Business context and reporting period
American Financial Group, Inc. (AFG) is an insurance holding company focused on specialty commercial property and casualty (P&C) insurance, fixed and indexed annuities, supplemental insurance, and other businesses. This Form 10-K reports the fiscal year ended December 31, 2010; it also provides fourth-quarter results. Unless noted, amounts are U.S. dollars.
Financial performance and condition
| Metric | 2010 | 2009 | Change / context |
|---|---|---|---|
| Total revenues | $4.497 billion | $4.320 billion | Up 4% |
| Operating earnings before tax | $689 million | $812 million | Down 15% |
| Net earnings attributable to shareholders | $479 million | $519 million | Down 8%; diluted EPS was $4.33 versus $4.45 |
| Core net operating earnings | $433 million | $493 million | Down 12%; diluted core EPS was $3.92 versus $4.23 |
| Operating cash flow | $864 million | $915 million | Down $51 million |
| Cash and cash equivalents | $1.099 billion | $1.120 billion | At year-end |
| Total assets | $32.454 billion | $27.683 billion | Increase was substantially affected by newly consolidated managed investment entities |
| Long-term debt | $952 million | $828 million | Debt to total capital was 18.9%, up from 17.6% |
| Shareholders’ equity | $4.470 billion | $3.781 billion | At year-end |
P&C: Net earned premiums were $2.550 billion, up 6%. Underwriting gain fell to $296 million from $417 million; the GAAP combined ratio rose to 88.5% from 82.7% (below 100% indicates an underwriting profit). Catastrophe losses were $49 million versus $18 million, while favorable prior-year reserve development declined to $158 million from $198 million. Investment income in the P&C segment was $335 million versus $414 million.
Annuity and supplemental insurance: Segment operating earnings before tax, excluding realized gains and losses, improved to $196 million from $162 million. Statutory annuity premiums increased to $2.280 billion from $1.434 billion, driven by indexed annuity and bank-channel sales. The company recorded a $28 million deferred acquisition cost write-off following assumption updates, partly reflecting investment yields and annuitization and death benefits.
Investments and margins: Total investment income was $1.191 billion, slightly below $1.200 billion. Realized securities gains were $101 million versus $43 million, including impairment charges. Available-for-sale fixed maturities had a fair value of $19.328 billion; 91% were investment grade. Net unrealized gains on fixed maturities were $838 million pretax at year-end. Management estimated that an immediate 100-basis-point rate increase would reduce fixed-maturity fair value by about $868 million, or 4.4%.
Q4 results: Fourth-quarter revenues were $1.156 billion and shareholder-attributable net earnings were $133 million, or diluted EPS of $1.23, compared with $1.125 billion, $161 million, and $1.38, respectively, in Q4 2009. Q4 2010 included $48 million of favorable prior-year loss development and $29 million of realized securities gains.
Material changes versus prior period
- Shareholder earnings and core earnings declined as weaker P&C underwriting and lower P&C investment income outweighed improved annuity and supplemental results and higher realized gains.
- AFG’s P&C combined ratio deteriorated 5.8 percentage points, mainly reflecting higher catastrophe losses and less favorable reserve development.
- Statutory annuity premiums rose substantially, with direct and indirect bank sales contributing to growth; supplemental insurance sales continued to be reshaped, including the sale of a marketing subsidiary and reduced emphasis on career-agent distribution.
- AFG acquired Vanliner in July 2010 for a final purchase price of $114 million, expanding moving-and-storage insurance. It also ceded unearned premiums from certain exited automotive-related business.
- AFG repurchased 10.3 million shares for $292 million and raised its quarterly dividend during 2010. It issued $132 million of 7% senior notes due 2050.
- New accounting rules led AFG to consolidate six CLOs beginning in 2010. The reported balance sheet added $2.537 billion of CLO assets and $2.323 billion of CLO liabilities; the entities’ losses attributable to other debt holders reduced reported earnings attributable to noncontrolling interests. CLO assets are not available for AFG’s general use, and AFG reported maximum exposure to loss of $17 million.
Outlook, risks, contingencies and unusual items
- Management expected 2011 P&C investment income to be about 10% below 2010; annuity and supplemental investment income was expected to exceed 2010, supported by expected segment growth. These are management estimates, not earnings guidance.
- The revised 2011 federal crop-insurance reinsurance agreement was expected to reduce annual pretax operating income by approximately $20 million, assuming premium levels similar to 2010.
- Key risks include uncertain P&C reserve adequacy, asbestos and environmental claims, adverse catastrophe and crop outcomes, reinsurer collectibility, investment credit and interest-rate exposure, annuity spread pressure and policyholder behavior, competition, regulation, and access to capital.
- Net A&E reserves were $342 million, with $74 million of related net reinsurance recoverables; gross A&E reserves were $416 million. Management considers the reserves adequate but warns that actual liabilities could differ materially. A 1% change in A&E loss-cost trends was estimated to affect net income by about $16 million.
- Italian public-hospital medical-malpractice reserves at Marketform generated $55 million of adverse prior-year development in 2010; $126 million of reserves remained for this run-off business. Management described the ultimate liability as uncertain.
- Unrealized investment losses, especially in residential mortgage-backed securities, may require future impairment charges if credit conditions worsen or AFG’s ability or intent to hold securities changes. AFG reported $216 million of gross unrealized fixed-maturity losses at year-end.
- Regulatory approval limits distributions from insurance subsidiaries. Up to approximately $801 million of subsidiary dividends were available to AFG in 2011 without regulatory clearance. AFG also had a $500 million revolving credit line, with no parent borrowings outstanding at year-end.
- AFG disclosed litigation and environmental and personal-injury contingencies tied to former railroad and manufacturing operations. The A.P. Green asbestos settlement of $123.5 million was accrued, but remains subject to conditions and pending appeals concerning the reorganization plan.
Most important facts for investors to verify
- Whether P&C reserve development remains favorable and catastrophe losses, particularly crop and severe-weather losses, stay within expectations.
- How the $416 million gross A&E reserve and Marketform’s $126 million Italian medical-malpractice reserve develop, and whether reinsurance recoveries are collectible.
- Whether annuity growth can sustain segment profitability despite low investment yields, minimum crediting-rate guarantees, surrenders, and assumption changes.
- Actual 2011 effects of the crop-insurance agreement and lower expected P&C investment income.
- Changes in credit quality, impairment exposure, interest-rate sensitivity, and reported results related to the consolidated CLOs.
- Parent-company liquidity, debt costs, insurance-subsidiary dividend capacity, and the use of cash for repurchases and dividends.