Good morning. My name is Tina, I'll be your conference operator today. At this time, I would like to welcome everyone to the American Financial Group 2011 second 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 star one on your telephone keypad. To withdraw your question, press the pound key. I would now like to turn the call over to Keith Jensen, Senior Vice President of American Financial Group. Please go ahead, sir.
Thank you, Tina. Good morning, welcome to American Financial Group's 2011 second 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 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 are based on estimates, assumptions, and projections which management believes are reasonable, but by their nature, are subject to risks and uncertainties. The factors which could cause actual results or financial condition 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 its 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 part of ongoing operations, such as net realized gains or losses on investments, the effects of accounting changes, discontinued operations, significant asbestos and environmental charges, and certain other non-recurring items. AFG believes this non-GAAP measure to be helpful 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, thank you for joining us. Yesterday afternoon, we released our 2011 second quarter results. Although our core net operating earnings for the second quarter were down $0.13 per share from the comparable 2010 period, we reported solid operating results that were consistent with our overall expectations. We are pleased that our catastrophe losses were modest, despite significant weather-related losses reported by the industry during the quarter. We believe that our specialty mix of insurance businesses, focused underwriting discipline, and the strong alignment of interest we've created with the leaders of each of our specialty business units have contributed to these results, it's no accident. I'm assuming that the participants on today's call have reviewed our earnings release and the supplemental materials posted on our website. I'll review a few highlights focus today's discussion on key issues.
I'll also briefly discuss our outlook for the remainder of 2011. Let me start by looking at our second quarter results, summarized on slides three and four of the webcast. Net earnings per share were $0.52 for the quarter. Year-to-date earnings per share were $1.31. 2011 results included the effect of an after-tax charge of $0.37 per share, resulting from strengthening reserves for asbestos and other environmental exposures within our property and casualty operations in former railroad and manufacturing operations. This charge was partially offset by realized gains of $0.11 per share in the second quarter. Our core net operating earnings were $81 million, or $0.78 per share for the quarter, compared to the prior year's results of $102 million or $0.91 per share.
Record operating earnings in our Annuity and Supplemental Insurance group were more than offset by lower underwriting profit in our specialty property and casualty operations and lower property and casualty investment income. Lower property and casualty underwriting profit was largely attributable to a $25 million pre-tax decrease in favorable reserve development. These results were partially offset by a $10 million increase in Annuity and Supplemental operating earnings and the favorable effect of our share repurchases. Six-month annualized 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. To that end, we continued our share repurchases and purchased 2.7 million shares of our common stock at an average price of $34.79 per share during the second quarter of 2011.
The average purchase price was approximately 90% of book value per share as of June 30th, 2011. We feel this remains an effective means of increasing shareholder value. There are approximately seven million shares remaining under our current repurchase authorization. Share repurchases are one of the several alternatives for deployment of our excess capital. We continue to strive for healthy, profitable organic growth, and we're always looking for opportunities to expand our specialty niche businesses through startups or acquisitions where it makes sense to do so. Based on the company's operating performance and its capital and liquidity position, we also announced yesterday an increase in our annual dividend from $0.65 per share to $0.70 per share, effective October 1st, 2011. This increase reflects our confidence in the company's financial condition and the prospects for long-term growth.
We've increased our dividend seven times in the last six years. The five-year annual compounded growth rate of our dividend is 12.5%. 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 3% since year-end to $38.69. Tangible book value on a comparable basis was $36.36 at June 30th, 2011, up 3% from year-end 2010. Our capital adequacy, financial condition, and liquidity remain strong and are key areas of focus for us. We've maintained capital in our insurance businesses at levels that support our operation and are in excess of the amounts required for our rating levels. At the end of the second quarter, our excess capital was approximately $710 million, which included cash at the parent company of approximately $315 million.
On slide five, you'll see the summary results for our specialty property and casualty operations. Our property and casualty specialty insurance operations generated an underwriting profit of $39 million, compared to $68 million in the second quarter of 2010. The reduced profit's primarily the result of a $25 million decrease in favorable reserve development, which was partially offset by lower catastrophe losses. Underwriting profit of the property and casualty specialty insurance operations for the first six months was $85 million, compared to $145 million in the comparable period in 2010. The year-to-date decrease is primarily the result of lower favorable reserve development. Favorable reserve development in our specialty property and casualty operations was $58 million through the first half of 2011, compared to $107 million in the same period in 2010.
