American Financial Group Inc (AFG) 2004 Q2 法說會逐字稿

Good day, Ladies and Gentlemen, and welcome to the Q2 2004 American Financial Group conference call. My name is Christy and I’ll be your coordinator for today. At this time all participants are in listen-only mode. We will be conducting a question-and-answer session towards the end of this conference. If at anytime during the call you require assistance please press star, followed by zero, and a coordinator will be happy to assist you. As a reminder, this conference is being recorded for replay purposes.

I would now like to turn the presentation over to your host for today’s call, Mr. Keith Jensen, Senior Vice President of American Financial Group. Please proceed sir.

Thank you. Good morning. I’m here with Carl Lindner, III and Craig Lindner, Co-Presidents of American Financial Group and we’d like to welcome you to the American Financial Group 2004 second quarter earnings results conference call. If you’re viewing the webcast 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. 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 form time to time in AFG’s filings with the Securities and Exchange Commission, including the Annual Report on Form 10-K and the Quarterly Report on Form 10-Q. We have not promised to update such forward-looking statements to reflect actual results or changes and assumptions or other factors that could affect these statements.

Many investors and analysts focus on quarterly earnings income, setting aside items that are not considered to be part of ongoing operations, such as net realized gains or losses on investments, effects of accounting changes, discontinued operations and certain non-recurring items. As such, quarterly earnings of our insurance operations for various periods will be discussed during this call.

Now I’m pleased to turn the time over to Carl Lindner, III, Co-President of American Financial Group to discuss our results.

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

Earlier this morning we released our 2004 second quarter results. Similar to the first quarter, our businesses continue their profitable trend and our results for this quarter were slightly ahead of market expectations. Our second quarter net earnings were 75 cents per share, up 31 cents per share over the 2003 second quarter, resulting from improved earnings in our insurance operations, partially offset by lower realized gains on investments.

Our second quarter core operating earnings were also 75 cents per share, significantly higher than the 2003 period. In the 2003 second quarter, it included charges for an arbitration decision within the Property and Casualty operations, as well as the negative effect of lower interest rates on the fixed annuity operations.

We’re pleased to announce the merger of Provident Financial Group and National City Corp was completed on July 1st. AFG received common and preferred shares equivalent to about eight million common shares of National City and a tax rate exchange of its Provident stock. American Financial Group will report an after-tax gain of approximately $130 million in the third quarter.

Of course, shareholders equity reflects any unrealized gain based on June 30th prices since AFG’s investment in Provident was carried at market value on our balance sheet.

We continue to strengthen our balance sheet. Leverages improved to 33.2 percent. Our financial flexibility is strong with about $40 million of parent company cash, an unused $280 million line of credit, and a shelf registration that provides access to the capital markets.

Let me talk about the Specialty Group results.

Property and Casualty Specialty Group reported a second quarter underwriting profit of nearly $32 million with a combined ratio of 94 percent, 1.7 points better than the 2003 second quarter. The Specialty Group’s gross written premiums grew 18 percent in the 2004 quarter compared to the 2003 period. We did achieve rate increases averaging about eight percent during the quarter. Even though pricing has moderated somewhat from last year, we continue to get double-digit increases in many of our Commercial Casualty markets. We’re also seeing strong volume growth in those business lines.

As indicated previously, 31 percent net written premium growth continues to outpace gross premium growth due to our increased retention in certain lines, such as Inland Marine, Trucking, Directors and Officers, and other targeted lines. We continue to believe that these increased retentions are appropriate in the current rate environment.

Let me turn to our Specialty Business Groups.

Our Property and Transportation Group again reported strong underwriting profitability in the 2004 second quarter, with a combined ratio of 84.6 percent. The lower combined ratio in the 2003 second quarter was primarily due to a much lower level of earned premiums related to our cession of six months of premiums under the physical damage quota share and some favorable development in the 2003 accident year recorded during that quarter. However, the combined ratio for the first half of 2004 of 84 percent is comparable to the ’03 period.

These profitable underwriting results continue to be driven by favorable prior-year development and the impact of rate increases. Net written premium growth was 24 percent, excluding the effects of the quota share agreement. I’m pleased with the continued strong growth in these businesses.

