辛辛納提金融 (CINF) 2007 Q3 法說會逐字稿

Good morning. My name is Anlee, and I will be your conference operator today. At this time I would like to welcome everyone to the Cincinnati Financial 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. Hello, everyone. This is Heather Wietzel, Cincinnati Financial's Investor Relations officer. Thank you for joining us on such short notice for our third quarter 2007 conference call. Note that we are canceling the call scheduled for October 31 since we have accelerated our reporting. This morning we issued the news release on our results and the repurchase, along with selected pages from our supplemental financial package and the listing of the securities that we owned at September 30. If you need copies of any of these materials please visit www.cinfin.com for all the information related to the quarter can be found on the investors page under financials and analysis. We anticipate completing the financial supplement soon, and we will send out an alert when the complete package is available on our website. We anticipate filing our 10-Q by Monday, November 5.

On today's call Chairman and Chief Executive Officer, Jack Schiff, 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 is provided with the release and is available on the investor page of our website 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. We know that a number of other insurance companies are also reporting results today and that your time is limited. We will try to keep our introductory remarks brief so you will have sufficient time for questions. As you saw in the release, third quarter operating income was essentially even with last year. Operating income per share for the nine months is up about 17% on strong first-half performance.

In the third quarter the expected benefit to our underwriting profit of very low catastrophe losses was offset by the effects of lower pricing, non-catastrophe weather-related losses and timing differences. In a moment I will address our view of our premium trends in the property casualty marketplace and then turn the call over to Ken who will talk about loss ratio and underwriting expense trends, as well as update our full-year outlook.

First I will address our Board's decision to expand the repurchase authorization. The Board replenished the authorization to reinforce to shareholders its confidence in our business and our long-term outlook. Beyond the higher authorization, by entering to an accelerated share repurchase agreement we chose to signal our belief that we can deliver increasing shareholder value over the long term. After completing the accelerated share repurchase we have about 13 million shares authorized for repurchase, and we will use the discretion the Board gave us to buy these shares. We expect to buy shares in the open market but the Board has given us the flexibility to pursue private transactions or accelerated share repurchases.

In this instance the Board believed our shareholders could benefit if we sold a portion of our Fifth Third position and used the proceeds to immediately repurchase our own shares. Ken will talk a little bit about the sale later. Share repurchase is a way to help us deliver increasing shareholder value when the price of our common stock is attractive, as it has been in recent months. The Board also remains committed to our dividend payout, which we have increased in each of the last forty-seven years. The Board will review the 2008 payout level on our normal schedule at the regular meeting in early February. Over the past ten years the Board has increased the cash dividend at a compound rate of 11%.

The softness of the insurance market is one of the factors presently putting stock prices of insurance companies, including Cincinnati Financial, under pressure. In the third quarter the reports we have been receiving from agents now for more than a year of ever more competitive commercial and personal lines marketplaces rose to a higher frequency and pitch. This increased competition coincided with economic pressures in some regions which also reduced premiums by affecting our policyholders' revenues and payrolls.

Also in the third quarter we wrote $72 million in new commercial business but felt that acceptances of our offers were below our normal level in recent years. We believe we are quoting prices appropriate to the quality of the risk and leaving unprofitable business on the table. We continue to evaluate new and renewal business on a case-by-case basis. Decisions are made by associates and agents with direct knowledge of the account. Over the long run our history says that this approach pays off very well for agents, for policyholders, and for stakeholders.

Our excellent nine-month combined ratio and improving outlook for the full-year ratio builds our confidence that we will achieve satisfactory performance in this cycle. Turning to our personal lines business, third quarter comparisons were more favorable as the rate structure in both years reflected the policy credits we put into place in mid 2006. Policyholder retention remained above 90% for both personal auto and homeowner, and new personalized premiums grew for the fifth consecutive quarter. Increased new business still doesn't fully offset the impact of lower rates on renewal business and lost business.

We continue to work to improve our personal lines operations, restoring momentum to this business remains a priority. We know that access to Cincinnati Insurance personal lines, broad coverages and great claim service is an essential piece for strategic planning in many of our agencies.

Ken, may I please turn things over to you this morning?

Thank you Jack for giving our comments on the marketplace. And thanks to all of you for joining us today. I am going to comment today on loss ratio and underwriting expense trends. We have not completed the full analysis that contributes to our normal commentary, including for example some of the line of business statistics. You will have that detail when our 10-Q is filed. After I cover the loss ratio and expense trends I will talk further about the repurchase and Fifth Third sale and our revised 2007 performance targets.

