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 2022 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 $22.645 billion at March 31, 2023, up $672 million from year-end 2022, including a $546 million increase in the fixed-maturity portfolio and a $126 million increase in the equity portfolio. (Dollars in millions) At March 31, 2023 At December 31, 2022 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 $ 9,367 53.0 % $ 8,749 38.6 % $ 9,020 52.2 % $ 8,299 37.8 % Tax-exempt fixed maturities 3,995 22.6 3,929 17.4 3,959 22.9 3,833 17.4 Common equities 3,862 21.9 9,589 42.3 3,851 22.3 9,454 43.0 Nonredeemable preferred equities 449 2.5 378 1.7 443 2.6 387 1.8 Total $ 17,673 100.0 % $ 22,645 100.0 % $ 17,273 100.0 % $ 21,973 100.0 % At March 31, 2023, substantially all of our consolidated investment portfolio, measured at fair value, is 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 $352 million of private equity investments, $60 million of real estate through direct property ownership and development projects in the United States, $36 million in Lloyd's deposits and $30 million of life policy loans at March 31, 2023. Cincinnati Financial Corporation First-Quarter 2023 10-Q Page 61 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 2023, the increase in fair value of our fixed-maturity portfolio reflected net purchases of securities and a decrease in net unrealized losses, primarily due to a decrease in U.S. Treasury yields that was partially offset by a widening of corporate credit spreads. At March 31, 2023, our fixed-maturity portfolio with an average rating of A2/A was valued at 94.9% of its amortized cost, compared with 93.5% at December 31, 2022. At March 31, 2023, our investment-grade and noninvestment-grade fixed-maturity securities represented 80.4% and 4.1% of the portfolio, respectively. The remaining 15.5% 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, 2023 At December 31, 2022 Weighted average yield-to-amortized cost 4.39 % 4.22 % Weighted average maturity 7.6 yrs 7.4 yrs Effective duration 4.6 yrs 4.7 yrs We discuss maturities of our fixed-maturity portfolio in our 2022 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 2023 10-Q Page 62 TAXABLE FIXED MATURITIES Our taxable fixed-maturity portfolio, with a fair value of $8.749 billion at March 31, 2023, included: (Dollars in millions) At March 31, 2023 At December 31, 2022 Investment-grade corporate $ 6,579 $ 6,369 States, municipalities and political subdivisions 820 789 Noninvestment-grade corporate 512 500 Government-sponsored enterprises 387 183 Commercial mortgage-backed 225 234 United States government 195 191 Foreign government 31 33 Total $ 8,749 $ 8,299 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 1.3% of the taxable fixed-maturity portfolio at March 31, 2023. Our investment-grade corporate bonds had an average rating of Baa1 by Moody's or BBB by S&P Global Ratings and represented 75.2% of the taxable fixed-maturity portfolio's fair value at March 31, 2023, compared with 76.7% at year-end 2022. The heaviest concentration in our investment-grade corporate bond portfolio, based on fair value at March 31, 2023, was the financial sector. It represented 42.2% of our investment-grade corporate bond portfolio, compared with 42.7% at year-end 2022. The energy sector represented 11.1% and was 10.8% at year-end 2022. No other sector exceeded 10% of our investment-grade corporate bond portfolio. As discussed in our 2022 Annual Report on Form 10-K, Item 1A, Risk Factors, Page 32, investments in the financial sector include various risks. See risk factors entitled “Financial disruption or a prolonged economic downturn could materially and adversely affect our investment performance” and “Our ability to achieve our performance objectives could be affected by changes in the financial, credit and capital markets or the general economy”. Our taxable fixed-maturity portfolio at March 31, 2023, included $225 million of commercial mortgage-backed securities with an average rating of Aa2/AA-. TAX-EXEMPT FIXED MATURITIES At March 31, 2023, we had $3.929 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, 2023. 