Q3 2022 Earnings Release Transcript

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EDITED TRANSCRIPT

AFG.N - Q3 2022 American Financial Group Inc Earnings Call

EVENT DATE/TIME: NOVEMBER 03, 2022 / 3:30PM GMT

OVERVIEW:

AFG reported 3Q22 core net operating EPS of $2.24. Expects 2022 core net operating EPS to be $11.00-11.75.

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NOVEMBER 03, 2022 / 3:30PM, AFG.N - Q3 2022 American Financial Group Inc Earnings Call

C O R P O R A T E P A R T I C I P A N T S

Brian S. Hertzman American Financial Group, Inc. - Senior VP & CFO

Carl Henry Lindner American Financial Group, Inc. - Co-President,Co-CEO & Director

Diane P. Weidner American Financial Group, Inc. - VP of IR

Stephen Craig Lindner American Financial Group, Inc. - Co-President,Co-CEO & Director

C O N F E R E N C E C A L L P A R T I C I P A N T S

Meyer Shields Keefe, Bruyette, & Woods, Inc., Research Division - MD

Michael Wayne Phillips Morgan Stanley, Research Division - Equity Analyst

Paul Newsome Piper Sandler & Co., Research Division - MD & Senior Research Analyst

P R E S E N T A T I O N

Operator

Thank you for standing by, and welcome to the American Financial Group 2022 Third Quarter Conference Call. (Operator Instructions) As a reminder, today's conference call is being recorded. I would now like to tuthe conference to your host, Ms. Diane Weidner, Vice President of Investor Relations. Please go ahead.

Diane P. Weidner - American Financial Group, Inc. - VP of IR

Good morning, and welcome to American Financial Group's Third Quarter 2022 Earnings Results Conference Call. We released our 2022 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 tuthe discussion over to Carl, I would like to 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 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 tuthe call over to Carl Lindner III to discuss our results.

Carl Henry Lindner - American Financial Group, Inc. - Co-President,Co-CEO & Director

Good morning. We're pleased to share highlights of AFG's 2022 third quarter results, after which Craig and Brian and I'll be glad to respond to any questions. We're very pleased with AFG's performance during the third quarter. We achieved an annualized core operating retuof over 17% in the quarter, with strong underwriting results despite elevated industry catastrophe losses.

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NOVEMBER 03, 2022 / 3:30PM, AFG.N - Q3 2022 American Financial Group Inc Earnings Call

Strategic positioning of our investment portfolio has continued to enable us to invest opportunistically, and the returns in our alternative investment portfolio again exceeded our expectations. Craig and I thank God, our talented management team, and all of our employees for helping us to achieve these exceptionally strong results. Returning capital to our shareholders is an important component of our capital management strategy and reflects our strong financial position and our confidence in AFG's financial future.

With our third quarter earnings release, we announced a special cash dividend of $2.00 per share payable on November 22, 2022 to shareholders of record on November 15, 2022. This special dividend is in addition to the Company's regular quarterly cash dividend of $0.63 per share most recently paid on October 25 of this year. With this special dividend, the Company has declared $12.00 per share in special dividends in 2022.

In the aftermath of Hurricane Ian, we're reminded of the critical role that insurance plays in the wake of catastrophes such as this. Our claims teams continue to work with our agents and policyholders to identify and process covered claims quickly and efficiently to help our customers restore their businesses and rebuild their communities. Our thoughts and prayers remain with those who have been affected by the devastation caused by Hurricane Ian.

I'll now tuthe discussion over to Craig to walk us through AFG's third quarter results, investment performance and our overall financial position at September 30.

Stephen Craig Lindner - American Financial Group, Inc. - Co-President,Co-CEO & Director

Thanks, Carl. Please tuto Slides 3 and 4 for summary earnings information for the quarter. AFG reported core net operating earnings of $2.24 per share, compared to $2.71 per share in the third quarter of 2021. The year-over-year decrease was primarily the result of lower year-over-year returns in AFG's alternative investment portfolio, as compared to the very strong performance of this portfolio in the prior year period.

On Slide 4, you'll see that net earnings included after tax non-core net realized losses on securities of $28 million, or $0.32 per share in the quarter. Included in this number is $21 million, or $0.24 per share in after tax net losses from the mark-to-market of equity securities that we continued to own at September 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. The details surrounding our $14.3 billion investment portfolio are presented on Slides 5 and 6. Pretax unrealized losses on AFG's fixed maturity portfolio were $701 million at the end of the third quarter, reflecting the increase in market interest rates and widened credit spreads compared to year-end 2021.

