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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 JUNE 30, 2002
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: 513/870-2000
*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--161,975,000 shares outstanding at July 31, 2002
$419,648,000 of 6.9% Senior Debentures Due 2028
Page 1 of 16
PART I
ITEM 1. FINANCIAL STATEMENTS
CINCINNATI FINANCIAL CORPORATION AND SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEETS
(in millions except per share data)
(Unaudited)
June 30, December 31,
Assets 2002 2001
------------ ------------
Investments
Fixed maturities (cost: 2002 -- $3,064;
2001 -- $3,012) ........................................... $ 3,108 $ 3,010
Equity securities (cost: 2002 -- $2,281;
2001 -- $2,174) ........................................... 8,764 8,495
Other invested assets ........................................ 68 66
Cash ............................................................ 121 93
Investment income receivable .................................... 94 93
Finance receivables ............................................. 31 27
Premiums receivable ............................................. 828 732
Reinsurance receivable .......................................... 514 515
Prepaid reinsurance premiums .................................... 45 28
Deferred policy acquisition costs ............................... 309 286
Property and equipment, net, for Company use .................... 120 125
Other assets .................................................... 127 99
Separate accounts ............................................... 404 390
------------ ------------
Total assets .............................................. $ 14,533 $ 13,959
============ ============
Liabilities
Insurance reserves:
Losses and loss expenses ..................................... $ 3,085 $ 2,932
Life policy reserves ......................................... 721 674
Unearned premiums ............................................... 1,188 1,062
Other liabilities ............................................... 286 283
Federal income taxes
Current .................................................... 18 10
Deferred ..................................................... 2,058 2,001
Notes payable ................................................... 183 183
6.9% Senior debentures due 2028 ................................. 420 420
5.5% Convertible senior debentures due 2002 ..................... 0 6
Separate accounts ............................................... 404 390
------------ ------------
Total liabilities ......................................... 8,363 7,961
------------ ------------
Shareholders' Equity
Common stock, par value - $2 per share; authorized 200 million
shares; issued 2002 -- 176 million shares; 2001 -- 174 million
shares; outstanding 2002 -- 162 million shares; 2001 -- 161
million shares ............................................... 351 350
Paid-in capital ................................................. 295 284
Retained earnings ............................................... 1,716 1,678
Accumulated other comprehensive income - unrealized
gains on investments and derivatives ......................... 4,246 4,113
------------ ------------
6,608 6,425
Less treasury stock at cost
(2002 and 2001 -- 13 million shares) ......................... (438) (427)
------------ ------------
Total shareholders' equity ................................ 6,170 5,998
------------ ------------
Total Liabilities and shareholders' equity ............. $ 14,533 $ 13,959
============ ============
Accompanying notes are an integral part of these condensed consolidated
financial statements.
