We are maintaining our Neutral recommendation on the shares of Cincinnati Financial Corp. (CINF), to reflect the gradually improving Commercial Lines, Personal Lines and Excess and Surplus Lines market. However, the continued low interest rate environment and the lack of a complete reversal in the insurance pricing cycle keeps us on the sidelines.
The Commercial Lines business is gradually witnessing improving market conditions after several years of significant competitive pressure. The segment has witnessed top-line growth in fiscal year 2011 with a 3% rise in net premium, which declined 1% and 26% in 2010 and 2009 respectively. This improvement came on the back of company initiatives as well as a gradual increase in insurance rates. The company has implemented predictive analytics to improve its pricing precision, while leveraging local relationships with its agents at the same time. We expect moderate top-line growth, as competitive pressure will somewhat offset moderate price increases.
Cincinnati’s Personal Line segment has been underperforming over the past few years. However, with new business gains, strong retention levels and rate increases that affected the homeowner line of business in 2009, the segment is back on track witnessing premium growth. The company’s investments in pricing precision and technology and new agency appointments are positively impacting the Personal Lines segment, thus helping it to produce a narrower loss ratio in that area. Going forward, with an improvement in the personal business market, the company will see increased premium growth.
Cincinnati’s Excess and Surplus line is also performing well. Despite a soft market environment, the segment has been able to achieve rate increases in the last 16 months. We expect the trend to continue, given the improving excess and surplus lines market.
A strong relationship with its agencies also bodes well for Cincinnati. The company made 133 new agency appointments during fiscal year 2011 and expects to add 130 agencies during the next fiscal. We believe that the increasing number of agencies will drive premium growth in the future.
However, Cincinnati faces some headwinds in the form of a low interest rate environment and exposure to catastrophes. While the low interest rates have curbed investment income, they have also adversely affected the company’s Life Insurance business, which sells interest sensitive products. While the U.S. economy is gradually recovering, there is still a lot of uncertainty surrounding a sustained recovery due to high unemployment, low GDP, declining home values and the Eurozone crisis.
Moreover, Cincinnati’s geographic concentration ties its performance in the Midwest region, which is prone to catastrophes. As such, the company’s operations are prone to catastrophe losses, imparting volatility to the earnings.
Nevertheless Cincinnati’s solid capital position with low reliance on debt gives it an inherent strength. It also remains a favorite with value investors, given its track record of increasing dividend for the past 51 years.
Based in Fairfield, Ohio, Cincinnati Financial closely competes with Harleysville Group Inc.(:HGIC) and Selective Insurance Group Inc. (SIGI). The company currently retains a Zacks # 3 Rank, which translates into a short-term ‘Hold’ rating.
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