American Financial Group Inc (AFG) 2013 Q1 法說會逐字稿

Good morning. My name is Tina, and I will be your conference operator today. At this time I would like to welcome everyone to the American Financial Group's 2013 first quarter results 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)

Thank you. Diane Weidner, you may begin your conference.

Thank you, Tina. Good morning, and welcome to American Financial Group first quarter 2013 earnings results conference call. I'm joined this morning by Carl Lindner III and Craig Lindner, co-CEOs of American Financial Group, and Jeff Consolino, AFG's Executive Vice President and Chief Financial Officer. 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, and are 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 and/or financial conditions differ materially from those suggested by such forward-looking statements include, but 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 report 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.

Our 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, such as net realized gains or losses, effects of certain accounting changes, discontinued operations and certain non-recurring items. AFG believes this non-GAAP measure to be a useful tool for analysts and investors in analyzing ongoing operating trends which will be discussed for various portions of 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 the call over to Carl Lindner III to discuss our results.

Yes, to begin this morning, Craig and I would like to extend an official welcome to Jeff Consolino. Jeff joined AFG in February, and today marks his first earnings conference call as AFG's Chief Financial Officer. Jeff, we are delighted that you joined AFG's executive leadership team, and we're looking forward to your remarks later in the call.

I'm assuming that our participants have reviewed our earnings release and the investor supplement posted on our website. You will notice that our quarterly investor supplements have been combined into one document and expanded to include additional schedules and disclosures that we believe will be useful to you in analyzing AFG's results.

We released our 2013 first quarter results yesterday afternoon. We are pleased to report an adjusted book value per share of $43.94 as of March 31, 2013. This represents growth of 3% during the quarter. Net earnings were $1.32 per diluted share, and include $0.40 per share of realized gains. Annualized return on equity was 12.4% for the 2013 first quarter, compared to 11.8% for the first quarter of 2012. Our core net operating earnings of $0.92 per share reflect a 27% increase in pre-tax core operating earnings in our annuity segment and solid underwriting results in our property and casualty businesses. Net written premiums in our property and casualty operations grew 16% overall when compared to the 2012 first quarter, with all three of our Specialty Property and Casualty groups reporting double-digit premium growth during the quarter. Based on AFG's results in the first 3 months of the year, we've increased our guidance for property and casualty net written premiums and core pre-tax operating earnings in our Annuity and Run-off segments, the details of which Craig and I will share later in the call. Our core operating earnings guidance for AFG remains unchanged from our previous estimated range of $3.60 to $4.00 per share, primarily as a result of the slower pace of anticipated share repurchase activity.

Let me begin with a review of our Specialty Property and Casualty results summarized on slides 4 and 5 of the webcast. On Slide 4, you'll see summary results for our Specialty Property and Casualty group. The Property and Casualty Specialty insurance operations recorded an underwriting profit of $48 million for the first quarter of 2013 and generated a combined operating ratio of 93.1, a 1.2 point increase from the first quarter of 2012. Higher profits in our Specialty and Casualty group were offset by lower profitability in our property and transportation, and specialty financial groups. Catastrophe losses were $10 million in the first quarter of 2013, primarily the result of March storms in the southeastern United States. Gross and net written premiums increased by approximately 12% and 16%, respectively, compared to the 2012 first quarter.

Although premiums were higher in all of our Specialty Property and Casualty sub-segments, our Specialty Casualty Group was the driver of this growth. We continue to see price strengthening in almost all of our property and casualty businesses, and achieved a 5% overall renewal rate increase in the fourth quarter, a sequential improvement in our overall pricing, with nearly three-fourths of our property and casualty business reporting pricing increases. Price strengthening was most evident in our California Workers Comp, excess and surplus lines, and executive liability businesses where we did achieve double-digit rate increases. Loss cost trends continue to be stable and appear to be benign across our portfolio of property and casualty businesses.

On Slide 5 you see a few highlights from each of our Specialty Property and Casualty business groups. Property and Transportation group, our largest sub-segment, reported lower profitability in the 2013 first quarter, primarily the result of lower earnings in our agricultural businesses and higher catastrophe losses. Our overall strategy with regard to our crop insurance program is relatively unchanged from prior years. We are in the final stages of completing a 5-year quota share reinsurance agreement with terms and conditions similar to our prior agreement. Additionally, our excess of loss treaty was renewed at an incremental cost of $2 million. Still a little too early to comment on spring crop conditions or outlook for harvest of our winter wheat book as conditions can vary considerably over the next month.

