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Maximilian Thompson

CINF AT A GLANCE

P/E ► 12.0 AVG EV/EBITDA ► 9.95 AVG ROA ► 2.8% AVG ROE ► 7.5% AVG Debt to Equity ► 2.08 AVG Interest Coverage Ratio ► 9.00 AVG

 

 

 

 

 

 

The Cincinnati Financial Corporation's (NASDAQ: CINF) sells commercial and personal (property and casualty) insurance through the Cincinnati Insurance Company. Writing commercial insurance accounts for 74% percent of its insurance writing revenues.^[1] It is the 20th largest domestic property and casualty insurance writer measured by premiums written.^[2] It has a 1.01% market share; the largest company in the market, American International Group (AIG), has a 19.78% market share.^[3]

CINF has a high combined ratio, indicating low profitability, relative to its competitors, because of its customers' claims from Hurricane Ike, which has eroded its profit from property insurance . ^[4] It's nine month operating income was reduced by 25 cents per share compared to last year's reduction of 5 cents per share due to catastrophe losses. ^[5]

More than 20% of CINF's 2007 revenue was from gains locked in from the sale of common stocks held in its investment portfolio.^[6] In reaction to instability in the financial sector, CINF has reduced its holdings of financial sector equities by 25% since midyear.^[7] It is reallocating investments to lower risk, lower potential return equities, which will impact long term gains from investments and CINF's profitability.

Corporate Overview

Cincinnati provides insurance products that local independent insurance agents sell to customers who need insurance. Cincinnati markets its standard insurance products through a network of 1,000 independent insurance retailing agencies in 34 states, though notably, it does not operate in California or Texas.^[8]A total of 4,087 employees work for Cincinnati. ^[9]

Financial Metrics

From 2006 to 2007, revenue decreased from $3.278 billion to $3.250 billion and net income decreased from $930 million to $855 million. From 2005 to 2006, revenue increased from $3.164 billion to $3.278 billion and net income increased from $602 million to $930 million. ^[10] In percentage terms, between 2005 and 2006, revenue increased by 3.6%, while net income increased by 54%.^[11] Between 2006 and 2007, revenue fell .8%, and net income decreased by 8%.^[12]

Cincinnati's Total Revenue, Net Income, and Profit Margin ^[13]

In mid 2008, the return on average equity -- the net income as a percent of average equity -- was 5.6%; for its peer group, the median return on average equity was 15.9% and the average was 14.95%.^[14] This means that relative to the amount of stock issued in the company, Cincinnati Financial has a much smaller net income than its peer group. A contributing factor to the lower average return on equity is that Cincinnati Financial uses much less debt than its peers. 15.45% of its balance sheet is debt, compared to its peer average of 21.45%, which is 38% higher.^[15]

The metric for profitability in the insurance industry is the combined loss, a ratio that reflects the percentage of each dollar sold of insurance policies that must actually be paid out as a claim or expense over the lives of the policies. A low combined ratio for a company indicates the insurance policies it has sold are profitable, because for every 1 dollar sold, a lower amount of money is paid out. For example, if the combined ratio is .6, this means that for every dollar of insurance sold, 60 cents are paid out and 40 cents are kept as earnings. A lower amount of money being paid out, the lower the combined ratio, indicates high earnings for the insurance company by definition.

Cincinnati Financial's combined ratio improved to 90.30% in 2007 from 94.30% in 2006. This is more in line with the combined ratio from 2005 (89.20%) and 2004 (89.80%). The company attributes this to low catastrophe losses ^[16]; money set aside for predicted losses on policies has consistently been greater than the actual amount of money required to settle claims, resulting in the difference between predicted losses and actual losses to be moved from reserves into earnings.

Business Segments

By Product

CINF generates income in two ways. The first way is through its realization of income on the insurance products it has sold. There are three primary product areas that generate regular revenue from business operations: Commercial, Personal, and Life. The second way it generates income is by managing a portfolio of investments. CINF gets a substantial amount of revenue ( 23% in 2007 of total yearly revenue) from its investment portfolio. However, the percentages below explain the relative importance of the different insurance products, so that the percentages assigned to each product area add up to 100% of the revenue from insurance products, not 100% of CINF's total annual revenue.

