American Financial Group Inc (AFG) 2004 Q1 法說會逐字稿

Good day, everyone and welcome to the American Financial Group first quarter 2004 earnings results conference call.

Today's conference is being recorded. With us today is Mr. Carl H. Linder, III and Mr. Craig Linder, Co-Presidents of American Financial Group. And Mr. Keith Jensen, Senior Vice President of American Financial Group.

And t this time I would like to turn the conference over to Mr. Keith Jensen. Please go ahead, sir.

Thank you.

Good morning and welcome to the American Financial Groups' 2004 first quarter earnings results conference call.

If you are viewing the webcast from our website, you can follow along with the slide presentation if you would like. Certain statements made during this call are not historical facts and may be considered forward-looking statements. They are based on estimates, assumptions and projections which management believes are reasonable, but by their nature subject to risks and uncertainties. The factors which could 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 results on form 10-Q.

We do not promise to update such forward-looking statements to reflect actual results or changes in assumptions or other factors that could affect these statements. Many investors and analysts focus on core earnings of companies, setting aside items that are not considered to be a 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.

Now it is my pleasure to turn the time over to Carl Linder, III, Co- President of American Financial Group.

Carl Lindner, III: Good morning and thank you for joining us. I would like to make a few initial comments and then we will open the lines for questions.

Earlier this morning we released our 2004 first quarter results. I am very pleased with our performance in the first quarter. Our businesses improved upon a profitable trend that we experienced during 2003 and our results for this quarter were ahead of our expectations.

Our first quarter net earnings were 98 cents a share, up 62 cents per share over the 2003 first quarter. Our first quarter core operating earnings were 72 cents per share, 14% higher than the 2003 period. For the 2004 first quarter, our Property and Casualty Group reported an underwriting profit of $30 million with a combined ratio of 93.8, an improvement of over 3 points and nearly $15 million compared to the 2003 period.

The 2003 first quarter included Infinity's personal lines results through the initial sale in mid-February of 2003. Overall the Property and Casualty groups gross and net written premiums for the first quarter were below the 2003 period as a result of the sale of our personal lines businesses.

In February, we announced the estimated effect of a proposed merger of Provident Financial Group with National City Corp which is expected to close in the second quarter of this year. This is a very positive step for AFG and its shareholders as well as our insurance operations that directly own the Provident stock. We expect American Financial Group to report a sizable realized gain of between $130 to $140 million depending on market prices. Since American Financial Group's investment in Provident is carried at market value on our balance sheet, shareholders equity would already reflect any unrealized gain based on March 31, 2004 prices. National City's stock is more liquid and pays a higher dividend than Provident. Also, my brother, Craig Lindner, AFG Co-President, will join National City's Board.

Now, let's talk about our Specialty Group results. Specialty Group reported a solid underwriting profit for the 10th consecutive quarter with a combined ratio of 93.3, about 4.5 points better than the 2003 first quarter. This was the result of improving underlying accident year results and substantially reduced adverse development during the quarter. The Specialty Group's gross written premiums grew 19% in the 2004 quarter, compared to the 2003 period. We achieved rate increases averaging about 11%.

Pricing has remained firm in many of the Commercial Casualty markets where we do business, and we are pleased that our premium growth exceeded our average rate increases, which is indicative of meaningful volume growth as well. Net premium growth was greater than gross premium growth due to our planned increased retention in certain lines such as Directors and Officers, Inland Marine, and other targeted lines. We believe that these increased retentions are appropriate in the current rate environment.

Now, turning to our Specialty Business Groups, our Property and Transportation Group reported strong underwriting profitability in 2004 first quarter. Their combined ratio of 83.5, improved 12.5 points compared to the same period a year ago. The improved underwriting results were driven by our Inland and Ocean Marine businesses and our Agricultural Operations due to favorable prior year development and the impact of rate increases. The improvement also includes the effect of a reinsurance profit sharing agreement. This group's underwriting results would have been in the high 80s without that agreement. Net written premiums grew 18% over the 2003 period, somewhat less than the gross written premium growth due to the timing of a reinsurance arrangement, but we do expect net written premiums to exceed gross premiums through the remainder of the year though.

Net written premiums for our Specialty Casualty businesses were up up 20% over the 2003 period. Growth in net written premiums exceeded gross written premium growth due to our planned increased retention in select casualty business lines, including executive liability in targeted markets. This group also generated a solid underwriting profit in the 2004 first quarter with a combined ratio of 93.8, 7 points better than the 2003 first quarter. This improvement came primarily from these same targeted markets and executive liability operations, including the benefits of nominal adverse development in 2004.

We indicated earlier that we were looking to these businesses for significant improvement in 2004, in part relying on improved development results. I am pleased that in the first quarter that that trend began to emerge. We continue to focus on controlled profitable growth and increased retentions in this (sic) businesses. Even though the Specialty Financial Group didn't report an underwriting profit for the first quarter, their combined ratio improved 8.7 points compared to the 2003 quarter. This was driven by a much lower underwriting loss in the lender services business.

