American Financial Group Inc (AFG) 2007 Q1 法說會逐字稿

Good day, ladies and gentlemen, and welcome to the American Financial Group 2007 first quarter earnings conference call. My name is Cammy, and it will be my pleasure to be your coordinator today. (OPERATOR INSTRUCTIONS) 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. Please proceed, sir.

Thank you. Good morning. I'm here this morning with Carl Lindner III and Craig Lindner, Co-CEO's of American Financial Group. We're pleased to welcome you to American Financial Group's 2007 first quarter earnings results conference call. If you're 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 based on estimates, assumptions and projections which management believes are reasonable but by their nature subject to risk and uncertainty. 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 reports on Form 10-Q. We do not promise to update such forward-looking statements to reflect actual results or changes in assumptions, or in 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 realized net -- net realized gains or losses on investments, the effects of accounting changes, discontinued operations and certain non-recurring items. AFG believes it to be a useful tool for analysts and investors in analyzing our ongoing operating trends and 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.

It's my pleasure now to turn this call over to Carl Lindner III, Co-Chief Executive Officer of American Financial Group.

Good morning and thank you for joining us. Please turn to Slide Three of the webcast. We released the 2007 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 great start toward meeting our objectives for the year. Let me cover a few of the highlights.

Net earnings were $0.92 per share compared to $0.85 per share in the 2006 first quarter. The 2006 results included the effect also of a $15 million or $0.13 per share gain from the sale of our investment in the Cincinnati Reds last year. Our record core net operating earnings of $112 million, $0.91 per share, were up 29% over the same period a year earlier, largely due to continuing strong underwriting margins and higher investment income in the Specialty Property and Casualty operations. Our financial condition and liquidity remain very strong. Our book value per share of $25.50 was up 17% compared to the end of the 2006 first quarter. We had about $385 million of excess capital at the end of the quarter.

Now, turning to Slide Four, the record underwriting profit of the Specialty Property and Casualty operations in the 2007 first quarter of $103 million was 48% higher than in the same period a year ago. The combined ratio improved 4.2 points to 83.8. This is the best combined ratio reported by our Property and Casualty Insurance segment in AFG's history. The 2007 results benefited from lower catastrophe losses, favorable reserve development, and profitable premium growth. Gross written premiums in the 2007 first quarter were slightly below the same period a year earlier as premium declines in the California Workers Comp and Specialty Casualty groups more than offset growth in the Property and Transportation and Specialty Financial groups. However, net written premiums were 5% higher resulting from greater premiums retention in many of our business lines.

Excluding the effect of California Workers Comp, average rates and the other Specialty operations through the 2007 first quarter were down about 2% from the same prior period. Catastrophe losses in the 2007 period were $1 million compared to $13 million in the 2006 period, primarily from severe storms in the Midwest last year. The 2007 results included $54 million or 8.4 points of favorable reserve development, including a $13.5 million charge related to a business that was sold a number of years ago. The 2006 results included $11 million or two points of favorable development.

Now I'd like to review the first quarter results for each of our Specialty business groups on Slide Five. Property and Transportation group continued its strong profitability in the 2007 first quarter. This group's combined ratio of 83.1 was four points higher than in the same period a year earlier. The increase was primarily due to lower underwriting profit in the agriculture insurance operations, partly offset by lower catastrophe losses. Net written premiums increased 6% above the 2006 first quarter, driven by new insurance programs at National Interstate and higher business volume in the Great American's Inland Marine and Trucking operations. Average rate levels for these businesses in the 2007 quarter were about the same as the year earlier. Gross written premium growth rate was impacted by our decision to exit the earthquake-exposed excess property business in the early part of 2006. If you take, absent this change, gross written premiums grew approximately 8%.

Our Specialty Casualty group reported outstanding underwriting profitability in the 2007 first quarter of $59 million, a notable increase over the $15 million underwriting profit reported in the 2006 first quarter. These results were largely driven by performance in the excess and surplus line and our mid-continent subs, general liability operations, and approximately $41 million of favorable development. The group's combined ratio improved 20.3 points to 72%. Net written premiums were 7% higher than in the 2006 period due to primarily to lower premiums seated under reinsurance agreements within our specialized program business. Gross written premiums were 4% lower, however, resulting primarily from volume reductions in our ENS business, reflecting stronger competition in these commercial casualty markets. Even though several business lines incurred rate increases, this group's overall rate was about 2% lower than in the 2006 first quarter.

