辛辛納提金融 (CINF) 2013 Q4 法說會逐字稿

Good morning. My name is Denise and I will be your conference operator today. At this time I would like to welcome everyone to the fourth-quarter 2013 financial results conference call. (Operator Instructions) Thank you.

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

Good morning, everyone. This is Dennis McDaniel, and we thank you for joining us for our fourth-quarter and full-year 2013 earnings conference call.

Late yesterday we issued a news release on our results, along with our supplemental financial package, including our quarter-end investment portfolio. To find copies of any of these documents, please visit our investor website, cinfin.com/investors. The shortest route to the information is the Quarterly Results link in the navigation menu on the far left.

On this call, you will first hear from Steve Johnston, President and Chief Executive Officer, and then from Chief Financial Officer Mike Sewell. 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: Executive Committee Chairman Jack Schiff, Junior; Chairman of the Board Ken Stecher; Chief Insurance Officer J.F. Scherer; 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 to 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 will turn the call over to Steve.

Thank you, Dennis, and good morning. Like last year, I am speaking with you today from Murfreesboro, Tennessee, the fourth stop on our 22-state tour of sales meetings with our independent agents. Our senior leadership team gets out and visits agents in the first half of each year, and it's always an energizing experience for us. We enjoy the chance to thank our agents in person for contributing to another year of underwriting profit and strong premium growth, and for trusting Cincinnati Insurance to serve the people and businesses in their communities.

We are pleased to report solid fourth-quarter and full-year 2013 operating results. As we consider our progress in building value for shareholders, we favor a long-term approach and manage our business accordingly.

Our ongoing initiatives, intended to improve insurance profitability and drive premium growth, led to an improved operating result for the full-year 2013. More favorable weather also contributed to our 2013 operating results.

I would like to mention, however, that we already know weather will affect our first-quarter 2014 results. Two winter storm events between January 3 and January 8 caused an estimated $65 million to $85 million in catastrophe losses for our Property Casualty segments. Most of our losses are from water damage related to frozen pipes that burst.

It is too early for us to provide a meaningful estimate of losses from severe weather that occurred later in January. While weather can always affect our financial results, we believe execution of our strategic initiatives will continue to provide benefits over time.

Our fourth-quarter and full-year combined ratios were below 94%, within the sub-95% range we aim for. On an accident year basis, before catastrophe losses, 2013 improved 4.3 points compared with 2012.

We plan to improve our combined ratio for 2014. We will earn a significant portion of 2013's steady renewal price increases over the next year, and many other initiatives we're implementing should benefit loss experience.

Premium growth for full-year 2013 was as we expected. Our Property Casualty net written premiums grew at a double-digit pace, benefiting from greater pricing precision and higher pricing overall.

For personal lines, full-year premiums reached $1 billion for the first time. We remain on course to reach our goal of $5 billion of consolidated annual direct written premiums by the end of 2015.

We continue to get more rate on lower-margin policies and retain higher-margin policies. As a result, our mix of business is shifting in a favorable direction.

On an average renewal price increase basis, commercial policies that renewed during the fourth quarter had estimated average price increases in the mid-single-digit range, just as strong as our third-quarter average. Also consistent with the third quarter, renewal price increases for our excess and surplus lines and our personal lines segments continued in the high single-digit and mid single-digit ranges, respectively.

Policy retention for both commercial and personal lines remained consistent with the year ago. Our commercial lines policy retention continues in the mid 80% range and personal lines policy retention continues in a low to mid 90% range.

Our full-year 2013 new business premiums, at $543 million, set another record high, despite the total of our fourth-quarter commercial and personal lines new business coming in $7 million lower than a year ago. Even more important than hitting a new record amount is the confidence we have in our new business pricing from our pricing analytics and modeling tools.

Commercial lines new business premium can vary substantially by quarter, in part due to timing of acquiring large policies or appointing new agencies. For example, fourth quarter of 2012 was particularly strong, with the highest volume of any quarter that year. The history shows that the fourth quarter is typically not our biggest quarter for commercial new business.

