American Financial Group Inc (AFG) 2011 Q1 法說會逐字稿

Good morning, my name is Bonnie, and I will be your conference operator today. At this time, I would like to welcome everyone to the American Financial Group 2011 first quarter earnings 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 now like to turn the call over to Mr. Keith Jensen, Senior Vice President. Please go ahead, sir.

Thank you very much. Good morning, and welcome to American Financial Group's 2011 first quarter earnings results conference call. I am joined this morning by Carl Lindner III and Craig Lindner, Co-CEOs of American Financial Group. If you're viewing the webcast from our website, you can following 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 they are based on estimates, assumptions and projections which management believes are reasonable but by their nature subject to risks and uncertainties.

The factors that could cause actual results and/or financial condition to differ materially from these suggested by the forward-looking statements include and are not limited to those discussed or identified from time-to-time in AFG's filings with the Securities & 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 annual results, or actual results or changes in assumptions, or other factors that could affect these statements.

Core net operating earnings is a non-GAAP financial measure which sets aside significant items that are generally not considered to be part of ongoing operations. These include net realized gains or losses on investments, the effects of accounting changes, discontinued operations, significant asbestos and environmental charges, and certain other non-recurring items. AFG believes that this non-GAAP measure to be a useful tool for analysts and investors as they analyze ongoing operating trends, and these will be discussed during various periods during the call. A reconciliation of net earnings attributable to shareholders to core net operating earnings is included in our earnings release.

Now I am pleased to turn the call over to Carl Lindner III to discuss our results.

Good morning and thank you for joining us. Yesterday afternoon we released our 2011 first quarter results. Although our core net operating earnings per share were down approximately 11% from the comparable 2010 period, we're pleased to report solid operating results that were consistent with our overall expectations. We are especially pleased with our continued strong property and casualty operating results, in a challenging property and casualty market place and the record operating results posted by our annuity and supplemental group. We believe that our specialization strategy and the strong alignment of interest, we have created with the leaders with each of our specialty business units have contributed to these results.

I am assuming that the participants on today's call have reviewed our earnings release and the supplemental materials posted on our website. I'll review a few highlights and focus today's discussion on a few key issues. I'll also briefly discuss our outlook for the remainder of 2011. Let's start by looking at our first quarter results summarized on slides three and four of the webcast.

Net earnings per share were $0.79 for the quarter, 15% lower than the comparable 2010 period. 2011 results included realized losses of $0.02 per share, and reflect the impact of share repurchases during the last two years. Our core net operating earnings were $86 million, or $0.81 per share, compared to the prior year's results of $103 million, or $0.91 per share. Record operated earnings in our annuity and supplemental insurance group were more than offset by lower underwriting profit in our specialty property and casualty insurance operations, and lower property and casualty investment income.

Annualized core operating return on equity was approximately 9%. 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 2.5 million shares of our common stock at an average price of $34.04 per share during the first quarter of 2011. The average purchase price was approximately 89% of book value per share as of March 31st, 2011.

We feel this remains an effective means of increasing shareholder value. There are approximately 10.2 million shares remaining under our current repurchase authorization which our Board extended in February this year. Share repurchases are one of the several alternatives for deployment of excess capital. In addition, we continue to strive for healthy profitable organic growth, and look for opportunities to expand our specialty niche businesses through start-ups or acquisitions where it makes sense to do so.

As you'll see on slide four, AFG's book value per share excluding appropriated retained earnings and unrealized gains and losses on fixed maturities increased 2% during the quarter to $38.33. Tangible book value on a comparable basis was $36.02 at March 31st, 2011, up 2% from year end 2010. Our capital adequacy, financial condition and liquidity remain strong and are key areas of focus for us. We've maintained capital in our insurance businesses at levels that support our operations and are in excess of amounts required for our rating levels. At the end of the first quarter, our excess capital was $890 million, which included cash at the parent company of approximately $330 million.

