American Financial Group Inc (AFG) 2010 Q4 法說會逐字稿

Good morning. My name is Latonya and I will be your conference operator today. At this time I would like to welcome everyone to the American Financial Group 2010 fourth-quarter and full-year earnings conference call. All lines have been placed on mute to prevent any background noise. After the speakers' remarks, there will be a question-and-answer session. (Operator Instructions)I would now like to hand the floor to Mr. Keith Jensen, Senior Vice President of American Financial Group. Thank you. Mr. Jensen, the floor is yours.

Thank you. Good morning and welcome to American Financial Group's 2010 fourth-quarter earnings results conference call. I'm joined this morning by Carl Lindner III, co-CEO of American Financial Group. If you are viewing the website from our web -- I'm sorry, 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 and are based on estimates, assumptions, and projections, which management believes are reasonable, but by their nature subject to risk and uncertainties. The factors which could cause actual results and/or financial condition 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 the quarterly reports on Form 10-Q. We do not promise to update such forward-looking statements to reflect actual results or changes and 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 generally not considered to be part of ongoing operations, such as net realized gains or losses on investments, the effect of accounting changes, discontinued operations, significant asbestos and environmental charges and certain other nonrecurring items. AFG believes the non-GAAP measure to be a useful tool for analysts and investors in analyzing ongoing operating trends and will be discussed for various periods during this call. A reconciliation of net earnings attributable to shareholders to core net operating earnings is included in our earnings release. Now I'm pleased to turn over the call to Carl Lindner III to discuss our results.

Good morning and thank you for joining us. We released our 2010 fourth-quarter and full-year results yesterday afternoon. Although less than our record results last year in 2009, our overall core net operating earnings were solid. Throughout the recent economic cycle, Craig and I have been pleased that we've achieved solid operating results through specialization and segmentation of our businesses. We want to thank God for his blessings and thank our talented management team and employees for their efforts this year and for the financial strength that allows us to pursue the plans for our organization to benefit our customers, agents, shareholders and employees over the long haul.

I'm assuming that everyone on today's call has reviewed our earnings release and the supplemental materials posted on the website. I'll review a few highlights and focus today's discussion on key issues. I'll also discuss our outlook for this year.

Let's start by looking at our 2010 results summarized on slides 3 and 5 of the webcast. Net earnings were $4.33 per share for the year. This included realized gains of $0.41 per share, which included $0.15 per share from the sale of a portion of our remaining interest in Verisk Analytics during the third quarter. Our core net operating earnings were $433 million, or $3.92 per share, compared to the prior-year's record results of $493 million, or $4.23 per year -- per share. A decrease of $104 million in pre-tax core earnings as compared to 2009 was primarily due to lower property and casualty investment income, lower favorable development in our runoff RVI business, crop earnings that, although very strong, were less than 2009 record levels, and catastrophe losses that were significantly greater than in the prior year. These items were partially offset by increasing earnings of our annuity and supplemental insurance business. The core operating return on equity for 2010 was approximately 11%. Annualized average return on equity on a comparable basis over a five-year period was approximately 14%.

One of our important strategic objectives is to deploy our excess capital in a way that enhances shareholder value. To that end, we continued our share repurchases and purchased 2.9 million shares of our common stock, at an average price of $31.39 per share during the 2010 fourth quarter. For context, the total shares repurchased during 2010 represent about 9% of AFG's outstanding shares at the beginning of the year. The average price of the shares repurchased during 2010 was $28.46 per share, or approximately 80% of year-end 2010 tangible book value per share. We feel this remains an effective means of increasing shareholder value. We returned capital to shareholders through $292 million in share repurchases, and $63 million in dividends. As of February 3, 2011, there were 2.4 million shares remaining under our current repurchase authorization. Management intends to recommend an extension of this authorization at our next board meeting.

As you'll see on slide four, AFG's book value per share, excluding appropriated retained earnings and unrealized gains from losses on fixed maturities, increased to $37.54, an increase of 14% from the $32.92 per share reported at year-end 2009. Tangible book value on a comparable basis was $35.24 at year-end 2010, up 15% from year-end 2009. Our capital adequacy, financial condition and liquidity remain strong, and are key areas of focus for us, especially as economic uncertainty continues. We've maintained capital in our insurance businesses at level -- levels that support our operations, or in excess of amounts required for rating levels. At the end of the year cash at the parent Company was approximately $375 million, with excess capital of $850 million. A summary of core operating results for the fourth quarter and full year appears on slide five.

