American Financial Group Inc (AFG) 2009 Q3 法說會逐字稿

Good morning. I will be your conference operator today. At this time I would like to welcome everyone to the American Financial Group 2009 third quarter earnings conference call. After the speakers, there will be a question-and-answer session. (Operator Instructions). Thank you. Now I would like to turn the conference over to Mr. Keith Jensen, Senior Vice President of American Financial Group. Please go ahead.

Thank you very much. Welcome. I'm here with Craig Lindner and Carl Lindner III, co-CEOs of American Financial Group. I am pleased to welcome you to the American Financial Group 2009 third quarter earnings results conference call. If you're viewing the webcast you can follow along with the slide presentation if you would like. Certain statements made during this call are not historical facts and may be considered forward-looking statements, and are based on estimates, assumptions, and projections which management believes are reasonable, but by their nature subject to risks and uncertainty. The factors which could cause actual results or financial condition 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 our 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 other factors that could affect those statements. Core net operating earnings is a non-GAAP financial measure which sets aside items that are generally not considered to be part of ongoing operations, such as net realized gains or losses on investments, effects of accounting changes, discontinued operations, significant asbestos and environmental charges and other nonrecurring items. AFG believes this non-GAAP measure to be a useful tool for analysts and investors in analyzing ongoing operating trends that will be discussed for various periods during this call. A reconciliation of net earnings attributal to shareholders, to core net operating earnings is included in our earnings release. I am pleased to turn 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. We released our 2009 third quarter results yesterday afternoon. AFG has again posted record operating results even as we are faced with an economic downturn and competitive market conditions. We also announced yesterday an increase in AFG's annual dividend to $0.55 per share beginning in January of 2010. This dividend will be the fifth consecutive annual dividend increase for the Company, and represents a 6% increase over the dividend paid in 2009. We believe it underscores the confidence of the Board and management in the Company's business and long-term financial outlook. We thank God for his blessings and we are grateful for a management team for their excellent work during this time of economic challenge. We believe that the depth and breadth of AFG specialty insurance expertise has enabled us to deliver high caliber service to our policy holders and agents and produce long-term value for its shareholders. I am assuming that the participants on today's call reviewed our earnings release and the supplemental materials posted on our website. I will review a few highlights and focus today's discussion on key issues in our outlook for the remainder of 2009 and 2010.

Our record third quarter and year-to-date core net operating earnings per share were up 9% and 5% from the same 2008 periods, reflecting improved underwriting results and our specialty property and casualty operations. We have an annualized return on equity of about 16%, including realized gains and losses for the first nine months of this year. Our net earnings of $1.09 per share for the 2009 third quarter and $3.07 for the first nine months of 2009 were also substantially higher than the prior year periods. Primarily because of improved core earnings and realized gains on investments, which include the offsetting effect of impairment charges.

Earlier this month, we announced a fourth quarter after tax realized gain of approximately $50 million or $0.42 per share on the sale of our 35% of our holdings in Verisk Analytics. We are very pleased with our returns on this investment and continue to hold approximately 6.7 million shares of class B common with the cost basis of approximately $24 million. Class B common shares are convertible into class A shares on a share per share basis after the expiration of holding periods, and had a market value of $191 million at yesterday's closing price.

Interest and other corporate expenses increased from the third quarter period primarily due to increased borrowing costs and expenses associated with their employee benefit plans. As you will see on Slide 4, AFG's book value per share including all unrealized gains and losses on investments increased to $31.49 as a result of the strong earnings performance and a significant improvement in the market value of our investment portfolio. This represents an increase of 46% from the $21.54 per share reported at the end of 2008. Intangible book value was $29.17 at September 30th, 2009, up 53% from year end '08.

