辛辛納提金融 (CINF) 2016 Q3 法說會逐字稿

Good afternoon. My name is Shannon and I will be your conference operator today. At this time I would like to welcome everyone to the Cincinnati Financial Corporation third-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. Mr. McDaniel, you may begin your call.

Hello, this is Dennis McDaniel from Cincinnati Financial. Thank you for joining us for our third-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, Chief Investment Officer Marty Hollenbeck, Chief Claims Officer for Cincinnati Insurance Marty Mullen and Senior Vice President Theresa Hoffer.

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 our 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, and good morning everyone. Thank you for joining us today to hear more about our third-quarter results.

Those results represent another solid quarter of carefully executing our strategy. They reflect personal interactions by our associates working with our agents and others to steadily improve our long-term performance by building one relationship at a time.

While our 92.4% third-quarter combined ratio was quite good, it was above the outstanding sub-90% result a year ago. However, it's satisfying to see our nine-month combined ratio measures, before the effects of catastrophes, performing about a percentage point better than a year ago.

We are also pleased with another quarter of strong investment performance. And Mike will soon comment on investment income growth and portfolio valuation gains.

Before that I will highlight a few more aspects of our insurance operations. We believe we are reporting a healthy rate of premium growth for each of our insurance segments. Our work toward greater pricing precision allows us to underwrite on a policy-by-policy basis and strengthens our confidence in selecting and pricing new business from our agencies.

Pricing was generally in line with the second quarter. Consistent with where loss ratios for us and the industry indicate the most need for higher premium rates, our commercial auto and personal auto policies experienced third-quarter average renewal price increases that were the highest among our major lines of business. Both had average percentage increases in the mid-single-digit range with personal auto near the high end of that range.

Our reinsurance assumed operations, known as Cincinnati Re, saw another quarter of steady growth as our team works to selectively build out a diversified portfolio of treaty business. Third-quarter underwriting results benefited from the June 30 loss reserves that are developing favorably as we obtain additional information on reinsured claims. The resulting favorable effect for the short tail portion of the portfolio contributed to a $6 million third-quarter underwriting profit for Cincinnati Re.

We also experienced ongoing progress in the expanding personal lines products and services we offer to our agencies' higher net worth clients. Almost one-fourth of the total $91 million in personal lines new business written premiums for the first nine months of 2016 came from high net worth policies.

We continue to see good performance for our Commercial Lines segment with a third-quarter combined ratio near 90%. Our Excess and Surplus Lines segment continued to report superb results with a combined ratio below 70% for both the three and nine months ended September 2016.

For our life insurance subsidiary, earned premiums continued to rise at a double-digit clip for both the third quarter and first nine months of 2016, even though unlocking of interest rate and similar actuarial assumptions slowed our year-to-date growth in income. Our primary measure of financial performance, the value creation ratio, reached 14% on the year-to-date basis with generally higher investment portfolio valuations boosting the strong 6% contribution from operating performance.

I will also briefly comment on estimated effects of Hurricane Matthew on fourth-quarter results. While it is still early, we estimate the catastrophe incurred loss effect to be between $40 million and $65 million pretax including a net effect of $5 million to $10 million from our reinsurance assumed operation.

While the financial impacts are important, the real story for us lies in the hard work of our field claims representatives. More than 50 associates volunteered to leave their families to help policyholders in Georgia, North Carolina and South Carolina put their lives back together.

We're here to pay claims. As our associates fulfill that promise with efficiency and empathy they become our greatest sales advantage. Satisfied policyholders will share their experience with their neighbors, giving our agents and us the opportunity to write more business and continue growing our Company.

With that, our Chief Financial Officer Mike Sewell will comment on other areas of our financial performance.

Great, thank you, Steve, and thanks to all of you for joining us today. I will begin my comments with a few third-quarter investment highlights.