On slide 6 you'll see summary results for our specialty property and casualty operations. We continue to focus on pricing our business to achieve appropriate returns. Accordingly, we've adjusted our planned premium levels to be consistent with what we feel acceptable returns are. The average renewal rates in the specialty operations during 2010 were flat compared to the prior year. Competitive pressures and lower spring agricultural commodity prices contributed to declines in gross written premiums during 2010. These declines were partially offset by premiums resulting from the third-quarter 2010 acquisition of Vanliner, premium growth from Marketform and higher fall agricultural commodity prices. Net written premiums for the full year increased, primarily as a result of a return to historically lower level of cessions under our crop quota share agreement. Gross investment income related to our property and casualty operations was down about 19% in 2010, when compared to the prior year. This is primarily due to decreased holdings in higher yielding investments and generally lower reinvestment rates, as we discussed during the last quarter's call.

Now I'd like to discuss a few highlights from each of our specialty business groups on slide seven and eight. The Property and Transportation Group reported 2010 underwriting profits that were about 40% lower than in 2009. Favorable crop yields contributed to strong results in our crop operations for the year; however, the results were lower than the record profitability that we had in 2009. Additionally, during 2010 this group incurred catastrophe losses due primarily to Midwest storms. These losses were approximately $30 million greater than the catastrophe losses in the prior year. Sustained competitive market conditions and lower favorable reserve development also contributed to the year-over-year decline in underwriting profit. We are pleased that almost all of our Property and Transportation businesses reported strong underwriting profits for the year. Average renewal rates for this group during 2010 were slightly down compared to the prior-year period.

Our Specialty Casualty group reported underwriting profits for 2010 that were 25% lower than 2009. The decrease was due to lower profitability in our general liability operations, primarily those that serve the home builders market, as well as in our California workers' comp business. These decreases were offset somewhat by improved results in our executive liability, targeted markets and excess and surplus lines operations. The majority of businesses in this group again produced excellent underwriting profit margins for the year. 2010 was impacted by underwriting losses in Marketform, primarily the result of the deterioration in the Italian med mal reserves. We didn't require any reserve increases in the fourth quarter of 2010, though. Average renewal rates for this group during 2010 were flat compared to the prior-year period.

Specialty Financial group reported lower underwriting profits during 2010, reflecting lower favorable reserve development, particularly in our runoff automobile residual value Insurance operations that was $50 million less than the prior year. The remaining leases associated with this business are de minimis at this point. All other businesses in this group produced excellent underwriting profit margins for the year. Average renewal rates for this group were flat during 2010.

Now I'd like to move on to a review of our annuity and supplemental insurance group on slide nine. Full-year 2010 core operating earnings before income taxes were 21% higher than in 2009 due to expense savings and improved results in our fixed annuity and supplemental businesses, driven by wider spreads and higher growth in our fixed annuity operations. These improvements were offset somewhat by lower earnings in our variable annuity business. Results for the 2010 fourth quarter included a $25 million pre-tax charge related primarily to the write-off of deferred acquisition costs in our fixed annuity business. This charge was recorded in connection with our review of major actuarial assumptions and included management's expectations of future interest rates and changes in future annuitization assumptions. Results in the fourth quarter of 2009 included a $13 million DAC write-off that was also related to the fixed annuity business.

Statutory premiums increased considerably over 2009 periods due to higher sales of single-premium annuities sold through banks and indexed annuities. In fact, the American Bankers Insurance Association recently announced that AFG's wholly- owned subsidiary, Great American Financial Resources, ranked in the top five in fixed annuity sales by banks and other depository institutions for the third-quarter 2010. We continue to experience strong persistency in our annuity businesses and remain committed to product designs that reward policyholders and agents for long-term persistency.

