辛辛納提金融 (CINF) 2006 Q4 法說會逐字稿

Good morning. My name is [Deshonsa] and I will be your conference operator today. At this time, I would like to welcome everyone to the Cincinnati Financial fourth quarter 2006 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 Deshonsa. Hello, this is Heather Wietzel, Cincinnati Financial's Investor Relations Officer. Welcome to our year-end 2006 conference call. This morning, we issued the final 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 the information related to the quarter can be found on the investor page under financials and analysis. On today's call, President and Chief Operating Officer Jim Benoski and Chief Financial Officer Ken Stecher will give prepared remarks, after which we will open the call for questions. Chairman and Chief Executive Officer Jack Schiff, Jr., is with us today, but his voice is not cooperating enough to let him give the introduction.

Before we move to that, 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, also under financials and analysis. Statutory data is prepared in accordance with statutory accounting rules as permitted by the state of Ohio, including the National Association of Insurance Commissioners Accounting Practices and Procedures Manual, and, therefore, is not reconciled to GAAP. So with that, let me turn the call over to Jim.

Thank you, Heather. Good morning to you all and thank you for joining us again today to hear about our 2006 results. Jack asked me to deliver our prepared remarks which are primarily on growth. When I finish, Ken Stecher will talk more about profitability and our outlook for 2007. And then we will open for your questions.

We wanted to start by highlighting the Board's action just last week to increase our indicated annual dividends by 6% to $1.42 per share for 2007. This sets the stage for the 47th consecutive year of increase in that measure. We are going to start with our financial results and then comment on what we are seeing in the commercial and personal lines marketplaces. On the insurance side, we continue to build our company for the long-term, offering the consistency that lets us earn a prominent position in our agency's offices, not just for one year, but for five, 10, 20, or even 50 years. Agencies continue to respond to our approach, successfully marketing our products to their better accounts. They gave us total new business of a record $357 million, very healthy commercial lines growth, and initial positive feedback on midyear changes in our Personal Lines pricing.

In the investments area, our equity portfolio outperformed the Standard & Poor's 500 for the year, helping us achieve record book value as well as record investment income, aided by dividend increases announced by 38 of the 50 common stock holdings in the portfolio. Operating income for 2006 was $2.82 per share, compared with the $3.17 in 2005. A number of factors we have talked about all year contributed to the decline, but some of the important trends in our business were masked by three items -- stock option expensing, this year's record level of catastrophe losses, and less savings from favorable development on prior period losses than the unusually high level of savings in 2005. We did add $722 million to surplus for the year, positioning us favorably for the long-term with the financial strength and stability to accommodate short-term fluctuations in some areas like those we saw in 2006.

Turning to the commercial lines marketplace, market conditions continued to grow more competitive over the course of 2006. There are no signs that trend is abating. As the year progressed, anecdotal reports of very aggressive pricing became somewhat more frequent. On balance, we would still call it a healthy market, as we continue to see underwriting taking place and terms and conditions remaining fairly stable. When we are faced with pricing that we believe is too aggressive, even on better accounts, we pass on the account.

Echoing our comments through 2006, credit for our strong new business growth goes to the special relationships and efforts of our agents and the field marketing teams that work with them. Our associates are in our agents' offices emphasizing the Cincinnati value proposition, calling on prospects with those agents, carefully evaluating risk exposure, and working up their best quotes for good accounts. Field marketing representatives report pricing down about 10% to 15% on average to write the same piece of new business we would have quoted in 2005.

On renewals, our headquarters underwriters are regularly talking with agents. Our field teams continue to help out, holding renewal review meetings with agency staff to make sure that each commercial account retains the characteristics that caused us to write the business initially. For quality risks, commercial underwriters are offering policy extensions of one and two additional years. Eligible policyholders appreciate the convenience -- retaining the terms and conditions they selected three years ago, still backed by our superior claims service and our A++ rating from AM Best Company. Plus they get stable rates on some of the shorter-tailed coverages within the policies.

Overall 5% to 10% price declines seem to be typical on the renewal side. The hard work of all of our associates underwriting business policy by policy is keeping our Commercial Lines growth well above the industry levels. Our Personal Lines business is moving forward. We continue to focus on three areas that should help us resume growing overall in this business area. First, I will talk about pricing. In July, we introduced insurance scores into our program of policy credits for homeowner and personal auto pricing. That program led to the second half's increase in new business for both personal auto and homeowner. It also led to improved retention of current business.

While these pricing refinements have reduced the premiums per policy, we believe they present an opportunity to work with agents who are marketing the advantages of our Personal Lines products to their preferred clientele. We are refining our rates on an ongoing basis to make sure our personal auto and homeowner rates are competitive and produce profitable business. Second, Diamond, our personal lines policy processing system, can help us resume our growth.

It is now in use by agencies writing approximately 90% of personal lines premium volume. We are encouraging commercial lines-only agencies to begin marketing our personal lines products as Diamond becomes available. Third, we are introducing product enhancements, including replacement cost coverage for newer autos and identity theft advocacy services for endorsements for homeowners. These steps should help us leverage the strides that have already been made in personal lines.

Across both our commercial and personal lines business and another strategy that has worked well for us is staffing new territories. In the first half of 2007, we will begin appointing agencies in a new northern Idaho territory, going beyond the presence we have had in the Boise, Twin Falls, and Idaho Falls areas since 1999. A little further down the road, the new northern Idaho territory will expand to include agencies in eastern Washington, a new state for us. We are also working to develop a schedule to do business in New Mexico.

