辛辛納提金融 (CINF) 2003 Q1 法說會逐字稿

Good afternoon. My name is Roderick and I will be your conference facilitator today.

At this time, I would like to welcome everyone to the Cincinnati Financial Corporation 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 period. If you would like to ask a question during this time, simply press star, then the number 1 on your telephone keypad. If you would like to withdraw your question, press the pound key. Thank you.

Miss Wietzel , you may begin your conference.

Thank you, and welcome again everyone to Cincinnati Financial Corporation's first quarter conference call.

By now you should have received a copy of the news release by fax. If you have not received your copy, it is available on the Web site at www.cinfin.com or you can call our offices at (513) 564-0700, and a copy can be faxed to you immediately.

On today's call, Jack Schiff, Jr., Chairman and Chief Executive Officer will begin, be followed by comments from Ken Stecher and Ken Miller, after which the call will be open for questions.

So with that, let me turn the call over to Jack.

Thanks Heather and thank you all for joining us today.

Before I turn to the quarter, please note that some of the matters we will be discussing today are forward-looking. These forward-looking statements involve certain risks and uncertainties, with respects to these risks and uncertainties we direct your attention to our news release and our various filings with the SEC.

Also reconciliation of non-GAAP information as required by Regulation G was provided with the release and is available on the investor's page of our Web site under the operations tab.

Statutory data is prepared in accordance with statutory accounting rules as defined by the National Association of Insurance Commissioners, Accounting Practices and Procedures Manual and therefore is not reconciled to GAAP.

I think this quarter, I'd be hard-pressed to sum up our reaction to the results with one generalization. On one hand, our property casualty business had a very strong quarter, and we're pleased by what we're seeing overall. On the other hand, however, we're not happy with the impact of the market on our portfolio. Even so, the investment operations reported some positives, and much of what we're facing in that arena is being driven entirely by the economy. We're confident we will see improvement when the economy turns back around.

Briefly, on the first quarter insurance results, total written premiums were up 11 percent, with commercial lines premiums up 11 percent, and personal lines premiums up 10 percent. New business written was just slightly below a year ago as we continue to make delivered case-by-case decisions to leave some accounts on the table. Excluding the workers' compensation line, where we are being very selective, commercial new business growth was about 1 percent.

The GAAP combined ratio came in at 95.1 percent, compared with 98.8 percent a year ago. And Ken Stecher will be talking more about the favorable profitability trends in a moment.

For the Life operations, we saw a healthy 7 percent increase in earned premium, and a 9 percent gain in operating income.

So, consolidating the pieces for the company as a whole, operating earnings per share were a very strong 60 cents, with just 1 cent for catastrophe losses. That compared with 49 cents and 6 cents per share from catastrophes in the last year's first quarter.

With 3 consecutive strong quarters on the insurance side, we can say with some certainty that we've turned the corner, benefiting from firm prices, rate increases, the underwriting actions we've taken over the past two years and our approach to the marketplace, not to mention the tremendous cooperation and support of our agents who, everyday, explain the various changes to policy-holders.

Now, for the other half of the picture. Investment income grew 6.3 percent in the quarter, despite the prevailing market conditions. We did benefit from the 2002 dividend increases made by many of the companies in our equity portfolio, which are particularly valuable when the bond market's under pressure. Book value was $32.10 at March 31st, due to the market value decline of Fifth Third, and a little bit from ALLTEL . Ken Miller will cover this detail in a few moments. But along with the surprise of HealthSouth, the effective economic conditions on market values led to asset impairments of both the bond and equity portfolios, totaling $53 million. This represented the bulk of the 25 cents per share in realized losses we reported in the first quarter. With these losses, net income was 35 cents per share, compared with 46 cents per share last year when we had 3 cents in realized losses.

Well, that's the big picture. As I mentioned, Ken Stecher and Ken Miller will be going into detail on some subjects, and I want to spend a few minutes talking about the marketplace and what we're dealing with as we look to continue our growth, and keep profitability at our target level.

As most of you know, many members of our senior management team spend much of the first quarter visiting with agents at a series of sales meetings in a variety of locations throughout our marketing area. The sales meetings are a chance to give agents an update on The Cincinnati Insurance Companies and even more important, a chance for us to listen to them and to our field representatives.

What we heard this year pointed to some moderation in the commercial marketplace and that was confirmed by what we're seeing in our results. In general, the agents are seeing renewal pricing for good to high quality accounts in the high single digits. The feedback we're receiving indicates that, for the most part, carriers are not looking for market share at the expense of rational pricing.

These conditions don't tend to drive renewal business into the marketplace. Instead, we have to rely on our agents to work hard to earn new business the old-fashioned way, by knocking on doors, showing prospective policy holders that their services add value to the insurance transaction. And we have to rely on our field staff to reinforce every day to agents that Cincinnati is the carrier of choice for the best accounts.

But these conditions really allow our approach and our agents to shine. We work with quality agencies, on average our 960 agencies, have more than twice the annual. Correction, on average our 960 agencies have more than twice the annual volume of other - of the other 41,000 independent insurance agencies. They are committed to doing business person-to-person, focusing on the broad value-added services, maintaining a strong financial condition and professional management.

We work closely with them to ensure they have the information and the tools that they need to be successful. It's been a highly successful partnership for 50 years and we think it remains a formula for continued success.

Of course, that's how the market looks for accounts that neatly fit the profile of a 'good' account. For those that don't, things are a little more challenging. For example, contractors are facing a tough market for insurance. Theirs is a situation we see as tailor made for our way of doing business, aided by the changes we've made over the last year to give us more control.

We've added aggregate limits to our general liability and umbrella coverage and taken other actions to educate our people on risk transfer and good business management. Since we're willing to evaluate each contractor individually, rather than take a broad-brush decision about this market segment, we have the opportunity to support our agents by being willing to provide coverage where the situation merits.