Third-quarter 2016 was our 13th consecutive quarter of investment income growth as it rose 3% on a pretax basis and 4% on an after-tax basis. That growth continues to reflect an increase in both interest and dividend income. Our equity portfolio experienced another quarter of nice growth and unrealized gains and we reported a 1% increase in fair value.

In total, we ended the third quarter of 2016 with a net unrealized gain of more than $2.7 billion, before taxes, including more than $2.1 billion in our equity portfolio. The bond portfolio's pretax average yield, reported at 4.63% for the third quarter, slightly exceeded 4.62% from the last year's third quarter.

Taxable bonds purchased during the first nine months of 2016 had an average pretax yield of 4.27%, 23 basis points lower than we experienced a year ago. Tax exempt bonds purchased averaged 2.89%, 45 basis points lower than a year ago. Our bond portfolio's effective duration at September 30 was 4.9 years, up slightly from 4.8 years at the end of June.

Cash flow from operating activities continued to provide funds for our investment portfolio. Funds generated from net operating cash flows for the first nine months of 2016 rose 9% compared with a year ago and helped generate $375 million of net purchases of securities for our investment portfolio.

As always, we work to carefully manage our expenses, at the same time strategically investing in our business. Our nine-month 2016 property-casualty underwriting expense ratio rose slightly, up 0.3 percentage points compared with a year ago.

Moving to the other side of the balance sheet, our loss reserves continue to experience favorable development as we apply a consistent approach to setting overall reserves. For the first nine months of 2016 favorable reserve development benefited our combined ratio by 4.6 percentage points, very similar to the same period a year ago and full-year 2015.

Reserve development for the first three quarters continued to be spread over most of our major lines and over recent accident years, including 55% for accident year 2015, 24% for accident year 2014 and 15% for accident year 2013. Overall reserves at the end of September, including accident year 2016 and net of reinsurance ceded, rose 6% from last year with IBNR representing more than half of that.

Our assessment of the Company's capital strength, liquidity and financial flexibility is that they remain at healthy levels. Capital management objectives include supporting future profitable growth of our insurance operations plus other areas such as returning capital to shareholders.

As usual, I will conclude with a summary of contributions during the third quarter to book value per share. They represent the main drivers of our value creation ratio.

Property casualty underwriting increased book value by $0.35. Life insurance operations added $0.05. Investment income, other than life insurance and reduced by noninsurance items, contributed $0.48.

The change in unrealized gains at September 30 for the fixed-income portfolio, net of realized gains and losses, decreased book value per share by $0.04. The change in unrealized gains at September 30 for the equity portfolio, net of realized gains and losses, increased book value by $0.51 and we declared $0.48 per share in dividends to shareholders. The net effect was a book value increase of $0.87 during the third quarter to a record $43.24 per share.

Now I will turn the call back over to Steve.

Thanks, Mike. 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, Marty Mullen, Marty Hollenbeck and Theresa Hoffer. Shannon, please open the call for questions.

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

Good morning. Congratulations on the quarter. I was wondering about what you're seeing in both the claim frequency numbers for both the commercial auto and the personal auto businesses and whether or not you saw a, particularly in commercial auto, an acceleration of frequency over the last couple of months or quarters?

Paul, this is Steve. And as we look at that, not that we don't see any issues with frequency, but for our auto lines it's been more of a severity issue than it has been a frequency issue. And so, obviously, I think we've had strong results.

Thanks for the compliment. There are some areas obviously that we need to work on and that would be the auto lines would be at the top of that list. And I think there is a lot of action that's taking place that makes us feel good about the progress.

It just does take a while for the various initiatives we've put in place, including rate, but in addition to rate to help the situation. I don't know if J.F. wanted to add anything to that.

Yes, Paul, going along with Steve's comment about rate, we did, particularly relative to commercial auto, we were at The Council of Agents & Brokers meeting a couple of weeks ago, met with 40 agencies, the larger agencies out there and the topic of conversation among those agencies was commercial auto and the fact that that market is firming up and that they are prepared to deliver rate increases. So that's kind of a big hurdle that there is an acknowledgment throughout the industry of the need for more rate. So we would anticipate that will continue into the future.

