CINF-2015.3.31-10Q


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, 2015.
 
¨       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 24, 2015, there were 164,358,202 shares of common stock outstanding.




CINCINNATI FINANCIAL CORPORATION
FORM 10-Q FOR THE QUARTER ENDED MARCH 31, 2015
 
TABLE OF CONTENTS
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Financial Results
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 



Cincinnati Financial Corporation First-Quarter 2015 10-Q
Page 2


Part I – Financial Information
Item 1.    Financial Statements (unaudited)
 
Cincinnati Financial Corporation and Subsidiaries
Condensed Consolidated Balance Sheets
(Dollars in millions except per share data)
 
March 31,
 
December 31,
 
 
2015
 
2014
Assets
 
 

 
 

Investments
 
 

 
 

Fixed maturities, at fair value (amortized cost: 2015—$8,961; 2014—$8,871)
 
$
9,596

 
$
9,460

Equity securities, at fair value (cost: 2015—$2,748; 2014—$2,728)
 
4,789

 
4,858

Short-term investments, at fair value (amortized cost: 2015—$25; 2014—$0)
 
25

 
—

Other invested assets
 
66

 
68

Total investments
 
14,476

 
14,386

Cash and cash equivalents
 
640

 
591

Investment income receivable
 
123

 
123

Finance receivable
 
70

 
75

Premiums receivable
 
1,433

 
1,405

Reinsurance recoverable
 
539

 
545

Prepaid reinsurance premiums
 
29

 
29

Deferred policy acquisition costs
 
571

 
578

Land, building and equipment, net, for company use (accumulated depreciation: 2015—$452; 2014—$446)
 
189

 
194

Other assets
 
63

 
75

Separate accounts
 
764

 
752

Total assets
 
$
18,897

 
$
18,753

 
 
 
 
 
Liabilities
 
 

 
 

Insurance reserves
 
 

 
 

Loss and loss expense reserves
 
$
4,623

 
$
4,485

Life policy and investment contract reserves
 
2,514

 
2,497

Unearned premiums
 
2,109

 
2,082

Other liabilities
 
581

 
648

Deferred income tax
 
824

 
840

Note payable
 
49

 
49

Long-term debt and capital lease obligations
 
825

 
827

Separate accounts
 
764

 
752

Total liabilities
 
12,289

 
12,180

 
 
 
 
 
Commitments and contingent liabilities (Note 12)
 
—

 
—

 
 
 
 
 
Shareholders' Equity
 
 

 
 

Common stock, par value—$2 per share; (authorized: 2014 and 2013—500 million shares; issued: 2015 and 2014—198.3 million shares)
 
397

 
397

Paid-in capital
 
1,210

 
1,214

Retained earnings
 
4,557

 
4,505

Accumulated other comprehensive income
 
1,716

 
1,744

Treasury stock at cost (2015— 34.0 million shares and 2014—34.6 million shares)
 
(1,272
)
 
(1,287
)
Total shareholders' equity
 
6,608

 
6,573

Total liabilities and shareholders' equity
 
$
18,897

 
$
18,753

 
 
 
 
 
 Accompanying Notes are an integral part of these Condensed Consolidated Financial Statements.


Cincinnati Financial Corporation First-Quarter 2015 10-Q
Page 3


Cincinnati Financial Corporation and Subsidiaries
Condensed Consolidated Statements of Income
(Dollars in millions except per share data)
Three months ended March 31,
 
2015
 
2014
Revenues
 

 
 

Earned premiums
$
1,094

 
$
1,027

Investment income, net of expenses
139

 
135

Realized investment gains, net
47

 
22

Fee revenues
3

 
3

Other revenues
2

 
2

Total revenues
1,285

 
1,189

Benefits and Expenses
 

 
 

Insurance losses and policyholder benefits
749

 
732

Underwriting, acquisition and insurance expenses
345

 
320

Interest expense
13

 
14

Other operating expenses
4

 
4

 Total benefits and expenses
1,111

 
1,070

Income Before Income Taxes
174

 
119

Provision for Income Taxes
 

 
 

Current
46

 
20

Deferred
—

 
8

Total provision for income taxes
46

 
28

Net Income
$
128

 
$
91

Per Common Share
 

 
 

Net income—basic
$
0.78

 
$
0.56

Net income—diluted
0.77

 
0.55

 
 
 
 
Accompanying Notes are an integral part of these Condensed Consolidated Financial Statements.

