Cincinnati Financial
C
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I Am the Face
I Am the Face
of Cincinnati
of Cincinnati
2005 Annual Report
Chairman’s Letter to Shareholders
Page 2
Furnishing Protection with a Human Touch
Page 12
2005 Annual Report on Form 10-K
Page 25
About Your Company
1
Financial Highlights
Cincinnati Financial
Corporation, formed in
1968, offers property
casualty insurance, its
main business, through its
subsidiaries. The
Cincinnati Insurance
Company, founded in
1950, leads the property
casualty group known as
The Cincinnati Insurance
Companies. The
Cincinnati Casualty
Company and The
Cincinnati Indemnity
Company round out that
group, known for its
strong customer focus on
a select group of
independent insurance
agencies that market its
broad range of business
and personal policies in
32 states. The Cincinnati
Life Insurance Company
primarily markets life
insurance and annuities.
CFC Investment Company
offers commercial leasing
and financing services.
CinFin Capital
Management Company
provides asset
management services to
institutions, corporations
and high net worth
individuals.
Financial highlights provide a snapshot of your
company’s financial results and strength.
2
To Our Shareholders
A letter from the chairman and chief executive
officer discusses events of 2005, your company’s
progress and issues that may affect it in 2006
and beyond.
Consolidated Pretax
Investment Income
Less expenses
(Dollars in millions)
2
9
4
5
6
4
6
2
5
5
4
4
1
2
4
2001 2002 2003 2004 2005
Property Casualty
Combined Ratio
Statutory
(Percent)
The Cincinnati Insurance Companies
Estimated industry (A.M. Best)
115.7
107.3
100.2 98.1
102.0
.
6
3
0
1
.
6
9
9
.
0
5
9
.
4
9
8
.
0
9
8
2001* 2002* 2003 2004 2005
7
8
9
Condensed Balance Sheets and Income Statement
Six-year Summary of Financial Information
Financial Performance Overview
2005 results for property casualty insurance operations, including commercial lines and
personal lines; life insurance operations; and investment operations.
12
The Face of Cincinnati
You are invited to go behind the scenes and meet
some of your company’s remarkable associates.
They carry out the everyday details that help local
independent agents serve policyholders. As they
describe their work, you’ll see how associates
integrate a genuine concern for people into every
process and every transaction.
21 Corporate Directors and Officers
22 Definitions of Non-GAAP Information
and Reconciliation to Comparable
GAAP Measures
25 Annual Report on Form 10-K
In the Annual Report on Form 10-K, a report required by the U.S. Securities and
Exchange Commission of all publicly traded companies, we describe your company’s
operations, its results and three-year trends, giving clear and thorough explanations with
supporting data.
Appendix
Subsidiary Officers and Directors
Inside Back Cover
Shareholder Information, Common Stock Price and Dividend Data
This report contains forward-looking statements that involve potential risks and uncertainties. Please see
Management’s Discussion and Analysis in the Annual Report on Form 10-K, which begins on Page 25, for
factors that could cause results to differ materially from those discussed.
Financial Highlights
Cincinnati Financial Corporation and Subsidiaries
(In millions except per share data)
Revenue Highlights
Years ended December 31,
2004
2005
Change %
Earned premiums . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Investment income, net of expenses . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Total revenues . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
$ 3,164
526
3,767
$ 3,020
492
3,614
Income Statement Data
Net income . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Net realized investment gains and losses, after tax . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Net income before realized investment gains and losses . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Per Share Data (diluted)
Net income . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Net realized investment gains and losses, after tax . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Net income before realized investment gains and losses . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Cash dividends declared . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Book value . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Average shares outstanding . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
$
$
$
$
$
602
40
562
3.40
0.23
3.17
1.21
34.88
177
$
$
$
$
$
584
60
524
3.28
0.34
2.94
1.04
35.60
178
Balance Sheet Data
Total assets . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Shareholders' equity . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
$ 16,003
6,086
$ 16,107
6,249
Ratio Data
Property casualty statutory combined ratio . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Return on equity . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Return on equity based on comprehensive income . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
89.0%
9.8
1.6
89.4%
9.4
4.6
4.8
6.9
4.2
3.1
(33.9)
7.3
3.7
(32.4)
7.8
16.1
(2.0)
(0.7)
(0.6)
(2.6)
Revenues
(Dollars in millions)
7
6
7
,
3
4
1
6
,
3
1
8
1
,
3
3
4
8
,
2
1
6
5
,
2
Net Income/
Dividends Paid
Per common share
(Dollars)
Net income before realized investment
gains and losses, before one-time items
Net income before one-time items
Dividends paid
Book Value
Per common share
(Dollars)
0
4
3
.
7
1
.
3
8
2
.
3
4
9
.
2
6
1
.
2
1
0
.
2
7
6
.
1
2
3
.
1
7
1
.
1
7
0
.
1
0
1
.
5
3
0
6
.
5
3
8
8
.
4
3
2
6
.
3
3
3
4
.
1
3
0.74
0.80
0.89
1.02
1.16
2001 2002 2003 2004 2005
2001 2002 2003* 2004 2005
2001 2002 2003 2004 2005
Over the past five years, revenues rose at
a compound annual rate of 10.1 percent,
reflecting growth of total earned premiums
and investment income. 2005 revenues
grew 4.2 percent as market conditions
slowed growth of property casualty earned
premiums. Realized gains made a positive
contribution in 2005 and 2004.
2005 net income and operating income
reached record highs. Cash dividends paid
to shareholders rose at an 11.6 percent
compound annual rate over the past five
years. The indicated annual dividend
payout rose 9.8 percent in February 2006
as the board increased the quarterly cash
dividend for the 46th consecutive year.
Book value was 2 percent below the
year-earlier level at year-end 2005.
Strong cash flow from operations was
offset by lower unrealized gains in the
investment portfolio.
*The Definitions of Non-GAAP Information and Reconciliation to Comparable GAAP Measures on Page 22 defines and reconciles measures presented in this
report that are not based on GAAP or statutory accounting principles.
1
To Our Shareholders:
Property Casualty
Net Earned Premiums
(Dollars in millions)
Personal lines
Commercial lines
2,919 3,058
4
5
2
,
2
6
2
1
,
2
2,653
8
0
9
,
1
2,391
1
2
7
,
1
2,073
3
5
4
,
1
0
2
6
0
7
6
5
4
7
3
9
7
4
0
8
2001 2002 2003 2004 2005
Property casualty net earned premiums
increased 4.8 percent in 2005. On the
statutory basis that facilitates industry
comparisons, net written premiums rose
2.6 percent, and the company continued
its track record of outpacing industry
growth, estimated at 0.7 percent.
Consolidated Assets
(Dollars in millions)
7
0
1
,
6
1
3
0
0
,
6
1
9
0
5
,
5
1
2
2
1
,
4
1
4
6
9
,
3
1
2001 2002 2003 2004 2005
Over the past five years, assets grew at
a 3.8 percent compound annual rate,
primarily because of 2.3 percent compound
annual growth in invested assets.
2005 10-K
For a detailed review of the
company's 2006 outlook, please
see the Executive Summary,
10-K Pages 31-35.
2
Your company set new records in
statutory written premiums reached
2005, with net income up 3.1 percent to
$3.076 billion, up 2.6 percent compared with
$602 million and operating income up
A.M. Best's estimate of 0.7 percent industry
7.3 percent to $562 million. This was the
growth. Life insurance written premiums
fourth consecutive year of higher property
reached $205 million, up 6.6 percent.
casualty underwriting profits. Investment
Statutory property casualty surplus, a key
income set another record, continuing our
measure of financial strength, remained
unbroken string of year-over-year increases
exceptionally strong at $4.194 billion.
in this measure.
Dividends from our Fifth Third Bancorp
common stock added $106 million to
investment income, which in total
contributed $526 million to earnings before
taxes. The growth rate reached 6.9 percent,
and we anticipate another good year in 2006,
in the same 6.5 percent to 7.0 percent range.
Lower unrealized gains in our investment
portfolio in 2005, due primarily to a lower
year-end market value of the Fifth Third
stock, led to book value of $34.88 versus
$35.60 at year-end 2004. Return on equity
improved to 9.8 percent from 9.4 percent,
while return on equity including
comprehensive income declined to
1.6 percent from 4.6 percent, also reflecting
year-end market values.
The cumulative, steady efforts of our
independent agents and our associates over
the past several years once again showed
results. Property casualty underwriting
profits rose 10.8 percent, contributing
$330 million before taxes. The statutory
combined ratio improved to 89.0 percent
from 89.4 percent, with commercial lines
continuing strong at 87.1 percent and
personal lines improving more than 10 points
to 94.3 percent. A.M. Best Co. estimates
the industry's 2005 combined ratio at
102 percent.
With increased competition in the current
marketplace, our 2005 property casualty
Issues and Perspectives
Looking beyond 2005's very satisfactory
numbers, certain trends suggest that 2006
will be a challenging year for our industry
and for your company. We anticipate that our
results may be tempered by our decisions to
give up short-term gain in order to achieve
long-term results. Briefly, these are the issues
and our perspective:
• The property casualty insurance
marketplace. Pricing on commercial lines
business, the source of 71 percent of our
premium revenues, is softening. It's
increasingly difficult to take business
away from the quality insurers that are
our main competition in our agents'
offices. After a few good years, there is
plenty of capital and surplus to support
growth, and every insurer wants to put it
to work. And, while we focused on
restoring personal lines profitability in
2005, other carriers refined their pricing
models and began reducing their prices
for good accounts. Even as we earned a
full-year underwriting profit on personal
lines for the first time since 1999, we
began working on plans to resume
personal lines growth.
As a result, we are projecting that our
2006 written premiums will be flat to
slightly up, with modest growth in
commercial lines offsetting a decline in
personal lines.
• Expenses. Your company is investing in
our future. Infrastructure improvements
include major automation projects that
improve service to and communication
with our agencies. We are incurring
expenses for new project development as
well as deployment and enhancement of
systems in operation. Current earnings
also are charged for the previously
capitalized costs of developing the
systems now in operation. We've also
added staff to work on these projects and
to service our growing business. And in
2006, we will begin expensing options as
required, with a per-share earnings impact
of about 2 cents per quarter.
For both commercial lines and personal
lines, lower 2006 earned premium
growth could contribute to a higher
expense ratio as we continue investing in
our infrastructure. Overall, we expect to
achieve a property casualty combined
ratio in the range of 92 percent to
94 percent, which would be excellent but
would not match our outstanding
89.2 percent GAAP ratio in 2005.
• Catastrophes and reinsurance. After two
years of multiple hurricanes and other
catastrophe losses, most observers believe
we are in a period with higher potential
for severe weather. Our 2005 catastrophe
losses were $127 million compared with
$148 million in 2004 and $97 million in
2003, including ceded and assumed
reinsurance. Considering this trend,
along with our increased retention under
2006 reinsurance agreements, we believe
catastrophe losses could contribute
between 4.0 to 4.5 percentage points
to our 2006 combined ratio, slightly
above historic levels.
We expect premium costs for all of our
2006 property casualty reinsurance
agreements to be about $7 million less
than 2005, without taking into account the
reinstatement premiums we paid in 2005.
However, reinsurance costs for some
business lines are rising. Our savings
primarily arose from the exceptional
financial strength that allowed us to
increase
our 2006
retentions,
the
deductible-
like
amounts
that we
would pay
before our
reinsurers would cover some or all of our
excess losses.
John J. Schiff, Jr., CPCU, chairman,
president and chief executive officer
• Reserve development. Insurers set aside
loss reserves from current earnings for
claims that are still in the settlement
process or that have not yet been reported.
Generally, as time goes on, we study
those reserves and adjust them if claims
are coming in lower or higher than
anticipated, with a corresponding benefit
or charge to current earnings. In 2004 and
2005, underwriting income and combined
ratios benefited from higher-than-normal
favorable development of reserves.
While we anticipate a benefit again in
2006, we expect it may improve our
combined ratio 2 to 3 percentage points,
compared with 5.7 points in 2005 and
6.7 points in 2004.
Productivity Drives Opportunities
While these trends could pressure your
company's short-term performance, we
nevertheless remain very confident about the
future. We have seen soft market pricing
before and know that our best approach is to
price every account in line with the risk we
assume, continuing to target a profit in our
overall insurance underwriting. We are
patient, and we have proven capable of
achieving industry-leading results, seeing
opportunities in all market cycles.
In May 2005, Independent Agent
Magazine looked at the 19 “Tiffany class”
U.S. publicly traded property casualty
2005 10-K
For a detailed review of the
company's property casualty
business, please see
Commercial Lines Insurance
Results of Operations, 10-K
Pages 41-47, and Personal
Lines Insurance Results of
Operations, 10-K Pages 47-52.
2005 10-K
For a detailed review of the
company's life insurance
business, please see
Life Insurance Results of
Operations, 10-K Pages 52-54.
3
Property Casualty
Statutory Surplus Ratio
Net written premiums to surplus
Estimated industry net written premiums
to surplus (A.M. Best)
1.3
1.1
1
.
0 1
.
1
1.2
0
.
1
1.1
1.0
7
.
0
7
.
0
2001 2002 2003 2004 2005
The company historically has maintained
its ratio of net written premiums to
statutory surplus below the industry
average. The lower the ratio, the stronger
a property casualty insurer's security for
policyholders and its capacity to support
business growth. In 2004, the company
transferred equity securities to the
property casualty subsidiary. The transfer
accounted for most of the reduction in the
ratio for 2005 and 2004.
Life Statutory Capital
and Surplus Ratio
(Percent)
Adjusted capital and surplus to liabilities
Estimated industry adjusted capital and
surplus to liabilities (A.M. Best)
3
.
2
5
7
.
9
3
2
.
9
3
2
.
0
4
3
.
7
3
insurers with the highest 2004 revenues.
of business, commercial auto and
Cincinnati Financial Corporation – No. 19 –
commercial packages. On the personal lines
stood at the top of the list for after-tax profits
side, our Diamond policy processing system
per employee.
is live, as of early 2006, in 10 states that
You don't have to look far to find the
represent approximately 85 percent of total
sources of this exceptional productivity.
personal lines premium volume, and many
Productivity Drives Progress
Your company has made strides in
agents are beginning to see the benefits of
easier renewal processing.
updating its technology. We're now placing
People Drive Productivity
our forms libraries and state manuals online.
The most important source of our
Several business areas have eliminated
waiting and duplication of effort by
productivity truly is our people. Their
effectiveness, above and beyond efficiency
centralizing their files in online document
or automation, leads to profits. From our
repositories, where they are simultaneously
14 investment portfolio managers
available on demand to multiple viewers.
responsible for our $12.657 billion of
Life insurance and claims operations have
securities, to our 100 field marketing
used this capability to streamline their
representatives who manage agency
processes and reduce turnaround time.
relationships and $282 million of new
Cincinnati and our vendor were recognized
commercial lines business, associates across
with a 2005 Best Practices Award from the
the company are highly skilled and intensely
Association for Information and Image
alert to opportunities to contribute to your
Management for enabling field claims
company's success.
representatives to remotely capture, index
In 2005, underwriters continued to pay
and submit supplemental claim materials,
particular attention to insurance-to-value and
such as pictures and audio files, via an
risk transfer when renewing policies. Field
Internet connection.
claims associates, led by Vice President
Our commercial lines department began
Charles “Bud” Stoneburner II, CPCU, as
imaging its files in 2005. By year-end, half
of early 2005, responded to more than
11.1
10.0
10.5
10.7
10.4
of its teams were using online underwriting
3,300 hurricane claims and more than
2001 2002 2003 2004 2005
renewals, with plans to include the other half
due under the policy and doing so with a
and policy files for new business and
200,000 claims in total, paying all that was
The ratio of statutory adjusted capital and
surplus to liabilities for Cincinnati Life
remained at more than three times the
estimated industry average in 2005,
reflecting the financial stability of
Cincinnati Life. The higher the ratio, the
stronger a life insurer's security for
policyholders and its capacity to support
business growth.
4
during 2006. Our commercial lines policy
human touch.
quoting system now is available in all of our
states, for all major product lines.
We launched a new, Web-based
commercial policy processing system,
e-CLAS™, late in 2005. The initial release
produces Ohio Businessowners Package
policies. We have plans to extend the system
in 2006 to our agents in additional states and
to start preparations for adding the next lines
The Relationship Mindset
Your company's professional claims
representatives continue to be our best
advertising program. Satisfied agents and
policyholders often report that they could
pay less for a policy from another carrier but
refuse to give up the service of their local
Cincinnati field associates.
Cincinnati associates connect with their
the top two carriers in three-quarters.
customers, coming forward to meet their
The independent agencies we select are
needs. That initiative extends to their
recognized across our industry as strong
2005 10-K
For a discussion of strategies
to cultivate relationships with
independent insurance agents,
please see Our Business and
Our Strategy, 10-K Pages 1-8.
Details related to technology
solutions are on 10-K
Pages 4-5, and details related
to insurer financial strength
ratings are on 10-K Pages 5-7.
community. In 2005, associates organized
sales organizations. This year, the
relief for tsunami and Katrina survivors, in
Independent Insurance Agents & Brokers
addition to participating in regular activities
of America gave one of our Minnesota
such as blood drives, school partnerships and
agents its most distinguished honor and
fund drives for the arts and United Way.
named 36 Cincinnati agencies among just
En masse, they put work aside for a few
139 chosen nationally for its 2005 Best
minutes, lining the streets in front of our
headquarters offices to joyfully welcome a
local battalion back safely from Iraq and to
Practices Study Group. Another agency in
North Carolina earned Rough Notes'
Marketing Agency of the Year title. These
somberly salute soldiers who had sacrificed
agencies market the worth of their service,
their lives.
their insurance skill and local knowledge
Deeply engaged with people, Cincinnati
along with Cincinnati product and service
associates have the right mindset to create
advantages. What they offer is a step above
the strong agency relationships cited by both
the rest, positioning them to go on the
A.M. Best and Fitch Ratings as they
offense as value players rather than compete
affirmed your company's financial strength
primarily on price.
ratings in 2005. The A++ from A.M. Best
We also go on the offense by continuously
places your company among the top
improving products and tools and refining
1.6 percent of property casualty insurance
our underwriting guidelines and rate
groups. Moody's Investors Service and
structures. During 2005, for example, we
Standard & Poor's Ratings Services also
introduced a new edition of our commercial
award very strong ratings to your company.
property form and our new Termsetter series
Franchise Worth
All of these superior ratings increase our
franchise value, attracting good agents by
giving them a sales point to emphasize with
the many insurance buyers who are willing
to pay a fair price for high quality protection.
In 2005, we began appointing agencies to
actively market in Delaware, our 32nd state
of operations. New appointments pushed us
past the 1,000 mark to 1,024 agency
relationships operating in 1,253 locations.
Leveraging the Cincinnati claims and ratings
of life insurance products. In 2006, we are
2005 10-K
working on improved worksite life products
For a detailed review of
investment operations, please
see Investments Results of
Operations, 10-K Pages 54-57.
and enrollment software, as well as expanded
eligibility and coverage updates for our
Businessowners Package Policy. Your
company's personal lines operations have
moved into the profitable range. In 2006, we
are working to improve our high policy
retention and attract desirable personal lines
accounts by adjusting rates, increasing our
loss-free credit and incorporating insurance
scores into our pricing.
advantages, each reporting agency location
Steady Over Time
produced $2.5 million of business, on
Our intention remains to be a steady
average, making us the top carrier within
market participant, capable of writing most
more than half of our agencies and one of
types of accounts served by local agencies.
5
Consolidated Pretax
Investment Income
Less expenses
(Dollars in millions)
2
9
4
5
6
4
6
2
5
5
4
4
1
2
4
2001 2002 2003 2004 2005
Consolidated pretax investment income
rose 6.9 percent in 2005. Dividend
increases announced during 2005 by
companies whose common stocks are
in the portfolio are expected to add
$15 million to investment income in 2006.
That steadiness is good for shareholders, too.
Poor's 500 Index. For the five years ending
In a study published in 2005, Aon Re Global
December 31, 2005, our total return reached
listed Cincinnati Financial as the first runner-
40.9 percent versus 2.8 percent for the
up among all commercial insurers for having
S&P 500. Cincinnati Financial has
the lowest earnings volatility over a two-year
outperformed the S&P 500 in 13 of the
period. Aon's premise is that less volatile
past 16 years.
earnings will, over time, lead to increased
Over time, we seek to increase earnings
shareholder value. It's a premise we share.
per share, book value and dividends at a rate
Over time, the effects of insurance pricing
that would allow long-term total return to
and economic cycles even out. At any point,
our shareholders to exceed that of the
we choose to look past the peaks and valleys,
Standard & Poor’s Composite 1500 Property
focusing on what it takes to assure growth
Casualty Insurance Index. Our five-year total
and profits over the longer term. That's the
return matched the Index return.
basis for our total return investment program
NASDAQ and Mergent, Inc., introduced a
and our emphasis on common stocks, which
new NASDAQ Dividend Achievers Index in
make up 54.8 percent of our consolidated
February 2006, naming Cincinnati Financial
portfolio's market value.
as a founding member. It is comprised of
We like stocks with steadily increasing
NASDAQ-listed companies that have
dividends and potential for appreciation.
increased annual regular dividend payments
While our financial stocks, including our
for the last 10 or more consecutive years.
largest holding in Fifth Third, are cyclical,
In fact, your 2006 indicated annual
they meet this longer-term investment
objective. In late 2005, we began selling our
dividend of $1.34 per share represents the
46th consecutive year of increase.
core holding in Alltel Corporation common
Your company's people are prepared to
stock when its business model and outlook
rise above any challenges that 2006 may
for dividend increases changed. With that
bring and to dedicate themselves to
sale complete early in 2006, we are investing
increasing shareholder value, over time.
2005 10-K
For a detailed review of the
company's financial results and
condition, please see Financial
Statements and Supplementary
the proceeds in line with our overall
investment objectives.
Respectfully,
Since 1996, the board of directors also
/S/ John J. Schiff, Jr.
has authorized investment in our own shares,
John J. Schiff, Jr., CPCU
Data, 10-K Page 77, and Notes
including the most recent authorization of
Chairman, President and
to Consolidated Financial
Statements, 10-K Page 84.
10 million shares approved in August 2005.
Chief Executive Officer
Your company returned $267 million to
March 10, 2006
shareholders during 2005, including
$63 million through repurchases of our
common stock and $204 million of cash
dividends paid. Shareholders also received a
5 percent stock dividend in April. Total
return to shareholders was 9.1 percent in
2005 versus 4.9 percent for the Standard &
6
Condensed Balance Sheets and Income Statements
Cincinnati Financial Corporation and Subsidiaries
(Dollars in millions)
Assets
At December 31,
2005
2004
Investments . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Cash . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Premiums receivable . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Reinsurance receivable . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Other assets . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Total assets . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Liabilities
Insurance reserves . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Unearned premiums . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Deferred income tax . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
6.125% senior notes due 2034 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
6.9% senior debentures due 2028 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
6.92% senior debentures due 2028 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Other liabilities . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Total liabilities . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Shareholders' Equity
Common stock and paid-in capital . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Retained earnings . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Accumulated other comprehensive income – unrealized gains on investments and derivatives . . . . . . . . . .
Treasury stock . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Total shareholders' equity . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Total liabilities and shareholders' equity . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
$ 12,702
119
1,116
681
1,385
_________
$ 16,003
_________
_________
$
5,004
1,559
1,622
371
28
392
941
_________
9,917
_________
1,358
2,088
3,284
(644)
_________
6,086
_________
$ 16,003
_________
_________
$ 12,677
306
1,119
680
1,325
_________
$ 16,107
_________
_________
$
4,743
1,539
1,834
371
420
–
951
_________
9,858
_________
988
2,057
3,787
(583)
_________
6,249
_________
$ 16,107
_________
_________
(Dollars in millions except per share data)
Revenues
2005
Years ended December 31,
2004
2003
Earned premiums . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Investment income, net of expenses . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Realized investment gains and losses . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Other income . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Total revenues . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Benefits and Expenses
Insurance losses and policyholder benefits . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Commissions . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Other operating expenses . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Total benefits and expenses . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
$
3,164
526
61
16
_________
3,767
_________
1,911
627
406
_________
2,944
_________
Income Before Income Taxes . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
823
Provision for Income Taxes . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Net Income . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
221
_________
$
602
_________
_________
Per Common Share
Net income – basic . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Net income – diluted . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
$
$
3.44
3.40
$
3,020
492
91
11
_________
3,614
_________
1,846
615
353
_________
2,814
_________
800
216
_________
$
584
_________
_________
$
$
3.30
3.28
$
2,748
465
(41)
9
_________
3,181
_________
1,887
536
278
_________
2,701
_________
480
106
_________
$
374
_________
_________
$
$
2.11
2.10
7
Six-year Summary Financial Information
Cincinnati Financial Corporation and Subsidiaries
(Dollars in millions except per share data)
Financial Highlights
Net income . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
One-time items* . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Net income before one-time items* . . . . . . . . . . . . . . . . . .
Net realized investment gains and losses, after tax . . . . . .
Net income before net realized investment gains
and losses, before one-time items* . . . . . . . . . . . . . . . .
Comprehensive income . . . . . . . . . . . . . . . . . . . . . . . . . . .
Per Share Data (diluted)
Net income . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
One-time items* . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Net income before one-time items* . . . . . . . . . . . . . . . . . .
Net realized investment gains and losses, after tax . . . . . .
Net income before net realized investment gains
and losses, before one-time items* . . . . . . . . . . . . . . . .
Cash dividends declared . . . . . . . . . . . . . . . . . . . . . . . . . . .
Book value . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Ratio Data
Investment yield-to-cost (pretax) . . . . . . . . . . . . . . . . . . . .
Debt-to-capital . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Return on equity (ROE) before one-time items* . . . . . . . .
ROE based on comprehensive income
before one-time items* . . . . . . . . . . . . . . . . . . . . . . . . . .
Property Casualty Insurance Operations (Statutory)
Written premiums . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Written premiums (adjusted)* . . . . . . . . . . . . . . . . . . . . . .
Earned premiums . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Loss ratio . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Loss expense ratio . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Underwriting expense ratio . . . . . . . . . . . . . . . . . . . . . . . .
Combined ratio (reported) . . . . . . . . . . . . . . . . . . . . . . .
Combined ratio (adjusted)* . . . . . . . . . . . . . . . . . . . . . .
Policyholders' surplus . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Commercial Lines Property Casualty Insurance Operations (Statutory)
Written premiums . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Written premiums (adjusted)* . . . . . . . . . . . . . . . . . . . . . .
Earned premiums . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Loss ratio . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Loss expense ratio . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Underwriting expense ratio . . . . . . . . . . . . . . . . . . . . . . . .
Combined ratio (reported) . . . . . . . . . . . . . . . . . . . . . . .
Combined ratio (adjusted)* . . . . . . . . . . . . . . . . . . . . . .
$ 2,290
2,306
2,254
46.6%
11.0
29.5
87.1%
87.1%
Personal Lines Property Casualty Insurance Operations (Statutory)
Written premiums . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Written premiums (adjusted)* . . . . . . . . . . . . . . . . . . . . . .
Earned premiums . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Loss ratio . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Loss expense ratio . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Underwriting expense ratio . . . . . . . . . . . . . . . . . . . . . . . .
Combined ratio (reported) . . . . . . . . . . . . . . . . . . . . . . .
Combined ratio (adjusted)* . . . . . . . . . . . . . . . . . . . . . .
$
786
791
804
56.7%
7.2
30.4
94.3%
94.3%
Life Insurance Operations (Statutory)
Written premiums . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Net income before realized investment gains and losses . .
Net income . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Gross life insurance face amount in force . . . . . . . . . . . . .
Admitted assets excluding separate account business . . . .
Risk-based capital
Total adjusted capital . . . . . . . . . . . . . . . . . . . . . . . . . . .
Authorized control level risk-based capital . . . . . . . . . .
2005
2004
2003
2002
2001
2000
Years ended December 31,
$
$
$
$
$
$
602
–
602
40
562
99
3.40
–
3.40
0.23
3.17
1.21
34.88
7.0%
11.5
9.8
$
$
$
$
$
$
584
–
584
60
524
287
3.28
–
3.28
0.34
2.94
1.04
35.60
7.2%
11.2
9.4
$
$
$
$
$
$
374
15
359
(27)
386
815
2.10
0.09
2.01
(0.15)
2.16
0.90
35.10
$
$
$
$
$
$
238
–
238
(62)
300
(232)
1.32
–
1.32
(0.35)
1.67
0.81
31.43
7.5%
8.9
6.0
7.9%
9.7
4.1
1.6
4.6
13.5
(4.0)
$ 3,076
3,097
3,058
49.2%
10.0
29.8
89.0%
89.0%
$ 4,194
$ 2,997
3,026
2,919
49.8%
10.3
29.3
89.4%
89.4%
$ 4,191
$ 2,186
2,209
2,126
43.4%
10.9
29.4
83.7%
83.7%
$
811
817
793
66.7%
8.9
29.0
104.6%
104.6%
$ 2,815
2,789
2,653
56.1%
11.6
26.5
94.2%
95.0%
$ 2,783
$ 2,031
2,009
1,908
51.2%
12.7
27.0
90.9%
91.6%
$
784
780
745
68.8%
8.9
25.2
102.9%
103.9%
$ 2,613
2,496
2,391
61.5%
11.4
25.5
98.4%
99.6%
$ 2,340
$ 1,905
1,795
1,721
57.8%
12.5
25.0
95.3%
96.8%
$
708
701
670
71.0%
8.7
26.8
106.5%
106.8%
$
205
10
21
51,493
1,882
$
193
26
28
44,921
1,713
$
143
27
20
38,492
1,572
$
220
20
17
32,486
1,477
$
$
$
$
$
$
193
–
193
(17)
210
150
1.07
–
1.07
(0.10)
1.17
0.76
33.62
8.1%
9.2
3.2
2.5
$ 2,590
2,188
2,073
66.8%
10.1
22.6
99.5%
103.6%
$ 2,533
$ 1,827
1,551
1,453
62.6%
11.8
22.3
96.7%
100.7%
$
763
637
620
76.7%
6.2
23.0
105.9%
110.4%
$
102
21
15
27,534
1,329
$
$
$
$
$
$
118
(25)
143
(2)
145
744
0.67
(0.14)
0.81
(0.01)
0.82
0.69
33.80
8.4%
9.4
2.5
13.5
$ 1,881
1,936
1,828
71.1%
11.4
30.0
112.5%
109.9%
$ 3,172
$ 1,275
1,326
1,232
71.1%
12.9
33.2
117.2%
114.4%
$
606
610
596
71.1%
8.1
31.4
110.6%
108.4%
$
140
28
30
23,525
1,201
* The Definitions of Non-GAAP Information and Reconciliation to Comparable GAAP Measures on Page 22 defines and reconciles measures presented in this report that are not based
on GAAP or statutory accounting principles.
8
511
52
491
47
443
50
420
47
457
44
503
76
Financial Performance Overview
Our local independent agents, field and headquarters associates achieved excellent financial results in 2005.
They invested in efforts that strengthen our position going into 2006, a year that may prove challenging for our
Premium Mix
Percent of 2005 consolidated
net earned premiums
industry. Top-notch claims service, especially the response to this year's many weather
catastrophes, firmed up policyholder loyalties. Active salesmanship produced more than
Life
3%
Personal
lines 26%
Commercial
lines
71%
$300 million of new business and many new policyholders. And our infrastructure
expanded with significant progress on technology and physical plant projects, helping
assure our ability to achieve the company's objectives over the long term.
All three of our insurance areas contributed to this year's strong underwriting results.
Commercial lines, which provided 71 percent of total earned premiums, brought in
$285 million of underwriting profit. Personal lines, which provided 26 percent of total earned premiums, added
$45 million in underwriting profit. Life insurance, which provided 3 percent of total earned premiums, contributed
20 cents per share to operating earnings, up from 18 cents last year. Our investment operations contributed
$526 million in pretax investment income, up 6.9 percent.
The next two pages give a brief overview of 2005 financial results for our insurance and investment operations.
We encourage you to read the Management's Discussion and Analysis in our Annual Report on Form 10-K Page 31,
for a detailed look at management's view of the results of operations and liquidity and capital resources.
Property Casualty Insurance Operations
We believe that our agent-centered strategy provides
important advantages as we go head-to-head with other
profitable, financially strong competitors in our
regional markets.
Across our commercial lines market areas, during 2005 we
saw continued signs of the soft market, with fewer increases
and more declines in renewal pricing, aside from any changes
in an account's exposures. Account quality, class of business,
size of account, location and the mix of carriers that compete
in that local market all continue as factors in pricing levels.
Commercial policyholders continue to respond favorably to
our agents' presentation of the Cincinnati value proposition –
customized coverage packages, personal claims service and
high financial strength ratings – all wrapped up in a
convenient three-year commercial policy.
14.7
11.7
14.0
13.0
The Cincinnati Insurance Companies
Estimated industry (A.M. Best)
Property Casualty
Net Written Premium
Growth (Adjusted*)
Statutory
(Percent)
The personal lines market
remains competitive. We are
further refining our rates and
premium credits. In
Diamond states, we plan in
July to introduce a limited
program of rate segments
that incorporate insurance
scores into pricing of
personal auto and
homeowner policies. These
changes better position our
agents to sell the value of
our homeowner auto package, superior claims service and
financial strength, which should help us resume growing in
this business area.
2001* 2002* 2003* 2004* 2005*
2.3
8.5
8.5
0.7
4.7
9.6
*The Definitions of Non-GAAP Information and Reconciliation to Comparable GAAP Measures on Page 22 defines and reconciles measures presented in this
report that are not based on GAAP or statutory accounting principles.
9
Other 2005 highlights of
the property casualty
operations included:
• 2.6 percent increase in
2005 total property
casualty net written
premiums, ahead of the
estimated industry average
growth rate of 0.7 percent.
• 89.2 percent GAAP
Property Casualty
Combined Ratio
Statutory
(Percent)
The Cincinnati Insurance Companies
Estimated industry (A.M. Best)
115.7
107.3
100.2 98.1
102.0
6
.
3
0
1
6
.
9
9
0
.
5
9
4
.
9
8
0
.
9
8
combined ratio (89.0 percent
statutory) for full-year
2005. Improvement
reflected lower catastrophe losses, continued strong
commercial lines underwriting results and a return to
personal lines underwriting profitability.
2001* 2002* 2003* 2004 2005
• $127 million in full-year 2005 catastrophe losses,
including ceded and assumed reinsurance. Catastrophe
losses added 4.1 percentage points to the 2005 combined
ratio. Full-year 2004 catastrophe losses of $148 million,
on the same basis, added 5.1 percentage points to last
year’s ratio.
• A net increase of 40 reporting agency locations in 2005.
We had 1,024 agency relationships with 1,253 reporting
agency locations marketing our insurance products at
year-end 2005, up from 986 agency relationships with
1,213 reporting agency locations at year-end 2004.
Commercial Lines Insurance Highlights
• 87.4 percent 2005 commercial lines GAAP combined ratio,
marking the second consecutive year with a sub-90 percent
combined ratio.
• 4.7 percent rise in 2005 commercial lines net written
premiums, with slower growth primarily due to a more
competitive pricing environment. The growth rate of
commercial lines written premium exceeded the
2.7 percent growth estimated on an industrywide basis.
• $282 million in new commercial lines business written
directly by agencies in 2005, unchanged from 2004.
• WinCPP, our commercial lines rate quoting system, rolled
out to all 32 states where our agents actively market our
insurance products to businesses.
• Ohio agents began using e-CLAS™, our Web-based
commercial lines policy processing system, to issue
Businessowners Package policies (BOPs) during 2005.
With almost $1 million in BOP premiums on that
processing system by year-end, we anticipate introducing
it in 2006 to agents in several other states and beginning
preparations to add product lines to enhance its utility.
Personal Lines Insurance Highlights
• 94.4 percent 2005 personal lines GAAP combined
ratio, reflecting substantial progress in lowering our
homeowner loss and loss expense ratio closer to
breakeven. 2005 was the first full year of profitability for
personal lines since 1999.
• 3.0 percent decline in 2005 personal lines net written
premiums, with 6.6 percent fourth-quarter decline.
• $32 million in new personal lines business written directly
by agencies in 2005, compared with $48 million last year.
• Diamond, the company's personal lines policy processing
system, in use at year-end in seven states. These states
represented approximately 70 percent of total 2005
personal lines earned premium volume. In 2005,
$417 million of personal lines' $786 million of written
premium was issued through Diamond.
• Diamond rollout to extend to six additional states in 2006.
Georgia, Kentucky and Wisconsin agents began using
Diamond in early 2006, with Minnesota, Missouri and
Tennessee rollouts planned for later in the year.
*The Definitions of Non-GAAP Information and Reconciliation to Comparable GAAP Measures on Page 22 defines and reconciles measures presented in this
report that are not based on GAAP or statutory accounting principles.
10
Life Insurance Operations
The Cincinnati Life Insurance Company contributed
2 cents more to our company's operating earnings this year,
reflecting higher earned premium with stable expenses and
mortality experience within pricing guidelines. Overall, the
life operation continues to
provide a consistent income
stream for our agents and the
company, helping to offset
some of the inevitable
fluctuations in property
casualty results.
Cincinnati Life —
Gross Life Policy Face
Amounts In Force
Excluding annuities, accident
and health business
(Dollars in millions)
Other 2005 highlights of
the life insurance operations
included:
• $205 million in 2005 total
life insurance operations
written premiums, up from
3
9
4
,
1
5
1
2
9
,
4
4
2
9
4
,
8
3
6
8
4
,
2
3
4
3
5
,
7
2
2001 2002 2003 2004 2005
Investment Operations
We remain committed to our buy-and-hold equity investing
strategy, which we believe is key to the company's long-term
growth and stability. During the second half of 2005, we
made moderate additions to our equity portfolio and anticipate
making equity investments in 2006 that provide both income
and the potential
for capital
appreciation over
the years.
Consolidated Investment Portfolio
As of December 31, 2005
(Dollars in millions)
Market (Fair) Value
Book Value
12,657
7,590
(Dollars in millions)
Book Value
Taxable fixed maturity
Tax-exempt fixed maturity
Common equity
Preferred equity
Short-term
Total
$ 3,304
2,083
1,961
167
75
$ 7,590
Market (Fair)
Value
$ 3,359
2,117
6,936
170
75
$12,657
Other 2005
highlights of
the investment
operations
included:
• 6.9 percent
increase
in pretax net
investment
income.
Interest income
from fixed-
$193 million in 2004. Written premiums for life insurance
operations for all periods include life insurance, annuity
and accident and health premiums. Life insurance 2004
premiums included the sale of two general account bank-
owned life insurance (BOLIs) policies totaling $10 million.
• 14.6 percent rise in face amount of life policies in force to
$51.493 billion at year-end 2005 from $44.921 billion at
year-end 2004. Applications submitted in 2005 rose
2.0 percent, with a 6.3 percent gain in worksite
applications.
• 16.1 percent rise in 2005 term life insurance gross written
premiums, benefiting from midyear introduction of a new
series of term products. The Termsetter Plus series
includes an optional return-of-premium feature.
Response to the new portfolio has been favorable, with
approximately 25 percent of applications requesting the
return-of-premium feature.
income investments contributed 53.3 percent of 2005 net
investment income. Dividend increases from common
stocks more than offset loss of income from sales or calls
of convertible preferred securities in the past 12 months.
Fifth Third, the company's largest equity holding,
contributed 43.6 percent of total dividend income in 2005.
• $15 million annually in additional investment income
expected from dividend increases announced during 2005
by Fifth Third and another 35 of the 49 common stock
holdings in the equity portfolio.
• $4.194 billion in statutory surplus for the property casualty
insurance group at year-end 2005, essentially unchanged
from year-end 2004. The ratio of common stock to
statutory surplus for the property casualty insurance group
portfolio was 97.0 percent at year-end 2005, compared
with 103.5 percent at year-end 2004.
• 33.9 percent ratio of investment securities held at the
holding-company level to total holding-company-only
assets at year-end 2005, in line with management's
below-40 percent target.
• 1.5 million of our shares repurchased at a total cost of
$63 million in 2005.
11
I Am the Face
I Am the Face
of Cincinnati
of Cincinnati
“Our business is to protect people against calamitous misfortunes and
catastrophes. It is our duty to furnish this protection – with a warm
human interest in those we insure – and in the most progressive and
efficient manner.”
This preamble appeared from 1957 to 1963 in your
Room to grow
company’s annual reports. Efficiency was a high priority then,
Meeting the needs of our independent insurance agencies
as it is today. And we continue to get the job done, furnishing
the protection expected by our agency customers and their
clients. Just as important, we integrate into every process and
every transaction a genuine concern for people.
In these pages, you’ll meet some of the associates who carry
out the everyday details related to “furnishing protection.”
They are remarkable. Their words reveal strong ownership not
has allowed us to grow more rapidly than the overall industry.
But substantial potential remains in our 32 active states.
In 26 states,
our market
share is less
than 1 percent.
To tap this
potential,
Cincinnati Market Share by State
Based on 2004 Direct Written Premiums
Above 5%
1% to 5%
Less than 1%
Inactive states
only of their individual jobs, but also of our mission to support
we have
the continued success of our local independent agents, who we
believe are best equipped to serve the policyholders in their
communities.
As a growing organization whose competitive edge has
always been our ability to provide the human touch, how do we
avoid becoming another large, impersonal organization of
people in cubicles, not fully awake to the impact – for better or
accelerated
efforts to
appoint new
agency
relationships.
In 2005 and
2004, we
added
worse – of their actions? How do we create totally vested
91 new agency
*
* DE in 2005
Headquarters (no branches)
associates willing to give of themselves in providing warm
relationships. We anticipate making 50 appointments in 2006.
human responses?
12
Growing relationships
We select and reward professional independent agents who
share our long-term focus – agents who do business person
to person; offer broad, value-added services; maintain sound
Cincinnati Market Share
Within Reporting
Agency Locations
Based on 2004 Direct
Written Premiums
(Percent)
Your company sees challenges in the coming year, as
market conditions for our property casualty insurance
business make it more difficult to grow and as our
investments in people and systems continue. We believe we’re
moving in the right direction and will move past those
challenges stronger than ever.
People are our major advantage. We are represented in the
marketplace by top, professional independent agents. We have
a culture that encourages associates to look within themselves
to find solutions, to increase and direct their efforts with
certainty that individual contributions make a difference.
24.3
We hear those individuals, almost 4,000 strong, each saying,
“I am the face of Cincinnati.” ■
11.5
5.1
0.5
Less
than
1 year
up to
5
years
up to
10
years
10 or
more
years
Product growth
Cincinnati is a regional carrier, serving local markets and
working with our agents account by account. This approach
balance sheets; and
manage their agencies
professionally. As agents
learn about Cincinnati,
they develop an
appreciation for our
approach and reward us
with a steadily increasing
share of their business.
We rank No. 1 or No. 2,
based on premium
volume, in 74 percent of
the reporting agency
locations that we have
served for more than five
years. There is
tremendous potential in the 196 reporting agency locations
that have marketed our products for less than five years,
even as we continue to grow with the 1,057 more established
reporting locations.
You’ll hear a consistent chorus of answers to these
questions as you follow these associates through the process
of getting business done to high standards:
• They have – and use – considerable authority to flexibly
respond to each situation. They take individual
responsibility for making, controlling, improving and
completing our processes.
• They have the right training to understand the big picture
as well as the close-up.
• Theirs is a team effort, empowering them to broadly define
their roles and broadly assist customers, knowing they can
draw on extensive experience and resources as needed.
has made us the
25th largest property
casualty insurer
based on net
premiums written. In
selected product
lines, it has made us
an even more
significant player. We
rank nationally
among the top
20 carriers for
commercial property,
commercial auto and
commercial casualty
insurance. We
Cincinnati’s Highest
Volume Lines
National Market Share and
Rank based on 2004 Direct
Written Premiums
(Percent)
1.7
1.5
#15
#16
1.2
#18
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achieve those ranks even though our market share in those
product lines is less than 2 percent, showing the potential that
remains as we continue to meet agent needs.
13
Putting a Personal Stamp on
‘The Process’
Behind every Cincinnati commercial
lines policy is a process involving
underwriters, raters, typists and
policy service specialists. But the last thing
Cincinnati wants agents to worry about is
“the process.”
“We want the personal touch,” said Susi Reasch, team
leader of the group serving Michigan agencies.
“Our relationship with the agent is very important.”
Supporting Reasch and the 10 other underwriters in her
group are three typists, five raters, three policy service
assistants and two Advanced Workstation Rating (AWR)
operators – specialists who work on automated policy
processing systems. Working closely with commercial lines
are associates from other Cincinnati headquarters
departments, including imaging and agency accounting.
“We all work well together,” Reasch said. “We all
understand the urgency of getting something done and getting
it right the first time.”
On a typical morning, Don Gray, an underwriter on
Reasch’s team, arrives at his desk to find e-mails from
agencies containing information he has requested to process
pending renewals. He interacts with agency staff via
telephone, too, on peak days making or receiving up to 40 calls.
He’s prompt at responding to questions, even if it’s just to let
the agency know he is researching the answer. “It’s just
courtesy,” he said. He knows the agents and customer service
14
representatives in each agency by name, and the conversation
is friendly as they exchange information.
Underwriting – or risk selection and pricing – on new
business is done in the field by the marketing representative,
but the headquarters underwriter helps set up the file. If Gray
has questions about new business, he can contact the
marketing representative or the agent. On renewal business,
Gray, who has been an underwriter for more than five years,
is responsible for underwriting the policy himself. He’ll
examine the loss history and work with the agency to make
sure the appropriate endorsements and exclusions are part of
the policy. He also takes care of requests for endorsements on
in-force policies.
Building a Better Underwriter
“It takes at least six months to train an underwriter,” said
Susi Reasch, a commercial lines team leader. Because the
agency relationship is the core Cincinnati value, underwriters
are assigned to agencies rather than to underwriting
specialties. It is each underwriter’s job to understand property,
liability, auto, inland marine, crime, umbrella and workers’
compensation coverages.
Underwriters begin training with structured classroom
sessions in Cincinnati’s own Training Center. They study
insurance coverage topics and various insurance operations
beyond underwriting: claims, loss control, machinery and
equipment, legal issues, product research and development,
and regulatory matters, among others. Specialists from inside
the company take turns teaching the topics.
“We teach relationships and negotiation and how to do a
good job with an agency,” Reasch said.
Upon graduating, new underwriters spend several months
observing and working under close supervision of a mentor.
When they have mastered the necessary skills, the
underwriters are assigned their own territories, usually smaller
ones at first. Managers are there to back up the new
underwriters as they learn.
And the learning doesn’t end after a territory is assigned.
Over time, some underwriters develop expertise in specific
areas. For example, Reasch is a crime and umbrella coverage
specialist. Besides serving her own agencies, she has
become a resource across the commercial lines department.
Associates also have numerous opportunities for
continuing education, both within the company and through
industry professional organizations. Many underwriters
continue to study throughout their careers, earning nationally
recognized designations in personal or commercial insurance
and insurance management, including the Chartered Property
Casualty Underwriter designation.
15
Above: Underwriter Don Gray
answers an agent’s question by
reviewing a policy online. Left:
Commercial North team members,
Susi Reasch, Sheryl Thacker,
Don Gray, Guynn Green and
Scott Smith, manager.
Policy service
assistants, imaging
associates, raters and
typists speed the process,
all serving as extra hands
or extra eyes. The
assistants deliver mail
and faxes; imaging
associates scan policies
into electronic files for
easy retrieval; raters
research premium
guidelines and typists or AWR operators finalize the policy.
Underwriters like Gray and Reasch draw on a variety of
reference materials, procedure guides and automated systems
to help them evaluate renewal business. Underwriting
managers and coverage area specialists – in areas such as
crime and umbrella – also are available to help.
By following established procedures, the commercial lines
team can be sure to cover every important step. Despite “the
process,” underwriters understand that flexibility and service
are key. When an agency has a request or issue, the
underwriter is able to stop and take care of it. That flexibility
is what keeps Reasch enthused about her job after 28 years.
“It’s not a factory,” she said, smiling. ■
Specialized Knowledge
Provides Sales Advantage
“Sales” is nowhere in Mike
Swiadas’ title, yet he sells
Cincinnati Insurance every day.
The machinery and equipment specialist
calls on his mechanical knowledge,
national boiler inspection certification
and insurance know-how to protect
policyholders from financial loss due to
equipment breakdown.
“After 31 years in the business,
I have a lot of information in my head,”
he noted. That helps the agent sell
the policy.
Swiadas routinely accompanies
agents, field marketing and loss control
representatives when they inspect
businesses seeking Cincinnati’s
“Thank you for the excellent description of your
coverage! This really is helpful to us in the field
selling your product. I started to work with Cincinnati
about eight months ago, and this type of response is
why you are quickly becoming my favorite carrier.”
Patrick Martell – Chittenden Insurance –
Portsmouth, New Hampshire
commercial coverage. The team inspections
help everyone better understand risks.
“It’s how we serve our clients,”
Swiadas said. “We all work together.”
Swiadas is certified by the National
Board of Boiler and Pressure Vessel
Inspectors. That means he has passed a
rigorous exam and continuing education
requirements. He also continues his
informal education, responding to equipment breakdown
claims and visiting agencies. Swiadas is an underwriter, too,
with authority to underwrite machinery risks.
“Cincinnati is a full-service insurance company,” explained
Duane Cantrell, field supervisor. “We want it to be easy to do
business with us.”
Underwriter Charles Harrison and Machinery & Equipment Specialist Mike Swiadas
discuss boiler coverage.
Cincinnati’s expertise in loss control and machinery and
equipment creates a key competitive advantage. Agents don’t
need a specialty carrier to cover boilers, turbines and other
equipment; Cincinnati can cover them. ■
16
A Relationship
Built to
Last a Lifetime
When a client chooses a Cincinnati Life insurance
policy, it’s the beginning of a relationship that can
last 60 years or more. Trust is vital.
“We understand we are helping a family or providing
business continuity,” said Mark McPheron, life underwriting
superintendent.
McPheron and his staff go into action when they receive
applications from independent agents. They check application
information and study medical exams to make sure the
applicant is a suitable candidate for life insurance.
Technology innovations, including LifePro® and imaging
software and an
electronic
workflow system,
collect
information in
one convenient
electronic file.
Underwriters and
policy issue
specialists have
easy access.
After the policy is issued, the Life Policy Service team
takes over. They handle transactions over the life of the
policy, including address changes, beneficiary changes,
loans, terminations or reinstatements, term expirations and
benefit changes.
Service representatives work with policyholders or through
an agent “once the policy has been released,” explained
Amanda Bowers, lead customer service representative.
When a policyholder dies, Ann Binzer’s life claims team
“Thanks for your prompt attention. I’m not sure the insured will ever appreciate
what it took for you to make this happen. I got a panicked call on Tuesday
saying that the bank needed a copy of the life insurance policy in order to
close. ‘That’s OK.’I told her. ‘The company overnighted the policies, can I bring
them out now?’Having the policies that fast really made our agency, your staff
and the company look great.”
Jamie Purmort – Purmort & Martin Insurance Agency – Sarasota, Florida
works to pay the claim. A processor gathers information from
the beneficiary to verify coverage and issue the check.
Currently, most claims are processed on paper, but in 2006,
the department expects to join the Claims Management
System. The goal is to have all claims files imaged to make
them more easily accessible.
Relatives often find policies long after a death. But
sometimes a call comes while grief is still fresh. The team is
trained to handle it.
“When a loved one dies, it’s a difficult
time,” said Binzer, manager of the
16-member Life & Health Claims
department. “We do what needs to
be done to get the claim paid.” ■
Above: Marsha Houston
and Amanda Bowers,
lead customer service
representatives.
Right: Underwriter Mark
McPheron with trainees
Teresa Rose and Kristy
Rumley and Stephanie
Johnson, policy issue
specialist.
Far right: Ann Binzer,
manager of Life &
Health Claims.
Communication,
Consistency,
Cooperation
Pieter Kes works from an office in his
home, like all of the 751 Cincinnati
claims associates who work in the
field. This allows him the flexibility to serve
agency customers and policyholders around
Birmingham, Alabama, promptly and on a
schedule that meets their needs.
The day after Hurricane Katrina hit the Gulf Coast and
spread destruction northward into his area, Kes already was in
action. He inspected eight properties that first day, making
sure they were secured.
“By responding quickly, we can help people avoid further
damage,” Kes said. “That helps policyholders, and it helps
our company, too.”
Cincinnati’s catastrophe response teams soon joined Kes,
helping him maintain quality service not only on storm
claims, but also on other claims.
Catastrophe response teams closed 77 percent of the
Katrina claims within eight weeks. Cincinnati’s automated
Claims Management System eased the process. Because
claims files now are electronic, emergency teams could easily
check the status on claims and move them toward resolution.
In addition to claims service, Kes also provides another set
of eyes in his territory. If he sees something an agent or
underwriter should know about – positive or negative – he
files a risk report. For example, while working on a claim, he
noticed vines growing across the entryway steps, creating a
potential hazard – and a potential liability. Kes wrote a risk
report that was shared with the agency and various Cincinnati
18
Above: Karen Gray, Bob Bernard and
Birdie McCane each play a role in
Diamond’s success. Right: Alabama
underwriting team – Bill Rizzo, Pat
Buchman, Tim Wright, Rob Treinen
and Carrie McKitrick.
associates. The agent
alerted the property owner
and the problem was fixed.
Pat Buchman routinely
sees such reports. As a
personal lines underwriter
in Cincinnati’s
headquarters, Buchman
flags items for review
when an Alabama policy
comes up for renewal.
It’s his job to make sure risks are correctly identified and
the appropriate premium charged. That diligence helps
get policyholders the right coverage and helps agencies
stay profitable.
“We like the involvement of the field claims
representatives,” said underwriting manager Tim Wright.
In underwriting and issuing a renewal policy through the
automated Diamond policy production system, the agent
might not get to see details of a home’s condition. But the
field claims representative does, allowing the Cincinnati team
to supply the agent with better information.
Another place where Buchman and Wright add value is
through detailed analysis of agency business. Every year,
Buchman reviews his assigned agencies and works with them
to improve the business they write. When he makes his
agency visits, there are no surprises. The key, he said, is to
“stick to the three C’s: communication, consistency and
cooperation.”
“It takes time to build that relationship up,” Wright said.
Communication makes it easier for Cincinnati to be flexible
when an agent asks for an accommodation on a hard-to-write
piece of business. With research and careful use of credits and
deductibles, underwriters can accept business that may not
precisely fit the guidelines, but that still will be profitable.
“Our philosophy is to try to find a way to write the
business,” Wright said. ■
When Storms Hit,
Cincinnati Claims Teams Shine
Before low pressure systems formed in the tropics...before
the 2005 hurricanes churned in the ocean...long before
“Katrina” was a household word, David Rice and his Cincinnati
field claims associates were planning for the worst while hoping
for the best.
Every December, Rice, manager of Cincinnati’s catastrophe
response teams, assembles a list of more than 400 volunteers
for “on call” duty throughout the upcoming year. When a
catastrophe such as a hurricane or tornado generates enough
claims to strain local operations, Rice quickly sends help.
Each team includes 10 claims representatives from across
Cincinnati’s
territories.
Although storm
duty can mean
12-hour days
away from
home for
weeks,
recruiting is not
difficult.
“People
want to help,”
Rice said.
Field Claims officers David Rice and Bud Stoneburner.
Below: Field Claims associates load a trailer with supplies
needed to respond to catastrophe claims.
“There’s a great deal of personal satisfaction going into a
catastrophe situation and making things better.”
Back at home, it’s business as usual. Associates cover for
storm volunteers. If the claims volume requires an extended
storm team presence, teams are rotated in and out until the
local staff finds the caseload manageable. The Claims
Management System makes it easy to reassign claims and for
all parties to track activity electronically.
Just as with normal claims operations, field claims
associates on catastrophe duty are committed to providing
prompt, personal and fair service.
“On storm duty, we do what we normally do,” Rice said.
“We just do more, and we do it faster and under very unusual
circumstances.”
19
Flexibility in the Field
It’s an awesome responsibility, yet a point of great pride.
“I am the face of Cincinnati to the agencies; the field
marketing representative is the person they turn to for
complaints and for praise,” explained Glenn Wernke, field
director in a Cincinnati sales territory that serves 13 agencies
around Indianapolis.
Unlike marketing representatives from most other
insurance companies, Wernke has the authority to decide
about new business himself. He estimates 90 percent of his
time is spent quoting and underwriting commercial lines
business. After 20 years in insurance, “I have a pretty good
idea of what’s a good risk and what’s a bad risk,” he said.
