Cincinnati Financial Corp (CINF) — Q2 2020 Earnings Call Transcript

Hello. This is Dennis McDaniel at Cincinnati Financial. Thank you for joining us for our second quarter 2020 earnings conference call. Like 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, Chairman, 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 Investment Officer, Marty Hollenbeck; and Cincinnati Insurance’s Chief Insurance Officer, Steve Spray; Chief Claims Officer, Marty Mullen; and Senior Vice President of Corporate Finance, 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.

Good morning everyone, and thank you for joining us today. As we shared in our pre-release, the second quarter was a challenging one, but we also saw reasons for optimism. That optimism stems from the proven track record of our agency-centered strategy in our investment approach, plus our ability to execute our plans. Operating performance was satisfactory, considering how catastrophe effects for any given quarter can cause income variability. Net income for the quarter more than doubled from the same period a year ago, and it was nice to see the positive effects of a recovering stock market during the second quarter of 2020. While non-GAAP operating income was $69 million less than the second quarter a year ago, a $79 million after-tax increase in catastrophe losses drove that change. Our 103.1% property casualty combined ratio was 6.6 percentage points higher than a year ago, with elevated catastrophe losses representing 6.5 points of the increase.

Thank you, Steve. And thanks to all of you for joining us today. Investment performance during the quarter provided more reasons for confidence in our proven business strategy. The pandemic has not changed how we approach investment management, and we believe that will continue to serve shareholders, policyholders, and others well over the long term. Investment income continued its steady growth of 4% for the second quarter and first six months of 2020, matching the rate of growth per full year 2019. Dividend income grew 6% for the second quarter. For the first half of the year, net purchases for the equity portfolio totaled $149 million. Interest income from our bond portfolio grew 3%, compared with the same quarter a year ago. Average yield was 4.11%, down one basis point from the second quarter of last year. The average pre-tax yield for our total of purchased taxable and tax-exempt bonds during the second quarter was 4.4%. We also continue to add to the fixed maturity portfolio with the net purchases during the first half of the year totaling $107 million. Investment portfolio valuation changes for the second quarter of 2020 were favorable for both our bond and stock portfolios. Much of the fair valued decreases during the first quarter of the year in our stock portfolio recovered during the second quarter of 2020.

Thanks, Mike. The second quarter is often the challenging one, and this year second quarter was certainly no exception. I applaud the efforts of our associates to stay focused on our insurance business, serving independent agents, underwriting risks, and paying claims while creating and embracing new ways to do so safely, effectively, and efficiently. This focus on the execution of our proven strategy will continue to help us grow profitably over time for the benefit of all stakeholders, while also creating shareholder value. As a reminder, with Mike and me today are Steve Spray, Marty Mullen, Marty Hollenbeck, and Theresa Hoffer. Maria, please open the call for questions.

Hey. Good day everybody.

Good morning, Mike.

Good morning. Now, first question, I think that we're all kind of curious whether you feel the underlying loss ratio is getting any benefit from COVID in terms of potentially just less loss activity due to certain areas being shut down in courts and just less economic activity? That's my first question.

I think we would have gotten some benefit during the second quarter. I think, as I mentioned, activity really did pick up in the second half of the second quarter. But I also think a driver of the improved performance was just the hard work that was done by our associates and the agents in terms of the improved pricing, improved segmentation of risks, inspection of properties, and basically just executing our strategy.

Okay. So there could have been some benefit and depending how the economy shapes up as the year progresses there. It could remain a slight benefit as well. Is that fair?

That's fair. We'll continue to monitor. It's hard to predict how things are going as we monitor activity and even look at outside sources like the Google Mobility data, which is public. It does seem that things are on the improve. But we'll keep an eye on it. I just think that the most important thing is that we focus on our business, focus on executing our strategy, and just keep our entire associate workforce and all the agents focused on not being distracted by outside things and to really execute our proven strategy.

