Earnings Call Transcript - AFG Q2 2022

Operator, Operator

Good day, ladies and gentlemen. Thank you for standing by, and welcome to American Financial Group's Second Quarter 2022 Results Conference Call. Please be advised that today's conference may be recorded. I would now like to hand the conference over to your speaker host, Diane Weidner, Vice President of Investor Relations. Please go ahead.

Diane Weidner, Vice President of Investor Relations

Good morning, and welcome to American Financial Group's Second Quarter 2022 Earnings Results Conference Call. We released our 2022 second 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 draw your attention to the 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 in responses to questions. A reconciliation of net earnings attributable to shareholders to core net operating earnings is included in our earnings release. And finally, if you're 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 III, Co-CEO

Good morning. We're pleased to share highlights of AFG's 2022 second quarter results, after which Craig, Brian and I will be glad to respond to your questions. AFG's financial performance during the second quarter was outstanding. We're pleased to report an annualized core operating return of nearly 21% in the quarter, including record second quarter underwriting profit alongside double-digit premium growth. Strategic positioning of our investment portfolio enabled us to invest opportunistically, and the returns in our alternative investment portfolio continued to exceed our expectations. Our entrepreneurial, opportunistic culture and disciplined operating philosophy have positioned us well in this increasing interest rate environment and favorable Property and Casualty market. Craig and I thank God, our talented management team, and all of our employees for helping us to achieve these exceptionally strong results. I'll now turn the discussion over to Craig to walk us through AFG's second quarter results, investment performance and our overall financial position at June 30.

Craig Lindner, Co-CEO

Thank you, Carl. Please turn to Slides 3 and 4 for summary earnings information for the quarter. AFG reported core net operating earnings of $2.85 per share, compared to $2.39 per share in the second quarter of 2021. The increase was primarily the result of significantly higher underwriting profit in our Specialty P&C insurance operations. As Carl mentioned, annualized core operating return on equity in the second quarter was a very strong 20.7%. On Slide 4, you'll see that net earnings included after-tax non-core realized losses on securities of $73 million, or $0.86 per share, in the quarter. Included in this number is $65 million, or $0.76 per share in after-tax losses from the mark-to-market of equity securities that we continued to own at June 30. Now I'd like to discuss the performance of AFG's investment portfolio, financial position and share a few comments about AFG's capital and liquidity. During the second quarter, we continued to act on the opportunities presented by the increasing interest rate environment and increased the duration of our P&C fixed maturity portfolio, including cash and cash equivalents, from approximately 2 years at December 31, 2021, to approximately 2.7 years at June 30, 2022. Our fixed maturity reinvestment rate is approximately 4.5% and compares favorably to the fixed maturity portfolio book yield of approximately 3.3% at the end of the second quarter. In addition, our portfolio of floating rate securities, most of which are tied to one-month or three-month indices, continue to benefit from rising interest rates. For the three months ended June 30, 2022, net investment income was slightly higher than the comparable 2021 period as both periods included very strong results from alternative investments. The annualized return on alternative investments in the second quarter of 2022 was approximately 12.4% compared to 21.1% for the 2021 quarter. The $62 million in pretax earnings from our portfolio of alternative assets in the 2022 quarter included $38 million in earnings from the sale of certain multi-family housing investments in a very favorable market. We held these investments for 4 to 5 years and achieved an average annual return in excess of 25% over that period. Excluding the impact of alternative investments, net investment income in our Property and Casualty insurance operations for the three months ended June 30, 2022 increased 18% year-over-year as a result of the impact of rising interest rates and higher balances of invested assets. Carl will come back to drivers of our overall increased guidance for 2022, but I'm going to take a few minutes now to talk about the investment income assumptions embedded in our updated guidance. First of all, we'll continue to benefit from the higher interest rate environment, both from our floating-rate fixed maturities and reinvestment opportunities. With regards to alternative investments, our guidance assumes an overall annual yield of 10% to 12% on alternative investments for the full year, based on the strong performance of this portfolio in the first half of 2022. Our guidance reflects minimal income from alternative investments in the second half of 2022, as we assume that the continued strong performance of multi-family housing investments will offset weaker performance of traditional private equity investments, which may be under pressure from the macro-economic environment. As a reminder, investments tied to multi-family housing represents approximately 55% of our alternative investment portfolio. As you can see on Slide 6, our investment portfolio continues to be high quality, with 91% of our fixed maturity portfolio rated investment grade and 98% of our P&C Group fixed maturity portfolio with an NAIC designation of 1 or 2, its highest two categories. Please turn to Slide 7, where you'll find a summary of AFG's financial position at June 30, 2022. Our excess capital was approximately $1.1 billion at June 30, 2022. This number included parent company cash and investments of approximately $750 million. During the quarter, we returned $728 million to our shareholders through the payment of our regular $0.56 per share quarterly dividend and $8.00 per share in a special dividend paid in May. Book value per share plus dividends declined nine-tenths of a point in the second quarter. Excluding unrealized losses related to fixed maturities, we achieved growth in adjusted book value per share plus dividends of 3.6% during the second quarter. The short duration of our fixed maturity portfolio and somewhat limited exposure to publicly traded common stocks when compared to some peer companies helped our performance in this period. Year to date, AFG paid $10.00 per share in special dividends and paid a total of $36.00 per share in special dividends since the sale of its annuity operations in May of 2021. Through a combination of these special dividends, share repurchases, the redemption of debt and the purchase of Verikai, we have deployed the $3.57 billion in cash proceeds from the sale of our Annuity business while continuing to be in a strong excess capital position. While all of AFG's excess capital is available for internal growth and acquisitions, based on assumptions underlying AFG's current guidance, we still expect to have $400 million to $500 million of excess capital available for potential share repurchases or additional special dividends through the end of 2022 while staying within our most restrictive debt to capital guideline.

