American Financial Group, Inc. — Q3 2019 Form 10-Q
Reporting period: Quarter and nine months ended September 30, 2019. AFG operates primarily in specialty property and casualty insurance and annuities. Dollar amounts are in millions unless stated otherwise.
Financial performance
| Metric | Q3 2019 | Q3 2018 | Nine months 2019 | Nine months 2018 |
|---|---|---|---|---|
| Total revenue | $2,123 | $2,008 | $6,107 | $5,460 |
| Earnings before income taxes | $177 | $244 | $849 | $678 |
| Net earnings attributable to shareholders | $147 | $204 | $686 | $559 |
| Diluted EPS | $1.62 | $2.26 | $7.55 | $6.17 |
| Core net operating earnings (non-GAAP) | $205 | $198 | $581 | $602 |
| Net investment income | $588 | $527 | $1,710 | $1,552 |
Q3 shareholder earnings fell 28%, chiefly reflecting realized securities losses versus gains a year earlier and weaker GAAP annuity results. Nine-month shareholder earnings rose 23%, substantially reflecting $222 million of realized securities gains versus $28 million of losses in 2018. Those results include equity-security fair-value changes. Core earnings were $2.25 per diluted share in Q3 and $6.39 for the nine-month period; management noted that comparisons are affected by its revised treatment of annuity-related market and assumption changes as non-core items beginning in Q2 2019.
Business performance and margins
- Property and casualty: Q3 net earned premiums increased 9% to $1,442 million; gross written premiums increased 12% to $2,351 million. Core pretax earnings rose 21% to $190 million, supported by underwriting and investment income. Specialty combined ratio improved to 94.0% from 95.7%; the aggregate ratio, including exited lines, improved to 96.3% from 97.2%.
- For nine months, P&C net earned premiums rose 6% to $3,815 million and core pretax earnings rose 5% to $546 million. Aggregate combined ratio was 94.7%, versus 94.4%; specialty was 93.8% in both periods. P&C underwriting profit was $200 million, compared with $201 million.
- Annuities: Q3 GAAP pretax earnings declined 38% to $73 million; nine-month earnings fell 31% to $234 million. Core pretax earnings were down 15% for Q3 and 14% for nine months. Lower investment yields, higher renewal option costs and interest-rate-sensitive FIA accounting affected results. Nine-month statutory annuity premiums declined 3% to $3,821 million; Q3 premiums fell 22% to $1,077 million.
- Fixed-annuity net interest spread decreased to 1.97% in Q3 from 2.08%, and to 2.02% for nine months from 2.22%. Overall net spread earned was 0.78% in Q3 and 0.83% for nine months. AFG said it expects net interest spread to narrow as newer products can be profitable at lower spreads.
Cash flow, financial position and liquidity
- Nine-month operating cash flow was $1,691 million, investing cash outflow $1,778 million, and financing cash inflow $1,265 million. Cash increased $1,178 million to $2,693 million. Operating cash flow excluding managed investment entity effects was $1.69 billion, up $520 million from the comparable period.
- At September 30, total assets were $69,067 million, total liabilities $62,746 million and shareholders’ equity $6,321 million. Cash and investments totaled $54,207 million. Available-for-sale fixed maturities had fair value of $45,503 million.
- Long-term debt carrying value was $1,423 million ($1,443 million principal). Debt to total capital was 21.2%, or 14.9% excluding subordinated debt. No scheduled principal payments were due in the balance of 2019 or the following five years. A $500 million revolving facility had no borrowings; it expires in June 2021.
- Annuity benefits accumulated were $39,651 million, up from $36,616 million at year-end 2018. The annuity subsidiary had $1.1 billion of Federal Home Loan Bank advances, with $350 million of estimated additional borrowing capacity.
- AFG paid a $1.50-per-share special dividend in May and, after quarter-end, declared a further $1.80-per-share special dividend, approximately $160 million in total.
Management commentary, risks and unusual items
- Management attributed premium growth partly to renewal pricing: overall P&C renewal rates rose approximately 3% in Q3 and 3% for the first nine months; excluding workers’ compensation, increases were approximately 6% and 5%, respectively.
- AFG recorded $29 million of Q3 pretax special asbestos and environmental charges: $18 million in P&C reserves and $11 million for former railroad and manufacturing exposures. P&C A&E reserves were $389 million net of reinsurance. Management identified reserve adequacy and former railroad/manufacturing contingencies as key areas of risk.
- AFG reported $46 million of P&C catastrophe losses for the first nine months, primarily from storms, Hurricane Dorian and Tropical Storm Imelda. It reported $134 million of favorable prior-year reserve development in Specialty operations, partly offset by adverse development in exited lines and A&E charges.
- The company’s investment portfolio is exposed to interest rates, credit, market values and mortgage prepayments. AFG estimated an immediate 100-basis-point rate increase would reduce fixed-maturity fair value by $2.052 billion and after-tax AOCI by approximately $910 million, after estimated offsets.
- Approximately 7% of fair-value assets were Level 3; management used significant unobservable inputs for some valuations. AFG’s maximum economic exposure to its managed CLOs was limited to its $179 million investment, but the consolidated CLO assets and liabilities appear separately on the balance sheet and are nonrecourse to AFG.
- Management cited potential risks from reserve revisions, reinsurer collectability, catastrophes, interest rates and equity markets, credit deterioration, competition, regulation, and cyber or technology disruptions. No specific earnings guidance was provided in the supplied filing text.
Important facts for investors to verify
- How much of earnings and EPS reflects recurring operating performance versus realized equity-security gains/losses and annuity fair-value and actuarial effects.
- Whether annuity investment yields, option costs, sales and net spreads continue to pressure segment profitability.
- Whether P&C favorable reserve development persists and whether A&E and exited-line reserve estimates require further increases.
- Investment portfolio credit quality, Level 3 valuation assumptions, and sensitivity to interest rates and market movements.
- Liquidity and capital implications of policyholder flows, FHLB advances, debt, and the declared special dividend.