Commercial insurance (74% of Revenue, $2.411 billion) is the largest revenue source for Cincinnati Financial. A weakening economic situation over the past few years, has led many national providers to compete with regional providers for commercial clients; the target for these products is small- to mid-size businesses. ^[19]The Commercial line's growth has declined sharply from its 2006 and 2005 growth rates. Net earned premiums grew 0.4% in 2007, 6.6% in 2006 and 6.0% in 2005.^[20] Commercial insurance is provided to secure business from the risk due to third-party liabilities from accidents, against physical loss or damage, company car trouble, workplace injuries, equipment, and executive compensation fraud.^[21]

Personal insurance (22% of Revenue, $714 million) accounts for the second largest revenue source. Its earned premiums declined 6.3% in 2007 and 5.3% in 2006 after rising 1.4% in 2005. ^[22] Personal insurance includes homeowners insurance and personal auto insurance.^[23]

Life insurance (4% of Revenue, $129 million) is the third largest revenue source. Life insurance net earned premiums grew 9.0% in 2007, 7.9% in 2006 and 5.7% in 2005. ^[24] Despite the diversification of marketing channels for life insurance products (banks, supermarkets, direct sales, etc), Cincinnati Financial does not plan to alter its exclusive use of the agency channel. ^[25] Life insurance products offered by the company include term insurance policies that pay when the insured person dies, worksite products that employers offer their employees, and disability insurance that offsets lost income in the event of a disability.^[26]

Cincinnati's Pre-tax Revenue by Product^[27]

Trends and Forces

Premiums for CINF's Commerical Insurance Decline with Companies Cutting Back

Commercial premiums are based on a company's payroll or sales, and as companies cut back on the size of their business, the size of the premiums they pay will decrease. ^[28] This will reduce the profitability of P&C insurance providers, particularly companies such as CINF that heavily rely on selling insurance to businesses. In 2007, 74% of Cincinnati's revenue came from commercial lines of insurance.^[29] Prices started to decline in late 2007. An industy-wide survey indicated an average price decrease of approximately 5%, with large account and specialty insured lines experiencing the largest decrease of nearly 9%. ^[30]

CINF has not been an exception to previous declines in P&C average ROE. Its ROE fell from 6.35% in 1997 to 1.97% in 2000, which was consistent with the rest of the the P&C industry. CINF recovered with the industry as well, climbing to an ROE above 12% in 2006.

P&C insurance ROE's are highly cyclical. ^[31]

Lower Returns from Portfolio Lead to Lower Investment Income

The large losses in the financial industry will affect CINF's revenue from investment sales and dividends, which made up 23% of revenues in 2007.^[32] At year-end 2007, the two largest industry concentrations within Cincinnati Financial's common stock holdings were the financial sector at 56.7 percent of total fair value and the healthcare sector at 10.1 percent.^[33] A core group of common stocks account for 82.2% percent of the equity portfolio; this core group is only 15 publically traded stocks. ^[34] Among the core stocks, the largest decliners have been the financial services stocks Wachovia (-76.47%), Alliance Bernstein (-72.25%), National City (-66.49%), and Fifth Third Bancorp (-51.77%) (from 5/28/08 to 11/25/08). When CINF liquidates these positions to fund the payment of insurance claims, it will realize stock loses unless the stocks recover their full value.

Cincinnati's Revenue Split between Premiums and Investments^[27]

Lack of Geographic Diversification leads to High Volatility, Risk

Many of the insurance policies CINF originates are concentrated in a geographic area, which means the company has a less diversified portfolio of risk than its competitors. 69.1% of CINF's insurance writing revenues came from only 10 states; these are concentrated in the Midwest with a few in the Southeast.^[35] Furthermore, Ohio and Illinois alone, which are adjoining states, account for 30.3% of net earned premiums.^[36]

CINF's financial performance already indicates the volatility of catastrophe claims associated with a high geographic concentration. In 2007, the company paid $26 million dollars in catastrophe losses associated with previously issued policies, whereas the year before, the company paid $176 million dollars in catastrophe losses.^[37] Most recently, Hurrican Ike reduced combined ratios to break even.^[38] Catastrophic weather events in the Midwest (particularly Ohio) affect a regional insurer like CINF much more than its national competitors, because the competitors continue to profit from their policies written in unaffected regions.

