UNITED STATES
SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

FORM 10-Q

For the transition period from ______________ to _____________.

Commission file number 0-4604

CINCINNATI FINANCIAL CORPORATION

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.

Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Act).

As of July 30, 2004, there were 168,307,665 shares of common stock outstanding.

CINCINNATI FINANCIAL CORPORATION
FORM 10-Q FOR THE THREE MONTHS AND SIX MONTHS ENDED JUNE 30, 2004

TABLE OF CONTENTS

PART I — FINANCIAL INFORMATION

ITEM 1. FINANCIAL STATEMENTS

Cincinnati Financial Corporation and Subsidiaries

Cincinnati Financial Corporation and Subsidiaries

Cincinnati Financial Corporation and Subsidiaries

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (unaudited)

NOTE 1 — ACCOUNTING POLICIES

The condensed consolidated financial statements include the accounts of Cincinnati Financial Corporation and its consolidated subsidiaries, each of which is wholly owned, and are presented in conformity with accounting principles generally accepted in the United States of America (GAAP). All significant intercompany balances and transactions have been eliminated in consolidation.

The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions that affect amounts reported in the financial statements and accompanying notes. Actual results could differ from those estimates. The December 31, 2003, consolidated balance sheet amounts are derived from the audited financial statements but do not include all disclosures herein required by accounting principles generally accepted in the United States of America.

The June 30, 2004, condensed consolidated financial statements of the company are unaudited. The company believes that all adjustments (consisting only of normal recurring accruals) necessary for fair presentation have been made. The results of operations for interim periods are not necessarily an indication of results to be expected for the remainder of the year. Per share amounts have been adjusted for the 5 percent stock dividend paid June 15, 2004, to shareholders of record on April 30, 2004.

Investments

Fixed maturities (bonds and notes) and equity securities (common and preferred stocks) have been classified as available for sale and are stated at fair values at June 30, 2004, and December 31, 2003.

At June 30, 2004, unrealized investment gains before taxes totaled $5.873 billion and unrealized investment losses in the investment portfolio amounted to $52 million. Total unrealized appreciation was primarily due to the company’s holdings in Fifth Third Bancorp (Nasdaq: FITB) and Alltel Corporation (NYSE:AT) common stock. The change in unrealized gains and losses on investments, net of taxes, described in the following table, are included in shareholders’ equity in accumulated other comprehensive income. The change in fixed maturities unrealized gains and losses for the second quarter and six months ended June 30, 2004, was due primarily to interest-rate driven market value fluctuations in the fixed maturity portfolio. The change in equity securities unrealized gains and losses for the second quarter and six months ended June 30, 2004, was due primarily to the decline in Fifth Third's market value, as well as the previously announced second-quarter 2004 sale of equity securities.

Realized gains and losses on investments are recognized in net income on a specific identification basis. See Investment Portfolio, Page 27, for additional discussion of the investment portfolio. Other-than-temporary declines in the fair value of investments are recognized in net income as realized investment losses at the time when facts and circumstances indicate such write-downs are warranted. In the three-month and six-month periods ended June 30, 2004, the company recorded $1 million and $3 million in other-than-temporary impairment charges, compared with $17 million and $69 million in other-than-temporary impairment charges in the comparable prior-year periods (see Investments Results of Operations, Page 24, for discussion of the impairment charges).

Reinsurance

In the accompanying condensed consolidated statements of income, premiums earned are net of ceded premiums, and insurance losses and policyholder benefits are net of reinsurance recoveries, as follows:

Effective April 1, 2004, the company expanded its property catastrophe reinsurance program, adding another $100 million layer in excess of $400 million and retaining 5 percent of the losses in this layer. See Property Casualty Insurance Operations, Page 14, for discussion of the company’s strategy to support the financial strength ratings of its property casualty insurance operations.

Stock Options

The company has qualified and non-qualified stock option plans under which options are granted to associates at prices which are not less than market price at the date of grant and that are exercisable over 10-year periods. The company applies Accounting Principles Board (APB) Opinion 25 and related interpretations in accounting for these plans. Accordingly, no compensation cost has been recognized for the stock option plans.

