辛辛納提金融 (CINF) 2016 Q2 法說會逐字稿

Good morning. My name is Shannon and I will be your conference operator today. At this time, I would like to welcome everyone to the second-quarter 2016 earnings conference call. (Operator Instructions)

It is now my pleasure to turn today's call over to Mr. Dennis McDaniel, Investor Relations Officer.

Hello, this is Dennis McDaniel from Cincinnati Financial. Thank you for joining us for our second-quarter 2016 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 the Cincinnati Insurance Company's Executive Committee Chairman, Jack Schiff, Jr.; Chairman of the Board Ken Stecher; Chief Insurance Officer for Cincinnati Insurance, J.F. Scherer; Principal Accounting Officer Eric Mathews; Chief Investment Officer Marty Hollenbeck; and Chief Claims Officer for Cincinnati Insurance, Marty Mullen.

Second, 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.

Now I will turn the call over to Steve.

Thank you, Dennis. Good morning and thank you for joining us today to hear more about our second-quarter results.

We are pleased to report satisfactory operating performance, despite second-quarter catastrophe loss effects that were slightly higher than our long-term average. Thanks to the steady efforts of our associates to support their local independent agents who represent Cincinnati Insurance, we still managed to generate a modest underwriting profit in the second quarter and our first-half 2016 consolidated property-casualty combined ratio of 95.4% is within 0.5 point of the first half of last year.

We are encouraged by improving underwriting results before the effects of catastrophes and believe we will see ongoing benefits from our various initiatives focused on profitability. Rising investment income and robust portfolio valuations at quarter end were another bright spot for recent performance. Higher investment income for the first half of 2016 offset a small decrease in property-casualty underwriting profit, leading to a 3% increase in operating income.

Mike Sewell will comment further on that in a moment. First, I will highlight some important points about our insurance operations.

Each of our segments continued to grow satisfactorily as we earned quality new business produced by our agencies. Pricing was generally consistent with the first quarter; however, personal auto was an exception, with average renewal rate percentage increases moving from the mid single-digit range to the high single-digit range. We believe that improved pricing for both our personal and commercial auto, along with other initiatives, will improve our results for those lines of business.

Expansion of our reinsurance assumed operation, known as Cincinnati Re, also continues to progress nicely. Cincinnati Re generated an underwriting loss of just under $1 million for the second quarter as a result of a $4 million estimated share of losses from the Fort McMurray, Canada, wildfire affecting the industry, plus what we believe is appropriate reserving for a diverse portfolio of reinsurance treaties.

We are also satisfied with the progress of expanding the personal lines products and services we offer to our agency's higher net worth clients. Nearly one-quarter of the total $59 million in personal lines new business written premiums for the first six months of 2016 came from high net worth policies.

We reported an underwriting profit for each of our property-casualty segments in the first half of 2016. As in most years, we anticipate the second half to better than the first.

The commercial lines segment produced a combined ratio just over 95% for the first half of the year, while that ratio for our excess and surplus segment was just under 75%. Our life insurance subsidiary, including income from its investment portfolio, also experienced another good quarter and first half of the year. For the first six months of 2016, earned premiums grew 11% and net income for our life insurance subsidiary rose 10% compared with last year.

Our primary measure of financial performance, the value creation ratio, was again strong at 4.6% for the second quarter and 10.5% for the first half of 2016. Generally higher valuations in securities markets augmented the contribution of our operating performance.

While we are pleased with ongoing good performance, we understand the need to remain focused on underwriting profitability and growth. We will do that as we seek to continually improve performance.

I will now ask our Chief Financial Officer, Mike Sewell, to share his highlights for other areas of our financial performance.

Great. Thank you, Steve, and thanks for all of you for joining us today. I will open with highlights of second-quarter investment results.

It was another stellar quarter for investments, including 6% growth in pretax investment income and 7% on an after-tax basis. We also experienced increases in the fair value and unrealized gain positions of both our equity and bond portfolios. We ended the second quarter of 2016 with a net unrealized gain of nearly $2.7 billion before taxes, including more than $2 billion for our common stock portfolio that reached more than $5 billion in fair value.

For our bond portfolio, interest income again grew 4%, in part due to net purchases of $309 million over the past four quarters. The bond portfolio's pretax average yield, reported at 4.64% for the second quarter and 4.65% for the first half of 2016, matched the year-ago periods.

Taxable bonds purchased during the first six months of 2016 had an average pretax yield of 4.5%, 8 basis points higher than we experienced a year ago. Tax exempt bonds purchased averaged 3.01%, 33 basis points lower than a year ago. Our bond portfolio's effective duration at June 30 was 4.8 years, up slightly from 4.7 years at year-end.

