Cincinnati Financial Corp. 10-K
United States Securities and Exchange Commission
Washington, D.C. 20549
Form 10-K
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ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF
1934. |
For the fiscal year ended December 31, 2005.
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TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934. |
For the transition period from to .
Commission file number 0-4604
Cincinnati Financial Corporation
(Exact name of registrant as specified in its charter)
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Ohio
(State of incorporation)
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31-0746871
(I.R.S. Employer Identification No.) |
6200 S. Gilmore Road
Fairfield, Ohio 45014-5141
(Address of principal executive offices) (Zip Code)
(513) 870-2000
(Registrants telephone number, including area code)
Securities registered pursuant to Section 12(b) of the Act:
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)
Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule
405 of the Securities
Act.
Yes þ
No o
Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or
Section 15(d) of the Act.
Yes
o No
þ
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 þ No o
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is
not contained herein, and will not be contained, to the best of registrants knowledge, in
definitive proxy or information statements incorporated by reference in Part III of this Form 10-K
or any amendment to this Form 10-K. o
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer,
or a non-accelerated filer. See definition of accelerated filer and large accelerated filer in
Rule 12b-2 of the Exchange Act.
(Check one): Large accelerated filer þ Accelerated filer o Non-accelerated filer o
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the
Exchange Act). Yes o No þ
The aggregate market value of voting stock held by nonaffiliates of the Registrant was
$6,181,583,530 as of June 30, 2005.
As of February 28, 2006, there were 174,106,280 shares of common stock outstanding.
Document Incorporated by Reference
Portions of the definitive Proxy Statement for Cincinnati Financial Corporations Annual Meeting of
Shareholders to be held on
May 6, 2006, are incorporated by reference into Parts II and III of this Form 10-K.
TABLE OF CONTENTS
Part I
Item 1. Business
Cincinnati Financial Corporation Introduction
We are an Ohio corporation formed in 1968. Through our subsidiaries, we have been in
business since 1950, marketing commercial, personal and life insurance through independent
insurance agencies to businesses and individuals. Our headquarters is in Fairfield, Ohio. At
year-end 2005, we had 3,983 associates, with approximately 2,800 headquarters associates
providing support to approximately 1,150 field associates.
Cincinnati Financial Corporation (CFC) owns 100 percent of three subsidiaries: The
Cincinnati Insurance Company, CFC Investment Company and CinFin Capital Management Company.
The Cincinnati Insurance Company owns 100 percent of our three smaller insurance
subsidiaries: The Cincinnati Casualty Company, The Cincinnati Indemnity Company and The
Cincinnati Life Insurance Company.
The Cincinnati Insurance Company, founded in 1950, leads the property casualty group known
as The Cincinnati Insurance Companies. The Cincinnati Casualty Company and The Cincinnati
Indemnity Company round out the property casualty insurance group, providing flexibility in
pricing and underwriting while ceding substantially all of their business to The Cincinnati
Insurance Company. The Cincinnati Life Insurance Company primarily markets life insurance
and annuities. CFC Investment Company complements the insurance subsidiaries with leasing
and financing services. CinFin Capital Management Company provides asset management services
to institutions, corporations and high net worth individuals.
Our filings with the Securities and Exchange Commission (SEC) are available, free of charge,
on our Web site, www.cinfin.com, as soon as possible after they have been filed with the
SEC. These filings include our annual reports on Form 10-K, our quarterly reports on Form
10-Q, current reports on Form 8-K, and amendments to those reports filed or furnished
pursuant to Section 13(a) or 15(d) of the Securities Exchange Act of 1934. In the following
pages we reference various Web sites. These Web sites, including our own, are not
incorporated by reference in this Annual Report on Form 10-K.
Periodically, we refer to estimated industry data so that we can give information about our
performance versus the overall insurance industry. Unless otherwise noted, the industry data
is prepared by A.M. Best Co., a leading insurance industry statistical, analytical and
financial strength rating organization. Information from A.M. Best is presented on a
statutory basis. When we provide our results on a comparable statutory basis, we label it as
such; all other company data is presented in accordance with accounting principles generally
accepted in the United States of America (GAAP) .
Our Business and Our Strategy
Introduction
Our company was founded more than 50 years ago by independent agents to support the
ability of local independent property casualty insurance agents to deliver quality financial
protection to people and businesses in their communities. Today, we operate much the same
way, actively marketing commercial insurance policies in 32 states through a select group of
independent insurance agencies. We actively market all of our personal lines insurance
policies in 22 of those states. We seek to become the life insurance carrier of choice for
the agencies that market our property casualty insurance products and offer other financial
services to help agents and their clients the policyholders.
Our company distinguishes itself in three ways:
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We cultivate relationships with the independent insurance agents who market our
policies and we make our decisions at the local level |
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We achieve claims excellence, covering the spectrum from our response to reported
claims to our approach to establishing reserves for not-yet-paid claims |
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We invest for long-term total return, using available cash flow to purchase equity
securities after covering insurance liabilities by purchasing fixed-maturity securities |
Cultivating Relationships with Independent Insurance Agents
The U.S. property casualty insurance industry is a highly competitive marketplace with
approximately 3,100 stock and mutual companies operating independently or in groups. No
single company or group dominates across all product lines and states. Insurance companies
(carriers) can market a broad array of products nationally or:
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choose to sell a limited product line or only one type of insurance (monoline carrier) |
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target a certain segment of the market (for example, personal insurance) |
2005 10-K Page 1
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focus on one or more states or regions (regional carrier) |
Property casualty insurers generally market their products through one or more distribution channels:
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independent agents, who represent multiple carriers, |
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captive agents, who represent one carrier exclusively, or |
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direct marketing through the mail or Internet |
Some carriers use more than one channel. For the most part, we compete with insurance
companies that market through independent insurance agents.
Independent Agency Distribution System
We are committed to the independent agency distribution system, offering a broad array
of commercial, personal and life insurance products through this channel. We recognize that
locally based independent agencies have relationships in their communities that can lead to
policyholder satisfaction, loyalty and profitable business. Our field associates provide
service and accountability to the agencies, living in the communities they serve and working
from offices in their homes, providing 24/7 availability to our agents.
At year-end 2005, our 1,024 agency relationships had 1,253 reporting agency locations
marketing our insurance products. An increasing number of agencies have multiple, separately
identifiable locations, reflecting their growth and consolidation of ownership within the
independent agency marketplace. We believe reporting agency locations, a new measure for
our company, accurately describes our agents scope of business and our presence within our
32 active states. At year-end 2004, we had 986 agency relationships with 1,213 reporting
agency locations. At year-end 2003, we had 957 agency relationships with 1,185 reporting
agency locations. In addition to providing data on reporting agency locations, we continue
to give agency relationships metrics, such as our penetration within each agency
relationship.
Property Casualty Agency Earned Premiums by State
In our 10 highest volume states, 853 reporting agency locations wrote 71.1 percent of
our 2005 total property casualty agency earned premium volume. Agency earned premiums are
premiums before reinsurance.
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(Dollars
in millions) |
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Earned |
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Percent |
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Reporting |
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Avg premium |
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premium |
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of total |
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Change % |
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agency locations |
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per location |
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Year ended December 31, 2005 |
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Ohio |
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$ |
737 |
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23.1 |
% |
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2.2 |
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224 |
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$ |
3.3 |
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Illinois |
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299 |
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9.4 |
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1.7 |
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112 |
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2.7 |
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Indiana |
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238 |
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7.4 |
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0.9 |
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99 |
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2.4 |
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Pennsylvania |
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192 |
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6.0 |
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8.0 |
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63 |
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3.0 |
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Michigan |
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173 |
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5.4 |
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(1.2 |
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88 |
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2.0 |
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Georgia |
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141 |
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4.4 |
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9.5 |
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59 |
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2.4 |
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Virginia |
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134 |
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4.2 |
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4.8 |
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53 |
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2.5 |
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North Carolina |
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130 |
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4.1 |
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10.7 |
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68 |
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1.9 |
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Wisconsin |
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125 |
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3.9 |
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6.4 |
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49 |
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2.6 |
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Kentucky |
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102 |
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3.2 |
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5.0 |
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38 |
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2.7 |
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All other states |
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923 |
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28.9 |
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8.9 |
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400 |
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2.3 |
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Total |
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$ |
3,194 |
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100.0 |
% |
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5.1 |
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1,253 |
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2.5 |
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Year ended December 31, 2004 |
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Ohio |
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$ |
722 |
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23.7 |
% |
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7.1 |
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224 |
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$ |
3.2 |
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Illinois |
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294 |
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9.7 |
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7.7 |
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113 |
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2.6 |
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Indiana |
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235 |
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7.7 |
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5.5 |
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96 |
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2.5 |
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Pennsylvania |
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177 |
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5.8 |
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14.8 |
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63 |
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2.8 |
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Michigan |
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175 |
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5.8 |
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12.2 |
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83 |
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2.1 |
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Georgia |
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129 |
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4.2 |
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10.1 |
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56 |
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2.3 |
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Virginia |
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127 |
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4.2 |
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12.8 |
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51 |
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2.5 |
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Wisconsin |
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118 |
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3.9 |
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10.4 |
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49 |
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2.4 |
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North Carolina |
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117 |
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3.9 |
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15.8 |
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66 |
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1.8 |
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Kentucky |
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97 |
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3.2 |
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10.3 |
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35 |
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2.8 |
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All other states |
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849 |
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27.9 |
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14.9 |
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377 |
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2.2 |
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Total |
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$ |
3,040 |
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100.0 |
% |
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10.8 |
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1,213 |
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2.5 |
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In 2004, the most recent period for which data is available, Cincinnati Insurance was the
No. 1 or No. 2 carrier in 74 percent of the reporting agency locations that have represented
us for more than five years. The independent agencies that we choose to market our products
share our philosophies. They do business person to person; offer broad, value-added
services; maintain sound balance sheets and manage their agencies professionally. On
average, we have a 17.3 percent share of the property casualty insurance in our
2005 10-K Page 2
reporting
agency locations. Our share is 24.3 percent in reporting agency locations that have
represented us for more than 10 years; 11.5 percent in agencies that have represented us for
five to 10 years; 5.1 percent in agencies that have represented us for one to five years;
and less than 1 percent in agencies that have represented us for less than one year.
Over the next decade, industry analysts predict successful agencies will have opportunities
to increase their size on average almost three-fold. Agencies are expected to continue to
pursue consolidation opportunities, buying or merging with other agencies to create stronger
organizations and expand service. In addition to the growing networks of agency locations
owned by banks and brokers, other agencies are addressing the consolidation by forming
voluntary associations. These associations, or clusters, share back office and other
functions to enhance economies, while maintaining their individual ownership structures.
No single agency relationship accounted for more than 1.1 percent of our total agency earned
premiums in 2005. Some of our agency relationships are with individual offices of bank- or
broker-owned organizations. Our relationships are with each office separately, however, no
bank- or broker-owned organization, in aggregate, accounted for more than 2.0 percent of our
total agency earned premiums in 2005.
Strengthening Our Agency Relationships
We follow a number of strategies to strengthen our relationships with the independent
property casualty insurance agencies that represent us:
Risk-specific Underwriting
We seek to be a consistent, predictable and reasonable carrier that agencies can rely
on to serve their clients. Our field and headquarters underwriters make risk-specific
decisions about both new business and renewals. On a case-by-case basis, we select risks we
can cover on acceptable terms and at adequate prices rather than underwriting solely by
geographic location or business class.
For new commercial lines business, this case-by-case underwriting and pricing is coordinated
by the local field marketing representatives. Our agents and our field marketing, loss
control, bond and machinery and equipment representatives know the people and businesses in
their communities and can make informed decisions about each risk. These field marketing
representatives also are responsible for selecting new independent agencies, coordinating
field teams of specialized company representatives and promoting all of the companys
products within the agencies they serve. Commercial lines policy renewals are managed by
headquarters underwriters who are assigned to specific agencies and consult with local field
staff, as needed.
We apply our risk-specific underwriting philosophy to personal lines new and renewal
business in a different process. Each agency brings us personal lines business from within
the geographic territory that it serves using its knowledge of the risks in those
communities. New and renewal business activities are supported by headquarters associates
assigned to individual agencies.
Competitive Insurance Products
We are committed to offering the products and services local agents need to serve their
clients the policyholders. Our commercial lines products are structured to allow flexible
combinations of coverages in a single package with a single expiration date. Our intent is
to write personal auto and homeowners coverages in personal lines packages that may also
include personal umbrella and other coverages. The package approach brings policyholders
convenience, discounts and a reduced risk of coverage gaps or disputes. At the same time, it
increases account retention and saves time and expense for the agency and our company.
Our commercial lines packages are typically offered on a three-year policy term for most
insurance coverages, a key competitive advantage. Although we offer three-year policy terms,
premiums for some coverages within those policies are adjustable at anniversary for the
subsequent annual period, and policies may be cancelled at any time at the discretion of the
policyholder. Contract terms often provide that rates for property, general liability,
inland marine and crime coverages, as well as policy terms and conditions, are fixed for the
term of the policy. The general liability exposure basis may be audited annually. Commercial
auto, workers compensation, professional liability and most umbrella liability coverages
within multi-year packages are rated at each of the policys annual anniversaries for the
next one-year period. The annual pricing could incorporate rate changes approved by state
insurance regulatory authorities between the date the policy was written and its annual
anniversary date, as well as changes in risk exposures and premium credits or debits
relating to loss experience, competition and other underwriting judgment factors. We
estimate that approximately 75 percent of 2005 commercial premiums were subject to annual
rating or were written on a one-year policy term.
In our experience, multi-year packages are somewhat less price sensitive for the
quality-conscious insurance buyers who we believe are typical clients of our independent
agents. Customized insurance programs on a three-year term complement the long-term
relationships these policyholders typically have with their agents and with the company. By
reducing annual administrative efforts, multi-year policies lower expenses for our company
and for our agents. The commitment we make to policyholders encourages long-term
relationships and reduces their need to annually re-evaluate their insurance carrier or
agency. We believe that the
2005 10-K Page 3
advantages of three-year policies in terms of policyholder
convenience, account retention and reduced administrative costs outweigh the potential
disadvantage of these policies, even in periods of rising rates.
Technology Solutions
We seek to continuously improve service to and communication with our agencies through
an expanding portfolio of software:
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Web-based quoting and policy processing systems that allow our agencies and our
field and headquarters associates to collaborate more efficiently on new and renewal
business and that give our agencies choice and control |
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Systems that automate our internal processes so our associates can spend more time
serving agents and policyholders |
Agencies access our quoting and policy processing systems via CinciLink®, our secure
agency-only Web site. CinciLink also provides other content that makes it easier to do
business with us, such as online policy loss information, software updates, online courses
on the companys products and services and electronic coverage forms libraries.
We also are giving independent agents enhanced access to Cincinnatis systems and client
data quickly and easily through their agency systems. We recognize the investment agencies
have made in agency management systems. In 2005, we gave agents access to CinciLink directly
from their agency systems by leveraging industry leading integration products, TransactNOW®
and Transformation Station®. In 2006, we plan to advance our usage of these products. For
commercial lines, we will enable upload of select client data from the leading agency
systems to our new commercial lines pricing and policy systems. For personal lines, agencies
will be able to access Diamond billing information and policy detail directly from their
agency systems.
Three commercial lines and one personal lines system form the core of our quoting and policy
processing systems:
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WinCPP® is an online commercial lines rate quoting system for businessowners,
commercial package, commercial auto and workers compensation policies. WinCPP is
available in all 32 states and used by all of our reporting agency locations. During
2006, we will add data sharing capabilities with agency systems and roll out quoting
for small specialty programs for metalworkers, professional artisan contractors and
garage owners. (A businessowners policy combines property, liability and business
interruption coverages for small businesses.) |
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e-CLAS is a commercial lines policy processing system. e-CLAS will
make it easier and more efficient for our agencies to issue and administer our
commercial lines policies. In 2005, we introduced e-CLAS to all of our agencies in Ohio
to process new and renewal businessowners policies. |
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Our primary long-term technology objectives are to: |
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complete development of e-CLAS for all of our commercial lines of business and |
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roll out the system to agencies in all of the states in which we do business |
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During 2006, we expect to roll out businessowners policy processing to four additional
states and provide dentists package policy processing in all five e-CLAS states. We also
will begin developing commercial auto and commercial package policy processing
capabilities. |
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CinciBond is an automated system to process license and permit surety bonds.
CinciBond enables agents to issue and print bonds at their offices. CinciBond was
delivered to all Ohio agencies and initial groups of Indiana and Illinois agencies in
2005. During 2006, we will continue to deploy CinciBond in Indiana and Illinois. |
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Diamond is a real-time personal lines policy processing system, supporting all six
of our personal lines of business and allowing once and done processing. After its
introduction in Kansas in 2002, we began full deployment of Diamond in 2004. At
year-end, Diamond was in use in agencies representing approximately 70 percent of our
2005 personal lines premium volume, including those in Alabama, Florida, Kansas,
Illinois, Indiana, Michigan and Ohio. In 2005, $417 million of our $786 million of
personal lines written premium was issued through Diamond. During 2005, we improved the
systems stability and speed and made additional enhancements requested by our
agencies. Training for agents in six states that represent another 21.5 percent of our
premium volume is scheduled for 2006. Agents in Georgia, Kentucky and Wisconsin began
using Diamond in early 2006 with Minnesota, Missouri and Tennessee roll-outs planned
for later in the year. |
Two systems that automate our internal processes so our associates can spend more time
serving agents and policyholders are accessed through CFCNet®, our secure intranet:
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CMS is a claims file management system. CMS, initially deployed in late 2003,
allows simultaneous access to claim files by headquarters and field claims associates.
Field and headquarters claims associates use CMS to process all reported claims in a
virtual claim file. We continue to refine the system |
2005 10-K Page 4
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to add capabilities to make our
associates more effective. Agent access to selected information is planned for 2006. |
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i-View is a commercial lines policy imaging and workflow system. This systems
online policy viewing capability should speed the delivery and booking of policies as
well as help expedite the claims process. We began rolling out i-View in 2004 and it
was in use by approximately 50 percent of commercial lines underwriting teams at
year-end 2005. Enhancements and infrastructure updates
were completed in late 2005. Roll-out to the remaining teams began in January 2006 and
we expect it will be completed during 2006. |
Life Insurance Offerings Diversify Revenues and Earnings
We support the independent agencies affiliated with our property casualty operations in
their programs to sell life insurance. The products offered by our life insurance subsidiary
round out and protect accounts and improve account persistency. At the same time, the life
operation looks to increase diversification of revenue and profitability sources for both
the agency and our company.
Our property casualty agencies make up the main distribution system for our life insurance
products. We also develop life business from other independent life insurance agencies. We
are careful to solicit business from these other agencies in a manner that does not conflict
with or compete with the marketing and sales efforts of our property casualty agencies. We
emphasize up-to-date products, responsive underwriting and high quality service as well as
competitive commissions.
Superior Financial Strength Ratings
In addition to the ratings of our parent company senior debt, our property casualty and
life operations are awarded insurer financial strength ratings. Insurer financial strength
ratings assess an insurers ability to meet its financial obligations to policyholders and
do not necessarily address matters that may be important to shareholders. As of March 3,
2006, our financial strength ratings were:
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Property Casualty |
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Parent Company |
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Insurance |
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Life Insurance |
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Senior Debt |
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Subsidiaries |
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Subsidiary |
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Financial Strength Ratings: |
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A. M. Best Co. |
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aa- |
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A++ |
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A+ |
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Fitch Ratings |
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A+ |
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AA |
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AA |
Moodys Investors Services |
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A2 |
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Aa3 |
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Standard & Poors Ratings Services |
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A |
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AA- |
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AA- |
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Property Casualty Statutory Ratings: |
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Risk-Based Capital (RBC) |
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$ |
4,254 |
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Authorized control level risk-based capital |
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635 |
|
|
|
|
|
Property casualty statutory surplus |
|
|
|
|
|
|
4,194 |
|
|
|
|
|
Property casualty written premium-surplus ratio |
|
|
|
|
|
|
0.7 |
x |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Life Statutory Ratings: |
|
|
|
|
|
|
|
|
|
|
|
|
Risk-Based Capital (RBC) |
|
|
|
|
|
|
|
|
|
$ |
511 |
|
Authorized control level risk-based capital |
|
|
|
|
|
|
|
|
|
|
52 |
|
Life statutory surplus |
|
|
|
|
|
|
|
|
|
|
451 |
|
Life statutory risk-based adjusted
surplus-liabilities ratio |
|
|
|
|
|
|
|
|
|
|
37.3 |
% |
We believe that our superior insurer financial strength ratings are clear, competitive
advantages in the segment of the insurance marketplace that our agents serve. Our financial
strength supports the consistent, predictable performance that our policyholders, agents,
associates and shareholders have always expected and received, and it must be able to
withstand significant challenges. The most important way we seek to ensure that we remain
consistent and predictable is to align agents interests with those of the company, giving
agents outstanding service and compensation to earn their best business.
|
|
A.M. Best In June 2005, A.M. Best affirmed its top A++ (Superior) financial
strength ratings and stable outlook for our property casualty subsidiaries. Less than 2
percent of the 1,064 insurer groups A.M. Best reviews annually qualify for the A++
rating. |
|
|
A.M. Best cited our superior risk-based capitalization, successful business position
developed through building a network of independent agents, very strong financial
flexibility and liquidity, excellent interest coverage measures and modest financial
leverage. A.M. Best said its ratings take into account our high common stock leverage,
elevated investment concentration and somewhat geographically concentrated market
profile. A.M. Best stated that it expects the property casualty groups overall
operating results and |
2005 10-K Page 5
|
|
capitalization will remain strong in the near term due to our
focused underwriting strategy, strong agency relations and consistently sound loss
reserving practices. |
|
|
Also in June 2005, A.M. Best affirmed its A+ (Superior) rating for The Cincinnati Life
Insurance Company. A.M. Best cited our life insurance subsidiarys strategic position
within Cincinnati Financial Corporation, our continuing focus on growth with a broad
portfolio of life insurance products, expanding geographical presence, emphasis on
full-time life insurance specialists, consistently positive statutory operating
performance and adequate level of capitalization to manage our risks. A.M. Best said its
rating considered the life subsidiarys significant exposure to common stocks, lower
operating profitability due to losses from accident and health business and the effect
on surplus of acquisition costs related to writing increased amounts of new business. |
|
|
Fitch Ratings In August 2005, Fitch affirmed its AA (Very Strong) insurer
financial strength ratings and stable outlook for our property casualty subsidiaries
and life insurance subsidiary. Fitch cited the strong financial condition of our
operating subsidiaries, excellent financial flexibility, successful total return
investment strategy and competitive advantage derived from long-term relationships with
independent agents who distribute our products. |
|
|
Fitch said its ratings consider the property casualty groups significant investment
concentration in a small number of common stocks, geographic concentration that
contributes to sizable catastrophe exposure and regulatory concentration and
underperforming homeowner line of business. Fitch stated that it expects that financial
leverage will remain at or near its current level over the intermediate term. |
|
|
Moodys Investors Service Following our announcement of third-quarter 2005
results, Moodys commented that the companys strong balance sheet and conservative
financial and operating leverage metrics continue to support the property casualty
subsidiaries Aa3 ratings. Moodys said that its ratings took into account the
increased volatility risk to capital and surplus presented by our equity exposure,
along with its potential liabilities. |
|
|
Moodys noted that the company was on track to achieve growth and profitability targets
in line with Moodys expectations for the current ratings. Moodys said it expects the
company will maintain our commercial pricing discipline along with our commitment to
agency relationships, an integral filter in the underwriting process. Further, Moodys
expects full deployment of our policy processing system will simplify the process to
introduce rate and product changes within our personal lines market. |
|
|
Standard & Poors Ratings Services In October 2005, Standard & Poors issued a
corporate ratings report with the rationale for its AA- (Very Strong) ratings of the
property casualty subsidiaries and its negative outlook. Standard & Poors based the
ratings, affirmed in September 2004, on the groups strong competitive position
afforded by its extremely loyal and productive independent agency force, high business
persistency, extremely strong capitalization and high degree of financial flexibility.
Standard & Poors said its outlook took into account the companys underperformance in
our homeowner business; very aggressive investment strategies; slow, deliberate
response to changing markets, and volatility related to geographic concentration. |
|
|
Standard & Poors stated that it expects that the company should continue to perform
well in its largest business segment, commercial lines, while lagging peers in personal
lines profitability over the near term. Although progress could be tempered by slower
growth, the sizeable equity position, adverse regulatory or judicial decisions or
catastrophes, Standard & Poors said, it expects capitalization and growth will remain
extremely strong and growth will be solid as new agency appointments and territory
subdivisions partially offset possible weakening in industry pricing. |
|
|
A December 2005 corporate ratings report gave the rationale for Standard & Poors AA-
(Very Strong) rating of The Cincinnati Life Insurance Company. Standard & Poors based
the rating, affirmed in September 2004, on the life subsidiarys strategic position
within our group of companies, an extraordinarily superior capital position, extremely
strong liquidity and the strength of its marketing position among independent agents.
Standard & Poors said its rating considered the modest but growing penetration of our
property casualty customer base, a narrow but growing product line and asset/liability
management in the early stage of development. Standard & Poors outlook included
expectations for premium growth of 9 percent, continued broadening of our product
portfolio, improved asset/liability management, continued extremely strong capital and
liquidity, as well as improved benchmarks for tracking penetration of the property
casualty customer base. |
While the potential for volatility exists due to our catastrophe exposures, investment
philosophy and bias toward incremental change, the ratings agencies consistently have
asserted that we have built appropriate financial strength and flexibility to manage that
volatility. We remain committed to
strategies that emphasize long-term stability over short-term benefits that might accrue by
quick reaction to changes in market conditions.
For example, through all market and economic cycles we maintain strong insurance company
statutory surplus, a solid reinsurance program, sound reserving practices and low interest
rate risk, as well as low debt and
2005 10-K Page 6
strong capital at the parent-company level. Investments
at the parent company give us flexibility to support our capitalization policies for the
subsidiaries, improve the ability of the insurance companies to write additional premiums
and maintain high insurer financial strength ratings.
In 2004,
we transferred approximately 32 million shares of our Fifth
Third Bancorp (Nasdaq: FITB)
common stock holding to the insurance subsidiary from the parent company to reduce parent
company investment assets. The transfer raised our property casualty statutory surplus and
reduced our ratio of net written premiums to statutory surplus. This ratio is a common
measure of operating leverage used in the property casualty industry. It serves as an
indicator of the companys premium growth capacity. The estimated property casualty industry
net written premium to statutory surplus ratio was 1.0 percent, 1.1 percent and 1.2 percent
in 2005, 2004 and 2003, respectively. We do not intend to leverage our lower ratio following
the asset transfer by accelerating growth or strengthening loss reserves. Rather, the
transfer allowed us to retain the financial flexibility that continues to support our high
insurer financial strength ratings.
Cincinnati Lifes statutory adjusted risk-based surplus increased 4.1 percent to $511
million at December 31, 2005, from $491 million a year earlier. Statutory adjusted
risk-based surplus as a percentage of liabilities, a key measure of life insurance company
capital strength, was 37.3 percent at year-end 2005 compared with an estimated industry
average ratio of 10.4 percent. The higher the ratio, the stronger an insurers security for
policyholders and its capacity to support business growth.
At year-end 2005 and 2004, the risk-based capital (RBC) for our property casualty and life
operations was exceptionally strong and well above levels that would have required
regulatory action.
Programs, Products and Services to Support Agency Growth
We continue to expand the services we provide that support agency opportunities.
Accessible field representatives are the first layer of support. Headquarters associates
also provide agencies with underwriting, accounting and technology assistance and training.
Company executives, headquarters underwriters and special teams regularly travel to visit
agencies. Agents have opportunities for direct, personal conversations with our senior
management team, and headquarters associates have opportunities to refresh their knowledge
of marketplace conditions and field activities.
The field marketing representatives are joined by field claims, loss control, machinery and
equipment, bond, premium audit, life insurance and leasing specialists. For example, our
field engineering and loss control representatives perform inspections and recommend
specific actions to improve the safety of the policyholders operations and the quality of
the agents insurance account.
We complement the property casualty operations by providing products and services that help
attract and retain high-quality independent insurance agencies. CFC Investment Company
offers equipment and vehicle leases and loans for independent insurance agencies, their
commercial clients and other businesses. It also provides commercial real estate loans to
help agencies operate and expand their businesses. CinFin Capital Management markets asset
management services to agencies and their clients, as well as other institutions,
corporations and high net worth individuals.
When we appoint agencies, we look for organizations with knowledgeable, professional staffs.
In turn, we make an exceptionally strong commitment to assist them in keeping their
knowledge up to date and educating new people they bring on board as they grow. Numerous
activities at our headquarters, in regional and agency locations and online fulfill this
commitment:
|
|
At our headquarters, we conduct roundtables for agency principals, as well as our
regular schedule of commercial lines, personal lines and life insurance agent schools
and seminars. These generally focus on Cincinnati product and underwriting information
and sales tips. In addition to schools for agents, we have opened seats for agents in
our structured classroom training for new underwriting
associates. Agency staff may return to their
agencies after the class or stay and become fully grounded in Cincinnati philosophy by serving
as an associate for a few years before returning to the agency. |
|
|
Associates travel to regional and agency locations to instruct classes and provide a
variety of educational support services. Teams conduct personal lines customer service
representative training and marketing seminars to promote cross-serving and sales of
bonds, leasing services, life worksite marketing, inland marine
coverages and our
program for dentists. Other teams help agencies learn to use our new systems or get the
most from their own agency management systems. Cincinnati associates even co-host
client seminars with our agencies on the benefits of worksite
marketing or risk management and risk transfer techniques, with customized programs that
address liability issues specific to contractor or dentist audiences. |
|
|
We now bring courses to agency desktops, where at any time agency staff can access
the Agency Learning Center through CinciLink, our secure agency-only Web site. The
Learning Center offers convenient, online courses and Web conferences, including
Cincinnati product information, Microsoft® Office topics and general business subjects.
Our new producer and customer service representative curricula guide students through a
progression of online courses and classroom instruction. |
2005 10-K Page 7
Except travel-related expenses for courses held at our headquarters, most programs are
offered at no cost to our agencies. While that approach may be extraordinary in our industry
today, the result is quality service for our policyholders and increased success for our
independent agencies.
Third-party Measures of Satisfaction and Performance
The National Association of Insurance Commissioners Online Consumer Information Source
(www.naic.org) measured our complaint ratio at a very low 0.25 versus the national median score of 1.00
for all property coverages in 2004, the most recent year for which data is available. NAIC
members head the state departments of insurance that regulate insurance.
The Professional Insurance Agents Association of Ohio surveyed its members in 2005 on
satisfaction with their insurance companies. We scored higher than any other insurer in the
categories of claims handling, commercial lines competitiveness and agency compensation.
Offsetting these top scores and other strong scores in personal lines policy service,
company management and field marketing support, were scores lower than all other insurers in
both the homeowner competitiveness and the personal auto competitiveness categories. As
discussed in Item 7, Personal Lines Insurance Results of Operations, Page 47, we are taking
steps to restore a competitive position in personal lines.
In a 2005 study, Ward Group named Cincinnati Insurance to its annual top 50 lists of
property casualty and life/health insurers in America. Insurers and groups qualify based on
financial safety, consistency and performance over a five-year period. Cincinnati is one of
only eight property casualty insurers that have qualified for the list in each of its 15
years and one of only 10 property casualty insurers whose life insurance affiliates also
qualified.
Growing with Our Agencies
One of our primary objectives is to increase our written premiums more rapidly than the
industry. We believe our agencies are growing more rapidly than the industry, and we seek to
maintain or increase our penetration within each agency as it grows.
Further improving service through the creation of smaller marketing territories that permit
our local field marketing representatives to devote more time to each agency relationship
should help us maintain or increase our penetration within each agency. At year-end 2005, we
had 100 field marketing territories, up from 92 at the end of 2004 and 87 at the end of
2003. A new Delaware/Maryland territory represented both the subdivision of our existing
Maryland territory and our entry into Delaware, our first new state since 2000. While we
continually study the regulatory and competitive environment in states where we could decide
to actively market our property casualty products, we have not announced plans to enter any
of those states in the near future.
Another way we seek to increase overall premiums is to selectively appoint new agency
relationships within our current marketing territories. In 2004, we set an objective to
establish approximately 50 new agency relationships each year. In 2005, we established 41
new agency relationships, and in 2004, we established 50 new relationships. These new
appointments and other changes in agency structures led to a net increase in reporting
agency locations of 40 in 2005 and 22 in 2004. We are very careful to protect the franchise
for current agencies when selecting and appointing new agencies.
Achieving Claims Excellence
Our claims philosophy reflects our belief that we will prosper as a company by
responding to claims person to person, paying covered claims promptly, preventing false
claims from unfairly adding to overall premiums and building financial strength to meet
future obligations. We also believe that our company should have the financial strength to
pay claims while also creating value for shareholders, leading to our emphasis on the
establishment of adequate claims reserves.
Superior Claims Service
Our 751 locally based field claims representatives work from their homes, assigned to
specific agencies. They respond personally to policyholders and claimants, typically within
24 hours of receiving an agencys claim report. We believe the person-to-person approach,
together with the resulting high level
of service that field claims representatives, familiar with an agency and its policyholders,
can provide, gives us a competitive advantage. We also help our agencies provide prompt
service to policyholders by giving agencies authority to immediately pay most first-party
claims up to $2,500.
Catastrophe Response Teams are comprised of volunteers from our experienced field claims
staff. As hurricanes threaten, these associates travel to strategic locations near the expected impact area. This puts them in position to quickly get to the affected area,
set up temporary offices and start calling on policyholders. Cincinnati takes pride in
giving our field personnel the tools and authority they need to do their jobs. In times of
widespread loss, our field claims representatives confidently and quickly resolve claims,
often writing checks for damages on the same day they inspect the loss. Our Claims
Management System introduced new efficiencies that are especially evident during
catastrophes. Electronic claim files allow for fast initial contact of
2005 10-K Page 8
policyholders and
easy sharing of information between rotating storm teams, headquarters and local field
claims representatives.
Cincinnatis claims associates work hard to control costs where appropriate. We have several
relationships with vendors that offer our insureds and claimants preferred rates. However,
our biggest cost control program is our field claims representatives. Field claims
representatives are educated continuously on new techniques and repair trends. These
representatives have experience with area body shops, which helps them negotiate the right
price with any facility the policyholder chooses.
We staff a Special Investigations Unit (SIU) with former law enforcement and claims
professionals who are available to gather facts to help determine the fair amount to pay
under a claim. While we believe its our job to pay all that is due under each policy, we
also want to prevent false claims from unfairly increasing overall premiums. Our SIU also
operates a computer forensic lab, using sophisticated software to recover data and
mitigating the cost of computer-related claims for business interruption and loss of
records.
Loss and Loss Expense Reserves
When claims are made by or against policyholders, any amounts that our property
casualty operations pay or expect to pay for covered claims are termed losses. The costs we
incur in investigating, resolving and processing these claims are termed loss expenses. Our
consolidated financial statements include property casualty loss and loss expense reserves
that estimate the costs of not-yet-paid claims incurred through December 31 of each year.
The reserves include estimates for claims that have been reported to us plus our estimates
for claims that have been incurred but not yet reported, along with our estimate for loss
expenses associated with processing and settling those claims. We develop the various
estimates based on individual claim evaluations and statistical projections. We reduce the
loss reserves by an estimate for the amount of salvage and subrogation we expect to recover.
For at least the past 10 years, our annual review of our estimates has led to savings from
favorable development of loss reserves from prior accident years.
We encourage you to review several sections of the Managements Discussion and Analysis
where we discuss our loss reserves in greater depth. In Item 7, Critical Accounting
Estimates, Property Casualty Loss and Loss Expense Reserves, Page 35, we discuss our process
for analyzing potential losses and establishing reserves. In Item 7, Property Casualty
Insurance Reserves, Page 61, we review reserve levels, including 10-year development of our
property casualty loss reserves.
Investing for Long-term Total-return
While we seek to generate an underwriting profit in our insurance operations, our
investments historically have provided our primary source of net income and contributed to
our financial strength, driving long-term growth in shareholders equity and book value.
Under the direction of the investment committee of the board of directors, our portfolio
managers seek to balance current investment income opportunities and long-term appreciation
so that current cash flows can be compounded to achieve above-average long-term total
return. We invest some portion of cash flow in tax-advantaged fixed-maturity and equity
securities to maximize after-tax earnings. With premiums generally received before claims
are made under the policies purchased with those premiums, particularly for business lines
such as workers compensation, we have substantial cash flow available for investment.
Insurance regulatory and statutory requirements established to protect policyholders from
investment risk have always influenced our investment decisions on an individual insurance
company basis. After covering both our intermediate and long-range insurance obligations
with fixed-maturity investments, we historically used available cash flow to invest in
equity securities. Investment in equity securities has played an important role in achieving
our portfolio objectives and has contributed to net unrealized investment gains of $5.067
billion at year-end 2005. We remain committed to our long-term equity focus, which we
believe is key to our companys long-term growth and stability.
Our segments
Consolidated financial results primarily reflect the results of our four reporting
segments. These segments are defined based on financial information we use to evaluate
performance and to determine the allocation of assets.
|
|
Commercial lines property casualty insurance |
|
|
Personal lines property casualty insurance |
We also frequently evaluate results for our consolidated property casualty operations, which
is the total of our commercial lines and personal lines segments. Our consolidated property
casualty operations generated 80.8 percent of our revenues in 2005. Revenues, income before
income taxes, and identifiable assets for each
2005 10-K Page 9
segment are shown in a table in Item 8, Note
17 to the Consolidated Financial Statements, Page 98. Some of that information also is
discussed in this section of this report, where we explain the business operations of each
segment. The financial performance of each segment is discussed in the Managements
Discussion and Analysis of Financial Condition and Results of Operations, which begins on
Page 31.
Commercial Lines Property Casualty Insurance Segment
The commercial lines property casualty insurance segment contributed $2.254 billion in
net earned premiums to total revenues and $285 million to income before income taxes in
2005. Commercial lines net earned premiums grew 6.0 percent in 2005, 11.4 percent in 2004
and 10.8 percent in 2003.
Four business lines commercial multi-peril, workers compensation, commercial auto and
other liability accounted for 89.7 percent of our commercial lines earned premiums.
|
|
Commercial multi-peril coverage is a combination of property and liability
coverages. Property insurance covers damages such as those caused by fire, wind, hail,
water, theft, vandalism and business interruption resulting from a covered loss.
Liability coverage insures businesses against third-party liability from accidents
occurring on their premises or arising out of their operations, such as injuries
sustained from products sold. |
|
|
Workers compensation coverages protect employers against specified benefits payable
under state or federal law for workplace injuries to employees. In some of our active
states, including Ohio, workers compensation coverage is a state monopoly, provided
solely by the state instead of by private insurers. |
|
|
Commercial auto coverages protect businesses against liability to others for both
bodily injury and property damage, medical payments to insureds and occupants of their
vehicles, physical damage to an insureds own vehicle from collision and various other
perils, and damages caused by uninsured motorists. |
|
|
Other liability coverages include commercial umbrella, commercial general liability
and most executive risk policies, which cover liability exposures including bodily
injury, directors and officers and employment practices, property damage arising from
products sold and general business operations. |
The remainder of our commercial lines earned premiums derives from a variety of other types
of insurance products that we offer to businesses, including fire and allied lines
commercial property policies, inland marine policies, fiduciary and surety bonds and
machinery and equipment policies.
We market our full portfolio of commercial insurance products in 1,245 of our reporting
agency locations and all 32 states where we actively market property casualty insurance.
There are eight reporting agency locations that market only our surety bond products. Our
emphasis is on products that agents can market to small- to mid-size businesses in their
communities.
In 2005, our 10 highest volume commercial lines states generated 68.8 percent of our agency
earned premium compared with 70.0 percent in the prior year. Agency earned premiums in the
10 highest volume states rose 5.2 percent in 2005 and 10.4 percent in 2004. Agency earned
premiums in the remaining 22 states rose 10.5 percent in 2005 and 16.2 percent in 2004.
Agency earned premiums are premiums before reinsurance.
2005 10-K Page 10
Commercial Lines Agency Earned Premiums by State
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(Dollars
in millions) |
|
Earned |
|
|
Percent |
|
|
|
|
|
Reporting |
|
|
Avg premium |
|
|
|
premium |
|
|
of total |
|
|
Change % |
|
|
agency locations |
|
|
per location |
|
|
Year ended December 31, 2005 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Ohio |
|
$ |
432 |
|
|
|
18.2 |
% |
|
|
4.0 |
|
|
|
224 |
|
|
$ |
1.9 |
|
Illinois |
|
|
241 |
|
|
|
10.1 |
|
|
|
2.8 |
|
|
|
112 |
|
|
|
2.1 |
|
Pennsylvania |
|
|
174 |
|
|
|
7.3 |
|
|
|
7.9 |
|
|
|
63 |
|
|
|
2.8 |
|
Indiana |
|
|
164 |
|
|
|
6.9 |
|
|
|
2.9 |
|
|
|
99 |
|
|
|
1.7 |
|
Michigan |
|
|
130 |
|
|
|
5.5 |
|
|
|
0.2 |
|
|
|
88 |
|
|
|
1.5 |
|
North Carolina |
|
|
125 |
|
|
|
5.3 |
|
|
|
11.1 |
|
|
|
68 |
|
|
|
1.8 |
|
Virginia |
|
|
112 |
|
|
|
4.7 |
|
|
|
4.6 |
|
|
|
53 |
|
|
|
2.1 |
|
Wisconsin |
|
|
98 |
|
|
|
4.1 |
|
|
|
8.7 |
|
|
|
49 |
|
|
|
2.0 |
|
Iowa |
|
|
82 |
|
|
|
3.4 |
|
|
|
6.6 |
|
|
|
45 |
|
|
|
1.8 |
|
Georgia |
|
|
79 |
|
|
|
3.3 |
|
|
|
13.6 |
|
|
|
59 |
|
|
|
1.3 |
|
All other states |
|
|
739 |
|
|
|
31.2 |
|
|
|
10.5 |
|
|
|
393 |
|
|
|
1.9 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total |
|
$ |
2,376 |
|
|
|
100.0 |
% |
|
|
6.8 |
|
|
|
1,253 |
|
|
|
1.9 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Year ended December 31, 2004 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Ohio |
|
$ |
415 |
|
|
|
18.7 |
% |
|
|
8.1 |
|
|
|
224 |
|
|
$ |
1.9 |
|
Illinois |
|
|
234 |
|
|
|
10.5 |
|
|
|
7.7 |
|
|
|
113 |
|
|
|
2.1 |
|
Pennsylvania |
|
|
162 |
|
|
|
7.3 |
|
|
|
14.4 |
|
|
|
63 |
|
|
|
2.6 |
|
Indiana |
|
|
160 |
|
|
|
7.2 |
|
|
|
6.8 |
|
|
|
96 |
|
|
|
1.7 |
|
Michigan |
|
|
130 |
|
|
|
5.8 |
|
|
|
11.3 |
|
|
|
83 |
|
|
|
1.6 |
|
North Carolina |
|
|
112 |
|
|
|
5.0 |
|
|
|
15.9 |
|
|
|
66 |
|
|
|
1.7 |
|
Virginia |
|
|
107 |
|
|
|
4.8 |
|
|
|
13.5 |
|
|
|
51 |
|
|
|
2.1 |
|
Wisconsin |
|
|
90 |
|
|
|
4.1 |
|
|
|
11.1 |
|
|
|
49 |
|
|
|
1.8 |
|
Iowa |
|
|
77 |
|
|
|
3.4 |
|
|
|
12.4 |
|
|
|
44 |
|
|
|
1.7 |
|
Tennessee |
|
|
72 |
|
|
|
3.2 |
|
|
|
14.4 |
|
|
|
30 |
|
|
|
2.4 |
|
All other states |
|
|
666 |
|
|
|
30.0 |
|
|
|
16.2 |
|
|
|
393 |
|
|
|
1.7 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total |
|
$ |
2,225 |
|
|
|
100.0 |
% |
|
|
12.0 |
|
|
|
1,212 |
|
|
|
1.8 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Commercial Lines Insurance Marketplace
For commercial lines, our competition predominately consists of those companies that
also distribute through independent agents. The independent agencies that market our
commercial lines products typically represent four to 12 standard market insurance carriers,
including both national and regional carriers, some of which may be mutual companies.
Generally, we believe regional carriers offer us the greatest competition on small- and
mid-size commercial accounts because they often are familiar with the local market and focus
on differentiating themselves through personal relationships with agencies. Carriers with a
national presence provide formidable competition on large commercial accounts and have
increasingly targeted smaller commercial accounts, marketing a service-center approach that
some agencies find efficient. In our experience, the level of competition varies state by
state and region by region, regardless of the carriers represented within a specific agency.
Since late 2003, the softening commercial lines marketplace has been characterized by
increased competition, particularly for quality new business. Generally, the level of
competition has varied by market, by line of business and by size of account. In most
markets where we compete, disciplined underwriting generally has remained the norm. We
believe carriers are modifying prices rather than changing policy terms and conditions.
Prior to Hurricanes Katrina, Rita and Wilma, we anticipated commercial lines insurance
market trends in 2006 would reflect accelerated competition with pressure on pricing from
the industrys increasing surplus and improving profitability. We are uncertain what effect
the hurricanes, and the related rise in the cost of reinsurance, may have on commercial
lines pricing throughout 2006.
Personal Lines Property Casualty Insurance Segment
The personal lines property casualty insurance segment contributed $804 million in net
earned premiums to total revenues and $45 million to income before income taxes in 2005.
Personal lines net earned premiums grew 1.4 percent in 2005, 6.4 percent in 2004 and 11.2
percent in 2003.
The personal auto line of business accounted for 53.8 percent and the homeowner line of
business accounted for 35.5 percent of personal lines net earned premium in 2005.
|
|
Personal auto coverages protect against liability to others for both bodily injury
and property damage, medical payments to insureds and occupants of their vehicle,
physical damage to an insureds own vehicle from collision and various other perils,
and damages caused by uninsured motorists. In addition, many |
2005 10-K Page 11
|
|
states require policies to
provide first-party personal injury protection, frequently referred to as no-fault
coverage. |
|
|
Homeowner coverages protect against losses to dwellings and contents from a wide
variety of perils, as well as liability arising out of personal activities both on and
off the covered premises. The company also offers coverage for condominium unit owners
and renters. |
The remainder of our personal lines earned premium was derived from a variety of other types
of insurance products we offer to individuals such as dwelling fire, inland marine, personal
umbrella liability and watercraft coverages.
We 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.) The remaining 458 locations are in states
where we either do not actively market these products or where we have determined, in
conjunction with agency management, that our personal lines products are not appropriate for
their agencies at this time.
In 2005, our 10 highest volume personal lines states generated 85.0 percent of our agency
earned premium compared with 85.1 percent in the prior year. Agency earned premiums in the
10 highest volume states rose 0.3 percent in 2005 and 6.5 percent in 2004. Agency earned
premiums in the remaining states rose 1.1 percent in 2005 and 12.9 percent in 2004. Agency
earned premiums are premiums before reinsurance.