Wernke visits his assigned agencies regularly, ready to
look at new business and give approvals or request more
information. “I try to quote the business right in their office, if
possible,” he said.
Cincinnati’s underwriting philosophy has always allowed
the field representative the flexibility to look at an excellent
risk in a good agency, even if it’s in a tough class of business.
“That sets us apart from the rest,” Wernke said. “No other
company gives that kind of flexibility.”
Wernke doesn’t work alone, however, and knows he can
call on field or headquarters team members for support,
whether it’s discussing an underwriting issue with a
commercial lines team member or working with the loss
control department to answer an agency question.
Cincinnati’s machinery and equipment and loss control
representatives also are based in the local communities.
Wernke added that agents appreciate having these experts on
hand to perform inspections and recommend specific actions
to improve the safety of a policyholder’s operations and the
quality of the agent’s insurance account.
The headquarters sales management team – all of whom
have underwriting and field marketing experience – also are
available to pitch in. “Our primary role is to support Glenn in
the field,” said Bill Clevidence, Wernke’s headquarters
manager. “We work with Glenn to help perpetuate the
agencies he serves and help improve their financial health.”
Recent technology advances have allowed Wernke to
submit quotes electronically, spending less time on paperwork
and more time in his customers’ offices. While the technology
is a nice benefit, it’s not usually what keeps an agency in the
Cincinnati family.
“The agencies who have
us wouldn’t give us up,”
Wernke said. “We care.
To them, the heart is
more important than the
tools.” ■
Left to right: Members of Cincinnati’s
Indianapolis field team: Allen Wilson,
Tim McCord, Glenn Wernke,
Tom Murray and Danny Nickleson.
20
Cincinnati Financial Corporation Directors and Officers
Directors (as of March 10, 2006)
William F. Bahl, CFA
Chairman
Bahl & Gaynor Investment Counsel, Inc.
Director since 1995 (1)(3)(4)(5*)
James E. Benoski
Vice Chairman and Chief Insurance Officer
Cincinnati Financial Corporation
Director since 2000 (3)(4)
Michael Brown
President
Cincinnati Bengals, Inc.
Director since 1980 (3)
Dirk J. Debbink
President
MSI General Corporation
Director since 2004 (1)
Kenneth C. Lichtendahl
President and Chief Executive Officer
Tradewinds Beverage Company
Director since 1988 (1*)(2)(5)
W. Rodney McMullen
Vice Chairman
The Kroger Co.
Director since 2001(2*)(4)
Gretchen W. Price
Vice President – Finance & Accounting
Global Operations
Procter & Gamble
Director since 2002 (1)(2)
John J. Schiff, Jr., CPCU
Chairman, President and Chief Executive Officer
Cincinnati Financial Corporation
Director since 1968 (3*)(4*)
Thomas R. Schiff
Chairman and Chief Executive Officer
John J. & Thomas R. Schiff & Co., Inc.
(insurance agency)
Director since 1975 (4)
John M. Shepherd
Chairman and Chief Executive Officer
The Shepherd Chemical Company
Director since 2001 (3)(5)
Douglas S. Skidmore
President and Chief Executive Officer
Skidmore Sales & Distributing Company, Inc.
Director since 2004 (1)
John F. Steele, Jr.
Chairman and Chief Executive Officer
Hilltop Basic Resources, Inc.
Director since 2005 (1)
Larry R. Webb, CPCU
President
Webb Insurance Agency, Inc.
Director since 1979 (3)
E. Anthony Woods
Chairman
Deaconess Associations, Inc.
Director since 1998 (2)(4)
* Committee Chair
(1) Audit Committee
(2) Compensation Committee; also
Lawrence H. Rogers II, adviser
(3) Executive Committee
(4) Investment Committee; also
Richard M. Burridge, CFA, adviser
(5) Nominating Committee
W.F. Bahl
J.E. Benoski
M. Brown
D.J. Debbink
K.C. Lichtendahl
W.R. McMullen
G.W. Price
J.J. Schiff, Jr.
Officers (as of March 10, 2006)
John J. Schiff, Jr., CPCU
Chairman, President and Chief Executive Officer
James E. Benoski
Vice Chairman and Chief Insurance Officer
Kenneth W. Stecher
Chief Financial Officer and Senior Vice President,
Secretary, Treasurer
Kenneth S. Miller, CLU, ChFC
Chief Investment Officer and Senior Vice President,
Assistant Secretary, Assistant Treasurer
Eric N. Mathews, CPCU, AIAF
Vice President, Assistant Secretary,
Assistant Treasurer
T.R. Schiff
J.M. Shepherd
D.S. Skidmore
J.F. Steele, Jr.
Directors Emeriti
Vincent H. Beckman
Robert J. Driehaus
John E. Field, CPCU
Jackson H. Randolph
Lawrence H. Rogers II
John Sawyer
Robert C. Schiff
Frank J. Schultheis
David B. Sharrock
Thomas J. Smart
Alan R. Weiler, CPCU
William H. Zimmer
L.R. Webb
E.A. Woods
21
Definitions of Non-GAAP Information and
Reconciliation to Comparable GAAP Measures
Cincinnati Financial Corporation prepares its public financial
statements in conformity with accounting principles generally
accepted in the United States of America (GAAP). Statutory data is
prepared in accordance with statutory accounting rules as defined by
the National Association of Insurance Commissioners’ (NAIC)
Accounting Practices and Procedures Manual and, therefore, is not
reconciled to GAAP data.
Management uses certain non-GAAP and non-statutory financial
measures to evaluate its primary business areas – property casualty
insurance, life insurance and investments – when analyzing both
GAAP and certain non-GAAP measures may improve understanding
of trends in the underlying business, helping avoid incorrect or
misleading assumptions and conclusions about the success or failure
of company strategies. Management adjustments to GAAP measures
generally: apply to non-recurring events that are unrelated to
business performance and distort short-term results; involve values
that fluctuate based on events outside of management’s control; or
relate to accounting refinements that affect comparability between
periods, creating a need to analyze data on the same basis.
• Net income before realized investment gains and losses: Net
income before realized investment gains and losses (readers also
may have seen this measure defined as operating income) is
calculated by excluding net realized investment gains and losses
from net income. Management evaluates net income before
realized investment gains and losses to measure the success of
pricing, rate and underwriting strategies. While realized
investment gains (or losses) are integral to the company’s
insurance operations over the long term, the determination to
realize investment gains or losses in any period may be subject to
management’s discretion and is independent of the insurance
underwriting process. Also, under applicable GAAP accounting
requirements, gains and losses can be recognized from certain
changes in market values of securities and embedded derivatives
without actual realization. Management believes that the level of
realized investment gains or losses for any particular period, while
it may be material, may not fully indicate the performance of
ongoing underlying business operations in that period.
For these reasons, many investors and shareholders consider net
income before realized investment gains and losses to be one of
the more meaningful measures for evaluating insurance company
performance. Equity analysts who report on the insurance industry
and the company generally focus on this metric in their analyses.
The company presents net income before realized investment gains
and losses so that all investors have what management believes to
be a useful supplement to GAAP information.
• Statutory accounting rules: For public reporting, insurance
companies prepare financial statements in accordance with GAAP.
However, insurers also must calculate certain data according to
statutory accounting rules as defined in the NAIC’s Accounting
Practices and Procedures Manual, which may be, and has been,
modified by various state insurance departments. Statutory data is
22
publicly available, and various organizations use it to calculate
aggregate industry data, study industry trends and compare
insurance companies.
• Written premium: Under statutory accounting rules, property
casualty written premium is the amount recorded for policies
issued and recognized on an annualized basis at the effective date
of the policy. Management analyzes trends in written premium to
assess business efforts. Earned premium, used in both statutory
and GAAP accounting, is calculated ratably over the policy term.
The difference between written and earned premium is
unearned premium.
• Written premium adjustment – statutory basis only: In 2002, the
company refined its estimation process for matching property
casualty written premiums to policy effective dates, which added
$117 million to 2002 written premiums. To better assess ongoing
business trends, management may exclude this adjustment when
analyzing trends in written premiums and statutory ratios that
make use of written premiums.
• Codification: Adoption of Codification of Statutory Accounting
Principles was required for Ohio-based insurance companies
effective January 1, 2001. The adoption of Codification changed
the manner in which the company recognized statutory property
casualty written premiums. As a result, 2001 statutory written
premiums included $402 million to account for unbooked
premiums related to policies with effective dates prior to
January 1, 2001. To better assess ongoing business trends,
management excludes this $402 million when analyzing written
premiums and statutory ratios that make use of written premiums.
• Life insurance gross written premiums: In analyzing the life
insurance company’s gross written premiums, management
excludes five larger, single-pay life insurance policies
(bank-owned life insurance or BOLIs) written in 2004, 2002, 2000
and 1999 to focus on the trend in premiums written through the
independent agency distribution channel.
• One-time charges or adjustments: Management analyzes earnings
and profitability excluding the impact of one-time items.
* In 2003, as the result of a settlement negotiated with a vendor,
pretax results included the recovery of $23 million of the
$39 million one-time, pretax charge incurred in 2000.
* In 2000, the company recorded a one-time charge of
$39 million, pre-tax, to write down previously capitalized costs
related to the development of software to process property
casualty policies.
* In 2000, the company earned $5 million in interest in the first
quarter from a $303 million single-premium BOLI policy that
was booked at the end of 1999 and segregated as a separate
account effective April 1, 2000. Investment income and realized
investment gains and losses from separate accounts generally
accrue directly to the contract holder and, therefore, are not
included in the company’s consolidated financials.
Reconciliation of Consolidated Financial Data
Cincinnati Financial Corporation and Subsidiaries
(Dollars in millions except per share data)
Income Statement Data
Net income . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
One-time items . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Net income before one-time items . . . . . . . . . . . . . . . . .
Net realized investment gains and losses . . . . . . . . . . . . . .
Net income before realized investment gains
and losses, before one-time items . . . . . . . . . . . . . . . . .
Per Share Data (diluted)
Net income . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
One-time items . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Net income before one-time items . . . . . . . . . . . . . . . . . . .
Net realized investment gains and losses . . . . . . . . . . . . . .
Net income before realized investment gains
and losses, before one-time items . . . . . . . . . . . . . . . . .
Return on Average Equity
Return on average equity . . . . . . . . . . . . . . . . . . . . . . . . . .
One-time items . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Return on average equity before one-time items . . . . . . . .
Return on Average Equity Based on Comprehensive Income
ROE based on comprehensive income . . . . . . . . . . . . . . .
One-time items . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
ROE based on comprehensive income before
one-time items . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Investment Income
2005
2004
2003
2002
2001
2000
Years ended December 31,
$
__________
602
–
602
40
$
__________
584
–
584
60
$
__________
374
15
359
(27)
$
__________
238
–
238
(62)
193
–
193
(17)
__________
__________
__________
__________
__________ __________
$
__________ __________
$
118
(25)
143
(2)
$
__________
__________
562
$
__________
__________
524
$
__________
__________
386
$
__________
__________
300
$
__________ __________
__________ __________
210
145
$
$
__________
3.40
–
3.40
0.23
$
__________
3.28
–
3.28
0.34
__________
__________
$
__________
2.10
0.09
2.01
(0.15)
__________
$
__________
1.32
–
1.32
(0.35)
__________
1.07
–
1.07
(0.10)
$
__________ __________
$
0.67
(0.14)
0.81
(0.01)
__________ __________
$
__________
__________
3.17
$
__________
__________
2.94
$
__________
__________
2.16
$
__________
__________
1.67
$
__________ __________
__________ __________
1.17
0.82
$
9.8%
–
__________
9.8%
__________
__________
9.4%
–
__________
9.4%
__________
__________
6.3%
(0.3)
__________
6.0%
__________
__________
4.1%
–
__________
4.1%
__________
__________
2.1%
0.4
__________ __________
2.5%
__________ __________
__________ __________
3.2%
–
3.2%
1.6%
–
__________
4.6%
–
__________
13.8%
(0.3)
__________
(4.0)%
–
__________
13.1%
0.4
__________ __________
2.5%
–
1.6%
__________
__________
4.6%
__________
__________
13.5%
__________
__________
(4.0)%
__________
__________
13.5%
__________ __________
__________ __________
2.5%
Investment income, net of expenses . . . . . . . . . . . . . . . . .
Bank-owned life insurance (BOLI) . . . . . . . . . . . . . . . . . .
Investment income, net of expenses, before BOLI . . . . . .
$
__________
$
__________
__________
526
–
526
$
__________
$
__________
__________
492
–
492
$
__________
$
__________
__________
465
–
465
$
__________
$
__________
__________
445
–
445
Reconciliation of Property Casualty Insurance Data (Statutory)(1)
$
$
__________ __________
$
__________ __________
__________ __________
415
(5)
410
421
–
421
$
Cincinnati Insurance Property Casualty Group
(Dollars in millions)
Premiums(1)
Written premiums (adjusted) . . . . . . . . . . . . . . . . . . . . . . .
Codification(2) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Written premiums adjustment(2) . . . . . . . . . . . . . . . . . . . .
Written premiums (reported)(2) . . . . . . . . . . . . . . . . . . . . .
Unearned premiums change . . . . . . . . . . . . . . . . . . . . . . . .
Earned premiums (GAAP) . . . . . . . . . . . . . . . . . . . . . . . . .
Year-over-year Growth Rate(1)
Written premiums (adjusted)(2) . . . . . . . . . . . . . . . . . . . . .
Written premiums (reported)(2) . . . . . . . . . . . . . . . . . . . . .
Earned premiums . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Combined Ratio(1)
2005
2004
2003
2002
2001
2000
Years ended December 31,
$ 3,097
–
(21)
__________
3,076
(18)
__________
$ 3,058
__________
__________
$ 3,026
–
(29)
__________
2,997
(78)
__________
$ 2,919
__________
__________
$ 2,789
–
26
__________
2,815
(162)
__________
$ 2,653
__________
__________
$ 2,496
–
117
__________
2,613
(222)
__________
$ 2,391
__________
__________
__________ __________
$ 2,188
402
–
2,590
(517)
__________ __________
$ 2,073
__________ __________
__________ __________
$ 1,936
(55)
–
1,881
(53)
$ 1,828
2.3%
2.6
4.8
8.5%
6.5
10.0
11.7%
7.7
10.9
14.0%
0.9
15.4
13.0%
37.7
13.3
15.2%
11.9
10.3
Combined ratio (reported) . . . . . . . . . . . . . . . . . . . . . . . . .
Codification(2) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Written premium adjustment
. . . . . . . . . . . . . . . . . . . . . .
One-time items . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Combined ratio (adjusted) . . . . . . . . . . . . . . . . . . . . . . . . .
Catastrophe losses . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Combined ratio excluding catastrophe losses (adjusted) . .
__________
89.0%
–
nm
–
89.0
(4.1)
__________
84.9%
__________
__________
__________
89.4%
–
nm
–
89.4
(5.1)
__________
84.3%
__________
__________
__________
94.2%
–
nm
0.8
95.0
(3.6)
__________
91.4%
__________
__________
__________
98.4%
–
1.2
–
99.6
(3.6)
__________
96.0%
__________
__________
__________ __________
112.5%
(0.9)
–
(1.7)
109.9
(2.7)
__________ __________
107.2%
__________ __________
__________ __________
99.5%
4.1
–
–
103.6
(3.1)
100.5%
Dollar amounts shown are rounded to millions; certain amounts may not add due to rounding. Ratios are calculated based on whole dollar amounts.
nm - not meaningful
1 Statutory data prepared in accordance with statutory accounting rules as defined by the National Association of Insurance Commissioners and filed with the appropriate
regulatory bodies.
2 Prior to 2001, property casualty written premiums were recognized as they were billed throughout the policy period. Effective January 1, 2001, written premiums have been recognized
on an annualized basis at the effective date of the policy. Written premiums for 2000 were reclassified to conform with the 2001 presentation; information was not readily available to
reclassify earlier year statutory data. The growth rates in written premiums between 1999 and 2000 are overstated because 1999 premiums were calculated on a billed basis.
23
Reconciliation of Commercial Lines Property Casualty Insurance Data (Statutory)(1)
Cincinnati Insurance Property Casualty Group
(Dollars in millions)
Premiums(1)
Written premiums (adjusted) . . . . . . . . . . . . . . . . . . . . . . .
Codification(2) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Written premiums adjustment(2) . . . . . . . . . . . . . . . . . . . . . .
Written premiums (reported)(2) . . . . . . . . . . . . . . . . . . . . .
Unearned premiums change . . . . . . . . . . . . . . . . . . . . . . . .
Earned premiums (GAAP) . . . . . . . . . . . . . . . . . . . . . . . . .
Year-over-year Growth Rate(1)
Written premiums (adjusted)(2) . . . . . . . . . . . . . . . . . . . . .
Written premiums (reported)(2) . . . . . . . . . . . . . . . . . . . . .
Earned premiums . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Combined Ratio(1)
2005
2004
2003
2002
2001
2000
Years ended December 31,
$ 2,306
–
(16)
__________
2,290
(36)
__________
$ 2,254
__________
__________
$ 2,209
–
(23)
__________
2,186
(60)
__________
$ 2,126
__________
__________
$ 2,009
–
22
__________
2,031
(123)
__________
$ 1,908
__________
__________
$ 1,795
–
110
__________
1,905
(184)
__________
$ 1,721
__________
__________
__________ __________
$ 1,551
276
–
1,827
(374)
__________ __________
$ 1,453
__________ __________
__________ __________
$ 1,326
(51)
–
1,275
(43)
$ 1,232
4.4%
4.7
6.0
10.0%
7.6
11.4
11.9%
6.6
10.8
15.8%
4.2
18.6
16.9%
43.3
17.9
20.5%
15.9
13.2
Combined ratio (reported) . . . . . . . . . . . . . . . . . . . . . . . . .
Codification(2) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Written premium adjustment
. . . . . . . . . . . . . . . . . . . . . .
One-time items . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Combined ratio (adjusted) . . . . . . . . . . . . . . . . . . . . . . . . .
Catastrophe losses . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Combined ratio excluding catastrophe losses (adjusted) . .
__________
87.1%
–
nm
–
87.1
(3.4)
__________
83.7%
__________
__________
__________
83.7%
–
nm
–
83.7
(3.4)
__________
80.3%
__________
__________
__________
90.9%
–
nm
0.7
91.6
(2.2)
__________
89.4%
__________
__________
__________
95.3%
–
1.5
–
96.8
(2.3)
__________
94.5%
__________
__________
Reconciliation of Personal Lines Property Casualty Insurance Data (Statutory)(1)
__________ __________
117.2%
(1.2)
–
(1.6)
114.4
(1.5)
__________ __________
112.9%
__________ __________
__________ __________
96.7%
4.0
–
–
100.7
(1.9)
98.8%
Cincinnati Insurance Property Casualty Group
(Dollars in millions)
Premiums(1)
Written premiums (adjusted) . . . . . . . . . . . . . . . . . . . . . . .
Codification(2) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Written premiums adjustment(2) . . . . . . . . . . . . . . . . . . . .
Written premiums (reported)(2) . . . . . . . . . . . . . . . . . . . . .
Unearned premiums change . . . . . . . . . . . . . . . . . . . . . . . .
Earned premiums (GAAP) . . . . . . . . . . . . . . . . . . . . . . . . .
Year-over-year Growth Rate(1)
2005
2004
2003
2002
2001
2000
Years ended December 31,
$
$
$
$
$
$
__________
__________
__________
__________
__________ __________
817
–
(6)
811
(18)
793
780
–
4
784
(39)
745
701
–
7
708
(38)
670
637
126
–
763
(143)
620
610
(4)
–
606
(10)
596
__________
$
__________
__________
__________
$
__________
__________
__________
$
__________
__________
__________
$
__________
__________
__________ __________
$
__________ __________
__________ __________
$
791
–
(5)
786
18
804
Written premiums (adjusted)(2) . . . . . . . . . . . . . . . . . . . . .
Written premiums (reported)(2) . . . . . . . . . . . . . . . . . . . . .
Earned premiums . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
(3.2)%
(3.0)
1.4
4.7%
3.4
6.4
12.0%
10.8
11.2
9.8%
(7.2)
8.1
4.6%
26.1
4.0
5.0%
4.3
4.6
Combined Ratio(1)
Combined ratio (reported) . . . . . . . . . . . . . . . . . . . . . . . . .
Codification(2) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Written premium adjustment
. . . . . . . . . . . . . . . . . . . . . .
One-time items . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Combined ratio (adjusted) . . . . . . . . . . . . . . . . . . . . . . . . .
Catastrophe losses . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Combined ratio excluding catastrophe losses (adjusted) . . .
__________
94.3%
–
nm
–
94.3
(6.3)
__________
88.0 %
__________
__________
104.6%
–
nm
–
__________
104.6
(9.7)
__________
94.9%
__________
__________
102.9%
–
nm
1.0
__________
103.9
(7.3)
__________
96.6%
__________
__________
106.5%
–
0.3
–
__________
106.8
(7.1)
__________
99.7%
__________
__________
__________ __________
110.6%
(0.2)
–
(2.0)
108.4
(5.4)
__________ __________
103.0%
__________ __________
__________ __________
105.9%
4.6
–
–
110.5
(5.8)
104.7%
Reconciliation of Life Insurance Company Data (Statutory)(1)
The Cincinnati Life Insurance Company
(Dollars in millions)
2005
2004
2003
2002
2001
2000
Years ended December 31,
Gross written premiums (reported) . . . . . . . . . . . . . . . . . . . .
Bank-owned life insurance (BOLI) adjustment . . . . . . . . . . .
Gross written premiums (adjusted) . . . . . . . . . . . . . . . . . . . .
$
__________
$
__________
__________
249
–
249
$
__________
$
__________
__________
230
(10)
220
$
__________
$
__________
__________
173
–
173
$
__________
$
__________
__________
244
(34)
210
$
$
__________ __________
$
__________ __________
__________ __________
157
(20)
137
122
–
122
$
Dollar amounts shown are rounded to millions; certain amounts may not add due to rounding. Ratios are calculated based on whole dollar amounts.
nm - Not meaningful
1 Statutory data prepared in accordance with statutory accounting rules as defined by the National Association of Insurance Commissioners and filed with the appropriate
regulatory bodies.
2 Prior to 2001, property casualty written premiums were recognized as they were billed throughout the policy period. Effective January 1, 2001, written premiums have been recognized
on an annualized basis at the effective date of the policy. Written premiums for 2000 were reclassified to conform with the 2001 presentation; information was not readily available to
reclassify earlier year statutory data. The growth rates in written premiums between 1999 and 2000 are overstated because 1999 premiums were calculated on a billed basis.
24
Cincinnati Financial
A
T
I
O
N
O
R
O
R
C
P
2005 Annual Report
on Form 10-K
Table of Contents
Part I
Item 1
Item 1A
Item 1B
Item 2
Item 3
Item 4
Part II
Item 5
Item 6
Item 7
Item 7A
Item 8
10-K Page
Business . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1
Risk Factors . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 21
Unresolved Staff Comments . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 25
Properties . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 26
Legal Proceedings . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 26
Submission of Matters to a Vote of Security Holders . . . . . . . . . . . . . . . . . . . . . . . . 26
Market for the Registrant's Common Equity, Related Stockholder
Matters and Issuer Purchases of Equity Securities . . . . . . . . . . . . . . . . . . . . . . . 27
Selected Financial Data . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 28
Management's Discussion and Analysis of Financial Condition
and Results of Operations . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 31
Quantitative and Qualitative Disclosures About Market Risk . . . . . . . . . . . . . . . . . . . 70
Financial Statements and Supplementary Data . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 77
Includes:
Responsibility for Financial Statements . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 77
Management's Annual Report on Internal Control Over Financial Reporting . . . . 78
Report of Independent Registered Public Accounting Firm . . . . . . . . . . . . . . . . . 79
Item 9
Changes in and Disagreements with Accountants on Accounting
Item 9A
Item 9B
Part III
Item 10
Item 11
Item 12
Item 13
Item 14
Part IV
Item 15
and Financial Disclosure . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 100
Controls and Procedures . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 100
Other Information . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 100
Directors and Executive Officers of the Registrant . . . . . . . . . . . . . . . . . . . . . . . . . 100
Executive Compensation . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 100
Security Ownership of Certain Beneficial Owners and Management
and Related Stockholder Matters . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 101
Certain Relationships and Related Transactions . . . . . . . . . . . . . . . . . . . . . . . . . . . 101
Principal Accountant Fees and Services . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 101
Exhibits and Financial Statement Schedules . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 101
Item 1.
Business
Part I
CINCINNATI FINANCIAL CORPORATION – INTRODUCTION
We are an Ohio corporation formed in 1968. Through our subsidiaries, we have been in business since 1950,
marketing commercial, personal and life insurance through independent insurance agencies to businesses and
individuals. Our headquarters is in Fairfield, Ohio. At year-end 2005, we had 3,983 associates, with
approximately 2,800 headquarters associates providing support to approximately 1,150 field associates.
Cincinnati Financial Corporation (CFC) owns 100 percent of three subsidiaries: The Cincinnati Insurance
Company, CFC Investment Company and CinFin Capital Management Company. The Cincinnati Insurance
Company owns 100 percent of our three smaller insurance subsidiaries: The Cincinnati Casualty Company,
The Cincinnati Indemnity Company and The Cincinnati Life Insurance Company.
The Cincinnati Insurance Company, founded in 1950, leads the property casualty group known as
The Cincinnati Insurance Companies. The Cincinnati Casualty Company and The Cincinnati Indemnity Company
round out the property casualty insurance group, providing flexibility in pricing and underwriting while ceding
substantially all of their business to The Cincinnati Insurance Company. The Cincinnati Life Insurance Company
primarily markets life insurance and annuities. CFC Investment Company complements the insurance
subsidiaries with leasing and financing services. CinFin Capital Management Company provides asset
management services to institutions, corporations and high net worth individuals.
Our filings with the Securities and Exchange Commission (SEC) are available, free of charge, on our Web site,
www.cinfin.com, as soon as possible after they have been filed with the SEC. These filings include our annual
reports on Form 10-K, our quarterly reports on Form 10-Q, current reports on Form 8-K, and amendments to
those reports filed or furnished pursuant to Section 13(a) or 15(d) of the Securities Exchange Act of 1934. In
the following pages we reference various Web sites. These Web sites, including our own, are not incorporated
by reference in this Annual Report on Form 10-K.
Periodically, we refer to estimated industry data so that we can give information about our performance versus
the overall insurance industry. Unless otherwise noted, the industry data is prepared by A.M. Best Co., a leading
insurance industry statistical, analytical and financial strength rating organization. Information from A.M. Best
is presented on a statutory basis. When we provide our results on a comparable statutory basis, we label it as
such; all other company data is presented in accordance with accounting principles generally accepted in the
United States of America (GAAP) .
OUR BUSINESS AND OUR STRATEGY
INTRODUCTION
Our company was founded more than 50 years ago by independent agents to support the ability of local
independent property casualty insurance agents to deliver quality financial protection to people and businesses
in their communities. Today, we operate much the same way, actively marketing commercial insurance policies
in 32 states through a select group of independent insurance agencies. We actively market all of our personal
lines insurance policies in 22 of those states. We seek to become the life insurance carrier of choice for the
agencies that market our property casualty insurance products and offer other financial services to help agents
and their clients – the policyholders.
Our company distinguishes itself in three ways:
• We cultivate relationships with the independent insurance agents who market our policies and we make
our decisions at the local level
• We achieve claims excellence, covering the spectrum from our response to reported claims to our
approach to establishing reserves for not-yet-paid claims
• We invest for long-term total return, using available cash flow to purchase equity securities after covering
insurance liabilities by purchasing fixed-maturity securities
CULTIVATING RELATIONSHIPS WITH INDEPENDENT INSURANCE AGENTS
The U.S. property casualty insurance industry is a highly competitive marketplace with approximately
3,100 stock and mutual companies operating independently or in groups. No single company or group
dominates across all product lines and states. Insurance companies (carriers) can market a broad array of
products nationally or:
•
•
choose to sell a limited product line or only one type of insurance (monoline carrier)
target a certain segment of the market (for example, personal insurance)
2005 10-K Page 1
focus on one or more states or regions (regional carrier)
•
Property casualty insurers generally market their products through one or more distribution channels:
•
•
independent agents, who represent multiple carriers,
captive agents, who represent one carrier exclusively, or
• direct marketing through the mail or Internet
Some carriers use more than one channel. For the most part, we compete with insurance companies that
market through independent insurance agents.
Independent Agency Distribution System
We are committed to the independent agency distribution system, offering a broad array of commercial,
personal and life insurance products through this channel. We recognize that locally based independent
agencies have relationships in their communities that can lead to policyholder satisfaction, loyalty and
profitable business. Our field associates provide service and accountability to the agencies, living in the
communities they serve and working from offices in their homes, providing 24/7 availability to our agents.
At year-end 2005, our 1,024 agency relationships had 1,253 reporting agency locations marketing our
insurance products. An increasing number of agencies have multiple, separately identifiable locations,
reflecting their growth and consolidation of ownership within the independent agency marketplace. We believe
“reporting agency locations,” a new measure for our company, accurately describes our agents’ scope of
business and our presence within our 32 active states. At year-end 2004, we had 986 agency relationships
with 1,213 reporting agency locations. At year-end 2003, we had 957 agency relationships with
1,185 reporting agency locations. In addition to providing data on reporting agency locations, we continue to
give agency relationships metrics, such as our penetration within each agency relationship.
Property Casualty Agency Earned Premiums by State
In our 10 highest volume states, 853 reporting agency locations wrote 71.1 percent of our 2005 total property
casualty agency earned premium volume. Agency earned premiums are premiums before reinsurance.
(Dollars in millions)
Year ended December 31, 2005
Ohio
Illinois
Indiana
Pennsylvania
Michigan
Georgia
Virginia
North Carolina
Wisconsin
Kentucky
All other states
Total
Year ended December 31, 2004
Ohio
Illinois
Indiana
Pennsylvania
Michigan
Georgia
Virginia
Wisconsin
North Carolina
Kentucky
All other states
Total
Earned
premium
Percent
of total
Change %
Reporting
agency locations
Avg premium
per location
$
$
$
$
737
299
238
192
173
141
134
130
125
102
923
3,194
722
294
235
177
175
129
127
118
117
97
849
3,040
23.1 %
9.4
7.4
6.0
5.4
4.4
4.2
4.1
3.9
3.2
28.9
100.0 %
23.7 %
9.7
7.7
5.8
5.8
4.2
4.2
3.9
3.9
3.2
27.9
100.0 %
2.2
1.7
0.9
8.0
(1.2)
9.5
4.8
10.7
6.4
5.0
8.9
5.1
7.1
7.7
5.5
14.8
12.2
10.1
12.8
10.4
15.8
10.3
14.9
10.8
224 $
112
99
63
88
59
53
68
49
38
400
1,253
224 $
113
96
63
83
56
51
49
66
35
377
1,213
3.3
2.7
2.4
3.0
2.0
2.4
2.5
1.9
2.6
2.7
2.3
2.5
3.2
2.6
2.5
2.8
2.1
2.3
2.5
2.4
1.8
2.8
2.2
2.5
In 2004, the most recent period for which data is available, Cincinnati Insurance was the No. 1 or No. 2 carrier
in 74 percent of the reporting agency locations that have represented us for more than five years.
The independent agencies that we choose to market our products share our philosophies. They do business
person to person; offer broad, value-added services; maintain sound balance sheets and manage their
agencies professionally. On average, we have a 17.3 percent share of the property casualty insurance in our
2005 10-K Page 2
reporting agency locations. Our share is 24.3 percent in reporting agency locations that have represented us
for more than 10 years; 11.5 percent in agencies that have represented us for five to 10 years; 5.1 percent in
agencies that have represented us for one to five years; and less than 1 percent in agencies that have
represented us for less than one year.
Over the next decade, industry analysts predict successful agencies will have opportunities to increase their
size on average almost three-fold. Agencies are expected to continue to pursue consolidation opportunities,
buying or merging with other agencies to create stronger organizations and expand service. In addition to the
growing networks of agency locations owned by banks and brokers, other agencies are addressing the
consolidation by forming voluntary associations. These associations, or “clusters,” share back office and other
functions to enhance economies, while maintaining their individual ownership structures.
No single agency relationship accounted for more than 1.1 percent of our total agency earned premiums in
2005. Some of our agency relationships are with individual offices of bank- or broker-owned organizations.
Our relationships are with each office separately, however, no bank- or broker-owned organization, in
aggregate, accounted for more than 2.0 percent of our total agency earned premiums in 2005.
Strengthening Our Agency Relationships
We follow a number of strategies to strengthen our relationships with the independent property casualty
insurance agencies that represent us:
Risk-specific Underwriting
We seek to be a consistent, predictable and reasonable carrier that agencies can rely on to serve their clients.
Our field and headquarters underwriters make risk-specific decisions about both new business and renewals.
On a case-by-case basis, we select risks we can cover on acceptable terms and at adequate prices rather than
underwriting solely by geographic location or business class.
For new commercial lines business, this case-by-case underwriting and pricing is coordinated by the local field
marketing representatives. Our agents and our field marketing, loss control, bond and machinery and
equipment representatives know the people and businesses in their communities and can make informed
decisions about each risk. These field marketing representatives also are responsible for selecting new
independent agencies, coordinating field teams of specialized company representatives and promoting all of
the company's products within the agencies they serve. Commercial lines policy renewals are managed by
headquarters underwriters who are assigned to specific agencies and consult with local field staff, as needed.
We apply our risk-specific underwriting philosophy to personal lines new and renewal business in a different
process. Each agency brings us personal lines business from within the geographic territory that it serves using
its knowledge of the risks in those communities. New and renewal business activities are supported by
headquarters associates assigned to individual agencies.
Competitive Insurance Products
We are committed to offering the products and services local agents need to serve their clients – the
policyholders. Our commercial lines products are structured to allow flexible combinations of coverages in a
single package with a single expiration date. Our intent is to write personal auto and homeowners coverages in
personal lines packages that may also include personal umbrella and other coverages. The package approach
brings policyholders convenience, discounts and a reduced risk of coverage gaps or disputes. At the same time,
it increases account retention and saves time and expense for the agency and our company.
Our commercial lines packages are typically offered on a three-year policy term for most insurance coverages,
a key competitive advantage. Although we offer three-year policy terms, premiums for some coverages within
those policies are adjustable at anniversary for the subsequent annual period, and policies may be cancelled at
any time at the discretion of the policyholder. Contract terms often provide that rates for property, general
liability, inland marine and crime coverages, as well as policy terms and conditions, are fixed for the term of the
policy. The general liability exposure basis may be audited annually. Commercial auto, workers compensation,
professional liability and most umbrella liability coverages within multi-year packages are rated at each of the
policy's annual anniversaries for the next one-year period. The annual pricing could incorporate rate changes
approved by state insurance regulatory authorities between the date the policy was written and its annual
anniversary date, as well as changes in risk exposures and premium credits or debits relating to loss
experience, competition and other underwriting judgment factors. We estimate that approximately 75 percent
of 2005 commercial premiums were subject to annual rating or were written on a one-year policy term.
In our experience, multi-year packages are somewhat less price sensitive for the quality-conscious insurance
buyers who we believe are typical clients of our independent agents. Customized insurance programs on a
three-year term complement the long-term relationships these policyholders typically have with their agents
and with the company. By reducing annual administrative efforts, multi-year policies lower expenses for our
company and for our agents. The commitment we make to policyholders encourages long-term relationships
and reduces their need to annually re-evaluate their insurance carrier or agency. We believe that the
2005 10-K Page 3
advantages of three-year policies in terms of policyholder convenience, account retention and reduced
administrative costs outweigh the potential disadvantage of these policies, even in periods of rising rates.
Technology Solutions
We seek to continuously improve service to and communication with our agencies through an expanding
portfolio of software:
• Web-based quoting and policy processing systems that allow our agencies and our field and headquarters
associates to collaborate more efficiently on new and renewal business and that give our agencies choice
and control
• Systems that automate our internal processes so our associates can spend more time serving agents and
policyholders
Agencies access our quoting and policy processing systems via CinciLink®, our secure agency-only Web site.
CinciLink also provides other content that makes it easier to do business with us, such as online policy loss
information, software updates, online courses on the company’s products and services and electronic coverage
forms libraries.
We also are giving independent agents enhanced access to Cincinnati’s systems and client data quickly and
easily through their agency systems. We recognize the investment agencies have made in agency management
systems. In 2005, we gave agents access to CinciLink directly from their agency systems by leveraging industry
leading integration products, TransactNOW® and Transformation Station®. In 2006, we plan to advance our
usage of these products. For commercial lines, we will enable upload of select client data from the leading
agency systems to our new commercial lines pricing and policy systems. For personal lines, agencies will be
able to access Diamond billing information and policy detail directly from their agency systems.
Three commercial lines and one personal lines system form the core of our quoting and policy processing
systems:
• WinCPP® is an online commercial lines rate quoting system for businessowners, commercial package,
commercial auto and workers compensation policies. WinCPP is available in all 32 states and used by all
of our reporting agency locations. During 2006, we will add data sharing capabilities with agency systems
and roll out quoting for small specialty programs for metalworkers, professional artisan contractors and
garage owners. (A businessowners policy combines property, liability and business interruption coverages
for small businesses.)
•
e-CLAS™ is a commercial lines policy processing system. e-CLAS will make it easier and more efficient for
our agencies to issue and administer our commercial lines policies. In 2005, we introduced e-CLAS to all of
our agencies in Ohio to process new and renewal businessowners policies.
Our primary long-term technology objectives are to:
○ complete development of e-CLAS for all of our commercial lines of business and
○
roll out the system to agencies in all of the states in which we do business
During 2006, we expect to roll out businessowners policy processing to four additional states and provide
dentists package policy processing in all five e-CLAS states. We also will begin developing commercial auto
and commercial package policy processing capabilities.
• CinciBond™ is an automated system to process license and permit surety bonds. CinciBond enables
agents to issue and print bonds at their offices. CinciBond was delivered to all Ohio agencies and initial
groups of Indiana and Illinois agencies in 2005. During 2006, we will continue to deploy CinciBond in
Indiana and Illinois.
• Diamond is a real-time personal lines policy processing system, supporting all six of our personal lines of
business and allowing once and done processing. After its introduction in Kansas in 2002, we began full
deployment of Diamond in 2004. At year-end, Diamond was in use in agencies representing approximately
70 percent of our 2005 personal lines premium volume, including those in Alabama, Florida, Kansas,
Illinois, Indiana, Michigan and Ohio. In 2005, $417 million of our $786 million of personal lines written
premium was issued through Diamond. During 2005, we improved the system’s stability and speed and
made additional enhancements requested by our agencies. Training for agents in six states that represent
another 21.5 percent of our premium volume is scheduled for 2006. Agents in Georgia, Kentucky and
Wisconsin began using Diamond in early 2006 with Minnesota, Missouri and Tennessee roll-outs planned
for later in the year.
Two systems that automate our internal processes so our associates can spend more time serving agents and
policyholders are accessed through CFCNet®, our secure intranet:
• CMS™ is a claims file management system. CMS, initially deployed in late 2003, allows simultaneous
access to claim files by headquarters and field claims associates. Field and headquarters claims
associates use CMS to process all reported claims in a virtual claim file. We continue to refine the system
2005 10-K Page 4
to add capabilities to make our associates more effective. Agent access to selected information is planned
for 2006.
•
i-View™ is a commercial lines policy imaging and workflow system. This system’s online policy viewing
capability should speed the delivery and booking of policies as well as help expedite the claims process.
We began rolling out i-View in 2004 and it was in use by approximately 50 percent of commercial lines
underwriting teams at year-end 2005. Enhancements and infrastructure updates were completed in late
2005. Roll-out to the remaining teams began in January 2006 and we expect it will be completed during
2006.
Life Insurance Offerings Diversify Revenues and Earnings
We support the independent agencies affiliated with our property casualty operations in their programs to sell
life insurance. The products offered by our life insurance subsidiary round out and protect accounts and
improve account persistency. At the same time, the life operation looks to increase diversification of revenue
and profitability sources for both the agency and our company.
Our property casualty agencies make up the main distribution system for our life insurance products. We also
develop life business from other independent life insurance agencies. We are careful to solicit business from
these other agencies in a manner that does not conflict with or compete with the marketing and sales efforts of
our property casualty agencies. We emphasize up-to-date products, responsive underwriting and high quality
service as well as competitive commissions.
Superior Financial Strength Ratings
In addition to the ratings of our parent company senior debt, our property casualty and life operations are
awarded insurer financial strength ratings. Insurer financial strength ratings assess an insurer’s ability to meet
its financial obligations to policyholders and do not necessarily address matters that may be important to
shareholders. As of March 3, 2006, our financial strength ratings were:
Financial Strength Ratings:
A. M. Best Co.
Fitch Ratings
Moody's Investors Services
Standard & Poor's Ratings Services
Property Casualty Statutory Ratings:
Risk-Based Capital (RBC)
Authorized control level risk-based capital
Property casualty statutory surplus
Property casualty written premium-surplus ratio
Life Statutory Ratings:
Risk-Based Capital (RBC)
Authorized control level risk-based capital
Life statutory surplus
Life statutory risk-based adjusted surplus-liabilities ratio
Parent Company
Senior Debt
Property Casualty
Insurance
Subsidiaries
Life Insurance
Subsidiary
aa-
A+
A2
A
A++
AA
Aa3
AA-
A+
AA
-
AA-
$
4,254
635
4,194
0.7 x
$
511
52
451
37.3 %
We believe that our superior insurer financial strength ratings are clear, competitive advantages in the segment
of the insurance marketplace that our agents serve. Our financial strength supports the consistent, predictable
performance that our policyholders, agents, associates and shareholders have always expected and received,
and it must be able to withstand significant challenges. The most important way we seek to ensure that we
remain consistent and predictable is to align agents’ interests with those of the company, giving agents
outstanding service and compensation to earn their best business.
• A.M. Best – In June 2005, A.M. Best affirmed its top A++ (Superior) financial strength ratings and stable
outlook for our property casualty subsidiaries. Less than 2 percent of the 1,064 insurer groups A.M. Best
reviews annually qualify for the A++ rating.
A.M. Best cited our superior risk-based capitalization, successful business position developed through
building a network of independent agents, very strong financial flexibility and liquidity, excellent interest
coverage measures and modest financial leverage. A.M. Best said its ratings take into account our high
common stock leverage, elevated investment concentration and somewhat geographically concentrated
market profile. A.M. Best stated that it expects the property casualty group’s overall operating results and
2005 10-K Page 5
capitalization will remain strong in the near term due to our focused underwriting strategy, strong agency
relations and consistently sound loss reserving practices.
Also in June 2005, A.M. Best affirmed its A+ (Superior) rating for The Cincinnati Life Insurance Company.
A.M. Best cited our life insurance subsidiary’s strategic position within Cincinnati Financial Corporation, our
continuing focus on growth with a broad portfolio of life insurance products, expanding geographical
presence, emphasis on full-time life insurance specialists, consistently positive statutory operating
performance and adequate level of capitalization to manage our risks. A.M. Best said its rating considered
the life subsidiary’s significant exposure to common stocks, lower operating profitability due to losses from
accident and health business and the effect on surplus of acquisition costs related to writing increased
amounts of new business.
•
Fitch Ratings – In August 2005, Fitch affirmed its AA (Very Strong) insurer financial strength ratings and
stable outlook for our property casualty subsidiaries and life insurance subsidiary. Fitch cited the strong
financial condition of our operating subsidiaries, excellent financial flexibility, successful total return
investment strategy and competitive advantage derived from long-term relationships with independent
agents who distribute our products.
Fitch said its ratings consider the property casualty group’s significant investment concentration in a small
number of common stocks, geographic concentration that contributes to sizable catastrophe exposure and
regulatory concentration and underperforming homeowner line of business. Fitch stated that it expects
that financial leverage will remain at or near its current level over the intermediate term.
• Moody’s Investors Service – Following our announcement of third-quarter 2005 results, Moody’s
commented that the company’s strong balance sheet and conservative financial and operating leverage
metrics continue to support the property casualty subsidiaries’ Aa3 ratings. Moody’s said that its ratings
took into account the increased volatility risk to capital and surplus presented by our equity exposure,
along with its potential liabilities.
Moody’s noted that the company was on track to achieve growth and profitability targets in line with
Moody’s expectations for the current ratings. Moody’s said it expects the company will maintain our
commercial pricing discipline along with our commitment to agency relationships, an integral filter in the
underwriting process. Further, Moody’s expects full deployment of our policy processing system will simplify
the process to introduce rate and product changes within our personal lines market.
• Standard & Poor’s Ratings Services – In October 2005, Standard & Poor’s issued a corporate ratings
report with the rationale for its AA- (Very Strong) ratings of the property casualty subsidiaries and its
negative outlook. Standard & Poor’s based the ratings, affirmed in September 2004, on the group’s strong
competitive position afforded by its extremely loyal and productive independent agency force, high
business persistency, extremely strong capitalization and high degree of financial flexibility.
Standard & Poor’s said its outlook took into account the company’s underperformance in our homeowner
business; very aggressive investment strategies; slow, deliberate response to changing markets, and
volatility related to geographic concentration.
Standard & Poor’s stated that it expects that the company should continue to perform well in its largest
business segment, commercial lines, while lagging peers in personal lines profitability over the near term.
Although progress could be tempered by slower growth, the sizeable equity position, adverse regulatory or
judicial decisions or catastrophes, Standard & Poor’s said, it expects capitalization and growth will remain
extremely strong and growth will be solid as new agency appointments and territory subdivisions partially
offset possible weakening in industry pricing.
A December 2005 corporate ratings report gave the rationale for Standard & Poor’s AA- (Very Strong) rating
of The Cincinnati Life Insurance Company. Standard & Poor’s based the rating, affirmed in September
2004, on the life subsidiary’s strategic position within our group of companies, an extraordinarily superior
capital position, extremely strong liquidity and the strength of its marketing position among independent
agents. Standard & Poor’s said its rating considered the modest but growing penetration of our property
casualty customer base, a narrow but growing product line and asset/liability management in the early
stage of development. Standard & Poor’s outlook included expectations for premium growth of 9 percent,
continued broadening of our product portfolio, improved asset/liability management, continued extremely
strong capital and liquidity, as well as improved benchmarks for tracking penetration of the property
casualty customer base.
While the potential for volatility exists due to our catastrophe exposures, investment philosophy and bias
toward incremental change, the ratings agencies consistently have asserted that we have built appropriate
financial strength and flexibility to manage that volatility. We remain committed to strategies that emphasize
long-term stability over short-term benefits that might accrue by quick reaction to changes in market
conditions.
For example, through all market and economic cycles we maintain strong insurance company statutory surplus,
a solid reinsurance program, sound reserving practices and low interest rate risk, as well as low debt and
2005 10-K Page 6
strong capital at the parent-company level. Investments at the parent company give us flexibility to support our
capitalization policies for the subsidiaries, improve the ability of the insurance companies to write additional
premiums and maintain high insurer financial strength ratings.
In 2004, we transferred approximately 32 million shares of our Fifth Third Bancorp (Nasdaq: FITB) common
stock holding to the insurance subsidiary from the parent company to reduce parent company investment
assets. The transfer raised our property casualty statutory surplus and reduced our ratio of net written
premiums to statutory surplus. This ratio is a common measure of operating leverage used in the property
casualty industry. It serves as an indicator of the company’s premium growth capacity. The estimated property
casualty industry net written premium to statutory surplus ratio was 1.0 percent, 1.1 percent and 1.2 percent
in 2005, 2004 and 2003, respectively. We do not intend to leverage our lower ratio following the asset transfer
by accelerating growth or strengthening loss reserves. Rather, the transfer allowed us to retain the financial
flexibility that continues to support our high insurer financial strength ratings.
Cincinnati Life’s statutory adjusted risk-based surplus increased 4.1 percent to $511 million at
December 31, 2005, from $491 million a year earlier. Statutory adjusted risk-based surplus as a percentage of
liabilities, a key measure of life insurance company capital strength, was 37.3 percent at year-end 2005
compared with an estimated industry average ratio of 10.4 percent. The higher the ratio, the stronger an
insurer’s security for policyholders and its capacity to support business growth.
At year-end 2005 and 2004, the risk-based capital (RBC) for our property casualty and life operations was
exceptionally strong and well above levels that would have required regulatory action.
Programs, Products and Services to Support Agency Growth
We continue to expand the services we provide that support agency opportunities. Accessible field
representatives are the first layer of support. Headquarters associates also provide agencies with underwriting,
accounting and technology assistance and training. Company executives, headquarters underwriters and
special teams regularly travel to visit agencies. Agents have opportunities for direct, personal conversations
with our senior management team, and headquarters associates have opportunities to refresh their knowledge
of marketplace conditions and field activities.
The field marketing representatives are joined by field claims, loss control, machinery and equipment, bond,
premium audit, life insurance and leasing specialists. For example, our field engineering and loss control
representatives perform inspections and recommend specific actions to improve the safety of the
policyholder’s operations and the quality of the agent’s insurance account.
We complement the property casualty operations by providing products and services that help attract and
retain high-quality independent insurance agencies. CFC Investment Company offers equipment and vehicle
leases and loans for independent insurance agencies, their commercial clients and other businesses. It also
provides commercial real estate loans to help agencies operate and expand their businesses. CinFin Capital
Management markets asset management services to agencies and their clients, as well as other institutions,
corporations and high net worth individuals.
When we appoint agencies, we look for organizations with knowledgeable, professional staffs. In turn, we make
an exceptionally strong commitment to assist them in keeping their knowledge up to date and educating new
people they bring on board as they grow. Numerous activities at our headquarters, in regional and agency
locations and online fulfill this commitment:
• At our headquarters, we conduct roundtables for agency principals, as well as our regular schedule of
commercial lines, personal lines and life insurance agent schools and seminars. These generally focus on
Cincinnati product and underwriting information and sales tips. In addition to schools for agents, we have
opened seats for agents in our structured classroom training for new underwriting associates. Agency staff
may return to their agencies after the class or stay and become fully grounded in Cincinnati philosophy by
serving as an associate for a few years before returning to the agency.
• Associates travel to regional and agency locations to instruct classes and provide a variety of educational
support services. Teams conduct personal lines customer service representative training and marketing
seminars to promote cross-serving and sales of bonds, leasing services, life worksite marketing, inland
marine coverages and our program for dentists. Other teams help agencies learn to use our new systems
or get the most from their own agency management systems. Cincinnati associates even co-host client
seminars with our agencies on the benefits of worksite marketing or risk management and risk transfer
techniques, with customized programs that address liability issues specific to contractor or dentist
audiences.
• We now bring courses to agency desktops, where at any time agency staff can access the Agency Learning
Center through CinciLink, our secure agency-only Web site. The Learning Center offers convenient, online
courses and Web conferences, including Cincinnati product information, Microsoft® Office topics and
general business subjects. Our new producer and customer service representative curricula guide students
through a progression of online courses and classroom instruction.
2005 10-K Page 7
Except travel-related expenses for courses held at our headquarters, most programs are offered at no cost to
our agencies. While that approach may be extraordinary in our industry today, the result is quality service for
our policyholders and increased success for our independent agencies.
Third-party Measures of Satisfaction and Performance
The National Association of Insurance Commissioners’ Online Consumer Information Source (www.naic.org)
measured our complaint ratio at a very low 0.25 versus the national median score of 1.00 for all property
coverages in 2004, the most recent year for which data is available. NAIC members head the state
departments of insurance that regulate insurance.
The Professional Insurance Agents Association of Ohio surveyed its members in 2005 on satisfaction with their
insurance companies. We scored higher than any other insurer in the categories of claims handling,
commercial lines competitiveness and agency compensation. Offsetting these top scores and other strong
scores in personal lines policy service, company management and field marketing support, were scores lower
than all other insurers in both the homeowner competitiveness and the personal auto competitiveness
categories. As discussed in Item 7, Personal Lines Insurance Results of Operations, Page 47, we are taking
steps to restore a competitive position in personal lines.
In a 2005 study, Ward Group named Cincinnati Insurance to its annual top 50 lists of property casualty and
life/health insurers in America. Insurers and groups qualify based on financial safety, consistency and
performance over a five-year period. Cincinnati is one of only eight property casualty insurers that have
qualified for the list in each of its 15 years and one of only 10 property casualty insurers whose life insurance
affiliates also qualified.
Growing with Our Agencies
One of our primary objectives is to increase our written premiums more rapidly than the industry. We believe
our agencies are growing more rapidly than the industry, and we seek to maintain or increase our penetration
within each agency as it grows.
Further improving service through the creation of smaller marketing territories that permit our local field
marketing representatives to devote more time to each agency relationship should help us maintain or
increase our penetration within each agency. At year-end 2005, we had 100 field marketing territories, up from
92 at the end of 2004 and 87 at the end of 2003. A new Delaware/Maryland territory represented both the
subdivision of our existing Maryland territory and our entry into Delaware, our first new state since 2000. While
we continually study the regulatory and competitive environment in states where we could decide to actively
market our property casualty products, we have not announced plans to enter any of those states in the near
future.
Another way we seek to increase overall premiums is to selectively appoint new agency relationships within our
current marketing territories. In 2004, we set an objective to establish approximately 50 new agency
relationships each year. In 2005, we established 41 new agency relationships, and in 2004, we established
50 new relationships. These new appointments and other changes in agency structures led to a net increase in
reporting agency locations of 40 in 2005 and 22 in 2004. We are very careful to protect the franchise for
current agencies when selecting and appointing new agencies.
ACHIEVING CLAIMS EXCELLENCE
Our claims philosophy reflects our belief that we will prosper as a company by responding to claims person to
person, paying covered claims promptly, preventing false claims from unfairly adding to overall premiums and
building financial strength to meet future obligations. We also believe that our company should have the
financial strength to pay claims while also creating value for shareholders, leading to our emphasis on the
establishment of adequate claims reserves.
Superior Claims Service
Our 751 locally based field claims representatives work from their homes, assigned to specific agencies. They
respond personally to policyholders and claimants, typically within 24 hours of receiving an agency’s claim
report. We believe the person-to-person approach, together with the resulting high level of service that field
claims representatives, familiar with an agency and its policyholders, can provide, gives us a competitive
advantage. We also help our agencies provide prompt service to policyholders by giving agencies authority to
immediately pay most first-party claims up to $2,500.
Catastrophe Response Teams are comprised of volunteers from our experienced field claims staff. As
hurricanes threaten, these associates travel to strategic locations near the expected impact area. This puts
them in position to quickly get to the affected area, set up temporary offices and start calling on policyholders.
Cincinnati takes pride in giving our field personnel the tools and authority they need to do their jobs. In times of
widespread loss, our field claims representatives confidently and quickly resolve claims, often writing checks
for damages on the same day they inspect the loss. Our Claims Management System introduced new
efficiencies that are especially evident during catastrophes. Electronic claim files allow for fast initial contact of
2005 10-K Page 8
policyholders and easy sharing of information between rotating storm teams, headquarters and local field
claims representatives.
Cincinnati’s claims associates work hard to control costs where appropriate. We have several relationships with
vendors that offer our insureds and claimants preferred rates. However, our biggest cost control program is our
field claims representatives. Field claims representatives are educated continuously on new techniques and
repair trends. These representatives have experience with area body shops, which helps them negotiate the
right price with any facility the policyholder chooses.
We staff a Special Investigations Unit (SIU) with former law enforcement and claims professionals who are
available to gather facts to help determine the fair amount to pay under a claim. While we believe it’s our job to
pay all that is due under each policy, we also want to prevent false claims from unfairly increasing overall
premiums. Our SIU also operates a computer forensic lab, using sophisticated software to recover data and
mitigating the cost of computer-related claims for business interruption and loss of records.
Loss and Loss Expense Reserves
When claims are made by or against policyholders, any amounts that our property casualty operations pay or
expect to pay for covered claims are termed losses. The costs we incur in investigating, resolving and
processing these claims are termed loss expenses. Our consolidated financial statements include property
casualty loss and loss expense reserves that estimate the costs of not-yet-paid claims incurred through
December 31 of each year. The reserves include estimates for claims that have been reported to us plus our
estimates for claims that have been incurred but not yet reported, along with our estimate for loss expenses
associated with processing and settling those claims. We develop the various estimates based on individual
claim evaluations and statistical projections. We reduce the loss reserves by an estimate for the amount of
salvage and subrogation we expect to recover. For at least the past 10 years, our annual review of our
estimates has led to savings from favorable development of loss reserves from prior accident years.