The Specialty Financial Group reported solid underwriting profitability in the 2007 first quarter. The 2.4 point combined ratio improvement primarily reflects better results in surety and fidelity and crime operations. The trade credit and financial institutions businesses also continued to generate excellent underwriting results. This group's combined ratio was impacted by the residual value business in run-off; however, this is the last year in which there are a meaningful number of cars with expiring leases. Excluding the RVI business, this group's combined ratio is about 89%. Gross and net written premiums for the 2007 first quarter were up 16% and 24%, respectively, over the same period last year. These increases were driven primarily by volume growth in our leasing and lending, financial institutions and surety operations. The net written premium growth rate benefited from greater premium retention in some of this business' -- this business group's business lines. Rates in this group were down about 2% in the 2007 first quarter.

Our California Workers Comp business again generated excellent profitability in the 2007 first quarter. Net written premiums, however, continued to be impacted by ongoing rate reductions. The combined ratio was 5.4 points better than in the 2006 first quarter and underwriting profit was 8% higher. The business continued to benefit from favorable prior year loss reserve development, reflecting the improving claims environment over the last several years. The 2007 period included $4.7 million or 7.5 points of favorable development compared to less than a million of unfavorable development in the 2006 period. 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 a full impact of the California reform legislation can be determined. Rate increases -- rate decreases in California averaged about 21% during the 2007 first quarter, reflecting the positive effect of the reforms in reducing the costs of workers compensation for employers. Our subsidiary, Republic Indemnity, filed for an additional 10 % rate reduction effective April 1, 2007. At these lower levels, we still expect to achieve healthy returns on this business.

Now, let's review our Annuity and Supplemental Insurance Group, managed by Great American Financial Resources, as shown on Slide Six. Statutory premiums for the 2007 first quarter were 63% above the 2006 first quarter due primarily to higher indexed annuity sales and an increase in supplemental insurance premiums resulting from the Ceres acquisition in August of 2006. These increases were partly offset by lower sales of traditional fixed annuities. Core net operating earnings from continuing operations for the 2007 first quarter as reported in Great American Financial Resources earnings release were 6% above the comparable prior year period, reflecting improvement in the supplemental insurance lines. While the supplemental lines results were improved over the comparable 2006 period, increased lapses and lower premiums in the Medicare Supplement segment, primarily as a result of competition from Medicare Advantage, could adversely impact future results. The improvement in the supplemental lines in 2007 was largely offset by lower earnings in the fixed annuity operations. In the 2006 first quarter, the fixed annuity results included $3.2 million of after-tax earnings related to a payment received from a Florida county in exchange for certain limitations on future development of a marina owned by the company.

Now I'd like to summarize some key aspects of our strategic focus on Slide Seven. Our operations will remain focused on specialty niche markets within the property and 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. As previously announced we continue to work on the proposed merger transaction, but if completed, would increase AFG's ownership of GAFRI to 100% and would be accretive to AFG's earnings by an annualized amount of about $0.07 per share. We'll continue to seek acquisition and start-up opportunities that follow our strategy of being a specialty insurance player. We'll also pursue internal growth opportunities for our existing Specialty Insurance businesses with emphasis on our Transportation and Inland Marine operations as well as the Annuity operations. We will continue to consider opportunistic share repurchases. During the first quarter, we repurchased 400,000 shares at an average price of $33.33.

We'll 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 volume and lines as needed to achieve appropriate returns. We'll continue to focus on achieving investment returns that outperform the market.

Now I'd like to reiterate our expectations for 2007 on Slide Eight. We expect growth in net written premiums of 4 to 6% in our Specialty Property and Casualty operations, with a stable to slightly better combined ratio. Excluding California Workers Comp, our expectation is that rates in our overall Specialty operations will decline slightly as some of our markets continue to be increasingly competitive. Our Property and Transportation businesses are expected to generate double-digit net written premium growth for the year, resulting from higher crop premiums, geographic penetration in our property and inland marine unit, and new programs in Great American's trucking operations as well as in our subsidiary, National Interstate. This group should also maintain excellent underwriting margins.

Specialty Casualties group's underwriting profit for the year should be higher than 2006 with a modest increase in net written premiums. We expect the underwriting margins of the Specialty Financial group to improve significantly over 2006 and its premiums to grow in the high single digits. With the 2007 filed rate reduction in the California Workers Comp group, we expect an overall rate decrease of approximately 20% in that business in 2007. As a result, we anticipate that this group's 2007 premiums will decline in excess of 15%. The combined ratio is expected to increase somewhat but should be in the low 80s or below, still producing excellent returns. As we have previously announced, we plan to conduct a ground-up review of our asbestos and environmental reserves this summer. While we don't know the results of that study, we note that our current three-year survival ratios exceed industry averages. We do expect the results of the study in the second or third quarter. In our Annuity and Supplemental Insurance Group, we expect premium growth and continued strong operating results.

