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 September 30, 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 October 24, 2011, there were 162,078,694 shares of common stock outstanding.
 
Cincinnati Financial Corporation Third-Quarter 2011 10-Q
Page 1
 
 
 
 
 
CINCINNATI FINANCIAL CORPORATION
 
FORM 10-Q FOR THE QUARTER ENDED SEPTEMBER 30, 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
   
Notes to Condensed Consolidated Financial Statements (unaudited)
7
   
Item 2.        Management’s Discussion and Analysis of Financial Condition and Results of Operations
20
   
Safe Harbor Statement
20
   
Introduction
22
   
Results of Operations
28
   
Liquidity and Capital Resources
46
   
Other Matters
49
   
Item 3.        Quantitative and Qualitative Disclosures about Market Risk
50
   
Fixed-Maturity Investments
50
   
Equity Investments
53
   
Unrealized Investment Gains and Losses
53
   
Item 4.        Controls and Procedures
56
   
Part II – Other Information
56
   
Item 1. Legal Proceedings
56
   
Item 1A. Risk Factors
56
   
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds
56
   
Item 3. Defaults upon Senior Securities
56
   
Item 4. (Removed and Reserved)
56
   
Item 5. Other Information
57
   
Item 6. Exhibits
57
 
Cincinnati Financial Corporation Third-Quarter 2011 10-Q
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)  
September 30,
    
December 31,
  
     
2011
    
2010
  
ASSETS
            
Investments
            
Fixed maturities, at fair value (amortized cost: 2011—$8,179; 2010—$7,888)
   $ 8,854     $ 8,383  
Equity securities, at fair value (cost: 2011—$2,132; 2010—$2,286)
     2,609       3,041  
Other invested assets
     66       84  
Total investments
     11,529       11,508  
Cash and cash equivalents
     308       385  
Investment income receivable
     117       119  
Finance receivable
     75       73  
Premiums receivable
     1,107       1,015  
Reinsurance receivable
     714       572  
Prepaid reinsurance premiums
     15       18  
Deferred policy acquisition costs
     512       488  
Land, building and equipment, net, for company use (accumulated depreciation:
       2011—$368; 2010—$352)
     228       229  
Other assets
     142       67  
Separate accounts
     665       621  
Total assets
   $ 15,412     $ 15,095  
                 
LIABILITIES
                
Insurance reserves
                
Loss and loss expense reserves
   $ 4,521     $ 4,200  
Life policy reserves
     2,179       2,034  
Unearned premiums
     1,657       1,553  
Other liabilities
     519       556  
Deferred income tax
     191       260  
Note payable
     104       49  
Long-term debt
     790       790  
Separate accounts
     665       621  
Total liabilities
     10,626       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
     1,098       1,091  
Retained earnings
     3,816       3,980  
Accumulated other comprehensive income
     703       769  
Treasury stock at cost (2011—34 million shares and 2010—34 million shares)
     (1,224 )     (1,201 )
Total shareholders' equity
     4,786       5,032  
Total liabilities and shareholders' equity
   $ 15,412     $ 15,095  
  
Accompanying notes are an integral part of these condensed consolidated financial statements.
 
Cincinnati Financial Corporation Third-Quarter 2011 10-Q
Page 3
 
 
 
 
 
Cincinnati Financial Corporation and Subsidiaries
 
Condensed Consolidated Statements of Income
 
(In millions except per share data)
  
Three months ended September 30,
    
Nine months ended September 30,
  
   
2011
    
2010
    
2011
    
2010
  
REVENUES
                        
Earned premiums
   $ 812     $ 784     $ 2,367     $ 2,299  
Investment income, net of expenses
     130       128       393       388  
Fee revenues
     1       1       3       3  
Other revenues
     3       3       8       6  
Realized investment gains (losses), net:
                                
Other-than-temporary impairments on fixed maturity securities
     (3 )     (1 )     (3 )     (3 )
Other-than-temporary impairments on fixed maturity securities transferred to other comprehensive income
     -       -       -       -  
Other realized investment gains, net
     1       156       80       143  
Total realized investment gains (losses), net
     (2 )     155       77       140  
Total revenues
     944       1,071       2,848       2,836  
                                 