Our capital adequacy, financial condition, and liquidity remain strong, and are key areas of at the focus for us especially in these times of economic uncertainty. We have maintained capital in our insurance businesses at levels that support our operations and are consistent with amounts required for rating levels. We are pleased to have completed a $350 million debt offering earlier this year. We used the proceeds of this offering to repay an outstanding indebtedness on our bank line. While we are paying a higher rate of interest, as compared to the rates on the bank line, prudent capital management remains a priority, and we see this new debt as an additional source of financial flexibility and liquidity. Our leverage of 19% remains well below the levels committed to the rating agencies and the market. At the end of September, available liquidity at the parent Company was in excess of $500 million, based on borrowings available under our bank line and cash and securities held at the parent Company. We anticipate continuing to generate additional capital and cash through operations through the remainder of 2009.

Our cash and cash equivalents of $1.4 billion in our insurance companies, along with our annuity group's membership in the Federal Home Loan Bank of Cincinnati provide us with great liquidity to meet any unexpected events. We are pleased that earlier this month Standard and Poor's changed our rating outlook from stable to positive. We believe this change is in part recognition of our strong operating earnings and the strength of our balance sheet and capitalization.

Now, turning to Slide 5, you will see summary results of our specialty property and casualty operations. Overall, underwriting profits in the 2009 third quarter were excellent. Generating a combined ratio of 83%, a 9 point improvement over the third quarter of '08. The largest components of this improvement included $51 million of improved underwriting profit from our run off automobile residual value insurance operations, as a result of significant improvement in used car values during the first nine months of the year. And $30 million of increased profitability in our crop operations, resulting from strong crop yields and favorable trends in commodity prices. These favorable results were partially offset by reduced underwriting results in several of our other businesses. We remain satisfied with the underwriting profits of most of our specialty businesses, and we achieved accident year returns in the mid teens. We continue to focus on pricing our business to achieve appropriate returns.

The average renewal rates in the specialty operations in the first nine months of 2009 were up slightly from the prior year period. The decrease in net written premiums for the third quarter were primarily the result of changes in our reinsurance for the crop business. We have an agreement under which we ceded 90% of our net premium compared to 50% in 2008. We are considering returning to the prior level of cessions for 2010, around 50%. The related profit sharing component allows us to benefit from the favorable results in this business.

Soft market conditions and planned volume reductions in certain product lines also contributed to the premium declines. The economic downturn has impacted premium levels as some of our insureds have a lower premium base, such as in our California Workers Comp Business. Also affected, are our general liability and property lines that serve home builders who are building fewer properties. Some of these business owners also choose to reduce coverage in tough economic times. Excluding crop, the overall decrease in net written premium for the quarter was about 11%. Gross investment income related to our Property and Casualty operations was up approximately 4% for the quarter, when compared to the same period last year. As we have benefited from higher yields, in this segments portfolio.

Now I would like to discuss a few highlights from each of our specialty business groups on slides 6 and 7. Property and Transportation Group generated excellent underwriting results during the third quarter and the first nine months of 2009 reporting increased underwriting profit and improvements in the combined ratio. Higher underwriting profits were driven primarily by improved results in our crop operations and lower catastrophe losses in our property and inland marine operations. According to data provided by the USDA, average corn and soybean yield estimates are running about 7% higher than last year's yield. Harvested corn and soybean crops, however, are lower than normal for this time of year. Notwithstanding some of the uncertainty surrounding a late harvest, we expect to have a very favorable crop results for the year. Commodity pricing for corn has held up nicely since the February base pricing, while soybeans are up about 14%. Given that the majority of our business is written with a deductible for the farmer of 25% or greater we think pricing related losses will be minimal this year. This group's average rates on renewal for the first nine months of the year were down slightly when compared to the same period a year earlier.

Moving on to our Specialty Casualty group, this group continued to produce strong underwriting profits in the third quarter and the first nine months, but at lower levels than 2008. Improved underwriting results in our Executive Liability operations were more than offset by lower underwriting profits in our excess and surplus lines, general liability, and targeted markets operations. Average renewal rates for the first nine months were flat compared to 2008. Significant competitive pressure in the excess and surplus lines continues and seems to be showing little sign of abating. Some of this business has moved back to standard lines in the wake of soft market conditions and rates in the non-admitted market are at a fraction of what they were in the hard market of 2000. We continue to see aggressive competition from tax-advantaged Bermuda companies, yet we have focused on maintaining our underwriting discipline to generate healthy returns in these lines of business and deliver high quality service to our policy holders.

