American Financial Group Inc (AFG) 2013 Q2 法說會逐字稿

Good morning. My name is Selima and I'll be your conference operator today. At this time I would like to welcome everyone to the American Financial Group 2013 second quarter results conference call. All the 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. I will now turn today's conference call over to Diane Weidner. Please go ahead.

Thank you, Selima. Good morning and welcome to American Financial Group's second 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 Chief Financial Officer. If you are viewing 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 that 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 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 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 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, such as net realized gains or losses, effects of certain accounting changes, discontinued operations, and certain nonrecurring items. AFG believes this 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 the call over to Carl Lindner III to discuss our results.

Good morning. We released our 2013 second quarter results yesterday afternoon. I'm assuming everyone's reviewed our earnings release and the investor supplement that's posted on our website. We're pleased to report an adjusted book value per share of $44.78 as of June 30, 2013. This represents growth of 2% during the quarter. Net earnings were $1.20 per diluted share and include $0.28 per share of realized gains and a charge of $0.04 per share for guaranteed fund assessments related to Executive Life Insurance Company of New York, a unaffiliated life insurance company. Annualized return on equity was 11.1% for the 2013 second quarter, compared to 10.2% for the second quarter of last year.

Our core net operating earnings of $0.96 per share were 5.5% higher than the comparable prior-year period and include a 39% increase in pretax core operating earnings in our annuity segment, with lower underwriting profitability within our Property and Casualty segment. Annualized core return on equity was 8.9% for the 2013 second quarter. Based on AFG's results in the first six months of the year, we have modified guidance in each of our specialty property and casualty groups, but we've not changed our overall guidance for property and casualty net written premiums or combined ratios. We have increased our core pretax operating earnings in our annuity and runoff segments, the details of which Craig and I will share later in the call. Our core operating earnings guidance for AFG has been increased to $3.70 to $4.10 per share from our previous estimated range of $3.60 to $4 per share.

Now let me begin with a review of our specialty property and casualty results which were summarized on slides 4 and 5 of the webcast. On slide 4, you'll see the summary results for our specialty property and casualty group. The property and casualty specialty insurance operations recorded an underwriting profit of $21 million for the second quarter of 2013, and generated a combined operating ratio of 97%, a 5.2-point increase from the second quarter of last year. Lower profitability in our property and transportation and specialty casualty groups were partially offset by higher profitability in our specialty financial group. Catastrophe losses were $19 million, or 2.6 points in the second quarter of 2013, compared to $6 million or 0.8 points in last year's second quarter.

Gross and net written premiums grew 2% overall when compared to the 2012 second quarter, with double-digit premium growth in our specialty casualty and specialty financial groups partially offset by lower premiums in our property and transportation group. We did have spring planting delays that resulted in late acreage reporting in our crop insurance business, which impacted overall specialty property and casualty premiums for the quarter. Excluding our crop business, growth in gross and net written premiums for the second quarter was 15% and 10%, respectively when compared to the 2012 period. Over two thirds of our property and casualty businesses reported pricing increases during the second quarter, helping us to achieve about a 5% overall renewal rate increase. This follows a similar increase in the first quarter of 2013, and is the seventh consecutive quarter that we have reported overall price strengthening. Loss cost trends continue to be stable, appear to be benign across almost all of our property and casualty businesses. Frequency is generally flat, and severity is tracking reasonably well with the core consumer price index.

On slide 5, you'll see a few highlights from each of our specialty property and casualty business groups. Property and transportation group, our largest subsegment by premiums, reported lower profitability in the quarter, primarily the result of lower earnings in our transportation business and higher catastrophe losses. I am disappointed in the poor underwriting results reported by this group during the quarter, particularly our 52%-owned National Interstates, where increased claim severity heavily impacted transportation results. We remain committed to obtaining appropriate rate increases in this business, and we'll reduce premium volume as needed until we know that we can get the pricing right.

