辛辛納提金融 (CINF) 2014 Q4 法說會逐字稿

Good morning. My name is Steve and I will be your conference operator today. At this time I would like to welcome everyone to the fourth-quarter 2014 earnings 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 from Cincinnati Financial. Thank you for joining us for our fourth-quarter 2014 earnings conference call.

Late yesterday we issued a news release about 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 Steven 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 Cincinnati Insurance Company's Executive Committee Chairman, Jack Schiff, Jr.; Chairman of the Board, Ken Stecher; Chief Insurance Officer for the Cincinnati Insurance Company, J.F. Scherer; Principal Accounting Officer, Eric Matthews; Chief Investment Officer, Marty Hollenbeck; and Chief Claims Officer for Cincinnati Insurance, Marty Mullen.

First please note that some of the matters we will be discussing 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 the 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, everyone. As in recent years I'm speaking with you today from Murfreesboro, Tennessee, the fourth stop on our tour of sales meetings with our independent agents in more than 20 states. Meeting annually with agents is essential to our relationship-oriented agency-centered strategy. We also enjoy this part of our job and find it energizing.

It is important to sincerely thank our agents in person for contributing to another year of underwriting profit and premium growth and for trusting Cincinnati Insurance as we earn the opportunity to serve the people and businesses in their communities.

Turning to our financial performance, we feel good about the strong operating results we reported for the fourth quarter and for the year 2014 that continue to reflect steady execution in our underwriting and pricing. We had our seventh consecutive quarter of investment income growth and rising valuations and equity security markets helped boost book value for your company.

Careful underwriting and disciplined pricing along with an improved expense ratio led to a fourth-quarter 2014 combined ratio of 90.4% lowering the full-year ratio to 95.6%. We are further segmenting our book of business using pricing precision and risk selection decisions that combine data models and underwriter judgment on a policy-by-policy basis. That's an ongoing focus as we seek to further improve underwriting results.

We think those actions will continue to provide benefits over time as we aim for a combined ratio below 95% in 2015.

Working with our agents, we benefit from the local presence of our field underwriters who make those decisions for all of our commercial new business. Their decisions are informed by analytics and risk inspection data from our ongoing loss control program. We are pleased that 2014 was another year in which we met our premium growth objective of outpacing industry growth thanks to strong retention and satisfactory renewal pricing.

Growth we reported for the fourth quarter reflected the favorable offsetting effect of the same factor that slowed growth reported last year, the 2013 estimate for business in the pipeline. I meant last quarter, reported last quarter of the 2013 estimate for business in the pipeline. As we noted several times before, we tend to avoid drawing conclusions about trends based on a single quarter of data for certain measures including premium growth.

Part of our long-term strategy is to appoint agencies in areas where we are underrepresented, taking care to preserve established agency relationships and the franchise value they enjoy.

In 2014, we appointed 99 new independent agencies and plan to appoint about 100 more in 2015. Our agency partners do a great job helping us retain profitable accounts. Policy retention for both commercial and personal lines was generally consistent with the year ago. Our commercial lines policy retention continues near the high end of the mid-80% range and personal lines policy retention continues in a low- to mid-90% range.

We continue to work hard to earn new business through our agencies. New products and services such as expanding programs offered through our Target Markets department are an important part of growing new business. We are also excited by new business opportunities we will see by expanding our current products and services aimed at high net worth policyholders and offered through our personal lines insurance segment. You will hear more about that over the next few quarters as we march towards a longer-term goal of $2 billion in annual personal lines segment premiums.

Although our new business volume was down from 2013, when new business premiums reached a record level for us, our agencies still produced over $0.5 billion in new business premiums in 2014.

For the fourth quarter, average renewal price increases for commercial lines remained in the low single-digit range, a little lower than in the third quarter. That average includes the muting effect of three-year policies that were not yet subject to renewal pricing during the fourth quarter.

For smaller commercial property and commercial auto policies that renewed during the fourth quarter, we continued to obtain meaningful price increases. Those commercial property policies experienced increases averaging in the high single-digit range and commercial auto averaged increases in the mid single-digit range. For our personal lines policies, renewal price increases averaged near the high end of the low single-digit range.

