1 UNITED STATES SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549 FORM 10-Q X Quarterly Report Under Section 13 or 15 (d) of the ------- Securities Exchange Act of 1934 FOR THE QUARTERLY PERIOD ENDED MARCH 31, 2001 Transition Report Pursuant to Section 13 or 15 (d) -------- of the Securities Exchange Act of 1934 ---------------------------------------------- Commission File Number 0-4604 CINCINNATI FINANCIAL CORPORATION -------------------------------- (Exact name of registrant as specified in its charter) An Ohio Corporation 31-0746871 (State or other jurisdiction of (I.R.S. Employer incorporation or organization) Identification No.) 6200 South Gilmore Road Fairfield, Ohio 45014-5141 (Address of principal executive offices) Registrant's telephone number, including area code: 513/870-2001 *Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15 (d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports) and (2) has been subject to such filing requirements for the past 90 days. YES X . NO . ------- ------- Securities registered pursuant to Section 12(g) of the Act: $2.00 Par Common--160,714,000 shares outstanding at March 31, 2001 $29,455,000 of 5.5% Convertible Senior Debentures Due 2002 $419,631,000 of 6.9% Senior Debentures Due 2028 Page 1 of 12
2 PART I ITEM 1. FINANCIAL STATEMENTS CINCINNATI FINANCIAL CORPORATION AND SUBSIDIARIES CONDENSED CONSOLIDATED BALANCE SHEETS (000's omitted) (Unaudited) March 31, December 31, 2001 2000 ---- ---- Assets - ------ Investments Fixed maturities (amortized cost: 2001--$2,884,009; 2000--$2,802,863) .............................. $ 2,866,750 $ 2,721,291 Equity securities (cost: 2001--$2,121,829; 2000--$2,067,984) .............................. 7,756,331 8,525,985 Other invested assets ............................. 68,428 68,560 Cash ................................................. 67,279 60,254 Investment income receivable ......................... 86,059 86,234 Finance receivables .................................. 29,812 30,718 Premiums receivable .................................. 657,693 652,340 Reinsurance receivables .............................. 281,764 214,576 Prepaid reinsurance premiums ......................... 19,225 15,246 Deferred acquisition costs pertaining to unearned premiums and to life policies in force ............ 266,257 258,734 Land, buildings and equipment for company use (at cost less accumulated depreciation) ............... 121,112 122,005 Other assets ......................................... 97,925 173,533 Separate accounts .................................... 376,613 357,615 ------------ ------------ Total assets ................................... $ 12,695,248 $ 13,287,091 ============ ============ Liabilities - ----------- Insurance reserves: Losses and loss expenses .......................... $ 2,531,900 $ 2,473,059 Life policy reserves .............................. 622,590 605,421 Unearned premiums .................................... 977,386 921,872 Other liabilities .................................... 250,638 257,254 Deferred income taxes ................................ 1,797,751 2,057,641 Notes payable ........................................ 158,000 170,000 6.9% Senior debentures due 2028 ...................... 419,631 419,631 5.5% Convertible senior debentures due 2002 .......... 29,455 29,603 Separate accounts .................................... 376,613 357,615 ------------ ------------ Total liabilities .............................. 7,163,964 7,292,096 ------------ ------------ Shareholders' equity - -------------------- Common stock, $2 per share; authorized 200,000 shares; issued 2001--172,958; 2000--172,883 shares; outstanding 2001--160,714; 2000--160,891 shares ... 345,915 345,766 Paid-in capital ...................................... 255,134 254,156 Retained earnings .................................... 1,658,765 1,619,954 Accumulated other comprehensive income-unrealized net capital gains ................................ 3,661,237 4,155,929 ------------ ------------ 5,921,051 6,375,805 Less treasury shares at cost (2001--12,244 shares; 2000--11,992 shares) .............................. (389,767) (380,810) ------------ ------------ Total shareholders' equity ..................... 5,531,284 5,994,995 ------------ ------------ Total liabilities and shareholders' equity .. $ 12,695,248 $ 13,287,091 ============ ============ Accompanying notes are an integral part of these condensed consolidated financial statements. 2