When we are ready, we will start out as we usually do. We will focus on commercial lines. We will evaluate introducing personal lines when we have established relationships with our independent agencies and the regulatory agencies and when our personal lines technology is ready for these states. While it takes about five years to begin getting significant premium in a new territory, we think Idaho, Washington, and New Mexico will be good opportunities, adding both to our growth potential and our geographical diversity.

One last comment. Our agents deserve a good deal of credit for making our results possible. We remain firmly committed to providing strong catastrophe responses and everyday personal claims service, to maintaining high financial strength ratings, and to ensuring that they are served by a local field team with a strong local knowledge and authority. These are the things that make Cincinnati franchise work and encourage our agents to let Cincinnati protect their best clients. We will keep working to honor that. Now Ken will shed some light on the financial details.

Thank you, Jim. Well done. And thanks to all of you for joining us today. As you saw in today's release, 2006 operating earnings were down $0.35. Softer pricing, increased loss severity, and higher underwriting expenses are playing a part in the results we are reporting. Jim already mentioned three items that are masking some of the underlying trends. Those three items are stock option expensing, which added $0.08 to our cost this year, catastrophe losses, which were $.19 above last year's level, and savings from favorable development on prior period losses, which is about $0.16 below the unusually high level in 2005. These totaled $0.43. Positives, such as growth in investment income and healthy non-cat underwriting in some business lines, helped offset their impact.

I am going to focus on the other factors in commercial lines and personal lines that affect our results. I will follow that with observations on the Life business and investments and then expand on the 2007 performance targets we mentioned in the release. The premium and loss data for our business lines is on pages 20 and 21 of our financial supplement. The release provides segment loss reserve development data for the fourth quarter and year. We are working on our full analysis and our 10-K will contain additional details. It is due to be filed on March 1.

I will begin with commercial lines, where growth trends remained excellent. The commercial lines full-year combined ratio was 3.9 percentage points above last year's level largely due to a higher loss and loss expense ratio, excluding catastrophe losses. The lower level of savings from favorable development accounted for about a third of that change. Softening prices and an increase in loss severity in the second half were the other major factors.

Commercial lines losses and reserve increases greater than $250,000 were high in the fourth quarter. New losses greater than $1 million were concentrated in commercial casualty, commercial auto, and workers' comp. We continue to study these losses by location, agency, type of business, agent policy, etc., and there are no concentrations that do not parallel our overall business mix. For example, the states where we write a larger share of our business account for an appropriate share.

Looking at each of our major commercial business lines individually, commercial casualty written premiums rose 7.7% in 2006. While casualty pricing continues to become more competitive, new business is strong. We are also getting a boost from the healthy business economy over the past several years as well as related exposure growth. Commercial casualty loss and loss expense ratio moved up in the fourth quarter on an uptick in larger general liability losses, which added about 9.5 points to the quarterly ratio. Savings from favorable development improved the commercial casualty ratio by 20.4 percentage points in the fourth quarter and 12 points for the year. We monitor these results closely, but we anticipate these types of fluctuations due to the nature and size of commercial umbrella liability policies and limits.

Commercial property written premiums are up 6.1% for 2006. That is overstated by 1.2 percentage points because last year's $5 million ceded reinsurance reinstatement premium reduced the 2005 written premiums we reported. Excluding catastrophes, commercial property's loss and loss expense ratio has remained relatively stable. Savings from favorable development reduced the fourth quarter ratio by 1.8 percentage points, while adverse development added 0.9 points for the year. While it is likely that increasing competitive market conditions may pressure margins in this area, we believe we are well-positioned.

Commercial auto results continue to reflect increasing competition. Commercial auto written premiums were flat for the year, with a 2.5% decline in the fourth quarter due to lower pricing on new and renewal business. Commercial auto is one of the business lines that we renew and price annually, so market trends may be reflected here more quickly than in other lines. Commercial auto also is generally one of the larger components of the typical package. For good accounts, adjustments may be made here to help price the entire package more competitively.

In the fourth quarter higher large losses in the million dollar plus category were offset by savings from favorable development that improved the ratio by 10 percentage points. Savings improved the full-year ratio by 4.6 points. We remain focused on commercial auto underwriting and rate levels, making certain that vehicle use is properly classified and driver suitability is monitored. These actions and a declining industry-wide frequency trend should help mitigate the projected increases in industry-wide severity and the effect of softening prices.

Turning to workers' compensation, written premiums rose 12.1% for the year. We continue to work to modestly expand our worker's compensation business in selected states where regulatory and market conditions are favorable. In the second half of 2006, we had a total of six losses greater than $1 million for this line. As we mentioned last quarter, over the summer we reviewed each of our established workers' compensation case reserves above $100,000 to take into account current trends and medical cost inflation and estimated payout periods.

Adverse development added 3.4 percentage points to the ratio in this year's fourth quarter and 2.5 points for the year. Before I turn to the personal lines side, let me observe that, overall, commercial lines results remain very strong. Premium growth for the year was an excellent 6.7%, full-year new commercial business rose 14.9%, and the combined ratio was 91.3%. Overall, we are in great shape in commercial lines, with the people, relationships and commitment to achieve our long-term objectives.