The decrease in favorable development was attributed primarily to our runoff automotive lines, a Specialty Casualty program book of business in our international operations. Year-to-date favorable development, including our A&E reserve strengthening, was $8 million through the first half of the year. The spring tornadoes and severe storms in the United States have produced devastating losses. Our thoughts and prayers remain with those impacted by these tragic events. AFG recorded $23 million in catastrophe losses in the second quarter stemming from these events. Catastrophe losses in 2011 were $11 million less than amounts reported in the prior year period. Our strict adherence to underwriting guidelines and efforts to reduce wind-exposed property coverages have served us well and helped us to manage our exposures to these events.
Gross and net written premiums were up about 10% through the first six months of the year compared to the first half of 2010. Additional premiums from National Interstate's third quarter 2010 acquisition of Vanliner and higher premiums in our crop operations resulting from increased spring commodity prices contributed in large measure to these results, offsetting declines in some other segments. Overall average renewal rates for the first half of 2011 were flat compared with the prior year period. With the increased industry catastrophe activity and some hardening in the reinsurance markets, I'm hoping to see some upward rate pressure, particularly in the property lines. The business environment continues to be competitive, we are achieving price increases in some of our businesses.
Gross investment income related to our property and casualty operations was down approximately 17% during the first half of 2011 when compared to the first six months of 2010. It's primarily due to decreased holdings in higher-yielding investments and generally lower reinvestment rates as we've discussed in prior calls. We expect the year-over-year decrease to decline during the latter half of the year, resulting in a decrease of approximately 12% for the year as a whole. I'd like to discuss a few highlights from each of our specialty business groups on slide six. Property and Transportation Group reported a small underwriting profit in the second quarter of 2011 compared to the underwriting profit of $8 million in the 2010 second quarter.
Lower favorable reserve development, particularly in our property and inland marine and crop insurance operations, and slightly lower underwriting profits in our agricultural businesses were partially offset by lower catastrophe losses. Catastrophe losses in this group were $18 million in the second quarter of 2011 compared to $30 million in the prior year period. Average renewal rates for this group during the first half of 2011 were flat when compared to the prior year period. Our largest Property and Transportation businesses reported solid underwriting margins during the first six months of 2011. Our crop business is the largest in this group. We started the growing season with concerns about excess moisture in the Midwest and the possibility of a reduction in planted acreage of corn crops.
With approximately three-fourths of our crop insurance book in corn and soybeans in the Midwestern area of the country, we are pleased that conditions improved to the point that crops were planted on track with five-year historical averages. In fact, recent reports from the USDA indicate that approximately two-thirds of the corn crop is in good or excellent condition. Soybean crops seem to be performing at about the same levels. This is encouraging, a successful growing season requires acceptable levels of precipitation also. Corn and soybean planting was somewhat delayed, the possibility of an early frost is a concern. This is always a possibility. Severe weather patterns have contributed to flooding in the Missouri River Valley and drought conditions that impacted the wheat crop in Texas and Oklahoma.
We have very little businesses in the geographic areas affected by the current drought conditions, we continue to monitor our exposures from the Missouri River flooding, which could affect a half million acres. Our current estimate of exposure causes us to expect lower profitability from this particular event of between $10 million-$15 million, which has been considered in our earnings guidance. Our Specialty Casualty Group's second quarter 2011 underwriting profit was slightly lower than the comparable 2010 period. Improved underwriting profit in our excess and surplus business and higher favorable development in our runoff legal professional liability book were more than offset by lower underwriting profitability in several of our other casualty businesses. Most of the businesses in this group produced strong underwriting margins during the first six months of this year.
Average renewal rates for this group during the first quarter of 2011 were flat compared to the prior year period. We discussed last quarter, we received preliminary notice of some potential claims arising primarily from market forms political risk business in Africa and the Middle East. We remain in the 180-day period associated with political risk insurance, during which the result of the unrest is assessed. AFG's share of any potential loss will be after application of available reinsurance, potential subrogation recovery, and will be substantially limited to our proportional share of market form. We don't believe that the impact and notices received to date will be material to AFG. This is a volatile environment that we're confronting, that we're continuing to monitor, and in which additional notices are possible.