But there's a variety of things we continue to do to try to address the severity issue. Most of what we would say are the exact same things that others in the industry are talking about. A whole variety of things.

Newer cars are more expensive to fix. Aluminum is being used more than steel and that's more expensive to repair. A lot of the same things.

Distracted driving continues to be an issue. A lot of accidents that we've noticed, no skid marks.

A lot of distracted walking and biking. We've had two very severe accidents in the Chicago area, you may have heard about them, where people in bike lanes and maybe not in bike lanes, a lot more biking, for example, in metropolitan areas have resulted in some larger claims.

The issue related to driver shortage continues to be one that's talked about a lot. Drivers, some statistics from the PCI conference, drivers that are under 30 years old are two times more likely to have accidents. And there is a lot of discussion about older drivers being brought back, folks that haven't retired, and drivers that are above 60 are 1.5 times more apt to have accidents. So we are seeing a lot of issues related to that.

So what we're trying to do is to amp up our loss control, making certain that as we visit policyholders that they have driver education programs, things of that nature. And then as we underwrite business an awful lot of attention, additional attention is being applied to the driver information, age of drivers, the types of vehicles that those drivers are assigned to, in other words young drivers to heavy trucks is a bad formula. So all of those things are going to be taken into consideration in addition to the rate that we expect to get.

But just to be clear on this, because what I am hearing from you I think is different from others in that on the commercial auto side we've had a severity issue for some time, notable big liability losses, but not a frequency issue until perhaps recently. Then on the auto side is the opposite. We've had sort of ongoing severity running or frequency, pardon me, ongoing severity running three to five per years, but frequency only rose beginning of, well, early beginning of 2015 and have gone through increases.

And it sounds like we've had some other companies talking about a spike in higher frequency, particularly on the commercial auto recently. You are saying it's not a frequency issue, it's all about the severity in your book. Is that fair or am I oversimplifying?

I wouldn't say it's unfair. I think that we do keep an eye on all elements of the pure premium, the frequency and the severity.

But I think as we see it with our book it is more, it is much more of a severity issue for both the personal and the commercial. I think that's been consistent with what we've seen and said through time here.

Thank you very much. I appreciate it.

(Operator Instructions) Scott Heleniak, RBC Capital Markets.

Hi, good morning. Just first on the E&S unit, obviously a great result there and I was just wondering if you could talk more about why that business continues to perform so much better than your peers? And I don't know if you have anything you can attribute to that to specifically, if it's mix or the risks you are writing or some of the relationships you have in placing that business. I don't know if you have any color around there because that business has done so well for quite a long time.

Yes, Scott, this is J.F. I guess I would probably put top of the list just our model doing business with our independent agents.

Unlike others in the E&S business we are not going through wholesalers. We are only doing business with established relationships with The Cincinnati Insurance Company.

We test that as far, as the amount of opportunity we have in our agencies they are somewhere in the area of $2 billion of E&S premium that's written with Cincinnati Insurance Company agents. We visit the agencies in person, in many cases with our excess and surplus lines underwriters, our field reps that are in the E&S side of things.

We include the premium, intermingle the premium with our standard market premiums and losses on the profit-sharing contract. So I think our agencies appreciate what we are doing. They want to make certain that the business they put with us isn't, for lack of a better word, the type of thing you throw against the wall and see if it sticks.

It's more carefully placed with us. I think our appetite is perhaps a little bit more conservative than most. Having said that, we will finish this year at $200 million at the end of our ninth full year in the E&S business.

And it's not as though we don't write some tougher risks. But I think the balance there has been good. Don Doyle and his team have been very disciplined about what we're doing.