Losses from spring storms in the southeastern US were the primary hurdle for the non-transportation businesses and the source of catastrophe losses in our property and inland marine operations. Catastrophe losses for this group totaled $18 million for the quarter, compared to $4 million in the prior-year period. Gross and net written premiums were down 16% and 11% during the second quarter of 2013, though if you exclude crop insurance, gross and net written premiums grew by 6% and 3%, respectively when compared to the 2012 second quarter. As discussed earlier, crop premiums were lower in the second quarter because excess moisture resulted in delays in planting spring crops, which subsequently delayed acreage reporting.

Crop premium's always impacted by annual planting decisions by each farmer. It's not until acreage reporting time that we know what crops have been planted, allowing us to determine and record the premium. Each year the timing of premium recognition is a bit different due to planting progress. This year's lower second quarter crop premium is the result of this variability. We expect a catch-up of these premiums in our third quarter results. Net written premiums in this group were also impacted by the increased cost of reinsurance programs during the second quarter. Our property and inland marine treaty increased in response to recent loss experience, and as we reported last quarter, our crop insurance excess-of-loss treaty was renewed at an incremental cost of about $2 million.

Yesterday's USDA reports indicate that corn and soybean crop conditions are very favorable, with both crops developing one to two weeks behind historical trends. Also, in addition to yield, we track commodity futures prices closely, and they serve a key role in determining profitability in our crop insurance business. Crop futures are currently trading at around $4.73, down about 16% from the spring discovery price. Our insureds share a portion of the commodity price risk through deductibles that they choose of up to 35%.

We recently renewed our crop quota share reinsurance agreement. It's a five-year agreement that commences with the 2013 reinsurance year. I'm pleased that terms and conditions are similar to our prior agreement. Overall renewal rates in the property and transportation group increased 6%, on average, for the quarter, following a 5% increase achieved in the first quarter of 2013. Our transportation and property and inland marine businesses reported sequential price increases for the quarter, consistent with our goal to get rates where they need to be to improve profitability of these operations. Our national interstate sub and our transportation businesses achieved quarterly price increases of 7% and 8%, respectively. And, our property and inland marine business achieved a 7% increase.

Specialty casualty group second quarter underwriting profit was slightly lower than the 2012 second quarter. An improvement in accident year results was offset by lower favorable prior year reserve development. Most of the businesses in this group produced strong underwriting profit margins during the quarter. Gross and net written premiums were up 23% and 16%, respectively for the second quarter 2013 when compared to the same prior-year periods. While nearly all businesses in this group reported growth, our workers compensation and excess and surplus lines were the primary sources of the higher premiums.

New business opportunities, increased exposures from higher payroll on existing accounts, strong retentions, and higher renewal pricing contributed to the growth in our workers comp business. In addition, new business opportunities and general market hardening have generated increased premiums in several of our excess and surplus lines businesses. Renewal pricing in this group was up approximately 5% for the second quarter, following a 6% increase achieved in the first quarter of 2013. Our executive liability, California workers' comp, and excess and surplus lines businesses achieved the highest increases. Our executive liability operations obtained 10% rate increases in consecutive quarters in 2013. And we achieved a 9% increase in our California workers' comp business during the second quarter, following a 13% increase in the first quarter.

The specialty financial group reported higher underwriting profit in the second quarter 2013 when compared to the prior year period, due primarily to higher underwriting profit in our financial institutions business, primarily from lender-placed mortgage property insurance. Businesses in this group continue to perform well, achieving an overall combined ratio of 86.6%. Gross and net written premiums were up 16% and 15% for the 2013 second quarter, respectively, from the comparable 2012 periods. Gross written premiums increased primarily as a result of growth in lender-placed mortgage property insurance. Despite experiencing some pricing pressure, we've benefited from changes in the competitive marketplace, and we've added several new accounts in this book of business. Renewal pricing in this group was down 1% for the second quarter, following a 1% increase achieved in the first quarter.

