辛辛納提金融 (CINF) 2010 Q1 法說會逐字稿

Good morning. My name is Louisa and I will be your conference operator today. At this time, I would like to welcome everyone to the Cincinnati Financial first-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.

Dennis McDaniel, Investor Relations Officer, you may begin your conference.

Hello. This is Dennis McDaniel, Investor Relations Officer for Cincinnati Financial. Thank you for joining us for first-quarter 2010 earnings conference call.

Late yesterday we issued a news release on our results along with our supplemental financial package, and we filed our quarterly report on form 10-Q. If you need copies of any of these documents, please visit our investor website, www.cinfin.com/investors. The shortest route to the information is in the far right-hand column via the quarterly results quick link.

On this call, you will first hear from Ken Stecher, President and Chief Executive Officer, and Chief Financial Officer, Steve Johnston. After their prepared remarks, investors participating on the call may ask questions. At that time, some responses may be made by others in the room with us including Chairman Jack Schiff Jr.; Executive Vice President, J.F. Scherer, Sales and Marketing; Principal Accounting Officer, Eric Mathews; Chief Investment Officer, Marty Hollenbeck; and Chief Claims Officer, Marty Mullen.

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 our various filings with the SEC.

Also a reconciliation of non-GAAP measures was provided with the news release. Statutory accounting data is prepared in accordance with statutory accounting rules and therefore is not reconciled to GAAP.

With that, I'll turn the call over to Ken.

Thanks, Dennis. Good morning to all of you. As highlighted in our news release, we reported improving trends from several areas while our industry continues to experience significant challenges, particularly in the commercial lines insurance market. Improvement has occurred over the past year in securities markets and our book value per share reflects that, with an increase of 25% while we also increased our shareholder dividend.

The mix we selected for our investment portfolio took advantage of favorable market movement. It's up 24% since this time last year. We also grew our first-quarter investment income by 5%. Growth in the portfolio and the income it produces reflect good choices made during 2009 as we invested over $1 billion in cash that was held at the beginning of the year.

We continue to add to our common stock portfolio, including net purchases of over $60 million during the first quarter, with the intention of balancing current income with long-term capital growth.

We have a track record of holding attractive stocks with unrealized capital gains making up over 25% of the equity portfolio. And we continue to monitor concentrations. Our largest common stock position now is about 1% of the total investment portfolio.

While our property casualty insurance underwriting results fell short of our goal of a combined ratio under 100%, we saw favorable trends in parts of that operation as well.

Our personal lines segment's combined ratio improved by almost 20 percentage points. While most of that was due to more favorable first-quarter weather, there also was improvement in the non-catastrophe loss ratio, reflecting rate increases implemented during 2009 plus better pricing per risk that we attribute in part to our homeowner predictive modeling efforts.

Last year at this time, our large volume of business in the Midwest made our property insurance results lag much of the industry due to weather-related losses. Results so far this year demonstrate how weather effects tend to even out over time.

Our excess and surplus lines operation made a positive contribution to premium revenue trends, with earned premiums more than doubling to $11 million for the quarter. We continue to carefully manage excess and surplus lines exposure not only through policy terms and conditions, but also by limiting our loss retention to $1 million per risk after reinsurance.

Competition for E&S business has been increasing and kept our new business written premium level flat. Agents continue to give us opportunities to round out client accounts, keeping a nonstandard part of the account in the Cincinnati Insurance family.

Earned premiums for our life insurance operation grew at a double-digit rate in the first quarter and it continues to be a steady contributor to corporate profit and book value.

Commercial lines is our largest segment and still is experiencing very strong competition, making it difficult to achieve price increases. While we achieved price increases on some accounts during the first quarter, on average policies renewed at a price estimated at less than 1% lower than a year ago, assuming no change in insured exposures or policy coverage terms.