Personal Lines Agency Earned Premiums by State
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(Dollars
in millions) |
|
Earned |
|
|
Percent |
|
|
|
|
|
Reporting |
|
|
Avg premium |
|
|
|
premium |
|
|
of total |
|
|
Change % |
|
|
agency locations |
|
|
per location |
|
|
Year ended December 31, 2005 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Ohio |
|
$ |
305 |
|
|
|
37.4 |
% |
|
|
(0.3 |
) |
|
|
211 |
|
|
$ |
1.4 |
|
Indiana |
|
|
74 |
|
|
|
9.0 |
|
|
|
(3.1 |
) |
|
|
65 |
|
|
|
1.1 |
|
Illinois |
|
|
59 |
|
|
|
7.2 |
|
|
|
(2.5 |
) |
|
|
78 |
|
|
|
0.8 |
|
Georgia |
|
|
62 |
|
|
|
7.6 |
|
|
|
4.8 |
|
|
|
46 |
|
|
|
1.4 |
|
Michigan |
|
|
43 |
|
|
|
5.2 |
|
|
|
(5.3 |
) |
|
|
66 |
|
|
|
0.6 |
|
Alabama |
|
|
40 |
|
|
|
4.9 |
|
|
|
4.3 |
|
|
|
24 |
|
|
|
1.7 |
|
Kentucky |
|
|
37 |
|
|
|
4.6 |
|
|
|
5.3 |
|
|
|
33 |
|
|
|
1.1 |
|
Wisconsin |
|
|
27 |
|
|
|
3.3 |
|
|
|
(1.2 |
) |
|
|
30 |
|
|
|
0.9 |
|
Florida |
|
|
26 |
|
|
|
3.2 |
|
|
|
6.9 |
|
|
|
10 |
|
|
|
2.6 |
|
Virginia |
|
|
21 |
|
|
|
2.6 |
|
|
|
5.8 |
|
|
|
23 |
|
|
|
0.9 |
|
All other states |
|
|
123 |
|
|
|
15.0 |
|
|
|
1.1 |
|
|
|
209 |
|
|
|
0.6 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total |
|
$ |
818 |
|
|
|
100.0 |
% |
|
|
0.4 |
|
|
|
795 |
|
|
|
1.0 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Year ended December 31, 2004 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Ohio |
|
$ |
306 |
|
|
|
37.6 |
% |
|
|
5.7 |
|
|
|
202 |
|
|
$ |
1.5 |
|
Indiana |
|
|
76 |
|
|
|
9.3 |
|
|
|
2.7 |
|
|
|
67 |
|
|
|
1.1 |
|
Illinois |
|
|
61 |
|
|
|
7.4 |
|
|
|
7.7 |
|
|
|
80 |
|
|
|
0.8 |
|
Georgia |
|
|
60 |
|
|
|
7.3 |
|
|
|
5.9 |
|
|
|
44 |
|
|
|
1.3 |
|
Michigan |
|
|
45 |
|
|
|
5.5 |
|
|
|
14.9 |
|
|
|
60 |
|
|
|
0.8 |
|
Alabama |
|
|
38 |
|
|
|
4.7 |
|
|
|
2.9 |
|
|
|
25 |
|
|
|
1.5 |
|
Kentucky |
|
|
36 |
|
|
|
4.4 |
|
|
|
13.3 |
|
|
|
31 |
|
|
|
1.1 |
|
Wisconsin |
|
|
28 |
|
|
|
3.4 |
|
|
|
8.2 |
|
|
|
30 |
|
|
|
0.9 |
|
Florida |
|
|
25 |
|
|
|
3.0 |
|
|
|
4.7 |
|
|
|
10 |
|
|
|
2.5 |
|
Virginia |
|
|
20 |
|
|
|
2.5 |
|
|
|
9.1 |
|
|
|
22 |
|
|
|
0.9 |
|
All other states |
|
|
120 |
|
|
|
14.9 |
|
|
|
12.9 |
|
|
|
207 |
|
|
|
0.6 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total |
|
$ |
815 |
|
|
|
100.0 |
% |
|
|
7.4 |
|
|
|
778 |
|
|
|
1.0 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Personal Lines Insurance Marketplace
In addition to carriers that market through independent agents, our personal lines
competition also includes carriers that market through captive agents and direct writers,
which our agencies clients may investigate independently. The independent agencies that
market our personal lines products typically represent five to eight standard personal lines
carriers.
In 2003, competition increased in the personal lines marketplace, driven by industrywide
improvement in results and favorable frequency and severity trends. This followed several
years of rising personal auto and homeowner rates and stricter enforcement of underwriting
standards across the industry. The increased competition in the past several years also
reflected implementation of tiered rating systems by a growing number of carriers. Carriers
that have adopted these systems use multiple variables to segment the market, relying in
part on credit-based information and offering a greater number of rate levels.
2005 10-K Page 12
We expect that competition in the personal auto and homeowners markets will continue to
increase over the next 12 to 24 months. Despite the record level of industrywide catastrophe
losses in 2005 and 2004, many personal lines carriers have reported strong operating results
in the past two years and continue to have healthy capital to support business growth. We
believe these carriers are focused on gaining market share through the introduction of new
products and services, increased advertising expenditures and the use of tiered rating
systems that may allow them to target higher quality risks with lower prices.
Life Insurance Segment
The life insurance segment contributed $106 million of net earned premiums and $7
million in income before income taxes in 2005. Life insurance segment profitability is
discussed in detail in Item 7, Life Insurance Results of Operations, Page 52.
The overall mission of our company is supported by The Cincinnati Life Insurance Company.
Cincinnati Life helps meet the needs of our agencies, including increasing and diversifying
agency revenues. We primarily focus on life products that produce revenue growth through a
steady stream of premium payments. By diversifying revenue and profitability for both the
agency and our company, this strategy enhances the already strong relationship built by the
combination of the property casualty and life companies.
Cincinnati Life seeks to become the life insurance carrier of choice for the independent
agencies that work with our property casualty operations. We emphasize up-to-date products,
responsive underwriting and high quality service as well as competitive commissions. At
year-end 2005, approximately 80 percent of our 1,253 property casualty reporting agency
locations offered Cincinnati Lifes products to their clients. We also develop life business
from other independent life insurance agencies. We are careful to solicit business from
these other agencies in a manner that does not conflict with or compete with the marketing
and sales efforts of our property casualty agencies.
Business Lines
Four lines of business term insurance, whole life insurance, universal life insurance
and worksite products account for approximately 86 percent of the life insurance segments
revenues:
|
|
Term insurance policies under which the benefit is payable only if the insured
dies during a specified period of time or term; no benefit is payable if the insured
survives to the end of the term. While premiums are fixed, they must be paid as
scheduled. The proposed insured is evaluated using normal underwriting standards. |
|
|
Whole life insurance policies that provide life insurance for the entire lifetime
of the insured; the death benefit is guaranteed never to decrease and premiums are
guaranteed never to increase. While premiums are fixed, they must be paid as scheduled.
These policies provide guaranteed cash values that are available to withdrawing
policyholders. The proposed insured is evaluated using normal underwriting standards. |
|
|
Universal life insurance long-duration life insurance policies. Contract premiums
are neither fixed nor guaranteed; however, the contract does specify a minimum interest
crediting rate and a maximum cost of insurance charge and expense charge. Premiums are
not fixed and may be varied by the contract owner. The cash values available to
withdrawing policyholders are not guaranteed and depend on the amount and timing of
actual premium payments and the amount of actual contract assessments. The proposed
insured is evaluated using normal underwriting standards. |
|
|
Worksite products term insurance, whole life insurance, universal life and
disability insurance offered to employees through their employer. Premiums are
collected by the employer using payroll deduction. Polices are issued using a
simplified underwriting approach and for smaller face amounts than similar, regularly
underwritten policies. Worksite insurance products provide our property casualty agency
force with excellent cross-serving opportunities for both commercial and personal
accounts. Agents report that offering worksite marketing to employees of their
commercial accounts provides a benefit to the employees at low cost to the employer.
Worksite marketing also connects agents with new customers who may not have previously
benefited from receiving the services of a professional independent insurance agent. |
In addition, Cincinnati Life markets:
|
|
Disability income insurance provides monthly benefits to offset the loss of income
when the insured person is unable to work due to accident or illness. |
|
|
Deferred annuities provide regular income payments that commence after the end of
a specified period or when the annuitant attains a specified age. During the deferral
period, any payments made under the contract accumulate at the crediting rate declared
by the company but not less than a contract-specified guaranteed minimum interest rate.
A deferred annuity may be surrendered during the deferral period for a cash value equal
to the accumulated payments plus interest less the surrender charge, if any. |
2005 10-K Page 13
|
|
Immediate annuities provide some combination of regular income and lump sum
payments in exchange for a single premium. Most of the immediate annuities written by
our life insurance segment are purchased by our property casualty companies to settle
casualty claims. |
Life Insurance Marketplace
Our life insurance company markets its products through approximately 1,000 of our
reporting agency locations in all but one of the 32 states where we actively market property
casualty insurance and through 453 additional independent life agencies in a total of 48
states. We do not market life insurance products in Alaska and New York.
We market our life insurance products either through independent agencies affiliated with
our property casualty operations or through independent life agencies. Our property casualty
agencies comprise the main distribution system for our life insurance products. Other life
insurance carriers continue to expand the use of nontraditional distribution channels such
as banks and financial planners as alternatives to the agency channel. We intend to market
solely through independent agencies, with an emphasis on enhancing our relationships with
the agencies affiliated with our property casualty insurance operations.
When marketing through our property casualty agencies we have several specific competitive
advantages. Because our property casualty operations are held in high regard, the property
casualty agencys management is predisposed to consider carefully our proposals to sell our
life products. All of our marketing efforts, property casualty and life, are directed by our
field marketing department, which assures consistency of message. Our life field marketing
representatives regularly meet face-to-face with the agency personnel responsible for life
insurance production. The resources of our life headquarters underwriters and other
associates are available to the field team to assist in the placement of agency business. We
find fewer and fewer of our competitors provide direct, personal contact between the agent
and the insurance carrier.
Also, we continue to emphasize the cross-serving opportunities between worksite marketing of
life insurance products and the property casualty agencys commercial accounts. For example,
in 2006, we are exploring additional programs to simplify the worksite sales process,
including electronic enrollment software. We also intend to enhance our worksite product
portfolio to make it more attractive to agents.
In both the property casualty and independent life agency distribution systems we enjoy the
competitive advantages of offering competitive, up-to-date products, providing close
personal attention and exhibiting financial strength and stability.
We primarily offer products targeted at addressing the needs of small businesses that
require key person coverage and individuals who require mortality coverage. Term insurance
is our largest life insurance product line. We continue to introduce new term products with
features our agents indicate are important. A new term series, which included a
return-of-premium feature, replaced the existing term portfolio during 2005. Reaction to the
new portfolio has been favorable with approximately 25 percent of applications requesting
the return-of-premium feature. In 2006 we are introducing a new universal life product that
offers a secondary guarantee that keeps the death benefit in force provided a competitive
minimum premium requirement is met.
Because of our strong capital position, we can offer a competitive product portfolio
including guaranteed products, giving our agents a marketing edge. Our life insurance
company maintained strong insurer financial strength ratings in 2005: A.M. Best A+
(Superior), Fitch AA (Very Strong) and Standard & Poors AA- (Very Strong, negative
outlook).
Offsetting our competitive advantages we continue to see consolidation within the life
insurance industry and an increased presence of large, well-capitalized carriers. The larger
carriers can offer a broader product line, including variable and equity-indexed products.
Our competitive advantage can be diminished because we do not have these types of products,
particularly during a time when the stock market is performing well.
Current statutory laws and regulations require redundant reserves, particularly for
preferred risk underwriting classes. These redundant reserves, in turn, depress statutory
earnings and require a large commitment of capital. Redundant reserves are a significant
issue, not just for our life insurance operations, but for all writers of term insurance and
universal life with secondary guarantees. However, larger carriers may be able to better
absorb or may be able to securitize the statutory reserve strain associated with
competitively priced term insurance and universal life with secondary guarantees.
The NAIC recognizes the problems caused by redundant reserves and is following a two-step
approach to provide relief. First, the NAIC has asked for comments on an amendment to the
mortality table mandated for statutory reserves to incorporate preferred underwriting
classifications. The amended table would lower reserve requirements for term insurance
products. It may be available for use in statutory statements by December 31, 2006. Second,
the NAIC proposes amending the actuarial guidelines for reserve requirements for universal
life policies with secondary guarantees. The
amendment would allow the use of low-level lapse rates in calculating reserves for these
types of universal life plans and also would result in lower reserves. It may be available
for use in statutory statements by December 31, 2007.
2005 10-K Page 14
For the longer term, the NAIC has asked for comment proposals on implementing a
principles-based reserving system rather than the current formulaic system. While still
capturing all material risks, a principles-based system would allow a company to use its own
experience, subject to credibility standards and appropriate margins for uncertainty. Also,
under the proposed principles-based system, the insurer would fully document and disclose
all its assumptions and methods to regulatory officials.
Investments Segment
The investment segment contributed $587 million of our total revenues in 2005,
primarily from net investment income and realized investment gains and losses from
investment portfolios managed for the holding company and each of the operating
subsidiaries. After deducting interest credited to contract holders of the life insurance
segment, the investments segment contributed $536 million of income before income taxes, or
65.1 percent of our total income before income taxes.
The fair value (market value) of our investment portfolio was $12.657 billion and $12.639
billion at year-end 2005 and 2004, respectively. The cash we generate from insurance
operations historically has been invested in three broad categories of investments:
|
|
Fixed-maturity investments Includes taxable and tax-exempt bonds and redeemable preferred stocks |
|
|
|
Equity investments Includes common and nonreedemable preferred stocks |
|
|
|
Short-term investments Primarily commercial paper |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(In millions) |
|
|
|
|
|
At December 31, |
|
|
|
|
|
|
|
2005 |
|
|
2004 |
|
|
|
Book value |
|
|
Fair value |
|
|
Book value |
|
|
Fair value |
|
|
Taxable fixed maturities |
|
$ |
3,304 |
|
|
$ |
3,359 |
|
|
$ |
3,161 |
|
|
$ |
3,376 |
|
Tax-exempt fixed maturities |
|
|
2,083 |
|
|
|
2,117 |
|
|
|
1,622 |
|
|
|
1,694 |
|
Common equities |
|
|
1,961 |
|
|
|
6,936 |
|
|
|
1,918 |
|
|
|
7,466 |
|
Preferred equities |
|
|
167 |
|
|
|
170 |
|
|
|
27 |
|
|
|
32 |
|
Short-term investments |
|
|
75 |
|
|
|
75 |
|
|
|
71 |
|
|
|
71 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total |
|
$ |
7,590 |
|
|
$ |
12,657 |
|
|
$ |
6,799 |
|
|
$ |
12,639 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Primarily as part of our program to support our high financial strength ratings almost all
of our insurance subsidiarys available cash flow since the second quarter of 2004 has been
used to purchase fixed-maturity investments. Our objective was to bring the property
casualty subsidiarys ratio of common stock to statutory surplus in line with our historic
sub-100 percent level. The ratio of common stock to statutory surplus for the property
casualty insurance group portfolio was 97.0 percent at year-end 2005 compared with 103.5
percent at year-end 2004 and 114.7 percent at year-end 2003.
During the same period, we took actions to reduce the parent companys ratio of investment
assets to total assets for the parent company below 40 percent, for the reasons we discuss
in Item 1A, Risk Factors, Page 21. The ratio of investment assets to total assets for the
parent company was 33.9 percent at year-end 2005, compared with 36.3 percent at year-end
2004 and 58.6 percent at year-end 2003.
Going forward, we will take into consideration insurance department regulations and ratings
agency comments, as well as the trend in these ratios, to determine what portion of new cash
flow should be invested in equity securities at the parent and insurance subsidiary levels.
In the past, we also have separately reported convertible security investments, which make
up approximately 2.4 percent of the total fair value of the investment portfolio. Beginning
this year, we are reporting and analyzing convertible securities as either fixed-maturity or
equity investments, based on the characteristics of the underlying security (bond or
preferred stock).
Fixed-maturity and Short-term Investments
By maintaining a well diversified fixed-maturity portfolio, we attempt to reduce
overall risk. We invest new money in the bond market on a continuous basis, targeting what
we believe to be optimal risk-adjusted after-tax yields. Risk, in this context, includes
interest rate, call, reinvestment rate, credit and liquidity risks. We do not make a
concerted effort to alter duration on a portfolio basis in response to anticipated movements
in interest rates. By continuously investing in the bond market, we build a
broad, diversified portfolio that we believe mitigates the impact of adverse economic
factors. In recent years, we have taken into account the trend toward a flatter corporate
yield curve by purchasing higher-quality corporate bonds with intermediate maturities as
well as tax-exempt municipal bonds and U.S. agency paper. Our focus on long-term total
return may result in variability in the levels of realized and unrealized investment gains
or losses from one period to the next.
We place a strong emphasis on purchasing current income-producing securities for the
insurance companies portfolios. Within the fixed-maturity portfolio, we invest in a blend
of taxable and tax-exempt securities to
2005 10-K Page 15
minimize our corporate taxes. With the exception of
U.S. agency paper, no individual issuers securities accounted for more than 1.0 percent of
the fixed-maturity portfolio at December 31, 2005.
Taxable Fixed-maturities
Taxable fixed-maturity bonds include:
|
|
$973 million in U.S. agency paper, which is rated AAA by both Moodys and Standard & Poors. |
|
|
|
$1.750 billion in investment-grade corporate bonds that have a Moodys rating at or
above Baa 3 or a Standard & Poors rating at or above BBB-. |
|
|
|
$358 million in high-yield corporate bonds that have a Moodys rating below Baa 3 or
a Standard & Poors rating below BBB-. |
|
|
|
$278 million in convertible bonds and redeemable preferred stocks. |
We seek to balance current income with potential changes in market value as well as changes
in credit risk when determining whether or not to hold these securities to maturity.
Similar to the equity portfolio, the taxable fixed-maturity portfolio is most heavily
concentrated in the financials sector, including banks, brokerage, finance and investment
and insurance companies. The financials sector represented 26.1 percent and 26.6 percent,
respectively, of book value and fair value of the taxable fixed-maturity portfolio at
December 31, 2005, compared with 24.1 percent and 24.6 percent of book value and fair value
at December 31, 2004. Although it is our largest concentration in a single sector, we
believe our percentage in the financials sector is below average for the corporate bond
market as a whole. No other sector or industry accounted for more than 10 percent of the
taxable fixed-maturity portfolio.
Tax-exempt Fixed-maturities
We traditionally have purchased municipal bonds focusing on schools and essential
services, such as sewer, water or others. While no single municipal issuer accounted for
more than 1.2 percent of the tax-exempt municipal bond portfolio at December 31, 2005, there
are higher concentrations within individual states. Holdings in Illinois, Indiana, Michigan,
Ohio and Texas accounted for 60.6 percent of the municipal bond portfolio at year-end 2005.
Fixed-maturity and Short-term Portfolio Ratings
Our investments in U.S. agency paper and insured municipal bonds over the past several
years have led to a significant rise in the percentage of A and higher rated fixed-maturity
and short-term holdings, based on fair value. The majority of our non-rated securities are
tax-exempt municipal bonds from smaller municipalities that chose not to pursue a credit
rating. Credit ratings as of December 31, 2005 and 2004, for the fixed-maturity and
short-term portfolio were:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(Dollars in millions) |
|
2005 |
|
|
2004 |
|
|
|
Fair |
|
|
Percent |
|
|
Fair |
|
|
Percent |
|
|
|
value |
|
|
to total |
|
|
value |
|
|
to total |
|
|
Moodys Ratings |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Aaa, Aa, A |
|
$ |
3,651 |
|
|
|
65.8 |
% |
|
$ |
3,101 |
|
|
|
60.3 |
% |
Baa |
|
|
1,094 |
|
|
|
19.7 |
|
|
|
1,069 |
|
|
|
20.8 |
|
Ba |
|
|
324 |
|
|
|
5.8 |
|
|
|
363 |
|
|
|
7.1 |
|
B |
|
|
110 |
|
|
|
2.0 |
|
|
|
125 |
|
|
|
2.4 |
|
Caa |
|
|
13 |
|
|
|
0.2 |
|
|
|
23 |
|
|
|
0.5 |
|
Ca |
|
|
0 |
|
|
|
0.0 |
|
|
|
11 |
|
|
|
0.2 |
|
C |
|
|
0 |
|
|
|
0.0 |
|
|
|
0 |
|
|
|
0.0 |
|
Non-rated |
|
|
359 |
|
|
|
6.5 |
|
|
|
449 |
|
|
|
8.7 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total |
|
$ |
5,551 |
|
|
|
100.0 |
% |
|
$ |
5,141 |
|
|
|
100.0 |
% |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Standard & Poors Ratings |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
AAA, AA, A |
|
$ |
3,233 |
|
|
|
58.3 |
% |
|
$ |
2,865 |
|
|
|
55.7 |
% |
BBB |
|
|
1,112 |
|
|
|
20.0 |
|
|
|
1,095 |
|
|
|
21.3 |
|
BB |
|
|
354 |
|
|
|
6.4 |
|
|
|
340 |
|
|
|
6.6 |
|
B |
|
|
117 |
|
|
|
2.1 |
|
|
|
154 |
|
|
|
3.0 |
|
CCC |
|
|
2 |
|
|
|
0.0 |
|
|
|
5 |
|
|
|
0.1 |
|
CC |
|
|
0 |
|
|
|
0.0 |
|
|
|
11 |
|
|
|
0.2 |
|
D |
|
|
0 |
|
|
|
0.0 |
|
|
|
4 |
|
|
|
0.1 |
|
Non-rated |
|
|
733 |
|
|
|
13.2 |
|
|
|
667 |
|
|
|
13.0 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total |
|
$ |
5,551 |
|
|
|
100.0 |
% |
|
$ |
5,141 |
|
|
|
100.0 |
% |
|
|
|
|
|
|
|
|
|
|
|
|
|
2005 10-K Page 16
Attributes of the fixed-maturity portfolio include:
|
|
|
|
|
|
|
|
|
|
|
Years ended December 31, |
|
|
2005 |
|
2004 |
|
Weighted average yield-to-book value |
|
|
5.4 |
% |
|
|
5.8 |
% |
Weighted average maturity |
|
9.5 |
yrs |
|
9.4 |
yrs |
Weighted average duration to worst |
|
5.4 |
yrs |
|
4.8 |
yrs |
Weighted average modified duration |
|
7.1 |
yrs |
|
6.9 |
yrs |
The decline in the yield-to-book between 2005 and 2004 was due to investments of new cash
flow as well as the reinvestment of calls and redemptions at interest rates below historic
norms. The average maturity was essentially unchanged. The modified duration remained nearly
flat while modified duration to worst, an option adjusted measure, increased. This was
primarily due to a slight increase in rates in the intermediate range of the yield curve and
our continued emphasis on purchasing municipal bonds, which have a lower pretax yield. We
discuss the maturity of our fixed-maturity portfolio in Item 8, Note 2 to the Consolidated
Financial Statements, Page 88.
Equity Investments
Our equity
investment portfolio includes both common stocks and nonreedemable preferred stocks.
Approximately 87.8 percent of the equity portfolio is made up of a core group of common
stocks that we monitor closely to gain an in-depth understanding of their organization and
industry. The portfolio also includes a broader group of smaller positions that are a source
of trading flexibility and other risk management advantages. Our equity investments had an
average dividend yield-to-cost of 11.7 percent at December 31, 2005, compared with 11.5
percent at December 31, 2004.
Common Stocks
At December 31, 2005, 35.1 percent of our common stock holdings (measured by fair
value) were held at the parent company level. Our common stock investments generally are
securities with annual dividend yields of 1.5 percent to 3.0 percent and histories of
dividend increases. Other criteria we evaluate include increasing sales and earnings, proven
management and a favorable outlook. When investing in common stock, we seek to identify some
companies in which we can accumulate more than 5 percent of their outstanding shares. At
year-end 2005, we held more than 5 percent of Fifth Third, FirstMerit Corporation, Piedmont
Natural Gas Company and First Financial Bancorp. There also is a core group of common stocks
in which the company holds a fair value of at least $100 million each. At year-end 2005,
there were 14 holdings in that core group.
Largest Common Stock Holdings
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(Dollars in millions) |
|
|
|
|
|
As of and for the year ended December 31, 2005 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Earned |
|
|
Earned |
|
|
|
Actual |
|
|
Fair |
|
|
Percent of |
|
|
dividend |
|
|
dividend to |
|
|
|
cost |
|
|
value |
|
|
fair value |
|
|
income |
|
|
fair value |
|
|
Fifth Third Bancorp |
|
$ |
283 |
|
|
$ |
2,745 |
|
|
|
39.6 |
% |
|
$ |
106 |
|
|
|
3.9 |
% |
ALLTEL Corporation |
|
|
117 |
|
|
|
801 |
|
|
|
11.6 |
|
|
|
20 |
|
|
|
2.5 |
|
ExxonMobil Corporation |
|
|
133 |
|
|
|
503 |
|
|
|
7.3 |
|
|
|
10 |
|
|
|
2.0 |
|
The Procter & Gamble Company |
|
|
105 |
|
|
|
335 |
|
|
|
4.8 |
|
|
|
6 |
|
|
|
1.8 |
|
National City Corporation |
|
|
171 |
|
|
|
329 |
|
|
|
4.7 |
|
|
|
14 |
|
|
|
4.3 |
|
PNC Financial Services Group, Inc. |
|
|
62 |
|
|
|
291 |
|
|
|
4.2 |
|
|
|
10 |
|
|
|
3.2 |
|
Wyeth |
|
|
62 |
|
|
|
204 |
|
|
|
2.9 |
|
|
|
4 |
|
|
|
2.0 |
|
Alliance Capital Management Holding L.P. |
|
|
53 |
|
|
|
179 |
|
|
|
2.6 |
|
|
|
9 |
|
|
|
5.0 |
|
U.S. Bancorp |
|
|
113 |
|
|
|
172 |
|
|
|
2.5 |
|
|
|
7 |
|
|
|
4.1 |
|
Wells Fargo & Company |
|
|
66 |
|
|
|
139 |
|
|
|
2.0 |
|
|
|
5 |
|
|
|
3.2 |
|
FirstMerit Corporation |
|
|
54 |
|
|
|
139 |
|
|
|
2.0 |
|
|
|
6 |
|
|
|
4.2 |
|
Johnson & Johnson |
|
|
115 |
|
|
|
139 |
|
|
|
2.0 |
|
|
|
3 |
|
|
|
2.0 |
|
Piedmont Natural Gas Company, Inc. |
|
|
62 |
|
|
|
134 |
|
|
|
1.9 |
|
|
|
4 |
|
|
|
2.9 |
|
Sky Financial Group, Inc. |
|
|
91 |
|
|
|
130 |
|
|
|
1.9 |
|
|
|
4 |
|
|
|
3.2 |
|
All other common stock holdings |
|
|
474 |
|
|
|
696 |
|
|
|
10.0 |
|
|
|
22 |
|
|
|
3.2 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total |
|
$ |
1,961 |
|
|
$ |
6,936 |
|
|
|
100.0 |
% |
|
$ |
230 |
|
|
|
3.3 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
In 2005, we sold 475,000 shares of our holdings of ALLTEL Corporation, which was our second
largest common stock holding at year-end. We completed the sale of the remaining 12,700,164
shares of ALLTEL common stock in January 2006. ALLTEL was an excellent investment for the
company for over 40 years, bringing an increasing flow of dividend income and healthy market
value appreciation. Because of the restructuring that ALLTEL announced in late 2005, we
determined that it no longer met our investment parameters.
This emphasis on a small group of equities and long-term investment horizon has resulted in
significant concentrations within the portfolio, as this buy-and-hold strategy over many
years has built up significant accumulated unrealized appreciation within the equity
portfolio. At year-end 2005, the largest industry
2005 10-K Page 17
concentrations within our common stock
holdings were the financials sector at 63.4 percent of total fair value and the healthcare
sector at 6.4 percent of total fair value.
Nonreedemable
Preferred Stocks
We evaluate preferred stocks similar to the evaluation we make for
fixed-maturity investments, seeking attractive relative yields. We generally focus on
investment-grade preferred stocks issued by companies that have a strong history of paying
common dividends, which provides us with another layer of protection. Additionally, when
possible we seek out preferred stocks that offer a dividend received deduction.
Additional information regarding the composition of investments is included in Item 8, Note
2 to the Consolidated Financial Statements, Page 88.
Other
We report as Other the operations of the parent company, CFC Investment Company and
CinFin Capital Management Company (excluding investment activities) as well as other income
of our insurance subsidiary. As of December 31, 2005, CFC Investment Company had 2,815
accounts and $101 million in gross receivables, compared with 2,489 and $92 million at
December 31, 2004. As of December 31, 2005, CinFin Capital had 64 institutional, corporate
and individual clients and $864 million under management, compared with 60 and $827 million
at December 31, 2004.
REGULATION
State Regulation
The business of insurance primarily is regulated by state law. Although our insurance
subsidiaries are domiciled in Ohio and primarily subject to Ohio insurance laws and
regulations, we also are subject to state regulatory authorities of all states in which we
write insurance. The state laws and regulations
that have the most significant effect on our insurance operations and financial reporting
are discussed below.
|
|
Insurance Holding Company Regulation Our subsidiaries primarily engage in the
property casualty insurance business and secondarily in the life insurance business,
both subject to regulation as an insurance holding company system by the State of Ohio.
These regulations require that we annually furnish financial and other information
about the operations of the individual companies within the holding company system. All
transactions within a holding company affecting insurers must be fair and equitable.
Notice to the state insurance commissioner is required prior to the consummation of
transactions affecting the ownership or control of an insurer and prior to certain
material transactions between an insurer and any person or entity in its holding
company. In addition, some of those transactions cannot be consummated without the
commissioners prior approval. |
|
|
|
Subsidiary Dividends The dividend-paying capacity of our insurance subsidiaries
is regulated by the laws of Ohio, the domiciliary state. This regulation requires an
insurance subsidiary to provide a 10-day advance informational notice to the Ohio
insurance department prior to payment of any dividend or distribution to its
shareholders (all of our smaller insurance subsidiaries are 100 percent owned by The
Cincinnati Insurance Company, which is 100 percent owned by Cincinnati Financial
Corporation). Ordinary dividends must be paid from earned surplus, which is the amount
of unassigned funds set forth in an insurance subsidiarys most recent statutory
financial statement. |
The Ohio Department of Insurance must give prior approval before the payment of an
extraordinary dividend by an insurance subsidiary to shareholders. You can find
information about the dividends paid by our insurance subsidiary in 2005 in Item 8, Note
8 to the Consolidated Financial Statements, Page 91.
|
|
Insurance Operations All of our insurance subsidiaries are subject to licensing
and supervision by departments of insurance in the states in which they do business.
The nature and extent of such regulations vary, but generally have their source in
statutes that delegate regulatory, supervisory and administrative powers to state
insurance departments. Such regulations, supervision and administration of the
insurance subsidiaries include, among others, the standards of solvency which must be
met and maintained; the licensing of insurers and their agents; the nature and
limitations on investments; deposits of securities for the benefit of policyholders;
regulation of policy forms and premium rates; policy cancellations and non-renewals;
periodic examination of the affairs of insurance companies; annual and other reports
required to be filed on the financial condition of insurers or for other purposes;
requirements regarding reserves for unearned premiums, losses and other matters; the
nature of and limitations on dividends to policyholders and shareholders; the nature
and extent of required participation in insurance guaranty funds; and the involuntary
assumption of hard-to-place or high-risk insurance business, primarily workers
compensation insurance.
|
2005 10-K Page 18
|
|
Insurance Guaranty Associations Each state has insurance guaranty association
laws under which the associations may assess life and property casualty insurers doing
business in the state for certain obligations of insolvent insurance companies to
policyholders and claimants. Typically, states assess each member insurer in an amount
related to the insurers proportionate share of business written by all member insurers
in the state. In 2005, our insurance subsidiaries incurred a negative $3 million for
guaranty associations. In 2004, our insurance subsidiaries incurred $2 million. We
cannot predict the amount and timing of any future assessments or refunds on our
insurance subsidiaries under these laws. |
|
|
|
Shared Market and Joint Underwriting Plans State insurance regulation requires
insurers to participate in assigned risk plans, reinsurance facilities and joint
underwriting associations, which are mechanisms that generally provide applicants with
various basic insurance coverages when they are not available in voluntary markets.
Such mechanisms are most commonly instituted for automobile and workers compensation
insurance, but many states also mandate participation in FAIR Plans or Windstorm Plans,
which provide basic property coverages. Participation is based upon the amount of a
companys voluntary market share in a particular state for the classes of insurance
involved. Underwriting results related to these organizations, which tend to be adverse
to our company, have been immaterial to our results of operations. |
|
|
|
Statutory Accounting For public reporting, insurance companies prepare financial
statements in accordance with GAAP. However, certain data also must be calculated
according to statutory accounting rules as defined in the NAICs Accounting Practices
and Procedures Manual. |
While not a substitute for any GAAP measure of performance, statutory data frequently is
used by industry analysts and other recognized reporting sources to facilitate
comparisons of the performance of insurance companies.
|
|
Insurance Reserves State insurance laws require that property casualty and life
insurance subsidiaries analyze the adequacy of reserves annually. Our appointed
actuaries must submit an opinion that reserves are adequate for policy claims-paying
obligations and related expenses. |
|
|
|
Risk-Based Capital Requirements The NAICs risk-based capital (RBC) requirements
for property casualty and life insurers serve as an early warning tool for the NAIC and
the state regulators to identify companies that may be undercapitalized and may merit
further regulatory action. The NAIC has a standard formula for annually assessing RBC.
The formula for calculating RBC for property casualty companies takes into account
asset and credit risks but places more emphasis on underwriting factors for reserving
and pricing. The formula for calculating RBC for life insurance companies takes into
account factors relating to insurance, business, asset and interest rate risks. |
Federal Regulation
Although the federal government and its regulatory agencies generally do not directly
regulate the business of insurance, federal initiatives often have an impact. Some of the
current and proposed federal measures that may significantly affect our business are
discussed below.
|
|
The Terrorism Risk Insurance Act of 2002 (TRIA) TRIA was signed into law on
November 26, 2002, and extended on December 22, 2005, in a revised form. TRIA provides
a temporary federal backstop for losses related to the writing of the terrorism peril
in property casualty insurance policies. TRIA now is scheduled to expire December 31,
2007. Under regulations promulgated under this statute, insurers are required to offer
terrorism coverage for certain lines of property casualty insurance, including
property, commercial multi-peril, fire, ocean marine, inland marine, liability,
aircraft, surety and workers compensation. In the event of a terrorism event defined by
TRIA, the federal government will reimburse terrorism claim payments subject to the
insurers deductible. The deductible is calculated as a percentage of subject written
premiums for the preceding calendar year. Our deductible was $328 million (15 percent
of 2004 subject premiums) in 2005, $199 million in 2004 (10 percent of 2003 subject
premiums) and $136 million in 2003 (7 percent of 2002 subject premiums). For 2006, the
deductible is an estimated $318 million (17.5 percent of 2005 subject premiums). |
|
|
|
Health Insurance Portability and Accountability Act of 1996 (HIPAA) We protect
consumer health information pursuant to regulations promulgated under HIPAA.
Regulations effective April 14, 2003, require health care providers such as doctors and
hospitals, as well as health and long-term care insurers and health care
clearinghouses, to institute physical and procedural safeguards to protect the health
records of patients and insureds. Effective October 16, 2003, additional regulations
required health plans to electronically transmit and receive standardized health care
information. These rules and regulations have had a minimal effect on us, as our health
insurance writings are limited to our self-funded health plan for our associates and a
small number of run-off medical and hospital expense insurance policies. We do not
actively market health, medical and hospital expense insurance policies.
|
2005 10-K Page 19
|
|
Office on Foreign Asset Control (OFAC) Subject to an Executive Order signed on
September 24, 2001, intended to thwart financing of terrorists and sponsors of
terrorism, financial institutions were required to block and report transactions and
attempted transactions between their organization and persons and organizations named
in a list published by OFAC. We currently use a combination of software, third-party
vendor and manual searches to accomplish our transaction blocking and reporting
activities. |
|
|
|
Investment Advisers Act of 1940 Our subsidiary, CinFin Capital Management
Company, operates an investment advisory business and is therefore subject to
regulation by the SEC as a registered investment adviser under the Investment Advisers
Act of 1940. This law imposes certain annual reporting, recordkeeping, client
disclosure and compliance obligations on CinFin Capital Management. |
2005 10-K Page 20
Item 1A. Risk Factors
Our business involves various risks and uncertainties that may affect achievement of
our business objectives. Many of the risks could have ramifications across our integrated
business activities. For example, while risks related to setting insurance rates and
establishing and adjusting loss reserves are insurance activities, errors in these areas
could have an impact on our investment activities. The following discussion should be viewed
as a starting point for understanding the significant risks we face. It is not a definitive
summary of their potential impact or of our strategies to manage and control the risks.
Please see Item 7, Managements Discussion and Analysis of Financial Condition and Results
of Operations, Page 31, for a discussion of those strategies.
The risks and uncertainties below are not the only ones we face. There are additional risks
and uncertainties that we currently do not believe are material. There also may be risk and
uncertainties of which we are not aware. If any risks or uncertainties discussed here
develop into actual events, they could have a material adverse effect on our business,
financial condition or results of operations. In that case, the market price of our common
stock could decline materially.
Readers should carefully consider this information together with the other information we
have provided in this report and in other reports and materials we file periodically with
the Securities and Exchange Commission as well as news releases and other information we
disseminate publicly.
We rely exclusively on independent insurance agents to distribute our products.
We market our products through independent, non-exclusive insurance agents. These
agents are not obligated to promote our products and can and do sell our competitors
products. We must offer insurance products that meet the needs of these agencies and their
clients. We need to maintain good relationships with the agencies that market our products.
If we do not, these agencies may market our competitors products instead of ours, which may
lead to us having a less desirable mix of business, which could affect our results of
operations.
Events or conditions that could diminish a competitive advantage that our independent
agencies enjoy:
|
|
Downgrade of the financial strength ratings of our insurance subsidiaries. We
believe our strong insurer financial strength ratings, in particular the A++ rating
from A.M. Best of our property casualty insurance subsidiaries, are an important
competitive advantage. Only 16 other insurance groups, or 1.7 percent of all insurance
groups, qualify for the A++, A.M. Bests highest rating. If our property casualty
ratings were downgraded, our agents might find it more difficult to market our products
or might choose to emphasize the products of other carriers, which could adversely
affect our results of operations. |
|
|
|
Concerns that doing business with us is difficult or perceptions that our level of
service is no longer a distinguishing characteristic in the marketplace. If agents or
policyholders believed that we were no longer providing the prompt, reliable personal
service that has long been a distinguishing characteristic of our insurance operations,
our results of operations could be adversely affected. |
|
|
|
Delays in the development, implementation, performance and benefits of technology
projects and enhancements or independent agent perceptions that our technology
solutions are inadequate to match their needs. |
A reduction in the number of independent agencies marketing our products, the failure of
these agencies to successfully market our products or the choice of these agencies to reduce
their writings of our products could reduce our revenues and our results of operations if we
were unable to replace them with agencies that produce adequate premiums.
Further, policyholders may choose a competitors product rather than our own because of real
or perceived differences in price, terms and conditions, coverage or service. If the quality
of the independent agencies with which we do business were to decline, that also might cause
policyholders to purchase their insurance through different agencies or channels. Increased
comfort in Internet purchasing could further reduce independent agencies writings of
personal lines products.
Please see Item 1, Our Business and Our Strategy, Page 1, for a discussion of our
relationships with independent insurance agents.
Competition could adversely affect our ability to sell policies at rates we deem
adequate.
The insurance industry is highly competitive. Competition in our insurance business is
based on many factors, including:
|
|
Competitiveness of premiums charged |
|
|
|
Underwriting and pricing methodologies that allow insurers to identify and flexibly price risks |
|
|
|
Underwriting discipline |
|
|
|
Terms and conditions of insurance coverage |
|
|
|
Rate at which products are brought to market
|
2005 10-K Page 21
|
|
Technological innovation |
|
|
|
Ability to control expenses |
|
|
|
Adequacy of financial strength ratings by independent ratings agencies such as A.M. Best |
|
|
|
Quality of services provided to agents and policyholders |
If we were unable to compete effectively because of one or more of these factors, our
premium writings could decline and our results of operations and financial condition could
be materially adversely affected.
Please see Item 7, Commercial Lines, Personal Lines and Life Insurance Results of
Operations, Page 41, Page 47, and Page 52, for a discussion of our competitive position in
the insurance marketplace.
Managing technology initiatives and meeting new data security requirements are
significant challenges.
While technology can streamline many business processes and ultimately reduce the
cost of operations, technology initiatives present short-term cost and implementation
risks. In addition, we may have inaccurate expense projections, implementation schedules
or expectations regarding the efficacy of the end product. These issues could escalate
over time.
Data security is subject to increasing regulation. We face rising costs and competing
time constraints in meeting compliance requirements of new and proposed regulations.
Computer viruses, hackers and other external hazards could expose our data systems to
security breaches. These increased risks and expanding regulatory requirements could
expose us to data loss, damages and significant increases in compliance costs.
Please see Item 1, Technology Solutions, Page 4, for a discussion of our technology
initiatives.
The effects of emerging or latent claim and coverage issues on our business are
uncertain.
As industry practices and legal, judicial, social and other environmental conditions
change, unexpected and unintended issues related to insurance claims and coverage may
emerge. These issues may adversely affect our business by either extending coverage beyond
our underwriting intent or by increasing the number or size of claims. In some instances,
these changes may not become apparent until some time after we have issued the insurance
policies that could be affected by the changes. As a result, the full extent of liability
under our insurance contracts may not be known for many years after a policy is issued. The
effects of such unforeseeable emerging and latent claim and coverage issues could adversely
affect our results of operations.
Please see Item 7, Property Casualty and Life Insurance Reserves, Page 61 and Page 67, for a
discussion of our reserving practices.
Our loss reserves, our largest liability, are based on estimates and could be
inadequate to cover our actual losses.
Our financial statements are prepared using GAAP. These principles require us to make
estimates and assumptions that affect the amounts reported in the Consolidated Financial
Statements and accompanying Notes. Actual results could differ materially from those
estimates. For a discussion of the significant accounting policies we use to prepare our
financial statements and the material implications of uncertainties associated with the
methods, assumptions and estimates underlying our critical accounting policies, please refer
to Item 7, Property Casualty Insurance Loss And Loss Expense Reserves, Page 35, and Item 8,
Note 1 to the Consolidated Financial Statements, Page 84.
Our most critical accounting estimate is of loss reserves. Loss reserves are the amounts we
expect to pay for covered claims and expenses we incur to adjust those claims. The loss
reserves we establish in our financial statements represent an estimate of amounts needed to
pay and administer claims arising from insured events that have occurred, including events
that have not yet been reported to us. Loss reserves are estimates and are inherently
uncertain; they do not and cannot represent an exact measure of liability. Accordingly, our
loss reserves for past periods could prove to be inadequate to cover our actual losses and
related expenses. Any changes in these estimates are reflected in our results of operations
during the period in which the changes are made. An increase in our loss reserves would
decrease earnings, while a decrease in our loss reserves would increase earnings.
The estimation process for unpaid loss and loss expense obligations involves uncertainty by
its very nature. We continually review the estimates and adjust the reserve as facts
regarding individual claims
develop, additional losses are reported and new information becomes known. Adjustments due
to loss development for prior years are reflected in the calendar year in which they are
identified.
2005 10-K Page 22
Unforeseen losses, the type and magnitude of which we cannot predict, may emerge in the
future. These additional losses could arise from changes in the legal environment,
catastrophic events, increases in loss severity or frequency, or other causes. Such future
losses could be substantial.
Please see Item 7, Property Casualty and Life Insurance Reserves, Page 61 and Page 67, for a
discussion of our reserving practices.
We could experience an unusually high level of losses due to catastrophic or
terrorism events or risk concentrations.
Our financial condition, cash flow and results of operations depend on our ability to
underwrite and set rates accurately for a full spectrum of risks. We establish our pricing
based on assumptions regarding the level of losses that will occur within classes of
business, geographic regions and other criteria. A number of factors could cause our
assumptions regarding future losses to be inaccurate.
In the normal course of our business, we provide coverage for exposures for which estimates
of losses are highly uncertain, in particular catastrophic and terrorism events.
Catastrophes can be caused by a number of events, including hurricanes, tornadoes,
windstorms, earthquakes, hailstorms, explosions, severe winter weather and fires. Due to the
nature of these events, we are unable to predict precisely the frequency or potential cost
of catastrophe occurrences. The extent of losses from a catastrophe is a function of both
the total amount of insured exposure in the area affected by the event and the severity of
the event.
We have catastrophe exposure to:
|
|
Hurricanes in the gulf and southeastern coastal regions. |
|
|
|
Earthquakes in the New Madrid fault zone, which lies within the central Mississippi
valley, extending from northeast Arkansas through southeast Missouri, western Tennessee
and western Kentucky to southern Illinois, southern Indiana and parts of Ohio. |
|
|
|
Tornado, wind and hail in the Midwest, Southeast, mid-Atlantic and Western regions. |
We have identified terrorism exposure to general commercial risks in the metropolitan
Chicago area as well as small co-op utilities, small shopping malls and small colleges
throughout our 32 active states.
Additionally, our life insurance subsidiary could be adversely affected in the event of an
epidemic such as the avian flu, particularly if the epidemic affects a broad range of the
population beyond just the very young or the very old.
Our results of operations would be adversely affected if the level of losses we experienced
over a period of time exceeded our actuarially determined expectations. In addition, our
financial condition would be adversely affected if we were required to sell securities prior
to maturity or at unfavorable prices to pay an unusually high level of loss and loss
expenses. Securities pricing might be even less favorable if a number of insurance companies
needed to sell securities during a short period of time because of unusually high losses
from catastrophic events.
Our geographic concentration ties our performance to business, economic and regulatory
conditions in certain states. We market our property casualty insurance product in 32
states, but our business is concentrated in the Midwest and Southeast. We also have exposure
in states where we do not actively market insurance when clients of our independent agencies
have business or properties in multiple states.
The Cincinnati Insurance Company also participates in three assumed reinsurance treaties
with two reinsurers that spread the risk of very high catastrophe losses among many
insurers. In 2006, we have exposure to assumed losses of 1 percent of property losses
between $400 million and $1.2 billion from a single event under an assumed reinsurance
treaty for Munich Re Group. The other two assumed reinsurance treaties are immaterial.
In the event of a severe catastrophic event or terrorist attack elsewhere in the world, our
insurance losses may be immaterial. However, the companies in which we invest might be
severely affected, which could affect our financial condition and results of operations.
Please see Item 7, Property Casualty and Life Insurance Reserves, Page 61 and Page 67, for a
discussion of our reserving practices.
Our ability to obtain or collect on our reinsurance protection could affect our
business, financial condition and results of operations.
We buy property casualty and life reinsurance coverage to mitigate the liquidity risk
of an unexpected rise in claims severity or frequency from catastrophic events or a single
large loss. The availability,
amount and cost of reinsurance depend on market conditions and may vary significantly. If we
are unable to obtain reinsurance on acceptable terms and in appropriate amounts, our
business and financial condition may be adversely affected.
