Cincinnati Financial Corporation (CINF) Earnings Call Transcript & Summary

Good afternoon, everyone. It's Meyer Shields again from KBW. Our next presentation or discussion is with leadership of Cincinnati Financial Corporation. We've got a good team here. We have Chairman, President, CEO, Steve Johnston; Mike Sewell, who is the CFO. We've also got Marty Hollenbeck and Dennis McDaniel on as well to answer questions as they arise. Steve is going to make some introductory comments, and then we'll jump into Q&A. And as we've been doing over the course of the day, we do have access to questions that you submit, and we are very eager to make sure that we're getting the information that our clients, our investors are looking for. So please feel free to send us questions, submit questions. And as time allows, we will be eager to incorporate those as well. And with that, I'm going to turn it over to Steve.

Thank you, Meyer. We appreciate the opportunity to be part of KBW's insurance conference, and we're glad many other are listening via webcast. Our comments today may include forward-looking information, and you can go to our website to read our safe harbor statement and related details, such as reconciliations of non-GAAP measures. I have a few prepared remarks about our strategy and what differentiates us. I'll also highlight recent year financial performance, and you'll see several reasons for confidence in future prospects of the company. We ranked among the 25th largest U.S. P&C insurance company, and our strategy has worked well. A key competitive advantage is the strength of our relationship with agencies representing Cincinnati Insurance. Our business model centers on independent agents, helping their success. We limit agency appointments providing value that is similar to franchise. The local presence of underwriters with authority to write new business, combined with excellent service, are essential for earning a growing share of an agency's best business. Also, our superior financial strength provide market stability and give agents confidence. Several financial aspects also distinguish us. We've already had 59 years of dividend increases, among the only 7 other publicly traded companies in the U.S. that we can find. When our next dividend is paid in October, that will mark 60 years of increases. We're not just paying a dividend over 60 years, but increasing the dividend every year for 60 years. A little over 1/3 of the investment portfolio is allocated to common stocks, and we've had 31 consecutive years of favorable reserve development, illustrating the strength of our balance sheet and the quality of our earnings. Our financial performance has been particularly strong over the past 5 years. For our primary performance measure, the value creation ratio, our most recent 5-year average at 14.2% exceeded the top end of our target range by 1.2 percentage points. We call it VCR, and it represents growth in book value plus dividends. It represents total economic return on capital, including the benefit of long-term equity portfolio appreciation. Importantly, stock prices of P&C companies tend to correlate with book value over the long term. We've been growing premiums faster than the industry, and we believe we're on track to do so again in 2020. In addition to growing faster than the industry, we want a combined ratio better than the industry. Over the past 5 years, our average of 94.3% was 5.9 points better. Investment income has grown steadily even in the low interest rate environment, and the equity portfolio has also performed well through 2019 with a 5-year CAGR of 12%, which is slightly better than the S&P 500 over that period of time. To conclude, we see several good reasons to invest in Cincinnati Financial. We have a history of successfully growing our business profitably, with a clear strategy for improving underwriting results. As a result, we can increase earnings and book value over the long term. Our record for increasing shareholder dividends is one of the best, reflecting the long-term view we take in managing our business. We believe our current dividend yield and price-to-book ratio are both attractive. Our capital also remains very strong, and the quality of our balance sheet is excellent. The company's management and Board of Directors remain confident about its future prospects for creating shareholder value. Thank you for your interest in Cincinnati Financial Corporation. CFO, Mike Sewell; Chief Investment Officer, Marty Hollenbeck; and Investor Relations Director, Dennis McDaniel, and I will be glad to address your questions.

Great. Thank you. So let me respond -- ask a question on one of the main points that you talked about, which is premium growth. And right now, when we look at Cincinnati, there are a lot more segments than there used to be, whether we're talking about global reinsurance, et cetera. Can you talk about within the individual, I'll call them product lines or segments, what the various growth drivers are expected to be?