Specialty Financial Group reported underwriting profits of $13 million in the second quarter of 2011, compared to $33 million in the second quarter of 2010. The absence of favorable development related to our runoff automobile residual value insurance operations and higher catastrophe losses in our financial institutions business were the primary drivers of these results. Almost all lines of business in this group produced strong underwriting margins during the first six months of this year. Average renewal rates for this group during the first half of 2011 were down about 1% compared to the prior year period. Let me move on to a review of our Annuity and Supplemental Insurance group. The Annuity and Supplemental Insurance group generated record core net operating earnings before income taxes of $56 million for the 2011 second quarter.
These record results are 22% higher than last year and reflect higher earnings in our fixed annuity operations, especially our bank distribution channel, as well as higher earnings in our supplemental health insurance operations. Core operating earnings before income taxes for the first half of 2011 were 20% higher than the comparable 2010 period. Record statutory premiums of $1 billion in the second quarter of 2011 and $1.8 billion in the first six months of 2011 were up more than 50% over the same periods last year. These increased premiums are the result of several factors. A continued focus on consumer-centric annuity design generally results in easier-to-understand products with higher effective crediting rates to consumers. An increase in sales of indexed annuities in the single premium market was driven primarily by the introduction of new products and features.
An increase in sales of annuities through the banks channel was due primarily to the addition of several new financial institutions. These increases were offset by lower sales of flexible or payroll deduction annuity premiums in the 403 or school teacher market. The 403 market has been significantly impacted by the downturn in the economy and decreased funding to schools, which has resulted in teacher layoffs and wage freezes. We believe this impact may result in permanent changes in how schools and teachers handle retirement plans and decisions. In response, we shifted our 403 distribution strategy away from a managing general agency model toward a direct-to-agent model similar to other companies in the industry.
The cost and commission savings resulting from this shift can be shared with consumers in the form of higher effective crediting rates, which is consistent with our consumer-centric strategy and should lead to higher premiums and returns in this segment of the annuity business. We recently completed the previously announced comprehensive study of AFG's asbestos and environmental exposures related to the runoff operations of our property and casualty group, and exposures related to former railroad and manufacturing operations and sites. Such studies are undertaken every two years with the aid of specialty actuarial and engineering firms and outside counsel. In the intervening years, we perform an in-depth internal review. As you can see, turning to slide nine, the P&C group's asbestos reserves were increased by $28 million net of reinsurance, and its environmental reserves were increased by $22 million net of reinsurance.
At June 30th, 2011, the property and casualty group's insurance reserves include $382 million net of reinsurance recoverables of A&E reserves. These property and casualty reserves include our assumed runoff reinsurance book and reserves related to primary coverages written. The increase in assumed reinsurance asbestos reserves resulted from an increase in anticipated aggregate exposures and several large settlements involving several insurers in which the company has a small proportional share. While we can't comment on specific cessions, some insurers have settled longstanding asbestos exposures with their insureds that are now being put through the reinsurance payment pipeline. It's difficult to say whether this constitutes a trend, but we recently have seen an uptick in precautionary notices, and these have been taken into account as we have strengthened our reserves.
With respect to our direct asbestos exposures, we experienced higher frequency and severity of mesothelioma and other cancer claims, as well as increased defense costs on many of these claims. These trends were partially offset by decline in the number of claims without serious injury and fewer new claims that required payment being reported to the company. The increase in environmental reserves was attributed primarily to a small number of increases on specific environmental claims at a handful of sites. We see no discernible trends related to environmental claims. At June 30th, 2011, our property and casualty three-year survival ratio, excluding amounts associated with the settlements of asbestos-related coverage litigation for A.P. Green Industries and another large claim, was an 11.5 times paid losses for asbestos reserves and 8.8 times paid losses for the total A&E reserves.
These ratios compare favorably with A.M. Best's most recent report on A&E survival ratios, which were 8.3 for asbestos and 7.7 for total industry A&E reserves. In addition, the study encompassed reserves for asbestos and environmental exposures of our former railroad and manufacturing operations. Asbestos reserves were increased by $3 million, largely in recognition of a higher number of expected mesothelioma and lung cancer cases than had been previously estimated, partially offset by a decrease in the number of claims without serious injury. We increased our environmental reserves by $6 million, largely as the result of higher estimated costs with respect to several existing sites. Please turn to slide 11 for a few highlights regarding our investment portfolio. During the second quarter of 2011, AFG recorded net realized gains of $12 million compared to $6 million in the prior year period.
