Unassociated Document
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
 
FORM 10-Q
(Mark one)
 
þ                 QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934.
 
For the quarterly period ended March 31, 2010.
 
¨                 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
  
31-0746871
  
 
(State or other jurisdiction of
incorporation or organization)
  
(I.R.S. Employer Identification No.)
  
         
 
6200 S. Gilmore Road, Fairfield, Ohio
  
45014-5141
  
 
(Address of principal executive offices)
  
(Zip code)
  
 
Registrant’s telephone number, including area code: (513) 870-2000
 
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.
 
þ Yes ¨ No
 
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).
 
¨ Yes ¨ No
 
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer or a smaller reporting company. See definition of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.
 
þ Large accelerated filer ¨ Accelerated filer ¨ Non-accelerated filer ¨ Smaller reporting company
(Do not check if a smaller reporting company)
 
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act):
 
¨ Yes þ No
 
As of April 26, 2010, there were 162,984,380 shares of common stock outstanding.
 
 
 
CINCINNATI FINANCIAL CORPORATION
FORM 10-Q FOR THE QUARTER ENDED MARCH 31, 2010
 
TABLE OF CONTENTS
 
Part I – Financial Information
3
Item 1.
Financial Statements (unaudited)
3
 
Condensed Consolidated Balance Sheets
3
 
Condensed Consolidated Statements Of Income
4
 
Condensed Consolidated Statements Of Shareholders’ Equity
5
 
Condensed Consolidated Statements Of Cash Flows
6
 
Notes To Condensed Consolidated Financial Statements (Unaudited)
7
     
Item 2.
Management’s Discussion and Analysis of Financial Condition and Results of Operations
17
 
Safe Harbor Statement
17
 
Introduction
19
 
Results of Operations
25
 
Liquidity and Capital Resources
38
 
Other Matters
40
     
Item 3.
Quantitative and Qualitative Disclosures about Market Risk
42
 
Fixed-Maturity Investments
42
 
Short-Term Investments
44
 
Equity Investments
44
 
Unrealized Investment Gains and Losses
45
     
Item 4.
Controls and Procedures
48
   
Part II – Other Information
48
Item 1.
Legal Proceedings
48
Item 1A.  
 Risk Factors
48
Item 2.
Unregistered Sales of Equity Securities and Use of Proceeds
48
Item 3.
Defaults upon Senior Securities
49
Item 4.
(Removed and Reserved)
49
Item 5.
Other Information
49
Item 6.
Exhibits
49
Signature
  
50
Exhibit 11
  
51
Exhibit 31A
  
52
Exhibit 31B
  
53
Exhibit 32
  
54

2
Part I – Financial Information
 
Financial Statements (unaudited)
 
Cincinnati Financial Corporation and Subsidiaries
Condensed Consolidated Balance Sheets
             
(In millions except per share data)
March 31,
    
December 31,
  
   
2010
    
2009
  
             
ASSETS
            
   Investments
            
      Fixed maturities, at fair value (amortized cost: 2010—$7,655; 2009—$7,514)
   $ 8,081     $ 7,855  
      Equity securities, at fair value (cost: 2010—$2,089; 2009—$2,016)
     2,838       2,701  
      Short-term investments, at fair value (amortized cost; 2010—$0; 2009—$6)
     —       6  
      Other invested assets
     83       81  
         Total investments
     11,002       10,643  
                 
   Cash and cash equivalents
     402       557  
   Investment income receivable
     116       118  
   Finance receivable
     75       75  
   Premiums receivable
     1,031       995  
   Reinsurance receivable
     570       675  
   Prepaid reinsurance premiums
     16       15  
   Deferred policy acquisition costs
     485       481  
   Land, building and equipment, net, for company use (accumulated depreciation:
       2010—$344; 2009—$335)
     249       251  
   Other assets
     55       45  
   Separate accounts
     615       585  
      Total assets
   $ 14,616     $ 14,440  
                 
LIABILITIES
                
   Insurance reserves
                
      Loss and loss expense reserves
   $ 4,119     $ 4,142  
      Life policy reserves
     1,862       1,783  
   Unearned premiums
     1,549       1,509  
   Other liabilities
     561       670  
   Deferred income tax
     206       152  
   Note payable
     49       49  
   6.125% senior notes due 2034
     371       371  
   6.9% senior debentures due 2028
     28       28  
   6.92% senior debentures due 2028
     391       391  
   Separate accounts
     615       585  
      Total liabilities
     9,751       9,680  
                 
