
|
WASHINGTON,
D.C. 20549
|
FORM
10-Q
|
(Mark
one)
þ QUARTERLY
REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF
1934.
For
the quarterly period ended March 31, 2010.
¨ TRANSITION
REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF
1934.
|
For
the transition period from _____________________ to
_____________________.
|
|
Commission
file number 0-4604
|
|
CINCINNATI
FINANCIAL CORPORATION
|
(Exact
name of registrant as specified in its charter)
Ohio
|
31-0746871
|
|||
(State
or other jurisdiction of
incorporation
or organization)
|
(I.R.S.
Employer Identification No.)
|
|||
6200
S. Gilmore Road, Fairfield, Ohio
|
45014-5141
|
|||
(Address
of principal executive offices)
|
(Zip
code)
|
Registrant’s
telephone number, including area code: (513) 870-2000
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.
þ Yes
¨
No
Indicate
by check mark whether the registrant has submitted electronically and posted on
its corporate Web site, if any, every Interactive Data File required to be
submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this
chapter) during the preceding 12 months (or for such shorter period that the
registrant was required to submit and post such files).
¨ Yes
¨
No
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
definition of “large accelerated filer,” “accelerated filer” and “smaller
reporting company” in Rule 12b-2 of the Exchange Act.
þ Large accelerated filer
¨
Accelerated filer ¨
Non-accelerated filer ¨
Smaller reporting company
(Do not
check if a smaller reporting company)
Indicate
by check mark whether the registrant is a shell company (as defined in Rule
12b-2 of the Exchange Act):
¨ Yes
þ
No
As of
April 26, 2010, there were 162,984,380 shares of common stock
outstanding.
CINCINNATI
FINANCIAL CORPORATION
FORM
10-Q FOR THE QUARTER ENDED MARCH 31, 2010
TABLE
OF CONTENTS
Part
I – Financial Information
|
3
|
|
Item
1.
|
Financial
Statements (unaudited)
|
3
|
Condensed
Consolidated Balance Sheets
|
3
|
|
Condensed
Consolidated Statements Of Income
|
4
|
|
Condensed
Consolidated Statements Of Shareholders’ Equity
|
5
|
|
Condensed
Consolidated Statements Of Cash Flows
|
6
|
|
Notes
To Condensed Consolidated Financial Statements (Unaudited)
|
7
|
|
Item
2.
|
Management’s
Discussion and Analysis of Financial Condition and Results of
Operations
|
17
|
Safe
Harbor Statement
|
17
|
|
Introduction
|
19
|
|
Results
of Operations
|
25
|
|
Liquidity
and Capital Resources
|
38
|
|
Other
Matters
|
40
|
|
Item
3.
|
Quantitative
and Qualitative Disclosures about Market Risk
|
42
|
Fixed-Maturity
Investments
|
42
|
|
Short-Term
Investments
|
44
|
|
Equity
Investments
|
44
|
|
Unrealized
Investment Gains and Losses
|
45
|
|
Item
4.
|
Controls
and Procedures
|
48
|
Part
II – Other Information
|
48
|
|
Item
1.
|
Legal
Proceedings
|
48
|
Item
1A.
|
Risk Factors |
48
|
Item
2.
|
Unregistered
Sales of Equity Securities and Use of Proceeds
|
48
|
Item
3.
|
Defaults
upon Senior Securities
|
49
|
Item
4.
|
(Removed
and Reserved)
|
49
|
Item
5.
|
Other
Information
|
49
|
Item
6.
|
Exhibits
|
49
|
Signature
|
50
|
|
Exhibit
11
|
51
|
|
Exhibit
31A
|
52
|
|
Exhibit
31B
|
53
|
|
Exhibit
32
|
54
|
2
Financial
Statements (unaudited)
|
Cincinnati
Financial Corporation and Subsidiaries
Condensed
Consolidated Balance Sheets
(In
millions except per share data)
|
March
31,
|
December
31,
|
||||||
2010
|
2009
|
|||||||
ASSETS
|
||||||||
Investments
|
||||||||
Fixed
maturities, at fair value (amortized cost: 2010—$7,655;
2009—$7,514)
|
$ | 8,081 | $ | 7,855 | ||||
Equity
securities, at fair value (cost: 2010—$2,089; 2009—$2,016)
|
2,838 | 2,701 | ||||||
Short-term
investments, at fair value (amortized cost; 2010—$0;
2009—$6)
|
— | 6 | ||||||
Other
invested assets
|
83 | 81 | ||||||
Total
investments
|
11,002 | 10,643 | ||||||
Cash
and cash equivalents
|
402 | 557 | ||||||
Investment
income receivable
|
116 | 118 | ||||||
Finance
receivable
|
75 | 75 | ||||||
Premiums
receivable
|
1,031 | 995 | ||||||
Reinsurance
receivable
|
570 | 675 | ||||||
Prepaid
reinsurance premiums
|
16 | 15 | ||||||
Deferred
policy acquisition costs
|
485 | 481 | ||||||
Land,
building and equipment, net, for company use (accumulated
depreciation:
2010—$344;
2009—$335)
|
249 | 251 | ||||||
Other
assets
|
55 | 45 | ||||||
Separate
accounts
|
615 | 585 | ||||||
Total
assets
|
$ | 14,616 | $ | 14,440 | ||||
LIABILITIES
|
||||||||
Insurance
reserves
|
||||||||
Loss
and loss expense reserves
|
$ | 4,119 | $ | 4,142 | ||||
Life
policy reserves
|
1,862 | 1,783 | ||||||
Unearned
premiums
|
1,549 | 1,509 | ||||||
Other
liabilities
|
561 | 670 | ||||||
Deferred
income tax
|
206 | 152 | ||||||
Note
payable
|
49 | 49 | ||||||
6.125%
senior notes due 2034
|
371 | 371 | ||||||
6.9%
senior debentures due 2028
|
28 | 28 | ||||||
6.92%
senior debentures due 2028
|
391 | 391 | ||||||
Separate
accounts
|
615 | 585 | ||||||
Total
liabilities
|
9,751 | 9,680 | ||||||
Commitments
and contingent liabilities (Note 9)
|
— | — | ||||||
SHAREHOLDERS'
EQUITY
|
||||||||
Common
stock, par value—$2 per share; (authorized: 2010—500 million
shares,
2009—500
million shares; issued: 2010—196 million shares, 2009—196 million
shares)
|
393 | 393 | ||||||
Paid-in
capital
|
1,081 | 1,081 | ||||||
Retained
earnings
|
3,865 | 3,862 | ||||||
Accumulated
other comprehensive income
|
722 | 624 | ||||||
Treasury
stock at cost (2010—33 million shares, 2009—34 million
shares)
|
(1,196 | ) | (1,200 | ) | ||||
Total
shareholders' equity
|
4,865 | 4,760 | ||||||
Total
liabilities and shareholders' equity
|
$ | 14,616 | $ | 14,440 | ||||
Accompanying
notes are an integral part of these condensed consolidated financial
statements.
|
3
Cincinnati
Financial Corporation and Subsidiaries
Condensed
Consolidated Statements Of Income
(In
millions except per share data)
|
Three
months ended March 31,
|
|||||||
2010
|
2009
|
|||||||
REVENUES
|
||||||||
Earned
premiums
|
$ | 746 | $ | 765 | ||||
Investment
income, net of expenses
|
130 | 124 | ||||||
Other
income
|
3 | 3 | ||||||
Realized
investment gains (losses), net
|
||||||||
Other-than-temporary
impairments on fixed maturity securities
|
(1 | ) | (40 | ) | ||||
Other-than-temporary
impairments on fixed maturity securities
transferred
to Other Comprehensive Income
|
— | — | ||||||
Other
realized investment gains, net
|
9 | 38 | ||||||
Total
realized investment gains (losses), net
|
8 | (2 | ) | |||||
Total
revenues
|
887 | 890 | ||||||
BENEFITS
AND EXPENSES
|
||||||||
Insurance
losses and policyholder benefits
|
516 | 581 | ||||||
Underwriting,
acquisition and insurance expenses
|
268 | 255 | ||||||
Other
operating expenses
|
4 | 6 | ||||||
Interest
expense
|
14 | 14 | ||||||
Total
benefits and expenses
|
802 | 856 | ||||||
INCOME
BEFORE INCOME TAXES
|
85 | 34 | ||||||
PROVISION
(BENEFIT) FOR INCOME TAXES
|
||||||||
Current
|
15 | (2 | ) | |||||
Deferred
|
2 | 1 | ||||||
Total
provision (benefit) for income taxes
|
17 | (1 | ) | |||||
NET
INCOME
|
$ | 68 | $ | 35 | ||||
PER
COMMON SHARE
|
||||||||
Net
income—basic
|
$ | 0.42 | $ | 0.22 | ||||
Net
income—diluted
|
0.42 | 0.22 | ||||||
Accompanying
notes are an integral part of these condensed consolidated financial
statements.
|
4
Cincinnati
Financial Corporation and Subsidiaries
Condensed
Consolidated Statements Of Shareholders’ Equity
(In
millions)
|
Accumulated
|
Total
|
||||||||||||||||||||||||||
Common
Stock
|
Other
|
Share-
|
||||||||||||||||||||||||||
Outstanding
|
|
Paid-In
|
Retained
|
Comprehensive
|
Treasury
|
holders'
|
||||||||||||||||||||||
Shares
|
Amount
|
Capital
|
Earnings
|
Income
|
Stock
|
Equity
|
||||||||||||||||||||||
Balance
December 31, 2008
|
162 | $ | 393 | $ | 1,069 | $ | 3,579 | $ | 347 | $ | (1,206 | ) | $ | 4,182 | ||||||||||||||
Net
income
|
— | — | — | 35 | — | — | 35 | |||||||||||||||||||||
Other
comprehensive income (loss), net
|
— | — | — | — | (278 | ) | — | (278 | ) | |||||||||||||||||||
Total
comprehensive income
|
(243 | ) | ||||||||||||||||||||||||||
Dividends
declared
|
— | — | — | (63 | ) | — | — | (63 | ) | |||||||||||||||||||
Stock-based
compensation
|
— | — | 3 | — | — | — | 3 | |||||||||||||||||||||
Reissued
|
— | — | — | — | — | 2 | 2 | |||||||||||||||||||||
Balance
March 31, 2009
|
162 | $ | 393 | $ | 1,072 | $ | 3,551 | $ | 69 | $ | (1,204 | ) | $ | 3,881 | ||||||||||||||
Balance
December 31, 2009
|
162 | $ | 393 | $ | 1,081 | $ | 3,862 | $ | 624 | $ | (1,200 | ) | $ | 4,760 | ||||||||||||||
Net
income
|
— | — | — | 68 | — | — | 68 | |||||||||||||||||||||
Other
comprehensive income (loss), net
|
— | — | — | — | 98 | — | 98 | |||||||||||||||||||||
Total
comprehensive income
|
166 | |||||||||||||||||||||||||||
Dividends
declared
|
— | — | — | (65 | ) | — | — | (65 | ) | |||||||||||||||||||
Stock
options exercised
|
1 | — | (2 | ) | — | — | 3 | 1 | ||||||||||||||||||||
Stock-based
compensation
|
— | — | 3 | — | — | — | 3 | |||||||||||||||||||||
Other
|
— | — | (1 | ) | — | — | 1 | — | ||||||||||||||||||||
Balance
March 31, 2010
|
163 | $ | 393 | $ | 1,081 | $ | 3,865 | $ | 722 | $ | (1,196 | ) | $ | 4,865 | ||||||||||||||
Accompanying
notes are an integral part of these condensed consolidated financial
statements.
|
5
Cincinnati
Financial Corporation and Subsidiaries
Condensed
Consolidated Statements Of Cash Flows
(In
millions)
|
Three
months ended March 31,
|
|||||||
2010
|
2009
|
|||||||
CASH
FLOWS FROM OPERATING ACTIVITIES
|
||||||||
Net
income
|
$ | 68 | $ | 35 | ||||
Adjustments
to reconcile net income to net cash provided by operating
activities:
|
||||||||
Depreciation,
amortization and other non-cash items
|
10 | 8 | ||||||
Realized
(gains) losses on investments
|
(8 | ) | 2 | |||||
Stock-based
compensation
|
3 | 3 | ||||||
Interest
credited to contract holders
|
13 | 9 | ||||||
Deferred
income tax expense
|
2 | 1 | ||||||
Changes
in:
|
||||||||
Investment
income receivable
|
2 | — | ||||||
Premiums
and reinsurance receivable
|
69 | (2 | ) | |||||
Deferred
policy acquisition costs
|
(10 | ) | (7 | ) | ||||
Other
assets
|
(4 | ) | (4 | ) | ||||
Loss
and loss expense reserves
|
(23 | ) | 7 | |||||
Life
policy reserves
|
28 | 25 | ||||||
Unearned
premiums
|
40 | 38 | ||||||
Other
liabilities
|
(29 | ) | (23 | ) | ||||
Current
income tax receivable/payable
|
(51 | ) | (52 | ) | ||||
Net
cash provided by operating activities
|
110 | 40 | ||||||
CASH
FLOWS FROM INVESTING ACTIVITIES
|
||||||||
Sale
of fixed maturities
|
74 | 62 | ||||||
Call
or maturity of fixed maturities
|
176 | 215 | ||||||
Sale
of equity securities
|
31 | 423 | ||||||
Collection
of finance receivables
|
7 | 6 | ||||||
Purchase
of fixed maturities
|
(431 | ) | (873 | ) | ||||
Purchase
of equity securities
|
(88 | ) | (345 | ) | ||||
Change
in short-term investments, net
|
6 | 71 | ||||||
Investment
in buildings and equipment, net
|
(8 | ) | (8 | ) | ||||
Investment
in finance receivables
|
(7 | ) | (6 | ) | ||||
Change
in other invested assets, net
|
1 | (3 | ) | |||||
Net
cash used in investing activities
|
(239 | ) | (458 | ) | ||||
CASH
FLOWS FROM FINANCING ACTIVITIES
|
||||||||
Payment
of cash dividends to shareholders
|
(63 | ) | (63 | ) | ||||
Contract
holder funds deposited
|
58 | 9 | ||||||
Contract
holder funds withdrawn
|
(17 | ) | (19 | ) | ||||
Excess
tax benefits on share-based compensation
|
(2 | ) | — | |||||
Other
|
(2 | ) | (3 | ) | ||||
Net
cash used in financing activities
|
(26 | ) | (76 | ) | ||||
Net
decrease in cash and cash equivalents
|
(155 | ) | (494 | ) | ||||
Cash
and cash equivalents at beginning of year
|
557 | 1,009 | ||||||
Cash
and cash equivalents at end of period
|
$ | 402 | $ | 515 | ||||
Supplemental
disclosures of cash flow information:
|
||||||||
Interest
paid (net of capitalized interest: 2010—$0; 2009—$0)
|
$ | — | $ | 1 | ||||
Income
taxes paid
|
67 | 50 | ||||||
Non-cash
activities:
|
||||||||
Equipment
acquired under capital lease obligations
|
$ | — | $ | 2 | ||||
Accompanying
notes are an integral part of these condensed consolidated financial
statements.
|
6
Notes
To Condensed Consolidated Financial Statements (Unaudited)
The
condensed consolidated financial statements include the accounts of Cincinnati
Financial Corporation and its consolidated subsidiaries, each of which are
wholly owned, and are presented in conformity with accounting principles
generally accepted in the United States of America (GAAP). All significant
intercompany balances and transactions have been eliminated in
consolidation.
The
preparation of financial statements in conformity with GAAP requires us to make
estimates and assumptions that affect amounts reported in the financial
statements and accompanying notes. Our actual results could differ from those
estimates. The December 31, 2009, consolidated balance sheet
amounts are derived from the audited financial statements but do not include all
disclosures required by GAAP.
Our March
31, 2010, condensed consolidated financial statements are unaudited. Certain
financial information that is included in annual financial statements prepared
in accordance with GAAP is not required for interim reporting and has been
condensed or omitted. We believe that we have made all adjustments, consisting
only of normal recurring accruals that are necessary for fair presentation.
These condensed consolidated financial statements should be read in conjunction
with our consolidated financial statements included in our 2009 Annual
Report on Form 10-K. The results of operations for interim periods do not
necessarily indicate results to be expected for the full year.
We have
changed our presentation of earned premiums in our condensed consolidated
statements of income effective the first quarter 2010. We have summarized
property casualty and life earned premiums to a single caption, “Earned
premiums.” See Note 6, Reinsurance. Page 13, for further detail on property
casualty and life earned premiums.
With the
adoption of Accounting Standards Codification (ASC) 320, Recognition and
Presentation of Other-Than-Temporary Impairments, in the second quarter of 2009,
we recognized a cumulative effect adjustment of $106 million, net of tax, to
reclassify the non-credit component of previously recognized impairments by
increasing retained earnings and reducing accumulated other comprehensive
income. ASC 320 does not allow retrospective application of the new
other-than-temporary impairment (OTTI) model. Our Condensed Consolidated
Statements of Income for the three months ended March 31, 2010, are not measured
on the same basis as prior period amounts and, accordingly, these amounts are
not comparable.
Adopted
Accounting Updates
ASU
2010-08, Technical Corrections to Various Topics
In
February 2010, the Financial Accounting Standards Board (FASB) issued Accounting
Standards Update (ASU) 2010-08, Technical Corrections to Various Topics. ASU
2010-08 does not change any of the fundamentals of U.S. GAAP, but it does
explain certain clarifications made to the guidance on embedded derivatives and
hedging. We have adopted ASU 2010-08, and it is effective for the first
reporting period after issuance and for fiscal years beginning after December
15, 2009. It did not have a material impact on our company’s financial position,
cash flows or results of operations.
ASU
2010-09, Subsequent Events
In
February 2010, the FASB issued ASU 2010-09, Subsequent Events. ASU 2010-09
removes the requirement for SEC filers to disclose the date through which
subsequent events have been evaluated in both issued and revised financial
statements. We have adopted ASU 2010-09, and it is effective for the first
reporting period after issuance. It did not have a material impact on our
company’s financial position, cash flows or results
of operations.
Pending
Accounting Updates
ASU
2010-06, Fair Value Measurements and Disclosures
In
January 2010, the FASB issued ASU 2010-06, Fair Value Measurements and
Disclosures. ASU 2010-06 applies to all entities that are required to make
disclosures about recurring or nonrecurring fair value measurements. ASU 2010-06
requires separate disclosures of the activity in the Level 3 category related to
any purchases, sales, issuances, and settlements on a gross basis. The effective
date of the disclosures regarding Level 3 category purchases, sales, issuances
and settlements is for interim and annual periods beginning after December 15,
2010. The portion of ASU 2010-06 that has not yet been adopted will not have a
material impact on our company’s financial position, cash flows or results of
operations as it focuses on additional disclosures.
7
Fixed
maturities (bonds and redeemable preferred stocks), equity securities (common
and non-redeemable preferred stocks) and short-term investments have been
classified as available for sale and are stated at fair values at March 31,
2010, and December 31, 2009.
The
change in unrealized gains and losses on investments, net of taxes, described in
the following table, is included in other comprehensive income and
shareholders’ equity.