Cincinnati Financial Corporation First-Quarter 2015 10-Q
Page 4


Cincinnati Financial Corporation and Subsidiaries
Condensed Consolidated Statements of Comprehensive Income
(Dollars in millions)
Three months ended March 31,
 
2015
 
2014
Net Income
$
128

 
$
91

Other Comprehensive (Loss) Income
 

 
 

Change in unrealized gains on investments, net of tax of $(15) and $41, respectively
(28
)
 
76

Amortization of pension actuarial loss and prior service cost, net of tax of $0 and $0, respectively
1

 
(1
)
Change in life deferred acquisition costs, life policy reserves and other, net of tax of $0 and $0, respectively
(1
)
 
(1
)
Other comprehensive (loss) income, net of tax
(28
)
 
74

Comprehensive Income
$
100

 
$
165

 
 
 
 

Cincinnati Financial Corporation and Subsidiaries
Condensed Consolidated Statements of Shareholders’ Equity
(In millions)
 
Common Stock
 
 
 
 
 
Accumulated
Other
Comprehensive
Income
 
 
 
Total
Share-
holders'
 Equity
 
 
Outstanding Shares
 
Amount
 
Paid-in Capital
 
Retained Earnings
 
 
Treasury Stock
 
Balance December 31, 2013
 
163.1

 
$
397

 
$
1,191

 
$
4,268

 
$
1,504

 
$
(1,290
)
 
$
6,070

Net income
 
—

 
—

 
—

 
91

 
—

 
—

 
91

Other comprehensive income, net
 
—

 
—

 
—

 
—

 
74

 
—

 
74

Dividends declared
 
—

 
—

 
—

 
(72
)
 
—

 
—

 
(72
)
Treasury stock acquired—share repurchase authorization
 
(0.1
)
 
—

 
—

 
—

 
—

 
(7
)
 
(7
)
Other
 
0.5

 
—

 
—

 
—

 
—

 
12

 
12

Balance March 31, 2014
 
163.5

 
$
397

 
$
1,191

 
$
4,287

 
$
1,578

 
$
(1,285
)
 
$
6,168

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Balance December 31, 2014
 
163.7

 
$
397

 
$
1,214

 
$
4,505

 
$
1,744

 
$
(1,287
)
 
$
6,573

Net income
 


 
—

 
—

 
128

 
—

 
—

 
128

Other comprehensive loss, net
 
—

 
—

 
—

 
—

 
(28
)
 
—

 
(28
)
Dividends declared
 
—

 
—

 
—

 
(76
)
 
—

 
—

 
(76
)
Treasury stock acquired—share repurchase authorization
 
—

 
—

 
—

 
—

 
—

 
—

 
—

Other
 
0.6

 
—

 
(4
)
 
—

 
—

 
15

 
11

Balance March 31, 2015
 
164.3

 
$
397

 
$
1,210

 
$
4,557

 
$
1,716

 
$
(1,272
)
 
$
6,608

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 Accompanying Notes are an integral part of these Condensed Consolidated Financial Statements.
 


Cincinnati Financial Corporation First-Quarter 2015 10-Q
Page 5


Cincinnati Financial Corporation and Subsidiaries
Condensed Consolidated Statements of Cash Flows
 (Dollars in millions)
 
Three months ended March 31,
 
 
2015
 
2014
Cash Flows From Operating Activities
 
 

 
 

Net income
 
$
128

 
$
91

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

 
 

Depreciation and amortization
 
14

 
13

Realized investment gains, net
 
(47
)
 
(22
)
Stock-based compensation
 
7

 
6

Interest credited to contract holders
 
12

 
10

Deferred income tax expense
 
—

 
8

Changes in:
 
 

 
 

Investment income receivable
 
—

 
5

Premiums and reinsurance receivable
 
(22
)
 
(50
)
Deferred policy acquisition costs
 
2

 
(5
)
Other assets
 
4

 
(5
)
Loss and loss expense reserves
 
138

 
64

Life policy reserves
 
20

 
49

Unearned premiums
 
27

 
59

Other liabilities
 
(100
)
 