Net written premiums of our Specialty Casualty businesses for the 2004 second quarter were up 12 percent over the ’03 period. This Group reported a modest underwriting profit.

Adverse development of $20 million within the Executive Liability operations during the quarter offset underwriting improvement in our Excess and Surplus and General Liability line. However, the combined ratio for this Group of businesses for the first half of ’04 was 96.8, 3.3 points better than the comparable ’03 period.

We expect the 2004 results to show continuing improvement over the 2003 period and we’ll continue to focus on controlled growth.

The Specialty Financial Group’s combined ratio for the ’04 second quarter of 101.5 was comparable to the previous quarter but improved nearly 12 points compared to the ’03 second quarter. This was largely due to significantly lower adverse development.

Our Surety Fidelity and Foreign Credit operations continue to generate solid underwriting profits. I expect this group to continue to show improvement over its ’03 results. However, the Group may not achieve breakeven this year as I had previously expected. This Group’s net written premiums increased 36 percent over the ’03 quarter, primarily due to the continued growth in the operation that provides collateral protection of financial institutions.

Now, let’s talk about our California Comp business.

California Workers’ Comp Group reported a strong underwriting profit for the second quarter. Net written premiums grew 27 percent over the ’03 quarter as a result of rating actions taken in ’03, as well as volume growth. We were pleased with the recently enacted Worker’s Comp reform in California. As a result of that Bill and market conditions we do expect rates to moderate during the remainder of ’04. We’ll continue to maintain our underwriting discipline in this market as we work through the implementation of the legislation.

We are optimistic the legislation will have positive effects on both the State’s businesses and one the Worker’s Comp insurance industry as well.

During the second quarter, we did reduce our reserves related to the World Trade Center loss by $9 million and this reserve reduction was partially offset by an increase in our reserves for reinsurance recoverables.

Now, let’s review our Annuity Supplemental and Life Insurance Group.

This Group’s core net operating earnings for the 2004 second quarter were higher than the 2003 period, resulting mainly from a 2003 charge related to the negative effect of lower interest rates on the fixed annuity operations. Statutory premiums for the second quarter were 14 percent below the ’03 period. In this low interest rate environment the Group continues to maintain its pricing targets and commission and interest crediting discipline, contributing to lower sales of single-premium annuities.

However, the Group’s 403-B Annuity line and Supplemental Insurance operations reported an increase in premiums. We are seeing improvements in the fundamentals of the annuity industry. With the higher levels of interest rates compared to last year, we’re continuing to achieve appropriate returns on new business and we expect this Group’s core operating earnings for 2004 to exceed ’03 by 25–30 percent.

In summary and with an outlook, we’re experiencing continuing strong written premium growth and solid underwriting profits in our Property and Casualty Specialty operations. We have a diverse group of Specialty Commercial businesses, many of which have strong market positions within their niches. I continue to emphasize that we’re committed to maintaining adequate pricing and underwriting discipline.

Rate increases for the first half averaged about nine percent and I believe pricing will remain firm in many of our Casualty markets for the remainder of ’04. We still expect our average rate increases to be around eight percent for the year.

I do expect the strong double-digit growth in net premiums that we’ve experienced through the first half of the year to continue through the year of 2004 based upon our continuing rate increases, volume growth, and the assessment of our reinsurance cessions.

I expect our Specialty Financial Group to continue to show improvement over ’03 and I expect the Property and Transportation and California’s Worker’s Comp businesses will continue to report strong results. The Specialty Casualty Group has experienced solid improvement through the first half of the year and we look for improved profitability for the remainder of ’04 compared to ’03.

The Annuity Supplemental and Life Insurance operations are generating a higher level of operating earnings and we look for continuing improvement in those operations.

Our financial leverage has continued to improve in ’04 and our long-term objective is to reduce our debt-to-capital to 30 percent or lower.

Based on our results for the first half of the year, we’re comfortable with our 2004 core earnings guidance of $2.85–$3.10 per share. I look forward to reporting our progress throughout the rest of the year.