About 85% of what we write is on the casualty side and we stay pretty strong with our terms and conditions. So I wouldn't say there's anything magical about it other than I think our model of doing business with just Cincinnati Insurance Company agencies has probably paid off for us.

Okay. And I would imagine, too, you're benefiting from increased submissions, too. As this business gets bigger you get a lot more looks, Is that a factor, too, recently?

Yes, one of the things that we are consistently doing is adding more and more field underwriters in this area. And so when you are calling on your agents person-to-person you do get more looks. We visit with a lot of our agency principals about the advantages we think we bring to the table, and as time goes on perhaps some of the habits that they are in using various E&S wholesalers we break through those and once that gets going there is a momentum associated with that.

Okay, that's helpful on that. Then just moving on to the Cincinnati Re, that's obviously been ramping up nicely, $50 million or so in premiums this year. And I saw you had three senior hires in the quarter, and wondering if you can share anything just about how the opportunities you see for just 2017 and the next few years and how you are looking at that business?

Well, thanks, Scott, good question. We are confident in the business. We do, and we appreciate your noticing that we have really hired some very talented people. Jamie Hole, who we've known for a long time, started that up.

Right on down the line, I won't call them out by names, but every single hire I think has been very strong, very experienced, come with a very variety of strong backgrounds and they are really working together as a team. I think it's important as we go forward to rely on their expertise and that we are going to take a conservative approach to it.

We didn't set up a Company to do this with capital allocated with a demand to produce a return on that capital. It's very much just allocated treaty by treaty as we look at them, and so I appreciate your noticing the talent. We feel confident in the people that we've hired, the business plan they've put together and our prospects going forward.

Got it. And then just last question was just on the accident year loss ratio in commercial, it was up a little bit and I was just wondering if there's anything unusual in there year over year, whether there was any non-cat weather or any other factor that drove that or any particular line that stuck out on that?

No, I think we feel confident in the strong results of the Commercial Lines. We've talked about commercial auto being a bit of an issue, and J.F. laid out all the initiatives that we've put in place. But I think we're confident any uptick can be attributed to noise and we feel pretty darn confident.

It was a tough comparison, too, I would note.

Yes, thank you.

Okay, that's all I have. Thanks.

Ian Gutterman, Balyasny.

Hi, thank you. I guess maybe to start off, this is probably for J.F.

Market competition, it sounds like it's fairly stable in your eyes. Is that right?

And the reason I ask is as you've listened to some of the commentary from others over the last quarter or so it feels like a number of your competitors are calling out that things are getting tougher. Are you seeing that or not as much in your business?

No, I think there might be a slightly muted effect from us because of our three-year policies. Not as many of our accounts go to market every year, so I think that's a real positive from our standpoint. There is competition out there.

It is muted by the firmness of the commercial auto side of things. And when we compete, we compete on an account-by-account basis. And there may be some carriers that may be more line of business oriented about how they compete, they may be seeing a different type of competition or more intense competition, for example.

But there is competition. It's modest. If a great account goes to market it will draw, it will definitely draw some attention. But the types of things that we may have heard in previous soft markets where there's reckless competition we don't see that occurring.

Got it, great. And then to follow up on the reinsurance, Steve, I guess you are about a year into it now, right?

So I don't know if you can give us a little more data on what the book looks like, maybe a split of short tail versus long tail or quota share XOL? Or just what I'm struggling with the most is just how to think about how cat-y it is. I guess like what kind of like you said it's tied to $10 million from Matthew, but if there is an event how should I think about that book or what a normal cat load is or however you are comfortable talking about it?

Right. That's a good question and something we monitor, as well.

It is very much an allocated capital model so we don't even put targets that we are going to have this much in property, this much in casualty and so forth. But if we look at it, this would be inception to date, so including last year we have just about $89 million in net written premium.

Of that about $43 million is on the property side, so that can give you a feel. It's almost 50/50. We feel pretty good that in about a year of existence, including the ramp-up and hiring of the talent and blending the team together, that we have had profitability so far.