Gross-to-net written premiums were up 7% and 10% during the first quarter of 2013, primarily due to higher premiums in our transportation businesses. Net written premiums also increased as a result of lower cessions of our winter wheat business. Overall renewal rates in this group increased 5% on average for the quarter, following a 4% increase achieved in the fourth quarter of 2012. Specialty and Casualty group reported higher underwriting profits during the first quarter, reflecting a lower accident year-loss ratio, as well as increased favorable reserve development in our executive liability and excess liability businesses.

Gross and net written premiums grew by double-digit percentages in the first quarter of 2013. While nearly all businesses in this group reported growth, our workers compensation and excess and surplus lines businesses were primary drivers of the higher premiums. Increased exposures from higher payroll on existing accounts, price increases and overall business growth have contributed to increases in our workers' comp businesses. New business opportunities and general market hardening have generated increased premiums in several of our excess and surplus lines businesses. Pricing in this group was up approximately 6% on average for the quarter, following a similar increase in the fourth quarter of 2012.

Specialty Financial group reported slightly lower underwriting profits in the first quarter of 2013. We're pleased with the results in the sub-segment of our Property and Casualty business, which produced a combined ratio of 88.5 for the quarter. The businesses in this group have performed well, achieving an overall combined ratio in the mid 70s to 80s over the past few years. Gross and net written premiums increased by 11% and 22%, respectively, primarily the result of growth in mortgage protection insurance offered by our financial institutions business. Pricing in this group was up 1% for the first quarter of 2013.

Now please turn to Slide 6 for an overview of the 2013 outlook for the Specialty Property and Casualty operations. Our objective is to achieve an increase of 4% to 6% in the specialty group's overall average renewal rates this year. We continue to expect to achieve a combined ratio between 91 and 95. We now estimate net written premiums in our Specialty Property and Casualty operations to be 8% to 12% higher than 2012 levels as compared to our previous guidance of 6% to 10%. Our 2013 expectations for the Property and Transportation group remain unchanged. We expect this group to produce a combined ratio in the 92% to 96% range. Guidance assumes normalized crop earnings for the year. We estimate this group's net written premiums to be up 3% to 7%, reflecting expectations that crop premiums will be down slightly, and also considers opportunities we see for growth in our transportation businesses.

We expect the Specialty Causality Group to produce a combined ratio in the 91% to 95% range. We now anticipate net written premiums will be up 13% to 17% based on the strong growth in the first quarter and indications of market hardening and continued growth in our workers comp and excess and surplus lines businesses. This is an increase from the 10% to 14% increase in our previous guidance. We expect the Specialty Financial group's combined ratio to be between 88% and 92%. We project net written premiums to be up 11% to 15% in this group, up from our previous guidance of 0% to 4%, primarily the result of growth in our Financial Institutions business. Additionally, we expect 2013 property and casualty investment income to be about 5% lower than in 2012.

I'll now turn the discussion over to Craig to review the results in our annuities segment and investment performance.

Thank you, Carl. The annuities segment reported record core pre-tax operating earnings in the 2013 first quarter that were 27% higher than the comparable 2012 period as you'll see on Slide 7. The increase in pre-tax core earnings was primarily a result of growth in AFG's annuity reserves and exceptionally strong investment results. Annuity premiums in the first quarter of 2013 were up more than 11% from the last quarter of 2012, but 22% lower than the first quarter of 2012. The decrease from the comparable prior-year period was expected and continues to reflect actions taken during 2012 to reduce crediting rates and agent commissions and response to the exceptionally low interest rate environment that began in the second quarter of 2012.

The focus on our Annuity business is to maintain appropriate spreads on our base of invested assets. On Slide 8, you'll find a comparison of average fixed annuity investments, average fixed annuity reserves, the net interest spread earned, and the net-spread earned. Over the last year, fixed annuity investments at amortized costs have grown by 14% and fixed annuity reserves have grown by 13%. Our net interest spread earned, which represents the difference between net investment income earned and interest credited, was 299 basis points during the first 3 months of 2013, an improvement of 11 basis points from the comparable prior-year period. The net spread earned represents our net interest spread, less other annuity-benefit expenses, acquisition expenses, and other operating expenses. For the first quarter of 2013, the net spread earned was 158 basis points, an improvement of 15 basis points from the first quarter of 2012. Additional information about the components of these spreads for AFG's fixed annuity operations can be found in AFG's quarterly investor supplement posted on our website.

Please turn to Slide 9 for an overview of the 2013 outlook for the Annuity segment, as well as the Run-off Long-Term Care and Life segment. Based on recent conditions and trends, we expect 2013 full-year core pre-tax operating earnings in our Annuity and Run-off Long-Term Care and Life segments to be 8% to 12% higher than the $252 million reported for the full year of 2012. We do not expect our Run-off Long-Term Care and Life segment to contribute material positive or negative results in 2013. We continue to expect premiums will be flat to down slightly for the full year as compared to last year as we continue to maintain strict pricing discipline in the pricing of our products.

