United States Securities and Exchange Commission

Form 10-K

For the fiscal year ended December 31, 2004.

For the transition period from                      to                     .

Commission file number 0-4604

Cincinnati Financial Corporation

(Exact name of registrant as specified in its charter)

6200 S. Gilmore Road

Fairfield, Ohio 45014-5141

(Address of principal executive offices) (Zip Code)

(513) 870-2000

(Registrant’s telephone number, including area code)

Securities registered pursuant to Section 12(b) of the Act:

None

Securities registered pursuant to Section 12(g) of the Act:

$2.00 par, common

(Title of Class)

6.9% Senior Debentures due 2028

(Title of Class)

Indicate by check mark whether the registrant: (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports) and (2) has been subject to such filing requirements for the past 90 days. þ Yes    o No

Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. o

Indicate by check mark whether the registrant is an accelerated filer (as defined in Exchange Act Rule 12b-2). þ Yes    o No

The aggregate market value of voting stock held by nonaffiliates of the Registrant was $6,479,492,390 as of June 30, 2004.

As of February 25, 2005, there were 167,249,902 shares of common stock outstanding.

Document Incorporated by Reference

Portions of the definitive Proxy Statement for Cincinnati Financial Corporation’s Annual Meeting of Shareholders to be held on April 23, 2005, are incorporated by reference into Parts II and III of this Form 10-K.

Table of Contents

Part I

Item 1. Business

Introduction

Cincinnati Financial Corporation (CFC or the company) is an Ohio corporation formed in 1968. Through its subsidiaries, CFC has been conducting insurance operations since 1950, marketing commercial, personal and life insurance. The company reports results in four segments:

•	Commercial lines property casualty insurance
•	Personal lines property casualty insurance
•	Life insurance
•	Investments

The commercial lines and personal lines property casualty insurance segments combined to generate 80.8 percent of the company’s revenues in 2004. Revenues, income before income taxes, and identifiable assets for these segments are included in Item 8, Note 17 to the Consolidated Financial Statements, Page 89. The company’s segments are defined based on the financial information used internally to evaluate performance and determine the allocation of assets.

CFC owns 100 percent of its three subsidiaries: The Cincinnati Insurance Company, CFC Investment Company and CinFin Capital Management Company. The Cincinnati Insurance Company owns 100 percent of its three subsidiaries: The Cincinnati Casualty Company, The Cincinnati Indemnity Company and The Cincinnati Life Insurance Company.

The Cincinnati Insurance Company, founded in 1950, leads the property casualty group known as The Cincinnati Insurance Companies. The Cincinnati Casualty Company and The Cincinnati Indemnity Company round out the property casualty insurance group, providing flexibility in pricing and underwriting while ceding substantially all of their business to The Cincinnati Insurance Company. The Cincinnati Life Insurance Company primarily markets life insurance and annuities. CFC Investment Company complements the insurance subsidiaries with leasing and financing services. CinFin Capital Management Company provides asset management services to institutions, corporations and high net worth individuals.

CFC’s headquarters is located in Fairfield, Ohio. At December 31, 2004, the company had 3,884 headquarters and field associates. The company’s filings with the Securities and Exchange Commission (SEC) are available, free of charge, on the company’s Web site, www.cinfin.com, as soon as possible after they have been filed with the SEC. Referenced Web sites, including the company’s Web site, are not incorporated by reference in this Annual Report on Form 10-K.

Unless otherwise noted, estimated industry data are referenced from materials presented on a statutory basis by A.M. Best Co., a leading insurance industry statistical, analytical and financial strength rating organization. Statutory data for the company is labeled as such; all other company data is presented on a GAAP basis.

Property Casualty Insurance Operations

Introduction

The company actively markets commercial insurance policies in 31 states through a select group of 986 independent insurance agencies as of December 31, 2004. It actively markets all of its personal lines insurance policies in 22 of those states.

In 2004, nine states with at least $100 million in commercial and personal lines agency earned premium generated approximately 69 percent of total property casualty premiums. In these states, agency earned premiums grew 9.2 percent, or $176 million. Ohio, where the company had 187 independent agencies at year-end 2004, accounted for 23.7 percent of total earned premiums. In the 22 states with less than $100 million in agency earned premium, agency earned premiums grew 15.0 percent, or $119 million, in 2004.

Competitive Environment

There are approximately 3,100 property casualty insurance companies in the United States operating independently or in groups and no single company or group is dominant. Property casualty insurers can distribute their products through independent insurance agents, who sell the products of many insurers, or captive agents, who sell the products of only one insurance company. Companies that use captive agents, as well as companies selling directly to consumers through the mail, Internet or telephone solicitations, are called direct writers.

The company is committed to the independent agent distribution system, recognizing that locally based independent agencies have relationships in their communities that lead to profitable business. The company’s field associates provide service and accountability to the agencies, living in the communities they serve and working from offices in their homes, providing 24/7 availability. The company differentiates itself by providing superior claims service and field

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underwriting, through locally based associates serving the needs of agents and policyholders; by offering competitive products, rates and compensation; and by maintaining high financial strength ratings.

In 2003, the most recent period for which data is available, Cincinnati Insurance was the No. 1 or No. 2 carrier in more than 70 percent of its agencies based on premium volume or number of policies. For commercial lines, the company views its competition as the companies that distribute through independent agents. For personal lines, policyholders are more likely to investigate insurance options both through independent agents and through personal research with captive agents or direct writers. The 986 independent agencies through which the company markets its commercial lines products normally represent four to 12 insurance carriers, including both national and regional carriers, some of which may be mutual companies. Management generally views regional carriers as more challenging competition because they often are familiar with the local market and focus on differentiating themselves through personal relationships with agencies.

Independent Agent Marketplace

Agencies chosen by the company demonstrate the same commitments that distinguish the company in the marketplace: doing business person to person; offering broad, value-added services; maintaining sound balance sheets and managing their agencies professionally. In 2003, the most recent year industry data is available, on average, Cincinnati’s agencies were larger than the industry average, with approximately 35 percent estimated to have more than $2 million in revenues. According to data from a specialized consulting service to independent agents, in 2000, approximately 22 percent of the 20,066 U.S. independent agents with more than $250,000 in revenues had more than $2 million in revenues. The consulting service projects continued consolidation in the agency marketplace, estimating that by 2010, the number of agencies with more than $250,000 in revenues will decline to approximately 11,700, of which approximately 40 percent will have more than $2 million in revenues. The company believes that its agencies will continue to be leading agencies.

In 2004, property casualty agencies representing the company averaged approximately $3.1 million in agency earned premiums for the company compared with approximately $2.9 million in 2003 and $2.6 million in 2002. Agencies that have represented the company for less than five years averaged slightly less than $1 million in agency earned premium for the company in 2004. Established agencies that have represented the company five years or more averaged approximately $3.4 million in agency earned premium for the company in 2004. No single agency accounted for more than 1.1 percent of the company’s total agency earned premiums in 2004.

Growth Strategies

In addition to growth of its agencies, the premium increases reflected efforts to improve customer service through the creation of smaller marketing territories, permitting local field marketing representatives to devote more time to each independent agency. At year-end 2004, the company had 92 property casualty field territories, up from 87 at the end of 2003 and 83 at the end of 2002. During 2005, the company plans to subdivide and staff at least eight additional territories, which would bring the total number of field territories to 100. As part of this program, the company plans to create a Delaware/Maryland territory in mid-2005. The planned Delaware/Maryland territory represents both the subdivision of the current Maryland territory and the company’s entry into Delaware, its first new state since 2000.

During 2004, the company selectively appointed 48 new agencies within existing marketing territories. The company plans to add 100 new agencies in 2005 and 2006. New appointments were made in 21 of the 31 states in which the company actively markets insurance. Care is taken when selecting and appointing new agencies to minimize market disruption for existing agencies. Of the 48 new agencies, 31 will market the company’s full complement of property casualty insurance and 17 will market commercial lines only. An additional three agencies were appointed in 2004 to market the company’s surety bond products, bringing its total of surety-only independent agencies to nine. These nine agencies are not included in the 986 property casualty agency total.

The company believes that it can continue to grow by taking actions intended to maintain or increase its penetration within its agencies and through the selective appointment of additional agencies. Other than Delaware, the company does not expect to enter any new states in the near future.

Competitive Position

The company’s competitive position reflects:

•	Field marketing staff who provide local decision-making authority. They are responsible for selecting new independent agencies as well as underwriting and pricing new commercial business. Because of their local presence, they are aware of local market conditions and are familiar with the risks for which they make these decisions. They round out their efforts by coordinating field teams of specialized company representatives and promoting all of the company’s products within the agencies they serve.
•	Risk-specific decisions made about both new business and renewals. On a case-by-case basis, the company selects risks it can cover on acceptable terms and at adequate prices rather than underwriting solely by geographic location or business class. For new commercial lines business, this case-by-case underwriting is coordinated by the local field marketing representatives and relies on their knowledge and agents’ knowledge of the people and

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businesses in their communities. Policy renewals are coordinated by headquarters underwriters who are assigned to specific agencies and consult with local field staff, as needed.

The company seeks to be a consistent, predictable and reasonable carrier that agencies can rely on to serve their communities.

•	Commitment to products and services needed to serve agency clients – the policyholders. The company’s commercial products are structured to allow many coverages to be combined in a single package with a single expiration date. The company’s commercial lines segment offers three-year policy terms for most insurance packages, a key competitive strategy. Although the company offers three-year terms, premiums for some coverages within those packages are adjustable at anniversary for the subsequent annual period, and policies may be cancelled at any time at the discretion of the policyholder. The package approach brings policyholders convenience, discounts and a reduced risk of coverage gaps or disputes. At the same time, it increases account retention and saves time and expense.
•	Superior claims service. Agencies generally have authority to pay first-party claims immediately up to $2,500. Locally based field claims representatives, who work from their homes, are assigned to specific agencies. They generally respond within 24 hours of receiving an agency’s claim report. The company believes the higher level of service provided by field claims representatives familiar with an agency and its policyholders provides it with a competitive advantage.
•	Improved service to and communication with agencies through an expanding portfolio of software. The company expects to continue to strengthen its relationships with agencies through the introduction and use of technology that is designed to bring agencies greater efficiencies and to permit associates to spend more time with people and less with paper. Certain technology project implementation phases were rescheduled to the first half of 2005, rather than the fourth quarter of 2004, because of testing of control systems as required by the Sarbanes-Oxley Act. These short-term schedule changes are not expected to significantly affect project completion timelines.

