American Financial Group Inc (AFG) 2015 Q3 法說會逐字稿

Good day, ladies and gentlemen, and welcome to the American Financial Group 2015 third-quarter financial conference call.

(Operator Instructions)

As a reminder, this call is being recorded. I would now like to turn the conference over to your host today, Ms. Diane Weidner Assistant Vice President, Investor Relations. Ma'am, you may begin.

Thank you. Good morning and welcome to American Financial Group's third-quarter 2015 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, 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 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 measures, which sets aside significant items that are generally not considered to be part of ongoing operations, such as net realized gains and losses, discontinued operations, and certain non-recurring items. AFG believes this non-GAAP measure is a useful tool for analysts and investors in analyzing ongoing operating trends, and will be discussed with various periods during this call. A reconciliation of net earnings attributable to shareholders to core net operating earnings is included in our earnings release.

If you are reading a transcript of this call, please note that it may not be authorized or reviewed for accuracy, as such, it may contain factual or transcription errors that could materially alter the intent of meaning of our statements. Now, I'm pleased to turn the call over to Carl Lindner III to discuss our results.

Good morning. We released our 2015 third-quarter results yesterday afternoon. I am assuming that our participants have reviewed our earnings release and the investor supplement posted on our website.

We are pleased with AFG's strong core net operating earnings, record third-quarter premiums achieved in our annuity segment, and healthy growth in our property and casualty operations. Core net operating earnings were a $1.38 per share, a decrease of $0.02 per share from the comparable prior-year period. These results reflect higher underwriting profit and higher net investment income in our specialty property and casualty insurance operations, which was more than offset by the impact that fair value accounting had on the results of our annuity segment.

Annualized core operating return on equity was 11.6% for the 2015 third quarter, compared to 12.3% for the third quarter of 2014. Net earnings per diluted share were $0.71 a share, and included a $0.58 per share for A&E reserve strengthening and $0.09 per share related to realized losses, and a loss on early retirement of debt. During the quarter, we repurchased $35 million of AFG common shares at an average price per share of $68.56. We also announced the special dividend of $1 per share payable in December.

Returning capital to our shareholders is an important component of our capital management strategy, and reflects our strong financial position and our confidence in AFG's financial future. We increased AFG's 2015 core operating earnings guidance to $5.30 to $5.60 per share, which is up from the range of $5.25 to $5.55 per share estimated previously. Craig and I will each discuss our guidance for each segment of our business later in the call.

Last week we formally celebrated the opening of Great American's newest property and casualty branch office in Singapore. Particular focus areas include marine, general liability, and professional and executive liability. Entry into the Singapore market has enabled us to expand our international footprint into Southeast Asia. We have a respected experienced team in place, and look forward to the profitable growth of our newest international business.

Now, let's take a closer look at AFG's results this quarter. If you would turn to slides 4 and 5 of the webcast, which include an overview of results in our specialty property and casualty operations. Beginning on slide 4, you will see that gross and net written premiums were both up 6% in the 2015 third-quarter compared to the same quarter a year earlier. Although the marketplace has become more competitive, we're still finding opportunities to grow our specialty property and casualty businesses. Underwriting profit was up 20% year-over-year, reflecting strong performance by the vast majority of our 31 businesses that comprise our specialty property and casualty group.

The third-quarter 2015 combined ratio of 92.9 improved by nearly a point from the comparable prior-year quarter, and included 1.2 points of favorable prior-year reserve development and 0.9 points in catastrophe losses. Overall specialty property and casualty group pricing was flat, and was impacted by price softening in our Worker's Comp businesses. We continue to focus on price adequacy, however, and achieved increases in over 40% of our property and casualty businesses during the third quarter, most notably in our property and transportation group.

With that, I would like to turn to slide 5, to review a few highlights from each of our specialty property and casualty business groups. Our property and transportation group reported a year-over-year improvement in underwriting results in the third quarter, as well as a sequential improvement from the second quarter of 2015. Higher profits in our agricultural and transportation businesses were partially offset by lower underwriting profitability in our property and inland marine and ocean marine businesses. Catastrophe losses for this group were $7 million in the third quarter of 2015, increasing from $1 million in the third quarter of 2014.