We are staying focused on identifying quality accounts and working to write insurance policies with an acceptable profit margin, walking away from business when necessary. Our largest drop in new business premium volume was in workers' compensation, currently an unprofitable line of business for our commercial lines segment. We aim to restore its profitability by carefully applying our underwriting guidelines along with other initiatives.

Lower premium volume is a factor that has put upward pressure on our underwriting expense ratio. Investment in technology also contributes to a higher expense ratio in the short term, but is justified over the long haul because we are confident there will be future benefits.

Our Company has a long tradition of holding sales meetings the first few months of each year where we meet with agents face-to-face to renew relationships and discuss our plans for the coming year. This year was no exception as we have hosted 20 meetings across the country. Some of the important things agents told us this year reaffirm our efforts to build out our technology, to maintain our agency focus and to provide local support in the field.

Our agency-centered business model has served us well for decades. We select agencies that are a good match philosophically and that have the potential to make us their number one or number two carrier by premium volume over time.

We are able to replicate the benefits of our model through expansion into new states, which also will benefit us in the long term through less earnings volatility from weather-related catastrophes.

Since 2007, we have entered five new states, New Mexico, Washington, Texas, Colorado, and Wyoming. Those states generated over 10% of our first-quarter 2010 commercial lines new business premium. In the second half of this year, we plan to enter Connecticut and Oregon.

Our growth initiatives in new states and agencies are part of a positioning strategy for long-term growth. Agencies we have appointed during the past five years write over $7 billion in aggregate property casualty insurance premiums for all companies they represent. That represents significant growth potential as we generally are able to earn a 10% share of a new agency's business within 10 years of its appointment.

The continuing selective expansion of our agency plant is one of several initiatives that move our business into a very favorable position for the future. By staying focused on quality coverage products, systems, and service, we are confident that we will bring value to all of the professional agencies that partner with us.

Now I will turn it over to Steve, who will discuss details of the quarter.

Thank you, Ken. During the first quarter, we continued to increase shareholder value. Our primary financial measure, the value creation ratio, was 3.4%. On an annualized basis, that falls within our target range of 12% to 15%.

Breaking down the value creation ratio, book value per share increased by 2.1% and our dividend to shareholders contributed 1.3%, with those two totaling to 3.4%. The first-quarter combined ratio, while an improvement over the first quarter of 2009, was an unprofitable 102.6. Catastrophes contributed 2.1 loss ratio points during the quarter and that number includes 1 point of favorable reserve development on prior years' catastrophe losses.

Total property and casualty reserves on prior accident years developed favorably, benefiting the first quarter loss ratio by 5.6 points. Our reserving philosophy remains unchanged. We continue to target total reserves in the upper half of the actuarial range.

The underwriting expense ratio for the quarter increased to 35.6% from 33.3% a year ago and calls for some discussion. The increase was due to a combination of both higher expenses and decreasing earned premiums. The main areas of higher expense include provisions for matters involving prior years related to Note 9, Commitments And Contingent Liabilities, as described in our 10-Q, and also technology-related costs.

We continue to invest in technologies that increase the ease of doing business for our agency partners, improve our pricing precision, and improve productivity. In terms of specific initiatives, we deployed an upgrade to our Diamond personal lines processing system to all states on February 1. We continued the rollout of our e-CLAS commercial lines processing system, which started with 11 states in 2009, and we plan to go live in another 19 states during 2010.

We also continue to develop more accurate rating plans. We implemented predictive modeling for homeowners and workers' compensation in the second half of 2008 and in 2009, and we have plans for personal auto in the third quarter of 2010, to be followed by the remaining commercial lines.

In January, we established a workers' compensation claims reporting center to more efficiently handle workers' compensation claims and contain costs. We are investing in additional loss cost control associates -- loss control associates, which we believe will result in better service to our agency partners and lower loss costs.

With all of these investments, we expect the expense ratio run rate for the remainder of 2010 to be in the 33% to 34% range.

