CINF-2013.3.31-10Q


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, 2013.
 
¨       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. 
þYes ¨ 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).
þYes ¨ No
 
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a nonaccelerated 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 ¨ Nonaccelerated 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 22, 2013, there were 163,435,801 shares of common stock outstanding.




CINCINNATI FINANCIAL CORPORATION
FORM 10-Q FOR THE QUARTER ENDED MARCH 31, 2013
 
TABLE OF CONTENTS
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 



Cincinnati Financial Corporation First-Quarter 2013 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)
 
March 31,
 
December 31,
 
 
2013
 
2012
ASSETS
 
 

 
 

Investments
 
 

 
 

Fixed maturities, at fair value (amortized cost: 2013—$8,323; 2012—$8,222)
 
$
9,169

 
$
9,093

Equity securities, at fair value (cost: 2013—$2,416; 2012—$2,369)
 
3,801

 
3,373

Other invested assets
 
67

 
68

Total investments
 
13,037

 
12,534

Cash and cash equivalents
 
380

 
487

Investment income receivable
 
117

 
115

Finance receivable
 
76

 
75

Premiums receivable
 
1,291

 
1,214

Reinsurance recoverable
 
620

 
615

Prepaid reinsurance premiums
 
26

 
26

Deferred policy acquisition costs
 
491

 
470

Land, building and equipment, net, for company use (accumulated depreciation: 2013—$398; 2012—$397)
 
216

 
217

Other assets
 
57

 
61

Separate accounts
 
726

 
734

Total assets
 
$
17,037

 
$
16,548

LIABILITIES
 
 

 
 

Insurance reserves
 
 

 
 

Loss and loss expense reserves
 
$
4,240

 
$
4,230

Life policy and investment contract reserves
 
2,310

 
2,295

Unearned premiums
 
1,875

 
1,792

Other liabilities
 
578

 
660

Deferred income tax
 
588

 
453

Note payable
 
104

 
104

Long-term debt and capital lease obligations
 
831

 
827

Separate accounts
 
726

 
734

Total liabilities
 
11,252

 
11,095

Commitments and contingent liabilities (Note 12)
 
—

 
—

SHAREHOLDERS' EQUITY
 
 

 
 

Common stock, par value—$2 per share; (authorized: 2013 and 2012—500 million shares; issued and outstanding: 2013 and 2012—197 million shares)
 
395

 
394

Paid-in capital
 
1,146

 
1,134

Retained earnings
 
4,109

 
4,021

Accumulated other comprehensive income
 
1,362

 
1,129

Treasury stock at cost (2013 and 2012—34 million shares)
 
(1,227
)
 
(1,225
)
Total shareholders' equity
 
5,785

 
5,453

Total liabilities and shareholders' equity
 
$
17,037

 
$
16,548

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


Cincinnati Financial Corporation First-Quarter 2013 10-Q
Page 3


CINCINNATI FINANCIAL CORPORATION AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF INCOME
 
 
Three months ended March 31,
(In millions except per share data)
 
2013
 
2012
REVENUES
 
 

 
 

Earned premiums
 
$
931

 
$
839

Investment income, net of expenses
 
128

 
131

Total realized investment gains, net
 
41

 
13

Fee revenues
 
1

 
1

Other revenues
 
2

 
2

Total revenues
 
1,103

 
986

BENEFITS AND EXPENSES
 
 

 
 

Insurance losses and policyholder benefits
 
568

 
582

Underwriting, acquisition and insurance expenses
 
300

 
274

Interest expense
 
13

 
14

Other operating expenses
 
5

 
4

 Total benefits and expenses
 
886

 
874

INCOME BEFORE INCOME TAXES
 
217

 
112

PROVISION FOR INCOME TAXES
 
 

 
 

Current
 
54

 
20

Deferred
 
9

 
6

Total provision for income taxes
 
63

 
26

NET INCOME
 
$
154

 
$
86

PER COMMON SHARE
 
 

 
 

Net income—basic
 
$
0.95

 
$
0.53

Net income—diluted
 
0.94

 
0.53

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

Cincinnati Financial Corporation First-Quarter 2013 10-Q
Page 4



CINCINNATI FINANCIAL CORPORATION AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
 
