American Financial Group Inc (AFG) 2007 Q4 法說會逐字稿

Good day, ladies and gentlemen, and welcome to the fourth quarter 2007 American Financial Group earnings conference call. My name is Shaquana and I will be your coordinator for today. At this time all participants are in a listen-only mode. We will facilitate a question and answer session towards the end of this conference. (OPERATOR INSTRUCTIONS)

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 very much. I'm joined by Craig Lindner and Carl Lindner, III, the co-CEOs of American Financial Group. We are pleased to welcome you to American Financial Group's fourth quarter and full year 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. They're based on estimates, assumptions and projections which management believes are reasonable but by their nature subject to risk and uncertainty. The factors which could cause actual results to differ materially from these 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 report on Form 10-K and 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. Quarter 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 loses on investments, the effects of accounting changes, discontinued operations, significant asbestos and environmental charges and certain other significant nonrecurring items. AFG believes it to be a useful tool for investors and analysts in analyzing ongoing operating trends and will be discussed for various periods during this call. A reconciliation of net earnings to core net operating earnings is encoded in our press release. Now I'm pleased to turn the call over to Carl Linder, III, Co-Chief Executive of American Financial Group.

Good afternoon and thank you for joining us. We released our 2007 fourth quarter and full year results this morning. I would like to start by covering some highlights from last year on slides three and four of the webcast. 2007 was another record operating year for American Financial Group with core net operating earnings up 28% over our 2006 record results. Our 2007 core net operating earnings generated a return on equity of 16%. Our outstanding results reflect continuing execution of our long-term strategy and our consistent focus on financial and pricing discipline and profitable growth. Craig and I want to thank our talented management team and employees for their efforts and contributions and we want to thank God for blessing AFG this past year. Our 2007 net earnings were dampened by second quarter charges to strengthen our A&E reserves and fourth quarter write-downs in our equity portfolio. Our 2006 net earnings included major gains from real estate sales, which did not occur last year.

I would like to note that AFG's 2007 net earnings generated a return on equity of about 13% and over the last five years it has averaged 14%. Our Specialty, Property and Casualty groups' underwriting profit reached another all-time high, benefiting from very favorable reserve development, unusually strong crop results, and a benign CAT year. During 2007, favorable development was nearly $100 million or 4 points, including the major A&E charge, compared to $57 million or about 2 points in 2006. As a result of our favorable operating results, we have generated significant amounts of excess capital. One of our important strategic objectives is to deploy our excess capital in a way that enhances shareholder value.

To that end, in 2007 we completed the buy-in of the minority shares of Great American Financial Resources. In addition, we took advantage of the opportunity provided by the decline in our stock price during the second half of 2007 to purchase 2.2 million shares of our common stock at an average price of $29.23 per share during the 2007 fourth quarter, bringing our total repurchases for the year to 6.9 million shares at an average price of $28.70.

In January of this year, we completed the previously announced acquisitions of Marketform Group, a Lloyd's insurer, and Strategic Comp, a leading provider of Workers' Compensation programs. Marketform is an integrated Lloyd's insurer that specializes in non-U.S. medical malpractice markets and will enable us to leverage several of our specialty lines in other parts of the world. Strategic Comp expands our base of expertise in the Workers' Comp arena, using a high deductible product approach. We expect both of these acquisitions to have a very positive effect on our future growth and profitability.

We also increased our 2008 common stock dividend by 25%, reinforcing our confidence in the Company's long-term financial outlook. We are pleased with our growth in book value in 2007, continuing the trend we've experienced over the past several years. Book value per share, excluding unrealized gains on fixed maturities, was 9% above year-end 2006 and over the past five years by its annual compounded growth was 14%.

Turning to slide five, I would like to review the results of our ongoing specialty operations. Underwriting profit in the 2007 fourth quarter was nearly double the amount in the 2006 fourth quarter and the combined ratio improved nearly 13 points. For the year, underwriting profit was up 57% with a 6 point improvement in combined ratio. Our crop insurance operations had a record year with results considerably higher than our previous record. While we believe we're positioned to continue growing the profitability of this business, 2007 was clearly an unusually profitable year.

