10-K 1 cinf-20131231x10k.htm 10-K CINF-2013.12.31-10K


United States Securities and Exchange Commission
Washington, D.C. 20549
 
Form 10-K
 
þ
ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934.
 
For the fiscal year ended December 31, 2013.
 
¨
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 of incorporation)
(I.R.S. Employer Identification No.)
 

6200 S. Gilmore Road
Fairfield, Ohio 45014-5141
(Address of principal executive offices) (Zip Code)
(513) 870-2000
(Registrant’s telephone number, including area code)
 
Securities registered pursuant to Section 12(b) of the Act:
None
Securities registered pursuant to Section 12(g) of the Act:
$2.00 par, common stock
(Title of Class)
6.125% Senior Notes due 2034
(Title of Class)
6.9% Senior Debentures due 2028
(Title of Class)
6.92% Senior Debentures due 2028
(Title of Class)
 
Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act. Yes þ      No ¨
 
Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act. Yes ¨      No þ
 
Indicate by check mark whether the registrant: (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports) and (2) has been subject to such filing requirements for the past 90 days. Yes þ No ¨
 

1



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 if 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). Yes þ      No ¨
 
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K (§229.405 of this chapter) is not contained herein, and will not be contained, to the best of registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. ¨
 
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of "large accelerated filer,” “accelerated filer" and smaller reporting company in Rule 12b-2 of the Exchange Act.
 
Large accelerated filer þ Accelerated filer ¨ Non-accelerated filer ¨ Smaller reporting company ¨
 
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Act). Yes ¨ No þ
 
The aggregate market value of voting stock held by nonaffiliates of the Registrant was $6,820,642,248 as of June 30, 2013.
 
As of February 21, 2014, there were 163,506,115 shares of common stock outstanding.
 
Document Incorporated by Reference
 
Portions of the definitive Proxy Statement for Cincinnati Financial Corporation’s Annual Meeting of Shareholders to be held on April 26, 2014, are incorporated by reference into Part III of this Form 10-K.

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2013 ANNUAL REPORT ON FORM 10-K
TABLE OF CONTENTS
Part I
 
Item 1.
Business
 
Cincinnati Financial Corporation – Introduction
 
Our Business and Our Strategy
 
Our Segments
 
Other
 
Regulation
Item 1A.
Risk Factors
Item 1B.
Unresolved Staff Comments
Item 2.
Properties
Item 3.
Legal Proceedings
Item 4.
Mine Safety Disclosures
Part II
 
Item 5.
Market for the Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities
Item 6
Selected Financial Data
Item 7.
Management's Discussion and Analysis of Financial Condition and Results of Operations
 
Introduction
 
Executive Summary
 
Critical Accounting Estimates
 
Recent Accounting Pronouncements
 
Results of Operations
 
Liquidity and Capital Resources
 
Safe Harbor Statement
Item 7A.
Quantitative and Qualitative Disclosures About Market Risk
Item 8.
Financial Statements and Supplementary Data
 
Responsibility for Financial Statements
 
Management’s Annual Report on Internal Control Over Financial Reporting
 
Report of Independent Registered Public Accounting Firm
 
Consolidated Balance Sheets
 
Consolidated Statements of Income
 
Consolidated Statements of Comprehensive Income
 
Consolidated Statements of Shareholders’ Equity
 
Consolidated Statements of Cash Flows
 
Notes to Consolidated Financial Statements
Item 9.
Changes in and Disagreements with Accountants on Accounting and Financial Disclosure
Item 9A.
Controls and Procedures
Item 9B.
Other Information
Part III
 
Item 10.
Directors, Executive Officers and Corporate Governance
Item 11.
Executive Compensation
Item 12.
Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters
Item 13.
Certain Relationships and Related Transactions, and Director Independence
Item 14.
Principal Accounting Fees and Services
Part IV
 
Item 15.
Exhibits, Financial Statement Schedules
 
 

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Part I

ITEM 1.    Business

Cincinnati Financial Corporation - Introduction
We are an Ohio corporation formed in 1968. Our lead subsidiary, The Cincinnati Insurance Company, was founded in 1950. Our main business is property casualty insurance marketed through independent insurance agencies in 39 states. Our headquarters is in Fairfield, Ohio. At year-end 2013, we employed 4,163 associates, including 2,845 headquarters associates who provide support to 1,318 field associates.
 
Cincinnati Financial Corporation owns 100 percent of three subsidiaries: The Cincinnati Insurance Company, CSU Producer Resources Inc. and CFC Investment Company. In addition, the parent company has an investment portfolio, owns the headquarters property and is responsible for corporate borrowings and shareholder dividends.
 
The Cincinnati Insurance Company owns 100 percent of our four additional insurance subsidiaries. Our standard market property casualty insurance group includes two of those subsidiaries – The Cincinnati Casualty Company and The Cincinnati Indemnity Company. This group writes a broad range of business, homeowner and auto policies. Other subsidiaries of The Cincinnati Insurance Company include The Cincinnati Life Insurance Company, which provides life insurance, disability income policies and fixed annuities, and The Cincinnati Specialty Underwriters Insurance Company, which offers excess and surplus lines insurance products.
 
The two noninsurance subsidiaries of Cincinnati Financial Corporation are CSU Producer Resources, which offers insurance brokerage services to our independent agencies so their clients can access our excess and surplus lines insurance products; and CFC Investment Company, which offers commercial leasing and financing services to our agencies, their clients and other customers.
 
Our filings with the U.S. Securities and Exchange Commission (SEC) are available, free of charge, on our website, cinfin.com/investors, as soon as possible after they have been filed with the SEC. These filings include annual reports on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K and amendments to those reports filed or furnished pursuant to Section 13(a) or 15(d) of the Securities Exchange Act of 1934. In the following pages we reference various websites. These websites, including our own, are not incorporated by reference in this Annual Report on Form 10-K.
 
Periodically, we refer to estimated industry data so that we can give information about our performance versus the overall insurance industry. Unless otherwise noted, the industry data is prepared by A.M. Best Co., a leading insurance industry statistical, analytical and insurer financial strength and credit rating organization. Information from A.M. Best is presented on a statutory accounting basis. When we provide our results on a comparable statutory accounting 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).
 

4



Our Business and Our Strategy
 
Introduction
The Cincinnati Insurance Company was founded over 60 years ago by four independent insurance agents. They established the mission that continues to guide all of the companies in the Cincinnati Financial Corporation family – to grow profitably and enhance the ability of local independent insurance agents to deliver quality financial protection to the people and businesses they serve by:
providing insurance market stability through financial strength
producing competitive, up-to-date products and services
developing associates committed to superior service

A select group of independent agencies in 39 states actively markets our property casualty insurance within their communities. At year-end 2013, standard market commercial lines and excess and surplus lines policies were marketed in all of those states, while personal lines policies were marketed in 30 of those states. Within our select group of agencies, we also seek to become the life insurance carrier of choice and to help agents and their clients – our policyholders – by offering leasing and financing services.
 
Three competitive advantages distinguish our company, positioning us to build shareholder value and to be successful overall:
Commitment to our professional independent insurance agencies and to their continued success
Financial strength that lets us be a consistent market for our agents’ business, supporting stability and confidence
Operating structure that supports local decision making, showcasing our claims excellence and allowing us to balance growth with underwriting discipline

The primary sources of our company’s net income are summarized below. We discuss the contribution to net income from each source in Item 7, Corporate Financial Highlights of Management’s Discussion and Analysis.
Underwriting profit (loss) - Includes revenues from earned premiums from insurance policies sold, reduced by losses and loss expenses from insurance coverages provided by those policies. Those revenues are further reduced by underwriting expenses from marketing policies or related administration of our insurance operation. The net result represents an underwriting profit when revenues exceed losses and expenses.
Investment income - Is generated primarily from investing premiums collected from insurance policies, until funds from cash or invested assets are needed to pay losses for insurance claims or other expenses. Interest income from bond investments or dividend income from stock investments are the main categories of our investment income.
Realized investment gains (losses) - Occur from appreciation or depreciation of invested assets over time. Gains or losses are generally recognized when invested assets are sold or become impaired.

Independent Insurance Agency Marketplace
The U.S. property casualty insurance industry is a highly competitive marketplace with more than 2,000 stock and mutual companies operating independently or in groups. No single company or group dominates across all product lines and states. Standard market insurance companies (carriers) can market a broad array of products nationally or:
choose to sell a limited product line or only one type of insurance (monoline carrier)
target a certain segment of the market (for example, personal insurance)
focus on one or more states or regions (regional carrier)

Standard market property casualty insurers generally offer insurance products through one or more distribution channels:
independent agents, who represent multiple carriers
captive agents, who represent one carrier exclusively
direct marketing to consumers

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For the most part, we compete with standard market insurance companies that market through independent insurance agents. Agencies marketing our commercial lines products typically represent six to 12 standard market insurance carriers for commercial lines products, including both national and regional carriers, most of which are mutual companies. Our agencies typically represent four to six standard personal lines carriers. We also compete with carriers that market personal lines products through captive agents and direct writers. Distribution through independent insurance agents or brokers represents nearly 60 percent of overall U.S. property casualty insurance premiums and approximately 80 percent of commercial property casualty insurance premiums, according to studies by the Independent Insurance Agents and Brokers of America.
 
We are committed exclusively to the independent agency channel. The independent agencies that we choose to market our standard lines insurance products share our philosophies. They do business person to person; offer broad, value-added services; maintain sound balance sheets; and manage their agencies professionally, targeting long-term success. We develop our relationships with agencies that are active in their local communities, providing important knowledge of local market trends, opportunities and challenges.
 
In addition to providing standard market property casualty insurance products, we operate our own excess and surplus lines insurance brokerage firm and insurance carrier so that we can offer our excess and surplus lines products exclusively to the independent agencies who market our other property casualty insurance products. We also market life insurance products through the agencies that market our property casualty products and through other independent agencies that represent The Cincinnati Life Insurance Company without also representing our other subsidiaries. We help our agencies meet the broader needs of their clients and increase and diversify their revenues and profitability by offering insurance solutions beyond our standard market property casualty insurance products.
 
The excess and surplus lines market exists due to a regulatory distinction. Generally, excess and surplus lines insurance carriers provide insurance that is unavailable in the standard market due to market conditions or characteristics of the insured persons or organizations that are caused by nature, their claim history or the characteristics of their business. Insurers operating in the excess and surplus lines marketplace generally market business through excess and surplus lines insurance brokers, whether they are small specialty insurers or specialized divisions of larger insurance organizations. We established an excess and surplus lines operation in response to requests to help meet the needs of agency clients when insurance is unavailable in the standard market. By providing superior service, we can help our agencies grow while also profitably growing our property casualty business.
 
At year-end 2013, our 1,450 property casualty agency relationships were marketing our standard market insurance products from 1,823 reporting locations. An increasing number of agencies have multiple, separately identifiable locations, reflecting their growth and consolidation of ownership within the independent agency marketplace. The number of reporting agency locations indicates our agents’ regional scope and the extent of our presence within our 39 active states. At year-end 2012, our 1,408 agency relationships had 1,758 reporting locations. At year-end 2011, our 1,312 agency relationships had 1,648 reporting locations.
 
We made 96, 140 and 133 new agency appointments in 2013, 2012 and 2011, respectively. Of these new appointments, 59, 109 and 93, respectively, were new relationships. The remainder included new branch offices opened by existing Cincinnati agencies and appointment of agencies that merged with a Cincinnati agency. These new appointments and other changes in agency structures or appointment status led to a net increase in agency relationships of 42, 96 and 67 and a net increase in reporting agency locations of 65, 110 and 104 in 2013, 2012 and 2011, respectively.
 
On average, we have a 12.0 percent share of the standard lines property casualty insurance purchased through our reporting agency locations, according to data from agency surveys. Our share is 16.1 percent in reporting agency locations that have represented us for more than 10 years; 8.0 percent in agencies that have represented us for six to 10 years; 5.4 percent in agencies that have represented us for two to five years; and 1.8 percent in agencies that have represented us for one year or less.
 
Our largest single agency relationship accounted for approximately 0.8 percent of our total property casualty earned premiums in 2013. No aggregate locations under a single ownership structure accounted for more than 2.1 percent of our earned premiums in 2013.
 

6



Financial Strength
We believe that our financial strength and strong capital and surplus position, reflected in our insurer financial strength ratings, are clear, competitive advantages in the segments of the insurance marketplace that we serve. This strength supports the consistent, predictable performance that our policyholders, agents, associates and shareholders have always expected and received, helping us withstand significant challenges.
 
While the potential exists for short-term financial performance variability due to our exposures to potential catastrophes or significant capital market losses, the rating agencies consistently have asserted that we have built appropriate financial strength and flexibility to manage that variability. We remain committed to strategies that emphasize being a consistent, stable market for our agents’ business rather than seeking short-term benefits that might accrue by quick, opportunistic reaction to changes in market conditions.
 
We use various principles and practices such as diversification and enterprise risk management to maintain strong capital. For example, we maintain a diversified investment portfolio by reviewing and applying diversification parameters and tolerances.
Our $9.121 billion fixed-maturity portfolio is diversified and exceeds total insurance reserves. The portfolio had an average rating of A2/A, and its fair value exceeded total insurance reserve liabilities by approximately 35 percent at December 31, 2013. No corporate bond exposure accounted for more than 0.7 percent of our fixed-maturity portfolio, and no municipal exposure accounted for more than 0.3 percent.
The strength of our fixed-maturity portfolio provides an opportunity to invest for potential capital appreciation by purchasing equity securities. Our $4.375 billion equity portfolio minimizes concentrations in single stocks or industries. At December 31, 2013, no single security accounted for more than 3.2 percent of our portfolio of publicly traded common stocks, and no single sector accounted for more than 18.7 percent.
 
Strong liquidity increases our flexibility through all periods to maintain our cash dividend and to continue to invest in and expand our insurance operations. At December 31, 2013, we held $1.564 billion of our cash and invested assets at the parent company level, of which $1.363 billion, or 87.1 percent, was invested in common stocks, and $91 million, or 5.8 percent, was cash and cash equivalents.
 
We minimize reliance on debt as a source of capital, maintaining the ratio of debt-to-total-capital below 20 percent. At December 31, 2013, this ratio at 12.8 percent was well below the target limit as capital remained strong while debt levels did not change from year-end 2012. Long-term debt at year-end 2013 totaled $790 million and our short-term debt was $104 million. The long-term debt consists of three nonconvertible, noncallable debentures, two due in 2028 and one in 2034. Ratings for our long-term debt are discussed in Item 7, Liquidity and Capital Resources, Additional Sources of Liquidity.
 
At year-end 2013 and 2012, risk-based capital (RBC) for our standard market property casualty insurance, excess and surplus lines insurance and life insurance subsidiaries was strong, far exceeding regulatory requirements.
We ended 2013 with a 0.9-to-1 ratio of property casualty premiums to surplus, a key measure of property casualty insurance company capacity and security. A lower ratio indicates more security for policyholders and greater capacity for growth by an insurer. We believe our ratio provides ample flexibility to diversify risk by expanding our operations into new geographies and product areas. The estimated industry average ratio was 0.7-to-1 at year-end 2013.
We ended 2013 with a 9.5 percent ratio of life statutory adjusted risk-based surplus to liabilities, a key measure of life insurance company capital strength. The estimated industry average ratio was 11.8 percent at year-end 2013. A higher ratio indicates an insurer’s stronger security for policyholders and capacity to support business growth.


7



(Dollars in millions) Statutory Information
 
At December 31,
 
 
2013
 
2012
Standard market property casualty insurance subsidiary
 
 

 
 

   Statutory capital and surplus
 
$
4,326

 
$
3,914

   Risk-based capital (RBC)
 
4,343

 
3,928

   Authorized control level risk-based capital
 
534

 
487

   Ratio of risk-based capital to authorized control level risk-based capital
 
8.1

 
8.1

   Written premium to surplus ratio
 
0.9

 
0.9

Life insurance subsidiary
 
 

 
 

   Statutory capital and surplus
 
$
247

 
$
276

   Risk-based capital (RBC)
 
264

 
290

   Authorized control level risk-based capital
 
31

 
29

   Ratio of risk-based capital to authorized control level risk-based capital
 
8.1

 
10.1

   Total liabilities excluding separate account business
 
2,807

 
2,626

   Life statutory risk-based adjusted surplus to liabilities ratio
 
9.5

 
11.1

Excess and surplus lines insurance subsidiary
 
 

 
 

   Statutory capital and surplus
 
$
228

 
$
199

   Risk-based capital (RBC)
 
228

 
199

   Authorized control level risk-based capital
 
25

 
20

   Ratio of risk-based capital to authorized control level risk-based capital
 
9.2

 
10.2

   Written premium to surplus ratio
 
0.6

 
0.5

 
 
 
 
 
 
The consolidated property casualty insurance group’s ratio of investments in common stock to statutory capital and surplus was 65.7 percent at year-end 2013 compared with 58.1 percent at year-end 2012.
 
