Cincinnati Financial Corporation (CINF) Q3 2015 Earnings Report, Transcript and Summary

Good morning, my name is Nick and I will be your conference operator today. At this time I would like to welcome everyone to the Third Quarter 2015 Earnings Conference Call. [Operator Instructions]. Thank you. Dennis McDaniel, Investor Relations Officer, you may begin your conference.

Hello, this is Dennis McDaniel at Cincinnati Financial. Thank you for joining us for our third quarter 2015 earnings conference call. Late yesterday we issued a news release about 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 Investors website, cinfin.com/investors. The shortest route to the information is a quarterly results link in the navigation menu on the far left. On this call you will first hear from Steve Johnston, Pres. 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 the Cincinnati Insurance Company's Executive Committee Chairman, Jack Schiff, Jr.; Chairman of the Board, Ken Stecher; Chief Insurance Officer for Cincinnati Insurance, J.F. Scherer; Principal Accounting Officer, Eric Matthews; Chief Investment Officer, Marty Hollenbeck; and Chief Claims Officer for Cincinnati Insurance, 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 those 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. Now I will turn the call over to Steve.

Thank you, Dennis. Good morning and thank you for joining us today to hear more about our third quarter results. Overall it was another strong quarter. Our results reflect well on our strategy and on the efforts of our associates and independent agents. We continue to see ongoing benefits from executing on the fundamentals while enhancing performance through various initiatives. Together our underwriting programs and investment philosophy translated into substantial underwriting profit and the ninth consecutive quarter in our streak of investment income growth. Disciplined underwriting and pricing on each policy was slightly offset by less favorable weather-related catastrophe of facts than in the third quarter of last year. In total we achieved a third quarter 2015 consolidated property casualty combined ratio of 87.8%. Our nine-month 2015 combined ratio before catastrophe effects was also 87.8%, improving that ratio from both full-year 2014 and 2013. Each of our major lines of business have performed well so far this year except for commercial auto and personal auto. We continue to take action through better pricing precision and other initiatives for improved performance over time for our auto business. In late 2011 we established a long-term target of profitably reaching $5 billion in direct written premiums by the end of 2015. While it looks like we won't quite reach that level this year, we have often emphasized that we seek to grow only where we believe we can do so profitably. I am pleased with our overall underwriting profitability so far this year and won't be disappointed if we don't write $5 billion in premium until 2016. Over the past five years or so our premium growth has approximately doubled the U.S. P&C industry. We continue to earn quality new business from our agencies including areas we've been emphasizing such as personal lines products and services for our agency's higher net worth clients. Of the $16 million increase in nine-month new business written premiums for our personal lines segment, nearly 20% of the increase was from high net worth policies. We launched Executive Capstone, our new suite of high net worth insurance products, in New York during September. We expect those products to contribute significantly to profitable premium growth over time. We're on track with progress for an initiative we announced in the second quarter, expansion of reinsurance assumed which we refer to as Cincinnati Re. We have an experienced executive leading the effort and continues to develop a small team of excellent people to help execute our plans. We aim to remain disciplined in this expansion, particularly during tough reinsurance market conditions. At September 30 we had entered into a handful of diverse treaties. If each treaty remains in effect for its full-term and premiums that are subject to the risks we're reinsuring occur as anticipated, we estimate those treaties should generate approximately $30 million in premiums over the next year or so. Premiums, losses and expenses recognized during the third quarter of 2015 for our reinsurance assumed program were each less than $500,000, an immaterial effect on results for the quarter. Turning to renewal policies, as we further segment our business we use pricing precision tools and informed underwriter judgment to select and retain policies at prices we believe provide an appropriate return for the risk we assume. Overall pricing for the third quarter was similar to the second quarter. Average renewal price increases for commercial lines continued at percentages in the low-single-digit range. That average includes the muting effect of three year policies that were not yet subject to renewal during the third quarter. For commercial property and commercial auto policies that did renew during the third quarter, we continue to obtain meaningful price increases with property averaging in the mid-single-digit range and auto averaging near the high end of the low-single-digit range. Our most profitable line of business in recent quarters, workers compensation, averaged slightly negative pricing during the quarter. While the average pricing change may have been negative, we continue to price on a policy-by-policy basis. Certain policies that we determined needed a price increase received it. Our personal auto policies average renewal price increases near the low end of the mid-single-digit range while home owner policies were a little higher in that range. For excess and surplus line segment, third quarter 2015 averaged renewal price percentage increases that were near the low end of the middle-single-digit range. The NS segment continues to perform very well producing another quarter with a combined ratio below 80% and double-digit growth in net written premium. Our life insurance subsidiary, including income from its investment portfolio, also had another good quarter. Strong growth in profit in the third quarter brought our nine-month life insurance results above last year's. Our primary measure of financial performance, the value creation ratio, is by design long-term in nature. We know that measure may sometimes fall below target in the short term due to securities market volatility. We're staying focused on underwriting profitability and growth. Our insurance business is in excellent shape contributing more significantly to this year's nine-month value creation than a year ago. We have confidence in all of our associates, in the relationships we build with independent agencies and in the ongoing benefits of our strategic initiatives that aim to continually improve performance. I would like to conclude by expressing my sympathy for those impacted by the flooding this fall. We sent a storm team of our own highly trained associates to South Carolina to meet face-to-face with policyholders, quickly beginning the recovery process. We currently estimate our total losses from that industry catastrophe event to reach between $4 million and $8 million -- that is $4 million and $8 million. I will now ask our Chief Financial Officer, Mike Sewell, to highlight other aspects of our recent financial performance.

