辛辛納提金融 (CINF) 2006 Q1 法說會逐字稿

Good morning. My name is Aleen and I will be your conference operator today. At this time, I would like to welcome everyone to the Cincinnati Financial Corporation conference call. All lines have been placed on mute to prevent any background noise. After the speakers' remarks there will be a question-and-answer session. (OPERATOR INSTRUCTIONS)

Ms. Wietzel, you may begin your conference.

Thank you, Aleen. Hello. This is Heather Wietzel, Cincinnati Financial's Investor Relations Officer. Welcome to our first-quarter 2006 conference call. This morning, we issued the news release, financial supplement and portfolio of securities owned. If you need copies of any of those materials, please visit www.cinfin.com, where all of the information related to the quarter can be found on the investors' page under Financials and Analysis. We would want to let you know that our first-quarter 10-Q should be filed later today and it will be available at the same spot on the website as well.

Our annual meeting of shareholders is scheduled for this Saturday, May 6, if you would like to join us here in Cincinnati.

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.

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

Also, reconciliation of non-GAAP information, as required by Regulation G, was provided with the release and is available on the investors' page of our website under Financials and Analysis. Statutory data is prepared in the 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, I would like to turn things over Jack.

Thank you, Heather, and good morning to all of you. And thank you for joining us to hear about Cincinnati Financial's first quarter. After my remarks, Ken Stecher will provide some details on financial results and review our 2006 outlook assumptions. Then we will open for your questions.

This was a satisfying quarter for Cincinnati Financial, with underwriting profits from both commercial and personal insurance and with commercial lines' growth above industry levels, including a pleasing amount of new business despite market conditions. Our property casualty loss and loss expense ratio was a bit better than last year's strong result, even with 5 points of storm losses included this time around.

Investment operations also were strong, with income up 9%. Book value rose $0.97 from year-end.

Before I discuss the marketplace, a couple of first-quarter items bear specific mention, both because they affect comparability and because they are an opportunity to talk a little about the philosophies that guide our actions over the long-term.

The first item, of course, is the hefty increase in our net income for the quarter. We benefited $412 million after-tax from completing our previously announced sale of our ALLTEL equity holding. That transaction and the cash flow it generated affected every measure, from our higher effective tax rate to our equity investing and our decision to repurchase more shares of Cincinnati Financial Corporation during the first quarter and all of last year.

Selling ALLTEL was an unusual event for us. We follow a buy-and-hold equity philosophy, and we did just that with ALLTEL for 40 years. But total return remains our focus. ALLTEL is in a mode where they want to reinvest in their business rather than commit to increasing future dividends. We think they will succeed, but steadily increasing dividends are one of our chief investment parameters.

Our investment department reinvested a large part of the sale proceeds in other equity holdings that give us more favorable prospects of a higher total return over the years, and that immediately replaced more than half of the dividend we used to receive from ALLTEL.

Our equity investing strategy continues to set us apart. We believe the dividend income we receive as a result of it helps us produce more consistent income through all cycles.

Another item that affected first-quarter numbers and reveals philosophy is options expensing. As you know, we have previously disclosed the impact options, but this is the first period that impact shows in our income statement, with $0.03 for the quarter and $0.08 estimated for the full year. I hope you look closer to see what we get in return for that expense and the value that creates for all shareholders.

The interesting thing about our stock options program is that a significant portion of the options don't go to the top officers. Our options philosophy is to help make owners of most of our associates who are in good standing and who stay with the Company.

For the grants made in this year's first-quarter, 89% of new options were awarded to associates other than the five officers in our proxy statement, with almost one-half of new options going to non-officers, which are our underwriters, our claim reps, our field marketing folks, and many, many more.

Making stock option grants a component of associate compensation has served us well, aligning interest throughout organization with those of other shareholders. This means that when an agent calls in with a request or a policyholder reports a loss, the associate who responds treats each transaction as an opportunity to support relationships and support the long-term goal of building our business into the future and building their own families' future net worth. As a result, we have dedicated associates. Our ratio of profits per employee is among the very highest in the industry per Fortune Magazine's annual rankings.