     Technology initiatives completed or ongoing include:

	°	CinciLink™, the company’s established Web site for agencies, enables agencies to access the company’s new Web-based systems and obtain information. The Web site includes content to make it easier for agencies to place business with the company, such as online policy loss information, software updates and a property casualty electronic coverage forms library. At the beginning of 2005, the Learning Center was added to CinciLink. It gives agency staff access to online courses on the company’s products and services and desktop computing.
	°	CMS™, a new claims file management system, initially was deployed in late 2003. Field claims associates in all states are using CMS to process all newly reported claims. Planned upgrades for 2005 include agency access to enter information on agency-issued claims checks and agency claims reporting via CMS.
	°	In 2004, WinCPP™, an online rate quoting system for commercial package, commercial auto and workers compensation policies, expanded to 18 states and now is available for agencies writing approximately 90 percent of the company’s total property casualty premiums. WinCPP was rolled out to two additional states in early 2005. Businessowner policy quoting capabilities were made available to one state in late 2004. Roll out into additional states is planned for 2005. A businessowners policy combines property, liability and business interruption coverages for small businesses.
	°	Training for Diamond, the new personal lines processing system, was completed for agents in Alabama, Indiana, Michigan and Ohio in 2004. The single-entry policy processing system streamlines policy issue, improves cash flow by reducing processing time and offers direct billing. Training for agents in Florida, Georgia, Illinois, Kentucky, Minnesota, Missouri, Tennessee and Wisconsin is scheduled for 2005. During the fourth quarter of 2004, Diamond was used to process approximately $70 million in written premiums for Alabama, Kansas, Indiana, Michigan and Ohio agencies, up from $45 million in the third quarter of 2004 and $12 million in the second quarter of 2004. The company continues to enhance Diamond.
	°	I-View, a commercial lines policy imaging and workflow system, was introduced in areas of the commercial lines underwriting department in mid-2004. I-View is expected to be available to all commercial lines underwriters by year-end 2005. This system’s online policy viewing capability is expected to enhance efficiency not only for commercial lines, but for other departments, including claims. The company believes this functionality should speed the delivery and booking of policies as well as help expedite the claims settlement process.
	°	For 2005, development and delivery of a full-featured commercial lines policy processing system is the company’s primary business-technology objective. A commercial lines policy processing system will make it easier and more efficient for agencies to issue and administer commercial lines policies with the company. The immediate goal is to deliver a full version of the system for businessowners policies to one or more of the company’s high volume states by the end of 2005. During 2004, the company delivered a prototype to a small group of Ohio agencies for testing. Responses were positive and additional development phases are in process.

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°

CinciBond™, a new automated system to process license and permit surety bonds, was delivered to a small group of Ohio agencies for testing in late 2004. CinciBond enables agents to issue and print bonds at their office. Responses were positive and delivery to the remaining Ohio agencies and those in several additional states is anticipated during late 2005.

	In all cases, the objective is to enhance the level of personal service that the company delivers by automating office functions.
•	Full-spectrum of products to enhance relationships with agencies – The Cincinnati Life Insurance Company, CFC Investment Company and CinFin Capital Management complement the property casualty operations by providing products and services that attract and retain high-quality independent insurance agencies.

	°	Cincinnati Life seeks to round out and protect accounts in the property casualty agency and to improve account persistency. At the same time, the life operation looks to increase diversification, revenues and profitability for both the agency and the company. This strategy enhances the already strong relationship built by the combination of the property casualty and life companies. Cincinnati Life seeks to become the life insurance carrier of choice for the independent agencies that work with the property casualty operations by providing competitive products, responsive underwriting, high quality service and reasonable commissions.
	°	CFC Investment Company offers equipment and vehicle leases and loans for independent insurance agencies, their commercial clients and other businesses. It also provides commercial real estate loans to agencies to help them operate and expand their businesses.
	°	CinFin Capital Management markets asset management services to agents and their customers, as well as other institutions, corporations and individuals.

•	Programs to support agency growth. These include education programs for agents and staff and financing for buildings and equipment. In 2004, the insurance subsidiaries augmented ongoing training programs with a number of special events, including seminars held around the country to encourage cross-serving policyholders by expanding awareness of the company’s broad portfolio of products among producing agents. Headquarters programs and agent schools are well attended and differentiate the company from its peers.
•	Superior financial strength ratings. Insurance companies are rated on their financial strength and claims-paying ability, providing consumers with comparative information. The company historically has been awarded high financial strength ratings that distinguish it from other carriers (see Financial Strength Ratings, Page 7). Among other factors, independent ratings organizations focus on items such as results of operations, capital resources and minimum policyholders’ surplus requirements as well as qualitative analysis. While management believes its financial position will continue to be strong, the independent rating agencies could change their criteria or the company’s ratings based on their ongoing reviews.
•	Consistently high rankings in surveys of insurance companies. In a 2004 study, Ward Group again named Cincinnati Insurance to its annual lists of the top 50 property casualty and life/health insurers in America. Insurers and groups qualify based on financial safety, consistency and performance over the past five years. Cincinnati is one of only eight property casualty insurers that have qualified for the list in each of its 14 years and one of only 10 property casualty insurers for which the life insurance affiliate also qualified.
	The National Association of Insurance Commissioners’ (NAIC) Online Consumer Information Sources measures the company’s low complaint ratio (www.naic.org) at 0.32 versus the national median of 1.00 for 2003, the most recent year for which data is available. NAIC members head state departments of insurance.

Loss and Loss Expense Reserves

When claims are made by or against policyholders, any amounts that the company’s property casualty operations pay or expect to pay to the claimant are termed losses. The costs of investigating, resolving and processing these claims are termed loss expenses. The consolidated financial statements include property casualty loss and loss expense reserves that estimate the costs of paying claims incurred through December 31 of each year. The reserves include estimates for claims that have been reported and estimates for claims that have been incurred but not yet reported, along with estimates of loss expenses associated with processing and settling those claims. The various estimates are developed based on individual claim evaluations and statistical projections. Loss reserves are reduced by the estimated amount of salvage and subrogation.

While the company believes that reported reserves are sufficient for all unpaid loss and loss expense obligations, the estimation process involves uncertainty by its very nature. The estimates are continually reviewed, and as facts regarding individual claims develop and new information becomes known, the reserve is adjusted as necessary. Adjustments due to loss development for prior years are reflected in the calendar year in which they are identified. Item 7, Property Casualty Loss and Loss Expense Reserves, Page 25, includes more information about the process used to analyze potential losses and establish reserves.

The anticipated effect of inflation is implicitly considered when estimating reserves for loss and loss expenses. While anticipated cost increases due to inflation are considered in estimating the ultimate claim costs, the increase in

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average severity of claims is caused by a number of factors that vary with the individual type of policy. Average severity projections are based on historical trends adjusted for anticipated changes in underwriting standards, policy provisions and general economic trends. These trends are monitored based on actual development. The company does not discount any of its property casualty loss and loss expense reserves.

A reconciliation of the beginning and ending balances of the company’s reserve for losses and loss expenses at December 31, 2004, 2003 and 2002, is presented in Item 8, Note 4 to the Consolidated Financial Statements, Page 82. The reconciliation of the December 31, 2003, reserve balance to net incurred losses one year later recognizes approximately $196 million in redundant reserves. The redundancy was partially due to the 2004 release of $32 million in Ohio uninsured motorist/underinsured motorist reserves as discussed in Item 7, Property Casualty Reserve Levels, Page 55.

Development of Loss and Loss Expenses

Differences between the property casualty reserves reported in the accompanying consolidated balance sheets (prepared in accordance with accounting principles generally accepted in the United States of America – GAAP) and those same reserves reported in the annual statements (filed with state insurance departments in accordance with statutory accounting practices – SAP), relate principally to the reporting of reinsurance recoverables, which are recognized as receivables for GAAP and as an offset to reserves for SAP.

The table above shows the development of the estimated reserves for loss and loss expenses for the years prior to 2004:

•	Section A shows the total property casualty loss and loss expense reserves recorded at the balance sheet date for each of the indicated calendar years on a gross and net basis. Those reserves represent the estimated amount of loss and loss expenses for claims arising in all prior years that are unpaid at the balance sheet date, including losses that have been incurred but not yet reported to the company.
•	Section B shows the cumulative net amount paid with respect to the previously recorded reserve as of the end of each succeeding year. For example, as of December 31, 2004, the company paid $953 million of loss and loss

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	expenses in calendar years 1995 through 2004, for losses that occurred in accident years 1994 and prior. As a result, an estimated $144 million of losses remain unpaid as of year-end 2004 (net re-estimated reserves of $1.097 billion less cumulative paid loss and loss expenses of $953 million).
•	Section C shows the re-estimated amount of the previously reported reserves based on experience as of the end of each succeeding year. The estimate is increased or decreased as more information becomes known about the frequency and severity of claims.
•	Section D, cumulative net redundancy, represents the aggregate change in the estimates for all years subsequent to the year the reserves were initially established. For example, reserves established at December 31, 1994, had developed a $335 million redundancy over 10 years, net of reinsurance, which has been reflected in income over the 10 years. The effects on income in 2004, 2003 and 2002 of changes in estimates of the reserves for loss and loss expenses for all accident years are shown in the reconciliation above.

In evaluating this information, it should be noted that each amount includes the effects of all changes in amounts for prior periods. For example, payments or reserve adjustments related to losses settled in 2004 but incurred in 1998 will be included in the cumulative deficiency or redundancy amount for 1999 and each subsequent year. In addition this table presents calendar year data, not accident or policy year development data, which readers may be more accustomed to analyzing. Conditions and trends that have affected development of the reserve in the past may not necessarily occur in the future. Accordingly, it may not be appropriate to extrapolate future redundancies or deficiencies based on this data.

Reinsurance

The company has property and casualty working reinsurance treaties for 2004 through reinsurance companies that have written its treaties for more than 15 years. The strong relationships the company has with these reinsurers has allowed the company to negotiate what it considers to be favorable terms and conditions during a difficult time in the market cycle. To add further diversification to the reinsurance program, Partner Reinsurance Company of the U.S. was added to the property per risk and casualty per occurrence treaties effective January 1, 2005, joining American Re-Insurance Company, GE Insurance Solutions and Swiss Reinsurance America Corporation. The property casualty working treaties align the company with what it considers to be four of the most financially sound reinsurance companies in the world. The company also secures property catastrophe coverage and catastrophic casualty protection.

The 2005 property and casualty reinsurance program encompasses five primary components:

•	Property per risk treaty – The primary purpose of the property treaty is to provide excess limits capacity up to $25 million, supplying adequate capacity for the majority of the risks the company writes. The ceded premium is estimated to be $31 million for 2005, compared with $27 million in 2004 and $25 million in 2003. In 2005, the company is retaining the first $3 million of each loss. Losses between $3 million and $25 million are reinsured at 100 percent. The $3 million base retention is new for 2005. For the past several years, the company retained $2 million with 40 percent co-participation for the next $3 million of loss. Losses in excess of $3 million were reinsured at 100 percent up to $25 million in 2004 and 2003.
•	Casualty per occurrence treaty – The casualty treaty provides the company with excess capacity up to $25 million. Similar to the property treaty, this provides sufficient capacity to write the vast majority of casualty accounts the company insures. The ceded premium is estimated to be $66 million in 2005, compared with $61 million in 2004 and $55 million in 2003. In 2005, the company is retaining the first $2 million of each casualty loss, and 60 percent of the next $2 million of loss. This structure is identical to 2004 and 2003. Losses in excess of $4 million are reinsured at 100 percent up to $25 million.
•	Casualty fourth excess treaty – The company also purchases a casualty reinsurance treaty that provides an additional $25 million in protection for certain casualty losses. This treaty, along with the casualty per occurrence treaty, provides a total of $50 million of protection for workers compensation losses, extra-contractual liability coverage and clash coverage, which is used when there is a single occurrence involving multiple policyholders of The Cincinnati Insurance Companies or multiple coverages for one insured. The ceded premium is estimated to be $2 million in 2005 up only slightly from 2004 and 2003.
•	Casualty fifth excess treaty — Effective March 1, 2005, the company purchased a new fifth excess treaty, which provides an additional $20 million in casualty loss coverage. Similar to the casualty fourth excess, the fifth excess treaty provides catastrophic coverage for workers compensation, extra-contractual liability coverage and clash coverage losses. The ceded premium is estimated to be $1 million for 2005.
•	Property catastrophe treaty – To protect against catastrophic events such as wind and hail, hurricanes or earthquakes, the company purchases property catastrophe reinsurance, with a limit up to $500 million. For the 2005 treaty, ceded premiums are estimated to be $30 million, up from $27 million in 2004, excluding the reinstatement premium, and $21 million in 2003. The premium increase for 2005 is partially due to the increase in the limit to $500 million effective April 1, 2004, from $400 million, to keep limits in line with increases in exposures due to company growth. The company will retain the first $25 million of losses arising out of a single

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event and will retain 40 percent of losses from $25 million to $45 million, down from 43 percent in 2004. The company retains 5 percent of all losses in excess of $45 million, up to $500 million.