Great, thank you, Steve. And thanks to all of you for joining us today. First I will highlight some important aspects of our third quarter investment results. While the fair value of our equity portfolio fell 4% during the quarter, we ended that period with a net unrealized gain of over $1.5 billion before taxes for our common stock holdings in total. We had another quarter of investment income growth with an increase of 4%. All 50 common stocks in our core portfolio increased their annual regular dividend over the 12-month period of October 2014 through September 2015. The median dividend increase for those stocks was 7.6%. For our equity maturity portfolio -- I'm sorry, for our fixed maturity portfolio interest income rose despite declining average yields in part due to 9-month 2015 net purchases totaling $486 million. The bond portfolio's third quarter 2015 pretax average yield reported at 4.62% was 14 basis points lower than a year ago. Taxable bonds purchased during the third quarter had an average pretax yield of 4.64% while tax exempt bonds purchased average 3.32%. In both cases those yields are higher than we experienced a year ago. Our bond portfolio's effective duration at September 30 was 4.7 years, up from 4.4 years at year end. The increase was due -- primarily due to the impact from rising interest rates on our callable bonds, not a change in strategy. Cash flow from operating activities again contributed to investment income growth. Funds generated from net operating cash flows for the first nine months of 2015 rose 19% compared with a year ago to $755 million and helped generate $624 million of net purchases of securities for our investment portfolio. We're still carefully managing our expenses. Because we continue to strategically invest in our business, third quarter and nine-month property-casualty underwriting expense ratios rose slightly compared with prior year periods. Moving to loss reserves, I will first remind you that our approach to setting overall reserves remains consistent with the past. We continue to aim for net amounts well into the upper half of the actuarially estimated range of net loss and loss expense reserves. For the first nine months of 2015, favorable reserve development on prior accident years benefited our combined ratio by 4.4 percentage points, slightly better than 3.9 points for the first nine months of last year and in line with the first half of this year. Although in commercial and personal auto our major lines of businesses have developed favorably so far this year, for our auto lines nearly 75% of the unfavorable reserve development was for accident years 2013 and 2014. Our nine-month of 2015 net favorable development was again spread over several accident years, including 41% for accident year 2014, 21% for accident year 2013, 29% for accident year 2012 and 9% for all older accident years in aggregate. Our capital strength remains excellent and includes liquidity and financial flexibility. Cash and marketable securities for our parent company at September 30 totaled just over $1.8 billion, up 1% from year end. Our strong capital is vital for ongoing growth of our insurance operations as well as other management actions such as returning capital to shareholders. During the third quarter we used $73 million for cash dividends to shareholders. We also used $21 million to repurchase 400,000 additional shares at an average cost of $51.74 per share. Similar to our share repurchases in recent years, it was a maintenance type action intended to partially offset issuance of shares through equity compensation plans. I will end my prepared remarks as usual, by summarizing the contributions during the third quarter to book value per share. They represent the main drivers of our value creation ratio. Property-casualty underwriting increased book value by $0.53; life insurance operations added $0.07; investment income other than life insurance and reduced by non-insurance items contributed $0.47. The change in unrealized gains at September 30 for the fixed income portfolio net of realized gains and losses decreased book value per share by $0.07. The change in unrealized gains at September 30 for the equity portfolio net of realized gains and losses decreased book value by $1.37. And we declared $0.46 per share in dividends to shareholders. The net effect was a book value decrease of $0.83 during the third quarter, to $38.77 per share. And now I will turn the call back over to Steve.

