Executive Compensation Summary

The following table summarizes the compensation of the company’s chief executive officer and the four most highly compensated executive officers for each of the last three years:

(1)

Option shares awarded have been adjusted to reflect the 5 percent stock dividends paid April 26, 2005, and June 15, 2004.

(2)

Pursuant to SEC rules, the column “Other Annual Compensation” is omitted because, in all cases, the amounts were less than the minimum required to be reported.

(3)

The company has no required disclosure under current SEC rules; however, it is providing voluntary disclosure for 2005. For 2003 and 2004 “n/a” indicates no disclosure.

(4)

Includes premiums paid for group life, officer life and personal umbrella insurance policies in the amounts of $9,108, $1,019 and $1,416, respectively; $4,000 for the travel and meals associated with spouse attendance at the company’s annual incentive meeting for agents; and $2,056 for annual business club dues.

(5)

Includes premiums paid for group life, officer life and personal umbrella insurance policies in the amounts of $11,077, $2,191 and $1,309, respectively; $4,000 for expenses associated with spouse travel to company’s annual incentive meeting for agents; $3,822 for use of company car; $300 safe driver award.

(6)

Includes premiums paid for group life, officer life and personal umbrella insurance policies in the amounts of $1,661, $1,213 and $1,160, respectively; $4,000 for expenses associated with spouse travel to company’s annual incentive meeting for agents; $5,762 annual business club dues; and $5,272 for use of company car; $2,628 executive tax services, $300 safe driver award.

(7)

Includes premiums paid for group life, officer life and personal umbrella insurance policies in the amounts of $3,536, $1,438 and $1,185, respectively; $4,000 for expenses associated with spouse travel to company’s annual incentive meeting for agents; $4,742 for use of company car; $263 for executive tax services; $343 for executive health examination; $300 safe driver award.

(8)

Includes premiums paid for group life, officer life and personal umbrella insurance policies in the amounts of $1,561, $850 and $1,738, respectively; $4,000 for expenses associated with spouse travel to company’s annual incentive meeting for agents; $1,925 for use of company car; $4,205 executive tax services; $343 for executive health examination; $300 safe driver award.

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(1)

Option shares awarded have been adjusted to reflect the 5 percent stock dividend paid April 26, 2005.

(2)

Options were granted on January 25, 2005. One-third of each option became exercisable on the first anniversary of grant in 2006, an additional one-third becomes exercisable on the second anniversary in 2007 and the remainder on the third anniversary in 2008, so long as employment continues with the company or its subsidiaries. There are no stock appreciation rights, performance units or other instruments granted in tandem with these options, nor are there any re-load provisions, tax reimbursement features or performance-based conditions to exercisability.

(3)

The option exercise price is 100 percent of the Nasdaq National Market’s closing price for the company’s stock on the day prior to the date of grant.

(4)

The assumed annual rates of stock price appreciation are prescribed in the proxy rules of the SEC and should not be construed as a forecast of future appreciation in the market price for the company’s common stock.  

The following table contains information for each of the named executive officers concerning the exercise of options during 2005 and the value of unexercised options for the company’s common stock at year-end 2005:

(1)

Option shares awarded have been adjusted to reflect the 5 percent stock dividends paid April 26, 2005, and June 15, 2004.

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Pension Plan

The following table sets forth the estimated annual benefits payable from the company’s qualified non-contributory pension plan under various assumptions as to the associate’s compensation level and years of service:

All individuals listed in the Summary Compensation Table are participants in the plan. For purposes of computing retirement benefits under the plan, for the individuals listed in the Summary Compensation Table, earnings for any given year as defined by the plan is the base rate of salary in effect on the last day of the plan year, subject to maximum recognizable compensation under Section 401(a)(17) of the Internal Revenue Code. This differs from salary as shown in the Summary Compensation Table. The annual earnings for 2005 qualifying under the qualified plan for each individual are $210,000. The years of service as of December 31, 2005, under the plan for those individuals are as follows: Mr. Benoski, 34 years, Mr. Joseph, 29 years, Mr. Scherer, 22 years, Mr. J. Schiff, Jr., 20 years; and; Mr. Stecher, 38 years.