The increases in gross and net written premiums in this group were due primarily to the growth in our transportation businesses as a result of new accounts and organic growth in several product lines, as well as higher premiums in our ag businesses. It's shaping up to be a good crop year, with solid profitability expected in our crop insurance business. Corn and soybean crops finished strong as August and September growing conditions were ideal.

Crops were able to reach maturity ahead of a major frost event. Early harvest yields are coming in better than expected, with many states, particularly those in the Western corn belt, projecting yields well above trend. Concern areas are portions of Illinois, Indiana and Ohio due to variable yields resulting from early-season excessive rainfall. We are pleased that the corn and soybean October harvest price discovery period closed with corn and soybean harvest prices about 8% below spring discovery prices.

In property and transportation, we continue to focus on adequate pricing. Overall renewal rates for this group increased 4% on average for the quarter with our National Interstate subsidiary achieving a 5% rate increase. I am pleased with the underwriting profitability reported by our specialty casualty group during the quarter. Nearly all the businesses in this group achieved strong underwriting margins.

I'm pleased, especially pleased with the profitability within our worker's compensation businesses, which helped to offset underwriting losses in our international operations. Next week, Martin Reith will be joining us as the CEO designate of Marketform, which operates Syndicate 2468 at Lloyd's of London. His success in building and leading insurance operations in the Lloyd's market is consistent with the core Great American Insurance Group tradition of specialty focus and consistent profitability.

Our leadership team will be working closely with Martin to get this business back on track. The majority of businesses in the specialty casualty group reported growth, particularly our excess and surplus businesses. This growth was partially offset by lower premiums in our general liability business, primarily the result of competitive market conditions, re-underwriting efforts within our Florida homebuilder's business, and the slowdown within the energy sector. Pricing in this group was down about 2%.

Our worker's compensation businesses reported a pricing decline of about 6% on average for the quarter, due primarily to lower renewal pricing in Florida. Excluding workers compensation, pricing in this group was up about 1% on average for the quarter. Our specialty financial group reported excellent profitability this quarter, with especially strong results in our financial institutions business. Every business in this group achieved excellent underwriting margins during the quarter, producing an overall calendar year combined of 81%. Growth and higher retentions in our financial institutions business were the primary factors driving a double-digit increase in net written premiums in this group during the quarter. Renewal pricing in this group was flat for the third quarter.

Now please turn to slide 6 for a summary view of our 2015 outlook for the specialty property and casualty operations. We now estimate that growth in net written premiums will be in the range of 6% to 8%, which has narrowed a bit from the range of 4% to 8% previously estimated. Our combined ratio guidance is unchanged and is expected to be between 92% and 94%.

We have increased our guidance for net written premiums in our property and transportation group. We now expect growth of 3% to 6%, an increase from our previous expectations, that premiums would be down 1% to up 2%. This change in guidance is primarily the result of higher than expected premiums in our transportation businesses. Our guidance for combined ratio remains 96% to 99% in this group.

The premium guidance for specialty casualty group was narrowed a bit. We now expect growth in a range of 10% to 12%, changed from our previous range of 8% to 12%. Our combined ratio guidance for this group continues to be in a range of 91% to 94%.

We've increased our estimate for growth in net written premiums in our specialty financial group to be in the range of 7% to 10%, which is an increase from the growth of 3% to 7% estimated previously, and the outlook for the combined ratio for this group has improved to a range of 80% to 83%, a 1 point improvement over our previous estimate of 81% to 84%. These changes are based on the group's strong results through the first nine months of the year.

Additionally, we now expect our property and casualty investment income to grow by 10%, an increase from growth of 8% estimated previously. On the pricing front, we now expect overall property and casualty renewal pricing to be flat to up 1%. I will now turn the discussion over to Craig to review the results in our annuity segment and AFG's investment performance.

Thank you, Carl. I will start with a view of our annuity outlook for the remainder of 2015. As you will see on slide 7, we are increasing our guidance for annuity earnings before the impact of fair value accounting by $5 million, to a range of $345 million to $355 million. Higher than previously expected net interest spreads is the primary factor driving the increase in our estimates.