Now let's 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 groups' overall renewal rates in 2013. We continue to expect to achieve a combined ratio between 91% and 95%, and net written premiums in our specialty property and casualty operations expect to be 8% to 12% higher than at last year's levels. We have adjusted our 2013 expectations for the property and transportation group. We now expect this group to produce a combined ratio in the 95% to 99% range, three points higher than our previous estimate.

Our guidance assumes normalized crop earnings for the year. And we estimate this group's net written premiums to be up 2% to 6%, slightly lower than the range of 3% to 7% estimated previously. Embedded in the guidance is our expectation that full-year 2013 crop net written premiums will be slightly lower than 2012. We expect the specialty casualty group to produce a combined ratio in the 89% to 93% range, an improvement from a range of 91% to 95% estimated previously. And we now anticipate net written premiums will be up 15% to 19%, based on strong growth in the first half of the year and indications of market hardening and continued growth in our workers' comp and E&S businesses. This is an increase from the 13% to 17% increase in our previous guidance.

And we expect the specialty financial group's combined ratio to be between 87% and 91%, a slight improvement from the 88% to 92% estimated previously. We continue to project net written premiums to be up 11% to 15% in this group, primarily the result of the growth in our financial institutions business. Finally, we continue to expect 2013 property and casualty investment income to be about 5% lower than last year. Now, I'd like to turn the discussion over to Craig to review our results in our annuity segment and investment performance.

Thank you, Carl. The annuity segment reported record core pretax operating earnings in the 2013 second quarter that were 39% higher than the comparable 2012 period, as you'll see on slide 7. The increase in core pretax earnings was primarily a result of growth in annuity assets and the favorable impact that rising interest rates had on AFG's fixed indexed annuity reserves.

Annuity premiums of $861 million in the 2013 second quarter increased sequentially by $237 million, or 38%, from the first quarter of 2013. This strong growth reflects successful distribution channel expansion, as well as new product development. In fact, we announced last week that several of our Great American Life fixed indexed annuity products are now offered by Wells Fargo advisors. Year-to-date, 2013 annuity premiums were down 13% from the comparable 2012 period. This decrease was anticipated, and reflects rate and commission actions taken by AFG in response to the exceptionally low interest rate environment. The focus of 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 cost have grown by 14%, and average fixed annuity reserves are up 12% compared to the last year. Our net interest spread earned, which represents the difference between net investment income earned and interest credited, was 302 basis points during the second quarter of 2013. This decrease of 14 basis points from the comparable prior-year period was due primarily to the runoff of higher-yielding investments.

Compared to last quarter, net interest spread earned was three basis points higher. The net spread earned represents our net interest spread less expenses, plus or minus any impact the fluctuations in the stock market or interest rates have on the accounting for our fixed indexed annuity assets and liabilities. For the second quarter of 2013, the net spread earned was 165 basis points, an improvement of 23 basis points from the second quarter of 2012, reflecting the impact that higher interest rates had on AFG's fixed indexed annuity business, partially offset by the runoff of higher-yielding investments. Compared to the first quarter, net spread earned widened by seven basis points. Additional information about the components of these spreads for AFG's fixed annuity operations can be found at 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 runoff long-term care and life segment. Our average annuity investments in reserves grew between 3% and 4% during the second quarter, a trend we expect to continue through the third and fourth quarters of 2013. Although net interest spread was up about three basis points in the second quarter, we expect these spreads to narrow as higher-yielding investments in our portfolio continue to run off. Furthermore, we expect net spreads, which are impacted by stock market performance and interest rates, to be closer to 130 to 140 basis points in the second half of the year as compared to approximately 160 basis points earned in the first half of the year. With consideration given to these factors, we expect 2013 full-year core pretax operating earnings in our annuity and runoff long-term care and life segments to be 13% to 18% higher than the $252 million reported for the full year of 2012. Based on strong sales during the second quarter, we now believe the annuity premiums will be flat to up slightly for the full year as compared to last year.

