American Financial Group, Inc. — FY 2011 Form 10-K
Reporting period: Year ended December 31, 2011. Although the request references 2011 Q4, this filing reports full-year results; selected fourth-quarter figures are noted below. AFG is an insurance holding company focused on specialty commercial property and casualty (P&C) insurance, fixed and indexed annuities, and supplemental insurance.
Financial performance and position
| Metric | 2011 | 2010 |
|---|---|---|
| Total revenue | $4.750 billion | $4.497 billion |
| Operating earnings before income taxes | $560 million | $689 million |
| Net earnings attributable to shareholders | $343 million; $3.33 diluted EPS | $479 million; $4.33 diluted EPS |
| Core net operating earnings, non-GAAP | $364 million; $3.53 diluted EPS | $433 million; $3.92 diluted EPS |
| Operating cash flow | $667 million | $864 million |
| Total assets | $36.042 billion | $32.454 billion |
| Shareholders’ equity | $4.545 billion | $4.470 billion |
| Long-term debt | $934 million | $952 million |
| Debt to total capital | 18.6% including real-estate debt | 18.9% |
P&C net earned premiums rose to $2.759 billion from $2.550 billion. Underwriting gain declined to $180 million from $296 million, and the GAAP combined ratio increased to 93.4% from 88.5% (below 100% indicates underwriting profit). The statutory combined ratio was 92.7%, compared with 87.3%.
Annuity and supplemental insurance pretax operating earnings, excluding realized gains and losses, increased to $224 million from $202 million. Statutory annuity premiums rose to $3.086 billion from $2.280 billion, driven chiefly by indexed and bank annuity sales. Total cash and investments were $25.577 billion. The fixed-maturity portfolio had $1.245 billion of net unrealized gains; approximately 90% was investment grade. A 100-basis-point increase in interest rates was estimated to reduce fixed-maturity fair value by $1.046 billion, or 4.7%.
At December 31, parent AFG held approximately $456 million in cash and securities and had an undrawn $500 million revolving credit facility expiring August 2013. Insurance subsidiaries’ capital ratios substantially exceeded risk-based capital requirements. The maximum insurance-subsidiary dividends available to AFG without regulatory approval in 2012 were approximately $546 million. The filing does not provide a conventional current ratio, which management says is not meaningful for its financial businesses.
Fourth-quarter 2011 revenue was $1.283 billion and net earnings attributable to shareholders were $109 million. The quarter included a $34 million charge for a deferred-tax-asset valuation allowance and $40 million of pretax realized gains from sales of Verisk shares.
Material changes versus 2010
- Revenue increased about 6%, but shareholder net earnings fell about 28% and core net operating earnings fell about 16%.
- P&C underwriting weakened: the combined ratio rose 4.9 percentage points, and underwriting gain decreased $116 million. Favorable prior-year reserve development fell to $69 million from $158 million; catastrophe losses were $46 million versus $49 million.
- AFG recorded a $50 million net special P&C charge to strengthen asbestos and environmental (A&E) reserves, following a comprehensive study. It also recorded a $9 million charge for former railroad and manufacturing exposures.
- Annuity premiums grew substantially, led by non-403(b) indexed annuities and bank sales. Investment income increased to $1.241 billion from $1.191 billion, but fixed-maturity yields excluding realized gains and losses declined to 5.7% from 6.2%.
- Operating cash flow declined by $197 million. Investing activities used $2.439 billion, while financing activities provided $1.997 billion; financing included $315 million of common-stock repurchases.
Outlook, risks, contingencies and unusual items
- No specific earnings or revenue guidance is provided. Management describes P&C market conditions as soft and prioritizes underwriting profitability over premium growth. Renewal-rate momentum was positive in specialty insurance in fourth-quarter 2011. AFG expected to use similar crop-reinsurance levels in 2012 as in 2011.
- Reserve estimates remain a major uncertainty. Net P&C unpaid losses and LAE were $6.520 billion; A&E reserves were $454 million gross and $362 million net of reinsurance. Management considers reserves adequate, but A&E outcomes are particularly difficult to estimate and may vary materially.
- Reinsurance recoverables totaled $2.942 billion on the balance sheet, including approximately $2.2 billion related to unpaid losses and LAE. AFG remains liable to policyholders if reinsurers fail to pay; collectibility and reinsurance availability are risks.
- Low interest rates can pressure annuity spreads and investment yields; rising rates may increase surrenders and depress asset values. Approximately half of annuity contracts were at, or within 10 basis points of, their guaranteed minimum crediting rate at year-end.
- Other key exposures include catastrophe and severe-weather losses, crop price and yield volatility, non-agency mortgage-backed securities, credit and market risk, competition, dependence on major bank annuity distribution partners, regulatory limits on dividends, and litigation. AFG had no sovereign debt from the European peripheral countries; total European fixed-maturity exposure was $1.189 billion.
- AFG ceased new long-term-care policy sales in 2010; net reserves were $490 million. Year-end testing showed a roughly $25 million excess of long-term-care reserves plus future premiums over projected claims costs and acquisition expenses, which could be eliminated by adverse experience.
- A 2011 accounting update for deferred policy acquisition costs, to be adopted retrospectively in 2012, would reduce reported 2011 DPAC from $1.105 billion to $901 million and reported equity from $4.545 billion to $4.412 billion on an adjusted basis. Adjusted 2011 net earnings were estimated at $342 million versus $343 million reported.
- The audited financial statements and internal-control opinion were unqualified; management and the auditor concluded internal control over financial reporting was effective as of December 31, 2011.
Most important facts for investors to verify
- Whether P&C loss trends and favorable reserve development remain sufficient to offset the higher 2011 loss ratio, catastrophe exposure and A&E reserve strengthening.
- Developments in the $454 million gross A&E reserve, former-operations contingencies, and the A.P. Green bankruptcy-plan proceedings; management expected the remand issue not to affect its settlement.
- Whether annuity growth—especially bank-channel and indexed sales—can sustain profitability amid low investment yields and concentration in three major bank sources.
- Reinsurer credit quality and recovery of the $2.942 billion balance-sheet recoverables, including the $212 million recoverable associated with the 1998 commercial-lines sale.
- The effects of retrospective DPAC accounting and the realizability of deferred tax assets, including the 2011 Marketform-related valuation allowance.
- Capital allocation and parent liquidity after $315 million of 2011 buybacks, including dividend capacity, the 2013 credit-facility expiry and any subsequent repurchases.