For our excess and surplus lines segment, the fourth-quarter 2014 average renewal price increases continued in the mid single-digit range. That segment of our business hit a home run in 2014 with the combined ratio below 80% and net written premiums up 20%.

Our life insurance subsidiary, including income from its investment portfolio, produced another quarter of steady earnings and again grew premiums in its largest product line, term life insurance.

January 1 marked the renewal of our primary property casualty reinsurance treaties. Our per-risk treaties' terms for 2015 are similar to last year except for increasing our retention by $2 million to $10 million per loss. That change and more favorable rates should result in approximately $21 million less in reinsurance cost for those treaties compared with 2014.

Our property catastrophe treaty also has terms similar to last year except for increasing our retention by $25 million to $100 million per event. We expect our ceded premiums for that treaty to be approximately $8 million less than last year.

In conclusion, our primary measure of long-term financial performance, the value creation ratio, ended 2014 at 12.6%. That result was toward the high end of our target which is an annual ratio averaging 10% to 13%. While a healthy stock market contributed, the majority of the 12.6% was due to the contribution of operating income.

I will now ask our Chief Financial Officer, Mike Sewell, to add his insights about our recent financial performance.

Great. Thank you, Steve, and thanks to all of you for joining us today.

I will start with some analysis of investment results. Both income and book value for the fourth-quarter and full-year 2014 benefited from our equity investing strategy. Dividend income from our stock portfolio rose 6% for the quarter and 13% for the year. Yet our core portfolio of 50 common stocks all 50 improved their annual regular dividend over the 12-month period ending December 2014 with a median increase of 8.3%.

Similar to others in our industry, yields for our bond portfolio continued to decline. The fourth-quarter 2014 pretax average yield reported at 4.72% was 13 basis points lower than a year ago while that measure on a full-year was 14 basis lower. Taxable bonds representing nearly 70% of our bond portfolio had a pretax yield of approximately 5.25% at the end of the fourth quarter 2014. The average yield for new taxable bonds purchased during the quarter was 4.49%.

For the same period, our tax-exempt bond portfolio yield was 3.78% and purchases during the quarter yielded 3.26%. Our bond portfolio's effective duration remains at the same level as one quarter ago at 4.4 years.

Cash flow from operating activities continues to help our investment income grow. Funds generated from net operating cash flows for the year 2014 were up 10% to $873 million contributing to $324 million of net purchases of securities for our investment portfolio.

Careful expense management continues to be a priority and together with premium growth contributed to a 1.3% point of improvement to our full-year 2014 underwriting expense ratio.

We like to analyze the underwriting expense ratio's two components, commissions and noncommission expenses. The commission components tend to vary with recent year underwriting profitability. It also considers three-year profitability by agency. So if the commission ratio were to rise, it should be more than offset by a lower loss ratio.

The noncommission component tends to vary as a result of investments we make in the property casualty business such as enhancing pricing and underwriting expertise. Again, we believe it would be worth the trade-off of a short-term increase in that component to create overall value for investors and others. We plan to continue to have noncommission expense dollar volume grow more slowly than premium volume producing a favorable effect on the noncommission expense ratio.

Next, let's turn to loss reserves. I like to emphasize that we follow a consistent approach and that we have experienced 26 consecutive years of overall favorable reserve development. We continue to aim for a reserve reported on our balance sheet to be at levels reflecting net amounts well into the upper half of the actuarial estimated range of net loss and loss expense reserves.

Our news release reported higher reserve estimates for our commercial casualty line of business. That translated in 2014 to a lower amount of total property casualty net favorable reserve development on prior accident years although in aggregate our other lines of businesses were slightly more favorable than in 2013. Once we complete all of our year-end reporting, you will be able to further analyze the details. For now I will highlight a few important items.

