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 $22.874 billion at September 30, 2023, up $901 million from year-end 2022, including a $711 million increase in the fixed-maturity portfolio and a $190 million increase in the equity portfolio.
(Dollars in millions) At September 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 $ 10,070 54.5 % $ 9,175 40.2 % $ 9,020 52.2 % $ 8,299 37.8 %
Tax-exempt fixed maturities 3,980 21.6 3,668 16.0 3,959 22.9 3,833 17.4
Common equities 3,978 21.6 9,678 42.3 3,851 22.3 9,454 43.0
Nonredeemable preferred
equities 421 2.3 353 1.5 443 2.6 387 1.8
Total $ 18,449 100.0 % $ 22,874 100.0 % $ 17,273 100.0 % $ 21,973 100.0 %
At September 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 $398 million of private equity investments, $63 million of real estate through direct property ownership and development projects in the United States, $42 million in Lloyd's deposits and $31 million of life policy loans at September 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 nine months of 2023, the increase in fair value of our fixed-maturity portfolio was due to net purchases of securities and tightening of corporate credit spreads, partially offset by an increase in our net unrealized loss position that reflected an increase in U.S. Treasury yields. At September 30, 2023, our fixed-maturity portfolio with an average rating of A2/A was valued at 91.4% of its amortized cost, compared with 93.5% at December 31, 2022.
At September 30, 2023, our investment-grade and noninvestment-grade fixed-maturity securities represented 80.6% and 3.9% 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 September 30, 2023 At December 31, 2022
Weighted average yield-to-amortized cost 4.48 % 4.22 %
Weighted average maturity 7.6 yrs 7.4 yrs
Effective duration 4.7 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 $9.175 billion at September 30, 2023, included:
(Dollars in millions) At September 30, 2023 At December 31, 2022
Investment-grade corporate $ 6,634 $ 6,369
States, municipalities and political subdivisions 756 789
Noninvestment-grade corporate 479 500
Government-sponsored enterprises 874 183
United States government 217 191
Commercial mortgage-backed 196 234
Foreign government 19 33
Total $ 9,175 $ 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 1.2% of the taxable fixed-maturity portfolio at September 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 72.3% of the taxable fixed-maturity portfolio's fair value at September 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
September 30, 2023, was the financial sector. It represented 40.2% of our investment-grade corporate bond portfolio, compared with 42.7% at year-end 2022. The energy sector represented 11.2% 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 September 30, 2023, included $196 million of commercial mortgage-backed securities with an average rating of Aa3/AA-.
TAX-EXEMPT FIXED MATURITIES
At September 30, 2023, we had $3.668 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 September 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 September 30, 2023 $ 14,050 $ 13,452 $ 12,843 $ 12,229 $ 11,629
At December 31, 2022 $ 13,300 $ 12,714 $ 12,132 $ 11,548 $ 10,974
The effective duration of the fixed-maturity portfolio as of September 30, 2023, was 4.7 years, matching 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 4.8% 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 $10.031 billion at September 30, 2023, included $9.678 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 September 30, 2023 $ 7,022 $ 8,025 $ 9,028 $ 10,031 $ 11,034 $ 12,037 $ 13,040
At December 31, 2022 $ 6,889 $ 7,873 $ 8,857 $ 9,841 $ 10,825 $ 11,809 $ 12,793
At September 30, 2023, Apple Inc. (Nasdaq:AAPL) was our largest single common stock holding with a fair value of $764 million, or 7.9% of our publicly traded common stock portfolio and 3.3% of the total investment portfolio. Thirty-seven 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 September 30, 2023 At December 31, 2022
Cincinnati
Financial S&P 500 Industry
Weightings Cincinnati
Financial S&P 500 Industry
Weightings
Sector:
Information technology 31.1 % 27.5 % 26.5 % 25.7 %
Financial 12.9 12.8 13.6 11.7
Healthcare 12.7 13.3 15.0 15.8
Industrials 11.7 8.3 11.9 8.7
Consumer staples 7.8 6.6 8.8 7.2
Consumer discretionary 7.5 10.7 7.7 9.8
Materials 4.9 2.4 5.0 2.7
Energy 4.9 4.7 5.0 5.2
Utilities 2.8 2.4 2.9 3.2
Real estate 2.3 2.4 2.3 2.7
Telecomm services 1.4 8.9 1.3 7.3
Total 100.0 % 100.0 % 100.0 % 100.0 %
UNREALIZED INVESTMENT GAINS AND LOSSES
At September 30, 2023, unrealized investment gains before taxes for the fixed-maturity portfolio totaled $29 million and unrealized investment losses amounted to $1.236 billion before taxes.
