Good morning. My name is Amy, and I will be your conference operator today. At this time, I would like to welcome everyone to the Cincinnati Financial second quarter earnings conference call. All lines have been placed on mute to prevent any background noise. After the speaker's remarks, there will be a question and answer session. If you would like to ask a question during this time, please press star, then the number 1 on your telephone keypad. If you would like to withdraw your question, please press the pound key. I will now turn the call over to Dennis McDaniel, investor relations officer. You may now begin.
Hello, this is Dennis McDaniel at Cincinnati Financial. Thank you for joining us for our second quarter 2013 earnings conference call. Late yesterday, we issued the news release on our results, along with our supplemental financial package, including our quarter and investment portfolio. To find copies of any of these documents, please visit our investor website, cinfin.com/investors. The shortest route to the information is the Quarterly Results link in the navigation menu on the far left. On this call, you'll first hear from Steve Johnston, President and Chief Executive Officer, and then from Chief Financial Officer Mike Sewell. After their prepared remarks, investors participating on the call may ask questions. At that time, some responses may be made by others in the room with us, including Executive Committee Chairman Jack Schiff Jr., Chairman of the Board Ken Stecher, Chief Insurance Officer J.F.
Scherer, Principal Accounting Officer Eric Mathews, Chief Investment Officer Marty Hollenbeck, and Chief Claims Officer Marty Mullen. Please note that some of the matters to be discussed today are forward-looking. These forward-looking statements involve certain risks and uncertainties. With respect to these risks and uncertainties, we direct your attention to our news release and to our various filings with the SEC. A reconciliation of non-GAAP measures was provided with the news release. Statutory accounting data is prepared in accordance with statutory accounting rules and therefore is not reconciled to GAAP. I'll turn the call over to Steve.
Good morning, and thank you for joining us today to hear more about our second quarter results. We are pleased to report our best second quarter operating results in several years, and solid first half 2013 performance. The results reflect the benefits of ongoing initiatives that aim to improve insurance profitability, drive premium growth, and create shareholder value over time. With our second quarter combined ratio of 96.4, our year-to-date combined ratio is 93.9, in the range of the sub 95% we are aiming for. While lower catastrophe losses helped our results, our combined ratio before catastrophe losses also improved for the first half of 2013. We remain confident that our loss reserve position continues to be well into the upper half of the actuarial range of estimates. We achieved the premium growth we expected for the first half of the year.
Each of our property casualty segments grew as they benefited from greater pricing precision and higher pricing overall. Commercial policies that renewed during the second quarter continued to average price increases in the mid-single-digit range, keeping pace with the first quarter. Increases on our smaller commercial property policies again reached the low double-digit range. Personal lines policies that renewed in the second quarter also averaged a price increase in the mid-single-digit range, with homeowner policies continuing in the high single-digit range. Our excess and surplus line segment experienced higher renewal prices for the 34th consecutive month, continuing at a low double-digit range. We continue to believe that our new business written premium growth reflects both the higher pricing we're able to get in the marketplace, as well as the cumulative effect of growth initiatives.
Our pricing analytics and modeling tools continue to give us confidence in the level of our new business pricing. We're seeing good growth from newer agents in addition to ones that have represented us for decades. Likewise, we see growth in newer states in addition to our more established areas of operation. Property casualty agency appointments are going well. We've appointed 63 new agencies as of June 30th, and now estimate that we'll exceed our initial 2013 goal of 65 agencies by about 15. Our life insurance segments earned premium growth slowed during the second quarter. The primary driver was the effect of unlocking of interest rate assumptions for certain universal life insurance products. For all of our insurance segments, we are careful to grow premiums only when we believe profitability is adequate.
The quality of our recent growth has been as expected, with overall pricing ahead of our loss cost trends. The second quarter produced investment income that nearly matched the same quarter a year ago, despite a drop in interest income. Our primary measure of financial performance, the Value Creation Ratio, is on good pace for 2013. Our Chief Financial Officer, Michael Sewell, will now discuss that further, along with other financial items.
Thank you, Steve, and thanks to all of you for joining us today. Our 6.4% year-to-date Value Creation Ratio is on track to reach our annual target range and is well ahead of last year. That rate includes -0.4% for the second quarter due to the -3.2% effect of the bond portfolio's lower valuation as a result of rising interest rates. Our company continues to benefit from our equity investing strategy during periods of rising interest rates or when investment income is pressured by a low interest rate environment. The stock portfolio grew during the second quarter, with pre-tax net unrealized gains up $38 million to over $1.4 billion. Dividend income was up 11% for the quarter and 8% for the first half. Equity securities at quarter end fair value represented 30% of invested assets, and there is some room for that percentage to increase.