We encourage you to review several sections of the Management’s Discussion and Analysis where we discuss
our loss reserves in greater depth. In Item 7, Critical Accounting Estimates, Property Casualty Loss and Loss
Expense Reserves, Page 35, we discuss our process for analyzing potential losses and establishing reserves.
In Item 7, Property Casualty Insurance Reserves, Page 61, we review reserve levels, including 10-year
development of our property casualty loss reserves.
INVESTING FOR LONG-TERM TOTAL-RETURN
While we seek to generate an underwriting profit in our insurance operations, our investments historically have
provided our primary source of net income and contributed to our financial strength, driving long-term growth in
shareholders’ equity and book value.
Under the direction of the investment committee of the board of directors, our portfolio managers seek to
balance current investment income opportunities and long-term appreciation so that current cash flows can be
compounded to achieve above-average long-term total return. We invest some portion of cash flow in
tax-advantaged fixed-maturity and equity securities to maximize after-tax earnings. With premiums generally
received before claims are made under the policies purchased with those premiums, particularly for business
lines such as workers compensation, we have substantial cash flow available for investment.
Insurance regulatory and statutory requirements established to protect policyholders from investment risk have
always influenced our investment decisions on an individual insurance company basis. After covering both our
intermediate and long-range insurance obligations with fixed-maturity investments, we historically used
available cash flow to invest in equity securities. Investment in equity securities has played an important role in
achieving our portfolio objectives and has contributed to net unrealized investment gains of $5.067 billion at
year-end 2005. We remain committed to our long-term equity focus, which we believe is key to our company’s
long-term growth and stability.
OUR SEGMENTS
Consolidated financial results primarily reflect the results of our four reporting segments. These segments are
defined based on financial information we use to evaluate performance and to determine the allocation of
assets.
• Commercial lines property casualty insurance
• Personal lines property casualty insurance
•
Life insurance
Investments
•
We also frequently evaluate results for our consolidated property casualty operations, which is the total of our
commercial lines and personal lines segments. Our consolidated property casualty operations generated
80.8 percent of our revenues in 2005. Revenues, income before income taxes, and identifiable assets for each
2005 10-K Page 9
segment are shown in a table in Item 8, Note 17 to the Consolidated Financial Statements, Page 98. Some of
that information also is discussed in this section of this report, where we explain the business operations of
each segment. The financial performance of each segment is discussed in the Management’s Discussion and
Analysis of Financial Condition and Results of Operations, which begins on Page 31.
COMMERCIAL LINES PROPERTY CASUALTY INSURANCE SEGMENT
The commercial lines property casualty insurance segment contributed $2.254 billion in net earned premiums
to total revenues and $285 million to income before income taxes in 2005. Commercial lines net earned
premiums grew 6.0 percent in 2005, 11.4 percent in 2004 and 10.8 percent in 2003.
Four business lines – commercial multi-peril, workers compensation, commercial auto and other liability –
accounted for 89.7 percent of our commercial lines earned premiums.
• Commercial multi-peril coverage is a combination of property and liability coverages. Property insurance
covers damages such as those caused by fire, wind, hail, water, theft, vandalism and business interruption
resulting from a covered loss. Liability coverage insures businesses against third-party liability from
accidents occurring on their premises or arising out of their operations, such as injuries sustained from
products sold.
• Workers compensation coverages protect employers against specified benefits payable under state or
federal law for workplace injuries to employees. In some of our active states, including Ohio, workers
compensation coverage is a state monopoly, provided solely by the state instead of by private insurers.
• Commercial auto coverages protect businesses against liability to others for both bodily injury and property
damage, medical payments to insureds and occupants of their vehicles, physical damage to an insured’s
own vehicle from collision and various other perils, and damages caused by uninsured motorists.
• Other liability coverages include commercial umbrella, commercial general liability and most executive risk
policies, which cover liability exposures including bodily injury, directors and officers and employment
practices, property damage arising from products sold and general business operations.
The remainder of our commercial lines earned premiums derives from a variety of other types of insurance
products that we offer to businesses, including fire and allied lines commercial property policies, inland marine
policies, fiduciary and surety bonds and machinery and equipment policies.
We market our full portfolio of commercial insurance products in 1,245 of our reporting agency locations and
all 32 states where we actively market property casualty insurance. There are eight reporting agency locations
that market only our surety bond products. Our emphasis is on products that agents can market to small- to
mid-size businesses in their communities.
In 2005, our 10 highest volume commercial lines states generated 68.8 percent of our agency earned
premium compared with 70.0 percent in the prior year. Agency earned premiums in the 10 highest volume
states rose 5.2 percent in 2005 and 10.4 percent in 2004. Agency earned premiums in the remaining
22 states rose 10.5 percent in 2005 and 16.2 percent in 2004. Agency earned premiums are premiums
before reinsurance.
2005 10-K Page 10
Commercial Lines Agency Earned Premiums by State
(Dollars in millions)
Year ended December 31, 2005
Ohio
Illinois
Pennsylvania
Indiana
Michigan
North Carolina
Virginia
Wisconsin
Iowa
Georgia
All other states
Total
Year ended December 31, 2004
Ohio
Illinois
Pennsylvania
Indiana
Michigan
North Carolina
Virginia
Wisconsin
Iowa
Tennessee
All other states
Total
Earned
premium
Percent
of total
Change %
Reporting
agency locations
Avg premium
per location
$
$
$
$
432
241
174
164
130
125
112
98
82
79
739
2,376
415
234
162
160
130
112
107
90
77
72
666
2,225
18.2 %
10.1
7.3
6.9
5.5
5.3
4.7
4.1
3.4
3.3
31.2
100.0 %
18.7 %
10.5
7.3
7.2
5.8
5.0
4.8
4.1
3.4
3.2
30.0
100.0 %
4.0
2.8
7.9
2.9
0.2
11.1
4.6
8.7
6.6
13.6
10.5
6.8
8.1
7.7
14.4
6.8
11.3
15.9
13.5
11.1
12.4
14.4
16.2
12.0
224 $
112
63
99
88
68
53
49
45
59
393
1,253
$
224
113
63
96
83
66
51
49
44
30
393
1,212
1.9
2.1
2.8
1.7
1.5
1.8
2.1
2.0
1.8
1.3
1.9
1.9
1.9
2.1
2.6
1.7
1.6
1.7
2.1
1.8
1.7
2.4
1.7
1.8
Commercial Lines Insurance Marketplace
For commercial lines, our competition predominately consists of those companies that also distribute through
independent agents. The independent agencies that market our commercial lines products typically represent
four to 12 standard market insurance carriers, including both national and regional carriers, some of which
may be mutual companies. Generally, we believe regional carriers offer us the greatest competition on small-
and mid-size commercial accounts because they often are familiar with the local market and focus on
differentiating themselves through personal relationships with agencies. Carriers with a national presence
provide formidable competition on large commercial accounts and have increasingly targeted smaller
commercial accounts, marketing a service-center approach that some agencies find efficient. In our
experience, the level of competition varies state by state and region by region, regardless of the carriers
represented within a specific agency.
Since late 2003, the softening commercial lines marketplace has been characterized by increased
competition, particularly for quality new business. Generally, the level of competition has varied by market, by
line of business and by size of account. In most markets where we compete, disciplined underwriting generally
has remained the norm. We believe carriers are modifying prices rather than changing policy terms and
conditions. Prior to Hurricanes Katrina, Rita and Wilma, we anticipated commercial lines insurance market
trends in 2006 would reflect accelerated competition with pressure on pricing from the industry’s increasing
surplus and improving profitability. We are uncertain what effect the hurricanes, and the related rise in the cost
of reinsurance, may have on commercial lines pricing throughout 2006.
PERSONAL LINES PROPERTY CASUALTY INSURANCE SEGMENT
The personal lines property casualty insurance segment contributed $804 million in net earned premiums to
total revenues and $45 million to income before income taxes in 2005. Personal lines net earned premiums
grew 1.4 percent in 2005, 6.4 percent in 2004 and 11.2 percent in 2003.
The personal auto line of business accounted for 53.8 percent and the homeowner line of business accounted
for 35.5 percent of personal lines net earned premium in 2005.
• Personal auto coverages protect against liability to others for both bodily injury and property damage,
medical payments to insureds and occupants of their vehicle, physical damage to an insured’s own vehicle
from collision and various other perils, and damages caused by uninsured motorists. In addition, many
2005 10-K Page 11
states require policies to provide first-party personal injury protection, frequently referred to as no-fault
coverage.
• Homeowner coverages protect against losses to dwellings and contents from a wide variety of perils, as
well as liability arising out of personal activities both on and off the covered premises. The company also
offers coverage for condominium unit owners and renters.
The remainder of our personal lines earned premium was derived from a variety of other types of insurance
products we offer to individuals such as dwelling fire, inland marine, personal umbrella liability and watercraft
coverages.
We market both homeowner and personal auto insurance products through 773 of our 1,253 reporting agency
locations in 22 of the 32 states in which we market commercial lines insurance. We market homeowner
products through 22 locations in three additional states (Maryland, North Carolina and West Virginia.) The
remaining 458 locations are in states where we either do not actively market these products or where we have
determined, in conjunction with agency management, that our personal lines products are not appropriate for
their agencies at this time.
In 2005, our 10 highest volume personal lines states generated 85.0 percent of our agency earned premium
compared with 85.1 percent in the prior year. Agency earned premiums in the 10 highest volume states rose
0.3 percent in 2005 and 6.5 percent in 2004. Agency earned premiums in the remaining states rose
1.1 percent in 2005 and 12.9 percent in 2004. Agency earned premiums are premiums before reinsurance.
Personal Lines Agency Earned Premiums by State
(Dollars in millions)
Year ended December 31, 2005
Ohio
Indiana
Illinois
Georgia
Michigan
Alabama
Kentucky
Wisconsin
Florida
Virginia
All other states
Total
Year ended December 31, 2004
Ohio
Indiana
Illinois
Georgia
Michigan
Alabama
Kentucky
Wisconsin
Florida
Virginia
All other states
Total
$
$
$
$
Earned
premium
Percent
of total
Change %
Reporting
agency locations
Avg premium
per location
305
74
59
62
43
40
37
27
26
21
124
818
306
76
61
60
45
38
36
28
25
20
120
815
37.4 %
9.0
7.2
7.6
5.2
4.9
4.6
3.3
3.2
2.6
15.0
100.0 %
37.6 %
9.3
7.4
7.3
5.5
4.7
4.4
3.4
3.0
2.5
14.9
100.0 %
(0.3)
(3.1)
(2.5)
4.8
(5.3)
4.3
5.3
(1.2)
6.9
5.8
1.1
0.4
5.7
2.7
7.7
5.9
14.9
2.9
13.3
8.2
4.7
9.1
12.9
7.4
211 $
65
78
46
66
24
33
30
10
23
209
795
202 $
67
80
44
60
25
31
30
10
22
207
778
1.4
1.1
0.8
1.4
0.6
1.7
1.1
0.9
2.6
0.9
0.6
1.0
1.5
1.1
0.8
1.3
0.8
1.5
1.1
0.9
2.5
0.9
0.6
1.0
Personal Lines Insurance Marketplace
In addition to carriers that market through independent agents, our personal lines competition also includes
carriers that market through captive agents and direct writers, which our agencies’ clients may investigate
independently. The independent agencies that market our personal lines products typically represent five to
eight standard personal lines carriers.
In 2003, competition increased in the personal lines marketplace, driven by industrywide improvement in
results and favorable frequency and severity trends. This followed several years of rising personal auto and
homeowner rates and stricter enforcement of underwriting standards across the industry. The increased
competition in the past several years also reflected implementation of tiered rating systems by a growing
number of carriers. Carriers that have adopted these systems use multiple variables to segment the market,
relying in part on credit-based information and offering a greater number of rate levels.
2005 10-K Page 12
We expect that competition in the personal auto and homeowners markets will continue to increase over the
next 12 to 24 months. Despite the record level of industrywide catastrophe losses in 2005 and 2004, many
personal lines carriers have reported strong operating results in the past two years and continue to have
healthy capital to support business growth. We believe these carriers are focused on gaining market share
through the introduction of new products and services, increased advertising expenditures and the use of
tiered rating systems that may allow them to target higher quality risks with lower prices.
LIFE INSURANCE SEGMENT
The life insurance segment contributed $106 million of net earned premiums and $7 million in income before
income taxes in 2005. Life insurance segment profitability is discussed in detail in Item 7, Life Insurance
Results of Operations, Page 52.
The overall mission of our company is supported by The Cincinnati Life Insurance Company. Cincinnati Life
helps meet the needs of our agencies, including increasing and diversifying agency revenues. We primarily
focus on life products that produce revenue growth through a steady stream of premium payments.
By diversifying revenue and profitability for both the agency and our company, this strategy enhances the
already strong relationship built by the combination of the property casualty and life companies.
Cincinnati Life seeks to become the life insurance carrier of choice for the independent agencies that work with
our property casualty operations. We emphasize up-to-date products, responsive underwriting and high quality
service as well as competitive commissions. At year-end 2005, approximately 80 percent of our 1,253 property
casualty reporting agency locations offered Cincinnati Life’s products to their clients. We also develop life
business from other independent life insurance agencies. We are careful to solicit business from these other
agencies in a manner that does not conflict with or compete with the marketing and sales efforts of our
property casualty agencies.
Business Lines
Four lines of business – term insurance, whole life insurance, universal life insurance and worksite products –
account for approximately 86 percent of the life insurance segment’s revenues:
•
Term insurance – policies under which the benefit is payable only if the insured dies during a specified
period of time or term; no benefit is payable if the insured survives to the end of the term. While premiums
are fixed, they must be paid as scheduled. The proposed insured is evaluated using normal underwriting
standards.
• Whole life insurance – policies that provide life insurance for the entire lifetime of the insured; the death
benefit is guaranteed never to decrease and premiums are guaranteed never to increase. While premiums
are fixed, they must be paid as scheduled. These policies provide guaranteed cash values that are
available to withdrawing policyholders. The proposed insured is evaluated using normal underwriting
standards.
• Universal life insurance – long-duration life insurance policies. Contract premiums are neither fixed nor
guaranteed; however, the contract does specify a minimum interest crediting rate and a maximum cost of
insurance charge and expense charge. Premiums are not fixed and may be varied by the contract owner.
The cash values available to withdrawing policyholders are not guaranteed and depend on the amount and
timing of actual premium payments and the amount of actual contract assessments. The proposed insured
is evaluated using normal underwriting standards.
• Worksite products – term insurance, whole life insurance, universal life and disability insurance offered to
employees through their employer. Premiums are collected by the employer using payroll deduction.
Polices are issued using a simplified underwriting approach and for smaller face amounts than similar,
regularly underwritten policies. Worksite insurance products provide our property casualty agency force
with excellent cross-serving opportunities for both commercial and personal accounts. Agents report that
offering worksite marketing to employees of their commercial accounts provides a benefit to the
employees at low cost to the employer. Worksite marketing also connects agents with new customers who
may not have previously benefited from receiving the services of a professional independent insurance
agent.
In addition, Cincinnati Life markets:
• Disability income insurance - provides monthly benefits to offset the loss of income when the insured
person is unable to work due to accident or illness.
• Deferred annuities - provide regular income payments that commence after the end of a specified period
or when the annuitant attains a specified age. During the deferral period, any payments made under the
contract accumulate at the crediting rate declared by the company but not less than a contract-specified
guaranteed minimum interest rate. A deferred annuity may be surrendered during the deferral period for
a cash value equal to the accumulated payments plus interest less the surrender charge, if any.
2005 10-K Page 13
•
Immediate annuities - provide some combination of regular income and lump sum payments in exchange
for a single premium. Most of the immediate annuities written by our life insurance segment are purchased
by our property casualty companies to settle casualty claims.
Life Insurance Marketplace
Our life insurance company markets its products through approximately 1,000 of our reporting agency
locations in all but one of the 32 states where we actively market property casualty insurance and through
453 additional independent life agencies in a total of 48 states. We do not market life insurance products in
Alaska and New York.
We market our life insurance products either through independent agencies affiliated with our property
casualty operations or through independent life agencies. Our property casualty agencies comprise the main
distribution system for our life insurance products. Other life insurance carriers continue to expand the use of
nontraditional distribution channels such as banks and financial planners as alternatives to the agency
channel. We intend to market solely through independent agencies, with an emphasis on enhancing our
relationships with the agencies affiliated with our property casualty insurance operations.
When marketing through our property casualty agencies we have several specific competitive advantages.
Because our property casualty operations are held in high regard, the property casualty agency’s management
is predisposed to consider carefully our proposals to sell our life products. All of our marketing efforts, property
casualty and life, are directed by our field marketing department, which assures consistency of message. Our
life field marketing representatives regularly meet face-to-face with the agency personnel responsible for life
insurance production. The resources of our life headquarters underwriters and other associates are available
to the field team to assist in the placement of agency business. We find fewer and fewer of our competitors
provide direct, personal contact between the agent and the insurance carrier.
Also, we continue to emphasize the cross-serving opportunities between worksite marketing of life insurance
products and the property casualty agency’s commercial accounts. For example, in 2006, we are exploring
additional programs to simplify the worksite sales process, including electronic enrollment software. We also
intend to enhance our worksite product portfolio to make it more attractive to agents.
In both the property casualty and independent life agency distribution systems we enjoy the competitive
advantages of offering competitive, up-to-date products, providing close personal attention and exhibiting
financial strength and stability.
We primarily offer products targeted at addressing the needs of small businesses that require key person
coverage and individuals who require mortality coverage. Term insurance is our largest life insurance product
line. We continue to introduce new term products with features our agents indicate are important. A new term
series, which included a return-of-premium feature, replaced the existing term portfolio during 2005. Reaction
to the new portfolio has been favorable with approximately 25 percent of applications requesting the return-of-
premium feature. In 2006 we are introducing a new universal life product that offers a secondary guarantee
that keeps the death benefit in force provided a competitive minimum premium requirement is met.
Because of our strong capital position, we can offer a competitive product portfolio including guaranteed
products, giving our agents a marketing edge. Our life insurance company maintained strong insurer financial
strength ratings in 2005: A.M. Best – A+ (Superior), Fitch -- AA (Very Strong) and Standard & Poor's –
AA- (Very Strong, negative outlook).
Offsetting our competitive advantages we continue to see consolidation within the life insurance industry and
an increased presence of large, well-capitalized carriers. The larger carriers can offer a broader product line,
including variable and equity-indexed products. Our competitive advantage can be diminished because we do
not have these types of products, particularly during a time when the stock market is performing well.
Current statutory laws and regulations require redundant reserves, particularly for preferred risk underwriting
classes. These redundant reserves, in turn, depress statutory earnings and require a large commitment of
capital. Redundant reserves are a significant issue, not just for our life insurance operations, but for all writers
of term insurance and universal life with secondary guarantees. However, larger carriers may be able to better
absorb or may be able to securitize the statutory reserve strain associated with competitively priced term
insurance and universal life with secondary guarantees.
The NAIC recognizes the problems caused by redundant reserves and is following a two-step approach to
provide relief. First, the NAIC has asked for comments on an amendment to the mortality table mandated for
statutory reserves to incorporate preferred underwriting classifications. The amended table would lower
reserve requirements for term insurance products. It may be available for use in statutory statements by
December 31, 2006. Second, the NAIC proposes amending the actuarial guidelines for reserve requirements
for universal life policies with secondary guarantees. The amendment would allow the use of low-level lapse
rates in calculating reserves for these types of universal life plans and also would result in lower reserves.
It may be available for use in statutory statements by December 31, 2007.
2005 10-K Page 14
For the longer term, the NAIC has asked for comment proposals on implementing a principles-based reserving
system rather than the current formulaic system. While still capturing all material risks, a principles-based
system would allow a company to use its own experience, subject to credibility standards and appropriate
margins for uncertainty. Also, under the proposed principles-based system, the insurer would fully document
and disclose all its assumptions and methods to regulatory officials.
INVESTMENTS SEGMENT
The investment segment contributed $587 million of our total revenues in 2005, primarily from net investment
income and realized investment gains and losses from investment portfolios managed for the holding company
and each of the operating subsidiaries. After deducting interest credited to contract holders of the life
insurance segment, the investments segment contributed $536 million of income before income taxes,
or 65.1 percent of our total income before income taxes.
The fair value (market value) of our investment portfolio was $12.657 billion and $12.639 billion at year-end
2005 and 2004, respectively. The cash we generate from insurance operations historically has been invested
in three broad categories of investments:
•
Fixed-maturity investments – Includes taxable and tax-exempt bonds and redeemable preferred stocks
• Equity investments – Includes common and nonredeemable preferred stocks
• Short-term investments – Primarily commercial paper
(In millions)
Taxable fixed maturities
Tax-exempt fixed maturities
Common equities
Preferred equities
Short-term investments
Total
At December 31,
2005
2004
Book value
Fair value
Book value
Fair value
$
$
3,304 $
2,083
1,961
167
75
7,590 $
3,359 $
2,117
6,936
170
75
12,657 $
3,161 $
1,622
1,918
27
71
6,799 $
3,376
1,694
7,466
32
71
12,639
Primarily as part of our program to support our high financial strength ratings almost all of our insurance
subsidiary’s available cash flow since the second quarter of 2004 has been used to purchase fixed-maturity
investments. Our objective was to bring the property casualty subsidiary’s ratio of common stock to statutory
surplus in line with our historic sub-100 percent level. The ratio of common stock to statutory surplus for the
property casualty insurance group portfolio was 97.0 percent at year-end 2005 compared with 103.5 percent
at year-end 2004 and 114.7 percent at year-end 2003.
During the same period, we took actions to reduce the parent company's ratio of investment assets to total
assets for the parent company below 40 percent, for the reasons we discuss in Item 1A, Risk Factors, Page 21.
The ratio of investment assets to total assets for the parent company was 33.9 percent at year-end 2005,
compared with 36.3 percent at year-end 2004 and 58.6 percent at year-end 2003.
Going forward, we will take into consideration insurance department regulations and ratings agency comments,
as well as the trend in these ratios, to determine what portion of new cash flow should be invested in equity
securities at the parent and insurance subsidiary levels.
In the past, we also have separately reported convertible security investments, which make up approximately
2.4 percent of the total fair value of the investment portfolio. Beginning this year, we are reporting and
analyzing convertible securities as either fixed-maturity or equity investments, based on the characteristics of
the underlying security (bond or preferred stock).
Fixed-maturity and Short-term Investments
By maintaining a well diversified fixed-maturity portfolio, we attempt to reduce overall risk. We invest new
money in the bond market on a continuous basis, targeting what we believe to be optimal risk-adjusted after-
tax yields. Risk, in this context, includes interest rate, call, reinvestment rate, credit and liquidity risks. We do
not make a concerted effort to alter duration on a portfolio basis in response to anticipated movements in
interest rates. By continuously investing in the bond market, we build a broad, diversified portfolio that we
believe mitigates the impact of adverse economic factors. In recent years, we have taken into account the
trend toward a flatter corporate yield curve by purchasing higher-quality corporate bonds with intermediate
maturities as well as tax-exempt municipal bonds and U.S. agency paper. Our focus on long-term total return
may result in variability in the levels of realized and unrealized investment gains or losses from one period to
the next.
We place a strong emphasis on purchasing current income-producing securities for the insurance companies'
portfolios. Within the fixed-maturity portfolio, we invest in a blend of taxable and tax-exempt securities to
2005 10-K Page 15
minimize our corporate taxes. With the exception of U.S. agency paper, no individual issuer's securities
accounted for more than 1.0 percent of the fixed-maturity portfolio at December 31, 2005.
Taxable Fixed-maturities
Taxable fixed-maturity bonds include:
• $973 million in U.S. agency paper, which is rated AAA by both Moody’s and Standard & Poor’s.
• $1.750 billion in investment-grade corporate bonds that have a Moody's rating at or above Baa 3 or a
Standard & Poor's rating at or above BBB-.
• $358 million in high-yield corporate bonds that have a Moody's rating below Baa 3 or a Standard & Poor's
rating below BBB-.
• $278 million in convertible bonds and redeemable preferred stocks.
We seek to balance current income with potential changes in market value as well as changes in credit risk
when determining whether or not to hold these securities to maturity.
Similar to the equity portfolio, the taxable fixed-maturity portfolio is most heavily concentrated in the financials
sector, including banks, brokerage, finance and investment and insurance companies. The financials sector
represented 26.1 percent and 26.6 percent, respectively, of book value and fair value of the taxable fixed-
maturity portfolio at December 31, 2005, compared with 24.1 percent and 24.6 percent of book value and fair
value at December 31, 2004. Although it is our largest concentration in a single sector, we believe our
percentage in the financials sector is below average for the corporate bond market as a whole. No other sector
or industry accounted for more than 10 percent of the taxable fixed-maturity portfolio.
Tax-exempt Fixed-maturities
We traditionally have purchased municipal bonds focusing on schools and essential services, such as sewer,
water or others. While no single municipal issuer accounted for more than 1.2 percent of the tax-exempt
municipal bond portfolio at December 31, 2005, there are higher concentrations within individual states.
Holdings in Illinois, Indiana, Michigan, Ohio and Texas accounted for 60.6 percent of the municipal bond
portfolio at year-end 2005.
Fixed-maturity and Short-term Portfolio Ratings
Our investments in U.S. agency paper and insured municipal bonds over the past several years have led to a
significant rise in the percentage of A and higher rated fixed-maturity and short-term holdings, based on fair
value. The majority of our non-rated securities are tax-exempt municipal bonds from smaller municipalities that
chose not to pursue a credit rating. Credit ratings as of December 31, 2005 and 2004, for the fixed-maturity
and short-term portfolio were:
(Dollars in millions)
Moody's Ratings
Aaa, Aa, A
Baa
Ba
B
Caa
Ca
C
Non-rated
Total
Standard & Poor's Ratings
AAA, AA, A
BBB
BB
B
CCC
CC
D
Non-rated
Total
2005
Fair
value
Percent
to total
2004
Fair
value
Percent
to total
65.8 % $
19.7
5.8
2.0
0.2
0.0
0.0
6.5
100.0 % $
58.3 % $
20.0
6.4
2.1
0.0
0.0
0.0
13.2
100.0 % $
3,101
1,069
363
125
23
11
0
449
5,141
2,865
1,095
340
154
5
11
4
667
5,141
60.3 %
20.8
7.1
2.4
0.5
0.2
0.0
8.7
100.0 %
55.7 %
21.3
6.6
3.0
0.1
0.2
0.1
13.0
100.0 %
$
$
$
$
3,651
1,094
324
110
13
0
0
359
5,551
3,233
1,112
354
117
2
0
0
733
5,551
2005 10-K Page 16
Attributes of the fixed-maturity portfolio include:
Weighted average yield-to-book value
Weighted average maturity
Weighted average duration to worst
Weighted average modified duration
Years ended December 31,
2005
2004
5.4 %
9.5 yrs
5.4 yrs
7.1 yrs
5.8 %
9.4 yrs
4.8 yrs
6.9 yrs
The decline in the yield-to-book between 2005 and 2004 was due to investments of new cash flow as well as
the reinvestment of calls and redemptions at interest rates below historic norms. The average maturity was
essentially unchanged. The modified duration remained nearly flat while modified duration to worst, an option
adjusted measure, increased. This was primarily due to a slight increase in rates in the intermediate range of
the yield curve and our continued emphasis on purchasing municipal bonds, which have a lower pretax yield.
We discuss the maturity of our fixed-maturity portfolio in Item 8, Note 2 to the Consolidated Financial
Statements, Page 88.
Equity Investments
Our equity investment portfolio includes both common stocks and nonredeemable preferred stocks.
Approximately 87.8 percent of the equity portfolio is made up of a core group of common stocks that we
monitor closely to gain an in-depth understanding of their organization and industry. The portfolio also includes
a broader group of smaller positions that are a source of trading flexibility and other risk management
advantages. Our equity investments had an average dividend yield-to-cost of 11.7 percent at
December 31, 2005, compared with 11.5 percent at December 31, 2004.
Common Stocks
At December 31, 2005, 35.1 percent of our common stock holdings (measured by fair value) were held at the
parent company level. Our common stock investments generally are securities with annual dividend yields of
1.5 percent to 3.0 percent and histories of dividend increases. Other criteria we evaluate include increasing
sales and earnings, proven management and a favorable outlook. When investing in common stock, we seek to
identify some companies in which we can accumulate more than 5 percent of their outstanding shares.
At year-end 2005, we held more than 5 percent of Fifth Third, FirstMerit Corporation, Piedmont Natural Gas
Company and First Financial Bancorp. There also is a core group of common stocks in which the company
holds a fair value of at least $100 million each. At year-end 2005, there were 14 holdings in that core group.
Largest Common Stock Holdings
(Dollars in millions)
As of and for the year ended December 31, 2005
Fifth Third Bancorp
ALLTEL Corporation
ExxonMobil Corporation
The Procter & Gamble Company
National City Corporation
PNC Financial Services Group, Inc.
Wyeth
Alliance Capital Management Holding L.P.
U.S. Bancorp
Wells Fargo & Company
FirstMerit Corporation
Johnson & Johnson
Piedmont Natural Gas Company, Inc.
Sky Financial Group, Inc.
All other common stock holdings
Total
Actual
cost
Fair
value
Percent of
fair value
283 $
117
133
105
171
62
62
53
113
66
54
115
62
91
474
1,961 $
2,745
801
503
335
329
291
204
179
172
139
139
139
134
130
696
6,936
39.6 % $
11.6
7.3
4.8
4.7
4.2
2.9
2.6
2.5
2.0
2.0
2.0
1.9
1.9
10.0
100.0 % $
Earned
dividend
income
106
20
10
6
14
10
4
9
7
5
6
3
4
4
22
230
Earned
dividend to
fair value
3.9 %
2.5
2.0
1.8
4.3
3.2
2.0
5.0
4.1
3.2
4.2
2.0
2.9
3.2
3.2
3.3
$
$
In 2005, we sold 475,000 shares of our holdings of ALLTEL Corporation, which was our second largest
common stock holding at year-end. We completed the sale of the remaining 12,700,164 shares of ALLTEL
common stock in January 2006. ALLTEL was an excellent investment for the company for over 40 years,
bringing an increasing flow of dividend income and healthy market value appreciation. Because of the
restructuring that ALLTEL announced in late 2005, we determined that it no longer met our investment
parameters.
This emphasis on a small group of equities and long-term investment horizon has resulted in significant
concentrations within the portfolio, as this buy-and-hold strategy over many years has built up significant
accumulated unrealized appreciation within the equity portfolio. At year-end 2005, the largest industry
2005 10-K Page 17
concentrations within our common stock holdings were the financials sector at 63.4 percent of total fair value
and the healthcare sector at 6.4 percent of total fair value.
Nonredeemable Preferred Stocks
We evaluate preferred stocks similar to the evaluation we make for fixed-maturity investments, seeking
attractive relative yields. We generally focus on investment-grade preferred stocks issued by companies that
have a strong history of paying common dividends, which provides us with another layer of protection.
Additionally, when possible we seek out preferred stocks that offer a dividend received deduction.
Additional information regarding the composition of investments is included in Item 8, Note 2 to the
Consolidated Financial Statements, Page 88.
OTHER
We report as “Other” the operations of the parent company, CFC Investment Company and CinFin Capital
Management Company (excluding investment activities) as well as other income of our insurance subsidiary.
As of December 31, 2005, CFC Investment Company had 2,815 accounts and $101 million in gross
receivables, compared with 2,489 and $92 million at December 31, 2004. As of December 31, 2005,
CinFin Capital had 64 institutional, corporate and individual clients and $864 million under management,
compared with 60 and $827 million at December 31, 2004.
REGULATION
STATE REGULATION
The business of insurance primarily is regulated by state law. Although our insurance subsidiaries are
domiciled in Ohio and primarily subject to Ohio insurance laws and regulations, we also are subject to state
regulatory authorities of all states in which we write insurance. The state laws and regulations that have the
most significant effect on our insurance operations and financial reporting are discussed below.
•
Insurance Holding Company Regulation – Our subsidiaries primarily engage in the property casualty
insurance business and secondarily in the life insurance business, both subject to regulation as an
insurance holding company system by the State of Ohio. These regulations require that we annually furnish
financial and other information about the operations of the individual companies within the holding
company system. All transactions within a holding company affecting insurers must be fair and equitable.
Notice to the state insurance commissioner is required prior to the consummation of transactions affecting
the ownership or control of an insurer and prior to certain material transactions between an insurer and
any person or entity in its holding company. In addition, some of those transactions cannot be
consummated without the commissioner’s prior approval.
• Subsidiary Dividends -- The dividend-paying capacity of our insurance subsidiaries is regulated by the laws
of Ohio, the domiciliary state. This regulation requires an insurance subsidiary to provide a 10-day advance
informational notice to the Ohio insurance department prior to payment of any dividend or distribution to
its shareholders (all of our smaller insurance subsidiaries are 100 percent owned by The Cincinnati
Insurance Company, which is 100 percent owned by Cincinnati Financial Corporation). Ordinary dividends
must be paid from earned surplus, which is the amount of unassigned funds set forth in an insurance
subsidiary’s most recent statutory financial statement.
The Ohio Department of Insurance must give prior approval before the payment of an extraordinary
dividend by an insurance subsidiary to shareholders. You can find information about the dividends paid by
our insurance subsidiary in 2005 in Item 8, Note 8 to the Consolidated Financial Statements, Page 91.
•
Insurance Operations – All of our insurance subsidiaries are subject to licensing and supervision by
departments of insurance in the states in which they do business. The nature and extent of such
regulations vary, but generally have their source in statutes that delegate regulatory, supervisory and
administrative powers to state insurance departments. Such regulations, supervision and administration of
the insurance subsidiaries include, among others, the standards of solvency which must be met and
maintained; the licensing of insurers and their agents; the nature and limitations on investments; deposits
of securities for the benefit of policyholders; regulation of policy forms and premium rates; policy
cancellations and non-renewals; periodic examination of the affairs of insurance companies; annual and
other reports required to be filed on the financial condition of insurers or for other purposes; requirements
regarding reserves for unearned premiums, losses and other matters; the nature of and limitations on
dividends to policyholders and shareholders; the nature and extent of required participation in insurance
guaranty funds; and the involuntary assumption of hard-to-place or high-risk insurance business, primarily
workers compensation insurance.
2005 10-K Page 18
•
Insurance Guaranty Associations -- Each state has insurance guaranty association laws under which the
associations may assess life and property casualty insurers doing business in the state for certain
obligations of insolvent insurance companies to policyholders and claimants. Typically, states assess each
member insurer in an amount related to the insurer’s proportionate share of business written by all
member insurers in the state. In 2005, our insurance subsidiaries incurred a negative $3 million for
guaranty associations. In 2004, our insurance subsidiaries incurred $2 million. We cannot predict the
amount and timing of any future assessments or refunds on our insurance subsidiaries under these laws.
• Shared Market and Joint Underwriting Plans -- State insurance regulation requires insurers to participate in
assigned risk plans, reinsurance facilities and joint underwriting associations, which are mechanisms that
generally provide applicants with various basic insurance coverages when they are not available in
voluntary markets. Such mechanisms are most commonly instituted for automobile and workers
compensation insurance, but many states also mandate participation in FAIR Plans or Windstorm Plans,
which provide basic property coverages. Participation is based upon the amount of a company’s voluntary
market share in a particular state for the classes of insurance involved. Underwriting results related to
these organizations, which tend to be adverse to our company, have been immaterial to our results of
operations.
• Statutory Accounting -- For public reporting, insurance companies prepare financial statements in
accordance with GAAP. However, certain data also must be calculated according to statutory accounting
rules as defined in the NAIC’s Accounting Practices and Procedures Manual.
While not a substitute for any GAAP measure of performance, statutory data frequently is used by industry
analysts and other recognized reporting sources to facilitate comparisons of the performance of insurance
companies.
•
Insurance Reserves -- State insurance laws require that property casualty and life insurance subsidiaries
analyze the adequacy of reserves annually. Our appointed actuaries must submit an opinion that reserves
are adequate for policy claims-paying obligations and related expenses.
• Risk-Based Capital Requirements -- The NAIC’s risk-based capital (RBC) requirements for property casualty
and life insurers serve as an early warning tool for the NAIC and the state regulators to identify companies
that may be undercapitalized and may merit further regulatory action. The NAIC has a standard formula for
annually assessing RBC. The formula for calculating RBC for property casualty companies takes into
account asset and credit risks but places more emphasis on underwriting factors for reserving and pricing.
The formula for calculating RBC for life insurance companies takes into account factors relating to
insurance, business, asset and interest rate risks.
FEDERAL REGULATION
Although the federal government and its regulatory agencies generally do not directly regulate the business of
insurance, federal initiatives often have an impact. Some of the current and proposed federal measures that
may significantly affect our business are discussed below.
•
The Terrorism Risk Insurance Act of 2002 (TRIA) – TRIA was signed into law on November 26, 2002, and
extended on December 22, 2005, in a revised form. TRIA provides a temporary federal backstop for losses
related to the writing of the terrorism peril in property casualty insurance policies. TRIA now is scheduled to
expire December 31, 2007. Under regulations promulgated under this statute, insurers are required to
offer terrorism coverage for certain lines of property casualty insurance, including property, commercial
multi-peril, fire, ocean marine, inland marine, liability, aircraft, surety and workers compensation. In the
event of a terrorism event defined by TRIA, the federal government will reimburse terrorism claim
payments subject to the insurer’s deductible. The deductible is calculated as a percentage of subject
written premiums for the preceding calendar year. Our deductible was $328 million (15 percent of
2004 subject premiums) in 2005, $199 million in 2004 (10 percent of 2003 subject premiums) and
$136 million in 2003 (7 percent of 2002 subject premiums). For 2006, the deductible is an estimated
$318 million (17.5 percent of 2005 subject premiums).
• Health Insurance Portability and Accountability Act of 1996 (HIPAA) – We protect consumer health
information pursuant to regulations promulgated under HIPAA. Regulations effective April 14, 2003,
require health care providers such as doctors and hospitals, as well as health and long-term care insurers
and health care clearinghouses, to institute physical and procedural safeguards to protect the health
records of patients and insureds. Effective October 16, 2003, additional regulations required health plans
to electronically transmit and receive standardized health care information. These rules and regulations
have had a minimal effect on us, as our health insurance writings are limited to our self-funded health plan
for our associates and a small number of run-off medical and hospital expense insurance policies. We do
not actively market health, medical and hospital expense insurance policies.
2005 10-K Page 19
• Office on Foreign Asset Control (OFAC) — Subject to an Executive Order signed on September 24, 2001,
intended to thwart financing of terrorists and sponsors of terrorism, financial institutions were required to
block and report transactions and attempted transactions between their organization and persons and
organizations named in a list published by OFAC. We currently use a combination of software, third-party
vendor and manual searches to accomplish our transaction blocking and reporting activities.
•
Investment Advisers Act of 1940 -- Our subsidiary, CinFin Capital Management Company, operates an
investment advisory business and is therefore subject to regulation by the SEC as a registered investment
adviser under the Investment Advisers Act of 1940. This law imposes certain annual reporting,
recordkeeping, client disclosure and compliance obligations on CinFin Capital Management.
2005 10-K Page 20
Item 1A. Risk Factors
Our business involves various risks and uncertainties that may affect achievement of our business objectives.
Many of the risks could have ramifications across our integrated business activities. For example, while risks
related to setting insurance rates and establishing and adjusting loss reserves are insurance activities, errors
in these areas could have an impact on our investment activities. The following discussion should be viewed as
a starting point for understanding the significant risks we face. It is not a definitive summary of their potential
impact or of our strategies to manage and control the risks. Please see Item 7, Management’s Discussion and
Analysis of Financial Condition and Results of Operations, Page 31, for a discussion of those strategies.
The risks and uncertainties below are not the only ones we face. There are additional risks and uncertainties
that we currently do not believe are material. There also may be risk and uncertainties of which we are not
aware. If any risks or uncertainties discussed here develop into actual events, they could have a material
adverse effect on our business, financial condition or results of operations. In that case, the market price of our
common stock could decline materially.
Readers should carefully consider this information together with the other information we have provided in this
report and in other reports and materials we file periodically with the Securities and Exchange Commission as
well as news releases and other information we disseminate publicly.
We rely exclusively on independent insurance agents to distribute our products.
We market our products through independent, non-exclusive insurance agents. These agents are not obligated
to promote our products and can and do sell our competitors’ products. We must offer insurance products that
meet the needs of these agencies and their clients. We need to maintain good relationships with the agencies
that market our products. If we do not, these agencies may market our competitors’ products instead of ours,
which may lead to us having a less desirable mix of business, which could affect our results of operations.
Events or conditions that could diminish a competitive advantage that our independent agencies enjoy:
• Downgrade of the financial strength ratings of our insurance subsidiaries. We believe our strong insurer
financial strength ratings, in particular the A++ rating from A.M. Best of our property casualty insurance
subsidiaries, are an important competitive advantage. Only 16 other insurance groups, or 1.7 percent of all
insurance groups, qualify for the A++, A.M. Best’s highest rating. If our property casualty ratings were
downgraded, our agents might find it more difficult to market our products or might choose to emphasize
the products of other carriers, which could adversely affect our results of operations.
• Concerns that doing business with us is difficult or perceptions that our level of service is no longer a
distinguishing characteristic in the marketplace. If agents or policyholders believed that we were no longer
providing the prompt, reliable personal service that has long been a distinguishing characteristic of our
insurance operations, our results of operations could be adversely affected.
• Delays in the development, implementation, performance and benefits of technology projects and
enhancements or independent agent perceptions that our technology solutions are inadequate to match
their needs.
A reduction in the number of independent agencies marketing our products, the failure of these agencies to
successfully market our products or the choice of these agencies to reduce their writings of our products could
reduce our revenues and our results of operations if we were unable to replace them with agencies that
produce adequate premiums.
Further, policyholders may choose a competitor’s product rather than our own because of real or perceived
differences in price, terms and conditions, coverage or service. If the quality of the independent agencies with
which we do business were to decline, that also might cause policyholders to purchase their insurance through
different agencies or channels. Increased comfort in Internet purchasing could further reduce independent
agencies' writings of personal lines products.
Please see Item 1, Our Business and Our Strategy, Page 1, for a discussion of our relationships with
independent insurance agents.
Competition could adversely affect our ability to sell policies at rates we deem adequate.
The insurance industry is highly competitive. Competition in our insurance business is based on many factors,
including:
• Competitiveness of premiums charged
• Underwriting and pricing methodologies that allow insurers to identify and flexibly price risks
• Underwriting discipline
•
Terms and conditions of insurance coverage
• Rate at which products are brought to market
2005 10-K Page 21
•
Technological innovation
• Ability to control expenses
• Adequacy of financial strength ratings by independent ratings agencies such as A.M. Best
• Quality of services provided to agents and policyholders
If we were unable to compete effectively because of one or more of these factors, our premium writings could
decline and our results of operations and financial condition could be materially adversely affected.
Please see Item 7, Commercial Lines, Personal Lines and Life Insurance Results of Operations, Page 41,
Page 47, and Page 52, for a discussion of our competitive position in the insurance marketplace.
Managing technology initiatives and meeting new data security requirements are significant
challenges.
While technology can streamline many business processes and ultimately reduce the cost of operations,
technology initiatives present short-term cost and implementation risks. In addition, we may have
inaccurate expense projections, implementation schedules or expectations regarding the efficacy of the
end product. These issues could escalate over time.
Data security is subject to increasing regulation. We face rising costs and competing time constraints in
meeting compliance requirements of new and proposed regulations. Computer viruses, hackers and other
external hazards could expose our data systems to security breaches. These increased risks and
expanding regulatory requirements could expose us to data loss, damages and significant increases in
compliance costs.
Please see Item 1, Technology Solutions, Page 4, for a discussion of our technology initiatives.
The effects of emerging or latent claim and coverage issues on our business are uncertain.
As industry practices and legal, judicial, social and other environmental conditions change, unexpected and
unintended issues related to insurance claims and coverage may emerge. These issues may adversely affect
our business by either extending coverage beyond our underwriting intent or by increasing the number or size
of claims. In some instances, these changes may not become apparent until some time after we have issued
the insurance policies that could be affected by the changes. As a result, the full extent of liability under our
insurance contracts may not be known for many years after a policy is issued. The effects of such
unforeseeable emerging and latent claim and coverage issues could adversely affect our results of operations.
Please see Item 7, Property Casualty and Life Insurance Reserves, Page 61 and Page 67, for a discussion of
our reserving practices.
Our loss reserves, our largest liability, are based on estimates and could be inadequate to cover
our actual losses.
Our financial statements are prepared using GAAP. These principles require us to make estimates and
assumptions that affect the amounts reported in the Consolidated Financial Statements and accompanying
Notes. Actual results could differ materially from those estimates. For a discussion of the significant accounting
policies we use to prepare our financial statements and the material implications of uncertainties associated
with the methods, assumptions and estimates underlying our critical accounting policies, please refer to Item
7, Property Casualty Insurance Loss And Loss Expense Reserves, Page 35, and Item 8, Note 1 to the
Consolidated Financial Statements, Page 84.
Our most critical accounting estimate is of loss reserves. Loss reserves are the amounts we expect to pay for
covered claims and expenses we incur to adjust those claims. The loss reserves we establish in our financial
statements represent an estimate of amounts needed to pay and administer claims arising from insured
events that have occurred, including events that have not yet been reported to us. Loss reserves are estimates
and are inherently uncertain; they do not and cannot represent an exact measure of liability. Accordingly, our
loss reserves for past periods could prove to be inadequate to cover our actual losses and related expenses.
Any changes in these estimates are reflected in our results of operations during the period in which the
changes are made. An increase in our loss reserves would decrease earnings, while a decrease in our loss
reserves would increase earnings.
The estimation process for unpaid loss and loss expense obligations involves uncertainty by its very nature. We
continually review the estimates and adjust the reserve as facts regarding individual claims develop, additional
losses are reported and new information becomes known. Adjustments due to loss development for prior years
are reflected in the calendar year in which they are identified.
2005 10-K Page 22
Unforeseen losses, the type and magnitude of which we cannot predict, may emerge in the future. These
additional losses could arise from changes in the legal environment, catastrophic events, increases in loss
severity or frequency, or other causes. Such future losses could be substantial.
Please see Item 7, Property Casualty and Life Insurance Reserves, Page 61 and Page 67, for a discussion of
our reserving practices.
We could experience an unusually high level of losses due to catastrophic or terrorism events or
risk concentrations.
Our financial condition, cash flow and results of operations depend on our ability to underwrite and set rates
accurately for a full spectrum of risks. We establish our pricing based on assumptions regarding the level of
losses that will occur within classes of business, geographic regions and other criteria. A number of factors
could cause our assumptions regarding future losses to be inaccurate.
In the normal course of our business, we provide coverage for exposures for which estimates of losses are
highly uncertain, in particular catastrophic and terrorism events. Catastrophes can be caused by a number of
events, including hurricanes, tornadoes, windstorms, earthquakes, hailstorms, explosions, severe winter
weather and fires. Due to the nature of these events, we are unable to predict precisely the frequency or
potential cost of catastrophe occurrences. The extent of losses from a catastrophe is a function of both the
total amount of insured exposure in the area affected by the event and the severity of the event.
We have catastrophe exposure to:
• Hurricanes in the gulf and southeastern coastal regions.
• Earthquakes in the New Madrid fault zone, which lies within the central Mississippi valley, extending from
northeast Arkansas through southeast Missouri, western Tennessee and western Kentucky to southern
Illinois, southern Indiana and parts of Ohio.
Tornado, wind and hail in the Midwest, Southeast, mid-Atlantic and Western regions.
•
We have identified terrorism exposure to general commercial risks in the metropolitan Chicago area as well as
small co-op utilities, small shopping malls and small colleges throughout our 32 active states.
Additionally, our life insurance subsidiary could be adversely affected in the event of an epidemic such as the
avian flu, particularly if the epidemic affects a broad range of the population beyond just the very young or the
very old.
Our results of operations would be adversely affected if the level of losses we experienced over a period of time
exceeded our actuarially determined expectations. In addition, our financial condition would be adversely
affected if we were required to sell securities prior to maturity or at unfavorable prices to pay an unusually high
level of loss and loss expenses. Securities pricing might be even less favorable if a number of insurance
companies needed to sell securities during a short period of time because of unusually high losses from
catastrophic events.
Our geographic concentration ties our performance to business, economic and regulatory conditions in certain
states. We market our property casualty insurance product in 32 states, but our business is concentrated in
the Midwest and Southeast. We also have exposure in states where we do not actively market insurance when
clients of our independent agencies have business or properties in multiple states.
The Cincinnati Insurance Company also participates in three assumed reinsurance treaties with two reinsurers
that spread the risk of very high catastrophe losses among many insurers. In 2006, we have exposure to
assumed losses of 1 percent of property losses between $400 million and $1.2 billion from a single event
under an assumed reinsurance treaty for Munich Re Group. The other two assumed reinsurance treaties are
immaterial.
In the event of a severe catastrophic event or terrorist attack elsewhere in the world, our insurance losses may
be immaterial. However, the companies in which we invest might be severely affected, which could affect our
financial condition and results of operations.
Please see Item 7, Property Casualty and Life Insurance Reserves, Page 61 and Page 67, for a discussion of
our reserving practices.
Our ability to obtain or collect on our reinsurance protection could affect our business,
financial condition and results of operations.
We buy property casualty and life reinsurance coverage to mitigate the liquidity risk of an unexpected rise in
claims severity or frequency from catastrophic events or a single large loss. The availability, amount and cost of
reinsurance depend on market conditions and may vary significantly. If we are unable to obtain reinsurance on
acceptable terms and in appropriate amounts, our business and financial condition may be adversely affected.
2005 10-K Page 23
In addition, we are subject to credit risk with respect to our reinsurers. Although we purchase reinsurance to
manage our risks and exposures to losses, this reinsurance does not discharge our direct obligations under the
policies we write. We would remain liable to our policyholders even if we were unable to recover what we
believe we are entitled to receive under our reinsurance contracts. Reinsurers might refuse or fail to pay losses
that we cede to them, or they might delay payment. For long-term cases, the creditworthiness of our reinsurers
may change before we can recover amounts to which we are entitled. A reinsurer’s insolvency, inability or
unwillingness to make payments under the terms of its reinsurance agreement with our insurance subsidiaries
could have a material adverse effect on our financial position and results of operations.
Prior to 2003, we participated in USAIG, a joint underwriting association of individual insurance companies that
collectively function as a worldwide insurance market for all types of aviation and aerospace accounts. At year-
end 2005, 36.9 percent, or $251 million, of our total reinsurance receivables were related to USAIG, primarily
for September 11, 2001, events. Although more than 99 percent of the reinsurance recoverables associated
with USAIG are backed by securities on deposit, if we are unable to collect these receivables, our financial
position and results of operations could be materially affected. We no longer participate in new business
generated by USAIG and its members.
Please see Item 7, 2006 Reinsurance Programs, Page 68, for a discussion of our reinsurance treaties.
Our ability to realize our investment objectives could affect our financial condition or our
results of operation.
We invest premiums received from policyholders and other available cash to generate investment income and
capital appreciation, maintaining sufficient liquidity to pay covered claims and operating expenses, service our
debt obligations and pay dividends. At year-end 2005, our investment portfolio was $12.657 billion, or
79.1 percent of our total assets. In 2005, our investment operations contributed 15.6 percent of our revenue
and 65.1 percent of our total income before income taxes.
Investment income is an important component of our revenues and net income. The ability to achieve our
investment objectives is affected by factors that are beyond our control, such as inflation, economic growth,
interest rates, world political conditions, terrorism attacks or threats and other widespread unpredictable
events. These events may adversely affect the economy generally and could cause our investment income or
the value of securities we own to decrease. A significant decline in our investment income could have an
adverse effect on our net income, and thereby on our shareholders’ equity and our policyholders’ surplus.
For more detailed discussion of risks associated with our investments; please refer to Item 7A, Qualitative and
Quantitative Disclosures About Market Risk, Page 70.
Our investment performance also could suffer because of the types of investments, industry groups and/or
individual securities in which we choose to invest. Market value changes related to these choices could cause a
material change in our financial condition or results of operations.
One of our investments, Fifth Third, accounted for 26.3 percent of our shareholders’ equity at year-end 2005
and dividends earned from our Fifth Third investment were 20.2 percent of our investment income in 2005.
If Fifth Third’s common stock price were to further decline significantly, our financial condition could be
materially affected. If Fifth Third were to decrease or discontinue its dividend, our results of operation could be
materially affected.
Because we currently own more than 10 percent of Fifth Third’s outstanding shares, we are limited in the
amount of Fifth Third stock we could sell in any given period. This limitation could lead us to hold a sizeable
position in Fifth Third even if it would no longer meet our investment parameters. This could result in a variety
of adverse consequences depending on the reason we had concluded Fifth Third no longer met our investment
parameters. For example, if Fifth Third were to stop paying dividends on its common stock, we would not be
able to reinvest quickly in other income-earning investments, which would have a material affect on our results
of operations.
Please see Item 1, Investments Segment, Page 15, and Item 7, Investments Results of Operations, Page 54,
and Liquidity and Capital Resources, Page 57, for discussion of our investment activities.
2005 10-K Page 24
Our status as an insurance holding company with no direct operations could affect our ability
to pay dividends in the future.
Cincinnati Financial Corporation is a holding company that transacts substantially all of its business through its
subsidiaries. Our primary assets are the stock in our operating subsidiaries and our investments. Consequently,
our cash flow to pay cash dividends and interest on our long-term debt depends on dividends we receive from
our operating subsidiaries and income earned on investments held at the parent-company level.
Dividends paid to us by our insurance subsidiary are restricted by the insurance laws of Ohio, our domiciliary
state. These laws establish minimum solvency and liquidity thresholds and limits. Currently, the maximum
dividend that may be paid without prior regulatory approval is limited to the greater of 10 percent of statutory
surplus or 100 percent of statutory net income for the prior calendar year, up to the amount of statutory
unassigned surplus as of the end of the prior calendar year. Dividends exceeding these limitations may be paid
only with prior approval of the Ohio Department of Insurance. Consequently, at times, we might not be able to
receive dividends from our insurance subsidiary or we might not receive dividends in the amounts necessary to
meet our debt obligations or to pay dividends on our common stock. This could affect our financial position.
Please see Item 1, Regulation, Page 18, and Item 8, Note 8 to the Consolidated Financial Statements,
Page 91, for discussion of insurance holding company dividend regulations.
We could make investment decisions or experience market value fluctuations that trigger
restrictions applicable to the parent company under the Investment Company Act of 1940.
Compared to other insurance holding companies, we hold a significant level of investment assets at the parent
company level. If these investment assets grow to account for more than 40 percent of parent company’s total
assets, excluding assets of our subsidiaries, we might become subject to regulation under the Investment
Company Act of 1940. Our operations are limited by the constraint that investment securities held at the
holding company level should remain below the 40 percent threshold described above. Efforts to stay below
the threshold could result in:
• Disposal of otherwise desirable investment securities, possibly under undesirable conditions. Such
dispositions could result in a lower return on investment, loss of investment income, and if we were unable
to manage the timing of the dispositions, we also might realize unnecessary capital gains, which would
increase our annual tax payment.
•
Limited opportunities to purchase equity securities that hold the potential for market value appreciation,
which could hamper book value growth over the long term.
• Maintenance of a greater portion of our portfolio of equity securities at the insurance subsidiary, which
would cause the parent to be more reliant on its subsidiaries for cash to fund parent-company obligations,
including shareholder dividends and interest on long-term debt.
If the parent company’s investment assets were to exceed the 40 percent ratio to total assets, excluding
investment in its subsidiaries, and if it were determined that the holding company was an unregistered
investment company, the holding company might be unable to enforce contracts with third parties, and third
parties could seek rescission of transactions with the holding company undertaken during the period that it
was an unregistered investment company, subject to equitable considerations set forth in the Investment
Company Act. In addition, the holding company could become subject to monetary penalties or injunctive relief,
or both, in an action brought by the SEC.
Please see Item 8, Note 15 to the Consolidated Financial Statements, Page 96, for discussion of the
Investment Company Act of 1940.
Item 1B.
None
Unresolved Staff Comments
2005 10-K Page 25
Properties
Item 2.
Cincinnati Financial Corporation owns our headquarters building located on 100 acres of land in Fairfield, Ohio.
