American Financial Group, Inc.

Good day, ladies and gentlemen, and thank you for standing by. Welcome to the American Financial Group 2019 first quarter results. At this time, all participants are in a listen-only mode. If anyone needs assistance during the conference, just press star and zero for an operator. Now it's my pleasure to turn the call to Diane Weitner, Assistant Vice President of Investor Relations.

Good morning. Good morning. and welcome to American Financial Group's first quarter 2019 earnings results conference call. I'm joined this morning by Carl Lindner III and Craig Lindner, co-CEOs of American Financial Group, and Jeff Consolino, AFG's CFO. Our press release, investor supplement, and webcast presentation are posted on AFG's website. These materials will be referenced during portions of today's call. Before I turn the discussion over to Carl, I would like to draw your attention to the notes on slide two of our webcast. Certain statements made during this call may be considered forward-looking statements as defined under the Private Securities Litigation Reform Act of 1995. These statements are not guarantees of future performance. Investors should consider the 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 are reading a transcript of this call, please note that it may not be authorized or reviewed for accuracy. Thus, it may contain factual or transcription errors that could materially alter the intent or meaning of our statement. Now, I am pleased to turn the call over to Carl Lindner III to discuss our results.

Good morning. We released our 2019 first quarter results yesterday afternoon. If you'd please turn to slide three of the webcast slides for an overview. AFG reported core operating earnings of $2.02 per share compared to $2.42 per share in the first quarter of 2018. Fair value accounting for fixed indexed annuities in our annuity segment significantly impacted the quarterly comparison. Annualized first quarter return on equity was a strong 14.5%. Our core insurance businesses continue to perform very well. We reported strong operating earnings in our specialty property and casualty operations and pre-tax earnings before fair value accounting that established a new all-time quarterly high for our annuity segment. Net earnings per share were $3.63 and included $1.61 per share in after-tax net realized gains on securities. Craig and I thank God our talented management team, and our great employees for helping to achieve these 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. In conjunction with our first quarter earnings release, we announced a special cash dividend of $1.50 per share payable on May 28th this year to shareholders of record on May 15th, 2019. The payment of the special dividend will not preclude AFG's consideration of a special dividend later in the year and is in addition to the company's regular quarterly cash dividend of 40 cents per share, most recently paid on April 25th, 2019. We are maintaining our 2019 core earnings guidance for AFG in the range of $8.35 to $8.85 per share. Craig and I will discuss our guidance for each segment of our business in more detail later in this call. Now I'd like to turn our focus to our property and casualty operations. If you would, please turn to slide four and five of the webcast. which include an overview of first quarter results. Our specialty property and casualty group performed very well during the quarter, with strong underwriting margins and healthy year-over-year growth in net written premiums. As you'll see on slide four, gross and net written premiums in our specialty property and casualty insurance operations grew by 5% and 4%, respectively, year-over-year, primarily due to the growth within our property and transportation and specialty casualty groups. Core operating earnings on AFG's property and casualty insurance operations were $185 million in the first quarter of 2019, slightly below the $188 million reported in the prior year period. The specialty property and casualty insurance operations generated an underwriting profit of $88 million in the 2019 first quarter compared to $92 million in the first quarter of last year, a decrease of 4%. Higher underwriting profitability in our property and transportation group was more than offset by lower underwriting profit in our specialty casualty and specialty financial groups. The first quarter combined first quarter 2019 combined ratio of 92.5% increased eight tenths of a point from the prior year period. And first quarter of 19 results included four points of favorable prior year reserve development compared to 5.1 points of favorable development in the comparable prior year. CAT losses were 1.1 points of the combined ratio in the first quarter of 2019. By comparison, CAT losses added 1.2 points in the prior year period. Overall, our accident year combined ratio, excluding CATs, improved slightly against last year's first quarter. Average renewal pricing across our entire property and casualty group was up 1% for the quarter. Though excluding our workers' comp business, renewal pricing was up slightly more than 4%, an improvement over the renewal rate increases that we achieved for the whole year in 2018. Renewal pricing is exceeding our expectations in each of our specialty property and casualty subsegments, which I'll discuss in more detail as we review the results of each. Lost cost trends remain stable, though we're keeping our eye on inflation and interest rates. Now I'd like to turn to slide five to review a few 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 first quarter of 2019, compared to $33 million in the comparable prior year period. Higher underwriting profit in our transportation businesses was Partially offset by lower underwriting profit in our agricultural property in the marine, ocean marine businesses as well as our Singapore branch. Catastrophe losses in this group were $9 million in the first quarter of 19 and $5 million in the comparable 2018 period. First quarter 2019 gross and net written premiums in this group were 3 and 6% higher respectively than the comparable prior year period. The growth in gross written premiums