UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
Quarterly Report Under Section 13 or 15 (d) of the
Securities Exchange Act of 1934
FOR THE QUARTERLY PERIOD ENDED SEPTEMBER 30, 2002
Commission File Number 0-4604
CINCINNATI FINANCIAL CORPORATION
An Ohio Corporation IRS Employer I.D.
No. 31-0746871
6200 South Gilmore Road
Fairfield, Ohio 45014-5141
(513) 870-2000
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15 (d) of the Securities Exchange Act of 1934
during the preceding 12 months (or for such shorter period that the registrant
was required to file such reports) and (2) has been subject to such filing
requirements for the past 90 days. YES X NO
Securities registered pursuant to Section 12(g) of the Act:
$2.00 Par Common - 161,490,000 shares outstanding at October 31, 2002
$419,651,000 of 6.9% Senior Debentures Due 2028
Page 1 of 20
CINCINNATI FINANCIAL CORPORATION 10-Q
ITEM I - FINANCIAL STATEMENTS
CINCINNATI FINANCIAL CORPORATION AND SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEETS
(UNAUDITED)
(Dollars in millions except per share data) September 30, December 31,
2002 2001
------------- ------------
ASSETS
Investments:
Fixed maturities (cost: 2002--$3,119; 2001--$3,012) $ 3,156 $ 3,010
Equity securities (cost: 2002--$2,358; 2001--$2,174) 7,816 8,495
Other invested assets 69 66
Cash 171 93
Investment income receivable 92 93
Finance receivables 33 27
Premiums receivable 850 732
Reinsurance receivables 485 515
Deferred policy acquisition costs 318 286
Property and equipment, net, for Company use
(accumulated depreciation: 2002--$148; 2001--$135) 131 125
Other assets 148 127
Separate accounts 415 390
-------- --------
TOTAL ASSETS $ 13,684 $ 13,959
======== ========
LIABILITIES
Insurance reserves:
Losses and loss expenses $ 3,068 $ 2,932
Life policy reserves 792 674
Unearned premiums 1,230 1,062
Other liabilities 348 283
Federal income taxes:
Current 8 10
Deferred 1,703 2,001
Notes payable 183 183
6.9% senior debentures due 2028 420 420
5.5% convertible senior debentures due 2002 0 6
Separate Accounts 415 390
-------- --------
TOTAL LIABILITIES 8,167 7,961
-------- --------
SHAREHOLDERS' EQUITY
Common stock, par value -- $2 per share; authorized 200 million shares;
issued shares: 2002 --176 million; 2001--175 million;
outstanding shares: 2002--162 million; 2001--162 million 352 350
Paid-in capital 296 284
Retained earnings 1,751 1,678
Accumulated other comprehensive income- unrealized
gains on investments and derivatives 3,581 4,113
-------- --------
5,980 6,425
Less treasury stock at cost (2002--14 million shares;
2001--13 million shares) (463) (427)
-------- --------
TOTAL SHAREHOLDERS' EQUITY $ 5,517 $ 5,998
======== ========
TOTAL LIABILITIES AND SHAREHOLDERS' EQUITY $ 13,684 $ 13,959
======== ========
Accompanying notes are an integral part of these condensed consolidated
financial statements.
2
CINCINNATI FINANCIAL CORPORATION 10-Q
CINCINNATI FINANCIAL CORPORATION AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF INCOME
(UNAUDITED)
(In millions except share data)
Nine months ended September 30, Three months ended September 30,
-------------------------------- --------------------------------
2002 2001 2002 2001
------------- ------------- ------------- -------------
REVENUES
Net earned premiums
Property casualty $ 1,749 $ 1,519 $ 610 $ 520
Life 60 55 21 17
Accident health 3 3 1 1
------------- ------------- ------------- -------------
Net earned premiums 1,812 1,577 632 538
Net investment income 331 313 113 106
Realized (losses) gains on investments (34) 8 (16) (3)
Other income 12 9 2 3
------------- ------------- ------------- -------------
TOTAL REVENUES 2,121 1,907 731 644
------------- ------------- ------------- -------------
BENEFITS AND EXPENSES
Insurance losses and policyholder benefits 1,360 1,227 448 445
Commissions 345 297 120 100
Other operating expenses 150 136 53 41
Taxes, licenses and fees 51 44 19 15
Increase in deferred policy acquisition costs (32) (22) (9) (6)
Interest expenses 26 30 9 10
Other expenses 6 13 1 5
------------- ------------- ------------- -------------
TOTAL BENEFITS AND EXPENSES 1,906 1,725 641 610
------------- ------------- ------------- -------------
INCOME BEFORE INCOME TAXES 215 182 90 34
------------- ------------- ------------- -------------
PROVISION (BENEFIT) FOR INCOME TAXES
Current 44 38 15 11
Deferred (11) (13) 3 (13)
------------- ------------- ------------- -------------
TOTAL PROVISION (BENEFIT) FOR INCOME TAXES 33 25 18 (2)
------------- ------------- ------------- -------------
NET INCOME $ 182 $ 157 $ 72 $ 36
============= ============= ============= =============
PER COMMON SHARE:
Net income (basic) $ 1.12 $ 0.98 $ 0.44 $ 0.23
============= ============= ============= =============
Net income (diluted) $ 1.11 $ 0.97 $ 0.44 $ 0.22
============= ============= ============= =============
Cash dividend declared $ 0.67 $ 0.63 $ 0.22 $ 0.21
============= ============= ============= =============
Average shares outstanding (basic) 161,971,032 161,022,373 161,965,384 159,277,116
Average shares outstanding (diluted) 163,491,420 163,296,968 163,222,154 161,846,406
Accompanying notes are an integral part of these condensed consolidated
financial statements.