(102
)
Current income tax receivable/payable
 
32

 
8

Net cash provided by operating activities
 
215

 
129

Cash Flows From Investing Activities
 
 

 
 

Sale of fixed maturities
 
13

 
24

Call or maturity of fixed maturities
 
267

 
252

Sale of equity securities
 
67

 
31

Purchase of fixed maturities
 
(348
)
 
(236
)
Purchase of equity securities
 
(67
)
 
(33
)
Purchase of short-term investments
 
(25
)
 
—

Investment in finance receivables
 
(3
)
 
(4
)
Collection of finance receivables
 
8

 
7

Investment in buildings and equipment, net
 
(1
)
 
(3
)
Change in other invested assets, net
 
1

 
1

Net cash (used in) provided by investing activities
 
(88
)
 
39

Cash Flows From Financing Activities
 
 

 
 

Payment of cash dividends to shareholders
 
(71
)
 
(67
)
Purchase of treasury shares
 
—

 
(7
)
Proceeds from stock options exercised
 
7

 
8

Contract holders' funds deposited
 
20

 
20

Contract holders' funds withdrawn
 
(33
)
 
(32
)
Excess tax benefits on stock-based compensation
 
3

 
—

Other
 
(4
)
 
(2
)
Net cash used in financing activities
 
(78
)
 
(80
)
Net change in cash and cash equivalents
 
49

 
88

Cash and cash equivalents at beginning of year
 
591

 
433

Cash and cash equivalents at end of period
 
$
640

 
$
521

Supplemental Disclosures of Cash Flow Information:
 
 

 
 

Income taxes paid
 
$
11

 
$
11

Noncash Activities:
 
 

 
 

Equipment acquired under capital lease obligations
 
$
3

 
$
5

Cashless exercise of stock options
 
5

 
4

 
 
 
 
 
 Accompanying Notes are an integral part of these Condensed Consolidated Financial Statements.

Cincinnati Financial Corporation First-Quarter 2015 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. Our December 31, 2014, condensed consolidated balance sheet amounts are derived from the audited financial statements but do not include all disclosures required by GAAP.
 
Our March 31, 2015, 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 2014 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.

Pending Accounting Updates

ASU 2014-09 Revenue from Contracts with Customers
In May 2014, the Financial Accounting Standards Board (FASB) issued Accounting Standards Update (ASU) 2014-09, Revenue from Contracts with Customers. ASU 2014-09 requires an entity to recognize revenue to depict the transfer of promised goods or services to customers in an amount that reflects the consideration to which the entity expects to be entitled in exchange for those goods and services. Insurance contracts do not fall within the scope of this ASU. The effective date of ASU 2014-09 is for annual reporting periods beginning after December 15, 2017. 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 2014-12, Compensation-Stock Compensation: Accounting for Share-Based Payments When the Terms of an Award Provide That a Performance Target Could Be Achieved after the Requisite Service Period
In June 2014, the FASB issued ASU 2014-12, Compensation-Stock Compensation: Accounting for Share-Based Payments When the Terms of an Award Provide That a Performance Target Could Be Achieved after the Requisite Service Period. ASU 2014-12 requires that performance targets that affect vesting and that could be achieved after the requisite service period be treated as performance conditions. The effective date of ASU 2014-12 is for interim and annual reporting periods beginning after December 15, 2015. 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 2015-02, Consolidation-Amendments to the Consolidation Analysis
In February 2015, the FASB Issued ASU 2015-02, Consolidation-Amendments to the Consolidation Analysis. ASU 2015-02 makes amendments to the current consolidation guidance, focusing mainly on the investment management industry; however, entities across all industries may be impacted. The effective date of ASU 2015-02 is for interim and annual reporting periods beginning after December 15, 2015. 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 2015-03, Interest-Imputation of Interest
In April 2015, the FASB Issued ASU 2015-03, Interest-Imputation of Interest. ASU 2015-03 reduces the complexity of disclosing debt issuance costs and debt discount and premium on the balance sheet by requiring that debt issuance costs related to a recognized debt liability be presented in the balance sheet as a direct deduction from the carrying amount of that debt liability, consistent with debt discounts. The effective date of ASU 2015-03 is for interim and annual reporting periods beginning after December 15, 2015. 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.


