Cincinnati Financial Corporation
Claims Service
Sells
Insurance
Responding,
reserving and
building relationships
for long-term
results
2006 Annual Report
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
About Your Company
1
Financial Highlights
Cincinnati Financial
Corporation, formed in
Financial highlights provide a snapshot of your
company’s financial performance and strength.
1968, offers property
2
To Our Shareholders
Consolidated Pretax
Investment Income
Less expenses
(Dollars in millions)
0
7
6 5
2
5
5
4
4
5
6
4
2
9
4
A letter from the chairman and vice chairman
discusses events of 2006, your company’s
performance and issues that may affect us in 2007 and beyond.
03
02
04
05
06
Condensed Balance Sheets and Income Statements
Six-year Summary of Financial Information
Property Casualty
Net Earned Premiums
(Dollars in millions)
Personal lines
Commercial lines
2,919 3,058 3,164
2,653
8
0
9
,
1
2,391
1
2
7
,
1
6
2
1
,
2
4
5
2
,
2
2
0
4
,
2
0
7
6
02
5
4
7
03
3
9
7
4
0
8
2
6
7
04
05
06
Financial Performance Overview
2006 results for property casualty insurance operations, including commercial lines and
personal lines; life insurance operations; and investment operations.
7
8
9
12 Claims Service Sells Insurance
20 Corporate Officers and Directors
21 Subsidiary Officers and Directors
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, our results and
three-year trends, giving clear and thorough explanations with supporting data.
Inside Back Cover
Shareholder Information, Common Stock Price and Dividend Data.
casualty insurance – its
main business – through
subsidiary companies.
The Cincinnati Insurance
Company, founded in
1950, leads the property
casualty group. 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.
Shareholder Information
Cincinnati Financial Corporation had approximately 12,000 shareholders of record as of December 31, 2006. Many of the
company’s independent agent representatives and most of the 4,048 associates of its subsidiaries own the company’s common stock.
Stock Listing
Common shares are traded under the symbol CINF on the NASDAQ Global Select Market.
Annual Meeting
The Annual Meeting of Shareholders of Cincinnati Financial Corporation will take place at 9:30 a.m. on Saturday, May 5, 2007, 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 2007, Cincinnati Financial Corporation tentatively has scheduled reports of interim results as follows:
First quarter ending March 31
Second quarter ending June 30
Third quarter ending September 30
May 2
August 7
October 31
Information regarding actual interim release dates and quarterly conference call webcasts is available approximately two weeks after
the end of each quarter on www.cinfin.com, by calling 513-870-2768 or by e-mailing investor_inquiries@cinfin.com.
Corporate Headquarters
Cincinnati Financial Corporation
6200 South Gilmore Road
Fairfield, Ohio 45014-5141
Phone: 513-870-2000
Fax: 513-870-2066
Independent Registered Public Accounting Firm
Deloitte & Touche LLP
250 East Fifth Street
Cincinnati, Ohio 45202-5109
Common Stock Price and Dividend Data
__________________________________________________________________________________________________
2006
___________________________________________________________________________________________________
2005
Quarter:
High . . . . . . . . . . . . . . . . . . . . . . . . . . . . $
Low . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Period-end close . . . . . . . . . . . . . . . . . .
Cash dividends declared . . . . . . . . . . . .
__________________
1st
45.56
42.07
42.07
0.335
__________________
2nd
$ 47.01
41.43
47.01
0.335
__________________
3rd
$ 48.44
45.93
48.12
0.335
4th
49.07
44.25
45.31
0.335
$
$
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
__________________
__________________
__________________
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 beginning on Page 25, for factors that could cause results to
differ materially from those discussed.
Source: NASDAQ Global Select Market
The common stock prices and dividend data above are adjusted to reflect the 5 percent stock dividend paid April 26, 2005.
Financial Highlights
Cincinnati Financial Corporation and Subsidiaries
(In millions except per share data)
Revenue Highlights
Years ended December 31,
2006
2005
Change %
Revenues
(Dollars in millions)
Revenues
4
1
6
3
,
1
8
1
3
,
3
4
8
2
,
0
5
5
7 4
6
7
3
,
,
Earned premiums . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Investment income, net of expenses . . . . . . . . . . . . . . . . . . . . . . . . .
Total revenues . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
$ 3,278
570
4,550
Income Statement Data
Net income . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Net realized investment gains and losses, after tax . . . . . . . . . . . . .
Net income before realized investment gains and losses* . . . . . . . .
$
$
930
434
496
$ 3,164
526
3,767
$
$
602
40
562
Per Share Data (diluted)
5.30
Net income . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
2.48
Net realized investment gains and losses, after tax . . . . . . . . . . . . .
Net income before realized investment gains and losses* . . . . . . . .
2.82
1.34
Cash dividends declared . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Book value . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
39.38
Weighted average shares outstanding . . . . . . . . . . . . . . . . . . . . . . . . 175,451,341
$
$
$
$
3.40
0.23
3.17
1.21
34.88
177,116,126
$
$
3.6
8.4
20.8
54.5
993.0
(11.8)
55.9
978.3
(11.0)
11.2
12.9
(0.9)
Balance Sheet Data
Total assets . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Shareholders’ equity . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
$ 17,222
6,808
$ 16,003
6,086
7.6
11.9
Ratio Data
Property casualty statutory combined ratio . . . . . . . . . . . . . . . . . . .
Return on equity . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Return on equity based on comprehensive income . . . . . . . . . . . . .
93.9%
14.4
16.4
89.0%
9.8
1.6
* 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.
03
02
04
Realized investment gain from Alltel
common stock sale
06
05
Revenue growth continued in 2006
with growth in pretax investment
income and consolidated property
casualty earned premiums. Revenues
and net income in each year reflect
realized investment gains and losses
including gains from the sale of our
Alltel common stock holdings in 2006.
Net Income/
Dividends Paid
Per common share
(Dollars)
Net income before realized
investment gains and losses (before
one-time item in 2003)*
Net income (before one-time item
in 2003)*
Dividends paid
0
3
.
5
8
2
.
3
4
9
.
2
0
4
.
3
7
1
.
3
2
8
.
2
1.02
1.16
1.31
7
6
.
1
2
3
.
1
6
1
.
2
1
0
.
2
0.80
0.89
03*
06
04
02
Realized investment gain (after tax)
from Alltel common stock sale
05
2006 operating income reflected lower
consolidated property casualty
underwriting profit. Cash dividends paid
to shareholders rose at a 12.1 percent
compound annual rate over the past
five years. In February 2007, the board
increased the indicated annual cash
dividend for the 47th consecutive year.
Book Value
Per common share
(Dollars)
8
3
.
9
3
0
1
.
5
3
0
6
.
5
3
8
8
.
4
3
3
4
.
1
3
02
04
05
03
06
Book value reached a record high of
$39.38 at year-end 2006. The $4.50
increase over 2005 reflected after-tax
appreciation in the equity portfolio and
earnings from operations.
1
To Our Shareholders:
Property Casualty
Net Earned Premiums
(Dollars in millions)
Personal lines
Commercial lines
2,919 3,058 3,164
2,653
8
0
9
1
,
2,391
1
2
7
1
,
6
2
1
,
2
4
5
2
,
2
2
0
4
2
,
0
7
6
5
4
7
3
9
7
4
0
8
2
6
7
02
04
06
03
05
Property casualty net earned
premiums increased 3.5 percent in
2006. On the statutory basis that
facilitates industry comparisons, net
written premiums rose 3.3 percent and
the company continued its track record
of outpacing industry growth, estimated
at 2.6 percent.
For better and for worse, your company
set many records in 2007. Revenues
rose to an all-time high, including
record pretax investment income. Record new
reinsurance premiums that we pay. We also
anticipate a combined ratio in the range of
97 percent to 99 percent, up from 93.9 percent
on a statutory basis in 2006. This target
business premiums boosted total net written
considers a number of factors, including
premiums. Market value appreciation
5.5 percentage points on the combined ratio for
contributed to record book value at
catastrophe losses, just as high as in 2006.
December 31, 2006. We reported our highest
We are not at all discouraged. We believe
ever realized gains on the sale of one large
it’s a great time to be in the insurance business.
equity holding, leading to record net income
Through all markets – for better or for worse –
of $930 million, or $5.30 per share.
we’re going to continue growing ahead of the
Excluding those substantial investment
overall industry, balancing growth and
gains, operating income declined 11.8 percent
profitability by careful underwriting and
to $2.82 per share. Lower underwriting profits
pricing, and identifying new ways to build on
from property casualty insurance, our main
the strengths that give us a competitive edge.
business, reflected record catastrophe losses and
Three commitments differentiate your
record large losses in the $1 million-plus
company, making it possible over time to
Consolidated Assets
(Dollars in millions)
category. In addition, expenses rose more
increase your shareholders’ equity and
rapidly than premiums as we continued
shareholder dividends. We measure our
9
0
5
,
5
1
7
0
1
,
6
1
3
0
0
,
6
1
2
2
2
,
7
1
2
2
1
,
4
1
investing in people and infrastructure, including
achievements, opportunities and initiatives to
technology that makes it easier for independent
tap those opportunities in terms of their ability
agents to do business with our company.
to help us meet those commitments:
We expect this higher level of catastrophe
Strong Agency Relationships
losses and expenses may continue in 2007.
We establish strong relationships with the most
Further, price competition is accelerating in our
professional independent agencies in each
industry, making it harder to achieve premium
growth and underwriting profitability. While the
industry overall was very profitable in 2006,
A.M. Best Co. estimates that total premiums
may be flat in 2007, and the industry
combined ratio may rise 3.5 percentage points
to 96.8 percent.
Our expectations for our own near-term
results consider these trends. We anticipate a
2007 growth rate in the low single digits,
reduced by an increase of $22 million in the
community, supporting them with a team of field
representatives authorized to make decisions at
the local level.
Over the past 10 years, we have selectively
added more than 400 highly professional
agencies. We finished 2006 with 1,289 agency
locations marketing our policies in 32 states,
including 55 new agency appointments over the
course of the year. As part of our plans for
2007, we expect to appoint at least 50 more
agencies. We are working on plans to enter
05
06
02
03
04
Over the past five years, assets grew
at a 4.3 percent compound annual
rate, primarily because of 3.6 percent
compound annual growth in invested
assets.
2
New Mexico and eastern Washington,
appointing our first agencies during 2007.
By the fifth year following an appointment, we
typically earn a prominent position among the
carriers serving that agency, with annual
premiums rising to an average of approximately
$2 million.
Our agency-centered focus led to healthy
commercial lines growth in 2006, with
net written premiums up 6.7 percent and new
business written by our agencies up
14.9 percent to a record $324 million. While
pricing trended down over the year, agents
appreciate the personal attention our field teams
provide to their accounts. Agents gave us plenty
of chances to quote new commercial accounts
and to offer loss control or other value-added
John J. Schiff, Jr., CPCU, chairman and chief executive officer,
and James E. Benoski, vice chairman, president and chief
operating officer
services that made the sale. Additionally, we
homeowner and personal auto policies. With
made commercial renewals easier for
more competitive rates, our agents found it
policyholders and agents, in many cases, by
easier to again sell Cincinnati service and
extending the policy period under the same
value to their preferred clientele. We don’t
terms and conditions. Many policyholders
expect to quickly solve our personal lines
respond positively to such policy extensions,
challenges, but personal lines is moving in the
choosing to keep their coverage with an insurer
right direction. Our pricing is more competitive;
that brings stability to the marketplace, carries
our Web-based processing system is active in
an A++ A.M. Best rating and has high standards
13 states and deploying to several more in
for claims service.
2007; and our product portfolio is expanding
Personal lines net written premiums
with several new or improved coverage
decreased 6.4 percent for the year; however, in
endorsements. Identity Theft Expense and
the second half of the year, retention improved
Advocacy Services Coverage is available now
and new business growth reached 17.6 percent,
in the 25 states where 794 agency locations
rebounding after several quarters of lower
actively market homeowner policies.
new business.
Replacement Cost Auto and Personal Auto Plus
That second half improvement led from our
will be available later this year in the 22 states
July introduction of policy credits that
where we have 772 agency locations actively
incorporate insurance scores into pricing of
marketing personal auto policies.
3
Property Casualty
Statutory Surplus Ratio
Net written premiums to surplus
Estimated industry net written
premiums to surplus (A.M. Best)
1.3
1.2
1
1
.
0
1
.
1.1
1.0
0.9
7
0
.
7
0
.
7
0
.
03
04
02
06
05
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 in the past
three years.
Life Statutory Capital
and Surplus Ratio
(Percent)
Adjusted capital and surplus
to liabilities
Estimated industry adjusted capital
and surplus to liabilities (A.M. Best)
7
.
9
3
2
.
9
3
2
.
0
4
3
.
7
3
8
.
7
3
In Florida, we requested in February 2007
Our three non-property casualty insurance
that our agents hold off on sending us new
subsidiaries also operate primarily to extend the
business of any type due to uncertain market
capabilities of our agents to provide full service
conditions. We are renewing and servicing
to the families and businesses in their
policies already on the books, but prefer to take
communities. In 2006, The Cincinnati Life
a wait-and-see approach until there is more free
Insurance Company focused mainly on term
market competition that supports stable
insurance, introducing a return-of-premium
insurance markets.
product series that was well received by agents.
Over the years, we have increased our
The company’s two financial services
share of business from each of the agencies that
subsidiaries continued to successfully leverage
markets our policies by offering a full line of
our insurance relationships and broaden
coverages that meet the needs of their clients.
our offerings. As of December 31, 2006,
In recent years, they have indicated a desire to
CFC Investment Company, which offers
offer our products and services to commercial
equipment and vehicle leases and loans,
accounts that require the flexibility of excess
reported 2,897 accounts representing
and surplus lines. Generally, excess and surplus
$108 million of contract receivables. CinFin
lines insurance carriers provide insurance that is
Capital Management Company, which
unavailable to businesses in the standard
offers asset management services, reported
market due to market conditions or due to
$960 million under management in 64 accounts.
characteristics of the insured risk that are
Together, the CFC Investment and CinFin
caused by nature, the insured’s history or the
Capital Management Companies contributed
nature of their business.
2 cents to 2006 earnings.
We have studied the option of putting some
Superior Claims Service
of our capital to work by starting a new
Prompt, fair claims service with a human touch
company for this purpose, and we believe it can
proves the value of our insurance programs and
10.0
10.5
10.7
10.6
10.7
contribute to our long-term objectives. We have
validates the agent’s decision to make us the
05
02
03
06
04
The ratio of statutory adjusted capital
and surplus to liabilities for Cincinnati
Life remained at more than three times
the estimated industry average in
2006. The higher the ratio, the stronger
a life insurer’s security for
policyholders and its capacity to
support business growth.
started the process of incorporating a new
subsidiary, determining its structure and
forming a team to research and develop
appropriate policy terms and conditions, rates
and underwriting guidelines. While we don’t
anticipate premiums from excess and surplus
lines this year, we do expect our increased
ability to compete for additional commercial
accounts to contribute to long-term growth.
carrier of choice for value-oriented clients.
Again in 2006, policyholders had ample
opportunities to benefit from the Cincinnati
relationship. Severe weather in 2006, mainly
across the Midwest, contributed to $175 million
of catastrophe losses. As a result, policyholders
reported approximately 13,000 claims through
February 28, 2007. Our field claims
representatives have closed 95 percent of the
claims, their prompt responses and personal
4
approach reflecting positively on our agents.
continued growth in the range of 6.5 percent
Our claims management system and new
to 7.0 percent.
tools, such as tablet computers, add speed and
Our equity investments also drive the
efficiency to all of our claims processes, and that
company’s long-term net worth, financial
was especially beneficial in these catastrophe
flexibility and stability. Your shareholders’
situations. We focus in the following pages of
equity rose to an all-time high of $6.808 billion,
this report on our claims operation, catastrophe
or $39.38 per share, at the end of 2006, an
response and claims technology. Here, we will
increase of 12.9 percent on a per share basis.
simply note that the promotion in May of our
While the sale of our Alltel Corporation
senior claims officer, Jim Benoski, to president
common stock holdings early in the year
and chief operating officer of Cincinnati
accounted for a large portion of the increase in
Financial and president and chief executive
2006 net income, it was not a factor in the
officer of The Cincinnati Insurance Company
increase in book value. That increase was
speaks a thousand words about the centrality of
attributable to the contribution of insurance
our claims operation to our business structure
operations and investment income, along with
and strategy.
significant appreciation over the course of the
Also in May, Chief Financial Officer Ken
year in the rest of the equity portfolio.
Stecher was named executive vice president of
The equity portfolio supports the
Cincinnati Financial and The Cincinnati
accumulation over time of unrealized gains that
Insurance Company, and chairman of the latter.
build book value for shareholders. This cushion
Ken’s leadership extends beyond his areas of
of financial strength and flexibility also
responsibility, influencing our company’s
benefits agents and policyholders, supporting a
success as he continues to capably oversee the
long-term perspective that leads us to behave
continuous improvement of our financial data,
consistently in the marketplace; make prompt,
transparency and estimates, including reserves
fair claims payments; set adequate reserves; and
for not yet paid claims.
continue investing in the infrastructure for
Successful Total Return Investing
We use available cash flow to cover
growth. Our insurance strategies and investment
strategies are a good match, and we believe
current insurance liabilities by purchasing
their combined results will continue bringing
fixed-maturity securities, then purchase equity
you value in 2007.
securities with the potential to bring us
increasing dividend income and long-term
appreciation.
Our buy-and-hold equity investing
strategy led to another year of record pretax
net investment income, up 8.4 percent to
$570 million. Our outlook for 2007 is for
During 2006, three independent ratings
organizations affirmed our high financial
strength ratings. A.M. Best awards our property
casualty companies its highest rating,
A++ (Superior), assigned to fewer than
2 percent of insurers. Fitch Ratings awards the
5
Consolidated Pretax
Investment Income
Less expenses
(Dollars in millions)
0
7
6 5
2
5
5
4
4
5
6
4
2
9
4
02
03
04
05
06
Consolidated pretax investment
income rose 8.4 percent in 2006.
Common stocks in the portfolio
announced dividend increases during
2006 that should add $16 million to
investment income in 2007.
AA (Very Strong) rating to all of our insurance
The board determined that 10 of the current
companies. Standard & Poor’s assigns the
15 members meet the applicable criteria
AA- (Very Strong) rating to the insurance
for independence.
companies, and revised its outlook to stable
Early in 2007, the board formalized several
from negative in July. Moody’s Investors
current company practices with updates to the
Service maintains an excellent Aa3 rating on
corporate governance guidelines on board
the property casualty insurance companies.
membership criteria, director elections and
Working for You
We look beyond 2006 and 2007 with
confidence. We remain committed to providing
a stable market for our agents’ high-quality
business, underwriting this business carefully
and producing steady value for our
shareholders, as represented by the board of
directors’ recent decision to increase our
2007 indicated annual dividend by 6 percent,
stock ownership guidelines for directors and
officers. Your company’s management and
directors purposefully align business decisions
with our mission, which includes fulfilling the
company’s obligations to independent agents,
policyholders and shareholders as well as
associates, suppliers and communities we serve.
We are working diligently to act with integrity
and to assure we will meet those obligations far
which would mark the 47th consecutive year
into the future.
Respectfully,
John J . Schiff, Jr., CPCU James E. Benoski
Chairman
Chief Executive Officer
Vice Chairman
President
Chief Operating Officer
Chief Insurance Officer
March 1, 2007
of increase in that measure. Their action
reflected our belief that we can achieve
above-industry-average growth in written
premiums and industry-leading profitability
over the long term by building on our proven
strategies: strong agency relationships
supported by local decision making; superior
claims service including solid reserves; and
total return investing that drives financial
strength.
The board also announced director
transitions in 2006. Michael Brown and
John M. Shepherd, current directors, will not
stand for re-election on May 5, 2007, due to
the company’s guidelines on director age.
Gregory T. Bier, CPA (Ret.), appointed by the
board in November, will stand for election at
the annual shareholders’ meeting this spring.
6
Condensed Balance Sheets and Income Statements
Cincinnati Financial Corporation and Subsidiaries
(Dollars in millions)
Assets
At December 31,
2006
2005
Investments . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Cash and cash equivalents . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
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 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Treasury stock . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Total shareholders’ equity . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Total liabilities and shareholders’ equity . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
$ 13,759
202
1,128
683
1,450
_________
$ 17,222
_________
_________
$
5,305
1,579
1,653
371
28
392
1,086
_________
10,414
_________
1,406
2,786
3,379
(763)
_________
6,808
_________
$ 17,222
_________
_________
$ 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
_________
_________
(Dollars in millions except per share data)
Revenues
2006
Years ended December 31,
2005
2004
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 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
$
3,278
570
684
18
_________
4,550
_________
2,128
630
463
_________
3,221
_________
Income Before Income Taxes . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
1,329
Provision for Income Taxes . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Net Income . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
399
_________
$
930
_________
_________
Per Common Share
Net income–basic . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Net income–diluted . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
$
$
5.36
5.30
$
3,164
526
61
16
_________
3,767
_________
1,911
627
406
_________
2,944
_________
823
221
_________
$
602
_________
_________
$
$
3.44
3.40
$
3,020
492
91
11
_________
3,614
_________
1,846
615
353
_________
2,814
_________
800
216
_________
$
584
_________
_________
$
$
3.30
3.28
2006: The company sold its holdings in Alltel common stock. The sale contributed $647 million (pretax) to realized investment gains and
revenues and $412 million (after tax), or $2.35 per share, to net income.
7
Six-year Summary Financial Information
Cincinnati Financial Corporation and Subsidiaries
(Dollars in millions except per share data)
2006
2005
2004
2003
2002
2001
Years ended December 31,
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
$
$
$
$
$
$
930
–
930
434
496
1,057
5.30
–
5.30
2.48
2.82
1.34
39.38
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* . .
6.8%
11.0
14.4
16.4
$
$
$
$
$
$
602
–
602
40
562
99
3.40
–
3.40
0.23
3.17
1.21
34.88
7.0%
11.5
9.8
1.6
$
$
$
$
$
$
584
–
584
60
524
287
3.28
–
3.28
0.34
2.94
1.04
35.60
7.2%
11.2
9.4
4.6
$
$
$
$
$
$
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
$
$
$
$
$
$
193
–
193
(17)
210
150
1.07
–
1.07
(0.10)
1.17
0.76
33.62
7.5%
8.9
6.0
13.5
7.9%
9.7
4.1
(4.0)
8.1%
9.2
3.2
2.5
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 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
$ 3,178
3,172
3,164
$ 3,076
3,097
3,058
$ 2,997
3,026
2,919
$ 2,815
2,789
2,653
$ 2,613
2,496
2,391
$ 2,590
2,188
2,073
51.9%
11.6
30.4
93.9%
93.9%
49.2%
10.0
29.8
89.0%
89.0%
49.8%
10.3
29.3
89.4%
89.4%
56.1%
11.6
26.5
94.2%
95.0%
61.5%
11.4
25.5
98.4%
99.6%
66.8%
10.1
22.6
99.5%
103.6%
$ 4,723
$ 4,194
$ 4,191
$ 2,783
$ 2,340
$ 2,533
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)* . . . . . . . . . . . . . . . . . . . . . . . . . . . .
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)* . . . . . . . . . . . . . . . . . . . . . . . . . . . .
$ 2,442
2,435
2,402
$ 2,290
2,306
2,254
$ 2,186
2,209
2,126
$ 2,031
2,009
1,908
$ 1,905
1,795
1,721
$ 1,827
1,551
1,453
48.4%
12.7
29.7
90.8%
90.8%
736
737
762
62.9%
8.3
32.4
103.6%
103.6%
$
46.6%
11.0
29.5
87.1%
87.1%
786
791
804
56.7%
7.2
30.4
94.3%
94.3%
$
43.4%
10.9
29.4
83.7%
83.7%
811
817
793
66.7%
8.9
29.0
104.6%
104.6%
$
51.2%
12.7
27.0
90.9%
91.6%
784
780
745
68.8%
8.9
25.2
102.9%
103.9%
$
57.8%
12.5
25.0
95.3%
96.8%
708
701
670
71.0%
8.7
26.8
106.5%
106.8%
$
62.6%
11.8
22.3
96.7%
100.7%
763
637
620
76.7%
6.2
23.0
105.9%
110.4%
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 . . . . . . . . . . . . . . .
$
161
(1)
28
56,971
2,026
$
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
$
102
21
15
27,534
1,329
556
67
511
52
491
47
443
50
420
47
457
44
* 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
Financial Performance Overview
This is a brief overview of 2006 financial results. We encourage you to read the
Management’s Discussion and Analysis in our Annual Report on Form 10-K, Page 31, for
additional details.
Insurance results for the year were mixed. In the face of growing competition, our local
independent agents brought us the highest level of new business and property casualty
insurance premiums in our history. Underwriting profits were $181 million, tempered by
higher catastrophe losses, increased loss severity and less savings from favorable
development of prior period losses as well as higher underwriting expenses.
Investment results were the highlight of the year. Our equity-focused investment
strategy led to another record-setting year for investment income and book value.
Property Casualty Insurance Operations
prior period losses compared with the unusually
Value-oriented policyholders continued in
high level of the past few years.
2006 to respond favorably to their local
Other highlights of 2006 performance
independent agents’ presentation of Cincinnati’s
included:
advantages. In the second half of the year,
(cid:129) 3.3 percent increase in property casualty net
agents and personal lines policyholders
written premiums, ahead of the estimated
responded to new pricing for Cincinnati’s
industry average growth rate of 2.6 percent.
personal lines products, leading to higher
(cid:129) 93.9 percent statutory property casualty
customer retention rates and rising new
combined ratio, slightly above the estimated
business.
industry average of 93.3 percent. Our
Offsetting those favorable growth trends,
combined ratio included 5.5 percentage
nine catastrophe events, primarily storms
points due to catastrophe losses compared
Premium Mix
Percent of 2006 consolidated
net earned premiums
(Percent)
Life
4%
Personal
lines
23%
Commercial lines
73%
Property Casualty
Net Written
Premium Growth
Statutory
(Percent)
The Cincinnati Insurance Companies
Estimated industry (A.M. Best)
14.0
15.1
11.7
9.6
6.5
4.4
2.6
-0.2
affecting our policyholders in the Midwest, led
with 1.7 percentage points estimated for
02*
03*
04
05
to a record level of catastrophe losses. Loss
the industry.
severity crept upward. And expenses rose more
(cid:129) A net increase of 37 reporting agency
rapidly than premiums as we made ongoing
locations. At year-end 2006, we had 1,066
investments in our people and our
agency relationships with 1,289 reporting
infrastructure, including technology and
locations marketing our insurance products.
systems to make it easier for agents to do
(cid:129) Full-year 2006 net savings from favorable
business with our company.
development improved the combined ratio
As anticipated, this year’s earnings
by 3.7 percentage points. In 2005, savings
reflected the adoption of stock option expensing
improved the ratio by 5.2 percentage points.
and less savings from favorable development on
* 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.
3.3
2.6
06
9
Commercial Lines Insurance Highlights
states representing 44 percent of BOP and
(cid:129) 6.7 percent growth in commercial lines net
DBOP premiums.
Property Casualty
Combined Ratio
Statutory
(Percent)
The Cincinnati Insurance Companies
Estimated industry (A.M. Best)
107.3
100.2 98.5
100.8
93.3
.
6
9
9
.
0
5
9
.
4
9
8
.
0
9
8
.
9
3
9
written premiums. Business policyholders
are continuing to respond favorably to their
local independent agents’ presentation of the
Cincinnati value proposition – customized,
multi-year coverage packages, superior
claims service, our A++ rating from
A.M. Best Co. and a local field force.
(cid:129) 14.9 percent increase in new commercial
lines business to a record $324 million. As
02*
03*
04
05
06
competition continues in our regional
markets, we believe we can sustain healthy
growth by outworking the competition. For
Cincinnati, that means maintaining strong
relationships with our established agencies,
writing a significant portion of each agency’s
business, giving outstanding claims service
to their clients and attracting new agencies.
(cid:129) $208 million commercial lines GAAP
underwriting profit, reflecting 90.8 percent
full-year statutory commercial lines
combined ratio. The ratio rose 3.7 percentage
points on softer pricing, increasing loss
severity, less savings from favorable
development on prior-period reserves and
adoption of stock option expensing.
(cid:129) Growth for the commercial lines portion of
the insurance industry was estimated at
1.0 percent in 2006, with a statutory
combined ratio of 94.3 percent.
(cid:129) 2007 plans include integration with agency
management systems for WinCPP®, the
company’s online, real-time commercial
lines rate quoting system used by all
agencies. Plans also include roll-out of
Businessowner and Dentist’s Package Policy
capabilities in 12 additional states for
e-CLAS®, the company’s Web-based policy
processing system currently used in seven
Personal Lines Insurance Operations
(cid:129) 6.4 percent decrease in personal lines net
written premiums, in part due to reduced
pricing effective July 2006. With pricing
reduced to better compete in the current
market, agents had more opportunity to sell
service and value.
(cid:129) 17.6 percent increase in new personal lines
business written directly by agencies for the
second half of 2006, following the mid-2006
pricing changes. Second-half new business
growth offset the decline in the first half of
2006, leading to 1.6 percent full-year new
business growth.
(cid:129) 103.6 percent 2006 statutory combined ratio.
The 9.3 percentage-point increase reflected a
5.0 percentage point rise in the catastrophe
loss ratio. Other factors were lower earned
premiums, less savings from favorable
development on prior period reserves, a
third-quarter 2006 increase in loss severity
and higher expenses.
(cid:129) Growth for the personal lines portion of
the insurance industry was estimated at
2.0 percent in 2006, with an estimated
combined ratio of 92.0 percent.
(cid:129) 82 percent of agencies writing personal lines
policies now use Diamond, the company’s
personal lines policy processing system.
Approximately 90 percent of total 2006
personal lines earned premium volume was
written in the 13 active Diamond states.
Agents in Pennsylvania and Virginia began
using Diamond early this year, with
additional states planned for later in 2007.
* 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
Cincinnati Life —
Gross Life Policy Face
Amounts In Force
Excluding annuities, accident
and health business
(Dollars in millions)
1
7
9
6
5
,
3
9
4
1
5
,
1
2
9
4
4
,
2
9
4
8
3
,
6
8
4
2
3
,
02
03
04
05
06
Life Insurance Operations
decreased to $30 million in 2006 from
The Cincinnati Life Insurance Company
$88 million in 2005.
contributed 19 cents to our company’s
2006 operating earnings. Overall, the life
(cid:129) 27.2 percent rise in 2006 term life insurance
net written premiums reflecting competitive
operation continues to provide a consistent
advantages of providing competitive,
income stream for our agents and the company,
up-to-date products, close personal attention
helping to offset some of the inevitable
fluctuations in property casualty results.
and policies backed by financial strength
and stability.
(cid:129) $161 million in 2006 total life insurance
(cid:129) $19 million increase in full-year 2006
operations net written premiums, compared
benefits and expenses, principally due to
with $205 million in 2005. Written
premiums for life insurance operations
reserve and mortality expense increases
associated with growth and aging of life
include life insurance, annuity and accident
insurance in force. Mortality experience
and health premiums. Since late 2005, the
company has de-emphasized annuities
because of an unfavorable interest rate
remained within pricing guidelines.
Adoption of stock option expensing
contributed approximately $1 million to
environment. Written annuity premiums
operating expenses.
Investment Operations
(cid:129) $684 million in full-year 2006 net realized
Our buy-and-hold equity investing strategy
investment gains (pretax), including
is key to the company’s long-term growth and
$647 million from the first-quarter sale
stability. In 2007, we anticipate allocating a
of the company’s holdings of Alltel
higher proportion of cash available for
common stock.
investment to equity securities. We continue to
(cid:129) 2.6 million shares repurchased in 2006,
identify companies with the potential for
under the board’s current authorization,
revenue, earnings and dividend growth, a strong
at a total cost of $118 million.
management team and favorable outlook. These
(cid:129) Book value of $39.38 at year-end 2006, up
equities offer a steadily increasing flow of
dividend income along with the potential for
capital appreciation. Highlights of 2006
investment operations included:
(cid:129) 8.4 percent increase in pretax net investment
income. This growth reflected new
$4.50 from year-end 2005
level. Invested assets rose
because of new investments
and appreciation in the equity
portfolio. Our equity holdings
outperformed the Standard &
investments, higher interest income from the
Poor’s 500 Index in 2006,
growing fixed-maturity portfolio and
returning 16.1 percent. While
increased dividend income from the common
we fell below that benchmark
stock portfolio.
(cid:129) $16 million annually in additional
investment income expected during 2007
from dividend increases announced during
2006 by Fifth Third Bancorp and another
for the five-year period that
just ended, total return on the
equity portfolio also surpassed
the return on the Index over
the 10- and 15-year periods
37 of the 50 common stock holdings in the
that better measure our success
equity portfolio.
as a buy-and-hold investor.
Consolidated Investment Portfolio
As of December 31, 2006
(Dollars in millions)
Book Value
Market (Fair) Value
13,699
8,455
(In millions)
Book Value Market (Fair)
Taxable fixed maturity
Tax-exempt fixed maturity
Common equity
Preferred equity
Short-term
Total
$ 3,357
2,382
2,400
221
95
$ 8,455
Value
$ 3,389
2,416
7,564
235
95
$13,699
11
Cincinnati has no cute
no celebrity pitchmen to
mascot, no clever slogan,
get our name in front of consumers.
Instead, our actions speak for us,
creating satisfied agents and
Field Authority Drives the
Claims Response Process
Cincinnati’s person-to-person approach
policyholders who spread the word
shapes every stage of our claims
about our responsive claims service.
response, heightening accountability and
Our organizational structure and
methods grow out of our approach to
creating satisfied agency clients.
Notification. Policyholders report claims to
the same local agency that sold their policy.
claims, which centers on the
The agency has authority to quickly pay
independent agency system. We sell
most covered claims up to $2,500.
policies exclusively through the
1,066 agencies that are our customers.
The agency sends a notice of loss
electronically to our automated
system, which forwards it to the
We believe our company can prosper
agency’s assigned field claims
over the long term only when each of
these appointed agencies succeeds.
representative who verifies
appropriate coverage is in force.
Contact. Within 24 hours of
Outstanding claims service to their
receiving the notice, a local field claims
clients builds our agents’ good
representative typically makes contact
reputations and increases our chances
to write their best accounts. Superior
with the policyholder or claimant and
inspects the damage. The field claims
representative often recommends or takes
service sells insurance.
steps to increase safety or reduce the
Accordingly, we dedicate almost a
policyholder’s risk of further damage or disruption.
fourth of our 4,048 associates to
claims functions at our Cincinnati
Fact-finding. The field claims representative works
with the policyholder or claimant to document the facts
of the case, including coverage liability, damage and valuation.
headquarters and across 32 states.
Policyholders select their own repair shops and vendors, and the field
That includes a field force of
approximately 732 field claims
claims representative verifies that estimates are reasonable. The field
claims representative has authority to settle the claim on the spot and is
fully equipped to issue a settlement check during the first visit with a
representatives and managers. Their
policyholder or claimant.
job is delivering on the promises our
continued on page 14
12
Loss Control
While we’re in the business
of helping people recover
financially after a loss, we find
it’s better to prevent losses from
ever happening. Loss control
introduces safety measures for
businesses that protect lives
and reduce disruption to
families and workplaces.
Our agents appreciate local
loss control representatives at
their service for sales
presentations, renewal
meetings and sound advice.
Agents and policyholders alike
can turn to loss control for
help in reducing workers’
compensation losses, fire
losses and other losses
Wrap-up. The field claims
representative sends estimates,
photos, statements and other
documentation electronically
to our system, where it is
immediately available for
review by managers who
assist with losses over
$35,000. This claims data
flows to financial and
reporting systems. The field
claims representative may
submit a risk review to the
underwriting department,
request loss control services
stemming from safety issues.
or refer new business
prospects to the agency.
Headquarters managers may
send satisfaction surveys.
Loss control helps keep
claims low, which can reduce
costs for our company, the
agency and the policyholder.
“The claims setting is
our best opportunity to
show policyholders that
their local agents and
Cincinnati act with their
best interests in mind.”