3
CINCINNATI FINANCIAL CORPORATION 10-Q
CONDENSED CONSOLIDATED STATEMENT OF SHAREHOLDERS' EQUITY
(UNAUDITED)
(In millions)
Nine Months Ended September 30, 2001 and 2002
------------------------------------------------------------------------------------------------
Accumulated
Other Total
Common Stock Treasury Paid-In Retained Comprehensive Shareholders'
Shares Amount Stock Capital Earnings Income Equity
------ -------- -------- --------- -------- ------------- -------------
BALANCE AT DECEMBER 31, 2000 173 $ 346 $ (381) $ 254 $ 1,620 $ 4,156 $ 5,995
=======
Net income 157 157
Change in accumulated other
comprehensive income, net
of income taxes of $62 (114) (114)
-------
Comprehensive income 43
Dividends declared (101) (101)
Purchase/issuance
of treasury shares (37) (37)
Stock options exercised 1 9 10
Conversion of debentures 1 2 14 16
---- ----- ------ ----- ------- ------- -------
BALANCE AT SEPTEMBER 30, 2001 174 $ 349 $ (418) $ 277 $ 1,676 $ 4,042 $ 5,926
==== ===== ====== ===== ======= ======= =======
BALANCE AT DECEMBER 31, 2001 175 $ 350 $ (427) $ 284 $ 1,678 $ 4,113 $ 5,998
-------
Net income 182 182
Change in accumulated other
comprehensive income, net
of income taxes of $286 (532) (532)
-------
Comprehensive income (350)
Dividends declared (108) (108)
Purchase/issuance
of treasury shares (36) (36)
Stock options exercised 1 6 7
Conversion of debentures 1 1 6 (1) 6
---- ----- ------ ----- ------- ------- -------
BALANCE AT SEPTEMBER 30, 2002 176 $ 352 $ (463) $ 296 $ 1,751 $ 3,581 $ 5,517
==== ===== ====== ===== ======= ======= =======
Accompanying notes are an integral part of these condensed consolidated
financial statements.
4
CINCINNATI FINANCIAL CORPORATION 10-Q
CINCINNATI FINANCIAL CORPORATION AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(UNAUDITED)
(In millions)
Nine months ended
September 30,
------------------------
2002 2001
---- ----
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income $ 182 $ 157
Adjustments to reconcile operating income
to net cash provided by operating activities:
Depreciation and amortization 14 19
Realized gains on investments 34 (8)
Interest credited to contractholders 15 14
Changes in:
Investment income receivable 1 (2)
Premiums and reinsurance receivable (130) (76)
Deferred policy acquisition costs (32) (22)
Other assets 19 18
Loss and loss expense reserves 186 153
Life policy reserves 104 34
Unearned premiums 168 120
Other liabilities 13 43
Deferred income taxes (12) (13)
Current income taxes (3) 60
----- -----
NET CASH PROVIDED BY OPERATING ACTIVITIES 559 497
===== =====
CASH FLOWS FROM INVESTING ACTIVITIES:
Sale of fixed maturities 64 22
Call or maturity of fixed maturities investments 222 167
Sale of equity securities investments 29 105
Collection of finance receivables 11 11
Purchase of fixed maturities investments (429) (382)
Purchase of equity securities investments (204) (206)
Investment in land, buildings and other equipment (20) (12)
Investment in finance receivables (17) (9)
Investment in other invested assets (4) 3
----- -----
NET CASH USED IN INVESTING ACTIVITIES (348) (301)
===== =====
CASH FLOWS FROM FINANCING ACTIVITIES:
Payment of cash dividends to shareholders (107) (99)
Purchase/issuance of treasury shares, net (36) (37)
Increase in notes payable 0 5
Proceeds from stock options exercised 7 10
Contract holder funds deposited 17 16
Contract holder funds withdrawn (14) (14)
----- -----
NET CASH USED IN FINANCIAL ACTIVITIES (133) (119)
----- -----
Net increase in cash 78 77
Cash at the beginning of the period 93 60
----- -----
CASH AT THE END OF THE PERIOD $ 171 $ 137
===== =====
Supplemental disclosures of cash flow information
Interest paid $ 18 $ 23
===== =====
Income taxes paid (refunded) $ 47 $ (24)
===== =====
The company converted the following securities during the nine-month periods ended September 30:
Conversion of 5.5% senior debentures to common stock $ 6 $ 17
===== =====
Conversion of fixed maturity to equity security investments $ 38 $ 48
===== =====
Accompanying notes are an integral part of these condensed consolidated
financial statements.
5
CINCINNATI FINANCIAL CORPORATION 10-Q
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
NOTE I - ACCOUNTING POLICIES
The condensed consolidated financial statements include the accounts of the
company and all of its subsidiaries, each of which is wholly owned, and are
presented in conformity with accounting principles generally accepted in the
United States of America. All significant inter-company investments and
transactions have been eliminated in consolidation. The December 31, 2001,
consolidated balance sheet amounts are derived from the audited financial
statements but do not include all disclosures required by accounting principles
generally accepted in the United States of America.
The preceding summary of financial information for Cincinnati Financial
Corporation and consolidated subsidiaries is unaudited but the company believes
that all adjustments (consisting only of normal recurring accruals) necessary
for fair presentation have been made. The results of operations for this interim
period are not necessarily an indication of results to be expected for the
remaining three months of the year. The sum of the quarterly reported amounts
may not equal the full year as each is computed independently.
INVESTMENTS -- Fixed maturities and equity securities have been classified as
available for sale and are carried at fair values at September 30, 2002, and
December 31, 2001.
UNREALIZED GAINS AND LOSSES (in millions) -- The increases (decreases) in
unrealized gains for fixed maturities and equity securities, net of income tax
effects, are as follows:
Nine months ended Three months ended
September 30, September 30,
------------------ ------------------
2002 2001 2002 2001
----- ----- ----- -----
Fixed maturities $ 25 $ 28 $ (5) $ (9)
Equity securities (557) (142) (659) (68)
----- ----- ----- -----
Total $(532) $(114) $(664) $ (77)
===== ===== ===== =====
Such amounts are included as additions to (deductions from) shareholders'
equity.
