CINCINNATI FINANCIAL CORP 10-Q

Item 3. Quantitative and Qualitative Disclosures About Market Risk Our greatest exposure to market risk is through our investment portfolio. Market risk is the potential for a decrease in securities' fair value resulting from broad yet uncontrollable forces such as: inflation, economic growth or recession, interest rates, world political conditions or other widespread unpredictable events. It is comprised of many individual risks that, when combined, create a macroeconomic impact. Our view of potential risks and our sensitivity to such risks is discussed in our 2021 Annual Report on Form 10-K, Item 7A, Quantitative and Qualitative Disclosures About Market Risk, Page 112. The fair value of our investment portfolio was $23.051 billion at March 31, 2022, down $1.286 billion from year-end 2021, including a $646 million decrease in the fixed-maturity portfolio and a $640 million decrease in the equity portfolio. (Dollars in millions) At March 31, 2022 At December 31, 2021 Cost or amortized cost Percent of total Fair value Percent of total Cost or amortized cost Percent of total Fair value Percent of total Taxable fixed maturities $ 8,470 51.3 % $ 8,467 36.7 % $ 8,344 51.0 % $ 8,858 36.4 % Tax-exempt fixed maturities 3,860 23.4 3,909 17.0 3,886 23.8 4,164 17.1 Common equities 3,743 22.7 10,245 44.4 3,697 22.6 10,862 44.6 Nonredeemable preferred equities 424 2.6 430 1.9 424 2.6 453 1.9 Total $ 16,497 100.0 % $ 23,051 100.0 % $ 16,351 100.0 % $ 24,337 100.0 % At March 31, 2022, substantially all of our consolidated investment portfolio, measured at fair value, are classified as Level 1 or Level 2. See Item 1, Note 3, Fair Value Measurements, for additional discussion of our valuation techniques. In addition to our investment portfolio, the total investments amount reported in our condensed consolidated balance sheets includes Other invested assets. Other invested assets included $249 million of private equity investments, $35 million of real estate through direct property ownership and development projects in the United States, $34 million in Lloyd's deposits and $30 million of life policy loans at March 31, 2022. Cincinnati Financial Corporation First-Quarter 2022 10-Q Page 55 FIXED-MATURITY SECURITIES INVESTMENTS By maintaining a well-diversified fixed-maturity portfolio, we attempt to reduce overall risk. We invest new money in the bond market on a regular basis, targeting what we believe to be optimal risk-adjusted, after-tax yields. Risk, in this context, includes interest rate, call, reinvestment rate, credit and liquidity risk. We do not make a concerted effort to alter duration on a portfolio basis in response to anticipated movements in interest rates. By regularly investing in the bond market, we build a broad, diversified portfolio that we believe mitigates the impact of adverse economic factors. In the first three months of 2022, the decrease in fair value of our fixed-maturity portfolio reflected net purchases of securities, offset by a decrease in net unrealized gains, primarily due to an increase in U.S. Treasury yields and to a lesser degree a widening of corporate credit spreads. At March 31, 2022, our fixed-maturity portfolio with an average rating of A3/A was valued at 100.4% of its amortized cost, compared with 106.5% at December 31, 2021. At March 31, 2022, our investment-grade and noninvestment-grade fixed-maturity securities represented 79.9% and 5.1% of the portfolio, respectively. The remaining 15.0% represented fixed-maturity securities that were not rated by Moody's or S&P Global Ratings. Attributes of the fixed-maturity portfolio include: At March 31, 2022 At December 31, 2021 Weighted average yield-to-amortized cost 4.00 % 4.02 % Weighted average maturity 7.9 yrs 8.0 yrs Effective duration 4.9 yrs 4.8 yrs We discuss maturities of our fixed-maturity portfolio in our 2021 Annual Report on Form 10-K, Item 8, Note 2, Investments, Page 134, and in this quarterly report Item 2, Investments Results. Cincinnati Financial Corporation First-Quarter 2022 10-Q Page 56 TAXABLE FIXED MATURITIES Our taxable fixed-maturity portfolio, with a fair value of $8.467 billion at March 31, 2022, included: (Dollars in millions) At March 31, 2022 At December 31, 2021 Investment-grade corporate $ 6,535 $ 6,807 States, municipalities and political subdivisions 901 931 Noninvestment-grade corporate 614 690 Commercial mortgage-backed 266 273 United States government 112 123 Foreign government 25 26 Government-sponsored enterprises 