—Jim Benoski, vice chairman,
president, chief operating officer
and chief insurance officer
Help Always
at Hand
In 2006, Cincinnati’s field claims
representatives cut the last cord to their
offices with new tablet personal
computers. Outfitted with wireless
cards, the tablets allow representatives to
carry their offices with them.
This mobility allows associates to handle multiple claims, complete documentation, print
checks and even add to the electronic file that other authorized reviewers can access. Our agile
and responsive claims operation is at the core of policyholder satisfaction. See the Consumer
Information Source at www.naic.org for Cincinnati’s low complaint ratios.
13
agents made, generating the best
advertising money can buy.
We approach claims differently
than the typical insurance company.
Superior Service Sells Insurance
First, Cincinnati field claims
We hear it over and over from agents,
representatives are assigned to specific
agencies, not to types of claims. When
policyholders and claimants: Prompt and
personal field claims service exceeded
expectations, not only settling a claim, but
agents sell our policies, they likely
winning a customer, selling an insurance
already know who will respond to
policy or securing a renewal.
future claims. Their Cincinnati field
claims representatives don’t work
You don’t know what your insurance
premium dollar is worth until you file
a claim. It’s worth everything when
from regional offices; they work from
you can repair your hail-damaged
their homes right in the community.
They respond to emergencies day or
roof and get your family back in
your home, when you can quickly
regain the use of your company’s
night and have the local knowledge to
delivery van after an accident, or
quickly assess and resolve claims.
when a valued customer injured on
Second, most of our field claims
representatives are true multi-line
your property receives prompt
payment of medical bills.
Service sets us apart, attracting
professionals, authorized to address
our agents’ value-oriented clients.
most claims whether on property or
It is the reason commercial
casualty, personal lines or commercial
policyholders ask agents to place their
personal policies with us and
lines policies. This difference
generations of families and businesses
leverages their local knowledge. It
means agents and policyholders can
expect the consistency and comfort of
“Whenever our service exceeds expectations, we’re going
a known relationship. The same high
to sell a policy – to a neighbor, friend, the insured by way
standards apply to claims involving a
of renewal, or through the agency by way of satisfaction
fender bender in the family car, an
and reputation.”
injury at the office or a fire at a
—Bud Stoneburner, CPCU, vice president and manager of field claims
continued on page 16
14
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 balance sheets; and manage their agencies
Cincinnati Market Share
Within Reporting
Agency Location
Based on 2005 Direct
Written Premiums
(Percent)
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 75 percent of
the reporting agency locations that we have served for
more than five years. There is tremendous potential in the
239 reporting agency locations that have marketed our
products for less than five years, even as we continue to
grow with the 1,050 more established reporting locations.
22.4
9.9
4.3
1.2
Less
than
1 year
1 to 5
years
5 to
10
years
10 or
more
years
stay with us. Satisfied policyholders are the
reason our policy retention rate is high in both
personal lines and commercial lines.
Our field claims representatives watch for
ways to assist the Cincinnati underwriting and
sales teams by helping to review renewal
business or submitting risk reports. They go
along when agents present coverage proposals,
giving potential policyholders a chance to shake
hands with the person who might someday look
them in the eye and say, “I’m here to help you.
Let’s get started.”
Storm Teams
The field claims representatives who respond to
weather catastrophes are volunteers on temporary
assignment from their home territories. Our own
experienced associates know our policy coverages and
service standards,
seamlessly providing
prompt, accurate
claims service.
Storm teams
mobilize on short
notice whenever large
numbers of losses
occur in a concentrated
area – sometimes deploying to a
staging area even before the bad
weather hits.
In addition to the help our
storm team quickly provides “on
the ground,” headquarters and
other field claims associates may
assist in prioritizing claims
through our electronic system,
initiating contact, advising
emergency measures and allowing smooth transitions as storm
teams rotate after two weeks.
15
manufacturing plant. Even when
complex or unusual claims require
specialists for support, the agency’s
assigned field claims representative
People Come First
remains the contact person.
We make all of our technology investments with people in
Third, Cincinnati field claims
mind. Our business is helping people recover financially
after insured losses, working to preserve their dignity in
representatives are trained to look for
the process.
coverage, paying what is due under
In the field, tools such as tablet PCs, digital cameras and
the policy. Our business is paying
covered claims. This approach
mobile printers allow field claims representatives to quickly
document and process the claim. They can write estimates
and print checks on the spot using software that
supports the long-term relationships
streamlines property claim estimates. What better way to
with agents and policyholders that
exceed policyholder expectations than to inspect the loss
lead to sustainable growth and
profitability.
and present the check in the same meeting?
At headquarters, claims supervisors have immediate
access to information through the claims management
Our field claims representatives
system, allowing them to manage large loss files and
take action both to pay covered claims
litigation, as well as review reserves set aside to pay each
and to reduce risk for the policyholder
and our company. Based on first-hand
claim. The system enables efficient file management,
accurate financial reporting and check authentication to
prevent fraud, keeping costs down both for the company and
observations made during the claim
for policyholders.
process, they may bring in our loss
control services to consult on safety
measures or write a risk report,
providing information that supports
proper underwriting and pricing at the
next renewal. They may refer
claimants or policyholders who need
an evaluation of their insurance needs
Product growth
Cincinnati is a regional carrier, serving local
markets and working with our agents account
by account. This approach has made us the
23rd largest insurance carrier based on net
premiums written. In selected product lines,
it has made us an even more significant
player. We rank nationally as one of the top
20 carriers for commercial property,
commercial auto and commercial casualty
to an agent. This experience makes
insurance. We achieve those ranks even
them the best candidates when we
continued on page 18
16
though our market share in those product
lines is less than 3 percent, showing the
potential that remains as we continue to
meet agents’ needs.
Cincinnati's Highest
Volume Lines
National Market Share and
Rank Based on 2005 Direct
Written Premiums
(Percent)
1.8
#15
1.5
1.3
0.6
#18
#15
#29
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“We compete by excelling
at agency relationships,
claims service and total
return investing.”
—Jack Schiff, Jr., CPCU, chairman
and chief executive officer
Managing Risk
Field claims representatives do
more than work with policyholders
to resolve claims. They directly
observe and often prepare risks
reports on the quality of the risks
we insure. Their assessments help
determine appropriate support or
actions by other business areas that
manage our policyholder and
agency relationships. Information
they provide also contributes to our
understanding of the diversity of our
book of business and concentrations
of risk within that book.
Whether evaluating our exposure
to risk from a single policy or from
overall business operations, our
approach recognizes the correlation
and interdependence of risks
across our entire company. At the
department level, various
associates have primary
responsibility for addressing
specific risk types and
communicating risks that may affect
other departments; at the enterprise
level, a senior officer, leads a cross-
departmental team that is building a
formal framework to identify,
aggregate, measure and manage
risks across our organization.
17
Special Investigations Unit
Cincinnati has its own staff of more than two dozen specialists who investigate potential
fraud. These claims professionals and former police officers cooperate with law enforcement
agencies who investigate and prosecute criminal
activity such as arson, theft or false injury claims.
Through its computer forensic lab, SIU uses
sophisticated software and data recovery techniques
to help restore a policyholder’s valuable business
records and save time lost to business interruption.
Their proprietary techniques often reclaim
irreplaceable information, even from equipment that
seems hopelessly charred, such as the computer
shown at left.
Reserves Help Us Honor
Obligations
need to recruit for headquarters claims
management positions.
The capstone of our claims
philosophy is our commitment to
maintain the financial strength that
backs our policies. Our ability to meet
policyholder obligations is evidenced
After evaluating a reported claim,
a field claims representative quickly
by strong ratings, including an A++
estimates the potential loss amount
from A.M. Best Co., its highest rating
– establishing a case reserve. Routed
awarded to less than 2 percent of
insurers.
through our automated claims
system, headquarters claims
representatives at various levels
The fiscal integrity of our claims
review and approve initial case
operations contributes to the
reserve amounts greater than
$35,000 and revisit case reserves at
company’s overall financial strength
90-day intervals.
as well. In paying covered claims
Some losses are not known to the
Information Flow
(cid:129) Workflow
(cid:129) Reports to agencies
(cid:129) Diaries
(cid:129) Financial data
(cid:129) External reporting
quickly and efficiently, we help
claimants recover while minimizing
administrative expenses. In working to
policyholder nor reported as claims
to the company for months, or even
years, after they occur. For example, you may not be aware that your roof
was damaged in a storm until the following spring. We take seriously our
identify and deter fraud, we keep such
obligation to pay those claims in our usual prompt and personal fashion,
costs from inflating policyholders’
whenever they are reported to us.
premiums. In recovering costs through
Our actuarial staff estimates quarterly the total cost of claims that
statistically could have occurred, with particularly detailed reviews
subrogation and salvage activities, we
occurring at the ends of the third and fourth quarters. These analyses form
further protect the interests of
the bases for the monthly reserves we carry. Taken as an expense, the
policyholders and the company. We
seek to set reserves that are sufficient
actuarial estimate encompasses both case reserves for already reported
claims and reserves for paying not yet reported claims. Shareholders
benefit as we set aside loss reserves in an amount adequate to maximize
and fair, proven over time to represent
future predictability, regardless of the timing of claims payments.
our future obligations to policyholders
Our reserving practices have distinguished our company. In each of the
for their past losses.
18
past 15 years, our actuaries’ detailed review has shown our prudence in
establishing estimates of amounts needed for future claims due to
past losses. Our sound practices have led to savings from favorable
development on prior period reserves in each of those years.
File Management Support
(cid:129) Paperless files
(cid:129) Anywhere
communication
(cid:129) Digital file
documentation
(cid:129) Catastrophe response
(cid:129) Privacy and security
safeguards
Field Claims
Representative
Human Expertise
(cid:129) Senior management support
(cid:129) Coverage experts
(cid:129) Local field team
(cid:129) Help Desk
support
(cid:129) Service
consultants
Education, Experience, Ethics
Our field claims representative training is
or more. After getting some field experience,
tailored to the needs and strengths of each
the trainees return to headquarters for
student. Rigorous classroom work combines
advanced classes.
with personal mentorship to lay a foundation
Experienced field claims representatives
of knowledge, commitment and integrity.
new to Cincinnati might start in a territory
The process takes at least three years for
with a mentor, then take the intermediate
trainees who have no prior claims
classroom training series. Through it all, we
experience. They study general insurance
work to build the professional skills of the
subjects, investigative techniques,
individual, conducting training the way we
interpersonal skills and company culture.
conduct our business, without cookie
Online courses supplement group sessions,
cutters. Rather, we invest in the person, and
and trainees have a mentor for six months
it pays off.
Room to grow
Meeting the needs of our independent
insurance agencies allows us to grow
more rapidly than the overall industry.
Substantial potential remains in our
32 active states. In 26 states, our market
share is less than 1 percent. To tap this
potential, we have accelerated efforts to
appoint new agencies. In 2005 and 2006,
we added 112 agency relationships. We
anticipate 50 new agency appointments in
2007, and potentially our first
appointments in New Mexico and eastern
Washington. We plan to enter those
states as we usually do – focusing on
commercial lines and later evaluating
personal lines options.
Cincinnati Market Share by State
Based on 2005 Direct Written Premiums
(Percent)
Above 5%
1% to 5%
Less than 1%
Inactive states
Future active states
announced in 2007
Headquarters (no branches)
19
Cincinnati Financial Corporation
Officers and Directors
(as of March 1, 2007)
Directors
William F. Bahl, CFA, CIC
Chairman
Bahl & Gaynor Investment Counsel, Inc.
Director since 1995 (1)(3)(4)(5*)
James E. Benoski
Vice Chairman, President, Chief Operating
Officer and Chief Insurance Officer
Cincinnati Financial Corporation
Director since 2000 (3)(4)
Gregory T. Bier, CPA (Ret.)
Managing Partner (Ret.), Cincinnati Office
Deloitte & Touche LLP
Director since 2006 (1)(4)
Michael Brown
President
Cincinnati Bengals, Inc.
Director since 1980 (3)
Dirk J. Debbink
President
MSI General Corporation
(design/build/construction)
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
Former Vice President - Finance & Accounting
Global Operations
Procter & Gamble
Director since 2002 (1)(2)
John J. Schiff, Jr., CPCU
Chairman and Chief Executive Officer
Cincinnati Financial Corporation
Director since 1968 (3*)(4*)
Officers
John J. Schiff, Jr., CPCU
Chairman and Chief Executive Officer
James E. Benoski
Vice Chairman, President, Chief Operating
Officer and Chief Insurance Officer
Kenneth W. Stecher
Chief Financial Officer, Executive Vice
President, Secretary and Treasurer
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.
(food distribution)
Director since 2004 (1)
John F. Steele, Jr.
Chairman and Chief Executive Officer
Hilltop Basic Resources, Inc.
(aggregates/concrete supplier)
Director since 2005 (1)
Larry R. Webb, CPCU
President
Webb Insurance Agency, Inc.
Director since 1979 (3)
E. Anthony Woods
Chairman
Deaconess Associations, Inc.
(health care)
Director since 1998 (2)(4)
(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
* Committee Chair
Kenneth S. Miller, CLU, ChFC
Chief Investment Officer, Senior Vice
President, Assistant Secretary and Assistant
Treasurer
Eric N. Mathews, CPCU, AIAF
Vice President, Assistant Secretary and
Assistant Treasurer
Directors Emeriti
Vincent H. Beckman
Robert J. Driehaus
John E. Field, CPCU
Jackson H. Randolph
Lawrence H. Rogers II
John Sawyer
20
Robert C. Schiff
Frank J. Schultheis
David B. Sharrock
Thomas J. Smart
Alan R. Weiler, CPCU
William H. Zimmer
W.F. Bahl
J.E. Benoski
G.T. Bier
D.J. Debbink
K.C. Lichtendahl
W.R. McMullen
G.W. Price
J.J. Schiff, Jr.
T.R. Schiff
D.S. Skidmore
J. F. Steele, Jr.
L.R. Webb
E.A. Woods
J.M. Shepherd
M. Brown
Michael Brown and John Shepherd are not
standing for re-election in May 2007. Mr. Brown
has been a director since 1980, participating in
activities of the compensation, executive and
nominating committees. Mr. Shepherd has served
on our board for six years, participating in
activities of the audit, executive and nominating
committees. Your company has benefited from
their perspectives as business owners with wide
responsibilities to others, sharing much in
common with the independent businesses
operated by our agencies and the businesses we
typically insure. We thank Mr. Brown and
Mr. Shepherd, as we also thank our shareholders
who elected them.
Subsidiary Officers and Directors
As of March 1, 2007, listed alphabetically
The Cincinnati Insurance Company (CIC)
The Cincinnati Indemnity Company (CID)
Executive Officers
James E. Benoski
CIC, CID, CCC Vice Chairman, Chief Executive Officer
and Chief Insurance Officer
CIC, CID President
CLIC Chief Executive Officer and Chief Insurance Officer
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
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, ARe
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, CCC, CLIC Chairman of the Executive
Committee; Director
CFC-I Director
Joan O. Shevchik, CPCU, CLU
CIC, CID, CCC Senior Vice President –
Corporate Communications
Kenneth W. Stecher
CIC, CID, CCC, CLIC Chairman, Chief Financial Officer,
Executive Vice President and Secretary
CFC-I Chief Financial Officer and 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
CIC, CID, CCC, CLIC, CCM Vice President –
Investments
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
Mark R. DesJardins, CPCU, AIM, AIC, ARP
CIC, CID, CCC Vice President – Education & Training
W. Dane Donham, AIM
CIC, CID, CCC Vice President – Commercial Lines
The Cincinnati Casualty Company (CCC)
The Cincinnati Life Insurance Company (CLIC)
CFC Investment Company (CFC-I)
CinFin Capital Management (CCM)
Donald J. Doyle, Jr., CPCU, AIM
CIC, CID, CCC, CLIC Senior Vice President –
Excess & Surplus Lines
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
Gregory D. Schmidt, CPCU, ARP, CPP,
ACP, ARC
CIC, CID, CCC, CLIC Vice President –
Staff Underwriting
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, AAI
CIC, CID, CCC Vice President – Commercial Lines
CIC, CID, CCC Vice President – Bond & Executive Risk
Steven A. Soloria, CFA, CPCU
Gary B. Givler
CIC, CID, CCC Vice President – Headquarters Claims
David T. Groff, CPCU, FCAS
CIC, CID, CCC Vice President – Staff Underwriting
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, CPCU
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, CLIC, CFC-I Vice President –
Purchasing/Fleet
Robyn C. Muhlberg
CIC, CID, CCC, CLIC Vice President –
Information Technology
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, CFA, CPCU, 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
Ronald L. Robinson
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 –
Inspection Services & Facilities
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 – Special Investigations
Stephen A. Ventre, CPCU, AIM
CIC, CID, CCC Vice President – Commercial Lines
Jody L. Wainscott
CIC, CID, CCC Vice President –
Research & Development
Michael B. Wedig, CPA
CIC, CID, CCC, CLIC Vice President – Corporate Accounting
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
CIC, CID, CCC, CLIC Director
Gregory T. Bier, CPA (Ret.)
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
21
Definitions of Non-GAAP Information and
Reconciliation to Comparable GAAP Measures
Cincinnati Financial Corporation prepares its public
consolidated 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 is
calculated by excluding net realized investment gains and
losses (defined as realized investment gains and losses after
applicable federal and state income taxes) 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.
22
• Statutory accounting rules: For public reporting, insurance
companies prepare consolidated 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 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 a
$39 million one-time, pretax charge incurred in 2000.
Reconciliation of Consolidated Financial Data
Cincinnati Financial Corporation and Subsidiaries
(Dollars in millions except per share data)
Years ended December 31,
. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
$
. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
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
. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
$
. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
. . . . . . . . . . . . . . . . . . . . .
. . . . . . . . . . . . . . . . .
. . . . . . . . . . . . . . . . . . . .
2006
2005
2004
2003
2002
2001
$
$
$
930
-
930
434
496
5.30
-
5.30
2.48
$
$
$
602
-
602
40
562
3.40
-
3.40
0.23
$
$
$
584
-
584
60
524
3.28
-
3.28
0.34
$
$
$
374
15
359
(27)
386
2.10
0.09
2.01
(0.15)
$
$
$
238
-
238
(62)
300
1.32
-
1.32
(0.35)
193
-
193
(17)
210
1.07
-
1.07
(0.10)
$
2.82
$
3.17
$
2.94
$
2.16
$
1.67
$
1.17
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
Return on average equity based on comprehensive income
One-time items
Return on average equity based on comprehensive income
before one-time items
. . . . . . .
. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
. . . . . . . . . . . . . . . . . . . . . . . . . .
14.4 %
-
14.4 %
16.4 %
-
16.4 %
9.8 %
-
9.8 %
1.6 %
-
1.6 %
9.4 %
-
9.4 %
4.6 %
-
6.3 %
(0.3)
6.0 %
13.8 %
(0.3)
4.1 %
-
4.1 %
(4.0) %
-
4.6 %
13.5 %
(4.0) %
3.2 %
-
3.2 %
2.5 %
-
2.5 %
Reconciliation of 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)
Combined ratio (reported)
Codification(2)
Written premium adjustment
One-time items
Combined ratio (adjusted)
Catastrophe losses
Combined ratio excluding catastrophe losses (adjusted)
. . . . . . . . . . . . . . . . . . . . . . . . .
. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
. . . . . . . . . . . . . . . . . . . . . . . .
. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
. . . . . . . . . . . . . . . . . . . . . . . . .
. . . . . . . . . . . . . . . . . . . . . . . . . . . . .
. . . . . . . . .
2006
2005
2004
2003
2002
2001
Years ended December 31,
3,172
-
6
3,178
(14)
3,164
$
$
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
$
$
2.4 %
3.3
3.5
93.9 %
-
nm
-
93.9
(5.5)
88.4 %
2.3 %
2.6
4.8
89.0 %
-
nm
-
89.0
(4.1)
84.9 %
8.5 %
6.5
10.0
89.4 %
-
nm
-
89.4
(5.1)
84.3 %
11.7 %
7.7
10.9
94.2 %
-
nm
0.8
95.0
(3.6)
91.4 %
14.0 %
0.9
15.4
98.4 %
-
1.2
-
99.6
(3.6)
96.0 %
2,188
402
-
2,590
(517)
2,073
13.0 %
37.7
13.3
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.
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)
Combined ratio (reported)
Codification(2)
Written premium adjustment
One-time items
Combined ratio (adjusted)
. . . . . . . . . . . . . . . . . . . . . . . . .
. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
. . . . . . . . . . . . . . . . . . . . . . . .
. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
. . . . . . . . . . . . . . . . . . . . . . . . .
. . . . . . . . . . . . . . . . . . . . . . . . . . . . .
. . . . . . . . .
Catastrophe losses
Combined ratio excluding catastrophe losses (adjusted)
2006
2005
2004
2003
2002
2001
Years ended December 31,
2,435
-
7
2,442
(40)
2,402
$
$
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
$
$
5.6 %
6.7
6.6
90.8 %
-
nm
-
90.8
(3.7)
87.1 %
4.4 %
4.7
6.0
87.1 %
-
nm
-
87.1
(3.4)
83.7 %
10.0 %
7.6
11.4
83.7 %
-
nm
-
83.7
(3.4)
80.3 %
11.9 %
6.6
10.8
90.9 %
-
nm
0.7
91.6
(2.2)
89.4 %
15.8 %
4.2
18.6
95.3 %
-
1.5
-
96.8
(2.3)
94.5 %
1,551
276
-
1,827
(374)
1,453
16.9 %
43.3
17.9
96.7 %
4.0
-
-
100.7
(1.9)
98.8 %
Reconciliation of Personal 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)
Combined ratio (reported)
Codification(2)
Written premium adjustment
One-time items
Combined ratio (adjusted)
Catastrophe losses
Combined ratio excluding catastrophe losses (adjusted)
. . . . . . . . . . . . . . . . . . . . . . . . .
. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
. . . . . . . . . . . . . . . . . . . . . . . .
. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
. . . . . . . . . . . . . . . . . . . . . . . . .
. . . . . . . . . . . . . . . . . . . . . . . . . . . . .
. . . . . . . . .
2006
2005
2004
2003
2002
2001
Years ended December 31,
737
-
(1)
736
26
762
$
$
(6.8) %
(6.4)
(5.3)
103.6 %
-
nm
-
103.6
(11.3)
92.3 %
791
-
(5)
786
18
804
$
$
(3.2) %
(3.0)
1.4
94.3 %
-
nm
-
94.3
(6.3)
88.0 %
817
-
(6)
811
(18)
793
$
$
4.7 %
3.4
6.4
104.6 %
-
nm
-
104.6
(9.7)
94.9 %
780
-
4
784
(39)
745
$
$
701
-
7
708
(38)
670
$
$
12.0 %
10.8
11.2
102.9 %
-
nm
1.0
103.9
(7.3)
96.6 %
9.8 %
(7.2)
8.1
106.5 %
-
0.3
-
106.8
(7.1)
99.7 %
637
126
-
763
(143)
620
4.6 %
26.1
4.0
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)
Gross written premiums (reported)
Bank-owned life insurance (BOLI) adjustments
Gross written premiums (adjusted)
. . . . . . . . . . . . . . . . . . . . .
. . . . . . . . . . . . . .
. . . . . . . . . . . . . . . . . . . . .
$
$
Years ended December 31,
2006
2005
2004
2003
2002
2001
206
-
206
$
$
249
-
249
$
$
230
(10)
220
$
$
173
-
173
$
$
244
(34)
210
$
$
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.
24
Cincinnati Financial Corporation
2006 Annual Report
on Form 10-K
Table of Contents
10-K Page
Part I
Business . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1
Item 1
Risk Factors . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 20
Item 1A
Item 1B Unresolved Staff Comments . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 24
Properties . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 25
Item 2
Legal Proceedings . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 25
Item 3
Submission of Matters to a Vote of Security Holders . . . . . . . . . . . . . . . . . . . . . . . . . . 25
Item 4
Part II
Item 5
Item 6
Item 7
Market for the Registrant's Common Equity, Related Stockholder
Matters and Issuer Purchases of Equity Securities . . . . . . . . . . . . . . . . . . . . . . . . . . 26
Selected Financial Data . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 28
Management's Discussion and Analysis of Financial Condition
and Results of Operations . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 30
Item 7A Quantitative and Qualitative Disclosures About Market Risk . . . . . . . . . . . . . . . . . . . . 72
Financial Statements and Supplementary Data . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 78
Item 8
Includes:
Responsibility for Financial Statements . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 78
Management's Annual Report on Internal Control Over Financial Reporting . . . . . 79
Report of Independent Registered Public Accounting Firm . . . . . . . . . . . . . . . . . . . 80
Notes to Consolidated Financial Statements . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 85
Item 9
Changes in and Disagreements with Accountants on Accounting
and Financial Disclosure . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 104
Item 9A Controls and Procedures . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 104
Item 9B Other Information . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 104
Part III
Item 10
Item 11
Item 12
Item 13
Item 14
Part IV
Item 15
Directors and Executive Officers of the Registrant . . . . . . . . . . . . . . . . . . . . . . . . . . . . 104
Executive Compensation . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 104
Security Ownership of Certain Beneficial Owners and Management
and Related Stockholder Matters . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 105
Certain Relationships and Related Transactions . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 105
Principal Accountant Fees and Services . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 105
Exhibits and Financial Statement Schedules . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 105
25
United States Securities and Exchange Commission
Washington, D.C. 20549
Form 10-K
(cid:59)
(cid:133)
ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934.
For the fiscal year ended December 31, 2006.
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934.
For the transition period from _____________________ to _____________________.
Commission file number 0-4604
Cincinnati Financial Corporation
(Exact name of registrant as specified in its charter)
Ohio
(State of incorporation)
31-0746871
(I.R.S. Employer Identification No.)
6200 S. Gilmore Road
Fairfield, Ohio 45014-5141
(Address of principal executive offices) (Zip Code)
(513) 870-2000
(Registrant’s telephone number, including area code)
Securities registered pursuant to Section 12(b) of the Act:
None
Securities registered pursuant to Section 12(g) of the Act:
$2.00 par, common stock
(Title of Class)
6.125% Senior Notes due 2034
(Title of Class)
6.9% Senior Debentures due 2028
(Title of Class)
6.92% Senior Debentures due 2028
(Title of Class)
Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act. Yes (cid:59) No (cid:134)
Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act. Yes (cid:134) No (cid:59)
Indicate by check mark whether the registrant: (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities
Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such
reports) and (2) has been subject to such filing requirements for the past 90 days. Yes (cid:59) No (cid:133)
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not
be contained, to the best of registrant's knowledge, in definitive proxy or information statements incorporated by reference in Part III
of this Form 10-K or any amendment to this Form 10-K. (cid:133)
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer.
See definition of "accelerated filer” and “large accelerated filer" in Rule 12b-2 of the Exchange Act.
(Check one): Large accelerated filer (cid:59) Accelerated filer (cid:133) Non-accelerated filer (cid:133)
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes (cid:134) No (cid:59)
The aggregate market value of voting stock held by nonaffiliates of the Registrant was $7,397,523,700 as of June 30, 2006.
As of February 16, 2007, there were 172,835,849 shares of common stock outstanding.
Portions of the definitive Proxy Statement for Cincinnati Financial Corporation’s Annual Meeting of Shareholders to be held on
May 5, 2007, are incorporated by reference into Parts II and III of this Form 10-K.
Document Incorporated by Reference
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 2006, we had 4,048 associates, with
2,888 headquarters associates providing support to 1,160 field associates.
Cincinnati Financial Corporation (CFC) owns 100 percent of three subsidiaries: The Cincinnati Insurance
Company, CFC Investment Company and CinFin Capital Management Company. In addition, the parent
company has an investment portfolio and is responsible for corporate borrowings and shareholder dividends.
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 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 also 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 over 3,900 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)
2006 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 2006, our 1,066 agency relationships had 1,289 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. Reporting
agency locations describes our agents’ scope of business and our presence within our 32 active states.
At year-end 2005, we had 1,024 agency relationships with 1,252 reporting agency locations. At year-end 2004,
we had 998 agency relationships with 1,213 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 Earned Premiums by State
In our 10 highest volume states, 877 reporting agency locations wrote 70.0 percent of our 2006 total property
casualty earned premium volume compared with 69.7 percent in 2005.
(Dollars in millions)
Year ended December 31, 2006
Ohio
Illinois
Indiana
Pennsylvania
Michigan
Georgia
North Carolina
Virginia
Wisconsin
Kentucky
Year ended December 31, 2005
Ohio
Illinois
Indiana
Pennsylvania
Michigan
Georgia
Virginia
North Carolina
Wisconsin
Kentucky
Earned
premiums
Percent of
total earned
Reporting
agency locations
Avg premium
per location
$
$
695
291
225
190
160
147
144
142
119
103
687
281
222
182
164
133
126
121
119
98
22.0 %
9.2
7.1
6.0
5.1
4.6
4.5
4.5
3.8
3.2
22.5 %
9.2
7.3
5.9
5.4
4.3
4.1
3.9
3.9
3.2
220
116
98
75
92
62
70
55
51
38
224
112
99
63
88
59
53
68
49
38
$
$
3.2
2.5
2.3
2.5
1.7
2.4
2.1
2.6
2.3
2.7
3.1
2.5
2.2
2.9
1.9
2.3
2.4
1.8
2.4
2.6
In 2005, the most recent period for which data is available, Cincinnati Insurance was the No. 1 or No. 2 carrier
in 75 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 15.7 percent share of the property casualty insurance in our
reporting agency locations. Our share is 22.4 percent in reporting agency locations that have represented us
for more than 10 years; 9.9 percent in agencies that have represented us for five to 10 years; 4.3 percent in
agencies that have represented us for one to five years; and 1.2 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,
2006 10-K Page 2
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 1.2 percent of our total agency earned premiums in
2006. 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 2.3 percent of our total agency earned premiums in 2006.
Strengthening Our Agency Relationships
We follow a number of strategies to strengthen our relationships with the independent property casualty
insurance agencies that represent us.
Emphasis on Relationships and Local Decision-making
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 representatives specializing in claims, loss control,
machinery and equipment, bond, premium audit, life insurance and leasing. For example, our field machinery
and equipment 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 account.
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.
Risk-specific Underwriting
We seek to be a consistent, predictable and reasonable property casualty 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 get to know the people and businesses in their communities and can make
informed decisions about each risk. These field marketing representatives also are responsible for selecting
new independent agencies, coordinating field teams of specialized company representatives and promoting all
of the company's products within the agencies they serve. Commercial lines policy renewals are managed by
headquarters underwriters who are assigned to specific agencies and consult with local field staff, as needed.
We apply our risk-specific underwriting philosophy to personal lines new and renewal business in a different
process. Each agency selects personal lines business from within the geographic territory that it serves, based
on the agent’s knowledge of the risks in those communities or familiarity with the policyholder. New and
renewal business activities are supported by headquarters associates assigned to individual agencies.
Competitive Insurance Products
We are committed to offering the property casualty 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 offer personal auto and
homeowners coverages together with other coverages such as personal umbrella. This approach brings
policyholders convenience, discounts and a reduced risk of coverage gaps or disputes. At the same time, it
increases account retention and saves time and expense for the agency and our company.
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 next 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
2006 10-K Page 3
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 2006 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
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.
Our personal lines policies are offered on a one-year term, except for homeowner policies in five states.
Competitive advantages of our personal lines coverages include a generous credit structure and customizable
endorsements for both the personal auto and homeowner policies. A newly introduced personal auto policy
endorsement is replacement cost coverage for newly purchased vehicles. Popular homeowner endorsements
include replacement cost for contents, inflation guard, identity theft mitigation and advocacy, flexible water
damage coverages and enhanced replacement cost coverage for older homes.
Technology Solutions
We seek to employ technology solutions and business process improvements that complement our core values
of local underwriting decisions, strong relationships with our independent agencies and superior claims service.
In recent years, we have made significant investments in state-of-the-art information technology platforms,
systems and Internet-based applications to:
• allow our agencies and our field and headquarters associates to collaborate more efficiently,
• provide our agencies the ability to access our systems and client data to process business transactions
from their offices,
• automate our internal processes so our associates can spend more time serving agents and policyholders,
and
•
reduce duplication and make our processes more effective to reduce company and agency costs.
Agencies access our systems and other electronic services via CinciLink®, our secure agency-only portal.
CinciLink provides an array of Web-based services and content that make it easier to do business with us, such
as commercial and personal lines rating and processing systems, policy loss information, sales and marketing
materials, educational courses on our products and services, and electronic libraries for property and casualty
coverage forms and state rating manuals.
Commercial Lines Technology – Through our WinCPP® commercial lines premium quoting system, agency and
company representatives are able to complete online, real-time premium quotes for new business and
renewals. WinCPP is used by all of our agency locations in the 32 states in which we actively market insurance
and provides quoting capabilities for nearly 100 percent of our new and renewal commercial lines business. In
2007, we will introduce agency integration technology for WinCPP; CinciBridge™ allows automated movement
of key underwriting data from an agent’s management system to WinCPP, reducing agents’ data entry and
allowing seamless quoting and rating capabilities.
Some small business accounts written as Businessowner Policies (BOP) and Dentist’s Package Policies (DBOP)
are eligible to be issued at our agency locations through our Web-based e-CLAS® policy processing system.
(A businessowner policy combines property, liability and business interruption coverages for small businesses.)
e-CLAS provides full policy lifecycle transactions including: quoting, issuance, policy changes, renewal
processing and policy printing at the agency location. These features make it easier and more efficient for our
agencies to issue and service these policies. e-CLAS is in use in seven states representing 44 percent of the
BOP and DBOP premiums. During 2007, we expect to roll-out e-CLAS to an additional 12 states for these policy
types. We also intend to introduce the CinciBridge agency integration technology with e-CLAS. Our primary
long-term technology objective is to complete development of e-CLAS for all of our commercial lines of
business.
Since 2004, we have been streamlining internal processes and achieving operational efficiencies in our
headquarters commercial lines operations through deployment of i-View™, a policy imaging and workflow
system. This system provides online access to electronic copies of policy files, enabling our underwriters to
respond to agent requests and inquiries more quickly and efficiently. i-View also automates internal workflows
through electronic routing of underwriting and processing work tasks. Sixty percent of non-workers’
compensation commercial lines policy files now are administered and retained electronically in i-View and our
field claims representatives can access these records to help them efficiently verify coverage and process
claims. We expect more than 90 percent of non-workers’ compensation commercial lines policy files will be
retained in i-View by year-end 2007.
2006 10-K Page 4
Personal Lines Technology – 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. Diamond incorporates features
frequently requested by our agencies such as direct bill and monthly payment plans, local and headquarters
policy printing options, data transfer to and from popular agency management systems and real-time
integration with data from third party sources needed to calculate final premiums such as insurance scores,
MVR reports and address verification. At year-end 2006, Diamond was in use in 13 states representing
approximately 90 percent of our personal lines premium volume. Agents in Pennsylvania and Virginia began
using Diamond in early 2007 with additional states planned for later in the year.
In 2006, we introduced PL-efiles, a policy imaging system, to our personal lines operations. Through year-end
2006, we had transitioned more than one-third of our Diamond personal lines files to PL-efiles, replacing paper
format with electronic copies of policy documents. PL-efiles complements the Diamond system by giving
personal lines underwriters and support staff online access to policy documents and data that enable them to
respond to agent requests and inquiries quickly and efficiently.
Claims Technology – Our property and casualty claims operation has streamlined processes and achieved
operational efficiencies through the use of CMS™, our claims file management system. Initially deployed in late
2003, CMS 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 to add capabilities to make our associates more effective. During 2006, we issued tablet
computers to our field claims representatives. These units allow our claims representatives to view and enter
information into CMS from any location, including an insured’s home or agent’s office, and to print claim
checks using portable printers. Agent access to selected CMS information is planned for 2007.
Surety and Executive Risk Technology – Advances in automation and streamlined business processes have
enabled us to offer our agencies a more efficient means to process certain surety bonds. This helps agencies
offer a complete package to their commercial clients. Since 2005, we have introduced CinciBond®, an
automated system to process license and permit surety bonds, to agents in 11 states representing 803 agency
reporting locations. CinciBond enables agents to rate, issue and print bonds at their offices. During 2007,
we expect to complete rollout in remaining states and add other popular surety bond types.
