辛辛納提金融 (CINF) 2007 Q2 法說會逐字稿

Good morning. My name is Candace, and I will be your conference operator today. 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 session. (OPERATOR INSTRUCTIONS). Thank you. Ms. Wietzel, you may begin your conference.

Thank you, Candace. Hello. This is Heather Wietzel, Cincinnati Financial's Investor Relations officer. Welcome to our second quarter 2007 conference call. This morning we issued the final news release, financial supplement, 10-Q 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 financial analysis. Before we turn to today's news I wanted to mention that we will be back on our normal schedule for our third quarter release and call. They're planned for Wednesday, October 31st.

On today's call Chairman and Chief Executive Officer, Jack Schiff 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, 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.

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

Thank you, Heather, and good morning to all of you. And thank you for joining us today to hear about our second quarter results. As we announced earlier in July, this was another strong quarter for us. Realized gains helped us achieve healthy growth in net income. Our insurance businesses generated operating income that rose 30.6% to $0.94 per share. Book value was $39.74, up slightly from year-end.

Our property casualty underwriting profit rose over 100% to $90 million. Our life insurance business added $0.05 per share to operating income. Pretax investment income rose 5% to $150 million. I am going to address the property casualty market and steps we are taking to maintain or increase our share of our agents' business. When that's done, Ken will talk more about insurance profitability, our investment results and the more positive view we are taking on the full-year results in light of this quarter's performance.

On the insurance side, a few weeks ago we held our annual Presidents Club event with independent agents who have made outstanding contributions to our Company's success over recent years. It was a good opportunity for our leaders to hear our agents' insights into their local markets. This year they have described an ever more competitive commercial and personal lines marketplace; they reiterated that renewal pricing pressure is rising and new business pricing is requiring even more flexibility and more careful risk selection.

Working closely with agents, we are using credits more frequently to retain renewals of quality business with variations by geographic region and class of business. To write the same piece of new business we would have quoted a year ago, they confirm our field marketing representatives comments that pricing is down about 10 to 15% on average. They mention that terms and conditions remain satisfactory. A position verified by views from our field sales and headquarters underwriters.

Our approach to these commercial lines market conditions can best be described in one word, consistency. While we will pass on an account, even a better account when we are faced with pricing that we believe is too aggressive or terms that are too aggressive, we are not sitting back in Cincinnati making those decisions on a line of business or a geographic basis. We continue to evaluate business on a case-by-case basis. Over time this approach has helped increase our share of our agents' business. We believe another way we can increase our share of our agencies business is by writing excess and surplus lines. Among the potential benefits we would gain flexibility in pricing, terms and conditions and using that flexibility to compete for additional accounts.

In the first half of 2007 we made progress towards establishing our excess and surplus lines operations. We have met with regulators in various states and will soon incorporate our new subsidiary in Delaware. At the same time, we will incorporate a wholly-owned brokerage subsidiary to provide exclusive access for our independent agencies to our excess and surplus lines products. We have an inter-departmental team that is identifying the excess and surplus lines and classes of business to target. They're developing underwriting guidelines and creating rate ranges for this business. They also have selected a policy administration system and have begun the process of hiring new, experienced insurance staff. All of this activity is leading to a 2008 rollout to our independent agencies. In 2008 we should see our first excess and surplus lines premium contribution.

In addition to growing with our current agencies, we also continue to build relationships with selected new agencies, either by making agency appointments in our active states or by entering new geographic areas. We completed 29 agency appointments in the first six months, a good start toward achieving our target of approximately 55 to 60 for the year. We appointed our first agencies in eastern Washington and northern Idaho during May and June. Our preparations to begin actively marketing in New Mexico are on schedule for the third quarter. We expect agencies in the two new states to begin marketing our products during the third quarter. New agency appointments play an important part in our long-term success.

For example, agencies we have appointed since 2002 contributed approximately 5% of agency direct premiums in the first half of 2007 and approximately 18% of our new business premiums. We believe the agencies we appoint over the next five years will further contribute to our success, even as agencies appointed in recent years contribute an even greater percentage.

Turning to our personal lines business, beginning in the third quarter comparisons should be more favorable as the rate structure in both years will reflect the policy credits we put into place in mid 2006. Since that time policyholder retention has exceeded 90% for both our personal auto and homeowner lines. New personal lines premiums have grown in each of the past four quarters after declining for several years. We've contracted with an outside consultant to provide insight into changes we can consider to better position our personal lines in this market. We will have their recommendations to help us shape strategy to further improve production and profitability. We continue to work to improve our personal lines operations, restoring the momentum to this business remains a priority for us.