Okay. Understood. Moving to the reinsurance segment, there was a pre-announcement regarding some COVID-related business interruption charges. Did those policies include a virus exclusion?

For the reinsurance Cincinnati Re, they had some pandemic-related losses that we did reflect in our pre-release. They scoured their policies, looking for instances where there would be affirmative coverage. I think it resulted from both the property book that they write and from the professional liability book that they write.

Okay. So yes. Affirmative then would just mean that there wouldn't be an exclusion. It will cover the hybrid related to COVID. Is what that means?

It means that there would be nothing in the policy language that would say that there needed to be direct physical damage or loss to property.

Okay, I understand. For my final question, I might return to the queue. Regarding the overall pricing environment, it seems that within the small and medium-sized business sector that Cincinnati targets, there are certain competitors seeking higher rates than others. Do you believe there is a strong demand for increased rates? When we assess the financial performance of most companies over the last couple of years, your results appear to be relatively stable, although COVID has certainly had a negative effect. I'm trying to gauge investor concerns about the pricing trend, which seems to be rising more than they initially anticipated, likely due to uncertainty surrounding COVID. If the losses related to COVID turn out to be manageable, as many industry participants, including your team, believe, do you anticipate that pricing will remain high, or could we see a downward trend?

From what we see, the trajectory is moving upward. As we mentioned, our pricing on average has gone higher than it has been in the second quarter. And I think the key point with us as we continue to look at every policy one by one. And we want to make sure that we get an adequate risk-adjusted price, given everything that we bring to the table, from our predictive models to our underwriting, to what claims brings to the table, loss inspection. We just want to make sure we understand the risks that we write, and that we price that next risk that we write adequately on a risk-adjusted basis. It does seem that the average of that has been moving up, and we would anticipate it continues to move up. But we also focus on the distribution around that average, to ensure that we're properly segmenting the book and looking at each policy on a one-by-one basis.

Okay. Thank you for the answers.

Thank you, Mike.

Good morning.

Good morning, Paul.

I would like to hear more about the components of growth. I believe I understand the math, but it seems there are opposing factors at play with price increases and the overall economic impact. I am a bit surprised by the growth, as I anticipated there would be a greater effect from the recession and companies closing down. Could you elaborate on what you are observing in that area? Additionally, how do you see the top line developing in the future?

Sure. And I think it's a continuation of the comment I had from the first quarter call is that, and I'll be still in Steve Spray's line here, and he'll probably get a chance to use it in a minute, that our business model seems to be built for this kind of disruption with the relationships that we have. And the way I described it in the last call is if you think of the economy as like a pie. That pie may shrink in times that we saw in the first half of the quarter. It may then start to grow as things rebound. But I think based on our business model, I think where the premium growth comes from is just the execution of our strategy. We feel in all circumstances through the quarter, we were getting a little bit bigger piece of that pie than we otherwise would, because of our business model, the fact that all of our field representatives, claims representatives, and everybody out there in the field work from their homes, in the communities with our great independent agents had the relationships in place, and we were really able to react very quickly to agency needs.

It sort of relatedly. What's going on from an agent count perspective? And has the pandemic had any impact on your efforts to expand geographically?

We continue to appoint agents. It's interesting the way you can do things virtually now. And really, I think we've capitalized on again, the field people really knowing their territories. They're responsible for understanding their whole territory with all the agents, not just the ones that represent us. They're able to make contact to do things virtually. And it's a credit to Steve Spray and Angie Delaney and the people out in the field that have really kept their focus. Because it's so easy with all this distraction around us to lose focus. And there's really been a tremendous emphasis throughout the company to keep everybody focused on the business, on the task at hand, and not to be distracted by everything.

Thank you. Keep safe.

Thank you, Paul. You too.

Thank you. Good morning. How are you?

Good. How are you?

I am doing well. Thanks. I was hoping to get a little more color on the sequential improvement in commercial casualty, specifically the accident year ex-Cat loss ratio?