Had compensation cost for the company’s stock option plans been determined based on the fair value at the grant dates for awards under those plans consistent with the method of Statement of Financial Accounting Standards (SFAS) No. 123 “Accounting for Stock-Based Compensation,” the company’s net income and earnings per share would have been reduced to the pro forma amounts indicated below:

In determining the pro forma amounts above, the fair value of each option was estimated on the date of grant using the binomial option-pricing model with the following weighted-average assumptions used for grants in the six months ended June 30, 2004 and 2003, respectively: dividend yield of 2.78 and 2.52 percent; expected volatility of 25.91 percent and 25.90 percent; risk-free interest rates of 4.30 percent and 4.26 percent; and expected lives of 10 years for all periods. Compensation expense in the pro forma disclosures is not indicative of future amounts as options vest over several years and additional grants generally are made each year.

Pension Plan

The measurement date for the company’s pension plan is December 31. The following summarizes the components of net periodic pension costs:

As of June 30, 2004, no contributions had been made; however, the company continues to anticipate contributing $8 million in 2004, as stated in the 2003 Annual Report on Form 10-K.

Reclassifications

Certain prior-period amounts have been reclassified to conform with the current-period classifications.

Recent Accounting Pronouncements

In March 2004, the Financial Accounting Standards Board ratified the consensus reached by the Emerging Issues Task Force in Issue 03-1, “The Meaning of Other-Than-Temporary Impairments and Its Application to Certain Investments” (EITF 03-1). EITF 03-1 is effective for the company in the third quarter of 2004. EITF 03-1 provides guidance for

determining when an investment is impaired, whether impairment is other than temporary, and measurement of an impairment loss. An impairment loss should be recognized equal to the difference between the investment’s carrying value and its fair value when an impairment is other than temporary. Subsequent to an other-than-temporary impairment loss, a debt security should be accounted for in accordance with Statement of Position No. 03-3, “Accounting for Loans and Certain Debt Securities Acquired in a Transfer,” which allows the accretion of the discount between the carrying value and expected value of a security if the amount and timing of the recognition of that difference in cash is reasonably estimable. EITF 03-1 also indicates that although not presumptive, a pattern of selling investments prior to the forecasted recovery may call into question an investor’s intent to hold the security until it recovers in value.

The EITF 03-1 impairment model applies to all investment securities accounted for under SFAS No. 115, “Accounting for Certain Investments in Debt and Equity Securities” and to investment securities accounted for under the cost method to the extent an impairment indicator exists or the reporting entity has estimated the fair value of the investment security in connection with SFAS No. 107, “Disclosures about Fair Value of Financial Instruments.”

The final consensus on EITF 03-1 included additional disclosure requirements incremental to those included in the company’s 2003 Annual Report on Form 10-K.

The company is currently evaluating the impact of EITF 03-1 on its process for determining other-than-temporary impairment for the affected securities. More specifically, the company is analyzing whether subsequent to adoption of the standard, its portfolio management practices for certain securities classified as available for sale pursuant to SFAS No. 115 could be interpreted as a pattern of selling, thereby affecting its designated intent to hold such investments for the period necessary to allow for the forecasted recovery of fair value pursuant to the requirements of EITF 03-1. As a result of this analysis, the company potentially may record as realized capital losses the unrealized net capital losses associated with certain securities classified as available for sale.

Adoption of this standard may accelerate the timing of recognition of certain impairment losses or otherwise result in impairment losses being recognized when they previously may not have been and may result in the designation of certain investment securities as trading. It also may increase the volatility of net income due to:

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The potential recognition of unrealized losses in situations where the company anticipates a full recovery of certain unrealized losses but does not desire to elect a permanent intent to hold the affected securities, regardless of internal and external facts and circumstances, until such time as they fully recover or mature; and

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Changes in the timing of the recognition of the difference between carrying value and expected settlement value of those debt securities for which an other-than-temporary impairment is taken.

Adoption of this standard is not expected to have a material impact on shareholders’ equity since fluctuations in fair value are already recorded in accumulated other comprehensive income.

Gross unrealized losses on available-for-sale securities were $52 million at June 30, 2004. The company is continuing to evaluate the impact of EITF 03-1 and is unable to estimate the impact of adoption in the third quarter of 2004. Any other-than-temporary impairment losses that may need to be recognized upon adoption will be dependent on market conditions and management’s intent and ability to hold any such impaired securities. The company’s current asset impairment policy is discussed in the 2003 Annual Report on Form 10-K, Page 19.

