UNITED STATESSECURITIES AND EXCHANGE COMMISSION
FORM 10-Q
(Mark one)
For the quarterly period ended September 30, 2004.
For the transition period from to .
Commission file number 0-4604
CINCINNATI FINANCIAL CORPORATION
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 o No
Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Act).þ Yes o No
As of October 29, 2004, there were 168,048,062 shares of common stock outstanding.
CINCINNATI FINANCIAL CORPORATIONFORM 10-Q FOR THE THREE MONTHS AND NINE MONTHS ENDED SEPTEMBER 30, 2004
TABLE OF CONTENTS
Cincinnati Financial CorporationForm 10-Q for the Quarter Ended September 30, 2004
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Part I – Financial Information
Item 1. Financial Statements
Cincinnati Financial Corporation and Subsidiaries
Accompanying notes are an integral part of these condensed consolidated financial statements.
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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, and are presented in conformity with accounting principles generally accepted in the United States of America (GAAP). All significant intercompany balances and transactions have been eliminated in consolidation.
The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions that affect amounts reported in the financial statements and accompanying notes. Actual results could differ from those estimates. The December 31, 2003, consolidated balance sheet amounts are derived from the audited financial statements but do not include all disclosures herein required by accounting principles generally accepted in the United States of America.
The September 30, 2004, condensed consolidated financial statements of the company are unaudited. The company believes that all adjustments (consisting only of normal recurring accruals) necessary for fair presentation have been made. The results of operations for interim periods are not necessarily an indication of results to be expected for the remainder of the year. Per share amounts have been adjusted for the 5 percent stock dividend paid June 15, 2004.
Investments
Fixed maturities (bonds and notes) and equity securities (common and preferred stocks) have been classified as available for sale and are stated at fair values at September 30, 2004, and December 31, 2003.
At September 30, 2004, unrealized investment gains before taxes totaled $5.753 billion and unrealized investment losses in the investment portfolio amounted to $20 million. Total unrealized appreciation was primarily due to the company’s holdings in Fifth Third Bancorp (Nasdaq: FITB) and Alltel Corporation (NYSE:AT) common stock. The change in unrealized gains and losses on investments, net of taxes, described in the following table, is included in shareholders’ equity as accumulated other comprehensive income. The change in fixed maturities unrealized gains and losses for the third quarter and nine months ended September 30, 2004, was due primarily to interest-rate driven market value fluctuations in the fixed maturity portfolio. The change in equity securities unrealized gains and losses for the third quarter and nine months ended September 30, 2004, was due primarily to the decline in Fifth Third’s market value as well as the previously announced second-quarter 2004 sale of equity securities.
Realized gains and losses on investments are recognized in net income on a specific identification basis. See Investment Portfolio, Page 29, for additional discussion of the investment portfolio. Other-than-temporary declines in the fair value of investments are recognized in net income as realized investment losses at the time when facts and circumstances indicate such write-downs are warranted. In the three-month and nine-month periods ended September 30, 2004, the company recorded $5 million and $8 million in other-than-temporary impairment charges, compared with $8 million and $77 million in other-than-temporary impairment charges in the comparable prior-year periods (see Investments Results of Operations, Page 25, for discussion of the impairment charges).
Reinsurance
In the accompanying condensed consolidated statements of income, premiums earned are net of ceded premiums, and insurance losses and policyholder benefits are net of reinsurance recoveries, as follows:
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The rise in reinsurance recoverables at September 30, 2004, primarily reflects the level of catastrophe losses during the third quarter of 2004.
Stock Options
The company has qualified and non-qualified stock option plans under which options are granted to associates at prices which are not less than market price at the date of grant and that are exercisable over 10-year periods. The company applies Accounting Principles Board (APB) Opinion 25 and related interpretations in accounting for these plans. Accordingly, no compensation cost has been recognized for the stock option plans.
Had compensation cost for the company’s stock option plans been determined based on the fair value at the grant dates for awards under those plans consistent with the method of Statement of Financial Accounting Standards (SFAS) No. 123 “Accounting for Stock-Based Compensation,” the company’s net income and earnings per share would have been reduced to the pro forma amounts indicated below:
In determining the pro forma amounts above, the fair value of each option was estimated on the date of grant using the binomial option-pricing model with the following weighted-average assumptions used for grants in the nine months ended September 30, 2004 and 2003, respectively: dividend yield of 2.69 and 2.52 percent; expected volatility of 25.70 percent and 25.90 percent; risk-free interest rates of 4.10 percent and 4.26 percent; and expected lives of 10 years for all periods. Compensation expense in the pro forma disclosures is not indicative of future amounts as options vest over several years and additional grants generally are made each year.
Pension Plan
The measurement date for the company’s pension plan is December 31. The following summarizes the components of net periodic pension costs:
In the third quarter of 2004, the company contributed $8 million to the pension plan, as discussed in the 2003 Annual Report on Form 10-K.
Reclassifications
Certain prior-period amounts have been reclassified to conform with the current-period classifications.
Recent Accounting Pronouncements
In March 2004, the Financial Accounting Standards Board ratified the consensus reached by the Emerging Issues Task Force in Issue 03-1, “The Meaning of Other-Than-Temporary Impairments and Its Application to Certain Investments” (EITF 03-1). The EITF reached a consensus on an other-than-temporary impairment model for debt and equity securities accounted for under SFAS No. 115, “Accounting for Certain Investments in Debt and Equity Securities,” and cost method
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investments. The basic model developed to evaluate whether an investment within scope of Issue 03-1 is other-than-temporarily impaired involves a three-step process including determining whether an investment is impaired (fair value less amortized cost), evaluating whether the impairment is other-than-temporary and, if other-than-temporary, requiring recognition of an impairment equal to the difference between the investment’s cost and fair value. In September 2004, the FASB issued Staff Position (FSP) No. EITF Issue 03-1-1, “Effective Date of Paragraphs 10-20 of EITF Issue No. 03-01.” This FSP delays the effective date of the measurement and recognition guidance contained in paragraphs 10-20 of Issue 03-1 at least until the fourth quarter of 2004. The amount of any other-than-temporary impairment that may need to be recognized in the future will be dependent on market conditions and management’s intent and ability to hold any such impaired securities. The company’s current asset impairment policy is discussed in the 2003 Annual Report on Form 10-K, Page 19.
Subsequent Events
As a result of the asset transfer, the company was able to access the capital markets, issuing $375 million of 6.125% senior notes on November 1, 2004.
