American Financial Group Inc (AFG) 2006 Q3 法說會逐字稿

Good day, ladies and gentlemen, and welcome to the American Financial Group 2006 Third Quarter Earnings Conference Call. [OPERATOR INSTRUCTIONS] I would now like to turn the call over to the Senior Vice President, Mr. Keith Jensen. Please proceed, sir.

Thank you. Good morning and welcome to American Financial Group's 2006 Third Quarter earnings results conference call. If you are viewing the webcast from our website 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. They're 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, the Quarterly Report on Form 10-Q.

We do not undertake 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 non-recurring 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 reconciliation of net earnings to core net operating earnings is included in our earnings release.

Now I'm pleased to turn the remainder of the call over to Carl Lindner III, Co-Chief Executive Officer of American Financial Group, to discuss our results.

Good morning and thank you for joining us. Please turn to Slide 3 of the webcast. Yesterday afternoon, we released the 2006 third quarter results for American Financial Group as well as for our 81% owned subsidiary Great American Financial Resources. Our overall results for the quarter and through the first nine months of the year are excellent.

I'd like to review a few highlights. Net earnings for the 2006 third quarter were $1.16 per share versus a $0.34 per share loss in the 2005 third quarter which reflected the effects of an A&E charge and losses from hurricanes. We again achieved record core net operating earnings per share of $1.19 in the third quarter, 42% higher than the 2005 period. This significant increase was driven by significantly higher underwriting profits in the specialty property, and casualty operations and higher investment income.

Our balance sheet and liquidity remains strong. At the end of 2006 third quarter, we had over $300 million of excess capital. Now, we consider excess capital to be parent company cash on hand plus the amount of dividends which may be paid by insurance subsidiaries to the parent and still remain above our capital commitments to rating agencies and borrowings we can incur while staying below our 25% debt to capital target.

Our debt to capital ratio was 23%. Shareholders' equity, excluding unrealized gains and losses on fixed maturities, was up 14% from year-end 2005 and our book value per share was $35.28 versus $31.28 at year-end 2005.

Turning to Slide 5, let's cover some third quarter highlights of the Specialty Property and Casualty group. As I indicated in our second quarter call, we expected our net written premium growth rate to be high single to low double-digit in the last six months of 2006. Net written premiums in the 2006 third quarter were 11% higher than in the same period a year earlier and our gross written premiums grew 13%. Growth in the Property and Transportation group and Specialty Casualty groups more than offset the California Workers' Comp premium decline resulting from significant rate decreases.

Our overall average rates were down about 2% from the prior year period; however, if you exclude the effect of the California Workers' Comp rate decreases, average rate levels were up about a percent. Specialty Property and Casualty operations achieved record underwriting profit of $82.2 million in the 2006 third quarter, up 91% compared to the 2005 third quarter. The 2006 quarter was not affected by any catastrophe losses whereas the same quarter last year included about $40 million of hurricane losses.

The 2006 third quarter results also benefited from about $28 million or 3.8 points of favorable loss reserve development compared to $15 million or 2.3 points in the 2005 period. The 2006 favorable development was primarily in our Specialty Casualty and California Workers' Comp groups. Through the first nine months of 2006, underwriting profit of the Specialty operations is up 56% compared to the same period last year with a 3.7 point improvement in the combined ratio. These results reflect the impact of our premium growth, rate adequacy in most of our businesses, lower catastrophe losses and favorable reserve development of about $51 million.

Now I'd like to review the results for each of our Specialty business groups on Slides 5 and 6. The Property and Transportation group has continued its trend of excellent growth and profitability through the third quarter of 2006. Net written premiums for the three and nine month periods were 14% above each of the same 2005 periods. The premium growth was driven by new business volume in the inland marine operations and additional crop premiums resulting from the 2005 acquisition of Farmers Crop Insurance Alliance. Rates remained stable during the quarter for these businesses with an average increase for the group of approximately 2% through the 2006 third quarter.

This group's 2006 third quarter combined ratio was 10.7 points better than the same period a year earlier primarily due to the absence of any hurricane losses. The group absorbed about $29 million of losses from Hurricanes Katrina and Rita in the third quarter last year. The group also benefited from solid underwriting profit recorded within the crop insurance operations for the 2006 accident year. While there have been some severe drought conditions reported in the western part of the country, our crop business is concentrated east of the Mississippi where conditions have been more favorable.

