Cincinnati Financial Corp (CINF) — Q1 2022 Earnings Call Transcript

Hello. This is Dennis McDaniel at Cincinnati Financial. Thank you for joining us for our first quarter 2022 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'll first hear from Chairman, President and Chief Executive Officer, Steve Johnston; 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; Cincinnati Insurance's President, Steve Spray; Chief Claims Officer, Marc Schambow; 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, 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.

Thank you, Dennis, and good morning, everyone. Thank you for joining us today to hear more about our first quarter results. It was another quarter of good operating performance. Our agency-focused strategy led to profitable growth and reflects well on the skill and dedication of our associates and excellent relationships with terrific independent agents. We reported a net loss of $273 million for the quarter, due to the recognition of a reduction in the fair value of securities held in our equity portfolio. Non-GAAP operating income for the first quarter of 2022 was up $31 million or 14% versus a year ago. Our 89.9% first quarter property casualty combined ratio was 1.3 percentage points better than last year's first quarter. The current accident year loss and loss expense ratio before catastrophe loss effects rose slightly compared with accident year 2021 measured at 3 months, reflecting an increase in large losses for our property lines of business. We again managed our business to healthy levels of policy retention with meaningful average renewal price increases for each of our property casualty insurance segments. Policy retention rates for both commercial and personal lines improved from a year ago to the upper 80% range. Consolidated property casualty net written premiums rose 12% for the first quarter of 2022. Our pricing segmentation efforts continue to support what we believe is profitable growth as our underwriters work to retain and write more profitable accounts while taking appropriate action on opportunities that we determine have inadequate pricing. We also believe renewal pricing during the first quarter was again ahead of our estimate for prospective loss cost trends for each property casualty segment. Our commercial lines insurance segment continued to experience estimated average renewal price increases in the mid-single-digit percentage range, similar to the fourth quarter. In the first quarter, personal lines average renewal price increases slowed by a small amount compared to the fourth quarter, remaining in the low single-digit range. Our excess and surplus lines insurance segment continued in the high single-digit range. Our commercial lines segment grew first quarter 2022 net written premiums by 8% and with a combined ratio of 92.3%. Our personal lines segment net written premium grew 11%, reflecting our continued planned expansion of high-net worth business produced by our agencies. The segment's first quarter combined ratio of 83.9%, improved 17.2 percentage points from a year ago, driven by lower catastrophe losses. Our excess and surplus lines segment had an 85.9% combined ratio and continued strong growth, with first quarter 2022 net written premiums rising by 25%. Cincinnati Re and Cincinnati Global each had a nice quarter with healthy growth. Cincinnati Re grew net written premiums by 30% for the first quarter of 2022 with a combined ratio in the mid-90% range. Cincinnati Global grew net written premiums by 24%, with a combined ratio also in the mid-90% range. Our life insurance subsidiary generated first quarter 2022 net income of $10 million, matching last year's first quarter, and grew term life insurance earned premiums by 6%. I'll conclude with the value creation ratio, our primary measure of long-term financial performance. VCR was negative 6.9% for the quarter, while net income before investment gains or losses contributed 1.9 percentage points. Lower investment valuations during the quarter resulted in the investment gains or losses component contributing negative 8.6 points. Now our Chief Financial Officer, Mike Sewell, will highlight several other important aspects of our financial performance.

Thank you, Steve, and thanks to everyone for being with us today. Investment income increased by 6% in the first quarter of 2022 compared to the same period last year. Dividend income for the first quarter rose by 12%, and we made net equity securities purchases totaling $34 million. Bond interest income grew by 4%, although the pretax average yield of 4.01% for the quarter declined by 13 basis points year-over-year. The average pretax yield for all purchased taxable and tax-exempt bonds during the first quarter was 3.64%. We also added more fixed maturity securities, with net purchases amounting to $109 million. The valuation changes of our investment portfolio in the first quarter were unfavorable for both our stock and bond holdings, with a net decrease of $746 million in unrealized gains in our bond portfolio. By the end of the first quarter, our total investment portfolio was valued at approximately $6.6 billion, including $46 million for our bond portfolio. Cash flow once again contributed to growth in investment income, with operating activities generating $198 million compared to $354 million in the previous year. Balancing strategic investments with expense management remains a priority. The property casualty underwriting expense ratio for the first quarter was 2.2 percentage points higher than last year, mainly due to increased profit-sharing commission accruals for agencies and related expenses. For loss reserves, we strive for consistency by aiming for net amounts in the upper half of the actuarially estimated range of net loss and loss expense reserves. We consider new information each quarter, including paid losses and case reserves, to update estimated ultimate losses and loss expenses. In the first quarter of 2022, we had $41 million of favorable property casualty development from prior accident years, which improved the combined ratio by 2.5 percentage points. We have seen considerable growth in commercial umbrella coverage within our commercial casualty lines, including a 16% increase in 2021, attributed to strong industry pricing. Although umbrella losses are generally infrequent but severe, we have faced a higher incidence of large losses, particularly for accident year 2019. In light of the increased uncertainty surrounding our umbrella business, we have bolstered reserves for certain accident years and estimated ultimate losses for 2022 at what we consider a prudent level. For the quarter, net reserve development was favorable by $46 million for 2021, $24 million for 2022, unfavorable by $28 million for 2020, and unfavorable by $1 million collectively for accident years prior to 2019. Now, regarding capital management, we continue to maintain a steady approach that includes share repurchases to offset share issuances through equity compensation plans. However, changing circumstances may prompt us to adjust the volume of repurchases. We believe our financial strength at quarter-end is robust and offers significant financial flexibility. In the first quarter of 2022, we repurchased 375,000 shares at an average price of $120.05 per share. As always, I'll summarize the contributions to book value per share for the first quarter. These contributions drive our value creation ratio. Property casualty underwriting increased book value by $0.81, while life insurance operations added $0.06. Investment income, excluding life insurance and net of non-insurance items, contributed $0.53. However, net investment gains and losses for the fixed income portfolio decreased book value by $3.67, and for the equity portfolio, it decreased by $3.33. We declared dividends of $0.69 per share to shareholders. Overall, this resulted in a book value decrease of $6.29 per share for the first quarter, bringing the total to $75.43 per share. Now, I will turn the call back over to Steve.