Now, please turn to slides 10 and 11 for a few highlights regarding our investment portfolio. AFG recorded second quarter 2013 net realized gains of $26 million after tax and after deferred acquisition costs compared to $9 million in the comparable prior-year period. Unrealized gains on fixed maturities were $462 million after tax, after DAC, at June 30, 2013, a decrease of $257 million during the quarter, reflecting the impact of rising interest rates. As you'll see on slide 11, our portfolio continues to be high-quality, with 86% of our fixed maturity portfolio rated investment grade, and 96% with an NAIC designation of 1 or 2, its highest two categories. We have 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 2013 consolidated second quarter results.

Thank you, Craig. Slide 12 shows highlights of our consolidated income statement for the three-month period ended June 30, 2013, and 2012 by sources of earnings. This table summarizes the segment results Carl and Craig just reviewed with you, and highlights other key items impacting AFG's consolidated results. Starting with core net operating earnings per share, AFG generated a 5.5% increase in core net operating earnings per diluted share to $0.96 per diluted share in the second quarter of 2013, as compared to $0.91 in the second quarter of 2012. We accomplished this, despite a slight decrease in our core net operating earnings year over year, thanks to the effect of share repurchase activity. Core net operating earnings for the 2013 second quarter were $87 million, as compared to $90 million in the prior year's quarter. Weighted average diluted common shares are 7% lower, though, at $91.5 million in the second quarter of 2013, down from $98.0 million in the year ago second quarter.

Looking at segment results, our P&C segment operating earnings were $82 million in the second quarter of 2013, compared to $103 million in the comparable 2012 period. This is a decrease of $21 million. Carl has discussed the factors impacting underwriting income in the specialty P&C group, which consist of elevated levels of CAT losses year over year, lower levels of reserve release, and disappointing results for our national interstate subsidiary. P&C net investment income declined by $4 million year over year, in line with our expectations. As Craig described, annuity segment earnings were up $23 million, or 39%, during the second quarter to a record $82 million, matching the P&C insurance group result. The three basis point-increase in interest spread earned from the first quarter to the second was the result of higher levels of cash invested in the second quarter.

Earnings contributed by other operating segments declined year over year by $19 million. It's important to remember that the second quarter of 2012 included $12 million in earnings from our Medicare supplement and critical illness business, which was sold effective August 2012. Interest expense in the quarter was $17 million, $1 million less than the prior-year period. Other expense decreased by $2 million during the 2013 second quarter. Finally, annualized core operating return on equity was 8.9% for the 2013 second quarter, compared to 9.2% in the second quarter of 2012.

Turning to slide 13, AFG's adjusted book value per share increased 5% during the first six months of 2013 to $44.78. Tangible book value on an adjusted basis at June 30, 2013 was $42.38. Our capital adequacy, financial condition, and liquidity remain strong. We maintain sufficient capital in our insurance businesses to meet our commitments to the rating agencies. Our excess capital was approximately $650 million at June 30, 2013. This includes cash at the parent company of approximately $265 million. During the second quarter of 2013, AFG repurchased 1.4 million common shares for the aggregate price of $67 million, or an average price of $48.37.

On slide 14, you'll find a recap of the 2013 guidance for AFG's core net operating earnings, as well as guidance discussed earlier in this 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. With that said, we would now like to open the lines for any questions.

(Operator Instructions) Amit Kumar, Macquarie.

Maybe two or three quick questions. First of all, just going back to the discussion on NATL, and I'm not sure you can speak for them. The way I understand is that there were two components, one was unusually large claims, and secondly, there was some development on business, which is already in runoff. Can you just briefly expand on was there anything beyond that? Should we worry about this going forward, or do you think that this has been put to bed this quarter?