Life Insurance Offerings Round Out Agency Relationships
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 to provide us with penetration in
geographic markets not served through our property casualty 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, high quality
service and competitive pricing.
Programs, Products and Services to Support Agency Growth
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 agency management 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 seminars on a variety of topics, such as marketing seminars to promote
cross-marketing of our products. Cincinnati associates also co-host client seminars with our agencies on a
2006 10-K Page 5
variety of topics such as risk transfer techniques. These customized programs address liability issues
specific to classes of business, such as contractors or dentists.
• 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.
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.
Superior Financial Strength Ratings
In addition to the ratings of our parent company senior debt, independent ratings firms award our property
casualty and life operations insurer financial strength ratings based on their quantitative and qualitative
analyses. These ratings assess an insurer’s ability to meet its financial obligations to policyholders and do not
necessarily address all of the matters that may be important to shareholders.
We believe that our strong surplus position and 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. We seek to ensure that
our performance remains consistent and predictable by aligning agents’ interests with those of the company,
giving agents outstanding service and compensation and earning their best business by enhancing their ability
to serve the businesses and individuals in their communities.
As of December 31, 2006, our financial strength ratings were unchanged from those reported in our
2005 Annual Report on Form 10-K. The outlook from Standard & Poor’s was raised to stable from negative.
Parent Company
Senior Debt
Rating
Property Casualty Insurance
Subsidiaries Financial
Strength Ratings
Life Insurance
Subsidiary Financial
Strength Ratings
A. M. Best Co.
Fitch Ratings
Moody's Investors Services
Standard & Poor's Ratings Services
aa-
A+
A2
A
A++ Superior
AA Very Strong
Aa3 Excellent
AA- Very Strong
Rating
Tier
1 of 16
4 of 21
4 of 12
4 of 21
Superior
A+
AA Very Strong
-
-
AA- Very Strong
Rating
Tier
2 of 16
4 of 21
-
4 of 21
Outlook
Stable
Stable
Stable
Stable
• A.M. Best Co. - On April 28, 2006, A.M. Best affirmed its financial strength rating (FSR) of A++ (Superior) for
our property casualty group, citing its superior risk-adjusted capitalization, very strong operating
performance, network of independent agents and strong overall underwriting results despite challenges to
achieve profitability in its personal lines business. Concurrently, A.M. Best downgraded its issuer credit
ratings for our property casualty insurance companies to aa+ from aaa, reflecting the company’s
investment and geographic risk concentrations at current rating levels. Additionally, A.M. Best affirmed the
FSR of A+ (Superior) and the issuer credit rating of aa- of The Cincinnati Life Insurance Company. The
outlook for all ratings is stable.
•
Fitch Ratings - On September 15, 2006, Fitch affirmed the AA insurer financial strength ratings of our three
property casualty companies and The Cincinnati Life Insurance Company. Fitch said the ratings are based
on the strong financial condition of our operating subsidiaries, excellent financial flexibility and successful
total return investment strategy. The ratings consider the property casualty group’s investment
concentration in a small number of common stocks and geographic concentration in Ohio and Midwestern
states.
• Moody’s Investors Service –In July 2006, Moody’s issued its Analysis, stating that overall, its Top 10 ratio
metrics suggest that our property casualty group continues to be appropriately positioned within the
Aa insurance financial strength rating category. Further, in its November 2006 comment after our third-
quarter earnings announcements, Moody’s said the stable outlook is supported by our conservative
financial and operational leverage profiles and by Moody’s belief that our operating model will enable us to
continue to compete effectively in our core markets. Moody’s noted that challenges include the
increasingly competitive environment in small and middle market commercial lines, lagging technology
systems, a concentrated portfolio and payment of sizable common stock dividends that reduce our fixed
charge coverage levels.
• Standard & Poor’s Ratings Services - On July 25, 2006, Standard & Poor’s Ratings Services affirmed its
AA- (Very Strong) financial strength and counterparty credit ratings on the property casualty group and
The Cincinnati Life Insurance Company. At the same time, Standard & Poor’s revised its outlook on the
company, our property casualty operating companies and Cincinnati Life to stable from negative.
2006 10-K Page 6
Standard & Poor’s said the revised outlook reflected the improved results on our homeowner book of
business, as well as its view of our ability to benefit from corrective actions we have effected over recent
years. Standard & Poor’s said it believes our unique approach to agency relationships should drive
profitable growth even in a softer pricing environment.
Statutory surplus for our property casualty insurance subsidiary was $4.723 billion at December 31, 2006,
with the ratio of property casualty common stock to statutory surplus at 97.3 percent, in line with our targeted
sub-100 percent level. At year-end 2005, property casualty statutory surplus was $4.220 billion, with the ratio
of common stock to surplus at 96.4 percent. Life statutory surplus was $479 million at December 31, 2006,
with the ratio of life common stock to statutory adjusted capital and surplus at 88.8 percent. At year-end 2005,
life statutory surplus was $451 million, with the ratio of common stock to statutory adjusted capital and
surplus at 83.5 percent.
Cincinnati Life’s statutory adjusted risk-based surplus increased 8.7 percent to $556 million at
December 31, 2006, from $511 million a year earlier. Statutory adjusted risk-based surplus as a percentage of
liabilities, a key measure of life insurance company capital strength, was 37.8 percent at year-end 2006
compared with an estimated industry average ratio of 10.7 percent. A higher ratio indicates an insurer’s
stronger security for policyholders and capacity to support business growth.
At year-end 2006 and 2005, 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.
We continue to review the risk management and capital requirement changes that rating agencies have
proposed for our industry. Additionally, we began a formal implementation of enterprise risk management in
2005. Responsibility for enterprise risk management has been assigned at the officer level, supported by a
team of representatives from business areas. The team reports to our president, our chief executive officer and
our board of directors, as appropriate, on detailed and summary risk assessments, risk metrics and risk plans.
Our use of operational audits, strategic plans and departmental business plans, as well as our culture of open
communications and our fundamental respect for our code of conduct, continue to help us manage risks on an
ongoing basis.
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, conservative reinsurance program, sound reserving practices and low interest rate risk, as well as low
debt and 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.
We believe that our property catastrophe reinsurance program provides adequate protection for large loss
events. Our strong capital position would allow the payment of claims if an event exceeded our reinsurance
program. Currently participating on our property per risk and casualty per-occurrence programs are Hannover
Reinsurance Company, Munich Reinsurance America, Partner Reinsurance Company of the U.S. and Swiss
Reinsurance America Corporation and its subsidiaries, all of which have A.M. Best insurer financial strength
ratings of A (Excellent) or A+ (Superior). Over the past several years, we also modified earthquake deductibles
in selected Midwestern states for both commercial and personal lines property coverages to reduce our
exposure to a single significant catastrophic event.
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, which was 0.7 at year-end 2006, 2005 and 2004. 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 0.9 at year-end 2006, 1.0 at year-end 2005 and 1.1 at year-end 2004. 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.
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.
To help us maintain or increase our penetration within each agency, we are further improving service through
the creation of smaller marketing territories that permit our local field marketing representatives to devote
2006 10-K Page 7
more time to each agency relationship. At year-end 2006, we had 102 field marketing territories, up from
100 at the end of 2005 and 92 at the end of 2004. We continually study the regulatory and competitive
environment in states where we could decide to actively market our property casualty products.
In January 2007, we announced we were working on plans to enter New Mexico and eastern Washington within
the next year. We will soon begin the process by preparing policy forms and rates to submit to the departments
of insurance in those states. Marketing efforts in New Mexico and Washington will begin following our initial
agency appointments.
Another way we seek to increase overall premiums is to expand our agency plant within our current marketing
territories. Our objective is to appoint approximately 50 additional sales offices, or points of distribution, each
year. In measuring progress towards this goal, we include appointment of new agency relationships with
Cincinnati (the primary focus of our goal). For those that we believe will produce a meaningful amount of new
business premiums, we also include appointment of agencies that merge with a Cincinnati agency and new
branch offices opened by existing Cincinnati agencies. We made 55, 57 and 58 new appointments in 2006,
2005 and 2004 respectively. Of these new appointments, 42, 41, and 48, respectively, were new
relationships. These new appointments and other changes in agency structures led to a net increase in
reporting agency locations of 37 in 2006, 39 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 loss reserves.
Superior Claims Service
Our 748 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 we have a competitive advantage because of the person-to-person approach and the
resulting high level of service that our field claims representatives provide. We also help our agencies provide
prompt service to policyholders by giving agencies authority to immediately pay most first-party claims 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
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. They have vendor resources that
provide negotiated pricing to our insureds and claimants and that help us determine appropriate pricing for
medical cost-related claims. Our field claims representatives also are educated continuously on new
techniques and repair trends. They can leverage their local knowledge and experience with area body shops,
which helps them negotiate the right price with any facility the policyholder chooses.
We staff a Special Investigations Unit (SIU) with former law enforcement and claims professionals who are
available to gather facts to uncover potential fraud. While we believe it’s our job to pay what 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 called IBNR, 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
2006 10-K Page 8
amount of salvage and subrogation we expect to recover. For more than 10 years, our annual review has led to
savings from favorable development of loss reserves on 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 63, 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 investment department 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. Premium
payments, generally received before claims are made, particularly for casualty business lines, create
substantial cash flow 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 significantly to total net unrealized investment gains of
$5.244 billion (pretax) at year-end 2006. 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 an
unusually low 69.5 percent of our total revenues in 2006 due to the sale of our Alltel Corporation common
stock holding. Revenues, income before income taxes, and identifiable assets for each segment are shown in a
table in Item 8, Note 17 to the Consolidated Financial Statements, Page 102. 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 $2.402 billion in net earned premiums
to total revenues and $208 million to income before income taxes in 2006. Commercial lines net earned
premiums grew 6.6 percent in 2006, 6.0 percent in 2005 and 11.4 percent in 2004.
Approximately 95 percent of our commercial lines premiums are written to provide accounts with coverages
from more than one of our business lines. As a result, we believe that commercial lines is best measured and
evaluated on a segment basis. However, we provide the line of business data to summarize growth and
profitability trends separately for our business lines. The seven commercial business lines are:
• Commercial casualty – Commercial casualty insurance provides coverage to businesses against third-party
liability from accidents occurring on their premises or arising out of their operations, including liability
coverage for injuries sustained from products sold as well as coverage for professional services, such as
dentistry. Specialized casualty policies may include liability coverage for employment practices liability
(EPLI), which protects businesses against claims by employees that their legal rights as employees of the
company have been violated, and other acts or failures to act under specified circumstances as well as
excess insurance and umbrella liability, including personal umbrella written as an endorsement to
commercial umbrella coverages. The commercial casualty business line includes liability coverage written
2006 10-K Page 9
on both a discounted and non-discounted basis as part of commercial package policies. Our ceded
participation in USAIG, a joint underwriting association, from 2003 and prior is included in the commercial
casualty business line.
• Commercial property – Commercial property insurance provides coverage for loss or damage to buildings,
inventory and equipment caused by fire, wind, hail, water, theft and vandalism as well as business
interruption resulting from a covered loss. Commercial property also includes crime insurance, which
provides coverage for losses due to embezzlement or misappropriation of funds by an employee, and
inland marine insurance, which provides coverage for a variety of mobile equipment, such as builder’s risk,
contractor’s equipment, cargo and electronic data processing equipment. Various property coverages can
be written as stand-alone policies or can be added to a package policy. The commercial property business
line includes property coverage written on both a non-discounted and discounted basis as part of
commercial package policies.
• Commercial auto – 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.
• Workers’ compensation – Workers’ compensation coverage protects employers against specified benefits
payable under state or federal law for workplace injuries to employees. We write workers’ compensation
coverage in all of our active states except North Dakota, Ohio and West Virginia, where coverage is
provided solely by the state instead of by private insurers.
• Specialty packages – Specialty packages include coverages for property, liability and business interruption
tailored to meet the needs of specific industry classes, such as artisan contractors, dentists, garage
operators, financial institutions, metalworkers, printers, religious institutions, or smaller, main street
businesses. Businessowner policies, which combine property, liability and business interruption coverages
for small businesses, are included in specialty packages.
• Surety and executive risk – This business line includes:
○ Contract and commercial surety bonds, which guarantee a payment or reimbursement for financial
losses resulting from dishonesty, failure to perform and other acts.
○ Fidelity bonds, which cover losses that policyholders incur as a result of fraudulent acts by specified
individuals or dishonest acts by employees.
○ Director and officer liability insurance, which covers liability for alleged errors in judgment, breaches of
duty and wrongful acts related to activities of for-profit or nonprofit organizations. Our director and
officer liability policy can optionally include EPLI coverage.
• Machinery and equipment – Specialized machinery and equipment coverage can provide protection for
loss or damage to boilers and machinery, including production and computer equipment, from sudden and
accidental mechanical breakdown, steam explosion, or artificially generated electrical current.
Our emphasis is on products that agents can market to small- to mid-size businesses in their communities.
Of our 1,289 reporting agency locations, six market only our surety and executive risk products and one
markets only our personal lines products. The remaining 1,282 locations, located in all 32 states in which we
actively do business, market some or all of our general commercial insurance products.
In 2006, our 10 highest volume commercial lines states generated 67.7 percent of our earned premiums
compared with 67.1 percent in the prior year. Earned premiums in the 10 highest volume states rose
7.4 percent in 2006 and rose 5.0 percent in the remaining 22 states.
2006 10-K Page 10
Commercial Lines Earned Premiums by State
(Dollars in millions)
Year ended December 31, 2006
Ohio
Illinois
Pennsylvania
Indiana
North Carolina
Michigan
Virginia
Wisconsin
Georgia
Tennessee
Year ended December 31, 2005
Ohio
Illinois
Pennsylvania
Indiana
Michigan
North Carolina
Virginia
Wisconsin
Iowa
Tennessee
Earned
premiums
Percent of
total earned
Reporting
agency locations
Avg premium
per location
$
$
410
238
172
160
136
124
120
96
84
81
389
224
164
151
122
115
105
92
76
73
17.1 %
9.9
7.2
6.7
5.7
5.2
5.0
4.0
3.5
3.4
17.2 %
10.0
7.3
6.7
5.4
5.1
4.7
4.1
3.4
3.2
219
116
75
98
70
92
55
51
62
37
224
112
63
99
88
68
53
49
45
32
$
$
1.9
2.1
2.3
1.6
1.9
1.3
2.2
1.9
1.4
2.2
1.7
2.0
2.6
1.5
1.4
1.7
2.0
1.9
1.7
2.3
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. Regional carriers traditionally have offered 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. National carriers traditionally have
provided 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
in non-coastal markets, particularly for quality new business, and there are no signs that trend is abating.
In 2006, competition for new business continued to intensify, and we also began to see significant market
softening extend to renewals. As market conditions have softened, we also believe distinctions between
regional and national carriers have blurred.
Over the course of 2006, anecdotal reports of very aggressive pricing became somewhat more frequent. But on
balance we believed the market remained healthy and we continued to see underwriting taking place and
terms and conditions remaining fairly stable. Generally, we believe carriers are modifying prices rather than
changing policy terms and conditions, but we have begun to see underwriting discipline slip to capture market
share in late 2006 and early 2007.
The hurricane activity that occurred in 2005 is still having significant impacts on the cost of catastrophe
reinsurance and property pricing remains very firm in catastrophe prone areas. We are uncertain what effect
the hurricanes, and the related rise in the cost of reinsurance, may have on commercial lines pricing in
non-coastal areas throughout 2007.
PERSONAL LINES PROPERTY CASUALTY INSURANCE SEGMENT
The personal lines property casualty insurance segment contributed $762 million in net earned premiums to
total revenues and reported a $27 million loss before income taxes in 2006. Personal lines net earned
premiums declined 5.3 percent in 2006 after rising 1.4 percent in 2005 and 6.4 percent in 2004.
We prefer to write personal lines coverage on an account basis that includes both auto and homeowner
coverages as well as coverages from the other personal business line. As a result, we believe that personal
lines is best measured and evaluated on a segment basis. However, we provide the line of business data to
summarize growth and profitability trends separately for the three business lines:
• Personal auto – This business line includes personal auto coverages that protect against liability to others
for both bodily injury and property damage, medical payments to insureds and occupants of their vehicle,
2006 10-K Page 11
physical damage to an insured’s own vehicle from collision and various other perils, and damages caused
by uninsured motorists. In addition, many states require policies to provide first-party personal injury
protection, frequently referred to as no-fault coverage.
• Homeowners – This business line includes homeowner coverages that 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.
• Other personal lines – This includes the variety of other types of insurance products we offer to individuals
such as dwelling fire, inland marine, personal umbrella liability and watercraft coverages.
We market both homeowner and personal auto insurance products through 772 of our 1,289 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 495 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 2006, our 10 highest volume personal lines states generated 84.7 percent of our earned premiums
compared with 83.3 percent in the prior year. Earned premiums in the 10 highest volume states declined
3.7 percent in 2006 and declined 13.1 percent in the remaining states.
Personal Lines Earned Premiums by State
(Dollars in millions)
Year ended December 31, 2006
Ohio
Indiana
Georgia
Illinois
Alabama
Kentucky
Michigan
Wisconsin
Florida
Virginia
Year ended December 31, 2005
Ohio
Indiana
Georgia
Illinois
Michigan
Kentucky
Alabama
Wisconsin
Virginia
Florida
Earned
premiums
Percent of
total earned
Reporting
agency locations
Avg premium
per location
$
$
285
65
63
53
39
38
36
23
22
22
299
71
60
57
42
38
36
27
21
20
37.4 %
8.5
8.3
6.9
5.1
5.0
4.7
3.1
2.9
2.8
37.2 %
8.8
7.5
7.0
5.3
4.7
4.4
3.3
2.6
2.5
204
65
52
76
25
33
64
28
10
19
211
65
46
78
66
33
24
30
23
10
$
$
1.4
1.0
1.2
0.7
1.6
1.2
0.6
0.8
2.2
1.2
1.4
1.1
1.3
0.7
0.6
1.2
1.5
0.9
0.9
2.0
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.
Prior to 2003, the industry had experienced several years of rising personal auto and homeowner rates and
stricter enforcement of underwriting standards across the industry. Since 2003, we have seen increased
competition in the personal lines marketplace, driven by industrywide improvement in results and favorable
frequency and severity trends. 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.
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 three 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 they believe allow them to target higher quality risks with lower prices.
2006 10-K Page 12
LIFE INSURANCE SEGMENT
The life insurance segment contributed $115 million of net earned premiums and a $1 million loss before
income taxes in 2006. Life insurance segment profitability is discussed in detail in Item 7, Life Insurance
Results of Operations, Page 54. Life insurance net earned premiums grew 7.9 percent in 2006, 5.7 percent in
2005 and 5.5 percent in 2004.
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 2006, approximately 81 percent of our 1,289 property
casualty reporting agency locations offered Cincinnati Life’s products to their clients. We also develop life
business from 507 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, universal life insurance, worksite products and whole life insurance –
account for approximately 90.6 percent of the life insurance segment’s revenues:
•
Term insurance – policies under which a death benefit is payable only if the insured dies during a specific
period of time or term. For policies without a return of premium provision, no benefit is payable if the
insured survives to the end of the term. For policies with a return of premium provision, a benefit equal to
the sum of all paid premiums 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.
• Universal life insurance – long-duration life insurance policies. Contract premiums are neither fixed nor
guaranteed; however, the contract does specify a minimum interest crediting rate and a maximum cost of
insurance charge and expense charge. Premiums are not fixed and may be varied by the contract owner.
The cash values available as a loan collateralized by the cash surrender value 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.
• Whole life insurance – policies that provide life insurance for the entire lifetime of the insured; the death
benefit is guaranteed never to decrease and premiums are guaranteed never to increase. While premiums
are fixed, they must be paid as scheduled. These policies provide guaranteed cash values that are
available as a loan collateralized by the cash surrender value to withdrawing policyholders. The proposed
insured is evaluated using normal underwriting standards.
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.
•
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.
2006 10-K Page 13
Life Insurance Marketplace
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 are available to 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 agents and
field team to assist in the placement of business. We find fewer and fewer of our competitors provide
direct, personal contact between the agent and the insurance carrier.
We continue to emphasize the cross-serving opportunities between worksite marketing of life insurance
products and the property casualty agency’s commercial accounts. In both the property casualty and
independent life agency distribution systems we enjoy the advantages of offering competitive, up-to-date
products, providing close personal attention and exhibiting financial strength and stability.
• We primarily offer products targeted at addressing the needs of 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, such as a return of premium rider. Reaction to our term
portfolio was favorable in 2006 with approximately 25 percent of applications requesting the return-of-
premium feature.
•
In 2007 we plan to enhance our term and other life insurance products, including an expanded worksite
product portfolio, and investigate new survivor universal life and whole life products. The priority is
expansion within the insurance agencies marketing our property casualty insurance products.
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 2006: A.M. Best – A+ (Superior), Fitch -- AA (Very Strong) and Standard & Poor's –
AA- (Very Strong). Our life insurance company has not chosen to establish a Moody’s rating.
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. We do not offer variable or equity-indexed products because of
the associated financial risk. That decision can affect our premium growth, particularly during times 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 National Association of Insurance Commissioners recognizes the problems caused by redundant reserves
and is considering 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 $1.254 billion of our total revenues in 2006, 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 $1.200 billion of income before income
taxes, or 90.3 percent of our total income before income taxes.
2006 10-K Page 14
The fair value (market value) of our investment portfolio was $13.699 billion and $12.657 billion at year-end
2006 and 2005, 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, 2006
At December 31, 2005
Book value
Fair value
Book value
Fair value
$
$
3,357 $
2,382
2,400
221
95
8,455 $
3,389 $
2,416
7,564
235
95
13,699 $
3,304 $
2,083
1,961
167
75
7,590 $
3,359
2,117
6,936
170
75
12,657
During 2006, our allocation of cash flows for new fixed-maturities and equity investments more closely
approximated our historical levels. The primary reason for the increase in the market value of the common
equity portfolio in 2006 was market appreciation of our holdings. The sale of our Alltel common stock and other
equity holdings more than offset new equity purchases. In 2005 and the second half of 2004, almost all of our
insurance subsidiary’s available cash flow was 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
subsidiary portfolio was 97.3 percent at year-end 2006 compared with 96.4 percent at year-end 2005 and
103.5 percent at year-end 2004.
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 20.
The ratio of investment assets to total assets for the parent company was 31.5 percent at year-end 2006
compared with 33.9 percent at year-end 2005 and 36.3 percent at year-end 2004.
Going forward, we also 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.
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 risk. 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
minimize our corporate taxes. With the exception of U.S. agency paper (government-sponsored entities),
no individual issuer's securities accounted for more than 0.8 percent of the fixed-maturity portfolio at
December 31, 2006.
Taxable Fixed-maturities
Our taxable fixed-maturity portfolio (at fair value) includes:
• $972 million in U.S. agency paper, which is rated AAA by both Moody’s and Standard & Poor’s.
• $1.818 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-.
• $321 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
2006 10-K Page 15
represented 27.2 percent and 27.7 percent, respectively, of book value and fair value of the taxable
fixed-maturity portfolio at December 31, 2006, compared with 26.1 percent and 26.6 percent of book value
and fair value at December 31, 2005. 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 1.1 percent of the tax-exempt
municipal bond portfolio at December 31, 2006, there are higher concentrations within individual states.
Holdings in Illinois, Indiana, Michigan, Ohio and Texas accounted for 61.9 percent of the municipal bond
portfolio at year-end 2006.
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 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
Attributes of the fixed-maturity portfolio include:
Weighted average yield-to-book value
Weighted average maturity
Effective duration
At December 31, 2006
Fair
value
Percent
to total
At December 31, 2005
Fair
value
Percent
to total
$
$
$
$
4,039
1,086
266
122
28
0
0
359
5,900
3,631
1,044
310
131
10
0
0
774
5,900
68.5 % $
18.4
4.5
2.1
0.5
0.0
0.0
6.0
100.0 % $
61.5 % $
17.7
5.3
2.2
0.2
0.0
0.0
13.1
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
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 %
Years ended December 31,
2006
2005
5.3 %
8.7 yrs
5.1 yrs
5.4 %
9.5 yrs
5.2 yrs
We discuss the maturity of our fixed-maturity portfolio in Item 8, Note 2 to the Consolidated Financial
Statements, Page 90.
Equity Investments
Our equity investment portfolio includes both common stocks and nonredeemable preferred stocks.
Approximately 82.4 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 organizations and industries. The portfolio also
includes a broader group of smaller positions that are a source of trading flexibility and other risk management
advantages. Following the sale of our Alltel common stock holding, average dividend yield-to-cost for our equity
investments declined to 9.9 percent at December 31, 2006, compared with 11.7 percent at
December 31, 2005.
Common Stocks
At December 31, 2006, 32.7 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
2006 10-K Page 16
ranging from 1.5 percent to 4.0 percent and with 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 2006, we held more than 5 percent of three companies: Fifth Third,
FirstMerit Corporation and Piedmont Natural Gas Company.
Those holdings are part of a core group of common stocks in which we hold a fair value of at least $100 million
each. At year-end 2006, there were 13 holdings in that core group.
Largest Common Stock Holdings
(Dollars in millions)
As of and for the year ended December 31, 2006
Fifth Third Bancorp
Exxon Mobil Corporation
The Procter & Gamble Company
National City Corporation
PNC Financial Services Group, Inc.
AllianceBernstein Holding L.P.
U.S. Bancorp
Johnson & Johnson
Wyeth
Wells Fargo & Company
Piedmont Natural Gas Company, Inc.
Sky Financial Group, Inc.
FirstMerit Corporation
All other common stock holdings
Total
Actual
cost
Fair
value
Percent of
fair value
Earned
dividend
income
Earned
dividend to
fair value
$
$
283 $
133
192
171
62
60
150
194
62
96
64
91
55
787
2,400 $
2,979
687
469
358
348
266
251
238
225
193
151
133
129
1,137
7,564
39.4 % $
9.1
6.2
4.7
4.6
3.5
3.3
3.1
3.0
2.5
2.0
1.8
1.7
15.1
100.0 % $
115
11
8
15
10
12
9
5
4
6
5
4
6
31
241
3.9 %
1.7
1.8
4.2
2.9
4.3
3.7
2.1
2.0
3.0
3.6
3.3
4.7
2.6
In January 2006, we sold 12,700,164 shares of our holdings of Alltel after selling 475,000 shares in
December 2005. Alltel had been our second largest common stock holding. 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. At year-end 2006, the largest industry concentrations within our
common stock holdings were the financials sector at 66.6 percent of total fair value and the healthcare sector
at 7.9 percent.
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 90.
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, 2006, CFC Investment Company had 2,897 accounts and $108 million in receivables,
compared with 2,815 accounts and $105 million in receivables at December 31, 2005.
As of December 31, 2006, CinFin Capital had 64 institutional, corporate and individual clients and
$960 million under management, compared with 64 and $864 million at December 31, 2005. Assets under
management rose because a single account placed additional funds with CinFin Capital in 2006.
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.
2006 10-K Page 17
•
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 group. 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 2006 in Item 8, Note 8 to the Consolidated Financial Statements, Page 93.
•
•
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.
Insurance Guaranty Associations – Each state has insurance guaranty association laws under which the
associations may assess life and property casualty insurers doing business in the state for certain
obligations of insolvent insurance companies to policyholders and claimants. Typically, states assess each
member insurer in an amount related to the insurer’s proportionate share of business written by all
member insurers in the state. Our insurance subsidiaries received a net refund of $500,000 and
$3 million from guaranty associations in 2006 and 2005. 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
2006 10-K Page 18
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 $318 million (17.5 percent of
2005 subject premiums) in 2006, $328 million (15 percent of 2004 subject premiums) in 2005 and
$199 million (10 percent of 2003 subject premiums) in 2004. For 2007, the deductible is an estimated
$388 million (20.0 percent of 2006 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.
• 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.
2006 10-K Page 19
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 risks 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 and 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 17 other insurance groups, or 1.6 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.
• Concerns that doing business with us is difficult or perceptions that our level of service is no longer a
distinguishing characteristic in the marketplace. This could occur if agents or policyholders believe that we
were no longer providing the prompt, reliable personal service that has long been a distinguishing
characteristic of our insurance operations.
• 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
affect 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 cyclical and intensely competitive. From time to time, the insurance industry goes
through prolonged periods of intense competition during which it is more difficult to attract new business and
maintain profitability. 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
• Speed at which products are brought to market
2006 10-K Page 20
•
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
• Claims satisfaction and reputation
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 42,
Page 49, and Page 54, 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 litigation, 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 changes in industry practices and regulations on our business are uncertain.
As industry practices and legal, judicial, social and other environmental conditions change, unexpected and
unintended issues related to insurance pricing, claims and coverage may emerge. These issues may adversely
affect our business by impeding our ability to obtain adequate rates for covered risks, extending coverage
beyond our underwriting intent or by increasing the number or size of claims. In some instances, unforeseeable
emerging and latent claim and coverage issues may not become apparent until 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 changes
could adversely affect our results of operations.
Please see Item 7, Property Casualty and Life Insurance Reserves, Page 63 and Page 69, 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 85.
Our most critical accounting estimate is loss reserves. Loss reserves are the amounts we expect to pay for
covered claims and expenses we incur to settle those claims. The loss reserves we establish in our financial
statements represent an estimate of amounts needed to pay and administer claims arising from insured
events that have 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 reserves as facts regarding individual claims develop,
additional losses are reported and new information becomes known. Adjustments due to loss development on
prior years are reflected in the calendar year in which they are identified.
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.
2006 10-K Page 21
Please see Item 7, Property Casualty and Life Insurance Reserves, Page 63 and Page 69, 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 against perils for which estimates of losses are
highly uncertain, in particular catastrophic and terrorism events. Catastrophes can be caused by a number of
events, including hurricanes, tornadoes, windstorms, earthquakes, hailstorms, explosions, severe winter
weather and fires. Due to the nature of these events, we are unable to predict precisely the frequency or
potential cost of catastrophe occurrences. 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 and Southeast and, to a certain extent, the mid-Atlantic.
•
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 a terrorist event or an
epidemic such as the avian flu, particularly if the epidemic were to affect 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 2007, we have exposure of up to
$8 million of assumed losses in three layers, from $875 million to $1.500 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. A catastrophe event also could affect our operations by damaging
our headquarters facility or disrupting our associates’ ability to perform their assigned tasks.
Please see Item 7, Property Casualty and Life Insurance Reserves, Page 63 and Page 69, for a discussion of
our reserving practices.
Our ability to obtain or collect on our reinsurance protection could affect our business,
financial condition, results of operations and cash flows.
We buy property casualty and life reinsurance coverage to mitigate the liquidity risk 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.
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
2006 10-K Page 22
unwillingness to make payments under the terms of its reinsurance agreement with our insurance subsidiaries
could have a material adverse effect on our financial position, results of operations and cash flows.
Prior to 2003, we participated in USAIG, a joint underwriting association of individual insurance companies that
collectively functions as a worldwide insurance market for all types of aviation and aerospace accounts. At
year-end 2006, 35.5 percent, or $242 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 69, for a discussion of our reinsurance treaties.
Our ability to realize our investment objectives could affect our financial condition, our results
of operations or cash flows.
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 2006, our investment portfolio was $13.699 billion, or
79.5 percent of our total assets. In 2006, our investment operations contributed 27.6 percent of our revenue
and 94.3 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 72.
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 25.7 percent of our shareholders’ equity at year-end 2006
and dividends earned from our Fifth Third investment were 20.2 percent of our investment income in 2006.
If Fifth Third’s common stock price were to decline significantly, our financial condition could be materially
affected. If Fifth Third were to decrease or discontinue its dividend, our results of operations and cash flows
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 quickly sell a part of our holdings to reinvest in other income-earning investments, which would have a
material effect on our results of operations.
Please see Item 1, Investments Segment, Page 14, and Item 7, Investments Results of Operations, Page 56,
and Liquidity and Capital Resources, Page 59, for discussion of our investment activities.
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 17, and Item 8, Note 8 to the Consolidated Financial Statements,
Page 93, for discussion of insurance holding company dividend regulations.
2006 10-K Page 23
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 with 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 its 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 99, for discussion of the
Investment Company Act of 1940.
Our business depends on the uninterrupted operation of our facilities, systems and business
functions.
Our business depends on our associate’s ability to perform necessary business functions, such as processing
new and renewal policies and claims. We increasingly rely on technology and systems to accomplish these
business functions in an efficient and uninterrupted fashion. Our inability to access our headquarters facilities
or a failure of technology, telecommunications or other systems could significantly impair our ability to perform
such functions on a timely basis. If sustained or repeated, such a business interruption or system failure could
result in a deterioration of our ability to write and process new and renewal business, serve our agents and
policyholders, pay claims in a timely manner or perform other necessary business functions. This could result in
a materially adverse effect on our operating results and financial condition.
Item 1B.
None
Unresolved Staff Comments
2006 10-K Page 24
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 $71 million as of December 31, 2006, 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).
Construction of a 690,000 total square foot underground garage and third office tower at our headquarters
building began in early 2005. We estimate a completion date of September 2008 for the project. We believe
this estimated $100 million expansion will accommodate our business needs for the foreseeable future.
The construction project is on schedule and on budget. As of December 31, 2006, construction costs totaled
$41 million, which is classified as land, building and equipment, net, for company use.
Cincinnati Financial Corporation owns the Fairfield Executive Center, which is located on the northwest corner
of our headquarters property. 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, 2006, 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 Springdale, Ohio, approximately
four miles from our headquarters. It contains approximately 102,000 rentable square feet. This property is
carried in the financial statements at $3 million as of December 31, 2006, and is classified as other invested
assets. At year-end 2006, two tenants occupied approximately 37 percent of the rentable square feet.
The remaining space is available for lease. The property is available for sale.
In 2006, The Cincinnati Insurance Company purchased an unoccupied building on 16 acres of land in
Springfield Township, Ohio, approximately six miles from our headquarters. We plan to renovate the
51,000 square foot building to serve as a data processing center and a disaster recovery center. The property,
including land, is carried on our financial statements at $3 million as of December 31, 2006, and is classified
as land, building and equipment, net, for company use.
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 its business.
Item 4.
No matters were submitted to a vote of security holders of Cincinnati Financial during the fourth
quarter of 2006.
Submission of Matters to a Vote of Security Holders
Legal Proceedings
2006 10-K Page 25
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, 2006.
Many of our independent agent representatives and most of the 4,048 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 Global Select Market. The common
stock prices and dividend data below reflects the 5 percent stock dividend paid April 26, 2005.
(Source: Nasdaq Global Select Market)
Quarter:
1st
2nd
2006
3rd
4th
1st
2005
2nd
3rd
High
Low
Period-end close
Cash dividends declared
$
45.56 $
42.07
42.07
0.335
47.01 $
41.43
47.01
0.335
48.44 $
45.93
48.12
0.335
49.07 $
44.25
45.31
0.335
43.92 $
40.84
41.53
0.290
43.12 $
38.38
39.56
0.305
42.64 $
39.00
41.89
0.305
4th
45.95
39.91
44.68
0.305
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 93.
Information regarding securities authorized for issuance under our equity compensation plans appears in the
Proxy Statement under “Securities Authorized for Issuance under Equity Compensation Plans.” This portion of
the Proxy Statement is incorporated herein by reference. Additional information about share-based
compensation granted under our equity compensation plans is available in Item 8, Note 16 to the Consolidated
Financial Statements, Page 100.
The board of directors has authorized share repurchases since 1996. We discuss the board authorization in
Item 7, Uses of Capital, Page 63. In 2006, we repurchased a total of 2,646,787 shares.
