American Financial Group, Inc. — Q1 2018 Form 10-Q
Business context and period: AFG is an insurance holding company focused primarily on specialty property and casualty insurance and fixed and fixed-indexed annuities. This unaudited report covers the three months ended March 31, 2018; comparisons are with Q1 2017 unless stated otherwise. Amounts are in millions except per-share data and ratios.
Key financial results
| Metric | Q1 2018 | Q1 2017 / prior date |
|---|---|---|
| Total revenues | $1,619 | $1,576 |
| Earnings before income taxes | $174 | $223 |
| Net earnings attributable to shareholders | $145 | $153 |
| Diluted EPS | $1.60 | $1.72 |
| Core net operating earnings (non-GAAP) | $219; $2.42 per diluted share | $151; $1.69 per diluted share |
| Net cash from operating activities | $391 | $(76) |
| Cash and cash equivalents | $1,659 at March 31 | $2,338 at December 31, 2017 |
| Total assets / shareholders’ equity | $60,656 / $5,183 at March 31 | $60,658 / $5,330 at December 31, 2017 |
| Long-term debt | $1,301 carrying value; $1,318 principal | Unchanged from December 31, 2017 |
AFG reported net cash used in investing activities of $1,656 and net cash provided by financing activities of $586; cash declined by $679 during the quarter. Operating cash flow included $31 from managed investment entities (CLOs); excluding that activity, operating cash flow was $360 versus $411 in Q1 2017. AFG had no borrowings under its $500 revolving credit facility, which expires in June 2021.
Material changes and segment performance
- Reported earnings fell despite stronger underlying results. GAAP net earnings declined $8, primarily because realized securities results swung to a $93 loss from a $3 gain. The 2018 loss chiefly reflected the new requirement to recognize equity-security fair-value changes in earnings; the company reported a $94 loss on equity securities still held at quarter-end. Core net operating earnings rose $68.
- Property and casualty: Pretax earnings increased to $184 from $171. Net earned premiums rose 8% to $1,107; gross written premiums rose 10% to $1,458. The aggregate combined ratio improved to 91.8% from 92.3% (below 100% indicates underwriting profit). Favorable prior-year reserve development was $56, compared with $28 in Q1 2017; current-quarter catastrophe losses were $13.
- Annuities: Pretax earnings increased 30% to $125. Net investment income rose 14% to $394, and the fixed-annuity net spread earned improved to 1.54% from 1.28%. Statutory annuity premiums fell 11% year over year to $1,148, but were up 26% from Q4 2017.
- Other and holding company: Pretax loss excluding realized securities results narrowed to $42 from $47, reflecting lower holding-company expenses and interest costs, partly offset by higher run-off life and health benefits.
The effective income tax rate was 19%, down from 30%, reflecting the 21% U.S. corporate statutory rate effective in 2018 and other tax items. AFG adopted new equity-security accounting guidance on January 1, 2018, reclassifying a $221 net unrealized gain from accumulated other comprehensive income to retained earnings at adoption. The change moved subsequent equity holding gains and losses into earnings.
Liquidity, capital and balance-sheet items
- Debt to total capital was 21.4% including subordinated debt and 16.5% excluding it. No scheduled principal payments were due for the remainder of 2018 or the following five years.
- AFG declared a $1.50 per-share special cash dividend in May 2018, payable May 25 to shareholders of record May 15; the aggregate payment was expected to be approximately $133.
- Accumulated other comprehensive income declined to $305 from $813 at year-end, primarily reflecting market-related unrealized losses on securities. Management estimated that an immediate 100-basis-point increase in interest rates would reduce after-tax AOCI by approximately $959.
- AFG’s fixed maturities were approximately 89% investment grade. It reported $263 of gross unrealized losses on fixed maturities and stated it intended and was able to hold the affected securities until recovery; impairment could nevertheless result if circumstances or intent change.
Outlook, commentary and risks
AFG provided no specific consolidated earnings or revenue guidance in the supplied filing text. Management noted that the annuity business’s net interest spread is expected to narrow in the future, although newer products can achieve desired profitability at lower spreads. Annuity earnings also remain sensitive to interest rates, equity markets, option costs and policyholder behavior; derivative fair-value accounting can create period-to-period volatility that management says may not reflect long-term product economics.
Key risks include insurance-reserve estimates, particularly asbestos, environmental and mass-tort claims; reinsurance recoverability and availability; catastrophe and severe-weather losses; investment valuation, credit quality and interest-rate movements; annuity persistency and mortality; and regulatory, tax and accounting changes. Management said there had been no significant changes to previously disclosed contingencies. It considered the provisional tax accounting for certain Tax Cuts and Jobs Act transition items subject to further clarification. The Fifth Circuit had issued a decision vacating the Department of Labor Fiduciary Rule; AFG described related regulatory developments and said proposed SEC conduct rules were not expected to materially affect premiums based on its initial assessment.
Management concluded disclosure controls were effective and reported no material change in internal control over financial reporting during the quarter. AFG reported no common-stock repurchases during Q1 2018; 4,132,838 shares remained authorized for repurchase.
Most important facts for investors to verify
- Whether the $219 of core net operating earnings and the $74 after-tax impact of realized securities losses are useful indicators of ongoing performance, given the accounting change and market-driven equity losses.
- The sustainability of the 91.8% P&C combined ratio and $56 of favorable prior-year reserve development, including catastrophe exposure and reserve adequacy.
- Whether annuity spread gains persist amid lower reinvestment yields, expected spread narrowing, changing sales volumes and derivative valuation volatility.
- The quality and liquidity of the investment portfolio, including unrealized losses, fair-value estimates and sensitivity to interest rates and credit deterioration.
- Parent and insurance-subsidiary capacity to meet obligations and fund dividends, including the announced special dividend and the annuity business’s FHLB advances.