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Executives

Keith Jensen - Senior Vice President

Carl Lindner III - Co-Chief Executive Officer

Craig Lindner - Co-Chief Executive Officer

Analysts

Amit Kumar - Macquarie

Ron Bobman - Capital Return

Jay Cohen - Bank of America/Merrill Lynch

American Financial Group, Inc. (AFG) Q4 2009 Earnings Call February 10, 2010 11:30 AM ET

Operator

Good morning. My name is [Sandrow] and I will be your conference operator today. At this time, I would like to welcome everyone to the American Financial Group 2009 fourth quarter earnings conference call. All lines have been placed on mute to prevent any background noise. After the speakers’ remarks there will be a question-and-answer session. (Operator instructions) Thank you.

Now, I’d like to turn the conference over to Keith Jensen, Senior Vice President of American Financial Group; please go ahead.

Keith Jensen

Thank you, good morning. I’m here with Craig Lindner and Carl Lindner III, Co-CEO’s of American Financial Group. We’re please to welcome you to American Financial Group’s 2009 fourth quarter earnings results conference call. If you are viewing the webcast from our website, you can follow along with the slide presentation if you’d like.

Certain statements made during this call are not historical facts and maybe considered forward-looking statements and are based on estimates, assumptions and projections, which management believes are reasonable, but by their nature, subject to risks and uncertainties.

The factors that could cause actual results or financial conditions to differ materially from those suggested by such forward-looking statements include, but are not limited to those discussed or identified from time-to-time in AFG’s filings with the Securities and Exchange Commission, including our Annual Report on Form 10-K and Quarterly Reports on Form 10-Q.

We do not promise to update such forward-looking statements to reflect actual results or changes in assumptions or other factors that could affect these statements. Core net operating earnings is a non-GAAP financial measure, which sets aside items that are generally not considered to be part of ongoing operations, such as net realized gains and losses on investments, the effects of accounting changes, discontinued operations, significant asbestos and environmental charges and other non-recurring items.

AFG believes this non-GAAP measure to be a useful tool for analysts and investors in analyzing the ongoing operating trends and will be discussed for various periods during this call. A reconciliation of net earnings attributable to shareholders to core net operating earnings is included in our earnings release.

Now, I’m pleased to turn the call over to Carl Lindner III, Co-Chief Executive Officer of American Financial Group to discuss our results.

Carl Lindner III

Good morning and thank you for joining us. We released our 2009 fourth quarter results yesterday afternoon. AFG has continued to post excellent operating results even as we are faced with soft pricing, increased commercial demand resulting from the depressed economy and fluctuations in investment valuations.

I am please to report that for the full year in 2009, our business has set new records by generating $493 million or $4.23 per share in core net operating earnings and $519 million or $4.45 per share in net earnings attributable to shareholders. The depth and breadth of AFG’s specialty insurance expertise has enabled us to deliver high caliber service to our policyholders and agents and produce long term value for shareholders.

Craig and I want to thank god for his blessing and thank our talented management team and employees for their efforts and contributions this year. I’m assuming that the participants on today’s call who have reviewed our earnings release and supplemental materials posted on our website.

I’ll review a few highlights and focus today’s discussion on key issues and our outlook for 2010. Let’s start by looking at our 2009 fourth quarter and full year results summarized on slides three through five of the webcast. Our fourth quarter core net operating earnings were $1.04 per share, the same as those in the prior year period. Full year core net operating results were up 4% over the 2008 period. The 2009 periods reflect improved underwriting results in our specialty property and casualty operations.

Our net earnings of $1.38 per share for the 2009 fourth quarter and $4.45 per share for the full year were also substantially higher than the 2008 periods, primarily because of net realized gains on investments. During the fourth quarter, we recorded an after-tax realized gain of $49 million or $0.42 per share on the sale of a portion of our holdings in connection with the IPO of risk analytics.

We’re very pleased with our returns on this investment and continue to hold approximately $6.7 million shares of Class B common with a cost basis of approximately $24 million. Class B shares are convertible into Class A shares on a share-per-share basis after the expiration of holding periods. The Class A shares had a market value of $186 million at Monday’s closing price.