 
Three months ended March 31,
(In millions)
 
2013
 
2012
NET INCOME
 
$
154

 
$
86

OTHER COMPREHENSIVE INCOME:
 
 

 
 

Unrealized gains on investments available for sale, net of tax of $124 and $80, respectively
 
232

 
148

Amortization of pension actuarial loss and prior service cost, net of tax of $1 and $1, respectively
 
1

 
1

Change in life deferred acquisition costs, life policy reserves and other, net of tax of $0 and ($2), respectively
 
—

 
(3
)
Other comprehensive income, net of tax
 
233

 
146

COMPREHENSIVE INCOME
 
$
387

 
$
232

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


Cincinnati Financial Corporation First-Quarter 2013 10-Q
Page 5


CINCINNATI FINANCIAL CORPORATION AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY
 
 
Common Stock
 
 
 
 
 
Accumulated
Other
 
 
 
Total
Share-
(In millions)
 
Outstanding Shares
 
Amount
 
Paid-in Capital
 
Retained Earnings
 
Comprehensive Income
 
Treasury Stock
 
holders' Equity
Balance as reported December 31, 2011
 
162

 
$
393

 
$
1,096

 
$
3,885

 
$
901

 
$
(1,220
)
 
$
5,055

Cumulative effect of a change in accounting for deferred policy acquisition costs, net of tax
 
—

 
—

 
—

 
(22
)
 
—

 
—

 
(22
)
Balance as adjusted December 31, 2011
 
162

 
393

 
1,096

 
3,863

 
901

 
(1,220
)
 
5,033

Net income
 
—

 
—

 
—

 
86

 
—

 
—

 
86

Other comprehensive income, net
 
—

 
—

 
—

 
—

 
146

 
—

 
146

Dividends declared
 
—

 
—

 
—

 
(65
)
 
—

 
—

 
(65
)
Stock-based awards exercised and vested
 
—

 
—

 
—

 
—

 
—

 
1

 
1

Stock-based compensation
 
—

 
—

 
4

 
—

 
—

 
—

 
4

Purchases
 
—

 
—

 
—

 
—

 
—

 
—

 
—

Other
 
—

 
—

 
—

 
—

 
—

 
2

 
2

Balance March 31, 2012
 
162

 
$
393

 
$
1,100

 
$
3,884

 
$
1,047

 
$
(1,217
)
 
$
5,207

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Balance December 31, 2012
 
163

 
$
394

 
$
1,134

 
$
4,021

 
$
1,129

 
$
(1,225
)
 
$
5,453

Net income
 
—

 
—

 
—

 
154

 
—

 
—

 
154

Other comprehensive income, net
 
—

 
—

 
—

 
—

 
233

 
—

 
233

Dividends declared
 
—

 
—

 
—

 
(66
)
 
—

 
—

 
(66
)
Stock-based awards exercised and vested
 
—

 
1

 
7

 
—

 
—

 
5

 
13

Stock-based compensation
 
—

 
—

 
5

 
—

 
—

 
—

 
5

Purchases
 
—

 
—

 
—

 
—

 
—

 
(9
)
 
(9
)
Other
 
—

 
—

 
—

 
—

 
—

 
2

 
2

Balance March 31, 2013
 
163

 
$
395

 
$
1,146

 
$
4,109

 
$
1,362

 
$
(1,227
)
 
$
5,785

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


Cincinnati Financial Corporation First-Quarter 2013 10-Q
Page 6


CINCINNATI FINANCIAL CORPORATION AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

 
 
Nine months endedThree months ended March 31,
(In millions)
 
2013
 
2012
CASH FLOWS FROM OPERATING ACTIVITIES
 
 

 
 

Net income
 
$
154

 
$
86

Adjustments to reconcile net income to net cash provided by operating activities:
 
 

 
 

Depreciation and amortization
 
9

 
11

Realized gains on investments, net
 
(41
)
 
(13
)
Stock-based compensation
 
5

 
4

Interest credited to contract holders
 
11

 
9

Deferred income tax expense
 
9

 
6

Changes in:
 
 

 
 