Based on where interest rates and the stock market are today, we now expect the full-year 2015 core pre-tax annuity operating earnings as reported will be $325 million to $335 million, a decrease of $5 million from our previous estimate. As we saw in the third quarter, significant changes in the stock market and/or interest rates, as compared to our expectations, can lead to a significant positive or negative impact on the annuity segment's results, due to the impact of fair value accounting.

You will also see on slide 7, that based on a recent sales trend, we've increased our premium guidance and now estimate the full-year 2015 annuity premiums will be in the range of $3.8 billion to $3.95 billion, an increase from the $3.7 billion achieved in 2014. Significant changes in interest rates and/or the stock market from our expectations could lead to additional positive or negative impacts on the annuity segment's results. These earnings expectations do not reflect any potential earnings impact from our annual unlocking fourth-quarter review of the major actuarial assumptions in our fixed annuity business. Since our net interest spreads are higher than previously projected, we currently believe that the unlocking will likely have a positive impact on earnings. The fundamentals of our annuity business remain very strong, despite the lower than expected reported earnings after fair value accounting.

Taking a look at results in the third quarter, you will see on slide 8 that core pretax annuity operating earnings before fair value accounting were $89 million or 2% higher than the prior-year period. AFG's 2015 earnings continue to benefit from growth in annuity assets, as well as the ability to maintain net interest spreads year-over-year. AFG's quarterly average annuity investments and reserves grew by approximately 13% year over year. The benefit of this growth was partially offset by the impact that the significant decrease in the stock market in the third quarter had on certain AFG annuity reserves.

Variances from expectations of certain items, such as projected interest rates, option costs and surrenders, as well as changes in the stock market, have an impact on accounting for indexed annuities. These accounting adjustments are recognized through AFG's reported core earnings. Many of these adjustments are not economic in nature, but rather impact the timing of reported results.

In the third quarter of 2015, the significant stock market decrease resulted in a large unfavorable impact on annuity earnings because of the impact of fair value accounting on fixed indexed annuities. In addition, interest rates decreased during the quarter, compared to the expectation that they would rise. This also had a negative impact on the annuity segment's core pre-tax operating earnings. In the third quarter of 2014, changes in the stock market and interest rates were much more moderate, resulting in a minor impact on annuity earnings.

I was very pleased with the annuity segment's record third-quarter annuity premiums of $1.32 billion, a 63% increase from the comparable prior-year period. During the second quarter of 2015, interest rates rose significantly from the first quarter 2015 lows, allowing AFG to raise the crediting rates on its annuities and to become much more competitive in the markets. This is in contrast to 2014, when interest rates generally decreased throughout the year, resulting in AFG lowering its credited rates, in order to maintain appropriate returns on sales.

The summary of the components of spreads for AFG's fixed annuity operations can be found on slide 9. Additional information can also be found in AFG's quarterly investor supplement posted on our website. In April, we announced a definitive agreement to sell our runoff long-term care insurance business to HC2 Holdings. Included in the sale are United Teachers Associates Insurance Company and Continental General Insurance Company, the legal entities that contained AFG's long-term care insurance business. This transaction will result in the disposition of substantially all of AFG's long-term care business. The transaction is expected to close prior to year-end, subject to customary conditions, including receipt of required regulatory approvals.

Now, please turn to slide 10 for a few highlights regarding our $38 billion investment portfolio. AFG recorded third-quarter 2015 net realized losses of $6 million after-tax and after deferred acquisition costs, compared to net realized gains of $8 million in the comparable prior-year period. As of September 30, 2015, unrealized gains on fixed maturities were $445 million after-tax, after DAC, and unrealized gains on equities were $44 million after tax.

As you will see on slide 11, our portfolio continues to be very high-quality, with 88% of our fixed maturity portfolio rated investment grade, and 98% with an NAIC designation of 1 or 2, it's two highest 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 our consolidated third-quarter 2015 results, and share a few comments about capital and liquidity.

Thank you, Craig. Slide 12 recaps AFG's third-quarter consolidated results by segment. Core net operating earnings per share in the quarter were $1.38, down $0.02 from Q3 2014's record $1.40. The impact of fair value accounting that Craig described reduced AFG's core net operating EPS by $0.16 in the 2015 third-quarter.