It's Steve Spray. I think it aligns with what Steve mentioned earlier regarding the implementation and execution of our segmentation strategy across all lines of business. As a package underwriter, we see that the market is providing us some opportunities, particularly in the excess casualty area, which I would categorize as a challenging market. We're actively looking for opportunities there, focusing on underwriting pricing. Ultimately, it comes down to fundamental execution and collaboration among all associates and agents on our segmentation strategy.

Okay. So that means that there's no significant reliance on possibly low actual claim counts in the quarter. It appears that other factors are contributing to that improvement.

I would say that's true, particularly for the commercial Casualty.

Okay. No, that's very helpful. Thank you. Second, basically an accounting question. For things like the domestic business interruption, defense, and the credit for uncollectible premiums, is there reason to expect those to continue in the third quarter?

I'll tackle the reserve question and turn over the premium part to Mike. Basically, we just booked our best estimate of the ultimate expense as of June 30, with the information that we have for all of the claims through June 30. So it is our best estimate of the ultimate expense number.

And then, this is Mike. As it relates to the premiums, anything that's related to uncollectible premiums as we look at the aging, the moratoriums, as that pulls off some states have might have continued some of that. So we are watching the aging of that. So we will evaluate that at the end of each quarter that we report out. And so that will be adjusted accordingly at that time. In the past, it's been very minor what we've had. And so this is a little bit elevated. But we've shown you the numbers that we've reported.

Okay. That's helpful. Thanks so much.

You're welcome.

Thank you, Meyer.

Yes. Good morning. Couple of questions.

Good morning, Mark.

Good morning. First, on the workers comp line of business, there was a pretty significant decline in premiums. And I don't think that was entirely a surprise. Would you be able to kind of split that, break that decline into sort of rate decreases, volume decreases and premium credits or something to just kind of give a flavor of maybe what some of the underlying pieces are? I'm sure there's a lot going on in that number.

Well, I think as the key is there's a lot going on there. And we can't say that the rate changes continued in the negative mid-single-digit range. I think we had seen - I think what makes it difficult, I think we had an executing underwriting discipline in segmenting the policies up until the pandemic. And so, we'd seen a decline in exposures and had that trend going. It may have accelerated a little bit as we came into the pandemic, but I'm hard-pressed to give you a percentage breakout in that regard. It's just awfully tough.

The pricing is somewhat helpful. Looking at the E&S line, there was a small reserve addition this quarter, which marks three consecutive quarters with at least a minor addition. Can you provide more details on what you're observing? It's quite uncommon for your company to have a reserve addition for more than one quarter in a row, so I'm particularly interested in this situation.

That's a good point, Mark, and a good question. Looking back at our 10-K, the development took place on accident years 2016 and prior. From the initial picks to year-end 2019, those years developed favorably by $156 million. In the first half of 2020, we added back $11 million across those accident years. The initial picks remain favorable compared to our current position, but we noticed a slight increase in loss payments this calendar year for those accident years compared to our expectations for some of the mature years. As a result, we prudently increased our reserves by $11 million. We are confident in the prospects for CSU and in our best estimate of the reserves recorded in the second quarter. Although the accident year combined ratio, including catastrophe losses, is higher this quarter, it remains at 91.0 for the quarter and 89.4 for the full year, which is still quite strong, especially in the E&S sector. We are now experiencing strong double-digit premium growth, and we have consistently increased rates, which accelerated in this quarter. We believe we are effectively managing limits and conditions. We feel good about the prospects for the CSU E&S business, but we had to adjust reserves when we noticed that payments in those accident years prior to 2017 exceeded our expectations in the first half of the year.