On slide five, you'll see summary results for our specialty property and casualty operations. Property and casualty specialty insurance operations generated an underwriting profit that was lower than the first quarter of 2010. The reduced profit is primarily the result of a $24 million decrease in favorable reserve development when compared to 2010 first quarter results. The combined ratio was 92, 5 points higher than the first quarter 2010.

The recent tornados in the United States, as well as the catastrophic natural disasters in Japan, Australia, and New Zealand, and the unrest in North Africa and the Middle East have all been sobering. We pray for God's blessing upon the many people that have been so heavily affected. Our catastrophe losses of $8 million in the 2011 first quarter were comparable to the amounts reported in the prior year. We're in the early stages of assessing our loss results from the most recent tornados and severe storms in the US. Our losses in Japan, Australia, New Zealand are minimal.

These events reinforced the wisdom in our taking an active approach to managing catastrophic risk, specifically quake and hurricane. Giving consideration to the changes recently introduced by RMS-11, our 1 in 250 year wind and quake exposures are less than 2% of shareholders equity. We have received preliminary notice of some potential claims arising primarily from Marketform's political-risk business in Africa and the Middle East. Typically, there's a 180-day period associated with political risk insurance during which the result of the unrest is assessed.

We're in that period and have commenced the early stages of investigation. AFG's share of any potential loss will be after the application of available reinsurance, potential subrogation recovery, and will be substantially limited to our proportional share of Marketform. We don't believe that the impact of notices received to date will be material to AFG. However, it's a volatile environment, and we're continuing to monitor and in which additional notices are possible.

While rains continue in much of Mid-west prompting some questions about excess moisture for crop insurers. For the most part, there isn't any meaningful loss to potential corn yields in much of the Mid-west unless planting is delayed until late May. Soybean planting would need to be delayed until late June before any meaningful loss of yield potential would occur. We continue to monitor the situation closely, although it's a little early to get overly concerned about excess moisture and preventive planting circumstances.

Gross and net written premiums were up modestly in the 2011 first quarter compared to the same quarter a year ago. Additional premiums from National Interstate's third quarter 2010 acquisition of Vanliner were offset somewhat by lower premium volume in our targeted markets operations, and the decision to exit our excess workers comp business. Overall average renewal rates for the first quarter of 2011 were flat when compared to the prior year period. While the business environment continues to be competitive, we are achieving price increases in more of our businesses.

Gross investment income related to our property and casualty operations was down approximately 20% during the first quarter of 2011 when compared to the first quarter of the prior year. This is primarily due to decreased holdings and higher yielding investments, and generate lower re-investment rates as we discussed during the last quarter's call.

Now I would like to discuss a few highlights from each of our specialty business groups on slide six. Property and transportation group reported first quarter 2011 underwriting profits of $33 million. About 4% higher than in the prior year period. Improved results in our agricultural operations were offset by lower underwriting profits in our transportation businesses, particularly those that serve independent owner/operators.

Catastrophe losses in this group were $5 million compared to $8 million in the prior year period. Almost all of our property and transportation businesses reported strong underwriting profits during the first quarter of 2011. Our average renewal rates for this group during 2011 so far were flat compared to the prior year period. Our specialty casualty group reported a first quarter 2011 underwriting profit of $2 million compared to an underwriting profit of $18 million in the first quarter of 2010. The lower underwriting profits were due primarily to a $19 million decrease in favorable reserve development.

Lower underwriting profits and a book of program business contributed in large measure to these results. Improved profitability in our general liability operations primarily those that serve the homebuilders industry, as well as in our executive liability and excess and surplus lines businesses, partially offset these results. Average renewal rates for this group during the first quarter of 2011 were up 1% compared to the prior year period. Specialty financial group reported underwriting profits of $10 million in the first quarter of 2011 compared to $21 million in the first quarter of 2010. Lower favorable reserve, favorable development resulting from a reserve increase and a run-off book of collateral mortgage protection insurance, and the absence of favorable development related to our run-off automobile residual value insurance operations more than offset higher underwriting profits in our financial institutions business. Average renewal rates for this group during the first quarter were down 1% compared to the prior year period.