Our full-year 2013 personal lines new business premiums came within $1 million of 2012. That was a satisfying result, given our underwriting actions around homeowners rates and deductibles that we implemented last spring.

We tend to avoid drawing conclusions about trends based on a single quarter of data for certain measures. That applies to new business premiums as well as renewal pricing, large losses, and prior accident year reserve development, among other things. Instead, we focus on executing our long-term strategy and are quite satisfied with our performance for 2013.

In our Life Insurance segment, earned premiums continue to grow during the quarter, contributing to full-year growth of 6%. For all of our Insurance segments we continue to be careful to grow premiums only when we believe profitability is adequate.

We will continue to appoint new agencies, and that adds to premium growth over time as those relationships mature. In 2014, we plan to appoint approximately 100 agencies.

January 1 marked the renewal of our reinsurance program. It is an important part of managing enterprise risk and helps protect capital and limit earnings volatility.

Our per-risk treaties remain substantially the same as 2013, except for increasing our retention by $1 million to $8 million per loss. That change and more favorable rates should result in a modest reduction in our 2014 reinsurance costs.

Our Property Catastrophe treaty provides coverage similar to last year.

In January, we replaced our expiring collateralized reinsurance with a new catastrophe bond providing $100 million of coverage. The coverage period now extends over three years, expiring January 18, 2017.

The coverage applies to severe convective storm losses in selected areas as well as supplemental coverage in the event of an earthquake. In addition to coverage provided last year, related to the New Madrid fault line, it includes several states in the Pacific Northwest.

For both coverage, convective storm and earthquake, the geography related to the coverage was expanded for 2014. The program now generally covers entire states where we have significant amounts of insured property risks, instead of just selected counties.

The storm aggregate coverage provides loss recovery when storm losses for all events in aggregate exceed $160 million, after a $5 million deductible per event.

For the second quarter in a row, investment income growth is another positive. That growth is impressive to us, considering that fourth-quarter 2012 included about $5 million of special or accelerated dividends, as issuers responded to anticipated tax law changes.

Finally, our primary measure of financial performance, the value creation ratio, confirms strong Company performance for the quarter and the year. That measure keeps every associate in our Company focused on individual and team performance, helping to create shareholder value over time. It was a 16.1% for the year and had averaged 13.1% over the past five years.

Our 2013 value creation ratio was aided by favorable trends in security markets. But I am more pleased with the 10% year-over-year improvement in the largest component, operating income, which contributed 8.5 points.

Our Chief Financial Officer, Mike Sewell, will now discuss the value creation ratio further, along with other financial terms.

Great. Thank you, Steve, and thanks to all of you for joining us today. As Steve noted, our performance for 2013 was strong. The 16.1% value creation ratio exceeded the 10% to 13% annual average we are targeting for 2013 through 2017.

2013 provided another example of the benefit of our equity investing strategy. In addition to a strong contribution to book value from appreciation in our stock portfolio valuation, rising dividend income offset lower interest income that was pressured by the low interest rate environment.

Our stock portfolio's pretax net unrealized gains reached nearly $1.9 billion at year-end, up 85% for the year and 23% for the quarter. Dividend income grew 6% for the year and 3% for the fourth quarter.

Our bond portfolio's pretax unrealized gains were at $481 million at year-end, down $390 million for the year and $55 million for the quarter. Yields for our bond portfolio continue to move lower, but at a slower pace as its fourth-quarter 2013 pretax yield of 4.84% was 17 basis points lower than a year ago. For the third quarter of 2013, that decline was 19 basis points.

Taxable bonds, representing about 7% of our bond portfolio, had a fourth-quarter and 2013 pretax yield of approximately 5.33%. The average yield for new taxable bonds purchased during the quarter was approximately 4.61%.

For the same period, our tax-exempt bond portfolio yield was approximately 3.9%, and purchases during the quarter yielded approximately 3.2%.

Our bond portfolio's effective duration measured 4.6 years at year-end 2013, up from 4.2 years one year ago.

Cash flow from operating activities continues to benefit investment income. At $787 million for the full-year 2013, net operating cash flow exceeded the same period a year ago by $149 million, or 23%, despite paying an additional $184 million in income taxes.

