Good morning. My name is Keena, and I'll be your conference operator today. At this time, I would like to welcome everyone to the American Financial Group 2011 third quarter earnings conference call. All lines have been placed on mute to prevent any background noise. After the speaker's remarks, there will be a question and answer session. If you would like to ask a question during this time, simply press dial one on your telephone keypad. To withdraw your question, press the pound key. Thank you. Mr. Keith Jensen, Senior VP of American Financial Group, you may begin.
Thank you. Good morning. This is Keith Jensen. We're pleased to welcome you to American Financial Group's 2011 third quarter earnings results conference call. I'm joined this morning by Carl Lindner III and Craig Lindner, Co-CEOs of American Financial Group. If you're viewing the webcast from our website, you can 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. They're based on estimates, assumptions, projections, which management believes are reasonable, but by their nature, subject to risk and uncertainty.
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 the 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 on investments, the effect of accounting changes, discontinued operations, significant asbestos and environmental charges, and certain non-recurring items.
AFG believes its non-GAAP measures to be a useful tool for analysts and investors in analyzing the ongoing operating results and will be discussed for various periods during this call. The 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, and thank you for joining us. Craig and I want to start out by thanking God for the life of AFG's founder and chairman, Carl H. Lindner Jr. We'd like to thank you all for all of your prayers and condolences in connection with the passing of our dad, Carl H. Lindner Jr. We're humbled by the outpouring of love from his many friends in Cincinnati and across the country. Not to mention the many tributes and fond memories shared with us over the past week. Until his final days, our dad shared his passion for our business with employees throughout the AFG organization. While his presence in our corporate offices and boardroom will be missed tremendously, his incredible legacy carries on through the many people whose lives he has profoundly touched over the years. Yesterday afternoon, we released our 2011 third quarter results.
Despite a challenging quarter for the industry, Craig and I are very pleased to report solid operating results that are consistent with our expectations. Core net operating earnings for the third quarter were down $0.17 per share from the comparable 2010 period. We are proud of our insurance professionals that have remained disciplined in their underwriting and product pricing decisions. This mindset, particularly right now, is essential given the continued low interest rate environment and national and global economic uncertainty. I'm assuming that the participants on today's call reviewed our earnings release and the supplemental materials posted on our website. I'll review a few highlights and focus today's discussion on key issues. I'll also briefly discuss our outlook for the remainder of 2011. Let's start by looking at our third quarter results summarized on slides three and four of the webcast.
Net earnings per share were $0.94 for the quarter, which included realized gains of $0.04 per share. Lower earnings in our insurance operations and lower realized gains were partially offset by the effect of share repurchases. Year to date, earnings per share were $2.24 per share. Our core net operating earnings for the third quarter were $91 million, or $0.90 per share, compared to the prior year's results of $117 million, or $1.07 per share. Core net operating earnings per share for the first nine months were 14% less than our 2010 results. Lower underwriting profit and lower investment income in our specialty property and casualty insurance operations were partially offset by increased earnings in our Annuity and Supplemental Insurance operations during the nine-month period. Nine-month annualized core operating return on equity was approximately 9%.
One of our important strategic objectives is to deploy our excess capital in a way that enhances shareholder value. We've continued our share repurchases and purchased 2.6 million shares of our common stock at an average price of $32.25 per share during the third quarter. The average purchase price was approximately 83% of book value per share as of September 30th, 2011. We feel this remains an effective means in increasing shareholder value. There are approximately five million shares remaining under our current repurchase authorization. In addition to share repurchases and dividends, we continue to seek other alternatives for deployment of excess capital. We strive for healthy, profitable organic growth and continue to look for opportunities to expand our specialty niche businesses through startups or acquisitions where it makes sense to do that.
As you'll see on slide four, AFG's book value per share, excluding appropriated retained earnings and unrealized gains and losses on fixed maturities, increased 4% since year-end to $39.09. Tangible book value on a comparable basis was $36.72 at September 30, 2011, up 4% from year-end 2010. Pleased to say that our capital adequacy, financial condition, and liquidity remain strong in our key areas of focus for us. We've maintained capital in our insurance businesses at levels that support our operations are in excess of amounts required for our rating levels. At the end of the third quarter, our excess capital was approximately $725 million, which included cash at the parent company of $315 million. On slide five, you'll see summary results for our specialty property and casualty operations.