As we've stated before, we do not believe that fair value accounting presents an accurate depiction of the results of operations for our annuity segment. Some in our industry choose to exclude it from core operating EPS. We have not. That $1.38 is based on core net operating earnings in the quarter of $123 million. You'll be able to see a more detailed view of these components on page 4 of our quarterly investor supplement.

P&C core pre-tax operating earnings improved by $23 million year-over-year due to P&C underwriting profit improving by $12 million, an increase in P&C net investment income of $7 million, and P&C other expenses decreasing by $4 million. As for the other components of AFG's core net operating earnings, Craig previously covered our annuity segment earnings, which were $19 million lower year-over-year, a result of the impact of fair value accounting for fixed indexed annuities.

Results in our run-off long-term care and life segment improved by $5 million. Interest expense of parent holding Company increased $1 million, due primarily to our 6 1/4% hybrid debt offering in September 2014. Other expense was $6 million higher than what was reported in the 2014 third-quarter. Last year's quarter was not indicative of a run rate for this line item.

Turning to slide 13, you will see a reconciliation of core net operating earnings to net earnings and diluted earnings per share. In addition to realized investment losses, and a loss on the redemption of AFG's 7% senior notes, net earnings in the quarter were reduced by an A&E reserve strengthening of $52 million after-tax or $0.58 per share. The components of our special A&E charge are further outlined at the bottom slide 13.

AM Best released its annual asbestos and environmental special report on October 27. That report shows an industry three-year adjusted survival ratio of 8.2 times paid losses as of year end 2014. The adjusted three-year survival ratio for AFG's, P&C insurance subsidiaries now stands at 11.5 times paid losses.

As indicated on slide 14, AFG's adjusted book value per share was $49.01 as of September 30, 2015. This is a decrease of $0.62 during the third quarter. The biggest piece of this decrease was a decrease of $86 million in unrealized gains on equity securities during the third quarter of 2015, which resulted in a decrease of $0.98 per share in adjusted book value per share. Tangible book value per share was $46.12 at September 30, 2015.

Our excess capital stood at approximately $700 million at September 30. In the quarter, we chose to increase our capital allocated to common stocks, where we increased our common stock to fair value by approximately 25%. While the S&P decreased by approximately 7% in Q3 2015, I would note that through the beginning of November, the S&P has risen quarter to date by over 9%. I would expect that much of the stock market impact on capital will have reversed subsequent to quarter end.

The pending sale of our runoff long-term care insurance business is expected to generate approximately $110 million in excess capital. We returned $57 million to our shareholders through dividends and share repurchases during the quarter. Approximately 3.2 million shares remain under our repurchase authorization. We plan to continue returning excess capital to our shareholders through the course and remainder of 2015. Notably, through the December special dividend of $1 per share announced in the press release, plus subject to market conditions, continued share repurchase.

Closing with slide 15, you can see a single page summary of our 2015 core earnings guidance. We have upped AFG's 2015 core operating earnings guidance at each end of the range by $0.05, to $5.30 to $5.60 per share. As a reminder, AFG's expected 2015 core operating results exclude non-core items, such as realized investment gains and losses, and other significant items that may not be indicative of ongoing operations. Now, we would like to open the lines for any questions.

(Operator Instructions)

Christopher Martin, Macquarie.

Congrats on the underwriting results this quarter and the annuity premium growth. I have two questions related to crop insurance. The first is regarding the proposed $3 billion in budget cuts to the program. How do you think this might impact the industry, and do you think that this could drive some more consolidation onto smaller players?

I don't think the bill as drafted is not good news for the crop industry, and definitely would probably have an impact on greater consolidation in my mind. I think right now, though, there is a supposed deal for it to be revised in the upcoming omnibus spending bill, and that seems to be a positive. But, we will continue to monitor that closely, and see what happens in that. I think that is a positive right now.

All right. Great. Thanks. And staying on the crop with the strong El Nino we have seen, typically that leads to favorable growing conditions. Do have an early outlook on what you expect 2016 to look like in both premiums and commodity pricing?