Please turn to slides 10-11 for a few highlights regarding our investment portfolio. AFG recorded first quarter 2013 net realized gains of $36 million after tax and after deferred acquisition costs, compared to $28 million in the comparable prior-year period. Unrealized gains on fixed maturities were $719 million after tax after DAC at March 31, 2013, virtually unchanged since year-end 2012. Our portfolio continues to be high quality with 86% of our fixed maturity portfolio rated investment grade and 97% with an NAIC designation of 1 or 2, the two highest categories. We provided additional detailed information on the various segments of our investment portfolio in the quarterly investor supplement on our website.

I will now turn the discussion over to Jeff, who will wrap-up our comments with an overview of our 2013 consolidated first quarter results.

Thank you, Craig. As Carl noted, this is my first earnings conference call as AFG's Chief Financial Officer. This is exciting for me. I'm going to strive to match the high performance standards set by my predecessor, Keith Jensen.

Slide 12 shows the highlights of our consolidated income statement for the three-month period ended March 31, 2013, and 2012. This will bridge the segment results Carl and Craig just reviewed with you to our consolidated results. AFG reported 7% increase and core net operating earnings per diluted share, $0.92 per diluted share in Q1 of 2013, as compared to $0.86 in Q1 2012. This is attributable to a lower average number of diluted shares, 91.0 million in the first quarter of 2013, as compared to 99.4 million in the year ago first quarter. Aggregate core net operating earnings were flat year-over-year at $84 million for the three-month period ended March 31, 2013, as compared to $85 million in the prior year's quarter. For our P&C segment, operating earnings were $96 million in the first quarter of 2013, compared to $100 million in the comparable 2012 period.

Specialty P&C underwriting profits of $48 million were unchanged from the prior-year period. P&C net investment income declined by $4 million year-over-year, in-line with our expectations as reinvestment rates continued to decline. As Craig described, Annuity segment earnings were up $16 million, or 27%, to a record $76 million. Earnings contributed by other operating segments declined year-over-year by $8 million. As a reminder the first quarter of 2012 included $6 million in earnings from our Medicare supplement and critical illness business, which was sold, effective August of 2012. As Craig noted earlier, we do not expect the Run-off Long-Term Care and Life segment to contribute materially to 2013 results. Interest expense is unchanged year-over-year at $17 million. Other expense increased by $5 million in the 2013 first quarter, reflecting higher holding company expenses, related to an adjustment for certain equity compensation plans. Finally, annualized core operating return on equity was 8.6% for the 2013 first quarter, compared to 8.9% in the first quarter of 2012. This is not shown on your slide.

Turning to Slide 13, AFG's adjusted book value per share increased 3% in the quarter to $43.94. Including the regular $0.195 dividend in the quarter, AFG total value creation, defined as growth and adjusted book value plus dividends, was 4%. Tangible book value on an adjusted basis at March 31, 2013 was $41.52. Our capital adequacy, financial condition and liquidity remains strong. AFG maintains sufficient capital in its insurance businesses to meet our commitments to the rating agencies. We were pleased to receive a ratings upgrade from Moody's on April 23. Our excess capital was $620 million at March 31, 2013. This included cash at the parent company of $225 million.

During the first quarter of 2013 AFG repurchased 61,586 shares of common stock at average price of $43.71 per share. AFG has been active repurchasing shares and returning capital to shareholders through dividends, returning $1.5 billion to shareholders over the preceding 5 calendar years, repurchasing 31% of shares outstanding at the outset of that five year period. AFG also looks to invest its excess capital where we see potential for healthy, profitable organic growth. More opportunities to expand our specialty niche businesses through acquisitions and start-ups, and meet our targeted return threshold. The growth in our Annuity and P&C Specialty Casualty business, as well as the launch of our Professional Liability division within our P&C operations in April, serve as examples.

On Slide 14, you'll find a recap of 2013 guidance for AFG's core net operating earnings, as well as guidance discussed earlier in the call for key financial measures in the Specialty Property and Casualty operations and the Annuity segment. These 2013 expected results exclude non-core items such as realized gains and losses as well as other significant items that may not be indicative of ongoing operations.

Now we would like to open the lines for any questions.

At this time if you would like to ask a question, please press star-1 on your telephone keypad. Your first question comes from Amit Kumar, Macquarie Capital.

Thanks, and good morning, and thanks for the new disclosure. It's very helpful.