Return on equity for 2009 was approximately 17% and an annualized average return on equity over a five year period was 12%, both measures include realized gains and losses. One of our important strategic objectives that deploy our excess capital on a way that enhances shareholder value, to that end, we purchased $3.3 million shares of our common stock at an average price at $24.62 per share during the 2009 fourth quarter.

We’ve also repurchased an additional $1.7 million shares through February eighth bringing total repurchases since October the $5 million shares and an average price of $24.79. We believe the purchase of shares the low book value is an appropriate means of increasing shareholders value.

As you’ll see on slide four, AFG’s book value per share including all unrealized gains and losses on investments increased to $33.35 as a result of strong earnings performance, a significant improvement in the market value of our investment portfolio, and a share repurchase activity. This represents an increase of 55% from the $21.54 per share reported at the end of 2008.

Tangible book value was $30.99 at December 31, 2009, up 63% from year end 2008. Our capital adequacy, financial condition and liquidity remain strong and our key areas of focus especially in these times of economic uncertainty. We’ve maintained capitals in our insurance businesses at level that support our operations are consistent with amounts required for our rating levels.

We’ve spoken often about keeping some powder dry and I believe that our management team has honored that philosophy in a manner that has allowed to us manage our business cautiously yet opportunistically. At the end of the year, available cash at the parent company was approximately $200 million with excess capital more than $450 million.

We anticipate continuing to generate additional capital and cash through operations during this year. Our cash and cash equivalence of $900 million and our insurance companies long with our Annuity Groups membership and our Federal Home Loan Bank of Cincinnati provide us with liquidity to meet any unexpected events.

Now turning to slide six, you’ll see summary results of our specialty property and casualty operations. Overall underwriting profits in the 2009 fourth quarter were excellent, generating a combined ratio of 84% of three point improvement over fourth quarter 2008. The largest components of this improvement included record profitability in our crop insurance operations resulting from attractive crop yields and relatively stable commodity prices.

Additionally favorable trends and used car sales prices resulted in a reversal of loss reserves and runoff, automobile residual value insurance operations. These improved results were partially offset by reduced underwriting results and Marketform’s Italian medical malpractice business and several of our other businesses. We’re satisfied with the overall property and casualty accident year return which is in the high teens.

We continue to focus on pricing our business to achieve appropriate returns. We simply won’t write business that won’t generate appropriate returns and as evidenced by reductions in top line growth in some lines. We know we’ll see the results of today’s pricing decisions for years to come and believe our disciplined approach will allow us to provide quality products to our insurers at competitive rates.

The average renewal rates and the specialty operations during 2009 were flat compared to the prior year. The decreases in net written premiums for the 2009 periods were primarily the result of our decision to exit certain automotive related lines of business as well as changes in our reinsurance for the crop business and lower crop prices. We have an agreement under which we seated 90% of our net premium as compared to 50% in 2008.

In 2010, we’ll return to the prior level of sessions. The related profit sharing component allows us to benefit from the favorable results in this business. As I mentioned, soft market conditions and planned volume reductions in certain product lines also contributed to the premium declines. If you exclude our crop operations, the overall decrease in net written premium for the 2009 fourth quarter was about 12% and 10% for the year.

Gross investment income related to our property and casualty operations was down approximately 8% for the quarter when compared to the same period last year. Primarily as a result of decreased holdings and higher yielding investments and generally lower reinvestment rates.

Now, I’d like to discuss a few highlights from each of our specialty business groups on slide seven and eight. Property and transportation group generated excellent underwriting results during the fourth quarter, full year 2009. Higher underwriting profits in both periods were driven primarily by a record profitability in our crop operations. In addition, catastrophe losses in the property and inland marine operations were significantly lower for the year.

The Risk Management Agency and The Federal Crop Insurance Corporation issued the first draft of the 2011 Standard Reinsurance Agreement commonly called the SRA in December of last year. Comment period closed in mid-January and a second draft is expected within the next several weeks.