In personal lines, the pricing changes we made midyear have reversed the previous downward trends in new business and policy retention. However, new business is not sufficient to offset the lower prices that our current personal lines policyholders are receiving at renewal. As a result, total net written premiums continue to decline in the second half of the year. This is putting pressure on margins in this business, particularly for the homeowner line. On the positive side, the uptick in large losses that we saw in homeowner in the third quarter appears to have been an aberration. While we are still concerned about overall severity, larger personal lines losses in the fourth quarter were more in line with previous quarters.

Personal lines also bore the brunt of the higher catastrophe losses, which are five percentage points higher than last year. In addition, the lower level of premium is highlighting the staffing and technology investments we are making in this business area, with the expense ratio continuing to rise. Looking at the two larger lines, the personal auto loss and loss expense ratio moved up to 74.3% in the fourth quarter from the very stable level of 61% over the past seven quarters. For homeowners, the loss and loss expense ratio, excluding catastrophe losses, slowed to 44.8%, the lowest level of the year, which is typical for the fourth quarter.

Despite that improvement, homeowner is one of the most competitive business lines and returning to profitability in this line remains a challenge. For homeowners, the full-year loss and loss expense ratio, including catastrophe losses, was 83% compared with 75.6% in the year earlier period, primarily due to 6.8 additional points in catastrophe losses. Personal lines is an important part of our relationship with many of our agents. We believe that by helping our agents grow over the long-term, personal lines can contribute positively to their results and ours.

That summarizes the key points for the property casualty business. Let me turn briefly to The Cincinnati Life Insurance Company, which saw operating earnings decline for the year largely because of stock option expense and some changes in internal expense allocations. Growth in mortality remained within expectations. Cincinnati Life contributed $0.19 to operating earnings for the year, compared with $0.20 in 2005. Overall, the life operation continues to provide a reliable income stream for our agents and the Company.

Good job is probably the most appropriate thing to say to our portfolio managers when we look at our investment operations. Investment income and book value both reached record levels. Over the year, we used available cash flow to purchase equity securities as opportunities presented themselves and we expect to do more of the same this year. We believe investment income growth could be in the range of 6.5% to 7% in 2007, on par with our expectations for 2006 before the additional contribution from selling our large Alltel holding. Also, we repurchased over 2.6 million shares and have more than 6.8 million shares remaining on the current authorization.

Before I turn the call back to Jim, let me review some of the assumptions that form the basis of our preliminary 2007 outlook. First, we anticipate consolidated commercial and personal lines premium growth to be in the low single digits. As Jim said, pricing in commercial lines marketplace continues to soften. There are many reasons we are confident about our ability to continue to grow profitably in commercial lines. AM Best estimates the overall commercial lines industry will contract by about 1% in 2007.

Efforts to add profitable new business remain at the top of the list for personal lines. We believe the lower pricing now in place for current customers will offset gains in new business in 2007, leading to another year of declining premium. AM Best is projecting only 1.2% growth for the personal lines industry in 2007. Our combined ratio target for the year is 97% to 99% based on four assumptions. One, that catastrophe losses will contribute approximately 5.5% to the combined ratio. We got hit pretty hard by catastrophes in 2006, but we think this range is appropriate based on our treaty retention and history. By the way, we recapped the 2007 reinsurance treaties in the release and we would be glad to take any questions on the topic during the Q&A.

I will note that the $22 million increase in premium is a factor in our 2007 outlook. On that score, based on our exposures, we are not expecting significant losses from Midwest storms in mid-January or the Florida storms last weekend. Second, we are assuming combined ratio savings from favorable development in line with our historic norms. Excluding 2004 and 2005, savings averaged about two points between 2000 and 2003. Third, we expect the combined will show some loss ratio deterioration as pricing becomes even more competitive and loss severity increases. And, fourth, our combined ratio target also reflects higher other underwriting expenses, as we continue to invest in people and technology.

Overall, we believe that 2007 expense ratio could be approximately 31.5%. I would add that a combined ratio in the range of 97% to 99% would keep us near the 96.8% that AM Best is estimating for the overall industry in 2007. Our history has been to produce above industry average growth in written premiums and industry-leading profitability. Over the long term, we believe our current book of business can continue to achieve that mark. Jim?

Thanks, Ken. Strong agency relationships give us that confidence and starting Monday, a team of Company leaders will go on the road to personally tend to those relationships. It is time for our annual sales meetings, starting out with four events in Charlotte, Atlanta, Birmingham, and Knoxville next week. Our message to the agents is consistent with our message to shareholders. It is a great time to be in the insurance business. Yes, there are challenges and there are also opportunities. Even as we continue to invest in improvements that situate us for the longer term, we see every sign that our agencies will continue to respond positively to our hallmark claims service, local decision making, and case-by-case flexibility. Thank you for your time today and your interest in Cincinnati Financial and The Cincinnati Insurance Companiesy.

Also before we open for questions, we want to let you know that we are aware our webcast may not be working for everyone. We have been assured that the Web replay will be complete and we will work with our vendor to make the replay available at www.cinfin.com as soon as possible. Operator, we are about ready to open for questions, but let me remind everyone that Jack, as well as J.F. Scherer, Ken Miller, Marty Hollenbeck Ken Stecher, and I are here to help field your questions. Operator, let's go ahead.

(OPERATOR INSTRUCTIONS). Charlie Gates, Credit Suisse.

I am sorry to the extent Jack is sick.

Charlie, I appreciate it. I am a little sick, but not so bad.