2005 10-K Page 23
In addition, we are subject to credit risk with respect to our reinsurers. Although we
purchase reinsurance to manage our risks and exposures to losses, this reinsurance does not
discharge our direct obligations under the policies we write. We would remain liable to our
policyholders even if we were unable to recover what we believe we are entitled to receive
under our reinsurance contracts. Reinsurers might refuse or fail to pay losses that we cede
to them, or they might delay payment. For long-term cases, the creditworthiness of our
reinsurers may change before we can recover amounts to which we are entitled. A reinsurers
insolvency, inability or unwillingness to make payments under the terms of its reinsurance
agreement with our insurance subsidiaries could have a material adverse effect on our
financial position and results of operations.
Prior to 2003, we participated in USAIG, a joint underwriting association of individual
insurance companies that collectively function as a worldwide insurance market for all types
of aviation and aerospace accounts. At year-end 2005, 36.9 percent, or $251 million, of our
total reinsurance receivables were related to USAIG, primarily for September 11, 2001,
events. Although more than 99 percent of the reinsurance recoverables associated with USAIG
are backed by securities on deposit, if we are unable to collect these receivables, our
financial position and results of operations could be materially affected. We no longer
participate in new business generated by USAIG and its members.
Please see Item 7, 2006 Reinsurance Programs, Page 68, for a discussion of our reinsurance
treaties.
Our ability to realize our investment objectives could affect our financial condition
or our results of operation.
We invest premiums received from policyholders and other available cash to generate
investment income and capital appreciation, maintaining sufficient liquidity to pay covered
claims and operating expenses, service our debt obligations and pay dividends. At year-end
2005, our investment portfolio was $12.657 billion, or 79.1 percent of our total assets. In
2005, our investment operations contributed 15.6 percent of our revenue and 65.1 percent of
our total income before income taxes.
Investment income is an important component of our revenues and net income. The ability to
achieve our investment objectives is affected by factors that are beyond our control, such
as inflation, economic growth, interest rates, world political conditions, terrorism attacks
or threats and other widespread unpredictable events. These events may adversely affect the
economy generally and could cause our investment income or the value of securities we own to
decrease. A significant decline in our investment income could have an adverse effect on our
net income, and thereby on our shareholders equity and our policyholders surplus. For more
detailed discussion of risks associated with our investments; please refer to Item 7A,
Qualitative and Quantitative Disclosures About Market Risk, Page 70.
Our investment performance also could suffer because of the types of investments, industry
groups and/or individual securities in which we choose to invest. Market value changes
related to these choices could cause a material change in our financial condition or results
of operations.
One of our investments, Fifth Third, accounted for 26.3 percent of our shareholders equity
at year-end 2005 and dividends earned from our Fifth Third investment were 20.2 percent of
our investment income in 2005. If Fifth Thirds common stock price were to further decline
significantly, our financial condition could be materially affected. If Fifth Third were to
decrease or discontinue its dividend, our results of operation could be materially affected.
Because we currently own more than 10 percent of Fifth Thirds outstanding shares, we are
limited in the amount of Fifth Third stock we could sell in any given period. This
limitation could lead us to hold a sizeable position in Fifth Third even if it would no
longer meet our investment parameters. This could result in a variety of adverse
consequences depending on the reason we had concluded Fifth Third no longer met our
investment parameters. For example, if Fifth Third were to stop paying dividends on its
common stock, we would not be able to reinvest quickly in other income-earning investments,
which would have a material affect on our results of operations.
Please see Item 1, Investments Segment, Page 15, and Item 7, Investments Results of
Operations, Page 54, and Liquidity and Capital Resources, Page 57, for discussion of our
investment activities.
2005 10-K Page 24
Our status as an insurance holding company with no direct operations could affect our
ability to pay dividends in the future.
Cincinnati Financial Corporation is a holding company that transacts substantially all
of its business through its subsidiaries. Our primary assets are the stock in our operating
subsidiaries and our investments. Consequently, our cash flow to pay cash dividends and
interest on our long-term debt depends on dividends we receive from our operating
subsidiaries and income earned on investments held at the parent-company level.
Dividends paid to us by our insurance subsidiary are restricted by the insurance laws of
Ohio, our domiciliary state. These laws establish minimum solvency and liquidity thresholds
and limits. Currently, the maximum dividend that may be paid without prior regulatory
approval is limited to the greater of 10 percent of statutory surplus or 100 percent of
statutory net income for the prior calendar year, up to the amount of statutory unassigned
surplus as of the end of the prior calendar year. Dividends exceeding these limitations may
be paid only with prior approval of the Ohio Department of Insurance. Consequently, at
times, we might not be able to receive dividends from our insurance subsidiary or we might
not receive dividends in the amounts necessary to meet our debt obligations or to pay
dividends on our common stock. This could affect our financial position.
Please see Item 1, Regulation, Page 18, and Item 8, Note 8 to the Consolidated Financial
Statements, Page 91, for discussion of insurance holding company dividend regulations.
We could make investment decisions or experience market value fluctuations that
trigger restrictions applicable to the parent company under the Investment Company Act of
1940.
Compared to other insurance holding companies, we hold a significant level of
investment assets at the parent company level. If these investment assets grow to account
for more than 40 percent of parent companys total assets, excluding assets of our
subsidiaries, we might become subject to regulation under the Investment Company Act of
1940. Our operations are limited by the constraint that investment securities held at the
holding company level should remain below the 40 percent threshold described above. Efforts
to stay below the threshold could result in:
|
|
Disposal of otherwise desirable investment securities, possibly under undesirable
conditions. Such dispositions could result in a lower return on investment, loss of
investment income, and if we were unable to manage the timing of the dispositions, we
also might realize unnecessary capital gains, which would increase our annual tax
payment. |
|
|
|
Limited opportunities to purchase equity securities that hold the potential for
market value appreciation, which could hamper book value growth over the long term. |
|
|
|
Maintenance of a greater portion of our portfolio of equity securities at the
insurance subsidiary, which would cause the parent to be more reliant on its
subsidiaries for cash to fund parent-company obligations, including shareholder
dividends and interest on long-term debt. |
If the parent companys investment assets were to exceed the 40 percent ratio to total
assets, excluding investment in its subsidiaries, and if it were determined that the holding
company was an unregistered investment company, the holding company might be unable to
enforce contracts with third parties, and third parties could seek rescission of
transactions with the holding company undertaken during the period that it was an
unregistered investment company, subject to equitable considerations set forth in the
Investment Company Act. In addition, the holding company could become subject to monetary
penalties or injunctive relief, or both, in an action brought by the SEC.
Please see Item 8, Note 15 to the Consolidated Financial Statements, Page 96, for discussion
of the Investment Company Act of 1940.
Item 1B. Unresolved Staff Comments
None
2005 10-K Page 25
Item 2. Properties
Cincinnati Financial Corporation owns our headquarters building located on 100 acres of
land in Fairfield, Ohio. This building contains approximately 800,000 total square feet. The
property, including land, is carried in our financial statements at $73 million as of
December 31, 2005, and is classified as land, building and equipment, net, for company use.
John J. & Thomas R. Schiff & Co. Inc., a related party, occupies approximately 6,750 square
feet (1 percent).
In 2004, we decided to undertake a $100 million building expansion at our headquarters
location in Fairfield, Ohio. Construction of an underground garage and third office tower
began in early 2005. The new tower will contain more than 690,000 total square feet,
including the garage. It will rise seven stories above three underground parking levels with
700 parking spaces. We estimate a completion date of September 2008 for the project. We
believe this expansion will accommodate our business needs for the foreseeable future. The
construction project is on schedule and on budget. As of December 31, 2005, construction
costs totaled $18 million.
Cincinnati Financial Corporation owns the Fairfield Executive Center, which is located on
the northwest corner of our headquarters property in Fairfield, Ohio. This is a four-story
office building containing approximately 124,000 square feet. The property is carried in the
financial statements at $7 million as of December 31, 2005, and is classified as land,
building and equipment, net, for company use. CFC and our subsidiaries occupy approximately
90 percent of the rentable square feet and unaffiliated tenants occupy approximately 10
percent.
The Cincinnati Life Insurance Company owns a four-story office building in the Tri-County
area of Cincinnati, Ohio. It contains approximately 102,000 rentable square feet. This
property is carried in the financial statements at $3 million as of December 31, 2005, and
is classified as other invested assets. Three tenants occupy approximately 50 percent of the
rentable square feet. The remaining space is available for lease.
Item 3. Legal Proceedings
Neither the company nor any of our subsidiaries is involved in any material litigation
other than ordinary, routine litigation incidental to the nature of our business.
Item 4. Submission of Matters to a Vote of Security Holders
No matters were submitted to a vote of security holders of Cincinnati Financial during
the fourth quarter of 2005.
2005 10-K Page 26
Part II
|
|
|
Item 5. |
|
Market for the Registrants Common Equity, Related Stockholder Matters and
Issuer Purchases of Equity Securities |
Cincinnati
Financial Corporation had approximately 12,000 shareholders of record as of
December 31, 2005. Many of our independent agent representatives and most of the 3,983
associates of our subsidiaries own the companys common stock. We are unable to accurately
quantify those holdings because many are beneficially held.
Our common shares are traded under the symbol CINF on the Nasdaq National Market. The common
stock prices and dividend data below reflect the 5 percent stock dividends paid June 15,
2004 and April 26, 2005.
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(Source: Nasdaq National Market) |
|
|
|
|
|
2005 |
|
|
|
|
|
|
|
|
|
2004 |
|
|
Quarter: |
|
1st |
|
2nd |
|
3rd |
|
4th |
|
1st |
|
2nd |
|
3rd |
|
4th |
|
High |
|
$ |
43.92 |
|
|
$ |
43.12 |
|
|
$ |
42.64 |
|
|
$ |
45.95 |
|
|
$ |
41.61 |
|
|
$ |
41.78 |
|
|
$ |
41.70 |
|
|
$ |
43.52 |
|
Low |
|
|
40.84 |
|
|
|
38.38 |
|
|
|
39.00 |
|
|
|
39.91 |
|
|
|
37.02 |
|
|
|
37.90 |
|
|
|
37.46 |
|
|
|
36.57 |
|
Period-end close |
|
|
41.53 |
|
|
|
39.56 |
|
|
|
41.89 |
|
|
|
44.68 |
|
|
|
39.41 |
|
|
|
41.45 |
|
|
|
39.26 |
|
|
|
42.15 |
|
Cash dividends declared |
|
|
0.290 |
|
|
|
0.305 |
|
|
|
0.305 |
|
|
|
0.305 |
|
|
|
0.250 |
|
|
|
0.262 |
|
|
|
0.262 |
|
|
|
0.262 |
|
Our ability to pay cash dividends may depend on the ability of our insurance subsidiary to
pay dividends to the parent company. The dividend restrictions of our insurance company
subsidiaries are discussed in Item 8, Note 8 to the Consolidated Financial Statements, Page
91.
Information regarding securities authorized for issuance under our equity compensation plans
appears in the Proxy Statement under Equity Compensation Plan Information. This portion of
the Proxy Statement is incorporated herein by reference. Additional information about
options granted under our equity compensation plans is available in Item 8, Note 8 and Note
16 to the Consolidated Financial Statements, Pages 91 and 97.
The board of directors has authorized share repurchases since 1996. We discuss the board
authorization in Item 7, Uses of Capital, Page 61. In 2005, we repurchased a total of
1,500,000 shares (unadjusted for stock dividends).
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total number of shares |
|
Maximum number of |
|
|
|
|
|
|
|
|
|
|
purchased as part of |
|
shares that may yet be |
|
|
Total number of |
|
Average price |
|
publicly announced |
|
purchased under the |
Month |
|
shares purchased |
|
paid per share |
|
plans or programs |
|
plans or programs |
|
January 1 -31, 2005 |
|
|
0 |
|
|
$ |
0.00 |
|
|
|
0 |
|
|
|
3,705,977 |
|
February 1-28, 2005 |
|
|
0 |
|
|
|
0.00 |
|
|
|
0 |
|
|
|
3,705,977 |
|
March 1-31, 2005 |
|
|
115,000 |
|
|
|
45.54 |
|
|
|
115,000 |
|
|
|
3,590,977 |
|
April 1-30, 2005 |
|
|
162,728 |
|
|
|
39.58 |
|
|
|
162,728 |
|
|
|
3,428,249 |
|
May 1-31, 2005 |
|
|
379,172 |
|
|
|
39.26 |
|
|
|
379,172 |
|
|
|
3,049,077 |
|
June 1-30, 2005 |
|
|
308,100 |
|
|
|
39.41 |
|
|
|
308,100 |
|
|
|
2,740,977 |
|
July 1-31, 2005 |
|
|
0 |
|
|
|
0.00 |
|
|
|
0 |
|
|
|
2,740,977 |
|
August 1-31, 2005 |
|
|
1,035 |
|
|
|
39.95 |
|
|
|
1,035 |
|
|
|
2,739,942 |
|
September 1-30, 2005 |
|
|
159,157 |
|
|
|
41.74 |
|
|
|
159,157 |
|
|
|
9,840,843 |
|
October 1-31, 2005 |
|
|
0 |
|
|
|
0.00 |
|
|
|
0 |
|
|
|
9,840,843 |
|
November 1-30, 2005 |
|
|
0 |
|
|
|
0.00 |
|
|
|
0 |
|
|
|
9,840,843 |
|
December 1-31, 2005 |
|
|
374,808 |
|
|
|
45.13 |
|
|
|
374,808 |
|
|
|
9,466,035 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Totals |
|
|
1,500,000 |
|
|
|
41.54 |
|
|
|
1,500,000 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
a) |
|
The current repurchase program became effective on September 1, 2005. It replaced a
program announced on February 6, 1999, which replaced a program approved in 1996 and
updated in 1998. |
|
b) |
|
The share amount approved for repurchase in 2005 was 10 million shares and the
share amount approved for repurchase in 1999 was 17 million shares. |
|
c) |
|
The current repurchase program has no expiration date.
|
|
d) |
|
No repurchase program has expired during the period covered by the above table. |
|
e) |
|
The program approved in 1999 was terminated prior to the expiration date when the
board approved the current program in August 2005. The program approved in 1996 and
updated in 1998 was terminated prior to expiration when the board approved a program in
February 1999. There have been no programs for which the issuer has not intended to
make further purchases. |
2005 10-K Page 27
Item 6. Selected Financial Data
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(In millions except per share data) |
|
|
|
|
|
Years ended December 31, |
|
|
|
|
2005 |
|
2004 |
|
2003 |
|
2002 |
|
Consolidated Income Statement Data |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Earned premiums |
|
$ |
3,164 |
|
|
$ |
3,020 |
|
|
$ |
2,748 |
|
|
$ |
2,478 |
|
Investment income, net of expenses |
|
|
526 |
|
|
|
492 |
|
|
|
465 |
|
|
|
445 |
|
Gross realized investment gains and losses |
|
|
61 |
|
|
|
91 |
|
|
|
(41 |
) |
|
|
(94 |
) |
Total revenues |
|
|
3,767 |
|
|
|
3,614 |
|
|
|
3,181 |
|
|
|
2,843 |
|
Net income |
|
|
602 |
|
|
|
584 |
|
|
|
374 |
|
|
|
238 |
|
|
Net income per common share: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Basic |
|
$ |
3.44 |
|
|
$ |
3.30 |
|
|
$ |
2.11 |
|
|
$ |
1.33 |
|
Diluted |
|
|
3.40 |
|
|
|
3.28 |
|
|
|
2.10 |
|
|
|
1.32 |
|
Cash dividends per common share: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Declared |
|
|
1.205 |
|
|
|
1.04 |
|
|
|
0.90 |
|
|
|
0.81 |
|
Paid |
|
|
1.162 |
|
|
|
1.02 |
|
|
|
0.89 |
|
|
|
0.80 |
|
|
Shares outstanding |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Weighted average, diluted |
|
|
177 |
|
|
|
178 |
|
|
|
178 |
|
|
|
180 |
|
|
Consolidated Balance Sheet Data |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Invested assets |
|
$ |
12,702 |
|
|
$ |
12,677 |
|
|
$ |
12,485 |
|
|
$ |
11,226 |
|
Deferred policy acquisition costs |
|
|
429 |
|
|
|
400 |
|
|
|
372 |
|
|
|
343 |
|
Total assets |
|
|
16,003 |
|
|
|
16,107 |
|
|
|
15,509 |
|
|
|
14,122 |
|
Loss and loss expense reserves |
|
|
3,661 |
|
|
|
3,549 |
|
|
|
3,415 |
|
|
|
3,176 |
|
Life policy reserves |
|
|
1,343 |
|
|
|
1,194 |
|
|
|
1,025 |
|
|
|
917 |
|
Long-term debt |
|
|
791 |
|
|
|
791 |
|
|
|
420 |
|
|
|
420 |
|
Shareholders equity |
|
|
6,086 |
|
|
|
6,249 |
|
|
|
6,204 |
|
|
|
5,598 |
|
Book value per share |
|
|
34.88 |
|
|
|
35.60 |
|
|
|
35.10 |
|
|
|
31.43 |
|
|
Property Casualty Insurance Operations |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Earned premiums |
|
$ |
3,058 |
|
|
$ |
2,919 |
|
|
$ |
2,653 |
|
|
$ |
2,391 |
|
Unearned premiums |
|
|
1,557 |
|
|
|
1,537 |
|
|
|
1,444 |
|
|
|
1,317 |
|
Loss and loss expense reserves |
|
|
3,629 |
|
|
|
3,514 |
|
|
|
3,386 |
|
|
|
3,150 |
|
Investment income, net of expenses |
|
|
338 |
|
|
|
289 |
|
|
|
245 |
|
|
|
234 |
|
Loss ratio |
|
|
49.2 |
% |
|
|
49.8 |
% |
|
|
56.1 |
% |
|
|
61.5 |
% |
Loss expense ratio |
|
|
10.0 |
|
|
|
10.3 |
|
|
|
11.6 |
|
|
|
11.4 |
|
Expense ratio |
|
|
30.0 |
|
|
|
29.7 |
|
|
|
27.0 |
|
|
|
26.8 |
|
Combined ratio |
|
|
89.2 |
% |
|
|
89.8 |
% |
|
|
94.7 |
% |
|
|
99.7 |
% |
|
|
|
|
|
Per share data adjusted to reflect all stock splits and dividends prior to December 31, 2005. |
One-time charges or adjustments:
2003 As the result of a settlement negotiated with a vendor, pretax results included
the recovery of $23 million of the $39 million one-time, pretax charge incurred in 2000.
2000 The company recorded a one-time charge of $39 million, pretax, to write down
previously capitalized costs related to the development of software to process property
casualty policies.
2000 The company earned $5 million in interest in the first quarter from a $303 million
single-premium bank-owned life insurance (BOLI) policy booked at the end of 1999 that was
segregated as a Separate Account effective April 1, 2000. Investment income and realized
investment gains and losses from separate accounts generally accrue directly to the contract
holder and, therefore, are not included in the companys consolidated financials.
2005 10-K Page 28
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
2001 |
|
|
2000 |
|
1999 |
|
1998 |
|
1997 |
|
1996 |
|
1995 |
|
|
$ 2,152 |
|
|
$ |
1,907 |
|
|
$ |
1,732 |
|
|
$ |
1,613 |
|
|
$ |
1,516 |
|
|
$ |
1,423 |
|
|
$ |
1,314 |
|
|
421 |
|
|
|
415 |
|
|
|
387 |
|
|
|
368 |
|
|
|
349 |
|
|
|
327 |
|
|
|
300 |
|
|
(25 |
) |
|
|
(2 |
) |
|
|
0 |
|
|
|
65 |
|
|
|
69 |
|
|
|
48 |
|
|
|
31 |
|
|
2,561 |
|
|
|
2,331 |
|
|
|
2,128 |
|
|
|
2,054 |
|
|
|
1,942 |
|
|
|
1,809 |
|
|
|
1,656 |
|
|
193 |
|
|
|
118 |
|
|
|
255 |
|
|
|
242 |
|
|
|
299 |
|
|
|
224 |
|
|
|
227 |
|
|
|
$ 1.10 |
|
|
$ |
0.67 |
|
|
$ |
1.40 |
|
|
$ |
1.31 |
|
|
$ |
1.64 |
|
|
$ |
1.21 |
|
|
$ |
1.24 |
|
|
1.07 |
|
|
|
0.67 |
|
|
|
1.37 |
|
|
|
1.28 |
|
|
|
1.61 |
|
|
|
1.17 |
|
|
|
1.19 |
|
|
0.76 |
|
|
|
0.69 |
|
|
|
0.62 |
|
|
|
0.55 |
|
|
|
0.50 |
|
|
|
0.44 |
|
|
|
0.39 |
|
|
0.74 |
|
|
|
0.67 |
|
|
|
0.60 |
|
|
|
0.54 |
|
|
|
0.49 |
|
|
|
0.43 |
|
|
|
0.38 |
|
|
|
179 |
|
|
|
181 |
|
|
|
186 |
|
|
|
190 |
|
|
|
188 |
|
|
|
191 |
|
|
|
191 |
|
|
|
$11,534 |
|
|
$ |
11,276 |
|
|
$ |
10,156 |
|
|
$ |
10,296 |
|
|
$ |
8,778 |
|
|
$ |
6,340 |
|
|
$ |
5,525 |
|
|
286 |
|
|
|
259 |
|
|
|
226 |
|
|
|
143 |
|
|
|
135 |
|
|
|
128 |
|
|
|
120 |
|
|
13,964 |
|
|
|
13,274 |
|
|
|
11,795 |
|
|
|
11,484 |
|
|
|
9,867 |
|
|
|
7,397 |
|
|
|
6,439 |
|
|
2,887 |
|
|
|
2,473 |
|
|
|
2,154 |
|
|
|
2,055 |
|
|
|
1,937 |
|
|
|
1,881 |
|
|
|
1,744 |
|
|
724 |
|
|
|
641 |
|
|
|
885 |
|
|
|
536 |
|
|
|
482 |
|
|
|
440 |
|
|
|
403 |
|
|
426 |
|
|
|
449 |
|
|
|
456 |
|
|
|
472 |
|
|
|
58 |
|
|
|
80 |
|
|
|
80 |
|
|
5,998 |
|
|
|
5,995 |
|
|
|
5,421 |
|
|
|
5,621 |
|
|
|
4,717 |
|
|
|
3,163 |
|
|
|
2,658 |
|
|
33.62 |
|
|
|
33.80 |
|
|
|
30.35 |
|
|
|
30.58 |
|
|
|
25.71 |
|
|
|
17.19 |
|
|
|
14.33 |
|
|
|
$ 2,073 |
|
|
$ |
1,828 |
|
|
$ |
1,658 |
|
|
$ |
1,543 |
|
|
$ |
1,454 |
|
|
$ |
1,367 |
|
|
$ |
1,263 |
|
|
1,060 |
|
|
|
920 |
|
|
|
835 |
|
|
|
458 |
|
|
|
442 |
|
|
|
424 |
|
|
|
407 |
|
|
2,894 |
|
|
|
2,416 |
|
|
|
2,093 |
|
|
|
1,979 |
|
|
|
1,889 |
|
|
|
1,824 |
|
|
|
1,691 |
|
|
223 |
|
|
|
223 |
|
|
|
208 |
|
|
|
204 |
|
|
|
199 |
|
|
|
190 |
|
|
|
180 |
|
|
66.6 |
% |
|
|
71.1 |
% |
|
|
61.6 |
% |
|
|
65.4 |
% |
|
|
58.3 |
% |
|
|
61.6 |
% |
|
|
57.6 |
% |
|
10.1 |
|
|
|
11.3 |
|
|
|
10.0 |
|
|
|
9.3 |
|
|
|
10.1 |
|
|
|
13.8 |
|
|
|
14.7 |
|
|
28.2 |
|
|
|
30.4 |
|
|
|
28.6 |
|
|
|
29.6 |
|
|
|
30.0 |
|
|
|
28.2 |
|
|
|
27.8 |
|
|
104.9 |
% |
|
|
112.8 |
% |
|
|
100.2 |
% |
|
|
104.3 |
% |
|
|
98.4 |
% |
|
|
103.6 |
% |
|
|
100.1 |
% |
2005 10-K Page 29
|
|
|
|
|
|
|
10-K Page |
|
Item 7. Managements Discussion and Analysis of Financial
Condition and Results of Operations |
Introduction |
|
|
31 |
|
Executive Summary |
|
|
31 |
|
Critical Accounting Estimates |
|
|
35 |
|
Results of Operations |
|
|
39 |
|
Consolidated
Property Casualty Insurance Results of Operations |
|
|
40 |
|
Commercial
Lines Insurance Results of Operations |
|
|
41 |
|
Personal
Lines Insurance Results of Operations |
|
|
47 |
|
Life Insurance Results of Operations |
|
|
52 |
|
Investments Results of Operations |
|
|
54 |
|
Liquidity and Capital Resources |
|
|
57 |
|
Sources of Liquidity |
|
|
57 |
|
Uses of Liquidity |
|
|
59 |
|
Property Casualty Insurance Reserves |
|
|
61 |
|
Life Insurance Reserves |
|
|
67 |
|
2006 Reinsurance Programs |
|
|
68 |
|
Safe Harbor
Statement |
|
|
69 |
|
|
|
|
|
|
Item 7A. Quantitative and Qualitative Disclosures About Market Risk |
Introduction |
|
|
70 |
|
Fixed-maturity Investments |
|
|
71 |
|
Short-term Investments |
|
|
72 |
|
Equity Investments |
|
|
72 |
|
Unrealized Investment Gains and Losses |
|
|
74 |
|
2005 10-K Page 30
Item 7. Managements Discussion and Analysis of Financial Condition and Results of
Operations
Introduction
The purpose of Managements Discussion and Analysis is to provide an understanding of
Cincinnati Financial Corporations consolidated results of operations and financial
position. Managements Discussion and Analysis should be read in conjunction with Item 6,
Selected Financial Data, Pages 28 and 29, and Item 8, Consolidated Financial Statements and
related Notes, beginning on Page 77. We present per share data on a diluted basis unless
otherwise noted and we have adjusted those amounts for all stock splits and dividends,
including the 5 percent stock dividend paid on April 26, 2005.
We begin with an executive summary of our results of operations and outlook, as well as
details on critical accounting policies and estimates. Periodically, we refer to estimated
industry data so that we can give information on our performance versus the overall
insurance industry. Unless otherwise noted, the industry data is prepared by A.M. Best, a
leading insurance industry statistical, analytical and financial strength rating
organization. Information from A.M. Best is presented on a statutory basis. When we provide
our results on a comparable statutory basis, we label it as such; all other company data is
presented on a GAAP basis.
Executive Summary
Cincinnati Financial Corporation is the parent company of the nations 19th
largest publicly traded property casualty insurer, based on statutory net written premium
volume through the first nine months of 2005. We primarily market commercial lines and
personal lines property casualty insurance products through a select group of independent
insurance agencies in 32 states. As we discussed in the business description in Item 1, we
believe three characteristics distinguish our company and allow us to build shareholder
value:
|
|
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 |
We provide additional detail on these subjects in the Results of Operations and Liquidity
and Capital Resources sections of this discussion.
Among the factors that influence the consolidated results of operations and financial
position of the company, we consider our relationships with independent insurance agents to
be the most significant. We seek to be an indispensable partner in each agencys success. To
continue to achieve our performance targets, we must maintain these strong relationships,
write a significant portion of each agencys business and attract new agencies.
Conditions in the property casualty markets were challenging in 2005, as we discuss in the
business description in Item 1, Our Business and Our Strategy, Page 1. In the commercial
lines marketplace, competition continues to accelerate, resulting in a lower premium growth
rate. In the personal lines marketplace, our personal lines rates in some territories have
not been in a competitive range that would allow our agents to market the benefits of our
products, resulting in declining policy retention and lower new business.
We believe consistently applying our long-term strategies rather than taking short-term
actions will allow us to address these challenges. We seek to meet our agents needs, with
an eye toward solutions and approaches that will give us an advantage
for five, 10 or even
more years. As we appoint new agencies, we are looking to build relationships that will grow
as successfully as those we have had for 40 or 50 years.
In 2005, we achieved most of our objectives for creating shareholder value, as we discuss on
Page 33. Although unrealized gains have been down in the past several years because of the
decline in the market value of our Fifth Third investment, we believe our portfolio
continues to have the potential to increase investment income and provide capital
appreciation over the long term.
Below we review highlights of our financial results for the past three years and measures of
the success of our efforts to create shareholder value.
2005 10-K Page 31
Corporate Financial Highlights
Income Statement and Per Share Data
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(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 |
|
In 2005, we reported record results, as described in detail in the results of
operations.
Revenue growth was slower in 2005 than in 2004 because of slowing consolidated property
casualty earned premium growth due to market conditions. Pretax investment income growth
accelerated over the three years. Realized gains made a positive contribution in 2005 and
2004 although we recorded a realized loss in 2003.
Net income and net income per share reached record levels in 2005 although the growth rates
were substantially lower in 2005 than in 2004. A number of factors affected the annual
growth rates, including:
|
|
The consolidated property casualty underwriting profit improved 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 losses are 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 outstanding may 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. |
The board of directors is committed to steadily increasing cash dividends and periodically
authorizing stock dividends and splits. Cash dividends declared per share rose 16.1 percent
and 14.4 percent in 2005 and 2004.
Balance Sheet Data and Performance Measures
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(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
Invested assets and total assets have been relatively flat over the past two years as
strong cash flow has been offset by lower unrealized investment
gains. This led to a modest
decline in shareholders equity and book value in 2005.
Comprehensive income is net income plus the change in net other accumulated
comprehensive income. Change in net other accumulated comprehensive income is the
year-over-year difference in unrealized gains on investments. In 2005 and 2004, comprehensive income declined because lower unrealized gains more than offset the increase
in net income. Unrealized gains were down primarily because of a decline in the market value
of our Fifth Third investment.
With net income growing and shareholders equity declining, return on equity rose over the
past three years. Return on equity based on comprehensive income, however, declined in
line with total comprehensive income.
We issued $375 million of long-term debt in 2004, raising total long-term debt to $791
million at year-end 2005 and 2004. Our ratio of long-term debt to capital (long-term
debt plus shareholders equity) rose in 2004 following the new debt issue and remained
stable in 2005.
Property Casualty Highlights
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(Dollars in millions) |
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2005-2004 |
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2004-2003 |
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2005 |
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2004 |
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2003 |
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Change % |
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Change % |
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Property casualty highlights |
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Written premiums |
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$ |
3,076 |
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$ |
2,997 |
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$ |
2,815 |
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2.6 |
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6.5 |
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Underwriting profit |
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330 |
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298 |
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140 |
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10.8 |
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113.3 |
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GAAP combined ratio |
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89.2 |
% |
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89.8 |
% |
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94.7 |
% |
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Statutory combined ratio |
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89.0 |
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89.4 |
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94.2 |
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The declining trend in overall written premium growth reflected the market factors
discussed in Item 1, Commercial Lines and Personal Lines Property Casualty Insurance
Segments, Page 10 and Page 11. In each of the past three years, our overall written premium
growth rate has exceeded that of the industry. The estimated industry growth rate was 0.7
percent, 4.7 percent and 9.6 percent in 2005, 2004 and 2003, respectively. The 2005 overall
industry premium growth rate included an estimated 33.9 percent decline in reinsurance
sector premiums.
Our consolidated property casualty insurance underwriting profit rose in 2005 and 2004, and
our combined ratio improved each year. (The combined ratio is the percentage of each premium
dollar spent on claims plus all expenses the lower the ratio, the better the
performance.) The 2005 improvement reflected lower catastrophe losses, continued strong
commercial lines underwriting results, a return to underwriting profitability for personal
lines and above-average savings from favorable loss reserve development from prior accident
years. The 2004 improvement reflected growth in premiums, in particular more adequate
premium per policy, the benefits of other underwriting efforts and above-average savings
from favorable loss reserve development from prior accident years.
The estimated industry average statutory combined ratios were 102.0 percent, 98.1 percent
and 100.2 percent for 2005, 2004 and 2003, respectively. The 2005 overall industry combined
ratio included an estimated 150.7 percent reinsurance sector ratio.
We also measure a variety of non-financial metrics for our property casualty operations. For
example, we monitor our rank within our reporting agency locations. In 2004, we ranked No. 1
or No. 2 by premium volume in 74 percent of the locations that have marketed our products
for more than five years. Other measures include subdivision of territories and new agency
appointments. In 2005, we subdivided eight field territories, raising the total to 100, and
appointed 41 new agency relationships. These new appointments and other changes in agency
structures led to a net increase in reporting agency locations of 40 in 2005.
Agent satisfaction with our technology solutions is, and will continue to be, a requirement
for maintaining our strong relationships with these agencies. In 2005, we made additional
progress in implementing technology solutions that we believe should make it easier for
agencies to do business with us. Among other milestones, we deployed our new commercial
lines policy processing system to all of our agencies in Ohio for use in processing new and
renewal businessowners policies. We also deployed our personal lines
policy processing system
in two additional states and made important upgrades and enhancements.
Measuring Our Success in 2006 and Beyond
We use a variety of metrics to measure the success of our strategies:
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Maintaining our strong relationships with our established agencies, writing a
significant portion of each agencys 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
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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. |
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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. |
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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. |
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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 weve 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: |
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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. |
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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. |
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o |
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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. |
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The estimated industry average 2006 combined ratio is 98.7 percent. |
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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. |
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We do not establish annual capital appreciation targets. Over the long term, our target
is to have the equity portfolio outperform the Standard & Poors 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. |
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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
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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. |
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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. |
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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 & Poors 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. |
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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. |
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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. |
Factors supporting our outlook for 2006 are discussed below in the Results of Operations for
each of the four business segments.
Critical Accounting Estimates
Cincinnati Financial Corporations financial statements are prepared using GAAP. These
principles require management to make estimates and assumptions that affect the amounts
reported in the Consolidated Financial Statements and accompanying Notes. Actual results
could differ materially from those estimates.
The significant accounting policies used in the preparation of the financial statements are
discussed in Item 8, Note 1 to the Consolidated Financial Statements, Page 84. In
conjunction with that discussion, material implications of uncertainties associated with the
methods, assumptions and estimates underlying the companys critical accounting policies are
discussed below. The audit committee of the board of directors reviews the annual financial
statements with management and the independent registered public accounting firm. These
discussions cover the quality of earnings, review of reserves and accruals, reconsideration
of the suitability of accounting principles, review of highly judgmental areas including
critical accounting policies, audit adjustments and such other inquiries as may be
appropriate.
Property Casualty Insurance Loss and Loss Expense Reserves
Overview
Our most significant estimates relate to our reserves for property casualty loss and
loss expenses. We believe that the stability of our business makes our historical data the
most important source for establishing adequate reserve levels. We base reserve estimates on
company experience and information from internal analyses and obtain additional information
from the appointed actuary. When reviewing reserves, we analyze historical data and estimate
the effect of various loss factors. We believe that the following represent the primary
risks to our ability to estimate loss reserves accurately:
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Court decisions or legislation that result in unanticipated coverage expansions on past and existing policies |
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Changes in medical inflation and mortality rates that affect workers compensation claims |
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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 |
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Changes in reinsurance coverage, not reflected in reserving data, that affect the
companys net payments and net case reserves |
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Payment and reporting pattern changes attributable to the implementation of a new
claims management system |
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Reporting pattern changes attributable to changes in case reserving practices,
particularly with respect to umbrella liability claims |
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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
Any of these factors could cause our ultimate loss experience to be better or worse than
reserves held, and the difference could be material. To the extent that reserves are
inadequate and strengthened, the amount of such increase is treated as a charge in the
period that the deficiency is recognized, raising the loss and loss expense ratio and
reducing earnings. To the extent that reserves are redundant and released, the amount of the
release is a credit in the period that the redundancy is recognized, reducing the loss and
loss expense ratio and increasing earnings.
A reserve change of $31 million would have a 1 percentage point effect on the loss and loss
expense ratio, based on 2005 earned premiums, a $20 million effect on income and an 11 cent
effect on net income per share.
Establishing Reserves
Reserves are established for the total of unpaid loss and loss expenses, including
estimates for claims that have been reported, estimates for claims that have been incurred
but not yet reported (IBNR) and estimates of loss expenses associated with processing and
settling those claims. Reserves are determined for the various lines of business. Loss
reserves are reduced by salvage and subrogation reserves.
We establish case reserves for claims that have been reported within the parameters of
coverage provided in the policy. Individual case reserves greater than $35,000 established
by field claims representatives are reviewed by experienced headquarters claims supervisors
while case reserves greater than $100,000 also are reviewed by headquarters claims managers.
The estimates reflect informed judgment and experience of our claims associates based on
general insurance reserving practices and their experience with the company. Case reserves
are reviewed on a 90-day cycle, or more frequently if specific circumstances require, based
on events such as the status of ongoing negotiations.
The anticipated effect of inflation is implicitly considered when estimating reserves for
loss and loss expenses. While anticipated cost increases due to inflation are considered in
estimating ultimate claim costs, increases in average severity of claims are caused by a
number of factors that vary by individual type of policy. Average severity projections are
based on historical trends adjusted for anticipated changes in underwriting standards,
policy provisions and general economic trends. We do not discount any of our property
casualty loss and loss expense reserves.
In 2001, we began to establish higher initial case reserves on serious injury claims to
reflect recent experience indicating the likelihood that juries would ignore significant
liability issues in cases involving seriously injured claimants.
To establish IBNR reserves on an annual basis, we use a variety of tools, including
actuarial and statistical methods. These may include but are not limited to:
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The Case Incurred Development Method |
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The Paid Development Method |
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The Bornhuetter-Ferguson Method |
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Probability Trend Family Methods |
Supplemental statistical information is compiled and reviewed to aid in the application of
the actuarial methods. The supplemental data also is used to evaluate the reasonableness of
estimates derived from the actuarial methods. This information includes:
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Industry loss frequency and severity and premium trends |
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Past, present and anticipated product pricing |
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Anticipated premium growth |
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Other quantifiable trends |
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Projected ultimate loss ratios |
We conduct our thorough evaluation of the adequacy of reserves as of the end of the third
quarter of each year. As a result, the most significant refinements in reserves historically
have been implemented
in the fourth quarter. Beginning in 2006, we are conducting a detailed supplemental review
as of the end of the fourth quarter of each year in parallel with the outside actuarial
review. Less detailed, periodic reviews of reserve adequacy are made at the other quarter
ends. A loss review committee, including internal actuaries and representatives from
management of multiple operating departments, is responsible for the quarterly review
process.
The internal actuaries provide a point estimate and a range to summarize their analysis. At
year-end 2005 and 2004, IBNR reserves differed from the internal actuarial point estimate by
less than 1 percent of our loss and loss expense reserve.
2005 10-K Page 36
Adjusting Reserves
While we believe that reported reserves provide for all unpaid loss and loss expense
obligations, the estimation processes involve a number of variables and assumptions. We
believe this uncertainty is mitigated by the historical stability of our book of business
and by our periodic reviews of estimates. As loss experience develops and new information
becomes known, the reserves are reviewed and adjusted as appropriate. In this process, we
monitor trends in the industry, cost trends, relevant court cases, legislative activity and
other current events in an effort to ascertain new or additional exposures to loss. If we
determine that reserves established in prior years were not sufficient or were excessive,
the change is reflected in current-year results.
Actuarial Review
As part of our internal processes, we utilize an appointed actuary to provide
management with an opinion regarding an acceptable range for adequate statutory reserves
based on generally accepted actuarial guidelines.
Historically, we have established adequate reserves that have fallen in the upper half of
the appointed actuarys range. This approach has resulted in recognition of reserve
redundancies for the past 10 years, as we discuss in Development of Loss and Loss Expenses,
Page 62. Modestly redundant reserves support our business strategy to retain high financial
strength ratings and remain a market for agencies business in all market conditions.
The appointed actuary conducts a thorough evaluation of the adequacy of reserves as of the
end of the third quarter of each year and conduct a supplemental review of full-year data at
year-end.
Asset Impairment
Fixed-maturity and equity investments are our largest assets. Certain estimates and
assumptions made by management relative to investment portfolio assets are critical. The
companys asset impairment committee continually monitors investments and all other assets
for signs of other-than-temporary and/or permanent impairment. Among other signs, the
committee monitors significant decreases in the market value of the assets, changes in legal
factors or in the business climate, an accumulation of costs in excess of the amount
originally expected to acquire or construct an asset, uncollectability of all other assets,
or other factors such as bankruptcy, deterioration of creditworthiness, failure to pay
interest or dividends or signs indicating that the carrying amount may not be recoverable.
The application of our impairment policy resulted in other-than-temporary impairment charges
and write-offs of investments that reduced our income before income taxes by $1 million, $6
million and $80 million in 2005, 2004 and 2003, respectively.
Other-than-temporary impairment in the value of securities is defined by the company as
declines in valuation that meet specific criteria established in the asset impairment
policy. Such declines often occur in conjunction with events taking place in the overall
economy and market, combined with events specific to the industry or operations of the
issuing corporation. These specific criteria include a declining trend in market value, the
extent of the market value decline and the length of time the value of the security has been
depressed, as well as subjective measures such as pending events and issuer liquidity.
Generally, these declines in valuation are greater than might be anticipated when viewed in
the context of overall economic and market conditions. We provide information regarding
valuation of our invested assets in Item 8, Note 2 to the Consolidated Financial Statements,
Page 88.
Our portfolio managers constantly monitor the status of their assigned portfolios for
indications of potential problems or issues that may be possible impairment issues. If an
impairment indicator is noted, the portfolio managers even more closely scrutinize the
security.
Impairment charges are recorded for other-than-temporary declines in value, if, in the asset
impairment committees judgment, there is little expectation that the value will be recouped
in the foreseeable future. The impairment policy defines a security as distressed when it is
trading below 70 percent of book value or has a Moodys or Standard & Poors credit rating
below B3/B-. Distressed securities receive additional scrutiny. In 2005 and earlier, a
security would have been written down in
the event of a declining market value for four consecutive quarters with quarter-end market
value below 50 percent of book value, or when a securitys market value is 50 percent below
book value for three consecutive quarters. Effective January 1, 2006, a security may be
written down in the event of a declining market value for four consecutive quarters with
quarter-end market value below 70 percent of book value, or when a securitys market value
is 70 percent below book value for three consecutive quarters. A sudden and severe drop in
market value that does not otherwise meet the above criteria is reviewed for possible
immediate impairment.
When evaluating other-than-temporary impairments, the committee considers the companys
ability to retain a security for a period adequate to recover a significant percentage of
cost. Because of the companys investment philosophy and strong capitalization, it can hold
securities that have the potential to recover value until their scheduled redemption, when
they might otherwise be deemed impaired. Investment assets that
2005 10-K Page 37
have already been impaired
are evaluated based on their adjusted book value and further written down, if deemed
appropriate. The decision to sell or write down an asset with impairment indications
reflects, at least in part, managements opinion that the security no longer meets the
companys investment objectives. We provide detailed information about securities trading in
a continuous loss position at year-end 2005 in Item 7A, Unrealized Investment Gains and
Losses, Page 74. Other-than-temporary declines in the fair value of investments are
recognized in net income as realized losses at the time when facts and circumstances
indicate such write-downs are warranted.
Permanent impairment charges (write-offs) are defined as those for which management believes
there is little potential for future recovery, for example, following the bankruptcy of the
issuing corporation. These permanent declines in the fair value of investments are written
off at the time when facts and circumstances indicate such write-downs are warranted, and
they are reflected in realized losses.
Other-than-temporary and permanent impairments are distinct from the ordinary fluctuations
seen in the value of a security when considered in the context of overall economic and
market conditions. Securities considered to have a temporary decline would be expected to
recover their market value, which may be at maturity. Under the same accounting treatment as
market value gains, temporary declines (changes in the fair value of these securities) are
reflected on our balance sheet in other comprehensive income, net of tax, and have no impact
on reported net income.
Life Insurance Policy Reserves
We establish the reserves for traditional life insurance policies based on expected
expenses, mortality, morbidity, withdrawal rates and investment yields, including a
provision for uncertainty. Once these assumptions are established, they generally are
maintained throughout the lives of the contracts. We use both our own experience and
industry experience adjusted for historical trends in arriving at our assumptions for
expected mortality, morbidity and withdrawal rates. We use our own experience and historical
trends for setting our assumptions for expected expenses. We base our assumptions for
expected investment income on our own experience adjusted for current economic conditions.
We establish reserves for our universal life, deferred annuity and investment contracts
equal to the cumulative account balances, which include premium deposits plus credited
interest less charges and withdrawals.
Employee Benefit Pension Plan
We have a defined benefit pension plan covering substantially all employees.
Contributions and pension costs are developed from annual actuarial valuations. These
valuations involve key assumptions including discount rates and expected return on plan
assets, which are updated each year. Any adjustments to these assumptions are based on
considerations of current market conditions. Therefore, changes in the related pension costs
or credits may occur in the future due to changes in assumptions.
The key assumptions used in developing the 2005 net pension expense were a 5.75 percent
discount rate, an 8.0 percent expected return on plan assets and rates of compensation
increases ranging from 5 percent to 7 percent. The 8.0 percent return on plan assets
assumption is based partially on the fact that substantially all of the investments held by
the pension plan are common stocks that pay annual dividends. We believe this rate is
representative of the expected long-term rate of return on these assets. These assumptions
were consistent with the prior year except that the discount rate was reduced by one fourth
of one percent due to current market conditions. In 2005, the net pension expense was $13
million. In 2006, we expect a net pension expense of $17 million, primarily as a result of a
0.25 percent reduction in the discount rate and increased service costs.
Holding all other assumptions constant, a 0.5 percentage point decline in the discount rate
would lower our 2006 net income before income taxes by $2 million. Likewise, a 0.5
percentage point decline in the expected return on plan assets would lower our 2005 income
before income taxes by $1 million.
In addition, the fair value of the plan assets exceeded the accumulated benefit obligation
by $8 million at year-end 2005 and $16 million at year-end 2004. The fair value of the plan
assets was less than the projected plan benefit obligation by $62 million at year-end 2005
and $41 million at year-end 2004. Market conditions and interest rates significantly affect
future assets and liabilities of the pension plan. We expect to contribute approximately $10
million to the pension plan in 2006.
Deferred Acquisition Costs
We establish a deferred asset for costs that vary with, and are primarily related to,
acquiring property casualty and life business. These costs are principally agent
commissions, premium taxes and certain underwriting costs, which are deferred and amortized
into income as premiums are earned. Deferred acquisition costs track with the change in
premiums. Underlying assumptions are updated periodically to reflect actual experience.
Changes in the amounts or timing of estimated future profits could result in adjustments to
the accumulated amortization of these costs.
2005 10-K Page 38
For property casualty policies, deferred acquisition costs are amortized over the terms of
the policies. For life policies, acquisition costs are amortized into income either over the
premium-paying period of the policies or the life of the policy, depending on the policy
type.
Contingent Commission Accrual
Another significant estimate relates to our accrual for contingent (profit-sharing)
commissions. We base the contingent commission accrual estimates on property casualty
underwriting results and on supplemental property casualty information. Contingent
commissions are paid to agencies using a formula that takes into account agency
profitability and other factors, such as prompt monthly payment of amounts due to the
company. Due to the complexity of the calculation and the variety of factors that can affect
contingent commissions for an individual agency, the amount accrued can differ from the
actual contingent commissions paid. The contingent commission accrual of $108 million in
2005 contributed 3.5 percentage points to the property casualty combined ratio. If
commissions paid were to vary from that amount by 5 percent, it would affect 2006 net income
by $4 million, or 2 cents per share, and the combined ratio by approximately 0.2 percentage
points.
Separate Accounts
We issue life contracts, referred to as bank-owned life insurance policies (BOLI).