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 2023 10-Q Page 63 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, 2023 $ 13,866 $ 13,268 $ 12,678 $ 12,082 $ 11,485 At December 31, 2022 $ 13,300 $ 12,714 $ 12,132 $ 11,548 $ 10,974 The effective duration of the fixed-maturity portfolio as of March 31, 2023, was 4.6 years, down from 4.7 years at year-end 2022. 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 4.7% 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 $9.967 billion at March 31, 2023, included $9.589 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, 2023 $ 6,977 $ 7,974 $ 8,970 $ 9,967 $ 10,964 $ 11,960 $ 12,957 At December 31, 2022 $ 6,889 $ 7,873 $ 8,857 $ 9,841 $ 10,825 $ 11,809 $ 12,793 At March 31, 2023, Apple Inc. (Nasdaq:AAPL) was our largest single common stock holding with a fair value of $758 million, or 7.9% of our publicly traded common stock portfolio and 3.3% of the total investment portfolio. Forty-one holdings among nine different sectors each had a fair value greater than $100 million. Cincinnati Financial Corporation First-Quarter 2023 10-Q Page 64 Common Stock Portfolio Industry Sector Distribution Percent of common stock portfolio At March 31, 2023 At December 31, 2022 Cincinnati Financial S&P 500 Industry Weightings Cincinnati Financial S&P 500 Industry Weightings Sector: Information technology 29.3 % 26.1 % 26.5 % 25.7 % Healthcare 13.1 14.2 15.0 15.8 Financial 12.6 12.9 13.6 11.7 Industrials 12.6 8.7 11.9 8.7 Consumer staples 8.7 7.2 8.8 7.2 Consumer discretionary 7.3 10.1 7.7 9.8 Energy 4.9 4.6 5.0 5.2 Materials 4.8 2.6 5.0 2.7 Utilities 2.9 2.9 2.9 3.2 Real estate 2.4 2.6 2.3 2.7 Telecomm services 1.4 8.1 1.3 7.3 Total 100.0 % 100.0 % 100.0 % 100.0 % UNREALIZED INVESTMENT GAINS AND LOSSES At March 31, 2023, unrealized investment gains before taxes for the fixed-maturity portfolio totaled $92 million and unrealized investment losses amounted to $776 million before taxes. The $684 million net unrealized loss position in our fixed-maturity portfolio at March 31, 2023, decreased in the first three months of 2023, primarily due to a decrease in U.S. Treasury yields that was partially offset by a widening of corporate credit spreads. The net loss position for our current fixed-maturity holdings will naturally decline over time as individual securities approach maturity. In addition, changes in interest rates can cause rapid, significant changes in fair values of fixed-maturity securities and the net loss 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, 2023, consisted of a net gain position in our equity portfolio of $5.656 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), Broadcom Inc. (Nasdaq:AVGO), UnitedHealth Group Inc. (NYSE:UNH), and AbbVie Inc. (NYSE:ABBV), which had a combined fair value of $2.411 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, 2023, 2,900 of the 4,606 fixed-maturity securities we owned had fair values below amortized cost, compared with 3,272 of the 4,521 securities we owned at year-end 2022. The 2,900 holdings with fair values below amortized cost at March 31, 2023, represented 39.9% of the fair value of our fixed-maturity investment portfolio and $776 million in unrealized losses. • 1,905 of the 2,900 holdings had fair value between 90% and 100% of amortized cost at March 31, 2023. These primarily consist of securities whose current valuation is largely the result of interest rate factors. The fair value of these 1,905 securities was $6.595 billion, and they accounted for $240 million in unrealized losses. • 969 of the 2,900 fixed-maturity holdings had fair value between 70% and 90% of amortized cost at March 31, 2023. We believe the 969 fixed-maturity securities will continue to pay interest and ultimately pay Cincinnati Financial Corporation First-Quarter 2023 10-Q Page 65 principal upon maturity. The issuers of these 969 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 $2.394 billion, and they accounted for $511 million in unrealized losses. • 26 of the 2,900 fixed-maturity holdings had fair value below 70% of amortized cost at March 31, 2023. We believe these fixed-maturity securities will continue to pay interest and ultimately pay principal upon maturity. The fair value of these securities was $49 million, and they accounted for $25 million in unrealized losses. 