Now for some details on investments. Pretax investment income increased by 5% to $130 million for the first quarter of this year. Pretax realized capital gains contributed $8 million. Also during the quarter, we closed out a couple of items that we inherited in the third quarter of 2008 at the height of the financial crisis. We sold the remaining $36 million of collateralized mortgage obligations that we received when we terminated our securities lending program.

While we realized the $12 million loss on the sale of the CMOs, they had recovered to well above their lows, and we feel the action reduces risk in our investment portfolio.

And we also received the final payment of $5 million from the previously frozen primary reserve money market fund, which generated a $1 million capital gain from the previously impaired level.

Overall, the pretax unrealized gain in the investment portfolio increased by $149 million during the quarter to nearly $1.2 billion, with the equity portfolio contributing approximately $64 million of the increase and the fixed income portfolio contributing approximately $85 million.

Liquidity, the balance sheet and our overall financial condition remain very strong, putting us in a solid position to grow profitably.

The P&C premium-to-surplus ratio stands at conservative 0.8-to-1 with property and casualty statutory surplus growing by $44 million during the quarter, and that is net of a $50 million dividend to the holding company. At the holding company level, we have approximately $1 billion in cash and marketable securities.

Summing everything up, the contributions to book value per share for the quarter are as follows; The property and casualty underwriting loss subtracted $0.07. Life insurance operations contributed $0.05. Investment income other than life insurance and reduced by noninsurance expenses netted to $0.40. The change in unrealized plus realized capital gains on investments netted $0.63 and we paid to our shareholders $0.395 per share in dividend.

The net effect for the first quarter was an increase in book value per share of $0.61 or 2.1%. The value creation ratio, which factors in both growth in book value and dividend contribution, finished the quarter at 3.4% and builds on the full-year 2009 VCR of 19.7%.

That concludes my prepared comments and I will turn it back over to you, Ken.

Thanks, Steve. Before we begin the question-and-answer session, let me remind shareholders about our Annual Shareholder Meeting on May 1 at the Cincinnati Art Museum. The meeting generally is attended by most of our directors and senior officers, and this year that will include a couple of new faces.

Linda Clement-Holmes was just appointed as a Director in January. She brings a great deal of executive experience in the technology area. John Kellington, our new Senior Vice President and Chief Information Officer, also has a great track record and broad knowledge of insurance technology. We are pleased to have them both on board and multiplying our efforts to make it easier for agents to do business with us.

We are fortunate to have many talented Board members and Company leaders devoted to the success of Cincinnati Financial Corporation and The Cincinnati Insurance Companies, and we thank investors and shareholders for supporting the good work they do.

To address investor questions, Jack Schiff Jr., J. F. Scherer, Eric Mathews, Marty Mullen, and Marty Hollenbeck are here with Steve and me. We are all available to respond. Louisa, we are ready for questions.

(Operator Instructions) Michael Phillips, Stifel Nicolaus.

Yes, I'm here. Steve, first question to you on reserves. You mentioned in the Q that casualty, commercial casualty development was from '08 and '09 accident years. Give us comfort on how that can be done so quickly on that long-tail line.

That's a good question, Mike, and I think it boils down to what we've been seeing in the casualty line and workers' comp for that matter, but in the casualty lines in terms of audit premium. So with audit premium going down, it's kind of an indication that exposure was less in those more recent accident years than one would have anticipated at the time.

So I think I can see on the one side where there be some concern that reserves might be being released too early, but I think it's really a reflection of just lower than anticipated exposure during the period. And just again, an emphasis of our comment that we are very consistent in our reserving practices and haven't done anything different in terms of our practice over that period of time.

I believe Michael's line has dropped. (Operator Instructions) Dan Johnson, Citadel.

Great, I've got two questions but I wanted to just sort of follow-up from that last one. I guess is the right way to think about it is that we are not releasing casualty reserves from more recent accident years based on some differing view of the performance of the year? We're basically releasing reserves sort of in line with reversing out some revenue that we had previously booked under assumptions that didn't turn out to be true? So this is just really losses that really weren't attached to real business?