Investment income receivable
 
(2
)
 
3

Premiums and reinsurance receivable
 
(82
)
 
(19
)
Deferred policy acquisition costs
 
(19
)
 
(14
)
Other assets
 
(2
)
 
(5
)
Loss and loss expense reserves
 
10

 
8

Life policy reserves
 
13

 
15

Unearned premiums
 
83

 
47

Other liabilities
 
(88
)
 
(10
)
Current income tax receivable/payable
 
(3
)
 
20

Net cash provided by operating activities
 
57

 
148

CASH FLOWS FROM INVESTING ACTIVITIES
 
 

 
 

Sale of fixed maturities
 
12

 
6

Call or maturity of fixed maturities
 
221

 
195

Sale of equity securities
 
98

 
99

Purchase of fixed maturities
 
(325
)
 
(304
)
Purchase of equity securities
 
(108
)
 
(96
)
Investment in buildings and equipment, net
 
(1
)
 
(2
)
Investment in finance receivables
 
(8
)
 
(9
)
Collection of finance receivables
 
7

 
9

Change in other invested assets, net
 
2

 
2

Net cash used in investing activities
 
(102
)
 
(100
)
CASH FLOWS FROM FINANCING ACTIVITIES
 
 

 
 

Payment of cash dividends to shareholders
 
(65
)
 
(64
)
Purchase of treasury shares
 
—

 
—

Increase in notes payable
 
—

 
—

Proceeds from stock options exercised
 
6

 
1

Contract holders' funds deposited
 
24

 
31

Contract holders' funds withdrawn
 
(31
)
 
(28
)
Excess tax benefits on stock-based compensation
 
8

 
1

Other
 
(4
)
 
(3
)
Net cash used in financing activities
 
(62
)
 
(62
)
Net change in cash and cash equivalents
 
(107
)
 
(14
)
Cash and cash equivalents at beginning of year
 
487

 
438

Cash and cash equivalents at end of period
 
$
380

 
$
424

Supplemental disclosures of cash flow information:
 
 

 
 

Interest paid
 
$
—

 
$
—

Income taxes paid
 
54

 
—

Non-cash activities:
 
 

 
 

Conversion of securities
 
$
43

 
$
3

Equipment acquired under capital lease obligations
 
12

 
6

Cashless exercise of stock options
 
9

 
—

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

Cincinnati Financial Corporation First-Quarter 2013 10-Q
Page 7


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. Our December 31, 2012, condensed consolidated balance sheet amounts are derived from the audited financial statements but do not include all disclosures required by GAAP.
 
Our March 31, 2013, 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 2012 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 2013-02, Reporting of Amounts Reclassified Out of Accumulated Other Comprehensive Income
 
In February 2013, the Financial Accounting Standards Board issued Accounting Standards Update (ASU) 2013-02, Reporting of Amounts Reclassified Out of Accumulated Other Comprehensive Income. ASU 2013-02 requires entities to present in either a single note or parenthetically on the face of the financial statements, the effect of significant amounts reclassified from each component of accumulated other comprehensive income based on its source and the income statement line items affected by the reclassification. The company adopted this ASU during the first quarter of 2013, and it did not have a material impact on our company’s financial position, cash flows or results of operations. See Note 7, Accumulated Other Comprehensive Income, for further details.
   

 

Cincinnati Financial Corporation First-Quarter 2013 10-Q
Page 8


NOTE 2 – INVESTMENTS
 
The following table provides cost or amortized cost, gross unrealized gains, gross unrealized losses and fair value for our invested assets:
(In millions)
 
Cost or
 
 
 
 
 
 
 
 
amortized
 
Gross unrealized
 
Fair
At March 31, 2013
 
cost
 
gains
 
losses
 
value
Fixed maturities:
 
 

 
 

 
 

 
 

States, municipalities and political subdivisions
 
$
3,006

 
$
233

 
$
1

 
$
3,238

Convertibles and bonds with warrants attached
 
27

 
—

 
—

 
27

United States government
 
7

 
1

 
—

 
8

Government-sponsored enterprises
 
168

 
—

 
1

 
167

Foreign government
 
13

 
—

 
—

 
13

Commercial mortgage-backed securities
 
38

 
1

 
—

 
39

Corporate securities
 
5,064

 
615

 
2

 
5,677

Subtotal
 
8,323

 
850

 
4

 
9,169

Equity securities:
 