We’ll now open the lines for questions. Thank you.

Thank you, sir. Ladies and Gentlemen, if you would like to ask a question please press star, followed by one, on your touchtone telephone. If your question has been answered or you wish to withdraw your question, press star, followed by two. Questions will be taken in the order received. Please standby for your first question.

And your first question comes from Charles Gates of CSFB. Please proceed sir.

Hey, good morning. My first question — book value per share, including FAS-115, and then excluding?

Carl H. Lindner, III: Book value including is $28.51, and excluding all gains, which would include the equity, so it’s going to have the Provident in it, would be $25.79. If you just exclude [indiscernible] gains it’s $27.89.

Maturing value of GFR at June 30?

Carl H. Lindner, III: I don’t have that in front of me, Charlie. I’ll have to get that.

OK. Can you summarize, or one of you summarize, adverse or favorable reserve development?

Sure, be happy to. During this quarter we had about $22 million of adverse development. As Carl said, we had $20 million in the D&O line. That compares to $68 million of adverse development in the same quarter last year.

I thought he made reference to reinsurance recoverable, a write-down of that, or maybe I misunderstood.

We set out a modest amount of additional reserves for reinsurance recoverable. If you remember from our previous calls, we’ve had a few fairly modest sized exposures in that 10–15 range from some of the reinsurers that have been troubled and we set up a few million dollars additional in the reserves.

And that’s included in the $22 million?

No, it isn’t — or, yes it is, I’m sorry. Yes, we did include it there.

OK. What line of coverage would that relate to?

Carl H. Lindner, III: It actually spread into each of the lines other than the California Worker’s Comp. There was a little bit in each of them.

I saw in the news release about the proposed sale of Transport.

Carl H. Lindner, III: Yes.

Two questions specific to Transport. Question number one would be, if there is likely a further charge in the third quarter specific to the disposition of that?

Carl H. Lindner, III: We don’t believe so.

And the final question, approximately what — on Transport — approximately what portion of your asbestos liability may be transferred with that?

Carl H. Lindner, III: It’s 12 or 13 percent, Charlie.

OK. So, approximately a couple of years ago, maybe two years ago, you sold something called ‘Stonewall’, I thought.

Carl H. Lindner, III: Yes, it was probably three or four years ago.

How much of it went with that?

Carl H. Lindner, III: My recollection is that was 25–30 percent.

So, was it incorrect to assume that if I add those together that I got approximately 37–43 percent of the liability has been transferred with the sale of Transport?

Carl H. Lindner, III: Of the liability as it existed prior to the Stonewall transfer, yes.

OK. My final question, I was looking at — there’s something called an S&L Insurance Daily, and in the S&L Insurance Daily it said, and maybe I got this wrong, that basically, I guess that you had reduced rates basically, average rate reduction from Republic Indemnity of 17.54 percent. Do I have that right, for California Worker’s Compensation? No, I guess it’s 20.5 percent.

I think what that may be referring to is the cumulative effect of the January and the July filed rates with the Department. In January I believe our filed rate reduction was about 14.9 percent. In July it was about seven percent, so cumulatively that might be the case.

Now, in actuality, for the first six months — in the first six months, reflecting other than just filed rates, you have debits and credits and other factors, other geographic factors, in our how we price our business. For instance, our second quarter or our first six months pricing in Republic was actually up about 15 percent.

I’m sorry; I’m getting confused. So basically you filed for two rate reductions, OK?

Yes. Every company filed — has had to file their filed rates, but there are various geographic factors, various debit and credit factors, based off of the classes of business, et cetera, et cetera. And your underwriters, risk by risk, determine what the actual price is using that as a base.

What I’m saying is that through the first six months of the year our prices actually were up 15 percent, though probably what’s going to happen in the second half of the year, Charlie, is due to the cumulative impact of that. My guess is our rates will probably be down 10–15 percent, reflecting both those changes.

Now, the good news is, as we like what’s coming out of the — so far out of the California Worker’s Comp Reform and we think that there should be some adjustment in rates based off of the positive things that have come out of the reform.