(In
millions)
|
Three
month ended March 31,
|
|||||||
2010
|
2009
|
|||||||
Change
in unrealized investment gains and losses and other
summary:
|
||||||||
Fixed
maturities
|
$ | 85 | $ | 97 | ||||
Equity
securities
|
64 | (510 | ) | |||||
Adjustment
to deferred acquisition costs and life policy reserves
|
(3 | ) | (4 | ) | ||||
Pension
obligations
|
1 | 1 | ||||||
Other
|
3 | (12 | ) | |||||
Income
taxes on above
|
(52 | ) | 150 | |||||
Total
|
$ | 98 | $ | (278 | ) | |||
The
following table analyzes cost or amortized cost, gross unrealized gains, gross
unrealized losses and fair value for our investments, along with the amount
of cumulative non-credit OTTI losses transferred to accumulated other
comprehensive income (AOCI) in accordance with ASC 320-10-65, Recognition and
Presentation of Other-Than-Temporary Impairments, for securities that also had a
credit impairment:
(In
millions)
|
|||||||||||||||||||||
Cost
or
amortized
|
Gross
unrealized
|
Fair
value
|
OTTI
in
AOCI
|
||||||||||||||||||
At
March 31,
|
cost
|
gains
|
losses
|
||||||||||||||||||
2010
|
|||||||||||||||||||||
Fixed
maturities:
|
|||||||||||||||||||||
States,
municipalities and political subdivisions
|
$ | 2,992 | $ | 122 | $ | 4 | $ | 3,110 | $ | — | |||||||||||
Convertibles
and bonds with warrants attached
|
81 | — | — | 81 | — | ||||||||||||||||
United
States government
|
4 | 1 | — | 5 | — | ||||||||||||||||
Government-sponsored
enterprises
|
329 | — | — | 329 | — | ||||||||||||||||
Foreign
government
|
3 | — | — | 3 | — | ||||||||||||||||
Short-term
investments
|
— | — | — | — | — | ||||||||||||||||
Collateralized
mortgage obligations
|
— | — | — | — | — | ||||||||||||||||
Corporate
bonds
|
4,246 | 323 | 16 | 4,553 | — | ||||||||||||||||
Total
|
$ | 7,655 | $ | 446 | $ | 20 | $ | 8,081 | $ | — | |||||||||||
Equity
securities
|
$ | 2,089 | $ | 774 | $ | 25 | $ | 2,838 |
NA
|
||||||||||||
At
December 31,
|
|||||||||||||||||||||
2009
|
|||||||||||||||||||||
Fixed
maturities:
|
|||||||||||||||||||||
States,
municipalities and political subdivisions
|
$ | 3,007 | $ | 128 | 6 | $ | 3,129 | $ | — | ||||||||||||
Convertibles
and bonds with warrants attached
|
91 | — | — | 91 | — | ||||||||||||||||
United
States government
|
4 | — | — | 4 | — | ||||||||||||||||
Government-sponsored
enterprises
|
354 | — | 7 | 347 | — | ||||||||||||||||
Foreign
government
|
3 | — | — | 3 | — | ||||||||||||||||
Short-term
investments
|
6 | — | — | 6 | — | ||||||||||||||||
Collateralized
mortgage obligations
|
37 | — | 6 | 31 | — | ||||||||||||||||
Corporate
bonds
|
4,018 | 268 | 36 | 4,250 | — | ||||||||||||||||
Total
|
$ | 7,520 | $ | 396 | $ | 55 | $ | 7,861 | $ | — | |||||||||||
Equity
securities
|
$ | 2,016 | $ | 714 | $ | 29 | $ | 2,701 |
NA
|
||||||||||||
The
unrealized investment gains at March 31, 2010, were largely due to a long-term
net gain position of $725 million for our common stock portfolio.
Contributing 10 percent or more of that net gain position
were two publicly-traded holdings totaling $225 million: The
Procter & Gamble Company (NYSE:PG) and Exxon Mobil Corporation
(NYSE:XOM). At March 31, 2010, we had $82 million fair value of hybrid
securities included in fixed maturities that follow ASC 815-15-25, Accounting
for Certain Hybrid Financial Instruments.
8
The table
below provides fair values and unrealized losses by investment category and by
the duration of the securities’ continuous unrealized loss
position:
(In
millions)
|
Less
than 12 months
|
12
months or more
|
Total
|
||||||||||||||||||||||
At March 31, |
Fair
value
|
Unrealized
losses
|
Fair
value
|
Unrealized
losses
|
Fair
value
|
Unrealized
losses
|
|||||||||||||||||||
2010
|
|||||||||||||||||||||||||
Fixed
maturities:
|
|||||||||||||||||||||||||
States,
municipalities and political subdivisions
|
$ | 153 | $ | 2 | $ | 30 | $ | 2 | $ | 183 | $ | 4 | |||||||||||||
Government-sponsored
enterprises
|
61 | — | 2 | — | 63 | — | |||||||||||||||||||
Corporate
bonds
|
316 | 8 | 161 | 8 | 477 | 16 | |||||||||||||||||||
Total
|
530 | 10 | 193 | 10 | 723 | 20 | |||||||||||||||||||
Equity
securities
|
78 | 3 | 226 | 22 | 304 | 25 | |||||||||||||||||||
Total
|
$ | 608 | $ | 13 | $ | 419 | $ | 32 | $ | 1,027 | $ | 45 | |||||||||||||
At
December 31,
|
|||||||||||||||||||||||||
2009
|
|||||||||||||||||||||||||
Fixed
maturities:
|
|||||||||||||||||||||||||
States,
municipalities and political subdivisions
|
$ | 196 | $ | 4 | $ | 29 | $ | 2 | $ | 225 | $ | 6 | |||||||||||||
Government-sponsored
enterprises
|
347 | 7 | — | — | 347 | 7 | |||||||||||||||||||
Short-term
investments
|
1 | — | — | — | 1 | — | |||||||||||||||||||
Collateralized
mortgage obligations
|
— | — | 27 | 6 | 27 | 6 | |||||||||||||||||||
Corporate
bonds
|
397 | 19 | 309 | 17 | 706 | 36 | |||||||||||||||||||
Total
|
941 | 30 | 365 | 25 | 1,306 | 55 | |||||||||||||||||||
Equity
securities
|
65 | 3 | 415 | 26 | 480 | 29 | |||||||||||||||||||
Total
|
$ | 1,006 | $ | 33 | $ | 780 | $ | 51 | $ | 1,786 | $ | 84 | |||||||||||||
Other-than-temporary
Impairment Charges
For the
three months ended March 31, 2010, there were no credit losses on fixed-maturity
securities for which a portion of OTTI has been recognized in other
comprehensive income. The following table provides the amount of OTTI
charges:
(In
millions)
|
Three
months ended March 31,
|
|||||||
2010
|
2009
|
|||||||
Other-than-temporary
impairment charges:
|
||||||||
Fixed
maturities
|
$ | 1 | $ | 50 | ||||
Equity
securities
|
— | — | ||||||
Total
|
$ | 1 | $ | 50 | ||||
During
the quarter ended March 31, 2010, we impaired two fixed-maturity securities for
a total of $1 million. At March 31, 2010, 69 fixed-maturity
investments with a total unrealized loss of $10 million had been in an
unrealized loss position for 12 months or more. Of that total, one
fixed-maturity security with a total unrealized loss of $1 million was trading
below 70 percent of book value. Eight equity securities with a total unrealized
loss of $22 million had been in an unrealized loss position for 12 months
or more, but none were trading below 70 percent of book value.
At
December 31, 2009, 121 fixed-maturity investments with a total unrealized loss
of $25 million had been in an unrealized loss position for 12 months or more. Of
that total, eight fixed maturity investments were trading below 70 percent
of book value with a total unrealized loss of $2 million. Ten equity
investments with a total unrealized loss of $26 million had been in an
unrealized loss position for 12 months or more as of December 31, 2009. Of
that total, no equity investments were trading below 70 percent of book
value.
Fair
Value Hierarchy
In
accordance with fair value measurements and disclosures, we categorized our
financial instruments, based on the priority of the observable and market-based
data for 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. Our valuation techniques have not changed from
December 31, 2009, and ultimately management determines fair value.
Financial
instruments are categorized based upon the following characteristics or inputs
to the valuation techniques:
·
|
Level
1 – Financial assets and liabilities for which inputs are observable and
are obtained from reliable quoted prices for identical assets or
liabilities in actively traded markets. This is the most reliable fair
value measurement and includes, for example, active exchange-traded equity
securities.
|
9
·
|
Level
2 – Financial assets and liabilities for which values are based on quoted
prices in markets that are not active or for which values are based on
similar assets and liabilities that are actively traded. This also
includes pricing models for which the inputs are corroborated by market
data.
|
·
|
Level
3 – Financial assets and liabilities for which values are based on prices
or valuation techniques that require inputs that are both unobservable and
significant to the overall fair value measurement. Level 3 inputs include
the following:
|
|
o
|
Quotes
from brokers or other external sources that are not considered
binding;
|
|
o
|
Quotes
from brokers or other external sources where it cannot be determined that
market participants would in fact transact for the asset or liability at
the quoted price;
|
|
o
|
Quotes
from brokers or other external sources where the inputs are not deemed
observable.
|
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 or out of the Level 3 category as
of the beginning of the quarter in which the reclassification
occurred.
The
following tables illustrate the fair value hierarchy for those assets measured
at fair value on a recurring basis for the three months ended March 31, 2010,
and December 31, 2009. We do not have any material liabilities carried at fair
value. There were no significant transfers between Level 1 and Level
2.
Fair
Value Disclosures for Assets
(In millions) |
Asset
fair value measurements at March 31, 2010 using:
|
|||||||||||||||
Quoted
prices in
active
markets for
identical
assets
(Level
1)
|
Significant
other
observable
inputs
(Level
2)
|
Significant
unobservable
inputs
(Level
3)
|
Total
|
|||||||||||||
Fixed
maturities, available for sale:
|
||||||||||||||||
Corporate
securities
|
$ | — | $ | 4,606 | $ | 28 | $ | 4,634 | ||||||||
Foreign
government
|
— | 3 | — | 3 | ||||||||||||
U.S.
Treasury and U.S. government agencies
|
5 | 329 | — | 334 | ||||||||||||
States,
municipalities and political subdivisions
|
— | 3,106 | 4 | 3,110 | ||||||||||||
Total
|
5 | 8,044 | 32 | 8,081 | ||||||||||||
Common
equities, available for sale
|
2,614 | 124 | — | 2,738 | ||||||||||||
Preferred
equities, available for sale
|
— | 94 | 6 | 100 | ||||||||||||
Taxable
fixed maturities separate accounts
|
— | 582 | — | 582 | ||||||||||||
Top
Hat Savings Plan
|
8 | — | — | 8 | ||||||||||||
Total
|
$ | 2,627 | $ | 8,844 | $ | 38 | $ | 11,509 | ||||||||
(In
millions)
|
Asset
fair value measurements at December 31, 2009 using:
|
|||||||||||||||
Quoted
prices in
active
markets for
identical
assets
(Level
1)
|
Significant
other
observable
inputs
(Level
2)
|
Significant
unobservable
inputs
(Level
3)
|
Total
|
|||||||||||||
Fixed
maturities, available for sale:
|
||||||||||||||||
Corporate
securities
|
$ | — | $ | 4,314 | $ | 27 | $ | 4,341 | ||||||||
Foreign
government
|
— | 3 | — | 3 | ||||||||||||
U.S.
Treasury and U.S. government agencies
|
4 | 347 | — | 351 | ||||||||||||
Collateralized
mortgage obligations
|
— | 31 | — | 31 | ||||||||||||
States,
municipalities and political subdivisions
|
— | 3,125 | 4 | 3,129 | ||||||||||||
Total
|
4 | 7,820 | 31 | 7,855 | ||||||||||||
Common
equities, available for sale
|
2,474 | 134 | — | 2,608 | ||||||||||||
Preferred
equities, available for sale
|
— | 88 | 5 | 93 | ||||||||||||
Short-term
investments
|
— | 6 | — | 6 | ||||||||||||
Taxable
fixed maturities separate accounts
|
— | 555 | — | 555 | ||||||||||||
Top
Hat Savings Plan
|
7 | — | — | 7 | ||||||||||||
Total
|
$ | 2,485 | $ | 8,603 | $ | 36 | $ | 11,124 | ||||||||
Each
financial instrument that was deemed to have significant unobservable inputs
when determining valuation is identified in the tables below by security type
with a summary of changes in fair value as of March 31, 2010. Total Level 3
assets were less than 1 percent of financial assets measured at fair value for
the three months ended March 31, 2010, and December 31, 2009.
10
(In
millions)
|
Asset
fair value measurements using significant unobservable inputs (Level
3)
|
|||||||||||||||||||||||
Corporate
fixed
maturities
|
Taxable
fixed
maturities-
separate
accounts
|
States,
municipalities
and
political
subdivisions
fixed
maturities
|
Common
equities
|
Preferred
equities
|
Total
|
|||||||||||||||||||
Beginning
balance, December 31, 2009
|
$ | 27 | $ | — | $ | 4 | $ | — | $ | 5 | $ | 36 | ||||||||||||
Total
gains or losses (realized/unrealized):
|
||||||||||||||||||||||||
Included
in earnings (or changes in net assets)
|
— | — | — | — | — | — | ||||||||||||||||||
Included
in other comprehensive income
|
— | — | — | — | 1 | 1 | ||||||||||||||||||
Purchases,
sales, issuances, and settlements
|
5 | — | — | — | — | 5 | ||||||||||||||||||
Transfers
in and/or out of Level 3
|
(4 | ) | — | — | — | — | (4 | ) | ||||||||||||||||
Ending
balance, March 31, 2010
|
$ | 28 | $ | — | $ | 4 | $ | — | $ | 6 | $ | 38 | ||||||||||||
(In
millions)
|
Asset
fair value measurements using significant unobservable inputs (Level
3)
|
|||||||||||||||||||||||
Taxable
fixed
maturities
|
Taxable
fixed
maturities-
separate
accounts
|
Tax-exempt
fixed
maturities
|
Common
equities
|
Preferred
equities
|
Total
|
|||||||||||||||||||
Beginning
balance, December 31, 2008
|
$ | 50 | $ | 6 | $ | 5 | $ | 64 | $ | 22 | $ | 147 | ||||||||||||
Total
gains or losses (realized/unrealized):
|
||||||||||||||||||||||||
Included
in earnings (or changes in net assets)
|
— | — | — | — | (3 | ) | (3 | ) | ||||||||||||||||
Included
in other comprehensive income
|
(1 | ) | — | — | — | 2 | 1 | |||||||||||||||||
Purchases,
sales, issuances, and settlements
|
— | — | — | — | — | — | ||||||||||||||||||
Transfers
in and/or out of Level 3
|
(11 | ) | (6 | ) | — | — | (15 | ) | (32 | ) | ||||||||||||||
Ending
balance, March 31, 2009
|
$ | 38 | $ | — | $ | 5 | $ | 64 | $ | 6 | $ | 113 | ||||||||||||
For the
three months ended March 31, 2010, one Level 3 corporate fixed-maturity security
was purchased for $5 million. As a result of the change in use of
observable or unobservable inputs throughout the first quarter of 2010, Level 3
corporate fixed-maturity securities decreased $4 million as one security
totaling $7 million transferred from Level 3 to Level 2 and one security
totaling $3 million transferred from Level 2 to Level 3. At March 31, 2010,
total fair value of assets priced with broker quotes and other non-observable
market inputs for the fair value measurements and disclosures was $38
million.
Fair
Value Disclosure for Senior Debt and Life Insurance Assets and
Liabilities
The
disclosures below are not affected by the fair value hierarchy but are presented
to provide timely information about the effects of current market conditions on
financial instruments that are not reported at fair value in our financial
statements.
This
table summarizes the principal amounts of our long-term debt excluding
unamortized discounts:
(In
millions)
|
March
31,
|
December
31,
|
|||||||||||
Interest
rate
|
Year
of issue
|
2010
|
2009
|
||||||||||
6.900%
|
1998
|
Senior
debentures, due 2028
|
$ | 28 | $ | 28 | |||||||
6.920%
|
2005
|
Senior
debentures, due 2028
|
391 | 391 | |||||||||
6.125%
|
2004
|
Senior
notes, due 2034
|
374 | 374 | |||||||||
Total
|
$ | 793 | $ | 793 | |||||||||
The fair
value of our senior debt approximated $761 million at March 31, 2010, compared
with $740 million at year-end 2009. Fair value was determined under the
fair value measurements and disclosures accounting rules 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 is $793 million. None of
the notes are encumbered by rating triggers. Also, we have a note payable with
outstanding principal amount of $49 million which approximates fair
value.
The fair
value of life policy loans outstanding principal and interest approximated
$44 million, compared with book value of $40 million reported in the
condensed consolidated balance sheets as of March 31, 2010.
Life
reserves and liabilities for deferred annuities and other investment contracts
were $800 million and $736 million for March 31, 2010, and December
31, 2009, respectively. Fair value for these deferred annuities and investment
contracts was $774 million and $737 million for March 31, 2010, and
December 31, 2009, respectively. Fair values of liabilities associated
with certain investment contracts are calculated based upon internally developed
models because active, observable markets do not exist for those items. To
determine the fair value, we make the following significant assumptions: (1) the
discount rates used to calculate the present value of expected payments are the
risk-free spot rates plus an A3 rated bond spread for financial issuers as
of March 31, 2010, to account for non-performance risk; (2) the rate of interest
credited to policyholders is the portfolio net earned interest rate less a
spread for expenses and profit; and
11
(3) additional
lapses occur when the credited interest rate is exceeded by an assumed
competitor credited rate, which is a function of the risk-free rate of the
economic scenario being modeled.
NOTE
4 – Deferred Acquisition Costs
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. Other underwriting operating expenses were $113 million and $98
million in the three months ended March 31, 2010 and 2009, respectively. The
table below shows the deferred policy acquisition costs and asset
reconciliation, including the amortized deferred policy acquisition
costs.
(In
millions)
|
Three
months ended March 31,
|
|||||||
2010
|
2009
|
|||||||
Deferred
policy acquisition costs asset at beginning of the period
|
$ | 481 | $ | 509 | ||||
Capitalized
deferred policy acquisition costs
|
171 | 166 | ||||||
Amortized
deferred policy acquisition costs
|
(161 | ) | (159 | ) | ||||
Amortized
shadow deferred policy acquisition costs
|
(6 | ) | (6 | ) | ||||
Deferred
policy acquisition costs asset at end of the period
|
$ | 485 | $ | 510 | ||||
There
were no premium deficiencies for the reported condensed consolidated statements
of income, as the sum of the anticipated loss and loss adjustment expenses,
policyholder dividends, maintenance expenses and underwriting expenses did not
exceed the related unearned premiums and anticipated investment
income.
NOTE
5 – Property Casualty Loss And Loss Expenses
This
table summarizes activity for our consolidated property casualty loss and loss
expense reserves:
(In
millions)
|
Three
months ended March 31,
|
|||||||
2010
|
2009
|
|||||||
Gross
loss and loss expense reserves, beginning of period
|
$ | 4,096 | $ | 4,040 | ||||
Less
reinsurance receivable
|
435 | 542 | ||||||
Net
loss and loss expense reserves, beginning of period
|
3,661 | 3,498 | ||||||
Net
incurred loss and loss expenses related to:
|
||||||||
Current
accident year
|
514 | 537 | ||||||
Prior
accident years
|
(39 | ) | 7 | |||||
Total
incurred
|
475 | 544 | ||||||
Net
paid loss and loss expenses related to:
|
||||||||
Current
accident year
|
113 | 142 | ||||||
Prior
accident years
|
301 | 337 | ||||||
Total
paid
|
414 | 479 | ||||||
Net
loss and loss expense reserves, end of period
|
3,722 | 3,563 | ||||||
Plus
reinsurance receivable
|
343 | 483 | ||||||
Gross
loss and loss expense reserves, end of period
|
$ | 4,065 | $ | 4,046 | ||||
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 decreased the
provision for loss and loss expenses by $39 million and increased the
provision for loss and loss expenses by $7 million for the three months
ended March 31, 2010 and 2009, respectively. The reserve for loss and loss
expenses in the condensed consolidated balance sheets also includes $53 million
as of March 31, 2010, and $47 million as of March 31, 2009, for
certain life and health loss and loss expense reserves.