BENEFITS AND EXPENSES
                                
Insurance losses and policyholder benefits
     656       575       2,032       1,686  
Underwriting, acquisition and insurance expenses
     260       258       772       772  
Other operating expenses
     4       4       14       11  
Interest expense
     13       13       40       40  
Total benefits and expenses
     933       850       2,858       2,509  
                                 
INCOME (LOSS) BEFORE INCOME TAXES
     11       221       (10 )     327  
                                 
PROVISION (BENEFIT) FOR INCOME TAXES
                                
Current
     17       59       (9 )     84  
Deferred
     (25 )     6       (33 )     (8 )
Total provision (benefit) for income taxes
     (8 )     65       (42 )     76  
                                 
NET INCOME
   $ 19     $ 156     $ 32     $ 251  
                                 
PER COMMON SHARE
                                
Net income—basic
   $ 0.12     $ 0.95     $ 0.20     $ 1.54  
Net income—diluted
     0.12       0.95       0.20       1.53  
 
Accompanying notes are an integral part of these condensed consolidated financial statements.
 
Cincinnati Financial Corporation Third-Quarter 2011 10-Q
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
     -       -       -       251       -       -       251  
Other comprehensive income, net
     -       -       -       -       190       -       190  
Total comprehensive income
                                                     441  
Dividends declared
     -       -       -       (194 )     -       -       (194 )
Stock options exercised
     1       -       (2 )     -       -       3       1  
Stock-based compensation
     -       -       9       -       -       -       9  
Purchases
     -       -       -       -       -       (10 )     (10 )
Other
     -       -       (1 )     -       -       4       3  
Balance September 30, 2010
     163     $  393     $ 1,087     $ 3,919     $ 814     $ (1,203 )   $ 5,010  
                                                         
Balance December 31, 2010
     163     $  393     $ 1,091     $ 3,980     $ 769     $ (1,201 )   $ 5,032  
                                                         
Net income
     -       -       -       32       -       -       32  
Other comprehensive loss, net
     -       -       -       -       (66 )     -       (66 )
Total comprehensive loss
                                                     (34 )
Dividends declared
     -       -       -       (196 )     -       -       (196 )
Stock options exercised
     -       -       (5 )     -       -       3       (2 )
Stock-based compensation
     -       -       10       -       -       -       10  
Purchases
     (1 )     -       -       -       -       (30 )     (30 )
Other
     -       -       2       -       -       4       6  
Balance September 30, 2011
     162     $  393     $ 1,098     $ 3,816     $ 703     $ (1,224 )   $ 4,786  
 
Accompanying notes are an integral part of these condensed consolidated financial statements.
 
Cincinnati Financial Corporation Third-Quarter 2011 10-Q
Page 5

 
 
 
 
Cincinnati Financial Corporation and Subsidiaries
 
Condensed Consolidated Statements of Cash Flows
 
(In millions)
  
Nine months ended September 30,
  
   
2011
    
2010
  
CASH FLOWS FROM OPERATING ACTIVITIES
            
Net income
   $ 32     $ 251  
Adjustments to reconcile net income to net cash provided by operating activities:
                
Depreciation, amortization and other non-cash items
     38       30  
Realized gains on investments
     (77 )     (140 )
Stock-based compensation
     10       9  
Interest credited to contract holders
     38       33  
Deferred income tax benefit
     (33 )     (8 )
Changes in:
                
Investment income receivable
     2       4  
Premiums and reinsurance receivable
     (231 )     81  
Deferred policy acquisition costs
     (33 )     (19 )
Other assets
     (1 )     (2 )
Loss and loss expense reserves
     321       83  
Life policy reserves
     89       86  
Unearned premiums
     104       64  
Other liabilities
     (49 )     (27 )
Current income tax receivable/payable
     (62 )     (28 )
Net cash provided by operating activities
     148       417  
CASH FLOWS FROM INVESTING ACTIVITIES
                