Individual risks with insured values in excess of $25 million as identified in the policy are handled through a different reinsurance mechanism. Property coverage for individual risks with insured values between $25 million and $50 million are reinsured under an automatic facultative treaty. For those risks with property values exceeding $50 million, the company negotiates the purchase of facultative coverage on an individual certificate basis. For casualty coverage on individual risks with limits exceeding $25 million, facultative reinsurance coverage is placed on an individual certificate basis.

Responding to the challenges presented by terrorism has become a very important issue for the insurance industry over the last three years. Terrorism coverage at various levels has been secured in all of the company’s reinsurance agreements. The broadest coverage for this peril is found in the property and casualty working treaties, which provide coverage for commercial and personal risks. The company’s property catastrophe treaty provides coverage for personal risks and the majority of its reinsurers provide limited coverage for commercial risks with total insured values of $10 million or less. For insured values between $10 million and $25 million, there also may be coverage in the property working treaty.

Reinsurance protection for the company’s surety business is covered under separate treaties with many of the same reinsurers that write the property casualty working treaties.

The estimated incremental cost increase of $13 million for the 2005 property casualty working reinsurance agreements is primarily due to the growth in the company’s premium base. The company believes it has the financial ability to absorb losses at the current retention levels, and the 2005 reinsurance agreements are a means of balancing reinsurance costs with what it considers to be an acceptable level of risk. Reinsurance does not relieve the company of its obligation to pay covered claims. The financial strength of the company’s reinsurers is important because the company’s ability to recover losses under one of the reinsurance agreements depends on the financial viability of the reinsurer.

Reinsurance protection for the company’s life insurance business is covered under separate treaties with many of the same reinsurers that write the property casualty working treaties. In 2005, the company modified its reinsurance protection for the life insurance business due to changes in the marketplace during 2004 that affected the cost and availability of reinsurance for term life insurance. Previously, the company retained 20 percent of each term policy, not to exceed $500,000, and ceded the balance of mortality risk and policy reserve. Under the new program, the company will continue to retain no more than a $500,000 exposure, ceding the balance using excess over retention mortality coverage, but will retain the policy reserve. Retaining the policy reserve has no direct impact on GAAP results. Because of the conservative nature of statutory reserving principles, retaining the policy reserve does have a negative impact on statutory income. The company currently is researching alternative reinsurance solutions to moderate the effect on statutory income of retaining the policy reserve for new term business. Management believes it will be able to structure this portion of the reinsurance program to provide the life insurance company with the ability to continue to grow in the term life insurance marketplace while appropriately managing risk, at a cost that allows the company to achieve its profit targets.

Financial Strength Ratings

Cincinnati Financial is awarded credit (debt) ratings (see Item 7, Long- and Short-term Debt, Page 60, for a discussion of the company’s credit ratings), and its insurance subsidiaries are awarded insurer financial strength ratings. The following summarizes the insurer financial strength ratings as of March 4, 2005. Insurer financial strength ratings assess an insurer’s ability to meet its financial obligations to policyholders and do not necessarily address matters that may be important to shareholders.

(See Life Insurance Segment, Page 12, for a discussion of life insurance subsidiary ratings.)

•	In March 2004, A.M. Best affirmed its top A++ (Superior) financial strength ratings and stable outlook for the company’s property casualty group and subsidiaries. Less than 2 percent of the approximately 1,090 insurer groups A.M. Best reviews annually qualify for the A++ rating.

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	A.M. Best cited the company’s superior risk-based capitalization, favorable operating results, long-standing independent agency distribution strategy and the stability created by its favorable loss reserve development and conservative accident-year reserving practices. A.M. Best said these strengths are somewhat offset by the group’s common stock leverage, catastrophe leverage and payout of stockholder dividends. Going forward, A.M. Best stated that it expects the group to maintain superior risk-adjusted capitalization as favorable operating margins generate growth in statutory surplus while both common stock and catastrophe leverage are reduced.
•	In March 2004 and again in October 2004, Fitch Ratings affirmed its AA (Very Strong) financial strength ratings and stable outlook for the company’s property casualty subsidiaries. Fitch cited the strong financial condition, operating profitability and above-average growth of the subsidiaries, as well as the group’s excellent financial flexibility and successful total return investment strategy.
	The rating considers the group’s concentrated equity portfolio, geographic concentration, catastrophe exposure and its improving but underperforming homeowners line of business. Fitch stated that it expects capitalization to remain strong, reflecting conservative loss reserving and adequate catastrophe reinsurance protection.
•	Following the company’s announcement of year-end 2004 results, Moody’s Investors Service commented that the company’s strong balance sheet and conservative financial and operating leverage metrics continue to support the property casualty subsidiaries’ Aa3 ratings. Moody’s considers that the company’s equity exposure, along with its potential liabilities, presents increased volatility risk to capital and surplus.
	Moody’s noted that the company is well positioned to continue to produce underwriting profits over the near term on its commercial lines business, as pricing levels are still adequate. On the personal lines side, Moody’s cited signs of improvement largely due to good results in the company’s private passenger auto business line and the company’s efforts to implement corrective underwriting actions in its homeowners business line.
•	In June 2004 and again in September 2004, Standard & Poor’s Ratings Services affirmed its AA- (Very Strong) ratings of the property casualty subsidiaries and its negative outlook. The ratings are based on the company’s strong, competitive business position, high business persistency, extremely strong capitalization and high degree of financial flexibility. Standard & Poor’s outlook considers the company’s underperformance in its homeowners’ business, aggressive investment strategies and slow, deliberate response to changing markets.
	Standard & Poor’s stated that it expects that the company should continue to perform well in its largest business segment, commercial lines, while lagging peers in personal lines profitability over the near term. Although progress could be tempered by the sizeable equity position, adverse regulatory or judicial decisions or catastrophes, Standard & Poor’s expects capitalization and growth will remain extremely strong, as new agency appointments and territory subdivisions partially offset possible weakening in industry pricing.

Management believes that its superior insurer financial strength ratings are clear, competitive advantages in the segment of the insurance marketplace that the company’s agents serve. The company’s financial strength supports the consistent, predictable performance that its policyholders, agents, associates and shareholders have always expected and received, and it must be able to withstand significant challenges. The most important way management seeks to ensure that the company remains consistent and predictable is to align agents’ interests with those of the company, giving agents outstanding service and compensation to earn their best business.

While the potential for volatility exists due to the company’s catastrophe exposures, investment philosophy and bias towards incremental change, the ratings agencies consistently have asserted that the company has built appropriate financial strength and flexibility to manage that volatility and seek higher long-term returns for shareholders. Management remains committed to strategies that emphasize long-term stability instead of quickly reacting to changes in market conditions to obtain short-term benefits. For example, the company maintains strong insurance company statutory-basis surplus, a solid reinsurance program, sound reserving practices and low interest rate risk, as well as low debt and strong capital at the parent-company level.

In 2004, the board of directors and management established parameters around the property casualty company’s strong statutory surplus position that led to some short-term actions. The new parameters allow the company to remain consistent with its long-term underwriting and equity investing strategies while responding to risk factors that are studied carefully by the ratings agencies.

In the second quarter of 2004, the company:

•	Changed the allocation of new property casualty portfolio investments to reduce the ratio of common stock to statutory surplus. The property casualty portfolio maintained that ratio below 100 percent throughout the 1990s. The ratio was 103.5 percent at year-end 2004 compared with 114.7 percent at year-end 2003 after moving as high as 120.5 percent after Codification was adopted in 2000 (see Regulation, Page 15, for information regarding Codification of Statutory Accounting Practices). The company anticipates allocating cash flow available for investment to fixed-income securities through mid-2005 (see Item 7, Investment Portfolio, Page 53, for additional information regarding portfolio allocation).
•	Sold or reduced common stock positions in the property casualty portfolio that the investment committee of the board of directors believed no longer met the company’s investment parameters (see Item 7, Investments Results

2004 10-K Page 8

	Of Operations, Page 47, for a discussion of equity securities sold during 2004). The $356 million sold was equivalent to less than 5 percent of the consolidated equity portfolio. The proceeds were reinvested in fixed income and convertible securities. The equity sales were a primary reason for the company’s high realized gains in 2004.
•	Added another $100 million layer to the property casualty reinsurance program, raising the limit to $500 million, effective April 1, 2004 (see Reinsurance, Page 6, for additional information regarding the company’s reinsurance programs).
•	Began changing homeowner policy earthquake deductibles to 10 percent from 5 percent.

These property casualty actions did not signal a change in the company’s overall investment philosophy. The company remains fully committed to a long-term equity focus that management believes is the key to the company’s long-term growth and stability (see Investments Segment, Page 13, for a discussion of the company’s investment strategy). The company currently intends to continue to invest for income and growth, focusing on a total-return strategy supported by investments in dividend-paying companies. Over the longer term, the company anticipates continuing to invest in equity securities to help achieve its portfolio objectives. However, the company believes that recent short-term actions to enhance the property casualty statutory surplus quality should support the predictability viewed by rating agencies as one of the company’s primary strengths, and by agents as a competitive advantage.

Commercial Lines Property Casualty Insurance Segment

The commercial lines property casualty insurance segment contributed $2.126 billion in net earned premiums to the company’s total revenues and $338 million to income before income taxes in 2004. Commercial lines net earned premiums grew 11.4 percent in 2004, 10.8 percent in 2003 and 18.6 percent in 2002.

The company markets its full complement of commercial products in all 986 property casualty independent agencies and all 31 states in which it markets property casualty insurance. The company’s emphasis is on providing products that agents can market to small- to mid-size businesses in their communities. The company monitors agency earned premium, which is earned premium before reinsurance, on a by-state basis to evaluate its performance on a geographic basis. In 2004, Illinois, Indiana, Michigan, North Carolina, Ohio, Pennsylvania and Virginia, each with at least $100 million in commercial lines agency earned premium, generated 59.3 percent of commercial lines premiums compared with 60.4 percent in the prior year. In these states, agency earned premiums grew 10.0 percent, or $120 million, in 2004 compared with 11.9 percent, or $127 million, in 2003. Ohio, where the company has 187 independent agencies, accounted for 18.7 percent of commercial lines earned premiums, versus 19.4 percent in 2003. In the remaining 24 states, agency earned premiums grew 15.2 percent and 17.7 percent, or $119 million and $118 million, in 2004 and 2003, respectively.