This building contains approximately 800,000 total square feet. The property, including land, is carried in our
financial statements at $73 million as of December 31, 2005, and is classified as land, building and
equipment, net, for company use. John J. & Thomas R. Schiff & Co. Inc., a related party, occupies approximately
6,750 square feet (1 percent).
In 2004, we decided to undertake a $100 million building expansion at our headquarters location in Fairfield,
Ohio. Construction of an underground garage and third office tower began in early 2005. The new tower will
contain more than 690,000 total square feet, including the garage. It will rise seven stories above three
underground parking levels with 700 parking spaces. We estimate a completion date of September 2008 for
the project. We believe this expansion will accommodate our business needs for the foreseeable future. The
construction project is on schedule and on budget. As of December 31, 2005, construction costs totaled
$18 million.
Cincinnati Financial Corporation owns the Fairfield Executive Center, which is located on the northwest corner
of our headquarters property in Fairfield, Ohio. This is a four-story office building containing approximately
124,000 square feet. The property is carried in the financial statements at $7 million as of December
31, 2005, and is classified as land, building and equipment, net, for company use. CFC and our subsidiaries
occupy approximately 90 percent of the rentable square feet and unaffiliated tenants occupy approximately
10 percent.
The Cincinnati Life Insurance Company owns a four-story office building in the Tri-County area of
Cincinnati, Ohio. It contains approximately 102,000 rentable square feet. This property is carried in the
financial statements at $3 million as of December 31, 2005, and is classified as other invested assets.
Three tenants occupy approximately 50 percent of the rentable square feet. The remaining space is available
for lease.
Item 3.
Neither the company nor any of our subsidiaries is involved in any material litigation other than ordinary,
routine litigation incidental to the nature of our business.
Item 4.
No matters were submitted to a vote of security holders of Cincinnati Financial during the fourth
quarter of 2005.
Submission of Matters to a Vote of Security Holders
Legal Proceedings
2005 10-K Page 26
Part II
Item 5.
Market for the Registrant’s Common Equity, Related
Stockholder Matters and Issuer Purchases of Equity
Securities
Cincinnati Financial Corporation had approximately 12,000 shareholders of record as of December 31, 2005.
Many of our independent agent representatives and most of the 3,983 associates of our subsidiaries own the
company’s common stock. We are unable to accurately quantify those holdings because many are beneficially
held.
Our common shares are traded under the symbol CINF on the Nasdaq National Market. The common stock
prices and dividend data below reflect the 5 percent stock dividends paid June 15, 2004 and April 26, 2005.
(Source: Nasdaq National Market)
Quarter:
1st
2nd
2005
3rd
4th
1st
2004
2nd
3rd
High
Low
Period-end close
Cash dividends declared
$
43.92 $
40.84
41.53
0.290
43.12 $
38.38
39.56
0.305
42.64 $
39.00
41.89
0.305
45.95 $
39.91
44.68
0.305
41.61 $
37.02
39.41
0.250
41.78 $
37.90
41.45
0.262
41.70 $
37.46
39.26
0.262
4th
43.52
36.57
42.15
0.262
Our ability to pay cash dividends may depend on the ability of our insurance subsidiary to pay dividends to the
parent company. The dividend restrictions of our insurance company subsidiaries are discussed in Item 8,
Note 8 to the Consolidated Financial Statements, Page 91.
Information regarding securities authorized for issuance under our equity compensation plans appears in the
Proxy Statement under “Equity Compensation Plan Information.” This portion of the Proxy Statement is
incorporated herein by reference. Additional information about options granted under our equity compensation
plans is available in Item 8, Note 8 and Note 16 to the Consolidated Financial Statements, Pages 91 and 97.
The board of directors has authorized share repurchases since 1996. We discuss the board authorization in
Item 7, Uses of Capital, Page 61. In 2005, we repurchased a total of 1,500,000 shares (unadjusted for stock
dividends).
Month
January 1 -31, 2005
February 1-28, 2005
March 1-31, 2005
April 1-30, 2005
May 1-31, 2005
June 1-30, 2005
July 1-31, 2005
August 1-31, 2005
September 1-30, 2005
October 1-31, 2005
November 1-30, 2005
December 1-31, 2005
Totals
Total number of
shares purchased
Average price
paid per share
Total number of shares
purchased as part of
publicly announced
plans or programs
Maximum number of
shares that may yet be
purchased under the
plans or programs
0 $
0
115,000
162,728
379,172
308,100
0
1,035
159,157
0
0
374,808
1,500,000
0.00
0.00
45.54
39.58
39.26
39.41
0.00
39.95
41.74
0.00
0.00
45.13
41.54
0
0
115,000
162,728
379,172
308,100
0
1,035
159,157
0
0
374,808
1,500,000
3,705,977
3,705,977
3,590,977
3,428,249
3,049,077
2,740,977
2,740,977
2,739,942
9,840,843
9,840,843
9,840,843
9,466,035
a) The current repurchase program became effective on September 1, 2005. It replaced a program announced on
February 6, 1999, which replaced a program approved in 1996 and updated in 1998.
b) The share amount approved for repurchase in 2005 was 10 million shares and the share amount approved for
repurchase in 1999 was 17 million shares.
c) The current repurchase program has no expiration date.
d) No repurchase program has expired during the period covered by the above table.
e) The program approved in 1999 was terminated prior to the expiration date when the board approved the current
program in August 2005. The program approved in 1996 and updated in 1998 was terminated prior to expiration
when the board approved a program in February 1999. There have been no programs for which the issuer has not
intended to make further purchases.
2005 10-K Page 27
Item 6.
Selected Financial Data
(In millions except per share data)
Consolidated Income Statement Data
Earned premiums
Investment income, net of expenses
Gross realized investment gains and losses
Total revenues
Net income
Net income per common share:
Basic
Diluted
Cash dividends per common share:
Declared
Paid
Shares outstanding
Weighted average, diluted
Consolidated Balance Sheet Data
Invested assets
Deferred policy acquisition costs
Total assets
Loss and loss expense reserves
Life policy reserves
Long-term debt
Shareholders' equity
Book value per share
Property Casualty Insurance Operations
Earned premiums
Unearned premiums
Loss and loss expense reserves
Investment income, net of expenses
Loss ratio
Loss expense ratio
Expense ratio
Combined ratio
$
$
$
$
Years ended December 31,
2005
2004
2003
2002
$
$
$
$
3,164
526
61
3,767
602
3.44
3.40
1.205
1.162
177
12,702
429
16,003
3,661
1,343
791
6,086
34.88
3,058
1,557
3,629
338
49.2 %
10.0
30.0
89.2 %
$
$
$
$
3,020
492
91
3,614
584
3.30
3.28
1.04
1.02
178
12,677
400
16,107
3,549
1,194
791
6,249
35.60
2,919
1,537
3,514
289
49.8 %
10.3
29.7
89.8 %
$
$
$
$
2,748
465
(41)
3,181
374
2.11
2.10
0.90
0.89
178
12,485
372
15,509
3,415
1,025
420
6,204
35.10
2,653
1,444
3,386
245
56.1 %
11.6
27.0
94.7 %
2,478
445
(94)
2,843
238
1.33
1.32
0.81
0.80
180
11,226
343
14,122
3,176
917
420
5,598
31.43
2,391
1,317
3,150
234
61.5 %
11.4
26.8
99.7 %
Per share data adjusted to reflect all stock splits and dividends prior to December 31, 2005.
One-time charges or adjustments:
2003 -- As the result of a settlement negotiated with a vendor, pretax results included the recovery of
$23 million of the $39 million one-time, pretax charge incurred in 2000.
2000 -- The company recorded a one-time charge of $39 million, pretax, to write down previously capitalized
costs related to the development of software to process property casualty policies.
2000 -- The company earned $5 million in interest in the first quarter from a $303 million single-premium
bank-owned life insurance (BOLI) policy booked at the end of 1999 that was segregated as a Separate Account
effective April 1, 2000. Investment income and realized investment gains and losses from separate accounts
generally accrue directly to the contract holder and, therefore, are not included in the company’s consolidated
financials.
2005 10-K Page 28
2001
2000
1999
1998
1997
1996
1995
$
$
$
$
$
$
$
$
2,152
421
(25)
2,561
193
1.10
1.07
0.76
0.74
179
11,534
286
13,964
2,887
724
426
5,998
33.62
2,073
1,060
2,894
223
66.6 %
10.1
28.2
104.9 %
$
$
$
$
1,907
415
(2)
2,331
118
0.67
0.67
0.69
0.67
181
11,276
259
13,274
2,473
641
449
5,995
33.80
1,828
920
2,416
223
71.1 %
11.3
30.4
112.8 %
$
$
$
$
1,732
387
0
2,128
255
1.40
1.37
0.62
0.60
186
10,156
226
11,795
2,154
885
456
5,421
30.35
1,658
835
2,093
208
61.6 %
10.0
28.6
100.2 %
$
$
$
$
1,613
368
65
2,054
242
1.31
1.28
0.55
0.54
190
10,296
143
11,484
2,055
536
472
5,621
30.58
1,543
458
1,979
204
65.4 %
9.3
29.6
104.3 %
$
$
$
$
1,516
349
69
1,942
299
1.64
1.61
0.50
0.49
188
8,778
135
9,867
1,937
482
58
4,717
25.71
1,454
442
1,889
199
58.3 %
10.1
30.0
98.4 %
$
$
$
$
1,423
327
48
1,809
224
1.21
1.17
0.44
0.43
191
6,340
128
7,397
1,881
440
80
3,163
17.19
1,367
424
1,824
190
61.6 %
13.8
28.2
103.6 %
1,314
300
31
1,656
227
1.24
1.19
0.39
0.38
191
5,525
120
6,439
1,744
403
80
2,658
14.33
1,263
407
1,691
180
57.6 %
14.7
27.8
100.1 %
2005 10-K Page 29
10-K Page
Item 7. Management’s Discussion and Analysis of Financial
Condition and Results of Operations
Introduction
Executive Summary
Critical Accounting Estimates
Results of Operations
Consolidated Property Casualty Insurance Results
of Operations
Commercial Lines Insurance Results of Operations
Personal Lines Insurance Results of Operations
Life Insurance Results of Operations
Investments Results of Operations
Liquidity and Capital Resources
Sources of Liquidity
Uses of Liquidity
Property Casualty Insurance Reserves
Life Insurance Reserves
2006 Reinsurance Programs
Safe Harbor Statement
31
31
35
39
40
41
47
52
54
57
57
59
61
67
68
69
Item 7A. Quantitative and Qualitative Disclosures About Market Risk
Introduction
Fixed-maturity Investments
Short-term Investments
Equity Investments
Unrealized Investment Gains and Losses
70
71
72
72
74
2005 10-K Page 30
Item 7.
Management's Discussion and Analysis of Financial
Condition and Results of Operations
INTRODUCTION
The purpose of Management’s Discussion and Analysis is to provide an understanding of Cincinnati Financial
Corporation’s consolidated results of operations and financial position. Management’s Discussion and Analysis
should be read in conjunction with Item 6, Selected Financial Data, Pages 28 and 29, and Item 8, Consolidated
Financial Statements and related Notes, beginning on Page 77. We present per share data on a diluted basis
unless otherwise noted and we have adjusted those amounts for all stock splits and dividends, including the
5 percent stock dividend paid on April 26, 2005.
We begin with an executive summary of our results of operations and outlook, as well as details on critical
accounting policies and estimates. Periodically, we refer to estimated industry data so that we can give
information on our performance versus the overall insurance industry. Unless otherwise noted, the industry
data is prepared by A.M. Best, a leading insurance industry statistical, analytical and financial strength rating
organization. Information from A.M. Best is presented on a statutory basis. When we provide our results on a
comparable statutory basis, we label it as such; all other company data is presented on a GAAP basis.
EXECUTIVE SUMMARY
Cincinnati Financial Corporation is the parent company of the nation’s 19th largest publicly traded property
casualty insurer, based on statutory net written premium volume through the first nine months of 2005. We
primarily market commercial lines and personal lines property casualty insurance products through a select
group of independent insurance agencies in 32 states. As we discussed in the business description in Item 1,
we believe three characteristics distinguish our company and allow us to build shareholder value:
• We cultivate relationships with the independent insurance agents who market our policies and we make
our decisions at the local level
• We achieve claims excellence, covering the spectrum from our response to reported claims to our
approach to establishing reserves for not-yet-paid claims
• We invest for long-term total return, using available cash flow to purchase equity securities after covering
insurance liabilities by purchasing fixed-maturity securities
We provide additional detail on these subjects in the Results of Operations and Liquidity and Capital Resources
sections of this discussion.
Among the factors that influence the consolidated results of operations and financial position of the company,
we consider our relationships with independent insurance agents to be the most significant. We seek to be an
indispensable partner in each agency’s success. To continue to achieve our performance targets, we must
maintain these strong relationships, write a significant portion of each agency’s business and attract new
agencies.
Conditions in the property casualty markets were challenging in 2005, as we discuss in the business
description in Item 1, Our Business and Our Strategy, Page 1. In the commercial lines marketplace, competition
continues to accelerate, resulting in a lower premium growth rate. In the personal lines marketplace, our
personal lines rates in some territories have not been in a competitive range that would allow our agents to
market the benefits of our products, resulting in declining policy retention and lower new business.
We believe consistently applying our long-term strategies rather than taking short-term actions will allow us to
address these challenges. We seek to meet our agents’ needs, with an eye toward solutions and approaches
that will give us an advantage for five, 10 or even more years. As we appoint new agencies, we are looking to
build relationships that will grow as successfully as those we have had for 40 or 50 years.
In 2005, we achieved most of our objectives for creating shareholder value, as we discuss on Page 33.
Although unrealized gains have been down in the past several years because of the decline in the market value
of our Fifth Third investment, we believe our portfolio continues to have the potential to increase investment
income and provide capital appreciation over the long term.
Below we review highlights of our financial results for the past three years and measures of the success of our
efforts to create shareholder value.
2005 10-K Page 31
CORPORATE FINANCIAL HIGHLIGHTS
Income Statement and Per Share Data
(Dollars in millions except share data)
Income statement data
Earned premiums
Investment income, net of expenses
Net realized gains and losses (pretax)
Total revenues
Net income
Per share data (diluted)
Net income
Cash dividends declared
2005
2004
2003
2005-2004
Change %
2004-2003
Change %
$
3,164 $
526
61
3,767
602
3.40
1.205
3,020 $
492
91
3,614
584
3.28
1.04
2,748
465
(41)
3,181
374
2.10
0.90
4.8
6.9
(33.1)
4.2
3.1
3.7
16.1
(0.7)
9.9
5.7
321.7
13.6
56.0
56.4
14.4
0.0
Weighted average shares outstanding
177,116,126
178,376,848
178,292,248
In 2005, we reported record results, as described in detail in the results of operations.
Revenue growth was slower in 2005 than in 2004 because of slowing consolidated property casualty earned
premium growth due to market conditions. Pretax investment income growth accelerated over the three years.
Realized gains made a positive contribution in 2005 and 2004 although we recorded a realized loss in 2003.
Net income and net income per share reached record levels in 2005 although the growth rates were
substantially lower in 2005 than in 2004. A number of factors affected the annual growth rates, including:
•
The consolidated property casualty underwriting profit improved substantially in 2004 and we sustained
healthy profitability in 2005. The factors behind the improvement are discussed in the Results of
Operations.
• Realized investment gains and losses are integral to our financial results over the long term. We have
substantial discretion in the timing of investment sales and, therefore, the gains or losses that will be
recognized in any period. That discretion generally is independent of the insurance underwriting process.
Also, applicable accounting standards require us to recognize gains and losses from certain changes in fair
values of securities and embedded derivatives without actual realization of those gains and losses.
Security sales led to realized gains in 2005 and 2004 while write-downs of impaired assets led to realized
losses in 2003.
○ 2005 − Realized investment gains raised net income by $40 million, or 23 cents per share, after tax
○ 2004 − Realized investment gains raised net income by $60 million, or 34 cents per share, after tax
○ 2003 − Realized investment losses reduced net income by $27 million, or 15 cents per share, after tax
• Weighted average shares outstanding may fluctuate from period to period because we regularly
repurchase shares under board authorizations and we issue shares when associates exercise stock
options. At year-end 2005, weighted average shares outstanding on a diluted basis had declined
1.3 million from year-end 2004.
•
In 2003, we recovered $23 million pretax from a settlement negotiated with a vendor. The recovery added
$15 million, or 8 cents per share, to net income. The negotiated settlement related to the $39 million
one-time, pretax charge incurred in 2000 to write off previously capitalized software development costs.
The board of directors is committed to steadily increasing cash dividends and periodically authorizing stock
dividends and splits. Cash dividends declared per share rose 16.1 percent and 14.4 percent in 2005
and 2004.
Balance Sheet Data and Performance Measures
(Dollars in millions except share data)
$
Balance Sheet Data
Invested assets
Total assets
Long-term debt
Shareholders' equity
Book value per share
Performance measures
Comprehensive income
Return on equity
Return on equity, based on comprehensive income
Debt-to-capital ratio
$
2005
2004
2003
$
12,702
16,003
791
6,086
34.88
$
99
9.8 %
1.6
11.5
$
12,677
16,107
791
6,249
35.60
$
287
9.4 %
4.6
11.2
12,485
15,509
420
6,204
35.10
815
6.3 %
13.8
8.9
2005-2004
Change %
2004-2003
Change %
0.2
(0.6)
0.0
(2.6)
(2.0)
1.5
3.9
88.4
0.7
1.4
(65.8)
(64.8)
2005 10-K Page 32
Invested assets and total assets have been relatively flat over the past two years as strong cash flow has been
offset by lower unrealized investment gains. This led to a modest decline in shareholders’ equity and book
value in 2005.
Comprehensive income is net income plus the change in net other accumulated comprehensive income.
Change in net other accumulated comprehensive income is the year-over-year difference in unrealized gains on
investments. In 2005 and 2004, comprehensive income declined because lower unrealized gains more than
offset the increase in net income. Unrealized gains were down primarily because of a decline in the market
value of our Fifth Third investment.
With net income growing and shareholders’ equity declining, return on equity rose over the past three years.
Return on equity based on comprehensive income, however, declined in line with total comprehensive income.
We issued $375 million of long-term debt in 2004, raising total long-term debt to $791 million at
year-end 2005 and 2004. Our ratio of long-term debt to capital (long-term debt plus shareholders’ equity) rose
in 2004 following the new debt issue and remained stable in 2005.
Property Casualty Highlights
(Dollars in millions)
Property casualty highlights
Written premiums
Underwriting profit
GAAP combined ratio
Statutory combined ratio
2005
2004
2003
$
$
3,076
330
89.2 %
89.0
$
2,997
298
89.8 %
89.4
2,815
140
94.7 %
94.2
2005-2004
Change %
2004-2003
Change %
2.6
10.8
6.5
113.3
The declining trend in overall written premium growth reflected the market factors discussed in Item 1,
Commercial Lines and Personal Lines Property Casualty Insurance Segments, Page 10 and Page 11. In each of
the past three years, our overall written premium growth rate has exceeded that of the industry. The estimated
industry growth rate was 0.7 percent, 4.7 percent and 9.6 percent in 2005, 2004 and 2003, respectively. The
2005 overall industry premium growth rate included an estimated 33.9 percent decline in reinsurance sector
premiums.
Our consolidated property casualty insurance underwriting profit rose in 2005 and 2004, and our combined
ratio improved each year. (The combined ratio is the percentage of each premium dollar spent on claims plus
all expenses -- the lower the ratio, the better the performance.) The 2005 improvement reflected lower
catastrophe losses, continued strong commercial lines underwriting results, a return to underwriting
profitability for personal lines and above-average savings from favorable loss reserve development from prior
accident years. The 2004 improvement reflected growth in premiums, in particular more adequate premium
per policy, the benefits of other underwriting efforts and above-average savings from favorable loss reserve
development from prior accident years.
The estimated industry average statutory combined ratios were 102.0 percent, 98.1 percent and
100.2 percent for 2005, 2004 and 2003, respectively. The 2005 overall industry combined ratio included an
estimated 150.7 percent reinsurance sector ratio.
We also measure a variety of non-financial metrics for our property casualty operations. For example, we
monitor our rank within our reporting agency locations. In 2004, we ranked No. 1 or No. 2 by premium volume
in 74 percent of the locations that have marketed our products for more than five years. Other measures
include subdivision of territories and new agency appointments. In 2005, we subdivided eight field territories,
raising the total to 100, and appointed 41 new agency relationships. These new appointments and other
changes in agency structures led to a net increase in reporting agency locations of 40 in 2005.
Agent satisfaction with our technology solutions is, and will continue to be, a requirement for maintaining our
strong relationships with these agencies. In 2005, we made additional progress in implementing technology
solutions that we believe should make it easier for agencies to do business with us. Among other milestones,
we deployed our new commercial lines policy processing system to all of our agencies in Ohio for use in
processing new and renewal businessowners policies. We also deployed our personal lines policy processing
system in two additional states and made important upgrades and enhancements.
MEASURING OUR SUCCESS IN 2006 AND BEYOND
We use a variety of metrics to measure the success of our strategies:
• Maintaining our strong relationships with our established agencies, writing a significant portion of each
agency’s business and attracting new agencies – In 2006, we expect to continue to rank No. 1 or No. 2 by
premium volume in at least 74 percent or more of the locations that have marketed our products for more
than five years. We expect to subdivide three field territories in 2006 and we are targeting 50 new agency
appointments.
2005 10-K Page 33
In 2006, we expect to make further progress in our efforts to improve service to and communication with
our agencies through our expanding portfolio of software. In particular, we will continue to deploy our
commercial lines and personal lines quoting and policy processing systems that allow our agencies and our
field and headquarters associates to collaborate on new and renewal business more efficiently and give
our agencies choice and control. We discuss our technology plans for 2006 in Item 1, Technology
Solutions, Page 4.
• Achieving above-industry-average growth in property casualty statutory net written premiums and
maintaining industry-leading profitability by leveraging our regional franchise and proven agency-centered
business strategy -- We believe our consolidated property casualty written premiums will be flat to slightly
up in 2006 compared with the 2.6 percent increase in 2005. We may not achieve our objective of above-
industry-average growth in 2006 because the modest growth we anticipate in commercial lines written
premiums, despite increasing competition, may be offsetting the rate-driven declines we anticipate in
personal lines written premiums. In addition, the overall industry premium growth is estimated at
3.3 percent in 2006, which includes an estimated 18.6 percent reinsurance sector growth rate.
The 2006 industry growth rate for the commercial lines sector is estimated at 2.3 percent and the personal
lines sector is estimated at 2.9 percent.
Our combined ratio estimate for 2006 is 92 percent to 94 percent on either a GAAP or statutory basis
compared with 89.2 percent on a GAAP basis in 2005. We believe the most significant difference will be a
lower level of savings from favorable loss reserve development from prior accident years. In 2006,
we believe that savings is likely to reduce the combined ratio in the range of 2 to 3 percentage points.
Higher-than-normal savings, particularly for liability coverages, reduced the 2005 combined ratio by
5.2 percentage points and the 2004 combined ratio by 6.7 percentage points.
We also have raised slightly our estimate of the impact to the 2006 combined ratio from catastrophe
losses to the range of 4.0 and 4.5 percentage points from our historic range of 3.0 to 3.5 percentage
points. We are taking into account the potential for severe weather, as we’ve seen in the past two years,
and the higher retention on our new catastrophe reinsurance treaty. Both the loss and loss expense ratio
and underwriting expense ratio trends could affect the combined ratios for our commercial lines and
personal lines segments:
○ The degree of price softening in the commercial lines marketplace will affect the 2006 loss and loss
expense ratio for that business area, as that ratio may move up slightly as pricing becomes more
competitive.
○ The personal lines 2006 loss and loss expense ratio primarily will reflect our ability to offer competitive
prices for our personal lines products in that changing marketplace. We believe we have taken the
appropriate actions to maintain that ratio near the improved level we achieved in 2005.
○ For both commercial lines and personal lines, lower growth rates could lead to further unfavorable
year-over-year comparisons in the ratios of deferred acquisition costs and other underwriting expenses
to earned premiums. Continued investment in technology also may contribute to an increase in other
underwriting expenses.
The estimated industry average 2006 combined ratio is 98.7 percent.
• Pursuing a total return investment strategy that generates both strong investment income growth and
capital appreciation − In 2006, we are estimating pretax investment income growth to again be in the
range of 6.5 percent to 7.0 percent. This outlook is based on the higher anticipated level of dividend
income from equity holdings, the investment of insurance operations cash flow and the higher-than-
historical allocation of new cash flow to fixed-maturity securities over the past 18 months.
We do not establish annual capital appreciation targets. Over the long term, our target is to have the equity
portfolio outperform the Standard & Poor’s 500 Index. Over the five years ended December 31, 2005,
our compound annual equity portfolio return was a negative 0.8 percent compared with a compound
annual total return of 0.5 percent for the Index. In 2005, our compound annual equity portfolio was a
negative 4.2 percent, compared with a compound annual total return of 4.9 percent for the Index. Our
equity portfolio underperformed the market for these periods because of the decline in the market value of
our holdings of Fifth Third common stock over the past five years.
•
Increasing the total return to shareholders through a combination of higher earnings per share, growth in
book value and increasing dividends − We do not announce annual targets for earnings per share or book
value. Earnings results in 2006 will be tempered by the first quarter adoption of Statement of Financial
Accounting Standards (SFAS) No. 123(R) “Share-Based Payments,” which requires expensing the cost of
associate options on our income statement. Our estimate of pro forma option expense, as detailed
in Item 8, Note 1 to the Consolidated Financial Statements, Page 84, would have reduced earnings per
share by 7 cents to 8 cents in each of the past three years.
2005 10-K Page 34
Over the long term, we look for our earnings per share growth to outpace that of a peer group of national
and regional property casualty insurance companies. Long-term book value growth should approximate
that of our equity portfolio.
The board of directors is committed to steadily increasing cash dividends and periodically authorizing stock
dividends and splits. In February 2006, the board increased the indicated annual dividend rate
9.8 percent, marking the 46th consecutive year of increases in our indicated dividend rate. We believe our
record of dividend increases is matched by only 11 other publicly traded corporations.
Over the long-term, we seek to increase earnings per share, book value and dividends at a rate that would
allow long-term total return to our shareholders to exceed that of the Standard & Poor’s Composite
1500 Property Casualty Insurance Index. Over the past five years, our total return to shareholders of
40.9 percent matched the return on that Index.
• Maintaining financial strength by keeping the ratio of debt to capital below 15 percent and purchasing
reinsurance to provide investment flexibility − Based on our present capital requirements, we do not
anticipate a material increase in debt levels during 2006. As a result, we believe our debt-to-capital ratio
will remain in the range of 11 percent to 12 percent.
In December 2005, we finalized our reinsurance program for 2006, updating it to maintain the balance
between the cost of the program and the level of risk we retain. Under the new program, our
2006 reinsurance premiums are expected to be $7 million lower than 2005, without taking into account
the reinstatement premium incurred in 2005. We provide more detail on our reinsurance programs in
2006 Reinsurance Programs, Page 68.
Factors supporting our outlook for 2006 are discussed below in the Results of Operations for each of the four
business segments.
CRITICAL ACCOUNTING ESTIMATES
Cincinnati Financial Corporation’s financial statements are prepared using GAAP. These principles require
management to make estimates and assumptions that affect the amounts reported in the Consolidated
Financial Statements and accompanying Notes. Actual results could differ materially from those estimates.
The significant accounting policies used in the preparation of the financial statements are discussed in Item 8,
Note 1 to the Consolidated Financial Statements, Page 84. In conjunction with that discussion, material
implications of uncertainties associated with the methods, assumptions and estimates underlying the
company’s critical accounting policies are discussed below. The audit committee of the board of directors
reviews the annual financial statements with management and the independent registered public accounting
firm. These discussions cover the quality of earnings, review of reserves and accruals, reconsideration of the
suitability of accounting principles, review of highly judgmental areas including critical accounting policies,
audit adjustments and such other inquiries as may be appropriate.
PROPERTY CASUALTY INSURANCE LOSS AND LOSS EXPENSE RESERVES
Overview
Our most significant estimates relate to our reserves for property casualty loss and loss expenses. We believe
that the stability of our business makes our historical data the most important source for establishing adequate
reserve levels. We base reserve estimates on company experience and information from internal analyses and
obtain additional information from the appointed actuary. When reviewing reserves, we analyze historical data
and estimate the effect of various loss factors. We believe that the following represent the primary risks to our
ability to estimate loss reserves accurately:
• Court decisions or legislation that result in unanticipated coverage expansions on past and existing policies
• Changes in medical inflation and mortality rates that affect workers compensation claims
• Changes in claim cost trends, including the effects of general economic and tort cost inflation, not
reflected in the historical data used to estimate loss reserves
• Changes in reinsurance coverage, not reflected in reserving data, that affect the company's net payments
and net case reserves
• Payment and reporting pattern changes attributable to the implementation of a new claims management
system
• Reporting pattern changes attributable to changes in case reserving practices, particularly with respect to
umbrella liability claims
• Absence of cost-effective methods for accurately assessing asbestos and environmental claim liabilities
(see Property Casualty Insurance Reserves, Asbestos and Environmental Reserves, Page 63, for discussion
of related reserve levels and trends)
2005 10-K Page 35
Any of these factors could cause our ultimate loss experience to be better or worse than reserves held, and the
difference could be material. To the extent that reserves are inadequate and strengthened, the amount of such
increase is treated as a charge in the period that the deficiency is recognized, raising the loss and loss expense
ratio and reducing earnings. To the extent that reserves are redundant and released, the amount of the release
is a credit in the period that the redundancy is recognized, reducing the loss and loss expense ratio and
increasing earnings.
A reserve change of $31 million would have a 1 percentage point effect on the loss and loss expense ratio,
based on 2005 earned premiums, a $20 million effect on income and an 11 cent effect on net income per
share.
Establishing Reserves
Reserves are established for the total of unpaid loss and loss expenses, including estimates for claims that
have been reported, estimates for claims that have been incurred but not yet reported (IBNR) and estimates of
loss expenses associated with processing and settling those claims. Reserves are determined for the various
lines of business. Loss reserves are reduced by salvage and subrogation reserves.
We establish case reserves for claims that have been reported within the parameters of coverage provided in
the policy. Individual case reserves greater than $35,000 established by field claims representatives are
reviewed by experienced headquarters claims supervisors while case reserves greater than $100,000 also are
reviewed by headquarters claims managers. The estimates reflect informed judgment and experience of our
claims associates based on general insurance reserving practices and their experience with the company. Case
reserves are reviewed on a 90-day cycle, or more frequently if specific circumstances require, based on events
such as the status of ongoing negotiations.
The anticipated effect of inflation is implicitly considered when estimating reserves for loss and loss expenses.
While anticipated cost increases due to inflation are considered in estimating ultimate claim costs, increases in
average severity of claims are caused by a number of factors that vary by individual type of policy. Average
severity projections are based on historical trends adjusted for anticipated changes in underwriting standards,
policy provisions and general economic trends. We do not discount any of our property casualty loss and loss
expense reserves.
In 2001, we began to establish higher initial case reserves on serious injury claims to reflect recent experience
indicating the likelihood that juries would ignore significant liability issues in cases involving seriously injured
claimants.
To establish IBNR reserves on an annual basis, we use a variety of tools, including actuarial and statistical
methods. These may include but are not limited to:
•
•
•
The Case Incurred Development Method
The Paid Development Method
The Bornhuetter-Ferguson Method
• Probability Trend Family Methods
Supplemental statistical information is compiled and reviewed to aid in the application of the actuarial
methods. The supplemental data also is used to evaluate the reasonableness of estimates derived from the
actuarial methods. This information includes:
•
Industry loss frequency and severity and premium trends
• Past, present and anticipated product pricing
• Anticipated premium growth
• Other quantifiable trends
• Projected ultimate loss ratios
We conduct our thorough evaluation of the adequacy of reserves as of the end of the third quarter of each year.
As a result, the most significant refinements in reserves historically have been implemented in the fourth
quarter. Beginning in 2006, we are conducting a detailed supplemental review as of the end of the fourth
quarter of each year in parallel with the outside actuarial review. Less detailed, periodic reviews of reserve
adequacy are made at the other quarter ends. A loss review committee, including internal actuaries and
representatives from management of multiple operating departments, is responsible for the quarterly review
process.
The internal actuaries provide a point estimate and a range to summarize their analysis. At year-end 2005 and
2004, IBNR reserves differed from the internal actuarial point estimate by less than 1 percent of our loss and
loss expense reserve.
2005 10-K Page 36
Adjusting Reserves
While we believe that reported reserves provide for all unpaid loss and loss expense obligations, the estimation
processes involve a number of variables and assumptions. We believe this uncertainty is mitigated by the
historical stability of our book of business and by our periodic reviews of estimates. As loss experience
develops and new information becomes known, the reserves are reviewed and adjusted as appropriate. In this
process, we monitor trends in the industry, cost trends, relevant court cases, legislative activity and other
current events in an effort to ascertain new or additional exposures to loss. If we determine that reserves
established in prior years were not sufficient or were excessive, the change is reflected in current-year results.
Actuarial Review
As part of our internal processes, we utilize an appointed actuary to provide management with an opinion
regarding an acceptable range for adequate statutory reserves based on generally accepted actuarial
guidelines.
Historically, we have established adequate reserves that have fallen in the upper half of the appointed
actuary's range. This approach has resulted in recognition of reserve redundancies for the past 10 years, as we
discuss in Development of Loss and Loss Expenses, Page 62. Modestly redundant reserves support our
business strategy to retain high financial strength ratings and remain a market for agencies' business in all
market conditions.
The appointed actuary conducts a thorough evaluation of the adequacy of reserves as of the end of the third
quarter of each year and conduct a supplemental review of full-year data at year-end.
ASSET IMPAIRMENT
Fixed-maturity and equity investments are our largest assets. Certain estimates and assumptions made by
management relative to investment portfolio assets are critical. The company's asset impairment committee
continually monitors investments and all other assets for signs of other-than-temporary and/or permanent
impairment. Among other signs, the committee monitors significant decreases in the market value of the
assets, changes in legal factors or in the business climate, an accumulation of costs in excess of the amount
originally expected to acquire or construct an asset, uncollectability of all other assets, or other factors such as
bankruptcy, deterioration of creditworthiness, failure to pay interest or dividends or signs indicating that the
carrying amount may not be recoverable.
The application of our impairment policy resulted in other-than-temporary impairment charges and write-offs of
investments that reduced our income before income taxes by $1 million, $6 million and $80 million in 2005,
2004 and 2003, respectively.
Other-than-temporary impairment in the value of securities is defined by the company as declines in valuation
that meet specific criteria established in the asset impairment policy. Such declines often occur in conjunction
with events taking place in the overall economy and market, combined with events specific to the industry or
operations of the issuing corporation. These specific criteria include a declining trend in market value, the
extent of the market value decline and the length of time the value of the security has been depressed, as well
as subjective measures such as pending events and issuer liquidity. Generally, these declines in valuation are
greater than might be anticipated when viewed in the context of overall economic and market conditions. We
provide information regarding valuation of our invested assets in Item 8, Note 2 to the Consolidated Financial
Statements, Page 88.
Our portfolio managers constantly monitor the status of their assigned portfolios for indications of potential
problems or issues that may be possible impairment issues. If an impairment indicator is noted, the portfolio
managers even more closely scrutinize the security.
Impairment charges are recorded for other-than-temporary declines in value, if, in the asset impairment
committee’s judgment, there is little expectation that the value will be recouped in the foreseeable future.
The impairment policy defines a security as distressed when it is trading below 70 percent of book value or has
a Moody's or Standard & Poor's credit rating below B3/B-. Distressed securities receive additional scrutiny.
In 2005 and earlier, a security would have been written down in the event of a declining market value for four
consecutive quarters with quarter-end market value below 50 percent of book value, or when a security’s
market value is 50 percent below book value for three consecutive quarters. Effective January 1, 2006,
a security may be written down in the event of a declining market value for four consecutive quarters with
quarter-end market value below 70 percent of book value, or when a security’s market value is 70 percent
below book value for three consecutive quarters. A sudden and severe drop in market value that does not
otherwise meet the above criteria is reviewed for possible immediate impairment.
When evaluating other-than-temporary impairments, the committee considers the company's ability to retain a
security for a period adequate to recover a significant percentage of cost. Because of the company's
investment philosophy and strong capitalization, it can hold securities that have the potential to recover value
until their scheduled redemption, when they might otherwise be deemed impaired. Investment assets that
2005 10-K Page 37
have already been impaired are evaluated based on their adjusted book value and further written down, if
deemed appropriate. The decision to sell or write down an asset with impairment indications reflects, at least in
part, management's opinion that the security no longer meets the company's investment objectives.
We provide detailed information about securities trading in a continuous loss position at year-end 2005 in
Item 7A, Unrealized Investment Gains and Losses, Page 74. Other-than-temporary declines in the fair value of
investments are recognized in net income as realized losses at the time when facts and circumstances indicate
such write-downs are warranted.
Permanent impairment charges (write-offs) are defined as those for which management believes there is little
potential for future recovery, for example, following the bankruptcy of the issuing corporation. These permanent
declines in the fair value of investments are written off at the time when facts and circumstances indicate such
write-downs are warranted, and they are reflected in realized losses.
Other-than-temporary and permanent impairments are distinct from the ordinary fluctuations seen in the value
of a security when considered in the context of overall economic and market conditions. Securities considered
to have a temporary decline would be expected to recover their market value, which may be at maturity. Under
the same accounting treatment as market value gains, temporary declines (changes in the fair value of these
securities) are reflected on our balance sheet in other comprehensive income, net of tax, and have no impact
on reported net income.
LIFE INSURANCE POLICY RESERVES
We establish the reserves for traditional life insurance policies based on expected expenses, mortality,
morbidity, withdrawal rates and investment yields, including a provision for uncertainty. Once these
assumptions are established, they generally are maintained throughout the lives of the contracts. We use both
our own experience and industry experience adjusted for historical trends in arriving at our assumptions for
expected mortality, morbidity and withdrawal rates. We use our own experience and historical trends for setting
our assumptions for expected expenses. We base our assumptions for expected investment income on our own
experience adjusted for current economic conditions.
We establish reserves for our universal life, deferred annuity and investment contracts equal to the cumulative
account balances, which include premium deposits plus credited interest less charges and withdrawals.
EMPLOYEE BENEFIT PENSION PLAN
We have a defined benefit pension plan covering substantially all employees. Contributions and pension costs
are developed from annual actuarial valuations. These valuations involve key assumptions including discount
rates and expected return on plan assets, which are updated each year. Any adjustments to these assumptions
are based on considerations of current market conditions. Therefore, changes in the related pension costs or
credits may occur in the future due to changes in assumptions.
The key assumptions used in developing the 2005 net pension expense were a 5.75 percent discount rate, an
8.0 percent expected return on plan assets and rates of compensation increases ranging from 5 percent to
7 percent. The 8.0 percent return on plan assets assumption is based partially on the fact that substantially all
of the investments held by the pension plan are common stocks that pay annual dividends. We believe this rate
is representative of the expected long-term rate of return on these assets. These assumptions were consistent
with the prior year except that the discount rate was reduced by one fourth of one percent due to current
market conditions. In 2005, the net pension expense was $13 million. In 2006, we expect a net pension
expense of $17 million, primarily as a result of a 0.25 percent reduction in the discount rate and increased
service costs.
Holding all other assumptions constant, a 0.5 percentage point decline in the discount rate would lower our
2006 net income before income taxes by $2 million. Likewise, a 0.5 percentage point decline in the expected
return on plan assets would lower our 2005 income before income taxes by $1 million.
In addition, the fair value of the plan assets exceeded the accumulated benefit obligation by $8 million at year-
end 2005 and $16 million at year-end 2004. The fair value of the plan assets was less than the projected plan
benefit obligation by $62 million at year-end 2005 and $41 million at year-end 2004. Market conditions and
interest rates significantly affect future assets and liabilities of the pension plan. We expect to contribute
approximately $10 million to the pension plan in 2006.
DEFERRED ACQUISITION COSTS
We establish a deferred asset for costs that vary with, and are primarily related to, acquiring property casualty
and life business. These costs are principally agent commissions, premium taxes and certain underwriting
costs, which are deferred and amortized into income as premiums are earned. Deferred acquisition costs track
with the change in premiums. Underlying assumptions are updated periodically to reflect actual experience.
Changes in the amounts or timing of estimated future profits could result in adjustments to the accumulated
amortization of these costs.
2005 10-K Page 38
For property casualty policies, deferred acquisition costs are amortized over the terms of the policies. For life
policies, acquisition costs are amortized into income either over the premium-paying period of the policies or
the life of the policy, depending on the policy type.
CONTINGENT COMMISSION ACCRUAL
Another significant estimate relates to our accrual for contingent (profit-sharing) commissions. We base the
contingent commission accrual estimates on property casualty underwriting results and on supplemental
property casualty information. Contingent commissions are paid to agencies using a formula that takes into
account agency profitability and other factors, such as prompt monthly payment of amounts due to the
company. Due to the complexity of the calculation and the variety of factors that can affect contingent
commissions for an individual agency, the amount accrued can differ from the actual contingent commissions
paid. The contingent commission accrual of $108 million in 2005 contributed 3.5 percentage points to the
property casualty combined ratio. If commissions paid were to vary from that amount by 5 percent, it would
affect 2006 net income by $4 million, or 2 cents per share, and the combined ratio by approximately
0.2 percentage points.
SEPARATE ACCOUNTS
We issue life contracts, referred to as bank-owned life insurance policies (BOLI). Based on the specific contract
provisions, the assets and liabilities for some BOLIs are legally segregated and recorded as assets and
liabilities of the separate accounts. Other BOLIs are included in the general account. For separate account
BOLIs, minimum investment returns and account values are guaranteed by the company and also include
death benefits to beneficiaries of the contract holders.
Separate account assets are carried at fair value. Separate account liabilities primarily represent the contract
holders' claims to the related assets and also are carried at the fair value of the assets. Generally, investment
income and realized investment gains and losses of the separate accounts accrue directly to the contract
holders and, therefore, are not included in our Consolidated Statements of Income. However, each separate
account contract includes a negotiated realized gain and loss sharing arrangement with the company.
This share is transferred from the separate account to our general account and is recognized as revenue or
expense. In the event that the asset value of contract holders' accounts is projected below the value
guaranteed by the company, a liability is established through a charge to our earnings.
For our most significant separate account, written in 1999, realized gains and losses are retained in the
separate account and are deferred and amortized to the contract holder over a five-year period, subject to
certain limitations. Upon termination or maturity of this separate account contract, any unamortized deferred
gains and/or losses will revert to the general account. In the event this separate account holder were to
exchange the contract for the policy of another carrier, there would be a surrender charge equal to 10 percent
of the contract’s account value during the first five years. Beginning in year six, the surrender charge decreases
2 percent a year to 0 percent in year 11. At year-end 2005, net unamortized realized gains amounted to
$1 million. In accordance with this separate account agreement, the investment assets must meet certain
criteria established by the regulatory authorities to whose jurisdiction the group contract holder is subject.
Therefore, sales of investments may be mandated to maintain compliance with these regulations, possibly
requiring gains or losses to be recorded, and charged to the general account. Potentially, losses could be
material; however, unrealized losses in the separate account portfolio were less than $4 million at year-end
2005.
RECENT ACCOUNTING PRONOUNCEMENTS
Information regarding recent accounting pronouncements is provided in Item 8, Note 1 to the Consolidated
Financial Statements, Page 84. We have determined that recent accounting pronouncements have not had nor
are they expected to have any material impact on our consolidated financial statements.
RESULTS OF OPERATIONS
The consolidated results of operations reflect the operating results of each of our four segments along with the
parent company and other non-insurance activities. The four segments are:
• Commercial lines property casualty insurance
• Personal lines property casualty insurance
•
Life insurance
Investments operations
•
We measure profit or loss for our property casualty and life segments based upon underwriting results.
Insurance underwriting results (profit or loss) represent net earned premium less loss and loss expenses and
underwriting expenses on a pretax basis. We also measure aspects of the performance of our commercial lines
2005 10-K Page 39
and personal lines segments on a combined property casualty insurance operations basis. Underwriting results
and segment pretax operating income are not a substitute for net income determined in accordance with GAAP.
For the combined property casualty insurance operations as well as the commercial lines and personal lines
segments, statutory accounting data and ratios are key performance indicators that we use to assess business
trends and to make comparisons to industry results, since GAAP-based industry data generally is not readily
available. We also use statutory accounting data and ratios as key performance indicators for our life insurance
operations. We do not believe that inflation has had a material effect on consolidated results of operations,
except to the extent that inflation may affect interest rates and claim costs.
Investments held by the parent company and the investment portfolios for the property casualty and life
insurance subsidiaries are managed and reported as the investments segment, separate from the underwriting
businesses. Net investment income and net realized investment gains and losses for our investment portfolios
are discussed in the Investments Results of Operations.
The calculations of segment data are described in more detail in Item 8, Note 17 of the Consolidated Financial
Statements, Page 98. The following sections review results of operations for each of the four segments.
Commercial Lines Insurance Results of Operations begins on Page 41, Personal Lines Insurance Results of
Operations begins on Page 47, Life Insurance Results of Operations begins on Page 52, and Investments
Results of Operations begins on Page 54. We begin with an overview of our consolidated property casualty
operations, which is the total of our commercial lines and personal lines segments. Our consolidated property
casualty operations generated 81.2 percent of our revenues in 2005, and certain factors affected both of our
property casualty segments.
CONSOLIDATED PROPERTY CASUALTY INSURANCE RESULTS OF OPERATIONS
(Dollars in millions)
Written premiums
Earned premiums
Loss and loss expenses excluding catastrophes
Catastrophe loss and loss expenses
Commission expenses
Underwriting expenses
Policyholder dividends
Underwriting profit
Ratios as a percent of earned premiums:
Loss and loss expenses excluding catastrophes
Catastrophe loss and loss expenses
Loss and loss expenses
Commission expenses
Underwriting expenses
Policyholder dividends
Combined ratio
2005
2004
2003
2005-2004
Change %
2004-2003
Change %
2.6
4.8
5.0
(14.8)
1.6
16.3
(52.3)
10.8
6.5
10.0
(5.6)
53.4
15.0
40.6
(25.0)
113.3
$
$
$
3,076
3,058
1,685
127
592
319
5
330
$
$
$
55.1 %
4.1
59.2
19.4
10.4
0.2
89.2 %
2,997
2,919
1,605
148
583
274
11
298
$
$
$
55.0 %
5.1
60.1
20.0
9.4
0.3
89.8 %
2,815
2,653
1,700
97
507
194
15
140
64.1 %
3.6
67.7
19.1
7.3
0.6
94.7 %
Factors that affected written premiums for property casualty insurance operations included:
• New business written directly by agencies – New business written directly by agencies was $314 million,
$330 million and $328 million in 2005, 2004 and 2003, respectively. New business levels reflect market
conditions for commercial and personal lines.
• Reinsurance reinstatement premiums – To restore affected layers of property catastrophe reinsurance
programs, we incurred $8 million and $11 million in reinsurance reinstatement premiums in 2005 and
2004.
Favorable development of loss reserves from prior accident years affected the combined ratio for property
casualty insurance operations. The 2005 and 2004 ratios benefited from higher than normal savings. The
2004 and 2003 ratios benefited from uninsured motorist/underinsured motorist (UM/UIM) reserve releases.
Following an Ohio Supreme Court decision in late 2003 to limit its 1999 Scott-Pontzer vs. Liberty Mutual
decision, we released UM/UIM reserves as follows:
• 2003 − We released $38 million pretax of previously established UM/UIM reserves, adding $25 million, or
14 cents per share, to net income in 2003.
• 2004 − In 2004, we reviewed outstanding UM/UIM claims for which litigation was pending. Those claims
represented approximately $37 million in previously established case reserves. During the first quarter of
2004, we filed motions for dismissal in various jurisdictions for specific claims and released an additional
$32 million in related case reserves. The reserve releases in 2004 added $21 million, or 12 cents per
share, to net income.
• 2005 − In 2005, we stopped separately reporting on UM/UIM-related reserve actions.
The discussions of property casualty segments provide additional detail regarding these factors.
2005 10-K Page 40
COMMERCIAL LINES INSURANCE RESULTS OF OPERATIONS
Overview -- Three-year Highlights
Performance highlights for the commercial lines segment include:
• Premiums – As competition in our commercial markets continues to increase, our written premium growth
rate has slowed because of the more competitive pricing environment and the underwriting discipline we
have maintained for both renewal and new business. The primary source of growth in the past three years
has been higher pricing on new and renewal commercial business aided by property insurance-to-value
initiatives and more accurate risk classification. These more than offset our deliberate decisions not to
write or renew certain business and the loss of some smaller accounts due to competition. We believe that
our written premium growth rate continues to exceed the average for the overall commercial lines industry,
which was estimated at 2.7 percent for 2005 and 2.3 percent for 2004. Earned premium growth has
slowed because of the declining growth rate of written premiums. Reinsurance reinstatement premiums
allocated to commercial lines reduced earned premium growth by 0.2 and 0.3 percentage points in
2005 and 2004, respectively.
• Combined ratio – Our commercial lines combined ratio was very strong in 2005 and 2004 largely due to
our programs to obtain more adequate premiums per policy and our underwriting efforts. The
3.3 percentage point increase in the 2005 ratio primarily was due to a rise in the loss and loss expense
ratio. The increase reflected a single large loss in 2005 that increased the ratio by 1.1 percentage points
and savings from favorable loss reserve development below the 2004 level. We discuss large losses and
other factors affecting the combined ratio beginning on Page 42. We discuss the savings from favorable
loss reserve development by commercial lines of business on Page 45.
Our commercial lines statutory combined ratio was 87.1 percent in 2005 compared with 83.7 percent in
2004 and 91.6 percent in 2003. By comparison, the estimated industry commercial lines combined ratio
was 99.1 percent in 2005, 102.5 percent in 2004 and 100.2 percent in 2003.
Growth and Profitability
As competition in the commercial markets has increased, we have maintained our pricing discipline for both
renewal and new business. Our independent agents reported steady pressure on pricing during 2005 and
communicated that winning new business and retaining renewals required more pricing flexibility and careful
risk selection. With the commercial lines pricing environment growing more competitive, we continue to rely on
factors other than price to drive sales. Our agents look for the best insurance program for their clients, not just
the best price. They serve policyholders well by presenting our value proposition – customized coverage
packages, personal claims service and high financial strength ratings – all wrapped up in a convenient
three-year commercial policy. We intend to remain a stable market for our agencies’ best business, and believe
that our case-by-case approach gives us a clear advantage. Our field marketing associates and our
independent agents work together to select risks and respond appropriately to local pricing trends. Historically,
they have proven capable of balancing risk and price to achieve growth in new business over the longer term.
Staying abreast of evolving market conditions is a critical function, accomplished in both an informal and a
formal manner. Informally, our field marketing representatives and underwriters are in constant receipt of
market intelligence from the agencies with which they work. Formally, our commercial lines product
management group and field marketing associates complete periodic market surveys to obtain competitive
intelligence. This market information helps to identify the top competitors by line of business or specialty
program and also identifies our market strengths and weaknesses. The analysis encompasses pricing, breadth
of coverage and underwriting/eligibility issues. In addition to reviewing our competitive position, our product
management group and our underwriting audit group review compliance with our underwriting standards as
well as the pricing adequacy of our commercial insurance programs and coverages. Further, our research and
development department analyzes opportunities and develops new products, new coverage options and
improvements to existing insurance products.
In 2003 and 2004, all lines of business grew because of higher premiums per policy. In 2005, growth largely
was driven by commercial multi-peril and other liability coverages with commercial auto premiums declining.
Commercial auto is one of the first lines to experience pricing pressure because it often represents the largest
portion of insurance costs for commercial policyholders. Commercial auto also is one of the larger, annually
priced components of our three-year policies.
We have more aggressively identified and measured exposures to match coverage amounts and premiums to
the risk. Where this matching is not possible, accounts are not renewed unless there are mitigating factors. As
a result, we experienced no growth in overall commercial lines policy counts from 2003 to 2005. Agents tell us
they agree with the need to carefully select risks and assure pricing adequacy. They appreciate the time our
associates invest in creating solutions for their clients while protecting profitability, whether that means
working on an individual case or developing modified policy terms and conditions that preserve flexibility,
choice and other sales advantages.
2005 10-K Page 41
For new business, our field marketing associates and agents are working together to select risks and respond
appropriately to local pricing trends. New commercial lines business was $282 million in 2005, unchanged
from 2004. New business was $268 million in 2003.
We discuss growth by commercial lines of business on Page45.
Commercial Lines Results
(Dollars in millions)
Written premiums
Earned premiums
Loss and loss expenses excluding catastrophes
Catastrophe loss and loss expenses
Commission expenses
Underwriting expenses
Policyholder dividends
Underwriting profit
Ratios as a percent of earned premiums:
Loss and loss expenses excluding catastrophes
Catastrophe loss and loss expenses
Loss and loss expenses
Commission expenses
Underwriting expenses
Policyholder dividends
Combined ratio
$
$
$
2005
2004
2003
2,290
2,254
1,222
76
438
228
5
285
$
$
$
54.2 %
3.4
57.6
19.5
10.1
0.2
87.4 %
2,186
2,126
1,083
71
423
200
11
338
$
$
$
2,031
1,908
1,176
42
361
147
15
167
50.9 %
61.6 %
3.4
54.3
19.9
9.4
0.5
2.2
63.8
18.9
7.7
0.8
84.1 %
91.2 %
2005-2004
Change %
2004-2003
Change %
4.7
6.0
12.9
6.0
3.6
13.5
(52.3)
(15.6)
7.6
11.4
(7.9)
68.9
17.1
36.8
(25.0)
102.3
Over the past three years, we have continued to focus on seeking and maintaining adequate premium per
exposure as well as pursuing non-pricing means of enhancing longer-term profitability. These have included
identifying the exposures we have for each risk and making sure we offer appropriate coverages, terms and
conditions and limits of insurance. We continue to adhere to our underwriting guidelines, to re-underwrite
books of business with selected agencies and to update policy terms and conditions, where necessary. In
addition, we continue to leverage our strong local presence. Our field marketing representatives have met with
every agency to reaffirm agreements on the extent of frontline renewal underwriting to be performed by local
agencies. Loss control, machinery and equipment and field claims representatives continue to conduct on-site
inspections. Field claims representatives prepare full risk reports on every account reporting a loss above
$100,000 or on any risk of concern. Multi-departmental task forces have implemented programs to address
concerns for specific areas such as contractor and commercial auto risks. These actions have helped to
mitigate rising loss severity.
We describe the significant costs components for the commercial lines segment below.
Loss and Loss Expenses (excluding catastrophe losses)
Loss and loss expenses include both net paid losses and reserve additions for unpaid losses as well as the
associated loss expenses. We believe more competitive market conditions were one factor in the
3.3 percentage point rise in the loss and loss expense ratio excluding catastrophes between 2005 and 2004.
In addition, 2005 results include a single large loss that was insufficiently covered through our facultative
reinsurance programs, which increased the 2005 loss and loss expenses by $24 million, net of reinsurance, or
1.1 percentage points. Savings from favorable loss reserve development was lower in 2005 than 2004, which
we discuss by commercial lines of business on Page 45.
Underwriting actions that led to higher premiums on a relatively stable level of exposures contributed to the
10.7 percentage point decline in the loss and loss expense ratio excluding catastrophes between 2004 and
2003. In addition, savings from favorable loss reserve development was significantly higher in 2004 than
2003.
Re-underwriting our commercial lines book of business in the early 2000s has had an impact on reserve
development patterns because we are seeing lower frequency of losses. The favorable development in
2005 and 2004 was also due to the headquarters claims department’s initiative, begun in 2001. Since 2001,
we have been establishing higher initial case reserves on severe injury claims because our experience
indicated that juries often ignore significant liability issues in cases involving seriously injured claimants. These
higher initial amounts produce case reserves that reflect our full exposure more accurately. But some claims
settle before reaching a jury and some juries make awards that are less than the “worst-case” scenario. As a
result, some change in our case reserve development patterns allowed us to also reduce IBNR in 2005.
We monitor incurred losses by size of loss, business line, risk category, geographic region, agency, field
marketing territory and duration of policyholder relationship, addressing concentrations or trends as needed.
Our 2005 analysis indicated no significant concentrations other than trends in business lines that we address
as part of our ongoing business operations. We also measure new losses and case reserve increases greater
than $250,000 to track frequency and severity.