During the first nine months of 2022, we acted on opportunities presented by the increasing interest rate environment and lengthened 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 September 30, 2022.

In the current interest rate environment, we're able to invest in high quality, medium-duration fixed maturity securities at yields of around 6%, which compare favorably to the 3.73% yield earned on fixed maturities in the third quarter of 2022 and 3.11% earned in the third quarter of 2021. In addition to the favorable impact of higher reinvestment rates, as we look forward, we expect our portfolio of floating rate securities, most of which are tied to 1-month or 3-month indices, to benefit from additional increases in short-term interest rates.

Altogether, assuming that future interest rates follow current market expectations, we expect the yield earned on our fixed maturity portfolio to increase by as much as 70 basis points by the fourth quarter of 2023 compared to 3.73% earned in the third quarter of 2022. Looking at results for the quarter, for the three months ended September 30, 2022, property & casualty net investment income was 12% lower than the comparable 2021 period.

The annualized retuon alternative investments in the third quarter of 2022 was approximately 7.1% compared to 20.3% for the 2021 quarter. Excluding the impact of alternative investments, net investment income in our property and casualty insurance operations for the three months ended September 30, 2022 increased by 35% year-over-year as a result of the impact of rising interest rates and higher balances of invested assets.

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NOVEMBER 03, 2022 / 3:30PM, AFG.N - Q3 2022 American Financial Group Inc Earnings Call

Our 2022 earnings guidance assumes an overall annual yield of 12% on alternative investments for the full year, based on the strong performance of these investments in the first nine months of the year, including $79 million in earnings related to the opportunistic sales of multi-family properties during the first six months of 2022.

Our guidance continues to reflect minimal income from alternative investments in the fourth quarter of 2022 as we assume that continued strong performance of our multi-family housing investments will offset weaker performance of traditional private equity investments. Valuations of our traditional private equity investments are generally reported on a quarter lag and the poor performance of public equity markets in the third quarter is expected to impact the fourth quarter performance of our private equity investments. Our disciplined, yet opportunistic investment approach has served us well, we believe we're well positioned in this current market environment.

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 97% of our P&C Group fixed maturities portfolio with an NAIC designation of 1 or 2, its highest two categories.

Please tuto Slide 7, where you'll find a summary of AFG's financial position at September 30, 2022. Our excess capital was approximately $1.3 billion at September 30, 2022. This number included parent company cash and investments of approximately $760 million. During the quarter, we returned $48 million to our shareholders through the payment of our regular $0.56 per share quarterly dividend.

Following the $2.00 special dividend declared yesterday, we project that less than $100 million of our remaining excess capital is available for share repurchases or additional special dividends through the end of the year 2022. As you may recall, the portion of our excess capital that we view as available for special dividends and share repurchases is limited by our total debt to cap target of 30%, and that capital number is impacted by unrealized gains and losses on fixed maturities. However, it's important to note that each dollar of debt repurchased frees up approximately $2.00 of excess capital for distribution to shareholders, and in today's market, we can repurchase our debt below par value.

AFG's book value per share plus dividends declined by approximately 2.0% in both the third quarter and nine-month periods ended September 30, 2022, reflecting unrealized losses on fixed maturities due to rising interest rates and widening credit spreads. Excluding unrealized losses related to fixed maturities, we achieved growth in adjusted book value per share plus dividends of 3.7% during the third quarter, and 12.7% year-to-date. The short duration of our fixed maturity portfolio and somewhat limited exposure to publicly traded common stocks when compared to some peers helped our performance in 2022.

With the $2.00 per share special dividend declared yesterday, AFG has declared $12.00 per share in special dividends in 2022 while continuing to be in a strong excess capital position. I'll now tuthe call back over to Carl to discuss the results of our P&C operations and our expectations for 2022.

Carl Henry Lindner - American Financial Group, Inc. - Co-President,Co-CEO & Director

Thank you, Craig. Now if you'd please tuto Slides 8 and 9 of the webcast, which include an overview of third quarter results. Operating earnings in our Property & Casualty business continue to be excellent, and I'm pleased to report exceptionally strong growth in gross and net written premiums during the quarter. Catastrophe losses were manageable, and we're continuing to achieve renewal pricing in excess of prospective loss ratio trends in the vast majority of our businesses, so that nearly all of our businesses are meeting or exceeding retuon equity targets.

As you'll see on Slide 8, the Specialty P&C insurance operations generated an underwriting profit of $158 million, compared to $169 million in the third quarter of 2021, a 7% decrease. Higher year-over-year underwriting profit in our Specialty Casualty Group was more than offset by lower underwriting profit in our Property and Transportation and Specialty Financial Groups.