Cincinnati Financial Corporation’s senior debt is rated by four independent rating firms. In addition, the rating firms award our property casualty and life operations insurance financial strength ratings based on their quantitative and qualitative analyses. These ratings 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 shareholders. Ratings may be subject to revision or withdrawal at any time by the ratings agency, and each rating should be evaluated independently of any other rating.
 
All of our insurance subsidiaries continue to be highly rated. During 2013, each of the four ratings firms affirmed our insurance financial strength ratings. Three of the four continued their stable outlook on the ratings and one revised its outlook to stable from negative.
 
As of February 25, 2014, our insurance financial strength ratings were:
 
Insurer Financial Strength Ratings
 
Rating
agency
Standard market property
casualty insurance subsidiary
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.
A+
Superior
2 of 16
A
Excellent
3 of 16
A
Excellent
3 of 16
Stable outlook (12/19/13)
Fitch Ratings
A+
Strong
5 of 21
A+
Strong
5 of 21
-
-
-
Stable outlook (11/12/13)
Moody's Investors
  Service
A1
Good
5 of 21
-
-
-
-
-
-
Stable outlook (4/30/13)
Standard & Poor's
  Ratings Services
A
Strong
6 of 21
A
Strong
6 of 21
-
-
-
Stable outlook (6/24/13)
 

8



On December 19, 2013, A.M. Best affirmed our financial strength ratings that it had assigned in December 2008, continuing its stable outlook. A.M. Best cited our superior risk-adjusted capitalization, conservative loss reserving standards and increasing application of predictive analytic modeling tools along with our historically strong operating performance that improved in 2012 and 2013. Concerns noted included geographic concentration and weakened underwriting results for the five-year period 2008-2012, primarily due to significant catastrophe-related losses. A.M. Best acknowledged the strong franchise value of our insurance subsidiaries and the financial flexibility of the holding company.

On June 24, 2013, Standard & Poor’s Ratings Services affirmed our ratings that it had assigned in July 2010, continuing its stable outlook. S&P said its rating reflected our strong competitive position and
extremely strong capital and earnings, and also noted our geographic diversity and diversification benefits
from our life insurance business. S&P stated that our risk position is moderate despite potential earnings
volatility stemming from exposure to weather-related catastrophe losses, and that its rating could be
unfavorably affected if capital adequacy deteriorated for a prolonged period of time or if earnings
weakened substantially.

On May 1, 2013 and on November 12, 2013, Fitch Ratings affirmed our ratings that it had assigned in August 2009, continuing its stable outlook. Fitch noted that ratings strengths include conservative capitalization, our sizeable holding company cash and marketable securities position and a moderate financial leverage ratio. Fitch noted our
reserve adequacy and benefits from our implementation of underwriting and pricing actions. Fitch said its
rating could be unfavorably affected by a combined ratio exceeding 105 percent on a sustained basis or by
deterioration in current balance sheet strengths.

On April 30, 2013, Moody’s Investors Service affirmed our insurance financial strength ratings that it had
assigned in September 2008, revising its outlook to stable from negative. Moody’s reported that its rating is
based on our entrenched regional franchise from our strong relationships with agents, our focus on small and
middle-market commercial lines risks and our good risk-adjusted capital position. Moody’ said other
strengths include consistent reserve strength with strong financial flexibility and substantial holding
company liquidity. Moody’s added that our strengths are tempered by factors such as exposure to Midwest
weather-related catastrophes, potential investment volatility due to a sizeable position in common equities
relative to peers and competition from well-capitalized nationwide commercial lines carriers.
 
Our debt ratings are discussed in Item 7, Liquidity and Capital Resources, Additional Sources of Liquidity.
 
Operating Structure
We offer our broad array of insurance products through the independent agency distribution channel. We recognize that locally based independent agencies have relationships in their communities and local marketplace intelligence that can lead to policyholder satisfaction, loyalty and profitable business. Several of our strategic initiatives are intended not only to help us compete but also to enhance support of agencies that represent us, thereby contributing to agency success. We seek to be a consistent and predictable property casualty carrier that agencies can rely on to serve their clients.
 
In our 10 highest volume states for consolidated property casualty premiums, 1,067 reporting agency locations wrote 63.8 percent of our 2013 consolidated property casualty earned premium volume compared with 1,039 locations and 65.4 percent in 2012. We continue efforts to geographically diversify our property casualty risks.
 

9



Consolidated Property Casualty Insurance Earned Premiums by State
(Dollars in millions)
Earned
premiums
% of total
earned
Agency
locations
Average
premium per
location
Year ended December 31, 2013
 

 

 

 

Ohio
$
685

18.5
%
242

$
2.8

Illinois
277

7.4

128

2.2

Indiana
248

6.7

112

2.2

Pennsylvania
209

5.6

94

2.2

Georgia
189

5.1

92

2.1

North Carolina
180

4.8

94

1.9

Michigan
179

4.8

139

1.3

Tennessee
138

3.7

58

2.4

Virginia
138

3.7

64

2.2

Kentucky
131

3.5

44

3.0

 
 
 
 
 
 
Field Focus
We rely on our force of 1,318 field associates to provide service and be accountable to our agencies for decisions we make at the local level. These associates live in the communities our agents serve, working from offices in their homes and providing 24/7 availability to our agents. Headquarters associates support agencies and field associates with underwriting, accounting, technology assistance, training and other services. Company executives and headquarters associates regularly travel to visit agencies, strengthening the personal relationships we have with these organizations. Agents have opportunities for direct, personal conversations with our senior management team, and headquarters associates have opportunities to refresh their knowledge of marketplace conditions and field activities.
 
The field team is coordinated by field marketing representatives responsible for underwriting new commercial lines business. They are joined by field representatives specializing in claims, loss control, personal lines, excess and surplus lines, machinery and equipment, bond, premium audit and life insurance. The field team provides many services for agencies and policyholders; for example, our loss control field representatives and others specializing in machinery and equipment risks perform inspections and recommend specific actions to improve the safety of the policyholder’s operations and the quality of the agent’s account.
 
Agents work with us to carefully select risks and help assure pricing adequacy. They appreciate the time our associates invest in creating solutions for their clients while protecting profitability, whether that means working on an individual case or customizing policy terms and conditions that preserve flexibility, choice and other sales advantages. We seek to develop long-term relationships by understanding the unique needs of their clients, who are also our policyholders.
 
We also are responsive to agent needs for well-designed property casualty products. Our commercial lines products are structured to allow flexible combinations of property and liability coverages in a single package with a single expiration date and several payment options. This approach brings policyholders convenience, discounts and a reduced risk of coverage gaps or disputes. At the same time, it increases account retention and saves time and expense for the agency and our company.
 
We employ technology solutions and business process improvements that:
allow our field and headquarters associates to collaborate with each other and with agencies more efficiently
provide our agencies the ability to access our systems and data from their agency management systems to process business transactions from their offices
allow policyholders to directly access, from their systems and mobile devices, pertinent policy information online in order to further improve efficiency for our agencies
automate our internal processes so our associates can spend more time serving agents and policyholders
reduce duplicated effort or friction points in technology processes, introducing more efficiency that reduces company and agency costs

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Agencies access our systems and other electronic services via their agency management systems or CinciLink®, our secure agency-only website. CinciLink provides an array of web-based services and content that makes doing business with us easier, such as commercial and personal lines rating and processing systems, policy loss information, educational courses about our products and services, accounting services, and electronic libraries for property and casualty coverage forms, state rating manuals and marketing materials.
 
Superior Claims Service
Our claims philosophy reflects our belief that we prosper as a company by responding to claims person to person, paying covered claims promptly, preventing false claims from unfairly adding to overall premiums and building financial strength to meet future obligations.
 
Our 778 locally based field claims associates work from their homes, assigned to specific agencies. They respond personally to policyholders and claimants, typically within 24 hours of receiving an agency’s claim report. We believe we have a competitive advantage because of the person-to-person approach and the resulting high level of service that our field claims representatives provide. We also help our agencies provide prompt service to policyholders by giving agencies authority to immediately pay most first-party claims under standard market policies up to $2,500. We believe this same local approach to handling claims is a competitive advantage for our agents providing excess and surplus lines coverage in their communities. Handling of these claims includes guidance from headquarters-based excess and surplus lines claims managers.
 
Our property casualty claims operation uses CMS, our claims management system, to streamline processes and achieve operational efficiencies. CMS allows field and headquarters claims associates to collaborate on reported claims through a virtual claim file. Our field claims representatives use tablet computers to view and enter information into CMS from any location, including a policyholder’s home or an agent’s office, and to print claim checks using portable printers. Agencies also can access selected CMS information such as activity notes on open claims.
 
Catastrophe response teams are comprised of volunteers from our experienced field claims staff who have the authority they need to do their jobs. In times of widespread loss, our field claims representatives confidently and quickly resolve claims, often writing checks on the same day they inspect the loss. CMS introduced new efficiencies that are especially evident during catastrophes. Electronic claim files allow for fast initial contact with policyholders and easy sharing of information and data by rotating storm teams, headquarters staff and local field claims representatives. When hurricanes or other weather events are predicted, we can identify through mapping technologies the expected number of our policyholders that may be impacted by the event and choose to have catastrophe response team members travel to strategic locations near the expected impact area. They are then in position to quickly get to the affected area, set up temporary offices and start calling on policyholders.

Our claims associates work to control costs where appropriate. They use vendor resources that provide negotiated pricing to our policyholders and claimants. Our field claims representatives also are educated continuously on new techniques and repair trends for vehicles. They can leverage their local knowledge and experience with area body shops, which helps them negotiate the right price with any facility the policyholder chooses.
 
We staff a Special Investigations Unit (SIU) with former law enforcement and claims professionals whose qualifications make them well suited to gathering facts to uncover potential fraud. While we believe our job is to pay what is due under each policy contract, we also want to prevent false claims from unfairly increasing overall premiums. Our SIU also operates a computer forensics lab, using sophisticated software to recover data and mitigate the cost of computer-related claims for business interruption and loss of records.
 
Insurance Products
We actively market property casualty insurance in 39 states through a select group of independent insurance agencies. For most agencies that represent us, we believe we offer insurance solutions for approximately 75 percent of the typical insurable risks of their clients. Our standard market commercial lines products and our excess and surplus lines are marketed in all 39 states while our standard market personal lines products are marketed in 30. We offer insurance coverage that includes business property and liability, automobile and homeowner as well as umbrella liability. We discuss our commercial lines, personal lines and excess and surplus lines insurance operations and products in Commercial Lines Property Casualty Insurance Segment, Personal Lines Property Casualty Insurance Segment, and Excess and Surplus Lines Property Casualty Insurance Segment.

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The Cincinnati Specialty Underwriters Insurance Company began excess and surplus lines insurance operations in January 2008. We structured this operation to exclusively serve the needs of the independent agencies that currently market our standard market insurance policies. When all or a portion of a current or potential client’s insurance program requires excess and surplus lines coverages, those agencies can write the whole account with Cincinnati, gaining benefits not often found in the broader excess and surplus lines market. Agencies have access to The Cincinnati Specialty Underwriters Insurance Company’s product line through CSU Producer Resources, the wholly owned insurance brokerage subsidiary of Cincinnati Financial Corporation.
 
We also support the independent agencies affiliated with our property casualty operations in their programs to sell life insurance. The life insurance, disability and fixed annuity products offered by our life insurance subsidiary round out and protect accounts and improve account persistency. At the same time, our life operation increases diversification of revenue and profitability sources for both the agency and our company.
 
Our property casualty agencies make up the main distribution system for our life insurance products. To help build scale, we also develop life insurance business from other independent life insurance agencies in geographic markets underserved through our property casualty agencies. We are careful to solicit business from these other agencies in a manner that does not compete with the life insurance marketing and sales efforts of our property casualty agencies. Our life insurance operation emphasizes up-to-date products, responsive underwriting, high-quality service and competitive pricing.
 
Other Services to Agencies
We complement our insurance operations by providing products and services that help attract and retain high-quality independent insurance agencies. When we appoint agencies, we look for organizations with knowledgeable, professional staffs. In turn, we make an exceptionally strong commitment to assist them in keeping their knowledge up to date and educating new people they bring on board as they grow. Numerous activities fulfill this commitment at our headquarters, online and in regional and agency locations.
 
Except for travel-related expenses to classes held at our headquarters, most programs are offered at no cost to our agencies. While that approach may be extraordinary in our industry today, the result is quality service for our policyholders and increased success for our independent agencies.
 
In addition to broad education and training support, we make available noninsurance financial services. CFC Investment Company offers equipment and vehicle leases and loans for independent insurance agencies, their commercial clients and other businesses. We also provide commercial real estate loans or other financial assistance to help agencies operate, expand and perpetuate their businesses. We believe that providing these services enhances agency relationships with the company and their clients, increasing loyalty while diversifying the agency’s revenues.
 
We’re studying opportunities to begin developing our consumer brand. Our goal is to support agents with tools and resources that help communicate the value of a Cincinnati policy to their clients and prospective clients. As part of that study, we began a small consumer advertising campaign in 2013 and will expand that effort to additional markets in 2014. During 2013, we initiated a social media presence, focusing on providing content that agents can share on their own sites.
 
Strategic Initiatives
Management has identified strategies that can position us for long-term success. The board of directors and management expect execution of our strategic plan to create significant value for shareholders over time. We broadly group these strategies into two areas of focus – improving insurance profitability and driving premium growth – correlating with important ways we measure progress toward our long-term financial objectives. A primary profitability long-term target is to produce a GAAP combined ratio over any five-year period that consistently averages within the range of 95 percent to 100 percent. A primary premium growth long-term target is to profitably grow to reach $5 billion of property casualty and life insurance annual direct written premiums by the end of 2015.

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Effective capital management is an important part of creating shareholder value, serving as a foundation to support other strategies focused on profitable growth of our insurance business, with the overall objective of long-term benefit for shareholders. Our capital management philosophy is intended to preserve and build our capital while maintaining appropriate liquidity. A strong capital position provides the capacity to support premium growth, and liquidity provides for our investment in the people and infrastructure needed to implement our other strategic initiatives. Our strong capital and liquidity also provide financial flexibility for shareholder dividends or other capital management actions.
Our strategies seek to position us to compete successfully in the markets we have targeted while optimizing the balance of risk and returns. We believe successful implementation of key initiatives that support our strategies will help us better serve our agent customers, reduce volatility in our financial results and achieve our long-term objectives despite shorter-term effects of difficult economic, market or pricing cycles. We describe our expectations for the results of these initiatives in Item 7, Executive Summary of Management’s Discussion and Analysis.
 
