American Financial Group Inc (AFG) 2003 Q4 法說會逐字稿

Good day and welcome to the American Financial Group 4th quarter 2003 earnings results conference call. Today's call is being recorded. With us today, we have Carl H Lindner, III, Co-President of American Financial Group, Craig Lindner, Co-President of American Financial Group and Keith Jensen, Senior Vice President of American Financial Group. Alt this time for opening remarks, I'd like to turn the conference over to Mr. Keith Jensen. Please go ahead, sir.

Thank you. Good morning and welcome to the American Financial Group 2003 fourth quarter earnings results conference call. If you're viewing the web cast from our web site, you can follow along with the slide presentation if you'd like. Certain statements made during this call are not historical facts and may be considered forward-looking statements and are based on estimates, assumptions and projections which management believes are reasonable but, by their nature, subject to risks and uncertainties.

The factors which cause actual results to differ materially from those suggested by such forward-looking statements include, but are not limited to, those discussed or identified from time to time in AFG's filings with the Securities and Exchange Commission, including the annual report on form 10K and the quarterly reports on form 10Q. We do not promise to update such forward-looking statements to reflect actual results or changes in assumptions or other factors that could affect the statements. Many investors and analysts focus on core earnings of companies, setting aside items that are not considered to be part of ongoing operations, such as net realized gains or losses on investments, the effects of accounting changes, discontinued operations and certain nonrecurring items. As such, the core earnings of our insurance operations for various periods will be discussed during this call.

With that said, I'd like to now turn the time over to Carl Lindner, III, Co-President of American Financial Group to discuss our results.

Good morning and thank you for joining us. We released our 2003 fourth quarter and full year results earlier this morning. We'll open the lines for questions after some initial comments. If you turn to slide 3, I'd like to talk about 2003 highlights. I'd like to start by saying that I'm pleased with what we were able to accomplish in 2003. Our underlying business was profitable and grew in line with our expectations. We had a couple of disappointments from litigation but overall I believe we had a very successful year.

In addition to our growth and profitability, we've provided capital to support our specialty commercial businesses, we strengthened our balance sheet and improved our financial flexibility. I'd like to highlight a few accomplishments. We completed the IPO of Infinity Property and Casualty Corporation and a subsequent sale of our remaining interest, raising over $465 million of capital. The market continued to recognize Infinity's value and we were pleased with the overall result of this sale. We completed long-term debt offerings at AFG and Great American Financial Resources and paid off their bank lines of credit.

We completed the merger with American Financial Corporation, which lowered our ongoing fixed charges and increased shareholders equity. We improved our capital strengths significantly during the year. Our stockholders equity increased by $350 million from $24.97 to $28.42 per share. We also improved our financial leverage in liquidity. At year-end, our debt-to-capital ratio had been reduced by about 8 points to 35%. Our insurance group's capital adequacy had increased and we had $100 million in parent company cash. Also, we continued to have significant unrealized gains in our investment portfolio.

At year-end, the pretax net unrealized gain on our bond portfolio was $378 million and $196 million on our equity securities. Let's talk about 2003 fourth quarter highlights. You'll find that summary on slide 4. I'm pleased to report that we again achieved very solid operating results for the fourth quarter in line with our expectations. Our fourth quarter net earnings were $2.68 per share, which included a tax benefit of $1.90 per share resulting from American Financial Group's merger with American Financial Corporation. The gain on the sale of our remaining interest in infinity was largely offset by a loss related to the planned disposal of Transport Insurance Company, an inactive company with only runoff insurance liabilities.

Net realized gains from the sales of other investments contributed about 11 cents per share to net earnings. Our fourth quarter core operating earnings were 65 cents per share and included 5 cents per share from our former ownership interest in infinity. For the 2003 fourth quarter, our property and casualty group reported an underwriting profit of just over $14 million with a combined ratio of 97, which is approximately the same as the 2002 period. The 2003 fourth quarter included higher losses from catastrophes as compared to the 2002 quarter and a 2002 fourth quarter benefited from very strong underwriting profit from the personal lines operations, now part of infinity.