   Commitments and contingent liabilities (Note 9)
     —       —  
                 
SHAREHOLDERS' EQUITY
                
   Common stock, par value—$2 per share; (authorized: 2010—500 million shares,
        2009—500 million shares; issued: 2010—196 million shares, 2009—196 million shares)
     393       393  
   Paid-in capital
     1,081       1,081  
   Retained earnings
     3,865       3,862  
   Accumulated other comprehensive income
     722       624  
   Treasury stock at cost (2010—33 million shares, 2009—34 million shares)
     (1,196 )     (1,200 )
      Total shareholders' equity
     4,865       4,760  
      Total liabilities and shareholders' equity
   $ 14,616     $ 14,440  
                 
Accompanying notes are an integral part of these condensed consolidated financial statements.
          

3
Cincinnati Financial Corporation and Subsidiaries
Condensed Consolidated Statements Of Income
       
(In millions except per share data)
  
Three months ended March 31,
  
   
2010
    
2009
  
REVENUES
            
   Earned premiums
   $ 746     $ 765  
   Investment income, net of expenses
     130       124  
   Other income
     3       3  
   Realized investment gains (losses), net
                
      Other-than-temporary impairments on fixed maturity securities
     (1 )     (40 )
      Other-than-temporary impairments on fixed maturity securities
         transferred to Other Comprehensive Income
     —       —  
      Other realized investment gains, net
     9       38  
         Total realized investment gains (losses), net
     8       (2 )
            Total revenues
     887       890  
                 
BENEFITS AND EXPENSES
                
   Insurance losses and policyholder benefits
     516       581  
   Underwriting, acquisition and insurance expenses
     268       255  
   Other operating expenses
     4       6  
   Interest expense
     14       14  
      Total benefits and expenses
     802       856  
                 
INCOME BEFORE INCOME TAXES
     85       34  
                 
PROVISION (BENEFIT) FOR INCOME TAXES
                
   Current
     15       (2 )
   Deferred
     2       1  
      Total provision (benefit) for income taxes
     17       (1 )
                 
NET INCOME
   $ 68     $ 35  
                 
PER COMMON SHARE
                
   Net income—basic
   $ 0.42     $ 0.22  
   Net income—diluted
     0.42       0.22  
                 
Accompanying notes are an integral part of these condensed consolidated financial statements.
          

4
Cincinnati Financial Corporation and Subsidiaries
Condensed Consolidated Statements Of Shareholders’ Equity
                                           
(In millions)
                          
Accumulated
    
Total
  
   
Common Stock
                
Other
        
Share-
  
   
Outstanding
 
    
Paid-In
    
Retained
    
Comprehensive
  
Treasury
    
holders'
  
   
Shares
  
Amount
    
Capital
    
Earnings
    
Income
Stock
    
Equity
  
                                           
Balance December 31, 2008
     162     $ 393     $ 1,069     $ 3,579     $ 347     $ (1,206 )   $ 4,182  
                                                         
Net income
     —       —       —       35       —       —       35  
Other comprehensive income (loss), net
     —       —       —       —       (278 )     —       (278 )
Total comprehensive income
                                                     (243 )
Dividends declared
     —       —       —       (63 )     —       —       (63 )
Stock-based compensation
     —       —       3       —       —       —       3  
Reissued
     —       —       —       —       —       2       2  
Balance March 31, 2009
     162     $ 393     $ 1,072     $ 3,551     $ 69     $ (1,204 )   $ 3,881  
                                                         
Balance December 31, 2009
     162     $ 393     $ 1,081     $ 3,862     $ 624     $ (1,200 )   $ 4,760  
                                                         
Net income
     —       —       —       68       —       —       68  
Other comprehensive income (loss), net
     —       —       —       —       98       —       98  
Total comprehensive income
                                                     166  
Dividends declared
     —       —       —       (65 )     —       —       (65 )
Stock options exercised
     1       —       (2 )     —       —       3       1  
Stock-based compensation
     —       —       3       —       —       —       3  
Other
     —       —       (1 )     —       —       1       —  
Balance March 31, 2010
     163     $ 393     $ 1,081     $ 3,865     $ 722     $ (1,196 )   $ 4,865  
                                                         
Accompanying notes are an integral part of these condensed consolidated financial statements.
          