Improve Insurance Profitability
Implementation of the initiatives described below is intended to enhance underwriting expertise and knowledge for our property casualty business, improving our ability to manage our business while also providing greater efficiency. By improving our capabilities to determine individual insurance policy pricing with better alignment to risk attributes, we can increase our effectiveness in managing profit margins. By improving internal processes and further developing performance metrics, we can continue improving efficiency and effectiveness. These initiatives also support the ability of the agencies that represent us to grow profitably by allowing them to more efficiently serve clients and manage expenses. Important initiatives for 2014 to improve insurance profitability include:
Enhance underwriting expertise and knowledge – We continue to increase our use of information and develop our skills for better underwriting performance, focusing on areas that will benefit most from additional effort. We also continue to expand our pricing capabilities by using predictive analytics, expecting cumulative benefits of these efforts to improve loss ratios over time. Expanded capabilities include streamlining and optimizing data to increase accuracy, timeliness and ease of use. Development of additional business data to support more accurate underwriting, more granular pricing and other business decision-making also continues through a multi-year, phased project. Project deliverables include enhancing our data management program in phases, including further developing the data warehouse used in our insurance operations.
Initiatives for 2014 include expanding pricing precision with ongoing enhancement of analytics and predictive modeling tools. These tools better align individual insurance policy pricing to risk attributes. We continue to further integrate such tools with policy administration systems to help our underwriting associates better target profitability and discuss pricing impacts with agency personnel. Use of enhanced pricing precision tools and techniques with our existing policies as they renew should strengthen loss ratios over time, allowing us to ensure we are competitive on the most desirable business and able to adapt more rapidly to changes in market conditions.
During 2014, we plan to introduce, in select states, predictive modeling for dwelling fire policies and a by-peril rating plan for homeowners. By-peril rating for homeowner policies is expected to improve pricing precision by separately pricing for the risk of losses from distinct perils, such as wind versus fire.
Work continues in 2014 on initiatives to more profitably underwrite property coverages, including more staff specialization, more inspections of insured property to provide enhanced underwriting knowledge and greater use of deductibles or other policy terms and conditions as policies renew. We will inspect or conduct loss control activities at a significant number of commercial properties and homes across several states, allowing us to emphasize roof conditions or other policy underwriting attributes in our pricing and risk selection processes. During the period 2013-2015, we plan to complete inspections for approximately 300,000 homes or business properties, including roughly 130,000 in 2014. We will also increase our use of higher minimum loss deductible amounts for homeowner policies and per-building deductibles for commercial risks, along with more use of wind and hail deductibles in areas subject to severe convective storm activity. We expect these actions, along with others such as more use of actual cash value coverage for older roofs, to improve underwriting profitability over time for our property-related lines of business.
Similar initiatives will continue to advance profitable underwriting of our commercial auto line of business. They include an ongoing focus on pricing precision, such as classification of insured commercial autos and improvements in the collection and use of commercial vehicle identification numbers.
Improve internal processes - Improved processes support our strategic goals, reducing internal costs and allowing us to focus more resources on providing agency services. Important process upgrades include

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continuing to streamline processing between company and agency management systems for more policies. This allows for processing of qualified personal lines or small commercial lines business without intervention by an underwriter or for routing of complex work items to the most appropriate associate for optimal service. This form of streamlined processing is already used on small accounts for our major commercial lines of business. In 2014, we plan to expand it to additional states for personal lines policies that qualify. Audits of policies processed without an underwriter continue to indicate that the streamlined processing is underwriting and issuing policies as intended.
We also plan to enhance policy processing by migrating additional types of coverages to our e-CLAS® CPP commercial lines policy administration system. Those coverages include workers compensation, management liability products and selected target market programs. We will offer enhanced policy billing or payment options in 2014 for both our standard market policies and our excess and surplus lines policies. Improved workflow tools should increase our efficiency, providing additional operational reporting metrics and making it easier for agencies to do business with us.
We measure the overall success of our strategy to improve insurance profitability primarily through our GAAP combined ratio for property casualty results, which we believe can consistently average within the range of 95 percent to 100 percent for any five-year period. We also compare our statutory combined ratio to the industry average to gauge our progress.

We expect these initiatives to contribute to our position as the No. 1 or No. 2 carrier based on premium volume in agencies that have represented us for at least five years. We again hit that mark in nearly 75 percent of such agencies based on 2012 premiums. We are working to increase the percentage of agencies where we achieve that rank.
 
Drive Premium Growth
Implementation of the operational initiatives below is intended to further penetrate each market we serve through our independent agencies. We expect strategies aimed at specific market opportunities, along with service enhancements, to encourage our agents to grow and to increase our share of their business. Our strategy includes evaluating demographics, historical profitability trends and historical catastrophe trends to estimate premium growth from existing agencies and to make careful projections about the number of additional agencies needed to achieve premium targets. Our focus remains on the key components of agent satisfaction based on factors that agents tell us are most important. Significant 2014 initiatives to drive premium growth include:
Expansion of our marketing and service capabilities - We continue to enhance our generalist approach to allow our appointed agencies to better compete in the marketplace by providing services an agents clients want and need. During 2014, we will continue to develop and coordinate targeted marketing, including cross-selling opportunities, through our Target Markets department. This area focuses on commercial product development, including identification of and promotional support for promising classes of business. We offered 18 target market programs to our agencies at the end of 2013. In 2014, we will work on developing two new programs, in addition to expanding product offerings within various programs. Our enhanced policy administration platforms will allow us to implement these new target market programs after 2014.
We plan to offer our customer care center for small commercial business policies, currently in pilot, to additional agencies in 2014. Our services include various policy administration functions routinely provided by agencies, allowing agency personnel to focus more on marketing efforts and on providing additional service to their clients as needed. We will also continue to add field marketing representatives where needed for additional agency support in targeted areas, including some specializing in personal lines or excess and surplus lines. Associates in our life insurance segment plan to increase opportunities for agencies to cross-sell to their clients by providing updated market sensitive products and services.
New agency appointments - We continue to appoint new agencies to develop additional points of distribution, focusing on areas where our property casualty insurance market share is less than 1 percent while also considering economic and catastrophe risk factors. In 2014, we are planning approximately 100 appointments of independent agencies that write in aggregate $1 billion or more in property casualty business annually with various insurance carriers. We generally appoint those agencies in order to have them represent us to sell life insurance, as well as our property casualty insurance, to their clients. We plan to appoint approximately 50 additional independent life agencies to offer only our life insurance products and service. Our excess and surplus lines marketing will focus on selected areas and seek to increase penetration with recently appointed agencies.

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We seek to build a close, long-term relationship with each agency we appoint. The contribution of new agencies to our property casualty premium growth should occur over several years, as time is required to fully realize the benefits of our agency relationships. We generally earn a 10 percent share of an agencys business within 10 years of its appointment. We also help our agents grow their business by attracting more clients in their communities through unique Cincinnati-style service. We carefully evaluate the marketing reach of each new appointment to ensure the territory can support both current and new agencies. In counting new agency appointments, we include appointment of new agency relationships with property casualty insurance group subsidiaries of The Cincinnati Insurance Companies. For those that we believe will produce a meaningful amount of new business premiums, we also count appointments of agencies that merge with an existing Cincinnati agency and new branch offices opened by current Cincinnati agencies. We made 96, 140 and 133 new appointments in 2013, 2012 and 2011, respectively, with 59, 109 and 93 representing new relationships.

We measure the overall success of our strategy to drive premium growth primarily through changes in net written premiums. Other important indicators that we are successfully executing initiatives to drive premium growth include tracking our progress toward our year-end 2015 direct written premiums target. We believe we can grow premiums faster than the industry average over any five-year period, while also achieving our long-term objective for underwriting profitability.
 
Our Segments
Consolidated financial results primarily reflect the results of our five reporting segments. These segments are defined based on financial information we use to evaluate performance and to determine the allocation of assets.
Commercial lines property casualty insurance
Personal lines property casualty insurance
Excess and surplus lines property casualty insurance
Life insurance
Investments
 
We evaluate results for our consolidated property casualty operations, which is the total of our commercial lines, personal lines and excess and surplus lines results.
 
Revenues, income before income taxes and identifiable assets for each segment are shown in a table in Item 8, Note 18 of the Consolidated Financial Statements. Some of that information is discussed in this section of this report, where we explain the business operations of each segment. The financial performance of each segment is discussed in Item 7, Management’s Discussion and Analysis of Financial Condition and Results of Operations.
 
Commercial Lines Property Casualty Insurance Segment
In 2013, the commercial lines property casualty insurance segment contributed net earned premiums of $2.636 billion, representing 58.2 percent of consolidated total revenues. This segment reported profit before income taxes of $186 million. Commercial lines net earned premiums rose 11 percent in 2013, 8 percent in 2012 and 2 percent in 2011.
 
Approximately 95 percent of our commercial lines premiums are written to provide 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 growth and profitability trends separately for our business lines. The seven commercial business lines are:
Commercial casualty – Provides coverage to businesses against third-party liability from accidents occurring on their premises or arising out of their operations, including liability coverage for injuries sustained from products sold as well as coverage for professional services, such as dentistry. Specialized casualty policies may include liability coverage for excess insurance and umbrella liability, including personal umbrella liability written as an endorsement to commercial umbrella coverages, and employment practices liability (EPLI), which protects businesses against claims by employees that their legal rights as employees of the company have been violated, and against other acts or failures to act under specified circumstances. The commercial casualty business line includes liability coverage written as part of commercial package policies.

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Commercial property – Provides coverage for loss or damage to buildings, inventory and equipment caused by covered causes of loss such as fire, wind, hail, water, theft and vandalism, as well as business interruption resulting from a covered loss. Commercial property also includes crime insurance, which provides coverage for losses such as embezzlement or misappropriation of funds by an employee, among others; and inland marine insurance, which provides coverage for builder’s risk, cargo, electronic data processing equipment and a variety of mobile equipment, such as contractor’s equipment. Various property coverages can be written as stand-alone policies or can be added to a commercial package policy.
Commercial auto – Protects businesses against liability to others for both bodily injury and property damage, medical payments to insureds and occupants of their vehicles, physical damage to an insured’s own vehicle from collision and various other perils, and damages caused by uninsured motorists.
Workers’ compensation – Covers employers for specified benefits payable under state or federal law for workplace injuries to employees. We write workers’ compensation coverage in all of our active states except North Dakota, Ohio, Washington and Wyoming, where coverage is provided solely by the state instead of by private insurers.
Specialty packages – Includes coverages for property, liability and business interruption tailored to meet the needs of specific industry classes such as artisan contractors, dentists, garage operators, financial institutions, metalworkers, printers, religious institutions or smaller main street businesses. Businessowners policies, which combine property, liability and business interruption coverages for small businesses, are included in specialty packages.
Management liability and surety (formerly surety and executive risk) – This business line includes:
Director and officer (D&O) liability insurance, which covers liability for actual or alleged errors in judgment, breaches of duty or other wrongful acts related to activities of for-profit or nonprofit organizations. Approximately 80 percent of our D&O policies and 47 percent of the D&O premium volume in force for 2013 were for nonprofit entities. Our director and officer liability policy can optionally include EPLI coverage, trustee and fiduciary coverage and Internet liability services coverage. 
Contract and commercial surety bonds, which guarantee a payment or reimbursement for financial losses resulting from dishonesty, failure to perform and other acts.
Fidelity bonds, which cover losses that policyholders incur as a result of fraudulent acts by specified individuals or dishonest acts by employees. 
Machinery and equipment – Specialized coverage provides protection for loss or damage to boilers and machinery, including production and computer equipment and business interruption, due to sudden and accidental mechanical breakdown, steam explosion or artificially generated electrical current.

Our emphasis is on products that agents can market to small to midsized businesses in their communities. Of our 1,823 reporting agency locations, 17 market only our management liability and surety products and 30 market only our personal lines products. The remaining 1,776 locations, located in all states in which we actively market, offer some or all of our standard market commercial insurance products.
 
In 2013, our 10 highest volume commercial lines states generated 61.1 percent of our earned premiums compared with 62.3 percent in 2012 and 63.3 percent in 2011 as we continued efforts to geographically diversify our property casualty risks. Earned premiums in the 10 highest volume states increased 8 percent in 2013 and increased 14 percent in the remaining 29 states. The number of reporting agency locations in our 10 highest volume states increased to 1,064 in 2013 from 1,035 in 2012.
 

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Commercial Lines Earned Premiums by State
(Dollars in millions)
Earned
premiums
% of total
earned
Agency
locations
Average
premium per
location
Year ended December 31, 2013
 

 

 

 

Ohio
$
395

15.0
%
241

$
1.6

Illinois
203

7.7

128

1.6

Pennsylvania
181

6.9

94

1.9

Indiana
163

6.2

110

1.5

North Carolina
129

4.9

92

1.4

Michigan
120

4.5

136

0.9

Virginia
111

4.2

64

1.7

Georgia
104

4.0

87

1.2

Wisconsin
103

3.9

54

1.9

Tennessee
100

3.8

58

1.7

 
 
 
 
 
 
For new commercial lines business, case-by-case underwriting and pricing is coordinated by our locally based field marketing representatives. Our agents and our field marketing, claims, loss control, premium audit, bond and machinery and equipment representatives get to know the people and businesses in their communities and can make informed decisions about each risk. Field marketing representatives also are responsible for selecting new independent agencies, coordinating field teams of specialized company representatives and promoting all of the company’s products within the agencies they serve.
 
Commercial lines policy renewals are managed by headquarters underwriters who are assigned to specific agencies and consult with local field staff as needed. As part of our team approach, headquarters underwriters also help oversee agency growth and profitability. They are responsible for formal issuance of all new business and renewal policies as well as policy endorsements. Further, the headquarters underwriters provide day-to-day customer service to agencies and our field marketing representatives by offering product training, answering underwriting questions, helping to determine underwriting eligibility and assisting with the mechanics of premium determination.
 
Our emphasis on small to midsized businesses is reflected in the mix of our commercial lines premium volume by policy size. Approximately 80 percent of our commercial in-force policies have annual premiums of $10,000 or less, accounting in total for approximately one-quarter of our 2013 commercial lines premium volume. The remainder of policies have annual premiums greater than $10,000, including in-force policies with annual premiums greater than $100,000 that account for slightly more than 15 percent of our 2013 commercial lines premium volume.
 
Our commercial lines packages typically are offered on a three-year policy term for most insurance coverages, a key competitive advantage. In our experience, multi-year packages appeal to the quality-conscious insurance buyers who we believe are typical clients of our independent agents. Customized insurance programs on a three-year term complement the long-term relationships these policyholders typically have with their agents and with the company. By reducing annual administrative efforts, multi-year policies lower expenses for our company and for our agents. The commitment we make to policyholders encourages long-term relationships and reduces their need to annually re-evaluate their insurance carrier or agency. We believe that the advantages of three-year policies in terms of improved policyholder convenience, increased account retention and reduced administrative costs outweigh the potential disadvantage of these policies, even in periods of rising rates.
 
Although we offer three-year policy terms, premiums for some coverages within those policies are adjustable at anniversary for the next annual period, and policies may be canceled at any time at the discretion of the policyholder. Contract terms often provide that rates for property, general liability, inland marine and crime coverages, as well as policy terms and conditions, are fixed for the term of the policy. However, the exposure we insure is reviewed annually, near the policy anniversary date, and the amount of premiums may be adjusted based on changes to that exposure.
 
The general liability exposure basis may be audited annually. Commercial auto, workers’ compensation, professional liability and most umbrella liability coverages within multi-year packages are rated at each of the

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policy's annual anniversaries for the next one-year period. The annual pricing could incorporate rate changes approved by state insurance regulatory authorities between the date the policy was written and its annual anniversary date, as well as changes in risk exposures and premium credits or debits relating to loss experience and other underwriting judgment factors. We estimate that approximately 75 percent of 2013 commercial premiums were subject to annual rating or were written on a one-year policy term.
 
We believe our commercial lines segment premiums reflect a higher concentration, relative to industry commercial lines premiums, in contractor-related businesses. Since economic activity related to construction, which can heavily influence insured exposures of contractors, may experience cycles that vary significantly with the economy as a whole, our commercial lines premium trends could vary from commercial lines premium trends for the property casualty insurance industry. In 2013, we estimated that policyholders with a contractor-related Insurance Services Office (ISO) general liability code accounted for approximately 35 percent of our general liability premiums, which are included in the commercial casualty line of business, and that policyholders with a contractor-related National Council on Compensation Insurance Inc. (NCCI) workers’ compensation code accounted for approximately 48 percent of our workers’ compensation premiums.
 
Understanding evolving market conditions is a critical function for our success, accomplished in both an informal commentary and a formal manner. Informally, our field marketing representatives, underwriters and Target Markets department associates routinely receive market intelligence from a variety of channels, including from the agencies with which they work. This market information helps identify the top competitors by line of business or specialty program and also identifies our market strengths and weaknesses. The information obtained encompasses pricing, breadth of coverage and underwriting/eligibility issues.
 
In addition to reviewing our competitive position, our product management group and our underwriting audit group review compliance with our underwriting standards as well as the pricing adequacy of our commercial insurance programs and coverages. Further, our Target Markets department analyzes opportunities and develops new products and services, new coverage options and improvements to existing insurance products.
 
We support our commercial lines operations with a variety of technology tools. e-CLAS CPP for commercial package and auto coverages now has rolled out to all of our appointed agencies in 36 states. It is being developed for additional coverages and remaining states that will be deployed over time. Since the initial deployment of e-CLAS in late 2009, more than 80 percent of our non-workers’ compensation commercial lines policies in force at the end of 2013 have been processed through e-CLAS. In addition to increasing efficiency for our associates, the system allows our agencies options to quote and produce commercial package policies in paper or electronic format from their offices and to bill policies through their agencies or through us. These features increase their ease of doing business with us. The e-CLAS platform also makes use of our real-time agency interface, CinciBridge®, which allows the automated movement of key underwriting data from an agency’s management system to e-CLAS. This reduces agents’ data entry tasks and allows seamless quoting, rating and issuance capability.
 