Now let's move on to review of our annuity and supplemental insurance group on slide seven. The annuity and supplemental insurance group generated record core net operating earnings before income taxes of $52 million for the 2011 first quarter. 18% higher than the same period a year earlier. These results reflect higher earnings in our fixed annuity operations, especially our bank distribution channel, as well as the impact of expense savings. Record statutory premiums of $779 million in the first quarter were 57% higher than the first quarter of 2010, primarily as a result of higher sales of annuities in the bank market. 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 please turn to slide eight for a few highlights regarding our investment portfolio. During the first quarter of 2011, AFG recorded after tax after DAC. realized losses of $3 million, compared to net realized gains of $3 million in the prior year period. After tax, after DAC unrealized gains on fixed maturities were $334 million, an increase of $8 million since December 31st, 2010. The vast majority of our investment portfolio was held in fixed maturities, with approximately 91% of our fixed maturity portfolio rated investment grade, and 96% with a designation of NAIC 1 or 2.

As we discussed last quarter, the continued run-off and disposition of securities in our non-agency RMBS portfolio as well as generally lower reinvestment rates has resulted in continued pressure on investment income. We have provided additional detailed information on the various segments of our investment portfolio in the investments supplement on our website.

I would now like to review our outlook for 2011. Our 2011 core net operating earnings guidance remains in the range of $3.30 to $3.70 per share. We expect results in our property and casualty and annuity and supplemental businesses to be consistent with the guidance provided in our call last quarter with a few minor adjustments. We now expect net written premiums in our specialty property and casualty operations to be 9% to 13% higher than 2010 levels. And we expect the property and transportation groups net written premiums to increase by approximately 14% to 18%, primarily as a result of projected higher spring commodity prices and National Interstate's acquisition of Vanliner. Additionally, we now estimate that 2011 investment income in AFG's property and casualty segment will be down approximately 12% for the full year.

A summary of our 2011 guidance is outlined on slide nine for your convenience. These 2011 expected results exclude the potential for significant catastrophe and crop losses, significant losses from political unrest, significant adjustments to asbestos and environmental reserves, large gains or losses from asset sales or impairments, and unlocking adjustments related to annuity deferred acquisition costs.

Now we would like to open the line for any questions. Thank you. Bonnie?

(Operator Instructions). Our first question comes from Amit Kumar of Macquarie.

Thanks and congratulations on the results. Just quickly maybe starting with Marketform, you said you don't expect the impact to be material. How do you define materiality?

We're thinking of that in the sort of traditional thought process against earnings of in the 5% to 10% sort of a subjective view of where materiality thresholds would be.

Okay. That's helpful.

And then maybe just staying on Q2, can you talk about the, I am I apologize if you talked about this. The recent tornados and the recent storms, do you have sort of an early view how that could also impact Q2 results?

Amit, I think it's probably too early for us. It's going to take us a few more weeks to kind of really get our arms around it. We have claims reported from a number of our business units with the largest activity from our agricultural business or financial institutions in our property among rain. But it's going to take us probably a few more weeks to really kind of get our arms around it.

Okay. That's helpful. Just going back to the crop discussion and obviously there's a lot of talk about delayed planting and it being at an all-time low compared to the past history, and corn is half of your top line. Maybe just revisit the discussion on cessions and losses, and what does happen if it is in fact delayed meaningfully?

Let's talk maybe about prevented planning just for a second. If preventive planning coverage would be triggered, it's typically, 60% of the coverage that would otherwise have been provided. That might be one thing to start with. But let's back up just for a second. Probably for preventive planning coverage to trigger, you're going to have to have unfavorable planning conditions that would need to persist until early June for corn, and probably early late June, early July for soybeans.

Really, corn goes into the ground before soybeans, and corn, I mean corn needs to probably get in by late May. And soybeans probably need to get in by late June. So it's a little early to really get too worried. While you're asking, though one interesting thing here recently was is the flooding of the Army Corp of Engineers, destroying a levee in a couple of different spots, and the flooding I think was 120,000 acres on that. We've done kind of a quick take on that.