Commercial Lines Agency Earned Premiums by State

From late-2003 through the end of 2004, competition has increased in the commercial lines marketplace, particularly to attract quality new business. In the company’s experience, the level of competition varies market-by-market, by line of business and by size of account. In most markets where the company competes, the company believes that disciplined underwriting generally remains the norm. In the company’s opinion, carriers are modifying prices rather than changing policy terms and conditions.

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As competition in the commercial markets has increased, the company has maintained its pricing discipline for both renewal and new business. While the company’s independent agents reported only modest pressure on renewal pricing at the end of 2004, they communicated that winning new business would require more pricing flexibility and careful risk selection. The company intends to remain a stable market for its agencies’ best business, and management believes that the company’s case-by-case approach gives it a clear advantage. The company’s field marketing associates and its independent agents work together to select risks and respond appropriately to local pricing trends. Historically, they have proven capable of balancing risk and price to achieve growth in new business over the longer term.

Looking ahead, management believes that opportunities to obtain new business and increase policy count will come from its strong relationships with independent agencies, subdivision of territories to enhance service and appointment of new agencies over the next several years. Offsetting new appointments will be continued consolidation within the independent agency marketplace and terminations of certain of its agency relationships.

Staying abreast of evolving market conditions is a critical function, accomplished in both an informal and a formal manner. Informally, the field marketing representatives are in constant receipt of market intelligence from the agencies with which they work. Formally, the commercial lines product management group completes periodic market surveys to obtain competitive intelligence. This market information helps to determine the top competitors by line of business or specialty program and also determines market strengths and weaknesses for the company. The analysis encompasses pricing, breadth of coverage and underwriting/eligibility issues. In addition to reviewing the company’s competitive position, the product management group performs underwriting audits to assess profitability initiatives. Further, the company’s research and development department analyzes opportunities and develops new products, new coverage options and improvements to existing insurance products.

The company’s standard approach is to write three-year policies, and it considers this a competitive advantage in the commercial lines market. Although the company offers three-year terms, premiums for some coverages within those policies are adjustable at anniversary for the subsequent annual period, and policies may be cancelled at any time at the discretion of the policyholder. While writing three-year policies would appear to restrict opportunities to quickly adjust pricing, contract terms provide that the rates for automobile, workers compensation, professional liability and most umbrella liability coverages within multi-year packages may be changed at each of the policy’s annual anniversaries for the next one-year period. The annual rate adjustments could incorporate rate changes approved by state insurance regulatory authorities between the date the policy was written and its annual anniversary date, as well as changes in risk exposures and premium credits or debits relating to loss experience, competition and other underwriting judgment factors. Management estimates that approximately 75 percent of 2004 commercial premium was written on a one-year policy term or was subject to annual rating adjustments.

In the company’s experience, multi-year packages can be marketed at rates that may be slightly higher than annual package rates. By reducing annual administrative efforts, multi-year policies reduce the company’s and agency’s expenses and the incentive for the policyholder to shop for a new policy every year. Management believes that the advantages of three-year policies in terms of policyholder convenience, account retention and reduced administrative costs outweigh the potential disadvantage of these policies, even in periods of rising rates.

Management believes that its three-year commercial policies are somewhat less price sensitive for quality-conscious insurance buyers who are typical customers of the company’s independent agents. For three years, or even over relationships that last decades, those policyholders have experienced the company’s personal claims service, benefited from the company’s coverage packages and relied on the company’s high financial strength ratings. Customized insurance programs on a three-year term complement the relationships these policyholders have with their agents and with the company. They may be less inclined to shop their accounts annually.

In 2003, the company resumed writing three-year policies for contractor risks in most states because of these advantages. In 2002, the company temporarily wrote one-year policies for contractor risks while awaiting state regulatory approval for two significant coverage changes in the company’s general liability and umbrella coverage forms. The changes brought the company’s policy forms in line with industry practices by capping the amount payable during a policy period (usually 12 months) for certain types of liability claims and by clarifying how a policy responds once the insured learns that injury or damage has occurred during a prior policy period. Looking ahead, the company expects that these changes will help the company better manage liability losses and remain a viable market for agents to place coverage for well-managed, reputable contractors. Underwriters carefully monitor new and renewal contractor business, continuing to write one-year policies when competitive or underwriting issues make three-year policies impractical.

Four business lines – commercial multi-peril, workers compensation, commercial automobile and other liability – account for approximately 90 percent of commercial lines earned premiums.

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Commercial multi-peril provides a combination of property and liability coverage. Property insurance covers damages such as those caused by fire, wind, hail, water, theft, vandalism and business interruption resulting from a covered loss. Liability coverage insures businesses against third-party liability from accidents occurring on their premises or arising out of their operations, such as injuries sustained from products sold.

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•	Workers compensation covers employers for specified benefits payable under state or federal law for workplace injuries to employees.
•	Commercial auto covers businesses for liability to others for both bodily injury and property damage, medical payments to insureds and occupants of their vehicles, physical damage to an insured’s own vehicle from collision and various other perils, and damages caused by uninsured motorists..
•	Other liability includes commercial umbrella, commercial general liability and most executive risk policies, which cover liability exposures including bodily injury, directors and officers and employment practices, property damage arising from products sold and general business operations.

The remainder of commercial lines earned premiums was derived from a variety of other types of insurance products the company offers to commercial customers, including fiduciary and surety bonds and machinery and equipment policies.

Personal Lines Property Casualty Insurance Segment

The personal lines property casualty insurance segment contributed $793 million in net earned premiums to the company’s total revenues and a $40 million loss before income taxes in 2004. Personal lines net earned premiums grew 6.4 percent in 2004, 11.2 percent in 2003 and 8.2 percent in 2002.

The company actively markets its personal lines products in 22 of the 31 states in which it markets commercial lines insurance and selected products within certain agencies in the nine remaining states. In 2004, Alabama, Georgia, Illinois, Indiana, Kentucky, Michigan and Ohio, each with $35 million or more in personal lines agency earned premium, generated 76.2 percent of personal lines premiums, compared with 76.9 percent in 2003. In these states, agency earned premiums grew 6.4 percent, or $37 million, in 2004, versus 8.6 percent, or $46 million, in the prior year. Ohio, where the company has 182 independent agencies writing personal lines products, accounted for 37.6 percent of 2004 personal lines agency earned premiums compared with 38.2 percent in 2003. In the remaining 21 states, agency earned premiums grew 10.7 percent and 16.2 percent, or $19 million and $24 million, in 2004 and 2003, respectively.

Personal Lines Agency Earned Premiums by State

Since 2000, the company has observed that the personal lines marketplace has focused on underwriting discipline rather than market share. The result has been an industry-wide improvement in profitability, augmented by favorable loss frequency and severity trends. Overall, rates for both personal auto and homeowner insurance have risen in conjunction with stricter enforcement of underwriting guidelines. Despite the record level of industry-wide catastrophe losses in 2004, competition began to increase during the year in the personal lines marketplace, with industry analysts observing a plateau in year-over-year rate filings.

The company markets homeowners and personal automobile insurance products through 706 of its 986 independent agencies. The 280 agencies that do not market the full complement of personal lines products either are located in states in which the company does not actively market these products or the company has determined, in conjunction with agency management, that the company’s personal lines products are not appropriate for their agencies at this time. Personal automobile accounted for 56.8 percent and homeowners accounted for 32.6 percent of personal lines net earned premium in 2004.

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Personal automobile covers liability to others for both bodily injury and property damage, medical payments to insureds and occupants of their vehicle, physical damage to an insured’s own vehicle from collision and various other perils, and damages caused by uninsured motorists.. In addition, many states require policies to provide first-party personal injury protection, frequently referred to as no-fault coverage.

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•	Homeowners covers losses to dwellings and contents from a wide variety of perils, as well as liability arising out of personal activities both on and off the covered premises. The company also offers coverage for condominium unit owners and renters.

The remainder of personal lines earned premium was derived from a variety of other types of insurance products the company offers to individuals such as dwelling fire, inland marine, personal umbrella liability and watercraft coverages.

Life Insurance Segment

The life insurance segment contributed $104 million of the company’s total revenues and a $2 million gain before income taxes in 2004. See Item 7, Life Insurance, Page 45, for additional information regarding life insurance segment profitability.

The Cincinnati Life Insurance Company’s mission complements that of the overall company: to provide products and services that attract and retain high quality independent insurance agencies. The company primarily focuses on life products that produce revenue growth through a steady stream of premiums.

Cincinnati Life seeks to round out and protect accounts in the property casualty agency and to improve account persistency. At the same time, the life operation looks to increase diversification, revenues and profitability for both the agency and the company. This strategy enhances the already strong relationship built by the combination of the property casualty and life companies.

Cincinnati Life seeks to become the life insurance carrier of choice for the independent agencies that work with the property casualty operations by providing competitive products, responsive underwriting, high quality service and reasonable commissions. At year-end 2004, approximately 89 percent of the company’s 986 property casualty agencies offered Cincinnati Life’s products to their policyholders. The life company also seeks to develop life business from other independent life insurance agencies in a manner that does not conflict or compete with the property casualty agencies.

Four lines of business – term insurance, whole life insurance, universal life insurance and worksite products – account for approximately 85 percent of the life insurance segment’s revenues:

•	Term insurance – policies under which the benefit is payable only if the insured dies during a specified period of time or term; no benefit is payable if the insured survives to the end of the term. While premiums are fixed, they must be paid as scheduled. The proposed insured is evaluated using normal underwriting standards.
•	Whole life insurance – policies that provide life insurance for the entire lifetime of the insured; the death benefit is guaranteed never to decrease and premiums are guaranteed never to increase. While premiums are fixed, they must be paid as scheduled. These policies provide specified cash values that are available to withdrawing policyholders. The proposed insured is evaluated using normal underwriting standards.
•	Universal life insurance – long-duration life insurance policies. Contract premiums are neither fixed nor guaranteed; however, the contract does specify a minimum interest crediting rate and a maximum cost of insurance charge and expense charge. Premiums are not fixed and may be varied by the contract owner. The cash values available to withdrawing policyholders are not guaranteed and depend on the amount and timing of actual premium payments and the amount of actual contract assessments. The proposed insured is evaluated using normal underwriting standards.
•	Worksite products – term insurance, whole life insurance, universal life and disability insurance offered to employees through their employer. Premiums are collected by the employer using payroll deduction. Polices are issued using a simplified underwriting approach and for smaller face amounts than similar regularly underwritten policies. Worksite insurance products provide the company’s property casualty agency force with excellent cross serving opportunities for both commercial and personal accounts. Agents find that offering worksite marketing to employees of their commercial accounts provides a benefit to the employees at low cost to the employer.