Our commitment to personal lines is part of a commitment to offer a market for about 75% of the risks our local agencies have the opportunity to write in their communities. We work to be a stable market for that business, to provide superior everyday claim service and catastrophe responses, as well as a team of field people with the knowledge and authority to make decisions locally. We maintain strong capital, in part so we never need to limit our insurance activity or competitiveness because of balance sheet constraints. Agents can count on us for that when the market is soft and when it is hard. When the stock market and interest rates are up and when they are down. Right now it is a tough environment both on the insurance side and on the investment side, which Ken Stecher will discuss momentarily.

One result of our consistency has been high financial strength ratings, which are a great marketing advantage for our agents in competitive times. As you may recall, A.M. Best affirmed its A++ rating of our property casualty companies in April. Now S&P has advised us that on July 21 it's very strong ratings of our insurance companies were affirmed, all with a stable outlook. That's great news. And on that positive note, I will turn the floor over to Ken Stecher to discuss insurance profitability, investment operations and our outlook.

Thank you, Jack, and thanks to all of you for joining us today. Jack briefly discussed property casualty market conditions and our business approach. I am going to comment just briefly on property casualty profitability, which benefited from the low level of catastrophe losses, which continued through July, and activities in our life operations. My primary focus will be on our investment operations and our revised 2007 performance targets.

First on the property casualty business, we remain cautiously optimistic about our commercial lines operations where trends remain similar to those in the first quarter. We believe our business model is one that can succeed through all market cycles, although softening prices by their nature will compress underwriting profits. Nonetheless, commercial lines generated a healthy 85.2% combined ratio for the second quarter. All of our commercial business lines contributed to the strong performance.

For personal lines, trends also remain similar to those in the first quarter. As Jack discussed, we see the rise in new business levels and policy retention rates since the second half of 2006 as positive indications. We are working to restore growth, for example, we are beginning to tap the potential of our commercial lines-only agencies, making progress in introducing some of them to our personal lines product line. Before I turn to the life operations, just a reminder that the premium and loss data for our commercial lines and personal lines businesses are on pages 21 and 22 of our financial supplement. We have also added a new table to the supplement on page 23 that summarizes reserve development by segment. It lays out the issue I raised last quarter about catastrophe loss development versus regular development. As a rule of thumb when we talk generally about reserving data, we include development of catastrophe losses. Most years those numbers have not been significant enough to be separately discussed.

To summarize the reserve trends so far this year, we're seeing healthy savings that reduced the first half combined ratio by 4.8 percentage points. About 1.1 percentage points of that savings was largely due to the first quarter favorable catastrophe loss development. In last year's first-half, reserve changes had virtually no impact on the combined.

Those are my comments on the property casualty business, although we would be glad to answer any questions during the Q&A session. Let me turn now to the Cincinnati Life Insurance Co., which contributed to our net income again this quarter. Slightly higher expenses reduced the quarter's contribution to $0.05 from $0.06. For the year to date the life company contributed $0.13 per share to net income versus $0.10 in last year's six months, reflecting favorable mortality and persistency experienced, as well as healthy earned premium and investment income growth. The life operation continues to provide a reliable income stream for our agents and our Company.

Before I turn to our outlook, I want to discuss our investment operations, including investment income and changes in our equity portfolio. But I will start with a subject of great interest to many of you, our capital management and repurchase activity. As you may remember, during the first quarter we used $64 million to repurchase 1.5 million of our shares. As we've said in the past, we balance the use of our available cash flow between the repurchase and investments based on a number of criteria. One criteria we consider is the valuation of our shares. For the first 25 trading days of the second quarter we were restricted from making purchases due to our established blackout guidelines. The average closing price for the stock was $45.41 from May 7, the first trading day after the blackout, through June 30. The stock did not move below $44 until the last week of the quarter when investment activities had used the cash we had available. Further, our new $150 million credit facility was not in place until July 2. As a result, during the second quarter we did not purchase any shares. We have again been blacked out since the first of July.

With our stock now trading at what we believe is an unjustifiably low valuation, our intention is to take advantage of opportunities for repurchase in the second half of 2007. If we believe the valuation warrants, we can return to the market on August 10 -- this coming Friday. There are approximately 5 million shares remaining for repurchase under the current Board authorization.