The property and casualty specialty insurance operations generated an underwriting profit of $56 million in the third quarter, compared to $68 million in the third quarter of last year. Results for the 2011 third quarter include an increase of $19 million in favorable reserve development. Losses from catastrophes totaled $13 million in the third quarter of 2011, primarily related to Hurricane Irene. Catastrophe losses in the third quarter of 2010 were $6 million. Once again, our catastrophe losses were modest, despite significant weather-related losses reported by the industry during the quarter. Underwriting profit for the first nine months of 2011 was $141 million, compared to $214 million in the comparable 2010 period. Favorable reserve development in our specialty property and casualty operations was $92 million through the first nine months of 2011, compared to $122 million in the same period in 2010.
The decrease in favorable development was attributed primarily to our runoff automobile residual value insurance business and a Specialty Casualty program book of business. Gross and net written premiums increased 24% and 30% respectively during the third quarter, and 16% and 18% respectively during the first nine months. Gross written premiums in 2011 included higher premiums in our Property and Transportation segment, particularly our crop and transportation businesses. The growth in net written premiums also reflects the impact of a third quarter 2010 reinsurance transaction in our Specialty Financial group. Overall average renewal rates for the first nine months were flat compared with the prior year period. We are pleased, however, that a few more of our businesses achieved price increases during the third quarter, though the market continues to remain competitive.
The decline in gross investment income related to our property and casualty operations was consistent with our expectations and due to decreased holdings in higher-yielding investments and generally lower reinvestment rates as we have discussed in our prior calls. Now let me discuss a few highlights from each of our specialty business groups on slide six. Property and Transportation Group reported an underwriting profit of $5 million in the 2011 third quarter, $36 million lower than the 2010 third quarter. Lower crop profits, higher catastrophe losses, and lower underwriting profits in our transportation businesses contributed to these results. Underwriting profit in the first nine months of 2011 decreased approximately $43 million from the comparable 2010 period. Most businesses in this group had strong underwriting margins through the first nine months of 2011.
Average renewal rates for this group during the first nine months of this year were flat compared to the prior year period. As respects to our crop business, corn and soybean harvests are underway. Approximately 65% of the nation's corn crop and approximately 80% of the soybean crop has been harvested. Reports from the field indicate that yields are variable. Commodity pricing for corn and soybeans is tracking favorably so far. The corn harvest price is currently 4% above the spring discovery pricing, and soybeans are down approximately 10%, well within the policy deductibles. Proposals surrounding cuts in federal funding for the crop insurance program appear to be in a favorable position. The two agricultural committees have been supportive of crop insurance as a component of the USDA's budget.
As funding for various provisions of the Farm Safety Net are evaluated to identify possible cuts, we believe that the funding for other USDA programs. The direct payment plan to farmers seem to be at a higher risk for cuts than the crop insurance program. We'll know more as the Super Committee reports its recommendations later in November. Our Specialty Casualty group reported an underwriting profit of $20 million in the 2011 third quarter, compared to an underwriting loss of $13 million in the third quarter of last year. The increase in underwriting profit was primarily attributable to a significant reduction in prior year adverse reserve development. Improved results in our general liability, E&S, and California comp businesses were offset somewhat by lower underwriting profits in our targeted markets operations.
Specialty Casualty underwriting profit in the first nine months of 2011 was $43 million, approximately $14 million higher than the comparable 2010 period. Higher underwriting profit in our P&T lines and improved prior year favorable reserve development more than offset underwriting losses in a block of program business. Most businesses in this group produced strong underwriting profit margins through the first nine months of 2011. Average renewal rates for this group during the first nine months of 2011 were up 1% when compared to the prior year period. We've had minimal claims arising from our political risk business in the Middle East and North Africa, and we don't currently expect significant losses to be incurred as a result of these events at this point. Specialty Financial Group reported underwriting profit of $23 million for the third quarter of 2011, compared to $36 million for the same period a year ago.
