10-K 1 v212346_10k.htm Unassociated Document
 
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, 2010.
 
¨
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 ¨

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 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.
(Check one):   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 Exchange Act). Yes ¨  No þ
 
The aggregate market value of voting stock held by nonaffiliates of the Registrant was $3,793,569,013 as of June 30, 2010.

As of February 21, 2011, there were 163,000,007 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 30, 2011, are incorporated by reference into Part III of this Form 10-K.

 
 

 
 
Table of Contents
 
Part I
 
3
Item 1.
Business
3
 
Cincinnati Financial Corporation – Introduction
3
 
Our Business and Our Strategy
3
 
Our Segments
12
 
Other
22
 
Regulation
22
Item 1A.
Risk Factors
24
Item 1B.
Unresolved Staff Comments
30
Item 2.
Properties
30
Item 3.
Legal Proceedings
30
Item 4.
(Removed and Reserved)
30
Part II
 
31
Item 5.
Market for the Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities
31
Item 6.
Selected Financial Data
34
Item 7.
Management's Discussion and Analysis of Financial Condition and Results of Operations
36
 
Introduction
36
 
Executive Summary
36
 
Critical Accounting Estimates
40
 
Recent Accounting Pronouncements
48
 
Results of Operations
48
 
Liquidity and Capital Resources
78
 
Safe Harbor Statement
92
Item 7A.
Quantitative and Qualitative Disclosures About Market Risk
93
 
Introduction
93
 
Fixed-Maturity Investments
94
 
Equity Investments
95
 
Application of Asset Impairment Policy
96
Item 8.
Financial Statements and Supplementary Data
98
 
Responsibility for Financial Statements
98
 
Management’s Annual Report on Internal Control Over Financial Reporting
99
 
Report of Independent Registered Public Accounting Firm
100
 
Consolidated Balance Sheets
101
 
Consolidated Statements of Income
102
 
Consolidated Statements of Shareholders’ Equity
103
 
Consolidated Statements of Cash Flows
104
 
Notes to Consolidated Financial Statements
105
Item 9.
Changes in and Disagreements with Accountants on Accounting and Financial Disclosure
131
Item 9A.
Controls and Procedures
131
Item 9B.
Other Information
131
Part III
 
132
Item 10.
Directors, Executive Officers and Corporate Governance
132
Item 11.
Executive Compensation
133
Item 12.
Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters
133
Item 13.
Certain Relationships and Related Transactions, and Director Independence
134
Item 14.
Principal Accountant Fees and Services
134
Part IV
 
134
Item 15.
Exhibits, Financial Statement Schedules
134
 
Index of Exhibits
146

 
 

 

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 agents in 39 states. Our headquarters is in Fairfield, Ohio. At year-end 2010, we employed 4,060 associates, with 2,838 headquarters associates providing support to 1,222 field associates.
 
At year-end 2010, Cincinnati Financial Corporation owned 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 annuities, and The Cincinnati Specialty Underwriters Insurance Company, which began offering excess and surplus lines insurance products in January 2008.
 
The two non-insurance 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, www.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).
 
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 market stability through financial strength
 
 
·
producing competitive, up-to-date products and services
 
 
·
developing associates committed to superior service
 
A select group of agencies in 39 states actively markets our property casualty insurance within their communities. Standard market commercial lines policies are marketed in all of those states, while personal lines policies are marketed in 29 of those states. Excess and surplus lines policies are available in 38 of those states. Within this select group, 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.

 
3

 

Three competitive advantages distinguish our company, positioning us to build shareholder value and to be successful overall:
 
 
·
Commitment to our network of 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
 
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, or
 
 
·
direct marketing to consumers
 
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, and 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. 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 opened our own excess and surplus lines insurance brokerage firm so that we could 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. Offering insurance solutions beyond our standard market property casualty insurance products helps our agencies meet the broader needs of their clients, and also serves to increase and diversify agency revenues and profitability.
 
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 person or organization that are caused by nature, the insured's claim history or the characteristics of their business. 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. 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.
 
At year-end 2010, our 1,245 property casualty agency relationships were marketing our standard market insurance products out of 1,544 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 2009, our 1,180 agency relationships had 1,463 reporting locations. At year-end 2008, our 1,133 agency relationships had 1,387 reporting locations.

 
4

 

We made 93, 87 and 76 new agency appointments in 2010, 2009 and 2008, respectively. Of these new appointments, 70, 65 and 52, 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 65, 47 and 41 and a net increase in reporting agency locations of 81, 76 and 60 in 2010, 2009 and 2008, respectively.
 
On average, we have a 12.4 percent share of the standard lines property casualty insurance purchased through our reporting agency locations. Our share is 17.7 percent in reporting agency locations that have represented us for more than 10 years; 6.7 percent in agencies that have represented us for six to 10 years; 4.1 percent in agencies that have represented us for one to five years; and 0.8 percent in agencies that have represented us for less than one year.
 
Our largest single agency relationship accounted for approximately 1.2 percent of our total property casualty earned premiums in 2010. No aggregate locations under a single ownership structure accounted for more than 2.2 percent of our earned premiums in 2010.
 
Financial Strength
 
We believe that our financial strength and strong 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 prospect 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 over 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. This includes maintaining a diversified investment portfolio by reviewing and applying diversification parameters and tolerances.
 
 
·
Our $8.383 billion fixed-maturity portfolio is diversified and exceeds total insurance reserves. At December 31, 2010, no corporate bond exposure accounted for more than 0.8 percent of our fixed-maturity portfolio and no municipal exposure accounted for more than 0.3 percent. The portfolio had an average rating of A2/A and its fair value exceeded total insurance reserve liability by approximately 35 percent.
 
 
·
The strength of our fixed-maturity portfolio provides an opportunity to invest for potential capital appreciation by purchasing equity securities. Our $3.041 billion equity portfolio minimizes concentrations in single stocks or industries. At December 31, 2010, no single security accounted for more than 6 percent of our portfolio of publicly traded common stocks, and no single sector accounted for more than 16 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, 2010, we held $1.042 billion of our cash and invested assets at the parent company level, of which $763 million, or 73.2 percent, was invested in common stocks, and $38 million, or 3.6 percent, was cash or 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, 2010, this ratio at 14.3 percent was well below the target limit as capital remained strong while debt levels were unchanged from year-end 2009. Our long-term debt consists of three non-convertible, non-callable debentures, two due in 2028 and one in 2034.
 
At year-end 2010 and 2009, risk-based capital (RBC) for our standard and excess and surplus lines property casualty operations and life operations was very strong, far exceeding regulatory requirements.
 
 
·
We ended 2010 with a 0.8-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. Our low ratio, compared with historical averages, gives us 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 for 2010.
 
 
·
We ended 2010 with a 14.1 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 12.0 percent for 2010. A higher ratio indicates an insurer’s stronger security for policyholders and capacity to support business growth.