We generally do guidance a little bit later, once we have a little bit better feel on things. I think one question I've been getting is about El Nino. Generally, the current predictions are for a strong El Nino event to influence weather patterns this winter. Generally for the crop industry, that's a positive event. To the extent that there is wetter than average conditions, particularly in California, or in some of the southern tier states which actually could bring drought relief to those regions. El Nino, our initial take is that could be positive. That is something that is talked a lot about right now.

I think you can get a little bit of a flavor if crop prices, the discovery prices are down 8% usually in the spring, discovery prices that establish premium levels for next year, generally when you look at the futures that tie to more of the spring time period and that, generally they are not down quite as much. I think that there should be a fairly stable -- my initial thought would be a stable outlook on premiums for next year, but it all depends on what those spring discovery prices are. Until that, you are able to measure that in the spring, it's kind of tough to prognosticate.

Great. Thanks. That's all I had.

Paul Newsome, Sandler O'Neill.

Congratulations on the quarter. I wanted to, and I apologize, I had to jump off the call briefly, so tell me if I'm being redundant. Perhaps a little bit more on the asbestos charge. It seemed a little bit larger than I think we've seen in the past. Why might that be? Are we getting -- at what point do you think we get to the point where those asbestos charges get pretty small?

Paul, it's Jeff Consolino. Thanks for your question. I guess in terms of your statement that the asbestos and environmental special charge is bigger than before, or what you've seen. Just in terms of history, we typically work with an internationally recognized independent actuarial firm on a two-year rotating basis, so the last time we had that outside firm in was 2013.

The charge we took this quarter of $79 million pretax is comparable to the $76 million of 2013. I guess I would challenge the assumption this is without precedent or unusual. As it relates to the overall asbestos and environmental environment, I do think that AM Best report issued at the end of October is fairly illustrative of what the industry is seeing, and we would say for our P&C business, the analysis was driven by slightly higher than expected indemnity and defense costs, and as the industry exposures to asbestos has matured, the focus of litigation has radiated out to smaller companies and companies with ancillary asbestos exposures, and our insurance to these kinds of exposures have been the driver of our reserve increases in prior periods.

As for environmental, we look at the environmental piece, primarily attributable to increased defense costs and a small number of claims where the costs for remediation have increased. I hope that gives you a good sense as to what is sitting inside that number. I guess I will leave it to you to follow up, if you have any further questions.

No. That's great. And I have a separate life insurance, entirely separate life insurance question. This is hopefully a fairly straightforward question. So I think of the fixed annuity business as being pretty straightforward. You basically make, the vast majority of what you make is in interest rate spread on asset side management. I'm looking at slide 8 and one of the things I noticed is that the average fixed annuity assets are up 13%, and the interest rate spread is also improved, which are both fantastic. But the core operating earnings was up only 2%. What would be the other factors that make that core not go up, say at least in line with the average fixed annuity investments?

This is Craig. The answer to that is the impact of the stock market decline on non-fair value items, specifically rider reserves. The decline in the stock market resulted in us needing to put up more reserves against the riders, and that is what accounts for that difference.

Great. Thank you.

Ryan Byrnes, Janney Montgomery.

Just had a question, obviously the big hire out in London, are there any initial changes, I guess strategy changes for Marketform that we should know about? And maybe try to figure out how much of a use of excess capital that could be going forward?

Good morning, Ryan, it's Jeff Consolino, and already I'm going to reverse myself and say good afternoon. We are excited, as Carl said, about the hire of Martin Reith to our London Marketform operation. Martin's track record speaks for itself, and we think he is the kind of leader that is consistent with the kind of leadership we have in our domestic US business. And Martin has not yet started at Marketform, and so I think it is premature and would be getting out ahead of him to talk about any changes that may transpire. Why don't we park that and keep track of it as his tenure starts to get underway. And likewise, I think I wouldn't want to talk about capital commitment or use of capital until we're further down the road in that change.

Got you. So you won't put any pressure on them quite yet. I understand that. And then, moving on to the workers comp market. I saw the Florida -- the state of Florida is looking to put through 5% rate reductions heading into next year. I just wanted to get your thoughts on that, and where the underlying margin of that business are going. I know that you have gotten a lot deeper with data and analytics, which are kind of softening that pressure, but I just wanted to get your thoughts there.