Cash flow from operating activities continued to fuel the investment income growth. Funds generated from net operating cash flows for the first half of 2016 rose 4% compared with a year ago to $490 million and helped generate $292 million of net purchases of securities for our investment portfolio. As always, we work to carefully manage our expenses at the same time of strategically investing in our business. Our first-half 2016 property-casualty underwriting expense ratio rose 0.2 percentage points compared with a year ago.

Our loss reserves continue to experience favorable development as we apply a consistent approach to setting overall reserves. For the first six months of 2016, favorable reserve development benefited our combined ratio by 5 percentage points compared with 4.4 points for the same period last year and similar to the 5.2 point rolling average for the prior four quarters. Reserve development so far in 2016 continued to be spread over most of our major lines and over recent accident years, including 55% for accident year 2015 and 22% for accident year 2014.

Overall reserves, including accident year 2016 and net of reinsurance, rose $229 million in the first half of 2016, including $133 million for the IBNR portion. Our capital strength, liquidity, and financial flexibility continued at healthy levels. Our capital remains ready to support future profitable growth of our insurance operations and other capital management actions, such as returning capital to shareholders.

As usual, I will conclude with a summary of contributions during the second quarter to book value per share; they represent the main drivers of our value creation ratio. Property-casualty underwriting increased book value by $0.04. Life insurance operations added $0.07. Investment income, other than life insurance and reduced by noninsurance items, contributed $0.47.

The change in unrealized gains at June 30 for the fixed income portfolio net of realized gains and losses increased book value per share by $0.72. The change in unrealized gains at June 30 for the equity portfolio net of realized gains and losses increased book value by $0.59, and we declared $0.48 per share in dividends to shareholders. The net effect was a book value increase of $1.41 during the second quarter to a record $42.37 per share.

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

Thank you, Mike. As you can see, we have a lot of positive trends carrying us into the second half of the year.

Our focus on incremental improvements is adding up and delivering great results that are worth noticing. In the last few months, Moody's, S&P, and Fitch have all affirmed our strong financial strength ratings maintaining their stable outlooks. Fortune Magazine also took notice of our progress this year as we joined the ranks of the Fortune 500 in June.

As we work together with our agency partners to maintain this momentum, we are confident that we will continue to produce value for shareholders in the near-term and for the long-term. 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.

I will also note that many of you know Eric Mathews, who we announced last fall will be retiring on July 29 after nearly 40 years with the Company. We thank Eric for his leadership of our accounting operations and wish him the best. Senior Vice President Theresa Hoffer will participate in future earnings conference calls instead of Eric.

As a reminder, with Mike and me today are Jack Schiff, Jr., Ken Stecher, J.F. Scherer, Marty Mullen, and Marty Hollenbeck, in addition to Eric Mathews. Shannon, please open the call for questions.

(Operator Instructions) Josh Shanker, Deutsche Bank.

Good morning, everyone. Another excellent quarter, as usual.

I wanted to ask a little about technique in reserving for personal lines versus commercial lines. Commercial lines have a tendency, almost consistently, to be quite redundant over a very long period of time and personal lines tend to whipsaw in both directions. I realize that obviously commercial liability and something like worker's comp is long-tailed in nature and that might have something to do with it. But given your conservative-ism in how you think about things, why are there these two different sort of tracks that they are on?

Josh, this is Mike Sewell. That's a great question. Hopefully -- you mentioned whipsaw; I'm not sure I probably would have defined it that way.

We do follow a consistent approach with our actuaries. Not changing how we do the reserves and look at them, but from time to time we will have I will call them refinements to the process as more information becomes available and so forth.

I think probably your comment might be specifically related to the personal lines and how maybe that fluctuated a little bit from the first quarter of this year to the second quarter and how maybe the second quarter was probably a little bit more in line with 2015 and 2014. Really, as we noted in our first-quarter 10-Q, and I think I may have made some comments in there, we did have a slight refinement on our personal lines business which was really related to what we call the AOE reserves. And so there were some expenses there that we refined. It moved about $9 million, $10 million worth of reserves from the personal line side to the commercial lines side.

Had we not made that refinement, you would've actually probably seen the personal lines prior-year development in the first quarter really be flat. So because we did that you saw some favorable development there and now, in the second quarter, really what's running the temperature is personal auto as well as commercial auto when you look at prior-year reserve development.

So absent some refinements, I think we are fairly consistent. We are consistent in the process and I think the numbers really show that.

I don't know if Steve or anyone else has any additional comments, but that might have been a little long-winded for you.

I will take as much information as I can get. New appointments on new agencies, to what extent when you are growing are you finding the appointments are trending in newer territories versus territories that you know well? To what extent is it possible for you to find agencies in territories that you know well that you think you can get a 30% to 40% share of their business out of? How are new adds looking these days?

Josh, this is J.F. In existing territories we have always taken the approach with the relatively low number of agencies we have to really appoint as few as possible in a particular area.