 
5

 
 
(Dollars in millions)                                              Statutory Information  
At December 31,
 
   
2010
   
2009
 
             
Standard market property casualty insurance subsidiary
           
Statutory surplus
  $ 3,777     $ 3,648  
Risk-based capital (RBC)
    3,793       3,664  
Authorized control level risk-based capital
    450       437  
Ratio of risk-based capital to authorized control level risk-based capital
    8.4       8.4  
Written premium to surplus ratio
    0.8       0.8  
                 
Life insurance subsidiary
               
Statutory surplus
  $ 303     $ 300  
Risk-based capital (RBC)
    318       316  
Authorized control level risk-based capital
    35       40  
Ratio of risk-based capital to authorized control level risk-based capital
    9.1       7.9  
Total liabilities excluding separate account business
    2,266       1,960  
Life statutory risk-based adjusted surplus to liabilities ratio
    14.1       16.3  
                 
Excess and surplus insurance subsidiary
               
Statutory surplus
  $ 172     $ 168  
Risk-based capital (RBC)
    172       168  
Authorized control level risk-based capital
    10       8  
Ratio of risk-based capital to authorized control level risk-based capital
    16.6       21.4  
Written premium to surplus ratio
    0.3       0.2  

The consolidated property casualty insurance group’s ratio of investments in common stock to statutory surplus was 55.3 percent at year-end 2010 compared with 58.4 percent at year-end 2009. The life insurance company’s ratio was 29.6 percent compared with 32.2 percent a year ago.
 
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 insurer 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 2010, Standard & Poor’s Rating Services lowered our ratings as described below. No other rating agency actions occurred during 2010.
 
As of February 25, 2011, our insurer financial strength ratings were:
 
Insurer Financial Strength Ratings
Rating
Agency
 
Standard Market Property Casualty
Insurance Subsidiary
 
Life Insurance
 Subsidiary
 
Excess and Surplus
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 (12/13/10)
   Fitch Ratings
 
A+
Strong
 5 of 21
 
A+
Strong
 5 of 21
 
-
-
-
 
Stable outlook (9/2/10)
   Moody's Investors
    Service
 
A1
Good
 5 of 21
 
-
-
-
 
-
-
-
 
Stable outlook (9/25/08)
   Standard & Poor's
    Ratings Services
 
A
Strong
 6 of 21
 
A
Strong
 6 of 21
 
-
-
-
 
Stable outlook (7/19/10)

On December 13, 2010, A.M. Best affirmed our ratings that it had assigned in February 2010, continuing its stable outlook. A.M. Best cited our superior risk-adjusted capitalization, conservative reserving philosophy and successful distribution within our targeted regional markets. Concerns noted by A.M. Best included geographic concentration, underwriting losses that began in 2008 and common stock leverage of approximately 50 percent of statutory surplus. A.M. Best said its concerns are offset by our conservative underwriting and reserving philosophies, with loss reserves more than fully covered by a highly rated, diversified bond portfolio, and by strategic initiatives to improve underwriting results.
 
On September 2, 2010, Fitch Ratings affirmed our ratings that it had assigned in August 2009, continuing its stable outlook. Fitch noted that ratings strengths include conservative capitalization, moderate holding company leverage, ample liquidity and competitive advantages from our distribution system. Fitch said the ratings recognize our steps taken to rebalance our common stock portfolio to reduce volatility of capital and earnings. Fitch noted concerns principally related to challenges from competitive market conditions and exposure to regional natural catastrophes and weather-related losses.

 
6

 

On July 19, 2010, Standard & Poor’s Ratings Services lowered the insurer financial strength ratings to A (Strong) from A+ (Strong) on our standard market property casualty companies and our life insurance subsidiary, and raised its outlook to stable. S&P said its actions reflected the recent decline in our earnings and deterioration of underwriting performance from historical levels. Standard & Poor’s noted our very strong capitalization and strong competitive position, supported by a very loyal and productive agency force and low-cost infrastructure. S&P also cited our improved enterprise risk management, including a more conservative and risk-averse investment portfolio, which supports capital stability.
 
Our debt ratings are discussed in Item 7, Liquidity and Capital Resources, Additional Sources of Liquidity, Page 79.
 
Operating Structure
 
We offer our broad array of insurance products through the independent agency 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. We seek to be a consistent and predictable property casualty carrier that agencies can rely on to serve their clients. For our standard market business, field and headquarters underwriters make risk-specific decisions about both new business and renewals.
 
In our 10 highest volume states for consolidated property casualty premiums, 956 reporting agency locations wrote 67.1 percent of our 2010 consolidated property casualty earned premium volume compared with 933 locations and 68.1 percent in 2009.
 
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, 2010
                       
Ohio
  $ 599       20.5 %     224     $ 2.7  
Illinois
    243       8.3       122       2.0  
Indiana
    197       6.8       105       1.9  
Pennsylvania
    176       6.0       83       2.1  
Georgia
    149       5.1       77       1.9  
North Carolina
    143       4.9       80       1.8  
Michigan
    126       4.3       116       1.1  
Virginia
    121       4.1       60       2.0  
Kentucky
    106       3.6       41       2.6  
Tennessee
    102       3.5       48       2.1  
Year ended December 31, 2009
                               
Ohio
  $ 611       21.0 %     224     $ 2.7  
Illinois
    253       8.7       119       2.1  
Indiana
    201       6.9       104       1.9  
Pennsylvania
    174       6.0       82       2.1  
Georgia
    148       5.1       71       2.1  
North Carolina
    138       4.8       75       1.8  
Michigan
    129       4.4       109       1.2  
Virginia
    121       4.2       60       2.0  
Wisconsin
    103       3.5       49       2.1  
Kentucky
    100       3.5       40       2.5  

Field Focus
 
We rely on our force of 1,222 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 also provide agencies with underwriting, accounting and technology assistance and training. Company executives, headquarters underwriters and special teams 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, machinery and equipment, bond, premium audit, life insurance and leasing. 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 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

 
7

 

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 seek to 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 client data to process business transactions from their offices
 
 
·
allow policyholders to directly access 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, and
 
 
·
reduce duplicated effort, introducing more efficient processes that reduce company and agency costs
 
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, sales and marketing materials, educational courses about our products and services, accounting services, and electronic libraries for property and casualty coverage forms and state rating manuals.
 
Superior Claims Service
 
Our claims philosophy reflects our belief that we will 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 763 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 an insured’s home or 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, and we give them the tools and 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 of policyholders and easy sharing of information and data by rotating storm teams, headquarters 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 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 insureds and claimants. Our field claims representatives also are educated continuously on new techniques and repair trends. 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 uniquely 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

 
8

 
 
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 are marketed in all 39 states while our standard market personal lines products are marketed in 29. At year-end 2010, CSU Producer Resources marketed our excess and surplus lines products in 38 states to agencies that represent Cincinnati Insurance. We discuss our commercial lines, personal lines and excess and surplus lines insurance operations and products in Commercial Lines Property Casualty Insurance Segment, Page 12, Personal Lines Property Casualty Insurance Segment, Page 15, and Excess and Surplus Lines Property Casualty Insurance Segment, Page 16.
 
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 parent-company Cincinnati Financial Corporation.
 
We also support the independent agencies affiliated with our property casualty operations in their programs to sell life insurance. The 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 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 the 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, in regional and agency locations and online.
 
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 non-insurance financial services. CFC Investment Company offers equipment and vehicle leases and loans for independent insurance agencies, their commercial clients and other businesses. It also provides commercial real estate loans to help agencies operate and expand 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.
 
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 the primary ways we measure our progress toward our long-term financial objectives.
 
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

 
9

 

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 the Management’s Discussion and Analysis, Page 36.
 