I think the industry will probably be talking to the government around whether there really is loss or not. But let's assume there is a loss. Based of the last year's figures, we probably have about $3.5 million of liability in that particular area.

That is helpful.

And can you sort of go back, and I know there was a lot of price sort of volatility in 2008. Can you just remind us, when you look at 2008 and look at things today, how does it compare?

Well, I can speak to today. Generally the current prices, futures prices, and that are above the spring strike prices by quite a bit.

So even if there's some speculation within the market which would bring prices down, that doesn't overly concern us at this point. Generally it's when you have a drop in prices that exposes you more in that. So I mean right now, if you take a look at the price of corn versus the discovery price, I think it's up probably 50%, soybeans up pretty close to the same amount. Yes if the worry is speculation and that. I think there's plenty of room probably for any kind of speculative bubble to adjust there, without it having some huge impact on us.

Alright. And then just one question and I will requeue after this. You talked about RMS-11. How does that impact your re-insurance purchase, or your top process behind your re-insurance purchase?

Well, we have January 1 renewal, so we don't have anything, that we're facing immediately. Last year our catastrophe cost went up I think low teens. When really talking to our re-insurers, quite a few of our re-insurers actually used a more conservative estimate than what RMS was in that. So RMS itself I think will have maybe some impact, will create a greater demand for coverage. In our case, I'm not really sure it really makes a whole, I don't think it's going to have that big of an impact with regards to our renewal.

I think our own experience this year will be a big driver. And then I think probably overall, I think there is going to be more pressure just from the worldwide storms. The storms here in the US, what has gone on in New Zealand, Australia. I think those are going to be the bigger driver on what the industries, what the re-insurers charge going forward, particularly to those who get hit hard in that. I think that will be the bigger drivers, worldwide storms versus RMS-11.

Got it. That's all for now. I will requeue, thanks.

Our next question comes from Jay Cohen of Merrill Lynch.

Thank you. Let's see, I'll start with maybe these political risks claims that you talked about from Marketform. I assume first of all, there is nothing in the first quarter for these potential losses?

That's correct.

And then secondly, what are the events that give rise to claims here? I always think about this business more in the form of nationalizations, or some sort of confiscation. What are the events that give rise to a claim?

There are two different, we write a small trade credit book out of FCIA in the United States, which is primarily trade credit, and then through Marketform we write a small book that would deal with things like political risk contract frustration. Let's talk about trade credit first. It would be kind of like a contract with a private company covering default or non-payment with no contractual right to do so. So example, if a beef company exports beef to a food distributor in a foreign country and the buyer refuses to pay without the right to do so. That would be an example of trade, a trade credit.

Contract frustration. An example would be a contract where the government or government-owned entity that covers cancellation for non-payment, government intervention or non-performance due to war, civil war, insurrection in the buyer's country. So an example might be a major oil company contracts to buy oil from the state oil company of Saudi Arabia. Civil war makes the export impossible. After a 180-day waiting period, coverage would be possible.

Political risk. That might be, an example might be a mobile oil rig that is destroyed during a civil war, or the government taking of a fixed asset or mobile goods following the abandonment because of the evacuations, government failing to issue a permit to export, confiscation, destruction due to riots, civil war, that type of thing.

Got it. So places like Egypt, some of these things obviously seem to be happening to some extent, and thus you may have some claims?

Right.

But it is important to focus, Jay, on the fact that even when an event happens, there is this 180-day period which is really trying to give time in the contract for resolution of the event, and as we've seen in some of these countries from the first sort of hint that there's going to be political unrest until it's all over, is really a relatively short period of time, and so if the asset comes back into production, or the trade credit is subsequently paid, you don't get hit for it because it was in a risk for a period of time.

Or in the case of oil, if there's a new government and that contract, the insurer renegotiates or the company renegotiates the contract with the new government and the contract is performing, then there wouldn't be a loss.