Net unrealized gains on fixed maturities were $421 million, an increase of $95 million since year-end 2010. The vast majority of our investment portfolio is held in fixed maturities, with approximately 91% rated investment grade and 97% with a designation of NAIC 1 or 2. As we discussed last quarter, the continued runoff and disposition of securities in our non-agency RMBS portfolio, as well as generally lower reinvestment rates, have 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 review our outlook for 2011. Our 2011 core net operating earnings guidance remains in the range of $3.30-$3.70 per share.
We expect results in our property and casualty and Annuity and Supplemental Insurance businesses to be consistent with the guidance provided in our call last quarter, with a few minor adjustments. We continue to expect growth in net written premiums in our specialty property and casualty operations to be 9%-13% higher than 2010 levels. We expect the Property and Transportation Group's net written premiums to be up 18%-22%, an increase from our original estimates, and that was 18%-22%, primarily as a result of higher spring commodity prices and National Interstate's acquisition of Vanliner. We now expect the Specialty Financial Group's net written premiums to be up 24%-28%, slightly lower than our original estimates. A summary of our 2011 guidance is outlined on slide 12 for your convenience.
These 2011 expected results exclude the potential for significant catastrophe and crop losses, significant losses from political unrest, significant adjustments to asbestos environmental reserves, large gains or losses from asset sales or impairments, and unlocking adjustments related to annuity deferred acquisition costs. Thank you. Now we'd like to open lines for any questions.
At this time, if you'd like to ask a question, please press star one on your telephone keypad. We'll pause for a moment to compile the Q&A roster. Your first question comes from Amit Kumar of Macquarie.
Jensen, good. Good morning. Congrats on the quarter. Just starting with the asbestos reserves charge. You talked about an uptick in notices. Can you also talk about what time frame or what time period these policies or the claims were from? What accident years was this uptick in?
With us, we've got Vito Perino, who led our group in doing this assessment with us. Vito, do you want to give a response?
Sure. I would say that it's a wide range of years. Our assumed reinsurance business spanned years in the '60s and '70s, then the underlying risks span those same periods. It's hard to really tie it to a specific accident year, and it really runs a span of years.
In terms of an uptick, is there more to it, or you think it's an aberration? Is it from, you see a lot of ads on TVs. Are these sort of peripheral defendants? What do you think is causing this uptick?
I think a couple of things. As Carl mentioned, we're seeing a different mix of mesothelioma and cancer claims versus non-impaired claims. I think everyone in the industry is seeing that. As a result, we're seeing more settlements put through the reinsurance payment pipeline. There is a tendency now to be moving down the tiers of defendants to more peripheral defendants, and that's tapping into some policies that hadn't previously been tapped. Again, this isn't a significant departure from what we've seen before. It is a departure, and we believe it's been addressed by the strengthening of our reserves.
Okay, that's helpful. Then on the environmental side, can you expand on that a bit more?
Sure. Again, we see no emerging trend on the environmental side. The strengthening here is really being driven by site-specific developments at a handful of sites. Different estimates of liability exposures and total exposures, but again, nothing significant at any given site or any trend we see developing on environmental.
Got it. Okay. That's helpful. Sort of changing topics here a bit. On the crop book, I didn't catch, there was a mention of $10 million-$15 million lower profitability. Was that from the crop book or did I?
Amit, specifically was an estimate that currently is just an estimate because it hasn't played out fully of the impact of the flooding in the upper Missouri Valley from the snow melt that's causing significant amounts of flooding in that. What we were trying to do is give you an indication as to about how much we estimate that'll affect the profitability of that line of business for us.
Got it. That's helpful.
It is baked into our earnings guidance.
Got it. Okay. That's helpful. That's the current scenario. Based on the trends you're seeing, it seems things are much, much better than we were talking about in Q1 conference call, and probably they'll be much better than 2008?
In terms of amount of corn and soybeans planted in that turned out pretty good. So far, 65% of the corn and soybean acres are rated good or excellent. That's a tad below what it was last year in that. I think the main things we're really focused on now is there needs to be adequate precipitation right in the Midwest heartland. We're also, as Keith mentioned, trying to assess the Missouri River flooding and how much exposure we have there ultimately. I think those are the issues. To another extent, I also mentioned an early frost since the crops were planted a little bit later. An early frost is always something you watch for, since the crops were planted a little bit later, an early frost could have a little bit more of an impact.