14 8 Total $ 8,467 $ 8,858 Our strategy is to buy, and typically hold, fixed-maturity investments to maturity, but we monitor credit profiles and fair value movements when determining holding periods for individual securities. With the exception of United States agency issues that include government-sponsored enterprises, no individual issuer's securities accounted for more than 0.9% of the taxable fixed-maturity portfolio at March 31, 2022. Our investment-grade corporate bonds had an average rating of Baa2 by Moody's or BBB by S&P Global Ratings and represented 77.2% of the taxable fixed-maturity portfolio's fair value at March 31, 2022, compared with 76.9% at year-end 2021. The heaviest concentration in our investment-grade corporate bond portfolio, based on fair value at March 31, 2022, was the financial sector. It represented 41.0% of our investment-grade corporate bond portfolio, compared with 41.4% at year-end 2021. The energy sector represented 10.7% and was less than 10% at year-end 2021. No other sector exceeded 10% of our investment-grade corporate bond portfolio. Our taxable fixed-maturity portfolio at March 31, 2022, included $266 million of commercial mortgage-backed securities with an average rating of Aa2/AA. TAX-EXEMPT FIXED MATURITIES At March 31, 2022, we had $3.909 billion of tax-exempt fixed-maturity securities with an average rating of Aa2/AA by Moody's and S&P Global Ratings. We traditionally have purchased municipal bonds focusing on general obligation and essential services issues, such as water, waste disposal or others. The portfolio is well diversified among approximately 1,700 municipal bond issuers. No single municipal issuer accounted for more than 0.6% of the tax-exempt fixed-maturity portfolio at March 31, 2022. INTEREST RATE SENSITIVITY ANALYSIS Because of our strong surplus, long-term investment horizon and ability to hold most fixed-maturity investments until maturity, we believe the company is adequately positioned if interest rates were to rise. Although the fair values of our existing holdings may suffer, a higher rate environment would provide the opportunity to invest cash flow in higher-yielding securities, while reducing the likelihood of untimely redemptions of currently callable securities. While higher interest rates would be expected to continue to increase the number of fixed-maturity holdings trading below 100% of amortized cost, we believe lower fixed-maturity security values due solely to interest rate changes would not signal a decline in credit quality. We continue to manage the portfolio with an eye toward both meeting current income needs and managing interest rate risk. Our dynamic financial planning model uses analytical tools to assess market risks. As part of this model, the effective duration of the fixed-maturity portfolio is continually monitored by our investment department to evaluate the theoretical impact of interest rate movements. Cincinnati Financial Corporation First-Quarter 2022 10-Q Page 57 The table below summarizes the effect of hypothetical changes in interest rates on the fair value of the fixed-maturity portfolio: (Dollars in millions) Effect from interest rate change in basis points -200 -100 - 100 200 At March 31, 2022 $ 13,620 $ 12,989 $ 12,376 $ 11,763 $ 11,151 At December 31, 2021 $ 14,327 $ 13,656 $ 13,022 $ 12,399 $ 11,768 The effective duration of the fixed-maturity portfolio as of March 31, 2022, was 4.9 years, up from 4.8 years at year-end 2021. The above table is a theoretical presentation showing that an instantaneous, parallel shift in the yield curve of 100 basis points could produce an approximately 5.0% change in the fair value of the fixed-maturity portfolio. Generally speaking, the higher a bond is rated, the more directly correlated movements in its fair value are to changes in the general level of interest rates, exclusive of call features. The fair values of average- to lower-rated corporate bonds are additionally influenced by the expansion or contraction of credit spreads. In our dynamic financial planning model, the selected interest rate change of 100 to 200 basis points represents our view 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 our results or financial condition, nor does it take into account any actions that we might take to reduce exposure to such risks. EQUITY INVESTMENTS Our equity investments, with a fair value totaling $10.675 billion at March 31, 2022, included $10.245 billion of common stock securities of companies generally