I would like to spend a moment on loss reserves. Following a consistent approach, we have experienced 25 consecutive years of overall favorable reserve development. We seek to remain into the upper half of the actuarially estimated range of net loss and loss expense reserves.

Our full-year 2013 favorable development on prior accident years, at 4.1 percentage points, was about one-third of the 2012 ratio. And the fourth-quarter ratio for 2013 was also much lighter than 2012.

The outlier periods are actually the 2012 periods. As we mentioned during our first-quarter conference call, in 2012 we observed a turning point in the terms of underwriting performance; and reductions in our IBNR reserves were outsized compared to a typical year. In fact, we added net IBNR reserves in each of the past five years with the exception of 2012.

As I said on this call for the third quarter, we believe we are exercising prudence by maintaining IBNR reserves at a higher level.

To help put this into perspective, let's review our level of reserve development over the past two decades. Favorable reserve development for the five years 2008 through 2012 averaged nearly 10 points. However, the 10-year average for 1997 through 2006 was 5 points, fairly close to our 2013 results.

If you annualize the aggregate favorable reserve development for the full-year 2013 compared to 2012, you'll find that 43% of the decrease is attributable to commercial Casualty and 24% to workers compensation. Our 2013 favorable development occurred for several accident years, including 69% for accident year 2012, 28% for accident year 2011, and 3% for all older accident years.

Expense management produced another good result. Our Property Casualty underwriting expense ratio for 2013 improved 0.3 percentage points, even with strategic investments to grow premiums and improve profitability.

Next let's turn to financial strength and liquidity, which both remained in excellent condition. We repurchased approximately 1 million shares during the fourth quarter at an average cost of $52.13. This repurchase activity was a maintenance type action intended to partially offset the issuance of shares through equity compensation plans.

Last week, the Board of Directors increased the shareholder dividend by 4.8%. This sets the stage for increasing our dividend for the 54th consecutive year.

Cash and marketable securities at the Parent Company stood at $1.5 billion at year-end, one-third higher than a year earlier. Our Property Casualty premium-to-surplus ratio remains at 0.9-to-1, providing ample capital and capacity to support continued premium growth in our Insurance segments.

I'll conclude my prepared comments by summarizing the contributions during the fourth quarter to book value per share. Property Casualty underwriting increased book value by $0.24. Life Insurance operations added $0.06. Investment income, other than Life Insurance and reduced by non-insurance items, contributed $0.36.

Valuation changes related to our pension plan contributed $0.30. The change in unrealized gains at December 31 for the fixed income portfolio, net of realized gains and losses, lowered book value per share by $0.21. The change in unrealized gains at December 31 for the equity portfolio, net of realized gains and losses, increased book value by $1.37.

And we declared $0.42 per share in dividends to shareholders. The net effect was a book value increase of $1.70 during the fourth quarter to $37.21 per share.

With that, I will turn the call back over to you, Steve.

Thanks, Mike. Some of you may have noticed two recent news releases about new people joining our Cincinnati family. In November, our Board welcomed David Osborn, a new Independent Director whose investment firm focuses, like us, on dividend growth strategies.

Just last week, we welcomed Will Van Den Heuvel to the Cincinnati team as our new Senior Vice President responsible for personal lines. Will brings an excellent track record of leadership experience in the personal lines marketplace and a proven commitment to the success of independent insurance agencies.

We see both of those additions as investments who will bring shareholders a good return over time. Just as important, in 2013, we reduced our underwriting expense ratio while investing in talented associates, with total staff growing 2.6%, or just over 100 net positions.

We know that our field force is a strong differentiator from competitors. On a percentage basis, field positions increased at a slightly higher rate than headquarters positions. Our agency customers appreciate the loss control and claims expertise we are placing in their communities.

At headquarters, we continue to invest in positions to support our pricing and data analytics improvements. We think we have just scratched the surface of the benefit we will see from our 2013 improvements. And we have the people, products, and processes in place to keep executing on our plans in 2014.

