Edgar Filing: CINCINNATI FINANCIAL CORP

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, 2011.

¨ 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 website, 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).

þ 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 25, 2011, there were 163,070,453 shares of common stock outstanding.

CINCINNATI FINANCIAL CORPORATION

FORM 10-Q FOR THE QUARTER ENDED MARCH 31, 2011

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
Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations	17
Safe Harbor Statement	17
Introduction	19
Results of Operations	24
Liquidity and Capital Resources	38
Other Matters	40
Item 3. Quantitative and Qualitative Disclosures about Market Risk	42
Fixed-Maturity Investments	42
Equity Investments	45
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	48
Item 4. (Removed and Reserved)	48
Item 5. Other Information	49
Item 6. Exhibits	49

Page 2

Part I – Financial Information

Item 1.

Financial Statements (unaudited)

Cincinnati Financial Corporation and Subsidiaries

Condensed Consolidated Balance Sheets

(In millions except per share data)	March 31,			December 31,
	2011			2010
ASSETS
Investments
Fixed maturities, at fair value (amortized cost: 2011—$8,033; 2010—$7,888)	$	8,536		$	8,383
Equity securities, at fair value (cost: 2011—$2,223; 2010—$2,286)		3,100			3,041
Other invested assets		68			84
Total investments		11,704			11,508
Cash and cash equivalents		379			385
Investment income receivable		117			119
Finance receivable		76			73
Premiums receivable		1,062			1,015
Reinsurance receivable		573			572
Prepaid reinsurance premiums		16			18
Deferred policy acquisition costs		503			488
Land, building and equipment, net, for company use (accumulated depreciation: 2011—$368; 2010—$352)		243			229
Other assets		66			67
Separate accounts		630			621
Total assets	$	15,369		$	15,095

LIABILITIES
Insurance reserves
Loss and loss expense reserves	$	4,239		$	4,200
Life policy reserves		2,106			2,034
Unearned premiums		1,586			1,553
Other liabilities		555			556
Deferred income tax		296			260
Note payable		49			49
Long-term debt		790			790
Separate accounts		630			621
Total liabilities		10,251			10,063

Commitments and contingent liabilities (Note 10)		—			—

SHAREHOLDERS' EQUITY
Common stock, par value—$2 per share; (authorized: 2011 and 2010—500 million shares; issued: 2011 and 2010—196 million shares)		393			393
Paid-in capital		1,090			1,091
Retained earnings		3,977			3,980
Accumulated other comprehensive income		855			769
Treasury stock at cost (2011—33 million shares and 2010—34 million shares)		(1,197	)		(1,201	)
Total shareholders' equity		5,118			5,032
Total liabilities and shareholders' equity	$	15,369		$	15,095

Accompanying notes are an integral part of these condensed consolidated financial statements.

Page 3

Cincinnati Financial Corporation and Subsidiaries

Condensed Consolidated Statements of Income

(In millions except per share data)	Three months ended March 31,
	2011			2010
REVENUES
Earned premiums	$	782		$	746
Investment income, net of expenses		131			130
Fee revenues		1			1
Other revenues		3			2
Realized investment gains (losses), net:
Other-than-temporary impairments on fixed maturity securities		-			(1	)
Other-than-temporary impairments on fixed maturity securities transferred to other comprehensive income		-			-
Other realized investment gains, net		12			9
Total realized investment gains, net		12			8
Total revenues		929			887

BENEFITS AND EXPENSES
Insurance losses and policyholder benefits		575			516
Underwriting, acquisition and insurance expenses		261			268
Other operating expenses		4			4
Interest expense		13			14
Total benefits and expenses		853			802

INCOME BEFORE INCOME TAXES		76			85

PROVISION (BENEFIT) FOR INCOME TAXES
Current		24			15
Deferred		(10	)		2
Total provision for income taxes		14			17

NET INCOME	$	62		$	68

PER COMMON SHARE
Net income—basic	$	0.38		$	0.42
Net income—diluted		0.38			0.42

Accompanying notes are an integral part of these condensed consolidated financial statements.