We believe we're on track for normal crop season. Through the first nine months of 2006, the overall group's combined ratio is 4 points better than in the 2005 period, reflecting lower catastrophe losses and higher favorable year the reserve development, primarily in the crop operations during the first half of the year.

Our Specialty Casualty Group has experienced significant improvement in its underwriting profitability and solid premium growth through the first nine months of the year. Its combined ratio for the 2006 third quarter was 10.7 points better than the 2005 third quarter, partly resulting from 4.8 points of favorable prior year reserve development.

The 2005 third quarter included 1.4 points of unfavorable reserve development. Through the first nine months of the year, the combined ratio is improved 8.6 points reflecting better results in all businesses in this group and 2.1 points of favorable reserve development. The results for the 2005 period were impacted by 4.5 points of unfavorable development primarily in the executive and professional liability operations. Net written premium growth for the 2006 third quarter in the nine month period was driven by volume growth and higher premium retention at several businesses.

We also restructured the specialized program business, re-insurance program, from quota share to a combination of quota share in excess of loss all effective September 1. As a result of the program business restructure, re-insurers returned approximately $26 million in premium to us. Rates remain stable in this group with an overall average rate increase of 1% through the first nine months of the year.

Specialty Financial Group reported an underwriting loss for the 2006 third quarter resulting from worse than expected results in the automobile residual value business that's in run-off. The RVI losses reflected a decrease in used car sales prices for luxury cars and SUVs. Excluding the effect of the RVI business, the combined ratio is 88%. All other businesses in this group generated underwriting profits. The group's combined ratio for the nine month period in '06 was comparable to the 2005 period. The increase in net written premiums continues to be driven largely by the surety and financial institutions operations. Rates in this group were down about 2% through the first nine months of the year compared to the same period last year, primarily due to lower pricing in the trade credit operations.

Now, our California Workers' Comp business has continued to produce outstanding profitability for the first nine months of the year with a combined ratio of 75.7, comparable to the 2005 nine month period. The 2006 results have continued to benefit from favorable prior year reserve development, reflecting the positive effects of reform over the last several years. The 2006 nine month period includes nearly $17 million of favorable development versus $13 million in the 2005 period.

We continue to monitor the impacts of changes in the California Workers' Comp environment; however, due to the long tail nature of this business, we'll continue to be conservative in our reserving until a higher percentage of claims have been paid and the full impact of reforms can be determined. The California Workers' Comp reform legislation has lowered workers' compensation costs, thus benefiting employers, been impacting premium levels. Net written premiums declined 22% and 17% for the 2006 three and nine month periods compared to same prior year periods, reflecting the effect of the lower rates somewhat offset by new volume growth.

Our average rate decrease in California through the first nine months of 2006 is approximately 34%. Republic Indemnity, our California Workers' Comp subsidiary, filed for an 11.2% rate decrease effective June 30, 2006. We believe that reduction was appropriate given consideration to the bureaus industry trends and our claims experience and book of business. Republic expects to file a 6.3% decrease effective for policies beginning or renewing on or after December 31, 2006, as recommended by the WCIRB. The effect of these 2006 filed rate changes should result in an overall rate decrease of approximately 14% in 2007 compared to 2006.

Now let's review our annuity and supplemental insurance group managed by Great American Financial Resources as shown on Slide 7. Statutory premiums for the 2006 third quarter were nearly double those in the 2005 third quarter, reflecting significantly higher fixed indexed annuity premiums. We reentered that market in the second quarter of 2005 and have experienced significant growth since then. Excluding the effect of $100 million of fixed annuities transferred to us in the first quarter of 2005 from policyholders of an unaffiliated company in rehab, premiums were up 55% for the first nine months of this year compared to the same prior year period due to higher fixed indexed annuity sales as well as increased 403 B annuities.

Core net operating earnings from continuing operations for the 2006 three and nine months period as reported in Great American Financial Resources Earnings Release were 30% and 24% above the comparable prior year periods. The increase for the quarter reflects improved results in each of the group's continuing lines of business, including the results from recent acquisitions and earnings from proceeds received in connection with the sale of a Puerto Rican sub. The year-to-date earnings increase is due to improvements in the fixed annuity operations resulting from a recent acquisition and higher real estate income, higher earnings in the run-off life operations resulting from an improvement in mortality experience and lower expenses in that operation, plus the earnings from proceeds received in connection with the sale of the Puerto Rican sub.