My first question relates to the discussion on capital management. You have a meaningful excess capital position. In the past, you have mentioned that you would like to keep $100 million to $200 million of it as dry powder. I'm curious, with minimal buy-backs this quarter, and where the stock is trading at, do you -- has the thought process changed as to how you view acquisitions going forward? And maybe just talk about that process, and also revisit what do you think -- I think Jeff mentioned returns. What do you think are appropriate returns for you to interest -- for you to be interested in an acquisition? Thanks.

Amit, this is Carl.

Hey.

On the acquisition side, you know us. We're always out there starting businesses up, looking for mainly small-to-medium size-type acquisitions, and if there is an occasional great, larger opportunity, we're always try to reserve horsepower to do something like that. We are now just starting our Professional Liability division. We're excited about starting that business. It's more of an E&E and E&O liability type of business.

We don't -- we're not getting ready to announce any major transaction or anything right this second, but -- so, really, we've not really changed our approach or appetite from kind of how we've looked at the world in the past.

But has the pipeline changed?

I don't think the pipe -- we're always looking at things. I wouldn't say the pipeline's changed. I think right now I do view -- now I'm going forward. I do think we're going to get an opportunity to look at more things, and particularly as we're looking to expand our business internationally. So I think in this environment I think there will be more opportunities.

In the past, you've talked about not really increasing the P&L, and you just mentioned internationally. I mean, are we talking internationals out of casualty-type operations? Or maybe just expand on that comment a bit.

I think there would be similar opportunities to the businesses that we're already in, though, if there's interesting opportunities, we'll look at them.

Is it mostly on the primary side, or would you even go on to the casualty reinsurance side?

I think it would be focussed on where we are focussed today, and that would be more on the primary side.

Got it. That is very helpful. The second question that I have is on the expanded -- the annuity disclosure. We've talked about the return on assets and you can compute it from Slide 8. How would you -- what would be the clean ROE of this business be?

This is Craig. What I want to tell you is in the first quarter, the ROE was approximately 11%. It did include some items that are potentially non-recurring that added a point or so to the return. If we adjust out certain thing that benefitted us, things like a little bit of investment income from pre-payments, the very strong performance of the stock market exceeded our estimate, our projection, of 2% per quarter. That added $4 million to the earnings of the Annuity business in the first quarter. If you adjust for a few things like that, that we did budget for, it brings that 11% number down to a little over 10%.

And when you sort of look forward, how does the dynamic of the older, lower spread business, which is running off, and is being replaced by higher spread, how does that impact that number going forward?

We think that the impact is a positive one. Certainly we're writing new business in returns that are well above the 10% level. What I will tell you is in this low-interest rate environment, the old higher GMIR business isn't running off nearly as quickly as we would have expected. We still have business on the books that was written in the '70s and '80s, which we expected to be -- most of it to be long gone, and it is sticking around.

Got it. That's helpful. The final question, and I'll stop here, is you said it is too early for crop and you're discussing the quote 52.5% quota share. Separately when you look at the mix of business, the corn is half of your book, approximately. Based on the late planting, or farmers switching to soy bean, how can your crop book change? Does it change materially if the switch happens, or is the change only on the margin if farmers do switch to another crop?

I don't think there would be major changes, Amit. It's again -- our perspective is right now there's things that make you most both optimistic and things that concern you. On the one hand, the entire Midwest has received much needed precipitation over the last 4 to 6 weeks, which has mitigated much of the drought concerns, particularly in the Eastern corn belt. We now have adequate top-soil moisture to get the crops off to a good start. However, as you know, the air and soil temperatures have kind of remained unreasonably cool, which has delayed planting. So planting progress is behind last year's pace and a week or two behind the 5-year average.

That said, I think if corn is planted by mid-to-late May, I think that things might be just fine. Soy beans, there's -- usually if they're planted by mid-to-late June things are okay, too. So it's really kind of early. Over the next 3 to 4 weeks, I think everybody will get a better feel of things. As far as the drought, a drought of the magnitude of the 2012 drought has some lingering effect on 2013 growing conditions.

However, when you look at historical data, that would suggest that there really is a low correlation between a prior-year drought and core yields the following year. The entire corn belt has seen significant rainfall over the past 6 weeks, which has recharged soil moisture in much of the corn and soy bean growing regions, and this year's crop yields will be affected more by the amount of rainfall received in July and August than it will be, I think, from the lingering effects of last year's drought. So, again, it's way too early to try to prognosticate that much.

Got it. Okay. I'll stop here, thanks. Thanks for all the answers.

Your next question comes from Ryan Byrnes, Langen McAlenney.