Page 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, 2009		162	$	393	$	1,081		$	3,862		$	624	$	(1,200	)	$	4,760

Net income		-		-		-			68			-		-			68
Other comprehensive income, 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

Balance December 31, 2010		163	$	393	$	1,091		$	3,980		$	769	$	(1,201	)	$	5,032

Net income		-		-		-			62			-		-			62
Other comprehensive income, net		-		-		-			-			86		-			86
Total comprehensive income																	148
Dividends declared		-		-		-			(65	)		-		-			(65	)
Stock options exercised		-		-		(2	)		-			-		3			1
Stock-based compensation		-		-		3			-			-		-			3
Other		-		-		(2	)		-			-		1			(1	)
Balance March 31, 2011		163	$	393	$	1,090		$	3,977		$	855	$	(1,197	)	$	5,118

Accompanying notes are an integral part of these condensed consolidated financial statements.

Page 5

Cincinnati Financial Corporation and Subsidiaries

Condensed Consolidated Statements of Cash Flows

(In millions)	Three months ended March 31,
	2011			2010
CASH FLOWS FROM OPERATING ACTIVITIES
Net income	$	62		$	68
Adjustments to reconcile net income to net cash provided by operating activities:
Depreciation, amortization and other non-cash items		11			10
Realized gains on investments		(12	)		(8	)
Stock-based compensation		3			3
Interest credited to contract holders		14			13
Deferred income tax (benefit) expense		(10	)		2
Changes in:
Investment income receivable		2			2
Premiums and reinsurance receivable		(46	)		69
Deferred policy acquisition costs		(15	)		(10	)
Other assets		(5	)		(4	)
Loss and loss expense reserves		39			(23	)
Life policy reserves		28			28
Unearned premiums		33			40
Other liabilities		(70	)		(29	)
Current income tax receivable/payable		23			(51	)
Net cash provided by operating activities		57			110
CASH FLOWS FROM INVESTING ACTIVITIES
Sale of fixed maturities		28			74
Call or maturity of fixed maturities		149			176
Sale of equity securities		133			31
Collection of finance receivables		6			7
Purchase of fixed maturities		(269	)		(431	)
Purchase of equity securities		(66	)		(88	)
Change in short-term investments, net		-			6
Investment in buildings and equipment, net		(2	)		(8	)
Investment in finance receivables		(9	)		(7	)
Change in other invested assets, net		-			1
Net cash used in investing activities		(30	)		(239	)
CASH FLOWS FROM FINANCING ACTIVITIES
Payment of cash dividends to shareholders		(64	)		(63	)
Contract holders' funds deposited		53			58
Contract holders' funds withdrawn		(22	)		(17	)
Excess tax benefits on share-based compensation		3			(2	)
Other		(3	)		(2	)
Net cash used in financing activities		(33	)		(26	)
Net change in cash and cash equivalents		(6	)		(155	)
Cash and cash equivalents at beginning of year		385			557
Cash and cash equivalents at end of period	$	379		$	402

Supplemental disclosures of cash flow information:
Interest paid	$	-		$	-
Income taxes paid		1			67
Non-cash activities:
Conversion of securities	$	-		$	-
Equipment acquired under capital lease obligations		19			-

Accompanying notes are an integral part of these condensed consolidated financial statements.

Page 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, 2010, condensed consolidated balance sheet amounts are derived from the audited financial statements but do not include all disclosures required by GAAP.

Our March 31, 2011, 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 2010 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.

Adopted 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 are for interim and annual periods beginning after December 15, 2010. This portion of ASU 2010-06 does not have a material impact on our company’s financial position, cash flows or results of operations as it focuses on additional disclosures.

ASU 2010-15, How Investments Held through Separate Accounts Affect an Insurer’s Consolidation Analysis of Those Investments

In April 2010, the FASB issued ASU 2010-15, How Investments Held through Separate Accounts Affect an Insurer’s Consolidation Analysis of Those Investments. ASU 2010-15 applies to all insurance entities that have separate accounts that meet the definition and requirements set in the Accounting Standards Codification Manual. ASU 2010-15 clarifies that an insurance entity should not consider any separate account interests held for the benefit of contract holders in an investment to be the insurer’s interests. The insurance entity should not combine those interests with its general account interest in the same investment when assessing the investment for consolidation. The insurance entity may combine those interests when the separate account interests are held for the benefit of a related-party policyholder as defined in the Variable Interest Subsections of Consolidation topic in the Codification Manual. The effective date of the amendments in this update is for interim and annual periods beginning after December 15, 2010, with early adoption permitted. The amendments in this update do not modify the disclosures currently required by GAAP and do not have a material impact on our company’s financial position, cash flows or results of operations.