These overall market conditions were reflected in the rate of written premium in our commercial book of business in the first quarter. And some preliminary feedback from our field staff indicates that new business growth should pick up in the second quarter.

The personal lines look maintained its steady growth as rates remained firm.

With that, let me turn things over to Ken Stecher.

Thank you, Jack.

It's a pleasure to be speaking with all of you today. Let me first touch on a couple of brief items, and then I'll turn to the commercial and personal line profitability details and the trends and specific business lines. I'll also comment on reserves and related items.

First a note on the scaled-back supplemental financial data you should have received this morning. The changes in what you received are due to Regulation G requirements and we'll be working to provide additional supplements over the next couple of months.

Second, on catastrophes, which accounted for only four-tenths of a percentage point on our combined, overall combined ratio, and actually added back 1.3 percentage points in personal lines, due to payroll and development from prior period events. We would have to observe that this is an aberration and we know the caps won't come in near this level for the year or just about any other period you can think of.

Third, on the claims analysis we provide, we saw a nice decline in the larger case reserve increases. Although we don't like to look at a single quarter as indicative of a trend, we've been working towards this type of result and we're hopeful that what we're seeing is an early signal that we're pegging these initial case reserves on reported claims more in line with higher loss cost and, therefore, we'll need to make fewer significant upward adjustments in the future.

Now looking at commercial lines, the first quarter GAAP combined ratio came in at 93.2 percent, including 1 percentage point for catastrophe losses, compared with 96.6 percent and 1.2 points in last year's first quarter. The expense ratio was up by about 1 percentage point due to higher commissions, particularly contingent commissions as profitability improves. The year-over-year improvement was driven entirely by a decline in the Loss and LAE ratio, with commercial auto and commercial umbrella posting strong improvements. And quickly, here's an update to the byline Loss and LAE data. Note that these ratios include catastrophes and large losses.

The Workers' Comp Loss in LAE for the quarter was 80.5 percent, a slight improvement from 82.2 percent at last year's first quarter. With a slight rise from third and fourth quarter levels, we're analyzing some adverse prior period development from assumed pools and our assigned risk book. With our tightened underwriting for Workers' Comp that is leading to lower levels of premiums, we generally think things here are headed in the right direction. The commercial auto Loss and LAE had a nice improvement at 56.8 percent, from 64.9 percent in the first quarter last year. The commercial umbrella Loss and LAE was at 47.7 percent, down from 78.1 percent a year ago. This line tends to be very volatile and swing with the large loss trends. It also was impacted by favorable development from older accident years.

For personal lines, the first quarter GAAP combined ratio was 99.9 percent, including a 1.3 percentage point benefit from catastrophes, compared with a ratio of 104.1 percent and 6 points from catastrophes last year, in the strongest quarter we had during 2002, excluding catastrophes. Now, by line here, the home owners' Loss and LAE was 63.1 percent versus 79.7 percent a year ago. Taking out catastrophes, which had a beneficial 4.4 point impact this quarter, the Loss and LAE was 67.6 percent versus 62.1 percent, within the non-cat range we are expecting for this year and leaving lots of room for improvement going forward. We're monitoring the trend in losses in the $35,000 to $100,000 range which were up somewhat in the quarter. The personal auto Loss and LAE was 72.4 percent versus 68.1 percent a year ago. With the strong results we reported over the past couple of years in personal auto, we weren't able to get meaningful rate increases approved last year until the fourth quarter. The increases we now are seeing are running in the high single-digits. For example, in Ohio rates rose by 7.1 percent effective the first of the year. With our one-year auto policies, we should see the benefit of these higher rates and a more satisfactory loss ratio as the year progresses.

Turning to reserves, first on UM/UIM , the Ponzer-Linko cases - as most of you remember, in the wake of two Ohio Supreme Court decisions affecting all insurers in the state, in the fourth quarter of 2000 we established a $110 million reserve for UM/UIM claims incurred but not yet reported.

In the first quarter we brought this reserve down by about 4.1 million, which puts the reserve balance at $21.7 million at March 31st.

There are some items pending that we should see resolved over the next few months. That will give us additional clarity on the outlook and a better sense of the overall UM/UIM reserve adequacy at the end of the second quarter.

Second you'll note that IBNR is at 22 million. That's a function of our growth more than anything else, and we think that's a pretty sustainable rate for the rest of the year.

Briefly on our outlook, we are very pleased to see the first quarter build on the results of the second half of 2002. At this stage, with the growth level we see on earned premiums, we are very comfortable looking for a full-year GAAP combined ratio of 99 percent, or 98.5 percent on a statutory basis.

Now if that sounds somewhat pessimistic, we don't mean it to be. We're just being cautious about catastrophe losses as the biggest unknown. As both Jack and I noted, the first quarter combined included a very low level of catastrophes.

Looking into the second quarter, as we said in the release, we've estimated $9 million in catastrophe losses for some Ohio and Kentucky storms last week. That's a preliminary number that we'll update in the 10-Q if needed, but it would represent about 1.5 percentage points on the combined ratio. And last year's second quarter, catastrophes were 8.1 percentage points.

Our outlook assumes accounts will average in the 3 percent range for the full year and is likely we'll see a quarter or two during the remainder of the year that's above the 3 percent level.

So let me turn things over to Ken Miller to discuss investments.

Thanks Ken. Good afternoon everyone.

The first quarter investment results were mixed at best. Continued low interest rates in a weaker than desired economy made investing anything but easy. Investment income however rose a healthy 6.3 percent. This gain was driven in large part by dividend increases in 2002, from 28 of the 46 stocks in our portfolio.

These increases will add about $12 million to annualized investment income in this year and accounted for approximately 43 percent of the first quarter's increase. However, with continued low interest rates, we feel prior guidance of 3.5 to 4.5 percent increase for the year is still appropriate.