Improve Insurance Profitability
 
Implementation of the three initiatives below is intended to improve pricing capabilities for our property casualty business, improving our ability to manage our business while also enhancing our efficiency. By improving pricing capabilities through the use of analytics tools, we can better manage profit margins. By improving agency-level planning, we can develop and execute growth and profitability plans that enhance our ability to achieve objectives at all levels in the organization. By improving internal processes and further developing performance metrics, we can be more efficient and effective. These initiatives also support the ability of the agencies that represent us to grow profitably by allowing them to serve clients faster and more efficiently manage expenses. The primary initiatives for 2011 to improve insurance profitability are:
 
 
·
Improve pricing precision using predictive analytics – We continue efforts to expand our pricing capabilities by using predictive analytics and expect cumulative benefits of these efforts to improve loss ratios over time. Development of additional business data to support accurate underwriting, pricing and other business decisions also continues. A phased project that will continue over the next several years will deploy a full data management program, including a data warehouse for our property casualty and life insurance operations, providing enhanced granularity of pricing data. Specific initiatives that are key to improving pricing precision are summarized below.
 
 
o
Commercial lines – In the second half of 2009, we began to use predictive modeling tools that align individual insurance policy pricing to risk attributes for our workers’ compensation line of business. During fourth-quarter 2010, we completed development of predictive models for our commercial auto line of business and also for general liability and commercial property coverages in commercial package accounts. We plan in 2011 to integrate these models into our policy processing systems. Underwriters using these tools will be able to target profitability and to provide pricing impacts to agency personnel. Additional reports to monitor use and results at several levels should also contribute to improved pricing.
 
 
o
Personal lines – Prior to 2010, we began to use predictive modeling tools for our homeowner line of business, and in late 2010 we began using similar analytics for personal auto. We believe we are successfully attracting more of our agents’ preferred business, based on the average quality of our book of business. Quality has improved as measured by the mix of business by insurance score. During 2011, we will continue to develop the models by calibrating pricing precision to allow us to write more business profitably. Further educational support for agency personnel and enhanced reporting to monitor results for all users will also be developed. These tools enable us to increase the speed of introducing new rates and model attributes, more rapidly adapting to changes in market conditions.
 
 
·
Improve agency-level planning for profitability and growth – Additional use of analytics tools will help us better understand business in more detail and communicate additional quantitative and qualitative information to agents and associates. Development of models at an agency level to predict profitability, along with enhanced reporting of related metrics, should facilitate coordination and consistent decision-making. During 2011, we expect to enhance our agency planning processes to develop multi-year profitability and growth plans. Evaluating agency and state-level plans through models that aggregate company-level results will help determine if executing plans formulated at those levels, in aggregate, are adequate to reach our broader performance objectives.
 
 
·
Improve internal processes and further deploy performance metrics – Improving processes supports our strategic goals and can reduce internal costs. Use of additional measurements to track progress and accountability for results will improve our overall effectiveness. Completion of development for additional coverages in our commercial lines policy administration system is expected to facilitate important internal process improvement initiatives for 2011. One important initiative aims to develop business rules and parameters for personal lines accounts that will allow processing of some business without intervention by an underwriter, for risks that meet qualifying underwriting criteria. The objective is to streamline processing for our agents and associates, permitting more time for risks that need additional service or attention. The initiative also includes developing technology to integrate automated steps into the current process plus changes in workflow, including auditing for compliance with eligibility requirements. We expect in the future a similar streamlined process will eventually be developed for parts of our commercial lines business.
 
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 be consistently below 100 percent for any five-year period.
 
In addition, we expect these initiatives to contribute to our rank as the No. 1 or No. 2 carrier based on premium volume in agencies that have represented us for at least five years. In 2010, we again earned that

 
10

 

rank in approximately 75 percent of the agencies that have represented Cincinnati Insurance for more than five years, based on 2009 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 agency network. We expect strategies aimed at specific market opportunities, along with service enhancements, to help our agents grow and increase our share of their business. The primary initiatives to drive premium growth are:
 
 
·
Gain a larger share of agency business – We will continue to execute on prior year growth initiatives and add new initiatives to improve our penetration in each market we serve through our independent agencies. Our focus remains on the key components of agent satisfaction based on factors agents tell us are most important.
 
 
o
Innovate our small business strategy – Additional focus on attributes that agencies weigh heavily in carrier selection for their clients is a key component of this initiative. Those attributes include technology ease of use and integration with agency management systems, flexible billing, product breadth and pricing, and service and marketing support for new business. The initiative includes refining workflows for the entire policy process and providing additional policyholder services. We also are developing and coordinating targeted marketing, including cross-selling opportunities, through our Target Markets department. This area focuses on new commercial product development, including identification and promotional support for promising classes of business. Small business policies are already an important part of our commercial lines property casualty insurance segment. Nearly 90 percent of our commercial in-force policies have annual premiums of $10,000 or less, accounting in total for approximately one-third of our 2010 commercial lines premium volume. Profitably growing our book of small business is expected to provide significant growth opportunities for the agencies that represent us while also benefiting the company. Small business does not typically trend quite as severely with pricing cycles, producing a more stable block of premium. This strategy also is expected to improve profitability due to lower expenses through more automation of data gathering and use of predictive analytics.
 
 
o
New agency appointments – We continue to appoint new agencies to develop additional points of distribution, focusing on markets where our market share is less than 1 percent while also considering economic and catastrophe risk factors. In 2011, we are targeting approximately 120 appointments of independent agencies, with a significant portion in the five states we entered since late 2008. We seek to build a close, long-term relationship with each agency we appoint. 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 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 a Cincinnati agency and new branch offices opened by existing Cincinnati agencies. We made 93, 87 and 76 new appointments in 2010, 2009 and 2008, respectively, with 70, 65 and 52 representing new relationships. One-quarter of the agencies appointed during 2010 were in the five states we entered since late 2008: Texas, Colorado, Wyoming, Connecticut and Oregon. The contribution of those states 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 agency’s 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.
 
 
·
Improve consumer relationships we undertake on behalf of our agencies – Improved interactions with consumers who are clients and prospects of our agents can drive more business to agents and help them grow. Through this initiative, we expect to identify the various ways we interact with consumers on behalf of our agencies and ensure that we do so in a manner that reinforces the value of the independent agent while establishing the value and service of a Cincinnati policy. By understanding and monitoring trends that drive consumer purchasing decisions, we can create positive interactions. We expect online policyholder services to continue evolving and will continue to work with agencies to meet the needs of their clients.
 
We measure the overall success of this strategy to drive premium growth primarily through changes in net written premiums, which we believe can grow faster than the industry average over any five-year period. On a compound annual growth rate basis over the five-year period 2006 through 2010, our property casualty net written premiums registered negative 0.7 percent, compared with an estimated negative 0.5 percent for the industry. Our premium mix is more heavily weighted in commercial lines, relative to the industry, and premium growth rates for the commercial lines segment of the industry have lagged the personal lines segment in recent years.

 
11

 

Our Segments
 
Consolidated financial results primarily reflect the results of our five reporting segments. In the fourth quarter of 2010, we revised our reportable operating segments to include excess and surplus lines. This segment includes results of The Cincinnati Specialty Underwriters Insurance Company and CSU Producer Resources. Historically, the excess and surplus lines results were reflected in Item 7, Other. We began offering excess and surplus lines insurance products in 2008. The line continues to grow since inception and separating it into a reportable segment allows readers to view this business in a manner similar to how it is managed internally when making operating decisions. Prior period data included in this annual report has been recasted to represent this new segment. 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 also 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, Page 127. Some of that information also 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 the Item 7, Management’s Discussion and Analysis of Financial Condition and Results of Operations, which begins on Page 36.
 