Personal Lines Property Casualty Insurance Segment
The personal lines property casualty insurance segment contributed net earned premiums of $961 million to consolidated total revenues, or 21.2 percent of the total, and reported profit before income taxes of $33 million in 2013. Personal lines net earned premiums rose 11 percent in 2013, 14 percent in 2012 and 6 percent in 2011.
 
We prefer to write personal lines coverage in accounts that include both auto and homeowner coverages as well as coverages that are part of our other personal business line. At the end of 2013, for example, 80 percent of our homeowner policies were accompanied by a personal auto policy in the same account. As a result of our account-based approach, 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 growth and profitability trends separately for three business lines:
Personal auto – Protects against liability to others for both bodily injury and property damage, medical payments to insureds and occupants of their vehicle, physical damage to an insured’s own vehicle from collision and various other perils, and damages caused by uninsured motorists. In addition, many states require policies to provide first-party personal injury protection, frequently referred to as no-fault coverage.

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Homeowner – Protects against losses to dwellings and contents from a wide variety of perils, as well as liability arising out of personal activities both on and off the covered premises. We also offer coverage for condominium unit owners and renters.
Other personal lines – This includes the variety of other types of insurance products we offer to individuals such as dwelling fire, inland marine, personal umbrella liability and watercraft coverages.

At year-end, we marketed personal lines insurance products through 1,361 or approximately 75 percent of our 1,823 reporting agency locations. The 1,361 personal lines agency locations are in 30 of the 39 states in which we offer standard market commercial lines insurance. We continue to evaluate opportunities to expand our marketing of personal lines to other states. Primary factors considered in the evaluation of a potential new state include weather-related catastrophe history and the legal climate.
 
Based on a decision made in late 2013, we will begin the process of nonrenewing personal lines policies written by our agencies located in the state of Florida. These non-renewals will affect homeowner and dwelling fire policies with effective dates starting in June of 2014 and will continue until all of those policies are nonrenewed. Nonrenewing the other polices written by our agencies located in Florida generally will commence in the second half of 2015. This decision was due to ongoing concerns that our total insured exposures in Florida did not align with our risk management objectives. In recent years, we had reduced our new business activity in Florida. In 2013, our property casualty net earned premiums from Florida agencies were 1.3 percent of total net earned premiums. We continue to market commercial lines insurance products in Florida, including commercial property coverages, and plan to continue investing in technology and product enhancements to support that market.

In 2013, our 10 highest volume personal lines states generated 79.6 percent of our earned premiums compared with 80.6 percent in 2012 and 80.7 percent in 2011. Earned premiums in the four highest volume states increased 6 percent in 2013 while increasing 17 percent in the remaining states, reflecting progress toward our long-term objective of geographic diversification through new states for our personal lines operation. The number of reporting agency locations in our 10 highest volume states increased 3 percent to 874 in 2013 from 847 in 2012.
 
Personal Lines Earned Premiums by State
(Dollars in millions)
Earned
premiums
% of total
earned
Agency
locations
Average
premium per
location
Year ended December 31, 2013
 

 

 

 

Ohio
$
278

29.0
%
215

$
1.3

Georgia
77

8.0

82

0.9

Indiana
75

7.8

91

0.8

Illinois
67

6.9

97

0.7

Michigan
54

5.6

120

0.5

Alabama
52

5.4

43

1.2

Kentucky
49

5.1

37

1.3

North Carolina
46

4.8

83

0.6

Tennessee
35

3.7

51

0.7

Minnesota
32

3.3

55

0.6

 
 
 
 
 
 
New and renewal personal lines business reflects our risk-specific underwriting philosophy. Each agency selects personal lines business primarily from within the geographic territory that it serves, based on the agent’s knowledge of the risks in those communities or familiarity with the policyholder. Personal lines activities are supported by headquarters associates assigned to individual agencies. At year-end 2013, we had 10 full-time personal lines field marketing representatives who have underwriting authority and visit agencies on a regular basis. They focus primarily on key states targeted for growth, reinforcing the advantages of our personal lines products and offering training in the use of our processing system.
 
All of our personal lines policies are written for a one-year term. Competitive advantages of our personal lines operation include broad coverage forms, flexible underwriting, superior claims service and endorsements allowing

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customization of coverage for both personal auto and homeowner policies. Our personal lines products are processed through Diamond, our Web-based, real-time personal lines policy processing system that supports streamlined processing. Diamond incorporates features frequently requested by our agencies such as prefilling of selected data for improved efficiency, easy-to-use screens, local and headquarters policy printing options, data transfer to and from popular agency management systems and real-time integration with third-party data such as insurance scores, motor vehicle reports and address verification.
 
Excess and Surplus Lines Property Casualty Insurance Segment
The excess and surplus lines property casualty segment contributed net earned premiums of $116 million to consolidated total revenues, or 2.6 percent of the total, and reported profit before income taxes of $14 million in 2013, its sixth year of operation. Excess and surplus lines net earned premium increased 25 percent in 2013, 33 percent in 2012 and 43 percent in 2011.
 
Our excess and surplus lines policies typically cover business risks with unique characteristics, such as the nature of the business or its claim history, that are difficult to profitably insure in the standard commercial lines market. Excess and surplus lines insurers have more flexibility in coverage terms and rates compared with standard lines companies, generally resulting in policies with higher rates and terms and conditions customized for specific risks, including restricted coverage where appropriate. We target small to midsized risks, seeking to avoid those we consider exotic in nature. Our average excess and surplus lines policy size is approximately $6,000 in annual premiums, and policyholders in many cases also have standard market insurance with one of our other subsidiaries. All of our excess and surplus lines policies are written for a maximum term of one year. Approximately 85 percent of our 2013 premium volume for the excess and surplus lines segment provided commercial casualty coverages and about 15 percent provided commercial property coverages. Those coverages are described below.
Commercial casualty – Covers businesses for third-party liability from accidents occurring on their premises or arising out of their operations, including products and completed operations. The majority of these policies have coverage limits of $1 million or less. Miscellaneous errors and omissions and professional coverage for liability from actual or alleged errors in judgment, breaches of duty or other wrongful acts related to activities of insured businesses is also available, as is excess liability coverage that adds another layer of protection to the insured’s other liability insurance policies. Typical businesses covered include contractors, consultants, bars or taverns and manufacturers. Policies covering liability at special events are also available.
Commercial property – Insures buildings, inventory, equipment and business income from loss or damage due to causes such as fire, wind, hail, water, theft and vandalism. Examples of property we commonly insure with excess and surplus lines policies include temporarily vacant buildings, restaurants and relatively higher-hazard manufacturing classes.

At the end of 2013, we marketed excess and surplus lines insurance products in each of the 39 states in which we offer standard market commercial lines insurance. Offering excess and surplus lines helps agencies representing The Cincinnati Insurance Companies meet the insurance needs of their clients when coverage is unavailable in the standard market. By providing outstanding service, we can help agencies grow and prosper while also profitably growing our property casualty business.
 
In 2013, our 10 highest volume excess and surplus lines states generated 61.9 percent of our earned premiums compared with 62.2 percent in 2012 and 62.8 percent in 2011.
 

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Excess and Surplus Lines Earned Premiums by State
(Dollars in millions)
Earned
premiums
% of total
earned
Year ended December 31, 2013
 

 

Ohio
$
12

10.6
%
Indiana
10

8.8

Texas
10

8.3

Georgia
8

7.0

Illinois
7

5.8

Missouri
6

4.8

Michigan
5

4.6

Alabama
5

4.3

North Carolina
5

3.9

Kentucky
4

3.8

 
 
 
 
Agencies representing The Cincinnati Insurance Companies produce over $2 billion in annual premiums for all carriers writing excess and surplus lines policies for their clients. We estimate that approximately half of that premium volume matches the targeted business types and coverages we offer through our excess and surplus lines segment. We structured the operations of this segment to meet the needs of these agencies and to market exclusively through them.
 
Agencies have access to Cincinnati Specialty Underwriters' product line through CSU Producer Resources, the wholly owned insurance brokerage subsidiary of Cincinnati Financial Corporation. CSU Producer Resources has binding authority on all classes of business written through Cincinnati Specialty Underwriters and maintains appropriate agent and surplus lines licenses to process nonadmitted business.
 
We seek to earn a share of each agency’s best excess and surplus lines accounts by offering several unique benefits. Agency producers have direct access through CSU Producer Resources to a group of our underwriters who focus exclusively on excess and surplus lines business. Those underwriters can tap into broader Cincinnati services to provide policyholders additional value and help agents build the relationship through experienced and responsive loss control and claims handling. CSU Producer Resources gives extra support to our independent agency producers by remitting surplus lines taxes and stamping fees and retaining admitted market diligent search affidavits, where required. Agencies marketing through CSU Producer Resources instead of a competing brokerage generally receive a higher commission because use of our internal brokerage subsidiary eliminates some of the intermediary costs. This business is factored in their profit-sharing agreement with The Cincinnati Insurance Companies.

We use a Web-based excess and surplus lines policy administration system to quote, bind, issue and deliver policies electronically to agents. This system provides integration to existing document management and data management systems, allowing for real-time processing of policies and billing. It provides a specimen policy detailing coverages when a policy is quoted and delivers electronic copies of policies to independent agency producers within minutes of underwriting approval and policy issue. In 2013, more than 95 percent of policies were issued within 24 hours of a request to bind a policy.
 
Life Insurance Segment
The life insurance segment contributed $189 million of net earned premiums, representing 4.2 percent of consolidated total revenues, and $9 million of income before income taxes in 2013. Life insurance net earned premiums grew 6 percent in 2013, 8 percent in 2012 and 4 percent in 2011.
 
The Cincinnati Life Insurance Company supports our agency-centered business model. Cincinnati Life helps meet the needs of our agencies, including increasing and diversifying agency revenues. We primarily focus on life products that feature a steady stream of premium payments and that have the potential for generating revenue growth through increasing demand. By diversifying revenue and profitability for both the agency and our company, this strategy enhances the already strong relationship built by the combination of the property casualty and life companies.

21



 
Life Insurance Business Lines
Four lines of business – term life insurance, universal life insurance, worksite products and whole life insurance – account for 95.8 percent of the life insurance segment’s revenues:
Term life insurance – Policies under which a death benefit is payable only if the insured dies during a specific period of time. For policies without a return of premium provision, no benefit is payable if the insured person survives to the end of the term. For policies in force with a return of premium provision, a benefit equal to the sum of all paid base premiums is payable if the insured person survives to the end of the term. Premiums are fixed, and they must be paid as scheduled. The policies are fully underwritten.
Universal life insurance – Long-duration life insurance policies. Contract premiums are neither fixed nor guaranteed; however, the contract does specify a minimum interest crediting rate and a maximum cost of insurance charge and expense charge. Premiums are not fixed and may be varied by the contract owner. The cash values, available as a loan collateralized by the cash surrender value, are not guaranteed and depend on the amount and timing of actual premium payments and the amount of actual contract assessments. The policies are fully underwritten.
Worksite products – Term life insurance, return of premium term life insurance, whole life insurance, universal life and disability insurance offered to employees through their employer. Premiums are collected by the employer using payroll deduction. Policies are issued using a simplified underwriting approach and on a guaranteed issue basis. Worksite insurance products provide our property casualty agency force with excellent cross-serving opportunities for both commercial and personal accounts. Agents report that offering worksite marketing to employees of their commercial accounts provides a benefit to the employees at no cost to the employer. Worksite marketing also connects agents with new customers who may not have previously benefited from receiving the services of a professional independent insurance agent.
Whole life insurance – Policies that provide life insurance for the entire lifetime of the insured. The death benefit is guaranteed never to decrease and premiums are guaranteed never to increase. While premiums are fixed, they must be paid as scheduled. These policies provide guaranteed cash values that are available as loans collateralized by the cash surrender value. The policies are fully underwritten.

In addition, Cincinnati Life markets:
Disability income insurance that provides monthly benefits to offset the loss of income when the insured person is unable to work due to accident or illness.
Deferred annuities that provide regular income payments that commence after the end of a specified period or when the annuitant attains a specified age. During the deferral period, any payments made under the contract accumulate at the crediting rate declared by the company but not less than a contract-specified guaranteed minimum interest rate. A deferred annuity may be surrendered during the deferral period for a cash value equal to the accumulated payments plus interest less the surrender charge, if any.
Immediate annuities that provide some combination of regular income and lump-sum payments in exchange for a single premium.

Life Insurance Distribution
Our life insurance subsidiary is licensed in 49 states and the District of Columbia. At year-end 2013, almost 88 percent of our 1,823 property casualty agency reporting locations offered Cincinnati Life products to their clients. We also develop life business from approximately 615 other independent life insurance agencies. We are careful to solicit business from these other agencies in a manner that does not conflict with or compete with the marketing and sales efforts of our property casualty agencies.
 
When marketing through our property casualty agencies, we have specific competitive advantages:
Because our property casualty operations are held in high regard, property casualty agency management is predisposed to consider selling our life products.
Marketing efforts for both our property casualty and life insurance businesses are directed by our field marketing department, which assures consistency of communication and operations. Life field marketing representatives are available to meet face-to-face with agency personnel and their clients as well.

22



Our life headquarters underwriters and other associates are available to the agents and field team to assist in the placement of business. Fewer and fewer of our competitors provide direct, personal support between the agent and the insurance carrier.

We continue to emphasize the cross-serving opportunities of our life insurance, including term and worksite products, for the property casualty agency’s personal and commercial accounts. In both the property casualty and independent life agency distribution systems, we enjoy the advantages of offering competitive, up-to-date products, providing close personal attention in combination with financial strength and stability.
We primarily offer products addressing the needs of businesses with key person and buy-sell coverages. We offer quality, personal life insurance coverage to personal and commercial clients of our agencies.
Term life insurance is our largest life insurance product line. We continue to introduce new term products with features our agents indicate are important, such as a return of premium benefit.
 
Because of our strong capital position, we can offer a competitive product portfolio including guaranteed products, giving our agents a marketing edge. Our life insurance company maintains strong insurer financial strength ratings: A.M. Best, A (Excellent); Fitch, A+ (Strong); and Standard & Poor’s A (Strong); as discussed in Financial Strength. Our life insurance company has chosen not to establish a Moody’s rating.
 
In 2013, our five highest volume states for life insurance premiums, based on information contained in statements filed with state insurance departments, are reflected in the table below.
 
Life Insurance Premiums by State
(Dollars in millions)
Earned
premiums
% of total
earned
Year ended December 31, 2013
 

 

Ohio
$
48

19.6
%
Pennsylvania
18

7.3

Indiana
17

6.7

Illinois
16

6.5

Michigan
13

5.2

 
 
 
 
Investments Segment
Revenues of the investments segment are primarily from net investment income and from realized investment gains and losses from investment portfolios managed for the holding company and each of the operating subsidiaries.
 
Our investment department operates under guidelines set forth in our investment policy statement along with oversight of the investment committee of our board of directors. These guidelines set parameters for risk tolerances governing, among other items, the allocation of the portfolio as well as security and sector concentrations. These parameters are part of an integrated corporate risk management program.
 
The fair value of our investment portfolio was $13.496 billion and $12.466 billion at year-end 2013 and 2012, respectively. The overall portfolio remained in an unrealized gain position as equity markets experienced strong returns in 2013, while the gain position for our fixed-maturity investments was reduced due to a general rise in interest rates.
 
The cash we generate from insurance operations historically has been invested in two broad categories of investments:
Fixed-maturity investments – Includes taxable and tax-exempt bonds and redeemable preferred stocks. During 2013, purchases were largely offset by redemptions and fair value declines. During 2012, purchases and market value gains offset sales and calls.
Equity investments – Includes common and nonredeemable preferred stocks. During both 2013 and 2012, purchases and fair value gains offset sales by relatively large amounts.