Higher catastrophe losses in our financial institutions business and lower prior year favorable RVI reserve development impacted 2011 results. Additionally, third quarter 2010 results reflect pre-tax income of approximately $8 million in connection with a reinsurance transaction involving the sale of earned premiums related to our automotive lines of business. Specialty Financial underwriting profit was $46 million for the nine-month period, compared to $91 million in the same 2010 period, primarily the result of lower favorable RVI reserve development in the 2010 reinsurance transaction. Almost all lines of business in this group produced strong underwriting margins during the first nine months of this year. Average renewal rates for this group during the first nine months of 2011 were down 1% compared to the prior year period. Now, I'd like to move on to a review of our Annuity and Supplemental Insurance group on slide eight.
Annuity and Supplemental Insurance group generated pre-tax core operating earnings in the first nine months of 2011 that were 6% higher than the first nine months of 2010. However, for the third quarter, pre-tax core operating earnings were 16% lower than in the comparable 2010 period. Higher third-quarter earnings due to asset growth and lower expenses were more than offset by the impact of the third quarter 2011 decrease in the stock market, and to a lesser extent, the accounting impact of lower interest rates on the company's fixed income, fixed indexed annuity operations. A 14% decline in the S&P 500 index during the third quarter of 2011 had a negative impact on variable and fixed indexed annuity results of approximately $8 million. Fixed indexed annuity results for the 2011 third quarter were also adversely impacted by approximately $4 million due to a decline in interest rates.
We expect that much of this negative impact will reverse over time. As a point of reference, there was no impact on earnings in the third quarter of 2010 because the positive impact of an 11% increase in the S&P 500 was offset by a decline in interest rates. AFG performs a review or unlocking of its major actuarial assumptions throughout the year with a more comprehensive review in the fourth quarter, including management's expectation of long-term reinvestment rates. Given current market conditions, the effect of any such fourth quarter unlocking is not expected to be material to AFG. Excluding the potential impact of any unlocking, AFG now expects that full-year 2011 Annuity and Supplemental core operating results will be 12%-15% higher than 2010, down from the earlier guidance of 15%-20%.
In the annuity business, again, that was 12%-15% higher than 2010, down from the earlier guidance of 15%-20%. In the annuity business, profitability is largely dependent on earning the spread between income earned on invested assets and amounts credited on annuity liabilities. AFG's spread continues to be excellent and has exceeded our expectations despite the recent interest rate environment. At the same time, the duration of our annuity assets and liabilities are very closely matched in September 30, 2011. Furthermore, in a declining and/or low interest rate environment, AFG receives some protection from spread compression. The ability to lower crediting rates subject to contractually guaranteed minimum interest rates. We began selling new policies with GMIRs below 2% in 2003. Almost all new business has been issued with a 1% GMIR since late 2010.
At September 30, 2011, the average crediting rate of all of our annuities was approximately 3.2%, while our average GMIR was approximately 2.6%. This margin provides AFG the flexibility to lower its crediting rates by up to 60 basis points on average in the future, should market interest rates continue to remain low for a long period of time. Statutory premiums of $992 million and $2.8 billion in the 2011 third quarter and first nine months were 20% and 40% higher, respectively, than the comparable periods in 2010. Third quarter results reflect increased sales of fixed indexed annuities in the single premium market, due primarily to the introduction of new products and features. Nine-month results also reflect higher fixed indexed annuity sales, as well as increased sales of annuities through banks, resulting from the addition of several new banks to the distribution network.
Sales of annuities have slowed since early September as we have lowered our crediting rates in response to the significant decrease in market interest rates. Please turn to slide nine for a few highlights regarding our investment portfolio. During the third quarter of 2011, AFG recorded net realized gains of $5 million compared to $15 million in the prior year period. Net unrealized gains on fixed maturities were $465 million, an increase of $139 million since December 31st, 2010. The vast majority of our investment portfolio is held in fixed maturities, with approximately 90% rated investment grade and 96 with a designation of NAIC 1 or 2. As discussed last quarter, the continued runoff and disposition of securities in our non-agency RMBS portfolio, as well as generally lower reinvestment rates, has resulted in continued pressure on investment income in our property and casualty business.
We provided additional detailed information on the various segments of our investment portfolio in the investment supplement on our website. I'd like to finish off with our outlook for 2011. As mentioned before, our 2011 core net operating earnings guidance remains in the range of $3.30 to $3.70 per share. We expect results to be consistent with the guidance provided in our call last quarter, with a few minor adjustments. We now expect growth in net written premiums in our specialty property and casualty operations to be in the range of 11%-14%, up from 9%-13% estimated earlier. We estimate our overall specialty property and casualty combined ratio to be in the range of 90%-93%, up slightly from our last estimate of 88%-92%.