Naturally, we were disappointed that the Commissioner chose a number higher than what the NCCI was choosing. Our results continue to date. We had good results at Summit, meets our expectations. I think the rate decline probably will help us, we will need to be more selective in our underwriting and tighten up our analytics model, such that we can maintain margins there, particularly in Florida.

So I think one way you can look through the lens of our own predictive analytics model and at that 5% rate reduction may work out to be more like 1% or 2%, based off of our mix of business. Our specific mix of business would be our initial take on that. If we have to tighten things, we will do that, in order to meet the margins.

Okay. Great. Thanks for the color.

(Operator Instructions)

Jay Cohen, Bank of America.

A couple of questions. First, in the property transportation business you highlighted some loss pressure or loss activity in property and in the Marine lines. I'm wondering were there unusual events -- unusual -- where there large events that led to that?

Jay, I would not say any large events. Certainly nothing that would be CAT like.

Just underlying pressure from pricing/claims standpoint?

Again. I think you have to look at the diversity of those businesses, Jay. I'm going to point to you to a couple things, since I'm not satisfied with the short answer. You can see in the supplement, and you can see in the press release that CAT losses year-over-year were higher. Let's put that aside, because we carve that out separately.

In terms of the underlying loss ratio, I would say a couple of things, I'm just going to try to refer to the schedule here quickly, if you don't mind. I show our loss and loss adjustment ratio for the quarter for property and transportation, excluding CATS and excluding prior-year developments at 74.6, a year ago that was 81.4. We had a more favorable crop quarter, given the comments that Carl made, and so we had a greater level of profitability and a lower loss ratio in crop. Likewise, a year ago, we talked about the pressures in transportation both in National Interstate and in our own individual owner-operator business for Great American. We have seen improvement in both of those.

Agribusiness and equine also have improved. So when you take those all out, you can see that the improvement is really attributable to all of those levels. So a higher level of CATS, offset by improving results in crop, trucking, National Interstate, equine and agribusiness, and that's what is moving the loss and LAE ratio on an accident year ex-CAT basis for that sub-segment.

I was looking at the same ratio, but I was looking at it relative to the first half of the year, where that ratio was in the 60s, and it seemed to pop up. I don't know if there is seasonality here, but I didn't know if there was just any loss activity. That's fine.

Okay. Thanks, Jay.

Secondly, Marketform. What is the underlying issue that needs to be resolved? Obviously you are not happy with the performance. What is the problem in that business?

I think, you know, we have not had a leadership group that has properly selected and priced the business in a decent number of the businesses. We have some great teams that have produced very profitable results, but we continue to be disappointed per our standards, that we've had the right leadership and the right team to get the job done. That's why we made the leadership change, and why we went out of our way to get somebody that had the best track record there.

We are not messing around. We want Marketform to be a very profitable venture for us. One of the few disappointments, when you look across our 31 different specialty businesses.

Great. So basic underwriting blocking and tackling, you need someone right for that job, then?

Exactly.

Great. Thanks for the answers.

Greg Peters, Raymond James.

Thank you for hosting the call and taking our questions. A couple of areas to touch on in the annuity segment. Can you provide some additional color behind the fair value accounting adjustment, and considering the market movement since the end of the third quarter, is it possible that there could be a positive adjustment going into the fourth quarter?

Greg, this is Craig. Let me give you a little more color on what impacted us in the third quarter. The two largest drivers of the $22 million fair value accounting hit that we took were the decline in the stock market and interest rates that ended the quarter a bit lower than we had expected. Obviously, we have had a very significant recovery in the stock market, so far in the fourth quarter, interest rates have moved up.

If you look at the guidance that we put into the news release that we issued last night, you will see that we are steering to, if you look at the midpoint of the guidance on operating earnings, we are steering to a $100 million operating number that compares to $67 million that we just reported in the third quarter, and that does include a nice recovery in the stock market. Our assumptions related to interest rates and the stock market that go into that guidance are that in the fourth quarter the stock market would increase by 8%. And I think as of this moment, it's up a little bit more than 8%, and it assumes that rates would trend up in the quarter.

