Cincinnati Financial (CINF): Over 50 Consecutive Years Of Dividend Growth & A 3.4% Yield by Simply Safe Dividends

Cincinnati Financial (CINF) has increased its dividend for 54 consecutive years, an impressive streak that only eight U.S. public companies can match.

With a 3.4% dividend yield, a large base of recurring revenue, and excellent free cash flow generation, CINF is the type of stock we like to own in our Top 20 Dividend Stocks portfolio.

Business Overview

Cincinnati Financial was formed in 1950 and is among the top 25 U.S. property casualty insurers today, offering business, home, and auto insurance. Insurance companies make money by writing and selling insurance policies (which typically breaks even or loses money for most insurers), and investing policy proceeds for income until claims need to be paid out (this is where the money is really made). Local independent insurance agencies market CINF’s policies within their communities, which span across nearly 40 states.

The company’s mix by premiums written in 2014 was 67% commercial, 25% personal, 5% life, and 3% excess & surplus. By state, 18% of CINF’s premiums came from Ohio, 7% from Illinois, 6% from Indiana, 6% from Pennsylvania, 5% from North Carolina, 5% from Georgia, and 5% from Michigan.

Business Analysis

Insurance companies live and die by managing risk. If insurers fail to price risk accordingly in their policies, they won’t be around for long. Compared to some insurers, CINF’s underwriting process is somewhat more aggressive because the company targets a combined ratio of 95% to 100%, which means that it expects its policies to be slightly profitable at best (when a combined ratio is below 100%, the company achieves an underwriting profit).

However, as seen below, CINF’s combined ratio has outperformed the industry all but one of the past five years. The company has also produced 26 years of favorable loss reserve developments, which means it has conservatively booked more losses than it has actually realized each year. Cincinnati Financial’s reinsurance program also limits its losses beyond certain thresholds, and its pristine balance sheet provides additional comfort.

Cincinnati Financial (CINF)

Source: CINF Investor Presentation

In addition to CINF’s proven risk management track record, the company has several other competitive advantages. Its large size (CINF is one of the 25 biggest U.S. P&C insurers) provides economies of scale in marketing, administrative operations, and support staff. Cincinnati Financial  is able to spread these costs over a sizable pool of insurance policies to keep its prices very competitive. CINF is also able to price its premiums lower than smaller competitors because its risk is reduced with a larger pool of policies.

Furthermore, the company’s long operating history, range of insurance products, and size provides branding benefits and trust with the agencies that market CINF’s policies. Establishing and supporting relationships with agencies takes significant time and cost but provides Cincinnati Financial with relatively low-cost distribution advantages.

Cincinnati Financial has over 1,500 agency relationships in nearly 2,000 locations across the country and does everything possible to support them. The company doesn’t compete with agencies by selling online or direct to consumers and employs nearly 3,000 associates who provide support to field associates. As a result, CINF is the number one or number two carrier by premium volume in nearly 75% of agencies partnered with it for five years or more, although an agency may represent dozens of carriers.

As seen below, CINF has also been effective at expanding its market share with agencies over time. CINF says that its net amount of agency relationships has increased by 28% since the end of 2009 and that it still only has about 11% market share of the estimated $39 billion total P&C premiums produced by currently appointed agencies, leaving plenty of room for future expansion of relationships.

Cincinnati Financial (CINF)

Source: CINF Investor Presentation

In addition to effective distribution channels, the insurance market also requires strict compliance with regulations and substantial amounts of capital to compete. A large pool of policies and financial assets are needed for an insurer to be able to pay out claims and survive catastrophes, creating barriers to entry for new players.

While catastrophic events can strike at any time, some states are more prone to them than others. For example, California and Florida are frequently hit by earthquakes, hurricanes, and other natural disasters. One of the things we like about Cincinnati Financial is that it has no presence in California and a minimal presence in Florida. Most of its operations are in the Midwest, perhaps reducing its exposure to catastrophes.

Finally, the mature state of the P&C insurance market provides another advantage for Cincinnati Financial. When a market’s growth rate is low, new entrants have to steal market share from incumbents to gain a foothold. CINF’s policy renewal rate is between 80% and 90% most years, providing a solid base of recurring revenue that helps it keep its policy prices competitive and market share stable. Insurance is also a product that is always in demand regardless of economic cycles, which has helped CINF generate consistent results.

Cincinnati Financial (CINF): Key Risks

The insurance industry goes through pricing cycles, which significantly impacts its profitability. Insurance is essentially a commodity, so pricing follows supply and demand. Demand is generally stable given the non-discretionary nature of insurance, so supply is the main driver.

When insurers have a healthy pool of profits, strong capital reserves, and excess underwriting capacity, they are more apt to lower pricing to chase market share. This environment typically results from several years of minimal natural disasters and catastrophes.

After a period of catastrophes and tighter capital conditions, there is less underwriting capacity in the market as insurers look to improve their financial condition. These periods are marked by better profitability and more rational pricing. Cincinnati Financial must put up with this cyclicality and remain disciplined with its pricing of risk and balance sheet strength, regardless of market conditions.

Of course, unexpected catastrophes are the biggest risk faced by insurers. A “perfect storm” can wipe out smaller, less disciplined players completely. As we mentioned earlier, CINF is fairly well diversified with the states it does business in, avoids some of the riskier ones like California, and has a long operating history which adds to our confidence in its conservative underwriting process. Even still, record high catastrophe losses in 2011 caused CINF’s payout ratio to spike over 150% – you can never be too sure with insurers. A.M. Best also noted that 2013-2015 marks the first time since the early 1970s that the industry’s underwriting has been profitable in three consecutive calendar years – perhaps the next underwriting profit cycle is about to begin.

Underwriting aside, Cincinnati Financial does have more risk with its investment portfolio than many other insurers because it has around 30% of its portfolio in common stocks (most other insurers invest 10-20% of their portfolio in stocks). The portfolio is diversified (no stock is more than 3.6% of the portfolio) and invested in dividend growth stocks (all 50 stocks raised their dividend last year), but these investments are still more volatile than investment grade bonds.

Finally, it’s worth noting that while the insurance industry

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