Thanks, Mike. In closing our prepared remarks I would like to share some other positive news we received during the quarter. While we don't seek accolades, it is nice when we're recognized for our efforts. Forbes has again ranked Cincinnati Financial Corporation among America's 50 most trustworthy financial companies in 2015. This marks the fifth consecutive time Forbes has recognized Cincinnati Financial for openness and integrity in accounting, governance and management. As we head into the last quarter of the year we're committed to maintaining the momentum we have created so far in 2015. We're confident that Cincinnati Financial is on the right track to deliver shareholder value far into the future. We appreciate this opportunity to respond to your questions and also look forward to meeting in person with many of you during the remainder of the year. As a reminder, with Mike and me today are Jack Schiff, Jr., Ken Stecher, J.F. Scherer, Eric Matthews, Marty Mullen and Marty Hollenbeck. Nick, would you please open the call for questions?

[Operator Instructions]. Your first question comes from Josh Shanker from Deutsche Bank. Your line is now open.

I wanted to get a little detail on your entry into the New York market and the appetite for high net worth homeowner's products there given incumbent carriers and whatnot.

Okay, Josh, this is J.F. We started things off in New York similar to the way we do things in other areas is to appoint a few agencies. So we have appointed 12 agencies in the New York City/Long Island area and two outside of that area but close by, so a total of 14 agencies. And our intent would be to keep the number of appointments at a fairly low amount. Our appetite, as advertised, is with Coverage A limits up to $50 million. While I wouldn't expect to see a lot of that at this level, but we clearly have an appetite that is reflective of the qualifications that Will Van Den Heuvel has brought to the Company along with the team of people he is continuing to assemble. So, we've got our marketing folks on the ground in that area, we also have which I think is an important consideration, some professionals that Will has recruited from -- that have worked with him in his prior areas to head up our risk control and our appraisal and valuation units in those areas as well. We have a specialist here in Cincinnati in high net worth, we have trained 100 of our field claims reps in high net worth areas. And so, I think we're prepared to provide the kind of claim service that distinguishes us around the country as well. So, it has been a good start. Obviously we're not trying to explode on the scene; we're trying to do things the way we normally do it, slow and steady. But the appetite from an agency standpoint to do business with us has been great.

And what about the source of business? Are you taking that business from incumbents? A lot of the high net worth writers say there are plenty of opportunities to gain business from the general market, people who are not being served by a high net worth specialist. [Indiscernible] New York is a pretty sophisticated buyer's market. What does the marketplace look like there?

Well, we're getting business. The agencies we have appointed have pretty much all been high net worth specialist agencies. So we're writing business in some cases from within their agencies, we have helped them write new accounts, have written some accounts that have previously been written by some of the major players in that area. But as you mention, an awful lot of that marketplace, the majority of that marketplace is currently being served by carriers that don't specialize in the high net worth area. And we're seeing some business not only in New York City and that area but also around the country from carriers that would not be in those top five carriers that everyone speaks of when it comes to mind.

And in terms of thinking about the current accident picks in commercial casualty, obviously a very, very good quarter and a big pick down in terms of the loss ratio. When you [indiscernible] that business what sort of allocation is IBNR and what allocation is case to the extent that when you make a big move in your new loss pick how do you think about that? Where is the data flow coming from that gives you your best estimate?

Yes, Josh, this is Steve. And basically we look at it in terms of estimating and making our actuaries do the best estimate of the ultimate accident year for each accident year. And they will use a variety of techniques for commercial casualty. In particular they are going to use a multiple regression technique on paid losses which would take any variability and claims reserve setting and so forth out of the equation, although they do also look at incurred methods, Bornhuetter-Ferguson methods and so forth. But there is an emphasis there on the paid losses and regressing along three different ways, the accident year, the report year and the calendar year. So, I think in answer to the question, the main point is to try the best, the actuaries try their best to pick the appropriate accident year ultimate, then they would subtract off the paids and the case reserves to arrive at the indicated IBNR.

Well, if I am getting too specific with the next question I completely understand. How far is the current ultimate pick for 2014 comparing cash with where you are picking 2015 today?

We have that, I need to find that exhibit probably in the supplement here.

I can come back to Dennis on it. I appreciate the help--

Okay, I think the way to look at it would be just to go to the supplement for that particular line and look at the current accident year before catastrophes which there wouldn't be for casualty -- any catastrophes and just multiplying that by the premium that would be the pick for the ultimate.

Your next question comes from Mark Dwelle from RBC Capital Markets. Your line is now open.

A few questions. Let me start with just clarifying a couple of numbers. In your opening remarks you said that the high net worth products were 20%, that is of the personal lines new business, not of all new business, right?

