辛辛納提金融 (CINF) 2005 Q2 法說會逐字稿

Good morning. My name is April (ph) and I will be your conference facilitator. At this time, I would like to welcome everyone to the Cincinnati Financial second-quarter 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. (OPERATOR INSTRUCTIONS) Miss Wietzel, you may begin your conference.

Hello. This is Heather Wietzel, Cincinnati Financial's Investor Relations Officer. Welcome to our second quarter conference call. This morning, we issued the second-quarter release, the 10-Q, the financial supplement and the portfolio securities owned. If you need copies of any of these materials, please visit our website, www.cinfin.com. All of the information related to the quarter can be found on the investor page under Financials and Analysis.

Also, we wanted to let you know that it is our intent to follow a similar schedule in future quarters, with our third-quarter conference call scheduled for Wednesday, November 2 at 11:00 AM.

On today's call, Chairman and Chief Executive Officer Jack Schiff Jr. and Chief Financial officer Ken Stecher will give prepared remarks, after which we will open the call for questions.

First, please note that some of the matters to be discussed today are forward-looking. These forward-looking statements involve certain risks and uncertainties. With respect to these risks and uncertainties, we direct your attention to our news release and to our various filings with the SEC.

Also, reconciliation of non-GAAP information, as required by Regulation G, was provided with the release and is available on the investor page of our website under Financials and Analysis. Statutory data was 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.

With that let me turn the call over to Jack.

Thank you, Heather. Good morning to all of you and thank you for joining us at our new time to hear about the second-quarter developments at Cincinnati Financial. Our results were covered thoroughly in the information we issued this morning. Ken Stecher will give some additional detail on the results in investments.

I am pleased to report that Chief Investment Officer Ken Miller is back in the office full-time and is available today to answer questions. Next quarter, he will give the investment update. I'm going to cover the commercial lines marketplace and the status of our personal lines business. Ken will report on life, which turned in another solid quarter.

First, let me highlight operating earnings, which came at $0.84 for the quarter, up 25% on continuing strong performance of our insurance operations and higher investment income.

Turning to commercial lines, profitability in the first half of this year has been outstanding. We continue to anticipate that 2005 will be another industry-leading year for the commercial lines segment. We are achieving this strong profitability because of the skilled underwriting of our agents and field and headquarters' associates. Second quarter results confirm that we have continued to maintain our pricing discipline on both renewals and new business, even if the short-term cost is slightly slower growth. We are continuing to grow and we think we will continue to grow profitably in the soft markets.

Our agents continue to bring us business opportunities, and Cincinnati Insurance continues the underwriting efforts that brought us these results. In the second quarter, we wrote $72 million in commercial lines' new business, compared with $75 million in the second quarter of 2004 and $71 million in 2003.

It is true we now need to be more flexible and may use more credits to retain renewals of quality business. Generally, the larger the account, the higher the credits tend to be. On smaller accounts, we are seeing some opportunities to get small increases, but variations by geographic region and class of business. But our business strategy makes a difference in today's market. Activities like the risk reviews prepared by our claim representatives and the renewal review meetings that (ph) our field teams hold with agents mean our headquarters underwriting associates have the benefit of the eyes and ears of the folks actually out in the field.

Because we look at each new opportunity individually, we believe we have a decided advantage. By taking authority to the field, making our decisions account-by-account, we continue to get the best, most informed view of what we should do state by state, agency by agency, which is the true competitive advantage Cincinnati Insurance enjoys.

We also continue to have a strong appetite for new business at appropriate prices, as we look to help our agencies succeed by balancing growth with profitability. Our program to subdivide field marketing territories is moving forward. We're giving our field associates more time to look at each account, improving service for our current agencies.

We're also appointing new agencies. At June 30, we were about halfway to our target of 50 appointments this year, with another 50 planned in 2006. These new relationships will help us continue our growth over the long-term. In 2004, 864 agencies that represented Cincinnati for more than five years averaged approximately $3.4 million each in agency earned premium. The 124 newer agencies with less than five years with Cincinnati averaged slightly less than $1 million each. We believe we can earn a larger position of the business of these newer agencies by meeting their needs. As they move closer to the average of our older agencies, they should represent a substantial growth opportunity for Cincinnati over the coming five to ten years.

As we hold the line on underwriting, we see commercial lines written premium growth of 3 to 5% in 2005, letting us continue to exceed property-casualty industry level growth over the long-term. AM Best estimates that industry net written premiums for commercial lines rose by 1.3% in the first quarter, but will actually decline by 1% for the full year 2005.

Now turning to our commercial (ph) lines segment, we are seeing some positive signs on the profitability side, even while we take actions to address the recent declines in written premiums and new business activity. Helped by the unusually low level of catastrophe losses, personal lines reported a six-month underwriting profit for the first time since 1999. On a rolling 12-month basis, they have generated $5 million in underwriting profits.

To put current results in context, you may remember that we addressed homeowner profitability by substantially increasing rates in 2003 and 2004 to bring premiums more in line with exposures through policy rate and policy changes. We also started transitioning that book of business to one-year policies. On the plus side, with rate increases we have instituted now in place for many of our homeowner policies, we are seeing some improvements at the bottom line for this business line.

Personal auto continued to report excellent results, but it became clear this year that our homeowner and auto rates in certain markets are not competitive. We are addressing that issue with rate modification in selected territories scheduled to take effect beginning September 1, as Ken will discuss. We believe our rate changes further open the door for agents sell the value of our homeowner-auto package, superior claims service and financial strength.