Now with the M&A activity that is occurring, a lot of consolidation in agencies, from time to time we would run into a case where, if we needed to augment our agencies in any particular area, the group from which we can choose might be smaller. But, fortunately, the desire for agencies that don't represent us to have a contract with us is still high.

We rarely are turned down when we prospect for agencies and so I'd say consequently -- and the fact is that there are a lot of agencies that don't represent us in a lot of territories. That's not a big concern for us. We have been able to find agencies to appoint.

30%, 40% of the volume in an agency is an ambitious target. We certainly want to be consequential to the agency. As you know, we talk about being number one or number two after we have been in an agency for five years, but we're not seeing any lack of opportunity for us to do that. It has worked out pretty darn well.

In newer states, particularly with what Will Van Den Heuvel is doing in the high net worth area, between the very good reputation that our agencies have earned for our company and they talk to agencies in some of these newer states for us, the door is pretty wide open for us to appoint agencies, for example, in lower New York, Manhattan, Long Island. We just recently opened New Jersey. California is soon to be opened and really no shortage of agencies to appoint there.

Fortunately, I think across the board, new states and existing states, we're in pretty good shape.

On the high net worth homeowners initiative, do you get any sense of the previous carrier? Is there any trend on where you are winning that business from?

Well, the opportunities are a result, as everyone knows, from the consolidation of carriers in that line. And so agencies, more than anything, want options they can offer to their policyholders. I just happened to see one come through this morning; it was from a direct writer, but we actually wrote the business that, frankly, hadn't -- that particular business hadn't been very well attended to.

But it's coming across the board. Actually the direct writer's write a tremendous percentage of that business, so it's not at all uncommon to see that. And then from the usual carriers; we are competing pretty favorably against anybody right now.

I think what's happening is that agencies, when they take a contract with us, they know as part of the approach we take to them is that if we will agree to appoint fewer agencies than perhaps brand X might appoint, in return for that we ask that the agency concentrate on making the relationship with us work. So we are very pleased with the number of at-bats we are getting. I think that's the most important thing.

Those agencies aren't forced to put any business with us, but if they are giving us the opportunities, which we are pleased that they are, we are very pleased with the result.

Well, continued good luck to all of you.

Paul Newsome, Sandler O'Neill.

Good morning. Congratulations on the call and the earnings.

I wanted to see if you could help us think about the trend in both the commercial and the personal lines of the accident year results, if you exclude the catastrophe loss, the so-called underlying combined ratio. Most folks are talking about commercial lines -- at least commercial lines pricing being lower than claim cost inflation and then other mitigating efforts. And, obviously, you have a little different discussion on the personal lines side.

I was wondering if you could kind of walk through your thoughts on both of those.

Paul, this is J.F. I think, in terms of the rate increases that we are getting on renewals, we are reasonably pleased with what we are seeing. In auto, both in private passenger and commercial autos, those are healthy and getting healthier.

So we think that between the underwriting actions that we are taking in those two lines of business, plus the rate increases -- as you know, we have been pretty aggressive about raising reserves on prior years and pretty conservative this year. We think that things are going in the right direction on auto.

Relative to loss cost in all the other lines, there's still a lot of initiatives that are in the works here -- loss control inspections, more specialization by line of business, as well as by industry -- that we think -- and then, of course, the segmentation and the analytics that we are employing. We just think we are being better selectors of risk and we are also addressing loss mitigation issues that is helping with our loss costs.

As it is right now, the improvement you are seeing in the accident year, excluding cats, would be exactly what we would expect to have happened. We are pleased with -- really everything is kind of falling into place. Still a lot more to do, frankly; we think there's a lot of improvements we can continue to make in those areas.

So do you think that current trend we've seen in the last year or two will continue to see improvements in the underlying combined ratio?

Paul, this is Steve and I agree 100% with J.F. He just nailed that answer. Maybe just putting it in a little bit of quantitative terms, we are getting rate increase. I think the segmentation that J.F. mentioned is working well. So that's helping us on the premium side.

Then there's also, as J.F. mentioned in terms of trend, which we look at as being future trend in terms of rate-making being prospective, so we're looking out trying to anticipate where loss trends are going in the prospective rating period or pricing period. And the points that J.F. made about the things that are going on on the underwriting side, especially in loss control, (technical difficulty) the Company being up we think is making us optimistic about the future of continuing to make improvements.

So I think from everything that we can see, in the near term anyway, we feel pretty good about our prospects.

Great, thanks a lot.

(Operator Instructions) Mike Zaremski, BAM Funds.

Good morning, gentlemen. My first question is on the catastrophe preannouncement. You pointed out in the release that this quarter's catastrophe load ended up being close to a normal in terms of the 10-year historical average.