For a long time we disclosed that historical paid loss patterns are a key assumption used to make projections necessary for estimating IBNR reserves. During 2014, paid losses for commercial casualty especially related to a few umbrella liability claims emerged at levels higher than we expected particularly for accident years 2005 and 2007. Considering that new data, we estimate a commercial casualty IBNR reserve for subsequent accident years at levels more likely to be adequate compared with recent past quarters.

Overall, our full-year 2014 net favorable development was as usual, spread over several accident years including 58% for accident year 2013, 15% for accident year 2012, 17% for accident year 2011, and 10% for all older accident years in aggregate.

The capital and liquidity position of the Company reflect both strength and financial flexibility. Cash and marketable securities for our parent Company at nearly $1.8 billion at the end of the fourth quarter was up 16% for the year. Our property casualty premium to surplus ratio at 0.9 to 1 continues to provide capital that adequately supports our plans for ongoing growth of insurance operations. We did not purchase additional shares during the fourth quarter, full-year 2014 share repurchases totaled 450,000 shares at an average price per share of $46.63.

I will conclude my prepared comments by summarizing the contributions during the fourth quarter to book value per share. Property casualty underwriting increased book value by $0.40. Life insurance operations added $0.06. Investment income other than life insurance and reduced by noninsurance items contributed $0.40. The change in unrealized gains at December 31 for the fixed income portfolio net of realized gains and losses decreased book value per share by $0.06.

The changes in unrealized gains at December 31 for the equity portfolio net of realized gains and losses increased book value by $0.77 and we declared $0.44 per share in dividends to shareholders. The net effect was a book value increase of $1.13 during the fourth quarter to a record high of $40.14 per share.

Now with that, I will turn the call back over to Steve.

Thanks, Mike. In closing our prepared remarks, I will note that during the fourth quarter, Fitch Ratings and A.M. Best affirmed their strong ratings of our companies. We were especially pleased that A.M. Best announced its positive outlook on the issuer credit rating of our newest company, The Cincinnati Specialty Underwriters. Since its start up in 2008, our excess of surplus lines business has established a good track record and we expect it to continue attracting more of our agents' business.

That is just one of many factors that give us confidence we can perform and benefit shareholders over the coming years. The Board of Directors demonstrated that they share that confidence by increasing the cash dividend to $0.46 per share. That action sets the stage for 55 consecutive years of dividend increases.

We appreciate this opportunity to respond to your questions and also look forward to meeting in person with many of you during the remainder of the year. As a reminder, with Mike and me today are Jack Schiff, Jr., Ken Stecher, J.F. Scherer, Eric Matthews, Marty Mullen and Marty Hollenbeck.

Stephen, please open the call for questions.

(Operator Instructions). Vincent DeAugustino.

Good morning, Cincinnati. Just to start, so the press release noted some actions on the agency management side in terms of the territories and then an affirmation of the commitment to agent service. So I am just curious if any of the plans there reflect any changes in the competitive landscape or if it is really just that is an affirmation of that agent model?

So this is J.F. Just an affirmation of the agent model, that is the theme of our sales meetings this week is how pleased we are with how they are performing for us. The way we define it for our agencies is that we obviously want to help them when it comes to writing insurance and helping them with their success there. But we are also very much interested in helping them with their business management, agency management, sales management types of things providing capital for them so that is really what we are hitting at there.

Okay. And then just for Steve and Mike, so sorry I was just trying to follow along with the reserve comments and simultaneously moving through your Schedule P which I may have gotten a little lost here. But if I heard things right, we are talking IBNR reserve movement primarily on accident years 2005 and 2007 for the commercial casualty. Was that the gist?

Yes, that is exactly right. It was really those two areas where we did see some increased payments. As we do look at paid losses, that helps to project our IBNR picks and so with some increased payments and then also a couple of reserve changes that were really just in those two accident years, and so it was that new information that we usually take our consistent conservative approach to setting reserves and so that is really what did it.

Vince, I might just tack on there that -- this is Steve. As we looked at 2005, 2007, the largest as Mike just mentioned was one claim in 2005, one in 2007 that emerged in the umbrella lines and I think we have had 26 years now of favorable development. There is two ways we could have looked at that. We could have said they are anomalies and we will just let that emergence come out of IBNR or I think the prudent approach and consistent with the way we do things is to actually react to that by increasing our factors which would then subsequently roll through the accident years and add additional IBNR to all of those accident years.

