Cincinnati Financial Corporation (CINF) Q4 2013 Earnings Report, Transcript and Summary

Good morning, my name is Denise, and I’ll be your conference operator today. At this time, I would like to welcome everyone to the fourth quarter 2013 financial results conference call. All lines have been placed on mute to prevent any background noise. After the speakers’ remarks, there will be a question and answer session. (Operator instructions) Thank you. Dennis McDaniel, Investor Relations Officer, you may begin your conference.

Good morning everyone, this is Dennis McDaniel, and we thank you for joining us for our fourth quarter and full year 2013 earnings conference call. Late yesterday we issued a news release on our results, along with our supplemental financial package, including our quarter-end investment portfolio. To find copies of any of these documents please visit our Investor website, cinfin.com/investors. The shortest route to the information is the quarterly results link in the navigation menu on the far left. On this call you will first hear from Steve Johnston, President and Chief Executive Officer and then from Chief Financial Officer, Mike Sewell. After their prepared remarks, investors participating on the call may ask questions. At that time some responses may be made by others in the room with us, including Executive Committee Chairman Jack Schiff, Jr., Chairman of the Board Ken Stecher, Chief Insurance Officer J.F. Scherer, Principal Accounting Officer Eric Matthews, Chief Investment Officer Marty Hollenbeck and Chief Claims Officer Marty Mullen. First please note that some of the matters to be discussed today are forward-looking. These forward-looking statements involve certain risks and uncertainties. With respect to these risks and uncertainties we direct your attention to our news release and to our various filings with the SEC. Also a reconciliation of non-GAAP measures was provided with the news release. Statutory accounting data is prepared in accordance with statutory accounting rules and therefore is not reconciled to GAAP. With that, I’ll turn the call over to Steve.

Thank you, Dennis, and good morning. Like last year, I am speaking with you today from Queens Borough [ph], Tennessee, the fourth stop on our 22-state tour of sales meeting with our independent agents. Our senior leadership team goes out in visitations in the first half of each year, and it’s always an energizing experience for us. We enjoy the chance to thank our agents in person for contributing to another year of underwriting profit and strong premium growth and for trusting Cincinnati Insurance to serve the people and businesses in their communities. We are pleased to report solid fourth quarter and full year of 2013 operating results. As we consider our progress in building value for shareholders, we favor a long-term approach and manage our business accordingly. Our ongoing initiatives intended to improve insurance profitability and drive premium growth lead to an improved operating result for the full year 2013. More favorable weather also contributed to our 2013 operating results. I’d like to mention however, that we already know weather will affect our first quarter 2014 results. Two winter storm events between January 3 and January 8 cost an estimated $65 million to $85 million in catastrophe losses for our property casualty segments. Most of our losses are from water damage related to frozen pipes that burst. It’s too early for us to provide a meaningful estimate of losses from severe weather that occurred later in January. While weather can always affect our financial results, we believe execution of our strategic initiatives continue to provide benefits over time. Our fourth quarter and full year combined ratios were below 94% within the 795% [ph] range we aim for. On an as per year basis for [ph] catastrophe losses, 2013 improved 4.3 points compared with 2012. We plan to improve our…