 

 
 

 
 

 
 

Common equities
 
2,331

 
1,346

 
2

 
3,675

Preferred equities
 
85

 
41

 
—

 
126

Subtotal
 
2,416

 
1,387

 
2

 
3,801

Total
 
$
10,739

 
$
2,237

 
$
6

 
$
12,970

At December 31, 2012
 
 

 
 

 
 

 
 

Fixed maturities:
 
 

 
 

 
 

 
 

States, municipalities and political subdivisions
 
$
3,040

 
$
250

 
$
1

 
$
3,289

Convertibles and bonds with warrants attached
 
31

 
—

 
—

 
31

United States government
 
7

 
1

 
—

 
8

Government-sponsored enterprises
 
164

 
—

 
—

 
164

Foreign government
 
3

 
—

 
—

 
3

Commercial mortgage-backed securities
 
27

 
1

 
—

 
28

Corporate securities
 
4,950

 
622

 
2

 
5,570

Subtotal
 
8,222

 
874

 
3

 
9,093

Equity securities:
 
 

 
 

 
 

 
 

Common equities
 
2,270

 
977

 
9

 
3,238

Preferred equities
 
99

 
37

 
1

 
135

Subtotal
 
2,369

 
1,014

 
10

 
3,373

Total
 
$
10,591

 
$
1,888

 
$
13

 
$
12,466

 
The net unrealized investment gains in our fixed-maturity portfolio are primarily the result of the current low interest rate environment that increased the fair value of our fixed-maturity portfolio. The three largest net unrealized investment gains in our common stock portfolio are from Exxon Mobil Corporation (NYSE:XOM), Chevron Corporation (NYSE:CVX) and The Procter & Gamble Company (NYSE:PG), which had a combined net gain position of $283 million. At March 31, 2013, we had $27 million fair value of hybrid securities included in fixed maturities that follow Accounting Standards Codification (ASC) 815-15-25, Accounting for Certain Hybrid Financial Instruments, compared with $31 million fair value of hybrid securities at December 31, 2012. 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 First-Quarter 2013 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 March 31, 2013
 
value
 
losses
 
value
 
losses
 
value
 
losses
Fixed maturities:
 
 

 
 

 
 

 
 

 
 

 
 

States, municipalities and political subdivisions
 
$
103

 
$
1

 
$
—

 
$
—

 
$
103

 
$
1

Government-sponsored enterprises
 
107

 
1

 
—

 
—

 
107

 
1

Commercial mortgage-backed securities
 
16

 
—

 
—

 
—

 
16

 
—

Corporate securities
 
118

 
1

 
13

 
1

 
131

 
2

Subtotal
 
344

 
3

 
13

 
1

 
357

 
4

Equity securities:
 
 

 
 

 
 

 
 

 
 

 
 

Common equities
 
74

 
2

 
—

 
—

 
74

 
2

Preferred equities
 
1

 
—

 
—

 
—

 
1

 
—

Subtotal
 
75

 
2

 
—

 
—

 
75

 
2

Total
 
$
419

 
$
5

 
$
13

 
$
1

 
$
432

 
$
6

At December 31, 2012
 
 

 
 

 
 

 
 

 
 

 
 

Fixed maturities:
 
 

 
 

 
 

 
 

 
 

 
 

States, municipalities and political subdivisions
 
$
53

 
$
1

 
$
—

 
$
—

 
$
53

 
$
1

Government-sponsored enterprises
 
1

 
—

 
—

 
—

 
1

 
—

Corporate securities
 
58

 
1

 
17

 
1

 
75

 
2

Subtotal
 
112

 
2

 
17

 
1

 
129

 
3

Equity securities:
 
 

 
 

 
 

 
 

 
 

 
 

Common equities
 
107

 
9

 
—

 
—

 
107

 
9

Preferred equities
 
4

 
1

 
—

 
—

 
4

 
1

Subtotal
 
111

 
10

 
—

 
—

 
111

 
10

Total
 
$
223

 
$
12

 
$
17

 
$
1

 
$
240

 
$
13

 