Turning to investment income, our investment department continues to work to maximize growth opportunities for both investment income and book value. In the second quarter we saw pretax interest income trends affected by the mix of fixed maturity investments we have been purchasing. In recent years our fixed maturity purchases have been weighted toward tax advantage bonds such as municipal bonds, which have a lower gross yield than taxable bonds. This, along with calls to some higher coupon bonds resulted in a small decline in pretax interest income for the second quarter.

Dividend income rose by 9.7% for the quarter and 13.1% for the year to date as we continue to benefit from new equity purchases and increasing dividend rates from the companies we hold in our common stock portfolio. In fact, at June 30 our common stock portfolio yield to market was 3.6% compared with 1.8% for the Standard & Poor's 500 index. However, because of the impact the mix of bond purchases is having on investment income, we are lowering our guidance for full year pretax investment income growth to approximately 6% from our previous 6.5 to 7%.

In the second quarter we continued to sell equities either to take advantage of opportunities to improve our yield prospects or because the investment no longer met our parameters. The previously announced trimming of our Exxon Mobile position reduced our holdings to 5 plus million shares with a market value of about $440 million on July 31. The sale contributed approximately $118 million after tax. We also sold other common stock holdings that no longer met our investment parameters including FirstMerit and the majority of our REIT holdings. These sales contributed approximately $67 million after tax. These proceeds largely were used during the second quarter to increase our positions in other equity holdings that have better yield prospects. Our investment department and investment committee monitor our entire equity portfolio on a continuous basis. Identifying these types of opportunities for redeployment is just what that monitoring was designed to accomplish.

Considering market conditions and our first-half results, we have made several changes to our full-year 2007 performance targets, including the update of our investment income growth target I mentioned just a moment ago. For our insurance operations, we now believe our 2007 consolidated commercial and personal lines written premiums will be even with last year's $3.2 billion. While we think personal lines premium comparisons will be more favorable in the second half, we don't think we will be able to overcome the first half decline for this segment. For commercial lines we are taking a conservative revenue view because of pricing trends.

Also, as we announced this morning, we are again adjusting our combined ratio target. The change reflects our even more positive full-year view as catastrophe losses remained at a very low level in the second quarter. Our new target for the year is a combined ratio at or below 95%. That reflects the same basic assumptions we made all year with two minor changes. One, that full-year catastrophe losses will contribute as much as 4.5 percentage points to the ratio, down from 5.5 points in 2006 and two, that we will have slightly more than two percentage points in savings in favorable development. Our other assumptions remain unchanged - that there will be some loss ratio deterioration and that the 2007 expense ratio would be approximately 31.5%.

I would note that we are aware that personal lines pricing and loss activity are at levels that could put pressure on our future consolidated combined ratio if those trends continue. As Jack discussed, we are pursuing a number of strategies in our personal lines business to achieve our long-term objectives for this segment.

Further, as Jack discussed there are many reasons we're confident about our ability to maintain healthy profitability in commercial lines even in today's market. Year to date the commercial lines combined ratio has been extremely strong, but we are looking forward to adding the excess and surplus lines next year. Over the long-term we think we're positioned well.

Thank you, Ken. Before we open for questions I will note that last week we held our annual August field meetings for associates of The Cincinnati Insurance Companies. Almost all of our field associates who work with our agencies across 33 active states came to Cincinnati for a long weekend. For each agency they work with, the key associates from both field and headquarters sat down together to review personnel, business activity and quality, the agency's plans for the future and all the factors that affect the agency's potential to grow profitably. Company officers participated and helped keep track of items that called for follow-up. It is this type of hands-on activity that gives us confidence about the future. We know our associates, our agents and our book of business. Similarly, we keep a close eye on the companies we invest in. We are familiar enough with details to make case-by-case decisions rather than across the board actions contributing to the financial strength that is our hallmark. Thank you for your time today and your interest in Cincinnati Financial and The Cincinnati Insurance Companies.

Candace, we are about ready to open for questions. But let me remind everyone that Jim Benoski, J.F. Scherer, Marty Hollenbeck, Ken Stecher and I are here to help you field your questions. So Candace, let's go ahead with questions.

(OPERATOR INSTRUCTIONS) Beth Malone, KeyBanc.

Thank you. Good morning. I was curious if we continue to have a very mild hurricane season going through the third quarter, is that a net positive to you or is it a net negative because it will create more capital that will increase competition?

I think it is a positive because claims will be down. All those other market influences maybe I should defer to J.F. for some market comments on those things.