Great. Thank you, Steve. And thanks to all of you for joining us today. As Steve noted, our performance for 2013 was strong. The 16.1% value creation ratio exceeded the 10% to 13% annual average we are targeting for 2013 through 2017. 2013 provided another example of the benefit of our equity investing strategy and in addition to a strong contribution to book value from appreciation and our stock portfolio evaluation rising dividend income offset lower interest income that was pressured by the low interest rate environment. Our stock portfolio’s pretax net unrealized gains reaching nearly $1.9 billion at year end, up 85% for the year and 23% for the quarter. Dividend income grew 6% for the year and 3% for the fourth quarter. Our bottom portfolio’s pretax unrealized gains were at $481 million at year end, down $390 million for the year and $55 million for the quarter. Yields for our bond portfolio continue to move lower but at a slower pace as its fourth quarter 2013 pretax yield of 4.84% was 17 basis points lower than the year ago. For the third quarter of 2013, that decline was 19 basis points. Taxable bonds representing about 70% of our bond portfolio had a fourth quarter and 2013 pretax yield of approximately 5.33%. The average yield for new taxable bonds purchased during the quarter was approximately 4.61%. For the same period, our tax exempt bond portfolio yield was approximately 3.9% and purchases during the quarter yielded approximately 3.2%. Our bond portfolio’s effective duration measured 4.6 years at year end 2013, up from 4.2 years, one year ago. Cash flow from operating activities continues to benefit investment income. At $787 million for the full year 2013, net bring [ph] cash flow exceeded the same period a year ago by $149 million…

Thanks, Mike. Some of you may have noticed through recent news releases about new people joining our Cincinnati family. In November, our Board welcomed David Osborn, a new independent director whose investment firm focuses like us on dividend growth strategies. And just last week, we welcomed Will Van Den Heuvel to the Cincinnati team as our new Senior Vice President responsible for personal lines. Will brings an excellent track record of leadership experience in the personalized marketplace and improving commitment to the success of independent insurance agencies. We see both of those additions as investments who will bring shareholders a good return overtime. Just as important, in 2013 we reduced our underwriting expense ratio while investing in talented associates with total staff growing 2.6% or just over 100 in that positions. We know that our field force is the strong differentiator from competitors. On a percentage basis, field positions increased at a slightly higher rate than headquarters positions. Our agency customers appreciate the loss control and claims expertise we are placing in their communities. At headquarters, we continue to invest in positions to support our pricing and data analytics improvements. We think we’ve just scratched the surface of the benefit we’ll see from our 2013 improvements and we have the people, products and processes in place to keep it executing on our plans in 2014. We appreciate this opportunity to respond to your questions and also look forward to meeting in person with many of you throughout this year. As a reminder, with Mike and me today are Jack Schiff Jr., Ken Stecher, J.F. Scherer, Eric Matthews, Marty Mullen and Marty Hollenback. Denise, we’re ready for you to open the call for questions.

(Operator Instructions) Okay, your first question comes from Mike Zaremski from Credit Suisse. Your line is open. Mike Zaremski – Credit Suisse: Hi, thanks for taking my questions.

Good morning Mike. Mike Zaremski – Credit Suisse: Good morning. First question, so you guys specifically mentioned in the press release too about ramping up inspections next year and you guys are investing in people and technology clearly. Should we expect then some impact the expense ratio as those kind of work through and I guess obviously, hopefully they help the loss ratio, what were you thinking about expenses with – given those initiatives?

Yes. Thanks Mike, this is Mike Sewell. As it’s related to that, my goal is still to work the expense ratio down closer to a 30 expense ratio. But with one of the investments that we’ve been making has contributing in a lot to the loss expense ratio if you’ve seen that going down. We have been increasing some of our headcount in strategic areas for growing premiums, also the loss control. But what we’re also doing is we’re making sure that that increase in investment is lower than the increase in premiums that we’re bringing on. So we were able to reduce the expense ratio by 0.3 points this year but in total we’re still spending more money and investing it where we believe we need to. And the results you’re seeing on the loss expense side.

Mike, this is J.F. Scherer. One thing I might add for example in personal lines, in the inspections, what those inspections are revealing has paid for about 60% of the cost of the inspections themselves. In other words, we find things that where we immediately increased the premium, things like stoves that people have in houses that we have searched our agents for in bright of other things [ph]. So as Mike said, the real focus is to improve the loss ratio of all these initiatives but we are finding an opportunity actually to increase premium by what we discover. Mike Zaremski – Credit Suisse: Okay, that’s helpful. Next, on reserves. So I appreciate all the great color you guys gave on the call and you guys give in the release. And if I’m thinking – if we’re thinking more high level, I mean, is – are you seeing loss cost inflation pick-up versus prior – couple years trends given maybe the pick-up in the economy or you guys moving into other territories and what not?

