American Financial Group Inc (AFG) 2008 Q3 法說會逐字稿

Good morning. My name is Tasha, and I will be your conference operator today. At this time I would like to welcome everyone to the third quarter, 2008 American Financial Group's earning conference call. All lines have been placed on mute to prevent any background noise. After the speaker's remarks, there will be a question-and-answer session. (OPERATOR INSTRUCTIONS). Thank you, I would like to turn the call over to Mr. Keith Jensen, Senior Vice President. Please go ahead, sir.

Thank you, good morning. I'm here with Carl Lindner, III Co-CEO of American Financial Group. We're pleased to welcome you to American Financial Group's 2008 third quarter earning's results conference call. If you are viewing the webcast from our website you can follow along with the slide presentation, if you 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 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 10K and quarterly reports Form 10Q We do not promise to update such forward-looking statements to reflect actual results or changes or 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 realized gains or losses on investments. Effects of accounting changes, discontinued operations, significant asbestos and environmental charges and certain other recurring items. AFG believes it could be a useful tool for analysts and investors in analyzing on going operating trends and will be discussed during various periods during this call. A reconciliation of net earnings to core net operating earnings is included in our earnings release.

Now, I'm please to turn the call over to Carl Lindner, III, Co-Chief Executive Officer of American Financial Group.

Good morning and thank you for joining us. We released our 2008 third quarter results yesterday afternoon. I'd like to start by covering some highlights on Slide three of the web cast. Core net operating earnings per share for the quarter were $0.98 compared to $0.97 in the 2007 third quarter. Improved results in our annuity and supplemental insurance operations and higher investment income were offset by lower underwriting results in our property and casualty operations, largely driven by catastrophe losses.

Record core net operating earnings for the first 9 months of 2008 were $3.03 a share compared to $2.81 a share for the comparable 2007 period. Net earnings were $0.18 per share compared to $0.93 per share in the 2007 third quarter. Our 2008 third quarter results were impacted by net realized losses on investments of approximately $94 million or $0.80 per share after tax. These charges include other than temporary impairments, as well as realized losses on sales of investments, primarily in the financial sector. Our insurance operating results for the quarter and through the 9 months of the year remained strong. We remain on target to meet the Company's 2008 operating objectives. We're particularly pleased with the results in our annuity and supplemental insurance businesses which benefited from increased spreads in the annuity lines in the quarter. Our concentration in fixed annuities has been particularly advantageous in the investment environment.

Through the first 9 months of 2008 our record core earnings per share are 8% above the 2007 period and our annualized core operating return on equity was 16%. Our capital adequacy, financial condition, and liquidity remain very strong as evidenced by Standard and Poor's recent report affirming with a stable outlook our investment grade debt ratings and our insurance operation's financial strength ratings. We've focused on maintaining appropriate liquidity and anticipate continuing to generate cash through our operating income. Our book value per share of $27.74, excluding unrealized gains and losses on fixed maturities was up 4% compared to $26.75 per share at the end of the 2007 third quarter. Book value per share including all unrealized gains and losses on investments was $24.05 compared to $26.08 at the end of the third quarter a year ago.

Turning to Slide four, I'd like to review the results of our Specialty Property and Casualty operations. Overall, underwriting profit in the 2008 third quarter of $72 million was 31% lower than the same period a year ago. The combined ratio increased 5 points to 91.5% as higher catastrophe losses, mostly from the wind related storm damage from Hurricanes Gustav and Ike. Higher losses from runoff operations, more than offset an increase in favorable reserve development. We recognize approximately $57 million in favorable reserve development in the third quarter, $31 million more than in the comparable period in 2007. Our underwriting profit and combined ratios through the first 9 months of 2008 reflects the affects of more competitive market conditions, better results returns are in line with our expectations.

I am encouraged by the stability of our overall rate levels, excluding the effect of California worker's comp, average renewal rates and the other specialty operations through the 2008 third quarter were down about 3% compared to renewal rate from the same prior year period. Gross and net written premiums were up significantly for the quarter. Mostly as a result of higher premiums in our crop operations. Gross investment income related to our property and casualty operations is up approximately 14% through the end of the third quarter as we have benefited from higher interest rates in this segment's portfolio.