is primarily attributable to new business opportunities in our transportation businesses. Overall, renewal rates in this group increased 4% on average in the first quarter of 2019, an improvement over renewal rate increases achieved last year. And I'm especially pleased with rate strengthening in our commercial auto liability and aviation businesses. We are closely monitoring the flooding in the Midwest and its potential impact on the agricultural community and specifically spring planting. Though through the use of mapping technology, we determined that approximately only one third of 1% of our insurance acreage is located in the flood impacted region. And we did have an opportunity to use this information in establishing our funding strategy in April. Generally speaking, also the corn planting window throughout much of the current flood impacted region runs from early to mid April through the end of May. The soybean planting window within this region runs from late April to the end of June. And with the current technology and equipment, the majority of our insurers can complete planting within a seven to 10 day window. So it's really early in the growing season, and we are hopeful that our growers will be successful in getting their crops in the ground within these time frames. We'll definitely have more details to share when we report our second quarter results. Specialty Casualty Group reported an underwriting profit of $36 million in the 2019 first quarter compared to $41 million in the comparable 18 period. Higher profitability in our alternative markets, especially human services and public sector businesses, were more than offset by lower underrunning profit in our excess and surplus lines and workers' compensation businesses. Despite lower year-over-year profit in our workers' compensation operations, these businesses continue to achieve excellent underrunning margins. Catastrophe losses for this group were $1 million in the first quarter of this year and $5 million in the comparable 2018 period. Gross and net written premiums for the first quarter of 2019 were up 7.5% respectively compared to the same period in 2018. Higher year-over-year gross written premiums within NEON, the addition of premiums from ABA Insurance Services, as well as improved pricing and higher retentions in our excess and surplus lines businesses were the primary drivers of the higher premiums. Lower premiums in our workers' compensation businesses partially offset the growth. The integration of ABA insurance services is proceeding as planned, and we continue to anticipate an incremental $40 to $50 million in net written premium from this business in 2019. Renewal pricing for specialty casualty group was down 1% during the first quarter. Now, when you exclude rate decreases in the workers' comp businesses, renewal rates in this group were actually up 5%, an improvement from the renewal rate increases that we achieved in 2018. We're seeing strong pricing momentum in our umbrella, excess liability, surplus lines, and public B&O businesses. The Specialty Financial Group reported an underwriting profit of $13 million in the first quarter of 2019 compared to $15 million in the first quarter of 2018. The decrease was primarily driven by lower underwriting profitability in our financial institutions business as 2018's first quarter benefited from commission reductions after the active 2017 catastrophe year. Catastrophe losses for this group were $2 million in the first quarter of 2019 compared to $3 million in the prior year quarter. First quarter gross written premiums were up 3%. Net written premiums were down 2%, respectively, when compared to the prior year period, primarily as a result of higher premiums in our fiduciary and crime businesses, which were offset by lower premiums in our surety and lending and leasing businesses. Renewal pricing in this group was up 3% for the quarter. Now please turn to slide six for a summary view of our 2019 outlook for the specialty property and casualty operations. We continue to expect a 2019 combined ratio for the specialty property and casualty group overall between 92 and 94%. Our guidance for growth and net written premiums is also unchanged in the range of flat to up 3% for the year. And looking at each segment, we continue to estimate a combined ratio in the range of 92 to 96% in our property and transportation group and growth in net rent premiums between 3 and 7% for the year. Our guidance assumes a normal level of crop earnings. We continue to expect our specialty casualty group to produce a combined ratio in the range of 91 to 95%. Net written premiums are expected to be down 2% to up 2%, consistent with our initial guidance. Net written premium guidance assumes lower premiums resulting from NEON's increased reinsurance seeded in 2019 and lower premiums in our workers' compensation businesses. These items will be offset by a full year of premiums, as I mentioned before, from ABA Insurance Services. We now expect the specialty financial group combined ratio to be in the range of 88% to 92%, revised upward from our initial estimate of 86% to 90%. Our projection for growth in net written premiums continues to be in the range of 3% to 7%. We expect modest growth across all of our businesses in this group. And we also expect double-digit rate increases in our financial institutions business by the end of this year. Our guidance with regard to net investment income is unchanged with results in 2019 expected to be lapped up 4% year over year. Keep in mind results in 2018 were exceptionally strong primarily due to the strong performance of limited partnerships and similar investments which we don't expect to continue. Given the broad-based improvements noted already in the renewal pricing across many of our specialty property and casualty businesses, we now expect overall property and casualty renewal pricing to be up 1% to 3% in 2019. And excluding workers' comp, we expect renewal rate increases to be in the range of 4% to 6%, up from the previous levels. I'll now turn the discussion over to Craig to review the results in our annuity segment and AFG's investment performance. Thank you.

