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Yesterday, property and casualty insurer Cincinnati Financial Corp. (CINF - Analyst Report) declared a preliminary pre-tax catastrophe loss (cat loss) estimate of about $88–$98 million, which will be reflected in its third quarter 2011 results.  The losses mainly emanated from Hurricane Irene and other catastrophes.

The Cincinnati, Ohio-based company stated that catastrophes affected its loss ratio by an average of 4.9 % for the third quarter and 4.4% on a full-year basis over the past decade. However, the impact of the recent catastrophe on the third quarter loss ratio will be approximately 11.5% to 12.5%, significantly higher than the historical average.

In the previous quarter, Cincinnati incurred huge storm losses of $290 million and reported an operating loss of 57 cents per share, which was, however, narrower than the Zacks Consensus Estimate of a loss of 64 cents per share.

Cincinnati’s use of reinsurance cover will, however, limit its loss. Sensing a high catastrophe activity, the company has replenished its catastrophe coverage for the remainder of 2011. The company’s current program provides coverage for any single catastrophe that causes losses above $70 million and up to $200 million, and coverage remains in place for losses up to $500 million. 

Other property and casualty insurers who suffered from bad weather during the third quarter include Assurant Inc. (AIZ - Analyst Report), The Chubb Corp. (CB - Analyst Report), W. R. Berkley Corp. (WRB - Analyst Report) and Tower Group Inc. (TWGP - Analyst Report). While Assurant forecasts a pre-tax cat loss of $80 million to $85 million, Chubb sees a significantly high catastrophe loss of $400 million to $475 million pre-tax. Besides, both Berkley and Tower expect an earnings hit of $50 – $60 million.

According to the Insurance Information Institute, the property and casualty industry was hit hard during the first half of the year, as profitability suffered greatly amid high cat losses. In the third quarter, hurricane Irene along with other catastrophes is estimated to have caused insured losses of $3 billion to $4 billion to the industry.

Year to date, weather-related losses for the industry are expected to trend above $25 billion, up $14.1 billion compared with the cat losses incurred in first-half 2010 and about thrice the $7.7 billion average for first-half catastrophe losses during the past ten years.

However, the only silver lining to these catastrophe activities is that the record high losses are gradually hardening the commercial lines pricing. Also, the recent market surveys by the CIAB (Council of Insurance Agents and Brokers) and MarketScout have indicated that the moderation of declining commercial lines pricing is accelerating, while select commercial lines pricing is witnessing rate increases in certain lines.

Almost 67% of the projected cat loss is attributable to Cincinnati’s Commercial Lines business, which is also its biggest business segment. The unit’s business exposure in the states of North Carolina and Virginia, which suffered from wind storms have caused a considerable loss. Moreover, the segment has been suffering from pricing pressure for the past several years.

Though the commercial lines rate is expected to harden, in the most recent conference call management noted price increases across certain areas (workers’ comp & E&S lines). Management also noted a continued pricing pressure in large account business, which is restraining the company’s commercial lines pricing. Moreover, management guided a lackluster across-the-board pricing improvement for all its lines. 

Cincinnati’s Personal Line segment, which consists of Personal auto, homeowners and other lines, had also underperformed from 2006 to 2009. However, with an improvement in new business levels, strong retention levels, as well as rate increases that affected the homeowner line in 2009, the segment has recently been witnessing premium growth.

Though management is looking to diversify property risks by writing more business in newer states (that carry lower inherent cat risk), we think this effort will take time before any noticeable benefit shows up in margins. Meanwhile, underwriting could be subject to volatility if the storm activity remains at historically high levels.

Despite the operating headwinds, Cincinnati has been able to keep its long-standing dividend increase streak (50 years and counting) intact this year, thus maintaining its attractiveness to the investors. But given the weakness surrounding the company’s business, we think that dividend alone will not be sufficient to encourage investors to remain invested over the long term. 

Considering Cincinnati’s uncertain operating environment, we are currently maintaining an Underperform recommendation. We may revisit our recommendation if the third quarter earnings release throws more positive light on the company’s operating environment.

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