REINSURANCE (in millions) -- Premiums earned are net of premiums on ceded
business, and insurance losses and policyholder benefits are net of reinsurance
recoveries in the accompanying statements of income as follows:
Nine months ended Three months ended
September 30, September 30,
------------------ ------------------
2002 2001 2002 2001
----- ----- ----- -----
Ceded premiums $251 $122 $ 95 $ 45
==== ==== ==== ====
Reinsurance recoveries $ 80 $139 $ 38 $ 36
==== ==== ==== ====
NEW ACCOUNTING STANDARDS - The Financial Accounting Standards Board issued
Statement of Financial Accounting Standards ("SFAS") No. 145 "Rescission of FASB
Statements No. 4, 44 and 64, Amendment of FASB Statement No. 13, and Technical
Corrections" in April 2002, SFAS No. 146 "Accounting for Costs Associated with
Exit or Disposal" in June 2002 and SFAS No. 147 "Accounting for Certain
Acquisitions of Banking or Thrift Institutions - an amendment of FASB Statement
No. 72 and 144 and FASB Interpretations No. 9" in October 2002. The adoption of
SFAS No. 145, SFAS No. 146 and SFAS No. 147 will not have a material impact on
the company's consolidated financial position or results of operations.
RECLASSIFICATIONS -- Certain prior amounts have been reclassified to conform
with the current period classifications.
6
CINCINNATI FINANCIAL CORPORATION 10-Q
NOTE II - STOCK OPTIONS
The company has primarily qualified stock option plans under which options are
granted to employees of the company at prices which are not less than market
price at the date of grant and which are exercisable over 10-year periods. On
September 30, 2002, outstanding options for Stock Plan IV totaled 1,276,813
shares with purchase prices ranging from a low of $14.63 to a high of $42.87;
outstanding options for Stock Plan V totaled 1,172,617 shares with purchase
prices ranging from a low of $20.47 to a high of $45.37; and outstanding options
for Stock Plan VI totaled 4,829,718 shares with purchase prices ranging from a
low of $29.38 to a high of $41.61. The company has not granted any options from
Stock Plan VII as of September 30, 2002.
The company estimated that the impact of expensing stock options, using a fair
value method (Black-Scholes) permitted by Statement of Financial Accounting
Standard No. 123, would reduce net income per share by approximately 2 cents for
the nine-month period ended September 30, 2002.
7
CINCINNATI FINANCIAL CORPORATION 10-Q
NOTE III - SEGMENT INFORMATION
The company is organized and operates principally in two industries and has four
reportable segments - commercial lines property casualty insurance, personal
lines property casualty insurance, life insurance and investment operations. The
accounting policies of the segments are the same as those described in Note I -
Accounting Policies. Revenue is primarily from unaffiliated customers.
Identifiable assets by segment are those assets, including investment
securities, used in the company's operations in each industry. Corporate and
other identifiable assets are principally cash and marketable securities.
Company management regularly reviews the segment information results in making
decisions about resources to be allocated to the segments and in assessing their
performance.
Segment information is summarized in the following table. Information regarding
income before income taxes and identifiable assets is not available for two
reportable segments, commercial lines insurance and personal lines insurance,
which are shown together for these purposes as property casualty insurance.
(In millions)
Nine months ended Three months ended
September 30, September 30,
------------------------ ------------------------
2002 2001 2002 2001
-------- ------- -------- -------
REVENUES
Commercial lines insurance $ 1,253 $ 1,057 $ 440 $ 364
Personal lines insurance 496 462 170 156
Life insurance 63 58 22 18
Investment operations 297 321 97 103
Corporate and other 12 9 2 3
------- ------- ------- -------
TOTAL REVENUES $ 2,121 $ 1,907 $ 731 $ 644
======= ======= ======= =======
INCOME (LOSS) BEFORE INCOME TAXES
Property casualty insurance $ (17) $ (78) $ 18 $ (47)
Life insurance (36) 2 (21) 0
Investment operations 297 296 104 96
Corporate and other (29) (38) (11) (15)
------- ------- ------- -------
TOTAL INCOME (LOSS) BEFORE INCOME TAXES $ 215 $ 182 $ 90 $ 34
======= ======= ======= =======
September 30, December 31,
2002 2001
------------- ------------
IDENTIFIABLE ASSETS
Property casualty insurance
Life insurance $ 6,869 $ 6,954
Corporate and other 1,857 1,752
4,958 5,253
TOTAL IDENTIFIABLE ASSETS ------- -------
$13,684 $13,959
======= =======
8
CINCINNATI FINANCIAL CORPORATION 10-Q
ITEM 2 - MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS (DOLLARS IN MILLIONS)
INTRODUCTION
This Management Discussion is intended to supplement the data contained in the
condensed consolidated financial statements and related notes of Cincinnati
Financial Corporation and subsidiaries.
FORWARD-LOOKING STATEMENTS
The following discussion contains certain forward-looking statements that
involve potential risks and uncertainties. The company's future results could
differ materially from those discussed. Factors that could cause or contribute
to such differences include, but are not limited to: unusually high levels of
catastrophe losses due to changes in weather patterns or other causes; increased
frequency and/or severity of claims; environmental events or changes; insurance
regulatory actions, legislation or court decisions that increase expenses or
place the company at a disadvantage in the marketplace; adverse outcomes from
litigation or administrative proceedings; recession or other economic conditions
resulting in lower demand for insurance products; sustained decline in overall
stock market values negatively affecting the company's equity portfolio, in
particular a continued and sustained decline in the market value of Fifth Third
Bancorp shares; events that lead to a significant decline in the market value of
a particular security and impairment of the asset; delays in the development,
implementation and benefits of technology enhancements; and decreased ability to
generate growth in investment income.