5
Cincinnati Financial Corporation and Subsidiaries
Condensed Consolidated Statements Of Cash Flows
             
(In millions)
  
Three months ended March 31,
  
   
2010
    
2009
  
CASH FLOWS FROM OPERATING ACTIVITIES
            
   Net income
   $ 68     $ 35  
   Adjustments to reconcile net income to net cash provided by operating activities:
                
      Depreciation, amortization and other non-cash items
     10       8  
      Realized (gains) losses on investments
     (8 )     2  
      Stock-based compensation
     3       3  
      Interest credited to contract holders
     13       9  
      Deferred income tax expense
     2       1  
      Changes in:
                
         Investment income receivable
     2       —  
         Premiums and reinsurance receivable
     69       (2 )
         Deferred policy acquisition costs
     (10 )     (7 )
         Other assets
     (4 )     (4 )
         Loss and loss expense reserves
     (23 )     7  
         Life policy reserves
     28       25  
         Unearned premiums
     40       38  
         Other liabilities
     (29 )     (23 )
         Current income tax receivable/payable
     (51 )     (52 )
            Net cash provided by operating activities
     110       40  
CASH FLOWS FROM INVESTING ACTIVITIES
                
   Sale of fixed maturities
     74       62  
   Call or maturity of fixed maturities
     176       215  
   Sale of equity securities
     31       423  
   Collection of finance receivables
     7       6  
   Purchase of fixed maturities
     (431 )     (873 )
   Purchase of equity securities
     (88 )     (345 )
   Change in short-term investments, net
     6       71  
   Investment in buildings and equipment, net
     (8 )     (8 )
   Investment in finance receivables
     (7 )     (6 )
   Change in other invested assets, net
     1       (3 )
            Net cash used in investing activities
     (239 )     (458 )
CASH FLOWS FROM FINANCING ACTIVITIES
                
   Payment of cash dividends to shareholders
     (63 )     (63 )
   Contract holder funds deposited
     58       9  
   Contract holder funds withdrawn
     (17 )     (19 )
   Excess tax benefits on share-based compensation
     (2 )     —  
   Other
     (2 )     (3 )
            Net cash used in financing activities
     (26 )     (76 )
Net decrease in cash and cash equivalents
     (155 )     (494 )
Cash and cash equivalents at beginning of year
     557       1,009  
Cash and cash equivalents at end of period
   $ 402     $ 515  
                 
Supplemental disclosures of cash flow information:
                
   Interest paid (net of capitalized interest: 2010—$0; 2009—$0)
   $ —     $ 1  
   Income taxes paid
     67       50  
Non-cash activities:
                
   Equipment acquired under capital lease obligations
   $ —     $ 2  
                 
Accompanying notes are an integral part of these condensed consolidated financial statements.
          

6
Notes To Condensed Consolidated Financial Statements (Unaudited)
 
NOTE 1 — Accounting Policies
 
The condensed consolidated financial statements include the accounts of Cincinnati Financial Corporation and its consolidated subsidiaries, each of which are wholly owned, and are presented in conformity with accounting principles generally accepted in the United States of America (GAAP). All significant intercompany balances and transactions have been eliminated in consolidation.
 
The preparation of financial statements in conformity with GAAP requires us to make estimates and assumptions that affect amounts reported in the financial statements and accompanying notes. Our actual results could differ from those estimates. The December 31, 2009, consolidated balance sheet amounts are derived from the audited financial statements but do not include all disclosures required by GAAP.
 
Our March 31, 2010, condensed consolidated financial statements are unaudited. Certain financial information that is included in annual financial statements prepared in accordance with GAAP is not required for interim reporting and has been condensed or omitted. We believe that we have made all adjustments, consisting only of normal recurring accruals that are necessary for fair presentation. These condensed consolidated financial statements should be read in conjunction with our consolidated financial statements included in our 2009 Annual Report on Form 10-K. The results of operations for interim periods do not necessarily indicate results to be expected for the full year.
 
We have changed our presentation of earned premiums in our condensed consolidated statements of income effective the first quarter 2010. We have summarized property casualty and life earned premiums to a single caption, “Earned premiums.” See Note 6, Reinsurance. Page 13, for further detail on property casualty and life earned premiums.
 
With the adoption of Accounting Standards Codification (ASC) 320, Recognition and Presentation of Other-Than-Temporary Impairments, in the second quarter of 2009, we recognized a cumulative effect adjustment of $106 million, net of tax, to reclassify the non-credit component of previously recognized impairments by increasing retained earnings and reducing accumulated other comprehensive income. ASC 320 does not allow retrospective application of the new other-than-temporary impairment (OTTI) model. Our Condensed Consolidated Statements of Income for the three months ended March 31, 2010, are not measured on the same basis as prior period amounts and, accordingly, these amounts are not comparable.
 
