辛辛納提金融 (CINF) 2004 Q3 法說會逐字稿

Good afternoon. At this time I would like to welcome everyone to the Cincinnati Financial Corporation Third Quarter 2004 Conference Call. (OPERATOR INSTRUCTIONS)

I would now like to turn the call over to Ms. Heather Wietzel. Please go ahead, ma’am.

Thank you, April. Hello, this is Heather Wietzel, Cincinnati Financial’s Investor Relations Officer. Welcome to our Third Quarter Conference Call. If you need the release, financial supplements, or other information and quarterly results, please visit www.cinfin.com for all of the information related to the quarter can be found on the Investor page under Financials & Analysis. If it’s more convenient, you may call 513-564-0700 to have a copy of any of this material faxed to you immediately.

On today’s call, Chairman and CEO Jack Schiff, Jr. and CFO Ken Stecher will give prepared remarks, after which we will open the call for questions. Before I turn the call over to Jack, please note that some of the matters we discuss today are forward-looking. These forward-looking statements involve 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, reconciliation of non-GAAP information is required by Regulation G, which is provided with the release and is available on the Investor’s page of our website under Financials & Analysis. Statutory data is prepared in accordance with statutory accounting rules as defined by the National Association of Insurance Commissioner’s Accounting Practices & Procedures manual and therefore is not reconciled to GAAP.

With that, let me turn the call over to Jack.

Thank you, Heather. There is no surprise in the level of losses from hurricanes and other weather events in the third quarter results we reported today, although we did see some benefits from favorable development from previous cuts. And we don’t think there should be any surprise either in how successful our agents have been in bringing us quality business and how well the underwriting results and efforts of our associates have worked out.

Despite the storms, operating earnings rose on a comparable basis. Our agents and Company associates deserve tremendous thanks for the positive results and trends they are generating through our shareholders. As today’s release says, we continue to believe those trends are paving the way to a strong performance in 2004 and an even better performance for the next year and beyond.

Results of the quarter were covered thoroughly in our release and I’m going to leave some of the details for Ken. I wanted to jump right in discussing 3 topics – the property casualty market, some follow-up on the financial strength and Investment Company Act topics of the past several quarters, and recent developments in New York and California.

First, to the marketplace. As we’ve seen in each of the last several quarters, competition and commercial lines market continues to ratchet up. Overall, net written premiums were up 3.7 percent after being reduced 1.5 percent by the reinsurance reinstatement premium. Commercial lines, net written premiums rose 5 percent with the restatement premium reducing the growth rate by 1.3 percentage points. Personal lines grew .5 percent, reduced by 2.1 percentage points by the reinstatement premium. Overall, new business reached the same level as last year’s third quarter with commercial lines up 2 percent and personal lines down 10 percent.

While market-by-market variations in the level of competition remain, we are seeing instances of aggressive pricing for a higher quality account. What we are seeing is poor accounts being priced by good accounts. Disciplined underwriting remains the norm. Our agents continue to tell us they can obtain account renewal price increases in the low single digits for most quality accounts. Naturally, there are geographic and class business variations. We have a strong appetite for new business, as we look to help our agencies succeed.

Our field team is there when the agent needs us. In particular, for the mid-sized accounts that require hands-on service in today’s market. They react quickly, helping to accept the quality of risks and to differentiate our agents from their peers. They’re in the agent’s office and the policyholder’s place of business. Our field claims staff continues to make outstanding contribution on catastrophe teams and also on a day-to-day basis. Their efforts are supported by field specialists in key areas, such as Worker’s Comp claims, construction claims, special investigations, and loss control.

Our strong local presence is good for policyholder and the agent and good for our underwriting efforts. It puts us in a position to insure that our premiums continue to be appropriate for the covered risk, not just for the new business but also for renewal. We involve the field teams in renewal interviews, working closely with our agents and headquarters underwriters.

Today’s release revisits our plans to continue subdividing our field territories, both to enhance service within our current agencies and to create opportunities to appoint new agencies. We see these steps as key to meeting or exceeding property casualty industry-level growth over the long term.

Now, turning to personal lines. First, this quarter took us another small step closer to our goal of restoring profitability to this business area. Second, it also puts us well into the process of deploying Diamond, our new personal lines policy processing system. All personal lines agencies in Indiana, Ohio, and Michigan are now using Diamond. These agencies represent more than 50 percent of our personal lines premium volume and are writing about $1 million in new and renewal premiums daily on the Diamond system.

Our Diamond team deserves recognition for their work, as do the customer service representatives in the agencies. We now can process all personal lines of Cincinnati business on the system. Taken together, the emphasis on profitability and the time spent on the introduction of Diamond have put pressure on our personal lines growth, particularly new business. At the same time, our personal lines retention rate remains above 90 percent, showing that current policyholders recognize the value that their agents and our Company bring to the table. We expect to make headway and continue to be fully committed to the personal lines business.

