Cincinnati Financial Corp (CINF) — Q3 2022 Earnings Call Transcript

Hello. This is Dennis McDaniel of Cincinnati Financial. Thank you for joining us for our third 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 and Chief Executive Officer, Steve Johnston; and then from Executive Vice President and 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 President, Steve Spray; Senior Vice President of Investments, Steve Soloria; and Cincinnati Insurance's 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. Good morning and thank you all for joining us today to hear more about our third quarter results. In addition to market volatility affecting the valuation of our investment portfolio, elevated inflation and natural catastrophe events affecting the industry also continued to pressure our property casualty insurance results. We remain well-positioned to improve performance through ongoing focus on successfully executing profitable growth strategies for our insurance operations similar to how we have managed past challenges. Our financial strength provides us the ability to maintain a long-term view, keeping a steady approach that can benefit all stakeholders. We reported a net loss of $418 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 of $114 million for the third quarter of 2022 was down $95 million from a year ago, including catastrophe losses that were $19 million higher on an after-tax basis. Our 103.9% third quarter property casualty combined ratio was 11.3 percentage points higher than the 92.6% for the third quarter of last year. Inflationary pressures led to higher estimated ultimate losses in rising loss ratios on a current accident year basis. While we experienced another quarter of favorable development on prior accident years, it was less favorable than a year ago. We continue to respond with underwriting selection and pricing actions in addition to prudent reserving for estimated ultimate losses. In addition to various premium rate increase filings with the states, underwriters have increased expectations to address current inflationary trends in areas such as risk selection criteria, pricing of policies, and adjusting premium factors for changes in exposure. Commercial umbrella loss experience has been elevated in recent quarters, and it's challenging to determine relevant drivers given unusual business activity and general uncertainty as the pandemic waned. For example, the third quarter of 2022 included three very large claims with estimated losses averaging $9 million each, while elevated losses during the second quarter were driven more by a higher frequency of smaller claims. We continue to carefully underwrite commercial umbrella risks and respond promptly to adequately reserve for emerging loss patterns, which we expect will eventually lead to a return of profitability for our commercial umbrella business. Overall, premium growth was strong. It included average renewal price increases for each of our property casualty insurance segments. Cincinnati Insurance appointed agencies continued their outstanding production and our underwriters are focused on working to retain and grow profitable accounts, while addressing areas where they judge pricing is not adequate segmenting opportunities on a policy by policy basis. Consolidated property casualty net written premiums rose 14% for the third quarter of 2022. That included a 12% increase in third quarter renewal written premiums including 11% each for our commercial lines and personal lines insurance segments. Higher renewal premiums included healthy increases for higher levels of insured exposures that are rising faster due to elevated inflation amounts. For example, our commercial property premium adjustments for rising costs of building materials so far this year are about double the level of last year. In addition to exposure increases, our commercial lines insurance segment continue to experience estimated average renewal price increases in the mid-single-digit percentage range, somewhat higher than the second quarter. Our excess and surplus lines insurance segment continued in the high-single-digit range, also higher than the second quarter. Personal lines average renewal price increases remained in the low-single-digit range with auto a little higher and homeowner a little lower than the second quarter. Personal auto insurance for the industry, including our book of business, generally needs higher premium rates to achieve profitability. Based on our rate filings that average low double-digit rate increases for policies effective beginning January 1, 2023, we expect the full-year 2023 personal auto written premium effect will be an average premium rate increase of approximately 10%. The commercial line segment grew third quarter 2022 net written premium by 10% with the combined ratio of 99.0%, reflecting elevated inflation effects and catastrophe losses 1.2 percentage points higher than a year ago. For our personal line segment net written premium grew 15%, mostly from our continued planned expansion of high net worth business produced by our agencies. Its third quarter combined ratio of 104.5% also reflected elevated inflation effects, while the catastrophe loss ratio was 4.1 percentage points lower than last year's third quarter. Our excess and surplus line segment had a 93.9% combined ratio and continued healthy growth with a third quarter 2022 net written premiums increase of 16%. Cincinnati Re and Cincinnati Global each experienced significant catastrophe losses from Hurricane Ian that drove their underwriting loss for the quarter. We expect catastrophe losses of that magnitude from time to time. Our estimate as of September 30 was within our expectations of loss potential for events of Ian's magnitude based on our models. Results of modeled effects estimating probable maximum losses are disclosed in our Annual Report on Form 10-K. Cincinnati Re grew third quarter 2022 net written premiums by 51%, while Cincinnati Global grew 21%, each having what we believe are good prospects for future profitability. Our life insurance subsidiary continued to perform quite well along with growth in term life insurance earned premiums of 4% that produced third quarter 2022 net income of $21 million and nearly tripled operating income of a year ago. We continue to use the value creation ratio as our primary measure of long-term financial performance. VCR was negative 8.4% for the third quarter of 2022. Net income before investment gains or losses made a positive contribution, but was again offset by lower investment valuations during the quarter. Next, Chief Financial Officer, Mike Sewell, will highlight several other points we consider important regarding our financial performance.