Thank you, Carl. I'll start with a review of our annuity results for the first quarter beginning on slide seven. Statutory annuity premiums were nearly $1.4 billion in the first quarter of 2019, an increase of 22% from the prior year period. The year-over-year increase was driven by higher sales of traditional fixed annuities in the financial institutions channel. While we're very pleased with premiums through the first quarter, we've implemented several rate decreases in response to decreases in market interest rates over the last several months, and these actions are expected to slow sales. Turning to earnings results, pre-tax annuity earnings were $90 million in the first quarter of 2019 compared to $125 million in the first quarter of 2018. Fair value accounting for fixed indexed annuities had an unfavorable impact of $44 million in the first quarter of 2019, compared to a favorable impact of $13 million in the 2018 first quarter. Turning to slide eight, you'll see that pre-tax annuity earnings before fair value accounting for fixed indexed annuities, were a quarterly record $134 million in the first quarter of 2019, an increase of 20% over the prior year period. These results were driven primarily by growth in the business and the favorable impact of a very strong stock market, partially offset by the unfavorable impact of higher crediting rates and option costs. The S&P 500 index increased by 13% in the first quarter of 2019. This strong stock market performance favorably impacted pre-tax annuity earnings before fair value accounting for FIAs, particularly FIAs with guaranteed benefits by $14 million, or 12 cents per share. The components of fair value accounting for FIAs are shown on slide 9. Under GAAP, a portion of the reserves for fixed indexed annuities is considered to be an embedded derivative and is recorded at fair value based on the estimated present value of certain expected future cash flows. Assumptions used in calculating this fair value include projected interest rates, option costs, surrenders, withdrawals, and mortality. Variances from these assumptions, as well as changes in the stock market, will generally result in a change in fair value. Items such as changes in interest rates and the performances of the stock market are not economic in nature for the current reporting period, but rather impact the timing of reported results. The impact of fair value accounting for fixed indexed annuities includes an ongoing expense for annuity interest accreted on the FIA embedded derivative reserve. The amount of interest accreted in any period is generally based on the size of the embedded derivative and current interest rates. We expect both the size of the embedded derivative and interest rates to rise, resulting in continued increases in interest on the embedded derivative liability. In the first quarter of 2019, corporate A2 rates decreased by approximately 49 basis points compared to the year-end market expectation that they would increase. This difference contributed to a significant unfavorable fair value accounting impact of $45 million or 39 cents per share. By comparison, a 13% increase in the S&P 500 index contributed to a favorable fair value accounting impact of $15 million or 13 cents per share for the first quarter of 2019. The majority of the impact of these two items is non-economic and is expected to reverse over time. By comparison, in the first quarter of 2018, the benefit of significantly higher than expected interest rates was minimally offset by the impact of a decrease in the stock market. For additional analysis of fair value accounting, see our quarterly investor supplement, which is posted on AFG's website. Turning to slide 10, you'll see that AFG's quarterly average annuity investments and reserves grew by approximately 12% and 11%, respectively, year over year. AFG's net interest spread in the first quarter of 2019 was lower than in the first quarter of 2018. The net interest spread in 2018 reflects exceptionally high returns on certain investments that are marked to market through operating earnings. The net interest spread in 2019 reflects higher crediting rates and option costs. AFG's net spread earned before fair value accounting for FIAs was higher in 2019 than in 2018, reflecting the favorable impact of a very strong stock market. AFG's net spread earned reflects the impact of changes in interest rates in both periods. Please turn to slide 11 for a summary of the 2019 outlook for the annuity segment. Based on the strong stock market performance to date in 2019, we now expect annuity earnings before the impact of fair value accounting for FIAs and unlocking to be in the range of $445 million to $475 million, an increase from the range of $435 million to $465 million previously provided. Included here are estimated annuity earnings sensitivities to incremental changes in the S&P 500 index, changes in corporate A2 rates, and changes and changes in the yields achieved on certain investments. These details have also been added as a new page in our quarterly investor supplement. Finally, we're modifying our previously announced annuity premium guidance based on sales through the first four months of the year. We believe, however, that recently implemented rate decreases on our annuity products and a continued focus on pricing discipline will temper new sales as we remain committed to achieving appropriate returns on new business. As a result, we now expect that our 2019 annuity sales will be flat to down slightly from the record $5.4 billion of premiums reported in 2018. Additional information on the annuity segment's earnings, premiums, investments, and reserves can be found at AFG's quarterly investor supplement posted on our website. Please turn to slide 13 for a few highlights regarding our $51 billion investment portfolio. AFG reported first quarter 2019 net realized gains on securities of $145 million after tax and after deferred acquisition costs. This compares the net realized losses on securities of $74 million in the first quarter of 2018. Approximately $127 million of the realized gains recorded in the first quarter of 2019 pertained to securities that AFG continued to hold at March 31, 2019. As of March 31, 2019, net unrealized gains done on fixed maturities were $464 million after tax, after DAC, an increase of $381 million since year end. As you'll see on slide 14, Our portfolio continues to be high quality with 91% of our fixed maturity portfolio rated investment grade and 98% with an NAIC designation of one or two, its highest two categories. We've provided additional detailed information on the various segments of our investment portfolio and the quarterly investor supplement on our website. I'll now turn the discussion over to Jeff, who will wrap up our comments with an overview of of our consolidated first quarter 2019 results and share a few comments about capital and liquidity.