NOTE 2 — SEGMENT INFORMATION
The company operates primarily in two industries, property casualty insurance and life insurance. Company management regularly reviews four reportable segments to make decisions about allocating resources and to assess performance:
Operations of the parent company, CFC Investment Company and CinFin Capital Management Company (excluding investment activities) and other income of the insurance subsidiaries are reported as Other.
Revenues are primarily from unaffiliated customers.
Income before income taxes for the insurance segments is defined as underwriting income (loss).
Income before income taxes for the investment operations segment is net investment income plus realized investment gains and losses for all fixed maturity and equity security investments of the entire company, less interest credited to contract holders of the life insurance segment.
Losses before income taxes for the Other category are primarily due to interest expense from debt of the parent company and operating expenses of the company’s headquarters.
Identifiable assets by segment are those assets used in the respective segment’s operations. Identifiable assets are not separately reported for two reportable segments – commercial lines and personal lines of property casualty insurance – because company management does not use this measure to analyze those segments. All fixed maturity and equity security investment assets, regardless of ownership, are included in the investment operations segment.
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The following table summarizes segment information:
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INTRODUCTION
The following discussion highlights significant factors influencing the consolidated results of operations and financial position of Cincinnati Financial Corporation (CFC). It should be read in conjunction with the consolidated financial statements and related notes included in the company’s 2003 Annual Report on Form 10-K. Dollar amounts are rounded to millions; calculations of percent changes are based on whole dollar amounts. Per share amounts have been adjusted for the 5 percent stock dividend paid June 15, 2004.
SAFE HARBOR STATEMENT
This is a “Safe Harbor” statement under the Private Securities Litigation Reform Act of 1995. Certain forward-looking statements contained herein involve potential risks and uncertainties. The company’s future results could differ materially from those discussed. Factors that could cause or contribute to such differences include, but are not limited to:
Further, the company’s insurance businesses are subject to the effects of changing social, economic and regulatory environments. Public and regulatory initiatives have included efforts to adversely influence and restrict premium rates, restrict the ability to cancel policies, impose underwriting standards and expand overall regulation. The company also is subject to public and regulatory initiatives that can affect the market value for its common stock, such as recent measures affecting corporate financial reporting and governance. The ultimate changes and eventual effects, if any, of these initiatives are uncertain.
Readers are cautioned that the company undertakes no obligation to review or update the forward-looking statements included in this material.
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RESULTS OF OPERATIONS
Overview — Financial Highlights
The consolidated results of operations reflect the operating results of each of the company’s four segments along with parent company and other non-insurance related activities. The four segments are:
Revenues for the three-month period increased, reflecting earned premium growth and realized losses in the third quarter of 2004 versus realized gains in the third quarter of 2003. Revenues for the nine-month period also increased, reflecting earned premiums growth and realized investment gains for the first nine months of 2004 versus realized investment losses in last year’s first nine months.
Net income for both periods rose due to the growth in revenues and higher pretax underwriting profits for the property casualty insurance segments due to premium growth and lower loss and loss expenses.
Realized investment gains and losses – A significant factor in the growth rate for net income in any period can be realized investment gains and losses. Management believes it is important to carefully consider the impact of realized investment gains and losses on net income when evaluating the company’s insurance segments: property casualty insurance and life insurance. Management believes the level of realized investment gains and losses for any particular period, while it may be material, may obscure the performance of ongoing underlying business operations in that period. While realized investment gains and losses are integral to the company’s insurance operations over the long term, the determination to recognize investment gains or losses in any period may be subject to management’s discretion and is independent of the insurance underwriting process. Moreover, under applicable accounting requirements, gains and losses can be recognized from certain changes in market values of securities without actual realization, such as changes in the valuation of embedded derivatives or other-than-temporary impairment charges.
In the third quarter of 2004, the after-tax impact of net realized investment losses was to lower net income by $5 million, or 3 cents per share, compared with net realized investment gains in last year’s third quarter that increased net income by $10 million, or 6 cents. For the first nine months of 2004, the after-tax impact of net realized investment gains was to increase net income by $36 million, or 21 cents per share, compared with net realized investment losses that reduced net income by $29 million, or 17 cents per share, in the first nine months of 2003. The company reported a net realized investment gain in the first nine months of 2004 primarily because of the previously disclosed sale of equity securities. In addition, other-than-temporary impairment charges declined. See Investments Results of Operations, Page 25, for additional information on net realized investment gains and losses.
Other considerations —
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Management considers the reserve release and software recovery to be unusual, and they should be taken into consideration when evaluating ongoing business operations.
Option expense – In the three months ended September 30, 2004 and 2003, reported net income per share on a diluted basis would have been reduced by 1 cent and 2 cents, respectively, if option expense, calculated using the binomial option-pricing model, had been included in operating expenses. In the nine months ended September 30, 2004 and 2003, reported net income per share on a diluted basis would have been reduced by 4 cents, if option expense, calculated using the binomial option-pricing model, had been included in operating expenses.
Book value – Due to a lower level of unrealized gains in the investment portfolio; book value per share declined to $36.21 at September 30, 2004, from the record year-end 2003 level of $36.85.
Comprehensive income – Accumulated other comprehensive income, which includes the accumulated unrealized gains on investments and derivatives, declined by $52 million in the third quarter of 2004. Return on equity based on comprehensive income for the third quarter of 2004 was 2.4 percent, compared with a negative 4.2 percent last year.
Effects of inflation – Management does not believe that inflation has had a material effect on our consolidated results of operations, except to the extent that inflation may affect interest rates and claim costs.
Outlook
Over the long term, management’s objective is to achieve steady growth while performing as an industry profitability leader. At the beginning of the year, management had established specific performance targets for full-year 2004. As circumstances warrant, management updates those targets based on its outlook for the insurance and investment markets and its progress in implementing operating strategies. For 2004, management now anticipates:
Factors supporting management’s outlook for 2004 are discussed in the Results of Operations for each of the four business segments.
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Property Casualty Insurance Operations
Within the property casualty insurance market, the company offers both commercial and personal policies through a network of independent agencies. Highlights of the performance for the combined property casualty insurance operations included:
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The Attorney General of the State of New York recently brought a suit against, and accepted guilty pleas from, participants in the insurance industry alleging certain illegal actions by these participants. Although the company does not do business with the party to the suit or those pleading guilty, is not involved in the suit at all and does not believe that the company’s business practices are of the same nature as those the suit alleges to have occurred, management cannot be certain of what ultimate effect the suit, as well as any increased regulatory oversight that might result from the suit, might have on the insurance industry as a whole, and thus on the company’s business.