2
CINCINNATI FINANCIAL CORPORATION AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF INCOME
(UNAUDITED)
(in millions except per share data)
Six Months Ended June 30, Three Months Ended June 30,
Revenues: 2002 2001 2002 2001
---------- ---------- ---------- ----------
Net earned premiums:
Property and casualty ...................... $ 1,139 $ 999 $ 580 $ 510
Life ....................................... 40 38 21 20
Accident and health ........................ 2 2 1 1
---------- ---------- ---------- ----------
Total ................................... 1,181 1,039 602 531
Net investment income ....................... 218 207 109 107
Realized (losses) gains on investments ...... (18) 11 (10) 6
Other income ................................ 9 6 2 1
---------- ---------- ---------- ----------
Total revenues ............................. 1,390 1,263 703 645
---------- ---------- ---------- ----------
Benefits & expenses:
Insurance losses and policyholder benefits .. 912 781 495 425
Commissions ................................. 225 197 113 102
Other operating expenses .................... 97 95 47 49
Taxes, licenses & fees ...................... 32 30 17 12
Increase in deferred policy acquisition costs (22) (16) (10) (9)
Interest expense ............................ 17 20 9 10
Other expenses .............................. 4 8 1 5
---------- ---------- ---------- ----------
Total benefits & expenses .................. 1,265 1,115 672 594
---------- ---------- ---------- ----------
Income before income taxes .................... 125 148 31 51
---------- ---------- ---------- ----------
Provision for income taxes:
Current ...................................... 29 27 10 8
Deferred ..................................... (14) (1) (14) (6)
---------- ---------- ---------- ----------
Total provision for income taxes ........... 15 26 (4) 2
---------- ---------- ---------- ----------
Net income .................................... $ 110 $ 122 $ 35 $ 49
========== ========== ========== ==========
Average shares outstanding (basic) ............ 162 162 162 161
Average shares outstanding (diluted) .......... 164 164 164 164
Per common share:
Net income (basic) ......................... $ .68 $ .75 $ .22 $ .30
========== ========== ========== ==========
Net income (diluted) ....................... $ .67 $ .74 $ .21 $ .30
========== ========== ========== ==========
Cash dividends declared .................... $ .4450 $ .4200 $ .2225 $ .2100
========== ========== ========== ==========
Accompanying notes are an integral part of these condensed consolidated
financial statements.
3
CINCINNATI FINANCIAL CORPORATION AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENT OF SHAREHOLDERS' EQUITY
(UNAUDITED)
(in millions)
SIX MONTHS ENDED JUNE 30, 2001 AND 2002
Accumulated
Other Total
Common Common Treasury Paid-In Retained Comprehensive Shareholders'
Shares Stock Stock Capital Earnings Income Equity
------ ------ -------- ------- -------- ------------- -------------
Bal. Dec. 31, 2000 .... 173 $ 346 $ (381) $ 254 $ 1,620 $ 4,156 $ 5,995
--------
Net income ............ 122 122
Change in accumulated
other comprehensive
income net of inc.
taxes of $20 ....... (38) (38)
--------
Comprehensive income .. 84
Div. declared ......... (68) (68)
Purchased/issuance of
treasury shares, net (17) (17)
Stock options exercised 2 2
Conversion of
debentures ......... 1 2 14 16
------ ------ ------- ------- -------- -------- --------
Bal. June 30, 2001 .... 174 $ 348 $ (398) $ 270 $ 1,674 $ 4,118 $ 6,012
====== ====== ======= ======= ======== ======== ========
Bal. Dec. 31, 2001 .... 175 $ 350 $ (427) $ 284 $ 1,678 $ 4,113 $ 5,998
--------
Net income ............ 110 110
Change in accumulated
other comprehensive
income net of inc.
taxes of $72 ....... 133 133
--------
Comprehensive income .. 243
Div. declared ......... (72) (72)
Purchased/issuance of
treasury shares, net (11) (11)
Stock options exercised 5 5
Conversion of
debentures ......... 1 1 6 7
------ ------ ------- ------- -------- -------- --------
Bal. June 30, 2002 .... 176 $ 351 $ (438) $ 295 $ 1,716 $ 4,246 $ 6,170
====== ====== ======= ======= ======== ======== ========
Accompanying notes are an integral part of these condensed consolidated
financial statements.