Now, I'd like to review the third quarter and 9 months results for each of our specialty business groups on Slides five and six. Property and Transportation group, our largest group generated solid underwriting profit through the first 9 months of the year. It's third quarter results were impacted by catastrophe losses primarily within Great American's Property and Inland Marine Division, and lower underwriting profit in our crop operations. Which were offset somewhat by higher favorable reserve development. Apart from the catastrophe losses this group produced exceptionally strong profitability in the end of 2008, third quarter. Gross and net written premiums, increased significantly for the quarter and year to date in 2008, largely due to higher spring commodity prices which benefit our crop operations. These increases more than offset the volume declines in Great American's Property and Inland Marine operations resulting from softer market conditions. We expect to recognize additional under writing profit in our crop operations in the fourth quarter. Crop yields and variations in commodity pricing are key factors in determining ultimate profitability in these operations. This group's average renewal rates for the first 9 months of the year were 3% below the same period a year earlier.

Let's move on to the Specialty Casualty Group. This group continued to produce strong underwriting profits in the 2008 third quarter and 9 month periods. The improvement in the combined ratio for the third quarter reflects better underwriting results and our executive liability and targeted markets operations, in a higher favorable reserve development. Through the first 9 months of the year, the combined ratio increased almost three points as the improved results center executive liability and targeted markets operations were more than offset by lower underwriting results and a general liability and excess in surplus lines as well as by lower favorable reserve development. Decreases in gross written premiums through the third quarter were driven primarily by volume reductions and our excess in surplus lines reflecting continuing competitive pressure in those commercial casualty markets and lower general liability premiums resulting from the softening in the home builder's market. These declines were partly offset by additional premium from the Market Form Group which was acquired in the 2008 first quarter.

Net written premiums for the 2008 third quarter and year to date increased over 2007 periods as additional premium volume from Market Form and a higher premium retention helped to offset the premium declines and the general liability and E&S lines. This group's overall average renewal rates for the first 9 months of 2008 were about 4% lower than the 2007 period.

Moving on to the Specialty Financial Group. They reported a small underwriting loss for the third quarter, these results were driven in large measure by underwriting losses in our runoff, auto RVI operations. Residual value insurance losses resulted from declines in used SUV and luxury car prices reflecting the impact of higher fuel prices over the past 12 months. This group remained profitable on a year-to-date basis, as improvements in Assurity and Fidelity and Crime operations and higher favorable development helped to offset lower underwriting results in the RVI and Financial Institutions business. Gross written premiums for the quarter were down 3% from the 2007 period. Primarily from declines in our lease and loan and financial institutions businesses. And this group's average renewal rates for the first 9 months were about 2% lower than in the year earlier.

Our California Workers Comp business has generated excellent profitability through the first 9 months of this year. Group's combined ratio for the 2008 third quarter was up 2 points from the 2007 third quarter while the 2008 year to date combined ratio is virtually unchanged from the 2007 period. Favorable reserve development was higher in the 2008 third quarter and 9 month periods. The improved claims environment resulting from the California Worker's Comp Reform Legislation has continued to benefit our insureds as well as the results and those of our industry. And due to the long-term, long-tailed nature of this business, we remain conservative in our reserving until a higher percentage of claims have been paid, a full impact of California Reform can be determined.

Gross and net written premiums increased for the quarter as increased sales of our new excess Workers Comp products offset the effects that continued lower rates in our traditional worker's comp business. Our average renewal rates were down approximately 13% in the third quarter. This past Friday, California Insurance Commissioner Poizner approved a 5% rate increase effective January 1, 2009. Primarily we'd expect the Republic Indemnity are California Worker's Comp subsidiary will file for a similar rate increase.