Further, the company's insurance businesses are subject to the effects of
changing social, economic and regulatory environments. Public and regulatory
initiatives have included efforts to adversely influence and restrict premium
rates, restrict the ability to cancel policies, impose underwriting standards
and expand overall regulation. The company is also subject to public and
regulatory initiatives that can affect the market value for its common stock,
such as recent measures impacting corporate financial reporting and governance.
The ultimate changes and eventual effects, if any, of these initiatives are
uncertain.
Readers are cautioned that the company undertakes no obligation to review or
update the forward-looking statements included in this material.
RESULTS OF OPERATIONS
As discussed in greater detail below, total revenues advanced 11 percent to
$2,121 for the nine-month period and 13.5 percent to $731 million for the
three-month period ending September 30, 2002. Revenue growth was driven by:
- - Earned premiums -- Earned premiums for the nine months ended September 30,
2002, increased $235 (15 percent) over the nine months ended September 30,
2001; and earned premiums for the three months ended September 30, 2002,
increased $94 (17 percent) over the three months ended September 30, 2001.
- - Investment income -- Investment income, net of expenses, increased $18 (6
percent) compared with the first nine months of 2001 and increased $7 (7
percent) compared with the three months ended September 30, 2001. Growth
was attributable to positive cash flow from insurance operations and
reinvestment of investment income, offset by a decrease in the average
yield for the bond portfolio as proceeds from higher-yielding called or
redeemed bonds were reinvested at lower prevailing interest rates.
- - Realized losses -- Realized losses on investments were $34 compared with
$8 in gains for the comparable nine-month periods ended September 30, 2002
and 2001, respectively; and realized losses of $16 compared with $3 in
losses in the third quarters of 2002 and 2001, respectively.
9
CINCINNATI FINANCIAL CORPORATION 10-Q
Insurance losses and policyholder benefits (net of reinsurance recoveries)
increased $133 (11 percent) for the first nine months of 2002 over the same
period in 2001. Third-quarter 2002 losses were $448 compared with $445 in the
third quarter of 2001, an increase of $3 (1 percent). For the first nine months
of 2002 compared with the same period in 2001, commission expenses increased
$48, related to premium growth; other operating expenses increased $14,
attributable to minimal increases in staff and other internal development costs;
and interest expense decreased $4, primarily due to lower short-term interest
rates.
PROPERTY CASUALTY INSURANCE OPERATIONS
(Dollars in millions)
Nine months ended Three months ended
September 30, September 30,
--------------------------- -----------------------
2002 2001 2002 2001
---- ---- ---- ----
Net earned premiums $ 1,749 $ 1,519 $ 610 $ 520
Net losses incurred 1,302 1,174 427 428
GAAP ratios:
Loss and loss expense ratio 74.3% 77.2% 70.0% 82.3%
Underwriting expense ratio 27.1% 28.4% 27.4% 27.3%
Combined ratio 101.4% 105.6% 97.4% 109.6%
Combined ratio excluding catastrophes 97.6% 102.0% 96.6% 107.0%
Net written premiums for the first nine months of 2002 increased by $251, or 15
percent, and net earned premiums increased by $230, or 15 percent. This growth
represents improved pricing and tightened underwriting, with new business
written on a case-by-case basis.
The GAAP combined ratio of 101.4 percent for the first nine months of 2002
improved from 105.6 percent for the comparable 2001 period. The loss and LAE
ratio improved to 74.3 percent, 2.9 percentage points lower than the first nine
months of 2001 and the expense ratio of 27.1 percent improved 1.3 percentage
points versus the same period in 2001. The nine-month 2002 loss ratio included
3.8 percentage points for catastrophe losses, compared with 3.6 percentage
points in the first nine months of 2001. Severe weather can cause wide, seasonal
swings in our quarterly property casualty results. Catastrophe losses in this
year's third-quarter contributed 0.8 percentage points to the quarter's combined
ratio versus 8.1 percentage points in the second quarter 2002. In 2001,
catastrophe losses contributed 2.6 percentage points to the third quarter
combined ratio and 6.9 percentage points to the second-quarter ratio. The 2002
expense ratio improvement was the result of expenses remaining relatively stable
while premiums increased. Higher reinsurance costs in 2002 affected the
nine-month combined ratio by 0.8 percentage points.
Property casualty losses increased $128, or 11 percent, for the first nine
months of 2002 compared with the same period in 2001. Nine-month 2002 losses
above $250 thousand (including case reserve increases greater than $250
thousand) were $298 for 510 claims, compared with $242 for 428 claims in the
same period in 2001. Losses below $250 thousand were $726, up $19 over the first
nine months of 2001. Catastrophe losses were higher by $11, due to nine separate
wind and hail storms in the first nine months of 2002 compared with five in the
first nine months of 2001.
Nine-month 2002 property casualty commissions increased $44, or 16 percent, in
line with the growth of written premiums.
10
CINCINNATI FINANCIAL CORPORATION 10-Q
COMMERCIAL LINES
(Dollars in millions)
Nine months ended Three months ended
September 30, September 30,
------------------------ -----------------------
2002 2001 2002 2001
------- ------- ------ -----
Net earned premiums $ 1,253 $ 1,057 $ 442 $ 364
Net losses incurred 889 787 296 291
GAAP ratios:
Loss and loss expense ratio 71.0% 74.5% 67.0% 79.8%
Loss and loss expense ratio
excluding catastrophes 68.3% 71.9% 65.7% 77.2%
Nine-month 2002 commercial lines earned premiums rose 19 percent and net written
premiums rose 18 percent to $1,353. Third-quarter earned premiums rose 21
percent and net written premiums rose 19 percent. Commercial lines represents 72
percent of the company's total property casualty business. New business growth
accelerated to 30 percent in the third quarter 2002 from 13 percent in the first
half of 2002. This growth is due to a combination of improved pricing, improved
adequacy of coverage limits sold and premiums charged in relation to risk
exposures and improved service from field representatives whose frequent
presence in agents' offices brings increased opportunities to write new
accounts. The company has tightened underwriting of new and renewal business,
particularly contractors and homeowners policies, for which one-year terms are
being offered where competition or regulation makes multi-year policy terms
impractical. Workers compensation new business fell 8 percent as the company
remained very selective about the business it chose to write at current rates.