The normal retirement pension is computed as a single life annuity. The annual payment is the greater of two calculated amounts.

The first calculated amount is the sum of:

1.

0.0045 percent per year of the associate’s highest five-year average earnings for the first 15 years of service, plus

2.

0.0135 percent per year of the associate’s highest five-year average earnings up to $35,000 for the first 15 years of service, plus the sum of:

a.

0.006 percent per year of the associate’s highest five-year average earnings for years 16 through 40, plus

b.

0.018 percent of the associate’s five-year average earnings up to $35,000 for years 16 through 40.

The second calculated amount is the sum of:

1.

0.009 percent per year of the associate’s highest five-year average earnings for the first 15 years of service, plus

2.

0.012 percent per year of the associate’s highest five-year average earnings for years 16 through 40.

Vesting is 100 percent after five years of service and there are no deductions for Social Security or other offset amounts.

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Supplemental Retirement Plan

Effective January 1, 1989, the company adopted a nonqualified, noncontributory Supplemental Retirement Plan for the benefit of 37 higher-paid associates whose projected retirement pension was reduced as a result of the amendment to the company’s qualified plan. The supplemental plan was designed to replace the pension benefit lost by those associates.

This plan is integrated with Social Security and a normal retirement pension is the sum of 0.0075 percent of the associate’s highest five-year average annual earnings below the integration level plus 0.0125 percent of the associate’s highest five-year average annual earnings in excess of the integration level, multiplied by the number of years of service. The integration level is equal to the average of the integration levels for the period of the associate’s employment, using wages paid, with a maximum of $6,000, for years beginning prior to 1976 and wages subject to Social Security tax for all years after 1975. The retirement benefit paid pursuant to the supplemental plan is the difference between the amount computed by the above formula and the amount payable from the qualified plan.

Effective January 1, 2000, the corporation transferred the accrued benefit amount of each plan member to the Qualified Retirement Plan as an additional special benefit, to be paid from the qualified plan. As of January 1, 2000, there were 12 associates entitled to a benefit from the Supplemental Retirement Plan. Any additional benefit amounts accrued from the Supplemental Retirement Plan after January 1, 2000, are to be paid from the Supplemental Retirement Plan.

Of the individuals listed in the Summary Compensation Table, only James E. Benoski and John J. Schiff, Jr., are participants in the plan. For purposes of determining benefits under the Supplemental Retirement Plan, annual earnings are defined as the base rate of salary in effect on the last day of the plan year. This differs from salary under the Summary Compensation Table. The annual earnings for 2005 as defined in the plan and the years of service as of December 31, 2005, for those individuals are as follows: Mr. Benoski, $429,363 and 34 years; and Mr. J. Schiff, Jr., $775,000 and 20 years.

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(1)

Option shares awarded have been adjusted to reflect the 5 percent stock dividends paid April 26, 2005, and June 15, 2004.

(2)

If shareholders approve the proposal for the Cincinnati Financial Corporation 2006 Stock Compensation Plan (2006 Plan), Stock Option Plan VIII will be canceled and the 10 million shares approved by shareholders for that plan will become the shares available for issuance under the 2006 Plan.

n/a

Not applicable

Report of the Audit Committee

The audit committee is responsible for monitoring the integrity of the company’s consolidated financial statements, the company’s system of internal controls, the qualifications and independence of the company’s independent registered accounting firm, the performance of the company’s internal audit department and independent registered accounting firm and the company’s compliance with certain legal and regulatory requirements. The committee has sole authority and responsibility to select, determine the compensation of, and evaluate the company’s independent registered accounting firm. The committee has six independent directors and operates under a written charter adopted by the board. The board has determined that each committee member is independent under the standards of director independence established by the Nasdaq listing requirements and is also “independent” for purposes of Section 10A(m)(3) of the Securities Exchange Act of 1934.