But first on the property casualty business. While catastrophe losses remain significantly lower than any of us would have anticipated, we did have an unusual run of non-catastrophe weather losses. Losses from wind, hail or flood outside of catastrophe events total $31 million or about 4 percentage points on the combined ratio in this year's third quarter compared with $13 million or about 1.6 points last year. Further, three of these claims resulted in $11 million in unusually large commercial property losses. One of those losses came from a tornado in North Dakota, and two came from flooding in northern Ohio. In each case industry-wide damage appears to have been just shy of the level for official designation of a catastrophe event.

Because these were a significant factor in raising losses greater than $1 million, one of the large loss categories we track to its highest level ever, we do not believe we are seeing the beginning of a trend to an even higher level of large losses. As a note, favorable development from prior year reserve releases continued at a healthy pace, reducing the nine-month combined ratio by 5.4 percentage points. About 0.6 percentage points of that savings was due to first quarter favorable catastrophe loss development. In last year's nine months savings reduced the combined ratio by about 1.5 points.

On the expense side the underwriting expense ratio declined by about one percentage point in the quarter due to lower commission expense. Non-commission expenses, however, rose by 1.2 points due to the timing of expenses for various state assessments from Michigan and Florida. For commercial lines, the decline in written premiums also caused unfavorable year-over-year comparisons of deferred acquisition costs.

Those are my comments on the property casualty business. We will be glad to try and answer any questions during the Q&A session. The Cincinnati Life Insurance Company contributed $0.05 to our net income again this quarter with $0.18 per share added to nine-month net income versus $0.15 last year. Before I turn to our outlook, I want to add some color on the repurchase.

Including the ASR agreement we announced today, we've used approximately $312 million to repurchase our stock this year. As we 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 of the criteria we consider is the valuation of our shares, which we have considered to be attractively priced in recent months. The Board believes our shareholders will benefit by using the sale of a portion of our Fifth Third holding to repurchase our attractively valued shares.

Fifth Third has been an excellent invested asset for our Company for over 50 years bringing an increasing flow of dividend income and a healthy return on our original investment. We continue to own a very sizable stake in Fifth Third and remain their largest shareholder. Fifth Third also continues to meet our investment parameters. We benefit from the significant contribution of Fifth Third's dividend to our investment income. Over the past five years Fifth Third has increased its dividend at a compound rate of 11.8%.

Jack mentioned the softness of the property casualty markets as one of the factors that is putting insurance stocks under pressure. Another concern is the industry's potential exposure to the credit markets, including sub-prime mortgages. We believe our Company's portfolio may have been judged too harshly on this score and that we are very well positioned. Our investment portfolio contains no mortgage loans or mortgage-backed securities. Our bond portfolio continued to hold steady in the third quarter. Widening credit spreads in the corporate sector were more than offset by the benefit the general flight the quality had on our municipal and agency portfolios. We are aware that some of the financial institutions we hold in our equity portfolio have indicated they are enduring more credit related issues than others.

As a group, however, the largest banks in our portfolio have not materially underperformed the broader sector this year. We believe our strategy will continue to allow us to maximize both income and capital appreciation over the long-term. And we also have sufficient strength and focus to get over the bumps in the insurance marketplace, taking into consideration our third-quarter results and actions we are making only minor changes to our full-year 2007 performance targets.

For our insurance operations we now believe full-year 2007 consolidated written premiums will decline on about par with the nine-month decline of 1.3%. While we think personal lines premium comparisons have become more favorable, we won't be able to overcome lower renewal premiums in this segment in 2007. For commercial lines, we are taking an even more conservative revenue view to be cautious in light of pricing trends. We are now targeting a combined ratio at or below 94%, which would put us near the 94.3% we recorded for 2006. The revised target reflects some basic assumptions: one, that the contribution from catastrophe losses will be even lower than we anticipated, offsetting the expected deterioration in the underlying loss ratio due to softer pricing and large loss trend; Two, that we will have more than two percentage points in full-year savings from favorable development; and three, that the 2007 expense ratio will be about 31%.

Our full-year 2007 investment income growth target remains approximately 6%. We have been successful in recent soft market cycles, outperforming the industry with lower combined ratios. Our case-by-case underwriting approach supported by field underwriters and loss control associates helps us retain quality accounts and places us in a position to benefit when the market changes. With adequate revenues and a strong capital position we expect to maximize opportunities in the future. Jack.

