þ | ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934. |
o | TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934. |
Ohio (State of incorporation) | 31-0746871 (I.R.S. Employer Identification No.) |
Fairfield, Ohio 45014-5141
(Address of principal executive offices) (Zip Code)
(Registrant’s telephone number, including area code)
None
Securities registered pursuant to Section 12(g) of the Act:
$2.00 par, common stock
(Title of Class)
6.125% Senior Notes due 2034
(Title of Class)
6.9% Senior Debentures due 2028
(Title of Class)
6.92% Senior Debentures due 2028
(Title of Class)
on Form 10-K for the Year Ended December 31, 2005
• | We cultivate relationships with the independent insurance agents who market our policies and we make our decisions at the local level |
• | We achieve claims excellence, covering the spectrum from our response to reported claims to our approach to establishing reserves for not-yet-paid claims |
• | We invest for long-term total return, using available cash flow to purchase equity securities after covering insurance liabilities by purchasing fixed-maturity securities |
2005 10-K Page 31
(Dollars in millions except share data) | 2005-2004 | 2004-2003 | ||||||||||||||||||
2005 | 2004 | 2003 | Change % | Change % | ||||||||||||||||
Income statement data | ||||||||||||||||||||
Earned premiums | $ | 3,164 | $ | 3,020 | $ | 2,748 | 4.8 | 9.9 | ||||||||||||
Investment income, net of expenses | 526 | 492 | 465 | 6.9 | 5.7 | |||||||||||||||
Net realized gains and losses (pretax) | 61 | 91 | (41 | ) | (33.1 | ) | 321.7 | |||||||||||||
Total revenues | 3,767 | 3,614 | 3,181 | 4.2 | 13.6 | |||||||||||||||
Net income | 602 | 584 | 374 | 3.1 | 56.0 | |||||||||||||||
Per share data (diluted) | ||||||||||||||||||||
Net income | 3.40 | 3.28 | 2.10 | 3.7 | 56.4 | |||||||||||||||
Cash dividends declared | 1.205 | 1.04 | 0.90 | 16.1 | 14.4 | |||||||||||||||
Weighted average shares outstanding | 177,116,126 | 178,376,848 | 178,292,248 | (0.7 | ) | 0.0 |
• | The consolidated property casualtyunderwriting profitimproved substantially in 2004 and we sustained healthy profitability in 2005. The factors behind the improvement are discussed in the Results of Operations. |
• | Realized investment gains and lossesare integral to our financial results over the long term. We have substantial discretion in the timing of investment sales and, therefore, the gains or losses that will be recognized in any period. That discretion generally is independent of the insurance underwriting process. Also, applicable accounting standards require us to recognize gains and losses from certain changes in fair values of securities and embedded derivatives without actual realization of those gains and losses. Security sales led to realized gains in 2005 and 2004 while write-downs of impaired assets led to realized losses in 2003. |
o | 2005 — Realized investment gains raised net income by $40 million, or 23 cents per share, after tax | ||
o | 2004 — Realized investment gains raised net income by $60 million, or 34 cents per share, after tax | ||
o | 2003 — Realized investment losses reduced net income by $27 million, or 15 cents per share, after tax |
• | Weighted average shares outstandingmay fluctuate from period to period because we regularly repurchase shares under board authorizations and we issue shares when associates exercise stock options. At year-end 2005, weighted average shares outstanding on a diluted basis had declined 1.3 million from year-end 2004. |
• | In 2003, we recovered $23 million pretax from a settlement negotiated with a vendor. The recovery added $15 million, or 8 cents per share, to net income. The negotiated settlement related to the $39 million one-time, pretax charge incurred in 2000 to write off previously capitalized software development costs. |
(Dollars in millions except per share data) | 2005-2004 | 2004-2003 | ||||||||||||||||||
2005 | 2004 | 2003 | Change % | Change % | ||||||||||||||||
Balance Sheet Data | ||||||||||||||||||||
Invested assets | $ | 12,702 | $ | 12,677 | $ | 12,485 | 0.2 | 1.5 | ||||||||||||
Total assets | 16,003 | 16,107 | 15,509 | (0.6 | ) | 3.9 | ||||||||||||||
Long-term debt | 791 | 791 | 420 | 0.0 | 88.4 | |||||||||||||||
Shareholders’ equity | 6,086 | 6,249 | 6,204 | (2.6 | ) | 0.7 | ||||||||||||||
Book value per share | 34.88 | 35.60 | 35.10 | (2.0 | ) | 1.4 | ||||||||||||||
Performance measures | ||||||||||||||||||||
Comprehensive income | $ | 99 | $ | 287 | $ | 815 | (65.8 | ) | (64.8 | ) | ||||||||||
Return on equity | 9.8 | % | 9.4 | % | 6.3 | % | ||||||||||||||
Return on equity, based on comprehensive income | 1.6 | 4.6 | 13.8 | |||||||||||||||||
Debt-to-capital ratio | 11.5 | 11.2 | 8.9 |
2005 10-K Page 32
(Dollars in millions) | 2005-2004 | 2004-2003 | ||||||||||||||||||
2005 | 2004 | 2003 | Change % | Change % | ||||||||||||||||
Property casualty highlights | ||||||||||||||||||||
Written premiums | $ | 3,076 | $ | 2,997 | $ | 2,815 | 2.6 | 6.5 | ||||||||||||
Underwriting profit | 330 | 298 | 140 | 10.8 | 113.3 | |||||||||||||||
GAAP combined ratio | 89.2 | % | 89.8 | % | 94.7 | % | ||||||||||||||
Statutory combined ratio | 89.0 | 89.4 | 94.2 |
• | Maintaining our strong relationships with our established agencies, writing a significant portion of each agency’s business and attracting new agencies– In 2006, we expect to continue to rank No. 1 or No. 2 by premium volume in at least 74 percent or more of the locations that have marketed our products for more than five years. We expect to subdivide three field territories in 2006 and we are targeting 50 new agency appointments. |
2005 10-K Page 33
In 2006, we expect to make further progress in our efforts to improve service to and communication with our agencies through our expanding portfolio of software. In particular, we will continue to deploy our commercial lines and personal lines quoting and policy processing systems that allow our agencies and our field and headquarters associates to collaborate on new and renewal business more efficiently and give our agencies choice and control. We discuss our technology plans for 2006 in Item 1, Technology Solutions, Page 4. |
• | Achieving above-industry-average growth in property casualty statutory net written premiums and maintaining industry-leading profitability by leveraging our regional franchise and proven agency-centered business strategy— We believe our consolidated property casualty written premiums will be flat to slightly up in 2006 compared with the 2.6 percent increase in 2005. We may not achieve our objective of above-industry-average growth in 2006 because the modest growth we anticipate in commercial lines written premiums, despite increasing competition, may be offsetting the rate-driven declines we anticipate in personal lines written premiums. In addition, the overall industry premium growth is estimated at 3.3 percent in 2006, which includes an estimated 18.6 percent reinsurance sector growth rate. The 2006 industry growth rate for the commercial lines sector is estimated at 2.3 percent and the personal lines sector is estimated at 2.9 percent. |
Our combined ratio estimate for 2006 is 92 percent to 94 percent on either a GAAP or statutory basis compared with 89.2 percent on a GAAP basis in 2005. We believe the most significant difference will be a lower level of savings from favorable loss reserve development from prior accident years. In 2006, we believe that savings is likely to reduce the combined ratio in the range of 2 to 3 percentage points. Higher-than-normal savings, particularly for liability coverages, reduced the 2005 combined ratio by 5.2 percentage points and the 2004 combined ratio by 6.7 percentage points. | |
We also have raised slightly our estimate of the impact to the 2006 combined ratio from catastrophe losses to the range of 4.0 and 4.5 percentage points from our historic range of 3.0 to 3.5 percentage points. We are taking into account the potential for severe weather, as we’ve seen in the past two years, and the higher retention on our new catastrophe reinsurance treaty. Both the loss and loss expense ratio and underwriting expense ratio trends could affect the combined ratios for our commercial lines and personal lines segments: |
o | The degree of price softening in the commercial lines marketplace will affect the 2006 loss and loss expense ratio for that business area, as that ratio may move up slightly as pricing becomes more competitive. | ||
o | The personal lines 2006 loss and loss expense ratio primarily will reflect our ability to offer competitive prices for our personal lines products in that changing marketplace. We believe we have taken the appropriate actions to maintain that ratio near the improved level we achieved in 2005. | ||
o | For both commercial lines and personal lines, lower growth rates could lead to further unfavorable year-over-year comparisons in the ratios of deferred acquisition costs and other underwriting expenses to earned premiums. Continued investment in technology also may contribute to an increase in other underwriting expenses. |
The estimated industry average 2006 combined ratio is 98.7 percent. |
• | Pursuing a total return investment strategy that generates both strong investment income growth and capital appreciation- In 2006, we are estimating pretax investment income growth to again be in the range of 6.5 percent to 7.0 percent. This outlook is based on the higher anticipated level of dividend income from equity holdings, the investment of insurance operations cash flow and the higher-than-historical allocation of new cash flow to fixed-maturity securities over the past 18 months. | |
We do not establish annual capital appreciation targets. Over the long term, our target is to have the equity portfolio outperform the Standard & Poor’s 500 Index. Over the five years ended December 31, 2005, our compound annual equity portfolio return was a negative 0.8 percent compared with a compound annual total return of 0.5 percent for the Index. In 2005, our compound annual equity portfolio was a negative 4.2 percent, compared with a compound annual total return of 4.9 percent for the Index. Our equity portfolio underperformed the market for these periods because of the decline in the market value of our holdings of Fifth Third common stock over the past five years. |
• | Increasing the total return to shareholders through a combination of higher earnings per share, growth in book value and increasing dividends- We do not announce annual targets for earnings per share or book value. Earnings results in 2006 will be tempered by the first quarter adoption of Statement of Financial Accounting Standards (SFAS) No. 123(R) “Share-Based Payments,” which requires expensing the cost of associate options on our income statement. Our estimate of pro forma option expense, as detailed in Item 8, Note 1 to the Consolidated Financial Statements, Page 84, would have reduced earnings per share by 7 cents to 8 cents in each of the past three years. |
2005 10-K Page 34
Over the long term, we look for our earnings per share growth to outpace that of a peer group of national and regional property casualty insurance companies. Long-term book value growth should approximate that of our equity portfolio. | ||