Commercial lines losses increased only $5 (2 percent) in the third quarter 2002,
compared with the same quarter in 2001. Nine-month 2002 losses rose $102 (13
percent), compared with 2001. Nine-month 2002 losses above $250 thousand were
$245 for 385 claims, compared with $205 for 352 claims in the same period in
2001. Losses below $250 thousand were $440, up $19 over the first nine months of
2001. Increasing severity of contractor and auto-related losses has contributed
to the higher level of large losses above $250 thousand since the beginning of
2001. To address this issue, the company is implementing more adequate pricing,
as well as changes to our general liability policy and underwriting guidelines
that should reduce exposure to these types of losses.
Catastrophe losses were $34 in the first nine months of 2002, up $9 over the
same period last year.
The nine-month 2002 GAAP loss and loss expense ratio was 71.0 percent, improved
from 74.5 percent in the first nine months of 2001. The third-quarter ratio was
67.0 percent, improved from 79.7 percent in the third quarter of 2001. Both
ratios improved due mostly to higher premiums.
11
CINCINNATI FINANCIAL CORPORATION 10-Q
PERSONAL LINES
(Dollars in millions)
Nine months ended Three months ended
September 30, September 30,
---------------------- ----------------------
2002 2001 2002 2001
----- ----- ----- -----
Net earned premiums $ 496 $ 462 $ 170 $ 156
Net losses incurred 412 387 132 137
GAAP ratios:
Loss and loss expense ratio 83.1% 83.8% 77.5% 88.1%
Loss and loss expense ratio
excluding catastrophes 76.5% 77.3% 78.1% 85.6%
Nine-month 2002 personal lines earned premiums rose 8 percent and net written
premiums rose 10 percent. Third-quarter earned premiums rose 9 percent and net
written premiums rose 12 percent. New business increased 22 percent in the third
quarter 2002, compared with the third quarter 2001. This is due to a combination
of higher rates, improved adequacy of coverage limits sold and premiums charged
in relation to risk exposures, and increased opportunities to write new accounts
as agents and policyholders in the uncertain marketplace perceive the value of
the company's high financial strength ratings and stability.
Kansas agencies began using an initial version of the company's new integrated
processing system for six lines of personal insurance in August 2002. This
system offers agencies more control and more choices, such as agency or direct
billing and printing at the company's headquarters or at the agency offices. The
company continues state-by-state development of the system and plans to roll out
this software to Michigan and Indiana agencies in 2003.
Nine-month 2002 personal lines losses rose $25 (7 percent), compared with 2001,
but decreased $6 (4 percent) for the third quarter of 2002, compared with the
same quarter in 2001. Nine-month 2002 losses above $250 thousand were $53 for
107 claims, compared with $37 for 75 claims in the same period in 2001. Losses
below $250 thousand were $286 for both nine-month periods.
Catastrophe losses were $34 for the first nine months of 2002, an increase of $4
over the same period last year.
The nine-month 2002 loss and loss expense ratio was 83.1 percent, compared with
83.8 percent in the first nine months of 2001. The third-quarter ratio was 77.5
percent, improved from 88.1 percent in the third quarter of 2001. Both ratios
improved primarily due to higher premiums.
The loss and LAE ratio for the homeowner line, which represents approximately 34
percent of personal lines earned premium, was 98.7 percent for the first nine
months of 2002 and 85.1 percent for the third quarter, well above levels the
company considers acceptable. To improve profitability in the homeowners line,
the company has focused on several issues and corrective actions:
- - Inadequate Rates - Increases averaging 10 percent went into effect in most
states by the end of the third quarter of 2002, with additional rate
increases already approved for early 2003 in several of the company's
largest premium volume states. Rate changes are applied to new business in
an approved state and to existing three-year policies as they come up for
renewal. Significant earned premium increases are expected over the next
three years as policies renew.
12
CINCINNATI FINANCIAL CORPORATION 10-Q
- - The need to more strictly underwrite and measure insured values - Selected
agencies are participating in a homeowner re-underwriting program. The
company is working with agencies to offer higher deductibles and verify
insurance to value levels with building coverage increases averaging about
15 percent.
- - The need to update products to increase control over risk and pricing -
Updated replacement cost and water damage coverage endorsements began to
roll out in September in three major personal lines states, Ohio, Michigan
and Indiana. Policyholders now choose the level of coverage they need and
pay a separate charge which is reflected in their premium.
These initiatives are all in their early stages and will be applied as policies
are renewed or new business is written. As a result, management anticipates
quarter-over-quarter improvement in profitability of the homeowners line as they
work through the three-year policy cycle, assuming catastrophes remain in an
acceptable range.
LIFE AND ACCIDENT HEALTH OPERATIONS
Net earned premiums of the company's life subsidiary increased $5 in the first
nine months of 2002, up 9 percent over the same period last year. The premium
growth in our life products is mainly attributable to increased sales of both
universal life and term insurance. Net written premiums for the first nine
months of 2002 increased by $71, up 94 percent. This growth includes a $33
single-premium bank owned life insurance policy and an increase of $32 in
annuities as agents continued to market attractive annuity features including
guaranteed interest and fixed income.
2002 policyholder benefits (net of reinsurance recoveries) increased $6, or 11
percent over the first nine months of 2001, as a result of growth in policy
reserves related to premium production increases. 2002 commissions increased $4,
up 27 percent over the first nine months of 2001. The increase in commission
expense is attributable to 59 percent growth of net written life insurance
premiums and 438 percent growth of annuities written. 2002 other operating
expenses increased $5, up 37 percent over the first nine months of 2001
principally due to higher regulatory and legal expenses.