The slowdown in written premium growth may also have been partially due to the focus of our resources and those of our agencies on the introduction of Diamond, our new personalized processing system. Diamond has been used in six states representing approximately 62% of the total 2004 personal lines earned premium volume. Through June 30, 2005, policies representing approximately $250 million of in-force premium have been issued through Diamond. Diamond gives agents new options that increase their choice and control and will offer significant efficiencies when policies renew. However, the system has an initial learning curve, requires substantial effort on the part of agencies to convert business to the system, and needs enhancements to achieve satisfactory stability and speed.

Despite these challenges, agents who have used the system for several months continue to give us positive comments on its capabilities. The planned enhancements should make the system perform more consistently and faster to better meet the needs of our agents. To accommodate the timing for that, we have pushed back rollout times slightly. By year-end, Diamond should be in place in states representing more than 80% of the 2004 personal lines earned premium. We continue to see the personal lines business as an essential component of our overall relationship with many of our agencies and their relationships with clients.

Let's get back to our results and outlook. Here is Ken Stecher.

It is a pleasure to speak with all of the today. Jack has covered the significant market trends in the commercial lines and personal lines area. I will give some key points to the property casualty operations, life, investments, and the balance sheet as well as we summarize our specific targets for 2005.

I would note that per-share data has been adjusted for the 5% stock dividend paid on April 26.

Let me begin with property casualty premiums. We know it is a bit difficult to wade through the written premium comparisons because of the effect of what we referred to as the premium estimate adjustment. On an apples-to-apples basis, six-month written premiums rose 2.6%, with commercial lines up 4.5%.

Bottom line, the premium estimate is an actuarial calculation of premiums for policies with effective dates before quarter end that are still in the policy issuing process when we closed the books for the quarter. The calculation allows us to include them, as they should be, in written premium.

We are comfortable with the process and the conclusions of the calculation. What we are seeing in the first half of this year is due to a change in the estimation methodology in last year's second quarter. The change skewed the first and second quarter growth comparisons. We have every reason to believe that once we get this quarter behind us, we will not need to look at the adjusted numbers to assess trends. We will continue to break out the data in the supplements for your reference.

Jack talked about factors affecting the commercial lines and personal lines premium trends, so let me add some color on property casualty profitability, which remains strong in the second quarter. The commercial lines quarterly combined ratio was essentially flat, as lower catastrophe losses this year offset last year's higher level of favorable development on prior accident year losses. For the six months, a lower commission ratio this year also helped offset the benefit of favorable development from the UM/UIM reserve release in last year's first quarter. The commercial lines results for this year's first half include the large fire loss we discussed last quarter.

Personal lines reported an unranked profit for both the quarter and year-to-date because of the unusually low level of catastrophe losses and progress being made on homeowner profitability, which I'll discuss in a moment.

First, let me review the reserve development topic for the property casualty business as a whole. In this year's second quarter, overall favorable development of $45 million reduced the loss and loss expense ratio by 5.8 percentage points. In last year's second quarter, we had $58 million of favorable development, which reduced the ratio by 8.1 percentage points.

For the six months, there was 31 million of favorable development this year, or about 2 points, compared with 62 million, or 4.3 points, last year, which included 32 million, or 2.2 points, from the UM/UIM reserve release.

Looking at the first six months of this year, we had favorable development in commercial, auto and other liability, but at levels generally below the year-ago level because of the UM/UIM release. We expect our reserving practices for umbrella claims played a part of favorable development for the other liability lines.

For the medical malpractice area, which relates primarily to our health care facility, professional liability product, favorable development rose as we've seen loss and loss expense trends moderate since 2001. For workers' comp, year-to-date development was unchanged, but the quarter had about 1 million in unfavorable development compared with 5 million in favorable development last year.

A big swing was in commercial multiperil, where we had a lower level of favorable development in the second quarter and higher adverse development year-to-date. This was attributable almost entirely to development of 2004 accident year claims.

Beyond the shifts in development, it was pretty much business as usual in commercial lines, showing the benefits of our attention to underwriting and careful risk selection. You'll find discussion if each line on page 21 of the 10-Q.

For personal lines, we are beginning to see bottom-line benefits from the homeowner rate increases we initiated in 2002 and 2003, with a six-month loss and loss expense ratio at 68.7%, including 4.3 points from catastrophe losses. The rate increases in 2002 and 2003 were intended to bring premiums more in line with exposures through rate and policy changes.

In Ohio and Indiana, we have moved about half of the homeowner policies to a one-year basis with some of the larger states not far behind. Overall, about 40% of policies have been converted to one-year policy terms. The rate changes planned for September will not give back all the rate we have added over the past several years, but will better position our homeowner and auto products in the market, which should help with growth and new business.

In Ohio, we will see average auto and homeowner rates decline from their present levels. On the homeowner side, this will largely be a function of a reduction in rates for higher valued homes, with other variations by territory. Indiana and Illinois rates also will decline. Individuals renewing from a three-year policy will still see an increase. Those renewing from a one-year policy may not see an increase, depending on number of factors.

We also recently learned that we have received approval of a needed increase in our Florida homeowner rates, where we will write about 14,000 policies for approximately 15 million in premiums.

Personal auto continued to report excellent results, with the loss and loss expense ratio at 61% for the first six months of this year.

