Cincinnati Financial Corp (CINF) — Q3 2023 Earnings Call Transcript

Hello. This is Dennis McDaniel at Cincinnati Financial. Thank you for joining us for our third quarter 2023 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; Chief Investment Officer, 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 we discuss 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 results. We are pleased with our operating performance in the third quarter as we again saw improved underwriting ratios for almost every major line of business compared with the first half of this year. The net loss of $99 million for the third quarter of 2023 included recognition of $362 million on an after-tax basis for the reduction of fair value of equity securities still held. We continue to believe the value of our equity portfolio will increase over the long term. As of September 30, it had $5.6 billion in appreciated value. It decreased 8% during the third quarter but has increased 2% since the end of last year. Non-GAAP operating income of $261 million for the third quarter more than doubled last year's $116 million, including a decrease of catastrophe losses of $58 million on an after-tax basis. The 94.4% third quarter 2023 property casualty combined ratio was 9.5 percentage points better than the third quarter of last year, including a decrease of 4.8 points for catastrophe losses. Our 2023 ex-cat accident year combined ratios are also better than '22, improving 3.4 percentage points for the third quarter and 1.7 points on a 9-month basis. Similar to last quarter, we also see signs of positive momentum in operating performance. Pricing segmentation by risk and significant average price increases contributed to the increase in our underlying profit combined with risk selection and other efforts to address elevated inflation effects on incurred losses. On a current accident year basis, measured at September 30, before catastrophe losses, our 2023 consolidated property casualty loss and loss expense ratio improved from 2022 by 4.3 percentage points on a case incurred basis. For the same time period, we increased the incurred but not reported or IBNR component of the ratio by 3.0 points as we continue to recognize uncertainty regarding ultimate losses, remaining prudent in our reserve estimates until longer-term loss cost trends become more clear. Agencies appointed by Cincinnati Insurance are producing profitable business for us, working with associates who provide outstanding service to agents and their clients. Our underwriters are working diligently to retain profitable accounts while managing loans that we determine have inadequate pricing. They are also careful in selecting risks and pricing new business policies. Estimated average renewal price increases for the third quarter continued at a healthy pace. Our Commercial Lines segment again averaged near the low end of the high single-digit percentage range, while our Excess and Surplus Lines Insurance segment continued in the high single-digit range. Personal Lines for the third quarter included auto rising to the low double-digit range and homeowner rising to the lower end of the high single-digit range. We reported 12% growth in consolidated property casualty net written premiums for the quarter. That included an 11% increase in third quarter renewal written premiums, reflecting higher levels of insured exposures in addition to price increases. Considering operating performance by insurance segment, I'll comment on premium growth and how profitability is improving compared to a year ago. Commercial Lines grew net written premiums 5% in the third quarter, reflecting pricing discipline. For example, lower written premiums this year for workers' compensation and commercial umbrella together reduced the third quarter 2023 growth rate for total Commercial Lines by 2 percentage points. The Commercial Lines combined ratio improved by 3.8 percentage points despite an increase of 2.2 points from higher catastrophe losses. Personal Lines grew net written premiums 29% with growth in middle market accounts in addition to Cincinnati Private Client business for our agencies high net worth clients. The combined ratio was 4.6 percentage points better than last year, including 2.0 points for lower catastrophe losses. Excess and Surplus Lines improved its combined ratio by 3.4 percentage points and continue to grow profitably with net written premiums up 6%. Both Cincinnati Re and Cincinnati Global, again enhanced our overall combined ratio and continue to demonstrate risk diversification benefits. Cincinnati Re's combined ratio for the third quarter of 2023 was an excellent 81.0% with net written premiums essentially matching last year's third quarter. Casualty premiums again decreased as we saw fewer attractive opportunities in certain segments of the market. Property premiums increased 24%, largely due to higher pricing while specialty premiums increased 31% due to attractive opportunities in pricing. Cincinnati Global's combined ratio was an excellent 79.5% while reporting strong growth with net written premiums up 21%. Our life insurance subsidiary again performed well, with third quarter 2023 net income up 9% and term life insurance earned premiums growing 2%. I'll conclude with our primary measure of long-term financial performance, the value creation ratio. While our VCR on a 9-month basis is 4.4%, our third quarter 2023 VCR was negative 2.6%. Net income before investment gains or losses for the quarter contributed positive 2.4%, lower valuation of our investment portfolio and other items contributed negative 5.0%. Next, Chief Financial Officer, Mike Sewell, will add his commentary about our financial performance.