In 2006, we see that dedication in the portfolio analysts who have promptly reinvested hundreds of millions of dollars and the claims representative who are responding personally to a couple of thousand catastrophe claims. We see it in the underwriters who are making sure our good accounts renew and the field marketing associates who increase new commercial business 11% at the same time they also appointed new agencies, bringing our total agency reporting locations to 1,263. In each case, associates rose to the occasion, performing like the owners they are. That gives us an advantage.

Now let me give you some marketplace observations. We are finding the marketplace -- commercial and personal -- just as tough as we have indicated in other recent quarters. However, we are maintaining our underwriting discipline and it appears other carriers are too.

On the commercial side, our strong new business growth was a result of special efforts and our good agency relationships, not any easing of price pressure. Our field marketing representative have been in our agent's offices asking for business, calling on prospects with those agents, carefully evaluating risk exposure, and working up their best quotes for good accounts. And our underwriters are talking to agents well in advance of policy renewal dates, communicating our desire to work with agents and to retain good accounts.

Their work has helped offset some of the premium decline we have seen in personal lines where pricing is competitive. We have decreased rates in selected territories and, in states using our Diamond system, we are introducing an expanded credit structure July 1, all to compete more effectively and on better homeowner and auto accounts.

We are proceeding carefully and deliberately. We like the progress we have made on profitability of the homeowner line and our consistent results on personal auto. The goal is to balance growth and profitability as we go forward. When it comes to both commercial and personal insurance, we believe our agents serve many clients who care first and foremost about the balance between quality and price and who fully appreciate our superior claims efforts, high financial strength ratings and the benefit of our package approach.

We are proud of the sales professionals who represent the Cincinnati Insurance Company. We thank them and support their efforts. They appreciate our strong catastrophe response and everyday personal claims service. They appreciate our ability to maintain the highest available rating from AM Best for 50 consecutive years. All of these things convince them that their clients should be protected by Cincinnati coverages. We will keep working to honor that.

Now Mr. Stecher, Ken would you shed some light on the financial details?

Thank you, Jack. And thanks to all of you for joining us today. Jack covered our response to the significant market trends in the commercial lines and personal lines area. Overall, our insurance and investment performance was strong in the first quarter.

Rather than go through information that is well covered in our written materials, I am going to walk through a few specific details of the property casualty and life performance, update you on the investing activities and review the assumptions behind our 2006 performance targets.

For the property casualty businesses, I am going to cover three specific subjects, loss reserve development, expense trends, and personal lines results. I will start by mentioning the restructuring we have done to our line of business reporting. It reflects changes we've made in our internal management reports to support easier market and trend analysis. Among the biggest differences is the breakout of data in the commercial property and commercial casualty lines. For reference, the 10-Q will have definitions of each business line and three years of historic data, along with data for this year and last year's first quarters. The financial supplement has data for the past five quarters.

Now for a brief update on loss reserve development. For the quarter, modest of reserve development added about 2 percentage points to the overall combined ratio, about on par with last year's first quarter. That reflects comparable development from commercial property and development from workers' comp and personal auto below last year's level. commercial casualty and commercial auto had savings in the first quarters of both years.

Now turning to expenses, as you saw in the release, total commission expense rose by about $15 million year-over-year. The comparison to last year's first quarter is affected by the release and last year's first quarter of an over accrual from 2004, as well as this year's slightly higher contingent commission accrual. We are at the higher level this year because of our continued strong profitability.

Noncommissioned or other underwriting expenses rose by about $18 million year-over-year, raising the commercial lines' combined ratio by 1.9 percentage points and the personal lines combined by 2.6 percentage points. About $6.5 million of the increase was due to stock option expense, which we are accounting for at the operating company level. Other factors were higher taxes, licenses and fees, technology costs, and other associate benefit costs.

We are expensing more and more of our technology costs as various systems move into production. Our activities now focus on adding product lines and/or states to systems that are in use, as well as adding agent-requested enhancements.

The personal lines' ratio also reflected the decline in earned premium. Although personal lines has higher expenses, we had another quarter of excellent progress in reducing the loss and loss expense ratio. Excluding catastrophes, the ratio declined to 55.1% from 62.8%.