with strong indications of paying and growing their dividends. Other criteria we evaluate include increasing sales and earnings, proven management and a favorable outlook. We believe our equity investment style is an appropriate long-term strategy. While our long-term financial position would be affected by prolonged changes in the market valuation of our investments, we believe our strong surplus position and cash flow provide a cushion against short-term fluctuations in valuation. Continued payment of cash dividends by the issuers of our common equity holdings can provide a floor to their valuation. The table below summarizes the effect of hypothetical changes in market prices on fair value of our equity portfolio. (Dollars in millions) Effect from market price change in percent -30% -20% -10% — 10% 20% 30% At March 31, 2022 $ 7,473 $ 8,540 $ 9,608 $ 10,675 $ 11,743 $ 12,810 $ 13,878 At December 31, 2021 $ 7,921 $ 9,052 $ 10,184 $ 11,315 $ 12,447 $ 13,578 $ 14,710 At March 31, 2022, Apple Inc. (Nasdaq:AAPL) was our largest single common stock holding with a fair value of $848 million, or 8.3% of our publicly traded common stock portfolio and 3.7% of the total investment portfolio. Forty-four holdings among 10 different sectors each had a fair value greater than $100 million. Cincinnati Financial Corporation First-Quarter 2022 10-Q Page 58 Common Stock Portfolio Industry Sector Distribution Percent of common stock portfolio At March 31, 2022 At December 31, 2021 Cincinnati Financial S&P 500 Industry Weightings Cincinnati Financial S&P 500 Industry Weightings Sector: Information technology 30.1 % 28.0 % 31.1 % 29.2 % Healthcare 14.2 13.6 13.5 13.3 Financial 13.9 11.1 14.2 10.7 Industrials 11.0 7.9 11.1 7.8 Consumer staples 7.3 6.1 6.9 5.9 Consumer discretionary 7.1 12.0 8.3 12.5 Energy 5.2 3.9 4.0 2.7 Materials 4.1 2.6 4.4 2.5 Utilities 2.9 2.7 2.2 2.5 Real estate 2.6 2.7 2.7 2.8 Telecomm services 1.6 9.4 1.6 10.1 Total 100.0 % 100.0 % 100.0 % 100.0 % UNREALIZED INVESTMENT GAINS AND LOSSES At March 31, 2022, unrealized investment gains before taxes for the fixed-maturity portfolio totaled $291 million and unrealized investment losses amounted to $245 million before taxes. The $46 million net unrealized gain position in our fixed-maturity portfolio at March 31, 2022, decreased in the first three months of 2022, primarily due to an increase in U.S. Treasury yields and to a lesser degree a widening of corporate credit spreads. The net gain position for our current fixed-maturity holdings will naturally decline over time as individual securities mature. In addition, changes in interest rates can cause rapid, significant changes in fair values of fixed-maturity securities and the net gain position, as discussed in Quantitative and Qualitative Disclosures About Market Risk. For federal income tax purposes, taxes on gains from appreciated investments generally are not due until securities are sold. We believe that the appreciated value of equity securities, compared with the cost of securities that is generally used as a tax basis, is a useful measure to help evaluate how fair value can change over time. On this basis, the net unrealized investment gains at March 31, 2022, consisted of a net gain position in our equity portfolio of $6.508 billion. Events or factors such as economic growth or recession can affect the fair value and unrealized investment gains of our equity securities. The five largest holdings in our common stock portfolio were Apple, Microsoft (Nasdaq:MSFT), Accenture Co. (NYSE:ACN), UnitedHealth Group Inc. (NYSE:UNH) and BlackRock Inc. (NYSE:BLK), which had a combined fair value of $2.633 billion. Unrealized Investment Losses We expect the number of fixed-maturity securities trading below amortized cost to fluctuate as interest rates rise or fall and credit spreads expand or contract due to prevailing economic conditions. Further, amortized costs for some securities are revised through write-downs recognized in prior periods. At March 31, 2022, 1,377 of the 4,362 fixed-maturity securities we owned had fair values below amortized cost, compared with 278 of the 4,329 securities we owned at year-end 2021. The 1,377 holdings with fair values below amortized cost at March 31, 2022, represented 31.6% of the fair value of our fixed-maturity investment portfolio and $245 million in unrealized losses. • 1,103 of the 1,377 holdings had fair value between 90% and 100% of amortized cost at March 31, 2022. These primarily consist of securities whose