Thank you, Steve, and thanks to all of you for joining us today. Investment income growth continued at a rate of 8% for the third quarter of 2022, compared with the third quarter of last year. Dividend income rose 8% for the quarter. Net equity securities purchased during the first nine months of 2022 totaled $47 million. Bond interest income grew 7% in the third quarter. The pre-tax average yield of 4.08% for the fixed maturity portfolio was 2 basis points higher than a year ago. The average pre-tax yield for the total of purchase taxable and tax exempt bonds continue to rise reaching 5.39% during the third quarter of 2022. We again purchased additional fixed maturity securities with net purchases totaling $534 million during the first nine months of the year. Valuation changes for our investment portfolio during the third quarter of 2022 were unfavorable in aggregate for both our stock and bond holdings. The overall net decrease was approximately $1.2 billion before tax effects, including an additional $514 million of unrealized losses in our bond portfolio. At the end of the quarter, total investment portfolio net appreciated value was approximately $3.5 billion. The equity portfolio was in a net gain position of $4.5 billion, while the fixed maturity portfolio was in a net loss position of just under $1.1 billion. Cash flow continues to fuel growth of investment income. Cash flow from operating activities for the first nine months of 2022 generated $1.4 billion compared with $1.5 billion a year ago. Regarding expense management, we continue to apply what we see as the appropriate balance between expense control and strategic investments in our business. The third quarter 2022 property casualty underwriting expense ratio was 1.3 percentage points lower than last year. Most of the decrease was from lower accruals for profit sharing commissions for agencies. Next, I'll comment on loss reserves. We continue to use a consistent approach that targets net amounts in the upper half of the actuarially estimated range of net loss and loss expense reserves. As we do each quarter, we consider new information such as paid losses and case reserves, and then updated estimated ultimate losses and loss expenses by accident year and line of business. In the first three quarters of 2022, our net addition to reserves was $814 million already exceeding the full-year amounts for both 2021 and 2020. We think that's a strong indication of the quality of our balance sheet. During the third quarter 2022, we experienced $43 million of property casualty net favorable development on prior accident years that benefited the combined ratio by 2.4 percentage points. On an all lines basis by accident year net reserve development for the first nine months of 2022 was favorable and included $94 million for 2021, $95 million for 2020 that was partially offset by unfavorable $46 million in aggregate for accident years prior to 2020. While we've recently reported significant unfavorable reserve development on prior accident years for our commercial casualty lines of business, the net $25 million for the first nine months of 2022 included $41 million for the commercial umbrella and net favorable amount was $16 million for other coverages included in commercial casualty. Moving on to briefly highlight our consistent approach to capital management, we again repurchased shares that include maintenance intended to offset shares issued through equity compensation plans. Importantly, we continue to believe we have plenty of financial flexibility and also believe that our financial strength remains in excellent shape. During the third quarter of 2022 we repurchased just under 2.1 million shares at an average price per share of $98.50. As usual, I'll conclude with a summary of third quarter contributions to book value per share. They represent the main drivers of our value creation ratio. Property casualty underwriting decreased book value by $0.12, life insurance operations increased book value $0.14. Investment income other than life insurance and net of non-insurance items added $0.42. Net investment gains and losses for the fixed income portfolio decreased book value per share by $2.58. Net investment gains and losses for the equity portfolio decreased book value by $3.46. And we declared $0.69 per share in dividends to shareholders. The net effect was a book value decrease of $6.29 per share during the third quarter to $60.01 per share. Now, I'll turn the call back over to Steve.