Well, take care of yourself.

I will.

One of you opined that you thought the commercial lines pricing off 10% to 15%. Could you elaborate on that remark?

Charlie, this is J.F. That comment was relative to the new business our field reps are seeing this year in contrast with -- throughout 2006, in contrast with what we saw in 2005. So we are, in general, saying that we have to be that much more aggressive to write new business. That did not apply overall to the renewal book of business. The renewal book comments were that we are showing in the mid-single digits to perhaps 10% off renewal rates -- not premiums, but rates -- with larger accounts sometimes requiring maybe a little more discount than that.

How do you define a larger account?

Well defined -- for us would be defined probably in excess of $50,000 premium would be the larger account that we write -- and we are seeing a little bit more competition requiring a little more discount.

One of you made the comment that you thought it was going to be more intense '07 versus '06. Could you elaborate on that?

Well, we just anticipate based on the good results that every carrier seems to be posting in terms of combined ratios, or their commercial lines loss ratios, the anecdotal comments we hear from the field based on our competitors talking with agencies. We are just assuming that based on all of that, we are bracing ourselves for a bit more competition this year.

Maybe this is inappropriate, but seemingly, your commentary with regard to competition appears more in line with what I would foresee than what many other companies are saying. I guess my, next question -- that was just a comment. My next question, given that the stock is now selling essentially at levels at which you have bought back stock in the past, I realize one of you opined as to the amount of stock you have available for purchase or whatever you call that, your authorization. Could you comment as to how you assess share repurchase at this point?

What we are doing is we are going to -- one of the things we do look at is the price compared to our book value. We also do look at it from the standpoint of trying to buy back at least enough to offset dilution. And we also then also take into account what other opportunities do we have and how we think they may benefit us in the long term. So we are looking at all those things when we consider how many shares to repurchase. And that has been pretty much what we have done consistently over the past few years.

I guess my final question -- seemingly, the stock is approaching -- well it sells now, I guess, at approximately, at 12% premium over tangible book value. I guess the question there is the fact that, one, shouldn't, I guess, an analyst should add in something for the infrastructure of the Company and basically the real estate, the building that you occupy. How do you assess that with regard to how you view the stock at current levels?

This is Ken Stecher. I think right now, I mean, I think that yes the pricing is softening. We believe that it will be. There will be probably some increases in combined ratios, which is, I believe, going to happen throughout the industry. But I believe that with the expansion in the new states, the appointment of additional agencies, I believe there is a lot of value going forward. And I think this is the time you know we are not going to be out there trying to aggressively write business at inappropriate rates, but I think this is an opportunity where agents, we can be of service to agents and potentially help them. And that will ultimately grow our business.

I think the other thing is you look at the overall portfolio, which is maybe what you are alluding to, it is marked to market. But we have a different strategy and that could provide greater value in the long term. And I think that definitely can put us in a position to increase our business and provide greater return in the long term.

I agree with you. Thank you. Jack, take care of yourself.

Beth Malone, KeyBanc.

Could one of you please comment on the severity trends that you are seeing? A number of companies have announced they are seeing increased severity, but it is hard to quantify exactly where that is coming from. And does that -- is that a result of the pricing environment that we are in, that you are going to see more severity going forward?

Beth, Jim Benoski. On the severity, I think, on the smaller claims, the auto physical damage, the smaller bodily injury, those are probably related to inflation, medical costs, and repair costs, parts, prices, and such as that. And our severity is up. I think on the larger claims, the ones that we seem to be having more of, that is more a reflection of more severe injuries. We are seeing more injuries of a greater severity than we have in the past, like quadriplegics, traumatic head injuries, and paraplegics. So the number of those claims we are getting seems to be up from what we got in the past. And I think the severity on the larger ones is just the nature of the injury that has been sustained.

Is there any idea why you would have more quadriplegics and paraplegics as a result? Does anybody know why that would be happening?

We have not been able to determine that. It just happened in the last -- I think it started about the second quarter and it has carried through the fourth quarter. And I hope it is not something that continues on, but you really don't know what is going to happen to someone that has been in an automobile accident. And you don't know what degree of injury they are going to sustain. So why we are having more, I could not answer that specifically.

Thanks. One other question. You may have already answered this, but when, Ken, when you were talking, I think, you were saying that there were three factors that I know affected the 2006 results relative to 2005 -- stocks options, cat losses, and reserve releases.

Yes.

Can you quantify what those were in the fourth quarter alone so we see how those have impacted that quarter? Or were you talking about just the fourth quarter?

What I was giving you were the yearly numbers. The cats for the fourth quarter were basically even with a year ago. The development for the fourth quarter was almost the same. It was 10 points for this year versus 10.3 last year. And the option expensing obviously was not in fourth quarter of the prior year, 2005.

Okay.

But it was $0.02, approximately $0.02 each quarter this year in 2006.

So the real difference that you saw fourth quarter '06 to '05 wasn't any of these factors? It was just, overall, just much more favorable experience in losses in 2005, relative to a more-normalized level in 2006?

I think 2006 was a little -- well, the severity definitely popped up. I can give you kind of a recap. I mean, you are probably referring to the 83.9 that we had last year. The large losses, $250,000 to $1 million, added about 4.9 points to the combined. And then when you roll in IBNR and LAE, and we did some -- our actuary did some allocation between IBNR and LAE, but when you add us together, that adds about 6.5 points.