In addition, Cincinnati Life markets:

•	Disability income insurance — provides monthly benefits to offset the loss of income when the insured person is unable to work due to accident or illness.
•	Deferred annuities — provide regular income payments that commence after the end of a specified period or when the annuitant attains a specified age. During the deferral period, any payments made under the contract accumulate at the crediting rate declared by the company but not less than a contract-specified guaranteed minimum interest rate of 3 percent to 4 percent. A deferred annuity may be surrendered during the deferral period for a cash value equal to the accumulated payments plus interest less the surrender charge, if any.
•	Immediate annuities — provide some combination of regular income and lump sum payments in exchange for a single premium. Most of the immediate annuities written by the life insurance segment are purchased by the company’s property casualty companies to settle casualty claims.

Cincinnati Life is a financially strong and stable life insurance company. Cincinnati Life’s statutory adjusted risk-based surplus increased 10.7 percent to $491 million at December 31, 2004, from $443 million a year earlier. Statutory

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adjusted risk-based surplus as a percentage of liabilities, a key measure of life insurance company capital strength, were 38.3 percent at year-end 2004 compared with an estimated industry average ratio of 10.5 percent. The higher the ratio, the stronger an insurer’s security for policyholders and its capacity to support business growth . A.M. Best – A+ (Superior), Fitch Ratings – AA (Very Strong) and Standard & Poor’s Ratings Services – AA- (Very Strong, negative outlook) maintained their ratings for Cincinnati Life in 2004.

Investments Segment

The investment segment contributed $583 million of the company’s total revenues in 2004, primarily from net investment income and realized investment gains and losses from investment portfolios managed for the holding company and each of the operating subsidiaries. Primarily from investment income, it contributed $537 million of income before income taxes, or 67.2 percent of total income before income taxes.

While the company seeks to generate an underwriting profit in its property casualty and life segments, the investment segment historically has provided the primary source of profits and contributed to the company’s financial strength, driving long-term growth in shareholders’ equity and book value.

Under the direction of the investment committee of the board of directors, the company’s analysts and portfolio managers seek to balance current investment income opportunities and long-term appreciation so that current cash flows from both insurance and investment operations can be compounded to achieve above-average long-term total return.

While focused on long-term total return, the company maintains liquidity to meet both its immediate and long-range insurance obligations with the purchase and maintenance of medium-risk fixed-maturity and equity securities. Historically, approximately 65 percent to 70 percent of available cash has been invested in fixed-income securities with the remaining 30 percent to 35 percent invested in equity and equity-linked securities.

In preparing the Consolidated Financial Statements, convertible securities are included in fixed-maturities or equity securities, based on the characteristics of the underlying security (bond or preferred stock). When monitoring and evaluating investment operations results, the company broadly categorizes investments as fixed-income securities, which includes investment-grade corporate bonds, high-yield corporate bonds and tax-exempt municipal bonds; and equity and equity-linked securities, which includes common and preferred stocks and all convertible securities.

At year-end 2004 and 2003, these five classes of assets accounted for the following:

Fixed-income Securities

By maintaining a well diversified fixed-income portfolio, the company attempts to reduce overall credit risk. The company invests new money in the bond market on a continuous basis, targeting what management believes to be optimal risk-adjusted after-tax yields. Risk, in this context, includes both credit and interest rate risk. Management does not make concerted efforts to alter duration on a portfolio basis in response to anticipated movements in interest rates. By continually investing in the bond market, the company builds a broad, diversified portfolio that management believes mitigates the impact of adverse economic factors. In recent years, the company has taken into account the trend toward a flatter corporate yield curve and an overall decline in credit quality by purchasing higher-quality corporate bonds with shorter maturities as well as tax-exempt municipal bonds and U.S. agency paper. The company’s focus on long-term total return may result in variability in the levels of realized and unrealized investment gains or losses from one period to the next.

With the exception of U.S. agency paper, no individual fixed-income issuer’s securities accounted for more than 0.6 percent of the fixed-income portfolio at December 31, 2004. For the insurance companies’ portfolios, strong emphasis is placed on purchasing current income-producing securities.

•	Investment-grade corporate bonds have a Moody’s rating at or above Baa 3 or a Standard & Poor’s rating at or above BBB-. The company seeks to balance current income with potential changes in market value as well as changes in credit risk when determining whether or not to hold these securities to maturity.
•	High-yield corporate bonds have a Moody’s rating below Baa 3 or a Standard & Poor’s rating below BBB-. The company’s strong capital position provides the flexibility to invest in these securities in addition to investment-grade corporate bonds. While such investments tend to have higher yields, they are inherently more risky, as their

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	ratings indicate, with a higher potential for default by the issuer. Historically, they have contributed positively to investment income and, in general, are less sensitive to interest rate fluctuations. Similar to investment-grade bonds, the company seeks to balance current income with potential changes in market value as well as changes in credit risk when determining whether or not to hold these securities to maturity. This security class is closely monitored for selective buying opportunities, but more importantly for changes in the market that may negatively affect existing holdings. See Item 7A, Unrealized Investment Gains and Losses, Page 66, for further discussion.
•	Tax-exempt municipal bonds are exempt from federal taxes, a feature the company continues to find attractive. However, the company invests in a blend of tax-exempt and taxable fixed-maturity securities because of alternative minimum tax effects. The company traditionally has purchased municipal bonds focusing on essential services, such as schools, sewer, water or others. While no single municipal issuer accounted for more than 1.4 percent of the tax-exempt municipal bond portfolio at December 31, 2004, concentrations within individual states can be high. Holdings in five states – Illinois, Indiana, Ohio, Texas and Washington – accounted for 61.0 percent of the municipal bond portfolio at year-end 2004.

Equity and Equity-linked Securities

The company’s equity and equity-linked securities portfolio includes a core group of common stocks that the company can monitor closely to gain an in-depth understanding of their organization and industry. It also includes a broader group of smaller positions in common and preferred stocks and convertible securities, which can be a source of trading flexibility and other risk management advantages. The company’s portfolio of equity investments had an average dividend yield-to-cost of 11.5 percent at December 31, 2004.

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Common stocks – At December 31, 2004, 35.8 percent of the common stock holdings (measured by market value) were held at the parent company level. Common stock investments generally are securities with annual dividend yields of 1.5 percent to 3.0 percent and histories of dividend increases. Other criteria include increasing sales and earnings, proven management and a favorable outlook.

Common Stock Holdings

When investing in common stock, management seeks to identify companies in which it can accumulate more than 5 percent of their outstanding shares. There also is a core group of common stocks in which the company holds a market value of at least $100 million. At year-end 2004, there were 14 holdings in that core group, including three of the four investments where the company held more than 5 percent of their outstanding shares. While this emphasis on a small group of equities and long-term investment horizon has resulted in significant concentrations within the portfolio, the company has followed this buy-and-hold strategy for many years, resulting in significant accumulated unrealized appreciation within the equity portfolio. At year-end 2004, the largest industry concentrations within these large common equity holdings were the financials sector at 65.9 percent of total market value and the healthcare sector at 5.7 percent of total market value. (See Item 7, Investment Results of Operations, Page 47, for a discussion of equity securities sold during 2004.)

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Convertible securities – For more than 30 years, the company has invested in convertible bonds and convertible preferred stocks. These securities are the primary trading vehicle in the portfolio. Management believes the conversion features enhance the overall values of these securities and does not believe that investments in convertible securities pose any significant risk to the company or its portfolio due to their characteristics. As a class, convertible securities tend to be less sensitive to interest rate changes than fixed-rate securities and less sensitive to market conditions than common stocks.

Additional information regarding the composition of investments is included in Item 8, Note 2 to the Consolidated Financial Statements, Page 80.

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Regulation

State Regulation

The business of insurance primarily is regulated by state law. Although the company’s insurance subsidiaries are domiciled in Ohio and primarily subject to Ohio insurance laws and regulations, the company also is subject to state regulatory authorities of all states in which it writes insurance. The state laws and regulations that have the most significant effect on the company’s insurance operations and financial reporting are discussed below.

•	Insurance Holding Company Regulation — The company’s subsidiaries primarily engage in the property casualty insurance business and secondarily in the life insurance business, both subject to regulation as an insurance holding company system by the State of Ohio, the domiciliary state of the company and its insurance subsidiaries. Such regulation requires that each insurance company in the system register with the department of insurance of its state of domicile and annually furnish financial and other information about the operations of the individual companies within the holding company system. All transactions within a holding company affecting insurers must be fair and equitable. Notice to the insurance commissioner is required prior to the consummation of transactions affecting the ownership or control of an insurer and prior to certain material transactions between an insurer and any person or entity in its holding company. In addition, some of those transactions cannot be consummated without the commissioner’s prior approval.
•	Subsidiary Dividends — The dividend-paying capacity of the company’s insurance subsidiary is regulated by the laws of Ohio, the domiciliary state. The insurance subsidiary must provide a 10-day advance informational notice to the Ohio insurance department prior to payment of any dividend or distribution to its shareholders. Ordinary dividends must be paid from earned surplus, which is the amount of unassigned funds set forth in the insurance subsidiary’s most recent statutory financial statement.
	Prior approval by the Ohio Department of Insurance is required before the payment of an extraordinary dividend to shareholders. See Item 8, Note 8 to the Consolidated Financial Statements, Page 83, for information concerning dividends paid by its insurance subsidiary in 2004.
•	Insurance Operations — The company’s insurance subsidiaries are subject to licensing and supervision by departments of insurance in the states in which they do business. The nature and extent of such regulations vary, but generally have their source in statutes that delegate regulatory, supervisory and administrative powers to state insurance departments. Such regulations, supervision and administration of the insurance subsidiaries include, among others, the standards of solvency which must be met and maintained; the licensing of insurers and their agents; the nature and limitations on investments; deposits of securities for the benefit of policyholders; regulation of policy forms and premium rates; periodic examination of the affairs of insurance companies; annual and other reports required to be filed on the financial condition of insurers or for other purposes; requirements regarding reserves for unearned premiums, losses and other matters; the nature of and limitations on dividends to policyholders and shareholders; the nature and extent of required participation in insurance guaranty funds; and the involuntary assumption of hard-to-place or high-risk insurance business, primarily workers compensation insurance.
	Loss ratio trends in property casualty insurance operations may be improved by actions such as changing the amounts or kinds of coverages provided by policies, providing loss prevention and risk management services, increasing premium rates, purchasing reinsurance or combining these and other actions. The ability of the insurance subsidiaries to respond to emerging adverse underwriting trends may be delayed, from time to time, by the effects of laws that require prior approval by insurance regulatory authorities of changes in policy forms and premium rates or that restrict the ability to cancel or non-renew insurance policies.
•	Insurance Guaranty Association Assessments — Each state has insurance guaranty association laws under which the associations may assess life and property casualty insurers doing business in the state for certain obligations of insolvent insurance companies to policyholders and claimants. Typically, states assess each member insurer in an amount related to the insurer’s proportionate share of business written by all member insurers in the state. Assessments to the company’s insurance subsidiaries were $2 million, net of refunds, in both 2004 and 2003. The company cannot predict the amount and timing of any future assessments on its insurance subsidiaries under these laws.
•	Shared Market and Joint Underwriting Plans — State insurance regulation requires insurers to participate in assigned risk plans, reinsurance facilities and joint underwriting associations, which are mechanisms that generally provide applicants with various basic insurance coverages when they are not available in voluntary markets. Such mechanisms are most commonly instituted for automobile and workers compensation insurance, but many states also mandate participation in FAIR Plans or Windstorm Plans, which provide basic property coverages. Participation is based upon the amount of a company’s voluntary market share in a particular state for the classes of insurance involved. Underwriting results related to these organizations, which tend to be adverse to the company, have been immaterial to the company or its results of operations.

