Item 3. Quantitative and Qualitative Disclosures About Market Risk
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 $23.372 billion at June 30, 2023, up $1,399 million from year-end 2022, including a $738 million increase in the fixed-maturity portfolio and a $661 million increase in the equity portfolio.
(Dollars in millions) At June 30, 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 $ 9,696 53.6 % $ 8,966 38.4 % $ 9,020 52.2 % $ 8,299 37.8 %
Tax-exempt fixed maturities 4,012 22.2 3,904 16.7 3,959 22.9 3,833 17.4
Common equities 3,939 21.8 10,124 43.3 3,851 22.3 9,454 43.0
Nonredeemable preferred
equities 443 2.4 378 1.6 443 2.6 387 1.8
Total $ 18,090 100.0 % $ 23,372 100.0 % $ 17,273 100.0 % $ 21,973 100.0 %
At June 30, 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 $368 million of private equity investments, $65 million of real estate through direct property ownership and development projects in the United States, $43 million in Lloyd's deposits and $31 million of life policy loans at June 30, 2023.
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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 six months of 2023, the increase in fair value of our fixed-maturity portfolio reflected net purchases of securities and a small decrease in net unrealized losses, primarily due to a decrease in U.S. Treasury yields as well as a tightening of corporate credit spreads. At June 30, 2023, our fixed-maturity portfolio with an average rating of A2/A was valued at 93.9% of its amortized cost, compared with 93.5% at December 31, 2022.
At June 30, 2023, our investment-grade and noninvestment-grade fixed-maturity securities represented 81.0% and 3.9% of the portfolio, respectively. The remaining 15.1% represented fixed-maturity securities that were not rated by Moody's or S&P Global Ratings.
Attributes of the fixed-maturity portfolio include:
At June 30, 2023 At December 31, 2022
Weighted average yield-to-amortized cost 4.55 % 4.22 %
Weighted average maturity 7.7 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.
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TAXABLE FIXED MATURITIES
Our taxable fixed-maturity portfolio, with a fair value of $8.966 billion at June 30, 2023, included:
(Dollars in millions) At June 30, 2023 At December 31, 2022
Investment-grade corporate $ 6,652 $ 6,369
States, municipalities and political subdivisions 808 789
Noninvestment-grade corporate 498 500
Government-sponsored enterprises 574 183
Commercial mortgage-backed 210 234
United States government 204 191
Foreign government 20 33
Total $ 8,966 $ 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 June 30, 2023. Our investment-grade corporate bonds had an average rating of Baa1 by Moody's or BBB by S&P Global Ratings and represented 74.2% of the taxable fixed-maturity portfolio's fair value at June 30, 2023, compared with 76.7% at year-end 2022.
The heaviest concentration in our investment-grade corporate bond portfolio, based on fair value at
June 30, 2023, was the financial sector. It represented 41.7% of our investment-grade corporate bond portfolio, compared with 42.7% at year-end 2022. The energy sector represented 11.4% 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 June 30, 2023, included $210 million of commercial mortgage-backed securities with an average rating of Aa2/AA-.
TAX-EXEMPT FIXED MATURITIES
At June 30, 2023, we had $3.904 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 June 30, 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.
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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 June 30, 2023 $ 14,056 $ 13,462 $ 12,870 $ 12,267 $ 11,660
At December 31, 2022 $ 13,300 $ 12,714 $ 12,132 $ 11,548 $ 10,974
The effective duration of the fixed-maturity portfolio as of June 30, 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 4.6% 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 $10.502 billion at June 30, 2023, included $10.124 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 June 30, 2023 $ 7,351 $ 8,402 $ 9,452 $ 10,502 $ 11,552 $ 12,602 $ 13,653
At December 31, 2022 $ 6,889 $ 7,873 $ 8,857 $ 9,841 $ 10,825 $ 11,809 $ 12,793
At June 30, 2023, Apple Inc. (Nasdaq:AAPL) was our largest single common stock holding with a fair value of $892 million, or 8.8% of our publicly traded common stock portfolio and 3.8% of the total investment portfolio. Thirty-nine holdings among eight different sectors each had a fair value greater than $100 million.
