AMERICAN FINANCIAL GROUP INC annual report, FY2013

Full document

American Financial Group, Inc. — 2013 Form 10-K

Reporting period: Fiscal year ended December 31, 2013; filed February 28, 2014. AFG is an insurance holding company operating primarily in specialty property and casualty insurance and fixed and fixed-indexed annuities. Unless noted, amounts are U.S. dollars.

Financial performance and position

  • Revenue and earnings: Total revenue was $5.092 billion, up 2.7% from $4.957 billion. Pretax earnings were $689 million versus $537 million. Net earnings attributable to shareholders were $471 million, down from $488 million; diluted EPS was $5.16 versus $5.09. Core net operating earnings, a non-GAAP measure, rose to $385 million from $314 million, and core diluted EPS increased to $4.22 from $3.27.
  • Property and casualty: Net written premiums grew 13% to $3.341 billion and net earned premiums grew 13% to $3.204 billion. Underwriting gain increased to $145 million from $87 million; the GAAP combined ratio improved to 95.5% from 96.9%. The 2013 result included $54 million of special pretax asbestos and environmental (A&E) charges; excluding those charges, core underwriting gain was $199 million. Specialty casualty and specialty financial improved, while property and transportation underwriting profit fell to $12 million from $19 million.
  • Annuities: Statutory annuity premiums increased 35% to $4.033 billion, led by financial-institution fixed-indexed sales. Pretax earnings rose to $323 million from $256 million. Annual net spread earned on fixed annuities increased to 1.60% from 1.48%, although net investment yield and net interest spread declined.
  • Cash flow and liquidity: Operating cash flow was $760 million, down from $817 million. Investing activities used $2.915 billion and financing activities provided $2.089 billion; cash and cash equivalents declined $66 million to $1.639 billion. AFG reported $576 million of parent-company cash and securities and an undrawn $500 million revolving credit facility expiring in December 2016. Insurance subsidiaries’ capital ratios substantially exceeded regulatory risk-based capital requirements.
  • Balance sheet and debt: Total assets were $42.087 billion, cash and investments $31.313 billion, shareholders’ equity $4.599 billion, and long-term debt $913 million. Debt-to-total-capital was 17.6%, below management’s stated 25% ceiling. The fixed-maturity portfolio had a $1.09 billion net unrealized gain at year-end, compared with $2.04 billion in 2012; a 100-basis-point rate increase was estimated to reduce its fair value by $1.204 billion pretax.
  • Shareholder returns: Cash dividends were $1.805 per share, including a $1.00 special dividend. AFG repurchased 1.45 million shares for $70 million, substantially fewer shares than in 2012.

Changes versus the prior comparable period

  • Core earnings improved substantially, driven by higher annuity profits and stronger specialty P&C underwriting. Reported net earnings nevertheless decreased because 2012 included the after-tax gain on the sale of the Medicare supplement and critical illness businesses and favorable tax settlements; 2013 also had higher A&E charges.
  • P&C net written premiums grew 13%, with specialty casualty up 23%. The aggregate combined ratio improved by 1.4 percentage points, while P&C investment income declined 4% to $263 million as portfolio yields fell.
  • Annuity premiums grew sharply, especially through financial institutions. However, management cited runoff of higher-yielding assets as a drag on spreads.
  • Operating cash flow declined by $57 million. Year-end shareholders’ equity was nearly unchanged, while total assets and annuity benefit liabilities increased.

Outlook, commentary, risks and unusual items

  • Outlook: Management expected fixed-annuity net spread earned to be approximately 1.35%–1.40% in 2014, below the 1.67% earned in fourth-quarter 2013, citing runoff of higher-yielding investments. AFG could lower average crediting rates by about 48 basis points on roughly $16 billion of eligible deferred annuities. No consolidated earnings guidance was provided in the supplied filing text.
  • Acquisitions and capital commitments: After year-end, AFG agreed to acquire Summit Holdings Southeast for an estimated $250 million, with anticipated total capital investment of about $400 million; Summit had more than $500 million of 2013 net written premiums. A subsidiary also launched a tender offer for the remaining National Interstate shares for approximately $286 million, subject to offer terms and completion.
  • Reserve uncertainty: P&C net A&E reserves were $301 million ($384 million gross) at year-end. AFG recorded a $54 million pretax P&C A&E charge in 2013; former railroad and manufacturing operations recorded a separate $22 million charge. The filing states that A&E outcomes are unusually difficult to estimate and could materially differ from recorded amounts. P&C loss reserves are also sensitive to claim severity, legal developments, inflation and actuarial assumptions.
  • Long-term care: AFG had stopped writing new long-term care policies in 2010; net reserves were $726 million. No additional loss-recognition charge was recorded in 2013, and management cited a $64 million pretax loss-recognition margin. Disclosed single-assumption sensitivities included a $50–$60 million reduction in that margin for 5% higher future morbidity, making future experience and approved rate increases important to monitor.
  • Market and operating risks: Key exposures include interest-rate and investment-market changes, credit losses and mortgage-backed securities, catastrophe and crop losses, reinsurance availability and collectibility, annuity surrenders and spread compression, competition, regulation, ratings, and technology/data-security events. AFG reported $2.122 billion of P&C unpaid-loss reinsurance recoverables, net of allowance, and remains liable to policyholders if reinsurers fail to pay.
  • Other notable items: 2013 included $221 million of realized gains on securities and a $5 million pretax state guaranty-fund assessment charge related to Executive Life of New York. The 2012 comparison included a $153 million pretax long-term-care loss-recognition charge, a $170 million pretax sale gain on the Medicare supplement and critical illness businesses, and tax benefits from IRS matters. These items make reported year-over-year earnings less directly comparable.

Important facts for investors to verify

  • Whether the Summit acquisition and National Interstate tender offer closed as planned, and their resulting capital, earnings and ownership effects.
  • Subsequent P&C reserve development, especially A&E, commercial auto, workers’ compensation and other long-tail claims; compare actual experience with the filing’s sensitivities.
  • Long-term-care claims, persistency, investment returns and regulatory approval of rate increases relative to the disclosed $64 million loss-recognition margin.
  • Whether annuity sales and policyholder persistency sustain earnings as higher-yielding assets mature, and whether the projected 2014 spread range is achieved.
  • Investment portfolio credit quality, unrealized losses, interest-rate sensitivity, and the collectibility and concentration of reinsurance recoverables.
  • Dividend and acquisition funding capacity at the parent company, including dependence on regulated subsidiary distributions and the availability of the revolving credit facility.