These increases more than offset an earnings decrease in the supplemental insurance operations that occurred in the first half of the year. As previously announced, Great American Financial Resources completed the acquisition of the Cirrus Group in August. We believe this is an excellent strategic fit for our supplemental health businesses and positions us as a leading player in the Medicare Supplement market.

Now, on Slides 8 and 9, I'd like to highlight some key aspects of our strategic focus and our outlook for the remainder of this year and in 2007. Our operational focus on specialty niche markets within the Property and Casualty, annuity and supplemental insurance industries will continue. Over the last year or so, we have completed several acquisitions and continue to look for additional opportunities that support this strategy. We're also pursuing internal growth opportunities for our existing Specialty Insurance businesses, in particular within the Transportation and inland marine operations and for annuity operations.

We remain committed to our strong underwriting culture and pricing discipline and continually monitor the adequacy of our rates in all of our markets. Our investment group targets achieving investment returns that will continue to out perform the market. Our long-term objective is to achieve returns on equity between 12 and 15% along with consistent growth and book value. We plan on maintaining our strong balance sheet with a debt to capital ratio of 25% or below.

For the fourth quarter of 2006, we estimate an after-tax gain of $29 million from the sale of certain New York assets. We expect high single to low double-digit growth and net written premiums and higher underwriting profits in our Specialty Property and Casualty operations than we recorded in the 2005 fourth quarter. Double-digit premium growth and excellent underwriting margins in our Property and Transportation businesses are expected to continue, including solid profitability in our crop insurance operations.

We expect the Specialty Casualty group's underwriting margins to remain strong with a moderate increase in premiums. As a result of the continuing significant rate reductions, we expect California Workers' Comp premiums to decline in excess of 20% year-over-year. We believe this business's combined ratio will be comparable to or less than the combined ratio through the 2006 nine month period. During the fourth quarter, we will complete our semi-annual review of the RVI element loss. Any effect of this review will be recorded in that quarter.

We expect the underwriting margins of the non-RVI Specialty Financial Group to remain strong. And in their separate earnings release yesterday, Great American Financial Resources announced that its 2006 core net operating earnings are expected to be between $1.58 and $1.62 per share which translates into a contribution to AFG's core net operating earnings of between $0.77 and $0.79 a share. We expect continued premium growth from indexed annuities and supplemental insurance as well as solid operating earnings within the annuity supplemental insurance and run-off flight operations. We've been pleased that throughout 2006 our operating results have repeatedly been stronger than our expectations. We now expect AFG's 2006 core operating earnings to be between $4.65 and $4.75 per share, at or above the upper end of our previous guidance.

Looking to 2007, we're enthusiastic about the upcoming year. We expect mid-single digit growth in net written premiums and a continuation of the strong underwriting profits in the Specialty operations. Our Property and Transportation premiums are expected to continue to grow at a high single to low double-digit rate. These businesses should maintain excellent underwriting margins. Specialty Casualty premiums are expected to be flat to slightly up in 2007 with healthy underwriting margins.

California Workers' Comp premiums are likely to decline around 10% compared to 2006 as rate reductions are moderating somewhat. While the combined ratio is expected to increase, we still expect it to be in the mid 80s or below. Specialty Financial Group's premiums should grow modestly. Depending on the used car market, we could experience some additional losses in our RVI business; however, we expect the group to achieve an underwriting profit. The number of cars with expiring leases will continue to decline as 2007 is the last year with a significant numbers of vehicles and loss contracts coming off lease.

Great American Financial Resources also announced in yesterday's earnings release that its 2007 core net operating earnings are expected to be between $1.60 and $1.70 per share. This would contribute between $0.78 and $0.83 per share to AFG's core net operating earnings. We expect to continue to introduce new products within our annuity and supplemental products group which should provide additional premium growth.

Finally, we've announced that we're targeting AFG 2007 core net operating earnings to be between $4.85 and $5.15 per share. These expected results exclude the potential for extraordinary catastrophe and crop losses, adjustments to A&E reserves or large real estate gains and that basically assumes a range of 4 to 7% growth in net written premium, stable combined ratio, a 4 to 6% increase in Property and Casualty investment income, and the high end of the range assumes some excess capital being put to work for some part of the year. Now we would like to open the lines for any questions. Thank you.

[OPERATOR INSTRUCTIONS] And your first question comes from the line of Charles Gates with Credit Suisse. Please proceed.