Thank you, Ken. Before we open for questions I will note that Fitch, Moody's and Standard & Poor's all affirmed our financial strength ratings during the third quarter while A.M. Best's affirmation was a second quarter event. We believe the families and businesses that depend on their local independent insurance agents are a segment of the insurance buying public that knows all insurance companies are not alike. They look for agents' opinion of a carrier first, and they may look for a third party objective opinion such as those offered by the rating organizations.

That is why we ask the rating organizations to review our financial data and condition and further visit us and evaluate management every year. We believe that high financial ratings help our agents market to discriminating policyholders who are centers of influence in their communities. We are not like other companies in several respects. We maintain a large field force and give them more decision-making authority. We write three-year commercial policies. We invest in equities after covering our liabilities with fixed income. Those are just three examples where we don't fit the typical mold. We know that makes it more of a challenge for the various rating agencies and also for investment analysts to measure and compare us with others. We appreciate the effort that goes into understanding how these points of differences are advantages that we have leveraged to succeed in the past, and will continue doing so in the future.

Thank you for your time today and your interest in Cincinnati Financial and the Cincinnati Insurance Companies. Operator, we are about ready to open for questions, but let me remind everyone that Jim Benoski, our President and Chief Operating Officer; J.F. Scherer, our Senior Vice President, sales and marketing; Marty Hollenbeck, our Vice President of Investments and Ken Stecher, our Chief Financial Officer and I are here to help field your questions. So operator, let's go ahead with questions.

(OPERATOR INSTRUCTIONS) Mike Phillips, Stifel Nicolaus.

A couple questions. One, I think Ken said year-to-date favorable development was around 5.4%. Is that correct?

That is correct, Mike.

So if I'm doing my math, I think that is about just under 7% on the quarter.

About 6.5%.

Good and any chance you can split that for us, personal and commercial?

I do have that split, but I don't have it by line. Commercial will be 7.2, and personal, 4.2.

Okay, perfect. The non cat losses that you guys talked about seemed to be kind of -- I know we hear it every quarter, a flood or tornado here or there, so it happens. But this quarter it seems to happen quite a bit. We've had Allstate, we've had a couple other companies reporting the same kind of thing. It is hard for folks like us to track that. I wonder if you had any thoughts on how to pay attention to that besides looking at ISO catastrophe numbers that this obviously didn't break the threshold for.

You're talking about the weather?

Yes, I am.

I don't know how you would track it unless you watch the national weather forecast. The floods in northern Ohio had a significant impact for us, and that is a commercial impact; most of the personal policies don't provide flood coverage. You know ISO's trigger for the cat is $25 million industry-wide. And we had two floods that were $7 million. It is a little bit hard to believe that the industry as a whole didn't have $25 million, but that was in newspapers and on television quite a bit. So that would be the only way I would know you would be able to track it.

The tornado that we had up in North Dakota was very isolated in just a very small area. We had one large building that was destroyed, of course that was on TV but still it was so small of an area hit that I don't think people would have thought much about it. But other than watching the national forecast and looking at the paper I don't know how you would track it.

Okay. That's kind of what I thought. Thanks. And I guess lastly, could you give us an update on -- you've had recent talks down in Florida with the regulators down there and kind update us on how the talks have been coming along.

We had a hearing scheduled, I think October 18, that was continued. We have supplied Florida with a lot of material that they had asked for. We filed a motion to limit the discovery of what we had to provide by subpoenas but the court had disallowed that saying it was not ready for a decision. But during the process we had discussions with the Florida Insurance Department, and they limited the discovery on their own. I don't know that they had time to go through all the material we had sent down there, and it is only my speculation that that is the reason that this hearing probably was continued. We think it will be reset end of year, maybe early '08.

Okay. Finally, you had a lot of news this quarter with the share repurchase and Fifth Third. What drove your decision to go ahead and report the full results this morning instead of later next week like you had initially planned?

Mike, I think the biggest factor was we knew with people anticipating less weather, everybody was increasing their earnings estimates, and our consensus went up fairly significantly also. We were able to pull the numbers together to a point that we felt comfortable going and releasing. The fact that we are at $0.66 versus consensus of $0.78, I believe, is a fairly decent miss and we thought it would be better that we get the news out sooner rather than later.

In the past we have kind of given I guess you'd say warnings or early indication of where we would be. This time the estimates kind of started to bump up in the midmonth and the numbers started to come together so we just decided we thought it was best to get all the news out.

And Ken, remember part of the whole timing issue we were facing was that we couldn't announce the share repurchase without the numbers out, and probably without the full numbers out. There are disclosure issues there. So that is the other piece of the puzzle.