Management is responsible for the financial reporting process, including the system of internal controls, for the preparation of consolidated financial statements in accordance with generally accepted accounting principles and for the report on the company’s internal control over financial reporting. The company’s independent registered public accounting firm is responsible for auditing those financial statements and expressing an opinion as to their conformity with accounting principles generally accepted in the United States of America and for attesting to management’s report on the company’s internal control over financial reporting. The committee’s responsibility is to oversee and review the financial reporting process and to review and discuss management’s report on the company’s internal control over financial reporting. The committee is not, however, professionally engaged in the practice of accounting or auditing and does not provide any expert or special assurance as to such financial statements concerning compliance with laws, regulations or generally accepted accounting principles or as to auditor independence. The committee relies, without independent verification, on the information provided to it and on the representations made by management and the independent registered accounting firm.

The committee held 10 meetings during the fiscal year ending December 31, 2005. These meetings were designed, among other things, to facilitate and encourage communication among the committee, management, the internal auditors and the company’s independent registered public accounting firm, Deloitte & Touche LLP. The committee discussed with the company’s internal auditors and Deloitte & Touche LLP the overall scope and plans for their respective audits. It met with the internal auditors and Deloitte & Touche LLP, with and without management present, to discuss the results of their examination and their evaluations of the company’s internal controls.

The committee reviewed and discussed the company’s progress on complying with Section 404 of the Sarbanes-Oxley Act of 2002, including the Public Company Accounting Oversight Board’s (PCAOB) Auditing

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Standard No. 2 regarding the audit of internal controls over financial reporting. The committee also performed a self-evaluation of its charter, policies and procedures as a part of the company’s Section 404 internal control auditing activities.

The committee reviewed and approved the audited consolidated financial statements for the fiscal year ended December 31, 2005, and the unaudited interim financial statements for the first three quarters of 2005, with management, the internal auditors and Deloitte & Touche LLP. The committee also discussed with management, the internal auditors and Deloitte & Touche LLP the process used to support certifications by the company’s chief executive officer and chief financial officer that are required by the SEC and the Sarbanes-Oxley Act of 2002 to accompany the company’s periodic filings with the SEC and the processes used to support management’s annual report on the company’s internal controls over financial reporting.

The committee also discussed with Deloitte & Touche LLP matters that independent registered public accounting firms must discuss with audit committees under generally accepted auditing standards and standards of the PCAOB, including, among other things, matters related to the conduct of the audit of the company’s consolidated financial statements and the matters required to be discussed by Statement on Auditing Standards No. 61, as amended (Communication with Audit Committees).

Deloitte & Touche LLP also provided written disclosures and the letter required by Independence Standards Board Standard No. 1 (Independence Discussions with Audit Committees) and represented that it was independent from the company. The committee discussed with Deloitte & Touche LLP their independence from the company. When considering Deloitte & Touche LLP’s independence, the committee considered if services they provided to the company beyond those rendered in connection with their audit of the company’s consolidated financial statements, reviews of the company’s interim condensed consolidated financial statements included in its Quarterly Reports on Form 10-Q and the attestation of management’s report on internal control over financial reporting were compatible with maintaining their independence. The committee also reviewed, among other things, the audit and audit-related tax services performed by, and the amount of fees paid for such services, to Deloitte & Touche LLP. The committee received regular updates on the amount of fees and scope of audit, audit-related and tax services provided.

Based on the above-mentioned review and these meetings, discussions and reports, and subject to the limitations on the committee’s role and responsibilities referred to above and in the Audit Committee Charter, the committee recommended to the board that the company’s audited consolidated financial statements for the fiscal year ended December 31, 2005, be included in the company’s Annual Report on Form 10-K. The committee also selected Deloitte & Touche LLP as the company’s independent registered accounting firm for the fiscal year ending December 31, 2006, and is presenting the selection to the shareholders for ratification.

Submitted by the audit committee:
William F. Bahl, Dirk J. Debbink, Kenneth C. Lichtendahl, Gretchen W. Price, Douglas S. Skidmore and John F. Steele, Jr.

(1)

2004 Audit Fees previously presented have been adjusted to include $250,000 paid in 2005 related to 2004 Sarbanes-Oxley procedures.