23



(In millions)
At December 31, 2013
 
At December 31, 2012
 
Cost or
Percent
 
 
Percent
 
Cost or
Percent
 
 
Percent
 
amortized cost
of total
 
Fair value
of total
 
amortized cost
of total
 
Fair value
of total
Taxable fixed maturities
$
5,814

52.1
%
 
$
6,211

46.0
%
 
$
5,473

51.7
%
 
$
6,137

49.2
%
Tax-exempt fixed maturities
2,824

25.3

 
2,910

21.6
%
 
2,749

26.0

 
2,956

23.7

Common equities
2,396

21.5

 
4,213

31.2
%
 
2,270

21.4

 
3,238

26.0

Nonredeemable preferred equities
127

1.1

 
162

1.2
%
 
99

0.9

 
135

1.1

Total
$
11,161

100.0
%
 
$
13,496

100.0
%
 
$
10,591

100.0
%
 
$
12,466

100.0
%
 
 
 
 
 
 
 
 
 
 
 
 
 
When allocating cash to various asset classes, we consider market-based factors such as risk adjusted after-tax yields as well as internal measures based on regulatory and rating agency guidance. During 2013, approximately one-eighth of net purchases were equity securities. Our investment allocation decisions consider internal measures, as well as insurance department regulations and rating agency guidance. We monitor a variety of metrics, including after-tax yields, the ratio of investments in common stocks to statutory capital and surplus for the property casualty insurance operations, and the parent company’s ratio of investment assets to total assets.
 
At year-end 2013, less than 1 percent of the value of our investment portfolio was made up of securities that are classified as Level 3 assets and that require management’s judgment to develop pricing or valuation techniques. We generally obtain at least two outside valuations for these assets and generally use the more conservative estimate. These investments include private placements, small issues and various thinly traded securities. See Item 7, Fair Value Measurements, and Item 8, Note 3 of the Consolidated Financial Statements, for additional discussion of our valuation techniques.
 
In addition to securities held in our investment portfolio, at year-end 2013, other invested assets included $36 million of life policy loans and $32 million of private equity investments.

Fixed-Maturity Investments
By maintaining a well diversified fixed-maturity portfolio, we attempt to manage overall interest rate, reinvestment, credit and liquidity risk. We pursue a buy-and-hold strategy and do not attempt to make large-scale changes to the portfolio in anticipation of rate movements. By investing new money on a regular basis and analyzing risk-adjusted after-tax yields, we work to achieve a laddering effect to our portfolio that may mitigate some of the effects of adverse interest rate movements.
 
Fixed-Maturity Portfolio Ratings
At year-end 2013, this portfolio’s fair value was 105.6 percent of amortized cost, down from 110.6 percent a year ago as a result of a general rise in interest rates.
 

24



The portfolio's fair value increased modestly in 2013 as an interest-rate driven decline in bond prices nearly offset net purchases that were most heavily concentrated in corporate bonds and commercial mortgage backed securities. The majority of our nonrated securities are tax-exempt municipal bonds from smaller municipalities that chose not to pursue a credit rating. Credit ratings at year-end 2013 and 2012 for the fixed-maturity portfolio were:
(In millions)
At December 31, 2013
 
At December 31, 2012
 
Fair
value
 
Percent
of total
 
Fair
value
 
Percent
of total
Moody's Ratings and Standard & Poor's Ratings combined:
 

 
 

 
 

 
 

Aaa, Aa, A, AAA, AA, A
$
5,468

 
59.9
%
 
$
5,544

 
61.0
%
Baa, BBB
3,197

 
35.1

 
3,180

 
35.0

Ba, BB
231

 
2.5

 
168

 
1.8

B, B
16

 
0.2

 
20

 
0.2

Caa, CCC
4

 
0.0

 
2

 
0.0

Daa, Da, D

 
0.0

 
1

 
0.0

Non-rated
205

 
2.3

 
178

 
2.0

Total
$
9,121

 
100.0
%
 
$
9,093

 
100.0
%
 
 
 
 
 
 
 
 
 
Our fixed-maturity portfolio as of December 31, 2013, included approximate maturing amounts with pretax average yields-to-book value as follows: 6.1 percent maturing in 2014 with a 4.8 percent yield, 7.6 percent in 2015 with a 4.5 percent yield, and 7.9 percent in 2016 with a 4.5 percent yield. Additional maturity periods for our fixed-maturity portfolio are shown in Item 8, Note 2 of the Consolidated Financial Statements. Attributes of the fixed-maturity portfolio include:
 
At December 31,
 
2013
 
2012
 
Weighted average yield-to-amortized cost
4.9

%
5.0

%
Weighted average maturity
6.2

yrs
6.3

yrs
Effective duration
4.5

yrs
4.2

yrs
 
 
 
 
 
 
Taxable Fixed Maturities
The fair values of our taxable fixed-maturity securities portfolio at the end of the last two years were:
(In millions)
At December 31,
 
2013
 
2012
Investment-grade corporate
$
5,293

 
$
5,388

States, municipalities and political subdivisions
301

 
334

Below investment-grade corporate
240

 
182

Government sponsored enterprises
200

 
164

Commercial mortgage backed
143

 
28

Convertibles and bonds with warrants attached
17

 
31

United States government
7

 
7

Foreign government
10

 
3

Total
$
6,211

 
$
6,137

 
 
 
 
 
While our strategy typically is to buy and hold fixed-maturity investments to maturity, we monitor credit profiles and fair value movements when determining holding periods for individual securities. With the exception of U.S. agency issues, no individual issuer's securities accounted for more than 1.0 percent of the taxable fixed-maturity portfolio at year-end 2013. Investment grade corporate bonds had an average rating of Baa1 by Moody’s or BBB+ by Standard & Poor’s and represented 87.5 percent of the taxable fixed-maturity portfolio’s fair value at year end 2013, compared with 87.8 percent in 2012.
 

25



The investment-grade corporate bond portfolio is most heavily concentrated in the financial-related sectors, including banking, financial services and insurance. The financial sectors represented 32.8 percent of fair value of this portfolio at year-end 2013, compared with 31.2 percent, at year-end 2012. Although the financial-related sectors make up our largest group of investment-grade corporate bonds, we believe our concentration is below the average for the corporate bond market as a whole. The real estate sector, including commercial mortgage back securities, accounted for 11.3 percent. No other sector exceeded 10 percent of our investment-grade corporate bond portfolio at year-end 2013.
 
Most of the $301 million of securities issued by states, municipalities and political subdivisions included in our taxable fixed-maturity portfolio at the end of 2013 were Build America Bonds.
 

26



Tax-Exempt Fixed Maturities
Our tax-exempt fixed-maturity securities portfolio’s fair value was $2.910 billion at December 31, 2013. The portfolio is well diversified among approximately 1,000 municipal bond issuers. No single municipal issuer accounted for more than 0.9 percent of the tax-exempt fixed-maturity portfolio at year-end 2013. Our largest municipal bond holdings were in these states:
(In millions)
Local issued general
 
Special revenue
 
State issued general
 
Fair value
 
Percent of
At December 31, 2013
obligation bonds
 
bonds
 
obligation bonds
 
total
 
total
Texas
$
385

 
$
66

 
$

 
$
451

 
15.5
%
Michigan
238

 
9

 

 
247

 
8.5

Indiana
8

 
232

 

 
240

 
8.2

Ohio
119

 
87

 
6

 
212

 
7.3

Illinois
184

 
19

 

 
203

 
7.0

Washington
150

 
32

 
5

 
187

 
6.4

Wisconsin
108

 
32

 
2

 
142

 
4.9

Pennsylvania
93

 
9

 
9

 
111

 
3.8

Arizona
55

 
31

 

 
86

 
3.0

Florida
24

 
62

 

 
86

 
3.0

New York
48

 
31

 
4

 
83

 
2.9

Colorado
45

 
17

 

 
62

 
2.1

New Jersey
44

 
17

 

 
61

 
2.1

Minnesota
42

 
7

 
2

 
51

 
1.8

Utah
31

 
19

 

 
50

 
1.7

All other states
338

 
270

 
30

 
638

 
21.8

Total
$
1,912

 
$
940

 
$
58

 
$
2,910

 
100.0
%
 
 
 
 
 
 
 
 
 
 
At December 31, 2012
 
 
 
 
 
 
 
 
 
Texas
$
398

 
$
95

 
$

 
$
493

 
16.7
%
Indiana
15

 
286

 

 
301

 
10.2

Michigan
260

 
12

 

 
272

 
9.2

Illinois
226

 
20

 

 
246

 
8.3

Ohio
135

 
96

 

 
231

 
7.8

Washington
174

 
39

 
3

 
216

 
7.3

Wisconsin
106

 
27

 
3

 
136

 
4.6

Pennsylvania
83

 
8

 

 
91

 
3.1

Florida
21

 
65

 

 
86

 
2.9

Arizona
55

 
26

 

 
81

 
2.7

Colorado
45

 
19

 

 
64

 
2.2

New Jersey
38

 
17

 

 
55

 
1.9

New York
29

 
24

 

 
53

 
1.8

Kansas
28

 
21

 

 
49

 
1.7

Minnesota
36

 
6

 

 
42

 
1.4

All other states
285

 
253

 
2

 
540

 
18.2

Total
$
1,934

 
$
1,014

 
$
8

 
$
2,956

 
100.0
%
 
 
 
 
 
 
 
 
 
 
 
At year-end 2013, our tax-exempt fixed-maturity portfolio, with a fair value of $2.910 billion, had an average rating of Aa2/AA. Over 58 percent or $1.696 billion of the portfolio is insured, and approximately 97 percent of the insured portion carried an underlying rating of at least A3 or A- by Moody’s or Standard & Poor’s at year end. We strongly prefer general obligation or essential services bonds, which we believe provide a superior risk profile. The top three revenue resources of the $940 million in special revenue bonds owned at year-end 2013 were 35 percent from leasing, 23 percent from water and sewer and 10 percent from higher education.

27



 
Equity Investments
After covering both our intermediate and long-range insurance obligations with fixed-maturity investments, we historically used available cash flow to invest in equity securities. Investment in equity securities has played an important role in achieving our portfolio objectives and has contributed to portfolio appreciation. We remain committed to our long-term equity focus, which we believe is key to our company’s long-term growth and stability.
 
Common Stocks
Our cash allocation for common stock purchases is implemented only after we ensure that our insurance reserves are adequately covered by our fixed-maturity investments. We believe our strategy of primarily investing in a diversified selection of larger-capitalization, high-quality, dividend-increasing companies generally results in reduced volatility relative to the broader equity markets.
 
At year-end 2013 and 2012, no holding had a fair value equal to or greater than 4 percent of our publicly traded common stock portfolio. BlackRock Inc. (NYSE:BLK) was our largest single common stock investment at year end, comprising 3.2 percent of the publicly traded common stock portfolio and 1.0 percent of the entire investment portfolio.
 
At year-end 2013, 32.4 percent of our common stock holdings (measured by fair value) were held at the parent- company level. The distribution of the portfolio among industry sectors is shown in the table below.
 
Common Stock Portfolio Industry Sector Distribution
 
Percent of Publicly Traded Common Stock Portfolio
 
At December 31, 2013
 
At December 31, 2012
 
Cincinnati
Financial
 
S&P 500 Industry
Weightings
 
Cincinnati
Financial
 
S&P 500 Industry
Weightings
Sector:
 

 
 

 
 

 
 

Information technology
18.7
%
 
18.6
%
 
16.0
%
 
19.1
%
Industrials
14.0

 
10.9

 
12.9

 
10.1

Financial
12.0

 
16.2

 
11.2

 
15.6

Healthcare
11.5

 
13.0

 
12.2

 
12.0

Energy
10.5

 
10.3

 
12.0

 
11.0

Consumer staples
10.5

 
9.8

 
11.7

 
10.6

Consumer discretionary
9.8

 
12.5

 
9.7

 
11.5

Materials
5.7

 
3.5

 
5.7

 
3.6

Utilities
4.2

 
2.9

 
4.8

 
3.4

Telecomm services
3.1

 
2.3

 
3.8

 
3.1

Total
100.0
%
 
100.0
%
 
100.0
%
 
100.0
%
 
 
 
 
 
 
 
 
 
Nonredeemable Preferred Stocks
We evaluate nonredeemable preferred stocks in a manner similar to our evaluation of fixed-maturity investments, seeking attractive relative yields. We generally focus on investment-grade nonredeemable preferred stocks issued by companies with strong histories of paying common dividends, providing us with another layer of protection. When possible, we seek out nonredeemable preferred stocks that offer a dividend received deduction for income tax purposes. We purchased $48 million and sold $23 million in this portfolio in 2013. During 2012, we purchased $27 million and sold $2 million.
 
Additional information about the composition of investments is included in Item 8, Note 2 of the Consolidated Financial Statements. A detailed listing of our portfolio is updated on our website, cinfin.com/investors, each quarter when we report our quarterly financial results.
 

28



Other
We report as Other the noninvestment operations of the parent company and its noninsurer subsidiary CFC Investment Company. This subsidiary offers commercial leasing and financing services to our agencies, their clients and other customers. At year-end 2013, CFC Investment Company had 2,516 accounts and $85 million in receivables, compared with 2,562 accounts and $75 million in receivables at year-end 2012.

Regulation
The business of insurance primarily is regulated by state law. All of our insurance company subsidiaries are domiciled in the state of Ohio except The Cincinnati Specialty Underwriters Insurance Company, which is domiciled in Delaware. Each insurance subsidiary is governed by the insurance laws and regulations in its respective state of domicile. We also are subject to state regulatory authorities of all states in which we write insurance. The state laws and regulations that have the most significant effect on our insurance operations and financial reporting are discussed below.
Insurance Holding Company Regulation – We are regulated as an insurance holding company system in the respective states of domicile of our primary standard market property casualty company subsidiary and its surplus lines and life insurance subsidiaries. These regulations require that we annually furnish financial and other information about the operations of the individual companies within the holding company system. All transactions within a holding company affecting insurers must be fair and equitable. Notice to the state insurance commissioner is required prior to the consummation of transactions affecting the ownership or control of an insurer and prior to certain material transactions between an insurer and any person or entity in its holding company group. In addition, some of those transactions cannot be consummated without the commissioner’s prior approval. Recent amendments to the Model Insurance Holding Company System Regulatory Act and Regulation, adopted by the National Association of Insurance Commissioners (NAIC) and passed by a number of state legislatures, require insurance holding company systems to provide regulators with more information about the risks posed by any noninsurance company subsidiaries in the holding company system.
Subsidiary Dividends – The Cincinnati Insurance Company is 100 percent owned by Cincinnati Financial Corporation. The dividend-paying capacity of The Cincinnati Insurance Company and its 100 percent owned subsidiaries is regulated by the laws of the applicable state of domicile. Under these laws, our insurance subsidiaries must provide a 10-day advance informational notice to the insurance commissioner for the domiciliary state prior to payment of any dividend or distribution to its shareholders. Generally, the most our insurance subsidiary can pay without prior regulatory approval is the greater of 10 percent of statutory capital and surplus or 100 percent of statutory net income for the prior calendar year.
The insurance company subsidiaries must give 30 days’ notice to and obtain prior approval from the state insurance commissioner before the payment of an extraordinary dividend as defined by the state’s insurance code. You can find information about the dividends paid by our insurance subsidiary in 2013 in Item 8, Note 9 of the Consolidated Financial Statements.
Insurance Operations – All of our insurance subsidiaries are subject to licensing and supervision by departments of insurance in the states in which they do business. The nature and extent of such regulations vary, but generally are rooted in statutes that delegate regulatory, supervisory and administrative powers to state insurance departments. Such regulations, supervision and administration of the insurance subsidiaries include, among others, the standards of solvency that must be met and maintained; the licensing of insurers and their agents and brokers; the nature and limitations on investments; deposits of securities for the benefit of policyholders; regulation of standard market policy forms and premium rates; policy cancellations and nonrenewals; periodic examination of the affairs of insurance companies; annual and other reports required to be filed on the financial condition of insurers or for other purposes; requirements regarding reserves for unearned premiums, losses and other matters; the nature of and limitations on dividends to policyholders and shareholders; the nature and extent of required participation in insurance guaranty funds; the involuntary assumption of hard-to-place or high-risk insurance business, primarily workers’ compensation insurance; and the collection, remittance and reporting of certain taxes and fees. Our primary insurance regulators have adopted the Model Audit Rule for annual statutory financial reporting. This regulation closely mirrors the Sarbanes-Oxley Act on matters such as auditor independence, corporate governance and internal controls over financial reporting. The regulation permits the audit committee of Cincinnati Financial Corporation’s board of directors to also serve as the audit committee of each of our insurance subsidiaries for purposes of this regulation.
Insurance Guaranty Associations – Each state has insurance guaranty association laws under which the associations may assess life and property casualty insurers doing business in the state for certain obligations of insolvent insurance companies to policyholders and claimants. Typically, states assess each member insurer in