12
NOTE
6 – Reinsurance
Our
condensed consolidated statements of income include earned consolidated property
casualty insurance premiums on assumed and ceded business:
(In
millions)
|
Three
months ended March 31,
|
|||||||
2010
|
2009
|
|||||||
Direct
earned premiums
|
$ | 744 | $ | 771 | ||||
Assumed
earned premiums
|
3 | 3 | ||||||
Ceded
earned premiums
|
(40 | ) | (42 | ) | ||||
Net
earned premiums
|
$ | 707 | $ | 732 | ||||
Our
condensed consolidated statements of income include incurred consolidated
property casualty insurance loss and loss expenses on assumed and ceded
business:
(In
millions)
|
Three
months ended March 31,
|
|||||||
2010
|
2009
|
|||||||
Direct
incurred loss and loss expenses
|
$ | 449 | $ | 526 | ||||
Assumed
incurred loss and loss expenses
|
2 | 4 | ||||||
Ceded
incurred loss and loss expenses
|
23 | 12 | ||||||
Net
incurred loss and loss expenses
|
$ | 474 | $ | 542 | ||||
Our
condensed consolidated statements of income include earned life insurance
premiums on assumed and ceded business:
(In
millions)
|
Three
months ended March 31,
|
|||||||
2010
|
2009
|
|||||||
Direct
earned premiums
|
$ | 50 | $ | 45 | ||||
Assumed
earned premiums
|
0 | 0 | ||||||
Ceded
earned premiums
|
(11 | ) | (12 | ) | ||||
Net
earned premiums
|
$ | 39 | $ | 33 | ||||
Our
condensed consolidated statements of income include life insurance contract
holders’ benefits incurred on assumed and ceded business:
(In
millions)
|
Three
months ended March 31,
|
|||||||
2010
|
2009
|
|||||||
Direct
contract holders' benefits incurred
|
$ | 57 | $ | 50 | ||||
Assumed
contract holders' benefits incurred
|
0 | 0 | ||||||
Ceded
contract holders' benefits incurred
|
(15 | ) | (11 | ) | ||||
Net
incurred loss and loss expenses
|
$ | 42 | $ | 39 | ||||
NOTE
7 – Employee Retirement Benefits
The
following summarizes the components of net periodic costs for our qualified and
supplemental pension plans:
(In
millions)
|
Three
months ended March 31
|
|||||||
2010
|
2009
|
|||||||
Service
cost
|
$ | 2 | $ | 2 | ||||
Interest
cost
|
3 | 3 | ||||||
Expected
return on plan assets
|
(3 | ) | (3 | ) | ||||
Amortization
of actuarial loss and prior service cost
|
1 | — | ||||||
Net
periodic benefit cost
|
$ | 3 | $ | 2 | ||||
See our
2009 Annual Report on Form 10-K, Item 8, Note 13, Employee Retirement Benefits,
Page 109 for information on our retirement benefits. We made matching
contributions of $2 million to our 401(k) savings plan during both the first
quarter of 2010 and 2009.
We made
no contribution to the pension plan during the first quarter of 2010. We
anticipate contributing $25 million during 2010 to our qualified pension
plan as indicated in our 2009 Annual Report on Form 10-K
NOTE
8 – Stock-Based Associate Compensation Plans
We
currently have four equity compensation plans that permit us to grant various
types of equity awards. We currently grant incentive stock options,
non-qualified stock options, service-based restricted stock units and
performance-based restricted stock units under our shareholder-approved 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
stock to our outside directors as a component of their annual compensation. For
additional information about our equity
13
compensation
plans, see our 2009 Annual Report on Form 10-K, Item 8, Note 17,
Stock-Based Associate Compensation Plans, Page 113.
A total
of 17 million shares are authorized to be granted under the shareholder-approved
plans. At March 31, 2010, six million shares were available for
future issuance under the plans.
Our
pretax and after-tax stock-based compensation costs are summarized
below:
(In
millions)
|
Three
months ended March 31,
|
|||||||
2010
|
2009
|
|||||||
Stock-based
compensation cost
|
$ | 3 | $ | 3 | ||||
Income
tax benefit
|
1 | 1 | ||||||
Stock-based
compensation cost after tax
|
$ | 2 | $ | 2 | ||||
Stock-Based
Awards
During
the first quarter of 2010, we granted 31,310 shares of common stock to our
directors for 2009 board service fees. Stock-based awards were granted to
associates during the first quarter of 2010 and are summarized in the tables
below.
As of
March 31, 2010, $20 million of unrecognized compensation costs related to
non-vested awards are expected to be recognized over a weighted-average period
of 2.2 years.
Here is a
summary of option information:
(Shares
in thousands)
|
Shares
|
Weighted-
average
exercise
price
|
||||||
2010
|
||||||||
Outstanding
at January 1, 2010
|
9,875 | $ | 36.67 | |||||
Granted
|
902 | 26.60 | ||||||
Exercised
|
(1 | ) | 26.59 | |||||
Forfeited
|
(841 | ) | 27.33 | |||||
Outstanding
at March 31, 2010
|
9,935 | 36.54 | ||||||
Here is a
summary of restricted stock unit information:
(Shares
in thousands)
|
Service-based
nonvested
shares
|
Weighted-
average
grant-
date
fair value
|
Performance-based
nonvested
shares
|
Weighted-
average
grant-
date
fair value
|
||||||||||||
Nonvested
at January 1, 2010
|
597 | $ | 31.60 | 121 | $ | 29.75 | ||||||||||
Granted
|
290 | 22.27 | 52 | 22.41 | ||||||||||||
Exercised
|
(154 | ) | 40.68 | 0 | 0.00 | |||||||||||
Forfeited
|
(2 | ) | 27.24 | 0 | 0.00 | |||||||||||
Cancelled
|
0 | 0.00 | (24 | ) | 40.74 | |||||||||||
Nonvested
at March 31, 2010
|
731 | 26.00 | 149 | 25.38 | ||||||||||||
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, is 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 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, erroneous coding of municipal tax locations and excessive
premium charges for uninsured motorist coverage. 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. The company
accounts for such activity, if any, through the establishment of legal expense
reserves included in underwriting expenses.
On a
quarterly basis, we review the outstanding lawsuits seeking such recourse. Based
on our quarterly review, we believe we have valid defenses to each. We believe
the ultimate liability, if any, with respect to these
14
lawsuits,
after consideration of provisions made for estimated losses, is 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.
NOTE
10 – Income Taxes
As of
December 31, 2009, we had no liability for unrecognized tax benefits. Details
about our liability for unrecognized tax benefits are found in our 2009 Annual
Report on Form 10-K, Item 8, Note 11, Income Taxes, Pages 108 and
109.
During
the current quarter, there was no material change in our liability for
unrecognized tax benefits. For the three months ended March 31, 2010, there have
been no changes to any assumptions regarding our liability for unrecognized tax
benefits that may be settled with the IRS in the next 12 months related to tax
years 2007 and 2008.
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:
·
|
Commercial
lines property casualty insurance
|
·
|
Personal
lines property casualty insurance
|
·
|
Life
insurance
|
·
|
Investments
|
We report
as Other the non-investment operations of the parent company and its non-insurer
subsidiaries, CFC Investment Company and CSU Producer Resources Inc. We
also report as Other the results of The Cincinnati Specialty Underwriters
Insurance Company, as well as other income of our standard market property
casualty insurance subsidiary. Also included in 2009 results for this segment
are the operations of a former subsidiary, CinFin Capital Management.
See our 2009 Annual Report on Form 10-K, Item 8, Note 18, Segment
Information, Page 115 for a description of revenue, income or loss before
income taxes and identifiable assets for each of the four segments.
15
Segment
information is summarized in the following table:
(In
millions)
|
Three
months ended March 31,
|
|||||||
2010
|
2009
|
|||||||
Revenues:
|
||||||||
Commercial
lines insurance
|
||||||||
Commercial
casualty
|
$ | 164 | $ | 187 | ||||
Commercial
property
|
121 | 121 | ||||||
Commercial
auto
|
95 | 99 | ||||||
Workers'
compensation
|
74 | 83 | ||||||
Specialty
packages
|
37 | 35 | ||||||
Surety
and executive risk
|
24 | 25 | ||||||
Machinery
and equipment
|
8 | 7 | ||||||
Total
commercial lines insurance
|
523 | 557 | ||||||
Personal
lines insurance
|
||||||||
Personal
auto
|
81 | 79 | ||||||
Homeowner
|
70 | 70 | ||||||
Other
personal lines
|
23 | 22 | ||||||
Total
personal lines insurance
|
174 | 171 | ||||||
Life
insurance
|
39 | 34 | ||||||
Investment
operations
|
138 | 122 | ||||||
Other
|
13 | 6 | ||||||
Total
|
$ | 887 | $ | 890 | ||||
Income
(loss) before income taxes:
|
||||||||
Insurance
underwriting results:
|
||||||||
Commercial
lines insurance
|
$ | (11 | ) | $ | (12 | ) | ||
Personal
lines insurance
|
(5 | ) | (35 | ) | ||||
Life
insurance
|
— | (1 | ) | |||||
Investment
operations
|
119 | 106 | ||||||
Other
|
(18 | ) | (24 | ) | ||||
Total
|
$ | 85 | $ | 34 | ||||
Identifiable
assets:
|
||||||||
March
31,
|
December
31,
|
|||||||
2010
|
2009
|
|||||||
Property
casualty insurance
|
$ | 1,995 | $ | 2,202 | ||||
Life
insurance
|
1,196 | 1,176 | ||||||
Investment
operations
|
11,040 | 10,684 | ||||||
Other
|
385 | 378 | ||||||
Total
|
$ | 14,616 | $ | 14,440 | ||||
16
Management’s
Discussion and Analysis of Financial Condition and Results of
Operations
|
The
following discussion highlights significant factors influencing the consolidated
results of operations and financial position of Cincinnati Financial Corporation
(CFC). It should be read in conjunction with the consolidated financial
statements and related notes included in our 2009 Annual Report on
Form 10-K. Unless otherwise noted, the industry data is prepared by
A.M. Best Co., 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).
We
present per share data on a diluted basis unless otherwise noted, adjusting
those amounts for all stock splits and dividends. Dollar amounts are rounded to
millions; calculations of percent changes are based on dollar amounts rounded to
the nearest thousand or million. Certain percentage changes are identified as
not meaningful (nm).
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 2009 Annual Report on Form 10-K, Item 1A, Risk Factors,
Page 23. 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:
·
|
Unusually
high levels of catastrophe losses due to risk concentrations, changes
in weather patterns, environmental events, terrorism incidents or
other causes
|
·
|
Increased
frequency and/or severity of claims
|
·
|
Inadequate
estimates or assumptions used for critical accounting
estimates
|
·
|
Recession
or other economic conditions resulting in lower demand for insurance
products or increased payment
delinquencies
|
·
|
Delays
in adoption and implementation of underwriting and pricing methods that
could increase our pricing accuracy, underwriting profit and
competitiveness
|
·
|
Inability
to defer policy acquisition costs for any business segment if pricing and
loss trends would lead management to conclude that segment could not
achieve sustainable profitability
|
·
|
Declines
in overall stock market values negatively affecting the company’s equity
portfolio and book value
|
·
|
Events,
such as the credit crisis, followed by prolonged periods of economic
instability or recession, that
lead to:
|
|
o
|
Significant
or prolonged decline in the value of a particular security or group of
securities and impairment of the
asset(s)
|
|
o
|
Significant
decline in investment income due to reduced or eliminated dividend payouts
from a particular security or group of
securities
|
|
o
|
Significant
rise in losses from surety and director and officer policies written for
financial institutions
|
·
|
Prolonged
low interest rate environment or other factors that limit the company’s
ability to generate growth in investment income or interest rate
fluctuations that result in declining values of fixed-maturity
investments, including declines in accounts in which we hold bank-owned
life insurance contract assets
|
·
|
Increased
competition that could result in a significant reduction in the company’s
premium volume
|
·
|
Changing
consumer insurance-buying habits and consolidation of independent
insurance agencies that could alter our competitive
advantages
|
·
|
Inability
to obtain adequate reinsurance on acceptable terms, amount of reinsurance
purchased, financial strength of reinsurers and the potential for
non-payment or delay in payment by
reinsurers
|
·
|
Events
or conditions that could weaken or harm the company’s relationships with
its independent agencies and hamper opportunities to add new agencies,
resulting in limitations on the company’s opportunities for growth, such
as:
|
17
|
o
|
Multi-notch
downgrades of the company’s financial strength
ratings
|
|
o
|
Concerns
that doing business with the company is too
difficult
|
|
o
|
Perceptions
that the company’s level of service, particularly claims service, is no
longer a distinguishing characteristic in the
marketplace
|
|
o
|
Delays
or inadequacies in the development, implementation, performance and
benefits of technology projects and
enhancements
|
·
|
Actions
of insurance departments, state attorneys general or other regulatory
agencies, including a change to a federal system of regulation from a
state-based system, that:
|
|
o
|
Restrict
our ability to exit or reduce writings of unprofitable coverages or lines
of business
|
|
o
|
Place
the insurance industry under greater regulatory scrutiny or result in new
statutes, rules
and regulations
|
|
o
|
Increase
our expenses
|
|
o
|
Add
assessments for guaranty funds, other insurance related assessments or
mandatory reinsurance arrangements; or that impair our ability to recover
such assessments through future surcharges or other rate
changes
|
|
o
|
Limit
our ability to set fair, adequate and reasonable
rates
|
|
o
|
Place
us at a disadvantage in the
marketplace
|
|
o
|
Restrict
our ability to execute our business model, including the way we compensate
agents
|
·
|
Adverse
outcomes from litigation or administrative
proceedings
|
·
|
Events
or actions, including unauthorized intentional circumvention of controls,
that reduce the company’s future ability to maintain effective internal
control over financial reporting under the Sarbanes-Oxley Act
of 2002
|
·
|
Unforeseen
departure of certain executive officers or other key employees due to
retirement, health or other causes that could interrupt progress
toward important strategic goals or diminish the effectiveness of certain
longstanding relationships with insurance agents and
others
|
·
|
Events,
such as an epidemic, natural catastrophe or terrorism, that could hamper
our ability to assemble our workforce at our headquarters
location
|
·
|
Difficulties
with technology or data security breaches could negatively affect our
ability to conduct business and our relationships with agents,
policyholders and others
|
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.
18
Introduction
Income
Statement and Per Share Data
(Dollars
in millions except share data)
|
Three
months ended March 31,
|
|||||||||||
2010
|
2009
|
Change
%
|
||||||||||
Income
statement data
|
||||||||||||
Earned
premiums
|
$ | 746 | $ | 765 | (2 | ) | ||||||
Investment
income, net of expenses
|
130 | 124 | 5 | |||||||||
Realized
investment gains and (losses), pretax
|
8 | (2 | ) |
nm
|
||||||||
Total
revenues
|
887 | 890 | 0 | |||||||||
Net
income
|
68 | 35 | 94 | |||||||||
Per
share data (diluted)
|
||||||||||||
Net
income
|
0.42 | 0.22 | 91 | |||||||||
Cash
dividends declared
|
0.395 | 0.39 | 1 | |||||||||
Weighted
average shares outstanding
|
163,310,451 | 162,663,625 | 0 | |||||||||
Revenues
were slightly lower for the first quarter of 2010 compared with the first
quarter of 2009 primarily due to lower earned premiums. Revenue trends and
investment revenues are discussed further in the respective sections of Results
of Operations, Page 25.
Realized
investment gains and losses are recognized on the sales of investments or as
otherwise required by GAAP. We have substantial discretion in the timing of
investment sales, and that timing generally is independent of the insurance
underwriting process. GAAP also requires us to recognize in income the gains or
losses from certain changes in fair values of securities even though we continue
to hold the securities.
Net
income increased for the first quarter of 2010 compared with the first quarter
of 2009, primarily due to improved property casualty underwriting results.
After-tax investment income and realized investment gains were also both higher.
Property casualty underwriting performance and investment results are discussed
below in Results of Operations, beginning on Page 25. As discussed in our 2009
Annual Report on Form 10-K, Item 7, Factors Influencing Our Future
Performance, Page 35, there are several reasons that our performance during 2010
may be below our long-term targets. In that annual report, as part of Results of
Operations, we also discussed the year 2010 outlook for each reporting
segment.
The board
of directors is committed to rewarding shareholders directly through cash
dividends and through share repurchase authorizations. Through 2009, the company
had increased the indicated annual cash dividend rate for 49 consecutive years,
a record we believe was matched by only 11 other publicly traded companies. Our
board regularly evaluates relevant factors in dividend-related decisions, and
the increase declared in August 2009 reflected confidence in our strong capital,
liquidity and financial flexibility, as well as progress through our initiatives
to improve earnings performance.
Balance
Sheet Data and Performance Measures
(Dollars
in millions except share data)
|
At
March 31,
|
At
December 31,
|
||||||
2010
|
2009
|
|||||||
Balance
sheet data
|
||||||||
Invested
assets
|
$ | 11,002 | $ | 10,643 | ||||
Total
assets
|
14,616 | 14,440 | ||||||
Short-term
debt
|
49 | 49 | ||||||
Long-term
debt
|
790 | 790 | ||||||
Shareholders'
equity
|
4,865 | 4,760 | ||||||
Book
value per share
|
29.86 | 29.25 | ||||||
Debt-to-capital
ratio
|
14.7 | % | 15.0 | % | ||||
Three
months ended March 31,
|
||||||||
2010
|
2009
|
|||||||
Performance
measure
|
||||||||
Value
creation ratio
|
3.4 | % | (5.7 | ) % | ||||
19
Invested
assets and total assets increased compared with year-end 2009, largely because
of the increased fair value of our investment portfolio at March 31, 2010, while
shareholders’ equity and book value per share increased approximately 2 percent.
Our debt-to-capital ratio (capital is the sum of debt plus shareholders’ equity)
improved slightly compared with the December 31, 2009, level. The first-quarter
value creation ratio, defined in the following section, also increased for 2010
compared with 2009, reflecting higher net income and growth in the fair value of
our investment portfolio. The $0.61 increase in book value per share during the
first three months of 2010 contributed 2.1 percentage points to the value
creation ratio while dividends declared at $0.395 per share contributed 1.3
points.
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 37 states as discussed in our 2009 Annual Report on Form 10-K, Item
1, Our Business and Our Strategy, Page 1.
We
maintain a long-term perspective that guides us in addressing immediate
challenges or opportunities while focusing on the major decisions that best
position our 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 long-term progress, we have defined a value creation metric 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. We refer to this measure as our value creation ratio, or VCR,
and it is made up of two primary components: (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. For the period 2010 through 2014, an annual
value creation ratio averaging 12 percent to 15 percent is our primary
performance target. Management believes this non-GAAP measure is a useful
supplement to GAAP information. With heightened economic and
market uncertainty since 2008, we believe the long-term nature of this
ratio is an appropriate way to measure our long-term progress in creating
shareholder value.
When
looking at our longer-term objectives, we see three performance
drivers:
·
|
Premium
growth -- We believe over any five-year period our agency relationships
and initiatives can lead to a property casualty written premium
growth rate that exceeds the industry average. The compound annual
growth rate of our net written premiums was negative 0.6 percent over the
five-year period 2005 through 2009, compared with negative 1.0
percent estimated growth rate for the property casualty insurance
industry.
|
For the
first three months of 2010, our property casualty net written premiums decreased
3 percent overall while our largest segment, commercial lines, decreased 6
percent. A.M. Best forecasts that net written premiums will decline
approximately 2 percent for the U.S. property casualty industry for the
year 2010, with the industry’s commercial lines segment declining nearly 6
percent. A.M. Best also expects a sluggish economic recovery and forecasts that
premium rates will be flat to slightly down throughout 2010. Given
continued weak pricing in the insurance marketplace, we continue to exercise
discipline for risk selection and pricing. Our careful underwriting approach and
continued weakness in the broader economy offset progress on growth initiatives
discussed below in Highlights of Our Strategies and Supporting
Initiatives.
Targeted
growth initiatives from recent years continue to mature over time, as measured
by property casualty new business written premiums through our independent
agents for current periods compared with the same period a year ago. In the
first three months of 2010, targeted growth highlights included $5 million
from three new commercial lines states where we began operating since 2008 and
$4 million from all states in total for our personal lines
operation.