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The company’s insurance subsidiaries have received information requests from the Departments of Insurance in Ohio and other states beginning November 1, 2004. These states, which sent requests to multiple insurance companies and other industry members, are surveying industry sales practices following recent allegations of unlawful conduct by certain insurers and brokers. The company anticipates receiving additional requests from other states in which it markets insurance through independent insurance agencies. The company intends to cooperate fully with the state insurance departments.
The discussion of the commercial lines and personal lines segments provides additional detail regarding property casualty strategies and trends.
Commercial Lines Results of Operations
Performance highlights for the commercial lines segment included:
Earned premiums – The primary source of earned premium growth for the three- and nine-month periods was slightly higher pricing on new and renewal commercial business and continued new business growth. The earned premium growth rates were reduced by 1.2 and 0.4 percentage points, respectively, by the reinsurance reinstatement premium. In the third quarter of 2004, commercial lines new business premiums written directly by agencies rose 2.0 percent to $73 million from $71 million a year earlier. In the first nine months of 2004, commercial lines new business premiums written directly by agencies rose 9.9 percent to a record $215 million from $195 million a year earlier.
The company’s standard approach is to write three-year commercial policies, which the company considers to be a competitive advantage in the commercial lines market, as further discussed in Item 1 of the 2003 Annual Report on Form 10-K. However, management estimates that approximately 75 percent of third-quarter 2004 commercial premiums were subject to annual rating within the three-year policy or were written on a one-year policy term.
Profitability – Improvement in commercial lines profitability primarily has been driven by more adequate premiums per exposure. In addition, the rate of growth in loss and loss expenses has slowed. The commercial lines combined ratio of 86.2 percent for the first nine months of 2004 included the benefit of the UM/UIM reserve release, which reduced the ratio by 2.0 percentage points. The commercial lines combined ratio of 92.1 percent and 92.2 percent for the third quarter and first nine months of 2003 included the benefit of the software recovery, which reduced the ratio by 2.9 percentage points and 1.0 percentage points, respectively.
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Line of Business Analysis
In total, commercial multi-peril, workers compensation, commercial auto and other liability accounted for approximately 90 percent of total commercial lines earned premium. Approximately 95 percent of the company’s commercial lines premiums are written as packages, providing accounts with coverages from more than one business line. The company believes that its commercial lines growth and profitability is best measured and evaluated on a segment basis.
Results for the business lines within the commercial lines segment have reflected the company’s emphasis on underwriting and obtaining adequate pricing for the covered risk. Other factors that have affected results for these lines included:
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Commercial Lines Outlook
During the remainder of 2004 and into 2005, the company anticipates commercial lines insurance market trends will reflect the pressure on pricing from the industry’s increasing surplus and improving profitability. During the third quarter, agents indicated that renewal price increases were running in the low single digits, with variations by geographic region and class of business. Aggressive pricing is occurring more frequently for higher quality accounts although disciplined underwriting appears to be the norm. Management expects competition to accelerate during the remainder of the year and into 2005. The company will continue to market its products to a broad range of business classes, price its products adequately and take a package approach. The company intends to maintain its underwriting selectively and to manage carefully its rate levels as well as maintain its programs that seek to accurately match exposures with appropriate premium. The creation of new marketing territories and appointment of new agencies over the next several years also could contribute to commercial lines growth.
For the full year, management anticipates commercial lines growth on a written premium basis to be slightly below its original target of 10 percent. When compared with results for 2003, management also anticipates incremental improvement in the already strong combined ratio.
Personal Lines Results of Operations
Performance highlights for the personal lines segment include:
Earned premiums – The primary source of growth in the three- and nine-month periods was higher rates for renewal personal lines business, reflecting additional premium from initiatives to ensure that policyholders purchase adequate coverage limits for the insured risk and to provide for specific charges for certain coverage extensions such as water damage. The earned premium growth rates were reduced by 2.1 and 0.7 percentage points, respectively, by the reinsurance reinstatement premium. Policy count remained relatively flat compared with the year-earlier period. The company continues to renew approximately 90 percent of personal lines policies, which the company believes indicates that current policyholders recognize the value that their agent and the company bring.
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In the first nine months of 2004, the roll-out of Diamond, the company’s new personal lines policy processing system, was completed for agencies in Indiana, Michigan and Ohio. These are three of the company’s largest personal lines states, accounting for 53.1 percent of personal lines premium volume in 2003. Diamond has been used by the company’s Kansas agencies since July 2002. Agencies that complete the training are able to immediately use the Diamond system to process new and renewal personal lines policies. Training for agents in Alabama and Florida is expected to begin in the fourth quarter of 2004, with training for agents in Illinois, Kentucky, Georgia and Wisconsin scheduled for 2005. Before entering each state, Diamond is modified to accommodate that state’s rules and rates.
Personal lines new business premiums written directly by agencies was $14 million in the third quarter of 2004 compared with $15 million in the third quarter of 2003, and $39 million for the first nine months of 2004 compared with $46 million in the prior nine-month period.
Combined ratio – The third-quarter and nine-month combined ratios rose when compared with the year-earlier period as higher catastrophe losses and a rise in underwriting expenses in 2004 as well as the benefit of the software recovery in 2003 offset improvement in the non-catastrophe loss and loss expenses ratio.
While generally seeking to leverage the relationships with the company’s independent agencies, efforts to improve personal lines profitability have focused on the personal auto and homeowner business lines as discussed below. The significant components of expenses for the personal lines segment were:
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The personal auto and homeowner business lines together account for approximately 90 percent of the total personal lines earned premiums. The company’s intent is to write personal auto and homeowner coverages in personal lines packages. The company believes that the personal lines business is best measured and evaluated on a segment basis.
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Personal Lines Outlook
In the personal lines marketplace, the company believes agents select Cincinnati for their value-oriented clients who seek to balance value and price and are attracted by Cincinnati’s superior claims service and the benefits of the company’s package approach. However, management is maintaining modest growth expectations for the personal lines area. Five factors are contributing to that view:
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The appointment of new agencies over the next several years also could contribute to personal lines growth.
