Cincinnati Financial Corp (CINF) — Q2 2017 Earnings Call Transcript

Hello. This is Dennis McDaniel from Cincinnati Financial. Thank you for joining us for our second quarter 2017 earnings conference call. We issued a news release on our results along with our supplemental financial package, including the 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 today's call, you'll 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 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 of Accounting for Cincinnati Insurance, 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, 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'll turn over the call to Steve.

Good morning and thank you for joining us today to hear more about our second quarter results. We are pleased to report second quarter 2017 operating results that outperformed last year’s second quarter. Our 98.3% property casualty combined ratio for the second quarter of this year was four points better than a year ago. It's also important to note that 98.3% was an improvement from the first quarter of 2017 despite an unfavorable effect from higher catastrophe losses. On a basis before catastrophe effects, our second quarter 2017 combined ratio was better than both the first quarter of this year and the fourth quarter of last year. We believe these improving trends bode well for the second half of 2017. Other good news for the second quarter of 2017 includes another solid quarter for our investment results and premium growth that continues to outpace the industry. Our associates continue their steady efforts to support the outstanding local independent agents who represent Cincinnati Insurance as they carefully underwrite each policy and provide personal service to agents and their clients. We believe we'll continue to see benefits over the long term from our various initiatives designed to support profitable growth in each of our insurance segments. Our commercial lines segment grew net written premiums by 2% and returned to producing an underwriting profit in the second quarter and for the first half of the year. Overall commercial lines estimated average pricing improved slightly from the first quarter of 2017, most notably for commercial auto. As Mike will explain further, our commercial casualty line of business returned to a more typical level of profitability. Although a high level of catastrophe losses continues to challenge our personalized segment, it reported another quarter of nice growth for both middle market and high net worth premiums. Estimated average pricing for personal lines in total was in line with the first quarter of 2017, again with significant personal auto rate increases needed. Our excess and surplus lines segment reported another excellent quarter including a combined ratio of 66.2% and premium growth of 20%. Cincinnati Re logged another quarter of strong underwriting results with steady premium growth and the combined ratio just under 80%. The third quarter of 2017 marks two years since Cincinnati Re began assuming risk and generating premiums. Through the second quarter of this year, its cumulative net underwriting profit totaled $20 million on $183 million of net written premiums and an estimated combined ratio of 81%. Our life insurance subsidiary continued its steady contribution to net income while growing second quarter 2017 term life insurance earned premiums by 8%. The steady growth of our life company, our E&S Company, and our reinsurance assume division diversifies our business helping to smooth results over time. Our primary measure of financial performance, the value creation ratio was 3.2% for the second quarter and 7.0% for the first half of the year. We are on pace for another year that reaches our long-term target of 10% to 13% on average. Each day brings new challenges to insurance companies. We see them as opportunities for our associates to compete and to deliver value to agencies and policyholders. We know that can translate into long-term shareholder value. Next, our Chief Financial Officer, Mike Sewell, will highlight other key areas of our financial performance and financial condition.

Great. Thank you, Steve, and thanks to all of you for joining us today. I'll start my remarks with some highlights of our investment results. Second quarter 2017 was our 16th consecutive quarter of investment income growth, rising 1% for the quarter and 2% for the first six months. As in recent quarters, both interest and dividend income growth contributed to growth. Our equity portfolio again reported growth in unrealized gains, up 6% for the quarter to nearly $2.6 billion. The bond portfolio's pre-tax average yield was 4.42% for the second quarter of 2017, down 22 basis points from last year's second quarter. Taxable bonds purchased during the second quarter of 2017 had an average pre-tax yield of 3.75%, and purchased tax-exempt bonds averaged 3.33% for a blended yield of 3.53%. Our bond portfolio's effective duration at June 30 was 5.2 years, matching March 31 and up slightly from five years at the end of December. Cash flow from operating activities continued to provide funds for our investment portfolio. Funds generated from net operating cash flows for the first six months of 2017 totaled $445 million, down $54 million or 11% from the first half of last year. An $85 million increase in catastrophe losses paid this year was a key contributor to the decrease. Careful management of expenses continues to be a priority, including investing strategically in our business. Our second quarter 2017 property casualty underwriting expense ratio improved slightly, and the six-month ratio was in line with a year ago. Next, I'll comment on reserves. We again experienced net favorable development on prior accident years as we apply a consistent approach to setting overall reserves. For the second quarter of 2017, favorable reserve development benefited our combined ratio by 3.2 percentage points. That was down 1.2 points from a year ago but fairly close to the 3.5 points we averaged over the past three calendar years. Our largest line of business, commercial casualty, returned to experiencing favorable reserve development for the second quarter of 2017 with a ratio of 2.5%. That line was similar to its longer-term ratios which averaged 2.6 points over the past three calendar years. Our commercial casualty second quarter 2017 loss and loss expense ratio of 57.7%, combined with an estimated underwriting expense ratio of 32 or so, indicates an estimated combined ratio of just under 90%. Favorable reserve development for the first six months of 2017 continued to be spread over most of our major lines of business and over several accident years, including 51% for accident year 2016, 12% for accident year 2015, 15% for accident year 2014, and 22% for 2013 and prior accident years. Touching briefly on capital management, our approach and financial strength remained stable. During the second quarter, we repurchased 800,000 shares at an average price per share of $69.73. As usual, I'll 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 $0.09. Life insurance operations added $0.07. Investment income other than life insurance and reduced by non-insurance items contributed $0.41. 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 $0.29. The change in unrealized gains at June 30 for the equity portfolio, net of realized gains and losses, increased book value by $0.54, and we declared $0.50 per share in dividends to shareholders. The net effect was a book value increase of $0.90 during the second quarter to a record $44.97 per share. And now I'll turn the call back over to Steve.