Cincinnati Financial Corporation First-Quarter 2015 10-Q
Page 7


NOTE 2 – Investments
The following table provides cost or amortized cost, gross unrealized gains, gross unrealized losses and fair value for our investment portfolio:
(Dollars in millions)
 
Cost or amortized cost
 
 
 
 
 
 
 
 
 
Gross unrealized
 
Fair value
At March 31, 2015
 
 
gains
 
losses
 
Fixed maturity securities:
 
 

 
 

 
 

 
 

Corporate
 
$
5,152

 
$
449

 
$
8

 
$
5,593

States, municipalities and political subdivisions
 
3,289

 
183

 
2

 
3,470

Commercial mortgage-backed
 
269

 
16

 
—

 
285

Government-sponsored enterprises
 
227

 
—

 
3

 
224

Foreign government
 
10

 
—

 
—

 
10

Convertibles and bonds with warrants attached
 
7

 
—

 
—

 
7

United States government
 
7

 
—

 
—

 
7

Subtotal
 
8,961

 
648

 
13

 
9,596

Equity securities:
 
 

 
 

 
 

 
 

Common equities
 
2,595

 
2,014

 
11

 
4,598

Nonredeemable preferred equities
 
153

 
38

 
—

 
191

Subtotal
 
2,748

 
2,052

 
11

 
4,789

Total
 
$
11,709

 
$
2,700

 
$
24

 
$
14,385

At December 31, 2014
 
 

 
 

 
 

 
 

Fixed maturity securities:
 
 

 
 

 
 

 
 

Corporate
 
$
5,117

 
$
420

 
$
11

 
$
5,526

States, municipalities and political subdivisions
 
3,267

 
178

 
2

 
3,443

Commercial mortgage-backed
 
250

 
9

 
—

 
259

Government-sponsored enterprises
 
213

 
—

 
5

 
208

Foreign government
 
10

 
—

 
—

 
10

Convertibles and bonds with warrants attached
 
7

 
—

 
—

 
7

United States government
 
7

 
—

 
—

 
7

Subtotal
 
8,871

 
607

 
18

 
9,460

Equity securities:
 
 

 
 

 
 

 
 

Common equities
 
2,583

 
2,099

 
3

 
4,679

Nonredeemable preferred equities
 
145

 
35

 
1

 
179

Subtotal
 
2,728

 
2,134

 
4

 
4,858

Total
 
$
11,599

 
$
2,741

 
$
22

 
$
14,318

 
 
 
 
 
 
 
 
 
 
The net unrealized investment gains in our fixed-maturity portfolio are primarily the result of the continued low interest rate environment that increased the fair value of our fixed-maturity portfolio. At March 31, 2015, we had $25 million of short-term investments, which consisted of commercial paper, that had no gross unrealized gains or losses. At December 31, 2014, we held no short-term investments. The seven largest unrealized investment gains in our common stock portfolio are from Exxon Mobil Corporation (NYSE:XOM), Honeywell International Incorporated (NYSE:HON), BlackRock Inc. (NYSE:BLK), Apple Inc. (Nasdaq:AAPL), The Procter & Gamble Company (NYSE:PG), RPM International (NYSE:RPM), and 3M Company (NYSE:MMM), which had a combined gross unrealized gain of $605 million. At March 31, 2015, Apple Inc. was our largest single common stock holding with a fair value of 3.8 percent of our publicly traded common stock portfolio and 1.2 percent of the total investment portfolio.


