American Financial Group Inc (AFG) 2006 Q1 法說會逐字稿

Good day, ladies and gentlemen. Thank you for standing by and welcome to the American Financial Group Q1 2006 earnings conference call. My name is Carlo, and I will be your coordinator for today's presentation. At this time, all our participants are in listen-only mode. We will be facilitating a question and answer session towards the end of today's prepared remarks. [OPERATOR INSTRUCTIONS].

I would now like to turn the presentation over to your host for today's conference, Keith Jensen, Senior Vice President. Please proceed sir.

Thank you. Good morning and welcome to American Financial Group's 2006 first quarter earnings results conference call. I'm joined by Carl Linder III and Craig Linder, the co-CEOs of American Financial Group. If you're viewing the Webcast from our Website, you can follow along with the slide presentation if you'd like.

I'd like to make you aware that the press release that was issued yesterday was incorrectly picked up by PR Newswire last night. They omitted one line in the first paragraph. That correction was made this morning at 10:00. So if you have a earnings release that you picked up before 10:00, there is a correction. The corrected sentence will read, or does read "The increased results from higher earnings from the Company's insurance operations and net realized gains on investments versus net realized losses in the 2005 period."

Certain statements made during this call are not historical facts and may be considered forward-looking statements, that 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 10-K, and quarterly report 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.

Core net operating earnings is a non-GAAP financial measure, which sets 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 nonrecurring items. AFG believes it to be a useful tool for investors and analysts in analyzing ongoing operating trends. As such, core net operating earnings for various periods will be discussed during this call, including the results of Great American Financial Resources, our 81% owned subsidiary listed on the New York Stock Exchange. A a reconciliation of net earnings to core net operating earnings is included in our earnings release.

Now I'm pleased to turn the time over to Carl Linder III, co-Chief Executive Officer of American Financial Group.

Good morning and thank you for joining us. Please turn to slide 3 of the Webcast.

We released the 2006 first quarter results for American Financial Group, as well as for our 81% owned subsidiary Great American Financial Resources yesterday afternoon. These results were excellent getting us off to a great start towards meeting our objectives for the year. Let me cover a few of the highlights.

Net earnings were 61% higher than in the 2005 first quarter, due primarily to higher insurance operating earnings, and a $15 million after-tax gain from the previously announced sale of our investment in the Cincinnati Reds. Core net operating earnings of $1.08 per share were up $0.18 compared to the same period a year earlier, largely due to continuing strong underwriting margins in the specialty property and casualty operations. We did meet our leverage objective at the end of the first quarter, and our liquidity remains very strong.

We repurchased $78 million of long-term debt, our debt to capital ratio was below 25%. We held $121 million of parent company cash and investments at the end of the quarter. And we replaced American Financial Group's credit line, as well as Great American Financial Resource's credit line, with a new combined $500 million, 5-year line of credit with more favorable terms.

Last week, we announced our agreement to sell the Chatham Bars Inn on Cape Cod for $166 million. We expect the sale to close during the second quarter, and we anticipate recognizing an after-tax gain of 27 to $29 million, or $0.34 to $0.36 per share. We believe that this transaction is an example of our expertise in acquiring selective properties, managing them profitably, and disposing of them as opportunities arise.

Turning to slide 4, let's talk about the 2006 property and casualty Specialty group. Gross and net written premiums in the 2006 first quarter were 5% higher than in the same period a year earlier. The increase was due primarily to strong growth in the property and transportation group. Partly offset by the expected decline in the California Workers' Compensation business resulting from ongoing rate decreases.

Overall rates in the 2006 first quarter were down about 2% from the prior year period. However, if you exclude the effect of our California Workers' Comp business, the average rate levels were actually up about 2%. The underwriting profit of the Specialty Property and Casualty operations in the 2006 first quarter were $26.5 million higher than in the same period a year ago. The combined ratio improved 4 points to 88.

The 2006 results included about $13 million, or 2.2 points of catastrophe losses, principally from severe storms in the Midwest. The same period in 2005 included about $2 million from cat losses, less than 0.5 point on the combined ratio. The 2006 results also benefited from about $10 million of favorable reserve development, compared to $10 million of unfavorable development in the 2005 period. Our combined this quarter was the best combined ratio reported by our Property and Casualty insurance segment in AFG's history, which we're proud of.

Now I'd like to review the first quarter results for each of our Specialty business groups on slide 5. The Property & Transportation group continued its strong growth and profitability trends in the 2006 first quarter. Net written premiums increased 14% above the 2005 first quarter. New premium volume resulting from the recent acquisition of Farmer's Crop Insurance Alliance contributed to the growth.

We retained about 40% of the Farmers' business renewals, for the states where we want to grow. It was a little bit lower than what we'd hoped, but it's well above the threshold for a double digit return on our investment. The crop premium growth also reflected higher commodity prices used to establish crop insurance coverages than in the 2005 first quarter.