The current draft of the SRA includes several proposed changes to reduce revenue to participating insurers. The fist policy covered by the new SRA terms will be effective July 1, 2010. So we’ll have one more calendar year of business subject to the current SRA terms. Regardless of the outcome, we ultimately need to adjust our business model to align delivery costs with underwriting margins. At this point, we’re early in the process and we’ll know more as the 2011 SRA is finalized.

Our Specialty Casualty group, posted an underwriting loss for the fourth quarter of 2009, primarily due to $48 million in adverse development recorded in Marketform’s Italian public hospital, medical malpractice business for 2008 and prior years, which Marketform has ceased writing. Approximately, one-third of this adverse development is offset by the portion of such losses attributable to non-controlling shareholders of Marketform. Excluding Marketform’s losses, the group had a combined ratio of 98% for the quarter.

Other businesses in this group, such as our specialty human services and strategic comp operations produced excellent underwriting profit margins, but these results were more than offset by lower underwriting profits in our excess and surplus lines and general liability operations and a higher accident year losses in a book of program business. This group produced a solid underwriting profit for the year, but at a lower level in 2008.

Average renewal rates for 2009 were flat compared to 2008. Moving on to the Specialty Financial group, they reported excellent underwriting profits for the fourth quarter and full year of 2009, a meaningful improvement over 2008 results. These improvements were driven by improved results in our runoff RBI business, where we recorded an additional $21 million of favorable development during the fourth quarter and $90 million for the year as a result of significant improvement in used car sales prices during 2009.

Earlier in 2009, AFG made a decision to exit certain automotive related lines of business, which along with the impact of the economy on sales of other auto related products contributed to declines in gross and net written premiums in this group. Average renewal rates for this group were up about 3% in 2009.

Our California Worker’s Comp business reported a $2 million underwriting gain for the fourth quarter and a small underwriting loss for the full year of 2009. AFG’s republic indemnity subsidiary filed for an 8% rate increase, effective January 1, 2010. In addition to the blended 8% rate increase filed last year, effective July 1, 2009.

Underwriting results continue to be affected by low are prices in a competitive environment. 2009 accident year combined ratio was a 112% compared to 94% in 2008. We firmly believe, that more rates is needed to achieve appropriate returns, especially as we’re seeing some increases in severity trends in this business primarily related to increases in medical costs. On a more encouraging note, our average renewal rates in California were up 9% for the quarter.

Now I’d like to move on to review of our Annuity and Supplemental Insurance Group on slide nine. Annuity and Supplemental Insurance Group generated pre-tax core operating earnings for the fourth quarter of 2009 that were approximately $3 million lower than the comparable period in 2008. Results for the fourth quarter include a $13 million pre-tax write-off of deferred acq costs related primarily to our fixed annuity business.

We recorded similar DAC write-offs in 2008 related primarily to the variable annuity business. These charges were recorded in connection with their review of major actuarial assumptions, including management’s expectation of investment yields.

Full year pre-tax core operating earnings in 2009 were $4 million, higher than 200 results. Increased spreads in our fixed annuity lines in the first half of 2009 and improved results in our variable annuity operations were partially offset by lower results in the long term care segment of our supplemental insurance operations. We continue to experience strong persistency in our annuity business.

During 2009, surrenders on our fixed annuity block were 14% lower than last year as many of our annuities are designed with surrender protection features. We continued to move toward product designs that reward policyholders and agents for long term persistency. We do believe the focus on healthcare reform and Medicaid cost reductions could expand demand for supplemental health products.

Statutory premiums for the fourth quarter of 2009 were down slightly from those in the fourth quarter 2008, as increased sales of traditional fixed annuities were more than offset by lower indexed annuity sales and lower sales through the bank distribution channel. The decrease in premium is consistent with our strategy of exercising financial discipline and the pricing of our annuity products.

Now please turn to slide 10 for a few highlights regarding our investment portfolio. During the fourth quarter of 2009, we recorded after-tax realized gains on investments of $40 million including the gain on a saleable portion of our risk investment mentioned earlier. This gain was partially offset by the net effect of impairments in gains on sales of other investments.