Pending Accounting Updates

ASU 2010-26, Accounting for Costs Associated with Acquiring or Renewing Insurance Contracts

In October 2010, the FASB issued ASU 2010-26, Accounting for Costs Associated with Acquiring or Renewing Insurance Contracts. ASU 2010-26 modifies the definitions of the type of costs incurred by insurance entities that can be capitalized in the successful acquisition of new and renewal contracts. ASU 2010-26 requires incremental direct costs of successful contract acquisition as well as certain costs related to underwriting, policy issuance and processing, medical and inspection and sales force contract selling for successful contract acquisition to be capitalized. These incremental direct costs and other costs are those that are essential to the contract transaction and would not have been incurred had the contract transaction not occurred. The effective date of ASU 2010-26 is for interim and annual reporting periods beginning after December 15, 2011. The ASU has not yet been adopted and we are currently evaluating the impact this ASU will have on our company’s financial position, cash flows or results of operations.

Page 7

NOTE 2 – Investments

Fixed maturities (bonds and redeemable preferred stocks) and equity securities (common and non-redeemable preferred stocks) have been classified as available for sale and are stated at fair values at March 31, 2011, and December 31, 2010. Realized gains and losses on investments are recognized in earnings on a specific identification basis.

The change in unrealized gains and losses, net of taxes, described in the following table, is included in other comprehensive income and shareholders’ equity.

(In millions)	Three months ended March 31,
	2011			2010
Change in unrealized investment gains and losses and other summary:
Fixed maturities	$	8		$	85
Equity securities		122			64
Adjustment to deferred acquisition costs and life policy reserves		-			(3	)
Pension obligations		1			1
Other		1			3
Income taxes on above		(46	)		(52	)
Total	$	86		$	98

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 other-than-temporary impairment (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		OTTI in
At March 31, 2011	cost		gains		losses		value		AOCI
Fixed maturities:
States, municipalities and political subdivisions	$	3,058	$	112	$	10	$	3,160	$	-
Convertibles and bonds with warrants attached		73		-		-		73		-
United States government		4		1		-		5		-
Government-sponsored enterprises		226		-		2		224		-
Foreign government		3		-		-		3		-
Corporate securities		4,669		408		6		5,071		-
Subtotal		8,033		521		18		8,536	$	-
Equity securities:
Common equities		2,149		858		11		2,996
Preferred equities		74		30		-		104
Subtotal		2,223		888		11		3,100	NA
Total	$	10,256	$	1,409	$	29	$	11,636

At December 31, 2010
Fixed maturities:
States, municipalities and political subdivisions	$	3,043	$	110	$	10	$	3,143	$	-
Convertibles and bonds with warrants attached		69		-		-		69		-
United States government		4		1		-		5		-
Government-sponsored enterprises		201		-		1		200		-
Foreign government		3		-		-		3		-
Corporate securities		4,568		404		9		4,963		-
Subtotal		7,888		515		20		8,383	$	-
Equity securities:
Common equities		2,211		757		28		2,940
Preferred equities		75		27		1		101
Subtotal		2,286		784		29		3,041	NA
Total	$	10,174	$	1,299	$	49	$	11,424

The unrealized investment gains at March 31, 2011, were largely due to a net gain position in our fixed income portfolio of $503 million and a net gain position in our common stock portfolio of $847 million. The primary contributors to the net gain position were The Procter & Gamble Company (NYSE:PG), Exxon Mobil Corporation (NYSE:XOM) and Chevron Corporation (NYSE:CVX) common stock, which had a combined net gain position of $333 million. At March 31, 2011, we had $73 million fair value of hybrid securities included in fixed maturities that follow ASC 815-15-25, Accounting for Certain Hybrid Financial Instruments. The hybrid securities are carried at fair value, and the changes in fair value are included in realized investment gains and losses.