The competition's at a pretty high level right now. I think there are some cases where I guess you might label it irresponsible, but for the most part I get the feeling regardless of how much capital is out there, there is some responsibility being played out by the underwriters of most insurance companies. Clearly it is aggressive out there. I guess the knee-jerk reaction would be that if that were the case competition heats up even more. But I guess I would be hard pressed to see it get that much worse.

I would also add I think that if you recall our property CAT premiums went up quite a bit in 2007, beginning January1. And if the CAT activity does remain low, I would expect some rate relief there which obviously would increase our net written premium.

Okay, and when you look at the experience you have from a catastrophe standpoint so far this year, is it all due to a better weather condition? Or is there some benefit from better technology in your underwriting, changes in how you look at the business, or do you attribute the lower catastrophe losses basically because the weather was good?

I think there are a couple of factors; one, we have changed our retentions in certain areas for the homeowner and things like that. So that would be a partial benefit. I think secondly, we try to disperse our risk by the underwriting strategy that we have and that the agents only write within 35 miles of their agency and things like that. We hope that dispersion kind of gives us some relief there. So I think on top of that the fact that if you recall last year we had three pretty serious hail events, and this year to date those have not occurred. And that is one type of catastrophe that can be very localized. And if it hits an area where we have a fairly heavy concentration our losses can be high. So I think it is a combination, but the good weather has definitely been a positive.

And then one question on the investment portfolio. With the market having changed so dramatically in the last few weeks, are you -- is there more opportunities that you see because of some of the yields that we're seeing on some of these financials? Are you looking differently at where you're going to place new money, or do you maintain the same strategy?

I definitely see some opportunity out there. With the long-term horizon that we take, we feel like we can weather the storm. Most of the banks we own have very little, for example, in the sub-prime area as far as exposure goes and they are being kind of brought down in the general downdraft. So, yes, we see value there, and we will look selectively to place some money there.

Now, I understand your stock is under pressure here and certainly not where you would like to see the valuation. Do you make it -- is there a conscious decision to decide that you will, with the market conditions the way they are, that you will make more investments, equity investments, in this environment and scale back your share repurchase? Do you balance the two out or are they two separate decisions that you're making?

I think they have to be -- we have to look at those things together, because cash flow and cash availability is an issue. But normally what we do is we do look at the opportunities that we have, both on the repurchase side and other investments that we can make.

As I said in my comments, we believe right now our stock is undervalued. And depending on the price when it comes out, when we come out of our blackout period at the end of the week, that is when we will make our decisions to see where our price is, what kind of other investment opportunities we have. So in the past probably -- you can probably guess from our repurchase activity we always have performed some type of balance.

Okay, thank you.

Charlie Gates, Credit Suisse.

A follow-up to Beth's questions, to the best of my knowledge there are only two years in the last, I guess 11, where you bought back substantial stock. That was 1999, and I've forgotten the circumstances there. And in 2005 it was in part I believe Alltel driven. Now even though you said in the news release that there was a possibility you could buy as much as 5 million shares; could one of you elaborate on your assessment of share repurchase recognizing that I heard what you said to Beth?

I forget exactly, you're right about 1999. We had a huge repurchase year, and I forget exactly what the driving factor was there. I think that we do have 5 million shares left under the repurchase authorization. If we would buy that many shares we probably would have to utilize quite a bit of the credit facility that I just placed effective July 2. 5 million shares would be approximately $200 million. I don't think -- first of all, the share repurchase would be in the parent company. It would not have that kind of liquidity. So the credit facility could be utilized. But I would be surprised that we would go to that extent that quickly. But at these levels we do believe that our stock is underpriced. So as you've seen in the past, when we think things are underpriced we have been a little more active than in other times. I think all I can do is kind of point to past history as to how that may play out. Is that fair?

That was a great answer. The second question, could one of you opine as to the competitive environment that you currently are encountering -- and I did read your projections for full-year underwriting result -- the competitive environment that you currently encounter. And perhaps in answering compare it to a period in time in the past when you had a similar environment?

I tell you I can't remember a time in the past when so many commercial lines combined ratios were in the mid-80s. So I guess I would make that comment first. The level of competitiveness throughout the year has gradually gotten more and more. The anecdotal stories you hear, and I know many conference calls talk about this; the anecdotal stories you hear about pretty substantial decreases are just that, and they are relatively few and far between. The broad marketplace in terms of what we are seeing and what it costs us to renew a policy on a rate basis is still in the mid-single-digit levels. That would then be tempered by exposure changes.