Based on the specific contract provisions, the assets and liabilities for some BOLIs are
legally segregated and recorded as assets and liabilities of the separate accounts. Other
BOLIs are included in the general account. For separate account BOLIs, minimum investment
returns and account values are guaranteed by the company and also include death benefits to
beneficiaries of the contract holders.
Separate account assets are carried at fair value. Separate account liabilities primarily
represent the contract holders claims to the related assets and also are carried at the
fair value of the assets. Generally, investment income and realized investment gains and
losses of the separate accounts accrue directly to the contract holders and, therefore, are
not included in our Consolidated Statements of Income. However, each separate account
contract includes a negotiated realized gain and loss sharing arrangement with the company.
This share is transferred from the separate account to our general account and is recognized
as revenue or expense. In the event that the asset value of contract holders accounts is
projected below the value guaranteed by the company, a liability is established through a
charge to our earnings.
For our most significant separate account, written in 1999, realized gains and losses are
retained in the separate account and are deferred and amortized to the contract holder over
a five-year period, subject to certain limitations. Upon termination or maturity of this
separate account contract, any unamortized deferred gains and/or losses will revert to the
general account. In the event this separate account holder were to exchange the contract for
the policy of another carrier, there would be a surrender charge equal to 10 percent of the
contracts account value during the first five years. Beginning in year six, the surrender
charge decreases 2 percent a year to 0 percent in year 11. At year-end 2005, net unamortized
realized gains amounted to $1 million. In accordance with this separate account agreement,
the investment assets must meet certain criteria established by the regulatory authorities
to whose jurisdiction the group contract holder is subject. Therefore, sales of investments
may be mandated to maintain compliance with these regulations, possibly requiring gains or
losses to be recorded, and charged to the general account. Potentially, losses could be
material; however, unrealized losses in the separate account portfolio were less than $4
million at year-end 2005.
Recent Accounting Pronouncements
Information regarding recent accounting pronouncements is provided in Item 8, Note 1 to
the Consolidated Financial Statements, Page 84. We have determined that recent accounting
pronouncements have not had nor are they expected to have any material impact on our
consolidated financial statements.
Results of Operations
The consolidated results of operations reflect the operating results of each of our
four segments along with the parent company and other non-insurance activities. The four
segments are:
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Commercial lines property casualty insurance |
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|
Personal lines property casualty insurance |
We measure profit or loss for our property casualty and life segments based upon
underwriting results. Insurance underwriting results (profit or loss) represent net earned
premium less loss and loss expenses and underwriting expenses on a pretax basis. We also
measure aspects of the performance of our commercial lines
2005 10-K Page 39
and personal lines segments on a combined property casualty insurance operations basis.
Underwriting results and segment pretax operating income are not a substitute for net income
determined in accordance with GAAP.
For the combined property casualty insurance operations as well as the commercial lines and
personal lines segments, statutory accounting data and ratios are key performance indicators
that we use to assess business trends and to make comparisons to industry results, since
GAAP-based industry data generally is not readily available. We also use statutory
accounting data and ratios as key performance indicators for our life insurance operations.
We do not believe that inflation has had a material effect on consolidated results of
operations, except to the extent that inflation may affect interest rates and claim costs.
Investments held by the parent company and the investment portfolios for the property
casualty and life insurance subsidiaries are managed and reported as the investments
segment, separate from the underwriting businesses. Net investment income and net realized
investment gains and losses for our investment portfolios are discussed in the Investments
Results of Operations.
The calculations of segment data are described in more detail in Item 8, Note 17 of the
Consolidated Financial Statements, Page 98. The following sections review results of
operations for each of the four segments. Commercial Lines Insurance Results of Operations
begins on Page 41, Personal Lines Insurance Results of Operations begins on Page 47, Life
Insurance Results of Operations begins on Page 52, and Investments Results of Operations
begins on Page 54. We begin with an overview of our consolidated property casualty
operations, which is the total of our commercial lines and personal lines segments. Our
consolidated property casualty operations generated 81.2 percent of our revenues in 2005,
and certain factors affected both of our property casualty segments.
Consolidated Property Casualty Insurance Results of Operations
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(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 |
% |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Factors that affected written premiums for property casualty insurance operations
included:
|
|
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. |
Favorable development of loss reserves from prior accident years affected the combined ratio
for property casualty insurance operations. The 2005 and 2004 ratios benefited from higher
than normal savings. The 2004 and 2003 ratios benefited from uninsured motorist/underinsured
motorist (UM/UIM) reserve releases. Following an Ohio Supreme Court decision in late 2003 to
limit its 1999 Scott-Pontzer vs. Liberty Mutual decision, we released UM/UIM reserves as
follows:
|
|
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. |
The discussions of property casualty segments provide additional detail regarding these
factors.
2005 10-K Page 40
Commercial Lines Insurance Results of Operations
Overview Three-year Highlights
Performance highlights for the commercial lines segment include:
|
|
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. |
Growth and Profitability
As competition in the commercial markets has increased, we have maintained our pricing
discipline for both renewal and new business. Our independent agents reported steady
pressure on pricing during 2005 and communicated that winning new business and retaining
renewals required more pricing flexibility and careful risk selection. With the commercial
lines pricing environment growing more competitive, we continue to rely on factors other
than price to drive sales. Our agents look for the best insurance program for their clients,
not just the best price. They serve policyholders well by presenting our value proposition
customized coverage packages, personal claims service and high financial strength ratings
all wrapped up in a convenient three-year commercial policy. We intend to remain a stable
market for our agencies best business, and believe that our case-by-case approach gives us
a clear advantage. Our field marketing associates and our independent agents work together
to select risks and respond appropriately to local pricing trends. Historically, they have
proven capable of balancing risk and price to achieve growth in new business over the longer
term.
Staying abreast of evolving market conditions is a critical function, accomplished in both
an informal and a formal manner. Informally, our field marketing representatives and
underwriters are in constant receipt of market intelligence from the agencies with which
they work. Formally, our commercial lines product management group and field marketing
associates complete periodic market surveys to obtain competitive intelligence. This market
information helps to identify the top competitors by line of business or specialty program
and also identifies our market strengths and weaknesses. The analysis encompasses pricing,
breadth of coverage and underwriting/eligibility issues. In addition to reviewing our
competitive position, our product management group and our underwriting audit group review
compliance with our underwriting standards as well as the pricing adequacy of our commercial
insurance programs and coverages. Further, our research and development department analyzes
opportunities and develops new products, new coverage options and improvements to existing
insurance products.
In 2003 and 2004, all lines of business grew because of higher premiums per policy. In 2005,
growth largely was driven by commercial multi-peril and other liability coverages with
commercial auto premiums declining. Commercial auto is one of the first lines to experience
pricing pressure because it often represents the largest portion of insurance costs for
commercial policyholders. Commercial auto also is one of the larger, annually priced
components of our three-year policies.
We have more aggressively identified and measured exposures to match coverage amounts and
premiums to the risk. Where this matching is not possible, accounts are not renewed unless
there are mitigating factors. As a result, we experienced no growth in overall commercial
lines policy counts from 2003 to 2005. Agents tell us they agree with the need to carefully
select risks and assure pricing adequacy. They appreciate the time our associates invest in
creating solutions for their clients while protecting profitability, whether that means
working on an individual case or developing modified policy terms and conditions that
preserve flexibility, choice and other sales advantages.
2005 10-K Page 41
For new business, our field marketing associates and agents are working together to select
risks and respond appropriately to local pricing trends. New commercial lines business was
$282 million in 2005, unchanged from 2004. New business was $268 million in 2003.
We discuss
growth by commercial lines of business on Page 45.
Commercial Lines Results
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(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 |
% |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Over the past three years, we have continued to focus on seeking and maintaining
adequate premium per exposure as well as pursuing non-pricing means of enhancing longer-term
profitability. These have included identifying the exposures we have for each risk and
making sure we offer appropriate coverages, terms and conditions and limits of insurance. We
continue to adhere to our underwriting guidelines, to re-underwrite books of business with
selected agencies and to update policy terms and conditions, where necessary. In addition,
we continue to leverage our strong local presence. Our field marketing representatives have
met with every agency to reaffirm agreements on the extent of frontline renewal underwriting
to be performed by local agencies. Loss control, machinery and equipment and field claims
representatives continue to conduct on-site inspections. Field claims representatives
prepare full risk reports on every account reporting a loss above $100,000 or on any risk of
concern. Multi-departmental task forces have implemented programs to address concerns for
specific areas such as contractor and commercial auto risks. These actions have helped to
mitigate rising loss severity.
We describe the significant costs components for the commercial lines segment below.
Loss and Loss Expenses (excluding catastrophe losses)
Loss and loss expenses include both net paid losses and reserve additions for unpaid
losses as well as the associated loss expenses. We believe more competitive market
conditions were one factor in the 3.3 percentage point rise in the loss and loss expense
ratio excluding catastrophes between 2005 and 2004. In addition, 2005 results include a single large loss that was insufficiently covered
through our facultative reinsurance programs, which increased the 2005 loss and loss
expenses by $24 million, net of reinsurance, or 1.1 percentage points. Savings from
favorable loss reserve development was lower in 2005 than 2004, which we discuss by
commercial lines of business on Page 45.
Underwriting actions that led to higher premiums on a relatively stable level of exposures
contributed to the 10.7 percentage point decline in the loss and loss expense ratio
excluding catastrophes between 2004 and 2003. In addition, savings from favorable loss
reserve development was significantly higher in 2004 than 2003.
Re-underwriting our commercial lines book of business in the early 2000s has had an impact
on reserve development patterns because we are seeing lower frequency of losses. The
favorable development in 2005 and 2004 was also due to the headquarters claims departments
initiative, begun in 2001. Since 2001, we have been establishing higher initial case
reserves on severe injury claims because our experience indicated that juries often ignore
significant liability issues in cases involving seriously injured claimants. These higher
initial amounts produce case reserves that reflect our full exposure more accurately. But
some claims settle before reaching a jury and some juries make awards that are less than the
worst-case scenario. As a result, some change in our case reserve development patterns
allowed us to also reduce IBNR in 2005.
We monitor incurred losses by size of loss, business line, risk category, geographic region,
agency, field marketing territory and duration of policyholder relationship, addressing
concentrations or trends as needed. Our 2005 analysis indicated no significant
concentrations other than trends in business lines that we address as part of our ongoing
business operations. We also measure new losses and case reserve increases greater than
$250,000 to track frequency and severity.
2005 10-K Page 42
These commercial lines large losses and case reserve increases have been in the range of 15
percent to 17 percent of annual earned premiums since 2003. The primary reason the
contribution of these losses to the loss and loss expense ratio rose in 2005 was higher
total new losses greater than $1 million. New losses greater than $1 million rose because of
a rise in the number of these losses and the single large loss noted above. Total
development and case reserve increases of $250,000 or more rose primarily because of two
verdicts that exceeded the reserves we had established.
Commercial Lines Losses by Size
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(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 |
% |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Catastrophe Loss and Loss Expenses
Commercial lines catastrophe losses, net of reinsurance and before taxes, were $76
million in 2005 compared with $71 million in 2004 and $42 million in 2003. The following
table shows losses incurred, net of reinsurance, and subsequent development, for catastrophe
losses in each of the past three years.
The Cincinnati Insurance Companies do not appoint agencies to actively market property
casualty insurance in Louisiana, Mississippi or Texas. Our Hurricane Katrina and Rita losses
included losses associated with commercial accounts written by agents in other states to
cover locations and vehicles in multiple states, including Louisiana, Mississippi and Texas.
Hurricane Katrina losses also included $18 million in assumed losses. The Cincinnati
Insurance Company participates in three assumed reinsurance treaties with two reinsurers
that spread the risk of very high catastrophe losses among many insurers. The assumed losses
from Hurricane Katrina included $16 million under a treaty with the Munich Re Group to
assume 2 percent of property losses between $400 million and $1.2 billion from a single
event. Munich Re has reserved its Hurricane Katrina losses above $1.2 billion. We reduced
our participation in the Munich Re assumed reinsurance treaty to 1 percent in 2006.
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 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Commission Expenses
Commercial lines commission expense as a percent of earned premium declined by 0.4
percentage points in 2005 after rising by 1.0 percentage points in 2004. Profit-sharing, or
contingent, commissions are calculated on the profitability of an agencys aggregate book of
business, taking into account longer-term profit, with a percentage for prompt payment of
premiums and other criteria, and reward our agents efforts. These profit-based commissions
generally fluctuate with our loss and loss expenses.
A refinement and subsequent release of a contingent commission over accrual from 2004 in the
first three months of 2005 was responsible for 0.3 percentage points of the decline in 2005.
The refinement reflected the use of final 2004 financial data to calculate the contingent
commissions paid in 2005. Our 2005 contingent commission accrual reflected our estimate of
the profit-sharing commissions that will be paid to our agencies in early 2006.
Underwriting Expenses
Non commission expenses rose to 10.1 percent of earned premium in 2005 from 9.4 percent
in 2004 and 7.7 percent in 2003. The three-year rise in the ratio largely was due to
unfavorable deferred acquisition cost comparisons resulting from slower premium growth,
higher staffing expenses and increased taxes and fees that were partially due to a state
guaranty fund refund in 2003. The software recovery discussed in Corporate Financial
Highlights, Page 32, reduced the 2003 ratio by 0.8 percentage points.
Policyholder Dividends
Policyholder dividend expense was 0.2 percent of earned premium in 2005 compared with
0.5 percent in 2004 and 0.8 percent in 2003.
2005 10-K Page 44
Line of Business Analysis
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(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 |
|
In total, the commercial multi-peril, workers compensation, commercial auto and other
liability lines of business accounted for 89.7 percent of total commercial lines earned
premium compared with 90.1 percent in 2004 and 90.5 percent in 2003. Approximately 95 percent of our commercial
lines premiums are written as packages, providing accounts with coverages from more than one
business line. We believe that our commercial lines segment is best measured and evaluated
on a segment basis. We have provided the table above and the discussion below to summarize
growth and profitability trends separately for each of the four primary business lines.
The accident year loss data provides current estimates of incurred loss and loss expenses
for the past five accident years. Accident year data classifies losses according to the year
in which the corresponding loss event occurred, regardless of when the losses are actually
reported, booked or paid.
Over the past three years, results for the business lines within the commercial lines
segment have reflected our emphasis on underwriting and obtaining adequate pricing for
covered risks, as discussed above.
Commercial Multi-peril
In 2005 and 2004, commercial multi-peril written premiums rose more rapidly than the
total for commercial lines as a higher proportion of liability coverages were written in
discounted packages because of competitive pricing pressures. Commercial multi-peril written
premiums were lower in 2003 when some liability coverages were moved to nondiscounted
policies. Nondiscounted policies are included in our other liability line of business.
Commercial multi-peril is our single largest business line. We believe this business lines
loss data provides the best indicator of the success of the growth and underwriting actions
that we have implemented during the past five years. The higher general liability base rates
that were effective in most states beginning in 2003 helped to offset a trend toward higher
construction costs for 2005 and 2004 property claims.
In each of the last three calendar years, reserve changes for prior periods have contributed
to results.
|
|
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 departments 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. |
In addition, the large loss discussed above added 2.9 percentage points to the 2005 ratio.
Workers Compensation
Conditions within the workers compensation market remained stable in 2005 and 2004
after improving between 1999 and 2003 as market pricing rose in most states, albeit offset
by continued rising trends in loss severity. In 2005, workers compensation written premiums
rose more rapidly than our total commercial lines written premiums as this business line
appeared to experience less competitive pricing pressures than the overall commercial lines
market in the second half of the year. As the commercial lines market has softened, however,
insurers have displayed a greater willingness to write more desirable risks, and growth in
the premium volume of state pools for workers compensation is declining.
Since 2002, we have chosen not to renew selected policies where we believed the aggregate
exposure risk was excessive. Any new or renewal policy covering 200 or more employees at any
one location receives added scrutiny as we seek to manage risk aggregation. We make workers
compensation available as part of package policies for commercial lines policyholders in
selected states as a competitive tool. We pay a lower commission rate on workers
compensation business, which means this line has a higher loss and loss expense breakeven
point than our other commercial business lines. In Ohio, our largest state, workers
compensation coverage is a state monopoly, provided solely by the state instead of by
private insurers.
The workers compensation loss and loss expense ratio rose in 2005 after remaining steady for
several years, largely because of a higher level of reserve strengthening for older accident
years.
|
|
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. |
Commercial Auto
Written premiums declined 2.4 percent in 2005 after rising 5.5 percent in 2004, below
the overall commercial lines growth rate. Commercial auto is one of the package policy
components for which we calculate pricing annually. This line tends to be highly sensitive
to competitive pressures.
In the past several years, we accelerated efforts to improve commercial auto underwriting
and rate levels, making certain that vehicle use was properly classified. As a result of
those actions and moderating industrywide severity and frequency trends, the loss and loss
expense ratio for commercial auto remained at an acceptable level in 2005 despite pricing
pressures, after improving from 2001 through 2004. Further, we continue to adhere to our
underwriting guidelines to assure accurate classification and pricing.
A significant factor in the calendar year-over-year changes has been savings from favorable
loss reserve development for prior years.
|
|
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. |
Other Liability
Other liability (commercial umbrella, commercial general liability and most executive
risk policies) written premiums also grew more rapidly than our total commercial lines
written premiums because of the growing number of policies written in non-discounted
programs and the continuing rise in liability pricing. The growth
2005 10-K Page 46
rate is decelerating, however, because a higher proportion of accounts are being
written in discounted packages because of competitive pricing pressures. Discounted policies
are included in our commercial multi-peril line of business.
Director and officer coverage accounted for approximately 11 percent of other liability
premium in 2005 compared with approximately 13 percent in 2004 and approximately 12 percent
in 2003. Our director and officer policies are offered primarily to nonprofit organizations,
reducing the risk associated with this line of business. As of December 31, 2005, three of
our in-force director and officer policies were for Fortune 500 companies, 38 were for
publicly traded companies (excluding banks and savings and loans) and 59 were for banks and
savings and loans with more than $500 million in assets.
In large part because this business line also includes umbrella coverages, the calendar year
loss and loss expense ratio tends to fluctuate significantly on a year-over-year basis. Our
headquarters claims departments initiative to establish higher initial case reserves on
severe injury claims has the greatest effect on this business line:
|
|
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. |
Commercial Lines Insurance Outlook
Industrywide commercial lines written premiums are expected to rise approximately 2.3
percent in 2006. During 2005, agents reported that renewal pricing pressure had risen since
the end of 2004 and new business pricing was requiring even more flexibility and more
careful risk selection. During 2005, we needed to use credits more frequently to retain
renewals of quality business the larger the account, the higher the credits, with
variations by geographic region and class of business. At the end of 2005, renewal rates on
property coverages were generally flat to modestly down, exclusive of any changes in an
accounts exposure. Renewal pricing on liability coverages was less affected by competitive
pricing pressures, with some increases possible.
We intend to continue to market our products to a broad range of business classes, price our
products adequately and take a package approach. We intend to maintain our underwriting
selectivity and carefully manage our rate levels, as well as our programs that seek to
accurately match exposures with appropriate premiums. We will continue to evaluate each risk
individually and to make decisions regarding rates, the use of three-year commercial
policies and other policy terms on a case-by-case basis, even in lines and classes of
business that are under competitive pressure. New marketing territories created over the
past several years and new agency appointments will contribute to commercial lines growth.
Prior to Hurricanes Katrina, Rita and Wilma, we anticipated 2006 commercial lines insurance
market trends would reflect accelerated competition with pressure on pricing from the
industrys increasing surplus and improving profitability. We are uncertain what the effect
of the hurricanes will be on commercial lines pricing going forward. We believe their effect
on pricing largely will be limited to coastal markets and business lines directly affected
by the storms.
We believe our approach should allow us to maintain most of the positive underlying
improvements in profitability that have occurred over the past several years, but we do not
believe favorable reserve development will contribute to underwriting profits as much in
2006 as in 2005 and 2004. In addition, underwriting expenses are rising. We discuss our
overall outlook for the property casualty insurance operations in Measuring Our Success in
2006 and Beyond, Page 33,.
Personal Lines Insurance Results of Operations
Overview Three-year Highlights
Performance highlights for the personal lines segment include:
|
|
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 years 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. |
Growth and Profitability
Personal lines insurance is a strategic component of our overall relationship with many
of our agencies and an important component of agency relationships with their clients. We
believe agents recommend Cincinnati personal insurance products for their value-oriented
clients who seek to balance quality and price and are attracted by Cincinnatis superior
claims service and the benefits of our package approach. In the past 12 to 18 months, our
personal lines rates in some territories did not allow our agents to market these benefits,
resulting in a slight decline in our policy retention rate from its historical level above
90 percent.
The same factors that reduced policy retention have had an impact on new personal lines
business. Personal lines new business premiums written directly by agencies declined 33.9
percent to $32 million in 2005 and declined 19.9 percent to $48 million in 2004.
We discuss premium trends by personal lines of business on Page 51.
Personal Lines Results
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
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 |
% |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Between 2000 and 2003, the industry implemented higher homeowner rates and imposed
stricter enforcement of underwriting standards. In late 2004, price competition returned as
insurers leveraged their higher profitability and stronger financial positions. The
marketplace continued to become more competitive throughout 2005.
We began a strategic shift in 2004 from our traditional three-year to one-year homeowner
policy terms. We are transitioning to one-year policies in conjunction with the
state-by-state deployment of Diamond, our personal lines policy processing system. One-year
policies allow us to promptly modify rates, terms and conditions in response to market
changes. In mid-2004, we also began modifying policy terms to change homeowner policy
earthquake deductibles to 10 percent from 5 percent in selected Midwestern states, reducing
the companys exposure to a single significant catastrophic event.
In 2004, as price competition began to emerge, we were in the early stages of our program to
improve profitability for our homeowner line by raising rates and making changes to our
policy terms and conditions.
From mid-2004 to mid-2005, we opted to delay rate changes because we felt it was important
to fully commit our programming resources to completing necessary modifications and upgrades
to our then-new Diamond policy processing system. During that time period, other carriers
began making more aggressive use of segmented pricing models, generating lower rates for
higher quality accounts. When some important system modifications were completed in
mid-2005, we began filing rate and credit changes to better position our products in the
market.
The introduction of Diamond in our higher volume states may also have contributed to lower
growth rates. The focus required by our agencies to convert to the newer technology and
adapt to new work flows may have diverted their resources from new business efforts. Diamond
gives agencies additional choices to consider for their business operations and for
policyholders. Agents are growing more familiar with the new options and workflow, and many
now are seeing benefits from efficiencies as they renew business through the system.
During 2005, we increased the systems processing power and availability and offered
additional functionality requested by agency staff. For example, we began offering
convenient account billing to direct bill customers,
2005 10-K Page 48
invoicing for multiple policies at one time, and electronic fund transfer, which accommodates new monthly payment plans. We
continue to respond to agency requests for enhancements as we prepare Diamond for additional
states.
Although our homeowner profitability lagged the industry, our actions resulted in
substantial improvement in our personal lines combined ratio over the past three years. Our
2005 statutory combined ratio improved to 94.3 percent while the estimated industry combined
ratio deteriorated 2.4 points to 97.3 percent. Moreover, we expect to realize additional
profit improvements in 2006 as we continue the conversion to one-year policies written with
updated rates, terms and conditions.
In mid-2006, we will introduce a limited program of rate segments incorporating insurance
scores into pricing for our personal auto and homeowner products in states using Diamond and
make other changes to our credits in states not yet using Diamond. This step should further
improve our ability to compete for our agents highest quality personal lines accounts. We
believe it will increase the opportunity to work with our agents on marketing the advantages
of our personal lines products and services to their clients, which would help us resume
growing in this business area.
We describe the significant costs components for the personal lines segment below.
Loss and Loss Expenses (excluding catastrophe losses)
Loss and loss expenses include both net paid losses and reserve additions for unpaid
losses as well as the associated loss expenses. The improvement in the loss and loss expense
ratio excluding catastrophes over the past three years was due to a 14.4 percentage point
improvement in the homeowner ratio excluding catastrophe losses between 2005 and 2003 and a
10.4 percentage point improvement in the personal auto ratio excluding catastrophe losses
over the same period. Savings from favorable loss reserve development, including the release
of UM/UIM reserves, influenced those improvements. We discuss homeowner and personal auto
trends separately beginning on Page 51.
We monitor incurred losses by size of loss, business line, risk category, geographic region,
agency, field marketing territory and duration of policyholder relationship, addressing
concentrations or trends as needed. Our 2005 analysis indicated no significant
concentrations other than trends in business lines that we address as part of our ongoing
business operations. We also measure new losses and case reserve adjustments greater than
$250,000 to track frequency and severity. These personal lines large losses and case reserve
increases declined as a percent of earned premiums in 2005 because of higher rates per
exposure.
Personal Lines Losses by Size
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
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
Catastrophe Loss and Loss Expenses
Personal lines catastrophe losses, net of reinsurance and before taxes, were $51
million in 2005 compared with $77 million in 2004 and $55 million in 2003. The following
table shows losses incurred, net of reinsurance, and subsequent development, for catastrophe
losses in each of the past three years.
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(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 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Commission Expenses
Commission expense as a percent of earned premium declined by 0.9 percentage points in
2005, largely paralleling the decline in written premiums, after rising 0.6 percentage
points in 2004. Profit-sharing, or contingent, commissions are calculated on the
profitability of an agencys aggregate book of business, taking into account longer-term
profit, with a percentage for prompt payment of premiums and other criteria. A refinement
and subsequent release of a contingent commission over accrual from 2004 in the first three
months of 2005 was responsible for 0.2 percentage points of the decline in 2005.
Underwriting Expenses
Noncommission expenses rose to 11.3 percent of earned premium in 2005 from 9.3 percent
in 2004 and 6.5 percent in 2003. The three-year rise in the ratio largely was due to higher
technology expenses, unfavorable deferred acquisition cost comparisons resulting from slower
premium growth, higher staffing expenses and increased taxes and fees that were partially
due to a state guaranty fund refund in 2003. The software recovery discussed in Corporate
Financial Highlights Page 32, reduced the 2003 ratio by 1.1 percentage points.
2005 10-K Page 50
Line of Business Analysis
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(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 |
|
The personal auto and homeowner business lines together accounted for 89.2 percent,
89.5 percent and 89.5 percent of total personal lines earned premiums in 2005, 2004 and
2003, respectively. Our intent is to write personal auto and homeowner coverages in personal
lines packages that may also include personal umbrella liability, watercraft and other
coverages. As a result, we believe that the personal lines segment is best measured and
evaluated on a segment basis. We have provided the table above and the discussion below to
summarize growth and profitability trends separately for the two primary business lines.
The accident year loss data provides current estimates of incurred loss and loss expenses
for the past five accident years. Accident year data classifies losses according to the year
in which the corresponding loss event occurred, regardless of when the losses are actually
reported, booked or paid.
Personal Auto
Written and earned premiums for the personal auto line declined in 2005 after rising in
2004. As noted above, the decline in 2005 primarily was due to price competition in some
states and territories, which has resulted in lower policy renewal retention and
significantly lower new business levels. We are continuing to modify selected rates and
credits to address our competitive position.
The loss and loss expense ratio for personal auto improved from an already strong level over
the three years because of higher pricing. For selected agencies, we use re-underwriting
programs to review and to strengthen underwriting standards, requiring motor vehicle reports
for insured drivers, and to develop strategies to increase the companys penetration of the
agencys personal lines business.
Calendar year-over-year changes in the loss and loss expense ratio have included loss
reserve development. In 2005, savings from favorable loss reserve development from prior
accident years lowered the loss and loss expense ratio by 1.6 percentage points. In 2004 and
2003, reserve strengthening added 0.2 percentage points and 2.1 percentage points,
respectively, to the loss and loss expense ratio.
Homeowner
Written and earned premiums for the homeowner line rose in 2005 and 2004. Written
premiums rose because of the effect of rate increases, which served to offset lower policy
renewal retention and significantly lower new business levels. Earned premiums continued to
benefit from written premium growth in earlier periods.
At year-end 2005, approximately 56 percent of all homeowner policies had been converted to a
one-year term, up from approximately 27 percent at year-end 2004. We are continuing to renew
homeowner policies for three-year terms in nine states until the Diamond roll out is planned
for those states. Renewal rates on those three-year policies reflect all rate changes
enacted over the past several years. This can cause those policies to renew at a
significantly higher cost for the policyholders, even if the price is competitive.
The loss and loss expense ratio for the homeowner line excluding catastrophe losses improved
in 2005 and 2004. Unusually high catastrophe losses in 2004 interrupted two years of
improvement in the loss and loss expense ratio including catastrophe losses. Favorable loss
reserve development from prior accident years lowered the loss and loss expense ratio by 1.0
percentage points in 2005, 2.2 percentage points in 2004 and 3.1 percentage points in 2003.
We continue to seek to improve homeowner results so that this line achieves profitability.
Since we generally do not allocate noncommission expenses to individual business lines, to
measure homeowner profitability, we
2005 10-K Page 51
assume total commission and underwriting expenses would contribute approximately 30 percentage points to our homeowner combined ratio. Lower levels
of premium growth could affect our ability to attain that level in 2006 and beyond.
We also assume catastrophe losses as a percent of homeowner earned premium would be in the
range of 17 percent. Over the past three years, catastrophe losses have averaged
approximately 21 percent of homeowner earned premiums. We believe it will take until 2007
for the full benefit of our pricing and underwriting actions to be reflected in homeowner
results.
Personal Lines Insurance Outlook
Industry experts currently anticipate industrywide personal lines written premiums will
rise approximately 2.9 percent in 2006, with personal auto premiums expected to rise about
2.5 percent and homeowner premiums expected to rise 4.2 percent.
A number of factors contribute to our assessment of the potential for personal lines growth:
|
|
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.) |
In addition to the rate modifications currently underway, we identify several other factors
that may affect the personal lines combined ratio in 2006 and beyond. Personal lines
underwriters continue to focus on insurance-to-value initiatives to verify that
policyholders are buying the correct level of coverage for the value of the insured risk,
and we are carefully maintaining underwriting standards. However, if premiums decline more
than we expect, the personal lines expense ratio may be higher than the 2005 level, because
some of our costs are relatively fixed, such as our planned investments in technology. We discuss our overall outlook for the property casualty insurance operations in
Measuring Our Success in 2006 and Beyond, Page 33.
Life Insurance Results of Operations
Overview Three-year Highlights
Performance highlights for the life insurance segment include:
|
|
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. |
Life Insurance Results
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
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 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Growth
We offer term, whole life and universal life products, fixed annuities and disability
income products. Revenues in 2005 were derived principally from:
|
|
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 |
Our life insurance subsidiary reported total statutory written premiums of $205 million in
2005 compared with $193 million in 2004, which included premiums for two general account
BOLI policies totaling $10 million, and $143 million in 2003. Written premiums for life
insurance operations for all periods include life insurance, annuity and accident and health
premiums.
In 2005, our life insurance segment experienced a 2.0 percent rise in applications submitted
and a 4.9 percent increase in gross face amounts issued, primarily due to continued strong
sales of term insurance marketed through the companys property casualty agency force.
Over the past several years, we have worked to maintain a portfolio of straightforward and
up-to-date products, primarily under the LifeHorizons name. Our product development efforts
emphasize death benefit protection and guarantees.
For example, a new term series that includes a return-of-premium feature replaced the
existing term portfolio in 2005. Reaction to the new portfolio has been favorable with
approximately 25 percent of applications requesting the return-of-premium feature. In 2006,
we are introducing a new universal life product that offers a secondary guarantee that keeps
the death benefit in force provided a competitive minimum premium requirement is met.
Distribution expansion remains a high priority. In the past several years, we have added
life field marketing representatives for the western and northeastern states.
Profitability
Life segment expenses consist principally of:
|
|
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 |
Life segment profitability depends largely on premium levels, the adequacy of product
pricing, underwriting skill and operating efficiencies. Life segment results include only
investment interest credited to contract holders (interest assumed in life insurance policy
reserve calculations). The remaining investment income is reported in the investment segment
results. The life investment portfolio is managed to earn target spreads between earned
investment rates on general account assets and rates credited to policyholders. We consider
the amount of assets under management and investment income for the life investment
portfolio as key performance indicators for the life insurance segment.
We seek to maintain a competitive advantage with respect to benefits paid and reserve
increases by consistently achieving better than average claims experience due to skilled
underwriting. Commissions paid by
2005 10-K Page 53
the life insurance operation are on par with industry averages. During the past several years, we have invested in imaging and workflow technology
and have significantly improved application processing. We have achieved efficiencies while
maintaining our service standards.
Life Insurance Outlook
As the life insurance company seeks to improve penetration of our property casualty
agencies, our objective is to increase premiums and contain expenses. We continue to
emphasize the cross-serving opportunities afforded by worksite marketing of life insurance
products. In 2006, we are exploring additional programs to simplify the worksite marketing
sales process, including electronic enrollment software. We also intend to enhance our
worksite product portfolio to make it more attractive to agents. We believe these strategies
will allow us to continue to increase our worksite marketing business area.
Term insurance is our largest life insurance product line. We continue to introduce new term
products with features our agents indicate are important. In addition to the changes in our
term life insurance portfolio, we are implementing our new universal life products.
Marketplace and regulatory changes during 2004 have affected the cost and availability of
reinsurance for term life insurance issued since the beginning of 2005. We are addressing
this situation by retaining no more than a $500,000 exposure, ceding the balance using
excess over retention mortality coverage and retaining the policy reserve. Retaining the
policy reserve has no direct impact on GAAP results. However, because of the conservative
nature of statutory reserving principles, retaining the policy reserve unduly depresses our
statutory earnings and requires a large commitment of capital. We anticipate favorable regulatory changes as we discuss in Item 1, Life Insurance Segment,
Page 13. We believe we will be able to continue to grow in the term life insurance
marketplace while appropriately managing risk, at a cost that allows the life insurance
company to achieve its internal performance targets.
Investments Results of Operations
Overview Three-year Highlights
The investment segment contributes investment income and realized gains and losses to
results of operations. Investments provide our primary source of pretax and after-tax
profits.
|
|
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. |
Investment Results
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
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 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Investment Income
The advantages of strong cash flow in the past three years have been somewhat offset by
the challenge of investing in a low interest rate environment. The allocation of new
investment dollars to fixed-maturity securities during most of 2005 and 2004 added to
investment income growth.
Overall, common stock dividends contributed 43.7 percent of pretax investment income in 2005
compared with 43.9 percent in 2004 and 42.3 percent in 2003. Fifth Third, our largest equity
holding, contributed 43.6 percent of total dividend income in 2005. We discuss our Fifth Third
investment in Item 7A, Quantitative and Qualitative Disclosures About Market Risk, Page 70.
In 2005, 36 of the 49 common stock holdings in the portfolio raised their indicated annual
dividend payout, as did 33 of the 51 in 2004 and 29 of 51 in 2003.
2005 10-K Page 54
Net Realized Investment Gains and Losses
Net realized investment gains and losses are made up of realized investment gains and
losses on the sale of securities, changes in the valuation of embedded derivatives within
certain convertible securities and other-than-temporary impairment charges. These three
areas are discussed below.
Realized Investment Gains and Losses
Realized investment gains in 2005 and 2004 largely were due to the sale of equity
holdings. We buy and sell both fixed-maturity and equity securities on an ongoing basis to
help achieve our portfolio objectives.
In 2005 and 2003, we had gains from the sale of equity holdings that no longer met our
investment parameters or were obtained from convertible securities whose underlying common
stock was never intended to be a long-term holding. Included in 2005 were the initial sales
of a portion of our ALLTEL holding. We completed the sale of our entire ALLTEL position in
January 2006. We discuss this sale in Item 1, Investments Segment, Page 15, and Item 8, Note
2 to the Consolidated Financial Statements, Page 88.
In 2004, we sold $356 million in equity holdings as part of a program to support the
financial strength ratings of our property casualty insurance operations. We selected
holdings to sell primarily based on the belief of the investment committee and management
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. Partial sales of holdings in which we held over $100 million
in fair value at year-end 2003 contributed $311 million.
We sold fixed-maturity investments during the past three years as part of our portfolio
management strategies. The majority of these were bonds disposed of due to rating or credit
concerns, including several in the airline and auto related industries. Although we prefer
to hold fixed-maturity investments until they mature, a decision to sell reflects our
perception of a change in the underlying fundamentals of the security and preference to
allocate those funds to investments that more closely meet the established parameters for
long-term stability and growth. Our opinion that a security fundamentally no longer meets
our investment parameters may reflect a loss of confidence in the issuers management, a
change in underlying risk factors (such as political risk, regulatory risk, sector risk or
credit risk), or a recovery from a previously impaired value.
Realized gains in the past three years also have included gains from the sale of previously
impaired securities.
Change in the Valuation of Embedded Derivatives
In 2005, we recorded $7 million in fair value declines compared with $10 million in
fair value increases in 2004 and $9 million in fair value increases in 2003. These changes
in fair value are due to the application of SFAS No. 133, which requires measurement of the
fluctuations in the value of the embedded derivative features in selected convertible
securities. The changes in fair values are recognized in net income in the period they
occur. See Item 8, Note 1 to the Consolidated Financial Statements, Page 84, for details on
the accounting for convertible security embedded options.
Other-than-temporary Impairment Charges
In 2005, we recorded $1 million in write-downs of investments that we deemed had
experienced an other-than-temporary decline in market value versus $6 million in 2004 and
$80 million in 2003. The factors we consider when evaluating impairments are discussed in
Critical Accounting Estimates, Asset Impairment, Page 37. The other-than-temporary
impairment charges represented less than 0.1 percent of our total invested assets at
year-end 2005 and 2004 and 0.6 percent of our total invested assets at year-end 2003.
Other-than-temporary impairment charges also include unrealized losses of holdings that we
have identified for sale but not yet completed a transaction.
The significant decline in other-than-temporary impairment in 2005 and 2004 was due to prior
impairments in the portfolio, disposition of certain securities in prior years and an
improvement in the general financial climate.
The majority of the other-than-temporary write-downs in the past three years were due to:
|
|
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
Other-than temporary impairment charges from the investment portfolio by the asset class we
described in Item 1, Investments Segment, Page 15, are summarized below:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
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 |
% |
Other-than temporary impairment charges from the investment portfolio by industry are
summarized as follows:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
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 |
) |
|
|
|
|
|
|
|
|
|
|
Investments Outlook
We believe investment income growth for 2006 could be in the range of 6.5 percent to
7.0 percent. Our outlook is based on the anticipated level of dividend income, the strong
cash flow from insurance operations and the higher-than-normal allocation of new cash flow
to fixed-maturity securities over the past 18 months. Dividend increases within the last 12
months by Fifth Third and another 35 of the 49 common stock holdings in the equity portfolio
should add $15 million to annualized investment income. In 2006, our investment department
will allocate the after-tax proceeds of the ALLTEL common stock sale in line with our
overall investment philosophy, with a focus on replacing the approximately $20 million in
ALLTEL dividend income received in 2005.
2005 10-K Page 56
We believe impairments in 2006 should be limited to securities that have been identified for
sale or that have experienced a sharp decline in fair value with little or no warning
because of issuer-specific events. All but two securities in the portfolio were trading at
or above 70 percent of book value at December 31, 2005. Our asset impairment committee
continues to monitor the investment portfolio. The current asset impairment policy is in
Critical Accounting Estimates, Asset Impairment, Page 37.
Other
In 2005, other income of the insurance subsidiaries, parent company operations and
non-investment operations of CFC Investment Company and CinFin Capital Management Company
resulted in $12 million in revenues compared with $8 million in 2004 and $7 million in 2003.
Losses before income taxes of $50 million in 2005 were primarily due to $52 million in
interest expense from debt of the parent company. Losses before income taxes were $37
million in 2004 and $38 million in 2003, when interest expense was $36 million and $33
million, respectively.
Taxes
Income tax expense was $221 million in 2005 compared with $216 million in 2004 and $106
million in 2003. The effective tax rate for 2005 was 26.8 percent compared with 27.0 percent
in 2004 and 22.0 percent in 2003. In addition to higher underwriting profits, the higher tax
rate in 2005 and 2004 reflected a higher level of capital gains, compared with capital
losses in 2003.
We pursue a strategy of investing some portion of cash flow in tax-advantaged fixed-maturity
and equity securities to minimize our overall tax liability and maximize after-tax earnings.
Details regarding our effective tax rate are found in Item 8, Note 10 to the Consolidated
Financial Statements, Page 93.
Liquidity and Capital Resources
Liquidity and capital resources represent the overall financial strength of our company
and our ability to generate cash flows to meet the short- and long-term cash requirements of
business obligations and growth needs. We seek to maintain prudent levels of liquidity and
financial strength for the protection of our policyholders, creditors and shareholders.
The parent companys primary means of meeting liquidity requirements are dividends from our
insurance subsidiary and income from investments held at the parent-company level supported
by our capital resources. At year-end 2005, we had shareholders equity of $6.086 billion
and total debt of $791 million. Our ability to access the capital markets and short-term
bank borrowing provide other potential sources of liquidity. One way we seek to maintain financial strength is by keeping
our ratio of debt to capital below 15 percent. Our parent companys cash requirements
include dividends to shareholders, interest payments on our long-term debt, common stock
repurchases and general operating expenses.
Our insurance subsidiarys primary sources of liquidity are premiums and investment income.
Its cash needs primarily consist of paying property casualty and life insurance loss and
loss expenses as well as ongoing operating expenses and payments of dividends to the parent
company. Although we have never sold investments to pay claims, the sale of investments
would provide an additional source of liquidity, if required. After satisfying operating
cash requirements, excess cash flows are invested in fixed-maturity and equity securities,
leading to the potential for increases in future investment income
and unrealized appreciation.
Sources of Liquidity
Subsidiary Dividends
Our insurance subsidiary declared dividends to the parent company of $275 million in
2005, $175 million in 2004 and $50 million in 2003. State of Ohio regulatory requirements
restrict the dividends insurance subsidiaries can pay. Generally, the most Ohio-domiciled
insurance subsidiaries can pay without prior regulatory approval is the greater of 10
percent of statutory surplus or 100 percent of statutory net income for the prior calendar
year up to the amount of statutory unassigned surplus as of the end of the prior calendar
year. Dividends exceeding these limitations may be paid only with approval of the Ohio
Department of Insurance. During 2006, total dividends that our lead insurance subsidiary can
pay to our parent company without regulatory approval are approximately $517 million.
Insurance Underwriting
Our property casualty and life insurance operations provide liquidity because premiums
generally are received before losses are paid under the policies purchased with those
premiums. After satisfying our cash requirements, excess cash flows are used for investment,
increasing future investment income.
2005 10-K Page 57
This table shows a summary of cash flow of the insurance subsidiary (direct method):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
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 |
|
|
|
|
|
|
|
|
|
|
|
Historically, cash receipts from property casualty and life insurance premiums, along
with investment income, have been more than sufficient to pay claims, operating expenses and
dividends to the parent company. While first-year life insurance expenses normally exceed
the premiums, subsequent premiums are used to generate investment income until the time the
policy benefits are paid.
After paying claims and operating expenses, cash flows from underwriting were essentially
unchanged in 2005 after rising 21.5 percent in 2004. We discuss our future obligations for
claims payments in Contractual Obligations, Page 59, and our future obligations for
underwriting expenses in Commissions and Other Underwriting Expenses, Page 60. Based on our
outlook for commercial lines, personal lines and life insurance, we believe that cash flows
from underwriting could decline in 2006. A lower level of cash flow available for investment
could lead to reduced potential for increases in future investment income and capital gains.
Investing Activities
Investment income is a primary source of liquidity for both the parent company and
insurance subsidiary. The transfer of equity holdings to our insurance subsidiary from the
parent company in 2004 increased the amount of investment income generated at the subsidiary
level but had no effect on consolidated investment income. As we discuss under Investments Results of Operations, Page
54, investment income rose in each of the past three years, and we expect investment income
to grow 6.5 percent to 7.0 percent in 2006.
Realized gains also can provide liquidity, although we follow a buy-and-hold investment
philosophy seeking to compound cash flows over the long-term. When we dispose of
investments, we generally reinvest the gains in new investment securities. Disposition of
investments occurs for a number of reasons:
|
|
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 committees and managements 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. |
We generally have substantial discretion in the timing of investment sales and, therefore,
the resulting gains or losses that are recognized in any period. That discretion generally
is independent of the insurance underwriting process. In 2006, we expect to continue to
limit the disposition of investments to those that no longer meet our investment parameters
or those that reach maturity or are called by the issuer. The sale of equity investments
that no longer meet our investment criteria can provide cash for investment in common stocks
that we perceive to have greater potential for capital appreciation and income growth.
Capital Resources
At year-end 2005, our debt-to-capital ratio was 11.5 percent. We had $791 million of
long-term debt and no borrowings on our short-term lines of credit. We generally have
minimized our reliance on debt financing although we may utilize lines of credit to fund
short-term cash needs.
We provide
details of our three long-term notes in Item 8, Note 7 to
the Consolidated Financial Statements, Page
91. None of the notes are encumbered by rating triggers.
2005 10-K Page 58
We issued $375 million aggregate principal amount of 6.125% senior notes in 2004. The $368
million net proceeds from the offering:
|
|
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. |
As of
March 3, 2006, our senior debt issues were rated aa- by A.M. Best, A+ by Fitch, A2 by
Moodys and A by Standard & Poors.
At year-end 2005, we had two lines of credit totaling $125 million with no outstanding
balance. One line of credit for $75 million was established more than five years ago and has
no financial covenants. The second line of credit is an unsecured $50 million line of credit
from Fifth Third Bank established in 2005. It is available for general corporate purposes
and contains customary financial covenants.
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.
As a long-term investor, we historically have followed a buy-and-hold investing strategy.
This policy has generated a significant amount of unrealized appreciation on equity
investments. Unrealized appreciation, before deferred income taxes, was $5.067 billion and
$5.840 billion at year-end 2005 and 2004, respectively. On an after-tax basis, it
constituted 54.0 percent of total shareholders equity at year-end 2005.
Off-balance Sheet Arrangements
We do not utilize any special-purpose financing vehicles or have any undisclosed
off-balance sheet arrangements (as that term is defined in applicable SEC rules) that are
reasonably likely to have a current or future material effect on the companys financial
condition, results of operation, liquidity, capital expenditures or capital resources.
Similarly, the company holds no fair-value contracts for which a lack of marketplace
quotations would necessitate the use of fair-value techniques.
Uses of Liquidity
Our parent company and insurance subsidiary have contractual and other obligations. In
addition, one of our primary uses of cash is to enhance shareholder return.
Contractual Obligations
At December 31, 2005, we estimated our future contractual obligations as follows:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
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 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Claims Payments
Our estimate of material commitments for net property casualty claims payments was
approximately 56.2 percent of the estimated contractual obligations at year-end 2005.
We direct our associates to settle claims and pay losses as quickly as practical and made
$1.752 billion in net claim payments during 2005. At year-end 2005, we had net property
casualty reserves of $3.111 billion, reflecting $1.605 billion in unpaid amounts on reported
claims (case reserves), $669 million in loss expense reserves and $837 million in estimates
of IBNR claims. The specific amounts and timing of obligations related to case reserves and
associated loss expenses are not set contractually. The amounts and timing of obligations
for IBNR claims and related loss expenses are unknown. We discuss the adequacy of our
property casualty and life insurance loss and loss expense reserves in Property Casualty
Insurance Reserves, Page 61.