The Inland Marine operation also experienced solid premium growth. Rate increases for these businesses averaged about 2%, being up 2% in the 2006 first quarter.

The Property & Transportation group's Combined Ratio of 79 improved 3.8 points compared to the same period a year earlier. This group in particular, the crop insurance operations, experienced favorable reserve development, which offset losses from the Midwest storms. The transportation, marine, and equine operations also generated outstanding underwriting profits.

Effective this month, we decided to discontinue writing earthquake-exposed excess property business produced by our Inland Marine group, and a division of ours in California. We concluded that the business no longer fit with our overall risk strategy. By doing this, we'll substantially reduce our correlated Property and Workers' Comp quake exposure that the Company has, and we feel that it's a good move.

Our Specialty Casualty group experienced solid growth and underwriting profitability in the 2006 first quarter, compared to the same period a year earlier. Net written premiums were 9% higher than in the 2005 period, driven primarily by volume growth, as well as greater premium retention in executive liability, and excess in surplus lines business. This group's overall average rate was about 2% higher than in the 2005 first quarter. It's Combined Ratio improved 4.1 points to 92.3, reflecting much lower unfavorable reserve development in the executive liability operations, and continuing strong underwriting profitability in the excess and surplus and targeted markets lines.

Specialty Financial group reported a small underwriting profit in the 2006 first quarter. The 5.2 point Combined Ratio improvement primarily reflects improved results in the residual value business. As announced last quarter, we will discontinue writing this business this year.

Our fidelity and crime, trade credit, and financial institutions businesses continue to generate excellent underwriting profits. The decline in net written premiums reflects an increase in premiums ceded under residual value reinsurance agreements. Rates in this group were about the same as in the 2005 first quarter.

Our California Workers' Comp business continues to report very strong profitability, but as indicated earlier, gross and net written premiums declined significantly as a result of ongoing rate reductions. Even though the combined ratio for the California's Workers' Comp business in the 2006 first quarter was about a point better than in the 2005 first quarter, underwriting profit was slightly lower, reflecting the effect of lower earned premiums. We expect that the California Workers' Comp current accident year underwriting margins will decrease during the remainder of the year, as a result of the rate reductions, but are still expected to be at very good levels.

Rate decreases in California averaged about 36% during the 2006 first quarter, reflecting the positive effect of reform legislation in reducing the cost of Workers' Comp for employers. Workers' Comp is a long tail business, which normally increased the uncertainty about the ultimate claims severity.

In California, the uncertainty is heightened due to recent reforms in proposed legislation. As a result, we believe it's appropriate to be somewhat conservative on our reserving, until more claims have been paid, and there's more certainty about the ultimate impact of reform.

Now let's review our Annuity and Supplemental Insurance group, managed by Great American Financial Resources as shown on slide 6. Statutory premiums for the 2006 first quarter were about 12% below the 2005 first quarter. The 2005 premiums included approximately $100 million of fixed annuities from policy holders of an unaffiliated company, and a rehabilitation, who chose to transfer their funds to us. Excluding that affect, the 2006 first quarter premiums were actually up 25% over the 2005 period, due primarily to reentering the indexed annuity market, and increased premiums in the 403-B Fixed Annuity line.

Core Net operating earnings from continuing operations from the 2006 first quarter as reported in Great American Financial Resource's earnings release, were 28% above the comparable prior year period, reflecting improvement in the fixed annuity and life operations, as well as the investment of dividends and proceeds, related to the sale of the Puerto Rican sub.

As previously announced, Great American Financial Resources has a definitive agreement to sell Chatham Bars Inn in Cape Cod. The sale will provide additional capital to be utilized to grow our Annuity and Supplemental Insurance lines, organically or through acquisitions. At the end of the first quarter, Great American Financial Resources had more than $200 million of excess capital.

Now I'd like to summarize some key aspects of our strategic focus and outlook on slide 7. Our operations were remained focus on specialty markets within the Property & Casualty, Annuity and Supplemental Insurance industries, where we have significant expertise, and can continue to build franchise value.

A significant objective is the appropriate use of our excess capital. We'll pursue several potential courses of action. We'll continue to seek acquisition and start-up opportunities that follow our strategy of being a specialty insurance player, with an emphasis on opportunities in the Annuity and Supplemental health area. We'll also pursue internal growth opportunities for our existing Specialty insurance businesses, with emphasis on our Transportation and Inland Marine operations. We'll continue or we'll consider opportunistic share repurchases, also.

Our goal is to grow profitably. We will remain committed to our strong underwriting culture, and pricing discipline, and continually monitor the adequacy of our rates in all markets. We'll reduce business volumes in lines as needed to achieve appropriate returns. We'll focus on achieving investment returns that outperform the market. Now for the remainder of '06, we expect growth and net written premiums of 5 to 7%, and a continuation of strong underwriting profits in our Specialty and Property & Casualty operations.