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Services Provided by the Independent Registered Public Accounting Firm

All services rendered by the independent registered public accounting firm are permissible under applicable laws and regulations. In 2004 and 2005, all services rendered by the independent registered accounting firm were pre-approved by the audit committee, and no fees were charged pursuant to the de minimus safe harbor exception to the pre-approval requirement described in the audit committee charter.

Under the pre-approval policy, the audit committee pre-approves specific services related to the primary service categories of audit services, audit related services, tax services, and other services. A “one-time” pre-approval dollar limit for specified services related to a specific primary category is established for the audit period. Examples of pre-approved non-audit services specified under the policy include: financial and tax due diligence, benefit plan audits, American Institute of Certified Public Accountants (AICPA) agreed-upon procedures, CFA Institute audits, security and privacy control-related assessments, technology control assessments, technology quality assurance, financial reporting control assessments, enterprise security architecture assessment, accounting consultations and audits in connection with acquisitions, tax planning and support, tax controversy assistance (IRS examinations), sales tax and lease compliance, employee benefit tax, tax compliance and support, tax research, tax planning and return preparation for company executives, corporate finance modeling assistance, allowable actuarial reviews and assistance, business risk management support and merger integration.

Engagements for services falling below the dollar threshold approved for specified services may be entered into with the consent of the chief financial officer. The committee must individually approve engagements for permissible services not included in the pre-approval list or that exceed the dollar threshold established for such services. All engagements are periodically reported to the audit committee. Pursuant to the rules of the SEC, the fees billed by the independent registered public accounting firm for services are disclosed in the table above.

Audit Fees – These are fees for professional services performed by the independent registered public accounting firm for the audit of the company’s annual financial statements; audit of management’s assessment of internal control over financial reporting; review of financial statements included in the company’s Form 10-K and Form 10-Q filings; and services that are normally provided in connection with statutory and regulatory filings or engagements.

Audit-related Fees – These are fees for assurance and related services performed by the independent registered public accounting firm that are reasonably related to the performance of the audit or review of the company’s financial statements. These services include: employee benefit and compensation plan audits; CFA Institute certifications; and information systems expense reviews.

Tax Fees – These are fees for professional services performed by the independent registered public accounting firm with respect to tax compliance, tax advice and tax planning. These services include: review of tax returns for the company; tax research and planning; tax audit assistance and tax work stemming from audit-related items. These services do not include any tax shelter work.

All Other Fees – These are fees for other permissible work performed by the independent registered public accounting firm in categories other than the above.

Proposal to Ratify Appointment of the Independent Registered Public Accounting Firm

The audit committee has appointed the firm of Deloitte & Touche LLP as the company’s independent registered public accounting firm for 2006.

Although action by shareholders in this matter is not required, the audit committee believes that it is appropriate to seek shareholder ratification of this appointment and to seriously consider shareholder opinion on this issue.

Representatives from Deloitte & Touche LLP, which also served as the company’s independent registered public accounting firm for the last calendar year, will be present at the 2006 Annual Meeting of Shareholders and will be afforded the opportunity to make any statements they wish and to answer appropriate questions.

To ratify the appointment of Deloitte & Touche LLP, a majority of votes cast at the meeting must be voted FOR the proposal.

The board of directors recommends a vote FOR the proposal to ratify appointment of the independent registered public accounting firm.

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Proposal to Adopt Cincinnati Financial Corporation Incentive Compensation Plan

Purpose

The board of directors of the company has approved and recommends shareholder approval of the proposal to adopt the Cincinnati Financial Corporation Incentive Compensation Plan (the plan). The purposes of the plan are to:

·

Link bonus compensation for the president and chief executive officer and the four other most highly compensated officers named in the Summary Compensation table to the company’s achievement of pre-established performance goals.

·

Maximize the company’s federal income tax deduction for the annual cash compensation paid to those executives pursuant to Section 162(m) of the Internal Revenue Code.