Our surety and fidelity businesses continued to generate solid underwriting profits, and I, for the whole group, I continue to expect, especially Financial Group, to achieve underwriting break even this year. We did experience 58% net premium growth in this group, primarily as a result of increased retentions in our Lender Services Group and significant growth in the operation that provides collateral protection to financial institutions. The 27% growth in California workers' comp net written premiums was somewhat less than the gross premiums growth due to reinsurance sessions (sic), a personal lines premium fronted for Infinity Property and Casualty. This growth in our California comp business was driven in large part by rating actions taken in 2003.

We continue to maintain our underwriting discipline in this volatile market and again reported a solid underwriting profit for the quarter. Our preliminary review of the legislation enacted a few days ago was encouraging. We believe that all interested parties have recognized the need for meaningful change and have taken a significant step in that direction. We applaud the Governor and both parties in the legislature for addressing the serious flaws that have existed in the system.

Now let's talk about our Annuity, Life and Health Group. This group's core net operating earnings for the 2004 first quarter were higher than the 2003 period resulting from improved results in the supplemental insurance operations, partially offset by the impact of continued low interest rates on a fixed annuity operations and higher interest expense. Statutory premiums for the first quarter were 16% below the 2003 period. In this historically low interest rate environment, the group continues to maintain its pricing targets and commission and interest crediting discipline, contributing to slower sales of single premium annuities. We continue to believe that the fundamentals of the annuity industry are improving, with the recent interest rate rebound since the end of the first quarter, along with continued improvement in the group's cost structure, we are achieving appropriate returns on new business. We expect this group's core operating earnings for 2004 to exceed 2003 by 20% to 25%.

In summary, and with that outlook, I am pleased with the continuing improvement in underwriting profits and written premium growth of our ongoing Specialty operations. We are well positioned as a niche player in the specialty commercial market and will continue to focus on continuing profitable growth opportunities. We remain committed to our pricing and underwriting discipline and are now targeting average rate increases for 2004 close to 8%.

We do expect underwriting improvement in the Specialty Financial Group, and especially in Property and Transportation and California workers' comp businesses should continue to report strong results, and we look for improved profitability in the Specialty Casualty Group. We expect double-digit growth in net premiums in 2004 based upon our continuing rate increases and our reassessment of our reinsurance sessions. 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 improved dramatically in 2003 and we remain committed to further reduce our debt to capital ratio towards our long-term objective of 30% or lower.

As a result of our stronger than expected first quarter results, we have increased our core earnings guidance to $2.85 to $3.10 per share, and we will continue to monitor this guidance through the year. I do look forward to reporting our progress throughout the rest of this year.

At this point, we'd love to take some questions.

Thank you. The question and answer session will be conducted electronically today. And if you would like to ask a question, please press star 1 on your touchtone phone. If you are joining us by a speakerphone today, make sure that your mute function is disengaged. That will allow the signal to reach our equipment. Once again, that is star 1 for questions, and we will pause for just a moment.

And e will take our first question today from Jay Cohen with Merrill Lynch.

Hi, it's actually Allison.

I just have a couple of quantification questions. Forgive me if this is somewhere and I didn't see it ,but I was wondering if you had your current book value per share? And the current debt to capital ratio as it stands now?

And then I know you talked about reduced prior year reserve development, but I was wondering if you could quantify that for the company as well?

Sure, Allison, this is Keith. Book value per share a GAAP basis is $30.98. Book value excluding unrealized bond gains is $27.36. The leverage, the leverage is 33.4%, and the way we do that is we take debt plus prefered, divided by total capital, excluding the unrealized gains on the bond portfolio.

And you asked about adverse development. Adverse development in this quarter was about $12 million as compared to about $21 last year.

And just as a followup, the book value now, the Provident thing, if I understand it correctly. So the Provident situation is fully reflected in this $30.98?

It would be fully reflected for the stock - for the price as of March 31.

Now, if I could have just one last question, the rate increases you are seeing in California workers' comp. Do you have that number?

Carl Lindner, III: Yes, Allison. This is Carl. We achieved about 14% in the first quarter, which we were very pleased with.

Thank you very much.

And moving on, we'll go next to Charlie Gates with Credit Suisse First Boston.

Hi, good morning. I have a couple of questions. My first question, what is the status of Transport Insurance?

We are in, in negotiations over the contract with the buyer.

So that may be a second quarter 2004 event?

I don't think it gets closed in the second quarter. We need to complete the negotiations on the contract and then go through regulatory approval, so I think it's more likely to be a third quarter.

Okay, so that was my first question. My second question. You indicated, or Carl indicated, I believe, that there was a gain in first quarter results as a result, - with regard to a reinsurance program. I didn't understand that.

I don't think you said there was a gain. I think that there was a difference in gross to net because of the change in the reinsurance program. If you look at our Property and Transportation.

I thought it was a profit sharing gain. I'm sorry.

Oh, okay. I'm sorry.

Oh, the profit sharing comes from our Inland Marine, the physical damage quota share. And the way that transaction is structured, there is a profit share that comes back so that we pay a reinsurers margin and to the extent that it outperforms baseline then the profit share comes back to us, so that would be the improvement as a result of that.

