Cincinnati Financial Annual Report 1997

Plain-text annual report

O U R C U S T O M E R I S T H E L O C A L I N D E P E N D E N T A G E N T . V A L U E F O R S H A R E H O L D E R S A N D P O L I C Y H O L D E R S I S T H E R E S U L T . C I N C I N N A T I F I N A N C I A L C O R P O R A T I O N 1 9 9 7 A N N U A L R E P O R T O U R C O M P A N Y Cincinnati Financial Corporation, formed in 1968, has ﬁve subsidiaries: • The lead property and casualty insurance subsidiary, The Cincinnati Insurance Company, was founded in 1950. It markets a broad range of business and personal policies in 27 states, operating with a strong customer focus on an elite corps of 973 local independent insurance agencies. The $2 billion target for direct premium written during the year 2000 requires us to become a larger, more aggressive company, building ﬁnancial strength that beneﬁts agents, policyholders, shareholders, associates • The Cincinnati Casualty Company and The Cincinnati Indemnity and community. Company round out the A++ rated property and casualty insurance group. Programmer Joann Gillming • The Cincinnati Life Insurance Company markets life, health and submitted this special logo, designed accident policies. • CFC Investment Company complements the insurance subsidiaries to inspire individuals and teams to with leasing, ﬁnancing and real estate services. take ownership of this goal. O U R M I S S I O N 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. O U R R E C O R D Over the past ﬁve years, the Company has experienced strong compound growth: • Net written property and casualty premium grew 7.7 percent annually. • Investment income, the primary source of Company proﬁts, rose 9.8 percent annually. • Book value grew 22.2 percent annually, reaching a record $85.06. • Earnings per share advanced 11.5 percent annually. • Cash dividends paid increased 12.2 percent annually, reaching an indicated annual total of $1.60 at December 31, 1997. • Total return to shareholders, including share appreciation and dividends, grew 22.8 percent annually compared to 19.2 percent for the Standard & Poor’s property casualty insurance group and 20.0 percent for the Standard & Poor’s 500 Index. O U R O U T L O O K We have resources and opportunities to grow proﬁtably, increasing effectiveness and shareholder value: • Beginning to actively market in two new states in 1998 and evaluating ﬁve more states for future years. • Expanding our distribution network for life insurance, ﬁnancing and leasing products and services. • Serving our agents better with a stronger local presence, work-saving technology initiatives and competitive products, rates and compensation. • CINF shares trading for the ﬁrst time as part of the Standard & Poor’s 500 Index. C O N T E N T S Financial Highlights . . . . . . . . . . . . . . . 1 Letter To Our Shareholders . . . . . . . . 2-3 Reports On Subsidiary Companies . . . . . . . . . . . . . . . . . 4-11 Selected Financial Information . . . 12-13 Management Discussion . . . . . . . . . 14-18 Responsibility For Financial Statements . . . . . . . . . . . . . . . . . . . 19 Independent Auditors’ Report . . . . . . . 19 Consolidated Financial Statements . . . . . . . . . . . . . . . . 20-23 Notes To Consolidated Financial Statements. . . . . . . . . 24-30 Subsidiary Ofﬁcers And Directors . . . . . . . . . . . . . . . . . 31 Corporate Ofﬁcers And Directors . . . . . . . . . . . . . . . . . 32 Shareholder Information And Price Range Of Common Stock. . . . 33 Selected Quarterly Financial Data . . . . . . . . . . . . . . . . 33 F I N A N C I A L H I G H L I G H T S Cincinnati Financial Corporation and Subsidiaries Comparative results 1997-1996 (000’s omitted except per share data and ratios) OPERATING PERFORMANCE 1997 1996 % Change Revenues . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Income Before Income Taxes . . . . . . . . . . . . . . . . . . . . . . . . . . . . Net Operating Income . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Net Capital Gains (after tax) . . . . . . . . . . . . . . . . . . . . . . . . . . . . Net Income . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ 1,942,384 394,559 254,375 45,000 299,375 $ 1,808,749 282,421 192,595 31,165 223,760 FINANCIAL POSITION Total Assets . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Shareholders’ Equity . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 9,493,425 4,716,965 7,045,514 3,162,889 PER SHARE DATA Net Operating Income . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Net Capital Gains . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Net Income . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Net Income (Diluted) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Dividends Declared . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Book Value . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Average Shares Outstanding . . . . . . . . . . . . . . . . . . . . . . . . . . . . PERFORMANCE RATIOS Combined Ratio . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Return on Equity . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Return on Equity Including Net Unrealized Gain and Loss . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . (1) Adjusted to reﬂect 5 percent stock dividends paid in April, 1996 and 1995. (2) Includes common stock equivalents for stock options and convertible debentures. 4.61 .82 5.43 5.31 1.64 85.06 55,179 97.7 7.6 42.6 7.4 39.7 32.1 44.4 33.8 34.7 49.1 33.6 46.4 35.4 35.5 12.3 49.6 (1.0) (5.1) (1.3) 3.45 .56 4.01 3.92 1.46 56.85 55,736 103.0 7.7 20.3 109.9 REVENUES (In Millions of Dollars) 1,655.7 1,512.5 1,442.2 1,942.4 1,808.7 NET INCOME/DIVIDENDS PAID* Per Common Share (In Dollars) SHAREHOLDERS’ EQUITY* Book Value Per Common Share (In Dollars) Net Income Dividends Paid 5.43 3.91 3.62 4.08 4.01 1.00 1.12 1.26 1.43 1.60 85.06 56.85 47.75 35.24 34.94 93 94 95 96 97 93 94 95 96 97 93 94 95 96 97 *Adjusted to reflect 5% stock dividends paid in April, 1995 and 1996. *Adjusted to reflect 5% stock dividends paid in April, 1995 and 1996. 1 T O O U R S H A R E H O L D E R S : PERFORMANCE OVERVIEW underwriting with a $24.8 million net independent life agent distribution Cincinnati Financial Corporation’s performance got stronger and stronger over the course of 1997. While revenues advanced 7.4 percent to $1.942 billion, total net income grew 33.8 percent to $299.4 million and net operating income rose 32.1 percent to $254.4 million. The weather and the stock market cooperated, reducing catastrophic storm losses and providing opportunities for higher investment income and capital gains. 1997 catastrophe losses were a more typical $25.5 million versus last year’s unusually high $64.7 million. Just as important, our customer focus on agents, consistent and disciplined underwriting practices and claims management proved their value. While growing premiums at twice the industry rate in 1997, we experienced lower overall claims loss trends. Proﬁtability returned to property and casualty insurance NET OPERATING INCOME* Per Common Share (In Dollars) 4.61 3.30 3.40 3.72 3.45 93 94 95 96 97 *Adjusted to reflect 5% stock dividends paid in April, 1995 and 1996. Net operating earnings rose to all-time highs for the year and for each of the last three quarters of 1997. 2 gain versus last year’s $45.0 million network, accelerate revenue growth, net underwriting loss. lower unit costs and achieve This year’s lower claims payments unparalleled service. joined with higher realized capital • We partnered with leading gains to increase cash ﬂow, technology consultants to begin contributing to 6.5 percent growth of developing an Intranet-based system investment income to $348.6 million. that will be accessible from our Net realized after-tax capital gains headquarters and from our ﬁeld were $45.0 million, up from representative and agent ofﬁces. $31.2 million last year. Higher equity This technology is planned to make values presented many opportunities us more efﬁcient and more effective, to sell convertible securities, which with systems that enhance our accounted for approximately trademark ﬂexibility and personal 70 percent of the net gains. relationships. Assets, shareholders’ equity and Early in 1998, we ﬁrmed up plans book value climbed to all-time highs. for another infrastructure item, As of December 31, 1997, assets were construction of a second ofﬁce tower up 34.7 percent over year-end 1996 on the CFC Headquarters property. at $9.493 billion. Shareholders’ We outgrew the current tower about equity was up 49.1 percent to a year ago and now have close to 300 $4.717 billion. Book value rose associates in other buildings. With to $85.06 from $56.85. continued steady growth, the new MOVING RESOURCES INTO PLACE building will ﬁll up very quickly following the two-year construction Our continued ability to grow is timeframe. limited only by our ability to develop our staff and technology resources. REWARDING SHAREHOLDERS During 1997 we made major progress: Standard & Poor’s added CINF • We expanded the leadership ranks to the S&P 500 Index at the close of of corporate ofﬁcers, promoting trading on December 17, 1997. The Theodore F. Elchynski to Chief S&P 500 is a key barometer of stock Financial Ofﬁcer and appointing Vice market activity and performance Presidents Kenneth S. Miller, CLU, benchmarks for professional money ChFC and Kenneth W. Stecher. managers. Selection to the index • The Cincinnati Life Insurance called attention to our strong market Company appointed President and position and operating results. Chief Operating Ofﬁcer David H. Following the announcement, trading Popplewell, FALU, LLIF and Senior increased and our share price soared. Vice President Glenn D. Nicholson, Two months down the road, the price LLIF, Senior Marketing Ofﬁcer. They seems stabilized at about one and a are rapidly implementing product and half times book value. marketing initiatives to expand the mission places agents at the center of our identity. We follow through, making sure every move enhances our agents’ ability to add value to the insurance transaction for people and businesses in their communities. Giving our agent customers what they need to compete continuously raises the bar, requiring us to set and exceed ever higher standards for products, proﬁtability, service and ﬁnancial strength. We are a specialty company. Our specialty is not a product niche; we prefer to offer a broad range of products so agents can rely on us to be their ﬁrst-choice carrier for all of their good business. Our specialty is a distribution strategy—the local independent agent strategy—and it offers abundant rewards for those who do it extremely well. We pledge to support our strong, dynamic independent agent customers as they ﬁnd and serve that large percentage of the population that wants more than commodity insurance products and services. That is what differentiates us from other companies, creating superior value for our agents, shareholders, policyholders, associates and community. Robert B. Morgan President and Chief Executive Ofﬁcer Left to right: John J. Schiff, Chairman of the Executive Committee; Robert B. Morgan, President and Chief Executive Ofﬁcer; John J. Schiff, Jr., CPCU, Chairman of the Board. During each of the past 37 years, split would improve liquidity of CINF your Company has raised cash shares, bringing convenience for dividends paid to shareholders. investors and supporting increased Adjusted for stock dividends and trading from mutual funds that invest splits, dividends paid per share rose to track the S&P 500 Index. to $1.60 in 1997 from $0.43 in 1987, For the year ended December 31, a 14.0 percent ten-year compound 1997, CINF’s 121 percent total growth rate. At their meeting in return to shareholders, including February of 1998, the Board of share appreciation and dividends, Directors declared a $0.05 per share was the ﬁfth highest among all increase in the regular quarterly cash S&P 500 Index companies. dividend, raising the indicated annual Cincinnati Financial’s convertible dividend to $1.84 per share. debenture was the top performing The Board also announced plans debenture in the country for 1997. to declare a three-for-one split to be The events of 1997 and the outlook distributed in May, pending share- for 1998 would appear to make this holder approval on April 4 of an a great time to own CFC shares. authorized share increase to 200 We thank you for your conﬁdence million from 80 million. This would be the 27th stock dividend or split over the past 41 years. Shareholders who purchased one share prior to the ﬁrst dividend in 1957, and who held all shares accrued from stock dividends and splits, would own 1,947 shares after the proposed distribution in May. The planned and for the opportunity to reward you, our loyal shareholders. OUR AGENT, OUR CUSTOMER, OUR ADVANTAGE John J. Schiff, Jr., CPCU Chairman of the Board While other companies may distribute through local independent agents and/or other channels, John J. Schiff Cincinnati is a company whose very Chairman of the Executive Committee 3 S E E I N G T H R O U G H L O C A L Where we have established top positions in agencies, a dedicated local ﬁeld staff makes it easier for agents to serve their communities. With more than 620 local resident ﬁeld claims representatives, we can often assign one or more to work full-time with a single agency, its policyholders and claimants. Paying claims is our business. Through these local adjusters, the agent provides key accounts with consistency and personal service when they need it most—when they have claims. Established agencies in developed states have regular, personal contact with various ﬁeld marketing representatives for property and casualty or life insurance, bonds or leasing. Additional ﬁeld representatives work with agency clients, providing premium audit, engineering and loss control services. By giving all of our ﬁeld staff full authority and placing them at the local level alongside agents, we strengthen the agents’ ability to deliver added value. David G. Winegarden, CPCU, President of Welt, Ambrisco, Winegarden Insurance, Inc., in Iowa City, Iowa, with Field Claims Manager Brent H. Burton, AIC. T A R G E T I N G T H E Y E A R 2 0 0 0 A N D B E Y O N D : E X P A N D I N G T H E P R O D U C T L I N E , E X T E N D I N G O U R R E A C H The Cincinnati Insurance Companies to provide products people need; to to write more accounts, more are preparing to welcome the next operate proﬁtably; to deliver prompt carefully, to compensate for the millennium as a larger, more and personal service; to listen and lower premium pricing brought aggressive competitor. Our target learn continuously; and to build about by intense price competition. is to reach $2 billion in direct ﬁnancial strength that beneﬁts Total direct workers’ compensation written premium during the year agents, policyholders, shareholders, premium fell 6 percent despite 2000. Along with this growth, associates and community. $30.1 million in new business. we are renewing our commitments GROSS WRITTEN PREMIUM CFC Property Casualty Companies (In Millions of Dollars) 1,566.7 1,476.0 1,377.4 1,287.3 1,216.8 93 94 95 96 97 In 1997 commercial insurance premiums were 67.8% and personal insurance premiums 32.2% of the total. 