Now for a brief update on the subject of financial strength and the Investment Company Act. In August, we announced the transfer of 32 million Fifth Third shares on the holding company to the property casualty company, leaving 27 million shares at the holding company level. The transfer moved our parent company ratio of investment assets to total assets to 35.7 percent at September 30, resolving our status under the Investment Company Act of 1940. The asset transfer did not change our objective for our property casualty (technical difficulty).

The quality of our surplus supports the predictability viewed by rating agencies as one of our Company’s primary strengths and by agents as a competitive advantage. We were working to achieve that objective by modestly adjusting the ratio of equities to property casualty surplus and by managing our catastrophe exposure.

In that regard, in the second quarter, the property casualty company had sold $350 million in equity securities and completed a $150 million exchange with the parent company, giving it some equity holdings in return for bond. We also temporarily allocated investment dollars to fixed maturities and convertible securities. We continued that investment allocation in the third quarter, but would stress that we still had the same long-term investment philosophy. Even before the asset transfer from the parent company, our property casualty group had generous capital and transfer was not a means to accelerate growth or strengthen policy reserves. Rather it maintains for the entire organization the financial flexibility that supports our high financial strength rating just as it did when the capital was held at the holding company.

Before I wrap up, I want to comment on the recent headlines about the insurance industry. While Cincinnati insurance has not received any official inquiries or information requests, we are reading the headlines just like you are. We are disappointed to see the insurance industry’s reputation suffering. In general, we do believe there are a lot of important definitions and distinctions that must be made and will be made. Most observers believe there are clear legal differences between the relationships of insurance buyers with their brokers who generally collect fees from buyers versus relationships of insurance buyers with sales agents who collect commissions from insurance companies. That said, most of you know that Cincinnati has been very open about our payment of contingent commissions to the independent agencies that contractually represent us. Unlike the placement service agreements that have been in the news, our contingent is based on the agent’s entire book of Cincinnati business. We primarily reward agents for being consistently profitable and for paying their accounts promptly. It’s a standard agreement used for all of our agencies and based on our own formula.

We believe our agents are in the best position to know which carrier is going to be the best match. All things considered to insure their local families and the small and mid-sized accounts we underwrite. We see plenty of very real healthy competition for this business from other carriers our agents represent. In our experience, the independent agent marketplace where we operate recognizes many competitive factors, including financial strength, claims service, price, and coverage differences.

Professional agents make complex choices and aim to build lasting relationships with the people in their community. Their reputations and futures are directly tied to their local community and we believe that those close connections support the choices. I will also note that we have more than 1,000 field representatives in those communities where we can observe how agencies interact with their customers. We regularly review the provisions of our agency compensation agreements and keep them up-to-date, competitive, and fair. We will continue these regular reviews.

Let me end my comments on this subtopic by saying we are proud of our agents and believe they earn the commissions we pay them. We compensate our agents for the results of fair, honest, and professional business services that foster customer loyalty and carrier loyalty as well.

Now to get back to our excellent results and outlook, here’s Ken.

Thank you, Jack. It’s a pleasure to speak with all of you today. I’ll start with a few comments on premiums and then talk about property casualty profitability, investments, and the balance sheet as well as our outlook and targets for 2004 and 2005.

The change with premium estimate adjustment, which we discussed last quarter, had a much less significant impact on third quarter premium growth rates. Details on the premium estimate amount for the quarter are in our financial supplement on pages 23 through 25. The estimation process remained in line with last quarter’s discussion. However, premium growth was reduced by the $11 million of reinsurance reinstatement premium. The reinstatement premium restores the layers of our catastrophe (treaty) (ph) that were capped for Hurricane Ivan losses.

We provided a lot of data on the third quarter catastrophe losses over the past few weeks, so I will just summarize the effect of those losses and the reinsurance reinstatement premium. And note that we did have savings from some prior period events. For commercial lines, third quarter catastrophe losses were $48 million, contributing 9 percentage points to that line’s combined ratio. Personal lines of catastrophe losses were $38 million, contributing 19.3 percentage points to the combined ratio. The non-catastrophe large loss results were favorable with lower loss expenses on a larger book of business. You’ll recall that data includes losses and adverse developments of above $250,000.

For commercial lines, the third quarter GAAP combined ratio was a strong 91.4 percent, even including the catastrophe losses. Although the 3-year commercial re-underwriting program is complete, we are continuing to apply the broad-based underwriting and re-underwriting approach, both at headquarters and in the field. It’s paying the dividends we expected it to pay. The details of the lines of business are in the financial supplement on page 26.