The personal auto loss and loss expense ratio was essentially unchanged last year, while the homeowner ratio, excluding catastrophe losses, declined to 52.9% from 70.7% last year, moving this business line close to breakeven.

On a trailing 12-month basis, the homeowner loss and loss expense ratio was 74.3%, compared with 94.2% last year. Our model for homeowners assumes that catastrophe losses will contribute about 17 points and that expenses will contribute about 31 points, updating that number for option expense. However, until our homeowner line is competitively priced for the good accounts we target and we are able to return to historic retention levels and attain new business growth, premium growth could be an issue.

With a rising fixed cost base due to our technology, spending, and the lower premiums, homeowners may not reach breakeven as quickly as we had hoped, more because of the expense ratio than underwriting issues. Again, as Jack discussed, we are moving ahead with rate and credit structure modifications that could position our homeowner and personal auto lines for growth.

The Cincinnati Life Insurance Company contributed $0.04 to operating earnings in the first quarter compared with $0.05 last year. 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. Higher realized capital gains due to the ALLTEL sale added another $0.16.

Now turning to investments and the balance sheet, we had the proceeds of the ALLTEL sale available for most of the quarter. We used that and operating cash to buy back 1.85 million shares at a total cost of $81 million, made $445 million in additional common stock investments. Our investment department focused on adding to our existing positions. We ended the quarter with $206 million in cash and equivalents. At March 31, book value was $0.97 above year-end. Fifth/Third's price ended the quarter up $1.64 from year-end and accounted for about $0.44 of that improvement.

Further, the remainder of our equity portfolio is regaining some traction. The portfolio return equaled that of the S&P 500 over the first three months of 2006. Over the long-term, we believe our buy-and-hold strategy will allow our portfolio return to exceed that of the index.

For the year-to-date, pretax investment income rose 9%, partially due to interest we earned on the $235 million that will be used in June to make the tax payment on the ALLTEL gains. At this point, our estimate for 2006 pretax investment income growth remains 6.5 to 7%, but we are pretty comfortable that it may be closer to the high end of that range.

Before I turn the call back to Jack, let me touch on a few topics related to the assumptions that form the basis of our preliminary 2006 property casualty outlook. As Jack said, we are confident that commercial lines, which provide almost 75% of our property casualty premiums, should see sufficient premium growth to more than offset the anticipated personal lines' decline. We are still looking for a full-year GAAP combined ratio of 92 to 94% for the total property casualty operations. As we said at year-end, that estimate assumes that savings from favorable reserve development could be 2 to 3%. That's a more typical range than the 5.2% we saw in 2005.

We also continue to think the expense ratio is likely to be between 30.5 and 31.5%, taking into account the option expense. Some of our costs are more fixed, such as our planned investments in technology. Their contribution to the expense ratio in 2006 may be higher because of slower premium growth.

Most important, as we said in our news release, cat losses in the first four months of the year are estimated to total about $94 million. Our target assumes that catastrophe losses will contribute between 4 and 4.5%, which works out to a full-year cat loss between 125 and $145 million. While we have the financial strength and flexibility to accommodate catastrophe losses above that level, if that is what Mother Nature brings, we would reevaluate our target under those circumstances.

Regardless of the impact of the weather, we expect 2006 will be another outstanding year. Back to you, Jack.

Thank you, Ken. Before we go to questions, I will remind each of you that the audio from our annual meeting of shareholders this Saturday morning will be available from a website. The meeting is a good chance to acknowledge our shareholders and friends in person, but if your schedule does not allow that, you're welcome to listen in.

Aleen, we are about ready to open for questions, so let me remind everyone that Jim Benoski, J.F. Scherer, Ken Miller and Marty Hollenbeck are here with us today to help field your questions. Let's go ahead with questions.

(OPERATOR INSTRUCTIONS) Ron Frank, Citigroup.

Two things if I could. One is Ken, the personal and commercial lines expense ratios were, of course, more distorted than the total, and for reasons you've outlined. I was wondering if you could relate that 30.5 to 31.5 corporate expectation to the individual segment expectations.