Commercial Lines Property Casualty Insurance Segment
 
The commercial lines property casualty insurance segment contributed net earned premiums of $2.154 billion to consolidated total revenues, or 57.1 percent of that total, and reported a gain before income taxes of $15 million in 2010. Commercial lines net earned premiums declined 2 percent in 2010, 5 percent in 2009 and 4 percent in 2008.
 
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 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; and excess insurance and umbrella liability, including personal umbrella liability written as an endorsement to commercial umbrella coverages. The commercial casualty business line includes liability coverage written on both a discounted and nondiscounted basis as part of commercial package policies.
 
 
·
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 a variety of mobile equipment, such as contractor’s equipment, builder’s risk, cargo and electronic data processing equipment. Various property coverages can be written as stand-alone policies or can be added to a package policy. The commercial property business line includes property coverage written on both a nondiscounted and discounted basis as part of commercial package policies.
 
 
·
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 – Protects employers against 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 and Washington, 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

 
12

 

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.
 
 
·
Surety and executive risk – This business line includes:
 
 
o
Contract and commercial surety bonds, which guarantee a payment or reimbursement for financial losses resulting from dishonesty, failure to perform and other acts.
 
 
o
Fidelity bonds, which cover losses that policyholders incur as a result of fraudulent acts by specified individuals or dishonest acts by employees.
 
 
o
Director and officer 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 70 percent of new policies and almost 40 percent of director and officer new business premiums written in 2010 were for nonprofit entities. Our director and officer liability policy can optionally include EPLI coverage.
 
 
·
Machinery and equipment – Specialized coverage provides protection for loss or damage to boilers and machinery, including production and computer equipment, from 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 1,544 reporting agency locations, 16 market only our surety and executive risk products and 11 market only our personal lines products. The remaining 1,517 locations, located in all states in which we actively market, offer some or all of our standard market commercial insurance products.
 
In 2010, our 10 highest volume commercial lines states generated 64.3 percent of our earned premiums compared with 65.3 percent in the prior year as we continued efforts to geographically diversify our property casualty risks. Earned premiums in the 10 highest volume states decreased 4 percent in 2010 and increased 1 percent in the remaining 29 states. The number of reporting agency locations in our 10 highest volume states increased to 954 in 2010 from 933 in 2009.
 
Commercial Lines Earned Premiums by State
 
(Dollars in millions)
 
Earned
premiums
   
% of total
earned
   
Agency
locations
   
Average
premium per
location
 
Year ended December 31, 2010
                       
Ohio
  $ 347       16.1 %     223     $ 1.6  
Illinois
    187       8.7       120       1.6  
Pennsylvania
    157       7.3       83       1.9  
Indiana
    133       6.2       104       1.3  
North Carolina
    120       5.6       78       1.5  
Virginia
    100       4.6       60       1.7  
Michigan
    96       4.5       115       0.8  
Georgia
    82       3.8       75       1.1  
Wisconsin
    81       3.8       48       1.7  
Tennessee
    79       3.7       48       1.6  
Year ended December 31, 2009
                               
Ohio
  $ 359       16.3 %     223     $ 1.6  
Illinois
    202       9.2       117       1.7  
Pennsylvania
    157       7.1       82       1.9  
Indiana
    140       6.4       103       1.4  
North Carolina
    127       5.8       74       1.7  
Michigan
    102       4.6       108       0.9  
Virginia
    101       4.6       60       1.7  
Georgia
    85       3.9       71       1.2  
Wisconsin
    83       3.8       49       1.7  
Iowa
    79       3.6       46       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. These 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, the headquarters underwriter also helps 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 marketing representatives by offering product training,

 
13

 

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. Nearly 90 percent of our commercial in-force policies have annual premiums of $10,000 or less, accounting in total for approximately one-third of our 2010 commercial lines premium volume. The remainder for policies with annual premiums greater than $10,000 includes in-force policies with annual premiums greater than $100,000 that account for slightly less than 15 percent of our 2010 commercial lines premium volume.
 
Our commercial lines packages are typically 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. 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 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 2010 commercial premiums were subject to annual rating or were written on a one-year policy term.
 
Staying abreast of evolving market conditions is a critical function, accomplished in both an informal and a formal manner. Informally, our field marketing representatives, underwriters and Target Markets department associates are in constant receipt of market intelligence from the agencies with which they work. Formally, our commercial lines product management group and field marketing associates conduct periodic surveys to obtain competitive intelligence. This market information helps identify the top competitors by line of business or specialty program and also identifies our market strengths and weaknesses. The analysis 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 30 states. It is being developed for additional coverages and states that will be deployed over time. Since the initial deployment of e-CLAS in late 2009, approximately one-third of our non-workers’ compensation commercial lines policies in force at the end of 2010 have been processed through e-CLAS. Due to the three-year policy term for much of our commercial lines business, some policies will not be due for renewal processing in e-CLAS until 2012. In addition to increasing efficiency for our associates, the system allows our agencies to quote and print commercial package policies in their offices, increasing 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.

 
14

 

Personal Lines Property Casualty Insurance Segment
 
The personal lines property casualty insurance segment contributed net earned premiums of $721 million to consolidated total revenues, or 19.1 percent of the total, and reported a loss before income taxes of $54 million in 2010. Personal lines net earned premiums grew 5 percent in 2010, after declining less than 1 percent in 2009 and 3 percent in 2008.
 
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. As a result, we believe that our personal lines business is best measured and evaluated on a segment basis. However, we provide line of business data to summarize 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.
 
 
·
Homeowners – 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. The company also offers 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 1,123 or approximately 73 percent of our 1,544 reporting agency locations. The 1,123 personal lines agency locations are in 29 of the 39 states in which we offer standard market commercial lines insurance and represent nearly 80 percent of the reporting agency locations in the 29 states. During 2010, we largely completed an initiative that began in 2008 to appoint for personal lines existing agencies marketing only our commercial lines insurance products. 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. The number of reporting agency locations in our 10 highest volume states increased 5 percent to 749 in 2010 from 711 in 2009.
 
In 2010, our 10 highest volume personal lines states generated 82.2 percent of our earned premiums compared with 84.1 percent in the prior year. Earned premiums in the 10 highest volume states increased 3 percent in 2010 while increasing 18 percent in the remaining states, reflecting progress toward our long-term objective of geographic diversification through new states for our personal lines operation.
 
Personal Lines Earned Premiums by State
 
(Dollars in millions)
 
Earned
premiums
   
% of total
earned
   
Agency
locations
   
Average
premium per
location
 
Year ended December 31, 2010
                       
Ohio
  $ 246       34.1 %     199     $ 1.2  
Georgia
    63       8.8       69       0.9  
Indiana
    59       8.2       82       0.7  
Illinois
    52       7.2       86       0.6  
Alabama
    42       5.9       38       1.1  
Kentucky
    40       5.5       37       1.1  
Michigan
    28       3.8       90       0.3  
Tennessee
    22       3.1       43       0.5  
North Carolina
    20       2.8       67       0.3  
Virginia
    20       2.8       38       0.5  
Year ended December 31, 2009
                               
Ohio
  $ 248       36.1 %     202     $ 1.2  
Georgia
    61       8.9       63       1.0  
Indiana
    57       8.4       79       0.7  
Illinois
    48       7.1       84       0.6  
Alabama
    41       5.9       36       1.1  
Kentucky
    36       5.3       35       1.0  
Michigan
    26       3.8       80       0.3  
Tennessee
    20       2.9       36       0.6  
Florida
    20       2.9       10       2.0  
Virginia
    19       2.8       35       0.5  

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, we had

 
15

 

seven full-time personal lines 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.
 