Regulatory Proceedings

On June 28, 2004, Cincinnati Financial Corporation filed an application with the Securities and Exchange Commission formally requesting an exemption for the holding company under Section 3(b)(2) of the Investment Company Act, which permits the SEC to exempt entities primarily engaged in business other than that of investing, reinvesting, owning, holding or trading in securities. Cincinnati Financial Corporation alternatively has asked the SEC for relief pursuant to Section 6(c) of the Investment Company Act that would exempt it from all the provisions of the Act because doing so is necessary or appropriate in the public interest consistent with the protection of investors and consistent with the purposes intended by the Investment Company Act. The company simultaneously contacted the SEC’s Division of Investment Management to discuss the status of Cincinnati Financial Corporation under the Investment Company Act.

Management strongly believes that Cincinnati Financial Corporation is not an investment company because it is engaged primarily in the business of property casualty and life insurance through subsidiaries it owns, rather than the business of investing, reinvesting, owning, holding or trading in securities. As of the filing date of this Form 10-Q, the matter is being actively considered by the SEC staff. See Item 5, Other Information, Application to SEC Requesting Exemption from Investment Company Act of 1940, Page 34, for additional information regarding the application.

NOTE 2 — SEGMENT INFORMATION

The company is organized and operates primarily in two industries, property casualty insurance and life insurance. Company management regularly reviews four reportable segments — commercial lines property casualty insurance, personal lines property casualty insurance, life insurance and investment operations — to make decisions about allocating resources and assessing their performance. Included in the Other category are operations of the parent company, CFC Investment Company and CinFin Capital Management Company (excluding investment activities) and other income of the insurance subsidiaries.

Revenues are primarily from unaffiliated customers. Revenue for the insurance segments is insurance premiums earned. Revenue for the investment operations segment consists of net investment income and realized investment gains and losses. Other revenue is primarily finance/lease income.

Income before income taxes for the commercial lines and personal lines insurance segments consists of underwriting profit (loss), which is defined as premiums earned minus loss and loss expenses incurred or policyholder benefits and underwriting expenses. Income before income taxes for the life insurance segment represents underwriting profit (loss),

which is defined as premiums earned plus separate account investment management fees less contract holder benefits incurred and expenses incurred plus investment interest credited to contract holders.

Income before income taxes for the investment operations segment consists of net investment income plus realized investment gains and losses, less interest credited to contract holders of the life insurance segment, for all fixed maturity and equity security investments, regardless of ownership. Losses before income taxes in the Other category are primarily due to interest expense from debt of the parent company and operating expenses of company headquarters.

Identifiable assets by segment are those assets used in the respective segment’s operations. Information regarding identifiable assets is not reported for two reportable segments — commercial lines and personal lines of property casualty insurance — because these amounts are not used by company management for analysis of those segments. All fixed maturity and equity security investment assets, regardless of ownership, are included in the investment operations segment.

Segment information is summarized in the following table:

ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

INTRODUCTION

The following discussion highlights significant factors influencing the consolidated results of operations and financial position of Cincinnati Financial Corporation (CFC). It should be read in conjunction with the consolidated financial statements and related notes included in the company’s 2003 Annual Report on Form 10-K. Dollar amounts are rounded to millions; calculations of percent changes are based on whole dollar amounts. Per share amounts have been adjusted for the 5 percent stock dividend paid June 15, 2004, to shareholders of record on April 30, 2004.

SAFE HARBOR STATEMENT

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:

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unusually high levels of catastrophe losses due to changes in weather patterns, environmental events, terrorism incidents or other causes

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increased frequency and/or severity of claims

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events or conditions that could weaken or harm the company’s relationships with its independent agencies and hamper opportunities to add new agencies, resulting in limitations on the company’s opportunities for growth, such as:

	•		downgrade of the company’s financial strength ratings,
	•		concerns that doing business with the company is too difficult or
	•		perceptions that the company’s level of service is no longer a distinguishing characteristic in the marketplace

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delays in the development, implementation, performance and benefits of technology projects and enhancements

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amount of reinsurance purchased and financial strength of reinsurers

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inaccurate estimates or assumptions used for critical accounting estimates, including loss reserves

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recession or other economic conditions or regulatory, accounting or tax changes resulting in lower demand for insurance products

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sustained decline in overall stock market values negatively affecting the company’s equity portfolio, in particular a sustained decline in the market value of Fifth Third Bancorp (Fifth Third) shares, a significant equity holding

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events that lead to a significant decline in the market value of a particular security and impairment of the asset

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prolonged low interest rate environment or other factors that limit the company’s ability to generate growth in investment income

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insurance regulatory actions, legislation or court decisions that increase expenses or place the company at a disadvantage in the marketplace

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adverse outcomes from litigation or administrative proceedings

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not receiving an exemptive order pursuant to the Investment Company Act of 1940 from the SEC, and the resulting changes that would be required in the company’s operations

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 company also is subject to public and regulatory initiatives that can affect the market value for its common stock, such as recent measures affecting corporate financial reporting and governance. The ultimate changes and eventual effects, if any, of these initiatives are uncertain.