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•	Statutory Accounting — For public reporting, insurance companies prepare financial statements in accordance with GAAP. However, certain data also must be calculated according to statutory accounting rules as defined in the National Association of Insurance Commissioners’ (NAIC) Accounting Practices and Procedures Manual.
	While not a substitute for any GAAP measure of performance, statutory data frequently is used by industry analysts and other recognized reporting sources to facilitate comparisons of the performance of insurance companies. When appropriate, the company uses statutory data to analyze trends or make comparisons to industry performance. Unless otherwise noted, estimated industry data is referenced from materials presented on a statutory basis by A.M. Best, a leading insurance industry statistical, analytical and financial strength rating organization. Statutory data for the company is labeled as such; all other company data is presented on a GAAP basis.
	The NAIC adopted the Codification of Statutory Accounting Principles (Codification) in March 1998. Codification, which standardizes regulatory accounting and reporting to state insurance regulators, became effective January 1, 2001. Codification now is incorporated into the NAIC Accounting Practices and Procedures Manual. Additionally, prior to 2001, the company’s property casualty insurance subsidiaries recognized written premiums as they were billed throughout the policy period, which was a previously acceptable method. Beginning on January 1, 2001, the subsidiaries began recognizing written premiums on an annualized basis at the effective date of the policy as required by Codification. This method of recognizing written premiums had no effect on earned premiums or other GAAP measures.
•	Insurance Reserves — State insurance laws require that property casualty insurance subsidiaries analyze the adequacy of reserves annually. The company’s outside actuaries must submit an opinion that reserves are adequate for policy claims-paying obligations and related expenses.
•	Risk-Based Capital Requirements — The NAIC’s risk-based capital (RBC) requirements for property casualty and life insurers serve as an early warning tool for the NAIC and the state regulators to identify companies that may be undercapitalized and may merit further regulatory action. The ratio of a company’s actual policyholders’ surplus to its minimum capital requirement determines whether any state regulatory action is required. At December 31, 2004, the company’s lead insurance subsidiary and each of its subsidiaries had more than sufficient capital to meet the RBC minimum requirements and had excess capacity beyond these requirements to write additional premiums.
•	Industry Sales Practices — Recently, the Attorney General of the State of New York brought a suit against participants in the insurance industry alleging certain illegal actions by an insurance brokerage firm. The company does not do business with the parties involved in the suit, does not use broker contracts in its business, is not involved in the suit at all and does not believe that its business practices are of the same nature as those the suit alleged to have occurred. On January 30, 2005, the Attorney General of the State of New York entered into a settlement agreement with certain participants, pursuant to which the brokerage agreed to pay into a fund to reimburse clients and take other actions, in full satisfaction of all liability to the Attorney General of the State of New York. Additionally, New York and other regulators have initiated other investigations within the insurance and insurance brokerage industry involving practices relating to compensation and other arrangements between brokers and insurers and their dealings with their clients and insureds. Management cannot be certain of what the ultimate effects might be on the insurance industry as a whole, and thus on the company’s business, of any increased regulatory oversight resulting from the suit or the other regulatory investigations.
	Insurance departments in Ohio and other states are sending letters of inquiry and other requests to multiple insurance companies and other industry members, to survey industry sales practices. The company’s insurance subsidiaries have received information requests from the Department of Insurance in Ohio and other states beginning November 1, 2004. A letter received by The Cincinnati Life Insurance Company from the Ohio Department of Insurance is similar to a NAIC model letter of inquiry, which contains questions and document production requests relating to arrangements and transactions with insurance producers. The company anticipates receiving additional inquiries from other states in which its markets insurance through licensed and appointed independent insurance agents. The company intends to fully cooperate with the state insurance departments.
	In December 2004, the NAIC adopted model legislation that includes new insurance producer compensation disclosure requirements. The model provides that producers who represent companies and do not receive compensation from the insured would have a duty to disclose that relationship in certain limited circumstances. It is uncertain whether this model legislation or any other legislation or regulation will be adopted in any of the jurisdictions in which the company operates. The NAIC further directed its task force on broker activities to consider developing additional model legislation, potentially addressing whether producer responsibility rises to the fiduciary level and whether there must be disclosure of all quotes received by a broker and of any agent-owned reinsurance arrangements. Management cannot be certain how such legislation or regulation, if proposed and adopted in any jurisdictions, might indirectly affect the company’s results of operations or financial condition.

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Federal Regulation

Although the federal government and its regulatory agencies generally do not directly regulate the business of insurance, federal initiatives often have an impact. Some of the current and proposed federal measures that may significantly affect the company’s business are discussed below.

•	The Terrorism Risk Insurance Act of 2002 (TRIA) – TRIA was signed into law on November 26, 2002 and provides a temporary federal backstop for losses related to the writing of the terrorism peril in property casualty insurance policies. TRIA currently is scheduled to expire December 31, 2005. Under regulations promulgated under this statute, insurers are required to offer terrorism coverage for certain lines of property casualty insurance, including property, commercial multi-peril, fire, ocean marine, inland marine, liability, commercial auto, aircraft, surety and workers compensation. In the event of a terrorism event defined by TRIA, the federal government will reimburse terrorism claim payments subject to the insurer’s deductible. The deductible is calculated as a percentage of premiums written for the preceding calendar year. The company’s deductible was $199 million in 2004 (10 percent of 2003 subject premiums) and $136 million in 2003 (10 percent of 2002 subject premiums). For 2005, the deductible will be $328 million (15 percent of 2004 subject premiums).
•	Health Insurance Portability and Accountability Act of 1996 (HIPAA) – The company’s life insurance subsidiary protects consumer health information pursuant to regulations promulgated under HIPAA. Regulations effective April 14, 2003, require health care providers such as doctors and hospitals, as well as health and long-term care insurers and health care clearinghouses, to institute physical and procedural safeguards to protect the health records of patients and insureds. Effective October 16, 2003, additional regulations require health plans to electronically transmit and receive standardized healthcare information. These rules and regulations should minimally affect the company as its health insurance writings are limited to its self-funded health plan for company associates and a small number of run-off medical and hospital expense insurance policies. The company does not actively market health, medical and hospital expense insurance policies.
•	Office on Foreign Asset Control (OFAC) – Subject to an Executive Order signed on September 24, 2001, intended to thwart financing of terrorists and sponsors of terrorism, the company, and financial institutions generally, were required to block and report transactions and attempted transactions between the company and persons and organizations named in a list published by OFAC. The company currently uses a combination of software, third-party vendor and manual searches to accomplish its transaction blocking and reporting activities.
•	Investment Company Act of 1940 – On June 28, 2004, the company submitted an application to the SEC seeking exemptive relief under the Investment Company Act of 1940. As of the filing date of this Form 10-K, the request for an exemptive order is still pending with the staff of the SEC. On August 26, 2004, the company announced that Cincinnati Financial Corporation transferred approximately 31.8 million shares of Fifth Third Bancorp common stock to The Cincinnati Insurance Company to address its status under the Investment Company Act. The 31.8 million shares had a market value of $1.600 billion on August 26, 2004. The transfer was authorized by Cincinnati Financial’s board of directors on August 13, 2004, and approved by the Ohio Department of Insurance on August 24, 2004. After the contribution, the ratio of investment securities held at the holding company level was 36.3 percent of total holding-company-only assets at December 31, 2004.
	As previously reported, as a result of a review made in June 2004, the company determined there was some uncertainty regarding the status of the Cincinnati Financial Corporation holding company under the Investment Company Act of 1940. On June 28, 2004, Cincinnati Financial Corporation filed an application with the SEC formally requesting an exemption for the holding company under Section 3(b)(2) of the Investment Company Act, which permits the SEC to exempt entities primarily engaged in business other than that of investing, reinvesting, owning, holding or trading in securities. Cincinnati Financial Corporation alternatively has asked the SEC for relief pursuant to Section 6(c) of the Investment Company Act that would exempt it from all the provisions of the Act because doing so is necessary or appropriate in the public interest consistent with the protection of investors and consistent with the purposes intended by the Investment Company Act. The company simultaneously contacted the SEC’s Division of Investment Management to discuss the status of Cincinnati Financial Corporation under the Investment Company Act.
	Management strongly believes the holding company is, and has been, outside the intended scope of the Investment Company Act because the company is, and has been, primarily engaged in the business of property casualty and life insurance through its subsidiaries. Several tests and enumerated exemptions determine whether a company meets the definition of an investment company under the Investment Company Act. One test states that a company is an investment company if it owns investment securities with a value greater than 40 percent of its total assets (excluding assets of its subsidiaries).
	Registered investment companies are not permitted to operate their business in the manner in which Cincinnati Financial is operated, nor are registered investment companies permitted to have many of the relationships that the parent company has with its affiliated companies. If it were to be determined that the parent company was an unregistered investment company before the asset transfer, Cincinnati Financial may be unable to enforce contracts with third parties, and third parties could seek to obtain rescission of transactions with Cincinnati

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	Financial undertaken during the period that it was an unregistered investment company, subject to equitable considerations set forth in the Investment Company Act. As a result, it could be determined that holders of Cincinnati Financial’s $420 million aggregate principal amount of 6.9% Senior Debentures due 2028 have a right to rescind such indebtedness, thereby requiring Cincinnati Financial to immediately repay such amounts. Cincinnati Financial may be unable to refinance such obligations on acceptable terms. However, Cincinnati Financial currently has available sufficient assets to fund such repayment and believes that its assets are adequate to meet its short- and long-term obligations.
	To avoid regulation under the Investment Company Act in the future, the company’s operations are, to an extent, limited by the constraint that investment securities held at the holding company level remain below the 40 percent threshold described above. These considerations could require the company to dispose of otherwise desirable investment securities under undesirable conditions or otherwise avoid economically advantageous transactions. Although management intends to manage assets to stay below the 40 percent threshold (unless the SEC grants the company’s request for an exemptive order), events beyond the company’s control, including significant appreciation in the market value of certain investment securities, could result in the company breaching the 40 percent threshold. While management believes that even in such circumstances the company would not be an investment company because it is primarily engaged in the business of insurance through its subsidiaries, the SEC, among others, could disagree with this position. If it were established that the company is an unregistered investment company, there would be a risk, among the other material adverse consequences described above, that the parent company could become subject to monetary penalties or injunctive relief, or both, in an action brought by the SEC.
•	Investment Advisers Act of 1940 — One of the company’s subsidiaries, CinFin Capital Management Company, operates an investment advisory business and is therefore subject to regulation by the SEC as a registered investment adviser under the Investment Advisers Act of 1940. This law imposes certain annual reporting, record keeping, client disclosure and compliance obligations on CinFin Capital Management.