Cincinnati Financial Corporation First-Quarter 2015 10-Q
Page 8


The table below provides fair values and gross unrealized losses by investment category and by the duration of the securities’ continuous unrealized loss positions:
(Dollars in millions)
 
Less than 12 months
 
12 months or more
 
Total
 
 
Fair value
 
Unrealized losses
 
Fair value
 
Unrealized losses
 
Fair value
 
Unrealized losses
At March 31, 2015
 
 
 
 
 
 
Fixed maturity securities:
 
 

 
 

 
 

 
 

 
 

 
 

Corporate
 
$
211

 
$
6

 
$
64

 
$
2

 
$
275

 
$
8

States, municipalities and political subdivisions
 
115

 
2

 
58

 
—

 
173

 
2

Commercial mortgage-backed
 
2

 
—

 
2

 
—

 
4

 
—

Government-sponsored enterprises
 
18

 
—

 
156

 
3

 
174

 
3

Subtotal
 
346

 
8

 
280

 
5

 
626

 
13

Equity securities:
 
 

 
 

 
 

 
 

 
 

 
 

Common equities
 
168

 
11

 
—

 
—

 
168

 
11

Nonredeemable preferred equities
 
5

 
—

 
15

 
—

 
20

 
—

Subtotal
 
173

 
11

 
15

 
—

 
188

 
11

Total
 
$
519

 
$
19

 
$
295

 
$
5

 
$
814

 
$
24

At December 31, 2014
 
 

 
 

 
 

 
 

 
 

 
 

Fixed maturity securities:
 
 

 
 

 
 

 
 

 
 

 
 

Corporate
 
$
261

 
$
8

 
$
90

 
$
3

 
$
351

 
$
11

States, municipalities and political subdivisions
 
17

 
—

 
135

 
2

 
152

 
2

Commercial mortgage-backed
 
3

 
—

 
23

 
—

 
26

 
—

Government-sponsored enterprises
 
11

 
—

 
181

 
5

 
192

 
5

Subtotal
 
292

 
8

 
429

 
10

 
721

 
18

Equity securities:
 
 

 
 

 
 

 
 

 
 

 
 

Common equities
 
85

 
3

 
—

 
—

 
85

 
3

Nonredeemable preferred equities
 
16

 
—

 
17

 
1

 
33

 
1

Subtotal
 
101

 
3

 
17

 
1

 
118

 
4

Total
 
$
393

 
$
11

 
$
446

 
$
11

 
$
839

 
$
22

 
 
 
 
 
 
 
 
 
 
 
 
 
 

Cincinnati Financial Corporation First-Quarter 2015 10-Q
Page 9


The following table provides investment income, realized investment gains and losses, the change in unrealized investment gains and losses, and other items:
(Dollars in millions)
Three months ended March 31,
 
2015
 
2014
Investment income:
 
 
 
Interest
$
105

 
$
104

Dividends
36

 
32

Other
—

 
1

Total
141

 
137

Less investment expenses
2

 
2

Total
$
139

 
$
135

 
 
 
 
Realized investment gains and losses summary:
 

 
 

Fixed maturities:
 

 
 

Gross realized gains
$
3

 
$
2

Gross realized losses
—

 
(1
)
Other-than-temporary impairments
—

 
—

Equity securities:
 

 
 

Gross realized gains
44

 
18

Gross realized losses
(1
)
 
—

Other-than-temporary impairments
—

 
(1
)
Other
1

 
4

Total
$
47

 
$
22

 
 
 
 
Change in unrealized investment gains and losses:
 

 
 

Fixed maturities
$
46

 
$
88

Equity securities
(89
)
 
29

Less income taxes
15

 
(41
)
Total
$
(28
)
 
$
76

 
 
 
 
 
During the three months ended March 31, 2015, there were no equity securities and no fixed-maturity securities other-than-temporarily impaired. 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 for the three months ended March 31, 2015 and 2014. At March 31, 2015, 70 fixed-maturity investments with a total unrealized loss of
$5 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. Two equity investments with a total unrealized loss of less than $1 million had been in an unrealized loss position for 12 months or more as of March 31, 2015. Of that total, no equity investments were trading below 70 percent of cost.
 
During 2014, we other-than-temporarily impaired six fixed-maturity securities. At December 31, 2014, 144 fixed-maturity investments with a total unrealized loss of $10 million had been in an unrealized loss position for 12 months or more. Of that total, no fixed-maturity investments had fair values below 70 percent of amortized cost. There were three equity security investments in an unrealized loss position for 12 months or more with a total unrealized loss of $1 million as of December 31, 2014. Of that total, no equity security investments had fair values below 70 percent of cost.
 


