Earnings Call Transcript - AFG Q3 2023

Diane Weidner, Vice President, Investor Relations

Good morning and welcome to American Financial Group's Third Quarter 2023 Earnings Results Conference Call. We released our 2023 third quarter results yesterday afternoon. Our press release, investor supplement and webcast presentation are posted on AFG's website under the Investor Relations section. These materials will be referenced during portions of today's call. I'm joined this morning by Carl Lindner III and Craig Lindner, Co-CEOs of American Financial Group; and Brian Hertzman, AFG's CFO. Before I turn the discussion over to Carl, I would like to draw your attention to notes on Slide 2 of our webcast. Some of the matters to be discussed today are forward-looking. These forward-looking statements involve certain risks and uncertainties that could cause actual results and/or financial condition to differ materially from these statements. A detailed description of these risks and uncertainties can be found in AFG's filings with the Securities and Exchange Commission, which are also available on our website. We may include references to core net operating earnings, a non-GAAP financial measure, in our remarks or responses to questions. 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, and as a result, it may contain factual or transcription errors that could materially alter the intent or meaning of our statements. Now I'm pleased to turn the call over to Carl Lindner III to discuss our results.

Carl Lindner, Co-CEO

Good morning. I’ll begin my remarks by sharing a few highlights from AFG’s 2023 third quarter after which Craig and I will walk through more details. We’ll then open it up for Q&A where Craig, Brian and I will respond to your questions. I am pleased to report strong underwriting results during the quarter despite elevated catastrophe losses; higher interest rates contributed to meaningfully higher year-over-year investment income culminating in a very strong annualized third quarter core operating return on equity of 18.3%. Our entrepreneurial opportunistic culture and disciplined operating philosophy continue to serve us well in a favorable property and casualty market and a dynamic economic environment. These factors, coupled with a commitment to effective capital management, enable us to continue to create long-term value for our shareholders. Craig and I thank God, our talented management team and our great employees for helping us to achieve these results. I'll now turn to the discussion over to Craig to walk us through AFG's third quarter results, investment performance and to discuss our overall financial position at September 30.

Craig Lindner, Co-CEO

Thanks, Carl. Please turn to Slides 3 and 4 for a summary of earnings information for the quarter. AFG reported core net operating earnings of $2.45 per share in the 2023 third quarter. Higher year-over-year net investment income was partially offset by lower underwriting profit in our Specialty Property and Casualty insurance operations. Now I'd like to turn to an overview of AFG's investment performance, financial position and share a few comments about AFG's capital and liquidity. The details surrounding our $14.8 billion investment portfolio are presented on Slides 5 and 6. The higher interest rate environment contributed to significantly higher year-over-year investment income. Looking at results for the third quarter, Property and Casualty net investment income was 17% higher than the comparable 2022 period. Excluding the impact