Clearly, what we are experiencing on new business is that every carrier is very defensive of their renewals, and they are out in front of their renewals offering decreases in advance, in some cases that keeps the account out of the marketplace and reduces our ability to quote it. And the fact that an incumbent carrier is willing to make reductions makes it a little more just tougher to write a new piece of business. It is very competitive out there, no question about it.

We are getting ample at-bats, call it the level of competitiveness, the approach we are taking isn't a significant change in our strategy at all. We wouldn't want to do that; we want to make certain that the accounts we write are high quality. We know for those high-quality accounts we are going to have to be more aggressively priced to write them. And we may very well not write as much new business. The trends are obviously showing we're not writing as much new business this year as we have last year, and that is not cause for panic for us. We want to maintain a solid, well underwritten book of business and we think our agents are going to continue to give us opportunities to write an ample amount of new business for the Company.

I guess that's the best way I can describe it. Anecdotally there are stories of carriers out there making very drastic changes. I would say that some carriers who have been out of the market, who suffered during the firming market, who lost market share and some cases really don't have much more to offer, at least in our opinion, than a cheap price, we're running into them. But there are many good, solid companies out there that are working very hard just to maintain their books of business.

A couple follow-up questions and then I will get off. One, what is a high-quality customer?

Well, in our view a high-quality customer is one that our agent has the ability of either having a strong relationship with or will have a strong relationship with in terms of their ability to understand the intricacies of that business's account. They are not an account that shops their insurance every single year looking for the cheapest price. And you can tell; our agents can guide us in that regard of the accounts that tend to be that way. We make, as you know, a longer-term commitment in that we provide a three-year policy in almost every case for our policyholders.

Our claims service is arguably the best in the country as stated by our agents. We have an A++ rating. We think we have a lot of value to offer, and so when we sit and talk with our agents about the kind of accounts we are willing to be aggressive about writing, we are looking for the kind of account that is looking for a longer-term relationship. We do that together with our agents by sending our field folks out to visit the policyholders. We are able to size it up first-hand and when all of those factors come together we are much more comfortable in being aggressively priced and offering the services that we have.

My second question, you said that your rates were off mid-single digit, I believe. But then you made some caveat about exposure. What was that?

We do a physical audit of policies that we do renew, to determine on a rate basis, in other words the credit structure that we use is what has changed. So for example on property we will take a look at the rate for $100 of insurance and the credit that we use and find perhaps that the rate itself, the additional credit we had to use caused the rate to go down perhaps 7%. However, because of inflation and because of building value adjustments we might increase the amount of coverage on the building by 8%. The net change there might be 1% increase in the overall premium we have but we have more exposure. So when I talk about changes I talk about rate, and payrolls may be up or down. Building valuations may be up or down. Contents may be up or down, and that will affect the ultimate premium.

So the rate basically understates or overstates the adverse impact of competition or do I have that wrong?

No. I think the rate is probably what you ought to use to determine what kind of competition is really out there. We write, for example, a lot in the construction industry. The construction industry in certain parts of the country is down. So therefore, the trigger for how much premium we charge would be two items, the rate and the amount of payroll that contractor anticipates that he'll have for the upcoming year. And so we won't -- I can tell you what the rate will be, we maybe say that we will write that insurance for $0.20 per $100 of payroll to pick a number out of the air, but if he is projecting a great year and his payrolls are going to be up 20%, then our premiums are going to be up 20%. Moderated by whatever rate decrease we might have. I hope that is clear.

It was great. Nice quarter, guys.

Mike Phillips, Stifel Nicolaus.

A couple questions. First on commercial lines. You talked about with the rates coming down and how you are passing on many accounts. I guess could you quantify for us in any way at all how much of the new business drop off was because of that versus what you didn't walk away from, but was purely rate driven?

The comments that we are getting from our field, and Jack mentioned in his remarks that we had the entire field force in this past weekend for a meeting -- the comments we are getting back are primarily that this time last year they would have successfully written several large accounts. And for us as a company, larger accounts would be $100,000 plus in premium. And what we are seeing, and we talked about this in previous calls, is that the larger the account the more attention it attracts in the marketplace and tends to be more competitively priced. And so to a very great degree our field reps are indicating that while they had the opportunity to compete for that account, the pricing levels just were below where we were successful. Our strike zone continues to be probably I guess what we call midmarket, $10,000 in premium up to about $100,000 and we're continuing to successfully write those accounts. The challenge for us probably in having an improved second half of the year will be the degree to which we can isolate those larger accounts that have a great appreciation for the value we bring and aren't underpriced. I would say that probably characterizes what we've seen differently -- different this year than last.