3 CINCINNATI FINANCIAL CORPORATION AND SUBSIDIARIES CONDENSED CONSOLIDATED STATEMENTS OF INCOME (UNAUDITED) (000's omitted except per share data) Three Months Ended March 31, 2001 2000 ---- ---- Revenues: Premium income: Property and casualty ................ $ 489,566 $ 430,370 Life ................................. 17,088 17,012 Accident and health .................. 853 711 --------- --------- Premiums earned ................... 507,507 448,093 Net investment income .................... 101,768 106,279 Realized gains on investments ............ 3,351 14,524 Other income ............................. 5,256 2,374 --------- --------- Total revenues ....................... 617,882 571,270 --------- --------- Benefits & expenses: Insurance losses and policyholder benefits 357,013 317,289 Commissions .............................. 94,229 84,526 Other operating expenses ................. 45,863 41,985 Taxes, licenses & fees ................... 17,627 13,497 Increase in deferred acquisition costs pertaining to unearned premiums and to life policies in force ........ (7,523) (4,001) Interest expense ......................... 10,206 9,162 Other expenses ........................... 3,575 5,284 --------- --------- Total benefits & expenses ............ 520,990 467,742 --------- --------- Income before income taxes .................. 96,892 103,528 --------- --------- Provision for income taxes: Current .................................. 18,334 21,578 Deferred ................................. 5,945 2,587 --------- --------- Total provision for income taxes ..... 24,279 24,165 --------- --------- Net income .................................. $ 72,613 $ 79,363 ========= ========= Average shares outstanding (diluted) ........ 166,154 164,859 ========= ========= Per common share: Net income (basic) ....................... $ .45 $ .49 ========= ========= Net income (diluted) ..................... $ .44 $ .48 ========= ========= Cash dividends declared .................. $ .21 $ .19 ========= ========= Accompanying notes are an integral part of these condensed consolidated financial statements. 3
4 CINCINNATI FINANCIAL CORPORATION AND SUBSIDIARIES CONDENSED CONSOLIDATED STATEMENT OF SHAREHOLDERS' EQUITY (UNAUDITED) (000's omitted) THREE MONTHS ENDED MARCH 31, 2000 AND 2001 Accumulated Common Treasury Other Total Common Stock Stock Paid-In Retained Comprehensive Shareholders' Shares Amount Amount Capital Earnings Income Equity ------ ------ ------ ------- -------- ------ ------ Bal. Dec. 31, 1999 171,862 $ 343,725 $(314,294) $237,859 $1,623,890 $ 3,530,104 $ 5,421,284 ----------- Net income 79,363 79,363 Change in unreal gains net of inc. taxes of $337,084 (626,014) (626,014) ----------- Comprehensive Income (loss) (546,651) Div. declared (30,549) (30,549) Purchase/issuance of treasury shares (49,671) 1 (49,670) Stock options exercised 379 757 7,525 8,282 Conversion of debentures 28 55 357 412 -------- --------- --------- -------- ---------- ----------- ----------- Bal. March 31, 2000 172,269 $ 344,537 $(363,965) $245,742 $1,672,704 $ 2,904,090 $ 4,803,108 ======== ========= ========= ======== ========== =========== =========== Bal. Dec. 31, 2000 172,883 $ 345,766 $(380,810) $254,156 $1,619,954 $ 4,155,929 $ 5,994,995 ----------- Net income 72,613 72,613 Change in unreal gains net of inc. taxes of $266,373 (494,692) (494,692) ----------- Comprehensive Income (loss) (422,079) Div. declared (33,802) (33,802) Purchase/issuance of treasury shares (8,957) (1) (8,958) Stock options exercised 65 129 851 980 Conversion of debentures 10 20 128 148 -------- --------- --------- -------- ---------- ----------- ----------- Bal. March 31, 2001 172,958 $ 345,915 $(389,767) $255,134 $1,658,765 $ 3,661,237 $ 5,531,284 ======== ========= ========= ======== ========== =========== =========== Accompanying notes are an integral part of these condensed consolidated financial statements. 4