Strong cash flow from insurance operations and investment income allowed for $145.3 million of net new investments in the first quarter. While we still like the equity markets, timing of sales and some internal guidelines kept the funds allocated to equities lower than we would desire. More than 90 percent of new funds were invested in investment grade corporate, government agency, and municipal bonds as we focus on high quality with intermediate maturities.

Most new bond purchases were in the seven to 10-year range for the taxable portfolio, where net new investments totaled $127.4 million, and in the 10 to 12-year range in the tax-exempt portfolio where new investments totaled $55.3 million. We also bought back approximately 940,000 shares of our stock at a cost of $33.2 million, taking advantage of strong cash flow and what we perceived as good buying opportunities during the quarter.

On the valuation side, the equity portfolio under performed the S&P 500 over the first three months of 2003.

We also had $62 million in realized capital losses. As we've seen this past year, three different items contribute to that total. First, FASB 133, which measures the change in the embedded option within convertible securities, resulted in a loss of $10 million this quarter versus a gain of $2 million in last year's first quarter.

Low interest rates in theory drive down the value of the embedded option, while increasing the value of the underlying bond or preferred stock. When interest rates rise, we should see the option value start to increase, and those corresponding gains will run through the income statement.

Second, realized capital gains from sales of securities were just short of $1 million, versus a four-million loss a year ago. You'll note we chose not to sell winners in our portfolio to offset impairments. We are positioning the portfolio for the long-term. Selling securities to offset impairment losses, especially where we have confidence in the security itself, doesn't fit with our philosophy.

That leads us to the $53 million in asset impairments we recorded in the quarter for market value declines deemed other than temporary, according to our policy. Airlines and related issues accounted for about $9.9 million of the impairments. Here, we have virtually eliminated our exposure to unsecured airline paper, and the market value of what remains in the portfolio at quarter-end was about 72 percent of book value.

Utilities accounted for another $24.7 million of the impairment. Many utilities were building infrastructure when the economy weakened and are still absorbing that added capacity. Compounding this problem was a liquidity squeeze that resulted from the need to refinance short-term liabilities, including credit facilities. Recovery here isn't outside the realm of possibility, but it is likely to take some time.

And finally, we wrote down about $8.7 million of our $11 million exposure to HealthSouth bonds and convertible securities. The remaining $9.5 million were spread across several small positions in companies that just haven't been able to withstand current economic conditions.

With the markets still generally weak, we continue to review any declines in asset values on an issue-by-issue basis. Further impairments may be necessary.

Before I close, I wanted to comment on our Fifth Third holding. Our investment philosophy weighs heavily on long-term considerations. While Fifth Third's value was affected by uncertainty surrounding the regulatory review, some of that uncertainty was removed when Fifth Third entered into an agreement with the Federal Reserve Bank and the Ohio Department of Commerce. In late March, Fifth Third outlined the series of steps it has been taking to strengthen the areas identified. At the time, Fifth Third noted that they are extremely serious about risk management and internal controls, and that they are working hard to take the necessary steps to strengthen procedures to fully cooperate with the regulatory agencies. They said that these efforts -- many of which have already begun -- will result in Fifth Third emerging from this process as an even stronger company.

Our equity standards in any market continue to be sales, earnings, and dividends, plus proven management and favorable outlook. We believe Fifth Third continues to meet those standards.

It's worth pointing out that our investment standards are applied to all of our equity holdings. We review every holding in our portfolio, including Fifth Third Bank. We are long-term investors, and we remain patient.

Jack, with that, I'll turn the call back to you.

Good job, Ken. Thanks, Ken, and Ken.

I think we've given you a good summary of where we stand on the insurance side and how pleased we are with our current position. We also feel that comfortable with the outlook for our investments. As long-term equity investors, we manage our investments the way we manage our insurance operations; through personal knowledge and relationships. Our philosophy is based on knowing and understanding the companies in which we invest, and on keeping the number of companies manageable. That philosophy is our culture, and Ken Miller and his team apply it constantly in a thoughtful, conscientious manner.

When short-term events affect our holdings, any of them, we take the time to understand the circumstances and evaluate for the long-term. Based on our - based on our ongoing and careful review, at this time we feel that Fifth Third continues to have the potential for sales growth, earnings growth, and dividend growth and has strong management team led by George Schaeffer and has a quite favorable outlook.

The Fifth Third management team has produced one of the most stellar records of any bank or any publicly traded company for that matter, in the past 20 years. We have confidence in the stock and more importantly we have confidence in our own investment strategy. We also have confidence in our business.

Relationships truly are at the heart of everything we do. And we feel good that the strength of those relationships provides real protection to our policyholder. Our policyholders know that they can count on their independent agents and on the financial strength of Cincinnati Financial Corporation when they need it.

As investors, you too can count on us as this quarter effectively demonstrates. Although the nature of our industry dictates there will always ups and downs, Cincinnati consistently delivers value over the long-term.

We're pleased with that record and maintain our outlook for the future and as we move towards investing, toward answering your questions today, I'd like to remind you that I'm joined by Jim Benoski, Cincinnati Financial's Chief Insurance Officer, and J.F. Scherer our Senior Vice President of Sales and Marketing.

And with that, Roderick, we're ready for questions.

Thank you.

At this time I would like to remind everyone if you would like to ask a question, please press star, 1 on your telephone keypad. We'll pause for just a moment to compile the Q&A roster.

Your first question comes from the line of Nancy Benacci with McDonald Investments.

Thank you. Good afternoon.

A couple of questions starting in terms of the commercial lines look and I just wanted to go over a little bit sort of, the slow down in growth and new business and your anticipation as you look out over the rest of this year. Are you finding at all, are you sensing that the slowdown in new business, do you know where it's going? Is it going to some of the newer competitors out there that have been really trying to target the small to mid-size commercial business? And do you think any of that sort of slowdown in growth is a concern on an ongoing basis? I guess that's the first question.