Was that gain significant to earnings?

It was not because, essentially what it does, Charlie, is causes you to earn a relatively normal return on your written premium. So it's not a change off of what you would earn off a written premium . So it's written premium earnings minus a marginal reinsurers margin.

Carl Lindner, III: Charlie, I think we were trying to point out there, that you know, that on a normal, kind of normalized basis, you know, that basis would be more in the high 80s. We just didn't want anybody to think that that was an ongoing run rate. But, you know, it is what it is, and we are happy with the 83, but on an ongoing basis, you know, this business is more likely to be in the high 80's.

Just to elaborate further. The number of dollars operating profit would be would be similar with or without the reinsurance agreement. What happens is by reinsuring you change the nominator and that's what causes the percentage underwriting to be different.

Is Lender Services the same as the residual value?

No, Lender Services is much broader than Residual Value but Residual Value is one of the products that's within Lender Services.

What is that, that is like lender's collateral protection?

Collateral protection is a large part of it. There is some GAAP insurance that is part of it. Collateral protection, though, would be the largest volume there.

Carl Lindner, III: Leased property, you know, those type of coverages.

What do you think that the April 16th, I guess, signing of this bill into law in the State of California will do to the competitive environment out there?

Carl Lindner, III: I still think that people are going to be very cautious. Charlie, we are not seeing much change, you know, at the moment, recognize this legislation is brand new. We have seen some new national carriers, the national carriers get cranked up a little bit, a little bit more. But we are -- I would expect there would be kind of a wait and see attitude kind of a little bit, maybe get a little bit new competition, but I wouldn't see any big rush.

Was there any reserving for asbestos in this quarter?

Carl Lindner, III: No, there wasn't.

Okay. I should let somebody else ask questions. Nice job, guys.

And our next question is from Sean Abboud with Goldman Sachs.

Hi, guys, how you doin? Congratulations on the quarter. Real quick question, one with regard to the adverse development.

What lines was that in? And, two, with regards to your converts outstanding, I know you guys have about 511million base, which I believe as of last quarter was about 180, 190 million accretive value. If that was to be converted, what would the leverage effect be? I just kind of want to, kind of, square that away with what I have? And on that conversion, sorry to be kind of running on here, but on that conversion, do those converts, does your equity value have to say above $32.30 area for some amount of time for those to convert into equity?

Carl Lindner, III: Nice start. I think your first question was adverse development and what lines? A little bit more than half of it was actually what, other than in the four areas we are talking about, we have reinsurance facility that had a little bit more than half of it and the remainder of it was split evenly between Specialty Financial and California workers' comp.

With respect to the conversion, we have not recently done the exact calculation in terms of what the dilution would be, but, the price needs to go above, about,- Is it $38? Above $38 for the conversion to become effective.

38, not 32?

Carl Lindner, III: Well, there's a 20% premium that has to be in the marketplace above the conversion price.

Okay. Thanks, guys.

And I would like to remind our audience, if you do have a question, to please press star 1 on your touchtone phone. We will go next to Matt Telezola (ph) with Merrill Lynch.

Hi, it's actually Jay Cohen. Sorry to tag team with Allison, but a couple of other questions that I had. I guess that one balance sheet, one income statement. The balance sheet, can you tell us what the level of equity is now that is associated with GAFRI? Do you have that?

I can give you GAFRI's book value per share .

Carl Lindner, III: Hang on just a second. Craig is getting that out for us.

Jay, GAFRI's book value per share is $17.60, and there's about 43 million shares outstanding, Craig. 47 million shares.

47 million shares out.

Carl Lindner, III: And AFG has 81%, 82%.

Right. Of GAFRI.

Okay.

Our carrying value might be slightly difference than that but not a lot.

Carl Lindner, III: It's pretty close.

It's pretty close.

So it's gonna have a value something probably north of $800 million?

Carl Lindner, III: That sounds like the right order of magnitude.

And you - annualizing the first quarter number suggestion, ROE, that's probably dragging down the overall ROE, is that fair at this point?

Carl Lindner, III: That is fair.

And then, just kind of a numbers question or explanation.

The other line, which was a negative 10.8, other expense line, $10.8 million, was up from a year ago, was up from kind of the regional run rate, and I am wondering if, what is behind that? What kinds of numbers should we assume going forward?

Let me make sure that I am getting exactly -- you are in the supplemental financial information?

Yes, other expense $10.8 million negative?

Got it, okay. That run rate went up, and it went up a little bit more than couple of million dollars. Primary driver of the increase is the effect on the retirement and savings plan and some deferred comp plans of the increase in the share price of the AFG stock.

Okay.

So that was the primary driver of that increase in this quarter. If you assume a relatively stable stock price, then the run rate would be somewhere in the 9 to $10 million range.

Great. That's helpful. Thanks, Keith. Okay.

And, gentlemen, there are no further questions at this time. I will turn the call back over to you for any closing remarks.

Carl Lindner, III: Okay. We appreciate everyone joining us, we look forward to reporting on our second quarter. Thank you.

That does conclude today's conference. I would like to thank everyone for joining us today