Thanks, Mike. In closing our prepared remarks, I'd like to share some additional positive news about our company. In June, S&P Global ratings affirmed its A plus financial strength rating for our standard market and life insurance subsidiaries and in April, A.M. Best affirmed with a stable outlook its rating of A Excellent for the Cincinnati Life Insurance Company. We were also pleased to be recognized for a sixth time by Forbes Magazine as one of the most trustworthy financial companies in America and to be included in the Fortune 500 for the second consecutive year. Our solid performance, combined with this news, gives us confidence that Cincinnati Financial is on track to deliver shareholder value far into the future. 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 J.F. Scherer, Marty Mullen, Marty Hollenbeck, and Theresa Hoffer. Jessie, please open the call for questions.

Good morning. Can you confirm that you have high net worth premiums in force? I believe you mentioned $7 million of new business licenses that contribute to the in-force number.

We have let's see here, estimating for the first half of the year, we have about $180 million in the high net worth segment.

Thanks. And I saw the commercial casualty as you mentioned, turned favorable for this quarter. I guess by just looking at the loss environment more broadly, are you seeing year-over-year changes in kind of inflation trends? Are you seeing juries paying higher awards or any changes in that sense?

No we haven't. We haven’t noticed that, to tell you the truth.

Hi, good morning. I'm curious if you could provide more details on the E&S performance, particularly regarding the specific lines or industry sectors where you're seeing significant results.

Did you say in the E&S segment? Yes, yes. It’s largely casualty driven. We do point out that I don't know if 40% or 45% of the risk that we write in E&S policy is on a standard Cincinnati policy, so there are a lot of situations where we'll write the property on a standard basis through Cincinnati Insurance, the casualty through the E&S company with appropriate terms and conditions, but the largest percentage of the premium is in casualty in the E&S company.

Could you discuss the submission flow in the E&S segment? Given the size of Cincinnati, I imagine you're seeing an increase in business, so what trends are you noticing in terms of new submission flow?

The submission flow is up this year, and we're happy about that. To build on Steve's earlier comments, the classification of the business we're writing reflects a generalist approach from our agencies. We don’t specifically target a line of business or an industry classification. It's encouraging that 44% of our E&S writings are linked to a P&C account, and our agencies write nearly $3 billion in E&S business collectively. Our focus remains on competing primarily for that existing business. We believe we have a strong value proposition in the E&S sector, and we're doing our best to write seasoned business within those agencies right now. While the submission flow is strong, there's considerable competition, especially for larger E&S accounts where some carriers are moving accounts back into the standard market. Our appetite here is conservative; we tend to operate between E&S and standard markets. It’s not surprising that some of our accounts are shifting back to the standard market in the current softer market conditions. However, despite losing some business to the standard market, the strong submission flow has allowed us to grow effectively.

Okay. And then I'm just wondering on the commercial lines that actually in your loss ratio look like that was up mostly because of property. Was there anything unusual in there? Just was that just kind of an uptick in non-cat weather? Do you see any kind of large losses or anything in the quarter?

That was a good observation. I think if you compare that the X cat, actually, we had a very, very favorable quarter a year ago in the property with a 36.3% loss ratio. The 49.7% that were post this year is right in line with what you would normally expect. Maybe one other area where there would be some large losses, if we look to the personal lines to the other category, we're up a little bit this year at 68.3% from where we were 42% a year ago. And as we dig into that, there were some of the larger umbrella losses. So, I think those would be the two points to describe other than the non-cat weather. I think I'd also like to make the point that if we just look at the X Cat exiting year for the quarter, these are the longer-term trends, including each of the full last three years, it's very much in line.

Okay. Yes, I want to just make sure I wasn't missing anything there but it makes sense. But then just final last question was the tax rate was lower than I have been tracking. Was that just the share-based compensation accounting change rule that came into effect, or was there anything else one-time in there?

Yes, this is Mike. What that really is, is when you take a look at what's driving that primarily is the underwriting profit for this quarter compared to other quarters. So, that's really what caused it to drop a little bit. You've got your preference items of the dividend received deduction or tax-exempt interest, etc. But the more underwriting profit you have, the more that that’s going to come in straight at the 35%. Less underwriting profit, you'll have a little bit less or more. And then, and so, therefore you've got your change there.

Excuse me, I might add we’d say municipals over corporate to some degree over the last 12 to 18 months, so that's starting to have a little bit of an impact.

Very good. Thank you, Jessie, and thanks to all of you for joining us today. We look forward to speaking with you again on our third quarter call. Thank you.