Our Property & Transportation businesses are expected to experience substantial net written premium growth, resulting from the Farmer's acquisition, coupled with growth in the Transportation and Inland Marine operations. This group should also maintain excellent underwriting margins. Specialty and Casualty groups underwriting margins should remain stable, with a modest increase in premiums. California Workers' Comp premiums will decline about 15%, as a result of the significant rate reductions, and we expect a calendar year Combined Ratio for the year of around 80%.

We expect to make an underwriting profit in the Specialty Financial group, and that it's gross premiums should grow moderately. In our Annuity and Supplemental Insurance group, we expect premium growth and continued diversification. We plan to further penetrate the indexed Annuity market, as well as introduce several new products during the balance of 2006. We also expect continued favorable core net operating earnings.

As I mentioned earlier, we expect to record a sizable gain from the sale of Chatham Bars Inn in the 2006 second quarter. As a result of our higher than expected first quarter earnings, we've increased our 2006 core operating earnings guidance for AFG to between $4.00 and $4.30 per share. We plan to maintain our strong balance sheet with a debt to capital ratio of 25% or below. Our long-term objective is to achieve returns on equity between 12 and 15% with consistent growth in book value.

Now we'd like to open the lines for any questions. Thank you.

Thank you, sir. Ladies and gentlemen, [OPERATOR INSTRUCTIONS] One moment, please. Sir, our first question is from the line of Charlie Gates with Credit Suisse.

Good morning.

Hi, Charlie.

I had three questions. My first question, you didn't utilize the [CEDA] during the first quarter, did you?

No, we did not.

Okay, that was my first question. My second question, other than California Workers' Comp, could you elaborate on the competitive environment in your major Property Casualty markets?

Sure. This is Carl. Let me start out by saying that I'm pleased with our first quarter pricing. As I mentioned before excluding California Comp, our pricing was up about 2%. So that's a good start.

And overall, I'd expect our pricing to be stable outside of California Comp, probably during the year. In all of our businesses, I'd say that the market is competitive. But I think with the storm losses that everybody took this past year, I sense, I would say that it's competitive but stable, with the main pricing pressures that I'd see have been really more in some of the non catastrophe-exposed property areas.

And in excess D&O, but our overall D&O pricing was really pretty stable this quarter. So I guess I'd categorize our pricing, and what I've seen in the marketplace, is pretty stable, but with selected decreases for different businesses.

My final question, maybe I misunderstood this, but the monies received for the sale of the hotel, the Chatham Bars Inn are going to basically be focused on life insurance Annuity acquisitions?

Charlie, that hotel is owned by Great American Financial Resources, so what you just said is correct.

Could you elaborate on what types of acquisitions those might entail?

Charlie, we'd love to grow in each of the lines of business that we're in today. That would be our focus.

Now, some of the monies basically, though, that I thought there was also another strategy there. And I thought the other strategy was taking some of the money basically from the sale of real estate, and putting it into other real estate?

We are doing that.

Okay.

We're investing in new real estate opportunities.

Well, congratulations on your sale. And congratulations on a great quarter.

Thanks.

And sir, we have a question from the line of Jay Cohen with Merrill Lynch.

Good morning, I've got a number of questions. The first is, can you quantify, I guess, the quake-exposed property premiums in the business that you'll be exiting?

Sure.

Sure. On a gross basis, it would be about $75 million, on a net basis, it's about $18 million.

That was heavily reinsured, okay. Secondly, you mentioned in the outlook considering share repurchase, I don't remember you talking about that before. Is that something kind of new you're adding to your arsenal to manage the ROE?

I think when we were Webcast at your conference, I mentioned that that opportunistic share repurchases would be something that we might consider. Naturally, our priority was to get our debt to capital down to our target, which we've done now.

And the other priority was naturally investing in high-returning new start-ups or acquisitions within the Property & Casualty or Annuity and Supplemental. But I think that we've been saying that that's an option.

Historically, the company had a fairly high dividend yield, it was up maybe until the year 2000. What's the feeling about the dividend policy at this point?

I think we'll, each year we review it. And we'll take a look and review our dividend, probably at least annually.

And I think I'd, add, Jay, at the time you're referring to, our dividend yield was in the 4, 4.5% range, which as we looked at our industry sector, was well above what the norm is in the sector and I think we're more in line with that at this point.

Definitely. Next question. On the investment income, Property & Casualty investment income, was there anything unusual, meaning good returns in a particular portfolio, or should we look at that as a fairly normalized yield for the portfolio?

We did during this quarter, have probably a higher than usual rate of prepayments on securities, and so it was running a little bit higher than what I would expect on a normalized basis. If you excluded that effect, investment income would be up about 7% on the quarter.