These factors may affect the personal lines growth rate, however, management believes that they will allow the company to improve the profitability of its homeowner line of business while maintaining or slightly improving personal auto profitability. While primarily focusing on longer-term targets for the homeowner line because of the existing base of three-year policies, management believes it will see steady improvement in the overall personal lines loss and loss expense ratio excluding catastrophes in the fourth quarter of 2004 and throughout 2005 as the company continues to work through the renewal policy cycle.
Life Insurance Results of Operations
Performance highlights for the life insurance segment include:
Revenues – Earned premiums grew 7.2 percent and 13.5 percent in the third quarter and first nine months of 2004. Since the beginning of the year, face amounts of in-force policies have grown 13.0 percent and applications submitted have grown 5.4 percent. Because of strong market demand for fixed-annuity products during 2004, annuity sales were $18 million in this year’s third quarter, compared with $3 million last year, and $49 million in the first nine months of 2004 compared with $34 million for the comparable prior period. Third-quarter and nine-month results reflected a positive response to recently introduced enhancements to the life insurance company’s term life insurance product portfolio.
Profitability – The GAAP-based income reported by the life insurance segment was modest because its investment income is included in investment segment results, except investment income credited to contract holders (interest assumed in life insurance policy reserve calculations). At the same time, management recognizes that assets under management, capital appreciation and investment income are integral to evaluation of the success of the life insurance segment because of the long duration of life policies. For that reason, management also evaluates GAAP data including results for investment activities on life insurance-related assets for The Cincinnati Life Insurance Company subsidiary, which comprises the life insurance segment. GAAP net income for Cincinnati Life declined 35.2 percent to $5 million for the third quarter from $8 million for the comparable 2003 period. Third-quarter realized losses in the life insurance company’s investment portfolio were due to the sale of airline bonds and a decline in the fair value of derivatives embedded in convertible securities. For the nine months ended September 30, 2004, GAAP net income including net realized investment gains and losses rose to $24 million from $14 million for the comparable 2003 period due primarily to net realized investment gains.
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Life Insurance Outlook
As the life insurance company seeks to increase penetration of the property casualty agencies, management’s objective is growth in premiums. Because of changes in the reinsurance marketplace, management is concerned about the future cost and availability of reinsurance for term life insurance products, which may affect the company’s ability to expand in this area. Term insurance is the company’s largest life insurance product line. Management is studying alternatives in conjunction with negotiating the 2005 renewal of the company’s life insurance reinsurance program.
During the third quarter, Cincinnati Life added a disability income product to its worksite marketing portfolio and made electronic enrollment available for worksite marketing programs. Other 2004 technology initiatives include placing the life insurance sales system on CinciLink, the company’s agency extranet. This will bring agents the convenience of online form completion and submission, eliminating the expense of frequent software-update mailings.
Investments Results of Operations
The investment segment contributes investment income and realized investment gains and losses to results of operations.
Investment income – Pretax net investment income reached a new record of $124 million in the third quarter of 2004, rising 6.1 percent over the third quarter of 2003. Growth in investment income continued to be driven by higher interest income due to increased cash flow invested in the fixed-income portfolio and to increased dividend income from the common stock portfolio.
Overall, dividends contributed 47.0 percent of pretax investment income in the third quarter of 2004, compared with 49.0 percent in the third quarter of 2003. Over the past 12 months, 39 of the 50 common stock holdings in the portfolio raised their indicated dividend payout. Those increases should add approximately $16 million to investment income on an annualized basis. Fifth Third, the company’s largest equity holding, contributed 39.8 percent of total dividend income in the third quarter of 2004.
Pretax net investment income was $365 million for the first nine months of 2004, rising 5.2 percent. Dividends contributed 48.1 percent of pretax investment income in the first nine months of 2004, compared with 48.6 percent in the first nine months of 2003. Fifth Third, the company’s largest equity holding, contributed 44.3 percent of total dividend income in the first nine months of 2004.
Net realized investment gains and losses – The company recorded $7 million in pretax net realized investment losses in the third quarter of 2004 compared with $15 million in pretax net realized investment gains in the third quarter of 2003.
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Investments Outlook
Management believes that it will achieve investment income growth above 4.5 percent in 2004 as a result of the anticipated growth in dividend income, the potential rise in interest rates, strong cash flow from insurance operations and the higher-than-normal allocation of new cash flow to fixed-income securities. While management does not forecast realized investment gains and losses, it believes that impairment charges in 2004 will be limited to securities marked to market because they have been identified for sale, or those where issuer-specific events cause sharp declines in market value with little or no warning.
The company’s asset impairment committee continues to monitor the investment portfolio. The company also is awaiting the Financial Accounting Standard Board’s final decision regarding EITF 03-1 (see Note 1, Recent Accounting Pronouncements, Page 8). Until that decision is announced, the company is unable to estimate the impact of adoption of the standard on its recognition of other-than-temporary impairment losses. The company’s current asset impairment policy is discussed in the 2003 Annual Report on Form 10-K, Page 19. The company believes that the committee’s ongoing reviews help to minimize the effect of changes in interest rates that may negatively change the value of the company’s holdings.
Other
Operations of the parent company and two of its subsidiaries, CFC Investment Company and CinFin Capital Management Company (excluding investment activities), and other income of the insurance subsidiaries contributed $4 million and $3 million in revenues in the third quarters of 2004 and 2003, respectively. Losses before income taxes of $9 million, compared with $7 million, were primarily due to interest expense from debt of the parent company and operating expenses of the company’s headquarters.
Taxes
Income tax expense was $23 million in the third quarter of 2004 compared with $33 million in the third quarter of 2003. The effective tax rate for the third quarter of 2004 was 20.3 percent compared with 24.3 percent for the same period last year because of lower underwriting profits primarily due to the higher level of catastrophe losses.
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Income tax expense was $137 million in the first nine months of 2004 compared with $65 million in the first nine months of 2003. The effective tax rate for the first nine months of 2004 was 25.9 percent compared with 20.8 percent for the same period last year. In addition to higher underwriting profits, the higher tax rate reflected the higher level of capital gains, which are taxed at a 35 percent rate, compared with capital losses in the first nine months of 2003.