Readers are cautioned that the company undertakes no obligation to review or update the forward-looking statements included in this material.

RESULTS OF OPERATIONS

Overview — Financial Highlights

The consolidated results of operations reflect the operating results of each of the company’s four segments along with parent company and other non-insurance related activities. Per share amounts have been adjusted for the 5 percent stock dividend paid June 15, 2004, to shareholders of record on April 30, 2004. The four segments are:

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commercial lines property casualty insurance

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personal lines property casualty insurance

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life insurance

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investments

Revenues for the three- and six-month periods increased due to growth in earned premiums and substantial realized investment gains in the second quarter of 2004. The company reported realized investment gains for the first six months of 2004, compared with realized investment losses in last year’s first six months. Net income rose due to the growth in revenues and higher pretax underwriting profits for the property casualty insurance operations.

Realized investment gains and losses – A significant factor in the growth rate for net income in any period can be realized investment gains and losses. Management believes it is important to carefully consider the impact of realized investment gains and losses on net income when evaluating the company’s operating segments: property casualty insurance and life insurance. Management believes the level of realized investment gains and losses for any particular period, while it may be material, may obscure the performance of ongoing underlying business operations in that period. While realized investment gains and losses are integral to the company’s insurance operations over the long term, the determination to recognize investment gains or losses in any period may be subject to management’s discretion and is independent of the insurance underwriting process. Moreover, under applicable accounting requirements, gains and losses can be recognized from certain changes in market values of securities without actual realization, such as changes in the valuation of embedded derivatives or other-than-temporary impairment charges.

In the second quarter of 2004, the after-tax impact of net realized investment gains was to increase net income by $36 million, or 21 cents per share, compared with net realized investment gains in last year’s second quarter that increased net income by $1 million, or 1 cent. For the first six months of 2004, the after-tax impact of net realized investment gains was to increase net income by $40 million, or 24 cents per share, compared with net realized investment losses that reduced net income by $39 million, or 23 cents per share, in the first six months of 2003. The company reported a net realized investment gain in the second quarter of 2004 primarily because of the previously disclosed sale of equity securities. In addition, other-than-temporary impairment charges declined. See Investments Results of Operations, Page 24, for additional information on net realized investment gains and losses.

Other considerations –Following the Ohio Supreme Court’s late 2003 decision to limit its 1999 Scott-Pontzer v. Liberty Mutual decision, during the first quarter of 2004, the company reviewed outstanding uninsured motorist/underinsured motorist (UM/UIM) claims for which litigation was pending. Those claims represented approximately $37 million in previously established case reserves. Over the three months ended March 31, 2004, the company filed motions for dismissal in various jurisdictions for specific claims and released $32 million in related case reserves in addition to the $38 million that was released in the fourth quarter of 2003. UM/UIM-related reserve changes had a minimal effect on second-quarter 2004 results and the company believes that UM/UIM-related reserve changes will be immaterial in coming quarters.

Management considers the reserve release to be unusual, and it should be taken into consideration when evaluating ongoing business operations. The reserve releases in the first quarter added $21 million, or 12 cents per share, to net income in the first six months of 2004. See the 2003 Annual Report on Form 10-K, Property Casualty Loss and Loss Expense Reserves, for additional information regarding UM/UIM reserves.

Option expense – In the three months ended June 30, 2004 and 2003, reported net income per share on a diluted basis would have been reduced by 1 cent and 2 cents, respectively, if option expense, calculated using the binomial option-pricing model, had been included in operating expenses. In the six months ended June 30, 2004 and 2003, reported net income per share on a diluted basis would have been reduced by 3 cents, if option expense, calculated using the binomial option-pricing model, had been included in operating expenses.

Book value – Due to a lower level of unrealized gains in the investment portfolio; book value per share declined to $36.27 at June 30, 2004, from the record year-end 2003 level of $36.85.