Month
January 1-31, 2006
February 1-28, 2006
March 1-31, 2006
April 1-30, 2006
May 1-31, 2006
June 1-30, 2006
July 1-31, 2006
August 1-31, 2006
September 1-30, 2006
October 1-31, 2006
November 1-30, 2006
December 1-31, 2006
Totals
Total number
of shares
purchased(1)
Average
price paid
per share
Total number of shares
purchased as part of
publicly announced
plans or programs(2)
Maximum number of
shares that may yet be
purchased under the
plans or programs
0 $
537,322
1,316,978
0
0
150,000
0
31,666
113,598
27,345
484,021
46,000
2,706,930
0.00
44.12
43.97
0.00
0.00
45.89
0.00
45.98
46.23
48.44
45.15
44.29
44.48
0
537,322
1,312,678
0
0
150,000
0
31,666
110,900
0
458,221
46,000
2,646,787
9,466,035
8,928,713
7,616,035
7,616,035
7,616,035
7,466,035
7,466,035
7,434,369
7,323,469
7,323,469
6,865,248
6,819,248
(1)
Includes 34,343 acquired in 2006, primarily in satisfaction of withholding taxes due upon exercise of stock options.
(2) The current repurchase program was announced on August 19, 2005, and became effective on September 1, 2005.
It replaced a program which had been in effect since 1999. No repurchase program has expired during the period
covered by the above table.
All of the repurchases reported in the table above were repurchased under our 2005 program, which was
approved for 10 million shares. At the time the 1999 program, which was for 17 million shares, was
superseded by the 2005 program, it had 2,739,942 shares remaining. Neither of the programs had an
expiration date but no further repurchases will occur under the 1999 program.
2006 10-K Page 26
Cumulative Total Return
As depicted in the graph below, the five–year total return on a $100 investment made December 31, 2001,
assuming the reinvestment of all dividends, was 49.4 percent for Cincinnati Financial Corporation’s common
stock compared with 71.4 percent for the Standard & Poor’s Composite 1500 Property & Casualty Insurance
Index and 35.0 percent for the Standard & Poor’s 500 Index.
•
The Standard & Poor’s Composite 1500 Property & Casualty Insurance Index includes 28 companies:
Ace Ltd., Allstate Corporation, AMBAC Financial Group, Berkley (W R) Corporation, Chubb Corporation,
Cincinnati Financial Corporation, Fidelity National Financial Inc., First American Corporation, Hanover
Insurance Group, Infinity Property Casualty Corporation, Landamerica Financial Group, MBIA Inc., Mercury
General Corporation, Ohio Casualty Corporation, Old Republic International Corporation, Philadelphia
Consolidated Holding Corporation, Proassurance Corporation, Progressive Corporation, RLI Corporation,
Safeco Corporation, Safety Insurance Group, SCPIE Holdings Inc., Selective Insurance Group Inc.,
St. Paul Travelers Companies Inc., Stewart Information Services, United Fire & Casualty Company,
XL Capital Ltd. and Zenith National Insurance Corp.
•
The Standard & Poor’s 500 Index includes a representative sample of 500 leading companies in a cross
section of industries of the U.S. economy. Although this index focuses on the large capitalization segment
of the market, it is widely viewed as a proxy for the total market.
Total Return Analysis
CFC vs. Market Indices
December 31 Totals
$200
$175
$150
$125
$100
$75
$50
2001
2002
2003
2004
2005
2006
Cincinnati Financial Corporation
S&P 500 Index
S&P Composite 1500 Property & Casualty Insurance Index
2006 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
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,
2006
2005
2004
2003
$
$
$
$
3,278
570
684
4,550
930
5.36
5.30
1.34
1.31
175
13,759
453
17,222
3,896
1,409
791
6,808
39.38
3,164
1,576
3,860
367
51.9 %
11.6
30.8
94.3 %
$
$
$
$
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 %
One-time charges or adjustments:
2006 – The company sold its holdings in Alltel Corporation common stock. The sale contributed $647 million
(pretax) to realized investment gains and revenues and $412 million (after tax), or $2.35 per share, to net
income.
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.
2006 10-K Page 28
2002
2001
2000
1999
1998
1997
1996
$
$
$
$
$
$
$
$
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 %
$
$
$
$
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 %
2006 10-K Page 29
Item 7. Management’s Discussion and Analysis of Financial Condition and
10-K Page
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
Item
7A. Quantitative and Qualitative Disclosures About Market Risk
Introduction
Fixed-maturity Investments
Short-term Investments
Equity Investments
Unrealized Investment Gains and Losses
31
31
35
40
41
42
49
54
56
59
59
61
63
69
69
71
72
73
74
74
75
2006 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 78. We present per share data on a diluted basis
unless otherwise noted and we have adjusted those amounts for all stock splits and dividends.
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 23rd largest property casualty insurer,
based on statutory net written premium volume through the first six months of 2006, the most recent period
for which this information is available. 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.
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 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 2006, we did not achieve some of our objectives for creating shareholder value. For the year, we reached
record levels of new business and total property casualty insurance premiums in the face of growing
competition. Business policyholders continued to respond favorably to their local independent agents’
presentation of the Cincinnati value proposition. In the second half of the year, agents and personal lines
policyholders responded to new pricing for Cincinnati’s personal lines products with higher customer retention
rates and rising new business. Further, our equity-focused investment strategy led to another year of record
investment income and record book value.
However, other factors dampened our enthusiasm for those favorable results. Nine catastrophe events,
primarily storms affecting our policyholders in the Midwest, led to a record level of catastrophe losses even as
the industry experienced a lighter catastrophe year. Loss severity crept upward. And ongoing investment in our
people and our infrastructure, including technology and systems to make it easier for agents to do business
with our company, contributed to expenses rising more rapidly than premiums.
Finally, 2006 earnings reflected the adoption of stock option expensing and, as anticipated, savings from
favorable development of prior period losses below the unusually high level in 2005.
We look beyond 2006 with a measure of optimism. We remain committed to providing a stable market for our
agents’ high quality business, underwriting this business carefully and producing steady value for our
shareholders, as represented by the board of directors’ recent decision to increase our 2007 indicated annual
2006 10-K Page 31
cash dividend by 6 percent, which would mark the 47th consecutive year of increase in that measure. We
believe we can achieve above-industry-average growth in written premiums and industry-leading profitability
over the long term by building on our proven strategies: strong agency relationships, local underwriting, quality
claims service, solid reserves and total return investing.
Over our 56 year history, our growth largely has been driven by increasing our share of the business written by
the agencies that market our products, growth of those agencies and, to a lesser extent, appointment of new
agencies and our periodic entry into new states. During 2007, we expect to make more than 50 new agency
appointments, including our initial appointments in two new states: New Mexico and Washington.
Over the years, we have been able to increase our share of our agencies’ business by making available
insurance products that meet the needs of the individuals and businesses in their communities. In recent
years, our agents have indicated their desire to have Cincinnati available as a market for commercial accounts
that require the flexibility of excess and surplus lines coverage.
Generally, excess and surplus lines insurance carriers provide insurance that is unavailable to businesses in
the standard market due to market conditions or due to characteristics of the insured that are caused by
nature, the insured's history or the nature of their business.
We have studied the option of providing excess and surplus lines coverage for several years and believe it
could contribute to our long-term objectives. Among the potential benefits, we could gain opportunities to
compete for additional accounts by having more flexibility in pricing and policy terms and conditions.
In 2007, we will take the initial steps necessary to incorporate a new excess and surplus subsidiary and
determine its structure. During the year we will appoint a team to begin researching and developing the
appropriate terms and conditions, rates and underwriting guidelines. We anticipate little, if any, premium
contribution from excess and surplus lines in 2007.
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. Detailed discussion of these topics appears in Results of Operations,
Page 40, and the Liquidity and Capital Resources, Page 59.
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
Realized investment gains and losses (pretax)
Total revenues
Net income
Per share data (diluted)
Net income
Cash dividends declared
$
$
Twelve months ended December 31,
2005
2004
2006
2006-2005
Change %
2005-2004
Change %
3,278 $
570
684
4,550
930
5.30 $
1.34
3,164 $
526
61
3,767
602
3.40 $
1.205
3,020
492
91
3,614
584
3.28
1.04
3.6
8.4
1,026.1
20.8
54.5
55.9
11.2
4.8
6.9
(33.1)
4.2
3.1
3.7
16.1
Weighted average shares outstanding
175,451,341
177,116,126
178,376,848
(0.9)
(0.7)
Revenues rose in 2006 and 2005. The growth in 2006 primarily reflected the sale of our Alltel common stock
holdings. In both years, rising pretax investment income offset slowing consolidated property casualty earned
premium growth.
Net income and net income per share reached record levels in 2006 and 2005. A number of factors
contributed to net income:
•
The consolidated property casualty underwriting profit declined in 2006 due to higher catastrophe losses,
increased loss severity and less savings from favorable development of prior period losses as well as
higher underwriting expenses. Underwriting profitability was healthy in 2005. The factors behind these
changes 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 investment gains in the past three years.
○ 2006 – Raised net income by $434 million, or $2.48 per share. The sale of our Alltel common stock
holding contributed $412 million, or $2.35 per share, of the gain.
2006 10-K Page 32
○ 2005 - Raised net income by $40 million, or 23 cents per share.
○ 2004 - Raised net income by $60 million, or 34 cents per share.
• 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 2006, weighted average shares outstanding on a diluted basis had declined 2 million
from year-end 2005.
The board of directors is committed to steadily increasing cash dividends and periodically authorizing stock
dividends and splits. Cash dividends declared per share rose 11.2 percent and 16.1 percent in 2006 and
2005.
Balance Sheet Data and Performance Measures
(Dollars in millions except share data)
Balance sheet data
Invested assets
Total assets
Short-term debt
Long-term debt
Shareholders' equity
Book value per share
Debt-to-capital ratio
Performance measures
Comprehensive income
Return on equity
Return on equity based on comprehensive income
At December 31,
2006
At December 31,
2005
At December 31,
2004
$
$
$
13,759
17,222
49
791
6,808
39.38
$
12,702
16,003
0
791
6,086
34.88
12,677
16,107
0
791
6,249
35.60
11.0 %
11.5 %
11.2 %
2006
Years ended December 31,
2005
2004
1,057
$
14.4 %
16.4
$
99
9.8 %
1.6
287
9.4 %
4.6
Invested assets and total assets rose in 2006 on new investments and appreciation in the equity portfolio.
Invested assets and total assets were flat in 2005 as strong cash flow for new investments was offset by lower
unrealized investment gains.
Comprehensive income is net income plus the year-over-year difference in unrealized gains on investments. In
2006, comprehensive income rose because of higher unrealized gains in the investment portfolio. In 2005 and
2004, comprehensive income was lower because of reduced unrealized gains primarily due to a decline in the
market value of our Fifth Third investment.
Return on equity rose in 2006 due to higher realized gains on investments. Return on equity based on
comprehensive income grew in 2006 due to the increase in accumulated other comprehensive income.
Our ratio of long-term debt to capital (long-term debt plus shareholders’ equity) declined in 2006 due to the
increase in shareholders’ equity due to higher accumulated other comprehensive income.
Property Casualty Highlights
(Dollars in millions)
Property casualty highlights
Written premiums
Earned premiums
Underwriting profit
GAAP combined ratio
Statutory combined ratio
Years ended December 31,
2005
2004
2006
2005-2004
2006-2005
Change % Change %
$
$
3,178
3,164
181
94.3 %
93.9
$
3,076
3,058
330
89.2 %
89.0
2,997
2,919
298
89.8 %
89.4
3.3
3.5
(45.2)
2.6
4.8
10.8
The trend in overall written premium growth reflected the competitive and market factors discussed in Item 1,
Commercial Lines and Personal Lines Property Casualty Insurance Segments, Page 9 and Page 11. In each of
the past three years, our overall written premium growth rate has exceeded that of the industry. Industry net
written premiums were estimated to grow 2.6 percent in 2006 and 4.4 percent in 2004, but declined
0.2 percent in 2005. In the past three years, industry premium trends have been obscured by the reinsurance
sector, where premiums were estimated to have risen 25.1 percent in 2006 after declining 28.2 percent in
2005.
Our consolidated property casualty insurance underwriting profit declined in 2006 after rising in 2005,
matching the trend in our combined ratio. (The combined ratio is the percentage of each premium dollar spent
on claims plus all expenses -- the lower the ratio, the better the performance.) 2006 performance was
tempered by higher catastrophe losses, increased loss severity and less savings from favorable development
on prior period losses as well as higher underwriting expenses.
2006 10-K Page 33
The estimated industry average statutory combined ratios were 93.3 percent, 100.8 percent and 98.5 percent
for 2006, 2005 and 2004, respectively. The 144.9 percent estimated reinsurance sector combined ratio
obscured the industry combined ratio in 2005.
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 2005, we ranked No. 1 or No. 2 by premium volume
in 75 percent of the locations that have marketed our products for more than five years. Other measures
include subdivision of territories and new agency appointments. We ended 2006 with 102 field territories,
subdividing three new territories and merging one into the surrounding regions. As discussed in Item 1,
Growing with Our Agencies, Page 7, we made 55 new agency appointments in 2006, 42 of which were new
relationships. These new appointments and other changes in agency structures led to a net increase in
reporting agency locations of 37 in 2006.
Agent satisfaction with our technology solutions is, and will continue to be, a requirement for maintaining our
strong relationships with these agencies. In 2006, 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 have deployed our new commercial lines policy processing system to agencies in seven states for use in
processing new and renewal businessowners policies. We also deployed our personal lines policy processing
system in six additional states and continued to make important upgrades and enhancements.
MEASURING OUR SUCCESS IN 2007 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 2007, we expect to continue to rank No. 1 or No. 2 by
premium volume in approximately 75 percent or more of the locations that have marketed our products for
more than five years. We expect to improve service to our agencies by subdividing or creating four field
territories in 2007. We also expect to appoint another 50 agencies. We are working on plans to enter New
Mexico and eastern Washington within the next year and will soon begin the process by preparing policy
forms and rates to submit to the departments of insurance in those states.
In 2007, 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 2007 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 growth in our consolidated property casualty written premiums may be in
the low single digits in 2007 compared with the 3.3 percent increase in 2006.
Legislative and regulatory developments in early 2007 added to the uncertainty that already existed for the
insurance industry in Florida. In February 2007, we asked our agents that they not send us new business
submissions. This request, which extends to all lines of insurance and other business areas, may result in
lower 2007 premium growth. It does not affect policies in force, which we will continue to support and
address at renewal, in line with our current underwriting guidelines and in compliance with Florida rules
and regulations. We continue to assess the changing insurance environment in Florida and hope to resume
writing policies in the state as the market stabilizes.
Overall industry premium growth is projected to be 0.1 percent in 2007, which includes an estimated
18.6 percent reinsurance sector growth rate. Net written premiums for the commercial lines industry are
expected to be flat in 2007 while the personal lines sector is expected to grow 1.2 percent.
Our combined ratio estimate for 2007 is 97 percent to 99 percent on either a GAAP or statutory basis
compared with 94.3 percent on a GAAP basis in 2006. The year-over-year increase reflects four
assumptions:
○ Catastrophe losses should contribute approximately 5.5 percentage points to the combined ratio.
We think this is an appropriate estimate based on our reinsurance treaty retention and catastrophe
loss experience in recent years.
○ Savings from favorable reserve development in line with our historical norms. Savings from favorable
development on prior period reserves averaged about 2 percentage points between 2000 and 2003.
Between 2004 and 2006, the average rose to an unusually high level of approximately 5 percentage
points.
○ Loss ratio deterioration as pricing becomes even more competitive and loss severity increases.
2006 10-K Page 34
○ Higher other underwriting expenses as we continue to invest in people and technology. We believe the
consolidated property casualty 2007 underwriting expense ratio could be approximately 31.5 percent.
For these reasons, we may not achieve our objective of an industry-leading combined ratio in 2007.
The projected industry average 2007 combined ratio is 96.8 percent.
• Pursuing a total return investment strategy that generates both strong investment income growth and
•
capital appreciation – In 2007, we are estimating pretax investment income growth to 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 current portfolio attributes.
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. In 2006, our compound annual equity portfolio
return was 16.1 percent, compared with a compound annual total return of 15.8 percent for the Index.
Over the five years ended December 31, 2006, our compound annual equity portfolio return was
2.0 percent compared with a compound annual total return of 6.2 percent for the Index. Our equity
portfolio underperformed the market for the five-year period because of the decline in the market value of
our holdings of Fifth Third common stock between 2002 and 2005.
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. 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 exceed
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 2007, the board increased the indicated annual dividend rate
6.0 percent, marking the 47th 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
49.4 percent was below the 71.4 percent return for 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 2007. As a result, we believe our debt-to-capital ratio
will remain approximately 11 percent.
In December 2006, we finalized our property casualty reinsurance program for 2007, updating it to
maintain the balance between the cost of the program and the level of risk we retain. Under the new
program, our 2007 reinsurance premiums are expected to be $22 million higher than in 2006.
We provide more detail on our reinsurance programs in 2007 Reinsurance Programs, Page 69.
Factors supporting our outlook for 2007 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 85. 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
2006 10-K Page 35
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 and to the use of a claims mediation process that promotes earlier liability settlement resolution
• Reporting pattern changes attributable to case reserving practices, particularly with respect to workers’
compensation claims
• Absence of cost-effective methods for accurately assessing asbestos and environmental claim liabilities
(see Property Casualty Insurance Reserves, Asbestos and Environmental Reserves, Page 66, for discussion
of related reserve levels and trends)
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 $32 million would have a 1 percentage point effect on the loss and loss expense ratio,
based on 2006 earned premiums, a $21 million effect on income and a 12 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 anticipated salvage and subrogation recoveries.
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 the 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. The higher reserves reflect
experience indicating the likelihood that juries would ignore significant liability issues in cases involving
seriously injured claimants.
In 2000, we began using a claims mediation process that promotes earlier liability settlement resolution.
By 2004, we had introduced the program into several states, which has provided favorable results.
To review 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 Models
2006 10-K Page 36
Supplemental statistical information is compiled and reviewed to aid in the application of actuarial methods
and models. The supplemental data also is used to evaluate the reasonableness of estimates derived from the
actuarial methods and models. 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. In 2006, we began 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 2006 and
2005, IBNR reserves differed from the internal actuarial point estimate by less than 2 percent of our loss and
loss expense reserve.
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 64. 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 conducts a supplemental review of full-year data at year-end.
ASSET IMPAIRMENT
Fixed-maturity and equity investments are our largest assets. The company's asset impairment committee
continually monitors these investments and all other assets for signs of other-than-temporary and/or
permanent impairment. 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 in both 2006 and 2005 and $6 million
in 2004.
Our portfolio managers constantly monitor the status of their assigned portfolios for indications of potential
problems that may be possible impairment issues. If a security is trading below book value, the portfolio
managers even more closely scrutinize the security. 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 quantitative measurements such as 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 qualitative 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
2006 10-K Page 37
market conditions. We provide information regarding valuation of our invested assets in Item 8, Note 2 to the
Consolidated Financial Statements, Page 90.
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.
A security valued between 90 percent and 100 percent of book value will not be monitored separately by the
committee. These assets generally are at this value because of interest rate-driven factors. A security valued
below 90 percent of book value is reported to the asset impairment committee. A security valued below
70 percent of book value is defined as distressed.
Distressed securities receive additional scrutiny. Effective January 1, 2006, a security will 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 intent and 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. In addition to evaluating the
security’s current valuation, the impairment committee reviews objective evidence that indicates the potential
for a recovery in value. Information is evaluated regarding the security, such as financial performance, near
term prospects and the financial condition of the region and industry in which the entity operates.
Securities that 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 a security 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
2006 in Item 7A, Unrealized Investment Gains and Losses, Page 75. An other-than-temporary decline in the fair
value of a security is recognized in net income as realized investment losses.
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. A permanent
decline in the fair value of a security is written off at the time when facts and circumstances indicate such
write-down is warranted, and is reflected in realized investment 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 accumulated 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. Some
of our universal life insurance policies contain no-lapse guarantee provisions. For these policies, we establish a
reserve in addition to the account balance based on expected no-lapse guarantee benefits and expected policy
assessments.
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.
Key assumptions used in developing the 2006 net pension obligation were a 5.75 percent discount rate and
rates of compensation increases ranging from 4 percent to 6 percent. Key assumptions used in developing the
2006 10-K Page 38
2006 net pension expense were a 5.50 percent discount rate, an 8 percent expected return on plan assets
and rates of compensation increases ranging from 5 percent to 7 percent.
In 2006, the net pension expense was $19 million. In 2007, we expect a net pension expense of $21 million,
primarily as a result of increased service costs, which are expected to more than offset a 0.25 percent
reduction in the discount rate.
Holding all other assumptions constant, a 0.5 percentage point decline in the discount rate would lower our
2007 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 2006 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 2006 and $8 million at year-end 2005. The fair value of the plan assets was less than the projected
plan benefit obligation by $58 million at year-end 2006 and $62 million at year-end 2005.
The 2005 accumulated benefit obligation and projected benefit obligation amounts were increased by
$6 million and $9 million, respectively, to include the company’s supplemental retirement plan (SERP).
Market conditions and interest rates significantly affect future assets and liabilities of the pension plan.
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.
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 property casualty contingent (profit-sharing)
commissions. We base the contingent commission accrual estimates on property casualty underwriting results
and on supplemental 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 $95 million in 2006 contributed 3.0 percentage points to the
property casualty combined ratio. If contingent commissions paid were to vary from that amount by 5 percent,
it would affect 2007 net income by $3 million (after tax), or 2 cents per share, and the combined ratio by
approximately 0.1 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 in 2007, the account holder would pay a surrender
charge equal to 4 percent of the contract’s account value. Since year five, the surrender charge has decreased
2 percent each policy year and will fall to 0 percent in policy year 11.
2006 10-K Page 39
At year-end 2006, net unamortized realized gains amounted to $2 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 $6 million at year-end 2006.
RECENT ACCOUNTING PRONOUNCEMENTS
Information regarding recent accounting pronouncements is provided in Item 8, Note 1 to the Consolidated
Financial Statements, Page 85. 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 (profit or
loss), which 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 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. We continue to monitor market trends in
construction costs that could affect claim payments and headquarters construction 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 102. The following sections review results of operations for each of the four segments.
Commercial Lines Insurance Results of Operations begins on Page 42, Personal Lines Insurance Results of
Operations begins on Page 49, Life Insurance Results of Operations begins on Page 54, and Investments
Results of Operations begins on Page 56. We begin with an overview of our consolidated property casualty
operations, which is the total of our commercial lines and personal lines segments.
2006 10-K Page 40
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
2006-2005
2005-2004
Change % Change %
2.6
3.3
3.5
8.8
37.9
0.7
13.9
208.1
(45.2)
4.8
5.0
(14.8)
1.6
16.3
(52.3)
10.8
$
$
$
2006
Years ended December 31,
2005
2004
3,178
3,164
1,833
175
596
363
16
181
$
$
$
58.0 %
5.5
63.5
18.8
11.5
0.5
94.3 %
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 %
In addition to the factors discussed in Commercial Lines and Personal Lines Insurance Results of Operations,
Page 42 and Page 49, growth and profitability for the property casualty insurance operations were affected by:
• New business written directly by agencies – New business written directly by agencies was $357 million,
$314 million and $330 million in 2006, 2005 and 2004, respectively. New business levels reflected
market conditions for commercial and personal lines as well as the advantages of our agency relationship
strategy.
• Savings from favorable development on prior period reserves reduced the combined ratio by
3.7 percentage points in 2006 compared with 5.2 and 6.7 percentage points in 2005 and 2004.
The unusually high level of savings in 2004 partially reflected the release of uninsured
motorist/underinsured motorist (UM/UIM) reserves following an Ohio Supreme Court decision in late 2003
to limit its 1999 Scott-Pontzer vs. Liberty Mutual decision.
•
The adoption of stock option expensing increased the 2006 combined ratio by 0.5 percentage points.
• Catastrophe losses contributed 5.5, 4.1 and 5.1 percentage points to the combined ratio in 2006, 2005
and 2004, respectively. Catastrophe losses in 2006 included wind and hail losses in March, April and
October, with incurred losses of $37 million, $37 million and $38 million, respectively. Of the almost
13,000 catastrophe claims reported through January 31, 2007, for all catastrophes in 2006, more than
95 percent are already closed. Our field claims representatives’ prompt responses and personal approach
reflect positively on our agents, supporting their marketing efforts. The following table shows catastrophe
losses incurred, net of reinsurance, for the past three years as well as the effect of loss development on
prior period catastrophe events.
The Cincinnati Insurance Companies do not appoint agencies to actively market property casualty
insurance in Louisiana, Mississippi or Texas. Our 2005 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 of 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. In 2006, we reduced our participation in the Munich Re assumed reinsurance treaty to
1 percent as discussed in Item 1A, Risk Factors, Page 20.
2006 10-K Page 41
Catastrophe Losses Incurred
(In millions, net of reinsurance)
Cause of loss
Dates
2006
Mar. 11-13
Apr. 2-3
Apr. 6-8
Apr. 13-15
Jun. 18-22
Jul. 19-21
Aug. 23-25
Oct. 2-4
Nov. 30 - Dec. 3 Wind, hail, ice, snow
Other 2006 catastrophes
Development on 2005 and prior catastrophes
Calendar year incurred total
Wind, hail
Wind, hail
Wind, hail
Wind, hail
Wind, hail, flood
Wind, hail, flood
Wind, hail, flood
Wind, hail, flood
2005
Wind, ice, snow
Jan. 4-6
Wind, hail
May 6-12
Hurricane Dennis
Jul. 9-11
Hurricane Katrina
Aug. 25-26
Hurricane Rita
Sep. 20-24
Hurricane Wilma
Oct. 24
Wind, hail
Nov. 6
Nov. 15-16
Wind
Other 2005 catastrophes
Development on 2004 and prior catastrophes
Calendar year incurred total
2004
May 17-19
May 21-27
Jul. 12-14
Aug. 13-14
Sep. 3-4
Sep. 15-21
Sep. 25-29
Dec. 22-25
Other 2004 catastrophes
Development on 2003 and prior catastrophes
Calendar year incurred total
Wind, hail
Wind, hail
Wind, hail
Hurricane Charley
Hurricane Frances
Hurricane Jeanne
Hurricane Ivan
Wind, ice, snow
Region
Midwest, Mid-Atlantic
Midwest
South
South
South
South
Midwest
Midwest
Midwest, South
Midwest, Mid-Atlantic
Midwest
South
South
South
South
Midwest
Midwest, South
Midwest, Mid-Atlantic
Midwest, Mid-Atlantic, South
Midwest, Mid-Atlantic, South
South
South
Mid-Atlantic, South
Midwest, Mid-Atlantic, South
Midwest, South
Years ended December 31,
Personal
lines
Commercial
lines
Total
$
$
$
$
$
$
29 $
12
13
4
3
4
5
7
4
7
1
89 $
0 $
4
5
36
3
13
2
2
0
11
76 $
1 $
11
7
16
4
4
21
5
3
(1)
71 $
8 $
5
24
6
2
1
2
31
4
3
0
86 $
1 $
8
2
11
0
12
9
10
0
(2)
51 $
9 $
20
5
10
7
2
18
8
2
(4)
77 $
37
17
37
10
5
5
7
38
8
10
1
175
1
12
7
47
3
25
11
12
0
9
127
10
31
12
26
11
6
39
13
5
(5)
148
The discussions of property casualty insurance segments provide additional detail regarding these factors.
COMMERCIAL LINES INSURANCE RESULTS OF OPERATIONS
Overview -- Three-year Highlights
Performance highlights for the commercial lines segment include:
• Premiums – Although competition in our commercial markets continued to increase, our written premium
growth rate increased in 2006, reflecting our agency relationships, strong new business growth, healthy
policy retention rates, more accurate risk classification, insurance-to-value initiatives, higher reinsurance
treaty retentions and exposure growth due to the healthy economy. These more than offset our deliberate
decisions not to write or renew certain business and the loss of some accounts due to competition. In the
more competitive pricing environment we have been careful to maintain our underwriting discipline for
both renewal and new business. We believe that our written premium growth rate continues to exceed the
average for the overall commercial lines industry, which was estimated at 1.0 percent in 2006 after
declining 0.4 percent in 2005. Earned premium growth remained relatively steady over the period.
• Combined ratio – Our commercial lines combined ratio rose to 91.3 percent in 2006 largely because of
softer pricing, increasing loss severity, less savings from favorable development on prior period reserves
and the adoption of stock option expensing. The combined ratio was very strong in 2005 and 2004.
We continue to focus on sound underwriting fundamentals and seek to obtain adequate premiums per
policy. A single large loss in 2005 increased the ratio in that year by 1.0 percentage point. We discuss large
2006 10-K Page 42
losses and other factors affecting the combined ratio beginning on Page 44. We discuss the savings from
favorable loss reserve development by commercial lines of business on Page 47.
Our commercial lines statutory combined ratio was 90.8 percent in 2006 compared with 87.1 percent in
2005 and 83.7 percent in 2004. By comparison, the estimated industry commercial lines combined ratio
was 94.3 percent in 2006, 99.7 percent in 2005 and 102.5 percent in 2004. We believe our results are
trending differently than the overall industry because the industry experienced unusually high catastrophe
losses in 2004 and 2005 and unusually low catastrophe losses in 2006.
Growth and Profitability
As competition in commercial markets has increased, we have focused on maintaining our pricing discipline for
both renewal and new business. Our independent agents continued to report steady pressure on pricing during
2006 and communicated that winning new business and retaining renewals required more pricing flexibility
and careful risk selection.
We believe our strong new business growth in 2006 and 2005 primarily was due to the local relationships and
efforts of our agents and the field marketing teams that work with them. Our field associates are in our agents’
offices emphasizing the Cincinnati value proposition, calling on prospects with those agents, carefully
evaluating risk exposure and working up their best quotes for good accounts.
For our renewal business, our headquarters underwriters talk regularly with agents. Our field teams are
available to assist the headquarters underwriters by holding renewal review meetings with agency staff to verify
that each commercial account retains the characteristics that caused us to write the business initially. For
quality risks, our commercial underwriters are offering policyholders the convenience of policy extensions of
one and two additional years. Policy extensions provide:
• Retention of the terms and conditions that policyholders originally selected, backed by our superior claims
service and our A++ rating from A.M. Best Co.
• Stable rates on some of the shorter-tail coverages within the policies.
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 independent agents, field marketing representatives and
headquarters underwriters 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 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 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 2006, strong new business activity, higher policy retention rates and higher premiums per policy led to net
written premium growth in all of our commercial lines of business, with commercial auto rising slightly. In 2005,
growth largely was driven by higher commercial casualty premiums 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.
From 2004 through 2006, we experienced no growth in overall commercial lines policy counts as growth in
accounts with premiums above $10,000 offset a decline in the number of smaller accounts. Agency emphasis
and technology considerations were the primary reasons for the shift.
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 $324 million in 2006, up from
$282 million in both 2005 and 2004.
We discuss growth by commercial lines of business on Page 47.
2006 10-K Page 43
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
2006
Years ended December 31,
2005
2004
2006-2005
2005-2004
Change % Change %
6.7
6.6
12.7
16.6
1.4
17.8
208.1
(27.0)
4.7
6.0
12.9
6.0
3.6
13.5
(52.3)
(15.6)
$
$
$
2,442
2,402
1,377
89
444
268
16
208
$
$
$
57.3 %
3.7
61.0
18.5
11.1
0.7
91.3 %
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
50.9 %
3.4
54.3
19.9
9.4
0.5
84.1 %
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 meet with local
agencies to reaffirm agreements on the extent of frontline renewal underwriting they will perform. Loss control,
machinery and equipment and field claims representatives continue to conduct on-site inspections.
Field claims representatives prepare full risk reports on any account reporting a loss above $100,000 or on
any risk of concern. These actions have helped to mitigate rising loss severity.
We describe the significant cost 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 changes for unpaid losses as well as the
associated loss expenses. We believe more competitive market conditions and softer pricing contributed to the
rise in the loss and loss expense ratio excluding catastrophe losses between 2004 and 2006. In addition,
2005 results include a single large loss that was insufficiently covered through our facultative reinsurance
programs, which increased 2005 loss and loss expenses by $22 million, net of reinsurance, or 1.0 percentage
points. Savings from favorable loss reserve development moved lower over the three years, which we discuss
by commercial lines of business on Page 47.
Re-underwriting our commercial lines book of business in the early 2000s has had a positive impact on loss
cost trends such as frequency of loss, resulting in significant savings from favorable reserve development.
The favorable development in 2005 and 2004 also was due to a headquarters claims department initiative,
begun in 2001, to establish higher initial case reserves on severe injury claims. The higher reserves reflect our
experience that juries often ignore significant liability issues in cases involving seriously injured claimants as
well as trends in medical cost inflation and life expectancies. 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.
Another factor in the rise in the loss and loss expense ratio excluding catastrophe losses in 2006 was
increasing loss severity, reflected primarily by an increase in new losses and case reserve increases greater
than $250,000. In total, commercial lines new losses and reserve increases greater than $250,000 rose to
21.3 percent of annual earned premiums in 2006 from 16.8 percent in 2005 and 14.9 percent in 2004. Those
amounts included an increase in new losses greater than $1 million. Our analysis indicated no unexpected
concentration of these losses and reserve increases by risk category, geographic region, policy inception,
agency or field marketing territory. We believe loss severity generally is rising, but we cannot predict the
magnitude of future increases. Severe injury was frequently the cause for new losses greater than $1 million.
We continue to analyze factors that could be contributing to a rise in severe injuries.
2006 10-K Page 44
Commercial Lines Losses by Size
(Dollars in millions)
Years ended December 31,
2005
2004
2006
Losses $1 million or more
Losses $250 thousand to $1 million
Development and case reserve increases of $250 thousand or more
Other losses excluding catastrophes
Total losses incurred excluding catastrophe losses
Catastrophe losses
Total losses incurred
$
$
180
139
193
561
1,073
89
1,162
$
$
124
105
149
596
974
76
1,050
$
$
Ratios 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 excluding catastrophes
Loss ratio excluding catastrophe losses
Catastrophe losses
Total loss ratio
7.5 %
5.8
8.0
23.4
44.7
3.7
48.4 %
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 %
2006-2005
Change %
45.3
32.3
29.5
(5.7)
10.3
16.6
10.7
2005-2004
Change %
54.3
1.2
12.7
11.1
14.2
6.0
13.6
Catastrophe Loss and Loss Expenses
Commercial lines catastrophe losses have been relatively stable as a percentage of net earned premiums over
the past three years.
Commission Expenses
Commercial lines commission expense as a percent of earned premium declined by 1.0 and 0.4 percentage
points in 2006 and 2005, respectively, primarily due to lower profit-sharing commissions on lower overall
underwriting profits. 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 the agencies’ 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 2006
contingent commission accrual reflected our estimate of the profit-sharing commissions that will be paid to our
agencies in early 2007.
Underwriting Expenses
Non-commission underwriting expenses rose to 11.1 percent of earned premiums in 2006 from 10.1 percent
in 2005 and 9.4 percent in 2004. We continue to invest in our associates and technology, which is contributing
to an increase in other underwriting expenses. Higher technology expense contributed 0.3 and 0.1 percentage
points to the increase in 2006 and 2005. Higher staffing expense contributed 0.9 percentage points to the
increase in 2006, with stock option expense accounting for 0.5 percentage points of that amount.
Policyholder Dividends
Policyholder dividend expense was 0.7 percent of earned premium in 2006 compared with 0.2 percent in
2005 and 0.5 percent in 2004. The increase in 2006 was a result of higher paid dividends and increased
accrual for future dividends. The increased accrual reflects the improved profitability of workers’ compensation
policies with respect to recent policy years.
Line of Business Analysis
Approximately 95 percent of our commercial lines premiums relate to accounts with coverages from more than
one of our business lines. As a result, we believe that commercial lines is best measured and evaluated on a
segment basis. However, we provide the line of business data to summarize growth and profitability trends
separately for our business lines.