We continue to work on several product and distribution initiatives to help further our premium growth. We're still projecting AFG's 2007 core net operating earnings to be between $3.23 and $3.43 per share. These expected earnings exclude the potential for significant catastrophe and crop losses, adjustments to asbestos and environmental reserves, and large real estate gains.

Now we would be open to any questions.

(OPERATOR INSTRUCTIONS) And your first question comes from the line of Charlie Gates with Credit Suisse. Please proceed.

Hi. Good morning. The one question I had, could one of you elaborate on the rationale for acquiring the 19% minority interest in Great American Financial Resources?

Sure, Charlie. This is Carl. Number one, we're increasing our investment, an existing investment in a core specialty-focused business which we've had significant expertise over time. Probably secondly, further simplifies AFG's organization structure even more than what Craig and I have over the past five years or so. Thirdly, it provides some immediate expense savings and additional synergies over time. It's accretive to AFG's earnings and actually improves our return on equity. It also allows for easier movement of capital throughout all of AFG's operations with the elimination, potential elimination of a public company and minority shareholders. We continue to evaluate other opportunities. We currently believe that this is the best use of our excess capital right now.

When you look at GAFRI over time, GAFRI's book value per share is growing at an annual compound growth rate of nearly 15% since its inception in 1992. So when you look at an all-in rate, the operating return on equity today because of the narrow spreads out there, which are narrow on a historic basis, also have held returns down. When you look at the all-in return over time, though, our book value really has, with our investment returns has grown about 15% since 1992. So yeah, that's really what our rationale is.

The only other question I have, could you elaborate on the appetite for share repurchase or assessment of share repurchase?

Yeah, Charlie, I think what we said is, is opportunistically we're interested in repurchasing shares. And as I said, in the first quarter we did repurchase 400,000 shares at a little -- around $33. We thought that was a prudent thing to do. And throughout the year, and as we see additional opportunities, that certainly would be one of our priorities. Naturally, higher priority, though, would be as we have internal growth opportunities or additional opportunities in either the specialty property and casualty or the annuity or supplemental insurance businesses to add to those or to start new businesses. That would be our priority probably.

Thank you.

Your next question comes from the line of John Gwynn with Morgan Keegan. Please proceed.

Thank you. Craig, the moderation and growth in net investment income over the past couple quarters, is that a reflection of the short-term rates and the increase there is sort of having a waning influence?

John, I think probably more a result of lapses picking up a bit in the business. Clearly, investment, reinvestment rates have come down as some of the higher yielding investments are rolling off and we're reinvesting at lower rates. That's having an impact, but you're also seeing a bit of a pick up in the lapse rate. So although new premiums are healthy, lapses are picking up a bit. That clearly is impacting the size of the portfolio and investment income.

Okay. And then in the case of GAFRI, you also in your release say about the result of competition from Medicare Advantage adversely impacting future results. What exactly is that?

I don't know how familiar you are with the Med Advantage program, but we have seen a pick up in lapses in our med-supp business, John, resulting from a very competitive alternative to med-supp of Med Advantage. It has very high reimbursement rates by the Federal government. In the past there have been very short windows to sign up for that Med Advantage product, but that has been opened up to the whole calendar year. The question is how long will the government continue to subsidize that product. If they continue to subsidize that product and continue to have open enrollment for the entire year, John, you're going to -- we think that you're going to continue to see high lapse rates in traditional med-supp products.

There was an article, John, I think in the Times or the Journal yesterday or the day before, I believe, that talked about the Democratic-controlled Congress is now really wanting to potentially cut back on that program, so it looks like there may be -- that may be helpful if that happens.

Okay.

John, obviously the result of higher lapses in med-supp is accelerated right off of either [inaudible] or deferred acquisition cost.

Right.

It's hard for us to know what the future is going to hold, but I can tell you the first quarter the lapse rates were significantly higher than expected.

Okay. And, Carl, the expense ratio in the P& C group was elevated this quarter particularly in Property and Transportation. Is that something that we should adjust for going forward?

Let me field that. John, this is Keith.

Hey, Keith.