A couple of observations are the commercial multi-peril bore the brunt of the commercial line’s catastrophe losses, which contributed 23 percentage points to this business area’s third quarter loss and loss expense ratio. Year-to-date, that puts the effect of catastrophe losses 4.6 percentage points ahead of last year’s level. Highlighting the strength of our underlying efforts, however, loss and loss expense ratio for commercial for multi-peril, including catastrophe losses, improved 4.8 percentage points for the 9 months.

Other liability also had an excellent quarter. This line includes umbrellas so it tends to fluctuate with the large loss trends. As you compare a line of business data to other periods, keep in mind that the fourth quarter 2003 and the first quarter of 2004 results for commercial, auto, and other liability included a benefit from the UIM reserve release.

Now for personal lines. Results followed the seasonal pattern we’ve seen over the past several years with another small step toward our target performance levels. Looking on a 9-month basis, the combined ratio excluding catastrophe losses and the software recovery improved slightly to 97 percent from 98.4 percent. That change reflected a decline of 4.8 percentage points and the loss and loss expense ratio excluding catastrophes on improvement in both the personal auto and homeowner lines and .9 of a percentage point rise in commission expense and a 2.5 percentage point rise in underwriting expenses excluding the software recovery. The higher expenses primarily were due to refinements in our cost allocation processes. We are identifying more things that are directly charged to personal lines. This is one of the beginning steps in developing actual combined ratios by line of business.

Looking more specifically at homeowners, which has a seasonal pattern and underlying results as well as storms, at September 30 rolling 12-month loss and loss expense ratio excluding catastrophes was 69.7 percent compared to 75 percent for the 12-months ended September 30 a year ago. Jack talked about our ongoing programs and objectives for personal lines. But we must acknowledge that substantial improvement is still required to return the homeowner line to profitability.

For all property casualty operations as a whole, the third quarter expense ratio was 29.3 percent compared with 28.7 percent last year, excluding the benefit of the software recovery. This increase was the result of a .2 percentage point rise in commission expense and a .4 percentage point in the other expense ratio.

You may remember, last year we increased the contingent commission accrual in the third quarter. So the commission expense ratios are much more comparable than they were through the first half of this year. Our contingent commissions are primarily calculated on the profitability of an agency’s aggregate book of business, taking into account longer term growth with a percentage for prompt payment of premiums and other criteria.

From 1998 through 2002, contingent commission averaged approximately 1 point on the combined as the Company incurred underwriting losses. In 2003, the contingent commission expense contributed about 2 points of the combined as the underwriting profit rose to $117 million. This year, the accrual is running at about 3.6 percentage points, as we generated an annualized underwriting profit of $290 million.

With the major technology initiative still in development, specifically our future commercial processing system and phase 2 of our new claim system, we capitalized an additional $2 million during the third quarter. It looks like the full year capitalization costs will be under $20 million compared to the $23 million we were anticipating. Technology depreciation in the quarter had .2 of a percentage point impact on the combined ratio and less than a 1 cent impact on earnings per share. For the full year, we would expect the impact on the combined to be less than .3 of a percentage point with a per-share impact of about 3 cents.

Briefly, for life we reported a decline in net income, including realized gains and losses, due to realized losses from the sale of airline bonds and a (FAS) (ph) 133 adjustment. On a year-to-date basis, the life cycle of this contribution was $24 million or 14 cents per share compared with $14 million or 9 cents per share last year.

Now turning to investments. Pretax investment income grew 6.1 percent in the third quarter as we continued to benefit from dividend increases by companies in the common stock portfolio and higher interest income from the cash flow invested in bonds. In light of the strong year-to-date growth in investment income, we now believe that the growth rate for the year will be above the target we initially set.

Realized losses in the quarter were primarily due to impairment charges, as we wrote down several airline-related bonds and the FAS 133 adjustments. With the increase in quality of the bond portfolio overall, impairments going forward should continue to mainly be securities marked to market because they have been identified for sale or classed with those related to issuer or industry-specific events.

Book value at September 30 was $36.21, off 6 cents from June 30, and 64 cents from year-end, primarily reflecting equity portfolio market value fluctuations. During the third quarter, we continued to use available cash to purchase primarily fixed income investments. As Jack mentioned, the short-term allocation strategy was intended to enhance the quality of the property casualty group’s strong surplus.

Our investment committee and investment department continue to evaluate potential equity purchases and anticipate the return for historic allocation sometime in the first half of 2005. Our equity investing strategy has been integral to our Company’s long-term success and book value growth. Our current holdings, which we closely monitor and evaluate, are making a significant contribution to current income through dividends and dividend increases and they hold the potential for future appreciation. A resumption of equity investing will enhance the potential for long-term shareholder return.