4
CINCINNATI FINANCIAL CORPORATION AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(UNAUDITED)
(in millions)
Six Months Ended June 30,
2002 2001
-------- --------
Cash flows from operating activities:
Net income ................................................ $ 110 $ 122
Adjustments to reconcile net income to net cash
provided by operating activities:
Depreciation and amortization .......................... 12 13
Realized losses/(gains) on investments ................. 18 (11)
Interest credited to contract holders .................. 10 10
Changes in:
Investment income receivable ....................... (1) (5)
Premiums and reinsurance receivable ................ (120) (112)
Deferred policy acquisition costs .................. (23) (16)
Other assets ....................................... (12) 11
Loss and loss expense reserves ..................... 153 118
Life policy reserves ............................... 37 18
Unearned premiums .................................. 125 95
Other liabilities .................................. 2 3
Deferred income tax ................................ (14) (1)
Current income tax ................................. 8 51
-------- --------
Net cash provided by operating activities ...... 305 296
-------- --------
Cash flows from investing activities:
Sale of fixed maturities investments ................... 53 9
Call or maturity of fixed maturities investments ....... 163 116
Sale of equity securities investments .................. 20 66
Collection of finance receivables ...................... 7 7
Purchase of fixed maturities investments ............... (297) (291)
Purchase of equity securities investments .............. (116) (137)
Investment in property and equipment ................... (18) (8)
Investment in finance receivables ...................... (11) (6)
Investment in other invested assets .................... (2) 2
-------- --------
Net cash used in investing activities .............. (201) (242)
-------- --------
Cash flows from financing activities:
Payment of cash dividends to shareholders .............. (70) (64)
Purchase of treasury shares, net ....................... (11) (17)
Increase in notes payable .............................. 0 5
Proceeds from stock options exercised .................. 5 2
Contract holder funds deposited ........................ 9 12
Contract holder funds withdrawn ........................ (9) (9)
-------- --------
Net cash used in financing activities .............. (76) (71)
-------- --------
Net increase (decrease) in cash .............................. 28 (17)
Cash at the beginning of period .............................. 93 60
-------- --------
Cash at the end of period .................................... $ 121 $ 43
======== ========
Supplemental disclosures of cash flow information:
Interest paid ............................................. $ 17 $ 23
======== ========
Income taxes paid (refunded) .............................. $ 22 $ (24)
======== ========
Supplemental disclosures of non-cash activities:
The Company converted the following securities during
the six-month period ended June 30:
Conversion of 5.5% senior debentures to common stock ...... $ 6 $ 16
======== ========
Conversion of fixed maturity to equity security investments $ 13 $ 23
======== ========
Accompanying notes are an integral part of these condensed consolidated
financial statements.
5
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, 2001,
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 are not necessarily an indication of results to be expected for the
remaining six months of the year. The sum of the quarterly reported amounts may
not equal the full year as each is computed independently.
INVESTMENTS -- Fixed maturities and equity securities have been classified as
available for sale and are carried at fair values at June 30, 2002, and December
31, 2001.
UNREALIZED GAINS AND LOSSES (in millions) -- The increases (decreases) in
unrealized gains for fixed maturities and equity securities (net of income tax
effects) for the six-month and three-month periods ended June 30 are as follows:
Six Months Ended June 30, Three Months Ended June 30,
2002 2001 2002 2001
-------- -------- -------- --------
Fixed maturities $ 30 $ 37 $ 25 $ (4)
Equity securities 103 (75) (267) 461
-------- -------- -------- --------
Total ......... $ 133 $ (38) $ (242) $ 457
======== ======== ======== ========
Such amounts are included as additions to (deductions from) shareholders'
equity.
REINSURANCE (in millions) -- Premiums earned are net of premiums on ceded
business, and insurance losses and policyholder benefits are net of reinsurance
recoveries in the accompanying statements of income as follows:
Six Months Ended June 30, Three Months Ended June 30,
2002 2001 2002 2001
-------- -------- -------- --------
Ceded premiums ....... $ 156 $ 77 $ 84 $ 40
======== ======== ======== ========
Reinsurance recoveries $ 42 $ 103 $ 26 $ 35
======== ======== ======== ========
RECLASSIFICATIONS - Certain prior amounts have been reclassified to conform with
the current period classifications.
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 10-year periods. On
June 30, 2002, outstanding options for Stock Plan No. IV totaled 1,296,214
shares with purchase prices ranging from a low of $12.14 to a high of $42.87,
outstanding options for Stock Plan V totaled 1,186,011 shares with purchase
prices ranging from a low of $20.47 to a high of $45.37 and outstanding options
for Stock Plan VI totaled 4,862,341 shares with purchase prices ranging from a
low of $29.38 to a high of $41.61. The Company has not granted any options from
Stock Plan No. VII as of June 30, 2002.
