Oct 30, 2007
Executives
Keith Jensen - IR Carl Lindner – Co-CEO Craig Lindner – Co-CEO
Operator
Welcome to the third quarter 2007 American Financial Groupearnings conference call. (Operator Instructions) I would now like to turn thecall over to Mr.
Keith Jensen, Senior Vice President. Please proceed, sir.
Keith Jensen
Good morning. I'm joined here today by Carl Lindner, III,and Craig Lindner, Co-CEOs of American Financial Group.
It's our pleasure towelcome you to the American Financial Group third quarter results conferencecall. If you're viewing the webcast from our website, you can follow along withthe slide presentation if you would like.
Certain statements made during the call are not historicalfacts and may be considered forward-looking statements. They are based onestimates, assumptions and projections which management believes are reasonable;but by their nature, are subject to risks and uncertainties.
The factors whichcould cause actual results to differ materially from those suggested by suchforward-looking statements include, but are not limited to, those discussed oridentified from time to time in AFG's filings with the Securities and ExchangeCommission. These include the annual report on Form 10-K and quarterly reportson Form 10-Q.
We do not promise to update such forward-looking statementsto reflect actual results or changes in assumptions, or other factors thatcould affect these statements. Core net operating earnings is a non-GAAP financial measurewhich sets aside items that are not considered to be part of ongoingoperations, such as net realized gains or losses on investments, affects ofaccounting changes, discontinued operations, special asbestos and environmentalcharges and certain other non-recurring items.
AFG believes it to be a usefultool for analysts and investors in analyzing ongoing operating trends, whichwill be discussed for various periods during this call. A reconciliation of netearnings to core net operating earnings is included in our earnings release.
It's now my pleasure to turn the time to Carl Lindner, III, Co-CEOof American Financial Group.
Carl Lindner
Good morning. We released American Financial Group’s 2007third quarter results yesterday afternoon and are pleased that you could joinus.
Please turn to Slide 3 of the webcast materials. Our overall results forthe quarter continued at an excellent pace.
Net earnings for the 2007 thirdquarter were $0.93 per share versus $0.77 per share in the 2006 third quarter.We again achieved record core net operating earnings in the third quarter, 22%higher in the same period a year earlier. Through the first nine months of2007, these core earnings were 24% above the 2006 period.
The significant increase was driven by improved underwritingprofits in the specialty property and casualty operations and higher investmentincome. Greg and I want to thank our talented management team and employees fortheir efforts and we want to thank God for blessing AFG's business.
Our financial condition and liquidity remain very strong.Our book value per share of $26.75 was up 14% compared to the end of the 2006third quarter. This is consistent with our long-term objective of attainingcompound growth in book value in excess of 10% per year.
We used $345 million of our excess capital during thequarter to complete the purchase of the minority shares of our subsidiary,Great American Financial Resources, and to buy back 3.8 million AFG shares.Through the first nine months of this year, we've repurchased 4.7 million AFGshares at an average price of about $28.44. We expect these transactions to addto earnings between $0.15 and $0.17 per share on an annualized basis.
We continue to make opportunistic buybacks ofour shares. Prior to year end, we plan to transfer the shares of ourGreat American Financial Resources that are owned by our Great AmericanInsurance subsidiary to AFG.
This will provide additional flexibility in themovement of capital and is expected to be viewed positively by rating agencies. We had about $190 million of excess capital at the end ofthe quarter.
AFG's $18 billion investment portfolio stands at the highestquality in our history. At September 30, 2007 investments and non-investment grade securitiesrepresented 5% of our investment portfolio.
Mortgage-backed and relatedsecurities represented about 27% of the portfolio, and 99% of those securitiesare rated AAA. Investments in securities with sub-prime asset-backed collateraltotal $498 million.
All of these investments are in short maturity tranches andare rated AAA. In addition, all these investments are in securities with fixedrate collateral.
We are pleased to note that as a result of our conservativeinvestment approach, we have experienced no downgrades and have realized noimpairment losses on the sub-prime securities held in our portfolio. Before I turn to more detail in our operations, we wouldlike to express our sympathies to those affected by the devastating fires in California.Since our book of business is focused on specialty commercial products, to datewe have not experienced any significant losses related to this disaster.
We arecontinuing to monitor our exposures, but don't expect this event to have amaterial adverse effect on our fourth quarter results. Turning to Slide 4, the underwriting profit of specialty propertyand casualty operations in the 2007 third quarter of $105 million was 27%higher than in the same period a year ago.
The combined ratio improved 2.5points to 86.2%. The 2007 third quarter results included about $26 million or3.4 points of favorable development compared to $28 million or 3.8 points inthe 2006 period.
The favorabledevelopment for the current and prior year periods came primarily from ourproperty and transportation, specialty casualty and Californiaworkers' comp groups. Through the first nine months of 2007, underwriting profitof the specialty operations was up 41% compared to the same period last year.These results reflect the impact of earned premium growth, continuing rateadequacy in most of our businesses, continued favorable reserve development andlower catastrophe losses.