Item 2. Properties

Cincinnati Financial Corporation owns its headquarters building located on 100 acres of land in Fairfield, Ohio. This building contains approximately 800,000 total square feet. John J. & Thomas R. Schiff & Co. Inc., a related party, occupies approximately 6,750 square feet (1 percent). The property, including land, is carried in the financial statements at $76 million as of December 31, 2004, and is classified as property and equipment, net, for company use.

CFC Investment Company owns the Fairfield Executive Center, which is located on the northwest corner of its headquarters property in Fairfield, Ohio. This is a four-story office building containing approximately 96,000 square feet. CFC and its subsidiaries occupy approximately 90 percent of the building and unaffiliated tenants occupy approximately 10 percent. The property is carried in the financial statements at $7 million as of December 31, 2004, and is classified as property and equipment, net, for company use.

The Cincinnati Life Insurance Company owns a four-story office building in the Tri-County area of Cincinnati, Ohio. It contains approximately 102,000 rentable square feet. An unaffiliated tenant currently leases 100 percent of the building through December 31, 2005. At this time, the company has not been informed that the tenant intends to vacate the property and the tenant has until August 2005 to notify the company of their intent. This property is carried in the financial statements at $3 million as of December 31, 2004, and is classified as other invested assets.

In 2004, the company decided to undertake a building expansion at its headquarters location in Fairfield, Ohio. Preparation for construction of an underground garage and third office tower began in January 2005. The new tower will contain more than 690,000 total square feet, including the garage. It will rise seven stories above three underground parking levels with 700 parking spaces. The construction has an estimated completion date of September 2008. The company believes this expansion will accommodate its business needs for the foreseeable future.

Item 3. Legal Proceedings

Neither the company nor any of its subsidiaries is involved in any material litigation other than ordinary, routine litigation incidental to the nature of its business.

Item 4. Submission of Matters to a Vote of Security Holders

No matters were submitted to a vote of security holders of Cincinnati Financial during the fourth quarter of 2004.

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Part II

Item 5.	Market for the Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities

Cincinnati Financial Corporation had approximately 11,850 shareholders of record as of December 31, 2004. Many of the company’s independent agent representatives and most of the 3,884 associates of its subsidiaries own the company’s common stock. Common shares are traded under the symbol CINF on the Nasdaq National Market. The common stock prices and dividend data below reflect the 5 percent stock dividend paid June 15, 2004; per share data has not been adjusted for the 5 percent stock dividend to be paid on April 26, 2005.

CFC’s ability to pay cash dividends may depend on the ability of its insurance subsidiary to pay dividends to the parent company. See Item 8, Note 8 to the Consolidated Financial Statements, Page 83, for discussion of dividend restrictions at the insurance company subsidiaries.

Information regarding securities authorized for issuance under equity compensation plans appears in the Proxy Statement under “Equity Compensation Plan Information.” This portion of the Proxy Statement is incorporated herein by reference. Additional information with respect to options under the company’s equity compensation plans is available in Item 8, Note 8 and Note 16 to the Consolidated Financial Statements, Pages 83 and 88.

The board of directors has authorized a share repurchase program (see Item 7, Cash Flow, Page 51, for additional information on the program). In 2004, repurchases were made as follows (amounts unadjusted for stock dividends):

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Item 6. Selected Financial Data

Per share data adjusted to reflect all stock splits and dividends prior to December 31, 2004.

One-time charges or adjustments:

2003 — As the result of a settlement negotiated with a vendor, pretax results included the recovery of $23 million of the $39 million one-time, pretax charge incurred in 2000.

2000 — The company recorded a one-time charge of $39 million, pretax, to write down previously capitalized costs related to the development of software to process property casualty policies.

2000 — The company earned $5 million in interest in the first quarter from a $303 million single-premium bank-owned life insurance (BOLI) policy booked at the end of 1999 that was segregated as a Separate Account effective April 1, 2000. Investment income and realized investment gains and losses from separate accounts generally accrue directly to the contract holder and, therefore, are not included in the company’s consolidated financials.

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2004 10-K page 21

Topics addressed in Item 7, Management’s Discussion and Analysis of Financial Condition and Results of Operations, and Item 7A, Quantitative and Qualitative Disclosures About Market Risk, include:

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Item 7.	Management’s Discussion and Analysis of Financial Condition and Results of Operations

Introduction

The purpose of the Management’s Discussion and Analysis is to provide an understanding of Cincinnati Financial Corporation’s (CFC) consolidated results of operations and financial position. It begins with an overview of the company and its outlook, a safe harbor statement that covers factors that could cause results to differ from those anticipated by management and details on the company’s critical accounting policies and estimates. It should be read in conjunction with Item 6, Selected Financial Data, Pages 20 and 21, and the Consolidated Financial Statements and related Notes, beginning on Page 72. Per share amounts have been adjusted for the 5 percent stock dividend paid June 15, 2004; per share data has not been adjusted for the 5 percent stock dividend to be paid on April 26, 2005.

Unless otherwise noted, estimated industry data are referenced from materials presented on a statutory basis by A.M. Best, a leading insurance industry statistical, analytical and financial strength rating organization. Statutory data for the company is labeled as such; all other company data is presented on a GAAP basis.

Executive Summary

Cincinnati Financial Corporation is the parent company of the nation’s 25^th largest property casualty insurer, based on statutory net written premium volume through the first nine months of 2004. The company marketed property casualty insurance products through a select group of 986 independent insurance agencies in 31 states at year-end 2004.

The company is built on a foundation of personal relationships with these local independent insurance agents. These agents have an informed, front line perspective that benefits policyholders as well as the company, helping to create profitability and value for shareholders. Local-resident field marketing and other associates live in the communities they serve, working from offices in their homes and providing 24/7 availability. They are assigned directly to agencies, where they are able to provide prompt and personal service, gain firsthand knowledge and be effective decision makers for the company. The company differentiates itself by its commitment to: providing exceptional claims service and field underwriting through locally based associates serving the needs of agents and policyholders; offering competitive products, rates and compensation; and maintaining excellent financial strength ratings. Headquarters associates, including approximately 600 underwriters, are assigned to specific agencies and provide important support to the field staff and agencies.

In addition to property casualty insurance products, the company offers life insurance, leasing and asset management services to help attract and retain high quality independent insurance agencies. This strategy helps diversify revenues and profitability for both the agency and the company and enhances the already strong relationship built by the property casualty operations.

Among the various factors that influence the consolidated results of operations and financial position of the company, management considers its relationships with independent agencies to be the most significant. To continue to achieve its performance targets, the company must maintain its strong relationships with the select group of agencies with which it does business, write a significant portion of each agency’s business and attract new agencies. The company seeks to be an indispensable partner in each agency’s success. The company measures its accomplishment of this objective based on being the largest or second largest carrier in each agency, either by dollars of premium or number of policies written, depending on the agency’s mix of business.

The company’s strong surplus and asset positions provide security for policyholders while allowing for a successful, equity-centered investment strategy.

By consistently applying long-term strategies rather than taking short-term actions, the company seeks to build shareholder value by:

•	Achieving above industry average growth in property casualty statutory net written premiums and maintaining industry-leading profitability by leveraging its regional franchise and proven agency-centered business strategy.
•	Pursuing a total return investment strategy that generates both strong investment income growth and capital appreciation.
•	Maintaining financial strength by keeping the ratio of debt to capital low and purchasing reinsurance to protect investment flexibility.
•	Increasing the total return to shareholders through a combination of higher earnings per share, growth in book value and increasing dividends. The board of directors is committed to steadily increasing cash dividends and periodically authorizing stock dividends and splits. The board has increased the indicated annual dividend rate for 45 consecutive years, a record the company believes is matched by only 11 other publicly traded corporations.

In 2004, the company reported record results, as described in detail in the results of operations. Statutory net written premium growth outpaced the estimated industry average while the combined ratio, a common measure of profitability

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for property casualty insurers, was significantly better than the estimated industry average. The growth rate of investment income reached its highest level in four years and book value reached a new record, as growth in net income more than offset market fluctuations in the equity portfolio. The company’s financial position continued to strengthen with assets at a record level.

The company currently is pursuing a number of strategies to help it achieve its performance objectives over the next several years:

•	Increasing business with existing agencies by continuing to provide personal service.
•	Improving ease of doing business and communication with agencies through an expanding portfolio of technology solutions. The company expects to continue to strengthen its relationships with agencies through the introduction and use of technology that is designed to bring agencies greater efficiencies and permit associates to spend more time with people and less with paper.
•	Subdividing field marketing territories to further increase the company’s representative’s presence in, and their ability to serve, each agency.
•	Appointing additional agencies in markets where the company has identified a need for insurance products and services and an opportunity to capture a greater market share.
•	Resume equity investing. The company remains fully committed to an equity investment focus that management believes is a key to the company’s long-term growth and stability. The company will continue to invest for income and growth, focusing on a total return strategy supported by investments in dividend-paying companies.

In 2005, management believes the company will achieve statutory net written premium growth in the mid-single digits and a GAAP combined ratio of 91 percent (equivalent to approximately 91 percent on a statutory basis). A.M. Best estimates that 2005 net written premiums industry-wide may rise by 1 percent and that the 2005 industry statutory combined ratio may be approximately 97.3 percent.

Currently, management anticipates pretax investment income growth in 2005 in the range of 5 percent to 6 percent. The investment portfolio is positioned for long-term capital appreciation. Equity and equity-linked securities make up 34.0 percent of the portfolio based on book value and 62.7 percent based on market value at year-end 2004.

Management expects that the impact of these anticipated strong operating results will be tempered in 2005 by the adoption of option expensing and slightly higher interest expense on long-term debt, which increased modestly with the November 2004 issue of $375 million aggregate principal amount of senior notes due 2034. The company will adopt Statement of Financial Accounting Standards (SFAS) No. 123 (R), “Share-Based Payment,” which calls for stock option expense to be included as a component of net income, in the third quarter of 2005. Pro forma option expense as disclosed in Item 8, Note 1 to the Consolidated Financial Statements, Page 76, would have reduced earnings per share by 7 cents in both 2004 and 2003 and 8 cents in 2002.