Cats were basically even and then the remaining incurred was down about 2.5 points. But then our expenses were up about 1.8. And the expenses there, the option will add about four tenths of a point, since that was not in 2005. Technology added about six tenths of a point. And then we were hit with a couple assessments from Michigan and Florida, they added about four tenths. We also had a settlement with the Internal Revenue Service. We had to pay some interest, which added about four tenths. So when you factor all those things together, you can kind of progress forward from the 83.9 to 94.5.

Just one last question. When you look at the market conditions obviously they are getting much more difficult than they have in the past. And your commitment to your agencies force, is that why we should anticipate that your expense costs are going to stay at these higher levels going forward. Because you have a commitment to that agency force that serves you very well over a long period of time, but when pricing becomes an issue and you have top line starting to not grow as much, do you feel you have to maintain a certain level of service and investment for that agency force?

I believe that we do. We are going to -- since the expense ratio did jump up to the magnitude that it did, some of those things are one-time items. But the technology is something we will look at and I think we will have to make a decision. Are some things that we don't necessarily have to do, but I think the bottom line is we want to continue to deliver technology to the agents because we believe over the long term, it is going to provide the value, which is going to increase the relationship and put us in a better position in their agency to allow them to be more profitable and more effective.

And if we can do that, we become a bigger player in their agency, which then will allow us to grow and increase profits. So I think to some extent that is true. I think we are making an investment in the future and we believe that the investments we make are going to solidify the relationships with these agencies.

Michael Phillips, Stifel Nicolaus.

In terms of the competitive landscape, have you noticed any -- I wonder if you notice any new competitors that you are running across in the past 12 months that you didn't run across prior to that, specifically in terms of regional players, not national players?

Michael, this is J.F. Scherer. I would say not. Our regional players tend to be the folks we would compete against most frequently and throughout the Midwest, Southeast, and even the far west, most of those companies have been in good shape and have been very active. We haven't -- every so often, a carrier will enter a new state and so we will see them more active in that particular state. But there has been nothing unusual going on in that area.

In terms of agencies doing book rollovers, any kind of change in the prevalence of that happening in the past 12 months?

To be honest with you, we don't see much of that. It tends to be competition account by account.

And then, my last question. If I have done my math right here, it looks like in terms of prior period reserve development, it looks like in '06 and in '05, if I have done this right, the first quarter you had unfavorable development. Does that that sound right?

That's correct, Mike. We did.

Just wanted to make sure. That's it. Thank you.

Stephan Petersen, Citadel.

Ken, I was wondering if -- I just want to follow up a little bit on Beth's question. Looking at the loss and loss expense ratio in the commercial lines for just the fourth quarter, did you quantify what you thought the higher severities were in the quarter in terms of that 57.6? Or was the number that you gave Beth, I think it was 4.9, was that an annual number?

No, that was the overall loss severity for the total property casualty. And what I was looking at was the supplement on page 16. That was total.

Okay. So, can you --

If you go to fourth quarter 2005, it was a 16.4 and now this year, it was 21.2.

I will find it. Thank you very much. That was all I needed. I appreciate it.

Paul Newsome, A.G. Edwards.

I was hoping you could talk a little bit more about your personal lines business. I'm scratching my head as to how it is going to become -- how it is going to return to profitability with reduced prices at a current combined ratio that, even if you adjusted for the bad luck with the weather, doesn't seem like an adequate rate of profitability. Maybe that has to do with the insurance scoring, but my sense is that your insurance scoring is putting you into the game. But it may not have the sophistication of those that have really made substantial advantages to the underwriting at this point. So I guess I am scratching my head as to how you get that business turned around, if at all. Could you help me with that?

Well, Paul, I think first of all, I think that with the system, the delivery of the Diamond system, I think we need to try to gain a little bit of geographic dispersion. I mean when you look at our book of business, we have about 45% or 46% of our homeowner premium in Ohio, Indiana, and Illinois. Three connected states. We have another 21 or so percent in Georgia, Alabama, and Florida. Again, hurricane potential prone. So that is two thirds of our homeowner book.

If we could get that spread with appropriate rates in some of these other areas of the country, the cat activity does appear to be in pockets and so there could be states where you don't have that cat exposure, which helps bring the overall ratio down. From my perspective, that is what I see when I look at the more-national carriers. And their results are definitely a lot better than ours. But they are writing business more across the country, in states where the cats had not occurred to the extent they did as far as we are concerned this year. So I think that is part of it. Secondly, to do that, we have got to get the system delivered so that we offer direct bill capabilities, we make it easier for the agents to do business with us.

This is Jim Benoski. Let me add we have a large number of our agencies that are commercial line agencies only. So we have a built-in market and as we get the automation out, we will be able to move into some of these agencies that are commercial-only, that already represent Cincinnati Insurance Company. And we think that is going to be a benefit to us.

I think, you know, your point is well taken that we have to get our rates and we have to get enough scale that we can make this a profitable line of business. You know 2005, it was profitable, after quite a few years of underwriting losses. 2006 we are back into the underwriting losses, so it is something we have to continue to work on.

