Why did reported earnings jump in 2001, and what is the underlying trend?

Reported net income rose to $193 million from $118 million, but 2000 was depressed by a one-time $39 million pre-tax ($25 million after-tax) asset impairment for abandoned software. Excluding that charge, net operating income rose 44% to $210 million, mainly because the underwriting loss narrowed. Investors should note that 2001 still included $17 million of net capital losses and that operating results depend heavily on underwriting discipline and rate increases.

How concentrated is the investment portfolio, and what is the risk to book value?

Equity securities total $8.5 billion, about 73% of the $11.6 billion portfolio, and Fifth Third Bancorp represents $4.5 billion of that, or 53% of equities. Unrealized equity appreciation before taxes was $6.3 billion, which is 68.5% of shareholders' equity after taxes. A 20% decline in Fifth Third's share price would reduce shareholders' equity by about 10%, or $3.59 per share, according to the filing's sensitivity analysis.

Is the company's loss reserve position adequate?

Management reports that reserves were adequate and released $62 million of redundancy in 2001, with the company historically positioning reserves in the upper half of its actuary's range. However, the filing also warns that average claim severity is rising due to medical costs and litigation, and that each percentage point increase in the loss and LAE ratio would reduce pre-tax operating income by about $21 million. Adjustments to prior years could be material.

What are the near-term earnings headwinds and outlook for 2002?

Management expects the statutory combined ratio to improve during 2002 from 103.6%, targeting its 101.3% five-year average if catastrophe losses are normal. Higher reinsurance costs are expected to reduce 2002 EPS by about 12 cents after tax, and the company will retain more risk under its new treaties. Homeowner rate increases averaging about 10% are expected to lift homeowner premiums 7% to 8% in 2002. Investment income growth is expected to remain above the industry average.

How strong is the company's financial position and credit profile?

Shareholders' equity was $6.0 billion with debt equal to about 4.4% of total assets, and the debt-to-net-worth ratio was 0.10 to 1.00 against a covenant maximum of 0.25 to 1.00. The property casualty group carries A.M. Best A++ and Moody's Aa3 ratings, while Standard & Poor's downgraded the parent's senior debentures to A+ and its insurance subsidiaries to AA- during 2001. Investors should monitor these ratings, since the filing acknowledges they could be lowered in the future.

CINF 10-K FY2001 Annual Report — Revenue, Net Income, EPS

01—Abstract

Summary

Summary of the 10-K filed March 27, 2002. Cited figures are marked; the original filing is the authoritative source.

Cincinnati Financial Corporation (CINF) closed 2001 with GAAP net income of $193 million^a, or $1.19 per diluted share, up from $118 million ($0.73) in 2000, which was depressed by a one-time $39 million pre-tax asset impairment charge for abandoned software.

Excluding that charge, net operating income rose 44% to $210 million^b, driven mainly by a lower underwriting loss. Revenue grew 9.9% to $2.561 billion, with net earned premiums up 13% to $2.152 billion, led by firmer commercial lines pricing. The GAAP combined ratio improved to 104.9% from 112.8% (110.7% excluding the impairment), but remains above management's 101.3% target, and management expects the ratio to improve during 2002 and sees a 12-cent after-tax EPS hit from higher reinsurance costs.

The main risks for investors are concentrated equity exposure and credit quality. Equity securities of $8.5 billion^c represent roughly 73% of the $11.6 billion investment portfolio, and Fifth Third Bancorp alone accounts for $4.5 billion, or 53% of equities. A 20% decline in that stock would cut book value by about $3.59 per share.

Realized capital losses of $17 million^d reflected $47 million of other-than-temporary impairments on non-investment-grade bonds during the highest corporate default rates since 1990-91. Reserve development was favorable, with a $62 million redundancy released, but the filing notes that severity trends are a permanent shift and that reserves are sensitive to loss-ratio changes. The balance sheet remains strong, with shareholders' equity of $6.0 billion (book value $37.07 per share, down slightly from $37.26), debt at about 4.4% of assets, and A.M.