During the first nine months of 2007, we've experiencedfavorable development of $81 million, or 4 points, including an A&E chargerecorded in the second quarter, compared to $51 million, or 2.7 points in thesame period a year earlier. Catastrophe losses have been negligible compared to $22million or 1.2 points last year.
While at varying levels, all of our majorgroups are producing profitable underwriting margins. I continue to beencouraged by the stability of our overall rate levels.
Excluding the effect of Californiaworkers' comp, average premium rates and other specialty operations were downabout 2% from last year in a relatively competitive environment. Net writtenpremiums in the third quarter were 4% higher than the same quarter last year,and gross written premiums were up 8%.
Growth in net written premiums is somewhat depressed due tothe 2006 restructuring of program business reinsurance that resulted in thereturn of approximately $26 million in premium to us last year. Strong growthin the property and transportation and specialty and financial groups more thanoffset declines in specialty casualty and the Californiaworkers' comp groups.
Year-to-date, gross and net written premiums were about 3%above 2006 levels due to the strong growth in the property and transportationgroup, particularly in the crop business. We also had strong growth in severalbusinesses in our specialty financial group.
This group was partially offset bysignificant rate reductions in the Californiacomp business, as well as our decisions to exit the residual value insuranceand earthquake-exposed excess property businesses in the early part of '06.Excluding the impact of these three businesses, gross and net written premiumswere up 7% in the 2007 period compared to the 2006 period. Turning to slides 5 and 6, I would like to cover the resultsof each of our specialty business groups.
The property and transportation groupcontinued its strong growth in profitability through the first nine months ofthis year. The group's third quarter underwriting profit was $18 million higherthan last year's third quarter and its combined ratio improved 4 points.
Theseimprovements were due primarily to higher underwriting profits in theagricultural operations. Our crop insurance earnings are up due to favorablecrop yields and acceptable crop pricing levels to date.
Our largest cropexposures are in corn and soybeans. We will have a better view of their resultsduring the fourth quarter, as prices and yields are finalized.
These strong results were partially offset by underwritinglosses in a run-off homebuilders operation although year-to-date combinedratios for the last two years are about the same, underwriting profits up 8%resulting from strong premium growth. Gross written premiums for the three andnine months were 22% and 12% higher than the comparable 2006 periods, driven byexcellent growth in our property, marine and agricultural operations.
Overthese same periods, net written premiums grew 18% and 10% respectively. We did see some rate pressure in several business groups inthis group during the third quarter.
Average rate levels through the first ninemonths of the year are down slightly from the year earlier. Now, our specialty and casualty group has maintainedoutstanding underwriting profitability through the third quarter this year.
Thegroup's combined ratio for the third quarter was 2.4 points higher than in theprior year. The 2007 results include $16 million, or 7.7 points of favorablereserve development compared to $10 million, or 4.8 points in the 2006 thirdquarter.
Through the first nine months of this year, this group'scombined ratio improved 11.6 points. These results included $96 million, or15.3 points of favorable development, principally from the excess and surplus linesin our mid-continent subsidiaries general liability operations.
Theseoperations have continued to generate excellent accident year underwritingresults also. Gross written premiums for the 2007 three and nine-monthperiods were 14% and 8% below the same periods in 2006, due primarily tostronger competition in our E&S business and a softening in the homebuildersmarket that affects our general liability coverages.
We are firmly committed tokeeping rates at a level that supports our profit objectives and we're preparedto walk away from businesses that don't meet those objectives. Through thefirst nine months of 2007, this group's overall average premium rate was about3% lower than in 2006 period.
Specialty financial group continued its trend of strongpremium growth and produced another solid underwriting profit. The group'scombined ratio of 93.4% for the 2007 third quarter improved 28.4 pointscompared to the 2006 third quarter.
Through the first nine months of this year,it was 13.9 points better than the same prior-year period. The improvements are primarily due to lower losses in theresidual value insurance business in runoff and higher underwriting profits inthis group's other insurance operations.
In fact, excluding the effect of RBI,the group's combined ratio would have been 88.6 for the first nine months of2007 compared to 93.7 for the same 2006 period. Gross and net written premiums for the third quarter were up14% over the prior year.
Through the first nine months of this year, gross andnet premiums were up 11% and 17%. Growth in the property coverages offeredunder collateral and mortgage protection insurance for financial institution insuredand in our surety operations were the primary drivers of the increased volume.Higher year-to-date net written premium growth rate is attributable to greaterpremium retention within the lease and loan operations.
The premium rates in this group were downabout 1% through the first nine months of the year. Now, our Californiaworkers' comp business continued to generate excellent profitability, though onlower premium levels.
Third quarter combined ratio of 77.5% was nearly 14points higher than last year. 2007 results include 10.2 points of favorablereserve development, whereas 2006 results included 22.3 points.
For the firstnine months of 2007, combined ratio is up only 3 points compared to the sameprior year period. 2007 results included 8.8 points of favorable developmentcompared to 7.5 points in the 2006 period.