Adopted Accounting Updates
 
ASU 2010-08, Technical Corrections to Various Topics
 
In February 2010, the Financial Accounting Standards Board (FASB) issued Accounting Standards Update (ASU) 2010-08, Technical Corrections to Various Topics. ASU 2010-08 does not change any of the fundamentals of U.S. GAAP, but it does explain certain clarifications made to the guidance on embedded derivatives and hedging. We have adopted ASU 2010-08, and it is effective for the first reporting period after issuance and for fiscal years beginning after December 15, 2009. It did not have a material impact on our company’s financial position, cash flows or results of operations.
 
ASU 2010-09, Subsequent Events
 
In February 2010, the FASB issued ASU 2010-09, Subsequent Events. ASU 2010-09 removes the requirement for SEC filers to disclose the date through which subsequent events have been evaluated in both issued and revised financial statements. We have adopted ASU 2010-09, and it is effective for the first reporting period after issuance. It did not have a material impact on our company’s financial position, cash flows or results of operations.
 
Pending Accounting Updates
 
ASU 2010-06, Fair Value Measurements and Disclosures
 
In January 2010, the FASB issued ASU 2010-06, Fair Value Measurements and Disclosures. ASU 2010-06 applies to all entities that are required to make disclosures about recurring or nonrecurring fair value measurements. ASU 2010-06 requires separate disclosures of the activity in the Level 3 category related to any purchases, sales, issuances, and settlements on a gross basis. The effective date of the disclosures regarding Level 3 category purchases, sales, issuances and settlements is for interim and annual periods beginning after December 15, 2010. The portion of ASU 2010-06 that has not yet been adopted will not have a material impact on our company’s financial position, cash flows or results of operations as it focuses on additional disclosures.
 
 
7
 
NOTE 2 – Investments
 
Fixed maturities (bonds and redeemable preferred stocks), equity securities (common and non-redeemable preferred stocks) and short-term investments have been classified as available for sale and are stated at fair values at March 31, 2010, and December 31, 2009.
 
The change in unrealized gains and losses on investments, net of taxes, described in the following table, is included in other comprehensive income and shareholders’ equity.
             
(In millions)
  
Three month ended March 31,
  
   
2010
    
2009
  
Change in unrealized investment gains and losses and other summary:
            
    Fixed maturities
   $ 85     $ 97  
    Equity securities
     64       (510 )
    Adjustment to deferred acquisition costs and life policy reserves
     (3 )     (4 )
    Pension obligations
     1       1  
    Other
     3       (12 )
    Income taxes on above
     (52 )     150  
      Total
   $ 98     $ (278 )
                 
 
The following table analyzes cost or amortized cost, gross unrealized gains, gross unrealized losses and fair value for our investments, along with the amount of cumulative non-credit OTTI losses transferred to accumulated other comprehensive income (AOCI) in accordance with ASC 320-10-65, Recognition and Presentation of Other-Than-Temporary Impairments, for securities that also had a credit impairment:
                                 
(In millions)
                
     
Cost or
amortized
    
Gross unrealized
    
Fair
value
    
OTTI in
AOCI
  
At March 31,
  
cost
    
gains
    
losses
              
2010
                                
Fixed maturities:
                              
 
States, municipalities and political subdivisions
   $ 2,992     $ 122     $ 4     $ 3,110     $ —  
 
Convertibles and bonds with warrants attached
     81       —       —       81       —  
 
United States government
     4       1       —       5       —  
 
Government-sponsored enterprises
     329       —       —       329       —  
 
Foreign government
     3       —       —       3       —  
 
Short-term investments
     —       —       —       —       —  
 
Collateralized mortgage obligations
     —       —       —       —       —  
 
Corporate bonds
     4,246       323       16       4,553       —  
 
    Total
   $ 7,655     $ 446     $ 20     $ 8,081     $ —  
Equity securities
   $ 2,089     $ 774     $ 25     $ 2,838    
NA
  
                                           
At December 31,
                                        
2009
                                          
Fixed maturities:
                                        
 
States, municipalities and political subdivisions
   $ 3,007     $ 128       6     $ 3,129     $ —  
 
Convertibles and bonds with warrants attached
     91       —       —       91       —  
 
United States government
     4       —       —       4       —  
 
Government-sponsored enterprises
     354       —       7       347       —  
 
Foreign government
     3       —       —       3       —  
 
Short-term investments
     6       —       —       6       —  
 
Collateralized mortgage obligations
     37       —       6       31       —  
 
Corporate bonds
     4,018       268       36       4,250       —  
 
    Total
   $ 7,520     $ 396     $ 55     $ 7,861     $ —  
Equity securities
   $ 2,016     $ 714     $ 29     $ 2,701    
NA
  
                                           
                                           
The unrealized investment gains at March 31, 2010, were largely due to a long-term net gain position of $725 million for our common stock portfolio. Contributing 10 percent or more of that net gain position were two publicly-traded holdings totaling $225 million: The Procter & Gamble Company (NYSE:PG) and Exxon Mobil Corporation (NYSE:XOM). At March 31, 2010, we had $82 million fair value of hybrid securities included in fixed maturities that follow ASC 815-15-25, Accounting for Certain Hybrid Financial Instruments.
 