2006 10-K Page 45
(Dollars in millions)
Commercial casualty:
Written premiums
Earned premiums
Loss and loss expenses incurred
Loss and loss expense ratio
Loss and loss expense ratio excluding catastrophes
Commercial property:
Written premiums
Earned premiums
Loss and loss expenses incurred
Loss and loss expense ratio
Loss and loss expense ratio excluding catastrophes
Commercial auto:
Written premiums
Earned premiums
Loss and loss expenses incurred
Loss and loss expense ratio
Loss and loss expense ratio excluding catastrophes
Workers' compensation:
Written premiums
Earned premiums
Loss and loss expenses incurred
Loss and loss expense ratio
Loss and loss expense ratio excluding catastrophes
Specialty packages:
Written premiums
Earned premiums
Loss and loss expenses incurred
Loss and loss expense ratio
Loss and loss expense ratio excluding catastrophes
Surety and executive risk:
Written premiums
Earned premiums
Loss and loss expenses incurred
Loss and loss expense ratio
Loss and loss expense ratio excluding catastrophes
Machinery and equipment:
Written premiums
Earned premiums
Loss and loss expenses incurred
Loss and loss expense ratio
Loss and loss expense ratio excluding catastrophes
Years ended December 31,
2005
2006
2004
2006-2005
Change %
2005-2004
Change %
$
$
$
$
$
$
$
$
$
$
$
$
$
$
838
831
440
53.0 %
53.0
505
491
282
57.5 %
43.6
450
453
278
61.5 %
60.6
379
366
313
85.4 %
85.4
144
141
94
66.3 %
54.9
97
93
47
50.7 %
50.7
29
27
12
42.0 %
41.6
$
$
$
$
$
$
$
779
759
302
39.8 %
39.8
476
467
300
64.2 %
49.3
448
457
274
60.1 %
60.0
338
328
299
90.9 %
90.9
138
137
92
67.0 %
61.8
85
80
27
34.2 %
34.2
26
26
6
22.4 %
22.5
708
686
321
46.8 %
46.8
455
440
240
54.5 %
42.1
458
450
236
52.4 %
52.1
320
313
251
80.3 %
80.3
135
133
80
59.9 %
47.4
85
80
21
26.6 %
26.6
25
24
5
20.6 %
20.2
7.7
9.5
45.8
6.1
5.1
(5.9)
0.3
(0.9)
1.5
12.1
11.4
4.7
4.6
3.2
2.1
15.3
16.3
72.2
8.7
5.8
98.7
10.0
10.7
(5.9)
4.5
6.0
24.9
(2.2)
1.5
16.3
5.4
5.1
18.9
2.1
2.5
14.6
(0.1)
(0.8)
27.9
6.8
8.0
17.1
The accident year loss data provides current estimates of incurred loss and loss expenses for the past three
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.
(Dollars in millions)
Loss and loss expenses incurred:
Commercial casualty
Commercial property
Commercial auto
Workers' compensation
Specialty packages
Surety and executive risk
Machinery and equipment
Loss and loss expenses ratio:
Commercial casualty
Commercial property
Commercial auto
Workers' compensation
Specialty packages
Surety and executive risk
Machinery and equipment
$
2006
Accident year
2005
2004
$
540
278
300
303
91
41
11
64.9 %
56.6
66.1
82.8
64.7
44.4
39.2
$
420
300
281
254
80
39
7
55.4 %
64.2
61.4
77.4
58.6
48.3
28.6
359
261
269
250
82
29
4
52.4 %
59.3
59.8
79.8
61.2
36.2
18.6
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.
2006 10-K Page 46
Commercial Casualty
Commercial casualty is our largest business line. Commercial casualty net written premium growth slowed in
2006, but remained above the overall growth rate for commercial lines. While casualty pricing continues to
become more competitive, new business is strong. We also are seeing a boost from the healthy business
economy over the past several years as well as related exposure growth.
The commercial casualty loss and loss expense ratio rose in 2006 after improving in 2005, but remained
within the range we consider appropriate. In each of the last three calendar years, activity in the reserves for
prior period losses has been the primary reason for the fluctuations in the loss and loss expense ratio.
• 2006 – Favorable development lowered the loss and loss expense ratio by 12.0 percentage points.
• 2005 – Favorable development lowered the loss and loss expense ratio by 22.5 percentage points.
• 2004 – Favorable development lowered the loss and loss expense ratio by 20.0 percentage points.
Over the three years, flat commercial umbrella loss costs helped produce savings through favorable
development on prior period reserves. Factors that contributed to the flat loss cost trend included commercial
lines re-underwriting efforts, Ohio judicial decisions regarding underinsured/uninsured motorist claims and a
claims mediation process that promoted earlier liability settlement resolution, which also contributed to lower
loss cost trends for our other general liability coverages. Once these commercial lines and claims initiatives are
fully implemented, loss cost trends could be expected to return to normal levels.
Another factor that helped produce savings through favorable development was the headquarters claims
department initiative to establish higher initial case reserves on serious injury claims. The higher reserves
reflect our experience indicating the likelihood that juries would ignore significant liability issues in cases
involving seriously injured claimants as well as trends in medical cost inflation and life expectancies.
In large part because this business line also includes umbrella coverages, the accident year loss and loss
expense ratio can fluctuate significantly on a year-over-year basis.
Commercial Property
Commercial property is our second largest business line. Commercial property net written premiums rose in
2006 and 2005. The primary reason for the more rapid growth in 2006 was a $5 million ceded reinsurance
reinstatement premium in 2005 to restore affected layers of our property catastrophe reinsurance program
following Hurricane Katrina. This added 1.2 percentage points to the 2006 growth rate.
The commercial property loss and loss expense ratio excluding catastrophe losses improved in 2006 after
rising in 2005 and remained within the range we consider appropriate. In each of the last three calendar years,
activity in the reserves for prior period losses contributed to the changes in the loss and loss expense ratio.
• 2006 – Reserve strengthening raised the loss and loss expense ratio by 0.9 percentage points.
• 2005 – Reserve strengthening raised the loss and loss expense ratio by 3.5 percentage points.
• 2004 – Reserve strengthening raised the loss and loss expense ratio by 0.3 percentage points.
In addition, the large loss discussed on Page 42 added 5.0 percentage points to the 2005 ratio.
Commercial Auto
Commercial auto net written premiums rose slightly in 2006 after declining 2.2 percent in 2005. We are
beginning to see the impact of the downward pressure on pricing on underwriting results. Commercial auto is
one of the business lines that we renew and price annually, so market trends may be reflected here more
quickly than in other lines. Commercial auto also is generally one of the larger components of the typical
package.
As a result of our underwriting activities and moderating industrywide severity and frequency trends, the loss
and loss expense ratio for commercial auto remained at an acceptable level in 2006 and 2005 despite
increasing due to pricing pressures. The increase in the loss and loss expense ratio in 2006 also reflected
a 2.9 percentage point rise in the ratio of $1 million plus losses to commercial auto earned premiums.
In each of the last three calendar years, favorable development on prior period losses, due to commercial lines
re-underwriting efforts and favorable frequency and severity trends, contributed to the changes in the loss and
loss expense ratio.
• 2006 – Favorable development lowered the loss and loss expense ratio by 4.6 percentage points.
• 2005 – Favorable development lowered the loss and loss expense ratio by 5.0 percentage points.
• 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.
2006 10-K Page 47
Workers’ Compensation
In 2006 and 2005, workers’ compensation written premiums rose more rapidly than our total commercial lines
written premiums. Workers’ compensation premiums are benefiting from the healthy business economy and
related payroll growth. Premiums also are benefiting from initiatives to modestly expand our workers’
compensation business in selected states. We cannot offer workers’ compensation coverage in Ohio,
our highest volume state, because it is provided solely by the state instead of private insurers.
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.
The workers’ compensation loss and loss expense ratio rose in 2005 after remaining steady for several years
and remained above our target levels in 2006. The 2005 rise largely was due to a higher level of reserve
strengthening for older accident years. The ratio remained above our target level in 2006 because of modest
reserve strengthening and seven new losses greater than $1 million, primarily in the second half of the year.
The seven losses in 2006 totaled $18 million and added 4.9 percentage points to the workers’ compensation
loss and loss expense ratio. There was only one similarly sized loss, for $1.6 million, in 2005 and none in
2004.
Our philosophy is to establish case reserves when we learn of a loss to reflect our best estimate of ultimate
payouts. The higher initial reserves established in 2006 for newly reported claims demonstrate our
commitment to applying our claims reserving philosophy to this business line.
In 2006, we also reviewed each of our established workers’ compensation case reserves above $100,000 in
light of current trends in medical cost inflation and estimated payout periods. The review led to the allocation of
approximately $60 million to case reserves held for specific claims from accident years going back as much as
20 years. Reductions to IBNR reserves offset approximately $44 million of those reserve increases. We had
raised workers’ compensation IBNR reserves in 2005, in light of the trends identified in the workers’
compensation market. However, small shifts in medical cost inflation and payout periods could have a
significant effect on our potential future liability compared with our current projections.
Activity in the reserves for prior period losses in the past three years included:
• 2006 – Reserve strengthening raised the loss and loss expense ratio by 2.6 percentage points,
as discussed above.
• 2005 – Reserve strengthening raised the loss and loss expense ratio by 12.9 percentage points.
The reserve strengthening primarily was due to medical cost inflation and longer estimated payout periods
compared with our original projections.
• 2004 – Reserve strengthening raised the loss and loss expense ratio by 4.9 percentage points, which also
was due to medical cost inflation.
Specialty Packages
Specialty packages net written premiums rose in 2006 and 2005. The rollout we have begun of our
commercial lines policy processing system should help us meet changing agency needs and address pricing,
technology and service systems other carriers have introduced for similar products in recent years.
The loss and loss expense ratio excluding catastrophe losses improved in 2006 after rising in 2005, but
remained within the range we consider appropriate. In each of the last three calendar years, activity in the
reserves for prior period losses contributed to the fluctuations in the loss and loss expense ratio.
• 2006 – Reserve strengthening raised the loss and loss expense ratio by 1.6 percentage points.
• 2005 – Reserve strengthening raised the loss and loss expense ratio by 10.9 percentage points.
• 2004 – Reserve strengthening raised the loss and loss expense ratio by 3.7 percentage points.
Surety and Executive Risk
Surety and executive risk net written premiums rose in 2006 and were unchanged in 2005. Healthy economic
activity drove the 2006 growth.
The loss and loss expense ratio rose in 2006 and 2005; however, surety and executive risk losses can
fluctuate significantly, and we do not believe that the increases indicate any new trend or risk.
Director and officer liability coverage accounted for 59.0 percent of surety and executive risk premiums in
2006 compared with 61.7 percent in 2005 and 65.7 percent in 2004. Our director and officer liability policies
are offered primarily to nonprofit organizations, reducing the risk associated with this line of business. As of
December 31, 2006, two of our in-force director and officer liability policies covered Fortune 500 companies,
36 covered publicly traded companies (excluding banks and savings and loans) and 57 covered banks and
savings and loans with more than $500 million in assets.
2006 10-K Page 48
In each of the last three calendar years, activity in the reserves for prior period losses contributed to the
changes in the loss and loss expense ratio.
• 2006 – Reserve strengthening raised the loss and loss expense ratio by 21.1 percentage points due to
case reserves additions for director and officer liability claims.
• 2005 – Favorable development lowered the loss and loss expense ratio by 5.4 percentage points.
• 2004 – Favorable development lowered the loss and loss expense ratio by 9.3 percentage points.
Machinery and Equipment
Machinery and equipment net written premiums rose in 2006 and 2005. Marketing by machinery and
equipment and field marketing representatives contributed to the 2006 growth.
The loss and loss expense ratio rose in 2006; however, machinery and equipment losses can fluctuate
significantly, and we do not believe that the increase indicates any new trend or risk.
In each of the last three calendar years, activity in the reserves for prior period losses contributed to the
changes in the loss and loss expense ratio.
• 2006 – Reserve strengthening raised the loss and loss expense ratio by 0.8 percentage points.
• 2005 – Favorable development lowered the loss and loss expense ratio by 3.7 percentage points.
• 2004 – Favorable development lowered the loss and loss expense ratio by 1.3 percentage points.
Commercial Lines Insurance Outlook
Industrywide commercial lines written premiums are expected to decline approximately 1.0 percent in 2007.
During 2006, agents again reported that renewal pricing pressure had risen and new business pricing was
requiring even more flexibility and more careful risk selection. During 2006, we continued to need 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. By year-end 2006, our field marketing
representatives reported pricing down about 10 percent to 15 percent on average to write the same piece of
new business we would have quoted in 2005. By comparison, 5 percent to 10 percent rate declines seem to be
typical for renewal business.
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.
We believe our approach should allow us to continue to underwrite commercial lines business profitably in
2007, but we do not believe favorable reserve development will contribute to underwriting profits as much in
2007 as in the past three years. In addition, underwriting expenses are rising. We discuss our overall outlook
for our property casualty insurance operations in Measuring Our Success in 2007 and Beyond, Page 34.
PERSONAL LINES INSURANCE RESULTS OF OPERATIONS
Overview -- Three-year Highlights
Performance highlights for the personal lines segment include:
• Premiums – As competition in our personal lines markets continued to increase and we continued to work
to generate consistent profitability in our personal lines market, our written premiums declined again in
2006, reflecting lower new business and policy retention rates through the first half of the year and lower
pricing in the second half of the year. Industry average written premium growth was estimated at
2.0 percent for 2006, 3.7 percent for 2005 and 6.6 percent for 2004.
Personal lines new business premiums written directly by agencies increased 1.6 percent to $33 million in
2006 after declining 33.9 percent to $32 million in 2005 and 19.9 percent to $48 million in 2004.
• Combined ratio – After improving substantially in 2005, the combined ratio increased in 2006 due to
higher catastrophe losses, less savings from favorable development on prior period reserves, an increase
in loss severity and higher expenses. Lower earned premiums exacerbated the year-over-year comparisons.
Our personal lines statutory combined ratio was 103.6 percent in 2006 compared with 94.3 percent in
2005 and 104.6 percent in 2004. By comparison, the estimated industry personal lines combined ratio
was 92.0 percent in 2006, 97.6 percent in 2005 and 94.9 percent in 2004. We believe our results are
trending differently than the overall industry because of the competitive and pricing factors discussed
below.
2006 10-K Page 49
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 late 2004, price competition returned to the personal lines market as insurers leveraged the higher
profitability and stronger financial positions that were the outcome of industrywide increases in homeowner
rates and stricter enforcement of underwriting standards between 2000 and 2003.
When price competition emerged in 2004, we were in the early stages of a program to improve profitability for
our homeowner line by raising rates and making changes to our policy terms and conditions. We raised our
personal lines rates in some territories too high to allow our agents to market the benefits of a Cincinnati policy,
leading to declines in our policy retention rates and lower new business levels between 2002 and 2005.
We opted to delay certain rate changes to address the competitive situation until mid-2005 because we felt it
was more 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, offering 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, but written premiums, new business and retention rates
continued to decline.
During the 2003 to 2005 period, we also were introducing Diamond in our higher volume states, which may
have contributed to lower growth rates. The focus required by our agencies to convert to our newer technology
and make the necessary adaptations to their 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 work flow, and many now are seeing
benefits from efficiencies as they renew business through the system.
During 2005 and 2006, 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, invoicing for multiple policies at one time, and electronic funds transfer, which accommodates new
monthly payment plans. We continue to respond to agency requests for enhancements as we prepare Diamond
for additional states.
In mid-2006, we introduced a limited program of policy credits to incorporate insurance scores into homeowner
and personal auto pricing. These were intended to improve our ability to compete for our agents’ highest quality
personal lines accounts, increasing the opportunity for our agents to market the advantages of our personal
lines products and services to their clients.
The policy credits contributed to increases in new business for both personal auto and homeowner for the first
time in several years. The new credit structure also led to improved retention of current business. However,
new business did not rise sufficiently to offset the lower prices that our current personal lines policyholders
received at renewal with these policy credits. As a result, total net written premiums continued to decline in the
second half of 2006. To build on the new business and retention trends of the second half of 2006, we will
need to monitor the competitiveness of our personal auto and homeowner rates on an ongoing basis and make
refinements as necessary.
Strategies to accelerate our personal lines growth are discussed in Personal Lines Outlook, Page 54. We
discuss premium trends by personal lines of business on Page 53.
2006 10-K Page 50
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
2006
Years ended December 31,
2005
2004
2006-2005
2005-2004
Change % Change %
(6.4)
(5.3)
(1.5)
69.8
(1.6)
4.2
(160.0)
(3.0)
1.4
(11.3)
(34.2)
(3.6)
24.0
214.0
$
$
$
736
762
456
86
152
95
(27)
$
$
$
59.9 %
11.3
71.2
19.9
12.5
103.6 %
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 %
In 2006, we did not achieve the profit levels we had hoped to realize, following the improvement of the
personal lines combined ratio in 2005. Instead, higher catastrophe losses and other factors caused the
2006 combined ratio to rise.
We describe the significant cost 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 changes for unpaid losses as well as the
associated loss expenses. The change in the loss and loss expense ratio excluding catastrophe losses between
2004 and 2006 largely was due to pricing and loss cost trends. Increased loss severity was seen primarily in
higher new losses and case reserve increases greater than $250,000. In total, personal lines new losses and
case reserve increases greater than $250,000 were 11.1 percent of annual earned premiums in 2006
compared with 8.2 percent in 2005 and 10.2 percent in 2004. Personal lines new losses and case reserve
increases declined as a percent of earned premiums in 2005, in part because of higher rates per exposure.
Our analysis indicated no unexpected concentration of these losses and case reserve increases by risk
category, geographic region, policy inception, agency or field marketing territory. In 2006, homeowner fires,
which spiked in the third quarter, were the most frequent cause for new losses greater than $1 million.
We believe loss severity generally is rising, but we cannot predict the magnitude of future increases.
Savings from favorable loss reserve development moved lower over the three years, which we discuss by
personal lines of business on Page 53.
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 excluding catastrophes
Total losses incurred excluding catastrophe losses
Catastrophe losses
Total losses incurred
$
$
Ratios 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 excluding catastrophes
Loss ratio excluding catastrophe losses
Catastrophe losses
Total loss ratio
Years ended December 31,
2005
2004
2006
23
39
22
309
393
86
479
$
$
3.0 %
5.2
2.9
40.5
51.6
11.3
62.9 %
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 %
2006-2005
Change %
79.1
14.5
16.8
(8.9)
(3.0)
69.8
5.1
2005-2004
Change %
(26.0)
(19.9)
(7.7)
(8.5)
(10.2)
(34.2)
(13.7)
Catastrophe Loss and Loss Expenses
Personal lines catastrophe losses, net of reinsurance and before taxes, contributed 5 percentage points more
to the combined ratio in 2006 because of an increase of $35 million in incurred catastrophe losses and lower
earned premium. The majority of these losses related to wind and hail from storms in Indiana and Ohio.
2006 10-K Page 51
Commission Expenses
Personal lines commission expense as a percent of earned premium rose by 0.7 percentage points in 2006
after declining by 0.9 percentage points in 2005. The 2006 change was primarily due to higher profit-sharing
commissions resulting from accrual and allocation adjustments. 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 the agencies’ 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 0.2 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 2006 contingent commission accrual reflected our estimate of the profit-sharing commissions that will be
paid to our agencies in early 2007.
Underwriting Expenses
Non-commission underwriting expenses increased 1.2 percentage points in 2006 and 2.0 percentage points in
2005. We continue to invest in our associates and technology, which is contributing to an increase in
non-commission underwriting expenses. Higher technology expense contributed 0.8 and 0.5 percentage points
to the increase in 2006 and 2005. Higher staffing expense contributed 0.8 to the increase in 2006, with stock
option expense accounting for 0.5 percentage points of that amount. Increases in those amounts in 2006 were
offset partially by savings in taxes, licenses and fees. The increase in 2005 reflected an unfavorable deferred
acquisition cost comparison of 1.0 percentage points due to premium declines.
Line of Business Analysis
We prefer to write personal lines coverage on an account basis that includes both auto and homeowner
coverages as well as coverages from the other personal business line. As a result, we believe that personal
lines is best measured and evaluated on a segment basis. However, we provide the line of business data to
summarize growth and profitability trends separately for the three business lines.
(Dollars in millions)
Personal auto:
Written premiums
Earned premiums
Loss and loss expenses incurred
Loss and loss expense ratio
Loss and loss expense ratio excluding catastrophes
Homeowner:
Written premiums
Earned premiums
Loss and loss expenses incurred
Loss and loss expense ratio
Loss and loss expense ratio excluding catastrophes
Other personal:
Written premiums
Earned premiums
Loss and loss expenses incurred
Loss and loss expense ratio
Loss and loss expense ratio excluding catastrophes
Years ended December 31,
2005
2006
2004
2006-2005
Change %
2005-2004
Change %
$
$
$
$
$
$
359
385
250
65.0 %
62.2
290
289
240
83.0 %
59.3
87
88
52
59.4 %
52.0
$
$
$
409
433
259
59.9 %
59.3
288
282
213
75.5 %
58.6
89
89
40
44.6 %
41.6
453
451
298
66.1 %
65.1
270
256
247
96.3 %
69.0
88
86
55
63.7 %
60.0
(12.4)
(11.2)
(3.5)
(9.6)
(4.0)
(13.0)
0.7
2.3
12.4
6.7
10.4
(13.4)
(2.0)
(1.1)
31.6
1.3
3.4
(27.6)
The accident year loss data provides current estimates of incurred loss and loss expenses for the past three
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.
(Dollars in millions)
Loss and loss expenses incurred:
Personal Auto
Homeowner
Other Personal
Loss and loss expenses ratio:
Personal Auto
Homeowner
Other Personal
2006
Accident year
2005
2004
$
$
248
235
77
64.5 %
81.5
88.0
$
272
219
58
62.8 %
77.6
65.4
303
255
64
67.3 %
99.6
74.4
2006 10-K Page 52
Personal Auto
Written and earned premiums for the personal auto line declined in 2006 and 2005. As noted above, the
decline primarily was due to price competition in some states and territories, which resulted in lower policy
renewal retention and significantly lower new business levels through mid-2006. We continue to monitor and
modify selected rates and credits to address our competitive position.
The loss and loss expense ratio for personal auto has remained satisfactory. For selected agencies, we use
re-underwriting programs to review and to strengthen underwriting standards, such as requiring motor vehicle
reports for insured drivers. We work with agencies to develop strategies to increase the company’s penetration
of the agency’s personal lines business. The rise in the ratio in 2006 was due to price reductions.
In each of the last three calendar years, activity in the reserves for prior period losses contributed to the
changes in the loss and loss expense ratio.
• 2006 – Reserve strengthening raised the loss and loss expense ratio by 0.6 percentage points.
• 2005 – Favorable development lowered the loss and loss expense ratio by 1.9 percentage points.
• 2004 – Reserve strengthening raised the loss and loss expense ratio by 0.2 percentage points.
Homeowner
The growth rate of written and earned premiums for the homeowner line slowed over the three-year period.
As discussed above, until mid-2006, the benefit of rate increases in 2004 and 2005 was being increasingly
offset by lower policy renewal retention rates and significantly lower new business levels. Earned premiums
rose more rapidly because of the benefit of higher written premium growth in earlier periods.
We began a strategic shift in 2004 to a more conventional one-year homeowner policy term from our traditional
three-year policy term. 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 modify
rates, terms and conditions more promptly in response to market changes. At year-end 2006, approximately
85 percent of all homeowner policies had been converted to a one-year term, up from approximately
56 percent at year-end 2005. We are continuing to renew homeowner policies for three-year terms in five
states that currently account for less than 1 percent of total personal lines premiums.
The loss and loss expense ratio for the homeowner line excluding catastrophe losses rose in 2006 after
improving in 2005. The increase in 2006 reflected a higher contribution from large losses. In each of the last
three calendar years, activity in the reserves for prior period losses also contributed to the changes in the loss
and loss expense ratio.
• 2006 – Reserve strengthening raised the loss and loss expense ratio by 1.5 percentage points.
• 2005 – Favorable development lowered the loss and loss expense ratio by 0.4 percentage points.
• 2004 – Favorable development lowered the loss and loss expense ratio by 2.7 percentage points.
We continue to seek to improve homeowner results so that this line achieves profitability. Since we generally do
not allocate non-commission expenses to individual business lines, to measure homeowner profitability,
we now assume total commission and underwriting expenses would contribute approximately 33 percentage
points to our homeowner combined ratio, up from a 32 percent assumption in prior years. Lower levels of
premium growth affected our ability to attain our expense ratio target in 2006 and may continue to do so in
the future.
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 22.2 percent of homeowner earned
premiums. We did not change our catastrophe loss assumption because the geographic concentration of these
losses has been unusual in the past three years.
We had hoped that by 2007 the full benefit of our pricing and underwriting actions would be reflected in
homeowner results and this line would be approaching breakeven. Pricing changes enacted in mid-2006,
however, have slowed our progress toward overall homeowner profitability.
Other Personal
Other personal written premiums were down slightly in 2006 after rising slightly in 2005. Lower retention and
new business for homeowner and personal auto during 2005 and the first half of 2006 contributed to the
decline, since most of our other personal coverages are endorsed to homeowner or auto policies.
The loss and loss expense ratio for other personal rose in 2006 due to higher personal umbrella and dwelling
fire losses in the second quarter. Personal umbrella losses can fluctuate significantly, and we do not believe
that the increase indicated any new trend or risk. In each of the last three calendar years, activity in the
reserves for prior period losses also contributed to the changes in the loss and loss expense ratio.
• 2006 – Favorable development lowered the loss and loss expense ratio by 28.6 percentage points.
• 2005 – Favorable development lowered the loss and loss expense ratio by 28.7 percentage points.
2006 10-K Page 53
• 2004 – Favorable development lowered the loss and loss expense ratio by 18.9 percentage points.
Personal Lines Insurance Outlook
Industry experts currently anticipate industrywide personal lines written premiums will rise approximately
1.2 percent in 2007. While the rise in new business levels and policy retention rates in the second half of 2006
are positive indications for our personal lines business, we believe our growth rate will be below that of the
industry in 2007.
We are pursuing a number of strategies in our personal lines business to achieve our long-term objectives for
this segment:
• Competitive rates –In mid-2006, we introduced insurance scores into our program of policy credits for
homeowner and personal auto pricing. That action led to the increased new business for both personal
auto and homeowners in the second half of 2006. It also led to improved retention of current business.
While these pricing refinements have reduced premiums per policy, we believe they present an opportunity
to attract our agents’ more quality conscious clientele.
• Policy characteristics – In keeping with industry practices, most of our homeowner products no longer
automatically provide guaranteed full replacement cost coverage in our basic policies. 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 have diminished some of the factors that distinguished our products.
• Diamond introduction –The Diamond system is in use by agencies writing approximately 90 percent of
personal lines premium volume. 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 47 percent and headquarters printing for 81 percent of policy transactions in 2006.
• 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 and geographic diversity.
We currently market both homeowner and personal auto insurance products through 772 of our
1,289 reporting agency locations in 22 of the 32 states where we market commercial lines insurance.
We market homeowner products through 22 locations in three additional states (Maryland, North Carolina
and West Virginia).
During 2007, we hope to add personal lines for 30 to 35 agency locations in the 13 states in which
Diamond is in use that currently market only our commercial lines products. During 2007, our field teams
and personal lines associates are contacting these agencies to re-introduce them to our personal lines
product line and technology. Expanding into these agencies would provide additional sources of premiums
and help geographically diversify our personal lines portfolio.
We identify several other factors that may affect the personal lines combined ratio in 2007 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 2006 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 2007 and Beyond, Page 34.
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 $56.971 billion at year-end 2006 from $51.493 billion at year-end 2005 and
$44.921 billion at year-end 2004.
• Profitability – The life insurance segment reports a small GAAP loss because its investment income is
included in investment segment results, except investment income credited to contract holders (interest
assumed in life insurance policy reserve calculations). The segment operating profit declined in 2006 after
improving in 2005 due to:
○ Higher mortality expenses compared with the year-earlier periods principally due to growth in life
insurance in force. Mortality experience remained within pricing guidelines.
○ Adoption of stock option expensing, which added approximately $1 million to 2006 other operating
expenses.
2006 10-K Page 54
At the same time, we recognize that 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 products. For that reason, we also evaluate GAAP data, including all investment activities on life
insurance-related assets, which grew 32.6 percent in 2006 to $63 million and 23.8 percent in 2005 to
$47 million. The life insurance company portfolio had pretax realized investment gains of $45 million in
2006 compared with $17 million in 2005 and $9 million in 2004.
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
Operating expenses incurred
Total benefits and expenses
Life insurance segment profit (loss)
Years ended December 31,
2005
2006
2004
$
$
$
161 $
115 $
3
118
122
(54)
51
119
(1) $
205 $
106 $
4
110
102
(51)
52
103
7 $
193
101
3
104
95
(46)
53
102
2
2006-2005
Change %
(21.3)
2005-2004
Change %
6.5
7.9
(0.3)
7.6
20.1
5.7
(1.8)
16.1
(115.4)
5.7
18.5
6.0
7.2
12.9
(0.3)
0.8
334.2
Growth
We offer term, whole life and universal life products, fixed annuities and disability income products.
Total statutory life insurance net written premiums were $161 million in 2006 compared with $205 million in
2005 and $193 million in 2004. Total statutory written premiums for life insurance operations for all periods
include life insurance, annuity and accident and health premiums. The change primarily was due to:
• Statutory written premiums for term and other life insurance products rose 12.7 percent to $127 million
for 2006 and declined 4.2 percent to $113 million for 2005.
• Statutory written annuity premiums declined $58 million in 2006 and increased $18 million in 2005.
Since late 2005, we have de-emphasized annuities because of an unfavorable interest rate environment.
Fee income from universal life products declined 14.9 percent to $23 million in 2006 and rose 2.7 percent in
2005 to $27 million. Separate account investment management fee income contributed $3 million, $4 million
and $3 million to total revenues in 2006, 2005 and 2004.
In 2006, our life insurance segment experienced a 0.3 percent rise in life applications submitted and a
10.6 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 banner. Our product development efforts emphasize death benefit protection
and guarantees.
Distribution expansion within our property casualty insurance agencies 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:
• Contract holders benefits incurred related to traditional life and interest-sensitive products accounted for
70.3 percent of 2006 total benefits and expenses, 66.0 percent of 2005 total benefits and expenses and
64.3 percent of 2004 total benefits and expenses.
• Operating expenses incurred, net of deferred acquisition costs, accounted for 29.7 percent of 2006 total
benefits and expenses, 34.0 percent of 2005 total benefits and expenses and 35.7 percent of 2004 total
benefits and expenses. Stock option expense added $1 million, or 0.7 percentage points, to expenses in
2006.
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 value
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
the life insurance operation are on par with industry averages. During the past several years, we have invested
2006 10-K Page 55
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. 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, we
introduced new universal life products including cash value accumulation products for adults and children.
Marketplace and regulatory changes continued to affect the availability of cost-effective reinsurance for term
life insurance. 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.
Because of the conservative nature of statutory reserving principles, retaining the policy reserve requires a
large commitment of capital and reduces statutory earnings. However, we believe the long-term profitability of
term life insurance serves to enhance GAAP results. Although the exact timing and details are uncertain, the
NAIC continues to make progress toward comprehensive reforms of statutory reserving principles, as we
discuss in 2007 Reinsurance Programs, Page 69.
In the future, we expect that assets under management, capital appreciation and investment income, which
are reported in investment segment results, will continue to be integral to our evaluation of the success of the
life insurance operations. While life insurance segment profit may continue to fluctuate near break-even, when
we also consider life insurance investment activities, we continue to believe the life insurance operations will
continue to provide a steady income stream to help offset the fluctuations of the property casualty insurance
business.
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 2006, rising 8.4 percent from the
prior record in 2005. 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 investment gains and losses – We reported realized investment gains in 2006 and 2005 largely
due to investment sales. The sale of our Alltel common stock holding contributed $647 million (pretax) of
the 2006 gain.
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
Investment operations income
Years ended December 31,
2005
2006
2004
2006-2005
2005-2004
Change % Change %
$
$
300 $
262
15
(7)
570
(54)
678
7
(1)
684
1,200 $
280 $
244
8
(6)
526
(51)
69
(7)
(1)
61
536 $
252
239
6
(5)
492
(46)
87
10
(6)
91
537
7.1
7.5
90.0
(19.3)
8.4
5.7
883.0
200.7
41.7
1,026.0
124.0
11.2
2.1
29.4
(22.3)
6.9
12.9
(20.7)
(167.2)
78.5
(33.1)
(0.4)
Investment Income
Growth in investment income reflected new investments, higher interest income from the growing fixed-
maturity portfolio and increased dividend income from the common stock portfolio. The advantages of strong
cash flow in the past three years for new investments have been somewhat offset by the challenge of investing
in a low interest rate environment. In 2006, proceeds from the sale of the Alltel holding that were later used to
make the applicable tax payments during the year were invested in short-term instruments that generated
approximately $5 million in interest income.
Overall, common stock dividends contributed 42.4 percent of pretax investment income in 2006 compared
with 43.7 percent in 2005 and 43.9 percent in 2004. Fifth Third, our largest equity holding, contributed
2006 10-K Page 56
43.8 percent of total dividend income in 2006. We discuss our Fifth Third investment in Item 7A, Quantitative
and Qualitative Disclosures About Market Risk, Page 75. In 2006, 38 of the 50 common stock holdings in the
portfolio raised their indicated annual dividend payout, as did 36 of 49 in 2005 and 33 of 51 in 2004.
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 the past three years 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.
• 2006 – We sold the remainder of our Alltel common stock holdings. We discuss this sale in Item 1,
Investments Segment, Page 14, and Item 8, Note 2 to the Consolidated Financial Statements, Page 90.
• 2005 – 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 gains from the initial sales of a portion of our Alltel holding.
• 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 strategic shift in business strategy that is not consistent with our
long-term outlook.
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 2006, we recorded $7 million in fair value increases compared with $7 million in fair value declines in 2005
and $10 million in fair value increases in 2004. 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 the discussion of Derivative Financial Instruments and Hedging Activities in Item 8,
Note 1 to the Consolidated Financial Statements, Page 85, for details on the accounting for convertible security
embedded options.
Other-than-temporary Impairment Charges
In 2006 and 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. 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 2006, 2005 and 2004. 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 the past three years was due to prior
impairments in the portfolio, disposition of certain securities in prior years and an improvement in the general
financial climate.
Other-than-temporary impairment charges from the investment portfolio by industry are summarized as follows:
(In millions)
Automotive
Airline
Other
Total
Years ended December 31,
2005
2004
2006
$
$
(1)
0
0
(1)
$
$
(1)
0
0
(1)
$
$
0
(5)
(1)
(6)
2006 10-K Page 57
Other-than-temporary impairment charges from the investment portfolio by the asset class we described in
Item 1, Investments Segment, Page 14, are summarized below:
(Dollars in millions)
Taxable fixed maturities:
Impairment amount
New book value
Percent to total owned
Number of securities impaired
Percent to total owned
Tax-exempt fixed maturities:
Impairment amount
New book value
Percent to total owned
Number of securities impaired
Percent to total owned
Common equities:
Impairment amount
New book value
Percent to total owned
Number of securities impaired
Percent to total owned
Total:
Impairment amount
New book value
Percent to total owned
Number of securities impaired
Percent to total owned
$
$
$
$
$
$
$
$
Years ended December 31,
2005
2004
2006
$
$
(1)
0
0 %
1
0 %
$
$
0
0
0 %
0
0 %
$
$
0
0
0 %
0
0 %
$
$
(1)
0
0 %
1
0 %
$
$
$
$
$
$
$
$
(1)
0
0 %
2
0 %
0
0
0 %
0
0 %
0
0
0 %
0
0 %
(1)
0
0 %
2
0 %
0
2
1 %
1
1 %
(5)
9
1 %
2
0 %
(1)
0
0 %
1
2 %
(6)
11
0 %
4
0 %
Investments Outlook
We believe investment income growth for 2007 could 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 current portfolio attributes. In 2007, we expect to allocate a higher
proportion of cash available for investment to equity securities, taking into consideration insurance department
regulations and ratings agency comments. We continue to identify companies with the potential for revenue,
earnings and dividend growth, a strong management team and favorable outlook. These equities offer the
potential for steadily increasing dividend income along with capital appreciation. Dividend increases within the
last 12 months by Fifth Third and another 37 of the 50 common stock holdings in the equity portfolio should
add $16 million to annualized investment income.
We believe impairments in 2007 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 securities in the portfolio were trading at or above 70 percent of book value at December 31, 2006.
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 2006, other income of the insurance subsidiaries, parent company operations and non-investment
operations of CFC Investment Company and CinFin Capital Management Company resulted in $14 million in
revenues compared with $12 million in 2005 and $8 million in 2004. Losses before income taxes of
$51 million in 2006 were primarily due to $51 million in interest expense from debt of the parent company.