Thank you, Mike. It's satisfying to see the steady execution of our initiatives producing these strong results. March and April brought a return of business travel and a return of our headquarters associates working together in person. It's wonderful to see so many familiar faces in the hallway and to be able to get out from behind our desk to visit with agents in our field teams across the country. This return to a bit of normalcy has produced an energy you can feel across our organization, bringing with it lots of optimism for the future of Cincinnati Financial. As a reminder, with Mike and me today are Steve Spray, Marc Schambow, Marty Hollenbeck, and Theresa Hoffer. Jesse, please open the call for questions.

I apologize if you covered this. I didn't think I caught it, but there seems to have been a lot of losses above $1 million, like in the $1 million to $5 million range. Is that inflation? Or is that just random noise? Or anything else?

Meyer, this is Steve, and good question. We think it's more in the random noise category for this first quarter. Certainly, we are keeping a close eye on inflation and so forth. But it's one quarter, it was largely in our property lines. And we will continue to keep a close eye on it. We think it was more random noise. And it did reflect about four points on the current accident year when comparing it to that 0.9% increase overall in the current accident year.

That's helpful. For my second question, we've noticed some degree of wage inflation, which seems to benefit workers' compensation premiums. Do you believe the impact on indemnity costs aligns with that trend, or is there a difference between the premium and the effects of rising wages?

Yes. We are monitoring the situation closely because payroll is the basis for workers' compensation exposure, which should benefit the premium side. Additionally, we are considering inflation. We are confident in our workers' compensation book. Even though loss ratios have been increasing due to a competitive industry environment and decreasing NCCI rates, we believe we have effectively managed workers' compensation as a smaller percentage of our overall commercial premium. At the same time, we are focused on supporting agents with what we regard as the best and most appropriately priced risks.

Okay. And if I can throw in one other real quick question. One of the competitors in the high-net worth homeowner space has talked about double-digit loss trends there. Does that match what you're seeing in your book?

No, I don't think we've been seeing double-digit loss trends in our book, no. And we do feel good about the high-net worth book. Thank you. Meyer.

I've got a few questions. So Meyer kind of touched on it a little bit. But I guess the increase in the current accident year loss ratio in the commercial lines segment, is that primarily attributable to the number of large losses in the quarter? Or is there kind of more work beneath the surface there?

Yes. And if we would break the commercial lines segment down, the current accident year rose by 1.2 points, and the effect of large losses on that was 5.1 points. So well more than the amount of the total increase in the current accident year.

There must be some typical large loss load that is included in a normal combined ratio. If your large losses were more typical, would there have been a 2- or 3-point improvement in the accident year loss ratio, assuming everything else was equal?

That's a good question. I don't have that information available right now. We have it, but over time, I can tell you that for the first quarter of 2022, there were 8.6 points in large losses over $1 million for the current accident year. In the first quarter of 2021, it was $3.5 million. The difference is the $5.1 million I just mentioned. I feel, although I don’t have the numbers, that $3.5 million seems more normal.

Got it. Okay. Marc, please proceed.

I'm sorry, this is Steve Spray. I wanted to add that it's standard for us to examine risk categories, geographic areas, policy inception dates, and agency or field marketing territories whenever we encounter a significant loss to identify any trends or patterns. So far, we haven't found any. As Steve mentioned, we believe this is just one quarter, and it's more relevant to analyze the data over a longer timeframe. However, we continuously monitor this situation.

While we still have you, Mark, Dennis, as usual, is quick to help me out with the numbers. In terms of what we're seeing, I could refer you to Page 65 of our K. There, it shows that it's more in the 4% range, which is slightly higher than what I mentioned earlier. For the current accident year losses above $1 million, we have $4.2 million for 2021, $3.6 million for 2020, and 4.6% for 2019. Additionally, for losses over $5 million, the amounts were 1.8, 0.9, and 0.5 million, respectively, which places us more in the 5 to 5.5 range for that.