Cincinnati Financial Corporation First-Quarter 2013 10-Q
Page 10


The following table provides realized investment gains and losses and the change in unrealized investment gains and losses and other items:
(In millions)
 
Three months ended March 31,
 
 
2013
 
2012
Investment income summary:
 
 
 
 
Interest on fixed maturities
 
$
102

 
$
106

Dividends on equity securities
 
27

 
26

Other investment income
 
1

 
1

Total
 
130

 
133

Less investment expenses
 
2

 
2

Total
 
$
128

 
$
131

 
 
 
 
 
Realized investment gains and losses summary:
 
 

 
 

Fixed maturities:
 
 

 
 

Gross realized gains
 
$
2

 
$
3

Gross realized losses
 
—

 
—

Other-than-temporary impairments
 
(2
)
 
—

Equity securities:
 
 

 
 

Gross realized gains
 
37

 
23

Gross realized losses
 
—

 
—

Other-than-temporary impairments
 
—

 
(16
)
Securities with embedded derivatives
 
1

 
4

Other
 
3

 
(1
)
Total
 
$
41

 
$
13

 
 
 
 
 
Change in unrealized gains and losses summary:
 
 

 
 

Fixed maturities
 
$
(25
)
 
$
49

Equity securities
 
381

 
179

Adjustment to deferred acquisition costs and life policy reserves
 
3

 
(7
)
Amortization of pension actuarial loss and prior service cost
 
2

 
2

Other
 
(3
)
 
2

Income taxes on above
 
(125
)
 
(79
)
Total
 
$
233

 
$
146

 
During the three months ended March 31, 2013 and 2012, there were no credit losses on fixed-maturity securities for which a portion of other-than-temporary impairment (OTTI) has been recognized in other comprehensive income.
 
During the three months ended March 31, 2013, we other-than-temporarily impaired five securities. At March 31, 2013, four fixed-maturity investments with a total unrealized loss of $1 million had been in an unrealized loss position for 12 months or more. Of that total, no fixed-maturity investments had fair values below 70 percent of amortized cost. There were no equity investments in an unrealized loss position for 12 months or more as of March 31, 2013.
 
At December 31, 2012, four fixed-maturity investments with a total unrealized loss of $1 million had been in an unrealized loss position for 12 months or more. Of that total, no fixed-maturity investments had fair values below 70 percent of amortized cost. There were no equity investments in an unrealized loss position for 12 months or more as of December 31, 2012.
 


Cincinnati Financial Corporation First-Quarter 2013 10-Q
Page 11


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, 2012, and ultimately management determines fair value. See our 2012 Annual Report on Form 10-K, Item 8, Note 3, Fair Value Measurements, Page 121, for information on characteristics and valuation techniques used in determining fair value.


Cincinnati Financial Corporation First-Quarter 2013 10-Q
Page 12


Fair Value Disclosures for Assets
The following tables illustrate the fair value hierarchy for those assets measured at fair value on a recurring basis at March 31, 2013, and December 31, 2012. We do not have any material liabilities carried at fair value. There were no transfers between Level 1 and Level 2 during the three month and twelve month periods ending March 31, 2013 and December 31, 2012, respectively.
(In millions)
 
Quoted prices in
active markets for
identical assets
(Level 1)
 
Significant other
observable inputs 
(Level 2)
 
Significant
unobservable
inputs
(Level 3)
 
Total
At March 31, 2013
 
 
 
 
Fixed maturities, available for sale:
 
 

 
 

 
 

 
 