TAXES
There was no significant change in the provision for federal income taxes from
operations for the nine months ending September 2002 compared with the same
period in 2001.
Nine-month 2002 total taxes, licenses and fees increased $7 over the comparable
2001 period, primarily because of changes in estimated amounts due to various
states and municipalities.
INVESTMENT OPERATIONS
The market value of the company's investments portfolio was $11,041 and $11,571
at September 30, 2002 and December 31, 2001, respectively. These investments
made up 81 percent of the company's $13,684 assets at September 30, 2002,
compared with 83 percent at December 31, 2001.
The company's primary investment strategy is to maintain liquidity to meet both
immediate and long-range insurance obligations through the purchase and
maintenance of medium-risk fixed-maturity bonds and equity securities.
Investment decisions on an individual insurance company basis are influenced by
insurance regulatory and statutory requirements that protect policyholders from
investment risk. Cash generated from insurance operations is invested almost
entirely in corporate, municipal, public utility and other fixed-maturity or
equity securities. Such securities are evaluated prior to purchase based on
yield and risk. Investments are primarily publicly-traded securities, classified
as available-for-sale in the accompanying financial statements. Changes in the
fair value of these securities are reported in other comprehensive income, net
of tax.
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CINCINNATI FINANCIAL CORPORATION 10-Q
The company also invests in convertible bonds and convertible preferred stocks
with conversion features that enhance the overall value of the security.
Management believes that investments in convertible securities pose no
significant risk to the company or its portfolio due to the relatively high
quality of the securities. Changes in the value of embedded derivative features
of these convertible securities are recognized in earnings currently.
In the first nine months of 2002, the company experienced an increase in
unrealized losses on investments, resulting in comprehensive loss of $350 in the
first nine months of 2002 compared with a comprehensive income of $43 in the
first nine months of 2001. Our 10 largest equity holdings produced a $472
decrease, net of tax, in unrealized gains in the first nine months of 2002. As
of October 31, 2002, the 10 largest equity holdings had recouped $215, after
tax, above their value at September 30, 2002, increasing book value $1.35 per
share.
INVESTMENT INCOME
Pre-tax investment income rose to $331 in the first nine months of 2002,
compared with $313 in the same period last year, up 6 percent. The increase was
driven primarily by greater dividend payouts from equity holdings and greater
interest earnings from a larger fixed maturities portfolio, with growth
generated by the increased cash flows from operations.
REALIZED GAINS (LOSSES) ON INVESTMENTS
Realized losses before federal taxes were $34 in the first nine months of 2002,
compared with realized gains of $8 for last year's first nine months included
the following:
- - $39 in write-downs of investments management deemed had experienced an
"other-than-temporary" decline in market value. The third-quarter 2002 net
capital losses included $8 of write-downs. The company's Asset Impairment
Committee continually monitors investments and other assets that have fair
values that are less than carrying amounts for signs of other-than-
temporary impairment. Among other factors, management considers the
amount and timing of declines in fair values, events impacting the
issuer, the significance of the declines in fair values, the length of
time of the declines, duration of fixed-maturity securities, and interest
payment defaults, among others, when determining investment impairment.
Impaired assets remain in the company's portfolio at the reduced value.
- - $9 in fair value declines in the first nine months of 2002 versus $1 in
fair value increases in the first nine months of 2001 due to the
application of Statement of Financial Accounting Standard No. 133, which
measures the fluctuations in the value of the embedded derivative features
in convertible securities.
- - $14 in gains in the first nine months of 2002 from assets sold in the
normal course of the company's investing activities compared with $7 in
gains in the first nine months of 2001.
MARKET RISK
The company could incur losses due to adverse changes in market rates and
prices. The primary market risk exposures are to changes in price for equity
securities and changes in interest rates and credit ratings for fixed maturity
securities. The company could alter the existing investment portfolios or change
the character of future investments to manage exposure to market risk. CFC, with
the board of directors, administers and oversees investment risk through the
investment committee, which provides executive oversight of investment
activities. The company has specific investment guidelines and policies that
define the overall framework used daily by investment portfolio managers to
limit the company's exposure to market risk. There have been no significant
changes to these guidelines during the nine months ended September 30, 2002.
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CINCINNATI FINANCIAL CORPORATION 10-Q
OUTLOOK
Over the long-term, the company continues to seek premium growth in excess of
industry averages, a return to historic profitability levels in its segments
through diligent underwriting practices, and growth of investment income.
PROPERTY CASUALTY INSURANCE OPERATIONS
The company believes it can continue to increase property casualty earned
premiums for the remainder of 2002 in line with the 15 percent growth rate of
the first nine months of this year. Rate increases that have taken effect since
mid-2001 are planned for the remainder of 2002 and beyond will be a major
component of growth in earned premiums this year and in 2003. While our
longer-term goal is a combined ratio under 100 percent, for the full-year 2002
the company had targeted a return to its five-year (1995-1999) average statutory
and GAAP combined ratio of 101.3 percent, assuming catastrophe losses for the
remainder of the year would be in the normal range of 2 to 3 percentage points.
Fourth-quarter catastrophe losses will include damage from tornadoes, strong
winds, and hail on November 9-10, 2002. Policyholders in the states of Alabama,
Georgia, Kentucky, Ohio, Pennsylvania and Tennessee were affected, with heavy
damage in northern Ohio. While early claim reports are just beginning to come
in, losses today are tentatively estimated at $15 to $20, which would result in
an approximately 2 to 3 percentage point contribution to the quarterly
catastrophe ratio. The normal range for total quarterly catastrophe losses is
2.5-3.0 percentage points.