Okay. That's helpful. It definitely helps clarify what the more normalized run rate might really look like. The second question is, do you have any exposure to the Russian-Ukraine conflict, either through Cincinnati Re or the Cincinnati Global book? I know you’ve historically covered some aviation, but I wasn’t sure if there was anything that might be affected.

Yes, we have experienced a small loss in our CGU, amounting to about $5 million. While this isn't a significant figure for the organization, our thoughts are with the people in Ukraine during this difficult time. For Cincinnati Re, the loss is minimal, and we will continue to monitor the situation. Overall, it's about $5 million for us for the quarter.

Okay. That's helpful. And then last question, I guess, kind of related to the investment portfolio. Do you have a sense of about how much of your portfolio might mature and roll over the course of, say, the next 12 months or the balance of '22? I'm really just trying to get a sense of kind of what portion of the fixed income portfolio will have the opportunity to renew at the relatively higher new money rates that we're all seeing right now.

Yes, Mark. I do actually have that information. So this is looking at the balance of 2022, about 4.4% of the portfolio; '23 6.3%; '24, just 8%; and '25, 9.3%. And book yields on that range from 3.7% up to about 4.5% in 2025.

I had a question on your multiyear policies in commercial. How does that impact your ability to reprice for the inflation we're seeing over the past 3 to 4 months?

Yes, John, Steve Spray. Yes, we're committed to that 3-year policy. We think it's important to our agents and our policyholders. It's consistent with our desire to have long-term relationships. And so when we can get an adequate rate for the risk terms and conditions, we're keen to offer a 3-year policy on our commercial packages. Just so you know on that too, or maybe to give you a little more color, what that does is that really locks in the rate for the property, general liability, crime, and inland marine coverages. And I would say this to you too, is every year, whether it be those policies that are renewing off of a 3-year or the coverages that are subject to annual adjustment, about 75% of our commercial premiums are subject to an anniversary adjustment even with that 3-year policy. Does that make sense?

Yes. I have a 3-year rate that I can adjust based on the change in TIV. This means there will be an annual inflation adjustment.

You can adjust it for an inflation on TIV. Right now, we're running that in the high single digits. Your general liability, which typically has your exposure, has premiums based on gross sales or payroll. As those increase, the premium goes up; it's just that the rate is locked in.

Right. Okay. How much of your portfolio overall is multiyear, if I just think of it crudely in terms of net premium written in commercial?

Yes, it's about 60% of our policy count.

Okay. Then the next question I had, on CGU and then with your new delegated authority of Lloyd's. How much business is that MGA putting through to your own syndicate versus putting through to other syndicates at Lloyd's? I'm just trying to get a sense for how big the that delegated authority business could be. Because, obviously, you have a limit on your capacity at Lloyd's in your syndicate, but if you're writing elsewhere, it would seem that you have a bigger underwriting capability, at least for your agent.

Right. And sure, John. Good question. We're just with our first coverage that we are handling through the delegated authority, and it's a deductible buydown. And for that particular product, and especially given this is our first, it will be for our syndicate. As we look to future and rolling out additional coverages, we would open it up to partnerships with other syndicates over there.

Got it. So I'm asking that a little bit a little bit too far in advance in terms of where you are. And then finally, just one last kind of numbers question. E&S, how much of your E&S business is written with a standard insurance contract? So I was just trying to get a sense of how much your agents are leveraging that platform for the standard commercial product they're also offering?

Yes. John, Steve Spray. About 50% of the time when our E&S company writes coverage, Cincinnati Insurance company writes business on the standard side. So it's a high percentage. It's key to what we do. It works really well for the agents. I could get into a lot of detail, having the same claims rep, having actually having the same resources at Cincinnati Insurance Company for our agents and for those policyholders, whether it's admitted or non-admitted, is a big, big deal, and we're trying to do more and more of it. And you can see with the growth and the profitability in CSU, both have been extremely strong. So we feel really good about where that is going forward.

And then the rest of the book there, that's not wholesale market stuff, right? That's still giving retail agents better access to the E&S market. Is my understanding correct there?

That is correct. CSU, our excess and surplus carrier and wholly owned subsidiary brokerage known as C Super, exclusively provides access to retail agents of Cincinnati Insurance Company for our non-admitted offerings. Our in-house brokerage does not engage in placing business in the wider excess and surplus market. This clarification might address part of your question at the end. We only work with our own non-admitted carrier and exclusively for licensed and appointed agents of Cincinnati Insurance Company.

The strategy is really focused on making things easier for all your agents. It's an agent-centric approach.

Absolutely. Everything we do. Yes, everything we do is agency-centric.

Thank you, Jesse, and thanks to all of you for joining us today. We hope to see some of you at our Annual Meeting of Shareholders on Saturday, May 7, at the Cincinnati Art Museum. You're also welcome to listen to our webcast of the meeting available at cinfin.com/investors. We look forward to speaking with you again on our second quarter call. Have a great day.