Okay. Thank you, Meyer. And I think when we talk about growth, the first thing we want to talk about is our relationship with our agents. And I think whenever anyone thinks about Cincinnati Insurance, they should think about it's an agency strategy that we have. And we look to grow through the various segments and various products that we offer through our agents in a way that is matching up with the way that they want to grow. Very much an agency strategy. So our commercial and personal lines are the largest 2 segments. We have, I think, an advantage in that we have all of our field people that work from their homes out in their communities with the agencies. And I think this has been a big advantage always, but it's been particularly advantageous here during the pandemic, and that we've always had work from home. All of our field people. So there was really no change when we went work from home with our field people. And they're all assigned to agencies. So the agents know how to get a hold of the person that they need to talk to. They don't have to go through any queues or anything like that. So it's been very seamless as we've gone to work from home. And we think those relationships between our people and the agencies is very crucial. But particularly, some of the areas that we've been growing are high net worth. It has really been growing nicely. We've been at this since 2015. And I think we've established ourselves as a top 4 writer in terms of high net worth. The growth has been good. We grew 32% on the high net worth in 2019, and we're up 28% through the first half of 2020. So I think a good value that we bring to our agents there as we grow into high net worth. E&S, CSU has also been a good driver of growth. It's been double-digit growth in recent years. We're up to about $300 million in 2019 premiums. And we still have plenty of room to grow within the agent's book there with the E&S. I guess, I would like to point out a little bit to the way we formed CSU back in 2008. It was a little bit different in that we only offer excess and surplus lines to our agents. And we also formed our own wholesaler, C-SUPR. And so I think it gives us an advantage only to be working with our own agents and to have our own broker, so to speak, with C-SUPR. So many of the things turned out to be the same, and that the agents have access to their underwriter. The profit sharing applies across the board, including the E&S. And we found that while CSU, the majority of the business there is casualty, we found about 40% of the casualty policies that CSU write have a standard Cincinnati commercial property policy attached. So it's been very seamless there, and we've had good growth, good profitability in CSU. Our life insurance company continues to grow nicely. Earned premiums grew 8% in 2018 and 2019. Up 10% so far in 2020. And the operating earnings have been up as well. And then Cincinnati Re and Cincinnati Global, a little bit newer there. We've had double-digit growth in the second quarter, and both are growing very nicely in a disciplined fashion. So we see great opportunities for profitable growth across our segments, and we think it all ties back to the agency strategy that we have.

Can you talk a little bit about the application of your traditional distribution strategy, and how that fits in Cincinnati Re and how it fits with Cincinnati Global?

Sure. With Cincinnati Global, one of the nice things there is we see growth both organically. And when we talk about Cincinnati Global, the purchase that we made there was from Munich Re, who is just a great company that we've had a great relationship with for a long time, really good people. We know each other well. They had 2 syndicates. The larger Munich name syndicate and a smaller syndicate, then named Beaufort, that we've since rebranded to Cincinnati Global. And our purchasing Cincinnati Global has allowed us to take a look at that and look to diversify the revenue stream there from what's been primarily property with a little bit of aviation into -- our plans are to go into more of the different lines of business within the Lloyd's marketplace. So we see good opportunity for diversifying and profitable growth within the Lloyd's marketplace. The other thing that we've done, which I think is a little more forward-looking, is we've taken C-SUPR, the brokerage or wholesaler that we've just mentioned, and we've licensed it as a Lloyd's cover holder. And that will allow us to -- if a risk would come in, maybe doesn't meet the risk appetite of the standard Cincinnati companies or CSU, we would have an avenue to Lloyd's, whether it be through our underwriter there, CGU, or other underwriters. And again, this is something that we're not doing right now that we're laying the groundwork for. Cincinnati Re, very similarly, it's giving us good diversified growth. It's what we call an allocated capital reinsurance company. We did not set up a separate entity, a separate company, fund it with a certain amount of capital. My fear there would be that there would be a tendency to need to grow to fill up the capital. We want to just allocate capital risk by risk there, let the underwriters, which are very experienced at Cincinnati Re, be able to look at contract by contract, estimate the capital that is necessary to support that contract and price it to a fair return without pressure to grow. And we think that one is working quite well in terms of -- we started that one in 2015 as well. It's been a -- with the weather and the hurricanes and fires and everything else, it's been a tough time for reinsurers. And still through June 30 of this year, inception to date, they're right around breakeven, and we feel they're well positioned. I think it's also had a synergistic value to the rest of the organization and thus, the agents in terms of the talent that's come in to help with risk modeling, different types of risks that has made us a broader, more knowledgeable company. While we're talking about growth and the excess and surplus lines company, one thing that we've been able to do with California homeowners is that market has been challenged by fires as last year. In a period of about 5 months, we were able to start writing homeowners on an excess and surplus lines basis through CSU, which gives us a little more in terms of what we can do with policy terms and conditions and pricing. So all the new entities that we've had, I think, have been successful. We've been successful in growing profitably and diversifying our revenue stream, and we see that continuing into the future.

Great. Thank you. Is there a target mix by the various segments? In other words, obviously, 2019, it was 85% commercial and personal. And you've talked about the benefits of diversification. I was hoping you could talk about -- I know there's -- things will always change based on market conditions, so it's a little bit of an [ open-ended ] question. But how do you see broadly a good long-term mix?