2005 10-K Page 42
These commercial lines large losses and case reserve increases have been in the range of 15 percent to
17 percent of annual earned premiums since 2003. The primary reason the contribution of these losses to the
loss and loss expense ratio rose in 2005 was higher total new losses greater than $1 million. New losses
greater than $1 million rose because of a rise in the number of these losses and the single large loss noted
above. Total development and case reserve increases of $250,000 or more rose primarily because of two
verdicts that exceeded the reserves we had established.
Commercial Lines Losses by Size
(Dollars in millions)
Losses $1 million or more
Losses $250 thousand to $1 million
Development and case reserve increases of $250 thousand or more
Other losses
Total losses incurred excluding catastrophe losses
Catastrophe losses
Total losses incurred
$
$
As a percent of earned premiums:
Losses $1 million or more
Losses $250 thousand to $1 million
Development and case reserve increases of $250 thousand or more
Other losses
Loss ratio excluding catastrophe losses
Catastrophe loss ratio
Total loss ratio
2005
2004
2003
124
105
149
596
974
76
1,050
$
$
5.5 %
4.7
6.6
26.4
43.2
3.4
46.6 %
80
103
133
536
852
71
923
$
$
3.8 %
4.9
6.2
25.1
40.0
3.4
43.4 %
89
117
121
608
935
42
977
4.6 %
6.2
6.3
31.9
49.0
2.2
51.2 %
2005-2004
Change %
54.3
1.2
12.7
11.1
14.2
6.0
13.6
2004-2003
Change %
(9.5)
(11.9)
9.9
(11.8)
(8.8)
68.9
(5.4)
Catastrophe Loss and Loss Expenses
Commercial lines catastrophe losses, net of reinsurance and before taxes, were $76 million in 2005 compared
with $71 million in 2004 and $42 million in 2003. The following table shows losses incurred, net of
reinsurance, and subsequent development, for catastrophe losses in each of the past three years.
The Cincinnati Insurance Companies do not appoint agencies to actively market property casualty insurance in
Louisiana, Mississippi or Texas. Our Hurricane Katrina and Rita losses included losses associated with
commercial accounts written by agents in other states to cover locations and vehicles in multiple states,
including Louisiana, Mississippi and Texas.
Hurricane Katrina losses also included $18 million in assumed losses. The Cincinnati Insurance Company
participates in three assumed reinsurance treaties with two reinsurers that spread the risk of very high
catastrophe losses among many insurers. The assumed losses from Hurricane Katrina included $16 million
under a treaty with the Munich Re Group to assume 2 percent of property losses between $400 million and
$1.2 billion from a single event. Munich Re has reserved its Hurricane Katrina losses above $1.2 billion.
We reduced our participation in the Munich Re assumed reinsurance treaty to 1 percent in 2006.
2005 10-K Page 43
Cause of loss
(In millions, net of reinsurance)
Occurence year
2005
May
July
August
September
October
November
November
Total
Wind, hail
Hurricane Dennis
Hurricane Katrina
Hurricane Rita
Hurricane Wilma
Wind, hail
Wind
Region
Midwest
South
South
South
South
Midwest
Midwest, South
2004
May
May
July
August
September
September
September
December
Others
Total
Wind, hail
Wind, hail
Wind, hail
Hurricane Charley
Hurricane Frances
Hurricane Jeanne
Hurricane Ivan
Wind, ice, snow
Midwest, Mid-Atlantic
Midwest, Mid-Atlantic, South
Midwest, Mid-Atlantic, South
South
South
Mid-Atlantic, South
Midwest, Mid-Atlantic, South
Midwest, South
2003 and prior
April
May
July
July
September
November
Others
Total
Calendar year total
Wind, hail
Wind, hail
Wind, hail
Wind, hail
Wind
Wind
Midwest, South
Midwest, South
Midwest, Mid-Atlantic, South
Midwest, Mid-Atlantic, South
Mid-Atlantic, South
Midwest, Mid-Atlantic, South
Incurred in calendar year ended December 31,
2003
2004
2005
$
$
4
5
36
3
13
2
2
65
0 $
0
8
0
1
1
1
0
0
11
0
1
0
(1)
0
0
0
0
76 $
1
11
7
16
4
4
21
5
3
72
(2) $
0
2
0
0
(1)
0
(1)
71 $
5
17
2
6
5
6
1
42
42
Commission Expenses
Commercial lines commission expense as a percent of earned premium declined by 0.4 percentage points in
2005 after rising by 1.0 percentage points in 2004. Profit-sharing, or contingent, commissions are calculated
on the profitability of an agency’s aggregate book of business, taking into account longer-term profit, with a
percentage for prompt payment of premiums and other criteria, and reward our agents’ efforts. These profit-
based commissions generally fluctuate with our loss and loss expenses.
A refinement and subsequent release of a contingent commission over accrual from 2004 in the first three
months of 2005 was responsible for 0.3 percentage points of the decline in 2005. The refinement reflected
the use of final 2004 financial data to calculate the contingent commissions paid in 2005. Our 2005
contingent commission accrual reflected our estimate of the profit-sharing commissions that will be paid to our
agencies in early 2006.
Underwriting Expenses
Non commission expenses rose to 10.1 percent of earned premium in 2005 from 9.4 percent in 2004 and
7.7 percent in 2003. The three-year rise in the ratio largely was due to unfavorable deferred acquisition cost
comparisons resulting from slower premium growth, higher staffing expenses and increased taxes and fees
that were partially due to a state guaranty fund refund in 2003. The software recovery discussed in Corporate
Financial Highlights, Page 32, reduced the 2003 ratio by 0.8 percentage points.
Policyholder Dividends
Policyholder dividend expense was 0.2 percent of earned premium in 2005 compared with 0.5 percent in
2004 and 0.8 percent in 2003.
2005 10-K Page 44
Line of Business Analysis
(Dollars in millions)
Calendar year
Commercial multi-peril:
Written premium
Earned premium
Loss and loss expenses incurred
Loss and loss expenses ratio
Loss and loss expense ratio excluding catastrophes
Workers compensation:
Written premium
Earned premium
Loss and loss expenses incurred
Loss and loss expenses ratio
Loss and loss expense ratio excluding catastrophes
Commercial auto:
Written premium
Earned premium
Loss and loss expenses incurred
Loss and loss expenses ratio
Loss and loss expense ratio excluding catastrophes
Other liability:
Written premium
Earned premium
Loss and loss expenses incurred
Loss and loss expenses ratio
Loss and loss expense ratio excluding catastrophes
Accident year
Loss and loss expenses incurred:
Commercial multi-peril
Workers compensation
Commercial auto
Other liability
Loss and loss expenses ratio:
Commercial multi-peril
Workers compensation
Commercial auto
Other liability
2005
2004
2003
2005-2004
Change %
2004-2003
Change %
$
$
$
$
$
$
$
$
$
$
809
796
443
55.7 %
47.5
338
328
300
91.3 %
91.3
447
456
273
59.8 %
59.7
458
442
187
42.4 %
42.4
2005
504
256
297
269
63.4 %
78.0
65.1
60.8
$
$
$
$
$
767
751
469
62.4 %
54.9
320
313
251
80.3 %
80.3
458
450
236
52.4 %
52.1
424
402
116
28.8 %
28.8
2004
459
245
268
210
61.2 %
78.3
59.6
52.3
713
673
442
65.6 %
59.9
304
293
235
80.5 %
80.5
434
419
240
57.3 %
56.5
377
342
183
53.6 %
53.6
5.4
5.9
(5.5)
5.5
5.1
19.4
(2.4)
1.4
15.7
7.9
9.8
61.7
7.6
11.6
6.1
5.2
6.8
6.6
5.5
7.4
(1.8)
12.5
17.6
(36.8)
2003
2002
2001
$
411
231
261
193
61.1 %
78.9
62.3
56.5
$
408
236
251
156
67.2 %
80.2
65.4
56.8
403
230
242
123
75.3 %
91.2
75.6
57.1
In total, the commercial multi-peril, workers compensation, commercial auto and other liability lines of business
accounted for 89.7 percent of total commercial lines earned premium compared with 90.1 percent in 2004
and 90.5 percent in 2003. Approximately 95 percent of our commercial lines premiums are written as
packages, providing accounts with coverages from more than one business line. We believe that our
commercial lines segment is best measured and evaluated on a segment basis. We have provided the table
above and the discussion below to summarize growth and profitability trends separately for each of the four
primary business lines.
The accident year loss data provides current estimates of incurred loss and loss expenses for the past five
accident years. Accident year data classifies losses according to the year in which the corresponding loss event
occurred, regardless of when the losses are actually reported, booked or paid.
Over the past three years, results for the business lines within the commercial lines segment have reflected our
emphasis on underwriting and obtaining adequate pricing for covered risks, as discussed above.
Commercial Multi-peril
In 2005 and 2004, commercial multi-peril written premiums rose more rapidly than the total for commercial
lines as a higher proportion of liability coverages were written in discounted packages because of competitive
pricing pressures. Commercial multi-peril written premiums were lower in 2003 when some liability coverages
were moved to nondiscounted policies. Nondiscounted policies are included in our other liability line of
business.
Commercial multi-peril is our single largest business line. We believe this business line’s loss data provides the
best indicator of the success of the growth and underwriting actions that we have implemented during the past
five years. The higher general liability base rates that were effective in most states beginning in 2003 helped to
offset a trend toward higher construction costs for 2005 and 2004 property claims.
In each of the last three calendar years, reserve changes for prior periods have contributed to results.
• 2005 – Favorable development lowered the loss and loss expense ratio by 7.7 percentage points.
The favorable development largely was due to lower commercial multi-peril exposures because of
2005 10-K Page 45
prior-year transfers of business to non-discounted policies and to the benefits of changes made in 2002 to
our general liability terms and conditions.
• 2004 – Reserve strengthening added 0.6 percentage points to the loss and loss expense ratio. Additions
to reserves for environment claims were offset by favorable development of case reserves for non-
environmental claims due to our headquarters claims department’s initiative to establish higher initial case
reserves on severe injury claims.
• 2003 – Reserve strengthening added 2.0 percentage points to the loss and loss expense ratio because we
added to our reserves for environmental claims.
In addition, the large loss discussed above added 2.9 percentage points to the 2005 ratio.
Workers Compensation
Conditions within the workers compensation market remained stable in 2005 and 2004 after improving
between 1999 and 2003 as market pricing rose in most states, albeit offset by continued rising trends in loss
severity. In 2005, workers compensation written premiums rose more rapidly than our total commercial lines
written premiums as this business line appeared to experience less competitive pricing pressures than the
overall commercial lines market in the second half of the year. As the commercial lines market has softened,
however, insurers have displayed a greater willingness to write more desirable risks, and growth in the
premium volume of state pools for workers compensation is declining.
Since 2002, we have chosen not to renew selected policies where we believed the aggregate exposure risk was
excessive. Any new or renewal policy covering 200 or more employees at any one location receives added
scrutiny as we seek to manage risk aggregation. We make workers compensation available as part of package
policies for commercial lines policyholders in selected states as a competitive tool. We pay a lower commission
rate on workers compensation business, which means this line has a higher loss and loss expense breakeven
point than our other commercial business lines. In Ohio, our largest state, workers compensation coverage is a
state monopoly, provided solely by the state instead of by private insurers.
The workers compensation loss and loss expense ratio rose in 2005 after remaining steady for several years,
largely because of a higher level of reserve strengthening for older accident years.
• 2005 – Reserve strengthening added 13.3 percentage points to the loss and loss expense ratio.
The reserve strengthening primarily was due to medical cost inflation and longer estimated payout periods
compared with our original projections.
• 2004 – Reserve strengthening added 4.9 percentage points to the loss and loss expense ratio, which also
was due to longer estimated payout periods.
• 2003 – Reserve strengthening added 4.3 percentage points to the loss and loss expense ratio, which also
was due to medical cost inflation.
Commercial Auto
Written premiums declined 2.4 percent in 2005 after rising 5.5 percent in 2004, below the overall commercial
lines growth rate. Commercial auto is one of the package policy components for which we calculate pricing
annually. This line tends to be highly sensitive to competitive pressures.
In the past several years, we accelerated efforts to improve commercial auto underwriting and rate levels,
making certain that vehicle use was properly classified. As a result of those actions and moderating
industrywide severity and frequency trends, the loss and loss expense ratio for commercial auto remained at
an acceptable level in 2005 despite pricing pressures, after improving from 2001 through 2004. Further, we
continue to adhere to our underwriting guidelines to assure accurate classification and pricing.
A significant factor in the calendar year-over-year changes has been savings from favorable loss reserve
development for prior years.
• 2005 – Favorable development lowered the loss and loss expense ratio by 5.3 percentage points.
The savings largely were due to moderating frequency and severity trends.
• 2004 – Favorable development lowered the loss and loss expense ratio by 10.5 percentage points,
including 4.6 percentage points due to the release of UM/UIM reserves. The remainder of the savings
largely was due to moderating frequency and severity trends.
• 2003 – Favorable development lowered the loss and loss expense ratio by 8.8 percentage points,
including 6.9 percentage points due to the release of UM/UIM case reserves. The release of
UM/UIM-related IBNR reserves also contributed.
Other Liability
Other liability (commercial umbrella, commercial general liability and most executive risk policies) written
premiums also grew more rapidly than our total commercial lines written premiums because of the growing
number of policies written in non-discounted programs and the continuing rise in liability pricing. The growth
2005 10-K Page 46
rate is decelerating, however, because a higher proportion of accounts are being written in discounted
packages because of competitive pricing pressures. Discounted policies are included in our commercial multi-
peril line of business.
Director and officer coverage accounted for approximately 11 percent of other liability premium in 2005
compared with approximately 13 percent in 2004 and approximately 12 percent in 2003. Our director and
officer policies are offered primarily to nonprofit organizations, reducing the risk associated with this line of
business. As of December 31, 2005, three of our in-force director and officer policies were for Fortune 500
companies, 38 were for publicly traded companies (excluding banks and savings and loans) and 59 were for
banks and savings and loans with more than $500 million in assets.
In large part because this business line also includes umbrella coverages, the calendar year loss and loss
expense ratio tends to fluctuate significantly on a year-over-year basis. Our headquarters claims department’s
initiative to establish higher initial case reserves on severe injury claims has the greatest effect on this
business line:
• 2005 – Favorable development lowered the loss and loss expense ratio by 18.4 percentage points.
Enforcement of stricter underwriting standards and a preference for lower limit policies contributed to
favorable development for our commercial umbrella coverages.
• 2004 – Favorable development lowered the loss and loss expense ratio by 32.5 percentage points,
including 2.0 percentage points due to the release of UM/UIM reserves.
• 2003 – Favorable development lowered the loss and loss expense ratio by 23.0 percentage points,
including 2.6 percentage points due to the release of UM/UIM reserves.
Commercial Lines Insurance Outlook
Industrywide commercial lines written premiums are expected to rise approximately 2.3 percent in 2006.
During 2005, agents reported that renewal pricing pressure had risen since the end of 2004 and new business
pricing was requiring even more flexibility and more careful risk selection. During 2005, we needed to use
credits more frequently to retain renewals of quality business – the larger the account, the higher the credits,
with variations by geographic region and class of business. At the end of 2005, renewal rates on property
coverages were generally flat to modestly down, exclusive of any changes in an account’s exposure. Renewal
pricing on liability coverages was less affected by competitive pricing pressures, with some increases possible.
We intend to continue to market our products to a broad range of business classes, price our products
adequately and take a package approach. We intend to maintain our underwriting selectivity and carefully
manage our rate levels, as well as our programs that seek to accurately match exposures with appropriate
premiums. We will continue to evaluate each risk individually and to make decisions regarding rates, the use of
three-year commercial policies and other policy terms on a case-by-case basis, even in lines and classes of
business that are under competitive pressure. New marketing territories created over the past several years
and new agency appointments will contribute to commercial lines growth.
Prior to Hurricanes Katrina, Rita and Wilma, we anticipated 2006 commercial lines insurance market trends
would reflect accelerated competition with pressure on pricing from the industry’s increasing surplus and
improving profitability. We are uncertain what the effect of the hurricanes will be on commercial lines pricing
going forward. We believe their effect on pricing largely will be limited to coastal markets and business lines
directly affected by the storms.
We believe our approach should allow us to maintain most of the positive underlying improvements in
profitability that have occurred over the past several years, but we do not believe favorable reserve
development will contribute to underwriting profits as much in 2006 as in 2005 and 2004. In addition,
underwriting expenses are rising. We discuss our overall outlook for the property casualty insurance operations
in Measuring Our Success in 2006 and Beyond, Page 33,.
PERSONAL LINES INSURANCE RESULTS OF OPERATIONS
Overview -- Three-year Highlights
Performance highlights for the personal lines segment include:
• Premiums – During the past three years, we have been working to address personal lines profitability.
Because of our actions, the 2005 personal lines combined ratio was below 100 percent for the first time
since 1999. However, as other carriers refined their pricing models , our pricing was less competitive and
written premiums declined in 2005 after slowing in 2004. Industry average written premium growth was
estimated at 3.5 percent for 2005 and 6.6 percent for 2004. Our earned premium growth has slowed as a
result of the written premium trend. Reinsurance reinstatement premiums allocated to personal lines
reduced our premium growth by 0.3 and 0.8 percentage points for 2005 and 2004, respectively.
• Combined ratio – The substantial improvement in the 2005 combined ratio reflected our progress in
lowering the homeowner loss and loss expense ratio and our lower catastrophe losses offset by higher
2005 10-K Page 47
noncommission underwriting expenses. The 2004 personal lines combined ratio was slightly above the
prior year’s level. Higher catastrophe losses and underwriting expenses offset the improvement in the
homeowner and personal auto loss and loss expense ratios excluding catastrophe losses.
Our personal lines statutory combined ratio was 94.3 percent in 2005 compared with 104.6 percent in
2004 and 102.9 percent in 2003. By comparison, the estimated industry personal lines combined ratio
was 97.3 percent in 2005, 94.9 percent in 2004 and 98.4 percent in 2003.
Growth and Profitability
Personal lines insurance is a strategic component of our overall relationship with many of our agencies and an
important component of agency relationships with their clients. We believe agents recommend Cincinnati
personal insurance products for their value-oriented clients who seek to balance quality and price and are
attracted by Cincinnati’s superior claims service and the benefits of our package approach. In the past 12 to
18 months, our personal lines rates in some territories did not allow our agents to market these benefits,
resulting in a slight decline in our policy retention rate from its historical level above 90 percent.
The same factors that reduced policy retention have had an impact on new personal lines business.
Personal lines new business premiums written directly by agencies declined 33.9 percent to $32 million in
2005 and declined 19.9 percent to $48 million in 2004.
We discuss premium trends by personal lines of business on Page 51.
Personal Lines Results
(Dollars in millions)
Written premiums
Earned premiums
Loss and loss expenses excluding catastrophes
Catastrophe loss and loss expenses
Commission expenses
Underwriting expenses
Underwriting profit (loss)
Ratios as a percent of earned premiums:
Loss and loss expenses excluding catastrophes
Catastrophe loss and loss expenses
Loss and loss expenses
Commission expenses
Underwriting expenses
Combined ratio
2005-2004
Change %
2004-2003
Change %
(3.0)
1.4
(11.3)
(34.2)
(3.6)
24.0
214.0
3.4
6.4
(0.4)
41.4
9.7
52.1
45.8
$
$
$
2005
2004
2003
786
804
463
51
154
91
45
$
$
$
57.6 %
6.3
63.9
19.2
11.3
94.4 %
811
793
522
77
160
74
(40)
$
$
$
65.9 %
9.7
75.6
20.1
9.3
105.0 %
784
745
524
55
146
47
(27)
70.3 %
7.3
77.6
19.5
6.5
103.6 %
Between 2000 and 2003, the industry implemented higher homeowner rates and imposed stricter
enforcement of underwriting standards. In late 2004, price competition returned as insurers leveraged their
higher profitability and stronger financial positions. The marketplace continued to become more competitive
throughout 2005.
We began a strategic shift in 2004 from our traditional three-year to one-year homeowner policy terms. We are
transitioning to one-year policies in conjunction with the state-by-state deployment of Diamond, our personal
lines policy processing system. One-year policies allow us to promptly modify rates, terms and conditions in
response to market changes. In mid-2004, we also began modifying policy terms to change homeowner policy
earthquake deductibles to 10 percent from 5 percent in selected Midwestern states, reducing the company’s
exposure to a single significant catastrophic event.
In 2004, as price competition began to emerge, we were in the early stages of our program to improve
profitability for our homeowner line by raising rates and making changes to our policy terms and conditions.
From mid-2004 to mid-2005, we opted to delay rate changes because we felt it was important to fully commit
our programming resources to completing necessary modifications and upgrades to our then-new Diamond
policy processing system. During that time period, other carriers began making more aggressive use of
segmented pricing models, generating lower rates for higher quality accounts. When some important system
modifications were completed in mid-2005, we began filing rate and credit changes to better position our
products in the market.
The introduction of Diamond in our higher volume states may also have contributed to lower growth rates.
The focus required by our agencies to convert to the newer technology and adapt to new work flows may have
diverted their resources from new business efforts. Diamond gives agencies additional choices to consider for
their business operations and for policyholders. Agents are growing more familiar with the new options and
workflow, and many now are seeing benefits from efficiencies as they renew business through the system.
During 2005, we increased the system’s processing power and availability and offered additional functionality
requested by agency staff. For example, we began offering convenient account billing to direct bill customers,
2005 10-K Page 48
invoicing for multiple policies at one time, and electronic fund transfer, which accommodates new monthly
payment plans. We continue to respond to agency requests for enhancements as we prepare Diamond for
additional states.
Although our homeowner profitability lagged the industry, our actions resulted in substantial improvement in
our personal lines combined ratio over the past three years. Our 2005 statutory combined ratio improved to
94.3 percent while the estimated industry combined ratio deteriorated 2.4 points to 97.3 percent. Moreover,
we expect to realize additional profit improvements in 2006 as we continue the conversion to one-year policies
written with updated rates, terms and conditions.
In mid-2006, we will introduce a limited program of rate segments incorporating insurance scores into pricing
for our personal auto and homeowner products in states using Diamond and make other changes to our credits
in states not yet using Diamond. This step should further improve our ability to compete for our agents’ highest
quality personal lines accounts. We believe it will increase the opportunity to work with our agents on marketing
the advantages of our personal lines products and services to their clients, which would help us resume
growing in this business area.
We describe the significant costs components for the personal lines segment below.
Loss and Loss Expenses (excluding catastrophe losses)
Loss and loss expenses include both net paid losses and reserve additions for unpaid losses as well as the
associated loss expenses. The improvement in the loss and loss expense ratio excluding catastrophes over the
past three years was due to a 14.4 percentage point improvement in the homeowner ratio excluding
catastrophe losses between 2005 and 2003 and a 10.4 percentage point improvement in the personal auto
ratio excluding catastrophe losses over the same period. Savings from favorable loss reserve development,
including the release of UM/UIM reserves, influenced those improvements. We discuss homeowner and
personal auto trends separately beginning on Page 51.
We monitor incurred losses by size of loss, business line, risk category, geographic region, agency, field
marketing territory and duration of policyholder relationship, addressing concentrations or trends as needed.
Our 2005 analysis indicated no significant concentrations other than trends in business lines that we address
as part of our ongoing business operations. We also measure new losses and case reserve adjustments
greater than $250,000 to track frequency and severity. These personal lines large losses and case reserve
increases declined as a percent of earned premiums in 2005 because of higher rates per exposure.
Personal Lines Losses by Size
(Dollars in millions)
Losses $1 million or more
Losses $250 thousand to $1 million
Development and case reserve increases of $250 thousand or more
Other losses
Total losses incurred excluding catastrophe losses
Catastrophe losses
Total losses incurred
$
$
As a percent of earned premiums:
Losses $1 million or more
Losses $250 thousand to $1 million
Development and case reserve increases of $250 thousand or more
Other losses
Loss ratio excluding catastrophe losses
Catastrophe loss ratio
Total loss ratio
2005
2004
2003
13
34
19
339
405
51
456
$
$
1.5 %
4.3
2.4
42.2
50.4
6.3
56.7 %
17
43
21
371
452
77
529
$
$
2.2 %
5.4
2.6
46.8
57.0
9.7
66.7 %
15
41
11
391
458
55
513
2.0 %
5.5
1.5
52.5
61.5
7.3
68.8 %
2005-2004
Change %
(26.0)
(19.9)
(7.7)
(8.5)
(10.2)
(34.2)
(13.7)
2004-2003
Change %
14.6
4.9
83.7
(5.2)
(1.4)
41.4
3.1
2005 10-K Page 49
Catastrophe Loss and Loss Expenses
Personal lines catastrophe losses, net of reinsurance and before taxes, were $51 million in 2005 compared
with $77 million in 2004 and $55 million in 2003. The following table shows losses incurred, net of
reinsurance, and subsequent development, for catastrophe losses in each of the past three years.
Cause of loss
(In millions, net of reinsurance)
Occurence year
2005
January
May
July
August
October
November
November
Total
Wind, ice snow, freezing
Wind, hail
Hurricane Dennis
Hurricane Katrina
Hurricane Wilma
Wind, hail
Wind
Region
Midwest, Mid-Atlantic
Midwest
South
South
South
Midwest
Midwest, South
2004
May
May
July
August
September
September
September
December
Others
Total
Wind, hail
Wind, hail
Wind, hail
Hurricane Charley
Hurricane Frances
Hurricane Jeanne
Hurricane Ivan
Wind, ice, snow
Midwest, Mid-Atlantic
Midwest, Mid-Atlantic, South
Midwest, Mid-Atlantic, South
South
South
Mid-Atlantic, South
Midwest, Mid-Atlantic, South
Midwest, South
2003
April
May
July
July
September
November
Others
Total
Calendar year total
Wind, hail
Wind, hail
Wind, hail
Wind, hail
Wind
Wind
Midwest, South
Midwest, South
Midwest, Mid-Atlantic, South
Midwest, Mid-Atlantic, South
Mid-Atlantic, South
Midwest, Mid-Atlantic, South
Incurred in calendar year ended December 31,
2003
2004
2005
$
$
1
8
2
11
12
9
10
53
0 $
0
(1)
0
1
0
1
(3)
0
(2)
0
0
0
0
0
0
0
0
51 $
9
20
5
10
7
2
18
8
2
81
(2) $
0
(1)
0
(1)
0
0
(4)
77 $
31
17
5
1
4
1
(4)
55
55
Commission Expenses
Commission expense as a percent of earned premium declined by 0.9 percentage points in 2005, largely
paralleling the decline in written premiums, after rising 0.6 percentage points in 2004. Profit-sharing, or
contingent, commissions are calculated on the profitability of an agency’s aggregate book of business, taking
into account longer-term profit, with a percentage for prompt payment of premiums and other criteria.
A refinement and subsequent release of a contingent commission over accrual from 2004 in the first three
months of 2005 was responsible for 0.2 percentage points of the decline in 2005.
Underwriting Expenses
Noncommission expenses rose to 11.3 percent of earned premium in 2005 from 9.3 percent in 2004 and
6.5 percent in 2003. The three-year rise in the ratio largely was due to higher technology expenses,
unfavorable deferred acquisition cost comparisons resulting from slower premium growth, higher staffing
expenses and increased taxes and fees that were partially due to a state guaranty fund refund in 2003.
The software recovery discussed in Corporate Financial Highlights Page 32, reduced the 2003 ratio by
1.1 percentage points.
2005 10-K Page 50
Line of Business Analysis
(Dollars in millions)
Calendar year
Personal auto:
Written premium
Earned premium
Loss and loss expenses incurred
Loss and loss expenses ratio
Loss and loss expense ratio excluding catastrophes
Homeowner:
Written premium
Earned premium
Loss and loss expenses incurred
Loss and loss expenses ratio
Loss and loss expense ratio excluding catastrophes
Accident year
Loss and loss expenses incurred:
Personal auto
Homeowner
Loss and loss expenses ratio:
Personal auto
Homeowner
2005
2004
2003
$
$
$
$
$
$
410
433
261
60.2 %
59.7
290
285
212
74.5 %
58.4
2005
267
215
61.8 %
75.4
$
$
$
453
451
298
66.1 %
65.1
273
259
249
96.1 %
69.3
2004
297
254
66.0 %
98.1
2005-2004
Change %
2004-2003
Change %
(9.4)
(4.0)
(12.5)
1.2
5.4
(2.1)
6.3
10.2
(14.6)
7.3
8.2
12.2
447
428
304
71.1 %
70.1
254
239
222
92.7 %
72.8
2003
2002
2001
$
305
227
71.2 %
95.0
$
289
207
74.3 %
98.6
259
193
71.9 %
101.4
The personal auto and homeowner business lines together accounted for 89.2 percent, 89.5 percent and
89.5 percent of total personal lines earned premiums in 2005, 2004 and 2003, respectively. Our intent is to
write personal auto and homeowner coverages in personal lines packages that may also include personal
umbrella liability, watercraft and other coverages. As a result, we believe that the personal lines segment is
best measured and evaluated on a segment basis. We have provided the table above and the discussion below
to summarize growth and profitability trends separately for the two primary business lines.
The accident year loss data provides current estimates of incurred loss and loss expenses for the past five
accident years. Accident year data classifies losses according to the year in which the corresponding loss event
occurred, regardless of when the losses are actually reported, booked or paid.
Personal Auto
Written and earned premiums for the personal auto line declined in 2005 after rising in 2004. As noted above,
the decline in 2005 primarily was due to price competition in some states and territories, which has resulted in
lower policy renewal retention and significantly lower new business levels. We are continuing to modify selected
rates and credits to address our competitive position.
The loss and loss expense ratio for personal auto improved from an already strong level over the three years
because of higher pricing. For selected agencies, we use re-underwriting programs to review and to strengthen
underwriting standards, requiring motor vehicle reports for insured drivers, and to develop strategies to
increase the company’s penetration of the agency’s personal lines business.
Calendar year-over-year changes in the loss and loss expense ratio have included loss reserve development. In
2005, savings from favorable loss reserve development from prior accident years lowered the loss and loss
expense ratio by 1.6 percentage points. In 2004 and 2003, reserve strengthening added 0.2 percentage points
and 2.1 percentage points, respectively, to the loss and loss expense ratio.
Homeowner
Written and earned premiums for the homeowner line rose in 2005 and 2004. Written premiums rose because
of the effect of rate increases, which served to offset lower policy renewal retention and significantly lower new
business levels. Earned premiums continued to benefit from written premium growth in earlier periods.
At year-end 2005, approximately 56 percent of all homeowner policies had been converted to a one-year term,
up from approximately 27 percent at year-end 2004. We are continuing to renew homeowner policies for
three-year terms in nine states until the Diamond roll out is planned for those states. Renewal rates on those
three-year policies reflect all rate changes enacted over the past several years. This can cause those policies to
renew at a significantly higher cost for the policyholders, even if the price is competitive.
The loss and loss expense ratio for the homeowner line excluding catastrophe losses improved in 2005 and
2004. Unusually high catastrophe losses in 2004 interrupted two years of improvement in the loss and loss
expense ratio including catastrophe losses. Favorable loss reserve development from prior accident years
lowered the loss and loss expense ratio by 1.0 percentage points in 2005, 2.2 percentage points in 2004 and
3.1 percentage points in 2003.
We continue to seek to improve homeowner results so that this line achieves profitability. Since we generally do
not allocate noncommission expenses to individual business lines, to measure homeowner profitability,
2005 10-K Page 51
we assume total commission and underwriting expenses would contribute approximately 30 percentage points
to our homeowner combined ratio. Lower levels of premium growth could affect our ability to attain that level
in 2006 and beyond.
We also assume catastrophe losses as a percent of homeowner earned premium would be in the range of
17 percent. Over the past three years, catastrophe losses have averaged approximately 21 percent of
homeowner earned premiums. We believe it will take until 2007 for the full benefit of our pricing and
underwriting actions to be reflected in homeowner results.
Personal Lines Insurance Outlook
Industry experts currently anticipate industrywide personal lines written premiums will rise approximately
2.9 percent in 2006, with personal auto premiums expected to rise about 2.5 percent and homeowner
premiums expected to rise 4.2 percent.
A number of factors contribute to our assessment of the potential for personal lines growth:
• Competitive rates – We are working on a number of rate setting initiatives to make our personal auto and
homeowner rates competitive in all of our territories. We work with our agents to establish rates that are
attractive to our agencies’ quality accounts. In mid-2006, we will introduce a limited program of rate
segments incorporating insurance scores into rates for our personal auto and homeowner policies to
further improve our pricing for our agents’ quality accounts. We believe the opportunity exists to work with
our agents to market the advantages of our personal lines products to their clients, which would help us
resume growing in this business area.
• Policy characteristics – In keeping with industry practices, most of our homeowner products no longer
automatically cover guaranteed replacement costs. We add specific charges for some optional coverages
previously included at no charge, such as limited replacement cost and water damage coverages.
Policyholders who need the water damage protection now can select the amount of coverage that meets
their needs. However, these changes and our transition to one-year homeowner policies may have
diminished the factors that distinguished our products.
• Diamond introduction – The use of the Diamond system by agencies writing approximately 70 percent of
personal lines volume is a significant accomplishment. We believe the system ultimately will make it easier
for agents to place personal auto, homeowner and other personal lines business with us, while greatly
increasing policy-issuance and policy-renewal efficiencies and providing direct-bill capabilities. Agents
using Diamond chose direct bill for 37 percent and headquarters printing for 75 percent of policy
transactions in 2005, options that generally were not available on our previous system.
• New agencies – The availability of Diamond should help us increase the number of agencies that offer our
personal lines products, which also should contribute to personal lines growth. We currently market both
homeowner and personal auto insurance products through 773 of our 1,253 reporting agency locations in
22 of the 32 states in which we market commercial lines insurance. We market homeowner products
through 22 locations in three additional states (Maryland, North Carolina and West Virginia.)
In addition to the rate modifications currently underway, we identify several other factors that may affect the
personal lines combined ratio in 2006 and beyond. Personal lines underwriters continue to focus on insurance-
to-value initiatives to verify that policyholders are buying the correct level of coverage for the value of the
insured risk, and we are carefully maintaining underwriting standards. However, if premiums decline more than
we expect, the personal lines expense ratio may be higher than the 2005 level, because some of our costs are
relatively fixed, such as our planned investments in technology. We discuss our overall outlook for the property
casualty insurance operations in Measuring Our Success in 2006 and Beyond, Page 33.
LIFE INSURANCE RESULTS OF OPERATIONS
Overview -- Three-year Highlights
Performance highlights for the life insurance segment include:
• Revenues – Revenue growth has accelerated over the past three years as gross in-force policy face
amounts increased to $51.493 billion at year-end 2005 from $44.921 billion at year-end 2004 and
$38.492 billion at year-end 2003.
• Profitability – The life insurance segment reports a small GAAP profit because investment income is
included in investment segment results, except investment income credited to contract holders (interest
assumed in life insurance policy reserve calculations). Results improved in 2005 and 2004 because
operating expenses remained level and mortality experience remained within pricing guidelines as
premiums continued to rise.
At the same time, we recognize assets under management, capital appreciation and investment income
are integral to evaluation of the success of the life insurance segment because of the long duration of life
2005 10-K Page 52
products. For that reason, we also evaluate GAAP data including all investment activities on life insurance-
related assets.
GAAP net income on that basis grew 23.8 percent in 2005 to $47 million and 74.1 percent in 2004 to
$38 million. The life insurance portfolio had pretax realized investment gains of $17 million in 2005
compared with $9 million of gains in 2004 and $10 million of pretax realized investment losses in 2003.
Life Insurance Results
(In millions)
Written premiums
Earned premiums
Separate account investment management fees
Total revenues
Contract holders benefits incurred
Investment interest credited to contract holders
Expenses incurred
Total expenses
Life insurance segment profit (loss)
2005
2004
2003
$
$
$
205 $
106 $
4
110
102
(51)
52
103
7 $
193 $
101 $
3
104
95
(46)
53
102
2 $
2005-2004
Change %
6.5
5.7
18.5
6.0
7.2
12.9
(0.3)
0.8
334.2
2004-2003
Change %
34.7
5.5
31.9
6.1
3.5
5.7
0.2
0.9
147.5
143
95
2
97
91
(43)
52
100
(3)
Growth
We offer term, whole life and universal life products, fixed annuities and disability income products. Revenues
in 2005 were derived principally from:
• Premiums from traditional products, principally term insurance, which contributed 71.3 percent
•
Fee income from interest-sensitive products, principally universal life insurance, which contributed
25.5 percent
• Separate account investment management fee income, which contributed 3.2 percent
Our life insurance subsidiary reported total statutory written premiums of $205 million in 2005 compared with
$193 million in 2004, which included premiums for two general account BOLI policies totaling $10 million, and
$143 million in 2003. Written premiums for life insurance operations for all periods include life insurance,
annuity and accident and health premiums.
In 2005, our life insurance segment experienced a 2.0 percent rise in applications submitted and a 4.9 percent
increase in gross face amounts issued, primarily due to continued strong sales of term insurance marketed
through the company’s property casualty agency force.
Over the past several years, we have worked to maintain a portfolio of straightforward and up-to-date products,
primarily under the LifeHorizons name. Our product development efforts emphasize death benefit protection
and guarantees.
For example, a new term series that includes a return-of-premium feature replaced the existing term portfolio in
2005. Reaction to the new portfolio has been favorable with approximately 25 percent of applications
requesting the return-of-premium feature. In 2006, we are introducing a new universal life product that offers a
secondary guarantee that keeps the death benefit in force provided a competitive minimum premium
requirement is met.
Distribution expansion remains a high priority. In the past several years, we have added life field marketing
representatives for the western and northeastern states.
Profitability
Life segment expenses consist principally of:
•
Insurance benefits paid and reserve increases related to traditional life and interest-sensitive products,
which accounted for 66.0 percent of 2005 expenses and 64.3 percent of 2004 expenses
• Commissions, general and other business expenses, net of deferred acquisition costs, which accounted for
34.0 percent of 2005 expenses and 35.7 percent of 2004 expenses
Life segment profitability depends largely on premium levels, the adequacy of product pricing, underwriting skill
and operating efficiencies. Life segment results include only investment interest credited to contract holders
(interest assumed in life insurance policy reserve calculations). The remaining investment income is reported in
the investment segment results. The life investment portfolio is managed to earn target spreads between
earned investment rates on general account assets and rates credited to policyholders. We consider the
amount of assets under management and investment income for the life investment portfolio as key
performance indicators for the life insurance segment.
We seek to maintain a competitive advantage with respect to benefits paid and reserve increases by
consistently achieving better than average claims experience due to skilled underwriting. Commissions paid by
2005 10-K Page 53
the life insurance operation are on par with industry averages. During the past several years, we have invested
in imaging and workflow technology and have significantly improved application processing. We have achieved
efficiencies while maintaining our service standards.
Life Insurance Outlook
As the life insurance company seeks to improve penetration of our property casualty agencies, our objective is
to increase premiums and contain expenses. We continue to emphasize the cross-serving opportunities
afforded by worksite marketing of life insurance products. In 2006, we are exploring additional programs to
simplify the worksite marketing sales process, including electronic enrollment software. We also intend to
enhance our worksite product portfolio to make it more attractive to agents. We believe these strategies will
allow us to continue to increase our worksite marketing business area.
Term insurance is our largest life insurance product line. We continue to introduce new term products with
features our agents indicate are important. In addition to the changes in our term life insurance portfolio, we
are implementing our new universal life products.
Marketplace and regulatory changes during 2004 have affected the cost and availability of reinsurance for
term life insurance issued since the beginning of 2005. We are addressing this situation by retaining no more
than a $500,000 exposure, ceding the balance using excess over retention mortality coverage and retaining
the policy reserve. Retaining the policy reserve has no direct impact on GAAP results. However, because of the
conservative nature of statutory reserving principles, retaining the policy reserve unduly depresses our
statutory earnings and requires a large commitment of capital. We anticipate favorable regulatory changes as
we discuss in Item 1, Life Insurance Segment, Page 13. We believe we will be able to continue to grow in the
term life insurance marketplace while appropriately managing risk, at a cost that allows the life insurance
company to achieve its internal performance targets.
INVESTMENTS RESULTS OF OPERATIONS
Overview -- Three-year Highlights
The investment segment contributes investment income and realized gains and losses to results of operations.
Investments provide our primary source of pretax and after-tax profits.
•
Investment income – Pretax investment income reached a new record in 2005, rising 6.9 percent from the
prior record in 2004. Growth in investment income over the past two years has been driven by strong cash
flow for new investments, higher interest income from the growing fixed-maturity portfolio and increased
dividend income from the common stock portfolio.
• Realized gains and losses – We reported realized gains in 2005 and 2004 largely due to investment sales.
The realized loss in 2003 was due to other-than-temporary impairment charges.
Investment Results
(In millions)
Investment income:
Interest
Dividends
Other
Investment expenses
Total net investment income
Investment interest credited to contract holders
Net realized investment gains and losses:
Realized investment gains and losses
Change in valuation of embedded derivatives
Other-than-temporary impairment charges
Net realized investment gains (losses)
Investment operations income
2005
2004
2003
2005-2004
Change %
2004-2003
Change %
$
$
280 $
244
8
(6)
526
(51)
69
(7)
(1)
61
536 $
252 $
239
6
(5)
492
(46)
87
10
(6)
91
537 $
235
227
8
(5)
465
(43)
30
9
(80)
(41)
381
11.2
2.1
29.4
(22.3)
6.9
12.9
(20.7)
(167.2)
78.5
(33.1)
(0.4)
7.2
5.0
(23.0)
(13.0)
5.6
5.7
189.9
7.9
92.0
321.7
40.6
Investment Income
The advantages of strong cash flow in the past three years have been somewhat offset by the challenge of
investing in a low interest rate environment. The allocation of new investment dollars to fixed-maturity
securities during most of 2005 and 2004 added to investment income growth.
Overall, common stock dividends contributed 43.7 percent of pretax investment income in 2005 compared
with 43.9 percent in 2004 and 42.3 percent in 2003. Fifth Third, our largest equity holding, contributed
43.6 percent of total dividend income in 2005. We discuss our Fifth Third investment in Item 7A, Quantitative
and Qualitative Disclosures About Market Risk, Page 70. In 2005, 36 of the 49 common stock holdings in the
portfolio raised their indicated annual dividend payout, as did 33 of the 51 in 2004 and 29 of 51 in 2003.
2005 10-K Page 54
Net Realized Investment Gains and Losses
Net realized investment gains and losses are made up of realized investment gains and losses on the sale of
securities, changes in the valuation of embedded derivatives within certain convertible securities and other-
than-temporary impairment charges. These three areas are discussed below.
Realized Investment Gains and Losses
Realized investment gains in 2005 and 2004 largely were due to the sale of equity holdings. We buy and sell
both fixed-maturity and equity securities on an ongoing basis to help achieve our portfolio objectives.
In 2005 and 2003, we had gains from the sale of equity holdings that no longer met our investment
parameters or were obtained from convertible securities whose underlying common stock was never intended
to be a long-term holding. Included in 2005 were the initial sales of a portion of our ALLTEL holding. We
completed the sale of our entire ALLTEL position in January 2006. We discuss this sale in Item 1, Investments
Segment, Page 15, and Item 8, Note 2 to the Consolidated Financial Statements, Page 88.
In 2004, we sold $356 million in equity holdings as part of a program to support the financial strength ratings
of our property casualty insurance operations. We selected holdings to sell primarily based on the belief of the
investment committee and management that these securities would have a lower dividend growth rate over the
next several years when compared with other holdings in the portfolio. We also considered the potential tax
effect of any unrealized gains. Partial sales of holdings in which we held over $100 million in fair value at
year-end 2003 contributed $311 million.
We sold fixed-maturity investments during the past three years as part of our portfolio management strategies.
The majority of these were bonds disposed of due to rating or credit concerns, including several in the airline
and auto related industries. Although we prefer to hold fixed-maturity investments until they mature, a decision
to sell reflects our perception of a change in the underlying fundamentals of the security and preference to
allocate those funds to investments that more closely meet the established parameters for long-term stability
and growth. Our opinion that a security fundamentally no longer meets our investment parameters may reflect
a loss of confidence in the issuer’s management, a change in underlying risk factors (such as political risk,
regulatory risk, sector risk or credit risk), or a recovery from a previously impaired value.
Realized gains in the past three years also have included gains from the sale of previously impaired securities.
Change in the Valuation of Embedded Derivatives
In 2005, we recorded $7 million in fair value declines compared with $10 million in fair value increases in
2004 and $9 million in fair value increases in 2003. These changes in fair value are due to the application of
SFAS No. 133, which requires measurement of the fluctuations in the value of the embedded derivative
features in selected convertible securities. The changes in fair values are recognized in net income in the
period they occur. See Item 8, Note 1 to the Consolidated Financial Statements, Page 84, for details on the
accounting for convertible security embedded options.
Other-than-temporary Impairment Charges
In 2005, we recorded $1 million in write-downs of investments that we deemed had experienced an other-than-
temporary decline in market value versus $6 million in 2004 and $80 million in 2003. The factors we consider
when evaluating impairments are discussed in Critical Accounting Estimates, Asset Impairment, Page 37.
The other-than-temporary impairment charges represented less than 0.1 percent of our total invested assets at
year-end 2005 and 2004 and 0.6 percent of our total invested assets at year-end 2003. Other-than-temporary
impairment charges also include unrealized losses of holdings that we have identified for sale but not yet
completed a transaction.
The significant decline in other-than-temporary impairment in 2005 and 2004 was due to prior impairments in
the portfolio, disposition of certain securities in prior years and an improvement in the general financial
climate.
The majority of the other-than-temporary write-downs in the past three years were due to:
• 2005 – one auto-related convertible preferred security for $1 million
• 2004 – two airline-related tax-exempt municipal bonds totaling $5 million
• 2003 – 31 high-yield corporate bonds written down $39 million and 10 convertible securities written down
$26 million. Market value declines in 2003 largely related to events specific to the issuer rather than
industry issues, although $58 million of the $80 million write-downs were concentrated in the
utility/merchant energy trading, airline and healthcare industries.
2005 10-K Page 55
Other-than temporary impairment charges from the investment portfolio by the asset class we described in
Item 1, Investments Segment, Page 15, are summarized below:
(Dollars in millions)
Taxable fixed maturities:
Number of securities impaired
Percent to total owned
Impairment amount
New book value
Percent to total owned
Tax-exempt fixed maturities:
Number of securities impaired
Percent to total owned
Impairment amount
New book value
Percent to total owned
Common equities:
Number of securities impaired
Percent to total owned
Impairment amount
New book value
Percent to total owned
Preferred equities:
Number of securities impaired
Percent to total owned
Impairment amount
New book value
Percent to total owned
Short-term investments:
Number of securities impaired
Percent to total owned
Impairment amount
New book value
Percent to total owned
Total:
Number of securities impaired
Percent to total owned
Impairment amount
New book value
Percent to total owned
Years ended December 31,
2004
2003
2005
2
0 %
(1)
1
0 %
$
0
0 %
0
0
0 %
$
0
0 %
0
0
0 %
$
0
0 %
0
0
0 %
$
0
0 %
0
0
0 %
$
2
0 %
(1)
1
0 %
$
$
1
1 %
0
2
1 %
2
0 %
(5)
9
1 %
1
2 %
(1)
0
0 %
0
0 %
0
0
0 %
0
0 %
0
0
0 %
$
$
$
$
$
4
0 %
(6)
11
0 %
$
$
42
6 %
(66)
36
1 %
5
1 %
(6)
3
0 %
2
4 %
(8)
5
0 %
0
0 %
0
0
0 %
0
0 %
0
0
0 %
49
3 %
(80)
44
1 %
$
$
$
$
$
$
$
Other-than temporary impairment charges from the investment portfolio by industry are summarized as follows:
(Dollars in millions)
Automotive
Airline
Utility/merchant energy/trading
Healthcare
Other
Total
Years ended December 31,
2004
2003
2005
(1)
0
0
0
0
(1)
$
$
0
(5)
0
0
(1)
(6)
$
$
(1)
(18)
(30)
(10)
(21)
(80)
$
$
Investments Outlook
We believe investment income growth for 2006 could be in the range of 6.5 percent to 7.0 percent.
Our outlook is based on the anticipated level of dividend income, the strong cash flow from insurance
operations and the higher-than-normal allocation of new cash flow to fixed-maturity securities over the past
18 months. Dividend increases within the last 12 months by Fifth Third and another 35 of the 49 common
stock holdings in the equity portfolio should add $15 million to annualized investment income. In 2006, our
investment department will allocate the after-tax proceeds of the ALLTEL common stock sale in line with our
overall investment philosophy, with a focus on replacing the approximately $20 million in ALLTEL dividend
income received in 2005.
2005 10-K Page 56
We believe impairments in 2006 should be limited to securities that have been identified for sale or that have
experienced a sharp decline in fair value with little or no warning because of issuer-specific events. All but two
securities in the portfolio were trading at or above 70 percent of book value at December 31, 2005. Our asset
impairment committee continues to monitor the investment portfolio. The current asset impairment policy is in
Critical Accounting Estimates, Asset Impairment, Page 37.
OTHER
In 2005, other income of the insurance subsidiaries, parent company operations and non-investment
operations of CFC Investment Company and CinFin Capital Management Company resulted in $12 million in
revenues compared with $8 million in 2004 and $7 million in 2003. Losses before income taxes of $50 million
in 2005 were primarily due to $52 million in interest expense from debt of the parent company. Losses before
income taxes were $37 million in 2004 and $38 million in 2003, when interest expense was $36 million and
$33 million, respectively.
TAXES
Income tax expense was $221 million in 2005 compared with $216 million in 2004 and $106 million in 2003.
The effective tax rate for 2005 was 26.8 percent compared with 27.0 percent in 2004 and 22.0 percent in
2003. In addition to higher underwriting profits, the higher tax rate in 2005 and 2004 reflected a higher level
of capital gains, compared with capital losses in 2003.
We pursue a strategy of investing some portion of cash flow in tax-advantaged fixed-maturity and equity
securities to minimize our overall tax liability and maximize after-tax earnings. Details regarding our effective
tax rate are found in Item 8, Note 10 to the Consolidated Financial Statements, Page 93.
LIQUIDITY AND CAPITAL RESOURCES
Liquidity and capital resources represent the overall financial strength of our company and our ability to
generate cash flows to meet the short- and long-term cash requirements of business obligations and growth
needs. We seek to maintain prudent levels of liquidity and financial strength for the protection of our
policyholders, creditors and shareholders.
The parent company’s primary means of meeting liquidity requirements are dividends from our insurance
subsidiary and income from investments held at the parent-company level supported by our capital resources.
At year-end 2005, we had shareholders’ equity of $6.086 billion and total debt of $791 million. Our ability to
access the capital markets and short-term bank borrowing provide other potential sources of liquidity. One way
we seek to maintain financial strength is by keeping our ratio of debt to capital below 15 percent. Our parent
company’s cash requirements include dividends to shareholders, interest payments on our long-term debt,
common stock repurchases and general operating expenses.
Our insurance subsidiary’s primary sources of liquidity are premiums and investment income. Its cash needs
primarily consist of paying property casualty and life insurance loss and loss expenses as well as ongoing
operating expenses and payments of dividends to the parent company. Although we have never sold
investments to pay claims, the sale of investments would provide an additional source of liquidity, if required.
After satisfying operating cash requirements, excess cash flows are invested in fixed-maturity and equity
securities, leading to the potential for increases in future investment income and unrealized appreciation.
SOURCES OF LIQUIDITY
Subsidiary Dividends
Our insurance subsidiary declared dividends to the parent company of $275 million in 2005, $175 million in
2004 and $50 million in 2003. State of Ohio regulatory requirements restrict the dividends insurance
subsidiaries can pay. Generally, the most Ohio-domiciled insurance subsidiaries can pay without prior
regulatory approval is the greater of 10 percent of statutory surplus or 100 percent of statutory net income for
the prior calendar year up to the amount of statutory unassigned surplus as of the end of the prior calendar
year. Dividends exceeding these limitations may be paid only with approval of the Ohio Department of
Insurance. During 2006, total dividends that our lead insurance subsidiary can pay to our parent company
without regulatory approval are approximately $517 million.
Insurance Underwriting
Our property casualty and life insurance operations provide liquidity because premiums generally are received
before losses are paid under the policies purchased with those premiums. After satisfying our cash
requirements, excess cash flows are used for investment, increasing future investment income.
2005 10-K Page 57
This table shows a summary of cash flow of the insurance subsidiary (direct method):
(In millions)
Written premiums
Loss and loss expenses paid
Commissions and other underwriting expenses paid
Insurance subsidiary cash flow from underwriting
Investment income received
Insurance subsidiary operating cash flow
Years ended December 31,
2004
2003
2005
$
$
3,187 $
1,752
951
484
427
911 $
3,055 $
1,694
889
472
362
834 $
2,771
1,617
774
380
332
712
Historically, cash receipts from property casualty and life insurance premiums, along with investment income,
have been more than sufficient to pay claims, operating expenses and dividends to the parent company. While
first-year life insurance expenses normally exceed the premiums, subsequent premiums are used to generate
investment income until the time the policy benefits are paid.
After paying claims and operating expenses, cash flows from underwriting were essentially unchanged in 2005
after rising 21.5 percent in 2004. We discuss our future obligations for claims payments in Contractual
Obligations, Page 59, and our future obligations for underwriting expenses in Commissions and Other
Underwriting Expenses, Page 60. Based on our outlook for commercial lines, personal lines and life insurance,
we believe that cash flows from underwriting could decline in 2006. A lower level of cash flow available for
investment could lead to reduced potential for increases in future investment income and capital gains.
Investing Activities
Investment income is a primary source of liquidity for both the parent company and insurance subsidiary.
The transfer of equity holdings to our insurance subsidiary from the parent company in 2004 increased the
amount of investment income generated at the subsidiary level but had no effect on consolidated investment
income. As we discuss under Investments Results of Operations, Page 54, investment income rose in each of
the past three years, and we expect investment income to grow 6.5 percent to 7.0 percent in 2006.
Realized gains also can provide liquidity, although we follow a buy-and-hold investment philosophy seeking to
compound cash flows over the long-term. When we dispose of investments, we generally reinvest the gains in
new investment securities. Disposition of investments occurs for a number of reasons:
• Sales of fixed-maturity investments – We prefer to hold fixed-maturity securities until maturity. Any decision
to sell or to reduce a holding reflects our perception of a change in the underlying fundamentals of the
security and our preference to allocate those funds to investments that more closely meet our established
parameters for long-term stability and growth.
• Call or maturity of fixed-maturity investments – Calls and maturities of fixed-maturity investments are a
function of the yield curve. The pace of calls of fixed maturities declined in 2005 because of a stabilization
of interest rates. In the past several years, we have purchased U.S. agency paper with higher coupons and
shorter call protection features.
• Sales of equity securities investments – In 2005, we continued to sell equity positions previously identified.
We also recorded the initial ALLTEL sales in 2005. Sales of equity securities rose in 2004 due to the sale
of $356 million in equity holdings as part of our program to support the financial strength ratings of our
property casualty insurance operations. Holdings to be sold were selected primarily based on the
investment committee’s and management’s belief that these securities would have a lower dividend
growth rate over the next several years when compared with other holdings in the portfolio. We also
considered the potential tax effect of any unrealized gains.
We generally have substantial discretion in the timing of investment sales and, therefore, the resulting gains or
losses that are recognized in any period. That discretion generally is independent of the insurance underwriting
process. In 2006, we expect to continue to limit the disposition of investments to those that no longer meet our
investment parameters or those that reach maturity or are called by the issuer. The sale of equity investments
that no longer meet our investment criteria can provide cash for investment in common stocks that we
perceive to have greater potential for capital appreciation and income growth.
Capital Resources
At year-end 2005, our debt-to-capital ratio was 11.5 percent. We had $791 million of long-term debt and no
borrowings on our short-term lines of credit. We generally have minimized our reliance on debt financing
although we may utilize lines of credit to fund short-term cash needs.
We provide details of our three long-term notes in Item 8, Note 7 of the Consolidated Financial Statements,
Page 91. None of the notes are encumbered by rating triggers.
2005 10-K Page 58
We issued $375 million aggregate principal amount of 6.125% senior notes in 2004. The $368 million net
proceeds from the offering:
• Paid off $183 million in short-term debt.
• Are financing the construction of an estimated $100 million office building and parking garage to be
situated at the headquarters located in Fairfield beginning in 2005, as announced in August 2004.
• Are available for general corporate purposes.