5 CINCINNATI FINANCIAL CORPORATION AND SUBSIDIARIES CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED) (000's omitted) Three Months Ended March 31, 2001 2000 ---- ---- Cash flows from operating activities: Net income ........................................... $ 72,613 $ 79,363 Adjustments to reconcile operating income to net cash provided by operating activities: Depreciation and amortization ..................... 7,114 4,969 Decrease (increase) in investment income receivable 175 (6,018) Increase in premiums receivable ................... (5,353) (28,713) Increase in reinsurance receivable ................ (67,188) (14,693) Increase (decrease) in prepaid reinsurance premiums (3,979) 571 Increase in deferred acquisition costs ............ (7,523) (3,998) Decrease in accounts receivable ................... 1,929 29,016 Decrease (increase) in other assets ............... 53,892 (2,358) Increase in loss and loss expense reserves ........ 58,841 31,593 Increase in life policy reserves .................. 17,169 12,342 Increase in unearned premiums ..................... 55,514 11,035 (Decrease) increase in other liabilities .......... (9,847) 34,638 Increase in deferred income taxes ................. 6,483 2,587 Realized gains on investments ..................... (3,351) (14,524) Increase in current income taxes .................. 17,746 38,381 --------- --------- Net cash provided by operating activities ..... 194,235 174,191 --------- --------- Cash flows from investing activities: Sale of fixed maturities .......................... 6,518 144,831 Call or maturity of fixed maturities investments .. 56,935 108,004 Sale of equity securities investments ............. 20,622 40,166 Collection of finance receivables ................. 3,433 3,512 Purchase of fixed maturities investments .......... (147,664) (607,833) Purchase of equity securities investments ......... (69,529) (78,160) Investment in land, buildings and equipment ....... (4,522) (14,861) Investment in finance receivables ................. (2,527) (2,647) Proceeds from (investment in) other invested assets 72 (2,287) --------- --------- Net cash used in investing activities ......... (136,662) (409,275) --------- --------- Cash flows from financing activities: Proceeds from stock options exercised ............. 980 8,282 Purchase/Issuance of treasury shares .............. (8,958) (49,670) (Decrease) increase in notes payable .............. (12,000) 19,000 Payment of cash dividends to shareholders ......... (30,570) (27,609) --------- --------- Net cash used in financial activities ......... (50,548) (49,997) --------- --------- Net decrease (increase) in cash ......................... 7,025 (285,081) Cash at the beginning of the period ..................... 60,254 339,554 --------- --------- Cash at the end of the period ........................... $ 67,279 $ 54,473 ========= ========= Supplemental disclosures of cash flow information Interest paid ........................................ $ 3,305 $ 1,636 ========= ========= Income taxes paid .................................... $ 0 $ (18,048) ========= ========= Accompanying notes are an integral part of these condensed consolidated financial statements. 5
6 CINCINNATI FINANCIAL CORPORATION AND SUBSIDIARIES NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) NOTE I - ACCOUNTING POLICIES The condensed consolidated financial statements include the accounts of the Company and all of its subsidiaries, each of which is wholly owned, and are presented in conformity with accounting principles generally accepted in the United States of America. All significant inter-company investments and transactions have been eliminated in consolidation. The December 31, 2000 consolidated balance sheet amounts are derived from the audited financial statements but do not include all disclosures required by accounting principles generally accepted in the United States of America. The preceding summary of financial information for Cincinnati Financial Corporation and consolidated subsidiaries is unaudited, but the Company believes that all adjustments (consisting only of normal recurring accruals) necessary for fair presentation have been made. The results of operations for this interim period is not necessarily an indication of results to be expected for the remaining nine months of the year. INVESTMENTS--Fixed maturities and equity securities have been classified as available for sale and are carried at fair values at March 31, 2001 and December 31, 2000. UNREALIZED GAINS AND LOSSES (000's omitted)--The increases (decreases) in unrealized gains for fixed maturities and equity securities (net of income tax effect) for the three-month periods ended March 31 are as follows: Fixed Equity Year Maturities Securities Total ---- ---------- ---------- ----- 2001 $ 41,354 $(536,046) $(494,692) 2000 $(19,587) $(606,427) $(626,014) Such amounts are included as deductions from shareholders' equity. REINSURANCE (000's omitted)--Premiums earned are net of $37,477 and $27,710 premiums on ceded business for March 31, 2001 and 2000, respectively. Insurance losses and policyholder benefits in the accompanying consolidated