Jack already mentioned the portfolio actions we took in the second and third quarters. As a result of the additional allocations to fixed income purchases, the second quarter equity sales and the market value change for Fifth Third fixed income securities on a cost basis represented 66 percent of the total consolidated portfolio and 37 percent on a market value basis at September 30.

For the property casualty companies, the ratio of common stock to statutory surplus was 106.7 percent at September 30, above the targeted level because of the transfer of Fifth Third shares from the parent company.

We also believe we remain well-positioned for the anticipated rise in interest rates with continuing strong cash flow for investment. We used $12 million for CFC stock repurchase this quarter, buying almost 300,000 shares. At quarter-end, we had $311 million in cash on the balance sheet after using $208 million for new investment during the quarter. We’ll continue to look for appropriate times to repurchase CFC shares while investing on the fixed income side for another quarter or so.

Before I turn the call back to Jack, let me quickly summarize the comments in the release regarding our outlook, which is highly favorable. Net written premium growth in the third quarter slowed slightly. That, along with continued perspective from our agents, has caused us to moderate our expectations for full year growth. Based on the commercialized 9-month growth rate of 7.4 percent, which was lower by .4 percentage points by the reinstatement premium, we think the full year growth rate for commercial lines will be below the 10 percent we were targeting. As a result, we’re now anticipating full year growth from the entire property casualty business closer to 7 percent versus our previous high single-digit target. For the year, we are looking for even better profitability than we initially anticipated, despite this quarter’s catastrophe losses.

Assuming minimal catastrophe losses for the fourth quarter, there have been none so far, we’re looking for the full year GAAP combined ratio to come in slightly below 92 percent or 91.5 percent on a statutory basis. Keep in mind our 2004 target includes about a 1 percentage point benefit from the UM UIM reserve release in the first quarter.

While it’s a bit early, we think we can do even better in 2005 and we won’t have the benefit of the UM UIM reserve release, assuming the catastrophe losses are in the more normal 3 to 3.5 percentage point range. As I mentioned a moment ago, we also believe that investment income growth will be above 4.5 percent this year. Taken together, these anticipated results would make 2004 another record year with the steady growth and industry-leading profitability that is our long-term objective.

Jack, back to you.

Thanks, Ken. I started this call by thanking our independent agents and Company associates for their efforts to build the long-term future of our Company. I want to conclude the same way because I simply cannot say enough about their dedication and focus and professionalism. As shareholders, we are seeing the results of their ongoing efforts.

Year-to-date, net income is up 60 percent. Operating income on a comparable basis is up 38 percent. And dividends declared by our board are up 11.5 percent. 2004 is looking to be another record year and 2005 and beyond hold great promise. I might add that there’s some others present here with me today along with Ken and myself. You should be aware that Jim Benoski, our Vice Chairman and leader of our headquarters claim department is present, and J.F. Scherer, our SVP in Sales and Marketing, is also here for your questions.

(OPERATOR INSTRUCTIONS) Michael Dion, Sandler O’Neill

I just wanted to get a little more color on the comments, both in the press release and on the conference call, about increased competition that you’re seeing. Maybe if you can be a little bit more specific in terms of size of account or type of business line, etc.

Mike, size of account does have a bit of a difference there. You probably read a little bit from the Council of Agents & Brokers where they were talking about some substantial decreases in some renewals. And that really isn’t the marketplace we operate in. What we’re seeing overall as far as renewals are concerned is still mid-single-digit increase capability. It is true, and what everyone’s talking about is that when it comes to new business there’s a more aggressive marketplace out there. You do have to be more aggressive to write new business.

Our Company does write its share of larger accounts and where we see larger size premiums accounts. We’re seeing on property driven accounts and the property section of those accounts anywhere from a flat to perhaps a 10 percent decrease on the rest of the lines, anywhere from a -5 to +5 renewal increase. Worker’s Comp, modest increases are prevalent; auto, flat to up by 5 percent. So there is a lot more competition out there, but we’re finding that when it comes to renewals we’re still able to place modest increases in pricing there with a fair amount of more competition on new business.

And J.F., would it be fair to say that there’s a little bit more competition on the larger account than the smaller account? How would you classify the size?

The size is a big factor there. I think when the market firmed up, the pendulum of tougher pricing swung quite afar to the stronger side on those larger accounts. Larger accounts always attract more interest. As a result, you’re seeing more competition there.

Stephan Petersen, Cochran Caronia.