29



an amount related to the insurer’s proportionate share of business written by all member insurers in the state. Our insurance companies received a savings of less than $1 million from guaranty association refunds in both 2013 and 2012. We cannot predict the amount and timing of any future assessments or refunds on our insurance subsidiaries under these laws.
Shared Market and Joint Underwriting Plans – State insurance regulation requires insurers to participate in assigned risk plans, reinsurance facilities and joint underwriting associations, which are mechanisms that generally provide applicants with various basic insurance coverages when they are not available in voluntary markets. Such mechanisms are most commonly instituted for automobile and workers’ compensation insurance, but many states also mandate participation in FAIR Plans or Windstorm Plans, which provide basic property coverages. Participation is based upon the amount of a company’s voluntary market share in a particular state for the classes of insurance involved. Underwriting results related to these organizations could be adverse to our company.
Statutory Accounting – For public reporting, insurance companies prepare financial statements in accordance with GAAP. However, certain data also must be calculated according to statutory accounting rules as defined in the NAIC’s Accounting Practices and Procedures Manual. While not a substitute for any GAAP measure of performance, statutory data frequently is used by industry analysts and other recognized reporting sources to facilitate comparisons of the performance of insurance companies.
Insurance Reserves – State insurance laws require that property casualty and life insurers annually analyze the adequacy of reserves. Our appointed actuaries must submit an opinion that reserves are adequate for policy claims-paying obligations and related expenses.
Investment Regulation – Insurance company investments must comply with laws and regulations pertaining to the type, quality and concentration of investments. Such laws and regulations permit investments in federal, state and municipal obligations, corporate bonds, preferred and common equity securities, mortgage loans, real estate and certain other investments, subject to specified limits and other qualifications. At December 31, 2013, the company believes it was in compliance with these laws and regulations in all material respects.
Risk-Based Capital Requirements – The NAIC’s risk-based capital (RBC) requirements for property casualty and life insurers serve as an early warning tool for the NAIC and state regulators to identify companies that may be undercapitalized and may merit further regulatory action. The NAIC has a standard formula for annually assessing RBC. The formula for calculating RBC for property casualty companies takes into account asset and credit risks but places more emphasis on underwriting factors for reserving and pricing. The formula for calculating RBC for life insurance companies takes into account factors relating to insurance, business, asset and interest-rate risks.

Although the federal government and its regulatory agencies generally do not directly regulate the business of insurance, federal legislation and administrative rules adopted to implement them do affect our business. Privacy laws, such as the Gramm-Leach-Bliley Act, the Fair Credit Reporting Act and the Health Insurance Portability and Accounting Act (HIPAA) are the federal laws that most affect our day-to-day operations. These apply to us because we gather and use personal nonpublic information to underwrite insurance and process claims. We also are subject to other federal laws, such as the Terrorism Risk Insurance Act (TRIA), anti-money laundering statute (AML), the Nonadmitted and Reinsurance Reform Act (NRRA), and the rules and regulations of the Office of Foreign Assets Control (OFAC).
 
Title V of the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010 (Dodd-Frank) created the Federal Insurance Office to monitor the insurance industry and gather information to identify issues or gaps in the regulation of insurers that could contribute to a systemic crisis in the insurance industry of the United States financial system, and to recommend to the Financial Stability Oversight Council that it designate an insurer as a systemically significant entity requiring additional supervision by the Federal Reserve Board. We do not expect Dodd-Frank to result in federal oversight of our operations as a systemically significant entity.
 
We do not expect to have any material effects on our expenditures, earnings or competitive position as a result of compliance with any federal, state or local provisions enacted or adopted relating to the protection of the environment. We currently do not have any material estimated capital expenditures for environmental control facilities.
 

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Enterprise Risk Management
We manage enterprise risk through formal risk management programs overseen by our chief risk officer, an executive officer of the company.  Our ERM framework includes the enterprise risk management risk committee, comprised of senior executive-level owners from across the enterprise, which is responsible for overseeing risk activities.  The risk committee activities are supported by a team of representatives from business areas that focus on identifying, evaluating and developing risk plans for emerging risks. A comprehensive report is provided quarterly to our chairman, our president and chief executive officer, our board of directors and our senior executive team, as appropriate, on the status of risk metrics relative to identified tolerances and limits, risk assessments and risk plans. Our use of operational audits, strategic plans and departmental business plans, as well as our culture of open communications and our fundamental respect for our Code of Conduct, continue to help us manage risks on an ongoing basis.

Our risk management programs include a formalized risk appetite element and a risk identification and quantification process. The overall enterprise objective is to appropriately balance risk and reward to achieve an appropriate return on risk capital.  The company’s key risks, including risks related to natural catastrophes, investments and operations, are discussed in Item 1A, Risk Factors.

We continue to study emerging risks, including climate change risk and its potential financial effects on our results of operation and on those we insure. These effects include deterioration in credit quality of our municipal or corporate bond portfolios and increased losses without sufficient corresponding increases in premiums. As with any risk, we seek to identify the extent of the risk exposure and possible actions to mitigate potential negative effects of risk, at an enterprise level.

ITEM 1A.   Risk Factors
Our business involves various risks and uncertainties that may affect achievement of our business objectives. Many of the risks could have ramifications across our organization. For example, while risks related to setting insurance rates and establishing and adjusting loss reserves are insurance activities, errors in these areas could have an impact on our investment activities, growth and overall results.
 
The following discussion should be viewed as a starting point for understanding the significant risks we face. It is not a definitive summary of their potential impacts or of our strategies to manage and control the risks. Please see Item 7, Management’s Discussion and Analysis of Financial Condition and Results of Operations, for a discussion of those strategies.
 
If any risks or uncertainties discussed here develop into actual events, they could have a material adverse effect on our business, financial condition or results of operations. In that case, the market price of our common stock could decline materially.
 
Readers should carefully consider this information together with the other information we have provided in this report and in other reports and materials we file periodically with the Securities and Exchange Commission as well as news releases and other information we disseminate publicly.
 
We rely exclusively on independent insurance agents to distribute our products.
We market our products through independent, nonexclusive insurance agents. These agents are not obligated to promote our products and can and do sell our competitors’ products. We must offer insurance products that meet the needs of these agencies and their clients. We need to maintain good relationships with the agencies that market our products. If we do not, these agencies may market our competitors’ products instead of ours, which may lead to us having a less desirable mix of business and could affect our results of operations.
 
Certain events or conditions could diminish our agents’ desire to produce business for us and the competitive advantage that our independent agencies enjoy, including:
Downgrade of the financial strength ratings of our insurance subsidiaries. We believe our strong insurer financial strength ratings, in particular, the A+ (Superior) ratings from A.M. Best for our standard market property casualty insurance group and each subsidiary in that group, are an important competitive advantage. See Item 1, Financial Strength, for additional discussion of our financial strength ratings.
Concerns that doing business with us is difficult or not profitable, perceptions that our level of service is no longer a distinguishing characteristic in the marketplace, perceptions that our products do not meet the needs of our

31



agents’ clients or perceptions that our business practices are not compatible with agents’ business models. Mergers and acquisitions could result in a concentration of a significant amount of premium in one agency.
Delays in the development, implementation, performance and benefits of technology systems and enhancements or independent agent perceptions that our technology solutions do not match their needs.

A reduction in the number of independent agencies marketing our products, the failure of agencies to successfully market our products or pay their accounts to us, changes in the strategy or operations of agencies or the choice of agencies to reduce their writings of our products could affect our results of operations if we were unable to replace them with agencies that produce adequate and profitable premiums.
 
Further, policyholders may choose a competitor’s product rather than our own because of real or perceived differences in price, terms and conditions, coverage or service. If the quality of the independent agencies with which we do business were to decline, that also might cause policyholders to purchase their insurance through different agencies or channels. Consumers, especially in the personal insurance segments, may increasingly choose to purchase insurance from distribution channels other than independent insurance agents, such as direct marketers. Increased advertising by insurers, especially direct marketers, could cause consumers to shift their buying habits, bypassing independent agents altogether.
 
Our credit ratings or financial strength ratings of our insurance subsidiaries could be downgraded.
A downgrade in one or more of our company’s credit or debt ratings could adversely impact our borrowing costs or limit our access to capital. Financial strength ratings reflect a rating agency’s opinion of our insurance subsidiaries’ financial strength, operating performance, strategic position and ability to meet obligations to policyholders. Our ratings are subject to periodic review and there is no assurance that our ratings will not be changed. Ratings agencies could change or expand their requirements or could find that our insurance subsidiaries no longer meet the criteria established for current ratings. If our property casualty insurer financial strength ratings were to be downgraded, our agents might find it more difficult to market our products or might choose to emphasize the products of other carriers. See Item 7, Liquidity and Capital Resources, Additional Sources of Liquidity, for additional discussion of ratings for our long-term debt.
 
We could experience an unusually high level of losses due to catastrophic, terrorism or pandemic events or risk concentrations.
In the normal course of our business, we provide coverage against perils for which estimates of losses are highly uncertain, in particular catastrophic and terrorism events. Catastrophes can be caused by a number of events, including hurricanes, tornadoes, windstorms, earthquakes, hailstorms, explosions, severe winter weather and fires. Due to the nature of these events, we are unable to predict precisely the frequency or potential cost of catastrophe occurrences. Various scientists and other experts believe that changing climate conditions have added to the unpredictability, frequency and severity of such natural disasters in certain parts of the world and have created additional uncertainty as to future trends and exposures. We cannot predict the impact that changing climate conditions may have on our results of operations nor can we predict how any legal, regulatory or social responses to concerns about climate change may impact our business. Additionally, man-made events, such as hydraulic fracturing, could cause damage from earth movement or create environmental hazards.
 
The extent of losses from a catastrophe is a function of both the total amount of insured exposure in the area affected by the event and the severity of the event. Our ability to appropriately manage catastrophe risk depends partially on catastrophe models, which may be affected by inaccurate or incomplete data, the uncertainty of the frequency and severity of future events and the uncertain impact of climate change. Additionally, these models are recalibrated and changed over time, with more data availability and changing opinions regarding the effect of current or emerging loss patterns and conditions. Please see Item 7, 2014 Reinsurance Programs, for a discussion of modeled losses considered in evaluating our reinsurance strategy.
 

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The geographic regions in which we market insurance are exposed to numerous natural catastrophes, such as:
Hurricanes in the gulf, eastern and southeastern coastal regions.
Earthquakes in many regions, most particularly in the New Madrid fault zone, which lies within the central Mississippi valley, extending from northeast Arkansas through southeast Missouri, western Tennessee and western Kentucky to southern Illinois, southern Indiana and parts of Ohio.
Tornado, wind and hail in the Midwest, South, Southeast, Southwest and the mid-Atlantic.
Wild fires in the West.

The occurrence of terrorist attacks in the geographic areas we serve could result in substantially higher claims under our insurance policies than we have anticipated. While we do insure terrorism risk in all areas we serve, we have identified our major terrorism exposure geographically as general commercial risks in the Tier 1 cities of metropolitan Chicago area, and to a much lesser degree, Washington DC, Houston and Los Angeles. We have a greater amount of business in less hazardous Tier 2 cities such as Atlanta, Phoenix-Mesa, Minneapolis, Cleveland, St. Louis, Denver, Tampa-St. Petersburg, Pittsburgh and Cincinnati. We have exposure to small co-op utilities, water utilities, wholesale fuel distributors, small shopping malls and small colleges throughout our 39 active states and, because of the number of associates located there, our Fairfield, Ohio, headquarters. Additionally, our life insurance subsidiary could be adversely affected in the event of a terrorist event or an epidemic such as the avian or swine flu, particularly if the epidemic were to affect a broad range of the population beyond just the very young or the very old. Our associate health plan is self-funded and could similarly be affected.
 
Our results of operations would be adversely affected if the level of losses we experience over a period of time were to exceed our actuarially determined expectations. In addition, our financial condition may be adversely affected if we were required to sell securities prior to maturity or at unfavorable prices to pay an unusually high level of loss and loss expenses. Securities pricing might be even less favorable if a number of insurance or other companies and other investors needed to sell securities during a short period of time because of unusually high losses from catastrophic events.
 
Our geographic concentration ties our performance to business, economic, environmental and regulatory conditions in certain states. We market our standard market property casualty insurance products in 39 states, but our business is concentrated in the Midwest and Southeast. We also have exposure in states where we do not actively market insurance when clients of our independent agencies have businesses or properties in multiple states.
 
The Cincinnati Insurance Company also participates in certain assumed reinsurance treaties with reinsurers that spread the risk of very large catastrophe losses among many insurers. At the beginning of 2014, two surplus share treaties were in effect with the largest treaty representing exposure for us of up to $3 million of assumed losses from a single catastrophic event. If there is a high frequency of very large catastrophe events during a coverage period of the treaty, our financial position and results of operations could be materially affected. Please see Item 7, 2014 Reinsurance Programs, for a discussion of our reinsurance treaties.
 
In the event of a severe catastrophic event or terrorist attack elsewhere in the world, our insurance losses may be immaterial. However, the companies we invest in might be severely affected, which could affect our financial condition and results of operations. Our reinsurers might experience significant losses, potentially jeopardizing their ability to pay losses we cede to them. It could also reduce the availability of reinsurance. If we cannot obtain adequate coverage at a reasonable cost, it could constrain where we can write business or reduce the amount of business we can write in certain areas. We also may be exposed to state guaranty fund assessments if other carriers in a state cannot meet their obligations to policyholders. A catastrophe or epidemic event also could affect our operations by damaging our headquarters facility, injuring associates and visitors at our Fairfield, Ohio, headquarters or disrupting our associates’ ability to perform their assigned tasks.
 
Our ability to achieve our performance objectives could be affected by changes in the financial, credit and capital markets or the general economy.
We invest premiums received from policyholders and other available cash to generate investment income and capital appreciation, while also maintaining sufficient liquidity to pay covered claims and operating expenses, service our debt obligations and pay dividends. The value of our invested assets is an important component of shareholders’ equity, also known as book value. Changes in the valuation of invested assets can significantly affect changes in book value per share, a key performance objective as discussed in Item 7, Executive Summary of the Management’s Discussion and Analysis.

33



 
For fixed-maturity investments such as bonds, which represented 67.6 percent of the fair value of our invested assets at the end of 2013, the inverse relationship between interest rates and bond prices leads to falling bond values during periods of increasing interest rates. A significant increase in the general level of interest rates could have an adverse effect on our shareholders’ equity.
 
Investment income is an important component of our revenues and net income. The ability to increase investment income and generate longer-term growth in book value is affected by factors beyond our control, such as: inflation, economic growth, interest rates, world political conditions, changes in laws and regulations, terrorism attacks or threats, adverse events affecting other companies in our industry or the industries in which we invest, market events leading to credit constriction, and other widespread unpredictable events. These events may adversely affect the economy generally and could cause our investment income or the value of securities we own to decrease. A significant decline in our investment income could have an adverse effect on our net income, and thereby on our shareholders’ equity and our statutory capital and surplus. For example, a significant increase in the general level of interest rates could lead to falling bond values. For more detailed discussion of risks associated with our investments, please refer to Item 7A, Quantitative and Qualitative Disclosures About Market Risk.
 
We issue life contracts with guaranteed minimum returns, referred to as bank-owned life insurance contracts (BOLIs). BOLI investment assets must meet certain criteria established by the regulatory authorities in the jurisdiction for which the group contract holder is subject. Therefore, sales of investments may be mandated to maintain compliance with these regulations, possibly requiring gains or losses to be recorded. We could experience losses if the assets in the accounts were less than liabilities at the time of maturity or termination.
 
Our investment performance also could suffer because of the types of investments, industry groups and/or individual securities in which we choose to invest. Market value changes related to these choices could cause a material change in our financial condition or results of operations.
 
At year-end 2013, common stock holdings made up 31.2 percent of our investment portfolio. Adverse news or events affecting the global or U.S. economy or the equity markets could affect our net income, book value and overall results, as well as our ability to pay our common stock dividend. See Item 7, Investments Results of Operations, and Item 7A, Quantitative and Qualitative Disclosures About Market Risk, for discussion of our investment activities.
 
