Cincinnati Financial Corporation (NASDAQ:CINF) Q4 2022 Earnings Call Transcript

Cincinnati Financial Corporation (NASDAQ:CINF) Q4 2022 Earnings Call Transcript February 7, 2023

Operator: Good day, and welcome to the Cincinnati Financial Corporation Fourth Quarter and Full-Year 2022 Earnings Conference Call. All participants will be in a listen-only mode. After today’s presentation, there will be an opportunity to ask questions. Please note that this event is being recorded. I would now like to turn the conference over to Dennis McDaniel, Investor Relations Officer. Please go ahead.

Dennis McDaniel: Hello. This is Dennis McDaniel at Cincinnati Financial. Thank you for joining us for our fourth quarter and full year 2022 earnings conference call. Late yesterday, we issued a news release on our results, along with our supplemental financial package, including our year-end investment portfolio. To find copies of any of these documents, please visit our investor website, cinfin.com/investors. The shortest route to the information is the quarterly results link in the navigation menu on the far left. On this call, you’ll first hear from Chairman and Chief Executive Officer, Steve Johnston; and then from Executive Vice President and Chief Financial Officer, Mike Sewell. After their prepared remarks, investors participating on the call may ask questions.

At that time, some responses may be made by others in the room with us, including President, Steve Spray, and Cincinnati Insurance’s Chief Investment Officer, Steve Solaria, Chief Claims Officer, Mark Schambow, and Senior Vice President of Corporate Finance, Theresa Hoffer. First, please note that some of the matters to be discussed today are forward-looking. These forward-looking statements involve certain risks and uncertainties. With respect to these risks and uncertainties, we direct your attention to our news release and to our various filings with the SEC. Also, a reconciliation of non-GAAP measures was provided with the news release. Statutory accounting data is prepared in accordance with statutory accounting rules and therefore is not reconciled to GAAP.

Now I’ll turn over the call to Steve.

Steve Johnston: Good morning, and thank you for joining us today to hear more about our results. We see positive momentum in several areas and are bullish (ph) about our future prospects despite 2022 financial results that were somewhat below our expectations. Challenges during the year included elevated inflation and higher losses from natural catastrophe events for us and the property casualty industry, in addition to the market volatility affecting the valuation of investment portfolios. Our experience in managing adversity, coupled with the company’s financial strength allows us to maintain a long-term view and supports our confidence as we execute our plans. Net income for the fourth quarter of 2022 was just over $1 billion, that’s 31% or $457 million less than last year’s outstanding fourth quarter, largely due to $307 million less benefit on an after-tax basis in the fair value of securities held in our equity portfolio.

Non-GAAP operating income of $202 million for the fourth quarter was down $118 million from a year ago, including catastrophe losses that were $66 million higher on an after-tax basis. Our 94.9% fourth quarter property casualty combined ratio was 10.7 percentage points higher than the 84.2% for the fourth quarter of last year, which was amongst the best combined ratios we’ve ever recorded. We think longer-term comparisons are also important. On a current accident year basis, excluding catastrophe losses, our 90.2% combined ratio compares favorably with each of the five years prior to 2020 and was 1.5 percentage points better than the average for that period with each accident year measured as of the respective year-end. On a calendar year basis, our 2022 combined ratio experienced a larger negative impact from catastrophe losses than in 2021, as they increased 4.2 percentage points for the fourth quarter and 1.2 points for the year.

Inflation also pressured our combined ratio throughout 2022, contributing to less favorable results for both the current accident year and for reserve development on prior accident years as we have increased reserves for estimated ultimate losses. We’ve responded with actions to improve underwriting selection and pricing, including premium rate increases and increased expectations by underwriters as they factor inflationary trends into areas such as risk selection criteria, pricing of policies and adjusting premium factors for changes in exposure. We believe we can successfully balance prudent underwriting and business growth to improve results next year with a 2023 GAAP combined ratio in the low to mid-90% range. We also believe our 2023 property casualty premium growth rate can be 8% or more.