The Company estimated that the impact of expensing stock options, using a fair
value method (Black Scholes), permitted by Statement of Financial Accounting
Standard No. 123, would reduce net income approximately 1-1/2 cents per share
for the six-month period ended June 30, 2002.
6
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, which Company management regularly reviews results in
making decisions about resources to be allocated to the segments and in
assessing 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.
Six Months Ended Three Months Ended
June 30, June 30,
------------------------ ------------------------
(in millions) 2002 2001 2002 2001
-------- -------- -------- --------
REVENUES
Commercial lines insurance .......... $ 813 $ 693 $ 415 $ 355
Personal lines insurance ............ 326 306 165 155
Life insurance ...................... 42 40 22 21
Investment operations ............... 200 218 99 113
Corporate and other ................. 9 6 2 1
-------- -------- -------- --------
Total revenues ................. $ 1,390 $ 1,263 $ 703 $ 645
======== ======== ======== ========
INCOME (LOSS) BEFORE INCOME TAXES
Property and casualty insurance ..... $ (35) $ (30) $ (44) $ (39)
Life insurance ...................... (15) 2 (14) --
Investment operations ............... 193 199 102 103
Corporate and other ................. (18) (23) (13) (13)
-------- -------- -------- --------
Total income before income taxes $ 125 $ 148 $ 31 $ 51
======== ======== ======== ========
June 30, December 31,
2002 2001
-------- --------
IDENTIFIABLE ASSETS
Property and casualty insurance ..... $ 7,266 $ 6,954
Life insurance ...................... 1,821 1,752
Corporate and other ................. 5,446 5,253
-------- --------
Total identifiable assets ....... $ 14,533 $ 13,959
======== ========
7
ITEM 2. Management's Discussion and Analysis of Financial Condition and
Results of Operations (dollars in millions)
INTRODUCTION
This Management Discussion is intended to supplement the data contained in the
condensed consolidated financial statements and related notes of Cincinnati
Financial Corporation and subsidiaries.
Forward-looking Statements
The following discussion contains 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 causes; the
frequency and severity of claims; environmental events or changes; changes in
insurance regulations, legislation or court decisions that place the Company at
a disadvantage in the marketplace; adverse outcomes from litigation or
administrative proceedings; recession or other economic conditions resulting in
lower demand for insurance products; sustained decline in overall stock market
values negatively affecting the Company's equity portfolio; delays in the
development, implementation and benefits of technology enhancements; and
decreased ability to generate growth in investment income.
Further, the Company's 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 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 in this material.
RESULTS OF OPERATIONS
As discussed in greater detail below, premiums earned for the six months ended
June 30, 2002, increased $142 (14 percent) over the six months ended June 30,
2001, and premiums earned for the three months ended June 30, 2002, increased
$71 (13 percent) over the three months ended June 30, 2001. Investment income,
net of expenses, increased $11 (5 percent) compared with the first six months of
2001 and increased $2 (1 percent) compared with the three months ended June 30,
2001. Investment income growth was attributable to cash flow from insurance
operations, offset by a decrease in the average yield for the bond portfolio due
to bonds with higher yields being reinvested at a lower yield, dictated by the
current market. Realized losses on investments amounted to $18 compared with $11
in gains for the comparable six-month period ended June 30, 2001, and $10 of
realized losses compared with $6 in gains in the second quarters of 2002 and
2001, respectively.
Insurance losses and policyholder benefits (net of reinsurance recoveries)
increased $131 (17 percent) for the first six months of 2002 over the same
period in 2001. Second-quarter 2002 losses were $495 compared with $425 in the
second quarter of 2001, an increase of $70 (16 percent). For the first six
months of 2002 over the same period in 2001, commission expenses increased $28,
other operating expenses increased $2, attributable to minimal increases in
staff and other internal development costs, and interest expense decreased $3,
primarily due to lower short-term interest rates.