Twenty years ago when no-fault insurance went to New York State you had companies adjusting rates prior to their knowledge of what the — it was state-mandated reductions, as I recall — prior to people’s knowledge of what would be the actual impact of the market. Is it somewhat similar?

Carl H. Lindner, III: I’m not that familiar going back. Let’s put it this way. We feel — it will take time to see how this legislation is implemented on reform, but we feel strongly enough about what we think are the positive impacts coming from it that we do think it makes sense to adjust rates some. And again, our underwriters will look at risk by risk and determine what the actual price will be. And I think the practical impact of that through the last half of the year will be, and we think our pricing on average will probably be off 10–15 percent. With what we know about the reform, we feel good about that and also, about our underlying profitability today is excellent.

Thank you.

And your next question comes from [Sean Abboud] with Goldman Sachs. Please proceed, sir.

Hey, guys, congratulations on the continued success. Just a couple of quick questions. The first one, I missed the leverage target by the end of the year. What was that target number?

Carl H. Lindner, III: I don’t think we gave an end-of-the-year. I believe we said over a number of years we’d like to — our target is to be under 30. Our current is 33 at the end of the quarter.

OK. Now, the sale of Transport, in terms of liability of asbestos and environmental, I’m assuming — does it hurt to assume that the liabilities that went with that business will be without recourse?

Carl H. Lindner, III: Yes, that’s correct.

OK. And lastly, recently we’ve seen a couple of issuers, especially in the Property and Casualty segment, that have improved earnings come to market and do new deals to take out converts out there. Any plan or anything sort of contingent plan for you guys to eventually get that convert out of the way to prevent future dilution?

Actually, we’re not looking at doing that currently, [Sean]. Your reference to future dilution is reference to the EITS proposed action, obviously not yet final. We are looking at some alternative that might be pursued with respect to that, but we’re not specifically planning to go to market at this point.

OK. Thank you very much, guys, and good luck.

And your next question comes from [Abe Schloss] of Madison Group. Please proceed sir.

Good morning. Just a quick question on the real estate holdings. If they were figured into our book value, how much would they add at their appreciated value?

Maybe you’d rather than deal with the book value because there is really quite a range, Abe. If we took the real estate holdings we believe, that on a pre-tax basis, there is an unrecognized gain that could be between $190–$270 million. Obviously that’s quite a range, but if you take that after-tax that would give you $120–$180 million or so of gain that’s not yet recognized.

It’s about $2 a share, you’d say?

Rough and dirty.

OK. And one other quick note. On the news releases on Dow Jones this morning it stated American Financial Group sees fourth quarter charge of about $36 million on the unit sale. And in the release you mentioned you took a $36 million charge in the fourth quarter of ’03. Now, which is correct, or does Dow Jones have to be corrected?

Carl H. Lindner, III: That was a 2003 fourth quarter.

OK. So Dow Jones has an error on their…

Carl H. Lindner, III: Yes.

OK. Thank you.

And your next question comes from Charles Gates of CSFB. Please proceed sir.

I have one follow-up question, guys. One of you said that I think there was $22 million of unfavorable development this year. You did have some positive development though that I think one of you made reference to. Does that mean you had unfavorable development generally and otherwise?

That’s a net number across our 20 some odd businesses. We had positives and negatives. The only one that’s substantial, as in greater than $10 million either positive or negative, is the one that Carl mentioned in his commentary with respect to the D&O. Everything else, there are smaller pluses and minuses.

My only other question is, Carl said in his opening remarks, and maybe I got this wrong, that pricing you saw overall up during the first half of this year. Did you say about eight percent?

Carl H. Lindner, III: Yes.

How do you see that evolving for the second half? That’s my last questions, I swear.

Carl H. Lindner, III: I think pricing has moderated some from the levels of the prior year on that. I think we used a target of around eight percent or so for the whole year and that’s what we’re going to stick with right now.

Can I take that to mean that eventually the same rate of increase that you saw in the first half, maybe you see in the second?

Carl H. Lindner, III: I think the actual for the six months is actually our prices are up nine percent.

So basically, seven versus nine, that’s not much of an adjustment.

Carl H. Lindner, III: No.

OK.