Even though gross and net written premiums declined in the 2007 fourth quarter compared to the same quarter a year earlier, the 2007 full year premiums were 2% higher than in 2006. Premium growth was impacted by significant rate declines in California Worker's Comp, softening market conditions within certain of our Specialty Casualty group operations and the impact of the RVI and earthquake exposed excess property operations previously placed in runoff. Excluding the impact of California Workers' Comp and the runoff businesses, actually 2007 net written premiums were up about 6% over 2006. I'm pleased that we've been able to maintain adequate rates in this competitive environment. Apart from the rate decreases in the California Workers' Comp business, average renewal rate levels in our other specialty operations were down about 2% in 2007. We're pleased that all of our businesses performed very well. Now I'd like to review the results for each of our specialty business groups on slide six and seven.

The Property and Transportation group produced outstanding profitability in 2007. The group's 2007 fourth quarter underwriting profit was double the amount in the 2006 fourth quarter with a 16 point improvement in the combined ratio. Underwriting profit for the year was 41% higher than 2006, with a 4 point combined ratio improvement. As I indicated earlier, our crop division produced phenomenal underwriting profits, reflecting additional earnings contribution from the 2005 Farmers Alliance acquisition and favorable crop prices and yields. We were blessed with no major catastrophe losses. Our property and inland marine and transportation businesses also generated improved results. The group's average renewal rates were down slightly for 2007. Our Specialty Casualty group's underwriting profitability increased significantly in 2007. Its 2007 fourth quarter combined ratio improved about 6 points over the same quarter a year earlier.

This resulted primarily from favorable reserve development, improved results in the executive and professional liability operations and in our targeted insurance programs. The full year combined ratio improved 10 points, driven by favorable development in our Mid-Continent subsidiary's general liability operations and our American Empire excess and surplus lines. This group experienced declines in gross and net written premiums in 2007 reflecting stronger competition in our excess and surplus lines, business and softening in the homebuilder's market that affects our general liability coverages. Keeping rates at level that support our profit objectives contributed to this group's excellent underwriting results. Average renewal premiums for the overall group declined about 3% for the year. Specialty Financial group's combined ratio for the 2007 fourth quarter improved 20 points compared to the 2006 fourth quarter and for the year improved nearly 16 points compared with 2006. These improvements resulted primarily from lower losses in the runoff automobile RVI business.

Excluding the affect of RVI, the group's combined ratio would have been about 89% for 2007, comparable to 2006. Each of the business units within this group produced solid underwriting profits for the year. Net written premiums for 2007 increased primarily due to the growth in financial institutions, lease and loan and fidelity and surety operations, as well as a decrease in premiums ceded under reinsurance agreements in the lease and loan businesses. The increase was partly offset by lower premiums resulting from the runoff of the RVI business. Average renewal rates in this group were down about 1% for the year. Our California Workers' Comp business produced excellent profitability in 2007 on lower premium levels. The increases in the combined ratio for the 2007 periods reflect the impact of significant rate reductions, which have been responsive to improving claims environment resulting from the California Workers' Comp reform legislation.

Favorable reserve development due to improved frequency and severity of claims continued during 2007. Due to the long tail nature of this business, we continue to be conservative in recognizing the benefits from the reform legislation until a higher percentage of claims have been paid and the ultimate impact of reforms can be determined. We are pleased that the reforms are working to decrease the overall cost of Workers' Compensation to the California economy. Renewal rate decreases averaged about 22% during 2007. We're encouraged that California Worker's Comp -- at the California Worker's Comp rating bureau, the WCARB, has recommended 4% to 5% rate increases. Although this increase was not instituted by California's Insurance Commissioner, we expect rates to stabilize in this market. Now let me review our Annuity and Supplemental Insurance group on slide eight. Higher earnings in the fixed annuity operations were more than offset by the impact of higher mortality in the runoff life operations.

The 2007 fourth quarter results included a $9.4 million write-off of deferred acquisition costs as a result of increasing future mortality assumptions in the runoff life operations. Supplemental insurance operations reflect a full year of earnings from the Ceres Group, which was acquired in August 2006. However, supplemental lines were negatively impacted by higher lapses and lower Medicare premiums in 2007, due primarily to increased competition from the government sponsored Medicare Advantage product. Although statutory premiums slowed in the 2007 fourth quarter, premiums for the 2007 full year reached a record level of $2 billion, 16% higher than 2006. This increase reflects the substantial growth early in the year in sales of single premium indexed annuities and higher sales of annuities in the 403 B segment, partially offset by lower sales of traditional single premium fixed annuities. In addition, supplemental insurance premiums increased significantly over 2006 due to the previously mentioned 2006 acquisition of the Ceres Group.