States, municipalities and political subdivisions
 
$
—

 
$
3,237

 
$
1

 
$
3,238

Convertibles and bonds with warrants attached
 
—

 
27

 
—

 
27

United States government
 
8

 
—

 
—

 
8

Government-sponsored enterprises
 
—

 
167

 
—

 
167

Foreign government
 
—

 
13

 
—

 
13

Commercial mortgage-backed securities
 
—

 
39

 
—

 
39

Corporate securities
 
—

 
5,674

 
3

 
5,677

Subtotal
 
8

 
9,157

 
4

 
9,169

Common equities, available for sale
 
3,675

 
—

 
—

 
3,675

Preferred equities, available for sale
 
—

 
124

 
2

 
126

Taxable fixed maturities separate accounts
 
—

 
705

 
—

 
705

Top Hat Savings Plan
 
11

 
—

 
—

 
11

Total
 
$
3,694

 
$
9,986

 
$
6

 
$
13,686

At December 31, 2012
 
 
 
 
 
 
 
 
Fixed maturities, available for sale:
 
 

 
 

 
 

 
 

States, municipalities and political subdivisions
 
$
—

 
$
3,288

 
$
1

 
$
3,289

Convertibles and bonds with warrants attached
 
—

 
31

 
—

 
31

United States government
 
8

 
—

 
—

 
8

Government-sponsored enterprises
 
—

 
164

 
—

 
164

Foreign government
 
—

 
3

 
—

 
3

Commercial mortgage-backed securities
 
—

 
28

 
—

 
28

Corporate securities
 
—

 
5,567

 
3

 
5,570

Subtotal
 
8

 
9,081

 
4

 
9,093

Common equities, available for sale
 
3,238

 
—

 
—

 
3,238

Preferred equities, available for sale
 
—

 
134

 
1

 
135

Taxable fixed-maturities separate accounts
 
—

 
689

 
—

 
689

Top Hat Savings Plan
 
9

 
—

 
—

 
9

Total
 
$
3,255

 
$
9,904

 
$
5

 
$
13,164

 
Each financial instrument that was deemed to have significant unobservable inputs when determining valuation is identified in the following tables by security type with a summary of changes in fair value as of March 31, 2013. Total Level 3 assets continue to be less than 1 percent of financial assets measured at fair value in the condensed consolidated balance sheets. Assets presented in the table below were valued based primarily on broker/dealer quotes for which there is a lack of transparency as to inputs used to develop the valuations. The quantitative detail of these unobservable inputs is neither provided nor reasonably available to us.


Cincinnati Financial Corporation First-Quarter 2013 10-Q
Page 13


The following tables provide the change in Level 3 assets for the three months ended March 31:
 
(In millions)
 
Corporate fixed
maturities
 
States,
municipalities
and political
subdivisions
fixed maturities
 
Preferred  equities
 
Total
Beginning balance, December 31, 2012
 
$
3

 
$
1

 
$
1

 
$
5

Total gains or losses (realized/unrealized):
 
 

 
 

 
 

 
 

Included in earnings
 
—

 
—

 
—

 
—

Included in other comprehensive income
 
—

 
—

 
—

 
—

Purchases
 
—

 
—

 
1

 
1

Sales
 
—

 
—

 
—

 
—

Transfers into Level 3
 
—

 
—

 
—

 
—

Transfers out of Level 3
 
—

 
—

 
—

 
—

Ending balance, March 31, 2013
 
$
3

 
$
1

 
$
2

 
$
6

 
 
 
 
 
 
 
 
 
Beginning balance, December 31, 2011
 
$
18

 
$
3

 
$
4

 
$
25

Total gains or losses (realized/unrealized):
 
 

 
 

 
 

 
 

Included in earnings
 
—

 
—

 
—

 
—

Included in other comprehensive income
 
3

 
—

 
2

 
5

Purchases
 
—

 
—

 
1

 
1

Sales
 
(3
)
 
(1
)
 
—

 
(4
)
Transfers into Level 3
 
1

 
—

 
—

 
1

Transfers out of Level 3
 
(3
)
 
—

 
—

 
(3
)
Ending balance, March 31, 2012
 
$
16

 
$
2

 
$
7

 
$
25

 

With the exception of the Level 3 reconciliation table, additional disclosure for the Level 3 category is not material.