Amit, this is Jeff Consolino. We can speak for National Interstate. They're consolidated in our financial results, but I would encourage you to get ahold of the conference call transcript from their call, which occurred this morning at 10.00, if you want to drill into what National Interstate discussed. In summary, the result was driven by the competitive conditions in the commercial auto market that have emerged over the last several years. National Interstate discovered that they were not as conservatively reserved as they wanted to be, specifically for accident year 2011, and specifically because of emergence of severity, which trends did not abate.

The solution for this is to get rates up across the business segments, and on the call, National Interstate discussed that they have walked away from approximately $35 million of premium year to date. Management further discussed their willingness to walk away from as much business as required in order to restore their margins. So, we think it's an appropriate move for them to get to the reserves to the level that they're at. They are not operating at an accident year-level of profitability that we'd like to see them at. But we have every confidence that management's corrective plan will result in restoring those margins over time, and we support management in those endeavors to make that happen.

And the reserve review -- was that internal, external, or was that generated by something else?

National Interstate's management, including financial management, undertook to study the results in conjunction with actuarial resources from American Financial Group.

Okay. That's helpful. The other question I had was, just going back to the crop discussion and the timing, can you broadly talk about what level of premiums will now shift into Q3 from Q2?

I think probably the important thing to focus on, Amit, is -- I think I mentioned baked in our guidance that our crop premiums, when all is said and done, will be down a little bit, low single-digit decreases in that. So whatever the shortfall, because of the late planting and that, will be caught up, in effect, in the third quarter. So the miss in premiums from where we'd projected this quarter will fall into the normal third quarter premiums that get reported will be there, but then the catch-up from the -- what wasn't reported this quarter will fall into the third quarter. I would point you towards where we're going to end up, and that's, we think, that our overall crop premiums will probably be down 2% to 3%, or something like that.

I was just trying to figure out the variability in the estimates, the Street estimates versus the possible variability because of the timing in Q3. But I can come back to that off-line. The only other question I had was firstly on the discussion on excess capital and talking about the utilization of capital. I'm curious, as you look forward, and obviously you've bought back a meaningful amount of stock in the past, what is the next lever? We've talked about looking at M&A candidates. But I'm curious, is there some sort of urgency saying that we have to get to probably a low double-digit sooner than later? Or is it more so let's keep on evaluating opportunities as they present themselves?

I think we're business as usual. We don't ever try to let cash burn a hole in our pocket. We have great growth opportunities, both on the annuity and the property and casualty side. We're doing opportunistic share repurchase when it makes sense. And we're going to continue to look at consecutive increases in our dividend. And we're always active in the M&A side. As mentioned before, generally where you find us is in starting things up or doing things in the $50 million to $500 million type of size. And that's our bread and butter. So those are the kind of things we continue to look at.

I guess what I was also trying to ask is the buyback, and especially where the stock is trading at now, does that thought process change going forward as you look towards 2014? Or how do you think of capital return versus the net income being generated in the quarter, exclusive of consolidation?

Amit, this is Jeff. In the quarter just behind us, the second quarter, when you aggregate our earnings minus dividends and repurchases, we still didn't fully repurchase the aggregate amount of net income in the quarter. There is no explicit goal to buy back, or otherwise dispose of, profits over and above our ordinary dividend. As Carl said, the mantra is to be thoughtful about return on capital not to let the excess capital -- quote-unquote -- burn a hole in our pocket and deploy it when we can meet our return thresholds. The change in the stock price, obviously, changes the dynamic in terms of the return opportunity in repurchasing stock. So we'll keep our powder dry and use that capital when we see outstanding opportunities.

That makes sense. Is there a longer term or a medium term return -- or I'm sorry -- longer or medium term, like return on equity goal, or not?