We recognize that weather and significant changes in industry market conditions that influence insurance policy pricing trends or some of the variables that will affect the property casualty results we ultimately report. In recent quarters, we’ve noted that commercial umbrella loss experience has been elevated. Although, still elevated in the fourth quarter, it was to a less degree than earlier in 2022. While recent profitability for our commercial umbrella business is not as strong as we previously estimated after strengthening reserves during 2020. The average combined ratio for the years 2018 through 2022 is still good, below 85% on a calendar year basis and below 90% on an accident year basis with development through year end 2022. Overall premium growth was very good and continues to incorporate pricing segmentation.

Our underwriters work to retain and write more profitable accounts while also addressing ones that we determine have inadequate pricing. They do an excellent job serving Cincinnati Insurance appointed agencies that are outstanding at producing business for us. Consolidated property casualty net written premiums rose 10% for the fourth quarter and 13% for the full year 2022, that includes a 13% increase in fourth quarter renewal written premiums with a significant portion from higher levels of insured exposures as we factor in elevated inflation. In addition to exposures increases, our Commercial Lines Insurance segment continued to experience estimated average renewal price increases in the mid-single digit percentage range, higher than the third quarter.

Our Excess and Surplus Lines Insurance segment continued in the high-single digit range. Personal lines average renewal price increases were at the high end of the low-single digits with both auto and homeowner higher than in the third quarter. As we previously disclosed, we expect premium rates for our personal auto line of business will continue to rise. Based on our rate filings that have averaged low double-digit rate increases for policies effective beginning January 1, 2023, we expect the full year 2023 personal auto written premium effect will be an average premium rate increase of approximately 10%. Policy retention rates improved from year end 2021 with our Commercial Lines segment moving higher in the upper 80% range. In our Personal Lines segment, rising to the low to mid-90% range.

Moving on to highlight premium growth and profitability by Insurance segment. The Commercial Lines segment grew both fourth quarter and full year 2022 net written premiums 9%. Its combined ratio for both the quarter and full year 2022 was approximately 99%. That’s above where we aim for and reflects elevated inflation effects and catastrophe losses that were higher than a year ago. For our personal lines segment, net written premium grew 16% for the quarter and 15% for the full year 2022, as we continued our planned expansion of high net worth business produced by our agencies. Its full year combined ratio was approximately 99% and reflected elevated inflation effects and is likewise above our near-term profit target. We have confidence that our proven long-term strategy and near-term actions we have taken will blend to improve results for both commercial and personal lines.

Our Excess and Surplus Line segment finished the year with a 90.4% combined ratio, a good result, combined with 2022 net written premium growing 18%. Cincinnati Re and Cincinnati Global each had another year of healthy growth. Cincinnati Re grew full year 2022 net written premiums by 27% with a combined ratio of 97.4%. Cincinnati Global had a 2022 combined ratio of 88.9% with net written premiums growing 23%. Our life insurance subsidiary continued its good performance with full year 2022 net income of $66 million, up 50% from a year ago and term life insurance earned premiums grew by 5%. On January 1 of this year, we again renewed each of our primary property casualty treaties that transfer part of our risk to reinsurers. Our strong capital supports retaining additional risk and managing cost of rising reinsurance ceded premiums.

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For our per risk treaties, terms and conditions for 2023 are fairly similar to 2022, other than premium rate increases that averaged approximately 13%. The primary objective of our property casualty treaty — catastrophe treaty is to protect our balance sheet. The treaty’s main change this year is retaining a greater share of losses for layers of coverage than what was effect for 2022, while adding $92 million of coverage in a new layer between $900 million and $1.1 billion. In 2023, we’ll retain all of the first $200 million of losses and the share of the next $900 million for a catastrophe event compared with 2022 when we retained the first $100 million and the share of the next $800 million. Should we experience a 2023 catastrophe event totaling $1.1 billion in losses, we’ll retain $542 million compared with $499 million in 2022 for an event of that magnitude.