Deterioration in the banking sector or in banks with which we have relationships could affect our results of operations. Our ability to maintain or obtain short-term lines of credit could be affected if the banks from which we obtain these lines are acquired, fail or are otherwise negatively affected. We may lose premium revenue if a bank that owns appointed agencies were to change its strategies. We could experience increased losses in our director and officer liability line of business if claims were made against insured financial institutions.
 
A deterioration of credit and market conditions could also impair our ability to access credit markets and could affect existing or future lending arrangements.
 
Our overall results could be affected if a significant portion of our commercial lines policyholders, including those purchasing surety bonds, are adversely affected by marked or prolonged economic downturns and events such as a downturn in construction and related sectors, tightening credit markets and higher fuel costs. Such events could make it more difficult for policyholders to finance new projects, complete projects or expand their businesses, leading to lower premiums from reduced payrolls and sales and lower purchases of equipment and vehicles. These events could also cause claims, including surety claims, to increase due to a policyholder’s inability to secure necessary financing to complete projects or to collect on underlying lines of credit in the claims process. Such economic downturns and events could have a greater impact in the construction sector where we have a concentration of risks and in geographic areas that are hardest hit by economic downturns.
 
Deteriorating economic conditions could also increase the degree of credit risk associated with amounts due from independent agents who collect premiums for payment to us and could hamper our ability to recover amounts due from reinsurers.
 

34



Our ability to properly underwrite and price risks and increased competition could adversely affect our results.
Our financial condition, cash flow and results of operations depend on our ability to underwrite and set rates accurately for a full spectrum of risks. We establish our pricing based on assumptions about the level of losses that may occur within classes of business, geographic regions and other criteria.
 
To properly price our products, we must collect, properly analyze and use data to make decisions and take appropriate action; the data must be sufficient, reliable and accessible; we need to develop appropriate rating methodologies and formulae; and we may need to identify and respond to trends quickly. We may overestimate or underestimate loss cost trends or these trends may unexpectedly change, leading to losing business by pricing risks above our competitors or charging rates too low to maintain profitability. Inflation trends, especially outside of historical norms, may make it more difficult to determine adequate pricing. If rates are not accurate, we may not generate enough premiums to offset losses and expenses or we may not be competitive in the marketplace.
 
Our ability to set appropriate rates could be hampered if a state or states where we write business refuses to allow rate increases that we believe are necessary to cover the risks insured. At least one state requires us to purchase reinsurance from a mandatory reinsurance fund. Such reinsurance funds can create a credit risk for insurers if not adequately funded by the state and, in some cases, the existence of a reinsurance fund could affect the prices charged for our policies. The effect of these and similar arrangements could reduce our profitability in any given period or limit our ability to grow our business.
 
The insurance industry is cyclical and intensely competitive. From time to time, the insurance industry goes through prolonged periods of intense competition during which it is more difficult to attract new business, retain existing business and maintain profitability. Competition in our insurance business is based on many factors, including:
Competitiveness of premiums charged
Relationships among carriers, agents, brokers and policyholders
Underwriting and pricing methodologies that allow insurers to identify and flexibly price risks
Compensation provided to agents
Underwriting discipline
Terms and conditions of insurance coverage
Speed with which products are brought to market
Product and marketing innovations, including advertising
Technological competence and innovation
Ability to control expenses
Adequacy of financial strength ratings by independent ratings agencies such as A.M. Best
Quality of services and tools provided to agents and policyholders
Claims satisfaction and reputation

If our pricing were incorrect or we were unable to compete effectively because of one or more of these factors, our premium writings could decline and our results of operations and financial condition could be materially adversely affected. Large competitors could intentionally disrupt the market by targeting certain lines or underpricing the market.
 
Please see the discussion of our Commercial Lines, Personal Lines, Excess and Surplus Lines and Life Insurance Segments in Item 1, for a discussion of our competitive position in the insurance marketplace.
 
Our pricing and capital models could be flawed.  
We use various predictive pricing models, stochastic models and/or forecasting techniques to help us to understand our business, analyze risk and estimate future trends. The output of these models is used to assist us in making underwriting, pricing, reinsurance, reserving and capital decisions and helps us set our strategic direction. These models contain numerous assumptions and are subject to uncertainties and limitations inherent in any statistical analysis. Actual results might differ from modeled output, resulting in pricing our products incorrectly, overestimating

35



or underestimating reserves, or inaccurately forecasting the impact of modeled events on our results. This could materially adversely impact the results of our operations.
 
Our loss reserves, our largest liability, are based on estimates and could be inadequate to cover our actual losses.
Our consolidated financial statements are prepared using GAAP. These principles require us to make estimates and assumptions that affect the amounts reported in the Consolidated Financial Statements and accompanying Notes. Actual results could differ materially from those estimates. For a discussion of the significant accounting policies we use to prepare our financial statements, the material implications of uncertainties associated with the methods, assumptions and estimates underlying our critical accounting policies and the process used to determine our loss reserves, please refer to Item 8, Note 1 of the Consolidated Financial Statements, and Item 7, Critical Accounting Estimates, Property Casualty Insurance Loss and Loss Expense Reserves and Life Insurance Policy Reserves.
 
Our most critical accounting estimate is loss reserves. Loss reserves are the amounts we expect to pay for covered claims and expenses we incur to settle those claims. The loss reserves we establish in our financial statements represent an estimate of amounts needed to pay and administer claims arising from insured events that have already occurred, including events that have not yet been reported to us. Loss reserves are estimates and are inherently uncertain; they do not and cannot represent an exact measure of liability. Inflationary scenarios, especially scenarios outside of historical norms or regulatory changes that affect the assumptions underlying our critical accounting estimates, may make it more difficult to estimate loss reserves. Accordingly, our loss reserves for past periods could prove to be inadequate to cover our actual losses and related expenses. Any changes in these estimates are reflected in our results of operations during the period in which the changes are made. An increase in our loss reserves would decrease earnings, while a decrease in our loss reserves would increase earnings.
 
Unforeseen losses, the type and magnitude of which we cannot predict, may emerge in the future. These additional losses could arise from changes in the legal environment, laws and regulations, climate change, catastrophic events, increases in loss severity or frequency, environmental claims, mass torts or other causes. Such future losses could be substantial. Inflationary scenarios may cause the cost of claims, especially medical claims, to rise, impacting reserve adequacy and our results of operations.
 
Our ability to obtain or collect on our reinsurance protection could affect our business, financial condition, results of operations and cash flows.
We buy property casualty and life reinsurance coverage to mitigate the liquidity risk and earnings volatility risk of an unexpected rise in claims severity or frequency from catastrophic events or a single large loss. The availability, amount and cost of reinsurance depend on market conditions and may vary significantly. If we were unable to obtain reinsurance on acceptable terms and in appropriate amounts, our business and financial condition could be adversely affected.
 
In addition, we are subject to credit risk with respect to our reinsurers. Although we purchase reinsurance to manage our risks and exposures to losses, this reinsurance does not discharge our direct obligations under the policies we write. We would remain liable to our policyholders even if we were unable to recover what we believe we are entitled to receive under our reinsurance contracts. Reinsurers might refuse or fail to pay losses that we cede to them, or they might delay payment. For long-tail claims, the creditworthiness of our reinsurers may change before we can recover amounts to which we are entitled. A reinsurer’s insolvency, inability or unwillingness to make payments under the terms of its reinsurance agreement with our insurance subsidiaries could have a material adverse effect on our financial position, results of operations and cash flows.
 
Please see Item 7, Liquidity and Capital Resources, 2014 Reinsurance Programs, for a discussion of selected reinsurance transactions.
 
Our business depends on the uninterrupted operation of our facilities, systems and business functions.
Our business depends on our associates’ ability to perform necessary business functions, such as processing new and renewal policies and claims. We increasingly rely on technology and systems to accomplish these business functions in an efficient and uninterrupted fashion. Our inability to access our headquarters facilities or a failure of technology, telecommunications or other systems could significantly impair our ability to perform such functions on a timely basis or affect the accuracy of transactions. If sustained or repeated, such a business interruption or system failure could result in a deterioration of our ability to write and process new and renewal business, serve our agents and policyholders, pay claims in a timely manner, collect receivables or perform other necessary business

36



functions. If our disaster recovery and business continuity plans did not sufficiently consider, address or reverse the circumstances of an interruption or failure, this could result in a materially adverse effect on our operating results and financial condition. This risk is exacerbated because approximately 68 percent of our associates work at our Fairfield, Ohio, headquarters.
 
Our ability to successfully execute business functions also depends on hiring and retaining qualified associates. Competition for high-quality executives and other key associates occurs within the insurance industry and from other industries. We also must effectively develop and manage associates, including providing training and resources. Such tools and information can allow them to effectively perform critical business functions and adapt to changing business needs. If we were unable to attract and retain certain associates, or if we fail to provide adequate training or resources, we could limit the success of executing our strategic plans and vital business functions.
 
The effects of changes in industry practices, laws and regulations on our business are uncertain.
As industry practices and legal, judicial, legislative, regulatory, political, social and other environmental conditions change, unexpected and unintended issues related to insurance pricing, claims and coverage, may emerge. These issues may adversely affect our business by impeding our ability to obtain adequate rates for covered risks, extending coverage beyond our underwriting intent, by increasing the number or size of claims, by varying assumptions underlying our critical accounting estimates or by increasing duties owed to policyholders beyond contractual obligations. In some instances, unforeseeable emerging and latent claim and coverage issues may not become apparent until sometime after we have issued the insurance policies that could be affected by the changes. As a result, the full extent of liability under our insurance contracts may not be known for many years after a policy is issued and our pricing and reserve estimates may not accurately reflect its effect.
 
We are required to adopt new or revised accounting standards issued by recognized authoritative organizations, including the Financial Accounting Standards Board (FASB) and the SEC. Future changes required to be adopted could change the current accounting treatment that we apply and could result in material adverse effects on our results of operations and financial condition.
 
Our investment income benefits from tax rate preferences for municipal bond interest and dividend income from equity securities. Market valuations for these securities also benefit from the tax-preference aspect of current tax laws, affecting the value of our investment portfolio and also shareholders’ equity. Future changes in tax laws could result in material adverse effects on our results of operations and financial condition.
 
The NAIC, state insurance regulators and state legislators continually re-examine existing laws and regulations governing insurance companies and insurance holding companies, specifically focusing on modifications to statutory accounting principles, interpretations of existing laws, regulations relating to product forms and pricing methodologies and the development of new laws and regulations that affect a variety of financial and nonfinancial components of our business. Any proposed or future legislation, regulation or NAIC initiatives, if adopted, may be more restrictive on our ability to conduct business than current regulatory requirements or may result in higher costs.
 
Federal laws and regulations, including those that may be enacted in the wake of the financial and credit crises, may have adverse effects on our business, potentially including a change from a state-based system of regulation to a system of federal regulation, the repeal of the McCarran Ferguson Act, and/or measures under the Dodd-Frank Act that establish the Federal Insurance Office and provide for a determination that a nonbank financial company presents systemic risk and therefore should be subject to heightened supervision by the Federal Reserve Board. It is not known how this federal office will coordinate and interact with the NAIC and state insurance regulators. Adoption or implementation of any of these measures may restrict our ability to conduct our insurance business, govern our corporate affairs or increase our cost of doing business.
 
The effects of such changes could adversely affect our results of operations. Please see Item 7, Critical Accounting Estimates, Property Casualty Insurance Loss and Loss Expense Reserves and Life Insurance Policy Reserves, for a discussion of our reserving practices.
 
Managing technology initiatives and meeting data security requirements are significant challenges.
While technology can streamline many business processes and ultimately reduce the cost of operations, technology initiatives present short-term cost, and also have implementation and operational risks. In addition, we may have

37



inaccurate expense projections, implementation schedules or expectations regarding the effectiveness and user acceptance of the end product. These issues could escalate over time. If we were unable to find and retain associates with key technical knowledge, our ability to develop and deploy key technology solutions could be hampered.
 
We necessarily collect, use and hold data concerning individuals and businesses with whom we have a relationship. Threats to data security, including unauthorized access and cyber attacks, rapidly emerge and change, exposing us to additional costs for protection or remediation and competing time constraints to secure our data in accordance with customer expectations and statutory and regulatory requirements.
 
While we take all commercially reasonable measures to keep our systems and data secure, it is difficult or impossible to defend against every risk being posed by changing technologies as well as criminals’ intent on committing cyber-crime. Increasing sophistication of cyber-criminals and terrorists make keeping up with new threats difficult and could result in a breach. Patching and other measures to protect existing systems and servers could be inadequate, especially on systems that are being retired. Controls employed by our U.S., off-shore and cloud vendors could prove inadequate. We could also experience a breach by intentional or negligent conduct on the part of associates or other internal sources. Our systems and those of our third-party vendors may become vulnerable to damage or disruption due to circumstances beyond our or their control, such as from catastrophic events, power anomalies or outages, natural disasters, network failures, and viruses and malware.
 
A breach of our security that results in unauthorized access to our data could expose us to a disruption or challenges relating to our daily operations as well as to data loss, litigation, damages, fines and penalties, significant increases in compliance costs and reputational damage.
 
Our status as an insurance holding company with no direct operations could affect our ability to pay dividends in the future.
Cincinnati Financial Corporation is a holding company that transacts substantially all of its business through its subsidiaries. Our primary assets are the stock in our operating subsidiaries and our investments. Consequently, our cash flow to pay cash dividends and interest on our long-term debt depends on dividends we receive from our operating subsidiaries and income earned on investments held at the parent-company level.
 
Dividends paid to our parent company by our insurance subsidiary are restricted by the insurance laws of Ohio, its domiciliary state. These laws establish minimum solvency and liquidity thresholds and limits. In 2014, the maximum dividend that may be paid without prior regulatory approval is limited to the greater of 10 percent of statutory capital and surplus or 100 percent of statutory net income for the prior calendar year, up to the amount of statutory unassigned capital and surplus as of the end of the prior calendar year. Dividends exceeding these limitations may be paid only with prior approval of the Ohio Department of Insurance. Consequently, at times, we might not be able to receive dividends from our insurance subsidiary, or we might not receive dividends in the amounts necessary to meet our debt obligations or to pay dividends on our common stock without liquidating securities. This could affect our financial position.
 
Please see Item 1, Regulation, and Item 8, Note 9 of the Consolidated Financial Statements, for discussion of insurance holding company dividend regulations.
 

ITEM 1B.    Unresolved Staff Comments
None
 
ITEM 2.    Properties
Cincinnati Financial Corporation owns our headquarters building located on 100 acres of land in Fairfield, Ohio. This building has 1,508,200 total square feet of available space. The property, including land, is carried in our financial statements at $141 million as of December 31, 2013, and is classified as land, building and equipment, net, for company use. John J. & Thomas R. Schiff & Co. Inc., a related party, occupies 6,750 square feet (less than 1 percent). This property is used by all segments reported in the Consolidated Financial Statements and accompanying Notes.
 

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Cincinnati Financial Corporation also owns the Fairfield Executive Center, which is located on the northwest corner of our headquarters property. This four-story office building has approximately 124,000 square feet of available space. The property is carried in the financial statements at $7 million as of December 31, 2013, and is classified as land, building and equipment, net, for company use. Unaffiliated tenants occupy 6 percent. This property is used by all segments reported in the Consolidated Financial Statements and accompanying Notes.
 
The Cincinnati Insurance Company owns the CFC Winton Center used for business continuity, with approximately 48,000 square feet of available space, located approximately six miles from our headquarters. The property, including land, is carried on our financial statements at $10 million as of December 31, 2013, and is classified as land, building and equipment, net, for company use. This property is used by all segments reported in the Consolidated Financial Statements and accompanying Notes.
 
ITEM 3.    Legal Proceedings
Neither the company nor any of our subsidiaries is involved in any material litigation other than ordinary, routine litigation incidental to the nature of its business.
 
ITEM 4.    Mine Safety Disclosures
This item is not applicable to the company.
 

Part II
ITEM 5.    Market for the Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities
Cincinnati Financial Corporation had approximately 77,000 shareholders of record as of December 31, 2013. While approximately 13,000 shareholders are registered, the majority of shareholders are beneficial owners whose shares are held in “street name” by brokers and institutional accounts. We believe many of our independent agent representatives and most of the 4,163 associates of our subsidiaries own the company’s common stock.
 