The bond portfolio's pre-tax unrealized gains declined $282 million during the quarter. Yields for our bond portfolio continued to move lower as its second quarter 2013 pre-tax yield of 4.92% fell 23 basis points from a year ago. That contributed to a 3% second quarter decline in interest income. Our bond portfolio's effective duration measured 4.4 years at the end of the quarter, up 4.2 years at the end of 2012. Cash flow from operating activities continues to benefit investment income. At $251 million for the first half of 2013, net operating cash flow is within $14 million of last year's first half after paying an additional $139 million this year for income taxes. Looking at our balance sheet, capital remained strong and reserve development on prior accident years during the quarter was at a typical level.
The second quarter benefited from 10.1 percentage points of net favorable reserve development compared with 10.4 points a year ago. Every major line of business contributed to the quarter's favorable development. Our six-month net favorable development was again spread over several accident years, including 53% for accident year 2012, 28% for accident year 2011, and 19% for all older accident years. As always, we prudently manage expenses. Our second quarterly property casualty underwriting expense ratio rose 0.4 percentage points, primarily due to higher commissions to agents. We continue to maintain financial strength and liquidity. Cash and marketable securities at the parent company reached more than $1.3 billion at June 30th, up 16% from the end of last year. Our premiums to surplus ratio remain at 0.9 to one, reflecting strong capital with capacity to support continued premium growth in our insurance segments.
I'll conclude my prepared comments by summarizing the contributions during the second quarter to book value per share. Property casualty underwriting increased book value by $0.14. Life insurance operations added $0.08. Investment income other than life insurance and reduced by non-insurance items contributed $0.53. The change in unrealized gains at June 30th for the fixed income portfolio, net of realized gains and losses, lowered book value per share by $1.12. The change in unrealized gains at June 30th for the equity portfolio, net of realized gains and losses, increased book value by $0.20. We paid $0.4075 per share in dividends to shareholders. The net effect was a book value decrease of $0.58 during the second quarter to $34.83 per share. With that, I'll turn the call back over to Steve.
Thanks, Mike. Our improved results in recent quarters are encouraging and the company's performance is being recognized. We were again recognized as one of Ward's 50 top performing P&C insurers based on safety, consistency, and superior performance over a five-year period ending 2012. During the second quarter, our credit and financial strength ratings were affirmed by Fitch, Moody's, and S&P. Moody's also upgraded its outlook on our rating to stable. We will continue efforts to improve performance, fulfilling our insurance promises to policyholders and providing outstanding service to agents as we add value for shareholders. I want to acknowledge the hard work and accomplishments of our independent agents and our associates. During the second quarter, we wrapped up over 20 meetings with agents across the U.S.
Next month, when all of our field associates meet in Cincinnati, we'll continue the discussion about how we can further improve service and performance. We appreciate this opportunity to respond to your questions and also look forward to meeting in person with many of you throughout this year. As a reminder, with Mike and me today are Jack Schiff Jr., Ken Stecher, J.F. Scherer, Eric M. Mathews, Marty Mullen, and Marty Hollenbeck. Amy, we're ready for you to open the call for questions.
At this time, if you would like to ask a question, please press star, then number 1 on your telephone keypad. Your first question comes from the line of Joshua Shanker from Deutsche Bank. Your line is open.
Good morning, everyone.
Morning, Josh.
I wanted to ask a few questions to start about homeowners. Growth was quite strong. I wanted to know, first off, if we could parse that into unit volume in traditional territories, unit volume in new territories.
rate. Two, talk about whether or not there's a lack of viable options for homeowners, and that's becoming a big opportunity for Cincinnati.
Josh, this is J.F. I guess to put into perspective, unit volume for us, since January of 2009, just to give you an idea, we're up 24% in homeowner policy count. We're up 35% in private passenger auto policy count. We've gone, and this is something to consider as well, we've gone from 73% of our book of business being packages, both the home and the auto, up to 81%. We have been pretty strong with our agents that if we can't write the auto with the homeowners, we're not interested. On new business, it would be a rare situation. That situation might be that we write the commercial, the private passenger autos, under the commercial lines. We're requiring the private passenger autos. That can have a way of muting a little bit of the homeowner growth.
Overall, maybe another item in terms of rates. We have been increasing rates. Over the past 15 quarters, we've increased homeowner rates by 43.4%. Now we've increased them more than that in some of the Midwestern states. For example, Ohio was 51.4%. That includes rate increases that'll go into effect a little later this year. One other item in terms of growth, just for purposes of personal lines, we've appointed 558 over that same period of time, 558 new locations to represent us in personal lines, 214 of which were commercial lines agencies that because they have a greater appreciation for our technology and how we can help them issue the policies, have started writing business with us. I think we have a lot of good things going. The increases, certainly on a percentage basis from newer states for us, has been strong.