Thanks Mike. Our fundamentals are strong and we have an excellent book of business curated from our agencies' best accounts. We clearly communicated across the organization the steps we need to take to improve challenged areas of our business and our underwriters are focused and aligned to those goals. Our financial strength remains excellent and allows us to keep concentrating on our long-term strategies and objectives of remaining a steady insurance market and producing shareholder value far into the future. As a reminder, with Mike and me today are Steve Spray, Steve Soloria, Marc Schambow, and Theresa Hoffer. Anthony, please open the call for questions.

Thank you and good morning. I wanted to ask for some additional insight into the decline in the accident year, particularly in commercial and excess and surplus lines, excluding the umbrella segment. Can you explain what factors are contributing to this, whether it's primarily related to inflation or if there are other considerations we should be aware of?

Hey Paul, good morning. This is Steve Spray. Let me address the E&S portion first. I would say that this segment is approximately 90% driven by casualty, which brings an inherent level of variability. E&S casualty is a severity-focused business, so expect fluctuations from quarter to quarter. It’s more insightful to evaluate it over an extended timeframe, and over the past nine months, it's clear that this segment continues to perform well. The E&S Company has achieved a combined ratio of 90 or better for nine consecutive years and is also performing well thus far this year. However, similar to what we are observing in the primary commercial business, there are inflationary pressures within the casualty segment, and we are taking prudent reserves to account for that.

And maybe on the regular commercial business, is there anything in there other than pure just general inflation?

Yes. I think it's general inflation. I think its businesses getting back to normal post-COVID or post-pandemic. And I think a lot of what we're seeing in the casualty book, the inflationary pressure is primarily on that commercial umbrella line.

Could you provide some insight into the overall cat exposure? It has been higher than usual over the past few years. I noticed that there's a significant amount of cat exposure reported by both Cincinnati Re and Cincinnati Global. How should we view the cat loss moving forward? Are the experiences we've seen in recent years a reasonable expectation? Is this aligned with the decisions made by Cincinnati? Historically, cat loss and claims have been relatively low, but it appears that the figures have shifted from about 4 to 7 to somewhere between 7 and 12. How should we approach this prospectively?

Paul, this is Steve Johnston. I believe we have a robust risk management process in place. We model various specific risks and find ourselves in a strong position concerning property pricing related to catastrophe exposure. Prices have already started to rise and are expected to continue their upward trend. Looking at CGU, our Lloyd's Syndicate has performed well, ranking in the top quartile among underwriters over the past two years. Even considering catastrophe events, their combined ratio has remained under 100 for the first nine months, along with significant rate growth. Additionally, they are diversifying into areas outside of property. Similarly, Cincinnati Re, which we started from the ground up just a few years ago, has built a skilled team that comprehensively understands risks both quantitatively and qualitatively. We are optimistic about the rate opportunities that lie ahead as we approach year-end renewals and into next year. We feel confident about our property and catastrophe-related exposures. We even include high net worth in this consideration, as it carries slightly more risk. However, due to our underwriting approach, the quality of the homes we underwrite, and the potential for increased rates, we are very confident in achieving strong rate hikes across all these sectors.

That's great. My question is whether this is an underwriting choice influenced by a couple of years with elevated catastrophe events due to moving into more property or if this is simply an anomaly for the past couple of years.