Competitive advantages of our personal lines operation include broad coverage forms, flexible underwriting, superior claims service, generous credit structure and customizable endorsements for both the 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 and allows streamlined processing. Diamond incorporates features frequently requested by our agencies such as pre-filling 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 $49 million to consolidated total revenues, or 1.3 percent of the total, and reported a loss before income taxes of $8 million in 2010, its third year of operation. Excess and surplus lines net earned premium increased 81 percent in 2010. Net earned premiums increased 440 percent to $27 million in 2009.
 
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 $5,000 in annual premiums, and policyholders in many cases also have standard market insurance with one of The Cincinnati Insurance Companies. Approximately 80 percent of our 2010 premium volume for the excess and surplus lines segment provided commercial casualty coverages and about 20 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 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 loss or damage to buildings, inventory, equipment and business income from causes of loss 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 2010, we marketed excess and surplus lines insurance products in 38 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 2010, our 10 highest volume excess and surplus lines states generated 65.1 percent of our earned premiums compared with 74.2 percent in the prior year.

 
16

 

Excess and Surplus Lines Earned Premiums by State
 
(Dollars in millions)
 
Earned
premiums
   
% of total
earned
 
Year ended December 31, 2010
           
Ohio
  $ 7       13.2 %
Indiana
    5       11.0  
Illinois
    4       8.3  
Georgia
    4       7.3  
Missouri
    2       4.7  
Michigan
    2       4.7  
Pennsylvania
    2       4.2  
North Carolina
    2       4.1  
Texas
    2       3.9  
Kentucky
    2       3.7  
Year ended December 31, 2009
               
Ohio
  $ 4       16.4 %
Indiana
    4       13.8  
Illinois
    3       11.5  
Georgia
    2       8.3  
Michigan
    1       5.3  
North Carolina
    1       4.8  
Missouri
    1       3.9  
Wisconsin
    1       3.7  
Minnesota
    1       3.3  
Virginia
    1       3.2  

Agencies representing The Cincinnati Insurance Companies write over $2 billion in annual premiums for excess and surplus lines business for all carriers in total that they represent. 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 market exclusively through them.
 
Agencies have access to The Cincinnati Specialty Underwriters Insurance Company’s product line through CSU Producer Resources, the wholly owned insurance brokerage subsidiary of parent-company Cincinnati Financial Corporation. CSU Producer Resources has binding authority on all classes of business written through The Cincinnati Specialty Underwriters Insurance Company and maintains appropriate agent and surplus lines licenses to process non-admitted 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 agencies’ broader Cincinnati relationships to bring their policyholders services such as experienced and responsive loss control and claims handling. CSU Producer Resources gives extra support to our producers by remitting surplus lines taxes and stamping fees and retaining admitted market diligent search affidavits, where required. Agencies marketing through CSU Producer Resources generally receive a higher commission because use of our internal brokerage subsidiary eliminates some of the intermediary costs. This business is also 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 also 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 producers within minutes of underwriting approval and policy issue. In 2010, more than 95 percent of policies were issued within 24 hours of a request to bind a policy. Also in 2010, we received the Celent Model Insurer Award, recognizing our efficient use of technology. We successfully leveraged our policy administration system to quickly enter a new market, developing our miscellaneous errors and omissions product in only three months and then issuing the first 50 policies within two weeks.
 
Life Insurance Segment
 
The life insurance segment contributed $158 million of net earned premiums, representing 4.2 percent of consolidated total revenues, and $7 million of income before income taxes in 2010. Life insurance segment profitability is discussed in detail in Item 7, Life Insurance Results of Operations, Page 73. Life insurance net earned premiums grew 10 percent in 2010, 13 percent in 2009 and less than 1 percent in 2008.
 
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 produce revenue growth through a steady stream of premium payments. By diversifying

 
17

 

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.
 
Life Insurance Business Lines
 
Four lines of business – term insurance, universal life insurance, worksite products and whole life insurance – account for approximately 96.9 percent of the life insurance segment’s revenues:
 
 
·
Term 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 inforce 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. Contracts with death benefit guarantees are available for individuals as well as for two lives on contracts called survivor universal life.
 
 
·
Worksite products – term insurance, return of premium term 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
 
Cincinnati Life seeks to become the life insurance carrier of choice for the independent agencies that work with our property casualty operations. We emphasize up-to-date products, responsive underwriting and high quality service as well as competitive commissions. At year-end 2010, almost 90 percent of our 1,544 property casualty reporting agency locations offered Cincinnati Life’s products to their clients. We also develop life business from approximately 500 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.
 
 
·
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.

 
18

 

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 personal and commercial clients of our agencies quality, personal life insurance coverage.
 
 
·
Term 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, and we have restructured our underwriting classifications to better meet the needs of their clients.
 
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, Page 5. Our life insurance company has chosen not to establish a Moody’s rating.
 
Investment Segment
 
Revenues of the investment 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 $11.424 billion and $10.562 billion at year-end 2010 and 2009, respectively. The overall portfolio remained in an unrealized gain position as strong returns in the equity and corporate bond markets more than offset a decline in the municipal bond market.
 
The cash we generate from insurance operations historically has been invested in three broad categories of investments:
 
 
·
Fixed-maturity investments – Includes taxable and tax-exempt bonds and redeemable preferred stocks. During 2010 and 2009, purchases and market value gains served to more than offset sales and calls.
 
 
·
Equity investments – Includes common and nonredeemable preferred stocks. During 2010, purchases and fair value gains more than offset sales. During 2009, sales slightly offset fair value appreciation of equity securities.
 
 
·
Short-term investments – Primarily commercial paper.
 
(In millions)
 
At December 31, 2010
   
At December 31, 2009
 
   
Book value
   
% of BV
   
Fair value
   
% of FV
   
Book value
   
% of BV
   
Fair value
   
% of FV
 
Taxable fixed maturities
  $ 5,139       50.5 %   $ 5,533       48.4 %   $ 4,644       48.6 %   $ 4,863       46.0 %
Tax-exempt fixed maturities
    2,749       27.0       2,850       25.0       2,870       30.1       2,992       28.3  
Common equities
    2,211       21.7       2,940       25.7       1,941       20.4       2,608       24.7  
Preferred equities
    75       0.8       101       0.9       75       0.8       93       0.9  
Short-term investments
    0       0.0       0       0.0       6       0.1       6       0.1  
Total
  $ 10,174       100.0 %   $ 11,424       100.0 %   $ 9,536       100.0 %   $ 10,562       100.0 %

We actively determine the portion of new cash flow to be invested in fixed-maturity and equity securities at the parent and insurance subsidiary levels. During 2010, approximately one-quarter of new cash flow was invested in equity securities, consistent with our long-term average. We 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 surplus for the property casualty and life insurance operations, and the parent company’s ratio of investment assets to total assets.
 
At year-end 2010, less than 1 percent of the value of our investment portfolio was made up of securities that do not actively trade on a public market and require management’s judgment to develop pricing or valuation techniques (Level 3 assets). 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, Page 46, and Item 8, Note 3 of the Consolidated Financial Statements Page 114, for additional discussion of our valuation techniques.
 