Under Internal Revenue Code Section 162(m), the compensation of any one of the five named executive officers, to the extent it exceeds $1 million per year, is a deductible expense by the company only when any amount of compensation exceeding $1 million is based upon the achievement of pre-established performance goals. Approval of this plan would allow the company to maximize its income tax deduction if the bonuses paid under the plan cause total compensation for any participant to exceed $1 million in any calendar year.

Plan Description

Only the five named executive officers are eligible to participate in the plan. Participants are eligible to receive awards under the plan upon achievement by the company and its subsidiaries on a consolidated basis of any two of the following performance goals:

1.

Specified percentage increase (targets to be established annually by the compensation committee) in gross direct written premiums for the calendar year over those for the prior year;

2.

Specified percentage increase (targets to be established annually by the compensation committee) in operating income for the calendar year over that of the prior year, excluding the effects of capital gains and losses, accounting changes and certain natural catastrophes;

3.

Exceeding the median annual percentage increase in earnings per share for the company’s peer group for the calendar year, excluding the effects of capital gains and losses and accounting changes.

The compensation committee sets the performance targets within the first 90 days of the calendar year to which the goals apply. The maximum bonus amount each participant is eligible to receive is $1 million annually, with the actual amount of any bonus set by the compensation committee pursuant to the overall compensation policies of the committee. If more than one person holds the office of president and chief executive officer in any calendar year, the committee may divide any award up to $1 million among those officers.

The board of directors may modify or terminate the plan at any time for any legal purpose. However, shareholder approval of any modifications to material terms of the plan is necessary for the company to retain its federal income tax deduction for compensation paid under this plan.

Summary

For the first time since 1999, total cash compensation awarded by the compensation committee exceeded $1 million in 2005 for one participant, the president and chief executive officer. The compensation committee’s policy is to provide reasonable total compensation that considers responsibilities, performance, economic conditions and peer group benchmarks. At the same time, it is prudent to minimize the company’s tax liability of compensation payments to our executive officers.

To approve the plan, a copy of which is attached as Appendix A, a majority of the shares present or represented by proxy at the meeting and entitled to vote must be voted FOR the proposal.

The board of directors recommends a vote FOR the proposal to adopt the Cincinnati Financial Corporation Incentive Compensation Plan.

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Proposal to Adopt Cincinnati Financial Corporation 2006 Stock Compensation Plan

Purpose

The board of directors of the company has approved and recommends shareholder approval of the proposal to adopt Cincinnati Financial Corporation 2006 Stock Compensation Plan. The plan would replace Stock Option Plan VIII, approved by shareholders in 2005. The purposes of the plan are:

·

To provide the compensation committee with additional flexibility by expanding the mix of available stock-based associate incentive compensation vehicles beyond just stock options. As a result of Statement of Financial Accounting Standards No. 123(R), “Shares Based Payments,” accounting treatment of options has changed, increasing the attractiveness of other vehicles.

·

To accommodate performance-based awards. The plan provides the compensation committee with flexibility to link various stock-based awards for certain executive officers and potentially others to predetermined performance goals, including the profitability of the company’s businesses and increases in shareholder value. This will maximize the company’s federal income tax deduction for compensation in the form of stock compensation paid to certain executives pursuant to Internal Revenue Code Section 162(m).

·

To increase direct ownership of the company’s common stock by associates more rapidly than an option-only plan by including vehicles that reduce the associate’s initial cash outlay.

·

To help attract and retain quality associates with a strong sense of ownership in the company’s performance. The plan encourages associates to retain shares of common stock earned through these incentives by potentially lowering their cash outlay to pay taxes, reducing the need for associates to sell shares to pay applicable income taxes for some types of awards.

The total number of shares to be available under the 2006 Plan is equal to the total number of shares which remain available under Stock Option Plan VIII. No shares have been granted under Stock Option Plan VIII since approval by shareholders in 2005. If shareholders approve the 2006 Plan, Stock Option Plan VIII will be canceled and no shares will be granted under it, but if shareholders do not approve the 2006 Plan, Stock Option Plan VIII will continue in operation.