Carl Lindner III, Co-CEO

I will now turn the call back to Carl to discuss the results of our P&C operations and to discuss our expectations for 2022. Thanks, Craig. Please refer to Slides 8 and 9 of the webcast for an overview of the second quarter results. Our Property and Casualty segment achieved a record for operating earnings in the second quarter, with nearly all of our businesses meeting or exceeding return on equity targets. As shown on Slide 8, the Specialty P&C insurance operations generated an underwriting profit of $197 million, up from $153 million in the second quarter of 2021, representing a 29% year-over-year increase, and setting a new record for second quarter underwriting profit. The increased underwriting profit in our Specialty Casualty and Specialty Financial Groups was partly offset by lower performance in our Property and Transportation Group. The combined ratio for the second quarter of 2022 was a solid 85.8%, improving 2.1 points from the previous year. This quarter's results included 1.6 points of catastrophe losses and 6.3 points of favorable prior year reserve development. Gross and net written premiums rose by 10% and 11%, respectively, compared to the same quarter last year. Each of the Specialty Property and Casualty Groups reported year-over-year growth due to new business opportunities, increased exposures, and a favorable renewal rate environment. The growth drivers varied across our Specialty Property and Casualty businesses. Overall, excluding crop, the year-over-year growth in gross written premium for the second quarter of 2022 is about 65% due to new business opportunities and changes in exposures, while about 35% is attributed to rate increases. Average renewal pricing across our P&C Group, excluding workers' comp, rose approximately 6% for the quarter and about 4% overall. Despite a slowdown in the rate of increases in certain lines, renewal rate increases in most of our businesses remain at or above the estimated prospective loss ratio trends, which have been about 5% for our Specialty P&C businesses, excluding workers' comp, and approximately 3% overall throughout 2022. The prospective loss ratio trend reflects our outlook on future loss costs considering the current economic and legal landscape, adjusted for automatic increases in premium on exposures that align with inflation. After excluding the impact of inflation-sensitive exposure growth, such as payrolls and property values, we estimate the underlying prospective loss cost trend to be closer to 5% overall and 6.5% excluding workers' compensation. With this context, we feel confident about the rate increases we've been achieving over the past few years, which have significantly exceeded loss ratio trends. Now, let's look at Slide 9 for highlights from each of our Specialty Property and Casualty business groups. The Property and Transportation Group reported an underwriting profit of $39 million in the second quarter of 2022, down from $62 million in the same quarter of 2021, due to larger losses and increased catastrophe losses impacting our property and inland marine business, as well as lower levels of favorable prior year reserve development compared to a higher favorable development in the first half of 2021. Some businesses benefited from lower claims frequency due to COVID-19 in early 2021. Catastrophe losses in this group, net of reinsurance and including reinstatement premiums, totaled $19 million in the second quarter of 2022, compared to $7 million in the same period last year. With higher catastrophe losses and reduced favorable development, the Property and Transportation Group achieved a 92.4% combined ratio in the quarter, 5.8 points higher than the same period in 2021. Gross and net written premiums in this group increased by 13% and 12%, respectively, compared to the same quarter in 2021, primarily driven by increased exposures and higher rates in our transportation businesses, as well as growth in our crop insurance business. All businesses in this group reported growth in gross written premiums during the quarter, with overall renewal rates increasing by 5% on average. Regarding our crop insurance, except for some isolated dry areas, much of the nation's corn and soybean crop is in good condition. Industry reports show that 61% of corn and 60% of soybean crops are rated good to excellent, consistent with last year. Current commodity pricing is favorable, with corn up about 1% and soybeans down about 4% from spring discovery prices. Assuming adequate rainfall throughout August, we expect an average or better crop year. The Specialty Casualty Group reported an underwriting profit of $130 million in the second quarter of 2022, compared to $71 million in the same quarter of 2021, primarily due to improved profitability in our workers' compensation, excess