You might return to sort of the hot news of the last couple of days, which is the agencies that serve California thing. And J.F., I was wondering if you might be able to provide a little bit more detail in terms of the agency agreements that you enter into with the representatives of your Company? Specifically, maybe whether or not you think Ohio, Michigan, and Indiana would be more akin to what Mr. Garamendi thinks the role of an agent is versus a broker? And a little bit more detail about agents versus brokers in general in terms of your world. I guess I would follow that up with a question as to whether or not an agent that plays business with you could also act in the role of a broker possibly with another carrier.

Yes, there is a lot of debate about the definition of an agent versus a broker. I would say first of all that our contracts with our agents are in the capacity that they are agents for us. Some states have a relationship, a defined relationship, of a broker and a broker license versus an agent and an agent license. We have no broker licenses. By definition, an agent represents us.

In the marketplace, even in that capacity, when they call on a policyholder, they talk to the policyholder about the fact that they also represent them and that they will provide them advice and do the best that they can to provide guidance in terms of carriers that would be selected and the types of insurance programs that would be put together. So I guess there is a bit of a definition problem country-wide in terms of broker versus agent.

It seems that most of this investigation is centering on the broker. As Jack said, by definition, receives their compensation direct from the policyholder. And in many cases, sign, as you are all aware, disclosure agreements that say to the policyholder what they’re receiving in the form of commission and what their duties will be. That’s really I guess a part of the insurance business that we don’t operate in. Placement service agreements, I’d never even heard of one before all of this came up. So it tends to be more akin to very large accounts and in the broker world.

As far as our arrangements are concerned with our agencies, we have one contingent contract. We have no special contracts for large agencies or small agencies. All 975 of our agencies have the same contract. It’s heavily weighted to profitability, as we’ve said. There are some small growth components in it, but from our standpoint what we try to incentivize with our agencies is that we can write highly profitable business over a long term, not declining in premium, and then we do reward the agent paying their account current to us in a little bit more of an accelerated fashion than what they would ordinarily pay.

I hope that answers, Stephan, kind of where you’re heading with that. I’ll be happy to answer any questions.

Yes. Would it be possible to find yourself in a situation where one of your agents might be acting as an agent for Cincinnati Financial and possibly acting as a broker for a competitor? I mean would the typical agreement that your agents sign be similar to what he or she would sign for the other carriers in his shop? Or is that just sort of negotiated on sort of a one off basis?

As you know, our competition tends in the lion share to be with regional carriers, local carriers. I think you’ll find that we all (technical difficulty) basis. That our standard commission contracts are pretty much the same. And the contingent or profit-sharing contracts that we all have our agencies sign and we offer to them are generally the same.

Is it possible that one of our agencies could also, if you will, be representing another carrier in a slightly different capacity or in a broker capacity? I suppose it is possible. Once again, I go back to the kinds of policies we write. Roughly 90 percent of our policies are less than $10,000 in (inaudible – cough). And so you don’t see that kind of activity in the small account arena, even the middle-sized premium arena, that we generally operate in. So it would be very rare. But to answer your question, I guess it’s possible.

I’ve got a couple of other questions, but I’ll get back in the queue.

Kelly Nash, Key Bank Capital Market

First, I wondered in your discussion about competition in the current marketplace, I wonder if you could touch on terms and conditions and if you’re seeing any pressure there?

Kelly, that’s the one, I guess, real positive thing that we’re seeing is that carriers are underwriting. Terms and conditions are generally staying pretty tough. Where you see activity tends to be more in just how aggressively priced people choose to be.

And then looking out into the next year and kind of where you see the rest of the cycle turning at this point. What are your expectations regarding next year as far as the overall marketplace and pricing?

That’s a crystal ball question. The events in Florida with the hurricanes, some are speculating that that might firm up the property market. I doubt that it will firm up the Iowa or Illinois or Wisconsin property market. So I think overall we’re anticipating with –- as far as the competitors we compete against, they’re all doing pretty well. Their loss ratios are down low. They’re feeling confident. So we’re anticipating that there will be a fair amount of competition still in the marketplace. I wish we could quantify just exactly to what degree that it will be there. Certainly from our standpoint our focus is to talk about the reasons why people buy insurance other than price. Things like an A++ rating, the 3-year policies that we use, the great claims service we have, the consistency with which we approach things. These are all the factors that also are taken into consideration at renewal time and also at new business time. So I know that it’s going to be competitive. We expect it to be that way and we’re just trying to gear up with all the factors that enter into the insurance sale.

And then finally one last question. Regarding claims cost trends, are you seeing anything unusual there that would give us cause for concern?

This is Jim Benoski. We haven’t seen anything other than the normal inflation. We saw some increase in claims costs on materials in the hurricane area. But generally nothing that would be of great concern.