·
|
Combined
ratio -- We believe our underwriting philosophy and initiatives can
generate a GAAP combined ratio over any five-year period that is
consistently below 100 percent. Our GAAP combined ratio averaged
95.6 percent over the five-year period 2005 through 2009. It was
below 100 percent in each year during the period except 2008 and 2009,
which averaged 102.5 percent including average catastrophe losses
that were 2.5 percentage points higher than the average for the 10-year
period prior to 2008. Our statutory combined ratio averaged 95.4 percent
over the five-year period 2005 through 2009 compared with an
estimated 98.8 percent for the property casualty
industry.
|
For the
first three months of 2010, our GAAP combined ratio was 102.6 percent. Our
statutory combined ratio was 101.1 percent, including 3.1 percentage points
of current accident year catastrophe losses offset by 5.6 percentage points of
favorable loss reserve development on prior accident years, compared with 105.1
percent, including 7.5 percentage points of current accident year
catastrophe losses and 0.9
20
percentage
points of unfavorable loss reserve development, for the first three months of
2009. A.M. Best forecasts the industry’s full-year 2010 statutory combined ratio
at 101.7 percent, including 4.0 percentage points of catastrophe losses and
a favorable impact of 2.3 percentage points from prior accident year reserve
releases. For the commercial lines industry segment, A.M. Best forecasts a
full-year 2010 statutory combined ratio at 103.7 percent, including 2.7
percentage points of catastrophe losses and a favorable impact of 2.1
percentage points from prior accident year reserve releases.
·
|
Investment
contribution -- We believe our investment philosophy and initiatives can
drive investment income growth and lead to a total return on our equity
investment portfolio over a five-year period that exceeds the five-year
return of the Standard & Poor’s 500 Index (S&P 500 Index). The
compound annual return for our equity portfolio over the five-year period
2005 through 2009 was negative 5.8 percent compared with positive 0.4
percent for the Index. Our equity portfolio underperformed the market for
the five-year period primarily because of the decline in the market value
of our previously large holdings in the financial services
sector.
|
Investment
income, on a before-tax basis, grew at a compound annual rate of
0.3 percent over the five-year period 2005 through 2009. It grew in each
year except 2008 and 2009, when we experienced a dramatic reduction in
dividend payouts by financial services companies held in our equity portfolio, a
risk we addressed aggressively during 2008, completing that effort in
early 2009.
For the
first three months of 2010, pretax investment income was $130 million, up
5 percent from $124 million for the same period in 2009. The increase
reflected higher interest income that offset lower dividends. The current
investment portfolio mix provides a balance of income stability and growth with
capital appreciation potential.
Highlights
of Our Strategies and Supporting Initiatives
Management
has worked to identify the strategies that can lead to long-term success, with
concurrence by the board of directors. Our strategies are intended to position
us to compete successfully in the markets we have targeted while appropriately
managing risk. We believe successful implementation of the initiatives that
support these strategies will help us better serve our agent customers, reduce
volatility in our financial results and weather difficult economic, market or
industry pricing cycles:
·
|
Manage
capital effectively – Continued focus on capital-related initiatives is
intended to manage our capital and provide financial flexibility so that
we can successfully grow our insurance business while also building
capital for the long-term benefit of shareholders. A strong capital
position provides the capacity to support premium growth and provides the
liquidity to pay claims while sustaining our investment in the people and
infrastructure needed to implement our other strategic
initiatives.
|
·
|
Improve
insurance profitability – Implementation of profit-focused initiatives is
intended to improve pricing capabilities for our property casualty
business and improve our overall efficiency. Improved pricing helps us
manage profit margins and greater efficiency helps control costs, together
improving overall profitability. These initiatives also seek to help the
agencies that represent us to grow profitably by allowing them to serve
clients efficiently and manage expenses
effectively.
|
·
|
Drive
premium growth – Implementation of premium growth-oriented initiatives is
intended to expand our geographic footprint and diversify our premium
sources to obtain profitable growth without significant additional
infrastructure expense. Diversified growth also may reduce earnings
volatility related to regional differences for risks of weather-related
catastrophes or potential negative changes in economic, judicial or
regulatory environments.
|
We
discuss initiatives supporting each of these three strategies below, along with
metrics we use to assess our progress.
Manage
Capital Effectively
Our
primary capital management initiatives are:
·
|
Maintain
a diversified investment portfolio by reviewing and applying
diversification parameters and tolerances – We discuss our portfolio
strategies in greater depth in our 2009 Annual Report on Form 10-K, Item
1, Investment Segment, Page 18.
|
|
o
|
High-quality
fixed-maturity portfolio that exceeds total insurance reserves – At March
31, 2010, the average rating of the $8.081 billion fixed maturity
portfolio was A2/A. The risk of potential decline of capital due to lower
bond values during periods of increasing interest rates is managed in part
through a generally laddered maturity schedule for this portfolio, as
approximately 28 percent will mature during 2010 through 2014. The
portfolio value exceeded total insurance reserve liability by
approximately 35 percent. In addition, we have assets in the form of
receivables from reinsurers, most with A.M. Best insurer financial
strength ratings of A or better. These assets directly relate to insurance
reserves, offsetting nearly 10 percent of that
liability.
|
21
|
o
|
Diversified
equity portfolio that has no concentrated positions in single stocks or
industries – At March 31, 2010, no single security accounted for more
than 5.7 percent of our portfolio of publicly traded common stocks, and no
single sector accounted for more than 16.9 percent. Because of the
strength of our fixed-maturity portfolio, we have the opportunity to
invest for potential capital appreciation by purchasing equity securities.
We seek to achieve a total return on the equity portfolio over any
five-year period that exceeds that of the Standard & Poor’s 500 Index
while taking similar or less risk.
|
|
o
|
Parent
company liquidity that increases our flexibility through all periods to
maintain our cash dividend and to continue to invest in and expand
our insurance operations – At March 31, 2010, we held
$1.086 billion of our cash and invested assets at the parent company
level, of which $711 million, or 65.5 percent, was invested in
common stocks, and $73 million, or 6.7 percent, was cash or
cash equivalents.
|
·
|
Develop
a comprehensive, enterprise-level catastrophe management program –
Weather-related catastrophe losses for our property casualty business can
significantly affect capital and cause earnings volatility. We continue to
work on a comprehensive program with key objectives that include
identifying an overall tolerance for catastrophe risk as well as regional
guidelines that work with our underwriting and reinsurance efforts. An
important element of this initiative is maintaining reinsurance coverage
from highly rated reinsurers to mitigate underwriting risk and to support
our ability to hold investments until maturity. See our 2009 Annual Report
on Form 10-K, Item 7, 2010 Reinsurance Programs, Page 79, for additional
details on our reinsurance.
|
·
|
Minimize
reliance on debt as a source of capital, maintaining the ratio of
debt-to-total capital below 20 percent – At March 31, 2010, this
ratio at 14.7 percent was well below the 20 percent target limit as
capital remained strong while debt levels were essentially unchanged from
year-end 2009. Our long-term debt consists of three non-convertible,
non-callable debentures, two due in 2028 and one
in 2034.
|
·
|
Identify
tolerances for other operational risks and calibrate management decisions
accordingly – Among the areas of focus in early 2010 were implications of
health care reform legislation and related income tax effects. Because our
employee benefit plans do not include subsidies related to retiree
prescription drug coverage, we have no corresponding tax effect due to the
legislation. We also continued work on managing exposure to risks related
to disaster recovery and business continuity. Our enterprise risk
management efforts also include evaluating emerging risks such as
potential changes in regulation at both the state and federal levels and
the potential effects of increased inflation on assets and
liabilities.
|
We
measure the overall success of our strategy to effectively manage capital
primarily by growing investment income and by achieving a total return on our
equity investment portfolio that exceeds the return of the S&P 500 Index
over any five-year period. We also monitor other measures. One of the most
significant is our ratio of property casualty net written premiums to statutory
surplus, which was 0.8-to-1 for the 12 months ended March 31, 2010,
unchanged from 0.8-to-1 at year-end 2009. This ratio is a common measure of
operating leverage used in the property casualty industry, with lower ratios
indicating more capacity for a company’s premium growth. A.M. Best estimated the
industry ratio was 0.8-to-1 at year-end 2009.
Another
means of verifying our capital management strategy is our financial strength
ratings. Our parent company’s senior debt is rated by four independent ratings
firms. In addition, the ratings firms award insurer financial strength ratings
to our property casualty and life companies based on their quantitative and
qualitative analyses. These ratings primarily 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.
22
As of
April 27, 2010, our credit and financial strength ratings were:
Insurance
Financial Strength Ratings
|
|||||||||||||||
Rating
Agency
|
Parent Company
Senior Debt
Rating
|
Standard
Market Property
Casualty
Insurance
Subsidiary
|
Life
Insurance
Subsidiary
|
Excess
and Surplus
Insurance
Subsidiary
|
Status
(date)
|
||||||||||
Rating
Tier
|
Rating
Tier
|
Rating
Tier
|
|||||||||||||
A.
M. Best Co.
|
a
|
A+
|
Superior
|
2
of 16
|
A
|
Excellent
|
3
of 16
|
A
|
Excellent
|
3
of 16
|
Stable
outlook (2/18/10)
|
||||
Fitch
Ratings
|
BBB+
|
A+
|
Strong
|
5
of 21
|
A+
|
Strong
|
5
of 21
|
–
|
–
|
–
|
Stable
outlook (8/6/09)
|
||||
Moody's
Investors Service
|
A3
|
A1
|
Good
|
5
of 21
|
–
|
–
|
–
|
–
|
–
|
–
|
Stable
outlook (9/25/08)
|
||||
Standard
& Poor's Ratings
Services
|
BBB+
|
A+
|
Strong
|
5
of 21
|
A+
|
Strong
|
5
of 21
|
–
|
–
|
–
|
Negative
outlook (06/30/08)
|
·
|
All
of our insurance subsidiaries continue to be highly rated. On February 18,
2010, A.M. Best affirmed our ratings that it had assigned in December
2008, continuing its stable outlook. A.M. Best cited our superior
risk-adjusted capitalization, strong five-year average operating
performance, historically redundant reserves and successful distribution
within our targeted regional markets. A.M. Best noted that common stock
leverage was approximately 50 percent of statutory surplus at year-end
2009, a concern offset by our conservative underwriting and reserving
philosophies, with loss reserves more than fully covered by a highly
rated, diversified bond portfolio. No other ratings agency actions have
occurred in 2010. Our debt ratings are discussed in our 2009 Annual Report
on Form 10-K, Item 7, Additional Sources of Liquidity, Page
69.
|
The main
initiatives to improve our insurance profitability include:
·
|
Improve
underwriting expertise – While most of our lines of business have
maintained underwriting profitability, we continue to work on improving
our capabilities in risk selection and pricing. For the lines of business
that are underperforming or that involve larger or more complex risks, we
take a comprehensive approach – with collaborative expertise among a team
of associates from underwriting, claims, loss control, marketing,
actuarial services and premium audit – focusing efforts toward
underwriting profitability. Progress during 2010 and future plans for key
initiatives are summarized below.
|
|
o
|
Improve
pricing capabilities in each line of business – Predictive modeling tools
that better align individual insurance policy pricing to risk attributes
were in use prior to 2010 for our homeowner and workers’ compensation
lines of business and are expected to improve loss ratios over time. Audit
processes are used to monitor compliance and to further develop risk
selection and pricing capabilities. We are developing predictive models
for all major lines of commercial insurance and for our personal auto line
of business, with both commercial auto and personal auto targeted for use
in late 2010. Other initiatives in progress include preparing regulatory
filings for multiple price tiers supporting predictive modeling and more
focused attention with measurements for discretionary rate credits applied
based on risk quality.
|
|
o
|
Improving
our business data, supporting accurate underwriting, pricing and decisions
– Over the next several years, we will deploy a full data management
program, including a data warehouse for our property casualty and life
insurance operations that will provide enhanced granularity of pricing
data. This is a phased, long-term project that is currently in progress.
In the interim, new data mining and reporting tools are being implemented
for use with existing databases.
|
·
|
Improve
expense management to make the best use of our resources – Our ongoing
investment in technology and workflow improvements will help us improve
efficiency and grow our business, when insurance market conditions
improve, without proportional increases in expenses. Efficiency gains
currently being realized allowed us recently to reallocate associates,
focusing resources on more strategic activities and initiatives. During
the first quarter of 2010, our overall associate count decreased
approximately 1 percent from the year-end 2009 level, primarily in data
entry functions related to initial benefits from our investment in new or
enhanced policy administration
systems.
|
·
|
Develop
and deploy technology plans – Technology continues to be key for improving
efficiencies and streamlining processes for our agencies, allowing us to
win an increasing share of their most profitable business. Our technology
initiatives seek to make it easier for agents to do business with us while
enhancing our tradition of local decision making by our agents and our
field representatives who live and work in our agents’ communities.
Ongoing technology development contributes to improved profitability
by
|
23
enhancing
internal efficiency and the organization of business data used for
underwriting and pricing. Progress during 2010 and future plans for
major technology initiatives are highlighted
below.
|
|
o
|
Commercial
lines policy administration system – In the fourth quarter of 2009, we
deployed a new system called e-CLAS®
CPP for commercial package and auto coverages to all of our appointed
agencies in 11 states. During the first quarter of 2010, the system was
deployed to three additional states. In total those first 14 states
produce approximately 60 percent of our commercial premium volume. We plan
to deploy the system to as many as 16 additional states throughout 2010.
The new system includes real-time quoting and policy issuance, direct bill
capabilities with several payment plans, and interface capabilities to
transfer selected policy data from agency management systems. The response
from agency users has been very positive, and we believe the new system
will further improve our position among the go-to carriers for our
agencies, having a positive impact on future growth of profitable
commercial lines business over the long
term.
|
|
o
|
Personal
lines policy administration system – In early 2010, a new version of this
system, called Diamond 5.x, was deployed to all agents that produce our
personal lines business. This Web-based system supports agency efficiency
through pre-filling of selected policy data and easy-to-use screens. We
continue to focus on making it easier for our agents to do business
with us, which we believe will significantly benefit our objective of
writing their highest quality accounts with superior profit margins.
During the first three months of 2010, agents continued to generate solid
growth for our personal lines segment as the number of policies in force
increased by over 1 percent from the year-end 2009
level.
|
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 insurance company based on premium volume in agencies that have
represented us for at least five years. In 2009, we again earned that rank in
more than 75 percent of the agencies that have represented Cincinnati Insurance
for more than five years, based on 2008 premiums. We are working to
increase the percentage of agencies where we have achieved that
rank.
Drive
Premium Growth
Key
initiatives to drive premium growth include:
·
|
New
agency appointments in 2010 – In 2010, we are targeting
65 appointments of independent agencies writing an aggregate $1
billion in property casualty premiums annually with all insurance
companies they represent. During the first three months of 2010, we
appointed 11 new agencies that write an aggregate of nearly $140 million
in property casualty premiums annually with various companies for an
average of approximately $13 million per agency. The smallest of the new
agencies writes approximately $1 million for all represented
companies and the largest writes nearly $50 million. In recent years
approximately 20 agencies that each write over $50 million for all
represented companies have been appointed to represent The Cincinnati
Insurance Companies. As of March 31, 2010, a total of 1,179 agency
relationships market our standard market insurance products from 1,460
reporting locations.
|
We seek
to build close, long-term relationships with each agency we appoint and
carefully evaluate the marketing reach of each new appointment to ensure the
territory can support both current and new agencies. Our 114 field marketing
territories are staffed by marketing representatives averaging 19 years of
industry experience and nine years as a Cincinnati Insurance field marketing
representative. They each lead a team of field associates who work together with
headquarters support associates to form our agent-centered business model that
provides local expertise, helps us better understand the accounts we underwrite
and creates another market advantage for our agents.
Expansion
into new states provides opportunities to replicate and leverage our highly
successful agent-centered business model through the appointment of additional
agencies. At March 31, 2010, our agents were actively marketing Cincinnati
Insurance policies in 37 states and we continue to study the regulatory and
competitive environment in other states. We are targeting entry into two new
states, Connecticut and Oregon, in the second half of 2010.
24
·
|
Earn
a larger share of business with currently appointed agents – We continue
to execute on growth initiatives begun in prior years, with a focus on the
key components of agent satisfaction. Important initiatives are summarized
below.
|
|
o
|
Deploy
new products and service enhancements that address agents’ needs – In
early 2010, we launched a Target Markets department intended to focus on
new commercial product development and support, including identification
of promising classes of business. A team of associates is dedicated full
time to this department and engaged in research supporting the target
markets initiative. Target Markets will develop associates with a focus
and subject matter expertise in specific industry segments. This support
is expected to allow our agents to capture a greater share of the business
in their communities and to place that business with The Cincinnati
Insurance Companies.
|
|
o
|
New
states – Reaching our desired market share within an independent agency
requires several years as relationships mature. We generally are able to
earn a 10 percent share of an agency’s business within 10 years of its
appointment. We also help our agents grow their business by attracting
more clients in their communities through our unique style of service. In
New Mexico and eastern Washington, states we entered in 2007, we appointed
13 agencies through 2009, earning an almost 5 percent share of their total
agency annual premium volume as of the end of 2009. In Texas, which we
entered in late 2008, net written premiums for the first three months of
2010 were $5 million compared with less than $1 million for the same
period of 2009.
|
|
o
|
Excess
& Surplus lines insurance – We entered this market in 2008 to better
serve our agents and offer a variety of coverages in 36 of the 37 states
where agents market our standard market coverages. Our agents write about
$2.5 billion annually of excess and surplus lines business with other
carriers and we plan to earn a profitable share by bringing
Cincinnati-style service to agents and policyholders. While we carefully
manage policy terms and conditions and limit our exposure of any single
risk to $1 million through reinsurance, our excess and surplus lines
business continues to grow at a healthy pace. During the first quarter of
2010, net written premiums were $12 million compared with
$7 million for the same period of 2009, an increase of 64
percent.
|
|
o
|
Personal
lines – Pricing refinements and improved ease of use for our agents
continue to benefit premium growth. Enhancement of our tiered rating
during 2009 helped to further improve our rate and credit structures to
attract and retain business for our agents’ more quality-conscious
clientele accounts, with pricing that targets long-term underwriting
profitability. During the first quarter of 2010, net written premiums
increased 7 percent while new business premiums increased 29
percent.
|
Opportunities
for future growth were enhanced as we continued to appoint agents that
formerly marketed only our commercial line products. During the first
quarter seven more of those agencies were activated to offer our personal
lines products, with 77 percent of our agents now offering personal lines
in the 29 states where those products are marketed. In addition, agents continue
to offer rollovers of seasoned business they previously placed with
other carriers.
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. For the first three months of
2010, our property casualty net written premiums declined by 3 percent,
compared with an estimated full-year 2010 2 percent decline for the
industry.
Despite
near-term challenges in insurance and financial markets that are reflected in
year-to-date 2010 financial performance, we have made significant progress
on our initiatives and remain confident that our strategy will deliver long-term
value for shareholders.
The
consolidated results of operations reflect the operating results of each of our
four segments along with the parent company and other activities reported as
“Other.” The four segments are:
·
|
Commercial
lines property casualty insurance
|
·
|
Personal
lines property casualty insurance
|
·
|
Life
insurance
|
·
|
Investments
|
We report
as Other the non-investment operations of the parent company and its non-insurer
subsidiaries, CFC Investment Company and CSU Producer Resources Inc. We
also report as Other the results of The Cincinnati Specialty Underwriters
Insurance Company, as well as other income of our standard market
25
property
casualty insurance subsidiary. See Item 1, Note 11, Segment Information, Page
15, for discussion of the calculations of segment data. Results of operations
for each of the four segments are discussed below.
Consolidated
property casualty insurance results include premiums and expenses for our
standard market insurance (commercial lines and personal lines segments) as well
as our surplus lines operations.
(Dollars
in millions)
|
Three
months ended March 31,
|
|||||||||||
2010
|
2009
|
Change
%
|
||||||||||
Earned
premiums
|
$ | 708 | $ | 732 | (3 | ) | ||||||
Loss
and loss expenses from:
|
||||||||||||
Current
accident year before catastrophe losses
|
492 | 482 | 2 | |||||||||
Current
accident year catastrophe losses
|
22 | 55 | (60 | ) | ||||||||
Prior
accident years before catastrophe losses
|
(32 | ) | 9 |
nm
|
||||||||
Prior
accident year catastrophe losses
|
(7 | ) | (2 | ) | (250 | ) | ||||||
Total
loss and loss expenses
|
475 | 544 | (13 | ) | ||||||||
Underwriting
expenses
|
252 | 243 | 4 | |||||||||
Underwriting
loss
|
$ | (19 | ) | $ | (55 | ) | 65 | |||||
Ratios
as a percent of earned premiums:
|
Pt.