Ron, I think that the commercial for the first quarter was 29.7, and that was up for a couple reasons. One, commissions were up 1.2 points. The other expenses were 1.9. Options were about almost half of that, about 0.8. So I think with the good commercial line growth, I think that that expense ratio will kind of stay there in that general area for the year.

Okay.

Personal lines was at 36.3. Again, 1.8 of that was commissions increase. Underwriting expenses -- technology's actually about 1.3 points of that. The options were about 0.8. So that is the majority of that.

The technology costs, I believe, for the balance of this year are going to remain at a higher level. We are getting very close to making the enhancements that the agents have requested. We are also getting to the point that the major states are out, are going to be in production by the end of the year. So --

So sound like between top line and technology, the burden is mostly on personal?

That is correct. And I think that once we get into next year, I believe the expenses from technology will start to drop. However, depending on the production, that will obviously have an impact on that ratio.

Thank you. And secondly, I was wondering if J.F. could expand on the comments in the press release. You devoted a fair amount of text to the competition in the Midwest and some caution that that may accelerate if competitors flee coastal areas and seek to make it up. Obviously, you've talked about that before some, but I was wondering if you could freshen up your observations for us related to those comments.

Ron, probably most of what we had to say was more of just a caution than anything else. I can't say that we are seeing, other than conversation, anything tangible in terms of things changing. Obviously there are certain carriers that are backing off the coasts in a real meaningful way. In some cases, those same carriers are backing out of earthquake, which has an impact on what they can do in the Midwest as well.

So we are not seeing anything drastic occurring yet, in that carriers have said okay, we are really going to target the Midwest, for example. The Midwest represents some catastrophe exposures as well. So it is speculation. It is an observation in the marketplace because of how tough it is on the coasts. But right now I can't say that we're seeing anything major happen.

So the point was more that the competition has not eased up any and it might accelerate if all of that happens, but you're not seeing it.

That is correct.

Fair enough. Thank you.

Kelly Nash, KeyBanc Capital Markets.

I wonder if you could first just clarify on the reserve development, that was adverse prior year reserve development that you experienced in the first quarter here?

Yes, Kelly. That was adverse development of about 2 points. I talked to some of our actuarial staff, and they believe that the first quarter development -- just like last year we had adverse in the first quarter. We don't have quite as much historical data on the development of hurricanes from the prior year.

And as you know, the last two years were fairly active. And that has kind of contributed to some adverse development in the first quarter from the commercial property side. So that's what we believe what we are seeing. But comparable to first quarter last year, we also had adverse development. But it was 2 points of adverse in this quarter.

Okay, and then is that on top of the 1 million that you included in the cat numbers that you provided in the press release?

That would be all rolled up together -- the 1 million in the cats would be in the 2 points.

Okay, thank you. Then looking at the share repurchase, obviously in this quarter you repurchased a much larger amount of shares in the quarter. Can you kind of discuss your outlook going forward, and then -- or was this more of a onetime event because of the cash you had on hand relative to the ALLTEL sale?

Kelly, this is Marty. I think for the remainder of the year, we will likely return more to a more normalized base that we've done for the last few years. I think we would be comfortable if we finished the year with between 2.5 and 3 million shares purchased.

Okay. Finally, I wonder if you could just touch a little bit more on loss cost trends, if you're seeing continued improvement in the favorable frequency trends that we've seen historically and then if you're noting anything usual on the severity side.

Kelly, Jim Benoski. The frequency is still pretty good -- it's flat to down. And severity obviously is an issue, as it is with most all companies, increase in cost of construction and increase in cost of new automobiles, all that adds to it. So I don't see anything out of the ordinary, but the severity is up a little and frequency is flat to down.

Okay, so offsetting some overall outlook for loss cost trends, you're relatively optimistic about the stability there?

I would say yes.

Thank you very much.

Charlie Gates, Credit Suisse.

Congratulations on a nice quarter, guys. Well done. I guess my first question, stepping back for a moment, where did the monies go that you received for the sale of ALLTEL?