8
 
The table below provides fair values and unrealized losses by investment category and by the duration of the securities’ continuous unrealized loss position:
                                       
(In millions)
  
Less than 12 months
    
12 months or more
    
Total
        
At March 31,    
Fair
value
    
Unrealized
losses
    
Fair
value
    
Unrealized
losses
    
Fair
value
    
Unrealized
losses
  
2010
                                      
Fixed maturities:
                                    
 
States, municipalities and political subdivisions
   $ 153     $ 2     $ 30     $ 2     $ 183     $ 4  
 
Government-sponsored enterprises
     61       —       2       —       63       —  
 
Corporate bonds
     316       8       161       8       477       16  
 
    Total
     530       10       193       10       723       20  
Equity securities
     78       3       226       22       304       25  
 
    Total
   $ 608     $ 13     $ 419     $ 32     $ 1,027     $ 45  
                                                   
At December 31,
                                                
2009
                                                  
Fixed maturities:
                                                
 
States, municipalities and political subdivisions
   $ 196     $ 4     $ 29     $ 2     $ 225     $ 6  
 
Government-sponsored enterprises
     347       7       —       —       347       7  
 
Short-term investments
     1       —       —       —       1       —  
 
Collateralized mortgage obligations
     —       —       27       6       27       6  
 
Corporate bonds
     397       19       309       17       706       36  
 
    Total
     941       30       365       25       1,306       55  
Equity securities
     65       3       415       26       480       29  
 
    Total
   $ 1,006     $ 33     $ 780     $ 51     $ 1,786     $ 84  
                                                   
 
Other-than-temporary Impairment Charges
 
For the three months ended March 31, 2010, there were no credit losses on fixed-maturity securities for which a portion of OTTI has been recognized in other comprehensive income. The following table provides the amount of OTTI charges:
             
(In millions)
  
Three months ended March 31,
  
   
2010
    
2009
  
Other-than-temporary impairment charges:
            
    Fixed maturities
   $ 1     $ 50  
    Equity securities
     —       —  
      Total
   $ 1     $ 50  
                 
 
During the quarter ended March 31, 2010, we impaired two fixed-maturity securities for a total of $1 million. At March 31, 2010, 69 fixed-maturity investments with a total unrealized loss of $10 million had been in an unrealized loss position for 12 months or more. Of that total, one fixed-maturity security with a total unrealized loss of $1 million was trading below 70 percent of book value. Eight equity securities with a total unrealized loss of $22 million had been in an unrealized loss position for 12 months or more, but none were trading below 70 percent of book value.
 
At December 31, 2009, 121 fixed-maturity investments with a total unrealized loss of $25 million had been in an unrealized loss position for 12 months or more. Of that total, eight fixed maturity investments were trading below 70 percent of book value with a total unrealized loss of $2 million. Ten equity investments with a total unrealized loss of $26 million had been in an unrealized loss position for 12 months or more as of December 31, 2009. Of that total, no equity investments were trading below 70 percent of book value.
 
NOTE 3 –Fair Value Measurements
 
Fair Value Hierarchy
 
In accordance with fair value measurements and disclosures, we categorized our financial instruments, based on the priority of the observable and market-based data for valuation technique, into a three-level fair value hierarchy. The fair value hierarchy gives the highest priority to quoted prices with readily available independent data in active markets for identical assets or liabilities (Level 1) and the lowest priority to unobservable market inputs (Level 3). When various inputs for measurement fall within different levels of the fair value hierarchy, the lowest observable input that has a significant impact on fair value measurement is used. Our valuation techniques have not changed from December 31, 2009, and ultimately management determines fair value.
 
Financial instruments are categorized based upon the following characteristics or inputs to the valuation techniques:
 
·
Level 1 – Financial assets and liabilities for which inputs are observable and are obtained from reliable quoted prices for identical assets or liabilities in actively traded markets. This is the most reliable fair value measurement and includes, for example, active exchange-traded equity securities.
 