Yes. That's a good question. We do not have a target for a long-term mix. We go back to our agency strategy. We are going to grow and grow profitably in the areas that support the growth of and the growth needs of our agencies. And if certain lines are more predominant than the growth plans of agencies over time, then that's typically where we'll grow. We want to be the company and the resource for the agents that we represent. We don't represent as many agents. As many do, we still have less than 2,000 appointed across 45 states. So we're going to very much focus on what is needed to support the agents. And basically, what we ask is just that the next policy that we write, on a risk-adjusted basis, is priced appropriately. And then we also manage the aggregates there for risk. But basically, we are very much segregating policies and looking at them one by one in terms of their individual characteristics and doing our best to underwrite and price them appropriately. We use all the various predictive models and analytics and data that we can bring to the table. But we also rely on traditional underwriting, and we'd like to say that we're at the intersection of the art and science of underwriting.

I do want to follow up that with one very, I'll call it, a Steve-specific question, because your background is, obviously, as an actuary. I don't know that you've been signing pricing quite recently. But it does seem as though an essential part of the strategy over the past few years has to be increase the granularity and the specification of pricing of your various products. I was hoping you could give us an update in terms of how that process has performed. Obviously, we see on the outside that it's performing well, but what else you see on the inside? And what else remains to be done for that particular effort?

Thank you. And for those of you that don't know us, Meyer and I go back quite a ways, and Meyer is also an actuary. So we have that common thread there. I appreciate the question. And yes, we have put a lot of effort into our analytics, our data, our people. I mean people drive everything in terms of the talent that we bring in. And not only -- don't I sign any -- off on any of the certifications. I'm out of my league with the talent that we've hired of late. I don't think I could get hired anymore as an entry-level actuary. They're extremely good. We're in the umpteenth model or update of models, they're continually looking to improve the models that we have. We've been at it for, I don't know, 10 years or so with the various lines of business that we're in. It's very much a policy-by-policy, risk-by-risk approach. And we have the analytics in place that for any agency, any risk at any time, we can look to see the modeled results. We can aggregate those modeled results up, and it gives us a good feel for where we are within an agency and looking at the entire book or looking at individual policies within the book. So I think it's been very successful work, going to continue to get better at it. I think some of the newer developments is on the personal lines side, we have a new pricing company, Cincinnati Casualty, that we've had some really good talent working with the data there, and we've come out with a new rating algorithm that is doing quite nicely and producing good new business growth for the risk that we think -- and competitively for the risk that we think merit the competitive pricing. So it's the -- it allows us to be very granular. And also, I think very importantly, a big important point on this is to look not only as we look at rate increases and so forth to look at the mean, but to look at the distribution around that central point estimate and really have a feel for the whole picture of risk there.

Thank you. How does that work for the lines of business with smaller premium volumes and, therefore, smaller databases of information? Global, Cincinnati Re, et cetera?

With Cincinnati Re, they're quite sophisticated in what they're doing with the cat modeling and the various pricing that they do. Jamie Hole, the leader of that organization, has come in and really brought some very good talent, both on the underwriting side, on the actuarial side. And so they're pretty sophisticated in the way they come up with estimates of the capital that's needed for each of the contracts. Lloyd's also, they are -- more part of Lloyd's, they do use analytics. But there, you're talking about more shared and layered, doing things the Lloyd's way. And they have a nice history of profitability in going about things the way that they're done at Lloyd's. I think they've had underwriting profit 20 out of the last 24 years, maybe. And I think last year, in 2019, they had the third best combined ratio in Lloyd's. So some of the operating areas, as you point out, they go about it a little bit different than others, but we're trying to use analytics and just people talent in all of our areas and try to be at that intersection of the art and science of underwriting where we use both.

Okay. You're comfortable with your competitive position then. In other words, that your capabilities match up with the companies that you would see of your major competition in each individual segment?

Yes, absolutely.

Okay. Fantastic. I have another mix-related question. This is a bit of an oddball. Workers' compensation is a line of business that you're underweight, and I was hoping you could talk through whether that is a strategic imperative? Whether it's just the fact that you're based in Ohio? And if there are any other drivers that could maybe change that?

Yes. No, that's a good point. And we are -- our largest state is Ohio. Ohio is a monopolistic state fund. So we don't write workers' comp on risk in Ohio. We also don't write California comp, which is a huge part of the market, and we don't write workers' comp in Florida. So we -- I do believe that we've been disciplined. Being around as long as I've been, workers' comp is one of the most cyclical lines that you're going to run into. I've seen it run wide variations in terms of its results. And so I don't think once you get too enthusiastic for it when it's doing well, or get too down on it when it needs improvement. But again, we take all the analytics that we have, use our predictive models, use our additional underwriting expertise and work with our agents to profitably grow that business. Now in terms of premium volume, it's actually been on the way down. Here lately, but I think part of that's due to rate decreases that have been taken, but another part of it due to the underwriting discipline that we've imposed while rates are on their way down.