Now let's turn to slide 10 for a few highlights regarding our investment portfolio. During 2010, we recorded after-tax, after-DAC, net realized gains of $46 million compared to $26 million in 2009. We're pleased that our $3 billion non-agency RMBS portfolio has generated an annualized total return since year-end 2007 that has significantly outperformed other fixed income indices over the same period. After-tax, after-DAC, net unrealized gains were $475 million at December 31, 2010. This number reflects an after-tax, after-DAC, unrealized gain on fixed maturities of $326 million. The vast majority of our investment portfolio is held in fixed maturities, with approximately 91% rated investment grade and 95% with a designation of NAIC I or II.

With much of the growing concerns surrounding solvency issues in various municipalities I'd like to take a moment to talk about our municipal investment portfolio, which we've outlined on slide 11. Our investment strategy for municipal securities has been consistent for many years. Our municipal bond portfolio is high quality, with approximately 95% rated NAIC I. The portfolio is well diversified across the states of issuance and individual issuers. Our holdings of state general obligation securities of California, Illinois, New Jersey, and New York, represent only 2% of our municipal bond portfolio. Approximately 70% of the portfolio is held in revenue bonds, while the remaining 30% is in general obligation bonds. We have provided additional detailed information on the various segments in our investment portfolio in the investment supplement on our website.

Now I'd like to cover our outlook for 2011 on slide 12. Our 2011 core net operating earnings guidance is $3.30 to $3.70 per share. 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 between 88% and 92%. We expect net written premiums in our specialty property and casualty operations to be 7% to 11% higher than 2010.

The Property and Transportation Group is expected to produce a combined ratio in the 87% to 91% range. Guidance assumes normalized crop earnings for the year, and also a reduction of approximately $20 million in crop operating results as a result of the 2011 standard reinsurance agreement, or SRA. Guidance assumes that the current corn and soybean prices hold through the February discovery period. We expect this group's net written premiums to increase by approximately 9% to 13%, mostly as a result of projecting higher spring commodity prices and National Interstate's acquisition of Vanliner.

We expect the Specialty Casualty Group to produce a combined ratio in the 92% to 96% range. We anticipate net written premiums will be down 1% to 5%. We plan to generate about $50 million in premium in blood stock, equine, specie, inland marine, ocean marine and political risk coverages through our Marketform subsidiary in 2011, an increase of about $10 million over 2010.

We look for the Specialty Financial group's combined ratio to be between 84% and 88%. Because of the ceding of the unearned premium associated with certain of our non-RVI automotive-related businesses during 2010, we project net written premiums to be up 28% to 32% in this group. As we talked about last quarter, the continued runoff and disposition of securities in our non-agency RMBS portfolio, as well as generally-lower reinvestment rates, will result in continued pressure on investment income. We estimate that 2011 investment income in AFG's Property and Casualty segment will be about 10% lower than 2010. Our investment focus is to achieve appropriate risk-adjusted returns with a total return orientation.

Based on recent market conditions and trends, we expect 2011 full-year core pre-tax operating earnings in our Annuity and Supplemental Insurance Group to be 15% to 20% higher than last year. Given the growth expected in 2011 in the Annuity and Supplemental Insurance business, this segment's investment income is expected to exceed that of the current year. These 2011 expected results exclude the potential for significant catastrophe and crop losses, significant adjustments to A&E reserves, large gains or losses from asset sales or impairments, and unlocking adjustments related to the annuity deferred acquisition costs.

Now we'd like to open the lines for any questions. Thank you.

Thank you. (Operator Instructions). And your first question comes from the line of Amit Kumar with Macquarie.

Thanks and good morning. Congrats on the quarter. I guess two questions; one is a bigger picture question and the second one is on guidance. Some of the larger commercial companies, such as Travelers, Chubb and WR Berkley, have talked about modest exposure improvement and rates being flat to modestly down. Can you talk about what your expectation is for rates and exposure for 2011?

Sure. I think on the property and casualty side our goal is to try to nudge prices upwards some. Realistically, with the current competitive conditions, if we can end up the year flat that would probably be a pretty good result. I'm optimistic that there may be some pricing traction maybe later on this year. As far as exposures, our workers' comp business is probably the place where we've seen some slight change. There's been three months of a small single-digit increase in payrolls, if you include January. That said, unemployment went up in California, I think, to 12.9% here recently, so still a tough economic situation in the state of California. And I think on other businesses, like homebuilders and that on liability, I think we've seen some stabilization in payrolls. Probably don't see quite -- we don't see it quite as much -- as far as any small increases as what we see in the comp side of our business.