Nancy, this is J.F. I think a lot of things occurred over the last several months. We've been, obviously, testing the marketplace trying to get as high of rates on new business as we can. And as everyone is reporting, the the pricing of new business or pricing of renewals is moderated into the high single-digit levels, particularly for the kinds of account we go after.

So as Ken mentioned in his remarks, there aren't as many accounts being driven in to the marketplace. We're conservative on workers' comp, and the fact that we are probably has a bit of an effect on that.

In checking with the field and many agencies about new business levels, we are seeing an up tick in it. So while we were concerned and a little surprised by the slowness of new business, really for the last couple of months of last year and the first couple months of this year, we think there'll be a bit of an improvement there.

Besides comp, are there any other lines or territorial regions that you were seeing a problem?

No, I wouldn't say there any territorial regions. Umbrella for us right now is, we've been conservative pricers there and I think the volatility of the larger claims warrants that. We're finding that there are some carriers out there that are a little bit more competitive on it than we are, or wanting to be a little lower priced than we are. So that's having a bit of an effect. Certainly the fact that so many carriers are getting into the smaller account, and by our definition smaller account would be $10 thousand and less, arena, that we're seeing some pressure there as well. Nothing we can't overcome, but it's competitive in that area.

OK. And then you still are focused on the multi-year polices. Is that correct?

That's correct.

And I think if I read correctly, in the release you indicated that you are booking those double-digit levels, is that correct still?

Yes, when a policy that's coming off a three-year term right now is renewed, we're still getting in the 12, 15 percent range on that particular policy.

OK. And I just wanted to ask a little more specifically on the comp book, just to make sure I'm understanding the potential for maybe additional surprises per se in that book. We've heard lots in the industry out there, you know, that there are issues. Can you give us a feel for how comfortable you feel with reserve levels in your comp book as we look at it today and the rest of the year?

Jim, did you want to take that one?

I think Ken.

Thank you, J.F. Nancy, as I commented on in my comments, we have added a little bit to reserves as a result of some involuntary and voluntary pools and also the traveler's book where we write the--we write the insurance on our paper, and we've added some reserves there. It's about 5 or $6 million. But I think overall with the--our direct book where we underwrite the policy and the risk, I feel very comfortable, you know, with our reserving there.

OK. And then one last question just for Jim, if you could talk a little bit more about the UM/UIM issue in Ohio and what the real concerns could be going forward in terms of some of the recent decisions.

OK, Nancy. We had probably, I would say the second quarter of '02, our highest increase in reserves on the two Ohio cases and it moderated quite a bit in the third and fourth quarter. In the first quarter of this year it's spiked up just a little. There were two cases that the Supreme Court decided, a Linko case and a Ponzer case and it was the old court and there was a Motion for Reconsideration on both of those cases. So we knew of some files that we had some reserve issues on, but we were waiting for the new court to make a decision on whether they would reconsider those and maybe give us some relief. But that was not the case so we have to--we've had to post these additional reserves. I think that'll probably continue into the second quarter and then hopefully after that, it'll start to moderate again.

But you don't sense that it is a major problem here going forward?

It's going to spike up again, I think, in the second quarter, Nancy. The one case, called Kemper, added about three years of exposure from 1997 until we changed the wording in the policy in 2000. So we had about three years of exposure there added.

OK.

In the other case, there's still some debatable issues there, but again, I think they're going--it's going to spike up. There have been some favorable cases coming down on the new issues that are getting to the court. It seems like we're getting the relief. These were on old cases decided by the prior court that the new court did not seem to want to overturn. So I think we'll see a spike up in the second quarter and then I believe it'll moderate again.

OK, great. Thanks very much, Jim. Appreciate it.

Thank you. Your next question comes from the line of Stephan Petersen of Cochran, Caronia Securities.

My question's for Ken Stecher, and I think you touched on it in your prepared remarks, the variance that we saw in your commercial multi-peril and how much of that was from adverse development?

Stephan, I quoted on the workers' comp, the commercial, auto and umbrella/

Oh, OK.

Umbrella, you know, we did see you know, quite a bit of improvement there, and also on the commercial auto.

OK, well then can you talk a little bit about commercial multi-peril, and the difference from the year-ago? Loss ratio of roughly 57 to this quarter's just shy of 69. Is there, there's no development, adverse development in there? Is there a few large losses or something?

The, just give me a second, I'm trying to, I know the multi-peril casualty is still giving us trouble. It's producing an estimated combined, you know, over 100 percent. So we still have that.

The casualty line did have some adverse prior year development of about seven percent and that's on about $58 million of earned premium.

OK.

So we are seeing some development there.

OK, I just needed clarification there. I'm just trying to separate sort of a run rate from what might be going on for past accent years. So that's my only question. Thank you very much.

You're welcome.

Thank you. Your next question comes from the line of Charles Gates of Credit Suisse First Boston.

Hey guys.

Hey Charlie.

I actually have, I guess, four questions. The first question, the reduced disclosure a function simply of this new concern with regard to quality and making sure everybody has the same thing at the same time.

Charlie, I think you're referring to Regulation G where we have to give a reconciliation of all items that are provided, all information that's provided on non-GAAP measurements. I think, is that what you're referring to?

Yes sir.

Please?

OK. I didn't know that was Regulation G.

Yes, and that, there's a couple reports. One was the one that would take you through all the statutory numbers and then we would throw in, we would list as one item, one line item, the GAAP adjustment.

That was awesome.

That report - we will work to develop something else that will replace that. The problem we have right now is it's hard to go from statutory to GAAP and do all the reconciliation's. And we just, to be honest, we just ran out of time with providing all that data. So we will work toward replacing that.

OK. My second question. One of you alluded to new entrance in your market, or companies coming down. Was that, was that a reference to companies such as I guess St. Paul, and to [Inaudible] Travelers in the Hartford? I say St. Paul only from the standpoint that I guess it was 15 months ago that Mr. Fishman (ph) decided he wanted to write smaller accounts?