That's right, Mike. We wanted to enter into this agreement and we couldn't do it unless we had released earnings.

Thanks. I appreciate that. That's all I have. Thank you.

Charlie Gates, Credit Suisse.

I have a couple questions. One, do you see any exposure to the California wildfires for the Company?

Very limited, Charlie. We have business in California, but we don't have any agents on the ground selling out there. It would be people from the Midwest maybe who would have vacation homes or businesses out there. I don't know, maybe Jim or Ken would have a comment on it.

Charlie, if we had any, it would be very limited. We have not had a report as yet of any claims.

There was the first question. My second question, I think commercial lines premiums rose some 4% in the first quarter of '07, 2% in the second quarter of '07 and declined some 6% in the third quarter. Could you elaborate on what occurred say third quarter versus second quarter from a pricing standpoint? And perhaps in answering the question to what extent is it -- I would think it would be real tough to sell three-year policies in a pricing environment where everybody knows pricing is going down.

This is J.F. A variety of things are impacting our growth rates. Obviously competition is, and just general rate reductions that we are seeing. New business is down, as was announced. We are seeing, and I am going to kind of give you a big picture view of what is happening overall. We are seeing really tough pricing pressure on writing new business; our field reps are telling us that to write a new piece of business this year, a similar account last year, requires as much as 15 to 20% more aggressive pricing. We are trending in about that range being down month-to-month, of being down about 18 to 20% in new business.

It is discouraging not to be able to write more in terms of dollar amounts, but the fact is that given the pricing levels we are able to respond on good accounts to help our agencies write the business, and we are quite confident that the quality of the business is good. Renewal pricing is going down low single digits on a rate basis. However, we are also seeing evidence of the economy having an effect on our premium bases. In other words, we write probably 45%, maybe slightly less of our premiums in the construction business. Those premiums are predicated on payrolls and sales of the contractors.

About 35% or so of our business is residential, and anecdotally I would give you an example we had an agent that was in here yesterday and described a residential contractor that he insures that last year had 45 electricians working for him and this year he is projecting eight. So consequently, for the accounts that we write of that nature we are going to be projecting lower premiums and also on audit, when we go back over the past year we are down about 10.5% in collected audits this year.

The other issue for us as far as third quarter was concerned was a matter of timing differences and looking at premiums. We have policies and premiums that are always in process to be booked. Some still on the agents' desks, some in our field reps' desks and some in process in here. I think you noticed that we indicated for the full year we are comfortable that we will finish the year as we stand right now at the end of the third quarter. So we are confident in our ability to write the commercial lines and continue to sustain albeit down a bit, good commercial lines, if not great commercial lines new business growth.

To answer your question about the three-year policy I know it seems unlikely in this marketplace, that people would find that attractive. There are an equal number of folks that would view given how competitive the marketplace would be that we may be at or close to the bottom. I honestly can't tell you whether we are there or not, but the consistency of our Company, the fact that we will offer a promise and this offer comes as Jack made reference to from a very financially strong company, an A++ Company, our agents, still with the same level of enthusiasm they always have had, will sell the three-year policy. So we are still at the same place we have in the past, issuing the policies on that basis, and we are very satisfied that it continues to be a competitive advantage for us.

I'm sorry, what portion of your business did you say, J.F., was construction related?

Premiums that we would receive would be in the mid-40s, perhaps low 40s of our GL premiums.

Of GL alone?

That's correct, general liability premiums.

Alone?

Correct.

Okay. My second question, and that is commercial construction as opposed to residential?

Of that number that I just mentioned about 35% would be residential.

So that is why you made the point that the fellow has 8 people working for him where he used to have more?

We are experiencing the same issues related to the housing market country-wide but from an insurance standpoint.

My second question, the announcement you made this morning with regard to share repurchase, the two-part announcement that we bought X shares during the period and we entered into this ASR was I suspect the most dramatic capital management action the Company has taken since 1999. To what extent would you see that possibly this action might be repeated again? What am I trying to say? The sale of in the future more Fifth Third stock and use of those monies to buy back Cincinnati stock.

Charlie, right now we think in this marketplace, we think our stock is attractive and we felt like this was a great opportunity to enter into agreement to repurchase our shares on a more accelerated basis. We looked at various ways to finance that, and a decision was made to sell the shares of Fifth Third as was noted. At this time the Board -- we have no authorization to sell any further Fifth Third shares. So at this point we have done all the Board has given us authority to do. We will continue to look at our stock price as we go forward just like we have historically, and we will make purchases when we think it is appropriate.