Those are the kinds of things that we're really watching and focused on right now.
That's fine.
Go ahead.
I mean, the other thing that I would emphasize for everyone is that we're at the second quarter. This is really early in the crop business. If you look back over our history, we will tend to have a better feel in the third quarter as to things like yield and commodity prices. It's really mid to late third quarter and fourth quarter when we're able to reasonably assess. At this point, we watch for major things that look like they will not be mitigated.
Yeah, I mean.
The real game is played in the third and fourth quarter.
Yeah. I think one other thing I might mention right now, when you look at the price risks from a price risk standpoint, I think we're in pretty good shape. When you look at the futures prices compared to the spring discovery prices, there's nothing there that would concern us right at this moment.
Got it. Just one final question, and I will re-queue. Just based on that comment, when do you pick the ranges or, I'm sorry, the states under the SRA? What states will you or what books will you ship into that? What is the time period when you decide?
That's an ongoing process. Each year, we don't decide which states we're going to be in or not. The way the program works, you have to write all comers. So basically, you have to not be providing a distribution to protect yourself on a gross basis from the states. What you can do, and where the real underwriting skill comes into play, is the buckets of reinsurance that are used under the FCIC. That can be an annual consideration. By and large, the high-risk areas are high-risk areas year in and year out, so it's not an individual state choosing at an individual time.
Got it. Okay, thanks so much. Congrats on the results. I will re-queue. Thanks.
Again, to ask a question, press star one. There are no further questions. Amit Kumar has another question.
Hey, sorry. I was a bit slow in hitting star one. Just two other questions. First of all, you did talk about the reserve development being much lower. Do you get the sense that you are getting to the point where a lot of those good last year's reserves have been released into earnings? Probably the impact diminishes going forward?
I think there's a constant process that goes on looking at reserves and reserve adequacy. As we've gone into a period now where there is not substantial rate movement and hasn't been for quite a period of time, I'm not surprised that it would moderate some, I don't think there's a direct one-to-one linkage there, and I think we'll see over time further development.
I think we still feel good about-
Yeah
the condition of our reserves today.
Okay, that's helpful. The only other question I had is, I might have missed this. Did you talk about the California comp book, the rate levels, and how do you feel about that going forward? There seems to be a lot of sort of different commentary coming out from that marketplace.
I can give you my outlook, and that's helpful.
Yeah, would love to.
It's still a more competitive market than what it should be. You've got, I think, the 2010 industry estimate, I think that's still out there. It's around 125. Republic's, for California only, would've been about 120. Looking to this year, we were able to take some price increase last year. I think our current perspective on 2011 that California only accident year for this year, we're estimating around 115. All of Republic probably be about 111. We feel that Republic's reserves continue to be solid. If you ask me on the price front, we're getting 8% year to date. We probably need 20% versus what we're getting in order to get our combined ratio down to 104 at a minimum and a 12%-14% return on equity. I think we're seeing some improvement on renewal payrolls, which is good.
I think actually excluding the excess workers' comp business that's running off, I believe that the underlying premium is maybe up 1% or something. Our business is not declining. Our primary business is not declining. It's not growing a lot right now due to the competitive market, I think we're probably generally been a bit more aggressive on the price increase front than our competitors.
Got it. Okay, that's all I have. Thanks. Thanks for the answers.
All right. Are there any other questions?
Yes. You have a question from Matt Rohrmann of KBW.
Good morning, guys.
Morning, Matt.
Just one quick details question. I know we've discussed in the past as you build up your bank distribution on the annuity side, were there any institutions added this quarter?
Yes, there were. We're adding institutions every quarter. We're looking to expand that niche for us, and we have been very successful in continuing to add banks.
Any of size of some of the previous larger institutions, or are these smaller community institutions?
They are not as big as the couple that are generating very large amounts of premium dollars, but they're not small banks. They're mid-size banks, typically, although we're close to doing a deal with another one of the top six, seven banks in terms of size in the nation.
Okay. All right, great. Thank you very much.
Thanks, Matt.
There are no further questions.
All right then. Thank you. We appreciate you taking the time with us this morning, and we'll look forward to reporting to you at the conclusion of the third quarter. Have a good day.
This concludes today's American Financial Group 2011 second quarter earnings conference call. You may now disconnect.