Thank you, Steve, and thanks to all of you for joining us today. Investment income again contributed nicely to improved operating results, growing 17% for the third quarter 2023 compared with the third quarter of 2022. Dividend income was up 5% for the quarter, in part due to net equity security purchases for the first 9 months of 2023, that totaled $89 million. Bond interest income continued to show strong growth, up 19% for the third quarter of this year. We added more fixed maturity securities to our investment portfolio with net purchases totaling just over $1 billion for the first 9 months of the year. The third quarter pretax average yield of 4.44% for the fixed maturity portfolio rose 36 basis points compared with last year. The average pretax yield for the total of purchased taxable and tax-exempt bonds during the third quarter for 2023 was 6.4%. Valuation changes in aggregate for the third quarter of 2023 were unfavorable for both our equity and bond portfolios. Before tax effects, the net loss was $463 million for the equity portfolio and $369 million for the bond portfolio. At the end of the quarter, total investment portfolio net appreciated value was approximately $4.4 billion. The equity portfolio was in a net gain position of $5.6 billion while the fixed maturity portfolio was in a net loss position of $1.2 billion. Cash flow continued to boost investment income, adding to the benefit of rising bond yields, cash flow from operating activities for the first 9 months of 2023 was nearly $1.5 billion, up $54 million from a year ago. We always strive for our expense management efforts to strike an appropriate balance between controlling expenses and making strategic investments in our business. The third quarter 2023 property casualty underwriting expense ratio was 0.6 percentage points higher than last year, primarily due to an increase in associate and travel-related expenses. On a 9-month basis, it was 0.4 points lower. Moving on to loss reserves. Our approach consistently aims for 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 an updated estimated ultimate losses and losses expenses by accident year in line of business. For the first 3 quarters of 2023, our net addition to property casualty loss and loss expense reserves was $655 million, including $539 million for the IBNR portion. During the third quarter, we experienced $53 million of property casualty net favorable reserve development on prior accident years that benefited the combined ratio by 2.7 percentage points. On an all lines basis by accident year, net reserve development for the first 9 months of 2023 included favorable $123 million for 2022, $7 million for 2021, $72 million for 2020 and $11 million in aggregate for accident years prior to 2020. In terms of capital management, we also have a consistent long-term approach. During the third quarter of 2023, we paid $115 million in dividends to shareholders. We did not repurchase any shares. Our assessment of our financial flexibility and our financial strength is that both are in excellent condition. 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 increased book value by $0.56. Life insurance operations increased book value, $0.73. Investment income, other than life insurance and net of noninsurance items added $1.04. Net investment gains and losses for the fixed income portfolio decreased book value by $1.86. Net investment gains and losses for the equity portfolio decreased book value by $2.33. And, we declared $0.75 per share in dividends to shareholders. The net effect was a book value decrease of $2.61 per share during the third quarter to $67.72 per share. Now I'll turn the call back over to Steve.

Thanks, Mike. I'm proud of the way our associates continue to help the independent agents who represent Cincinnati Insurance navigate this challenging market. We're sticking to our fundamentals, listening, offering solutions, and building strong relationships. Because our field associates live in the communities our agents serve, we see and respond quickly to market pressures most impacting them. We are then able to find solutions that contribute to our agent success, leading to long-term shareholder value. As a reminder, with Mike and me today are Steve Spray, Steve Soloria, Marc Schambow, and Theresa Hoffer. Gary, please open the call for questions.