The third quarter 2022 combined ratio was a strong 91.1%, 2.1 points higher than the 89.0% reported in the comparable prior year period. Results for the '22 third quarter include 2.5 points in catastrophe losses and 3.1 points of favorable prior year reserve development. Catastrophes, primarily due to Hurricane Ian, impacted AFG's underwriting results for the third quarter of 2022 by $39 million, including the impact of reinstatement premiums and the favorable impact of the reduction in certain profitability-based commissions due to agents, which related to the catastrophe losses.

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NOVEMBER 03, 2022 / 3:30PM, AFG.N - Q3 2022 American Financial Group Inc Earnings Call

Gross and net written premiums increased 19% and 15%, respectively, in the 2022 third quarter compared to the prior year quarter. Year-over-year growth was reported within each of the Specialty P&C groups, as a result of a combination of new business opportunities, increased exposures and a good renewal rate environment.

The drivers of growth vary considerably across our portfolio of specialty P&C businesses. In the aggregate, year-over-year growth in gross written premium for the first nine months of '22 excluding crop is about 60% attributable to new business opportunities and change in exposures and about 40% attributable to rate increases.

Average renewal pricing across our P&C Group, excluding workers' comp, was up about 6% for the quarter, and up approximately 5% overall, in line with and slightly higher, respectively, compared to renewal increases reported in the prior quarter. Renewal rate increases in the majority of our businesses continue to be at or in excess of estimated prospective loss ratio trends, which have been approximately 5% for our Specialty Property and Casualty businesses excluding workers' comp and approximately 3% overall throughout this year.

We've been focused on achieving adequate pricing for some time and have achieved overall rate increases across our entire specialty book for 25 straight quarters. We feel very good about the level of rate increases that we continue to achieve and the impact of cumulative rate increases over time, which has enabled us to stay ahead of prospective loss ratio trends and help us to feel even more confident in the adequacy of our reserves.

Now I'd like to tuto Slide 9 to review a few highlights from each of our Specialty Property and Casualty Groups. The Property and Transportation Group reported an underwriting profit of $39 million in the third quarter of 2022 compared to $45 million in the third quarter of '21, primarily as a result of lower year-over-year crop profitability when compared to a very strong 2021 crop year.

Catastrophe losses in this group, net of reinsurance and inclusive of reinstatement premiums, were $13 million in the third quarter of this year, compared to $14 million in the comparable 2021 period. The businesses in the Property and Transportation Group achieved a 95.4% calendar year combined ratio overall in the third quarter, 1.9 points higher than the comparable period in 2021.

When you look at our underwriting results from quarter-to-quarter, it's important to remember that we eathe largest portion of our crop premiums in the third quarter each year, and generally book that business at a combined ratio in the high 90s until the fourth quarter when the harvest process is substantially complete and the level of underwriting profit can be better estimated. Accordingly, the combined ratio for the Property Transportation Group is elevated in the third quarter because crop has been booked in the high 90s. Said another way, earned premiums in the crop business were 40% higher year-on-year in the 2022 third quarter, so the crop business had a larger impact on third quarter results than in the prior period. Excluding crop from both periods, the calendar year combined ratio for the Property and Transportation Group is generally consistent with the 2021 period, which was a strong quarter for this group.

The month of October serves as the discovery period for the majority of our coand our soybean business. Harvest pricing for cosettled 16% higher than spring discovery prices, while soybean pricing was 4% lower, both within desired ranges of volatility. The coand soybean harvest is running well ahead of averages, with approximately 76% and 88% of these crops harvested, respectively. Despite the USDA's reduced yield estimates and widespread Florida citrus losses due to Hurricane Ian, we continue to expect to have an average crop year from a profitability standpoint.

Third quarter 2022 gross and net written premiums in this group were 30% and 24% higher, respectively, when compared to the 2021 third quarter. While nearly all businesses in this group reported higher year-over-year premiums in the quarter, the growth was driven by higher commodity futures pricing in our crop insurance business. Excluding the impact of crop insurance, third quarter 2022 gross and net written premiums increased 14% and 10%, respectively, when compared to the 2021 third quarter. Overall renewal rates in this group increased 5% on average for the third quarter of this year, consistent with renewal rates achieved in the second quarter of this year.

Now the Specialty Casualty Group reported an underwriting profit of $118 million in the 2022 third quarter compared to $110 million in the comparable 2021 period, primarily the result of higher year-over-year profitability in our executive liability, social services and mergers and acquisitions liability business, which was partially offset by an overall decrease in favorable prior year reserve development. Underwriting profitability in our workers' comp businesses overall continues to be excellent.

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