Thank you, Craig. Slide 15 summarizes AFG's first quarter consolidated core operating earnings results. AFG reported core EPS of $2.02 in Q1 2019. Core net operating earnings in the quarter were $184 million. The year-over-year decrease in core earnings in the 2019 first quarter was primarily the result of the impact of fair value accounting on our annuity segment's results, which Craig detailed for you earlier in this call. Interest and other corporate expenses were relatively unchanged year-over-year. Parent company interest expense decreased increased by $1 million from Q1 2018 as a result of the March 2019 issuance of $125 million principal amount of hybrid 40-year, 5.7% subordinated to ventures due in 2059. Other expenses were flat year over year. Slide 16 provides a reconciliation of core net operating earnings to net earnings. Accounting guidance adopted on January 1st, 2018 requires holding gains and losses in equity securities to be recognized in net earnings, which will contribute significantly to volatility in reported GAAP earnings. In the first quarter of 2019, AFG recognized $145 million, or $1.61 per share, and net after-tax realized gains on securities, reversing nearly 80% of the Q4 2018 negative mark-to-market. As indicated on slide 17, AFG's adjusted book value per share was $58.02 as of March 31, 2019. Annualized growth in book value per share plus dividends was an impressive 26% in the first quarter of 2019, powered by the rebound in the equity markets. We returned $36 million to our shareholders in the first quarter with the payment of our regular quarterly dividend. The aggregate amount of the special dividend announced yesterday will be approximately $135 million and will be paid at the end of this month. Parent cash was $215 million at the end of the first quarter. We maintained solid levels of capital in our insurance businesses to meet our commitments to the rating agencies. Our excess capital stood at approximately $1.1 billion at March 31, 2019 due to strong gap earnings and the issuance of our $125 million loan. 5.78% hybrid in the 2019 first quarter. We plan to hold approximately $200 million to $300 million as dry powder to maintain our flexibility for opportunities as they may arise. Our management team reviews all opportunities for the deployment of capital on a regular basis. Wrapping up, Page 18 shows a single-page presentation of our updated 2019 core earnings guidance. Our guidance assumes an effective tax rate of approximately 20% on core pre-tax operating earnings. AFG's expected 2019 core operating results exclude non-core items such as realized gains and losses and other significant items that may not be indicative of ongoing operations. With that, now we'd like to open the lines for any questions.