Cincinnati Life Insurance Company contributed $0.13 to earnings in the first half of 2005 compared with $0.10 cents last year. The higher contribution reflected higher earned premium with stable expenses and mortality experience within pricing guidelines, and higher realized capital gains adding $0.01. Overall, the life operation continues to provide a consistent income stream for our agents and the Company, helping to offset some of the inevitable fluctuations in property casualty results.

Now turning to investments. Pre-tax investment income grew 7.3% for the second quarter and 6.5% for the six months. The increase was driven by higher interest income from the fixed-income portfolio. Common stock dividend income for both periods was essentially unchanged from last year. Dividend increases from common stocks made up for the loss of income from convertible preferred securities sold or called over the past 12 months.

Investment income growth in 2005 is likely to be driven primarily by interest income, although dividend increases announced by holdings in the equity portfolio over the last 12 months should add $19 million to annualized investment income going forward.

We used $34 million for CFC stock repurchases during the second quarter, buying 850,000 shares. We will continue to look for appropriate times to repurchase our stock. At the end of the second quarter, we had $172 million in cash on the balance sheet, down from $306 million at year-end, after making approximately $332 million in net new investments during the first half.

Our Board's investment committee and the Investment Department continue to look at potential equity purchases as we evaluate uses of cash. We also are monitoring the ratio of common stock to statutory surplus, which was down to 98.4% at the end of the quarter, and the ratio of parent company investment assets to total parent company assets, which was 34.9% at quarter end. Going forward, parent company investment activity will need to be monitored to keep that ratio below the 40% level.

We did not resume common stock investments in the first half, putting a fair amount of cash to work in the buyback. We did, however, buy about 55 million in nonconvertible preferreds, which are treated as fixed income by the rating agencies and offer attractive relative yields. Our equity investing strategy has been integral to our Company's long-term success and book value growth, and we have every reason to expect we will resume our common stock investment activities during the second half of 2005.

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.

Book value recovered slightly from March 31, but is still below year-end 2004, on improved valuation in the bond portfolio and market value gains of equities in the portfolio other than Fifth Third. The decline in Fifth Third's market value accounted for about $1.60 of the change in book value since year-end. With regulatory issues and associated expenses behind them, we feel Fifth Third is well positioned for growth.

Given the difficulties over the past couple of years, the market is now skeptical of Fifth Third's business model. We believe their model is sound. After considering its performance in the first six months of 2005, we continue to believe Fifth Third is one of the better growth stories in the financial services sector over the long term.

Before I turn the call back to Jack, let me quickly add some details to the comments in the release regarding our performance outlook. As Jack said, conditions in the commercial lines market remain competitive and our agents and field associates are working on getting the right balance between growth and profitability. In that context, we're still comfortable with our estimate of commercial lines written premium growth in the 3 to 5% range.

For personal lines, we still expect written premiums to decline by about 5%, as we adjust our rate structure to be more both profitable and competitive, as our agents and associates work on full Diamond deployment and conversion of three-year homeowner policies to one year. With about 70% of premiums coming from commercial lines, we continue to see overall full-year property casualty written premiums growing in the low single digits.

We are taking a fairly conservative stance on our outlook for the combined ratio. Through the first six months of 2005, pass-through losses contributed an unusually low 1.1 percentage points to the overall combined ratio of 88.2%. Typically, the most severe weather-related catastrophe events, particularly hurricanes, occur in the third quarter. We will review our 2005 targets when the third quarter is complete and we have more details on actual catastrophe losses.

Already, Hurricane Dennis affected the Cincinnati Insurance Companies' policyholders in Alabama, Florida, Georgia, and Mississippi. We currently estimate losses in the range of 11 million from this event. So for now, we are looking for the overall 2005 GAAP combined ratio to be at or below 93%. That target assumes full-year capacity losses will contribute about 3.5 percentage points.

We are also presuming that favorable loss reserve development will be in line with our historical levels, particularly since we won't have the help we had in 2004 from the UM/UIM reserve release.

For commercial lines, we are estimating a 2005 commercial lines combined ratio at or below 90%. For personal lines, we are expecting the combined ratio for the year near breakeven. For investment income, we're now looking for growth for the consolidated portfolio in line with the 6.5% we have seen in the first half of this year. And finally, interest expense will be up incrementally about $0.05 from 2004.

We believe achieving our growth and profitability targets will make 2005 another good year for Cincinnati, supporting the steady growth and industry-leading profitability that are our long-term objectives. Jack?

Thank you, Ken. I think that about covers our prepared remarks. Before we open up for questions, I wanted to reiterate our positive outlook.

In commercial lines, our agents continue to bring us business opportunities and we continue to maintain the pricing discipline that keeps our results strong. The personal lines area is heading in the right direction and the life business is making steady contributions. Our investment group has strong cash flow to work with and is generating excellent results. We think we are in good shape, with a great future ahead of us.

Let me remind you all that Jim Benoski, our Vice Chairman and Chief Insurance Officer, J.F. Scherer, our Senior Vice President of Sales and Marketing, Ken Miller, our Chief Investment Officer and his investment team, are here to help me and Ken Stecher field your questions. So let's go ahead with some questions.

(OPERATOR INSTRUCTIONS) Ron Frank, Smith Barney.