8
Property Casualty Insurance Operations
Property Casualty Subsidiary Financial Highlights
Six Months Ended June 30, Three Months Ended June 30,
2002 2001 2002 2001
-------- -------- -------- --------
Net earned premiums* $ 1,139 $ 999 $ 580 $ 510
Net losses incurred 874 746 475 405
GAAP loss ratio 76.8% 74.7% 81.9% 79.5%
GAAP expense ratio 27.0 29.0 26.2 28.6
GAAP combined ratio 103.8% 103.7% 108.1% 108.1%
GAAP combined ratio excluding catastrophes 98.4% 99.5% 100.0% 101.2%
* The above earned premium figures are net of inter- company premiums.
The GAAP combined ratio of 103.8 percent for the six months of 2002 compares
with 103.7 percent for the six months ending 2001. The loss and LAE ratio was
76.8 percent, an increase of 2.1 percentage points over the first six months of
2001 and the expense ratio of 27.0 percent was 2.0 percentage points lower than
the same period in 2001. The six-month 2002 loss ratio included 5.4 percentage
points for catastrophe losses, compared with 4.2 percentage points in the first
six months of 2001. As the first and second quarters of both 2002 and 2001
demonstrated, severe weather can cause wide, seasonal swings in our property
casualty results. Catastrophe losses in this year's second quarter contributed
8.1 percentage points to the quarter's combined ratio versus 2.6 percentage
points in the first quarter of this year. In 2001, catastrophe losses
contributed 6.9 percentage points in the second quarter combined ratio and 1.4
percentage points in the first quarter ratio.
The 2002 expense ratio improvement was the result of expenses remaining
relatively stable while premiums increased. Higher reinsurance costs in 2002
impacted the 2002 combined ratio by 0.8 percentage points.
Net written premiums for the first six months of 2002 increased by $159, a 15
percent increase, and net earned premiums increased by $140, a 14 percent
increase. The premium growth rate is being generated by rate increases and
commercial lines renewal premium increases, with total premiums for most
commercial lines of business growing at double- digit rates on lower policy
counts. We're more aggressively identifying and measuring exposures to match
coverage amounts and premiums to the risk. Where this is not possible, we are
not renewing accounts. Rate increases will be a major component of growth in
earned premium this year and into 2003.
Six-month 2002 commercial lines earned premiums increased by $120, a 17 percent
increase over 2001. Commercial written premiums included new business growth of
$122, or 13 percent. Six-month 2002 personal lines earned premiums increased
$20, a 7 percent increase. Personal written premiums included new business
growth of $32, or 41 percent.
The property casualty companies continued to experience higher claims severity
with total losses increasing $128, or 17 percent, in the first six months of
2002 compared with the same period in 2001. First-half 2002 losses above $250
thousand (including case reserve increases greater than $250 thousand) were $198
for 340 individual claims, compared with $146 for 262 claims in the same period
in 2001. Losses below $250 thousand were $471, $23 (5 percent) above the first
half of 2001. Catastrophe losses were higher by $20, due to eight separate wind
and hail storms in the first six months of 2002 compared with three in 2001.
The six-month 2002 loss and LAE ratio of 76.8 percent reflected these continuing
high levels of claims, with the impact mitigated by the quarter's strong premium
growth. The commercial lines loss and LAE ratio was 73.0 percent in 2002
compared with 71.4 percent in 2001. On commercial business, field marketing
representatives and underwriters are doing a good job of writing appropriately
priced accounts. We are implementing changes to our general liability policy and
underwriting guidelines that should reduce contractor- and auto-related losses.
Of the 34 losses above $1 million incurred since the beginning of the year, 10
were personal or commercial non-contractor auto losses and 13 were
contractor-related general liability or auto losses.