4 PROPERTY AND CASUALTY INSURANCE Net written property and casualty premiums reached $1.472 billion, up 6.4 percent. The combined loss and expense ratio improved to 97.7 percent, our best annual ratio since 1988. This proﬁtability and an all-time high of $202.6 million in new business helped offset depressed pricing of commercial accounts. Commercial Insurance Net written premiums for commercial insurance grew only 3.6 percent to $987.3 million with a 53.2 percent pure loss ratio. We had While we expect low pricing to prevail into 1998, strong unit growth and underwriting quality of our accounts position us favorably for longer-term growth. Sales of our new Commercial Output Policy (COP) began in October. Our agents wrote 26 COP policies for a total of $1.7 million by year-end. This product offers ﬂexible pricing and coverage for larger property risks. As agencies consolidate and eliminate carriers, they need to represent a company that can handle complex, marquee accounts. We expect the COP and the Special Accounts Marketing E Y E S Iowa—Active marketing began in 1982. Program (SAMP) for larger accounts Worldwide Commercial General growth came from these increases, to become an important source of Liability endorsement. much of it comes from new business growth. In the ﬁrst month of 1998, Cincinnati earned the highest as our agents look for stable markets total SAMP premiums were already overall score on surveys of 30,000 and achieve economies by reducing $3.0 million versus $7.8 million agents across 16 commercial product the number of carriers they represent. in all of 1997. lines, according to Property/Casualty Some insurers have reduced Working with professional trade Rates & Ratings newsletter (August, writings in order to remedy high associations, we continued to gain 1997). Cincinnati was named concentration of risk in certain endorsements of our products and Company of the Year by the Young regions. Others have reduced access to their members for our local Agents Committee of the Independent coverages or experimented with agents. In several states, associations Insurance Agents of North Carolina, distribution methods. Agents are of dentists, funeral service providers where we market primarily weighing other carriers’ lack of or water quality dealers recommend commercial insurance. And focus against our commitment and Cincinnati coverage and service. Cincinnati earned the top spot are giving us their prime personal Other popular commercial on an agent survey conducted insurance accounts. products attained production by the Professional Independent 1998 product innovations will milestones this year. The Cincinnati Insurance Agents of Illinois, our include a new Master Group Personal Commercial Umbrella crossed the second largest state by premium Umbrella Liability Policy. Electronic $100 million mark and Employment volume. funds transfer and other ﬂexible Practices Liability Insurance, on the Personal Insurance billing options may boost worksite market for less than two years, On the personal insurance side, net marketing. We will capitalize on reached $4 million. We will heighten written premiums grew 12.4 percent renewed agent interest in stable, our product advantages during 1998 to $484.3 million with a 68.9 percent personal lines business by “blitzing” with introduction of an improved pure loss ratio. Proﬁtability is 50 agencies with our interdepart- Property Optional Coverage improving due to homeowner and mental teams empowered to remove endorsement, an improved automobile rate increases approved all barriers to production, from Businessowners Policy and a new in many states. While some premium systems issues to producer education. 5 P U T T I N G R E S O U R C E S W H Upstate New York—Active marketing begins in 1998. Expansion Activities This will not change as we diversify Plans for 1998 call for opening The Cincinnati Insurance geographically by reaching into new Montana and two upstate New York Companies are represented by fewer states, and as we increase market territories, as well as adding than 1,000 agencies while some other penetration by forming new territories territories in Louisville and Greater insurers appoint many thousands. in established ones. Our count should Atlanta. Additionally, some We are from the “do more with less” remain fairly stable, with new territories where we market school of thought. By being very agencies taking the place of commercial insurance will be opened selective in our representation, we can consolidated agencies or agencies for personal insurance. We are invest in better relationships, earn discontinued for not living up to our evaluating possible entry over future more loyalty and expect a higher expectations. During 1997, we made years into ﬁve new states—Delaware, percentage of agency premium. 34 new agency appointments. During Idaho, Oregon, Utah and Washington. NET PREMIUM INCOME The Cincinnati Life Insurance Company (In Millions of Dollars) 1998, we expect to appoint 84. We are appointing ﬁnancially strong, sales-oriented agencies that 62.9 invest in technology and people to 56.4 grow with us in the future. These 48.7 49.1 50.9 93 94 95 96 97 Total life, health, accident and annuity premiums earned rose 11.5 percent in 1997. 6 elite agencies have put out the welcome mat for us as we began marketing in new states and expanded established territories. During 1997, we opened North Dakota and split off new marketing territories in several proﬁtable areas where we wanted to increase service and do more business. We staffed new territories in Wisconsin, Missouri, Tennessee, Illinois and Michigan. LIFE INSURANCE The Cincinnati Life Insurance Company contributed $29.2 million to net income, up 10.2 percent over last year. Net operating income rose 23.3 percent to $24.8 million. Total net written premiums grew 7.6 percent to $92.4 million. Direct term life insurance premiums rose 16.8 percent to $14.8 million. Near the end of 1997, we rolled out a new term policy to launch the Life Horizons product series. We will introduce additional new and improved Life Horizons products at the rate of about one per E R E T H E Y C O U N T Where we are considering entry into a market, research includes visits with state regulators, independent agents and leaders of insurance and agent groups. We decide to actively market in a new state when we determine that agents and their customers will beneﬁt from Cincinnati products and services. The process includes a thorough review of the competitive climate, geographical risks, laws and regulations. First, we identify states compatible with risk-based underwriting, healthy competition and proﬁt potential; then we prioritize and gear up by ﬁling products for state insurance department approval and programming our systems. Next, we prospect for agencies, selecting those that share our commitments to customers—to carefully underwrite risks and tailor coverages, to deliver superior claims service, to use technology to enhance effectiveness and to operate ﬁnancially strong, sales and growth-oriented organizations. Vice Presidents Jody L. Wainscott and Thomas A. Joseph, CPCU, researched market conditions in upstate New York, now selected for activation of two territories. quarter during 1998, including low- As we form these complementary, businesses. 1997 net after-tax cost universal life, guaranteed whole nonconﬂicting independent life earnings rose to $2.2 million versus life and worksite universal life policies. agent relationships, our property $1.2 million in 1996. Gross Cincinnati Life has an established and casualty agencies will beneﬁt receivables have doubled over expertise in the worksite marketing from product development, ﬁeld the past three years, reaching area, which brings convenient payroll representative training, streamlining $62.8 million at year-end 1997. deduction policies and professional of processes and our higher proﬁle. The leasing customer base is agent service to underserved Cincinnati’s property and casualty 50 percent independent property consumers. Direct premiums from Claims Department is now funding casualty agents and a large portion worksite marketing rose 8.9 percent claims settlements with Cincinnati of our business comes from agent to $13.3 million in 1997. Worksite Life annuity purchases. A total of referrals of their commercial marketing is increasing in popularity 45 of these structured settlements insurance clients. Many agencies among employers in search of brought in $8.3 million of annuity lease or ﬁnance agency management valuable low-cost beneﬁts. We premium in 1997. During the ﬁrst systems that Cincinnati Insurance plan to market worksite products month of 1998, four cases were funds under incentive agreements aggressively during 1998. settled with $2 million in annuity requiring speciﬁed levels of premium We continue to develop the life premium. This inter-company growth and proﬁtability. insurance production network made cooperation provides secure income We have begun to deploy a leasing up of Cincinnati’s property and and convenience for claimants, while ﬁeld sales force, improving support casualty agents, which was the source keeping funds in our investment for agencies and their clients while of approximately 93 percent of new stream. life premiums in 1997. Additionally, we have begun appointing independent life agencies to sell our products in states such as California and Texas, where Cincinnati has no property and casualty agents. FINANCIAL SERVICES CFC Investment Company leases and ﬁnances equipment and vehicles for independent agencies, their commercial clients and other providing direct availability of our ﬁnancial services to businesses. During the ﬁrst part of 1998, our fourth ﬁeld sales territory should open and our representative will begin calling on lease/ﬁnance prospects in Illinois and Wisconsin. 7 P E R S O N A L C O M M I T M E N T , Where we have appointed new agents to represent us, the relationship ofﬁcially begins with a Cincinnati tradition, the agent’s visit to our Cincinnati headquarters. The agent meets personally with executives, sales and accounting ofﬁcers, underwriting and supply associates. The purpose is to work out logistics and learn about policies and procedures—but more importantly, it is to launch friendships and open doors so agents know they have personal access to all of us, all of the time. This pledge of unprecedented personal access is reafﬁrmed by regular executive travel to agencies, annual sales meetings in 27 ﬁeld locations, territory visits by underwriters, invitations to sales classes and agent roundtables at CFC Headquarters and many more opportunities to listen to our agent customers, the most effective voices for the businesses and families we insure. Assistant Vice President Duane I. Swanson, CIC, with Thomas C. Dawson, CPCU, CIC, who is CEO of Dawson Insurance Agency in Fargo, North Dakota. The agency was appointed in May 1997. T A R G E T I N G T H E Y E A R 2 0 0 0 A N D B E Y O N D S U P E R I O R S E R V I C E A N D P E O P L E — B R I D G E S T O P R O F I T A B I L I T Y Under today’s competitive Process Improvement—Every per month; now fewer than 4,000 conditions, running our business department is examining internal ﬁles were pending for 54 of the past proﬁtably requires a commitment and interdepartmental processes. By 56 weeks. to invest, on the customer’s behalf, discovering and recognizing internal Technology—New systems are in state-of-the-art technical and customers, we have been able to presenting us with opportunities human resources. During 1997, we restructure workﬂows and stream- to eliminate duplicate effort, sharpened our service advantages: line processes, gaining speed and speed service and communicate COMBINED LOSS AND EXPENSE RATIO* ON PROPERTY CASUALTY BUSINESS Estimated Industry Average CFC 107.2 105.7 105.1 104.7 103.0 100.1 100.6 99.4 accuracy. Cross-functional teams more effectively. This year, the formed in many areas to ﬁnd the Information Systems Department best way to deliver timely, personal introduced systems and training for service. Whether processing a accounting, leasing and investment policy change, examining a claim, functions. They continued system calculating a premium or com- and network upgrades to address mission, introducing a new product Year 2000 issues; the few systems not or evaluating proposed territory yet compliant will be by mid-year expansions, we found room to 1999. In Commercial Lines, the improve and made positive changes. DocuSolve typing system proved 100.4 97.7 In the Commercial Lines to be a powerful tool to improve Department, service requests rose processing time. DocuSolve cut 18 percent over 1996 to 565,000, training time by 50 percent and 93 94 95 96 97 *Before policyholder dividends yet service complaints declined cut errors affecting accounting and 16 percent versus last year. Four premium audit functions. Our goal 1997 ratios represent the highest proﬁtability since 1979 for the industry and the highest since 1988 for Cincinnati. 8 years ago, work-in-progress ﬁles held is that raters and typists will have in the department averaged 12,000 access to online procedures and P E R S O N A L A C C E S S CFC Headquarters, Cincinnati, OH—Our ﬁrst North Dakota agents made pre-appointment visits during 1997. underwriting guidelines. New in 1997, up 24 percent over 1996 informed, strong competitors. software will allow us to bypass recoveries. Similar success came Public Responsibility—We serve paper ﬁles and bring key policy from fraud investigation efforts our agents and our industry by being pages online. and managed care techniques active participants in the legislative Information Systems rolled out applied to workers’ compensation and regulatory processes impacting software and completed training to claims. A glass program and an your Company. We study proposals upgrade and standardize software, auto estimate service will soon bring and take positions in support of tort including a new e-mail system, on all consumers new options for quick, reform and against activist state company personal computers. They easy repairs at a cost savings. Supreme Court candidates. We installed a super data server for an Education—We continue extensive support private enterprise solutions Intranet-based policy processing and programs to train professional versus unfunded federal assumption administration system now under associates, encouraging them to of liability for catastrophic claims. development. A single, integrated acquire industry credentials and 1997 activities included work to system will replace the current certiﬁcations, develop customer preserve the deduction for dividends manual work processes between our service awareness and acquire received so taxation of the same ﬁeld and headquarters operations. computer skills. New programs in income at multiple levels would not We will connect headquarters to our 1997 included a school to develop occur. We supported the Commerce Intranet as early as this year, then new Cincinnati Life ﬁeld marketing Committee version of banking reform connect ﬁeld staff and agents in 1999. representatives with a level of legislation, which afﬁrms state Claims Management—The timely, technical expertise, company authority over insurance, whether personal, fair claims service we knowledge and authority parallel transactions are made by an provide cements our agents’ bond to that of our property and casualty insurance company or by a bank. with clients. Claims management ﬁeld marketing representatives. We believe strong state regulation programs are introducing new New programs for agents included serves the public and our industry conveniences and economies for alternative risk transfer seminars, better than any proposals for dual consumers. Our Subrogation and designed to increase awareness of federal/state regulation of insurance. Salvage unit recovered $30.9 million market trends and make them 9 B U I L D I N G M O M E N T U M Maryland—Active marketing began in December 1994. T A R G E T I N G T H E Y E A R 2 0 0 0 A N D B E Y O N D B U I L D I N G F I N A N C I A L S T R E N G T H INDEPENDENT RATINGS AND RANKINGS Companies’ property and casualty Poor’s expects margins to be sustained group and to each subsidiary. This with anticipated premium growth of A.M. Best Company A++ (Superior) is their highest rating, awarded to seven to nine percent over the next The A.M. Best Company, the only 7 percent of companies and three to ﬁve years.” leading provider of insurer ratings, 3 percent of rating units in 1997. Best Forbes (April 21, 1997): The annually conducts an extensive quantitative and qualitative evaluation. Best assigns the A++ rating to The Cincinnati Insurance asserts, “Despite the highly competitive Cincinnati Insurance Companies’ market conditions…Cincinnati is well proﬁts per employee surpass those positioned to continue its superior earned by our peers. Per capita operating performance, with its productivity of $93,300 more than TOTAL SHAREHOLDER RETURN (1997 Share Appreciation Plus Dividends) CINF 121.2 S&P Multi-line Insurers 56.5 S&P Property