In the fourth quarter of 2000, the company established a $110 reserve for Ohio
uninsured and underinsured motorists claims, as a result of two Ohio Supreme
Court decisions affecting all auto insurers in the state. In the first nine
months of 2002, $32 of new claims was recorded, reducing the remaining reserves
for such claims to $25. In the third quarter of 2002, however, only 86 new
claims were reported, a decline from the 109 reported in the second quarter of
2002. In addition, favorable development on older claims is appearing.
Management believes the reserve is adequate to cover additional claims that may
arise during 2002. Management will continue to monitor these claims and revise
its estimates of the related ultimate liabilities and reserves accordingly.
Management also will continue to monitor any additional rulings regarding
uninsured motorist cases that come before the Ohio Supreme Court, where two
conservative judges recently were elected.
At this time, the Company believes that the risk of material future losses
associated with asbestos claims is relatively low based on analysis of reported
claims, maximum retentions and reinsurance treaties in place at the time. During
the years that asbestos liability was a concern, our Company was a relatively
small insurer that did not insure many risks typically associated with asbestos
exposures.
Management also believes that the risk of future losses associated with mold
claims is relatively low. In 2002, the Company has received approximately 150
claims associated with mold-related losses, representing less than .06 percent
of the total year-to-date claim count. To minimize future risk, property
coverage clarifications and restrictions on mold damage are being implemented,
where and when permitted by regulatory authorities of various jurisdictions.
INVESTMENT OPERATIONS
The company anticipates full-year 2002 growth in investment income will be in
line with the 6 percent growth rate achieved for the first nine months of the
year.
Based on its continuing review of the investment portfolio and market conditions
as of October 29, 2002, and based on the company's evaluative criteria for
analyzing the investment portfolio, if market conditions continue to be adverse,
these criteria may be met during the fourth quarter 2002, which would lead to an
additional other than temporary impairment for the company's fixed maturity and
equity securities amounting to approximately be $40 to $65. This represents only
0.4 percent to 0.6 percent of September 30, 2002 invested assets.
15
CINCINNATI FINANCIAL CORPORATION 10-Q
LIQUIDITY AND CAPITAL RESOURCES
CASH FLOW
Management expects cash flow generated from operations will continue to be the
company's primary source of newly invested funds.
Nine-month 2002 cash flow from operating activities was $559, up from $497 in
the first nine months of 2001. Cash flow used for investing activities was $348,
principally purchases of fixed maturity and equity securities, in the first nine
months of 2002, compared with $301 in the same period last year. Cash flow used
for financing activities was $133 this year, principally dividend payments to
our shareholders, compared with $119 last year.
DEBT
The company's 5.5 percent convertible senior debentures matured on May 1, 2002.
Substantially all of the outstanding debentures at that date were converted to
common stock. The company had $420 of senior debt due May 20, 2028 and
short-term debt of $183, the same as at December 31, 2001.
DIVIDENDS
The company declared a dividend of 22 -1/4 cents per share, payable October 15,
2002, to shareholders of record on September 22, 2002. This dividend was up 6
percent over the third-quarter 2001 dividend.
COMMON STOCK REPURCHASES
The company's board of directors has authorized the repurchase of outstanding
shares. At September 30, 2002, 7.0 million shares remained authorized for
repurchase at any time in the future. During the first nine months of 2002, 954
thousand shares were repurchased at a cost of $37 per share. An additional 178
thousand shares were repurchased in October 2002, bringing the total repurchases
since the board's first authorization in 1996 to 14.2 million shares.
OTHER MATTERS
SIGNIFICANT ACCOUNTING POLICIES
The company does not utilize any special purpose financing vehicles or have any
undisclosed off-balance sheet arrangements. Similarly, the company holds no fair
value contracts for which a lack of marketplace quotations would necessitate the
use of fair value techniques.
During the three or nine-month periods ended September 30, 2002, the company did
not change any significant accounting policies from those utilized in the
preparation of the consolidated financial statements as of and for the year
ended December 31, 2001. Please refer to the company's Annual Report to
Shareholders incorporated by reference within that Form 10-K for a discussion of
significant accounting policies.
NEW ACCOUNTING STANDARDS - The Financial Accounting Standards Board issued
Statement of Financial Accounting Standards ("SFAS") No. 145 "Rescission of FASB
Statements No. 4, 44 and 64, Amendment of FASB Statement No. 13, and Technical
Corrections" in April 2002, SFAS No. 146 "Accounting for Costs Associated with
Exit or Disposal" in June 2002 and SFAS No. 147 "Accounting for Certain
Acquisitions of Banking or Thrift Institutions - an amendment of FASB Statement
No. 72 and 144 and FASB Interpretations No. 9" in October 2002. The adoption of
SFAS No. 145, SFAS No. 146 and SFAS No. 147 will not have a material impact on
the company's consolidated financial position or results of operations.
16
CINCINNATI FINANCIAL CORPORATION 10-Q
ITEM 4 - CONTROLS AND PROCEDURES
(a) Within 90 days before filing this report, we evaluated the
effectiveness of the design and operation of our disclosure
controls and procedures. Our disclosure controls and
procedures are the controls and other procedures that we
designed to ensure that we record, process, summarize and
report in a timely manner the information we must disclose in
reports that we file with or submit to the SEC. John J.
Schiff, our chairman and chief executive officer, and Kenneth
W. Stecher, our treasurer and chief financial officer,
participated in and reviewed this evaluation. Based on this
evaluation, Messrs. Schiff and Stecher concluded that, as of
the date of their evaluation, our disclosure controls were
effective in timely alerting us to material information
required to be included in our periodic SEC reports. It should
be noted that the design of any system of controls is based in
part upon certain assumptions about the likelihood of future
events, and there can be no assurance that any design will
succeed in achieving its stated goals under all potential
future conditions, regardless of how remote.
(b) Since the date of the evaluation described above, there have
not been any significant changes in our internal accounting
controls or in other factors that could significantly affect
those controls.
17
CINCINNATI FINANCIAL CORPORATION 10-Q
PART II - OTHER INFORMATION
ITEM 1. Legal Proceedings
The company is involved in no material litigation other than routine litigation
incident to the nature of the insurance business.