9
The six-month personal lines loss and LAE ratio was 86.0 percent in 2002,
compared with 81.7 percent in the first half of 2001, reflecting both higher
losses and the lower growth rate in personal lines premiums. The personal lines
loss and LAE ratio in 2002 included 10.3 percentage points for catastrophes
versus 8.5 percentage points in 2001.
The homeowner line is an area of concern to the Company, and we've made several
changes to improve profitability. Rate increases averaging 10 percent went into
effect in most states by the end of the second quarter of 2002. We continue to
work with agencies on re-underwriting their homeowner business and selling
appropriate limits to cover the full value of the risk. Our updated replacement
cost and water damage coverages began to roll out in August. These initiatives
are all in the early stages now. While it takes time to apply changes as
policies are renewed, we expect to see quarter-over-quarter improvement as we
work through the three-year policy cycle.
Property casualty commissions increased $26, or 14 percent, reflecting higher
commissions related to the growth of written premiums.
Life and Accident Health Operations
Earned premiums of our life company increased $2 in the first six months of
2002, a 5 percent increase over the same period last year. The premium growth in
our life products is mainly attributable to increased sales of both universal
life and term insurance.
2002 policyholder benefits increased $3, or 7 percent over the first six months
of 2001, as a result of growth in policy reserves related to premium production
increases. Commissions increased $2, a 22 percent increase over the first six
months of 2001. The increase in commission expense is attributable to a 9
percent growth in net written life insurance premiums and a 27 percent growth in
annuities.
Taxes
There was no significant change in the provision for federal income taxes from
operations for the six months and three months ending June 2002 compared to the
same period in 2001.
Total taxes, licenses and fees increased $2 in the first half of 2002 compared
with the first half of 2001, primarily because of changes in estimated amounts
due to various states and municipalities.
INVESTMENT OPERATIONS
In the first half of 2002, the Company experienced an increase in unrealized
gains on investments, resulting in comprehensive income of $243 in the first six
months of 2002 compared with a comprehensive income of $84 in the first six
months of 2001. Our top 10 equity holdings produced a $96 increase, net of tax,
in unrealized gains in the first six months of 2002.
Investment Income
Pre-tax investment income rose to $218 in the first six months of 2002, compared
with $207 in the same period last year, a 5 percent increase. The increase in
investment income was driven primarily by greater dividend payouts on our equity
portfolio and higher interest earnings because of the growth of the fixed
maturities portfolio, generated by the increases on cash flows from operations.
10
Realized Gains (Losses) on Investments
Realized losses before federal taxes were $18 in the first six months of 2002,
compared with realized gains of $11 for the first six months last year. Included
in the six-month 2002 net capital loss were write-downs of $31 for investments
management deemed impaired, including $8 of WorldCom issues. The second quarter
2002 net capital losses included $25 of write-downs. There were no asset
impairments in the first half 2001.
The Company's Asset Impairment Committee continually monitors investments and
other assets that have fair values that are less than carrying amounts for signs
of other-than-temporary impairment. Factors such as the amount and timing of
declines in fair values, events impacting the issuer, the significance of the
declines, the length of time (six to nine months) of the declines, duration of
fixed-maturity securities, and interest payment defaults, among others, are
considered when determining investment impairment.
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 and there have been no
significant changes to these guidelines during the six months ended June 30,
2002.
OUTLOOK
Over the long-term, the Company continues to seek premium growth in excess of
industry averages, a return to historic profitability levels in its segments
through stringent underwriting practices, and growth of investment income.
Property Casualty Insurance Operations
The Company believes it can continue to increase earned premiums for the
remainder of 2002 in line with the 14 percent growth rate of the first half of
this year. In addition, the Company has targeted a return to its five year
(1995-1999) average statutory and GAAP combined ratio of 101.3 percent, assuming
catastrophe losses for the remainder of the year in the range of 2 to 3
percentage points.
Property casualty ceded reinsurance premiums increased by $76 for the first six
months of 2002 compared with the first six months of 2001, adding approximately
0.8 percentage points to the 2002 combined ratio and reducing earnings per share
by 6 cents. Management continues to project the total 2002 impact of increased
ceded premiums will reduce earnings per share by 12 cents per share.