Casualty Group 42.6 S&P 500 33.4 increasing market presence, disciplined doubles the industry median of $44,600. underwriting approach and highly Fortune (April 28, 1997): Ranked successful distribution strategy.” Standard & Poor’s AA+ (Excellent) Standard & Poor’s bases the by revenues, Cincinnati Financial Corporation is the 21st largest U. S. publicly traded property and casualty property casualty group’s AA+ claims- insurer or reinsurer. Within the paying ability rating on superior Fortune 1000 across all industries, capitalization and ﬁnancial ﬂexibility, we are number 652. as well as an excellent operating National Underwriter (July 21, 1997): performance characterized by above- Based on 1996 net written premiums, average premium growth and very strong margins. “Standard & Poor’s believes that a low-cost infrastructure and agency focus will continue to be an unmatched competitive advantage Cincinnati moved up two spots to place 30th among stock, mutual, reciprocal and Lloyds insurance companies and 21st among stock insurers. The CINF share price, already trending up over the course of 1997, rose sharply in December. for The Cincinnati Insurance Business Insurance (August 25, 1997): Companies. Therefore, Standard & Ward Financial Group analyzes 10 Where new agencies are building their Cincinnati business, the ﬁeld marketing representative heads up an intensive effort to move Cincinnati into one of the top two positions among the agency’s carriers within ﬁve years. The ﬁeld marketing representative teaches agents to be front-line Cincinnati underwriters, to know our appetite for business and to customize our ﬂexible policies appropriately for their clients. This involves doing whatever the agent needs, from visiting accounts with agents to removing production barriers by marshaling resources from Cincinnati’s claims, information systems, underwriting and other areas. Cincinnati’s unique, no-branch-ofﬁce structure and assignment of full decision-making authority set these ﬁeld marketing representatives apart as one of the agency’s most valuable assets. William P. Grifﬁn, Jr., President of Bartlett, Vermilye & Grifﬁn, Inc., in Easton, Maryland and Regional Director Sean M. Connolly, CIC, AIM. ﬁve-year statutory data to ﬁnd combined from 1985-1996. They income and assets by accepting the best insurers for their top analyzed 158 insurance carriers, reasonable risks associated with 50 benchmark group. Ward’s concluding that a clear focus paired concentrated equity investments and 50 insurers set themselves apart by with effective execution leads to with our preference for bonds that meeting two sets of high standards— success for companies of all sizes and hold potential for upgrades. This return for shareholders balanced by distribution models. philosophy led to unusual proﬁtability solvency for policyholders. Cincinnati is one of just nine insurer groups named to both Ward’s lists in 1997, our seventh consecutive year qualifying for the property/casualty list and ﬁfth year on the life/health list. Forbes (January 12, 1998): Cincinnati Financial Corporation’s 15.1 percent proﬁt margin (12-month net income divided by sales) is the highest among Forbes’ top 28 publicly traded U. S. property and casualty insurers. Best’s Review (January 1998): Best’s ranks Cincinnati Financial in the ﬁrst tier of “market leaders—those that maintain a competitive distribution advantage…and carry A.M. Best’s highest ratings.” Conning Commentary (February 1998): Conning named Cincinnati to their Steller Performer category based on operating ratios for all insurance lines USING STRENGTH TO INVEST STRATEGICALLY Exceptional ﬁnancial strength is what allows Cincinnati Financial to balance safety and return while pursuing an aggressive, equity- centered investment strategy. Our surplus, more than ample for our insurance operations, supports a and a surge in book value during 1997. The market recognized the growing net worth of your Company when CINF became an S&P 500 Index stock on December 17. INVESTMENT INCOME Less Expenses (In Millions of Dollars) 348.6 327.3 highly effective total return strategy 300.0 that is atypical for our industry. Historically, we have achieved steadily increasing income and appreciation by managing companies in the portfolio the same way we manage insurance agency relationships—select a few very good ones poised to continue proﬁtable growth, take a large stake and pay close personal attention. With strong surplus, we can continue to increase 262.6 239.4 93 94 95 96 97 34 of the 62 stocks in the equity portfolio announced dividend increases in 1997, boosting future annualized income by $8.1 million. 11 S E L E C T E D F I N A N C I A L I N F O R M A T I O N (000’s omitted except per share data and ratios) Cincinnati Financial Corporation and Subsidiaries 1997 Years Ended December 31, 1995 1996 1994 TOTAL ASSETS................................................. LONG-TERM OBLIGATIONS ............................ $9,493,425 58,430 $ $ 7,045,514 79,847 $ $6,109,298 80,000 $ $4,734,279 80,000 $ REVENUES Premium Income.................................................. Investment Income (Less Expense)....................... Realized Gains on Investments ............................. Other Income ....................................................... NET INCOME BEFORE REALIZED GAINS ON INVESTMENTS In Total................................................................ Per Common Share .............................................. NET INCOME In Total................................................................ Per Common Share .............................................. Per Common Share (Diluted) ............................... $1,516,378 348,597 69,230 8,179 $ 1,422,897 327,307 47,946 10,599 $ 254,375 4.61 $ 192,595 3.45 $ 299,375 5.43 5.31 $ 223,760 4.01 3.92 CASH DIVIDENDS DECLARED Per Common Share .............................................. CASH DIVIDENDS PAID Per Common Share .............................................. $ $ 1.64 1.60 $ $ 1.46 1.43 $1,314,126 300,015 30,781 10,729 $ 207,342 3.72 $ 227,350 4.08 3.99 $ $ 1.28 1.26 $1,219,033 262,649 19,557 11,267 $ 188,538 3.40 $ 201,230 3.62 3.54 $ $ 1.16 1.12 PROPERTY AND CASUALTY OPERATIONS Gross Premiums Written ...................................... Net Premiums Written ......................................... Premiums Earned ................................................ $1,566,688 1,471,603 1,453,526 $ 1,476,011 1,383,525 1,366,544 $1,377,426 1,295,852 1,263,257 $1,287,280 1,190,824 1,169,940 Loss Ratio ............................................................ Loss Expense Ratio .............................................. Underwriting Expense Ratio................................. Combined Ratio ................................................... 58.3% 10.1% 29.3% 97.7% 61.6% 13.8% 27.6% 103.0% 57.6% 14.7% 27.1% 99.4% 63.3% 9.8% 27.5% 100.6% Investment Income Before Taxes .......................... $ 199,427 $ 190,318 $ 180,074 $ 162,260 Property and Casualty Reserves Unearned Premiums............................................. Losses .................................................................. Loss Adjustment Expense..................................... $ 418,465 1,373,950 402,698 $ 401,562 1,319,286 383,135 $ 385,418 1,274,180 306,570 $ 353,697 1,213,383 218,642 Statutory Policyholders’ Surplus .......................... $2,468,944 $ 1,608,084 $1,268,597 $ 998,595 *1993 earnings include a credit for $13,845,000 ($.25 per share) cumulative effect of a change in the method of accounting for income taxes to conform with FASB Statement No. 109 and a net charge of $8,641,000 ($.16 per share) related to the effect of the 1993 increase in income tax rates on deferred taxes recorded for various prior year items. 12 Cincinnati Financial Corporation and Subsidiaries 1993 1992 1991 1990 1989 1988 1987 $4,602,288 80,000 $ $4,098,713 80,000 $ $3,513,749 182 $ $2,626,156 202 $ $2,602,990 753 $ $ 2,163,341 890 $ $1,828,032 3,898 $ $1,140,791 239,436 51,529 10,396 $1,038,772 218,942 35,885 10,552 $ 182,530* 3.30* $ 147,669 2.69 $ 216,024* 3.91* 3.81* $ 171,325 3.12 3.08 $ $ 1.02 1.00 $ $ .93 .90 $ 947,576 193,220 7,641 12,698 $ 141,273 2.59 $ 146,280 2.69 2.67 $ $ .83 .81 $ 871,196 167,425 1,488 8,822 $ 128,052 2.37 $ 128,962 2.38 2.37 $ $ .73 .71 $ 813,313 149,285 4,678 7,134 $ 754,335 130,885 6,423 10,281 $ 747,266 108,915 3,845 7,686 $ 111,477 2.08 $ 124,618 2.34 $ 114,490 2.14 2.11 $ 128,748 2.42 2.40 $ $ .66 .63 $ $ .52 .51 $ $ $ $ 90,714 1.74 93,154 1.79 1.76 .45 .43 $1,216,766 1,123,780 1,092,135 $1,089,901 1,014,971 992,335 $ 996,807 930,296 903,465 $ 896,204 838,554 828,046 $ 845,346 790,971 771,205 $ 782,143 718,853 712,771 $ 763,925 702,785 687,429 63.5% 8.7% 27.9% 100.1% 63.8% 9.0% 29.0% 101.8% 61.6% 9.2% 28.9% 99.7% 61.6% 9.0% 29.0% 99.6% 61.6% 9.0% 29.1% 99.7% 55.1% 10.1% 30.7% 95.9% 61.8% 10.4% 27.5% 99.7% $ 153,190 $ 141,958 $ 126,332 $ 110,827 $ 97,661 $ 84,379 $ 67,871 $ 333,550 1,100,051 193,305 $ 302,473 960,571 177,262 $ 280,404 825,952 160,260 $ 254,000 692,081 140,501 $ 244,011 616,730 124,993 $ 224,545 522,162 109,323 $ 218,840 449,159 84,359 $1,011,609 $ 933,529 $ 735,557 $ 477,355 $ 494,460 $ 422,521 $ 346,623 Per share data adjusted for three-for-one stock split in 1992 and stock dividends of 5 percent in 1996, 1995 and 1987. 13 M A N A G E M E N T D I S C U S S I O N Cincinnati Financial Corporation and Subsidiaries INTRODUCTION This Management Discussion is intended to supplement the data contained in the ﬁnancial statements and related notes of Cincinnati Financial Corporation and subsidiaries. Cincinnati Financial Corporation (CFC) has ﬁve subsidiaries. The lead property and casualty insurance subsidiary, The Cincinnati Insurance Company, markets a broad range of business and personal policies in 27 states through an elite corps of 973 independent insurance agencies. Also engaged in the property and casualty business are The Cincinnati Casualty Company, which works on a direct billing basis, and The Cincinnati Indemnity Company, which markets nonstandard policies for preferred risk accounts. The Cincinnati Life Insurance Company markets life, health and accident policies through property and casualty agencies and independent life agencies. CFC Investment Company complements the insurance subsidiaries with leasing, ﬁnancing and real estate services. Investment operations are CFC’s primary source of proﬁts, with a total return strategy emphasizing investment in ﬁxed maturities securities as well as equity securities that contribute to current earnings through dividend increases and add to net worth through long-term appreciation. The following discussion, related consolidated ﬁnancial statements and accompanying notes contain certain forward- looking statements that involve potential risks and uncertain- ties. The Company’s future results could differ materially from those discussed. Factors that could cause or contribute to such differences include, but are not limited to: unusually high levels of catastrophe losses due to changes in weather patterns or other natural causes; changes in insurance regulations or legis- lation that place the Company at a disadvantage in the market- place; recession or other economic conditions resulting in lower demand for insurance products; sustained decline in overall stock market values negatively impacting the Company’s equity portfolio and the ability to generate investment income; and, the potential inability of the Company and/or the independent agents with which it works to complete the necessary information system changes required to handle the Year 2000 issue. Readers are cautioned that the Company undertakes no obligation to review or update the forward- looking statements included in this material. RESULTS OF OPERATION Overview of Results—Primarily as a result of continued market penetration and entry into new states, CFC revenues have increased at a compound annual rate of 8.3%, reaching $1.942 billion in 1997, with property/casualty net written premiums growing at a 7.7% rate to $1.472 billion over the past ﬁve years. In the same ﬁve-year period, total net income, including realized capital gains, grew at an 11.8% rate to $299.4 million, or $5.43 per share, from $216.0 million, or $3.91, while net operating income increased at an 11.5% rate to $254.4 million, or $4.61 per share, from $182.5 million, or $3.30, in 1993. Book value grew at a 22.2% compound rate over the same period to $85.06 per share from $31.26. A number of factors, including the Company’s strong reputation among independent insurance agencies and management’s belief that the Company can achieve additional market penetration in states in which it currently operates, have led management to target $2 billion in direct written premiums during the year 2000, up from $1.621 billion in 1997. At the same time, the Company seeks to generate an underwriting proﬁt and maximize annual growth in investment income. The following discusses and analyzes results for the three- year period ending December 31, 1997 and provides insight into management’s strategic direction for the Company. (000,000 omitted except per share data and ratios) Revenues Net Operating Income Net Capital Gains (after tax) Net Income Net Operating Income Per Share Net Capital Gains Per Share Net Income Per Share Catastrophe Losses Catastrophe Losses Per Share (after tax) 1997 $1,942.4 254.4 45.0 299.4 4.61 .82 5.43 25.5 .30 $ $ $ Change $ $133.7 61.8 13.8 75.6 1.16 .26 $ 1.42 $ (39.2 ) (.45) $ Change % 7) 32) 44) 34) 34) 46) 35) (60) (60) 1996 $1,808.7 192.6 31.2 223.8 3.45 .56 4.01 64.7 .75 $ $ $ Change $ $153.0 (14.7 ) 11.2 (3.5 ) (.30) .20 (.10) $ $ 37.6 .44 $ Change % 9 (7 ) 56 (2 ) (7 ) 54 (2 ) 138 142 1995 $ 1,655.7 207.3 20.0 227.3 3.72 .36 4.08 27.1 .31 $ $ $ Change $ $143.2 18.8 7.3 26.2 .32 .14 $ .46 $ 6.4 .07 $ Change % 9 10 58 13 9 68 13 31 28 The Company’s ﬁnancial results for the three years ending December 31, 1997 reﬂect steady growth in new insurance business and high retention of renewal business quoted on behalf of the Company’s independent insurance agents, offset by competitive property and casualty pricing. In addition, 1997 marked a return to a more normal level of catastrophe losses from the unusually high 1996 level. Results for 1997 also reﬂect the Company’s consistent underwriting philosophy and strategy-maintaining high underwriting standards by carefully evaluating individual risks, reviewing agency performance and controlling overall expenses. Net operating income for 1997 rose substantially over the prior year. The Company generated 6.5% growth in pre-tax investment income and an underwriting proﬁt versus an 14 Cincinnati Financial Corporation and Subsidiaries underwriting loss in 1996, primarily due to lower catastrophe losses. In 1996, net operating income declined 7% because of the catastrophe losses, while pre-tax investment income rose 9.1%. The contribution from net realized capital gains after-tax rose in both years primarily due to the sale of equity securities. PROPERTY AND CASUALTY INSURANCE OPERATIONS (000,000 omitted except per share data and ratios) Gross Written Premiums Net Written Premiums Net Earned Premiums Loss and LAE Ratio Expense Ratio Combined Ratio 1997 $1,566.7 1,471.6 1,453.5 68.4% 29.3% 97.7% Change $ $ 90.7 88.1 87.0 n/a n/a n/a Change % 6.1) 6.4) 6.4) (9.3) 6.2) (5.1) 1996 $1,476.0 1,383.5 1,366.5 75.4% 27.6% 103.0% Change $ $ 98.6 87.6 103.2 n/a n/a n/a Change % 7.2 6.8 8.2 4.3 1.8 3.6 1995 $1,377.4 1,295.9 1,263.3 72.3% 27.1% 99.4% Change $ $ 90.1 105.1 93.4 n/a n/a n/a Change % 7.0) 8.8) 8.0) (1.1) (1.5) (1.2) Premiums—While premium growth rates have declined in 1997 and 1996, the Company’s property and casualty group continued to increase net written premiums at rates well above estimated industry growth rates. In 1997 and 1996, the primary source of growth was personal lines insurance, for which net written premiums advanced 12.4% in 1997 (9.4% in 1996), while commercial lines insurance growth was 3.6% (5.6% in 1996). During 1997 and 1996, the commercial insurance market experienced intense price competition, most notably in workers’ compensation where market-share competition and