The board of directors is committed to steadily increasing cash dividends and periodically authorizing stock dividends and splits. In February 2006, the board increased the indicated annual dividend rate 9.8 percent, marking the 46th consecutive year of increases in our indicated dividend rate. We believe our record of dividend increases is matched by only 11 other publicly traded corporations. | ||
Over the long-term, we seek to increase earnings per share, book value and dividends at a rate that would allow long-term total return to our shareholders to exceed that of the Standard & Poor’s Composite 1500 Property Casualty Insurance Index. Over the past five years, our total return to shareholders of 40.9 percent matched the return on that Index. |
• | Maintaining financial strength by keeping the ratio of debt to capital below 15 percent and purchasing reinsurance to provide investment flexibility- Based on our present capital requirements, we do not anticipate a material increase in debt levels during 2006. As a result, we believe our debt-to-capital ratio will remain in the range of 11 percent to 12 percent. | |
In December 2005, we finalized our reinsurance program for 2006, updating it to maintain the balance between the cost of the program and the level of risk we retain. Under the new program, our 2006 reinsurance premiums are expected to be $7 million lower than 2005, without taking into account the reinstatement premium incurred in 2005. We provide more detail on our reinsurance programs in 2006 Reinsurance Programs, Page 68. |
• | Court decisions or legislation that result in unanticipated coverage expansions on past and existing policies |
• | Changes in medical inflation and mortality rates that affect workers compensation claims |
• | Changes in claim cost trends, including the effects of general economic and tort cost inflation, not reflected in the historical data used to estimate loss reserves |
• | Changes in reinsurance coverage, not reflected in reserving data, that affect the company’s net payments and net case reserves |
• | Payment and reporting pattern changes attributable to the implementation of a new claims management system |
• | Reporting pattern changes attributable to changes in case reserving practices, particularly with respect to umbrella liability claims |
• | Absence of cost-effective methods for accurately assessing asbestos and environmental claim liabilities (see Property Casualty Insurance Reserves, Asbestos and Environmental Reserves, Page 63, for discussion of related reserve levels and trends) |
2005 10-K Page 35
• | The Case Incurred Development Method |
• | The Paid Development Method |
• | The Bornhuetter-Ferguson Method |
• | Probability Trend Family Methods |
• | Industry loss frequency and severity and premium trends |
• | Past, present and anticipated product pricing |
• | Anticipated premium growth |
• | Other quantifiable trends |
• | Projected ultimate loss ratios |
2005 10-K Page 36
2005 10-K Page 37
2005 10-K Page 38
• | Commercial lines property casualty insurance |
• | Personal lines property casualty insurance |
• | Life insurance |
• | Investments operations |
2005 10-K Page 39
(Dollars in millions) | 2005-2004 | 2004-2003 | ||||||||||||||||||
2005 | 2004 | 2003 | Change % | Change % | ||||||||||||||||
Written premiums | $ | 3,076 | $ | 2,997 | $ | 2,815 | 2.6 | 6.5 | ||||||||||||
Earned premiums | $ | 3,058 | $ | 2,919 | $ | 2,653 | 4.8 | 10.0 | ||||||||||||
Loss and loss expenses excluding catastrophes | 1,685 | 1,605 | 1,700 | 5.0 | (5.6 | ) | ||||||||||||||
Catastrophe loss and loss expenses | 127 | 148 | 97 | (14.8 | ) | 53.4 | ||||||||||||||
Commission expenses | 592 | 583 | 507 | 1.6 | 15.0 | |||||||||||||||
Underwriting expenses | 319 | 274 | 194 | 16.3 | 40.6 | |||||||||||||||
Policyholder dividends | 5 | 11 | 15 | (52.3 | ) | (25.0 | ) | |||||||||||||
Underwriting profit | $ | 330 | $ | 298 | $ | 140 | 10.8 | 113.3 | ||||||||||||
Ratios as a percent of earned premiums: | ||||||||||||||||||||
Loss and loss expenses excluding catastrophes | 55.1 | % | 55.0 | % | 64.1 | % | ||||||||||||||
Catastrophe loss and loss expenses | 4.1 | 5.1 | 3.6 | |||||||||||||||||
Loss and loss expenses | 59.2 | 60.1 | 67.7 | |||||||||||||||||
Commission expenses | 19.4 | 20.0 | 19.1 | |||||||||||||||||
Underwriting expenses | 10.4 | 9.4 | 7.3 | |||||||||||||||||
Policyholder dividends | 0.2 | 0.3 | 0.6 | |||||||||||||||||
Combined ratio | 89.2 | % | 89.8 | % | 94.7 | % | ||||||||||||||
• | New business written directly by agencies – New business written directly by agencies was $314 million, $330 million and $328 million in 2005, 2004 and 2003, respectively. New business levels reflect market conditions for commercial and personal lines. |
• | Reinsurance reinstatement premiums – To restore affected layers of property catastrophe reinsurance programs, we incurred $8 million and $11 million in reinsurance reinstatement premiums in 2005 and 2004. |
• | 2003 — We released $38 million pretax of previously established UM/UIM reserves, adding $25 million, or 14 cents per share, to net income in 2003. |
• | 2004 — In 2004, we reviewed outstanding UM/UIM claims for which litigation was pending. Those claims represented approximately $37 million in previously established case reserves. During the first quarter of 2004, we filed motions for dismissal in various jurisdictions for specific claims and released an additional $32 million in related case reserves. The reserve releases in 2004 added $21 million, or 12 cents per share, to net income. |
• | 2005 — In 2005, we stopped separately reporting on UM/UIM-related reserve actions. |
2005 10-K Page 40
• | Premiums – As competition in our commercial markets continues to increase, our written premium growth rate has slowed because of the more competitive pricing environment and the underwriting discipline we have maintained for both renewal and new business. The primary source of growth in the past three years has been higher pricing on new and renewal commercial business aided by property insurance-to-value initiatives and more accurate risk classification. These more than offset our deliberate decisions not to write or renew certain business and the loss of some smaller accounts due to competition. We believe that our written premium growth rate continues to exceed the average for the overall commercial lines industry, which was estimated at 2.7 percent for 2005 and 2.3 percent for 2004. Earned premium growth has slowed because of the declining growth rate of written premiums. Reinsurance reinstatement premiums allocated to commercial lines reduced earned premium growth by 0.2 and 0.3 percentage points in 2005 and 2004, respectively. |
• | Combined ratio – Our commercial lines combined ratio was very strong in 2005 and 2004 largely due to our programs to obtain more adequate premiums per policy and our underwriting efforts. The 3.3 percentage point increase in the 2005 ratio primarily was due to a rise in the loss and loss expense ratio. The increase reflected a single large loss in 2005 that increased the ratio by 1.1 percentage points and savings from favorable loss reserve development below the 2004 level. We discuss large losses and other factors affecting the combined ratio beginning on Page 42. We discuss the savings from favorable loss reserve development by commercial lines of business on Page 45. | |
Our commercial lines statutory combined ratio was 87.1 percent in 2005 compared with 83.7 percent in 2004 and 91.6 percent in 2003. By comparison, the estimated industry commercial lines combined ratio was 99.1 percent in 2005, 102.5 percent in 2004 and 100.2 percent in 2003. |
2005 10-K Page 41
(Dollars in millions) | 2005-2004 | 2004-2003 | ||||||||||||||||||
2005 | 2004 | 2003 | Change % | Change % | ||||||||||||||||
Written premiums | $ | 2,290 | $ | 2,186 | $ | 2,031 | 4.7 | 7.6 | ||||||||||||
Earned premiums | $ | 2,254 | $ | 2,126 | $ | 1,908 | 6.0 | 11.4 | ||||||||||||
Loss and loss expenses excluding catastrophes | 1,222 | 1,083 | 1,176 | 12.9 | (7.9 | ) | ||||||||||||||
Catastrophe loss and loss expenses | 76 | 71 | 42 | 6.0 | 68.9 | |||||||||||||||
Commission expenses | 438 | 423 | 361 | 3.6 | 17.1 | |||||||||||||||
Underwriting expenses | 228 | 200 | 147 | 13.5 | 36.8 | |||||||||||||||
Policyholder dividends | 5 | 11 | 15 | (52.3 | ) | (25.0 | ) | |||||||||||||
Underwriting profit | $ | 285 | $ | 338 | $ | 167 | (15.6 | ) | 102.3 | |||||||||||
Ratios as a percent of earned premiums: | ||||||||||||||||||||
Loss and loss expenses excluding catastrophes | 54.2 | % | 50.9 | % | 61.6 | % | ||||||||||||||
Catastrophe loss and loss expenses | 3.4 | 3.4 | 2.2 | |||||||||||||||||
Loss and loss expenses | 57.6 | 54.3 | 63.8 | |||||||||||||||||
Commission expenses | 19.5 | 19.9 | 18.9 | |||||||||||||||||
Underwriting expenses | 10.1 | 9.4 | 7.7 | |||||||||||||||||
Policyholder dividends | 0.2 | 0.5 | 0.8 | |||||||||||||||||
Combined ratio | 87.4 | % | 84.1 | % | 91.2 | % | ||||||||||||||
2005 10-K Page 42
(Dollars in millions) | 2005-2004 | 2004-2003 | ||||||||||||||||||
2005 | 2004 | 2003 | Change % | Change % | ||||||||||||||||
Losses $1 million or more | $ | 124 | $ | 80 | $ | 89 | 54.3 | (9.5 | ) | |||||||||||
Losses $250 thousand to $1 million | 105 | 103 | 117 | 1.2 | (11.9 | ) | ||||||||||||||
Development and case reserve increases of $250 thousand or more | 149 | 133 | 121 | 12.7 | 9.9 | |||||||||||||||
Other losses | 596 | 536 | 608 | 11.1 | (11.8 | ) | ||||||||||||||
Total losses incurred excluding catastrophe losses | 974 | 852 | 935 | 14.2 | (8.8 | ) | ||||||||||||||
Catastrophe losses | 76 | 71 | 42 | 6.0 | 68.9 | |||||||||||||||
Total losses incurred | $ | 1,050 | $ | 923 | $ | 977 | 13.6 | (5.4 | ) | |||||||||||
As a percent of earned premiums: | ||||||||||||||||||||
Losses $1 million or more | 5.5 | % | 3.8 | % | 4.6 | % | ||||||||||||||
Losses $250 thousand to $1 million | 4.7 | 4.9 | 6.2 | |||||||||||||||||
Development and case reserve increases of $250 thousand or more | 6.6 | 6.2 | 6.3 | |||||||||||||||||
Other losses | 26.4 | 25.1 | 31.9 | |||||||||||||||||
Loss ratio excluding catastrophe losses | 43.2 | 40.0 | 49.0 | |||||||||||||||||
Catastrophe loss ratio | 3.4 | 3.4 | 2.2 | |||||||||||||||||
Total loss ratio | 46.6 | % | 43.4 | % | 51.2 | % | ||||||||||||||
2005 10-K Page 43
(In millions, net of reinsurance) | Incurred in calendar year ended December 31, | |||||||||||||||
Occurence year | Cause of loss | Region | 2005 | 2004 | 2003 | |||||||||||
2005 | ||||||||||||||||
May | Wind, hail | Midwest | $ | 4 | ||||||||||||
July | Hurricane Dennis | South | 5 | |||||||||||||
August | Hurricane Katrina | South | 36 | |||||||||||||
September | Hurricane Rita | South | 3 | |||||||||||||
October | Hurricane Wilma | South | 13 | |||||||||||||
November | Wind, hail | Midwest | 2 | |||||||||||||
November | Wind | Midwest, South | 2 | |||||||||||||
Total | 65 | |||||||||||||||
2004 | ||||||||||||||||
May | Wind, hail | Midwest, Mid-Atlantic | 0 | $ | 1 | |||||||||||
May | Wind, hail | Midwest, Mid-Atlantic, South | 0 | 11 | ||||||||||||