Safe Harbor Statement

This is a “Safe Harbor” statement under the Private Securities Litigation Reform Act of 1995. Certain forward-looking statements contained herein involve potential risks and uncertainties. The company’s future results could differ materially from those discussed. Factors that could cause or contribute to such differences include, but are not limited to:

•	Unusually high levels of catastrophe losses due to changes in weather patterns, environmental events, terrorism incidents or other causes
•	Ability to obtain adequate reinsurance on acceptable terms, amount of reinsurance purchased and financial strength of reinsurers
•	Increased frequency and/or severity of claims
•	Events or conditions that could weaken or harm the company’s relationships with its independent agencies and hamper opportunities to add new agencies, resulting in limitations on the company’s opportunities for growth, such as:

	°	Downgrade of the company’s financial strength ratings,
	°	Concerns that doing business with the company is too difficult or
	°	Perceptions that the company’s level of service, particularly claims service, is no longer a distinguishing characteristic in the marketplace

•	Insurance regulatory actions, legislation or court decisions or legal actions that increase expenses or place us at a disadvantage in the marketplace
•	Delays in the development, implementation, performance and benefits of technology projects and enhancements
•	Inaccurate estimates or assumptions used for critical accounting estimates, including loss reserves

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•	Events that reduce the company’s ability to maintain effective internal control over financial reporting under the Sarbanes-Oxley Act of 2002 in the future

•	Recession or other economic conditions or regulatory, accounting or tax changes resulting in lower demand for insurance products

•	Sustained decline in overall stock market values negatively affecting the company’s equity portfolio, in particular a sustained decline in the market value of Fifth Third Bancorp shares, a significant equity holding

•	Events that lead to a significant decline in the market value of a particular security and impairment of the asset

•	Prolonged low interest rate environment or other factors that limit the company’s ability to generate growth in investment income

•	Adverse outcomes from litigation or administrative proceedings

•	Effect on the insurance industry as a whole, and thus on the company’s business, of the suit brought by the Attorney General of the State of New York against participants in the insurance industry, as well as any increased regulatory oversight that might result from the suit

•	Limited flexibility in conducting investment activities if the restrictions imposed by the Investment Company Act of 1940 were to become applicable to the parent company

Further, the company’s insurance businesses are subject to the effects of changing social, economic and regulatory environments. Public and regulatory initiatives have included efforts to adversely influence and restrict premium rates, restrict the ability to cancel policies, impose underwriting standards and expand overall regulation. The company also is subject to public and regulatory initiatives that can affect the market value for its common stock, such as recent measures affecting corporate financial reporting and governance. The ultimate changes and eventual effects, if any, of these initiatives are uncertain.

Readers are cautioned that the company undertakes no obligation to review or update the forward-looking statements included herein.

Critical Accounting Policies and Estimates

Cincinnati Financial Corporation’s financial statements are prepared using GAAP. These principles require management to make estimates and assumptions that affect the amounts reported in the Consolidated Financial Statements and accompanying Notes. Actual results could differ materially from those estimates.

The significant accounting policies used in the preparation of the financial statements are discussed in Item 8, Note 1 to the Consolidated Financial Statements, Page 76. In conjunction with that discussion, material implications of uncertainties associated with the methods, assumptions and estimates underlying the company’s critical accounting policies are discussed below. The audit committee of the board of directors reviews the annual financial statements with management and the independent registered public accounting firm. These discussions cover the quality of earnings, review of reserves and accruals, reconsideration of the suitability of accounting principles, review of highly judgmental areas including critical accounting policies, audit adjustments and such other inquiries as may be appropriate.

Property Casualty Insurance Loss and Loss Expense Reserves

Overview

The most significant estimates relate to the company’s reserves for property casualty loss and loss expenses. Management believes that the stability of the company’s business makes its historical data the most important source for establishing adequate reserve levels.

Management bases reserve estimates on company experience and information from internal analyses, obtaining additional information from consulting outside actuaries. When reviewing reserves, management analyzes historical data and estimates the effect of various loss development factors. Management believes that the following represent the primary risks to its ability to estimate loss reserves accurately:

•	Court decisions that result in unanticipated coverage expansions on past and existing policies

•	Changes in medical inflation and mortality rates that affect workers compensation claims

•	Changes in claim cost trends, including the effects of general economic and tort cost inflation, not reflected in the historical data used to estimate loss reserves

•	Changes in reinsurance coverage, not reflected in reserving data, that affect the company’s net payments and net case reserves

•	Payment and reporting pattern changes attributable to the implementation of a new claims management system

•	Reporting pattern changes attributable to changes in case reserving practices, particularly with respect to umbrella claims

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•	Absence of cost-effective methods for assessing asbestos and environmental claim liabilities accurately (see Property Casualty Reserve Levels, Asbestos and Environmental Reserves, Page 56, for discussion of related reserve levels and trends)

Any of these factors can cause the company’s ultimate loss experience to be better or worse than reserves held, and the difference could be material. To the extent that reserves are inadequate and strengthened, the amount of such increase is treated as a charge in the period that the deficiency is recognized, raising the loss and loss expense ratio and reducing earnings. To the extent that reserves are redundant and released, the amount of the release is a credit in the period that the redundancy is recognized, reducing the loss and loss expense ratio and increasing earnings.

A reserve change of $29 million has a 1 percentage-point effect on the loss and loss expense ratio, based on 2004 earned premiums. Each 1 percentage point change in the loss and loss expense ratio has a $19 million effect on income and an 11 cent per share effect on net income per share, based on 2004 earned premiums.

Establishing Reserves

Reserves are established for the total of unpaid loss and loss expenses, including estimates for claims that have been reported, estimates for claims that have been incurred but not yet reported (IBNR) and estimates of loss expenses associated with processing and settling those claims. Reserves are determined for the various lines of business. Loss reserves are reduced by salvage and subrogation reserves.

Management establishes case reserves for claims that have been reported within the parameters of coverage provided in the policy. Individual case reserves greater than $35,000 established by field claims representatives are reviewed by experienced headquarters claims supervisors while case reserves greater than $100,000 are reviewed by headquarters claims managers. The estimates reflect informed judgment and experience of the company’s claims associates based on general insurance reserving practices and their experience with the company. Case reserves are reviewed on a 90-day cycle, or more frequently if specific circumstances require, based on events such as the status of ongoing negotiations.

In 2001, the company began to establish higher initial case reserves on serious liability claims to reflect recent experience indicating the likelihood that juries would ignore significant liability issues in cases involving seriously injured claimants.

To establish IBNR reserves on an annual basis, management uses a variety of tools, including actuarial and statistical methods. These may include but are not limited to:

•	The Case Incurred Development Method

•	The Paid Development Method

•	The Bornhuetter-Ferguson Method

Supplemental statistical information is compiled and reviewed to aid in the application of the actuarial methods. The supplemental data also is used to evaluate the reasonableness of estimates derived from the actuarial methods. This information includes:

•	Industry loss frequency and severity and premium trends

•	Past, present and anticipated product pricing

•	Anticipated premium growth

•	Other quantifiable trends

•	Projected ultimate loss ratios

Management conducts its thorough evaluation of the adequacy of reserves as of the end of the third quarter of each year. As a result, the most significant refinements in reserves historically have been implemented in the fourth quarter. Less detailed, periodic reviews of reserve adequacy are made at the other quarter ends. A loss review committee, including internal actuaries and representatives from management of multiple operating departments, is responsible for the quarterly review process.

The internal actuaries provide a point estimate to summarize their analysis. At year-end 2004 and 2003, IBNR reserves differed from the internal actuarial point estimate by less than 1 percent of the company’s loss and loss expense reserve.

Adjusting Reserves

While the company believes that reported reserves provide for all unpaid loss and loss expense obligations, the estimation processes involve a number of variables and assumptions. Management believes this uncertainty is mitigated by the historical stability of the company’s book of business and by its periodic reviews of estimates. As loss experience develops and new information becomes known, the reserve is reviewed and adjusted as appropriate. In this process, the company monitors trends in the industry, relevant court cases, legislative activity and other current events in an effort to ascertain new or additional exposures to loss. If management determines that reserves established in prior years were not sufficient or were excessive, the change is reflected in current-year results.

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Outside Actuarial Review

As part of its internal processes, management utilizes an outside actuary to provide management with an opinion regarding an acceptable range for adequate statutory reserves based on generally accepted actuarial guidelines.

Historically, the company has established adequate reserves that have fallen in the upper half of the outside actuary’s range. This approach has resulted in recognition of reserve redundancies (see Item 1, Property Casualty Loss and Loss Expense Reserves, Development of Loss and Loss Expenses, Page 5, for a 10-year history of reserve development). Modestly redundant reserves support the company’s business strategy to retain high financial strength ratings and remain a market for agencies’ business in all market conditions.

The outside actuaries conduct a thorough evaluation of the adequacy of reserves as of the end of the third quarter of each year and conduct a supplemental review of full-year data at year-end.

Highly Uncertain Exposures

In the normal course of its business, the company may provide coverage for exposures for which estimates of losses are highly uncertain. Most significant are catastrophic events. Due to the nature of these events, management is unable to predict precisely the frequency or potential cost of catastrophe occurrences. However, in an effort to control such losses, the company foregoes marketing property casualty insurance in California, reviews aggregate exposures to huge disasters and monitors its exposure in certain coastal regions. The company has catastrophe exposure to:

•	Hurricanes in the gulf and southeastern coastal regions

•	Earthquakes in the New Madrid fault zone, which lies within the central Mississippi valley, extending from northeast Arkansas through southeast Missouri, western Tennessee and western Kentucky to southern Illinois and southern Indiana

•	Tornado, wind and hail in the Midwest, Southeast and mid-Atlantic regions

The company uses the Risk Management Solutions and Applied Insurance Research models to evaluate exposures to a once-in-250-year event in determining appropriate reinsurance coverage programs. Reinsurance mitigates the risk of these highly uncertain exposures and limits the maximum net loss that can arise from large risks or risks concentrated in areas of exposure. In conjunction with these activities, the company also continues to explore and analyze credible scientific evidence, including the impact of global climate change, which may affect its exposure under insurance policies. Management’s decisions regarding the appropriate level of property casualty risk retention are affected by various factors, including changes in the company’s underwriting practices, capacity to retain risks and reinsurance market conditions. See Item 1, Reinsurance, Page 6, for a discussion of the company’s 2005 reinsurance treaties.

Asset Impairment

Fixed-income and equity investments are the company’s largest assets. Certain estimates and assumptions made by management relative to investment portfolio assets are critical. The company’s asset impairment committee continually monitors investments and all other assets for signs of other-than-temporary and/or permanent impairment. Among other signs, the committee monitors significant decreases in the market value of the assets, changes in legal factors or in the business climate, an accumulation of costs in excess of the amount originally expected to acquire or construct an asset, uncollectability of all other assets, or other factors such as bankruptcy, deterioration of creditworthiness, failure to pay interest or dividends or signs indicating that the carrying amount may not be recoverable.

The application of the company’s impairment policy resulted in other-than-temporary impairment charges and write-offs of investments that reduced the company’s income before income taxes by $6 million, $80 million and $98 million in 2004, 2003 and 2002, respectively.

Other-than-temporary impairment in the value of securities is defined by the company as declines in valuation that meet specific criteria established in the asset impairment policy. Such declines often occur in conjunction with events taking place in the overall economy and market, combined with events specific to the industry or operations of the issuing corporation. These specific criteria include a declining trend in market value, the extent of the market value decline and the length of time the value of the security has been depressed, as well as subjective measures such as pending events and issuer liquidity. Generally, these declines in valuation are greater than might be anticipated when viewed in the context of overall economic and market conditions. See Investment Portfolio, Page 53, for information regarding valuation of the invested assets.

Impairment charges are recorded for other-than-temporary declines in value, if, in the asset impairment committee’s judgment, there is little expectation that the value will be recouped in the foreseeable future. The impairment policy defines a security as distressed when it is trading below 70 percent of book value or has a Moody’s or Standard & Poor’s credit rating below B3/B-. Distressed securities are monitored as potentially impaired. The security may be written down in the event of a declining market value for four consecutive quarters with quarter-end market value below 50 percent of book value, or when a security’s market value is 50 percent below book value for three consecutive quarters. A sudden and severe drop in market value that does not otherwise meet the above criteria is reviewed for possible immediate impairment. Notwithstanding the above, the company’s portfolio managers constantly

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