Thank you. And ladies and gentlemen, if you have a question at this time, press star and one of your touch-tone telephone. If your question has been answered or you wish to remove from the queue, just press the pound or hash key. And our first question is from Greg Peters with Raymond James. Your line is open.

Good afternoon. I just have a couple small questions. In the property transportation business, I was wondering if you could comment on how your commercial auto book is performing, maybe also add in some color on national interstate. And then, Craig, also on the property and casualty business, In the financial institutions, I think in your comments, you said that you expect the financial institutions business rate environment to go up. I think you said like 10% later in the year. And I was just trying to square that with the combined ratio expectations of 88 to 92. And then I have a question in your annuity business.

Hi Greg, this is Carl. Happy to give a little color on our commercial auto business. Overall, very pleased with the performance of our commercial auto business. National Interstate and our Great American Trucking part of our business are achieving the combined ratio targets that we've set. Actually, you know, with our house in order, I feel we're in a good position to take advantage of a market that's still in a correction mode So, you know, feel very good. That said, on the, you know, the severity trends for the industry, in our, even our severity trends, you know, in commercial auto liability are causing us to continue to take, you know, pretty solid rate on that part of the business. We got about 8% price increase on that part of National Winter States business, and you know, we'll continue to take rate in that. So I feel good about our business. And, you know, again, I think with our house in order, I think we're in a position to take advantage of a market that's in a correction mode. On the specialty financial, I think you're referring to a comment about expecting double-digit increases in our financial institutions business. You know, I think I think throughout this year, I think we're going to see the pricing levels escalate on that book. And I think we do expect to be able to, by the time year-end comes, to achieve a double-digit rate on that book. So I think that's a positive. Our combined ratio in our overall specialty financial business is so good that, you know, to get – and we try to be as exacting as we can. Naturally, rate increases of that magnitude on that part of our business have to help going into next year. Right.

Thank you for those answers, Carl. Switching to the annuity business, Greg. I was looking at page 16 and I noted your comments about changing your rates and how it might affect sales going forward. I was looking on page 16 sequentially noting the lower results in broker-dealer single premium annuity business. I assume that's just a reflection of competitive market where some of your peers might be more aggressive, but maybe you can add some additional color there.

Sure, Greg. Part of it is a reflection of just a pretty competitive marketplace right now. What I would say is we really focused on that segment as having potential, and we were one of the really early players to be successful in growing that segment of our business in a pretty major way. Since then, some of our competitors who weren't focusing on that segment have made it a priority to penetrate that segment of distribution. I think that's the answer, Greg.

All right. Carl and Craig, thank you very much for your time. Sure.

Thank you. And our next question is from Christopher Campbell with KBW. Your line is open.

Hi. Good afternoon, gentlemen. My first question is on capital management. So the special dividend only uses up about $150 million, which still leaves close to a billion in excess capital based on the $1.1 billion you disclosed at quarter end. So I guess just given you're retaining this, should we expect something inorganic to happen sometime soon?

I think we've said in the past that, you know, we feel we're sensitive when our capital gets to be a billion dollars or over to, you know, be more aggressive in using it. You know, with the special dividend that's paid, it will push it under a billion dollars. As in every year, every year is a little different mixture. No, but I wouldn't assume that there's some big deal on the table right now or anything. I think if you look over historically, this is very normal. We have plenty of flexibility to continue to look at opportunities on the acquisition side and As I mentioned earlier, this special dividend we declared doesn't preclude us from declaring another one, you know, towards the end of the year as we've done in prior years also. So, you know, I think we're pretty good capital managers over time. You know, some of the acquisitions like Summit and bringing in National Interstate, the rest of that, all those transactions earned very significant double-digit returns on equity, so. Those are the kinds of things that we're looking to do. You know, we don't do things just to do them and that. We're fairly picky, tougher buyers, and that's just the way we look at things. I hope that gives you a little color.

Yeah, it does, definitely. And I think you had mentioned in response to one of the prior questions about, you know, being interested in commercial auto given, you know, the problems a lot of competitors are having. Would that be something that you would be – interested in pursuing if it came up? Well, sure.