July | Wind, hail | Midwest, Mid-Atlantic, South | 8 | 7 | ||||||||||||
August | Hurricane Charley | South | 0 | 16 | ||||||||||||
September | Hurricane Frances | South | 1 | 4 | ||||||||||||
September | Hurricane Jeanne | Mid-Atlantic, South | 1 | 4 | ||||||||||||
September | Hurricane Ivan | Midwest, Mid-Atlantic, South | 1 | 21 | ||||||||||||
December | Wind, ice, snow | Midwest, South | 0 | 5 | ||||||||||||
Others | 0 | 3 | ||||||||||||||
Total | 11 | 72 | ||||||||||||||
2003 and prior | ||||||||||||||||
April | Wind, hail | Midwest, South | 0 | (2 | ) | $ | 5 | |||||||||
May | Wind, hail | Midwest, South | 1 | 0 | 17 | |||||||||||
July | Wind, hail | Midwest, Mid-Atlantic, South | 0 | 2 | 2 | |||||||||||
July | Wind, hail | Midwest, Mid-Atlantic, South | (1 | ) | 0 | 6 | ||||||||||
September | Wind | Mid-Atlantic, South | 0 | 0 | 5 | |||||||||||
November | Wind | Midwest, Mid-Atlantic, South | 0 | (1 | ) | 6 | ||||||||||
Others | 0 | 0 | 1 | |||||||||||||
Total | 0 | (1 | ) | 42 | ||||||||||||
Calendar year total | $ | 76 | $ | 71 | $ | 42 | ||||||||||
2005 10-K Page 44
(Dollars in millions) | 2005-2004 | 2004-2003 | ||||||||||||||||||
Calendar year | 2005 | 2004 | 2003 | Change % | Change % | |||||||||||||||
Commercial multi-peril: | ||||||||||||||||||||
Written premium | $ | 809 | $ | 767 | $ | 713 | 5.4 | 7.6 | ||||||||||||
Earned premium | 796 | 751 | 673 | 5.9 | 11.6 | |||||||||||||||
Loss and loss expenses incurred | 443 | 469 | 442 | (5.5 | ) | 6.1 | ||||||||||||||
Loss and loss expenses ratio | 55.7 | % | 62.4 | % | 65.6 | % | ||||||||||||||
Loss and loss expense ratio excluding catastrophes | 47.5 | 54.9 | 59.9 | |||||||||||||||||
Workers compensation: | ||||||||||||||||||||
Written premium | $ | 338 | $ | 320 | $ | 304 | 5.5 | 5.2 | ||||||||||||
Earned premium | 328 | 313 | 293 | 5.1 | 6.8 | |||||||||||||||
Loss and loss expenses incurred | 300 | 251 | 235 | 19.4 | 6.6 | |||||||||||||||
Loss and loss expenses ratio | 91.3 | % | 80.3 | % | 80.5 | % | ||||||||||||||
Loss and loss expense ratio excluding catastrophes | 91.3 | 80.3 | 80.5 | |||||||||||||||||
Commercial auto: | ||||||||||||||||||||
Written premium | $ | 447 | $ | 458 | $ | 434 | (2.4 | ) | 5.5 | |||||||||||
Earned premium | 456 | 450 | 419 | 1.4 | 7.4 | |||||||||||||||
Loss and loss expenses incurred | 273 | 236 | 240 | 15.7 | (1.8 | ) | ||||||||||||||
Loss and loss expenses ratio | 59.8 | % | 52.4 | % | 57.3 | % | ||||||||||||||
Loss and loss expense ratio excluding catastrophes | 59.7 | 52.1 | 56.5 | |||||||||||||||||
Other liability: | ||||||||||||||||||||
Written premium | $ | 458 | $ | 424 | $ | 377 | 7.9 | 12.5 | ||||||||||||
Earned premium | 442 | 402 | 342 | 9.8 | 17.6 | |||||||||||||||
Loss and loss expenses incurred | 187 | 116 | 183 | 61.7 | (36.8 | ) | ||||||||||||||
Loss and loss expenses ratio | 42.4 | % | 28.8 | % | 53.6 | % | ||||||||||||||
Loss and loss expense ratio excluding catastrophes | 42.4 | 28.8 | 53.6 |
Accident year | 2005 | 2004 | 2003 | 2002 | 2001 | |||||||||||||||
Loss and loss expenses incurred: | ||||||||||||||||||||
Commercial multi-peril | $ | 504 | $ | 459 | $ | 411 | $ | 408 | $ | 403 | ||||||||||
Workers compensation | 256 | 245 | 231 | 236 | 230 | |||||||||||||||
Commercial auto | 297 | 268 | 261 | 251 | 242 | |||||||||||||||
Other liability | 269 | 210 | 193 | 156 | 123 | |||||||||||||||
Loss and loss expenses ratio: | ||||||||||||||||||||
Commercial multi-peril | 63.4 | % | 61.2 | % | 61.1 | % | 67.2 | % | 75.3 | % | ||||||||||
Workers compensation | 78.0 | 78.3 | 78.9 | 80.2 | 91.2 | |||||||||||||||
Commercial auto | 65.1 | 59.6 | 62.3 | 65.4 | 75.6 | |||||||||||||||
Other liability | 60.8 | 52.3 | 56.5 | 56.8 | 57.1 |
• | 2005 – Favorable development lowered the loss and loss expense ratio by 7.7 percentage points. The favorable development largely was due to lower commercial multi-peril exposures because of |
2005 10-K Page 45
prior-year transfers of business to non-discounted policies and to the benefits of changes made in 2002 to our general liability terms and conditions. |
• | 2004 – Reserve strengthening added 0.6 percentage points to the loss and loss expense ratio. Additions to reserves for environment claims were offset by favorable development of case reserves for non-environmental claims due to our headquarters claims department’s initiative to establish higher initial case reserves on severe injury claims. |
• | 2003 – Reserve strengthening added 2.0 percentage points to the loss and loss expense ratio because we added to our reserves for environmental claims. |
• | 2005 – Reserve strengthening added 13.3 percentage points to the loss and loss expense ratio. The reserve strengthening primarily was due to medical cost inflation and longer estimated payout periods compared with our original projections. |
• | 2004 – Reserve strengthening added 4.9 percentage points to the loss and loss expense ratio, which also was due to longer estimated payout periods. |
• | 2003 – Reserve strengthening added 4.3 percentage points to the loss and loss expense ratio, which also was due to medical cost inflation. |
• | 2005 – Favorable development lowered the loss and loss expense ratio by 5.3 percentage points. The savings largely were due to moderating frequency and severity trends. |
• | 2004 – Favorable development lowered the loss and loss expense ratio by 10.5 percentage points, including 4.6 percentage points due to the release of UM/UIM reserves. The remainder of the savings largely was due to moderating frequency and severity trends. |
• | 2003 – Favorable development lowered the loss and loss expense ratio by 8.8 percentage points, including 6.9 percentage points due to the release of UM/UIM case reserves. The release of UM/UIM-related IBNR reserves also contributed. |
2005 10-K Page 46
• | 2005 – Favorable development lowered the loss and loss expense ratio by 18.4 percentage points. Enforcement of stricter underwriting standards and a preference for lower limit policies contributed to favorable development for our commercial umbrella coverages. |
• | 2004 – Favorable development lowered the loss and loss expense ratio by 32.5 percentage points, including 2.0 percentage points due to the release of UM/UIM reserves. |
• | 2003 – Favorable development lowered the loss and loss expense ratio by 23.0 percentage points, including 2.6 percentage points due to the release of UM/UIM reserves. |
• | Premiums – During the past three years, we have been working to address personal lines profitability. Because of our actions, the 2005 personal lines combined ratio was below 100 percent for the first time since 1999. However, as other carriers refined their pricing models , our pricing was less competitive and written premiums declined in 2005 after slowing in 2004. Industry average written premium growth was estimated at 3.5 percent for 2005 and 6.6 percent for 2004. Our earned premium growth has slowed as a result of the written premium trend. Reinsurance reinstatement premiums allocated to personal lines reduced our premium growth by 0.3 and 0.8 percentage points for 2005 and 2004, respectively. |
• | Combined ratio – The substantial improvement in the 2005 combined ratio reflected our progress in lowering the homeowner loss and loss expense ratio and our lower catastrophe losses offset by higher |
2005 10-K Page 47
noncommission underwriting expenses. The 2004 personal lines combined ratio was slightly above the prior year’s level. Higher catastrophe losses and underwriting expenses offset the improvement in the homeowner and personal auto loss and loss expense ratios excluding catastrophe losses. | ||
Our personal lines statutory combined ratio was 94.3 percent in 2005 compared with 104.6 percent in 2004 and 102.9 percent in 2003. By comparison, the estimated industry personal lines combined ratio was 97.3 percent in 2005, 94.9 percent in 2004 and 98.4 percent in 2003. |
2005-2004 | 2004-2003 | |||||||||||||||||||
(Dollars in millions) | 2005 | 2004 | 2003 | Change % | Change % | |||||||||||||||
Written premiums | $ | 786 | $ | 811 | $ | 784 | (3.0 | ) | 3.4 | |||||||||||
Earned premiums | $ | 804 | $ | 793 | $ | 745 | 1.4 | 6.4 | ||||||||||||
Loss and loss expenses excluding catastrophes | 463 | 522 | 524 | (11.3 | ) | (0.4 | ) | |||||||||||||
Catastrophe loss and loss expenses | 51 | 77 | 55 | (34.2 | ) | 41.4 | ||||||||||||||
Commission expenses | 154 | 160 | 146 | (3.6 | ) | 9.7 | ||||||||||||||
Underwriting expenses | 91 | 74 | 47 | 24.0 | 52.1 | |||||||||||||||
Underwriting profit(loss) | $ | 45 | $ | (40 | ) | $ | (27 | ) | 214.0 | 45.8 | ||||||||||
Ratios as a percent of earned premiums: | ||||||||||||||||||||
Loss and loss expenses excluding catastrophes | 57.6 | % | 65.9 | % | 70.3 | % | ||||||||||||||
Catastrophe loss and loss expenses | 6.3 | 9.7 | 7.3 | |||||||||||||||||
Loss and loss expenses | 63.9 | 75.6 | 77.6 | |||||||||||||||||
Commission expenses | 19.2 | 20.1 | 19.5 | |||||||||||||||||
Underwriting expenses | 11.3 | 9.3 | 6.5 | |||||||||||||||||
Combined ratio | 94.4 | % | 105.0 | % | 103.6 | % | ||||||||||||||
2005 10-K Page 48
2005-2004 | 2004-2003 | |||||||||||||||||||
(Dollars in millions) | 2005 | 2004 | 2003 | Change % | Change % | |||||||||||||||
Losses $1 million or more | $ | 13 | $ | 17 | $ | 15 | (26.0 | ) | 14.6 | |||||||||||
Losses $250 thousand to $1 million | 34 | 43 | 41 | (19.9 | ) | 4.9 | ||||||||||||||
Development and case reserve increases of $250 thousand or more | 19 | 21 | 11 | (7.7 | ) | 83.7 | ||||||||||||||
Other losses | 339 | 371 | 391 | (8.5 | ) | (5.2 | ) | |||||||||||||
Total losses incurred excluding catastrophe losses | 405 | 452 | 458 | (10.2 | ) | (1.4 | ) | |||||||||||||
Catastrophe losses | 51 | 77 | 55 | (34.2 | ) | 41.4 | ||||||||||||||
Total losses incurred | $ | 456 | $ | 529 | $ | 513 | (13.7 | ) | 3.1 | |||||||||||
As a percent of earned premiums: | ||||||||||||||||||||
Losses $1 million or more | 1.5 | % | 2.2 | % | 2.0 | % | ||||||||||||||
Losses $250 thousand to $1 million | 4.3 | 5.4 | 5.5 | |||||||||||||||||
Development and case reserve increases of $250 thousand or more | 2.4 | 2.6 | 1.5 | |||||||||||||||||
Other losses | 42.2 | 46.8 | 52.5 | |||||||||||||||||
Loss ratio excluding catastrophe losses | 50.4 | 57.0 | 61.5 | |||||||||||||||||
Catastrophe loss ratio | 6.3 | 9.7 | 7.3 | |||||||||||||||||
Total loss ratio | 56.7 | % | 66.7 | % | 68.8 | % | ||||||||||||||
�� |
2005 10-K Page 49
(In millions, net of reinsurance) | Incurred in calendar year ended December 31, | |||||||||||||||
Occurence year | Cause of loss | Region | 2005 | 2004 | 2003 | |||||||||||
2005 | ||||||||||||||||
January | Wind, ice snow, freezing | Midwest, Mid-Atlantic | $ | 1 | ||||||||||||
May | Wind, hail | Midwest | 8 | |||||||||||||
July | Hurricane Dennis | South | 2 | |||||||||||||
August | Hurricane Katrina | South | 11 | |||||||||||||
October | Hurricane Wilma | South | 12 | |||||||||||||
November | Wind, hail | Midwest | 9 | |||||||||||||
November | Wind | Midwest, South | 10 | |||||||||||||
Total | 53 | |||||||||||||||
2004 | ||||||||||||||||
May | Wind, hail | Midwest, Mid-Atlantic | 0 | $ | 9 | |||||||||||