Page 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, 2011	Fair value		Unrealized losses		Fair value		Unrealized losses		Fair value		Unrealized losses
Fixed maturities:
States, municipalities and political subdivisions	$	312	$	9	$	9	$	1	$	321	$	10
Government-sponsored enterprises		149		2		-		-		149		2
Corporate securities		339		4		31		2		370		6
Subtotal		800		15		40		3		840		18
Equity securities:
Common equities		206		11		-		-		206		11
Preferred equities		5		-		23		-		28		-
Subtotal		211		11		23		-		234		11
Total	$	1,011	$	26	$	63	$	3	$	1,074	$	29

At December 31, 2010
Fixed maturities:
States, municipalities and political subdivisions	$	325	$	9	$	9	$	1	$	334	$	10
Government-sponsored enterprises		133		1		-		-		133		1
Corporate securities		354		6		39		3		393		9
Subtotal		812		16		48		4		860		20
Equity securities:
Common equities		337		28		-		-		337		28
Preferred equities		5		-		23		1		28		1
Subtotal		342		28		23		1		365		29
Total	$	1,154	$	44	$	71	$	5	$	1,225	$	49

Net realized gains were $12 million for the three months ended March 31, 2011, compared with net realized gains of $8 million for the same period in 2010. The realized gains for the three months ended March 31, 2011, were $42 million, offset by a $30 million impairment charge.

Other-than-temporary Impairment Charges

During the three months ended March 31, 2011, 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 for the three months ended March 31, 2011:

(In millions)	Three months ended March 31,
	2011		2010
Fixed maturities	$	-	$	1
Equity securities		30		-
Total	$	30	$	1

During the quarter ended March 31, 2011, we impaired one equity security and one fixed-maturity security for a total of $30 million. At March 31, 2011, 15 fixed-maturity investments with a total unrealized loss of $3 million had been in an unrealized loss position for 12 months or more, but none were trading below 70 percent of book value. At March 31, 2011, three equity securities with a total unrealized loss of less than $1 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, 2010, 17 fixed-maturity investments with a total unrealized loss of $4 million had been in an unrealized loss position for 12 months or more. Of that total, no fixed maturity investments were trading below 70 percent of book value. Three equity investments with a total unrealized loss of $1 million had been in an unrealized loss position for 12 months or more as of December 31, 2010. 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 those used at December 31, 2010, and ultimately management determines fair value.

Page 9

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 active markets. This is the most reliable fair value measurement and includes, for example, active exchange-traded equity securities.

·	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:

Quotes from brokers or other external sources that are not considered binding;

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; or

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, 2011, and December 31, 2010. 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, 2011 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:
States, municipalities and political subdivisions	$	-	$	3,156	$	4	$	3,160
Convertibles and bonds with warrants attached		-		73		-		73
United States government		5		-		-		5
Government-sponsored enterprises		-		224		-		224
Foreign government		-		3		-		3
Corporate securities		-		5,060		11		5,071
Subtotal		5		8,516		15		8,536
Common equities, available for sale		2,996		-		-		2,996
Preferred equities, available for sale		-		98		6		104
Taxable fixed maturities separate accounts		-		604		-		604
Top Hat Savings Plan		9		-		-		9
Total	$	3,010	$	9,218	$	21	$	12,249

(In millions)	Asset fair value measurements at December 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	$	-	$	4,943	$	20	$	4,963
Convertibles and bonds with warrants attached		-		69		-		69
Foreign government		-		3		-		3
United States government		5		-		-		5
Government-sponsored enterprises		-		200		-		200
States, municipalities and political subdivisions		-		3,139		4		3,143
Subtotal		5		8,354		24		8,383
Common equities, available for sale		2,940		-		-		2,940
Preferred equities, available for sale		-		96		5		101
Taxable fixed maturities separate accounts		-		606		2		608
Top Hat Savings Plan		9		-		-		9
Total	$	2,954	$	9,056	$	31	$	12,041

Page 10

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, 2011. Total Level 3 assets were less than 1 percent of financial assets measured at fair value for the three months ended March 31, 2011, and December 31, 2010. At March 31, 2011, total fair value of assets priced with broker quotes and other non-observable market inputs for the fair value measurements and disclosures was $21 million.