of alternative investments, net investment income in our P&C insurance operations for the three months ended September 30, 2023, increased 33% year-over-year. As you'll see on Slide 6, approximately 68% of our portfolio is invested in fixed maturities. In the current interest rate environment, we're able to invest in high-quality, medium-duration fixed maturity securities at yields of approximately 6%. Current reinvestment rates compare favorably to the 4.68% yield earned on fixed maturities at our P&C portfolio during the third quarter of 2023 and 3.63% earned for the full year in 2022. We have a long-standing commitment to quality, with 93% of this portfolio rated investment grade and 96% of the P&C portfolio rated NAIC 1 or 2, and have strategically managed duration to take advantage of market opportunities. We expect the yield earned on our P&C fixed maturity portfolio to increase by about 10 basis points in the fourth quarter of 2023 compared to the 4.68% earned in the third quarter of 2023. Our third quarter 2023 P&C net investment income includes an annualized return on alternative investments of 4.2% compared to a 7.1% return for the 2022 third quarter. Third quarter 2023 alternative investment returns were lower in both the multifamily and private equity components of this portfolio. The average annual return on AFG's alternative investments over the five years ended December 31, 2022, was approximately 14%. Our guidance for 2023 continues to reflect a return of approximately 9% at our $2.4 billion portfolio of alternative investments. Please turn to Slide 7, where you'll find a summary of AFG's financial position at September 30, 2023. Our excess capital was approximately $660 million at the end of the third quarter. This number included parent company cash and investments of approximately $364 million. During the quarter, we returned $138 million to our shareholders through the payment of a regular $0.63 per share quarterly dividend and $86 million in share repurchases. As part of our earnings release, we declared a special cash dividend of $1.50 per share payable on November 22, 2023, to shareholders of record on November 13, 2023. The aggregate amount of this special dividend will be approximately $126 million. This special dividend is in addition to the company's regular quarterly cash dividend of $0.71 per share, which was recently increased 12.5% over the previously declared rate and paid on October 25, 2023. With this special dividend, the company has declared $5.50 per share in special dividends in 2023. Looking at a longer-term horizon, AFG has declared $43.50 per share in special dividends since the end of 2020, representing $3.7 billion returned to shareholders. Carl and I consider these special dividends an important component of total shareholder return. In addition, we paid nearly $600 million in regular dividends and repurchased approximately $500 million in common shares over this period. We expect our operations to continue to generate significant excess capital throughout the remainder of 2022, 2023, and into 2024, which provides ample opportunity for additional share repurchases or special dividends over the next year. For the three months ended September 30, 2023, AFG's growth in book value per share plus dividends was 1.9%, and year-to-date growth in book value per share plus dividends was 11.9%. Excluding unrealized losses related to fixed maturities, we achieved growth in adjusted book value per share plus dividends of 3.1% during the third quarter and 11.3% year-to-date.