Overall, the property and casualty's gross and net written premiums for the fourth quarter were below the 2002 period, resulting from the sales of our personal lines businesses. Turning to slide 5, I'd like to discuss specialty group results. A specialty group reported a solid underwriting profit for the ninth consecutive quarter with a combined ratio of 96.1. This was an improvement of 2 points compared to the 2002 fourth quarter. Most of our businesses reported underwriting profits and achieved double-digit premium growth. We did experience about 6 points of adverse development during the fourth quarter, principally from our home builders runoff in certain states that we've discontinued and certain general liability business.

We continued to capitalize on new business opportunities and lines such as crop hail insurance, government mode apparel, transportation, excess and surplus lines, Inland Marine, D&O and California Comp. The specialty group's gross written premiums grew over 15% in the 2003 fourth quarter compared to the 2002 period. A large part of this growth continued to stem from our rate actions. The specialty group's net written premiums for the 2003 quarter were 37% over the prior year's fourth quarter resulting from the impact of premiums seated under a physical damage reinsurance agreement that was expanded in the 2002 fourth quarter. We did see some moderation in pricing during the second half of the year with rate increases averaging around 16% in the fourth quarter.

Pricing has remained firm in many of the commercial casualty markets where we do business. Now let's review our annuity life and health group. It's found on slide 6. This group's core net operating earnings for the 2003 fourth quarter were significantly higher than the 2002 period. The 2002 quarter included a $4.3 million write-off of variable annuity acquisition costs. Statutory premiums for the fourth quarter were 21% below the 2002 period, primarily due to lower fixed annuity sales. In this historically low interest rate environment, this group continues to maintain its pricing targets and commission and interest crediting discipline in order to improve profitability.

In January of this year, Great American Financial Resources sold $86 million of 7.25 senior debentures and has called it's higher coupon Trust Preferreds of 9,25% for redemption. This was in addition to a rights offering in the third quarter and debt offering in the fourth quarter that enabled the Company to completely pay down it's bank line of credit and to provide capital to its operations. We continue to believe that the fundamentals of the annuity industry are improving. With the recent interest rate and stock market rebound, along with a significant improvement in the group's cost structure, we're achieving appropriate returns on new business. As far as 2003 full year results, go to slide 7. Our net earnings for the full year of $4.12 were considerably higher than '02.

2003 included higher tax benefits and net realized gains on sales of investments while 2002 results were impacted by impairment losses in our fixed income portfolio and the goodwill write-off associated with the new accounting standard. Our 2003 core operating earnings of $2.22 per share were lower than '02 because of a 41 cent per share charge recorded in the second quarter principally due to an unfavorable arbitration decision relating to a property claim arising from a discontinued business within our property and casualty group. On slide 8, let me discuss 2003 full year results for the property and casualty group and annuity life and health group. Property and casualty group reported a combined ratio of 96.6 excluding 2.3 points for the arbitration charge compared to 99.8 in '02. That excludes a 1.2 point charge related to an asbestos litigation settlement.

Specialty groups' results were in line with our objectives for 2003. With a combined ratio of 96% for the full year, a 2.4 point improvement over '02. The specialty group's gross written premiums grew nearly 20% over '02 resulting from rate increases and volume growth in certain businesses, partly offset by planned reductions in less profitable lines of business. Rate increases averaged about 20% for the '03 full year. The core net operating earnings of annuity life and health group were below '02 results. Statutory premiums in '03 were 8% below '02. This business experienced a challenging interest rate environment during 2003 which impacted the growth and returns on their fixed annuity business.

Now, beginning with the 2003 year, we'll be providing supplemental information about our specialty segment. Premium and underwriting information is being presented in four groupings as illustrated on slide 9. Specialty property and transportation, which is primarily includes our bus, truck, inland and ocean marine and agricultural products businesses, which make up about 28% of net written premium, these tend to be shorter-tail property-related businesses. Our next reporting piece is specialty casualty, which makes up about 37% of net written premiums. This includes our executive and professional liability businesses, our excess in surplus lines business and our general liability lines.