 
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·
Level 2 – Financial assets and liabilities for which values are based on quoted prices in markets that are not active or for which values are based on similar assets and liabilities that are actively traded. This also includes pricing models for which the inputs are corroborated by market data.
 
·
Level 3 – Financial assets and liabilities for which values are based on prices or valuation techniques that require inputs that are both unobservable and significant to the overall fair value measurement. Level 3 inputs include the following:
 
 
o
Quotes from brokers or other external sources that are not considered binding;
 
 
o
Quotes from brokers or other external sources where it cannot be determined that market participants would in fact transact for the asset or liability at the quoted price;
 
 
o
Quotes from brokers or other external sources where the inputs are not deemed observable.
 
We conduct a thorough review of fair value hierarchy classifications on a quarterly basis. Reclassification of certain financial instruments may occur when input observability changes. As noted below in the Level 3 disclosure table, reclassifications are reported as transfers in or out of the Level 3 category as of the beginning of the quarter in which the reclassification occurred.
 
The following tables illustrate the fair value hierarchy for those assets measured at fair value on a recurring basis for the three months ended March 31, 2010, and December 31, 2009. We do not have any material liabilities carried at fair value. There were no significant transfers between Level 1 and Level 2.
 
Fair Value Disclosures for Assets
                         
(In millions)  
Asset fair value measurements at March 31, 2010 using:
  
   
Quoted prices in
active markets for
identical assets
(Level 1)
    
Significant other
observable inputs
(Level 2)
    
Significant
unobservable
inputs
(Level 3)
    
Total
  
Fixed maturities, available for sale:
                        
   Corporate securities
   $ —     $ 4,606     $ 28     $ 4,634  
   Foreign government
     —       3       —       3  
   U.S. Treasury and U.S. government agencies
     5       329       —       334  
   States, municipalities and political subdivisions
     —       3,106       4       3,110  
        Total
     5       8,044       32       8,081  
Common equities, available for sale
     2,614       124       —       2,738  
Preferred equities, available for sale
     —       94       6       100  
Taxable fixed maturities separate accounts
     —       582       —       582  
Top Hat Savings Plan
     8       —       —       8  
        Total
   $ 2,627     $ 8,844     $ 38     $ 11,509  
                                 
 
                         
(In millions)
  
Asset fair value measurements at December 31, 2009 using:
  
   
Quoted prices in
active markets for
identical assets
(Level 1)
    
Significant other
observable inputs
(Level 2)
    
Significant
unobservable
inputs
(Level 3)
    
Total
  
Fixed maturities, available for sale:
                        
   Corporate securities
   $ —     $ 4,314     $ 27     $ 4,341  
   Foreign government
     —       3       —       3  
   U.S. Treasury and U.S. government agencies
     4       347       —       351  
   Collateralized mortgage obligations
     —       31       —       31  
   States, municipalities and political subdivisions
     —       3,125       4       3,129  
        Total
     4       7,820       31       7,855  
Common equities, available for sale
     2,474       134       —       2,608  
Preferred equities, available for sale
     —       88       5       93  
Short-term investments
     —       6       —       6  
Taxable fixed maturities separate accounts
     —       555       —       555  
Top Hat Savings Plan
     7       —       —       7  
        Total
   $ 2,485     $ 8,603     $ 36     $ 11,124  
                                 
 
Each financial instrument that was deemed to have significant unobservable inputs when determining valuation is identified in the tables below by security type with a summary of changes in fair value as of March 31, 2010. Total Level 3 assets were less than 1 percent of financial assets measured at fair value for the three months ended March 31, 2010, and December 31, 2009.
 
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(In millions)
  
Asset fair value measurements using significant unobservable inputs (Level 3)
  
   
Corporate
fixed
maturities
    
Taxable fixed
maturities-
separate accounts
    
States,
municipalities
and political
subdivisions
fixed maturities
    
Common
equities
    
Preferred
equities
    
Total
  
Beginning balance, December 31, 2009
   $ 27     $ —     $ 4     $ —     $ 5     $ 36  
Total gains or losses (realized/unrealized):
                                                
  Included in earnings (or changes in net assets)
     —       —       —       —       —       —  
  Included in other comprehensive income
     —       —       —       —       1       1  
Purchases, sales, issuances, and settlements
     5       —       —       —       —       5  
Transfers in and/or out of Level 3
     (4 )     —       —       —       —       (4 )
Ending balance, March 31, 2010
   $ 28     $ —     $ 4     $ —     $ 6     $ 38  
                                                 