Got it, that's helpful. And then just quickly moving on to guidance and then I'll requeue. In terms of -- maybe just starting from the top, the property and transportation expectation, can you break out the expectation from Vanliner for 2011? I know you mentioned the crop change of $20 million or so, but can you just remind us what that number is?

On the crop side, I think that related to SRA impact, negative impact on the crop earnings side. Crop premiums, if the current prices hold during the February discovery periods, I would think we might see our direct or gross premiums in that go up 30% or so. We won't actually know until the end of the discovery period and what the actual prices for corn and soy bean are, and that. So as far as the crop business, that's our -- that would be our best guess in that. Keith, you want to talk to National Interstate and Vanliner?

Sure. As was disclosed at the time we bought Vanliner, there is a portion of that business that is dedicated to moving and storage and that was our prime interest. We expected at the time that we would have premiums in the $100 million a year range on an ongoing basis. National Interstate has not reported earnings yet so it's not appropriate yet for us to give specifics but -- other than to say that we're within a reasonable range of that expectation.

All right. And then just finally, and I'll requeue. On the annuity and supplemental life side, you talked about changes in expectations of lowering your reinvestment rate and changes in future annuitization assumptions. Can you just talk what those assumptions are and what the changes were? That would be quite helpful.

Well, the changes are really coming -- if you look at the table that's in the press release, you'll see that there's been a significant increase in the reduction through the bank line and that's a result of two major things that have happened in this past year and we expect to continue fueling the growth on a go-forward basis. First of all, as you know, PNC bought National City so we were able to access -- in the PNC side we're their leading provider, so that means there's been a multiple of retail branches that we've been able to go into that were not previously available. And there's a line that we've called Bank Indirect, which is really brokers and agents that write business for other banks, and so among the banks we added to the portfolio this year would be Regions and BB&T. That continues to be an area of emphasis for us and it will be a significant driver of future growth.

With respect to profitability, we have made some assumptions and you saw that we have taken a charge during this quarter for deferred acquisition costs. That's due to a change in our expectation of reinvestment rates over the next few years and we've ratcheted those down a bit from what they were in prior years. That ratcheting down was partially offset by increasing our expectation with respect to expense benefit of changes that we're making in our expenses, as well as some changes -- well, I guess those are the two -- no, I'm forgetting one -- oh, yes, as well as an assumption that there would be a lower crediting rate on a go-forward basis that matches somewhat the decrease in that assumption of the reinvestment rate.

Got it. That's helpful. I'll requeue. Thanks.

Thank you. (Operator Instructions). And your next question comes from the line of Jay Cohen with Banc of America-Merrill Lynch.

Yes, thank you. I guess the question was on your estimate for what you think excess capital is. I think you said $850 million. You have to maybe remind me -- I thought that number was quite a bit lower when you've talked about that number in the past, but remind me what you had been saying and if it is an increase in excess capital, what's the source of that?

It is somewhat of an increase, although not dramatic. As I think back, I think in the third quarter we were talking in terms of a $600 million to $650-ish million number, if I remember right. But excess capital, the way we've defined that, it's parent Company cash, plus the amount that we can borrow against our line of credit and still stay within the 22% commitment on financial leverage that we have made to the rating agencies. Plus any excess capital that's in the insurance companies that could be taken out of the insurance companies and still meet the capital adequacy requirements of the rating agencies for the surplus of the insurance companies. So it's really got those three components in it, Jay.

So I guess what's happened that as you continue to buy back stock, that excess capital number continues to grow. I remember that being, I think it was $400 million, maybe three or four quarters ago, then $600 million, now $850 million. Where's the growth coming from? Is it in the insurance subs? You're simply not growing, and thus freeing up capital?

Right. Because as you stay flat in terms of the size of your premium, you're not creating additional capital demands and more of the earnings flows directly to excess capital.

Got it. I guess your buybacks have been less than your earnings?

Correct.

And to a lesser extent, we've -- the equities have gone up some, particularly Verisk.