This is Marty. We had approximately $560 million net of taxes in proceeds from the ALLTEL sale. About $445 million of that went into common equities, and the balance was kind of spread around municipal bonds and other issues. But probably a little over 80% of it went back into common stock.

So those would be represented with the securities that you sent out this morning?

Yes.

Okay. That's the only question I have. Once again, nice quarter.

[Michael Phillips], Stifel Nicolaus.

I just wanted to turn back to the commercial lines for a second. With the new business growth, I was wondering if you have any sense of whether that's coming from more original competitors like yourself or more of the national players, or any sense on that?

New business really is across the board. I can't say that there's a carrier out that that's any weaker or stronger than the next. So we have taken a look that as well. We've had some luck on larger accounts. That tends to be the ball park of the larger carrier. But so much of our competition is regional carriers that change from state to state. If we do well, that is who we are competing with and that would be who we are taking the business from.

Okay, thank you very much.

Mike Dion, Sandler O'Neill.

My question is on the personal lines segment. You have indicated last few quarters now and also in this press release that as far as your personal lines rates kind of getting marked down to market, if you will, as far as getting more competitive. I wish you could spend a little time on both the auto and homeowners side, and maybe just expand on how far you thought the rates previously were off the market. Were your rates 5, 10% higher?

Then what is your expectation once the rates get set to market? Are you going to be in line, perhaps lower than the market? And then what the outlook on the personal lines growth would be, once they're at your target goal.

Mike, this is Jack. We have had numerous homeowner rate increases over the last four years. And the reason I go back four years is that we still have a number of our policies on three-year terms. I would guess in the range of maybe one-fourth of our homeowner policies in the Diamond states, which are the states where we've started to go to one-year policies more recently, there are still some states out there that are not in our Diamond sights yet, and they are still issuing three-year policies. But there are a few.

But I bring this up because I think it is important when you look at where our rates are, it depends upon when that policy incepted and how far through its three-year term that it is. We are trying to adjust the rates in states where we had rate increases that we think have overshot the mark -- I've heard J.F. use that phrase before. And we have made some nice adjustments over the last 6 to 9 months.

And I think with July 1, we should have some more good adjustments. But those will be in selected territories, Mike. They won't be across the board. And the rate changes that we're going to have, the credits that we'll come up with, also will be in selected territories.

And it will be our first chance at taking into account a little bit of some of the nontraditional rate factors that we have not used in the past. Others call them insurance scoring. We're going to use some of those features for the first time, and some of our better credit-rated accounts will get a possible reduction in premium. And I say possible because we still use the merit rating idea, that if you have claims, your insurance rates are probably going to be higher than if you don't have claims.

But I think J.F. is in the trenches every day on these questions and maybe J.F. can add some more to it.

I think Jack covered an awful lot of it. I think the key for us is that during the past several years, we have been relying exclusively on the merit rating approach that we have taken traditionally. So to say how much our rates we had overshot, it depended on credit scoring and a variety of things that other carriers had used.

So as Jack mentioned, the big transition for us July 1 will be the introduction of multivariant rating to our book of business. Will we be as precise or expert as a Progressive? Of course not. But it's not necessary for us. We don't have to be as exacting because we're not selling on a commodity basis.

I think we will find for the very good credit scores, very good insurance scores, a fairly decent decrease. That's going to affect our current book of business a bit as well. But our belief is that beginning with July 1, we're heading in the right direction of being more precise about how we apply our rating schemes and that that will stabilize our book of business, and then over time allow us to write more new business.

Okay. As far as the July 1 date goes, will you be introducing the multivariant rating for both homeowners and personal auto at the time?

Yes, that correct. And that would only be in Diamond states, where we have the functional ability to use Diamond to affect these rates.

And as far as a portion of the personal lines book, would that approximately represent close to two-thirds or --?

Yes, it would maybe be slightly larger than that. By the end of the year, we're going to have Diamond active in states that represent 90% of our premium. So we are going to be in a position beginning with July 1 and then continuing through the end of the year and early next to really speed up our ability to apply this kind of a rating approach.