We appreciate this opportunity to respond to your questions, and also look forward to meeting in person with many of you throughout this year. As a reminder, with Mike and me today are Jack Schiff, Junior; Ken Stecher; J.F. Scherer; Eric Mathews; Marty Mullen; and Marty Hollenbeck. Denise, we are ready for you to open the call for questions.

(Operator Instructions) Mike Zaremski, Credit Suisse.

Hi. Thanks for taking my questions. First question. You guys specifically mentioned in the press release, too, about ramping up inspections next year; and you guys are investing in people and technology, clearly. Should we expect, then, some impacts to the expense ratio as those work through?

And I guess obviously, hopefully, they help the loss ratio. But what should we be thinking about expenses, given those initiatives?

Thanks, Mike. This is Mike Sewell. As it's related to that, my goal is still to work the expense ratio down closer to a 30 expense ratio. But with a lot of the investments that we have been making, has -- contributing a lot to the loss expense ratio, and as you have seen that going down.

We have been increasing some of our headcount in strategic areas for growing premiums, also the loss control. But what we are also doing is we are making sure that that increase in investment is lower than the increase in premiums that we are bringing on.

So we were able to reduce the expense ratio by 0.3 points this year. But in total we are still spending more money and investing it where we believe we need to. And the results you are seeing on the loss expense side.

Mike, it's J.F. Scherer. One thing I might add, for example in personal lines in the inspections, what those inspections are revealing has paid for about 60% of the cost of the inspections themselves. In other words, we find things where we immediately increase the premium, things like stoves that people have in houses that we have surcharges for and a variety of other things.

So as Mike said, the real focus is to improve the loss ratio with all these initiatives, but we are finding an opportunity actually to increase premium by what we discover.

Okay. That's helpful. Next on reserves. I appreciate all the great color you guys gave on the call and you guys give in the release. If I am thinking -- if we are thinking more high-level, are you seeing loss cost inflation tick up versus prior couple years' trends? Given maybe the pickup in the economy, or you guys are moving into other territories, and whatnot.

Mike, this is Steve Johnston. Actually, we aren't. I think we are seeing pretty steady trends in terms of loss cost trends, and I think it does have to do with the work that we are doing in the loss prevention side of things to keep those trends lower.

So we are seeing our rate exceed our loss cost trend, and rates in the mid single digits. And we'd say loss cost trends are more in the low single digits and they're remaining steady.

Would you say workers comp is below historical trend still?

Yes, that is a fair assessment.

Okay. Thanks, guys.

Ian Gutterman, Balyasny Asset Management.

Good morning, guys. Thank you. I guess, first, any more color you can give on the January cat events? Just a couple other people have said similar things; I was trying to get a little bit better understanding why pipe storms are causing what seems almost like Q2 cat loads rather than Q1 cat loads.

Hi, Ian. This is Marty Mullen. That January -- the second cat in January was the main event for us from January 5 through the 8th. It's a different type of storm.

The claims are split up about 50-50 commercial and personal lines. But for us the experience in loss is more about 70% in commercial.

So it's for us about a 3-, 4-state event; but as you know, the cat involved 17 states. I think that is why you are seeing the type of disclosure you are seeing, because it is such a widespread event; and it's four days.

But for us, about 95% of the losses all related to freezing. And Ohio is our biggest state, with 35% of the claim count.

Very helpful. Thank you. The other area of claims that I think was mentioned in the release was auto claims inflation. Can you just -- again you're not the only company that mentioned that this quarter. But are you seeing a tick up in BI trends? And any additional color you can give on that?

This is Steve again. I think in that particular line there would be a little bit of an uptick. I think severity in particular.

But I don't think it is anything that is unreasonable or within our ability -- or outside of our ability to address with rate, pricing precision, segmentation, and continuing to work our initiatives in terms of keeping those loss costs under control from the loss control side.

Okay. So that didn't have any impact on the new business there, that you pulled back your appetite when you saw that loss trend or anything like that?

No, I think our appetites remain consistent, long-term focus, and we feel very good about the business.

Okay. Was that increase in trend across the country, across types of drivers? Or was it concentrated in any area?