Dan, this is Steve. I think that's right. I guess I am just trying to emphasize that we didn't pull reserves out for any other reason than different pick from our actuaries based on their view of the exposure and that that exposure has turned out to be less at audit than it was going into the policy periods.

Okay, okay, that makes fine sense. On the expense front, the 33 to 34 that we talked about, was that for the full year 2010 or was that for the remaining three quarters of 2010?

That would be for the full year.

And then when you think about the pluses and the minuses, let's just work with the assumption that we're not headed into some fabulous hard market anytime in the next year, year and a half. What do we have that's going to help us the most to -- I guess what's going to influence the most the expense ratio as you look out over the next year or two?

I think, Dan, this is Steve again. I think it's a combination of where is our earned premium going to go? And you appropriately reference the market and so there's some uncertainty there. Also I think that we have some technology rollouts, some investment. And we are seeing the pay back on that on the personal lines already I think in terms of growth and lowering of the loss ratio.

But I think -- maybe I will just get to a point here. I think that the expense discussion this quarter is a tougher one. We had an increase in our contingent liability reserve this quarter from a matter of several years ago, it's a legal matter affecting personal lines. We think it's non-reocurring. So I think you will appreciate the sensitivity of the issue and that I can't give you any more detail on that one event.

So we've got this one-time expense in there, but I didn't want anybody to walk away thinking that that explained everything. We do have the technology investments that we are seeing pay back on. Our premiums are down, so I thought the best way to communicate that is to give the run rate that we think for the full year, and that is in the 33% to 34% range.

I didn't want anybody to come away from the call thinking that we had a one-time event and that our 32.8% from last year would hold up, because as you mentioned, we have had some pressure on the premium side and I think we are making some very appropriate investments in our technology.

Great, thank you very much.

Michael Phillips, Stifel Nicolaus.

Thanks, can you guys hear me. I don't know what happened there. I didn't drop off. So I heard all Dan's questions, so I appreciate that. Sticking with comp and commercial casualty, the premium drop wasn't as bad this quarter and I was wondering -- it doesn't sound like it's because of rates. Sort of a one-time quarterly anomaly because of the audits or something else going on? Would we expect it to go back down like it has in the past couple of quarters? Is it more of an audit thing I guess is the question, an exposure issue?

Mike, this is Steve again. I think we're seeing a little bit of both. I think that we are seeing the audit pressure, but I also think that prudently as we manage the results in that line and start to deploy our predictive modeling, we are I think seeing some premiums decrease down there in workers' comp as a positive. We are just now rolling out the predictive modeling. I saw some of the first reports on retention by decile. It looks like our decile management is effective in that we saw the retention on the poorer modeled risks lower than the retention on the better modeled risks. But with an early deployment like -- or a recent deployment and a long tail line like that, I think it's probably too premature to get into exactly the impact on the loss ratio yet. But I do think that the premium going down is a combination of the audits and more prudent underwriting.

Okay, one more if I can throw out there. Can you talk about -- apologies -- you might have mentioned this earlier. I don't did you did on the call, but somewhere else earlier. The predictive modeling that you are doing now for comp, was that something -- was that a tool you built in house or is it something you paid for outside?

We partner with consultants on most all of our predictive modeling, but we have been also staffing up in our actuarial department internally and see it as a partnership. We see the value, though, in the consultants that are doing this 100% of their time.

Okay. Thanks, Steve. The last one on the comp development, this is where I think I got cut off last time, maybe Steve was just trying to throw me off because he heard me talk about comps. (multiple speakers)

Can you say what accident years that was? Is that more of the older years? I mean, you've been kind of flip flopping back around and it is a long tail, but kind of more recent, more older accident years, where was that?

It was across the board. In terms of the dollars, it was down around $9 million -- or favorable development of $9 million. We saw minus 5 from accident years '07 through '08 and minus 5 from accident years prior to '07.

Okay, thank you very much.