Got it.

Subrogation also plays a big role, in lot of these claims and that too.

Right, right.

And it sound like you have reinsurance in place as well?

We do have a reinsurance program.

Great. Second question. You mentioned in the specialty casualty business, program business that was down, it sounded like it might not be performing that well. Can you be more specific on what type of programs that is?

We don't write a lot of program business. I kind of have a bias against writing very much of it. But there were a couple of programs in particular that we got rid of where there has been some unfavorable development.

Primarily in the hospitality arena, some bed and breakfast-type operations and temporary housing operations.

Okay. And then the last one was in the specialty financial business. Again, probably need a little education. Collateralized mortgage protection business, can you just kind of go through what that business is, and why you're getting some reserve development there?

It's a business that we wrote a little bit of back in 2002, 2003, and 2004 that has been in run-off ever since then, where Fannie Mae was the lender, and we were insuring the collateral up to the outstanding loan value, and we're starting to see a few claims on that as we've indicated.

Does this have the potential to balloon into something, any time you mention mortgage, sirens start to go off. Could this balloon into something potentially much larger?

It could have some additional development, but this is not something that we expect has the potential of becoming something like the residual value that you and we have talked about over the years, and now is gone.

Just because it's a much smaller business for you, or was at the time?

It was a smaller business, the aggregate limits are dramatically smaller.

Great. Very good. Thank you.

(Operator Instructions). Our next question comes from Amit Kumar of Macquarie.

Thanks. I guess three quick follow-up questions. First of all, just on the discussion on excess capital, and it's utilization, I just wanted to go back and revisit NATL National Interstate. Recently we saw another parent take-out at sub. Has your view changed based on the current market conditions, or should we expect no change in perpetuity?

I don't think anything is ever in perpetuity, but we continue to look at National Interstate as a core operation for us. And yes, a core part of our business in that. And again, I think if you continue to take a look at our stock's valuation, we think repurchasing our shares continues to be more attractive than purchasing National Interstate shares. If you just look at the valuation differences and that in the short term. Perpetuity, nothing is ever in perpetuity.

I was just trying.

Nice try, Amit.

I guess two other quick questions are, there has been some discussion on modest change or improvement in the California comp market. And maybe, we haven't talked about that in a while. Maybe we can revisit that, in terms of trends?

Sure.

Yes, I think when you look at the industry numbers right now, I mean they are terrible, but there is modest improvement, from industry estimates I think are going from 129 to 125. We probably would estimate Republic at about 115 or 116 for 2010, and that might be modestly better. It's a competitive market still although there is price being taken, and we may be on the more aggressive price side with a 8% change year-to-date.

Probably to get our business back to a 13% to 15% return, and a low-100s combined ratio, we need to get 20% instead of the 8% that we're getting right now. And the market is not allowing us to currently get that. We feel our reserves are solid. In our business today, probably some different than others.

I think probably the good news is I think Governor Brown is saying that he's not going to look at any new workers comp bills the next couple of years. So I think you should have a pretty steady environment. The economy seems to be improving. I think at Republic, renewal payrolls, seem to be increasing. And the California economy seems to be somewhat on the mend. I think those are all positives. But we need to get more price in order to get our business back to a solid return.

Recently there was this discussion coming out of WCIRB, and they were planning to issue that notification and it did not happen, and it became an informational filing regarding a 40% rate increase. What is the biggest impediment in terms of you trying to get a price increase?

Each individual company can file their own price increases and that. From my standpoint, there probably isn't too much of an impediment. It is the competitive environment.

Everyone needs to file more significant rate increases, and renew their business at that for the business to improve. That's not happening yet. There's still some companies that are too aggressive out there, which is hard to explain, hard to understand. I do think California comp and workers comp nationally probably has to be the kind of the leading edge of price correction activity really within our industry, when you take a look at the results and that.

Okay. And in terms of you just mentioned the competition. Are these public companies or non-public companies?

Some of both.

That is interesting. Okay.