That's very helpful color. That definitely puts a frame on the situation. One more question, if I may. I know second quarter is normally your highest quarter for catastrophe losses. But this quarter was even higher than a normal high quarter. And I know there were a fair number of volume of PCS events. Maybe just talked about what you were seeing? Whether there are geographies or types of storms? Maybe just provide a little bit more depth to the Cat number to help understand that? And what made it so much higher than kind of what it had been even in other heavy second quarters?

Yes. Let me just throw a couple of numbers. And then I think, Marty, will probably want to give a little bit more color. But thinking about the second quarter of this year, there were about 20 cats that were in there compared to about 16 last year. Two of the cats were about the same size, about $50 million a piece, and those were both occurring right there at the beginning of April. When you look at the states those were in, there's about 15 states or more for each of those, and so, for a particular region, it's going to be across the board. The next largest was about $27 million. And then we had the civil unrest and of course that, as you know, was kind of across the country. So maybe Marty got a little bit more information or color you'd like to add.

Sure. Thanks, Mike. This is Marty Mullen. I’d like to provide some additional details on what Mike described. The events in question occurred mainly in Southeast Tennessee and Arkansas, caused by hail and tornadic winds. I take pride in how our Cat teams were able to mobilize to those areas during the COVID situation and manage claims according to our Cat strategy, while ensuring safety precautions were observed. It’s notable that large hail affected some parts of our commercial footprint, and we responded accordingly. Overall, we managed these claims well given the circumstances, and we've received positive feedback from our agents and policyholders. I hope that gives you more insight. Do you have any other questions, Mike?

I think that's some good additional detail. I appreciate that. And that's all the questions.

Hey. Thanks for the follow-ups. I'll ask some questions on business interruption. Is there's any change in any of the terms or conditions to add a virus exclusion on new business?

We're continually looking at that. At this point, we do not have plans to add the virus exclusion. We feel that our standard policy language is strong. We feel confident in it. Our standard and commercial property policies do not provide coverage for business interruption claims unless there is direct physical damage or loss to property. And because the virus does not produce direct physical damage or loss of property, we believe strongly that no coverage exists for this peril. And now, two judges, one in Michigan and one in New York recently voiced their agreement that viruses do not satisfy the direct physical damage requirement.

Okay. Understood. And some of the reinsurers have been saying that they've been adding communicable disease exclusion. Curious, if you had any reinsurance renew lately and that language was added?

Not that I'm aware of. No. Our general property policies renew January 1st, catastrophe and per accident.

Okay. That's what I thought. And lastly, sometimes investors ask about one of Cincinnati's unique policy advantages is that some clients can sign up for a three-year term. Can you kind of remind us how to think about the three-year term in the context of how rate earns in?

Yes, our three-year policy provides a significant advantage in the marketplace as it demonstrates our commitment to long-term relationships, consistency, and stability. It has consistently been beneficial for us. Our retention rates at the first and second anniversaries of a three-year policy are approximately 10 points higher than those for standard renewals. Regarding the rate guarantee, your property, general liability, crime, and marine coverages come with strong guarantees. While premiums may fluctuate based on exposure, the rates remain guaranteed. However, auto, workers compensation, and umbrella policies can be adjusted annually. It's worth noting that about 75% of our premiums are subject to annual adjustments, but the three-year policy is a key feature of Cincinnati and aligns with our value proposition for long-term, sustainable relationships.

And just curious, do you think it has anything to do with why, I think your top lines held in better than expected that maybe agents anecdotally are kind of gravitating if the consensus is pricing is going to go higher, maybe agents are kind of gravitating more to that product? Or is it just more so, some of your competitors might be retrenching a little bit, and you guys aren't?

I think it's a good question. It's probably a little bit of both, I think. Agents and policyholders appreciate that contrary to popular belief, policyholders don't like to go through the renewal process every year. I think that helps them from an efficiency standpoint. Again, it shows long-term commitment, both agents and the policyholders. I think with the rising pricing, I think all of our tools we have today, like Steve said, allow us to price each risk on a risk-adjusted basis at levels that we think are satisfactory for returning a profit. I can tell you, the pricing metrics on our new business have continued to get better and better. And I think a lot of that has to do with execution, but I also think the market is providing us a little bit of lift as well.