   
(In millions)
  
Asset fair value measurements using significant unobservable inputs (Level 3)
  
   
Taxable
fixed
maturities
    
Taxable fixed
maturities-
separate accounts
    
Tax-exempt
fixed
maturities
    
Common
equities
    
Preferred
equities
    
Total
  
Beginning balance, December 31, 2008
   $ 50     $ 6     $ 5     $ 64     $ 22     $ 147  
Total gains or losses (realized/unrealized):
                                                
  Included in earnings (or changes in net assets)
     —       —       —       —       (3 )     (3 )
  Included in other comprehensive income
     (1 )     —       —       —       2       1  
Purchases, sales, issuances, and settlements
     —       —       —       —       —       —  
Transfers in and/or out of Level 3
     (11 )     (6 )     —       —       (15 )     (32 )
Ending balance, March 31, 2009
   $ 38     $ —     $ 5     $ 64     $ 6     $ 113  
   
 
For the three months ended March 31, 2010, one Level 3 corporate fixed-maturity security was purchased for $5 million. As a result of the change in use of observable or unobservable inputs throughout the first quarter of 2010, Level 3 corporate fixed-maturity securities decreased $4 million as one security totaling $7 million transferred from Level 3 to Level 2 and one security totaling $3 million transferred from Level 2 to Level 3. At March 31, 2010, total fair value of assets priced with broker quotes and other non-observable market inputs for the fair value measurements and disclosures was $38 million.
 
Fair Value Disclosure for Senior Debt and Life Insurance Assets and Liabilities
 
The disclosures below are not affected by the fair value hierarchy but are presented to provide timely information about the effects of current market conditions on financial instruments that are not reported at fair value in our financial statements.
 
This table summarizes the principal amounts of our long-term debt excluding unamortized discounts:
   
(In millions)
          
March 31,
    
December 31,
  
Interest rate
  
Year of issue
  
2010
    
2009
  
                     
 
6.900%
  
1998
  
Senior debentures, due 2028
   $ 28     $ 28  
 
6.920%
  
2005
  
Senior debentures, due 2028
     391       391  
 
6.125%
  
2004
  
Senior notes, due 2034
     374       374  
         
  Total
   $ 793     $ 793  
     
 
The fair value of our senior debt approximated $761 million at March 31, 2010, compared with $740 million at year-end 2009. Fair value was determined under the fair value measurements and disclosures accounting rules based on market pricing of these or similar debt instruments that are actively trading. Fair value can vary with macro-economic concerns. Regardless of the fluctuations in fair value, the outstanding principal amount of our long-term debt is $793 million. None of the notes are encumbered by rating triggers. Also, we have a note payable with outstanding principal amount of $49 million which approximates fair value.
 
The fair value of life policy loans outstanding principal and interest approximated $44 million, compared with book value of $40 million reported in the condensed consolidated balance sheets as of March 31, 2010.
 
Life reserves and liabilities for deferred annuities and other investment contracts were $800 million and $736 million for March 31, 2010, and December 31, 2009, respectively. Fair value for these deferred annuities and investment contracts was $774 million and $737 million for March 31, 2010, and December 31, 2009, respectively. Fair values of liabilities associated with certain investment contracts are calculated based upon internally developed models because active, observable markets do not exist for those items. To determine the fair value, we make the following significant assumptions: (1) the discount rates used to calculate the present value of expected payments are the risk-free spot rates plus an A3 rated bond spread for financial issuers as of March 31, 2010, to account for non-performance risk; (2) the rate of interest credited to policyholders is the portfolio net earned interest rate less a spread for expenses and profit; and
 
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(3) additional lapses occur when the credited interest rate is exceeded by an assumed competitor credited rate, which is a function of the risk-free rate of the economic scenario being modeled.
 
NOTE 4 – Deferred Acquisition Costs
 
The expenses associated with issuing insurance policies – primarily commissions, premium taxes and underwriting costs – are deferred and amortized over the terms of the policies. We update our acquisition cost assumptions periodically to reflect actual experience, and we evaluate our deferred acquisition cost for recoverability. Other underwriting operating expenses were $113 million and $98 million in the three months ended March 31, 2010 and 2009, respectively. The table below shows the deferred policy acquisition costs and asset reconciliation, including the amortized deferred policy acquisition costs.
   