Carl H. Lindner, III: We’re not going to change our pricing perspective unless we see something different at this point, but again, we have a few Specialty lines where the pricing has actually gone up, things like Equine Mortality, and just based off its own little cycle.

Probably one of the big unknowns is really what’s going to happen in the California Worker’s Comp. I told you about, to the best of my feel, where I think we’ll be, but that could swing the overall quite a bit either way.

Equine Mortality is it my [indiscernible] is the way you pay for it?

Carl H. Lindner, III: Exactly.

OK. Thank you.

Carl H. Lindner, III: All but a couple of people have gone out of that market, which leaves us as the largest there and that’s given us some great opportunities to write quite a bit of business and to increase pricing there.

But you wouldn’t do like this horse that won the Kentucky Derby?

Carl H. Lindner, III: We’d write some thoroughbred, but the biggest part of it is really pleasure and other types of horses, show horses.

On the most expensive horse what would you retain, or is that an inappropriate question?

Carl H. Lindner, III: No, it’s not inappropriate. I’d have to go take a look at our specific reinsurance treaty, but it wouldn’t be “know your socks off” type of numbers. We have treaties in place that would limit any one loss to something that would be pretty reasonable.

OK, thank you.

Let me just — Charlie, I was unable to answer your question on GFRs carrying value. Net carrying value is $756 million.

Thank you.

And again, that is star, followed by one, for any questions. And your next question comes from Jay Cohen of Merrill Lynch. Please proceed, sir.

Yes, I’m interested to hear your comments on the pricing environment, which, to me, it sounded a bit more upbeat than what I’m hearing from others, particularly in the Professional Liability area. I’m wondering why, and I guess it’s sort of a business mix issue, where you guys focus versus others, but I just want to get your perspective on it.

Carl H. Lindner, III: Jay, this is Carl. I think some of the things you see, reports and things, I think are more focused on the Fortune 500, big broker type reports, heavily weighted towards Property, Excess Property, D&O, Excess Liability, and bigger accounts. And I do think that probably the trend is softening quite a bit.

Our business is more focused on the small and mid-market in the different Specialty lines with some large account business. So, I think it’s our mixture and California Comp, for instance, believe it or not, we achieved about a 15-percent increase in rate in the first six months and grew the business 27 percent in net written premiums. So, our D&O business, I think, was flat rather than being down as maybe some others.

So, when you look at — and we had various Specialty Casualty lines that continue to get double-digit increases. And as I mentioned to Charlie, a couple of smaller unique lines where we’re continuing to get decent increases.

So, yes, I am a little bit surprised. In the second quarter we did achieve eight percent, but we had pretty good discipline.

So it sounds like the business mix is pretty unique, so it’s not, I guess, too shocking, but the next question on capital, and this is a question that I probably would not have even thought about asking you guys a couple of years ago, but you’ve been in de-leveraging mode. You’ve made a lot of progress there. Obviously, you have the gain from the bank sale as well coming. Top line growth was slow next year, do you find yourself thinking about what do you do with excess capital a year out?

Carl H. Lindner, III: Well, I do think we are in a little bit different position. Again, we continue to believe that we have an opportunity to continue to have healthy growth within the businesses. We also are continuing to use this quota share facility on the short-tailed Property lines to a certain extent. Next year we have an opportunity, if we want to, to not go forward with that, which is probably $40–$50 million in premiums just on its own.

We still feel like our opportunities are pretty good for growth, so we wouldn’t see ourselves in an excess capital position necessarily based off of those opportunities.

I think the other point, Jay, just to be clear, we will recognize the $130 million gain on Provident, but in terms of capital, that capital is already embedded in the operating companies because they’ve been on a mark-to-market basis as time has gone by.

Good point, OK. That’s great! Thanks for the answer; that’s helpful.

Again, that is star, followed by one, for any questions. You have no questions at this time.

Carl H. Lindner, III: OK. If that’s all the questions we appreciate your joining us today and we look forward to reporting our third-quarter results. Have a good day.

Ladies and Gentlemen, thank you for your participation in today’s conference. This concludes the presentation. You may now disconnect. Good day!