Specialty financial makes up about 16% of net written premiums and includes our products primarily for the benefit of financial institutions such as our lender services business and our surety and Fidelity lines. The fourth reporting line is California Worker's Comp, which makes up about 15% of our net written premiums. And then we have an other line, which includes an internal reinsurance facility and our discontinued operations. We believe this additional information will help investors better understand our businesses. In 2003, we experienced growth in each of the specialty business groups as a result of the rate actions we've been taking and selected unit growth.

In addition, our specialty property and transportation group experienced excellent profitability and almost 30% growth in gross written premiums. This growth was driven by our national interstate subsidiary and our mode-apperil crop business. National owner stack growth was fueled by significant expansion of it's captive truck programs and we were successful as many other companies left the government mode-apperil business. We were successful in acquiring additional business in that area. Our specialty casualty business had double-digit growth and generated a solid underwriting profit.

Within that business, our excess in surplus lines businesses had outstanding results, which were partially offset by adverse development and certain general liability lines. Specialty financial was the only group not reporting an underwriting profit. The underwriting loss was a result of declines in our residual value and surety businesses. In our California Worker's Comp business, we experienced almost 25% growth in California Worker's Comp premiums as we benefited from the repositioning being imposed on the state fund. We have been very successful in maintaining our underwriting discipline and reported good underwriting profits. Let me finish with our summary and outlook on slide 10.

I'm pleased with the consistently strong underwriting profits and written premium growth of our ongoing specialty operations. We're well positioned as a niche player and a specialty commercial market and we'll focus on continuing profitable growth opportunities. We remain committed to our pricing and underwriting discipline and are targeting average rate increases of 5 to 8% in 2004. My expectations are in the first quarter we should still be achieving close to double-digit increases. We expect improvement in the specialty group combined ratio in 2004.

When you look at the various businesses we expect continued improvement in the specialty casualty group. We feel the specialty property in transportation and California Worker's Comp businesses should continue their strong results. And our goal for our specialty financial business is achieving an underwriting break-even by year end '04 and underwriting profitability in '05. We do plan to increase our retention of written premiums. I expect this increased retention to be about 5%. For example, we are significantly reducing our sessions under our physical damage quota share. As a result, we expect double-digit growth in net written premium in '04.

We expect continued operating earnings improvement in our annuity life group and will continue to improve its cost structure and maintain pricing discipline. Our financial leverage has dramatically improved over '02 and we remain committed to further decreases as we move towards our long-term objective of 30% debt to capital. We eliminated a higher preferred dividend as a result of the conversion of the series J Preferred securities to AFG common stock and this month we sold $115 million of 7.125 senior debentures in order to redeem higher coupon Trust Preferred Securities. Based on our current view of '04, I remain comfortable with our core earnings guidance of $2.75 to $3.00 per share. I look forward to reporting our progress for this year. Thank you and we'll take questions.

Thank you. The question and answer session will be conducted electronically today. If you would like ask a question, please do so by pressing the star key followed by the digit 1 on your touchtone phone. If you using a speakerphone, please make sure that your mute function is turned off to allow your signal to reach our equipment. Once again, that's star 1 to ask a question. We will pause for just a moment. We will take our first question from Charlie Gates with CSFB.

Hi, good morning.

Good morning.

A couple of questions. My first question, if you look at the page that shows total property casualty operations and specialty group it appears for the quarter there was approximately $40 million of sales not included in the specialty group. What is that?

Charlie, the primary thing that's there is the residual runoff business of our personal lines. If you remember we sold infinity, we also sold the majority of our direct personal but we still have some of that that's in runoff and then there's a few just minor other businesses there.

Is that the operation, for example, that was in Mexico?

That operation would be one of those, that's not in runoff. There are pieces of the old Great American personal lines business that are in runoff.

Okay. If we go to the new disclosure, which is tremendous, what lines were you talking about when you said you saw pricing improvement, I believe, in the 5 to 8% area?