Okay. Then as far as your expectation, balancing out lower premium rates, perhaps you pick up some additional volume once your rates are close to the market rate. It is at that time where you expect personal lines' premiums to maybe flatten out and you might actually start to see some increase? Is that fair to say?

I guess I would feel that there is some momentum right now that we have, where we had a decline in new business. That is going to have to stabilize. The fact that our new business has been down several quarters in personal lines, it's going to take more than just the end of the year before we would stabilize our growth rate. I would think it would be early in 2007 that we would look for more of that and then the resumption of growth.

Okay, that's helpful. Thank you.

Matt Carletti, Cochran, Caronia, Waller.

Actually, all of my questions have been answered. I guess I didn't get into the queue quick enough. But congrats on a great quarter.

(OPERATOR INSTRUCTIONS) And a follow-up from Kelly Nash, KeyBanc.

I wondered if we could discuss the personal lines a little bit more in terms of the impact of Diamond. Is there any way you could provide a metric that would indicate with the rollout of Diamond, you have agents using it as a processing system more frequently or you're able to add new agents that weren't previously on working on your Personal Lines? Or Just something along those lines so we can get some metrics around the importance of the Diamond rollout.

Kelly, Diamond clearly was necessary for us in terms of the introduction of our ability to produce policies for agencies, as well as the direct-bill issue. And that is working out fine. We have got 15 new locations in the first quarter that represent us for personal lines, so that is an indication.

Just to put it into some perspective, we have 1,263 reporting locations, with 427 that do not represent us in personal pines. There is probably 10% of those that as agencies they just don't sell much of it. But the balance of the group have not chosen Cincinnati Insurance Company because of technology and billing. So we are overcoming that objection right there.

So I think from our viewpoint, Diamond is what the doctor ordered. We continue to tweak it and make it better. I think in terms of the issues that agencies had with Cincinnati personal lines in the automation area, that is being overcome.

The challenge for us, I think as much as anything, is to make certain that from a ratings standpoint, a setting of rates standpoint, we've got it right there. And as we've already talked about, July 1 begins that process for us.

So it's not going to bounce back extremely fast. I wouldn't expect it to. But I think we've got things in-place right now to make us an attractive market. Keep in mind you won't find many agencies that say they sell Cincinnati personal lines as a commodity and that they're looking to compete with commodity players in personal lines. That's not our target either.

So with the improved automation, with the ability to get our rates more targeted, with our A++ rating, with our consistency, with the great claims service that our field claims reps provide, we are feeling pretty darn good about the future of personal lines.

Okay. Then on retention, could you just touch on what retention numbers look like in personal lines relative to maybe where they have been historically?

Kelly, I believe the last figures I have seen, they were in the upper 80 range. And I think prior to some of the rate difficulties or we overshot a little bit, historically it was maybe more in the low 90s.

I've got a couple numbers here for you. homeowners, for example, had really been consistently in the 91 to 92 range going back to 2003 and early 2004. We're in the 87 to 88 range in homeowners, and the same would be true for private passenger auto. That is on a policy count basis.

And as you look the improvement really coming from the more competitive rates as well as the agents having an easier system to use should move those numbers back towards the historical levels?

That is our goal.

Thank you very much.

[Fred Nelson].

I sure want to thank you for the wonderful philosophy of empowering all the people in your organization and those you donate to with charity to go to the highest level of their life. And it's fun for me to hear that, that it's still alive in America. And I just really want to say thank you, thank you, thank you to all of you. It is a great gift.

Thank you, Fred. You are a good friend of Cincinnati Financial. We appreciate it.

You are good people. How is the little investment counseling business doing?

Fred, it's coming along fine. We've got some new initiatives that we are working on that we think will start bearing fruit later this year.

Is that Marty talking?

Yes.

Good for you! Thank you. Thank you, gentlemen and ladies.

At this time, there are no further questions. I would like to turn it over to Mr. Schiff for any closing remarks.

Thank you, Aleen, and thank you everyone for joining us today. We appreciate your interest in Cincinnati Financial. Good day.

Ladies and gentlemen, this concludes today's Cincinnati Financial Corporation conference call. You may now disconnect.