We are maintaining our Neutral recommendation on the shares of Cincinnati Financial Corp. (CINF) following second quarter earnings release. The company is set to benefit from the gradually improving Commercial Lines, Personal Lines and, Excess and Surplus Lines insurance rates. However, the continued low interest rate environment as well as 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 observed top-line growth in 2011 with a 3% rise in net premium, compared with a decline of 1% and 26% in 2010 and 2009, respectively.
This improvement came on the back of the company’s 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. We expect considerate top-line growth in the long run, as competitive pressure will somewhat offset moderate price increases.
Cincinnati Financial’s Personal Line segment has been underperforming over the past few years. However, with new business gains, strong retention levels and rate increases, the segment is witnessing premium growth at the current level.
The company’s investments in pricing precision and technology, along with new agency appointments, are positively impacting the segment, thus helping it to produce a narrower loss ratio. Going forward, with an improvement in the personal business market, the company will see increased premium growth.
Cincinnati Financial’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 22 months. We expect the trend to continue, since the excess and surplus lines market is improving.
A strong relationship with its agencies also bodes well for Cincinnati Financial. The company made 133 new agency appointments during fiscal 2011 and expects to add 130 agencies in the next fiscal year. We believe that the increasing number of agencies will drive premium growth in the future.
However, the company 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.
Moreover, Cincinnati Financial’s business is highly concentrated in the Midwest region, which is prone to catastrophes. Due to this, the company’s operations are heavily exposed to catastrophe losses, imparting volatility to the earnings.
Nevertheless, Cincinnati Financial’s solid capital position with low reliance on debt, gives it an inherent strength. It also remains a favorite with value investors, with its track record of increasing dividend for the past 51 years.
Based in Fairfield, Ohio, Cincinnati Financial closely competes with Harleysville Group Inc. 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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