I was speaking overall. You know, if you look at our overall specialty group, I feel that our targets are to achieve 5 to 8% for the whole year of '04 and I feel in the first quarter that we'll still be able to achieve double digit for the overall specialty group.

What kind of rate increases are you getting in California Comp? Would that be in line with that 5 to 8?

Actually in the fourth quarter we achieved over 40% increase in California Worker's Comp. And going into this next year, we probably feel like we'll still, at least for some period, be able to get significant increase, though not as significant as 40, obviously.

I hadn't realized the state had allowed rate increases of that order of magnitude.

Well, some of the new provisions take effect going into this year. And each company files their own type of plans based off of their own experience using some of the industry stuff as a benchmark. So, each company is a little bit different in how they're approaching things. We have made our filing, it's our own unique filing and part of it has to do with how your business renews and how much increase you got in prior periods. As I said, the increase there, we still feel in California Worker's Comp, for some period this year, that we'll get some increase.

Now, you offered some comments about others with regard to commercial trucking and then you spoke about national interstate. Would you elaborate on that?

Yeah, if you go to the new breakout, under the specialty property and transportation -

Yes, sir.

business line, under the supplemental information, national interstate is a, Keith, 68% owned? 68% owned subsidiary that specializes in buses, limos and various other specialty businesses. And they've built a very unique and successful truck captive business there. That has really helped their growth. So, that national interstate ownership in businesses, in that property and transportation segment, or not segment, but business line.

Two more questions and then I will let somebody else ask questions. As you look at this new presentation, what portion of this business, other than the California Comp, would you say is excess in surplus lines?

Probably on a net basis, again, if you go to the new -- that would be under specialty casualty --

Yes, sir.

Probably roughly 30 to 35 -- 30% to 1/3 or something like that.

Of specialty casualty or total writings?

Of specialty casualty.

Okay.

Total writings would probably be 8%.

Okay.

9%.

I guess I should let somebody else ask questions. Thank you.

And once again, if you would like ask a question please do so by pressing star 1 on your touchtone telephone. We will take our next question from Jay Cohen of Merrill Lynch.

Good morning.

Good morning, Jay.

You mentioned, I think I missed this, but I heard you mention 6 points of adverse development in the fourth quarter. I don't know if I got that right.

That was accurate. Primarily from home builders business.

Right.

And some general liability business. A little bit of D&O.

So, ex that you would have been in the low 90s, from an accident year standpoint in the fourth quarter?

Yeah, I think that'd probably be the math.

Then why not think of a lower loss or lower combined ratio in '04? My guess is that your range probably suggests a combined ratio of 95 to 97 or something? Why wouldn't it be lower if on an accident year basis you're running in the low 90s.

I think, Jay, on that our expectations are set at a level that we believe are conservative but our experience has been running on a calendar year basis in the mid-90s. We clearly believe that there's a potential for improving over that but we have not yet delivered that and so we're not projecting that in our forecast.

Fair point. Next question. You mentioned net written premium growth in '04 in the double-digit range. Is that for just a specialty business? Or is that overall?

Well that would be in our remaining specialty, our overall specialty property and casualty business.

And I think it's fair to say, Jay, that overall as we continue running off what's left of the personal line, specialty and total are going to become essentially the same.

The first quarter should be a tough comparison, like the middle of the first quarter is when you decided to sell infinity?

Actually we closed the sale halfway through the first quarter of last year.

Okay. So first quarter still -- that's a tough comparison but the balance of the year is more apples to apples.

That's right. What you'd need to do on the first quarter is go back and look at the quarterly data that we disclosed at the end of the first quarter and you will be able to break out the personal lines pretty easily.

Yeah, I think we've got that. That's good. Super! Thanks for the answers.

All right.

And we do have a followup question from Charlie Gates of CSFB.

Is the builder's program that you made reference to, is that construction defects?

Yes, part of that would be construction defect type claims or other type of home builders liability.

What was the decision a couple of years ago? I've forgotten it momentarily. Is that California? Montrose!