Two things, if I could. First of all, Ken, I was a little surprised to hear you talk about adverse development on the '04 year in CMP. I certainly have not heard a lot of complaints about developments on '03 and '04 -- certainly for '97 to '01, but not for the more recent years. It struck me as unusual and I was wondering if you elaborate.

And broadly on the homeowner's line, I am finding myself a little bit confused. The X catastrophe loss ratio has jumped around a great deal the last four quarters -- 75, 58, 71, 58. You seemed to be considerably more cautious on the outlook as of the last conference call; now seem a bit more optimistic. And yet prices still seem to remain under pressure, and I was wondering if you could bring that all together for me in terms of the outlook.

Okay, Ron. On your first question, on the multiperil property, I believe that some of that was commercial related and I believe we had some development on prior-year hurricane activities. I think that is showing up there. Other than that, I don't believe there is anything that we can identify that would be of significance, other than the numbers do reflect that occurring.

Secondly on the homeowner, when we look at the trailing 12 months of the homeowner line, June of '03 homeowner X cats was 73.9, '04, 70.9, '05, 66.4. So we are seeing incremental improvement. It is still not where it needs to be. I am still being cautious, mainly because of the concern of the slower -- obviously, we're writing less business, as you know. There is a little uncertainty as to what the earned income increase will be going forward. Obviously, that could impact the combined.

Overall, I believe we are making progress. If you look at the combined for the first six months, and if I go back --what I did was I went back and looked at the last four or five years of catastrophe activity, but I excluded last year, since that seemed to be a little out of the normal range. And over the four years, excluding 2004, average cats on personal lines would be 6.5 points. First half of this year, we have 2.1, so there is a 4.4 difference. And you add that to our 94 combined, it is up close to 98.5.

So I think based on that, probably should come in maybe a little better than the hundreds. But at this point in time, as you said, with the volatility moving around in that area, I decided to just leave our guidance the way it is for now.

Stepping back for a minute, Ken and by taking the 50,000 foot up view, am I remember incorrectly? It seemed last quarter like the message was we still feel okay about homeowners, but it is going to take a little longer than we had hoped. And this quarter, there seems to be a moderately more optimistic tone. Is that a fair inference?

I believe that is fair.

Okay, thanks very much.

Charlie Gates, CSFB.

Nice quarter. I heard what Ken said about share repurchase, read the news release. And I am looking at a table that shows share repurchase back to the mid-90s. Could you collaborate on how you assess share repurchase today?

Sure, Charlie. We still continue to look at it in multiple ways. One, we try to pretty much monitor our book value on a fairly daily basis. We do that just by a model that has been developed in the investment department. We kind of -- just like I'm sure you probably do -- you could probably monitor our large equity holdings and as they move, that can adjust the book value.

So we take a look at that. We take a look at our stock price. And then we also look at the cash availability that we have. We look at other investments that we could make. And then we also would take into consideration, just like we did in the fourth quarter last year when a block of shares became available, that million share block that we did acquire, if something like that would come along, we also would take a look at that.

So we are using all of those factors. And also, we have to keep in mind, like the first quarter, as you know, we only purchased 115,000 shares, because of the blackout for the month of January, with our earnings release coming out in early February. Also, we had the month of February pretty much in blackout because of all the bond activity that we were going, with registration of our November bond issue and the reoffer of the '98 (ph) bonds, we kind of had a blackout for that. So the blackout periods also do come into play, and it's just depending on what is going on with the Company.

My second question, could one of you speak to what is the impact of writing three-year commercial lines policies on your commercial lines business today from a competitive standpoint?

Charlie, this is J. F. Believe it or not, even in a marketplace of declining prices, the idea of writing a three-year policy, making a three-year commitment, we believe still continues to be a significant advantage for our agents and for us. So it is for our agents to say to a policyholder -- and there are no true crystal balls -- certainly, there is a softening market right now. No one knows what is going to happen over the next three years. There has been volatility in the marketplace.

For an agent to go to a penalty holder with an A++ rated company, with a competitive price, with the kind of service we offer in claims, and then to say that this insurance company will make a three-year promise in terms of many of the coverages that they are offering, is a serious advantage in the marketplace today. It is always and consistently been something that we believe builds good, long-term relationships for us.

So at any rate, we still view this to be a significant issue. We realize, of course, when we write a three-year policy, we're on it for three years. An agency could have a claim -- or, I'm sorry, a policyholder could have a claim. We are still on it for three years. That is a commitment that we make. So for our agents, I think if you were to canvass them, not us, what do they think about the three-year policy right now, they would be quite enthusiastic about it even in this moment.

One of you -- I think it was Mr. Schiff -- made reference to the fact that the average premium for some 800 agencies I believe is $3 million, and for new agencies it is much less than that -- like it's $1 million, something like that. This is my last question at this time. What causes the new agency to want to ramp up its production to the 3?

It is J. F. again. Probably everything I just mentioned. The fact that we are in the agents' offices and proving to the new agent, because we systematically write more and more policies, handle more and more claims, that we are a Company that the agency can feel comfortable about putting a substantial amount of business for the long-term. This is not a quarter-to-quarter approach we make, even perhaps, for that matter, a year-to-year approach.

Ours is a very long-term approach with our agents. We hope they will view us as a Company that they can put a very high percentage of their business. We back it up with great claims service, responsive underwriting, and great financial stability. That is not something that all carriers can offer. And simply over time and with the proof, I would say probably as much as anything else, the quality of the claims service that we offer, the proof that we can back up the promises and commitments that our agencies make causes them to have an increasing amount of confidence to put more and more business with us.