Can we start off by discussing the 193 new agent appointments this year? How long does it typically take for them to reach some minimum level of premium on a per agent basis? Alternatively, what production targets do you have in mind for the new agents? Also, can you clarify your comments regarding the agents who are focusing solely on Personal Lines?

Yes, Greg, this is Steve Spray. It really depends agency by agency. One thing I think as a company, we've always prided ourselves on is we do business with the best independent agents out there. And we are very deliberate about the agencies we appoint. We spend a lot of time making sure that it's a fit for both us and the agency. So when we go into a relationship, we feel pretty confident that we're aligned and that the future will bear fruit. It just depends on the size of the agency, maybe the state and community but over time, we are the #1 or #2 carrier as measured by premium volume in the majority of the agencies we do business with for at least 5 years or more. So that gives you a little flavor of the trajectory that we have. And so it just depends but we don't want to be just an inconsequential player in any agency.

I believe you mentioned in the press release that a portion of those figures were related to Personal Lines only. Was that focused on specific regions? Can you provide more details on that?

Yes, sure, Greg. Sorry, you asked that. Typically, Personal Lines only agencies will be private client or high net worth focused agencies to where maybe as an example, let's say, in the state of California, we're not active there for Commercial Lines right now. So if we make an agency appointment in California would be Personal Lines only, and it would be high net worth or private client-focused.

Got it. All right. I guess pivoting to the commercial lines side of the business. If we look at new business trends in your commercial, it's kind of flattish the last couple of quarters. And by the way, we've heard some other carriers talk about pockets of increased competition. Maybe you can give us some perspective inside your book of commercial, where you're seeing some headwinds from competition and where you're seeing some opportunities?

Yes, Steve Spray, Greg. The new business you mentioned focuses on underwriting discipline, pricing segmentation, and the consistent approach from our field underwriters regarding pricing. The market is always competitive and differs by state and territory, depending on our competitors. However, our proven strategy of selecting the best agents, assigning field associates to those agencies, and making local decisions has been effective for us over the long term. Over the past decade, the accuracy in pricing, the segmentation, and the tools at our disposal have significantly contributed to our profitability. Our new business underwriters are collaborating with our agents in the field to implement this disciplined strategy, which has exerted some pressure on new business this year. Nonetheless, as the commercial market has experienced some disruption this year, we are witnessing more opportunities in underwriting terms, conditions, quality, and pricing that we find satisfactory.

Okay. The final question is about Personal Lines. Your results for the quarter show you're performing well compared to the rest of the market, and there's significant growth in new business written. Could you provide an updated perspective on the trends in your Personal Lines business, particularly in auto and property? If possible, please separate the two.

Sure. First of all, we are pleased and encouraged by the improvement in our core loss ratio in Personal Lines. We are experiencing some pressure due to inflation and increased catastrophe levels, but we are confident that we will achieve adequate rate increases moving forward. Approximately 55% of our Personal Lines business is classified as private client, while about 45% is middle market. This is essential for our agency model, allowing us to be a preferred carrier for our agents regardless of the home's size. Our local, fast, and empathetic claims handling places us in a strong position for future growth in all Personal Lines. Despite the loss ratio pressures from inflation and heightened catastrophe activity, we remain optimistic about our direction. There are numerous opportunities and disruptions in the Personal Lines market. Honestly, I've never encountered a more challenging market than what we see in Personal Lines today. With our solid balance sheet, agency strategy, expertise, and precise pricing, we believe we are well-positioned for future growth in this segment.