I think it is the prudent way to look at that and I am confident as you look at our Schedule P's that you will find our reserves and balance sheet at least as strong at the end of 2014 as you did at the end of 2013.

I guess the root of the question and I appreciate all of that, Steve, and we are on board with believing that you guys are acting prudently to what you are seeing. So no real question there. I guess mechanically when I look at kind of Schedule P's, right now I'm just flipping through CMP and then the two other liability lines and really IBNR in those out years at last year's maturities are really kind of small. So when I look at the reserve movements in the quarter maybe I'm not capturing everything with those three lines but am I missing anything there in thinking that by this point in maturity there really shouldn't be that much movement? And I guess that question would then be were these couple of claims just really large in size?

Yes, I think it is more the anomaly that I think one was for about $5 million, one was for about $4 million and I do think as we look at where we carry IBNR, there is more uncertainty in the more recent years than there is in the older years and I do think that they tend to be outliers.

Sorry to take that point and kind of confirm my understanding, so was the claim activity on those years and that influenced some IBNR moves here in more recent years as well?

That is correct.

Okay, I understand it much better now. Thank you. And then just one last one for Marty on the investment side. So we can obviously see the energy MLP and equity energy investments move around a little bit so the historical stuff we are good with. What I am kind of curious about is in the current environment do you see this as an opportunity on the energy side or is it something where you are kind of cautiously proceeding?

We are probably a little bit more cautious. We were fairly fully invested in this sector in the energy, the large cap names we have got in the common stock portfolio have actually hung in there fairly well, Exxon, Conoco, Chevron. The MLP space was never a particularly large one for us. We haven't been adding to that in recent years so I think we are just going to hang steady where we are at right now.

Okay. Thanks for all of the answers and best of luck, guys. Thank you.

Mark Dwelle, RBC Capital Markets.

Good morning. I think you just covered some of my questions but just to finalize or hopefully finalize on the reserve addition, so the total reserve addition in the quarter was about $32 million in the commercial segment. If $9 million of it was related to specific claims, what was the total amount of addition? And I guess were there offsetting releases in other areas that kind of netted it down to the $32 million?

I think that is true. It is looked at accident year for each accident year within each line of business and so you are going to have areas moving in different directions that would offset.

Can you provide the amounts of what the overall positive was and the overall negative that netted down to the 32? I suppose I can derive it from the Schedule P.

I'm trying to see the 32. This is Mike. But on the commercial, on the one item I'm looking at -- and Dennis, correct me if I am wrong, total commercial it was a $26 million that was added, $29 million was from commercial casualty strengthen and commercial auto was strengthened $15 million. The large offset was the management liability which was favorable by $12 million, workers' comp was favorable by $7 million, commercial property was slightly favorable for $2 million for the quarter.

Maybe I did my math wrong. I was taking the 4.4 combined ratio points and dividing it backwards I guess netting down the catastrophe losses. Maybe it comes to that lower figure. I'm sorry.

That is exactly right. So as Steve said, you do have some offsetting and all of those numbers I just gave you are spread over several accident years, evenly spread basically.

Got it. Okay. That completely satisfies me on that topic. Let's move over to new business. The amount of new business in the quarter was a nice uptick relative to last quarter but it was still down a little bit year-over-year which I was a little bit surprised at. Any comments you can provide there?

Mark, this is J.F. We mentioned in the release that workers' comp was down a fair amount for us this year. We had a significant year in 2013 there and that was in the area of larger workers' comp. It is an area that we are conservative on, very pleased with the progress we are making on the loss ratio for a lot of reasons. But we just simply did not write as many larger workers' comp claims and that can tend to have a slightly muting effect on overall package business because typically our agents like to put the workers' comp with the package.

So I chalk that up to conservatism on that particular line of business, maybe overly conservative I suppose but that would have been a factor.