Fair Value Disclosure for Assets and Liabilities Not Carried at Fair Value
 
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 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
 
 
 
2013
 
2012
 
2013
 
2012
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

 

Cincinnati Financial Corporation First-Quarter 2013 10-Q
Page 14


The following table shows fair values of our note payable and long-term debt subject to fair value disclosure requirements:
 
(In millions)
 
Quoted prices in
active markets for
identical assets
(Level 1)
 
Significant other
observable inputs 
(Level 2)
 
Significant
unobservable
inputs
(Level 3)
 
Total
At March 31, 2013
 
 
 
 
Note payable
 
$
—

 
$
104

 
$
—

 
$
104

6.900% senior debentures, due 2028
 
—

 
32

 
—

 
32

6.920% senior debentures, due 2028
 
—

 
504

 
—

 
504

6.125% senior notes, due 2034
 
—

 
428

 
—

 
428

Total
 
$
—

 
$
1,068

 
$
—

 
$
1,068

 
 
 
 
 
 
 
 
 
At December 31, 2012
 
 
 
 
 
 
 
 
Note payable
 
$
—

 
$
104

 
$
—

 
$
104

6.900% senior debentures, due 2028
 
—

 
31

 
—

 
31

6.920% senior debentures, due 2028
 
—

 
479

 
—

 
479

6.125% senior notes, due 2034
 
—

 
431

 
—

 
431

Total
 
$
—

 
$
1,045

 
$
—

 
$
1,045

 
 
The following table shows the fair value of our life policy loans, included in other invested assets, subject to fair value disclosure requirements:
 
(In millions)
 
Quoted prices in
active markets for
identical assets
(Level 1)
 
Significant other
observable inputs 
(Level 2)
 
Significant
unobservable
inputs
(Level 3)
 
Total
At March 31, 2013
 
 
 
 
Life policy loans
 
$
—

 
$
—

 
$
48

 
$
48

 
 
 
 
 
 
 
 
 
At December 31, 2012
 
 
 
 
 
 
 
 
Life policy loans
 
$
—

 
$
—

 
$
50

 
$
50

 
Outstanding principal and interest for these life policy loans was $36 million and $37 million at March 31, 2013, and December 31, 2012, respectively.
 
The following table shows fair values of our deferred annuities and structured settlements, included in life policy and investment contract reserves, subject to fair value disclosure requirements:
 
(In millions)
 
Quoted prices in
active markets for
identical assets
(Level 1)
 
Significant other
observable inputs 
(Level 2)
 
Significant
unobservable
inputs
(Level 3)
 
Total
At March 31, 2013
 
 
 
 
Deferred annuities
 
$
—

 
$
—

 
$
898

 
$
898

Structured settlements
 
—

 
235

 
—

 
235

Total
 
$
—

 
$
235

 
$
898

 
$
1,133

 
 
 
 
 
 
 
 
 
At December 31, 2012
 
 
 
 
 
 
 
 
Deferred annuities
 
$
—

 
$
—

 
$
898

 
$
898

Structured settlements
 
—

 
240

 
—

 
240

Total
 
$
—

 
$
240

 
$
898

 
$
1,138


Recorded reserves for the deferred annuities and structured settlements were $1.046 billion and $1.043 billion at March 31, 2013, and December 31, 2012, respectively.


Cincinnati Financial Corporation First-Quarter 2013 10-Q
Page 15



NOTE 4 – 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,
 
 
2013
 
2012
Gross loss and loss expense reserves, beginning of period
 
$
4,169

 
$
4,280

Less reinsurance receivable
 
356

 
375

Net loss and loss expense reserves, beginning of period
 
3,813

 
3,905

Net incurred loss and loss expenses related to:
 
 

 
 

Current accident year
 
534

 
655

Prior accident years
 
(10
)
 
(116
)
Total incurred
 
524

 
539

Net paid loss and loss expenses related to:
 
 

 
 

Current accident year
 
121

 
132

Prior accident years
 
392

 
375

Total paid
 
513

 
507

Net loss and loss expense reserves, end of period
 
3,824

 
3,937

Plus reinsurance receivable
 
349

 
352

Gross loss and loss expense reserves, end of period
 
$
4,173

 
$
4,289

 
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 that 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. The amount we will actually have to pay for claims can be highly uncertain. This uncertainty, together with the size of our reserves, makes the loss and loss expense reserves our most significant estimate. The reserve for loss and loss expenses in the condensed consolidated balance sheets also included $67 million at March 31, 2013, and $58 million at March 31, 2012, for certain life and health loss and loss expense reserves.