May | Wind, hail | Midwest, Mid-Atlantic, South | 0 | 20 | ||||||||||||
July | Wind, hail | Midwest, Mid-Atlantic, South | (1 | ) | 5 | |||||||||||
August | Hurricane Charley | South | 0 | 10 | ||||||||||||
September | Hurricane Frances | South | 1 | 7 | ||||||||||||
September | Hurricane Jeanne | Mid-Atlantic, South | 0 | 2 | ||||||||||||
September | Hurricane Ivan | Midwest, Mid-Atlantic, South | 1 | 18 | ||||||||||||
December | Wind, ice, snow | Midwest, South | (3 | ) | 8 | |||||||||||
Others | 0 | 2 | ||||||||||||||
Total | (2 | ) | 81 | |||||||||||||
2003 and prior | ||||||||||||||||
April | Wind, hail | Midwest, South | 0 | (2 | ) | $ | 31 | |||||||||
May | Wind, hail | Midwest, South | 0 | 0 | 17 | |||||||||||
July | Wind, hail | Midwest, Mid-Atlantic, South | 0 | (1 | ) | 5 | ||||||||||
July | Wind, hail | Midwest, Mid-Atlantic, South | 0 | 0 | 1 | |||||||||||
September | Wind | Mid-Atlantic, South | 0 | (1 | ) | 4 | ||||||||||
November | Wind | Midwest, Mid-Atlantic, South | 0 | 0 | 1 | |||||||||||
Others | 0 | 0 | (4 | ) | ||||||||||||
Total | 0 | (4 | ) | 55 | ||||||||||||
Calendar year total | $ | 51 | $ | 77 | $ | 55 | ||||||||||
2005 10-K Page 50
(Dollars in millions) | 2005-2004 | 2004-2003 | ||||||||||||||||||
Calendar year | 2005 | 2004 | 2003 | Change % | Change % | |||||||||||||||
Personal auto: | ||||||||||||||||||||
Written premium | $ | 410 | $ | 453 | $ | 447 | (9.4 | ) | 1.2 | |||||||||||
Earned premium | 433 | 451 | 428 | (4.0 | ) | 5.4 | ||||||||||||||
Loss and loss expenses incurred | 261 | 298 | 304 | (12.5 | ) | (2.1 | ) | |||||||||||||
Loss and loss expenses ratio | 60.2 | % | 66.1 | % | 71.1 | % | ||||||||||||||
Loss and loss expense ratio excluding catastrophes | 59.7 | 65.1 | 70.1 | |||||||||||||||||
Homeowner: | ||||||||||||||||||||
Written premium | $ | 290 | $ | 273 | $ | 254 | 6.3 | 7.3 | ||||||||||||
Earned premium | 285 | 259 | 239 | 10.2 | 8.2 | |||||||||||||||
Loss and loss expenses incurred | 212 | 249 | 222 | (14.6 | ) | 12.2 | ||||||||||||||
Loss and loss expenses ratio | 74.5 | % | 96.1 | % | 92.7 | % | ||||||||||||||
Loss and loss expense ratio excluding catastrophes | 58.4 | 69.3 | 72.8 |
Accident year | 2005 | 2004 | 2003 | 2002 | 2001 | |||||||||||||||
Loss and loss expenses incurred: | ||||||||||||||||||||
Personal auto | $ | 267 | $ | 297 | $ | 305 | $ | 289 | $ | 259 | ||||||||||
Homeowner | 215 | 254 | 227 | 207 | 193 | |||||||||||||||
Loss and loss expenses ratio: | ||||||||||||||||||||
Personal auto | 61.8 | % | 66.0 | % | 71.2 | % | 74.3 | % | 71.9 | % | ||||||||||
Homeowner | 75.4 | 98.1 | 95.0 | 98.6 | 101.4 |
2005 10-K Page 51
• | Competitive rates – We are working on a number of rate setting initiatives to make our personal auto and homeowner rates competitive in all of our territories. We work with our agents to establish rates that are attractive to our agencies’ quality accounts. In mid-2006, we will introduce a limited program of rate segments incorporating insurance scores into rates for our personal auto and homeowner policies to further improve our pricing for our agents’ quality accounts. We believe the opportunity exists to work with our agents to market the advantages of our personal lines products to their clients, which would help us resume growing in this business area. |
• | Policy characteristics – In keeping with industry practices, most of our homeowner products no longer automatically cover guaranteed replacement costs. We add specific charges for some optional coverages previously included at no charge, such as limited replacement cost and water damage coverages. Policyholders who need the water damage protection now can select the amount of coverage that meets their needs. However, these changes and our transition to one-year homeowner policies may have diminished the factors that distinguished our products. |
• | Diamond introduction – The use of the Diamond system by agencies writing approximately 70 percent of personal lines volume is a significant accomplishment. We believe the system ultimately will make it easier for agents to place personal auto, homeowner and other personal lines business with us, while greatly increasing policy-issuance and policy-renewal efficiencies and providing direct-bill capabilities. Agents using Diamond chose direct bill for 37 percent and headquarters printing for 75 percent of policy transactions in 2005, options that generally were not available on our previous system. |
• | New agencies – The availability of Diamond should help us increase the number of agencies that offer our personal lines products, which also should contribute to personal lines growth. We currently market both homeowner and personal auto insurance products through 773 of our 1,253 reporting agency locations in 22 of the 32 states in which we market commercial lines insurance. We market homeowner products through 22 locations in three additional states (Maryland, North Carolina and West Virginia.) |
• | Revenues – Revenue growth has accelerated over the past three years as gross in-force policy face amounts increased to $51.493 billion at year-end 2005 from $44.921 billion at year-end 2004 and $38.492 billion at year-end 2003. |
• | Profitability – The life insurance segment reports a small GAAP profit because investment income is included in investment segment results, except investment income credited to contract holders (interest assumed in life insurance policy reserve calculations). Results improved in 2005 and 2004 because operating expenses remained level and mortality experience remained within pricing guidelines as premiums continued to rise. | |
At the same time, we recognize assets under management, capital appreciation and investment income are integral to evaluation of the success of the life insurance segment because of the long duration of life |
2005 10-K Page 52
products. For that reason, we also evaluate GAAP data including all investment activities on life insurance-related assets. | ||
GAAP net income on that basis grew 23.8 percent in 2005 to $47 million and 74.1 percent in 2004 to $38 million. The life insurance portfolio had pretax realized investment gains of $17 million in 2005 compared with $9 million of gains in 2004 and $10 million of pretax realized investment losses in 2003. |
2005-2004 | 2004-2003 | |||||||||||||||||||
(In millions) | 2005 | 2004 | 2003 | Change % | Change % | |||||||||||||||
Written premiums | $ | 205 | $ | 193 | $ | 143 | 6.5 | 34.7 | ||||||||||||
Earned premiums | $ | 106 | $ | 101 | $ | 95 | 5.7 | 5.5 | ||||||||||||
Separate account investment management fees | 4 | 3 | 2 | 18.5 | 31.9 | |||||||||||||||
Total revenues | 110 | 104 | 97 | 6.0 | 6.1 | |||||||||||||||
Contract holders benefits incurred | 102 | 95 | 91 | 7.2 | 3.5 | |||||||||||||||
Investment interest credited to contract holders | (51 | ) | (46 | ) | (43 | ) | 12.9 | 5.7 | ||||||||||||
Expenses incurred | 52 | 53 | 52 | (0.3 | ) | 0.2 | ||||||||||||||
Total expenses | 103 | 102 | 100 | 0.8 | 0.9 | |||||||||||||||
Life insurance segment profit (loss) | $ | 7 | $ | 2 | $ | (3 | ) | 334.2 | 147.5 | |||||||||||
• | Premiums from traditional products, principally term insurance, which contributed 71.3 percent |
• | Fee income from interest-sensitive products, principally universal life insurance, which contributed 25.5 percent |
• | Separate account investment management fee income, which contributed 3.2 percent |
• | Insurance benefits paid and reserve increases related to traditional life and interest-sensitive products, which accounted for 66.0 percent of 2005 expenses and 64.3 percent of 2004 expenses |
• | Commissions, general and other business expenses, net of deferred acquisition costs, which accounted for 34.0 percent of 2005 expenses and 35.7 percent of 2004 expenses |
2005 10-K Page 53
• | Investment income – Pretax investment income reached a new record in 2005, rising 6.9 percent from the prior record in 2004. Growth in investment income over the past two years has been driven by strong cash flow for new investments, higher interest income from the growing fixed-maturity portfolio and increased dividend income from the common stock portfolio. |
• | Realized gains and losses – We reported realized gains in 2005 and 2004 largely due to investment sales. The realized loss in 2003 was due to other-than-temporary impairment charges. |
2005-2004 | 2004-2003 | |||||||||||||||||||
(In millions) | 2005 | 2004 | 2003 | Change % | Change % | |||||||||||||||
Investment income: | ||||||||||||||||||||
Interest | $ | 280 | $ | 252 | $ | 235 | 11.2 | 7.2 | ||||||||||||
Dividends | 244 | 239 | 227 | 2.1 | 5.0 | |||||||||||||||
Other | 8 | 6 | 8 | 29.4 | (23.0 | ) | ||||||||||||||
Investment expenses | (6 | ) | (5 | ) | (5 | ) | (22.3 | ) | (13.0 | ) | ||||||||||
Total net investment income | 526 | 492 | 465 | 6.9 | 5.6 | |||||||||||||||
Investment interest credited to contract holders | (51 | ) | (46 | ) | (43 | ) | 12.9 | 5.7 | ||||||||||||
Net realized investment gains and losses: | ||||||||||||||||||||
Realized investment gains and losses | 69 | 87 | 30 | (20.7 | ) | 189.9 | ||||||||||||||
Change in valuation of embedded derivatives | (7 | ) | 10 | 9 | (167.2 | ) | 7.9 | |||||||||||||
Other-than-temporary impairment charges | (1 | ) | (6 | ) | (80 | ) | 78.5 | 92.0 | ||||||||||||
Net realized investment gains (losses) | 61 | 91 | (41 | ) | (33.1 | ) | 321.7 | |||||||||||||
Investment operations income | $ | 536 | $ | 537 | $ | 381 | (0.4 | ) | 40.6 | |||||||||||
2005 10-K Page 54
• | 2005 – one auto-related convertible preferred security for $1 million |
• | 2004 – two airline-related tax-exempt municipal bonds totaling $5 million |
• | 2003 – 31 high-yield corporate bonds written down $39 million and 10 convertible securities written down $26 million. Market value declines in 2003 largely related to events specific to the issuer rather than industry issues, although $58 million of the $80 million write-downs were concentrated in the utility/merchant energy trading, airline and healthcare industries. |
2005 10-K Page 55
Years ended December 31, | ||||||||||||
(Dollars in millions) | 2005 | 2004 | 2003 | |||||||||
Taxable fixed maturities: | ||||||||||||
Number of securities impaired | 2 | 1 | 42 | |||||||||
Percent to total owned | 0 | % | 1 | % | 6 | % | ||||||
Impairment amount | $ | (1 | ) | $ | 0 | $ | (66 | ) | ||||
New book value | 1 | 2 | 36 | |||||||||
Percent to total owned | 0 | % | 1 | % | 1 | % | ||||||
Tax-exempt fixed maturities: | ||||||||||||
Number of securities impaired | 0 | 2 | 5 | |||||||||
Percent to total owned | 0 | % | 0 | % | 1 | % | ||||||
Impairment amount | $ | 0 | $ | (5 | ) | $ | (6 | ) | ||||
New book value | 0 | 9 | 3 | |||||||||
Percent to total owned | 0 | % | 1 | % | 0 | % | ||||||
Common equities: | ||||||||||||
Number of securities impaired | 0 | 1 | 2 | |||||||||
Percent to total owned | 0 | % | 2 | % | 4 | % | ||||||
Impairment amount | $ | 0 | $ | (1 | ) | $ | (8 | ) | ||||
New book value | 0 | 0 | 5 | |||||||||
Percent to total owned | 0 | % | 0 | % | 0 | % | ||||||
Preferred equities: | ||||||||||||
Number of securities impaired | 0 | 0 | 0 | |||||||||
Percent to total owned | 0 | % | 0 | % | 0 | % | ||||||