The historic pattern of using premium receipts for the payment of loss and loss expenses has
enabled us to extend slightly the maturities of our investment portfolio beyond the
estimated settlement date of the loss reserves. The modified duration of our fixed-maturity portfolio was 7.1 years at
year-end 2005. By contrast, the duration of our loss and loss expense reserves was 3.1 years
and the duration of all liabilities was 2.8 years. We believe this difference in duration
does not affect our ability to meet current obligations because cash flow
2005 10-K Page 59
from operations is sufficient to meet these obligations. In addition, our investment strategy has led to
substantial unrealized gains from holdings in equity securities. These equity holdings could
be liquidated to meet higher than anticipated loss and loss expenses.
We believe that our insurance subsidiaries maintain sufficient liquidity to pay claims and
operating expenses, as well as meet commitments in the event of unforeseen circumstances
such as catastrophe losses, reinsurer insolvencies, changes in the timing of claims
payments, increases in claims severity, reserve deficiencies or inadequate premium rates. We
believe catastrophic events are the most likely cause of an unexpected rise in claims
severity or frequency.
Our reinsurance program mitigates the liquidity risk of a single large loss or an unexpected
rise in claims severity or frequency due to a catastrophic event. Reinsurance does not
relieve us of our obligation to pay covered claims. The financial strength of our reinsurers
is important because our ability to recover for losses under one of our reinsurance
agreements depends on the financial viability of the reinsurer.
While we believe that historical performance of property casualty and life loss payment
patterns is a reasonable source for projecting future claims payments, there is inherent
uncertainty in this estimate of contractual obligations. We believe that we could meet our
obligations under a significant and unexpected change in the timing of these payments
because of the liquidity of our invested assets, strong financial position and access to
lines of credit.
Long-term Debt and Interest on Long-Term Debt
Our estimate of material commitments for long-term debt was approximately 14.4 percent
and our estimate of material commitments for interest on long-term debt was approximately
23.6 percent of the estimated contractual obligations at year-end 2005.
Our interest expense rose in 2005 to an annual rate of approximately $52 million due to our
2004 issuance of $375 million aggregate principal amount of 6.125% senior notes due 2034. We
generally have tried to minimize our reliance on debt financing and do not expect a material
increase in interest expense in the near future.
Annuitization Obligations
Our estimate of material commitments for obligations due under annuities written by our
life insurance subsidiary was approximately 3.5 percent of the estimated contractual
obligations at year-end 2005.
Headquarters Building Expansion
The construction of our new office building and parking garage to be situated at our
headquarters located in Fairfield is expected to require approximately $83 million over the
next three years. The construction project is on schedule and on budget. As of December 31,
2005, construction costs totaled $18 million. We expect construction to be completed by
September 2008.
We invested $100 million of the proceeds from our 2004 issuance of $375 million aggregate
principal amount of 6.125% senior notes due 2034 in short-term investments to fund this
obligation.
Computer Hardware and Software
We expect to need approximately $14 million over the next five years for material
commitments for computer hardware and software, including maintenance contracts on hardware
and other known obligations. We discuss below the non-contractual expenses we anticipate for
computer hardware and software in 2006.
Commissions and Other Underwriting Expenses
In addition to our contractual obligations, our insurance operations use cash for
commission and other underwriting expenses.
As discussed above, commissions and other underwriting expenses paid rose in each the past
two years, reflecting the operating expense trends we discuss in the Commercial Lines and
Personal Lines Insurance Results of Operations, Page 41 and Page 47. Commission payments also
include contingent, or profit-sharing, commissions, which are paid to agencies using a
formula that takes into account agency profitability and other factors, such as prompt
monthly payment of amounts due to the company. Commission payments generally track with
written premiums. Contingent commission payments in 2006 will be influenced by the excellent
profitability we generated in 2005 and 2004.
Many of our operating expenses are not contractual obligations, but reflect the ongoing
expenses of our business. Staffing is the largest component of our operating expenses and is
expected to rise again in 2006, reflecting the 4.3 percent average annual growth in our
associate base over the past three years. Our associate base has grown as we focus on
enhancing service to our agencies and staffing additional field territories. Other expenses
should rise in line with our growth.
2005 10-K Page 60
In addition to contractual obligations for hardware and software, we anticipate investing
approximately $16 million in key technology initiatives in 2006, including spending for the
development and rollout of our commercial lines policy processing systems that we discuss in
Item 1, Technology Solutions, Page 4. Capitalized development costs related to key
technology initiatives totaled $11 million in 2005. These activities are conducted at our
discretion and we have no material contractual obligations for activities planned as part of
these projects.
Investing Activities
Excess cash flows from underwriting, investment and other corporate activities are
invested in fixed-maturity and equity securities on an ongoing basis to help achieve our
portfolio objectives. See Item 1, Investments Segment, Page 15, for a discussion of our
investment strategy, portfolio allocation and quality. Since the second quarter of 2004,
virtually all of our available cash flow has been used to purchase fixed-maturity
investments to reduce our property casualty subsidiarys ratio of common stock to statutory
surplus.
Purchases of fixed-maturity securities rose significantly in 2005 and 2004. Due to the
allocation of a higher percentage of new investment dollars to fixed-maturity investments,
equity securities purchases in 2005 and 2004 were below the level of 2003. Purchases in 2005
included $144 million of nonredeemable preferred stock. We evaluate nonreedemable preferred
stocks similar to the evaluation we make for fixed-maturity investments, seeking attractive
relative yields.
In 2006, we anticipate continuing to use the majority of available cash flow to purchase
fixed-maturity investments and preferred stock. Common stock purchases primarily will be
funded with proceeds of common stock sales. The trend of ratios we monitor could permit some
common stock purchases with cash flow from operations.
Uses of Capital
Uses of cash to enhance shareholder return include:
|
|
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
Registrants 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. |
Property Casualty Insurance Reserves
At year-end 2005, the total reserve balance, net of reinsurance, was $3.111 billion,
compared with $2.977 billion at year-end 2004 and $2.845 billion at year-end 2003. We
provide a reconciliation of the property casualty reserve balances with the loss and loss
expense liability on the balance sheet in Item 8, Note 4 to the Consolidated Financial Statements, Page 90. The reserves reflected in the
financial statements are managements best estimate.
The appointed actuarys range for adequate statutory reserves, net of reinsurance, was
$2.921 billion to $3.153 billion for 2005; $2.794 billion to $3.032 billion for 2004; and
$2.696 billion to $2.906 billion for 2003. The assumptions used to establish the recommended
ranges were consistent with the actuarys practices. Historically, we have established
reserves in the upper half of the actuarys range, as discussed in Critical Accounting
Estimates, Property Casualty Loss and Loss Expense Reserves, Page 35.
2005 10-K Page 61
In addition to our conclusions regarding adequate reserve levels, other factors that have
affected reserve levels over the past three years included:
|
|
Increases in coverage in force in selected business lines |
|
|
Higher initial case reserves on liability claims |
|
|
Judicial decisions and mass tort claims |
|
|
Loss cost inflation in selected lines |
The types of coverages we offer and the risk levels retained have a direct influence on the
development of claims. Specifically, claims that develop quickly and have lower risk
retention levels generally are more predictable.
As we discuss in Commercial Lines Insurance Segment Reserves, Page 64, re-underwriting the
commercial lines book of business beginning in 2000, including decisions to non-renew
certain policyholders due to risk levels and to increase rates to better reflect exposure
levels, has resulted in improved profitability. We believe the program has led to a lower
risk profile for the overall commercial lines segment, which has contributed to favorable
loss reserve trends.
As we discuss in Personal Lines Insurance Segment Reserves, Page 66, we are seeking to
improve our personal lines segment performance, in particular the homeowner business line,
partially by reducing risk exposure through changes in policy terms and conditions. We do
not expect our actions in personal lines to have a material impact on loss reserve trends,
largely due to the relatively short-tail nature of homeowner claims.
In 2003 and 2004, $70 million in reserves were released following the November 2003 Ohio
Supreme Courts limiting of its 1999 Scott-Pontzer v. Liberty Mutual decision. The reserve
releases were primarily made in the commercial auto and other liability business lines.
Following the fourth-quarter 2003 reserve review, reserve levels were modified to reflect
managements assessment that mold claims behaved similar to asbestos and environmental
claims, and reserves for these claims should be estimated using similar methods. These
changes have been seen predominately in the commercial multi-peril business line. We expect
that mold exclusions added to our commercial policies beginning in 2003 will mitigate this
issue after 2006.
Further, beginning in 2003, reserve levels reflected the need to establish higher expense
reserves because of the rise in litigation costs due to larger and more complex claims.
These changes have been seen predominately in commercial multi-peril and other liability
business lines. Beginning in 2002, our conclusions regarding reserve levels for all business
lines reflected refinement of the manner in which the value of future salvage and
subrogation for claims already incurred were estimated.
Development of Loss and Loss Expenses
We reconcile the beginning and ending balances of our reserve for loss and loss
expenses at December 31, 2005, 2004 and 2003, in Item 8, Note 4 to the Consolidated
Financial Statements, Page 90. The reconciliation of our year-end 2004 reserve balance to
net incurred losses one year later recognizes approximately $160 million in redundant
reserves.
The table below shows the development of the estimated reserves for loss and loss expenses
the past 10 years.
|
|
Section A shows 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 B shows 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 C shows 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 |
|
$ |
453 |
|
|
$ |
499 |
|
|
$ |
522 |
|
|
$ |
591 |
|
|
$ |
697 |
|
|
$ |
758 |
|
|
$ |
799 |
|
|
$ |
817 |
|
|
$ |
817 |
|
|
$ |
907 |
|
|
|
|
|
Two years later |
|
|
732 |
|
|
|
761 |
|
|
|
853 |
|
|
|
943 |
|
|
|
1,116 |
|
|
|
1,194 |
|
|
|
1,235 |
|
|
|
1,235 |
|
|
|
1,293 |
|
|
|
|
|
|
|
|
|
Three years
later |
|
|
884 |
|
|
|
965 |
|
|
|
1,067 |
|
|
|
1,195 |
|
|
|
1,378 |
|
|
|
1,455 |
|
|
|
1,455 |
|
|
|
1,519 |
|
|
|
|
|
|
|
|
|
|
|
|
|
Four years later |
|
|
992 |
|
|
|
1,075 |
|
|
|
1,207 |
|
|
|
1,327 |
|
|
|
1,526 |
|
|
|
1,526 |
|
|
|
1,614 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Five years later |
|
|
1,049 |
|
|
|
1,152 |
|
|
|
1,283 |
|
|
|
1,412 |
|
|
|
1,412 |
|
|
|
1,623 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Six years later |
|
|
1,093 |
|
|
|
1,205 |
|
|
|
1,333 |
|
|
|
1,333 |
|
|
|
1,464 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Seven years
later |
|
|
1,123 |
|
|
|
1,146 |
|
|
|
1,239 |
|
|
|
1,366 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Eight years
later |
|
|
1,146 |
|
|
|
1,045 |
|
|
|
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-estimatedlatest |
|
$ |
1,208 |
|
|
$ |
1,332 |
|
|
$ |
1,460 |
|
|
$ |
1,602 |
|
|
$ |
1,757 |
|
|
$ |
2,010 |
|
|
$ |
2,178 |
|
|
$ |
2,377 |
|
|
$ |
2,649 |
|
|
$ |
2,817 |
|
|
|
|
|
Re-estimated
recoverablelatest |
|
|
180 |
|
|
|
172 |
|
|
|
182 |
|
|
|
209 |
|
|
|
216 |
|
|
|
243 |
|
|
|
504 |
|
|
|
542 |
|
|
|
532 |
|
|
|
539 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Gross liability
re-estimatedlatest |
|
$ |
1,388 |
|
|
$ |
1,504 |
|
|
$ |
1,642 |
|
|
$ |
1,811 |
|
|
$ |
1,973 |
|
|
$ |
2,253 |
|
|
$ |
2,682 |
|
|
$ |
2,919 |
|
|
$ |
3,181 |
|
|
$ |
3,356 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Cummulative gross
redundancy |
|
$ |
302 |
|
|
$ |
320 |
|
|
$ |
247 |
|
|
$ |
167 |
|
|
$ |
120 |
|
|
$ |
148 |
|
|
$ |
183 |
|
|
$ |
231 |
|
|
$ |
205 |
|
|
$ |
158 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
In evaluating the development of our estimated reserves for loss and loss expenses for
the past 10 years, note that each amount includes the effects of all changes in amounts for
prior periods. For example, payments or reserve adjustments related to losses settled in
2005 but incurred in 1999 are included in the cumulative deficiency or redundancy amount for
2000 and each subsequent year. In addition, this table presents calendar year data, not
accident or policy year development data, which readers may be more accustomed to analyzing.
Conditions and trends that have affected development of the reserves in the past may not
necessarily occur in the future. Accordingly, it may not be appropriate to extrapolate
future redundancies or deficiencies based on this data.
Differences between the property casualty reserves reported in the accompanying consolidated
balance sheets (prepared in accordance with GAAP) and those same reserves reported in the
annual statements (filed with state insurance departments in accordance with statutory
accounting practices SAP), relate principally to the reporting of reinsurance
recoverables, which are recognized as receivables for GAAP and as an offset to reserves for
SAP.
Asbestos and Environmental Reserves
We believe that our asbestos and environmental reserves, including mold reserves, are
adequate at this time and that these coverage areas are immaterial to our financial position
due to the types of accounts we have insured in the past.
Loss and loss expenses incurred for all asbestos and environmental claims were $12 million,
or 0.7 percent of total loss and loss expenses in 2005, compared with $41 million, or 2.4
percent in 2004, and $28 million, or 1.6 percent, in 2003. The increase in 2004 was
primarily due to mold claims prior to the introduction of the mold exclusion to our policy
forms.
2005 10-K Page 63
Net reserves for all asbestos and environmental claims were $132 million in 2005 compared
with $135 million in 2004 and $105 million in 2003. Net reserves for all asbestos and
environmental claims were 4.2 percent, 4.5 percent and 3.7 percent of total reserves, in
2005, 2004 and 2003, respectively.
We generally wrote commercial accounts after the development of coverage forms that exclude
asbestos cleanup costs. We believe our exposure to risks associated with past production
and/or installation of asbestos materials is minimal because we primarily were a personal
lines company when most of the asbestos exposure occurred. The commercial coverage we did
offer was predominantly related to local-market construction activity rather than asbestos
manufacturing. Further, over the past four years, to limit our exposure to mold and other
environmental risks going forward, we have revised policy terms where permitted by state
regulation. We continue to evaluate our exposure to silicosis and welding claims, but
believe our exposure is minimal.
Commercial Lines Insurance Segment Reserves
For the business lines in the commercial lines insurance segment, the following table
shows the breakout of gross reserves among case, IBNR and loss expense reserves. The rise in
total gross reserves for our commercial business lines was related to our growth. Commercial
multi-peril reserve growth also was related to the higher proportion of commercial lines
catastrophe losses in 2005 compared with
2004. Workers compensation reserve growth also was related to medical cost inflation and
longer estimated payout periods as we discussed in Commercial Lines Insurance Results of
Operations, Page 41.
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
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 |
% |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
As a result of underwriting actions taken since 2000 and a generally favorable
insurance marketplace, the commercial lines segment has been able to obtain higher premium
per exposure. As a result, profitability has improved due to higher revenue on stable loss
and loss expenses.
2005 10-K Page 64
The following table provides the amounts of net reserve changes made over the past three
years by commercial line of business and accident year:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
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 overall favorable development recorded in the commercial lines reserves illustrates
the potential for revisions inherent in estimating reserves, especially in long-tail lines
such as other liability. With the exception of the UM/UIM reserve releases and other
significant changes in assumptions discussed above, commercial lines reserve development
over the past three years was consistent with:
|
|
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
Personal Lines Insurance Segment Reserves
For the business lines in the personal lines insurance segment, the following table
shows the breakout of gross reserves among case, IBNR and loss expense reserves. Total gross
reserves were down slightly from year-end 2004 due to normal claims activity on a lower
policy count and lower personal lines catastrophe reserves in 2005 than in 2004.
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
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 |
% |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Over the past three years, higher-than-normal catastrophe losses have contributed to
the personal lines loss and loss expenses.
2005 10-K Page 66
The following table provides the amounts of net reserve changes made over the past three
years by personal line of business and accident year:
|
|
|
|
|
|
|
|
|
|
|
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 |
% |
The overall favorable development recorded in the personal lines segment reserves
illustrates the potential for revisions inherent in estimating reserves. Personal lines
reserve development over the past three years was consistent with:
|
|
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 |
Life Insurance Reserves
Gross life policy reserves were $1.343 billion at year-end 2005, compared with $1.194
billion at year-end 2004. We establish reserves for traditional life insurance policies
based on expected expenses, mortality, morbidity, withdrawal rates and investment yields,
including a provision for uncertainty. Once these assumptions are established, they
generally are maintained throughout the lives of the contracts. We use both our own
experience and industry experience adjusted for historical trends in arriving at our
assumptions for expected mortality, morbidity and withdrawal rates. We use our own
experience and historical trends for setting
2005 10-K Page 67
our assumptions for expected expenses. We base our assumptions for expected investment
income on our own experience adjusted for current economic conditions.
We establish reserves for our universal life, deferred annuity and investment contracts
equal to the cumulative account balances, which include premium deposits plus credited
interest less charges and withdrawals.
We regularly review our life insurance business to ensure that any deferred acquisition cost
associated with the business is recoverable and that our actuarial liabilities (life
insurance segment reserves) make sufficient provision for future benefits and related
expenses.
2006 Reinsurance Programs
A single large loss or an unexpected rise in claims severity or frequency due to a
catastrophic event could present us with a liquidity risk. In an effort to control such
losses, we forego marketing property casualty insurance in specific geographic areas,
monitor our exposure in certain coastal regions, review aggregate exposures to huge
disasters and purchase reinsurance. We use the Risk Management Solutions and Applied
Insurance Research models to evaluate exposures to a once-in-250-year event in determining
appropriate reinsurance coverage programs. In conjunction with these activities, we also
continue to evaluate information provided by our reinsurance broker. These various sources
explore and analyze credible scientific evidence, including the impact of global climate
change, which may affect our exposure under insurance policies.
Reinsurance mitigates the risk of highly uncertain exposures and limits the maximum net loss
that can arise from large risks or risks concentrated in areas of exposure. Managements
decisions regarding the appropriate level of property casualty risk retention are affected
by various factors, including changes in our underwriting practices, capacity to retain
risks and reinsurance market conditions. Reinsurance does not relieve us of our obligation
to pay covered claims. The financial strength of our reinsurers is important because our
ability to recover for losses covered under one of our reinsurance agreements depends on the
financial viability of the reinsurer.
Currently participating on our property and casualty per-occurrence programs are American
Reinsurance Company, GE Insurance Solutions, Partner Reinsurance Company of the U.S. and
Swiss Reinsurance America Corporation, all of which have A.M. Best insurer financial
strength ratings of A (Excellent) or A+ (Superior). Our property catastrophe program is
subscribed through a broker by reinsurers from the United States, Bermuda, London and Europe
markets.
The estimated incremental premium savings is $7 million for the 2006 property casualty
reinsurance agreements, without taking into account the reinstatement premium incurred in
2005. The savings primarily is due to higher retention levels and to lower rates for the
casualty per occurrence program, which offset higher rates for the property per occurrence
and property catastrophe programs.
Primary components of the 2006 property and casualty reinsurance program include:
|
|
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. |
Individual risks with insured values in excess of $25 million as identified in the policy
are handled through a different reinsurance mechanism. We reinsure property coverage for
individual risks with insured values between $25 million and $50 million under an automatic
facultative treaty. For those risks with property values exceeding $50 million, we negotiate
the purchase of facultative coverage on an individual certificate basis. For casualty
coverage on individual risks with limits exceeding $25 million, facultative reinsurance
coverage is placed on an individual certificate basis.
Responding to the challenges presented by terrorism has become a very important issue for
the insurance industry over the last three years. Terrorism coverage at various levels has
been secured in all of our reinsurance agreements. The broadest coverage for this peril is
found in the property and casualty working treaties, which provide coverage for commercial
and personal risks. Our property catastrophe treaty provides coverage for personal risks and
the majority of its reinsurers provide limited coverage for commercial risks with total
insured values of $10 million or less. For insured values between $10 million and $25
million, there also may be coverage in the property working treaty.
Reinsurance protection for the companys surety business is covered under separate treaties
with many of the same reinsurers that write the property casualty working treaties.
Reinsurance protection for our life insurance business is covered under separate treaties
with many of the same reinsurers that write the property casualty working treaties. In 2005,
we modified our reinsurance protection for our term life insurance business due to changes
in the marketplace that affected the cost and availability of reinsurance for term life
insurance. We are retaining no more than a $500,000 exposure, ceding the balance using
excess over retention mortality coverage, and retaining the policy reserve. Retaining the
policy reserve has no direct impact on GAAP results. However, because of the conservative
nature of statutory reserving principles, retaining the policy reserve unduly depresses our
statutory earnings and requires a large commitment of our capital. We also have catastrophe
reinsurance coverage on our life insurance operations that reimburses us up to $20 million
for covered net losses in excess of $5 million. The treaty contains a reinstatement
provision, provided the covered losses were not due to terrorism.
The NAIC has asked for comments on proposals to modify statutory accounting procedures to
reduce the negative effect on statutory life insurance income. We expect the NAIC proposals
will be adopted. If they are not, we believe we will be able to structure a reinsurance
program to provide the life insurance company with the ability to continue to grow in the
term life insurance marketplace while appropriately managing risk, at a cost that allows us
to achieve our life insurance company profit targets.
Safe Harbor Statement
This is our Safe Harbor statement under the Private Securities Litigation Reform Act
of 1995. Our business is subject to certain risks and uncertainties that may cause actual
results to differ materially from those suggested by the forward-looking statements in this
report. Some of those risks and uncertainties are discussed in Item 1A, Risk Factors, Page
21. Although we often review or update our forward-looking statements when events warrant,
we caution our readers that we undertake no obligation to do so.
Factors that could cause or contribute to such differences include, but are not limited to:
|
|
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 companys relationships with its
independent agencies and hamper opportunities to add new agencies, resulting in
limitations on the companys opportunities for growth, such as: |
|
o |
|
Downgrade of the companys financial strength ratings, |
|
|
o |
|
Concerns that doing business with the company is too difficult or |
|
|
o |
|
Perceptions that the companys 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 companys
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 companys 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 companys
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 companys
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 companys 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 |
Further, the companys 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 also is
subject to public and regulatory initiatives that can affect the market value for its common
stock, such as recent measures affecting 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 herein.
Item 7A. Quantitative and Qualitative Disclosures About Market Risk
Introduction
Market risk is the potential for a decrease in securities value resulting from broad
yet uncontrollable forces such as: inflation, economic growth, interest rates, world
political conditions or other widespread unpredictable events. It is comprised of many
individual risks that, when combined, create a macroeconomic impact. The company accepts and
manages risks in the investment portfolio as part of the means of achieving portfolio
objectives. Some of the risks are:
|
|
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 |
Company-specific risk is the potential for a particular issuer to experience a decline in
valuation due to the impact of sector or market risk on the holding or because of issues
specific to the firm:
|
|
Fraud the potential for a negative impact on an issuers performance due to actual
or alleged illegal or improper activity of individuals it employs |
|
|
|
Credit the potential for deterioration in an issuers 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 |
The investment committee of the board of directors monitors the investment risk management
process primarily through its executive oversight of our investment activities. We take an
active approach to managing market and other investment risks, including the
accountabilities and controls over these activities. Actively managing these market risks is
integral to our operations and could require us to change the character of future
investments purchased or sold or require us to shift the existing asset portfolios to manage
exposure to market risk within acceptable ranges.
Sector risk is the potential for a negative impact on a particular industry due to its
sensitivity to factors that make up market risk. Market risk affects general supply/demand
factors for an industry and will affect companies within that industry to varying degrees.
Risks associated with the five asset classes described in Item 1, Investments Segment, Page
15, can be summarized as follows (H high, A average, L low):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
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 |
|
Fixed-maturity Investments
For investment-grade corporate bonds, the inverse relationship between interest rates
and bond prices leads to falling bond values during periods of increasing interest rates.
Although the potential for a worsening financial condition, and ultimately default, does
exist with investment-grade corporate bonds, their higher-quality financial profiles make
credit risk less of a concern than for lower-quality investments. We address this risk by
consistently investing within a particular maturity range, which has, over the years,
provided the portfolio with a laddered maturity schedule, which we believe is less subject
to large swings in value due to interest rate changes. While a single maturity range may see
values drop due to general interest rate levels, other maturity ranges will be less affected
by those changes. Additionally, purchases are spread across a wide spectrum of industries
and companies, diversifying our holdings and minimizing the impact of specific industries or
companies with greater sensitivities to interest rate fluctuations.
The primary risk related to high-yield corporate bonds is credit risk or the potential for a
deteriorating financial structure. A weak financial profile can lead to rating downgrades
from the credit rating agencies, which can put further downward pressure on bond prices.
Interest rate risk is less of a factor with high-yield corporate bonds, as valuation is
related more directly to underlying operating performance than to general interest rates.
This puts more emphasis on the financial results achieved by the issuer rather than general
economic trends or statistics within the marketplace. We address this concern by analyzing
issuer- and industry-specific financial results and by closely monitoring holdings within
this asset class.
The primary risks related to tax-exempt bonds are interest rate risk and political risk
associated with the specific economic environment within the political boundaries of the
issuing municipal entity. We address these concerns by focusing on municipalities
general-obligation debt and on essential-service bonds. Essential-service bonds derive a
revenue stream from the services provided by the municipality, which are vital to the people
living in the area (water service, sewer service, etc.). Another risk related to tax-exempt
bonds is regulatory risk or the potential for legislative changes that would negate the
benefit of owning tax-exempt
2005 10-K Page 71
bonds. We monitor regulatory activity for situations that may
negatively affect current holdings and its ongoing strategy for investing in these
securities.
The final, less significant risk is a small exposure to credit risk for a portion of the
tax-exempt portfolio that has support from corporate entities. Examples are bonds insured by
corporate bond insurers or bonds with interest payments made by a corporate entity through a
municipal conduit/authority. While decisions regarding these investments primarily consider
the underlying municipal situation, the existence of third-party insurance reduces risk in
the event of default. In circumstances in which the municipality is unable to meet its
obligations, risk would be increased if the insuring entity were experiencing financial
duress. Because of our diverse exposure and selection of higher-rated entities with strong
financial profiles, we do not believe this is a material concern.
Interest Rate Sensitivity Analysis
Because of our strong surplus, long-term investment horizon and ability to hold most
fixed-maturity investments until maturity, we believe the company is well positioned if
interest rates were to rise. A higher rate environment would provide the opportunity to
invest cash flow in higher-yielding securities, while reducing the likelihood of calls of
the higher-yielding U.S. agency paper purchased over the past year. While higher interest
rates would be expected to continue to increase the number of fixed-maturity holdings
trading below 100 percent of book value, we believe lower fixed-maturity security values due
solely to interest rate changes would not signal a decline in credit quality.
A dynamic financial planning model developed during 2002 uses analytical tools to assess
market risks. As part of this model, the modified duration of the fixed-maturity portfolio
is continually monitored by our investment department to evaluate the theoretical impact of
interest rate movements.
We measure modified duration and duration to worst. The table below summarizes the effect of
hypothetical changes in interest rates on the fixed-maturity portfolio under both duration
scenarios:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
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 |
|
The modified duration of our portfolio is currently 7.1 years and the modified duration
of the redeemable preferred portfolio is currently 10.4 years. A 100 basis-point movement in
interest rates would result in an approximately 7.2 percent change in the market value of
the combined portfolios. Generally speaking, the higher a bonds rating, the more directly
correlated movements in its market value will be to changes in the general level of interest
rates. Therefore, the municipal bond portfolio is more likely to respond to a changing
interest rate scenario. Our U.S. agency paper portfolio, because it generally has very
little call protection, has a low duration and would not be expected to be as responsive to
rate movements. Lower investment grade and high-yield corporate bond values are driven by
credit spreads, as well as their durations, in response to interest rate movements.
In the dynamic financial planning model, the selected interest rate change of 100 basis
points represents our views of a shift in rates that is quite possible over a one-year
period. The rates modeled should not be considered a prediction of future events as interest
rates may be much more volatile in the future. The analysis is not intended to provide a
precise forecast of the effect of changes in rates on our results or financial condition,
nor does it take into account any actions that we might take to reduce exposure to such
risks.
Short-term Investments
Our short-term investments present minimal risk as we generally purchase the highest
quality commercial paper.
Equity Investments
Common stocks are subject to a variety of risk factors encompassed under the umbrella
of market risk. General economic swings influence the performance of the underlying
industries and companies within those industries. A downturn in the economy will have a
negative impact on an equity portfolio. Industry- and company-specific risks have the
potential to substantially affect the market value of the companys equity portfolio. We
address these risks by maintaining investments in a small group of holdings that we can
analyze closely, better understanding their business and the related risk factors.
At December 31, 2005, the company held 14 individual equity positions valued at
approximately $100 million or above, see Item 1, Investments Segment, Page 15, for
additional details on these holdings. These equity positions accounted for approximately
93.8 percent of the unrealized appreciation of the entire portfolio.
2005 10-K Page 72
We believe our equity investment style centered on companies that pay and increase
dividends to shareholders is an appropriate long-term strategy. While our long-term
financial position would be affected by prolonged changes in the market valuation of our
investments, we believe our strong surplus position and cash flow provide a cushion against
short-term fluctuations in valuation. We believe that the continued payment of cash
dividends by the issuers of the common equities we hold also should provide a floor to their
valuation.
Our investments are heavily weighted toward the financials sector, which represented 63.4
percent of the total fair value of the common stock portfolio at December 31, 2005.
Financials sector investments
typically underperform the overall market during periods when interest rates are expected to
rise. We historically have seen these types of short-term fluctuations in market value of
its holdings as potential buying opportunities but are cognizant that a prolonged downturn
in this sector could create a long-term negative effect on the portfolio.
Over the longer term, our objective is for the performance of our equity portfolio to exceed
that of the broader market. 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 Standard & Poors 500 Index, a common benchmark of market
performance. 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 that 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.
The primary risk related to preferred stock is similar to those related to investment grade
corporate bonds. Falling interest rates will adversely impact market values due the normal
inverse relationship between rates and yields. Credit risk exists due to their subordinate
position in the capital structure. We minimize this risk by primarily purchasing investment
grade preferred stocks of issuers with a strong history of paying a common stock dividend.
Fifth Third Bancorp Holding
One of our common stock holdings, Fifth Third, accounted for 26.3 percent of our
shareholders equity at year-end 2005 and dividends earned from our Fifth Third investment
were 20.2 percent of our investment income in 2005.
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
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 |
|
|
|
|
|
Based on 2005 results, a 10 percent change in dividends earned from our Fifth Third
holding would result in an $11 million change in pretax investment income and a $9 million
change in after-tax earnings.
Every $1.00 change in the market price of Fifth Thirds common stock has approximately a 27
cent impact on our book value per share. A 20 percent change in the market price of Fifth
Thirds common stock from its year-end 2005 closing price would result in a $549 million
change in assets and a $357 million change in after-tax unrealized gains.
Fifth Thirds market value over the past three years has been impacted by a difficult
interest rate environment and the residual effects of a regulatory review that was concluded
in early 2004. We believe that they have come out of the process a stronger bank
operationally and we believe the management team can execute on the strategy for growth they
have defined. During this challenging period for the bank, we have continued to benefit from
their superior dividend growth. In September 2005, Fifth Third increased its indicated
annual dividend by 8.6 percent, which is expected to contribute an additional $9 million to
investment income on an annualized basis.
2005 10-K Page 73
Unrealized Investment Gains and Losses
At December 31, 2005, unrealized investment gains before taxes totaled $5.145 billion
and unrealized investment losses in the investment portfolio amounted to $78 million.
Unrealized Investment Gains
The unrealized gains at year-end 2005 were primarily due to long-term gains from the
companys holdings in the common stock of Fifth Third (Nasdaq: FITB) and Alltel Corporation
(NYSE: AT). Reflecting the companys long-term investment philosophy, of the 1,082 securities
trading at or above book value, 767, or 70.9 percent, have shown unrealized gains for more
than 24 months.
Unrealized Investment Losses Potential Other-than-temporary Impairments
The asset impairment policy evaluates significant decreases in the market value of the
assets; changes in legal factors or in the business climate; or other such factors
indicating whether or not the carrying amount may be recoverable. A declining trend in
market value, the extent of the market value decline and the length of time in which the
value has been depressed are objective measures that can be outweighed by subjective
measures such as impending events and issuer liquidity. In 2005 and earlier, impairment is
evaluated in the event of a declining market value for four consecutive quarters with
quarter-end market value below 50 percent of book value, or when a securitys market value
is 50 percent below book value for three consecutive quarters. Effective January 1, 2006,
impairment may be evaluated in the event a declining market value for four consecutive
quarters with quarter-end market value below 70 percent of book value, or when a securitys
market value is 70 percent below book value for three consecutive quarters. In addition to
applying the impairment policy, the status of the portfolio is constantly monitored by the
companys portfolio managers for indications of potential problems or issues that may be
possible impairment issues. If an impairment indicator is noted, the portfolio managers even
more closely scrutinize the security. During 2005 and 2004, a total of six securities were
written down as other-than-temporarily impaired.
We expect the number of securities trading below 100 percent of book value to fluctuate as
interest rates rise or fall. Further, book values for some securities have been revised due
to impairment charges recognized during 2003 and 2002. At December 31, 2005, 732 of the
1,814 securities we owned were trading below 100 percent of book value compared with 208 of
the 1,593 securities we owned at
December 31, 2004. Of the 732 holdings trading below book value at December 31, 2005, 714
were trading between 90 percent and 100 percent of book value.
The 732 holdings trading below book value at December 31, 2005, represented 22.3 percent of
invested assets and $78 million in unrealized losses. We deem the risk related to securities
trading between 70 percent and 100 percent of book value to be relatively minor and at least
partially offset by the earned income potential of these investments.
|
|
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. |
Holdings trading below 70 percent of book value are monitored more closely for potential
other-than-temporary impairment. At December 31, 2005, two auto-related holdings with a fair
value of $8 million were trading below 70 percent of book value. At year-end 2004, no
securities were trading below 70 percent of book value.
As
discussed in Critical Accounting Estimates, Asset Impairment, Page 37, when evaluating
other-than-temporary impairments, we consider our ability to retain a security for a period
adequate to recover a substantial portion of its cost. Because of our investment philosophy
and strong capitalization, we can hold securities until their scheduled redemption that
might otherwise be deemed impaired as we evaluate their potential for recovery based
economic, industry or company factors.
2005 10-K Page 74
The following table summarizes the investment portfolio by period of time:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
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
The following table summarizes the investment portfolio:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
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
Item 8. Financial Statements and Supplementary Data
Responsibility for Financial Statements
We have prepared the consolidated financial statements of Cincinnati Financial
Corporation and our subsidiaries for the year ended December 31, 2005, in accordance with
accounting principles generally accepted in the United States of America (GAAP).
We are responsible for the integrity and objectivity of these financial statements. The
amounts, presented on an accrual basis, reflect our best estimates and judgment. These
statements are consistent in all material aspects with other financial information in the
Annual Report on Form 10-K. Our accounting system and related internal controls are designed
to assure that our books and records accurately reflect the companys transactions in
accordance with established policies and procedures as implemented by qualified personnel.
Our board of directors has established an audit committee of independent outside directors.
We believe these directors are free from any relationships that could interfere with their
independent judgment as audit committee members.
The audit committee meets periodically with management, our independent registered public
accounting firm and our internal auditors to discuss how each is handling responsibilities.
The audit committee reports on their findings to the board of directors. The audit committee
recommends to the board the annual appointment of the independent registered public
accounting firm. The audit committee reviews with this firm the scope of the audit
assignment and the adequacy of internal controls and procedures.
Deloitte & Touche LLP, our independent registered public accounting firm, audited the
consolidated financial statements of Cincinnati Financial Corporation and subsidiaries for
the year ended December 31, 2005. Their report is on Page 79. Deloittes auditors met with
our audit committee to discuss the results of their examination. They have the opportunity
to present their opinions about the adequacy of internal controls and the quality of
financial reporting without management present.
2005 10-K Page 77
Managements Annual Report on Internal Control Over Financial Reporting
The management of Cincinnati Financial Corporation and its subsidiaries is responsible
for establishing and maintaining adequate internal controls, designed to provide reasonable
assurance regarding the reliability of financial reporting and the preparation of financial
statements for external purposes in accordance with accounting principles generally accepted
in the United States of America (GAAP). The companys internal control over financial
reporting includes those policies and procedures that:
1. |
|
Pertain to the maintenance of records that, in reasonable detail, accurately and
fairly reflect the transactions and dispositions of the assets of the company; |
|
2. |
|
Provide reasonable assurance that transactions are recorded as necessary to permit
preparation of financial statements in accordance with GAAP and that receipts and
expenditures of the company are being made only in accordance with authorizations of
management and the directors of the company; and |
|
3. |
|
Provide reasonable assurance regarding prevention or timely detection of
unauthorized acquisition, use or disposition of the companys assets that could have a
material effect on the financial statements. |
All internal control systems, no matter how well designed, have inherent limitations,
including the possibility of human error and the circumvention of overriding controls.
Accordingly, even effective internal control can provide only reasonable assurance with
respect to financial statement preparation and presentation. Further, because of changes in
conditions, the effectiveness of internal control may vary over time.
The companys management assessed the effectiveness of the companys internal control over
financial reporting as of December 31, 2005, as required by Section 404 of the Sarbanes
Oxley Act of 2002. Managements assessment is based on the criteria established in the
Internal Control Integrated Framework issued by the Committee of Sponsoring Organizations
of the Treadway Commission and was designed to provide reasonable assurance that the company
maintained effective internal control over financial reporting as of December 31, 2005. The
assessment led management to conclude that, as of December 31, 2005, the companys internal
control over financial reporting was effective based on those criteria.
The companys independent registered public accounting firm has issued an attestation report
on our internal control over financial reporting as of December 31, 2005, and the companys
management assessment of our internal control over financial reporting. This report appears
below.
/S/ John J. Schiff, Jr.
Chairman, President and Chief Executive Officer
/S/ Kenneth W. Stecher
Chief Financial Officer, Senior Vice President, Secretary and Treasurer
(Principal Accounting Officer)
March 10, 2006
2005 10-K Page 78
Report of Independent Registered Public Accounting Firm
To the Shareholders and Board of Directors of Cincinnati Financial Corporation:
We have audited the accompanying consolidated balance sheets of Cincinnati Financial
Corporation and subsidiaries (the company) as of December 31, 2005 and 2004, and the related
consolidated statements of income, shareholders equity, and cash flows for each of the three
years in the period ended December 31, 2005. Our audits also included the financial statement
schedules listed in the Index at Item 15(c). We also have audited managements assessment,
included in the accompanying Managements Annual Report on Internal Control Over Financial
Reporting report, that the company maintained effective internal control over financial
reporting as of December 31, 2005, based on the criteria established in the Internal
ControlIntegrated Framework issued by the Committee of Sponsoring Organizations of the
Treadway Commission. The companys management is responsible for these financial statements
and financial statement schedules, for maintaining effective internal control over financial
reporting, and for its assessment of the effectiveness of internal control over financial
reporting. Our responsibility is to express an opinion on these financial statements and
financial statement schedules, an opinion on managements assessment, and an opinion on the
effectiveness of the companys internal control over financial reporting based on our audits.
We conducted our audits in accordance with the standards of the Public Company Accounting
Oversight Board (United States). Those standards require that we plan and perform the audit to
obtain reasonable assurance about whether the financial statements are free of material
misstatement and whether effective internal control over financial reporting was maintained in
all material respects. Our audit of financial statements included examining, on a test basis,
evidence supporting the amounts and disclosures in the financial statements, assessing the
accounting principles used and significant estimates made by management, and evaluating the
overall financial statement presentation. Our audit of internal control over financial
reporting included obtaining an understanding of internal control over financial reporting,
evaluating managements assessment, testing and evaluating the design and operating
effectiveness of internal control, and performing such other procedures as we considered
necessary in the circumstances. We believe that our audits provide a reasonable basis for our
opinions.
A companys internal control over financial reporting is a process designed by, or under the
supervision of, the companys principal executive and principal financial officers, or persons
performing similar functions, and effected by the companys board of directors, management,
and other personnel to provide reasonable assurance regarding the reliability of financial
reporting and the preparation of financial statements for external purposes in accordance with
accounting principles generally accepted in the United States of America. A companys internal
control over financial reporting includes those policies and procedures that: (1) pertain to
the maintenance of records that, in reasonable detail, accurately and fairly reflect the
transactions and dispositions of the assets of the company; (2) provide reasonable assurance
that transactions are recorded as necessary to permit preparation of financial statements in
accordance with generally accepted accounting principles and that receipts and expenditures of
the company are being made only in accordance with authorizations of management and directors
of the company; and (3) provide reasonable assurance regarding prevention or timely detection
of unauthorized acquisition, use, or disposition of the companys assets that could have a
material effect on the financial statements.
Because of the inherent limitations of internal control over financial reporting, including
the possibility of collusion or improper management override of controls, material
misstatements due to error or fraud may not be prevented or detected on a timely basis. Also,
projections of any evaluation of the effectiveness of the internal control over financial
reporting to future periods are subject to the risk that the controls may become inadequate
because of changes in conditions, or that the degree of compliance with the policies or
procedures may deteriorate.
In our opinion, the consolidated financial statements referred to above present fairly, in all
material respects, the financial position of the company as of December 31, 2005 and 2004, and
the results of its operations and its cash flows for each of the three years in the period
ended December 31, 2005, in conformity with accounting principles generally accepted in the
United States of America. Also, in our opinion, such financial statement schedules, when
considered in relation to the basic consolidated financial statements taken as a whole,
present fairly, in all material respects, the information set forth therein. Also, in our
opinion, managements assessment that the company maintained effective internal control over
financial reporting as of December 31, 2005, is fairly stated, in all material respects, based
on the criteria established in Internal ControlIntegrated Framework issued by the Committee
of Sponsoring Organizations of the Treadway Commission. Furthermore, in our opinion, the
company maintained, in all material respects, effective internal control over financial
reporting as of
December 31, 2005, based on the criteria established in Internal ControlIntegrated Framework
issued by the Committee of Sponsoring Organizations of the Treadway Commission.
/S/ Deloitte & Touche LLP
Cincinnati, Ohio
March 6, 2006
2005 10-K Page 79
Cincinnati Financial Corporation and Subsidiaries
Consolidated Balance Sheets
|
|
|
|
|
|
|
|
|
|
|
At December 31, |
|
(Dollars in millions except per share data) |
|
2005 |
|
|
2004 |
|
|
ASSETS |
|
|
|
|
|
|
|
|
Investments |
|
|
|
|
|
|
|
|
Fixed maturities, at fair value (amortized cost: 2005$5,387; 2004$4,783) |
|
$ |
5,476 |
|
|
$ |
5,070 |
|
Equity securities, at fair value (cost: 2005$2,128; 2004$1,945) |
|
|
7,106 |
|
|
|
7,498 |
|
Short-term investments, at fair value (cost: 2005$75; 2004$71) |
|
|
75 |
|
|
|
71 |
|
Other invested assets |
|
|
45 |
|
|
|
38 |
|
Cash and cash equivalents |
|
|
119 |
|
|
|
306 |
|
Investment income receivable |
|
|
117 |
|
|
|
107 |
|
Finance receivable |
|
|
105 |
|
|
|
95 |
|
Premiums receivable |
|
|
1,116 |
|
|
|
1,119 |
|
Reinsurance receivable |
|
|
681 |
|
|
|
680 |
|
Prepaid reinsurance premiums |
|
|
14 |
|
|
|
15 |
|
Deferred policy acquisition costs |
|
|
429 |
|
|
|
400 |
|
Land,
building and equipment, net, for company use (accumulated depreciation: 2005$232; 2004$206) |
|
|
168 |
|
|
|
156 |
|
Other assets |
|
|
66 |
|
|
|
75 |
|
Separate accounts |
|
|
486 |
|
|
|
477 |
|
|
|
|
|
|
|
|
Total assets |
|
$ |
16,003 |
|
|
$ |
16,107 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
LIABILITIES |
|
|
|
|
|
|
|
|
Loss and loss expense reserves |
|
|
|
|
|
|
|
|
Loss and loss expense reserves |
|
$ |
3,661 |
|
|
$ |
3,549 |
|
Life policy reserves |
|
|
1,343 |
|
|
|
1,194 |
|
Unearned premiums |
|
|
1,559 |
|
|
|
1,539 |
|
Other liabilities |
|
|
455 |
|
|
|
474 |
|
Deferred income tax |
|
|
1,622 |
|
|
|
1,834 |
|
6.125% senior notes due 2034 |
|
|
371 |
|
|
|
371 |
|
6.9% senior debentures due 2028 |
|
|
28 |
|
|
|
420 |
|
6.92% senior debenture due 2028 |
|
|
392 |
|
|
|
0 |
|
Separate accounts |
|
|
486 |
|
|
|
477 |
|
|
|
|
|
|
|
|
Total liabilities |
|
|
9,917 |
|
|
|
9,858 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
SHAREHOLDERS EQUITY |
|
|
|
|
|
|
|
|
Common stock, par value-$2 per share; authorized: 2005-500 million shares, 2004-
200 million shares; issued: 2005-194 million shares, 2004-185 million shares |
|
|
389 |
|
|
|
370 |
|
Paid-in capital |
|
|
969 |
|
|
|
618 |
|
Retained earnings |
|
|
2,088 |
|
|
|
2,057 |
|
Accumulated other comprehensive incomeunrealized gains on investments and derivatives |
|
|
3,284 |
|
|
|
3,787 |
|
Treasury stock at cost (200520 million shares, 200418 million shares) |
|
|
(644 |
) |
|
|
(583 |
) |
|
|
|
|
|
|
|
Total shareholders equity |
|
|
6,086 |
|
|
|
6,249 |
|
|
|
|
|
|
|
|
Total liabilities and shareholders equity |
|
$ |
16,003 |
|
|
$ |
16,107 |
|
|
|
|
|
|
|
|
Accompanying notes are an integral part of this statement.