Our common shares are traded under the symbol CINF on the Nasdaq Global Select Market.
(Source: Nasdaq Global Select Market)
 
2013
 
2012
Quarter:
 
1st
 
2nd
 
3rd
 
4th
 
1st
 
2nd
 
3rd
 
4th
High
 
$
47.35

 
$
50.60

 
$
50.01

 
$
53.74

 
$
36.05

 
$
38.12

 
$
40.22

 
$
40.96

Low
 
39.60

 
44.53

 
43.62

 
46.61

 
30.06

 
33.06

 
36.50

 
36.96

Period-end close
 
47.22

 
45.92

 
47.16

 
52.37

 
34.51

 
38.07

 
37.87

 
39.16

Cash dividends declared
 
0.4075

 
0.4075

 
0.42

 
0.42

 
0.4025

 
0.4025

 
0.4075

 
0.4075

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
We discuss the factors that affect our ability to pay cash dividends and repurchase shares in Item 7, Liquidity and Capital Resources. Regulatory restrictions on dividends our insurance subsidiary can pay to the parent company are discussed in Item 8, Note 9 of the Consolidated Financial Statements.
 

39



The following summarizes securities authorized for issuance under our equity compensation plans as of December 31, 2013:
Plan category
 
Number of securities to be
issued upon exercise of
outstanding options,
warrants and rights at
December 31, 2013
 
Weighted-average exercise
price of outstanding
options, warrants and rights
 
Number of securities remaining
available for future issuance under
equity compensation plan (excluding
securities reflected in column (a)) at
December 31, 2013
 
 
(a)
 
(b)
 
(c)
Equity compensation plans
    approved by security holders
 
6,332,299

 
$
38.39

 
7,714,566

Equity compensation plans not
    approved by security holders
 

 

 

    Total
 
6,332,299

 
$
38.39

 
7,714,566

 
 
 
 
 
 
 
 
The number of securities remaining available for future issuance includes: 6,841,330 shares available for issuance under the Cincinnati Financial Corporation 2012 Stock Compensation Plan (the 2012 Plan), 674,519 shares available for issuance under the Cincinnati Financial Corporation 2006 Stock Compensation Plan (the 2006 Plan), and 198,717 shares available for issuance of share grants under the Director’s Stock Plan of 2009. Both the 2012 Plan and 2006 Plan allow for issuance of stock options, service-based, or performance-based restricted stock units, stock appreciation rights or other equity-based grants. Awards other than stock options and stock appreciation rights granted from the 2012 and 2006 plans are counted as three shares against the plan for each one share of common stock actually issued. Additional information about stock-based associate compensation granted under our equity compensation plans is available in Item 8, Note 17 of the Consolidated Financial Statements.
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
January 1-31, 2013
 
5,776

 
$
41.73

 
5,776

 
7,121,462

February 1-28, 2013
 
100,628

 
44.60

 
100,628

 
7,020,834

March 1-31, 2013
 
93,709

 
46.15

 
93,709

 
6,927,125

April 1-30, 2013
 
30,274

 
48.17

 
30,274

 
6,896,851

May 1-31, 2013
 
82,600

 
49.27

 
82,600

 
6,814,251

June 1-30, 2013
 
7,535

 
46.55

 
7,535

 
6,806,716

July 1-31, 2013
 
15,325

 
49.06

 
15,325

 
6,791,391

August 1-31, 2013
 
88,935

 
49.04

 
88,935

 
6,702,456

September 1-30, 2013
 
37,081

 
45.88

 
37,081

 
6,665,375

October 1-31, 2013
 
33,718

 
50.34

 
33,718

 
6,631,657

November 1-30, 2013
 
968,968

 
52.05

 
968,968

 
5,662,689

December 1-31, 2013
 
113,196

 
51.83

 
113,196

 
5,549,493

Totals
 
1,577,745

 
50.55

 
1,577,745

 
 

 
 
 
 
 
 
 
 
 
 
We did not sell any of our shares that were not registered under the Securities Act during 2013. The board of directors has authorized share repurchases since 1996. Purchases are expected to be made generally through open market transactions. During 2013, we acquired 577,745 shares for $28 million from associates as consideration for options exercised. The board gives management discretion to purchase shares at reasonable prices in light of circumstances at the time of purchase, subject to SEC regulations. We have 5,549,493 shares available for purchase under our programs at December 31, 2013.
 
On October 24, 2007, the board of directors expanded the existing repurchase authorization to approximately 13 million shares. The prior repurchase program for 10 million shares was announced in 2005, replacing a program that had been in effect since 1999. No repurchase program has expired during the period covered by the above table. Neither the 2005 nor 1999 program had an expiration date, but no further repurchases will occur under the 1999 program.
 

40



Cumulative Total Return
As depicted in the graph below, the five-year total return on a $100 investment made December 31, 2008, assuming the reinvestment of all dividends, was 131.5 percent for Cincinnati Financial Corporation’s common stock compared with 93.8 percent for the Standard & Poor’s Composite 1500 Property & Casualty Insurance Index and 128.2 percent for the Standard & Poor’s 500 Index.
 
The Standard & Poor’s Composite 1500 Property & Casualty Insurance Index included 27 companies at year-end 2013: Ace Limited, The Allstate Corporation, Amerisafe Inc., Aspen Insurance Holdings Limited, W. R. Berkley Corporation, The Chubb Corporation, Cincinnati Financial Corporation, Employers Holdings Inc., Fidelity National Financial Inc., First American Financial Corporation, The Hanover Insurance Group Inc., HCI Group Inc., Infinity Property and Casualty Corporation, Meadowbrook Insurance Group Inc., Mercury General Corporation, The Navigators Group Inc., Old Republic International Corporation, ProAssurance Corporation, The Progressive Corporation, RLI Corp., Safety Insurance Group Inc., Selective Insurance Group Inc., Stewart Information Services Corporation, Tower Group Inc., The Travelers Companies Inc., United Fire & Casualty Company and XL Group Public Limited Company.
 
The Standard & Poor’s 500 Index includes a representative sample of 500 leading companies in a cross section of industries of the U.S. economy. Although this index focuses on the large capitalization segment of the market, it is widely viewed as a proxy for the total market.
 
 
*$100 invested on December 31, 2008, in stock or index, including reinvestment of dividends.
 Fiscal year ending December 31.
 


41



ITEM 6.    Selected Financial Data
(In millions except per share data, shares outstanding in thousands)
 
Years ended December 31,
 
 
2013
 
2012
 
2011
 
2010
 
2009
Consolidated Income Statement Data
 
 

 
 

 
 

 
 

 
 

Earned premiums
 
$
3,902

 
$
3,522

 
$
3,194

 
$
3,082

 
$
3,054

Investment income, net of expenses
 
529

 
531

 
525

 
518

 
501

Realized investment gains and losses*
 
83

 
42

 
70

 
159

 
336

Total revenues
 
4,531

 
4,111

 
3,803

 
3,772

 
3,903

Net income
 
517

 
421

 
164

 
375

 
431

Net income per common share:
 
 

 
 
 
 
 
 
 
 
Basic
 
$
3.16

 
$
2.59

 
$
1.01

 
$
2.30

 
$
2.65

Diluted
 
3.12

 
2.57

 
1.01

 
2.30

 
2.65

Cash dividends per common share:
 
 
 
 
 
 
 
 
 
 
Declared
 
1.655

 
1.62

 
1.605

 
1.59

 
1.57

Paid
 
1.6425

 
1.615

 
1.6025

 
1.585

 
1.565

Weighted average shares outstanding, diluted
 
165,400

 
163,661

 
163,259

 
163,274

 
162,867

Consolidated Balance Sheet Data
 
 
 
 
 
 
 
 
 
 
Total investments
 
$
13,564

 
$
12,534

 
$
11,801

 
$
11,508

 
$
10,643

Net unrealized investment gains
 
2,335

 
1,875

 
1,489

 
1,250

 
685

Deferred policy acquisition costs
 
565

 
470

 
477

 
458

 
454

Total assets
 
17,662

 
16,548

 
15,635

 
15,065

 
14,413

Gross loss and loss expense reserves
 
4,311

 
4,230

 
4,339

 
4,200

 
4,142

Life policy reserves
 
2,390

 
2,295

 
2,214

 
2,034

 
1,783

Long-term debt
 
790

 
790

 
790

 
790

 
790

Shareholders' equity
 
6,070

 
5,453

 
5,033

 
5,012

 
4,742

Book value per share
 
37.21

 
33.48

 
31.03

 
30.79

 
29.14

Shares outstanding
 
163,109

 
162,874

 
162,186

 
162,782

 
162,741

Value creation ratio
 
16.1
%
 
12.6
%
 
6.0
%
 
11.1
%
 
19.7
%
Consolidated Property Casualty Operations Data
 
 
 
 
 
 
 
 
 
 
Earned premiums
 
$
3,713

 
$
3,344

 
$
3,029

 
$
2,924

 
$
2,911

Unearned premiums
 
1,970

 
1,790

 
1,631

 
1,551

 
1,507

Gross loss and loss expense reserves
 
4,241

 
4,169

 
4,280

 
4,137

 
4,096

Investment income, net of expenses
 
348

 
351

 
350

 
348

 
336

Loss and loss expense ratio
 
61.9
%
 
63.9
%
 
77.0
%
 
68.9
%
 
71.7
%
Underwriting expense ratio
 
31.9

 
32.2

 
32.3

 
32.9

 
32.8

Combined ratio
 
93.8
%
 
96.1
%
 
109.3
%
 
101.8
%
 
104.5
%
 
 
 
 
 
 
 
 
 
 
 
 
On January 1, 2012, we retrospectively adopted ASU 2010-26, Accounting for Costs Associated with Acquiring or Renewing Insurance Contracts. All prior years’ information has been restated.
 
* Realized investment gains and losses are integral to our financial results over the long term, but our substantial discretion in the timing of investment sales may cause this value to fluctuate substantially. Also, applicable accounting standards require us to recognize gains and losses from certain changes in fair values of securities and embedded derivatives without actual realization of those gains and losses. We discuss realized investment gains for the past three years in Item 7, Investments Results of Operations.

42





ITEM 7.    Management's Discussion and Analysis of Financial Condition and Results of Operations
 
Introduction
The purpose of Management’s Discussion and Analysis is to provide an understanding of Cincinnati Financial Corporation’s consolidated results of operations and financial condition. Our Management’s Discussion and Analysis should be read in conjunction with Item 6, Selected Financial Data, and Item 8, Consolidated Financial Statements and related Notes. We present per share data on a diluted basis unless otherwise noted, adjusting those amounts for all stock splits and stock dividends.
 
We begin with an executive summary of our results of operations, followed by an overview of our strategy, an outlook for future performance and details on critical accounting estimates. In several instances, we refer to estimated industry data so that we can provide information on our performance within the context of the overall insurance industry. 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 accounting basis. When we provide our results on a comparable statutory accounting 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).

Through The Cincinnati Insurance Company, Cincinnati Financial Corporation is one of the 25 largest property casualty insurers in the nation, based on net written premium volume for the first nine months of 2013, among approximately 2,000 U.S. stock and mutual insurer groups. We market our insurance products through a select group of independent insurance agencies in 39 states as discussed in Item 1, Our Business and Our Strategy.
 
The U.S. economy, the insurance industry and our company continue to face many challenges. Our long-term perspective has allowed us to address immediate challenges while also focusing on the major decisions that best position the company for success through all market cycles. We believe that this forward-looking view consistently benefits our shareholders, agents, policyholders and associates.
 
To measure our progress, we have defined a measure of value creation that we believe captures the contribution of our insurance operations, the success of our investment strategy and the importance we place on paying cash dividends to shareholders. We refer to this measure as our value creation ratio, or VCR, and it is made up of two primary components: (1) our rate of growth in book value per share plus (2) the ratio of dividends declared per share to beginning book value per share. This measure, intended to be all-inclusive regarding changes in book value per share, uses originally reported book value per share in cases where book value per share has been adjusted, such as after the adoption of Accounting Standards Updates with a cumulative effect of a change in accounting.
 
Executive Summary
Our value creation ratio, defined above, is our primary performance target. VCR trends are shown in the table below.
 
 
One
year
 
Three-year
% average
 
Five-year
% average
Value creation ratio
 
 

 
 

 
 

   As of December 31, 2013
 
16.1
%
 
11.6
%
 
13.1
%
   As of December 31, 2012
 
12.6

 
9.9

 
5.2

   As of December 31, 2011
 
6.0

 
12.3

 
1.5

 
 
 
 
 
 
 
 
For the period 2013 through 2017, we are targeting an annual value creation ratio averaging 10 percent to 13 percent. We exceeded that target for 2013, and for the five-year period that ended in 2013. For the period 2009 through 2012, our annual value creation ratio averaged 12.4 percent, within the 12 percent to 15 percent five-year target range established in early 2009, soon after the U.S. credit crisis. For several years following the credit crisis, interest rates generally declined and credit spreads tightened, increasing the contribution

43



of valuation gains from our fixed-maturity securities to the VCR. Those gains contributed between 2 percent and 3 percent annually to VCR during 2010 through 2012. While that contribution is not expected to occur in the subsequent five-year period, as evidenced in 2013, management believes the company will continue to produce strong underwriting results.

The next two tables show the primary components of our value creation ratio, first on a percentage basis and then on a per-outstanding-share basis. Analysis of the components aids understanding of our financial performance. Our financial results are further analyzed in the Corporate Financial Highlights section below.

 
 
Years ended December 31,
 
 
2013
 
2012
 
2011
Value creation ratio major components
 
 
 
 
 
 
Net income before net realized gains
 
8.5
 %
 
7.7
 %
 
2.4
 %
Change in realized and unrealized gains, fixed-maturity securities
 
(4.5
)
 
2.7

 
2.7

Change in realized and unrealized gains, equity securities
 
10.9

 
2.8

 
1.3

Other
 
1.2

 
(0.6
)
 
(0.4
)
Value creation ratio
 
16.1
 %
 
12.6
 %
 
6.0
 %
 
 
 
 
 
 
 
 
The 2013 value creation ratio benefited from improved operating results as well as higher valuation for our equity securities investment portfolio. A lower valuation for our fixed-maturity securities investment portfolio, before the effect of security purchases during 2013, partially offset the higher valuation in our equity portfolio. The contribution from operating results rose 0.8 percentage points in 2013, compared with 2012, while the contribution from realized gains plus the change in unrealized gains from our investment portfolios rose 0.9 points. The 2013 VCR also benefited from other items that affected book value per share, primarily a contribution from updated valuations and related assumptions for our employee benefit pension plan. The 2011 value creation ratio was depressed primarily due to unusually high catastrophe losses that lowered the ratio by 3.3 percentage points compared with 2010 and also drove a 56 percent decline in net income.

(Dollars are per share)
 
Years ended December 31,
 
 
2013
 
2012
 
2011
Book value change per share
 
 
 
 
 
 
End of period book value
 
$
37.21

 
$
33.48

 
$
31.03

Less beginning of period book value
 
33.48

 
31.03

 
30.79

Change in book value
 
$
3.73

 
$
2.45

 
$
0.24

 
 
 
 
 
 
 
Change in book value
 
 

 
 

 
 

Net income before realized gains
 
$
2.84

 
$
2.41

 
$
0.74

Change in realized and unrealized gains, fixed-maturity securities
 
(1.50
)
 
0.84

 
0.83

Change in realized and unrealized gains, equity securities
 
3.64

 
0.86

 
0.39

Dividend declared to shareholders
 
(1.66
)
 
(1.62
)
 
(1.61
)
Other
 
0.41

 
(0.04
)
 
(0.11
)
Total change in book value
 
$
3.73

 
$
2.45

 
$
0.24

 
 
 
 
 
 
 

We believe our value creation ratio, a non-GAAP measure, is a useful supplement to GAAP information. With the continuation of economic and market uncertainty in recent years, the long-term nature of this measure provides a meaningful measure of our long-term progress in creating shareholder value. A reconciliation of this non-GAAP measure to comparable GAAP measures is shown in the table below.

44



(Dollars are per share)
 
Years ended December 31,
 
 
2013
 
2012
 
2011
Book value change per share
 
 

 
 

 
 

Book value as originally reported December 31, 2011
 
 

 
 
 
$
31.16

Cumulative effect of a change in accounting for deferred policy
    acquisition costs, net of tax
 
 

 
 
 
(0.13
)
Book value as adjusted December 31, 2011
 
 

 
 
 
$
31.03

 
 
 
 
 
 
 
Value creation ratio