We expect 2023 ceded premiums for these treaties in total to be approximately $130 million, approximately $16 million or 14% higher than the actual $114 million of ceded premiums for these treaties in 2022. Our investment department continued to perform quite well, and Mike will provide some details. Investments is another area where we like to keep an eye on longer-term trends. For example, for the five years ended with 2022, our equity portfolio, compound annual total shareholder return was 11.1%, 170 basis points better than the S&P 500 Index. I’ll conclude with the value creation ratio, our primary measure of long-term financial performance. Net income before investment gains or losses contributed favorably to VCR 2.1% for the fourth quarter and 5.2% for the full year 2022.

The contribution from valuation of our investment portfolio was mixed, 10.5% favorable for the quarter, but unfavorable by 19.4% for the year due to challenges for both the stock and bond markets. A positive VCR of 12.8% for the quarter improved our 2022 full year VCR to negative 14.6%. Although that’s below our expectations for a typical year, the 11.2% annual average over the past five years is within our annual average target range of 10% to 13%. Now our Chief Financial Officer, Mike Sewell, will add comments about several other important points for evaluating our financial performance.

Michael Sewell: Thank you, Steve, and thanks to all of you for joining us today. Investment income continued to grow at an outstanding pace, up 12% for the fourth quarter and 9% for full year 2022 compared with the same periods of last year. Dividend income rose 7% for the quarter. Net equity securities purchased during 2022 totaled $36 million. Bond interest income was up 11% in the fourth quarter. The pretax average yield of 4.16% for the fixed maturity portfolio was 17 basis points higher than a year ago. The average pretax yield for the total of purchased taxable and tax-exempt bonds continue to rise to 5.01% during full year 2022. We continue to emphasize investing in fixed maturity securities with net purchases during the year totaling $788 million.

Valuation changes for our investment portfolio during the fourth quarter of 2022 were favorable in aggregate for both our stock and bond holdings. The overall net gain for the quarter was nearly $1.3 billion before tax effects, including an additional $230 million of unrealized gains in our bond portfolio. At the end of 2022, total investment portfolio net appreciated value was approximately $4.7 billion. The equity portfolio was in a net gain position of $5.5 billion, while the fixed maturity portfolio was in a net loss position of $847 million. Cash flow, in addition to rising bond yields contributed to the 7% increase in interest income we reported for the year. Cash flow from operating activities for full year 2022 generated almost $2.1 billion, a record high amount, up 4% from a year ago.

For the fourth quarter of this year, it rose 36%. Turning to expense management. Our objective is to appropriately balance expense control with continuing to make strategic investments in our business. The full year 2022 property casualty underwriting expense ratio was 0.2 percentage points lower than last year reflecting lower accruals for agency profit-sharing commissions. Regarding loss reserves, our approach remains consistent and target net amounts in the upper half of the actuarially estimated range of net loss and loss expense reserves. We have now had $34 million of net favorable development on prior accident years. As we do each quarter, we consider new information such as paid losses and case reserves and then updated estimated ultimate losses and loss expenses by accident year and line of business.

During 2022, our net increase in the property casualty loss and loss expense reserves was $1.029 billion, a 15% increase from the net reserve balance at year end 2021. The IBNR portion of that reserve addition was $765 million a further indication of the quality of our balance sheet. For full year 2022, we experienced $159 million of property casualty net favorable reserve development on prior accident years that benefited the combined ratio by 2.3 percentage points. Of that $159 million in net favorable development, $25 million of the net unfavorable amount from our commercial casualty lines of business, including an unfavorable $41 million for commercial umbrella and a net favorable $16 million for other coverages included in commercial casualty.

On an all-lines basis by accident year, net reserve development for the full year 2022 included favorable $96 million for 2021, favorable $124 million for 2020, unfavorable $72 million for 2019 and a favorable $11 million in aggregate for accident years prior to 2019. Our approach to capital management also remains consistent, and we repurchased shares that include maintenance intended to offset shares issued through equity compensation plans. We still believe we have plenty of flexibility and also believe that our financial strength is in great shape. During the fourth quarter of 2022, we repurchased just over 101,000 shares at an average price per share of $109.55. As in the past, I’ll conclude with a summary of the fourth quarter contributions to book value per share.