Comprehensive income – Accumulated other comprehensive income, which includes the accumulated unrealized gains on investments and derivatives, declined by $207 million in the second quarter. Return on equity based on comprehensive income was a negative 3.3 percent, compared with a positive 55.2 percent last year, because of a decline in accumulated unrealized gains, compared with an increase in accumulated unrealized gains in last year’s second quarter.

Outlook

Over the long term, management’s objective is to achieve steady growth while performing as an industry profitability leader. At the beginning of the year, management had established specific performance targets for full-year 2004. With results for the first half of the year available, management has updated those targets based on its outlook for the insurance and investment markets and its progress in implementing operating strategies. Management now anticipates:

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Property casualty written and earned premium growth in the high single digits as commercial lines pricing softens and the company maintains modest shorter-term expectations for new personal lines business. Management’s outlook for premium growth is unchanged from the beginning of the year. The outlook is based on comments from various agencies and production results, feedback from the company’s field marketing representatives and account retention trends, as well as plans for new agency appointments and staffing of new marketing territories.

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Combined ratio for the property casualty insurance operations in the range of 92 percent. This target represents a 2 percentage-point improvement over the previous target for 2004 of 94 percent. Management’s outlook takes into account an approximate 1 percentage-point full-year benefit from the UM/UIM reserve release and approximately 3.0 to 3.5 percentage points for catastrophe losses. In 2003, the company reported a combined ratio of 94.7 percent, which included a benefit of 0.8 percentage points from a software recovery and 1.4 percentage points from the release of UM/UIM reserves and 3.6 percentage points from catastrophe losses.

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Investment income growth above 4.5 percent due to the investment of a greater percentage of available cash flow in fixed income securities during the second quarter and potentially into the third and fourth quarters of 2004. Management previously had estimated investment income growth in the range of 3.5 percent to 4.5 percent.

Factors supporting management’s outlook for 2004 are discussed in the results of operations for each of the four business segments.

Property Casualty Insurance Operations

Within the property casualty insurance market, the company offers both commercial and personal policies through a network of independent agencies. Highlights of the performance for the combined property casualty insurance operations included:

•		Earned premiums –Growth in the three- and six-month periods ended June 30, 2004, was due to insurance industry pricing levels, as the company continues to obtain higher premiums on new and renewal business and leverages the competitive characteristics discussed in its 2003 Annual Report on Form 10-K, Item 1, Property Casualty Insurance Operations. The company continues to apply its relationship-based strategies, including a case-by-case approach to new business and account renewals. Growth also has reflected the efforts to improve customer service through the creation of smaller marketing territories, permitting local field marketing representatives to devote more time to each independent agency. At June 30, 2004, the company had 91 property casualty field territories, up from 87 at the beginning of 2003. During the remainder of 2004, the company plans to split and staff at least two and up to six additional territories.
		Management considers statutory net written premium growth to be a key performance indicator, since it can be used to compare the company’s growth to industry performance and allows it to evaluate the success of its strategies. In the second quarter of 2004, the company’s statutory net written premiums on an adjusted basis rose 7.6 percent to $761 million from $707 million in last year’s second quarter. Statutory net written premiums were adjusted for the effect of a refinement adopted in 2002 of the company’s estimation process for matching written premiums to policy effective dates. Management also considers new business measures to be a key indicator of the success of its competitive strategies. Second-quarter new business written directly by agencies was $87 million, essentially unchanged from a year earlier as commercial lines new business growth offset a decline in personal lines new business.
		In the first six months of 2004, the company’s statutory net written premiums on a reported basis rose 7.9 percent to $1.524 billion from $1.413 billion in the first six months of 2003. New business written directly by agencies for the six months ended June 30, 2004, was $167 million, up 7.7 percent over the first six months of last year, as growth in commercial lines new business offset a decline in personal lines new business.
•		Underwriting results and combined ratio – For the second quarter of 2004, the overall property casualty combined ratio improved 6.5 percentage points to 91.9 percent because the 11.8 percentage-point decline in the loss and loss expense ratio offset a higher underwriting expense ratio. The commission expense ratio rose by 1.4 percentage points due to higher accrual for contingent commissions. The non-commission expense ratio increased by 3.9 percentage points, in part due to higher operating expenses related to improving processing time through investments in technology and staffing.