(In millions)
  
Three months ended March 31,
  
   
2010
    
2009
  
             
Deferred policy acquisition costs asset at beginning of the period
   $ 481     $ 509  
Capitalized deferred policy acquisition costs
     171       166  
Amortized deferred policy acquisition costs
     (161 )     (159 )
Amortized shadow deferred policy acquisition costs
     (6 )     (6 )
   Deferred policy acquisition costs asset at end of the period
   $ 485     $ 510  
                 
 
There were no premium deficiencies for the reported condensed consolidated statements of income, as the sum of the anticipated loss and loss adjustment expenses, policyholder dividends, maintenance expenses and underwriting expenses did not exceed the related unearned premiums and anticipated investment income.
 
NOTE 5 – Property Casualty Loss And Loss Expenses
 
This table summarizes activity for our consolidated property casualty loss and loss expense reserves:
   
(In millions)
  
Three months ended March 31,
  
   
2010
    
2009
  
Gross loss and loss expense reserves, beginning of period
   $ 4,096     $ 4,040  
  Less reinsurance receivable
     435       542  
Net loss and loss expense reserves, beginning of period
     3,661       3,498  
Net incurred loss and loss expenses related to:
                
  Current accident year
     514       537  
  Prior accident years
     (39 )     7  
      Total incurred
     475       544  
Net paid loss and loss expenses related to:
                
  Current accident year
     113       142  
  Prior accident years
     301       337  
      Total paid
     414       479  
                 
Net loss and loss expense reserves, end of period
     3,722       3,563  
  Plus reinsurance receivable
     343       483  
Gross loss and loss expense reserves, end of period
   $ 4,065     $ 4,046  
                 
 
We use actuarial methods, models, and judgment to estimate, as of a financial statement date, the property casualty loss and loss expense reserves required to pay for and settle all outstanding insured claims, including incurred but not reported (IBNR) claims, as of that date. The actuarial estimate is subject to review and adjustment by an inter-departmental committee that includes actuarial management and is familiar with relevant company and industry business, claims and underwriting trends, as well as general economic and legal trends, that could affect future loss and loss expense payments.
 
Because of changes in estimates of insured events in prior years, we decreased the provision for loss and loss expenses by $39 million and increased the provision for loss and loss expenses by $7 million for the three months ended March 31, 2010 and 2009, respectively. The reserve for loss and loss expenses in the condensed consolidated balance sheets also includes $53 million as of March 31, 2010, and $47 million as of March 31, 2009, for certain life and health loss and loss expense reserves.
 
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NOTE 6 – Reinsurance
 
Our condensed consolidated statements of income include earned consolidated property casualty insurance premiums on assumed and ceded business:
   
(In millions)
  
Three months ended March 31,
  
   
2010
    
2009
  
Direct earned premiums
   $ 744     $ 771  
Assumed earned premiums
     3       3  
Ceded earned premiums
     (40 )     (42 )
   Net earned premiums
   $ 707     $ 732  
   
 
Our condensed consolidated statements of income include incurred consolidated property casualty insurance loss and loss expenses on assumed and ceded business:
   
(In millions)
  
Three months ended March 31,
  
   
2010
    
2009
  
Direct incurred loss and loss expenses
   $ 449     $ 526  
Assumed incurred loss and loss expenses
     2       4  
Ceded incurred loss and loss expenses
     23       12  
   Net incurred loss and loss expenses
   $ 474     $ 542  
   
 
Our condensed consolidated statements of income include earned life insurance premiums on assumed and ceded business:
   
(In millions)
  
Three months ended March 31,
  
   
2010
    
2009
  
Direct earned premiums
   $ 50     $ 45  
Assumed earned premiums
     0       0  
Ceded earned premiums
     (11 )     (12 )
   Net earned premiums
   $ 39     $ 33  
   
 
Our condensed consolidated statements of income include life insurance contract holders’ benefits incurred on assumed and ceded business:
   
(In millions)
  
Three months ended March 31,
  
   
2010
    
2009
  
Direct contract holders' benefits incurred
   $ 57     $ 50  
Assumed contract holders' benefits incurred
     0       0  
Ceded contract holders' benefits incurred
     (15 )     (11 )
   Net incurred loss and loss expenses
   $ 42     $ 39  
   
 
NOTE 7 – Employee Retirement Benefits
 
The following summarizes the components of net periodic costs for our qualified and supplemental pension plans:
   
(In millions)
  
Three months ended March 31
  
   
2010
    
2009
  
Service cost
   $ 2     $ 2  
Interest cost
     3       3  
Expected return on plan assets
     (3 )     (3 )
Amortization of actuarial loss and prior service cost
     1       —  
   Net periodic benefit cost
   $ 3     $ 2