The board of directors wishes to continue extending equity ownership beyond the company’s executives to all levels of associates, potentially including hourly associates. To best serve shareholders for the long term, the board wants to align the interests of associates with the interests of shareholders.

Historically, stock options have translated into ownership as most associates generally hold their shares, funding the option purchases without cashing in a portion of the grant. The company’s associates have a direct stake in building future success for your company. Although the company does not have access to information about broker accounts, management estimates that approximately 92 percent of associates hold shares of Cincinnati Financial Corporation.

We believe that, had the amended plan been in effect in fiscal 2005, the amount of awards granted under the plan would not have been materially different than the awards granted under Stock Option Plans Nos. VI and VII, as displayed in the table below.

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(1)

Option shares awarded have been adjusted to reflect the 5 percent stock dividend paid April 26, 2005.

(2)

Includes shares listed above for the top five executives and nondirector executive officers listed on Page 5.

Plan Description

The plan provides for grants to those associates of the company and its subsidiaries selected by the compensation committee of the board of directors of common stock-backed awards for up to a total of 10 million shares of the company’s $2.00 par value common stock. Awards in any form other than stock options shall be counted against that 10 million-share limit as three shares for every award granted. The plan is presented in Appendix B.

The awards to be made in the future to current or future participants will be decided at that time and cannot be determined at this time. The actual awards depend on a number of factors, including the company’s performance, an individual’s potential contribution to the business, compensation practices at the time, retention issues and the company’s stock price.

Eligibility. As with the company’s existing plans, all full-time associates of the company and its subsidiaries are eligible to receive awards under the plan. Approximately 3,900 associates currently are eligible.

Plan Administration. The plan constitutes an unfunded plan and is administered by the compensation committee, which must include at least two directors who are “non-employee directors” within the meaning of SEC Rule 16b-3 and who are “outside directors” for purposes of Section 162(m) of the Internal Revenue Code.

Types of Awards. The plan provides for stock incentives of several types, including stock options, stock appreciation rights, restricted stock, restricted stock units and other stock-based awards. Awards of all types may be made subject to performance standards established by the compensation committee.

Stock options granted under the plan may either be incentive stock options qualifying under Section 422 of the Internal Revenue Code or nonqualified options, both exercisable for the company’s $2.00 par value common stock. At the time of grant, the compensation committee determines the exercise price for options granted under the plan, which may not be less than fair market value of the company’s common stock at that date. As of March 1, 2006, the Nasdaq national Market’s closing price for the company’s stock was $44.34.

The compensation committee also determines the term of each option, which may not exceed 10 years from the date of grant. Options become exercisable in accordance with a vesting schedule established by the compensation committee at the time of grant. Depending on the type of option, the compensation committee may permit an option to be exercised by the participant either for a cash payment or the delivery of shares of the company’s common stock held by the participant, potentially including shares acquired upon exercise of the option.

As under any of the company’s prior stock option plans, the aggregate fair market value cannot exceed $100,000, determined at the time of grant, for the shares of common stock any participant may acquire through incentive stock options that become exercisable for the first time during any calendar year. Additionally, the compensation committee may not grant an amount of stock options to any one plan participant during any consecutive three years which may be converted into more than 300,000 shares of common stock. At its sole discretion, the compensation committee may provide, at the time of grant, that the shares to be issued upon an option’s exercise be in the form of restricted stock or other similar securities, or the compensation committee may reserve the right to so provide after the time of grant.

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In general, if a plan participant’s employment is terminated, other than for death, disability, retirement or specified actions initiated by the company, all of the participant’s unexerciseable options are forfeited and all exercisable options may be exercised within a specified period following termination, or they too will terminate.

Shares of restricted common stock also may be awarded. The restricted stock vests and becomes transferable upon the satisfaction of conditions set forth in the restricted stock award agreement. Restricted stock awards may be forfeited if, for example, the recipient’s employment terminates before the award vests. Except as specified in the restricted stock award agreement, the holder of a restricted stock award has all the rights of a holder of common stock, including the right to receive dividends on the restricted shares.