Change
|
|||||||||||
Current
accident year before catastrophe losses
|
69.5 | % | 65.8 | % | 3.7 | |||||||
Current
accident year catastrophe losses
|
3.1 | 7.5 | (4.4 | ) | ||||||||
Prior
accident years before catastrophe losses
|
(4.6 | ) | 1.2 | (5.8 | ) | |||||||
Prior
accident year catastrophe losses
|
(1.0 | ) | (0.3 | ) | (0.7 | ) | ||||||
Total
loss and loss expenses
|
67.0 | 74.2 | (7.2 | ) | ||||||||
Underwriting
expenses
|
35.6 | 33.3 | 2.3 | |||||||||
Combined
ratio
|
102.6 | % | 107.5 | % | (4.9 | ) | ||||||
Combined
ratio:
|
102.6 | % | 107.5 | % | (4.9 | ) | ||||||
Contribution
from catastrophe losses and prior years
|
||||||||||||
reserve
development
|
(2.5 | ) | 8.4 | (10.9 | ) | |||||||
Combined
ratio before catastrophe losses and prior
|
||||||||||||
years
reserve development
|
105.1 | % | 99.1 | % | 6.0 | |||||||
Our
consolidated property casualty insurance operations generated an underwriting
loss of $19 million for the three months ended March 31, 2010, compared
with an underwriting loss of $55 million for the three months ended March
31, 2009. The main drivers of improvement included lower prior accident
year losses for our commercial lines workers’ compensation business and lower
catastrophe losses for our personal lines homeowner business as discussed
below.
We
measure and analyze property casualty underwriting results primarily by the
combined ratio and its component ratios. The combined ratio is the
percentage of incurred losses plus all expenses per each premium dollar -- the
lower the ratio, the better the performance. An underwriting profit results when
the combined ratio is below 100 percent. A combined ratio above
100 percent indicates that an insurance company’s losses and expenses
exceeded premiums.
The
combined ratio can be affected significantly by catastrophe losses and other
large losses as discussed in detail below. The combined ratio can also be
affected by updated estimates of loss and loss expense reserves established for
claims that occurred in prior periods, referred to as prior accident years.
Development on prior accident year reserves favorably affected the combined
ratio by 5.6 percentage points in the first quarter compared with an
unfavorable effect of 0.9 percentage points in the first quarter of 2009.
These ratios include development on prior period catastrophe loss reserves
as shown in the table above. The higher amount of favorable development for the
first three months of 2010 compared with 2009 was driven by a reversal of last
year’s development trend for the workers’ compensation line of business as
discussed in Commercial Lines Results of Operations on Page 28.
26
The
underwriting expense ratio for the first three months of 2010 increased compared
with the same periods of 2009. The increase was primarily due to both lower
earned premiums and higher expenses. The main areas of higher expenses included
technology costs to enhance and maintain our recently deployed policy
administration systems and provisions for matters involving prior years and
related to Note 9, Commitments and Contingent Liabilities, Page 14.
(Dollars
in millions)
|
Three
months ended March 31,
|
|||||||||||
2010
|
2009
|
Change
%
|
||||||||||
Agency
renewal written premiums
|
$ | 682 | $ | 695 | (2 | ) | ||||||
Agency
new business written premiums
|
92 | 97 | (5 | ) | ||||||||
Other
written premiums
|
(18 | ) | (14 | ) | (29 | ) | ||||||
Net
written premiums
|
756 | 778 | (3 | ) | ||||||||
Unearned
premium change
|
(48 | ) | (46 | ) | (4 | ) | ||||||
Earned
premiums
|
$ | 708 | $ | 732 | (3 | ) | ||||||
The
trends in net written premiums and earned premiums summarized in the table above
reflect a continuation of strong competition in our markets plus economic
recession impacts on insured exposures, partially offset by the effects of the
premium growth strategies we discussed in our 2009 Annual Report on Form 10-K,
Item 1, Our Business and Our Strategy, Page 10. The main drivers of trends
for 2010 are discussed by segment on Pages 28 and 32.
Consolidated
property casualty agency new business written for the three months ended March
31, 2010, decreased $5 million compared with the same period of 2009. New
business premiums grew significantly for our personal lines segment and slightly
for our excess and surplus lines operation while declining for our commercial
lines segment. We continued to experience new business growth related to
initiatives for geographic or product line expansion into new and underserved
areas. Agents appointed during 2009 or 2010 produced an increase in standard
lines new business of $8 million for the first quarter of 2010 compared with the
first quarter of 2009. As we appoint new agencies who choose to move accounts to
us, we report these accounts as new business to us. While this business was new
to us, in many cases it was not new to the agent. We believe these seasoned
accounts tend to be priced more accurately than business that is less familiar
to our agent due to it being recently obtained from a competing
agent.
Catastrophe
losses contributed 2.1 percentage points to the combined ratio in the three
months ended March 31, 2010, compared with 7.2 percentage points in the
same period of 2009.
The
following table shows catastrophe losses incurred, net of reinsurance, as well
as the effect of loss development on prior period catastrophe events. We
individually list catastrophe events for which our incurred losses reach or
exceed $5 million.
(In
millions, net of reinsurance)
|
Three
months ended March 31,
|
|||||||||||||
Commercial
|
Personal
|
|||||||||||||
Dates
|
Cause
of loss
|
Region
|
lines
|
lines
|
Total
|
|||||||||
2010
|
||||||||||||||
Jan.
7
|
Freezing,
wind
|
South,
Midwest
|
$ | 4 | $ | 2 | $ | 6 | ||||||
Feb.
4
|
Ice,
snow, wind
|
East,
Midwest
|
4 | 1 | 5 | |||||||||
Feb.
9
|
Ice,
snow, wind
|
East,
Midwest
|
6 | 2 | 8 | |||||||||
All
Other
|
2 | 1 | 3 | |||||||||||
Development
on 2009 and prior catastrophes
|
(6 | ) | (1 | ) | (7 | ) | ||||||||
Calendar
year incurred total
|
$ | 10 | $ | 5 | $ | 15 | ||||||||
2009
|
||||||||||||||
Jan.
26-28
|
Flood,
freezing, ice, snow
|
South,
Midwest
|
$ | 6 | $ | 14 | $ | 20 | ||||||
Feb.
10-13
|
Flood,
hail, wind
|
South,
Midwest, East
|
11 | 19 | 30 | |||||||||
Feb.
18-19
|
Wind,
hail
|
South
|
— | 5 | 5 | |||||||||
Development
on 2008 and prior catastrophes
|
(3 | ) | 1 | (2 | ) | |||||||||
Calendar
year incurred total
|
$ | 14 | $ | 39 | $ | 53 | ||||||||
27
(Dollars
in millions)
|
Three
months ended March 31,
|
|||||||||||
2010
|
2009
|
Change
%
|
||||||||||
Earned
premiums
|
$ | 523 | $ | 557 | (6 | ) | ||||||
Loss
and loss expenses from:
|
||||||||||||
Current
accident year before catastrophe losses
|
372 | 363 | 2 | |||||||||
Current
accident year catastrophe losses
|
16 | 17 | (6 | ) | ||||||||
Prior
accident years before catastrophe losses
|
(29 | ) | 11 |
nm
|
||||||||
Prior
accident year catastrophe losses
|
(6 | ) | (3 | ) | (100 | ) | ||||||
Total
loss and loss expenses
|
353 | 388 | (9 | ) | ||||||||
Underwriting
expenses
|
181 | 181 | 0 | |||||||||
Underwriting
loss
|
$ | (11 | ) | $ | (12 | ) | 0 | |||||
Ratios
as a percent of earned premiums:
|
Pt.
Change
|
|||||||||||
Current
accident year before catastrophe losses
|
71.1 | % | 65.2 | % | 5.9 | |||||||
Current
accident year catastrophe losses
|
3.0 | 3.1 | (0.1 | ) | ||||||||
Prior
accident years before catastrophe losses
|
(5.5 | ) | 2.1 | (7.6 | ) | |||||||
Prior
accident year catastrophe losses
|
(1.2 | ) | (0.6 | ) | (0.6 | ) | ||||||
Total
loss and loss expenses
|
67.4 | 69.8 | (2.4 | ) | ||||||||
Underwriting
expenses
|
34.7 | 32.4 | 2.3 | |||||||||
Combined
ratio
|
102.1 | % | 102.2 | % | (0.1 | ) | ||||||
Combined
ratio:
|
102.1 | % | 102.2 | % | (0.1 | ) | ||||||
Contribution
from catastrophe losses and prior years
|
||||||||||||
reserve
development
|
(3.7 | ) | 4.6 | (8.3 | ) | |||||||
Combined
ratio before catastrophe losses and prior
|
||||||||||||
years
reserve development
|
105.8 | % | 97.6 | % | 8.2 | |||||||
Overview
First-quarter
performance highlights for the commercial lines segment include:
Premiums
– Commercial lines earned premiums and net written premiums declined
during the first quarter 2010 due to lower insured exposure levels from
the weak economy, slightly lower pricing and continued strong competition
that caused us to decline opportunities to write new or renewal business
we considered underpriced. The premiums table below analyzes the
components of earned premiums.
|
Both
renewal and new business premium volume reflected a weak economy in many
geographic regions, resulting in lower levels of insured exposures. Economic
impacts were relatively greater on our contractor-related business, which
primarily affects certain lines of business, as discussed in our 2009 Annual
Report on Form 10-K, Item 7, Commercial Lines Insurance Results of Operations,
Page 50. These lower exposures are reflected by the more significant decrease in
written premiums for our commercial casualty and workers’ compensation business
relative to other commercial business as shown in the Commercial Lines of
Business Analysis below. Premiums for these two lines of business include the
result of policy audits that adjust initial premium amounts based on differences
between estimated and actual sales or payroll related to a specific policy.
Audits contributed $14 million of the $34 million earned premium decline in the
first quarter of 2010.
Lower
pricing contributed to the decrease in agency renewal written premiums. We work
with our agents to retain accounts with manageable risk characteristics that
support the lower average prevailing prices in the marketplace. Our agents,
assisted by our field associates who handle underwriting, claims, loss control
or premium audit responsibilities, provide us with insight on local market
conditions. We use such insights in making decisions intended to adequately
price business to achieve target profit margins. We measure average changes in
commercial lines renewal pricing as the rate of change in renewal premium for
the new policy period compared with the premium for the expiring policy period,
assuming no change in the level of insured exposures or policy coverage between
those periods for respective policies. Our commercial lines policies averaged an
estimated price decline of slightly less than 1 percent during the first quarter
of 2010, improving modestly from a low-single-digit range average decline for
the second half of 2009. Compared with averages, more significant declines
sometimes occur, particularly for larger accounts.
28
New
business written premiums for commercial lines also decreased during the first
quarter of 2010. Our three newest states for our commercial lines operation –
Texas, Colorado and Wyoming – generated an increase in new business of $5
million for the first three months of 2010 compared with the same period of
2009, while other states in total decreased by nearly $14 million or 19 percent.
The trend of writing fewer policies with annual premiums of $100,000 or more
continued during the first quarter, reflecting significant competition for
larger accounts.
Commercial
Lines Insurance Premiums
(Dollars
in millions)
|
Three
months ended March 31,
|
|||||||||||
2010
|
2009
|
Change
%
|
||||||||||
Agency
renewal written premiums
|
$ | 533 | $ | 557 | (4 | ) | ||||||
Agency
new business written premiums
|
66 | 76 | (13 | ) | ||||||||
Other
written premiums
|
(11 | ) | (7 | ) | (57 | ) | ||||||
Net
written premiums
|
588 | 626 | (6 | ) | ||||||||
Unearned
premium change
|
(65 | ) | (69 | ) | 6 | |||||||
Earned
premiums
|
$ | 523 | $ | 557 | (6 | ) | ||||||
·
|
Combined
ratio – The commercial lines combined ratio for the first quarter of 2010
was essentially unchanged compared with the first quarter of 2009 as a
higher underwriting expense ratio offset improvement in the total loss and
loss expense ratio. The ratio for current accident year loss and loss
expenses before catastrophe losses of 71.1 percent declined slightly
compared with the 72.5 percent accident year 2009 result measured as of
December 31, 2009. New losses greater than $4 million, shown in
the table below, had a first-quarter 2010 ratio impact of 1.1 percentage
points compared with 2.4 percentage points for full-year 2009 and
drove the ratio decline for the 2010 accident
year.
|
The net
effect of reserve development for prior accident years during the first three
months of 2010 was favorable for commercial lines overall at $35 million
compared with unfavorable development of $8 million for the same period in
2009. The unfavorable reserve development for prior accident years during the
first quarter of 2009 was primarily due to a $20 million workers’
compensation reserve increase for prior accident year reserves resulting from a
higher loss cost inflation estimate. For the first three months of 2010, most of
the favorable reserve development for prior accident years occurred in the
commercial casualty line of business for accident years 2008 and 2009. The
favorable reserve development recognized for commercial casualty is due mainly
to lower estimates of loss cost trend and case reserve emergence that was
lighter than anticipated. Reserve estimates are inherently uncertain as
described in our 2009 Annual Report on Form 10-K, Item 7, Property Casualty
Insurance Loss and Loss Expense Reserves, Page 38.
Our loss
and loss expense ratio for workers’ compensation remained high at 91.4 percent
and was a primary reason the commercial lines segment did not produce an
underwriting profit. As discussed on Page 23, predictive modeling for workers’
compensation is expected to improve pricing accuracy, therefore improving
profitability and the related ratios over time. Other actions taken to improve
workers’ compensation results include assigning additional staff to specialize
in workers’ compensation claims handling, increasing the use of loss control
risk evaluation services and promoting the timely reporting of claims. Direct
reporting of workers’ compensation claims, implemented in early 2010, provides
detailed information for prompt assignment of claims handling expertise
appropriate for each case. More specialized claims handling and earlier
reporting are expected to enable our claims representatives to manage and
contain the costs of claims that have already occurred more effectively, while
additional loss control services are intended to prevent worker-related
accidents or lessen the severity of injuries when accidents occur.
The
underwriting expense ratio for the first three months of 2010 increased compared
with the same period of 2009. The increase was primarily due to lower earned
premiums and higher technology expenses related to our recently deployed
commercial lines policy administration system.
29
Other
factors contributing to the change in the commercial lines combined ratio were
lower pricing, lower audit premiums and normal loss cost inflation. Underwriting
results and related measures for the combined ratio are summarized in the table
above. The tables and discussion below provide additional details for the
primary drivers of underwriting results.
Commercial
Lines Insurance Losses by Size
(Dollars
in millions)
|
Three
months ended March 31,
|
|||||||||||
2010
|
2009
|
Change
%
|
||||||||||
New
losses greater than $4,000,000
|
$ | 6 | $ | 9 | (33 | ) | ||||||
New
losses $1,000,000-$4,000,000
|
32 | 26 | 23 | |||||||||
New
losses $250,000-$1,000,000
|
40 | 47 | (15 | ) | ||||||||
Case
reserve development above $250,000
|
32 | 51 | (37 | ) | ||||||||
Total
large losses incurred
|
110 | 133 | (17 | ) | ||||||||
Other
losses excluding catastrophe losses
|
161 | 174 | (7 | ) | ||||||||
Catastrophe
losses
|
10 | 14 | (29 | ) | ||||||||
Total
losses incurred
|
$ | 281 | $ | 321 | (12 | ) | ||||||
Ratios
as a percent of earned premiums:
|
Pt.
Change
|
|||||||||||
New
losses greater than $4,000,000
|
1.1 | % | 1.7 | % | (0.6 | ) | ||||||
New
losses $1,000,000-$4,000,000
|
6.1 | 4.7 | 1.4 | |||||||||
New
losses $250,000-$1,000,000
|
7.7 | 8.4 | (0.7 | ) | ||||||||
Case
reserve development above $250,000
|
6.2 | 9.1 | (2.9 | ) | ||||||||
Total
large loss ratio
|
21.1 | 23.9 | (2.8 | ) | ||||||||
Other
losses excluding catastrophe losses
|
30.8 | 31.2 | (0.4 | ) | ||||||||
Catastrophe
losses
|
1.8 | 2.5 | (0.7 | ) | ||||||||
Total
loss ratio
|
53.7 | % | 57.6 | % | (3.9 | ) | ||||||
We
continue to monitor new losses and case reserve increases greater than $250,000
for trends in factors such as initial reserve levels, loss cost inflation and
settlement expenses. Our analysis continues to indicate no unexpected
concentration of these large losses and case reserve increases by risk category,
geographic region, policy inception, agency or field marketing territory. In the
first quarter of 2010, the ratio for these losses and case reserve increases
were 2.8 percentage points less than last year’s first quarter, primarily due to
a lower number of claims and incurred losses for the general liability coverage.
We believe results for the three-month period largely reflected normal
fluctuations in loss patterns and normal variability in the large case reserves
for claims above $250,000.
30
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 premium and loss trends
separately for each line.
(Dollars
in millions)
|
Three
months ended March 31,
|
|||||||||||
2010
|
2009
|
Change
%
|
||||||||||
Commercial
casualty:
|
||||||||||||
Written
premiums
|
$ | 191 | $ | 209 | (9 | ) | ||||||
Earned
premiums
|
164 | 187 | (12 | ) | ||||||||
Loss
and loss expenses incurred
|
96 | 103 | (7 | ) | ||||||||
Loss
and loss expense ratio
|
58.3 | % | 55.2 | % | ||||||||
Contribution
from catastrophe losses
|
0.0 | 0.0 | ||||||||||
Contribution
from prior period reserve development
|
(12.7 | ) | (9.7 | ) | ||||||||
Commercial
property:
|
||||||||||||
Written
premiums
|
$ | 129 | $ | 132 | (2 | ) | ||||||
Earned
premiums
|
121 | 121 | 0 | |||||||||
Loss
and loss expenses incurred
|
86 | 83 | 4 | |||||||||
Loss
and loss expense ratio
|
71.0 | % | 69.0 | % | ||||||||
Contribution
from catastrophe losses
|
8.3 | 7.4 | ||||||||||
Contribution
from prior period reserve development
|
(1.8 | ) | 4.8 | |||||||||
Commercial
auto:
|
||||||||||||
Written
premiums
|
$ | 103 | $ | 110 | (6 | ) | ||||||
Earned
premiums
|
95 | 99 | (4 | ) | ||||||||
Loss
and loss expenses incurred
|
58 | 59 | (2 | ) | ||||||||
Loss
and loss expense ratio
|
61.0 | % | 59.7 | % | ||||||||
Contribution
from catastrophe losses
|
(1.0 | ) | (0.1 | ) | ||||||||
Contribution
from prior period reserve development
|
(7.1 | ) | 1.7 | |||||||||
Workers'
compensation:
|
||||||||||||
Written
premiums
|
$ | 95 | $ | 104 | (9 | ) | ||||||
Earned
premiums
|
74 | 83 | (11 | ) | ||||||||
Loss
and loss expenses incurred
|
67 | 97 | (31 | ) | ||||||||
Loss
and loss expense ratio
|
91.4 | % | 117.5 | % | ||||||||
Contribution
from catastrophe losses
|
0.0 | 0.0 | ||||||||||
Contribution
from prior period reserve development
|
(11.9 | ) | 24.0 | |||||||||
Specialty
packages:
|
||||||||||||
Written
premiums
|
$ | 39 | $ | 38 | 3 | |||||||
Earned
premiums
|
37 | 35 | 6 | |||||||||
Loss
and loss expenses incurred
|
33 | 34 | (3 | ) | ||||||||
Loss
and loss expense ratio
|
89.0 | % | 96.0 | % | ||||||||
Contribution
from catastrophe losses
|
1.1 | 13.7 | ||||||||||
Contribution
from prior period reserve development
|
10.0 | 5.9 | ||||||||||
Surety
and executive risk:
|
||||||||||||
Written
premiums
|
$ | 23 | $ | 25 | (8 | ) | ||||||
Earned
premiums
|
24 | 25 | (4 | ) | ||||||||
Loss
and loss expenses incurred
|
13 | 8 | 63 | |||||||||
Loss
and loss expense ratio
|
51.1 | % | 30.3 | % | ||||||||
Contribution
from catastrophe losses
|
0.0 | 0.0 | ||||||||||
Contribution
from prior period reserve development
|
4.0 | (17.3 | ) | |||||||||
Machinery
and equipment:
|
||||||||||||
Written
premiums
|
$ | 8 | $ | 8 | 0 | |||||||
Earned
premiums
|
8 | 7 | 14 | |||||||||
Loss
and loss expenses incurred
|
— | 4 |
nm
|
|||||||||
Loss
and loss expense ratio
|
6.1 | % | 59.3 | % | ||||||||
Contribution
from catastrophe losses
|
(1.0 | ) | 4.5 | |||||||||
Contribution
from prior period reserve development
|
(17.2 | ) | 17.5 |
As
discussed above, the loss and loss expense ratio component of the combined ratio
is an important measure of underwriting profit and performance. Catastrophe
losses are volatile and can distort short-term profitability trends,
particularly for certain lines of business. Development of loss and loss expense
reserves on prior accident years can also distort trends in measures of
profitability for recently written business. To illustrate these effects, we
separate their impact on the ratios shown in the table above. For the three
months ended March 31, 2010, the only commercial lines of business with
significant adverse profitability trends are workers’ compensation and specialty
packages. As discussed above, we are taking action to improve pricing and reduce
31
loss
costs for workers’ compensation, which is expected to benefit future
profitability trends. Most of the specialty package profit deterioration is due
to large losses, which should return nearer to historical averages.