You know, if we have our house in order, and that could mean more organic growth than, you know, what we're assuming today, or it could, you know, if there's an opportunity on the acquisition side that made sense for us, sure. Right now, we feel there's, you know, great opportunities in the market, you know, probably organically. So I hope that helps.

That makes sense. And then just, yeah, I've seen some articles about, you know, it's rumored that you guys might be considering disposing of, like, neon. Does hardening pricing at Lloyd's, does that change any of the calculus? And if that were to occur, what is neon sitting on AFG's book set? And then how much existing capital could that free up?

Chris, good afternoon. This is Jeff Consolino. Just to start with, we don't comment on market speculation one way or the other, whether it pertains to buying or selling businesses. Overall, NEON is on our books effectively at zero. And so... most of our capital at Lloyd's is provided in the form of letters of credit rather than tangible capital.

Okay. Got it.

And then just, you know, one last one is on annuities. You know, I'm certainly not an expert on it, but my understanding is that most of the life peers report the earnings net of the fair value adjustments to kind of make it cleaner and I guess, could you just give us color on why AFG doesn't follow this approach?

This is Craig. It's something that we've studied from time to time and will continue to study. I think some of our peers do define core operating earnings in a different way than we do. We were actually very pleased with the first quarter. If you look at the underlying fundamentals, they were really very strong. We had a very strong premium quarter. We were able to hit targeted returns or exceed targeted returns on new business. The earnings were impacted in a major way by the decline in interest rates, which resulted in, you know, an increase in the embedded derivative, which we flow through earnings that hit the earnings by some $45 million. It is purely a timing issue. It has nothing to do with the underlying economics. So when you kind of normalize things, we were actually very pleased with the quarter. We are continuing to study whether or not it makes sense to change our definition of core operating earnings. Just to say that.

Okay, great. That's very helpful. And then just one last one on the guidance update on the P&C pricing. Looks like you increased that about 100 bits on the lower and the upper end. So I'm just kind of wondering, but, like, the underwriting guidance didn't change at all. So is your view of, like, rates are getting better, but lost cost inflation is also creeping up? Would that be a fair assessment of why guidance isn't changing?

Well, you know, things you do today, you really impact future periods. You know, most policies earn over a 12-month period of time. You know, we're almost halfway through the year at this point. So, no, we're not – you know, it doesn't reflect any change in our perspective about the stability on the loss cost side or claim side. I think it reflects more of a – optimistic, enthusiastic outlook as to the direction of pricing that we see. You know, we're seeing, you know, in businesses like D&O right now, you know, some snippets. We don't have our final April pricing and, you know, stats in and all that. But, you know, I'm getting excerpts from our folks in businesses like public company D&O and other parts of our business that make us more optimistic as to, you know, where our pricing is going to go for the rest of the year. So I think it reflects more of that optimism.

Okay, great. Well, thanks for all the answers. Back to Locke in the second quarter.

Thank you. Our next question comes from Paul Newsome with Sandler O'Neill. Your line is open.

I've just got one left, Bob. You've been great about returning shareholder money on a timely basis, but I'm curious about whether or not the math has changed enough that we might see a switch from special due ends to stock repurchases. And just talk about that process, if you would.

You know, I think that's something that we're always, you know, quarter by quarter, month by month, we're always trying to find the best uses for excess capital, you know, whether that's organic growth, acquiring something, share repurchases, returning capital in the form of special dividends. I think, you know, the first quarter is an indication that, you know, we continue to feel right or wrong or otherwise that, returning capital to our shareholders in the form of special dividends is a very effective, positive strategy.

I'm not arguing it's positive, but the valuation of the stock is down. Is there some point where there's an inflection point where you decide that it's just better to repurchase stock than give dividends, or is the dividend just sort of kind of how you think things should be done on a regular basis?