Carl Lindner, Co-CEO

Thanks, Craig. Please turn to Slides 8 and 9 of the webcast, which include an overview of our third quarter results. As you'll see on Slide 8, third quarter 2023 Property and Casualty operating earnings increased 3% year-over-year. Underwriting margins continue to be strong and are generating desired returns in nearly all of our Specialty Property and Casualty businesses. And we're growing our Specialty Property and Casualty businesses through increasing exposures, new opportunities and a continued favorable pricing environment. The Specialty Property and Casualty insurance operations generated an underwriting profit of $143 million compared to $158 million in the third quarter of 2022, a 9% decrease. Higher year-over-year underwriting profit in our Property and Transportation and Specialty Financial groups was more than offset by lower underwriting profit in our Specialty Casualty Group. The third quarter 2023 combined ratio was a strong 92.2%, 1.1 points higher than the 91.1% reported in the comparable prior year period. Results for the 2023 third quarter include three points in catastrophe losses, 0.5 points higher than last year's third quarter, and 2.3 points of favorable prior year reserve development, 0.8 lower than the comparable period. Gross written premiums were flat, and net written premiums were up 4% when compared to the third quarter of 2022. As we discussed last quarter, earlier plantings of corn and soybeans pushed some crop insurance premium into 2023 second quarter versus third. Our 2023 crop premiums also reflect the impact of less favorable spring commodity futures pricing and related volatility in 2023 compared to 2022. Excluding the crop business, gross and net written premiums grew by a healthy 7% and 10%, respectively, when compared to the prior year period. Average renewal pricing across our Property & Casualty Group, excluding workers' comp, was up approximately 7% for the quarter, 2 points higher than the previous quarter. Including workers' comp, renewal rates were up approximately 5%, or one point higher than renewal increases reported in the prior quarter. This is our 29th consecutive quarter to report overall renewal rate increases. We're achieving renewal rate increases in excess of prospective loss ratio trends to meet or exceed targeted returns. Now I'd like to turn to Slide 9 to review a few highlights from each of our Specialty Property and Casualty business groups. Improved underwriting results in our Property and Transportation group were the result of higher underwriting profit in our Transportation, Property and Inland Marine and Ocean Marine businesses, which was partially offset by lower profitability in our Agricultural business. Third quarter 2023 gross and net written premiums in this group were 8% and 6% lower, respectively, than the comparable prior year period because of the earlier plantings of corn and soybeans and the impact of spring commodity futures pricing and related volatility on premiums in our crop insurance business, as I discussed earlier. Excluding our crop business, gross and net written premiums grew by 2% and 4%, respectively, when compared to the 2022 quarter. Most of the remaining businesses in this group reported growth in gross and net written premiums during the quarter as a result of higher rates, new business opportunities and organic growth. We continue to stay focused on rate adequacy, particularly in our Property business. Just as important as rate, we're closely monitoring insured values to ensure that premiums appropriately reflect inflationary considerations. Overall renewal rates in this group increased 6% on average in the third quarter of 2023, consistent with the pricing achieved in this group for the second quarter of 2023. I'm pleased we're continuing to achieve rate increases in niches like commercial auto liability, which are in the high single digits. The month of October is the discovery period for the majority of our corn and all of our soybean business. Harvest pricing for corn and soybeans settled 17% and 7% lower than spring discovery prices, respectively. Crop maturity is ahead of last year, and the harvest is underway with approximately 71% and 85% of corn and soybean crops harvested, respectively. Both are ahead of five-year averages. Yield variability will be important to our final results. Based on what we know about harvest pricing, coupled with the impact from hail damage throughout the Western Corn Belt over the past couple of months that impacted our private products, we're now expecting a below-average crop year. The Specialty Casualty Group reported lower year-over-year underwriting profit reflecting lower levels of favorable prior year reserve development in our workers' comp businesses, higher catastrophe losses and lower underwriting profit in our targeted markets business, which was impacted by a large property loss in our programs business. The businesses in the Specialty Casualty Group achieved a strong 89.4% calendar year combined ratio overall in the third quarter, 6.8 points higher than the exceptionally strong results achieved in the comparable prior year period. Underwriting margins at this level produced returns in the mid-20s for this group, and we continue to be very pleased with these results. Third quarter 2023 gross and net written premiums increased 4% and 7%, respectively, when compared to the same prior year period. Factors contributing to the year-over-year growth included payroll growth in our workers' comp businesses, along with new business opportunities, strong policy retention and rate increases in several of our targeted market businesses, as well as new opportunities and higher policy renewals in our excess and surplus lines business. This growth was partially offset by lower year-over-year premiums