(Dollars
in millions)
|
Three
months ended March 31,
|
|||||||||||
2010
|
2009
|
Change
%
|
||||||||||
Earned
premiums
|
$ | 174 | $ | 171 | 2 | |||||||
Loss
and loss expenses from:
|
||||||||||||
Current
accident year before catastrophe losses
|
111 | 115 | (3 | ) | ||||||||
Current
accident year catastrophe losses
|
6 | 38 | (84 | ) | ||||||||
Prior
accident years before catastrophe losses
|
(4 | ) | (2 | ) | (100 | ) | ||||||
Prior
accident year catastrophe losses
|
(1 | ) | 1 |
nm
|
||||||||
Total
loss and loss expenses
|
112 | 152 | (26 | ) | ||||||||
Underwriting
expenses
|
67 | 54 | 24 | |||||||||
Underwriting
loss
|
$ | (5 | ) | $ | (35 | ) | 86 | |||||
Ratios
as a percent of earned premiums:
|
Pt.
Change
|
|||||||||||
Current
accident year before catastrophe losses
|
63.7 | % | 67.4 | % | (3.7 | ) | ||||||
Current
accident year catastrophe losses
|
3.3 | 22.0 | (18.7 | ) | ||||||||
Prior
accident years before catastrophe losses
|
(2.3 | ) | (1.4 | ) | (0.9 | ) | ||||||
Prior
accident year catastrophe losses
|
(0.3 | ) | 0.6 | (0.9 | ) | |||||||
Total
loss and loss expenses
|
64.4 | 88.6 | (24.2 | ) | ||||||||
Underwriting
expenses
|
38.1 | 32.1 | 6.0 | |||||||||
Combined
ratio
|
102.5 | % | 120.7 | % | (18.2 | ) | ||||||
Combined
ratio:
|
102.5 | % | 120.7 | % | (18.2 | ) | ||||||
Contribution
from catastrophe losses and prior years
|
||||||||||||
reserve
development
|
0.7 | 21.2 | (20.5 | ) | ||||||||
Combined
ratio before catastrophe losses and prior
|
||||||||||||
years
reserve development
|
101.8 | % | 99.5 | % | 2.3 | |||||||
Overview
Performance
highlights for the personal lines segment include:
Premiums
– Personal lines earned premiums and net written premiums increased for
the first quarter of 2010 due to higher renewal and new business premiums
that reflected improved pricing.
|
Agency
renewal written premiums increased 4 percent in the first quarter of 2010
because of rate increases plus strong policy retention rates. Pricing changes
during 2009 included an expansion of pricing points and pricing
sophistication, incorporating insurance scores and credits for policies on
above-average quality risks. Various rate changes were implemented beginning
October 2009, including increases for the homeowner line of business
averaging approximately 6 percent, with some individual policy rate increases in
the double-digit range. Similar rate changes, with a slightly higher average
rate effect, are expected to be implemented in the fourth quarter of 2010 for
states representing the majority of our personal lines business.
Personal
lines new business written premiums continued a strong growth trend, increasing
at a rate of 29 percent for the three months ended March 31, 2010. We
continue to be successful in attracting more of our agents’ preferred business
as the average quality of our book of business has improved.
Significant new business growth occurred in states where we have operated
for decades as well as states where we significantly expanded our personal lines
product offerings and automation capabilities beginning in 2008. Some of what we
report as new business came from accounts that were not new to our agents. We
believe these seasoned accounts tend to be priced more accurately than business
that is less familiar to our agents.
We
continue to implement strategies discussed in our 2009 Annual Report on
Form 10-K, Item 1, Our Business and Our Strategy, Page 9, to enhance
our response to marketplace changes and help achieve our long-term objectives
for personal lines growth and profitability. These strategies include expansion
during recent years into four western states with historical industry
catastrophe loss ratios that are significantly better than our historical ratios
for states where we operated prior to that expansion.
32
Personal
Lines Insurance Premiums
(Dollars
in millions)
|
Three
months ended March 31,
|
|||||||||||
2010
|
2009
|
Change
%
|
||||||||||
Agency
renewal written premiums
|
$ | 143 | $ | 137 | 4 | |||||||
Agency
new business written premiums
|
18 | 14 | 29 | |||||||||
Other
written premiums
|
(6 | ) | (6 | ) | 0 | |||||||
Net
written premiums
|
155 | 145 | 7 | |||||||||
Unearned
premium change
|
19 | 26 | (27 | ) | ||||||||
Earned
premiums
|
$ | 174 | $ | 171 | 2 | |||||||
·
|
Combined
ratio – The personal lines combined ratio for the first quarter of 2010
improved 18.2 percentage points compared with the first quarter of
2009, primarily due to lower weather-related catastrophe losses. The ratio
for current accident year loss and loss expenses before catastrophe losses
of 63.7 percent improved 7.2 percentage points compared with the 70.9
percent accident year 2009 result measured as of December 31, 2009. Rate
increases and lower large losses were the primary drivers of the
improvement. New losses greater than $250,000, shown in the table below,
had a first-quarter 2010 ratio impact of 7.0 percentage points compared
with 10.1 percentage points for full-year 2009 and accounted for 3.1
percentage points of the decline for the 2010 accident
year.
|
In
addition to the rate increases discussed above, we continue to refine our
pricing to better match premiums to the risk of loss on individual policies. We
also continue to increase pricing sophistication that considers insurance scores
and other attributes of risk for the insured exposure. The results of improved
pricing per risk and the broad-based rate increases are expected to improve the
combined ratio over the next several quarters. In addition, greater geographic
diversification is expected over time to reduce the volatility of homeowner
underwriting results attributable to weather-related catastrophe
losses.
Personal
lines reserve development for prior accident years during the first three months
of 2010 trended favorably, similar to trends for the same period of 2009. Most
of the favorable reserve development for prior accident years recognized during
2009 occurred in the personal auto line of business. Reserve estimates are
inherently uncertain as described in our 2009 Annual Report on Form 10-K, Item
7, Property Casualty Insurance Loss and Loss Expense Reserves, Page
38.
The
underwriting expense ratio for the first three months of 2010 increased compared
with the first quarter of 2009. The increase was primarily due to provisions for
matters involving prior years and related to Note 9, Commitments and Contingent
Liabilities, Page 14. In addition, costs to develop and maintain our recently
deployed personal lines policy administration system increased the expense
ratio.
Personal
Lines Insurance Losses by Size
(Dollars
in millions)
|
Three
months ended March 31,
|
|||||||||||
2010
|
2009
|
Change
%
|
||||||||||
New
losses greater than $4,000,000
|
$ | 0 | $ | 0 |
nm
|
|||||||
New
losses $1,000,000-$4,000,000
|
3 | 1 | 200 | |||||||||
New
losses $250,000-$1,000,000
|
10 | 15 | (33 | ) | ||||||||
Case
reserve development above $250,000
|
3 | 5 | (40 | ) | ||||||||
Total
large losses incurred
|
16 | 21 | (24 | ) | ||||||||
Other
losses excluding catastrophe losses
|
76 | 74 | 3 | |||||||||
Catastrophe
losses
|
5 | 39 | (87 | ) | ||||||||
Total
losses incurred
|
$ | 97 | $ | 134 | (28 | ) | ||||||
Ratios
as a percent of earned premiums:
|
Pt.
Change
|
|||||||||||
New
losses greater than $4,000,000
|
0.0 | % | 0.0 | % | 0.0 | |||||||
New
losses $1,000,000-$4,000,000
|
1.5 | 0.8 | 0.7 | |||||||||
New
losses $250,000-$1,000,000
|
5.5 | 8.6 | (3.1 | ) | ||||||||
Case
reserve development above $250,000
|
1.9 | 3.0 | (1.1 | ) | ||||||||
Total
large losses incurred
|
8.9 | 12.4 | (3.5 | ) | ||||||||
Other
losses excluding catastrophe losses
|
43.4 | 43.3 | 0.1 | |||||||||
Catastrophe
losses
|
3.0 | 22.6 | (19.6 | ) | ||||||||
Total
loss ratio
|
55.3 | % | 78.3 | % | (23.0 | ) | ||||||
We
continue to monitor new losses and case reserve increases greater than $250,000
for trends in factors such as initial reserve levels, loss cost inflation and
settlement expenses. Our analysis continues to indicate no unexpected
concentration of these large losses and case reserve increases by risk category,
geographic region, policy inception, agency or field marketing territory. In the
first quarter of 2010, the ratio for these losses and case reserve increases was
3.5 percentage points less than last year’s first quarter, primarily due to a
lower number of claims and incurred losses for the personal auto line of
business. We believe results for the
33
three-month
period largely reflected normal fluctuations in loss patterns and normal
variability in the large case reserves for claims
above $250,000.
Personal
Lines of Business Analysis
We prefer
to write personal lines coverages 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 the line of business data
to summarize premium and loss trends separately for each line.
(Dollars
in millions)
|
Three
months ended March 31,
|
|||||||||||
2010
|
2009
|
Change
%
|
||||||||||
Personal
auto:
|
||||||||||||
Written
premiums
|
$ | 73 | $ | 68 | 7 | |||||||
Earned
premiums
|
81 | 79 | 3 | |||||||||
Loss
and loss expenses incurred
|
47 | 50 | (6 | ) | ||||||||
Loss
and loss expense ratio
|
58.2 | % | 63.6 | % | ||||||||
Contribution
from catastrophe losses
|
(0.1 | ) | 0.3 | |||||||||
Contribution
from prior period reserve development
|
(4.7 | ) | 3.4 | |||||||||
Homeowner:
|
||||||||||||
Written
premiums
|
$ | 60 | $ | 56 | 7 | |||||||
Earned
premiums
|
70 | 70 | 0 | |||||||||
Loss
and loss expenses incurred
|
53 | 93 | (43 | ) | ||||||||
Loss
and loss expense ratio
|
76.0 | % | 132.9 | % | ||||||||
Contribution
from catastrophe losses
|
6.9 | 51.5 | ||||||||||
Contribution
from prior period reserve development
|
1.6 | 6.5 | ||||||||||
Other
personal:
|
||||||||||||
Written
premiums
|
$ | 22 | $ | 21 | 5 | |||||||
Earned
premiums
|
23 | 22 | 5 | |||||||||
Loss
and loss expenses incurred
|
12 | 9 | 33 | |||||||||
Loss
and loss expense ratio
|
51.5 | % | 37.8 | % | ||||||||
Contribution
from catastrophe losses
|
2.8 | 11.0 | ||||||||||
Contribution
from prior period reserve development
|
(7.8 | ) | (38.2 | ) |
As
discussed above, the loss and loss expense ratio component of the combined ratio
is an important measure of underwriting profit and performance. Catastrophe
losses are volatile and can distort short-term profitability trends,
particularly for certain lines of business. Development of loss and loss expense
reserves from prior accident years can also distort trends in measures of
profitability for recently written business. To illustrate these effects, we
separate their impact on the ratios shown in the table above. For the three
months ended March 31, 2010, the personal line of business with the most
significant adverse profitability trend was homeowner. As discussed above, we
continue to take action to improve pricing per risk and overall rates, which is
expected to improve future profitability trends. In addition we anticipate that
the long-term future average for the catastrophe loss ratio would improve due to
gradual geographic diversification into states less prone to catastrophe
losses.
Life
Insurance Results
(In
millions)
|
Three
months ended March 31,
|
|||||||||||
2010
|
2009
|
Change
%
|
||||||||||
Earned
premiums
|
$ | 39 | $ | 33 | 18 | |||||||
Separate
account investment management fees
|
— | 1 |
nm
|
|||||||||
Total
revenues
|
39 | 34 | 15 | |||||||||
Contract
holders' benefits incurred
|
42 | 39 | 8 | |||||||||
Investment
interest credited to contract holders
|
(19 | ) | (16 | ) | (19 | ) | ||||||
Operating
expenses incurred
|
16 | 12 | 33 | |||||||||
Total
benefits and expenses
|
39 | 35 | 11 | |||||||||
Life
insurance segment profit (loss)
|
$ | — | $ | (1 | ) |
nm
|
||||||
Overview
Performance
highlights for the life insurance segment include:
·
|
Revenues
– Revenues were higher for the three months ended March 31, 2010,
driven by an earned premium increase largely due to growth from term life
insurance products and universal life insurance products. Term life
insurance earned premiums increased 21 percent while universal life earned
premiums increased 17 percent in the first three months of 2010 compared
with the same period
|
34
of 2009. Earned premiums for the first quarter included $22 million of term life insurance, $9 million of universal life insurance, and $8 million of other life insurance, annuity, and disability income products. |
Gross
in-force life insurance policy face amounts increased to $70.936 billion at
March 31, 2010, from $69.815 billion at year-end 2009.
Fixed
annuity deposits received for the first quarter of 2010 were $65 million
compared with $12 million for the same period of 2009. Fixed annuity
deposits have a minimal impact to earned premiums because deposits received are
initially recorded as a liability with a portion representing profit
subsequently earned over time. We do not write variable or equity-indexed
annuities.
·
|
Profitability
– Our life insurance segment typically reports only a small profit or loss
on a GAAP basis because most of its investment income is included in our
investment segment results. We include only investment income credited to
contract holders (interest assumed in life insurance policy reserve
calculations) in our life insurance segment results. Profit of less than
$1 million for our life insurance segment in the first quarter of 2010
compared favorably with a $1 million loss for the first quarter of
2009 when the segment experienced less favorable mortality
experience.
|
Although
we exclude most of our life insurance company investment income from our life
insurance segment results, we recognize that assets under management,
capital appreciation and investment income are integral to evaluation of
the success of the life insurance segment because of the long duration of
life products. On a basis that includes investment income and realized gains or
losses from life insurance-related invested assets, the life insurance
company reported a net profit of $7 million in the three months ended March
31, 2010, compared with a net loss of $9 million for the same period of 2009.
The life insurance company portfolio had after-tax realized investment loss of
$1 million in the three months ended March 31, 2010, compared with after-tax
realized investment losses of $18 million for the same period of
2009.
Life
segment expenses consist principally of contract holders (policyholders)
benefits incurred related to traditional life and interest-sensitive products
and operating expenses incurred, net of deferred acquisition costs. Total
benefits rose in the first quarter of 2010 due to increased levels of policy
reserves associated with growth in earned life insurance premiums. Net death
claims remained within our range of pricing expectations. Operating expenses
increased principally because of the level of commission expense associated with
new term life insurance and fixed annuity policies, partially offset by deferred
acquisition costs related to these products.
Overview
The
investment segment contributes investment income and realized gains and losses
to results of operations. Investments traditionally are our primary source of
pretax and after-tax profits.
Investment
Income
Pretax
investment income increased 5 percent for the three months ended
March 31, 2010, primarily due to higher interest income somewhat
offset by a decline in dividend income, reflecting an increased allocation to
fixed-maturity securities over the past year. In our 2009 Form 10-K,
Item 1, Investments Segment, Page 18 and Item 7, Investments
Outlook, Page 67, we discussed our portfolio strategies. We discuss risks
related to our investment income and our fixed-maturity and equity investment
portfolios in Item 3, Quantitative and Qualitative Disclosures About Market
Risk, Page 42.
35
Investment
Results
(In
millions)
|
Three
months ended March 31,
|
|||||||||||
2010
|
2009
|
Change
%
|
||||||||||
Total
investment income, net of expenses, pre-tax
|
$ | 130 | $ | 124 | 5 | |||||||
Investment
interest credited to contract holders
|
(19 | ) | (16 | ) | (19 | ) | ||||||
Realized
investment gains and losses summary:
|
||||||||||||
Realized
investment gains and losses, net
|
3 | 52 | (94 | ) | ||||||||
Change
in fair value of securities with embedded derivatives
|
6 | (4 | ) | nm | ||||||||
Other-than-temporary
impairment charges
|
(1 | ) | (50 | ) | 98 | |||||||
Total
realized investment gains and losses, net
|
8 | (2 | ) |
nm
|
||||||||
Investment
operations income
|
$ | 119 | $ | 106 | 12 | |||||||
(In
millions)
|
Three
months ended March 31,
|
|||||||||||
2010
|
2009
|
Change
%
|
||||||||||
Investment
income:
|
||||||||||||
Interest
|
$ | 107 | $ | 96 | 11 | |||||||
Dividends
|
24 | 27 | (11 | ) | ||||||||
Other
|
1 | 3 | (67 | ) | ||||||||
Investment
expenses
|
(2 | ) | (2 | ) | 0 | |||||||
Total
investment income, net of expenses, pre-tax
|
130 | 124 | 5 | |||||||||
Income
taxes
|
(32 | ) | (29 | ) | (10 | ) | ||||||
Total
investment income, net of expenses, after-tax
|
$ | 98 | $ | 95 | 3 | |||||||
Effective
tax rate
|
24.5 | % | 23.1 |
%
|
|
|||||||
Average
invested assets
|
$ | 11,302 | $ | 9,645 | ||||||||
Average
yield pre-tax
|
4.6 | % | 5.1 |
%
|
|
|||||||
Average
yield after-tax
|
3.5 | % | 3.9 |
%
|
|
|||||||
Net
Realized Gains and Losses
We
reported net realized investment gains of $8 million in the three months ended
March 31, 2010, as net gains from investment sales and bond calls plus an
increase in fair value of securities with embedded derivatives were partially
offset by other-than-temporary impairment charges. We reported a $2 million net
realized investment loss in the three months ended March 31, 2009, as net
gains from investment sales and bond calls were offset by other-than-temporary
impairment charges and the change in fair value of securities with embedded
derivatives.
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.
Accounting requirements for other-than-temporary impairment charges for the
fixed-maturity portfolio are disclosed in Item 1, Note 2, Investments on Page
8.
The total
realized investment gains for the first quarter of 2010 include:
·
|
$9
million in gains from the sale of various common stock
holdings.
|
·
|
$5
million in net losses from fixed-maturity sales and
calls.
|
·
|
$6
million in gains from changes in fair value of securities with embedded
derivatives.
|
·
|
$1
million in other-than-temporary impairment charges to write down holdings
of fixed maturities.
|
The $5
million in net losses included a $1 million gain in short-term investments due
to the final receipt from the Reserve Primary Fund that exceeded the impaired
basis. The net losses also included $12 million in losses due to the sales of
all of the remaining holdings of collateralized mortgage
obligations.