Cincinnati Financial Corporation First-Quarter 2015 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, 2014, and ultimately management determines fair value. See our 2014 Annual Report on Form 10-K, Item 8, Note 3, Fair Value Measurements, Page 137, for information on characteristics and valuation techniques used in determining fair value.
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, 2015, and December 31, 2014. We do not have any material liabilities carried at fair value. There were no transfers between Level 1 and Level 2.
(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, 2015
 
 
 
 
Fixed maturities, available for sale:
 
 

 
 

 
 

 
 

Corporate
 
$
—

 
$
5,575

 
$
18

 
$
5,593

States, municipalities and political subdivisions
 
—

 
3,469

 
1

 
3,470

Commercial mortgage-backed
 
—

 
285

 
—

 
285

Government-sponsored enterprises
 
—

 
224

 
—

 
224

Foreign government
 
—

 
10

 
—

 
10

Convertibles and bonds with warrants attached
 
—

 
7

 
—

 
7

United States government
 
7

 
—

 
—

 
7

Subtotal
 
7

 
9,570

 
19

 
9,596

Common equities, available for sale
 
4,598

 
—

 
—

 
4,598

Nonredeemable preferred equities, available for sale
 
—

 
189

 
2

 
191

Short-term investments
 
—

 
25

 
—

 
25

Separate accounts taxable fixed maturities
 
—

 
725

 
—

 
725

Top Hat savings plan mutual funds and common
  equity (included in Other assets)
 
19

 
—

 
—

 
19

Total
 
$
4,624

 
$
10,509

 
$
21

 
$
15,154

At December 31, 2014
 
 
 
 
 
 
 
 
Fixed maturities, available for sale:
 
 

 
 

 
 

 
 

Corporate
 
$
—

 
$
5,508

 
$
18

 
$
5,526

States, municipalities and political subdivisions
 
—

 
3,443

 
—

 
3,443

Commercial mortgage-backed
 
—

 
259

 
—

 
259

Government-sponsored enterprises
 
—

 
208

 
—

 
208

Foreign government
 
—

 
10

 
—

 
10

Convertibles and bonds with warrants attached
 
—

 
7

 
—

 
7

United States government
 
7

 
—

 
—

 
7

Subtotal
 
7

 
9,435

 
18

 
9,460

Common equities, available for sale
 
4,679

 
—

 
—

 
4,679

Nonredeemable preferred equities, available for sale
 
—

 
177

 
2

 
179

Separate accounts taxable fixed-maturities
 
—

 
731

 
—

 
731

Top Hat savings plan mutual funds and common
  equity (included in Other assets)
 
18

 
—

 
—

 
18

Total
 
$
4,704

 
$
10,343

 
$
20

 
$
15,067

 
 
 
 
 
 
 
 
 

Cincinnati Financial Corporation First-Quarter 2015 10-Q
Page 11


 
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, 2015. 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.
 
 
 
 
 
 
 
 
 
 
 
The following tables provide the change in Level 3 assets for the three months ended March 31:
(Dollars in millions)
Asset fair value measurements using significant unobservable inputs (Level 3)
 
 
Corporate
fixed
maturities
 
Commercial
mortgage-
backed fixed maturities
 
States,
municipalities
and political
subdivisions
fixed maturities
 
Nonredeemable preferred
equities
 
Total
Beginning balance, January 1, 2015
 
$
18

 
$
—

 
$
—

 
$
2

 
$
20

Total gains or losses (realized/unrealized):
 
 
 
 
 
 

 
 

 
 

Included in net income
 
—

 
—

 
—

 
—

 
—

Included in other comprehensive income
 
—

 
—

 
—

 
—

 
—

Purchases
 
—

 
—

 
—

 
—

 
—

Sales
 
—

 
—

 
—

 
—

 
—

Transfers into Level 3
 
—

 
—

 
1

 
—

 
1

Transfers out of Level 3
 
—

 
—

 
—

 
—

 
—

Ending balance, March 31, 2015
 
$
18

 
$
—

 
$
1

 
$
2

 
$
21

 
 
 
 
 
 
 
 
 
 
 
Beginning balance, January 1, 2014
 
$
2

 
$
—

 
$
—

 
$
2

 
$
4

Total gains or losses (realized/unrealized):
 
 
 
 
 
 

 
 