The $1.207 billion net unrealized loss position in our fixed-maturity portfolio at September 30, 2023, increased in the first nine months of 2023, primarily due to an increase in U.S. Treasury yields that were partially offset by 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 September 30, 2023, consisted of a net gain position in our equity portfolio of $5.632 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 JPMorgan Chase & Co (NYSE:JPM), which had a combined fair value of $2.605 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 September 30, 2023, 4,490 of the 4,707 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 4,490 holdings with fair values below amortized cost at September 30, 2023, represented 95.0% of the fair value of our fixed-maturity investment portfolio and $1.236 billion in unrealized losses.
• 2,831 of the 4,490 holdings had fair value between 90% and 100% of amortized cost at September 30, 2023. These primarily consist of securities whose current valuation is largely the result of interest rate factors. The fair value of these 2,831 securities was $8.696 billion, and they accounted for $365 million in unrealized losses.
• 1,457 of the 4,490 fixed-maturity holdings had fair value between 70% and 90% of amortized cost at
September 30, 2023. We believe the 1,457 fixed-maturity securities will continue to pay interest and ultimately
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pay principal upon maturity. The issuers of these 1,457 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 $3.170 billion, and they accounted for $705 million in unrealized losses.
• 202 of the 4,490 fixed-maturity holdings had fair value below 70% of amortized cost at September 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 $337 million, and they accounted for $166 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 September 30, 2023 Fair value Unrealized
losses Fair value Unrealized
losses Fair
value Unrealized
losses
Fixed-maturity securities:
Corporate $ 1,283 $ 58 $ 5,431 $ 642 $ 6,714 $ 700
States, municipalities and political subdivisions 2,331 89 1,902 400 4,233 489
Government-sponsored enterprises 742 17 95 6 837 23
United States government 80 1 130 5 210 6
Commercial mortgage-backed 1 — 194 18 195 18
Foreign government 9 — 5 — 14 —
Total $ 4,446 $ 165 $ 7,757 $ 1,071 $ 12,203 $ 1,236
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
United States government 146 3 41 2 187 5
Commercial mortgage-backed 215 13 14 3 229 16
Foreign government 25 1 4 — 29 1
Total $ 8,760 $ 706 $ 800 $ 202 $ 9,560 $ 908
At September 30, 2023, applying our invested asset impairment policy, we determined that the total of $1.236 billion, for securities in an unrealized loss position in the table above, was not the result of a credit loss.
During the first nine 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 nine months of 2023. During the first nine 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 September 30, 2023
Taxable fixed maturities:
Fair valued below 70% of amortized cost 118 $ 354 $ 238 $ (116) $ 8
Fair valued at 70% to less than 100% of amortized cost 2,102 9,253 8,445 (808) 300
Fair valued at 100% and above of amortized cost 120 463 492 29 24
Investment income on securities sold in current year — — — — 12
Total 2,340 10,070 9,175 (895) 344
Tax-exempt fixed maturities:
Fair valued below 70% of amortized cost 84 149 99 (50) 3
Fair valued at 70% to less than 100% of amortized cost 2,186 3,683 3,421 (262) 88
Fair valued at 100% and above of amortized cost 97 148 148 — 4
Investment income on securities sold in current year — — — — 2
Total 2,367 3,980 3,668 (312) 97
Fixed-maturities summary:
Fair valued below 70% of amortized cost 202 503 337 (166) 11
Fair valued at 70% to less than 100% of amortized cost 4,288 12,936 11,866 (1,070) 388
Fair valued at 100% and above of amortized cost 217 611 640 29 28
Investment income on securities sold in current year — — — — 14
Total 4,707 $ 14,050 $ 12,843 $ (1,207) $ 441
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.