ITEM 2. Changes in Securities
There have been no material changes in securities during the third quarter.
ITEM 3. Defaults Upon Senior Securities
The company has not defaulted on any interest or principal payment, and no
arrearage in the payment of dividends has occurred.
ITEM 4. Submission of Matters to a Vote of Security Holders
No special matters were voted upon by security holders during the third quarter.
ITEM 5. Other Information
The Company's chief executive officer and chief financial officer have furnished
to the SEC the certification with respect to this Form 10-Q that is required by
Section 906 of the Sarbanes-Oxley Act of 2002.
ITEM 6. Exhibits and Reports on Form 8-K
(a) Exhibits:
Exhibit 11 - Statement re-computation of Per Share Earnings.
Exhibit 99.1 - Certification Pursuant to 18 U.S.C. Section 1350, as Adopted
Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002
Exhibit 99.2 - Certification Pursuant to 18 U.S.C. Section 1350, as Adopted
Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002
(b) The company was not required to file any reports on Form 8-K during the
quarter ended September 30, 2002.
Signature
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
CINCINNATI FINANCIAL CORPORATION
November 13, 2002
By /s/ Kenneth W. Stecher
-----------------------------------
Kenneth W. Stecher
Chief Financial Officer
18
CINCINNATI FINANCIAL CORPORATION 10-Q
Certification of Principal Executive Officer
Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002
and Securities and Exchange Commission Release 34-46427
I, John J. Schiff Jr., certify that:
1. I have reviewed this quarterly report on Form 10-Q of Cincinnati Financial
Corporation.
2. Based on my knowledge, this quarterly report does not contain any untrue
statement of a material fact or omit to state a material fact necessary to
make the statements made, in light of the circumstances under which such
statements were made, not misleading with respect to the period covered by
this quarterly report;
3. Based on my knowledge, the financial statements, and other financial
information included in this quarterly report, fairly present in all
material respects the financial condition, results of operations and cash
flows of the registrant as of, and for, the periods presented in this
quarterly report;
4. The registrant's other certifying officer and I are responsible for
establishing and maintaining disclosure controls and procedures (as
defined in Exchange Act Rules 13a-14 and 15-d14) for the registrant and we
have:
a) designed such disclosure controls and procedures to ensure that
material information relating to the registrant, including its
consolidated subsidiaries, is made known to us by others within
those entities, particularly during the period in which this
quarterly report is being prepared;
b) evaluated the effectiveness of the registrant's disclosure controls
and procedures as of a date within 90 days prior to the filing date
of this quarterly report (the "Evaluation Date"); and
c) presented in this quarterly report our conclusions about the
effectiveness of the disclosure controls and procedures based on our
evaluation as of the Evaluation Date;
5. The registrant's other certifying officer and I have disclosed, based on
our most recent evaluation, to the registrant's auditors and the audit
committee of registrant's board of directors (or persons performing the
equivalent function):
a) all significant deficiencies in the design or operation of internal
controls which could adversely affect the registrant's ability to
record, process, summarize and report financial data and have
identified for the registrant's auditors any material weaknesses in
internal controls; and
b) any fraud, whether or not material, that involves management or
other employees who have a significant role in the registrant's
internal controls; and
6. The registrant's other certifying officer and I have indicated in this
quarterly report whether or not there were significant changes in internal
controls or in other factors that could significantly affect internal
controls subsequent to the date of our most recent evaluation, including
any corrective actions with regard to significant deficiencies and
material weakness.
/s/ John J. Schiff, Jr.
____________________________________
John J. Schiff, Jr.
Chairman and Chief Executive Officer
November 13, 2002
19
CINCINNATI FINANCIAL CORPORATION 10-Q
Certification of Principal Financial Officer
Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002
and Securities and Exchange Commission Release 34-46427
I, Kenneth W. Stecher, certify that:
1. I have reviewed this quarterly report on Form 10-Q of Cincinnati Financial
Corporation.
2. Based on my knowledge, this quarterly report does not contain any untrue
statement of a material fact or omit to state a material fact necessary to
make the statements made, in light of the circumstances under which such
statements were made, not misleading with respect to the period covered by
this quarterly report;
3. Based on my knowledge, the financial statements, and other financial
information included in this quarterly report, fairly present in all
material respects the financial condition, results of operations and cash
flows of the registrant as of, and for, the periods presented in this
quarterly report;
4. The registrant's other certifying officer and I are responsible for
establishing and maintaining disclosure controls and procedures (as
defined in Exchange Act Rules 13a-14 and 15-d14) for the registrant and we
have:
a) designed such disclosure controls and procedures to ensure that
material information relating to the registrant, including its
consolidated subsidiaries, is made known to us by others within
those entities, particularly during the period in which this
quarterly report is being prepared;
b) evaluated the effectiveness of the registrant's disclosure controls
and procedures as of a date within 90 days prior to the filing date
of this quarterly report (the "Evaluation Date"); and
c) presented in this quarterly report our conclusions about the
effectiveness of the disclosure controls and procedures based on our
evaluation as of the Evaluation Date;
5. The registrant's other certifying officer and I have disclosed, based on
our most recent evaluation, to the registrant's auditors and the audit
committee of registrant's board of directors (or persons performing the
equivalent function):
a) all significant deficiencies in the design or operation of internal
controls which could adversely affect the registrant's ability to
record, process, summarize and report financial data and have
identified for the registrant's auditors any material weaknesses in
internal controls; and
b) any fraud, whether or not material, that involves management or
other employees who have a significant role in the registrant's
internal controls; and
6. The registrant's other certifying officer and I have indicated in this
quarterly report whether or not therewere significant changes in internal
controls or in other factors that could significantly affect internal
controls subsequent to the date of our most recent evaluation, including
any corrective actions with regard to significant deficiencies and
material weakness.
/s/ Kenneth W. Stecher
___________________________
Kenneth W. Stecher
Chief Financial Officer
November 13, 2002
20