		Second-quarter catastrophe losses were $46 million including losses experienced by policyholders during three periods of severe weather in May across 18 Midwestern and mid-Atlantic states. The second quarter catastrophe losses contributed 6.5 percentage points to the property casualty combined ratio and the effect on after-tax earnings per share for the second quarter was 18 cents.
		For the first six months of 2004, the overall property casualty combined ratio improved 7.3 percentage points to 89.5 percent as the result of the same factors that contributed to the improvement in the three-month period as well as a 2.2 percentage-point benefit from the release of the UM/UIM reserves and the low level of catastrophe losses in the first quarter. These more than offset the 1.7 percentage-point rise in the commission expense ratio due to higher agency contingent commission accruals related to strong underwriting profitability.
		In 2003, second-quarter catastrophe losses were $47 million, contributing 7.1 percentage points to the combined ratio, with an 18 cent impact on earnings per share, and six-month catastrophe losses were $49 million, contributing 3.8 percentage points, with a 19 cent impact on earnings per share.
•		Technology updates – As described in the 2003 Annual Report on Form 10-K, the company expects to continue to strengthen its relationships with agencies through the introduction and use of technology that brings agencies greater efficiencies and permits associates to spend more time with people and less with paper. Certain technology project implementation phases may occur in the first half of 2005 rather than the fourth quarter of 2004 because of testing of control systems as required by the Sarbanes-Oxley Act. These short-term schedule changes are not expected to impact project completion timelines.
		For the company’s major technology initiatives, $11 million was capitalized during the first six months of 2004, in line with management’s expectation of $23 million in capitalized costs over the course of 2004. Depreciation for both the three and six months ended June 30, 2004, had a two-tenths of a percentage point impact on the overall property casualty combined ratio. For the full year, the impact on the overall combined ratio is estimated to be less than three-tenths of a percentage point.
		WinCPP, an online system for commercial lines rate quoting, was expanded to 13 states and now is available for agencies writing more than 77 percent of commercial lines premiums. During the second quarter, the company also delivered a partial version of its commercial lines processing system for business owner policies to a small group of Ohio agencies. Feedback was positive and additional phases now are in development.
		Agent training for Diamond, the new personal lines processing system, began in Indiana and Michigan in late March and was completed by June 2004. Training for Ohio agents began in late June and is expected to run through the end of the year. Agents in Alabama, Florida, Illinois, Kentucky, Georgia and Wisconsin are expected to be trained on a state-by-state basis beginning in the second half of 2004 and running throughout 2005. Agencies that have received Diamond training begin using the system immediately. During the second quarter of 2004, Diamond was used to process $12 million in written premiums for Kansas, Indiana, Michigan and Ohio agencies, up from $3 million in the first quarter of 2004 when only Kansas agencies were using the system.
		CMS, a new claims file management system, initially was deployed in late 2003. Field claims associates in all states are using CMS to process all newly reported claims. I-View, an imaging and workflow system, began initial pilot testing in the commercial lines area with full implementation anticipated by year-end 2005. This system is expected to enhance efficiency for commercial lines processing.
•		Financial strength ratings – During the second quarter, the company acted to lower the ratio of common stock to statutory surplus for the property casualty company portfolio, along with other actions to support strong policyholder surplus. In addition to the sale of $356 million in equity securities, the insurance subsidiaries transferred $153 million of equity holdings to the parent company in exchange for bonds. Further, it allocated essentially 100 percent of new investment dollars to fixed-maturity and convertible securities in the second quarter and anticipates continuing this allocation at least through the end of the third quarter of 2004. Further, the company reduced its property catastrophe exposure by adding another $100 million layer to its catastrophe reinsurance program, raising the overall limit to $500 million, and began to move homeowner earthquake deductibles to 10 percent from 5 percent.
		These property casualty actions are not a signal of a change in the company’s overall investment philosophy. The company remains fully committed to a long-term equity focus that management believes is the key to the company’s long-term growth and stability. The company will continue to invest for income and growth, focusing on a total-return strategy with steady or increasing dividend income. Over the longer term, the company anticipates continuing to allocate approximately 25 percent to 35 percent of cash flow to equities.

See Item 1 of the 2003 Annual Report on Form 10-K for information regarding the company’s insurer financial strength ratings. At June 30, 2004, statutory surplus for the property casualty insurance group was $2.884 billion, up $104 million from year-end 2003. The ratio of common stock to statutory surplus for the property casualty insurance group portfolio was 93.7 percent at June 30, 2004, compared with 114.7 percent at year-end 2003.