Losses before income taxes were $50 million and $37 million in 2005 and 2004, when interest expense was
$52 million and $36 million, respectively.
TAXES
Income tax expense was $399 million in 2006 compared with $221 million in 2005 and $216 million in 2004.
The effective tax rate for 2006 was 30.0 percent compared with 26.8 percent in 2005 and 27.0 percent in
2004. The sale of our Alltel common stock holdings in the first three months of 2006, which generated a
$647 million pretax gain, was the primary reason for the change in effective tax rate for the year. Growth in the
tax-exempt municipal bond portfolio, higher investment income from dividends and lower operating earnings
also contributed to the change in the effective tax rate for 2006.
2006 10-K Page 58
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. For our insurance subsidiaries,
approximately 85 percent of income from tax-advantaged fixed-maturity investments is exempt from federal tax
calculations. Our non-insurance subsidiaries own no tax-advantaged fixed-maturity investments. For our
insurance subsidiaries, the dividend received deduction exempts approximately 60 percent of dividends from
qualified equities from federal tax calculations. The dividend received deduction exempts 70 percent of
dividends from qualified equities for our non-insurance subsidiaries. Details regarding our effective tax rate are
found in Item 8, Note 10 to the Consolidated Financial Statements, Page 95.
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 2006, we had shareholders’ equity of $6.808 billion and total debt of $840 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 collection of 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, 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 both 2006 and 2005
and $175 million in 2004. State of Ohio regulatory requirements restrict the dividends insurance subsidiaries
can pay. During 2007, total dividends that our lead insurance subsidiary can pay to our parent company
without regulatory approval are approximately $572 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.
This table shows a summary of cash flow of the insurance subsidiary (direct method):
(In millions)
Premiums collected
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,
2005
2006
2004
$
$
3,285 $
(1,859)
(1,036)
390
471
861 $
3,187 $
(1,752)
(995)
440
427
867 $
3,055
(1,694)
(894)
467
362
829
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 declined in 2006 from the level of
2005 and 2004. We discuss our future obligations for claims payments in Contractual Obligations, Page 61,
and our future obligations for underwriting expenses in Commissions and Other Underwriting Expenses,
Page 62. Insurance subsidiary operating cash flow remained stable over the three years, however, due to rising
investment income.
Based on our outlook for commercial lines, personal lines and life insurance, we believe that cash flows from
underwriting could decline again in 2007. A lower level of cash flow available for investment could lead to lower
investment income and reduced potential for capital gains.
2006 10-K Page 59
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 56, investment income rose in each of
the past three years, and we expect investment income could grow 6.5 percent to 7.0 percent in 2007.
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 continued to decline in 2006 as interest
rates generally shifted upward.
• Sales of equity securities investments – The decision to divest an equity position is generally reached after
careful analysis regarding the direction the company is headed and how well it meets our investment
parameters. In 2006, we completed the sale of our Alltel common stock holdings and made other sales of
all or part of smaller holdings.
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 2007, 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 dividend growth and capital appreciation.
Capital Resources
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 $5.244 billion and $5.067 billion at year-end 2006 and 2005, respectively.
On an after-tax basis, it constituted 49.6 percent of total shareholders' equity at year-end 2006.
At year-end 2006, our debt-to-capital ratio was 11.0 percent. Based on our present capital requirements, we do
not anticipate a material increase in debt levels during 2007. As a result, we believe our debt-to-capital ratio
will remain approximately 11 percent.
We had $791 million of long-term debt and $49 million in 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 93. None of the notes are encumbered by rating triggers.
On April 28, 2006, A.M. Best affirmed its senior debt ratings and issuer credit rating (ICR) of aa- of Cincinnati
Financial Corporation. On September 15, 2006, Fitch Ratings affirmed its AA- issuer default rating and
A+ senior debt ratings of Cincinnati Financial Corporation. Moody’s maintains our senior debt ratings at A2-.
On July 25, 2006, Standard & Poor’s Ratings Services affirmed its A (Strong) counterparty credit rating on
Cincinnati Financial Corporation.
At December 31, 2006, we had two lines of credit totaling $125 million with $49 million outstanding. 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 and renewed
annually. It is available for general corporate purposes and contains customary financial covenants. During
2006, CFC Investment Company, our commercial leasing and financing subsidiary, replaced $49 million of
intercompany debt with $49 million in borrowings against our $75 million line of credit to improve cash flow for
the parent company. This line of credit matures on February 28, 2007, and we expect to renew it under terms
and conditions that are essentially unchanged.
During 2006, we entered into an interest-rate swap as an economic cash flow hedge of variable interest
payments for certain variable-rate debt obligations ($49 million notional amount). Under this interest-rate swap
contract, we have agreed to pay a fixed rate of interest for a three-year period. The contract is intended to be a
hedge against changes in the amount of future cash flows associated with the related interest payments.
The interest-rate swap contract is reflected at fair value in our balance sheet. SFAS No. 133 “Accounting for
Derivative Financial Instruments and Hedging Activities,” as amended, requires changes in the fair value of the
2006 10-K Page 60
company’s derivative financial instruments to be recognized periodically as realized gains or losses on the
consolidated statement of income or as a component of accumulated other comprehensive income in
shareholders’ equity, respectively. We recorded a $324,000 investment loss in 2006 due to the decline in the
fair value of the interest-rate swap.
In October 2006, we completed the necessary requirements for the interest-rate swap to qualify for hedge
accounting treatment under SFAS No. 133. We expect that the interest-rate swap will be a highly effective
hedge and that future changes in the fair value of the interest-rate swap will be recorded as a component of
accumulated other comprehensive income. As a result, we do not expect any significant amounts to be
reclassified into earnings in the next 12 months.
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 obligations and other commitments.
In addition, one of our primary uses of cash is to enhance shareholder return.
Contractual Obligations
At December 31, 2006, we estimated our future contractual obligations as follows:
(In millions)
Interest on long-term debt
Long-term debt
Short-term debt
Annuitization obligations
Headquarters building expansion
Computer hardware and software
Other invested assets
Net life claims payments
Subtotal
Net property casualty claims payments
Total
Within
1 year
Payment due by period
Years
Years
4-5
2-3
More than
5 years
Total
$
$
52 $
0
49
17
45
9
10
9
191
1,074
1,265 $
104 $
0
0
47
17
11
12
0
191
1,150
1,341 $
104 $
0
0
30
0
2
3
0
139
493
632 $
996 $
795
0
104
0
0
1
0
1,896
639
2,535 $
1,256
795
49
198
62
22
26
9
2,417
3,356
5,773
Long-term Debt and Interest on Long-Term Debt
Our estimate of material commitments for interest on long-term debt was approximately 21.8 percent and our
estimate of material commitments for long-term debt was 13.8 percent of the estimated contractual
obligations at year-end 2006.
Our interest expense remained unchanged in 2006 at an annual rate of approximately $52 million.
We generally have tried to minimize our reliance on debt financing and do not expect a material increase in
interest expense from long-term debt in the near future.
Short-term Debt
Our estimate of material commitments for short-term debt was 1.0 percent of material commitments at
year-end 2006. On February 28, 2007, we plan to renew our $49 million outstanding note payable drawn on
our $75 million in line of credit.
Annuitization Obligations
Our estimate of material commitments for obligations due under annuities written by our life insurance
subsidiary was approximately 3.4 percent of the estimated contractual obligations at year-end 2006.
Headquarters Building Expansion
The completion of our new office building and parking garage to be situated at our headquarters located in
Fairfield is expected to require approximately $62 million over the next two years. The construction project is on
schedule and on budget. As of December 31, 2006, construction costs totaled $41 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.
2006 10-K Page 61
Computer Hardware and Software
We expect to need approximately $22 million over the next five years for current 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 2007.
Property Casualty Claims Payments
Our estimate of material commitments for net property casualty claims payments was approximately
58.1 percent of the estimated contractual obligations at year-end 2006.
We direct our associates to settle claims and pay losses as quickly as practical and made $1.763 billion in
net claim payments during 2006. At year-end 2006, we had net property casualty reserves of $3.356 billion,
reflecting $1.843 billion in unpaid amounts on reported claims (case reserves), $771 million in loss expense
reserves and $742 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 63.
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 effective duration of our fixed-maturity portfolio was 5.1 years at year-end 2006. By contrast, the
duration of our loss and loss expense reserves was 2.9 years and the duration of all liabilities was 2.6 years.
We believe this difference in duration does not affect our ability to meet current obligations because cash flow
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.
Other Commitments
In addition to our contractual obligations, we have other operational commitments.
Commissions and Other Underwriting Expenses
As discussed above, commissions and non-commission 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 42 and Page 49. 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. Commission payments generally track with written premiums. Contingent
commission payments in 2007 will be influenced by the decline in profitability we experienced in 2006.
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 2007,
reflecting the 2.9 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
$35 million in key technology initiatives in 2007, of which approximately $14 million will be capitalized.
Technology projects for 2007 include continued spending on our personal lines policy processing system and
investment in the development and rollout of our commercial lines policy processing system that we discuss in
Item 1, Technology Solutions, Page 4. Capitalized development costs related to key technology initiatives
totaled $15 million in 2006. These activities are conducted at our discretion and we have no material
contractual obligations for activities planned as part of these projects.
2006 10-K Page 62
Data Processing and Disaster Recovery Center
We expect to spend approximately $5 million in 2007 to begin renovation of a newly purchased building that
will serve as our data processing and disaster recovery center.
Qualified Pension Plan
Effective in 2008, the Pension Protection Act of 2006 changes the manner in which pension funding is
determined. We currently are assessing the impact of this Act but do not except it to have a material effect on
our results of operations or financial position. We anticipate contributing $10 million to the plan in 2007.
Investing Activities
After fulfilling operating requirements, 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 14, for a discussion of our investment strategy, portfolio allocation and
quality. From the second quarter of 2004 until year-end 2005, virtually all of our available cash flow was used
to purchase fixed-maturity investments to reduce our property casualty subsidiary’s ratio of common stock to
statutory surplus. In 2006, equity purchases returned to a more significant level.
In 2007 we anticipate a resumption of active equity investing while also continuing to be cognizant of rating
agency and regulatory guidelines. See Item 1, Investments Segment, Page 14, for a discussion of our
investment strategy, portfolio allocation and quality.
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 38 percent of net
income as dividends, with the remaining 62 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 2007, the board of directors authorized a 6.0 percent increase in the regular quarterly cash
dividend to an indicated annual rate of $1.42 per share. In 2006, 2005 and 2004, we paid cash dividends
of $228 million and $204 million and $177 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 from share-based compensation. In
2006, 2005 and 2004, we used $120 million, $63 million and $66 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 2006, 6.8 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 26. Between February 1999
and year-end 2006, we have repurchased 17.4 million shares at a total cost to the company of
$661 million. We do not adjust the number of shares repurchased and average price per repurchased
share for stock dividends.
PROPERTY CASUALTY INSURANCE RESERVES
At year-end 2006, the total reserve balance, net of reinsurance, was $3.356 billion, compared with
$3.111 billion at year-end 2005 and $2.977 billion at year-end 2004. 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 92. The reserves reflected in the consolidated financial
statements are management’s best estimate.
The appointed actuary's range for adequate statutory reserves, net of reinsurance, was $3.194 billion to
$3.440 billion for 2006; $2.921 billion to $3.153 billion for 2005; and $2.794 billion to $3.032 billion for
2004. 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 activity
• Higher initial case reserves on liability claims
2006 10-K Page 63
• Workers’ compensation case reserving practices
•
•
Increased loss expenses due to higher legal fees
Judicial decisions and mass tort claims
• Changes in reinsurance treaty retentions
•
Loss cost inflation in selected lines
• Higher loss adjustment expense due to a claims mediation process that promotes earlier liability
settlement resolution
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 66, 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, contributing to favorable
loss reserve trends.
As we discuss in Personal Lines Insurance Segment Reserves, Page 68, 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 2006, we reviewed each of our established workers’ compensation case reserves above $100,000 in light of
current trends in medical cost inflation and estimated payout periods. The review led to the allocation of
additional amounts to case reserves held for specific claims from accident years going back as many as
20 years. Our intent is to bring workers’ compensation case reserve adequacy more in line with our other
business lines although our success may be affected by additional medical cost inflation and longer life spans.
In 2003 and 2004, $70 million in reserves were released following the November 2003 Ohio Supreme Court's
decision limiting its 1999 Scott-Pontzer v. Liberty Mutual decision. The reserve releases were primarily made in
the commercial auto and commercial casualty 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 casualty 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 the commercial casualty business line. 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, 2006, 2005 and 2004, in Item 8, Note 4 to the Consolidated Financial Statements, Page 92.
The reconciliation of our year-end 2005 reserve balance to net incurred losses one year later recognizes
approximately $116 million in redundant reserves.
The table on Page 65 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 unpaid loss and loss expenses for claims arising in the indicated calendar year and
all prior accident years 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, 2006, we had paid $1.175 billion of loss
and loss expenses in calendar years 1997 through 2006, for losses that occurred in accident years
1996 and prior. An estimated $148 million of losses remained unpaid as of year-end 2006
(net re-estimated reserves of $1.323 billion from Section C less cumulative paid loss and loss expenses
of $1.175 billion).
2006 10-K Page 64
• 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, 1996, had developed a $379 million redundancy over 10 years, net of reinsurance, which
was reflected in income over the 10 years. The table shows redundant reserves as a negative number.
The effects on income in 2006, 2005 and 2004 of changes in estimates of the reserves for loss and loss
expenses for all accident years are shown in the reconciliation below.
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 2006 but incurred in 2000 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.
(In millions)
A. Originally reported reserves for unpaid loss and loss expenses:
1996
1997
1998
1999
Calendar year ended December 31,
2001
2000
2002
2003
2004
2005
2006
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
Cumulative gross redundancy
$
$
$
$
$
$
$
$
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 $
3,860
504
3,356
453 $
732
884
992
1,049
1,093
1,123
1,146
1,159
1,175
1,582 $
1,470
1,405
1,380
1,326
1,333
1,333
1,332
1,305
1,323
(120) $
(232)
(297)
(322)
(376)
(369)
(369)
(370)
(397)
(379)
499 $
761
965
1,075
1,152
1,205
1,239
1,260
1,279
1,623 $
1,551
1,520
1,465
1,466
1,463
1,460
1,435
1,456
(154) $
(226)
(257)
(312)
(311)
(314)
(317)
(342)
(321)
522 $
833
1,067
1,207
1,283
1,333
1,366
1,390
591 $
943
1,195
1,327
1,412
1,464
1,496
697 $
758 $
799 $
817 $
907 $
944
1,116
1,378
1,526
1,623
1,680
1,194
1,455
1,614
1,717
1,235
1,519
1,716
1,293
1,626
1,426
1,724 $
1,728
1,636
1,615
1,608
1,602
1,577
1,593
1,912 $
1,833
1,802
1,771
1,757
1,733
1,739
2,120 $
2,083
2,052
2,010
1,999
1,992
2,307 $
2,263
2,178
2,153
2,127
(116) $
(112)
(204)
(225)
(232)
(238)
(263)
(247)
(20) $
(99)
(130)
(161)
(175)
(199)
(193)
(62) $
(99)
(130)
(172)
(183)
(190)
(45) $
(89)
(174)
(199)
(225)
2,528 $
2,377
2,336
2,299
2,649 $
2,546
2,489
2,817 $
2,743
2,995
(80) $
(231)
(272)
(309)
(196) $
(299)
(356)
(160) $
(234)
(116)
1,323 $
183
1,506 $
1,456 $
198
1,654 $
1,593 $
224
1,817 $
1,739 $
230
1,969 $
1,992 $
259
2,251 $
2,127 $
532
2,659 $
2,299 $
568
2,867 $
2,489 $
547
3,036 $
2,743 $
551
3,294 $
2,995
517
3,512
(318) $
(235) $
(161) $
(124) $
(150) $
(206) $
(283) $
(350) $
(220) $
(117)
2006 10-K Page 65
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 0.6 percent of
total loss and loss expenses in 2006, compared with $12 million, or 0.7 percent in 2005 and $42 million, or
2.4 percent, in 2004.
Net reserves for all asbestos and environmental claims were $131 million in 2006 compared with $130 million
in 2005 and $128 million in 2004. Net reserves for all asbestos and environmental claims were 3.9 percent,
4.2 percent and 4.3 percent of total reserves in 2006, 2005 and 2004, 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 we have revised policy terms where
permitted by state regulation to limit our exposure to mold and other environmental risks going forward.
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 is partially due to our growth. The increase also reflected higher loss expense
reserves due to a claims mediation process that promoted earlier liability settlement resolution and increased
loss expenses due to higher legal fees. In addition, commercial casualty, workers’ compensation and surety
and executive risk gross reserves rose because of the increase in large losses as we discussed in Commercial
Lines Insurance Results of Operations, Page 42. Reserve practices discussed above also contributed.
(In millions)
At December 31, 2006
Commercial casualty
Commercial property
Commercial auto
Workers' compensation
Specialty packages
Surety and executive risk
Machinery and equipment
Total
At December 31, 2005
Commercial casualty
Commercial property
Commercial auto
Workers' compensation
Specialty packages
Surety and executive risk
Machinery and equipment
Total
Loss reserves
Case
reserves
IBNR
reserves
Loss
expense
reserves
Total
gross
reserves
Percent
of total
$
$
$
$
923 $
132
274
411
80
67
5
1,892 $
859 $
135
268
283
63
36
3
1,647 $
437 $
31
52
277
1
1
3
802 $
451 $
40
55
333
0
0
3
882 $
483
36
64
99
5
32
1
720 $
423 $
36
65
79
12
32
0
647 $
1,843
199
390
787
86
100
9
3,414
1,733
211
388
695
75
68
6
3,176
54.0 %
5.8
11.4
23.1
2.5
2.9
0.3
100.0 %
54.6 %
6.6
12.2
21.9
2.4
2.1
0.2
100.0 %
2006 10-K Page 66
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, 2006
2005 accident year
2004 accident year
2003 accident year
2002 accident year
2001 accident year
2000 accident year
1999 and prior accident years
Deficiency/(redundancy)
Reserves as originally estimated
Reserves re-estimated as of December 31, 2006
Deficiency/(redundancy)
Impact on loss and loss expense ratio
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
Deficiency/(redundancy)
Reserves as originally estimated
Reserves re-estimated as of December 31, 2005
Deficiency/(redundancy)
Impact on loss and loss expense ratio
As of December 31, 2004
2001 accident year
2000 accident year
1999 accident year
1998 accident year
1997 accident year
1996 accident year
1995 and prior accident years
Deficiency/(redundancy)
Reserves as originally estimated
Reserves re-estimated as of December 31, 2004
Deficiency/(redundancy)
Impact on loss and loss expense ratio
Commercial
casualty
Commercial
property
Commercial
auto
Workers'
compensation
Specialty
packages
Surety &
executive risk
Machinery &
equipment
Totals
$
$
$
$
$
$
$
$
$
$
$
$
$
$
$
$
$
$
$
$
$
$
$
$
(52)
(21)
(12)
2
(9)
(9)
2
(99)
1,359
1,260
(99)
(12.0) %
(78)
(51)
(17)
(7)
8
(1)
(25)
(171)
1,332
1,161
(171)
(22.5) %
(46)
(44)
(27)
(19)
(1)
(1)
2
(136)
1,280
1,144
(136)
(20.0) %
$
$
$
$
$
$
$
$
$
$
$
$
17
(3)
(3)
(1)
(4)
(1)
0
5
160
165
5
0.9 %
23
(3)
(3)
(1)
0
0
1
17
104
121
17
3.5 %
7
(2)
(7)
0
0
0
0
(2)
101
99
(2)
(0.3) %
$
$
$
$
$
$
$
$
$
$
$
$
(17)
1
1
(2)
(2)
(1)
(1)
(21)
386
365
(21)
(4.6) %
(15)
(5)
(1)
(1)
0
0
(1)
(23)
372
349
(23)
(5.0) %
(11)
(10)
(4)
(5)
(7)
(3)
(8)
(48)
382
334
(48)
(10.5) %
$
$
$
$
$
$
$
$
$
$
$
$
(2)
5
0
(3)
(1)
1
9
9
634
643
9
2.6 %
9
13
8
3
3
3
2
41
558
599
41
12.9 %
(5)
1
6
3
2
1
6
14
515
529
14
4.9 %
$
$
$
$
$
$
$
$
$
$
$
$
3
(1)
1
0
0
(1)
0
2
73
75
2
1.6 %
7
3
2
0
2
0
1
15
72
87
15
10.9 %
3
1
1
0
0
0
0
5
75
80
5
3.7 %
$
$
$
$
$
$
$
$
$
$
$
$
7
(3)
(1)
1
1
0
0
5
63
68
5
6.3 %
2
(4)
0
(1)
0
0
(1)
(4)
64
60
(4)
(5.4) %
(1)
(3)
(1)
(1)
0
0
(1)
(7)
57
50
(7)
(9.3) %
$
$
$
$
$
$
$
$
$
$
$
$
1
0
0
0
0
0
0
1
6
7
1
2.8 %
(1)
0
0
0
0
0
0
(1)
5
4
(1)
(3.7) %
0
0
0
0
0
0
0
0
5
5
0
(1.3) %
(43)
(22)
(14)
(3)
(15)
(11)
10
(98)
2,681
2,583
(98)
(4.1) %
(53)
(47)
(11)
(7)
13
2
(23)
(126)
2,507
2,381
(126)
(5.6) %
(53)
(57)
(32)
(22)
(6)
(3)
(1)
(174)
2,415
2,241
(174)
(8.2) %
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 commercial casualty. 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
The initiative, begun in 2000 and expanded to other states in 2004, to use a claims mediation process
that promotes earlier liability settlement resolution
Increased loss expenses due to higher legal fees
• Workers’ compensation claim reserve practices
• Higher than expected medical inflation affecting the workers’ compensation line
• Changes in reinsurance treaty retentions
• 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
2006 10-K Page 67
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
2005 due to the decline in premiums in this business line. Homeowner gross reserves reflected the increase in
large losses as we discussed in Personal Lines Insurance Results of Operations, Page 49.
(In millions)
At December 31, 2006
Personal auto
Homeowners
Other personal
Total
At December 31, 2005
Personal auto
Homeowners
Other personal
Total
Loss reserves
Case
reserves
IBNR
reserves
Loss
expense
reserves
Total
gross
reserves
Percent
of total
$
$
$
$
169 $
69
55
293 $
175 $
70
52
297 $
5 $
24
61
90 $
4 $
21
67
92 $
32 $
17
14
63 $
34 $
18
12
64 $
206
110
130
446
213
109
131
453
46.2 %
24.7
29.1
100.0 %
47.1 %
24.0
28.9
100.0 %
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, 2006
2005 accident year
2004 accident year
2003 accident year
2002 accident year
2001 accident year
2000 accident year
1999 and prior accident years
Deficiency/(redundancy)
Reserves as originally estimated
Reserves re-estimated as of December 31, 2006
Deficiency/(redundancy)
Impact on loss and loss expense ratio
As of December 31, 2005
2002 accident year
2001 accident year
2000 accident year
1999 accident year
1998 accident year
1997 accident year
1996 and prior accident years
Deficiency/(redundancy)
Reserves as originally estimated
Reserves re-estimated as of December 31, 2005
Deficiency/(redundancy)
Impact on loss and loss expense ratio
As of December 31, 2004
2001 accident year
2000 accident year
1999 accident year
1998 accident year
1997 accident year
1996 accident year
1995 and prior accident years
Deficiency/(redundancy)
Reserves as originally estimated
Reserves re-estimated as of December 31, 2004
Deficiency/(redundancy)
Impact on loss and loss expense ratio
Personal
auto
Homeowner
Other
personal
Totals
$
$
$
$
$
$
$
$
$
$
$
$
$
$
$
$
$
$
$
$
$
$
$
$
4
6
(3)
(2)
(2)
(1)
0
2
213
215
2
0.6 %
0
0
(3)
(4)
(1)
0
0
(8)
231
223
(8)
(1.9) %
9
1
(3)
(3)
(1)
(1)
(1)
1
224
225
1
0.2 %
$
$
$
$
$
$
$
$
$
$
$
$
5
1
0
(1)
0
0
0
5
99
104
5
1.5 %
0
(2)
0
0
0
1
0
(1)
114
113
(1)
(0.4) %
(1)
(1)
(4)
(1)
0
0
0
(7)
90
83
(7)
(2.7) %
(7)
(2)
(4)
(4)
(2)
(3)
(3)
(25)
118
93
(25)
(28.6) %
(5)
(11)
(3)
(3)
0
0
(3)
(25)
125
100
(25)
(28.7) %
(3)
(4)
(5)
(3)
0
0
(1)
(16)
116
100
(16)
(18.9) %
$
$
$
$
$
$
$
$
$
$
$
$
2
5
(7)
(7)
(4)
(4)
(3)
(18)
430
412
(18)
(2.4) %
(5)
(13)
(6)
(7)
(1)
1
(3)
(34)
470
436
(34)
(4.3) %
5
(4)
(12)
(7)
(1)
(1)
(2)
(22)
430
408
(22)
(2.8) %
2006 10-K Page 68
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:
•
The initiative, begun in 2001, to establish higher initial case reserves on liability claims in the period in
which the claim is reported
• Settlements that differed from the established case reserves
• Changes in reinsurance treaty retentions
• 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 $1.409 billion at year-end 2006, compared with $1.343 billion at year-end
2005. 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. Some
of our universal life insurance policies contain no-lapse guarantee provisions. For these policies, we establish a
reserve in addition to the account balance based on expected no-lapse guarantee benefits and expected policy
assessments.
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.
2007 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 and financial 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 (RMS) and Applied Insurance Research (AIR) models to evaluate exposures 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 Hannover Reinsurance
Company, Munich Reinsurance America, Partner Reinsurance Company of the U.S. and Swiss Reinsurance
America Corporation and its subsidiaries, 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 European markets.
Primary components of the 2007 property and casualty reinsurance program include:
• Property per risk treaty – The primary purpose of the property treaty is to provide 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 $35 million for 2007,
compared with $30 million in 2006 and $29 million in 2005. We retain the first $4 million of each loss.
Losses between $4 million and $25 million are reinsured at 100 percent.
2006 10-K Page 69
• Casualty per occurrence treaty – The casualty treaty provides 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 $50 million in 2007, compared with $45 million in 2006 and $64 million in 2005.
We retain the first $4 million of each loss. Losses between $4 million and $25 million are reinsured at
100 percent.
We have modified our casualty per occurrence treaty for director and officer policies for four Fortune 1000
companies and one financial services company. For one of the five companies, our retention could be as
high as $15 million rather than the $4 million for a typical policy; for one of the companies, our retention
could be as high as $10 million; for the remaining three 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 2007 and is comparable with the premium paid in 2006.
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 2007, comparable with the
premium paid in 2006.
• 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
2007 treaty, ceded premiums are estimated to be $49 million, up from $38 million in 2006, and
$29 million, excluding the reinstatement premium, in 2005. The premium increase for 2007 primarily was
due to the difficult market conditions brought on in part by the record catastrophe losses experienced by
reinsurance companies in recent years. Our retention on this program remains at $45 million and
we will retain:
○ 5 percent of losses between $45 million and $200 million
○ 14 percent of losses between $200 million and $300 million
○ 18 percent of losses between $300 million and $500 million
Our maximum exposure to a 2007 catastrophic event that resulted in $500 million in losses would be
$103 million compared with $68 million in 2006. The largest catastrophe loss in our history was
$87 million before reinsurance.
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 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 five 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. In addition, our property catastrophe treaty provides
coverage for personal risks and the majority of our reinsurers provide limited coverage for commercial risks
with total insured values of $10 million or less.
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
2006 10-K Page 70
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, and contains protection for
extra-contractual liability coverage losses. For term life insurance business written prior to 2005, we retain
10 percent to 25 percent of each term policy, not to exceed $500,000, ceding the balance or mortality risk and
policy reserve.
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 our Item 1A, Risk Factors, Page 20. 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
Increased frequency and/or severity of claims
Inaccurate estimates or assumptions used for critical accounting estimates
•
•
• Events or actions, including unauthorized intentional circumvention of controls, that reduce the company’s
future ability to maintain effective internal control over financial reporting under the Sarbanes-Oxley Act of
2002
• 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
○ Perceptions that the company’s level of service, particularly claims service, is no longer a
distinguishing characteristic in the marketplace
• Delays or inadequacies in the development, implementation, performance and benefits of technology
projects and enhancements
• Ability to obtain adequate reinsurance on acceptable terms, amount of reinsurance purchased, financial
strength of reinsurers and the potential for non-payment or delay in payment by reinsurers
•
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
• Actions of insurance departments, state attorneys general or other regulatory agencies that:
○ Restrict our ability to exit or reduce writings of unprofitable coverages or lines of business
○ Place the insurance industry under greater regulatory scrutiny or result in new statutes, rules and
regulations
Increase our expenses
○
○ Add assessments for guaranty funds, other insurance related assessments or mandatory reinsurance
arrangements; or that impair our ability to recover such assessments through future surcharges or
other rate changes
○ Limit our ability to set fair, adequate and reasonable rates
○ Place us at a disadvantage in the marketplace or
○ Restrict our ability to execute our business model, including the way we compensate agents
• Sustained decline in overall stock market values negatively affecting the company’s equity portfolio and
book value; in particular a sustained decline in the market value of Fifth Third shares, a significant equity
holding
• Recession or other economic conditions or regulatory, accounting or tax changes resulting in lower demand
for insurance products
2006 10-K Page 71
• 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 or interest-rate fluctuations that result in declining values of fixed-maturity
investments
• Adverse outcomes from litigation or administrative proceedings
•
Investment activities or market value fluctuations that trigger restrictions applicable to the parent company
under the Investment Company Act of 1940
• Events, such as an avian flu epidemic, natural catastrophe, terrorism or construction delays, that could
hamper our ability to assemble our workforce at our headquarters location
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.
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
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.
2006 10-K Page 72
Risks associated with the five asset classes described in Item 1, Investments Segment, Page 14, 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
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 untimely redemptions of currently callable securities. 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 effective duration of the fixed-maturity portfolio is continually monitored by our
investment department to evaluate the theoretical impact of interest rate movements.
2006 10-K Page 73
The table below summarizes the effect of hypothetical changes in interest rates on the fixed-maturity portfolio:
(In millions)
At December 31, 2006
At December 31, 2005
Fair value of
fixed maturity
portfolio
100 basis point
spread decrease
Effective duration
$
5,805 $
5,476
6,099 $
5,759
100 basis point
spread increase
5,511
5,194
The effective duration of the fixed maturity portfolio is currently 5.1 years. A 100 basis point movement in
interest rates would result in an approximately 5.1 percent change in the market value of the fixed maturity
portfolio. Generally speaking, the higher a bond is rated, the more directly correlated movements in its market
value will be to changes in the general level of interest rates, exclusive of call features. The market values of
average- to lower-rated corporate bonds are additionally influenced by the expansion or contraction of credit
spreads. In prior reporting periods we have expressed our interest rate sensitivity using both modified duration
and duration to worst measures. Going forward, we will use effective duration, a measure we believe more
accurately depicts duration on an option-adjusted basis.
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 can 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, 2006, the company held 13 individual equity positions valued at approximately $100 million
or above, see Item 1, Investments Segment, Page 14, for additional details on these holdings. These equity
positions accounted for approximately 91.8 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.
Our investments are heavily weighted toward the financials sector, which represented 66.6 percent of the total
fair value of the common stock portfolio at December 31, 2006. 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 our 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, 2006, our compound annual equity portfolio return was
2.0 percent compared with a compound annual total return of 6.2 percent for the
Standard & Poor’s 500 Index, a common benchmark of market performance. In 2006, our annual equity
portfolio return was 16.1 percent, compared with an annual total return of 15.8 percent for that Index.
Our equity portfolio underperformed the market for the five-year period because of the decline in the market
value of our holdings of Fifth Third common stock between 2002 and year-end 2005.
The primary risks related to preferred stocks are similar to those related to investment grade corporate bonds.
Falling interest rates adversely affect market values due to the normal inverse relationship between rates and
yields. Credit risk exists due to the subordinate position of preferred stocks 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.
2006 10-K Page 74
Fifth Third Bancorp Holding
One of our common stock holdings, Fifth Third, accounted for 25.7 percent of our shareholders’ equity at
year-end 2006 and dividends earned from our Fifth Third investment were 20.2 percent of our investment
income in 2006.
(In millions except market price data)
Fifth Third Bancorp common stock holding:
Dividends earned
Percent of total net 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
$
$
Years ended December 31,
2005
2006
$
115
20.2 %
106
20.2 %
At December 31,
2006
At December 31,
2005
$
73
40.93
283
2,979
1,752
38.2 %
21.7
43.8
25.7
73
37.72
283
2,745
1,600
38.6 %
21.6
45.1
26.3
Based on 2006 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 $10 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 2006 closing price would result in a $596 million change in assets and a $387 million change in
after-tax unrealized gains.
The market value of Fifth Third, our largest holding, has been affected by the residual effects of a regulatory
review concluded in 2004 and, more recently, by a difficult interest rate environment. We believe that its
management team can execute on the strategy for growth its management has defined. During this challenging
period for the bank, we have continued to benefit from its superior dividend growth. In June 2006, Fifth Third
increased its indicated annual dividend by 5.3 percent, which is expected to contribute an additional $6 million
to investment income on an annualized basis.
UNREALIZED INVESTMENT GAINS AND LOSSES
At December 31, 2006, unrealized investment gains before taxes totaled $5.303 billion and unrealized
investment losses in the investment portfolio amounted to $59 million.
Unrealized Investment Gains
The unrealized gains at December 31, 2006, were due to long-term gains from our holdings of Fifth Third
common stock, which contributed 51.9 percent of the gain, and from our other common stock holdings,
including ExxonMobil Corporation, The Procter & Gamble Company and PNC Financial Services Group, which
each contributed at least 5 percent of the gain. Reflecting the company’s long-term investment philosophy, of
the 1,294 securities trading at or above book value, 633, or 48.9 percent, have shown unrealized gains for
more than 24 months.
Unrealized Investment Losses – Potential Other-than-temporary Impairments
During 2006 and 2005, a total of three 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, 2006, 679 of the 1,973 securities we owned were trading below
100 percent of book value compared with 732 of the 1,814 securities we owned at December 31, 2005, and
208 of the 1,593 securities we owned at December 31, 2004.
The 679 holdings trading below book value at December 31, 2006, represented 19.8 percent of invested
assets and $59 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.
• 671 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 671 securities
was $2.698 billion at December 31, 2006, and they accounted for $55 million in unrealized losses.
2006 10-K Page 75
• Eight of these holdings were trading below 90 percent of book value at December 31, 2006. The fair value
of these holdings was $30 million, and they accounted for the remaining $4 million in unrealized losses.
These holdings are being monitored for credit- and industry-related risk factors, but we believe the changes
in value primarily are due to normal fluctuations and economic factors.
Of these securities, the largest is a media-related convertible debenture with a fair value of $9 million and
an unrealized loss of $1.5 million. No other security had an unrealized loss in excess of $1 million.
• No holdings were trading below 70 percent of book value at December 31, 2006.
As discussed in Critical Accounting Estimates, Asset Impairment, Page 37, when evaluating
other-than-temporary impairments, we consider our intent and 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 on economic, industry or company factors.
The following table summarizes the length of time securities in the investment portfolio have been in a
continuous unrealized gain or loss position.