For the three months ended March 31, 2013, we experienced $10 million of favorable development on prior accident years, including $12 million favorable development in commercial lines, $4 million adverse development in personal lines and
$2 million favorable development in excess and surplus lines. There was $7 million from favorable development of catastrophe losses for the three months ended March 31, 2013, compared with $22 million of favorable development of catastrophe losses that occurred for the three months ended March 31, 2012.




Cincinnati Financial Corporation First-Quarter 2013 10-Q
Page 16


NOTE 5 – LIFE POLICY AND INVESTMENT CONTRACT RESERVES
 
We establish the reserves for traditional life insurance policies based on expected expenses, mortality, morbidity, withdrawal rates, timing of claim presentation 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.
 
We establish reserves for the company’s universal life, deferred annuity and structured settlement policies 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.

This table summarizes our life policy and investment contract reserves:
 
(In millions)
 
March 31,
2013
 
December 31, 2012
Ordinary/traditional life
 
$
760

 
$
752

Universal life
 
487

 
483

Deferred annuities
 
852

 
850

Structured settlements
 
194

 
193

Other
 
17

 
17

Total life policy and investment contract reserves
 
$
2,310

 
$
2,295


 
NOTE 6 – DEFERRED ACQUISITION COSTS
 
Expenses directly related to successfully acquiring 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 the costs for recoverability. The table below shows the deferred policy acquisition costs and asset reconciliation.
 
(In millions)
 
Three months ended March 31,

 
2013
 
2012
Deferred policy acquisition costs asset at beginning of period
 
$
470

 
$
477

Capitalized deferred policy acquisition costs
 
198

 
170

Amortized deferred policy acquisition costs
 
(179
)
 
(156
)
Amortized shadow deferred policy acquisition costs
 
2

 
(8
)
Deferred policy acquisition costs asset at end of period
 
$
491

 
$
483


No premium deficiencies were recorded in the condensed consolidated statements of income, as the sum of the anticipated loss and loss adjustment expenses, policyholder dividends and unamortized deferred acquisition expenses did not exceed the related unearned premiums and anticipated investment income.
 

Cincinnati Financial Corporation First-Quarter 2013 10-Q
Page 17


NOTE 7 – ACCUMULATED OTHER COMPREHENSIVE INCOME
 
Accumulated other comprehensive income includes changes in unrealized gains and losses on available for sale investments and other invested assets, changes in pension obligations and changes in life deferred acquisition costs, life policy reserves and other as follows:    

(In millions)
 
Three months ended March 31,
 
 
2013
 
 
2012
 
 
Before tax
 
Income tax
 
Net
 
 
Before tax
 
Income tax
 
Net
Accumulated unrealized gains, net, on investments available for sale, beginning of period
 
$
1,875

 
$
647

 
$
1,228

 
 
$
1,489

 
$
512

 
$
977

 
 
 
 
 
 
 
 
 
 
 
 
 
 
Other comprehensive income before reclassification
 
397

 
139

 
258

 
 
241

 
84

 
157

Reclassification adjustment for realized gains, net, included in net income
 
(41
)
 
(15
)
 
(26
)
 
 
(13
)
 
(4
)
 
(9
)
Effect on other comprehensive income
 
356

 
124

 
232

 
 
228

 
80

 
148

Accumulated unrealized gains, net, on investments available for sale, end of period
 
$
2,231

 
$
771

 
$
1,460

 
 
$
1,717

 
$
592

 
$
1,125

 
 
 
 
 
 
 
 
 
 
 
 
 
 
Accumulated unrealized losses, net, for pension obligations, beginning of period
 
$
(101
)
 
$
(35
)
 
$
(66
)
 
 
$
(88
)
 
$
(31
)
 
$
(57
)
Other comprehensive income before reclassification
 
—

 
—

 
—

 
 
—

 
—

 
—

Reclassification adjustment for amortization of actuarial loss and prior service cost, net, included in net income
 
2

 
1

 
1

 
 
2

 
1

 
1

Effect on other comprehensive income
 
2

 
1