American Financial Group, Inc. — Q1 2016 Form 10-Q
Reporting period: Three months ended March 31, 2016; comparisons are with Q1 2015 unless noted. AFG is an insurance holding company focused on specialty property and casualty insurance and fixed and fixed-indexed annuities. Amounts below are in millions of dollars except per-share data and ratios.
Financial performance and position
- Revenue: Total revenue was $1,475, up from $1,297. P&C net earned premiums rose 5% to $998; net investment income increased 6% to $411.
- Earnings: Net earnings attributable to shareholders were $101, or $1.14 diluted per share, versus $19, or $0.21. The comparison is substantially affected by the $162 pretax estimated loss recorded in Q1 2015 on the subsequent sale of the long-term care business. Core net operating earnings, a company-defined non-GAAP measure, were $111 ($1.25 diluted per share), versus $112 ($1.25).
- P&C underwriting: Pretax earnings rose 22% to $162. The combined ratio improved to 91.2% from 93.7% (below 100% indicates underwriting profit); underwriting gain increased to $87 from $60. Favorable prior-year reserve development was $28, versus $7.
- Annuities: Pretax earnings declined 29% to $53. Fixed-annuity net spread earned fell to 0.74% from 1.21%, reflecting lower investment yields and more adverse fair-value effects from fixed-indexed annuity derivatives. Annuity premiums increased 58% to $1,285.
- Cash flow: Operating cash flow was $335, down from $397; investing cash outflow was $1,196, compared with $968; financing cash inflow was $872, versus $440. Cash and cash equivalents ended the quarter at $1,231, up $11 during the quarter. Financing inflows included $941 of net annuity receipts after surrenders, benefits and withdrawals.
- Balance sheet and capital: Total assets were $51,038 and total shareholders’ equity was $4,755 at March 31. Cash and investments totaled $39,437. Long-term debt was $998 carrying value ($1,020 principal); debt-to-total-capital was 18.4%, compared with 18.5% at year-end. The common dividend was $0.28 per share, versus $0.25.
- Investment portfolio: Available-for-sale fixed maturities had a fair value of $33,921; approximately 88% of fixed maturities were investment grade. Q1 realized securities losses were $18, including $52 of net impairment charges. Other comprehensive income was $146, bringing AOCI to $448.
Material changes and unusual items
- The December 2015 sale of substantially all run-off long-term care business materially changed the year-over-year comparison. AFG recorded a $162 pretax sale loss in Q1 2015; Q1 2016 no longer includes the sold subsidiaries. AFG retained a small block of about 1,700 long-term care policies, with approximately $35 of reserves.
- AFG reported $18 of realized securities losses in Q1 2016 versus $19 of gains in Q1 2015. Q1 2016 impairments included $41 on equity securities and $16 on fixed maturities, notably affecting financial institution and energy-related investments.
- AFG expects total tax benefits of $97 related to the long-term care sale. Approximately $66 was received through reduced estimated tax payments in Q1 and just over $30 through a tax refund in April 2016; remaining amounts are reflected as receivables.
- AFG repurchased 1.1 million shares for $76 in Q1 2016, compared with $31 in Q1 2015. The board authorized an additional 3 million shares for repurchase in February.
Outlook, liquidity, risks and contingencies
- The filing provides no specific consolidated earnings guidance. Management said lower yields and reinvestment of maturing higher-yielding assets are pressuring annuity investment returns and expects annuity net interest spread to narrow in the future.
- Management said the 2017 Department of Labor fiduciary rule may bring additional compliance costs and temporary annuity sales disruption during transition, but did not expect a material impact on AFG based on its analysis to date.
- AFG stated it believed parent and insurance-subsidiary liquidity were sufficient. Its $500 revolving credit facility, with no borrowings outstanding, expires in December 2016; AFG expected to replace it with a similar five-year facility. Annuity subsidiary GALIC had $935 of Federal Home Loan Bank advances and estimated about $600 of additional borrowing capacity.
- AFG proposed acquiring the remaining National Interstate shares for approximately $293 ($30 per share); the filing describes a proposal, not a completed acquisition.
- Key risks include reserve adequacy, particularly asbestos, environmental and mass-tort claims; reinsurance recoverability; investment credit and valuation risk; interest-rate and market volatility; catastrophe losses; and changes in regulation, competition, rates and policyholder behavior. The filing reported no significant change in previously disclosed contingencies.
- AFG estimated that an immediate 100-basis-point increase in interest rates would reduce fixed-maturity fair value by about $1,709 pretax and reduce AOCI by an estimated $612 after tax and other adjustments. Management also noted that fair-value accounting for fixed-indexed annuity derivatives can create earnings volatility that may not reflect the products’ long-term economics.
Important facts for investors to verify
- Whether P&C underwriting gains and favorable reserve development persist, and how reserve estimates evolve.
- Whether annuity spreads, investment yields and fixed-indexed annuity fair-value impacts improve or continue to pressure segment earnings.
- The composition, impairment outlook and valuation assumptions for securities, including Level 3 assets and energy- and financial-sector exposures.
- Progress on replacing the revolving credit facility, the proposed National Interstate acquisition, and the effects of FHLB funding and annuity cash flows.
- Receipt and final amount of sale-related tax benefits, and any material developments in legacy claims or other contingencies.