Thank you.

Mike Dion, Sandler O'Neill.

I was wondering, Ken, if you could perhaps go through the guidance in relation to the commercial life segment as well, given that the six-month numbers for the combined at 86%, well below the 90% target, I guess, given the historical cat levels. I guess if you add the personal lines cushion to the potential commercial lines cushion, it looks like you could have some potential upset at your end.

Mike, I think that is possible that we could have some potential upside. I think that just because of the uncertainty in the commercial lines pricing marketplace, we are just taking a conservative view. There are no signs that I can see right now, other than the developments we believe -- the favorable development that we have seen last year versus this year, probably is not going to be the same extent as the numbers I had mentioned in my comments. So I think that is going to take, probably, the combined up a little bit in the balance of the year.

That is a forward-looking statement by our actuarial staff and we will just have to see how things develop. But I do believe that we could better 90%, which is why I said at or below.

Okay, fair enough. I guess you alluded to your comments earlier in the call about getting a rate increase in Florida. Given the volatility in the market down there, maybe perhaps you could take a moment to talk about the rate increase and where you see some Cincinnati Financial's role in Florida.

Maybe I could turn that over to J. F. since that's a more marketing thing. Obviously, from the accounting side, you know, with the losses that have occurred down there, we believe that we need this rate increase just to try to cover the claims cost and the other operating costs that we have. But I think strategically from marketing, I'll let J. F. handle that part of it.

Mike, Florida is an important state to us, though I would not say that we are heavily represented down there. We only have 10 agencies that write personal lines for us down there. As was mentioned in the remarks, we write about 14,000 policies, so it is not a tremendous amount. We have excellent agencies down there that do a good job of targeting things.

A 23% increase in our rates are needed. We have put heavy emphasis on higher deductibles, a great deal of selectivity, and because of the low number of agents and the way we approach things in Florida, we are approaching it on a long-term basis. So, good agencies down there, excellent policyholders who have been with us for a long time. We are just working with the Department of Insurance down there to make sure we can attain the appropriate rate levels.

And the rate increase there was approved? Do you have that percentage increase?

23%.

Okay, great. Thank you very much.

Kelly Nash, KeyBanc Capital Markets.

A couple of questions. First, I wondered if you could comment on kind of -- in both personal and commercial lines, what you see as an effective overall rate, either increase or decrease in these lines, including the impact from some of the credits that you mentioned.

J.F., why don't you -- it's from a marketing view.

I think what Jack made reference to, that it tends to be all over the board. On larger accounts, they do attract quite a bit of attention, and as a result, I will tell you, it can be anywhere. But I think it is fair to say 0 to 10% down on the larger accounts. We are in fact seeing still, though it is declining, we're still seeing the opportunity to get modest increases. And I make the statements all exclusive of exposure increases.

So we're still seeing an opportunity on the medium-sized accounts to get a modest increase. Part of that opportunity comes from the fact that we will write a three-year policy and we are able to sell a slightly higher premium. So that would be the marketplace we are seeing.

There is no question, though, we are seeing companies out there that have less to differentiate themselves than we do, and price tends to be the first differentiator. So there is a slightly higher profile of those companies.

Having said that, though, I guess the good news continues to be that pretty disciplined underwriting still is maintained; that the real aggressive pricing that we are seeing -- and I can't say I really heard many exceptions to this -- have been on excellent accounts.

On the personal line side of things, I think the effect of multivariant rating are probably more evident than anything. It is awfully hard to say that there is a rate increase or rate decrease. It is more a case of the kind of sophistication that carriers are trying to bring to assigning a rate to all the variances that they use or variables they use in their system.

It seems relatively stable out there. We sell value. We try to obviously highlight the fact that we have great claims service and things of the nature on the personal line side that we are not seeing volatility in pricing quite so much in personal lines as we are in commercial.

And then in personal lines, obviously, you are transitioning off of some of the three-year accounts there. But when do you expect to see pricing at basically on the bulk of the book, where it probably needs to be to effectively compete in this market?

Relative to the three-year policy, that we're looking into '07 before all of those policies have gone through the cycle. I think there will be a footnote to what we have to say about our homeowner results until about that time. The rate changes that we have made for September is our effort to continue to slide into where we think we need to be on our homeowner book of business. There's no question that we missed the mark a bit, and at the same time, the marketplace changed a bit in terms of the levels that we set for our homeowner book of business. The decline in new business is reflective of that.

But what we believe is that the rate changes we made for what we view to be the more attractive accounts for us -- in some cases, the higher value homeowners -- we think is going to narrow that gap and make us more competitive.

And on the commercial lines side, excluding the impact of credits, any other notable changes you are seeing in terms of coverages terms and conditions?

Not especially, no. It seems to be fairly stable in that regard. We are not seeing much in the way of any retraction of any terms or conditions, nor anything too drastic. I think the marketplace -- probably as much as anything, the thing that is conspicuous to me as I talk to a lot of agencies and just listen to the conversations, is that over the last three or four years, there has been a tremendous trend to higher deductibles, that policyholders are saying they are buying insurance for the big claim.

And that no doubt has had an effect on frequency. We are not seeing those people deciding now to back down from a higher deductible that they went to a lower deductible. We like that. I think that allows us to attract and work with a policyholder that's a little bit more claims conscious. So you add all that together, that's a good sign.