Okay. I understand. And thanks again for the insights.

Yes. Thanks and good morning.

Good morning, Phil.

I wanted to follow up on a previous question regarding the potential benefits to commercial frequency from the economic slowdown. In my opinion, and I hope I'm not overemphasizing this, the impact on frequency may be more significant in a short tail line compared to a long tail line. Could you provide any insights on the duration of the business? I would appreciate it.

Okay. Phil, good question. I'm not sure I can give a number answer to that. But I do think just as with most things, with the property coverage in terms of business activity and so forth, you would know sooner, it's a shorter tail than the longer tail casualty lines. And I think all that, as we put out, our best estimates for reserves and so forth is considered and there's always consideration when you do reserving between stability and responsiveness. I think our actuaries have done a good job there. And we've put together a quarter here with our best estimate on the reserves. I think you bring up a good point and asking about the property versus the casualty.

Thank you. In response to an earlier question, you mentioned the foundational work with agent relationships and how it's supporting production. Can you provide insights into whether you're capturing a larger portion of new business? Are agents directing more renewals to you? What elements illustrate the benefits of these relationships?

Yes, it's a combination of factors. Our business model performs well in good times and has proven to be resilient and effective during tougher periods. We have fewer but deeper relationships, which helps us manage more effectively. Our field associates have the authority to make decisions and are embedded in the community, which fosters strong trust and opens up communication. If an account is taken by another carrier and the agent feels it's inappropriate, they can easily reach out to us because we are responsive and present in the community. Our field associates are creatively reaching out to agencies, which has contributed to our growth. We are seeing new opportunities, including some renewals from other carriers.

And Phil, I agree with everything Steve said and would like to add some comments as we progress through the quarter. In terms of new business, our numbers compared to previous quarters were affected. However, while submissions from our agencies were down in the first half of the second quarter, we actually saw an increase in submissions during the second half of the second quarter compared to the same period last year.

Yes. That kind of leads me to my last question. I know it's early, but is there any July read on how that submission activity has trended? And I'm wondering if we've had a pullback in some states now as the shelter in place comes back into play. Has that put any initial pressure on submission activity?

I haven't seen it. In fact, I really hesitate to comment on the third quarter yet, since so much is in flux still. But I haven't seen the pullback. But that's not to say that it wouldn't be there. And there's a bit of a pipeline as business comes in. So I should really probably be pretty careful about commenting at all on the third quarter here.

Not necessarily. It's unfair to ask you. But I appreciate the attempt. Thanks so much guys, and be well.

Thank you. You too.

Thanks. Let me just ask. This is for . I apologize for forgetting it. But given the overall trend of the economy towards reopening, can you give us some insight in terms of how business disruption in claim filings and I mean, here, again, domestically, how those trended over the course of the quarter?

We don't comment a lot on the detail of the number of claims or the sequence of individual claims over the quarter there. I would say they did trail off towards the as time went on.

Meyer, this is Marty Mullen. Here's a comment. I think what we're seeing in some of the courts is, they're focusing on criminal prosecutions and follow-up, because those that take priority. Because during the COVID shutdown, the courts were inactive. So the criminal cases I think, in most dockets are taking precedent, over the civil cases, not saying that they aren't receiving attention, but I know there's a lot of energy by the courts to make sure that they get current on the criminal prosecutions first.

Okay. Thank you.

Hi, gentlemen, hope everyone's well. Sounds like it. I was wondering with all the stress in the world and particularly in your markets. Are you seeing any reduction in claim settlement values?

I have not noticed that, Ron.

Okay. Thank you.

Thank you.

Thank you, Maria. And thanks to all of you for joining us today. We look forward to speaking with you again on our third quarter call. Have a great day.