The company pursues a strategy of investing some portion of cash flow in tax-advantaged fixed maturities and equity securities to minimize its overall tax liability and maximize after-tax earnings. See Note 10 to the Consolidated Financial Statements in the 2003 Annual Report on Form 10-K for detail regarding the company’s effective income tax rate. Management now anticipates that the effective annual tax rate for 2004 will be in the 25 percent to 28 percent range compared with its earlier estimate of the 21 percent to 24 percent range. The increase reflects the company’s strong profitability and achievement of its performance objectives of an underwriting profit and growth in investment income.
Liquidity and Capital Resources
Cash Flow
The company’s property casualty and life insurance operations generated positive cash flows from underwriting of $577 million in the first nine months of 2004, compared with $369 million a year earlier. This underwriting cash flow, defined as premiums collected less losses, loss expenses, commissions and other underwriting expenses paid, primarily was due to growth of insurance premiums. In addition, investment income from the insurance operations generated cash flows of $264 million, compared with $253 million a year earlier.
The insurance subsidiaries invested $1.349 billion and $968 million in fixed-income and equity securities in the first nine months of 2004 and 2003, respectively. Those purchases were offset by sales of fixed-income securities totaling $92 million and $88 million, and by calls and maturities of fixed-income securities totaling $496 million and $300 million in the first nine months of 2004 and 2003, respectively. Sales, calls or maturities of equity and equity-linked securities totaled $432 million and $130 million in the same periods. During the second quarter of 2004, the company sold $356 million in equity holdings and $30 million in equity-linked holdings, designating the proceeds for reinvestment in fixed income and convertible securities. These figures do not include the transfer of $153 million in equity holdings to the parent company in exchange for fixed-income securities in the second quarter. See Property Casualty Insurance Operations, Page 14, for discussion of the company’s strategy to support the financial strength ratings of its property casualty insurance operations.
In the first nine months of 2004 and 2003, the company’s property casualty insurance subsidiary paid ordinary dividends of $75 million and $50 million, respectively, to the parent company. Management anticipates its insurance subsidiaries may pay additional ordinary dividends to the parent company in the fourth quarter of 2004. The subsidiaries can pay up to $203 million in additional ordinary dividends to the parent company in 2004 before needing approval from the Ohio Department of Insurance.
As a result of investment income from its investments and dividends and borrowings from its property casualty insurance subsidiary, the parent company met its cash requirements for general operating expenses, interest payments on its long- and short-term debt, dividends to shareholders and common stock repurchases. In addition, the company used $128 million to pay off one of its short-term credit lines.
Investing activities for the parent company generated $74 million of cash flow in the first nine months of 2004 compared with $27 million in the comparable prior period.
Dividends
Cincinnati Financial has increased the indicated annual cash dividend rate to shareholders for 44 consecutive years and, periodically, the board of directors authorizes stock dividends or splits. In January 2004, the board of directors authorized
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a 10.0 percent increase in the regular quarterly cash dividend to an indicated annual rate of $1.10. At the same time, the board also authorized a 5 percent stock dividend paid June 15, 2004. This was the 28th stock dividend or split declared over the past 47 years.
Common Stock Repurchase
In the third quarter of 2004, the company repurchased 296,800 shares at an average price of $39.84. Common stock repurchases for treasury occur whenever management believes that stock prices on the open market are favorable for such repurchases. At a minimum, the company would expect to offset dilution of option exercises. At September 30, 2004, fewer than 5 million shares remained authorized for repurchase. See Part II, Item 2, Unregistered Sales of Equity Securities and Use of Proceeds, Page 36, for additional information regarding the stock repurchase activity.
On August 26, 2004, the company announced that Cincinnati Financial Corporation transferred investment securities with a market value of $1.600 billion to The Cincinnati Insurance Company, the lead property casualty insurance subsidiary. This action was related to the company’s June 28, 2004 application to the SEC seeking exemptive relief under the Investment Company Act of 1940. The transfer was authorized by Cincinnati Financial’s board of directors on August 13, 2004, and approved by the Ohio Department of Insurance on August 24, 2004.
The asset transfer resolved the holding company’s current status under the Investment Company Act (see Item 5, Other Information, Status of Application to SEC Requesting Exemption from Investment Company Act of 1940, Page 37, for additional details). See Item 5, Other Information, for discussion of the risks associated with the application for exemptive relief.
The company issued a 30 year, $375 million aggregate principal amount of 6.125% senior notes on November 1, 2004. The $368 million net proceeds from the offering will be used to:
The notes will bear interest at a rate of 6.125% per year from November 1, 2004, payable semi-annually on May 1 and November 1 of each year, beginning on May 1, 2005. The notes were issued in a transaction exempt from the registration requirements under the Securities Act of 1933, as amended. The notes were sold to qualified institutional buyers in reliance on Rule 144A of the Securities Act. Independent rating agencies awarded the new 6.125% senior notes the same ratings that they had awarded the existing 6.90% senior notes.
Management continues to believe that cash provided by its insurance operations is adequate to meet anticipated short-term and long-term obligations and that those funds will continue to be the company’s primary source of funds.
Future liquidity could be affected by catastrophe losses in excess of the company’s catastrophe reinsurance treaties, which now provide coverage for gross losses up to $500 million. The company has no significant exposure to assumed reinsurance, which accounted for no more than 2.4 percent of earned premiums in each of the last three years and is expected to remain at or near this level in 2004.
Further, if it were to be determined that the company was an unregistered investment company before the asset transfer, Cincinnati Financial may be unable to enforce contracts with third parties, and third parties could seek to obtain rescission of transactions with Cincinnati Financial undertaken during the period that it was an unregistered investment company, subject to equitable considerations set forth in the Investment Company Act. As a result, it could be determined that holders of Cincinnati Financial’s $420 million aggregate principal amount of 6.90% Senior Debentures due 2028 have a right to rescind such indebtedness, thereby requiring Cincinnati Financial to immediately repay such amounts. Cincinnati Financial may be unable to refinance such obligations on acceptable terms as a result of its potential status under the Investment Company Act. However, Cincinnati Financial currently has available sufficient assets to fund such repayment and believes that its assets are adequate to meet its short- and long-term obligations (see Item 5, Other Information, Status of Application to SEC Requesting Exemption from Investment Company Act of 1940, Page 37, for additional information).
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Assets
At September 30, 2004, the consolidated investment portfolio made up 77.2 percent of total assets, which increased to $15.806 billion from $15.509 billion at December 31, 2003. The remainder consisted primarily of other invested assets (0.2 percent), premium receivables (7.3 percent), reinsurance receivables (4.7 percent), deferred acquisition costs (2.5 percent) and separate accounts (3.0 percent). These percentages have remained relatively constant over the last few years.