Now I'd like to move on to review of our Annuity and Supplemental Insurance Group on Slide seven. Annuity and Supplemental Insurance Group generated core operating earnings before income taxes for the 2008 third quarter that were 42% higher than the same period a year earlier. The increase reflects higher earnings in the annuity operations, primarily as a result of improved spreads on fixed annuities. In addition earning in our supplemental insurance business were higher than last year due primarily due to favorable results in our long-term care businesses. These increases were partially offset by lower earnings in our variable Annuity and runoff life operations. (inaudible - technical difficulty)

Core operating earnings before income tax this is for the first 9 months of 2008 improved 15% over the same 2007 period. As higher earnings attributable to the fix Annuity and supplemental insurance operations were partially offset by earnings declines in our earnings declines in our variable annuity and runoff life operations. We continue to work toward improving the Annuity and Supplemental Insurance Groups return on equity and are encouraged by the improved results in this group. Statutory premiums for the third quarter of 2008 were 21% higher than the third quarter of 2007. Annuity sales through our new bank distribution channel launched in the second quarter of last year. As well as sales of traditional annuities -- in a single premium market. Premiums to the first 9 months of this year increased 7% over the prior year period. Increase from annuity sales through the bank channel were offset by lower index annuity sales. We don't expect any material write-offs in our annuity business for this year. We hedge index annuities with highly matched over-the-counter options and exposure on that line is minimal. Since our variable annuity business is relatively small and we have very few policies with living benefit or similar riders. We expect very little DAC write-off.

Turning to Slide eight, our third quarter results include net after tax realized losses of $46 millions on equity securities including after tax losses of on of approximately $21 million on sales of preferred and common equity investments in Fanny Mae, Freddie Mac, WAMU (Washington Mutual), Lehman Brothers and AIG. Also included in realized losses were other than temporary impairments, over half of which were attributable investments in the communications sector, with the remainder primarily related to the investments in the financial and transportation sectors. In addition we reported net after tax realized losses totaling 48 million dollars on fixed maturity investments in the 3rd quarter, including after tax losses of (inaudible - technical difficulty) $24 million on the sales of fixed maturities issued by WAMU(Washington Mutual), Lehman Brothers, and AIG. There continue to be challenges in the global credit markets, these events have resulted in widening spreads between US Government bonds and Investment grade and high-yield bonds to all time highs, this has affected the values for many of our fixed maturity investments. As of September 30, AFG had after tax, unrealized losses of $426 million on its fixed maturity portfolio. Our investments are high quality with investment grade securities representing 94% of our fixed income portfolio. Because of our high quality portfolio and strong liquidity, we have both the ability and intent to hold our fixed income investments to maturity or until they recover in value. We believe over time values will be restored as spreads to treasuries near to more normal levels.

We recognize the markets interest in issues related to mortgage backed securities. Our investment philosophy with respect to these securities has been consistent over many years, and has been almost entirely focused on the senior tranche of these securities. We believe that we have little risk of a material loss on this portfolio. We had minimal exposure to other investments that we have received widespread attention recently. We have no credit default swaps, we have less than $34 million of asset backed CDO's and we have less than $50 million in what would be deemed it alternative investments, principle private investment funds.

In the aggregate, these holdings represent less than 1/2 of 1% of our investment portfolio. More information about our investment portfolio may be found in our financial and investment supplements, which are posted on our website.

Now, I'd like to summarize some key aspects of our strategic focus outlined on slide nine. We're a company that's focused on specially niche markets within the property and casualty insurance and Annuity and supplemental insurance industries where we have significant expertise. We'll maintain financial leverage and capital adequacy that's consistent with our rating levels and commitments to rating agencies in the market. 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 have and will continue to 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 indices, while effectively managing our portfolio risk and will evaluate opportunities within our real estate portfolio. Our long-term objective is to achieve operating returns on equity in the range of 12 to 15%, along with consistent growth and book value.