That is correct.

Okay, so that sort of $6 million-ish for about one month worth of work?

Yes, but the point and I think to emphasize a little bit what J.F. said is that we launched the Capstone high net worth in New York in September. But we have also added four endorsements to our Executive Classic which would have been our existing high-end homeowners -- to bring it up to snuff and are selling the high net worth product through existing agencies throughout the country. So that growth there would also be counted in terms of the high net worth new business.

Mark, this is J.F. Yes, I would just emphasize what Steve said there. Since Will has joined the Company we've communicated to all of our agencies across the country that we have a more comfortable appetite for the high net worth. I think before -- and we have mentioned before about 10% of what we have written has been high net worth, though I would probably describe it more mass affluent with Coverage A limits of $2 million or less. And so, when we say high net worth, it is $1 million Coverage A or more. We're still -- and we're writing a lot in the $1 million to $2 million to $3 million range. So, the response we're getting from agencies throughout the country that already had represented us for personal lines has been improved.

Okay, so just to paraphrase what you said, it would be a mistake to assume that the $6 million is all New York area. Some of it is New York certainly, but it is also the rest of the Cincinnati map is in that total via the endorsement of the existing product?

A small percentage would be New York.

Okay, that was my first question and actually you answered my other question related to high net worth on where the limits tend to kick in. The second question I had, again, in your opening remarks, Steve, you mentioned the Cincinnati Re and I think you said $30 million of premium, was that right or --?

Yes, that was correct and we might want to just amplify a little bit in terms of how we're booking the premium and I will turn it over to Mike to maybe touch on that.

Yes that would be great. Hey, Mark, it is Mike. So currently Cincinnati Re, we have six contracts or treaties and they are generally running 12 to 18 months in duration. And although the premiums are not always known on day one, we estimate that we will receive $32 million over the periods compared to the $15 million that we reported at the end of the second quarter. So we basically have doubled that amount. The amounts that we have reported in the third quarter financials though are not material quite yet. When we write a contract we may know what the entire premium or we may not know what the entire premium will be until the cedent actually cedes all the risk to us. So an example might be, say, if I use an example like workers compensation in California. We may not know what the final premium on the specific contract will be until we know how much ultimately the cedent rights and cedes to us. So at any given point in time it can be difficult to give a future written or earned number of projections. So, but what we have stated so far is we're going to walk, not run, as we build this business and we're only going to take risk with superior returns that enhance our VCR. So congratulations right now to [indiscernible] and the team for I think a great start and we will have more to report to you in future quarters.

And Mark, this is Steve. And kind of the intention on the disclosure here is that we're being our usual prudent self when it comes to booking revenue, but we also want to let you know that we have six contracts out there that have the potential of ultimately producing $30 million in written premium. So we could have losses, we're being cautious on both sides I think.

Most of that was exactly what I was going to ask. The two other little bits related to that and again this is really more just a disclosure and where I find it. I assume all of this is currently being reported up through the commercial lines unit and that those amounts are also showing up in the new business written premiums totals.

That is another great question, Mark and I probably should have touched on that. We're doing this similar to the way we did our E&S business when it was a start-up. So currently it is in other for our segment business. So you won't necessarily see it in there. When it gets to be larger it will actually be reflected as its own segment within the Q. So it's in other right now, so you really can't see it because it's so small. So again, we expect it to grow and then at some point it will be material enough to break out as its own segment. So you will soon see commercial lines, personal lines, E&S, Cincinnati Re assumed life investments and then you will end up with other. So that is the way we're expecting it to go.

Okay, good on that. And then the last question that I had -- in the commercial lines unit you had an excellent quarter from an accident year standpoint and even a non-accident year standpoint. But the improvement in the accident year, I guess in the commentary in the press release you talked about the nine-month improvement related to non-cat weather and large claim losses and so forth. Do those comments apply equally to the quarterly improvement?

This is Steve. I believe they do. I think the quarter and the year -- it has been pretty consistent across time.

So what I am really more directly asking or indirectly asking is, so, to some extent that is just -- I mean obviously it is good any time, but there is likely to be some mean reversion on that in some other quarters where those things start to swing back against you.

Well, I want to make sure I was stating it right. We were trying to peel right down to the core ex-cat accident year. And we just feel we're making incremental steady improvement. It is not huge but it is -- we're just grinding it out and we're going to have some noise based on large losses and so forth. But we feel that with the initiatives in place we're still -- have runway to go on some incremental improvement. But I would make those comments more in terms of the nine-month data in that there is less variability there.