.: Mike Zaremski – Credit Suisse: And would you say workers’ comp is below historical trend still?

Yes, that’s a fear assessment. Mike Zaremski – Credit Suisse: Okay. Thanks, guys.

Thank you, Mike.

Your next question comes from Ian Gutterman with Balyasny Asset Management. You’re line is open. Ian Gutterman – Balyasny Asset Management: Hi. Good morning guys. Thank you. I guess first, any more color you can give on the January cat events? Just – isn’t – a couple other people have said similar things, I was trying to get a little bit better understanding why pipe storms are causing what seems like – almost like Q2 cat loads rather than Q1 cat loads?

Hi, Ian. This is Marty Mullen. The January – the second cat load [ph] of January was the main event for us from January 5 to the 8, different type of storm, the claims are split up about 50-50 commercial and personal line. But for us the spreads in losses [ph] and losses were about 70% commercial. So it’s three – for us it’s about three or four state event but as you know the cat involved 17-stage. And I think that’s why you’re seeing the type of disclosure you’re seeing because of such a widespread event and it’s four days. But for us about 95% of the losses are already late into freezing [ph]. And Ohio is our biggest state with 35% of the claim count. Ian Gutterman – Balyasny Asset Management: Very helpful, thank you. The other area of claim that I think was mentioned in the release was auto claims inflation. Can you just – again, you’re not the only company that mentioned that this quarter. But are you seeing a tick up in BI trends? And any additional color you can give on that?

This is Steve again. And I think in that particular line there would be a little bit of an uptake. I think severity in particular. But I don’t think it’s anything that’s unreasonable or within our ability or outside of our ability to address with rate pricing precision, segmentation, and continuing to work our initiatives in terms of keeping those loss cost under control from the loss control side. Ian Gutterman – Balyasny Asset Management: Okay. So that didn’t have any impact on the new business there that you pulled back your appetite when you saw that loss trend or anything like that?

No. I think our appetites remained consistent, long-term focused and we feel – we feel very good about the business. Ian Gutterman – Balyasny Asset Management: Okay. And was that increase in trend kind of across the country or across types of drivers or was it concentrated in any area?

We didn’t see it concentrated in any particular area. No. Ian Gutterman – Balyasny Asset Management: Okay, great. Repurchase, you bought back some stock for the first time in a while, I was just curious if that’s something we should expect to continue or if this was maybe a one-time thing for option dilution or something like that?

Hi, Ian. It’s Mike here. We do it from time to time. The last time we did buyback a little over 1 million shares in 2011 with the stock price being up, folks exercise its stock [ph] options. We really thought it was prudent to do a maintenance type of activity on that to at least keep the share relatively flat. So we did the win and do the 1 million shares to average cost that you heard earlier. So I think if we look out into the future I think we’re going to be watching share count. And with the growth, we’ll do maintenance when we need to do the maintenance. But at the same time we’re using our capital. As I mentioned that the Board increased the dividend 4.8%. So setting that up for the 54th consecutive year, there’s various ways we use our capital and including investing in the business to growth premiums and reduce the losses. There’s a combination of areas that we use our capital and that was one to – really I view it as a maintenance type matter. Ian Gutterman – Balyasny Asset Management: Great. And then just maybe lastly, any thoughts on the equity portfolio? Obviously the market was great last year. It’s pulling out this year. Have there been any sort of thoughts of reallocating either among sectors or just overall exposure, something to get more defensive or is it pretty much steady as she goes?

Any authority [ph], how was it? Not really. We’re – again, we’re long-term investors. The income off of [ph] the portfolio, the tax preferred status of the dividend is well account just as much really as price fluctuations. We’re pretty contempt with where we’re at below 30s as the percentage of the overall portfolio. We look at a number of different ways. So we’re not going to undergo any significant reallocation of invested asset at this point. Ian Gutterman – Balyasny Asset Management: Great. Okay, I think that answers it actually. Thank you so much.