The other factor that occurred and really started to occur I think really maybe in the second quarter but clearly I think most carriers are feeling they have reached pretty close to rate adequacy and rather than signaling to their agents that they would be asking for and requiring fairly substantial rate increases at renewal, instead they are defending their renewals more strongly. So the atmosphere we are competing in is one where there aren't as many what I would consider to be good accounts or easier or more desirable accounts out in the marketplace. We still have our pipeline full but segmentation is playing through for every carrier and so the accounts that need the most rate or might have more poor experience are the ones that are more likely out in the marketplace so it is just tougher from that standpoint.

A few other things I would comment on and I don't know how it affects other carriers but the M&A activity that has occurred over the last three, four years, that is fairly disruptive at the agency level as some producers leave. The acquirers change the appetite for some agencies. We react to that. In some cases it works out favorably for us and in some cases the consequence might be that we would appoint more agencies and that takes a little bit more time for things to gear up.

So we are not pushing any panic buttons in terms of the fact that new business was down. CSU, our access and surplus lines division, continues strong. We think we have tremendous potential there. Personal lines has stabilized and we think that you will see an increase in new business in 2015 there.

So it is maybe a little wordy but those are kind of the observations that we have. It is very reinforcing to be out this week with our agencies and hear their opinions of the marketplace and their confidence in us.

So we will keep our pipeline full and we will be good selectors of business as this year proceeds.

Great answer, J.F. You actually knocked out the next two questions that I was going to ask with that answer. So good job. Thanks very much.

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

Good morning, folks. If I heard it correctly, you are hoping to get a combined ratio next year below 95 which is about where you were today. And tell me if I am wrong. But my first question is that, is that a hope to get the accident year lower as well or is that also a function of a normalization of reserve releases [effectively]?

You are correct that we do want to have the calendar year go below 95 but that also implies an accident year improvement as well and no change in our relative reserve margin.

Terrific. And then big picture, where do you see the best opportunities for underwriting improvement? Is it on the personal lines side or the commercial lines side of your house?

Paul, I will throw my two cents worth here. We are putting a lot of effort and we have mentioned this the last several quarters, into I guess you might say non-rate related improvement. We still are seeing rate increases both in personal and commercial lines as has already been mentioned.

I might add particularly on accounts that renew, an awful lot of what is being said by agents that have been interviewed or brokers that have been interviewed, we are not hearing that at being quite so dire in talking to our agencies this week so we think there is still opportunities with modest rate increases. But we have put a lot of effort in the last few years and we are going to continue to accelerate that in loss control, in claims specialization, in underwriting specialization so -- and in just general inspections of business.

So we expect those kinds of activities will help us discover accounts that when we wrote them perhaps years ago, they were better accounts than they are today so we will react accordingly there and then our loss control efforts will help with loss mitigation efforts.

Marty might want to comment on the claims side of things but the great improvement we have had in workers' comp for example we think can continue in the progress we have been making there and that has been a combination of loss control but most especially claims specialization.

I might just add that the continued segmentation is exactly a part of what J.F. was just mentioning and that will continue as well.

So that sounds like more opportunity on the commercial side than the personal lines side of the house given (multiple speakers) primarily commercial lines thing?

Loss control would be but the inspection initiative we have been inspecting about 100,000 structures a year in personal lines and not that our agencies don't keep track of things, but where we have taken the approach that we are going to augment what our agencies do by really inspecting 100% for example of all the new business that we are writing. And we have quite a few houses and dwelling fire policies on the books that need someone to take a look at them as well. So I fully expect that there is going to be some lift in personal lines from that initiative.

This is Steve. I agree totally with J.F. It was nice to see this year 2014, that all of our business segments came in at under 100 and I think they are all -- as J.F. mentioned, working feverishly to continue to improve and I see improvement potential in all segments.

Great, thank you.

Josh Shanker, Deutsche Bank.

Good morning, everyone. Curious about the life insurance business to the extent that over the years I know you have always kept it to a small part of the overall portfolio. How much capital does it tie up and is it accretive to ROE or about the same ROE as the rest of the business? Could you potentially unlock value if you were to send that business elsewhere?