Impairment amount | $ | 0 | $ | 0 | $ | 0 | ||||||
New book value | 0 | 0 | 0 | |||||||||
Percent to total owned | 0 | % | 0 | % | 0 | % | ||||||
Short-term investments: | ||||||||||||
Number of securities impaired | 0 | 0 | 0 | |||||||||
Percent to total owned | 0 | % | 0 | % | 0 | % | ||||||
Impairment amount | $ | 0 | $ | 0 | $ | 0 | ||||||
New book value | 0 | 0 | 0 | |||||||||
Percent to total owned | 0 | % | 0 | % | 0 | % | ||||||
Total: | ||||||||||||
Number of securities impaired | 2 | 4 | 49 | |||||||||
Percent to total owned | 0 | % | 0 | % | 3 | % | ||||||
Impairment amount | $ | (1 | ) | $ | (6 | ) | $ | (80 | ) | |||
New book value | $ | 1 | $ | 11 | $ | 44 | ||||||
Percent to total owned | 0 | % | 0 | % | 1 | % |
Years ended December 31, | ||||||||||||
(Dollars in millions) | 2005 | 2004 | 2003 | |||||||||
Automotive | $ | (1 | ) | $ | 0 | $ | (1 | ) | ||||
Airline | 0 | (5 | ) | (18 | ) | |||||||
Utility/merchant energy/trading | 0 | 0 | (30 | ) | ||||||||
Healthcare | 0 | 0 | (10 | ) | ||||||||
Other | 0 | (1 | ) | (21 | ) | |||||||
Total | $ | (1 | ) | $ | (6 | ) | $ | (80 | ) | |||
2005 10-K Page 56
2005 10-K Page 57
Years ended December 31, | ||||||||||||
(In millions) | 2005 | 2004 | 2003 | |||||||||
Written premiums | $ | 3,187 | $ | 3,055 | $ | 2,771 | ||||||
Loss and loss expenses paid | 1,752 | 1,694 | 1,617 | |||||||||
Commissions and other underwriting expenses paid | 951 | 889 | 774 | |||||||||
Insurance subsidiary cash flow from underwriting | 484 | 472 | 380 | |||||||||
Investment income received | 427 | 362 | 332 | |||||||||
Insurance subsidiary operating cash flow | $ | 911 | $ | 834 | $ | 712 | ||||||
• | Sales of fixed-maturity investments – We prefer to hold fixed-maturity securities until maturity. Any decision to sell or to reduce a holding reflects our perception of a change in the underlying fundamentals of the security and our preference to allocate those funds to investments that more closely meet our established parameters for long-term stability and growth. |
• | Call or maturity of fixed-maturity investments – Calls and maturities of fixed-maturity investments are a function of the yield curve. The pace of calls of fixed maturities declined in 2005 because of a stabilization of interest rates. In the past several years, we have purchased U.S. agency paper with higher coupons and shorter call protection features. |
• | Sales of equity securities investments – In 2005, we continued to sell equity positions previously identified. We also recorded the initial ALLTEL sales in 2005. Sales of equity securities rose in 2004 due to the sale of $356 million in equity holdings as part of our program to support the financial strength ratings of our property casualty insurance operations. Holdings to be sold were selected primarily based on the investment committee’s and management’s belief that these securities would have a lower dividend growth rate over the next several years when compared with other holdings in the portfolio. We also considered the potential tax effect of any unrealized gains. |
2005 10-K Page 58
• | Paid off $183 million in short-term debt. |
• | Are financing the construction of an estimated $100 million office building and parking garage to be situated at the headquarters located in Fairfield beginning in 2005, as announced in August 2004. |
• | Are available for general corporate purposes. |
Payment due by period | |||||||||||||||||||||||
Within | Years | Years | More than | ||||||||||||||||||||
(In millions) | 1 year | 2-3 | 4-5 | 5 years | Total | ||||||||||||||||||
Contractual obligations: | |||||||||||||||||||||||
Net property casualty claims payments | $ | 1,009 | $ | 1,054 | $ | 474 | $ | 574 | $ | 3,111 | |||||||||||||
Net life claims payments | 6 | 0 | 0 | 0 | 6 | ||||||||||||||||||
Interest on long-term debt | 52 | 104 | 104 | 1,048 | 1,308 | ||||||||||||||||||
Long-term debt | 0 | 0 | 0 | 795 | 795 | ||||||||||||||||||
Annuitization obligations | 15 | 45 | 30 | 104 | 194 | ||||||||||||||||||
Headquarters building expansion | 20 | 63 | 0 | 0 | 83 | ||||||||||||||||||
Computer hardware and software | 10 | 2 | 1 | 1 | 14 | ||||||||||||||||||
Other invested assets | 9 | 10 | 1 | 0 | 20 | ||||||||||||||||||
Total | $ | 1,121 | $ | 1,278 | $ | 610 | $ | 2,522 | $ | 5,531 | |||||||||||||
2005 10-K Page 59
2005 10-K Page 60
• | Dividends to shareholders – Over the past 10 years, the company has paid an average of 42 percent of net income as dividends, with the remaining 58 percent available to reinvest for future growth and for share repurchases. The ability of the company to continue paying cash dividends is subject to factors the board of directors may deem relevant. | |
In February 2006, the board of directors authorized a 9.8 percent increase in the regular quarterly cash dividend to an indicated annual rate of $1.34 per share. In 2005, 2004 and 2003, we paid cash dividends of $204 million, $177 million and $156 million. |
• | Common stock repurchase – Our board believes that stock repurchases can help fulfill our commitment to enhancing shareholder value. Consequently, the board has authorized the repurchase of outstanding shares. Common stock repurchases for treasury have continued at a steady pace over the last several years and occur when we believe that stock prices on the open market are favorable for such repurchases. At a minimum, we would expect the repurchase to offset dilution of option exercises. In 2005, 2004 and 2003, we used $63 million, $66 million and $55 million for share repurchase. | |
In 2005, the board authorized a 10 million share repurchase program to replace a program authorized in 1999. At year-end 2005, 9.5 million shares remained authorized for repurchase under the 2005 program. | ||
The details of the repurchase activity are described in Item 5, Market for the Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities, Page 27. Between February 1999 and year-end 2005, we have repurchased 14.8 million shares at a total cost to the company of $543 million. We do not adjust number of shares repurchased and average price per repurchased share for stock dividends. |
2005 10-K Page 61
• | Increases in coverage in force in selected business lines |
• | New business |
• | Higher initial case reserves on liability claims |
• | Judicial decisions and mass tort claims |
• | Loss cost inflation in selected lines |
• | Section Ashows our total property casualty loss and loss expense reserves recorded at the balance sheet date for each of the indicated calendar years on a gross and net basis. Those reserves represent the estimated amount of loss and loss expenses for claims arising in all prior years that are unpaid at the balance sheet date, including losses that have been incurred but not yet reported to the company. |
• | Section Bshows the cumulative net amount paid with respect to the previously recorded reserve as of the end of each succeeding year. For example, as of December 31, 2005, we had paid $1.053 billion of loss and loss expenses in calendar years 1996 through 2005, for losses that occurred in accident years 1995 and prior. An estimated $130 million of losses remain unpaid as of year-end 2005 (net re-estimated reserves of $1.183 billion less cumulative paid loss and loss expenses of $1.053 billion). |
• | Section Cshows the re-estimated amount of the previously reported reserves based on experience as of the end of each succeeding year. The estimate is increased or decreased as we learn more about the frequency and severity of claims. |
• | Section D, cumulative net redundancy, represents the aggregate change in the estimates for all years subsequent to the year the reserves were initially established. For example, reserves established at December 31, 1995, had developed a $398 million redundancy over 10 years, net of reinsurance, which has been reflected in income over the 10 years. The effects on income in 2005, 2004 and 2003 of changes in estimates of the reserves for loss and loss expenses for all accident years are shown in the reconciliation below. |
2005 10-K Page 62
Calendar year ended December 31, | ||||||||||||||||||||||||||||||||||||||||||||
(In millions) | 1995 | 1996 | 1997 | 1998 | 1999 | 2000 | 2001 | 2002 | 2003 | 2004 | 2005 | |||||||||||||||||||||||||||||||||
A. Originally reported reserves for unpaid loss and loss expenses: | ||||||||||||||||||||||||||||||||||||||||||||
Gross of reinsurance | $ | 1,690 | $ | 1,824 | $ | 1,889 | $ | 1,978 | $ | 2,093 | $ | 2,401 | $ | 2,865 | $ | 3,150 | $ | 3,386 | $ | 3,514 | $ | 3,629 | ||||||||||||||||||||||
Reinsurance recoverable | 109 | 122 | 112 | 138 | 161 | 219 | 513 | 542 | 541 | 537 | 518 | |||||||||||||||||||||||||||||||||
Net of reinsurance | $ | 1,581 | $ | 1,702 | $ | 1,777 | $ | 1,840 | $ | 1,932 | $ | 2,182 | $ | 2,352 | $ | 2,608 | $ | 2,845 | $ | 2,977 | $ | 3,111 | ||||||||||||||||||||||
B. Cumulative net paid as of: | ||||||||||||||||||||||||||||||||||||||||||||
One year later | $ | 395 | $ | 453 | $ | 499 | $ | 522 | $ | 591 | $ | 697 | $ | 758 | $ | 799 | $ | 817 | $ | 907 | ||||||||||||||||||||||||
Two years later | 630 | 732 | 761 | 853 | 943 | 1,116 | 1,194 | 1,235 | 1,293 | |||||||||||||||||||||||||||||||||||
Three years later | 801 | 884 | 965 | 1,067 | 1,195 | 1,378 | 1,455 | 1,519 | ||||||||||||||||||||||||||||||||||||
Four years later | 881 | 992 | 1,075 | 1,207 | 1,327 | 1,526 | 1,614 | |||||||||||||||||||||||||||||||||||||
Five years later | 946 | 1,049 | 1,152 | 1,283 | 1,412 | 1,623 | ||||||||||||||||||||||||||||||||||||||
Six years later | 977 | 1,093 | 1,205 | 1,333 | 1,464 | |||||||||||||||||||||||||||||||||||||||
Seven years later | 1,009 | 1,123 | 1,239 | 1,366 | ||||||||||||||||||||||||||||||||||||||||
Eight years later | 1,031 | 1,146 | 1,260 | |||||||||||||||||||||||||||||||||||||||||
Nine years later | 1,045 | 1,159 | ||||||||||||||||||||||||||||||||||||||||||
Ten years later | 1,053 | |||||||||||||||||||||||||||||||||||||||||||
C. Net reserves re-estimated as of: | ||||||||||||||||||||||||||||||||||||||||||||
One year later | $ | 1,429 | $ | 1,582 | $ | 1,623 | $ | 1,724 | $ | 1,912 | $ | 2,120 | $ | 2,307 | $ | 2,528 | $ | 2,649 | $ | 2,817 | ||||||||||||||||||||||||
Two years later | 1,380 | 1,470 | 1,551 | 1,728 | 1,833 | 2,083 | 2,263 | 2,377 | 2,546 | |||||||||||||||||||||||||||||||||||
Three years later | 1,279 | 1,405 | 1,520 | 1,636 | 1,802 | 2,052 | 2,178 | 2,336 | ||||||||||||||||||||||||||||||||||||
Four years later | 1,236 | 1,380 | 1,465 | 1,615 | 1,771 | 2,010 | 2,153 | |||||||||||||||||||||||||||||||||||||
Five years later | 1,227 | 1,326 | 1,466 | 1,608 | 1,757 | 1,999 | ||||||||||||||||||||||||||||||||||||||
Six years later | 1,189 | 1,333 | 1,463 | 1,602 | 1,733 | |||||||||||||||||||||||||||||||||||||||
Seven years later | 1,205 | 1,333 | 1,460 | 1,577 | ||||||||||||||||||||||||||||||||||||||||
Eight years later | 1,210 | 1,332 | 1,435 | |||||||||||||||||||||||||||||||||||||||||
Nine years later | 1,208 | 1,305 | ||||||||||||||||||||||||||||||||||||||||||
Ten years later | 1,183 | |||||||||||||||||||||||||||||||||||||||||||
D. Cumulative net redundancy as of: | ||||||||||||||||||||||||||||||||||||||||||||