Okay. I know there's a lot of discussion about whether workers' compensation pricing is approaching the bottom. I do find myself on the pessimistic side there because higher unemployment might actually be a little bit of a benefit to the industry. But do you -- does Cincinnati have a position? Do you have any particular expectations for work comp pricing?

I think it's getting better. I think it's improving. And we're doing everything we can to implement discipline there. But I do think we're seeing signs of improvement in the rate for workers' compensation.

Okay. Excellent. Just want to make sure I'm not on mute. Can you compare the pricing that you're taking with what we see externally? I know the surveys all differ with one another, so it's a tough question.

It is.

Just for comparisons. But how you see your -- maybe a way to ask it is, as you implement the pricing -- I'm sorry, price increases that you've discussed in most lines of business, how that's translating into changing your competitive position at your agencies?

Yes. And I think it is tough to use some of the industry pricing tools. We look at them for sure, but we're going to pay more attention to what our analytics are coming up with. Because generally, it's at an aggregate level. There's going to be all sorts of differences in mix of the type of business written by the various companies that are contributing to the larger pricing tools. So we're going to pay a lot more attention to what we're seeing in our own book in terms of the relative adequacy of that pricing. I think also, we've got a steady approach. So with the industry, the starting place of -- is going to play into some of the sizes of the rate increases. I think maybe an area specifically to talk about might be excess to surplus lines, where we're getting increases, and it's increasing. It's going up at an increasing rate, maybe lower than what you've seen at some of the national metrics that you look at in terms of rate change. But in CSU, we don't write commercial auto, which has been getting big increases in the [ NS ] space. We don't really write D&O, which has been getting outsized increases as well. So there's a difference in mix and also on premium size as well, where some of the smaller policies are a little bit more stable.

Okay. Great. I do want to put forward one -- actually, probably a few, but questions on the investment side. So I guess, maybe that's best directed towards Marty. So we're in an environment where we've seen interest rates fall dramatically, probably more than we expected pre-pandemic. And we've seen, at least from an index perspective, relatively high equity valuations right now. So can you talk about how those developments are incorporated in the allocation of current money?

Sure. One thing we don't do in periods of this kind of sort of dislocation is radically change what we feel has worked for decades. So we're still consistent with our equity allocation, looking for value. On the fixed income front, as we like to say, we turn over a lot of rocks. We're looking at some less liquid situations, things of that nature, one-off bank bonds, different things like that. So we're still poking around the corners. We are not taking on inherently greater risk to achieve investment income goals. Our equity portfolio has always helped us in that regard. We've had a number of consecutive quarters of year-on-year investment income increases, owing largely to the equity portfolio. That was a little bit more challenged in Q2. We were still plus 6%. That was coming off 5 consecutive quarters of sort of low double digits dividend income increases, so not to be unexpected in this -- in current environment. So we are not radically changing, we're not trying to go to a heavy cash position necessarily. So we just -- we stick with the long-term trend of what we've been doing, and it seems to be working.

Okay. Does the change in business mix -- and I recognize that it's been slow, but the introduction of reinsurance premiums that are presumably longer tail or other aspects, does that change -- does that require a different investment path?

Not really. For the allocated capital model, it's all in there together. We do, in the life insurance company, do some asset liability matching. So we got some product buckets that are longer that we take deliberate looks at longer duration, fixed income there. But on the P&C side, it's typically a mix of roughly, say, 10-year new issue corporate bonds, 15- to 18-year tax-exempt munis for quality with a few other variants mixed in there. So now that the new CGU is its own animal, it's self-contained. They're a very high-quality, low-duration portfolio that is segregated. But as far as Cinci Re goes, that's -- it's all in together.

Okay. And you sound very comfortable with munis as an investment class.

We are. We are very diverse and deliberately so. So yes, spread that risk.

Okay. Fantastic. I want to talk about technology because one of the points that we're trying to delve into with every company is the current state of technical investments. This has gone from an abstract discussion. 10 years ago, we didn't get into much detail. We just knew that the industry probably had room for improvement. And now we're seeing, whether it's companies that are entirely insured tech or legacy companies that are successfully incorporating technology, there are different ramifications of the technological investments that different companies are making. And I was hoping you can give us -- get us up to speed, maybe provide some examples of where we see that at Cincinnati?