Again, this is Jeff. This Company understands very well the returns they are getting in the core businesses, whether it's the annuity business or the specialty property and casualty businesses. That's measured on an ongoing basis. And that's the foundation for the targets that the employees have in those segments for achieving their personal goals. So we can maintain a return-on-capital discipline at the unit level without having to worry about the total consolidated level. As Carl has said in previous discussions, you could deploy that capital to do something that would be -- quote-unquote -- accretive, given today's low interest rate environment, but we're not of a mind to sacrifice any return on capital goals just to do something.

Yes, Amit. We want to grow book value double digit -- at a double-digit compounded annual rate, which means we're looking for total returns of double-digit plus. So --

Got it. That was the answer I was looking for. That's all I have. Thanks for all the answers.

Ryan Byrnes, Janney Capital.

Quickly wanted to drill down a little bit in the annuities segments. The earnings guidance -- if I look at the first half of the year, I've got it up about 33%, but then, obviously, the guidance is up 13% to 18% for the year. In order for me to get there, I need to have it flat in the back half of the year. And obviously, you guys talked about higher-yielding assets coming off in the back half of the year. Just want to see, is any more granularity there? And also what that can mean for 2014? Is that going to be a constant pressure going forward?

At today's interest rate level, yes. The -- today's reinvestment rate is lower than the existing portfolio rate. We do have some ability to manage the credited rates, and we've done that over the last several years. But, although we do expect to see continued growth in earnings, certainly, that's our goal over the next several years. But, it really is a function of where reinvestment rates are, but at today's interest rate levels, the reinvestment rates today are lower than the portfolio rate, so that will continue to put some pressure on spreads.

And to quantify -- what -- I'm just trying to figure out the spread there -- the difference between the assets that are coming off versus the new money opportunities for you guys.

The existing portfolio rate, I can get the exact number, but it's something in excess of 5% -- I want to say it's in the neighborhood of 5.25%, and today's reinvestment rate would be a little over 4%.

Great. Thanks for that. And quickly, just trying to -- sorry, going back over to Jeff here, with the National Interstate, I think they quantified it as basically $11.5 million, those large losses that they flowed through their accident year loss ratio. Now, is that completely all flow through to you guys, as well? I'm just trying to figure out what a pure accident year loss ratio would be in that segment without that National Interstate stuff.

Sure. If you strip out National Interstate, which earned about $128 million of premium in the quarter from property and transportation, and you strip out CAT losses, the conclusion you should reach is the overall segment was about breakeven on an underwriting basis, excluding National Interstate and excluding CATs.

Great. Thanks for that. And quickly, my last question, just in the specialty casualty segment, the last couple quarters you guys noted rate increases in the 5% to 6% range, but then I noted that the underlying loss ratio was flat year over year. Just wanted to see -- obviously it sounds like earned premiums should be coming through at higher rate. Just wanted to see if there are any -- anything I'm missing there?

No. I think you're seeing a conservative approach to booking those years. We have seen favorable development emanating from that book of business. So we're just trying to make sure we maintain reserve adequacy and reserve strength at the same time we're growing that business.

Yes. We're pleased with both the rate-on-rate and the growth in premium that we're seeing across almost all of our specialty casualty businesses. So it's -- obviously, disappointed on the property and transportation with National Interstate, our property and inland marine business with the catastrophes. But we're taking steps, and there was a sequential improvement in pricing from the first to the second quarter in our property and transportation segment. I think -- where I'm excited about is we had a good quarter, despite a hiccup from CATs and National Interstate, it really validates our model -- the diversification that we have across our portfolio and that. Not all businesses are going to do well at one time, and that. And we love our business model.

Great. Thanks for the answers, guys.

Vincent DeAugustino.

For Craig, on the annuity side, there was a little bit of a jump in the acquisition impact on the net spread earned at about 100 basis points. And so just curious if there's anything notable there or any change in your commission strategy or appetite for flows that might be impacting that?

This is Jeff Consolino. If you don't mind, I'm going to field that question. I don't know if you have the supplement close at hand, but that data would be on page 13 of the investor financial supplement. What you have in that particular line item is affected by the FAS 133 fair value adjustments related to the embedded derivatives in equity-indexed annuities.