There was a Montrose decision in California. The majority of the construction defect or home builders development that we've had actually is not California, it's Nevada based though it's not solely limited to Nevada and we still maintain some profitable home builders in some other states, but we have exited Nevada and the states that are associated with where we're finding the adverse development. That exit was about a year and a half ago.

And that business, basically, is included in my specialty financial line?

No that business would be included in your specialty casualty.

Okay. So it suggests that other business was real good to offset the problem, basically, in that specific area.

That's fair.

Okay. And the specialty financial, that business adversely affected by the residual value program that you made reference to?

That's right. And surety, the surety part of the Surety and Fidelity business had a combined over 100.

Could you elaborate on that, Carl, as to --

Yeah, we're pretty much of a mid-market surety type company. I give our guys a lot of credit, they steered us clear of the Enrons, Tycoes, the big Fortune 500 kinds of fidelity and surety type of issues and that, but just in the mid-market construction companies, with the kind of soft economy over the past two or three years, we haven't been immune, you've seen surety results have been pretty poor for the whole industry. We've been adjusting our pricing and our terms and our underwritings some and we feel good that's a business, if you look at over a 10, 20-year period of time, we've done very well in and we would expect to continue to do well there.

The disclosure is much improved. That's just a statement.

Thank you.

And once again, if you would like to ask a question, please do so by pressing star 1 at this time. We will take our next question from Sean Abold of Goldman Sachs.

Hey, guys, just a really quick question with regards to the holding company and liquidity there and then also dividend capacity? And then a quick follow-up.

Sure, dividend capacity for '04 without requiring regulatory approvals at about $180 million.

Uh-huh.

Holding company liquidity, we closed year end with about $100 million --

I'm sorry, can you say that again?

$100 million of parent company cash at year end. In addition to that, from a liquidity perspective, there are unused lines of credit, both at the American Financial Goup holding company, that's $280 million and $155 million of Great American Financial Resources.

Okay. And of that 180 dividend capacity, how much do you guys expect to use?

Actually as we look forward, we see some great growth opportunities and so my suspicion is that we will use substantially less than that. Because we have the opportunities to reinvest that into our businesses.

Okay. And then really quickly, in terms of your bank line, that 280 million, is that the only bank line now that you have left after paying back the rest of the bank lines at the other subsidiaries?

No, there's two bank lines, one is at the parent company, American Financial Group for $280 million. The other is $155 million at Great American Financial Resources.

Okay. Okay, guys, thanks.

All right.

Thank you. Our next question will come from Brian Matellionus(ph) Citigroup.

Morning, guys. It's actually Dave McGowan at Citi.

Hi, Dave.

Hi. Not sure we're going to be able to go through this on the conference call, maybe we can get in touch on the line, but I wanted to ask you a quick question. In thinking about your adverse development this quarter, I was looking at some of the scheduled piece. In the other liability line, are there some changes in reinsurance program for the '02 accident year that sort of changed either your paid or developed trends? Because it looks a lot different. I'm coming up with strange numbers as I try and look at AFG reserve adequacy.

We may want to do some of that offline, but there were a couple of fairly substantial changes in the reinsurance during 2002. The largest of those was a reinsurance program that we put in place on our multi-peril crop insurance where we ceded about $200 million more than we had in the previous year. Actually in '03 it moved then to $300 million. So, that would be a large one. The other area that we had a change in the reinsurance would have been in the quota share physical damage. As to specifically looking at GL lines, I'd need to get into some other material to respond more directly on that.

All right, why don't I give you guys a buzz and we can talk about it offline.

That'd be fine.

Thank you.

We will take our next question from Jay Cohen of Merrill Lynch.

You know what, I just realized my question is available in your information so I don't have it anymore.

All right. The question, that is. No problem.

Thanks.

And Mr. Jensen and Mr. Lindner, I will now turn the conference back over to you for any additional or closing remarks.

Great, thank you. Thank you for joining us. We've appreciated your support and appreciate your taking the time to join us this morning. We look forward to reporting to you at the end of our first quarter. Goodbye.

And that does conclude today's conference. Thank you for your participation. You may now disconnect.