Meyer Shields, Legg Mason

I have two questions for you. First of all, within the life segment, if you compare (inaudible – clearing throat) quarter results in 2002 on a gross basis, losses and benefits of the ratio of earned premiums are a lot higher than they were back in 2002. Is there anything driving that?

Meyer, I just think it’s basically the fact that our life (indiscernible) is increasing at quite a great rate. I know the mortality costs have been fairly stable. So I think the increase in life reserves is included in that number. So as our business would continue to grow that number would be increasing. But there’s nothing else that I’m aware of that’s going on there.

Okay. This is a little complicated. Let me see if I can get it out right. In the press release on page 5 you talk about written premiums of about $1 million a day for the agents that are on Diamond. Is that the production rate when they are completely adapted?

Meyer, those are the combination of renewal, premiums, and new premiums that we’re putting on the system. That’s evidence of the ability of the system to absorb that kind of production inflow within a day’s time.

Okay. Because what I was trying to do, and maybe this makes no sense, I’m hoping you can clarify it for me, is if you annualize that and you double it for the balance of your book of business then that gets you, let’s say, $2 million a day over the course of a year, $500 million in production. That’s a lot lower than last year. I’m sure that that’s wrong and I don’t know why.

I haven’t done the numbers as well as you have. We will still have a number of states who will not be on the Diamond system at the end of this year. And if they are on they system, they will be newly on the system just learning the education to it and the system. It will take a while for all of our home and auto policies to be fully engaged on Diamond.

Okay. And there’s obviously other production going on that’s not included in that number.

There is production going on, but I think the accurate reflection in our prepared tax is that our new homeowner auto premium is down from what it was last year. The overall revenue for a homeowner/auto is up. But on a new account basis our premiums are down.

Okay. Got it.

George Largay, Dawson-Herman Capital Management

I had two questions relative to these contingent commissions. I was wondering, in a profitable year like 2004, what would be the maximum percentage that a contingent commission could represent to an agency? My second question is that on the surface, just as an insurance buyer, it would seem that any price reduction agreed to by an agent would directly reduce the profitability of an account, would directly reduce his contingent commission, and would also seem to create an inherent conflict. I’m just wondering what your thoughts are on that?

It’s an interesting question, George. First of all, it’s difficult to guess what the agent’s overall income and office expenses are and how that might equate to the contingent commission. Some years an agent might expect to get a large contingent because he used his business very profitably. But because of reserve increases that occurred during the year on a loss that might have happened two or three years earlier that reserve would tend to decrease the profitability for that calendar year. It makes it difficult to size up how that commission might be received, or the contingent profit sharing commission, might be received by the agency.

What was your second question, sir?

I guess maybe to quantify the first question was in a typical very profitable year in terms of revenue paid to an agency, what percent would the contingent commissions max out to be? I don’t even have a clue as to what the answer to that is.

I’ll ask J.F. to help me out on this. Let me kind of put it in a top view looking down. I think our commissions generally in a year are 16 percent, relatively speaking, of written premium. And if you have a particularly good year in contingents, profitability, that might add another 2 or 3 points to that contingent. So we might be as high as 18 or 19 percent in the aggregate in a good year. We would wish for that quite honestly. The other side of that is it’s been actually a couple of decades since we’ve had these kinds of possibilities for contingent payments.

Okay. My other question was just on the surface it seems like that since any reduction in premium that an agent would agree to would be an automatic dollar, almost dollar-per-dollar reduction in the profitability in an account, why there wouldn’t seem to be on the surface an inherent conflict of interest between the buyer and the seller and the transaction.

George, it doesn’t really work on an account-by-account basis. We aggregate all the premiums that we collect from an agency for that calendar year and then we aggregate all the loss incurred for that calendar year. It doesn’t match up very well on an account-by-account basis. If there is more coming in than going out, then we agree to share part of that profit with our agents. And then on an account-by-account basis it’s not really broken down that way. I’m certain not by us, and I suspect not by our agents as well.

Stephan Petersen, Cochran Caronia

Just another quick follow-up with J.F. How long are your typical agency contracts? Are they in perpetuity or renewed annually?

The contracts that we signed, agency contracts and the contingent contracts, are in force until cancelled.

Okay. And then on a totally different topic, now that we’ve kind of put the hurricanes behind us and it starts to get to be early sort of reinsurance negotiation time, have you heard any comments from your re-insurers in terms of pricing or what the market might look like at the beginning of the year vis-à-vis property reinsurance renewal rate?

Hi Stephan, this is Jim Benoski. I think that’s going to be on a company-by-company basis really. We would hope to have a favorable rate on the casualty side. We’ve had some larger property losses this year and we may get a slight increase on the property side. I don’t think it’s going to be anything dramatic. Casualty, I think we’re in fairly good shape. Property, maybe not quite as good. Negotiations have not begun.