Paul, this is Jeff Consolino. The way you're phrasing the question kind of invites us to say never, which, of course, we should never say. You know, this company has been a purchaser of stocks in the past, retiring about a third of the shares outstanding at various points. And so that's always very much a part of the thought process. You know, clearly we've got a – picture of our earnings power and confidence in our future, that would be really a neutral across repurchase or dividends. As Carl said, with the first quarter special dividend, that'll go out and that'll be a significant return of capital that goes to all shareholders, but the CEOs are always evaluating the merits of share repurchase and looking at things like years to pay back and return on investment and the like. So I don't think we can tell you with a bright line what would trigger that. It's just our evaluation of the circumstances as we're preparing to return capital. We do have significant excess capital, so if the opportunity arose to retire a significant component of our shares outstanding at a good return on investment, past actions show that we'd be ready to do it.

Very fair answer. Thank you.

Thank you. And our next question is from Amit Kumar with Buckingham Research. Your line is open.

Thanks, and good afternoon. Maybe I'll take this in reverse order, following up Paul's question on capital management. The special dividend, the cash dividend in Q1, does... Should we not expect a special dividend in Q2? I was trying to remember what was the timing. If the excess capital remains strong at that point, should we not be surprised if we see another special dividend, or how should I think about that timing?

Amit, last year we announced the $1.50 special dividend at this time of year. and then a second $1.50 special dividend in the fourth quarter, which was payable before year end. We're always evaluating things, but I think when you get to the fourth quarter, not only do you have the benefit of having gone through the year and evaluated other options and either pursued them or not, but you're in the business planning process, and you can have a clear picture of how much capital you want to support organic growth initiatives and other things. So again, there's no cookie cutter approach, but when you look at the last couple of years, it's been a second quarter, fourth quarter kind of split between these significant special dividends we've paid. Got it.

That's helpful. The other question I had, I think Chris was talking about this or someone else regarding the commercial auto environment. And everyone's trying to ask about protective insurance, which I'm sure you want to answer. Is there a way to talk about has commercial auto environment improved enough over the past six months or 12 months for you to think differently? Or just because maybe you've had better successes than others, maybe you can do a better job in that space. Maybe just talk about the relative attractiveness of commercial auto today versus, you know, maybe six months or a year ago.

Amit, you know, I think we really kind of got our house in order last year also, you know, once the whole year was completed and that. We're meeting the combined ratio targets that we've set. We're still taking rate, as I mentioned before, on the commercial auto liability side at National Interstate because the severity trends are still, you know, pretty high within the industry in that. So... because we're meeting our targets, and I think our house is in order, you know, we feel like we're in a position to take advantage of a market that I mentioned, you know, is definitely still in a correction mode, you know, when you see what's going, you know, when you understand what's happening in the marketplace and that. So lots of corrective actions being taken by others, lots of price re-underwriting, and all that. So that you know, should provide opportunities for us, you know, for organic growth, potentially acquisitions. But, you know, we're very disciplined. You know, that's just our approach to things. We've been out, you know, we're different than others probably in that we're in our seventh, probably we've taken seven years of rate increase. You know, so this wasn't, it wasn't a quick turnaround. at National Interstate. It took a while because of the severity, friends. And, you know, my guess is the rest of the market, they're definitely not in their seventh year of rate increase would be my guess. Some may be in their first or second year or fourth year or whatever. So I think it's going to take a while for things from industry results to get better.

I agree, and I know that. The national interest rate change was phenomenal, and I heard that Jeff maxed out his seamless budget for you. So the other question I had was going back to the agriculture discussion, and I think I heard it correctly. You said 33 basis point of 1%, so it's clearly de minimis. On another call, there was a comment made. But most of the flooding was already, I guess, in flood zones, you know, floodplains, et cetera. So that's why there wasn't much of an ag impact. And yet we have seen completely different commentary coming out of some of these agriculture bureaus. And I was trying to maybe you could help us better understand what exactly is going on on the ground and also refresh us as to the timeline, you know, when planting happens, when delayed planting happens. If things do worsen, when do we start seeing the impact in the numbers?