2005 10-K Page 80
Cincinnati Financial Corporation and Subsidiaries
Consolidated Statements of Income
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Years ended December 31, |
|
(In millions except per share data) |
|
2005 |
|
|
2004 |
|
|
2003 |
|
|
REVENUES |
|
|
|
|
|
|
|
|
|
|
|
|
Earned premiums |
|
|
|
|
|
|
|
|
|
|
|
|
Property casualty |
|
$ |
3,058 |
|
|
$ |
2,919 |
|
|
$ |
2,653 |
|
Life |
|
|
106 |
|
|
|
101 |
|
|
|
95 |
|
Investment income, net of expenses |
|
|
526 |
|
|
|
492 |
|
|
|
465 |
|
Realized investment gains and losses |
|
|
61 |
|
|
|
91 |
|
|
|
(41 |
) |
Other income |
|
|
16 |
|
|
|
11 |
|
|
|
9 |
|
|
|
|
|
|
|
|
|
|
|
Total revenues |
|
|
3,767 |
|
|
|
3,614 |
|
|
|
3,181 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
BENEFITS AND EXPENSES |
|
|
|
|
|
|
|
|
|
|
|
|
Insurance losses and policyholder benefits |
|
|
1,911 |
|
|
|
1,846 |
|
|
|
1,887 |
|
Commissions |
|
|
627 |
|
|
|
615 |
|
|
|
536 |
|
Other operating expenses |
|
|
290 |
|
|
|
260 |
|
|
|
204 |
|
Taxes, licenses and fees |
|
|
72 |
|
|
|
75 |
|
|
|
67 |
|
Increase in deferred policy acquisition costs |
|
|
(19 |
) |
|
|
(30 |
) |
|
|
(42 |
) |
Interest expense |
|
|
51 |
|
|
|
38 |
|
|
|
34 |
|
Other expenses |
|
|
12 |
|
|
|
10 |
|
|
|
15 |
|
|
|
|
|
|
|
|
|
|
|
Total benefits and expenses |
|
|
2,944 |
|
|
|
2,814 |
|
|
|
2,701 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
INCOME BEFORE INCOME TAXES |
|
|
823 |
|
|
|
800 |
|
|
|
480 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
PROVISION (BENEFIT) FOR INCOME TAXES |
|
|
|
|
|
|
|
|
|
|
|
|
Current |
|
|
188 |
|
|
|
171 |
|
|
|
130 |
|
Deferred |
|
|
33 |
|
|
|
45 |
|
|
|
(24 |
) |
|
|
|
|
|
|
|
|
|
|
Total provision for income taxes |
|
|
221 |
|
|
|
216 |
|
|
|
106 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
NET INCOME |
|
$ |
602 |
|
|
$ |
584 |
|
|
$ |
374 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
PER COMMON SHARE |
|
|
|
|
|
|
|
|
|
|
|
|
Net incomebasic |
|
$ |
3.44 |
|
|
$ |
3.30 |
|
|
$ |
2.11 |
|
Net incomediluted |
|
$ |
3.40 |
|
|
$ |
3.28 |
|
|
$ |
2.10 |
|
Accompanying notes are an integral part of this statement.
2005 10-K Page 81
Cincinnati Financial Corporation and Subsidiaries
Consolidated Statements of Shareholders Equity
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
At
December 31, |
|
(In millions) |
|
2005 |
|
|
2004 |
|
|
2003 |
|
|
COMMON STOCK NUMBER OF SHARES |
|
|
|
|
|
|
|
|
|
|
|
|
Beginning of year |
|
|
167 |
|
|
|
160 |
|
|
|
162 |
|
5% stock dividend |
|
|
9 |
|
|
|
8 |
|
|
|
0 |
|
Purchase of treasury shares |
|
|
(2 |
) |
|
|
(1 |
) |
|
|
(2 |
) |
|
|
|
|
|
|
|
|
|
|
End of year |
|
|
174 |
|
|
|
167 |
|
|
|
160 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
COMMON STOCK |
|
|
|
|
|
|
|
|
|
|
|
|
Beginning of year |
|
$ |
370 |
|
|
$ |
352 |
|
|
$ |
352 |
|
5% stock dividend |
|
|
18 |
|
|
|
18 |
|
|
|
0 |
|
Stock options exercised |
|
|
1 |
|
|
|
0 |
|
|
|
0 |
|
|
|
|
|
|
|
|
|
|
|
End of year |
|
|
389 |
|
|
|
370 |
|
|
|
352 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
PAID-IN CAPITAL |
|
|
|
|
|
|
|
|
|
|
|
|
Beginning of year |
|
|
618 |
|
|
|
306 |
|
|
|
300 |
|
5% stock dividend |
|
|
341 |
|
|
|
312 |
|
|
|
0 |
|
Stock loan |
|
|
0 |
|
|
|
(3 |
) |
|
|
0 |
|
Stock options exercised |
|
|
9 |
|
|
|
3 |
|
|
|
6 |
|
Other |
|
|
1 |
|
|
|
0 |
|
|
|
0 |
|
|
|
|
|
|
|
|
|
|
|
End of year |
|
|
969 |
|
|
|
618 |
|
|
|
306 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
RETAINED EARNINGS |
|
|
|
|
|
|
|
|
|
|
|
|
Beginning of year |
|
|
2,057 |
|
|
|
1,986 |
|
|
|
1,772 |
|
Net income |
|
|
602 |
|
|
|
584 |
|
|
|
374 |
|
5% stock dividend |
|
|
(359 |
) |
|
|
(330 |
) |
|
|
0 |
|
Dividends declared |
|
|
(212 |
) |
|
|
(183 |
) |
|
|
(160 |
) |
|
|
|
|
|
|
|
|
|
|
End of year |
|
|
2,088 |
|
|
|
2,057 |
|
|
|
1,986 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
ACCUMULATED OTHER COMPREHENSIVE INCOME |
|
|
|
|
|
|
|
|
|
|
|
|
Beginning of year |
|
|
3,787 |
|
|
|
4,084 |
|
|
|
3,643 |
|
Change in accumulated other comprehensive income, net |
|
|
(503 |
) |
|
|
(297 |
) |
|
|
441 |
|
|
|
|
|
|
|
|
|
|
|
End of year |
|
|
3,284 |
|
|
|
3,787 |
|
|
|
4,084 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
TREASURY STOCK |
|
|
|
|
|
|
|
|
|
|
|
|
Beginning of year |
|
|
(583 |
) |
|
|
(524 |
) |
|
|
(469 |
) |
Purchase |
|
|
(63 |
) |
|
|
(66 |
) |
|
|
(55 |
) |
Reissued for stock options |
|
|
2 |
|
|
|
7 |
|
|
|
0 |
|
|
|
|
|
|
|
|
|
|
|
End of year |
|
|
(644 |
) |
|
|
(583 |
) |
|
|
(524 |
) |
|
|
|
|
|
|
|
|
|
|
Total shareholders equity |
|
$ |
6,086 |
|
|
$ |
6,249 |
|
|
$ |
6,204 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
COMPREHENSIVE INCOME |
|
|
|
|
|
|
|
|
|
|
|
|
Net income |
|
$ |
602 |
|
|
$ |
584 |
|
|
$ |
374 |
|
Change in accumulated other comprehensive income, net |
|
|
(503 |
) |
|
|
(297 |
) |
|
|
441 |
|
|
|
|
|
|
|
|
|
|
|
Total comprehensive income |
|
$ |
99 |
|
|
$ |
287 |
|
|
$ |
815 |
|
|
|
|
|
|
|
|
|
|
|
Accompanying notes are an integral part of this statement.
2005 10-K Page 82
Cincinnati Financial Corporation and Subsidiaries
Consolidated Statements of Cash Flows
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Years ended December 31, |
|
(In millions) |
|
2005 |
|
|
2004 |
|
|
2003 |
|
|
CASH FLOWS FROM OPERATING ACTIVITIES |
|
|
|
|
|
|
|
|
|
|
|
|
Net income |
|
$ |
602 |
|
|
$ |
584 |
|
|
$ |
374 |
|
Adjustments to reconcile net income to net cash provided by operating activities: |
|
|
|
|
|
|
|
|
|
|
|
|
Depreciation and amortization |
|
|
33 |
|
|
|
28 |
|
|
|
30 |
|
Realized (gains) losses on investments |
|
|
(61 |
) |
|
|
(91 |
) |
|
|
41 |
|
Negotiated settlement-software cost recovery |
|
|
0 |
|
|
|
0 |
|
|
|
(23 |
) |
Interest credited to contract holders |
|
|
28 |
|
|
|
24 |
|
|
|
23 |
|
Changes in: |
|
|
|
|
|
|
|
|
|
|
|
|
Investment income receivable |
|
|
(10 |
) |
|
|
(8 |
) |
|
|
(1 |
) |
Premiums and reinsurance receivable |
|
|
2 |
|
|
|
(118 |
) |
|
|
(97 |
) |
Deferred policy acquisition costs |
|
|
(19 |
) |
|
|
(30 |
) |
|
|
(42 |
) |
Other assets |
|
|
5 |
|
|
|
(13 |
) |
|
|
17 |
|
Loss and loss expense reserves |
|
|
112 |
|
|
|
134 |
|
|
|
239 |
|
Life policy reserves |
|
|
84 |
|
|
|
109 |
|
|
|
75 |
|
Unearned premiums |
|
|
20 |
|
|
|
93 |
|
|
|
127 |
|
Other liabilities |
|
|
(17 |
) |
|
|
83 |
|
|
|
14 |
|
Deferred income tax |
|
|
33 |
|
|
|
45 |
|
|
|
(24 |
) |
Current income tax |
|
|
(7 |
) |
|
|
(17 |
) |
|
|
63 |
|
|
|
|
|
|
|
|
|
|
|
Net cash provided by operating activities |
|
|
805 |
|
|
|
823 |
|
|
|
816 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
CASH FLOWS FROM INVESTING ACTIVITIES |
|
|
|
|
|
|
|
|
|
|
|
|
Sale of fixed maturities investments |
|
|
243 |
|
|
|
175 |
|
|
|
192 |
|
Call or maturity of fixed maturities investments |
|
|
466 |
|
|
|
664 |
|
|
|
457 |
|
Sale of equity securities investments |
|
|
104 |
|
|
|
536 |
|
|
|
217 |
|
Collection of finance receivables |
|
|
34 |
|
|
|
32 |
|
|
|
25 |
|
Purchase of fixed maturities investments |
|
|
(1,297 |
) |
|
|
(1,718 |
) |
|
|
(1,143 |
) |
Purchase of equity securities investments |
|
|
(219 |
) |
|
|
(148 |
) |
|
|
(335 |
) |
Change in short-term investments, net |
|
|
(4 |
) |
|
|
(71 |
) |
|
|
3 |
|
Investment in buildings and equipment, net |
|
|
(44 |
) |
|
|
(33 |
) |
|
|
(38 |
) |
Investment in finance receivables |
|
|
(45 |
) |
|
|
(46 |
) |
|
|
(33 |
) |
Collection of negotiated settlement-software cost recovery |
|
|
0 |
|
|
|
9 |
|
|
|
14 |
|
Change in other invested assets, net |
|
|
(9 |
) |
|
|
(1 |
) |
|
|
(1 |
) |
|
|
|
|
|
|
|
|
|
|
Net cash used in investing activities |
|
|
(771 |
) |
|
|
(601 |
) |
|
|
(642 |
) |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
CASH FLOWS FROM FINANCING ACTIVITIES |
|
|
|
|
|
|
|
|
|
|
|
|
Proceeds from 6.125% senior notes |
|
|
0 |
|
|
|
371 |
|
|
|
0 |
|
Debt issuance costs from 6.125% senior notes |
|
|
0 |
|
|
|
(4 |
) |
|
|
0 |
|
Payment of cash dividends to shareholders |
|
|
(204 |
) |
|
|
(177 |
) |
|
|
(156 |
) |
Purchase/issuance of treasury shares |
|
|
(61 |
) |
|
|
(59 |
) |
|
|
(55 |
) |
Decrease in notes payable |
|
|
0 |
|
|
|
(183 |
) |
|
|
0 |
|
Proceeds from stock options exercised |
|
|
11 |
|
|
|
3 |
|
|
|
6 |
|
Contract holder funds deposited |
|
|
87 |
|
|
|
93 |
|
|
|
45 |
|
Contract holder funds withdrawn |
|
|
(54 |
) |
|
|
(51 |
) |
|
|
(35 |
) |
|
|
|
|
|
|
|
|
|
|
Net cash used in financing activities |
|
|
(221 |
) |
|
|
(7 |
) |
|
|
(195 |
) |
|
|
|
|
|
|
|
|
|
|
Net increase (decrease) in cash and cash equivalents |
|
|
(187 |
) |
|
|
215 |
|
|
|
(21 |
) |
Cash and cash equivalents at beginning of year |
|
|
306 |
|
|
|
91 |
|
|
|
112 |
|
|
|
|
|
|
|
|
|
|
|
Cash and cash equivalents at end of year |
|
$ |
119 |
|
|
$ |
306 |
|
|
$ |
91 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Supplemental disclosures of cash flow information: |
|
|
|
|
|
|
|
|
|
|
|
|
Interest paid |
|
$ |
51 |
|
|
$ |
34 |
|
|
$ |
34 |
|
Income taxes paid |
|
|
195 |
|
|
|
188 |
|
|
|
65 |
|
Conversion of fixed maturity to equity security and fixed
maturity investments |
|
|
42 |
|
|
|
23 |
|
|
|
51 |
|
Accompanying notes are an integral part of this statement.
2005 10-K Page 83
Notes to Consolidated Financial Statements
1. Summary of Significant Accounting Policies
Nature of Operations
We underwrite insurance through four companies that market through local independent
insurance agents. Our products include a broad range of business and personal policies, as
well as life and disability income insurance and annuities. We also provide finance/leasing
products and asset management services through our CFC Investment Company and CinFin Capital
Management Company subsidiaries.
Basis of Presentation
Our consolidated financial statements include the accounts of the parent company and
our wholly owned subsidiaries. We present our statements in accordance with accounting
principles generally accepted in the United States of America (GAAP). In consolidating our
accounts, we have eliminated significant intercompany balances and transactions.
In accordance with GAAP, we have made estimates and assumptions that affect the amounts we
report and discuss in the financial statements and accompanying notes. Actual results could
differ from our estimates.
Earnings per Share
Net income per common share is based on the weighted average number of common shares
outstanding during each of the respective years. We calculate net income per common share
(diluted) assuming the exercise of stock options. We have adjusted shares and earnings per
share to reflect all stock splits and dividends prior to December 31, 2005, including the 5
percent stock dividend paid April 26, 2005.
Stock Options
We have qualified and non-qualified stock option plans under which we grant options to
employees. We grant these options, which can be exercised over 10-year periods, at prices
that are not less than market price at the date of grant. We apply Accounting Principles
Board (APB) Opinion 25 and related interpretations in accounting for these plans.
Accordingly, we do not recognize any compensation cost for the plans.
Had we determined compensation costs for our stock option plans based on the fair value at
the grant dates, consistent with Statement of Financial Accounting Standards (SFAS) No.
123(R) Share-Based Payments, our net income and earnings per share would have been reduced
to the pro forma amounts indicated below:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Years ended December 31, |
|
(In millions except per share data) |
|
|
|
|
|
2005 |
|
|
2004 |
|
|
2003 |
|
|
Net income |
|
As reported |
|
$ |
602 |
|
|
$ |
584 |
|
|
$ |
374 |
|
Stock-based employee compensation expense determined
under fair value based method for all awards, net of
related tax effects |
|
|
|
|
|
|
13 |
|
|
|
12 |
|
|
|
12 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Pro forma |
|
$ |
589 |
|
|
$ |
572 |
|
|
$ |
362 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net income per common sharebasic |
|
As reported |
|
$ |
3.44 |
|
|
$ |
3.30 |
|
|
$ |
2.11 |
|
|
|
Pro forma |
|
|
3.36 |
|
|
|
3.24 |
|
|
|
2.04 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net income per common sharediluted |
|
As reported |
|
$ |
3.40 |
|
|
$ |
3.28 |
|
|
$ |
2.10 |
|
|
|
Pro forma |
|
|
3.32 |
|
|
|
3.21 |
|
|
|
2.03 |
|
In determining these pro forma amounts, we estimated the fair value of each option on the
date of grant. We used the binomial option-pricing model with the following weighted-average
assumptions in 2005, 2004 and 2003, respectively: dividend yield of 2.66 percent, 2.40
percent and 2.40 percent; expected volatility of 25.61 percent, 25.65 percent and 26.03
percent; risk-free interest rates of 4.62 percent, 4.37 percent and 4.20 percent; and
expected lives of 10 years for all years. Our compensation expense in the pro forma
disclosures does not indicate future amounts, as options vest
over several years and we generally make additional grants each year. The options we grant
in our plans vest over three years.
Property Casualty Insurance
Property casualty policy written premiums are deferred and earned on a pro rata basis
over the terms of the policies. We record as unearned premium the portion of written
premiums that apply to unexpired policy terms. We do not consider investment income
potential in setting insurance policy premiums. The expenses associated with issuing
insurance policies primarily insurance agent commissions, premium taxes and underwriting
costs are deferred and amortized over the terms of policies.
We establish reserves to cover the expected cost of claims or losses and our expenses
related to investigating, processing and resolving claims. Although determining the
appropriate amount of reserves including reserves for catastrophe losses is inherently
uncertain, we base our decisions on past experience and
2005 10-K Page 84
current facts. Reserves are based on
claims reported prior to the end of the year and estimates of unreported claims. We take
into account the fact that we may recover some of our costs through salvage and subrogation.
We regularly review and update reserves using the most current information available. Any
resulting adjustments are reflected in current operations.
The Cincinnati Insurance Companies actively market property casualty insurance policies in
32 states. Our 10 largest states generated 71.1 percent, 72.1 percent and 73.1 percent of
total property casualty premiums in 2005, 2004 and 2003, respectively. Ohio, our largest
state, accounted for 23.1 percent, 23.7 percent and 24.6 percent of total earned premiums in
2005, 2004 and 2003. Agencies in Georgia, Illinois, Indiana, Michigan, North Carolina,
Pennsylvania and Virginia each contributed between 4 percent and 10 percent of premium
volume in 2005. No single agency accounted for more than 1.1 percent of the companys total
agency direct earned premiums in 2005.
Life and Health Insurance
We offer several types of life and health insurance and we account for each according
to the duration of the contract. Short-duration contracts are written to cover claims that
arise during a short, fixed term of coverage. We generally have the right to change the
amount of premium charged or cancel the coverage at the end of each contract term. Group
life insurance is an example. We account for short-duration contracts similarly to property
casualty contracts.
Long-duration contracts are written to provide coverage for an extended period of time.
Traditional long-duration contracts require policyholders to pay scheduled gross premiums,
generally not less frequently than annually, over the term of the coverage. Premiums for
these contracts are recognized as revenue when due. Whole life insurance is an example. Some
traditional long-duration contracts have premium payment periods shorter than the period
over which coverage is provided. For these contracts the excess of premium over the amount
required to pay expenses and benefits is recognized over the term of the coverage rather
than over the premium payment period. Ten-pay whole life insurance is an example.
We establish a liability for traditional long-duration contracts as we receive premiums. The
amount of this liability is the present value of future expenses and benefits less the
present value of future net premiums. Net premium is the portion of gross premium required
to provide for all expenses and benefits. We estimate future expenses and benefits and net
premium using assumptions for expected expenses, mortality, morbidity, withdrawal rates and
investment income. We include a provision for adverse deviation, meaning we allow for some
uncertainty in making our assumptions. We establish our assumptions when the contract is
issued and we generally maintain those assumptions for the life of the contract. We use both
our own experience and industry experience, adjusted for historical trends, in arriving at
our assumptions for expected mortality, morbidity and withdrawal rates. We use our own
experience and historical trends for setting our assumption for expected expenses. We base
our assumption for expected investment income on our own experience, adjusted for current
economic conditions.
When we issue a traditional long-duration contract, we capitalize acquisition costs.
Acquisition costs are costs which vary with, and are primarily related to, the production of
new business. We then charge these deferred acquisition costs to expenses over the premium
paying period of the contract and we use the same assumptions that we use when we establish
the liability for the contract.
Universal life contracts are long-duration contracts for which contractual provisions are
not fixed, unlike whole life insurance. Universal life contracts allow policyholders to vary
the amount of premium, within limits, without our consent. However we may vary the mortality
and expense charges, within limits, and the interest crediting rate used to accumulate
policy values. We do not record universal life premiums as revenue. Instead we recognize as
revenue the mortality charges, administration charges
and surrender charges when received. Some of our universal life contracts assess
administration charges in the early years of the contract that are compensation for services
we will provide in the later years of the contract. These administration charges are
deferred and are recognized over the period when we provide those future services.
For universal life long-duration contracts we maintain a liability equal to the policyholder
account value. There is no provision for adverse deviation.
When we issue a universal life long-duration contract we capitalize acquisition costs. We
then charge these capitalized costs to expenses over the term of coverage of the contract.
When we charge deferred acquisition costs to expenses, we use assumptions based on our best
estimates of long-term experience. We review and modify these assumptions on a regular
basis.
Separate Accounts
We issue life contracts with guaranteed minimum returns, referred to as bank-owned life
insurance contracts (BOLIs). We legally segregate and record as separate accounts the assets
and liabilities for some of our BOLIs, based on the specific contract provisions. We
guarantee minimum investment returns, account values and death benefits for our separate
account BOLIs. Our other BOLIs are general account products.
2005 10-K Page 85
We carry the assets of separate account BOLIs at fair value. The liabilities on separate
account BOLIs primarily are the contract holders claims to the related assets and are
carried at the fair value of the assets. If the BOLI asset value is projected below the
value we guaranteed, a liability is established by a charge to the companys earnings.
Generally, investment income and realized investment gains and losses of the separate
accounts accrue directly to the contract holder and we do not include them in the
Consolidated Statements of Income. Revenues and expenses for the company related to the
separate accounts consist of contractual fees and mortality, surrender and expense risk
charges. Also, each separate account BOLI includes a negotiated gain and loss sharing
arrangement with the company. A percentage of each separate accounts realized gain and loss
representing contract fees and assessments accrues to us and is transferred from the
separate account to the companys general account and is recognized as revenue or expense.
Reinsurance
We work to reduce risk and uncertainty by buying property casualty and life
reinsurance. Reinsurance contracts do not relieve us from our duty to policyholders, but
rather help protect our financial strength to perform that duty. We estimate loss amounts
recoverable from our reinsurers based on the reinsurance policy terms. Historically, our
claims with reinsurers have been paid. We do not have an allowance for uncollectible
reinsurance.
We also serve in a limited way as a reinsurer for other insurance companies, reinsurers and
involuntary state pools. We record our transactions for such assumed reinsurance based on
reports provided to us by the ceding reinsurer.
Cash and Cash Equivalents
Cash and cash equivalents include cash and money market funds.
Investments
Our portfolio investments are primarily in publicly traded fixed-maturity, equity and
short-term investments, classified as available for sale in the accompanying financial
statements. Valuations of all of our investments are based on either listed prices or data
provided by an outside resource that supplies global securities pricing. Changes in the fair
value of these securities, based on the listed prices or information from the outside
resource, are reported on the balance sheet in other comprehensive income, net of tax.
Fixed-maturity investments (taxable and tax-exempt bonds) and equity investments (common and
preferred stocks) are classified as available for sale and recorded at fair value in the
financial statements. Short-term investments are classified as available for sale and
recorded at amortized cost, which approximates fair value, in the financial statements. The
number of fixed-maturity securities trading below 100 percent of book value can be expected
to fluctuate as interest rates rise or fall. Because of our strong surplus and long-term
investment horizon, we expect to hold most fixed-maturity investments until maturity,
regardless of short-term fluctuations in fair values.
We include unrealized gains and losses on investments, net of taxes, in shareholders equity
as accumulated other comprehensive income. Realized gains and losses on investments are
recognized in net income on a specific identification basis.
Investment income consists mainly of interest and dividends. We record interest on an
accrual basis and record dividends at the ex-dividend date. We amortize premiums and
discounts on fixed-maturity securities using the interest method.
Facts and circumstances sometimes warrant investment write-downs. We record such
other-than-temporary declines as realized investment losses.
Fair Value Disclosures
We base fair value for investments in equity and fixed-maturity securities (including
redeemable preferred stock and assets held in separate accounts) on quoted market prices or
on data provided by an outside resource that supplies global securities pricing.
We estimate fair value for liabilities under investment-type insurance contracts (annuities)
using discounted cash flow calculations. We base the calculations on interest rates offered
on contracts of similar nature and maturity. We base fair value for long-term senior notes
on the quoted market prices for such notes.
Derivative Financial Instruments and Hedging Activities
Some of our investments contain embedded options. These investments include convertible
debt and convertible preferred stock. We calculate fair value and account for the embedded
options separately. The changes in fair values of embedded derivates are recognized in net
income in the period they occur.
SFAS No. 133 Accounting for Derivative Financial Instruments and Hedging Activities, as
amended, or any subsequent changes in fair values of these instruments, have not had a
significant impact on the accompanying consolidated financial statements. We do not engage
in any hedging activities.
2005 10-K Page 86
Lease/Finance
Our CFC Investment Company subsidiary provides auto and equipment direct financing
(leases and loans) to commercial and individual clients. We generally transfer ownership of
the property to the client as the terms of the leases expire. Our lease contracts contain
bargain purchase options. We record income over the financing term using the interest
method.
We capitalize and amortize lease or loan origination costs over the life of the financing
using the interest method. These costs may include, but are not limited to: finder fees,
broker fees, filing fees and the cost of credit reports.
Asset Management
Our CinFin Capital Management subsidiary generates revenue from management fees. We set
those fees based on the market value of assets under management, and we record our revenue
as it is earned.
Land, Building and Equipment
We record building and equipment at cost less accumulated depreciation. Our
depreciation is based on estimated useful lives (ranging from three years to 391/2 years)
using straight-line and accelerated methods. Depreciation expense recorded in 2005, 2004 and
2003 was $33 million, $30 million and $31 million, respectively. We monitor land, building
and equipment for potential impairments. Potential impairments include a significant
decrease in the market values of the assets, considerable cost overruns on projects or a
change in legal factors or business climate, or other factors that indicate that the
carrying amount may not be recoverable.
We capitalize costs for internally developed computer software during the application
development stage. These costs generally consist of external consulting, payroll and
payroll-related costs.
Income Taxes
We calculate deferred income tax liabilities and assets using tax rates in effect for
the time when temporary differences in book and taxable income are estimated to reverse. We
recognize deferred income taxes for numerous temporary differences between our taxable
income and book-basis income and other changes in shareholders equity. Such temporary
differences relate primarily to unrealized gains on investments and differences in the
recognition of deferred acquisition costs and insurance reserves. We charge deferred income
taxes associated with unrealized appreciation (except the amounts related to the effect of
income tax rate changes) to shareholders equity in accumulated other comprehensive income.
We charge deferred taxes associated with other differences to income.
New Accounting Pronouncements
Statement of Financial Accounting Standards No. 123(R)
In December 2004, the Financial Accounting Standards Board (FASB) issued SFAS No.
123(R), which is a revision of SFAS No. 123, Accounting for Stock-Based Compensation, and
supersedes APB Opinion No. 25. On April 21, 2005, the Securities and Exchange Commission
amended the effective date, stating that companies can choose implementation in either the
reporting period beginning after June 15, 2005, or December 15, 2005. We intend to adopt
SFAS No. 123(R) in the first quarter of 2006.
SFAS No. 123(R) permits companies to adopt its requirements using either a modified
prospective or a modified retrospective method. We currently utilize a standard
option-pricing model (binomial option-pricing model) to measure the fair value of stock
options granted to associates. Upon the adoption of SFAS No. 123(R), we will use the
modified prospective method to measure the fair value of associate stock options.
Subject to a complete review of the requirements of SFAS No. 123(R), based on stock options
granted to associates through year-end 2005, we estimate that the adoption of SFAS No.
123(R) will reduce 2006 net income by approximately 8 cents per share.
Statement of Financial Accounting Standards No. 154
In May 2005, the FASB issued SFAS No. 154, which eliminated the requirement in APB
Opinion No. 20, Accounting Changes, that modified the requirements for the accounting and
reporting of a change in accounting principles. APB Opinion No. 20 required changes in
accounting principles be included as an accumulated amount in the income statement in the
period of change.
SFAS No. 154 requires that changes in accounting principles be retrospectively applied. The
new accounting principle is applied at the beginning of the first period presented, as if
that principle had always been used. The cumulative effect is applied to the applicable
assets and liabilities with a corresponding offset to opening retained earnings. SFAS No.
154 is effective for accounting changes and corrections of errors made in fiscal years
beginning after December 15, 2005. We do not expect SFAS No. 154 to have any material impact
on the companys consolidated financial statements.
2005 10-K Page 87
Reclassifications
We have reclassified certain prior-year amounts to conform with current-year
classifications.
2. Investments
|
|
|
|
|
|
|
|
|
|
|
|
|
(In millions) |
|
Years ended December 31, |
|
|
|
2005 |
|
|
2004 |
|
|
2003 |
|
|
Investment income summarized by investment category: |
|
|
|
|
|
|
|
|
|
|
|
|
Interest on fixed maturities |
|
$ |
280 |
|
|
$ |
252 |
|
|
$ |
235 |
|
Dividends on equity securities |
|
|
244 |
|
|
|
239 |
|
|
|
227 |
|
Other investment income |
|
|
8 |
|
|
|
6 |
|
|
|
7 |
|
|
|
|
|
|
|
|
|
|
|
Total |
|
|
532 |
|
|
|
497 |
|
|
|
469 |
|
Less investment expenses |
|
|
6 |
|
|
|
5 |
|
|
|
4 |
|
|
|
|
|
|
|
|
|
|
|
Total |
|
$ |
526 |
|
|
$ |
492 |
|
|
$ |
465 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Realized investment gains and losses summarized by investment category: |
|
|
|
|
|
|
|
|
|
|
|
|
Fixed maturities: |
|
|
|
|
|
|
|
|
|
|
|
|
Gross realized gains |
|
$ |
36 |
|
|
$ |
36 |
|
|
$ |
35 |
|
Gross realized losses |
|
|
(1 |
) |
|
|
(20 |
) |
|
|
(25 |
) |
Other-than-temporary impairments |
|
|
(1 |
) |
|
|
(5 |
) |
|
|
(73 |
) |
Equity securities: |
|
|
|
|
|
|
|
|
|
|
|
|
Gross realized gains |
|
|
40 |
|
|
|
101 |
|
|
|
37 |
|
Gross realized losses |
|
|
(6 |
) |
|
|
(30 |
) |
|
|
(17 |
) |
Other-than-temporary impairments |
|
|
0 |
|
|
|
(1 |
) |
|
|
(7 |
) |
Embedded derivatives |
|
|
(7 |
) |
|
|
10 |
|
|
|
9 |
|
|
|
|
|
|
|
|
|
|
|
Total |
|
$ |
61 |
|
|
$ |
91 |
|
|
$ |
(41 |
) |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Change in unrealized investment gains and losses summarized by investment category: |
|
|
|
|
|
|
|
|
|
|
|
|
Fixed maturities |
|
$ |
(198 |
) |
|
$ |
(6 |
) |
|
$ |
211 |
|
Equity securities |
|
|
(575 |
) |
|
|
(448 |
) |
|
|
488 |
|
Adjustment to deferred acquisition costs and life policy reserves |
|
|
6 |
|
|
|
3 |
|
|
|
(13 |
) |
Other |
|
|
18 |
|
|
|
(6 |
) |
|
|
(9 |
) |
Income taxes on above |
|
|
246 |
|
|
|
160 |
|
|
|
(236 |
) |
|
|
|
|
|
|
|
|
|
|
Total |
|
$ |
(503 |
) |
|
$ |
(297 |
) |
|
$ |
441 |
|
|
|
|
|
|
|
|
|
|
|
The fair value of the conversion features embedded in convertible securities was a loss of
$7 million at year-end 2005, a gain of $10 million at year-end 2004 and a gain of $9 million
at year-end 2003.
At December 31, 2005, contractual maturity dates for fixed-maturity and short-term
investments were:
|
|
|
|
|
|
|
|
|
|
|
|
|
(In millions) |
|
Amortized |
|
|
Fair |
|
|
% of Fair |
|
|
|
cost |
|
|
value |
|
|
value |
|
|
Maturity dates occuring: |
|
|
|
|
|
|
|
|
|
|
|
|
Less than one year |
|
$ |
154 |
|
|
$ |
156 |
|
|
|
2.8 |
% |
One year through five years |
|
|
602 |
|
|
|
613 |
|
|
|
11.0 |
|
After five years through ten years |
|
|
2,900 |
|
|
|
2,919 |
|
|
|
52.6 |
|
After ten years through twenty years |
|
|
1,550 |
|
|
|
1,599 |
|
|
|
28.8 |
|
Over twenty years |
|
|
256 |
|
|
|
264 |
|
|
|
4.8 |
|
|
|
|
|
|
|
|
|
|
|
Total |
|
$ |
5,462 |
|
|
$ |
5,551 |
|
|
|
100.0 |
% |
|
|
|
|
|
|
|
|
|
|
Actual maturities may differ from contractual maturities when there is a right to call or
prepay obligations with or without call or prepayment penalties.
At December 31, 2005, investments with book value of $63 million and fair value of $65
million were on deposit with various states in compliance with regulatory requirements.
2005 10-K Page 88
The following table analyzes cost or amortized cost, gross unrealized gains, gross
unrealized losses and fair value for our investments:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(In millions) |
|
Cost or |
|
|
Gross unrealized |
|
|
Fair |
|
At December 31, |
|
amortized cost |
|
|
gains |
|
|
losses |
|
|
value |
|
|
2005 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Fixed maturities: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
States, municipalities and political subdivisions |
|
$ |
2,083 |
|
|
$ |
48 |
|
|
$ |
14 |
|
|
$ |
2,117 |
|
Convertibles and bonds with warrants attached |
|
|
269 |
|
|
|
17 |
|
|
|
8 |
|
|
|
278 |
|
Public utilities |
|
|
139 |
|
|
|
6 |
|
|
|
1 |
|
|
|
144 |
|
United States government and government agencies
and authorities |
|
|
1,000 |
|
|
|
0 |
|
|
|
20 |
|
|
|
980 |
|
All other corporate bonds and short-term investments |
|
|
1,971 |
|
|
|
88 |
|
|
|
27 |
|
|
|
2,032 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total |
|
$ |
5,462 |
|
|
$ |
159 |
|
|
$ |
70 |
|
|
$ |
5,551 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Equity securities |
|
$ |
2,128 |
|
|
$ |
4,986 |
|
|
$ |
8 |
|
|
$ |
7,106 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
2004 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Fixed maturities: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
States, municipalities and political subdivisions |
|
$ |
1,622 |
|
|
$ |
75 |
|
|
$ |
3 |
|
|
$ |
1,694 |
|
Convertibles and bonds with warrants attached |
|
|
368 |
|
|
|
56 |
|
|
|
2 |
|
|
|
422 |
|
Public utilities |
|
|
134 |
|
|
|
13 |
|
|
|
1 |
|
|
|
146 |
|
United States government and government agencies
and authorities |
|
|
1,076 |
|
|
|
4 |
|
|
|
4 |
|
|
|
1,076 |
|
All other corporate bonds and short-term investments |
|
|
1,654 |
|
|
|
151 |
|
|
|
2 |
|
|
|
1,803 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total |
|
$ |
4,854 |
|
|
$ |
299 |
|
|
$ |
12 |
|
|
$ |
5,141 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Equity securities |
|
$ |
1,945 |
|
|
$ |
5,558 |
|
|
$ |
5 |
|
|
$ |
7,498 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
This table reviews unrealized losses and fair values by investment category and by length of
time securities have been in a continuous unrealized loss position:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(In millions) |
|
Less than 12 months |
|
|
12 months or more |
|
|
Total |
|
|
|
Fair |
|
|
Unrealized |
|
|
Fair |
|
|
Unrealized |
|
|
Fair |
|
|
Unrealized |
|
At December 31, |
|
value |
|
|
losses |
|
|
value |
|
|
losses |
|
|
value |
|
|
losses |
|
|
2005: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Fixed maturities: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
States, municipalities and political subdivisions |
|
$ |
754 |
|
|
$ |
8 |
|
|
$ |
173 |
|
|
$ |
6 |
|
|
$ |
927 |
|
|
$ |
14 |
|
Convertibles and bonds with warrants attached |
|
|
73 |
|
|
|
3 |
|
|
|
39 |
|
|
|
6 |
|
|
|
112 |
|
|
|
9 |
|
Public utilities |
|
|
44 |
|
|
|
1 |
|
|
|
6 |
|
|
|
0 |
|
|
|
50 |
|
|
|
1 |
|
United States government and government
agencies and authorities |
|
|
608 |
|
|
|
8 |
|
|
|
354 |
|
|
|
11 |
|
|
|
962 |
|
|
|
19 |
|
All other corporate bonds and short-term
investments |
|
|
387 |
|
|
|
11 |
|
|
|
284 |
|
|
|
16 |
|
|
|
671 |
|
|
|
27 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total |
|
|
1,866 |
|
|
|
31 |
|
|
|
856 |
|
|
|
39 |
|
|
|
2,722 |
|
|
|
70 |
|
Equity securities: |
|
|
59 |
|
|
|
2 |
|
|
|
47 |
|
|
|
6 |
|
|
|
106 |
|
|
|
8 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total |
|
$ |
1,925 |
|
|
$ |
33 |
|
|
$ |
903 |
|
|
$ |
45 |
|
|
$ |
2,828 |
|
|
$ |
78 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
2004: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Fixed maturities: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
States, municipalities and political subdivisions |
|
$ |
194 |
|
|
$ |
2 |
|
|
$ |
59 |
|
|
$ |
1 |
|
|
$ |
253 |
|
|
$ |
3 |
|
Convertibles and bonds with warrants attached |
|
|
26 |
|
|
|
1 |
|
|
|
27 |
|
|
|
1 |
|
|
|
53 |
|
|
|
2 |
|
Public utilities |
|
|
10 |
|
|
|
0 |
|
|
|
5 |
|
|
|
1 |
|
|
|
15 |
|
|
|
1 |
|
United States government and government
agencies and authorities |
|
|
295 |
|
|
|
3 |
|
|
|
70 |
|
|
|
1 |
|
|
|
365 |
|
|
|
4 |
|
All other corporate bonds and short-term
investments |
|
|
101 |
|
|
|
1 |
|
|
|
14 |
|
|
|
1 |
|
|
|
115 |
|
|
|
2 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total |
|
|
626 |
|
|
|
7 |
|
|
|
175 |
|
|
|
5 |
|
|
|
801 |
|
|
|
12 |
|
Equity securities: |
|
|
59 |
|
|
|
4 |
|
|
|
23 |
|
|
|
1 |
|
|
|
82 |
|
|
|
5 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total |
|
$ |
685 |
|
|
$ |
11 |
|
|
$ |
198 |
|
|
$ |
6 |
|
|
$ |
883 |
|
|
$ |
17 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
At December 31, 2005, 177 fixed-maturity investments with a total unrealized loss of $39
million and three equity securities with a total unrealized loss of $6 million had been in
that position for 12 months or more. All were trading between 70 percent to less than 100
percent of book value.
At December 31, 2004, 23 fixed-maturity investments with a total unrealized loss of $5
million and one equity security with a total unrealized loss of $1 million had been in that
position for 12 months or more. All were trading between 70 percent to less than 100 percent
of book value.
2005 10-K Page 89
Investments
in companies that exceed 10 percent of our shareholders
equity at December 31 include:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(In millions) |
|
2005 |
|
2004 |
|
|
Cost |
|
Fair value |
|
Cost |
|
Fair value |
|
Issuers: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Fifth Third Bancorp common stock |
|
$ |
283 |
|
|
$ |
2,745 |
|
|
$ |
283 |
|
|
$ |
3,443 |
|
ALLTEL Corporation common stock
and fixed maturity |
|
|
122 |
|
|
|
807 |
|
|
|
137 |
|
|
|
794 |
|
In December 2005, we sold 475,000 shares of our holdings of ALLTEL Corporation common stock.
On January 24, 2006, we completed the sale of our remaining 12,700,164 shares. The sale
contributed $27 million to our 2005 pretax realized gains. The $549 million gain from the
sale in 2006 will be recognized in pretax realized investment gains and losses in the first
quarter of 2006. After-tax proceeds from the sale totaled approximately $558 million.
3. Deferred Acquisition Costs
This table summarizes components of our deferred policy acquisition costs asset:
|
|
|
|
|
|
|
|
|
|
|
|
|
(In millions) |
|
At
December 31, |
|
|
|
2005 |
|
|
2004 |
|
|
2003 |
|
|
Deferred policy acquisition costs asset beginning of year |
|
$ |
400 |
|
|
$ |
372 |
|
|
$ |
343 |
|
Capitalized deferred policy acquisition costs |
|
|
683 |
|
|
|
657 |
|
|
|
615 |
|
Amortized deferred policy acquisition costs |
|
|
(664 |
) |
|
|
(626 |
) |
|
|
(573 |
) |
Amortized shadow deferred policy acquisition costs |
|
|
10 |
|
|
|
(3 |
) |
|
|
(13 |
) |
|
|
|
|
|
|
|
|
|
|
Deferred policy acquisition costs asset end of year |
|
$ |
429 |
|
|
$ |
400 |
|
|
$ |
372 |
|
|
|
|
|
|
|
|
|
|
|
4. Property Casualty Loss and Loss Expenses
This table summarizes activity in the reserve for loss and loss expenses:
|
|
|
|
|
|
|
|
|
|
|
|
|
(In millions) |
|
|
|
|
|
Years ended December 31, |
|
|
|
|
|
|
2005 |
|
|
2004 |
|
|
2003 |
|
|
Gross loss and loss expense reserves, January 1 |
|
$ |
3,514 |
|
|
$ |
3,386 |
|
|
$ |
3,150 |
|
Less reinsurance receivable |
|
|
537 |
|
|
|
541 |
|
|
|
542 |
|
|
|
|
|
|
|
|
|
|
|
Net loss and loss expense reserves, January 1 |
|
|
2,977 |
|
|
|
2,845 |
|
|
|
2,608 |
|
|
|
|
|
|
|
|
|
|
|
Net incurred loss and loss expenses related to: |
|
|
|
|
|
|
|
|
|
|
|
|
Current accident year |
|
|
1,972 |
|
|
|
1,949 |
|
|
|
1,877 |
|
Prior accident years |
|
|
(160 |
) |
|
|
(196 |
) |
|
|
(80 |
) |
|
|
|
|
|
|
|
|
|
|
Total incurred |
|
|
1,812 |
|
|
|
1,753 |
|
|
|
1,797 |
|
|
|
|
|
|
|
|
|
|
|
Net paid loss and loss expenses related to: |
|
|
|
|
|
|
|
|
|
|
|
|
Current accident year |
|
|
772 |
|
|
|
804 |
|
|
|
762 |
|
Prior accident years |
|
|
906 |
|
|
|
817 |
|
|
|
799 |
|
|
|
|
|
|
|
|
|
|
|
Total paid |
|
|
1,678 |
|
|
|
1,621 |
|
|
|
1,561 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net loss and loss expense reserves, December 31 |
|
|
3,111 |
|
|
|
2,977 |
|
|
|
2,845 |
|
Plus reinsurance receivable |
|
|
518 |
|
|
|
537 |
|
|
|
541 |
|
|
|
|
|
|
|
|
|
|
|
Gross loss and loss expense reserves, December 31 |
|
$ |
3,629 |
|
|
$ |
3,514 |
|
|
$ |
3,386 |
|
|
|
|
|
|
|
|
|
|
|
We base property casualty loss and loss expenses reserve estimates on our experience and on
information gathered from internal analyses and our appointed actuary. When reviewing
reserves, we analyze historical data and estimate the effect of various other factors, such
as industry loss frequency and severity and premium trends; past, present and anticipated
product pricing; anticipated premium growth; other quantifiable trends; and projected
ultimate loss ratios.
Because of changes in estimates of insured events in prior years, we decreased the provision
for loss and loss expenses by $160 million, $196 million and $80 million in calendar years
2005, 2004 and 2003. These decreases are partly due to the effects of settling reported
(case) and unreported (IBNR) reserves established in prior years for amounts less than
expected.
Following the Ohio Supreme Courts late 2003 decision to limit its 1999 Scott-Pontzer v.
Liberty Mutual decision, we released $38 million pretax of previously established
uninsured/under-insured motorist (UM/UIM) reserves. In 2004, we released an additional $32
million in related case reserves. After that release, we stopped separately reporting on
UM/UIM related reserve actions.
We reported total catastrophe losses, net of reinsurance and before taxes, of $127 million
for 2005, compared with $148 million for 2004 and $97 million in 2003. Most catastrophe
losses are incurred in the calendar year of the event.
The reserve for loss and loss expenses in the accompanying balance sheets also includes $32
million, $35 million and $29 million at December 31, 2005, 2004 and 2003, respectively, for
certain life health losses.
2005 10-K Page 90
5. Life Policy Reserves
We establish the reserves for traditional life insurance policies based on expected
expenses, mortality, morbidity, withdrawal rates and investment yields, including a
provision for uncertainty. Once these assumptions are established, they generally are
maintained throughout the lives of the contracts. We use both our own experience and
industry experience, adjusted for historical trends, in arriving at our assumptions for
expected mortality, morbidity and withdrawal rates as well as for expected expenses. We base
our assumptions for expected investment income on our own experience adjusted for current
economic conditions.
We establish reserves for the companys universal life, deferred annuity and investment
contracts equal to the cumulative account balances, which include premium deposits plus
credited interest less charges and withdrawals.
Here is a summary of our life policy reserves:
|
|
|
|
|
|
|
|
|
(In millions) |
|
At
December 31, |
|
|
|
2005 |
|
|
2004 |
|
|
Ordinary/traditional life |
|
$ |
419 |
|
|
$ |
378 |
|
Universal life |
|
|
376 |
|
|
|
358 |
|
Annuities |
|
|
523 |
|
|
|
435 |
|
Other |
|
|
25 |
|
|
|
23 |
|
|
|
|
|
|
|
|
Total |
|
$ |
1,343 |
|
|
$ |
1,194 |
|
|
|
|
|
|
|
|
At December 31, 2005, and 2004, the fair value associated with the annuities shown above was
approximately $563 million and $477 million, respectively.
6. Notes Payable
We had two lines of credit with commercial banks amounting to $125 million with no
outstanding balance at year-end 2005. We had no compensating balance requirement on
short-term debt for either 2005 or 2004. We did not use either of these lines of credit in
2005. We had one line of credit with a commercial bank amounting to $75 million with no
outstanding balance at year-end 2004.
During 2004, we terminated an interest-rate swap entered into by CFC Investment Company in
2001 as a cash hedge of variable interest payments for certain variable-rate debt
obligations. When we paid off the underlying debt, we terminated this agreement at a cost of
$2 million, net of tax.
7. Senior Debt
This table summarizes the principal amounts of our long-term debt:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(In millions) |
|
|
|
|
|
|
|
|
|
|
|
Interest |
|
Year of |
|
|
|
|
|
|
|
At
December 31, |
|
rate |
|
issue |
|
|
|
|
|
|
|
2005 |
|
|
2004 |
|
|
6.125% |
|
2004 |
|
Senior notes, due 2034 |
|
|
|
|
|
$ |
375 |
|
|
$ |
375 |
|
6.92% |
|
2005 |
|
Senior debentures, due 2028 |
|
|
|
|
|
|
392 |
|
|
|
0 |
|
6.90% |
|
1998 |
|
Senior debentures, due 2028 |
|
|
|
|
|
|
28 |
|
|
|
420 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total |
|
|
|
|
|
$ |
795 |
|
|
$ |
795 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
The fair value of our senior debt approximated $870 million at year-end 2005 and
approximated $843 million at year-end 2004.
During 2005, we completed the exchange of outstanding 6.125% senior notes due 2034 for up to
$375 million aggregate principal amount of newly issued 6.125% series B senior notes due
2034, which are substantially identical to the old 6.125% senior notes except that they have
been registered under the Securities Act of 1933, as amended. As of the expiration of the
exchange offer, $365 million aggregate principal amount of the outstanding notes had been
tendered and accepted for exchange. That transaction had no effect on the companys
financial statements. We also completed our offer to exchange outstanding 6.90% senior
debentures due 2028 for up to $420 million aggregate principal amount of newly issued 6.92%
senior debentures due 2028. Holders of $392 million aggregate principal amount of the 6.90%
senior debentures opted to exchange their bonds for newly issued 6.92% senior debentures.