In addition to securities held in our investment portfolio, at year-end 2010, other invested assets included $40 million of life policy loans, $28 million of venture capital fund investments, $5 million of investment in real estate and $11 million of other invested assets.
 
Fixed-maturity and Short-term 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-

 
19

 

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 and Short-term Portfolio Ratings
 
As of year-end 2010, this portfolio’s fair value was 106.3 percent of book value, up from last year due to both a decline in the general level of treasury rates and a continued tightening of credit spreads.
 
The portfolio grew in 2010 due to a large volume of purchases. These purchases were most concentrated in the investment grade corporate bond market. Although the average rating of our bond portfolio remained unchanged, the number of bonds rated Aaa/AAA decreased and the number of bonds rated Aa/AA increased. The rating distribution change was driven by net redemptions of U.S. agency (government-sponsored enterprises) bonds due to call activity and an increase in purchases of Build America Bonds. The majority of our non-rated securities are tax-exempt municipal bonds from smaller municipalities that chose not to pursue a credit rating. Credit ratings at year-end 2010 for the fixed-maturity and short-term portfolios were:
 
(In millions)
 
At December 31, 2010
   
At December 31, 2009
 
   
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
  $ 5,216       62.2 %   $ 4,967       63.2 %
Baa, BBB
    2,656       31.7       2,302       29.3  
Ba, BB
    241       2.9       279       3.5  
B, B
    42       0.5       44       0.6  
Caa, CCC
    19       0.2       29       0.4  
Ca, CC
    0       0.0       3       0.0  
Daa, Da, D
    1       0.0       0       0.0  
Non-rated
    208       2.5       237       3.0  
Total
  $ 8,383       100.0 %   $ 7,861       100.0 %

Our fixed-maturity portfolio as of December 31, 2010, included approximate maturing amounts with pretax average yields-to-book value as follows: 3.4 percent maturing in 2011 with a 5.9 percent yield, 5.4 percent in 2012 with a 5.5 percent yield, and 8.6 in 2013 percent with a 4.7 percent yield, Additional maturity periods for our fixed-maturity portfolio are shown in Item 8, Note 2 of the Consolidated Financial Statements, Page 111. Attributes of the fixed-maturity portfolio include:
 
   
At December 31,
   
2010
 
2009
Weighted average yield-to-book value
    5.5  
%
    5.9  
%
Weighted average maturity
    6.2  
yrs
    7.5  
yrs
Effective duration
    5.0  
yrs
    5.3  
yrs

Taxable Fixed Maturities
 
Our $5.533 billion taxable fixed-maturity portfolio (at fair value) at year-end included:
 
(In millions)
 
At December 31,
 
   
2010
   
2009
 
Investment-grade corporate
  $ 4,695     $ 3,941  
States, municipalities and political subdivisions
    293       137  
Below investment-grade corporate
    268       309  
Government sponsored enterprises
    200       347  
Convertibles and bonds with warrants attached
    69       91  
United States government
    5       4  
Foreign government
    3       3  
Collateralized mortgage obligations
    -       31  
Short-term investments
    -       6  
Total
  $ 5,533     $ 4,869  

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 1.1 percent of the taxable fixed-maturity portfolio at year-end 2010. Investment grade corporate bonds had an average rating of Baa1 by Moody’s or BBB+ by Standard & Poor’s and represented 84.8 percent of the taxable fixed maturity portfolio’s fair value at year end 2010, compared with 80.9 percent in 2009.
 
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 28.9 percent of fair value of this portfolio at year-end 2010, compared with 25.3 percent, at year-end 2009. 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. Energy was the only other

 
20

 

sector that exceeded 10 percent of our investment-grade corporate bond portfolio, at 10.0 percent of fair value at year-end 2010.
 
Most of the $293 million of securities issued by states, municipalities and political subdivisions securities included in our taxable fixed maturity portfolio at the end of 2010 were Build America Bonds.
 
Tax-exempt Fixed Maturities
 
Our tax-exempt fixed maturity portfolio’s fair value was $2.850 billion at December 31, 2010. We traditionally have purchased municipal bonds focusing on general obligation and essential services, such as sewer, water or others. The portfolio is well diversified among approximately 1,000 municipal bond issuers. No single municipal issuer accounted for more than 0.7 percent of the tax-exempt fixed maturity portfolio at year-end 2010. Municipal bond holdings in our larger states were:
 
(In millions)
 
At December 31, 2010
 
State issued general
obligation bonds
   
Local issued
general obligation
bonds
   
Special revenue
bonds
   
Total
   
Percent of
total
 
Texas
  $ -     $ 425     $ 107     $ 532       18.7 %
Indiana
    -       21       328       349       12.2  
Michigan
    -       245       12       257       9.0  
Illinois
    -       219       23       242       8.5  
Ohio
    -       131       107       238       8.4  
Washington
    -       166       32       198       6.9  
Wisconsin
    -       116       19       135       4.7  
Florida
    -       19       67       86       3.0  
Pennsylvania
    -       67       9       76       2.7  
Arizona
    -       46       30       76       2.7  
Colorado
    -       37       15       52       1.8  
New Jersey
    -       28       17       45       1.6  
Kansas
    -       24       20       44       1.5  
New York
    3       15       21       39       1.4  
Utah
    -       20       17       37       1.3  
All other states
    -       233       211       444       15.6  
Total
  $ 3     $ 1,812     $ 1,035     $ 2,850       100.0 %
                                         
At December 31, 2009
                                       
Texas
  $ -     $ 455     $ 112     $ 567       19.0 %
Indiana
    -       21       356       377       12.6  
Michigan
    -       246       15       261       8.7  
Illinois
    -       223       28       251       8.4  
Ohio
    -       128       105       233       7.8  
Washington
    -       170       39       209       7.0  
Wisconsin
    -       130       20       150       5.0  
Florida
    -       19       69       88       2.9  
Arizona
    -       46       32       78       2.6  
Pennsylvania
    -       67       10       77       2.6  
Colorado
    -       37       16       53       1.8  
Kansas
    -       23       21       44       1.5  
New Jersey
    -       25       17       42       1.4  
Missouri
    -       19       21       40       1.3  
New York
    3       13       22       38       1.3  
All other states
    -       263       221       484       16.1  
Total
  $ 3     $ 1,885     $ 1,104     $ 2,992       100.0 %

At year-end 2010, our tax-exempt fixed maturity portfolio, with a fair value of $2.850 billion, had an average rating of Aa2/AA. Almost 80 percent or $2.245 billion of the portfolio is insured, and approximately 93 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.
 
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 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.

 
21

 

At December 31, 2010, one holding had a fair value equal to or greater than 5 percent of our publicly traded common stock portfolio compared with two holdings at that level at year-end 2009. The Procter & Gamble Company (NYSE:PG) is our largest single common stock investment, comprising 5.2 percent of the publicly traded common stock portfolio and 1.3 percent of the investment portfolio.
 
At year-end 2010, 26.0 percent of our common stock holdings (measured by fair value) were held at the parent company level.
 