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, 2023 Fair value Unrealized losses Fair value Unrealized losses Fair value Unrealized losses Fixed-maturity securities: Corporate $ 3,910 $ 158 $ 2,273 $ 368 $ 6,183 $ 526 States, municipalities and political subdivisions 1,287 48 890 178 2,177 226 Government-sponsored enterprises 263 3 7 1 270 4 Commercial mortgage-backed 107 5 116 11 223 16 United States government 121 1 52 3 173 4 Foreign government 10 — 2 — 12 — Total $ 5,698 $ 215 $ 3,340 $ 561 $ 9,038 $ 776 At December 31, 2022 Fixed-maturity securities: Corporate $ 5,651 $ 412 $ 661 $ 168 $ 6,312 $ 580 States, municipalities and political subdivisions 2,600 274 77 29 2,677 303 Government-sponsored enterprises 123 3 3 — 126 3 Commercial mortgage-backed 215 13 14 3 229 16 United States government 146 3 41 2 187 5 Foreign government 25 1 4 — 29 1 Total $ 8,760 $ 706 $ 800 $ 202 $ 9,560 $ 908 At March 31, 2023, applying our invested asset impairment policy, we determined that the total of $776 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 2023, no fixed-maturity securities were written down to fair value, due to an intention to be sold. Changes in allowance for credit losses were less than $1 million during the first three months of 2023. During the first three months of 2022, one security was written down to fair value due to an intention to be sold, resulting in less than $1 million of noncash charges, in addition to less than $1 million in changes in allowance for credit losses. During the full year of 2022, we wrote down three securities and recorded $5 million in impairment charges. At December 31, 2022, 3,272 fixed-maturity securities with a total unrealized loss of $908 million were in an unrealized loss position. Of that total, 49 fixed-maturity securities had fair values below 70% of amortized cost. Cincinnati Financial Corporation First-Quarter 2023 10-Q Page 66 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, 2023 Taxable fixed maturities: Fair valued below 70% of amortized cost 19 $ 57 $ 38 $ (19) $ 1 Fair valued at 70% to less than 100% of amortized cost 1,935 8,215 7,563 (652) 90 Fair valued at 100% and above of amortized cost 306 1,095 1,148 53 16 Investment income on securities sold in current year — — — — 1 Total 2,260 9,367 8,749 (618) 108 Tax-exempt fixed maturities: Fair valued below 70% of amortized cost 7 17 11 (6) — Fair valued at 70% to less than 100% of amortized cost 939 1,525 1,426 (99) 11 Fair valued at 100% and above of amortized cost 1,400 2,453 2,492 39 21 Investment income on securities sold in current year — — — — — Total 2,346 3,995 3,929 (66) 32 Fixed-maturities summary: Fair valued below 70% of amortized cost 26 74 49 (25) 1 Fair valued at 70% to less than 100% of amortized cost 2,874 9,740 8,989 (751) 101 Fair valued at 100% and above of amortized cost 1,706 3,548 3,640 92 37 Investment income on securities sold in current year — — — — 1 Total 4,606 $ 13,362 $ 12,678 $ (684) $ 140 At December 31, 2022 Fixed-maturities summary: Fair valued below 70% of amortized cost 49 $ 91 $ 61 $ (30) $ 3 Fair valued at 70% to less than 100% of amortized cost 3,223 10,377 9,499 (878) 392 Fair valued at 100% and above of amortized cost 1,249 2,511 2,572 61 92 Investment income on securities sold in current year — — — — 23 Total 4,521 $ 12,979 $ 12,132 $ (847) $ 510 See our 2022 Annual Report on Form 10-K, Item 7, Critical Accounting Estimates, Asset Impairment, Page 58.