And then finally, it was very helpful to have the average premium base for the newer agencies versus the existing ones or the ones that have been with you longer. Is there any way to give a little more specifics to, as you add new territories, how quickly these new territories ramp up in terms of number of relationships you are able to add, how quickly -- just so that we can appreciate the impact that could have on your long-term growth strategy?

I really wish I could quantify it pretty specifically. There are territory splits that we're making that probably will have a better effect or more of an effect on the quality of the underwriting than it will on the growth. But the additional time that a field rep will have in the territory will allow them to do many things, some of which in some territories will be to appoint agencies and write new business; in other cases. simply to make sure they're reviewing everything that they need to.

We have opened six new states in the last ten years, and I guess I could use that as a bit of an indicator, because obviously all the agents in those states are new. The new business we wrote in those six states represented 10.1% of all of our new business last year, but represented 5.5% of the overall total premium we have. So it is a good indication that when exposed to Cincinnati Insurance Company, given the opportunity and where we, in many cases -- Utah, New York -- we're adding our third territory in New York, and Minnesota we have four territories, expanded from the original two -- just a good indication that there is a lot of opportunities for us in the newer areas, but also in some of the areas where we have been penetrated a long time.

So I wish I could quantify it for you. I wish I could tell you you could put a percentage on it. I can tell you, though, the results are favorable.

Okay, and the number of agencies you added, was that a net number?

The 20? We are up to 995 total now, so the 23 that we talked about was not net. That was overall new relationships.

Okay. Could you just remind us what the net number would be?

Net for the year? Last year was 986 -- so we are up 9.

Great, thank you.

Meyer Shields, Legg Mason.

A couple of quick questions on homeowners. First of all, was there strengthening related to the hurricanes of last year?

I don't believe there was in the homeowner area; it was mostly in the commercial.

Okay. I thought I saw (ph) something in the Q. How important are rate levels in homeowners from a competitive standpoint relative to auto? I'm asking because we saw Progressive and Geico, who are aggressively looking for auto business. And I don't know that there is the same level of intensity in the marketplace, and I was wondering if you could tell me how you think about that when you're considering rate reductions.

This is Jack Schiff Jr., Meyer. I would like to just comment on that. The homeowner rates, I think, drive the purchase of the homeowner-auto policy. That is just an anecdotal view as an agent, but people value their homes very dearly and want them protected satisfactorily. They want to talk with their insurance agents about the insurance under their homes.

Their auto insurance is a little more pedestrian. I won't call it easy to compare, but for some reason, they take a little more relaxed view of their auto insurance coverage. And I say it in this light because I think we need to resolve our homeowner situation, put it in the black nicely, have things go well for our homeowner-auto agents all across the countryside.

And maybe J. F. has a different marketing view from that, but it is not a mathematical approach, but I think from a marketing standpoint you need to be strong in both home and auto insurance, but I think the people who drive the sale through the home market I think have a longer policy duration with that particular insurer. J. F., any --?

I think you just hit the nail on the head.

Okay, great.

In the Q, we do say there is a modest level of unfavorable development on prior accident year losses, but it wasn't attributable to the cats. So you did read there's some slight unfavorable development; it is not necessarily cat related.

Fair enough. One last question, if I can, again in personal lines. Can you talk about how the lost cost trends you are seeing in auto and home compare to, I guess, the numbers that ISO puts out or any other metric?

This is Jim Benoski. On the homeowner side, both frequency and our severity have been fairly flat. We had a spike-up, obviously, in April of '03 on the incurred loss when we had the bad hail storm in Columbus, Ohio, and then a spike-up again in September of '04 because of the catastrophes we had in Florida. But other than that, both frequency and severity have been fairly flat for the last six quarters.

Okay, can you talk about auto for a second?

Not much change in the auto either. I think first quarter of '04 until to the end of the second quarter of '06, our average paid claim in auto has gone up about $200 for a six-quarter period. The claim count, again, is fairly flat except during the hail storm and the hurricane down in Florida.

Great, thank you very much.

Ira Zuckerman, Stanford Group.

Jack or somebody else, you talked about cutting auto rights in a number of key states. Can you give us an idea of the kind of magnitude and where your competition is coming from at this juncture for auto? Is it coming from other agency companies or is it coming from direct writers at this point?

May I offer an answer first, Ira -- this is Jack Schiff -- and then J.F. from the marketing standpoint? Ohio is our largest state from a homeowner-auto standpoint. That is in a range of 40% of our personal lines premiums. So that has to be the area that we looked very carefully at, which territories are correctly priced, and we are studying those carefully. Auto is going to have a very slight reduction in rate, principally in the physical damage area of an auto policy. The homeowner rates will be reduced also very slightly, but that will be in the higher-valued home policies that J.F. alluded to earlier.

We think that will give our agents a little more staying power when they go up against other carriers in the community. I think it will give our agents some staying power also with other carriers within their office. We will just have to go out and use what J.F. mentioned about selling our claims service, our availability of people, and I think maybe J.F. should comment a little bit.

Ira, I think our competition tends to be most within our agencies. Some of the carriers that you mentioned have been, obviously, a significant impact in the marketplace in general. But our battlefield tends to be within our agencies' offices and the less commodity conscious purchasers that they do business with. That is not to say that they don't compete against these other guys.