Well, I think our actual cat losses over the last couple of years have really not been that outsized. We've been in a position where years ago before we went into more diversification of our book a year with a heavy cat loss like this could put us over 100%, and did, if you look back to 2011 in those type of years. And now with, I think a better spread of risk; we can take body blows like this. We're still under 100% year-to-date and feel that we are bullish about the fourth quarter towards taking our streak of sub-100 combined ratios to 11 consecutive years. And I think over those, that time period, we've outperformed the industry on a combined ratio basis by about 5 points, and we've been growing at about half again the rate, this is in total, which puts us in a good position to invest well. And as you've seen with the investment income as Mike described, pre-tax up 9% year-to-date. Amongst that, dividend increase is up 13%. The equity portfolio has outperformed the S&P 500, both on a year-to-date basis and on a five-year trailing that drives our cash flow. And if you would look at our cash flow over time, it really has increased. If we would go back to 2012, our cash flow from operations was $247 million. It's increased very steadily ever since then up to about $1.1 billion in the 2016, 2017 time period up to nearly $2 billion a year ago. As Mike mentioned, we're at $1.4 billion through nine months compared to $1.5 billion. Excuse me, so that's our strategy, Paul, is we're going to grow over the long pool, as Steve mentioned, we think above the industry rate. We're going to do it with a combined ratio that is better. We're going to provide overwhelming claim service. We're going to invest well, both with our fixed income and our equity portfolio. Generate a lot of cash that we can then return to shareholders as we've done with our dividends by increasing them some 62 years in a row. We're going to continue to have a strong balance sheet as our reserves have developed favorably, I think, 33 years in a row. That's just our basic strategy over time is to steadily execute our strategy, and we think it will deliver value for our shareholders for a long time to come.

Hey guys, good morning. So I just piggybacking off the last question. So it sounds like from your answer, if we think about the outlook for Cincinnati Re into 2023. It feels like your appetite remains focused towards growth and the Cincinnati Re's results over the last couple of years or, I guess, I don't want to put words in your mouth, but you're okay with those results and kind of no change in strategy there.

I anticipate significant rate increases. It's important to note that only about one-third of the Cincinnati Re premiums, which total just over $0.5 billion through nine months, are property. Another half are casualty, and the remaining one-sixth are specialty. We will carefully evaluate how we allocate capital in the property sector relative to the pricing we expect on a risk-adjusted basis for the contracts and policies available to us. Cincinnati Re is currently performing just over 100, around 103 inception to date. Given the challenges in the reinsurance market during that time, I'm not disappointed with this performance. We have successfully built a strong team without incurring extra costs and are now well-positioned to take advantage of the market as prices firm, doing so on a risk-adjusted basis.

I guess just curious if Cincinnati Re gives you guys some diversification, but is the combined ratio target for Cincinnati Re meaningfully lower than the company-wide range?

Yes. It's lower than the company range, yes.

Okay, great. Switching gears to commercial casualty, I appreciate your honesty about the unusual activity this quarter, which featured larger claims compared to prior quarters with some smaller claims. It seems there won’t be a significant post-pandemic shift, hopefully, and you're attributing it to a normalization and some unusual trends over the last couple of years. It appears you’re not planning to make any significant changes to terms and conditions or rethink multi-year policies. It sounds like you’re maintaining a steady approach, taking some rate adjustments but not implementing broader changes in response to the unusual trends from the past few quarters.

We are going to take strong action. It's important to acknowledge that our umbrella book experiences inherent volatility. In 2019, our paid losses for umbrella increased by 80%. In 2018 and 2020, however, they decreased by 35%. This indicates there will be some variability. We are fully committed to addressing this, and I believe Steve Spray can provide more details on our specific plans for umbrella.

Yes. Thanks, Steve. Good morning again, Mike. I want to assure you that we are actively addressing the umbrella book. As Steve mentioned, it represents a significant portion of our business, exceeding $500 million. We have a long history of successfully managing umbrella policies and possess substantial expertise in this area. We are confident in this line of business, which has delivered strong performance. From 2017 to 2021, our umbrella excess book consistently had combined ratios below 80. While we are experiencing inflationary pressures, as noted by Steve in his remarks and in our quarterly report, the book requires rate adjustments. We are implementing specific rate increases for the umbrella and also benefiting from changes in underlying exposures, as umbrella pricing is tied to general liability and auto policies. We closely analyze every major loss to identify any trends related to geography, business segments, or agency representatives and have found no concerning trends. Our commercial umbrella is mainly influenced by underlying commercial auto losses, which can impact the umbrella coverage. As Steve indicated, we are fully committed to risk selection, pricing strategies, and evaluating our capacity allocation across different jurisdictions and market segments. This is a discipline we have maintained for a long time, and I am confident in our ability to restore profitability. We have made careful reserving decisions in light of the uncertainties we face. As Steve said, we are all working together on this.