Yes, Charlie, this is JF, if I made that comment, St. Paul is the more notable one because in our competitive marketplace they had pretty much taken themselves out of that marketplace and have gotten back in with a bit of a splash. Travelers and Hartford are at about the same levels they've always been.

But the St. Paul is the new guy on the block?

They're the ones that are introducing themselves, or reintroducing themselves. Everyone else, we compete against, which are primarily the regional carriers have been, and will continue to be in that small account area.

Fifteen years ago, wasn't St. Paul a leader in what they used to call back then BOP, Business Owner Policy or is my mind slipping?

I don't know about that. I don't know...they were a player. They were much more of a player than they have been recently.

OK, so they were there and then they leave and now they decided to come back?

It seems so.

OK. My final question, one of you, and maybe this is a J.F. comment also, one of you pined that you saw basically I think rate increases on the high-single digits for new risks, double digits for renewal risks and I got lost somewhere in that discussion.

OK. Our renewals, coming off of three-year policies are in the double-digits and are still in the 15 percent range.

OK.

What the marketplace is seeing, and what our agents are telling us they're seeing on renewals is more in the high-single digit levels.

You mean like eight, nine.

Yes.

OK, but you guys don't write, you don't really have any D&O to speak of, do you?

Not, obviously not the level of ...

You had it for that thing down in Birmingham about three years ago, but fortunately I don't think you have that anymore - Vesta, didn't you.

Correct, we're not on that any longer.

Yes, OK, but going on, you're not really a player for D&O, you don't write medical malpractice. You don't write the more complex casualty liability risk, do you?

No medical malpractice and right, we would not consider ourselves a market in the complex AI, if I recall the AIG types of risks, very complicated risks. We do write some non-profits D&O for the non-profits primarily.

This is my final question. To what extent do you see in your marketplace at all the ramifications of these 15 new property casualty reinsures created post the 9-11 event? What am I referring to? How about things like Arch?

Ken, I don't know, do you want to grab that one?

Oh, let, may I try that one J.F.?

You bet.

The Bermuda property catastrophe reinsures are well capitalized. There are a lot of new investments have gone into them. They help us on our property catastrophe treaty, Charlie.

Yes sir.

But not so much on our working treaties that help support our regular flow of every day business. The property cat carriers, you see more and more influence coming to Bermuda from London. They're still a notable influence in Western Europe, and I would say there's also some important influence in the U.S., and that kind of is the way we divide up the participants on our property cats treaty. And we see these new entrants in the last two years now, last year-and-a-half, being helpful in our reinsurance, our property cat reinsurance buys.

We, I don't know how quite to say this, so I don't say the wrong thing, but we had a good experience a couple months ago with the renewal of our property cat treaty. So we think we're in pretty good shape. We think that market's in pretty good shape, too, but remember they haven't had any storms for a couple of years. And when they don't have storms, they look wonderful.

And people annualize it.

That's, well that's right, you think, because there's an absence, you think they're never going to happen again. I don't want to start talking about storms on this call Charlie. I think you understand why.

Thank you very much sir.

All right. Thanks.

Your next question comes from the line of Ron Frank of Salomon Smith Barney.

Hi everyone. I've got a handful too, if it's OK. First I wanted to explore this issue of the auto loss ratio a little more. It - the GAAP loss ratio ex caps that you addressed, Ken, it deteriorated over 200 basis points. And it just seems to me that that's kind of a steep decline before you could convince the departments to give you some rate relief. And I'm wondering why it got quite so far as to cause that kind of year-over-year deterioration before either you filed for the relief of before the departments gave you a break.

Ron I can't speak to the timing of our rate increase request, but in the first quarter numbers there are about four points of that Loss and LAE number that related to prior development on the liability side. So maybe the fact that some of this developed a little slowly may have impacted our ability to get the rate request in or get it approved a little sooner.

OK. It doesn't seem that prior year development in auto has been a big issue for the peers for a while. Is there a reason you can identify that it would have showed up relatively late on your book?

At this time, I can't, no.

OK. Next thing, I guess is for J.F. J.F., you talked about the new business a little bit and the idea of sort of testing the waters in terms of rate, trying to get the maximum rate that you can and it's interaction with new business and that there's an uptick perhaps coming in second quarter.

Is - should I read into that that maybe, you know, here and there you overreached slightly on rate and that you've made an adjustment for that?

Yes. That's a good assessment of it. I think everyone was trying to hold the line on tougher rate increases and have found that for the very good accounts our - the competition out there isn't raising rates at renewal nearly the level that they were. Not, therefore, not bringing those accounts into the marketplace with as much frequency. And so to write the very best of accounts, we're going to have to be a little bit more aggressive with the price.

OK. But presumably you still think you're well in line with need?

I think so, yes. For example, our package new business is up 2.3 percent over last year and last year's first quarter was a very good first quarter. So, no we're not pressing the panic button at all there.

OK. Back to Ken, if I may. Ken, you may have addressed this, buy why does the CMP liability trend in terms of the loss ratio, deviate from the other lines so much?

Ron at this - I'm not quite sure, I'm sorry, on that one either. We are studying the developments and we're looking to see if there are some things that possibly were indicators that we didn't pick up on. But at this point I don't really have a good answer for you, I'm sorry.

OK. No problem. Maybe we can follow-up.

And then lastly on UIM, you know, I think it was Jim who mentioned that it's expected to spike a bit second quarter and then settle down. I just want to make sure I'm clear on this. Do you think your reserve for that spike or is that an indication that we should expect that to affect earnings in the second quarter?

Ron, we still have, I think, about $22 million in the IBNR and depending on what happens in the second quarter, we'll have to wait and see if that's going to be sufficient. I do think it will - I think will spike up over the third and fourth quarters of last year.