So we would benchmark ourselves against, in many cases, the state domiciled carriers and that changes from state to state. Allstate certainly is present now in independent agencies and has enjoyed significant success as well.

Thank you.

Charlie Gates, CSFB.

Two final questions. One -- and if it was in part of your documentation, I apologize -- what was the duration of the fixed income securities portfolio at June 30, approximately?

Seven years.

Seven. The second question is, I think it is on page 4 of your news release, you see that commissions year-over-year in commercial lines insurance -- and maybe I'm missing something -- were down from 20.8% to 19.3. What does that reflect?

Charlie, that is year-to-date. That basically is almost entirely due to the fact of the drop in the contingent commission. You know we had about 0.5 points of savings in the first quarter. And then the fact that we are accruing it at close to the same amount for contingent commission in total, there is more being allocated to the personal lines as our results have improved. So the contingent commission for the six months is down about 1.3 points. So that is almost all of it.

How do you determine the contingent commission?

We go through a calculation where we look at the underwriting profitability in the Company as a whole. We look at the growth in premium. We look at when they pay their accounts. We take all the factors that go into that calculation and then we annualize that and come up with our estimate. There's other issues -- stop loss agreements and things like that. So on an interim basis, it is pretty much a forward-looking calculation.

Now, this contingent commission, this hasn't got anything to do with whatever Spitzer was doing with --?

No, this does not. This is based on agency profitability with us -- in all policies --

It has nothing to do it with whatever occurred in the brokerage industry?

That is correct.

Thanks.

Ron Frank, Smith Barney.

Kelly Nash, KeyBanc Capital Markets.

Just two follow-up questions. One, I wondered if you could comment on retention levels and any notable changes you are seeing there in both commercial and personal lines.

Kelly, on the commercial lines side, just a slight decline from the numbers we've talked about in the past. On the personal lines side, we are seeing a bit of a decrease there from the low 90s to the high 80s. And so what we have discussed in the past, the fact that new business has been down, is showing its impact in that particular area. And we don't like to see the trend there, obviously -- that's part of all the actions we are taking, but that would give a flavor on the retention for us.

And then the commercial lines, is that more an indication of the competition that you are seeing in the pricing environment?

That would be correct. We're not seeing -- in fact, in terms of nonrenewals, where we have found accounts that we don't think measure up, that has continued to decline quite a bit. So we're pretty confident that the book of business that we have from a quality standpoint is in good shape. It is just that we are seeing the effects of some competition.

And then secondly, regarding Diamond, I know that you have noted that the system is in place in six states, which represent about 62% of '04 personalized premium volume. What percentage of agencies in these states are actively using Diamond?

All of them, I guess. In other words, if they are appointed with us and they are in that state, they would now be using Diamond. The only agencies, I guess, if you were to take the full state that would not be using Diamond would be agencies not producing personal lines for us.

This is Jack Schiff Jr. May I add to that a little big? The agents have an automation system from Cincinnati that has been very effective for decades. But they are aware that we're going to phase that system out as the Diamond system rolls into their territories. So it is not a question of if they are going to change over but a question that they will change over.

And our job at Cincinnati Insurance is to educate them and cultivate them and work with them as they learn this new system. And some of the agents who are quite prominent in the premium volumes of homeowner-auto, it is a massive undertaking to transfer all the business that they have under the prior automation system into the new automation system, and that has slowed down the education process and also the work process. We have plans to attack that over the next couple of months, and we think we will make some good progress through year-end.

Okay, and are you see many agencies that maybe previously weren't operating on a personal lines basis with you now deciding to because of the new Diamond system?

I would not say many, but agencies are -- in Michigan in particular we have had several agencies that waited for Diamond to be introduced before they wanted to start representing us for personal lines. We really think that the Diamond system, though up to this point, the learning curve, as we have described has been there.

But we really think that the Diamond system is what the doctor ordered. It provides for those agencies that heretofore were not representing us for personal lines exactly what they were looking for in the form of automation and billing. So there is a transition we're going through, but we are very confident that this system for the future for us is what the doctor ordered.

Thanks.

(OPERATOR INSTRUCTIONS) Lara Devieux, Wachovia Securities.

Actually just had a follow-up question about the Diamond system. Can you give us how long you would consider the learning curve to be? And then also, would you be able to provide maybe a differential in premium volume between the agents that are up to the speed and the ones that either don't have the system or I guess just being rolled out to them, just so we can see the benefits there?

This is Jack Schiff, Jr. I will try to answer the learning curve part and hope that someone can find the second part of your question about the premium volumes.

We find that it is actually a pretty good system and it is pretty easy to learn. The difficult part that I think is taking the data that's in the prior automation system, transferring it to the new, and then adding the additional questions that we are asking now that are not related to Diamond; they are just related to the underwriting process, which is new information that the agencies are requested to gather from their policyholders.

And those are new questions from an underwriting standpoint. They are not attributed to Diamond because they are part of the transition; however, it is new information that the agent has to spend to develop this information. I would say the learning curve is measured in months, maybe even weeks. The comfortable level is probably longer than that, but I see that still being less than a year. On the other part, I don't know --

Lara, would you restate again what you're looking for on that?

Can you give us a differential on premium volume, like how much agents are producing with you with their own systems versus agents that aren't on the system -- is there any difference yet?