Units representing the right to receive common stock, cash, or both (as the compensation committee determines) also may be awarded. Restricted stock units vest upon the satisfaction of conditions specified in the award agreements. Restricted stock units may be forfeited if, for example, the recipient’s employment terminates before the award vests. Except as specified, the holder of a restricted stock unit or award has none of the rights of a holder of common stock unless and until shares of common stock are actually delivered in satisfaction of such units. The compensation committee may not grant more than 100,000 common shares worth of restricted stock and restricted stock units to any one plan participant during any three-year period.

Stock appreciation rights (or SARs) may be granted either singly or in combination with underlying stock options. SARs entitle the holder upon exercise to receive an amount in any combination of cash or shares of common stock (as the compensation committee determines) equal in value to the excess of the fair market value of the shares covered by such right over the grant price. The grant price for SARs may not be less than the fair market value of the common stock on the date of grant.

The plan also provides for other potential awards that may be denominated in, valued by reference to, or otherwise based on or related to, common stock. The compensation committee specifies the terms of grant, purchase, exercise, exchange or conversion of other stock-based awards. These awards may include, for example, performance shares that entitle the recipient to receive, upon satisfaction of performance goals or other conditions, a specified number of shares of common stock or the cash equivalent thereof. Where the value of such stock-based award is based on the difference between the fair market value of the shares covered by such award and the exercise price, the grant price for such award may not be less than the fair market value on the date of grant. The compensation committee may not grant more than 100,000 common shares worth of SARs and other stock-based compensation to any one plan participant during any three year period.

Performance-based awards may be issued to participants for no cash consideration or for such minimum consideration as may be required by applicable law, either alone or in addition to other awards granted under the plan. The compensation committee determines the performance criteria to be achieved during any performance period under the plan and the length of the performance period. Performance awards are generally paid only after the end of the relevant performance period. Performance awards may be paid in cash, shares of common stock, other property or any combination thereof, as the compensation committee determines, in its sole discretion, at the time of payment. Performance awards may be paid in a lump sum or in installments following the close of the performance period.

Acceleration of Awards Provisions . In the event an associate’s employment is terminated within 12 months after the effective date of and due to a change in control as defined in the 2006 Plan, all stock options and SARs held by the associate as of the date of termination would become fully vested and immediately exercisable; the restrictions applicable to outstanding restricted stock, restricted stock units, and other stock-based awards would lapse; and the awards would become free of all restrictions and fully vested.

Amendment and Termination. The board of directors can amend the plan to meet changes in law or regulations or for any other purpose that at the time may be permitted by law, except that the total number of shares to be issued through the plan may not increase and the board may not decrease the participant’s exercise price of stock options, SARs or other stock-based awards to an amount less than the fair market value on the date of the grant. Additionally, the compensation committee may not cancel an issued stock option and replace it with a different stock option with a lower grant price.

Proceeds. The proceeds from the sale to participants of common stock upon the exercise of any and all stock options and any other stock-based compensation issued under the 2006 Plan constitute general funds of the company and may be used by it for any purpose.

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Accounting and Federal Income Tax

The board of directors recognizes that shareholders are interested in the impact of stock option expense on net income. Since 1996, following FASB accounting standards, the company has clearly disclosed the estimated impact of stock options on net income and earnings per share in a Note to the Financial Statements and fully complied with amended requirements for disclosures in quarterly financial statements. The company will adopt SFAS No. 123(R), “Share-Based Payment,” which calls for stock option expense to be included as a component of net income, in the first quarter of 2006. Pro forma option expense as disclosed in a note to the 2005 Consolidated Financial Statements would have reduced earnings per share by 8 cents in 2005 and by 7 cents in both 2004 and 2003.