(Dollars in millions)
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
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
0 $
28
145
173
0
95
437
532
0
0
7
7
0
0
24
24
0
1
2
3
0
124
615
739 $
0
(2)
12
10
0
(1)
9
8
0
0
10
10
0
0
6
6
0
0
0
0
0
(3)
37
34
0 $
55
12
67
0
12
14
26
0
1
6
7
0
2
2
4
0
0
0
0
0
(3)
2
(1)
0
0
1
1
0
(2)
267
265
0
0
0
0
0
0
0
0
0 $
195
7
202
0
213
3
216
0
1
2
3
0
1
0
1
0
0
0
0
0
(33)
1
(32)
0
(3)
0
(3)
0
0
14
14
0
0
0
0
0
0
0
0
0 $
40
258
298
0
34
337
371
0
0
33
33
0
1
5
6
0
0
0
0
0
(12)
67
55
0
(2)
31
29
0
0
4,875
4,875
0
(1)
8
7
0
0
0
0
0
70
34
104 $
0
(5)
270
265
0
410
12
422 $
0
(36)
15
(21)
0
75
633
708 $
0
(15)
4,981
4,966
2006 10-K Page 76
The following table summarizes the investment portfolio:
(Dollars in millions)
Number
of issues
Book
value
Fair
value
Gross
unrealized
gain/loss
Gross
investment
income
At December 31, 2006
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, 2005
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
0 $
0 $
0 $
0 $
318
422
0
740
0
354
791
0
1,145
0
2
48
0
50
0
4
31
0
35
0
1
2
0
3
1,943
1,414
0
3,357
0
785
1,597
0
2,382
0
35
2,365
0
2,400
0
18
203
0
221
0
6
89
0
95
1,893
1,496
0
3,389
0
778
1,638
0
2,416
0
33
7,531
0
7,564
0
18
217
0
235
0
6
89
0
95
(50)
82
0
32
0
(7)
41
0
34
0
(2)
5,166
0
5,164
0
0
14
0
14
0
0
0
0
0
0
679
1,294
0
1,973 $
2 $
730
1,082
0
1,814 $
0
2,787
5,668
0
8,455 $
12 $
2,894
4,684
0
7,590 $
0
2,728
10,971
0
13,699 $
8 $
2,820
9,829
0
12,657 $
0
(59)
5,303
0
5,244 $
(4) $
(74)
5,145
0
5,067 $
0
100
93
10
203
0
26
72
3
101
0
0
240
1
241
0
1
11
0
12
0
0
0
5
5
0
127
416
19
562
1
118
387
18
524
2006 10-K Page 77
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, 2006, 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, 2006. Their
report is on Page 80. 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.
2006 10-K Page 78
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, 2006, 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, 2006. The assessment led management to conclude that, as of December 31, 2006, 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, 2006, and the company’s management assessment of our
internal control over financial reporting. This report appears below.
/S/ John J. Schiff, Jr.
___________________________
John J. Schiff, Jr., CPCU
Chairman and Chief Executive Officer
/S/ Kenneth W. Stecher
___________________________
Kenneth W. Stecher
Chief Financial Officer, Executive Vice President, Secretary and Treasurer
(Principal Accounting Officer)
February 23, 2007
2006 10-K Page 79
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
To the Shareholders and Board of Directors of Cincinnati Financial Corporation:
We have audited the consolidated balance sheets of Cincinnati Financial Corporation and subsidiaries (the company) as of
December 31, 2006 and 2005, and the related consolidated statements of income, shareholders’ equity, and cash flows for
each of the three years in the period ended December 31, 2006. 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 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, 2006, 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, 2006 and 2005, and the results of its operations and its cash flows for each of
the three years in the period ended December 31, 2006, 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, 2006, 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, 2006, based on the criteria established in Internal Control—Integrated Framework issued by the
Committee of Sponsoring Organizations of the Treadway Commission.
As discussed in Note 1 to the Consolidated Financial Statements, the company adopted the provisions of Statement of
Financial Accounting Standards No. 123(R), Share Based Payment, on January 1, 2006, and the recognition and related
disclosure provisions of Statement of Financial Accounting Standards No. 158, Employers’ Accounting for Defined Benefit
Pension Plans and Other Postretirement Benefit Plans on December 31, 2006.
/S/ Deloitte & Touche LLP
Cincinnati, Ohio
February 23, 2007
2006 10-K Page 80
CINCINNATI FINANCIAL CORPORATION AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(Dollars in millions except per share data)
ASSETS
Investments
Fixed maturities, at fair value (amortized cost: 2006—$5,739; 2005—$5,387)
Equity securities, at fair value (cost: 2006—$2,621; 2005—$2,128)
Short-term investments, at fair value (amortized cost: 2006—$95; 2005—$75)
Other invested assets
Total investments
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:
2006—$261; 2005—$232)
Other assets
Separate accounts
Total assets
LIABILITIES
Insurance reserves
Loss and loss expense reserves
Life policy reserves
Unearned premiums
Other liabilities
Deferred income tax
Note payable
6.125% senior notes due 2034
6.9% senior debentures due 2028
6.92% senior debentures due 2028
Separate accounts
Total liabilities
Commitments and contingent liabilities (Note 15)
SHAREHOLDERS' EQUITY
Common stock, par value—$2 per share; (authorized: 2006—500 million shares,
2005—500 million shares; issued: 2006—196 million shares, 2005—194 million shares)
Paid-in capital
Retained earnings
Accumulated other comprehensive income
Treasury stock at cost (2006—23 million shares, 2005—20 million shares)
Total shareholders' equity
Total liabilities and shareholders' equity
Accompanying notes are an integral part of this statement.
December 31,
2006
December 31,
2005
5,805 $
7,799
95
60
13,759
202
121
108
1,128
683
13
453
193
58
504
17,222 $
3,896 $
1,409
1,579
533
1,653
49
371
28
392
504
10,414
5,476
7,106
75
45
12,702
119
117
105
1,116
681
14
429
168
66
486
16,003
3,661
1,343
1,559
455
1,622
0
371
28
392
486
9,917
—
—
391
1,015
2,786
3,379
(763)
6,808
17,222 $
389
969
2,088
3,284
(644)
6,086
16,003
$
$
$
$
2006 10-K Page 81
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
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.
2006
Years ended December 31,
2005
2004
3,163 $
115
570
684
18
4,550
2,128
630
354
77
(21)
53
3,221
1,329
404
(5)
399
930 $
5.36 $
5.30
3,058 $
106
526
61
16
3,767
1,911
627
302
72
(19)
51
2,944
823
188
33
221
602 $
3.44 $
3.40
2,919
101
492
91
11
3,614
1,846
615
270
75
(30)
38
2,814
800
171
45
216
584
3.30
3.28
$
$
$
2006 10-K Page 82
CINCINNATI FINANCIAL CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF SHAREHOLDERS’ EQUITY
2006
Years ended December 31,
2005
2004
(In millions)
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
Share-based compensation
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
Other comprehensive income, net
Cumulative effect of change in accounting for pension obligations
End of year
TREASURY STOCK
Beginning of year
Purchase
Reissued
End of year
$
389 $
0
2
391
370 $
18
1
389
969
0
0
28
17
1
1,015
2,088
930
0
(232)
2,786
3,284
127
(32)
3,379
(644)
(120)
1
(763)
618
341
0
9
0
1
969
2,057
602
(359)
(212)
2,088
3,787
(503)
0
3,284
(583)
(63)
2
(644)
Total shareholders' equity
$
6,808 $
6,086 $
COMMON STOCK - NUMBER OF SHARES OUTSTANDING
Beginning of year
5% stock dividend
Shares issued
Purchase of treasury shares
End of year
COMPREHENSIVE INCOME
Net income
Other comprehensive income, net
Total comprehensive income
Accompanying notes are an integral part of this statement.
174
0
1
(2)
173
$
$
930 $
127
1,057 $
167
9
0
(2)
174
602 $
(503)
99 $
2006 10-K Page 83
352
18
0
370
306
312
(3)
3
0
0
618
1,986
584
(330)
(183)
2,057
4,084
(297)
0
3,787
(524)
(66)
7
(583)
6,249
160
8
0
(1)
167
584
(297)
287
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, amortization and other non-cash items
Realized gains on investments
Share-based compensation
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
Call or maturity of fixed maturities
Sale of equity securities
Collection of finance receivables
Purchase of fixed maturities
Purchase of equity securities
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 of treasury shares
Increase in notes payable
Proceeds from stock options exercised
Contract holder funds deposited
Contract holder funds withdrawn
Excess tax benefits on share-based compensation
Other
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 (net of capitalized interest: 2006—$2; 2005—$1; 2004—$0)
Income taxes paid
Non-cash activities:
Conversion of fixed maturity to equity security and fixed maturity investments
Equipment acquired under capital lease obligations
Accompanying notes are an integral part of this statement.
2006 10-K Page 84
Years ended December 31,
2005
2004
2006
$
930 $
602 $
38
(684)
17
31
(3)
(13)
(21)
17
235
81
20
(5)
(5)
(23)
615
110
343
859
35
(753)
(689)
(15)
(52)
(41)
0
(11)
(214)
0
0
(228)
(120)
49
27
32
(78)
2
(2)
(318)
83
119
202 $
53 $
429
50 $
12
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)
0
0
(221)
(187)
306
119 $
51 $
195
42 $
0
$
$
$
584
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)
0
0
(7)
215
91
306
34
188
23
0
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 consolidated 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, 2006, including the 5 percent stock dividend paid April 26, 2005.
Share-based Compensation
We grant qualified and non-qualified stock options (share-based compensation) under our plans. These stock
options are granted to associates at an exercise price that is not less than market price at the date of grant
and are exercisable over 10 year periods. Prior to January 1, 2006, we accounted for those plans under the
recognition and measurement provisions of APB Opinion No. 25, Accounting for Stock Issued to Employees,
and related interpretations, as permitted by the Statement of Financial Accounting Standards (SFAS) No. 123,
Accounting for Stock-Based Compensation. No stock-based employee compensation cost was recognized in the
Statement of Income for the years ended December 31, 2005 and 2004, as all options granted under those
plans had an exercise price equal to the market value of the underlying common stock on the date of grant.
Effective January 1, 2006, we adopted the fair value recognition provisions of SFAS No. 123(R), Share Based
Payment, using the modified-prospective-transition method. We have elected to use the alternative method for
determining the beginning balance of the additional paid-in capital pool, as described in FASB Staff
Position 123(R)-3. See Note 16, Page 100, for more information regarding our share-based compensation.
Property Casualty Insurance
Property casualty policy written premiums are deferred and recorded as earned premiums 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. The expenses associated with issuing insurance policies – primarily commissions,
premium taxes and underwriting costs – are deferred and amortized over the terms of policies.
Certain property casualty policies are not booked before the effective date. An actuarial estimate is made to
determine the amount of unbooked written premiums. The majority of the estimate is unearned and does not
have a material impact on earned premium.
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
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 year insurance losses and policyholder benefits.
The Cincinnati Insurance Companies actively market property casualty insurance policies in 32 states. Our
10 largest states generated 70.0 percent and 69.7 percent of total property casualty premiums in 2006 and
2005. Ohio, our largest state, accounted for 22.0 percent and 22.5 percent of total earned premiums in 2006
and 2005. Agencies in Georgia, Illinois, Indiana, Michigan, North Carolina, Pennsylvania and Virginia each
contributed between 4 percent and 10 percent of premium volume in 2006. No single agency relationship
accounted for more than 1.2 percent of the company's total agency direct earned premiums in 2006.
2006 10-K Page 85
Policyholder Dividends
Certain workers’ compensation policies include the possibility of an insured earning a return of a portion of
their premium, called a policyholder dividend. The dividend is generally calculated by determining the
profitability of a policy year along with the associated premium. We reserve for all probable future policyholder
dividend payments.
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 record premiums 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
policy 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. Some of our universal life policies contain no-lapse guarantee provisions.
For these policies, we establish a reserve in addition to the account balance, based on expected no-lapse
guarantee benefits and expected policy assessments.
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 policy
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.
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.
2006 10-K Page 86
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 related to 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 our general
account and is recognized as revenue or expense.
Reinsurance
We 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 at fair value in the consolidated financial statements. Fixed-maturity investments
(taxable bonds, tax-exempt bonds and redeemable preferred stocks) and equity investments (common and
non-redeemable preferred stocks) are classified as available for sale and recorded at fair value in the
consolidated financial statements. Short-term investments are classified as available for sale and recorded at
amortized cost, which approximates fair value, in the consolidated 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 intend to hold 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 effective 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 primarily 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. When a price is not available from these sources, as
the case of securities that are not publicly traded, we determine the fair value using quotes from independent
brokers. The fair value of investments priced by independent brokers is less than 1 percent of the fair value of
our total investment portfolio.
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 and notes payable 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.
In 2006, CFC Investment Company, our commercial leasing and financing subsidiary, replaced $49 million of
intercompany debt with borrowings against one of our short-term lines of credit to improve cash flow for the
parent company. During the third quarter, we entered into an interest-rate swap to manage the variability of
interest payments for certain variable-rate debt obligations ($49 million notional amount). Under this interest-
rate swap contract, we have agreed to pay a fixed rate of interest for a three-year period. The contract is
intended to be a hedge against changes in the amount of future cash flows associated with the related interest
2006 10-K Page 87
payments for our short-term line of credit. The interest-rate swap contract is reflected at fair value in our
consolidated balance sheet.
SFAS No. 133, as amended, requires changes in the fair value of the company’s derivative financial
instruments to be recognized periodically as realized gains or losses on the consolidated statement of income
or as a component of accumulated other comprehensive income in shareholders’ equity, respectively.
We recognized a $324,000 pretax realized investment loss due to the decline in the fair value of the interest
rate swap prior to qualifying for hedge accounting treatment.
In October, we completed the necessary requirements for the interest-rate swap to qualify for hedge accounting
treatment under SFAS No. 133. We expect that the interest-rate swap will be a highly effective hedge and that
future changes in the fair value of the interest-rate swap will be recorded as a component of accumulated other
comprehensive income. We do not expect any significant amounts to be reclassified into earnings in the next
12 months. The fair value of the company’s interest rate swap was $430,000 at December 31, 2006.
Securities Lending Program
In 2006, we began actively participating in a securities lending program under which certain fixed-maturity
securities from our investment portfolio are loaned to other institutions for short periods of time. We require
collateral in excess of the market value of the loaned securities. The collateral is invested in accordance with
our guidelines in high-quality, short-duration instruments to generate additional investment income.
The market value of the loaned securities is monitored on a daily basis and additional collateral is added or
refunded as the market value of the loaned securities changes. The securities lending collateral is recognized
as an asset, and classified as securities lending collateral, with a corresponding liability for the obligation to
return the collateral.
We maintain the right and ability to redeem the fixed-maturity securities loaned on short notice and continue to
earn interest on the securities. We maintain effective control over the securities that we have loaned, which are
classified as invested assets on our consolidated balance sheets. Interest income on collateral, net of fees,
was $697,000 for the twelve months ended December 31, 2006. At December 31, 2006, we had no securities
on loan and held no collateral. We recalled our securities on loan prior to year end for statutory reporting
reasons. We have continued the securities lending program in 2007.
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. Certain equipment held under
capital leases also is classified as property and equipment with the related lease obligations recorded as
liabilities. 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 2006, 2005 and 2004 was
$38 million, $33 million and $30 million, respectively. We monitor land, building and equipment for potential
impairments. Potential impairments may 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
2006 10-K Page 88
changes) to shareholders’ equity in accumulated other comprehensive income. We charge deferred taxes
associated with other differences to income.
New Accounting Pronouncements
SFAS No. 155, Accounting for Certain Hybrid Financial Instruments, an amendment of
SFAS Nos. 133 and 140
In February 2006, Financial Accounting Standards Board (FASB) issued SFAS No. 155. This accounting
standard permits fair value re-measurement for any hybrid financial instrument containing an embedded
derivative that otherwise would require bifurcation; clarifies which interest-only strips and principal-only strips
are not subject to the requirements of SFAS No. 133; establishes a requirement to evaluate interests in
securitized financial assets to identify them as freestanding derivatives or as hybrid financial instruments
containing an embedded derivative requiring bifurcation; clarifies that concentrations of credit risk in the form
of subordination are not embedded derivatives; and amends SFAS No. 140 to eliminate the prohibition on a
qualifying special-purpose entity from holding a derivative financial instrument pertaining to a beneficial
interest other than another derivative financial instrument. SFAS No. 155 is effective for all financial
instruments acquired or issued after the beginning of an entity’s first fiscal year beginning after
September 15, 2006.
We adopted SFAS No. 155 on January 1, 2007, to permit fair value re-measurement for our hybrid financial
instruments that contain embedded derivatives that required bifurcation under the original provisions of
SFAS No. 133. The adoption is not expected to have a material impact on our results of operations or financial
position.
SFAS No. 157, Fair Value Measurements
In September 2006, FASB issued SFAS No. 157, which defines fair value, establishes a framework for
measuring fair value, and expands disclosures about fair value measurements. The provisions of SFAS No. 157
are effective for financial statements issued for fiscal years beginning after November 15, 2007, and interim
periods within those fiscal years. We currently are evaluating the timing and impact of adopting SFAS No. 157
on our financial position.
SFAS No. 158, Employers’ Accounting for Defined Benefit Pension and Other Postretirement
Plans, an amendment of SFAS Nos. 87, 88, 106, and 132(R)
In September 2006, FASB issued SFAS No. 158, which requires that we recognize the over-funded or under-
funded status of our defined benefit plans as an asset or liability. SFAS No. 158 is effective as of
December 31, 2006, with changes in the funded status recognized through accumulated other comprehensive
income in the year in which they occur.
The adoption of SFAS No. 158 resulted in an increase in liabilities of approximately $32 million on an after-tax
basis with a corresponding reduction in accumulated other comprehensive income and shareholders’ equity.
SFAS No. 158 did not change the amount of net periodic benefit expense recognized in an entity’s results of
operations.
SAB No. 108, Considering the Effects of Prior Year Misstatements when Qualifying
Misstatements in Current Year Financial Statements
In September 2006, the SEC issued Staff Accounting Bulletin (SAB) No. 108 to address diversity in practice in
quantifying financial statement misstatements. SAB 108 requires that we quantify misstatements based on
their impact on each of our financial statements and related disclosures. SAB 108 is effective as of
December 31, 2006, allowing a one-time transitional cumulative effect adjustment to retained earnings as of
January 1, 2006, for errors that were not previously deemed material, but are material under the guidance in
SAB No. 108.The impact of adopting SAB No. 108 did not result in a material effect on our results of operations
and financial position.
Interpretation No. 48, Accounting for Uncertainty in Income Taxes, an interpretation of SFAS
No. 109
In July 2006, FASB issued FASB Interpretation No. 48, Accounting for Uncertainty in Income Taxes. FIN 48 is an
interpretation of SFAS No. 109, Accounting for Income Taxes. This Interpretation clarifies the accounting for
uncertainty in income taxes recognized in an enterprise’s financial statements in accordance with
SFAS No. 109. This Interpretation prescribes a recognition threshold and measurement attribute for the
financial statement recognition and measurement of a tax position taken or expected to be taken in a tax
return. This Interpretation also provides guidance on de-recognition, classification, interest and penalties,
accounting in interim periods, disclosure, and transition. This Interpretation is effective for fiscal years
beginning after December 15, 2006. We adopted FIN 48 as of January 1, 2007, as required. In the first quarter
of 2007, we will record a cumulative effect adjustment of a change in accounting principle as prescribed by
FIN 48. We do not expect FIN 48 to have a material effect on our results or operations or financial position.
2006 10-K Page 89
SOP 05-1, Accounting by Insurance Enterprises for Deferred Acquisition Costs in Connection
with Modifications or Exchanges of Insurance Contracts
In October 2005, the American Institute of Certified Public Accountants issued Statement of Position
(SOP) 05-1, which provides accounting guidance for deferred policy acquisition costs on internal replacements
of insurance and investment contracts other than those specifically described in SFAS No. 97, Accounting and
Reporting by Insurance Enterprises for Certain Long-Duration Contracts and for Realized Gains and Losses
from the Sale of Investments. SOP 05-1 defines an internal replacement as a modification in product benefits,
features, rights or coverages that occurs by the exchange of a contract for a new contract, or by amendment,
endorsement or rider to a contract, or by the election of a feature or coverage within a contract. Internal
replacement contracts are those that are substantially changed from the replaced contract and are accounted
for as an extinguishment of the replaced contract. Nonintegrated contract features are accounted for as
separately issued contracts. Modifications resulting from the election of a feature or coverage within a contract
or from an integrated contract feature generally do not result in an internal replacement contract subject to
SOP 05-1 provided certain conditions are met. The provisions of SOP 05-1 are effective for internal
replacements occurring in fiscal years beginning after December 15, 2006. We do not expect this statement to
have a material impact on our results of operations or financial position.
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 summary:
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
Other
Total
Change in unrealized investment gains and losses and other summary:
Fixed maturities
Equity securities
Adjustment to deferred acquisition costs and life policy reserves
Other
Income taxes on above
Total
Years ended December 31,
2005
2004
2006
$
$
$
$
$
$
300 $
262
15
577
7
570 $
27 $
(2)
(1)
656
(5)
0
7
2
684 $
(23) $
200
2
2
(54)
127 $
280 $
244
8
532
6
526 $
36 $
(1)
(1)
40
(6)
0
(7)
0
61 $
(198) $
(575)
6
18
246
(503) $
252
239
6
497
5
492
36
(20)
(5)
101
(30)
(1)
10
0
91
(6)
(448)
3
(6)
160
(297)
At December 31, 2006, contractual maturity dates for fixed-maturity and short-term investments were:
(In millions)
Maturity dates occurring:
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
$
$
203 $
787
2,860
1,729
255
5,834 $
204
802
2,865
1,763
266
5,900
3.5 %
13.6
48.5
29.9
4.5
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, 2006, investments with book value of $64 million and fair value of $66 million were on
deposit with various states in compliance with regulatory requirements.
2006 10-K Page 90
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,
2006
Fixed maturities:
States, municipalities and political subdivisions
Convertibles and bonds with warrants attached
Public utilities
United States government
Government-sponsored enterprises
Foreign government
All other corporate bonds and short-term investments
Total
Equity securities
2005
Fixed maturities:
States, municipalities and political subdivisions
Convertibles and bonds with warrants attached
Public utilities
United States government
Government-sponsored enterprises
Foreign government
All other corporate bonds and short-term investments
Total
Equity securities
Cost or
amortized
cost
Gross unrealized
gains
losses
Fair
value
$
$
$
$
$
$
2,382 $
264
140
5
995
3
2,045
5,834 $
2,621 $
2,083 $
270
139
5
992
3
1,970
5,462 $
2,128 $
40 $
17
4
0
0
0
61
122 $
5,181 $
48 $
17
5
0
0
0
89
159 $
4,986 $
6 $
3
2
0
23
0
22
56 $
3 $
14 $
9
1
0
19
0
27
70 $
8 $
2,416
278
142
5
972
3
2,084
5,900
7,799
2,117
278
143
5
973
3
2,032
5,551
7,106
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,
2006
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
Government-sponsored enterprises
Foreign government
All other corporate bonds and short-term investments
Total
Equity securities:
Total
2005
Fixed maturities:
States, municipalities and political subdivisions
Convertibles and bonds with warrants attached
Public utilities
United States government
Government-sponsored enterprises
All other corporate bonds and short-term investments
Total
Equity securities:
Total
$
$
$
$
190 $
6
4
3
1
3
88
295
39
334 $
754 $
73
44
1
607
387
1,866
59
1,925 $
1 $
0
0
0
0
0
2
3
2
5 $
8 $
3
1
0
8
11
31
2
33 $
589 $
43
54
1
970
0
726
2,383
11
2,394 $
173 $
39
6
0
354
284
856
47
903 $
5 $
3
2
0
23
0
20
53
1
54 $
6 $
6
0
0
11
16
39
6
45 $
779 $
49
58
4
971
3
814
2,678
50
2,728 $
927 $
112
50
1
961
671
2,722
106
2,828 $
6
3
2
0
23
0
22
56
3
59
14
9
1
0
19
27
70
8
78
At December 31, 2006, 482 fixed-maturity investments with a total unrealized loss of $53 million and three
equity securities 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.
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.
2006 10-K Page 91
Investments in companies that exceed 10 percent of our shareholders’ equity at December 31 include:
(In millions)
Issuers:
Fifth Third Bancorp common stock
Exxon Mobil Corporation common stock
Alltel Corporation common stock and fixed maturity
2006
2005
Cost
Fair value
Cost
Fair value
$
283 $
133
0
2,979 $
687
0
283 $
133
122
2,745
503
807
We sold 12,700,164 shares of our holdings of Alltel Corporation common stock in January 2006 and
475,000 shares in December 2005. The sale contributed $647 million and $27 million to our 2006 and
2005 pretax realized gains. The sale contributed $412 million and $15 million to net income in 2006 and
2005, respectively.
3.
This table summarizes components of our deferred policy acquisition costs asset:
DEFERRED ACQUISITION COSTS
(In millions)
Deferred policy acquisition costs asset at beginning of year
Capitalized deferred policy acquisition costs
Amortized deferred policy acquisition costs
Amortized shadow deferred policy acquisition costs
Deferred policy acquisition costs asset at end of year
2006
At December 31,
2005
2004
$
$
429 $
706
(685)
3
453 $
400 $
683
(664)
10
429 $
372
657
(626)
(3)
400
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
Years ended December 31,
2005
2004
2006
$
$
3,629 $
518
3,111
3,514 $
537
2,977
2,124
(116)
2,008
819
944
1,763
1,972
(160)
1,812
772
906
1,678
3,356
504
3,860 $
3,111
518
3,629 $
3,386
541
2,845
1,949
(196)
1,753
804
817
1,621
2,977
537
3,514
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 $116 million, $160 million and $196 million in calendar years 2006, 2005 and 2004. 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.
The reserve for loss and loss expenses in the consolidated balance sheets also includes $36 million,
$32 million and $35 million at December 31, 2006, 2005 and 2004, respectively, for certain life and health
losses.
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.
2006 10-K Page 92
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. Some of our universal life policies contain no-lapse guarantee provisions. For these policies,
we establish a reserve in addition to the account balance, based on expected no-lapse guarantee benefits and
expected policy assessments.
Here is a summary of our life policy reserves:
(In millions)
Ordinary/traditional life
Universal life
Annuities
Other
Total
At December 31,
2006
2005
$
$
453 $
396
537
23
1,409 $
419
376
523
25
1,343
At both December 31, 2006 and 2005, the fair value associated with the annuities shown above was
approximately $563 million.
NOTES PAYABLE
6.
We had two lines of credit with commercial banks amounting to $125 million with an outstanding balance of
$49 million at year-end 2006. We had no compensating balance requirement on short-term debt for either
2006 or 2005. We had two lines of credit with commercial banks amounting to $125 million with no
outstanding balance at year-end 2005. Interest rates charged on such borrowings ranged from 5.90 percent to
6.03 percent during 2006.
The company’s subsidiary, CFC Investment Company, entered into an interest-rate swap agreement during
2006, which expires in three years, to hedge future cash flows (thereby obtaining a fixed interest rate of
5.985 percent) related to certain variable rate debt obligations. This swap is reflected at fair value in the
consolidated balance sheets and the unrealized loss, net of tax, at December 31, 2006, of $69,000 is a
component of shareholders’ equity in accumulated other comprehensive income. The company does not
expect any significant amounts to be reclassified into earnings as a result of interest rate changes in the
next 12 months.
7.
This table summarizes the principal amounts of our long-term debt excluding unamortized discounts:
SENIOR DEBT
(In millions)
Interest Year of
rate
issue
6.90% 1998
6.92% 2005
6.125% 2004
Senior debentures, due 2028
Senior debentures, due 2028
Senior notes, due 2034
Total
At December 31,
2006
2005
$
$
28 $
392
375
795 $
28
392
375
795
The fair value of our senior debt approximated $850 million at year-end 2006 and $870 million at year-end
2005. None of the notes are encumbered by rating triggers.
SHAREHOLDERS’ EQUITY AND DIVIDEND RESTRICTIONS
8.
Our insurance subsidiary declared dividends to the parent company of $275 million in 2006, $275 million in
2005 and $175 million in 2004. 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 2007, the total dividends that our lead insurance subsidiary may pay to our parent company
without regulatory approval will be approximately $572 million.
As of December 31, 2006, 11.6 million shares of common stock were available for future stock option grants.
Declared cash dividends per share were $1.34, $1.21 and $1.04 for the years ended December 31, 2006,
2005 and 2004, respectively.
2006 10-K Page 93
Accumulated Other Comprehensive Income
The change in unrealized gains and losses on investments and derivatives included:
(In millions)
Accumulated unrealized gains
(losses) on securities available
for sale at January 1
Net unrealized gains (losses)
Reclassification adjustment for
(gains) losses included in net
income
Adjustment to deferred
acquisition costs and
life policy reserves
Effect on other comprehensive
income
Accumulated unrealized gains
(losses) on securities available
for sale at December 31
Accumulated unrealized gains
(losses) on derivatives used in
cash flow hedging relationships
at January 1
Net unrealized gains (losses)
Reclassification adjustment for
(gains) losses included in net
income
Effect on other comprehensive
income
Accumulated unrealized gains
(losses) on derivatives used in
cash flow hedging
relationships at December 31
Accumulated unrealized losses
for pension obligations at
January 1
Cumulative effect of change
in accounting for pension
obligations
Accumulated unrealized losses
for pension obligations at
December 31
Accumulated other
comprehensive income at
January 1
Other comprehensive income (loss)
Cumulative effect of change in
accounting for pension
obligations
Accumulated other
comprehensive income
at December 31
Before
tax
2006
Income
tax
Net
Years ended December 31,
2005
Income
tax
Before
tax
Net
Before
tax
2004
Income
tax
Net
$
5,060 $
880
1,776 $
298
3,284 $
582
5,809 $
(692)
2,022 $
(226)
3,787 $
(466)
6,269 $
(372)
2,183 $
(131)
4,086
(241)
(701)
(245)
(456)
(61)
(21)
(40)
(91)
(31)
(60)
2
181
1
54
1
127
4
1
3
3
1
2
(749)
(246)
(503)
(460)
(161)
(299)
$
5,241 $
1,830 $
3,411 $
5,060 $
1,776 $
3,284 $
5,809 $
2,022 $
3,787
$
$
$
$
$
0 $
0
0 $
0
0 $
0
0 $
0
0 $
0
0 $
0
(3) $
0
(1) $
0
(2)
0
0
0
0
0
0
0
0
0
0
0
0
0
3
3
1
1
0 $
0 $
0 $
0 $
0 $
0 $
0 $
0 $
0 $
0 $
0 $
0 $
0 $
0 $
0 $
0 $
(49)
(17)
(32)
0
0
0
0
0
(49) $
(17) $
(32) $
0 $
0 $
0 $
0 $
0 $
2
2
0
0
0
0
5,060 $
181
1,776 $
54
3,284 $
127
5,809 $
(749)
2,022 $
(246)
3,787 $
(503)
6,266 $
(457)
2,182 $
(160)
4,084
(297)
(49)
(17)
(32)
0
0
0
0
0
0
$
5,192 $
1,813 $
3,379 $
5,060 $
1,776 $
3,284 $
5,809 $
2,022 $
3,787
9.
Our statements of income include earned property casualty premiums on assumed and ceded business:
REINSURANCE
(In millions)
Direct earned premiums
Assumed earned premiums
Ceded earned premiums
Net earned premiums
Years ended December 31,
2005
2006
2004
$
$
3,296 $
26
(158)
3,164 $
3,209 $
28
(179)
3,058 $
3,062
32
(175)
2,919
2006 10-K Page 94
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
Years ended December 31,
2005
2006
2004
$
$
2,072 $
13
(77)
2,008 $
1,898 $
40
(126)
1,812 $
1,870
17
(134)
1,753
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
Other
Total
Net deferred tax liability
At December 31,
2006
2005
1,824 $
142
36
2,002
190
109
22
28
349
1,653 $
1,788
135
32
1,955
179
108
26
20
333
1,622
$
$
The provision for federal income taxes is based upon a consolidated income tax return for the company and
subsidiaries. As of December 31, 2006, 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
Years ended December 31,
2005
2004
2006
35.0 %
35.0 %
35.0 %
(2.2)
(3.9)
1.1
30.0 %
(3.2)
(5.7)
0.7
26.8 %
(2.5)
(5.7)
0.2
27.0 %
Filed tax returns for calendar years 2000 through 2005 are currently open with the Internal Revenue Service.
As of December 31, 2005, federal income taxes had not been provided for on our life insurance subsidiary’s
Policyholder Surplus Account (PSA), which totaled $14 million as of December 31, 2005 and 2004.
The American Jobs Creation Act of 2004 suspended for a two-year period beginning January 1, 2005, the tax
liability of a stock life insurance company on distributions made from the PSA. In July 2006, the company’s life
insurance subsidiary declared and paid a $14 million dividend, eliminating its PSA balance as of
December 31, 2006.
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, 2006.
2006 10-K Page 95
Here are calculations for basic and diluted earnings per share:
(In millions)
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
Number of anti-dilutive option shares
Exercise price of anti-dilutive option shares
Years ended December 31,
2005
2004
2006
930 $
602 $
584
173,423,395
2,027,946
175,451,341
175,062,669
2,053,457
177,116,126
176,476,722
1,900,126
178,376,848
5.36 $
5.30
1,336,150
45.26
3.44 $
3.40
0
— $
3.30
3.28
264,602
41.14
$
$
$
The only current source of dilution of our common shares is outstanding stock options to purchase shares of
common stock. The above table shows the number of anti-dilutive options shares at year-end 2006, 2005 and
2004. We did not include these options in the computation of net income per common share (diluted) because
their exercise would have an anti-dilutive effect.
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 but we do pay all operating expenses.
Benefits for the defined benefit pension plan are based on years of credited service and compensation level.
Contributions are based on the frozen entry age actuarial cost method. We also maintain a supplemental
retirement plan (SERP) with liabilities of approximately $5 million to $9 million at year-end 2006 and 2005.
The SERP is included in the obligation and expense amounts. Our pension expense is composed of several
components that are determined using the projected unit credit actuarial cost method and are based on
certain actuarial assumptions.
Key assumptions used in developing the 2006 net pension obligation were a 5.75 percent discount rate and
rates of compensation increases ranging from 4 percent to 6 percent. To determine the discount rate, the
plan’s particular liability characteristics – the amounts, timing and interest sensitivity of expected benefit
payments – were evaluated and then matched to a yield curve based on actual high-quality corporate bonds
across a full maturity spectrum. Once the plan’s projected cash flows matched the yield curve, a present value
was developed, which was then calibrated to a single-equivalent discount rate. That discount rate, when
applied to a single sum, would generate the necessary cash flows to pay benefits when due. It was increased
by 0.25 percentage points in 2006 due to market interest rates conditions. We based the rates of
compensation increase on the company’s historical data, which led us to lower the range from the 5 percent to
7 percent used in previous years.
Key assumptions used in developing the 2006 net pension expense were a 5.50 percent discount rate,
an 8 percent expected return on plan assets and rates of compensation increases ranging from 5 percent to
7 percent. The 8 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 0.25 percentage points due to market interest
rate conditions.
2006 10-K Page 96
Benefit obligation activity using an actuarial measurement date at December 31 follows:
(In millions)
Change in projected benefit obligation:
Benefit obligation at beginning of year
Service cost
Interest cost
Plan amendments
Actuarial loss
Benefits paid
Projected 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 (unfunded) status:
Funded (unfunded) status at end of year
Qualified Pension Plan
2005
2006
Supplemental Pension Plan
Totals
2006
2005
2006
2005
$
$
$
$
$
$
235 $
16
14
0
11
(10)
266 $
200 $
173
35
10
(10)
208 $
199 $
13
12
0
18
(7)
235 $
165 $
158
12
10
(7)
173 $
9 $
0
0
0
0
(4)
5 $
4 $
0
0
4
(4)
0 $
5 $
0
1
3
0
0
9 $
6 $
0 $
0
0
0
0 $
244 $
16
14
0
11
(14)
271 $
204 $
173 $
35
14
(14)
208 $
204
13
13
3
18
(7)
244
171
158
12
10
(7)
173
(58) $
(62) $
(5) $
(9) $
(63) $
(71)
The accumulated benefit obligation was $204 million and $171 million at December 31, 2006 and 2005,
respectively. The fair value of our stock comprised $29 million (14 percent of total plan assets) at
December 31, 2006, and $29 million (17 percent of total plan assets) at December 31, 2005.
