American Financial Group, Inc. — Q2 2010 Form 10-Q
Reporting period: Quarter and six months ended June 30, 2010. AFG is an insurance holding company focused on specialty property and casualty insurance, annuities, and supplemental insurance. Financial statement amounts below are in millions, except per-share data.
Key financial results
| Metric | Q2 2010 | Q2 2009 | First half 2010 | First half 2009 |
|---|---|---|---|---|
| Total revenues | $1,052 | $1,096 | $2,086 | $2,102 |
| Operating earnings before income taxes | $158 | $206 | $305 | $374 |
| Net earnings attributable to shareholders | $108 | $127 | $214 | $231 |
| Diluted earnings per share | $0.97 | $1.09 | $1.90 | $1.98 |
| Net cash provided by operating activities | Not presented by quarter | $461 | $492 |
- First-half investment income was $589 versus $599; realized securities gains were $15 versus a $26 loss in 2009. First-half impairment charges recognized in earnings were $37 versus $127.
- Property and casualty earned premiums were $1,151 for the first half versus $1,187. Life, accident and health premiums were $228 versus $219.
- Specialty P&C underwriting profit was $68 in Q2 and $145 for the first half, versus $112 and $217, respectively, in 2009. Aggregate combined ratios were 89.1% for Q2 and 88.4% for the first half, compared with 82.3% and 82.0%. Ratios below 100% indicate underwriting profit.
- Annuity and supplemental insurance pretax operating earnings increased $4 in Q2 and $9 for the first half from the comparable 2009 periods.
Financial position, liquidity and capital
- At June 30, total assets were $30.526 billion, total liabilities $26.095 billion, shareholders’ equity $4.285 billion, and total equity including noncontrolling interests $4.431 billion. Total assets and liabilities include newly consolidated CLO entities.
- Cash and cash equivalents were $1.011 billion, down from $1.120 billion at December 31, 2009. Cash and investments totaled $20.927 billion. First-half cash flows were $461 provided by operations, $707 used in investing, and $137 provided by financing; net cash decreased $109.
- Long-term debt was $851, up from $828 at year-end. Debt to total capital was 17.8%, versus 17.6% at year-end. AFG reported no borrowings under its $500 million revolving facility at June 30; it replaced that facility in August with a three-year $500 million credit line.
- AFG repurchased 5.6 million shares for $151 during the first half. Cash dividends were $0.275 per share for the half, compared with $0.26 in 2009.
Material changes and management commentary
- Shareholder earnings declined year over year. Management attributed the decline mainly to lower P&C underwriting profit from higher weather-related losses and lower investment income; improved annuity and supplemental results partly offset these factors.
- P&C underwriting profit was reduced by catastrophe losses of $34 in Q2, compared with $11 a year earlier. Favorable prior-year reserve development was $62 versus $80. For the first half, catastrophe losses increased $31 and favorable reserve development decreased $37 year over year.
- Management cited soft pricing, competitive pressures, depressed economic conditions, and lower spring commodity prices as factors behind lower P&C premiums. First-half average renewal rates were flat year over year.
- Beginning January 1, 2010, new accounting guidance required consolidation of six CLOs managed by AFG. At adoption, the $245 excess of CLO assets over liabilities was recorded in appropriated retained earnings, not as ordinary operating earnings. At June 30, CLO assets were $2.432 billion and liabilities $2.209 billion; AFG’s maximum ultimate economic exposure was limited to its CLO investment, valued at $11. CLO fair-value changes and losses attributable to other CLO debt holders affect reported results and comparability.
- AFG’s available-for-sale fixed maturities had fair value of $17.950 billion and gross unrealized losses of $292 at June 30. Management stated it intended and had the ability to hold securities with unrealized losses until recovery, but future impairment charges could be material. A 100-basis-point immediate rise in interest rates was estimated to reduce fixed-maturity fair value by $843, or 4.6%.
Outlook, risks and unusual items
- The filing provides no specific earnings or revenue guidance. Management’s forward-looking statements are subject to economic and interest-rate conditions, securities-market performance, credit quality, catastrophe losses, reserve development, reinsurance availability and collectability, regulation, litigation, competition, and policyholder behavior.
- AFG completed an internal review of asbestos and environmental exposures in Q2, increasing reserves by $8. P&C asbestos and environmental reserves were $360 net of reinsurance at June 30. Management reported no newly identified trends it believed significantly affected overall reserve adequacy; insurance reserves and former railroad and manufacturing exposures remain key areas of estimation risk.
- AFG reported a favorable federal court judgment in an IRS dispute concerning tax reserves, but the Government could appeal. If effectively settled, open tax years could reduce unrecognized tax benefits by up to $36 and related accrued interest by $11; these amounts exclude $17 previously paid to the IRS.
- On July 1, subsidiary National Interstate completed the $128 cash acquisition of Vanliner Group, funded with cash and bank-facility borrowings. Vanliner wrote approximately $104 of gross premiums in 2009; its results will be included beginning in the September 2010 financial statements.
- AFG was negotiating a reinsurance transaction for certain runoff automotive lines that, if completed, would reduce Q3 P&C net written premiums by approximately $105. AFG also expected potential pretax gains aggregating approximately $25 from real estate sales and a lease termination; completion was not assured.
Most important facts for investors to verify
- Whether P&C catastrophe losses, reserve development, and pricing conditions continue to pressure underwriting results.
- The quality and valuation sensitivity of mortgage-backed and other investment holdings, and any subsequent impairment charges.
- The effects of CLO consolidation on reported earnings, equity, and comparability, including the distinction between AFG-attributable results and noncontrolling-interest losses.
- Completion and financial impact of the Vanliner acquisition, proposed reinsurance transaction, and expected real estate and lease-related gains.
- Developments in asbestos/environmental reserves and the IRS case, including any appeal or final settlement.