It is too soon to be able to measure that. It really is. Obviously, in every state, agencies are converting everything from the old system to the new. The issue in terms of new business or in terms of new business levels is not Diamond. It is really rate. And so the issue tends to be not so much that Diamond is or is not difficult to use from that standpoint. Jack covered the learning curve part of it. It is more a case of making certain that we are properly priced in all of those states.

Okay, great. Thank you.

Charlie Gates, CSFB.

I'm sorry if I am killing you. This is my last question, I promise. One of you said in response to a question I believe from Kelly Nash that there was a lot of work with regard to converting to this new Diamond system, that it was some kind of a significant task. Here is the question. Who paid for that? Does the agent pay for that or did the Company pay for that?

This is Jack Schiff, Charlie. The Company developed the Diamond system and paid for it, and we capitalized it through the process of the development over several years are now starting to expense it as Diamond rolls into play. We make no charge whatsoever to the agent for the use of the Diamond system. We pay them. The agents receive the same sales and service commission rates today as they did two and three and four and five years ago for personal lines, whether it is on the prior automation system or on the Diamond system.

But if I am converting my book -- I am an agent for you. If I convert my book of business to this Diamond system, this undertaking, you are paying for that rather than me, right?

I don't think so -- but I will say --.

Okay, so the agent pays for that.

The agent pays in time. But I know of two agencies that Cincinnati Insurance receives substantial amount of homeowner-auto that the burden would just be almost overwhelming to that agency to use simply their present staff people to put this information into the new system. Cincinnati Insurance, from time to time, for days -- maybe even as much as one week -- permitted those agencies to have the benefit of one of the CIC staff members in their office to help out with temporary workflow.

So Cincinnati Insurance will try to accommodate those kind of things where it is extraordinary within an agency. But for the most part, the agents absorb this extra cost of putting information into the new Diamond system.

Nice quarter, and it is nice to have Mr. Miller on the call.

Charlie, this is Heather. We have spoken so much on the initial conversion, I just want to throw in that a year after the agents start putting business in, there will be a tremendous time savings on the renewal process. So this is an upfront time investment. It is not an ongoing time investment.

Okay, thank you.

Fred Nelson (ph), (indiscernible).

There is a wonderful article on the knowledge economy going to the creative economy that has been powered by a gentleman back in Cincinnati that works for Procter & Gamble by the name of Lafley. He talks about empowering people to go to the highest level of their mind.

And the wealth of Cincinnati and the great joy has been compounding of cash flow by the selectivity of putting money into ownership of companies where the people fit this mold. And all of a sudden it appears that the regulators that give you the ratings have come in and said, oh no, we don't want that anymore. That is not what we demand. To keep your rating, you have to make a shift in the way you put money to work.

And I just hope to gosh that it doesn't kill the creativity of the wonderful people in the Investment Department and the management of the Company that have really subscribed to this philosophy for --.

Fred, you compliment Cincinnati financial by putting A.G. Lafley and Procter & Gamble on our conference call. Those folks are absolutely remarkable.

Yes.

We have the benefit of living in Cincinnati and watching a lot of the folks who have relied on Procter & Gamble for generations and the ones who work there today. They are truly outstanding people.

I am with you on the way the outside influences seem to be baring on American business. I think if the folks in the trenches, the ones that do the everyday work, that make the difference, one of the things that we follow in Cincinnati Financial as we get larger, how can we keep the personal contract with our agents in the field, with our field marketing reps, our claim reps who are out in the field? How can we keep those in touch with the home office underwriters, the home office claim department? And believe me, we work very hard to do this.

In fact, this weekend you might be interested. We have a three-day session here in Cincinnati where we bring all of our field personnel, about 1200 people, 1300 people, and we talk for a little bit of business in the mornings and we have a little bit of monkey business in the afternoons and the evenings. And it is just a reacquaintance with one another, but it is some serious business and it is friendly conversation, and sometimes you need these things in business to keep things going well.

But these are the personal qualities that we think make corporate America one of the advantages for the people who work for them and also the products that come from them. And I am getting to be a little bit like you, when I start to expand and get talkative, but you do it so much better, and I should be listening to what you say.

I just wanted to say, you've got such wonderful people in the Investment Department that build wealth and equity so the compounding of cash dividend rates (technical difficulty) -- I just hope that we don't want them to get discouraged because their creativity and what they do best get blocked by the regulators. That is what concerns me.

Because then that information flow stops -- and it is lose-lose instead of win-win. So I just want to encourage everybody to keep going. And I don't know as a shareholder what I can do except to empower you. But you don't want to lose that great creativity that is in that department, because it's the key of your whole business organization (ph).

Fred, this is Ken Miller. As always, you are very kind.

You deserve more than that. What can we do to make sure that you continue to have a shopping list of capital that you can put to work in equity so the dividends can grow and the investment income can grow and the book value can grow, and you have more money to have surplus so you can do more insurance? That's all I am concerned about.

You are very kind, Fred.

I think everybody heard the message.

Yes, we did, Fred.

It's not being negative; it's just being positive. The article in BusinessWeek is fabulous, about up out of the box, into the open, you need to be seen. It is on the cover and it is just a fabulous thing on America because what built our whole country is the creativity of human beings, and it is fabulous. Thank you for letting me speak.

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

Yes, April, thank you, and thank everyone for joining us today. We see many positives for Cincinnati Financial and the Cincinnati Insurance Companies. We appreciate your sustained interest. Talk with you next time. Goodbye.

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