Thanks. Two questions on personal lines, if I could. First, I am hearing a lot about new agency appointments and new products and the great success you've had in the past four quarters with new business. Can you give more details of plans, strategy to turn around the -- you're still real close if not just right a little bit above current period breakeven and how you want to bring that back down again to profitability.

A couple of areas in terms of the profitability, Jack mentioned in his remarks about the fact that we were working with an outside consultant. One of the -- the biggest area for us in our ability to write new business was the introduction of insurance scoring last July. And we have in effect three tiers. We are in the process right now of expanding the data we gather, buying more data and creating an opportunity for us to fine-tune our rating process. That's going to be key to our success. It makes us more profitable, creates the ability for us to write more business, but also to improve the profitability along those lines. So that would be the first item I would mention.

At the end of the second quarter we had 1,297 reporting locations in some of your information you would note. Of those about 476 are commercial-only appointments for us. These are agencies that have chosen over the years not to do business with us in personal lines, and that would be primarily driven by the automation and direct bill issue to their agency. There will be a substantial percentage of those agencies that we will be able to go back to now that we are offering automation and direct bill and more refined pricing and ask them to represent us in that area. We like our prospects for our ability to convince them to do that. But for us as a Company the key to our success I think right now continues to be the refinement of our pricing process and the use of more and more data to allow us to price more specifically and underwrite better through that insurance scoring mechanism.

And you kind of touched on it there but my last question, if I could ask it in a little bit more detail here is when you approach those agents that are commercial only to offer some personal lines, simply what is their reaction? Are they oh, okay I hear the automation and the more refined pricing, but what are the buts? Or are they pretty open to taking on the personal lines?

No. I think in fairness the buts are that you've had a tough time over the last several years in being able to write new business; their loss ratio in personal lines is higher than commercial lines, and their commercial lines loss ratio with us may be great. They will want to have confidence that we have the pricing right before they take the plunge. Personal lines tends to be a line of business that would be consolidated within an agency, whereas personal lines .... Itwould be common for an agency to have six or eight or even 10 standard market carriers in commercial lines. They might want to have two or three in personal lines. So they don't want to dabble in personal lines with a carrier. They would want to make a full commitment with a substantial amount of business with us. And I think for them getting their arms around and their comfort that our automation is sound, and it is and that our direct billing process is out there and being used, and it is. I think the main issue right now continues to be making certain that we are competitively priced and that not only competitively priced but the process of pricing allows us to attract above-average business. So that is the but when we ask them.

Mike, this is Ken if I could just add one additional comment on the expenses, a lot of the reasons why they did not use us for personal lines before was lack of technology, as J.F. said. But in the states where we are currently writing or have that process for that system in place the cost to write the additional premium will be very low. The technology is already there, as we said before. So I think that if we can accomplish those objectives we can definitely bring the combined ratio down to personal lines.

Okay, great. Thanks very much, guys.

Heather Hunt, Citigroup.

Thank you, and good morning. I just wondered if we could switch over and talk a little bit more about personal lines. On the homeowners side you had good experience this quarter but some of your regionals here had higher loss ratios. I was just wondering if you could comment on the disparity in that? Is that just a function of your improved underwriting, weather, regional exposure or what do you think that really is a factor of?

I don't know if I can say for certain, but I know some other carriers that were more regional had higher catastrophe activity from the homeowners just by the parts of the country they were in. Up in the northeast where we had very little personal lines exposure. So from my perspective I think the benefit was we were blessed with very good weather this past quarter.

Okay, and you think is competition on pricing, has it been more severe than in other areas or other product lines?

No, I think personal lines competition is pretty intense. It is intense from an advertising standpoint; everybody can see that, and carriers continue to refine their models and they are really going after it. So yes, we are seeing as much price competition in personal lines as we are in commercial.

Okay, great. Thanks. A follow-up just on your written premiums versus new business. In your press release it says that you had $10 million from new business in personal lines. So if I back that out of written premiums, the decline is will be even higher than the 6.8%. So I guess I was just wondering if you could reconcile the written premiums decline with new business growth.

That is very difficult to do, I have not done that. A lot of factors come into play. You obviously have retention, you have renewals. Maybe at different rates and all those factors come into play. So I don't know that would probably be a pretty difficult exercise to --.

And is it like in a big picture sense maybe? Are you getting better pricing on new business than you are on older business? And are you maybe starting to be willing to walk away from older business where you can't get the good pricing?

You are just talking personal lines homeowner at this point?

Yes, personal lines overall.