mandated rate reductions in some states led to renewal account discounts of as much as a third from the previous year’s premium. The Company is committed to prudent underwriting standards and emphasizing account proﬁtability. The emphasis on proﬁtability contributed to the 53.2% pure loss ratio for the commercial lines area, in line with the 54.8% reported in 1996. As a result of the market factors, direct written workers’ compensation premiums in 1997 declined 6% and growth in other commercial insurance lines was limited. Management believes these competitive forces will continue for at least the next six to twelve months. To help offset these pressures, the Company is emphasizing personal lines insurance, entering new states to expand market opportunities, pursuing a marketing strategy that permits ﬁeld representatives to spend more time assisting the independent insurance agents and expanding its life insurance operations. The Company sees heightened interest from independent insurance agents in writing personal lines insurance as a means of buffering the price competition in the commercial sector and stabilizing their revenue. CFC is taking advantage of this trend by encouraging independent agents to move to the Company their proven, proﬁtable business. Agents who are streamlining operations by reducing the number of carriers they represent have been rolling-over entire books of business to the Company. Management believes CFC can achieve additional market penetration by leveraging its strong relationships with independent agencies and entering new states. The Company also can take advantage of key competitive advantages of CFC’s insurance products, for example three- and ﬁve-year policies for many types of insurance coverage. At year-end 1997, approximately 98% of the Company’s property and casualty premium volume was in states in which the Company has had a presence since 1994 or earlier. Over the past three years, the Company has added nine marketing representatives in several established states, restructuring territories so that each representative has fewer agencies to serve. This has allowed ﬁeld representatives to appoint additional agencies and, more importantly, spend more time with each agent. During 1998, management anticipates adding two marketing territories in existing regions. Entry into new states also has been a source of premium growth. At year-end 1997, the states the Company entered between 1994 and 1997 contributed more than $28 million of property and casualty premium volume. An example of these successful new market entries is Minnesota, where premium volume reached $11.7 million in 1997, up from $800,000 in 1994. During 1996 and 1997, the Company began marketing commercial lines in North Dakota and added personal lines in Arkansas, Maryland, Minnesota, North Dakota, Pennsylvania and Vermont. During 1998, management anticipates beginning to market insurance products in Montana and in two planned upstate New York territories. Five western states currently are being researched with the intention of selecting one or two additional states in which to seek approval during 1998 to market the Company’s products in 1999. The Company’s criteria for entry into new states include a favorable regulatory climate. Expenses—The Company recorded a $24.8 million under- writing proﬁt in 1997 compared with an $45.0 million underwriting loss in 1996 and a $1.4 million underwriting proﬁt in 1995. The 1997 underwriting proﬁt, reﬂecting a combined ratio of 97.7%, was primarily the result of a more normal level of catastrophe losses contributing to a seven point reduction in the loss and loss adjustment expense ratio compared with 1996. The return to a more normal level of catastrophe losses also helped offset a one and seven-tenths point increase in the expense ratio. The underwriting loss in 1996, reﬂecting a combined ratio of 103.0%, was the result of the higher catastrophe losses, as well as a half percentage point increase in the expense ratio over 1995. 15 M A N A G E M E N T D I S C U S S I O N ( C O N T I N U E D ) Cincinnati Financial Corporation and Subsidiaries The expense ratio increased in both years as the Company raised spending on staff and costs associated with upgrading technology and facilities to accommodate anticipated growth in premium volume while making computer systems Year 2000 compliant. Because the Company issues three- and ﬁve- year policies, management believes that Year 2000 compliance issues have been initiated for most of the computer systems. Many systems are already Year 2000 compliant; most other programs will be compliant by year- end 1998, with the balance completed during 1999. Management believes this goal will be attained. CFC’s largest risk lies with Year 2000 compliance by its independent agencies, which handle most of the customer billing and collections. In response to this concern, CFC is proactively contacting agents regarding this issue and will be monitoring each agency’s actions closely. Adding to expenses in 1997 were higher proﬁt-sharing commissions to many of the Company’s independent insurance agents, due to the overall proﬁtability of the business they wrote. In 1997, catastrophe losses accounted for 1.8% of the combined ratio, more closely in line with the Company’s historic results and in contrast to the unusually high 4.7% from ten large storms in 1996. In 1995, catastrophe losses accounted for 2.1% of the combined ratio. Due to the nature of catastrophic events, management is unable to predict accurately the frequency or potential cost of such occurrences in the future; however, the Company has continued not to market property and casualty insurance in California, not to write ﬂood insurance, to review exposure to huge disasters and reduce coverage in certain coastal regions in an effort to control such catastrophe losses. For property catastrophes, the Company retains the ﬁrst $25 million of losses and is reinsured to cover 95% of the losses from $25 million up to $200 million. As discussed in the Notes to the Consolidated Financial Statements, the Company’s insurance reserve liabilities are estimated by management based upon Company experience data. The Company consistently has established property and casualty insurance reserves, including adjustments of estimates, using information from internal analysis and review by external actuaries. Though uncertainty always exists as to the adequacy of established reserves, management believes this uncertainty is less than it otherwise would be, due to the stability of the Company’s book of business. Such reserves are related to various lines of business and will be paid out over future periods. Reserves for environmental claims have been reviewed and the Company believes that the reserves are adequate. Environmental exposures are minimal as a result of the types of risks the Company has insured in the past. Historically, most commercial accounts written post-date the coverages, which afford clean-up costs and Superfund responses. 16 Life and Accident and Health—CFC’s life insurance subsidiary had total net premium income for 1997 of $62.9 million, up from $56.4 million in 1996 and $50.9 million in 1995. Life insurance premiums were $54.7 million, $48.7 million and $43.6 million, respectively. The life insurance subsidiary contributed 10% of CFC’s operating income in 1997, 1996 and 1995. During 1997, the Company hired a new president for the life insurance subsidiary. Under his direction, the life insurance subsidiary is expanding worksite marketing activities, introducing a competitive new life insurance product series and researching opportunities to sell life insurance in states in which the Company does not have property and casualty agency representation. The initiatives, which were undertaken in the second half of 1997, had little impact on results for the year. Management believes, however, that opportunities exist to increase the life insurance subsidiary’s contribution to total operating income through expanded life insurance sales. Investment Income and Investments—Investment income rose 6.5% to $348.6 million in 1997 and increased 9.1% to $327.3 million in 1996. The slower growth rate in 1997 reﬂected the amount of ﬁxed maturities investments called early and the generally lower interest rate environment. The increases were primarily the result of investing the cash ﬂows from operating activities and dividend increases from equity securities in the investment portfolio. In 1997, 34 of the 62 common stocks in the Company’s investment portfolio increased dividends during the year, adding more than $8.1 million to future annualized investment earnings. The Company’s primary investment strategy is to maintain liquidity to meet both immediate and long-range insurance obligations through the purchase and maintenance of medium- risk, ﬁxed maturity and equity securities, while earning optimal returns on the equity portfolio through higher dividends and capital appreciation. The Company’s investment decisions on an individual insurance company basis are inﬂuenced by insurance statutory requirements designed to protect policyholders from investment risk. Cash generated from insurance operations is invested almost entirely in corporate, municipal, public utility and other ﬁxed maturity securities or equity securities. Such securities are evaluated prior to purchase based on yield and risk. Investments in common stocks have emphasized securities with an annual dividend yield of at least 2%-3% and annual dividend increases. The Company’s portfolio of equity investments had an average dividend yield to cost of 7.8% at December 31, 1997. Management’s strategy in equity investments includes identifying approximately ten to twelve companies, for the core of the investment portfolio, in which the Company can accumulate 10%-20% of their common stock. Cincinnati Financial Corporation and Subsidiaries INVESTMENT ASSETS As of December 31 (Market Value In Millions of Dollars) Others Preferred Stock Common Stocks Taxable Bonds Tax Exempt Bonds 4,241.3 40.8 565.3 1,753.5 4,216.9 43.6 554.3 1,675.9 1,073.9 1,173.6 6,344.4 42.4 465.6 3,274.6 5,535.7 46.9 577.3 2,464.5 1,583.3 1,686.4 1,863.0 807.8 93 769.5 94 863.7 95 875.4 96 888.2 97 COMPOSITION OF EQUITY INVESTMENTS As of December 31, 1997 (In Millions of Dollars) Public Utilities Industrial, Miscellaneous Banks, Trusts and Insurance Common Stock Portfolio by Cost 1,302.2 176.9 493.4 631.9 Common Stock Portfolio by Market Value 5,468.9 692.1 1,114.5 3,662.3 Preferred Stock Portfolio by Cost 423.7 22.7 278.4 122.6 Preferred Stock Portfolio by Market Value 530.4 28.2 336.8 165.4 Interest and Income Taxes—The Company’s income tax expense was $95.2 million, $58.7 million and $67.8 million for 1997, 1996 and 1995, respectively, while the effective tax rate was 24.12%, 20.77% and 22.98%, for the same periods. The higher tax rate in 1997 primarily was due to the strong underwriting proﬁt recorded for the year and higher capital gains. The lower rate in 1996 was partially the result of a higher percentage of net income earned from tax- exempt interest on state, municipal and political subdivision ﬁxed maturities and dividends received on equity investments. The Company incurred no additional alternative minimum tax expenses for the three years. CASH FLOW AND LIQUIDITY 8,797.1 46.6 530.4 5,468.9 (000,000 omitted) Net cash provided by operating activities Net cash used in investing activities Net cash (used) provided in ﬁnancing 1997 $ 427.0 (282.5) (124.2) 1996 $ 308.3 (224.8) (43.7) 1995 $ 389.5 (443.9) 26.2 activities Net increase (decrease) in cash Cash at beginning of year Cash at end of year Supplemental Interest paid Income taxes paid 20.2 59.9 80.2 21.8 95.5 39.9 20.0 59.9 20.9 65.0 (28.2) 48.3 20.0 16.0 67.0 Cash Flow—Over the past three years, operating cash ﬂows have been sufﬁcient to meet operating needs and provide for ﬁnancing needs and increased investment. Management expects operating cash ﬂow will continue to be CFC’s primary source of funds because no substantial changes are anticipated in the Company’s mix of business nor are there plans to reduce protection by ceded reinsurance agreements with ﬁnancially stable reinsurance companies. Further, the Company has no signiﬁcant exposure to assumed reinsurance. Assumed reinsurance comprised no more than 3% of gross premiums in each of the last three years. The change in net cash used in investing activities reﬂected a steady increase over the three years in calls of ﬁxed maturity investments, offset in 1997 by increased purchases of ﬁxed maturities and equity securities. Cash ﬂows used in net purchases of ﬁxed maturity and equity securities, respectively, amounted to $122.6 million and $134.1 million in 1997, $98.0 million and $95.4 million in 1996, and $309.7 million and $114.9 million in 1995. Over the three-year period, the primary increases in net cash used for ﬁnancing activities were for the payment of cash dividends and the purchase of treasury shares. Notes Payable — Increases in notes payable, primarily short-term debt used to enhance liquidity, were reduced from $91.9 million in 1995 to $41.1 million in 1996 to $18.5 million in 1997. Management used short-term debt for cash management and other purposes. Dividends — CFC has increased cash dividends to shareholders for 37 consecutive years and, periodically, the Board of Directors authorizes stock dividends or splits. In February 1997, the CFC Board voted to increase the regular quarterly dividend by four cents to an indicated annual rate of $1.64 per share. On February 7, 1998, the Board authorized a 12.2% increase, raising the regular quarterly dividend by ﬁve cents to an indicated annual rate of $1.84. At the same time, the Board announced its intention to declare a three-for-one split to be distributed on May 15, 1998, to shareholders of record as of April 24, 1998, contingent upon shareholder approval of a proposal to increase authorized shares to 200 million from 80 million. Since 1987, the Company’s Board of Directors has authorized four additional stock splits or stock dividends: 17 M A N A G E M E N T D I S C U S S I O N ( C O N T I N U E D ) Cincinnati Financial Corporation and Subsidiaries a 5% stock dividend in 1996; a 5% stock dividend in 1995; a three-for-one stock split in 1992; and, a 5% stock dividend in 1987. After the stock dividend in 1996, a shareholder who purchased one Cincinnati Insurance share before 1957 would own 649 CFC shares, if all shares from accrued stock dividends and splits were held. The Company’s policy for the past ten years has been to reinvest approximately 70% of net income in future growth and to distribute remaining income as dividends. The ability of the Company to continue paying cash dividends is subject to such factors as the Board of Directors may deem relevant. FINANCIAL CONDITION Assets—Cash and marketable securities of $8.831 billion make up 93.0% of the Company’s $9.493 billion assets; this compares with 90.3% in 1996 and 90.2% in 1995. The Company has only minor investments in real estate and mortgages, which are typically illiquid. At December 31, 1997, the Company’s portfolio of ﬁxed maturity securities had an average yield-to-cost of 8.4% and an average maturity of 12 years. For the insurance companies’ purposes, strong emphasis has been placed on purchasing current income-producing securities and maintaining such securities as long as they continue to meet the Company’s yield and risk criteria. Historically, municipal bonds have been attractive due to their tax-exempt feature. Essential service (e.g., schools, sewer, water, etc.) bonds issued by municipalities are prevalent in this area. Many of these bonds are not rated due to the small size of their offerings. At year-end 1997 and 1996, investments totaling approximately $836 million and $729 million ($797 million and $706 million at cost) of the Company’s $8.797 billion and $6.344 billion investment portfolio related to securities rated non-investment grade or not rated by Moody’s Investors Service or Standard & Poor’s. Such investments, which tend to have higher yields, historically have beneﬁted the Company’s results of operations. Further, many have been upgraded to investment grade while owned by CFC. Because of alternative minimum tax matters, the Company uses a blend of tax-exempt and taxable ﬁxed maturity securities. Tax exempt bonds comprise 10% of invested assets as of December 31, 1997, compared with 14% at year-end 1996 and 16% at year-end 1995. Additional information regarding the composition of investments, together with maturity data regarding investments in ﬁxed maturities, is included in the Notes to Consolidated Financial Statements. Market Risk—The Company could incur losses due to adverse changes in market rates and prices. The Company’s primary market risk exposures are to changes in price for equity securities and changes in interest rates and credit ratings for ﬁxed maturity securities. The Company could alter the existing investment portfolios or change the character of future investments to manage exposure to market risk. CFC, with the Board of Directors, administers and oversees investment risk through 18 the Investment Committee, which provides executive oversight of investment activities. The Company has speciﬁc investment guidelines and policies that deﬁne the overall framework used daily by investment portfolio managers to limit the Company’s exposure to market risk. Liabilities and Shareholders’ Equity—At December 31, 1997, long- and short-term debt were 4%, insurance reserves were 25% and total shareholders’ equity was 50% of total assets, with remaining liabilities consisting of unearned premiums, deferred income taxes and other liabilities. Debt—Total long- and short-term debt was less than 5% of total assets at year-end 1997 and 1996. At December 31, 1997 and 1996, long-term debt consisted of $58.4 million and $79.8 million, respectively, of convertible debentures. Short-term debt is used to provide working capital as discussed above. Equity—Shareholders’ equity has continued to grow as a percentage of total assets, reaching 50% for 1997 from 45% for 1996 and 44% for 1995, due to retained earnings and unrealized appreciation of investments. Statutory risk-based capital requirements became effective for life insurance companies in 1993 and for property casualty companies in 1994. The Company’s capital has been well above required amounts in each year since those effective dates. 