Okay. And then one more question, and this is it, I promise. When you were talking initially, Carl, about the Workers' Comp business in California, I thought I heard you say the Combined Ratio would deteriorate.

And I assume you meant from the first quarter through the balance of the year, but that sort of 80% guidance you just gave for the full year, suggests an improvement from the first quarter. I must have misread or misheard the first comment?

No, I think I was referring to accident year. Naturally you've got, we have our accident year results are very solid, but as we have rate decreases that are being taken this year, this year's current accident year will move up some. At the same time, they should still continue to be at excellent levels. And I think that ties in also with my comment on calendar year Combined Ratio.

That was the 80%, calendar year? The full year?

Yes.

Okay. Great. Thanks.

Sir, our next question is from the line of John Gwynn, Morgan Keegan.

Good morning. I've got a couple of quickies for Farmer Jensen. Keith, in the crop insurance book, obviously there's been some recent publicity about a predicted drought in the Midwest. I've not followed crop very closely historically, but I don't know if that comes up every year this time of the year, or if that's something new this year. Would you care to make your own prediction on that?

My crystal ball isn't so perfect that I can predict weather, we're obviously very early in the year. The planting season is just beginning, and so it would be premature to forecast what we think the weather is going to look like.

But for that reason, John, we do not recognize profits on the accident year early in the year. We really wait until the third and fourth quarter when we have a better fix on what will happen, and what the pricing is likely to be.

John, this is Carl. And in fact, part of the favorable development from crop from last year, this year, the Illinois situation didn't turn out to be as bad as what we thought. And once all the claims were settled and that the counties that were hit hardest didn't happen to be counties that we thought that we were as heavily involved in. So it is a business where you need to wait until the claims are settled, and the year progresses. So a good, that's why a good geographic spread is so important in this business.

Right. As I understand it, in that business, you agree to cover the exposures before you collect the premium. Is that correct?

Yes.

And do you book it when you collect it?

We book it as it's written.

As it's written, but not collected?

The collection happens over a period of time. But it is basically all collected prior to the time that you really run any of the risk.

Okay and Keith, are you still increasing your retentions on that book?

On the crop, no. We've kept that fairly stable. It has two traunches of reinsurance, as you may remember, about 20 to 25% of the book is reinsured under a federal program that's part of the Department of Agriculture, and then we reinsure about 50% of the remainder with Munich Re, and that's consistent with what we were doing last year.

Okay. And on your long-term debt to capital calculation, how actually does that work? Is that just --?

We're using equity excluding unrealized gains on fixed maturity securities, because our belief is that fluctuates with market interest rates, and since it's in general our intent to hold to maturity, we don't think that's a relevant factor. So we take that as shareholders equity, plus minority interest, plus the debt, and then divide it into the debt.

Okay. And Craig, on GFR, the index annuities that you started ramping up this year, is that an equity product, or something else?

It is an equity product, John.

Is this something that you're competing with the likes of American Equity with?

Yes, we are. Although not all the products are like American Equity's products. Yes, we are competing against American Equity.

Okay.

They have more products than we do. We're being very careful to be compliant with the design of our products.

Right. I understand. Keith, one quick last question. When show you holding company cash and investments, does that include GAFRI's holding company?

It does not. The AFG 121 is AFG only. GAFRI, at the end of the quarter was another 70.

Okay. Great. Thanks a lot.

You're welcome.

And sir, we have a follow up question from the line of Charlie Gates.

The one follow up question, in the past, you've helped analysts and observers guesstimate what the value of the real estate is. Could you update that analysis with the sale of Chatham Bars?

The sure the components of the real estate holdings are similar to what we've described in the past, in that we have apartments and hotels that are cash flow producing. We have some undeveloped land, and we have New York City air rights. If you take all of those together, and exclude the Chatham Bars Inn, our estimate currently of pre-tax unrealized depreciation would be in the 165 to 225 range.

So the 165 to 225, that excludes the Chatham Bars Inn?

Correct.

Thank you.

Again, ladies and gentlemen, [OPERATOR INSTRUCTIONS] And sir, we have another question from the line of Jay Cohen.

Can you update as to your, the carrying value for GAFRI and national interstate?

Sure. National interstate, our carrying value is 7.65 a share, and our carrying value on GAFRI is 19.47 a share, and that's all in making no adjustment for unrealized gains or losses.

Great. Thank you very much.

And this concludes our question and answer portion of today's program. I'd like to turn it over to Mr. Jensen for any further comments.

Thank you very much. We appreciate you joining us and appreciate your continued support. And we will look forward to reporting to you at the end of the next quarter. Thank you.

Ladies and gentlemen, we thank you for your participation in today's conference. This concludes your presentation, and you may now disconnect.