CINF - Cincinnati Financial: Robust Quarterly Performance Driven By Investment Gains

2023-08-07 07:26:26 ET

Summary

• Cincinnati Financial reported a significant turnaround in net income, going from a loss to a profit, mainly due to unrealized equity gains.
• The company improved its underwriting margins in the second quarter but faced challenges in the first quarter with higher catastrophe losses and claims inflation.
• CINF plans to implement more aggressive rate increases and refine its pricing strategy to offset inflationary pressures and achieve long-term profitability.

Executive Summary

Cincinnati Financial ( CINF ) recently released its quarterly results , showing an impressive turnaround in net income from a $818 million loss in the previous year to a profit of $534 million. Year-to-date post-tax profit also rose significantly by $1.8 billion to reach $759 million, mainly due to unrealized equity gains, in contrast to significant losses in the same period last year.

During the second quarter, the company successfully improved its underwriting margins, achieving a quarterly combined ratio of 97.6%. However, the insurance portfolio faced challenges in the first quarter, with higher catastrophe losses and claims inflation, leading to a deteriorated year-to-date combined ratio compared to the same period last year.

Quarterly Improvement But Weaker Underwriting Margins

Over the past ten years, Cincinnati Financial has maintained an average GAAP combined ratio of 94.8%, with peak values observed in 2020 and 2022.

Both years were adversely affected by higher-than-expected catastrophe losses. Additionally, the impact of rising inflation, which began in 2022, has continued to affect the company's performance in 2023.

In the second quarter, Cincinnati Financial achieved an underwriting profit of $47 million, which effectively offset the underwriting losses recorded in the first quarter. The underwriting profit was driven by strong performance in both the commercial and specialty segments.

However, the excess and surplus line experienced a decline in underwriting profit on both quarterly and year-to-date levels.

The quarterly combined ratio was 92.2%, and the year-to-date combined ratio was 91.1%, representing an increase of 7.1 and 5.6 points, respectively, compared to the same periods last year. Meanwhile, policy renewals experienced estimated average price increases in the high-single-digit range.

In contrast, the commercial business was the only segment that recorded higher underwriting income, with year-to-date gains of $31 million compared to $14 million last year.

The overall standard commercial lines policies saw estimated renewal price increases near the low end of the high-single-digit range. However, the insurer has been seeking stricter renewal terms and conditions on policies that are believed to have relatively weaker pricing, resulting in the retention of fewer of those policies.

However, the personal insurance business faced challenges with higher catastrophe losses during this period, which led to a substantial increase in the loss ratio.

In response to inflationary pressures, the company is planning to implement more aggressive rate increases in future quarters. For the personal auto line of business, the insurer expects an average rate increase of approximately 10% for the full year 2023. As for the homeowner line of business, premium rates for the first six months of 2023 increased at average percentages in the mid-single-digit range.

Moreover, the company is actively refining its pricing strategy to better align premiums with the risk of loss on individual policies. The combination of improved pricing precision and broad-based rate increases is aimed at positioning the combined ratio at a profitable level over the long term.

For 2023, the underwriting income is expected to be lower than in 2022 due to inflationary pressures, which are not expected to be fully offset by the implementation of pricing initiatives.

Strong Investment Returns Driven by Equity Unrealized Gains and Higher Investment Yield

Cincinnati Financial recognized a significant investment gain. As of June 30, the equity portfolio had $6.1 billion in appreciated value, increasing 8% since the end of the first quarter.

Moreover, the year-to-date investment income surged by 13% to reach $430 million, showing significant growth compared to the previous year.

The second quarter particularly made a positive impact, contributing $220 million to the overall increase.

Valuation

Currently, the stock is valued at 1.55 times the book value, which is slightly lower than its 5-year average of 1.6.

As a result, investors may find the company attractive for investment at this time. However, it is important to note that this is not my personal belief. The safety margin may not be sufficient due to the company's dependency on the equity market performance and the weaker underwriting margins. Nevertheless, on a long-term perspective, the company is well-positioned and has the potential to perform well.

Final Thoughts

Cincinnati Financial has impressed investors by surpassing analysts' estimates, primarily driven by stronger underwriting margins and higher unrealized equity gains. The weight of the equity portfolio in the total investment portfolio, (more than 30% of the total investment portfolio), is a double-edged sword that may impact the recorded profits both positively and negatively. Consequently, it can influence investors' perception of the company's solvency and performance.

In the long run, Cincinnati Financial is expected to deliver strong performance from both underwriting and investment perspectives. As of now, I have decided not to invest in Cincinnati Financial due to an insufficient safety margin. Nevertheless, if I were already a shareholder of Cincinnati Financial, I would keep my shares

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