Thank you, Ian.

Your next question comes from Vincent DeAugustino from KBW. Your line is open. Vincent DeAugustino – Keefe Bruyette & Woods Inc.: Hi, and good morning everyone.

Good morning. How are you, Vincent? Vincent DeAugustino – Keefe Bruyette & Woods Inc.: Doing well. Steve, you’ve mentioned your bringing Will on, and I’m just kind of curious given his experience at Chubb and AIG before, kind of in conjunction with something if I’m recalling correctly, you discussed with some agents earlier in 2013. That was about Cincinnati’s homeowner business, being kind of maybe positioned as a Chubb-like product. And I was just wondering if you might be able to provide an update kind of on that initiative. And then wonder – if, say, Will’s addition has anything to do with that strategy?

This is – this is J.F. Just by way of comment, as a company, about 20% of what we currently write would be in the, I guess you might call it the more affluent personal lines area. But clearly bringing Will on in addition to his background, this is a great personal lines executive across the Board. What we all want to do is to fortify what we’re doing, expand what we’re doing in a more affluent marketplace. We’re not talking about going in to the ultra-affluent. I guess the way I would describe it would be more as it is describing the industry as a massive loss which by definition I guess we’d say coverage A homeowner limits of about $500,000 or $1 million up to the $4 million, $5 million, $6 million or $7 million range. Clearly, Will’s experience throughout his career allows him to bring a tremendous amount of expertise in that area. Our agencies write a lot of that business. And so we think that just by fine-tuning the product, adding more expertise at the underwriting level, more expertise and our ability to write schedules, loads, jewelry that types of things that go with the affluent marketplace, it’s going to open the door I think to a lot of opportunities for us. Vincent DeAugustino – Keefe Bruyette & Woods Inc.: Okay. That color is pretty helpful. And just one other question, and, J.F., I guess, it’s probably best for you, I’m just curious if you’ve noticed any demand for the three-year policies declining recently?

What we’re seeing and as Steve mentioned we’re seeing a steady renewal increases in our commercial line’s book of business in the fourth quarter. And we’re getting larger increases on the classes of business with the policies that are at least adequately priced. Anecdotally, what I would tell you is that we’re driving higher rate obviously on the more quarterly [ph] priced accounts that we have. And we have seen less of a take-up on the three-year policy because we’re very aggressive about what we would want on those policies. It works to renew them on a three-year basis, which we view as a good thing. In other words if the policy holder stays with this obviously as an account we want to keep, we did a good one-year increase, we’re going to get another of that less adequately priced policy next year and the year after. The good thing is that on the most adequately priced policies, the uptake for the three-year policy remains excellent. It continues to be and where it’s being reinforced all three days this week when we write our sales meetings, buyer agencies and it’s a tremendous advantage for us. Vincent DeAugustino – Keefe Bruyette & Woods Inc.: Good. Good. Thank you very much.

Your next question comes from Mark Dwelle with RBC Capital Market. Your line is open. Mark Dwelle – RBC Capital Markets LLC: Yes, good morning, a couple of questions. Mike, I think you write off the percentage of the product period development that related to some of the different accident years. Was that for the quarter or for the full-year to date?

That was for the – that was for the full-year. Mark Dwelle – RBC Capital Markets LLC: Okay. I guess in hearing those figures, it strikes me as that sort of short-tail loaded which is to say the – is that because the older accident years there’s a mix of adverse as well as favorable, it’s bringing that older accident year percentage down so low, I might think of kind of three to four-year tail on a lot of your business.