We didn't see it concentrated in any particular area, no.

Great. Repurchase, you bought back some stock for the first time in a while. I was just curious if that is something we should expect to continue, or if this was maybe a one-time thing for option dilution or something like that.

Hi, Ian; it's Mike here. We do it from time to time. The last time we did buy back a little over 1 million shares in 2011.

With the stock price being up, folks exercised stock options. We really thought it was prudent to do a maintenance type activity on that to at least keep the shares relatively flat.

So we did go in and do the 1 million shares at the average cost that you heard earlier. So I think as we look out into the future, I think we are going to be watching share count; and with the growth we will do maintenance when we need to do maintenance.

But at the same time we are using our capital. As I mentioned, the Board increased the dividend 4.8%. So setting that up for the 54th consecutive year, there is various ways we use our capital, including investing in the business to grow premiums and reduce the losses.

There is a combination of areas that we use our capital, and that was one that really I viewed as a maintenance type matter.

Great. Then just maybe lastly, any thoughts on the equity portfolio? Obviously the market was great last year. It is pulling out this year.

Have there been any thoughts of reallocating either among sectors or just overall exposure, something to get more defensive? Or is it pretty much steady as she goes?

Hey, Ian. It's Marty Hollenbeck. Not really, we are long-term investors.

The income off of the portfolio, the tax-preferred status of the dividends, will count just as much really as price fluctuations. We are pretty content with where we are at, in the low 30%s as a percentage of the overall portfolio.

We look at it a number of different ways. So we are not going to undergo any significant reallocations of investment assets at this point.

Great, okay, I think it answers it actually. Thank you so much.

Vincent DeAugustino, KBW.

Hi, good morning, everyone. Steve, you had mentioned bringing Will on, and I am just curious, given his experience at Chubb and AIG before, in conjunction with something -- if I am recalling correctly -- you discussed with some agents earlier in 2013. That was about Cincinnati's homeowner business being maybe positioned as a Chubb-like product.

I was just wondering if you might be able to provide an update on that initiative. And then wonder if, say, Will's addition has anything to do with that strategy.

Vincent, this is J.F. Just by way of comment, as a Company, about 20% of what we currently write would be in the -- I guess you might call it the more affluent personal lines area. But clearly bringing Will on, in addition to his background just as a great personal lines executive across-the-board, what we want to do is to fortify what we are doing, expand what we are doing in the more affluent marketplace.

We are not talking about going into the ultra affluent. I guess the way I would describe it would be more as is described in the industry as a mass affluence, which by definition I guess we would say Coverage A homeowner limits of about $0.5 million or $1 million, up to the $4 million, $5 million, $6 million, $7 million range.

Clearly Will's experience throughout his career allows him to bring a tremendous amount of expertise in that area. Our agencies write a lot of that business, and so we think that just by fine-tuning the product, adding more expertise at the underwriting level, more expertise in our ability to write schedules, boats, jewelry, the types of things that go with the affluent marketplace, is going to open the door, I think, to a lot of opportunities for us.

Okay. The color is pretty helpful. Just one other question; and, J.F., I guess this would probably be best for you.

I am just curious if you have noticed any demand for the three-year policies declining recently.

What we are seeing -- and as Steve mentioned, we are seeing steady renewal increases in our commercial lines book of business in the fourth quarter. And we are getting larger increases on the classes of business with the policies that are at least adequately priced.

Anecdotally, what I would tell you is that we are driving higher rate, obviously, on the more poorly priced accounts that we have. And we have seen less of a take-up on the three-year policy because we are very aggressive about what we would want on those policies if we're to renew them on a three-year basis - which we view as a good thing. In other words, if a policyholder stays with us, obviously it is an account we want to keep. We get a good one year increase; we are going to get another at-bat at that less adequately priced policy next year and the year after.

The good thing is that on the most adequately priced policies, the uptake for the three-year policy remains excellent, and it continues to be. It is being reinforced all three days this week when we are at our sales meetings by our agencies that it is a tremendous advantage for us.

Good, great. Thank you very much.