One year later | $ | 152 | $ | 120 | $ | 154 | $ | 116 | $ | 20 | $ | 62 | $ | 45 | $ | 80 | $ | 196 | $ | 160 | ||||||||||||||||||||||||
Two years later | 201 | 232 | 226 | 112 | 99 | 99 | 89 | 231 | 299 | |||||||||||||||||||||||||||||||||||
Three years later | 302 | 297 | 257 | 204 | 130 | 130 | 174 | 272 | ||||||||||||||||||||||||||||||||||||
Four years later | 345 | 322 | 312 | 225 | 161 | 172 | 199 | |||||||||||||||||||||||||||||||||||||
Five years later | 354 | 376 | 311 | 232 | 175 | 183 | ||||||||||||||||||||||||||||||||||||||
Six years later | 392 | 369 | 314 | 238 | 199 | |||||||||||||||||||||||||||||||||||||||
Seven years later | 376 | 369 | 317 | 263 | ||||||||||||||||||||||||||||||||||||||||
Eight years later | 371 | 370 | 342 | |||||||||||||||||||||||||||||||||||||||||
Nine years later | 373 | 397 | ||||||||||||||||||||||||||||||||||||||||||
Ten years later | 398 | |||||||||||||||||||||||||||||||||||||||||||
Net liability re-estimated—latest | $ | 1,183 | $ | 1,305 | $ | 1,435 | $ | 1,577 | $ | 1,733 | $ | 1,999 | $ | 2,153 | $ | 2,336 | $ | 2,546 | $ | 2,817 | ||||||||||||||||||||||||
Re-estimated recoverable—latest | 179 | 174 | 189 | 214 | 222 | 248 | 513 | 548 | 526 | 539 | ||||||||||||||||||||||||||||||||||
Gross liability re-estimated—latest | $ | 1,362 | $ | 1,479 | $ | 1,624 | $ | 1,791 | $ | 1,955 | $ | 2,247 | $ | 2,666 | $ | 2,884 | $ | 3,072 | $ | 3,356 | ||||||||||||||||||||||||
Cummulative gross redundancy | $ | 328 | $ | 345 | $ | 265 | $ | 187 | $ | 138 | $ | 154 | $ | 199 | $ | 266 | $ | 314 | $ | 158 | ||||||||||||||||||||||||
2005 10-K Page 63
Loss reserves | Loss | Total | ||||||||||||||||||
Case | IBNR | expense | gross | Percent | ||||||||||||||||
(In millions) | reserves | reserves | reserves | reserves | of total | |||||||||||||||
At December 31, 2005 | ||||||||||||||||||||
Commercial multi-peril | $ | 505 | $ | 101 | $ | 228 | $ | 834 | 26.3 | % | ||||||||||
Workers compensation | 283 | 333 | 79 | 695 | 21.9 | |||||||||||||||
Commercial auto | 267 | 56 | 65 | 388 | 12.2 | |||||||||||||||
Other liability | 312 | 368 | 140 | 820 | 25.9 | |||||||||||||||
All other lines of business | 277 | 24 | 135 | 436 | 13.7 | |||||||||||||||
Total | $ | 1,644 | $ | 882 | $ | 647 | $ | 3,173 | 100.0 | % | ||||||||||
At December 31, 2004 | ||||||||||||||||||||
Commercial multi-peril | $ | 465 | $ | 123 | $ | 227 | $ | 815 | 27.0 | % | ||||||||||
Workers compensation | 258 | 278 | 75 | 611 | 20.3 | |||||||||||||||
Commercial auto | 254 | 58 | 64 | 376 | 12.5 | |||||||||||||||
Other liability | 288 | 377 | 111 | 776 | 25.7 | |||||||||||||||
All other lines of business | 289 | 19 | 130 | 438 | 14.5 | |||||||||||||||
Total | $ | 1,554 | $ | 855 | $ | 607 | $ | 3,016 | 100.0 | % | ||||||||||
2005 10-K Page 64
Commercial | Workers | Commercial | Other | ||||||||||||||||||||
(Dollars in millions) | multi-peril | compensation | auto | liability | |||||||||||||||||||
As of December 31, 2005 | |||||||||||||||||||||||
2004 accident year | $ | 5 | $ | (9 | ) | $ | 16 | $ | 36 | ||||||||||||||
2003 accident year | 22 | (13 | ) | 5 | 32 | ||||||||||||||||||
2002 accident year | 9 | (8 | ) | 2 | 6 | ||||||||||||||||||
2001 accident year | 7 | (3 | ) | 1 | 1 | ||||||||||||||||||
2000 accident year | 0 | (3 | ) | 0 | (8 | ) | |||||||||||||||||
1999 accident year | 2 | (3 | ) | 0 | 0 | ||||||||||||||||||
1998 and prior accident years | 16 | (4 | ) | 10 | (17 | ) | |||||||||||||||||
Redundancy/(deficiency) | $ | 61 | $ | (43 | ) | $ | 34 | $ | 50 | ||||||||||||||
Reserves as originally estimated | $ | 760 | $ | 557 | $ | 372 | $ | 599 | |||||||||||||||
Reserves re-estimated as of December 31, 2005 | 699 | 600 | 338 | 549 | |||||||||||||||||||
Redundancy/(deficiency) | $ | 61 | $ | (43 | ) | $ | 34 | $ | 50 | ||||||||||||||
Impact on loss and loss expense ratio | 7.7 | % | (13.3 | )% | 7.4 | % | 11.2 | % | |||||||||||||||
As of December 31, 2004 | |||||||||||||||||||||||
2003 accident year | $ | (5 | ) | $ | 5 | $ | 11 | $ | 36 | ||||||||||||||
2002 accident year | 2 | (1 | ) | 10 | 41 | ||||||||||||||||||
2001 accident year | 5 | (6 | ) | 4 | 27 | ||||||||||||||||||
2000 accident year | 4 | (3 | ) | 4 | 13 | ||||||||||||||||||
1999 accident year | 0 | (2 | ) | 7 | 2 | ||||||||||||||||||
1998 accident year | 1 | (1 | ) | 3 | 0 | ||||||||||||||||||
1997 and prior accident years | (11 | ) | (7 | ) | 8 | 12 | |||||||||||||||||
Redundancy/(deficiency) | $ | (4 | ) | $ | (15 | ) | $ | 47 | $ | 131 | |||||||||||||
Reserves as originally estimated | $ | 691 | $ | 514 | $ | 381 | $ | 635 | |||||||||||||||
Reserves re-estimated as of December 31, 2004 | 695 | 529 | 334 | 504 | |||||||||||||||||||
Redundancy/(deficiency) | $ | (4 | ) | $ | (15 | ) | $ | 47 | $ | 131 | |||||||||||||
Impact on loss and loss expense ratio | (0.6 | )% | (4.9 | )% | 10.5 | % | 32.5 | % | |||||||||||||||
As of December 31, 2003 | |||||||||||||||||||||||
2002 accident year | $ | (3 | ) | $ | (1 | ) | $ | 11 | $ | 36 | |||||||||||||
2001 accident year | 2 | (3 | ) | 2 | 15 | ||||||||||||||||||
2000 accident year | (10 | ) | (2 | ) | 7 | 5 | |||||||||||||||||
1999 accident year | 5 | (1 | ) | 11 | 6 | ||||||||||||||||||
1998 accident year | (2 | ) | 0 | 2 | 3 | ||||||||||||||||||
1997 accident year | (2 | ) | (1 | ) | 1 | 5 | |||||||||||||||||
1996 and prior accident years | (3 | ) | (5 | ) | 3 | 9 | |||||||||||||||||
Redundancy/(deficiency) | $ | (13 | ) | $ | (13 | ) | $ | 37 | $ | 79 | |||||||||||||
Reserves as originally estimated | $ | 609 | $ | 477 | $ | 383 | $ | 580 | |||||||||||||||
Reserves re-estimated as of December 31, 2003 | 622 | 490 | 346 | 501 | |||||||||||||||||||
Redundancy/(deficiency) | $ | (13 | ) | $ | (13 | ) | $ | 37 | $ | 79 | |||||||||||||
Impact on loss and loss expense ratio | (2.0 | )% | (4.3 | )% | 8.8 | % | 23.0 | % |
• | The initiative, begun in 2001, to establish higher initial case reserves on liability claims in the period in which the claim is reported. |
• | Higher than expected medical inflation affecting the workers compensation line |
• | Settlements that differed from the established case reserves |
• | Changes in case reserves based on new information for specific claims or classes of claims |
• | Differences in the timing of actual settlements compared with the payout patterns assumed in the accident year IBNR reductions |
• | Lower risk profile after 2001 due to commercial lines underwriting initiatives |
2005 10-K Page 65
Loss reserves | Loss | Total | ||||||||||||||||||
Case | IBNR | expense | gross | Percent | ||||||||||||||||
(In millions) | reserves | reserves | reserves | reserves | of total | |||||||||||||||
At December 31, 2005 | ||||||||||||||||||||
Personal auto | $ | 175 | $ | 4 | $ | 34 | $ | 213 | 46.9 | % | ||||||||||
Homeowners | 70 | 21 | 18 | 109 | 23.8 | |||||||||||||||
All other lines of business | 55 | 67 | 12 | 134 | 29.3 | |||||||||||||||
Total | $ | 300 | $ | 92 | $ | 64 | $ | 456 | 100.0 | % | ||||||||||
At December 31, 2004 | ||||||||||||||||||||
Personal auto | $ | 181 | $ | 15 | $ | 35 | $ | 231 | 46.4 | % | ||||||||||
Homeowners | 81 | 21 | 23 | 125 | 25.1 | |||||||||||||||
All other lines of business | 57 | 73 | 12 | 142 | 28.5 | |||||||||||||||
Total | $ | 319 | $ | 109 | $ | 70 | $ | 498 | 100.0 | % | ||||||||||
2005 10-K Page 66
Personal | ||||||||
(Dollars in millions) | auto | Homeowners | ||||||
As of December 31, 2005 | ||||||||
2004 accident year | $ | 2 | $ | 1 | ||||
2003 accident year | 0 | 2 | ||||||
2002 accident year | 2 | 0 | ||||||
2001 accident year | 4 | 1 | ||||||
2000 accident year | 1 | 0 | ||||||
1999 accident year | 1 | (1 | ) | |||||
1998 and prior accident years | 2 | 0 | ||||||
Redundancy/(deficiency) | $ | 12 | $ | 3 | ||||
Reserves as originally estimated | $ | 231 | $ | 114 | ||||
Reserves re-estimated as of December 31, 2005 | 219 | 111 | ||||||
Redundancy/(deficiency) | $ | 12 | $ | 3 | ||||
Impact on loss and loss expense ratio | 2.7 | % | 1.0 | % | ||||
As of December 31, 2004 | ||||||||
2003 accident year | $ | (9 | ) | $ | 0 | |||
2002 accident year | (1 | ) | 1 | |||||
2001 accident year | 3 | 4 | ||||||
2000 accident year | 3 | 1 | ||||||
1999 accident year | 1 | 0 | ||||||
1998 accident year | 1 | 0 | ||||||
1997 and prior accident years | 1 | 0 | ||||||
Redundancy/(deficiency) | $ | (1 | ) | $ | 6 | |||
Reserves as originally estimated | $ | 224 | $ | 89 | ||||
Reserves re-estimated as of December 31, 2004 | 225 | 83 | ||||||
Redundancy/(deficiency) | $ | (1 | ) | $ | 6 | |||
Impact on loss and loss expense ratio | (0.2 | )% | 2.2 | % | ||||
As of December 31, 2003 | ||||||||
2002 accident year | $ | (8 | ) | $ | 2 | |||
2001 accident year | (4 | ) | 5 | |||||
2000 accident year | 0 | 0 | ||||||
1999 accident year | 2 | 1 | ||||||
1998 accident year | 0 | 0 | ||||||
1997 accident year | 1 | 0 | ||||||
1996 and prior accident years | 0 | 0 | ||||||
Redundancy/(deficiency) | $ | (9 | ) | $ | 8 | |||
Reserves as originally estimated | $ | 201 | $ | 96 | ||||
Reserves re-estimated as of December 31, 2003 | 210 | 88 | ||||||
Redundancy/(deficiency) | $ | (9 | ) | $ | 8 | |||
Impact on loss and loss expense ratio | (2.1 | )% | 3.1 | % |
• | Settlements that differed from the established case reserves |
• | Changes in case reserves based on new information for specific claims or classes of claims |
• | Differences in the timing of actual settlements compared with the payout patterns assumed in the accident year IBNR reductions |
• | Recognition of favorable case reserve development |
2005 10-K Page 67
• | Property per risk treaty – The primary purpose of the property treaty is to provide excess limits capacity up to $25 million, supplying adequate capacity for the majority of the risks we write and also includes protection for extra-contractual liability coverage losses. The ceded premium is estimated to be $30 million for 2006, compared with $29 million in 2005 and $27 million in 2004. In 2006, we are retaining the first $4 million of each loss. Losses between $4 million and $25 million are reinsured at 100 percent. The $4 million base retention is new for 2006. Last year, we retained the first $3 million of every property loss. Losses in excess of $3 million were reinsured at 100 percent up to $25 million in 2005. | |
• | Casualty per occurrence treaty – The casualty treaty provides excess limits capacity up to $25 million. Similar to the property treaty, this provides sufficient capacity to cover the vast majority of casualty accounts we insure and also includes protection for extra-contractual liability coverage losses. The ceded premium is estimated to be $47 million in 2006, compared with $64 million in 2005 and $61 million in 2004. In 2006, we are changing to a flat $4 million retention. Previously, we retained the first $2 million of each casualty loss, and 60 percent of the next $2 million of loss. Losses in excess of $4 million are reinsured at 100 percent up to $25 million. | |