statements of income are net of $67,435 and $22,866 reinsurance recoveries for March 31, 2001 and 2000, respectively. NOTE II - STOCK OPTIONS The Company has primarily qualified stock option plans under which options are granted to employees of the Company at prices which are not less than market price at the date of grant and which are exercisable over ten-year periods. On March 31, 2001, outstanding options for Stock Plan IV totalled 1,984,025 shares with purchase prices ranging from a low of $10.07 to a high of $42.87, outstanding options for Stock Plan V totalled 1,179,470 shares with purchase prices ranging from a low of $20.47 to a high of $45.37 and outstanding options for Stock Plan VI totalled 3,971,277 shares with purchase prices ranging from a low of $29.38 to a high of $41.47. 6
7 NOTE III - SEGMENT INFORMATION The Company is organized and operates principally in two industries and has four reportable segments--commercial lines property and casualty insurance, personal lines property and casualty insurance, life insurance and investment operations. The accounting policies of the segments are the same as those described in Note I - Accounting Policies. Revenue is primarily from unaffiliated customers. Identifiable assets by segment are those assets, including investment securities, used in the Company's operations in each industry. Corporate and other identifiable assets are principally cash and marketable securities. Segment information, for which results are regularly reviewed by Company management in making decisions about resources to be allocated to the segments and assess their performance, is summarized in the following table. Information regarding income before income taxes and identifiable assets is not available for two reportable segments - commercial lines and personal lines - property casualty insurance. Quarter Ended March 31, (000's omitted) 2001 2000 ---- ---- REVENUES Commercial lines insurance .......... $ 337,943 $ 283,393 Personal lines insurance ............ 151,623 146,977 Life insurance ...................... 17,941 17,723 Investment operations ............... 105,119 120,803 Corporate and other ................. 5,256 2,374 ------------ ------------ Total revenues ................. $ 617,882 $ 571,270 ============ ============ INCOME BEFORE INCOME TAXES Property and casualty insurance ..... $ 8,412 $ 7,459 Life insurance ...................... 2,556 (312) Investment operations ............... 95,991 108,186 Corporate and other ................. (10,067) (11,805) ------------ ------------ Total income before income taxes $ 96,892 $ 103,528 ============ ============ IDENTIFIABLE ASSETS Property and casualty insurance ..... $ 6,311,238 $ 5,144,927 Life insurance ...................... 1,650,825 1,455,394 Corporate and other ................. 4,733,185 3,963,587 ------------ ------------ Total identifiable assets ...... $ 12,695,248 $ 10,563,908 ============ ============ NOTE IV - FINANCIAL ACCOUNTING PRONOUNCEMENTS The Company adopted Statement of Financial Accounting Standards No. 133 (SFAS 133), Accounting for Derivative Instruments and Hedging Activities, on January 1, 2001. SFAS 133 requires that all derivative financial instruments, such as convertible debt, convertible preferred stock, interest rate swap contracts and foreign exchange contracts, be recognized in the financial statements and measured at fair value regardless of the purpose or intent for holding them. Changes in the fair market value of derivative financial instruments are either recognized periodically in income or shareholders' equity (as a component of comprehensive income), depending on whether the derivative is being used to hedge changes in fair value or cash flows. The adoption of SFAS 133 did not have a significant impact on the consolidated results of operations, financial position or cash flows of the Company because the Company does not have significant derivative activity. 7
8 Subsequent to March 31, 2001, the Company entered into an interest rate swap as a cash flow hedge of variable interest payments. (The risk designated as being hedged is the risk of changes in cash flows attributable to changes in market interest rates.) For this interest rate swap contract under which the Company agrees to pay a fixed rate of interest, the contract is considered to be a hedge against changes in the amount of future cash flows associated with the Company's interest payments of certain variable rate debt obligations ($31 million notional amount). Accordingly, the interest rate swap contract will be reflected at fair value in the Company's consolidated balance sheet and the related gain or loss on this contract will be a component of comprehensive income. The net effect of this accounting on the Company's operating results will be that interest expense on the portion of variable rate debt being hedged will generally be recorded based on fixed interest rates. 8