After-tax unrealized gains were $166 million at December 31, 2009. This number reflects a pre-tax unrealized gain on fixed maturities of $93 million. The vast majority of our portfolio is held in fixed maturities with approximately 92% being rated investment grade and 95% with a designation of NAIC 1 or 2. We have provided additional detailed information on the various segments of our investment portfolio in the investment supplement on our website.

Now I’d like to cover our outlook for 2010 on slides 11 and 12. We announced yesterday that, we increased our 2010 core net operating earnings to be in the range of $3.30 to $3.70 per share. Key assumptions factored into our 2010 guidance, include less favorable reserve development than we recorded in 2009. Underwriting profits in our crop operations, they were expected to be lower than the record results produced in 2009. A continued soft P&C market and lower investment returns.

During 2009, we enjoyed the benefits of higher investment returns particularly in our property and casualty business due to opportunistic purchases of investments. For 2010, we expect the investment returns in our property and casualty business to be approximately $70 million lower than 2009 results, primarily due to the sale and runoff of higher yielding non-agency residential mortgage backed securities and generally lower reinvestment rates.

We expect to maintain adequate rates in our specialty property and casualty operations, because of our strong underwriting culture and expect to achieve a combined ratio of about 88% to 91%. That said we’re targeting modest increases and overall average renewal rates in 2010 due to competitive conditions in certain markets. We expect net written premiums in our specialty property and casualty operations to be up 10% to 12%, as we return to historical levels of reinsurance sessions under our crop quota share agreement.

The property and transportation group is expected to maintain its excellent underwriting track record for the combined ratio in the 84% to 88% range. Guidance assumes accident year crop earnings at a more normal run rate, therefore lower than our record 2009 results. We expect this group’s net written premiums to increase by approximately 25% to 30%, primarily as a result of higher retention in our crop operations.

In 2010, we plan to include our California worker’s comp results with our specialty casualty group results due to the decreasing size of this book of business. We expect the combined specialty casualty group to generate strong underwriting profit with the combined ratio in the 91% to 95% range. We anticipate net written premiums will be flat to up 3% and we look for the specialty financial groups combined ratio between 55% and 88%. We project net written premiums to be down 4% to 6%, due primarily to our exit from additional auto related businesses.

Based on recent market conditions and trends, we expect 2010, full year core pre-tax operating earnings in annuity and supplemental insurance group to be 10% to 15% higher than in 2009. These 2010 expected results exclude the potential for significant catastrophe and crop losses, significant adjustments to asbestos and environmental reserves and large gains or losses from asset sales or impairments.

Thank you. Now, we’d lake to open the lines for any questions.

Question-and-Answer Session

Operator

(Operator Instructions) Your first question comes from Amit Kumar - Macquarie.

Amit Kumar - Macquarie

Just maybe let’s start with the crop book. Can you just give us what annual adjustment was in Q4, which reduced expenses?

Craig Lindner

I was decreased by virtue of the 2008 act by 2.5%. I don’t know if that’s what you’re looking for Amit?

Amit Kumar - Macquarie

Yes, can you sort of give an absolute dollar number, which obviously the expense ratio to 5.3%?

Craig Lindner

I don’t have the absolute number with me on A&O specifically.

Amit Kumar - Macquarie

Its okay, maybe I can circle back on that. Just staying on the crop book and obviously, we’ve heard, and read, and talked about the changes to the SRA. Simplistically, can you give us your viewpoint regarding the proposed annual reduction, maybe refresh us as to what funds you are in, the state groups and the crops, and if we were to look at the SRA draft as of today, what would be a possible EPS impact on a normalized basis?

Craig Lindner

I think that generally with what is initially proposed and what ends up being reality is so much different. We’ve been hard at work along with the industry really trying to hash out, the industry’s response and try to hash out what might be the final forum that we’re going to see in a couple weeks.

Maybe in a few weeks, we might be able to give you a little bit better clarity, as we understand exactly what the changes are going to be in that. I guess Keith, if you were to take a crack in the existing field, the way that’s proposed initial and probably wouldn’t impact us by 25%?