The following table provides the change in Level 3 assets for the three months ended March 31, 2011. As a result of available observable inputs, two Level 3 corporate fixed-maturity securities transferred into Level 2 resulting in a $9 million decrease. There were no other significant changes to Level 3 assets during this period.

(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, 2010		$	20		$	2		$	4	$	-	$	5	$	31
Total gains or losses (realized/unrealized):
Included in earnings (or changes in net assets)			-			-			-		-		-		-
Included in other comprehensive income			-			-			-		-		-		-
Purchases, sales, issuances, and settlements			-			-			-		-		-		-
Transfers into Level 3			-			-							1		1
Transfers out of Level 3			(9	)		(2	)		-		-		-		(11	)
Ending balance, March 31, 2011		$	11		$	-		$	4	$	-	$	6	$	21

(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, 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

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 book value and principal amounts of our long-term debt:

(In millions)					Book value				Principal amount
					March 31,		December 31,		March 31,		December 31,
Interest rate			Year of issue		2011		2010		2011		2010
	6.900	%	1998	Senior debentures, due 2028	$	28	$	28	$	28	$	28
	6.920	%	2005	Senior debentures, due 2028		391		391		391		391
	6.125	%	2004	Senior notes, due 2034		371		371		374		374
				Total	$	790	$	790	$	793	$	793

The fair value of our senior debt approximated $789 million at March 31, 2011, compared with $783 million at year-end 2010. 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 conditions. Regardless of the fluctuations in fair value, the outstanding principal amount of our long-term debt is $793 million. None of the long-term debt is encumbered by rating triggers. Also, we have one 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 $45 million, compared with book value of $39 million reported in the condensed consolidated balance sheets at March 31, 2011.

Life reserves and liabilities for deferred annuities and other investment contracts were $982 million and $930 million at March 31, 2011, and December 31, 2010, respectively. Fair value for these deferred annuities and investment contracts was $967 million and $933 million at March 31, 2011, and December 31, 2010, 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

Page 11

issuers at March 31, 2011, 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 (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 costs for recoverability. 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,
	2011			2010
Deferred policy acquisition costs asset, beginning of period	$	488		$	481
Capitalized deferred policy acquisition costs		178			171
Amortized deferred policy acquisition costs		(163	)		(161	)
Amortized shadow deferred policy acquisition costs		-			(6	)
Deferred policy acquisition costs asset, end of period	$	503		$	485

There were no premium deficiencies recorded in 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,
	2011			2010
Gross loss and loss expense reserves, beginning of period	$	4,137		$	4,096
Less reinsurance receivable		326			435
Net loss and loss expense reserves, beginning of period		3,811			3,661
Net incurred loss and loss expenses related to:
Current accident year		588			514
Prior accident years		(58	)		(39	)
Total incurred		530			475
Net paid loss and loss expenses related to:
Current accident year		129			113
Prior accident years		359			301
Total paid		488			414

Net loss and loss expense reserves, end of period		3,853			3,722
Plus reinsurance receivable		326			343
Gross loss and loss expense reserves, end of period	$	4,179		$	4,065

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 prior accident years’ loss and loss expenses by $59 million and $39 million for the three months ended March 31, 2011 and 2010. A primary cause of the decrease was a reduction in actual exposures, relative to expectations when prior years reserves were initially set, especially for the commercial casualty line of business. The reserve for loss and loss expenses in the condensed consolidated balance sheets also includes $60 million at March 31, 2011, and $53 million at March 31, 2010, for certain life and health loss and loss expense reserves.

NOTE 6 – Life 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 as well as for expected expenses. We base our assumptions for expected investment income on our own experience adjusted for current economic conditions.

Page 12

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.