9 ITEM 2. Management's Discussion and Analysis of Financial Condition and Results of Operations (000's omitted) This Management Discussion is intended to supplement the data contained in the financial statements and related notes of Cincinnati Financial Corporation and subsidiaries. The following discussion related to the condensed consolidated financial statements and accompanying notes contain certain forward-looking statements that involve potential risks and uncertainties. The Company's future results could differ materially from those discussed. Factors that could cause or contribute to such differences include, but are not limited to: unusually high levels of catastrophe losses due to changes in weather patterns or other natural causes; changes in insurance regulations or legislation that place the Company at a disadvantage in the marketplace; recession or other economic conditions resulting in lower demand for insurance products; sustained decline in overall stock market values negatively impacting the Company's equity portfolio and the ability to generate investment income. Readers are cautioned that the Company undertakes no obligation to review or update the forward-looking statements included in this material. Premiums earned for the three months ended March 31, 2001 have increased $59,414 (13%) over the three months ended March 31, 2000. For our property and casualty insurance companies, gross written premiums increased $83,434, net written premiums increased by $69,094 and net earned premiums increased by $59,365. The premium growth rates are greater than last year primarily because of rate increases. Commercial lines new business increased 5%. Earned premiums of our life company increased $218. The premium growth in our life products is mainly attributable to increased sales of both traditional and work site marketing products. For the three-month period ended March 31, 2001, investment income, net of expenses, has increased $.9 (1%) when compared with the first three months of 2000, excluding $5.3 million in 2000 interest income from a bank-owned life insurance (BOLI) policy. Lack of growth was attributable to the average yield for the bond portfolio decreasing and lower dividends earned in the quarter. Realized gains on investments for the three months ended March 31, 2001 amounted to $3,351 compared to $14,524 for the comparable three-month period March 31, 2000. Insurance losses and policyholder benefits (net of reinsurance recoveries) increased $39,724 (13%) for the first three months of 2001 over the same period in 2000. Property and casualty company losses increased $43,376 in the first quarter of 2001, compared to the first quarter of 2000, while policy holder benefits decreased $3,652 over the first quarter of 2000 in the life insurance subsidiary. The increase in property casualty losses is primarily due to a 30% increase in losses incurred for claims $250 or less. Catastrophic claims were lower by $1,415 in the same period. Commission expenses increased $9,703 for the first quarter of 2001 compared to the same period of 2000. Property and casualty commissions increased $10,503, reflecting higher contingent commissions and higher growth of premiums written. Life commissions decreased $800. In the first quarter 2000, a backlog of "Triple X" term insurance processing resulted in higher premiums and commissions. 2001 commissions are lower, as these policies now are paying a renewal commission instead of a first year commission. Other operating expenses increased $3,878 for the three-month period ended March 31, 2001 compared to the same period for 2000. The increase is attributable to increases in staff and other internal development costs associated with our investment in infrastructure to support future growth. Taxes, licenses and fees increased $4,130 for the first quarter of 2001 compared to the first quarter of 2000 primarily due to growth in written premiums. Interest expense increased $1,044 for the three-month period ended March 31, 2001 compared to the same period for 2000. A large portion of the increase is attributable to more short-term debt held at March 31, 2001. 9