We
believe that if the improving liquidity in the markets were to reverse, or the
economic recovery were to significantly stall, we could experience declines in
portfolio values and possible additional other-than-temporary-impairment
charges. Of the 2,534 securities in the portfolio, only one, a
fixed-maturity security, was trading below 70 percent of book value at
March 31, 2010. Our asset impairment committee regularly monitors the
portfolio.
36
The table
below provides additional detail for other-than-temporary impairment
charges.
(In
millions)
|
Three
months ended March 31,
|
|||||||
2010
|
2009
|
|||||||
Fixed
maturities
|
||||||||
Financial
|
$ | — | $ | 19 | ||||
Services
cyclical
|
— | 11 | ||||||
Real
estate
|
— | 7 | ||||||
Consumer
cyclical
|
— | 1 | ||||||
Other
|
1 | 2 | ||||||
Total
fixed maturities
|
1 | 40 | ||||||
Preferred
equities
|
||||||||
Financial
|
— | 10 | ||||||
Total
preferred equities
|
— | 10 | ||||||
Total
|
$ | 1 | $ | 50 | ||||
We report
as Other the non-investment operations of the parent company and its non-insurer
subsidiaries, CFC Investment Company and CSU Producers Resources Inc. We
also report as Other the results of The Cincinnati Specialty Underwriters
Insurance Company, as well as other income of our standard market property
casualty insurance subsidiary.
Losses
before income taxes for Other were largely driven by interest expense from debt
of the parent company. Loss and loss expenses and underwriting expenses for
Other are from our excess and surplus lines operation, and for the first three
months of 2010 were nearly offset by excess and surplus lines earned
premiums.
(In
millions)
|
Three
months ended March 31,
|
|||||||||||
2010
|
2009
|
Change
%
|
||||||||||
Interest
and fees on loans and leases
|
$ | 2 | $ | 2 | 0 | |||||||
Earned
premiums
|
11 | 4 | 175 | |||||||||
Other
revenues
|
— | — | 0 | |||||||||
Total
revenues
|
13 | 6 | 117 | |||||||||
Interest
expense
|
13 | 14 | (7 | ) | ||||||||
Losses
and loss expenses
|
10 | 3 | 233 | |||||||||
Underwriting
expenses
|
4 | 8 | (50 | ) | ||||||||
Operating
expenses
|
4 | 5 | (20 | ) | ||||||||
Total
expenses
|
31 | 30 | 3 | |||||||||
Pre-tax
loss
|
$ | (18 | ) | $ | (24 | ) | 25 | |||||
We had
$17 million of income tax expense in the three months ended March 31, 2010,
compared with a $1 million income tax benefit for the same period of 2009.
The effective tax rate for the three months ended March 31, 2010, was 19.7
percent compared with negative 4.5 percent in the same period last
year.
The
change in our effective tax rate was primarily due to changes in pretax income
from underwriting results, changes in investment income and the amount of
realized investment gains and losses. Modestly lower tax exempt interest and a
lower dividend received deduction also contributed to the change in our
effective tax rate.
Historically,
we have pursued 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. See Tax-Exempt Fixed Maturities,
Page 43 for further discussion on municipal bond purchases in our fixed-maturity
investment portfolio. 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 our 2009 Annual Report on Form 10-K, Item 8,
Note 11, Income Taxes, Page 108.
37
At March
31, 2010, shareholders’ equity was $4.865 billion compared with
$4.760 billion at December 31, 2009. Total debt was
$839 million at March 31, 2010 and at December 31, 2009. At March 31, 2010,
cash and cash equivalents totaled $402 million compared with $557 million at
December 31, 2009.
Sources
of Liquidity
Subsidiary
Dividends
Our lead
insurance subsidiary declared dividends of $50 million to the parent company
during the first three months of 2010 compared with none for the first three
months of 2009. For the full-year 2009 dividends declared totaled $50 million.
State of Ohio regulatory requirements restrict the dividends our insurance
subsidiary can pay. During 2010, total dividends that our insurance subsidiary
could pay to our parent company without regulatory approval are approximately
$365 million.
Investing
Activities
Investment
income is a source of liquidity for both the parent company and its insurance
subsidiary. We continue to focus on portfolio strategies to balance
near-term income generation and long-term book value growth.
Parent
company obligations can be funded with income on investments held at the parent
company level or through realized gains on that portfolio, although we prefer to
follow an investment philosophy seeking to compound cash flows over the long
term. These sources of capital can help minimize subsidiary dividends to the
parent company, protecting insurance subsidiary capital.
See our
2009 Annual Report on Form 10-K, Item 1, Investment Segment, Page 18, for a
discussion of our historic investment strategy, portfolio allocation and
quality.
Insurance
Underwriting
Our
property casualty and life insurance underwriting operations provide liquidity
because we generally receive premiums before paying losses under the policies
purchased with those premiums. After satisfying our cash requirements, we use
excess cash flows for investment, increasing future investment
income.
Historically,
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. While first-year life
insurance expenses normally exceed first-year premiums, subsequent premiums are
used to generate investment income until the time the policy benefits are
paid.
The table
below shows a summary of cash flow for property casualty insurance (direct
method):
(Dollars
in millions)
|
Three
months ended March 31,
|
|||||||
2010
|
2009
|
|||||||
Premiums
collected
|
$ | 718 | $ | 750 | ||||
Loss
and loss expenses paid
|
(414 | ) | (479 | ) | ||||
Commissions
and other underwriting expenses paid
|
(290 | ) | (295 | ) | ||||
Insurance
subsidiary cash flow from underwriting
|
14 | (24 | ) | |||||
Investment
income received
|
89 | 80 | ||||||
Insurance underwriting
cash flow
|
$ | 103 | $ | 56 | ||||
Collected
premiums for property casualty insurance are down $32 million for the first
three months of 2010, similar to the decline in net written premiums, but was
offset by a $65 million decrease in loss and loss expenses paid, primarily due
to lower catastrophe
paid losses.
Our life
insurance subsidiary underwriting cash flow was $41 million for the three months
ended March 31, 2010, down $6 million from underwriting cash flow
reported in the first quarter 2009.
We discuss
our future obligations for claims payments and for underwriting expenses in our
2009 Annual Report on Form 10-K, Item 7, Contractual Obligations,
Page 71, and Other Commitments, also on Page 71.
Capital
Resources
At March
31, 2010, our total debt-to-capital ratio improved to 14.7 percent, with
$790 million in long-term debt and $49 million in borrowings on our
short-term lines of credit. Based on our present capital requirements, we do not
anticipate a material increase in debt levels during 2010. As a result, we
believe that changes in our debt-to-capital ratio will continue to be largely a
function of the contribution of unrealized investment gains or losses to
shareholders’ equity.
We
provide details of our three long-term notes in our 2009 Annual Report on Form
10-K, Item 8, Note 8, Senior Debt, Page 106. None of the notes are encumbered by
rating triggers. Our debt ratings are described in Progress Toward Long-Term
Value Creation, Page 20.
38
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.
USES
OF LIQUIDITY
Our
parent company and insurance subsidiary have contractual obligations and other
commitments. In addition, one of our primary uses of cash is to enhance
shareholder return.
Contractual
Obligations
In our
2009 Annual Report on Form 10-K, Item 7, Contractual Obligations, Page 71, we
estimated our future contractual obligations as of December 31, 2009. There have
been no material changes to our estimates of future contractual
obligations.
Other
Commitments
In
addition to our contractual obligations, we have other operational
commitments.
·
|
Commissions
– Commissions paid were $203 million in the first three months of 2010.
Commission payments generally track with written
premiums.
|
·
|
Other
underwriting expenses – Many of our underwriting expenses are not
contractual obligations, but reflect the ongoing expenses of our business.
Non-commission underwriting expenses paid were $112 million in the
first three months of 2010.
|
·
|
In
addition to contractual obligations for hardware and software, we
anticipate capitalizing approximately $20 million in spending for key
technology initiatives in 2010. Capitalized development costs related to
key technology initiatives were $5 million in the first three months
of 2010. These activities are conducted at our discretion, and we
have no material contractual obligations for activities planned as part of
these projects.
|
Investing
Activities
After
fulfilling operating requirements, we invest cash flows from underwriting,
investment and other corporate activities in fixed-maturity and equity
securities on an ongoing basis to help achieve our portfolio objectives. See
Progress Toward Long-Term Value Creation, Page 20, for a discussion of current
refinements to our investment strategies that reflect our risk management
activities. We discuss certain portfolio attributes in Item 3, Quantitative and
Qualitative Disclosures about Market Risk, Page 42.
Uses
of Capital
Uses of
cash to enhance shareholder return include dividends to shareholders. In
February 2010, the board of directors declared a regular quarterly
cash dividend of 39.5 cents per share for an indicated annual rate
of $1.58 per share. During the first three months of 2010, $63 million
was used for cash dividends to shareholders.
For the
business lines in the commercial and personal lines insurance segments, the
following tables show the breakout of gross reserves among case, IBNR and loss
expense reserves, net of salvage and subrogation reserves. Reserving practices
are discussed in our 2009 Annual Report on Form 10-K, Item 7, Property Casualty
Insurance Loss and Loss Expense Reserves, Page 38.
The
decline in total gross reserves primarily was due to lower case reserves for the
commercial casualty line of business.
39
Commercial
Lines Insurance Segment Reserves
(In
millions)
|
Loss
reserves
|
Loss
|
Total
|
|||||||||||||||||
Case
|
IBNR
|
expense
|
gross
|
Percent
|
||||||||||||||||
reserves
|
reserves
|
reserves
|
reserves
|
of
total
|
||||||||||||||||
At
March 31, 2010
|
||||||||||||||||||||
Commercial
casualty
|
$ | 1,022 | $ | 305 | $ | 528 | $ | 1,855 | 50.3 | % | ||||||||||
Commercial
property
|
96 | 14 | 31 | 141 | 3.8 | |||||||||||||||
Commercial
auto
|
263 | 46 | 65 | 374 | 10.1 | |||||||||||||||
Workers'
compensation
|
450 | 462 | 144 | 1,056 | 28.5 | |||||||||||||||
Specialty
packages
|
79 | 3 | 11 | 93 | 2.5 | |||||||||||||||
Surety
and executive risk
|
119 | 0 | 56 | 175 | 4.7 | |||||||||||||||
Machinery
and equipment
|
1 | 3 | 1 | 5 | 0.1 | |||||||||||||||
Total
|
$ | 2,030 | $ | 833 | $ | 836 | $ | 3,699 | 100.0 | % | ||||||||||
At
December 31, 2009
|
||||||||||||||||||||
Commercial
casualty
|
$ | 1,044 | $ | 309 | $ | 540 | $ | 1,893 | 50.8 | % | ||||||||||
Commercial
property
|
84 | 15 | 31 | 130 | 3.5 | |||||||||||||||
Commercial
auto
|
266 | 47 | 65 | 378 | 10.1 | |||||||||||||||
Workers'
compensation
|
452 | 458 | 143 | 1,053 | 28.3 | |||||||||||||||
Specialty
packages
|
68 | 5 | 10 | 83 | 2.2 | |||||||||||||||
Surety
and executive risk
|
128 | (2 | ) | 55 | 181 | 4.9 | ||||||||||||||
Machinery
and equipment
|
2 | 3 | 1 | 6 | 0.2 | |||||||||||||||
Total
|
$ | 2,044 | $ | 835 | $ | 845 | $ | 3,724 | 100.0 | % | ||||||||||
Personal
Lines Insurance Segment Reserves
(In
millions)
|
Loss
reserves
|
Loss
|
Total
|
|||||||||||||||||
Case
|
IBNR
|
expense
|
gross
|
Percent
|
||||||||||||||||
reserves
|
reserves
|
reserves
|
reserves
|
of
total
|
||||||||||||||||
At
March 31, 2010
|
||||||||||||||||||||
Personal
auto
|
$ | 120 | $ | (4 | ) | $ | 28 | $ | 144 | 43.0 | % | |||||||||
Homeowner
|
61 | 21 | 16 | 98 | 29.3 | |||||||||||||||
Other
personal
|
42 | 42 | 9 | 93 | 27.7 | |||||||||||||||
Total
|
$ | 223 | $ | 59 | $ | 53 | $ | 335 | 100.0 | % | ||||||||||
At
December 31, 2009
|
||||||||||||||||||||
Personal
auto
|
$ | 130 | $ | (4 | ) | $ | 28 | $ | 154 | 44.2 | % | |||||||||
Homeowner
|
56 | 26 | 17 | 99 | 28.4 | |||||||||||||||
Other
personal
|
45 | 42 | 9 | 96 | 27.4 | |||||||||||||||
Total
|
$ | 231 | $ | 64 | $ | 54 | $ | 349 | 100.0 | % | ||||||||||
Gross
life policy reserves were $1.862 billion at March 31, 2010, compared with
$1.783 billion at year-end 2009, reflecting continued growth in fixed annuities
and life insurance policies in force. We discuss our life insurance reserving
practices in our 2009 Annual Report on Form 10-K, Item 7, Life Insurance Policy
Reserves, Page 42.
Significant
Accounting Policies
Our
significant accounting policies are discussed in our 2009 Annual Report on
Form 10-K, Item 8, Note 1, Summary Of Significant Accounting Policies, Page
94, and updated in Note 1, Accounting Policies, beginning on Page
7.
In
conjunction with those discussions, in the Management’s Discussion and Analysis
in the 2009 Annual Report on Form 10-K, management reviewed the estimates
and assumptions used to develop reported amounts related to the most significant
policies. Management discussed the development and selection of those accounting
estimates with the audit committee of the board of directors.
40
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. Fair
Value Measurements and Disclosures, ASC 820-10, 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.
The fair
value measurement and disclosure 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 ASC 820-10, 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
1, Note 3, Fair Value Measurements, Page 9.
Level
1 and Level 2 Valuation Techniques
Over 99
percent of the $10.919 billion of securities in our investment portfolio
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.
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 corporate fixed-maturity securities include certain private placements,
small issues, general corporate bonds and medium-term notes.
Level 3 state, municipal and political subdivisions fixed-maturity
securities include various thinly traded municipal bonds. 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.
Pricing for securities classified as Level 3 could not be corroborated by
similar securities priced using observable inputs.
Management
ultimately determined the pricing for each Level 3 security that we considered
to be the best exit price valuation. As of March 31, 2010, total Level 3
assets were less than 1 percent of our investment portfolio measured at fair
value. Broker quotes are obtained for thinly traded securities that subsequently
fall within the Level 3 hierarchy. We have generally obtained two
non-binding quotes from brokers and, after evaluating, our investment
professionals typically selected the more conservative price for fair
value.
41
Quantitative
and Qualitative Disclosures about
Market Risk
|
Our
greatest exposure to market risk is through our investment portfolio. Market
risk is the potential for a decrease in securities value resulting from broad
yet uncontrollable forces such as: inflation, economic growth or recession,
interest rates, world political conditions or other widespread unpredictable
events. It is comprised of many individual risks that, when combined, create a
macroeconomic impact.
Our view
of potential risks and our sensitivity to such risks is discussed in our 2009
Annual Report on Form 10-K, Item 7a, Quantitative and Qualitative
Disclosures about Market Risk, Page 82.
The fair
value of our investment portfolio was $10.919 billion at March 31, 2010,
compared with $10.562 billion at year-end 2009.
(In
millions)
|
At
March 31, 2010
|
At
December 31, 2009
|
||||||||||||||||||||||||||||||
Book
value
|
%
of BV
|
Fair
value
|
%
of FV
|
Book
value
|
%
of BV
|
Fair
value
|
%
of FV
|
|||||||||||||||||||||||||
Taxable
fixed maturities
|
$ | 4,813 | 49.4 | % | $ | 5,122 | 46.9 | % | $ | 4,644 | 48.6 | % | $ | 4,863 | 46.0 | % | ||||||||||||||||
Tax-exempt
fixed maturities
|
2,842 | 29.1 | 2,959 | 27.1 | 2,870 | 30.1 | 2,992 | 28.3 | ||||||||||||||||||||||||
Common
equities
|
2,014 | 20.7 | 2,739 | 25.1 | 1,941 | 20.4 | 2,608 | 24.7 | ||||||||||||||||||||||||
Preferred
equities
|
75 | 0.8 | 99 | 0.9 | 75 | 0.8 | 93 | 0.9 | ||||||||||||||||||||||||
Short-term
investments
|
— | 0.0 | — | 0.0 | 6 | 0.1 | 6 | 0.1 | ||||||||||||||||||||||||
Total
|
$ | 9,744 | 100.0 | % | $ | 10,919 | 100.0 | % | $ | 9,536 | 100.0 | % | $ | 10,562 | 100.0 | % | ||||||||||||||||
Our
consolidated portfolio contains $38 million of assets for which values are based
on prices or valuation techniques that require management judgment (Level 3
assets). We generally 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.
As of
March 31, 2010, total Level 3 assets were less than 1 percent of investment
portfolio assets measured at fair value. See Item 1, Note 3, Fair Value
Measurements, Page 9, for additional discussion of our valuation
techniques.
In
addition, Other invested assets included $40 million of life policy loans and
liens, $26 million of venture capital fund investments and $17 million of other
assets as of March 31, 2010.
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.
In the
first quarter of 2010, the municipal bond market was flat while the corporate
bond market extended its rally, leading to a slight increase in valuations for
our bond portfolio. As of March 31, 2010, our bond portfolio was at 105.6
percent of its book value, compared with 104.5 percent at
December 31, 2009.
Credit
ratings as of March 31, 2010, compared with December 31, 2009, for the
fixed-maturity and short-term portfolios were:
(In
millions)
|
At
March 31, 2010
|
At
December 31, 2009
|
||||||||||||||||
Fair
value
|
Percent
to
total
|
Fair
value
|
Percent
to
total
|
|||||||||||||||
Moody's
Ratings and Standard & Poor's Ratings combined
|
||||||||||||||||||
Aaa,
Aa, A, AAA, AA, A
|
$ | 5,078 | 62.8 | % | $ | 4,967 | 63.2 | % | ||||||||||
Baa,
BBB
|
2,434 | 30.1 | 2,302 | 29.3 | ||||||||||||||
Ba,
BB
|
288 | 3.6 | 279 | 3.5 | ||||||||||||||
B,
B
|
45 | 0.6 | 44 | 0.6 | ||||||||||||||
Caa,
CCC
|
19 | 0.2 | 29 | 0.4 | ||||||||||||||
Ca,
CC
|
— | 0.0 | 3 | 0.0 | ||||||||||||||
Non-rated
|
217 | 2.7 | 237 | 3.0 | ||||||||||||||
Total
|
$ | 8,081 | 100.0 | % | $ | 7,861 | 100.0 | % | ||||||||||
42
Attributes
of the fixed-maturity portfolio include:
At
March 31,
|
At
December 31,
|
|||||||
2010
|
2009
|
|||||||
Weighted
average yield-to-book value
|
5.6% | 5.9% | ||||||
Weighted
average maturity
|
7.4
yrs
|
7.5
yrs
|
||||||
Effective
duration
|
5.2
yrs
|
5.3
yrs
|
||||||
We
discuss maturities of our fixed-maturity portfolio in our 2009 Annual Report on
Form 10-K, Item 8, Note 2, Investments, Page 100.
Taxable
Fixed Maturities
Our
taxable fixed-maturity portfolio (at fair value) includes:
|
·
|
$329
million in U.S. agency paper that is rated Aaa/AAA by Moody’s and Standard
& Poor’s, respectively.
|
|
·
|
$4.254
billion in investment-grade corporate bonds that have a Moody's rating at
or above Baa3 or a Standard & Poor's rating at or above
BBB-.
|
|
·
|
$305
million in high-yield corporate bonds that have a Moody's rating below
Baa3 and a Standard & Poor's rating below
BBB-.
|
|
·
|
$151
million in taxable municipal bonds that have an average rating of Aa3/AA
by Moody’s and Standard & Poor’s,
respectively.
|
|
·
|
$83
million in convertible bonds and redeemable preferred
stocks.
|
Our
strategy typically is to buy and hold fixed-maturity investments to maturity,
but we monitor credit profiles and fair value movements when determining holding
periods for individual securities.