in our mergers and acquisitions liability and executive liability businesses. Renewal pricing for this group, excluding our workers' comp businesses, was up approximately 8% in the third quarter. Rates were up 5%, including workers' comp. Both measures reflect a two-point improvement over the renewal pricing in the previous quarter. I'm especially pleased with continued strong rate increases achieved in our public entity, excess liability, and social services businesses. Now the Specialty Financial Group reported higher year-over-year underwriting profit in the third quarter, primarily as a result of lower catastrophe losses within our financial institutions business. This group reported a strong combined ratio of 87.6% for the third quarter of 2023, an improvement of 3.7 points over the prior year period. Third quarter 2023 gross and net written premiums were up 39% and 48%, respectively, when compared to the prior year period. While nearly all businesses in this group reported year-over-year growth, our financial institutions business was the primary driver of the higher premiums, which resulted from growth in the mortgage protection and residential investor businesses. Growth in this business is an example of where we're acting on opportunities presented by the tightening property market and improving policy terms. Overall, renewal rates in this group were up about 5% for the third quarter. Turning to our A&E reserves during the third quarter of 2023, we completed our annual ground-up review of our asbestos and environmental exposures related to the runoff operations within the Property and Casualty Group. No new trends were identified, and claims activity was generally consistent with our expectations. As a result, there was no net change to the Property and Casualty Group's A&E reserves. We continue to enjoy robust survival ratios which are well above the industry averages and are one measure of the strength of our A&E reserves. We also assess the adequacy of our asbestos environmental reserves for our historic railroad and manufacturing operations. As a result of the study, AFG recorded a special noncore A&E charge to increase its liabilities for environmental exposures by $15 million or $12 million after tax due to changes primarily to the scope and cost of investigation and an increase in estimated remediation costs at a number of sites. Now please turn to Slide 10, where you'll see a full-page summary of our 2023 outlook. Overall, we continue to expect an ongoing favorable property and casualty market with growth arising from new business opportunities, continued rate increases and increasing exposures. Based on the results reported in the first nine months of the year and expectations for the remainder of the year, we continue to estimate AFG's 2023 core net operating earnings to be in the range of $10.15 to $11.15 per share. Our guidance reflects our updated expectations of a below-average crop year, offset by higher than previously expected net investment income. At the midpoint, our guidance suggests a strong full year 2023 core return on equity of about 20%. As Craig noted, we continue to assume a return on alternative investments for the full year of 2023 of approximately 9% compared to 13.2% earned on these investments in 2022. We now expect a 2023 combined ratio for the Specialty Property and Casualty Group overall between 90% and 92%, revised upward one point at the midpoint from our previous guidance due to our updated expectation of a lower-than-average crop year. Our guidance for growth in the Specialty Property & Casualty net written premiums is now estimated to be slightly higher and in the range of 6% to 8%. Excluding crop, we now expect 2023 year-over-year growth in the range of 7% to 10%. Now looking at each sub-segment. Based on our results through the third quarter and expectation of a below-average crop year, we now expect a combined ratio in the range of 92% to 95% in our Property and Transportation Group. We continue to expect net written premiums for this group to be in a range of flat to up 2%. As noted last quarter, growth for the year will be tempered by the nonrenewal of about $50 million in premiums related to underperforming transportation accounts and growth in our alternative risk transfer business, which has higher premium cessions, along with the lower crop premiums due to the impact of lower spring commodity prices and related volatility on crop rates. We continue to expect our Specialty Casualty Group to produce a combined ratio in the range of 85% to 88%. Our guidance continues to assume strong profitability in our workers' comp businesses overall, but at a higher calendar year combined ratio when compared to the exceptional results reported in the prior year. We continue to expect net written premiums to be 5% to 9% higher than 2022 results. And we now estimate the Specialty Financial Group's combined ratio to be in the range of 88% to 91%, an improvement from the previous range of 89% to 93%. We've increased our guidance for growth in net written premiums for this group to be in the range of 28% to 32%, up five points from our previous guidance, primarily as a result of market opportunities in our financial institutions business. Based on the results through the first nine months of the year, we continue to expect renewal rates to increase between 3% and 5% overall. Excluding workers' comp, we now expect renewal rates increases to be in the range of 5% to 7%. Craig and I are proud of our proven track record of long-term value creation. We believe that our strong balance sheet, financial flexibility position us very well as we close out 2023 and look forward to 2024. We'll now open the lines for the Q&A portion of today's call. And Craig and Brian and I will be happy to respond to your questions.