In mid-2005, we modified our casualty per occurrence treaty for director and officer policies for five Fortune 1000 companies and one financial services company. For three of the six companies, our retention per policy could be as high as $15 million rather than the $4 million for a typical policy; for one of the other companies, our retention per policy could be as high as $14 million; for the other two companies, our retention per policy could be as high as $5 million. We believe the additional risk undertaken with these selected policies remains at an acceptable level based on our financial strength. We arranged for this exception for this small group of companies to maintain business relationships with key agencies and insureds. We intend to review this element of our working treaties on an ongoing basis. | ||
• | Casualty excess treaties – We purchase a casualty reinsurance treaty that provides an additional $25 million in protection for certain casualty losses. This treaty, along with the casualty per occurrence treaty, provides a total of $50 million of protection for workers compensation, extra-contractual liability coverage and clash coverage losses, which is used when there is a single occurrence involving multiple |
2005 10-K Page 68
policyholders of The Cincinnati Insurance Companies or multiple coverages for one insured. The ceded premium is estimated to be $2 million in 2006 up only slightly from 2005 and 2004. |
We purchase another casualty excess treaty, which provides an additional $20 million in casualty loss coverage. This treaty also provides catastrophic coverage for workers compensation and extra-contractual liability coverage losses. The ceded premium is estimated to be $1 million for 2006, similar to the premium paid in 2005. |
• | Property catastrophe treaty – To protect against catastrophic events such as wind and hail, hurricanes or earthquakes, we purchase property catastrophe reinsurance, with a limit up to $500 million. For the 2006 treaty, ceded premiums are estimated to be $38 million, up from $29 million in 2005, excluding the reinstatement premium, and $27 million in 2004, excluding the reinstatement premium. The premium increase for 2006 primarily is due to the difficult market conditions brought on in part by the record catastrophe losses experienced by reinsurance companies in 2005. We increased our retention on this program to $45 million and we will retain 5 percent of losses between $45 million and $500 million. In 2005, we retained the first $25 million of losses arising out of a single event, 40 percent of losses from $25 million to $45 million and 5 percent of all losses in excess of $45 million, up to $500 million. |
• | Unusually high levels of catastrophe losses due to risk concentrations, changes in weather patterns, environmental events, terrorism incidents or other causes | |
• | Ability to obtain adequate reinsurance on acceptable terms, amount of reinsurance purchased and financial strength of reinsurers | |
• | Increased frequency and/or severity of claims |
2005 10-K Page 69
• | Events or conditions that could weaken or harm the company’s relationships with its independent agencies and hamper opportunities to add new agencies, resulting in limitations on the company’s opportunities for growth, such as: |
o | Downgrade of the company’s financial strength ratings, | ||
o | Concerns that doing business with the company is too difficult or | ||
o | Perceptions that the company’s level of service, particularly claims service, is no longer a distinguishing characteristic in the marketplace |
• | Increased competition that could result in a significant reduction in the company’s premium growth rate | |
• | Underwriting and pricing methods adopted by competitors that could allow them to identify and flexibly price risks, which could decrease our competitive advantages | |
• | Insurance regulatory actions, legislation or court decisions or legal actions that increase expenses or place us at a disadvantage in the marketplace | |
• | Delays or inadequacies in the development, implementation, performance and benefits of technology projects and enhancements | |
• | Inaccurate estimates or assumptions used for critical accounting estimates, including loss reserves | |
• | Events that reduce the company’s ability to maintain effective internal control over financial reporting under the Sarbanes-Oxley Act of 2002 in the future | |
• | Recession or other economic conditions or regulatory, accounting or tax changes resulting in lower demand for insurance products | |
• | Sustained decline in overall stock market values negatively affecting the company’s equity portfolio; in particular a sustained decline in the market value of Fifth Third shares, a significant equity holding | |
• | Events that lead to a significant decline in the value of a particular security and impairment of the asset | |
• | Prolonged low interest rate environment or other factors that limit the company’s ability to generate growth in investment income | |
• | Adverse outcomes from litigation or administrative proceedings | |
• | Effect on the insurance industry as a whole, and thus on the company’s business, of the actions undertaken by the Attorney General of the State of New York and other regulators against participants in the insurance industry, as well as any increased regulatory oversight that might result | |
• | Investment activities or market value fluctuations that trigger restrictions applicable to the parent company under the Investment Company Act of 1940 |
• | Political – the potential for a decrease in market value due to the real or perceived impact of governmental policies or conditions | |
• | Regulatory – the potential for a decrease in market value due to the impact of legislative proposals or changes in laws or regulations | |
• | Economic – the potential for a decrease in value due to changes in general economic factors (recession, inflation, deflation, etc.) |
2005 10-K Page 70
• | Revaluation – the potential for a decrease in market value due to a change in relative value (change in market multiple) of the market brought on by general economic factors | |
• | Interest-rate – the potential for a decrease in market value of a security or portfolio due to its sensitivity to changes (increases or decreases) in the general level of interest rates |
• | Fraud – the potential for a negative impact on an issuer’s performance due to actual or alleged illegal or improper activity of individuals it employs | |
• | Credit – the potential for deterioration in an issuer’s financial profile due to specific company issues, problems it faces in the course of its operations or industry-related issues | |
• | Default – the possibility that an issuer will not make a required payment (interest payment or return of principal) on its debt. Generally this occurs after its financial profile has deteriorated (credit risk) and it no longer has the means to make its payments |
Taxable | Tax-exempt | Preferred | Short-term | |||||||||||||||||
fixed maturities | fixed maturities | Common equities | equities | investments | ||||||||||||||||
Political | A | H | A | A | L | |||||||||||||||
Regulatory | A | A | A | A | L | |||||||||||||||
Economic | A | A | H | A | L | |||||||||||||||
Revaluation | A | A | H | A | L | |||||||||||||||
Interest rate | H | H | A | H | L | |||||||||||||||
Fraud | A | L | A | A | L | |||||||||||||||
Credit | A | L | A | A | L | |||||||||||||||
Default | A | L | A | A | L |
2005 10-K Page 71
Fair value | Modified duration | Duration to worst | ||||||||||||||||||
of fixed | 100 basis | 100 basis | 100 basis | 100 basis | ||||||||||||||||
maturity | point spread | point spread | point spread | point spread | ||||||||||||||||
(In millions) | portfolio | decrease | increase | decrease | increase | |||||||||||||||
At December 31, 2005 | $ | 5,476 | $ | 5,868 | $ | 5,084 | $ | 5,779 | $ | 5,173 | ||||||||||
At December 31, 2004 | 5,070 | 5,445 | 4,695 | 5,326 | 4,814 |
2005 10-K Page 72
Years ended December 31, | ||||||||||||
(In Millions except market price data) | 2005 | 2004 | 2003 | |||||||||
Fifth Third Bancorp common stock holding: | ||||||||||||
Dividends earned | $ | 106 | $ | 95 | $ | 82 | ||||||
Percent of total investment income | 20.2 | % | 19.4 | % | 17.7 | % | ||||||
At December 31, | ||||||||||||
2005 | 2004 | |||||||||||
Shares held | 73 | 73 | ||||||||||
Closing market price of Fifth Third | $ | 37.72 | $ | 47.30 | ||||||||
Book value of holding | 283 | 283 | ||||||||||
Fair value of holding | 2,745 | 3,443 | ||||||||||
After-tax unrealized gain | 1,600 | 2,054 | ||||||||||
Market value as a percent of total equity investments | 38.6 | % | 45.9 | % | ||||||||
Market value as a percent of invested assets | 21.6 | 27.2 | ||||||||||
Market value as a percent of total shareholders’ equity | 45.1 | 55.1 | ||||||||||
After-tax unrealized gain as a percent of total shareholders’ equity | 26.3 | 32.9 |
2005 10-K Page 73
• | 714 of these holdings were trading between 90 percent and 100 percent of book value. The value of these securities fluctuates primarily because of changes in interest rates. The fair value of these 714 securities was $2.717 billion at December 31, 2005, and they accounted for $57 million in unrealized losses. | |
• | 18 of these holdings were trading below 90 percent of book value at December 31, 2005. The fair value of these holdings was $111 million, and they accounted for the remaining $21 million in unrealized losses. These holdings are being monitored for credit- and industry-related risk factors. Of these securities, seven are bonds or convertible preferred stocks of auto industry-related issuers and one is a common stock of a pharmaceutical company. These eight securities account for $69 million of the fair value of holdings trading below 90 percent of book value. The remaining ten are smaller positions in a variety of industries. |
2005 10-K Page 74
6 Months or less | > 6-12 Months | > 12-24 Months | > 24-36 Months | |||||||||||||||||||||||||||||
Gross | Gross | Gross | Gross | |||||||||||||||||||||||||||||
Number | unrealized | Number | unrealized | Number | unrealized | Number | unrealized | |||||||||||||||||||||||||
(Dollars in millions) | of issues | gain/loss | of issues | gain/loss | of issues | gain/loss | of issues | gain/loss | ||||||||||||||||||||||||
Taxable fixed maturities: | ||||||||||||||||||||||||||||||||
Trading below 70% of book value | 2 | $ | (4 | ) | 0 | $ | 0 | 0 | $ | 0 | 0 | $ | 0 | |||||||||||||||||||
Trading at 70% to less than 100% of book value | 185 | (22 | ) | 57 | (17 | ) | 46 | (12 | ) | 5 | (1 | ) | ||||||||||||||||||||
Trading at 100% and above of book value | 37 | 3 | 14 | 1 | 35 | 5 | 346 | 102 | ||||||||||||||||||||||||
Total | 224 | (23 | ) | 71 | (16 | ) | 81 | (7 | ) | 351 | 101 | |||||||||||||||||||||
Tax-exempt fixed maturities: | ||||||||||||||||||||||||||||||||
Trading below 70% of book value | 0 | 0 | 0 | 0 | 0 | 0 | 0 | 0 | ||||||||||||||||||||||||
Trading at 70% to less than 100% of book value | 357 | (8 | ) | 32 | (3 | ) | 32 | (3 | ) | 3 | 0 | |||||||||||||||||||||
Trading at 100% and above of book value | 51 | 1 | 43 | 1 | 105 | 3 | 384 | 43 | ||||||||||||||||||||||||
Total | 408 | (7 | ) | 75 | (2 | ) | 137 | 0 | 387 | 43 | ||||||||||||||||||||||
Common equities: | ||||||||||||||||||||||||||||||||
Trading below 70% of book value | 0 | 0 | 0 | 0 | 0 | 0 | 0 | 0 | ||||||||||||||||||||||||