The company is evaluating its available options to address the holding company’s status under the Investment Company Act of 1940, as announced on June 28, 2004 (see Item 5, Other Information, Application to SEC Requesting Exemption from Investment Company Act of 1940, Page 34, for more detail regarding the holding company’s status under the Investment Company Act). Some actions under consideration could increase the property casualty insurance group’s statutory surplus and its ratio of common stock to statutory surplus.

The discussion of the commercial lines and personal lines segments provides additional detail regarding these strategies and trends.

Commercial Lines Results of Operations

Performance highlights for the commercial lines segment included:

Earned premiums – The primary source of earned premium growth for the three- and six-month periods was higher pricing on new and renewal commercial business and continued solid new business growth. In the second quarter of 2004, commercial lines new business premiums written directly by agencies rose 5.9 percent to a record $75 million from $71 million a year earlier. In the first six months of 2004, commercial lines new business premiums written directly by agencies rose 14.4 percent to a record $142 million from $124 million a year earlier.

The company’s standard approach is to write three-year commercial policies, which the company considers to be a competitive advantage in the commercial lines market, as further discussed in Item 1 of the 2003 Annual Report on Form 10-K. However, management estimates that approximately 75 percent of second-quarter 2004 commercial premiums were subject to annual rating within the three-year policy or were written with a one-year policy term.

Profitability – Improvement in commercial lines profitability primarily has been driven by more adequate premiums per exposure. In addition, careful attention to underwriting has slowed the rate of growth in loss and loss expenses. The commercial lines combined ratio for the first six months of 2004 of 83.5 percent included the benefit of the UM/UIM reserve release, which reduced the ratio by 3.0 percentage points.

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Losses incurred – Losses incurred includes both net paid losses and net reserve additions for unpaid losses. As a result of market conditions and underwriting actions in the past several years, which have led to higher premiums on a relatively stable level of exposure, the second-quarter loss ratio improved to 43.1 percent, compared with 53.7 percent last year. Net reserve additions for unpaid losses grew by $21 million during the second quarter of 2004, compared with $48 million during the second quarter of 2003 because of favorable development of case reserves. The six-month

		loss ratio improved to 42.9 percent, including $31 million or 3.0 percentage points from the UM/UIM reserve release, compared with 53.3 percent last year. Net reserve additions for unpaid losses grew by $49 million during the first six months of 2004, compared with $89 million during the comparable prior period.
		Management monitors incurred losses by size of loss, business line, risk category, geographic region, agency, field marketing territory and duration of policyholder relationship, addressing concentrations or trends as needed. Analysis of loss data by average size of loss over the past several years supports management’s belief that the increase in loss severity is not a temporary phenomenon.
		Management evaluates new losses and case reserve adjustments greater than $250,000 to monitor frequency and severity. The second-quarter 2004 ratio of new losses and case reserve adjustments greater than $250,000 to earned premiums was 15.9 percent, compared with 17.2 percent a year ago. Management does not believe the year-over-year variation indicates any new trend.

Commercial Lines Losses Incurred Analysis

•		Loss expenses incurred – Loss expenses declined as a percent of earned premium in the three and six months ended June 30, 2004, due to premium growth, lower claims severity and lower reserve increases.
•		Catastrophe losses – Commercial lines catastrophe losses, net of reinsurance and before taxes, were $15 million and $16 million in the three- and six-month periods ended June 30, 2004, compared with $14 million and $18 million in the comparable prior periods.

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Commission and underwriting (non-commission) expenses incurred – The increase in the total underwriting expense ratio in both the three- and six-month periods reflected a rise in both the commission expense ratio and the underwriting expense ratio. The commission expense ratio rose in both periods because the contingent commission accrual reflected continued strong growth and profitability. Underwriting expense growth reflected fluctuations in deferred acquisition costs and the guaranty fund expense as well as investments in staff and technology to improve processes. Investment continues in major technology initiatives. Some systems now are live and, therefore, the associated expenses for enhancements and upgrades cannot be capitalized.

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Policyholder dividends incurred – Policyholder dividend expense as a percent of earned premiums was 0.7 percent and 0.6 percent in the three and six months ended June 30, 2004, compared with 0.4 percent and 0.7 percent in the comparable prior periods. The second-quarter 2004 increase reflected higher accrual of future workers compensation dividend payments.

Line of Business Analysis