The
largest non-financial sectors in our investment-grade corporate bond portfolio,
based on fair value at March 31, 2010, are energy and utilities,
representing 11.7 percent and 10.4 percent, respectively, compared with 11.9
percent and 10.4 percent at year-end 2009. The financial-related sectors of
banks, brokerage, finance and investment and insurance companies represented
26.6 percent of fair value of our investment-grade corporate bond portfolio at
March 31, 2010, compared with 25.3 percent at year-end 2009. We believe our
weighting in financial-related sectors is below the average for the corporate
bond market as a whole.
At
March 31, 2010, we had $2.959 billion of tax-exempt fixed-maturity
securities with an average rating of Aa3/AA by Moody’s and Standard &
Poor’s, respectively. We traditionally have purchased municipal bonds focusing
on general obligation and essential services issues, such as water, waste
disposal and others. While no single municipal issuer accounted for more than
0.7 percent of the tax-exempt municipal bond portfolio at March 31, 2010, there
are higher concentrations within individual states. Holdings in our two most
concentrated states, Texas and Indiana, together accounted for 31.2 percent
of the municipal bond portfolio at March 31, 2010, compared with 31.9 percent at
year-end 2009.
Interest
Rate Sensitivity Analysis
Because
of our strong surplus, long-term investment horizon and ability to hold most
fixed-maturity investments until maturity, we believe the company is adequately
positioned if interest rates were to rise. Although the fair values of our
existing holdings may suffer, 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. We continue to explore ways to reduce
exposure to risks related to a rise in interest rates.
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:
(In
millions)
|
Interest
Rate Shift in Basis Points
|
|||||||||||||||||||
-200
|
-100
|
0
|
100
|
200
|
||||||||||||||||
At
March 31, 2010
|
$ | 8,941 | $ | 8,506 | $ | 8,081 | $ | 7,649 | $ | 7,240 | ||||||||||
At
December 31, 2009
|
$ | 8,705 | $ | 8,279 | $ | 7,855 | $ | 7,428 | $ | 7,024 | ||||||||||
43
The
effective duration of the fixed-maturity portfolio as of March 31, 2010 was 5.2
years, compared with 5.3 years at year-end 2009. A 100 basis point
movement in interest rates would result in an approximately 5.3 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 fair
value will be to changes in the general level of interest rates, exclusive of
call features. The fair values of average- to lower-rated corporate bonds are
additionally influenced by the expansion or contraction of credit
spreads.
In our
dynamic financial planning model, the selected interest rate change of 100 to
200 basis points represents our view 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.
At March
31, 2010, we had no short-term investments compared with $6 million at
year-end 2009. Our short-term investments consisted 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.
Our
common stock investments generally are securities of companies with strong
indications of paying and growing their dividends. 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. While our long-term financial position would be affected by prolonged
changes in the market valuation of our investments, we believe our strong
surplus position and cash flow provide a cushion against short-term fluctuations
in valuation. Continued payment of cash dividends by the issuers of the common
equities we hold can provide a floor to their valuation. A $100 million
unrealized change in the value of the common stocks owned at period end would
cause a change of $65 million, or approximately 40 cents per share, in
our shareholders’ equity.
At March
31, 2010, two holdings had a fair value equal to or greater than 5 percent of
our publicly-traded common stock portfolio compared with two holdings meeting
that criteria at year-end 2009. Procter & Gamble is our largest single
common stock investment, comprising 5.7 percent of the publicly traded common
stock portfolio and 1.4 percent of the investment portfolio. The
second common stock with a fair value greater than 5 percent of our
publicly-traded common stock portfolio is Pepsico (NYSE:PEP), comprising
5.1 percent of the publicly traded common stock portfolio and
1.2 percent of the investment portfolio.
Common
Stock Portfolio Industry Sector Distribution
Percent
of Publicly Traded Common Stock Portfolio
|
||||||||||||||||
At
March 31, 2010
|
At
December 31, 2009
|
|||||||||||||||
Cincinnati
Financial
|
S&P
500 Industry
Weightings
|
Cincinnati
Financial
|
S&P
500 Industry
Weightings
|
|||||||||||||
Sector:
|
||||||||||||||||
Healthcare
|
16.9 | % | 12.1 | % | 18.0 | % | 12.6 | % | ||||||||
Consumer
staples
|
16.2 | 11.3 | 15.5 | 11.4 | ||||||||||||
Financial
|
11.9 | 16.5 | 10.2 | 14.4 | ||||||||||||
Energy
|
10.9 | 10.9 | 11.0 | 11.5 | ||||||||||||
Information
technology
|
10.6 | 18.9 | 11.0 | 19.8 | ||||||||||||
Industrials
|
9.8 | 10.5 | 9.2 | 10.2 | ||||||||||||
Consumer
discretionary
|
9.2 | 10.1 | 9.6 | 9.6 | ||||||||||||
Utilities
|
6.0 | 3.4 | 6.7 | 3.7 | ||||||||||||
Materials
|
5.3 | 3.5 | 5.1 | 3.6 | ||||||||||||
Telecomm
services
|
3.2 | 2.8 | 3.7 | 3.2 | ||||||||||||
Total
|
100.0 | % | 100.0 | % | 100.0 | % | 100.0 | % | ||||||||
44
Unrealized
Investment Gains and Losses
At March
31, 2010, unrealized investment gains before taxes for the consolidated
investment portfolio totaled $1.220 billion and unrealized investment losses
amounted to $45 million.
Unrealized
Investment Gains
The
unrealized investment gains at March 31, 2010, largely were due to a long-term
net gain position of $725 million for our common stock portfolio.
Contributing 10 percent or more of that net gain position were two publicly
traded holdings totaling $225 million in gains: Procter & Gamble and Exxon
Mobil.
Unrealized
Investment Losses
We expect
the number of securities trading below 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 are revised through
impairment charges recognized in prior periods.
During
the first quarter of 2010, two fixed-maturity securities were written down
as other-than-temporarily impaired, resulting in a pretax, non-cash charge of $1
million. During the same period of 2009, we impaired 29 securities
resulting in a $50 million other-than-temporary impairment charge.
At March
31, 2010, 254 of the 2,534 securities we owned were trading below book value
compared with 355 of the 2,505 securities we owned at year-end 2009.
The 254 holdings trading below book value at March 31, 2010,
represented 9.3 percent of fair value of invested assets and $45 million in
unrealized losses.
|
·
|
243
of these holdings were trading between 90 percent and 100 percent of book
value. The value of these securities fluctuates primarily because of
changes in interest rates. 16 of these are equity securities that may be
subject to other-than-temporary impairment should they not recover by the
recovery date we determined. The remainder of the 243 securities primarily
consists of fixed-maturity securities whose current valuation is largely
the result of interest rate factors. The fair value of these
243 securities was $887 million at March 31, 2010, and they accounted
for $27 million in unrealized
losses.
|
|
·
|
Ten
of these holdings were trading between 70 percent and 90 percent of book
value at March 31, 2010. Three of these securities are equity
securities that may be subject to other-than-temporary impairment should
they not recover by the recovery date we determined. The remaining seven
are fixed-maturity securities that we believe will continue to pay
interest and ultimately principal upon maturity. The fair value of these
10 securities was $139 million, and they accounted for $18 million in
unrealized losses.
|
|
·
|
One
of these holdings was trading below 70 percent of book value at March 31,
2010. It is a fixed-maturity security that we believe will continue to pay
interest and ultimately principal upon maturity. The fair value and the
book value of this holding was $1
million.
|
The table
below reviews fair values and unrealized losses by investment category and by
the overall duration of the securities’ continuous unrealized loss
position.
(In
millions)
|
Less
than 12 months
|
12
months or more
|
Total
|
||||||||||||||||||||||
At
March 31,
|
Fair
value
|
Unrealized
losses
|
Fair
value
|
Unrealized
losses
|
Fair
value
|
Unrealized
losses
|
|||||||||||||||||||
2010
|
|||||||||||||||||||||||||
Fixed
maturities:
|
|||||||||||||||||||||||||
States,
municipalities and political subdivisions
|
$ | 153 | $ | 2 | $ | 30 | $ | 2 | $ | 183 | $ | 4 | |||||||||||||
Government-sponsored
enterprises
|
61 | — | 2 | — | 63 | — | |||||||||||||||||||
Corporate
bonds
|
316 | 8 | 161 | 8 | 477 | 16 | |||||||||||||||||||
Total
|
530 | 10 | 193 | 10 | 723 | 20 | |||||||||||||||||||
Equity
securities
|
78 | 3 | 226 | 22 | 304 | 25 | |||||||||||||||||||
Total
|
$ | 608 | $ | 13 | $ | 419 | $ | 32 | $ | 1,027 | $ | 45 | |||||||||||||
At
December 31,
|
|||||||||||||||||||||||||
2009
|
|||||||||||||||||||||||||
Fixed
maturities:
|
|||||||||||||||||||||||||
States,
municipalities and political subdivisions
|
$ | 196 | $ | 4 | $ | 29 | $ | 2 | $ | 225 | $ | 6 | |||||||||||||
Government-sponsored
enterprises
|
347 | 7 | — | — | 347 | 7 | |||||||||||||||||||
Short-term
investments
|
1 | — | — | — | 1 | — | |||||||||||||||||||
Collateralized
mortgage obligations
|
— | — | 27 | 6 | 27 | 6 | |||||||||||||||||||
Corporate
bonds
|
397 | 19 | 309 | 17 | 706 | 36 | |||||||||||||||||||
Total
|
941 | 30 | 365 | 25 | 1,306 | 55 | |||||||||||||||||||
Equity
securities
|
65 | 3 | 415 | 26 | 480 | 29 | |||||||||||||||||||
Total
|
$ | 1,006 | $ | 33 | $ | 780 | $ | 51 | $ | 1,786 | $ | 84 | |||||||||||||
At March
31, 2010, 69 fixed-maturity securities with a total unrealized loss of $10
million had been in an unrealized loss position for 12 months or more. Of that
total, one fixed-maturity security with a fair value of
45
$1 million
was trading under 70 percent of book value and accounted for $1 million in
unrealized losses; six fixed-maturity securities with a fair value of $28
million were trading from 70 percent to less than 90 percent of book value
and accounted for $5 million in unrealized losses; and 62 fixed-maturity
securities with a fair value of $164 million were trading from 90 percent to
less than 100 percent of book value and accounted for $4 million in
unrealized losses.
At March
31, 2010, 8 equity securities with a total unrealized loss of $22 million
had been in an unrealized loss position for 12 months or more. Of that total,
none were trading under 70 percent of book value; three equity securities with a
fair value of $108 million were trading from 70 percent to less than 90 percent
of book value and accounted for $12 million in unrealized losses; and five
equity securities with a fair value of $118 million were trading from 90
percent to less than 100 percent of book value and accounted for
$10 million in unrealized losses.
As of
March 31, 2010, applying our invested asset impairment policy, we determined
that the $45 million in unrealized losses described above were not
other-than-temporarily impaired.
During
2009, we impaired 50 securities. At December 31, 2009, 121 fixed-maturity
investments with a total unrealized loss of $25 million had been in an
unrealized loss position for 12 months or more. Of that total, eight
fixed-maturity investments were trading below 70 percent of book value with a
total unrealized loss of $2 million. Ten equity investments with a total
unrealized loss of $26 million had been in an unrealized loss position for 12
months or more as of December 31, 2009. Of that total, no equity investments
were trading below 70 percent of book value.
46
The
following table summarizes the investment portfolio by severity of
decline:
(In
millions)
|
Number
of
issues
|
Book
value
|
Fair
value
|
Gross
unrealized
gain/loss
|
Gross
investment
income
|
|||||||||||||||
At
March 31, 2010
|
||||||||||||||||||||
Taxable
fixed maturities:
|
||||||||||||||||||||
Fair
value below 70% of book value
|
1 | $ | 1 | $ | 1 | $ | — | $ | — | |||||||||||
Fair
value at 70% to less than 100% of book value
|
168 | 619 | 602 | (17 | ) | 8 | ||||||||||||||
Fair
value at 100% and above book value
|
974 | 4,193 | 4,519 | 326 | 67 | |||||||||||||||
Securities
sold in current year
|
— | — | — | — | 2 | |||||||||||||||
Total
|
1,143 | 4,813 | 5,122 | 309 | 77 | |||||||||||||||
Tax-exempt
fixed maturities:
|
||||||||||||||||||||
Fair
value below 70% of book value
|
— | — | — | — | — | |||||||||||||||
Fair
value at 70% to less than 100% of book value
|
66 | 123 | 120 | (3 | ) | 1 | ||||||||||||||
Fair
value at 100% and above book value
|
1,229 | 2,719 | 2,839 | 120 | 30 | |||||||||||||||
Securities
sold in current year
|
— | — | — | — | — | |||||||||||||||
Total
|
1,295 | 2,842 | 2,959 | 117 | 31 | |||||||||||||||
Common
equities:
|
||||||||||||||||||||
Fair
value below 70% of book value
|
— | — | — | — | — | |||||||||||||||
Fair
value at 70% to less than 100% of book value
|
15 | 300 | 277 | (23 | ) | 3 | ||||||||||||||
Fair
value at 100% and above book value
|
57 | 1,714 | 2,462 | 748 | 19 | |||||||||||||||
Securities
sold in current year
|
— | — | — | — | — | |||||||||||||||
Total
|
72 | 2,014 | 2,739 | 725 | 22 | |||||||||||||||
Preferred
equities:
|
||||||||||||||||||||
Fair
value below 70% of book value
|
— | — | — | — | — | |||||||||||||||
Fair
value at 70% to less than 100% of book value
|
4 | 29 | 27 | (2 | ) | — | ||||||||||||||
Fair
value at 100% and above book value
|
20 | 46 | 72 | 26 | 1 | |||||||||||||||
Securities
sold in current year
|
— | — | — | — | — | |||||||||||||||
Total
|
24 | 75 | 99 | 24 | 1 | |||||||||||||||
Short-term
investments:
|
||||||||||||||||||||
Fair
value below 70% of book value
|
— | — | — | — | — | |||||||||||||||
Fair
value at 70% to less than 100% of book value
|
— | — | — | — | — | |||||||||||||||
Fair
value at 100% and above book value
|
— | — | — | — | — | |||||||||||||||
Securities
sold in current year
|
— | — | — | — | — | |||||||||||||||
Total
|
— | — | — | — | — | |||||||||||||||
Portfolio
summary:
|
||||||||||||||||||||
Fair
value below 70% of book value
|
1 | 1 | 1 | — | — | |||||||||||||||
Fair
value at 70% to less than 100% of book value
|
253 | 1,071 | 1,026 | (45 | ) | 12 | ||||||||||||||
Fair
value at 100% and above book value
|
2,280 | 8,672 | 9,892 | 1,220 | 117 | |||||||||||||||
Investment
income on securities sold in current year
|
— | — | — | — | 2 | |||||||||||||||
Total
|
2,534 | $ | 9,744 | $ | 10,919 | $ | 1,175 | $ | 131 | |||||||||||
At
December 31, 2009
|
||||||||||||||||||||
Portfolio
summary:
|
||||||||||||||||||||
Fair
value below 70% of book value
|
9 | $ | 8 | $ | 5 | $ | (3 | ) | $ | 1 | ||||||||||
Fair
value at 70% to less than 100% of book value
|
346 | 1,862 | 1,781 | (81 | ) | 79 | ||||||||||||||
Fair
value at 100% and above book value
|
2,150 | 7,666 | 8,776 | 1,110 | 391 | |||||||||||||||
Investment
income on securities sold in current year
|
— | — | — | — | 31 | |||||||||||||||
Total
|
2,505 | $ | 9,536 | $ | 10,562 | $ | 1,026 | $ | 502 | |||||||||||
See our
2009 Annual Report on Form 10-K, Item 7, Critical Accounting Estimates, Asset
Impairment, Page 42.
47
Item
4.
|
Controls
and Procedures
|
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
March 31, 2010. 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
information required to be disclosed in the company’s reports under the
Exchange Act is recorded, processed, summarized and reported within the
time periods specified in the Securities and Exchange Commission’s rules
and forms, and
|
·
|
that
such information is accumulated and communicated to the company’s
management, including its chief executive officer and chief financial
officer, as appropriate, to allow timely decisions regarding required
disclosures.
|
Changes
in Internal Control over Financial Reporting – During the three months ended
March 31, 2010, 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.
Part
II – Other Information
Item
1.
|
Legal
Proceedings
|
Neither
the company nor any of our subsidiaries is involved in any litigation believed
to be material other than ordinary, routine litigation incidental to the nature
of its business.
Item
1A.
|
Risk
Factors
|
Our risk
factors have not changed materially since they were described in our 2009 Annual
Report on Form 10-K filed February 26, 2010.
Unregistered
Sales of Equity Securities and Use of
Proceeds
|
We did
not sell any of our shares that were not registered under the Securities Act
during the first three months of 2010. The board of directors has authorized
share repurchases since 1996. We discuss the board authorization in our 2009
Annual Report on Form 10-K, Item 7, Liquidity and Capital Resources, Parent
Company Liquidity, Page 68. The board gives management discretion to purchase
shares at reasonable prices in light of circumstances at the time of purchase,
subject to SEC regulations.
Period |
Total
number
of
shares
purchased
|
Average
price
paid
per
share
|
Total
number of shares
purchased
as part of
publicly
announced
plans
or programs
|
Maximum
number of
shares
that may yet be
purchased
under the
plans
or programs
|
||||||||||||
January
1-31, 2010
|
0 | $ | 0.00 |
0
|
9,044,097 | |||||||||||
February
1-28, 2010
|
0 | 0.00 | 0 | 9,044,097 | ||||||||||||
March
1-31, 2010
|
0 | 0.00 | 0 | 9,044,097 | ||||||||||||
Totals
|
0 | 0.00 | 0 | |||||||||||||
On
October 24, 2007, the board of directors expanded the existing repurchase
authorization to approximately 13 million shares. 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. Neither the 2005 nor 1999 program had an
expiration date, but no further repurchases will occur under the 1999
program.
48
Item
3.
|
Defaults
upon Senior Securities
|
We have
not defaulted on any interest or principal payment, and no arrearage in the
payment of dividends has occurred.
Item
4.
|
(Removed
and Reserved)
|
Item
5.
|
Other
Information
|
None.
Item
6.
|
Exhibits
|
Exhibit
No.
|
Exhibit
Description
|
3.1A
|
Amended
Articles of Incorporation of Cincinnati Financial Corporation
(incorporated by reference to the company’s 1999 Annual Report on Form
10-K dated March 23, 2000) (File No. 000-04604)
|
3.1B
|
Amendment
to Article Fourth of Amended Articles of Incorporation of Cincinnati
Financial Corporation (incorporated by reference to Exhibit 3(i) filed
with the company’s Current Report on Form 8-K dated
July 15, 2005)
|
3.2
|
Regulations
of Cincinnati Financial Corporation (incorporated by reference to the
company’s Definitive Proxy Statement dated March 2, 1992, Exhibit 2) (File
No. 000-04604)
|
11
|
Statement
re: Computation of per share earnings for the three months ended
March 31, 2010, contained in Exhibit 11 of this
report, Page 51
|
31A
|
Certification
pursuant to Section 302 of the Sarbanes Oxley Act of 2002 –
Chief Executive Officer
|
31B
|
Certification
pursuant to Section 302 of the Sarbanes Oxley Act of 2002 –
Chief Financial Officer
|
32
|
Certification
pursuant to Section 906 of the Sarbanes Oxley Act of
2002
|
49
Pursuant
to the requirements 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.
CINCINNATI
FINANCIAL CORPORATION
Date:
April 28, 2010
/S/ Eric
N. Mathews
Eric N.
Mathews, CPCU, AIAF
Vice
President, Assistant Secretary and Assistant Treasurer
(Principal
Accounting Officer)
50