During the past year, there's been a great deal of attention and concern focused on issues related to the subprime mortgage securities. I'd like to take a few minutes to provide an overview of our position. Our investment philosophy with respect to the securities that make up our mortgage-backed securities portfolio has been consistent over many years and very conservative, which has cushioned us against significant market value declines. At December 31, 2007, mortgage backed and related securities represented about 27% of the portfolio and 99% of those securities were rated triple A. Investments in non-investment grade securities represented 5% of our investment portfolio. On slide nine you can see that investments and securities with subprime asset backed collateral totaled $483 million, less than 3% of our investment portfolio. Over 99% of these investments are rated AAA with fixed rate collateral.

Most of these securities are in shorter maturity tranches with a weighted average life of four years. Fair value of $483 million represented approximately 94% of these securities' amortized cost so that the subprime portfolio had an unrealized loss of approximately $29 million at year-end. Equity investments represent about 5% of our portfolio. In the fourth quarter we recognized an other than temporary impairment of $84 million pretax related to our equity investments. Approximately $67 million of the impairment is due to our investment in financial institutions, of which our largest is National City, net investment as related to our sale of Provident Bank a few years ago. Nat City, along with a number of other banks, has experienced a significant decline in share price over time. Nevertheless, over the past four years, including this 2007 pretax charge, we had net -- we had a net pretax gain of about $165 million associated with the sale of Provident and a 60% reduction in our position in Nat City through subsequent sales of its stock.

There's also been a great deal of attention on securities that are credit enhanced by financial guarantors. If you turn to slide 10, at December 31, 2007, the Company owned approximately $855 million of such securities, including $596 million of insured municipal bonds, $152 million in insured subprime securities. Now those were included in the $583 million that I discussed previously or $483 million. $8 million in uninsured residential mortgage backed securities and $99 million of insured corporate bonds. 90% of the insured municipal bonds carrying an explicit underlying rating with an average rating of A plus and 50% of the insured corporate bonds carrying explicit underlying rating with an average rating of BBB plus. None of the insured subprime securities or insured residential mortgage-backed securities carry an explicit underlying rating. Based on current information, we do not believe our risk of loss on the securities without underlying credit ratings would be material to our financial condition.

There is more detail on our investment portfolio at our quarterly investor information posted on our website. We are careful in monitoring our Property and Casualty insurance operating exposures related to the subprime issues. From a claims perspective, we have very few claims or notices of claims. We've reviewed those claims as well as the potential for loss from other insureds. Based on this review and what we currently know, we have no significant individual losses and don't believe that our aggregate operating losses related to subprime issues are material to our financial condition. We've also considered the impact that this issue may have on our business going forward. A few of our businesses, most notably homebuilders, mortgage collateral protection and inland marine, may have some decreases in volume as the housing market softens. We do not expect the financial impact of this softening to be material.

Let's talk about strategic focus. Our overriding goal is to increase long-term shareholder value by using our strong balance sheet and excess capital to intelligently expand our businesses. On slide 11, we've outlined important aspects of our strategy that we believe will be drivers for the future and allow us to achieve that goal. We're focused on specialty niche markets within the property and casualty insurance and annuity and supplemental insurance industries where we have significant expertise. We'll pursue appropriate uses of our excess capital, including internal growth opportunities within our existing portfolio of businesses, acquisition and startup opportunities that meet our specialty strategy and financial objectives, and opportunistic share repurchases and changes in dividend levels. During these times of volatile financial markets it may be smart to keep some of our powder dry, as we feel there could be quite a few good opportunities. We remain committed to our strong underwriting culture, pricing discipline and risk management philosophy and continually monitor the adequacy of our rates in all markets.

We'll reduce business volume and lines as needed to achieve appropriate underwriting results. Our investment group will focus on achieving returns over the long-term that outperform various market indexes, while effectively managing our portfolio risk. We'll leverage the expertise of this group as we plan to pursue opportunities and manage certain types of investment vehicles for sophisticated entities. Our long-term objective is to achieve returns on equity between 12% and 15% along with consistent growth in book value.

At AFG we're enthusiastic about this year. Our expectations for 2008 are outlined on slides 12 and 13. Our Property and Casualty Specialty operations should generate net written premium growth in the range of 4% to 7% and a strong underwriting profit with a combined ratio in the range of 87% to 89%. This investment income is projected to increase between 2% to 4%. Many of our businesses aren't subject to an overall insurance cycle and are affected more by changes in their own specialized markets. Because of our strong underwriting culture we expect to maintain adequate rates.