 
 
Included in net income
 
—

 
—

 
—

 
—

 
—

Included in other comprehensive income
 
—

 
—

 
—

 
—

 
—

Purchases
 
—

 
—

 
—

 
—

 
—

Sales
 
—

 
—

 
—

 
—

 
—

Transfers into Level 3
 
6

 
5

 
—

 
—

 
11

Transfers out of Level 3
 
—

 
—

 
—

 
—

 
—

Ending balance, March 31, 2014
 
$
8

 
$
5

 
$
—

 
$
2

 
$
15

 
 
 
 
 
 
 
 
 
 
 

Additional disclosures for the Level 3 category are not material.

Fair Value Disclosures 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:
(Dollars in millions)
 
 
 
Book value
 
Principal amount
 
 
 
 
 
 
March 31,
 
December 31,
 
March 31,
 
December 31,
Interest rate
 
Year of issue
 
 
 
2015
 
2014
 
2015
 
2014
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
 
372

 
372

 
374

 
374

 

 
 
 
Total
 
$
791

 
$
791

 
$
793

 
$
793

 
 
 
 
 
 
 
 
 
 
 
 
 
 

Cincinnati Financial Corporation First-Quarter 2015 10-Q
Page 12


The following table shows fair values of our note payable and long-term debt:
(Dollars 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, 2015
 
 
 
 
Note payable
 
$
—

 
$
49

 
$
—

 
$
49

6.900% senior debentures, due 2028
 
—

 
35

 
—

 
35

6.920% senior debentures, due 2028
 
—

 
508

 
—

 
508

6.125% senior notes, due 2034
 
—

 
459

 
—

 
459

Total
 
$
—

 
$
1,051

 
$
—

 
$
1,051

 
 
 
 
 
 
 
 
 
At December 31, 2014
 
 
 
 
 
 
 
 
Note payable
 
$
—

 
$
49

 
$
—

 
$
49

6.900% senior debentures, due 2028
 
—

 
34

 
—

 
34

6.920% senior debentures, due 2028
 
—

 
496

 
—

 
496

6.125% senior notes, due 2034
 
—

 
449

 
—

 
449

Total
 
$
—

 
$
1,028

 
$
—

 
$
1,028

 
 
 
 
 
 
 
 
 
 
The following table shows the fair value of our life policy loans, included in other invested assets:
(Dollars 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, 2015
 
 
 
 
Life policy loans
 
$
—

 
$
—

 
$
39

 
$
39

 
 
 
 
 
 
 
 
 
At December 31, 2014
 
 
 
 
 
 
 
 
Life policy loans
 
$
—

 
$
—

 
$
39

 
$
39

 
 
 
 
 
 
 
 
 
 
Outstanding principal and interest for these life policy loans was $30 million and $31 million at March 31, 2015, and December 31, 2014, respectively.
 
The following table shows fair values of our deferred annuities and structured settlements, included in life policy and investment contract reserves:
(Dollars 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, 2015
 
 
 
 
Deferred annuities
 
$
—

 
$
—

 
$
909

 
$
909

Structured settlements
 
—

 
225

 
—

 
225

Total
 
$
—

 
$
225

 
$
909

 
$
1,134

 
 
 
 
 
 
 
 
 
At December 31, 2014
 
 
 
 
 
 
 
 
Deferred annuities
 
$
—

 
$
—

 
$
897

 
$
897

Structured settlements
 
—

 
217

 
—

 
217

Total
 
$
—

 
$
217

 
$
897

 
$
1,114

 
 
 
 
 
 
 
 
 

Recorded reserves for the deferred annuities were $863 million at March 31, 2015, and December 31, 2014. Recorded reserves for the structured settlements were $181 million and $182 million at March 31, 2015, and December 31, 2014, respectively.