Keith Jensen

25% to 30%, I think.

Craig Lindner

We don’t expect that to be the final result. Generally, the industry hashes through things, and usually there are some compromises that are made, but we’ll see.

Amit Kumar - Macquarie

Directionally, do you see those compromises happening at this time? Because I know if you go back and look at the earlier draft, the final thing was very different, but just based on the climate this time around, do you think that you would be able to make meaningful headway in sort of producing some of these numbers or where do you stand on that?

Craig Lindner

I would think so and there are things that we can also do within our business though.

Amit Kumar - Macquarie

What would those be?

Keith Jensen

Let me go back. Commissions would be a major thing that we’d look at. That’s one of the things that the industry has been providing input as the people in Washington are working through the bill.

I guess the other observation, I’d make that makes me optimistic that there will be improvement is that. This would be, if it was carried out exactly as drafted would be a fairly significant hit into an area where the national interest in terms of farm policy would tend to want to moderate it. There’s clearly going to be some adjustment, but they can’t make it so draconian that they dramatically affect the economic of the farmers.

Amit Kumar - Macquarie

Maybe I’ll take this offline. I guess just moving on, can you maybe just talk about the Marketform, Italian med mal adverse development, honestly I was a bit surprised just based at least on the broader med mal trends. Was there something specific going on in that hospital book, which resulted in this? Is that development now sort of at the fully policy limits? Maybe just give a bet more color on this?

Keith Jensen

Sure. I’d be happy to. This was focused, as you said in the public hospital arena. The majority of the issues seem to be around the birthing site, the work is done as babies are born and some of the issues that arose. We also had an issue with one TPA that was not performing and doing adequate reviews of potential claims and making initial claims adjustments.

In connection with a closeout of a year of account we had actual review by a third party actuary, went in as they examined it found a number of issues that are being worked on. We terminated the contract with that administrator because they were proposing a significant issue.

Another thing I’d point out, Amit, is the number $48 million is what’s embedded in the underwriting, but because we have minority shareholders in the agency that share in this, the net effect pre-tax to us is about $32 million. So it’s something that we’re concerned about. We continue to work aggressively on. We think that it was isolated in Italy. Our other med mal books are performing very well. This is one that we’re working to get behind us.

Amit Kumar - Macquarie

Order the size of the book as a percent of premium overall?

Keith Jensen

It’s been put into runoff so it’s zero percent of premium as we go forward.

Amit Kumar - Macquarie

What is historical basis, before this put in runoff, what percent…?

Keith Jensen

My recollection is it was about 20% of the Marketform premium.

Amit Kumar - Macquarie

So if I understand this correctly, you are saying it was a localized issue, and not sort of indicative of the entire Marketform franchise?

Craig Lindner

Correct. In fact, all of the other books of business in the Marketform franchise are performing according to our expectations and we’re really pleased with the startups. As you know, we went into Marketform, part of our objective was to take five businesses that we’ve done well in the U.S. and expand their geographic region. Those processes are going quite well.

Amit Kumar - Macquarie

Just one more question and I’ll re-queue. In terms of capital management and obviously, you have the buyback. You have the excess capital number in the slide. How do you view this going forward, in terms of making changes to the dividend payout or looking at some of the debt? I don’t think it’s imminent, but maybe just talk about what’s the broader top process here?

Carl Lindner III

This is Carl. I think, as far as plans for excess capital, capital management and that, we do want to keep some powder dry. There’s some chance that you could see interest rates move backup over this next year. We want to have appropriate flexibility both defensively and offensively to take advantage of opportunities.

Share repurchases below book value would continue to be something that we think makes a lot of sense. As you know, we’ve started up and done small to medium sized acquisitions over many years. We’re continuing to look at opportunities and we’ll continue to do that.

So I think those would be the primary approach that we’re going to take to capital management, excess capital. As far as we’ve increased our dividend, I think each of the last four years. At the end of this year, we’ll revisit that. We think that steady increases in dividends over a long period of time are meaningful to investors. So Craig and I understand that.