They represent the main drivers of our value creation ratio. Property casualty underwriting increased book value by $0.47. Life insurance operations increased book value $0.10. Investment income, other than life insurance and net of non-insurance items added $0.83. Net investment gains and losses for the fixed income portfolio increased book value per share by $1.14. Net investment gains and losses for the equity portfolio increased book value by $5.15. And we declared $0.69 per share in dividends to shareholders. The net effect was a book value increase of $7 per share during the fourth quarter to $67.01 per share. Now I’ll turn the call back over to Steve.

Steve Johnston: Thanks, Mike. We faced a number of challenges in 2022 and still recorded an underwriting profit for our insurance business. That result bolsters our belief that we’ll see future benefits from our efforts to continually refine pricing precision and segmentation and our efforts to expand our geographic footprint and produce — and product offerings. When you consider our financial strength, our experienced service-oriented associates and our Premier Agency force, I’m confident we’ll be able to continue delivering shareholder value far into the future. Our Board of Directors shares that confidence and expressed it by increasing our quarterly cash dividend 9% last month, setting the stage for a 63 year of rising dividend payments.

So that’s not just paying the dividend for 63 straight years. That sets the stage for increasing the dividend for a 63 consecutive year. We believe that’s a record that can only be matched by seven other publicly traded U.S. companies. As a reminder, with Mike and me today are Steve Spray, Steve Soloria, Marc Schambow and Theresa Hoffer. Cole, please open the call for questions.

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Q&A Session

Operator: Thank you. And we will now begin the question-and-answer session. And our first question today will come from Paul Newsome with Piper Sandler. Please go ahead. Hello, Paul. Perhaps your line is muted.

Paul Newsome: Good morning.

Steve Johnston: Good morning, Paul. No worries.

Paul Newsome: Congratulations on the year and the quarter.

Steve Johnston: Thank you.

Paul Newsome: I was hoping you could give us a little bit more color on investment income, which given the higher interest rates, your view on how much the portfolio yield could improve over the course of the year? And any thoughts on changing or different — the allocation that you’ve had the last many years here in terms of buys versus equities and what you’re doing within those fixed income as well?

Steve Soloria: Paul, this is Steve Soloria here. Just in terms of moving forward, the allocation will remain virtually the same. We’ve taken advantage of the increase in rates over the course of the year to our benefits. We’ll continue to do so, but we’ll try and maintain an even keel and stay disciplined in our allocation moving forward. In terms of last year, as mentioned previously, the aggregates or kind of blended rate for the year was about 5%. Comparing that year-over-year, a year ago, we were at about 3.5%. So we picked up about 150 basis points on purchases over the year. Looking forward, as the Fed begins to hopefully slow down the rate increases, we’ll probably see a bit of a pullback in the purchase yield moving forward, but we think we’ve booked some pretty nice yields over the course of the year, which will benefit us for the next eight to 10 years.

Paul Newsome: Maybe as a second question, can you give us some further thoughts on claims inflation for the commercial line side of the house. Obviously, social inflation is top of mind to everyone in the business. And do you think the uptick in what you’re doing with pricing is sufficient to overcome what you perceive as the prospective inflation improves.

Steve Johnston: Yeah. Thanks, Paul. This is Steve. And we do see the inflation. As we just mentioned, have had our reserves developed favorably now for 34 years. And as a part of that, we try to be very prospective as we look at how we set our reserves and our pricing and be very prudent about it. And we do think that we are in a position for our rates to keep pace and exceed inflation. And I think that comes from a combination of the pure net rates that our net rate increases I went over in my fixed part of the call here and also exposure increases that we’re getting both in personal and commercial lines.

Paul Newsome: So do you think the underlying claims inflation is essentially less than combination of the exposure benefit plus the pure rate or do you think it’s actually even lower than the pure rate at this point?

Steve Johnston: I think the combination of the two, they’re both kind of intertwined in terms of the overall premium that we’re able to charge. And the exposure base does contemplate to a certain degree, the inflation and building costs and so forth.

Paul Newsome: Thank you. Always appreciate the help guys.

Steve Johnston: Thank you, Paul.

Operator: And our next question will come from Mike Zaremski with BMO. Please go ahead.