Mark Dwelle, RBC Capital Market.

Yes, good morning. A couple questions. Mike, I think you read off the percentage of the prior period development that related to some of the different accident years. Was that for the quarter or for the full year to date?

That was for the full year.

Okay. I guess hearing those figures it strikes me as that is short-tail loaded, which is to say -- is that because the older accident years, there is a mix of adverse as well as favorable that is bringing that older accident year percentage down so low? Normally I think of a three- to four-year tail on a lot of your business.

No, that is fair to say. There was a little less in those older accident years. We did notice that in workers' comp going back a few years, there was some payments that we made in the current year; and we just thought it was prudent to be very careful with those years. We added a little bit to those older accident years.

So that is what resulted in the lower percentile for the older accident years that I quoted.

Okay. Then, somebody commented -- I can't remember who -- about the new business being lower in the fourth quarter as compared to other quarters in the year. Why would that be the case?

I mean, I guess the anecdotal thought is always that salespeople are hungry to get their quotas in the fourth quarter and would drive more new business rather than less. Maybe your guys just all hit your targets earlier in the year; I don't know.

Yes, this is Steve, Mark. I think we have had some variability, but I do think that there is more economic activities going on generally in the second and third quarter in our operating territories, where construction is going on, the weather is warmer. And more times than not the fourth quarter is not the largest quarter for new business.

2012 was an outlier. It was just a great quarter. But that is normally not the case, and I think it is probably driven by the economic activity in our areas.

Okay. Just wanted to clarify. When you -- the splits that you gave on the early winter storm activity, that was 70% commercial, 30% personal. That is what you are seeing so far?

In loss, that's correct.

Okay. That's all my questions. Thank you.

(Operator Instructions) Paul Newsome, Sandler O'Neill.

Good morning. Hey, I just wanted to ask about any reactions you have seen or had to the Travelers Quantum product, and just generally the idea that personal lines, auto in particular but maybe even home, are going to increasingly go towards lower commission, sort of a better customer cost.

Paul, this is J.F. Of course, we're out with agents this week. It hasn't come up. We are not getting any feedback at all on it.

So, steady as she goes, I guess. That was it. That was all I wanted to ask. Thanks, guys.

Yes, at least as far as our strategy, our agents, what we are talking to them about in personal lines, we are just not getting much feedback. We had been encouraged by the response we have gotten in personal lines over the last year.

I guess by way of a little commentary, and Steve mentioned it in his remarks, but new business in personal lines tailed off a bit for us towards the end of the year; and we will have a real tough comparison in the first quarter. But that is almost by design, in the sense that we've got two rate increases on homeowners that are earning their way through the book, plus we strengthened our underwriting stance on age of roofs, deductibles, things of that nature.

So I think our agencies, once again relative to how they approach personal lines with us, they do use comparative raters, they are not enamored by them, and they are not enamored by the commoditization of personal lines. However, they do write some business that would be in that category.

It is clear from the reaction to Will Van Den Heuvel at the sales meetings that they are very enthused about the fact that we are going to fortify our activity in the higher-valued homeowner, higher-valued client arena, where there is more profitability from an underwriting standpoint and more profitability at the agency level to write that kind of business. And it is the marquee account; it's the significant policyholders in the community.

So I guess maybe we would be a bad carrier to canvass for opinions on other companies' approaches from that standpoint. But I can say that the reaction to what we are doing has been pretty good.

I would add, Paul, that our strategy -- you know us well -- is an agency strategy. And what we are doing now in personal lines with some of these higher-valued homes is very consistent with what we have done over time in trying to provide every type of product that our agencies need to be successful.

If you look back to -- excess and surplus lines would've been an example. Target markets is another example. And now what we are doing in personal lines is very consistent with our agent-oriented strategy.

That's great. Thanks, guys. Appreciate it.

Okay. There are no further questions. At this time I will turn the call back over to Steve Johnston.

Thank you, Denise, and thanks to everybody for joining us today. We appreciate your interest in Cincinnati Financial Corporation and look forward to speaking with you again on our first-quarter call.

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