Amit Kumar - Macquarie

So if I understand this correctly, what’s the remainder in your buyback and is it likely that it would be expanded just based on your comment on the price to book?

Craig Lindner

Yes. Keith, I think there’s 1.5 million…?

Keith Jensen

1.1 million left.

Craig Lindner

1.1 million left and we have a Board meeting tomorrow and we’re going to be asking whether it to be an additional 5 million shares authorized to repurchase.

Operator

Your next question comes from Ron Bobman - Capital Return.

Ron Bobman - Capital Return

I’m not familiar with the Cincinnati, you have time zone relative to the East Coast. I had a question about Marketform as well. I was wondering it sounded like I think it was Carl’s comment. It’s really sort of aside from the Italian med mal book, there’s no other change to the underwriting guidelines that you’re employing. I think, you said that just for the…?

Keith Jensen

That’s correct.

Ron Bobman - Capital Return

Are the losses that are coming through from that book going to cause any complications or problems to close out, I’m not sure what year it would have been closed out, ‘06 or ‘07 for the syndicate. Is that going to be a problem at all or no?

Keith Jensen

‘07 is the year in question, and that call needs to be made by the end of this month and so we’ll be working that through over the next two or three weeks and making a final decision.

Ron Bobman - Capital Return

Then Carl, you mentioned the plan with Marketform was to sort of use it as an on-tray or vehicle to sort of replicate some of the specialty lines that you write in the U.S. and for the most part, my impression is that you sort of have the localized approach to underwriting whether it be workers comp concentrating in California, crop in certain parts of the country and presumably you have sort of localized operations.

The Marketform vehicle sort of underwriting from London insurance across Continental Europe is a bit of a departure from that. Is that not the case or…?

Carl Lindner III

Well, we’ve hired some really top local talent that understands those markets. So I don’t think it’s really a departure from what our philosophy is. We’ve in the area Specie and Equine, and Ocean Marine, some of the lines that we want to expand off the Marketform platform.

We’ve hired some highly talented individuals that have worked in and looked at business in those markets for a long time. We’ve had good success here this past year. We probably expect to add, I don’t know probably expect to write, Keith, $50 million to $70 million this year of the four, five expansion lines that we’ve set out and so far, we think the loss experience looks about as expected.

Ron Bobman - Capital Return

Marketform, I thought used to write a little over $100 million of premium. Is it dropping down or are you just set highlighting a couple subsets of the $100 million?

Craig Lindner

What he just said is additive to what the current…

Operator

Your next question comes from Jay Cohen - Bank of America/Merrill Lynch.

Jay Cohen - Bank of America/Merrill Lynch

Three topics, at first maybe a quick one, we’ll start with Verisk. After your required holding period is up, will you be marking that position to market?

Keith Jensen

Jay, we’re actually marking it to market now. As we would any secured it, we’ll run that gain loss on sale of investments at the point, if it comes we dispose of any of the shares, but at this point, we’re marking to market.

Jay Cohen - Bank of America/Merrill Lynch

So that unrealized gain is in your book value already?

Keith Jensen

That’s correct. Just be aware that in the market we’re cognizant of the fact that what we hold is not immediately saleable, so we’ve taken a slight discount to what the currently trading shares are, but it’s less than 10% discount.

Jay Cohen - Bank of America/Merrill Lynch

Then just to follow-up on the casualty business, first on Marketform. Where in your P&L is that offset related to I guess the minority interest in Marketforms?

Keith Jensen

Compare with any earnings attributable to non-controlling shareholders your old minority interest.

Jay Cohen - Bank of America/Merrill Lynch

Last question this is surplus, was your statutory surplus helped it all by the change in accounting regarding valuing mortgage securities on a statutory basis?

Craig Lindner

Yes, it was, by a number that is approaching $200 million.

Jay Cohen - Bank of America/Merrill Lynch

That’s total for the company property casualty and life?

Craig Lindner

That’s correct. Biggest part of it on the life side, because of the portfolio was much bigger there.

Operator

Your next question comes from Amit Kumar - Macquarie.