Our retention in homeowners and private passenger auto is good. It is in the low 90s. So we are actually seeing fewer people walking away. The pricing for the similar account is exactly the same on a new piece of business as it is on a renewal. So there would not be any changes relative to that.

Heather, one other point. We did kind of adjust our rates July 1 of last year, so that made us more competitive. So for the first half of the year we've had comparisons that were really apples to oranges. I think the third quarter those rates have been in place for twelve months now, and you might get a better sense of the actual comparison of renewals and new business and so on.

All right. Thanks.

(OPERATOR INSTRUCTIONS) Charlie Gates, Credit Suisse.

The only other question I had was to the extent that commercial lines pricing is going down and you guys are writing three-year policies, to what extent does that adversely affect sales in this current environment?

Charlie, it actually, it is a positive for us in the environment. As I mentioned, when we talked before I think a very high percentage of our accounts as a result of the guidance our agents give us are accounts that are looking for the long-term. We offer the long-term; a higher percentage of our accounts are not being remarketed right now in the current pricing environment. But that is a positive for us, and agents continue to like the three-year policy and policyholders do, too in this marketplace. No one's crystal ball can tell them what is going to happen in the marketplace over the next three years. There could be hurricanes. There could be a terrorist event. There could be many types of things that could be disruptive to the market. Yet an A++ rated carrier is willing to make a three-year promise to a policyholder. That continues to be a very powerful tool for us in writing new business and also retaining the business we have.

Can you see any impact -- I promise this is the last question -- do you see any impact as a result of Ohio Casualty getting married on your business?

No, I can't say that we see any impact at all.

What would be the logical impact if there was something to occur?

Well, I don't know what Liberty Mutual's plans are in terms of how they may want to change Ohio Casualty, whether it be price competitiveness or lines of business, that type of thing. I think that would be, if you will, the wild-card that they make some changes there. Aside from that, we really have not seen any impact at all from this change and really haven't heard anyone speculate about the impact other than if there would be a strategy change imposed by Liberty as the parent.

Thank you.

Dan Baransky, Fox-Pitt.

I had a question on your agency appointments and your plans for this year. How much of that is in your expansion states, and how much of that is coming from the expansion states?

From the expansion states we currently have three appointments, two in Washington, one in northern Idaho, which isn't a new state but a new territory. We would anticipate probably a couple more appointments there bringing that to a total of five. And I would think somewhere in the four to five range in New Mexico now that we've got our field rep in place there. So we are looking at 50 from existing states and 8 to 10 more from the new state territory.

And just give me a sense, one of the things that agents have liked about Cincinnati is sort of the exclusivity and if you are going to appoint 50 new agents, how do we know that you are keeping that exclusivity or that sort of territorial exclusivity that the agents like?

That is a big issue. We have 102 territories, to appoint 50 agencies in 102 territories isn't going at it with a shotgun certainly. However you can be sure that in every single territory when we consider what we are going to do we are talking to the agents that represent us already. Asking them can we expand the relationship? Is there anything more to do for you that we are not already doing? And in many cases those agencies actually give us some help in suggesting who we might appoint. There is a little bit of art to that. You can analyze the total population in the area and say that we can certainly justify a certain number of agency appointments, but we cherish the long-term relationship we have with our agents. We write a very high percentage of many of those agents' book of business. In some part it is because we have made the sacrifice of not having too many agencies, and we've concentrated on developing great relationships, long-term relationships that pay off for us in the long run. So 50 is I guess maybe you can say almost a modest number, but we go through a tremendous amount of investigation. First of all when we appoint an agency we make certain that there is a balance in the territory between the existing agencies and we think that is about the right number.

And of the 476 commercial-only agents, how can we gauge the traction you are getting with seeing them convert to persona lines? Was that a higher number before and now it is 476 and --

No. We are in the process right now of actually making some of those appointments. I think 39 so far this year is where we are -- hold on just a second. Let's make sure. 24 in the last six months and 25 targeted for the rest of the year. We are being careful about that. But we've been running at about that rate, that 476 on a percentage basis as a total is about right to where we've been. And one of the things that we are making these changes only in those states where our automation system Diamond has already been rolled out. Those numbers we are talking about will include non Diamond states.

We will be going in to those states with Diamond over the coming months. Those opportunities will start to open up the rest of this year and particularly next year for a lot of those commercial lines agencies.

And then I have two sort of ethereal type questions. One, what do you think or what do you conjecture about and given your industry experience, what could turn this market around again? I guess the last hard market was sort of a confluence of events and sort of presented a perfect storm for a hard market. What could bring back the hard market?