OK.

And probably a little bit more than the first quarter of this year. What the unknown in that is that we're not able to track positive development until the end of each month.

Yes.

So even though we've got reserves going in and some increases going in, we don't get the positive development report till the end of the month. So some of it'll be coming down; I don't know how much.

Right.

That's what happened in the fourth quarter; we had quite a bit of positive development and ended up with a negative. So, just--it's hard to tell how much of that we'll get until the end of each month.

All right. But you weren't sending some big signal regarding the level of IBNR is my sense.

No, not at this point.

OK.

Ron, if I could just add, you know on the CMP casualty question, it is coming from the year 2000, we've identified that, but I haven't been able to go back to say a specific risk or what might be driving that.

To some extent fair to say it's...some of the...just bottom of the cycle stuff?

Possibly.

Yes, OK. Thanks very much.

Thank you. Your next question comes from the line of Mike Dion of Sandler O'Neill.

Good afternoon, all. My question concerns Workers' Comp and is your deliberate decision to write less Workers' Comp having an impact on some of your top-line growth? And if so, how is the outlook for the rest of the year kind of affect those growth assumptions typically as it pertains to Workers' Comp?

Ken, you want me to take that?

Yes.

Our new business on the comp, for example, was down 31 percent for the first quarter and it was down substantially in the first quarter last year. We've chosen to non-renew some very large Workers' Comp accounts where you have the aggregation of employee issue that's related to the terrorism issue. So there's a variety of those issues at play here. We're simply being more conservative in the comp area. I would--but we still write a good bit of it and we'll continue to be a writer of comp. The degree to what--to which that will affect our overall writings, in other words if we don't write the comp, will we then be precluded from writing the rest of the package, right now isn't surfacing. There's still mono-line carriers out there that will write that business. We're just of the opinion at this point that there's so much volatility on the comp line we're better off to be conservative in that area and if our agents can put the comp business with a mono-line carrier and then reward us with the package business and the umbrella and the auto, we're very satisfied with that.

And if rates were to change on comp to make it more attractive, would you then include that in your package accounts, is that...

We're constantly reassessing that; we take a look at that sometimes on a state-by-state basis where the environment there we think is either better or worse than others. But certainly, yes; if rates were to go up, that would certainly affect our opinion about writing more business.

Great. Thank you.

Your next question comes from the line of Dave Sheusi of J.P. Morgan.

Good afternoon, everybody. How's everybody doing?

How you doing, Dave?

Hi, Dave.

Good. Just a couple of quick questions here. I mean, we've talked a little bit about the top line, we understand why things happened like they did; you know rates appear to be decelerating, competition's up, new business appears to lag, you know, I guess year-over-year. Maybe we can kind of address how you're thinking about the business, you know, 12 to 18 months out how you're going to regenerate, or at least sustain current growth levels. And so that's my first question.

And my second question is surrounding the investment losses, about $10 million related to the fluctuation in market values, the embedded options and convertible securities. Can you talk a little bit about the sensitivity of that and how you guys look at that portfolio on that piece?

If you like, I'll take the growth question first. One of the strategies we have to continually improve the picture for us is the splitting of our territories, which enables our field underwriters to spend more time in each of our agents' offices. We did so seven times last year and the benefits of that we think will present themselves as this year goes on. And we do have plans for anywhere from six to eight territories, depending on us finding the proper field underwriter this year and earlier next.

So I think in terms of us accessing business through the right agents in the states where we operate, I think the opportunities are there. We continue to see consolidation of agencies where there are larger agencies, which create more opportunities for us.

And so like I say, it was disappointing to see the moderation of the growth level in most commercial lines for us in the first quarter, but we're getting some signs that we can continue on with strong new business growth.

And just to remind us, how many territories do you have to date?

84 right now.

OK.

We opened on in North Carolina. We're in 31 states, 84 separate territories.

And I guess on average, how many field representatives are allocated to each territory?

One per 84, in other words, we have 84 field underwrites, field reps that underwrite and price all the new commercial lines of business we write, as well as promoting all the other lines of business.

OK, great.

Dave on the question on SFAS 133, this is Ken Miller. We did book the embedded options of $10.2 million loss for the quarter. You know, we attribute that to the lower interest rate environment as I had discussed in my initial comments.

We do think that when interest rates start to rise, that we will see less going through other comprehensive income. For the quarter we had just under $13 million in gains, and other comprehensive income, and that's tied directly to the underlying host, whether it be the bond or the preferred stock.

We think as interest rates rise, you'll see a reverse in that pattern, and so we still like convertible securities. It's a large part of our thought, although not a large portfolio in and of itself. We are running about $450 million I think through our portfolios right now.

Great. Thank you.

You're welcome.

Your next question comes from the line of Paul Newsome of AG Edwards.

Good afternoon. Just a quick question, I was wondering if you could just revisit your comments that you've put most of the cash, new cash into bonds, but sort of regretted that. Could you just review with us, kind of how you want to allocate your cash flow and if maybe that has changed or not changed in the past?

Sure. Paul, this is Ken Miller again. It really hasn't changed. Historically we've been on the equity side, 30 to 40 percent. We would like to see that number continue. On the fixed income side you would be looking at 60 to 70 percent. This particular quarter, the number was, I think slightly over 90 percent. In large part, there were two factors that were involved there. One, the first being we made some late end-of-the-quarter sales of some securities, I'm going to and by late quarter, I'm talking specifically about the month of March. And we didn't have an opportunity to reinvest those funds.

The other item that I alluded to is in one, The Cincinnati Insurance Company, which is the largest subsidiary, we have some internal guidelines that is more strict than what our statutory needs would be for the state of Ohio, where under certain circumstances we have to limit new equity purchases. We've bumped into those guidelines for the first time here in recent history.

And so we're taking a peak at that and I think as the market rebounds, some of that should correct itself and when it does, we'll be back into the equity markets just as we always have been.