Scott Heleniak, RBC Capital Markets.

Good morning. Wondering if you could talk about what kind of price declines you are seeing for new commercial business. I know you talked about flat for renewal, but obviously it's a bigger deal for you guys as you are rolling out everything to new states. I'm just wondering what you are seeing on that front relative to renewal pricing.

Scott, this is J.F. Scherer. It is especially competitive on the new business side. Obviously you have to pick and choose. What we continue to see is particularly on larger accounts very, very aggressive pricing across the board really.

In terms of quantifying it last year versus this year, a little tough because exposures continue to be down a bit. But we are seeing -- much difference between the renewal pricing stability that we are starting to see and what it takes to write a new piece of business.

As we go into new states, what we find as compared to existing states is a larger percentage of the new business we write are in accounts that are controlled by agencies. When we make an agency appointment, there's a more deliberate effort on the part of the agency to do business with Cincinnati. We tend to get a look at their current book of business where there's more control and where you don't have to go out into the marketplace and compete against everyone for the new business.

So we are, as you -- as we reported, doing well in Texas, New Mexico, Colorado, and in the newer states. It's not quite as price sensitively priced new business as it would be in some of our more established states where the new business tends to be new to the agency as well.

Okay and then along those lines just wondering if you could talk about some of the loss trends. I know it's kind of early, but just quantifying some of the loss trends in some of the newer states that you've expanded into I guess since 2007, how that's comparing to your expectations in some of the other states?

Well, I think our loss ratios -- as far as loss trends, I couldn't give you a specific on that, but as far as Texas and a variety of the newer states are concerned, as far as the loss activity that we've seen, we are pleased with what we are seeing. We are seeing very good accounts, seasoned accounts for the agencies, accounts that they know the history. So we're not seeing anything surprising at all in that area.

We actually in Texas I might add, our excess and surplus lines company has been well received there as well. So we are pleased with the activity levels.

Okay, and my last question is on the investment front. Dividend income is still a little bit down. I think you mentioned putting new money into equities. I was just wondering how you're thinking about that over the balance of the year? The cash balance is at about $1 billion now, so what is your expectation about -- or outlook for the investment portfolio? And what kind of investment income growth assumptions you are looking at for this year?

It's Marty Hollenbeck. Dividend income was down actually slightly from fourth quarter. That was almost exclusively due to some anomalies in the fourth quarter that inflated that number a little bit. For example, Met Life is a company that pays a single yearly dividend that accrued in the fourth quarter. Additionally, we had two other stocks that pay quarterly, but for particular accounting reasons that dividend accrued twice in the fourth quarter.

So going forward, we will probably stick to our historical pattern of about a quarter of new money going into the equity portfolio. Right now we are at 25% roughly of the overall portfolio in equity, a number we are comfortable with. So we are I think for the first time in a number of years back to a reinvestment pattern that more matches what we had historically done.

Interest income was up actually 1.5% sequentially from fourth quarter. That's about a 6% annualized rate, so that is a number that we are pretty pleased with in this rate environment.

Okay, thanks.

(Operator Instructions) Dan Schlemmer, Macquarie.

Good morning. Speaking -- staying on the investment portfolio, if I heard the prepared remarks correctly, I think what you said is your largest single holding is now 1% of the portfolio. Just correct if I'm wrong. I just want to know is that something you intend to stick to as a limit going forward or is that just more that's where you are currently at? What would you see as sort of a limit on an individual holding? Maybe if you can comment a little bit on what you would see as a concentration risk within an industry too?

Good question. Right now Procter & Gamble is our largest holding. As Steve mentioned, it is 1% of the overall portfolio and 5.7% of the equity portfolio. We have a hard limit of 10% of the equity portfolio for a single name.

As far as sectors go, we kind of monitor on both an overall basis and I think we're at about maybe a 30% limit there as well as a multiple of the S&P weighting for some of the smaller sectors. And we are currently in line with all of those limits.