Specialty Financial group reported excellent underwriting profits for the third quarter and the first nine months driven by the improved results in our run-off RVI business, our remaining RVI reserves relate primarily, to Canadian RVI contracts with Honda that terminate through the end of 2010. If frequency and severity continue at current levels we would expect additional favorable development. The foreign trade credit operations achieved significant rate increases for the first nine months of 2009. Average rate renewal rates for the other businesses in this group were flat.

Our California Workers Comp business reported a small underwriting loss for the third quarter and first nine months of 2009. Underwriting results were affected by lower prices due to a competitive environment. We are seeing some increases in severity trends in this business, primarily related to increases in medical costs. We are encouraged to see rates strengthening in this part of our business as our average renewal rates in California are up 6% for the quarter. The WCIRB has recommended a 22.8% increase in pure premium rates effective January 1st, 2010. Based on 2009 loss experience, and anticipated loss costs from recent court decisions about the permanent disability ratings schedule and is subject to administrative review. We do believe that more rate is needed to achieve appropriate returns in this part of our business.

Now I would like to move to a review of our annuity and supplemental insurance group on slide 8. Profitability to fixed annuity line is benefited from increased spread during 2009. Our annuity and supplemental insurance operations help us fulfill our specialization strategy and balance the ebbs and flows of our overall property and casualty insurance market cycles. The annuity and supplemental insurance group generated pretax core operating earnings for the third quarter that were approximately 5% lower than the comparable period in 2008. However, the first nine months of these earnings are 6% above the same 2008 period. Increased spreads in our fixed annuity lines have been a primary contributor to these results. Though our operating earnings and supplemental insurance operations more than offset these improvements in the third quarter. We continue to experience strong persistency in our annuity business. For the first nine months of 2009, surrenders in our fixed annuity block are unchanged over the same period last year. As many of our annuities are designed with surrender protection features, we continue to move toward product designs that reward policy holders and agents for long-term persistency. We believe the focus on healthcare reform and Medicaid cost reduction could expand demand for supplemental health products. Statutory premiums for the third quarter of 2009 were lower than those in the third quarter of 2008, primarily due to lower sales of the indexed annuities in the single premium market. The decrease in premium is consistent with our strategy of exercising financial discipline in the pricing of our annuity products.

Now please turn to slide 9 for a few highlights regarding our investment portfolio. During the third quarter of 2009 we recorded after tax realized gains on investments of $3 million including the offsetting effect of other than temporary impairments of $17 million after tax. After tax unrealized gains were $127 million at September 30th, 2009. The vast majority of our portfolio is held on fixed maturities with approximately 92% being investment grade. We have provided additional detailed information on the various segments of our investment portfolio and the investment supplement on our website.

I would like to cover our expectations for the remainder of 2009 on slides 10 and 11. We have increased our core net operating earnings guidance for 2009 to be between $4.05 to $4.25 per share. Key factors influencing this change include better than expected underwriting results in our crop operations and favorable development in our run off RVI operations. We expect to maintain adequate rates in our Specialty Property and Casualty operations because of our strong underwriting culture, and expect to achieve a combined ratio of about 81% to 83%. That said we are targeting flat to modest increases in overall average renewal rates for the remainder of the year. We expect net written premiums in our Specialty Property and Casualty operations to be down 17% to 20% from 2008 levels, primarily due to the increased reinsurance cessions under our crop quota share agreement and a weakness in the economy. Excluding crop we expect a decline of 6% to 9%. Based on recent market conditions, we expect full year core operating earnings in our annuity and supplemental insurance group to be 8% to 10% higher than in 2008, excluding the potential effect of the customary fourth quarter review of deferred acquisition costs. We Expect that any resulting DAC write-off will not have a material impact on AFG's earnings guidance for the year. You will find additional details about our outlook for the specialty property and casualty segments on slide 11.