I want to revisit the topic of growth and risk selection, specifically for Commercial Lines. When I take a step back, I notice that Cincinnati Financial's pricing power is quite comparable to many of your competitors, yet your overall growth rate is significantly lower than your historical performance in relation to the industry. You've mentioned several times that you're adjusting your appetite for risk, which isn't surprising at this point. However, I'm curious about whether you're actually losing business due to pricing, since your pricing levels align with those of your peers. Alternatively, is there a possibility that for certain lines, you're raising casualty rates more than the average? Also, has your fundamental risk selection process changed? Are you now less willing to take on specific risks or actively trying to exit certain risks? I'm interested in understanding your current positioning on this journey and whether your growth rate will return to past levels compared to the industry if your appetite shifts.

Yes. Mike, Steve Spray again. Steve Johnston mentioned in his opening remarks about the net written premium aspect of Commercial. To start, we are experiencing a two-point drag on Commercial Lines due to workers' compensation and umbrella or excess, both for different reasons. Workers' compensation is about a one-point drag that has persisted for several years, primarily because of the rate decreases being implemented across the industry. The situation with the umbrella is more deliberate, as it began over a year ago in Commercial Lines. In certain jurisdictions and states, we have taken aggressive and appropriate underwriting actions on our umbrella book by reducing limits and, in some cases, shedding some of that business. This is also affecting our Commercial Lines growth. Regarding your comment about returning to historical levels or stepping back from other business, I believe we have a winning strategy. Our model, which focuses on local business relationships with the best agents and face-to-face interactions, has proven successful for many years. Our risk selection, claims handling, and loss control have all consistently improved since I joined the company 32 years ago. Our pricing precision and segmentation have significantly enhanced over the last decade. We now have better tools, unlike when I was a field representative 15 years ago. Our field and renewal underwriters use these tools to ensure that if we cannot achieve an acceptable rate on a risk-adjusted basis, we will walk away from that account and wait for better opportunities. Our priority is maintaining an underwriting profit, and we have achieved 11.5 consecutive years of underwriting profit, which we aim to continue. I am not concerned about long-term growth at Cincinnati Insurance Company. We are actively pursuing agency appointments and have ample opportunity to continue that growth. Our E&S company is expanding, and while the situation in Personal Lines is evolving, I do not worry about our growth potential moving forward.

That's a comprehensive and useful response. My follow-up question is about your strategic moves to increase IBNR. You've mentioned greater uncertainty regarding the loss cost trend environment. Additionally, you've indicated that growth may be slightly slower. Would it be reasonable to say that Cincinnati anticipates a higher loss cost trend going forward compared to one or two years ago? Is that an accurate assessment?

Greg, this is Steve Johnston. And I think what we've seen was kind of a rapid acceleration of inflation starting at the beginning of 2021. It is now in the last several months moderated, still going up, but moderated. I think just with the way that we time our rate increases in rolling on to the book, it takes a little while for them to actually reach all the policyholders. But the key point, I think, is that we are very prospective in terms of the way we look at inflation. The most important thing we can do is to look out into the prospective policy periods that we're pricing for right now, do our best to estimate the loss costs and the inflation impact on that prospective period and set the pricing right and do it on an individual policy-by-policy basis the best we can. And I think we're in a good position to continue doing that.

Okay. So you clearly feel it sounds like pricing is in excess of loss trend, knock on wood, if everything plays out. If you don't agree with that...

I would agree with that.

Looking at kind of results line by line in the Commercial segment, it seemed like quite a few saw year-over-year improvement but the workers' compensation line sticks out a little bit kind of the second quarter in a row where we've seen a decent bit of pressure on the underlying loss ratio. I was just curious if we could get more color on what's going on there. I mean, obviously, you've referenced the pricing pressure for that book. But we've also heard some other peers talk about concerns regarding medical inflation. And if you all could just give us some more color on what's happening there?

Yes, Grace, this is Steve Spray. Thank you for your question. The combined ratio for the accident year and the loss ratio for workers' compensation are indeed under pressure. However, the calendar year is still performing well. I apologize for repeating myself, but we are facing downward pressure on the rates set by the rating bureaus. Fortunately, at Cincinnati Insurance Company, we have maintained a conservative approach regarding the workers' compensation line. We possess considerable expertise and are prepared to grow that business when the pricing becomes attractive. Currently, we are evaluating each risk individually and are actively pursuing new workers' compensation business. However, as you noted, medical inflation can have a long-term impact. At this moment, I don't see anything unusual regarding medical inflation, but this line of business is certainly under pressure in terms of accident year results, primarily due to rate pressure.