Investment Portfolio
The market value of the company’s investments securities was $12.204 billion at September 30, 2004. See the 2003 Annual Report on Form 10-K, Investment Portfolio, Page 44, for additional background regarding the investment portfolio and valuation.
Insurance regulatory and statutory requirements designed to protect policyholders from investment risk influence the company’s investment decisions on an individual insurance company basis. Cash generated from insurance operations is invested almost entirely in five classes of assets evaluated for yield and risk prior to purchase. During the second and third quarters of 2004, the company temporarily changed the allocation of new property casualty portfolio investments to help reduce the ratio of common stock to statutory surplus below 100 percent, a level generally maintained in the property casualty portfolio throughout the 1990s. The ratio of common stock to statutory surplus for the property casualty insurance group portfolio was 106.7 percent at September 30, 2004, compared with 114.7 percent at year-end 2003.
Due to the transfer of $1.600 billion in investment securities to its property casualty subsidiary, management anticipates continuing the temporary allocation of cash flow to fixed-income and convertible security purchases until mid-2005. Management believes the company will return to its historic investment pattern, allocating 65 percent to 75 percent of cash flow to fixed-income securities, during 2005. See Property Casualty Insurance Operations, Page 14, for discussion of the company’s strategy to support the financial strength ratings of its property casualty insurance operations.
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Liabilities and Shareholders’ Equity
At September 30, 2004, insurance reserves were 49.6 percent of total liabilities, which increased to $9.722 billion from $9.305 billion at December 31, 2003. The remainder consisted primarily of unearned premiums (16.1 percent), deferred income tax (18.2 percent) and long- and short-term debt (4.9 percent). In the first nine months of 2004, the company repaid one short-term line of credit. The debt percentage is expected to return to its historic levels at December 31, 2004, due to the sale of $375 million in senior notes on November 1, 2004.
The company had one line of credit totaling $75 million, with the outstanding balance on the line totaling $58 million at September 30, 2004, compared with $183 million on two lines of credit at year-end 2003. During the second and third quarters of 2004, the company paid off $128 million of short-term debt.
On November 1, 2004, the company issued senior notes with an aggregate principal amount of $375 million that will mature on November 1, 2034. The notes will bear interest at a rate of 6.125% per year from November 1, 2004, payable semi-annually in arrears on May 1 and November 1 of each year, beginning on May 1, 2005. Interest expense on the company’s short- and long-term debt was $27 million (pretax), or 11 cents per share (after tax), for the first nine months of 2004, which excludes interest expense on intercompany debt. Assuming the company had issued the 6.125% senior notes on January 1, 2004, and used the proceeds as indicated, management estimates interest expense would have been $39 million (pretax), or 15 cents per share (after tax), for the first nine months of 2004.
Cincinnati Financial Corporation may redeem the 6.125% senior notes, at its option, at any time in whole, or from time to time in part, prior to maturity. The redemption price will be equal to the greater of 100 percent of the principal amount of the notes or the sum of the present values of the remaining scheduled payments of principal and interest, discounted to the redemption date on a semiannual basis at a comparable treasury rate plus 15 basis points, plus in each case, interest accrued but not paid to the date of redemption.
Under the terms of the notes indenture, an event of default is defined as: first, default for 30 days in payment of any interest on the notes; second, failure to pay principal and premium, if any, when due; third, failure to observe or perform any other covenant in the indenture or notes (except a covenant or warranty whose breach or default in performance is specifically dealt with in the events in default section), if such failure continues for 30 days after written notice by the trustee or the holders of at least 25 percent in aggregate principal amount of the notes then outstanding; and fourth, uncured or unwaived failure to pay principal of or interest on any other obligation for borrowed money beyond any period of grace if (a) the aggregate principal amount of any such obligation is in excess of $50 million and (b) Cincinnati Financial Corporation is not contesting the default in such payment in good faith by appropriate proceedings; or (c) certain events of bankruptcy, insolvency, receivership or reorganization.
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Under a registration rights agreement to be executed in connection with the offering, Cincinnati Financial Corporation will:
The following table shows the company’s capitalization and interest expense at September 30, 2004, and as adjusted to reflect the November 1 debt offering and planned use of proceeds:
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Other Matters
Off-Balance Sheet Arrangements
The company does not utilize any special-purpose financing vehicles or have any undisclosed off-balance sheet arrangements (as that term is defined in applicable SEC rules) that are reasonably likely to have a current or future material effect on the company’s financial condition, results of operation, liquidity, capital expenditures or capital resources. Similarly, the company holds no fair-value contracts for which a lack of marketplace quotations would necessitate the use of fair-value techniques.
Significant Accounting Policies
During the nine months ended September 30, 2004, the company did not change any significant accounting policies from those utilized in the preparation of the consolidated financial statements as of and for the year ended December 31, 2003, which are discussed in Note 1 to the Consolidated Financial Statements in the company’s 2003 Annual Report on Form 10-K and updated in Note 1 to the Condensed Consolidated Financial Statements beginning on Page 7.
In conjunction with those discussions, in the Management’s Discussion and Analysis contained in the 2003 Annual Report on Form 10-K, management reviewed the estimates and assumptions used to develop reported amounts related to the most significant policies. Management discussed the development and selection of those accounting estimates with the audit committee of the board of directors.
Market risk is the potential for a decrease in value resulting from broad yet uncontrollable forces such as inflation, economic growth, interest rates, world political conditions or other widespread unpredictable events. It is comprised of many individual risks that, when combined, create a macroeconomic impact. The company’s view of potential risks and its sensitivity to such risks is discussed in the 2003 Annual Report on Form 10-K.
Fixed-Income Securities
By allocating approximately two-thirds of invested cash flows to the fixed-income portfolio over the longer term, the company believes it enhances portfolio stability and diversity. Compared with common stocks, fixed-income investments generally are less volatile and provide a more consistent income stream. Overall credit risk is reduced by diversifying the fixed-income portfolio among approximately 1,300 securities.
Interest Rate Risk
Because of the company’s strong surplus, long-term investment horizon and its ability to hold most fixed-income investments until maturity, management believes the company is well positioned if interest rates were to rise. A higher rate environment would provide the opportunity to invest cash flow in higher-yielding securities, while reducing the likelihood of calls of the higher-yielding U.S. agency paper purchased over the past year. While higher interest rates would be expected to continue to increase the number of fixed-income holdings trading below 100 percent of book value, management believes lower fixed-income security values due solely to interest rate changes would not signal a decline in credit quality.