As that adjustment runs through, it's effectively an acceleration or deceleration of pretax earnings, and would be subject to the same acceleration or deceleration of deferred acquisition costs and any other move would be unrealized gains or losses. The so-called K factor is approximately 50% on that. And so if you have a move of, say, 40 basis points on change in fair value derivatives, you would expect about a 20-point increase in the DAC, which would elevate it from an 80 basis-point run rate to 100 basis points. So you're going to see an effect running through the acquisition expense because of DAC in those movements on an ongoing basis. No change in the aggregate on commission or anything like that in this quarter.

Okay. Got it. This looks like it was a modeling issue on my end, then. And then, coming off the National Interstate call not too long ago, and sorry to keep hitting on this, but one of the things that I think is most interesting about AFG is your discipline and ability to just not walk away from premiums when margins don't make sense, but to also divest business units when that also makes sense. And so when I hear National Interstate say that there has to be an underwriting margin of at least 4% on any given product, and I understand that 4% might be the floor, but a 4% cut-off rate doesn't seem to jive with your thresholds, because what you can find out is that even though you thought the product was pricing to [96], really it comes in at a [104].

So my question comes down to your strategy with National Interstate, not just because of the core this quarter, but National's results have lagged AFG's for some time now. And with what may seem like a difference in underwriting targets, I'm just curious if it's in your intention to stick this out, or if there's any chance that we may see something similar to some of your past divestitures, where what you're thinking about is an internal time horizon where, despite your confidence in management that they get it right, do you walk away? I'm just curious how you're thinking about this longer term.

This is Carl. I wouldn't -- I don't think we're looking at anything different long term. We like National Interstate's business model, particularly the uniqueness in their alternative risk business and their market position and passenger transportation. We work through -- we at AFG, we work through things more often than dispose of things, and take a different strategic direction. We still view National Interstate as a core specialty part of our business, and we're going to work through things.

As I mentioned before, we're getting rates up. Jeff mentioned the business that's been let go. We'll have the -- over time, there will be the same return expectations and underwriting targets in National Interstate as there are consistent with the rest of the Company. So --

And I listened to the National Interstate call as well. I frankly don't remember any 4% targets being put out there. As you know, over time, National Interstate has achieved far better results than just the 4 percentage point underwriting margin. Management is aiming to get back into the low [90s] on an accident year basis. Admittedly, that'll take time, and it will take the application of rate and the discipline to walk away from accounts and business that can't meet those aspirations. But we're committed to seeing them get through that and we AFG will be patient and supply whatever resources we can to help them achieve their goals.

I think commercial auto's dragged the market a little bit overall. It's probably been competitive a little bit longer. And so I think the commercial auto part of the business is a little bit behind the rest of the business overall in our industry on rate increase and that. So, that's the way I'd look at it.

Okay. Perfect. And just to be clear, the comment about the 4% was coming from a conference back in February, so completely agree that the top up on the transcript today, just going back a little bit earlier this year. Thanks for the answers and looking forward to talking to you guys soon. Thanks.

Thank you.

Jay Cohen, Bank of America.

Couple questions. First is, your own transportation business, I assume the results in that business were quite a bit better than what National Interstate announced.

Yes. They were. In our own transportation business, we like the trend on the accident year combined ratio, in particular. So we're not too worried on that. It's pretty much physical damage only with guys that own their own rigs and that. We like the trends, actually, on that part of the business.

Okay. That's helpful. Secondly, what's one line item in our model that was different than what you guys announced -- and that was the underlying loss ratio in the specialty financial business seemed really quite strong in the quarter. And I was wondering if there was anything unusual in that number?

Hi, Jay. This is Jeff. The underlying loss ratio -- going to the supplement here for specialty financial, which is page 10 -- we have an underlying loss ratio for the current accident year, excluding CAT, of 32.9%. And that is the sequential improvement from 40% in the last quarter. I think it represents -- let me just pull out one more piece of data here -- a continued strong performance by our lenders mortgage property protection business. And that's a large component of that overall.