On Cincinnati Re, you mentioned reducing casualty premiums in that book for a couple of quarters now. We've also noticed more players in the market expressing concerns over casualty loss cost trends recently. I'm curious if you believe there's anything particularly new happening in casualty reinsurance or if the recent comments are surprising to you. Additionally, do you think opportunities in property, specialty, etc., will outweigh any ongoing pressure on the casualty part of that book, allowing it to return to growth next year?

Thank you, Grace. Really good question. And I think it boils down to our model at Cincinnati Re and that we didn't really actually form a company Cincinnati Re. It writes on Cincinnati Insurance paper. So there's the A+ quality there. And then it's an allocated capital model. So what we try to do is just look at every contract as it comes up. We don't try to do things this much in property, this much in casualty this much in specialty. Just look at each contract that becomes available to us on its own merits and if we can get the target hurdle rate that we're looking for and feel good about how it fits into our overall risk model, we'll go ahead and write that. So I would think that we will see movements in the various business lines that reflect that. I think right now, just what we're seeing is certain lines like professional liability, transactional liability, and so forth are areas where we felt that the pricing and sometimes the opportunity are not as good as they've been in the past, where we are seeing really good opportunity in the property and specialty lines. So we'll just go at that contract by contract and very bullish with everything that Cincinnati Re is bringing to us in terms of profitability and diversification.

Great. Two questions on Personal Lines. First, is there any appreciable difference in the profitability of private clients and middle market?

We are not currently disclosing the difference in loss ratios between our specific segments of middle market and high net worth or private clients. However, I can tell you that historically, the private client segment has significantly outperformed the middle market. We believe we can achieve similar outcomes over time, although we don't intend to subsidize the middle market. It is essential for the middle market to be self-sufficient, and we have the right pricing and agency support in place. We expect both segments to be profitable, but we anticipate that over time, the high net worth and private client segment will continue to outperform.

Okay. That's very helpful. I completely understood. Second question, a couple of companies have talked about moderating rent cost inflation, specifically for auto physical damage. And I was wondering whether you're seeing that in the third quarter as well?

We have seen it in just certain areas within physical damage. As we look at replacement vehicles, rental cars, that sort of thing. But again, we're still kind of looking at inflation on how it's been cumulatively since 2021 as we use that data to forecast the loss cost and the premium needed in the prospective periods. And so we're being cautious, I think, in terms of where we are with our inflation rates, but we do feel that we're getting ahead of our loss cost trends. We are ahead of our loss cost trends with our pricing. And I think we benefited from that while we had a stay-at-home credit during 2020. We did not actually decrease the auto rates. And I think that's helping us now as we contemplate inflation and our pricing.

I got a call last night from a lady pushing 90, thanking me for Cincinnati Financial and I told her that I would refer that today on the phone on the conference call, and she didn't even know you had one. But the question is battery-operated vehicles of all types, has that changed the pricing of insurance, replacement costs, and accidents? Do you have any comments you can share?

Yes, Fred, this is Steve Johnston. We need to ensure we consider the associated costs as we increase the number of electric vehicles in our fleet, as this will lead to higher battery costs. They are, in my opinion, less complex with fewer parts involved, so it is a different scenario. However, it will be a challenge to manage these costs as we adjust our pricing, but we are confident we can handle it. Also, please thank your friend for reaching out to us; we appreciate the feedback.

Well, thank you. The battery-operated cars I have people in the farming business with pickup trucks and other machinery, and they say it's not an easy thing to work with. And they'll ask the question about insurance soon so thank you for the best you do. I really appreciate it.

Well, thank you, Fred. It's always good to hear from you.

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