I would like now I would like to cover our outlook for 2010 on slide 12. We announced yesterday, that we expect our 2010 core net operating earnings to be in the range of $3.10 to $3.50 per share. This guidance is lower than that for 2009 due to the level of favorable reserve development recorded in '09, especially in our run off RVI business. The above average profitability projected in our crop operations in 2009 have continued soft market and lower investment returns expected in 2010. 2009 and 2010 expected results exclude the potential for significant catastrophe and crop losses, significant adjustments to A&E and large gains or losses from asset sales or impairments. Now we would like to open the lines up for any questions. Thank you.

(Operator Instructions) We will pause just a moment to compile the Q&A roster. Your first question comes from the line of Amit Kumar with Fox-Pitt Kelton.

Strong results. I guess just going back on your color on the rate, Bill Berkley in his comment this morning talked about the industry where he suggested that '09 accident year would be 108 to 100 and 2010 will be 110 to 112 and he forecasted that this would eventually lead to price increases of roughly 8% to 10% for 2010 and perhaps even more for 2011. Based on your business segments, and what you are seeing out there, would you directionally agree with this forecast or are you seeing something different in your business lines.

First of all let me speak to the industry and Bill's comments about the industry, it is hard to put a precise time on when things are going to happen. But the rubber has to hit the road here. With regards to increasing accident year combined ratios and the need for additional price for the industry, clearly we think we are operating with better underwriting results in the industry. So, that said, we feel our accident years today for '09 still give us the mid teens kind of ROEs but California Comp clearly we need rate, we got 6% in the quarter, but we probably need another 10% to 12% on top of that to assure us that we can produce the accident year underwriting profitability in that business that we need long term. Property and Transportation those are unique businesses.

The crop business is in a class of its own and really doesn't correlate to a lot of the other businesses in the industry which I think is probably a strength for us and it doesn't correlate to hurricane and cat exposed property or other businesses. So that business is clearly a lot different and kind of stands on its own. As well as maybe some businesses like equine mortality or financial institutions -- our financial institutions book and our specialty financial part that really is kind of a contra core economy, kind of a business where it is growing pretty good. That said, in many of our property & transportation and casualty business, we need to achieve some rate. I think our 2010 guidance clearly reflects my opinion about prices, and we are trying to reflect a very reasonable, realistic viewpoint of where accident year combineds are going for us and for the industry in that guidance.

That's very helpful. I guess just related to that, in terms of the competition I know you talked about that in the opening comment, but are you seeing sort of inflection point, where you see that the margins are being eroded for them, and hence, they are at that point where they might start pulling back, or is the aggression still the same.

I think we have in a competitive environment, not a crazy competitive environment, but generally when you listen to everybody's earnings reports -- and generally everybody, rates on renewals are fairly stable. But it is very competitive for new business. And some large competitors that have been on the ropes protecting renewals pretty substantially in that. So I would say that this is a competitive market, very competitive marketplace, not crazy at this point and I think everybody -- I think the industry is on the verge of really needing some substantial rate.

That's helpful. Can you, I guess it is related to what you just said. Can you maybe also talk a bit about the claims inflation trends you might be seeing.

Keith, do you want to speak to that? I don't think we are seeing anything unusual. I think we are California the only segment probably it is a little different, California comp where because of reform, we saw very moderate inflation in the past. I think we are back to a more normal severity or inflation mode in California Comp now that we are away from reform.

What's your forecast overall as we head into maybe coming out of this recessionary environment? When you see that change or I guess pick up down the road?

There's a chance that you could see inflation tick up a couple of years from now. Certainly it doesn't seem to be any signs right now, and in any of the industry statistics or in our claim stats. Keep in mind, AFG may be a little different in that 45% of our business is short tail property, transportation, shorter tail businesses to begin with. So, inflation probably doesn't have as big of a potential impact on reserves or long term.

Okay. That's helpful. Maybe changing gears here, can you remind us what were the remaining reserves on the RVI book? I think you mentioned in the opening comment that is if trends continue there could be a possibility of additional reserve releases.

The remaining reserves as of the end of the year were in the $50 million range.

50 million.

Both domestic and Canadian reserve.

Domestic and Canadian. There's a news release that talks about the sale of the premier dealer services to PDS holdings.