None of the notes are encumbered by rating triggers.
8. Shareholders Equity and Dividend Restrictions
Our insurance subsidiary declared dividends to the company of $275 million in 2005,
$175 million in 2004 and $50 million in 2003. State of Ohio regulatory requirements restrict
the dividends insurance subsidiaries can pay. Generally, the most Ohio-domiciled insurance
subsidiaries can pay without prior regulatory approval is the greater of 10 percent of
statutory surplus or 100 percent of statutory net income for the prior calendar year up to
the amount of statutory unassigned surplus as of the end of the prior calendar year.
Dividends exceeding
2005 10-K Page 91
these limitations may be paid only with approval of the Ohio Department
of Insurance. During 2006, the total dividends that our lead insurance subsidiary may pay to
our parent company without regulatory approval will be approximately $517 million.
Our board of directors on August 19, 2005, announced a program to repurchase up to 10
million shares of outstanding stock effective September 1, 2005. The new program replaced a
1999 repurchase authorization. Between September 1, 2005, and December 31, 2005, we
purchased 534,000 shares at a cost of $24 million. At year-end 2005, 9.5 million shares
remained authorized for repurchase at any time in the future. Repurchase shares are not
adjusted for stock dividends.
As of December 31, 2005, 13 million shares of common stock were available for future stock
option grants.
Declared cash dividends per share were $1.21, $1.04 and 90 cents for the years ended
December 31, 2005, 2004 and 2003, respectively.
Accumulated Other Comprehensive Income
The change in unrealized gains and losses on investments and derivatives included:
|
|
|
|
|
|
|
|
|
|
|
|
|
(In millions) |
|
Years ended December 31, |
|
|
|
2005 |
|
|
2004 |
|
|
2003 |
|
|
Unrealized holding investment gains and losses on securities and derivatives
|
|
$ |
(694 |
) |
|
$ |
(369 |
) |
|
$ |
649 |
|
Reclassification adjustment: |
|
|
|
|
|
|
|
|
|
|
|
|
Adjustment to deferred acquisition costs and life policy reserves |
|
|
6 |
|
|
|
3 |
|
|
|
(13 |
) |
Net realized (gain) loss on investments and derivatives |
|
|
(61 |
) |
|
|
(91 |
) |
|
|
41 |
|
Income taxes on above |
|
|
246 |
|
|
|
160 |
|
|
|
(236 |
) |
|
|
|
|
|
|
|
|
|
|
Total |
|
$ |
(503 |
) |
|
$ |
(297 |
) |
|
$ |
441 |
|
|
|
|
|
|
|
|
|
|
|
Income taxes relate to each component above ratably.
9. Reinsurance
Our statements of income include earned property casualty premiums on assumed and ceded
business:
|
|
|
|
|
|
|
|
|
|
|
|
|
(In millions) |
|
Years ended December 31, |
|
|
|
2005 |
|
|
2004 |
|
|
2003 |
|
|
Direct written premiums |
|
$ |
3,231 |
|
|
$ |
3,141 |
|
|
$ |
2,949 |
|
Assumed written premiums |
|
|
23 |
|
|
|
33 |
|
|
|
44 |
|
Ceded written premiums |
|
|
(178 |
) |
|
|
(177 |
) |
|
|
(178 |
) |
|
|
|
|
|
|
|
|
|
|
Net written premiums |
|
$ |
3,076 |
|
|
$ |
2,997 |
|
|
$ |
2,815 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Direct earned premiums |
|
$ |
3,209 |
|
|
$ |
3,062 |
|
|
$ |
2,808 |
|
Assumed earned premiums |
|
|
28 |
|
|
|
32 |
|
|
|
56 |
|
Ceded earned premiums |
|
|
(179 |
) |
|
|
(175 |
) |
|
|
(211 |
) |
|
|
|
|
|
|
|
|
|
|
Net earned premiums |
|
$ |
3,058 |
|
|
$ |
2,919 |
|
|
$ |
2,653 |
|
|
|
|
|
|
|
|
|
|
|
Our statements of income include incurred property casualty loss and loss expenses on
assumed and ceded business:
|
|
|
|
|
|
|
|
|
|
|
|
|
(In millions) |
|
Years ended December 31, |
|
|
|
2005 |
|
|
2004 |
|
|
2003 |
|
|
Direct incurred loss and loss expenses |
|
$ |
1,898 |
|
|
$ |
1,870 |
|
|
$ |
1,856 |
|
Assumed incurred loss and loss expenses |
|
|
40 |
|
|
|
17 |
|
|
|
44 |
|
Ceded incurred loss and loss expenses |
|
|
(126 |
) |
|
|
(134 |
) |
|
|
(103 |
) |
|
|
|
|
|
|
|
|
|
|
Net incurred loss and loss expenses |
|
$ |
1,812 |
|
|
$ |
1,753 |
|
|
$ |
1,797 |
|
|
|
|
|
|
|
|
|
|
|
2005 10-K Page 92
10. Income Taxes
Here is a summary of the major components of our net deferred tax liability:
|
|
|
|
|
|
|
|
|
(In millions) |
|
At December 31, |
|
|
|
2005 |
|
|
2004 |
|
|
Deferred tax liabilities: |
|
|
|
|
|
|
|
|
Unrealized gains on investments and derivatives |
|
$ |
1,788 |
|
|
$ |
2,033 |
|
Deferred acquisition costs |
|
|
135 |
|
|
|
129 |
|
Other |
|
|
32 |
|
|
|
38 |
|
|
|
|
|
|
|
|
Total |
|
|
1,955 |
|
|
|
2,200 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Deferred tax assets: |
|
|
|
|
|
|
|
|
Loss and loss expense reserves |
|
|
179 |
|
|
|
180 |
|
Unearned premiums |
|
|
108 |
|
|
|
107 |
|
Life policy reserves |
|
|
26 |
|
|
|
28 |
|
Capital loss carryforward |
|
|
0 |
|
|
|
19 |
|
Other |
|
|
20 |
|
|
|
32 |
|
|
|
|
|
|
|
|
Total |
|
|
333 |
|
|
|
366 |
|
|
|
|
|
|
|
|
Net deferred tax liability |
|
$ |
1,622 |
|
|
$ |
1,834 |
|
|
|
|
|
|
|
|
The provision for federal income taxes is based upon a consolidated income tax return for
the company and subsidiaries. As of December 31, 2005, we had no capital loss carry
forwards.
The differences between the statutory income tax rates and our effective income tax rates
are as follows:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Years ended December 31, |
|
|
|
2005 |
|
|
2004 |
|
|
2003 |
|
|
Tax at statutory rate |
|
|
35.0 |
% |
|
|
35.0 |
% |
|
|
35.0 |
% |
Increase (decrease) resulting from: |
|
|
|
|
|
|
|
|
|
|
|
|
Tax-exempt municipal bonds |
|
|
(3.2 |
) |
|
|
(2.5 |
) |
|
|
(3.8 |
) |
Dividend exclusion |
|
|
(5.7 |
) |
|
|
(5.7 |
) |
|
|
(8.6 |
) |
Other |
|
|
0.7 |
|
|
|
0.2 |
|
|
|
(0.6 |
) |
|
|
|
|
|
|
|
|
|
|
Effective rate |
|
|
26.8 |
% |
|
|
27.0 |
% |
|
|
22.0 |
% |
|
|
|
|
|
|
|
|
|
|
Filed tax returns for calendar years 2000 through 2004 are currently open with the Internal
Revenue Service. Federal income taxes are not provided for on our life insurance
subsidiarys Policyholder Surplus Account (PSA), which totaled $14 million at December 31,
2005, 2004 and 2003. Prior to 2005, U.S. tax rules provided that tax was due only on amounts
distributed from the PSA. Had a distribution from the PSA occurred prior to 2005, tax due
would have been approximately $5 million at current federal income tax rates.
The tax liability of a stock life insurance company on distributions made from the PSA was
suspended beginning January 1, 2005, by the American Jobs Creation Act of 2004. As a result
of this legislation, our life insurance subsidiary has the ability to distribute amounts
from its PSA to the parent company prior to December 31, 2006, without incurring federal
income tax, thereby permanently eliminating the $5 million tax previously disclosed.
11. Net Income Per Common Share
Basic earnings per share are computed based on the weighted average number of shares
outstanding. Diluted earnings per share are computed based on the weighted average number of
common and dilutive potential common shares outstanding. We have adjusted shares and
earnings per share to reflect all stock splits and dividends prior to December 31, 2005.
Here are calculations for basic and diluted earnings per share:
|
|
|
|
|
|
|
|
|
|
|
|
|
(Dollars in millions except share data) |
|
Years ended December 31, |
|
|
|
2005 |
|
|
2004 |
|
|
2003 |
|
|
Numerator: |
|
|
|
|
|
|
|
|
|
|
|
|
Net incomebasic and diluted |
|
$ |
602 |
|
|
$ |
584 |
|
|
$ |
374 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Denominator: |
|
|
|
|
|
|
|
|
|
|
|
|
Weighted-average common shares outstanding |
|
|
175,062,669 |
|
|
|
176,476,722 |
|
|
|
177,119,594 |
|
Effect of stock options |
|
|
2,053,457 |
|
|
|
1,900,126 |
|
|
|
1,172,654 |
|
|
|
|
|
|
|
|
|
|
|
Adjusted weighted-average shares |
|
|
177,116,126 |
|
|
|
178,376,848 |
|
|
|
178,292,248 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Earnings per share: |
|
|
|
|
|
|
|
|
|
|
|
|
Basic |
|
$ |
3.44 |
|
|
$ |
3.30 |
|
|
$ |
2.11 |
|
Diluted |
|
$ |
3.40 |
|
|
$ |
3.28 |
|
|
$ |
2.10 |
|
The only current source of dilution of our common shares is outstanding stock options to
purchase shares of common stock. At year-end 2005, all outstanding options were included in
the calculation. At year-end 2004
2005 10-K Page 93
and 2003, there were 0.3 million and 2.2 million
outstanding options that we did not include in this calculation. We did not include these
options in the computation of net income per common share (diluted) because their exercise
prices were greater than the average market price of the common shares.
12. Pension Plan
We sponsor a defined contribution plan (401(k) savings plan) and a defined benefit
pension plan covering substantially all employees. We do not contribute to the 401(k) plan.
Benefits for the defined benefit plan are based on years of credited service and
compensation level. Contributions are based on the frozen entry age actuarial cost method.
We also maintained a supplemental executive retirement plan, with liabilities of
approximately $4 million, at year-end 2005 and 2004. Our pension expense is composed of
several components that are determined using the projected unit credit actuarial cost
method, and they are based on certain actuarial assumptions.
Here is more detailed information about our defined benefit pension plan:
|
|
|
|
|
|
|
|
|
(In millions) |
|
Years ended December 31, |
|
|
|
2005 |
|
|
2004 |
|
|
Change in benefit obligation: |
|
|
|
|
|
|
|
|
Benefit obligation at beginning of year |
|
$ |
199 |
|
|
$ |
167 |
|
Service cost |
|
|
13 |
|
|
|
11 |
|
Interest cost |
|
|
12 |
|
|
|
10 |
|
Actuarial loss |
|
|
18 |
|
|
|
14 |
|
Benefits paid |
|
|
(7 |
) |
|
|
(3 |
) |
|
|
|
|
|
|
|
Benefit obligation at end of year |
|
$ |
235 |
|
|
$ |
199 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Accumulated benefit obligation |
|
$ |
165 |
|
|
$ |
142 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Change in plan assets: |
|
|
|
|
|
|
|
|
Fair value of plan assets at beginning of year |
|
$ |
158 |
|
|
$ |
138 |
|
Actual return on plan assets |
|
|
12 |
|
|
|
15 |
|
Employer contributions |
|
|
10 |
|
|
|
8 |
|
Benefits paid |
|
|
(7 |
) |
|
|
(3 |
) |
|
|
|
|
|
|
|
Fair value of plan assets at end of year |
|
$ |
173 |
|
|
$ |
158 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Funded status: |
|
|
|
|
|
|
|
|
Funded status at end of year |
|
$ |
(62 |
) |
|
$ |
(41 |
) |
Unrecognized net actuarial gain |
|
|
52 |
|
|
|
34 |
|
Unrecognized net transitional asset |
|
|
(1 |
) |
|
|
(1 |
) |
Unrecognized prior service cost |
|
|
7 |
|
|
|
7 |
|
|
|
|
|
|
|
|
Accrued pension cost |
|
$ |
(4 |
) |
|
$ |
(1 |
) |
|
|
|
|
|
|
|
We use a December 31 measurement date for our plans. The accumulated benefit obligation was
$165 million and $142 million at December 31, 2005, and 2004, respectively. The fair value
of our stock comprised $29 million (17 percent of total plan assets) at December 31, 2005,
and $27 million (17 percent of total plan assets) at December 31, 2004.
We evaluate our pension plan assumptions annually and update them as necessary. The discount
rate assumptions for our benefit obligation track with Moodys Aa bond yield, and yearly
adjustments reflect any changes to those bond yields. Compensation increase assumptions
reflect historical calendar year compensation increases.
Here is a summary of the assumptions we use to determine our benefit obligation:
|
|
|
|
|
|
|
|
|
|
|
Years ended December 31, |
|
|
2005 |
|
2004 |
|
Discount rate |
|
|
5.50 |
% |
|
|
5.75 |
% |
Rate of compensation increase |
|
|
5-7 |
|
|
|
5-7 |
|
Here is a breakdown of the components of our net periodic benefit cost:
|
|
|
|
|
|
|
|
|
|
|
|
|
(In millions) |
|
Years ended December 31, |
|
|
|
2005 |
|
|
2004 |
|
|
2003 |
|
|
Service cost |
|
$ |
13 |
|
|
$ |
11 |
|
|
$ |
9 |
|
Interest cost |
|
|
12 |
|
|
|
10 |
|
|
|
9 |
|
Expected return on plan assets |
|
|
(13 |
) |
|
|
(12 |
) |
|
|
(13 |
) |
Amortization of actuarial gain |
|
|
1 |
|
|
|
0 |
|
|
|
(1 |
) |
|
|
|
|
|
|
|
|
|
|
Net pension expense |
|
$ |
13 |
|
|
$ |
9 |
|
|
$ |
4 |
|
|
|
|
|
|
|
|
|
|
|
We expect to contribute approximately $10 million to our pension plan in 2006.
2005 10-K Page 94
Here is a summary of the assumptions we use to determine our net expense for the plan:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Years ended December 31, |
|
|
2005 |
|
2004 |
|
2003 |
|
Discount rate |
|
|
5.75 |
% |
|
|
6.00 |
% |
|
|
6.50 |
% |
Expected return on plan assets |
|
|
8.00 |
|
|
|
8.00 |
|
|
|
8.00 |
|
Rate of compensation increase |
|
|
5-7 |
|
|
|
5-7 |
|
|
|
5-7 |
|
Our pension plan asset allocations by category are:
|
|
|
|
|
|
|
|
|
(In millions) |
|
At December 31, |
|
|
|
2005 |
|
|
2004 |
|
|
Asset category: |
|
|
|
|
|
|
|
|
Equity securities |
|
|
93 |
% |
|
|
91 |
% |
Fixed maturities |
|
|
5 |
|
|
|
7 |
|
Cash and cash equivalents |
|
|
2 |
|
|
|
2 |
|
|
|
|
|
|
|
|
Total |
|
|
100 |
% |
|
|
100 |
% |
|
|
|
|
|
|
|
For 2006, we expect to target 90 percent of our pension plan assets for equity securities
and 10 percent for fixed maturities and cash.
We expect to make the following benefit payments, which reflect expected future service:
|
|
|
|
|
(In millions) |
|
Pension |
For the years ended December 31, |
|
benefits |
|
2006 |
|
$ |
5 |
|
2007 |
|
|
7 |
|
2008 |
|
|
10 |
|
2009 |
|
|
10 |
|
2010 |
|
|
9 |
|
Years 2011-2015 |
|
|
84 |
|
13. Statutory Accounting Information
Insurance companies use statutory accounting practices (SAP) as prescribed by
regulatory authorities. Statutory accounting differs in certain respects from GAAP. The
following table reconciles GAAP consolidated net income for the years ended December 31, and
shareholders equity at December 31, with total statutory net income and capital and
surplus:
|
|
|
|
|
|
|
|
|
|
|
|
|
(In millions) |
|
Years ended December 31, |
|
|
|
2005 |
|
|
2004 |
|
|
2003 |
|
|
Consolidated net income per GAAP |
|
$ |
602 |
|
|
$ |
584 |
|
|
$ |
374 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Adjustments: |
|
|
|
|
|
|
|
|
|
|
|
|
Deferred policy acquisition costs |
|
|
(19 |
) |
|
|
(30 |
) |
|
|
(42 |
) |
Deferred income taxes |
|
|
13 |
|
|
|
73 |
|
|
|
(13 |
) |
Income from derivatives |
|
|
19 |
|
|
|
(10 |
) |
|
|
(9 |
) |
Elimination of intercompany realized gain |
|
|
(2 |
) |
|
|
88 |
|
|
|
0 |
|
Parent company and undistributed net
income of non insurance subsidiaries |
|
|
(41 |
) |
|
|
(84 |
) |
|
|
(67 |
) |
Other |
|
|
(19 |
) |
|
|
6 |
|
|
|
10 |
|
|
|
|
|
|
|
|
|
|
|
Insurance subsidiaries net income per SAP |
|
$ |
553 |
|
|
$ |
627 |
|
|
$ |
253 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Balances by major business type: |
|
|
|
|
|
|
|
|
|
|
|
|
Property casualty insurance |
|
$ |
532 |
|
|
$ |
599 |
|
|
$ |
233 |
|
Life insurance |
|
|
21 |
|
|
|
28 |
|
|
|
20 |
|
|
|
|
|
|
|
|
|
|
|
Total |
|
$ |
553 |
|
|
$ |
627 |
|
|
$ |
253 |
|
|
|
|
|
|
|
|
|
|
|
2005 10-K Page 95
|
|
|
|
|
|
|
|
|
(In millions) |
|
At
December 31, |
|
|
|
2005 |
|
|
2004 |
|
|
Consolidated shareholders equity per GAAP |
|
$ |
6,086 |
|
|
$ |
6,249 |
|
|
|
|
|
|
|
|
|
|
Adjustments: |
|
|
|
|
|
|
|
|
Deferred policy acquisition costs |
|
|
(429 |
) |
|
|
(400 |
) |
Investments at fair value |
|
|
(102 |
) |
|
|
(272 |
) |
Deferred income taxes |
|
|
172 |
|
|
|
238 |
|
Parent company and undistributed net income of non-insurance subsidiaries |
|
|
(1,439 |
) |
|
|
(1,550 |
) |
Reserves and non-admitted assets |
|
|
(13 |
) |
|
|
(11 |
) |
Other |
|
|
(81 |
) |
|
|
(63 |
) |
|
|
|
|
|
|
|
Insurance subsidiaries shareholders equity per SAP |
|
$ |
4,194 |
|
|
$ |
4,191 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Balances by major business type: |
|
|
|
|
|
|
|
|
Property casualty insurance |
|
$ |
3,743 |
|
|
$ |
3,752 |
|
Life insurance |
|
|
451 |
|
|
|
439 |
|
|
|
|
|
|
|
|
Total |
|
$ |
4,194 |
|
|
$ |
4,191 |
|
|
|
|
|
|
|
|
14. Transactions with Affiliated Parties
We paid certain officers and directors, or insurance agencies of which they are
shareholders, commissions of approximately $6 million, $11 million and $19 million on
premium volume of approximately $41 million, $76 million, and $132 million for 2005, 2004
and 2003, respectively.
On November 15, 2004, we repurchased 1 million shares of Cincinnati Financial common stock
from Robert C. Schiff, Trustee, Robert C. Schiff Revocable Trust originally dated November
21, 2001. Robert C. Schiff is a founder of the company and retired as director of Cincinnati
Financial Corporation in November 2004. The stock was sold to Cincinnati Financial at an
aggregate purchase price equal to 99 percent of the product of (a) 1,000,000 multiplied by
(b) $43.45, the last reported sale price per share of the common stock on the Nasdaq
National Market at the close of trading on November 12, 2004.
15. Contingencies
Legal issues are part of the normal course of business for all companies. As such, we
have various litigation and claims against us in process and pending. Having analyzed those
claims with our legal counsel, we believe the outcomes of normal insurance matters will not
have a material effect on our consolidated financial position or results of operations. We
further believe that the outcomes of non-insurance matters will be covered by insurance
coverage or will not have a material effect on our consolidated financial position or
results of operations.
As previously reported, in June 2004 we discovered some uncertainty regarding the status of
the Cincinnati Financial Corporation holding (parent) company under the Investment Company
Act of 1940. Several tests and enumerated exemptions determine whether a company meets the
definition of an investment company under the Investment Company Act. In particular, one
test states that a company may be an investment company if it owns investment securities
with a value greater than 40 percent of its total assets (excluding assets of its
subsidiaries), a level which the holding company exceeded between 1991 and August 2004.
On June 28, 2004, Cincinnati Financial Corporation filed an application with the SEC
formally requesting an exemption for the holding company under Section 3(b)(2) of the
Investment Company Act. Section 3(b)(2) specifically permits the SEC to exempt entities
primarily engaged in business other than that of investing, reinvesting, owning, holding or
trading in securities. Cincinnati Financial Corporation alternatively asked the SEC for
relief pursuant to Section 6(c) of the Investment Company Act, which would exempt it from
all the provisions of the Act because doing so is necessary or appropriate in the public
interest, consistent with the protection of investors and consistent with the purposes
intended by the Investment Company Act.
Following its SEC filing, the holding company transferred investment securities to our
subsidiary, The Cincinnati Insurance Company, in August 2004, lowering the holding companys
ratio of investment securities to holding-company-only assets below 40 percent. We have
maintained that ratio below the 40 percent level since the time of the transfer.
Because the ratio is below 40 percent, we believe the SEC staff is not actively considering
the application.
We strongly believe the holding company is, and has been, outside the intended scope of the
Investment Company Act because the company is, and has been, primarily engaged in the
business of property casualty and life insurance through its subsidiaries. As a registered
investment company, the holding company would not be permitted to operate its business as it
currently operates, nor would a registered investment company be permitted to have many of
the relationships that the holding company has with its affiliated companies.
2005 10-K Page 96
To increase certainty that regulation under the Investment Company Act would not apply to
the company in the future, our operations are limited by the constraint that investment
securities held at the holding company level should remain below the 40 percent threshold
described above. Efforts to stay below the threshold could result in:
|
|
|
A need to dispose of otherwise desirable investment securities, possibly under
undesirable conditions. Such dispositions could result in a lower return on investment
because of market value fluctuations. Dispositions also could result in loss of
investment income that we may be unable to replace in a timely fashion. If we were
unable to manage the timing of the dispositions, we also might realize unnecessary
capital gains, which would increase our annual tax payment. |
|
|
|
|
Limited opportunities to purchase equity securities that hold the potential for
market value appreciation. Historically, the holding company has successfully invested
in equity securities that provided both income and capital appreciation, contributing
to long-term growth in book value.
Constraining our ability to pursue this strategy and invest in equity securities could
hamper book value growth over the long term. |
|
|
|
|
Maintenance of a greater portion of our portfolio of equity securities at our
insurance subsidiary. As a result of the transfer of assets to ensure compliance with
the 40 percent threshold, the holding
company now is more reliant on that subsidiary for cash to fund parent-company
obligations, including shareholder dividends and interest on long-term debt. |
Although we intend to manage assets to stay below the 40 percent threshold, events beyond
our control, including significant appreciation in the value of certain investment
securities, could result in the holding company exceeding the 40 percent threshold. While we
believe that even in such circumstances the company would not be an investment company
because it is primarily engaged in the business of insurance through its subsidiaries, the
SEC, among others, could disagree with this position.
If it were determined that the holding company is an unregistered investment company, the
holding company might be unable to enforce contracts with third parties, and third parties
could seek rescission of transactions with the holding company undertaken during the period
that it was an unregistered investment company, subject to equitable considerations set
forth in the Investment Company Act. In addition, the holding company could become subject
to monetary penalties or injunctive relief, or both, in an action brought by the SEC.
16. Stock Options
See Note 1 for a general description of our stock option plans. Here is a summary of
options information:
|
|
|
|
|
|
|
|
|
(Shares in thousands) |
|
|
|
|
|
Weighted-average |
|
Years ended December 31, |
|
Shares |
|
|
exercise price |
|
|
2005 |
|
|
|
|
|
|
|
|
Outstanding at beginning of year |
|
|
9,698 |
|
|
$ |
32.05 |
|
Granted/reinstated |
|
|
1,504 |
|
|
|
41.62 |
|
Exercised |
|
|
(467 |
) |
|
|
24.18 |
|
Forfeited/revoked |
|
|
(146 |
) |
|
|
35.89 |
|
|
|
|
|
|
|
|
|
Outstanding at end of year |
|
|
10,589 |
|
|
|
33.70 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Options exercisable at end of year |
|
|
7,794 |
|
|
$ |
31.69 |
|
Weighted-average fair value of options granted during the year |
|
|
|
|
|
|
12.49 |
|
|
|
|
|
|
|
|
|
|
2004 |
|
|
|
|
|
|
|
|
Outstanding at beginning of year |
|
|
8,791 |
|
|
$ |
30.63 |
|
Granted/reinstated |
|
|
1,439 |
|
|
|
38.81 |
|
Exercised |
|
|
(397 |
) |
|
|
24.02 |
|
Forfeited/revoked |
|
|
(135 |
) |
|
|
34.29 |
|
|
|
|
|
|
|
|
|
Outstanding at end of year |
|
|
9,698 |
|
|
|
32.05 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Options exercisable at end of year |
|
|
7,050 |
|
|
$ |
30.50 |
|
Weighted-average fair value of options granted during the year |
|
|
|
|
|
|
11.18 |
|
|
|
|
|
|
|
|
|
|
2003 |
|
|
|
|
|
|
|
|
Outstanding at beginning of year |
|
|
7,845 |
|
|
$ |
29.96 |
|
Granted/reinstated |
|
|
1,366 |
|
|
|
32.47 |
|
Exercised |
|
|
(295 |
) |
|
|
20.47 |
|
Forfeited/revoked |
|
|
(125 |
) |
|
|
32.79 |
|
|
|
|
|
|
|
|
|
Outstanding at end of year |
|
|
8,791 |
|
|
|
30.63 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Options exercisable at end of year |
|
|
6,303 |
|
|
$ |
29.57 |
|
Weighted-average fair value of options granted during the year |
|
|
|
|
|
|
9.82 |
|
2005 10-K Page 97
Options outstanding and exercisable consisted of the following at December 31, 2005:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Options outstanding |
|
|
Options exercisable |
|
|
|
|
|
|
|
Weighted-average |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
remaining |
|
|
|
|
|
|
Weighted-average |
|
|
|
|
|
|
Weighted-average |
|
Range of exercise prices |
|
Shares |
|
|
contractual life |
|
|
|
|
|
|
exercise price |
|
|
Shares |
|
|
exercise price |
|
|
|
|
$17.07 to 19.34 |
|
|
474 |
|
|
|
0.36 |
yrs |
|
|
|
$ |
18.50 |
|
|
|
474 |
|
|
$ |
18.50 |
|
$20.37 to 24.14 |
|
|
309 |
|
|
|
1.28 |
yrs |
|
|
|
|
20.70 |
|
|
|
309 |
|
|
|
20.70 |
|
$26.63 to 29.92 |
|
|
1,066 |
|
|
|
4.00 |
yrs |
|
|
|
|
27.07 |
|
|
|
1,066 |
|
|
|
27.07 |
|
$30.60 to 35.00 |
|
|
4,938 |
|
|
|
5.16 |
yrs |
|
|
|
|
32.65 |
|
|
|
4,515 |
|
|
|
32.67 |
|
$36.17 to 38.87 |
|
|
2,065 |
|
|
|
6.28 |
yrs |
|
|
|
|
38.46 |
|
|
|
1,162 |
|
|
|
38.20 |
|
$41.14 to 41.62 |
|
|
1,737 |
|
|
|
7.97 |
yrs |
|
|
|
|
41.55 |
|
|
|
268 |
|
|
|
41.15 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total |
|
|
10,589 |
|
|
|
5.40 |
yrs |
|
|
|
|
33.70 |
|
|
|
7,794 |
|
|
|
31.69 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
17. Segment Information
We operate primarily in two industries, property casualty insurance and life insurance.
We regularly review four different reporting segments to make decisions about allocating
resources and assessing performance:
|
|
|
Commercial lines property casualty insurance |
|
|
|
|
Personal lines property casualty insurance |
|
|
|
|
Life insurance |
|
|
|
|
Investment operations |
We report as Other the operations of the parent company, CFC Investment Company and CinFin
Capital Management Company (excluding investment activities) as well as other income of our
insurance subsidiary.
Revenues come primarily from unaffiliated customers:
|
|
|
All three insurance segments record revenues from insurance premiums earned. Life
insurance segment revenues also include fees from separate account investment
management fees. |
|
|
|
|
Our investment operations revenues are pretax net investment income plus realized
investment gains and losses. |
|
|
|
|
Other revenues are primarily finance/lease income. |
Income or loss before income taxes for each segment is reported based on the nature of that
business areas operations. To explain:
|
|
|
Income before income taxes for the insurance segments is defined as underwriting
income or loss. |
|
|
|
|
For commercial lines and personal lines insurance segments, we calculate
underwriting income or loss by recording premiums earned minus loss and loss expenses
and underwriting expenses incurred. |
|
|
|
|
For the life insurance segment, we determine underwriting income or loss by taking
premiums earned and separate account investment management fees, minus contract holder
benefits and expenses incurred, plus investment interest credited to contract holders. |
|
|
|
|
Income before income taxes for the investment operations segment is net investment
income plus realized investment gains and losses for all fixed-maturity and equity
security investments of the entire company, minus investment interest credited to
contract holders of the life insurance segment. |
|
|
|
|
Loss before income taxes for the Other category is primarily due to interest expense
from debt of the parent company and operating expenses of our headquarters. |
Identifiable assets are used by each segment in its operations. We do not report the
identifiable assets for the commercial or personal lines segments because we do not use that
measure to analyze the segments. We include all fixed-maturity and equity security
investment assets, regardless of ownership, in the investment operations segment.
2005 10-K Page 98
This table summarizes segment information:
|
|
|
|
|
|
|
|
|
|
|
|
|
(In millions) |
|
Years ended December 31, |
|
|
|
2005 |
|
|
2004 |
|
|
2003 |
|
|
Revenues: |
|
|
|
|
|
|
|
|
|
|
|
|
Commercial lines insurance |
|
|
|
|
|
|
|
|
|
|
|
|
Commercial multi-peril |
|
$ |
796 |
|
|
$ |
751 |
|
|
$ |
673 |
|
Workers compensation |
|
|
328 |
|
|
|
313 |
|
|
|
293 |
|
Commercial auto |
|
|
456 |
|
|
|
450 |
|
|
|
419 |
|
Other liability |
|
|
442 |
|
|
|
402 |
|
|
|
342 |
|
Other commercial lines |
|
|
232 |
|
|
|
210 |
|
|
|
181 |
|
|
|
|
|
|
|
|
|
|
|
Total commercial lines insurance |
|
|
2,254 |
|
|
|
2,126 |
|
|
|
1,908 |
|
|
|
|
|
|
|
|
|
|
|
Personal lines insurance |
|
|
|
|
|
|
|
|
|
|
|
|
Personal auto |
|
|
433 |
|
|
|
451 |
|
|
|
428 |
|
Homeowner |
|
|
285 |
|
|
|
259 |
|
|
|
239 |
|
Other personal lines |
|
|
86 |
|
|
|
83 |
|
|
|
78 |
|
|
|
|
|
|
|
|
|
|
|
Total personal lines insurance |
|
|
804 |
|
|
|
793 |
|
|
|
745 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Life insurance |
|
|
110 |
|
|
|
104 |
|
|
|
97 |
|
Investment operations |
|
|
587 |
|
|
|
583 |
|
|
|
424 |
|
Other |
|
|
12 |
|
|
|
8 |
|
|
|
7 |
|
|
|
|
|
|
|
|
|
|
|
Total |
|
$ |
3,767 |
|
|
$ |
3,614 |
|
|
$ |
3,181 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Income (loss) before income taxes: |
|
|
|
|
|
|
|
|
|
|
|
|
Insurance underwriting results: |
|
|
|
|
|
|
|
|
|
|
|
|
Commercial lines insurance |
|
$ |
285 |
|
|
$ |
338 |
|
|
$ |
167 |
|
Personal lines insurance |
|
|
45 |
|
|
|
(40 |
) |
|
|
(27 |
) |
Life insurance |
|
|
7 |
|
|
|
2 |
|
|
|
(3 |
) |
Investment operations |
|
|
536 |
|
|
|
537 |
|
|
|
381 |
|
Other |
|
|
(50 |
) |
|
|
(37 |
) |
|
|
(38 |
) |
|
|
|
|
|
|
|
|
|
|
Total |
|
$ |
823 |
|
|
$ |
800 |
|
|
$ |
480 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Identifiable assets: |
|
|
|
|
|
|
|
|
|
|
|
|
Property casualty insurance |
|
$ |
2,167 |
|
|
$ |
2,317 |
|
|
|
|
|
Life insurance |
|
|
845 |
|
|
|
837 |
|
|
|
|
|
Investment operations |
|
|
12,774 |
|
|
|
12,746 |
|
|
|
|
|
Other |
|
|
217 |
|
|
|
207 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total |
|
$ |
16,003 |
|
|
$ |
16,107 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Quarterly Supplementary Data (Unaudited)
This table includes unaudited quarterly financial information for the years ended
December 31, 2005 and 2004:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(Dollars in millions except per share data) |
|
Quarter |
|
|
1st |
|
2nd |
|
3rd |
|
4th |
|
Full year |
|
2005 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Revenues |
|
$ |
916 |
|
|
$ |
940 |
|
|
$ |
944 |
|
|
$ |
967 |
|
|
$ |
3,767 |
|
Income before income taxes |
|
|
195 |
|
|
|
215 |
|
|
|
151 |
|
|
|
261 |
|
|
|
823 |
|
Net income |
|
|
144 |
|
|
|
158 |
|
|
|
117 |
|
|
|
183 |
|
|
|
602 |
|
Net income per common sharebasic |
|
|
0.82 |
|
|
|
0.90 |
|
|
|
0.67 |
|
|
|
1.04 |
|
|
|
3.44 |
|
Net income per common sharediluted |
|
|
0.81 |
|
|
|
0.89 |
|
|
|
0.66 |
|
|
|
1.03 |
|
|
|
3.40 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
2004 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Revenues |
|
$ |
870 |
|
|
$ |
923 |
|
|
$ |
879 |
|
|
$ |
942 |
|
|
$ |
3,614 |
|
Income before income taxes |
|
|
201 |
|
|
|
214 |
|
|
|
113 |
|
|
|
272 |
|
|
|
800 |
|
Net income |
|
|
146 |
|
|
|
155 |
|
|
|
90 |
|
|
|
192 |
|
|
|
584 |
|
Net income per common sharebasic |
|
|
0.83 |
|
|
|
0.88 |
|
|
|
0.51 |
|
|
|
1.10 |
|
|
|
3.30 |
|
Net income per common sharediluted |
|
|
0.82 |
|
|
|
0.87 |
|
|
|
0.50 |
|
|
|
1.09 |
|
|
|
3.28 |
|
Note: The sum of the quarterly reported amounts may not equal the full year as each is computed independently.
2005 10-K Page 99
Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure
We had no disagreements with the independent registered public accounting firm on
accounting and financial disclosure during the last two fiscal years.
Item 9A. Controls and Procedures
The company maintains disclosure controls and procedures (as that term is defined in
Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934, as amended
(Exchange Act)).
Any controls and procedures, no matter how well designed and operated, can provide only
reasonable assurance of achieving the desired control objectives. The companys management,
with the participation of the companys chief executive officer and chief financial officer,
has evaluated the effectiveness of the design and operation of the companys disclosure
controls and procedures as of December 31, 2005. Based upon that evaluation, the companys
chief executive officer and chief financial officer concluded that the design and operation
of the companys disclosure controls and procedures provided reasonable assurance that the
disclosure controls and procedures are effective to ensure:
|
|
that information required to be disclosed in the companys reports under the
Exchange Act is recorded, processed, summarized and reported within the time periods
specified in the Securities and Exchange Commissions rules and forms, and |
|
|
|
that such information is accumulated and communicated to the companys management,
including its chief executive officer and chief financial officer, as appropriate, to
allow timely decisions regarding required disclosures. |
In addition, there was no change in the companys internal controls over financial reporting
(as that term is defined in Rules 13a-15(f) and 15d-15(f) under the Exchange Act) that
occurred during the quarter ended December 31, 2005 that has materially affected, or is
reasonably likely to materially affect, the companys internal control over financial
reporting.
Managements Annual Report on Internal Control Over Financial Reporting and the Attestation
Report of the Independent Registered Public Accounting Firm are set forth in Item 8, Pages
78 and 79.
Item 9B. Other Information
None
Part III
Our Proxy Statement will be filed with the SEC in preparation for the 2006 Annual
Meeting of Shareholders no later than April 14, 2006. As permitted in Paragraph G(3) of the
General Instructions for Form 10-K, we are incorporating by reference to that statement
portions of the information required by Part III as noted in Item 10 through Item 14 below.
Item 10. Directors and Executive Officers of the Registrant
a) Information about our directors and executive officers is in the Proxy Statement
under Security Ownership of Principal Shareholders and Management, Information Regarding
Nondirector Executive Officers and Information regarding Nominees and Directors.
b) Information about Section 16(a) beneficial ownership reporting compliance appears in the
Proxy Statement under Section 16(a) Beneficial Ownership Reporting Compliance.
c) Information about the Code of Ethics for Senior Financial Officers appears in the 2004
Proxy Statement as an appendix and is available in the Investors section of our Web site,
www.cinfin.com. Our code of ethics applies to those who are responsible for preparing and
disclosing our financial information. This includes our chief executive officer, chief
financial officer, chief investment officer and others performing similar functions or
reporting directly to these officers.
d) Information about our audit committee membership and our financial expert compliance
appears in the Proxy Statement under Information Regarding the Board of Directors and
Report of the Audit Committee.
e) The procedures under which shareholders may recommend director nominees have not changed
during the reporting period. Information on the nominating committee processes appears in
the Proxy Statement under Information Regarding the Board of Directors.
Item 11. Executive Compensation
Information on executive compensation appears in the Proxy Statement under Executive
Compensation Summary.
2005 10-K Page 100
Item 12. Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters
a) Information on the security ownership of certain beneficial owners and management
appears in the Proxy Statement under Security Ownership of Principal Shareholders and
Management.
b) Information on securities authorized for issuance under equity compensation plans appears
in the Proxy Statement under Equity Compensation Plan Information. Additional information
on options under our equity compensation plans is available in Item 8, Note 8 and Note 16 to
the Consolidated Financial Statements, Pages 91 and 97.
Item 13. Certain Relationships and Related Transactions
Information about certain relationships and related transactions appears in the Proxy
Statement under Certain Relationships and Transactions and Compensation Committee
Interlocks and Insider Participation.
Item 14. Principal Accountant Fees and Services
Information about independent registered public accounting firm fees and services and
audit committee pre-approval policies and procedures appears in the Proxy Statement under
Report of the Audit Committee, Fees Billed by the Independent Registered Public
Accounting Firm and Services Provided by the Independent Registered Public Accounting
Firm.