(In millions)	March 31,		December 31,
	2011		2010
Ordinary/traditional life	$	640	$	628
Universal life		467		459
Deferred annuities		783		730
Investment contracts		199		200
Other		17		17
Total gross reserves	$	2,106	$	2,034

NOTE 7 – 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,
	2011			2010
Direct earned premiums	$	780		$	744
Assumed earned premiums		5			3
Ceded earned premiums		(40	)		(40	)
Net earned premiums	$	745		$	707

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,
	2011			2010
Direct incurred loss and loss expenses	$	527		$	449
Assumed incurred loss and loss expenses		15			2
Ceded incurred loss and loss expenses		(12	)		23
Net incurred loss and loss expenses	$	530		$	474

Our condensed consolidated statements of income include earned life insurance premiums on ceded business:

(In millions)	Three months ended March 31,
	2011			2010
Direct earned premiums	$	50		$	50
Assumed earned premiums		-			-
Ceded earned premiums		(13	)		(11	)
Net earned premiums	$	37		$	39

Our condensed consolidated statements of income include life insurance contract holders’ benefits incurred on ceded business:

(In millions)	Three months ended March 31,
	2011			2010
Direct contract holders' benefits incurred	$	53		$	57
Assumed contract holders' benefits incurred		-			-
Ceded contract holders' benefits incurred		(8	)		(15	)
Net incurred loss and loss expenses	$	45		$	42

NOTE 8 – 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,
	2011			2010
Service cost	$	3		$	2
Interest cost		3			3
Expected return on plan assets		(4	)		(3	)
Amortization of actuarial loss and prior service cost		1			1
Net periodic benefit cost	$	3		$	3

Page 13

See our 2010 Annual Report on Form 10-K, Item 8, Note 13, Employee Retirement Benefits, Page 121 for information on our retirement benefits. We made matching contributions of $2 million to our 401(k) savings plan during both the first quarter of 2011 and 2010.

We contributed $35 million to our qualified pension plan during the first quarter of 2011. We do not anticipate further contributions to our qualified pension plan during the remainder of 2011.

NOTE 9 – Stock-Based Associate Compensation Plans

We currently have four equity compensation plans that permit us to grant various types of equity awards. We currently grant incentive stock options, non-qualified stock options, service-based restricted stock units and performance-based restricted stock units, including some with market-based performance objectives, under our shareholder-approved plans. We also have a Holiday Stock Plan that permits annual awards of one share of common stock to each full-time associate for each full calendar year of service up to a maximum of 10 shares. One of our equity compensation plans permits us to grant stock to our outside directors as a component of their annual compensation. For additional information about our equity compensation plans, see our 2010 Annual Report on Form 10-K, Item 8, Note 17, Stock-Based Associate Compensation Plans, Page 125.

A total of 16.9 million shares are authorized to be granted under the shareholder-approved plans. At March 31, 2011, 4.3 million shares were available for future issuance under the plans.

Stock-Based Awards

During the first quarter of 2011, we granted 24,492 shares of common stock to our directors for 2010 board service fees. Stock-based awards were granted to associates during the first quarter of 2011 and are summarized in the tables below. Stock-based compensation cost after tax was $2 million for both the three months ended March 31, 2011 and 2010.

As of March 31, 2011, $24 million of unrecognized compensation costs related to non-vested awards is expected to be recognized over a weighted-average period of 2.4 years.

Here is a summary of option information:

(Shares in thousands)	Shares			Weighted- average exercise price
Outstanding at January 1, 2011		9,690		$	36.59
Granted		876			34.04
Exercised		(14	)		26.82
Forfeited or expired		(939	)		33.05
Outstanding at March 31, 2011		9,613			36.72

Here is a summary of restricted stock unit information:

(Shares in thousands)	Service-based nonvested shares			Weighted-average grant-date fair value		Performance-based nonvested shares			Weighted-average grant-date fair value
Nonvested at January 1, 2011		716		$	26.00		149		$	26.08
Granted		298			29.59		41			31.77
Vested		(215	)		34.48		-			0.00
Forfeited or canceled		(4	)		24.57		(43	)		32.56
Nonvested at March 31, 2011		795			25.06		147			25.78

NOTE 10 – Commitments and Contingent Liabilities

In the ordinary course of conducting business, the company and its subsidiaries are named as defendants in various legal proceedings. Most of these proceedings are claims litigation involving the company’s insurance subsidiaries in which the company is either defending or providing indemnity for third-party claims brought against insureds who are litigating first-party coverage claims. The company accounts for such activity through the establishment of unpaid loss and loss adjustment expense reserves. We believe that the ultimate liability, if any, with respect to such ordinary-course claims litigation, after consideration of provisions made for potential losses and costs of defense, is immaterial to our consolidated financial condition, results of operations and cash flows.

