How much of the 2006 earnings increase was driven by the Alltel stock sale rather than operating performance?

The Alltel sale contributed $412 million after tax, or $2.35 per share, to 2006 net income. Without that gain, 2006 net income would have been substantially lower than the reported record of roughly $1.0 billion, and the property casualty underwriting profit declined from 2005 levels as the combined ratio rose to 94.3% from 89.2%.

Why did the property casualty combined ratio deteriorate in 2006?

Management attributed the increase to record catastrophe losses (5.5 points of the combined ratio, up from 4.1 in 2005), rising loss severity especially in commercial lines large losses, less favorable development of prior-year reserves (3.7 points vs. 5.2 points), and higher underwriting expenses from technology and staffing investments as well as stock option expensing.

How concentrated is the investment portfolio and what risk does that create?

The portfolio is heavily weighted toward equities. Fifth Third Bancorp represents roughly 25.7% of shareholders' equity and about 20.2% of investment income from dividends, and financials make up 66.6% of the common stock fair value. Because the company holds more than 10% of Fifth Third, it faces limits on how much it can sell, so a decline in Fifth Third's share price or dividend would materially affect results and book value.

What is the outlook for premium growth and profitability in 2007?

Management expects consolidated property casualty written premium growth in the low single digits, versus 3.3% in 2006. It also projects a 2007 combined ratio of 97%-99%, reflecting assumed catastrophe losses of about 5.5 points, lower favorable reserve development, and rising underwriting expenses. The company suspended new business submissions from Florida agents in February 2007, which may reduce 2007 premium growth.

Is the company's financial strength and dividend sustainable?

Financial strength appears solid: insurer financial strength ratings are A (Superior) from A.M. Best, AA (Very Strong) from Fitch and S&P, and A2 from Moody's senior debt; the debt-to-capital ratio is about 11% and the property casualty subsidiary has $4.7 billion in statutory surplus. Dividends are supported by about $572 million that the lead insurance subsidiary can pay to the parent without regulatory approval in 2007. However, dividend capacity depends on subsidiary earnings and equity market values, and the company notes its dividend is about 38% of net income over the past decade.

CINF 10-K FY2006 Annual Report — Revenue, Net Income, EPS

01—Abstract

Summary

Summary of the 10-K filed February 28, 2007. Cited figures are marked; the original filing is the authoritative source.

Cincinnati Financial Corporation (CINF) reported a record year for net income and per-share earnings in 2006, but the result was driven largely by a one-time gain rather than underwriting strength.

Net income rose to record levels with diluted EPS of $5.30^a (up from $3.40), boosted by the $647 million pretax ($412 million after-tax, or $2.35 per share) gain from selling its Alltel common stock. Excluding that sale, the company's core results were weaker: the consolidated property casualty combined ratio deteriorated to 94.3% from 89.2%, driven by record catastrophe losses, rising loss severity, less favorable reserve development, and higher expenses. Management also indicated that its 2007 combined ratio could rise to 97%-99%.

The balance sheet remained strong. Shareholders' equity increased to $6.808 billion^b (book value per share $39.38), total assets reached $17.2 billion, and the debt-to-capital ratio was a conservative 11.0%. Statutory surplus for the property casualty subsidiary grew to $4.723 billion, and the company's insurer financial strength ratings (A.M.

Best A, Fitch AA, S&P AA-) were unchanged. The investment portfolio, which is heavily concentrated in equities (notably Fifth Third Bancorp, roughly 25.7% of shareholders' equity), generated record investment income and large unrealized gains of $5.2 billion^c pretax. Looking ahead, management expects premium growth in the low single digits in 2007, pressure from softening commercial lines pricing, and a suspension of new business submissions in Florida.

The company also plans to enter New Mexico and eastern Washington and to form an excess and surplus lines subsidiary. Investors should weigh the strong capital position and long dividend-growth record (47 consecutive years of increases) against the deteriorating underwriting trend, dependence on equity market performance, and concentration risk in Fifth Third.

02—Key points

Key Highlights

Record 2006 net income with diluted EPS of $5.30, up 55.9% from $3.40, largely due to the $412 million after-tax ($2.35 per share) gain from selling Alltel common stock.
Core property casualty underwriting weakened: the GAAP combined ratio rose to 94.3% from 89.2%, reflecting record catastrophe losses (5.5 points), higher loss severity, and less favorable prior-year reserve development (3.7 points vs. 5.2 in 2005).
Total revenues rose 20.8% to $4.55 billion, but this growth was primarily driven by realized investment gains; earned premiums grew a modest 3.6% to $3.28 billion.
Balance sheet strength: shareholders' equity of $6.808 billion (book value per share $39.38), debt-to-capital ratio of 11.0%, and property casualty statutory surplus of $4.723 billion.
Concentrated equity portfolio: Fifth Third Bancorp alone represents about 25.7% of shareholders' equity, and the common stock portfolio is 66.6% financials, creating significant market-value and dividend-concentration risk.
Guidance for 2007 points to a combined ratio of 97%-99%, low single-digit premium growth, and a 6.5%-7.0% increase in pretax investment income.
Dividend policy remains shareholder-friendly: the indicated annual dividend was raised 6% to $1.42 per share, marking the 47th consecutive year of increases, and $120 million was spent on share repurchases in 2006.

03—Questions

Frequently Asked Questions

How much of the 2006 earnings increase was driven by the Alltel stock sale rather than operating performance?
The Alltel sale contributed $412 million after tax, or $2.35 per share, to 2006 net income. Without that gain, 2006 net income would have been substantially lower than the reported record of roughly $1.0 billion, and the property casualty underwriting profit declined from 2005 levels as the combined ratio rose to 94.3% from 89.2%.
Why did the property casualty combined ratio deteriorate in 2006?
Management attributed the increase to record catastrophe losses (5.5 points of the combined ratio, up from 4.1 in 2005), rising loss severity especially in commercial lines large losses, less favorable development of prior-year reserves (3.7 points vs. 5.2 points), and higher underwriting expenses from technology and staffing investments as well as stock option expensing.
How concentrated is the investment portfolio and what risk does that create?
The portfolio is heavily weighted toward equities. Fifth Third Bancorp represents roughly 25.7% of shareholders' equity and about 20.2% of investment income from dividends, and financials make up 66.6% of the common stock fair value. Because the company holds more than 10% of Fifth Third, it faces limits on how much it can sell, so a decline in Fifth Third's share price or dividend would materially affect results and book value.
What is the outlook for premium growth and profitability in 2007?
Management expects consolidated property casualty written premium growth in the low single digits, versus 3.3% in 2006. It also projects a 2007 combined ratio of 97%-99%, reflecting assumed catastrophe losses of about 5.5 points, lower favorable reserve development, and rising underwriting expenses. The company suspended new business submissions from Florida agents in February 2007, which may reduce 2007 premium growth.
Is the company's financial strength and dividend sustainable?
Financial strength appears solid: insurer financial strength ratings are A (Superior) from A.M. Best, AA (Very Strong) from Fitch and S&P, and A2 from Moody's senior debt; the debt-to-capital ratio is about 11% and the property casualty subsidiary has $4.7 billion in statutory surplus. Dividends are supported by about $572 million that the lead insurance subsidiary can pay to the parent without regulatory approval in 2007. However, dividend capacity depends on subsidiary earnings and equity market values, and the company notes its dividend is about 38% of net income over the past decade.

04—Continue

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