If I am thinking of this on an accident-year basis, are you currently pricing at a higher accident year than you were in '05 and '06 because of these price declines? Or is that just not the case? It is just that the mix shift will help you out with essentially keeping an accident year that is at or better than what (technical difficulty) currently --

This is JF. I think your comment before about the insurance scoring and it is true that compared to many carriers, we are not as sophisticated. But the introduction of insurance scoring was designed, and it will become more refined, to improve our prospects for the above-average accounts and to take away credits for the below average accounts. We were experiencing evidence that we were not competitive price-wise on higher insurance-scored accounts and we were losing some of that business. So I think a significant part of our confidence that we're going to return to profitability in the homeowner line does revolve around the insurance scoring that we have introduced and our plans for continued sophistication in that area.

Auto has actually gone pretty well for us, private passenger auto has. It is the homeowner that has really been the frustrating line of business for us. And as Ken said, diversifying where we write business in homeowner as well as just gaining on the sophistication of some of the scoring methods is where we place our confidence.

Thanks, folks. I will stop beating up on you and everyone stay away from Jack so you can stay well.

Thanks, Paul.

Scott Heleniak, Ferris Baker Watts.

Just wondering if you could talk about Florida, what you guys anticipate seeing there as far as where you are going to operate and are you going to be changing any of your policies there, dropping policies, or any changes there in Florida?

We are still trying to figure out what the legislature has done there. We are committed to writing personal lines of business and commercial lines of business in Florida, but we have not really decided what direction we are going to go. I think there are a number of carriers that have indicated that they are either pulling out or cutting off business, but we have not yet made that decision.

And then on your large account business, can you give what percent of your overall mix that is for commercial and maybe how much that is? I am guessing it is down year-over-year, but maybe you could give a number on how much it is down?

How much of the -- would you repeat that, please?

First of all, I am just asking what percent of your commercial business is large account.

Well, I will just give you some perspective. 86.5% of our policies are less than $10,000 in premiums, so we have a lot of policies. The premiums less than 10,000 would be 31.7%. That will give you some sort of flavor. We obviously have a lot of small policies, but in terms of smaller than $10,000 in premium, that makes up 31.7% of our overall premium writings.

And then within your guidance, are you assuming to have a continuation of the loss trends you are seeing in commercial auto and workers comp that you see in the past two quarters? Are you anticipating that for '07 as well, or will we see more like what we saw in the first couple of quarters of '06?

I think what we're looking at, Scott, is pretty much just additional severity from the softening pricing and the same kind of activity that we have been seeing recently. That is in the assumptions. As I said in my comments, the 5.5 catastrophe, 5.5 points for catastrophes. Less favorable development, we had 3.7 points this year, down to maybe the historic level of two. And then the additional expenses that were discussed previously to continue to deliver the technology and so on. And if you take the full year and kind of factor in those things, it gets you close to 97%. So that was kind of the rationale behind the target that we set.

Daniel Baransky, Fox-Pitt Kelton.

I just had a few questions. I was curious on the growth rate in commercial lines in the quarter was pretty good compared to what we have been seeing. And I am wondering what your doing, sort of, in that line that is causing that sort of exceptional growth?

Well Dan, we did have a great year last year as far as new commercial lines business. We were up about 15%. From a practical standpoint, on a day-to-day basis, we are doing a lot of what we always do. We have 102 territories. We have a field underwriter that staffs that territory. We have done a lot more, if you will, team selling. We are trying to leverage the value we bring and not make this just a price game.

Our field claims staff, our loss control staff it is not unusual for those folks to accompany an agent out on a renewal or a piece of new business and help sell the business. Our agencies hold us in very high regard related to things like financial strength and the quality of our claims service. Our three-year policy, even though it is a softening market, is a very attractive proposition. So we have simply leveraged a lot of that. In our agencies, we try to go after their marquee accounts. We have been writing some larger accounts and so that is, once again, helped the new business in commercial lines.

Okay --

And if I could add also and we have a fairly stable book of business, in terms of -- our three-year policies cause us to have to turn over our book of business much less frequently. And though we have certain lines of business that renew annually, the commercial auto for example, and that can be subject to more price competition, I think overall we have got a very stable book of business. So when we write some additional amount of new business, it does complement our renewal book a little better perhaps than carriers that would have everything on an annual basis.

Okay. And I was wondering -- your homeowner's book. How far have you progressed along from converting that to the three-year to the one-year policies?

Right now, 85%. Right now, our policies are now on a one-year term.

And sorry if I am beating a dead horse. I also had to get off the call for a second. Can you just give me an explanation I guess of what you're seeing in these severity trends? I'm just kind of maybe baffled at what is causing those to crop up all of a sudden during the second half of 2006? I know you have sort of indicated there is nothing, sort of, extra special or sort of a trend within the losses, but I'm just trying to get a handle on what is causing these to crop up all of the sudden?

It started really in the second quarter of '06 and it has continued through the third and fourth. But we have looked at it just about from every angle you can think of -- new policies, uh, states, lines of business -- and it is pretty much spread across the board. The only common factor seems to be that the injuries are more severe. The million-dollar claim, you can have somebody that has got multiple broken bones. Now we are seeing quad or traumatic head injuries that have huge reserves of $3-$4-$5 million. So the only common factor so far it looks like is the severity of the injury itself. And what causes that, I don't know yet.

And is the severity within, sort of, your casualty lines or your property lines? And is it mostly medical cost inflation that is impacting these or is there any sort of --

Well it's -- sorry. It is in mostly commercial auto and general liability on the BI side. There are a few large fires, but those are -- that is not out of the norm. It is the injury out of the auto and the GL lines that are causing us the concern. I think one reason, you have people are living a lot longer now because of medical improvements. And someone that is a quadriplegic might have lived 10 years, now they may even have a normal life expectancy. So I think medical improvement is causing us to reserve those at a higher rate.