and surplus lines, and executive liability sectors. This group achieved a strong 80.1% combined ratio in the second quarter, an improvement of 7.8 points from the same period last year. Gross and net written premiums for the second quarter of 2022 rose by 6% and 9%, respectively, compared to the prior year period. Excluding workers' compensation, gross and net written premiums grew by 6% and 11%. Key factors for year-over-year premium growth included increased exposures in our excess and surplus lines, rate increases, and new business opportunities in target markets, alongside payroll growth in our workers' compensation. However, this growth was partly offset by lower premiums in our mergers and acquisitions liability business. Most businesses in this group experienced good renewal pricing and premium growth in the second quarter, with renewal pricing, excluding workers' compensation, increasing by 7%, and overall renewal rates up by 4%. Next, the Specialty Financial Group reported an underwriting profit of $37 million in the second quarter of 2022, up from $21 million in the same quarter of 2021, driven by improvements in our trade credit and fidelity/crime businesses. This group maintained excellent underwriting margins and achieved an impressive 78.4% combined ratio for the second quarter, showing an eight-point improvement from the previous year. Gross and net written premiums increased by 13% and 11%, respectively, compared to the prior year. Growth in this quarter was supported by new business opportunities within our lender services, exposure growth, and opportunities in our trade credit and surety businesses. Renewal pricing in this group rose by approximately 2% for the quarter. Moving to Slide 10, you'll find our 2022 outlook summary. We continue to expect a favorable property and casualty market with growth opportunities from both ongoing rate increases and exposure growth. Based on strong results through the second quarter, we now expect AFG's core net operating earnings for 2022 to be between $10.75 and $11.75 per share, reflecting an increase of $0.25 per share at the midpoint of our previous guidance. Our updated guidance indicates higher anticipated underwriting profits in our Specialty Casualty and Specialty Financial Groups as well as an average crop year. Earlier in the call, Craig shared our expectations about full-year investment income. We expect the combined ratio for the Specialty Property and Casualty Group to be between 85% and 87%. Net written premiums are now anticipated to be 9% to 13% higher than the $5.6 billion reported in 2021, which is an increase of 1 percentage point from our previous estimate. For each sub-segment, we now estimate a combined ratio in the range of 88% to 91% in the Property and Transportation Group, which continues to assume average crop results for the year. We expect net written premium growth in this group to be between 13% and 17%, an increase from the previously estimated range of 11% to 15%. For the Specialty Casualty Group, a combined ratio in the range of 79% to 83% is anticipated, with guidance reflecting strong performance across all businesses, including profitability for our workers' compensation operations. We expect net written premiums to be 6% to 10% higher than last year's results, consistent with our initial guidance. Premium growth will be tempered by rate reductions in our workers' compensation portfolio due to favorable loss experience. Excluding workers' compensation, we now expect premiums in this group to range between 9% and 13%, up from 7% to 11%. The Specialty Financial Group's combined ratio is expected to be between 81% and 85%, with net written premiums for this group projected to rise by 4% to 8%. Based on first-half results, we now anticipate renewal rates to increase between 4% and 6% across our Specialty P&C operations overall. Excluding comp, we expect renewal rates increases to be in the range of 5% to 7%. Both projections reflect a slight decrease from our earlier guidance. Craig and I are pleased to report these strong results for the second quarter and take pride in our long-term value creation. We believe our entrepreneurial and opportunistic culture, along with our robust balance sheet and financial flexibility, positions us well for the remainder of 2022. We'll now open the lines for questions. Craig, Brian, and I are here to respond to any inquiries. Thank you.

Operator, Operator

And our first question is from Michael Phillips with Morgan Stanley.

Michael Phillips, Analyst

Thank you. Good morning everybody. I was hoping you could kind of run through whatever detail you would like. I guess what segments of your business are kind of most exposed to recessionary environments? And as you highlight those, kind of what impacts you think it might have on those businesses?