The only other, this is the final question. I do appreciate your patience. You are having a lot of growth from the indirect bank annuity segment and index annuity segment, and it is becoming a bigger proportion of your earnings with every passing quarter. I'm just wondering, what's your ultimate appetite for this market going forward?

This is Craig. We don't have a specific number in mind. If we can earn what we think are the appropriate returns in the business, then we would like to continue to grow it. If we can't, then we will slow it down.

Okay.

Our strategy is to on a continual basis, try to allocate capital to the places that have the best returns.

Okay. And maybe just remind us, this is through the brokers who are writing a mortgage policy? And can you just refresh us what exactly this indirect product--?

They're either fixed annuities or indexed annuities that are sold through the banks, but there is some type of a broker arrangement, brokerage arrangement with the banks, so there's an intermediary who is involved with the sale to the bank's customers. And they are selling all annuity products. The biggest would be indexed annuities.

And these bank customers, I am just trying to understand the profile of it better. Are these the ones who have, sort of a checking deposit, or are these mortgage customers? Who exactly are these people?

They could be mortgage customers, but there is no relationship between what we're doing and the mortgage business.

Right.

They are typically customers who are looking for a decent return on their investments, and if they're willing to go a bit longer buying the bank product, then it could be a replacement to a CD.

Okay. Got it. That is actually very helpful. That's pretty much it. Thanks so much. Thanks for the answers.

Thank you. Our next question comes from Ron Bobman of Capital Returns.

Hi. I think Carl commented on California comp. I was curious if you would give us sort of maybe at least some directional information on the sort of rate and quoting environments in some of your other commercial lines, and sort of not so much necessarily first quarter activity, but what you're seeing sort of towards the end of the first quarter and coming into this second quarter?Is the rating environment status quo, continuing to improve, deteriorating, maybe some of the major line categories that you are active in?Thanks a hot.

Sure. In the property and transportation, I think we as we disclosed, our pricing went up about a point, and our specialty casualty segment pricing was flat, and the property and transportation went down 1%. I think if you, overall the lines that we seem to be getting price in California comp we mentioned we're getting about 8%. We are getting on the program business that we're staying on, we're getting some price there. And businesses like all of the non-US med mal out of Marketform, we're getting some decent price there. Marine liability because of the various events worldwide, they are in our Marketform book. We're getting some price in that part of our book. And then smaller price increases in a number of other areas. So I am heartened that it seems like we're getting, there are more of our businesses where we are getting some price increase, versus it being outside of workers comp, they are not being too many places looking backwards. So I think the rate environment seems to be improving at this point.

Are your business unit heads directing their underwriters and field underwriters to be a little bit more emboldened in trying to get rate? Are you getting any sort of commentary from the unit heads along those lines, or no change really?

I think it really depends on the profitability business by business as to the aggressiveness. If we have great continued returns in businesses, it's a bit harder, your focus may be more on retention of business, versus trying to push through huge increases. Businesses like California comp, I think I just spoke to what I think we really need versus what we're getting, and we're going to be fairly aggressive.

All I know is that as our Republic subsidiary, we're losing more market share over the last couple years than our other competitors. So that kind of tells you how aggressive we are there. So again, I think the tone depends on the profitability business by business in that. Program business, we have a small part of our, a very small percent of our business in that, but we've been pretty aggressive on the price side, and canceled a few accounts and other accounts, the business we're taking an aggressive approach.

Actually, if I could have an unrelated question. Since Amit went on and on and on, I feel I can follow up. On the crop business, should we assume that as it relates to sort of sessions to the government program, or even third party reinsurance, that your crop operation might buy, that it hasn't really, you haven't changed the amount of reinsurance protection, either government or private for the current crop year as compared to last year? Is that a decent assumption?

Yes, that is a decent assumption.

Okay. Thanks a lot, and best of luck.

Thank you.

At this time there are no further questions.

Alright. Thank you. We've appreciated your time today. Appreciate your interest. And we'll look forward to reporting to you on our second period results. Thank you, have a good day.

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