That's very helpful. I have another question regarding personal lines. We can analyze the data, but it's important to note that you have more of a super-regional focus compared to some national competitors, and it seems you've been taking slightly less rate than many peers over the last year. You've mentioned in recent quarters that you plan to start increasing rates in personal lines, particularly in auto. I'm curious, when you talk with your agents, do you anticipate this will affect your top-line growth? Will it alter your near-term strategy? Also, do you think some of the business you've written over the last year may not be very profitable, but you believe you are playing the long game, particularly in the high net worth sector, and that over time, you'll exceed your cost of capital? Thank you.

Yes, that's a great question, Mike. I'll do my best to cover everything in my answer, and please feel free to ask for clarification if needed. Currently, we have an even split between high net worth and middle market. Our middle market business has faced challenges for several years due to necessary rate adjustments, and in some states, we've had to be quite aggressive with those changes. This has put pressure on the growth of our middle market personal lines, which is still feeling that pressure. However, we believe we have reached the lowest point. In fact, new business in the middle market for personal lines has shown improvement this year. The personal auto sector has performed well over the last three years, although we are indeed facing inflationary pressures this year. This is what Steve referred to regarding the rates we plan to implement in 2023. The high net worth segment is performing exceptionally well, and historically, it has outperformed middle market personal lines. The last few years have been challenging for the industry, especially with catastrophic events, but we believe we are well-positioned in the personal lines market at this time. Our 50:50 balance is unique and sets us apart in the market, which our agents appreciate. We are also becoming more sophisticated and targeted in our pricing strategies. As a result, the outlook for personal lines moving forward looks very promising.

You got everything in there. Thank you.

Okay. Thanks, Mike.

Thanks, Mike.

Hey, good morning. This is actually Sid on for Greg. We've got a couple of questions on the reserve charges in commercial casualty and commercial auto. So hoping maybe you could unpack that for a minute and provide any additional information.

Sure. Let me start by saying that for the quarter, we experienced favorable development of $43 million, which translates to 2.4 points for the quarter. Over the past few years, we've generally seen favorable development in the range of 2.5 to 5 points. This quarter is on the lower end of that range but still within it. Breaking it down further, every line showed favorable development except for commercial casualty and auto, both commercial and personal. The commercial casualty for the quarter was unfavorable by $23 million, with $16 million of that tied to commercial umbrella. We did see some reserve strengthening for the accident years of 2021 and 2020 during this quarter, although for older accident years concerning commercial umbrella, the results were favorable. Looking at the year-to-date figures, we have a total favorable development of $143 million. Commercial casualty on a year-to-date basis was unfavorable by $25 million. Diving into those numbers, the umbrella was unfavorable by $41 million, while the other segments of commercial casualty were favorable by $16 million. Across accident years, commercial casualty was favorable for both 2021 and 2020 but unfavorable for 2019 and prior years. I would also note that commercial auto and personal auto both were unfavorable on a year-to-date and quarterly basis, with the unfavorable development mainly in 2019 and earlier accident years, while being favorable for accident years 2021 and 2020. That covers a lot of numbers, and I hope this clarifies the details. If there are any further questions or if anyone else would like to add, please feel free to do so. Thank you.

Good morning. I wanted to quickly ask about the commercial umbrella. You provided some good details on that, and you noted that this quarter was more about severity issues compared to the frequency in the second quarter. Can you explain how significant the difference in frequency was between the second and third quarters? Also, was the severity primarily due to adverse litigation in that segment?

I don't have the exact frequency numbers. There was less frequency in the third quarter. I wouldn't necessarily categorize it as litigation; rather, we're receiving some claims and considering how to set the reserve. These claims are larger than what we had in the second quarter. We're just trying to clarify that the second quarter was driven more by frequency for commercial umbrella, while the third quarter was more about severity.

Thank you, Anthony, and thanks to all of you for joining us today. We look forward to speaking with you again on our fourth quarter call.