And just another sort of housekeeping question. You know, I noticed the dividend keeps going up, which is wonderful, but it's also a pretty high payout ratio, especially compared to net income. Are you, you know, what is your thoughts on continuing to increase the dividend?

Dave, I mean Paul, this is Jack Schiff,Jr., I think the dividend's very important to our shareholders. We treated it devoutly, very religiously. We think our operations are moving in the right direction. The one thing that we don't talk much about that I think supports our operating strength is that we have a good reserving policy, a very strong case reserving policy, and that we've reinforced over the last couple of years or so. And when we show the earnings that we do, we feel that we're able to raise the dividend with comfort and still plow back good new purchases that are going go build long-term for our company.

Now also recognizing that most of an insurance company's bottom line profits comes from investment income, and with the bond interest rates, dropping as they've done in the last six to eight months, I think we're going to have a challenge to get the kind of cash flow from our investments that we've received in decades prior to this. So it'll be interesting for us to watch also how we're able to increase our net income so that we don't pay out a prohibitive percentage of our earnings and dividends each year.

Great. Thanks.

OK, and if you would like to ask a question, please press star and 1 on your telephone keypad.

We do a have a follow-up question from the line of Charles Gates of Credit Suisse First Boston.

Hi, I've got three more questions. First question, how do you envision your place in the market with sale of personal auto insurance, versus that of Progressive? When I think of progressive now I guess they've got 40 percent of their business through the direct platform and you have this all progressive.com and the 1-800-Autopro. How do you vision your place in the auto market versus that?

Jack, do you want me to take that?

That'd be great, J.F., thank you.

Charlie, I think when it comes to what our agents do with personalized clients, they continue to, we feel still have a good opportunity to write their business. Progressive is a darn good competitor. They're writing standard business and preferred business now in the marketplace, we think very effectively.

Where we think we shine with our agents is the quality of claim service that we offer to the personal clients that they're doing business with, and that while Progressive will continue to provide very good competition, we think we stand a good chance continually of earning the business from the independent agents that represent us.

Second question, if you were to go back in history - and maybe this is an inappropriate question - but if you were to back in history and trying to find a period of time similar from a commercial lines underwriting standpoint to what you guys got now, what period would that be?

J.F., would you try this one again, too?

Well, I - Charlie, I guess 1986 was a time when that was truly a hard market where I think more drastic pricing, more restriction in marketplace took place than it did here over the last year-and-a-half and continues to take here. It starts predating me a little bit to give [Inaudible] ...

OK. It's ancient history.

Well, I guess this is a firm marketplace, as Jack mentioned in his comments in certain lines of business and very difficult lines obviously the D&O the - you mentioned the malpractice ...

Yes, sir. Very tough.

... areas. But for the kind of business that most carriers write a lot of, it's firm but not desperately hard.

You had no exposure basically to the - what do call it? - the World Trade Center, did you?

No.

OK. My final question - then I won't ask another one to you - what's the status or how is Jimmy?

Oh, Jim Miller is fine. Ken, you want to comment first, or shall I just go ahead.

Charlie, I think Jim is doing very well. He's - he has spent the biggest part of the last four months down at his home in Florida.

OK.

He is probably in the process of driving back today as we speak. And then I think what he'll do is spend the summer here. He's been very helpful I think in the transition and I actually was with him in February and then again in the beginning of April. So, he's doing quite well. He looks very relaxed as you might expect.

Thank you very much, sir.

All right, Charlie, somebody said that Jim Miller's handicap on the golf course dropped considerably in the last two months or so. I don't know about that. Those are just some of the rumors that I've heard.

That's wonderful. Thank you very much, sir.

All right.

I have a follow-up question from the line of Nancy Benacci of McDonald Investments.

Just a couple cleanup items here - looking at your 10-K and that page 51 on your outlook piece and based on what we've just heard on the call today, it sounds like you're being very conservative with sticking with the 99 sort of GAAP combined ratio considering what we saw in the first quarter and what you've indicated in terms of new unit growth starting to pick up as we move through the rest of the year and the other items. Can you talk a little bit more about your - you know, are there other lurking issues out there that you're just really concerned with? I mean I know obviously cats are - you know, nobody can call cats, but that's even with factoring in sort of the normal three points for the year.

Hi, Nancy. I think catastrophes are the biggest reason why we are being a little cautious with our guidance on the full year combined. That is the reason. As you know as the wind blows in the second and third quarter predominantly, that can dramatically change our results. We have to continue to monitor, as Jim has said, the Ohio UM/UIM issue. But I think that catastrophes, as far as I'm concerned, is the most - is the biggest thing that we have to watch.

OK. And then--that's definitely fair. And then just, Ken Miller, if you could just clarify your use of new money right now, where it is in terms of length of investment, just to clarify again?

Sure, Nancy. In the bond area, you know in the first quarter roughly 90 percent of new money went into fixed income purchases. Probably 60 percent of that, maybe slightly higher, was in taxable. And what we're looking at there are bonds in the seven to ten-year range, fairly high quality. You know we have purchased some agency, government agency bonds for what is the first time. We actually find those somewhat compelling right now when you look at the spreads between, say an A-rated corporate and where you can buy agency paper at. On the tax exempt side, we're buying in the, I would tell you the 8-12 year range, depending on the issue, and we think that that makes a lot of sense for us as well. Historically on the tax exempt side we were pretty much strictly 20 year buyers, so we have shortened that maturity and we think when we look at the after-tax spreads there that they look pretty attractive to us. You know we're buying, at those rates, tax or equivalents of probably 6.25 to 6.5 percent.

OK. And then just on the impairment issue - I mean certainly there don't seem to be absolute steadfast rules as to what determines what gets impaired and what doesn't. Can you give us a sense of whether you've become much more conservative and what you're going to--where you're going to impair and not?