Josh, this is Mike Sewell. There is a difference between GAAP and stat reporting and how much you need to when you are setting the reserves which then ends up with a capital that you have. And so from a GAAP standpoint, you have less reserves that are required so you have more capital. And so when you look at the capital that we have and it is producing I will say in round numbers $40 million of net income, that is a little bit lower ROE than what it would be on a statutory standpoint.

There will be -- the states are looking at principles-based reserves and when we get there we think we can free up some of the capital in the life company and if we had this principles-based reserves today, I would suspect that our capital in the life company would be somewhere in the $350 million to $400 million range so it would be a 10% ROE that you would have there which would be right in line with our 10% to 13% goal for our VCR.

So we are very excited about the life company, we hope that the principles-based reserves will be changed -- or we will get to it and it is producing a nice result and it has added to the overall VCR for us.

Do you have an initiative in place to grow it?

Do we have an initiative in place to grow the life company?

We are still working on that and that is a part of -- and we have been doing it. They are a part of the sales meetings that go out, trying to really expand the sales especially related to the term product. Our term product was up 7% for the year which we are excited about. Dave Popplewell, the President of the Life Insurance Company is out beating the bushes and is out on the sales meeting talking to the property casualty agencies about cross-selling and being able to increase and improve the top-line results. J.F.?

Josh, 70% of our new life premiums tend to come from property and casualty agencies. One of the things that we are doing is trying to link together our homeowners sales in an automated way through simplified-issue policies to write more term insurance and help agencies in the course of writing personal lines business. So that has been the case.

We continue to fortify our field presence on our life insurance company. What tends to work very well is when you have a good professional who is calling on the agencies when it comes to the more business life insurance types of things to help navigate that process. So, yes, we continue. It is like a lot of things that we do, it is a very nice complement to the overall relationship we have with our agencies and our agencies appreciate it.

Thank you and good luck with that.

Vincent DeAugustino, KBW.

Thanks for taking the follow-up. I think I may ask this question every year around this time so here you go. But with the agency sales meetings, I'm just curious if agents are giving you any wish lists where they would like to see any new products or maybe it is technology widgets from Cincinnati?

(inaudible) and I, we have been really hitting them pretty hard with a lot of the things that we are doing. I would have to say that the general tone is that between what Will Van Den Heuvel is doing in the high net worth area, they are pleased to hear about that. They are also pleased to hear that when it comes to middle market personal lines, Will is reinforcing our activity there. They are pleased with the automation that we have there. We have gone through several years of rate increases, pretty darn strong rate increases in the homeowner area and that is not as strong any longer so the pressure is gone there.

CSU, is a -- we get a lot of feedback on that. Our agencies write ballpark $2 billion in excess and surplus lines premium and so we have tremendous opportunity to grow our E&S company there. We gradually increase our appetite in that line of business and so they are pleased to hear the news on that.

Our Target Markets division has 17 programs and that is going to expand. If there is anything I guess that has really created most of a wish list or a discussion at our sales meetings would be that they would ask that we continue to grow that particular division. Every agency, every aggressive agency I would say, is niche-ing. They have producers that go after certain industry classes and while it is not unusual for carriers to have that, what is a bit unusual from our standpoint is the fact that we have some managers in those areas that will go out and travel with agencies, go out and make sales calls with those agencies. So maybe we outwork the competition a little bit better in that category.

So I would say those would be the major areas that we have improved. Loss control continues to be a benefit, our agencies are good at taking our loss control rep, our claims rep and our field underwriters out actually on the sales call and feedback we get on that is excellent. So no particular area. Cyber is talked about a bit. It is being talked about by everyone but that is on the radar screen for everyone as an emerging coverage that we are pleased to tell them we have some things in the works on.

Okay, sounds good. Thanks for all the answers and look forward to talking soon.

Thank you. There are no further questions at this time. Steve Johnston, I turn the call back to you.

Thank you, Stephen, and thanks to everyone for joining us today. We appreciate your interest in Cincinnati Financial and we look forward to speaking with you again on our first-quarter 2015 call. Have a great day.

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