The company is using a dynamic financial planning model developed during 2002 to further incorporate analytical tools in assessing market risks. Management believes the model is improving the company’s ability to measure the impact on bond values resulting from changes in interest rates. Improved measurement of the impact of interest rate changes should allow for improved matching of the company’s assets and liabilities.
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When interest rates were on a declining trend, the company monitored duration to the call date as a measure of its interest rate sensitivity. If rates rise, as is widely anticipated, the company also will measure duration to maturity, as this may become the more conservative measure. The table below summarizes the company’s interest rate risk and shows the effect of hypothetical changes in interest rates on the market value of the fixed-income portfolio under both duration scenarios:
In the dynamic financial planning model, the selected interest rate change of 100 basis points represents management’s views of a shift in rates that is quite possible over a one-year period. The rates modeled should not be considered a prediction of future events as interest rates may be much more volatile in the future. The analysis is not intended to provide a precise forecast of the effect of changes in rates on the company’s results or financial condition, nor does it take into account any actions that might be taken to reduce exposure to such risks.
Equity and Equity-Linked Securities
Management believes the company’s equity investment style – centered on companies that pay and increase dividends to shareholders – is an appropriate long-term strategy. While the company’s long-term financial position would be affected by prolonged changes in the market valuation of its investments, management believes the company’s strong surplus position and cash flow provide it with a cushion against short-term fluctuations in valuation. The company believes that the continued payment of cash dividends by the issuers of the common equities held by the company also should provide a floor to their valuation.
The company’s investments are heavily weighted toward the financials sector, which represented 67.5 percent of the total market value of the common stock portfolio at September 30, 2004. Financials sector investments typically underperform the overall market during periods when interest rates are expected to rise. Management historically has seen these types of short-term fluctuations in market value of its holdings as potential buying opportunities but is cognizant that a prolonged downturn in this sector could create a long-term negative effect on the portfolio.
While past performance cannot guarantee future returns, over the longer term, the performance of the company’s equity portfolio has exceeded that of the broader market, achieving a compound annual return of 4.96 percent for the five years ended September 30, 2004, compared with a compound annual decline of 1.30 percent for the Standard & Poor’s 500 Index, a common benchmark of market performance. In the third quarter of 2004, the equity portfolio outperformed the market, declining 1.72 percent, compared with the Standard & Poor’s 500’s decline of 1.88 percent.
The company holds 72.8 million shares of Fifth Third common stock at a cost of $283 million. The market value of the company’s Fifth Third position was $3.582 billion at September 30, 2004, or 48.7 percent of the company’s total common equity portfolio, compared with $4.301 billion, or 52.7 percent, at year-end 2003. The after-tax unrealized gain represented by the company’s Fifth Third position was $2.144 billion, or 57.5 percent of the company’s total after-tax unrealized gains at September 30, 2004, compared with $2.612 billion, or 63.8 percent at year-end 2003. The Fifth Third position represented $12.76 of the company’s total book value of $36.21 per share at September 30, 2004, compared with $15.50 at year-end 2003. Every $1.00 change in the market price of Fifth Third’s common stock has approximately a 28 cent impact on book value per share. A 20 percent ($9.84) change in the market price of Fifth Third’s common stock, which was $49.22 at September 30, 2004, would result in a $716 million change in assets and a $466 million change in after-tax unrealized gains. This would affect shareholders’ equity by 7.7 percent and book value by $2.77 per share.
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Potential Impairments
The following table summarizes the portfolio at September 30, 2004, and December 31, 2003:
At September 30, 2004, unrealized investment gains before taxes totaled $5.753 billion and unrealized investment losses in the investment portfolio amounted to $20 million. The unrealized appreciation was primarily due to the company’s holdings in the common stock of Fifth Third (Nasdaq: FITB) and Alltel Corporation (NYSE:AT).
The number of securities trading below 100 percent of book value at September 30, 2004, was slightly above the number at December 31, 2003, but substantial below the 321 trading at that level at June 30, 2004. The change from June 30, 2004, was primarily due to the decline in bond yields over the three months. The number of securities trading below 100 percent of book value can be expected to fluctuate as interest rates rise or fall. In addition, the portfolio benefited from continued improvements in the credit quality of the bond portfolio, as rated by Standard & Poor’s and Moody’s. Further, book values for some securities have been revised due to impairment charges recognized during 2003 and 2002. During the first nine months of 2004, three securities were written down as other-than-temporarily impaired.
Management monitors securities trading below 70 percent of book value for potential other-than-temporary impairment. At September 30, the airline-related security trading below 70 percent of book value had been at that level for six months or less and represented just $1 million in book value and gross unrealized losses of less than $1 million.
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The following table details the portfolio’s gross unrealized gains and losses as of September 30, 2004:
Management deems the risk related to securities trading between 70 percent and 100 percent of book value to be relatively minor and at least partially offset by the earned income potential of these investments. At September 30, 2004, 126 securities were trading between 70 percent and 100 percent of book value, up from 116 at year-end 2003. The securities trading between 70 percent and 100 percent of book value at September 30, 2004, represented 6.2 percent of invested assets and $20 million in unrealized losses.
Of the total 127 holdings trading below book value at September 30, 2004, 116 were trading at or above 90 percent of book value. The value of these securities fluctuates primarily because of changes in interest rates. The market value of these 116 securities was $728 million at September 30, 2004, and they accounted for less than $14 million in unrealized losses.
The remaining 11 securities, which accounted for the remaining $6 million in unrealized losses, are being monitored for credit- and industry-related risk factors. Of these securities, three are airline-related.
Reflecting the company’s long-term investment philosophy, of the 1,345 securities trading at or above book value, 686, or 51 percent, have shown unrealized gains for more than 24 months.
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Item 4. Controls and Procedures
(a) Evaluation of Disclosure Controls and Procedures
The effectiveness of the design and operation of disclosure controls and procedures was evaluated under the supervision and with the participation of management, including the chief executive officer and chief financial officer. Based on that evaluation, the chief executive officer and chief financial officer concluded that the company’s disclosure controls and procedures were effective as of the end of the third quarter and provided reasonable assurance that the information required to be disclosed by the company in its periodic reports is accumulated and communicated to management, including its principal executive and principal financial officers, as appropriate to allow timely decisions regarding disclosure and is recorded, processed, summarized and reported within the time periods required by law. The company’s management, including the chief executive officer and chief financial officer, does not expect that its disclosure controls and procedures will prevent or detect all error and all fraud. Such controls and procedures controls can only provide reasonable, not absolute, assurance that the objectives of the disclosure controls and procedures are met.