Thank you.

Beth Malone, KeyBanc.

Just could you just talk a little bit more about what you are seeing? There are new markets that you have entered into, Washington State and some others. And I am just wondering are you seeing the same kind of pricing competition in those markets as a new entrant? Is that going to take longer than you thought possibly to get established given the cycles?

Our status in the two new states, Washington we have two agencies appointed with a few in the process of being appointed. And in New Mexico we have three right now appointed. And several more coming in. We've written our first premiums in both of those states. I would suspect to answer your question the competition is as aggressive out there as it is in here. However, I think we do have the agencies we appointed focusing on us, as a new carrier and trying to create a good relationship with us. So it is awfully early in the game to really give you a strong opinion as to whether or not we will get a very slow start out there. I don't anticipate it based on the enthusiasm we are hearing from the agents who visit us, which is part of the appointment process. They fly out here and visit us. They seem very anxious to start putting business with us.

A question on the non-cat weather. In hindsight in past cycles have you ever found that these spike ups in non-cat weather and we are hearing about severity and frequency spikes from other carriers in the same market, in hindsight do you look back and realize that maybe it wasn't so much a non-cat weather event as it was just a manifestation of the pricing pressure? That it is really reflective of the fact that you may not be getting adequate pricing for the risks you are taking or a change in the conditions, in terms and conditions?

I will start off. I think obviously there is some pricing pressure being worked into these numbers. But the overall size of the dollars we are talking about is really the main driver. The non-cat weather last year as an example, was $13 million. This year it is almost $31 million. So pricing does come into play a little bit on the impact and the combined. But the dollar amounts and the losses definitely are a key factor.

I can't recall a quarter where we have had as much non-cat. I don't recall having three extremely large weather-related claims that were not involved in a catastrophe. We had $11 million in three claims non-cat weather. We've never had anything like that in the past.

Okay. Thank you.

Paul Moomaw, Hester Capital.

Yes, back on capital management, regarding the mechanics of the ASR, do you have an estimated end of Q4 share count?

The outstanding at the end of the third quarter was 169,953,000. So if we buy back 4 million shares that would obviously be 165,953,000.

Okay. You said something in your characterization that the Board believes we would benefit from the sale of Fifth Third and purchase of Cincinnati Financial shares. Does that represent a change at all in the methodology of analyzing and managing the portfolio away from your investment committee or anything like that?

No, it does not. The investment committee of the Board is still the committees that analyzes all the transactions and gives the management the authority to either buy or sell different sell securities.

Okay. And on the timing and mechanics of the Fifth Third sale, the sale seems like the characterization is that it is complete, so was it in the last two days or so? I was calculating on -- tell me if my math is wrong -- the proceeds imply $29.45 a share, something like that. It seems like for the price to be that low it would have had to have been very recently.

We did a block sale last evening after the market closed.

Okay, so you are using a banker for that?

Yes, we are.

Okay, and is the capital gain on the Fifth Third share sale part of the investment income growth estimates of 6% for the year?

No, it is not. That is a capital gains. It will be reflected as in the capital gains and losses section. And since we are using the proceeds of the sale to repurchase the stock, there won't be any impact on the investment income growth number.

Okay, and lastly, how is it again that the tax on the capital gains is as low as what you detail in the release?

Well, the basis of the stock was approximately $18 per share, I believe what we sold.

Okay. Thanks very much for the details.

Beth Malone, KeyBanc.

Just a question on the share repurchases so I am clear and I understand it. The banker gave you the shares, and then they will go out in the public market and buy them?

That is correct.

(multiple speakers) why did you decide to it that way as opposed to Cincinnati Financial going out and buying the 4 million shares over time and getting the benefit of any weakness that might result from the fact that the market is a little bit more choppy and your fundamentals are a little bit more challenged in this pricing environment?

We will be; they will be buying the shares for us at the current market prices. Over time --

Okay, but you get to record them now?

Yes, we just get the benefit of recording them now.

Okay, all right.

It is going to be -- we're still going to benefit depending on how the market moves on our stock.

Okay.

What we did is we, in announcing the transaction we gave the number of shares times yesterday's closing price, but that does not mean that would be the total price that we pay for all 4 million, and there will be a settlement at the end of the term.

Okay. All right. Thank you.

(OPERATOR INSTRUCTIONS) At this time there are no further questions.

Thank you all for joining us today. We very much appreciate your interest in Cincinnati Financial. If there are any follow-up questions, please feel free to contact us. Thank you.

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