It assumes, as an example, that the 10-year corporate A2 rate would be at a 369, which is about where it is today. So it assumes an 8% increase in the stock market. It assumes interest rates stay around where they are today. And if that happens, we recover -- in the guidance, we assume we were going to recover, we were going to have a positive impact from fair value accounting of approximately $8 million, and that is what is included in our guidance from an operating earnings number in the fourth quarter of $100 million.

Thank you for the color, Craig. If you could add, or if I look at, it looks like you are going to be able to achieve in terms of operating earnings within the annuity segment for 2015, how do you think about the returns on allocated capital that you expect to get this year, relative to your long-term objectives?

The return that we are projecting after the negative impact of fair value accounting, which frankly we are not a big fan of, but including fair value accounting, the return this year is projected to be between 11% and 12%, not including realized gains on stocks.

Right And is that consistent with your long-term objective?

What we've seen certainly over the last four or five years, there is an uptrend in the returns in the annuity business. We have been bogged down by a block of higher GMIR business. The new business that we are putting on the books has a return that we find to be very attractive. It is still impacted by some of the older business that has 3% and 4% GMIRs. So new business targeted returns are in the neighborhood of 12%, and over the last three or four years, we've exceeded that by a fairly significant margin.

Thank you for those answers. If I could continue further and switch gears, over to the Worker's Compensation business. I believe, Carl, in your comments, you implied that there are rate decreases in the environment, in other states other than Florida. And I was wondering if you could provide us some perspective on how we should think about the impact of these rate decreases as we look to 2016 projections?

I think it probably impacts our growth, obviously, I think as you have rate decrease that both in Florida and California and the third quarter in California, we had about a 6% price decline. I think about 3% year to date 2015. I think the immediate effect is, for instance in California, we are probably going to grow low single digit this year versus the double-digit growth that we've had in the past. In Summit, 5% price decline will probably mean that we will write less premium than what we had projected for Summit this year and probably some next year.

I mentioned in Summit that we are highly focused on predictive analytics, and as the rates have moved down there we have tightened up our underwriting grid and are using our modeling more extensively, and we will try to do the same thing in the other workers comp business that we write also. The good news is we have excellent margins when you look at our worker's compensation business today and if maybe versus some others, we can give up a few points of margin, and still be earning really good returns. So I think that is probably my perspective on it.

Thank you for that color. If I could just close out with a discussion on capital management. I am sure that many of your shareholders, yourselves included, appreciate the special dividend but there is an ongoing discussion and argument in the institutional shareholder market about whether you get any credit for special dividends among institutional investors. I was hoping that maybe you could weigh in with your opinion on that? And, also, just provide some commentary about how you balance the formula between share repurchase and dividends in terms of capital management?

There is probably not any ideal answer to that question. I think most shareholders, you know we usually get out a couple of times after each quarter and talk to our investors and generally the feedback around special dividends is generally very positive. Definitely more positive than negative comments we get.

You have to put that special dividends in the context of just intelligent overall management of excess capital. We think that we have done an excellent job of that over time. We have combined acquisition opportunities and organic growth opportunities along, with a consistent double-digit compounded increase in dividends, along with special dividends. The mix of how we look at things every year is a little bit different, based off of our opportunities to grow organically, what potential acquisitions we have on the plate, and generally come the fourth quarter, we know where we are going to end up by year end.

And generally if we think a special dividend is appropriate, and we still have the capital to take advantage of the other opportunities that we have, that is when we focus in and make that decision around special dividends, and that. Naturally, sure, I would love to be in a tight market where we can grow the business 20% and take advantage of that, but the reality right now is it's a very competitive market. I think we have been effective at picking places to grow organically, where rates are adequate, and provide attractive returns, and I think we've been good at picking out appropriate acquisition opportunities like Summit, and a number of the other start-up businesses that we've been engaged in. So I hope that answers your question.

It does, and thank you for answering all of the questions I had.

Thank you. That does conclude our question-and-answer period for today. I would like to hand the conference back over to Ms. Weidner for any closing remarks.

Thank you, and thank you for joining us this morning as we review our third-quarter results. We look forward to talking to all again as we look at next quarter. Have a good day.

Thank you for your participation in today's conference. This does conclude the program and you may all disconnect. Have a great rest of your day.