We're continuing to write business in the Ohios, the Indianas and the Illinois. We're a lot more pleased with the growth or with the rate levels that we're at. A couple things have happened this year. I think it was mentioned before, April the 1st, we strengthened our underwriting requirements. We've required higher deductibles on homeowners on all new business. We've also added an actual cash value endorsement to the homeowner policy if the roofs are 15 years or older. We're not writing shake shingles, for example. We're managing rooftops a little stronger, and I think that has had a tendency, as we would've expected it to mute the new business in the second quarter. Between rate increases, tougher underwriting, and a third thing, a lot more inspections.
We're going to be inspecting over this year and the next two years, 300,000 structures in personal lines for us to verify the condition of the property. Add it all together, I think we're comfortable we're going to have a more profitable book of business. Secondly, it is going to have an effect of slowing growth down just a little. I hope that wasn't more than you were asking for, that gives you a little bit of an overview of how we're doing in homeowner.
More is always better. On these inspections, obviously they can be a lot of things, is roof a particularly important part of this inspection process, or what are you really trying to get at?
Roof is a significant part of it. We have some of our employees that do those inspections, vendors that we've hired to do them with a specific focus on roofs. They're actually taking, with cameras that can zoom in on it, pictures of the shingles and the best they can verifying how old the shingles are. We're also looking for overall condition of property, whether it's casualty, cracked sidewalks, things of that nature, dogs that we didn't know about, wood burning stoves, verifying the protection class the property's in. Sometimes we have it as a better protection class than it's actually in. It's across the board, pictures front and back, pictures of every deficiency. Very thorough. We're pleased with how our agencies approach doing business with us. We are verifying everything right now.
On the investment portfolio, I was actually surprised a little bit at the book value shrinkage. I look at your investment portfolio as more resilient than peers, but it was kind of about a peer level. Is there any reallocation that's going on in your mind with, say, the 2Q surge in interest rates and thinking about the next 18 months out?
Josh, it's Marty Hollenbeck. Not really. We actually welcome a gradual rise in interest rates. It spiked a bit in the second quarter, we'd still like to see it work its way up further. Obviously, the balance sheet takes a quick hit. It takes longer for the income statement to get the benefits of that, nonetheless, we would welcome it. Our bond portfolio, I don't think, to be honest with you, took as big a hit as you might think into book value. We have a pretty generous dividend which comes out of that as well. We have a slightly higher duration, we have less allocated to fixed income and certainly as a percentage of our shareholders' equity, that is the case. We're not doing anything dramatically different going forward. Corporate bonds, municipal bonds, and dividend-growing stocks are still our favorite asset classes.
Okay. Well, thank you, Marty, congratulations on a good quarter.
Thank you.
Thank you.
Your next question comes from the line of Scott Heleniak of RBC Capital Markets. Your line is open.
All right, thanks. Morning.
Morning, Scott.
I was just wondering if you could touch on the new business growth. It was good in the quarter. I guess it was down a little bit, the pace, but I was just wondering if you could touch on that. Was there certain areas, more so than others, where you decided to dial back on, and if you could just talk about that a little bit?
Yeah, Scott, as I already mentioned on homeowners, we expected the new business to moderate a little bit on that, and consequently, since we're only accepting packages, private passenger auto. Otherwise, no. Actually, there are timing differences and booking differences. I think the best way to look at all of this is over the first six months of the year. Frankly, it's going along as planned. We'd projected out to the end of 2015 to be a $5 billion company, and just keep in mind, it does include life insurance. The kind of new business that we expected to write, we're actually a little bit ahead of plan on it. The only thing I would say that was somewhat remarkable in the second quarter was the level of competition on larger accounts. They always draw a crowd, that's not surprising.
We saw, I guess, a bit of a tick up in terms of the aggressiveness of the marketplace in that area. After we really dug into it turned out not to be as remarkable as we thought, but I guess that's just, I suppose, worth mentioning. Across the lines of business, we write packages, so we're not writing or targeting commercial auto or workers' comp or something of that nature. All in all, I'd have to say I finished the quarter pleased with what we saw.
What is the pricing differential? You mentioned large account business. What's the pricing differential between your sort of core small to mid account customer and then a large account customer? Where's pricing for the large account business that you were talking about? Is that kind of just low single digits?
No, it's a little bit better than that. I'd say overall, a little below five, I suppose, with the smaller accounts up towards 10%.