10 There was no significant change in the provision for federal income taxes for the first three months of 2001 compared to the first three months of 2000. In the first quarter of 2001 and 2000, the Company experienced a decrease in unrealized gains in investments resulting in comprehensive income of ($422,079) in 2001 compared to ($546,651) in 2000. Our top 10 equity holdings accounted for $517,697 of the decrease in unrealized gains for 2001. Market Risk - The Company could incur losses due to adverse changes in market rates and prices. The Company's primary market risk exposures are to changes in price for equity securities and changes in interest rates and credit ratings for fixed maturity securities. The Company could alter the existing investment portfolios or change the character of future investments to manage exposure to market risk. CFC, with the Board of Directors, administers and oversees investment risk through the Investment Committee, which provides executive oversight of investment activities. The Company has specific investment guidelines and policies that define the overall framework used daily by investment portfolio managers to limit the Company's exposure to market risk. The Company's Board of Directors has authorized the repurchase of outstanding shares. At March 31, 2001, 8.9 million shares remain authorized for repurchase at any time in the future. During the first quarter 2001, 252 shares were repurchased at a cost of $8,967. As of March 31, 2001, the Company has repurchased 12,027 shares. 10
11 PART II OTHER INFORMATION ITEM 1. Legal Proceedings The Company is involved in no material litigation other than routine litigation incident to the nature of the insurance industry. ITEM 2. Changes in Securities There have been no material changes in securities during the first quarter. ITEM 3. Defaults Upon Senior Securities The Company has not defaulted on any interest or principal payment, and no arrearage in the payment of dividends has occurred. ITEM 4. Submission of Matters to a Vote of Security Holders No special matters were voted upon by security holders during the first quarter. ITEM 5. Other Information No matters to report. ITEM 6. Exhibits and Reports on Form 8-K (a) Exhibits included: Exhibit 11--Statement re-Computation of Per Share Earnings. (b) The Company was not required to file any reports on Form 8-K during the quarter ended March 31, 2001. Signature Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized. CINCINNATI FINANCIAL CORPORATION -------------------------------- (Registrant) Date May 8, 2001 --------------------------- By/s/ Kenneth W. Stecher ----------------------------- Kenneth W. Stecher Chief Financial Officer 11
1 EXHIBIT 11 CINCINNATI FINANCIAL CORPORATION STATEMENT RE-COMPUTATION OF PER SHARE EARNINGS (000's omitted except per share data) Three Months Ended March 31, 2001 2000 ---- ---- Basic earnings per share: Net income ....................................... $ 72,613 $ 79,363 ======== ======== Average shares outstanding ....................... $162,888 $161,430 ======== ======== Net income per common share ...................... $ .45 $ .49 ======== ======== Diluted earnings per share: Net income ....................................... $ 72,613 $ 79,363 Interest on convertible debentures--net of tax.... 263 328 -------- -------- Net income for per share calculation (diluted).... $ 72,876 $ 79,691 ======== ======== Average shares outstanding ....................... 162,688 161,430 Effective of dilutive securities: 5.5% convertible senior debentures ............... 1,980 2,443 Stock options ................................... 1,486 986 -------- -------- Total dilutive shares ............................ 166,154 164,859 ======== ======== Net income per common share (diluted) ............ $ .44 $ .48 ======== ======== ANTI-DILUTIVE SECURITIES Options to purchase 963 and 2,669 shares of the Company with exercise prices ranging from $37.88 to $45.37 per share were outstanding at March 31, 2001, and exercise prices ranging from $33.00 to $45.37 per share were outstanding at March 31, 2000. The shares were not included in the computation of diluted earnings per share for the three-month periods ended March 31, 2001 and 2000, since inclusion of these options would have anti-dilutive effects, as the options-exercise prices exceeded the respective average market prices of the Company's shares. 12
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