Best A++ and Moody's Aa3 ratings for the property casualty group. The company extended its dividend streak to 41 consecutive years and raised the indicated annual dividend 6% to $0.89. Shares outstanding were 161.8 million as of March 1, 2002, and the aggregate market value held by nonaffiliates was $5.54 billion.

02—Key points

Key Highlights

Net income rose 63% to $193 million ($1.19 diluted EPS) from $118 million in 2000, which included a $39 million pre-tax software impairment charge; net operating income rose 44% to $210 million.
Net earned premiums grew 13% to $2.152 billion, with commercial lines up 18% on firmer pricing and personal lines up 4%.
GAAP combined ratio improved to 104.9% from 112.8% in 2000, though still above management's 101.3% five-year target; statutory combined ratio was 103.6%.
Favorable prior-year reserve development released $62 million, versus $20 million in 2000, though severity trends are described as a permanent industry shift.
Equity portfolio of $8.5 billion (about 73% of investments) is heavily concentrated, with Fifth Third Bancorp at $4.5 billion (53% of equities); a 20% drop in that stock would reduce book value by about $3.59 per share.
Net capital losses of $17 million included $47 million of impairments on non-investment-grade bonds; roughly 22% of the fixed-income portfolio is below investment grade.
Dividend increased 6% to an indicated $0.89 annual rate, marking 41 consecutive years of increases; book value per share was $37.07.

03—Questions

Frequently Asked Questions

Why did reported earnings jump in 2001, and what is the underlying trend?
Reported net income rose to $193 million from $118 million, but 2000 was depressed by a one-time $39 million pre-tax ($25 million after-tax) asset impairment for abandoned software. Excluding that charge, net operating income rose 44% to $210 million, mainly because the underwriting loss narrowed. Investors should note that 2001 still included $17 million of net capital losses and that operating results depend heavily on underwriting discipline and rate increases.
How concentrated is the investment portfolio, and what is the risk to book value?
Equity securities total $8.5 billion, about 73% of the $11.6 billion portfolio, and Fifth Third Bancorp represents $4.5 billion of that, or 53% of equities. Unrealized equity appreciation before taxes was $6.3 billion, which is 68.5% of shareholders' equity after taxes. A 20% decline in Fifth Third's share price would reduce shareholders' equity by about 10%, or $3.59 per share, according to the filing's sensitivity analysis.
Is the company's loss reserve position adequate?
Management reports that reserves were adequate and released $62 million of redundancy in 2001, with the company historically positioning reserves in the upper half of its actuary's range. However, the filing also warns that average claim severity is rising due to medical costs and litigation, and that each percentage point increase in the loss and LAE ratio would reduce pre-tax operating income by about $21 million. Adjustments to prior years could be material.
What are the near-term earnings headwinds and outlook for 2002?
Management expects the statutory combined ratio to improve during 2002 from 103.6%, targeting its 101.3% five-year average if catastrophe losses are normal. Higher reinsurance costs are expected to reduce 2002 EPS by about 12 cents after tax, and the company will retain more risk under its new treaties. Homeowner rate increases averaging about 10% are expected to lift homeowner premiums 7% to 8% in 2002. Investment income growth is expected to remain above the industry average.
How strong is the company's financial position and credit profile?
Shareholders' equity was $6.0 billion with debt equal to about 4.4% of total assets, and the debt-to-net-worth ratio was 0.10 to 1.00 against a covenant maximum of 0.25 to 1.00. The property casualty group carries A.M. Best A++ and Moody's Aa3 ratings, while Standard & Poor's downgraded the parent's senior debentures to A+ and its insurance subsidiaries to AA- during 2001. Investors should monitor these ratings, since the filing acknowledges they could be lowered in the future.

04—Continue

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