Continuing favorable prior year reserve development reflectsthe improved frequency and severity of claims resulting from the Californiareform legislation. While gross and net written premiums continue to beimpacted by a lower rate environment, the reform legislation has significantlyreduced workers' compensation costs for employers.
Rate decreases in Californiaaveraged about 23% during the first nine months. We expect to see a slowdown inrate decreases in this business.
In fact, the WCIRB has actually recommended amodest increase in rates beginning in 2008. We're achieving strong returns on thisbusiness and are optimistic that we can continue to do so at these rate levels.
Now let's turn to our annuity and supplemental insurancegroup on slide 7. Statutory premiums of $491 million in the third quarter of2007 were essentially unchanged in the third quarter of 2006.
Premiums of $1.5billion in the first nine months were 31% higher than the comparable 2006period. Year-to-date increases reflect substantially higher fixed indexedannuity premiums, partially offset by lower sales of traditional fixed annuities.In addition, supplemental insurance premiums increased substantially over the2006 period due to the acquisition of the Ceres Group in August of 2006.
In the 2007 third quarter improvement in the operatingearnings of the fixed annuity lines were more than offset by declines in thesupplemental insurance segment and higher mortality in the runoff life insuranceoperations. Third quarter 2006 supplemental insurance results included $3.4million of pre-tax earnings related to favorable claims development in theMedicare supplement business.
Through the first nine months of 2007, core operatingearnings are slightly below the 2006 period. Year-to-date 2006 results included$4.9 million of pretax earnings related to a payment received from a Floridacounty in exchange for certain limitations on future development of a marinaowned by the company.
Now I would like to summarize some key aspects of ourstrategic focus on Slide 8. Our operations will remain focused on specialtyniche markets within the property and casualty, annuity and supplementalinsurance industries, where we have significant expertise and can continue to buildfranchise value.
The significant objective is the appropriate use of ourexcess capital. We're pursuing several potential courses of action.
We're goingto continue to seek acquisition and startup opportunities that follow ourstrategy of being a specialty insurance player. We'll also pursue internalgrowth opportunities for our existing specialty insurance businesses, withemphasis on our transportation and inland marine operations, as well as theannuity operations.
We're also going to continue opportunistic sharerepurchases. We remain committed to our strong underwriting culture and pricingdiscipline and continually monitor the adequacy of our rates in all markets.
We'llreduce business volume in lines as needed to achieve appropriate returns. We'llfocus on maintaining investment returns that outperform the market.
Return onequity is targeted between 12% and 15%. I would like to reiterate our expectations for 2007 andprovide an outlook for 2008 on Slide 9.
For 2007, we continue to expect growthin net written premiums of 3% to 5% in our specialty property and casualtyoperations with a combined ratio stable to slightly better than 2006. Excluding the Californiaworkers' comp business, our expectation is that rates in our overall specialtyoperations will decline slightly, as some of our markets continue to beincreasingly competitive.
Our property and transportation businesses areexpected to generate double-digit net written premium growth for the year,resulting from higher crop premiums, geographic penetration in our property andinland marine unit, and new programs in Great American's trucking operations,as well as in our subsidiary, National Interstate. This group should alsomaintain excellent underwriting margins.
Specialty casualty group’s underwriting profit for the yearshould be higher than 2006, with a mid-single-digit decrease in net writtenpremiums resulting from competitive pressures in our E&S business andseveral other casualty lines. We expect to significantly improve underwriting margins inthe specialty financial group over 2006 to be sustained for the remainder of2007 and its premium to grow in the mid-teens.
We are expecting rate decreases in our Californiaworkers' comp to subside somewhat during the 2007 fourth quarter. As a result,we now anticipate that this group's 2007 net written premiums will declinebetween 15% to 20%.
Combined ratios are expected to increase somewhat, butshould still be in the low 80s or below, still producing excellent returns. In our annuity and supplemental insurance group, we expectpremium growth and stable operating results.
We continue to work on severalproduct and distribution initiatives to help further this group's premium andearnings growth. We plan to examine the AFG common stock dividend amountduring the fourth quarter.
Based on results so far this year and the trends inour business, we are increasing our forecast of AFG's 2007 core net operatingearnings to be between $3.70 and $3.80 per share from the previous $3.45 to$3.65 per share. Looking to 2008, Craig and I are optimistic about theupcoming year.
We expect stable net written premiums and a continuation of thestrong underwriting profits in the specialty operations. We look to improve thereturns on our annuity and supplemental insurance group and expect that groupto contribute between 15% to 20% of AFG's overall operating earnings.
Finally, we have announced that we are preliminarilytargeting AFG 2008 core net operating earnings to be between $3.75 and $3.95per share. The 2007 and 2008 expected results exclude the potential forextraordinary catastrophe and crop losses, adjustments to A&E reserves orlarge real estate gains.
Now, Craig and I would be pleased to answer any questions.Thank you.
Operator
(Operator Instructions) Sir, there are no questions at thistime.
Keith Jensen
Thank you for joining us for our third quarter conferencecall. We look forward to reporting our full year at the end of the fourthquarter.
Thank you and have a nice day.