1997 (000,000 omitted) Shareholders’ equity excluding retained $ 469.5 1996 1995 $ 502.3 $ 342.0 earnings and unrealized gains on investments Retained earnings Unrealized gains on investments Total shareholders’ equity 1,341.7 2,905.8 $ 4,717.0 1,156.6 1,132.9 1,527.7 1,159.4 $3,162.9 $ 2,658.0 As a long-term investor, the Company has followed a buy-and-hold strategy for more than 38 years. A signiﬁcant amount of unrealized appreciation on equity investments has been generated as a result of this policy. Unrealized appreciation on equity investments, before deferred income taxes, was $4.273 billion as of December 31, 1997 and constituted 49% of the total investment portfolio; 71% of the equities investment portfolio; and, after deferred income taxes, 59% of total shareholders’ equity. Such unrealized appreciation, before deferred income taxes, amounted to $2.203 billion and $1.618 billion, at year- end 1996 and 1995, respectively. On November 22, 1996, the Board of Directors authorized the repurchase of up to three million of the Company’s outstanding shares as management deemed appropriate over an unspeciﬁed period of time. As of December 31, 1997, the Company had repurchased 934,041 shares, at an accumulated cost of $68.1 million. R E S P O N S I B I L I T Y F O R F I N A N C I A L S T A T E M E N T S Cincinnati Financial Corporation and Subsidiaries The accompanying ﬁnancial statements of Cincinnati Financial Corporation and subsidiaries for the year ended December 31, 1997 were prepared by management in conformity with generally accepted accounting principles. The management of the Company is responsible for the integrity and objectivity of the ﬁnancial statements, which are presented on an accrual basis of accounting and include amounts based upon management’s best estimates and judgment. Other ﬁnancial information in the Annual Report is consistent with that in the ﬁnancial statements. The accounting plan and related system of internal controls are designed to assure that the books and records reﬂect the transactions of the Company in accordance with established policies and procedures as implemented by qualiﬁed personnel. The Board of Directors has established an Audit Committee composed of outside Directors who are believed to be free from any relationships that could interfere with the exercise of independent judgment as Audit Committee members. The Audit Committee meets periodically with management, the independent auditors and the internal auditor to make inquiries as to the manner in which the responsibilities of each are being discharged and reports thereon to the Board of Directors. In addition, the Audit Committee recommends to the Board of Directors the annual appointment of the independent auditors with whom the Audit Committee reviews the scope of the audit assignment, adequacy of internal controls and internal audit procedures. Deloitte & Touche LLP, independent auditors, have audited the ﬁnancial statements of Cincinnati Financial Corporation and subsidiaries for the year ended December 31, 1997 and their report is included herein. The auditors meet with members of the Audit Committee of the Board of Directors to discuss the results of their examination and are afforded the opportunity to present their opinions in the absence of management personnel with respect to the adequacy of internal controls and the quality of ﬁnancial reporting of the Company. I N D E P E N D E N T A U D I T O R S ’ R E P O R T To the Shareholders and Board of Directors of Cincinnati Financial Corporation: We have audited the consolidated balance sheets of Cincinnati Financial Corporation and subsidiaries as of December 31, 1997 and 1996 and the related consolidated statements of income, shareholders’ equity and cash ﬂows for each of the three years in the period ended December 31, 1997. These ﬁnancial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on these ﬁnancial statements based on our audits. We conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the ﬁnancial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the ﬁnancial statements. An audit also includes assessing the accounting principles used and signiﬁcant estimates made by management, as well as evaluating the overall ﬁnancial statement presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, such consolidated ﬁnancial statements present fairly, in all material respects, the ﬁnancial position of Cincinnati Financial Corporation and subsidiaries at December 31, 1997 and 1996 and the results of their operations and their cash ﬂows for each of the three years in the period ended December 31, 1997 in conformity with generally accepted accounting principles. Cincinnati, Ohio February 4, 1998 19 C O N S O L I D A T E D B A L A N C E S H E E T S (000’s omitted) Cincinnati Financial Corporation and Subsidiaries December 31, 1997 1996 ASSETS Investments Fixed maturities, at fair value (cost: 1997—$2,571,549; 1996—$2,431,785) .................................................................................. $ 2,751,219 $ 2,561,805 Equity securities, at fair value (cost: 1997—$1,725,855; 1996—$1,537,189) .................................................................................. Other invested assets ..................................................................................... Cash ................................................................................................................. Investment income receivable ............................................................................ Finance receivables............................................................................................ Premiums receivable.......................................................................................... Reinsurance receivable....................................................................................... Prepaid reinsurance premiums........................................................................... Deferred acquisition costs pertaining to unearned 5,999,271 46,560 80,168 74,520 31,715 158,539 109,110 23,612 premiums and to life policies in force ............................................................ 135,313 Land, buildings and equipment for Company use (at cost, less accumulated depreciation: 1997—$97,248; 1996—$85,541) ....................... Other assets ....................................................................................................... 52,559 30,839 3,740,180 42,419 59,933 70,446 26,864 162,045 115,906 22,924 127,588 50,071 65,333 Total assets ............................................................................................... $ 9,493,425 $ 7,045,514 LIABILITIES Insurance reserves Losses and loss expenses................................................................................ Life policy reserves ........................................................................................ Unearned premiums .......................................................................................... Other liabilities .................................................................................................. Deferred income taxes........................................................................................ Notes payable .................................................................................................... 5.5% convertible senior debentures due 2002 .................................................... Total liabilities .......................................................................................... $ 1,936,534 482,447 443,054 168,959 1,406,478 280,558 58,430 4,776,460 $ 1,881,167 440,281 425,750 116,589 676,893 262,098 79,847 3,882,625 SHAREHOLDERS’ EQUITY Common stock, par value—$2 per share; authorized 80,000 shares; issued, 1997—56,464; 1996—55,829 ...................................................................... Paid-in capital ................................................................................................... Retained earnings .............................................................................................. Unrealized gains on investments ........................................................................ ................................................................................................................. Less treasury shares at cost (1997—1,012 shares; 1996—192 shares)............... Total shareholders’ equity ......................................................................... 112,927 429,137 1,341,730 2,905,756 4,789,550 (72,585) 4,716,965 111,657 401,862 1,132,880 1,527,707 3,174,106 (11,217) 3,162,889 Total liabilities and shareholders’ equity ................................................... $ 9,493,425 $ 7,045,514 Accompanying notes are an integral part of this statement. 20 C O N S O L I D A T E D S T A T E M E N T S O F I N C O M E (000’s omitted except per share data) Cincinnati Financial Corporation and Subsidiaries Years Ended December 31, 1997 1996 1995 REVENUE Premium income Property and casualty . . . . . . . . . . . . . . . . . . . . Life . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Accident and health . . . . . . . . . . . . . . . . . . . . . . Net premiums earned . . . . . . . . . . . . . . . . . . . . . Investment income . . . . . . . . . . . . . . . . . . . . . . . . . Realized gains on investments . . . . . . . . . . . . . . . . Other income . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Total revenues . . . . . . . . . . . . . . . . . . . . . . . . . . $ 1,453,526 54,742 8,110 1,516,378 348,597 69,230 8,179 1,942,384 BENEFITS AND EXPENSES Insurance losses and policyholder beneﬁts . . . . . . . Commissions . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Other operating expenses . . . . . . . . . . . . . . . . . . . . Taxes, licenses and fees . . . . . . . . . . . . . . . . . . . . . Increase in deferred acquisition costs pertaining to unearned premiums and to life policies in force . . Interest expense . . . . . . . . . . . . . . . . . . . . . . . . . . . Other expenses . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1,054,924 282,690 139,030 48,573 (7,725) 20,821 9,512 $ 1,366,544 48,694 7,659 1,422,897 327,307 47,946 10,599 1,808,749 1,087,105 259,291 117,034 43,392 (7,999) 20,102 7,403 $ 1,263,257 43,551 7,318 1,314,126 300,015 30,781 10,729 1,655,651 964,216 244,862 97,909 38,887 (10,086) 17,231 7,444 Total beneﬁts and expenses . . . . . . . . . . . . . . . . 1,547,825 1,526,328 1,360,463 INCOME BEFORE INCOME TAXES . . . . . . . . . . . . 394,559 282,421 295,188 PROVISION FOR INCOME TAXES Current . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Deferred . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Total provision for income taxes . . . . . . . . . . . . 107,046 (11,862) 95,184 67,827 (9,166) 58,661 76,012 (8,174) 67,838 NET INCOME . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ 299,375 $ 223,760 $ 227,350 PER COMMON SHARE Net Income . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Net Income (diluted) . . . . . . . . . . . . . . . . . . . . . . . Cash dividends (declared) . . . . . . . . . . . . . . . . . . . $ $ $ 5.43 5.31 1.64 $ $ $ 4.01 3.92 1.46 $ $ $ 4.08 3.99 1.28 Accompanying notes are an integral part of this statement. 21 C O N S O L I D AT E D S T AT E M E N T S O F S H A R E H O L D E R S ’ E Q U I T Y (000’s omitted) Cincinnati Financial Corporation and Subsidiaries Balance, December 31, 1994 ................. $ 100,872 $ (914) $ 105,792 $ 1,133,105 $ 601,192 Common Stock Treasury Stock Paid-In Capital Retained Earnings Unrealized Gains on Investments Net income ............................................ Change in unrealized gains on investments....................................... Income taxes on unrealized gains........... Dividends declared ................................ 5% stock dividend at market................. Purchase/issuance of treasury shares ...... Stock options exercised.......................... 5,043 253 (470) Balance, December 31, 1995 ................. 106,168 (1,384) Net income ............................................ Change in unrealized gains on investments....................................... Income taxes on unrealized gains........... Dividends declared ................................ 5% stock dividend at market................. Purchase/issuance of treasury shares ...... Stock options exercised.......................... Conversion of debentures ...................... 5,304 178 7 (9,833) Balance, December 31, 1996 ................. 111,657 (11,217) 127,338 182 3,860 237,172 160,453 870 3,221 146 401,862 Net income ............................................ Change in unrealized gains on investments....................................... Income taxes on unrealized gains........... Dividends declared ................................ Purchase/issuance of treasury shares ...... Stock options exercised.......................... Conversion of debentures ...................... 310 960 (61,368) 654 6,164 20,457 227,350 (71,262) (132,566)* 858,763 (300,567) 1,156,627 1,159,388 223,760 (81,498) (166,009)* 566,644 (198,325) 1,132,880 1,527,707 299,375 (90,525) 2,120,075 (742,026) Balance, December 31, 1997 ................. $ 112,927 $ (72,585) $ 429,137 $ 1,341,730 $ 2,905,756 *Includes $183,718 and $251,851 for fractional shares paid in April 1995 and 1996, respectively. Accompanying notes are an integral part of this statement. 