Hi. Congratulations on a tremendous quarter. Nice going! I guess my first question, could you elaborate on competition both in Property and Transportation in the Specialty Casualty units?

Yes, hi, Charlie. This is Carl. All of our Markets remain pretty competitive, and so we look at our pricing, I'm pleased with our third quarter and nine months pricing, again, excluding California comp, our renewal pricing is up about a percent. Property and Transportation, our pricing is up a couple percent which is pretty solid, probably includes some impact , though we for what's been going on with Property rates on the coast and that, we're not as exposed as much as other companies, so I think in the Specialty Casualty area, probably the biggest impact competitively is we're seeing business move away from our excess and surplus lines Company back to primary Markets and we're seeing probably the umbrella business is probably a bit more price competitive than some of our other businesses. Any large Casualty accounts throughout our Specialty Casualty Area generally draw more attention also. Definitely in our Markets are more attention also. Definitely in our Markets are very competitive in both those areas and so we're pleased with where our pricing is right now.

My second question, is there with this planned sale Real Estate, the $29 million, is there any way you can help us with the scope or size of the off balance sheet Real Estate asset that remain?

Sure. I'd be happy to do that, Charlie. This is Keith. As we've talked about in previous releases, we really have a couple of major areas of off balance sheet unrealized gains, one is in the apartment and resort hotel businesses and other is in some in undeveloped property if we take those together on a pretax basis, the unrealized gain we estimate is between 100 and $140 million at this point.

That's supposed to stay with the $29 million?

That's correct, Charlie.

Okay and then my final question at this time would be, I believe Mr. Winger made reference to a fourth quarter review of reserves for this year residual value business. Is that something you should worry about or could you elaborate on that?

Sure. This is something that we have done routinely on a semi- annual basis, Charlie, where we really look at what the ultimate expected outcomes are given what the current pricing in the market is. We don't expect it to be a huge number, but it's something where there's some uncertainty and so we're going to take a look at it during the fourth quarter but we've reflected in our guidance what our expectation is with respect to the outcome of that study.

Thank you.

Gentlemen, your next question comes from the line of John Gwynn with Morgan Keegan. Please proceed.

Keith, on the Farmer's Crop Alliance acquisition, are we at the point where you can give us a net cost of that acquisition?

We're not, John. The way that that acquisition works, We're not, John. The way that that acquisition works, there was a fixed amount at the date of close and then there's a two year look back period and so at the end of two years which is still almost another year away at this point, we'll look back and look at premium retention and at that point, make the final pay out.

Okay. And Keith, your tax rate for the quarter was elevated a bit relative to the prior two quarters. Is there any guidance there?

I think I looked at that again this morning, John, and tax rates are running about, they've run between 37 to 38%. We were up about half a percent on that calculation. I think that range is probably a reasonable range.

Okay. And the manufacturing environmental exposures in Gaffry that you all mention is a risk factor in some of your files, is that reviewed on an annual or quarterly basis and is a review under way now?

We absolutely look at it on a quarterly basis. We close the books and if there was something unusual, we would deal with that. Our plan is to look at that exposure along with our other asbestos and environmental exposures as we announced in 2007.

Okay. And Carl, asbestos has been an issue for you all historically as it is with any Company that's been around very long. Do you take any special comfort in [berkshire's] transaction with [Equitoss] assuming that's a real deal?

Well, we don't have loads of exposure. We don't have much exposure to[Equitoss] from a recoverable standpoint, so Keith, I don't think it really impacts --

No, I guess where I was coming from was someone must have some positive outlooks on asbestos to do a transaction like that.

Sure. I think that has to reflect long term or short-term perspective about the asbestos, if you --

Okay, thanks.

As a reminder please press star one to place a question. And your next question comes from the line of Dan Baransky of Fox-Pitt Kelton.

Just have some questions on the quarter. Just curious what percent of your book to business would you categorize as excess in surplus today? Hello?

Yes, we're here.

Okay.

Just give me a minute and I'll get an estimate for you on that. Do you have a second question?

Yes, sorry. The financial institution business you do in your Casualty book, I guess, where is the focus predominantly? Is this sort of large fortune 1,000-type Company? If you could give me the flavor of what that book to business is.

Hold on just one second here, Dan. Dan, going to your first question, about 15% of the gross written would be excess in surplus.

Okay, thanks.

Okay do you want to do the second one again?

Of your financial institutions business, I Guess what's the sort of predominant risk you're writing in there? Is it fortune 1,000-type companies zero r is it smaller companies, just if you could give me a sense of that?