Should we look at that number as maybe a little better than a normalized run rate or is this -- could this be the new run rate for that business?

You have our guidance for the year. And so -- I think where we came out on guidance for the year in that subsegment reflect our expectations going forward for that subclass and every class in specialty financial.

Jay, in property you can have a little variability quarter to quarter. So I'm not sure I'd read something strong into that.

Got it. Last question was the tax rate on core earnings. That -- it jumps around a bit. I'm wondering if you can give us any guidance on the ongoing tax rate we should be assuming for core earnings.

Jay, this is Jeff. If you look at operating earnings, the effective tax rate is around 29% in the quarter. You would expect on $123 million of pretax core operating earnings roughly $43 million of tax expense at this rate of 35% federal tax rate. We are, of course, a investor in tax exempt instruments and other things that have permanent differences for tax. And so with our book to tax versus the expected there's about $6 million of difference for taxes of interest and other permanent differences.

That's fairly stable. With National Interstate, we usually have double taxation on their earnings -- once at the National Interstate corporate level, and once to build up on top of that our deferred tax liability. Because National Interstate's earnings went into reverse this quarter rather than getting an offset against those permanent differences exacerbated it. So I think the normal tax rate that you would have seen in past quarters will reassert itself, assuming that National Interstate continues to be profitable. So I would view this as a blip.

Got it. That's helpful. Good explanation. Thank you.

Amit Kumar, Macquarie.

Two quick follow-ups. You mentioned on the question regarding disposition of NATL, you said you like NATL, it's a core holdings. The stock is down 17%. If it's a core holding, why wouldn't you be adding to that here? And probably ramping up your ownership of the company, if you believe in the long-term prospects?

Amit, we do believe in the long-term prospects of the company. And we are currently the majority stockholder in the company and consolidate its results on our financial statements. Whether or not we acquire any shares of National Interstate would be wholly dependent on what our other capital allocation decisions are. And speaking as the Chief Financial Officer of the company, we think we have better opportunities to invest our capital, or will have better opportunities to invest our capital. That's something that might be subject to change over time, in contrast to Carl's earlier statement where our view of National Interstate with its specialty focus, and it's niche orientation, and ART expertise, this is a specialty business that we like, and would like to own, effectively, forever.

So we're happy with the ownership level as it is. We could evaluate it in the future, depending on stock price, but we have a great many other possible uses for our capital. And that would be just thrown into the mix of where we are putting our capital to work.

So if I understand this correctly, what you're saying is that other avenues of future capital deployment would probably earn a better return versus a stock which is down 17% today?

Sounds like you've got a particular idea in mind. I'm not quite picking it up, though, Amit. You're not being subtle enough. Again, speaking as the CFO, rather than a co-CEO, I look at the price level for AFG common stock. I look at the price level for National Interstate common stock. I personally have a hard time recommending that we would be an acquirer of additional shares at National Interstate compared to AFG, and that's just share repurchase.

Yes. I totally understand that, based on various trading at on a price-to-book basis. That's helpful. The only other question I had was in the opening remarks you mentioned something about lender-placed business expanding. And I couldn't quite catch that entire comment. I think you were alluding to the growth in specialty financial. Can you just expand on that comment? You said the lender-placed grew while others pulled back, or something like that.

I think because of some competitive marketplace changes in that, we've had some opportunities, and we've picked up a number of accounts that are allowing -- is allowing that particular part of our specialty financial business to grow. So --

Okay. That's all I have. Thanks for all the answers.

And there are no further questions.

Okay. Thank you, Selima. Thank you all for joining us this morning. We look forward to talking to you again when we report our third quarter results. Thank you, and have a great day.

Thank you. This will conclude today's conference call. You may now disconnect your lines.