current valuation is largely the result of interest rate factors. The fair value of these 1,103 securities was $3.063 billion, and they accounted for $121 million in unrealized losses. • 274 of the 1,377 fixed-maturity holdings had fair value between 70% and 90% of amortized cost at March 31, 2022. We believe the 274 fixed-maturity securities will continue to pay interest and ultimately pay Cincinnati Financial Corporation First-Quarter 2022 10-Q Page 59 principal upon maturity. The issuers of these 274 securities have strong cash flow to service their debt and meet their contractual obligation to make principal payments. The fair value of these securities was $846 million, and they accounted for $124 million in unrealized losses. • None of the fixed-maturity holdings had fair value below 70% of amortized cost at March 31, 2022. The table below reviews fair values and unrealized losses by investment category and by the overall duration of the securities' continuous unrealized loss position. (Dollars in millions) Less than 12 months 12 months or more Total At March 31, 2022 Fair value Unrealized losses Fair value Unrealized losses Fair value Unrealized losses Fixed maturity securities: Corporate $ 2,603 $ 157 $ 78 $ 9 $ 2,681 $ 166 States, municipalities and political subdivisions 977 72 21 4 998 76 Commercial mortgage-backed 128 2 10 — 138 2 United States government 72 1 — — 72 1 Foreign government 7 — — — 7 — Government-sponsored enterprises 10 — 3 — 13 — Total $ 3,797 $ 232 $ 112 $ 13 $ 3,909 $ 245 At December 31, 2021 Fixed maturity securities: Corporate $ 861 $ 13 $ 15 $ — $ 876 $ 13 States, municipalities and political subdivisions 105 2 2 1 107 3 Commercial mortgage-backed 10 — 11 — 21 — United States government 48 — — — 48 — Foreign government 16 — — — 16 — Government-sponsored enterprises 7 — — — 7 — Total $ 1,047 $ 15 $ 28 $ 1 $ 1,075 $ 16 At March 31, 2022, applying our invested asset impairment policy, we determined that the total of $245 million, for securities in an unrealized loss position in the table above, was not the result of a credit loss. During the first three months of 2022, one fixed-maturity security that was written down to fair value, due to an intention to be sold, and changes in allowance for credit losses were each less than $1 million. During the first three months of 2021, no securities were written down to fair value due to an intention to be sold and we had no allowance for credit losses. During the full year of 2021, we wrote down five securities and recorded $1 million in impairment charges. At December 31, 2021, 278 fixed-maturity securities with a total unrealized loss of $16 million were in an unrealized loss position. Of that total, no fixed-maturity securities had fair values below 70% of amortized cost. Cincinnati Financial Corporation First-Quarter 2022 10-Q Page 60 The following table summarizes the investment portfolio by severity of decline: (Dollars in millions) Number of issues Amortized cost Fair value Gross unrealized gain (loss) Gross investment income At March 31, 2022 Taxable fixed maturities: Fair valued below 70% of amortized cost — $ — $ — $ — $ — Fair valued at 70% to less than 100% of amortized cost 974 3,607 3,403 (204) 32 Fair valued at 100% and above of amortized cost 1,146 4,863 5,064 201 58 Investment income on securities sold in current year — — — — 2 Total 2,120 8,470 8,467 (3) 92 Tax-exempt fixed maturities: Fair valued below 70% of amortized cost — — — — — Fair valued at 70% to less than 100% of amortized cost 403 547 506 (41) 4 Fair valued at 100% and above of amortized cost 1,839 3,313 3,403 90 27 Investment income on securities sold in current year — — — — — Total 2,242 3,860 3,909 49 31 Fixed-maturities summary: Fair valued below 70% of amortized cost — — — — — Fair valued at 70% to less than 100% of amortized cost 1,377 4,154 3,909 (245) 36 Fair valued at 100% and above of amortized cost 2,985 8,176 8,467 291 85 Investment income on securities sold in current year — — — — 2 Total 4,362 $ 12,330 $ 12,376 $ 46 $ 123 At December 31, 2021 Fixed-maturities summary: Fair valued below 70% of amortized cost — $ — $ — $ — $ — Fair valued at 70% to less than 100% of amortized cost 278 1,091 1,075 (16) 17 Fair valued at 100% and above of amortized cost 4,051 11,139 11,947 808 427 Investment income on securities sold in current year — — — — 33 Total 4,329 $ 12,230 $ 13,022 $ 792 $ 477 See our 2021 Annual Report on Form 10-K, Item 7, Critical Accounting Estimates, Asset Impairment, Page 57.