Hi. Good morning, everybody. Just quickly going back to the capital management discussion, I just wanted to get your thought process, maybe, on -- get valuation -- have the factor as well in a little bit of the slowdown in the first quarter. Obviously, you had been trading at a premium-to-book ex-AOCI. Is that a way you guys look at it, as well?

It is. As we've said in the past, we're going to be opportunistic in our repurchase of shares. Prices around book value or below, as you know, we have repurchased a very large percent of our shares that are outstanding, and that doesn't mean that we're not going to repurchase shares at current prices. We currently have a repurchase program in place. It just means that we're not going to be as aggressive as we would be at lower prices.

We understand the return that is available to us from share repurchases, and we also see attractive opportunities, as Carl talked, to invest some capital in our existing businesses. We have a responsibility as a management team to deploy that capital in areas that provide the highest return, and we're continually evaluating that.

Okay. And then mixing it up here a little bit to talk about, obviously, you showed some strong growth in the PC business, and you guys noted that some of it was from the E&S market. Obviously, there has been some headlines on a potential new, very large player in the space. But just wanted to see what your thoughts are, I guess, on Berkshire entering the space. Is there any overlap in the lines of business that you guys do? I just want to see what kind of impact you guys see in that market.

You know, we're used to competitors kind of coming and going. Berkshire, with their resources, clearly, is in a position to have more meaningful impact on the market. That said, generally the business, when you look at the business that we're targeting in that, it's more at a small and medium size occasionally -- occasional larger opportunities in that.

I'm not sure we overlap quite as much as -- with, I think, what Berkshire is going to be targeting, is what AIG and some of the other players do. So, sure, they're very capable. It will have an impact. I think there are others that they will overlap more with that will have a bigger impact than with us.

Okay. Great, thanks for the answers, guys.

Again, if you would like to ask any questions, please press star-one on your telephone keypad. You have a follow-up question from Amit Kumar from Macquarie Capital.

Quickly, just going back to the capital discussion, maybe I'm seeing too much into this, but you did not talk about revisiting the dividend down the road. Has anything changed on that process, or are you still open to revisiting the dividend as, maybe, one or two quarters down the road?

I wouldn't take anything by us leaving that out. Our approach is we see value in building a predictable stream of increasing dividends over time. We think investors value that. That continues to be important in our consideration of using excess capital, and, as you know, last year our investors got a little kiss right at the end of the year, and our management. So, no, I think dividends clearly continue to be part of our capital strategy.

And then, as you know, AFG has increased its dividend each year over the past seven years, to elaborate on Carl's point.

Yes, last five years, we've had a 12.5% compounded annual increase in our dividend.

Got it. And then just going back, I guess, to Republic Indemnity, in terms of when you started to look at the lost cost trends and pricing, has anything changed, or are we still on the right track there? I mean, are we getting more pricing? Lost costs seem to have stabilized. Has anything changed on that front from the last quarter?

No, I think we continue to be more optimistic. We have a market that's firming. We're getting double-digit renewal price increase in the fourth quarter and the first quarter. Our expectations are that we'll get double-digit price increase for the year. Last year, probably our latest estimate of accident year for California comps for us is -- last year is probably 108.

That is a little better than the industry; the way this industry estimates, 127. Republic's always been much better. With a double-digit price increase, that gives us some optimism that we're moving back toward a business that can have a double-digit return. At about a 4% interest rate, 100 combined ratio, for instance is equivalent to about 10% return on equity. We feel good about our reserves adequacy. Lost cost trends are low single digit. So for all of those reasons, rate, some increase in business opportunities from the market, we're looking at strong double-digit growth for California comp this year.

Got it. On the flip side, are there any areas where you would have expected rates to improve more relatively and which are still seeing competitive pressure?

You know, there aren't too many. I'm liking what I'm seeing in the D&O space today. We're getting double-digit increases there. That's been the laggard, I think, last year a little bit. It wasn't until latter part of the year that I think the market was seeing significant increases in that. So I like what I'm seeing there.

Got it.

I don't think there's any areas -- if there is one in our Equine business, that seems to be -- our equine mortality. It seems to be a little more competitive than what it should be in that. I would like to see us achieve a bit more rate there.

Got it. And I guess final question would be, do you have the unrealized gains from your real estate holdings handy? Is that number available?

I do not have that number.

I can follow up off-line. That's okay.

Okay.

That is all I have. Thanks, and congratulations on the quarter.

And there are no further questions at this time. Diane, are there any closing remarks?

Thank you, Tina. Thank you all for joining us this morning. We look forward to speaking to you again when we report our second quarter results.

This concludes today's American Financial Group 2013 first quarter results conference call. You may now disconnect.