As of March 3, 2006, our senior debt issues were rated aa- by A.M. Best, A+ by Fitch, A2 by Moody’s and A by
Standard & Poor’s.
At year-end 2005, we had two lines of credit totaling $125 million with no outstanding balance. One line of
credit for $75 million was established more than five years ago and has no financial covenants. The second
line of credit is an unsecured $50 million line of credit from Fifth Third Bank established in 2005. It is available
for general corporate purposes and contains customary financial covenants.
Based on our present capital requirements, we do not anticipate a material increase in debt levels during
2006. As a result, we believe our debt-to-capital ratio will remain in the range of 11 percent to 12 percent.
As a long-term investor, we historically have followed a buy-and-hold investing strategy. This policy has
generated a significant amount of unrealized appreciation on equity investments. Unrealized appreciation,
before deferred income taxes, was $5.067 billion and $5.840 billion at year-end 2005 and 2004, respectively.
On an after-tax basis, it constituted 54.0 percent of total shareholders' equity at year-end 2005.
Off-balance Sheet Arrangements
We do not utilize any special-purpose financing vehicles or have any undisclosed off-balance sheet
arrangements (as that term is defined in applicable SEC rules) that are reasonably likely to have a current or
future material effect on the company’s financial condition, results of operation, liquidity, capital expenditures
or capital resources. Similarly, the company holds no fair-value contracts for which a lack of marketplace
quotations would necessitate the use of fair-value techniques.
USES OF LIQUIDITY
Our parent company and insurance subsidiary have contractual and other obligations. In addition, one of our
primary uses of cash is to enhance shareholder return.
Contractual Obligations
At December 31, 2005, we estimated our future contractual obligations as follows:
(In millions)
Payment due by period
Within
1 year
Years
2-3
Years
4-5
More than
5 years
Total
Contractual obligations:
Net property casualty claims payments
Net life claims payments
Interest on long-term debt
Long-term debt
Annuitization obligations
Headquarters building expansion
Computer hardware and software
Other invested assets
Total
$
$
1,009 $
6
52
0
15
20
10
9
1,121 $
1,054 $
0
104
0
45
63
2
10
1,278 $
474 $
0
104
0
30
0
1
1
610 $
574 $
0
1,048
795
104
0
1
0
2,522 $
3,111
6
1,308
795
194
83
14
20
5,531
Claims Payments
Our estimate of material commitments for net property casualty claims payments was approximately
56.2 percent of the estimated contractual obligations at year-end 2005.
We direct our associates to settle claims and pay losses as quickly as practical and made $1.752 billion in
net claim payments during 2005. At year-end 2005, we had net property casualty reserves of $3.111 billion,
reflecting $1.605 billion in unpaid amounts on reported claims (case reserves), $669 million in loss expense
reserves and $837 million in estimates of IBNR claims. The specific amounts and timing of obligations related
to case reserves and associated loss expenses are not set contractually. The amounts and timing of obligations
for IBNR claims and related loss expenses are unknown. We discuss the adequacy of our property casualty and
life insurance loss and loss expense reserves in Property Casualty Insurance Reserves, Page 61.
The historic pattern of using premium receipts for the payment of loss and loss expenses has enabled us to
extend slightly the maturities of our investment portfolio beyond the estimated settlement date of the loss
reserves. The modified duration of our fixed-maturity portfolio was 7.1 years at year-end 2005. By contrast, the
duration of our loss and loss expense reserves was 3.1 years and the duration of all liabilities was 2.8 years.
We believe this difference in duration does not affect our ability to meet current obligations because cash flow
2005 10-K Page 59
from operations is sufficient to meet these obligations. In addition, our investment strategy has led to
substantial unrealized gains from holdings in equity securities. These equity holdings could be liquidated to
meet higher than anticipated loss and loss expenses.
We believe that our insurance subsidiaries maintain sufficient liquidity to pay claims and operating expenses,
as well as meet commitments in the event of unforeseen circumstances such as catastrophe losses, reinsurer
insolvencies, changes in the timing of claims payments, increases in claims severity, reserve deficiencies or
inadequate premium rates. We believe catastrophic events are the most likely cause of an unexpected rise in
claims severity or frequency.
Our reinsurance program mitigates the liquidity risk of a single large loss or an unexpected rise in claims
severity or frequency due to a catastrophic event. Reinsurance does not relieve us of our obligation to pay
covered claims. The financial strength of our reinsurers is important because our ability to recover for losses
under one of our reinsurance agreements depends on the financial viability of the reinsurer.
While we believe that historical performance of property casualty and life loss payment patterns is a
reasonable source for projecting future claims payments, there is inherent uncertainty in this estimate of
contractual obligations. We believe that we could meet our obligations under a significant and unexpected
change in the timing of these payments because of the liquidity of our invested assets, strong financial position
and access to lines of credit.
Long-term Debt and Interest on Long-Term Debt
Our estimate of material commitments for long-term debt was approximately 14.4 percent and our estimate of
material commitments for interest on long-term debt was approximately 23.6 percent of the estimated
contractual obligations at year-end 2005.
Our interest expense rose in 2005 to an annual rate of approximately $52 million due to our 2004 issuance of
$375 million aggregate principal amount of 6.125% senior notes due 2034. We generally have tried to
minimize our reliance on debt financing and do not expect a material increase in interest expense in the near
future.
Annuitization Obligations
Our estimate of material commitments for obligations due under annuities written by our life insurance
subsidiary was approximately 3.5 percent of the estimated contractual obligations at year-end 2005.
Headquarters Building Expansion
The construction of our new office building and parking garage to be situated at our headquarters located in
Fairfield is expected to require approximately $83 million over the next three years. The construction project is
on schedule and on budget. As of December 31, 2005, construction costs totaled $18 million. We expect
construction to be completed by September 2008.
We invested $100 million of the proceeds from our 2004 issuance of $375 million aggregate principal amount
of 6.125% senior notes due 2034 in short-term investments to fund this obligation.
Computer Hardware and Software
We expect to need approximately $14 million over the next five years for material commitments for computer
hardware and software, including maintenance contracts on hardware and other known obligations.
We discuss below the non-contractual expenses we anticipate for computer hardware and software in 2006.
Commissions and Other Underwriting Expenses
In addition to our contractual obligations, our insurance operations use cash for commission and other
underwriting expenses.
As discussed above, commissions and other underwriting expenses paid rose in each the past two years,
reflecting the operating expense trends we discuss in the Commercial Lines and Personal Lines Insurance
Results of Operations, Page 41 and Page 47. Commission payments also include contingent, or profit-sharing,
commissions, which are paid to agencies using a formula that takes into account agency profitability and other
factors, such as prompt monthly payment of amounts due to the company. Commission payments generally
track with written premiums. Contingent commission payments in 2006 will be influenced by the excellent
profitability we generated in 2005 and 2004.
Many of our operating expenses are not contractual obligations, but reflect the ongoing expenses of our
business. Staffing is the largest component of our operating expenses and is expected to rise again in 2006,
reflecting the 4.3 percent average annual growth in our associate base over the past three years. Our associate
base has grown as we focus on enhancing service to our agencies and staffing additional field territories. Other
expenses should rise in line with our growth.
In addition to contractual obligations for hardware and software, we anticipate investing approximately
$16 million in key technology initiatives in 2006, including spending for the development and rollout of our
2005 10-K Page 60
commercial lines policy processing systems that we discuss in Item 1, Technology Solutions, Page 4.
Capitalized development costs related to key technology initiatives totaled $11 million in 2005. These activities
are conducted at our discretion and we have no material contractual obligations for activities planned as part
of these projects.
Investing Activities
Excess cash flows from underwriting, investment and other corporate activities are invested in fixed-maturity
and equity securities on an ongoing basis to help achieve our portfolio objectives. See Item 1, Investments
Segment, Page 15, for a discussion of our investment strategy, portfolio allocation and quality. Since the
second quarter of 2004, virtually all of our available cash flow has been used to purchase fixed-maturity
investments to reduce our property casualty subsidiary’s ratio of common stock to statutory surplus.
Purchases of fixed-maturity securities rose significantly in 2005 and 2004. Due to the allocation of a higher
percentage of new investment dollars to fixed-maturity investments, equity securities purchases in 2005 and
2004 were below the level of 2003. Purchases in 2005 included $144 million of nonredeemable preferred
stock. We evaluate nonreedemable preferred stocks similar to the evaluation we make for fixed-maturity
investments, seeking attractive relative yields.
In 2006, we anticipate continuing to use the majority of available cash flow to purchase fixed-maturity
investments and preferred stock. Common stock purchases primarily will be funded with proceeds of common
stock sales. The trend of ratios we monitor could permit some common stock purchases with cash flow from
operations.
Uses of Capital
Uses of cash to enhance shareholder return include:
• Dividends to shareholders – Over the past 10 years, the company has paid an average of 42 percent of net
income as dividends, with the remaining 58 percent available to reinvest for future growth and for share
repurchases. The ability of the company to continue paying cash dividends is subject to factors the board
of directors may deem relevant.
In February 2006, the board of directors authorized a 9.8 percent increase in the regular quarterly cash
dividend to an indicated annual rate of $1.34 per share. In 2005, 2004 and 2003, we paid cash dividends
of $204 million, $177 million and $156 million.
• Common stock repurchase – Our board believes that stock repurchases can help fulfill our commitment to
enhancing shareholder value. Consequently, the board has authorized the repurchase of outstanding
shares. Common stock repurchases for treasury have continued at a steady pace over the last several
years and occur when we believe that stock prices on the open market are favorable for such repurchases.
At a minimum, we would expect the repurchase to offset dilution of option exercises. In 2005, 2004 and
2003, we used $63 million, $66 million and $55 million for share repurchase.
In 2005, the board authorized a 10 million share repurchase program to replace a program authorized in
1999. At year-end 2005, 9.5 million shares remained authorized for repurchase under the 2005 program.
The details of the repurchase activity are described in Item 5, Market for the Registrant’s Common Equity,
Related Stockholder Matters and Issuer Purchases of Equity Securities, Page 27. Between February 1999
and year-end 2005, we have repurchased 14.8 million shares at a total cost to the company of
$543 million. We do not adjust number of shares repurchased and average price per repurchased share
for stock dividends.
PROPERTY CASUALTY INSURANCE RESERVES
At year-end 2005, the total reserve balance, net of reinsurance, was $3.111 billion, compared with
$2.977 billion at year-end 2004 and $2.845 billion at year-end 2003. We provide a reconciliation of the
property casualty reserve balances with the loss and loss expense liability on the balance sheet in Item 8,
Note 4 to the Consolidated Financial Statements, Page 90. The reserves reflected in the financial statements
are management’s best estimate.
The appointed actuary's range for adequate statutory reserves, net of reinsurance, was $2.921 billion to
$3.153 billion for 2005; $2.794 billion to $3.032 billion for 2004; and $2.696 billion to $2.906 billion for
2003. The assumptions used to establish the recommended ranges were consistent with the actuary’s
practices. Historically, we have established reserves in the upper half of the actuary's range, as discussed in
Critical Accounting Estimates, Property Casualty Loss and Loss Expense Reserves, Page 35.
In addition to our conclusions regarding adequate reserve levels, other factors that have affected reserve levels
over the past three years included:
•
Increases in coverage in force in selected business lines
• New business
2005 10-K Page 61
• Higher initial case reserves on liability claims
•
Judicial decisions and mass tort claims
Loss cost inflation in selected lines
•
The types of coverages we offer and the risk levels retained have a direct influence on the development of
claims. Specifically, claims that develop quickly and have lower risk retention levels generally are more
predictable.
As we discuss in Commercial Lines Insurance Segment Reserves, Page 64, re-underwriting the commercial
lines book of business beginning in 2000, including decisions to non-renew certain policyholders due to risk
levels and to increase rates to better reflect exposure levels, has resulted in improved profitability. We believe
the program has led to a lower risk profile for the overall commercial lines segment, which has contributed to
favorable loss reserve trends.
As we discuss in Personal Lines Insurance Segment Reserves, Page 66, we are seeking to improve our
personal lines segment performance, in particular the homeowner business line, partially by reducing risk
exposure through changes in policy terms and conditions. We do not expect our actions in personal lines to
have a material impact on loss reserve trends, largely due to the relatively short-tail nature of homeowner
claims.
In 2003 and 2004, $70 million in reserves were released following the November 2003 Ohio Supreme Court's
limiting of its 1999 Scott-Pontzer v. Liberty Mutual decision. The reserve releases were primarily made in the
commercial auto and other liability business lines. Following the fourth-quarter 2003 reserve review, reserve
levels were modified to reflect management’s assessment that mold claims behaved similar to asbestos and
environmental claims, and reserves for these claims should be estimated using similar methods. These
changes have been seen predominately in the commercial multi-peril business line. We expect that mold
exclusions added to our commercial policies beginning in 2003 will mitigate this issue after 2006.
Further, beginning in 2003, reserve levels reflected the need to establish higher expense reserves because of
the rise in litigation costs due to larger and more complex claims. These changes have been seen
predominately in commercial multi-peril and other liability business lines. Beginning in 2002, our conclusions
regarding reserve levels for all business lines reflected refinement of the manner in which the value of future
salvage and subrogation for claims already incurred were estimated.
Development of Loss and Loss Expenses
We reconcile the beginning and ending balances of our reserve for loss and loss expenses at
December 31, 2005, 2004 and 2003, in Item 8, Note 4 to the Consolidated Financial Statements, Page 90.
The reconciliation of our year-end 2004 reserve balance to net incurred losses one year later recognizes
approximately $160 million in redundant reserves.
The table below shows the development of the estimated reserves for loss and loss expenses the past
10 years.
• Section A shows our total property casualty loss and loss expense reserves recorded at the balance sheet
date for each of the indicated calendar years on a gross and net basis. Those reserves represent the
estimated amount of loss and loss expenses for claims arising in all prior years that are unpaid at the
balance sheet date, including losses that have been incurred but not yet reported to the company.
• Section B shows the cumulative net amount paid with respect to the previously recorded reserve as of the
end of each succeeding year. For example, as of December 31, 2005, we had paid $1.053 billion of loss
and loss expenses in calendar years 1996 through 2005, for losses that occurred in accident years
1995 and prior. An estimated $130 million of losses remain unpaid as of year-end 2005 (net re-estimated
reserves of $1.183 billion less cumulative paid loss and loss expenses of $1.053 billion).
• Section C shows the re-estimated amount of the previously reported reserves based on experience as of
the end of each succeeding year. The estimate is increased or decreased as we learn more about the
frequency and severity of claims.
• Section D, cumulative net redundancy, represents the aggregate change in the estimates for all years
subsequent to the year the reserves were initially established. For example, reserves established at
December 31, 1995, had developed a $398 million redundancy over 10 years, net of reinsurance, which
has been reflected in income over the 10 years. The effects on income in 2005, 2004 and 2003 of
changes in estimates of the reserves for loss and loss expenses for all accident years are shown in the
reconciliation below.
2005 10-K Page 62
(In millions)
A. Originally reported reserves for unpaid loss and loss expenses:
1995
1996
1997
1998
Calendar year ended December 31,
2000
1999
2001
2002
2003
2004
2005
Gross of reinsurance
Reinsurance recoverable
Net of reinsurance
B. Cumulative net paid as of:
One year later
Two years later
Three years later
Four years later
Five years later
Six years later
Seven years later
Eight years later
Nine years later
Ten years later
C. Net reserves re-estimated as of:
One year later
Two years later
Three years later
Four years later
Five years later
Six years later
Seven years later
Eight years later
Nine years later
Ten years later
D. Cumulative net redundancy as of:
One year later
Two years later
Three years later
Four years later
Five years later
Six years later
Seven years later
Eight years later
Nine years later
Ten years later
Net liability re-estimated—latest
Re-estimated recoverable—latest
Gross liability re-estimated—latest
Cummulative gross redundancy
$
$
$
$
$
$
$
$
1,690 $
109
1,581 $
1,824 $
122
1,702 $
1,889 $
112
1,777 $
1,978 $
138
1,840 $
2,093 $
161
1,932 $
2,401 $
219
2,182 $
2,865 $
513
2,352 $
3,150 $
542
2,608 $
3,386 $
541
2,845 $
3,514 $
537
2,977 $
3,629
518
3,111
395 $
630
801
881
946
977
1,009
1,031
1,045
1,053
1,429 $
1,380
1,279
1,236
1,227
1,189
1,205
1,210
1,208
1,183
152 $
201
302
345
354
392
376
371
373
398
453 $
732
884
992
1,049
1,093
1,123
1,146
1,159
1,582 $
1,470
1,405
1,380
1,326
1,333
1,333
1,332
1,305
120 $
232
297
322
376
369
369
370
397
499 $
761
965
1,075
1,152
1,205
1,239
1,260
522 $
853
1,067
1,207
1,283
1,333
1,366
591 $
943
1,195
1,327
1,412
1,464
697 $
758 $
799 $
817 $
907
1,116
1,378
1,526
1,623
1,194
1,455
1,614
1,235
1,519
1,293
1,623 $
1,551
1,520
1,465
1,466
1,463
1,460
1,435
1,724 $
1,728
1,636
1,615
1,608
1,602
1,577
1,912 $
1,833
1,802
1,771
1,757
1,733
2,120 $
2,083
2,052
2,010
1,999
2,307 $
2,263
2,178
2,153
2,528 $
2,377
2,336
2,649 $
2,546
2,817
154 $
226
257
312
311
314
317
342
116 $
112
204
225
232
238
263
20 $
99
130
161
175
199
62 $
99
130
172
183
45 $
89
174
199
80 $
231
272
196 $
299
160
1,183 $
179
1,362 $
1,305 $
174
1,479 $
1,435 $
189
1,624 $
1,577 $
214
1,791 $
1,733 $
222
1,955 $
1,999 $
248
2,247 $
2,153 $
513
2,666 $
2,336 $
548
2,884 $
2,546 $
526
3,072 $
2,817
539
3,356
328 $
345 $
265 $
187 $
138 $
154 $
199 $
266 $
314 $
158
In evaluating the development of our estimated reserves for loss and loss expenses for the past 10 years, note
that each amount includes the effects of all changes in amounts for prior periods. For example, payments or
reserve adjustments related to losses settled in 2005 but incurred in 1999 are included in the cumulative
deficiency or redundancy amount for 2000 and each subsequent year. In addition, this table presents calendar
year data, not accident or policy year development data, which readers may be more accustomed to analyzing.
Conditions and trends that have affected development of the reserves in the past may not necessarily occur in
the future. Accordingly, it may not be appropriate to extrapolate future redundancies or deficiencies based on
this data.
Differences between the property casualty reserves reported in the accompanying consolidated balance sheets
(prepared in accordance with GAAP) and those same reserves reported in the annual statements (filed with
state insurance departments in accordance with statutory accounting practices – SAP), relate principally to the
reporting of reinsurance recoverables, which are recognized as receivables for GAAP and as an offset to
reserves for SAP.
Asbestos and Environmental Reserves
We believe that our asbestos and environmental reserves, including mold reserves, are adequate at this time
and that these coverage areas are immaterial to our financial position due to the types of accounts we have
insured in the past.
Loss and loss expenses incurred for all asbestos and environmental claims were $12 million, or 0.7 percent of
total loss and loss expenses in 2005, compared with $41 million, or 2.4 percent in 2004, and $28 million, or
1.6 percent, in 2003. The increase in 2004 was primarily due to mold claims prior to the introduction of the
mold exclusion to our policy forms.
2005 10-K Page 63
Net reserves for all asbestos and environmental claims were $132 million in 2005 compared with $135 million
in 2004 and $105 million in 2003. Net reserves for all asbestos and environmental claims were 4.2 percent,
4.5 percent and 3.7 percent of total reserves, in 2005, 2004 and 2003, respectively.
We generally wrote commercial accounts after the development of coverage forms that exclude asbestos
cleanup costs. We believe our exposure to risks associated with past production and/or installation of asbestos
materials is minimal because we primarily were a personal lines company when most of the asbestos exposure
occurred. The commercial coverage we did offer was predominantly related to local-market construction activity
rather than asbestos manufacturing. Further, over the past four years, to limit our exposure to mold and other
environmental risks going forward, we have revised policy terms where permitted by state regulation. We
continue to evaluate our exposure to silicosis and welding claims, but believe our exposure is minimal.
Commercial Lines Insurance Segment Reserves
For the business lines in the commercial lines insurance segment, the following table shows the breakout of
gross reserves among case, IBNR and loss expense reserves. The rise in total gross reserves for our
commercial business lines was related to our growth. Commercial multi-peril reserve growth also was related to
the higher proportion of commercial lines catastrophe losses in 2005 compared with 2004. Workers
compensation reserve growth also was related to medical cost inflation and longer estimated payout periods as
we discussed in Commercial Lines Insurance Results of Operations, Page 41.
(In millions)
At December 31, 2005
Commercial multi-peril
Workers compensation
Commercial auto
Other liability
All other lines of business
Total
At December 31, 2004
Commercial multi-peril
Workers compensation
Commercial auto
Other liability
All other lines of business
Total
Loss reserves
Case
reserves
IBNR
reserves
Loss
expense
reserves
Total
gross
reserves
Percent
of total
$
$
$
$
505 $
283
267
312
277
1,644 $
465 $
258
254
288
289
1,554 $
101 $
333
56
368
24
882 $
123 $
278
58
377
19
855 $
228 $
79
65
140
135
647 $
227 $
75
64
111
130
607 $
834
695
388
820
436
3,173
815
611
376
776
438
3,016
26.3 %
21.9
12.2
25.9
13.7
100.0 %
27.0 %
20.3
12.5
25.7
14.5
100.0 %
As a result of underwriting actions taken since 2000 and a generally favorable insurance marketplace, the
commercial lines segment has been able to obtain higher premium per exposure. As a result, profitability has
improved due to higher revenue on stable loss and loss expenses.
2005 10-K Page 64
The following table provides the amounts of net reserve changes made over the past three years by
commercial line of business and accident year:
(Dollars in millions)
As of December 31, 2005
2004 accident year
2003 accident year
2002 accident year
2001 accident year
2000 accident year
1999 accident year
1998 and prior accident years
Redundancy/(deficiency)
Reserves as originally estimated
Reserves re-estimated as of December 31, 2005
Redundancy/(deficiency)
Impact on loss and loss expense ratio
As of December 31, 2004
2003 accident year
2002 accident year
2001 accident year
2000 accident year
1999 accident year
1998 accident year
1997 and prior accident years
Redundancy/(deficiency)
Reserves as originally estimated
Reserves re-estimated as of December 31, 2004
Redundancy/(deficiency)
Impact on loss and loss expense ratio
As of December 31, 2003
2002 accident year
2001 accident year
2000 accident year
1999 accident year
1998 accident year
1997 accident year
1996 and prior accident years
Redundancy/(deficiency)
Reserves as originally estimated
Reserves re-estimated as of December 31, 2003
Redundancy/(deficiency)
Impact on loss and loss expense ratio
Commercial
multi-peril
Workers
compensation
Commercial
auto
Other
liability
$
$
$
$
$
$
$
$
$
$
$
$
5
22
9
7
0
2
16
61
760
699
61
7.7 %
(5)
2
5
4
0
1
(11)
(4)
691
695
(4)
(0.6) %
(3)
2
(10)
5
(2)
(2)
(3)
(13)
609
622
(13)
(2.0) %
$
$
$
$
$
$
$
$
$
$
$
$
(9)
(13)
(8)
(3)
(3)
(3)
(4)
(43)
557
600
(43)
(13.3) %
5
(1)
(6)
(3)
(2)
(1)
(7)
(15)
514
529
(15)
(4.9) %
(1)
(3)
(2)
(1)
0
(1)
(5)
(13)
477
490
(13)
(4.3) %
$
$
$
$
$
$
$
$
$
$
$
$
16
5
2
1
0
0
10
34
372
338
34
7.4 %
11
10
4
4
7
3
8
47
381
334
47
10.5 %
11
2
7
11
2
1
3
37
383
346
37
8.8 %
36
32
6
1
(8)
0
(17)
50
599
549
50
11.2 %
36
41
27
13
2
0
12
131
635
504
131
32.5 %
36
15
5
6
3
5
9
79
580
501
79
23.0 %
$
$
$
$
$
$
$
$
$
$
$
$
The overall favorable development recorded in the commercial lines reserves illustrates the potential for
revisions inherent in estimating reserves, especially in long-tail lines such as other liability. With the exception
of the UM/UIM reserve releases and other significant changes in assumptions discussed above, commercial
lines reserve development over the past three years was consistent with:
•
The initiative, begun in 2001, to establish higher initial case reserves on liability claims in the period in
which the claim is reported.
• Higher than expected medical inflation affecting the workers compensation line
• Settlements that differed from the established case reserves
• Changes in case reserves based on new information for specific claims or classes of claims
• Differences in the timing of actual settlements compared with the payout patterns assumed in the accident
year IBNR reductions
•
Lower risk profile after 2001 due to commercial lines underwriting initiatives
2005 10-K Page 65
Personal Lines Insurance Segment Reserves
For the business lines in the personal lines insurance segment, the following table shows the breakout of gross
reserves among case, IBNR and loss expense reserves. Total gross reserves were down slightly from year-end
2004 due to normal claims activity on a lower policy count and lower personal lines catastrophe reserves in
2005 than in 2004.
(In millions)
At December 31, 2005
Personal auto
Homeowners
All other lines of business
Total
At December 31, 2004
Personal auto
Homeowners
All other lines of business
Total
Loss reserves
Case
reserves
IBNR
reserves
Loss
expense
reserves
Total
gross
reserves
Percent
of total
$
$
$
$
175 $
70
55
300 $
181 $
81
57
319 $
4 $
21
67
92 $
15 $
21
73
109 $
34 $
18
12
64 $
35 $
23
12
70 $
213
109
134
456
231
125
142
498
46.9 %
23.8
29.3
100.0 %
46.4 %
25.1
28.5
100.0 %
Over the past three years, higher-than-normal catastrophe losses have contributed to the personal lines loss
and loss expenses.
The following table provides the amounts of net reserve changes made over the past three years by personal
line of business and accident year:
(Dollars in millions)
As of December 31, 2005
2004 accident year
2003 accident year
2002 accident year
2001 accident year
2000 accident year
1999 accident year
1998 and prior accident years
Redundancy/(deficiency)
Reserves as originally estimated
Reserves re-estimated as of December 31, 2005
Redundancy/(deficiency)
Impact on loss and loss expense ratio
As of December 31, 2004
2003 accident year
2002 accident year
2001 accident year
2000 accident year
1999 accident year
1998 accident year
1997 and prior accident years
Redundancy/(deficiency)
Reserves as originally estimated
Reserves re-estimated as of December 31, 2004
Redundancy/(deficiency)
Impact on loss and loss expense ratio
As of December 31, 2003
2002 accident year
2001 accident year
2000 accident year
1999 accident year
1998 accident year
1997 accident year
1996 and prior accident years
Redundancy/(deficiency)
Reserves as originally estimated
Reserves re-estimated as of December 31, 2003
Redundancy/(deficiency)
Impact on loss and loss expense ratio
2005 10-K Page 66
Personal
auto
Homeowners
$
$
$
$
$
$
$
$
$
$
$
$
$
$
$
$
$
$
$
$
$
$
$
$
2
0
2
4
1
1
2
12
231
219
12
2.7 %
(9)
(1)
3
3
1
1
1
(1)
224
225
(1)
(0.2) %
(8)
(4)
0
2
0
1
0
(9)
201
210
(9)
(2.1) %
1
2
0
1
0
(1)
0
3
114
111
3
1.0 %
0
1
4
1
0
0
0
6
89
83
6
2.2 %
2
5
0
1
0
0
0
8
96
88
8
3.1 %
The overall favorable development recorded in the personal lines segment reserves illustrates the potential for
revisions inherent in estimating reserves. Personal lines reserve development over the past three years was
consistent with:
• Settlements that differed from the established case reserves
• Changes in case reserves based on new information for specific claims or classes of claims
• Differences in the timing of actual settlements compared with the payout patterns assumed in the accident
year IBNR reductions
• Recognition of favorable case reserve development
LIFE INSURANCE RESERVES
Gross life policy reserves were $1.343 billion at year-end 2005, compared with $1.194 billion at year-end
2004. We establish reserves for traditional life insurance policies based on expected expenses, mortality,
morbidity, withdrawal rates and investment yields, including a provision for uncertainty. Once these
assumptions are established, they generally are maintained throughout the lives of the contracts. We use both
our own experience and industry experience adjusted for historical trends in arriving at our assumptions for
expected mortality, morbidity and withdrawal rates. We use our own experience and historical trends for setting
our assumptions for expected expenses. We base our assumptions for expected investment income on our own
experience adjusted for current economic conditions.
We establish reserves for our universal life, deferred annuity and investment contracts equal to the cumulative
account balances, which include premium deposits plus credited interest less charges and withdrawals.
We regularly review our life insurance business to ensure that any deferred acquisition cost associated with the
business is recoverable and that our actuarial liabilities (life insurance segment reserves) make sufficient
provision for future benefits and related expenses.
2005 10-K Page 67
2006 REINSURANCE PROGRAMS
A single large loss or an unexpected rise in claims severity or frequency due to a catastrophic event could
present us with a liquidity risk. In an effort to control such losses, we forego marketing property casualty
insurance in specific geographic areas, monitor our exposure in certain coastal regions, review aggregate
exposures to huge disasters and purchase reinsurance. We use the Risk Management Solutions and Applied
Insurance Research models to evaluate exposures to a once-in-250-year event in determining appropriate
reinsurance coverage programs. In conjunction with these activities, we also continue to evaluate information
provided by our reinsurance broker. These various sources explore and analyze credible scientific evidence,
including the impact of global climate change, which may affect our exposure under insurance policies.
Reinsurance mitigates the risk of highly uncertain exposures and limits the maximum net loss that can arise
from large risks or risks concentrated in areas of exposure. Management’s decisions regarding the appropriate
level of property casualty risk retention are affected by various factors, including changes in our underwriting
practices, capacity to retain risks and reinsurance market conditions. Reinsurance does not relieve us of our
obligation to pay covered claims. The financial strength of our reinsurers is important because our ability to
recover for losses covered under one of our reinsurance agreements depends on the financial viability of the
reinsurer.
Currently participating on our property and casualty per-occurrence programs are American Reinsurance
Company, GE Insurance Solutions, Partner Reinsurance Company of the U.S. and Swiss Reinsurance America
Corporation, all of which have A.M. Best insurer financial strength ratings of A (Excellent) or A+ (Superior). Our
property catastrophe program is subscribed through a broker by reinsurers from the United States, Bermuda,
London and Europe markets.
The estimated incremental premium savings is $7 million for the 2006 property casualty reinsurance
agreements, without taking into account the reinstatement premium incurred in 2005. The savings primarily is
due to higher retention levels and to lower rates for the casualty per occurrence program, which offset higher
rates for the property per occurrence and property catastrophe programs.
Primary components of the 2006 property and casualty reinsurance program include:
• Property per risk treaty – The primary purpose of the property treaty is to provide excess limits capacity up
to $25 million, supplying adequate capacity for the majority of the risks we write and also includes
protection for extra-contractual liability coverage losses. The ceded premium is estimated to be $30 million
for 2006, compared with $29 million in 2005 and $27 million in 2004. In 2006, we are retaining the first
$4 million of each loss. Losses between $4 million and $25 million are reinsured at 100 percent.
The $4 million base retention is new for 2006. Last year, we retained the first $3 million of every property
loss. Losses in excess of $3 million were reinsured at 100 percent up to $25 million in 2005.
• Casualty per occurrence treaty – The casualty treaty provides excess limits capacity up to $25 million.
Similar to the property treaty, this provides sufficient capacity to cover the vast majority of casualty
accounts we insure and also includes protection for extra-contractual liability coverage losses. The ceded
premium is estimated to be $47 million in 2006, compared with $64 million in 2005 and $61 million in
2004. In 2006, we are changing to a flat $4 million retention. Previously, we retained the first $2 million of
each casualty loss, and 60 percent of the next $2 million of loss. Losses in excess of $4 million are
reinsured at 100 percent up to $25 million.
In mid-2005, we modified our casualty per occurrence treaty for director and officer policies for five
Fortune 1000 companies and one financial services company. For three of the six companies, our
retention per policy could be as high as $15 million rather than the $4 million for a typical policy; for one of
the other companies, our retention per policy could be as high as $14 million; for the other two companies,
our retention per policy could be as high as $5 million. We believe the additional risk undertaken with
these selected policies remains at an acceptable level based on our financial strength. We arranged for
this exception for this small group of companies to maintain business relationships with key agencies and
insureds. We intend to review this element of our working treaties on an ongoing basis.
• Casualty excess treaties – We purchase a casualty reinsurance treaty that provides an additional
$25 million in protection for certain casualty losses. This treaty, along with the casualty per occurrence
treaty, provides a total of $50 million of protection for workers compensation, extra-contractual liability
coverage and clash coverage losses, which is used when there is a single occurrence involving multiple
policyholders of The Cincinnati Insurance Companies or multiple coverages for one insured. The ceded
premium is estimated to be $2 million in 2006 up only slightly from 2005 and 2004.
We purchase another casualty excess treaty, which provides an additional $20 million in casualty loss
coverage. This treaty also provides catastrophic coverage for workers compensation and extra-contractual
liability coverage losses. The ceded premium is estimated to be $1 million for 2006, similar to the
premium paid in 2005.
2005 10-K Page 68
• Property catastrophe treaty – To protect against catastrophic events such as wind and hail, hurricanes or
earthquakes, we purchase property catastrophe reinsurance, with a limit up to $500 million. For the
2006 treaty, ceded premiums are estimated to be $38 million, up from $29 million in 2005, excluding the
reinstatement premium, and $27 million in 2004, excluding the reinstatement premium. The premium
increase for 2006 primarily is due to the difficult market conditions brought on in part by the record
catastrophe losses experienced by reinsurance companies in 2005. We increased our retention on this
program to $45 million and we will retain 5 percent of losses between $45 million and $500 million. In
2005, we retained the first $25 million of losses arising out of a single event, 40 percent of losses from
$25 million to $45 million and 5 percent of all losses in excess of $45 million, up to $500 million.
Individual risks with insured values in excess of $25 million as identified in the policy are handled through a
different reinsurance mechanism. We reinsure property coverage for individual risks with insured values
between $25 million and $50 million under an automatic facultative treaty. For those risks with property values
exceeding $50 million, we negotiate the purchase of facultative coverage on an individual certificate basis.
For casualty coverage on individual risks with limits exceeding $25 million, facultative reinsurance coverage is
placed on an individual certificate basis.
Responding to the challenges presented by terrorism has become a very important issue for the insurance
industry over the last three years. Terrorism coverage at various levels has been secured in all of our
reinsurance agreements. The broadest coverage for this peril is found in the property and casualty working
treaties, which provide coverage for commercial and personal risks. Our property catastrophe treaty provides
coverage for personal risks and the majority of its reinsurers provide limited coverage for commercial risks with
total insured values of $10 million or less. For insured values between $10 million and $25 million, there also
may be coverage in the property working treaty.
Reinsurance protection for the company’s surety business is covered under separate treaties with many of the
same reinsurers that write the property casualty working treaties.
Reinsurance protection for our life insurance business is covered under separate treaties with many of the
same reinsurers that write the property casualty working treaties. In 2005, we modified our reinsurance
protection for our term life insurance business due to changes in the marketplace that affected the cost and
availability of reinsurance for term life insurance. We are retaining no more than a $500,000 exposure, ceding
the balance using excess over retention mortality coverage, and retaining the policy reserve. Retaining the
policy reserve has no direct impact on GAAP results. However, because of the conservative nature of statutory
reserving principles, retaining the policy reserve unduly depresses our statutory earnings and requires a large
commitment of our capital. We also have catastrophe reinsurance coverage on our life insurance operations
that reimburses us up to $20 million for covered net losses in excess of $5 million. The treaty contains a
reinstatement provision, provided the covered losses were not due to terrorism.
The NAIC has asked for comments on proposals to modify statutory accounting procedures to reduce the
negative effect on statutory life insurance income. We expect the NAIC proposals will be adopted. If they are
not, we believe we will be able to structure a reinsurance program to provide the life insurance company with
the ability to continue to grow in the term life insurance marketplace while appropriately managing risk, at a
cost that allows us to achieve our life insurance company profit targets.
SAFE HARBOR STATEMENT
This is our “Safe Harbor” statement under the Private Securities Litigation Reform Act of 1995. Our business is
subject to certain risks and uncertainties that may cause actual results to differ materially from those
suggested by the forward-looking statements in this report. Some of those risks and uncertainties are
discussed in Item 1A, Risk Factors, Page 21. Although we often review or update our forward-looking
statements when events warrant, we caution our readers that we undertake no obligation to do so.
Factors that could cause or contribute to such differences include, but are not limited to:
• Unusually high levels of catastrophe losses due to risk concentrations, changes in weather patterns,
environmental events, terrorism incidents or other causes
• Ability to obtain adequate reinsurance on acceptable terms, amount of reinsurance purchased and
financial strength of reinsurers
•
Increased frequency and/or severity of claims
• Events or conditions that could weaken or harm the company’s relationships with its independent agencies
and hamper opportunities to add new agencies, resulting in limitations on the company’s opportunities for
growth, such as:
○ Downgrade of the company’s financial strength ratings,
○ Concerns that doing business with the company is too difficult or
2005 10-K Page 69
○ Perceptions that the company’s level of service, particularly claims service, is no longer a
distinguishing characteristic in the marketplace
•
Increased competition that could result in a significant reduction in the company’s premium growth rate
• Underwriting and pricing methods adopted by competitors that could allow them to identify and flexibly
price risks, which could decrease our competitive advantages
•
Insurance regulatory actions, legislation or court decisions or legal actions that increase expenses or place
us at a disadvantage in the marketplace
• Delays or inadequacies in the development, implementation, performance and benefits of technology
projects and enhancements
•
Inaccurate estimates or assumptions used for critical accounting estimates, including loss reserves
• Events that reduce the company’s ability to maintain effective internal control over financial reporting
under the Sarbanes-Oxley Act of 2002 in the future
• Recession or other economic conditions or regulatory, accounting or tax changes resulting in lower demand
for insurance products
• Sustained decline in overall stock market values negatively affecting the company’s equity portfolio; in
particular a sustained decline in the market value of Fifth Third shares, a significant equity holding
• Events that lead to a significant decline in the value of a particular security and impairment of the asset
• Prolonged low interest rate environment or other factors that limit the company’s ability to generate growth
in investment income
• Adverse outcomes from litigation or administrative proceedings
• Effect on the insurance industry as a whole, and thus on the company’s business, of the actions
undertaken by the Attorney General of the State of New York and other regulators against participants in
the insurance industry, as well as any increased regulatory oversight that might result
•
Investment activities or market value fluctuations that trigger restrictions applicable to the parent company
under the Investment Company Act of 1940
Further, the company’s insurance businesses are subject to the effects of changing social, economic and
regulatory environments. Public and regulatory initiatives have included efforts to adversely influence and
restrict premium rates, restrict the ability to cancel policies, impose underwriting standards and expand overall
regulation. The company also is subject to public and regulatory initiatives that can affect the market value for
its common stock, such as recent measures affecting corporate financial reporting and governance.
The ultimate changes and eventual effects, if any, of these initiatives are uncertain.
Readers are cautioned that the company undertakes no obligation to review or update the forward-looking
statements included herein.
Item 7A. Quantitative and Qualitative Disclosures About Market
Risk
INTRODUCTION
Market risk is the potential for a decrease in securities value resulting from broad yet uncontrollable forces
such as: inflation, economic growth, interest rates, world political conditions or other widespread unpredictable
events. It is comprised of many individual risks that, when combined, create a macroeconomic impact. The
company accepts and manages risks in the investment portfolio as part of the means of achieving portfolio
objectives. Some of the risks are:
• Political – the potential for a decrease in market value due to the real or perceived impact of governmental
policies or conditions
• Regulatory – the potential for a decrease in market value due to the impact of legislative proposals or
changes in laws or regulations
• Economic – the potential for a decrease in value due to changes in general economic factors (recession,
inflation, deflation, etc.)
• Revaluation – the potential for a decrease in market value due to a change in relative value (change in
market multiple) of the market brought on by general economic factors
•
Interest-rate – the potential for a decrease in market value of a security or portfolio due to its sensitivity to
changes (increases or decreases) in the general level of interest rates
2005 10-K Page 70
Company-specific risk is the potential for a particular issuer to experience a decline in valuation due to the
impact of sector or market risk on the holding or because of issues specific to the firm:
•
Fraud – the potential for a negative impact on an issuer’s performance due to actual or alleged illegal or
improper activity of individuals it employs
• Credit – the potential for deterioration in an issuer’s financial profile due to specific company issues,
problems it faces in the course of its operations or industry-related issues
• Default – the possibility that an issuer will not make a required payment (interest payment or return of
principal) on its debt. Generally this occurs after its financial profile has deteriorated (credit risk) and it no
longer has the means to make its payments
The investment committee of the board of directors monitors the investment risk management process
primarily through its executive oversight of our investment activities. We take an active approach to managing
market and other investment risks, including the accountabilities and controls over these activities. Actively
managing these market risks is integral to our operations and could require us to change the character of
future investments purchased or sold or require us to shift the existing asset portfolios to manage exposure to
market risk within acceptable ranges.
Sector risk is the potential for a negative impact on a particular industry due to its sensitivity to factors that
make up market risk. Market risk affects general supply/demand factors for an industry and will affect
companies within that industry to varying degrees.
Risks associated with the five asset classes described in Item 1, Investments Segment, Page 15, can be
summarized as follows (H – high, A – average, L – low):
Political
Regulatory
Economic
Revaluation
Interest rate
Fraud
Credit
Default
Taxable
Tax-exempt
fixed maturities
A
A
A
A
H
A
A
A
fixed maturities
H
A
A
A
H
L
L
L
Common
equities
A
A
H
H
A
A
A
A
Preferred
equities
A
A
A
A
H
A
A
A
Short-term
investments
L
L
L
L
L
L
L
L
FIXED-MATURITY INVESTMENTS
For investment-grade corporate bonds, the inverse relationship between interest rates and bond prices leads to
falling bond values during periods of increasing interest rates. Although the potential for a worsening financial
condition, and ultimately default, does exist with investment-grade corporate bonds, their higher-quality
financial profiles make credit risk less of a concern than for lower-quality investments. We address this risk by
consistently investing within a particular maturity range, which has, over the years, provided the portfolio with a
laddered maturity schedule, which we believe is less subject to large swings in value due to interest rate
changes. While a single maturity range may see values drop due to general interest rate levels, other maturity
ranges will be less affected by those changes. Additionally, purchases are spread across a wide spectrum of
industries and companies, diversifying our holdings and minimizing the impact of specific industries or
companies with greater sensitivities to interest rate fluctuations.
The primary risk related to high-yield corporate bonds is credit risk or the potential for a deteriorating financial
structure. A weak financial profile can lead to rating downgrades from the credit rating agencies, which can put
further downward pressure on bond prices. Interest rate risk is less of a factor with high-yield corporate bonds,
as valuation is related more directly to underlying operating performance than to general interest rates. This
puts more emphasis on the financial results achieved by the issuer rather than general economic trends or
statistics within the marketplace. We address this concern by analyzing issuer- and industry-specific financial
results and by closely monitoring holdings within this asset class.
The primary risks related to tax-exempt bonds are interest rate risk and political risk associated with the
specific economic environment within the political boundaries of the issuing municipal entity. We address these
concerns by focusing on municipalities' general-obligation debt and on essential-service bonds. Essential-
service bonds derive a revenue stream from the services provided by the municipality, which are vital to the
people living in the area (water service, sewer service, etc.). Another risk related to tax-exempt bonds is
regulatory risk or the potential for legislative changes that would negate the benefit of owning tax-exempt
bonds. We monitor regulatory activity for situations that may negatively affect current holdings and its ongoing
strategy for investing in these securities.
The final, less significant risk is a small exposure to credit risk for a portion of the tax-exempt portfolio that has
support from corporate entities. Examples are bonds insured by corporate bond insurers or bonds with interest
payments made by a corporate entity through a municipal conduit/authority. While decisions regarding these
2005 10-K Page 71
investments primarily consider the underlying municipal situation, the existence of third-party insurance
reduces risk in the event of default. In circumstances in which the municipality is unable to meet its obligations,
risk would be increased if the insuring entity were experiencing financial duress. Because of our diverse
exposure and selection of higher-rated entities with strong financial profiles, we do not believe this is a material
concern.
Interest Rate Sensitivity Analysis
Because of our strong surplus, long-term investment horizon and ability to hold most fixed-maturity investments
until maturity, we believe the company is well positioned if interest rates were to rise. A higher rate
environment would provide the opportunity to invest cash flow in higher-yielding securities, while reducing the
likelihood of calls of the higher-yielding U.S. agency paper purchased over the past year. While higher interest
rates would be expected to continue to increase the number of fixed-maturity holdings trading below
100 percent of book value, we believe lower fixed-maturity security values due solely to interest rate changes
would not signal a decline in credit quality.
A dynamic financial planning model developed during 2002 uses analytical tools to assess market risks.
As part of this model, the modified duration of the fixed-maturity portfolio is continually monitored by our
investment department to evaluate the theoretical impact of interest rate movements.
We measure modified duration and duration to worst. The table below summarizes the effect of hypothetical
changes in interest rates on the fixed-maturity portfolio under both duration scenarios:
(In millions)
At December 31, 2005
At December 31, 2004
Fair value
of fixed
maturity
portfolio
Modified duration
100 basis
point spread
decrease
100 basis
point spread
increase
$
5,476 $
5,868 $
5,070
5,445
5,084
4,695
Duration to worst
100 basis
point spread
decrease
100 basis
point spread
increase
$
5,779 $
5,326
5,173
4,814
The modified duration of our portfolio is currently 7.1 years and the modified duration of the redeemable
preferred portfolio is currently 10.4 years. A 100 basis-point movement in interest rates would result in an
approximately 7.2 percent change in the market value of the combined portfolios. Generally speaking, the
higher a bond’s rating, the more directly correlated movements in its market value will be to changes in the
general level of interest rates. Therefore, the municipal bond portfolio is more likely to respond to a changing
interest rate scenario. Our U.S. agency paper portfolio, because it generally has very little call protection, has a
low duration and would not be expected to be as responsive to rate movements. Lower investment grade and
high-yield corporate bond values are driven by credit spreads, as well as their durations, in response to interest
rate movements.
In the dynamic financial planning model, the selected interest rate change of 100 basis points represents our
views of a shift in rates that is quite possible over a one-year period. The rates modeled should not be
considered a prediction of future events as interest rates may be much more volatile in the future. The analysis
is not intended to provide a precise forecast of the effect of changes in rates on our results or financial
condition, nor does it take into account any actions that we might take to reduce exposure to such risks.
SHORT-TERM INVESTMENTS
Our short-term investments present minimal risk as we generally purchase the highest quality commercial
paper.
EQUITY INVESTMENTS
Common stocks are subject to a variety of risk factors encompassed under the umbrella of market risk.
General economic swings influence the performance of the underlying industries and companies within those
industries. A downturn in the economy will have a negative impact on an equity portfolio. Industry- and
company-specific risks have the potential to substantially affect the market value of the company's equity
portfolio. We address these risks by maintaining investments in a small group of holdings that we can analyze
closely, better understanding their business and the related risk factors.
At December 31, 2005, the company held 14 individual equity positions valued at approximately $100 million
or above, see Item 1, Investments Segment, Page 15, for additional details on these holdings. These equity
positions accounted for approximately 93.8 percent of the unrealized appreciation of the entire portfolio.
We believe our equity investment style – centered on companies that pay and increase dividends to
shareholders – is an appropriate long-term strategy. While our long-term financial position would be affected by
prolonged changes in the market valuation of our investments, we believe our strong surplus position and cash
flow provide a cushion against short-term fluctuations in valuation. We believe that the continued payment of
cash dividends by the issuers of the common equities we hold also should provide a floor to their valuation.
2005 10-K Page 72
Our investments are heavily weighted toward the financials sector, which represented 63.4 percent of the total
fair value of the common stock portfolio at December 31, 2005. Financials sector investments typically
underperform the overall market during periods when interest rates are expected to rise. We historically have
seen these types of short-term fluctuations in market value of its holdings as potential buying opportunities but
are cognizant that a prolonged downturn in this sector could create a long-term negative effect on the portfolio.
Over the longer term, our objective is for the performance of our equity portfolio to exceed that of the broader
market. Over the five years ended December 31, 2005, our compound annual equity portfolio return was a
negative 0.8 percent compared with a compound annual total return of 0.5 percent for the
Standard & Poor’s 500 Index, a common benchmark of market performance. In 2005, our compound annual
equity portfolio was a negative 4.2 percent, compared with a compound annual total return of 4.9 percent for
that Index. Our equity portfolio underperformed the market for these periods because of the decline in the
market value of our holdings of Fifth Third common stock over the past five years.
The primary risk related to preferred stock is similar to those related to investment grade corporate bonds.
Falling interest rates will adversely impact market values due the normal inverse relationship between rates
and yields. Credit risk exists due to their subordinate position in the capital structure. We minimize this risk by
primarily purchasing investment grade preferred stocks of issuers with a strong history of paying a common
stock dividend.
Fifth Third Bancorp Holding
One of our common stock holdings, Fifth Third, accounted for 26.3 percent of our shareholders’ equity at year-
end 2005 and dividends earned from our Fifth Third investment were 20.2 percent of our investment income in
2005.
(In millions except market price data)
Fifth Third Bancorp common stock holding:
Dividends earned
Percent of total investment income
Shares held
Closing market price of Fifth Third
Book value of holding
Fair value of holding
After-tax unrealized gain
Market value as a percent of total equity investments
Market value as a percent of invested assets
Market value as a percent of total shareholders' equity
After-tax unrealized gain as a percent of total shareholders' equity
$
$
2005
Years ended December 31,
2004
2003
$
106
20.2 %
$
95
19.4 %
82
17.7 %
At December 31,
2005
2004
$
73
37.72
283
2,745
1,600
38.6 %
21.6
45.1
26.3
73
47.30
283
3,443
2,054
45.9 %
27.2
55.1
32.9
Based on 2005 results, a 10 percent change in dividends earned from our Fifth Third holding would result in an
$11 million change in pretax investment income and a $9 million change in after-tax earnings.
Every $1.00 change in the market price of Fifth Third’s common stock has approximately a 27 cent impact on
our book value per share. A 20 percent change in the market price of Fifth Third’s common stock from its
year-end 2005 closing price would result in a $549 million change in assets and a $357 million change in
after-tax unrealized gains.
Fifth Third’s market value over the past three years has been impacted by a difficult interest rate environment
and the residual effects of a regulatory review that was concluded in early 2004. We believe that they have
come out of the process a stronger bank operationally and we believe the management team can execute on
the strategy for growth they have defined. During this challenging period for the bank, we have continued to
benefit from their superior dividend growth. In September 2005, Fifth Third increased its indicated annual
dividend by 8.6 percent, which is expected to contribute an additional $9 million to investment income on an
annualized basis.
2005 10-K Page 73
UNREALIZED INVESTMENT GAINS AND LOSSES
At December 31, 2005, unrealized investment gains before taxes totaled $5.145 billion and unrealized
investment losses in the investment portfolio amounted to $78 million.
Unrealized Investment Gains
The unrealized gains at year-end 2005 were primarily due to long-term gains from the company's holdings in
the common stock of Fifth Third (Nasdaq: FITB) and Alltel Corporation (NYSE: AT). Reflecting the company’s
long-term investment philosophy, of the 1,082 securities trading at or above book value, 767, or 70.9 percent,
have shown unrealized gains for more than 24 months.
Unrealized Investment Losses – Potential Other-than-temporary Impairments
The asset impairment policy evaluates significant decreases in the market value of the assets; changes in legal
factors or in the business climate; or other such factors indicating whether or not the carrying amount may be
recoverable. A declining trend in market value, the extent of the market value decline and the length of time in
which the value has been depressed are objective measures that can be outweighed by subjective measures
such as impending events and issuer liquidity. In 2005 and earlier, impairment is evaluated in the event of a
declining market value for four consecutive quarters with quarter-end market value below 50 percent of book
value, or when a security’s market value is 50 percent below book value for three consecutive quarters.
Effective January 1, 2006, impairment may be evaluated in the event a declining market value for four
consecutive quarters with quarter-end market value below 70 percent of book value, or when a security’s
market value is 70 percent below book value for three consecutive quarters. In addition to applying the
impairment policy, the status of the portfolio is constantly monitored by the company’s portfolio managers for
indications of potential problems or issues that may be possible impairment issues. If an impairment indicator
is noted, the portfolio managers even more closely scrutinize the security. During 2005 and 2004, a total of six
securities were written down as other-than-temporarily impaired.
We expect the number of securities trading below 100 percent of book value to fluctuate as interest rates rise
or fall. Further, book values for some securities have been revised due to impairment charges recognized
during 2003 and 2002. At December 31, 2005, 732 of the 1,814 securities we owned were trading below
100 percent of book value compared with 208 of the 1,593 securities we owned at December 31, 2004.
Of the 732 holdings trading below book value at December 31, 2005, 714 were trading between 90 percent
and 100 percent of book value.
The 732 holdings trading below book value at December 31, 2005, represented 22.3 percent of invested
assets and $78 million in unrealized losses. We deem the risk related to securities trading between 70 percent
and 100 percent of book value to be relatively minor and at least partially offset by the earned income
potential of these investments.
• 714 of these holdings were trading between 90 percent and 100 percent of book value. The value of these
securities fluctuates primarily because of changes in interest rates. The fair value of these 714 securities
was $2.717 billion at December 31, 2005, and they accounted for $57 million in unrealized losses.
• 18 of these holdings were trading below 90 percent of book value at December 31, 2005. The fair value of
these holdings was $111 million, and they accounted for the remaining $21 million in unrealized losses.
These holdings are being monitored for credit- and industry-related risk factors. Of these securities, seven
are bonds or convertible preferred stocks of auto industry-related issuers and one is a common stock of a
pharmaceutical company. These eight securities account for $69 million of the fair value of holdings
trading below 90 percent of book value. The remaining ten are smaller positions in a variety of industries.
Holdings trading below 70 percent of book value are monitored more closely for potential other-than-temporary
impairment. At December 31, 2005, two auto-related holdings with a fair value of $8 million were trading below
70 percent of book value. At year-end 2004, no securities were trading below 70 percent of book value.
As discussed in Critical Accounting Estimates, Asset Impairment, Page37, when evaluating
other-than-temporary impairments, we consider our ability to retain a security for a period adequate to recover
a substantial portion of its cost. Because of our investment philosophy and strong capitalization, we can hold
securities until their scheduled redemption that might otherwise be deemed impaired as we evaluate their
potential for recovery based economic, industry or company factors.