That said, we anticipate a modest decline in our overall average renewal rates in 2008 due to competitive conditions in certain markets. Now we expect net written premiums in our Property and Transportation group to increase 6% to 9%, fuelled primarily by improved geographic penetration in our property and inland marine operations, as well as some new initiatives in our transportation businesses. This group should also maintain it's excellent underwriting track record with a combined ratio in a range of 85% to 89%. While we expect increase in competitive pressures in certain of our operations in our Specialty Casualty Group, we're projecting growth between 6% and 9% net written premiums. We're optimistic about growth opportunities in this group resulting from our recent investment in Marketform, the Lloyd's insurer that focuses on Specialty Property and Casualty insurance products outside of the United States and is a market leader in the non-U.S. med mal market. We believe this acquisition positions us to grow several of our specialty businesses in the international marketplace.

Excluding the impact of Marketform, business in this group is expected to be down mid single-digits. We also expect the acquisition of Strategic Comp Holdings to provide our Workers' Comp programs will further expand our penetration and increase our geographic coverage in the Workers' Comp market. We expect Specialty Casualty Group to generate strong underwriting profit with a combined ratio in the range of 85% to 89%. The underwriting margins over at Specialty Financial group are expected to continue to improve. We project net written premium growth in the range of 3% to 6%, as most of the Specialty Financial businesses are expected to grow modestly. We'd look for this group's combined ratio to be in the range of 88% to 92%. As I mentioned earlier, we expect to see rates in the California Workers' Comp market stabilize. As such, we'd anticipate that net written premiums would be down 3% to 5% this year. The combined ratio is expected to increase somewhat but should be between 84% and 88%, still producing excellent returns on this business.

We've previously announced our intent to perform a ground-up internal review of our asbestos and environmental exposures every year in a study using an outside actuarial firm every other year. Accordingly we'll perform an internal study during 2008. We expect the core pretax operating earnings of our Annuity and Supplemental Insurance Group to be 5% to 10% higher than in 2007. Increased competition from the government sponsored Medicare Advantage product will likely continue to impact our supplemental insurance operations. We expect these premiums to be flat to slightly down in 2008. We do expect 5% to 10% growth in annuity sales. We consider excess capital to be parent Company cash plus borrowings we could incur while staying below our 24% debt-to-capital target. After taking into consideration capital already used for Marketform and Strategic Comp, we expect to generate around $350 million of excess capital during the remainder of the year.

We continue to expect our 2008 core net operating earnings to be between $3.75 and $3.95 per share. These expected earnings exclude the potential for significant catastrophe and crop losses, unforeseen major adjustments to A&E reserves and large gains or losses from asset sales. Now we'd like to open the lines for any questions. Thank you.

(OPERATOR INSTRUCTIONS) Please stand by while we compile a list. And your first question comes from the line of John Gwynn with Morgan Keegan. Please proceed.

Thank you. Keith or Carl, the drop in the expense ratio in Property and Transportation, is that a function of the crop business or -- the drop in the fourth quarter?

It is a function of the crop business, John. The way that works with the reinsurance arrangement and some profit sharing features, as we have strong profit years that will be charged against expense.

But it's not a change in the CD commission or anything.

No it's not.

Okay. Great. On GAFRI, the acquisition of the minority interest, did that have an impact on statutory surplus?

No, it didn't.

Okay. Is GAFRI still stacked under Great American?

No it's not. It's been dividended out from Great American and it's directly under American Financial Group. What that has done has enabled us to have a smoother capital flow without having to take two steps through a regulated entities.

Right. And is that also the reason that stat surplus was -- well stat surplus is a consolidated number, right, on your supplement?

Yes, it is.

Why was that down?

That would be down because you would not have the double count from the statutory surplus of GAFRI under GAI.

Okay. Keith, I keep wondering, on crop insurance, it looks like the expense reimbursement adjustment contained in the whatever bill is going to come out of this committee, is really not a very material item. Is that a correct interpretation?

That's fair. There are two proposals. There's a Senate version and a House version. The Senate version is proposing a 2% reduction in the administrative and overhead expense allowance. The House version is proposing a 3% and for the larger players that really is not a significant amount. I think what it tends to be is a barrier for people getting into the business on the small end because they do not have the economies of scale.

Great. Thanks a lot.

As a reminder. If would you like to ask a question, please press star one. At this time, there are no further questions. I would now like to turn the call back over to Mr. Keith Jensen for closing remarks.

Thank you very much and we'd express our appreciation to all of you for joining us today and we will look forward to reporting to you at the end of the next quarter. Thank you, have a good day.

Thank you for your participation in today's conference. This concludes the presentation. You may now disconnect and have a good day.