You know the policy changes a little bit tweaking as we move forward. We actually think that we're in pretty good shape now. When we look at the number of bonds that we have--that are trading under 70 percent of--on a market value basis, that number has come down pretty dramatically in comparison to where it had been. And if you'll bear with me a second--if we were to impair every bond that we held that we're trading less than 70 percent of market right now, we'd be looking at a par value of slightly under $78 million and we would book an additional just under $32 million in losses. So we think that that's pretty good.

OK. And then just one wrap-up question.

Nancy, I might also add that when our second quarter Q comes out, we'll be giving--or the first quarter Q, sorry, we'll be giving some additional guidance there as well.

OK, great. That will be helpful. Then just one wrap-up for J.F.. We've had lots of discussion on this call regarding new business growth and, you know, concerns of where it is right now and competitors coming in this industry. And having just finished your swing of the country at the agent meetings, are you feeling still pretty comfortable I guess is the question, that what you're booking as business coming in, either new or renewal, is what you want to be booking at the right combine ratio?

We're really dissatisfied with the new business in the first quarter. It was discouraging to see that it wasn't up anymore than it was. But the quality of the business that we're seeing is excellent. I think the effort that our agencies are putting into selecting the right accounts, our field reps are doing a good job in that regard. I think our underwriters in the home office in terms of what they are or are not renewing, but to say we're 100 percent satisfied this isn't going to come out of our mouths. But the fact is that we're very encouraged about the quality of the business that we're writing.

We're just going to be out there digging for more of the new business, and having finished 24 out of 25 of those meetings, where you're talking to as many agencies as we are, we're not sensing any discouragement on their part or any sense of pessimism about what they can do with us this year.

So it was discouraging to see a little bit of a downtrend in new business in commercial lines, but we just have a lot of optimism that's going to turn around.

Great. Thanks for the clarification.

Nancy, may I add a word or two, this is Jack again. I think J.F. is overly modest in the way he talks about the reception by our agents to some of the things that we've asked them to do the last two-and-a-half years. I don't like paperwork and I think we've hoisted a lot of paperwork on our agents. I think it's had a desirable result, but I also think it's been very time consuming to get it done with the detail and the accuracy that we've requested. And my worry is that we've putting them into a paperwork habit, rather than a selling habit. And I think we don't want to change away from our view of wanting to get underwriting profit. I think we can keep doing that.

But I think the agents and J.F. and his field marketing people in combination with our home office underwriters have performed extraordinarily well the last 20 to 30 months. They've had to talk with policyholders on a case-by-case basis, and the questions that come back and the answers have questions and it gets into very lengthy things.

The results I think are quite extraordinary for what we're asking them to do. And I agree, do agree with J.F. that we're displeased that the new business is not increasing by a greater amount. But the interesting thing is the new businesses is in the range of, and J.F. will help me with this, but maybe in the range of $300 million a year and it's interesting that it's being sustained at that level.

And I think there's good opportunity for us out there. I think the agents welcome our view towards the system and the market that we offer, and I think we've got a pretty good future along this line.

I don't know J.F., you might want to add even something more to what we talked about.

No, that would be my sense. We're going to monitor how things flow in the next couple months, but I think it's, you know, as Jack said, I think it's very encouraging.

Great. Thanks very much.

Your next question comes from the line of David Graham of Metropolitan West Capital Management.

Yes, I had to duck out temporarily, so I hope I'm not duplicating somebody else's question, but I wondered, you know, how far out can you see, you know the firmness in the property and casualty underwriting cycle continuing and why?

Well everybody wants to be able to answer that question with some degree of certainty. I think my sense would be that the kinds of increases that are the higher commercial lines increases that we're seeing right now, there seems to be a lot of confidence that that's going to be sustainable into the, I guess, mid, near to mid future. And why? I suppose every carrier's still seeing some effects of severity. There's still activity on the casualty lines, and as a result, I think loss costs will continue to go up, and there will need to be that kind of an increase moving forward.

In personal lines and the homeowner area, I suspect there's going to be a pretty firm marketplace going forward in that area and we've talked about the mid to high single digit increases in the private passenger auto.

Ok, thank you.

Our next question comes from the line of Fred Nelson of Crowell, Weedon.

This has been a very serious conference call, wow. How are the people that you lost to the service that were taken out, have they all survived? Have you got any feedback at all? That's something I'd sure like to know.

Yes Fred, we've got 7 active duty, all are well. We have one subject to call up in May, but we've heard nothing negative about any of it. We just are anxious to get them back.

That's real positive. Thank you for that. Your investment counseling business? How's it going along?

: Fred, it's going pretty well. At the end of the first quarter, we had 43 accounts and the assets under management were approximately $741 million about a 2 percent increase. But, things are going as expected. I think we'll start to see some fruits the marketing people that we hired. And they're making a lot of calls, I know that.

That's wonderful. At one time, you had some reserve for asbestos. That's not a very big liability, is it?

It hasn't changed anything at all, Fred. We think that the asbestos claims that we get are relatively where we had lower limits on reinsurance and we think right now we're ok with that.

A couple of questions coming to me here as the quality of the reinsurance companies raising their rates and the quality and their ability to pay claims, have you given much -- I know you've given a lot of thought to that, and can you share it all?

We've not had any problems at all. In fact, the claims we submit are paid promptly.

That's good. Well, thank you. That's all from me.

Thanks, Fred.

At this time, there are no other questions. Mr. Schiff, are there any closing remarks?

Yes, there are. Thank you everyone for joining us today. In closing, I want to reiterate that we see many positives in our industry and in our company. Cincinnati Financial and The Cincinnati Insurance Companies have built strong relationships, strong results and a strong outlook. We are in excellent shape and we look forward to continuing our record of providing value to agents, policy holders and share holders. Thank you.

This concludes today's Cincinnati Financial conference call. You may now disconnect.