In the fourth quarter of 2000, the Company established a $110 reserve for Ohio
uninsured, underinsured motorists claims, as a result of two Ohio Supreme Court
decisions affecting all auto insurers in the state. In the first half of 2002,
$28 of new claims was recorded, reducing the remaining reserves for such claims
to $28. Management is monitoring the level of claims closely, although it
believes the reserve is adequate to cover additional claims that may arise
during 2002. Management will continue to monitor these claims and revise its
estimates of the related ultimate liabilities and reserves accordingly.
Investment Operations
Investment income grew 5 percent in the first six months of 2002 compared with
the same period in 2001 due to the factors stated above. The Company anticipates
investment income growth will be in the 5 to 6 percent range for the remainder
of 2002.
11
LIQUIDITY AND CAPITAL RESOURCES
Cash Flow
Management expects cash flow generated from operations will continue to be the
Company's primary source of newly invested funds.
First half 2002 cash flow from operating activities was $305, up slightly from
$296 in the first half 2001. Cash flow used for investing activities was $201 in
the first half of 2002, compared with $242 in the same period last year. This
decrease was largely the result of uninvested cash. Cash flow used for financing
activities was $76 this year, compared with $71 last year.
Debt
The Company's 5.5 percent convertible senior debentures matured on May 1, 2002.
The outstanding debentures at that date were substantially all converted to
common stock.
Dividends
The Company declared a dividend of 22-1/4 cents per share, payable July 15,
2002, for shareholders of record on June 22, 2002. This dividend was an increase
of 6 percent over the second quarter 2001.
Common Stock Repurchases
The Company's Board of Directors has authorized the repurchase of outstanding
shares. At June 30, 2002, 7.6 million shares remained authorized for repurchase
at any time in the future. During the first half of 2002, 284 thousand shares
were repurchased at a cost of $11 and an additional 264 thousand shares were
repurchased following the end of the second quarter, bringing the total
repurchases since the board's 1996 authorization to 13.5 million shares.
OTHER MATTERS
Significant Accounting Policies
The Company did not change any significant accounting policies during the three
or six-month periods ended June 30, 2002, from those utilized in the preparation
of the consolidated financial statements as of and for the year ended December
31, 2001. Please refer to the Company's Annual Report to Shareholders
incorporated by reference within that Form 10-K for a discussion of significant
accounting policies.
12
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 second 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
On April 6, 2002, the registrant held its Annual Meeting of Stockholders for
which the Board of Directors solicited proxies; all nominees named in the
Registrant's Proxy Statement were elected.
Shares (in millions)
For Against/Abstain
--- ---------------
W. Rodney McMullen 141 2
James G. Miller 141 2
Thomas R. Schiff 140 3
Frank J. Schultheis 140 3
Larry R. Webb 140 3
A proposal was made to require the Board to nominate independent directors to
constitute a majority of the Board and 100 percent of the audit, nominating and
compensation committees.
Shares (in millions)
For Against/Abstain
--- ---------------
29 97
A proposal to adopt Stock Option Plan VII was approved.
Shares (in millions)
For Against/Abstain
--- ---------------
136 7
ITEM 5. Other Information
No matters to report.
ITEM 6. Exhibits and Reports on Form 8-K
(a) Exhibits:
Exhibit 11--Statement re-computation of Per Share Earnings.
Exhibit 99.1--Certification Pursuant to 18 U.S.C. Section 1350,
as Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of
2002
Exhibit 99.2--Certification Pursuant to 18 U.S.C. Section 1350,
as Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of
2002
(b) The Company was not required to file any reports on Form 8-K
during the quarter ended June 30, 2002.
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 August 13, 2002
---------------------
By /s/ Kenneth W. Stecher
-----------------------------
Kenneth W. Stecher
Chief Financial Officer
13