Got it. And what's the go-forward plan for the investment portfolio at this point?

Well, the general action you'll see us taking a little bit more of a position in equities, not dramatic, but a little bit. We had increased our penetration in municipals. We think this is an opportunistic time to be buying, as long as we are very disciplined in those purchases. We're continuing to have some annual runoff of the mortgage-backed securities which we're taking primarily into higher grade corporates. I don't think you should expect to see a dramatic sort of earth change, but those would be the trends that I would expect us to see over the next year.

And some selective real estate -- increasing our real estate investments on an opportunistic basis and --

Yes, it sounds like -- seems like a number of those moves are opportunistic in nature, which I guess does fit your past MO from an investment standpoint. That's helpful.

All right.

Thank you. (Operator Instructions). We do have a follow-up question from the line of Amit Kumar of Macquarie.

Thanks. Three quick follow ups. First of all, just going back to the discussion on growth from Marketform, just -- I know we've had some reserve additions from that segment operation and now you're talking about growing from that. Maybe just talk a little bit about what gives you comfort that we won't see some of the issues we have seen in the past regarding reserve additions?

Again, the reserve changes have been from Italian hospital business, which we haven't been writing for really about two years. Our non-US med mal business has not really substantially grown. Where the growth is coming from are in a few businesses that we have -- that we wanted to expand our footprint and where we've done very well historically, things like blood stock, equine, fidelity, specie, ocean marine, where we're just accessing the international market where we didn't have any access. We were seeing risks in the past but we didn't have the platform to write those. We've invested in -- over the past couple years we've invested in top-notch talent --underwriting talent in each of those areas and the real growth in Marketform is really coming from those lines, not med mal.

So when you say it's top talent, so essentially it's the older relationships which these people have which will result in the growth or do you think there's --

All these people came out of syndicates that -- they came out of syndicates that were well-known and where the individuals were well-known with good underwriting track records and experience. And we're the largest writer of equine mortality in the United States, for instance, but there's quite a few horses in that, particularly on the thoroughbred side, that we weren't getting access to that Lloyd's and that market really had access to. So we've been able to expand our footprint and use the knowledge base that we already have to access business in other countries that we couldn't access before.

We're the num -- I believe we're probably one of the top three armored car and casino writers in the fidelity and crime in the world. We've been able to access the world market. Some -- but, again, Lloyd's, that's one of their historical specialities and we've been able to access business that we couldn't access before.

Ocean marine, we were doing a strategic review of ocean marine -- I think it was about a year ago or so -- and there was kind of a startling number when -- of the -- when you look at where the world's ocean marine business is sourced, I think 50%, 60% was -- or 50% or so was sourced out of Europe in that. And only having a US operation you just didn't get access to the larger ocean Marine market, so for us, that was really a necessity to gain access to that if our business was going to grow, where a lot of the world's growth today is outside of the US.

Hopefully you're not growing in -- around Suez Canal, right?

There you go. (laughter)

Just two other quick questions, on one of them on capital management. Does your guidance -- and I apologize if I missed this -- factor in any buybacks?

Yes, I think it assumes a similar amount of buybacks as what we had last year.

Okay, that's helpful. And just finally, some companies have talked about probably passing the inflection point on the loss trends. Can you just quickly talk about the frequency and severity of trends in your lines?

Yes, we have 25 different businesses. We could spend a lot of time. California comp, again, is only 4% or so of the -- 5% of the business, Amit, but that's probably the business in the stable of businesses that we have where we've seen frequency and severity begin to tick up after four or five great years after reform, where it went the opposite direction. Almost couldn't get any lower than that. And I think that's probably the line of business where we've seen a distinct change. Most of our other businesses have excellent profitability and loss costs still seem pretty benign. I think we've definitely been helped, as well as the industry, by loss costs -- the inflation of lost costs, which has been more benign than what all of us would have thought.

Got it. Thanks, thanks for all the answers.

Thank you. There are no further questions at this time. I would like to return the floor for closing remarks.

Thank you. We appreciate your taking the time with us this morning and we'll look forward to reporting at our first quarter. Thank you and have a good day.

Thank you for participating in today's American Financial Group's 2010 fourth-quarter and full-year earnings conference call. You may now disconnect.