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Common Stock Portfolio Industry Sector Distribution
Percent of common stock portfolio
At June 30, 2023 At December 31, 2022
Cincinnati
Financial S&P 500 Industry
Weightings Cincinnati
Financial S&P 500 Industry
Weightings
Sector:
Information technology 31.9 % 28.3 % 26.5 % 25.7 %
Industrials 12.4 8.5 11.9 8.7
Financial 12.3 12.4 13.6 11.7
Healthcare 12.2 13.4 15.0 15.8
Consumer staples 8.1 6.7 8.8 7.2
Consumer discretionary 7.4 10.7 7.7 9.8
Materials 4.6 2.4 5.0 2.7
Energy 4.4 4.1 5.0 5.2
Utilities 2.8 2.6 2.9 3.2
Real estate 2.5 2.5 2.3 2.7
Telecomm services 1.4 8.4 1.3 7.3
Total 100.0 % 100.0 % 100.0 % 100.0 %
UNREALIZED INVESTMENT GAINS AND LOSSES
At June 30, 2023, unrealized investment gains before taxes for the fixed-maturity portfolio totaled $62 million and unrealized investment losses amounted to $900 million before taxes.
The $838 million net unrealized loss position in our fixed-maturity portfolio at June 30, 2023, decreased in the first six months of 2023, primarily due to a decrease in U.S. Treasury yields as well as a tightening 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 June 30, 2023, consisted of a net gain position in our equity portfolio of $6.120 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), JPMorgan Chase & Co (NYSE:JPM) and UnitedHealth Group Inc. (NYSE:UNH), which had a combined fair value of $2.805 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 June 30, 2023, 3,452 of the 4,673 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 3,452 holdings with fair values below amortized cost at June 30, 2023, represented 80.7% of the fair value of our fixed-maturity investment portfolio and $900 million in unrealized losses.
• 2,321 of the 3,452 holdings had fair value between 90% and 100% of amortized cost at June 30, 2023. These primarily consist of securities whose current valuation is largely the result of interest rate factors. The fair value of these 2,321 securities was $7.626 billion, and they accounted for $280 million in unrealized losses.
• 1,108 of the 3,452 fixed-maturity holdings had fair value between 70% and 90% of amortized cost at
June 30, 2023. We believe the 1,108 fixed-maturity securities will continue to pay interest and ultimately pay
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principal upon maturity. The issuers of these 1,108 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 $2.720 billion, and they accounted for $602 million in unrealized losses.
• 23 of the 3,452 fixed-maturity holdings had fair value below 70% of amortized cost at June 30, 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 $35 million, and they accounted for $18 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 June 30, 2023 Fair value Unrealized
losses Fair value Unrealized
losses Fair
value Unrealized
losses
Fixed-maturity securities:
Corporate $ 2,133 $ 94 $ 4,347 $ 514 $ 6,480 $ 608
States, municipalities and political subdivisions 1,042 11 1,897 251 2,939 262
Government-sponsored enterprises 502 6 32 2 534 8
Commercial mortgage-backed 1 — 208 17 209 17
United States government 144 2 60 3 204 5
Foreign government 15 — — — 15 —
Total $ 3,837 $ 113 $ 6,544 $ 787 $ 10,381 $ 900
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 June 30, 2023, applying our invested asset impairment policy, we determined that the total of $900 million, for securities in an unrealized loss position in the table above, was not the result of a credit loss.
During the first six months of 2023, one fixed-maturity security was written down to fair value, due to an intention to be sold, resulting in $4 million of noncash charges. Changes in allowance for credit losses were $3 million during the first six months of 2023. During the first six months of 2022, two fixed-maturity securities were 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 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.
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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 June 30, 2023
Taxable fixed maturities:
Fair valued below 70% of amortized cost 15 $ 33 $ 22 $ (11) $ 1
Fair valued at 70% to less than 100% of amortized cost 2,057 8,915 8,154 (761) 192
Fair valued at 100% and above of amortized cost 236 748 790 42 24
Investment income on securities sold in current year — — — — 6
Total 2,308 9,696 8,966 (730) 223
Tax-exempt fixed maturities:
Fair valued below 70% of amortized cost 8 20 13 (7) —
Fair valued at 70% to less than 100% of amortized cost 1,372 2,313 2,192 (121) 35
Fair valued at 100% and above of amortized cost 985 1,679 1,699 20 29
Investment income on securities sold in current year — — — — 1
Total 2,365 4,012 3,904 (108) 65
Fixed-maturities summary:
Fair valued below 70% of amortized cost 23 53 35 (18) 1
Fair valued at 70% to less than 100% of amortized cost 3,429 11,228 10,346 (882) 227
Fair valued at 100% and above of amortized cost 1,221 2,427 2,489 62 53
Investment income on securities sold in current year — — — — 7
Total 4,673 $ 13,708 $ 12,870 $ (838) $ 288
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.
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Text extracted from the filing as submitted to EDGAR. Formatting, tables and exhibits are simplified for reading; the original document is authoritative for anything you rely on.