The company and its subsidiaries also are occasionally involved in other legal actions, some of which assert claims for substantial amounts. These actions include, among others, putative class actions seeking certification of a state or national class. Such putative class actions have alleged, for example, improper reimbursement of medical providers paid under workers’ compensation insurance policies, erroneous coding of municipal tax locations and excessive premium charges for uninsured motorist coverage. The company’s insurance subsidiaries also are occasionally parties to individual actions in which extra-contractual damages,

Page 14

punitive damages or penalties are sought, such as claims alleging bad faith in the handling of insurance claims.

On a quarterly basis, we review the outstanding lawsuits. Under current accounting guidance, we establish accruals for lawsuits when it is probable that a loss has been incurred and we can reasonably estimate its potential exposure. The company accounts for such probable and estimable losses, if any, through the establishment of legal expense reserves. Based on our quarterly review, we believe that our accruals for probable and estimable lawsuits are reasonable and that the amounts accrued do not have a material effect on our consolidated financial condition or results of operations. However, if any one or more of these cases results in a judgment against us or settlement for an amount that is significantly greater than the amount accrued, the resulting liability could have a material effect on the company’s consolidated results of operations or cash flows. Based on our quarterly review, for any other matter for which the risk of loss is more than remote we are unable to reasonably estimate the potential loss or establish a reasonable range of loss.

NOTE 11 – Income Taxes

As of March 31, 2011, we had no liability for unrecognized tax benefits.

As of December 31, 2010, we had no liability for unrecognized tax benefits. Details about our liability for unrecognized tax benefits are found in our 2010 Annual Report on Form 10-K, Item 8, Note 11, Income Taxes, Page 120.

The differences between the 35 percent statutory income tax rate and our effective income tax rate were as follows:

	Three months ended March 31,
	2011			2010
Tax at statutory rate		35.0	%		35.0	%
Increase (decrease) resulting from:
Tax-exempt income from municipal bonds		(11.4	)		(10.8	)
Dividend received exclusion		(6.7	)		(5.2	)
Other		1.5			1.0
Effective rate		18.4	%		20.0	%

NOTE 12 – Segment Information

We operate primarily in two industries, property casualty insurance and life insurance. We regularly review our reporting segments to make decisions about allocating resources and assessing performance:

·	Commercial lines property casualty insurance

·	Personal lines property casualty insurance

·	Excess and Surplus lines property and casualty insurance

·	Life insurance

·	Investments

As discussed in our 2010 Annual Report on Form 10-K, Item 8, Note 18, Segment Information, we revised our reportable segments during the fourth quarter of 2010 to establish a separate reportable segment for excess and surplus lines. This new segment includes results of The Cincinnati Specialty Underwriters Insurance Company and CSU Producer Resources. Historically, the excess and surplus lines results were reflected in Other. Prior period data included in this quarterly report has been adjusted to represent this new segment.

We report as Other the non-investment operations of the parent company and its non-insurer subsidiary, CFC Investment Company. See our 2010 Annual Report on Form 10-K, Item 8, Note 18, Segment Information, Page 115 for a description of revenue, income or loss before income taxes and identifiable assets for each of the five segments.

Page 15

Segment information is summarized in the following table:

(In millions)	Three months ended March 31,
	2011		2010
Revenues:
Commercial lines insurance
Commercial casualty	$	172	$	164
Commercial property		126		121
Commercial auto		96		95
Workers' compensation		76		74
Specialty packages		37		37
Surety and executive risk		25		24
Machinery and equipment		8		8
Commercial lines insurance premiums		540		523
Fee revenue		1		1
Total commercial lines insurance		541		524

Personal lines insurance
Personal auto		89		81
Homeowner		76		70
Other personal lines		25		23
Personal lines insurance premiums		190		174
Fee revenue		-		-
Total personal lines insurance		190		174

Excess and surplus lines insurance		15		11
Life insurance		38		39
Investment operations		143		138
Other