Part IV
Item 15. Exhibits and Financial Statement Schedules
a) Financial Statements information contained in Part II, Item 8 of this report,
Pages 80 83
b) Exhibits see Index of Exhibits, Page 113
c) Financial Statement Schedules
Schedule I Summary of Investments Other than Investments in Related Parties, Page
102
Schedule II Condensed Financial Statements of Registrant, Page 104
Schedule III Supplementary Insurance Information, Page 107
Schedule IV Reinsurance, Page 109
Schedule V Valuation and Qualifying Accounts, Page 110
Schedule VI Supplementary Information Concerning Property Casualty Insurance
Operations, Page 111
2005 10-K Page 101
Schedule I
|
|
|
|
|
|
|
|
|
|
|
|
|
Cincinnati Financial Corporation and Subsidiaries |
|
Summary of Investments - Other than Investments in Related Parties |
|
(In millions) |
|
At December 31, 2005 |
|
|
|
Cost or amortized |
|
|
|
|
|
|
Balance sheet |
|
Type of investment |
|
cost |
|
|
Fair value |
|
|
amount |
|
|
Fixed maturities: |
|
|
|
|
|
|
|
|
|
|
|
|
United States government and government agencies
and authorities: |
|
|
|
|
|
|
|
|
|
|
|
|
The Cincinnati Insurance Company |
|
$ |
623 |
|
|
$ |
610 |
|
|
$ |
610 |
|
The Cincinnati Casualty Company |
|
|
6 |
|
|
|
7 |
|
|
|
7 |
|
The Cincinnati Indemnity Company |
|
|
2 |
|
|
|
2 |
|
|
|
2 |
|
The Cincinnati Life Insurance Company |
|
|
369 |
|
|
|
362 |
|
|
|
362 |
|
|
|
|
|
|
|
|
|
|
|
Total |
|
|
1,000 |
|
|
|
981 |
|
|
|
981 |
|
|
|
|
|
|
|
|
|
|
|
States, municipalities and political subdivisions: |
|
|
|
|
|
|
|
|
|
|
|
|
The Cincinnati Insurance Company |
|
|
1,927 |
|
|
|
1,958 |
|
|
|
1,958 |
|
The Cincinnati Casualty Company |
|
|
117 |
|
|
|
118 |
|
|
|
118 |
|
The Cincinnati Indemnity Company |
|
|
34 |
|
|
|
34 |
|
|
|
34 |
|
The Cincinnati Life Insurance Company |
|
|
5 |
|
|
|
7 |
|
|
|
7 |
|
|
|
|
|
|
|
|
|
|
|
Total |
|
|
2,083 |
|
|
|
2,117 |
|
|
|
2,117 |
|
|
|
|
|
|
|
|
|
|
|
Public utilities: |
|
|
|
|
|
|
|
|
|
|
|
|
The Cincinnati Insurance Company |
|
|
53 |
|
|
|
54 |
|
|
|
54 |
|
The Cincinnati Casualty Company |
|
|
4 |
|
|
|
4 |
|
|
|
4 |
|
The Cincinnati Indemnity Company |
|
|
1 |
|
|
|
1 |
|
|
|
1 |
|
The Cincinnati Life Insurance Company |
|
|
80 |
|
|
|
83 |
|
|
|
83 |
|
Cincinnati Financial Corporation |
|
|
1 |
|
|
|
1 |
|
|
|
1 |
|
|
|
|
|
|
|
|
|
|
|
Total |
|
|
139 |
|
|
|
143 |
|
|
|
143 |
|
|
|
|
|
|
|
|
|
|
|
Convertibles and bonds with warrants attached: |
|
|
|
|
|
|
|
|
|
|
|
|
The Cincinnati Insurance Company |
|
|
221 |
|
|
|
229 |
|
|
|
229 |
|
The Cincinnati Casualty Company |
|
|
0 |
|
|
|
0 |
|
|
|
0 |
|
The Cincinnati Indemnity Company |
|
|
1 |
|
|
|
1 |
|
|
|
1 |
|
The Cincinnati Life Insurance Company |
|
|
42 |
|
|
|
43 |
|
|
|
43 |
|
CinFin Capital Management Company |
|
|
0 |
|
|
|
0 |
|
|
|
0 |
|
Cincinnati Financial Corporation |
|
|
5 |
|
|
|
5 |
|
|
|
5 |
|
|
|
|
|
|
|
|
|
|
|
Total |
|
|
269 |
|
|
|
278 |
|
|
|
278 |
|
|
|
|
|
|
|
|
|
|
|
All other corporate bonds: |
|
|
|
|
|
|
|
|
|
|
|
|
The Cincinnati Insurance Company |
|
|
933 |
|
|
|
958 |
|
|
|
958 |
|
The Cincinnati Casualty Company |
|
|
30 |
|
|
|
31 |
|
|
|
31 |
|
The Cincinnati Indemnity Company |
|
|
13 |
|
|
|
14 |
|
|
|
14 |
|
The Cincinnati Life Insurance Company |
|
|
805 |
|
|
|
837 |
|
|
|
837 |
|
Cincinnati Financial Corporation |
|
|
115 |
|
|
|
117 |
|
|
|
117 |
|
|
|
|
|
|
|
|
|
|
|
Total |
|
|
1,896 |
|
|
|
1,957 |
|
|
|
1,957 |
|
|
|
|
|
|
|
|
|
|
|
Total fixed maturities |
|
$ |
5,387 |
|
|
$ |
5,476 |
|
|
$ |
5,476 |
|
|
|
|
|
|
|
|
|
|
|
2005 10-K Page 102
Schedule I (Continued)
|
|
|
|
|
|
|
|
|
|
|
|
|
Cincinnati Financial Corporation and Subsidiaries |
|
Summary of Investments - Other than Investments in Related Parties |
|
(In millions) |
|
At December 31, 2005 |
|
|
|
Cost or amortized |
|
|
|
|
|
|
Balance sheet |
|
(In
millions)
Type of investment |
|
cost |
|
|
Fair value |
|
|
amount |
|
|
Equity securities: |
|
|
|
|
|
|
|
|
|
|
|
|
Common stocks: |
|
|
|
|
|
|
|
|
|
|
|
|
Public utilities: |
|
|
|
|
|
|
|
|
|
|
|
|
The Cincinnati Insurance Company |
|
$ |
120 |
|
|
$ |
372 |
|
|
$ |
372 |
|
The Cincinnati Casualty Company |
|
|
5 |
|
|
|
14 |
|
|
|
14 |
|
The Cincinnati Life Insurance Company |
|
|
14 |
|
|
|
67 |
|
|
|
67 |
|
CinFin Capital Management Company |
|
|
0 |
|
|
|
0 |
|
|
|
|
|
Cincinnati Financial Corporation |
|
|
82 |
|
|
|
559 |
|
|
|
559 |
|
|
|
|
|
|
|
|
|
|
|
Total |
|
|
221 |
|
|
|
1,012 |
|
|
|
1,012 |
|
|
|
|
|
|
|
|
|
|
|
Banks, trust and insurance companies: |
|
|
|
|
|
|
|
|
|
|
|
|
The Cincinnati Insurance Company |
|
|
431 |
|
|
|
2,228 |
|
|
|
2,228 |
|
The Cincinnati Casualty Company |
|
|
16 |
|
|
|
77 |
|
|
|
77 |
|
The Cincinnati Indemnity Company |
|
|
0 |
|
|
|
0 |
|
|
|
0 |
|
The Cincinnati Life Insurance Company |
|
|
56 |
|
|
|
162 |
|
|
|
162 |
|
CinFin Capital Management Company |
|
|
1 |
|
|
|
1 |
|
|
|
1 |
|
Cincinnati Financial Corporation |
|
|
433 |
|
|
|
1,603 |
|
|
|
1,603 |
|
|
|
|
|
|
|
|
|
|
|
Total |
|
|
937 |
|
|
|
4,071 |
|
|
|
4,071 |
|
|
|
|
|
|
|
|
|
|
|
Industrial, miscellaneous and all other: |
|
|
|
|
|
|
|
|
|
|
|
|
The Cincinnati Insurance Company |
|
|
526 |
|
|
|
1,304 |
|
|
|
1,304 |
|
The Cincinnati Casualty Company |
|
|
19 |
|
|
|
58 |
|
|
|
58 |
|
The Cincinnati Indemnity Company |
|
|
6 |
|
|
|
15 |
|
|
|
15 |
|
The Cincinnati Life Insurance Company |
|
|
90 |
|
|
|
198 |
|
|
|
198 |
|
CinFin Capital Management Company |
|
|
3 |
|
|
|
3 |
|
|
|
3 |
|
Cincinnati Financial Corporation |
|
|
159 |
|
|
|
275 |
|
|
|
275 |
|
|
|
|
|
|
|
|
|
|
|
Total |
|
|
803 |
|
|
|
1,853 |
|
|
|
1,853 |
|
|
|
|
|
|
|
|
|
|
|
Nonredeemable preferred stocks: |
|
|
|
|
|
|
|
|
|
|
|
|
The Cincinnati Insurance Company |
|
|
128 |
|
|
|
132 |
|
|
|
132 |
|
The Cincinnati Casualty Company |
|
|
0 |
|
|
|
0 |
|
|
|
0 |
|
The Cincinnati Indemnity Company |
|
|
0 |
|
|
|
0 |
|
|
|
0 |
|
The Cincinnati Life Insurance Company |
|
|
31 |
|
|
|
30 |
|
|
|
30 |
|
CinFin Capital Management Company |
|
|
0 |
|
|
|
0 |
|
|
|
0 |
|
Cincinnati Financial Corporation |
|
|
8 |
|
|
|
8 |
|
|
|
8 |
|
|
|
|
|
|
|
|
|
|
|
Total |
|
|
167 |
|
|
|
170 |
|
|
|
170 |
|
|
|
|
|
|
|
|
|
|
|
Total equity securities |
|
$ |
2,128 |
|
|
$ |
7,106 |
|
|
$ |
7,106 |
|
|
|
|
|
|
|
|
|
|
|
Short-term investments: |
|
|
|
|
|
|
|
|
|
|
|
|
The Cincinnati Insurance Company |
|
$ |
75 |
|
|
$ |
75 |
|
|
$ |
75 |
|
|
|
|
|
|
|
|
|
|
|
Other invested assets: |
|
|
|
|
|
|
|
|
|
|
|
|
Real estate: |
|
|
|
|
|
XXXX |
|
|
|
|
The Cincinnati Life Insurance Company |
|
$ |
3 |
|
|
XXXX |
|
$ |
3 |
|
|
|
|
|
|
|
|
|
|
|
|
Policy loans: |
|
|
|
|
|
XXXX |
|
|
|
|
The Cincinnati Life Insurance Company |
|
|
29 |
|
|
XXXX |
|
|
29 |
|
|
|
|
|
|
|
|
|
|
|
|
Notes receivable: |
|
|
|
|
|
XXXX |
|
|
|
|
Cincinnati Financial Corporation |
|
|
13 |
|
|
XXXX |
|
|
13 |
|
|
|
|
|
|
|
|
|
|
|
|
Total other invested assets |
|
$ |
45 |
|
|
XXXX |
|
$ |
45 |
|
|
|
|
|
|
|
|
|
|
|
|
Total investments |
|
$ |
7,635 |
|
|
XXXX |
|
$ |
12,702 |
|
|
|
|
|
|
|
|
|
|
|
|
2005 10-K Page 103
Schedule II
Cincinnati Financial Corporation (parent company only)
Condensed Balance Sheets
|
|
|
|
|
|
|
|
|
(In millions) |
|
At
December 31, |
|
|
|
2005 |
|
|
2004 |
|
|
ASSETS |
|
|
|
|
|
|
|
|
Investments |
|
|
|
|
|
|
|
|
Fixed maturities, at fair value |
|
$ |
123 |
|
|
$ |
129 |
|
Equity securities, at fair value |
|
|
2,444 |
|
|
|
2,680 |
|
Short-term investments, at fair value |
|
|
0 |
|
|
|
21 |
|
Other invested assets |
|
|
13 |
|
|
|
7 |
|
Cash and cash equivalents |
|
|
7 |
|
|
|
28 |
|
Equity in net assets of subsidiaries |
|
|
4,685 |
|
|
|
4,732 |
|
Investment income receivable |
|
|
17 |
|
|
|
17 |
|
Land, building and equipment, net, for company use (accumulated depreciation:
2005$61; 2004$51) |
|
|
98 |
|
|
|
77 |
|
Prepaid federal income tax |
|
|
32 |
|
|
|
21 |
|
Other assets |
|
|
17 |
|
|
|
14 |
|
Due from subsidiaries |
|
|
144 |
|
|
|
63 |
|
|
|
|
|
|
|
|
Total assets |
|
$ |
7,580 |
|
|
$ |
7,789 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
LIABILITIES |
|
|
|
|
|
|
|
|
Dividends declared but unpaid |
|
$ |
53 |
|
|
$ |
46 |
|
Deferred federal income tax |
|
|
635 |
|
|
|
688 |
|
6.125% senior notes due 2034 |
|
|
371 |
|
|
|
371 |
|
6.9% senior debentures due 2028 |
|
|
28 |
|
|
|
420 |
|
6.92% senior debentures due 2028 |
|
|
392 |
|
|
|
0 |
|
Other liabilities |
|
|
15 |
|
|
|
15 |
|
|
|
|
|
|
|
|
Total liabilities |
|
|
1,494 |
|
|
|
1,540 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
SHAREHOLDERS EQUITY |
|
|
|
|
|
|
|
|
Common stock |
|
|
389 |
|
|
|
370 |
|
Paid-in capital |
|
|
969 |
|
|
|
618 |
|
Retained earnings |
|
|
2,088 |
|
|
|
2,057 |
|
Accumulated other comprehensive incomeunrealized gains on investments and derivatives |
|
|
3,284 |
|
|
|
3,787 |
|
Treasury stock at cost |
|
|
(644 |
) |
|
|
(583 |
) |
|
|
|
|
|
|
|
Total shareholders equity |
|
|
6,086 |
|
|
|
6,249 |
|
|
|
|
|
|
|
|
Total liabilities and shareholders equity |
|
$ |
7,580 |
|
|
$ |
7,789 |
|
|
|
|
|
|
|
|
|
|
|
|
|
This condensed financial information should be read in conjunction with the Consolidated Financial Statements and Notes included
in Part II, Item 8, Page 77. |
2005 10-K Page 104
Schedule II (Continued)
Cincinnati Financial Corporation (parent company only)
Condensed Statements of Income
|
|
|
|
|
|
|
|
|
|
|
|
|
(In millions) |
|
Years ended December 31, |
|
|
|
2005 |
|
|
2004 |
|
|
2003 |
|
|
REVENUES |
|
|
|
|
|
|
|
|
|
|
|
|
Dividends from subsidiaries |
|
$ |
275 |
|
|
$ |
175 |
|
|
$ |
50 |
|
Investment income, net of expenses |
|
|
89 |
|
|
|
110 |
|
|
|
131 |
|
Realized gains (losses) on investments |
|
|
2 |
|
|
|
18 |
|
|
|
(23 |
) |
Other revenue |
|
|
10 |
|
|
|
9 |
|
|
|
7 |
|
|
|
|
|
|
|
|
|
|
|
Total revenues |
|
|
376 |
|
|
|
312 |
|
|
|
165 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
EXPENSES |
|
|
|
|
|
|
|
|
|
|
|
|
Interest expense |
|
|
52 |
|
|
|
36 |
|
|
|
33 |
|
Depreciation expense |
|
|
3 |
|
|
|
3 |
|
|
|
4 |
|
Other expenses |
|
|
16 |
|
|
|
14 |
|
|
|
15 |
|
|
|
|
|
|
|
|
|
|
|
Total expenses |
|
|
71 |
|
|
|
53 |
|
|
|
52 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
INCOME BEFORE INCOME TAXES AND EARNINGS OF SUBSIDIARIES |
|
|
305 |
|
|
|
259 |
|
|
|
113 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Income tax provision (benefit) |
|
|
(7 |
) |
|
|
3 |
|
|
|
(1 |
) |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
NET INCOME BEFORE EARNINGS OF SUBSIDIARIES |
|
|
312 |
|
|
|
256 |
|
|
|
114 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Increase in undistributed earnings of subsidiaries |
|
|
290 |
|
|
|
328 |
|
|
|
260 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
NET INCOME |
|
$ |
602 |
|
|
$ |
584 |
|
|
$ |
374 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
This condensed financial information should be read in conjunction with the Consolidated Financial Statements and Notes included
in Part II, Item 8, Page 77. |
2005 10-K Page 105
Schedule II (Continued)
Cincinnati Financial Corporation (parent company only)
Condensed Statements of Cash Flows
|
|
|
|
|
|
|
|
|
|
|
|
|
(In millions) |
|
Years ended December 31, |
|
|
|
2005 |
|
|
2004 |
|
|
2003 |
|
|
CASH FLOWS FROM OPERATING ACTIVITIES |
|
|
|
|
|
|
|
|
|
|
|
|
Net income |
|
$ |
602 |
|
|
$ |
584 |
|
|
$ |
374 |
|
Adjustments to reconcile net income to net cash provided by operating activities: |
|
|
|
|
|
|
|
|
|
|
|
|
Depreciation and amortization |
|
|
3 |
|
|
|
3 |
|
|
|
4 |
|
Realized (gains) losses on investments |
|
|
(2 |
) |
|
|
(18 |
) |
|
|
23 |
|
Changes in: |
|
|
|
|
|
|
|
|
|
|
|
|
Investment income receivable |
|
|
0 |
|
|
|
10 |
|
|
|
1 |
|
Current federal income taxes |
|
|
(12 |
) |
|
|
(30 |
) |
|
|
(2 |
) |
Deferred income taxes |
|
|
19 |
|
|
|
20 |
|
|
|
(10 |
) |
Other assets |
|
|
(3 |
) |
|
|
(2 |
) |
|
|
(1 |
) |
Other liabilities |
|
|
0 |
|
|
|
6 |
|
|
|
2 |
|
Undistributed earnings of subsidiaries |
|
|
(290 |
) |
|
|
(328 |
) |
|
|
(260 |
) |
|
|
|
|
|
|
|
|
|
|
Net cash provided by operating activities |
|
|
317 |
|
|
|
245 |
|
|
|
131 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
CASH FLOWS FROM INVESTING ACTIVITIES |
|
|
|
|
|
|
|
|
|
|
|
|
Sale of fixed-maturity investments |
|
|
8 |
|
|
|
193 |
|
|
|
50 |
|
Maturity of fixed-maturity investments |
|
|
2 |
|
|
|
50 |
|
|
|
71 |
|
Sale of equity security investments |
|
|
18 |
|
|
|
36 |
|
|
|
8 |
|
Purchase of fixed-maturity investments |
|
|
(9 |
) |
|
|
(95 |
) |
|
|
(47 |
) |
Purchase of equity security investments |
|
|
(12 |
) |
|
|
(196 |
) |
|
|
(33 |
) |
Change in short-term investments, net |
|
|
21 |
|
|
|
(21 |
) |
|
|
0 |
|
Investment in buildings and equipment, net |
|
|
(24 |
) |
|
|
(1 |
) |
|
|
(1 |
) |
Change in other invested assets, net |
|
|
(8 |
) |
|
|
(1 |
) |
|
|
2 |
|
|
|
|
|
|
|
|
|
|
|
Net cash (used in) provided by investing activities |
|
|
(4 |
) |
|
|
(35 |
) |
|
|
50 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
CASH FLOWS FROM FINANCING ACTIVITIES |
|
|
|
|
|
|
|
|
|
|
|
|
Proceeds from 6.125% senior notes |
|
|
0 |
|
|
|
371 |
|
|
|
0 |
|
Debt issuance costs from 6.125% senior notes |
|
|
0 |
|
|
|
(4 |
) |
|
|
0 |
|
Decrease in notes payable |
|
|
0 |
|
|
|
(152 |
) |
|
|
0 |
|
Payment of cash dividends to shareholders |
|
|
(204 |
) |
|
|
(177 |
) |
|
|
(156 |
) |
Purchase/issuance of treasury shares |
|
|
(61 |
) |
|
|
(59 |
) |
|
|
(55 |
) |
Proceeds from stock options exercised |
|
|
11 |
|
|
|
3 |
|
|
|
6 |
|
Net transfers to subsidiaries |
|
|
(80 |
) |
|
|
(170 |
) |
|
|
28 |
|
|
|
|
|
|
|
|
|
|
|
Net cash used in financing activities |
|
|
(334 |
) |
|
|
(188 |
) |
|
|
(177 |
) |
|
|
|
|
|
|
|
|
|
|
Net increase (decrease) in cash and cash equivalents |
|
|
(21 |
) |
|
|
22 |
|
|
|
4 |
|
Cash and cash equivalents at beginning of year |
|
|
28 |
|
|
|
6 |
|
|
|
2 |
|
|
|
|
|
|
|
|
|
|
|
Cash and cash equivalents at end of year |
|
$ |
7 |
|
|
$ |
28 |
|
|
$ |
6 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
This condensed financial information should be read in conjunction with the Consolidated Financial Statements and Notes included
in Part II, Item 8, Page 77. |
2005 10-K Page 106
Schedule III
Cincinnati Financial Corporation and Subsidiaries
Supplementary Insurance Information
|
|
|
|
|
|
|
|
|
|
|
|
|
(In millions) |
|
Years ended December 31, |
|
|
|
2005 |
|
|
2004 |
|
|
2003 |
|
|
Deferred policy acquisition costs: |
|
|
|
|
|
|
|
|
|
|
|
|
Commercial lines insurance |
|
$ |
226 |
|
|
$ |
218 |
|
|
$ |
207 |
|
Personal lines insurance |
|
|
85 |
|
|
|
88 |
|
|
|
80 |
|
|
|
|
|
|
|
|
|
|
|
Total property casualty insurance |
|
|
311 |
|
|
|
306 |
|
|
|
287 |
|
Life insurance |
|
|
118 |
|
|
|
94 |
|
|
|
85 |
|
|
|
|
|
|
|
|
|
|
|
Total |
|
$ |
429 |
|
|
$ |
400 |
|
|
$ |
372 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Future policy benefits, losses, claims and expense losses: |
|
|
|
|
|
|
|
|
|
|
|
|
Commercial lines insurance |
|
$ |
3,173 |
|
|
$ |
3,016 |
|
|
$ |
2,933 |
|
Personal lines insurance |
|
|
456 |
|
|
|
498 |
|
|
|
453 |
|
|
|
|
|
|
|
|
|
|
|
Total property casualty insurance |
|
|
3,629 |
|
|
|
3,514 |
|
|
|
3,386 |
|
Life insurance |
|
|
1,362 |
|
|
|
1,213 |
|
|
|
1,040 |
|
|
|
|
|
|
|
|
|
|
|
Total (1) |
|
$ |
4,991 |
|
|
$ |
4,727 |
|
|
$ |
4,426 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Unearned premiums: |
|
|
|
|
|
|
|
|
|
|
|
|
Commercial lines insurance |
|
$ |
1,150 |
|
|
$ |
1,112 |
|
|
$ |
1,037 |
|
Personal lines insurance |
|
|
407 |
|
|
|
425 |
|
|
|
407 |
|
|
|
|
|
|
|
|
|
|
|
Total property casualty insurance |
|
|
1,557 |
|
|
|
1,537 |
|
|
|
1,444 |
|
Life insurance |
|
|
2 |
|
|
|
2 |
|
|
|
2 |
|
|
|
|
|
|
|
|
|
|
|
Total (1) |
|
$ |
1,559 |
|
|
$ |
1,539 |
|
|
$ |
1,446 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Other policy claims and benefits payable: |
|
|
|
|
|
|
|
|
|
|
|
|
Commercial lines insurance |
|
$ |
0 |
|
|
$ |
0 |
|
|
$ |
0 |
|
Personal lines insurance |
|
|
0 |
|
|
|
0 |
|
|
|
0 |
|
|
|
|
|
|
|
|
|
|
|
Total property casualty insurance |
|
|
0 |
|
|
|
0 |
|
|
|
0 |
|
Life insurance |
|
|
13 |
|
|
|
16 |
|
|
|
14 |
|
|
|
|
|
|
|
|
|
|
|
Total (1) |
|
$ |
13 |
|
|
$ |
16 |
|
|
$ |
14 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Premium revenues: |
|
|
|
|
|
|
|
|
|
|
|
|
Commercial lines insurance |
|
$ |
2,254 |
|
|
$ |
2,126 |
|
|
$ |
1,908 |
|
Personal lines insurance |
|
|
804 |
|
|
|
793 |
|
|
|
745 |
|
|
|
|
|
|
|
|
|
|
|
Total property casualty insurance |
|
|
3,058 |
|
|
|
2,919 |
|
|
|
2,653 |
|
Life insurance |
|
|
106 |
|
|
|
101 |
|
|
|
95 |
|
|
|
|
|
|
|
|
|
|
|
Total |
|
$ |
3,164 |
|
|
$ |
3,020 |
|
|
$ |
2,748 |
|
|
|
|
|
|
|
|
|
|
|
2005 10-K Page 107
Schedule III (Continued)
Cincinnati Financial Corporation and Subsidiaries
Supplementary Insurance Information
|
|
|
|
|
|
|
|
|
|
|
|
|
(In millions) |
|
Years ended December 31, |
|
|
|
2005 |
|
|
2004 |
|
|
2003 |
|
|
Investment income, net of expenses: |
|
|
|
|
|
|
|
|
|
|
|
|
Commercial lines insurance |
|
$ |
0 |
|
|
$ |
0 |
|
|
$ |
0 |
|
Personal lines insurance |
|
|
0 |
|
|
|
0 |
|
|
|
0 |
|
|
|
|
|
|
|
|
|
|
|
Total property casualty insurance (3) |
|
|
338 |
|
|
|
289 |
|
|
|
245 |
|
Life insurance |
|
|
99 |
|
|
|
91 |
|
|
|
89 |
|
|
|
|
|
|
|
|
|
|
|
Total |
|
$ |
437 |
|
|
$ |
380 |
|
|
$ |
334 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Benefits, claims losses and settlement expenses: |
|
|
|
|
|
|
|
|
|
|
|
|
Commercial lines insurance |
|
$ |
1,298 |
|
|
$ |
1,154 |
|
|
$ |
1,218 |
|
Personal lines insurance |
|
|
514 |
|
|
|
599 |
|
|
|
579 |
|
|
|
|
|
|
|
|
|
|
|
Total property casualty insurance |
|
|
1,812 |
|
|
|
1,753 |
|
|
|
1,797 |
|
Life insurance |
|
|
102 |
|
|
|
95 |
|
|
|
91 |
|
|
|
|
|
|
|
|
|
|
|
Total |
|
$ |
1,914 |
|
|
$ |
1,848 |
|
|
$ |
1,888 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Amortization of deferred policy acquisition costs: |
|
|
|
|
|
|
|
|
|
|
|
|
Commercial lines insurance |
|
$ |
473 |
|
|
$ |
448 |
|
|
$ |
398 |
|
Personal lines insurance |
|
|
168 |
|
|
|
162 |
|
|
|
160 |
|
|
|
|
|
|
|
|
|
|
|
Total property casualty insurance |
|
|
641 |
|
|
|
610 |
|
|
|
558 |
|
Life insurance |
|
|
23 |
|
|
|
16 |
|
|
|
15 |
|
|
|
|
|
|
|
|
|
|
|
Total (2) |
|
$ |
664 |
|
|
$ |
626 |
|
|
$ |
573 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Other operating expenses: |
|
|
|
|
|
|
|
|
|
|
|
|
Commercial lines insurance |
|
$ |
198 |
|
|
$ |
186 |
|
|
$ |
125 |
|
Personal lines insurance |
|
|
77 |
|
|
|
72 |
|
|
|
33 |
|
|
|
|
|
|
|
|
|
|
|
Total property casualty insurance |
|
|
275 |
|
|
|
258 |
|
|
|
158 |
|
Life insurance |
|
|
29 |
|
|
|
37 |
|
|
|
37 |
|
|
|
|
|
|
|
|
|
|
|
Total (2) |
|
$ |
304 |
|
|
$ |
295 |
|
|
$ |
195 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Written premiums: |
|
|
|
|
|
|
|
|
|
|
|
|
Commercial lines insurance |
|
$ |
2,290 |
|
|
$ |
2,186 |
|
|
$ |
2,031 |
|
Personal lines insurance |
|
|
786 |
|
|
|
811 |
|
|
|
784 |
|
|
|
|
|
|
|
|
|
|
|
Total property casualty insurance |
|
|
3,076 |
|
|
|
2,997 |
|
|
|
2,815 |
|
Accident health insurance |
|
|
3 |
|
|
|
3 |
|
|
|
3 |
|
|
|
|
|
|
|
|
|
|
|
Total |
|
$ |
3,079 |
|
|
$ |
3,000 |
|
|
$ |
2,818 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Notes to Schedule III: |
|
(1) |
|
The sum of future policy benefits, losses, claims and expense losses, unearned
premium and other policy claims and other policy claims and benefits payable is equal to the
sum of loss and loss expense, life policy reserves and unearned premiums reported in the
companys consolidated balance sheets. |
|
(2) |
|
The sum of amortization of deferred policy acquisition costs and other operating
expenses is equal to the sum of Commissions; Other operating expenses; Taxes, licenses and
fees; Increase in deferred acquisition costs; and Other expenses shown in the consolidated
statements of income, less other expenses not applicable to the above insurance segments. |
|
(3) |
|
This segment information is not regularly allocated to segments and reviewed by company
management in making decisions about resources to be allocated to the segments or to assess
their performance. |
2005 10-K Page 108
Schedule IV
Cincinnati Financial Corporation and Subsidiaries
Reinsurance
|
|
|
|
|
|
|
|
|
|
|
|
|
(Dollars in millions) |
|
Years ended December 31, |
|
|
|
2005 |
|
|
2004 |
|
|
2003 |
|
|
Gross premiums: |
|
|
|
|
|
|
|
|
|
|
|
|
Life insurance in force |
|
$ |
51,488 |
|
|
$ |
44,916 |
|
|
$ |
38,486 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Earned premiums
|
|
|
|
|
|
|
|
|
|
|
|
|
Commercial lines insurance |
|
$ |
2,386 |
|
|
$ |
2,246 |
|
|
$ |
2,046 |
|
Personal lines insurance |
|
|
823 |
|
|
|
816 |
|
|
|
762 |
|
|
|
|
|
|
|
|
|
|
|
Total property casualty insurance |
|
|
3,209 |
|
|
|
3,062 |
|
|
|
2,808 |
|
Life insurance |
|
|
150 |
|
|
|
138 |
|
|
|
125 |
|
|
|
|
|
|
|
|
|
|
|
Total |
|
$ |
3,359 |
|
|
$ |
3,200 |
|
|
$ |
2,933 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Ceded to other companies: |
|
|
|
|
|
|
|
|
|
|
|
|
Life insurance in force |
|
$ |
30,705 |
|
|
$ |
28,196 |
|
|
$ |
23,296 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Earned premiums
|
|
|
|
|
|
|
|
|
|
|
|
|
Commercial lines insurance |
|
$ |
157 |
|
|
$ |
148 |
|
|
$ |
193 |
|
Personal lines insurance |
|
|
22 |
|
|
|
27 |
|
|
|
18 |
|
|
|
|
|
|
|
|
|
|
|
Total property casualty insurance |
|
|
179 |
|
|
|
175 |
|
|
|
211 |
|
Life insurance |
|
|
44 |
|
|
|
37 |
|
|
|
30 |
|
|
|
|
|
|
|
|
|
|
|
Total |
|
$ |
223 |
|
|
$ |
212 |
|
|
$ |
241 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Assumed from other companies: |
|
|
|
|
|
|
|
|
|
|
|
|
Life insurance in force |
|
$ |
5 |
|
|
$ |
5 |
|
|
$ |
6 |
|
|
|
|
|
|
|
|
|
|
|
Earned premiums
|
|
|
|
|
|
|
|
|
|
|
|
|
Commercial lines insurance |
|
$ |
25 |
|
|
$ |
28 |
|
|
$ |
55 |
|
Personal lines insurance |
|
|
3 |
|
|
|
4 |
|
|
|
1 |
|
|
|
|
|
|
|
|
|
|
|
Total property casualty insurance |
|
|
28 |
|
|
|
32 |
|
|
|
56 |
|
Life insurance |
|
|
0 |
|
|
|
0 |
|
|
|
0 |
|
|
|
|
|
|
|
|
|
|
|
Total |
|
$ |
28 |
|
|
$ |
32 |
|
|
$ |
56 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net premiums: |
|
|
|
|
|
|
|
|
|
|
|
|
Life insurance in force |
|
$ |
20,788 |
|
|
$ |
16,725 |
|
|
$ |
15,196 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Earned premiums
|
|
|
|
|
|
|
|
|
|
|
|
|
Commercial lines insurance |
|
$ |
2,254 |
|
|
$ |
2,126 |
|
|
$ |
1,908 |
|
Personal lines insurance |
|
|
804 |
|
|
|
793 |
|
|
|
745 |
|
|
|
|
|
|
|
|
|
|
|
Total property casualty insurance |
|
|
3,058 |
|
|
|
2,919 |
|
|
|
2,653 |
|
Life insurance |
|
|
106 |
|
|
|
101 |
|
|
|
95 |
|
|
|
|
|
|
|
|
|
|
|
Total |
|
$ |
3,164 |
|
|
$ |
3,020 |
|
|
$ |
2,748 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Percentage of amount assumed to net: |
|
|
|
|
|
|
|
|
|
|
|
|
Life insurance in force |
|
|
0.0 |
% |
|
|
0.0 |
% |
|
|
0.0 |
% |
Earned premiums
|
|
|
|
|
|
|
|
|
|
|
|
|
Commercial lines insurance |
|
|
1.1 |
% |
|
|
1.3 |
% |
|
|
2.9 |
% |
Personal lines insurance |
|
|
0.4 |
|
|
|
0.5 |
|
|
|
0.2 |
|
Total property casualty insurance |
|
|
0.9 |
|
|
|
1.1 |
|
|
|
2.1 |
|
Life insurance |
|
|
0.0 |
|
|
|
0.1 |
|
|
|
0.1 |
|
Total |
|
|
0.9 |
|
|
|
1.1 |
|
|
|
2.0 |
|
2005 10-K Page 109
Schedule V
Cincinnati Financial Corporation and Subsidiaries
Valuation and Qualifying Accounts
|
|
|
|
|
|
|
|
|
|
|
|
|
(In millions) |
|
At
December 31, |
|
|
|
2005 |
|
|
2004 |
|
|
2003 |
|
|
Allowance for doubtful receivables: |
|
|
|
|
|
|
|
|
|
|
|
|
Balance at beginning of period |
|
$ |
0 |
|
|
$ |
0 |
|
|
$ |
1 |
|
Additions charged to costs and expenses |
|
|
1 |
|
|
|
0 |
|
|
|
0 |
|
Other additions |
|
|
0 |
|
|
|
0 |
|
|
|
0 |
|
Deductions |
|
|
0 |
|
|
|
0 |
|
|
|
(1 |
) |
|
|
|
|
|
|
|
|
|
|
Balance at end of period |
|
$ |
1 |
|
|
$ |
0 |
|
|
$ |
0 |
|
|
|
|
|
|
|
|
|
|
|
2005 10-K Page 110
Schedule VI
Cincinnati Financial Corporation and Subsidiaries
Supplementary Information Concerning Property Casualty Insurance Operations
|
|
|
|
|
|
|
|
|
|
|
|
|
(In millions) |
|
Years ended December 31, |
|
|
|
2005 |
|
|
2004 |
|
|
2003 |
|
|
Deferred policy acquisition costs: |
|
|
|
|
|
|
|
|
|
|
|
|
Commercial lines insurance |
|
$ |
226 |
|
|
$ |
218 |
|
|
$ |
207 |
|
Personal lines insurance |
|
|
85 |
|
|
|
88 |
|
|
|
80 |
|
|
|
|
|
|
|
|
|
|
|
Total |
|
$ |
311 |
|
|
$ |
306 |
|
|
$ |
287 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Reserves for unpaid claims and claim adjustment expenses: |
|
|
|
|
|
|
|
|
|
|
|
|
Commercial lines insurance |
|
$ |
3,173 |
|
|
$ |
3,016 |
|
|
$ |
2,933 |
|
Personal lines insurance |
|
|
456 |
|
|
|
498 |
|
|
|
453 |
|
|
|
|
|
|
|
|
|
|
|
Total |
|
$ |
3,629 |
|
|
$ |
3,514 |
|
|
$ |
3,386 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Reserve discount deducted |
|
$ |
0 |
|
|
$ |
0 |
|
|
$ |
0 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Unearned premiums: |
|
|
|
|
|
|
|
|
|
|
|
|
Commercial lines insurance |
|
$ |
1,150 |
|
|
$ |
1,112 |
|
|
$ |
1,037 |
|
Personal lines insurance |
|
|
407 |
|
|
|
425 |
|
|
|
407 |
|
|
|
|
|
|
|
|
|
|
|
Total |
|
$ |
1,557 |
|
|
$ |
1,537 |
|
|
$ |
1,444 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Earned premiums: |
|
|
|
|
|
|
|
|
|
|
|
|
Commercial lines insurance |
|
$ |
2,254 |
|
|
$ |
2,126 |
|
|
$ |
1,908 |
|
Personal lines insurance |
|
|
804 |
|
|
|
793 |
|
|
|
745 |
|
|
|
|
|
|
|
|
|
|
|
Total |
|
$ |
3,058 |
|
|
$ |
2,919 |
|
|
$ |
2,653 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Investment income: |
|
|
|
|
|
|
|
|
|
|
|
|
Commercial lines insurance (1) |
|
$ |
0 |
|
|
$ |
0 |
|
|
$ |
0 |
|
Personal lines insurance (1) |
|
|
0 |
|
|
|
0 |
|
|
|
0 |
|
|
|
|
|
|
|
|
|
|
|
Total |
|
$ |
338 |
|
|
$ |
289 |
|
|
$ |
245 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Loss and loss expenses incurred related to current accident year: |
|
|
|
|
|
|
|
|
|
|
|
|
Commercial lines insurance (1) |
|
$ |
0 |
|
|
$ |
0 |
|
|
$ |
0 |
|
Personal lines insurance (1) |
|
|
0 |
|
|
|
0 |
|
|
|
0 |
|
|
|
|
|
|
|
|
|
|
|
Total |
|
$ |
1,972 |
|
|
$ |
1,949 |
|
|
$ |
1,877 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Loss and loss expenses incurred related to prior accident years: |
|
|
|
|
|
|
|
|
|
|
|
|
Commercial lines insurance (1) |
|
$ |
0 |
|
|
$ |
0 |
|
|
$ |
0 |
|
Personal lines insurance (1) |
|
|
0 |
|
|
|
0 |
|
|
|
0 |
|
|
|
|
|
|
|
|
|
|
|
Total |
|
$ |
(160 |
) |
|
$ |
(196 |
) |
|
$ |
(80 |
) |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Amortization of deferred policy acquisition costs: |
|
|
|
|
|
|
|
|
|
|
|
|
Commercial lines insurance |
|
$ |
473 |
|
|
$ |
448 |
|
|
$ |
398 |
|
Personal lines insurance |
|
|
168 |
|
|
|
162 |
|
|
|
160 |
|
|
|
|
|
|
|
|
|
|
|
Total |
|
$ |
641 |
|
|
$ |
610 |
|
|
$ |
558 |
|
|
|
|
|
|
|
|
|
|
|
Paid loss and loss expenses: |
|
|
|
|
|
|
|
|
|
|
|
|
Commercial lines insurance |
|
$ |
1,126 |
|
|
$ |
1,062 |
|
|
$ |
1,003 |
|
Personal lines insurance |
|
|
552 |
|
|
|
559 |
|
|
|
558 |
|
|
|
|
|
|
|
|
|
|
|
Total |
|
$ |
1,678 |
|
|
$ |
1,621 |
|
|
$ |
1,561 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Written premiums: |
|
|
|
|
|
|
|
|
|
|
|
|
Commercial lines insurance |
|
$ |
2,290 |
|
|
$ |
2,186 |
|
|
$ |
2,031 |
|
Personal lines insurance |
|
|
786 |
|
|
|
811 |
|
|
|
784 |
|
|
|
|
|
|
|
|
|
|
|
Total |
|
$ |
3,076 |
|
|
$ |
2,997 |
|
|
$ |
2,815 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Note to Schedule VI: |
|
(1) |
|
This segment information is not regularly allocated to segments and not reviewed by
company management in making decisions about resources to be allocated to the segments or to
assess their performance. |
2005 10-K Page 111
Signatures
Pursuant to the requirements of Section 13 or 15 (d) 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
|
|
|
|
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/S/ Kenneth W. Stecher |
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By:
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Kenneth W. Stecher |
Title: |
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Chief Financial Officer, Senior Vice President, Secretary and Treasurer |
Date:
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March 10, 2006 |
Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been
duly signed below by the following persons on behalf of the registrant and in the capacities
and on the dates indicated.
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Signature |
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/S/ John J. Schiff, Jr.
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Chairman, President, Chief Executive Officer and
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March 6, 2006 |
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Director |
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/S/ Kenneth W. Stecher
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Chief Financial Officer, Senior Vice President,
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March 10, 2006 |
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Secretary and Treasurer (Principal Accounting Officer) |
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/S/ William F. Bahl
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Director
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February 28, 2006 |
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/S/ James E. Benoski
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Vice Chairman, Chief Insurance Officer and
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March 1, 2006 |
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Director |
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/S/ Michael Brown
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Director
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March 1, 2006 |
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/S/ Dirk J. Debbink
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Director
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March 2, 2006 |
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/S/ Kenneth C. Lichtendahl
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Director
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March 2, 2006 |
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/S/ W. Rodney McMullen
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Director
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March 1, 2006 |
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/S/ Gretchen W. Price
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Director
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March 2, 2006 |
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/S/ Thomas R. Schiff
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Director
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March 2, 2006 |
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/S/ John M. Shepherd
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Director
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February 28, 2006 |
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/S/ Douglas S. Skidmore
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Director
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March 1, 2006 |
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/S/ John F. Steele, Jr.
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Director
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March 1, 2006 |
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/S/ Larry R. Webb
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Director
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March 2, 2006 |
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/S/ E. Anthony Woods
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Director
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March 2, 2006 |
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2005 10-K Page 112
Index of Exhibits
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Exhibit No. |
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Exhibit Description |
3.1A
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Amended Articles of Incorporation of Cincinnati Financial Corporation (1) |
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3.1B
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Amendment to Article Fourth of Amended Articles of Incorporation of Cincinnati Financial Corporation (2) |
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3.2
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Regulations of Cincinnati Financial Corporation (3) |
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4.1
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Indenture with The Bank of New York Trust Company (4) |
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4.2
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Supplemental Indenture with The Bank of New York Trust Company (4) |
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4.3
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Second Supplemental Indenture with The Bank of New York Trust Company (5) |
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4.4
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Form of 6.125% Exchange Note Due 2034 (included in Exhibit 4.2) |
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4.5
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Form of 6.92% Debentures Due 2028 (included in Exhibit 4.3) |
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4.6
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Indenture with the First National Bank of Chicago (subsequently assigned to The Bank of New York Trust
Company)(6) |
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4.7
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Form of 6.90% Debentures Due 2028 (included in Exhibit 4.6) |
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10.1
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Agreement with Messer Construction (7) |
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10.2
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Stock Repurchase Agreement dated November 12, 2004 with Robert C. Schiff, Trustee, Robert C. Schiff Revocable
Trust (7) |
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10.3
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Purchase Agreement with J.P. Morgan Securities Inc. and UBS Securities LLC (8) |
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10.4
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2003 Non-Employee Directors Stock Plan (9) |
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10.5
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Cincinnati Financial Corporation Stock Option Plan No. V (10) |
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10.6
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Cincinnati Financial Corporation Stock Option Plan No. VI (11) |
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10.7
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Cincinnati Financial Corporation Stock Option Plan No. VII (12) |
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10.8
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Standard Form of Nonqualified and Incentive Option Agreements for Stock Option Plan No. V (7) |
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10.9
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Standard Form of Nonqualified and Incentive Option Agreements for Stock Option Plan No. VI (7) |
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10.10
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Standard Form of Nonqualified and Incentive Option Agreements for Stock Option Plan No. VII (7) |
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10.11
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Cincinnati Financial Corporation Stock Option Plan No. VIII (9) |
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10.12
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Registration Rights Agreement with J.P. Morgan Securities Inc. and UBS Securities LLC (4) |
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10.13
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Form of Dealer Manager Agreement between Cincinnati Financial and UBS Securities LLC (13) |
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10.14
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Standard Form of Incentive Stock Option Agreement for Stock Option Plan VIII (14) |
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10.15
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Standard Form of Nonqualified Stock Option Agreement for Stock Option Plan VIII (15) |
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10.16
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Standard Form of Combined Incentive/Nonqualified Stock Option for Stock Option Plan VI (16) |
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10.17
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364-Day Credit Agreement by and among Cincinnati Financial Corporation and CFC Investment Company, as Borrowers,
and Fifth Third Bank, as Lender (17) |
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10.18
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Director and Named Executive
Officer Compensation Summary (18) |
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10.19
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Executive Compensation Plan (19) |
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11
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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 |
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14
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Cincinnati Financial Corporation
Code of Ethics for Senior Financial Officers
(20) |
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21
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Cincinnati Financial Corporation Subsidiaries contained in Part I, Item 1 of this report, Page 1 |
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23
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Consent of Independent Registered Public Accounting Firm, Page 114 |
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31.1
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Certification pursuant to Section 302 of the Sarbanes Oxley Act of 2002 Chief Executive Officer, Page 115 |
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31.2
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Certification pursuant to Section 302 of the Sarbanes Oxley Act of 2002 Chief Financial Officer, Page 116 |
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32
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Certification pursuant to Section 906 of the Sarbanes Oxley Act of 2002, Page 117 |
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1 |
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Incorporated by reference to the
companys 1999 Annual Report on Form 10-K dated March 23, 2000 (File No.
000-04604). |
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2 |
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Incorporated by reference to Exhibit 3(i)
filed with the companys Current Report on Form 8-K dated July 15, 2005. |
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3 |
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Incorporated by reference to the companys
Definitive Proxy Statement dated March 2, 1992, Exhibit 2 (File No. 000-04604). |
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4 |
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Incorporated by reference to the companys
Current Report on Form 8-K dated November 2, 2004, filed with respect to the
issuance of the companys 6.125% Senior Notes due November 1, 2034. |
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5 |
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Incorporated by reference to the companys
Current Report on Form 8-K dated May 9, 2005, filed with respect to the
completion of the companys exchange offer and rescission offer for its 6.90%
senior debentures due 2028. |
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6 |
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Incorporated by reference to the
companys registration statement on Form S-3 effective May 22, 1998 (File No.
333-51677). |
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7 |
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Incorporated by reference to the companys
2004 Annual Report on Form 10-K dated March 11, 2005. |
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8 |
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Incorporated by reference to the companys
Current Report on Form 8-K dated November 1, 2004, filed with respect to the
issuance of the companys 6.125% Senior Notes due November 1, 2034. |
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9 |
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Incorporated by reference to the companys
Definitive Proxy Statement dated March 21, 2005. |
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10 |
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Incorporated by reference to the companys
Definitive Proxy Statement dated March 2, 1996 (File No. 000-04604). |
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11 |
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Incorporated by reference to the companys
Definitive Proxy Statement dated March 1, 1999 (File No. 000-04604). |
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12 |
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Incorporated by reference to the companys
Definitive Proxy Statement dated March 8, 2002. |
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13 |
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Incorporated by reference to the companys
Registration Statement on Form S-4 filed March 21, 2005 (File No. 333-123471). |
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14 |
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Incorporated by reference to Exhibit 10.1
filed with the companys Current Report on Form 8-K dated July 15, 2005. |
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15 |
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Incorporated by reference to Exhibit 10.2
filed with the companys Current Report on Form 8-K dated July 15, 2005. |
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16 |
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Incorporated by reference to Exhibit 10.3
filed with the companys Current Report on Form 8-K dated July 15, 2005. |
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17 |
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Incorporated by reference to Exhibit 10.1
filed with the companys Current Report on Form 8-K dated May 31, 2005. |
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18 |
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Incorporated by reference to the companys
Definitive Proxy Statement to be filed no later than April 14, 2006. |
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19 |
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Incorporated by reference to Exhibit 10.2
filed with the companys Current Report on Form 8-K dated November 23, 2005. |
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20 |
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Incorporated by reference to the companys
Definitive Proxy Statement dated March 18, 2004. |
2005 10-K Page 113
EX-23
Exhibit 23
Independent Registered Public Accounting Firm Consent
We consent to the incorporation by reference in Registration Statements No. 333-85953
(on Form S-8), No. 333-24815 (on Form S-8), No. 333-24817 (on Form S-8), No. 333-49981 (on
Form S-8), No. 333-103509 (on Form S-8), No. 333-103511 (on Form S-8), , No. 333-121429 (on
Form S-4), No. 333-123471 (on Form S-4), and No. 333-126714 (on Form S-8) of Cincinnati
Financial Corporation of our report dated March 6, 2006 relating to the consolidated
financial statements and financial statement schedules of Cincinnati Financial Corporation
and managements report of the effectiveness of internal control over financial reporting
appearing in this Annual Report on Form 10-K of Cincinnati Financial Corporation for the
year ended December 31, 2005.
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/S/ Deloitte & Touche LLP |
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Deloitte & Touche LLP
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Cincinnati, Ohio |
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March 10, 2006 |
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2005 10-K Page 114
EX-31(A)
Exhibit 31A
Certification pursuant to Section 302 of the Sarbanes Oxley Act of 2002
I, John J. Schiff, Jr., certify that:
1. |
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I have reviewed this Annual Report on Form 10-K of Cincinnati Financial
Corporation; |
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2. |
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Based on my knowledge, this 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 report; |
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3. |
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Based on my knowledge, the financial statements, and other financial information
included in this 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 report; |
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4. |
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The registrants other certifying officer and I are responsible for establishing
and maintaining disclosure controls and procedures (as defined in Exchange Act Rules
13a-15(e) and 15d-15(e)) and internal control over financial reporting (as defined in
Exchange Act Rules 13a-15(f) and 15d-15(f)) for the registrant and have: |
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designed such disclosure controls and procedures, or caused such
disclosure controls and procedures to be designed under our supervision, 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 report is being prepared; |
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b) |
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designed such internal control over financial reporting , or caused
such internal control over financial reporting to be designed under our
supervision, to provide reasonable assurance regarding the reliability of
financial reporting and the preparation of financial statements for external
purposes in accordance with generally accepted accounting principals; |
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c) |
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evaluated the effectiveness of the registrants disclosure controls and
procedures and presented in this report our conclusions about the effectiveness
of the disclosure controls and procedures, as of the end of the period covered
by this report based on such evaluation; and |
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d) |
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disclosed in this report any change in the registrants internal
control over financial reporting that occurred during the registrants most
recent fiscal quarter (the registrants fourth fiscal quarter in the case of an
annual report) that has materially affected, or is reasonably likely to
materially affect, the registrants internal control over financial reporting;
and |
5. |
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The registrants other certifying officer and I have disclosed, based on our most
recent evaluation of internal control over financial reporting, to the registrants
auditors and the audit committee of registrants board of directors (or persons
performing the equivalent functions): |
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a) |
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all significant deficiencies and material weaknesses in the design or
operation of internal controls over financial reporting which are reasonably
likely to adversely affect the registrants ability to record, process,
summarize and report financial information; and |
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b) |
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any fraud, whether or not material, that involves management or other
employees who have a significant role in the registrants internal control over
financial reporting. |
Date: March 10, 2006
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/S/ John J. Schiff, Jr. |
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John J. Schiff, Jr.
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Chairman, President and Chief Executive Officer |
2005 10-K Page 115
EX-31(B)
Exhibit 31B
Certification pursuant to Section 302 of the Sarbanes Oxley Act of 2002
I, Kenneth W. Stecher, certify that:
1. |
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I have reviewed this Annual Report on Form 10-K of Cincinnati Financial
Corporation; |
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Based on my knowledge, this 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 report; |
3. |
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Based on my knowledge, the financial statements, and other financial information
included in this 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 report; |
4. |
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The registrants other certifying officer and I are responsible for establishing
and maintaining disclosure controls and procedures (as defined in Exchange Act Rules
13a-15(e) and 15d-15(e)) and internal control over financial reporting (as defined in
Exchange Act Rules 13a-15(f) and 15d-15(f)) for the registrant and have: |
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a) |
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designed such disclosure controls and procedures, or caused such
disclosure controls and procedures to be designed under our supervision, 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 report is being prepared; |
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b) |
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designed such internal control over financial reporting , or caused
such internal control over financial reporting to be designed under our
supervision, to provide reasonable assurance regarding the reliability of
financial reporting and the preparation of financial statements for external
purposes in accordance with generally accepted accounting principals; |
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c) |
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evaluated the effectiveness of the registrants disclosure controls and
procedures and presented in this report our conclusions about the effectiveness
of the disclosure controls and procedures, as of the end of the period covered
by this report based on such evaluation; and |
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d) |
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disclosed in this report any change in the registrants internal
control over financial reporting that occurred during the registrants most
recent fiscal quarter (the registrants fourth fiscal quarter in the case of an
annual report) that has materially affected, or is reasonably likely to
materially affect, the registrants internal control over financial reporting;
and |
5. |
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The registrants other certifying officer and I have disclosed, based on our most
recent evaluation of internal control over financial reporting, to the registrants
auditors and the audit committee of registrants board of directors (or persons
performing the equivalent functions): |
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a) |
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all significant deficiencies and material weaknesses in the design or
operation of internal controls over financial reporting which are reasonably
likely to adversely affect the registrants ability to record, process,
summarize and report financial information; and |
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b) |
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any fraud, whether or not material, that involves management or other
employees who have a significant role in the registrants internal control over
financial reporting |
Date: March 10, 2006
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/S/ Kenneth W. Stecher |
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Kenneth W. Stecher
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Chief Financial Officer, Senior Vice President, Secretary and Treasurer |
(Principal Accounting Officer) |
2005 10-K Page 116
EX-32
Exhibit 32
Certification pursuant to Section 906 of the Sarbanes Oxley Act of 2002
The certification set forth below is being submitted in connection with this report on
Form 10-K for the purpose of complying with Rule 13a-14(b) or Rule 15d-14(b) of the
Securities Exchange Act of 1934 and Section 1350 of Chapter 63 of Title 18 of the United
States Code.
John J. Schiff, Jr., the chief executive officer, and Kenneth W. Stecher, the chief
financial officer, of Cincinnati Financial Corporation each certifies that, to the best of
his knowledge:
1. |
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the report fully complies with the requirements of Section 13(a) or 15(d) of the
Exchange Act; and |
2. |
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the information contained in the report fairly presents, in all material respects,
the financial condition and results of operations of Cincinnati Financial Corporation. |
Date: March 10, 2006
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/S/ John J. Schiff, Jr. |
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John J. Schiff, Jr.
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Chairman, President and Chief Executive Officer |
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/S/ Kenneth W. Stecher |
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Kenneth W. Stecher
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Chief Financial Officer, Senior Vice President, Secretary and Treasurer |
(Principal Accounting Officer) |
2005 10-K Page 117
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