Common Stock Portfolio Industry Sector Distribution
 
   
Percent of Publicly Traded Common Stock Portfolio
 
   
At December 31, 2010
   
At December 31, 2009
 
   
Cincinnati
 Financial
   
S&P 500 Industry
Weightings
   
Cincinnati
Financial
   
S&P 500 Industry
Weightings
 
Sector:
                       
   Consumer staples
    15.4 %     10.6 %     15.5 %     11.4 %
   Healthcare
    14.1       10.9       18.0       12.6  
   Information technology
    13.0       18.7       11.0       19.8  
   Energy
    12.9       12.0       11.0       11.5  
   Industrials
    11.7       11.0       9.2       10.2  
   Financial
    11.7       16.1       10.2       14.4  
   Consumer discretionary
    8.3       10.6       9.6       9.6  
   Materials
    5.2       3.7       5.1       3.6  
   Utilities
    4.2       3.3       6.7       3.7  
   Telecomm services
    3.5       3.1       3.7       3.2  
     Total
    100.0 %     100.0 %     100.0 %     100.0 %

Preferred Stocks
 
We evaluate preferred stocks in a manner similar to our evaluation of fixed-maturity investments, seeking attractive relative yields. We generally focus on investment-grade preferred stocks issued by companies with strong histories of paying common dividends, providing us with another layer of protection. When possible, we seek out preferred stocks that offer a dividend received deduction for income tax purposes. Events in the fall of 2008 and into early 2009 led us to re-evaluate the riskiness of all preferred securities, particularly those of banking institutions. As a result, during 2009 we downsized this portfolio by $82 million of fair value to $93 million. We made no additional purchases or sales for this portfolio during 2010.
 
Short-Term Investments
 
At December 31, 2010, we had no short-term investments, compared with $6 million at year-end 2009. Our short-term investments consisted primarily of commercial paper, demand notes or bonds purchased within one year of maturity.
 
Additional information about the composition of investments is included in Item 8, Note 2 of the Consolidated Financial Statements, Page 111. A detailed listing of our portfolio is updated on our website, www.cinfin.com/investors, each quarter when we report our quarterly financial results.
 
Other
 
We report as Other the non-investment operations of the parent company and its subsidiary CFC Investment Company. This subsidiary offers commercial leasing and financing services to our agencies, their clients and other customers. As of year-end 2010, CFC Investment Company had 2,227 accounts and $73 million in receivables, compared with 2,286 accounts and $75 million in receivables at year-end 2009.
 
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, which is domiciled in the state of 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 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.

 
22

 

 
·
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 policyholder surplus or 100 percent of statutory net income for the prior calendar year. Dividends exceeding these limitations may be paid only with approval of the insurance department of the domiciliary state.
 
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 2010 in Item 8, Note 9 of the Consolidated Financial Statements, Page 118.
 
 
·
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 have their source 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 non-renewals; 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. In 2010, our primary insurance regulators 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.
 
The legislative and regulatory climate in Florida continues to create uncertainty for the insurance industry. In February 2007, we adopted a marketing stance of continuing to service existing accounts while writing no new business relationships in Florida. This remained our stance through 2009, except in the lines of directors and officers, surety, machinery and equipment and life insurance, which we resumed writing in June 2007, subject to existing guidelines. In 2009, we cautiously resumed writing additional commercial lines new business while working to more actively manage the associated catastrophe risk, carefully underwriting new commercial submissions and non-renewing commercial and personal lines policies that present the most risk of loss because of their age, construction and geographic characteristics. In 2010, our property casualty net written premiums from Florida agencies were 1.7 percent of net written premiums, compared with 1.9 percent in 2009.
 
On August 24, 2007, the company received administrative subpoenas from the Florida Office of Insurance Regulation seeking documents and testimony concerning insurance for residential risks located in Florida and communications with reinsurers, risk modeling companies, rating agencies and insurance trade associations. We produced documents to respond to the subpoenas. The Office of Insurance Regulation canceled and has not rescheduled the hearing noticed in the subpoena for October 18, 2007. Although inactive, these subpoenas remain outstanding as of December 31, 2010. We continue to assess the changing insurance environment in Florida and hope to resume writing our complete portfolio of insurance products in the state as the market stabilizes.
 
 
·
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 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 $3 million from guaranty associations in 2010 and a savings of less than $2 million in 2009. 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’

 
23

 

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.
 
 
·
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 non-public 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), 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 counsel that it designate an insurer as a systemically significant entity requiring additional supervision by the Federal Reserve Board. Although rules have not yet been proposed or implemented to govern the determination that a non-bank financial company, such as an insurance company, presents systemic risk, we do not expect such rules, when adopted, 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.
 
 
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, Page 36, 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, non-exclusive 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’

 
24

 

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) rating from A.M. Best for our standard market property casualty insurance subsidiaries, are an important competitive advantage. Ratings agencies could change or expand their requirements. If our property casualty 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 1, Our Business and Our Strategy, Page 3, 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 agents’ clients or perceptions that our business practices are not compatible with agents’ business models.
 
 
·
Delays in the development, implementation, performance and benefits of technology projects and enhancements or independent agent perceptions that our technology solutions are inadequate to 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 due 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.
 
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.
 
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, the accuracy of 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.
 
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 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.
 
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 as general commercial risks in the metropolitan Chicago area, small co-op utilities, small shopping malls and small colleges throughout our 39 active states and, because of the number of associates located there, our Fairfield 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.

 
25

 

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 three assumed reinsurance treaties with two reinsurers that spread the risk of very high catastrophe losses among many insurers. In 2010, the largest treaty had exposure of up to $7 million of assumed losses in three layers, from $1.0 billion to $1.7 billion, from a single event under an assumed reinsurance treaty for Munich Re Group. Amounts related to the other two treaties are immaterial.
 
In the event of a severe catastrophic event or terrorist attack elsewhere in the world, our insurance losses may be immaterial. However, the companies in which we invest 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. 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.
 
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 policyholders’ 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, Page 93.
 
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. We discuss other risks associated with our separate account BOLIs in Item 7, Critical Accounting Estimates, Separate Accounts, Page 47.
 
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 2010, common stock holdings made up 25.5 percent of our invested assets. 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, Page 75, and Item 7A, Quantitative and Qualitative Disclosures About Market Risk, Page 93, 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 purchased, fail or are otherwise negatively affected. We may lose premium 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.

 
26

 

Deteriorating 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.
 
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. 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 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.
 
Please see the discussion of our Commercial Lines, Personal Lines, Excess and Surplus Lines and Life Insurance Segments in Item 1, Page 12, Page 15 and Page 16, for a discussion of our competitive position in the insurance marketplace.

 
27

 

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 and the material implications of uncertainties associated with the methods, assumptions and estimates underlying our critical accounting policies, please refer to Item 8, Note 1 of the Consolidated Financial Statements, Page 105, and Item 7, Critical Accounting Estimates, Property Casualty Insurance Loss and Loss Expense Reserves and Life Insurance Policy Reserves, Page 41 and Page 44.
 
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, 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.
 
The process used to determine our loss reserves is discussed in Item 7, Critical Accounting Estimates, Property Casualty Insurance Loss and Loss Expense Reserves and Life Insurance Policy Reserves, Page 41 and Page 44.
 
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, 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.
 
We participated in USAIG, a joint underwriting association of individual insurance companies that collectively functions as a worldwide insurance market for all types of aviation and aerospace accounts. Our participation was terminated after policy year 2002. At year-end 2010, 19 percent, or $110 million, of our total reinsurance receivables were related to USAIG, primarily for events of September 11, 2001, offset by $118 million of amounts ceded to other pool participants and reinsurers. If the pool participants and reinsurers were unable to fulfill their financial obligations and all security collateral that supports the participants’ obligations became worthless, we could be liable for an additional pool liability of $230 million and our financial position and results of operations could be materially affected. Currently all pool participants and reinsurers are financially solvent.
 