Sale of fixed maturities
     47       136  
Call or maturity of fixed maturities
     592       757  
Sale of equity securities
     410       128  
Collection of finance receivables
     23       21  
Purchase of fixed maturities
     (934 )     (1,145 )
Purchase of equity securities
     (179 )     (276 )
Change in short-term investments, net
     -       7  
Investment in buildings and equipment, net
     (12 )     (14 )
Investment in finance receivables
     (23 )     (17 )
Change in other invested assets, net
     5       1  
Net cash used in investing activities
     (71 )     (402 )
CASH FLOWS FROM FINANCING ACTIVITIES
                
Payment of cash dividends to shareholders
     (191 )     (189 )
Purchase of treasury shares
     (30 )     (10 )
Increase in notes payable
     55       -  
Contract holders' funds deposited
     81       130  
Contract holders' funds withdrawn
     (64 )     (53 )
Excess tax benefits on share-based compensation
     3       1  
Other
     (8 )     (6 )
Net cash used in financing activities
     (154 )     (127 )
Net change in cash and cash equivalents
     (77 )     (112 )
Cash and cash equivalents at beginning of year
     385       557  
Cash and cash equivalents at end of period
   $ 308     $ 445  
                 
Supplemental disclosures of cash flow information:
                
Interest paid
   $ 27     $ 27  
Income taxes paid
     53       113  
Non-cash activities:
                
Conversion of securities
   $ -     $ 5  
Equipment acquired under capital lease obligations
     24       -  
 
Accompanying notes are an integral part of these condensed consolidated financial statements.

Cincinnati Financial Corporation Third-Quarter 2011 10-Q
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 is wholly owned. These statements are presented in conformity with accounting principles generally accepted in the United States of America (GAAP). All 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 September 30, 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 Financial Accounting Standards Board (FASB) issued Accounting Standards Update (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 these separate disclosures is 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 forth 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 the 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 capitalization of 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. 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. We plan to adopt ASU 2010-26 retrospectively. We estimate that at September 30, 2011, approximately $100 million of the total $512 million deferred acquisition costs asset is subject to further analysis to determine what can continue to be capitalized. We estimate $35-65 million of the $100 million may relate to successful acquisition of new and renewal contracts and will be deferrable and capitalized. The ASU has not yet been adopted, and we will report at December 31, 2011, the impact it will have on our company’s financial position, cash flows or results of operations.
 
Cincinnati Financial Corporation Third-Quarter 2011 10-Q
Page 7

 
 
 
 
ASU 2011-04, Fair Value Measurements, Amendments to Achieve Common Fair Value Measurement and Disclosure Requirements in U.S. GAAP and IFRS
 
In May 2011, the FASB issued ASU 2011-04, Fair Value Measurements, Amendments to Achieve Common Fair Value Measurement and Disclosure Requirements in U.S. GAAP and International Financial Reporting Standards (IFRS). The ASU converges fair value measurement and disclosures among U.S. GAAP and IFRS. ASU 2011-04 changes certain fair value measurement principles and expands disclosure requirements, particularly for Level 3 inputs. The ASU is effective for interim and annual periods beginning after December 15, 2011, and should be applied prospectively. The ASU has not yet been adopted and will not have a material impact on our company’s financial position, cash flows or results of operations.
 
ASU 2011-05, Presentation of Comprehensive Income
 
In June 2011, the FASB issued ASU 2011-05, Presentation of Comprehensive Income. ASU 2011-05 requires entities to present the total of comprehensive income, the components of net income, and the components of other comprehensive income either in a single continuous statement of comprehensive income or in two separate but consecutive statements. The ASU is effective for interim and annual reporting periods beginning after December 15, 2011, and should be applied prospectively. The ASU has not yet been adopted and will not have a material impact on our company’s financial position, cash flows or results of operations, as it relates to modified presentation of existing financial statements.
 