Great. Thanks. Then separate question on the premium growth. You know, what you're seeing is sort of a down in commercial and some increase in premium on the personal lines side, which somewhat mirrors what we are seeing industry wide. I wonder if you can sort of comment on that. How much of the increase is coming from the changes -- if you have a sense how much is coming from changes you're making on the pricing and technology on the personal lines sides and how much is driven just by overall market conditions? That divergence between the growth in commercial versus growth in personal lines.

I will take a stab at this. This is J.F. In personal lines, certainly it's a combination of improved technology that we rolled out and perfecting the pricing modeling together with that. We are where we want to be, in the ballpark. Not the lowest on the street, but in the ballpark on the pricing. That is -- we weren't for several years and our agencies, our current agencies along with agencies in newer areas out West, North Carolina, several other new states where they have been very pleased with their relationship with us like our claims service have really given us a lot of opportunity in the personal lines area.

On the commercial lines side, as I mentioned earlier, it is much tougher on the larger accounts. Maybe to add a little color, the new business for us in property was up 22.5% in the quarter. Policies were up 9.1%. In casualty, we were up 3.5% in policies but down 2.1% in new business premium.

The big issue for us in terms of affecting our new business growth was workers' comp. We were down 41% in new business in workers' comp but down 20.7% in new policies in comp. So as we are seeing the marketplace, we are more comfortable operating in the sub-$100,000 size of accounts that we continue to have some success in that area. But it is a bit reckless, if you will, in terms of the pricing of new business at the upper end.

So we are just having an increasing number of situations where we won't go there because it doesn't make sense. But in terms of victories, in terms of effectiveness with our agencies, in terms of the numbers of new business policies we are writing for our agencies, in that middle area, that most especially $10,000 to $100,000 range, we find ourselves being effective and I think our agencies appreciate that.

We are defending our position in our agencies in terms of our preferred position and doing what we can to pick off appropriately priced larger accounts. So I guess -- maybe that's more than you asked for but it may be a bit of a picture of what we are faced with.

That's great color, thanks a lot. Last question real quick. You mentioned you know the number of states you have added and you have a few more going. I haven't followed -- I'm not sure what it is exactly, but I think you are basically in every state except for the largest single state. You know, as you face these growth pressures, just wonder if that's something you will revisit or if there's any thoughts on could you guys -- would you have an interest in being in California and expanding into that territory? Is that something that's on the horizon?

California is really the only -- from a population standpoint -- meaningful state that we are not in. We are in 37 states now. Oregon and Connecticut will raise that to 39.

California is a bit down on the list currently in terms of a place to activate. We are examining in every single state market share. We think we have a lot of opportunities in all states, certainly the Midwest because of the economic pressures within the Midwest, Ohio, Michigan, Pennsylvania, Illinois. Not so much in terms of near-term opportunities, but we've got tremendous opportunities, we think, in a variety of states including Texas.

So we do have teams of people that examine every single state, and California is not being ignored. But we think with what we have on the drawing boards right now, competing for a larger share of our agencies' books of business, the improvements we have made in personal lines, our excess and surplus lines company are doing well. Our target markets division is getting up and running. We are satisfied right now that we have got enough on our plate in the states that we are in and going to enter into next year or this year to keep us busy.

Dan, this is Ken. If I can just add a little more to what J.F. said. We think -- we have quite a few states that we have been in for quite a few years that our market share in that state is less than 1%. As we deliver the technology, we're going to try to focus on increasing that market share. We're not going to get anywhere near like we have in Ohio with approximately 5%, but if we can bring those states up to 1% or possibly between 1% and 2%, I think it gives is a lot of opportunity for growth.

As J.F. said, we will continue to look at the new states but we don't believe we have to make that move at this time, that we have other opportunities.

A lot of great info there. Thank you.

There are no further questions at this time. I would like to now turn the call back over to Ken Stecher.

Thank you, Louisa, and thank you all for joining us today. We look forward to speaking with you again on our second-quarter call.

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