Thanks. Okay. You know, I think I kind of addressed things. But, yeah, I think the statistic, you know, we use mapping technology, you know, pretty thoroughly. And with that, over the past, you know, couple of months, you know, we determined that about one-third of 1% of our insured acreage is located in flood impacted, you know, in the flood impacted regions. So, you know, we had an opportunity because of that use of that technology. You know, we had an opportunity to use that information that we got in establishing our funding strategy. You know, you every year, companies in this business, you know, you can choose how much risk you want to take, you know, within the funding, your funding strategy. So we were able to use that information. So I think the bigger picture is not maybe so much the flood impact, it's really preventative planning, you know, at some point. But again, when you understand the corn planting windows really extend until the end of May, and soybean planting extends to the end of June. And then also sometimes if corn planting windows are missed, farmers will choose to plant soybeans, you know, versus corn and that kind of thing. You know, it would seem like there's still plenty of flexibility when you understand that it only takes with technology farmers to, you know, You know, he takes them a seven- to ten-day window to plan. So it's really early to really try to prognosticate, you know, what the impact is. And is it a book monthly RP? I think we'll know more, you know, we'll know more in the second, as we report second quarter earnings. You know, we'll know more over, you know, by the end of June. exactly kind of where we stand. And is your book mostly revenue protection or yield? Well, most of the business is revenue coverage and that. Actually, I think crop hail business doesn't include flood. You know, just for your information. Most of the business is really revenue coverage.

Got it. Okay.

That's all I had. It's early in this. Like I said, we're keeping our eye on it. Commodity prices, you know, doesn't seem to be too much going on there that's concerning. Soybean prices, you know, I think I was looking at today, you know, they're maybe down, I think it was 8% to 10%, 8%, 9%, something like that. So we don't really get, on the commodity price side, we don't get too concerned if the yields are decent until you start getting up into 16 to 20% changes in commodity price. Thank you.

Thank you. Ladies and gentlemen, as a reminder to ask a question, just press star and one to get in the queue. Our next question is from Ron Mark in touch with Lomas Capital. Your line is open.

Thank you. Good afternoon, Diane and gentlemen. Two quick questions. One numbers question. Your annuity business, I think you're guiding to spreads for the balance of the year in that range of 117 to 127 bps before fair value. I think that's about 15 bps lower than what you earned this quarter and the year ago quarter. Is that yield curve, new money rate, unlocking? Can you get underneath that a little bit and see why spreads would be under pressure? And then a second question on ROE. At the outset, you mentioned your very fine 14.5% ROE. I think quick back of the envelope, that implies roughly a 21% ROE for P&C and 11% for life. Number one, is that range roughly correct? Number two, are you earning above cost of capital in both businesses? And number three, is long-term stewards of capital? Is that kind of gap or range acceptable long-term? especially as noted earlier with the accounting, the 11% is a lumpy 11%. Thank you.

So that's a lot of questions. Let me start out with how I can tell you the return on the annuity business in the first quarter was around 11%, but that is after incurring a $45 million hit related to something that really is not economic in nature. It's just the result of a decline in interest rates and discounting the embedded derivative at a lower rate. So if you make some adjustment, if you've got to normalize things, I think it gets you back to a very acceptable return on the annuity business. And as it relates to PNC returns, Jeff, you want to?

Sure. Ron, I guess just to close off on Craig's comment, if you go ahead and strip out the effect of fair value accounting in total, which is, of course, a complicated item made up of many elements, the return on capital for the annuity business after tax exceeds 15% in the quarter. So, you know, any inference that the The business is not earning its cost of capital, I think, is not correct.

And if you look at the midpoint of guidance for the year, that would result in something in the neighborhood of a 13% after-tax return unleveraged.

As for P&C, we feel like we're earning about a 15% or 16% after-tax return on a gap basis in that business. So that would be consistent with what Craig said when you roll it up for the whole company.

And in terms of decreasing spreads, a couple of things are impacting that. One thing you have to take into consideration, though, is with the lower tax rate, we don't have to earn the same interest spread to earn the targeted rate of return. A lower tax rate obviously impacts that. There are A couple of things that are impacting the cost of funds going up a little bit. We do have some federal home loan bank borrowings. Those rates have gone up a bit. The option costs are slightly higher today than they have been historically. So there are a few things that are affecting the cost of funds. But you do have to take into consideration that we don't need the same spread to earn our targeted rate of return. because tax rates are lower today.

Very detailed answers. Thank you.

Thank you. And I'm not showing any further questions in the queue. I would like to turn the call back to Diane Whitener for her final remarks.

Thank you, Carmen, and thank you all for joining us this morning. We look forward to talking with you again when we share our second quarter results.

And with that, ladies and gentlemen, we thank you for participating in today's conference. This concludes the program, and you may all disconnect. Have a wonderful day.