Cincinnati Financial Corporation First-Quarter 2015 10-Q
Page 13


NOTE 4 – Property Casualty Loss and Loss Expenses
This table summarizes activity for our consolidated property casualty loss and loss expense reserves:
(Dollars in millions)
 
Three months ended March 31,
 
 
2015
 
2014
Gross loss and loss expense reserves, beginning of period
 
$
4,438

 
$
4,241

Less reinsurance recoverable
 
282

 
299

Net loss and loss expense reserves, beginning of period
 
4,156

 
3,942

Net incurred loss and loss expenses related to:
 
 

 
 

Current accident year
 
711

 
705

Prior accident years
 
(22
)
 
(29
)
Total incurred
 
689

 
676

Net paid loss and loss expenses related to:
 
 

 
 

Current accident year
 
147

 
197

Prior accident years
 
399

 
387

Total paid
 
546

 
584

Net loss and loss expense reserves, end of period
 
4,299

 
4,034

Plus reinsurance recoverable
 
278

 
289

Gross loss and loss expense reserves, end of period
 
$
4,577

 
$
4,323

 
 
 
 
 
 
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 $46 million at March 31, 2015, and $52 million at March 31, 2014, for certain life and health loss and loss expense reserves.

For the three months ended March 31, 2015, we experienced $22 million of favorable development on prior accident years, including $14 million of favorable development in commercial lines, $3 million of favorable development in personal lines and $5 million of favorable development in excess and surplus lines. This included
$11 million from favorable development of catastrophe losses for the three months ended March 31, 2015. We recognized favorable reserve development during the three months ended March 31, 2015, of $15 million for the workers' compensation line, $11 million for the commercial property line and $7 million for the homeowner line due to reduced uncertainty of prior accident year loss and loss adjustment expense for these lines. Our commercial auto line developed unfavorably by $11 million for the three months ended March 31, 2015, due to higher loss cost effects in recent accident years, resulting in an increase of our reserve estimate for claims that have not yet been settled.

For the three months ended March 31, 2014, we experienced $29 million of favorable development on prior accident years, including $3 million of favorable development in commercial lines, $17 million of favorable development in personal lines and $9 million of favorable development in excess and surplus lines. This included
$9 million from favorable development of catastrophe losses for the three months ended March 31, 2014.



Cincinnati Financial Corporation First-Quarter 2015 10-Q
Page 14


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:
(Dollars in millions)
 
March 31,
2015
 
December 31, 2014
Ordinary/traditional life
 
$
891

 
$
875

Deferred annuities
 
863

 
863

Universal life
 
533

 
530

Structured settlements
 
181

 
182

Other
 
46

 
47

Total life policy and investment contract reserves
 
$
2,514

 
$
2,497

 
 
 
 
 

 
NOTE 6 – Deferred Policy Acquisition Costs
Expenses directly related to successfully acquired 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.
(Dollars in millions)
Three months ended March 31,

2015
 
2014
Deferred policy acquisition costs asset, beginning of period
$
578

 
$
565

Capitalized deferred policy acquisition costs
207

 
206

Amortized deferred policy acquisition costs
(209
)
 
(201
)
Amortized shadow deferred policy acquisition costs
(5
)
 
(6
)
Deferred policy acquisition costs asset, end of period
$
571

 
$
564

 
 
 
 

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 2015 10-Q
Page 15


NOTE 7 – Accumulated Other Comprehensive Income
Accumulated other comprehensive income (AOCI) includes changes in unrealized gains and losses on investments, changes in pension obligations and changes in life deferred acquisition costs, life policy reserves and other as follows:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
(Dollars in millions)
Three months ended March 31,
 
2015
 
 
2014
 
Before tax
 
Income tax
 
Net
 
 
Before tax
 
Income tax
 
Net
Investments:
 
 
 
 
 
 
 
 
 
 
 
 
AOCI, beginning of period
$
2,719

 
$
942

 
$
1,777

 
 
$
2,335

 
$
808

 
$
1,527

OCI excluding realized gains recognized in net income
3

 
1

 
2

 
 
135

 
48

 
87

Realized gains recognized in net income
(46
)
 
(16
)
 
(30
)
 
 
(18
)
 
(7
)
 
(11
)
OCI
(43
)
 
(15
)
 
(28
)
 
 
117

 
41

 
76

AOCI, end of period
$
2,676

 
$
927

 
$
1,749

 
 
$
2,452

 
$
849

 
$
1,603

 
 
 
 
 
 
 
 
 
 
 
 
 
Pension obligations:
 
 
 
 
 
 
 
 
 
 
 
 
AOCI, beginning of period