2005 10-K Page 74
The following table summarizes the investment portfolio by period of time:
(Dollars in millions)
6 Months or less
> 6 - 12 Months
> 12 - 24 Months
> 24 - 36 Months
Number
of issues
Gross
unrealized
gain/loss
Number
of issues
Gross
unrealized
gain/loss
Number
of issues
Gross
unrealized
gain/loss
Number
of issues
Gross
unrealized
gain/loss
Taxable fixed maturities:
Trading below 70% of book value
Trading at 70% to less than 100% of book value
Trading at 100% and above of book value
Total
Tax-exempt fixed maturities:
Trading below 70% of book value
Trading at 70% to less than 100% of book value
Trading at 100% and above of book value
Total
Common equities:
Trading below 70% of book value
Trading at 70% to less than 100% of book value
Trading at 100% and above of book value
Total
Preferred equities:
Trading below 70% of book value
Trading at 70% to less than 100% of book value
Trading at 100% and above of book value
Total
Short-term investments:
Trading below 70% of book value
Trading at 70% to less than 100% of book value
Trading at 100% and above of book value
Total
Summary:
Trading below 70% of book value
Trading at 70% to less than 100% of book value
Trading at 100% and above of book value
Total
2 $
185
37
224
0
357
51
408
0
1
5
6
0
8
11
19
0
0
2
2
(4)
(22)
3
(23)
0
(8)
1
(7)
0
0
3
3
0
(2)
1
(1)
0
0
0
0
0 $
57
14
71
0
32
43
75
0
1
1
2
0
0
4
4
0
0
0
0
0
(17)
1
(16)
0
(3)
1
(2)
0
0
1
1
0
0
1
1
0
0
0
0
0 $
46
35
81
0
32
105
137
0
2
4
6
0
0
3
3
0
0
0
0
0
(12)
5
(7)
0
(3)
3
0
0
(5)
8
3
0
0
0
0
0
0
0
0
0 $
5
346
351
0
3
384
387
0
0
35
35
0
1
2
3
0
0
0
0
0
(1)
102
101
0
0
43
43
0
0
4,968
4,968
0
(1)
4
3
0
0
0
0
2
551
106
659 $
(4)
(32)
8
(28)
0
90
62
152 $
0
(20)
4
(16)
0
80
147
227 $
0
(20)
16
(4)
0
9
767
776 $
0
(2)
5,117
5,115
2005 10-K Page 75
The following table summarizes the investment portfolio:
(Dollars in millions)
At December 31, 2005
Taxable fixed maturities:
Trading below 70% of book value
Trading at 70% to less than 100% of book value
Trading at 100% and above of book value
Securities sold in current year
Total
Tax-exempt fixed maturities:
Trading below 70% of book value
Trading at 70% to less than 100% of book value
Trading at 100% and above of book value
Securities sold in current year
Total
Common equities:
Trading below 70% of book value
Trading at 70% to less than 100% of book value
Trading at 100% and above of book value
Securities sold in current year
Total
Preferred equities:
Trading below 70% of book value
Trading at 70% to less than 100% of book value
Trading at 100% and above of book value
Securities sold in current year
Total
Short-term investments:
Trading below 70% of book value
Trading at 70% to less than 100% of book value
Trading at 100% and above of book value
Securities sold in current year
Total
Portfolio summary:
Trading below 70% of book value
Trading at 70% to less than 100% of book value
Trading at 100% and above of book value
Securities sold in current year
Total
At December 31, 2004
Portfolio summary:
Trading below 70% of book value
Trading at 70% to less than 100% of book value
Trading at 100% and above of book value
Securities sold in current year
Total
Number
of issues
Book value
Fair value
Gross
unrealized
gain/loss
Gross
investment
income
2 $
12 $
8 $
293
432
0
727
0
424
583
0
1,007
0
4
45
0
49
0
9
20
0
29
0
0
2
0
2
2
730
1,082
0
1,814 $
0 $
208
1,385
0
1,593 $
1,839
1,453
0
3,304
0
941
1,142
0
2,083
0
51
1,910
0
1,961
0
63
104
0
167
0
0
75
0
75
12
2,894
4,684
0
7,590 $
0 $
900
5,899
0
6,799 $
1,787
1,564
0
3,359
0
927
1,190
0
2,117
0
46
6,890
0
6,936
0
60
110
0
170
0
0
75
0
75
8
2,820
9,829
0
12,657 $
0 $
883
11,756
0
12,639 $
(4) $
(52)
111
0
55
0
(14)
48
0
34
0
(5)
4,980
0
4,975
0
(3)
6
0
3
0
0
0
0
0
(4)
(74)
5,145
0
5,067 $
0 $
(17)
5,857
0
5,840 $
1
84
99
15
199
0
32
55
3
90
0
1
229
0
230
0
1
3
0
4
0
0
1
0
1
1
118
387
18
524
0
32
427
32
491
2005 10-K Page 76
Item 8.
Financial Statements and Supplementary Data
RESPONSIBILITY FOR FINANCIAL STATEMENTS
We have prepared the consolidated financial statements of Cincinnati Financial Corporation and our
subsidiaries for the year ended December 31, 2005, in accordance with accounting principles generally
accepted in the United States of America (GAAP).
We are responsible for the integrity and objectivity of these financial statements. The amounts, presented on
an accrual basis, reflect our best estimates and judgment. These statements are consistent in all material
aspects with other financial information in the Annual Report on Form 10-K. Our accounting system and related
internal controls are designed to assure that our books and records accurately reflect the company’s
transactions in accordance with established policies and procedures as implemented by qualified personnel.
Our board of directors has established an audit committee of independent outside directors. We believe these
directors are free from any relationships that could interfere with their independent judgment as audit
committee members.
The audit committee meets periodically with management, our independent registered public accounting firm
and our internal auditors to discuss how each is handling responsibilities. The audit committee reports on their
findings to the board of directors. The audit committee recommends to the board the annual appointment of
the independent registered public accounting firm. The audit committee reviews with this firm the scope of the
audit assignment and the adequacy of internal controls and procedures.
Deloitte & Touche LLP, our independent registered public accounting firm, audited the consolidated financial
statements of Cincinnati Financial Corporation and subsidiaries for the year ended December 31, 2005. Their
report is on Page 79. Deloitte’s auditors met with our audit committee to discuss the results of their
examination. They have the opportunity to present their opinions about the adequacy of internal controls and
the quality of financial reporting without management present.
2005 10-K Page 77
MANAGEMENT’S ANNUAL REPORT ON INTERNAL CONTROL OVER FINANCIAL
REPORTING
The management of Cincinnati Financial Corporation and its subsidiaries is responsible for establishing and
maintaining adequate internal controls, designed to provide reasonable assurance regarding the reliability of
financial reporting and the preparation of financial statements for external purposes in accordance with
accounting principles generally accepted in the United States of America (GAAP). The company’s internal
control over financial reporting includes those policies and procedures that:
1. Pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the
transactions and dispositions of the assets of the company;
2. Provide reasonable assurance that transactions are recorded as necessary to permit preparation of
financial statements in accordance with GAAP and that receipts and expenditures of the company are
being made only in accordance with authorizations of management and the directors of the company; and
3. Provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use or
disposition of the company’s assets that could have a material effect on the financial statements.
All internal control systems, no matter how well designed, have inherent limitations, including the possibility of
human error and the circumvention of overriding controls. Accordingly, even effective internal control can
provide only reasonable assurance with respect to financial statement preparation and presentation. Further,
because of changes in conditions, the effectiveness of internal control may vary over time.
The company’s management assessed the effectiveness of the company’s internal control over financial
reporting as of December 31, 2005, as required by Section 404 of the Sarbanes Oxley Act of 2002.
Management’s assessment is based on the criteria established in the Internal Control – Integrated Framework
issued by the Committee of Sponsoring Organizations of the Treadway Commission and was designed to
provide reasonable assurance that the company maintained effective internal control over financial reporting
as of December 31, 2005. The assessment led management to conclude that, as of December 31, 2005, the
company’s internal control over financial reporting was effective based on those criteria.
The company’s independent registered public accounting firm has issued an attestation report on our internal
control over financial reporting as of December 31, 2005, and the company’s management assessment of our
internal control over financial reporting. This report appears below.
/S/ John J. Schiff, Jr.
Chairman, President and Chief Executive Officer
/S/ Kenneth W. Stecher
Chief Financial Officer, Senior Vice President, Secretary and Treasurer
(Principal Accounting Officer)
March 10, 2006
2005 10-K Page 78
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
To the Shareholders and Board of Directors of Cincinnati Financial Corporation:
We have audited the accompanying consolidated balance sheets of Cincinnati Financial Corporation and
subsidiaries (the company) as of December 31, 2005 and 2004, and the related consolidated statements of
income, shareholders’ equity, and cash flows for each of the three years in the period ended December 31, 2005.
Our audits also included the financial statement schedules listed in the Index at Item 15(c). We also have audited
management’s assessment, included in the accompanying Management’s Annual Report on Internal Control Over
Financial Reporting report, that the company maintained effective internal control over financial reporting as of
December 31, 2005, based on the criteria established in the Internal Control—Integrated Framework issued by
the Committee of Sponsoring Organizations of the Treadway Commission. The company’s management is
responsible for these financial statements and financial statement schedules, for maintaining effective internal
control over financial reporting, and for its assessment of the effectiveness of internal control over financial
reporting. Our responsibility is to express an opinion on these financial statements and financial statement
schedules, an opinion on management’s assessment, and an opinion on the effectiveness of the company’s
internal control over financial reporting based on our audits.
We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board
(United States). Those standards require that we plan and perform the audit to obtain reasonable assurance
about whether the financial statements are free of material misstatement and whether effective internal control
over financial reporting was maintained in all material respects. Our audit of financial statements included
examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements,
assessing the accounting principles used and significant estimates made by management, and evaluating the
overall financial statement presentation. Our audit of internal control over financial reporting included obtaining
an understanding of internal control over financial reporting, evaluating management’s assessment, testing and
evaluating the design and operating effectiveness of internal control, and performing such other procedures as
we considered necessary in the circumstances. We believe that our audits provide a reasonable basis for our
opinions.
A company’s internal control over financial reporting is a process designed by, or under the supervision of,
the company’s principal executive and principal financial officers, or persons performing similar functions, and
effected by the company’s board of directors, management, and other personnel to provide reasonable assurance
regarding the reliability of financial reporting and the preparation of financial statements for external purposes in
accordance with accounting principles generally accepted in the United States of America. A company’s internal
control over financial reporting includes those policies and procedures that: (1) pertain to the maintenance of
records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of
the company; (2) provide reasonable assurance that transactions are recorded as necessary to permit
preparation of financial statements in accordance with generally accepted accounting principles and that receipts
and expenditures of the company are being made only in accordance with authorizations of management and
directors of the company; and (3) provide reasonable assurance regarding prevention or timely detection of
unauthorized acquisition, use, or disposition of the company’s assets that could have a material effect on the
financial statements.
Because of the inherent limitations of internal control over financial reporting, including the possibility of collusion
or improper management override of controls, material misstatements due to error or fraud may not be prevented
or detected on a timely basis. Also, projections of any evaluation of the effectiveness of the internal control over
financial reporting to future periods are subject to the risk that the controls may become inadequate because of
changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.
In our opinion, the consolidated financial statements referred to above present fairly, in all material respects,
the financial position of the company as of December 31, 2005 and 2004, and the results of its operations and
its cash flows for each of the three years in the period ended December 31, 2005, in conformity with accounting
principles generally accepted in the United States of America. Also, in our opinion, such financial statement
schedules, when considered in relation to the basic consolidated financial statements taken as a whole, present
fairly, in all material respects, the information set forth therein. Also, in our opinion, management’s assessment
that the company maintained effective internal control over financial reporting as of December 31, 2005, is fairly
stated, in all material respects, based on the criteria established in Internal Control—Integrated Framework issued
by the Committee of Sponsoring Organizations of the Treadway Commission. Furthermore, in our opinion, the
company maintained, in all material respects, effective internal control over financial reporting as of
December 31, 2005, based on the criteria established in Internal Control—Integrated Framework issued by the
Committee of Sponsoring Organizations of the Treadway Commission.
/S/ Deloitte & Touche LLP
Cincinnati, Ohio
March 6, 2006
2005 10-K Page 79
CINCINNATI FINANCIAL CORPORATION AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(Dollars in millions except per share data)
ASSETS
Investments
Fixed maturities, at fair value (amortized cost: 2005—$5,387; 2004—$4,783)
Equity securities, at fair value (cost: 2005—$2,128; 2004—$1,945)
Short-term investments, at fair value (cost: 2005—$75; 2004—$71)
Other invested assets
Cash and cash equivalents
Investment income receivable
Finance receivable
Premiums receivable
Reinsurance receivable
Prepaid reinsurance premiums
Deferred policy acquisition costs
Land, building and equipment, net, for company use (accumulated depreciation:
2005—$232; 2004—$206)
Other assets
Separate accounts
Total assets
LIABILITIES
Insurance reserves
Loss and loss expense reserves
Life policy reserves
Unearned premiums
Other liabilities
Deferred income tax
6.125% senior notes due 2034
6.9% senior debentures due 2028
6.92% senior debenture due 2028
Separate accounts
Total liabilities
SHAREHOLDERS' EQUITY
Common stock, par value-$2 per share; authorized: 2005-500 million shares, 2004-
200 million shares; issued: 2005-194 million shares, 2004-185 million shares
Paid-in capital
Retained earnings
Accumulated other comprehensive income—unrealized gains on investments and derivatives
Treasury stock at cost (2005—20 million shares, 2004—18 million shares)
Total shareholders' equity
Total liabilities and shareholders' equity
Accompanying notes are an integral part of this statement.
At December 31,
2005
2004
5,476 $
7,106
75
45
119
117
105
1,116
681
14
429
168
66
486
16,003 $
3,661 $
1,343
1,559
455
1,622
371
28
392
486
9,917
389
969
2,088
3,284
(644)
6,086
16,003 $
5,070
7,498
71
38
306
107
95
1,119
680
15
400
156
75
477
16,107
3,549
1,194
1,539
474
1,834
371
420
0
477
9,858
370
618
2,057
3,787
(583)
6,249
16,107
$
$
$
$
2005 10-K Page 80
CINCINNATI FINANCIAL CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF INCOME
(In millions except per share data)
REVENUES
Earned premiums
Property casualty
Life
Investment income, net of expenses
Realized investment gains and losses
Other income
Total revenues
BENEFITS AND EXPENSES
Insurance losses and policyholder benefits
Commissions
Other operating expenses
Taxes, licenses and fees
Increase in deferred policy acquisition costs
Interest expense
Other expenses
Total benefits and expenses
INCOME BEFORE INCOME TAXES
PROVISION (BENEFIT) FOR INCOME TAXES
Current
Deferred
Total provision for income taxes
NET INCOME
PER COMMON SHARE
Net income—basic
Net income—diluted
Accompanying notes are an integral part of this statement.
2005
Years ended December 31,
2004
2003
3,058 $
106
526
61
16
3,767
1,911
627
290
72
(19)
51
12
2,944
823
188
33
221
2,919 $
101
492
91
11
3,614
1,846
615
260
75
(30)
38
10
2,814
800
171
45
216
602 $
584 $
3.44 $
3.40 $
3.30 $
3.28 $
2,653
95
465
(41)
9
3,181
1,887
536
204
67
(42)
34
15
2,701
480
130
(24)
106
374
2.11
2.10
$
$
$
$
2005 10-K Page 81
CINCINNATI FINANCIAL CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF SHAREHOLDERS’ EQUITY
(In millions)
COMMON STOCK - NUMBER OF SHARES
Beginning of year
5% stock dividend
Purchase of treasury shares
End of year
COMMON STOCK
Beginning of year
5% stock dividend
Stock options exercised
End of year
PAID-IN CAPITAL
Beginning of year
5% stock dividend
Stock loan
Stock options exercised
Other
End of year
RETAINED EARNINGS
Beginning of year
Net income
5% stock dividend
Dividends declared
End of year
ACCUMULATED OTHER COMPREHENSIVE INCOME
Beginning of year
Change in accumulated other comprehensive income, net
End of year
TREASURY STOCK
Beginning of year
Purchase
Reissued for stock options
End of year
Total shareholders' equity
COMPREHENSIVE INCOME
Net income
Change in accumulated other comprehensive income, net
Total comprehensive income
Accompanying notes are an integral part of this statement.
2005
At December 31,
2004
2003
167
9
(2)
174
370 $
18
1
389
618
341
0
9
1
969
2,057
602
(359)
(212)
2,088
3,787
(503)
3,284
(583)
(63)
2
(644)
160
8
(1)
167
352 $
18
0
370
306
312
(3)
3
0
618
1,986
584
(330)
(183)
2,057
4,084
(297)
3,787
(524)
(66)
7
(583)
6,086 $
6,249 $
602 $
(503)
99 $
584 $
(297)
287 $
162
0
(2)
160
352
0
0
352
300
0
0
6
0
306
1,772
374
0
(160)
1,986
3,643
441
4,084
(469)
(55)
0
(524)
6,204
374
441
815
$
$
$
$
2005 10-K Page 82
CINCINNATI FINANCIAL CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(In millions)
CASH FLOWS FROM OPERATING ACTIVITIES
Net income
Adjustments to reconcile net income to net cash provided by operating activities:
Depreciation and amortization
Realized (gains) losses on investments
Negotiated settlement-software cost recovery
Interest credited to contract holders
Changes in:
Investment income receivable
Premiums and reinsurance receivable
Deferred policy acquisition costs
Other assets
Loss and loss expense reserves
Life policy reserves
Unearned premiums
Other liabilities
Deferred income tax
Current income tax
Net cash provided by operating activities
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
Change in short-term investments, net
Investment in buildings and equipment, net
Investment in finance receivables
Collection of negotiated settlement-software cost recovery
Change in other invested assets, net
Net cash used in investing activities
CASH FLOWS FROM FINANCING ACTIVITIES
Proceeds from 6.125% senior notes
Debt issuance costs from 6.125% senior notes
Payment of cash dividends to shareholders
Purchase/issuance of treasury shares
Decrease in notes payable
Proceeds from stock options exercised
Contract holder funds deposited
Contract holder funds withdrawn
Net cash used in financing activities
Net increase (decrease) in cash and cash equivalents
Cash and cash equivalents at beginning of year
Cash and cash equivalents at end of year
Supplemental disclosures of cash flow information:
Interest paid
Income taxes paid
Conversion of fixed maturity to equity security and fixed maturity investments
Accompanying notes are an integral part of this statement.
Years ended December 31,
2004
2003
2005
$
602 $
584 $
33
(61)
0
28
(10)
2
(19)
5
112
84
20
(17)
33
(7)
805
243
466
104
34
(1,297)
(219)
(4)
(44)
(45)
0
(9)
(771)
0
0
(204)
(61)
0
11
87
(54)
(221)
(187)
306
119 $
51 $
195
42
28
(91)
0
24
(8)
(118)
(30)
(13)
134
109
93
83
45
(17)
823
175
664
536
32
(1,718)
(148)
(71)
(33)
(46)
9
(1)
(601)
371
(4)
(177)
(59)
(183)
3
93
(51)
(7)
215
91
306 $
34 $
188
23
$
$
374
30
41
(23)
23
(1)
(97)
(42)
17
239
75
127
14
(24)
63
816
192
457
217
25
(1,143)
(335)
3
(38)
(33)
14
(1)
(642)
0
0
(156)
(55)
0
6
45
(35)
(195)
(21)
112
91
34
65
51
2005 10-K Page 83
SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
1.
Nature of Operations
We underwrite insurance through four companies that market through local independent insurance agents.
Our products include a broad range of business and personal policies, as well as life and disability income
insurance and annuities. We also provide finance/leasing products and asset management services through
our CFC Investment Company and CinFin Capital Management Company subsidiaries.
Basis of Presentation
Our consolidated financial statements include the accounts of the parent company and our wholly owned
subsidiaries. We present our statements in accordance with accounting principles generally accepted in the
United States of America (GAAP). In consolidating our accounts, we have eliminated significant intercompany
balances and transactions.
In accordance with GAAP, we have made estimates and assumptions that affect the amounts we report and
discuss in the financial statements and accompanying notes. Actual results could differ from our estimates.
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. We calculate net income per common share (diluted) assuming the
exercise of stock options. We have adjusted shares and earnings per share to reflect all stock splits and
dividends prior to December 31, 2005, including the 5 percent stock dividend paid April 26, 2005.
Stock Options
We have qualified and non-qualified stock option plans under which we grant options to employees. We grant
these options, which can be exercised over 10-year periods, at prices that are not less than market price at the
date of grant. We apply Accounting Principles Board (APB) Opinion 25 and related interpretations in accounting
for these plans. Accordingly, we do not recognize any compensation cost for the plans.
Had we determined compensation costs for our stock option plans based on the fair value at the grant dates,
consistent with Statement of Financial Accounting Standards (SFAS) No. 123(R) “Share-Based Payments,”
our net income and earnings per share would have been reduced to the pro forma amounts indicated below:
(In millions except per share data)
Net income
Stock-based employee compensation expense determined
under fair value based method for all awards, net of
related tax effects
Net income per common share—basic
Net income per common share—diluted
As reported
Pro forma
As reported
Pro forma
As reported
Pro forma
$
$
$
$
Years ended December 31,
2004
2003
2005
602 $
584 $
13
589 $
3.44 $
3.36
3.40 $
3.32
12
572 $
3.30 $
3.24
3.28 $
3.21
374
12
362
2.11
2.04
2.10
2.03
In determining these pro forma amounts, we estimated the fair value of each option on the date of grant. We
used the binomial option-pricing model with the following weighted-average assumptions in 2005, 2004 and
2003, respectively: dividend yield of 2.66 percent, 2.40 percent and 2.40 percent; expected volatility of
25.61 percent, 25.65 percent and 26.03 percent; risk-free interest rates of 4.62 percent, 4.37 percent and
4.20 percent; and expected lives of 10 years for all years. Our compensation expense in the pro forma
disclosures does not indicate future amounts, as options vest over several years and we generally make
additional grants each year. The options we grant in our plans vest over three years.
Property Casualty Insurance
Property casualty policy written premiums are deferred and earned on a pro rata basis over the terms of the
policies. We record as unearned premium the portion of written premiums that apply to unexpired policy terms.
We do not consider investment income potential in setting insurance policy premiums. The expenses
associated with issuing insurance policies – primarily insurance agent commissions, premium taxes and
underwriting costs – are deferred and amortized over the terms of policies.
We establish reserves to cover the expected cost of claims – or losses – and our expenses related to
investigating, processing and resolving claims. Although determining the appropriate amount of reserves
including reserves for catastrophe losses is inherently uncertain, we base our decisions on past experience and
2005 10-K Page 84
current facts. Reserves are based on claims reported prior to the end of the year and estimates of unreported
claims. We take into account the fact that we may recover some of our costs through salvage and subrogation.
We regularly review and update reserves using the most current information available. Any resulting
adjustments are reflected in current operations.
The Cincinnati Insurance Companies actively market property casualty insurance policies in 32 states. Our
10 largest states generated 71.1 percent, 72.1 percent and 73.1 percent of total property casualty premiums
in 2005, 2004 and 2003, respectively. Ohio, our largest state, accounted for 23.1 percent, 23.7 percent and
24.6 percent of total earned premiums in 2005, 2004 and 2003. Agencies in Georgia, Illinois, Indiana,
Michigan, North Carolina, Pennsylvania and Virginia each contributed between 4 percent and 10 percent of
premium volume in 2005. No single agency accounted for more than 1.1 percent of the company's total agency
direct earned premiums in 2005.
Life and Health Insurance
We offer several types of life and health insurance and we account for each according to the duration of the
contract. Short-duration contracts are written to cover claims that arise during a short, fixed term of coverage.
We generally have the right to change the amount of premium charged or cancel the coverage at the end of
each contract term. Group life insurance is an example. We account for short-duration contracts similarly to
property casualty contracts.
Long-duration contracts are written to provide coverage for an extended period of time. Traditional long-
duration contracts require policyholders to pay scheduled gross premiums, generally not less frequently than
annually, over the term of the coverage. Premiums for these contracts are recognized as revenue when due.
Whole life insurance is an example. Some traditional long-duration contracts have premium payment periods
shorter than the period over which coverage is provided. For these contracts the excess of premium over the
amount required to pay expenses and benefits is recognized over the term of the coverage rather than over the
premium payment period. Ten-pay whole life insurance is an example.
We establish a liability for traditional long-duration contracts as we receive premiums. The amount of this
liability is the present value of future expenses and benefits less the present value of future net premiums. Net
premium is the portion of gross premium required to provide for all expenses and benefits. We estimate future
expenses and benefits and net premium using assumptions for expected expenses, mortality, morbidity,
withdrawal rates and investment income. We include a provision for adverse deviation, meaning we allow for
some uncertainty in making our assumptions. We establish our assumptions when the contract is issued and
we generally maintain those assumptions for the life of the contract. We use both our own experience and
industry experience, adjusted for historical trends, in arriving at our assumptions for expected mortality,
morbidity and withdrawal rates. We use our own experience and historical trends for setting our assumption for
expected expenses. We base our assumption for expected investment income on our own experience, adjusted
for current economic conditions.
When we issue a traditional long-duration contract, we capitalize acquisition costs. Acquisition costs are costs
which vary with, and are primarily related to, the production of new business. We then charge these deferred
acquisition costs to expenses over the premium paying period of the contract and we use the same
assumptions that we use when we establish the liability for the contract.
Universal life contracts are long-duration contracts for which contractual provisions are not fixed, unlike whole
life insurance. Universal life contracts allow policyholders to vary the amount of premium, within limits, without
our consent. However we may vary the mortality and expense charges, within limits, and the interest crediting
rate used to accumulate policy values. We do not record universal life premiums as revenue. Instead we
recognize as revenue the mortality charges, administration charges and surrender charges when received.
Some of our universal life contracts assess administration charges in the early years of the contract that are
compensation for services we will provide in the later years of the contract. These administration charges are
deferred and are recognized over the period when we provide those future services.
For universal life long-duration contracts we maintain a liability equal to the policyholder account value. There
is no provision for adverse deviation.
When we issue a universal life long-duration contract we capitalize acquisition costs. We then charge these
capitalized costs to expenses over the term of coverage of the contract. When we charge deferred acquisition
costs to expenses, we use assumptions based on our best estimates of long-term experience. We review and
modify these assumptions on a regular basis.
Separate Accounts
We issue life contracts with guaranteed minimum returns, referred to as bank-owned life insurance contracts
(BOLIs). We legally segregate and record as separate accounts the assets and liabilities for some of our BOLIs,
based on the specific contract provisions. We guarantee minimum investment returns, account values and
death benefits for our separate account BOLIs. Our other BOLIs are general account products.
2005 10-K Page 85
We carry the assets of separate account BOLIs at fair value. The liabilities on separate account BOLIs primarily
are the contract holders’ claims to the related assets and are carried at the fair value of the assets. If the BOLI
asset value is projected below the value we guaranteed, a liability is established by a charge to the company’s
earnings.
Generally, investment income and realized investment gains and losses of the separate accounts accrue
directly to the contract holder and we do not include them in the Consolidated Statements of Income.
Revenues and expenses for the company related to the separate accounts consist of contractual fees and
mortality, surrender and expense risk charges. Also, each separate account BOLI includes a negotiated gain
and loss sharing arrangement with the company. A percentage of each separate account’s realized gain and
loss representing contract fees and assessments accrues to us and is transferred from the separate account to
the company’s general account and is recognized as revenue or expense.
Reinsurance
We work to reduce risk and uncertainty by buying property casualty and life reinsurance. Reinsurance contracts
do not relieve us from our duty to policyholders, but rather help protect our financial strength to perform that
duty. We estimate loss amounts recoverable from our reinsurers based on the reinsurance policy terms.
Historically, our claims with reinsurers have been paid. We do not have an allowance for uncollectible
reinsurance.
We also serve in a limited way as a reinsurer for other insurance companies, reinsurers and involuntary state
pools. We record our transactions for such assumed reinsurance based on reports provided to us by the ceding
reinsurer.
Cash and Cash Equivalents
Cash and cash equivalents include cash and money market funds.
Investments
Our portfolio investments are primarily in publicly traded fixed-maturity, equity and short-term investments,
classified as available for sale in the accompanying financial statements. Valuations of all of our investments
are based on either listed prices or data provided by an outside resource that supplies global securities pricing.
Changes in the fair value of these securities, based on the listed prices or information from the outside
resource, are reported on the balance sheet in other comprehensive income, net of tax. Fixed-maturity
investments (taxable and tax-exempt bonds) and equity investments (common and preferred stocks) are
classified as available for sale and recorded at fair value in the financial statements. Short-term investments
are classified as available for sale and recorded at amortized cost, which approximates fair value, in the
financial statements. The number of fixed-maturity securities trading below 100 percent of book value can be
expected to fluctuate as interest rates rise or fall. Because of our strong surplus and long-term investment
horizon, we expect to hold most fixed-maturity investments until maturity, regardless of short-term fluctuations
in fair values.
We include unrealized gains and losses on investments, net of taxes, in shareholders’ equity as accumulated
other comprehensive income. Realized gains and losses on investments are recognized in net income on a
specific identification basis.
Investment income consists mainly of interest and dividends. We record interest on an accrual basis and
record dividends at the ex-dividend date. We amortize premiums and discounts on fixed-maturity securities
using the interest method.
Facts and circumstances sometimes warrant investment write-downs. We record such other-than-temporary
declines as realized investment losses.
Fair Value Disclosures
We base fair value for investments in equity and fixed-maturity securities (including redeemable preferred
stock and assets held in separate accounts) on quoted market prices or on data provided by an outside
resource that supplies global securities pricing.
We estimate fair value for liabilities under investment-type insurance contracts (annuities) using discounted
cash flow calculations. We base the calculations on interest rates offered on contracts of similar nature and
maturity. We base fair value for long-term senior notes on the quoted market prices for such notes.
Derivative Financial Instruments and Hedging Activities
Some of our investments contain embedded options. These investments include convertible debt and
convertible preferred stock. We calculate fair value and account for the embedded options separately. The
changes in fair values of embedded derivates are recognized in net income in the period they occur.
SFAS No. 133 “Accounting for Derivative Financial Instruments and Hedging Activities,” as amended, or any
subsequent changes in fair values of these instruments, have not had a significant impact on the
accompanying consolidated financial statements. We do not engage in any hedging activities.
2005 10-K Page 86
Lease/Finance
Our CFC Investment Company subsidiary provides auto and equipment direct financing (leases and loans) to
commercial and individual clients. We generally transfer ownership of the property to the client as the terms of
the leases expire. Our lease contracts contain bargain purchase options. We record income over the financing
term using the interest method.
We capitalize and amortize lease or loan origination costs over the life of the financing using the interest
method. These costs may include, but are not limited to: finder fees, broker fees, filing fees and the cost of
credit reports.
Asset Management
Our CinFin Capital Management subsidiary generates revenue from management fees. We set those fees
based on the market value of assets under management, and we record our revenue as it is earned.
Land, Building and Equipment
We record building and equipment at cost less accumulated depreciation. Our depreciation is based on
estimated useful lives (ranging from three years to 39½ years) using straight-line and accelerated methods.
Depreciation expense recorded in 2005, 2004 and 2003 was $33 million, $30 million and $31 million,
respectively. We monitor land, building and equipment for potential impairments. Potential impairments
include a significant decrease in the market values of the assets, considerable cost overruns on projects or a
change in legal factors or business climate, or other factors that indicate that the carrying amount may not be
recoverable.
We capitalize costs for internally developed computer software during the application development stage.
These costs generally consist of external consulting, payroll and payroll-related costs.
Income Taxes
We calculate deferred income tax liabilities and assets using tax rates in effect for the time when temporary
differences in book and taxable income are estimated to reverse. We recognize deferred income taxes for
numerous temporary differences between our 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. We charge deferred income
taxes associated with unrealized appreciation (except the amounts related to the effect of income tax rate
changes) to shareholders’ equity in accumulated other comprehensive income. We charge deferred taxes
associated with other differences to income.
New Accounting Pronouncements
Statement of Financial Accounting Standards No. 123(R)
In December 2004, the Financial Accounting Standards Board (FASB) issued SFAS No. 123(R), which is a
revision of SFAS No. 123, “Accounting for Stock-Based Compensation,” and supersedes APB Opinion No. 25.
On April 21, 2005, the Securities and Exchange Commission amended the effective date, stating that
companies can choose implementation in either the reporting period beginning after June 15, 2005, or
December 15, 2005. We intend to adopt SFAS No. 123(R) in the first quarter of 2006.
SFAS No. 123(R) permits companies to adopt its requirements using either a modified prospective or a
modified retrospective method. We currently utilize a standard option-pricing model (binomial option-pricing
model) to measure the fair value of stock options granted to associates. Upon the adoption of SFAS No.
123(R), we will use the modified prospective method to measure the fair value of associate stock options.
Subject to a complete review of the requirements of SFAS No. 123(R), based on stock options granted to
associates through year-end 2005, we estimate that the adoption of SFAS No. 123(R) will reduce 2006 net
income by approximately 8 cents per share.
Statement of Financial Accounting Standards No. 154
In May 2005, the FASB issued SFAS No. 154, which eliminated the requirement in APB Opinion No. 20,
“Accounting Changes,” that modified the requirements for the accounting and reporting of a change in
accounting principles. APB Opinion No. 20 required changes in accounting principles be included as an
accumulated amount in the income statement in the period of change.
SFAS No. 154 requires that changes in accounting principles be retrospectively applied. The new accounting
principle is applied at the beginning of the first period presented, as if that principle had always been used. The
cumulative effect is applied to the applicable assets and liabilities with a corresponding offset to opening
retained earnings. SFAS No. 154 is effective for accounting changes and corrections of errors made in fiscal
years beginning after December 15, 2005. We do not expect SFAS No. 154 to have any material impact on the
company’s consolidated financial statements.
2005 10-K Page 87
Reclassifications
We have reclassified certain prior-year amounts to conform with current-year classifications.
2.
(In millions)
INVESTMENTS
Investment income summarized by investment category:
Interest on fixed maturities
Dividends on equity securities
Other investment income
Total
Less investment expenses
Total
Realized investment gains and losses summarized by investment category:
Fixed maturities:
Gross realized gains
Gross realized losses
Other-than-temporary impairments
Equity securities:
Gross realized gains
Gross realized losses
Other-than-temporary impairments
Embedded derivatives
Total
Change in unrealized investment gains and losses summarized by investment category:
Fixed maturities
Equity securities
Adjustment to deferred acquisition costs and life policy reserves
Other
Income taxes on above
Total
2005
Years ended December 31,
2004
2003
$
$
$
$
$
$
280
244
8
532
6
526
36
(1)
(1)
40
(6)
0
(7)
61
(198)
(575)
6
18
246
(503)
$
$
$
$
$
$
252
239
6
497
5
492
36
(20)
(5)
101
(30)
(1)
10
91
(6)
(448)
3
(6)
160
(297)
$
$
$
$
$
$
235
227
7
469
4
465
35
(25)
(73)
37
(17)
(7)
9
(41)
211
488
(13)
(9)
(236)
441
The fair value of the conversion features embedded in convertible securities was a loss of $7 million at
year-end 2005, a gain of $10 million at year-end 2004 and a gain of $9 million at year-end 2003.
At December 31, 2005, contractual maturity dates for fixed-maturity and short-term investments were:
(In millions)
Maturity dates occuring:
Less than one year
One year through five years
After five years through ten years
After ten years through twenty years
Over twenty years
Total
Amortized
cost
Fair
value
% of Fair
value
$
$
154
602
2,900
1,550
256
5,462
$
$
156
613
2,919
1,599
264
5,551
2.8 %
11.0
52.6
28.8
4.8
100.0 %
Actual maturities may differ from contractual maturities when there is a right to call or prepay obligations with
or without call or prepayment penalties.
At December 31, 2005, investments with book value of $63 million and fair value of $65 million were on
deposit with various states in compliance with regulatory requirements.
2005 10-K Page 88
The following table analyzes cost or amortized cost, gross unrealized gains, gross unrealized losses and fair
value for our investments:
(In millions)
At December 31,
2005
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 and short-term investments
Total
Equity securities
2004
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 and short-term investments
Total
Equity securities
$
$
$
$
$
$
Cost or
amortized cost
Gross unrealized
gains
losses
Fair
value
2,083 $
269
139
1,000
1,971
5,462 $
2,128 $
1,622 $
368
134
1,076
1,654
4,854 $
1,945 $
48 $
17
6
0
88
159 $
4,986 $
75 $
56
13
4
151
299 $
5,558 $
14 $
8
1
20
27
70 $
8 $
3 $
2
1
4
2
12 $
5 $
2,117
278
144
980
2,032
5,551
7,106
1,694
422
146
1,076
1,803
5,141
7,498
This table reviews unrealized losses and fair values by investment category and by length of time securities
have been in a continuous unrealized loss position:
(In millions)
At December 31,
2005:
Fixed maturities:
Less than 12 months
Fair
value
Unrealized
losses
12 months or more
Fair
value
Unrealized
losses
Total
Fair
value
Unrealized
losses
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 and short-term investments
Total
Equity securities:
Total
2004:
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 and short-term investments
Total
Equity securities:
Total
$
$
$
$
754 $
73
44
608
387
1,866
59
1,925 $
194 $
26
10
295
101
626
59
685 $
8 $
3
1
8
11
31
2
33 $
2 $
1
0
3
1
7
4
11 $
173 $
39
6
354
284
856
47
903 $
59 $
27
5
70
14
175
23
198 $
6 $
6
0
11
16
39
6
45 $
1 $
1
1
1
1
5
1
6 $
927 $
112
50
962
671
2,722
106
2,828 $
253 $
53
15
365
115
801
82
883 $
14
9
1
19
27
70
8
78
3
2
1
4
2
12
5
17
At December 31, 2005, 177 fixed-maturity investments with a total unrealized loss of $39 million and three
equity securities with a total unrealized loss of $6 million had been in that position for 12 months or more. All
were trading between 70 percent to less than 100 percent of book value.
At December 31, 2004, 23 fixed-maturity investments with a total unrealized loss of $5 million and one equity
security with a total unrealized loss of $1 million had been in that position for 12 months or more. All were
trading between 70 percent to less than 100 percent of book value.
2005 10-K Page 89
Investments in companies that exceed 10 percent of our shareholders’ equity at December 31 include:
(In millions)
Issuers:
Fifth Third Bancorp common stock
ALLTEL Corporation common stock and fixed maturity
$
2005
2004
Cost
Fair value
Cost
Fair value
283 $
122
2,745 $
807
283 $
137
3,443
794
In December 2005, we sold 475,000 shares of our holdings of ALLTEL Corporation common stock.
On January 24, 2006, we completed the sale of our remaining 12,700,164 shares. The sale contributed
$27 million to our 2005 pretax realized gains. The $549 million gain from the sale in 2006 will be recognized
in pretax realized investment gains and losses in the first quarter of 2006. After-tax proceeds from the sale
totaled approximately $558 million.
3.
This table summarizes components of our deferred policy acquisition costs asset:
DEFERRED ACQUISITION COSTS
(In millions)
Deferred policy acquisition costs asset beginning of year
Capitalized deferred policy acquisition costs
Amortized deferred policy acquisition costs
Amortized shadow deferred policy acquisition costs
Deferred policy acquisition costs asset end of year
2005
At December 31,
2004
2003
$
$
400 $
683
(664)
10
429 $
372 $
657
(626)
(3)
400 $
343
615
(573)
(13)
372
4.
This table summarizes activity in the reserve for loss and loss expenses:
PROPERTY CASUALTY LOSS AND LOSS EXPENSES
(In millions)
Gross loss and loss expense reserves, January 1
Less reinsurance receivable
Net loss and loss expense reserves, January 1
Net incurred loss and loss expenses related to:
Current accident year
Prior accident years
Total incurred
Net paid loss and loss expenses related to:
Current accident year
Prior accident years
Total paid
Net loss and loss expense reserves, December 31
Plus reinsurance receivable
Gross loss and loss expense reserves, December 31
2005
Years ended December 31,
2004
2003
$
$
3,514 $
537
2,977
1,972
(160)
1,812
772
906
1,678
3,111
518
3,629 $
3,386 $
541
2,845
1,949
(196)
1,753
804
817
1,621
2,977
537
3,514 $
3,150
542
2,608
1,877
(80)
1,797
762
799
1,561
2,845
541
3,386
We base property casualty loss and loss expenses reserve estimates on our experience and on information
gathered from internal analyses and our appointed actuary. When reviewing reserves, we analyze historical
data and estimate the effect of various other factors, such as industry loss frequency and severity and
premium trends; past, present and anticipated product pricing; anticipated premium growth; other quantifiable
trends; and projected ultimate loss ratios.
Because of changes in estimates of insured events in prior years, we decreased the provision for loss and loss
expenses by $160 million, $196 million and $80 million in calendar years 2005, 2004 and 2003. These
decreases are partly due to the effects of settling reported (case) and unreported (IBNR) reserves established
in prior years for amounts less than expected.
Following the Ohio Supreme Court’s late 2003 decision to limit its 1999 Scott-Pontzer v. Liberty Mutual
decision, we released $38 million pretax of previously established uninsured/under-insured motorist (UM/UIM)
reserves. In 2004, we released an additional $32 million in related case reserves. After that release, we
stopped separately reporting on UM/UIM related reserve actions.
We reported total catastrophe losses, net of reinsurance and before taxes, of $127 million for 2005, compared
with $148 million for 2004 and $97 million in 2003. Most catastrophe losses are incurred in the calendar year
of the event.
The reserve for loss and loss expenses in the accompanying balance sheets also includes $32 million,
$35 million and $29 million at December 31, 2005, 2004 and 2003, respectively, for certain life health losses.
2005 10-K Page 90
LIFE POLICY RESERVES
5.
We establish the reserves for traditional life insurance policies based on expected expenses, mortality,
morbidity, withdrawal rates and investment yields, including a provision for uncertainty. Once these
assumptions are established, they generally are maintained throughout the lives of the contracts. We use both
our own experience and industry experience, adjusted for historical trends, in arriving at our assumptions for
expected mortality, morbidity and withdrawal rates as well as for expected expenses. We base our assumptions
for expected investment income on our own experience adjusted for current economic conditions.
We establish reserves for the company’s universal life, deferred annuity and investment contracts equal to the
cumulative account balances, which include premium deposits plus credited interest less charges and
withdrawals.
Here is a summary of our life policy reserves:
(In millions)
Ordinary/traditional life
Universal life
Annuities
Other
Total
At December 31,
2005
2004
$
$
419 $
376
523
25
1,343 $
378
358
435
23
1,194
At December 31, 2005, and 2004, the fair value associated with the annuities shown above was approximately
$563 million and $477 million, respectively.
NOTES PAYABLE
6.
We had two lines of credit with commercial banks amounting to $125 million with no outstanding balance at
year-end 2005. We had no compensating balance requirement on short-term debt for either 2005 or 2004. We
did not use either of these lines of credit in 2005. We had one line of credit with a commercial bank amounting
to $75 million with no outstanding balance at year-end 2004.
During 2004, we terminated an interest-rate swap entered into by CFC Investment Company in 2001 as a cash
hedge of variable interest payments for certain variable-rate debt obligations. When we paid off the underlying
debt, we terminated this agreement at a cost of $2 million, net of tax.
7.
This table summarizes the principal amounts of our long-term debt:
SENIOR DEBT
(In millions)
Interest Year of
rate
issue
6.125% 2004
6.92% 2005
6.90% 1998
Senior notes, due 2034
Senior debentures, due 2028
Senior debentures, due 2028
Total
At December 31,
2005
2004
$
$
375 $
392
28
795 $
375
0
420
795
The fair value of our senior debt approximated $870 million at year-end 2005 and approximated $843 million
at year-end 2004.
During 2005, we completed the exchange of outstanding 6.125% senior notes due 2034 for up to $375 million
aggregate principal amount of newly issued 6.125% series B senior notes due 2034, which are substantially
identical to the old 6.125% senior notes except that they have been registered under the Securities Act of
1933, as amended. As of the expiration of the exchange offer, $365 million aggregate principal amount of the
outstanding notes had been tendered and accepted for exchange. That transaction had no effect on the
company’s financial statements. We also completed our offer to exchange outstanding 6.90% senior
debentures due 2028 for up to $420 million aggregate principal amount of newly issued 6.92% senior
debentures due 2028. Holders of $392 million aggregate principal amount of the 6.90% senior debentures
opted to exchange their bonds for newly issued 6.92% senior debentures.
None of the notes are encumbered by rating triggers.
SHAREHOLDERS’ EQUITY AND DIVIDEND RESTRICTIONS
8.
Our insurance subsidiary declared dividends to the company of $275 million in 2005, $175 million in 2004
and $50 million in 2003. State of Ohio regulatory requirements restrict the dividends insurance subsidiaries
can pay. Generally, the most Ohio-domiciled insurance subsidiaries can pay without prior regulatory approval is
the greater of 10 percent of statutory surplus or 100 percent of statutory net income for the prior calendar year
up to the amount of statutory unassigned surplus as of the end of the prior calendar year. Dividends exceeding
2005 10-K Page 91
these limitations may be paid only with approval of the Ohio Department of Insurance. During 2006, the total
dividends that our lead insurance subsidiary may pay to our parent company without regulatory approval will be
approximately $517 million.
Our board of directors on August 19, 2005, announced a program to repurchase up to 10 million shares of
outstanding stock effective September 1, 2005. The new program replaced a 1999 repurchase authorization.
Between September 1, 2005, and December 31, 2005, we purchased 534,000 shares at a cost of
$24 million. At year-end 2005, 9.5 million shares remained authorized for repurchase at any time in the future.
Repurchase shares are not adjusted for stock dividends.
As of December 31, 2005, 13 million shares of common stock were available for future stock option grants.
Declared cash dividends per share were $1.21, $1.04 and 90 cents for the years ended December 31, 2005,
2004 and 2003, respectively.
Accumulated Other Comprehensive Income
The change in unrealized gains and losses on investments and derivatives included:
(In millions)
Unrealized holding investment gains and losses on securities and derivatives
Reclassification adjustment:
Adjustment to deferred acquisition costs and life policy reserves
Net realized (gain) loss on investments and derivatives
Income taxes on above
Total
$
$
Income taxes relate to each component above ratably.
2005
Years ended December 31,
2004
2003
(694) $
6
(61)
246
(503) $
(369) $
3
(91)
160
(297) $
649
(13)
41
(236)
441
9.
Our statements of income include earned property casualty premiums on assumed and ceded business:
REINSURANCE
(In millions)
Direct written premiums
Assumed written premiums
Ceded written premiums
Net written premiums
Direct earned premiums
Assumed earned premiums
Ceded earned premiums
Net earned premiums
2005
Years ended December 31,
2004
2003
$
$
$
$
3,231 $
23
(178)
3,076 $
3,209 $
28
(179)
3,058 $
3,141 $
33
(177)
2,997 $
3,062 $
32
(175)
2,919 $
2,949
44
(178)
2,815
2,808
56
(211)
2,653
Our statements of income include incurred property casualty loss and loss expenses on assumed and ceded
business:
(In millions)
Direct incurred loss and loss expenses
Assumed incurred loss and loss expenses
Ceded incurred loss and loss expenses
Net incurred loss and loss expenses
2005
Years ended December 31,
2004
2003
$
$
1,898 $
40
(126)
1,812 $
1,870 $
17
(134)
1,753 $
1,856
44
(103)
1,797
2005 10-K Page 92
10.
Here is a summary of the major components of our net deferred tax liability:
INCOME TAXES
(In millions)
Deferred tax liabilities:
Unrealized gains on investments and derivatives
Deferred acquisition costs
Other
Total
Deferred tax assets:
Loss and loss expense reserves
Unearned premiums
Life policy reserves
Capital loss carryforward
Other
Total
Net deferred tax liability
At December 31,
2005
2004
1,788 $
135
32
1,955
179
108
26
0
20
333
1,622 $
2,033
129
38
2,200
180
107
28
19
32
366
1,834
$
$
The provision for federal income taxes is based upon a consolidated income tax return for the company and
subsidiaries. As of December 31, 2005, we had no capital loss carry forwards.
The differences between the statutory income tax rates and our effective income tax rates are as follows:
Tax at statutory rate
Increase (decrease) resulting from:
Tax-exempt municipal bonds
Dividend exclusion
Other
Effective rate
2005
Years ended December 31,
2004
2003
35.0 %
(3.2)
(5.7)
0.7
26.8 %
35.0 %
(2.5)
(5.7)
0.2
27.0 %
35.0 %
(3.8)
(8.6)
(0.6)
22.0 %
Filed tax returns for calendar years 2000 through 2004 are currently open with the Internal Revenue Service.
Federal income taxes are not provided for on our life insurance subsidiary’s Policyholder Surplus Account (PSA),
which totaled $14 million at December 31, 2005, 2004 and 2003. Prior to 2005, U.S. tax rules provided that
tax was due only on amounts distributed from the PSA. Had a distribution from the PSA occurred prior to 2005,
tax due would have been approximately $5 million at current federal income tax rates.
The tax liability of a stock life insurance company on distributions made from the PSA was suspended
beginning January 1, 2005, by the American Jobs Creation Act of 2004. As a result of this legislation, our life
insurance subsidiary has the ability to distribute amounts from its PSA to the parent company prior to
December 31, 2006, without incurring federal income tax, thereby permanently eliminating the $5 million tax
previously disclosed.
NET INCOME PER COMMON SHARE
11.
Basic earnings per share are computed based on the weighted average number of shares outstanding. Diluted
earnings per share are computed based on the weighted average number of common and dilutive potential
common shares outstanding. We have adjusted shares and earnings per share to reflect all stock splits and
dividends prior to December 31, 2005.
Here are calculations for basic and diluted earnings per share:
(Dollars in millions except share data)
Numerator:
Net income—basic and diluted
Denominator:
Weighted-average common shares outstanding
Effect of stock options
Adjusted weighted-average shares
Earnings per share:
Basic
Diluted
2005
Years ended December 31,
2004
2003
602 $
584 $
374
175,062,669
2,053,457
177,116,126
176,476,722
1,900,126
178,376,848
177,119,594
1,172,654
178,292,248
3.44 $
3.40 $
3.30 $
3.28 $
2.11
2.10
$
$
$
The only current source of dilution of our common shares is outstanding stock options to purchase shares of
common stock. At year-end 2005, all outstanding options were included in the calculation. At year-end 2004
2005 10-K Page 93
and 2003, there were 0.3 million and 2.2 million outstanding options that we did not include in this calculation.
We did not include these options in the computation of net income per common share (diluted) because their
exercise prices were greater than the average market price of the common shares.
PENSION PLAN
12.
We sponsor a defined contribution plan (401(k) savings plan) and a defined benefit pension plan covering
substantially all employees. We do not contribute to the 401(k) plan. Benefits for the defined benefit plan are
based on years of credited service and compensation level. Contributions are based on the frozen entry age
actuarial cost method. We also maintained a supplemental executive retirement plan, with liabilities of
approximately $4 million, at year-end 2005 and 2004. Our pension expense is composed of several
components that are determined using the projected unit credit actuarial cost method, and they are based on
certain actuarial assumptions.
Here is more detailed information about our defined benefit pension plan:
(In millions)
Change in benefit obligation:
Benefit obligation at beginning of year
Service cost
Interest cost
Actuarial loss
Benefits paid
Benefit obligation at end of year
Accumulated benefit obligation
Change in plan assets:
Fair value of plan assets at beginning of year
Actual return on plan assets
Employer contributions
Benefits paid
Fair value of plan assets at end of year
Funded status:
Funded status at end of year
Unrecognized net actuarial gain
Unrecognized net transitional asset
Unrecognized prior service cost
Accrued pension cost
Years ended December 31,
2005
2004
199
13
12
18
(7)
235
165
158
12
10
(7)
173
(62)
52
(1)
7
(4)
$
$
$
$
$
$
$
167
11
10
14
(3)
199
142
138
15
8
(3)
158
(41)
34
(1)
7
(1)
$
$
$
$
$
$
$
We use a December 31 measurement date for our plans. The accumulated benefit obligation was $165 million
and $142 million at December 31, 2005, and 2004, respectively. The fair value of our stock comprised
$29 million (17 percent of total plan assets) at December 31, 2005, and $27 million (17 percent of total plan
assets) at December 31, 2004.
We evaluate our pension plan assumptions annually and update them as necessary. The discount rate
assumptions for our benefit obligation track with Moody’s Aa bond yield, and yearly adjustments reflect any
changes to those bond yields. Compensation increase assumptions reflect historical calendar year
compensation increases.
Here is a summary of the assumptions we use to determine our benefit obligation:
Discount rate
Rate of compensation increase
Here is a breakdown of the components of our net periodic benefit cost:
Years ended December 31,
2005
2004
5.50 %
5-7
5.75 %
5-7
(In millions)
Service cost
Interest cost
Expected return on plan assets
Amortization of actuarial gain
Net pension expense
2005
Years ended December 31,
2004
2003
$
$
13
12
(13)
1
13
$
$
11
10
(12)
0
9
$
$
9
9
(13)
(1)
4
We expect to contribute approximately $10 million to our pension plan in 2006.
2005 10-K Page 94
Here is a summary of the assumptions we use to determine our net expense for the plan:
Discount rate
Expected return on plan assets
Rate of compensation increase
Our pension plan asset allocations by category are:
(In millions)
Asset category:
Equity securities
Fixed maturities
Cash and cash equivalents
Total
2005
Years ended December 31,
2004
5.75 %
8.00
5-7
6.00 %
8.00
5-7
2003
6.50 %
8.00
5-7
At December 31,
2005
2004
93 %
5
2
100 %
91 %
7
2
100 %
For 2006, we expect to target 90 percent of our pension plan assets for equity securities and 10 percent for
fixed maturities and cash.
We expect to make the following benefit payments, which reflect expected future service:
(In millions)
For the years ended December 31,
2006
2007
2008
2009
2010
Years 2011-2015
Pension
benefits
$
STATUTORY ACCOUNTING INFORMATION
13.
Insurance companies use statutory accounting practices (SAP) as prescribed by regulatory authorities.
Statutory accounting differs in certain respects from GAAP. The following table reconciles GAAP consolidated
net income for the years ended December 31, and shareholders’ equity at December 31, with total statutory
net income and capital and surplus:
(In millions)
Consolidated net income per GAAP
Adjustments:
Deferred policy acquisition costs
Deferred income taxes
Income from derivatives
Elimination of intercompany realized gain
Parent company and undistributed net income of non insurance subsidiaries
Other
Insurance subsidiaries net income per SAP
Balances by major business type:
Property casualty insurance
Life insurance
Total
$
$
$
$
2005
Years ended December 31,
2004
602
$
584
$
2003
(19)
13
19
(2)
(41)
(19)
553
532
21
553
$
$
$
(30)
73
(10)
88
(84)
6
627
599
28
627
$
$
$
5
7
10
10
9
84
374
(42)
(13)
(9)
0
(67)
10
253
233
20
253
2005 10-K Page 95
(In millions)
Consolidated shareholders' equity per GAAP
Adjustments:
Deferred policy acquisition costs
Investments at fair value
Deferred income taxes
Parent company and undistributed net income of non-insurance subsidiaries
Reserves and non-admitted assets
Other
Insurance subsidiaries shareholders' equity per SAP
Balances by major business type:
Property casualty insurance
Life insurance
Total
At December 31,
2005
2004
6,086
$
6,249
(429)
(102)
172
(1,439)
(13)
(81)
4,194
3,743
451
4,194
$
$
$
(400)
(272)
238
(1,550)
(11)
(63)
4,191
3,752
439
4,191
$
$
$
$
TRANSACTIONS WITH AFFILIATED PARTIES
14.
We paid certain officers and directors, or insurance agencies of which they are shareholders, commissions of
approximately $6 million, $11 million and $19 million on premium volume of approximately $41 million,
$76 million, and $132 million for 2005, 2004 and 2003, respectively.
On November 15, 2004, we repurchased 1 million shares of Cincinnati Financial common stock from
Robert C. Schiff, Trustee, Robert C. Schiff Revocable Trust originally dated November 21, 2001. Robert C. Schiff
is a founder of the company and retired as director of Cincinnati Financial Corporation in November 2004.
The stock was sold to Cincinnati Financial at an aggregate purchase price equal to 99 percent of the product of
(a) 1,000,000 multiplied by (b) $43.45, the last reported sale price per share of the common stock on the
Nasdaq National Market at the close of trading on November 12, 2004.
CONTINGENCIES
15.
Legal issues are part of the normal course of business for all companies. As such, we have various litigation
and claims against us in process and pending. Having analyzed those claims with our legal counsel, we believe
the outcomes of normal insurance matters will not have a material effect on our consolidated financial position
or results of operations. We further believe that the outcomes of non-insurance matters will be covered by
insurance coverage or will not have a material effect on our consolidated financial position or results of
operations.
As previously reported, in June 2004 we discovered some uncertainty regarding the status of the Cincinnati
Financial Corporation holding (parent) company under the Investment Company Act of 1940. Several tests and
enumerated exemptions determine whether a company meets the definition of an investment company under
the Investment Company Act. In particular, one test states that a company may be an investment company if it
owns investment securities with a value greater than 40 percent of its total assets (excluding assets of its
subsidiaries), a level which the holding company exceeded between 1991 and August 2004.
On June 28, 2004, Cincinnati Financial Corporation filed an application with the SEC formally requesting an
exemption for the holding company under Section 3(b)(2) of the Investment Company Act. Section 3(b)(2)
specifically permits the SEC to exempt entities primarily engaged in business other than that of investing,
reinvesting, owning, holding or trading in securities. Cincinnati Financial Corporation alternatively asked the
SEC for relief pursuant to Section 6(c) of the Investment Company Act, which would exempt it from all the
provisions of the Act because doing so is necessary or appropriate in the public interest, consistent with the
protection of investors and consistent with the purposes intended by the Investment Company Act.
Following its SEC filing, the holding company transferred investment securities to our subsidiary, The Cincinnati
Insurance Company, in August 2004, lowering the holding company’s ratio of investment securities to holding-
company-only assets below 40 percent. We have maintained that ratio below the 40 percent level since the
time of the transfer.