(b) Changes in Internal Control Over Financial Reporting
The chief executive officer and chief financial officer also have concluded that there were no significant changes in the third quarter of 2004 to the company’s internal controls over financial reporting or in other factors that have materially affected, or are reasonably likely to materially affect, the company’s internal control over financial reporting. During the third quarter, the company continued its comprehensive review of its internal controls over financial reporting required for compliance with Section 404 of the Sarbanes-Oxley Act of 2002. This review includes documenting and testing of internal controls. During the course of these activities, the company has identified various components of the internal controls that management believes should be improved. The company’s review continues, but to date, it has not identified any material weaknesses in its internal controls as defined by the Public Company Accounting Oversight Board. The company is nonetheless making improvements to its internal controls over financial reporting as a result of its review efforts. These planned improvements include the formalization of accounting policies and procedures, account reconciliations, financial statement analysis, review and authorization of transactions, and security of applications, databases and transactions.
Part II – Other Information
Item 1. Legal Proceedings
There has been no material change in the status of previously reported proceedings. The company’s subsidiaries are involved in various lawsuits arising in the ordinary course of business. While the ultimate outcome of such matters cannot be predicted with certainty, in the opinion of management, no such matter is likely to have a material adverse effect on the company’s consolidated financial position.
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds
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The company’s board of directors has authorized the repurchase of outstanding shares. The company has repurchased 16.4 million shares at a cost of $543 million between the inception of the program in 1996 and September 30, 2004. At September 30, 2004, fewer than 5 million shares remain authorized for repurchase at any time in the future.
Item 3. Defaults upon Senior Securities
The company has not defaulted on any interest or principal payment, and no arrearage in the payment of dividends has occurred.
Item 4. Submission of Matters to a Vote of Security Holders
No matters were submitted to a vote of security holders during the quarter.
Item 5. Other Information
Status of Application to SEC Requesting Exemption from Investment Company Act of 1940
On August 26, 2004, the company announced that Cincinnati Financial Corporation transferred investment securities with a market value of $1.600 billion to The Cincinnati Insurance Company, the lead property casualty insurance subsidiary. This action was related to the company’s June 28, 2004, application to the SEC seeking exemptive relief under the Investment Company Act of 1940. The transfer was authorized by Cincinnati Financial’s board of directors on August 13, 2004, and approved by the Ohio Department of Insurance on August 24, 2004.
After the contribution of $1.600 billion in marketable investment securities to The Cincinnati Insurance Company from the holding company, the ratio of investment securities held at the holding company level was 35.7 percent of total holding-company-only assets at September 30, 2004.
As previously reported, as a result of a review made in June 2004, the company determined there was some uncertainty regarding the status of the Cincinnati Financial Corporation holding company under the Investment Company Act of 1940. On June 28, 2004, Cincinnati Financial Corporation filed an application with the Securities and Exchange Commission formally requesting an exemption for the holding company under Section 3(b)(2) of the Investment Company Act, which permits the SEC to exempt entities primarily engaged in business other than that of investing, reinvesting, owning, holding or trading in securities. Cincinnati Financial Corporation alternatively has asked the SEC for relief pursuant to Section 6(c) of the Investment Company Act that would exempt it from all the provisions of the Act because doing so is necessary or appropriate in the public interest consistent with the protection of investors and consistent with the purposes intended by the Investment Company Act. The company simultaneously contacted the SEC’s Division of Investment Management to discuss the status of Cincinnati Financial Corporation under the Investment Company Act. As of the filing date of this Form 10-Q, the request for an exemptive order has not been acted on by the staff of the SEC.
Management strongly believes the holding company is, and has been, outside the intended scope of the Investment Company Act because the company is, and has been, primarily engaged in the business of property casualty and life insurance through our subsidiaries. Several tests and enumerated exemptions determine whether a company meets the definition of an investment company under the Investment Company Act. One test states that a company is an investment company if it owns investment securities with a value greater than 40 percent of its total assets (excluding assets of its subsidiaries).
Registered investment companies are not permitted to operate their business in the manner in which Cincinnati Financial is operated, nor are registered investment companies permitted to have many of the relationships that the parent company has with its affiliated companies. If it were to be determined that the company was an unregistered investment company before the asset transfer, Cincinnati Financial may be unable to enforce contracts with third parties, and third parties could seek to obtain rescission of transactions with Cincinnati Financial undertaken during the period that it was an unregistered investment company, subject to equitable considerations set forth in the Investment Company Act. As a result, it could be determined that holders of Cincinnati Financial’s $420 million aggregate principal amount of 6.90% Senior Debentures due 2028 have a right to rescind such indebtedness, thereby requiring Cincinnati Financial to immediately repay such amounts. Cincinnati Financial may be unable to refinance such obligations on acceptable terms as a result of its potential status under the Investment Company Act. However, Cincinnati Financial currently has available sufficient assets to fund such repayment and believes that its assets are adequate to meet its short- and long-term obligations.
To avoid regulation under the Investment Company Act in the future, the company’s operations will to an extent be limited by the constraint that investment securities held at the holding company level remain below the 40 percent
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threshold described above. These considerations could require the company to dispose of otherwise desirable investment securities under undesirable conditions or otherwise avoid economically advantageous transactions. Although management intends to manage assets to stay below the 40 percent threshold (unless the SEC grants the company’s request for an exemptive order), events beyond our control, including significant appreciation in the market value of certain investment securities, could result in the company breaching the 40 percent threshold. Although management believes that even in such circumstances the company would not be an investment company because it is primarily engaged in the business of insurance through its subsidiaries, the SEC among others could disagree with this position. If it were established that the company is an unregistered investment company, there would be a risk, among the other material adverse consequences described above, that the company could become subject to monetary penalties or injunctive relief, or both, in an action brought by the SEC.
Item 6. Exhibits and Reports on Form 8-K
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Signature
Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.
Date: November 8, 2004
/S/ Kenneth W. Stecher
Kenneth W. StecherChief Financial Officer and Senior Vice President, Secretary, Treasurer(Principal Accounting Officer)
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