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 September 30, 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 September 30,
    
Nine months ended September 30,
  
   
2011
    
2010
    
2011
    
2010
  
Change in unrealized gains and losses summary:
                        
Fixed maturities
   $ 76     $ 198     $ 180     $ 407  
Equity securities
     (379 )     85       (278 )     (105 )
Adjustment to deferred acquisition costs and life policy reserves
     (7 )     (11 )     (11 )     (18 )
Pension obligations
     1       -       3       1  
Other
     1       2       4       7  
Income taxes on above
     108       (96 )     36       (102 )
Total
   $ (200 )   $ 178     $ (66 )   $ 190  
 
Cincinnati Financial Corporation Third-Quarter 2011 10-Q
Page 8 
 
 
 
 
 
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 September 30, 2011
  
cost
    
gains
    
losses
    
Value
    
AOCI
  
                               
Fixed maturities:
                              
States, municipalities and political subdivisions
   $ 3,020     $ 220     $ 1     $ 3,239     $ -  
Convertibles and bonds with warrants attached
     69       -       -       69       -  
United States government
     6       1       -       7       -  
Government-sponsored enterprises
     217       -       -       217       -  
Foreign government
     3       -       -       3       -  
Corporate securities
     4,864       472       17       5,319       -  
Subtotal
     8,179       693       18       8,854     $ -  
Equity securities:
                                        
Common equities
     2,057       548       96       2,509          
Preferred equities
     75       26       1       100          
Subtotal
     2,132       574       97       2,609    
NA
  
Total
   $ 10,311     $ 1,267     $ 115     $ 11,463          
                                         
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 September 30, 2011, were largely due to a net gain position in our fixed maturity portfolio of $675 million and a net gain position in our common stock portfolio of $452 million. The net unrealized investment gains in our fixed maturity portfolio are primarily composed of $455 million in unrealized gains from the corporate bond portfolio and $219 million in net unrealized gains from the municipal bond portfolio. The primary contributors to the net gain position in the common stock portfolio were Exxon Mobil Corporation (NYSE:XOM), The Procter & Gamble Company (NYSE:PG) and Chevron Corporation (NYSE:CVX) common stock, which had a combined net gain position of $251 million.
    
Of the 182 holdings with fair value below cost or amortized cost at September 30, 2011, the three largest contributors to the $115 million unrealized losses were equity securities. The fair value of these three securities was $125 million, and they accounted for $55 million in unrealized losses. Two securities have traded below cost for less than six months. One security has traded below cost for less than nine months.
 
Management reviews quantitative measurements such as a declining trend in fair value, the extent of the fair value decline and the length of time the value of the security has been depressed, as well as qualitative measures such as pending events, credit ratings and issuer liquidity when analyzing for other-than-temporary declines in value. Non-cash charges to income, as realized investment losses, are recorded when it is determined the value will not be recovered within a designated recovery period.
 
At September 30, 2011, we had $69 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.
 
Cincinnati Financial Corporation Third-Quarter 2011 10-Q
Page 9 
 
 
 
 
 
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
  
   
Fair
    
Unrealized
    
Fair
    
Unrealized
    
Fair
    
Unrealized
  
At September 30, 2011
  
value
    
losses
    
value
    
losses
    
value
    
losses
  
Fixed maturities:
                                    
States, municipalities and political subdivisions
   $ 17     $ 1     $ 6     $ -     $ 23     $ 1  
United States government
     1       -       -       -       1       -  
Government-sponsored enterprises
     70       -       -       -       70       -  
Corporate securities
     448       14       28       3       476       17  
Subtotal
     536       15       34       3       570       18  
Equity securities:
                                                
Common equities
     571       96       -       -       571       96  
Preferred equities
     8       -       18       1       26       1  
Subtotal
     579       96       18       1       597       97  
Total
   $ 1,115     $ 111     $ 52     $ 4     $ 1,167     $ 115  
                                                 
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  
  
For the three months ended September 30, 2011, the net realized loss of $2 million includes $19 million in gross realized gains and $17 million in gross realized losses from sales of securities. For the three months ended September 30, 2010, the net realized gain of $155 million includes $148 million in gross realized gains and less than $1 million in gross realized losses from sales of securities. For the nine months ended September 30, 2011, the net realized gain of $77 million includes $136 million in gross realized gains and $35 million in gross realized losses from sales of securities. For the nine months ended September 30, 2010, the net realized gain of $140 million includes $177 million in gross realized gains and $12 million in gross realized losses from sales of securities.
 