Sure. That is a third party administrator that works primarily on product in the auto market. It is an area we have strategically concluded that we are going to disengage from. We have discontinued our excess wear and tear and our gap product. This is part of that departure: it is a very small dollar value for us.

That's helpful. I guess final question, when you talk about the 2010 guidance, can you give any sort of broad guidelines similar to what you have on slide 11, what you do for '09. Can you briefly go through some of the lines and talk about 2010?

We are right in the middle of our business planning right now. Generally we release that information, but usually comes with our year-end results.

Okay. That's all for now. Thanks so much.

Thank you. Your next question comes from the line of Abe Schloss with Maxim Group.

Good morning and congratulations on a great quarter again. Just, you announced you are taking a $15 million gain on VRSK in the fourth quarter, and I am wondering how you will translate that gain and plus the unrealized gain we have in the stock with the stock of $28 into our current book value.

All of that is included in the current book value. If you think of it, we have about 117 million shares outstanding and on our remaining holdings in Verisk, they would be at a valued at yesterday's closing, in the 190 million range with 25 million of cost basis. So call that 165. So you would be approximately $1.50 of book value associated.

That's in our book value.

That's pretax. $1 after tax.

Okay. Thank you.

Thank you. And your next question comes from the line of Jay Cohen with Bank of America.

Hey a couple of questions, just to follow up on that Verisk question. So the remaining ownership that will be mark to market going forward.

Yes, that's correct, Jay.

So you will have some unrealized gain there, assuming the stock stays where it is.

Right.

I want to switch to the topic of capital. Obviously your GAAP equity has recovered dramatically. Statutory surplus has continued to creep up. Premiums shrinking, it looks like just based on simplistic measures, that you're getting back to a level of excess capital. I know you guys think about it relative to the rating agencies. I am wondering how you feel about your capital relative to what is needed from a rating standpoint.

We feel real good that we have got over $500 million of liquidity. We are at the capital levels we need for the business, and so that -- we are -- that allows us to do what we do best, and that is find things to businesses to add, businesses to acquire. We are always looking. Also it gives us the flexibility to potentially repurchase shares, if we feel that is a good investment. And we just increased our common stock dividend. So, I think between those three kind of things, those are the kind of things we are looking for as well as the normal organic growth opportunities. So the economy clearly is slowed the opportunity for the usual organic growth.

I think the other thing, Jay that I would highlight is we are doing all of those things in a parent holding company perspective but in the operating companies from a statutory perspective, the level of capitalization is at the top end or above the capital required for the rating categories depending on whether you look at the BCAR or the S&P cap adequacy.

I think Jay even with the recovery in the market, after such a volatile couple years in the economy, we want to keep a little powder dry, not just to -- for potential opportunities, or defensively. Things continue to bounce around a little bit.

So you think about the opportunities to deploy excess capital. With your stock trading 80% of reported book value, does that make share repurchase a more attractive alternative if your goal is to grow book value per share.

I would think so.

I'm assuming in your 2010 guidance, there is no share repurchase activity assumed in that guidance?

That's correct.

Okay. That's great. Thank you.

Thank you. (Operator Instructions) You do have a follow up question from Amit Kumar with Fox-Pitt Kelton.

The last question in terms of your capital levels, are there any segments or specific lines you would be interested in sort of expanding down the road?

I think outside of the businesses, Keith talked about, the auto related financial product -- financial insurance products, we are interested in expanding really pretty much all of our businesses as the right opportunities come along.

So no new entities or niches I guess?

Sure. We're interested in starting new niches. We started an environmental liability business over the last 12 to 18 months and we are always starting things up and always looking. So pretty good time to look at things, too.

Right. Right. Okay. That's pretty much it. Thanks again and once again congrats on the quarter.

Thank.

Thank you.

Thank you. There are no further questions at this time. I would like to turn the call back over to the floor for any closing remarks.

Thank you very much. We appreciate your taking the time to be with us this morning, and we look forward to reporting our year-end results early next year. Thank you. Have a good day.

Thank you, ladies and gentlemen. This does conclude today's conference call. You may now disconnect.