Trading at 70% to less than 100% of book value | 1 | 0 | 1 | 0 | 2 | (5 | ) | 0 | 0 | |||||||||||||||||||||||
Trading at 100% and above of book value | 5 | 3 | 1 | 1 | 4 | 8 | 35 | 4,968 | ||||||||||||||||||||||||
Total | 6 | 3 | 2 | 1 | 6 | 3 | 35 | 4,968 | ||||||||||||||||||||||||
Preferred equities: | ||||||||||||||||||||||||||||||||
Trading below 70% of book value | 0 | 0 | 0 | 0 | 0 | 0 | 0 | 0 | ||||||||||||||||||||||||
Trading at 70% to less than 100% of book value | 8 | (2 | ) | 0 | 0 | 0 | 0 | 1 | (1 | ) | ||||||||||||||||||||||
Trading at 100% and above of book value | 11 | 1 | 4 | 1 | 3 | 0 | 2 | 4 | ||||||||||||||||||||||||
Total | 19 | (1 | ) | 4 | 1 | 3 | 0 | 3 | 3 | |||||||||||||||||||||||
Short-term investments: | ||||||||||||||||||||||||||||||||
Trading below 70% of book value | 0 | 0 | 0 | 0 | 0 | 0 | 0 | 0 | ||||||||||||||||||||||||
Trading at 70% to less than 100% of book value | 0 | 0 | 0 | 0 | 0 | 0 | 0 | 0 | ||||||||||||||||||||||||
Trading at 100% and above of book value | 2 | 0 | 0 | 0 | 0 | 0 | 0 | 0 | ||||||||||||||||||||||||
Total | 2 | 0 | 0 | 0 | 0 | 0 | 0 | 0 | ||||||||||||||||||||||||
Summary: | ||||||||||||||||||||||||||||||||
Trading below 70% of book value | 2 | (4 | ) | 0 | 0 | 0 | 0 | 0 | 0 | |||||||||||||||||||||||
Trading at 70% to less than 100% of book value | 551 | (32 | ) | 90 | (20 | ) | 80 | (20 | ) | 9 | (2 | ) | ||||||||||||||||||||
Trading at 100% and above of book value | 106 | 8 | 62 | 4 | 147 | 16 | 767 | 5,117 | ||||||||||||||||||||||||
Total | 659 | $ | (28 | ) | 152 | $ | (16 | ) | 227 | $ | (4 | ) | 776 | $ | 5,115 | |||||||||||||||||
2005 10-K Page 75
Gross | Gross | |||||||||||||||||||
Number | unrealized | investment | ||||||||||||||||||
(Dollars in millions) | of issues | Book value | Fair value | gain/loss | income | |||||||||||||||
At December 31, 2005 | ||||||||||||||||||||
Taxable fixed maturities: | ||||||||||||||||||||
Trading below 70% of book value | 2 | $ | 12 | $ | 8 | $ | (4 | ) | $ | 1 | ||||||||||
Trading at 70% to less than 100% of book value | 293 | 1,839 | 1,787 | (52 | ) | 84 | ||||||||||||||
Trading at 100% and above of book value | 432 | 1,453 | 1,564 | 111 | 99 | |||||||||||||||
Securities sold in current year | 0 | 0 | 0 | 0 | 15 | |||||||||||||||
Total | 727 | 3,304 | 3,359 | 55 | 199 | |||||||||||||||
Tax-exempt fixed maturities: | ||||||||||||||||||||
Trading below 70% of book value | 0 | 0 | 0 | 0 | 0 | |||||||||||||||
Trading at 70% to less than 100% of book value | 424 | 941 | 927 | (14 | ) | 32 | ||||||||||||||
Trading at 100% and above of book value | 583 | 1,142 | 1,190 | 48 | 55 | |||||||||||||||
Securities sold in current year | 0 | 0 | 0 | 0 | 3 | |||||||||||||||
Total | 1,007 | 2,083 | 2,117 | 34 | 90 | |||||||||||||||
Common equities: | ||||||||||||||||||||
Trading below 70% of book value | 0 | 0 | 0 | 0 | 0 | |||||||||||||||
Trading at 70% to less than 100% of book value | 4 | 51 | 46 | (5 | ) | 1 | ||||||||||||||
Trading at 100% and above of book value | 45 | 1,910 | 6,890 | 4,980 | 229 | |||||||||||||||
Securities sold in current year | 0 | 0 | 0 | 0 | 0 | |||||||||||||||
Total | 49 | 1,961 | 6,936 | 4,975 | 230 | |||||||||||||||
Preferred equities: | ||||||||||||||||||||
Trading below 70% of book value | 0 | 0 | 0 | 0 | 0 | |||||||||||||||
Trading at 70% to less than 100% of book value | 9 | 63 | 60 | (3 | ) | 1 | ||||||||||||||
Trading at 100% and above of book value | 20 | 104 | 110 | 6 | 3 | |||||||||||||||
Securities sold in current year | 0 | 0 | 0 | 0 | 0 | |||||||||||||||
Total | 29 | 167 | 170 | 3 | 4 | |||||||||||||||
Short-term investments: | ||||||||||||||||||||
Trading below 70% of book value | 0 | 0 | 0 | 0 | 0 | |||||||||||||||
Trading at 70% to less than 100% of book value | 0 | 0 | 0 | 0 | 0 | |||||||||||||||
Trading at 100% and above of book value | 2 | 75 | 75 | 0 | 1 | |||||||||||||||
Securities sold in current year | 0 | 0 | 0 | 0 | 0 | |||||||||||||||
Total | 2 | 75 | 75 | 0 | 1 | |||||||||||||||
Portfolio summary: | ||||||||||||||||||||
Trading below 70% of book value | 2 | 12 | 8 | (4 | ) | 1 | ||||||||||||||
Trading at 70% to less than 100% of book value | 730 | 2,894 | 2,820 | (74 | ) | 118 | ||||||||||||||
Trading at 100% and above of book value | 1,082 | 4,684 | 9,829 | 5,145 | 387 | |||||||||||||||
Securities sold in current year | 0 | 0 | 0 | 0 | 18 | |||||||||||||||
Total | 1,814 | $ | 7,590 | $ | 12,657 | $ | 5,067 | $ | 524 | |||||||||||
At December 31, 2004 | ||||||||||||||||||||
Portfolio summary: | ||||||||||||||||||||
Trading below 70% of book value | 0 | $ | 0 | $ | 0 | $ | 0 | $ | 0 | |||||||||||
Trading at 70% to less than 100% of book value | 208 | 900 | 883 | (17 | ) | 32 | ||||||||||||||
Trading at 100% and above of book value | 1,385 | 5,899 | 11,756 | 5,857 | 427 | |||||||||||||||
Securities sold in current year | 0 | 0 | 0 | 0 | 32 | |||||||||||||||
Total | 1,593 | $ | 6,799 | $ | 12,639 | $ | 5,840 | $ | 491 | |||||||||||
2005 10-K Page 76
/S/ Kenneth W. Stecher | ||||
By: | Kenneth W. Stecher | |||
Title: | Chief Financial Officer, Senior Vice President, Secretary and Treasurer | |||
Date: | March 15, 2006 |
Exhibit No. | Exhibit Description | |
3.1A | Amended Articles of Incorporation of Cincinnati Financial Corporation (1) | |
3.1B | Amendment to Article Fourth of Amended Articles of Incorporation of Cincinnati Financial Corporation (2) | |
3.2 | Regulations of Cincinnati Financial Corporation (3) | |
4.1 | Indenture with The Bank of New York Trust Company (4) | |
4.2 | Supplemental Indenture with The Bank of New York Trust Company (4) | |
4.3 | Second Supplemental Indenture with The Bank of New York Trust Company (5) | |
4.4 | Form of 6.125% Exchange Note Due 2034 (included in Exhibit 4.2) | |
4.5 | Form of 6.92% Debentures Due 2028 (included in Exhibit 4.3) | |
4.6 | Indenture with the First National Bank of Chicago (subsequently assigned to The Bank of New York Trust Company)(6) | |
4.7 | Form of 6.90% Debentures Due 2028 (included in Exhibit 4.6) | |
10.1 | Agreement with Messer Construction (7) | |
10.2 | Stock Repurchase Agreement dated November 12, 2004 with Robert C. Schiff, Trustee, Robert C. Schiff Revocable Trust (7) | |
10.3 | Purchase Agreement with J.P. Morgan Securities Inc. and UBS Securities LLC (8) | |
10.4 | 2003 Non-Employee Directors’ Stock Plan (9) | |
10.5 | Cincinnati Financial Corporation Stock Option Plan No. V (10) | |
10.6 | Cincinnati Financial Corporation Stock Option Plan No. VI (11) | |
10.7 | Cincinnati Financial Corporation Stock Option Plan No. VII (12) | |
10.8 | Standard Form of Nonqualified and Incentive Option Agreements for Stock Option Plan No. V (7) | |
10.9 | Standard Form of Nonqualified and Incentive Option Agreements for Stock Option Plan No. VI (7) | |
10.10 | Standard Form of Nonqualified and Incentive Option Agreements for Stock Option Plan No. VII (7) | |
10.11 | Cincinnati Financial Corporation Stock Option Plan No. VIII (9) | |
10.12 | Registration Rights Agreement with J.P. Morgan Securities Inc. and UBS Securities LLC (4) | |
10.13 | Form of Dealer Manager Agreement between Cincinnati Financial and UBS Securities LLC (13) | |
10.14 | Standard Form of Incentive Stock Option Agreement for Stock Option Plan VIII (14) | |
10.15 | Standard Form of Nonqualified Stock Option Agreement for Stock Option Plan VIII (15) | |
10.16 | Standard Form of Combined Incentive/Nonqualified Stock Option for Stock Option Plan VI (16) | |
10.17 | 364-Day Credit Agreement by and among Cincinnati Financial Corporation and CFC Investment Company, as Borrowers, and Fifth Third Bank, as Lender (17) | |
10.18 | Director and Named Executive Officer Compensation Summary (18) | |
10.19 | Executive Compensation Plan (19) | |
11 | Statement re: Computation of per share earnings for the years ended December 31, 2005, 2004 and 2003, contained in Note 11 to the Consolidated Financial Statements included in Part II, Item 8 of this report, Page 93 | |
14 | Cincinnati Financial Corporation Code of Ethics for Senior Financial Officers (20) | |
21 | Cincinnati Financial Corporation Subsidiaries contained in Part I, Item 1 of this report, Page 1 | |
23 | Consent of Independent Registered Public Accounting Firm, Page 114 | |
31.1 | Certification pursuant to Section 302 of the Sarbanes Oxley Act of 2002 – Chief Executive Officer | |
31.2 | Certification pursuant to Section 302 of the Sarbanes Oxley Act of 2002 – Chief Financial Officer | |
32 | Certification pursuant to Section 906 of the Sarbanes Oxley Act of 2002 |
1 | Incorporated by reference to the company’s 1999 Annual Report on Form 10-K dated March 23, 2000 (File No. 000-04604). | |
2 | Incorporated by reference to Exhibit 3(i) filed with the company’s Current Report on Form 8-K dated July 15, 2005. | |
3 | Incorporated by reference to the company’s Definitive Proxy Statement dated March 2, 1992, Exhibit 2 (File No. 000-04604). | |
4 | Incorporated by reference to the company’s Current Report on Form 8-K dated November 2, 2004, filed with respect to the issuance of the company’s 6.125% Senior Notes due November 1, 2034. | |
5 | Incorporated by reference to the company’s Current Report on Form 8-K dated May 9, 2005, filed with respect to the completion of the company’s exchange offer and rescission offer for its 6.90% senior debentures due 2028. | |
6 | Incorporated by reference to the company’s registration statement on Form S-3 effective May 22, 1998 (File No. 333-51677). | |
7 | Incorporated by reference to the company’s 2004 Annual Report on Form 10-K dated March 11, 2005. | |
8 | Incorporated by reference to the company’s Current Report on Form 8-K dated November 1, 2004, filed with respect to the issuance of the company’s 6.125% Senior Notes due November 1, 2034. | |
9 | Incorporated by reference to the company’s Definitive Proxy Statement dated March 21, 2005. | |
10 | Incorporated by reference to the company’s Definitive Proxy Statement dated March 2, 1996 (File No. 000-04604). | |
11 | Incorporated by reference to the company’s Definitive Proxy Statement dated March 1, 1999 (File No. 000-04604). | |
12 | Incorporated by reference to the company’s Definitive Proxy Statement dated March 8, 2002. | |
13 | Incorporated by reference to the company’s Registration Statement on Form S-4 filed March 21, 2005 (File No. 333-123471). | |
14 | Incorporated by reference to Exhibit 10.1 filed with the company’s Current Report on Form 8-K dated July 15, 2005. | |
15 | Incorporated by reference to Exhibit 10.2 filed with the company’s Current Report on Form 8-K dated July 15, 2005. | |
16 | Incorporated by reference to Exhibit 10.3 filed with the company’s Current Report on Form 8-K dated July 15, 2005. | |
17 | Incorporated by reference to Exhibit 10.1 filed with the company’s Current Report on Form 8-K dated May 31, 2005. | |
18 | Incorporated by reference to the company’s Definitive Proxy Statement to be filed no later than April 14, 2006. | |
19 | Incorporated by reference to Exhibit 10.2 filed with the company’s Current Report on Form 8-K dated November 23, 2005. | |
20 | Incorporated by reference to the company’s Definitive Proxy Statement dated March 18, 2004. |