And so we feel good about it. But we are not going to be, as a start-up here we are not going to put demands in terms of growth or particular mixes of business. We just want them to look at them one by one, try to determine how much capital we would want to allocate to that particular contract, really make sure that we understand it quantitatively and qualitatively and if we do then we will go forward with that contract.

And we will keep you posted as the numbers might move. But I have to say, it's been pretty balanced as it's turned out.

Okay. And the non-property component, is that mostly traditional casualty or is there UK motor or mortgage insurance or some of the more trendy type things? Or is it just vanilla casualty or how should I think about that?

I think it's mainly United States. I don't think we have much in terms of international. We do have a little bit of mortgage insurance but not much at all.

It's a contract or two that they very much have vetted. So I would say that it's a pretty standard, in terms of reinsurance anyway a pretty standard book of casualty business.

Perfect. And then just my last topic was last year for the first time you did essentially a fifth dividend, I guess a special dividend.

Given how results have been this year and capital being in good shape have you given any thoughts to whether that something you would want to repeat? Or is that really just a one-time thing and don't expect it going forward?

I thought that question might come up. So I pulled the press release from last November. And I think we were trying to be pretty transparent then that we were looking at this as a one-time special dividend and that we did cite the increase in operating earnings being up 30% from where they had been the prior year and just wanting to reward shareholders.

And we are going to continue to look at capital management heading in on this 56th year of increasing our dividends and feel very confident in everything that we are doing. But did want to -- I think we were trying to put the message out last year that that was to be considered a one-time event.

Got it. Just checking. All right, thanks. Good luck.

(Operator Instructions) Josh Shanker, Deutsche Bank.

Good morning, everyone. Can we talk a little about life insurance strategy? It seems like you guys have grown it somewhat healthily this year.

It's still a very, very small part of the business. Why does it make sense for Cincinnati to be the owner of this business? And what is the opportunity?

And is cross-sell successful or is it most of it sold through life insurance agents at this point? How should we think about it?

Yes, we are again confident in the life insurance business. We think there are cross-serving opportunities there.

About I think 70% of the premium or so comes from our P&C agencies and as you know whenever multiple policies are involved the retention rate on all of them goes up. We do have some exciting products I think that are on the development board that we've talked about with our agents and they are excited about.

And it would be an easy-issue term policy that would be marketed through our P&C agents where we would be able to ask just a few questions and draw on data that they've provided through their personal lines applications to be inputs into a predictive model such that we could offer up to $500,000 in term coverage right on the spot, so that we think that's going to roll out early next year. The early trials that we've been putting that through seem to make it something that we're confident in.

The worksite products that we have on the commercial line side are a nice complement to what we are doing through our commercial insurance. And so we do think it very much complements what we do on the P&C side, allows us to have higher retention. And we are confident in the growth of Cincinnati Life going forward.

Is the point of to some extent all you have to do is ask that you give someone a product they didn't have before and they are going to sell it? Or are there particular competitive advantages to the Cincinnati product versus what is already in the market?

I think the latter. I think there will be some competitive advantages to this product.

Because -- how would that work? Term to my mind is a pretty generic product overall. How do you see you having an advantage in that market?

Just the ease of the issue and how it would be coordinated with the sale of the personal lines P&C products I think makes it relatively unique.

You wouldn't need a medical test with this product?

That's correct. I mean, assuming the questions that are answered are answered and the data that we collect comes back in a favorable light, there would not need to be the blood draw, the medical exam and so forth.

Interesting. All right, well, good luck. Keep us updated.

Okay, thank you, Josh.

At this time I would return the conference to Mr. Steve Johnston. Mr. Johnston, please take over.

Okay, thank you, Shannon. Thanks to all of you for joining us today.

We look forward to speaking with you again on our fourth-quarter call. Thank you very much.

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