We now estimate our Property and Transportation net written premiums to increase 20%-24%, up from our previous guidance of 18%-20%. It is our expectation that our crop insurance operations will be solidly profitable this year, but slightly below our expectations. As a result, we expect the combined ratio in the Property and Transportation group to be in the range of 92%-96%, up from the 87%-91% originally projected. Net written premiums in our Specialty Financial group are expected to be up 20%-24%, a decrease from our previous estimate of 24%-28%. As previously mentioned, pre-tax operating earnings in our Annuity Supplemental group are expected to increase 12%-15% over the 2010 results, slightly lower than our original estimate of an increase of 15%-20%.
A summary of our 2011 guidance is outlined on slide 10 for your convenience. These 2011 expected results exclude the potential for significant catastrophe crop losses, significant adjustments to asbestos and environmental reserves, large gains or losses from asset sales or impairments, and unlocking adjustments related to annuity deferred acquisition costs. Thank you. We'd like to open the lines for any questions.
At this time, if you would like to ask a question, press star one on your telephone keypad. Your first question comes from Amit Kumar of Macquarie.
Thanks, good morning, congrats on the quarter. Just maybe, you know, going back to the discussion on crop, I think I heard you mention that you expect it to be slightly below expectations. I'm just wondering, based on what we know so far, I guess Q2 and Q3 are the main quarters in terms of losses and earned premiums, can you just expand on that comment, and what could be the possible range of expectations at this point for the 2011 crop year?
Well, first of all, Amit, we have our estimates baked into our guidance to start with.
In addition, I think you mentioned that the majority of the profits are recognized in the second and third quarter. That's not correct. It's third and fourth quarter, with fourth quarter traditionally having been heavier because at that point, you finalized your understanding and knowledge of yields, and you've passed the measurement period for pricing, which takes place through the month of October. I would expect, as in most other years, that we'll really have a much firmer view in the fourth quarter. At this point, we're really in the very beginning of the earnings recognition process.
Yeah. As I mentioned before, with two-thirds of the crops harvested and almost through the price discovery period in October. We're kind of throwing out our best assessment at this point, which will be firmed up as Keith mentioned. We're going to have a solidly profitable full year. It's going to be slightly lower than our expectations, but that's kind of baked into our year-end estimate of our guidance.
Okay. That's helpful. I had thought that you do pick out the buckets and the ranges, and the loss picks in the earlier part of the year. That was my thought process, that there was a deadline where you had to pick out the buckets hence you had a clearer view what the range might be.
Actually, Amit, let me just interrupt for a second. Actually, in the first two quarters of the year, for the crop year, we don't recognize any income because at that point, planting, in many cases, hasn't even been completed. We really are not choosing current year amounts in any way, shape, or form until you get into the third quarter.
Any crop profits that are in the first half relate to a development on the-
Prior
favorable development from the prior year.
Got it. Okay. In terms of the premium impact from Vanliner, does that sort of normalize going forward? Obviously, you've had meaningful growth in the past quarters. Do we see that premiums sort of trend down, or what's the thought process there?
Well, Vanliner, if you remember, was an acquisition we made mid-year last year.
For the first 12 months, obviously, of ownership, we had to do a year-to-year comparison to get delta due to that. In addition, when we bought Vanliner, it had about $160 million of premium, about $60 of which was in traditional trucking business. Almost all of that has been run off and non-renewed. The baseline would be in the $90-$100 range.
We hope and expect that we'll see some growth in that, but the dramatic growth you've seen this year.
is a leap as a result of adding that extra $100 million of premium over a 12-month period.
We're kind of back to a more normal growth track. I think their management team is excited, though, about the opportunities to leverage the moving and storage in the captive area, and that we didn't really figure a lot of that happening, but which we think there's some good possibilities there.
Got it. That's very helpful. Then just very quick questions. Can you comment about your exposure to club deals? One of the companies in your space had meaningful adverse development from a professional liability exposure to private equity hedge funds and investment managers. Can you talk about your exposure to that line, and do you have any club deals in your professional liability?