Okay. And then the last quick kind of follow-up question on Diamond. Where does Diamond go from here? I mean it looks like you’re over the hump here. What in terms of states is left to kind of round out the system?

Stephan, this is Jim Benoski again. I think we’re in Kansas, Indiana, Michigan, Ohio. Agents are fully on line. Alabama is the next state. I hope to be completed in ’04, followed by Florida. And then just a series –- Florida probably first quarter along with a series of other states. I think the majority of the premium is in the Indiana, Michigan, and Ohio areas, and maybe Florida. So those are the bigger states. Three of those 4 are already on line.

Okay.

Before we go to the next question, I’d like to go back to the contingent commission question. I think I answered the question correctly as to how much contingent commission is a percent of premium. However, that’s not the way Cincinnati insurance calculates our contingent commission. We look at the profit that’s earned by the agent and then we pay a percentage of that profit. So it’s not really part of the premium calculation whatsoever. It might be matched up as a percent of the premium, but it’s not derived that way. It all comes from learning what the profit is from that particular agency and then paying a percent of that profit to the agency.

Operator, I think we’re ready for the next question.

(OPERATOR INSTRUCTIONS) David Sheusi, J.P. Morgan

Just a quick follow-up here, clarification on the investment income side. It looks like the guidance that you’re laying out for next year is running at a 4 to 4.5 percent growth rate into ’05. That seems to be a little bit cautious. I guess maybe keeping with your philosophy, but is there anything unusual as you look out on the investment income side that would drive that conservatism? And then can you give us an update in terms of the reallocation of the asset portfolio?

Dave, this is Ken Stecher. As we said in my comments, we hope to return in the first half of next year back purchasing equities again. So that would slow down the rate of investment income growth. Obviously the stocks that we like to buy normally yield 2 to 3 percent. For the greater part of this year we’ve invested in bonds, which we’re paying 4 to 5 percent, are tax exempts that are in the 3.5 to 4 percent range. So that could slow the growth rate a little bit there. We do want to get back to the historic allocation next year of 25 to 35 percent of our new money going into equities and the balance into the bond portfolio. So I think the reason you’re seeing a little bit -- maybe just a little tempered estimate there is getting back to our historic investment strategy. This year has almost all of the new money going into the bond market.

Okay.

Meyer Shields, Legg Mason

This is a related question. I know that you’ve curtailed equity purchases for this year. Does that include dividend reinvestment?

Meyer, we do not do any dividend reinvestment. We take all the cash dividends and then decide where it’s best to invest those funds.

Sam Harvey, Harvey Investment Company

I’ve got 3 questions here. One, I’m curious, the other operating expenses seem to jump up in the third quarter. I haven’t done the math too much, but I think they were $63 million versus $32 million. How is that?

Sam, that basically is last year we had that software recovery of approximately $23 million.

Okay. So that’s where it fell in the income statement.

That’s correct.

I’m curious. I heard in one of the calls I was listening to that there was a real softness in the commercial auto renewals. Have you noticed that at all in your pricing?

Sam, this is J.F. Scherer. No, we have not. As a matter of fact we’ve seen –- depends on what you call real softness. I assume you mean just in a decline?

Yes.

No, we’re not seeing that. We’re seeing the modest increases, low single-digit increases.

Okay. Another question is, on the business of the regulatory oversight of Cincinnati Financial, did the rearrangement of the assets –- you implied that it put it to bed. Well, is that it? Is that over or is there still rulings and whatnot to come through to validate what you’ve done? Or is it all over as far as that question for the Company is concerned?

Sam, this is Ken Stecher again. What we accomplished by moving the assets down is we now got that key percentage below 40 percent. So at least at this point we don’t have to worry about filing under the 40 Act. However, we did file the Exemptive Relief Order asking the SEC to look at our fact pattern and render a decision that we are not an investment holding company, that we are a property casualty insurance company.

And they have not responded to that yet.

They have not responded to that yet.

Okay.

What we’re hoping is that they will respond to that and it just kind of takes one uncertainty away from anything that might occur in the future. Our investment strategy is to try to build net worth.

Right. But that issue is somewhat still out there until they get back to you.

That is correct.

One last thing. I’ve always thought of the company as something as a penny-pinching outfit. I am curious about the $100 million new headquarters. Did that include the garage or is the garage part of that? Or has that already been done? I guess I’m interested in the salvage value you’d get from moving from where you are or just sort of a little bit of a discussion of -- that’s a significant cash outlay -- of just what exactly is going on there and how it may help the productivity of the company.