And my second question is and I know you can't provide guidance but let's say we have the sort of current state of deterioration for several more quarters or even a couple of years. How quickly can the combined ratio and the loss ratio deteriorate from here?

We are all shaking our heads.

Those are tough questions, Dan. I think obviously one thing that could hasten the return to a harder market would be obviously if losses really accelerated or some other changes in the capital markets to where the capital that the companies have would be decreased. And maybe they wouldn't be able to meet the same operating numbers that they want to hit as far as leverage or premiums to surplus, those types of things. So I guess capital right now, everybody is making a lot of money, and they have a lot of capital. And so they are trying to be aggressive in trying to increase their business and market share. So I think that would be my answer there.

Secondly, as far as deterioration, you can go back into the late '90s when the soft market was really sort of at its peak and most of the industry was writing well north of 100% combined ratios. And they were making it additional profit basically profit off investment income. So what we have right now is obviously interest rates are down considerably from where they were in that period of time. I don't have the numbers, but I'm sure that the yield on the bond portfolios are down considerably from that point in time. So they are not going to have as much investment income. So I think that they may not let the combined ratios go as far north of 100 as maybe they did previously.

Our objective, as you know, has always been to be better than the industry from that standpoint, which means we did have a few years of in the 100 to 103, 104% combined range. Excluding the year 2000 where there is a couple of special events but we were still better than the industry in those points in time. So I guess that our objective would be even if the combined ratios do rise because of pricing and competition, and I think we would still, our objective would still be to have a book of business that would produce a better result and a better operating profit as a percentage of our premium income than our peers.

Is there any way to -- and this is my last question -- is there any way to sort of quantify given the current state of the market and if these trends continue what kind of deterioration could come through? Is it a loss ratio point a year, is it 2 points year? I'm not quite sure how to think about that.

I think that's difficult. I mean, if the losses -- if the premium stayed soft and inflation really ramped up, your loss cost would probably increase at a greater rate than you would have anticipated so I think that would accelerate it. But if the premiums continue to come down and inflation stays very benign, then the loss cost wouldn't increase as much. It would take longer to get to that point, but I think there's a lot of factors that could enter into that.

All right, great. Thanks for your feedback.

Beth Malone, KeyBanc.

I just have two follow-up questions. One is on the trends in frequency and severity; a number of companies have mentioned that frequency seems to be remaining relatively low, there was a little uptick. What have you seen from that perspective? And do you think this is, there is some change in the overall market that is going to sustain these lower levels of severity and frequency?

I think our frequency is still flat. Higher deductibles, also policyholders retaining the smaller losses and not reporting them I believe has an impact on it. And obviously this year because of the lack of storm activity severity is, does tick up but I don't think it ticks up more than the rate of inflation for us.

Okay, and one last question on the merger and acquisition activity in the marketplace; you all have not been overly active in that, but do you see opportunities or do you see further consolidation taking place given the market conditions and where prices for some of these companies have gone in terms of their stock price?

I think you are right. For us to entertain any kind of M&A activity would have to be some really special, unique opportunity. So I don't believe that we would see much interest in ourselves acquiring somebody. I think you are obviously right that when the stock prices are depressed that is something that does make some companies more attractive. And so if these levels do stay down or I could see where there could see increased activity.

Okay. Thank you.

Fred Nelson, Crowell, Weedon.

I just wanted to share with you I have a tremendous amount of gratitude for the great effort your organization provides all of your people, and it is really appreciated by me and my customers. A couple of things. The investment counseling business, can you comment? On the bond portfolio for corporates, do you have any exposure there to home builders that may not make it or lenders that may not make it? And what factors do you use for forecasting inflation?

The money management business is doing fine. It is chugging along slow but steady.

Thank you.

On the bond portfolio the total home builder exposure we have is less than 2% of the overall picture of our bond portfolio. Three quarters of that is investment-grade right now and certainly there has been some pricing weakness. None of the ones we own right now look like they won't make it but obviously that can change, but we're keeping a very close eye on it and monitoring very closely.

As far as inflation, Fred, we really don't try to forecast inflation, nor do we forecast interest rates. We just take a much more steady, broad approach and kind of take what the market gives us over time.

Thank you.

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

Candace there are, and I would like to thank everyone for joining us today. We appreciate your interest in Cincinnati Financial. We will be talking with you. If you wish to question us, call us. We are glad to receive your calls. Thank you and goodbye.