22 C O N S O L I D A T E D S T A T E M E N T S O F C A S H F L O W S (000’s omitted) Cincinnati Financial Corporation and Subsidiaries Years Ended December 31, 1997 1996 1995 $ 299,375 $ 223,760 $ 227,350 Cash ﬂows from operating activities: Net income................................................................................. Adjustments to reconcile net income to net cash ﬂows provided by operating activities: Depreciation and amortization............................................... Increase in investment income receivable ............................... Decrease (increase) in premiums receivable ........................... Decrease (increase) in reinsurance receivable......................... (Increase) decrease in prepaid reinsurance premiums .............. Increase in deferred acquisition costs ..................................... Increase in accounts receivable .............................................. Decrease (increase) in other assets ......................................... Increase in loss and loss expense reserves ............................... Increase in life policy reserves ................................................ Increase in unearned premiums ............................................. Increase in other liabilities ..................................................... Decrease in deferred income taxes.......................................... Realized gains on investments................................................ Other ..................................................................................... 11,327 (4,074) 3,506 6,796 (688) (7,725) (7,230) 42,084 55,367 42,166 17,304 49,672 (11,862) (69,230) 169 Net cash provided by operating activities........................... 426,957 Cash ﬂows from investing activities: Sale of ﬁxed maturities investments ........................................... Call or maturity of ﬁxed maturities investments ......................... Sale of equity securities investments........................................... Collection of ﬁnance receivables................................................. Purchase of ﬁxed maturities investments.................................... Purchase of equity securities investments ................................... Investment in land, buildings and equipment............................. Investment in ﬁnance receivables ............................................... Increase in other invested assets ................................................. Net cash used in investing activities................................... Cash ﬂows from ﬁnancing activities: Proceeds from stock options exercised........................................ Purchase/issuance of treasury shares.......................................... Increase in notes payable ........................................................... Payment of cash dividends to shareholders ................................ 138,741 376,496 266,296 8,588 (637,858) (400,405) (16,485) (13,439) (4,471) (282,537) 6,474 (60,714) 18,460 (88,405) Net cash (used) provided in ﬁnancing activities ................. (124,185) Net increase (decrease) in cash ....................................................... Cash at beginning of year ............................................................... 20,235 59,933 7,100 (5,401) (928) (12,223) (1,089) (7,999) (2,080) (31,538) 137,633 37,017 17,126 6,984 (9,272) (47,946) (2,805) 308,339 219,131 247,205 257,981 10,449 (564,317) (353,340) (17,798) (17,032) (7,030) (224,751) 3,399 (8,963) 41,093 (79,203) (43,674) 39,914 20,019 9,641 (8,976) (19,145) (36,558) 2,231 (10,086) (3,900) (6,773) 191,237 33,169 26,505 9,522 (8,174) (30,781) 14,245 389,507 118,986 187,320 255,542 8,222 (616,001) (370,445) (10,538) (12,335) (4,666) (443,915) 4,113 (287) 91,889 (69,542) 26,173 (28,235) 48,254 Cash at end of year......................................................................... Supplemental disclosures of cash ﬂow information: Interest paid............................................................................... Income taxes paid ...................................................................... $ 80,168 $ 59,933 $ 20,019 $ 21,823 $ 95,488 $ 20,922 $ 65,000 $ 16,001 $ 67,000 Accompanying notes are an integral part of this statement. 23 N O T E S T O C O N S O L I D A T E D F I N A N C I A L S T A T E M E N T S Cincinnati Financial Corporation and Subsidiaries 1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES NATURE OF OPERATIONS—Cincinnati Financial Corporation (the “Company”) sells insurance primarily in the Midwest and Southeast through a network of local independent agents. Insurance products sold include ﬁre, automobile, casualty, bonds and all related forms of property and casualty insurance as well as life insurance and accident and health insurance. BASIS OF PRESENTATION—The consolidated ﬁnancial statements include the accounts of the Company and its subsidiaries, each of which is wholly owned, and are presented in conformity with generally accepted accounting principles. Generally accepted accounting principles differ in certain respects from statutory insurance accounting practices prescribed or permitted for insurance companies by regulatory authorities. All signiﬁcant inter-company balances and transactions have been eliminated in consolidation. The preparation of ﬁnancial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions. The accompanying consolidated ﬁnancial statements include estimates for such items as insurance reserves and income taxes. Actual results could differ from those estimates. PROPERTY AND CASUALTY INSURANCE— Expenses incurred in the issuance of policies are deferred and amortized over the terms of the policies. Anticipated investment income is not considered in determining if a premium deﬁciency related to insurance contracts exists. Policy premiums are included in income on a pro rata basis over the terms of the policies. Losses and loss expense reserves are based on claims reported prior to the end of the year and estimates of unreported claims. LIFE INSURANCE—Policy acquisition costs are deferred and amortized over the premium paying period of the policies. Life policy reserves are based on anticipated rates of mortality derived primarily from industry experience data, anticipated withdrawal rates based principally on Company experience and estimated future interest earnings using initial interest rates ranging from 3% to 101⁄2%. Interest rates on approximately $324,000,000 and $296,000,000 of such reserves at December 31, 1997 and 1996, respectively, are periodically adjusted based upon market conditions. Payments received for investment, limited pay and universal life-type contracts are recognized as income only to the extent of the current cost of insurance and policy administration, with the remainder recognized as liabilities and included in life policies reserves. unearned premiums and reserves for unpaid losses are accounted for in substantially the same manner as property and casualty insurance discussed above. REINSURANCE—In the normal course of business, the Company seeks to reduce losses that may arise from catastrophes or other events that cause unfavorable underwriting results by reinsuring certain levels of risk in various areas of exposure with other insurance companies, reinsurers and involuntary state pools. Reinsurance contracts do not relieve the Company from any obligation to policy- holders. Although the Company historically has not experienced uncollectible reinsurance, failure of reinsurers to honor their obligations could result in losses to the Company. Amounts recoverable from reinsurers are estimated in a manner consistent with the claim liability associated with the reinsured policy. The Company also assumes some reinsurance from other insurance companies, reinsurers and involuntary state pools. Such assumed reinsurance activity is recorded principally on the basis of reports received from the ceding companies. INVESTMENTS—Fixed maturities (bonds and notes) and equity securities (common and preferred stocks) are classiﬁed as available for sale and are stated at fair values. Unrealized gains and losses on investments, net of income taxes associated therewith, are included in shareholders’ equity. Realized gains and losses on sales of investments are recognized in net income on a speciﬁc identiﬁcation basis. INCOME TAXES—Deferred tax liabilities and assets are computed using the tax rates in effect for the time when temporary differences in book and taxable income are estimated to reverse. Deferred income taxes are recognized for numerous temporary differences between the Company’s taxable income and book-basis income and other changes in shareholders’ equity. Such temporary differences relate primarily to unrealized gains on investments and differences in the recognition of deferred acquisition costs and insurance reserves. Deferred taxes associated with unrealized appreciation (except the amounts related to the effect of income tax rate changes) are charged to shareholders’ equity, and deferred taxes associated with other differences are charged to income. EARNINGS PER SHARE—Net income per common share is based on the weighted average number of common shares outstanding during each of the respective years. The calculation of net income per common share (diluted) assumes the conversion of convertible senior debentures and the exercise of stock options. ACCIDENT AND HEALTH INSURANCE—Expenses incurred in the issuance of policies are deferred and amortized over a ﬁve-year period. Policy premium income, FAIR VALUE DISCLOSURES—Fair values for investments in ﬁxed maturity securities (including redeemable preferred stock) are based on quoted market prices, where available. 24 Cincinnati Financial Corporation and Subsidiaries For such securities not actively traded, fair values are estimated by discounting expected future cash ﬂows using a current market rate applicable to the yield, credit quality and maturity of the investments. Fair values for equity securities are based on quoted market prices. The fair values for liabilities under investment-type insurance contracts (annuities) are estimated using discounted cash ﬂow calculations, based on interest rates currently being offered for similar contracts with maturities consistent with those remaining for the contracts being valued. Fair values for short-term notes payable are estimated using interest rates currently available to the Company. Fair values for long-term convertible debentures are based on the quoted market prices for such debentures. OTHER—Statement of Financial Accounting Standards (SFAS) No. 128 “Earnings Per Share” was adopted in 1997, and all prior period earnings per share data has been restated. SFAS No. 130 “Reporting Comprehensive Income” will be effective for the Company in 1998. This statement requires ﬁnancial statement reporting of comprehensive income, which includes net income and other items, such as the change in unrealized gains on investments, net of income taxes. SFAS No. 131 “Disclosures About Segments of an Enterprise and Related Information” will be effective for the Company in 1998 and will require additional disclosures for the Company’s operating segments. RECLASSIFICATIONS—Certain prior year amounts have been reclassiﬁed to conform with 1997 classiﬁcations. 2. INVESTMENTS (000’s omitted) Investment income summarized by investment category: Interest on ﬁxed maturities ....................................................................... Dividends on equity securities................................................................... Other investment income .......................................................................... $ Total .................................................................................................... Less investment expenses.......................................................................... Years Ended December 31, 1997 1996 1995 218,065 128,403 6,865 353,333 4,736 $ 208,907 118,932 5,744 333,583 6,276 $ 186,071 111,458 6,480 304,009 3,994 Net investment income ......................................................................... $ 348,597 $ 327,307 $ 300,015 Realized gains on investments summarized by investment category: Fixed maturities: Gross realized gains.............................................................................. Gross realized losses ............................................................................. $ 22,075 (6,732) $ 20,823 (10,207) $ 14,466 (7,263) Equity securities: Gross realized gains.............................................................................. Gross realized losses ............................................................................. 62,337 (8,450) 47,310 (9,980) 38,705 (15,127) Realized gains on investments .............................................................. $ 69,230 $ 47,946 $ 30,781 Change in unrealized gains on investments summarized by investment category: Fixed maturities ....................................................................................... Equity securities ....................................................................................... $ 49,650 2,070,425 $ (18,257) 584,901 Change in unrealized gains on investments........................................... $ 2,120,075 $ 566,644 $ 181,475 677,288 $ 858,763 25 N O T E S T O C O N S O L I D A T E D F I N A N C I A L S T A T E M E N T S ( C O N T I N U E D ) Cincinnati Financial Corporation and Subsidiaries Analysis of cost, gross unrealized gains, gross unrealized losses and fair value as of December 31, 1997 and 1996 (000’s omitted): 1997 Fixed maturities: States, municipalities and political subdivisions ..... Convertibles and bonds with warrants attached ..... Public utilities........................................................ United States government and government agencies and authorities .................................... All other corporate bonds....................................... Cost $ 843,064 103,124 74,871 9,278 1,541,212 Total ................................................................. $ 2,571,549 Equity securities......................................................... $ 1,725,855 1996 Fixed maturities: States, municipalities and political subdivisions ..... Convertibles and bonds with warrants attached ..... Public utilities........................................................ United States government and government agencies and authorities .................................... All other corporate bonds....................................... $ 838,008 125,629 85,573 8,790 1,373,785 Total ................................................................. $ 2,431,785 Equity securities......................................................... $ 1,537,189 Gross Unrealized Gains Gross Unrealized Losses $ 47,811 7,973 4,982 258 125,174 $ 186,198 $ 4,277,294 $ 38,457 7,626 3,697 156 88,713 $ 138,649 $ 2,207,805 $ $ $ $ $ $ 2,645 1,705 18 22 2,138 6,528 3,878 1,092 1,630 349 143 5,415 8,629 4,814 Fair Value $ 888,230 109,392 79,835 9,514 1,664,248 $2,751,219 $5,999,271 $ 875,373 131,625 88,921 8,803 1,457,083 $2,561,805 $3,740,180 Contractual maturity dates for investments in ﬁxed maturity securities as of December 31, 1997 (000’s omitted): Maturity dates occurring: One year or less .................................................. After one year through ﬁve years ........................ After ﬁve years through ten years........................ After ten years .................................................... Total .............................................................. Cost $ 58,119 337,683 905,388 1,270,359 $ 2,571,549 Fair Value % of Fair Value $ 58,306 360,838 958,526 1,373,549 $ 2,751,219 2.1 13.1 34.9 49.9 100.0 Actual maturities may differ from contractual maturities when there exists a right to call or prepay obligations with or without call or prepayment penalties. At December 31, 1997, investments with a cost of $51,585,000 were on deposit with various states in compliance with certain regulatory requirements. Investments in companies that exceed 10% of the Company’s shareholders’ equity include the following as of December 31 (000’s omitted): 1997 Fair Value Cost 1996 Fair Value Cost Fifth Third Bancorp common stock......................... Alltel Corporation common stock ............................ $ 255,089 95,810 $ $ 2,612,607 $ 522,527 $ 238,087 95,720 $ $ 1,331,625 $ 399,252 3. DEFERRED ACQUISITION COSTS Acquisition costs incurred and capitalized during 1997, 1996 and 1995 amounted to $322,117,000, $303,111,000 and $282,399,000, respectively. Amortization of deferred acquisition costs was $314,392,000, $295,112,000 and $272,313,000 for 1997, 1996 and 1995, respectively. 