I guess in my seat I was a little bit surprised it was around that historical average, given your lack of personal lines exposure in Texas. So my question is whether your team at Cincy was surprised by the level of losses this quarter.

This is Mike. Thanks for the question. We really weren't surprised because it really was falling in line, when you are looking at five-year, 10-year averages. The largest catastrophe and, maybe Marty might be able to talk about that, really was in San Antonio, Texas, and having that run up.

We don't have personal lines there; it's only commercial lines. So that might have caught maybe some of the analysts I'll say off guard a little bit, having that being in there, because that was running about $55 million, $56 million. There were some other ones in there that were in the -- I will call it in the $15 million to $25 million range, but probably not necessarily a surprise when we look at the five-year, 10-year averages and so forth.

But the last couple years we have had pretty good catastrophe loss ratios and so this one being elevated a little bit. So maybe if I turn it over to Marty for some of the details of some of our cats.

Sure, thanks, Mike. The comment on San Antonio is accurate. It's about a $56 million end of the second quarter loss for us and all commercial. Everything you read -- San Antonio was not on the map in Texas as far as being a hail risk for the industry. It was supposed to be an area that really wasn't very prolific as far as previous hail events and so I think it caught everybody by a little bit of a surprise to the extent that the hailstorm hit San Antonio.

As a result of that, I think the losses were a little greater in the industry than probably were anticipated for us. We certainly took our share of those commercial losses. That actually was twice the size of any other cat we had for the quarter. The other ones were mainly Midwestern storms related to particular hail losses in several states over several days.

Other than that, there really wasn't anything unusual in the quarter as far as those events.

Okay, that's helpful. One follow-up. Kind of on the other hand, while catastrophes pushed up the absolute combined ratio, the accident year, excluding catastrophe loss ratio, was the best it's been in 10 years, if my model is right.

Can you speak to why it has improved so much so we can better think about its sustainability? I don't know if there were any unusual items or maybe cats were high and that ate up some of the non-cat weather.

Mike, this is J.F. again. Similar to what we mentioned with Josh, and I think Paul as well, I think there's a momentum going right now for a variety of areas. One of the things we are very pleased with is the predictive modeling and analytics that we have employed, both in personal lines and in commercial lines. That's continues to get more and more refined.

We are segmenting our book of business better than we ever have. I think we've done a good job of integrating it with more of standard underwriting (technical difficulty), a little of the art and the science combination that we talked about in the past. Our agents have been great in cooperating with that. (technical difficulty) for an agent to explain the science part of this to policyholders, but I think we've done a good job there. And agencies have come through for us.

We've expanded our loss control significantly over the last five years, really that last six or seven years. We're inspecting risks that we hadn't inspected in the past. The inspections that we are making are much more in depth than we have in the past. We are discovering things, both good and bad, that allow us to make a more informed decision.

We've gotten off risks that we should've gotten off of. We've said yes to risks that maybe in the past we would've thought were a little tough in terms of their industry classifications, so that's working out real well.

I'd say, in particular, in personal lines the inspections have also afforded a lift in the area of insurance to value, so we are increasing premiums there. Getting a better ratio of premium to risk for ourselves there.

It's not one thing; it's a lot of things that are working well. I don't think there's anything particularly unique to what we're doing as to what other companies are doing. I just think we have probably executed pretty well so far in this process. And as Steve said a few minutes ago, there's still I think a lot of optimism moving forward we can continue to improve.

Got it. So it sounds like -- maybe you can remind me; I know you guys have talked in the past about combined ratio goals over time. It feels like things -- there's more momentum and things are potentially -- I don't want to put words in your mouth -- going better than planned a year or two ago. Is that the right way to think about things?

I think so. With the plans that we've laid out and that we've been working towards, like J.F. just mentioned, we always wanted to be, I will say, in that 95 to 100 combined range. But with interest rates where they're at today on the investment side, we've always been striving to be below 95 combined and really driving everything we can on a current accident-year basis, ex-cat basis. We are really having to drive it to where we are at today and to keep the momentum going.

I would just add to that an example would be, that we are pleased with, is the introduction of high net worth to our personal lines book of business. That segment of personal lines in the industry has always been much more profitable.

For us, though we weren't writing very high net worth, I would say our book of business previous to Will Van Den Heuvel joining the Company was more mass affluent than it was high net worth. But it performed 10 points better than our middle-market personal lines book of business.

So as you can tell from the weighting of new business in high net worth this quarter versus middle-market, we are increasing the proportion of high net worth. And so there've been a lot of deliberate steps that we have taken to position our book of business to perform better than the 95 to 100 that Mike mentioned.

Got it, thank you.

(Operator Instructions) As there are no further questions on the phone lines at this time, I would return the call to Mr. Steve Johnston.

Thank you, Shannon; excellent job. And thanks for all of you for joining us today. We look forward to speaking with you again on our third-quarter call. Thank you.

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