Amit Kumar - Macquarie

Just maybe follow up cleanup questions. In terms of the adverse development, there was some other adverse development apart from Italian med mal. Can you just sort of expand on that a bit?

Craig Lindner

The adverse development, as you said, Italian med mal was certainly a part of it. We had some modest amounts. I’m just looking down my list here to see, if there’s anything else that the largest other was less than $3 million. So there’s a potpourri of items that went in, but a huge driver with the Italian med mal.

Amit Kumar - Macquarie

Maybe just going back to the guidance change, can you sort of talk about what incrementally changed apart from the buyback?

Carl Lindner III

I think probably plain and simple is probably the amount of share repurchase activity that we’ve had in the fourth quarter and first quarter and as the markets we’ve returned, the impact on the excess capital that we have to use this year towards additional share repurchases or acquisitions.

Amit Kumar - Macquarie

So it’s only the buyback. You’re view hasn’t changed whatsoever from the time of Q3 call to current?

Keith Jensen

During that time to be fair, Amit, we have finalized the ground up financial planning process for the next year and that didn’t drive huge changes, but there were certainly fine tunings that took place in that process.

Amit Kumar - Macquarie

Maybe I missed this. Can you just sort of talk about a bit more about investment portfolio and your plans for the new money?

Keith Jensen

We saw some extraordinary opportunities last year to invest in both mortgage backed securities as well as corporates, and frankly, the spreads on most things have tightened up fairly significantly, and recently we’ve been de-risking the portfolio. We’re investing mainly in a high grade corporates.

The non-agency residential mortgage-baked securities are running off, and frankly, the combination of this couple of things, the lower reinvestment rate and run-off of some; higher yielding paper is going to result in a decline and investment income.

Amit Kumar - Macquarie

Maybe just one final question related to that. Can you talk about what your expectations are for inflation going forward?

Carl Lindner III

We would be concerned about it over the next; if you look at over a little longer period of time and we are doing everything that we can to prepare for the day when inflation is going to rear its head I don’t think it’s going to happen anytime soon, but certainly over the next two or three years, we would expect to have higher rates.

We’re going to position the portfolio as best we can, and structure our annuity products as best we can to prepare for that day. I think the duration of our assets today is actually slightly shorter than the duration of liabilities. We’re keeping an unusually large amount of cash in the portfolios and the design of the annuity products, as I mentioned, is changing to give us added protection against a rise in rates.

Craig Lindner

I would just add a couple thoughts with respect to the property and casualty. You’ll remember the property and casualty business, the duration of reserves is about 2.5 years and the duration of the investments associated with property and casualty would be shorter than what they are in the annuity and supplemental businesses and so that plus the fact that we’re looking carefully at trends that we can adjust.

We just don’t have a huge exposure because not much of the book is long term so it turns over pretty quickly and we can stay an asset and liability perspective on a pretty similar basis.

Operator

Your final question comes from Jay Cohen - Bank of America/Merrill Lynch

Jay Cohen - Bank of America/Merrill Lynch

Just to make sure we cover this fully. The adverse development in the casualty business outside of Marketform, you said there was no major thing, but are there any trends?

I think this is a pretty sensitive issue, I think a lot of investors and analysts that are watching the development that we’ve seen are looking for any inflection points and I’m wondering if you look at this quarter and 3G is there something here that’s broadly speaking is somewhat disturbing form a clients inflation standpoint that you need to start addressing?

Carl Lindner III

I don’t, Jay. When I look at this from, an adverse development in the quarter is driven primarily by the Marketform issue, which is not an inflation indicator at all and when I look at across the year in each of the individual quarters, there have been favorable development. Of course you can’t continue with that forever, but by the same token. I don’t see anything dramatic that’s changing where we have been.

Operator

Thank you. There are no further questions at this time. I would like to hand the call back over to the floor for any closing remarks.

Keith Jensen

Thank you very much and we’d express appreciation for all of you for joining us this morning and look forward to reporting our first quarter results this year progresses. Thank you and have a good day.

Operator

Thank you, ladies and gentlemen. This does conclude today’s American Financial Group 2009 fourth quarter earnings conference call. You may now disconnect.

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