26 Cincinnati Financial Corporation and Subsidiaries 4. LOSSES AND LOSS EXPENSES Activity in the reserve for losses and loss expenses is summarized as follows (000’s omitted): Years Ended December 31, 1996 1995 1997 Balance at January 1 .............. $1,824,296 121,881 1,702,415 Less reinsurance receivable .. Net balance at January 1 ........ Incurred related to: $1,690,461 $1,510,150 78,125 1,432,025 109,719 1,580,742 Current year......................... Prior years............................ Total incurred......................... Paid related to: 1,115,140 (119,654) 995,486 1,183,251 (151,996 ) 1,031,255 1,040,541 (126,509) 914,032 Current year......................... Prior years............................ Total paid............................... Net balance at December 31... Plus reinsurance receivable .. 467,843 453,410 921,253 1,776,648 112,235 Balance at December 31 ......... $1,888,883 514,186 395,396 909,582 1,702,415 121,881 396,856 368,459 765,315 1,580,742 109,719 $ 1,824,296 $1,690,461 As a result of changes in estimates of insured events in prior years, the provision for losses and loss expenses decreased by $119,654,000, $151,996,000 and $126,509,000 in 1997, 1996 and 1995. These decreases are due in part to the effects of settling reported (case) and unreported (IBNR) reserves established in prior years for less than expected. The reserve for losses and loss expenses in the accom- panying balance sheets also includes $47,651,000 and $56,871,000 at December 31, 1997 and 1996, respectively, for certain life/health losses and loss checks payable. 5. LIFE POLICY RESERVES Life policy reserves have been calculated using the account value basis for universal life and annuity policies and primarily the Basic Table (select) mortality basis for ordinary/traditional, industrial and other policies. Following is a summary of such reserves (000’s omitted): Ordinary/traditional life.................. Universal life................................... Annuities......................................... Industrial ........................................ Other .............................................. Total ............................................ 1997 $137,734 202,696 121,284 16,470 4,263 $482,447 1996 $123,473 183,967 112,496 16,881 3,464 $440,281 At December 31, 1997 and 1996, the fair value associated with the annuities shown above approximated $123,000,000 and $114,000,000, respectively. 6. NOTES PAYABLE The Company and subsidiaries had no compensating balance requirement on debt for either 1997 or 1996. Notes payable in the accompanying balance sheets are short term, and interest rates charged on such borrowings ranged from 5.14% to 8.50% during 1997 which resulted in an average interest rate of 6.14%. At December 31, 1997 and 1996, the fair value of the notes payable approximated the carrying value and the weighted average interest rate approximated 6.44% and 6.12%, respectively. 7. CONVERTIBLE SENIOR DEBENTURES The convertible senior debentures are convertible by the debenture holders into shares of common stock at a conversion price of $44.63 (22.41 shares for each $1,000 principal). At December 31, 1997 and 1996, the fair value of the debentures approximated $175,000,000 and $115,000,000, respectively. 8. REINSURANCE Property and casualty premium income in the accompanying statements of income includes approximately $41,694,000, $41,139,000 and $36,956,000 of earned premiums on assumed business and is net of approximately $94,397,000, $91,396,000 and $83,805,000 of earned premiums on ceded business for 1997, 1996 and 1995, respectively. Written premiums for 1997, 1996 and 1995 consist of the following (000’s omitted): Direct business........... Assumed business ...... Ceded business........... Net .......................... 1997 $1,523,915 42,773 (95,085) $1,471,603 1996 $1,433,340 42,671 (92,486) $1,383,525 1995 $1,338,205 39,221 (81,574) $1,295,852 Insurance losses and policyholder beneﬁts in the accompanying statements of income are net of approximately $34,744,000, $44,770,000 and $40,316,000 of reinsurance recoveries for 1997, 1996 and 1995, respectively. 9. FEDERAL INCOME TAXES Signiﬁcant components of the Company’s net deferred tax liability as of December 31, 1997 and 1996 are as follows (000’s omitted): 1997 1996 Deferred tax liabilities: Unrealized gains on investments ................ $1,558,580 42,936 Deferred acquisition costs .......................... 10,514 Other.......................................................... 1,612,030 Total .......................................................... Deferred tax assets: Losses and loss expense reserves ................ Unearned premiums................................... Life policy reserves..................................... Other.......................................................... Total .......................................................... 127,994 29,293 19,460 28,805 205,552 Net deferred tax liability............................... $1,406,478 $816,554 38,966 8,447 863,967 133,692 28,109 15,962 9,311 187,074 $676,893 The provision for federal income taxes is based upon a consolidated income tax return for the Company and subsidiaries. 27 N O T E S T O C O N S O L I D A T E D F I N A N C I A L S T A T E M E N T S ( C O N T I N U E D ) Cincinnati Financial Corporation and Subsidiaries The differences between the statutory federal rates and the Company’s effective federal income tax rates are as follows: Tax at statutory rate........................... Increase (decrease) resulting from: Tax-exempt municipal bonds ........... Dividend exclusion........................... Other ............................................... Effective rate...................................... 1997 Percent 35.00 1996 Percent 35.00 1995 Percent 35.00 (4.44) (6.54) .10 24.12 (6.41) (8.50) .68 20.77 (6.10) (8.04) 2.12 22.98 No provision has been made (at December 31, 1997, 1996 and 1995) for federal income taxes on approximately $14,000,000 of the life insurance subsidiary’s retained earnings, since such taxes will become payable only to the extent that such retained earnings are distributed as dividends or exceed limitations prescribed by tax laws. The Company does not contemplate any such dividend. 11. PENSION PLAN The Company and subsidiaries have a deﬁned beneﬁt pension plan covering substantially all employees. Beneﬁts are based on years of credited service and compensation level. Contributions to the plan are based on the frozen entry age actuarial cost method. Pension expense is composed of several components that are determined using the projected unit credit actuarial cost method and based on certain actuarial assumptions. The following table sets forth the plan’s funded status and the amounts recognized in the Company’s balance sheets as of December 31, 1997 and 1996 (000’s omitted): Actuarial present value of accumulated beneﬁt obligation (vested beneﬁts: 1997—$34,094; 1996—$29,704) ........................................ Plan assets at fair value ................................ Actuarial present value of projected 1997 1996 $ 35,202 $ 30,740 $133,470 $ 92,740 10. NET INCOME PER COMMON SHARE beneﬁt obligation ....................................... 61,457 54,208 (000’s omitted except per share data) 1997 Net income per common share..... $299,375 Shares Income Per Share (Numerator) (Denominator) Amount $5.43 55,179 Effect of dilutive securities: 5.5% convertible senior debentures ............................. Stock options ......................... Net income per common share 2,712 1,309 443 Plan assets in excess of projected beneﬁt obligation ....................................... 72,013 38,532 Unrecognized net transition asset at January 1, 1987 ($7,774 amortized over 21 years) ............................................ Unrecognized prior service costs ................... Unrecognized net gain .................................. (3,702) (397) (68,558) (4,072) (437) (34,730) (diluted)................................... $ 302,087 56,931 $5.31 Accrued pension cost .................................... $ (644) $ (707) 1996 Net income per common share..... $ 223,760 55,736 $4.01 the following components (000’s omitted): Net pension expense for 1997, 1996 and 1995 includes Service cost for current year ......... Interest cost .................................. Actual return on plan assets.......... Net amortization and deferral....... Net pension expense ..................... 1997 $ 3,449 3,938 (43,752) 36,302 (63) $ 1996 $ 3,306 3,572 (15,057) 8,615 436 $ 1995 $ 2,555 3,014 (20,717) 14,720 (428) $ The weighted average discount rate used in determining the actuarial present value of the projected beneﬁt obligation as of December 31 was 6.75%, 7% and 6.75% in 1997, 1996 and 1995, respectively. The rates of increase in future compensation levels were 5% to 7% for each year. The expected long-term rate of return on retirement plan assets, consisting principally of equity securities (including those of the Company), was 8% as of December 31, 1997, 1996 and 1995. Effect of dilutive securities: 5.5% convertible senior debentures ............................. Stock options ......................... Net income per common share 2,859 1,789 256 (diluted)................................... $ 226,619 57,781 $3.92 1995 Net income per common share..... $227,350 55,668 $4.08 Effect of dilutive securities: 5.5% convertible senior debentures ............................. Stock options ......................... Net income per common share 2,860 1,793 221 (diluted)................................... $ 230,210 57,682 $3.99 Options to purchase 25,000, 486,000 and 124,000 shares of common stock were outstanding during 1997, 1996 and 1995, respectively, but were not included in the computation of net income per common share (diluted) because the options’ exercise prices were greater than the average market price of the common shares. 28 Cincinnati Financial Corporation and Subsidiaries 12. SHAREHOLDERS’ EQUITY AND RESTRICTION 13. STATUTORY ACCOUNTING INFORMATION The insurance subsidiaries paid cash dividends to the Company of approximately $95,500,000, $77,027,000 and $143,773,000 in 1997, 1996 and 1995, respectively. Dividends paid to the Company by insurance subsidiaries are restricted by regulatory requirements of the insurance subsidiaries’ domiciliary state. Generally, the maximum dividend that may be paid without prior regulatory approval is limited to the greater of 10% of statutory surplus or 100% 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 can be paid only with approval of the insurance department of the subsidiaries’ domiciliary state. During 1998, the total dividends that can be paid to the Company without regulatory approval are approximately $246,941,000. 314,178 shares of common stock were available for future stock option grants, as of December 31, 1997. On November 22, 1996, the Board of Directors of the Company authorized the repurchase of up to three million of the Company’s outstanding shares as management deemed appropriate, over an unspeciﬁed period of time. As of December 31, 1997, the Company had repurchased 934,041 shares. 15. STOCK OPTIONS Net income and shareholders’ equity, as determined in ac- cordance with statutory accounting practices for the Company’s insurance subsidiaries, are as follows (000’s omitted): Years Ended December 31, 1996 1997 1995 Net income: Property/casualty insurance subsidiaries .......................... $ 212,808 $ 136,041 $ 152,003 Life/health insurance subsidiary ............................ $ 6,261 $ (1,812) $ 7,096 December 31, 1997 1996 Shareholders’ equity: Property/casualty insurance subsidiaries Life/health insurance subsidiary........... $ 2,148,746 $ 320,198 $ 1,393,954 $ 214,130 14. TRANSACTION WITH AFFILIATED PARTIES The Company paid certain ofﬁcers and directors, or insurance agencies of which they are shareholders, commissions of approximately $11,780,000, $10,874,000 and $10,034,000 on premium volume of approximately $78,727,000, $70,418,000 and $60,720,000 for 1997, 1996 and 1995, respectively. The Company has primarily qualiﬁed stock option plans under which options are granted to employees of the Company at prices which are not less than market price at the date of grant and which are exercisable over ten-year periods. The Company applies APB Opinion 25 and related Interpretations in accounting for these plans. Accordingly, no compensation cost has been recognized for the stock option plans. Had compensation cost for the Company’s stock option plans been determined based on the fair value at the grant dates for awards under those plans consistent with the method of SFAS No. 123, the Company’s net income and earnings per share would have been reduced to the pro forma amounts indicated below: Net income Net income per common share Net income per common share (diluted) As reported Pro forma As reported Pro forma As reported Pro forma 1997 $ 299,375 296,078 5.43 5.41 5.31 5.25 $ $ 1996 $ 223,760 221,665 4.01 3.98 3.92 3.89 $ $ $ 1995 $ 227,350 227,106 4.08 4.08 3.99 3.99 $ In determining the pro forma amounts above, the fair value of each option was estimated on the date of grant using the Binomial option-pricing model with the following weighted-average assumptions used for grants in 1997, 1996 and 1995, respectively: dividend yield of 1.22%, 2.26% and 2.26%; expected volatility of 19.67%, 20.5% and 21.3%; risk-free interest rates of 5.89%, 6.56% and 5.73%; and expected lives of ten years for all years. Compensation cost comprehended in the above pro forma disclosures is not indicative of future amounts (when the SFAS No. 123 methodology will be applied to additional outstanding nonvested awards). 29 N O T E S T O C O N S O L I D A T E D F I N A N C I A L S T A T E M E N T S ( C O N T I N U E D ) Cincinnati Financial Corporation and Subsidiaries (000’s omitted except per share data) A summary of options information for the years ended December 31, 1997, 1996 and 1995 follows: Shares Outstanding at beginning of year 1,258,164 218,479 Granted (155,143) Exercised (10,743) Forfeited/revoked 1,310,757 Outstanding at end of year 702,930 Options exercisable at end of year Weighted-average fair value of 1997 Weighted-Average Exercise Price $ 47.93 62.91 33.93 53.89 53.64 1996 Shares Weighted-Average Shares Exercise Price $ 40.24 60.76 37.38 58.68 47.93 895,249 512,603 (90,926) (58,762) 1,258,164 652,010 892,131 155,713 (136,291 ) (16,304 ) 895,249 641,655 1995 Weighted-Average Exercise Price $ 36.19 53.17 29.18 39.91 40.24 options granted during the year $ 22.97 $ 20.55 $ 15.80 Options outstanding at December 31, 1997 consisted of the following: Options Outstanding Options Exercisable Range of Exercise Prices $12 to 15 22 to 31 33 to 44 46 to 57 59 to 64 67 to 69 79 to 100 Number 34,056 48,993 237,763 297,270 482,175 166,500 44,000 1,310,757 Weighted-Average Remaining Contractual Life .25 yrs 2.50 yrs 4.15 yrs 6.57 yrs 8.31 yrs 9.28 yrs 9.75 yrs 6.91 yrs Weighted-Average Exercise Price $ 13.77 25.22 37.04 50.45 61.13 68.06 90.79 53.64 Number 34,056 48,993 237,763 229,571 152,547 0 0 702,930 Weighted-Average Exercise Price $ 13.77 25.22 37.04 50.24 61.05 n/a n/a 44.61 16. SEGMENT INFORMATION (000’s omitted) The Company operates principally in two industries—property and casualty insurance and life insurance. Information concerning the Company’s operations in different industries is presented below. Revenue is primarily from unafﬁliated customers. Identiﬁable assets by industry are those assets that are used in the Company’s operations in each industry. Corporate assets are principally cash and marketable securities. Property/casualty insurance ...................................................... Life/health insurance ................................................................ Investment income (less required interest on life reserves) ......... Realized gains on investments ................................................... Other......................................................................................... General corporate expenses ....................................................... Total ..................................................................................... Property/casualty insurance ...................................................... Life/health insurance ................................................................ Other......................................................................................... Corporate assets ........................................................................ Total ..................................................................................... 30 30 1997 $ 28,955 2,763 321,620 69,230 865 (28,874) $ 394,559 Income Before Income Taxes 1996 $ (44,449) (2,906) 305,211 47,946 3,337 (26,718) $ 282,421 1997 $ 4,953,259 1,094,445 66,227 3,379,494 $ 9,493,425 Identiﬁable Assets 1996 $ 3,986,658 902,354 53,351 2,103,151 $ 7,045,514 1995 $ 2,894 (2,512) 279,346 30,781 4,979 (20,300) $ 295,188 1995 $ 3,526,900 809,418 44,487 1,728,493 $ 6,109,298 S U B S I D I A R Y O F F I C E R S A N D D I R E C T O R S AS OF DECEMBER 31, 1997, LISTED ALPHABETICALLY The Cincinnati Insurance Company (CIC) The Cincinnati Casualty Company (CCC) EXECUTIVE OFFICERS William T. Camp The Cincinnati Indemnity Company (CID) The Cincinnati Life Insurance Company (CLIC) Cheryl L. Frey CIC, CID, CCC Vice President—Administrative Services CFC-I President and Director Theodore F. Elchynski CIC, CID, CCC, CLIC, CFC-I Senior Vice President— Accounting, Secretary and Director CIC, CID, CCC Treasurer James G. Miller CIC, CID, CCC, CLIC, CFC-I Senior Vice President — Investments CFC-I Treasurer and Director CIC, CID Director Robert B. Morgan CIC, CID, CCC, CLIC Chief Executive Ofﬁcer and Director CIC, CID President CFC-I Director Larry R. Plum, CPCU CCC President and Director CIC, CID Senior Vice President—Personal Lines and Director CLIC Director David H. Popplewell, FALU, LLIF CLIC President, Chief Operating Ofﬁcer and Director J. F. Scherer CIC, CID, CCC, CLIC Senior Vice President—Sales & Marketing and Director John J. Schiff CIC, CID, CCC Chairman of the Executive Committee and Director CLIC, CFC-I Director John J. Schiff, Jr., CPCU CIC, CID, CCC Chairman of the Board and Director CLIC, CFC-I Director Timothy L. Timmel CIC, CID, CCC, CLIC, CFC-I Senior Vice President— Operations and Director OFFICERS AND DIRECTORS Michael R. Abrams CIC, CID, CCC, CLIC Assistant Treasurer—Investments Donald R. Adick, FLMI CLIC Senior Vice President—Administration Dawn M. Alcorn CIC, CID, CCC Secretary—Administrative Services R. Larry Arlen, CPCU, CLU, ARP, AIAF, AIM CLIC Assistant Secretary—Life Claims Charles M. Armentrout, AIC CIC, CID, CCC Secretary—Claims William R. Backs CFC-I Vice President—Sales Ricky G. Baker CIC, CID, CCC, CLIC Assistant Secretary—Information Systems Patricia L. Barnhart CIC, CID, CCC Assistant Treasurer—Accounting Brad E. Behringer CLIC Assistant Vice President—Life Underwriting James E. Benoski CIC, CID, CCC, CLIC Senior Vice President—Claims CCC Director Douglas A. Bogenreif, CLU CLIC Assistant Secretary—Life Development David L. Burbrink CLIC Assistant Vice President—Advanced Planning Thomas D. Candella CIC, CID, CCC Assistant Secretary—Personal Lines Daniel C. Cappel CIC, CID, CCC Assistant Vice President—Accounting Richard W. Cumming, FSA, ChFC CIC, CID, CCC, CLIC Senior Vice President—Chief Actuary CLIC Director Joel W. Davenport, AAI, CPCU CIC, CID, CCC Assistant Secretary—Commercial Lines James H. Deal, CPCU, CLU CIC, CID, CCC, CLIC Vice President—Education & Training J. Michael Dempsey, CLU CLIC Vice President—Education & Training Mark R. DesJardins, CPCU, AIC, AIM CIC, CID, CCC Secretary—Education & Training Dean W. Dicke CIC, CID, CCC Senior Vice President—Field Claims CCC Director Donald J. Doyle, Jr., AIM CIC, CID, CCC, CLIC Secretary—Information Systems John C. DuBois CIC, CID, CCC Assistant Secretary—Personal Lines Frederick A. Ferris CIC, CID, CCC Secretary—Commercial Lines John E. Field, CPCU CIC, CID Director Bruce S. Fisher, CPCU, AIC CIC, CID, CCC Assistant Vice President—Claims Craig W. Forrester, CLU CIC, CID, CCC, CLIC Vice President—Information Systems Michael E. Francois CIC, CID, CCC Assistant Secretary—Sales & Marketing Michael J. Gagnon CIC, CID, CCC Vice President—Claims William J. Geier, CLU, ChFC, FLMI, CPCU CIC, CID, CCC, CLIC Secretary—Information Systems Scott A. Gilliam CIC, CID, CCC Assistant Secretary—Government Relations Gary B. Givler CIC, CID, CCC Assistant Secretary—Claims Kevin E. Guilfoyle CFC-I Assistant Vice President—Real Estate David L. Helmers, CPCU CIC, CID, CCC Vice President—Personal Lines Theresa A. Hoffer CIC, CID, CCC Assistant Treasurer—Accounting Martin F. Hollenbeck CIC, CID, CCC, CLIC Assistant Treasurer—Investments Timothy D. Huntington, AU, CPCU CIC, CID, CCC Assistant Secretary—Commercial Lines Thomas A. Joseph, CPCU CIC, CID, CCC Vice President—Commercial Lines CCC Director Thomas H. Kelly CIC, CID, CCC Vice President—Bond Christopher O. Kendall, CPCU, AAM, AIM, ARE CIC, CID, CCC Assistant Vice President—Commercial Lines Bob R. Kerns CIC, CID, CCC, CLIC Senior Vice President—Staff Underwriting CCC Director Gary J. Kline, CPCU CIC, CID, CCC Secretary—Commercial Lines Robert L. Laymon CIC, CID, CCC Secretary—Bond Steven W. Leibel CIC, CID, CCC Assistant Secretary—Personal Lines Jerry L. Litton CIC, CID, CCC Assistant Treasurer—Accounting Frank D. Love, CPCU CIC, CID, CCC, CFC-I Senior Vice President—Administrative Services, Engineering and Sales CLIC Director Kenneth C. Mack, AIM CIC, CID, CCC Secretary—Personal Lines Michael J. Martini CLIC Assistant Secretary—Life Policy Services Eric N. Mathews, AIAF CIC, CID, CCC Vice President—Accounting Richard L. Mathews CIC, CID, CCC Assistant Secretary—Information Systems Richard P. Matson CIC, CID, CCC, CLIC, CFC-I Assistant Vice President— Purchasing Daniel T. McCurdy CIC, CID, CCC Senior Vice President—Bond CCC Director Janet K. McVay CIC, CID, CCC Assistant Secretary—Personal Lines Kenneth S. Miller, CLU, ChFC CIC, CID, CCC, CLIC Vice President—Investments Martin J. Mullen, CPCU CIC, CID, CCC Assistant Secretary—Claims Urban G. Neville CIC, CID, CCC, CLIC Senior Vice President—Information Systems CCC Director Gary A. Nichols CIC, CID, CCC Assistant Secretary—Claims Glenn D. Nicholson, LLIF CLIC Senior Vice President and Senior Marketing Ofﬁcer Robert J. Nieberding, CLU CIC, CID, CCC, CLIC Vice President—Information Systems Marc A. O’Dowd, CPA, CPCU CIC, CID, CCC, CLIC Internal Audit Ofﬁcer Carol A. Oler, AIM CIC, CID, CCC, CLIC Assistant Secretary—Information Systems David H. Park, CLU CIC, CID, CCC, CLIC Assistant Secretary—Information Systems D. Kae Parrott, AIM CIC, CID, CCC, CLIC Secretary—Information Systems Todd H. Pendery, FLMI CLIC Secretary—Accounting Marc C. Phillips, CPCU CIC, CID, CCC Assistant Secretary—Commercial Lines David A. Pierce CIC, CID, CCC, CLIC Assistant Secretary—Information Systems John P. Ringstrom CIC, CID, CCC Assistant Secretary—Claims Charles E. Robinson, CPCU CIC, CID, CCC Secretary—Field Claims Ronald L. Robinson CIC, CID, CCC Assistant Secretary—Field Claims CFC Investment Company (CFC-I) Christopher J. Roehm CIC, CID, CCC Assistant Secretary—Personal Lines Michael A. Rouse CIC, CID, CCC Assistant Secretary—Commercial Lines Thomas J. Scheid CIC, CID, CCC, CLIC Assistant Vice President—Staff Underwriting Robert C. Schiff CIC, CID, CCC, CLIC Director Thomas R. Schiff CIC, CID, CCC, CLIC Director Gregory D. Schmidt, CPCU, ARP, CSF CIC, CID, CCC, CLIC Assistant Vice President—Staff Underwriting William E. Scholz CIC, CID, CCC Assistant Secretary—Sales & Marketing Don E. Schricker CIC, CID, CCC Vice President—Personal Lines Frank J. Schultheis CIC, CID Director Norman R. Settle CIC, CID, CCC Vice President—Engineering and Loss Control Dennis D. Shamp CIC, CID, CCC Assistant Vice President—Special Projects Joan O. Shevchik, CPCU, CLU CIC, CID, CCC Secretary—Publications J. B. Shockey, CPCU, CLU CIC, CID, CCC Vice President—Sales & Marketing Scott K. Smith CIC, CID, CCC Assistant Secretary—Commercial Lines Kenneth W. Stecher CIC, CID, CCC, CLIC Senior Vice President—Accounting CLIC Treasurer and Director Henry W. Stein, Jr. CIC, CID, CCC Vice President—Commercial Lines Charles P. Stoneburner, II, CPCU CIC, CID, CCC Assistant Secretary—Claims Duane I. Swanson, CIC CIC, CID, CCC Assistant Secretary—Sales & Marketing Eric N. Taylor, CLU, ChFC CLIC Assistant Secretary—Sales & Marketing Michael A. Terrell, CPCU, RPLU CIC, CID, CCC Assistant Secretary—Sales & Marketing Roger E. Thomas, AIC CIC, CID, CCC Assistant Vice President—Claims Scott L. Unger CIC, CID, CCC Secretary—Bond Philip J. Van Houten, CFE, FCLS CIC, CID, CCC Secretary—Claims Jody L. Wainscott CIC, CID, CCC Vice President—Staff Underwriting William H. Ware, Jr., CLU, ChFC CLIC Vice President—Sales & Marketing David A. Webb, CLU, ChFC, FLMI CIC, CID, CCC, CLIC Secretary—Information Systems Larry R. Webb, CPCU CIC, CID Director Alan R. Weiler, CPCU CIC, CID Director Paul W. Wells CIC, CID, CCC Secretary—Bond Mark A. Welsh CIC, CID, CCC , CLIC Secretary—Staff Underwriting Mark S. Wietmarschen CIC, CID, CCC Secretary—Commercial Lines Gregory J. Ziegler CIC, CID, CCC, CLIC, CFC-I Vice President—Personnel _____________________________ Edward P. Brueggeman CIC, CID, CCC, CLIC Associate Counsel John F. Gannon CIC, CID, CCC, CLIC Associate Counsel Eugene M. Gelfand CIC, CID, CCC, CLIC Counsel Mark J. Huller CIC, CID, CCC, CLIC Senior Counsel G. Gregory Lewis CIC, CID, CCC, CLIC Counsel Lisa A. Love CIC, CID, CCC, CLIC Associate Counsel Barry A. Meyer CIC, CID, CCC, CLIC Associate Counsel Stephen C. Roach CIC, CID, CCC, CLIC Associate Counsel CIC DIRECTORS EMERITI Vincent H. Beckman Hayden D. Davis Robert J. Driehaus Richard L. Hildbold, CPCU Harry M. Turner, Chairman Emeritus Robert B. Woods William H. Zimmer 31 31 C I N C I N N A T I F I N A N C I A L C O R P O R A T I O N O F F I C E R S A N D D I R E C T O R S William F. Bahl Michael Brown Richard M. Burridge John E. Field William R. Johnson Kenneth C. Lichtendahl James G. Miller Robert B. Morgan Jackson H. Randolph John J. Schiff John J. Schiff, Jr. Robert C. Schiff Thomas R. Schiff Frank J. Schultheis Larry R. Webb Alan R. Weiler OFFICERS AS OF DECEMBER 31, 1997 Robert B. Morgan President and Chief Executive Ofﬁcer John J. Schiff, Jr., CPCU Chairman of the Board John J. Schiff Chairman of the Executive Committee Theodore F. Elchynski Senior Vice President, Chief Financial Ofﬁcer, Secretary and Treasurer James G. Miller Senior Vice President, Chief Investment Ofﬁcer, Assistant Secretary and Assistant Treasurer Kenneth S. Miller, CLU, ChFC Vice President, Assistant Secretary and Assistant Treasurer Kenneth W. Stecher Vice President, Assistant Secretary and Assistant Treasurer DIRECTORS AS OF DECEMBER 31, 1997 William F. Bahl, CFA(2)(5) President—Bahl & Gaynor, Inc. (investment advisors) Director since 1995 32 Michael Brown(2)(6) President and General Manager— Cincinnati Bengals, Inc. Director since 1980 Richard M. Burridge, CFA(1)(5) Chairman—The Burridge Group, Inc. (investment advisors) Director since 1987 John E. Field, CPCU(4) Vice Chairman—Wallace & Turner, Inc. (insurance agency) Director since 1995 William R. Johnson President and Chief Operating Ofﬁcer— H. J. Heinz Company Director since 1996 Kenneth C. Lichtendahl(1)(2) President and Chief Executive Ofﬁcer— Hudepohl-Schoenling Brewing Company Director since 1988 James G. Miller Senior Vice President and Chief Investment Ofﬁcer—Cincinnati Financial Corporation Director since 1996 Robert B. Morgan(4)(5) President and Chief Executive Ofﬁcer— Cincinnati Financial Corporation Director since 1978 Jackson H. Randolph(1)(5)(6) Chairman—CINergy Corporation Director since 1986 DIRECTORS EMERITI Vincent H. Beckman Robert J. Driehaus David R. Huhn Lawrence H. Rogers, II(3) John Sawyer David B. Sharrock Thomas J. Smart Harry M. Turner Charles I. Westheimer William H. Zimmer John J. Schiff(4)(5) Chairman of the Executive Committee— Cincinnati Financial Corporation Director since 1968 John J. Schiff, Jr., CPCU(4)(5)(6) Chairman—Cincinnati Financial Corporation Director since 1968 Robert C. Schiff Chairman and Chief Executive Ofﬁcer— Schiff, Kreidler-Shell, Inc. (insurance agency) Director since 1968 Thomas R. Schiff(5) Chairman and Chief Executive Ofﬁcer— John J. & Thomas R. Schiff & Co., Inc. (insurance agency) Director since 1975 Frank J. Schultheis(4) President—Schultheis Insurance Agency, Inc. Director since 1995 Larry R. Webb, CPCU President—Webb Insurance Agency, Inc. Director since 1979 Alan R. Weiler, CPCU(4) President and Chief Executive Ofﬁcer— Archer-Meek-Weiler Agency, Inc. (insurance agency) Director since 1992 (1) Audit Committee (2) Compensation Committee (3) Advisor to Compensation Committee (4) Executive Committee (5) Investment Committee (6) Nominating Committee S H A R E H O L D E R I N F O R M A T I O N Cincinnati Financial Corporation had approximately 10,320 shareholders of record as of December 31, 1997. Most of CFC’s 2,670 associates and many of our independent agent representatives own stock in their Company. 49 percent of CFC’s outstanding shares are held by registered owners. ANNUAL MEETING The Annual Meeting of Shareholders of Cincinnati Financial Corporation will take place at 9:30 a.m. on Saturday, April 4, 1998, at the Cincinnati Art Museum in Eden Park, Cincinnati, Ohio. SHAREHOLDER SERVICES Please direct inquiries about stock transfer, dividend reinvestment, dividend direct deposit, lost certiﬁcates, change of address and elimination of duplicate mailings to T. F. Elchynski, Chief Financial Ofﬁcer, Cincinnati Financial Corporation, P.O. Box 145496, Cincinnati, Ohio 45250-5496, (513)870-2639 or e-mail to investor_inquiries@cinﬁn.com. FORM 10-K Shareholders may request a copy of Form 10-K for 1997. Cincinnati Financial Corporation ﬁles the Annual Report on Form 10-K with the Securities and Exchange Commission. You may access this document through a link to the SEC’s EDGAR database from our Web site, www.cinﬁn.com. P R I C E R A N G E O F C O M M O N S T O C K Shares are traded nationally over the counter. Closing sale price is quoted under the symbol CINF on the National Market List of Nasdaq (National Association of Securities Dealers Automated Quotation System). Tables below show the price range reported for each quarter based on daily last sale prices. 1997 1996 Quarter High............................ Low ............................ Dividend Paid ............. 1st $ 73 1⁄4 62 .37 2nd $ 82 1⁄2 67 3⁄8 .41 3rd $ 83 3⁄4 78 1⁄2 .41 4th $ 140 3⁄4 83 7⁄8 .41 1st $ 64 1⁄4 57 5⁄8 .32 2nd $ 63 1⁄2 57 3⁄8 .37 3rd $ 58 13⁄16 54 .37 4th $ 65 3⁄16 54 1⁄4 .37 S E L E C T E D Q U A R T E R L Y F I N A N C I A L D A T A (000’s omitted except per share data) Financial data for each quarter in the two years ended December 31, Quarter Revenues ..................................................... Income Before Income Taxes........................ Net Income .................................................. Net Income Per Common Share ................... Net Income Per Common Share (Diluted) .... Quarter Revenues ..................................................... Income Before Income Taxes........................ Net Income .................................................. Net Income Per Common Share ................... Net Income Per Common Share (Diluted) .... 1st $ 483,737 98,278 74,047 1.33 1.30 1st $ 451,798 76,449 59,448 1.07 1.04 2nd $ 484,203 100,341 75,830 1.37 1.33 2nd $ 442,042 67,022 54,396 .98 .95 1997 3rd $ 492,038 101,964 77,000 1.42 1.37 1996 3rd $ 455,681 58,658 46,949 .84 .82 4th $ 482,406 93,975 72,498 1.32 1.28 4th $ 459,227 80,291 62,966 1.13 1.10 Full Year $1,942,384 394,559 299,375 5.43 5.31 Full Year $1,808,749 282,421 223,760 4.01 3.92 Note: The sum of the quarterly reported amounts may not equal the full year as each is computed independently. Printed on recycled paper CINCINNATI FINANCIAL CORPORATION The Cincinnati Insurance Company The Cincinnati Casualty Company The Cincinnati Indemnity Company The Cincinnati Life Insurance Company CFC Investment Company P.O. Box 145496 Cincinnati, Ohio 45250-5496 (513) 870-2000 www.cinﬁn.com

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