And let's say this trend persists over the next several quarters, I am just curious what kind of actions could you take to remediate this if it were to continue? Or is this just something you're going to have to accept within your sort of makeup of your book of business?

We are looking at the claims or at the risks that these claims are coming from and is there anything from an underwriting standpoint we can do. But I don't know how you are going to mitigate an injury when somebody is in an automobile and is struck by another car maybe broadside and their head hits the windshield, and now they have a traumatic brain injury. I don't know how you're going to mitigate that.

That is all I have. I will let someone else ask questions.

Ron Bobman, Capital Returns.

On the topic of mitigating some of these costs, could you talk about your reinsurance renewal and whether you made any changes to the structure and to the participant list? That is my first question.

This is Ken Stecher. Our retentions are basically the same. Our property casualty working treaties we have -- we've kept $4 million retention and then it's a $25 million program, so we have $21 million of 100% reinsurance. And then above that we go out and purchase facultative on the (indiscernible), and the rates there are up about 14%, '07 over '06.

On the catastrophe side, our rates are up about 28%. Our retention is still the same at $45 million, but at the upper layers when we went out and took the program to market, the upper layers were not completely sold or purchased. So we're retaining 14% of the layer [100X of 2], and we are retaining 18% of [200X of 3].

So we could have a $103 million loss if we had a $500 million total loss. In other words, that would be $103 million to us compared with $68 million in 2006. Does that explain?

I understand your -- did you say Aon went to market? Did you change your insurance broker?

No, we still use Towers-Perrin, I'm sorry.

My bad. And then on the casualty side, sort of back to the severity losses. I think '06 over '05, your retention went from two up to four, which I'm sure makes severity more painful. Any changes there or is that a different renewal date?

The renewal date is the same. The first of the year. The '05 and '06 -- the '06 program was four. Prior to that, it was $3.3 million for casualty and $3 million for property. We had a co-participation in there.

And that is the same going for '07. You are going to keep the retention at four, is that right?

That's correct, yes.

Thanks for that. Any changes to the players? I know you had some A- -- you had some A- participants in years past. Any change of attitude about having A- reinsurers on the program?

We evaluate those every year. This year, you know GE is now part of Swiss, so we have American Re, Partner Re, and we have added Hannover Re of Germany. So that is a new player. Some of our participation rates have changed slightly, but we still have the four major players. On the property cat, there has been some movement in those, but we have tried to stay at A- or greater as far as the ratings of those players.

On the hot topic of Florida, could you share -- I think on the last call you had fewer than two dozen agents down there. I'm less concerned about the agent count, although it sounds so small, as to how much premium you write in Florida in the different major segments.

We will have you that for you in just a second, Ron.

While you are working on that, is your initial read -- and I know you said your analysis is not complete -- but is your initial read on Florida, I guess personal lines and homeowners in particular, that it is a less attractive line of business for you in '07 than it was last year in light of these changes? I mean, is your bias more negative on the prospects for the state and the expected opportunity?

We received a 51% rate increase. It was implemented 12/1 of '06, which we think is going to be okay going forward. We had another 10% age credit, reduction of age credit. We think that is frozen, so we will get a 51% rate increase. What has happened, the state of Florida is supposed to come out with factors for us to include in rates. And we will make a rate filing after that. We don't know what those factors are until March 1, so I think it will be then when we really decide what we think we need to do.

But isn't -- I assumed that your 50% approved rate increase, the December '06, was in large part, or meaningful amount, predicated on increased reinsurance costs. And I thought that the factor was, in some respects, I know it is a harsh word, in effect a sort of rollback the inflation that companies like you faced for your reinsurance costs. So isn't that vulnerable?

The rate?

The 51% approval that you got. Do you have to make up a spring filing that says under the new legislation in Florida, our reinsurance savings are going to be effectively X and the state is saying we have got to pass that on to consumers?

That is what we understand, but I don't know really where that is, to tell you the truth.

How about that premium volume for Florida?

Our premium in Florida is 103 million -- $103.076 million. That represents 3.14% of our overall writings. 4.2% of our business in personal lines is in Florida, compared to the overall 2.8 in commercial. We write about $32 million in personal lines there. Homeowners, about $17 million in direct premium. Commercial lines is around $71.4 million in direct premiums down there.

And I assume that the homeowners number, in large part, doesn't reflect the 51% rate increase, right? You had insignificant renewals post the effective date, is that right?

That is correct.

Thanks a lot and good luck on that front.

Thank you.

Lara Devieux, Wachovia Securities.

Can you just provide us with more details on your expansion into New Mexico and Washington? I guess first, why those states? And then also, what are your plans for identifying and appointing agents and hiring field reps? And then last, can you just talk about the process of setting rates?

Lara, this is JF. Washington, I guess we will start up north. We are already in Idaho and the distance between Southern Idaho and northern Idaho, as far as field rep traveling up there, was too great. And northern Idaho in and of itself is not a large enough territory to support someone. Our field rep in Montana, is very familiar with the agencies in Eastern Washington and so we have decided to go ahead in the eastern part of the state only. And as soon as our field rep in Washington, or in Montana completes all the due diligence, gathering information that we will need to have to make those rate filings, she will make a good number of these appointments. And we will relieve her and add a new field rep who will live in Spokane and call on agencies in eastern Washington and northern Idaho.