Please see Item 7, 2011 Reinsurance Programs, Page 90, for a discussion of our reinsurance treaties.
 
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

 
28

 

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 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 70 percent of our associates work at our Fairfield, Ohio, headquarters.
 
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 or by increasing the number or size of claims. 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.
 
We are required to adopt new or revised accounting standards issued by recognized authoritative organizations, including the Financial Accounting Standards Board 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.
 
The National Association of Insurance Commissioners (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 affects 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 non-bank financial company presents systemic risk and therefore should be subject to heightened supervision by the Federal Reserve Board. 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, Page 41 and Page 44, for a discussion of our reserving practices.
 
Managing technology initiatives and meeting new 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 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 employees 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 rapidly emerge and change, exposing us to rising costs and competing time constraints to secure our data in accordance with customer expectations and statutory and regulatory requirements. A breach of our security that results in unauthorized access to our data could expose us to data loss, litigation, damages, fines and penalties, significant increases in compliance costs and reputational damage.
 
Please see Item 1, Strategic Initiatives, Page 9 for a discussion of our technology initiatives.
 
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

 
29

 

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. Currently, the maximum dividend that may be paid without prior regulatory approval is limited to the greater of 10 percent of statutory surplus or 100 percent of statutory net income for the prior calendar year, up to the amount of statutory unassigned 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, Page 22, and Item 8, Note 9 of the Consolidated Financial Statements, Page 118, 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 approximately 1,508,200 total square feet of available space. The property, including land, is carried in our financial statements at $159 million as of December 31, 2010, and is classified as land, building and equipment, net, for company use. John J. & Thomas R. Schiff & Co. Inc., a related party, occupies approximately 6,750 square feet (less than 1 percent).
 
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 $5 million as of December 31, 2010, and is classified as an other invested asset. Unaffiliated tenants occupy approximately 5 percent. All unoccupied space is currently available for lease.
 
The Cincinnati Insurance Company owns a building 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 $11 million as of December 31, 2010, and is classified as land, building and equipment, net, for company use.
 
 
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.
(Removed and Reserved)

 
30

 
 
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 13,000 shareholders of record as of December 31, 2010. This number does not represent the total number of shareholders because some shares are beneficially held in “street name” by brokers and others on behalf of individual owners of our shares. Many of our independent agent representatives and most of the 4,060 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)
 
2010
   
2009
 
Quarter:
 
1st
   
2nd
   
3rd
   
4th
   
1st
   
2nd
   
3rd
   
4th
 
High
  $ 29.65     $ 30.38     $ 29.39     $ 32.27     $ 29.66     $ 26.94     $ 26.31     $ 26.89  
Low
    25.50       25.65       25.25       28.68       17.84       21.40       21.30       25.05  
Period-end close
    28.91       25.87       28.82       31.69       22.87       22.35       25.99       26.24  
Cash dividends declared
    0.395       0.395       0.40       0.40       0.39       0.39       0.395       0.395  

We discuss the factors that affect our ability to pay cash dividends and repurchase shares in Item 7, Liquidity and Capital Resources, Page 78. One factor we address is regulatory restrictions on the dividends our insurance subsidiary can pay to the parent company, which also is discussed in Item 8, Note 9 of the Consolidated Financial Statements, Page 118.
 
The following summarizes securities authorized for issuance under our equity compensation plans as of December 31, 2010:
 
Plan category
 
Number of securities to be
issued upon exercise of
outstanding options,
warrants and rights at
December 31, 2010
   
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, 2010
 
   
(a)
   
(b)
   
(c)
 
Equity compensation plans approved by security holders
    9,689,800     $ 36.59       5,980,147  
Equity compensation plans not approved by security holders
    -       -       -  
Total
    9,689,800     $ 36.59       5,980,147  

The number of securities remaining available for future issuance includes: 5,627,553 shares available for issuance under the Cincinnati Financial Corporation 2006 Stock Compensation Plan, which can be issued as stock options, service-based, or performance-based restricted stock units, stock appreciation rights or other equity-based grants; 83,904 shares of stock options available for issuance under the Cincinnati Financial Corporation Stock Option Plan VII and 268,690 shares available for issuance of share grants under the Director’s Stock Plan of 2009. 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, Page 125.
 
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, 2010
    0     $ 0.00       0       9,044,097  
February 1-28, 2010
    0       0.00       0       9,044,097  
March 1-31, 2010
    0       0.00       0       9,044,097  
April 1-30, 2010
    0       0.00       0       9,044,097  
May 1-31, 2010
    332,748       26.49       332,748       8,711,349  
June 1-30, 2010
    45,000       26.49       45,000       8,666,349  
July 1-31, 2010
    0       0.00       0       8,666,349  
August 1-31, 2010
    0       0.00       0       8,666,349  
September 1-30, 2010
    0       0.00       0       8,666,349  
October 1-31, 2010
    0       0.00       0       8,666,349  
November 1-30, 2010
    0       0.00       0       8,666,349  
December 1-31, 2010
    0       0.00       0       8,666,349  
Totals
    377,748       26.49       377,748          

 
31

 

We did not sell any of our shares that were not registered under the Securities Act during 2010. The board of directors has authorized share repurchases since 1996. Purchases are expected to be made generally through open market transactions. The board gives management discretion to purchase shares at reasonable prices in light of circumstances at the time of purchase, subject to U.S. Securities and Exchange Commission (SEC) regulations. During 2010, we repurchased 377,748 shares at an average cost of $26.49 per share.
 
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.

 
32

 

Cumulative Total Return
 
As depicted in the graph below, the five–year total return on a $100 investment made December 31, 2005, assuming the reinvestment of all dividends, was a negative 10.3 percent for Cincinnati Financial Corporation’s common stock compared with a negative 12.9 percent for the Standard & Poor’s Composite 1500 Property & Casualty Insurance Index and a 12.0 percent return for the Standard & Poor’s 500 Index.
 
The Standard & Poor’s Composite 1500 Property & Casualty Insurance Index includes 25 companies: Ace Ltd., Allstate Corporation, Amerisafe Inc., W. R. Berkley Corporation, Berkshire Hathaway, Chubb Corporation, Cincinnati Financial Corporation, Employers Holdings Inc., Fidelity National Financial Inc., First American Financial Corporation, Hanover Insurance Group Inc., Infinity Property & Casualty Corporation, Mercury General Corporation, Navigators Group Inc., Old Republic International Corporation, Proassurance Corporation, Progressive Corporation, RLI Corporation, Safety Insurance Group Inc., Selective Insurance Group Inc., Stewart Information Services, Tower Group Inc., Travelers Companies Inc., United Fire & Casualty Company and XL Capital Ltd.
 
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.
 

 
33

 

 
Item 6.
Selected Financial Data
 
(In millions except per share data)
 
Years ended December 31,
 
   
2010
   
2009
   
2008
   
2007
 
Consolidated Income Statement Data
                       
Earned premiums
  $ 3,082     $ 3,054     $ 3,136     $ 3,250  
Investment income, net of expenses
    518       501       537       608  
Realized investment gains and losses*
    159       336       138       382  
Total revenues
    3,772       3,903       3,824       4,259  
Net income
    377       432       429       855  
Net income per common share: