Document


UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
 
(Mark one)
þ        QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934. 
For the quarterly period ended June 30, 2016.
 
¨       TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934. 
For the transition period from _____________________ to _____________________.
Commission file number 0-4604
 
CINCINNATI FINANCIAL CORPORATION
(Exact name of registrant as specified in its charter)
 
Ohio
 
31-0746871
(State or other jurisdiction of
incorporation or organization)
 
(I.R.S. Employer Identification
No.)
 
 
 
6200 S. Gilmore Road, Fairfield, Ohio
 
45014-5141
(Address of principal executive offices)
 
(Zip code)
 
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. 
þYes ¨ No
 
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate website, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).
þYes ¨ No
 
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a nonaccelerated filer or a smaller reporting company. See definition of “large accelerated filer,” “accelerated filer” and “smaller reporting company" in Rule 12b-2 of the Exchange Act.
 
þ Large accelerated filer ¨ Accelerated filer ¨ Nonaccelerated filer ¨ Smaller reporting company 
(Do not check if a smaller reporting company)
 
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act):
¨Yes þ No
 
As of July 22, 2016, there were 164,575,858 shares of common stock outstanding.




CINCINNATI FINANCIAL CORPORATION AND SUBSIDIARIES
FORM 10-Q FOR THE QUARTER ENDED JUNE 30, 2016
 
TABLE OF CONTENTS
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Financial Results
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 



Cincinnati Financial Corporation Second-Quarter 2016 10-Q
Page 2


Part I – Financial Information
Item 1.    Financial Statements (unaudited)
 
Cincinnati Financial Corporation and Subsidiaries
Condensed Consolidated Balance Sheets
(Dollars in millions except per share data)
 
June 30,
 
December 31,
 
 
2016
 
2015
Assets
 
 

 
 

Investments
 
 

 
 

Fixed maturities, at fair value (amortized cost: 2016—$9,518; 2015—$9,324)
 
$
10,138

 
$
9,650

Equity securities, at fair value (cost: 2016—$3,189; 2015—$2,938)
 
5,242

 
4,706

Other invested assets
 
79

 
67

Total investments
 
15,459

 
14,423

Cash and cash equivalents
 
547

 
544

Investment income receivable
 
126

 
129

Finance receivable
 
58

 
62

Premiums receivable
 
1,529

 
1,431

Reinsurance recoverable
 
557

 
542

Prepaid reinsurance premiums
 
73

 
54

Deferred policy acquisition costs
 
624

 
616

Land, building and equipment, net, for company use (accumulated depreciation:
   2016—$367; 2015—$459)
 
186

 
185

Other assets
 
195

 
154

Separate accounts
 
797

 
748

Total assets
 
$
20,151

 
$
18,888

 
 
 
 
 
Liabilities
 
 

 
 

Insurance reserves
 
 

 
 

Loss and loss expense reserves
 
$
4,970

 
$
4,718

Life policy and investment contract reserves
 
2,624

 
2,583

Unearned premiums
 
2,349

 
2,201

Other liabilities
 
743

 
717

Deferred income tax
 
844

 
638

Note payable
 
28

 
35

Long-term debt and capital lease obligations
 
825

 
821

Separate accounts
 
797

 
748

Total liabilities
 
13,180

 
12,461

 
 
 
 
 
Commitments and contingent liabilities (Note 12)
 
—

 
—

 
 
 
 
 
Shareholders' Equity
 
 

 
 

Common stock, par value—$2 per share; (authorized: 2016 and 2015—500 million shares; issued: 2016 and 2015—198.3 million shares)
 
397

 
397

Paid-in capital
 
1,237

 
1,232

Retained earnings
 
4,915

 
4,762

Accumulated other comprehensive income
 
1,714

 
1,344

Treasury stock at cost (2016— 33.8 million shares and 2015—34.4 million shares)
 
(1,292
)
 
(1,308
)
Total shareholders' equity
 
6,971

 
6,427

Total liabilities and shareholders' equity
 
$
20,151

 
$
18,888

 
 
 
 
 
 Accompanying Notes are an integral part of these Condensed Consolidated Financial Statements.


Cincinnati Financial Corporation Second-Quarter 2016 10-Q
Page 3


Cincinnati Financial Corporation and Subsidiaries
Condensed Consolidated Statements of Income
(Dollars in millions except per share data)
Three months ended June 30,
 
Six months ended June 30,
 
2016
 
2015
 
2016
 
2015
Revenues
 

 
 

 
 

 
 

Earned premiums
$
1,173

 
$
1,111

 
$
2,327

 
$
2,205

Investment income, net of expenses
149

 
140

 
294

 
279

Realized investment gains, net
44

 
60

 
105

 
107

Fee revenues
3

 
3

 
6

 
6

Other revenues
2

 
2

 
3

 
4

Total revenues
1,371

 
1,316

 
2,735

 
2,601

Benefits and Expenses
 

 
 

 
 

 
 

Insurance losses and contract holders' benefits
821

 
712

 
1,545

 
1,461

Underwriting, acquisition and insurance expenses
366

 
340

 
726

 
685

Interest expense
13

 
13

 
26

 
26

Other operating expenses
5

 
3

 
7

 
7

 Total benefits and expenses
1,205

 
1,068

 
2,304

 
2,179

Income Before Income Taxes
166

 
248

 
431

 
422

Provision (Benefit) for Income Taxes
 

 
 

 
 

 
 

Current
48

 
70

 
113

 
116

Deferred
(5
)
 
2

 
7

 
2

Total provision for income taxes
43

 
72

 
120

 
118

Net Income
$
123

 
$
176

 
$
311

 
$
304

Per Common Share
 

 
 

 
 

 
 

Net income—basic
$
0.75

 
$
1.07

 
$
1.89

 
$
1.85

Net income—diluted
0.74

 
1.06

 
1.87

 
1.84

 
 
 
 
 
 
 
 
Accompanying Notes are an integral part of these Condensed Consolidated Financial Statements.

Cincinnati Financial Corporation Second-Quarter 2016 10-Q
Page 4


Cincinnati Financial Corporation and Subsidiaries
Condensed Consolidated Statements of Comprehensive Income
(Dollars in millions)
 
Three months ended June 30,
 
Six months ended June 30,
 
 
2016
 
2015
 
2016
 
2015
Net Income
 
$
123

 
$
176

 
$
311

 
$
304

Other Comprehensive (Loss) Income
 
 

 
 

 
 

 
 

Change in unrealized gains on investments, net of tax of $103, $(112), $203 and $(127), respectively
 
186

 
(207
)
 
376

 
(235
)
Amortization of pension actuarial loss and prior service cost, net of tax of $0, $1, $1 and $1, respectively
 
1

 
1

 
1

 
2

Change in life deferred acquisition costs, life policy reserves and other, net of tax of $(3), $2, $(4) and $1, respectively
 
(4
)
 
4

 
(7
)
 
3

Other comprehensive income (loss), net of tax
 
183

 
(202
)
 
370

 
(230
)
Comprehensive Income (Loss)
 
$
306

 
$
(26
)
 
$
681

 
$
74

 
 
 
 
 
 
 
 
 
Accompanying Notes are an integral part of these Condensed Consolidated Financial Statements.


Cincinnati Financial Corporation Second-Quarter 2016 10-Q
Page 5


Cincinnati Financial Corporation and Subsidiaries
Condensed Consolidated Statements of Shareholders' Equity
(Dollars in millions)
 
Six months ended June 30,
 
 
2016
 
2015
Common Stock
 
 
 
 
   Beginning of year
 
$
397

 
$
397

   Share-based awards
 
—

 
—

   End of period
 
397

 
397

 
 
 
 
 
Paid-In Capital
 
 
 
 
   Beginning of year
 
1,232

 
1,214

   Share-based awards
 
(10
)
 
(11
)
   Share-based compensation
 
13

 
11

   Other
 
2

 
2

   End of period
 
1,237

 
1,216

 
 
 
 
 
Retained Earnings
 
 
 
 
   Beginning of year
 
4,762

 
4,505

   Net income
 
311

 
304

   Dividends declared
 
(158
)
 
(151
)
   End of period
 
4,915

 
4,658

 
 
 
 
 
Accumulated Other Comprehensive Income
 
 
 
 
   Beginning of year
 
1,344

 
1,744

   Other comprehensive income, net
 
370

 
(230
)
   End of period
 
1,714

 
1,514

 
 
 
 
 
Treasury Stock
 
 
 
 
   Beginning of year
 
(1,308
)
 
(1,287
)
   Share-based awards
 
23

 
23

   Shares acquired - share repurchase authorization
 
(2
)
 
(20
)
   Shares acquired - share-based compensation plans
 
(7
)
 
(6
)
   Other
 
2

 
2

   End of period
 
(1,292
)
 
(1,288
)
 
 
 
 
 
      Total Shareholders' Equity
 
$
6,971

 
$
6,497

 
 
 
 
 
(In millions)
 
 
 
 
Common Stock - Shares Outstanding
 
 
 
 
   Beginning of year
 
163.9

 
163.7

   Share-based awards
 
0.7

 
0.8

   Shares acquired - share repurchase authorization
 
—

 
(0.4
)
   Shares acquired - share-based compensation plans
 
(0.1
)
 
(0.1
)
   Other
 
—

 
—

   End of period
 
164.5

 
164.0

 
 
 
 
 
Accompanying Notes are an integral part of these Condensed Consolidated Financial Statements.
 


Cincinnati Financial Corporation Second-Quarter 2016 10-Q
Page 6


Cincinnati Financial Corporation and Subsidiaries
Condensed Consolidated Statements of Cash Flows
 (Dollars in millions)
 
Six months ended June 30,
 
 
2016
 
2015
Cash Flows From Operating Activities
 
 

 
 

Net income
 
$
311

 
$
304

Adjustments to reconcile net income to net cash provided by operating activities:
 
 

 
 

Depreciation and amortization
 
24

 
27

Realized investment gains, net
 
(105
)
 
(107
)
Stock-based compensation
 
13

 
11

Interest credited to contract holders'
 
25

 
22

Deferred income tax expense
 
7

 
2

Changes in:
 
 

 
 

Investment income receivable
 
3

 
1

Premiums and reinsurance receivable
 
(132
)
 
(93
)
Deferred policy acquisition costs
 
(26
)
 
(15
)
Other assets
 
(39
)
 
(6
)
Loss and loss expense reserves
 
252

 
206

Life policy reserves
 
50

 
47

Unearned premiums
 
148

 
109

Other liabilities
 
(42
)
 
(68
)
Current income tax receivable/payable
 
1

 
30

Net cash provided by operating activities
 
490

 
470

Cash Flows From Investing Activities
 
 

 
 

Sale of fixed maturities
 
15

 
19

Call or maturity of fixed maturities
 
820

 
675

Sale of equity securities
 
208

 
221

Purchase of fixed maturities
 
(975
)
 
(1,005
)
Purchase of equity securities
 
(360
)
 
(229
)
Purchase of short-term investments
 
—

 
(75
)
Investment in finance receivables
 
(10
)
 
(6
)
Collection of finance receivables
 
15

 
15

Investment in buildings and equipment, net
 
(7
)
 
(5
)
Change in other invested assets, net
 
(13
)
 
1

Net cash used in investing activities
 
(307
)
 
(389
)
Cash Flows From Financing Activities
 
 

 
 

Payment of cash dividends to shareholders
 
(151
)
 
(145
)
Shares acquired - share repurchase authorization
 
(2
)
 
(20
)
Payments of note payable
 
(7
)
 
—

Proceeds from stock options exercised
 
13

 
11

Contract holders' funds deposited
 
50

 
41

Contract holders' funds withdrawn
 
(77
)
 
(67
)
Excess tax benefits on stock-based compensation
 
2

 
4

Other
 
(8
)
 
(9
)
Net cash used in financing activities
 
(180
)
 
(185
)
Net change in cash and cash equivalents
 
3

 
(104
)
Cash and cash equivalents at beginning of year
 
544

 
591

Cash and cash equivalents at end of period
 
$
547

 
$
487

Supplemental Disclosures of Cash Flow Information:
 
 

 
 

Interest paid
 
$
26

 
$
26

Income taxes paid
 
110

 
83

Noncash Activities
 
 

 
 

Conversion of securities
 
$
3

 
$
—

Equipment acquired under capital lease obligations
 
12

 
6

Cashless exercise of stock options
 
7

 
6

 
 
 
 
 
 Accompanying Notes are an integral part of these Condensed Consolidated Financial Statements.

Cincinnati Financial Corporation Second-Quarter 2016 10-Q
Page 7


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. These statements are presented in conformity with accounting principles generally accepted in the United States of America (GAAP). All intercompany balances and transactions have been eliminated in consolidation.
 
The preparation of financial statements in conformity with GAAP requires us to make estimates and assumptions that affect amounts reported in the financial statements and accompanying notes. Our actual results could differ from those estimates. Our December 31, 2015, condensed consolidated balance sheet amounts are derived from the audited financial statements but do not include all disclosures required by GAAP.
 
Our June 30, 2016, condensed consolidated financial statements are unaudited. Certain financial information that is included in annual financial statements prepared in accordance with GAAP is not required for interim reporting and has been condensed or omitted. We believe that we have made all adjustments, consisting only of normal recurring accruals, that are necessary for fair presentation. These condensed consolidated financial statements should be read in conjunction with our consolidated financial statements included in our 2015 Annual Report on Form 10-K. The results of operations for interim periods do not necessarily indicate results to be expected for the full year.

Adopted Accounting Updates

ASU 2014-12, Compensation-Stock Compensation: Accounting for Share-Based Payments When the Terms of an Award Provide That a Performance Target Could Be Achieved after the Requisite Service Period
In June 2014, the Financial Accounting Standards Board (FASB) issued Accounting Standards Update (ASU) 2014-12, Compensation-Stock Compensation: Accounting for Share-Based Payments When the Terms of an Award Provide That a Performance Target Could Be Achieved after the Requisite Service Period. ASU 2014-12 requires that performance targets that affect vesting and that could be achieved after the requisite service period be treated as performance conditions. The effective date of ASU 2014-12 was for interim and annual reporting periods beginning after December 15, 2015. The company adopted this ASU and it did not have a material impact on our company’s financial position, cash flows or results of operations.

ASU 2015-02, Consolidation-Amendments to the Consolidation Analysis
In February 2015, the FASB issued ASU 2015-02, Consolidation-Amendments to the Consolidation Analysis. ASU 2015-02 makes amendments to the current consolidation guidance, focusing mainly on the investment management industry; however, entities across all industries may be impacted. The effective date of ASU 2015-02 was for interim and annual reporting periods beginning after December 15, 2015. The company adopted this ASU and it did not have a material impact on our company’s financial position, cash flows or results of operations.

Pending Accounting Updates

ASU 2014-09 Revenue from Contracts with Customers
In May 2014, the FASB issued ASU 2014-09, Revenue from Contracts with Customers. ASU 2014-09 requires an entity to recognize revenue to depict the transfer of promised goods or services to customers in an amount that reflects the consideration to which the entity expects to be entitled in exchange for those goods and services. Insurance contracts do not fall within the scope of this ASU. The effective date of ASU 2014-09 is for annual reporting periods beginning after December 15, 2017. The ASU has not yet been adopted; however, it is not expected to have a material impact on our company’s financial position, cash flows or results of operations.

ASU 2015-09, Financial Services-Insurance: Disclosures about Short-Duration Contracts
In May 2015, the FASB issued ASU 2015-09, Financial Services-Insurance: Disclosures About Short-Duration Contracts. ASU 2015-09 requires entities to provide additional disclosures about the liability for loss and loss expense reserves to increase the transparency of significant estimates. ASU 2015-09 also requires entities to disclose information about significant changes in methodologies and assumptions used to calculate the liability for loss and loss expense reserves, including reasons for the change and the effects on the financial statements. ASU 2015-09 also requires entities to disclose a rollforward of the liability of loss and loss expense reserves for annual and interim reporting periods. The effective date of ASU 2015-09 is for annual reporting periods beginning

Cincinnati Financial Corporation Second-Quarter 2016 10-Q
Page 8


after December 15, 2015, and interim reporting periods beginning after December 15, 2016. The ASU has not yet been adopted and will not have a material impact on our company’s financial position, cash flows or results of operations, but the ASU will require additional disclosures to our annual and interim reporting periods.

ASU 2016-01, Financial Instruments - Overall (Subtopic 825-10) - Recognition and Measurement of Financial Assets and Financial Liabilities
In January 2016, the FASB issued ASU 2016-01, Financial Instruments - Overall (Subtopic 825-10) - Recognition and Measurement of Financial Assets and Financial Liabilities. ASU 2016-01 revises the accounting related to the classification and measurement of investments in equity securities and the presentation of certain fair value changes for financial liabilities measured at fair value. The effective date of ASU 2016-01 is for interim and annual reporting periods beginning after December 15, 2017. The ASU has not yet been adopted. Management is currently evaluating the impact on our company’s consolidated financial position, cash flows and results of operations.

ASU 2016-02, Leases (Topic 842)
In February 2016, the FASB issued ASU 2016-02, Leases (Topic 842). The main provision of ASU 2016-02 requires the recognition of lease assets and lease liabilities by lessees for those leases classified as operating leases under previous GAAP. The effective date of ASU 2016-02 is for interim and annual reporting periods beginning after December 15, 2018. The ASU has not yet been adopted. Management is currently evaluating the impact on our company’s consolidated financial position, cash flows and results of operations.

ASU 2016-07, Investments - Equity Method and Joint Ventures (Topic 323): Simplifying the Transition to the Equity Method of Accounting
In March 2016, the FASB issued ASU 2016-07, Equity Method and Joint Ventures (Topic 323): Simplifying the Transition to the Equity Method of Accounting. ASU 2016-07 eliminates the requirement to retroactively adjust an investment, results of operations, and retained earnings once an investment qualifies for use of the equity method. It requires the equity method investor to add the cost of acquiring the additional interest in the investee to the current basis of the investor's previously held interest and adopt the equity method of accounting as of the date the investment becomes qualified for equity method accounting without retroactive adjustment. The effective date of ASU 2016-07 is for interim and annual reporting periods beginning after December 15, 2016. The ASU has not yet been adopted; however, it is not expected to have a material impact on our company's consolidated financial position, cash flows or results of operations.

ASU 2016-09, Compensation - Stock Compensation (Topic 718): Improvements to Employee Share-Based Payment Accounting
In March 2016, the FASB issued ASU 2016-09, Stock Compensation (Topic 718): Improvements to Employee Share-Based Payment Accounting. ASU 2016-09 simplifies and improves several aspects of the accounting for share-based payment transactions, including the income tax consequences, classification of awards as either equity or liabilities, and classification on the statement of cash flows. The effective date of ASU 2016-09 is for interim and annual reporting periods beginning after December 15, 2016. The ASU has not yet been adopted; however, it is not expected to have a material impact on our company's consolidated financial position, cash flows or results of operations.

ASU 2016-13, Financial Instruments - Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments
In June 2016, the FASB issued ASU 2016-13, Financial Instruments - Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments. ASU 2016-13 amends previous guidance on the impairment of financial instruments by adding an impairment model that allows an entity to recognize expected credit losses as an allowance rather than impairing as they are incurred. The new guidance is intended to reduce complexity of credit impairment models and result in a more timely recognition of expected credit losses. The effective date of ASU 2016-13 is for interim and annual reporting periods beginning after December 15, 2019. The ASU has not yet been adopted; however, it is not expected to have a material impact on our company's consolidated financial position, cash flows or results of operations.



Cincinnati Financial Corporation Second-Quarter 2016 10-Q
Page 9


NOTE 2 – Investments
The following table provides cost or amortized cost, gross unrealized gains, gross unrealized losses and fair value for our investment portfolio:
(Dollars in millions)
 
Cost or amortized cost
 
 
 
 
 
 
 
 
 
Gross unrealized
 
Fair value
At June 30, 2016
 
 
gains
 
losses
 
Fixed maturity securities:
 
 

 
 

 
 

 
 

Corporate
 
$
5,498

 
$
366

 
$
27

 
$
5,837

States, municipalities and political subdivisions
 
3,538

 
264

 
—

 
3,802

Commercial mortgage-backed
 
293

 
17

 
—

 
310

Government-sponsored enterprises
 
170

 
—

 
—

 
170

Foreign government
 
10

 
—

 
—

 
10

Convertibles and bonds with warrants attached
 
5

 
—

 
—

 
5

United States government
 
4

 
—

 
—

 
4

Subtotal
 
9,518

 
647

 
27

 
10,138

Equity securities:
 
 

 
 

 
 

 
 

Common equities
 
3,002

 
2,080

 
65

 
5,017

Nonredeemable preferred equities
 
187

 
38

 
—

 
225

Subtotal
 
3,189

 
2,118

 
65

 
5,242

Total
 
$
12,707

 
$
2,765

 
$
92

 
$
15,380

At December 31, 2015
 
 

 
 

 
 

 
 

Fixed maturity securities:
 
 

 
 

 
 

 
 

Corporate
 
$
5,294

 
$
255

 
$
96

 
$
5,453

States, municipalities and political subdivisions
 
3,440

 
172

 
1

 
3,611

Commercial mortgage-backed
 
287

 
4

 
2

 
289

Government-sponsored enterprises
 
284

 
—

 
6

 
278

Foreign government
 
10

 
—

 
—

 
10

Convertibles and bonds with warrants attached
 
5

 
—

 
—

 
5

United States government
 
4

 
—

 
—

 
4

Subtotal
 
9,324

 
431

 
105

 
9,650

Equity securities:
 
 

 
 

 
 

 
 

Common equities
 
2,749

 
1,787

 
51

 
4,485

Nonredeemable preferred equities
 
189

 
32

 
—

 
221

Subtotal
 
2,938

 
1,819

 
51

 
4,706

Total
 
$
12,262

 
$
2,250

 
$
156

 
$
14,356

 
 
 
 
 
 
 
 
 
 
The net unrealized investment gains in our fixed-maturity portfolio are primarily the result of the continued low interest rate environment that increased the fair value of our fixed-maturity portfolio. Our commercial mortgage-backed securities had an average rating of Aa1/AA at June 30, 2016, and December 31, 2015. The seven largest unrealized investment gains in our common stock portfolio are from Exxon Mobil Corporation (NYSE:XOM), Honeywell International Incorporated (NYSE:HON), Johnson and Johnson (NYSE:JNJ), The Procter & Gamble Company (NYSE:PG), Hasbro Incorporated (Nasdaq:HAS), 3M Co (NYSE:MMM) and BlackRock Inc. (NYSE:BLK), which had a combined gross unrealized gain of $647 million. At June 30, 2016, Johnson and Johnson was our largest single common stock holding with a fair value of $153 million, which was 3.0 percent of our publicly traded common stock portfolio and 1.0 percent of the total investment portfolio.


Cincinnati Financial Corporation Second-Quarter 2016 10-Q
Page 10


The table below provides fair values and gross unrealized losses by investment category and by the duration of the securities’ continuous unrealized loss positions:
(Dollars in millions)
 
Less than 12 months
 
12 months or more
 
Total
 
 
Fair value
 
Unrealized losses
 
Fair value
 
Unrealized losses
 
Fair value
 
Unrealized losses
At June 30, 2016
 
 
 
 
 
 
Fixed maturity securities:
 
 

 
 

 
 

 
 

 
 

 
 

Corporate
 
$
252

 
$
9

 
$
258

 
$
18

 
$
510

 
$
27

States, municipalities and political subdivisions
 
2

 
—

 
1

 
—

 
3

 
—

Commercial mortgage-backed
 
5

 
—

 
9

 
—

 
14

 
—

Government-sponsored enterprises
 
20

 
—

 
—

 
—

 
20

 
—

Subtotal
 
279

 
9

 
268

 
18

 
547

 
27

Equity securities:
 
 

 
 

 
 

 
 

 
 

 
 

Common equities
 
546

 
65

 
—

 
—

 
546

 
65

Nonredeemable preferred equities
 
19

 
—

 
18

 
—

 
37

 
—

Subtotal
 
565

 
65

 
18

 
—

 
583

 
65

Total
 
$
844

 
$
74

 
$
286

 
$
18

 
$
1,130

 
$
92

At December 31, 2015
 
 

 
 

 
 

 
 

 
 

 
 

Fixed maturity securities:
 
 

 
 

 
 

 
 

 
 

 
 

Corporate
 
$
1,099

 
$
63

 
$
133

 
$
33

 
$
1,232

 
$
96

States, municipalities and political subdivisions
 
47

 
1

 
22

 
—

 
69

 
1

Commercial mortgage-backed
 
103

 
2

 
2

 
—

 
105

 
2

Government-sponsored enterprises
 
100

 
2

 
127

 
4

 
227

 
6

Subtotal
 
1,349

 
68

 
284

 
37

 
1,633

 
105

Equity securities:
 
 

 
 

 
 

 
 

 
 

 
 

Common equities
 
270

 
51

 
—

 
—

 
270

 
51

Nonredeemable preferred equities
 
35

 
—

 
—

 
—

 
35

 
—

Subtotal
 
305

 
51

 
—

 
—

 
305

 
51

Total
 
$
1,654

 
$
119

 
$
284

 
$
37

 
$
1,938

 
$
156

 
 
 
 
 
 
 
 
 
 
 
 
 

Contractual maturity dates for fixed-maturity investments were:
(Dollars in millions)
 
Amortized
cost
 
Fair
value
 
% of fair
value
At June 30, 2016
 
 
 
Maturity dates:
 
 

 
 

 
 

Due in one year or less
 
$
446

 
$
454

 
4.5
%
Due after one year through five years
 
3,046

 
3,273

 
32.3

Due after five years through ten years
 
3,708

 
3,896

 
38.4

Due after ten years
 
2,318

 
2,515

 
24.8

Total
 
$
9,518

 
$
10,138

 
100.0
%
 
 
 
 
 
 
 

Actual maturities may differ from contractual maturities when there is a right to call or prepay obligations with or without call or prepayment penalties.
 

Cincinnati Financial Corporation Second-Quarter 2016 10-Q
Page 11


The following table provides investment income, realized investment gains and losses, the change in unrealized investment gains and losses, and other items:
(Dollars in millions)
Three months ended June 30,
 
Six months ended June 30,
 
2016
 
2015
 
2016
 
2015
Investment income:
 
 
 
 
 
 
 
Interest
$
110

 
$
106

 
$
219

 
$
211

Dividends
41

 
35

 
78

 
71

Other
—

 
1

 
1

 
1

Total
151

 
142

 
298

 
283

Less investment expenses
2

 
2

 
4

 
4

Total
$
149

 
$
140

 
$
294

 
$
279

 
 
 
 
 
 
 
 
Realized investment gains and losses summary:
 

 
 

 
 

 
 

Fixed maturities:
 

 
 

 
 

 
 

Gross realized gains
$
4

 
$
7

 
$
7

 
$
10

Gross realized losses
—

 
—

 
(1
)
 
—

Other-than-temporary impairments
—

 
(3
)
 
(2
)
 
(3
)
Equity securities:
 

 
 

 
 

 
 

Gross realized gains
38

 
56

 
100

 
100

Gross realized losses
—

 
—

 
(1
)
 
(1
)
Other-than-temporary impairments
—

 
(1
)
 
—

 
(1
)
Other
2

 
1

 
2

 
2

Total
$
44

 
$
60

 
$
105

 
$
107

 
 
 
 
 
 
 
 
Change in unrealized investment gains and losses:
 

 
 

 
 

 
 

Fixed maturities
$
178

 
$
(184
)
 
$
294

 
$
(138
)
Equity securities
111

 
(135
)
 
285

 
(224
)
Less income taxes
(103
)
 
112

 
(203
)
 
127

Total
$
186

 
$
(207
)
 
$
376

 
$
(235
)
 
 
 
 
 
 
 
 
 
During the three months ended June 30, 2016, there were no equity securities and two new fixed-maturity securities other-than-temporarily impaired. During the six months ended June 30, 2016, there were no equity securities and four fixed-maturity securities other-than-temporarily impaired. There were no credit losses on fixed-maturity securities for which a portion of other-than-temporary impairment (OTTI) has been recognized in other comprehensive income for the three and six months ended June 30, 2016 and 2015. At June 30, 2016, 53 fixed-maturity investments with a total unrealized loss of $18 million had been in an unrealized loss position for 12 months or more. Of that total, no fixed-maturity investments had fair values below 70 percent of amortized cost. At June 30, 2016, two equity investments with a total unrealized loss of less than $1 million had been in an unrealized loss position for 12 months or more. Of that total, no equity investments had fair values below 70 percent of amortized cost.
 
During 2015, we other-than-temporarily impaired 20 securities. At December 31, 2015, 69 fixed-maturity investments with a total unrealized loss of $37 million had been in an unrealized loss position for 12 months or more. Of that total, five fixed-maturity investments had fair values below 70 percent of amortized cost. There were no equity security investments in an unrealized loss position for 12 months or more as of December 31, 2015.
 


Cincinnati Financial Corporation Second-Quarter 2016 10-Q
Page 12


NOTE 3 – Fair Value Measurements

In accordance with accounting guidance for fair value measurements and disclosures, we categorized our financial instruments, based on the priority of the observable and market-based data for the valuation technique used, into a three-level fair value hierarchy. The fair value hierarchy gives the highest priority to quoted prices with readily available independent data in active markets for identical assets or liabilities (Level 1) and the lowest priority to unobservable market inputs (Level 3). When various inputs for measurement fall within different levels of the fair value hierarchy, the lowest observable input that has a significant impact on fair value measurement is used. Our valuation techniques have not changed from those used at December 31, 2015, and ultimately management determines fair value. See our 2015 Annual Report on Form 10-K, Item 8, Note 3, Fair Value Measurements, Page 133, for information on characteristics and valuation techniques used in determining fair value.

Fair Value Disclosures for Assets
The following tables illustrate the fair value hierarchy for those assets measured at fair value on a recurring basis at June 30, 2016, and December 31, 2015. We do not have any material liabilities carried at fair value. There were no transfers between Level 1 and Level 2.
(Dollars in millions)
 
Quoted prices in
active markets for
identical assets
(Level 1)
 
Significant other
observable inputs (Level 2)
 
Significant
unobservable
inputs
(Level 3)
 
Total
At June 30, 2016
 
 
 
 
Fixed maturities, available for sale:
 
 

 
 

 
 

 
 

Corporate
 
$
—

 
$
5,785

 
$
52

 
$
5,837

States, municipalities and political subdivisions
 
—

 
3,802

 
—

 
3,802

Commercial mortgage-backed
 
—

 
310

 
—

 
310

Government-sponsored enterprises
 
—

 
170

 
—

 
170

Foreign government
 
—

 
10

 
—

 
10

Convertibles and bonds with warrants attached
 
—

 
5

 
—

 
5

United States government
 
4

 
—

 
—

 
4

Subtotal
 
4

 
10,082

 
52

 
10,138

Common equities, available for sale
 
5,017

 
—

 
—

 
5,017

Nonredeemable preferred equities, available for sale
 
—

 
225

 
—

 
225

Separate accounts taxable fixed maturities
 
—

 
754

 
1

 
755

Top Hat savings plan mutual funds and common
  equity (included in Other assets)
 
23

 
—

 
—

 
23

Total
 
$
5,044

 
$
11,061

 
$
53

 
$
16,158

At December 31, 2015
 
 
 
 
 
 
 
 
Fixed maturities, available for sale:
 
 

 
 

 
 

 
 

Corporate
 
$
—

 
$
5,402

 
$
51

 
$
5,453

States, municipalities and political subdivisions
 
—

 
3,611

 
—

 
3,611

Commercial mortgage-backed
 
—

 
289

 
—

 
289

Government-sponsored enterprises
 
—

 
278

 
—

 
278

Foreign government
 
—

 
10

 
—

 
10

Convertibles and bonds with warrants attached
 
—

 
5

 
—

 
5

United States government
 
4

 
—

 
—

 
4

Subtotal
 
4

 
9,595

 
51

 
9,650

Common equities, available for sale
 
4,485

 
—

 
—

 
4,485

Nonredeemable preferred equities, available for sale
 
—

 
218

 
3

 
221

Separate accounts taxable fixed maturities
 
—

 
736

 
1

 
737

Top Hat savings plan mutual funds and common
  equity (included in Other assets)
 
21

 
—

 
—

 
21

Total
 
$
4,510

 
$
10,549

 
$
55

 
$
15,114

 
 
 
 
 
 
 
 
 
 

Cincinnati Financial Corporation Second-Quarter 2016 10-Q
Page 13


Each financial instrument that was deemed to have significant unobservable inputs when determining valuation is identified in the following tables by security type with a summary of changes in fair value as of June 30, 2016. Total Level 3 assets continue to be less than 1 percent of financial assets measured at fair value in the condensed consolidated balance sheets. Assets presented in the table below were valued based primarily on broker/dealer quotes for which there is a lack of transparency as to inputs used to develop the valuations. The quantitative detail of these unobservable inputs is neither provided nor reasonably available to us.

The following table provides the change in Level 3 assets for the three months ended June 30:
 (Dollars in millions)
 
Asset fair value measurements using significant unobservable inputs (Level 3)
 
 
Corporate
fixed
maturities
 
Separate accounts taxable fixed maturities
 
States,
municipalities
and political
subdivisions
fixed maturities
 
Nonredeemable preferred
equities
 
Total
Beginning balance, April 1, 2016
 
$
51

 
$
1

 
$
—

 
$
2

 
$
54

Total gains or losses (realized/unrealized):
 
 

 
 
 
 

 
 

 
 

Included in net income
 
—

 
—

 
—

 
—

 
—

Included in other comprehensive income
 
—

 
—

 
—

 
—

 
—

Purchases
 
17

 
—

 
—

 
—

 
17

Sales
 
—

 
—

 
—

 
(2
)
 
(2
)
Transfers into Level 3
 
—

 
—

 
—

 
—

 
—

Transfers out of Level 3
 
(16
)
 
—

 
—

 
—

 
(16
)
Ending balance, June 30, 2016
 
$
52

 
$
1

 
$
—

 
$
—

 
$
53

 
 
 
 
 
 
 
 
 
 
 
Beginning balance, April 1, 2015
 
$
18

 
$
—

 
$
1

 
$
2

 
$
21

Total gains or losses (realized/unrealized):
 
 

 
 
 
 

 
 

 
 

Included in net income
 
—

 
—

 
—

 
—

 
—

Included in other comprehensive income
 
—

 
—

 
—

 
—

 
—

Purchases
 
—

 
—

 
—

 
—

 
—

Sales
 
—

 
—

 
—

 
—

 
—

Transfers into Level 3
 
—

 
—

 
—

 
—

 
—

Transfers out of Level 3
 
—

 
—

 
—

 
—

 
—

Ending balance, June 30, 2015
 
$
18

 
$
—

 
$
1

 
$
2

 
$
21

 
 
 
 
 
 
 
 
 
 
 

Cincinnati Financial Corporation Second-Quarter 2016 10-Q
Page 14


The following table provides the change in Level 3 assets for the six months ended June 30:
(Dollars in millions)
Asset fair value measurements using significant unobservable inputs (Level 3)
 
 
Corporate
fixed
maturities
 
Separate
accounts
taxable
fixed
maturities
 
States,
municipalities
and political
subdivisions
fixed maturities
 
Nonredeemable
preferred
equities
 
Total
Beginning balance, January 1, 2016
 
$
51

 
$
1

 
$
—

 
$
3

 
$
55

Total gains or losses (realized/unrealized):
 
 
 
 
 
 

 
 

 
 

Included in net income
 
—

 
—

 
—

 
—

 
—

Included in other comprehensive income
 
—

 
—

 
—

 
(1
)
 
(1
)
Purchases
 
22

 
—

 
—

 
—

 
22

Sales
 
—

 
—

 
—

 
(2
)
 
(2
)
Transfers into Level 3
 
—

 
—

 
—

 
—

 
—

Transfers out of Level 3
 
(21
)
 
—

 
—

 
—

 
(21
)
Ending balance, June 30, 2016
 
$
52

 
$
1

 
$
—

 
$
—

 
$
53

 
 
 
 
 
 
 
 
 
 
 
Beginning balance, January 1, 2015
 
$
18

 
$
—

 
$
—

 
$
2

 
$
20

Total gains or losses (realized/unrealized):
 
 
 
 
 
 

 
 

 
 
Included in net income
 
—

 
—

 
—

 
—

 
—

Included in other comprehensive income
 
—

 
—

 
—

 
—

 
—

Purchases
 
—

 
—

 
—

 
—

 
—

Sales
 
—

 
—

 
—

 
—

 
—

Transfers into Level 3
 
—

 
—

 
1

 
—

 
1

Transfers out of Level 3
 
—

 
—

 
—

 
—

 
—

Ending balance, June 30, 2015
 
$
18

 
$
—

 
$
1

 
$
2

 
$
21

 
 
 
 
 
 
 
 
 
 
 

Additional disclosures for the Level 3 category are not material.

Fair Value Disclosures for Assets and Liabilities Not Carried at Fair Value
 
The disclosures below are presented to provide timely information about the effects of current market conditions on financial instruments that are not reported at fair value in our condensed consolidated financial statements.
 
This table summarizes the book value and principal amounts of our long-term debt:
(Dollars in millions)
 
 
 
Book value
 
Principal amount
 
 
 
 
 
 
June 30,
 
December 31,
 
June 30,
 
December 31,
Interest rate
 
Year of issue
 
 
 
2016
 
2015
 
2016
 
2015
6.900
%
 
1998
 
Senior debentures, due 2028
 
$
26

 
$
26

 
$
28

 
$
28

6.920
%
 
2005
 
Senior debentures, due 2028
 
391

 
391

 
391

 
391

6.125
%
 
2004
 
Senior notes, due 2034
 
369

 
369

 
374

 
374

 

 
 
 
Total
 
$
786

 
$
786

 
$
793

 
$
793

 
 
 
 
 
 
 
 
 
 
 
 
 
 

Cincinnati Financial Corporation Second-Quarter 2016 10-Q
Page 15


The following table shows fair values of our note payable and long-term debt:
(Dollars in millions)
 
Quoted prices in
active markets for
identical assets
(Level 1)
 
Significant other observable inputs (Level 2)
 
Significant
unobservable
inputs
(Level 3)
 
Total
At June 30, 2016
 
 
 
 
Note payable
 
$
—

 
$
28

 
$
—

 
$
28

6.900% senior debentures, due 2028
 
—

 
35

 
—

 
35

6.920% senior debentures, due 2028
 
—

 
516

 
—

 
516

6.125% senior notes, due 2034
 
—

 
457

 
—

 
457

Total
 
$
—

 
$
1,036

 
$
—

 
$
1,036

 
 
 
 
 
 
 
 
 
At December 31, 2015
 
 
 
 
 
 
 
 
Note payable
 
$
—

 
$
35

 
$
—

 
$
35

6.900% senior debentures, due 2028
 
—

 
31

 
—

 
31

6.920% senior debentures, due 2028
 
—

 
480

 
—

 
480

6.125% senior notes, due 2034
 
—

 
425

 
—

 
425

Total
 
$
—

 
$
971

 
$
—

 
$
971

 
 
 
 
 
 
 
 
 
 
The following table shows the fair value of our life policy loans included in other invested assets:
(Dollars in millions)
 
Quoted prices in
active markets for
identical assets
(Level 1)
 
Significant other
observable inputs (Level 2)
 
Significant
unobservable
inputs
(Level 3)
 
Total
At June 30, 2016
 
 
 
 
Life policy loans
 
$
—

 
$
—

 
$
42

 
$
42

 
 
 
 
 
 
 
 
 
At December 31, 2015
 
 
 
 
 
 
 
 
Life policy loans
 
$
—

 
$
—

 
$
40

 
$
40

 
 
 
 
 
 
 
 
 
 
Outstanding principal and interest for these life policy loans totaled $30 million and $31 million at June 30, 2016, and December 31, 2015, respectively.
 
The following table shows fair values of our deferred annuities and structured settlements included in life policy and investment contract reserves:
(Dollars in millions)
 
Quoted prices in
active markets for
identical assets
(Level 1)
 
Significant other
observable inputs (Level 2)
 
Significant
unobservable
inputs
(Level 3)
 
Total
At June 30, 2016
 
 
 
 
Deferred annuities
 
$
—

 
$
—

 
$
928

 
$
928

Structured settlements
 
—

 
220

 
—

 
220

Total
 
$
—

 
$
220

 
$
928

 
$
1,148

 
 
 
 
 
 
 
 
 
At December 31, 2015
 
 
 
 
 
 
 
 
Deferred annuities
 
$
—

 
$
—

 
$
886

 
$
886

Structured settlements
 
—

 
208

 
—

 
208

Total
 
$
—

 
$
208

 
$
886

 
$
1,094

 
 
 
 
 
 
 
 
 

Recorded reserves for the deferred annuities were $863 million and $860 million at June 30, 2016, and December 31, 2015, respectively. Recorded reserves for the structured settlements were $173 million and $174 million at June 30, 2016, and December 31, 2015, respectively.



Cincinnati Financial Corporation Second-Quarter 2016 10-Q
Page 16


NOTE 4 – Property Casualty Loss and Loss Expenses
This table summarizes activity for our consolidated property casualty loss and loss expense reserves:
(Dollars in millions)
 
Three months ended June 30,
 
Six months ended June 30,
 
 
2016
 
2015
 
2016
 
2015
Gross loss and loss expense reserves, beginning
 of period
 
$
4,750

 
$
4,577

 
$
4,660

 
$
4,438

Less reinsurance recoverable
 
272

 
278

 
281

 
282

Net loss and loss expense reserves, beginning of
 period
 
4,478

 
4,299

 
4,379

 
4,156

Net incurred loss and loss expenses related to:
 
 

 
 

 
 

 
 

Current accident year
 
808

 
724

 
1,531

 
1,435

Prior accident years
 
(49
)
 
(70
)
 
(111
)
 
(92
)
Total incurred
 
759

 
654

 
1,420

 
1,343

Net paid loss and loss expenses related to:
 
 

 
 

 
 

 
 

Current accident year
 
328

 
304

 
474

 
451

Prior accident years
 
301

 
294

 
717

 
693

Total paid
 
629

 
598

 
1,191

 
1,144

Net loss and loss expense reserves, end of period
 
4,608

 
4,355

 
4,608

 
4,355

Plus reinsurance recoverable
 
310

 
292

 
310

 
292

Gross loss and loss expense reserves, end of
 period
 
$
4,918

 
$
4,647

 
$
4,918

 
$
4,647

 
 
 
 
 
 
 
 
 
 
We use actuarial methods, models and judgment to estimate, as of a financial statement date, the property casualty loss and loss expense reserves required to pay for and settle all outstanding insured claims, including incurred but not reported (IBNR) claims, as of that date. The actuarial estimate is subject to review and adjustment by an inter-departmental committee that includes actuarial management that is familiar with relevant company and industry business, claims and underwriting trends, as well as general economic and legal trends that could affect future loss and loss expense payments. The amount we will actually have to pay for claims can be highly uncertain. This uncertainty, together with the size of our reserves, makes the loss and loss expense reserves our most significant estimate. The reserve for loss and loss expenses in the condensed consolidated balance sheets also included $52 million at June 30, 2016, and $44 million at June 30, 2015, for certain life and health loss and loss expense reserves.

For the three months ended June 30, 2016, we experienced $49 million of favorable development on prior accident years, including $58 million of favorable development in commercial lines, $10 million of adverse development in personal lines and $1 million of favorable development in excess and surplus lines. We recognized favorable reserve development during the three months ended June 30, 2016, of $23 million for the workers' compensation line, $20 million for the commercial casualty line, $15 million for the other commercial lines and $14 million for the commercial property line due to reduced uncertainty of prior accident year loss and loss adjustment expense for these lines. Our personal auto line developed unfavorably by $14 million for the three months ended June 30, 2016, largely due to $8 million of adverse development for accident year 2015. Our commercial auto line developed unfavorably by $13 million for the three months ended June 30, 2016, due to higher loss cost effects in recent accident years, resulting in an increase of our reserve estimate for claims that have not yet been settled.


Cincinnati Financial Corporation Second-Quarter 2016 10-Q
Page 17


For the six months ended June 30, 2016, we experienced $111 million of favorable development on prior accident years, including $87 million of favorable development in commercial lines, $8 million of favorable development in personal lines, $15 million of favorable development in excess and surplus lines and $1 million of favorable development in our reinsurance assumed operations. This included $7 million from favorable development of catastrophe losses for the six months ended June 30, 2016. We recognized favorable reserve development during the six months ended June 30, 2016, of $35 million for the workers' compensation line, $23 million for the commercial casualty line, $22 million for the commercial property line and $28 million for the other commercial lines due to reduced uncertainty of prior accident year loss and loss adjustment expense for these lines. Our commercial auto line developed unfavorably by $21 million for the six months ended June 30, 2016, due to higher loss cost effects in recent accident years, resulting in an increase of our reserve estimate for claims that have not yet been settled. Our personal auto line developed unfavorably by $6 million for the six months ended June 30, 2016 for accident years prior to 2015.

For the three months ended June 30, 2015, we experienced $70 million of favorable development on prior accident years, including $63 million of favorable development in commercial lines, $2 million of adverse development in personal lines and $9 million of favorable development in excess and surplus lines. We recognized favorable reserve development during the three months ended June 30, 2015, of $41 million for the workers' compensation line and $23 million for the commercial casualty line due to reduced uncertainty of prior accident year loss and loss adjustment expense for these lines. Our commercial auto line developed unfavorably by $11 million for the three months ended June 30, 2015, due to higher loss cost effects in recent accident years, resulting in an increase of our reserve estimate for claims that have not yet been settled.

For the six months ended June 30, 2015, we experienced $92 million of favorable development on prior accident years, including $77 million of favorable development in commercial lines, $1 million of favorable development in personal lines and $14 million of favorable development in excess and surplus lines. This included $11 million from favorable development of catastrophe losses for the six months ended June 30, 2015. We recognized favorable development during the six months ended June 30, 2015, of $56 million for the workers' compensation line, $20 million for the commercial casualty line and $15 million for the commercial property line due to reduced uncertainty of prior accident year loss and loss adjustment expenses for these lines. Our commercial auto line developed unfavorably by $23 million for the six months ended June 30, 2015, due to higher loss cost effects in recent accident years, resulting in an increase of our reserve estimate for claims that have not yet been settled.



Cincinnati Financial Corporation Second-Quarter 2016 10-Q
Page 18


NOTE 5 – Life Policy and Investment Contract Reserves
We establish the reserves for traditional life insurance policies based on expected expenses, mortality, morbidity, withdrawal rates, timing of claim presentation and investment yields, including a provision for uncertainty. Once these assumptions are established, they generally are maintained throughout the lives of the contracts. We use both our own experience and industry experience, adjusted for historical trends, in arriving at our assumptions for expected mortality, morbidity and withdrawal rates as well as for expected expenses. We base our assumptions for expected investment income on our own experience adjusted for current economic conditions.
 
We establish reserves for the company’s universal life, deferred annuity and structured settlement policies equal to the cumulative account balances, which include premium deposits plus credited interest less charges and withdrawals. Some of our universal life policies contain no-lapse guarantee provisions. For these policies, we establish a reserve in addition to the account balance, based on expected no-lapse guarantee benefits and expected policy assessments.

This table summarizes our life policy and investment contract reserves:
(Dollars in millions)
 
June 30,
2016
 
December 31, 2015
Life policy reserves:
 
 
 
 
Ordinary/traditional life
 
$
975

 
$
943

Other
 
44

 
44

Subtotal
 
1,019

 
987

Investment contract reserves:
 
 
 
 
Deferred annuities
 
863

 
860

Universal life
 
563

 
558

Structured settlements
 
173

 
174

Other
 
6

 
4

Subtotal
 
1,605

 
1,596

Total life policy and investment contract reserves
 
$
2,624

 
$
2,583

 
 
 
 
 



Cincinnati Financial Corporation Second-Quarter 2016 10-Q
Page 19


NOTE 6 – Deferred Policy Acquisition Costs
Expenses directly related to successfully acquired insurance policies – primarily commissions, premium taxes and underwriting costs – are deferred and amortized over the terms of the policies. We update our acquisition cost assumptions periodically to reflect actual experience, and we evaluate the costs for recoverability. The table below shows the deferred policy acquisition costs and asset reconciliation.
(Dollars in millions)
Three months ended June 30,
 
Six months ended June 30,

2016
 
2015
 
2016
 
2015
Property casualty:
 
 
 
 
 
 
 
Deferred policy acquisition costs asset, beginning of period
$
397

 
$
377

 
$
388

 
$
379

Capitalized deferred policy acquisition costs
218

 
209

 
428

 
405

Amortized deferred policy acquisition costs
(203
)
 
(196
)
 
(404
)
 
(394
)
Deferred policy acquisition costs asset, end of period
$
412

 
$
390

 
$
412

 
$
390

 
 
 
 
 
 
 
 
Life:
 
 
 
 
 
 
 
Deferred policy acquisition costs asset, beginning of period
$
221

 
$
194

 
$
228

 
$
199

Capitalized deferred policy acquisition costs
12

 
12

 
24

 
23

Amortized deferred policy acquisition costs
(11
)
 
(8
)
 
(22
)
 
(19
)
Amortized shadow deferred policy acquisition costs
(10
)
 
12

 
(18
)
 
7

Deferred policy acquisition costs asset, end of period
$
212

 
$
210

 
$
212

 
$
210

 
 
 
 
 
 
 
 
Consolidated:
 
 
 
 
 
 
 
Deferred policy acquisition costs asset, beginning of period
$
618

 
$
571

 
$
616

 
$
578

Capitalized deferred policy acquisition costs
230

 
221

 
452

 
428

Amortized deferred policy acquisition costs
(214
)
 
(204
)
 
(426
)
 
(413
)
Amortized shadow deferred policy acquisition costs
(10
)
 
12

 
(18
)
 
7

Deferred policy acquisition costs asset, end of period
$
624

 
$
600

 
$
624

 
$
600

 
 
 
 
 
 
 
 

No premium deficiencies were recorded in the condensed consolidated statements of income, as the sum of the anticipated loss and loss adjustment expenses, policyholder dividends and unamortized deferred acquisition expenses did not exceed the related unearned premiums and anticipated investment income.
 

Cincinnati Financial Corporation Second-Quarter 2016 10-Q
Page 20


NOTE 7 – Accumulated Other Comprehensive Income
Accumulated other comprehensive income (AOCI) includes changes in unrealized gains and losses on investments, changes in pension obligations and changes in life deferred acquisition costs, life policy reserves and other as follows:
(Dollars in millions)
 
Three months ended June 30,
 
 
2016
 
 
2015
 
 
Before tax
 
Income tax
 
Net
 
 
Before tax
 
Income tax
 
Net
Investments:
 
 
 
 
 
 
 
 
 
 
 
 
 
AOCI, beginning of period
 
$
2,384

 
$
822

 
$
1,562

 
 
$
2,676

 
$
927

 
$
1,749

OCI before realized gains recognized in net income
 
331

 
118

 
213

 
 
(260
)
 
(91
)
 
(169
)
Realized gains recognized in net income
 
(42
)
 
(15
)
 
(27
)
 
 
(59
)
 
(21
)
 
(38
)
OCI
 
289

 
103

 
186

 
 
(319
)
 
(112
)
 
(207
)
AOCI, end of period
 
$
2,673

 
$
925

 
$
1,748

 
 
$
2,357

 
$
815

 
$
1,542

 
 
 
 
 
 
 
 
 
 
 
 
 
 
Pension obligations:
 
 
 
 
 
 
 
 
 
 
 
 
 
AOCI, beginning of period
 
$
(41
)
 
$
(13
)
 
$
(28
)
 
 
$
(35
)
 
$
(12
)
 
$
(23
)
OCI excluding amortization recognized in net income
 
—

 
—

 
—

 
 
—

 
—

 
—

Amortization recognized in net income
 
1

 
—

 
1

 
 
2

 
1

 
1

OCI
 
1

 
—

 
1

 
 
2

 
1

 
1

AOCI, end of period
 
$
(40
)
 
$
(13
)
 
$
(27
)
 
 
$
(33
)
 
$
(11
)
 
$
(22
)
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Life deferred acquisition costs, life policy reserves and other:
 
 
 
 
 
 
 
 
 
 
 
 
 
AOCI, beginning of period
 
$
(3
)
 
$
—

 
$
(3
)
 
 
$
(14
)
 
$
(4
)
 
$
(10
)
OCI before realized gains recognized in net income
 
(5
)
 
(2
)
 
(3
)
 
 
7

 
3

 
4

Realized gains recognized in net income
 
(2
)
 
(1
)
 
(1
)
 
 
(1
)
 
(1
)
 
—

OCI
 
(7
)
 
(3
)
 
(4
)
 
 
6

 
2

 
4

AOCI, end of period
 
$
(10
)
 
$
(3
)
 
$
(7
)
 
 
$
(8
)
 
$
(2
)
 
$
(6
)
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Summary of AOCI:
 
 
 
 
 
 
 
 
 
 
 
 
 
AOCI, beginning of period
 
$
2,340

 
$
809

 
$
1,531

 
 
$
2,627

 
$
911

 
$
1,716

Investments OCI
 
289

 
103

 
186

 
 
(319
)
 
(112
)
 
(207
)
Pension obligations OCI
 
1

 
—

 
1

 
 
2

 
1

 
1

Life deferred acquisition costs, life policy reserves and other OCI
 
(7
)
 
(3
)
 
(4
)
 
 
6

 
2

 
4

Total OCI
 
283

 
100

 
183

 
 
(311
)
 
(109
)
 
(202
)
AOCI, end of period
 
$
2,623

 
$
909

 
$
1,714

 
 
$
2,316

 
$
802

 
$
1,514

 
 
 
 
 
 
 
 
 
 
 
 
 
 

Cincinnati Financial Corporation Second-Quarter 2016 10-Q
Page 21


(Dollars in millions)
Six months ended June 30,
 
2016
 
 
2015
 
Before tax
 
Income tax
 
Net
 
 
Before tax
 
Income tax
 
Net
Investments:
 
 
 
 
 
 
 
 
 
 
 
 
AOCI, beginning of period
$
2,094

 
$
722

 
$
1,372

 
 
$
2,719

 
$
942

 
$
1,777

OCI excluding realized gains recognized in net income
682

 
239

 
443

 
 
(257
)
 
(90
)
 
(167
)
Realized gains recognized in net income
(103
)
 
(36
)
 
(67
)
 
 
(105
)
 
(37
)
 
(68
)
OCI
579

 
203

 
376

 
 
(362
)
 
(127
)
 
(235
)
AOCI, end of period
$
2,673

 
$
925

 
$
1,748

 
 
$
2,357

 
$
815

 
$
1,542

 
 
 
 
 
 
 
 
 
 
 
 
 
Pension obligations:
 
 
 
 
 
 
 
 
 
 
 
 
AOCI, beginning of period
$
(42
)
 
$
(14
)
 
$
(28
)
 
 
$
(36
)
 
$
(12
)
 
$
(24
)
OCI excluding amortization recognized in net income
—

 
—

 
—

 
 
—

 
—

 
—

Amortization recognized in net income
2

 
1

 
1

 
 
3

 
1

 
2

OCI
2

 
1

 
1

 
 
3

 
1

 
2

AOCI, end of period
$
(40
)
 
$
(13
)
 
$
(27
)
 
 
$
(33
)
 
$
(11
)
 
$
(22
)
 
 
 
 
 
 
 
 
 
 
 
 
 
Life deferred acquisition costs, life policy reserves and other:
 
 
 
 
 
 
 
 
 
 
 
 
AOCI, beginning of period
$
1

 
$
1

 
$
—

 
 
$
(12
)
 
$
(3
)
 
$
(9
)
OCI excluding realized gains recognized in net income
(9
)
 
(3
)
 
(6
)
 
 
6

 
2

 
4

Realized gains recognized in net income
(2
)
 
(1
)
 
(1
)
 
 
(2
)
 
(1
)
 
(1
)
OCI
(11
)
 
(4
)
 
(7
)
 
 
4

 
1

 
3

AOCI, end of period
$
(10
)
 
$
(3
)
 
$
(7
)
 
 
$
(8
)
 
$
(2
)
 
$
(6
)
 
 
 
 
 
 
 
 
 
 
 
 
 
Summary of AOCI:
 
 
 
 
 
 
 
 
 
 
 
 
AOCI, beginning of period
$
2,053

 
$
709

 
$
1,344

 
 
$
2,671

 
$
927

 
$
1,744

Investments OCI
579

 
203

 
376

 
 
(362
)
 
(127
)
 
(235
)
Pension obligations OCI
2

 
1

 
1

 
 
3

 
1

 
2

Life deferred acquisition costs, life policy reserves and other OCI
(11
)
 
(4
)
 
(7
)
 
 
4

 
1

 
3

Total OCI
570

 
200

 
370

 
 
(355
)
 
(125
)
 
(230
)
AOCI, end of period
$
2,623

 
$
909

 
$
1,714

 
 
$
2,316

 
$
802

 
$
1,514

 
 
 
 
 
 
 
 
 
 
 
 
 

Investments realized gains and life deferred acquisition costs, life policy reserves and other realized gains are recorded in the realized investment gains, net, line item in the condensed consolidated statements of income. Amortization on pension obligations is recorded in the insurance losses and contract holders' benefits and underwriting, acquisition and insurance expenses in the condensed consolidated statements of income.


Cincinnati Financial Corporation Second-Quarter 2016 10-Q
Page 22


NOTE 8 – Reinsurance
Primary components of our property casualty operations assumed reinsurance include involuntary and voluntary assumed as well as contracts from our reinsurance assumed operations, known as Cincinnati ReSM. Primary components of our ceded reinsurance include a property per risk treaty, property excess treaty, casualty per occurrence treaty, casualty excess treaty, property catastrophe treaty and catastrophe bonds and retrocessions on our reinsurance assumed operations. Management's decisions about the appropriate level of risk retention are affected by various factors, including changes in our underwriting practices, capacity to retain risks and reinsurance market conditions.

Our condensed consolidated statements of income include earned consolidated property casualty insurance premiums on assumed and ceded business: 
(Dollars in millions)
 
Three months ended June 30,
 
Six months ended June 30,
 
 
2016
 
2015
 
2016
 
2015
Direct earned premiums
 
$
1,137

 
$
1,093

 
$
2,256

 
$
2,169

Assumed earned premiums
 
16

 
3

 
31

 
5

Ceded earned premiums
 
(39
)
 
(37
)
 
(77
)
 
(74
)
Earned premiums
 
$
1,114

 
$
1,059

 
$
2,210

 
$
2,100

 
 
 
 
 
 
 
 
 
 
Our condensed consolidated statements of income include incurred consolidated property casualty insurance loss and loss expenses on assumed and ceded business:
(Dollars in millions)
 
Three months ended June 30,
 
Six months ended June 30,
 
 
2016
 
2015
 
2016
 
2015
Direct incurred loss and loss expenses
 
$
792

 
$
675

 
$
1,440

 
$
1,366

Assumed incurred loss and loss expenses
 
11

 
1

 
21

 
0

Ceded incurred loss and loss expenses
 
(44
)
 
(22
)
 
(41
)
 
(23
)
Incurred loss and loss expenses
 
$
759

 
$
654

 
$
1,420

 
$
1,343

 
 
 
 
 
 
 
 
 
 
Our change in ceded incurred compared to prior years resulted from an increase in current accident year losses.

Our life insurance company purchases reinsurance for protection of a portion of the risk that is written. Primary components of our life reinsurance program include individual mortality coverage and aggregate catastrophe and accidental death coverage in excess of certain deductibles.

Our condensed consolidated statements of income include earned life insurance premiums on ceded business: 
(Dollars in millions)
 
Three months ended June 30,
 
Six months ended June 30,
 
 
2016
 
2015
 
2016
 
2015
Direct earned premiums
 
$
75

 
$
68

 
$
146

 
$
133

Ceded earned premiums
 
(16
)
 
(16
)
 
(29
)
 
(28
)
Earned premiums
 
$
59

 
$
52

 
$
117

 
$
105

 
 
 
 
 
 
 
 
 
 

Cincinnati Financial Corporation Second-Quarter 2016 10-Q
Page 23


Our condensed consolidated statements of income include life insurance contract holders' benefits incurred on ceded business: 
(Dollars in millions)
 
Three months ended June 30,
 
Six months ended June 30,
 
 
2016
 
2015
 
2016
 
2015
Direct contract holders' benefits incurred
 
$
80

 
$
72

 
$
156

 
$
144

Ceded contract holders' benefits incurred
 
(18
)
 
(14
)
 
(31
)
 
(26
)
Contract holders' benefits incurred
 
$
62

 
$
58

 
$
125

 
$
118

 
 
 
 
 
 
 
 
 

The ceded benefits incurred can vary depending on the type of life insurance policy held and the year the policy was sold.

NOTE 9 – Income Taxes
As of June 30, 2016, and December 31, 2015, we had no liability for unrecognized tax benefits.
 
The differences between the 35 percent statutory federal income tax rate and our effective income tax rate were as follows:
(Dollars in millions)
 
Three months ended June 30,
 
Six months ended June 30,
 
 
2016
 
2015
 
2016
 
2015
Tax at statutory rate:
 
$
58

 
35.0
 %
 
$
87

 
35.0
 %
 
$
151

 
35.0
 %
 
$
148

 
35.0
 %
Increase (decrease) resulting from:
 
 

 
 

 
 

 
 

 
 

 
 

 
 

 
 

Tax-exempt income from municipal bonds
 
(8
)
 
(4.8
)
 
(8
)
 
(3.2
)
 
(17
)
 
(3.9
)
 
(16
)
 
(3.8
)
Dividend received exclusion
 
(8
)
 
(4.8
)
 
(7
)
 
(2.8
)
 
(16
)
 
(3.7
)
 
(15
)
 
(3.6
)
Other
 
1

 
0.5

 
0

 
0.0

 
2

 
0.4

 
1

 
0.4

Provision for income taxes
 
$
43

 
25.9
 %
 
$
72

 
29.0
 %
 
$
120

 
27.8
 %
 
$
118

 
28.0
 %
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
The provision for federal income taxes is based upon filing a consolidated income tax return for the company and its subsidiaries. As of June 30, 2016, we had no operating or capital loss carry forwards.

NOTE 10 – Net Income Per Common Share
Basic earnings per share are computed based on the weighted average number of common shares outstanding. Diluted earnings per share are computed based on the weighted average number of common and dilutive potential common shares outstanding using the treasury stock method. The table shows calculations for basic and diluted earnings per share:
(In millions except per share data)
 
Three months ended June 30,
 
Six months ended June 30,
 
2016
 
2015
 
2016
 
2015
Numerator:
 
 

 
 

 
 

 
 

Net income—basic and diluted
 
$
123

 
$
176

 
$
311

 
$
304

Denominator:
 
 

 
 

 
 

 
 

Basic weighted-average common shares outstanding
 
164.5

 
164.1

 
164.4

 
164.1

Effect of share-based awards:
 
 

 
 

 
 

 
 

Stock options
 
1.1

 
0.9

 
1.1

 
0.9

Nonvested shares
 
0.9

 
0.5

 
0.8

 
0.5

Diluted weighted-average shares
 
166.5

 
165.5

 
166.3

 
165.5

Earnings per share:
 
 

 
 

 
 

 
 

Basic
 
$
0.75

 
$
1.07

 
$
1.89

 
$
1.85

Diluted
 
0.74

 
1.06

 
1.87

 
1.84

Number of anti-dilutive share-based awards:
 
0.3

 
0.7

 
0.4

 
0.7

 
 
 
 
 
 
 
 
 


Cincinnati Financial Corporation Second-Quarter 2016 10-Q
Page 24


The sources of dilution of our common shares are certain equity-based awards. See our 2015 Annual Report on Form 10-K, Item 8, Note 17, Share-Based Associate Compensation Plans, Page 152, for information about equity-based awards. The above table shows the number of anti-dilutive share-based awards for the three and six months ended June 30, 2016 and 2015. We did not include these share-based awards in the computation of net income per common share (diluted) because their exercise would have anti-dilutive effects.

NOTE 11 – Employee Retirement Benefits
The following summarizes the components of net periodic benefit cost for our qualified and supplemental pension plans:
(Dollars in millions)
 
Three months ended June 30,
 
Six months ended June 30,
 
 
2016
 
2015
 
2016
 
2015
Service cost
 
$
2

 
$
3

 
$
5

 
$
6

Interest cost
 
4

 
4

 
7

 
7

Expected return on plan assets
 
(4
)
 
(5
)
 
(9
)
 
(9
)
Amortization of actuarial loss and prior service
 cost
 
1

 
2

 
2

 
3

Net periodic benefit cost
 
$
3

 
$
4

 
$
5

 
$
7

 
 
 
 
 
 
 
 
 

See our 2015 Annual Report on Form 10-K, Item 8, Note 13, Employee Retirement Benefits, Page 146, for information on our retirement benefits. We made matching contributions totaling $4 million and $3 million to our
401(k) and Top Hat savings plans during the second quarter of 2016 and 2015 and contributions of $8 million and $7 million for the first half of 2016 and 2015, respectively.

We contributed $5 million to our qualified pension plan during the first six months of 2016. We also contributed
$8 million to our qualified pension plan during the third quarter of 2016 and do not anticipate further contributions during the remainder of 2016.

NOTE 12 – Commitments and Contingent Liabilities
In the ordinary course of conducting business, the company and its subsidiaries are named as defendants in various legal proceedings. Most of these proceedings are claims litigation involving the company's insurance subsidiaries in which the company is either defending or providing indemnity for third-party claims brought against insureds or litigating first-party coverage claims. The company accounts for such activity through the establishment of unpaid loss and loss expense reserves. We believe that the ultimate liability, if any, with respect to such ordinary-course claims litigation, after consideration of provisions made for potential losses and costs of defense, is immaterial to our consolidated financial condition, results of operations and cash flows.
 
The company and its subsidiaries also are occasionally involved in other legal and regulatory proceedings, some of which assert claims for substantial amounts. These actions include, among others, putative class actions seeking certification of a state or national class. Such proceedings have alleged, for example, breach of an alleged duty to search national databases to ascertain unreported deaths of insureds under life insurance policies. The company's insurance subsidiaries also are occasionally parties to individual actions in which extra-contractual damages, punitive damages or penalties are sought, such as claims alleging bad faith handling of insurance claims or writing unauthorized coverage or claims alleging discrimination by former or current associates.
 
On a quarterly basis, we review these outstanding matters. Under current accounting guidance, we establish accruals when it is probable that a loss has been incurred and we can reasonably estimate its potential exposure. The company accounts for such probable and estimable losses, if any, through the establishment of legal expense reserves. Based on our quarterly review, we believe that our accruals for probable and estimable losses are reasonable and that the amounts accrued do not have a material effect on our consolidated financial condition or results of operations. However, if any one or more of these matters results in a judgment against us or settlement for an amount that is significantly greater than the amount accrued, the resulting liability could have a material effect on the company's consolidated results of operations or cash flows. Based on our most recent review, our estimate for any other matters for which the risk of loss is not probable, but more than remote, is less than $1 million.


Cincinnati Financial Corporation Second-Quarter 2016 10-Q
Page 25


NOTE 13 – Segment Information
We operate primarily in two industries, property casualty insurance and life insurance. We regularly review our reporting segments to make decisions about allocating resources and assessing performance. Our reporting segments are:
•
Commercial lines insurance
•
Personal lines insurance
•
Excess and surplus lines insurance
•
Life insurance
•
Investments

We report as Other the noninvestment operations of the parent company and its noninsurer subsidiary, CFC Investment Company and Cincinnati Re, our reinsurance assumed operations. See our 2015 Annual Report on Form 10-K, Item 8, Note 18, Segment Information, Page 155, for a description of revenue, income or loss before income taxes and identifiable assets for each of the five segments.


Cincinnati Financial Corporation Second-Quarter 2016 10-Q
Page 26


Segment information is summarized in the following table: 
(Dollars in millions)
 
Three months ended June 30,
 
Six months ended June 30,
 
 
2016
 
2015
 
2016
 
2015
Revenues:
 
 

 
 

 
 

 
 

Commercial lines insurance
 
 

 
 

 
 

 
 

Commercial casualty
 
$
263

 
$
252

 
$
520

 
$
496

Commercial property
 
215

 
203

 
429

 
399

Commercial auto
 
147

 
139

 
291

 
275

Workers' compensation
 
89

 
90

 
178

 
183

Other commercial
 
57

 
61

 
113

 
125

Commercial lines insurance premiums
 
771

 
745

 
1,531

 
1,478

Fee revenues
 
1

 
1

 
2

 
2

Total commercial lines insurance
 
772

 
746

 
1,533

 
1,480

 
 
 
 
 
 
 
 
 
Personal lines insurance
 
 

 
 

 
 

 
 

Personal auto
 
135

 
125

 
266

 
248

Homeowner
 
121

 
114

 
240

 
228

Other personal
 
32

 
33

 
65

 
64

Personal lines insurance premiums
 
288

 
272

 
571

 
540

Fee revenues
 
1

 
—

 
2

 
1

Total personal lines insurance
 
289

 
272

 
573

 
541

 
 
 
 
 
 
 
 
 
Excess and surplus lines insurance
 
45

 
42

 
88

 
82

Fee revenues
 
—

 
1

 
—

 
1

Total excess and surplus lines insurance
 
45

 
43

 
88

 
83

 
 
 
 
 
 
 
 
 
Life insurance premiums
 
59

 
52

 
117

 
105

Separate account investment management fees
 
1

 
1

 
2

 
2

Total life insurance
 
60

 
53

 
119

 
107

 
 
 
 
 
 
 
 
 
Investments
 
 
 
 
 
 
 
 
    Investment income, net of expenses
 
149

 
140

 
294

 
279

    Realized investment gains, net
 
44

 
60

 
105

 
107

Total investment revenue
 
193

 
200

 
399

 
386

 
 
 
 
 
 
 
 
 
Other
 
 
 
 
 
 
 
 
Cincinnati Re insurance premiums
 
10

 
—

 
20

 
—

Other
 
2

 
2

 
3

 
4

Total other revenue
 
12

 
2

 
23

 
4

Total revenues
 
$
1,371

 
$
1,316

 
$
2,735

 
$
2,601

 
 
 
 
 
 
 
 
 
Income (loss) before income taxes:
 
 

 
 

 
 

 
 

Insurance underwriting results
 
 

 
 

 
 

 
 

Commercial lines insurance
 
$
26

 
$
97

 
$
76

 
$
123

Personal lines insurance
 
(20
)
 
(25
)
 
8

 
(28
)
Excess and surplus lines insurance
 
5

 
11

 
22

 
15

Life insurance
 
1

 
1

 
—

 
(2
)
Investments
 
171

 
178

 
355

 
343

Other
 
(17
)
 
(14
)
 
(30
)
 
(29
)
Total income before income taxes
 
$
166

 
$
248

 
$
431

 
$
422

Identifiable assets:
 
June 30,
2016
 
December 31, 2015
Property casualty insurance
 
$
2,888

 
$
2,717

Life insurance
 
1,422

 
1,325

Investments
 
15,506

 
14,485

Other
 
335

 
361

Total
 
$
20,151

 
$
18,888

 
 
 
 
 

Cincinnati Financial Corporation Second-Quarter 2016 10-Q
Page 27


Item 2.    Management’s Discussion and Analysis of Financial Condition and
Results of Operations
The following discussion highlights significant factors influencing the condensed consolidated results of operations and financial position of Cincinnati Financial Corporation. It should be read in conjunction with the consolidated financial statements and related notes included in our 2015 Annual Report on Form 10-K. Unless otherwise noted, the industry data is prepared by A.M. Best Co., a leading insurance industry statistical, analytical and financial strength rating organization. Information from A.M. Best is presented on a statutory basis. When we provide our results on a comparable statutory basis, we label it as such; all other company data is presented in accordance with accounting principles generally accepted in the United States of America (GAAP).
 
We present per share data on a diluted basis unless otherwise noted, adjusting those amounts for all stock splits and dividends. Dollar amounts are rounded to millions; calculations of percent changes are based on dollar amounts rounded to the nearest million. Certain percentage changes are identified as not meaningful (nm).
 
SAFE HARBOR STATEMENT
This is our “Safe Harbor” statement under the Private Securities Litigation Reform Act of 1995. Our business is subject to certain risks and uncertainties that may cause actual results to differ materially from those suggested by the forward-looking statements in this report. Some of those risks and uncertainties are discussed in our 2015 Annual Report on Form 10-K, Item 1A, Risk Factors, Page 26.
 
Factors that could cause or contribute to such differences include, but are not limited to:

•
Unusually high levels of catastrophe losses due to risk concentrations, changes in weather patterns, environmental events, terrorism incidents or other causes
•
Increased frequency and/or severity of claims or development of claims that are unforeseen at the time of policy issuance
•
Inadequate estimates, assumptions or reliance on third-party data used for critical accounting estimates
•
Declines in overall stock market values negatively affecting the company’s equity portfolio and book value
•
Domestic and global events resulting in capital market or credit market uncertainty, followed by prolonged periods of economic instability or recession, that lead to:
◦
Significant or prolonged decline in the fair value of a particular security or group of securities and impairment of the asset(s)
◦
Significant decline in investment income due to reduced or eliminated dividend payouts from a particular security or group of securities
◦
Significant rise in losses from surety and director and officer policies written for financial institutions or other insured entities
•
Prolonged low interest rate environment or other factors that limit the company’s ability to generate growth in investment income or interest rate fluctuations that result in declining values of fixed-maturity investments, including declines in accounts in which we hold bank-owned life insurance contract assets
•
Recession or other economic conditions resulting in lower demand for insurance products or increased payment delinquencies
•
Difficulties with technology or data security breaches, including cyberattacks, that could negatively affect our ability to conduct business and our relationships with agents, policyholders and others
•
Disruption of the insurance market caused by technology innovations such as driverless cars that could decrease consumer demand for insurance products
•
Delays, inadequate data developed internally or from third parties, or performance inadequacies from ongoing development and implementation of underwriting and pricing methods, including telematics and other usage-based insurance methods, or technology projects and enhancements expected to increase our pricing accuracy, underwriting profit and competitiveness
•
Increased competition that could result in a significant reduction in the company’s premium volume
•
Changing consumer insurance-buying habits and consolidation of independent insurance agencies that could alter our competitive advantages

Cincinnati Financial Corporation Second-Quarter 2016 10-Q
Page 28


•
Inability to obtain adequate ceded reinsurance on acceptable terms, amount of reinsurance coverage purchased, financial strength of reinsurers and the potential for nonpayment or delay in payment by reinsurers
•
Inability to defer policy acquisition costs for any business segment if pricing and loss trends would lead management to conclude that segment could not achieve sustainable profitability
•
Inability of our subsidiaries to pay dividends consistent with current or past levels
•
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:
◦
Downgrades of the company’s financial strength ratings
◦
Concerns that doing business with the company is too difficult
◦
Perceptions that the company’s level of service, particularly claims service, is no longer a distinguishing characteristic in the marketplace
◦
Inability or unwillingness to nimbly develop and introduce coverage product updates and innovations that our competitors offer and consumers expect to find in the marketplace
•
Actions of insurance departments, state attorneys general or other regulatory agencies, including a change to a federal system of regulation from a state-based system, that:
◦
Impose new obligations on us that increase our expenses or change the assumptions underlying our critical accounting estimates
◦
Place the insurance industry under greater regulatory scrutiny or result in new statutes, rules and regulations
◦
Restrict our ability to exit or reduce writings of unprofitable coverages or lines of business
◦
Add assessments for guaranty funds, other insurance-related assessments or mandatory reinsurance arrangements; or that impair our ability to recover such assessments through future surcharges or other rate changes
◦
Increase our provision for federal income taxes due to changes in tax law
◦
Increase our other expenses
◦
Limit our ability to set fair, adequate and reasonable rates
◦
Place us at a disadvantage in the marketplace
◦
Restrict our ability to execute our business model, including the way we compensate agents
•
Adverse outcomes from litigation or administrative proceedings
•
Events or actions, including unauthorized intentional circumvention of controls, that reduce the company’s future ability to maintain effective internal control over financial reporting under the Sarbanes-Oxley Act of 2002
•
Unforeseen departure of certain executive officers or other key employees due to retirement, health or other causes that could interrupt progress toward important strategic goals or diminish the effectiveness of certain longstanding relationships with insurance agents and others
•
Events, such as an epidemic, natural catastrophe or terrorism, that could hamper our ability to assemble our workforce at our headquarters location
Further, the company’s insurance businesses are subject to the effects of changing social, global, 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 measures affecting corporate financial reporting and governance. The ultimate changes and eventual effects, if any, of these initiatives are uncertain.



Cincinnati Financial Corporation Second-Quarter 2016 10-Q
Page 29


CORPORATE FINANCIAL HIGHLIGHTS
 
Net Income and Comprehensive Income Data
(Dollars in millions except per share data)
 
Three months ended June 30,
 
Six months ended June 30,
 
 
2016
 
2015
 
% Change
 
2016
 
2015
 
% Change
Earned premiums
 
$
1,173

 
$
1,111

 
6

 
$
2,327

 
$
2,205

 
6

Investment income, net of expenses (pretax)
 
149

 
140

 
6

 
294

 
279

 
5

Realized investment gains, net (pretax)
 
44

 
60

 
(27
)
 
105

 
107

 
(2
)
Total revenues
 
1,371

 
1,316

 
4

 
2,735

 
2,601

 
5

Net income
 
123

 
176

 
(30
)
 
311

 
304

 
2

Comprehensive income
 
306

 
(26
)
 
nm

 
681

 
74

 
820

Net income per share—diluted
 
0.74

 
1.06

 
(30
)
 
1.87

 
1.84

 
2

Cash dividends declared per share
 
0.48

 
0.46

 
4

 
0.96

 
0.92

 
4

Diluted weighted average shares outstanding
 
166.5

 
165.5

 
1

 
166.3

 
165.5

 
0

 
 
 
 
 
 
 
 
 
 
 
 
 

Total revenues rose for the second quarter and the first six months of 2016, compared with the same periods of 2015, primarily due to higher earned premiums. Premium and investment revenue trends are discussed further in the respective sections of Financial Results.
 
Realized investment gains and losses are recognized on the sales of investments or as otherwise required by GAAP. We have substantial discretion in the timing of investment sales, and that timing generally is independent of the insurance underwriting process. GAAP also requires us to recognize in net income the gains or losses from certain changes in fair values of securities even though we continue to hold the securities.
 
Net income for the second quarter of 2016, compared with the same period of 2015, decreased $53 million, reflecting a decrease in property casualty underwriting income of $47 million after taxes and a $10 million decrease in after-tax net realized investment gains. Higher catastrophe losses, mostly weather related, were $56 million more after taxes and unfavorably affected both net income and property casualty underwriting income. After-tax investment income in our investment segment results for the second quarter of 2016 rose $7 million compared with the same quarter of 2015. Life insurance segment results on a pretax basis for second-quarter 2016 matched second-quarter 2015.

For the six months ended June 30, 2016, net income rose $7 million compared with the first six months of 2015, primarily due to an $11 million increase in after-tax investment income. Property casualty underwriting income decreased by $3 million after taxes, driven by an unfavorable $50 million effect from higher catastrophe losses that offset improvement in other loss experience from our underwriting operations. After-tax net realized investment gains and losses for the first half of 2016 were $1 million lower than a year ago. Life insurance segment results on a pretax basis improved by $2 million.

Performance by segment is discussed below in Financial Results. As discussed in our 2015 Annual Report on Form 10-K, Item 7, Factors Influencing Our Future Performance, Page 45, there are several reasons that our performance during 2016 may be below our long-term targets. In that annual report, as part of Financial Results, we also discussed the full-year 2016 outlook for each reporting segment.
 
The board of directors is committed to rewarding shareholders directly through cash dividends and through share repurchase authorizations. Through 2015, the company had increased the indicated annual cash dividend rate for 55 consecutive years, a record we believe was matched by only eight other publicly traded companies. In January 2016, the board of directors increased the regular quarterly dividend to 48 cents per share, setting the stage for our 56th consecutive year of increasing cash dividends. During the first six months of 2016, cash dividends declared by the company increased more than 4 percent compared with the same period of 2015. Our board regularly evaluates relevant factors in decisions related to dividends and share repurchases. The 2016 dividend increase reflected our strong earnings performance and signaled management’s and the board’s positive outlook and confidence in our outstanding capital, liquidity and financial flexibility.


Cincinnati Financial Corporation Second-Quarter 2016 10-Q
Page 30


Balance Sheet Data and Performance Measures
(In millions except share data)
 
At June 30,
 
At December 31,
 
 
2016
 
2015
Total investments
 
$
15,459

 
$
14,423

Total assets
 
20,151

 
18,888

Short-term debt
 
28

 
35

Long-term debt
 
786

 
786

Shareholders' equity
 
6,971

 
6,427

Book value per share
 
42.37

 
39.20

Debt-to-total-capital ratio
 
10.5
%
 
11.3
%
 
 
 
 
 

Total assets at June 30, 2016, increased 7 percent compared with year-end 2015, and included 7 percent growth in investments largely driven by higher fair values for many securities in our portfolio. Shareholders’ equity increased 8 percent, and book value per share also increased 8 percent during the first six months of 2016. Our debt-to-total-capital ratio (capital is the sum of debt plus shareholders’ equity) was lower than at year-end 2015.

Our value creation ratio is a non-GAAP measure defined below and is our primary performance metric. That ratio was 10.5 percent for the first six months of 2016, and was better than the same period in 2015 primarily due to higher net gains from our investment portfolio. The $3.17 increase in book value per share during the first six months of 2016 contributed 8.1 percentage points to the value creation ratio, while dividends declared at $0.96 per share contributed 2.4 points. Value creation ratio trends in total and by major components, along with a reconciliation of the non-GAAP measure to comparable GAAP measures, are shown in the tables below.
 
 
Three months ended June 30,
 
Six months ended June 30,
 
 
2016
 
2015
 
2016
 
2015
Value creation ratio major components:
 
 

 
 

 
 

 
 

Net income before net realized gains
 
1.4
%
 
2.1
 %
 
3.8
 %
 
3.5
 %
Change in fixed-maturity securities, realized
  and unrealized gains
 
1.8

 
(1.8
)
 
3.0

 
(1.3
)
Change in equity securities, realized and
  unrealized gains
 
1.4

 
(0.8
)
 
3.9

 
(1.2
)
Other
 
0.0

 
0.1

 
(0.2
)
 
(0.1
)
     Value creation ratio
 
4.6
%
 
(0.4
)%
 
10.5
 %
 
0.9
 %
 
 
 
 
 
 
 
 
 

(Dollars are per share)
 
Three months ended June 30,
 
Six months ended June 30,
 
 
2016
 
2015
 
2016
 
2015
Book value change per share:
 
 
 
 
 
 
 
 
End of period book value
 
$
42.37

 
$
39.60

 
$
42.37

 
$
39.60

Less beginning of period book value
 
40.96

 
40.22

 
39.20

 
40.14

     Change in book value
 
$
1.41

 
$
(0.62
)
 
$
3.17

 
$
(0.54
)
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Change in book value:
 
 

 
 

 
 

 
 

Net income before realized gains
 
$
0.58

 
$
0.84

 
$
1.48

 
$
1.43

Change in fixed-maturity securities, realized
   and unrealized gains
 
0.72

 
(0.71
)
 
1.18

 
(0.52
)
Change in equity securities, realized and
   unrealized gains
 
0.59

 
(0.32
)
 
1.52

 
(0.50
)
Dividend declared to shareholders
 
(0.48
)
 
(0.46
)
 
(0.96
)
 
(0.92
)
Other
 
0.00

 
0.03

 
(0.05
)
 
(0.03
)
Change in book value
 
$
1.41

 
$
(0.62
)
 
$
3.17

 
$
(0.54
)
 
 
 
 
 
 
 
 
 

Cincinnati Financial Corporation Second-Quarter 2016 10-Q
Page 31


 
(Dollars are per share)
 
Three months ended June 30,
 
Six months ended June 30,
 
 
2016
 
2015
 
2016
 
2015
Value creation ratio:
 
 

 
 

 
 

 
 

End of period book value
 
$
42.37

 
$
39.60

 
$
42.37

 
$
39.60

Less beginning of period book value
 
40.96

 
40.22

 
39.20

 
40.14

Change in book value
 
1.41

 
(0.62
)
 
3.17

 
(0.54
)
Dividend declared to shareholders
 
0.48

 
0.46

 
0.96

 
0.92

Total value creation
 
$
1.89

 
$
(0.16
)
 
$
4.13

 
$
0.38

 
 
 
 
 
 
 
 
 
Value creation ratio from change in book
   value*
 
3.4
%
 
(1.5
)%
 
8.1
%
 
(1.4
)%
Value creation ratio from dividends declared to
  shareholders**
 
1.2

 
1.1

 
2.4

 
2.3

Value creation ratio
 
4.6
%
 
(0.4
)%
 
10.5
%
 
0.9
 %
 
 
 
 
 
 
 
 
 
*Change in book value divided by the beginning of period book value
 
 
 
 
**Dividend declared to shareholders divided by beginning of period book value
 
 
 
 


DRIVERS OF LONG-TERM VALUE CREATION
Operating through The Cincinnati Insurance Company, Cincinnati Financial Corporation is one of the 25 largest property casualty insurers in the nation, based on 2015 net written premiums for approximately 2,000 U.S. stock and mutual insurer groups. We market our insurance products through a select group of independent insurance agencies as discussed in our 2015 Annual Report on Form 10-K, Item 1, Our Business and Our Strategy, Page 5. At June 30, 2016, we actively marketed through agencies located in 40 states. We maintain a long-term perspective that guides us in addressing immediate challenges or opportunities while focusing on the major decisions that best position our company for success through all market cycles.

To measure our long-term progress in creating shareholder value, our value creation ratio is our primary financial performance target. As discussed in our 2015 Annual Report on Form 10-K, Item 7, Executive Summary, Page 40, management believes this non-GAAP measure is a meaningful indicator of our long-term progress in creating shareholder value, is a useful supplement to GAAP information and has three primary performance drivers:

•
Premium growth – We believe our agency relationships and initiatives can lead to a property casualty written premium growth rate over any five-year period that exceeds the industry average. For the first six months of 2016, our consolidated property casualty net written premium year-over-year growth was 6 percent, comparing favorably with A.M. Best's February 2016 projection of approximately 2 percent full-year growth for the industry. For the five-year period 2011 through 2015, our growth rate was approximately double that of the industry. The industry's growth rate excludes its mortgage and financial guaranty lines of business.
•
Combined ratio – We believe our underwriting philosophy and initiatives can generate a GAAP combined ratio over any five-year period that is consistently within the range of 95 percent to 100 percent. For the first six months of 2016, our GAAP combined ratio was 95.4 percent and our statutory combined ratio was 94.1 percent, both including 9.3 percentage points of current accident year catastrophe losses partially offset by 5.0 percentage points of favorable loss reserve development on prior accident years. As of February 2016, A.M. Best projected the industry's full-year 2016 statutory combined ratio at approximately 99 percent, including approximately 5 percentage points of catastrophe losses and a favorable effect of approximately 2 percentage points of loss reserve development on prior accident years. The industry's ratio again excludes its mortgage and financial guaranty lines of business.
•
Investment contribution – We believe our investment philosophy and initiatives can drive investment income growth and lead to a total return on our equity investment portfolio over a five-year period that exceeds the five-year return of the Standard & Poor’s 500 Index. For the first six months of 2016, pretax investment income was $294 million, up 5 percent compared with the same period in 2015. We believe our investment portfolio mix provides an appropriate balance of income stability and growth with capital appreciation potential.


Cincinnati Financial Corporation Second-Quarter 2016 10-Q
Page 32


Highlights of Our Strategy and Supporting Initiatives
Management has worked to identify a strategy that can lead to long-term success, with concurrence by the board of directors. Our strategy is intended to position us to compete successfully in the markets we have targeted while appropriately managing risk. Further description of our long-term, proven strategy can be found in our 2015 Annual Report on Form 10-K, Item 1, Our Business and Our Strategy, Page 5. We believe successful implementation of initiatives that support our strategy will help us better serve our agent customers and reduce volatility in our financial results while we also grow earnings and book value over the long term, successfully navigating challenging economic, market or industry pricing cycles.

•
Manage insurance profitability – Implementation of these initiatives is intended to enhance underwriting expertise and knowledge, thereby increasing our ability to manage our business while also gaining efficiency. Better profit margins can arise from additional information and more focused action on underperforming product lines, plus pricing capabilities we are expanding through the use of technology and analytics. In addition to enhancing company efficiency, improving internal processes also supports the ability of the independent agencies that represent us to grow profitably by allowing them to serve clients faster and to more efficiently manage agency expenses.
We continue to enhance our property casualty underwriting expertise and to effectively and efficiently underwrite individual policies and process transactions. Ongoing initiatives supporting this work include expanding our pricing and segmentation capabilities through experience and use of predictive analytics and additional data. Our segmentation efforts emphasize identification and retention of insurance policies we believe have relatively stronger pricing, while seeking more aggressive renewal terms and conditions on policies we believe have relatively weaker pricing. An area of concentration in 2016 is improving underwriting and rate adequacy for our commercial auto and personal auto lines of business. Our commercial auto policies that renewed during the first six months of 2016 experienced an estimated average price percentage increase in the mid-single-digit range, while our personal auto policies that renewed during that period averaged an estimated price percentage increase near the low end of the high-single-digit range.
•
Drive premium growth – Implementation of these initiatives is intended to further penetrate each market we serve through our independent agencies. Strategies aimed at specific market opportunities, along with service enhancements, can help our agents grow and increase our share of their business. Diversified growth also may reduce variability of losses from weather-related catastrophes.
We continue to appoint new agencies to develop additional points of distribution. In 2016, we are planning approximately 100 appointments of independent agencies that offer most or all of our property casualty insurance products. During the first six months of 2016, we appointed 44 new agencies that meet that criteria. We also appointed another 64 agencies to market only personal lines insurance products for us. As of June 30, 2016, a total of 1,576 agency relationships market our property casualty insurance products from 2,032 reporting locations.
We plan to appoint additional agencies that focus on high net worth personal lines clients. In 2016, we are targeting approximately $25 million in high net worth new business written premiums, including premiums from our Executive Capstone™ suite of insurance products and services. During the first six months of 2016, our agencies produced for us approximately $14 million in high net worth new business written premiums. In the first quarter of 2016, we appointed agencies in the state of New Jersey and began to offer personal lines insurance products for the unique needs of high net worth personal lines clients. That state represents our 40th state for marketing property casualty insurance, including 32 states where we market personal lines policies.
 
Financial Strength
An important part of our long-term strategy is financial strength, which is described in our 2015 Annual Report on Form 10-K, Item 1, Our Business and Our Strategy, Financial Strength, Page 7. One aspect of our financial strength is prudent use of reinsurance ceded to help manage financial performance variability due to catastrophe loss experience. A description of how we use reinsurance ceded is included in our 2015 Annual Report on Form 10-K, Item 7, Liquidity and Capital Resources, 2016 Reinsurance Ceded Programs, Page 101. Another aspect of our financial strength is our investment portfolio, which remains well-diversified as discussed in this quarterly report in Item 3, Quantitative and Qualitative Disclosures About Market Risk. Our strong parent-company liquidity and financial strength increase our flexibility to maintain a cash dividend through all periods and to continue to invest in and expand our insurance operations.


Cincinnati Financial Corporation Second-Quarter 2016 10-Q
Page 33


At June 30, 2016, we held $1.952 billion of our cash and invested assets at the parent-company level, of which $1.772 billion, or 90.8 percent, was invested in common stocks, and $88 million, or 4.5 percent, was cash or cash equivalents. Our debt-to-total-capital ratio of 10.5 percent remains well below our target limit. Another important indicator of financial strength is our ratio of property casualty net written premiums to statutory surplus, which was 1.0-to-1 for the 12 months ended June 30, 2016, matching year-end 2015.

Financial strength ratings assigned to us by independent rating firms also are important. In addition to rating our parent company’s senior debt, four firms award insurer financial strength ratings to one or more of our insurance subsidiary companies based on their quantitative and qualitative analyses. These ratings primarily assess an insurer’s ability to meet financial obligations to policyholders and do not necessarily address all of the matters that may be important to investors. Ratings are under continuous review and subject to changes or withdrawal at any time by the rating agency. Each rating should be evaluated independently of any other rating; please see each rating agency's website for its most recent report on our ratings.

All of our insurance subsidiaries continue to be highly rated. As of July 25, 2016, our insurer financial strength ratings were:
Rating
agency
Standard market property casualty insurance subsidiaries
Life insurance
 subsidiary
Excess and surplus lines insurance subsidiary
Date of most recent
affirmation or action
 
 
 
Rating
tier
 
 
Rating
tier
 
 
Rating
tier
 
A.M. Best Co.
 ambest.com
A+
Superior
2 of 16
A
Excellent
3 of 16
A+
Superior
2 of 16
Stable outlook (03/10/16)
Fitch Ratings
 fitchratings.com
A+
Strong
5 of 21
A+
Strong
5 of 21
-
-
-
Stable outlook (07/12/16)
Moody's Investors  Service
 moodys.com
A1
Good
5 of 21
-
-
-
-
-
-
Stable outlook (05/24/16)
S&P Global  Ratings
 spratings.com
A+
Strong
5 of 21
A+
Strong
5 of 21
-
-
-
Stable outlook (06/28/16)
 
On March 10, 2016, A.M. Best affirmed, with a stable outlook, its rating for The Cincinnati Life Insurance Company, including a financial strength rating of A (Excellent) and an issuer credit rating of "a+." According to A.M. Best, the ratings reflect Cincinnati Life's positive premium growth trends, good quality investment portfolio, adequate capitalization and strategic role within Cincinnati Financial Corporation. A.M. Best noted factors that could lead to a negative rating action, including: a reduction in A.M. Best’s view of the strategic importance of Cincinnati Life to its parent, a material decline in risk-adjusted capital as measured by BCAR, continued spread compression on interest-sensitive reserves that could adversely impact operating earnings or a change in business mix with a greater focus on less creditworthy products.

On May 24, 2016, Moody's Investors Service Ratings affirmed, with a stable outlook, the A1 financial strength rating it assigned to us in September 2008. Moody's reported that our ratings reflect our longstanding franchise, which benefits from strong relationships with independent agents, a focus on small and middle market commercial risks and robust capital adequacy. Moody's cited our strengths, including a conservative reserve position, low financial leverage and substantial holding company liquidity, but noted these strengths are tempered by exposure to catastrophes, limited scale in personal lines, potential investment volatility reflecting a sizeable common equity position and competition from well-capitalized nationwide commercial lines carriers.

On June 28, 2016, S&P Global Ratings (formerly known as Standard & Poor’s Ratings Services) affirmed, with a stable outlook, its financial strength rating of A+ on our standard market property casualty and life insurance subsidiaries. S&P said its rating reflected our strong competitive position, low country and industry risk, and extremely strong capital and earnings. S&P noted its rating could be lowered if capital adequacy deteriorated significantly for a prolonged period or if earnings weakened to substantially less than its base-case assumptions.


Cincinnati Financial Corporation Second-Quarter 2016 10-Q
Page 34


On July 12, 2016, Fitch Ratings affirmed, with a stable outlook, the A+ financial strength rating for our standard market property casualty and life insurance subsidiaries. Fitch reported that the affirmation reflects balance sheet strengths, improved financial performance since 2012, adequate and well-managed reserves, and implementation of claims management and risk management tools. Fitch noted that its rating could be lowered if our combined ratio exceeds 105 percent on a sustained basis, if profitability on recent growth deteriorates, or if we fail to maintain a “very strong” score on Fitch’s Prism capital model.



Cincinnati Financial Corporation Second-Quarter 2016 10-Q
Page 35


CONSOLIDATED PROPERTY CASUALTY INSURANCE HIGHLIGHTS
Consolidated property casualty insurance results include premiums and expenses for our standard market insurance segments (commercial lines and personal lines), our excess and surplus lines segment and our reinsurance assumed operations.
(Dollars in millions)
 
Three months ended June 30,
 
Six months ended June 30,
 
 
2016
 
2015
 
% Change
 
2016
 
2015
 
% Change
Earned premiums
 
$
1,114

 
$
1,059

 
5

 
$
2,210

 
$
2,100

 
5

Fee revenues
 
2

 
2

 
0

 
4

 
4

 
0

Total revenues
 
1,116

 
1,061

 
5

 
2,214

 
2,104

 
5

Loss and loss expenses from:
 
 

 
 

 
 

 
 

 
 

 
 

Current accident year before catastrophe losses
 
643

 
645

 
0

 
1,325

 
1,302

 
2

Current accident year catastrophe losses
 
165

 
79

 
109

 
206

 
133

 
55

Prior accident years before catastrophe losses
 
(49
)
 
(70
)
 
30

 
(104
)
 
(81
)
 
(28
)
Prior accident years catastrophe losses
 
—

 
—

 
0

 
(7
)
 
(11
)
 
36

Loss and loss expenses
 
759

 
654

 
16

 
1,420

 
1,343

 
6

Underwriting expenses
 
347

 
324

 
7

 
688

 
651

 
6

Underwriting profit
 
$
10

 
$
83

 
(88
)
 
$
106

 
$
110

 
(4
)
 
 
 
 
 
 
 
 
 
 
 
 
 
Ratios as a percent of earned premiums:
 
 

 
 

 
Pt. Change

 
 

 
 

 
Pt. Change

    Current accident year before catastrophe losses
 
57.8
 %
 
60.9
 %
 
(3.1
)
 
59.9
 %
 
62.0
 %
 
(2.1
)
    Current accident year catastrophe losses
 
14.8

 
7.5

 
7.3

 
9.3

 
6.3

 
3.0

    Prior accident years before catastrophe losses
 
(4.4
)
 
(6.6
)
 
2.2

 
(4.7
)
 
(3.9
)
 
(0.8
)
    Prior accident years catastrophe losses
 
0.0

 
0.0

 
0.0

 
(0.3
)
 
(0.5
)
 
0.2

Loss and loss expenses
 
68.2

 
61.8

 
6.4

 
64.2

 
63.9

 
0.3

Underwriting expenses
 
31.1

 
30.6

 
0.5

 
31.2

 
31.0

 
0.2

Combined ratio
 
99.3
 %
 
92.4
 %
 
6.9

 
95.4
 %
 
94.9
 %
 
0.5

 
 
 
 
 
 
 
 
 
 
 
 
 
Combined ratio
 
99.3
 %
 
92.4
 %
 
6.9

 
95.4
 %
 
94.9
 %
 
0.5

Contribution from catastrophe losses and prior
  years reserve development
 
10.4

 
0.9

 
9.5

 
4.3

 
1.9

 
2.4

Combined ratio before catastrophe losses and
  prior years reserve development
 
88.9
 %
 
91.5
 %
 
(2.6
)
 
91.1
 %
 
93.0
 %
 
(1.9
)
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Our consolidated property casualty insurance operations generated an underwriting profit of $10 million and $106 million for the three and six months ended June 30, 2016. The three-month decrease of $73 million, compared with second-quarter 2015, was driven by an increase of $86 million in losses from weather-related natural catastrophes. The six-month decrease of $4 million, compared with the first half of 2015, included an increase of $77 million in losses from weather-related natural catastrophes. We believe future property casualty underwriting results will continue to benefit from price increases and our ongoing initiatives to improve pricing precision and loss experience related to claims and loss control practices.
For all property casualty lines of business in aggregate, net loss and loss expense reserves at June 30, 2016, were $229 million higher than at year-end 2015, including $133 million for the incurred but not reported (IBNR) portion. The $229 million reserve increase raised year-end 2015 net loss and loss expense reserves by 5 percent.

We measure and analyze property casualty underwriting results primarily by the combined ratio and its component ratios. The GAAP-basis combined ratio is the percentage of incurred losses plus all expenses per each earned premium dollar – the lower the ratio, the better the performance. An underwriting profit results when the combined ratio is below 100 percent. A combined ratio above 100 percent indicates that an insurance company’s losses and expenses exceeded premiums.

Our consolidated property casualty combined ratio for the second quarter of 2016 rose 6.9 percentage points, compared with the same period of 2015, including 7.3 points from higher catastrophe losses and loss expenses.

Cincinnati Financial Corporation Second-Quarter 2016 10-Q
Page 36


For the first six months of 2016, compared with the same period of 2015, our consolidated property casualty combined ratio rose 0.5 percentage points, including 3.2 points from higher catastrophe losses and loss expenses.
 
The combined ratio can be affected significantly by natural catastrophe losses and other large losses as discussed in detail below. The combined ratio can also be affected by updated estimates of loss and loss expense reserves established for claims that occurred in prior periods, referred to as prior accident years. Net favorable development on prior accident year reserves, including reserves for catastrophe losses, benefited the combined ratio by 5.0 percentage points in the first six months of 2016, compared with 4.4 percentage points in the same period of 2015. Net favorable development is discussed in further detail in Financial Results by property casualty insurance segment.
 
The ratio for current accident year loss and loss expenses before catastrophe losses improved in the first six months of 2016. The 59.9 percent ratio for the first six months of 2016 decreased 2.1 percentage points compared with the 62.0 percent accident year 2015 ratio measured as of June 30, 2015, despite an increase of 0.4 percentage points in the ratio for large losses of $1 million or more per claim, discussed below.
 
The underwriting expense ratio increased 0.5 and 0.2 percentage points for the second quarter and first six months of 2016, compared with the same periods of 2015. Strategic investments that include enhancement of underwriting expertise offset the favorable effects of higher earned premiums and ongoing expense management efforts.

Consolidated Property Casualty Insurance Premiums
(Dollars in millions)
 
Three months ended June 30,
 
Six months ended June 30,

 
2016
 
2015
 
% Change
 
2016
 
2015
 
% Change
Agency renewal written premiums
 
$
1,057

 
$
1,018

 
4

 
$
2,085

 
$
2,001

 
4

Agency new business written premiums
 
143

 
138

 
4

 
268

 
254

 
6

Cincinnati Re net written premiums
 
16

 
—

 
nm

 
35

 
—

 
nm

Other written premiums
 
(22
)
 
(14
)
 
(57
)
 
(47
)
 
(47
)
 
0

Net written premiums
 
1,194

 
1,142

 
5

 
2,341

 
2,208

 
6

Unearned premium change
 
(80
)
 
(83
)
 
4

 
(131
)
 
(108
)
 
(21
)
Earned premiums
 
$
1,114

 
$
1,059

 
5

 
$
2,210

 
$
2,100

 
5

 
 
 
 
 
 
 
 
 
 
 
 
 
 
The trends in net written premiums and earned premiums summarized in the table above largely reflect the effects of price increases. Price increase trends that heavily influence renewal written premium increases or decreases and other premium growth drivers for 2016 are discussed in more detail by segment below in Financial Results.
 
Consolidated property casualty net written premiums for the three and six months ended June 30, 2016, grew $52 million and $133 million compared with the same periods of 2015. Each of our property casualty segments continued to grow during the first six months of 2016. Our premium growth initiatives from prior years have provided an ongoing favorable effect on growth during the current year, particularly as newer agency relationships mature over time.

Consolidated property casualty agency new business written premiums rose $5 million and $14 million for the second quarter and first six months of 2016, compared with the same periods of 2015. New business written premiums in the second quarter and first half of 2016 were higher than the same periods of 2015 for each of our property casualty insurance segments. New agency appointments during 2015 and 2016 produced an $18 million increase in standard lines new business for the first six months of 2016 compared with the same period of 2015. As we appoint new agencies that choose to move accounts to us, we report these accounts as new business. While this business is new to us, in many cases it is not new to the agent. We believe these seasoned accounts tend to be priced more accurately than business that may be less familiar to our agent upon obtaining it from a competing agent.

Net written premiums increased $35 million for the first half of 2016, compared with the same period of 2015, when we began to expand our reinsurance assumed operations, known as Cincinnati ReSM. Cincinnati Re assumes risks through reinsurance treaties and in some cases cedes part of the risk and related premiums to one or more unaffiliated reinsurance companies through transactions known as retrocessions. For the first six months of 2016, earned premiums for Cincinnati Re totaled $20 million, compared with none earned in the same period a year ago.

Cincinnati Financial Corporation Second-Quarter 2016 10-Q
Page 37


 
Other written premiums include premiums ceded to reinsurers as part of our reinsurance ceded program. A decrease in ceded premiums for the second quarter and first half of 2016, compared with the same periods of 2015, contributed less than $1 million and $2 million to 2016 net written premium growth.
 
Catastrophe losses and loss expenses typically have a material effect on property casualty results and can vary significantly from period to period. Losses from natural catastrophes contributed 14.8 and 9.0 percentage points to the combined ratio in the second quarter and first six months of 2016, compared with 7.5 and 5.8 percentage points in the same periods of 2015. Some of those losses were applicable to annual loss deductible provisions of our collateralized reinsurance funded through catastrophe bonds. For our collateralized reinsurance arrangement effective January 18, 2014, aggregate losses occurring from January 18, 2016, through June 30, 2016, totaled $8 million from two occurrences, where aggregate losses reached the applicable loss deductible provision for the specific geographic locations included in the severe convective storm portion of that coverage. If aggregate losses, after the $5 million per occurrence deductible, exceed $160 million during an annual coverage period, we can recover the excess through funds that collateralize the catastrophe bonds. The following table shows consolidated property casualty insurance catastrophe losses and loss expenses incurred, net of reinsurance, as well as the effect of loss development on prior period catastrophe events. We individually list declared catastrophe events for which our incurred losses reached or exceeded $10 million.

Consolidated Property Casualty Insurance Catastrophe Losses and Loss Expenses Incurred
(Dollars in millions, net of reinsurance)
 
Three months ended June 30,
 
Six months ended June 30,
 
 
 
Comm.
 
Pers.
 
E&S
 
 

 
Comm.
 
Pers.
 
E&S
 
 

Dates
Event
Region
lines
 
lines
 
lines
 
Total
 
lines
 
lines
 
lines
 
Total
2016
 
 
 

 
 

 
 

 
 

 
 

 
 

 
 

 
 

Apr. 2-3
Hail, Wind
Midwest,
Northeast, South
$
6

 
$
6

 
$
—

 
$
12

 
$
6

 
$
6

 
$
—

 
$
12

Apr. 10-15
Flood, hail, wind
South
55

 
—

 
1

 
56

 
55

 
—

 
1

 
56

Apr. 25-28
Flood, hail, wind
Midwest, South
9

 
4

 
—

 
13

 
9

 
4

 
—

 
13

Apr. 29-May 3
Flood, hail, wind
Midwest, South
18

 
7

 
—

 
25

 
18

 
7

 
—

 
25

May 7-10
Flood, hail, wind
Midwest, South, West
14

 
6

 
—

 
20

 
14

 
6

 
—

 
20

May 11-12
Flood, hail, wind
Midwest, South
11

 
2

 
—

 
13

 
11

 
2

 
—

 
13

May 21-28
Flood, hail, wind
Midwest, South, West
11

 
2

 
—

 
13

 
11

 
2

 
—

 
13

All other 2016 catastrophes
 
5

 
7

 
1

 
13

 
35

 
18

 
1

 
54

Development on 2015 and prior catastrophes
(1
)
 
1

 
—

 
—

 
(6
)
 
(1
)
 
—

 
(7
)
Calendar year incurred total
$
128

 
$
35

 
$
2

 
$
165

 
$
153

 
$
44

 
$
2

 
$
199

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
2015
 
 
 

 
 

 
 

 
 

 
 

 
 

 
 

 
 

Feb. 16-27
Freezing, ice and snow, wind
Midwest, Northeast, South
$
1

 
$
—

 
$
—

 
$
1

 
$
33

 
$
9

 
$
—

 
$
42

Apr. 7-10
Flood, hail, wind
Midwest,
Northeast, South
8

 
15

 
—

 
23

 
8

 
15

 
—

 
23

Apr. 18-20
Flood, hail, wind
Midwest, South
6

 
6

 
—

 
12

 
6

 
6

 
—

 
12

All other 2015 catastrophes
 
28

 
14

 
1

 
43

 
35

 
20

 
1

 
56

Development on 2014 and prior catastrophes
—

 
—

 
—

 
—

 
(9
)
 
(2
)
 
—

 
(11
)
Calendar year incurred total
$
43

 
$
35

 
$
1

 
$
79

 
$
73

 
$
48

 
$
1

 
$
122

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 


Cincinnati Financial Corporation Second-Quarter 2016 10-Q
Page 38


The following table includes data for losses incurred of $1 million or more per claim, net of reinsurance.
 
Consolidated Property Casualty Insurance Losses Incurred by Size
(Dollars in millions, net of reinsurance)
 
Three months ended June 30,
 
Six months ended June 30,
 
 
2016
 
2015
 
% Change
 
2016
 
2015
 
% Change
Current accident year losses greater than
   $5,000,000
 
$
23

 
$
5

 
360

 
$
23

 
$
17

 
35

Current accident year losses $1,000,000-
  $5,000,000
 
34

 
24

 
42

 
76

 
61

 
25

Large loss prior accident year reserve
  development
 
3

 
(4
)
 
(175
)
 
3

 
11

 
(73
)
Total large losses incurred
 
60

 
25

 
140

 
102

 
89

 
15

Losses incurred but not reported
 
34

 
38

 
(11
)
 
107

 
81

 
32

Other losses excluding catastrophe losses
 
399

 
417

 
(4
)
 
801

 
835

 
(4
)
Catastrophe losses
 
163

 
78

 
109

 
196

 
120

 
63

Total losses incurred
 
$
656

 
$
558

 
18

 
$
1,206

 
$
1,125

 
7

 
 
 
 
 
 
 
 
 
 
 
 
 
Ratios as a percent of earned premiums:
 
 
 
 
 
Pt. Change
 
 
 
 
 
Pt. Change
Current accident year losses greater than
   $5,000,000
 
2.0
%
 
0.5
 %
 
1.5

 
1.0
%
 
0.8
%
 
0.2

Current accident year losses $1,000,000-
  $5,000,000
 
3.1

 
2.1

 
1.0

 
3.5

 
2.9

 
0.6

Large loss prior accident year reserve
  development
 
0.3

 
(0.3
)
 
0.6

 
0.1

 
0.5

 
(0.4
)
Total large loss ratio
 
5.4

 
2.3

 
3.1

 
4.6

 
4.2

 
0.4

Losses incurred but not reported
 
3.1

 
3.6

 
(0.5
)
 
4.8

 
3.9

 
0.9

Other losses excluding catastrophe losses
 
35.7

 
39.6

 
(3.9
)
 
36.2

 
39.8

 
(3.6
)
Catastrophe losses
 
14.6

 
7.3

 
7.3

 
8.9

 
5.7

 
3.2

Total loss ratio
 
58.8
%
 
52.8
 %
 
6.0

 
54.5
%
 
53.6
%
 
0.9

 
 
 
 
 
 
 
 
 
 
 
 
 
 
We believe the inherent variability of aggregate loss experience for our portfolio of larger policies is greater than that of our portfolio of smaller policies, and we continue to monitor the variability in addition to general inflationary trends in loss costs. Our analysis continues to indicate no unexpected concentration of large losses and case reserve increases by risk category, geographic region, policy inception, agency or field marketing territory. The second-quarter 2016 property casualty total large losses incurred of $60 million, net of reinsurance, were higher than both the $54 million quarterly average during 2015 and the $25 million for the second quarter of 2015. The ratio for these large losses was 3.1 percentage points higher compared with last year’s second quarter. The second-quarter 2016 amount of total large losses incurred helped contribute to the increase in the six-month 2016 total large loss ratio, compared with 2015, in addition to a first-quarter 2016 ratio that was 2.2 points lower than the first quarter of 2015. We believe results for the three- and six-month periods largely reflected normal fluctuations in loss patterns and normal variability in large case reserves for claims above $1 million. Losses by size are discussed in further detail in results of operations by property casualty insurance segment.
 

FINANCIAL RESULTS
Consolidated results reflect the operating results of each of our five segments along with the parent company and other activities reported as “Other.” The five segments are:
•
Commercial lines property casualty insurance
•
Personal lines property casualty insurance
•
Excess and surplus lines property casualty insurance
•
Life insurance
•
Investments


Cincinnati Financial Corporation Second-Quarter 2016 10-Q
Page 39


COMMERCIAL LINES INSURANCE RESULTS
(Dollars in millions)
 
Three months ended June 30,
 
Six months ended June 30,

 
2016
 
2015
 
% Change
 
2016
 
2015
 
% Change
Earned premiums
 
$
771

 
$
745

 
3

 
$
1,531

 
$
1,478

 
4

Fee revenues
 
1

 
1

 
0

 
2

 
2

 
0

Total revenues
 
772

 
746

 
3

 
1,533

 
1,480

 
4

Loss and loss expenses from:
 
 

 
 

 
 

 
 

 
 

 
 

Current accident year before catastrophe losses
 
429

 
437

 
(2
)
 
897

 
886

 
1

Current accident year catastrophe losses
 
129

 
43

 
200

 
159

 
82

 
94

Prior accident years before catastrophe losses
 
(57
)
 
(63
)
 
10

 
(81
)
 
(68
)
 
(19
)
Prior accident years catastrophe losses
 
(1
)
 
—

 
nm

 
(6
)
 
(9
)
 
33

Loss and loss expenses
 
500

 
417

 
20

 
969

 
891

 
9

Underwriting expenses
 
246

 
232

 
6

 
488

 
466

 
5

Underwriting profit
 
$
26

 
$
97

 
(73
)
 
$
76

 
$
123

 
(38
)
 
 
 
 
 
 
 
 
 
 
 
 
 
Ratios as a percent of earned premiums:
 
 
 
 
 
Pt. Change
 
 
 
 
 
Pt. Change
Current accident year before catastrophe losses
 
55.7
 %
 
58.7
 %
 
(3.0
)
 
58.6
 %
 
59.9
 %
 
(1.3
)
Current accident year catastrophe losses
 
16.8

 
5.8

 
11.0

 
10.4

 
5.6

 
4.8

Prior accident years before catastrophe losses
 
(7.4
)
 
(8.6
)
 
1.2

 
(5.3
)
 
(4.6
)
 
(0.7
)
Prior accident years catastrophe losses
 
(0.2
)
 
0.1

 
(0.3
)
 
(0.4
)
 
(0.6
)
 
0.2

Loss and loss expenses
 
64.9

 
56.0

 
8.9

 
63.3

 
60.3

 
3.0

Underwriting expenses
 
31.9

 
31.2

 
0.7

 
31.9

 
31.6

 
0.3

Combined ratio
 
96.8
 %
 
87.2
 %
 
9.6

 
95.2
 %
 
91.9
 %
 
3.3

 
 
 
 
 
 
 
 
 
 
 
 
 
Combined ratio
 
96.8
 %
 
87.2
 %
 
9.6

 
95.2
 %
 
91.9
 %
 
3.3

Contribution from catastrophe losses and prior
  years reserve development
 
9.2

 
(2.7
)
 
11.9

 
4.7

 
0.4

 
4.3

Combined ratio before catastrophe losses and
  prior years reserve development
 
87.6
 %
 
89.9
 %
 
(2.3
)
 
90.5
 %
 
91.5
 %
 
(1.0
)
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Overview
Performance highlights for the commercial lines segment include:
•
Premiums – Earned premiums and net written premiums for the commercial lines segment grew during the second quarter and first half of 2016, primarily due to renewal premium growth that continued to reflect price increases and a higher level of insured exposures. Higher new business written premiums for the first six months of 2016 also contributed to growth. The table below analyzes the primary components of premiums. We continue using predictive analytics tools to improve pricing precision and segmentation while also leveraging our local relationships with agents through the efforts of our teams that work closely with them. We seek to maintain appropriate pricing discipline for both new and renewal business as our agents and underwriters assess account quality to make careful decisions on a case-by-case basis whether to write or renew a policy.
Agency renewal written premiums rose 3 percent for both the three and six months ended June 30, 2016, reflecting price increases and improving economic conditions. During the second quarter of 2016, our overall standard commercial lines policies continued to average estimated renewal price increases at percentages in the low-single-digit range, similar to the first quarter of 2016. We continue to segment commercial lines policies, emphasizing identification and retention of policies we believe have relatively stronger pricing. Conversely, we have been seeking stricter renewal terms and conditions on policies we believe have relatively weaker pricing, in turn retaining fewer of those policies. As a result, the average change in commercial lines renewal pricing was somewhat lower than in 2015. We measure average changes in commercial lines renewal pricing as the percentage rate of change in renewal premium for the new policy period compared with the premium for the expiring policy period, assuming no change in the level of insured exposures or policy coverage between those periods for the respective policies.

Cincinnati Financial Corporation Second-Quarter 2016 10-Q
Page 40


Our average overall commercial lines renewal pricing change includes the impact of flat pricing of certain coverages within package policies written for a three-year term that were in force but did not expire during the period being measured. Therefore, the change in average commercial lines renewal pricing we report reflects a blend of three-year policies that did not expire and other policies that did expire during the measurement period. For commercial lines policies that did expire and were then renewed during the second quarter of 2016, we estimate that our average percentage price increase for both commercial auto and commercial property lines were in the mid-single-digit range. The estimated average percentage price change for our commercial casualty line of business was an increase in the low-single-digit range, and for workers’ compensation it was a decrease in the low-single-digit range.
Renewal premiums for our commercial casualty and workers’ compensation lines include the results of policy audits that adjust initial premium amounts based on differences between estimated and actual sales or payroll related to a specific policy. Audits completed during the second quarter and first six months of 2016 contributed $20 million and $41 million to net written premiums, respectively. Audits contributed less than $1 million of the $10 million net increase in net written premiums for the second quarter of 2016 and $4 million of the $54 million net increase in net written premiums for the first six months of 2016, compared with the same periods a year ago. The $53 million increase in earned premiums during the first six months of 2016, compared with 2015, included an increase from audit premiums of $1 million.
New business written premiums for commercial lines increased less than $1 million and $8 million during the second quarter and first six months of 2016, compared with the same periods of 2015. During the first six months of 2016, new business written premiums grew for each major line of business in our commercial lines segment except for commercial auto, which decreased by less than 1 percent. Trend analysis for year-over-year comparisons of individual quarters are more difficult to assess for commercial lines new business written premiums, due to inherent variability. That variability is often driven by larger policies with annual premiums greater than $100,000.
Other written premiums include premiums ceded to reinsurers as part of our reinsurance ceded program. A decrease in ceded premiums contributed $2 million to net written premium growth for the first six months of 2016, compared with the same period of 2015, while second-quarter 2016 ceded premiums essentially matched the same quarter of 2015.

Commercial Lines Insurance Premiums
(Dollars in millions)
 
Three months ended June 30,
 
Six months ended June 30,
 
 
2016
 
2015
 
% Change
 
2016
 
2015
 
% Change
Agency renewal written premiums
 
$
718

 
$
699

 
3

 
$
1,476

 
$
1,429

 
3

Agency new business written premiums
 
93

 
93

 
0

 
180

 
172

 
5

Other written premiums
 
(14
)
 
(5
)
 
(180
)
 
(32
)
 
(31
)
 
(3
)
Net written premiums
 
797

 
787

 
1

 
1,624

 
1,570

 
3

Unearned premium change
 
(26
)
 
(42
)
 
(38
)
 
(93
)
 
(92
)
 
(1
)
Earned premiums
 
$
771

 
$
745

 
3

 
$
1,531

 
$
1,478

 
4

 
 
 
 
 
 
 
 
 
 
 
 
 
 
•
Combined ratio – The commercial lines combined ratio rose for the three and six months ended June 30, 2016, compared with the same periods last year, largely due to weather-related natural catastrophe losses and loss expenses that were 10.7 and 5.0 percentage points higher, respectively.
Catastrophe losses and loss expenses accounted for 16.6 and 10.0 percentage points of the combined ratio for the second quarter and first six months of 2016, compared with 5.9 and 5.0 percentage points for the same periods a year ago. The 10-year annual average for that catastrophe measure through 2015 for the commercial lines segment was 4.4 percentage points, and the five-year annual average was 5.6 percentage points.
The net effect of reserve development on prior accident years during the second quarter and first six months of 2016 was favorable for commercial lines overall by $58 million and $87 million compared with $63 million and $77 million for the same periods in 2015. For the six months ended June 30, 2016, our workers’ compensation line of business was the largest contributor to the total commercial lines net favorable reserve development on prior accident years, followed by our commercial casualty line of business and other commercial lines, which was largely attributable to director and officer liability insurance. Those contributions were partially offset by unfavorable development for our commercial auto line of business. The net favorable reserve development recognized during the first six months of 2016 for our commercial lines segment was distributed mainly between

Cincinnati Financial Corporation Second-Quarter 2016 10-Q
Page 41


accident years 2015 and 2014, and was primarily due to lower-than-anticipated loss emergence on known claims. Reserve estimates are inherently uncertain as described in our 2015 Annual Report on Form 10-K, Item 7, Critical Accounting Estimates, Property Casualty Insurance Loss and Loss Expense Reserves, Page 46.
The commercial lines underwriting expense ratio increased 0.7 and 0.3 percentage points for the second quarter and first six months of 2016, compared with the same periods of 2015. Strategic investments that include enhancement of underwriting expertise offset the favorable effects of higher earned premiums and ongoing expense management efforts.
Underwriting results and related measures for the combined ratio are summarized in the first table of Commercial Lines Insurance Results. The tables and discussion below provide additional details for certain primary drivers of underwriting results.

Commercial Lines Insurance Losses Incurred by Size
(Dollars in millions, net of reinsurance)
 
Three months ended June 30,
 
Six months ended June 30,
 
 
2016
 
2015
 
% Change
 
2016
 
2015
 
% Change
Current accident year losses greater than
   $5,000,000
 
$
23

 
$
5

 
360

 
$
23

 
$
17

 
35

Current accident year losses $1,000,000-
  $5,000,000
 
33

 
14

 
136

 
69

 
38

 
82

Large loss prior accident year reserve
   development
 
4

 
(4
)
 
nm

 
3

 
11

 
(73
)
Total large losses incurred
 
60

 
15

 
300

 
95

 
66

 
44

Losses incurred but not reported
 
2

 
17

 
(88
)
 
66

 
48

 
38

Other losses excluding catastrophe losses
 
244

 
274

 
(11
)
 
499

 
546

 
(9
)
Catastrophe losses
 
126

 
43

 
193

 
151

 
72

 
110

Total losses incurred
 
$
432

 
$
349

 
24

 
$
811

 
$
732

 
11

 
 
 
 
 
 
 
 
 
 
 
 
 
Ratios as a percent of earned premiums:
 
 
 
 
 
Pt. Change
 
 
 
 
 
Pt. Change
Current accident year losses greater than
   $5,000,000
 
2.9
%
 
0.7
 %
 
2.2

 
1.5
%
 
1.2
%
 
0.3

Current accident year losses $1,000,000-
  $5,000,000
 
4.2

 
1.7

 
2.5

 
4.5

 
2.6

 
1.9

Large loss prior accident year reserve
   development
 
0.6

 
(0.5
)
 
1.1

 
0.2

 
0.7

 
(0.5
)
Total large loss ratio
 
7.7

 
1.9

 
5.8

 
6.2

 
4.5

 
1.7

Losses incurred but not reported
 
0.3

 
2.2

 
(1.9
)
 
4.3

 
3.2

 
1.1

Other losses excluding catastrophe losses
 
31.6

 
37.0

 
(5.4
)
 
32.6

 
37.0

 
(4.4
)
Catastrophe losses
 
16.4

 
5.8

 
10.6

 
9.9

 
4.9

 
5.0

Total loss ratio
 
56.0
%
 
46.9
 %
 
9.1

 
53.0
%
 
49.6
%
 
3.4

 
 
 
 
 
 
 
 
 
 
 
 
 

We continue to monitor new losses and case reserve increases greater than $1 million for trends in factors such as initial reserve levels, loss cost inflation and claim settlement expenses. Our analysis continues to indicate no unexpected concentration of these large losses and case reserve increases by risk category, geographic region, policy inception, agency or field marketing territory. The second-quarter 2016 commercial lines total large losses incurred of $60 million, net of reinsurance, were higher than both the quarterly average of $42 million during 2015 and the $15 million total large losses incurred for the second quarter of 2015. The ratio for these large losses was 5.8 percentage points higher compared with last year’s second-quarter ratio. The second-quarter 2016 amount of total large losses incurred helped contribute to the increase in the six-month 2016 total large loss ratio, compared with 2015, offsetting a first-quarter 2016 ratio that was 2.3 points lower than the first quarter of 2015. We believe results for the three- and six-month periods largely reflected normal fluctuations in loss patterns and normal variability in large case reserves for claims above $1 million.


Cincinnati Financial Corporation Second-Quarter 2016 10-Q
Page 42


Commercial Lines of Business Analysis
Approximately 95 percent of our commercial lines premiums relate to accounts with coverages from more than one of our business lines. As a result, we believe that our commercial lines business is best measured and evaluated on a segment basis. However, we provide line-of-business data to summarize premium and loss trends separately for each line. The ratios shown in the table below are components of loss and loss expenses as a percentage of earned premiums.  
(Dollars in millions)
 
Three months ended June 30,
 
Six months ended June 30,
 
 
2016
 
2015
 
% Change
 
2016
 
2015
 
% Change
Commercial casualty:
 
 

 
 

 
 

 
 

 
 

 
 

Written premiums
 
$
278

 
$
274

 
1

 
$
563

 
$
540

 
4

Earned premiums
 
263

 
252

 
4

 
520

 
496

 
5

Current accident year before catastrophe losses
 
58.7
 %
 
59.6
 %
 
 

 
59.5
 %
 
59.4
 %
 
 

Current accident year catastrophe losses
 
—

 
—

 
 

 
—

 
—

 
 

Prior accident years before catastrophe losses
 
(7.5
)
 
(9.1
)
 
 

 
(4.4
)
 
(4.1
)
 
 

Prior accident years catastrophe losses
 
—

 
—

 
 

 
—

 
—

 
 

Total loss and loss expenses ratio
 
51.2
 %
 
50.5
 %
 
 

 
55.1
 %
 
55.3
 %
 
 

Commercial property:
 
 

 
 

 
 

 
 

 
 

 
 

Written premiums
 
$
223

 
$
218

 
2

 
$
448

 
$
424

 
6

Earned premiums
 
215

 
203

 
6

 
429

 
399

 
8

Current accident year before catastrophe losses
 
36.3
 %
 
42.1
 %
 
 

 
43.8
 %
 
47.8
 %
 
 

Current accident year catastrophe losses
 
57.6

 
19.6

 
 

 
35.7

 
18.2

 
 

Prior accident years before catastrophe losses
 
(5.4
)
 
(2.0
)
 
 

 
(3.6
)
 
(2.0
)
 
 

Prior accident years catastrophe losses
 
(1.0
)
 
0.1

 
 

 
(1.6
)
 
(1.8
)
 
 

Total loss and loss expenses ratio
 
87.5
 %
 
59.8
 %
 
 

 
74.3
 %
 
62.2
 %
 
 

Commercial auto:
 
 

 
 

 
 

 
 

 
 

 
 

Written premiums
 
$
156

 
$
149

 
5

 
$
314

 
$
298

 
5

Earned premiums
 
147

 
139

 
6

 
291

 
275

 
6

Current accident year before catastrophe losses
 
76.3
 %
 
75.8
 %
 
 

 
76.9
 %
 
74.1
 %
 
 

Current accident year catastrophe losses
 
2.2

 
1.3

 
 

 
1.4

 
0.7

 
 

Prior accident years before catastrophe losses
 
9.1

 
8.3

 
 

 
7.4

 
8.4

 
 

Prior accident years catastrophe losses
 
—

 
(0.2
)
 
 

 
(0.1
)
 
(0.2
)
 
 

Total loss and loss expenses ratio
 
87.6
 %
 
85.2
 %
 
 

 
85.6
 %
 
83.0
 %
 
 

Workers' compensation:
 
 

 
 

 
 

 
 

 
 

 
 

Written premiums
 
$
86

 
$
89

 
(3
)
 
$
191

 
$
193

 
(1
)
Earned premiums
 
89

 
90

 
(1
)
 
178

 
183

 
(3
)
Current accident year before catastrophe losses
 
70.9
 %
 
77.6
 %
 
 

 
72.2
 %
 
74.5
 %
 
 

Current accident year catastrophe losses
 
—

 
—

 
 

 
—

 
—

 
 

Prior accident years before catastrophe losses
 
(25.5
)
 
(44.8
)
 
 

 
(20.1
)
 
(30.3
)
 
 

Prior accident years catastrophe losses
 
—

 
—

 
 

 
—

 
—

 
 

Total loss and loss expenses ratio
 
45.4
 %
 
32.8
 %
 
 

 
52.1
 %
 
44.2
 %
 
 

Other commercial lines:
 
 

 
 

 
 

 
 

 
 

 
 

Written premiums
 
$
54

 
$
55

 
(2
)
 
$
108

 
$
113

 
(4
)
Earned premiums
 
57

 
61

 
(7
)
 
113

 
125

 
(10
)
Current accident year before catastrophe losses
 
37.8
 %
 
42.7
 %
 
 

 
42.1
 %
 
48.6
 %
 
 

Current accident year catastrophe losses
 
3.8

 
3.4

 
 

 
2.2

 
6.6

 
 

Prior accident years before catastrophe losses
 
(28.2
)
 
(13.6
)
 
 

 
(25.5
)
 
(6.7
)
 
 

Prior accident years catastrophe losses
 
1.3

 
1.2

 
 

 
0.7

 
(0.7
)
 
 

Total loss and loss expenses ratio
 
14.7
 %
 
33.7
 %
 
 

 
19.5
 %
 
47.8
 %
 
 

 
 
 
 
 
 
 
 
 
 
 
 
 

As discussed above, the loss and loss expenses ratio component of the combined ratio is an important measure of underwriting profit and performance. Catastrophe losses are volatile and can distort short-term profitability trends, particularly for certain lines of business. Development of loss and loss expense reserves on prior accident years can also distort trends in measures of profitability for recently written business. To illustrate these effects,

Cincinnati Financial Corporation Second-Quarter 2016 10-Q
Page 43


we separate their impact on the ratios shown in the table above. For the six months ended June 30, 2016, the commercial line of business with the most significant profitability challenge was commercial auto. For the first six months of 2016, our commercial auto policies experienced average renewal price percentage increases in the mid-single-digit range, which we believe will help improve profitability in future quarters. We further discuss current initiatives for commercial auto in the Highlights of Our Strategy and Supporting Initiatives section of this quarterly report and in our 2015 Annual Report on Form 10-K, Item 7, Commercial Lines of Business Analysis, Page 67.

PERSONAL LINES INSURANCE RESULTS
(Dollars in millions)
 
Three months ended June 30,
 
Six months ended June 30,
 
 
2016
 
2015
 
% Change
 
2016
 
2015
 
% Change
Earned premiums
 
$
288

 
$
272

 
6

 
$
571

 
$
540

 
6

Fee revenues
 
1

 
—

 
nm

 
2

 
1

 
100

Total revenues
 
289

 
272

 
6

 
573

 
541

 
6

Loss and loss expenses from:
 
 

 
 

 
 

 
 

 
 

 
 

Current accident year before catastrophe losses
 
180

 
179

 
1

 
360

 
358

 
1

Current accident year catastrophe losses
 
34

 
35

 
(3
)
 
45

 
50

 
(10
)
Prior accident years before catastrophe losses
 
9

 
2

 
350

 
(7
)
 
1

 
(800
)
Prior accident years catastrophe losses
 
1

 
—

 
nm

 
(1
)
 
(2
)
 
50

Loss and loss expenses
 
224

 
216

 
4

 
397

 
407

 
(2
)
Underwriting expenses
 
85

 
81

 
5

 
168

 
162

 
4

Underwriting profit (loss)
 
$
(20
)
 
$
(25
)
 
(20
)
 
$
8

 
$
(28
)
 
nm

 
 
 
 
 
 
 
 
 
 
 
 
 
Ratios as a percent of earned premiums:
 
 
 
 
 
Pt. Change
 
 
 
 
 
Pt. Change
Current accident year before catastrophe losses
 
62.5
%
 
65.9
 %
 
(3.4
)
 
63.0
 %
 
66.3
 %
 
(3.3
)
Current accident year catastrophe losses
 
12.1

 
12.8

 
(0.7
)
 
7.9

 
9.2

 
(1.3
)
Prior accident years before catastrophe losses
 
3.1

 
1.1

 
2.0

 
(1.2
)
 
0.2

 
(1.4
)
Prior accident years catastrophe losses
 
0.3

 
(0.2
)
 
0.5

 
(0.2
)
 
(0.4
)
 
0.2

Loss and loss expenses
 
78.0

 
79.6

 
(1.6
)
 
69.5

 
75.3

 
(5.8
)
Underwriting expenses
 
29.5

 
29.6

 
(0.1
)
 
29.4

 
30.0

 
(0.6
)
Combined ratio
 
107.5
%
 
109.2
 %
 
(1.7
)
 
98.9
 %
 
105.3
 %
 
(6.4
)
 
 
 
 
 
 
 
 
 
 
 
 
 
Combined ratio
 
107.5
%
 
109.2
 %
 
(1.7
)
 
98.9
 %
 
105.3
 %
 
(6.4
)
Contribution from catastrophe losses and prior
   years reserve development
 
15.5

 
13.7

 
1.8

 
6.5

 
9.0

 
(2.5
)
Combined ratio before catastrophe losses and
   prior years reserve development
 
92.0
%
 
95.5
 %
 
(3.5
)
 
92.4
 %
 
96.3
 %
 
(3.9
)
 
 
 
 
 
 
 
 
 
 
 
 
 

Overview
Performance highlights for the personal lines segment include:
•
Premiums – Personal lines earned premiums and net written premiums for the second quarter and first six months of 2016 continued to grow, primarily due to rising renewal written premiums. Price increases and a high level of policy retention contributed to premium growth. The table below analyzes the primary components of premiums.
Agency renewal written premiums increased 6 percent for both the second quarter and first six months of 2016, largely reflecting rate increases. We estimate that premium rates for our personal auto line of business increased at average percentages near the low end of the high-single-digit range during the first six months of 2016, with the second-quarter 2016 average increase higher than in the first quarter of 2016. For our homeowner line of business, we estimate that rate increases for the first six months of 2016 averaged a percentage in the mid-single-digit range. For both our personal auto and homeowner lines of business, some individual policies experienced lower or higher rate changes based on each risk's specific characteristics and enhanced pricing precision enabled by predictive models.
Personal lines new business written premiums grew 13 percent and 9 percent during the second quarter and first six months of 2016, compared with the same periods of 2015. Nearly all of that growth came from high net

Cincinnati Financial Corporation Second-Quarter 2016 10-Q
Page 44


worth clients of our agencies. First-half 2016 personal lines new business written premiums from high net worth policies totaled approximately $14 million.
Other written premiums include premiums ceded to reinsurers as part of our reinsurance ceded program. A decrease in ceded premiums contributed less than $1 million to net written premium growth for both the second quarter and first six months of 2016, compared with the same periods of 2015.
We continue to implement strategies discussed in our 2015 Annual Report on Form 10-K, Item 1, Strategic Initiatives, Page 12, to enhance our responsiveness to marketplace changes and to help achieve our long-term objectives for personal lines growth and profitability. These strategies include initiatives to more profitably underwrite personal auto policies.
 
Personal Lines Insurance Premiums
(Dollars in millions)
 
Three months ended June 30,
 
Six months ended June 30,
 
 
2016
 
2015
 
% Change
 
2016
 
2015
 
% Change
Agency renewal written premiums
 
$
302

 
$
285

 
6

 
$
538

 
$
508

 
6

Agency new business written premiums
 
34

 
30

 
13

 
59

 
54

 
9

Other written premiums
 
(6
)
 
(6
)
 
0

 
(11
)
 
(12
)
 
8

Net written premiums
 
330

 
309

 
7

 
586

 
550

 
7

Unearned premium change
 
(42
)
 
(37
)
 
(14
)
 
(15
)
 
(10
)
 
(50
)
Earned premiums
 
$
288

 
$
272

 
6

 
$
571

 
$
540

 
6

 
 
 
 
 
 
 
 
 
 
 
 
 
 
•
Combined ratio – Our personal lines combined ratio improved by 1.7 and 6.4 percentage points for the three and six months ended June 30, 2016, compared with the same periods of 2015, including 0.2 and 1.1 points from lower weather-related natural catastrophe losses and loss expenses.
In addition to the average rate increases discussed above, we continue to refine our pricing to better match premiums to the risk of loss on individual policies. The results of improved pricing precision and broad-based rate increases are expected to help position the combined ratio at a profitable level over the long term. In addition, greater geographic diversification is expected to reduce the volatility of homeowner loss ratios attributable to weather-related catastrophe losses over time.
Catastrophe losses and loss expenses accounted for 12.4 and 7.7 percentage points of the combined ratio for the three and six months ended June 30, 2016, compared with 12.6 and 8.8 percentage points for the same periods of 2015. The 10-year annual average catastrophe loss ratio through 2015 for the personal lines segment was 10.9 percentage points, and the five-year annual average was 11.4 percentage points.
Personal lines net reserve development on prior accident years netted to an unfavorable $10 million for the second quarter but a favorable $8 million for the first six months of 2016. In the first six months of 2016, our homeowner and other personal lines of business developed favorably, largely for accident year 2015, while our personal auto line of business developed unfavorably for several accident years prior to 2015. The six-month personal lines total reserve development was $7 million more favorable than the same period of 2015 and included a first-quarter 2016 refinement to reserves for loss expenses. The refinement transferred approximately $10 million of reserves for loss expenses, primarily for our personal auto line of business, to various lines of business in our commercial lines segment. For losses only, our six-month 2016 personal auto prior accident year net reserve development was unfavorable by $14 million. In the first six months of 2016, our personal lines segment net favorable reserve development was attributable primarily to accident year 2015. Reserve estimates are inherently uncertain as described in our 2015 Annual Report on Form 10-K, Item 7, Critical Accounting Estimates, Property Casualty Insurance Loss and Loss Expense Reserves, Page 46.
The underwriting expense ratio decreased 0.1 percentage points for the second quarter and 0.6 percentage points for first six months of 2016, compared with the same periods of 2015. The decreases reflect an unusually high ratio for the 2015 periods from changes in estimates related to allocations of deferred acquisition costs by segment. That effect also offset the effect of strategic investments that include enhancement of underwriting expertise.
 

Cincinnati Financial Corporation Second-Quarter 2016 10-Q
Page 45


Personal Lines Insurance Losses Incurred by Size
(Dollars in millions, net of reinsurance)
 
Three months ended June 30,
 
Six months ended June 30,
 
 
2016
 
2015
 
% Change
 
2016
 
2015
 
% Change
Current accident year losses greater than
   $5,000,000
 
$
—

 
$
—

 
nm

 
$
—

 
$
—

 
nm

Current accident year losses $1,000,000-
  $5,000,000
 
—

 
10

 
(100
)
 
6

 
22

 
(73
)
Large loss prior accident year reserve
   development
 
(2
)
 
—

 
nm

 
(1
)
 
—

 
nm

Total large losses incurred
 
(2
)
 
10

 
nm

 
5

 
22

 
(77
)
Losses incurred but not reported
 
23

 
14

 
64

 
34

 
21

 
62

Other losses excluding catastrophe losses
 
141

 
136

 
4

 
274

 
270

 
1

Catastrophe losses
 
35

 
34

 
3

 
43

 
47

 
(9
)
Total losses incurred
 
$
197

 
$
194

 
2

 
$
356

 
$
360

 
(1
)
 
 
 
 
 
 
 
 
 
 
 
 
 
Ratios as a percent of earned premiums:
 
 
 
 
 
Pt. Change
 
 
 
 
 
Pt. Change
Current accident year losses greater than
   $5,000,000
 
—
 %
 
—
%
 
0.0

 
—
 %
 
—
%
 
0.0

Current accident year losses $1,000,000-
  $5,000,000
 
—

 
3.5

 
(3.5
)
 
1.0

 
4.1

 
(3.1
)
Large loss prior accident year reserve
   development
 
(0.7
)
 
0.1

 
(0.8
)
 
(0.1
)
 
—

 
(0.1
)
Total large loss ratio
 
(0.7
)
 
3.6

 
(4.3
)
 
0.9

 
4.1

 
(3.2
)
Losses incurred but not reported
 
8.1

 
5.1

 
3.0

 
6.0

 
3.9

 
2.1

Other losses excluding catastrophe losses
 
48.9

 
50.0

 
(1.1
)
 
47.9

 
49.8

 
(1.9
)
Catastrophe losses
 
12.2

 
12.5

 
(0.3
)
 
7.6

 
8.7

 
(1.1
)
Total loss ratio
 
68.5
 %
 
71.2
%
 
(2.7
)
 
62.4
 %
 
66.5
%
 
(4.1
)
 
 
 
 
 
 
 
 
 
 
 
 
 

We continue to monitor new losses and case reserve increases greater than $1 million for trends in factors such as initial reserve levels, loss cost inflation and claim settlement expenses. Our analysis continues to indicate no unexpected concentration of these large losses and case reserve increases by risk category, geographic region, policy inception, agency or field marketing territory. In the second quarter of 2016, the personal lines total large loss ratio, net of reinsurance, was 4.3 percentage points lower than last year’s second quarter. The second-quarter 2016 amount of total large losses incurred helped contribute to the decrease in the six-month 2016 total large loss ratio, compared with 2015, in addition to a first-quarter 2016 ratio that was 2.1 points lower than the first quarter of 2015. We believe results for the three- and six-month periods largely reflected normal fluctuations in loss patterns and normal variability in large case reserves for claims above $1 million.
 

Cincinnati Financial Corporation Second-Quarter 2016 10-Q
Page 46


Personal Lines of Business Analysis
We prefer to write personal lines coverages on an account basis, including auto and homeowner coverages as well as coverages from the other personal business line. As a result, we believe that our personal lines business is best measured and evaluated on a segment basis. However, we provide line of business data to summarize premium and loss trends separately for each line. The ratios shown in the table below are components of loss and loss expenses as a percentage of earned premiums.
(Dollars in millions)
 
Three months ended June 30,
 
Six months ended June 30,
 
 
2016
 
2015
 
% Change
 
2016
 
2015
 
% Change
Personal auto:
 
 

 
 

 
 

 
 

 
 

 
 
Written premiums
 
$
154

 
$
142

 
8

 
$
277

 
$
256

 
8
Earned premiums
 
135

 
125

 
8

 
266

 
248

 
7
Current accident year before catastrophe losses
 
79.5
 %
 
79.7
 %
 
 

 
79.3
 %
 
80.8
 %
 
 
Current accident year catastrophe losses
 
1.9

 
2.3

 
 

 
1.4

 
1.2

 
 
Prior accident years before catastrophe losses
 
10.6

 
5.8

 
 

 
2.3

 
4.4

 
 
Prior accident years catastrophe losses
 
(0.1
)
 
(0.1
)
 
 

 
(0.2
)
 
(0.3
)
 
 
Total loss and loss expenses ratio
 
91.9
 %
 
87.7
 %
 
 

 
82.8
 %
 
86.1
 %
 
 
Homeowner:
 
 

 
 

 
 

 
 

 
 

 
 
Written premiums
 
$
140

 
$
132

 
6

 
$
243

 
$
230

 
6
Earned premiums
 
121

 
114

 
6

 
240

 
228

 
5
Current accident year before catastrophe losses
 
49.1
 %
 
52.9
 %
 
 

 
50.3
 %
 
54.1
 %
 
 
Current accident year catastrophe losses
 
25.4

 
25.6

 
 

 
16.0

 
19.0

 
 
Prior accident years before catastrophe losses
 
(0.8
)
 
(2.4
)
 
 

 
(3.0
)
 
(3.7
)
 
 
Prior accident years catastrophe losses
 
0.8

 
(0.3
)
 
 

 
(0.4
)
 
(0.7
)
 
 
Total loss and loss expenses ratio
 
74.5
 %
 
75.8
 %
 
 

 
62.9
 %
 
68.7
 %
 
 
Other personal:
 
 

 
 

 
 

 
 

 
 

 
 
Written premiums
 
$
36

 
$
35

 
3

 
$
66

 
$
64

 
3
Earned premiums
 
32

 
33

 
(3
)
 
65

 
64

 
2
Current accident year before catastrophe losses
 
42.0
 %
 
58.2
 %
 
 

 
43.1
 %
 
53.9
 %
 
 
Current accident year catastrophe losses
 
4.7

 
8.4

 
 

 
5.2

 
5.6

 
 
Prior accident years before catastrophe losses
 
(13.5
)
 
(4.9
)
 
 

 
(9.0
)
 
(1.9
)
 
 
Prior accident years catastrophe losses
 
0.0

 
0.0

 
 

 
0.1

 
(0.4
)
 
 
Total loss and loss expenses ratio
 
33.2
 %
 
61.7
 %
 
 

 
39.4
 %
 
57.2
 %
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
As discussed above, the loss and loss expenses ratio component of the combined ratio is an important measure of underwriting profit and performance. Catastrophe losses are volatile and can distort short-term profitability trends, particularly for certain lines of business. Development of loss and loss expense reserves on prior accident years can also distort trends in measures of profitability for recently written business. To illustrate these effects, we separate their impact on the ratios shown in the table above. For the six months ended June 30, 2016, the line of business in our personal lines insurance segment with the most significant profitability challenge was personal auto. During the first six months of 2016, premium rate increases that allow for more pricing precision on our personal auto policies continued to be implemented at average percentages near the low end of the high-single-digit range. We continue to work toward greater pricing precision in addition to broad-based rate increases to help improve profitability over the long term. 
 


Cincinnati Financial Corporation Second-Quarter 2016 10-Q
Page 47


EXCESS AND SURPLUS LINES INSURANCE RESULTS
(Dollars in millions)
 
Three months ended June 30,
 
Six months ended June 30,
 
 
2016
 
2015
 
% Change
 
2016
 
2015
 
% Change
Earned premiums
 
$
45

 
$
42

 
7

 
$
88

 
$
82

 
7

Fee revenues
 
—

 
1

 
(100
)
 
—

 
1

 
(100
)
Total revenues
 
45

 
43

 
5

 
88

 
83

 
6

Loss and loss expenses from:
 
 

 
 

 
 

 
 

 
 

 
 

Current accident year before catastrophe losses
 
26

 
29

 
(10
)
 
53

 
58

 
(9
)
Current accident year catastrophe losses
 
2

 
1

 
100

 
2

 
1

 
100

Prior accident years before catastrophe losses
 
(1
)
 
(9
)
 
89

 
(15
)
 
(14
)
 
(7
)
Prior accident years catastrophe losses
 
—

 
—

 
nm

 
—

 
—

 
nm

Loss and loss expenses
 
27

 
21

 
29

 
40

 
45

 
(11
)
Underwriting expenses
 
13

 
11

 
18

 
26

 
23

 
13

Underwriting profit
 
$
5

 
$
11

 
(55
)
 
$
22

 
$
15

 
47

 
 
 
 
 
 
 
 
 
 
 
 
 
Ratios as a percent of earned premiums:
 
 
 
 
 
Pt. Change
 
 
 
 
 
Pt. Change
Current accident year before catastrophe losses
 
56.7
 %
 
69.3
 %
 
(12.6
)
 
59.8
 %
 
70.7
 %
 
(10.9
)
Current accident year catastrophe losses
 
3.2

 
0.6

 
2.6

 
1.9

 
0.9

 
1.0

Prior accident years before catastrophe losses
 
(1.9
)
 
(20.2
)
 
18.3

 
(16.4
)
 
(17.0
)
 
0.6

Prior accident years catastrophe losses
 
0.0

 
(0.1
)
 
0.1

 
(0.1
)
 
(0.2
)
 
0.1

Loss and loss expenses
 
58.0

 
49.6

 
8.4

 
45.2

 
54.4

 
(9.2
)
Underwriting expenses
 
29.4

 
26.4

 
3.0

 
29.4

 
27.7

 
1.7

Combined ratio
 
87.4
 %
 
76.0
 %
 
11.4

 
74.6
 %
 
82.1
 %
 
(7.5
)
 
 
 
 
 
 
 
 
 
 
 
 
 
Combined ratio
 
87.4
 %
 
76.0
 %
 
11.4

 
74.6
 %
 
82.1
 %
 
(7.5
)
Contribution from catastrophe losses and prior
   years reserve development
 
1.3

 
(19.7
)
 
21.0

 
(14.6
)
 
(16.3
)
 
1.7

Combined ratio before catastrophe losses and
   prior years reserve development
 
86.1
 %
 
95.7
 %
 
(9.6
)
 
89.2
 %
 
98.4
 %
 
(9.2
)
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 Overview
Performance highlights for the excess and surplus lines segment include:
•
Premiums – Excess and surplus lines net written premiums continued to grow during the second quarter and first six months of 2016. Growth in renewal written premiums was the main contributor to the increase.
Renewal written premiums rose 9 percent and 11 percent for the three and six months ended June 30, 2016, compared with the same periods of 2015, reflecting the opportunity to renew many accounts for the first time, as well as higher renewal pricing. June 2016 marked the 70th consecutive month of positive average price changes for the excess and surplus lines segment of our property casualty business. For the second quarter and the first half of 2016, excess and surplus lines policy renewals experienced estimated average percentage price increases near the high end of the low-single-digit range. We measure average changes in excess and surplus lines renewal pricing as the percentage rate of change in renewal premium for the new policy period compared with the premium for the expiring policy period, assuming no change in the level of insured exposures or policy coverage between those periods for respective policies.
New business written premiums produced by agencies rose modestly, by $1 million, for both for the second quarter and first six months of 2016, compared with the same periods of 2015, reflecting careful underwriting in a highly competitive market. Some of what we report as new business came from accounts that were not new to our agents. We believe our agents’ seasoned accounts tend to be priced more accurately than business that may be less familiar to them.
 

Cincinnati Financial Corporation Second-Quarter 2016 10-Q
Page 48


Excess and Surplus Lines Insurance Premiums
(Dollars in millions)
 
Three months ended June 30,
 
Six months ended June 30,
 
 
2016
 
2015
 
% Change
 
2016
 
2015
 
% Change
Agency renewal written premiums
 
$
37

 
$
34

 
9

 
$
71

 
$
64

 
11

Agency new business written premiums
 
16

 
15

 
7

 
29

 
28

 
4

Other written premiums
 
(2
)
 
(3
)
 
33

 
(4
)
 
(4
)
 
0

Net written premiums
 
51

 
46

 
11

 
96

 
88

 
9

Unearned premium change
 
(6
)
 
(4
)
 
(50
)
 
(8
)
 
(6
)
 
(33
)
Earned premiums
 
$
45

 
$
42

 
7

 
$
88

 
$
82

 
7

 
 
 
 
 
 
 
 
 
 
 
 
 
 
•
Combined ratio – The excess and surplus lines combined ratio rose 11.4 percentage points for the second quarter 2016, compared with the same period of 2015, as a lower ratio for current accident year losses and loss expenses before catastrophe losses was offset by less favorable reserve development on prior accident years before catastrophe losses. For the first six months of 2016, the combined ratio improved by 7.5 percentage points, compared with the first six months of 2015, driven by lower ratios for current accident year losses and loss expenses before catastrophe losses.
Catastrophe losses and loss expenses accounted for 3.2 and 1.8 percentage points of the combined ratio for the three and six months ended June 30, 2016, compared with 0.5 and 0.7 percentage points for the same periods of 2015.
Excess and surplus lines net favorable reserve development on prior accident years as a ratio to earned premiums was 1.9 percent and 16.5 percent for the second quarter and first six months of 2016, compared with 20.3 percent and 17.2 percent for the same periods of 2015. The net favorable reserve development recognized during the first six months of 2016 was distributed almost evenly among accident years 2015, 2014 and 2013. It was due primarily to lower-than-anticipated loss emergence on known claims. Reserve estimates are inherently uncertain as described in our 2015 Annual Report on Form 10-K, Item 7, Critical Accounting Estimates, Property Casualty Insurance Loss and Loss Expense Reserves, Page 46.
The underwriting expense ratio for the second quarter and first six months of 2016 increased, compared with the same periods of 2015. Strategic investments that include enhancement of underwriting expertise offset the favorable effects of higher earned premiums and ongoing expense management efforts.
 

Cincinnati Financial Corporation Second-Quarter 2016 10-Q
Page 49


Excess and Surplus Lines Insurance Losses Incurred by Size
(Dollars in millions, net of reinsurance)
 
Three months ended June 30,
 
Six months ended June 30,
 
 
2016
 
2015
 
% Change
 
2016
 
2015
 
% Change
Current accident year losses greater than
   $5,000,000
 
$
—

 
$
—

 
nm

 
$
—

 
$
—

 
nm

Current accident year losses $1,000,000-
  $5,000,000
 
1

 
—

 
nm

 
1

 
1

 
0

Large loss prior accident year reserve
   development
 
1

 
—

 
nm

 
1

 
—

 
nm

Total large losses incurred
 
2

 
—

 
nm

 
2

 
1

 
100

Losses incurred but not reported
 
9

 
7

 
29

 
7

 
12

 
(42
)
Other losses excluding catastrophe losses
 
5

 
7

 
(29
)
 
14

 
19

 
(26
)
Catastrophe losses
 
2

 
1

 
100

 
2

 
1

 
100

Total losses incurred
 
$
18

 
$
15

 
20

 
$
25

 
$
33

 
(24
)
 
 
 
 
 
 
 
 
 
 
 
 
 
Ratios as a percent of earned premiums:
 
 
 
 
 
Pt. Change
 
 
 
 
 
Pt. Change
Current accident year losses greater than
   $5,000,000
 
—
%
 
—
%
 
0.0

 
—
%
 
—
%
 
0.0

Current accident year losses $1,000,000-
  $5,000,000
 
2.2

 
—

 
2.2

 
1.1

 
1.2

 
(0.1
)
Large loss prior accident year reserve
   development
 
1.7

 
—

 
1.7

 
0.7

 
—

 
0.7

Total large loss ratio
 
3.9

 
—

 
3.9

 
1.8

 
1.2

 
0.6

Losses incurred but not reported
 
20.3

 
18.3

 
2.0

 
7.8

 
15.1

 
(7.3
)
Other losses excluding catastrophe losses
 
12.7

 
17.5

 
(4.8
)
 
16.6

 
23.5

 
(6.9
)
Catastrophe losses
 
3.1

 
0.4

 
2.7

 
1.7

 
0.6

 
1.1

Total loss ratio
 
40.0
%
 
36.2
%
 
3.8

 
27.9
%
 
40.4
%
 
(12.5
)
 
 
 
 
 
 
 
 
 
 
 
 
 
 
We continue to monitor new losses and case reserve increases greater than $1 million for trends in factors such as initial reserve levels, loss cost inflation and claim settlement expenses. Our analysis continues to indicate no unexpected concentration of these large losses and case reserve increases by risk category, geographic region, policy inception, agency or field marketing territory. In the second quarter of 2016, the excess and surplus lines total ratio for large losses, net of reinsurance, was 3.9 percentage points higher compared with last year’s second quarter. The second-quarter 2016 amount of total large losses incurred helped contribute to the increase in the six-month 2016 total large loss ratio, compared with 2015, offsetting a first-quarter 2016 ratio that was 2.9 points lower than the first quarter of 2015. We believe results for the three- and six-month periods largely reflected normal fluctuations in loss patterns and normal variability in large case reserves for claims above $1 million.
 


Cincinnati Financial Corporation Second-Quarter 2016 10-Q
Page 50


LIFE INSURANCE RESULTS
(Dollars in millions)
 
Three months ended June 30,
 
Six months ended June 30,
 
 
2016
 
2015
 
% Change
 
2016
 
2015
 
% Change
Earned premiums
 
$
59

 
$
52

 
13
 
$
117

 
$
105

 
11

Separate account investment management fees
 
1

 
1

 
0
 
2

 
2

 
0

Total revenues
 
60

 
53

 
13
 
119

 
107

 
11

Contract holders' benefits incurred
 
62

 
58

 
7
 
125

 
118

 
6

Investment interest credited to contract holders'
 
(22
)
 
(22
)
 
0
 
(44
)
 
(43
)
 
(2
)
Underwriting expenses incurred
 
19

 
16

 
19
 
38

 
34

 
12

Total benefits and expenses
 
59

 
52

 
13
 
119

 
109

 
9

Life insurance segment income (loss)
 
$
1

 
$
1

 
0
 
$
—

 
$
(2
)
 
100

 
 
 
 
 
 
 
 
 
 
 
 
 
 
Overview
Performance highlights for the life insurance segment include:
•
Revenues – Revenues increased for the six months ended June 30, 2016, primarily due to higher earned premiums from term insurance products.
Net in-force life insurance policy face amounts increased to $54.664 billion at June 30, 2016, from $52.735 billion at year-end 2015.
Fixed annuity deposits received for the three and six months ended June 30, 2016, were $14 million and $26 million compared with $9 million and $17 million for same periods of 2015. Fixed annuity deposits have a minimal impact to earned premiums because deposits received are initially recorded as liabilities. Profit is earned over time by way of interest-rate spreads. We do not write variable or equity-indexed annuities.
 
Life Insurance Premiums
(Dollars in millions)
 
Three months ended June 30,
 
Six months ended June 30,

 
2016
 
2015
 
% Change
 
2016
 
2015
 
% Change
Term life insurance
 
$
38

 
$
35

 
9
 
$
75

 
$
69

 
9
Universal life insurance
 
10

 
9

 
11
 
21

 
19

 
11
Other life insurance, annuity and disability
   income products
 
11

 
8

 
38
 
21

 
17

 
24
Net earned premiums
 
$
59

 
$
52

 
13
 
$
117

 
$
105

 
11
 
 
 
 
 
 
 
 
 
 
 
 
 
 
•
Profitability – Our life insurance segment typically reports a small profit or loss on a GAAP basis because profits from investment income spreads are included in our investment segment results. We include only investment income credited to contract holders (including interest assumed in life insurance policy reserve calculations) in our life insurance segment results. A gain of less than $1 million for our life insurance segment in the first six months of 2016, compared with a loss of $2 million for the same period of 2015, was largely due to increased premium revenues in 2016.
Life insurance segment benefits and expenses consist principally of contract holders’ (policyholders’) benefits incurred related to traditional life and interest-sensitive products and operating expenses incurred, net of deferred acquisition costs. Total benefits increased in the first six months of 2016. Mortality results increased from the same period of 2015 but were slightly less than our 2016 projections.
Operating expenses for the first six months of 2016 increased compared with the same period a year ago. For the first six months of 2016, unlocking of interest rate and other actuarial assumptions decreased the amount of expenses deferred to future periods, increasing operating expenses. For the first six months of 2015, unlocking increased the amount of expenses deferred to future periods, decreasing operating expenses.
Pretax earnings for the first six months of 2016, and for the comparable period of 2015, were reduced by less than $1 million due to unlocking of interest rates and other actuarial assumptions.
We recognize that assets under management, capital appreciation and investment income are integral to evaluating the success of the life insurance segment because of the long duration of life products. On a

Cincinnati Financial Corporation Second-Quarter 2016 10-Q
Page 51


basis that includes investment income and realized gains or losses from life-insurance-related invested assets, the life insurance company reported a net profit of $12 million and $22 million in the three and six months ended June 30, 2016, compared with a net profit of $11 million and $20 million for the same periods of 2015. The life insurance company portfolio had net after-tax realized investment gains of less than $1 million and $1 million for the three and six months ended June 30, 2016, compared with $1 million and $2 million for the three and six months ended June 30, 2015.

INVESTMENTS RESULTS
 
Overview
The investments segment contributes investment income and realized gains and losses to results of operations. Investments traditionally are our primary source of pretax and after-tax profits.
 
Investment Income
Pretax investment income increased 6 percent and 5 percent for the three and six months ended June 30, 2016, compared with the same periods of 2015. Interest income rose due to net purchases of fixed-maturity securities that offset the continuing effects of the low interest rate environment. Higher dividend income reflected rising dividend rates and net purchases of equity securities.

Investments Results
(Dollars in millions)
 
Three months ended June 30,
 
Six months ended June 30,

 
2016
 
2015
 
% Change
 
2016
 
2015
 
% Change
Total investment income, net of expenses
 
$
149

 
$
140

 
6

 
$
294

 
$
279

 
5

Investment interest credited to contract holders'
 
(22
)
 
(22
)
 
0

 
(44
)
 
(43
)
 
(2
)
Realized investment gains, net
 
44

 
60

 
(27
)
 
105

 
107

 
(2
)
Investments profit, pretax
 
$
171

 
$
178

 
(4
)
 
$
355

 
$
343

 
3

 
 
 
 
 
 
 
 
 
 
 
 
 

We continue to position our portfolio considering both the challenges presented by the current low interest rate environment and the risks presented by potential future inflation. As bonds in our generally laddered portfolio mature or are called over the near term, we will be challenged to replace their current yield. The table below shows the average pretax yield-to-amortized cost associated with expected principal redemptions for our fixed-maturity portfolio. The expected principal redemptions are based on par amounts and include dated maturities, calls and prefunded municipal bonds that we expect will be called during each respective time period.
(Dollars in millions)
 
 
 
At June 30, 2016
% Yield
 
Principal redemptions
Fixed-maturity pretax yield profile:
 
 
 
Expected to mature during the remainder of 2016
4.23
%
 
$
294

Expected to mature during 2017
4.79

 
645

Expected to mature during 2018
5.77

 
1,011

Average yield and total expected redemptions from the remainder of 2016 through 2018
5.22

 
$
1,950

 
 
 
 


Cincinnati Financial Corporation Second-Quarter 2016 10-Q
Page 52


The table below shows the average pretax yield-to-amortized cost for fixed-maturity securities acquired during the periods indicated. The average yield of 4.65 percent for the first six months of 2016 was lower than the 4.70 percent average yield-to-amortized cost of the fixed-maturity securities portfolio at the end of 2015.
 
Three months ended June 30,
 
Six months ended June 30,
 
2016
 
2015
 
2016
 
2015
Average pretax yield-to-amortized cost on new
   fixed-maturities:
 
 
 
 
 
 
 
Acquired taxable fixed-maturities
4.30
%
 
4.48
%
 
4.50
%
 
4.42
%
Acquired tax-exempt fixed-maturities
2.96

 
3.43

 
3.01

 
3.34

Average total fixed-maturities acquired
4.03

 
3.93

 
4.08

 
3.90

 
 
 
 
 
 
 
 

While our bond portfolio more than covers our insurance reserve liabilities, we believe our diversified common stock portfolio of mainly blue chip, dividend-paying companies represents one of our best investment opportunities for the long term. In our 2015 Annual Report on Form 10-K, Item 1, Investments Segment, Page 21, and Item 7, Investments Outlook, Page 88, we discussed our portfolio strategies. We discuss risks related to our investment income and our fixed-maturity and equity investment portfolios in this quarterly report Item 3, Quantitative and Qualitative Disclosures About Market Risk.

The table below provides details about investment income. Average yields in this table are based on the average invested asset and cash amounts indicated in the table, using fixed-maturity securities valued at amortized cost and all other securities at fair value.
(Dollars in millions)
 
Three months ended June 30,
 
Six months ended June 30,
 
 
2016
 
2015
 
% Change
 
2016
 
2015
 
% Change
Investment income:
 
 

 
 

 
 
 
 

 
 

 
 
Interest
 
$
110

 
$
106

 
4
 
$
219

 
$
211

 
4
Dividends
 
41

 
35

 
17
 
78

 
71

 
10
Other
 
—

 
1

 
nm
 
1

 
1

 
0
Less investment expenses
 
2

 
2

 
0
 
4

 
4

 
0
Investment income, pretax
 
149

 
140

 
6
 
294

 
279

 
5
Less income taxes
 
35

 
33

 
6
 
70

 
66

 
6
Total investment income, after-tax
 
$
114

 
$
107

 
7
 
$
224

 
$
213

 
5
 
 
 
 
 
 
 
 
 
 
 
 
 
Investment returns:
 
 
 
 
 
 
 
 
 
 
 
 
Effective tax rate
 
23.9
%
 
23.9
%
 
 
 
23.8
%
 
23.7
%
 
 
Average invested assets plus cash and cash
   equivalents
 
$
15,223

 
$
14,534

 
 
 
$
15,014

 
$
14,488

 
 
Average yield pretax
 
3.92
%
 
3.85
%
 
 
 
3.92
%
 
3.85
%
 
 
Average yield after-tax
 
3.00

 
2.94

 
 
 
2.98

 
2.94

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Fixed-maturity returns:
 
 
 
 
 
 
 
 
 
 
 
 
Effective tax rate
 
27.3
%
 
27.2
%
 
 
 
27.3
%
 
27.1
%
 
 
Average amortized cost
 
$
9,480

 
$
9,143

 
 
 
$
9,421

 
$
9,085

 
 
Average yield pretax
 
4.64
%
 
4.64
%
 
 
 
4.65
%
 
4.65
%
 
 
Average yield after-tax
 
3.38

 
3.38

 
 
 
3.38

 
3.39

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 

Cincinnati Financial Corporation Second-Quarter 2016 10-Q
Page 53


Net Realized Gains and Losses
We reported net realized investment gains of $44 million and $105 million for the three and six months ended June 30, 2016, compared with $60 million and $107 million for the same periods of 2015. The total net realized investment gains for the first six months of 2016 included $99 million in net gains from sales of various common and preferred stock holdings, matching the same period of 2015.
 
Investment gains or losses are recognized upon the sales of investments or as otherwise required under GAAP. The timing of realized gains or losses from sales can have a material effect on results in any quarter. However, such gains or losses usually have little, if any, effect on total shareholders’ equity because most equity and fixed-maturity investments are carried at fair value, with the unrealized gain or loss included as a component of accumulated other comprehensive income (AOCI). Accounting requirements for other-than-temporary impairment (OTTI) charges for the fixed-maturity portfolio are disclosed in our 2015 Annual Report on Form 10-K, Item 8, Note 1, Summary of Significant Accounting Policies, Page 123.
 
Of the 3,211 securities in the portfolio, no fixed-maturity or equity securities were trading below 70 percent of amortized cost at June 30, 2016. Our asset impairment committee regularly monitors the portfolio, including a quarterly review of the entire portfolio for potential OTTI charges. We believe that if the improving liquidity in the markets were to reverse or the economic recovery were to significantly stall, we could experience declines in portfolio values and possibly additional OTTI charges.
 
The table below provides additional detail for OTTI charges:
(Dollars in millions)
 
Three months ended June 30,
 
Six months ended June 30,
 
 
2016
 
2015
 
2016
 
2015
Fixed maturities:
 
 

 
 

 
 

 
 

Utilities
 
$
—

 
$
—

 
$
2

 
$
—

Basic industry
 
—

 
3

 
$
—

 
3

Total fixed maturities
 
—

 
3

 
2

 
3

Common equities:
 
 

 
 

 
 

 
 

Financial
 
—

 
1

 
—

 
1

Total common equities
 
—

 
1

 
—

 
1

Total
 
$
—

 
$
4

 
$
2

 
$
4

 
 
 
 
 
 
 
 
 
 

OTHER
We report as Other the noninvestment operations of the parent company and a noninsurance subsidiary, CFC Investment Company. We also report as Other the underwriting results of Cincinnati Re, our reinsurance assumed operation, including earned premiums, loss and loss expenses and underwriting expenses.

Total revenues for the first six months of 2016 for our Other operations increased, compared with the same period of 2015, primarily due to earned premiums from Cincinnati Re. Total expenses for Other also increased for the first six months of 2016, primarily due to losses and loss expenses and underwriting expenses from Cincinnati Re.

Other loss in the table below represents losses before income taxes. The net result of Cincinnati Re for the first six months of 2016 was a small underwriting loss of less than $1 million. For both periods shown, Other loss resulted largely from interest expense from debt of the parent company.

Cincinnati Financial Corporation Second-Quarter 2016 10-Q
Page 54


(Dollars in millions)
 
Three months ended June 30,
 
Six months ended June 30,
 
 
2016
 
2015
 
% Change
 
2016
 
2015
 
% Change
Interest and fees on loans and leases
 
$
1

 
$
1

 
0

 
$
2

 
$
3

 
(33
)
Earned premiums
 
10

 
—

 
nm

 
20

 
—

 
nm

Other revenues
 
1

 
1

 
0

 
1

 
1

 
0

Total revenues
 
12

 
2

 
500

 
23

 
4

 
475

Interest expense
 
13

 
13

 
0

 
26

 
26

 
0

Loss and loss expenses
 
8

 
—

 
nm

 
14

 
—

 
nm

Underwriting expenses
 
3

 
—

 
nm

 
6

 
—

 
nm

Operating expenses
 
5

 
3

 
67

 
7

 
7

 
0

Total expenses
 
29

 
16

 
81

 
53

 
33

 
61

Other loss
 
$
(17
)
 
$
(14
)
 
(21
)
 
$
(30
)
 
$
(29
)
 
3

 
 
 
 
 
 
 
 
 
 
 
 
 
 

TAXES
We had $43 million and $120 million of income tax expense for the three and six months ended June 30, 2016, compared with $72 million and $118 million for the same periods of 2015. The effective tax rates for the three and six months ended June 30, 2016, were 25.9 percent and 27.8 percent compared with 29.0 percent and 28.0 percent for the same periods last year. The change in our effective tax rate was primarily due to changes in pretax income from underwriting results and realized investment gains and losses, with immaterial changes in the amount of permanent book-tax differences.
 
Historically, we have pursued a strategy of investing some portion of cash flow in tax-advantaged fixed-maturity and equity securities to minimize our overall tax liability and maximize after-tax earnings. See Tax-Exempt Fixed Maturities in this quarterly report Item 3, Quantitative and Qualitative Disclosures About Market Risk for further discussion on municipal bond purchases in our fixed-maturity investment portfolio. For our property casualty insurance subsidiaries, approximately 85 percent of interest from tax-advantaged fixed-maturity investments and approximately 60 percent of dividends from qualified equities are exempt from federal tax after applying proration from the 1986 Tax Reform Act. Our noninsurance companies own an immaterial amount of tax-advantaged fixed-maturity investments. For our noninsurance companies, the dividend received deduction exempts 70 percent of dividends from qualified equities. Our life insurance company does not own tax-advantaged fixed-maturity investments or equities subject to the dividend received deduction. Details about our effective tax rate are in this quarterly report Item 1, Note 9 – Income Taxes. 

LIQUIDITY AND CAPITAL RESOURCES
At June 30, 2016, shareholders’ equity was $6.971 billion compared with $6.427 billion at December 31, 2015. Total debt was $814 million at June 30, 2016, $7 million less than at December 31, 2015. At June 30, 2016, cash and cash equivalents totaled $547 million compared with $544 million at December 31, 2015.

SOURCES OF LIQUIDITY
 
Subsidiary Dividends
Our lead insurance subsidiary declared dividends of $200 million to the parent company in the first six months of 2016, matching the same period of 2015. For full-year 2015, subsidiary dividends declared totaled $447 million. State of Ohio regulatory requirements restrict the dividends our insurance subsidiary can pay. For full-year 2016, total dividends that our insurance subsidiary could pay to our parent company without regulatory approval are approximately $534 million.
 

Cincinnati Financial Corporation Second-Quarter 2016 10-Q
Page 55


Investing Activities
Investment income is a source of liquidity for both the parent company and its insurance subsidiary. We continue to focus on portfolio strategies to balance near-term income generation and long-term book value growth.
 
Parent company obligations can be funded with income on investments held at the parent-company level or through sales of securities in that portfolio, although our investment philosophy seeks to compound cash flows over the long term. These sources of capital can help minimize subsidiary dividends to the parent company, protecting insurance subsidiary capital.

See our 2015 Annual Report on Form 10-K, Item 1, Investments Segment, Page 21, for a discussion of our historic investment strategy, portfolio allocation and quality.
 
Insurance Underwriting
Our property casualty and life insurance underwriting operations provide liquidity because we generally receive premiums before paying losses under the policies purchased with those premiums. After satisfying our cash requirements, we use excess cash flows for investment, increasing future investment income.
 
Historically, cash receipts from property casualty and life insurance premiums, along with investment income, have been more than sufficient to pay claims, operating expenses and dividends to the parent company.
 
The table below shows a summary of operating cash flow for property casualty insurance (direct method):
(Dollars in millions)
 
Three months ended June 30,
 
Six months ended June 30,
 
 
2016
 
2015
 
% Change
 
2016
 
2015
 
% Change
Premiums collected
 
$
1,185

 
$
1,119

 
6

 
$
2,349

 
$
2,206

 
6

Loss and loss expenses paid
 
(629
)
 
(598
)
 
(5
)
 
(1,191
)
 
(1,144
)
 
(4
)
Commissions and other underwriting expenses
   paid
 
(321
)
 
(302
)
 
(6
)
 
(763
)
 
(715
)
 
(7
)
Cash flow from underwriting
 
235

 
219

 
7

 
395

 
347

 
14

Investment income received
 
96

 
94

 
2

 
198

 
189

 
5

Cash flow from operations
 
$
331

 
$
313

 
6

 
$
593

 
$
536

 
11

 
 
 
 
 
 
 
 
 
 
 
 
 
 
Collected premiums for property casualty insurance rose $143 million during the first six months of 2016, compared with the same period in 2015. Loss and loss expenses paid increased $47 million, including a $22 million increase for catastrophe losses and loss expenses. Commissions and other underwriting expenses paid rose $48 million, primarily due to higher commissions paid to agencies, reflecting the increase in collected premiums.
 
We discuss our future obligations for claims payments and for underwriting expenses in our 2015 Annual Report on Form 10-K, Item 7, Contractual Obligations, Page 93, and Other Commitments also on Page 93.
 
Capital Resources
At June 30, 2016, our debt-to-total-capital ratio was 10.5 percent, with $786 million in long-term debt and $28 million in borrowing on our revolving short-term line of credit. That line of credit had a $35 million balance at December 31, 2015. At June 30, 2016, $197 million was available for future cash management needs. Based on our capital requirements at June 30, 2016, we do not anticipate a material increase in debt levels during the remainder of 2016. As a result, we expect changes in our debt-to-total-capital ratio to continue to be largely a function of the contribution of unrealized investment gains or losses to shareholders’ equity.
 
We provide details of our three, long-term notes in this quarterly report Item 1, Note 3 – Fair Value Measurements. None of the notes are encumbered by rating triggers.
 
Four independent ratings firms award insurer financial strength ratings to our property casualty insurance companies and three firms rate our life insurance company. Those firms made no changes to our parent company debt ratings during the first six months of 2016. Our debt ratings are discussed in our 2015 Annual Report on Form 10-K, Item 7, Liquidity and Capital Resources, Other Sources of Liquidity, Page 91.
 

Cincinnati Financial Corporation Second-Quarter 2016 10-Q
Page 56


Off-Balance Sheet Arrangements
We do not use any special-purpose financing vehicles or have any undisclosed off-balance sheet arrangements (as that term is defined in applicable SEC rules) that are reasonably likely to have a current or future material effect on the company’s financial condition, results of operation, liquidity, capital expenditures or capital resources. Similarly, the company holds no fair-value contracts for which a lack of marketplace quotations would necessitate the use of fair-value techniques.
 
USES OF LIQUIDITY
Our parent company and insurance subsidiary have contractual obligations and other commitments. In addition, one of our primary uses of cash is to enhance shareholder return.
 
Contractual Obligations
In our 2015 Annual Report on Form 10-K, Item 7, Contractual Obligations, Page 93 we estimated our future contractual obligations as of December 31, 2015. There have been no material changes to our estimates of future contractual obligations since our 2015 Annual Report on Form 10-K.

Other Commitments
In addition to our contractual obligations, we have other property casualty operational commitments.
•
Commissions – Commissions paid were $484 million in the first six months of 2016. Commission payments generally track with written premiums, except for annual profit-sharing commissions typically paid during the first quarter of the year.
•
Other underwriting expenses – Many of our underwriting expenses are not contractual obligations, but reflect the ongoing expenses of our business. Noncommission underwriting expenses paid were $279 million in the first six months of 2016.
•
Technology costs – In addition to contractual obligations for hardware and software, we anticipate capitalizing up to $6 million in spending for key technology initiatives in 2016. Capitalized development costs related to key technology initiatives were $4 million in the first six months of 2016. These activities are conducted at our discretion, and we have no material contractual obligations for activities planned as part of these projects.

We contributed $5 million to our qualified pension plan during the first six months of 2016. We also contributed $8 million to our qualified pension plan during the third quarter of 2016 and do not anticipate further contributions during the remainder of 2016.
 
Investing Activities
After fulfilling operating requirements, we invest cash flows from underwriting, investment and other corporate activities in fixed-maturity and equity securities on an ongoing basis to help achieve our portfolio objectives. We discuss our investment strategy and certain portfolio attributes in this quarterly report Item 3, Quantitative and Qualitative Disclosures About Market Risk.
 
Uses of Capital
Uses of cash to enhance shareholder return include dividends to shareholders. In January and May 2016, the board of directors declared a regular quarterly cash dividend of 48 cents per share for an indicated annual rate of $1.92 per share. During the first six months of 2016, we used $151 million to pay cash dividends to shareholders.


PROPERTY CASUALTY INSURANCE RESERVES
For the business lines in the commercial and personal lines insurance segments, and in total for the excess and surplus lines segment, the following table details gross reserves among case, IBNR (incurred but not reported) and loss expense reserves, net of salvage and subrogation reserves. Reserving practices are discussed in our 2015 Annual Report on Form 10-K, Item 7, Property Casualty Insurance Loss and Loss Expense Obligations and Reserves, Page 94.
 
Total gross reserves at June 30, 2016, increased $258 million compared with December 31, 2015. Case reserves for losses increased $125 million, IBNR reserves increased by $129 million and total loss expense reserves

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Page 57


increased by $4 million. Accounting for most of the total gross increase was the aggregate of our commercial property, commercial casualty and commercial auto lines of business.

Property Casualty Gross Reserves
(Dollars in millions)
 
Loss reserves
 
Loss
 
Total
 
 
 
 
Case
 
IBNR
 
expense
 
gross
 
Percent
At June 30, 2016
 
reserves
 
reserves
 
reserves
 
reserves
 
of total
Commercial lines insurance:
 
 

 
 

 
 

 
 

 
 

Commercial casualty
 
$
933

 
$
499

 
$
540

 
$
1,972

 
40.1
%
Commercial property
 
289

 
19

 
53

 
361

 
7.3

Commercial auto
 
346

 
97

 
96

 
539

 
11.0

Workers' compensation
 
379

 
559

 
92

 
1,030

 
20.9

Other commercial
 
122

 
17

 
80

 
219

 
4.5

Subtotal
 
2,069

 
1,191

 
861

 
4,121

 
83.8

Personal lines insurance:
 
 

 
 

 
 

 
 

 
 

Personal auto
 
211

 
20

 
62

 
293

 
6.0

Homeowner
 
84

 
25

 
26

 
135

 
2.7

Other personal
 
47

 
48

 
5

 
100

 
2.0

Subtotal
 
342

 
93

 
93

 
528

 
10.7

Excess and surplus lines
 
92

 
87

 
61

 
240

 
4.9

Cincinnati Re
 
3

 
26

 
—

 
29

 
0.6

Total
 
$
2,506

 
$
1,397

 
$
1,015

 
$
4,918

 
100.0
%
At December 31, 2015
 
 

 
 

 
 

 
 

 
 

Commercial lines insurance:
 
 

 
 

 
 

 
 

 
 

Commercial casualty
 
$
897

 
$
462

 
$
542

 
$
1,901

 
40.8
%
Commercial property
 
192

 
28

 
42

 
262

 
5.6

Commercial auto
 
330

 
66

 
89

 
485

 
10.4

Workers' compensation
 
389

 
549

 
91

 
1,029

 
22.1

Other commercial
 
139

 
17

 
92

 
248

 
5.3

Subtotal
 
1,947

 
1,122

 
856

 
3,925

 
84.2

Personal lines insurance:
 
 

 
 

 
 

 
 

 
 

Personal auto
 
211

 
(7
)
 
69

 
273

 
5.9

Homeowner
 
80

 
13

 
25

 
118

 
2.5

Other personal
 
52

 
50

 
5

 
107

 
2.3

Subtotal
 
343

 
56

 
99

 
498

 
10.7

Excess and surplus lines
 
91

 
80

 
56

 
227

 
4.9

Cincinnati Re
 
—

 
10

 
—

 
10

 
0.2

Total
 
$
2,381

 
$
1,268

 
$
1,011

 
$
4,660

 
100.0
%
 
 
 
 
 
 
 
 
 
 
 
 
LIFE POLICY AND INVESTMENT CONTRACT RESERVES
Gross life policy and investment contract reserves were $2.624 billion at June 30, 2016, compared with $2.583 billion at year-end 2015, reflecting continued growth in life insurance policies in force. We discuss our life insurance reserving practices in our 2015 Annual Report on Form 10-K, Item 7, Life Insurance Policyholder Obligations and Reserves, Page 101.
 


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OTHER MATTERS
 
SIGNIFICANT ACCOUNTING POLICIES
Our significant accounting policies are discussed in our 2015 Annual Report on Form 10-K, Item 8, Note 1, Summary of Significant Accounting Policies, Page 123, and updated in this quarterly report Item 1, Note 1, Accounting Policies.
 
In conjunction with those discussions, in the Management’s Discussion and Analysis in the 2015 Annual Report on Form 10-K, management reviewed the estimates and assumptions used to develop reported amounts related to the most significant policies. Management discussed the development and selection of those accounting estimates with the audit committee of the board of directors.
 

Item 3.    Quantitative and Qualitative Disclosures About Market Risk
Our greatest exposure to market risk is through our investment portfolio. Market risk is the potential for a decrease in securities’ fair value resulting from broad yet uncontrollable forces such as: inflation, economic growth or recession, interest rates, world political conditions or other widespread unpredictable events. It is comprised of many individual risks that, when combined, create a macroeconomic impact.
 
Our view of potential risks and our sensitivity to such risks is discussed in our 2015 Annual Report on Form 10-K, Item 7a, Quantitative and Qualitative Disclosures About Market Risk, Page 108.
 
The fair value of our investment portfolio was $15.380 billion at June 30, 2016, up $1.024 billion from year-end 2015, including a $488 million increase in the fixed-maturity portfolio and a $536 million increase in the equity portfolio.
(Dollars in millions)
 
At June 30, 2016
 
At December 31, 2015
 
 
Cost or
amortized cost
 
Percent 
of total
 
Fair value
 
Percent 
of total
 
Cost or
amortized cost
 
Percent 
of total
 
Fair value
 
Percent 
of total
Taxable fixed maturities
 
$
6,295

 
49.5
%
 
$
6,689

 
43.5
%
 
$
6,170

 
50.3
%
 
$
6,353

 
44.3
%
Tax-exempt fixed
  maturities
 
3,223

 
25.4

 
3,449

 
22.4

 
3,154

 
25.7

 
3,297

 
23.0

Common equity
   securities
 
3,002

 
23.6

 
5,017

 
32.6

 
2,749

 
22.4

 
4,485

 
31.2

Nonredeemable
  preferred equity
  securities
 
187

 
1.5

 
225

 
1.5

 
189

 
1.6

 
221

 
1.5

Total
 
$
12,707

 
100.0
%
 
$
15,380

 
100.0
%
 
$
12,262

 
100.0
%
 
$
14,356

 
100.0
%
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
At June 30, 2016, our consolidated investment portfolio included $53 million of assets for which values are based on prices or valuation techniques that require significant management judgment (Level 3 assets). This represented less than 1 percent of investment portfolio assets measured at fair value. See Item 1, Note 3, Fair Value Measurements, for additional discussion of our valuation techniques. We have generally obtained and evaluated two nonbinding quotes from brokers; then, our investment professionals determined our best estimate of fair value. These investments include private placements, small issues and various thinly traded securities.
 
In addition to our investment portfolio, the total investments amount reported in our condensed consolidated balance sheets includes Other invested assets. Other invested assets included $30 million of life policy loans, $33 million of private equity investments and $16 million of real estate through direct property ownership and development projects in the United States at June 30, 2016.
 


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FIXED-MATURITY INVESTMENTS
By maintaining a well-diversified fixed-maturity portfolio, we attempt to reduce overall risk. We invest new money in the bond market on a regular basis, targeting what we believe to be optimal risk-adjusted, after-tax yields. Risk, in this context, includes interest rate, call, reinvestment rate, credit and liquidity risk. We do not make a concerted effort to alter duration on a portfolio basis in response to anticipated movements in interest rates. By regularly investing in the bond market, we build a broad, diversified portfolio that we believe mitigates the impact of adverse economic factors.
 
Our investment portfolio had no European sovereign debt holdings at June 30, 2016. On that date, we owned other European-based securities, primarily corporate bonds, totaling $330 million in fair value. The composition of our European-based holdings at June 30, 2016, did not materially change from the $339 million fair value total at year-end 2015. We discussed our European-based holdings in our 2015 Annual Report on Form 10-K, Item 7a, Quantitative and Qualitative Disclosures About Market Risk, Page 108.
 
In the first six months of 2016, the increase in fair value of our fixed-maturity portfolio was driven by the combination of net purchases of securities and an increase in net unrealized gains reflecting a decrease in interest rates. At June 30, 2016, our fixed-maturity portfolio with an average rating of A3/A was valued at 106.5 percent of its amortized cost, compared with 103.5 percent at December 31, 2015.
 
At June 30, 2016, our investment-grade and noninvestment-grade fixed-maturity securities represented 89.9 percent and 4.5 percent of the portfolio, respectively. The remaining 5.6 percent represented fixed-maturity securities that were not rated by Moody's or S&P Global Ratings.

Attributes of the fixed-maturity portfolio include:
 
 
At June 30, 2016
 
At December 31, 2015
Weighted average yield-to-amortized cost
 
4.67
%
 
4.70
%
Weighted average maturity
 
7.1
yrs
 
6.9
yrs
Effective duration
 
4.8
yrs
 
4.7
yrs
 
 
 
 
 
 
 
 
We discuss maturities of our fixed-maturity portfolio in our 2015 Annual Report on Form 10-K, Item 8, Note 2, Investments, Page 130, and in this quarterly report Item 2, Investments Results.
 


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TAXABLE FIXED MATURITIES
Our taxable fixed-maturity portfolio, with a fair value of $6.689 billion at June 30, 2016, included:
(Dollars in millions)
 
At June 30, 2016
 
At December 31, 2015
Investment-grade corporate
 
$
5,379

 
$
5,060

States, municipalities and political subdivisions
 
353

 
314

Below investment-grade corporate
 
458

 
393

Commercial mortgage-backed
 
310

 
289

Government sponsored enterprises
 
170

 
278

Foreign government
 
10

 
10

Convertibles and bonds with warrants attached
 
5

 
5

United States government
 
4

 
4

Total
 
$
6,689

 
$
6,353

 
 
 
 
 
 
Our strategy is to buy, and typically hold, fixed-maturity investments to maturity, but we monitor credit profiles and fair value movements when determining holding periods for individual securities. With the exception of United States agency issues that include government-sponsored enterprises, no individual issuer’s securities accounted for more than 0.9 percent of the taxable fixed-maturity portfolio at June 30, 2016. Our investment-grade corporate bonds had an average rating of Baa2 by Moody’s or BBB+ by S&P Global Ratings and represented 80.4 percent of the taxable fixed-maturity portfolio’s fair value at June 30, 2016, compared with 79.7 percent at year-end 2015.
 
The heaviest concentration in our investment-grade corporate bond portfolio, based on fair value at June 30, 2016, was the financial-related sectors. It represented 40.2 percent of our investment-grade corporate bond portfolio, compared with 37.9 percent at year-end 2015. At June 30, 2016, the real estate sector, including commercial mortgage-backed securities, accounted for 15.0 percent and the insurance sector accounted for 12.6 percent. No other sector exceeded 10 percent of our investment-grade corporate bond portfolio.

Most of the $353 million of securities issued by states, municipalities and political subdivisions included in our taxable fixed-maturity portfolio at June 30, 2016, were Build America Bonds.
 
Our taxable fixed-maturity portfolio at June 30, 2016, included $310 million of commercial mortgage-backed securities with an average rating of Aa1/AA.


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TAX-EXEMPT FIXED MATURITIES
At June 30, 2016, we had $3.449 billion of tax-exempt fixed-maturity securities with an average rating of Aa2/AA by Moody’s and S&P Global Ratings. We traditionally have purchased municipal bonds focusing on general obligation and essential services issues, such as water, waste disposal or others. The portfolio is well diversified among more than 1,400 municipal bond issues. No single municipal issuer accounted for more than 0.7 percent of the tax-exempt fixed-maturity portfolio at June 30, 2016.

INTEREST RATE SENSITIVITY ANALYSIS
Because of our strong surplus, long-term investment horizon and ability to hold most fixed-maturity investments until maturity, we believe the company is adequately positioned if interest rates were to rise. Although the fair values of our existing holdings may suffer, a higher rate environment would provide the opportunity to invest cash flow in higher-yielding securities, while reducing the likelihood of untimely redemptions of currently callable securities. While higher interest rates would be expected to continue to increase the number of fixed-maturity holdings trading below 100 percent of amortized cost, we believe lower fixed-maturity security values due solely to interest rate changes would not signal a decline in credit quality. We continue to manage the portfolio with an eye toward both meeting current income needs and managing interest rate risk.
 
Our dynamic financial planning model uses analytical tools to assess market risks. As part of this model, the effective duration of the fixed-maturity portfolio is continually monitored by our investment department to evaluate the theoretical impact of interest rate movements.
 
The table below summarizes the effect of hypothetical changes in interest rates on the fair value of the fixed-maturity portfolio:
(Dollars in millions)
 
Effect from interest rate change in basis points
 
 
-200
 
 -100
 
-
 
100
 
200
At June 30, 2016
 
$
11,157

 
$
10,636

 
$
10,138

 
$
9,647

 
$
9,174

At December 31, 2015
 
$
10,585

 
$
10,112

 
$
9,650

 
$
9,189

 
$
8,748

 
 
 
 
 
 
 
 
 
 
 
 
The effective duration of the fixed-maturity portfolio as of June 30, 2016, was 4.8 years, up from 4.7 years at year-end 2015. The above table is a theoretical presentation showing that an instantaneous, parallel shift in the yield curve of 100 basis points could produce an approximately 4.9 percent change in the fair value of the fixed-maturity portfolio. Generally speaking, the higher a bond is rated, the more directly correlated movements in its fair value are to changes in the general level of interest rates, exclusive of call features. The fair values of average- to lower-rated corporate bonds are additionally influenced by the expansion or contraction of credit spreads.
 
In our dynamic financial planning model, the selected interest rate change of 100 to 200 basis points represents our view of a shift in rates that is quite possible over a one-year period. The rates modeled should not be considered a prediction of future events as interest rates may be much more volatile in the future. The analysis is not intended to provide a precise forecast of the effect of changes in rates on our results or financial condition, nor does it take into account any actions that we might take to reduce exposure to such risks.



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EQUITY INVESTMENTS
Our equity investments, with a fair value totaling $5.242 billion at June 30, 2016, included $5.017 billion of common stock securities of companies generally with strong indications of paying and growing their dividends. Other criteria we evaluate include increasing sales and earnings, proven management and a favorable outlook. We believe our equity investment style is an appropriate long-term strategy. While our long-term financial position would be affected by prolonged changes in the market valuation of our investments, we believe our strong surplus position and cash flow provide a cushion against short-term fluctuations in valuation. Continued payment of cash dividends by the issuers of our common equity holdings can provide a floor to their valuation.

The table below summarizes the effect of hypothetical changes in market prices on fair value of our equity portfolio.
(Dollars in millions)
Effect from market price change in percent
 
 
-30%
 
-20%
 
-10%
 
—
 
10%
 
20%
 
30%
At June 30, 2016
 
$
3,669

 
$
4,194

 
$
4,718

 
$
5,242

 
$
5,766

 
$
6,290

 
$
6,815

At December 31, 2015
 
$
3,294

 
$
3,765

 
$
4,235

 
$
4,706

 
$
5,177

 
$
5,647

 
$
6,118

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 

At June 30, 2016, Johnson & Johnson (NYSE:JNJ) was our largest single common stock holding with a fair value of $153 million, or 3.0 percent of our publicly traded common stock portfolio and 1.0 percent of the total investment portfolio. Twenty holdings among eight different sectors each had a fair value greater than $100 million.
 
Common Stock Portfolio Industry Sector Distribution
 
Percent of publicly traded common stock portfolio
 
At June 30, 2016
 
At December 31, 2015
 
Cincinnati
 Financial
 
S&P 500 Industry
Weightings
 
Cincinnati
Financial
 
S&P 500 Industry
Weightings
Sector:
 

 
 

 
 

 
 

Information technology
15.5
%
 
19.8
%
 
18.4
%
 
20.7
%
Healthcare
14.4

 
14.7

 
12.2

 
15.1

Industrials
14.1

 
10.2

 
14.0

 
10.0

Financial
12.8

 
15.7

 
15.4

 
16.5

Consumer discretionary
12.1

 
12.3

 
10.6

 
12.9

Consumer staples
11.2

 
10.6

 
11.0

 
10.1

Energy
8.4

 
7.4

 
7.7

 
6.5

Materials
5.3

 
2.8

 
4.9

 
2.8

Utilities
4.0

 
3.6

 
3.8

 
3.0

Telecomm services
2.2

 
2.9

 
2.0

 
2.4

Total
100.0
%
 
100.0
%
 
100.0
%
 
100.0
%
 
 
 
 
 
 
 
 
 


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UNREALIZED INVESTMENT GAINS AND LOSSES
At June 30, 2016, unrealized investment gains before taxes for the consolidated investment portfolio totaled
$2.765 billion and unrealized investment losses amounted to $92 million.
 
The net unrealized investment gains at June 30, 2016, consisted of a pretax net gain position in our fixed-maturity portfolio of $620 million and a net gain position in our equity portfolio of $2.053 billion. The net gain position in our fixed-maturity portfolio increased in the first six months of 2016 due largely to credit spread widening in our corporate bond portfolio, among other factors. The net gain position for our current fixed-maturity holdings will naturally decline over time as individual securities mature. In addition, changes in interest rates can cause rapid, significant changes in fair values of fixed-maturity securities and the net gain position, as discussed in Quantitative and Qualitative Disclosures About Market Risk. Events or factors such as economic growth or recession can also affect the fair value of our equity securities. The seven largest contributors to our common stock portfolio net gain position were Exxon Mobil Corporation (NYSE:XOM), Honeywell International Inc. (NYSE:HON), Johnson & Johnson (NYSE:JNJ), The Procter & Gamble Company (NYSE:PG), Hasbro Inc. (Nasdaq:HAS), 3M Co (NYSE: MMM) and Blackrock Inc. (NYSE:BLK), which had a combined gross unrealized gain position of $647 million.

Unrealized Investment Losses
We expect the number of securities trading below amortized cost to fluctuate as interest rates rise or fall and credit spreads expand or contract due to prevailing economic conditions. Further, amortized costs for some securities are revised through OTTI recognized in prior periods. At June 30, 2016, 118 of the 3,211 securities we owned had fair values below amortized cost, compared with 414 of the 3,163 securities we owned at year-end 2015. The 118 holdings with fair values below cost or amortized cost at June 30, 2016, represented 7.3 percent of the fair value of our investment portfolio and $92 million in unrealized losses.
•
102 of the 118 holdings had fair value between 90 percent and 100 percent of amortized cost at June 30, 2016. Nine of these 102 holdings are equity securities that may be subject to OTTI charges taken through earnings should they not recover by the recovery dates we determined. The fair value of these nine equity securities was $311 million, and they accounted for $9 million in unrealized losses. The remaining 93 securities primarily consist of fixed-maturity securities whose current valuation is largely the result of interest rate factors. The fair value of these 93 securities was $473 million, and they accounted for $13 million in unrealized losses.
•
16 of the 118 holdings had fair value between 70 percent and 90 percent of amortized cost at June 30, 2016. Five of these 16 holdings were equity securities that may be subject to OTTI charges taken through earnings should they not recover by the dates we determined. The fair value of these equity securities was $272 million, and they accounted for $56 million in unrealized losses. We believe the remaining 11 fixed-maturity securities will continue to pay interest and ultimately pay principal upon maturity. The issuers of these 11 securities have strong cash flow to service their debt and meet their contractual obligation to make principal payments. The fair value of these securities was $74 million, and they accounted for $14 million in unrealized losses.
•
No holdings had fair value below 70 percent of amortized cost at June 30, 2016.


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The table below reviews fair values and unrealized losses by investment category and by the overall duration of the securities’ continuous unrealized loss position.
(Dollars in millions)
 
Less than 12 months
 
12 months or more
 
Total
 
Total
 
 
Fair
 
Unrealized
 
Fair
 
Unrealized
 
fair
 
unrealized
At June 30, 2016
 
value
 
losses
 
value
 
losses
 
value
 
losses
Fixed maturity securities:
 
 

 
 

 
 

 
 

 
 

 
 

Corporate
 
$
252

 
$
9

 
$
258

 
$
18

 
$
510

 
$
27

States, municipalities and political subdivisions
 
2

 
—

 
1

 
—

 
3

 
—

Commercial mortgage-backed
 
5

 
—

 
9

 
—

 
14

 
—

Government-sponsored enterprises
 
20

 
—

 
—

 
—

 
20

 
—

Subtotal
 
279

 
9

 
268

 
18

 
547

 
27

Equity securities:
 
 

 
 

 
 

 
 

 
 

 
 

Common equities
 
546

 
65

 
—

 
—

 
546

 
65

Nonredeemable preferred equities
 
19

 
—

 
18

 
—

 
37

 
—

Subtotal
 
565

 
65

 
18

 
—

 
583

 
65

Total
 
$
844

 
$
74

 
$
286

 
$
18

 
$
1,130

 
$
92

At December 31, 2015
 
 

 
 

 
 

 
 

 
 

 
 

Fixed maturity securities:
 
 
 
 

 
 

 
 

 
 

 
 

Corporate
 
$
1,099

 
$
63

 
$
133

 
$
33

 
$
1,232

 
$
96

States, municipalities and political subdivisions
 
47

 
1

 
22

 
—

 
69

 
1

Commercial mortgage-backed
 
103

 
2

 
2

 
—

 
105

 
2

Government-sponsored enterprises
 
100

 
2

 
127

 
4

 
227

 
6

Subtotal
 
1,349

 
68

 
284

 
37

 
1,633

 
105

Equity securities:
 
 

 
 

 
 

 
 

 
 

 
 

Common equities
 
270

 
51

 
—

 
—

 
270

 
51

Nonredeemable preferred equities
 
35

 
—

 
—

 
—

 
35

 
—

Subtotal
 
305

 
51

 
—

 
—

 
305

 
51

Total
 
$
1,654

 
$
119

 
$
284

 
$
37

 
$
1,938

 
$
156

 
 
 
 
 
 
 
 
 
 
 
 
 
 
At June 30, 2016, 53 fixed-maturity securities with a total unrealized loss of $18 million had been in an unrealized loss position for 12 months or more. Of that total, no fixed-maturity securities had a fair value below 70 percent of amortized cost; 10 fixed-maturity securities with a fair value of $57 million had a fair value from 70 percent to less than 90 percent of amortized cost and accounted for $11 million in unrealized losses; and 43 fixed-maturity securities with a fair value of $211 million had fair values from 90 percent to less than 100 percent of amortized cost and accounted for $7 million in unrealized losses.
 
At June 30, 2016, two equity securities with a fair value of $18 million had been in an unrealized loss position for 12 months or more. These equity securities had a fair value from 90 percent to less than 100 percent of amortized cost and accounted for less than $1 million in unrealized losses.
 
At June 30, 2016, applying our invested asset impairment policy, we determined that the total of $18 million, for securities in an unrealized loss position for 12 months or more in the table above, was not other-than-temporarily impaired.


Cincinnati Financial Corporation Second-Quarter 2016 10-Q
Page 65


During the second quarter of 2016, two securities were written down through an impairment charge, for a total of four during the six months ended June 30, 2016. OTTI resulted in pretax, noncash charges of less than $1 million and $2 million for the three and six months ended June 30, 2016. During the first six months of 2015, no securities were written down through impairment charges.
 
During full-year 2015, we wrote down 20 securities and recorded $52 million in OTTI charges. At December 31, 2015, 69 fixed-maturity investments with a total unrealized loss of $37 million had been in an unrealized loss position for 12 months or more. Of that total, five fixed-maturity investments had fair values below 70 percent of amortized cost. There were no equity security investments in an unrealized loss position for 12 months or more as of December 31, 2015.


Cincinnati Financial Corporation Second-Quarter 2016 10-Q
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The following table summarizes the investment portfolio by severity of decline:
(Dollars in millions)
 
 
 
 
 
 
 
 
 
 
At June 30, 2016
 
Number
of 
issues
 
Cost or 
amortized
cost
 
Fair
 value
 
Gross 
unrealized 
gain/loss
 
Gross
investment
income
Taxable fixed maturities:
 
 
 
 
 
 
 
 
 
 
Fair valued below 70% of amortized cost
 
—

 
$
—

 
$
—

 
$
—

 
$
—

Fair valued at 70% to less than 100% of amortized cost
 
103

 
573

 
546

 
(27
)
 
14

Fair valued at 100% and above of amortized cost
 
1,355

 
5,722

 
6,143

 
421

 
142

Securities sold in current year
 
—

 
—

 
—

 
—

 
7

Total
 
1,458

 
6,295

 
6,689

 
394

 
163

Tax-exempt fixed maturities:
 
 

 
 

 
 

 
 

 
 

Fair valued below 70% of amortized cost
 
—

 
—

 
—

 
—

 
—

Fair valued at 70% to less than 100% of amortized cost
 
1

 
1

 
1

 
—

 
—

Fair valued at 100% and above of amortized cost
 
1,650

 
3,222

 
3,448

 
226

 
54

Securities sold in current year
 
—

 
—

 
—

 
—

 
2

Total
 
1,651

 
3,223

 
3,449

 
226

 
56

Common equities:
 
 

 
 

 
 

 
 

 
 

Fair valued below 70% of cost
 
—

 
—

 
—

 
—

 
—

Fair valued at 70% to less than 100% of cost
 
9

 
611

 
546

 
(65
)
 
5

Fair valued at 100% and above of cost
 
60

 
2,391

 
4,471

 
2,080

 
66

Securities sold in current year
 
—

 
—

 
—

 
—

 
—

Total
 
69

 
3,002

 
5,017

 
2,015

 
71

Nonredeemable preferred equities:
 
 

 
 

 
 

 
 

 
 

Fair valued below 70% of cost
 
—

 
—

 
—

 
—

 
—

Fair valued at 70% to less than 100% of cost
 
5

 
37

 
37

 
—

 
1

Fair valued at 100% and above of cost
 
28

 
150

 
188

 
38

 
6

Securities sold in current year
 
—

 
—

 
—

 
—

 
—

Total
 
33

 
187

 
225

 
38

 
7

Portfolio summary:
 
 

 
 

 
 

 
 

 
 

Fair valued below 70% of cost or amortized cost
 
—

 
—

 
—

 
—

 
—

Fair valued at 70% to less than 100% of cost or amortized cost
 
118

 
1,222

 
1,130

 
(92
)
 
20

Fair valued at 100% and above of cost or amortized cost
 
3,093

 
11,485

 
14,250

 
2,765

 
268

Investment income on securities sold in current year
 
—

 
—

 
—

 
—

 
9

Total
 
3,211

 
$
12,707

 
$
15,380

 
$
2,673

 
$
297

 
 
 
 
 
 
 
 
 
 
 
At December 31, 2015
 
 

 
 

 
 

 
 

 
 

Portfolio summary:
 
 

 
 

 
 

 
 

 
 

Fair valued below 70% of cost or amortized cost
 
9

 
$
76

 
$
47

 
$
(29
)
 
$
4

Fair valued at 70% to less than 100% of cost or amortized cost
 
405

 
2,018

 
1,891

 
(127
)
 
66

Fair valued at 100% and above of cost or amortized cost
 
2,749

 
10,168

 
12,418

 
2,250

 
478

Investment income on securities sold in current year
 
—

 
—

 
—

 
—

 
30

Total
 
3,163

 
$
12,262

 
$
14,356

 
$
2,094

 
$
578

 
 
 
 
 
 
 
 
 
 
 
 
See our 2015 Annual Report on Form 10-K, Item 7, Critical Accounting Estimates, Asset Impairment, Page 50.


Cincinnati Financial Corporation Second-Quarter 2016 10-Q
Page 67


Item 4.        Controls and Procedures
Evaluation of Disclosure Controls and Procedures – The company maintains disclosure controls and procedures (as that term is defined in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934, as amended (Exchange Act)).
 
Any controls and procedures, no matter how well designed and operated, can provide only reasonable assurance of achieving the desired control objectives. The company’s management, with the participation of the company’s chief executive officer and chief financial officer, has evaluated the effectiveness of the design and operation of the company’s disclosure controls and procedures as of June 30, 2016. Based upon that evaluation, the company’s chief executive officer and chief financial officer concluded that the design and operation of the company’s disclosure controls and procedures provided reasonable assurance that the disclosure controls and procedures are effective to ensure:
•
that information required to be disclosed in the company’s reports under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in the Securities and Exchange Commission’s rules and forms, and
•
that such information is accumulated and communicated to the company’s management, including its chief executive officer and chief financial officer, as appropriate, to allow timely decisions regarding required disclosures.

Changes in Internal Control over Financial Reporting – During the three months ended June 30, 2016, there were no changes in our internal controls over financial reporting that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.
 

Part II – Other Information
Item 1.    Legal Proceedings
Neither the company nor any of our subsidiaries are involved in any litigation believed to be material other than ordinary, routine litigation incidental to the nature of our business.
 

Item 1A.    Risk Factors
Our risk factors have not changed materially since they were described in our 2015 Annual Report on Form 10-K filed February 26, 2016.
 

Item 2.    Unregistered Sales of Equity Securities and Use of Proceeds
We did not sell any of our shares that were not registered under the Securities Act during the first six months of 2016. The board of directors has authorized share repurchases since 1996. Purchases are expected to be made generally through open market transactions. The board gives management discretion to purchase shares at reasonable prices in light of circumstances at the time of purchase, subject to SEC regulations. On October 24, 2007, the board of directors expanded the existing repurchase authorization to approximately 13 million shares. We have 4,064,493 shares available for purchase under our programs at June 30, 2016.
Period
 
Total number
 of shares
 purchased
 
Average
 price paid
 per share
 
Total number of shares 
purchased as part of
publicly announced
plans or programs
 
Maximum number of
shares that may yet be
purchased under the
plans or programs
April 1-30, 2016
 
—

 
—

 
—

 
4,099,493

May 1-31, 2016
 
—

 
—

 
—

 
4,099,493

June 1-30, 2016
 
35,000

 
$
69.56

 
35,000

 
4,064,493

Totals
 
35,000

 
69.56

 
35,000

 
 

 
 
 
 
 
 
 
 
 

Cincinnati Financial Corporation Second-Quarter 2016 10-Q
Page 68



Item 6.    Exhibits
Exhibit No.
 
Exhibit Description
3.1
 
Amended and Restated Articles of Incorporation of Cincinnati Financial Corporation (incorporated by reference to the company’s 2010 Annual Report on Form 10-K dated February 25, 2011, Exhibit 3.1)
3.2
 
Regulations of Cincinnati Financial Corporation, as amended through May 1, 2010 (incorporated by reference to the company’s Quarterly Report on Form 10-Q for the quarter ended June 30, 2010, Exhibit 3.2)
10.1
 
Cincinnati Financial Corporation 2016 Stock Compensation Plan (incorporated by reference to the company's Definitive Proxy Statement dated March 16, 2016, Appendix B)
10.2
 
First Amendment of Cincinnati Financial Corporation 2016 Stock Compensation Plan (incorporated by reference to Exhibit 99.1 filed with the Company's current report on Form 8-K dated April 11, 2016)
31A
 
Certification pursuant to Section 302 of the Sarbanes Oxley Act of 2002 – Chief Executive Officer
31B
 
Certification pursuant to Section 302 of the Sarbanes Oxley Act of 2002 – Chief Financial Officer
32
 
Certification pursuant to Section 906 of the Sarbanes Oxley Act of 2002
101.INS
 
XBRL Instance Document
101.SCH
 
XBRL Taxonomy Extension Schema Document
101.CAL
 
XBRL Taxonomy Extension Calculation Linkbase Document
101.DEF
 
XBRL Taxonomy Extension Definition Linkbase Document
101.LAB
 
XBRL Taxonomy Extension Label Linkbase Document
101.PRE
 
XBRL Taxonomy Extension Presentation Linkbase Document
 


Cincinnati Financial Corporation Second-Quarter 2016 10-Q
Page 69


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
Date: July 26, 2016
 
/S/ Eric N. Mathews
Eric N. Mathews, CPCU, AIAF
Vice President, Assistant Secretary and Assistant Treasurer
(Principal Accounting Officer)


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