Well, the financial institutions business is actually, at least as we term if we're talking the same thing, is a business where we provide collateral protection or mortgage protection insurance for institutions against their lending or leasing, and they would tend to be middle market-type institutions by and large.

Okay. Your '07 EPS guidance, what's sort of, I guess, how do you think about the Crop book of business within that in your cat load? Is it sort of a normalized run rate?

Yes. In our estimations, Dan, we do a normalized run rate for both Crop and cats. We don't assume a zero for cats and we don't assume record years for Crop. We're trying to take something that if we look over a period of years would be a more normalized run rate.

And it reflects kind of normal swings, year to year. I think as I said earlier, wouldn't reflect a major drought year where there would be a significant swing.

And I guess if we think of the last two years in the Crop book to business which appeared to perform fairly well, would you turn to past years as above average for the Crop business?

I don't think at this point we're prepared to fine on the 2006 Crop year but if you look at 2004 and 2005, I think we've indicated previously both of those were above an average run rate.

Okay. The change to the reinsurance buying and the Casualty segment, that was effective September 1 of this year you said?

Yes.

And is there any sense, I guess, from the changes of sort of what your retention is going to? I guess maybe the retention for the entire segment, what we can think about, the net retention and I guess on individual risk basis, has there been any sort of change you can quantify there?

Well, I think in our comments about 2007 with premiums being up modestly reflect the impact of that particular change and that particular part of our business, and we'll definitely, there will be an annualized benefit from the decision we made on that particular part of our business that will positively impact next year, even with that, with competition where it is, we don't see that business growing much more than a little bit.

Okay. So I guess to kind of circle back on my original question then, would this 65% retention ratio, you see that kind of going higher or lower? How should we think about that retention ratio in the quarter for that segment?

Probably higher.

Higher? All right sorry, just writing this down. So the other thing I had was if we think of the Property growth in the quarter and we sort of were to back off the Crop business, do you have a sense of what the other books of business grew like in the quarter?

I'm just looking for that, Dan.

Okay.

Back off Crop, this growth was -- the other businesses would have grown probably in the mid single-digits.

On a gross basis?

On a gross basis.

And I guess the last one I had was in your California Workers Comp business, I just have two questions. One, how does the I guess the recent proposed change of nine something percent out there, how does that play in with your 6.3% rate decrease and --

Well there's always a difference of opinion between the WCIRB somewhat and the commissioner and generally the commissioner always wants a bigger decrease than what the WCIRB does, so ours reflects the WCIRB and where we think we should be.

And I guess what's the we think we should be. And I guess what's the -- how much sway does a commissioner have on what you ultimately charge?

I don't think we're going to have a problem with what we're filing.

Okay.

Again, we've reflected changes in our pricing and as our loss costs have benefited pretty steadily over the past two or three years, when you look at the decreases we've taken, I don't think we have very much risk at all in those rates not being accepted.

I'm sorry to monopolize the call I just have two last quick questions. One, the reserve leases in California Workers Comp, do you have any sense what accent those years were for and to me the 16 million seems a little bit high just in the previous quarters you've mentioned that you weren't going to be too aggressive I guess in taking credit for that line too soon given the long tail nature in this kind of curious how the 16 million fits in with that viewpoint and then I just have one last question.

Dan, I don't have the details here with me but it clearly spread more than one year back. I think it went back over the last two or three years.

The 16? So more earlier years than prior?

I don't have that with me but that's my recollection if that helps you.

Okay, and then the last question I have, do you have any sort of metrics you can give us about this RVI business, maybe perhaps like the number of autos that were insured before and the number you still have insured on your lap book or just some sort of sense of what's left versus what there was before and I guess you did give us some sort of light guidance for '07 and what you expect but anything else you can add there?

I don't have vehicle details with me but I would just say that we used to have four major accounts. Three of those are at a point now where either they are completely run-off in terms of what they're developing. There's one account that is a source of the development that we're experiencing right now.

Okay. Great. Thanks, I'll let other people ask questions. Thank you.

At this time there are no more questions in queue. I would like to turn the call over to Mr. Keith Jensen for closing remarks. Please proceed, sir.

Thank you. We appreciate your spending the time with us this morning and we'll look forward to reporting to you at year-end. Thank you once again. Goodbye.

Thank you for attending today's conference. This concludes the presentation. You may now disconnect and have a great day.