American Financial Group, Inc. — Q1 2017 Form 10-Q
Reporting period: Three months ended March 31, 2017; unaudited. AFG operates primarily in specialty property and casualty insurance and fixed and fixed-indexed annuities, with run-off long-term care and life operations and holding-company activities.
Financial performance and position
- Revenue: $1.576 billion, up 7% from $1.475 billion in Q1 2016. Net earned P&C premiums were $1.022 billion, up 2%; net investment income was $435 million, up 6%.
- Earnings: Net earnings attributable to shareholders were $153 million, or $1.72 diluted per share, versus $101 million, or $1.14, a year earlier. Core net operating earnings, a non-GAAP measure, were $151 million ($1.69 diluted per share), compared with $111 million ($1.25).
- Profitability: P&C pretax earnings were $171 million versus $162 million. The aggregate P&C combined ratio worsened to 92.3% from 91.2%, although it remained below 100%, indicating an underwriting profit. Annuity pretax earnings rose to $96 million from $53 million; fixed-annuity net spread earned was 1.28%, versus 0.74%.
- Cash flow: Operating cash flow was negative $76 million, compared with positive $408 million in Q1 2016. AFG attributed much of the year-over-year swing to managed investment entity (CLO) activity: excluding that activity, operating cash flow was $411 million versus $463 million. Investing cash outflow was $1.194 billion; financing cash inflow was $1.053 billion. Cash and equivalents fell $217 million to $1.890 billion.
- Balance sheet and liquidity: Total assets were $57.464 billion and total equity was $5.195 billion at March 31, 2017. Long-term debt had a $1.283 billion carrying value ($1.308 billion principal); the $500 million revolving credit facility was undrawn. Debt to total capital was 21.4%, including subordinated debt, and 16.5% excluding it. Insurance subsidiaries’ liquidity and capital were considered sufficient by management.
- Shareholder return: The quarterly common dividend was $0.3125 per share. On May 3, 2017, the board declared a subsequent special dividend of $1.50 per share, approximately $132 million in aggregate.
Material changes versus Q1 2016
- Shareholder net earnings increased $52 million. AFG reported $3 million of realized securities gains versus $18 million of losses in Q1 2016; core earnings also increased, led by annuity earnings and higher P&C investment income.
- P&C gross written premiums grew 7% and net written premiums grew 5%. Underwriting profit declined to $78 million from $87 million: improvement in property and transportation was more than offset by weaker specialty casualty and specialty financial results. The loss and LAE ratio increased to 59.6% from 58.2%.
- Annuity pretax earnings improved substantially, in part because Q1 2016 had an unfavorable fair-value impact from fixed-indexed annuity derivatives. AFG cautions that these derivative marks can be volatile and may not reflect the products’ long-term economics.
- Reported operating cash flow shifted from positive to negative, substantially reflecting greater CLO-related cash-flow effects. AFG reported no common-stock repurchases in Q1 2017, versus $76 million in Q1 2016.
Outlook, risks, contingencies and unusual items
- No specific consolidated earnings or revenue guidance is provided in the filing. Management expects annuity net interest spreads to narrow over time as new business and reinvestments earn lower yields than portions of the existing portfolio.
- The Department of Labor fiduciary rule’s effective date had been delayed to June 9, 2017, with certain requirements deferred until January 1, 2018. AFG expected compliance changes to affect 2017 annuity premiums, but did not expect a material effect on results; the rule’s ultimate form and timing remained uncertain.
- Key estimation risks include P&C claims reserves, particularly asbestos, environmental and mass-tort claims; reinsurance recoverability; acquisition-cost recoverability; and investment valuation and impairment judgments. Management considered reserves adequate. Prior-year P&C reserve development was favorable by $28 million in the quarter.
- Investment and market risks include interest-rate movements, credit deterioration, prepayments, and fair-value uncertainty. AFG estimated that an immediate 100-basis-point rate increase would reduce the after-tax AOCI impact by approximately $709 million, after related offsets. About 89% of fixed maturities were investment grade.
- Other notable items: a hotel sale generated $13 million of pretax income; the quarter included $3 million of net realized securities gains. AFG also recorded a $6 million charge related to a deferred gain on a 1998 retroactive reinsurance transaction. The filing reports no significant change in previously disclosed contingencies.
- Forward-looking results are exposed to catastrophe and severe-weather losses, reserve development, reinsurance availability and credit quality, interest rates and securities markets, regulation, competition, and tax or accounting changes.
Important facts for investors to verify
- Whether improved annuity earnings and core operating earnings persist after separating growth, investment performance, and fixed-indexed annuity fair-value effects.
- Future P&C loss trends and reserve development, particularly in specialty casualty and financial lines, and the effect of the higher combined ratio.
- CLO-related cash flows and consolidated CLO assets and liabilities: AFG states it has no right to use CLO assets and no obligation to pay CLO liabilities.
- Investment portfolio credit quality, unrealized losses, Level 3 valuation assumptions, and exposure to interest-rate changes.
- The final implementation and business impact of the DOL fiduciary rule, and the cash and capital effects of the declared $132 million special dividend.