Other-than-temporary Impairment Charges
 
During the three and nine months ended September 30, 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 and nine months ended September 30, 2011:
 
(In millions)
  
Three months ended September 30,
    
Nine months ended September 30,
  
   
2011
    
2010
    
2011
    
2010
  
Fixed maturities
   $ 3     $ 1     $ 3     $ 3  
Equity securities
     -       -       30       33  
Total
   $ 3     $ 1     $ 33     $ 36  
 
During the quarter ended September 30, 2011, we impaired four fixed-maturity securities for $3 million. At September 30, 2011, 13 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 amortized cost. At September 30, 2011, two equity securities with a total unrealized loss of $1 million had been in an unrealized loss position for 12 months or more, but none were trading below 70 percent of amortized cost.
 
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 amortized cost. 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 amortized cost.
 
Cincinnati Financial Corporation Third-Quarter 2011 10-Q
Page 10

 
 
 
 
NOTE 3 – Fair Value Measurements
 
Fair Value Hierarchy
 
In accordance with accounting guidance for fair value measurements and disclosures, we categorized our financial instruments, based on the priority of the observable and market-based data for the valuation technique used, 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.
 
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:
 
 
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; or
 
 
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.
 
Cincinnati Financial Corporation Third-Quarter 2011 10-Q
Page 11 

 
 
 
 
The following tables illustrate the fair value hierarchy for those assets measured at fair value on a recurring basis at September 30, 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 September 30, 2011 using:
  
   
Quoted prices in
          
Significant
        
   
active markets for
    
Significant other
    
unobservable
        
   
identical assets
    
observable inputs
    
inputs
        
   
(Level 1)
    
(Level 2)
    
(Level 3)
    
Total
  
Fixed maturities, available for sale:
                        
States, municipalities and political subdivisions
   $ -     $ 3,236     $ 3     $ 3,239  
Convertibles and bonds with warrants attached
     -       69       -       69  
United States government
     7       -       -       7  
Government-sponsored enterprises
     -       217       -       217  
Foreign government
     -       3       -       3  
Corporate securities
     -       5,297       22       5,319  
Subtotal
     7       8,822       25       8,854  
Common equities, available for sale
     2,509       -       -       2,509  
Preferred equities, available for sale
     -       94       6       100  
Taxable fixed maturities separate accounts
     -       631       -       631  
Top Hat Savings Plan
     7       -       -       7  
Total
   $ 2,523     $ 9,547     $ 31     $ 12,101  
 
(In millions)
  
Asset fair value measurements at December 31, 2010 using:
  
   
Quoted prices in
          
Significant
        
   
active markets for
    
Significant other
    
unobservable
        
   
identical assets
    
observable inputs
    
inputs
        
   
(Level 1)
    
(Level 2)
    
(Level 3)
    
Total
  
Fixed maturities, available for sale:
                        
States, municipalities and political subdivisions
   $ -     $ 3,139     $ 4     $ 3,143  
Convertibles and bonds with warrants attached
     -       69       -       69  
United States government
     5       -       -       5  
Government-sponsored enterprises
     -       200       -       200  
Foreign government
     -       3       -       3  
Corporate securities
     -       4,943       20       4,963  
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  
 
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 September 30, 2011. Total Level 3 assets continue to be less than 1 percent of financial assets measured at fair value. At September 30, 2011, total fair value of assets priced with broker quotes and other non-observable market inputs for the fair value measurements and disclosures was $31 million.
 