Yes. No, that’s fair to say. There was a little less in those older accident years. And we did notice that in workers’ comp going back a few years, there was some payments that we made in the current year and we just thought it was prudent to be very careful with those years. We added a little bit to those order accident years. And so that’s what resulted in the lower percentile for the order accident years that I quoted. Mark Dwelle – RBC Capital Markets LLC: Okay. Then I – somebody commented, I can’t remember who, about the new business being lower in the fourth quarter as compared to other quarters in the year. Why would that be the case? I mean I guess the anecdotal thought is always that sales people are hungry to get their quotas in the fourth quarter to drive more new business rather than last. Have you guys just all hit your targets earlier in the year, I don’t know?

Yes. I think – this is Steve, Mark. And I think we had some variability but I do think that there’s more economic activity going on generally in the second and third quarter in our operating territories were constructions going on, the weather is warmer, and more times than not, the fourth quarter is not the largest quarter for new business. 2012 was an outlier, it was just a great quarter but that’s normally not the case. And I think it’s probably driven by the economic activity in our areas. Mark Dwelle – RBC Capital Markets LLC: Okay. And I just wanted to clarify when you – the splits that you gave on the early winter storm activity, that was 70% commercial, 30% personal, that was – that’s what you’re seeing so far?

In law – in law [ph], that’s correct. Mark Dwelle – RBC Capital Markets LLC: Okay. That’s all my questions. Thank you.

Thank you, Mark.

(Operator instructions) Your next question comes from Paul Newsome with Sandler O’Neill. Your line is open. Paul Newsome – Sandler O’Neill: Good morning.

Good morning, Paul. Paul Newsome – Sandler O’Neill: Hey, I just wanted to ask about any reactions you’ve seeing or have to the travelers’ core in [ph] product and just generally the idea that personal lines, auto in particular but maybe even home are going to increasingly go towards lower commission sort of better customer cost.

Paul, this is J. F. Of course we’re out with the agents this week they haven’t come up. We’re not getting any feedback at all on it. Paul Newsome – Sandler O’Neill: So steady as she goes, I guess. That all just – that’s all I want to ask. Thanks guys.

Yes. At least as far as our strategy, our agents, what we are talking to them about in personal lines, we’re just not getting much feedback. We’ve been encouraged by the response we’ve gotten in personal lines over the last year. I guess by way of a little commentary and Steve mentioned in his remarks that new business in personal lines tailed off a bit for us towards the end of the year. And we have a real tough comparison in the first quarter. But that’s almost by this final [ph] assessment we’ve got two rate increases on homeowners that are earning its way through the book plus we strengthen our underwriting stance on agent for us [ph], deductible things of that nature. So I think our agency is once again, relative to how they approach personal lines with us, they do use comparative writers. They’re not enamored by the commoditization of personal lines. However they do rights in business that would be in that category. I mean, it’s clear from the reaction to Will tend to both the [ph] sales meetings that they’re very introduced about the fact that we’re going to fortify our activity in the higher valued homeowner – higher valued client arena where there is more profitability from an underwriting standpoint and more profitability at the agency level to write that kind of business. And it’s the marquee accounts. It’s the significant policy holders in the community. So I guess maybe we’d be a bad carrier to canvass for opinions on other company’s approaches from that standpoint. But I can say that the reaction to what we’re doing has been pretty good.

And I’d had Paul, that our strategy, you know as well as an agency strategy and what we’re doing now in personal lines with some of these higher valued homes is very consistent with what we’ve done over time in trying to provide every type of product that our agencies need to be successful. If you look back to access a surplus lines, it would have been an example, target markets and other example. And now what we’re doing in personal lines is very consistent with our agent aware in [ph] strategy. Paul Newsome – Sandler O’Neill: That’s great. Thanks guys. I appreciate it.

Thanks, Paul.

Okay. There are no further questions [indiscernible], I’m going to turn the call back over to Steve Johnston.

Thank you, Denise. And thanks everybody for joining us today. We appreciate your interest in Cincinnati Financial Corporation. And look forward to speaking with you again on our first quarter call.

Okay. That concludes today’s conference call. You may now disconnect.