At December 31, 2005 there were no amounts recognized in accumulated other comprehensive income for the
plans. A reconciliation follows of the funded status at the end of the measurement period to the amounts
recognized in the statement of financial position at December 31, 2006:
(In millions)
Amounts recognized in the statement of financial position consist of:
Noncurrent liability
Total
Amounts recognized in accumulated other comprehensive income not yet recognized
as a component of net periodic benefit cost consist of:
Net actuarial loss/(gain)
Prior service cost
Total
Qualified
Supplemental
Pension Plan Pension Plan
Total
$
$
$
$
(58) $
(58) $
(5) $
(5) $
(63)
(63)
40 $
6
46 $
(1) $
4
3 $
39
10
49
The projected benefit obligation and fair value of plan assets for pension plans with a projected benefit
obligation in excess of plan assets at December 31 follows:
(In millions)
Projected benefit obligation in excess of plan assets:
Projected benefit obligation at end of year
Fair value of plan assets at end of year
Qualified Pension Plan
2005
2006
Supplemental Pension Plan
Total
2006
2005
2006
2005
$
266 $
208
235 $
173
5 $
0
9 $
0
271 $
208
244
173
The projected benefit obligation, accumulated benefit obligation and fair value of plan assets for pension plans
with an accumulated benefit obligation in excess of plan assets at December 31 follows:
(In millions)
Accumulated benefit obligation in excess of plan assets:
Projected benefit obligation at end of year
Accumulated benefit obligation at end of year
Fair value of plan assets at end of year
Supplemental Pension Plan
2006
2005
$
5 $
4
0
9
6
0
The weighted-average assumptions used to determine benefit obligations at December 31 follows:
Discount rate
Rate of compensation increase
2006
2005
5.75 %
4-6
5.50 %
5-7
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
2006 10-K Page 97
changes to those bond yields. Compensation increase assumptions reflect historical calendar year
compensation increases.
Here are the components of our net periodic benefit cost at December 31:
(In millions)
$
Service cost
Interest cost
Expected return on plan assets
Amortization of actuarial
gain, prior service cost
and transition asset
Net periodic benefit cost
$
Qualified Pension Plan
2005
2004
2006
16 $
14
(14)
13 $
12
(13)
11 $
10
(12)
2
18 $
1
13 $
0
9 $
Supplemental Pension Plan
2005
2004
2006
0 $
0
0
1
1 $
0 $
1
0
0
1 $
0 $
0
0
0
0 $
Total
2005
2004
2006
16 $
14
(14)
13 $
13
(13)
3
19 $
1
14 $
11
10
(12)
0
9
Here is a summary of the weighted-average assumptions we use to determine our net expense for the plan:
Qualified Pension Plan
2005
2004
2006
Supplemental Pension Plan
2005
2004
2006
Discount rate
Expected return on plan assets
Rate of compensation increase
5.50 %
8.00
5-7
5.75 %
8.00
5-7
6.00 %
8.00
5-7
5.50 %
5.75 %
6.00 %
NA
5-7
NA
5-7
NA
5-7
Our pension plan asset allocations by category are:
Asset category:
Equity securities
Fixed maturities
Cash and cash equivalents
Total
At December 31,
2005
2006
94 %
4
2
100 %
93 %
5
2
100 %
We expect to contribute approximately $10 million to our pension plan in 2007 with a target allocation of
90 percent equity securities and 10 percent 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,
2007
2008
2009
2010
2011
Years 2012-2016
Qualified
Supplemental
Pension Plan Pension Plan
$
9 $
Total
9
14
13
12
15
109
0 $
2
0
2
0
1
12
13
10
15
108
The estimated costs that will be amortized from accumulated other comprehensive income into net periodic
benefit cost over the next year are as follows:
(In millions)
Actuarial (gain)/loss
Prior service cost
Total
Qualified
Pension Plan
$
$
2
0
2
Supplemental
Pension Plan
(1)
1
0
$
$
Total
1
1
2
$
$
The incremental effect of applying SFAS No. 158 on individual line items in the statement of financial position
at December 31, 2006, follows:
(In millions)
Qualified Pension Plan
With
FAS 158
Increase/
(Decrease)
Without
FAS 158
Supplemental Pension Plan
With
FAS 158
Increase/
(Decrease)
Without
FAS 158
Without
FAS 158
Total
With
FAS 158
Other liabilities
Deferred income tax
Accumulated other
comprehensive income
$
12 $
(4)
58 $
(20)
46 $
(16)
0
(30)
(30)
2 $
(1)
0
5 $
(2)
(2)
3 $
(1)
(2)
Increase/
(Decrease)
49
(17)
63 $
(22)
14 $
(5)
0
(32)
(32)
STATUTORY ACCOUNTING INFORMATION
13.
Insurance companies use statutory accounting practices (SAP) as prescribed by regulatory authorities. The
three primary differences between SAP and GAAP are:
• policy acquisition costs are expensed when incurred,
•
life insurance reserves are based upon different actuarial assumptions and
• deferred income taxes are valued and established using a different basis.
2006 10-K Page 98
Statutory net income and capital and surplus determined in accordance with SAP prescribed or permitted by
insurance regulatory authorities for four legal entities, our insurance subsidiary and its three insurance
subsidiaries, are as follows:
(In millions)
SAP Net Income
The Cincinnati Insurance Company
The Cincinnati Casualty Company
The Cincinnati Indemnity Company
The Cincinnati Life Insurance Company
$
572 $
15
2
28
517 $
13
2
21
588
9
2
28
Years ended December 31,
2005
2004
2006
$
Capital and Surplus
At December 31,
2006
2005
4,723 $
282
62
479
4,220
263
63
451
Statutory capital and surplus for our insurance subsidiary, The Cincinnati Insurance Company, includes capital
and surplus of its three insurance subsidiaries.
TRANSACTIONS WITH AFFILIATED PARTIES
14.
We paid certain officers and directors, or insurance agencies of which they are shareholders, commissions of
approximately $7 million, $6 million and $11 million on premium volume of approximately $40 million,
$41 million and $76 million for 2006, 2005 and 2004, respectively.
COMMITMENTS AND CONTINGENT LIABILITIES
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, results of operations or cash flows. 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,
results of operations or cash flows.
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.
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
2006 10-K Page 99
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.
EQUITY COMPENSATION PLANS
16.
As a result of adopting SFAS No. 123(R) on January 1, 2006, our income before income taxes for the year
ended December 31, 2006, was reduced by $17 million. Our net income for the year ended
December 31, 2006, was reduced by $14 million. If we had continued to account for stock-based
compensation under APB Opinion No. 25, there would have been no effect on net income. The weighted-
average grant-date fair value of options granted during 2006 and 2005 was $10.09 and $12.49, respectively.
The total intrinsic value of options exercised during the years ended December 31, 2006, 2005 and 2004, was
$22 million, $9 million and $6 million, respectively. The total intrinsic value of options vested during the years
ended December 31, 2006, 2005 and 2004, was $10 million, $12 million and $11 million. (Intrinsic value is
the market price less the exercise price.)
Under the modified-prospective-transition method, in 2006, we recognized:
•
•
•
compensation cost for all stock options granted subsequent to January 1, 2006, based on the grant-date
fair value estimated in accordance with the provisions of SFAS No. 123(R)
compensation cost for all non-vested stock options granted prior to January 1, 2006, that vested during
2006, based on the grant date fair value estimated in accordance with the original provisions of
SFAS No. 123 and
compensation cost for all non-vested stock options that have nonsubstantive vesting requirements, such
as those to associates who are eligible for retirement.
Results for prior periods have not been retrospectively adjusted for SFAS No. 123(R). As of
December 31, 2006, we had $14 million of unrecognized total compensation cost related to non-vested stock
options. That cost will be recognized over a weighted-average period of 1.7 years. SFAS No. 123(R) also
requires us to classify certain tax benefits related to share-based compensation deductions as cash from
financing activities. As of December 31, 2006, these tax benefits totaled $2 million.
In determining the share-based compensation amounts for 2006, the fair value of each option granted in 2006
was estimated on the date of grant using the binomial option-pricing model with the following weighted average
assumptions used for grants in 2006: dividend yield of 3.22 percent; expected volatility ranging from 20.25 to
27.12 percent; risk-free interest rates ranging from 4.5 to 4.61 percent; and expected lives of five to seven
years.
The following table illustrates the effect on net income and earnings per share if we had applied the fair value
recognition provisions of SFAS No. 123 to options granted under our stock option plans prior to our adoption of
SFAS No. 123(R) on January 1, 2006. For purposes of this pro forma disclosure, the fair value of each option
was estimated on the date of grant using the binomial option-pricing model with the following weighted-average
assumptions used for grants in:
• 2005 – Dividend yield of 2.66 percent; expected volatility of 25.61 percent; risk-free interest rate of
4.62 percent; and expected lives of 10 years.
• 2004 – Dividend yield of 2.40 percent; expected volatility of 25.65 percent; risk-free interest rate of
4.37 percent; and expected lives of 10 years.
2006 10-K Page 100
(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
Here is a summary of options information:
(Dollars in millions, shares in thousands)
As reported
Pro forma
As reported
Pro forma
As reported
Pro forma
2006
Outstanding at beginning of year
Granted/reinstated
Exercised
Forfeited/revoked
Outstanding at end of period
Options exercisable at end of period
Weighted-average fair value of options granted during the period
2005
Outstanding at beginning of year
Granted/reinstated
Exercised
Forfeited/revoked
Outstanding at end of period
Options exercisable at end of period
Weighted-average fair value of options granted during the period
2004
Outstanding at beginning of year
Granted/reinstated
Exercised
Forfeited/revoked
Outstanding at end of period
Options exercisable at end of period
Weighted-average fair value of options granted during the period
Years ended December 31,
2005
2004
$
$
$
$
602 $
13
589 $
3.44 $
3.36
3.40 $
3.32
584
12
572
3.30
3.24
3.28
3.21
Weighted-
average
exercise
Aggregate
intrinsic
value
Shares
10,589 $
1,372
(1,084)
(210)
10,667
7,985 $
9,698 $
1,504
(467)
(146)
10,589
7,794 $
8,791 $
1,439
(397)
(135)
9,698
7,050 $
33.70
45.26
24.93
36.16
36.03 $
33.70 $
10.09
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
99
93
116
101
98
82
Cash received from the exercise of options was $27 million, $11 million and $10 million for the years ended
December 31, 2006, 2005 and 2004, respectively. The tax benefit realized on options exercised was
$3 million for the year ended December 31, 2006, and less than $1 million for the years ended
December 31, 2005 and 2004.
Options outstanding and exercisable consisted of the following at December 31, 2006:
(Shares in thousands)
Range of exercise prices
$15.00 to $19.99
$20.00 to $24.99
$25.00 to $29.99
$30.00 to $34.99
$35.00 to $39.99
$40.00 to $44.99
$45.00 to $49.99
Total
Options outstanding
Weighted-average
remaining contractual
life
0.11 yrs
0.28 yrs
3.01 yrs
4.19 yrs
5.31 yrs
6.94 yrs
9.08 yrs
5.28 yrs
$
Weighted-
average
exercise price
19.34
20.60
27.07
32.66
38.44
41.54
45.26
36.03
Shares
2
161
944
4,571
1,968
1,685
1,336
10,667
Options exercisable
Weighted-
average
exercise price
19.34
20.60
27.07
32.66
38.34
41.45
45.26
33.70
Shares
2 $
161
944
4,571
1,535
757
15
7,985
The weighted-average remaining contractual life for exercisable awards as of December 31, 2006, was
4.24 years. As of December 31, 2006, 11.6 million shares of common stock were available for future stock
option grants. We currently issue new shares for option exercises.
2006 10-K Page 101
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 non-investment operations of the parent company, CFC Investment Company and
CinFin Capital Management Company (excluding client 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 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:
•
•
•
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 calculate underwriting income or loss by recording 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 separately 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.
2006 10-K Page 102
This table summarizes segment information:
(In millions)
Revenues:
Commercial lines insurance
Commercial casualty
Commercial property
Commercial auto
Workers' compensation
Specialty packages
Surety and executive risk
Machinery and equipment
Total commercial lines insurance
Personal lines insurance
Personal auto
Homeowner
Other personal lines
Total personal lines insurance
Life insurance
Investment operations
Other
Consolidated eliminations
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
Years ended December 31,
2005
2004
2006
$
$
$
$
$
$
831 $
491
453
366
141
93
27
2,402
385
289
88
762
118
1,254
15
(1)
4,550 $
208 $
(27)
(1)
1,200
(51)
1,329 $
759 $
467
457
328
137
80
26
2,254
433
282
89
804
110
587
12
0
3,767 $
285 $
45
7
536
(50)
823 $
686
440
450
313
133
80
24
2,126
451
256
86
793
104
583
8
0
3,614
338
(40)
2
537
(37)
800
2,220 $
886
13,820
296
17,222 $
2,167
845
12,774
217
16,003
QUARTERLY SUPPLEMENTARY DATA (UNAUDITED)
This table includes unaudited quarterly financial information for the years ended December 31, 2006
and 2005:
(Dollars in millions except per share data)
2006
Revenues
Income before income taxes
Net income
Net income per common share—basic
Net income per common share—diluted
2005
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
$
$
1,607 $
834
552
3.17
3.13
916 $
195
144
0.82
0.81
981 $
175
132
0.77
0.76
940 $
215
158
0.90
0.89
967 $
148
115
0.67
0.66
944 $
151
117
0.67
0.66
995 $
172
130
0.75
0.75
967 $
261
183
1.04
1.03
4,550
1,329
930
5.36
5.30
3,767
823
602
3.44
3.40
Note: The sum of the quarterly reported amounts may not equal the full year as each is computed independently.
First-quarter and full-year 2006 – The company sold its holdings in Alltel Corporation common stock in the
first quarter of 2006. The sale contributed $647 million to revenues and $412 million, or $2.35 per share,
to net income.
2006 10-K Page 103
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
Evaluation of Disclosure 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, 2006. 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
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.
•
Changes in Internal Control over Financial Reporting – During the three months ended December 31, 2006,
there were no changes in our internal controls over financial reporting that have materially affected, or are
reasonably likely to materially affect, our 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 79 and 80.
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 2007 Annual Meeting of Shareholders no
later than April 13, 2007. 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 the Board of 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” appeared 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 “Compensation of Named
Executive Officers and Directors,” which includes the “Report of the Compensation Committee” and the
“Compensation Discussion and Analysis.”
Executive Compensation
2006 10-K Page 104
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 “Compensation of Named Executive Officers and Directors,” which includes
“Securities Authorized for Issuance under Equity Compensation Plans.” Additional information on share-based
compensation under our equity compensation plans is available in Item 8, Note 16 to the Consolidated
Financial Statements, Page 100.
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 “Audit-related Matters,” which
includes the “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 81-85
b) Exhibits – see Index of Exhibits, Page 117
c) Financial Statement Schedules
Schedule I – Summary of Investments -- Other than Investments in Related Parties, Page 106
Schedule II – Condensed Financial Statements of Registrant, Page 108
Schedule III – Supplementary Insurance Information, Page 111
Schedule IV – Reinsurance, Page 113
Schedule V – Valuation and Qualifying Accounts, Page 114
Schedule VI – Supplementary Information Concerning Property Casualty Insurance Operations, Page 115
2006 10-K Page 105
SCHEDULE I
(In millions)
Type of investment
Fixed maturities:
United States government:
The Cincinnati Insurance Company
The Cincinnati Life Insurance Company
Total
Government-sponsored enterprises:
The Cincinnati Insurance Company
The Cincinnati Casualty Company
The Cincinnati Indemnity Company
The Cincinnati Life Insurance Company
Total
Foreign government:
The Cincinnati 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 Life Insurance 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
Cincinnati Financial Corporation and Subsidiaries
Summary of Investments - Other than Investments in Related Parties
Cost or
amortized cost
At December 31, 2006
Fair
value
Balance sheet
amount
$
$
1 $
4
5
1 $
4
5
620
6
2
367
995
3
3
2,218
127
32
5
2,382
55
4
1
78
2
140
163
92
9
264
605
6
2
359
972
3
3
2,248
129
32
7
2,416
56
4
1
79
2
142
174
95
9
278
977
27
10
819
117
1,950
5,739 $
995
29
11
837
117
1,989
5,805 $
1
4
5
605
6
2
359
972
3
3
2,248
129
32
7
2,416
56
4
1
79
2
142
174
95
9
278
995
29
11
837
117
1,989
5,805
2006 10-K Page 106
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 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 Life Insurance Company
CinFin Capital Management Company
Cincinnati Financial Corporation
Total
Total equity securities
Short-term investments:
The Cincinnati Insurance Company
The Cincinnati Life Insurance Company
Total short-term investments
Other invested assets:
Real estate:
The Cincinnati Life Insurance Company
Policy loans:
The Cincinnati Life Insurance Company
Limited partnerships:
Cincinnati Financial Corporation
Total other invested assets
Total investments
Cost or
amortized cost
At December 31, 2006
Fair
value
Balance sheet
amount
$
$
$
$
$
$
$
82 $
2
11
1
29
125
466
16
59
1
502
1,044
703
19
6
118
4
381
1,231
169
38
0
14
221
2,621 $
92 $
3
95 $
3
32
25
60
8,515
144 $
7
28
1
86
266
2,485
84
182
2
1,813
4,566
1,784
71
18
283
5
571
2,732
182
39
0
14
235
7,799 $
92 $
3
95 $
—
—
—
—
—
$
$
$
144
7
28
1
86
266
2,485
84
182
2
1,813
4,566
1,784
71
18
283
5
571
2,732
182
39
0
14
235
7,799
92
3
95
3
32
25
60
13,759
2006 10-K Page 107
SCHEDULE II
(In millions)
Cincinnati Financial Corporation (parent company only)
Condensed Balance Sheets
At December 31,
2006
2005
ASSETS
Investments
Fixed maturities, at fair value
Equity securities, 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:
2006—$64; 2005—$61)
Prepaid federal income tax
Other assets
Due from subsidiaries
Total assets
LIABILITIES
Dividends declared but unpaid
Deferred federal income tax
6.92% senior debentures due 2028
6.9% senior debentures due 2028
6.125% senior notes due 2034
Other liabilities
Total liabilities
SHAREHOLDERS' EQUITY
Common stock
Paid-in capital
Retained earnings
Accumulated other comprehensive income
Treasury stock at cost
Total shareholders' equity
Total liabilities and shareholders' equity
$
128 $
2,484
25
38
5,303
16
121
0
19
150
8,284 $
58 $
526
392
28
371
101
1,476
391
1,015
2,786
3,379
(763)
6,808
8,284 $
$
$
$
123
2,444
13
7
4,685
17
98
32
17
144
7,580
53
635
392
28
371
15
1,494
389
969
2,088
3,284
(644)
6,086
7,580
This condensed financial information should be read in conjunction with the Consolidated Financial Statements and Notes included
in Part II, Item 8, Page 78.
2006 10-K Page 108
Cincinnati Financial Corporation (parent company only)
Condensed Statements of Income
Years ended December 31,
2005
2004
2006
SCHEDULE II (CONTINUED)
(In millions)
REVENUES
Dividends from subsidiaries
Investment income, net of expenses
Realized gains on investments
Other revenue
Total revenues
EXPENSES
Interest expense
Depreciation expense
Other expenses
Total expenses
INCOME BEFORE INCOME TAXES AND EARNINGS OF SUBSIDIARIES
PROVISION (BENEFIT) FOR INCOME TAXES
Current
Deferred
Total provision for income taxes
NET INCOME BEFORE EARNINGS OF SUBSIDIARIES
Increase in undistributed earnings of subsidiaries
$
275 $
98
410
10
793
51
3
18
72
721
153
(11)
142
579
351
275 $
89
2
10
376
52
3
16
71
305
(27)
20
(7)
312
290
175
110
18
9
312
36
3
14
53
259
(17)
20
3
256
328
584
NET INCOME
$
930 $
602 $
This condensed financial information should be read in conjunction with the Consolidated Financial Statements and Notes included
in Part II, Item 8, Page 78.
2006 10-K Page 109
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) 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-maturities
Call or maturity of fixed-maturities
Sale of equity securities
Purchase of fixed-maturities
Purchase of equity securities
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,
2005
2004
2006
$
930 $
602 $
1
(410)
1
48
(11)
2
16
(351)
226
4
36
511
(42)
(351)
3
(26)
(8)
127
0
0
0
(228)
(119)
30
(5)
(322)
31
7
38 $
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 $
$
584
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
This condensed financial information should be read in conjunction with the Consolidated Financial Statements and Notes included
in Part II, Item 8, Page 78.
2006 10-K Page 110
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
Consolidated eliminations
Total
Cincinnati Financial Corporation and Subsidiaries
Supplementary Insurance Information
2006
Years ended December 31,
2005
2004
$
$
$
$
$
$
$
$
$
$
235 $
80
315
138
453 $
3,414 $
446
3,860
1,430
5,290 $
1,195 $
382
1,577
2
1,579 $
0 $
0
0
15
15 $
2,402 $
762
3,164
115
(1)
3,278 $
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
0
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
0
3,020
2006 10-K Page 111
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
Consolidated eliminations
Total
2006
Years ended December 31,
2005
2004
$
$
$
$
$
$
$
$
$
$
0 $
0
367
108
475 $
1,466 $
542
2,008
122
2,130 $
504 $
160
664
21
685 $
224 $
87
311
30
341 $
2,442 $
736
3,178
3
(1)
3,180 $
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
0
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
0
3,000
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; and Increase in deferred acquisition
costs 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.
2006 10-K Page 112
SCHEDULE IV
(Dollars in millions)
Gross amounts:
Life insurance in force
Earned premiums
Commercial lines insurance
Personal lines insurance
Total property casualty insurance
Life insurance
Consolidated eliminations
Total
Ceded amounts to other companies:
Life insurance in force
Earned premiums
Commercial lines insurance
Personal lines insurance
Total property casualty insurance
Life insurance
Total
Assumed amounts from other companies:
Life insurance in force
Earned premiums
Commercial lines insurance
Personal lines insurance
Total property casualty insurance
Life insurance
Total
Net amounts:
Life insurance in force
Earned premiums
Commercial lines insurance
Personal lines insurance
Total property casualty insurance
Life insurance
Consolidated eliminations
Total
Percentage of amounts 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
2006
Years ended December 31,
2005
2004
$
$
$
$
$
$
$
$
$
$
$
$
56,968
2,513
783
3,296
159
(1)
3,454
31,744
134
24
158
44
202
3
24
2
26
0
26
25,227
2,402
762
3,164
115
(1)
3,278
$
$
$
$
$
$
$
$
$
$
$
$
51,488
2,386
823
3,209
150
0
3,359
30,705
157
22
179
44
223
5
25
3
28
0
28
20,788
2,254
804
3,058
106
0
3,164
$
$
$
$
$
$
$
$
$
$
$
$
44,916
2,246
816
3,062
138
0
3,200
28,196
148
27
175
37
212
5
28
4
32
0
32
16,725
2,126
793
2,919
101
0
3,020
0.0 %
1.1 %
0.4
0.9
0.0
0.9
0.0 %
1.1 %
0.4
0.9
0.0
0.9
0.0 %
1.3 %
0.5
1.1
0.1
1.1
2006 10-K Page 113
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
2006
At December 31,
2005
2004
$
$
1 $
1
0
(1)
1 $
0 $
1
0
0
1 $
0
0
0
0
0
2006 10-K Page 114
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
Personal lines insurance
Total
Loss and loss expenses incurred related to prior accident years:
Commercial lines insurance
Personal lines insurance
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
2006
Years ended December 31,
2005
2004
$
$
$
$
$
$
$
$
$
$
$
$
$
$
$
$
$
$
$
$
$
235 $
80
315 $
3,414 $
446
3,860 $
0 $
1,194 $
382
1,576 $
2,402 $
762
3,164 $
0 $
0
367 $
1,564 $
560
2,124 $
(98) $
(18)
(116) $
504 $
160
664 $
1,218 $
545
1,763 $
2,442 $
736
3,178 $
226 $
85
311 $
3,173 $
456
3,629 $
0 $
1,150 $
407
1,557 $
2,254 $
804
3,058 $
0 $
0
338 $
1,424 $
548
1,972 $
(126) $
(34)
(160) $
473 $
168
641 $
1,126 $
552
1,678 $
2,290 $
786
3,076 $
218
88
306
3,016
498
3,514
0
1,112
425
1,537
2,126
793
2,919
0
0
289
1,328
621
1,949
(174)
(22)
(196)
448
162
610
1,062
559
1,621
2,186
811
2,997
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.
2006 10-K Page 115
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, Executive Vice President, Secretary and Treasurer
February 28, 2007
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/ Gregory T. Bier
Gregory T. Bier
/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, Chief Executive Officer and Director
Date
February 28, 2007
Chief Financial Officer, Executive Vice President, Secretary
and Treasurer (Principal Accounting Officer)
February 28, 2007
Director
February 28, 2007
Vice Chairman, President, Chief Operating Officer,
Chief Insurance Officer and Director
Director
Director
Director
Director
Director
Director
Director
Director
Director
Director
Director
Director
2006 10-K Page 116
February 28, 2007
February 28, 2007
February 28, 2007
February 28, 2007
February 28, 2007
February 28, 2007
February 28, 2007
February 28, 2007
February 28, 2007
February 28, 2007
February 28, 2007
February 28, 2007
February 28, 2007
INDEX OF EXHIBITS
Exhibit Description
Exhibit No.
3.1A
3.1B
3.2
4.1
4.2
4.3
4.4
4.5
4.6
4.7
10.1
10.2
10.3
10.4
10.5
10.6
10.7
10.8
10.9
10.10
10.11
10.12
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)
2003 Non-Employee Directors’ Stock Plan (8)
Cincinnati Financial Corporation Stock Option Plan No. VI (9)
Cincinnati Financial Corporation Stock Option Plan No. VII (10)
Standard Form of Nonqualified and Incentive Option Agreements for Stock Option Plan No. VI (7)
Cincinnati Financial Corporation Incentive Compensation Plan (11)
Cincinnati Financial Corporation 2006 Stock Compensation Plan (11)
Standard Form of Combined Incentive/Nonqualified Stock Option for Stock Option Plan VI (12)
364-Day Credit Agreement by and among Cincinnati Financial Corporation and CFC Investment Company,
as Borrowers, and Fifth Third Bank, as Lender (13)
Director and Named Executive Officer Compensation Summary (11)
Executive Compensation Plan (14)
Amendment No. 1 to Credit Agreement by and among Cincinnati Financial Corporation and CFC investment Company,
as Borrower, and Fifth Third Bank, as lender. (15)
(1)
(2)
(3)
(4)
Incorporated by reference to the company’s 1999 Annual Report on Form 10-K dated March 23, 2000 (File No. 000-04604).
Incorporated by reference to Exhibit 3(i) filed with the company’s Current Report on Form 8-K dated July 15, 2005.
Incorporated by reference to the company’s Definitive Proxy Statement dated March 2, 1992, Exhibit 2 (File No. 000-04604).
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.
Incorporated by reference to the company’s registration statement on Form S-3 effective May 22, 1998 (File No. 333-51677).
(6)
(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 Definitive Proxy Statement dated March 21, 2005.
Incorporated by reference to the company’s Definitive Proxy Statement dated March 1, 1999 (File No. 000-04604).
(9)
(10) Incorporated by reference to the company’s Definitive Proxy Statement dated March 8, 2002 (File No. 000-04604).
(11) Incorporated by reference to the company’s Definitive Proxy Statement to be filed no later than April 13, 2007.
(12) Incorporated by reference to Exhibit 10.3 filed with the company’s Current Report on Form 8-K dated July 15, 2005.
(13) Incorporated by reference to Exhibit 10.1 filed with the company’s Current Report on Form 8-K dated May 31, 2005.
(14) Incorporated by reference to Exhibit 10.2 filed with the company’s Current Report on Form 8-K dated November 23, 2005.
(15) Incorporated by reference to Exhibit 10.01 filed with the company’s Current Report on Form 8-K dated May 26, 2006.
2006 10-K Page 117
10.13
10.14
10.15
10.16
10.17
10.18
10.19
10.20
10.21
10.22
10.23
10.24
11
14
21
23
31.1
31.2
32
Cincinnati Financial Corporation Supplemental Retirement Plan (16)
Standard Form of Incentive Stock Option Agreement for Stock Option Plan VII (17)
Standard Form of Nonqualified Stock Option Agreement for Stock Option Plan VII (18)
Standard Form of Incentive Stock Option Agreement for the 2006 Stock Compensation Plan (19)
Standard Form of Nonqualified Stock Option Agreement for the 2006 Stock Compensation Plan (20)
Restricted Stock Unit Agreement for John J. Schiff, Jr., dated January 31, 2007 (21)
Restricted Stock Unit Agreement for James E. Benoski., dated January 21, 2007 (21)
Restricted Stock Unit Agreement for Jacob F. Scherer, Jr., dated January 31, 2007 (21)
Restricted Stock Unit Agreement for Kenneth W. Stecher., dated January 31, 2007 (21)
Restricted Stock Unit Agreement for Thomas A. Joseph, dated January 31, 2007 (21)
Form of Restricted Stock Unit Agreement for use under the Cincinnati Financial Corporation 2006 Stock Purchase
Incentive Plan (service-based)
Form of Restricted Stock Unit Agreement for use under the Cincinnati Financial Corporation 2006 Stock Purchase
Incentive Plan (performance-based)
Statement re: Computation of per share earnings for the year ended December 31, 2006 and 2005, contained in
Note 11 to the Consolidated Financial Statements included in Part II, Item 8 of this report,, Page 95
Cincinnati Financial Corporation Code of Ethics for Senior Financial Officers (22)
Cincinnati Financial Corporation Subsidiaries contained in Part I, Item 1, Page 1
Consent of Independent Registered Public Accounting Firm, Page 119
Certification pursuant to Section 302 of the Sarbanes Oxley Act of 2002 – Chief Executive Officer, Page 120
Certification pursuant to Section 302 of the Sarbanes Oxley Act of 2002 – Chief Financial Officer, Page 121
Certification pursuant to Section 906 of the Sarbanes Oxley Act of 2002, Page 122
__________________________________________________________
(16) Incorporated by reference to Exhibit 10.17 filed with the company’s Quarterly Report on Form 10-Q for the quarter ended September 30, 2006.
(17) Incorporated by reference to Exhibit 10.1 filed with the company’s Current Report on Form 8-K dated October 20, 2006.
(18) Incorporated by reference to Exhibit 10.2 filed with the company’s Current Report on Form 8-K dated October 20, 2006.
(19) Incorporated by reference to Exhibit 10.3 filed with the company’s Current Report on Form 8-K dated October 20, 2006.
(20) Incorporated by reference to Exhibit 10.4 filed with the company’s Current Report on Form 8-K dated October 20, 2006.
(21) Incorporated by reference to the company’s Current Report on Form 8-K dated January 31, 2007.
(22) Incorporated by reference to the company’s Definitive Proxy Statement dated March 18, 2004.
2006 10-K Page 118
EXHIBIT 23
Consent of Independent Registered Public Accounting Firm
We consent to the incorporation by reference in Registration Statement 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), as amended, of Cincinnati Financial Corporation of our
report dated February 23, 2007, relating to the consolidated financial statements and financial statement
schedules of Cincinnati Financial Corporation and subsidiaries and management's report of the effectiveness
of internal control over financial reporting (which report expresses an unqualified opinion and includes an
explanatory paragraph relating to the company’s adoption of Statement of Financial Accounting Standards No.
123(R), Share Based Payment, on January 1, 2006, and the recognition and related disclosure provisions of
Statement of Financial Accounting Standards No. 158, Employers’ Accounting for Defined Benefit Pension
Plans and Other Postretirement Benefit Plans, on December 31, 2006) appearing in this Annual Report on
Form 10-K of Cincinnati Financial Corporation for the year ended December 31, 2006.
/S/ Deloitte & Touche LLP
________________________
Deloitte & Touche LLP
Cincinnati, Ohio
February 28, 2007
2006 10-K Page 119
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: February 28, 2007
/S/ John J. Schiff, Jr.
________________________
John J. Schiff, Jr., CPCU
Chairman and Chief Executive Officer
2006 10-K Page 120
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: February 28, 2007
/S/ Kenneth W. Stecher
________________________
Kenneth W. Stecher
Chief Financial Officer, Executive Vice President, Secretary and Treasurer
(Principal Accounting Officer)
2006 10-K Page 121
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: February 28, 2007
/S/ John J. Schiff, Jr.
________________________
John J. Schiff, Jr., CPCU
Chairman and Chief Executive Officer
/S/ Kenneth W. Stecher
________________________
Kenneth W. Stecher
Chief Financial Officer, Executive Vice President, Secretary and Treasurer
(Principal Accounting Officer)
2006 10-K Page 122
About Your Company
1
Financial Highlights
Cincinnati Financial
Corporation, formed in
Financial highlights provide a snapshot of your
company’s financial performance and strength.
1968, offers property
2
To Our Shareholders
Consolidated Pretax
Investment Income
Less expenses
(Dollars in millions)
0
7
6 5
2
5
5
4
4
5
6
4
2
9
4
A letter from the chairman and vice chairman
discusses events of 2006, your company’s
performance and issues that may affect us in 2007 and beyond.
03
02
04
05
06
Condensed Balance Sheets and Income Statements
Six-year Summary of Financial Information
Property Casualty
Net Earned Premiums
(Dollars in millions)
Personal lines
Commercial lines
2,919 3,058 3,164
2,653
8
0
9
,
1
2,391
1
2
7
,
1
6
2
1
,
2
4
5
2
,
2
2
0
4
,
2
0
7
6
02
5
4
7
03
3
9
7
4
0
8
2
6
7
04
05
06
Financial Performance Overview
2006 results for property casualty insurance operations, including commercial lines and
personal lines; life insurance operations; and investment operations.
7
8
9
12 Claims Service Sells Insurance
20 Corporate Officers and Directors
21 Subsidiary Officers and Directors
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, our results and
three-year trends, giving clear and thorough explanations with supporting data.
Inside Back Cover
Shareholder Information, Common Stock Price and Dividend Data.
casualty insurance – its
main business – through
subsidiary companies.
The Cincinnati Insurance
Company, founded in
1950, leads the property
casualty group. 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.
Shareholder Information
Cincinnati Financial Corporation had approximately 12,000 shareholders of record as of December 31, 2006. Many of the
company’s independent agent representatives and most of the 4,048 associates of its subsidiaries own the company’s common stock.
Stock Listing
Common shares are traded under the symbol CINF on the NASDAQ Global Select Market.
Annual Meeting
The Annual Meeting of Shareholders of Cincinnati Financial Corporation will take place at 9:30 a.m. on Saturday, May 5, 2007, 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 2007, Cincinnati Financial Corporation tentatively has scheduled reports of interim results as follows:
First quarter ending March 31
Second quarter ending June 30
Third quarter ending September 30
May 2
August 7
October 31
Information regarding actual interim release dates and quarterly conference call webcasts is available approximately two weeks after
the end of each quarter on www.cinfin.com, by calling 513-870-2768 or by e-mailing investor_inquiries@cinfin.com.
Corporate Headquarters
Cincinnati Financial Corporation
6200 South Gilmore Road
Fairfield, Ohio 45014-5141
Phone: 513-870-2000
Fax: 513-870-2066
Independent Registered Public Accounting Firm
Deloitte & Touche LLP
250 East Fifth Street
Cincinnati, Ohio 45202-5109
Common Stock Price and Dividend Data
__________________________________________________________________________________________________
2006
___________________________________________________________________________________________________
2005
Quarter:
High . . . . . . . . . . . . . . . . . . . . . . . . . . . . $
Low . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Period-end close . . . . . . . . . . . . . . . . . .
Cash dividends declared . . . . . . . . . . . .
__________________
1st
45.56
42.07
42.07
0.335
__________________
2nd
$ 47.01
41.43
47.01
0.335
__________________
3rd
$ 48.44
45.93
48.12
0.335
4th
49.07
44.25
45.31
0.335
$
$
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
__________________
__________________
__________________
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 beginning on Page 25, for factors that could cause results to
differ materially from those discussed.
Source: NASDAQ Global Select Market
The common stock prices and dividend data above are adjusted to reflect the 5 percent stock dividend paid April 26, 2005.
Cincinnati Financial Corporation
Claims Service
Sells
Insurance
Responding,
reserving and
building relationships
for long-term
results
2006 Annual Report
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