Operator, Operator

Thank you. Our first question comes from the line of Meyer Shields with KBW. Your line is now open.

Unidentified Analyst, Analyst

Hi, good morning. Thank you for taking my questions. My first question is about the A&E reserve charge. Is that a one-time charge for this quarter?

Brian Hertzman, CFO

This is Brian. On A&E, we monitor our A&E exposures, both in our Property and Casualty operations and in our runoff railroad and manufacturing operations every quarter. Then on an annual basis, we do an in-depth review of those reserves. So this charge in this quarter is related to that annual deep review of the exposures in the runoff railroad manufacturing operations. So it is the first charge of that size we had in a number of years, but we do monitor it all the time. So there's always the possibility of expense there, but this is coming out of that annual once-a-year deeper view.

Unidentified Analyst, Analyst

Got you. So for next year, would it be like similar charges? Just curious.

Brian Hertzman, CFO

We are not aware of anything currently that isn't recorded, but this situation might change. We have incurred charges in previous years. The purpose of our annual review is to identify any issues that may exist, but predicting future developments is inherently uncertain.

Unidentified Analyst, Analyst

Got you. Thank you. My second question is on the renewal pricing still trending up. Can you break down the way on rates and exposures?

Brian Hertzman, CFO

This is Brian again. So when we talk about renewal pricing, we're giving you just the pricing increase, not the exposure increase. So the exposure increases would help to increase premium growth beyond what we're giving you just for rate. So what we're giving for rate is just the price component.

Unidentified Analyst, Analyst

Sorry about that. Okay, thank you.

Operator, Operator

Thank you. Our next question comes from the line of Michael Zaremski with BMO. Your line is now open.

Michael Zaremski, Analyst

Good afternoon. I heard you mention that profitability in workers' compensation may not be as strong as last year, but it will still be quite profitable. Is this a new update, or is it consistent with what you shared last quarter when you revised your outlook? Also, regarding workers' compensation, has there been any change in pricing since last quarter? Higher interest rates seem to be beneficial in that area. Furthermore, some of your competitors have mentioned that they are not observing any significant shifts in medical trends but are monitoring the situation closely.

Carl Lindner, Co-CEO

Yes. My comments have been consistent throughout the year. This quarter serves as a reminder that we have strong workers' comp results, although they won't match the levels of 2022 due to lower favorable development from prior years. Regarding the loss ratio trend, we observe similar patterns as others have noted, with no significant changes overall. Our prospective loss ratio trend appears to be down by about 4% or maybe closer to 2%. In California, only the Republic business is currently operating at an underwriting loss, while our other businesses—Summit, Strategic Comp, and National Interstates—are performing very well. We're confident in our reserve position, and the workers' comp market remains competitive with strong results across the industry. Year-to-date, pricing in our overall workers' comp business has decreased about 4%, which doesn't seem to differ much from the trends observed in the last couple of quarters. I hope this information is helpful.

Michael Zaremski, Analyst

Yes, that's helpful. Switching to the topic of casualty excluding workers' compensation, I recall that last quarter you mentioned a rising trend in certain inflationary lawsuits, such as those related to public entities and commercial auto. You adjusted your expectations a bit since then. I'm curious if anything has changed in the past quarter. It seems like pricing is moving in a positive direction. Have you been considering adding to your reserves or making any adjustments?

Carl Lindner, Co-CEO

Yes. The positive aspect is that it is a significant renewal period for public entities. The good news aligns with what I mentioned in the previous call about the changes we've implemented in that area. We are experiencing strong double-digit price increases during this period, along with decreasing limits and raising retentions. We are actively engaged in mock trials and are closely monitoring claims. We are undertaking several initiatives. Overall, I am very pleased with the third quarter, especially with the substantial price increases in public entities, which contributed to the overall growth of the segment.

Michael Zaremski, Analyst

Okay. Lastly, regarding the Crop acquisition, I know you have provided guidance on it, but I am curious if your perspective has changed now that you have more information. When considering not just this year but also next year and beyond, has the normal crop year outlook changed because of the acquisition or other factors?

Carl Lindner, Co-CEO

Yes, the dollar amount will fluctuate due to increased business, but I believe our profit margins will likely remain consistent.

Operator, Operator

Thank you. Our next question comes from the line of Andrew Andersen with Jefferies. Your line is open.

Andrew Andersen, Analyst

Hey good afternoon. Just looking at reserves in the quarter and reserve development. Can you kind of help us think about how social inflation impacted movements this quarter? Has your view of social inflation changed?

Brian Hertzman, CFO

This is Brian. So we're still being very mindful of social inflation and think that it is something that the industry as a whole is going to be monitoring for a long time. So when you look at our Casualty segment, the lower levels of favorable development reflect two things. One is the lower levels of favorable development coming out of workers' comp that we talked about earlier. And then also, we're not seeing favorable development in the social inflation expense business that we might have seen in previous periods. So I would say there's an absence of favorable development. There are ins and outs, where some units have had some unfavorable development. But overall, I would say social inflation is reducing our favorable development as much as it would be increasing any adverse development.