Because the ratio is below 40 percent, we believe the SEC staff is not actively considering the application.
We strongly believe the holding company is, and has been, outside the intended scope of the Investment
Company Act because the company is, and has been, primarily engaged in the business of property casualty
and life insurance through its subsidiaries. As a registered investment company, the holding company would
not be permitted to operate its business as it currently operates, nor would a registered investment company
be permitted to have many of the relationships that the holding company has with its affiliated companies.
2005 10-K Page 96
To increase certainty that regulation under the Investment Company Act would not apply to the company in the
future, our operations are limited by the constraint that investment securities held at the holding company level
should remain below the 40 percent threshold described above. Efforts to stay below the threshold could result
in:
• A need to dispose of otherwise desirable investment securities, possibly under undesirable conditions.
Such dispositions could result in a lower return on investment because of market value fluctuations.
Dispositions also could result in loss of investment income that we may be unable to replace in a timely
fashion. If we were unable to manage the timing of the dispositions, we also might realize unnecessary
capital gains, which would increase our annual tax payment.
•
Limited opportunities to purchase equity securities that hold the potential for market value appreciation.
Historically, the holding company has successfully invested in equity securities that provided both income
and capital appreciation, contributing to long-term growth in book value. Constraining our ability to pursue
this strategy and invest in equity securities could hamper book value growth over the long term.
• Maintenance of a greater portion of our portfolio of equity securities at our insurance subsidiary. As a result
of the transfer of assets to ensure compliance with the 40 percent threshold, the holding company now is
more reliant on that subsidiary for cash to fund parent-company obligations, including shareholder
dividends and interest on long-term debt.
Although we intend to manage assets to stay below the 40 percent threshold, events beyond our control,
including significant appreciation in the value of certain investment securities, could result in the holding
company exceeding the 40 percent threshold. While we believe that even in such circumstances the company
would not be an investment company because it is primarily engaged in the business of insurance through its
subsidiaries, the SEC, among others, could disagree with this position.
If it were determined that the holding company is an unregistered investment company, the holding company
might be unable to enforce contracts with third parties, and third parties could seek rescission of transactions
with the holding company undertaken during the period that it was an unregistered investment company,
subject to equitable considerations set forth in the Investment Company Act. In addition, the holding company
could become subject to monetary penalties or injunctive relief, or both, in an action brought by the SEC.
16.
See Note 1 for a general description of our stock option plans. Here is a summary of options information:
STOCK OPTIONS
(Shares in thousands)
Years ended December 31,
2005
Outstanding at beginning of year
Granted/reinstated
Exercised
Forfeited/revoked
Outstanding at end of year
Options exercisable at end of year
Weighted-average fair value of options granted during the year
2004
Outstanding at beginning of year
Granted/reinstated
Exercised
Forfeited/revoked
Outstanding at end of year
Options exercisable at end of year
Weighted-average fair value of options granted during the year
2003
Outstanding at beginning of year
Granted/reinstated
Exercised
Forfeited/revoked
Outstanding at end of year
Options exercisable at end of year
Weighted-average fair value of options granted during the year
2005 10-K Page 97
Weighted-
average exercise
price
Shares
9,698 $
1,504
(467)
(146)
10,589
7,794 $
8,791 $
1,439
(397)
(135)
9,698
7,050 $
7,845 $
1,366
(295)
(125)
8,791
6,303 $
32.05
41.62
24.18
35.89
33.70
31.69
12.49
30.63
38.81
24.02
34.29
32.05
30.50
11.18
29.96
32.47
20.47
32.79
30.63
29.57
9.82
Options outstanding and exercisable consisted of the following at December 31, 2005:
Options outstanding
Options exercisable
Range of excercise prices
$17.07 to 19.34
$20.37 to 24.14
$26.63 to 29.92
$30.60 to 35.00
$36.17 to 38.87
$41.14 to 41.62
Total
Shares
474
309
1,066
4,938
2,065
1,737
10,589
Weighted-
average
remaining
contractual life
Weighted-
average exercise
price
Weighted-
average exercise
price
Shares
$
0.36 yrs
1.28 yrs
4.00 yrs
5.16 yrs
6.28 yrs
7.97 yrs
5.40 yrs
18.50
20.70
27.07
32.65
38.46
41.55
33.70
474 $
309
1,066
4,515
1,162
268
7,794
18.50
20.70
27.07
32.67
38.20
41.15
31.69
SEGMENT INFORMATION
17.
We operate primarily in two industries, property casualty insurance and life insurance. We regularly review four
different reporting segments to make decisions about allocating resources and assessing performance:
• Commercial lines property casualty insurance
• Personal lines property casualty insurance
•
Life insurance
Investment operations
•
We report as “Other” the operations of the parent company, CFC Investment Company and CinFin Capital
Management Company (excluding investment activities) as well as other income of our insurance subsidiary.
Revenues come primarily from unaffiliated customers:
• All three insurance segments record revenues from insurance premiums earned. Life insurance segment
revenues also include fees from separate account investment management fees.
• Our investment operations’ revenues are pretax net investment income plus realized investment gains and
losses.
• Other revenues are primarily finance/lease income.
Income or loss before income taxes for each segment is reported based on the nature of that business area’s
operations. To explain:
•
•
•
•
•
Income before income taxes for the insurance segments is defined as underwriting income or loss.
For commercial lines and personal lines insurance segments, we calculate underwriting income or loss by
recording premiums earned minus loss and loss expenses and underwriting expenses incurred.
For the life insurance segment, we determine underwriting income or loss by taking premiums earned and
separate account investment management fees, minus contract holder benefits and expenses incurred,
plus investment interest credited to contract holders.
Income before income taxes for the investment operations segment is net investment income plus realized
investment gains and losses for all fixed-maturity and equity security investments of the entire company,
minus investment interest credited to contract holders of the life insurance segment.
Loss before income taxes for the Other category is primarily due to interest expense from debt of the
parent company and operating expenses of our headquarters.
Identifiable assets are used by each segment in its operations. We do not report the identifiable assets for the
commercial or personal lines segments because we do not use that measure to analyze the segments. We
include all fixed-maturity and equity security investment assets, regardless of ownership, in the investment
operations segment.
2005 10-K Page 98
This table summarizes segment information:
(In millions)
Revenues:
Commercial lines insurance
Commercial multi-peril
Workers compensation
Commercial auto
Other liability
Other commercial lines
Total commercial lines insurance
Personal lines insurance
Personal auto
Homeowner
Other personal lines
Total personal lines insurance
Life insurance
Investment operations
Other
Total
Income (loss) before income taxes:
Insurance underwriting results:
Commercial lines insurance
Personal lines insurance
Life insurance
Investment operations
Other
Total
Identifiable assets:
Property casualty insurance
Life insurance
Investment operations
Other
Total
2005
Years ended December 31,
2004
2003
673
293
419
342
181
1,908
428
239
78
745
97
424
7
3,181
167
(27)
(3)
381
(38)
480
$
$
$
$
$
$
796 $
328
456
442
232
2,254
433
285
86
804
110
587
12
3,767 $
285 $
45
7
536
(50)
823 $
2,167 $
845
12,774
217
16,003 $
751 $
313
450
402
210
2,126
451
259
83
793
104
583
8
3,614 $
338 $
(40)
2
537
(37)
800 $
2,317
837
12,746
207
16,107
QUARTERLY SUPPLEMENTARY DATA (UNAUDITED)
This table includes unaudited quarterly financial information for the years ended December 31, 2005
and 2004:
(Dollars in millions except per share data)
2005
Revenues
Income before income taxes
Net income
Net income per common share—basic
Net income per common share—diluted
2004
Revenues
Income before income taxes
Net income
Net income per common share—basic
Net income per common share—diluted
$
$
1st
2nd
Quarter
3rd
4th
Full year
916 $
195
144
0.82
0.81
870 $
201
146
0.83
0.82
940 $
215
158
0.90
0.89
923 $
214
155
0.88
0.87
944 $
151
117
0.67
0.66
879 $
113
90
0.51
0.50
967 $
261
183
1.04
1.03
942 $
272
192
1.10
1.09
3,767
823
602
3.44
3.40
3,614
800
584
3.30
3.28
Note: The sum of the quarterly reported amounts may not equal the full year as each is computed independently.
2005 10-K Page 99
Item 9.
Changes in and Disagreements with Accountants on
Accounting and Financial Disclosure
We had no disagreements with the independent registered public accounting firm on accounting and financial
disclosure during the last two fiscal years.
Item 9A. Controls and Procedures
The company maintains disclosure controls and procedures (as that term is defined in Rules 13a-15(e) and
15d-15(e) under the Securities Exchange Act of 1934, as amended (Exchange Act)).
Any controls and procedures, no matter how well designed and operated, can provide only reasonable
assurance of achieving the desired control objectives. The company’s management, with the participation of
the company’s chief executive officer and chief financial officer, has evaluated the effectiveness of the design
and operation of the company’s disclosure controls and procedures as of December 31, 2005. Based upon
that evaluation, the company’s chief executive officer and chief financial officer concluded that the design and
operation of the company’s disclosure controls and procedures provided reasonable assurance that the
disclosure controls and procedures are effective to ensure:
•
•
that information required to be disclosed in the company’s reports under the Exchange Act is recorded,
processed, summarized and reported within the time periods specified in the Securities and Exchange
Commission’s rules and forms, and
that such information is accumulated and communicated to the company’s management, including its
chief executive officer and chief financial officer, as appropriate, to allow timely decisions regarding
required disclosures.
In addition, there was no change in the company’s internal controls over financial reporting (as that term is
defined in Rules 13a-15(f) and 15d-15(f) under the Exchange Act) that occurred during the quarter ended
December 31, 2005 that has materially affected, or is reasonably likely to materially affect, the company’s
internal control over financial reporting.
Management’s Annual Report on Internal Control Over Financial Reporting and the Attestation Report of the
Independent Registered Public Accounting Firm are set forth in Item 8, Pages 78 and 79.
Item 9B. Other Information
None
Directors and Executive Officers of the Registrant
Part III
Our Proxy Statement will be filed with the SEC in preparation for the 2006 Annual Meeting of Shareholders no
later than April 14, 2006. As permitted in Paragraph G(3) of the General Instructions for Form 10-K, we are
incorporating by reference to that statement portions of the information required by Part III as noted in Item 10
through Item 14 below.
Item 10.
a) Information about our directors and executive officers is in the Proxy Statement under “Security Ownership
of Principal Shareholders and Management,” “Information Regarding Nondirector Executive Officers” and
“Information regarding Nominees and Directors.”
b) Information about Section 16(a) beneficial ownership reporting compliance appears in the Proxy Statement
under “Section 16(a) Beneficial Ownership Reporting Compliance.”
c) Information about the “Code of Ethics for Senior Financial Officers” appears in the 2004 Proxy Statement as
an appendix and is available in the Investors section of our Web site, www.cinfin.com. Our code of ethics
applies to those who are responsible for preparing and disclosing our financial information. This includes our
chief executive officer, chief financial officer, chief investment officer and others performing similar functions or
reporting directly to these officers.
d) Information about our audit committee membership and our financial expert compliance appears in the
Proxy Statement under “Information Regarding the Board of Directors” and “Report of the Audit Committee.”
e) The procedures under which shareholders may recommend director nominees have not changed during the
reporting period. Information on the nominating committee processes appears in the Proxy Statement under
“Information Regarding the Board of Directors.”
Item 11.
Information on executive compensation appears in the Proxy Statement under “Executive Compensation
Summary.”
Executive Compensation
2005 10-K Page 100
Item 12.
Security Ownership of Certain Beneficial Owners and
Management and Related Stockholder Matters
a) Information on the security ownership of certain beneficial owners and management appears in the Proxy
Statement under “Security Ownership of Principal Shareholders and Management.”
b) Information on securities authorized for issuance under equity compensation plans appears in the Proxy
Statement under “Equity Compensation Plan Information.” Additional information on options under our equity
compensation plans is available in Item 8, Note 8 and Note 16 to the Consolidated Financial Statements,
Pages 91 and 97.
Item 13.
Information about certain relationships and related transactions appears in the Proxy Statement under “Certain
Relationships and Transactions” and “Compensation Committee Interlocks and Insider Participation.”
Principal Accountant Fees and Services
Item 14.
Information about independent registered public accounting firm fees and services and audit committee pre-
approval policies and procedures appears in the Proxy Statement under “Report of the Audit Committee,”
“Fees Billed by the Independent Registered Public Accounting Firm” and “Services Provided by the Independent
Registered Public Accounting Firm.”
Certain Relationships and Related Transactions
Part IV
Exhibits and Financial Statement Schedules
Item 15.
a) Financial Statements – information contained in Part II, Item 8 of this report, Pages 80 - 83
b) Exhibits – see Index of Exhibits, Page 113
c) Financial Statement Schedules
Schedule I – Summary of Investments -- Other than Investments in Related Parties, Page 102
Schedule II – Condensed Financial Statements of Registrant, Page 104
Schedule III – Supplementary Insurance Information, Page 107
Schedule IV –Reinsurance, Page 109
Schedule V – Valuation and Qualifying Accounts, Page 110
Schedule VI – Supplementary Information Concerning Property Casualty Insurance Operations,
Page 111
2005 10-K Page 101
SCHEDULE I
(In millions)
Cincinnati Financial Corporation and Subsidiaries
Summary of Investments - Other than Investments in Related Parties
Type of investment
Fixed maturities:
United States government and government agencies and authorities:
The Cincinnati Insurance Company
The Cincinnati Casualty Company
The Cincinnati Indemnity Company
The Cincinnati Life Insurance Company
Total
States, municipalities and political subdivisions:
The Cincinnati Insurance Company
The Cincinnati Casualty Company
The Cincinnati Indemnity Company
The Cincinnati Life Insurance Company
Total
Public utilities:
The Cincinnati Insurance Company
The Cincinnati Casualty Company
The Cincinnati Indemnity Company
The Cincinnati Life Insurance Company
Cincinnati Financial Corporation
Total
Convertibles and bonds with warrants attached:
The Cincinnati Insurance Company
The Cincinnati Casualty Company
The Cincinnati Indemnity Company
The Cincinnati Life Insurance Company
CinFin Capital Management Company
Cincinnati Financial Corporation
Total
All other corporate bonds:
The Cincinnati Insurance Company
The Cincinnati Casualty Company
The Cincinnati Indemnity Company
The Cincinnati Life Insurance Company
Cincinnati Financial Corporation
Total
Total fixed maturities
$
$
At December 31, 2005
Cost or amortized
cost
Fair value
Balance sheet
amount
623 $
6
2
369
1,000
1,927
117
34
5
2,083
53
4
1
80
1
139
221
0
1
42
0
5
269
933
30
13
805
115
1,896
5,387 $
610 $
7
2
362
981
1,958
118
34
7
2,117
54
4
1
83
1
143
229
0
1
43
0
5
278
958
31
14
837
117
1,957
5,476 $
610
7
2
362
981
1,958
118
34
7
2,117
54
4
1
83
1
143
229
0
1
43
0
5
278
958
31
14
837
117
1,957
5,476
2005 10-K Page 102
SCHEDULE I (CONTINUED)
Cincinnati Financial Corporation and Subsidiaries
Summary of Investments - Other than Investments in Related Parties
(In millions)
Type of investment
Equity securities:
Common stocks:
Public utilities:
The Cincinnati Insurance Company
The Cincinnati Casualty Company
The Cincinnati Life Insurance Company
CinFin Capital Management Company
Cincinnati Financial Corporation
Total
Banks, trust and insurance companies:
The Cincinnati Insurance Company
The Cincinnati Casualty Company
The Cincinnati Indemnity Company
The Cincinnati Life Insurance Company
CinFin Capital Management Company
Cincinnati Financial Corporation
Total
Industrial, miscellaneous and all other:
The Cincinnati Insurance Company
The Cincinnati Casualty Company
The Cincinnati Indemnity Company
The Cincinnati Life Insurance Company
CinFin Capital Management Company
Cincinnati Financial Corporation
Total
Nonredeemable preferred stocks:
The Cincinnati Insurance Company
The Cincinnati Casualty Company
The Cincinnati Indemnity Company
The Cincinnati Life Insurance Company
CinFin Capital Management Company
Cincinnati Financial Corporation
Total
Total equity securities
Short-term investments:
The Cincinnati Insurance Company
Other invested assets:
Real estate:
The Cincinnati Life Insurance Company
Policy loans:
The Cincinnati Life Insurance Company
Notes receivable:
Cincinnati Financial Corporation
Total other invested assets
Total investments
At December 31, 2005
Cost or amortized
cost
Fair value
Balance sheet
amount
$
$
$
$
$
$
120 $
5
14
0
82
221
431
16
0
56
1
433
937
526
19
6
90
3
159
803
128
0
0
31
0
8
167
2,128 $
75 $
3
29
13
45
7,635
372 $
14
67
0
559
1,012
2,228
77
0
162
1
1,603
4,071
1,304
58
15
198
3
275
1,853
132
0
0
30
0
8
170
7,106 $
75 $
XXXX
XXXX
XXXX
XXXX
XXXX
XXXX
XXXX
XXXX
$
$
$
372
14
67
559
1,012
2,228
77
0
162
1
1,603
4,071
1,304
58
15
198
3
275
1,853
132
0
0
30
0
8
170
7,106
75
3
29
13
45
12,702
2005 10-K Page 103
SCHEDULE II
(In millions)
Cincinnati Financial Corporation (parent company only)
Condensed Balance Sheets
At December 31,
2005
2004
ASSETS
Investments
Fixed maturities, at fair value
Equity securities, at fair value
Short-term investments, at fair value
Other invested assets
Cash and cash equivalents
Equity in net assets of subsidiaries
Investment income receivable
Land, building and equipment, net, for company use (accumulated depreciation:
2005—$61; 2004—$51)
Prepaid federal income tax
Other assets
Due from subsidiaries
Total assets
LIABILITIES
Dividends declared but unpaid
Deferred federal income tax
6.125% senior notes due 2034
6.9% senior debentures due 2028
6.92% senior debentures due 2028
Other liabilities
Total liabilities
SHAREHOLDERS' EQUITY
Common stock
Paid-in capital
Retained earnings
Accumulated other comprehensive income—unrealized gains on investments and derivatives
Treasury stock at cost
Total shareholders' equity
Total liabilities and shareholders' equity
$
123 $
2,444
0
13
7
4,685
17
98
32
17
144
7,580 $
53 $
635
371
28
392
15
1,494
389
969
2,088
3,284
(644)
6,086
7,580 $
$
$
$
129
2,680
21
7
28
4,732
17
77
21
14
63
7,789
46
688
371
420
0
15
1,540
370
618
2,057
3,787
(583)
6,249
7,789
This condensed financial information should be read in conjunction with the Consolidated Financial Statements and Notes included
in Part II, Item 8, Page 77.
2005 10-K Page 104
SCHEDULE II (CONTINUED)
(In millions)
REVENUES
Dividends from subsidiaries
Investment income, net of expenses
Realized gains (losses) on investments
Other revenue
Total revenues
EXPENSES
Interest expense
Depreciation expense
Other expenses
Total expenses
Cincinnati Financial Corporation (parent company only)
Condensed Statements of Income
Years ended December 31,
2004
2003
2005
$
275 $
89
2
10
376
52
3
16
71
305
(7)
312
290
175 $
110
18
9
312
36
3
14
53
259
3
256
328
50
131
(23)
7
165
33
4
15
52
113
(1)
114
260
374
INCOME BEFORE INCOME TAXES AND EARNINGS OF SUBSIDIARIES
Income tax provision (benefit)
NET INCOME BEFORE EARNINGS OF SUBSIDIARIES
Increase in undistributed earnings of subsidiaries
NET INCOME
$
602 $
584 $
This condensed financial information should be read in conjunction with the Consolidated Financial Statements and Notes included
in Part II, Item 8, Page 77.
2005 10-K Page 105
SCHEDULE II (CONTINUED)
Cincinnati Financial Corporation (parent company only)
Condensed Statements of Cash Flows
(In millions)
CASH FLOWS FROM OPERATING ACTIVITIES
Net income
Adjustments to reconcile net income to net cash provided by operating activities:
Depreciation and amortization
Realized (gains) losses on investments
Changes in:
Investment income receivable
Current federal income taxes
Deferred income taxes
Other assets
Other liabilities
Undistributed earnings of subsidiaries
Net cash provided by operating activities
CASH FLOWS FROM INVESTING ACTIVITIES
Sale of fixed-maturity investments
Maturity of fixed-maturity investments
Sale of equity security investments
Purchase of fixed-maturity investments
Purchase of equity security investments
Change in short-term investments, net
Investment in buildings and equipment, net
Change in other invested assets, net
Net cash (used in) provided by investing activities
CASH FLOWS FROM FINANCING ACTIVITIES
Proceeds from 6.125% senior notes
Debt issuance costs from 6.125% senior notes
Decrease in notes payable
Payment of cash dividends to shareholders
Purchase/issuance of treasury shares
Proceeds from stock options exercised
Net transfers to subsidiaries
Net cash used in financing activities
Net increase (decrease) in cash and cash equivalents
Cash and cash equivalents at beginning of year
Cash and cash equivalents at end of year
Years ended December 31,
2004
2003
2005
$
602 $
584 $
3
(2)
0
(12)
19
(3)
0
(290)
317
8
2
18
(9)
(12)
21
(24)
(8)
(4)
0
0
0
(204)
(61)
11
(80)
(334)
(21)
28
7 $
3
(18)
10
(30)
20
(2)
6
(328)
245
193
50
36
(95)
(196)
(21)
(1)
(1)
(35)
371
(4)
(152)
(177)
(59)
3
(170)
(188)
22
6
28 $
$
374
4
23
1
(2)
(10)
(1)
2
(260)
131
50
71
8
(47)
(33)
0
(1)
2
50
0
0
0
(156)
(55)
6
28
(177)
4
2
6
This condensed financial information should be read in conjunction with the Consolidated Financial Statements and Notes included
in Part II, Item 8, Page 77.
2005 10-K Page 106
SCHEDULE III
(In millions)
Deferred policy acquisition costs:
Commercial lines insurance
Personal lines insurance
Total property casualty insurance
Life insurance
Total
Future policy benefits, losses, claims and expense losses:
Commercial lines insurance
Personal lines insurance
Total property casualty insurance
Life insurance
Total (1)
Unearned premiums:
Commercial lines insurance
Personal lines insurance
Total property casualty insurance
Life insurance
Total (1)
Other policy claims and benefits payable:
Commercial lines insurance
Personal lines insurance
Total property casualty insurance
Life insurance
Total (1)
Premium revenues:
Commercial lines insurance
Personal lines insurance
Total property casualty insurance
Life insurance
Total
Cincinnati Financial Corporation and Subsidiaries
Supplementary Insurance Information
2005
Years ended December 31,
2004
2003
$
$
$
$
$
$
$
$
$
$
226 $
85
311
118
429 $
3,173 $
456
3,629
1,362
4,991 $
1,150 $
407
1,557
2
1,559 $
0 $
0
0
13
13 $
2,254 $
804
3,058
106
3,164 $
218 $
88
306
94
400 $
3,016 $
498
3,514
1,213
4,727 $
1,112 $
425
1,537
2
1,539 $
0 $
0
0
16
16 $
2,126 $
793
2,919
101
3,020 $
207
80
287
85
372
2,933
453
3,386
1,040
4,426
1,037
407
1,444
2
1,446
0
0
0
14
14
1,908
745
2,653
95
2,748
2005 10-K Page 107
SCHEDULE III (CONTINUED)
Cincinnati Financial Corporation and Subsidiaries
Supplementary Insurance Information
(In millions)
Investment income, net of expenses:
Commercial lines insurance
Personal lines insurance
Total property casualty insurance (3)
Life insurance
Total
Benefits, claims losses and settlement expenses:
Commercial lines insurance
Personal lines insurance
Total property casualty insurance
Life insurance
Total
Amortization of deferred policy acquisition costs:
Commercial lines insurance
Personal lines insurance
Total property casualty insurance
Life insurance
Total (2)
Other operating expenses:
Commercial lines insurance
Personal lines insurance
Total property casualty insurance
Life insurance
Total (2)
Written premiums:
Commercial lines insurance
Personal lines insurance
Total property casualty insurance
Accident health insurance
Total
2005
Years ended December 31,
2004
2003
$
$
$
$
$
$
$
$
$
$
0 $
0
338
99
437 $
1,298 $
514
1,812
102
1,914 $
473 $
168
641
23
664 $
198 $
77
275
29
304 $
2,290 $
786
3,076
3
3,079 $
0 $
0
289
91
380 $
1,154 $
599
1,753
95
1,848 $
448 $
162
610
16
626 $
186 $
72
258
37
295 $
2,186 $
811
2,997
3
3,000 $
0
0
245
89
334
1,218
579
1,797
91
1,888
398
160
558
15
573
125
33
158
37
195
2,031
784
2,815
3
2,818
Notes to Schedule III:
(1) The sum of future policy benefits, losses, claims and expense losses, unearned premium and other policy
claims and other policy claims and benefits payable is equal to the sum of loss and loss expense, life policy
reserves and unearned premiums reported in the company’s consolidated balance sheets.
(2) The sum of amortization of deferred policy acquisition costs and other operating expenses is equal to the
sum of Commissions; Other operating expenses; Taxes, licenses and fees; Increase in deferred acquisition
costs; and Other expenses shown in the consolidated statements of income, less other expenses not
applicable to the above insurance segments.
(3) This segment information is not regularly allocated to segments and reviewed by company management in
making decisions about resources to be allocated to the segments or to assess their performance.
2005 10-K Page 108
SCHEDULE IV
(Dollars in millions)
Gross premiums:
Life insurance in force
Earned premiums
Commercial lines insurance
Personal lines insurance
Total property casualty insurance
Life insurance
Total
Ceded to other companies:
Life insurance in force
Earned premiums
Commercial lines insurance
Personal lines insurance
Total property casualty insurance
Life insurance
Total
Assumed from other companies:
Life insurance in force
Earned premiums
Commercial lines insurance
Personal lines insurance
Total property casualty insurance
Life insurance
Total
Net premiums:
Life insurance in force
Earned premiums
Commercial lines insurance
Personal lines insurance
Total property casualty insurance
Life insurance
Total
Percentage of amount assumed to net:
Life insurance in force
Earned premiums
Commercial lines insurance
Personal lines insurance
Total property casualty insurance
Life insurance
Total
Cincinnati Financial Corporation and Subsidiaries
Reinsurance
2005
Years ended December 31,
2004
2003
$
$
$
$
$
$
$
$
$
$
$
$
51,488
2,386
823
3,209
150
3,359
30,705
157
22
179
44
223
5
25
3
28
0
28
20,788
2,254
804
3,058
106
3,164
$
$
$
$
$
$
$
$
$
$
$
$
44,916
2,246
816
3,062
138
3,200
28,196
148
27
175
37
212
5
28
4
32
0
32
16,725
2,126
793
2,919
101
3,020
$
$
$
$
$
$
$
$
$
$
$
$
38,486
2,046
762
2,808
125
2,933
23,296
193
18
211
30
241
6
55
1
56
0
56
15,196
1,908
745
2,653
95
2,748
0.0 %
0.0 %
0.0 %
1.1 %
0.4
0.9
0.0
0.9
1.3 %
0.5
1.1
0.1
1.1
2.9 %
0.2
2.1
0.1
2.0
2005 10-K Page 109
SCHEDULE V
(In millions)
Allowance for doubtful receivables:
Balance at beginning of period
Additions charged to costs and expenses
Other additions
Deductions
Balance at end of period
Cincinnati Financial Corporation and Subsidiaries
Valuation and Qualifying Accounts
2005
At December 31,
2004
2003
$
$
0 $
1
0
0
1 $
0 $
0
0
0
0 $
1
0
0
(1)
0
2005 10-K Page 110
SCHEDULE VI
Cincinnati Financial Corporation and Subsidiaries
Supplementary Information Concerning Property Casualty Insurance Operations
(In millions)
Deferred policy acquisition costs:
Commercial lines insurance
Personal lines insurance
Total
Reserves for unpaid claims and claim adjustment expenses:
Commercial lines insurance
Personal lines insurance
Total
Reserve discount deducted
Unearned premiums:
Commercial lines insurance
Personal lines insurance
Total
Earned premiums:
Commercial lines insurance
Personal lines insurance
Total
Investment income:
Commercial lines insurance (1)
Personal lines insurance (1)
Total
Loss and loss expenses incurred related to current accident year:
Commercial lines insurance (1)
Personal lines insurance (1)
Total
Loss and loss expenses incurred related to prior accident years:
Commercial lines insurance (1)
Personal lines insurance (1)
Total
Amortization of deferred policy acquisition costs:
Commercial lines insurance
Personal lines insurance
Total
Paid loss and loss expenses:
Commercial lines insurance
Personal lines insurance
Total
Written premiums:
Commercial lines insurance
Personal lines insurance
Total
2005
Years ended December 31,
2004
2003
226 $
85
311 $
3,173 $
456
3,629 $
218 $
88
306 $
3,016 $
498
3,514 $
207
80
287
2,933
453
3,386
0 $
0 $
0
1,150 $
407
1,557 $
2,254 $
804
3,058 $
0 $
0
338 $
0 $
0
1,972 $
0 $
0
(160) $
473 $
168
641 $
1,126 $
552
1,678 $
2,290 $
786
3,076 $
1,112 $
425
1,537 $
2,126 $
793
2,919 $
0 $
0
289 $
0 $
0
1,949 $
0 $
0
(196) $
448 $
162
610 $
1,062 $
559
1,621 $
2,186 $
811
2,997 $
1,037
407
1,444
1,908
745
2,653
0
0
245
0
0
1,877
0
0
(80)
398
160
558
1,003
558
1,561
2,031
784
2,815
$
$
$
$
$
$
$
$
$
$
$
$
$
$
$
$
$
$
$
$
$
Note to Schedule VI:
(1) This segment information is not regularly allocated to segments and not reviewed by company management
in making decisions about resources to be allocated to the segments or to assess their performance.
2005 10-K Page 111
SIGNATURES
Pursuant to the requirements of Section 13 or 15 (d) of the Securities Exchange Act of 1934, the registrant has
duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.
Cincinnati Financial Corporation
/S/ Kenneth W. Stecher
_____________________
By:
Title:
Date:
Kenneth W. Stecher
Chief Financial Officer, Senior Vice President, Secretary and Treasurer
March 10, 2006
Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been duly signed below
by the following persons on behalf of the registrant and in the capacities and on the dates indicated.
Signature
/S/ John J. Schiff, Jr.
John J. Schiff, Jr.
/S/ Kenneth W. Stecher
Kenneth W. Stecher
/S/ William F. Bahl
William F. Bahl
/S/ James E. Benoski
James E. Benoski
/S/ Michael Brown
Michael Brown
/S/ Dirk J. Debbink
Dirk J. Debbink
/S/ Kenneth C. Lichtendahl
Kenneth C. Lichtendahl
/S/ W. Rodney McMullen
W. Rodney McMullen
/S/ Gretchen W. Price
Gretchen W. Price
/S/ Thomas R. Schiff
Thomas R. Schiff
/S/ John M. Shepherd
John M. Shepherd
/S/ Douglas S. Skidmore
Douglas S. Skidmore
/S/ John F. Steele, Jr.
John F. Steele, Jr.
/S/ Larry R. Webb
Larry R. Webb
/S/ E. Anthony Woods
E. Anthony Woods
Title
Chairman, President, Chief Executive Officer and Director
Date
March 6, 2006
Chief Financial Officer, Senior Vice President, Secretary
and Treasurer (Principal Accounting Officer)
March 10, 2006
Director
February 28, 2006
Vice Chairman, Chief Insurance Officer and Director
March 1, 2006
Director
Director
Director
Director
Director
Director
Director
Director
Director
Director
Director
2005 10-K Page 112
March 1, 2006
March 2, 2006
March 2, 2006
March 1, 2006
March 2, 2006
March 2, 2006
February 28, 2006
March 1, 2006
March 1, 2006
March 2, 2006
March 2, 2006
4.6
10.2
Exhibit No.
3.1A
3.1B
3.2
4.1
4.2
4.3
4.4
4.5
4.7
10.1
INDEX OF EXHIBITS
Exhibit Description
Amended Articles of Incorporation of Cincinnati Financial Corporation (1)
Amendment to Article Fourth of Amended Articles of Incorporation of Cincinnati Financial Corporation (2)
Regulations of Cincinnati Financial Corporation (3)
Indenture with The Bank of New York Trust Company (4)
Supplemental Indenture with The Bank of New York Trust Company (4)
Second Supplemental Indenture with The Bank of New York Trust Company (5)
Form of 6.125% Exchange Note Due 2034 (included in Exhibit 4.2)
Form of 6.92% Debentures Due 2028 (included in Exhibit 4.3)
Indenture with the First National Bank of Chicago (subsequently assigned to The Bank of New York Trust
Company) (6)
Form of 6.90% Debentures Due 2028 (included in Exhibit 4.6)
Agreement with Messer Construction (7)
Stock Repurchase Agreement dated November 12, 2004 with Robert C. Schiff, Trustee, Robert C. Schiff Revocable
Trust (7)
Purchase Agreement with J.P. Morgan Securities Inc. and UBS Securities LLC (8)
2003 Non-Employee Directors’ Stock Plan (9)
Cincinnati Financial Corporation Stock Option Plan No. V (10)
Cincinnati Financial Corporation Stock Option Plan No. VI (11)
Cincinnati Financial Corporation Stock Option Plan No. VII (12)
Standard Form of Nonqualified and Incentive Option Agreements for Stock Option Plan No. V (7)
Standard Form of Nonqualified and Incentive Option Agreements for Stock Option Plan No. VI (7)
Standard Form of Nonqualified and Incentive Option Agreements for Stock Option Plan No. VII (7)
Cincinnati Financial Corporation Stock Option Plan No. VIII (9)
Registration Rights Agreement with J.P. Morgan Securities Inc. and UBS Securities LLC (4)
Form of Dealer Manager Agreement between Cincinnati Financial and UBS Securities LLC (13)
Standard Form of Incentive Stock Option Agreement for Stock Option Plan VIII (14)
Standard Form of Nonqualified Stock Option Agreement for Stock Option Plan VIII (15)
Standard Form of Combined Incentive/Nonqualified Stock Option for Stock Option Plan VI (16)
364-Day Credit Agreement by and among Cincinnati Financial Corporation and CFC Investment Company, as
Borrowers, and Fifth Third Bank, as Lender (17)
Director and Named Executive Officer Compensation Summary (18)
Executive Compensation Plan (19)
Statement re: Computation of per share earnings for the years ended December 31, 2005, 2004 and 2003,
contained in Note 11 to the Consolidated Financial Statements included in Part II, Item 8 of this report, Page 93
Cincinnati Financial Corporation Code of Ethics for Senior Financial Officers (20)
Cincinnati Financial Corporation Subsidiaries contained in Part I, Item 1 of this report, Page 1
Consent of Independent Registered Public Accounting Firm, Page 114
Certification pursuant to Section 302 of the Sarbanes Oxley Act of 2002 – Chief Executive Officer, Page 115
Certification pursuant to Section 302 of the Sarbanes Oxley Act of 2002 – Chief Financial Officer, Page 116
Certification pursuant to Section 906 of the Sarbanes Oxley Act of 2002, Page 117
10.3
10.4
10.5
10.6
10.7
10.8
10.9
10.10
10.11
10.12
10.13
10.14
10.15
10.16
14
21
23
31.1
31.2
32
10.18
10.19
10.17
11
1 Incorporated by reference to the company’s 1999 Annual Report on Form 10-K dated March 23, 2000 (File No. 000-04604).
2 Incorporated by reference to Exhibit 3(i) filed with the company’s Current Report on Form 8-K dated July 15, 2005.
3 Incorporated by reference to the company’s Definitive Proxy Statement dated March 2, 1992, Exhibit 2 (File No. 000-04604).
4 Incorporated by reference to the company’s Current Report on Form 8-K dated November 2, 2004, filed with respect to the issuance of the
company’s 6.125% Senior Notes due November 1, 2034.
5 Incorporated by reference to the company’s Current Report on Form 8-K dated May 9, 2005, filed with respect to the completion of the company’s
exchange offer and rescission offer for its 6.90% senior debentures due 2028.
6 Incorporated by reference to the company’s registration statement on Form S-3 effective May 22, 1998 (File No. 333-51677).
7 Incorporated by reference to the company’s 2004 Annual Report on Form 10-K dated March 11, 2005.
8 Incorporated by reference to the company’s Current Report on Form 8-K dated November 1, 2004, filed with respect to the issuance of the
company’s 6.125% Senior Notes due November 1, 2034.
9 Incorporated by reference to the company’s Definitive Proxy Statement dated March 21, 2005.
10 Incorporated by reference to the company’s Definitive Proxy Statement dated March 2, 1996 (File No. 000-04604).
11 Incorporated by reference to the company’s Definitive Proxy Statement dated March 1, 1999 (File No. 000-04604).
12 Incorporated by reference to the company’s Definitive Proxy Statement dated March 8, 2002.
13 Incorporated by reference to the company’s Registration Statement on Form S-4 filed March 21, 2005 (File No. 333-123471).
14 Incorporated by reference to Exhibit 10.1 filed with the company’s Current Report on Form 8-K dated July 15, 2005.
15 Incorporated by reference to Exhibit 10.2 filed with the company’s Current Report on Form 8-K dated July 15, 2005.
16 Incorporated by reference to Exhibit 10.3 filed with the company’s Current Report on Form 8-K dated July 15, 2005.
17 Incorporated by reference to Exhibit 10.1 filed with the company’s Current Report on Form 8-K dated May 31, 2005.
18 Incorporated by reference to the company’s Definitive Proxy Statement to be filed no later than April 14, 2006.
19 Incorporated by reference to Exhibit 10.2 filed with the company’s Current Report on Form 8-K dated November 23, 2005.
20 Incorporated by reference to the company’s Definitive Proxy Statement dated March 18, 2004.
2005 10-K Page 113
EXHIBIT 23
Independent Registered Public Accounting Firm Consent
We consent to the incorporation by reference in Registration Statements No. 333-85953 (on Form S-8),
No. 333-24815 (on Form S-8), No. 333-24817 (on Form S-8), No. 333-49981 (on Form S-8), No. 333-103509
(on Form S-8), No. 333-103511 (on Form S-8), , No. 333-121429 (on Form S-4), No. 333-123471
(on Form S-4), and No. 333-126714 (on Form S-8) of Cincinnati Financial Corporation of our report dated
March 6, 2006 relating to the consolidated financial statements and financial statement schedules of
Cincinnati Financial Corporation and management's report of the effectiveness of internal control over financial
reporting appearing in this Annual Report on Form 10-K of Cincinnati Financial Corporation for the year ended
December 31, 2005.
/S/ Deloitte & Touche LLP
______________________
Deloitte & Touche LLP
Cincinnati, Ohio
March 10, 2006
2005 10-K Page 114
EXHIBIT 31A
Certification pursuant to Section 302 of the Sarbanes Oxley Act of 2002
I have reviewed this Annual Report on Form 10-K of Cincinnati Financial Corporation;
I, John J. Schiff, Jr., certify that:
1.
2. Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to
state a material fact necessary to make the statements made, in light of the circumstances under which
such statements were made, not misleading with respect to the period covered by this report;
3. Based on my knowledge, the financial statements, and other financial information included in this report,
fairly present in all material respects the financial condition, results of operations and cash flows of the
registrant as of, and for, the periods presented in this report;
4. The registrant's other certifying officer and I are responsible for establishing and maintaining disclosure
controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) and internal control
over financial reporting (as defined in Exchange Act Rules 13a-15(f) and 15d-15(f)) for the registrant and
have:
a) designed such disclosure controls and procedures, or caused such disclosure controls and
procedures to be designed under our supervision, to ensure that material information relating to
the registrant, including its consolidated subsidiaries, is made known to us by others within those
entities, particularly during the period in which this report is being prepared;
b) designed such internal control over financial reporting , or caused such internal control over
financial reporting to be designed under our supervision, to provide reasonable assurance
regarding the reliability of financial reporting and the preparation of financial statements for
external purposes in accordance with generally accepted accounting principals;
c) evaluated the effectiveness of the registrant's disclosure controls and procedures and presented
in this report our conclusions about the effectiveness of the disclosure controls and procedures,
as of the end of the period covered by this report based on such evaluation; and
d) disclosed in this report any change in the registrant’s internal control over financial reporting that
occurred during the registrant’s most recent fiscal quarter (the registrant’s fourth fiscal quarter in
the case of an annual report) that has materially affected, or is reasonably likely to materially
affect, the registrant’s internal control over financial reporting; and
5. The registrant's other certifying officer and I have disclosed, based on our most recent evaluation of
internal control over financial reporting, to the registrant's auditors and the audit committee of registrant's
board of directors (or persons performing the equivalent functions):
a) all significant deficiencies and material weaknesses in the design or operation of internal controls
over financial reporting which are reasonably likely to adversely affect the registrant's ability to
record, process, summarize and report financial information; and
b) any fraud, whether or not material, that involves management or other employees who have a
significant role in the registrant's internal control over financial reporting.
Date: March 10, 2006
/S/ John J. Schiff, Jr.
____________________
John J. Schiff, Jr.
Chairman, President and Chief Executive Officer
2005 10-K Page 115
EXHIBIT 31B
Certification pursuant to Section 302 of the Sarbanes Oxley Act of 2002
I have reviewed this Annual Report on Form 10-K of Cincinnati Financial Corporation;
I, Kenneth W. Stecher, certify that:
1.
2. Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to
state a material fact necessary to make the statements made, in light of the circumstances under which
such statements were made, not misleading with respect to the period covered by this report;
3. Based on my knowledge, the financial statements, and other financial information included in this report,
fairly present in all material respects the financial condition, results of operations and cash flows of the
registrant as of, and for, the periods presented in this report;
4. The registrant's other certifying officer and I are responsible for establishing and maintaining disclosure
controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) and internal control
over financial reporting (as defined in Exchange Act Rules 13a-15(f) and 15d-15(f)) for the registrant and
have:
a) designed such disclosure controls and procedures, or caused such disclosure controls and
procedures to be designed under our supervision, to ensure that material information relating to
the registrant, including its consolidated subsidiaries, is made known to us by others within those
entities, particularly during the period in which this report is being prepared;
b) designed such internal control over financial reporting , or caused such internal control over
financial reporting to be designed under our supervision, to provide reasonable assurance
regarding the reliability of financial reporting and the preparation of financial statements for
external purposes in accordance with generally accepted accounting principals;
c) evaluated the effectiveness of the registrant's disclosure controls and procedures and presented
in this report our conclusions about the effectiveness of the disclosure controls and procedures,
as of the end of the period covered by this report based on such evaluation; and
d) disclosed in this report any change in the registrant’s internal control over financial reporting that
occurred during the registrant’s most recent fiscal quarter (the registrant’s fourth fiscal quarter in
the case of an annual report) that has materially affected, or is reasonably likely to materially
affect, the registrant’s internal control over financial reporting; and
5. The registrant's other certifying officer and I have disclosed, based on our most recent evaluation of
internal control over financial reporting, to the registrant's auditors and the audit committee of registrant's
board of directors (or persons performing the equivalent functions):
a) all significant deficiencies and material weaknesses in the design or operation of internal controls
over financial reporting which are reasonably likely to adversely affect the registrant's ability to
record, process, summarize and report financial information; and
b) any fraud, whether or not material, that involves management or other employees who have a
significant role in the registrant's internal control over financial reporting
Date: March 10, 2006
/S/ Kenneth W. Stecher
____________________
Kenneth W. Stecher
Chief Financial Officer, Senior Vice President, Secretary and Treasurer
(Principal Accounting Officer)
2005 10-K Page 116
EXHIBIT 32
Certification pursuant to Section 906 of the Sarbanes Oxley Act of 2002
The certification set forth below is being submitted in connection with this report on Form 10-K for the purpose
of complying with Rule 13a-14(b) or Rule 15d-14(b) of the Securities Exchange Act of 1934 and Section 1350
of Chapter 63 of Title 18 of the United States Code.
John J. Schiff, Jr., the chief executive officer, and Kenneth W. Stecher, the chief financial officer, of Cincinnati
Financial Corporation each certifies that, to the best of his knowledge:
1.
2.
the report fully complies with the requirements of Section 13(a) or 15(d) of the Exchange Act; and
the information contained in the report fairly presents, in all material respects, the financial condition and
results of operations of Cincinnati Financial Corporation.
Date: March 10, 2006
/S/ John J. Schiff, Jr.
____________________
John J. Schiff, Jr.
Chairman, President and Chief Executive Officer
/S/ Kenneth W. Stecher
____________________
Kenneth W. Stecher
Chief Financial Officer, Senior Vice President, Secretary and Treasurer
(Principal Accounting Officer)
2005 10-K Page 117
Subsidiary Officers and Directors
As of March 10, 2006, listed alphabetically
The Cincinnati Insurance Company (CIC)
The Cincinnati Indemnity Company (CID)
Executive Officers
James E. Benoski
CIC, CID, CCC Vice Chairman of the Board
CIC, CID, CCC, CLIC Chief Insurance Officer and
Senior Vice President–Headquarters Claims
Director of all subsidiaries
Craig W. Forrester, CLU
CIC, CID, CCC, CLIC Senior Vice President–
Information Technology
Thomas A. Joseph, CPCU
CIC, CID, CCC Senior Vice President–
Commercial Lines; Director
Eric N. Mathews, CPCU, AIAF
CIC, CID, CCC, CLIC, Senior Vice President–
Corporate Accounting
Daniel T. McCurdy
CIC, CID, CCC Senior Vice President–
Bond & Executive Risk; Director
Kenneth S. Miller, CLU, ChFC
CIC, CID, CCC, CLIC Chief Investment Officer and
Senior Vice President–Investments
CFC-I President and Chief Operating Officer
CCM President
Director of all subsidiaries
Larry R. Plum, CPCU
CCC President
CIC, CID Senior Vice President–Personal Lines
CIC, CID, CCC, CLIC Director
David H. Popplewell, FALU, LLIF
CLIC President and Chief Operating Officer; Director
J. F. Scherer
CIC, CID, CCC, CLIC Senior Vice President–
Sales & Marketing; Director
CFC-I Director
John J. Schiff, Jr., CPCU
CIC, CID Chairman, President and
Chief Executive Officer
CCC Chairman and Chief Executive Officer
CLIC Chief Executive Officer
CIC, CID, CCC, CLIC, CFC-I Director
Joan O. Shevchik, CPCU, CLU
CIC, CID, CCC Senior Vice President–
Corporate Communications
Kenneth W. Stecher
CIC, CID, CCC, CLIC, CFC-I Chief Financial
Officer and Senior Vice President–
Corporate Accounting; Secretary
CCM Treasurer
Director of all subsidiaries
Timothy L. Timmel
CIC, CID, CCC, CLIC, CFC-I Senior Vice
President–Operations; Director
Senior Officers
Michael R. Abrams
CCM Vice President
Donald R. Adick, FLMI
CLIC Senior Vice President–Life Marketing
Administration
Dawn M. Alcorn
CIC, CID, CCC Vice President–
Administrative Services
Brad E. Behringer
CLIC Senior Vice President and Chief Underwriter
David L. Burbrink
CLIC Vice President–Life Field Services
Richard W. Cumming, ChFC, CLU, FSA, MAAA
CIC, CID, CCC, CLIC Senior Vice President and
Chief Actuary
CLIC Director
Joel W. Davenport, CPCU, AAI
CIC, CID, CCC Vice President–Commercial Lines
J. Michael Dempsey, CLU
CLIC Vice President–Life Marketing Administration
Appendix
The Cincinnati Casualty Company (CCC)
The Cincinnati Life Insurance Company (CLIC)
CFC Investment Company (CFC–I)
CinFin Capital Management (CCM)
Mark R. DesJardins, CPCU, AIM, AIC, ARP
CIC, CID, CCC Vice President–Education & Training
Donald J. Doyle, Jr., CPCU, AIM
CIC, CID, CCC, CLIC Senior Vice President–
Internal Audit
Harold L. Eggers, CLU, FLMI, FALU, HIAA
CLIC Vice President–Life Policy Issue
Frederick A. Ferris
CIC, CID, CCC Vice President–Commercial Lines
Bruce S. Fisher, CPCU, AIC
CIC, CID, CCC Vice President–Headquarters Claims
Carl C. Gaede, CPCU, AFSB
CIC, CID, CCC Vice President–Bond & Executive Risk
Michael J. Gagnon
CIC, CID, CCC Vice President–Headquarters Claims
Gary B. Givler
CIC, CID, CCC Vice President–Headquarters Claims
Kevin E. Guilfoyle
CFC-I Senior Vice President–Leasing
David L. Helmers, CPCU, API, ARe, AIM
CIC, CID, CCC Vice President–Personal Lines
Theresa A. Hoffer
CIC, CID, CCC, CLIC Vice President–
Corporate Accounting
CIC, CID, CCC Treasurer
Martin F. Hollenbeck, CFA
CIC, CID, CCC, CLIC, CCM Vice President–
Investments
Timothy D. Huntington, CPCU, AU
CIC, CID, CCC Vice President–Commercial Lines
Thomas H. Kelly
CIC, CID, CCC Vice President–Bond & Executive Risk
Christopher O. Kendall, CPCU, AIT, AIM,
ARe, ARM, ARP
CIC, CID, CCC Vice President–Commercial Lines
Gary J. Kline, CPCU
CIC, CID, CCC Vice President–Commercial Lines
Robert L. Laymon,
CIC, CID, CCC Vice President–Bond & Executive Risk
Steven W. Leibel, CPCU, AIM
CIC, CID, CCC Vice President–Personal Lines
Jerry L. Litton
CFC-I Treasurer
Richard L. Mathews, CPCU
CIC, CID, CCC, CLIC Vice President–
Information Technology
Richard P. Matson
CIC, CID, CCC, CFC-I, CLIC Vice President–
Purchasing/Fleet
Martin J. Mullen, CPCU
CIC, CID, CCC Vice President–Headquarters Claims
Gary A. Nichols
CIC, CID, CCC Vice President–Headquarters Claims
Glenn D. Nicholson, LLIF
CLIC Senior Vice President and Senior Marketing
Officer; Director
Michael K. O'Connor, CPCU, CFA, AFSB
CCM Vice President
Todd H. Pendery, FLMI
CIC, CID, CCC, CLIC Vice President–
Corporate Accounting
CLIC Treasurer
Marc C. Phillips, CPCU, AIM
CIC, CCC, CID Vice President–Commercial Lines
Charles E. Robinson, CPCU
CIC, CID, CCC Vice President–Field Claims
Michael A. Rouse
CIC, CID, CCC Vice President–Commercial Lines
Thomas J. Scheid
CIC, CID, CCC, CLIC Vice President–
Premium Audit, Loss Control, Machinery &
Equipment Specialties
Gregory D. Schmidt, CPCU, ARP, CPP, ACP, ARC
CIC, CID, CCC, CLIC Vice President–
Staff Underwriting
Norman R. Settle
CIC, CID, CCC Senior Vice President–
Administrative Services
J. B. Shockey, CPCU, CIC, CLU
CIC, CID, CCC Vice President–Sales & Marketing
David W. Sloan
CFC-I Vice President–Leasing
Scott K. Smith, CPCU, ARM, AIM, AU
CIC, CID, CCC Vice President–Commercial Lines
Steven A. Soloria, CFA
CIC, CID, CCC, CLIC, CCM, Vice President–
Investments
CCM Secretary
Charles P. Stoneburner II, CPCU
CIC, CID, CCC Vice President–Field Claims
Gary B. Stuart
CIC, CID, CCC Vice President–Sales & Marketing
Duane I. Swanson, CIC
CIC, CID, CCC Vice President–Sales & Marketing
Philip J. Van Houten, CFE, FCLS
CIC, CID, CCC Vice President–Headquarters Claims
Stephen A. Ventre, CPCU, AIM
CIC, CID, CCC Vice President–Commercial Lines
Jody L. Wainscott
CIC, CID, CCC Vice President–
Research & Development
Mark A. Welsh
CIC, CID, CCC, CLIC Vice President–
Regulatory & Consumer Relations
Mark S. Wietmarschen
CIC, CID, CCC Vice President–Commercial Lines
Heather J. Wietzel
CIC, CID, CCC Vice President and
Investor Relations Officer
Gregory J. Ziegler
CIC, CID, CCC, CLIC, CFC–I Vice President–
Personnel
Teresa C. Cracas
CIC, CID, CCC, CLIC 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 Senior Counsel
Stephen C. Roach
CIC, CID, CCC, CLIC Counsel
Non-Officer Directors
William F. Bahl, CFA
CIC, CID, CCC, CLIC Director
W. Rodney McMullen
CIC, CID, CCC, CLIC Director
Thomas R. Schiff
CIC, CID, CCC, CLIC Director
Larry R. Webb, CPCU
CIC, CID CCC Director
E. Anthony Woods
CIC, CID, CCC, CLIC Director
CIC Directors Emeriti
Vincent H. Beckman
Robert J. Driehaus
Richard L. Hildbold, CPCU
Robert C. Schiff
William H. Zimmer
Shareholder Information
Cincinnati Financial Corporation had approximately 12,000 shareholders of record as of December 31, 2005. Many of the company’s
independent agent representatives and most of the 3,983 associates of its subsidiaries own the company’s common stock.
Stock Listing
Common shares are traded under the symbol CINF on the Nasdaq National Market.
Annual Meeting
The Annual Meeting of Shareholders of Cincinnati Financial Corporation will take place at 9:30 a.m. on Saturday, May 6, 2006, at the
Cincinnati Art Museum in Eden Park, Cincinnati, Ohio. If you are unable to attend, you may listen to an audio webcast from the Investors
section of the company’s Web site, www.cinfin.com.
Shareholder Services
Please direct inquiries about stock transfer, dividend reinvestment, dividend direct deposit, lost certificates, change of address or electronic
delivery and elimination of duplicate mailings to Kenneth W. Stecher, Chief Financial Officer, Cincinnati Financial Corporation,
P.O. Box 145496, Cincinnati, Ohio 45250-5496, (513) 870-2639, or e-mail shareholder_inquiries@cinfin.com.
Form 10-K
Cincinnati Financial Corporation’s Annual Report on Form 10-K, filed annually with the Securities and Exchange Commission, is included in
this Annual Report. Additional copies are available at no cost by contacting Mr. Stecher. You also may access and print this document from the
Investors section of www.cinfin.com.
Interim Communications
During 2006, Cincinnati Financial Corporation is tentatively scheduled to report interim results as follows:
First quarter ending March 31
Second quarter ending June 30
Third quarter ending September 30
May 3
August 2
November 1
Confirmation of release dates and quarterly conference call webcasts is available approximately two weeks after the end of each quarter on
www.cinfin.com, or call (513) 870-2768 or inquire via e-mail to investor_inquiries@cinfin.com.
Corporate Headquarters
Independent Registered Public Accounting Firm
Cincinnati Financial Corporation
6200 South Gilmore Road
Fairfield, Ohio 45014-5141
Phone: (513) 870-2000
Fax: (513) 870-2066
Deloitte & Touche LLP
250 East Fifth Street
Cincinnati, Ohio 45202-5109
Common Stock Price and Dividend Data
__________________________________________________________________________________________________
2005
___________________________________________________________________________________________________
2004
Quarter:
High . . . . . . . . . . . . . . . . . . . . . . . . . . . . $
Low . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Period-end close . . . . . . . . . . . . . . . . . .
Cash dividends declared . . . . . . . . . . . .
__________________
1st
43.92
40.84
41.53
0.290
__________________
2nd
$ 43.12
38.38
39.56
0.305
__________________
3rd
$ 42.64
39.00
41.89
0.305
4th
45.95
39.91
44.68
0.305
$
$
1st
41.61
37.02
39.41
0.250
__________________
2nd
$ 41.78
37.90
41.45
0.262
$
3rd
41.70
37.46
39.26
0.262
__________________
4th
$ 43.52
36.57
42.15
0.262
__________________
__________________
__________________
Source: Nasdaq National Market
The common stock prices and dividend data above are adjusted to reflect the 5 percent stock dividends paid June 15, 2004, and April 26, 2005.
CINCINNATI FINANCIAL CORPORATION
The Cincinnati Insurance Company
The Cincinnati Casualty Company
The Cincinnati Indemnity Company
The Cincinnati Life Insurance Company
CFC Investment Company
CinFin Capital Management Company
P.O. Box 145496
Cincinnati, Ohio 45250-5496
(513) 870-2000
www.cinfin.com