American Financial Group, Inc. — Q2 2017 Form 10-Q
Business context and reporting period. AFG is an insurance holding company focused on specialty property and casualty insurance and fixed and fixed-indexed annuities, with run-off long-term care and life operations. This unaudited report covers the quarter and six months ended June 30, 2017; financial amounts are in U.S. dollars unless stated otherwise.
Financial results and position
| Metric | Q2 2017 | Q2 2016 | Six months 2017 | Six months 2016 |
|---|---|---|---|---|
| Total revenues | $1.646 billion | $1.581 billion | $3.222 billion | $3.056 billion |
| Net earnings attributable to shareholders | $145 million | $54 million | $298 million | $155 million |
| Diluted EPS | $1.61 | $0.62 | $3.32 | $1.76 |
| Core net operating earnings (non-GAAP) | $145 million | $113 million | $296 million | $224 million |
| Core diluted EPS (non-GAAP) | $1.61 | $1.28 | $3.29 | $2.53 |
| Net investment income | $460 million | $423 million | $895 million | $834 million |
- Premiums and underwriting: Q2 P&C net earned premiums rose 4% to $1.065 billion; gross written premiums increased 8% to $1.503 billion. The P&C combined ratio improved to 93.4% from 100.3%, including exited lines; Specialty combined ratio was 93.2% versus 93.9%. For the first half, P&C net earned premiums increased 3% to $2.087 billion and the aggregate combined ratio improved to 92.8% from 95.9%.
- Segment earnings: Q2 pretax P&C earnings were $163 million versus $112 million; annuity earnings were $85 million versus $76 million. First-half pretax P&C earnings were $334 million versus $274 million and annuity earnings were $181 million versus $129 million.
- Margins and investment yields: Fixed-annuity net spread earned was 1.11% in Q2 versus 1.08%, and 1.19% for the first half versus 0.91%. However, fixed-annuity net interest spread declined to 2.61% in Q2 from 2.84%, and to 2.59% for the first half from 2.69%, largely because investment yields declined. P&C investment yield was 3.86% in Q2 versus 3.76%.
- Cash flow: First-half operating cash flow was $574 million versus $496 million; investing used $1.994 billion versus $1.817 billion; financing provided $1.520 billion versus $1.649 billion. Cash and cash equivalents increased $100 million to $2.207 billion. Annuity receipts exceeded surrenders, benefits and withdrawals by $1.43 billion in both first-half periods.
- Balance sheet and capital: At June 30, cash and investments totaled $44.779 billion, total assets were $58.618 billion, total liabilities $53.306 billion, and shareholders’ equity $5.312 billion. Long-term debt carrying value was $1.405 billion ($1.428 billion principal). Debt to total capital was 22.8% including subordinated debt and 18.0% excluding it, versus 22.1% and 17.0% at year-end 2016. AFG reported no borrowings on its $500 million revolving facility.
- Dividends: AFG paid a $1.50-per-share special cash dividend in May, in addition to regular dividends; first-half cash dividends paid were $185 million. No common shares were repurchased in the first half.
Changes, outlook, risks and unusual items
- Reported earnings growth reflects stronger core results as well as comparisons with 2016 non-core items: a $65 million charge for exiting Neon business lines and a $32 million gain on sale of an apartment property. Q2 2017 also included a $7 million pretax loss on retirement of debt; first-half 2017 included a $13 million pretax gain on sale of a hotel in Q1. Realized securities results improved to an $8 million Q2 gain from a $16 million loss, and to an $11 million first-half gain from a $34 million loss.
- Favorable prior-year P&C reserve development was $23 million in Q2 and $50 million for the first half, compared with $30 million and no net development, respectively, in the comparable periods. Management identifies reserve estimates, especially asbestos, environmental and mass-tort exposures, and reinsurance recoverability as significant judgment areas. A comprehensive external study of asbestos and environmental exposures was expected in Q3 2017.
- In June, AFG issued $350 million of 4.50% Senior Notes due 2047, redeemed $230 million of 6⅜% notes, and planned to redeem $125 million of 5¾% notes in August. Management expected these transactions to produce approximately $6 million in annual pretax interest savings. The Q2 debt redemption generated the $7 million write-off of unamortized issuance costs.
- Management expects annuity net interest spread to narrow over time as new and reinvested assets earn lower yields. It said implementation of the Department of Labor fiduciary rule could affect annuity premiums during the remainder of 2017 and into 2018, but did not expect a material impact on results; the rule’s timing and form remained uncertain.
- AFG disclosed no new formal earnings guidance. Its forward-looking statements identify risks including interest-rate and market movements, catastrophe losses, reserve development, reinsurance availability and collectability, credit quality, regulation, competition, and changes in annuity persistency and mortality. A 100-basis-point immediate rise in rates was estimated to reduce after-tax AOCI by about $743 million, after related balance-sheet offsets.
- AFG’s fixed-indexed annuity embedded derivatives are materially sensitive to assumptions and market inputs; their reported fair-value liability was $2.129 billion at June 30. Approximately 4% of fair-value assets were Level 3; much of that Level 3 asset valuation relied on non-binding broker quotes.
Important facts for investors to verify
- Reconcile GAAP earnings growth with core earnings and the prior-year Neon charge, apartment-property gain, and securities impairments.
- Track reserve development and the results of the planned asbestos and environmental exposure study, including potential effects on reserves.
- Monitor annuity investment yields, credited rates, net interest spread, fixed-indexed derivative marks, and sales impacts from the fiduciary rule.
- Confirm completion and terms of the planned August 2017 note redemption and whether the expected annual interest savings are realized.
- Assess investment-portfolio credit quality, Level 3 valuation uncertainty, interest-rate sensitivity, and catastrophe/reinsurance protection.