Andrew Andersen, Analyst

Okay. Regarding the workers' comp business, could you clarify the loss ratio trend and pricing from the calendar year perspective? Specifically, how should we compare your workers' comp accident year picks to last year?

Brian Hertzman, CFO

Sure. So a couple of things are going on there. One is, as Carl mentioned, there are rate decreases happening in workers' comp. So that puts some pressure on the accident year. And then even though we haven't been experiencing medical cost inflation, we're mindful of that and being careful to consider that, as we said, current year accident pick. So the accident year loss ratio in workers' comp would be a little bit higher for those two things, but still producing those ROEs when you look at the business overall that Carl mentioned earlier.

Operator, Operator

Thank you. Our next question comes from the line of Gregory Peters with Raymond James. Your line is now open.

Gregory Peters, Analyst

Good afternoon, everyone. I’d like to start with my first question regarding Craig's presentation about the investment portfolio and its performance. Craig, you noted that fixed income yields have increased to around 6%, which is a significant improvement from a year ago. Could you provide some insight into how the higher yield environment may influence your allocations for new investments, whether by industry group or sector? Additionally, as investments mature, how are you managing those allocations within the portfolio?

Craig Lindner, Co-CEO

Sure, Greg. I wouldn't say that we are significantly altering our allocations. I'd say, certainly, fixed income is more attractive than it's been in a long time. So probably a bit heavier weighting to medium-term fixed maturity investments versus certain other asset classes. But I wouldn't expect us to change the allocations in a very significant way. We do think on the real estate side as an example, there are going to be some really interesting opportunities over the next couple of years. And time will tell whether we're right on how things are going to evolve there. But we do think that there's going to be an opportunity to get some extraordinary returns in the real estate market. I don't think you should expect to see a significant change, though, in the allocation in the investment portfolio.

Gregory Peters, Analyst

Okay. Fair enough. It makes sense. And then I guess, pivot back to Carl. And let's focus on the property business, Property and Transportation business ex-crop. I think you called out in your comments, an underperforming book of transportation business, maybe it was $50 million that you're re-underwriting. Can you give us some perspective within your Property and Transportation business of how the competitive landscape is? Do you feel like there's more pressure from competition at this juncture? Or do you feel like it's status quo? Any updated perspective would be helpful.

Craig Lindner, Co-CEO

Are you asking me to focus on commercial auto in particular? Is that...

Gregory Peters, Analyst

Yes, commercial auto is one area of focus. However, within Property Transportation, there are additional segments beyond just commercial auto, excluding crop. My emphasis is specifically on the ex-crop business in Property Transportation.

Craig Lindner, Co-CEO

Yes, we have several different businesses, with our transportation sector being a major component. The situation within transportation is mixed; some areas are more competitive while others are starting to tighten. Notably, some competitors like Nationwide are exiting parts of this market. Despite this, our business has consistently performed well over the years. However, the commercial auto liability segment isn't meeting our expectations, currently around 101, and we have been implementing significant rate increases of about 10% year-to-date due to this. This contrasts with a prospective loss ratio trend of about 7%. Overall, when we combine our operations in this area, we’ve seen mid-single-digit net written premium growth over the past nine months. Additionally, sectors such as our nonstandard aviation, Property Inland Marine, and Ocean Marine continue to present growth opportunities, and we are achieving positive results in these areas. This reflects the strength of some of the larger businesses within Property and Transportation, excluding workers' compensation.

Gregory Peters, Analyst

Great. Well, thanks for the detail.

Operator, Operator

Thank you. Our next question comes from the line of Paul Newsome of Piper Sandler. Your line is now open.

Diane Weidner, Vice President, Investor Relations

Thank you, and thank you all for joining us today as we've walked through our third quarter 2023 results. If you have any other questions, feel free to reach out to our IR department, and we look forward to talking with you next quarter. This concludes our call for today. Thank you.

Operator, Operator

This concludes today's conference call. Thank you for participating. You may now disconnect.