Carl Lindner III, Co-CEO

I'm not sure if there's any one part of our business that would be more exposed than others in that. In fact, I think something like lender, some of the businesses that don't correlate to the cycle like lender-placed property could be the opposite if things slow down and there are more foreclosures within the business. We're not huge in commercial multi-peril, for instance, which probably since we're not a big Main Street commercial package writer, I would think within the industry that, that would be an area of particularly small- to medium-sized commercial package type business that might get impacted more than others. But we're in the non-profit package space pretty well and have some targeted package business. But overall, we're really pretty small in comparison in that area to others. So those would be my thoughts.

Michael Phillips, Analyst

Thank you. You provided some positive comments about an average or better crop year, assuming there is sufficient rainfall in August. If the drought continues over the next few weeks or months, what do you think the potential downside could be?

Carl Lindner III, Co-CEO

Well, like I said, commodity prices are in good shape. When you look at the crop conditions right now, I'm very optimistic at this point. And when you take a look at this week, it seems like starting in August, we're getting some rainfall across the country. So I'm very optimistic at this point, but we can tell you a whole lot more at the third quarter conference call.

Operator, Operator

And our next question coming from the line of Paul Newsome with Piper Sandler.

Paul Newsome, Analyst

Good morning, congrats on the quarter. Apologies, I got myself a little confused about your rate versus inflation commentary. And it sounds like you are essentially excluding from claims inflation as well as rate inflation numbers, the effect of the exposure increases within your book of business. Is that a fair way of characterizing it or am I just getting myself confused?

Brian Hertzman, CFO

So, this is Brian. What we're trying to clarify in Carl's comments is that when we look at the loss ratio trends, the loss ratio trend is our loss cost adjusted for the positive impact of exposure changes. This includes the automatic factors where premiums increase due to rising payroll or property values. We have been indicating a 5% loss ratio trend, which incorporates about 1.5% favorable impact from these exposure changes. Carl pointed out that if we take our overall loss ratio trend of 5% and exclude workers' comp, removing the effect of exposure changes raises it to 6.5%. So, when we discuss loss ratio trends, that reflects adjustments for exposure. In contrast, when we refer to rate increases, we are solely addressing renewal rate increases without considering exposure.

Carl Lindner III, Co-CEO

Yes, there has been some discussion from Evan and others. I want to ensure that our investors have a consistent number to reference. One important point is that we haven't made changes to that number. The prospective loss ratio and loss cost trends we've used have remained stable since the start of the year, with only slight adjustments made between the first and second quarter on the liability side. Overall, we've maintained that level of prospective loss cost trend or loss ratio trends throughout the year.

Paul Newsome, Analyst

Okay. I think it's very relevant. I believe we will have upcoming discussions not just about AFG but regarding the impact of exposure on loss trends in comparison to the rate aspect. Do you have any specific insights on how much this might influence your portfolios or what an increase in exposure effectively means in terms of rate?

Carl Lindner III, Co-CEO

I think Brian just kind of gave that to you.

Brian Hertzman, CFO

We will examine the exposure aspect of the loss ratio. If we disregard changes in exposure, our anticipated loss cost trend stands at 6.5%, which adjusts to 5% when considering exposure. Therefore, I would interpret the change in exposure as being favorable for the loss ratio by approximately 1.5%.

Carl Lindner III, Co-CEO

Yes, excluding comp.

Paul Newsome, Analyst

Is that essentially assuming that every point is equivalent to the rate? Is that how I should interpret it?

Carl Lindner III, Co-CEO

We're aiming to align rates to maintain an advantage over loss ratio trends. In the second quarter, we achieved about a 6% rate increase, while the loss ratio trend is around 5%. Within our portfolio, there are segments like public D&O, which constitutes approximately 22% of our D&O business, but this sector has recently seen a slight decline in rates, marking the first time we've observed a price drop in public D&O. We generally take an opportunistic approach in this area since it's not the majority of our business. While there are certain segments where rates fall below loss cost trends, they are not numerous. Notably, we face increased competition in Fortune 1000 excess liability, where the influx of 10 to 15 competitors over two years is impacting rates. Overall, our Specialty Casualty combined ratio remains strong, indicating we have some flexibility if trends shift. I remain optimistic, as most of our business continues to meet or surpass our loss ratio expectations, which positions us well moving forward.

Operator, Operator

Our next question coming from the line of C. Gregory Peters with Raymond James.