Okay. Then I'm just wondering if you could talk about the E&S business. Obviously, everyone's talking about how more business is coming into E&S, just wondering if you guys could touch on just the opportunities now that Cincinnati has versus a couple of years ago, maybe there's an opportunity to grow that at a faster rate than maybe you thought.
Well, what we're seeing in our book, keep in mind, we are pretty conservative in our underwriting appetite. I think there's a fair amount of business that's on the fringe that kind of floats back and forth between the standard market and the E&S market. What we have seen in that area, larger accounts, we've seen a lot of competition from standard carriers. We've lost a few accounts in that regard. We're not seeing them from other E&S carriers in terms of the competition. That was noticeable really through the first six months of this year. We still think we have a great opportunity. I can't say that we've seen anything in the way that the market has changed that has caused us to think the doors are really going to fly open and some business is going to come in. Still deliberate.
We're still trying to be pretty conservative about what we do. As a general statement, we're seeing some standard market players take some business out. Other than that, it's been pretty steady for us.
Okay. Just kind of tracking along as planned then, I guess. Okay. The only other question I had was, you guys mentioned equities being 30% invested assets, and I'm just wondering, you said there's a little bit of room to move that higher and what did you have in mind as far as how much higher? Is there a new policy on that as far as how high they can go?
Hey, Scott, it's Marty Hollenbeck. There's a lot that goes into that decision. We look at really from the bottom up, by entity, by company, in regards to regulatory issues, tax issues, et cetera. We don't have a hard target. Obviously, the last few years, equities of the type we buy have been very attractive just on a pure income basis. They're still relatively so by historical standards. We're not looking for a large scale bump up. I think we were just trying to convey the fact that we had not reached a maximum there. We do have some room.
Right.
Yeah.
Okay. Thanks a lot.
Again, if you would like to ask a question, please press star, then the number one on your telephone keypad. Your next question comes from the line of Vincent DeAugustino of KBW. Your line is open.
Hi, good morning, everyone.
Morning, Vince.
Just to start off, a question for Marty Hollenbeck and Marty Mullen. Curious if you guys have had any good debates lately on interest rates versus loss cost trends and the relationship there, and just how you're feeling about both looking out.
This is Marty Hollenbeck. I'll go first. Again, with the influence that the Fed has, we just don't see interest rates dramatically galloping from here. I mean, we had a nice spike
Frankly, the equity markets are up since this whole thing started. We don't see rates taking off anytime soon. Inflation appears to be under control. Looking out past three years is probably not worth the time to spend on it at this juncture. We see a slow drift up, but not a considerable move in interest rates. This is on the investment side. Marty can comment on the claims side.
Sure. Thank you, Marty. Marty Mullen, Vince. Mainly focusing on certain initiatives within different avenues of our operation. In particular, for instance, work comp, we're focusing on medical spend and the consolidation of vendors, and really focusing on work comp specialization, which I think is really proving beneficial. In addition to that, on the property side, we've identified large property specialists that are now responding to large commercial and homeowner fires in an effort to, first of all, bring that Cincinnati service firsthand to a large policyholder, but also cut down on the expenses incurred with adjusting those types of fees. Those are just a couple of examples of special initiatives we have in place.
Okay, perfect. Then, just on our side, about a month ago, we hosted a call on predictive claims initiatives with Deloitte Consulting. The key takeaway for us is that underwriting margins, you can potentially get upwards of five points or better with the implementation of predictive claims tools. From what I recall, I think that was something that had interested you guys is a future upgrade on top of what you've done from the predictive pricing tool side. I'm curious if that might still be on the horizon and if it's something that we might expect to see within the next two or three years.
Yes. This is Steve. We agree with you 100% on the importance of that, the potential benefits. We are definitely into that. It's fallen within Marty Mullen's area in our actuarial group. We agree that we see that as a very important initiative that we can put in place and one that's got a lot of room yet to help with the loss cost trends. I don't know if Marty wanted to add anything in addition to that.
Sure. Thanks, Steven. Vincent, our first foray into that is going to be in workers' compensation and our predictive analytics approach at forecasting outcomes based on the type of information received initially at the outset of the call of the claim. We hope to have our first implementation of that by the end of the third quarter or fourth quarter of this year. We're pretty excited about that opportunity.
Great. That's actually a lot closer than I was expecting. Perfect. That's all I had, and nice quarter, and thanks for taking the questions. Thank you.
Thank you.
There are no further questions at this time. I turn the call back over to the presenters.
Well, Amy, thank you. Thank you for moderating the call, and thanks to all of you for joining us today. We look forward to speaking with you again on our third quarter call, if not before. Have a great day.
This concludes today's conference call. You may now disconnect.