Competition

Cincinnati Financial Corporation's self-defined direct competition consists of the following:

• Chubb (CB) is a U.S. property and casualty insurance that provides commercial and personal insurance. 43% of its premium writing revenues are from commercial insurance and 30% are from personal.^[39]
• Hartford Financial Services Group (HIG)'s P&C segment is among of the top ten in the U.S., based on net premiums written. It offers business, personal, and specialty insurance.
• SAFECO (SAF)'s largest premium generating states are California, Washington, and Texas. Business Insurance accounted for 27.1% of 2006 net written premiums, while personal insuracne accoutned for 65.8%. ^[40]
• Selective Insurance Group (SIGI) is a regional insurance company that provides P&C insurance coverage to 22 states in the Eastern and Midwestern regions.
• The Travelers Companies (TRV) has field offices in every state in the US as well as international operations. It provides a wide range of personal, business, and financial insurance products. Travelers is the 93rd largest company on the Fortune 500.

^[41]

Market Share

Cincinnati Financial has captured 1.01% of domestic property and casualty insurance premiums, ranking as the 20th largest insurance company by market share.

^[42]

References

1. ↑ CINF. Annual Report, 10-k, Segment Information.
2. ↑ National Association of Insurance Commissioners. Annual Report 2008.
3. ↑ National Association of Insurance Commissioners. Annual Report 2008.
4. ↑ CINF. Cincinnati Financial Reports Profitable 2008 Third Quarter.
5. ↑ CINF. Cincinnati Financial Reports Profitable 2008 Third Quarter.
6. ↑ CINF. Cincinnati Financial Reports Profitable 2008 Third Quarter.
7. ↑ CINF. Cincinnati Financial Reports Profitable 2008 Third Quarter.
8. ↑ CINF. Annual Report, 10-K, Property Casualty Earned Premiums by State.
9. ↑ CINF. Annual Report, 10-K, Property Casualty Earned Premiums by State.
10. ↑ CINF. Form 10-K on 29-Feb-2008, Pg 33.
11. ↑ CINF. Form 10-K on 29-Feb-2008, Pg 33.
12. ↑ CINF. Form 10-K on 29-Feb-2008, Pg 33.
13. ↑ CINF Form 10-K, 29-Feb-2008
14. ↑ CINF. CFC Reports Second-quarter 2008 Results, Investors, Financial Analysis.
15. ↑ CINF. CFC Reports Second-quarter 2008 Results, Investors, Financial Analysis.
16. ↑ CINF. Annual Report 2007.
17. ↑ Wikinvest. Property and Casualty Insurance Wikinvest Article.
18. ↑ CINF. Annual Report, 10-k, Segment Information.
19. ↑ CINF. Annual Report, 10-k, Commercial Lines Property Casualty Insurance Segment , Pg 12.
20. ↑ CINF. Annual Report, 10-k, Segment Information.
21. ↑ CINF. Annual Report, 10-k, Segment Information.
22. ↑ CINF. Annual Report, 10-k, Commercial Lines Property Casualty Insurance Segment , Pg 12.
23. ↑ CINF. Annual Report, 10-k, Segment Information.
24. ↑ CINF. Annual Report, 10-k, Commercial Lines Property Casualty Insurance Segment , Pg 12.
25. ↑ CINF. Annual Report, 10-k, Commercial Lines Property Casualty Insurance Segment , Pg 14.
26. ↑ CINF. Annual Report, 10-k, Segment Information.
27. ↑ ^{27.0 27.1} [1]
28. ↑ The Business Review. Property/Casualty insurance agencies staring at leaner times.
29. ↑ CINF. Annual Report, 10-k, Segment Information.
30. ↑ Reuters, Towers Perrin Survey. 17-Jan-2008 BW20080117 Towers Perrin Commercial Insurance Pricing Study Reports Modest Price Decreases.
31. ↑ Friedman, Fliescher, Lowe, LLC. The Insurance Industry's Ability to Attract Capital Given Historically Low ROE.
32. ↑ CINF. Annual Report, 10-k.
33. ↑ CINF. Annual Report, 10-k, Investment Segment.
34. ↑ CINF. Annual Report, 10-k, Investment Segment.
35. ↑ CINF. Annual Report, 10-K, Property Casualty Earned Premiums by State.
36. ↑ CINF. Annual Report, 10-K, Property Casualty Earned Premiums by State.
37. ↑ John J. Schiff, Jr., Chairman and CEO, Cincinnati Financial. 2007 Fourth-quarter and Full-year Letter to Shareholders, Executive Perspective.
38. ↑ CINF. Cincinnati Financial Reports Profitable 2008 Third Quarter.
39. ↑ CB 2007, 10-K, Item 7A, pg. 28-36
40. ↑ SAF 2007, 10-K
41. ↑ CINF. CFC Reports Second-quarter 2008 Results, Investors, Financial Analysis.
42. ↑ National Association of Insurance Commissioners. Annual Report 2008.