Okay. And then last question, Mike. You had mentioned the buybacks, those were all bus quarter, right? There wasn't anything incremental this quarter this quarter.

Actually there was incremental this quarter. So, it is by coincidence maybe. There was 400,000 shares in the second quarter and also an additional 400,000 shares in the third quarter. So year to date we have purchased back 800,000 shares for a total price of just a little over $41 million. So it is kind of averaging in the low $51 per share.

[Operator Instructions]. Your next question comes from Ian Gutterman from Balyasny. Your line is now open.

I guess my first question is, the E&S business had a spectacular quarter on an underlying of about an 82% accident year. Normally that is say in the -- I know it bounces around a lot, but I think it is the best you have ever had potentially. Anything unusual there? Was it just a lack of property events or change of mix? I was curious what was going on there.

Ian, this is J.F. No, our mix really hasn't changed much, it is about 15% property, so it is a pretty heavy casualty book of business. I think the newsworthy items in E&S and it was mentioned as well, is that we're seeing a lot of pressure on larger accounts almost all of which are going into the standard market. So competition has kind of accelerated there. I think we have just done the folks that are -- [indiscernible] and the folks that are running E&S have just done a really good job of making certain that we're being thorough underwriters. I think we have got a good opportunity within our agencies. Our agency's right ballpark $2.5 billion in E&S business in their agencies and our model is unique. I think we provide a good option for our agencies. And so, I think we can continue to be pretty choosy about what we write. And from the very beginning Don has taken the approach that if we're going to -- being in this business there are going to be times when you have to be tougher and maybe not grow as much, though I don't think we're at that point yet. But we have been able to continue I think growing it. We have got 61 consecutive months of rate increase, so I think that fortifies the results there. So all in all nothing has changed, nothing that would have caused that loss ratio to go down a lot more. We're just continuing to be we think pretty good fundamental underwriters.

And then before I move on to Mike since I have you here. On commercial auto, switching topics, any additional color you can give on sort of where you are seeing pressure in the book? Meaning is it local vans, is it the construction business, is it stuff you had that is maybe longer haul? I am just kind of curious where -- or maybe it is all the above. But I am just curious if there is any particular areas that stand out.

Yes, I was going to say yes, yes and yes, there is really no smoking gun that I can tell you on commercial auto. There is a variety of things. For us as you probably noted, it is a severity issue not a frequency issue. And we're seeing and the industry is seeing, with the economy improving, a lot of newer employees, therefore a lot of newer drivers that are out there. Some of the drivers of which and we have seen it in some of our claims, are in our view perhaps a little too young to be driving the size of truck that they have been given responsibility for. Regrettably we find that out after the fact. The American Truckers Association, just I guess by way of a comment, said that at the end of 2014 there was a shortage of 38,000 drivers and at the end of this year there would be a shortage of 48,000 drivers. So we're trying to concentrate better at verifying driving records, driving experience and the assignment of vehicles to particular drivers help out there. But even in Ohio which is our gold standard state as far as profitability, it has been a little tougher here in Ohio. We noticed on -- when you drive around I am sure in your area and they have signs above the highway that says the number of deaths. Well, the number of deaths on Ohio highways is up double-digits this year. This is anecdotal to my way of a description, but distracted driving we believe also has had some effect obviously not on the frequency, but had some situations where there were no skid marks and somebody that was texting or talking on the phone piles into someone and so I think the industry is searching for a variety of things that are contributing to this. But, I think it is not one thing, it is a lot of things.

And just related, does it put any pressure on the comp book for certain types of customers? Meaning if I have a business that has a lot of delivery vans or something and obviously if someone gets in an accident on the job I assume there is a comp payout too. So does that create any inflation pressure on comp as well?

It could very well and something we're paying attention to. When our loss control folks go out they are on the lookout for that type of thing. We haven't seen it in our comp book yet, but we're looking for it.

And then just lastly for Mike, was there any change in any of the segments in I guess adjusting the picks for the year? Meaning like do you sort of true up the year in this quarter at all? And so maybe some of the change from trend is related to catch up from either releasing or adding from the first half?

Yes, you know the picks really haven't moved a whole lot. We look at it every quarter, the actuaries perform a thorough review during the quarter. So I would say it has been fairly flat from quarter to quarter, but it is a thorough review each quarter when they are looking at the picks.

[Operator Instructions]. There are no further questions at this time. Mr. Steve Johnston, I turn the call back over to you.

Well, thank you, Nick and thanks to all of you for joining us today. We look forward to speaking with you again on our fourth quarter call. Have a great day.