I'd like to reiterate our expectations for the remainder of 2008, and provide an outlook for 2009 on slides 10 and 11. We now expect net written premiums to be 5 to 7% above the prior year in our Specialty Property and Casualty operations with a combined ratio in the range of 86 to 88%. Because of our strong underwriting culture, we expect to maintain adequate rates. That said, we anticipate a modest decline in our overall renewal rates in 2008 due to competitive conditions in certain markets. (inaudible - technical difficulty) We expect net written premiums in our Property and Transportation group to increase 10 to 14%, fueled primarily by higher crop premiums, which are a result of higher spring crop prices. In addition, some new initiatives in our transportation business will provide premium growth. This group should also maintain its excellent underwriting track record with a combined ratio in the range of 88 to 92.

Our 2008 guidance is based on assumptions that our accident year underwriting results in our crop operations will be 60% lower or approximately 70 million dollars lower than our record 2007 results. Still a solid year. The impact from lower average (inaudible - technical difficulty) commodity prices will be offset somewhat by insurance deductibles of 25 to 30%. And yields that are projected to be at or above historical averages, we remain optimistic about growth opportunities in the Specialty Casualty Group, resulting from our investment in market form and resulting international expansion opportunities. We also expect the strategic comp acquisition to further expand our penetration, increase our geographic coverage in the Worker's Comp market. Therefore, we project 1 to 3% growth in net written premiums. We also expect this group to generate strong underwriting profit with a combined ratio in the range of 78 to 81%. We are pleased with a performance of our Specialty Financial Group through the first 9 months of the year. We're disappointed with the recent results in the runoff RVI business.

Overall, we expect underwriting margins for the year to improve over 2007. We look for this group's combined ratio to be in the range of 93 to 96. We project net written premiums to be flat for 2008. We are please with the performance of our California Worker's Comp business in the first 9 months of this year, combined ratio should be between 77 and 80%. Providing excellent returns on this business. With the expansion of our excess Worker's Comp program, we anticipate that net premiums would be down about 3 to 5% this year. Based on recent market conditions, and favorable trends, we expect full-year core pretax operating earnings in our Annuity and Supplemental insurance group to be 20 to 25% higher than in 2007. This growth will be driven by meaningful benefits of widening investment spreads in our Fix Annuity business. Anticipated earnings it growth in the Fixed Annuity and Supplemental Insurance lines is expected to be partially offset by lower earnings in the variable annuity and runoff life operations. Our 2008 core net operating earnings guidance remains at between $3.90 and $4.10 per share. Looking to 2009, we expect stable net written premiums and a continuation of the healthy underwriting profits in our Specialty Operations, albeit at a lower level than in 2008. In our Annuity and Supplemental operations in 2009, we expect solid growth in core operating earnings.

Finally, we've announced that we expect our 2009 core net operating earnings to be in the range of $3.65 to $3.85 per share. This 2009 guidance reflects strong projected earnings growth in our Annuity operations, and higher investment income in our Property and Casualty operations. These increases will be offset by the effects of a more competitive Property and Casualty marketplace. For 2008 and 2009 expected results, include the potential for extraordinary catastrophe and crop losses and adjustments to A&E reserves, now we would like to open the lines for any questions. Thank you.

(OPERATOR INSTRUCTIONS). Your first question comes from the line of Amit Kumar with Fox-Pitt Kelton.

I guess going back to the discussion on your life operation and recently there's been a lot of focus on risk-based capital and RBC ratios, I go back and look at your '07 RBC ratios for your life operations, they seem to be in the, I guess 0.330 to 0.350 range. I was wondering you could update that number for us and maybe just talk about, what your target range is? That's my first question.

This is Keith Jensen. As a practical matter, what we do, Amit is target our capital based on the S&P model. Because we've found that to be a more restrictive capital model than the RBC calculations, as we manage capital and target how much to put into each of our businesses, we really use that as our primary pressure, and in that regard, as you probably know, S&P's been in the process of changing their cap adequacy model but we have over the past several years and in this period of transition, continue to target 150% of the S&P adequacy model as our target, and so from that perspective, I would expect actually that during the course of this year, the RBC level at the life operations will actually increase a bit, because of changes in the S&P model that are driving us to put additional capital in.

That's helpful. In terms of -- maybe just expanding the discussion and maybe moving on to the P&C operations, what's a target premium to surplus in the current cycle for target premium to surplus in the current cycle for you.