Corporate Federal Income Tax. To the extent that a participant recognizes ordinary income in the circumstances described below, the company is entitled to a corresponding deduction provided that, among other things: (i) the income meets the test of reasonableness, is an ordinary and necessary business expense and is not an “excess parachute payment” within the meaning of Section 280G of the Internal Revenue Code and is not disallowed by the $1 million limitation under Section 162(m) of the Internal Revenue Code on compensation paid to specified executive officers and (ii) any applicable reporting obligations are satisfied. Section 162(m) of the Internal Revenue Code limits the federal income tax deduction for compensation paid to the chief executive officer and the four other most highly compensated executive officers of a publicly held corporation (covered employees) to $1 million per fiscal year, with exceptions for certain performance-based compensation made under qualifying, shareholder-approved plans. The 2006 Plan is designed so that certain stock option awards, restricted stock awards, performance awards and other stock unit awards under the plan will constitute performance-based compensation for purposes of Section 162(m). If shareholders approve the 2006 Plan, these awards may continue to qualify for the performance-based compensation exception to Section 162(m).

Participant Federal Income Tax . In general, an optionee recognizes no income at the time a nonqualified option is granted; at the time of exercise of a nonqualified option, the optionee recognizes ordinary income for the difference between the purchase price paid for the shares and the fair market value of the nonrestricted shares on the date of exercise; and at the time of sale of shares acquired through the exercise of a nonqualified option, any appreciation (or depreciation) in the value of the shares after the date of exercise is treated as either short-term or long-term capital gain (or loss) depending on how long the participant has held the shares.

An optionee generally recognizes no income upon the grant or qualifying exercise of an incentive stock option. However, for purposes of calculating the optionee’s alternative minimum tax, if any, the difference between the fair market value of the shares at exercise and the purchase price constitutes an item of adjustment. If the optionee makes no disqualifying disposition, shares acquired through exercise of an incentive option within two years after the grant date or within one year after the transfer of the shares to the optionee, then any proceeds from selling the shares in excess of the purchase price are taxed to the optionee as long-term capital gain and any loss sustained is a long-term capital loss. If shares acquired upon the exercise of an incentive stock option are disposed of prior to the expiration holding period described above, the optionee generally recognizes ordinary income in the year of disposition in an amount equal to any excess of the fair market value over the purchase price at the time of exercise (or, if less, the amount realized on the disposition of the shares in a sale or exchange). Any further gain or loss realized by the optionee generally is taxed as short-term or long-term gain or loss, depending on the holding period.

A participant recognizes no income in connection with the grant of a stock appreciation right. When the stock appreciation right is exercised, the participant normally is required to include as taxable ordinary income in the year of exercise the total amount of any cash plus the fair market value of any nonrestricted shares received pursuant to the exercise.

A recipient of a restricted common stock award generally are subject to tax at ordinary income rates on the fair market value of the restricted shares reduced by any amount paid for the shares by the recipient, at such time as the shares are no longer subject to a substantial risk of forfeiture or restrictions on transfer for purposes of Section 83 of the Internal Revenue Code. However, a recipient who so elects under Section 83(b) of the Internal Revenue Code within 30 days of the date of receipt of the shares has taxable ordinary income on the date of receipt equal to the excess of the fair market value of the shares (determined without regard to the risk of forfeiture or restrictions on transfer) over any purchase price paid for the shares. If a Section 83(b) election has not been made, any dividends received with respect to restricted shares that are subject at that time to a

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substantial risk of forfeiture and restrictions on transfer generally are treated as taxable ordinary income to the recipient.

Generally, a participant recognizes no income in connection with the grant of a restricted stock unit or any performance-based award. Subject to the specific terms of the award, when the award is paid to the participant, the participant normally is required to include as taxable ordinary income in the year of payment the total amount of any cash plus the fair market value of any nonrestricted shares of common stock, actually or constructively receive.

Summary

By replacing the current Stock Option Plan VIII with the proposed 2006 Stock Compensation Plan, your company can expand the mix of stock-based incentives, increasing the compensation committee’s flexibility. The plan would accommodate performance-based awards, maximize the company’s tax deductions and encourage associates to be vested owners whose interests are aligned with those of other shareholders.

To approve the plan, a copy of which is attached as Appendix B, a majority of shares present or represented by proxy at the meeting and entitled to vote must be voted FOR the proposal.

The board of directors recommends a vote FOR the proposal to adopt the 2006 Stock Compensation Plan.