Sam, that’s a great question. We do pinch pennies around here. The difficult thing about the new building with the underground garage is that we never thought we would build a garage. Although 20 years ago, if you look at the original site plans that showed the construction of the first tower that you might remember seeing, the site plan actually accommodates 4 equal towers like that. So the tower that we’re putting up starting in the January excavation will be tower number 3. And if we do not put a parking garage underground underneath tower number 3, then we have to deal with the parking garage out in the middle of the open lot. And 10 years from now, or 15 years from now, if fortunes are good to us and we’re able to expand our business and need a fourth building, this gives us the latitude and the option to build that new garage for the new building in a much wider space that’s all part of our same premises.

Actually, this building that we’re putting up that’s $95 or $100 million, whatever we estimate it to be, this will really put us in good shape for the next at least 10 years. And that doesn’t take into account some of the achievements we’ll make in automation or some other conveniences that we’ll find in a productivity way.

So it’s amazing that we have we’re able to spend zero dollars for ground and just start putting up the building on our same site. The architects, the engineers, and the contractor 20 years ago put us in good shape for the future. It’s nice to be able to have the comfort of everybody at this one site all working together. I could bore you with a lot more things of the advantage of working out of one site like this. It’s very effective and efficient and I won’t do that to you. But you’re right, it is a big, expensive project and we think hard about it before we go ahead with it.

Alright. Thank you a lot.

Fred Nelson, (Indiscernible)

I really want to thank all of you for the kindness and the courtesy that your public relation firm puts out and the secretaries and the ladies that answer the telephones in your various departments when I call. It’s just fabulous that you have people that are people-oriented. I want you to know that I really, really appreciate that. I would like to ask how Ken Miller is doing.

Ken’s doing better every week. It’s fun to watch him heal. He still comes to work every Thursday for half a day. We’re grateful to see him then. We’re not pushing him too hard.

Who can I say thank you for sending those flowers to the families of the claims reps that traveled to help alleviate some of the pain the people that got hurt by those storms? I think that’s fabulous.

I’ll pass that on to our claims folks. Those are the spouses of our claim reps who are entitled to flowers and good wishes. Of all the people who have really worked hard in the last 6 to 8 weeks in our Company that field claim reps have. I’ve been talking for a week now that 15 percent of our field claim people are in Florida and Alabama working to take care of storms. And all of a sudden, Fred, I figured out that 85 percent of our claims people are back in our regular territories and they’re handling 100 percent of our day-to-day claims. So they’re both being kind of overworked in their own capacity and we’re grateful for them.

One of the fellows here at the table said that I’m behind. Ken Miller actually comes in 2 days a week now and he smiles when he’s in here.

Wonderful. The insurance commissioner in California is elected and we always hear the term pay to play out here. I believe back where you are they’re appointed. So there’s probably a lot of difference in the way insurance is handled and your contingencies are filed with your various commissioners that are appointed over ones that are elected. Would that be something that I’m okay to say?

In Ohio, the insurance commissioner is appointed by the governor of the state. In contrast, in Georgia the insurance commissioner is elected by the public. So we deal in all these venues and we think we can deal in them successfully.

The real reason our agents do business with them is our claims excellence and also the field marketing person who calls on their agency. Our field marketing rep lives in the same or nearby in the communities where our agents are located. These reps visit those agents directly. That’s really what carries the weight of the Cincinnati insurance company marketing sales effort for the benefit of the agent.

I don’t want to speculate what goes through the minds of the different state’s attorney general or the departments of insurance around the country. I think we recognize that it’s in their hands. We’re going to be following what they decide is going to be the subject of the moment.

Not to change the subject, but Ken Stecher had a comment on Ken Miller and I thought I’d give it back to Ken for a second.

Fred, I talked to Ken last night. My wife and I had dinner with him and his wife. He’s going to be coming in a third day starting in the next couple of weeks. So he will be in at least 3 half days.

That’s wonderful. The taxes on the dividend income versus the corporate income, it’s still favorable to invest in equities, isn’t it, because of the tax status of that?

That’s correct.

Okay. That has not changed at all.

Not to this point.

No. And the other thing is your investment counseling business, is that still moving in a positive direction or is it still there?

Oh yes, it’s still there. We’re still getting new customers. Mike Abrams is in the room. He handles a lot of those because they’re equities and convertibles.

That’s fabulous.

Maybe, Mike, you want to make a comment on it.

Sure. Fred, at the end of the quarter we had just over $800 million in assets under management and that was broken out roughly 59 accounts. Of that 59, 32 were individuals and 27 were institutional clients.

Thank you all for all the effort and how you treat people. I just am in awe of how wonderful it is and I just want to say to all of you just keep going.

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

Thank you everyone for joining us today. We see many positives for the Cincinnati insurance companies. We appreciate your interest.

This concludes today’s conference call. You may now disconnect.