Down in New Mexico, really pretty much a natural progression there. We are in Arizona and doing great. We find the climate in terms of economic, judicial, legislative climate, regulatory climate in New Mexico good. Not much in the way of catastrophes there, so we like that environment. We sent a team of people to New Mexico, as they have been to Washington and some other states where we have investigated, and we found a very receptive agency force and felt that we could really expand.

It is important to us to have geographical diversity and so these two states and northern Idaho we think work well into that. Our next step then, we have already done a lot of research, our next step will be to really get a good handle on the competitive environment in all of those areas in terms of where are the rate levels, who are the players. As I mentioned, when we travel out there and we do visit agents. And so we have already a fairly large group of agents, comparatively speaking, in New Mexico and Washington that are interested in representing us. So we will spend the next several months gathering information, continuing to talk to agents, and would anticipate no problem as far as the agency appointments are concerned and getting started as soon as possible.

Great. Thank you for your answer.

Charlie Gates, Credit Suisse.

You write three-year policies and pricing is falling. To what extent is that a negative from the standpoint of sales, because clearly, the agent knows the pricing is going down or would think it. And maybe the customer does as well?

Well, Charlie, sometimes that does come up, but generally speaking, a commercial client is looking for stability. They don't want to renew their policy every year. And from a new business standpoint, we are competitively priced, but we are stable and the agent that represents us conveys that. The other issue is no one knows what is going to happen down the road. There have been catastrophes and terrorism events that have changed the marketplace. And when an A++-rated carrier is willing to make a three-year promise to a policyholder with an agency being able to so confidently talk about the quality of claims service we give, it still is a good value proposition.

You make the point, though, that from time to time, for those kinds of policyholders that are looking for year-to-year advantages that they might be able to get in their insurance program, frankly, we don't really try and target that kind of policyholder to begin with, nor do our agents. And so surprising as it might seem, our agencies, I believe, if you were to say to them list of the top two advantages of Cincinnati Insurance Company in the commercial marketplace right now, our multiyear policy would be one of them.

Beth Malone, KeyBanc.

I just wanted to ask one more question about your expansion plans. How do you look at that relative to the pricing competition that you are obviously seeing in the marketplace? Is expansion going to be as aggressive when you realize that pricing is coming down? And do you want to spend more of your resources focused on renewals where the rate declines aren't quite as bad as trying to get new business where rate is much less?

Our decision to go into these states are decades-long considerations. We are planning on being there for a very long time. From a resource standpoint, literally, in terms of how we open a new state, the field underwriter that we will put out there will work out of their -- as they do in all the other territories -- they will work out of their home. The cost is the cost of a computer, a fax machine, a copier, a particleboard desk, and then some furniture. And so we don't really expend a tremendous amount of resources to get started in a state. Certainly there is some homework you have to do, but we can get started quick.

Ours is a very long-term outlook in terms of how we approach the business. Certainly, in New Mexico and Washington it is a soft market there as well, but we do think if you appoint the right agents, if you go out and out-work the competition for the right accounts that we stand a good chance of writing some very good business in those states, even this year. Even as soft as the market might be. So ours is a very long-term outlook and so we would not view timing as the issue as we look into a new state.

Daniel Baransky, Fox-Pitt Kelton.

I have two questions. One, there was a significant bump in the dividends in the worker's comp line in the quarter. Is there anything that we should highlight there?

I think it is just a calculation of the loss of data and looking at the activity -- the calendar year and accident year information. It is an actuarial calculation and they kind of set the reserve for us.

Okay. There hasn't been any change in sort of your approach to credits or anything there?

Dan, J.F. We try to be very conservative on the comp side. We are experiencing in some states in the Midwest some aggressive pricing there. And from time to time, we will have to add some credit to worker's comp accounts, but it is a conservative line for us.

Okay. And the other thing I had was more sort of ethereal. On your technology, it's really a two-part question. One, I guess, what kind of feedback do you get to your agents on how they view sort of your technology versus other people that they use in their offices. And, two, I would also inquire, sort of, how do you feel about your own internal capabilities to price and segment the data against what you feel is probably currently being done by your peer group as well?

On the technology side, on the Diamond product we have, we have gotten favorable response from our agents. It's got a lot of good features and I think the initial conversion into the Diamond is the biggest issue. But once they are in, going forward, we think it is a good product and we are getting good feedback. Also on the commercial lines technology we have got for the BOP and the Dentist BOP, even though it is in just a few states and it is only on that small line of business, there is the feedback on that is also positive. I think the issues are can't you do it faster and that is what we are trying to focus on right now.

Just to mention in the press release under commercial lines, you know we are talking about integration with their agency management system to our WinCPP, which is our online real-time quoting system. And that will help them allow -- they won't have to re-enter the data. So that is going to be rolled out this quarter. And that should be a positive. And J.F. would have more anecdotal information, because he works with the agents all the time.

Dan, what we have introduced they have liked. And I think Jim hit the nail on the head. They just want more of it. The types of things we are doing for the agencies to make it easier to do business with us is what they are looking for. And they are just anxious for us to keep bringing it on.

At this time there are no further questions. Are there any closing remarks?

Thank you everyone for joining us today. We appreciate your interest in Cincinnati Financial. Thank you.

Thank you. This concludes today's conference call. You may now disconnect.