I'd give you a similar answer to that, we actually don't use a targeted premium to surplus, again, with the P&C side we have very similarly to what we do in life, we target to meet the Standard & Poor's's and AMVEST cap adequacy ranges that would be at the level above our current rating, what we've tried to do is take cap adequacy off the table as a rating factor. It continued to be at the high end of the ranges, so for us, premium to surplus is an outcome rather than a target. So whatever the capital that's required under those models is -- becomes the denominator in that calculation and it is really a outcome rather than the target.

You said high-end of of the ranges, is that what you said?

Yes, it is.

Quickly moving on. Recently we've seen a lot of chatter coming out of the (inaudible) -- talking about perhaps seeing the first signs of some sort of change coming on the horizon, we've seen different commentary, but I guess the consensus is that at least the signs point to that direction and obviously there's a lag on how that affects the primary guys. I was wondering if you could comment specifically on what you may be hearing out there, and what is your view on the cycle turn especially based in the last couple months.

Generally the property and casualty markets continued to be very competitive, though the property and casualty industry, their excess capital has to be impacted a lot by the hurricane losses and the impairment, the asset write-downs, the third quarter and this year. I think there's a lot less excess capital for the industry to play around with. I think that makes me enthusiastic about maybe a quicker turn in property and casualty pricing, and I think capital and this environment is very dear to everyone, and certainly our discipline and our approach is going to be to make every dollar a capital account and we don't have businesses that are earning the right returns we're going to begin to try to nudge pricing.

Final question. In terms of opportunities coming out of AIG, we've seen a lot of smaller or mid level players talk about them. And also we've seen some of these companies raise the limits on their policies to make them more attractive in chasing that sliver. Have you undertaken any specific steps recently to sort of tap on to those opportunities.

Not really, we provide pretty large limits in a lot of the businesses that we would compete, and in particular, we would have capacity in the D&O to provide $25 million plus type of limits, we also had that capacity in our excess liability, I think probably even up to $50 million in a couple of those lines, so if anything, though, I think with what's going on with AIG. I think there could be a trend or a tendency for insureds and agents to want to use layering of large casualty accounts, maybe more than what they have in the past. I recognize some competitors are bumping limits up, and that may be effective, but I think there will also be a trend of going back to having more insurers just to spread the risk, you know, versus less where you have large D&O limits or large excess liability umbrella limits going on, so which one, when it's over, is hard to say at this point. I've kind of heard, both theories kind of be be put out there.

And then are you seeing a meaningful increase in submissions or coats.

Yes, I think we're seeing some increase in submissions related to AIG's problems and frankly probably some others. So we see that as a -- an opportunity. That said, AIG seems to be even more price competitive than what they have been in the past. I'm not sure that bodes well for the Fed's loan long-term if that's the case, though.

Okay, that's very helpful. Thanks so much.

Your next question comes from the line of [Abe Shalof] of Maxim.

Hello, this is Marvin Weinstock, my question is, with our book value over 24 at this point. There any potential for American financial buy backs?

I think there's always a potential for American financial stock buy backs, I think right now at this juncture, as Craig and I have said in the past, we're trying to keep the powder dry, when you have volatile financial markets like this, and you also have some potential opportunities in the annuities side or in specific property and casualty businesses or even in the investment portfolio, I think today we're probably erring more toward keeping some powder dry versus share repurchase.

Thank you. One other question.

Hi, it's Ab on here. Just a quick question, as far as our dividend policy goes, we've had a couple increases recently. Is our dividend secure and any chance of an increase.

Craig and I usually do a review toward the end of the year, and, you know, as far as any dividend increases and that, we'll -- we plan on doing the same review.

Okay. Thank you. First of all, congratulations.

Thank you.

Again, if you would like to ask a question, press star then the number one on your telephone keypad. Again, to ask a question, press star one. There are no audio questions at this time.

All right. Well, thank you very much for joining us, we appreciate your attention and we look forward to reporting at your end to you. Thank you and have a good day.

This concludes today's conference call, you may now disconnect.