Probably not on a go-forward basis. What we have is a circumstance with the crop business that under the accounting rules, as we have the profit-sharing, that goes to offset the expense ratio. And, as you know, last year we had a good crop first quarter, this year we had the California freeze which essentially took us into a loss position, so we gave up the opportunity that we had of the profit-sharing offsetting the expense ratio. So I would not expect that to be an ongoing thing.

So it's sort of the same impact you'd have from a saving commission credit?

Yes.

Okay. Keith, one more --.

And John, higher crop prices, if anything, probably are going to help our revenues some, probably in that part of our business, and higher premiums allow us to spread our fixed charges over a higher premium base. So we're thinking that with Crop prices, the direction that's happened and as that drives and determines our premiums there and it looks like that could help a little bit, so I wouldn't see any impact on expense.

Okay. Thank you. And, Keith, on the tax rate? That was up a bit, too.

Yeah, there's two things that drove that, John. It's probably about $0.04 a share above what you'd get using the statutory rate. We had some final settlements on some state taxes and then the non-deductability of some stock compensation awards drove that. Both of those would be first quarter-only events. We would expect, if you look at the year as a whole, you're probably dealing with a statutory rate on an ongoing basis.

35 or 36?

Yes.

Okay, great. Thanks a lot.

(OPERATOR INSTRUCTIONS) Your next question, gentlemen, comes from the line of Abe [Shwath] with Maxim Group. Please proceed.

Good morning. Congratulations on a great quarter. Just a quick question. In light of our earnings to be in the area of $400 million this year, any chance of raising any -- any more guidance, better guidance on 2008?

Not at this time.

Okay. Thank you.

We usually don't formally have the next year's guidance until the end of the year.

Okay. Thank you.

The analysts regularly update, but we don't.

Well, they've been pretty flat.

Your next question comes from the line of Jay Cohen with Merrill Lynch. Please proceed.

Yeah, a couple of questions. In the Specialty Casualty business, I guess that's where the reserve releases were most pronounced, and I'm wondering if as something changed there, what really suggested to you that reserves were that redundant? So that's question number one. And then secondly, I know you have been one of the group of insurance companies that is challenging some of the tax issues related to offshore companies, and I'm wondering if you can give us an update on what some of your efforts have led to in Washington.

Let me take your first question, Jay. This is Keith. The reserve relations that you indicated are primarily in the Casualty and the majority of those were in our mid-continent subsidiary, and what we're seeing is a sustained pattern of significantly lower frequency. As you might expect, the actuaries, as they looked at it initially there was one or two quarters last year where we saw the beginnings of it, thought it potentially could be an anomaly, and that has continued into the first quarter of this year. And so we have come to believe it's not an anomaly and that a release in the revision of our estimates was appropriate. The other area in Casualty that has had a smaller but still meaningful redundancy indicated is in our excess and surplus lines, and that also is a frequency driven item.

What accident years are those releases coming from?

They are primarily coming out of '01, '02, '03, '04.

Great. And then any updates on the tax issue?

Well, Jay, this is Carl. We, like everybody else, continue to watch the movement of offshore entities into the primary insurance business, and, I mean, that's a concern to us over the longer term, if you have guys that have a tax advantage out there doing that. So we're working with other domestic insurers, including Bill Berkley of W. R. Berkley, to try to promote an equitable solution to that issue. As Bill stated, taxation structures drive business decisions. Business generated domestically as well as overseas can be sheltered from taxation in the various offshore entities. And what we hope to do is to increase awareness of the implications of that to the insurance marketplace and into the tax system as a whole when it gets down to it. So we're working very hard with him and with quite a lot of other insurers to try to come up with an equitable solution.

Any guess as to when a bill might be introduced?

Not at this time.

Okay. Thanks.

Your next question is a follow-up question from the line of John Gwynn with Morgan Keegan. Go ahead, sir.

Carl, is the A&E review going to include or incorporate the old manufacturing environmental liabilities that reside at GAFRI?

Yeah, Keith, you want to?

Yes, that will be included. We're going to look at the old environmental -- the timing on the GAFRI might lag by a month or two behind what the A&E study will be but the A&E study will be comprehensive, including insurance reserves and residual reserves from exposures from both the rail properties and the old manufacturing properties.

Thanks a lot.

(OPERATOR INSTRUCTIONS) And at this time, we have no more questions in queue. I would now like to turn our call back over to Mr. Jensen for closing remarks. Please proceed, sir.

Thank you very much. We appreciate you joining us for our first quarter call and we'll look forward to reporting to you as the year progresses. Thank you and have a nice day.

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