Cincinnati Financial Corporation Third-Quarter 2011 10-Q
Page 12 
 
 
 
 
 
The following table provides the change in Level 3 assets for the three months ended September 30, 2011. Level 3 corporate fixed-maturity securities increased by $7 million as one security was purchased for $8 million, two securities totaling $8 million were transferred into Level 2 and one security totaling $7 million was transferred into Level 3. 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)
  
               
States,
              
               
municipalities and
              
   
Corporate
    
Taxable fixed
    
political
              
   
fixed
    
maturities-
    
subdivisions fixed
    
Preferred
        
   
maturities
    
separate accounts
    
maturities
    
equities
    
Total
  
Beginning balance, June 30, 2011
   $ 15     $ -     $ 4     $ 7     $ 26  
Total gains or losses (realized/unrealized):
                                        
Included in earnings (or changes in net assets)
     -       -       -       -       -  
Included in other comprehensive income
     -       -       -       (1 )     (1 )
Purchases
     8       -       -       -       8  
Sales
     -       -       (1 )     -       (1 )
Transfers into Level 3
     7       -       -       -       7  
Transfers out of Level 3
     (8 )     -       -       -       (8 )
Ending balance, September 30, 2011
   $ 22     $ -     $ 3     $ 6     $ 31  
 
(In millions)
  
Asset fair value measurements using significant unobservable inputs (Level 3)
  
               
States,
              
               
municipalities and
              
   
Corporate
    
Taxable fixed
    
political
              
   
fixed
    
maturities-
    
subdivisions fixed
    
Preferred
        
   
maturities
    
separate accounts
    
maturities
    
equities
    
Total
  
Beginning balance, June 30, 2010
   $ 23     $ -     $ 4     $ 5     $ 32  
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
     (4 )     2       -       -       (2 )
Transfers in and/or out of Level 3
     1       -       -       -       1  
Ending balance, September 30, 2010
   $ 21     $ 2     $ 4     $ 5     $ 32  
 
Cincinnati Financial Corporation Third-Quarter 2011 10-Q
Page 13
 
 
 
 
 
The following table provides the change in Level 3 assets for the nine months ended September 30, 2011. Level 3 corporate fixed-maturity securities increased $2 million for the nine months ended September 30, 2011. The change in corporate fixed-maturity securities resulted from the transfer of five securities totaling $20 million into Level 2, two securities totaling $7 million transferred into Level 3 and the purchase of two securities totaling $15 million. 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)
  
               
States,
              
               
municipalities and
              
   
Corporate
    
Taxable fixed
    
political
              
   
fixed
    
maturities-
    
subdivisions fixed
    
Preferred
        
   
maturities
    
separate accounts
    
maturities
    
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
     15       -       -       -       15  
Sales
     -       -       (1 )     -       (1 )
Transfers into Level 3
     7       -       -       1       8  
Transfers out of Level 3
     (20 )     (2 )     -       -       (22 )
Ending balance, September 30, 2011
   $ 22     $ -     $ 3     $ 6     $ 31  
 
(In millions)
  
Asset fair value measurements using significant unobservable inputs (Level 3)
  
   
Taxable
    
Taxable fixed
    
 
              
   
fixed
    
maturities-
    
 Tax-exempt fixed
    
Preferred
        
   
maturities
    
separate accounts
    
maturities
    
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
     (2 )     2       -       -       -  
Transfers in and/or out of Level 3
     (5 )     -       -       -       (5 )
Ending balance, September 30, 2010
   $ 21     $ 2     $ 4     $ 5     $ 32  
 
Fair Value Disclosure for Senior Debt and Life Insurance Assets and Liabilities
 
The disclosures below 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 condensed consolidated financial statements.
 
This table summarizes the amortized cost and principal amounts of our long-term debt:
 
(In millions)
          
Book value
    
Principal amount
  
           
September 30,
    
December 31,
    
September 30,
    
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 $815 million at September 30, 2011, compared with $783 million at year-end 2010. Fair value was determined under the fair value measurements and disclosure accounting rules based on market pricing of similar debt instruments that are actively trading. Fair value can vary with macroeconomic 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 variable rate note payable with outstanding principal amount of $104 million, which approximates fair value. The additional $55 million in short-term borrowing in the third quarter was primarily to fund share repurchases using our relatively low-cost source of borrowing.
 
The fair value of life policy loans outstanding principal and interest approximated $41 million, compared with amortized cost of $38 million reported in the condensed consolidated balance sheets at September 30, 2011. The fair value of life policy loans outstanding principal and interest approximated $46 million, compared with amortized cost of $40 million reported in the consolidated balance sheets at December 31, 2010.