Talking about exposure to hedge funds or private.
Yes.
If we could get back to you on that. That really hasn't come up as a red flag to us one way or the other generally. I know we probably write some of that business, but there's nothing that's really been a red flag to us at this point.
Got it. That's very helpful. Last question I will read you. Capital management. We've seen in the past that you've raised the dividend. You talked about buyback. You have excess capital of $725 million. How do you view a change in the dividend policy or a special dividend or acquisitions going forward? Where would you be in those options?
I think we're going to continue with our stock showing where it is in relation to book value. I think share repurchase will continue to be a focus. Also, acquisitions. We certainly, we've taken our dividend up 4.5% compounded over 5 years, and we'll continue to also look at that. As far as special dividend, there aren't any plans on the table to do that right now. As with everything, we're always continually looking for what the highest and best use of capital are.
Okay. Thanks for your answers.
The next question comes from Matt Rohman of Keefe, Bruyette & Woods.
Good morning, folks.
Morning.
Just two questions, I guess. Following up on the capital management question. Carl, obviously trading below book value, any buybacks immediately accretive is trading at book value. Is that sort of a hard inflection point in terms of how aggressive you could be with a buyback on a quarter-to-quarter basis?
I think as long as our stock's trading at a pretty good discount to book value, it's very attractive. That said, acquisition opportunities that are accretive and add to the franchise value of the company could also be just as important in that.
Okay, great. Just going to the ANS business for a second. Obviously growth has been strong all year, slowed as crediting rates have come down a little bit. You guys have done a great job setting up your bank partnerships to drive that growth. As growth starts to slow from such a strong pace, would you tend to be more open now to looking at increasing the number of partnerships going forward to continue to support that growth?
This is Craig. Yeah, we're always looking for opportunities to add high-quality distribution partners. The answer to that is yes.
Okay, great. Thanks very much, guys.
Again, to ask a question, press star one. Your next question comes from Jay Cohen of Bank of America.
Morning, Jay.
Good morning. Actually, good afternoon. Thank you. I guess a couple questions. First is just to get a sense of the new money yields relative to the portfolio yields. Where are you putting new money these days, and what kind of yields are you seeing?
Jay, this is Craig. We're putting new money in a variety of things. It's principally high-grade corporate bonds. We have gotten more active. Our real estate group has gotten more active in originating some directly originated commercial loans. We found some very interesting opportunities the last six, nine months. Have been able to put some money at it at pretty attractive yields. I think on the real estate loans that we have made, I'm going to just guess that we've got an average yield of 6.5%.
On the real estate?
On the real estate. The biggest part of new money, though, is going into high-grade, principally corporate bonds. There we're getting, probably on average, I'm going to guess 125 off Treasuries or some number like that. We were very underweight on the life side in commercial mortgage loan exposure. We have taken up our exposure in commercial mortgage-backed securities in principally the senior most tranches with lots of subordination, lots of equity. We kind of picked our time when the market was in disarray and gotten some pretty attractive yields on those investments. I'm just going to take a guess of 2.25, 2.50 off Treasuries or something in that neighborhood.
The property and casualty side, probably one of the biggest changes over the last year and a half, has been us going from underweight munis to high-quality munis to more of a market weight. We feel like we really purchased them at the right time.
Great. Second question. You referenced your willingness to look at M&A opportunities. Historically, you have been pretty opportunistic and pretty good at finding those opportunities. My question is, are you seeing more deals become available in the market because of some of the stress in the system?
I don't think we're seeing more deals at this point. We always see a steady stream. We always have a steady stream of things that we're looking at. I don't think, Keith, what's your-
There's not an increase. As Carl said, there is a steady stream. If you look at the pattern over the last few years, you'll see things like Vanliner or the Farmers Alliance deal, where they were large enough to hit the radar screen externally. We also find that it's very advantageous deals that are in the $30 million-$50 million range to add on to existing books of business quite profitably.
Got it. That's helpful. Thank you.
There are no further questions at this time.
All right. Well, thank you all for joining us. We appreciate you taking your time this morning, and we look forward to reporting on the full year results in January.
This concludes American Financial Group 2011 third quarter earnings conference call. You may now disconnect.