American Financial Group, Inc. — 2013 Third-Quarter Form 10-Q
Reporting period: Quarter and nine months ended September 30, 2013; comparisons are to the corresponding 2012 periods. AFG is principally a specialty property-and-casualty insurer and fixed/fixed-indexed annuity provider. Financial amounts below are in millions of dollars except per-share data and ratios.
Key financial results
| Metric | Q3 2013 | Q3 2012 | Nine months 2013 | Nine months 2012 |
|---|---|---|---|---|
| Total revenues | $1,443 | $1,538 | $3,730 | $3,749 |
| Earnings before income taxes | $142 | $285 | $443 | $567 |
| Net earnings attributable to shareholders | $83 | $226 | $313 | $438 |
| Diluted earnings per share | $0.92 | $2.39 | $3.44 | $4.50 |
| Core net operating earnings (non-GAAP) | $97 | $78 | $268 | $253 |
| Cash dividends per common share | $0.195 | $0.175 | $0.585 | $0.525 |
Lower GAAP earnings primarily reflect the absence of 2012’s after-tax $101 million gain on the sale of the Medicare supplement and critical illness businesses and $28 million tax benefit from a tax case resolution, plus higher 2013 asbestos and environmental (A&E) charges. Core earnings increased, reflecting stronger Specialty P&C and annuity results.
Operations and material comparisons
- Property and casualty: Q3 net earned premiums rose 12% to $949 million; nine-month premiums rose 12% to $2.345 billion. Q3 core pretax earnings were $115 million versus $73 million; nine-month core pretax earnings were $293 million versus $281 million. Specialty underwriting improved: its combined ratio was 93.5% for Q3 versus 98.2%, and 94.4% for nine months in both years. The aggregate combined ratio, including discontinued lines, was 99.1% for Q3 and 97.0% year to date.
- Annuities: Pretax earnings were $78 million in Q3 versus $69 million and $231 million for nine months versus $188 million. Nine-month annuity premiums increased 9% to $2.652 billion. Growth and improved fixed-indexed annuity results supported earnings, while lower investment yields pressured spreads. Fixed-annuity net spread earned was 1.50% in Q3 and 1.58% for nine months.
- Run-off long-term care and life: Pretax loss was $4 million in Q3 versus $2 million earnings; nine-month loss was $7 million versus $8 million earnings. Management attributed higher long-term-care benefit costs primarily to increased new claims.
- Investment income and realized gains: Net investment income was $338 million in Q3 versus $326 million and $996 million for nine months versus $972 million. Realized securities gains were $56 million in Q3 versus $85 million and $154 million year to date versus $145 million. The prior-year comparisons also included subsidiary-sale gains.
Financial position, cash flow and liquidity
- At September 30, 2013, total assets were $40.947 billion, total liabilities $36.237 billion, and shareholders’ equity $4.542 billion. Cash and cash equivalents were $1.331 billion, down from $1.705 billion at year-end 2012. Accumulated other comprehensive income was $570 million, versus $831 million at year-end.
- Long-term debt was $913 million, down from $953 million at year-end. Debt to total capital was 17.8% including real-estate-secured debt (16.8% excluding it), versus 19.4% and 18.4%, respectively. AFG reported no borrowings on its $500 million revolving facility; $12 million was outstanding on National Interstate’s $100 million credit agreement.
- Nine-month operating cash flow was $388 million versus $487 million; investing cash outflow was $1.913 billion versus $938 million; financing cash inflow was $1.151 billion versus $753 million. Cash declined $374 million, compared with a $302 million increase in 2012. The operating cash-flow comparison was affected by AFG’s $124 million payment on a previously accrued asbestos settlement.
- Management stated it believes the parent and insurance subsidiaries have sufficient liquidity and capital. The filing notes that traditional current/noncurrent liquidity ratios are not meaningful for AFG’s financial businesses.
Outlook, unusual items and risks
- No formal earnings guidance is provided. Management expects annuity net interest spreads to narrow as higher-yielding investments run off. It expected fixed-annuity net spread earned to be approximately 1.30%–1.40% in Q4 2013, compared with 1.50% in Q3.
- Q3 2013 included $54 million of pretax P&C A&E reserve strengthening and $22 million for A&E exposures from former railroad and manufacturing operations. A comprehensive external study cited higher defense costs, claim severity and remediation estimates; management reported no newly identified broad industry trends. P&C net A&E reserves were $341 million at quarter-end.
- AFG paid $124 million in Q2 on the previously accrued A.P. Green asbestos settlement. It also recorded a $5 million pretax charge for expected state guaranty-fund assessments related to the ELNY liquidation; management did not expect significant additional ELNY charges.
- Key stated risks include reserve adequacy—especially A&E and run-off long-term care—reinsurance collectability, interest-rate and securities-market movements, investment impairments, catastrophe losses, annuity persistency and pricing, regulation, and ratings changes. AFG estimated an immediate 100-basis-point rate increase would reduce fixed-maturity fair value by about $1.168 billion pretax. Approximately 3% of fair-value assets were Level 3; much of that valuation relied on non-binding broker quotes.
- AFG’s CLO exposure was limited to its investments, with fair value of $303 million at September 30; the company stated it had no contractual obligation or intention to provide additional CLO support. The filing reported effective disclosure controls and no material change in internal control over financial reporting during the quarter.
Most important facts for investors to verify
- Whether P&C growth and favorable Specialty underwriting persist, particularly given the year-to-date 100.4% combined ratio in property and transportation and higher catastrophe losses.
- Further development in A&E reserves, former-operations environmental liabilities, and the run-off long-term-care claims experience.
- Whether annuity investment spreads narrow as management anticipates, and how interest rates, sales growth and policyholder behavior affect returns and liquidity.
- The quality and valuation of investment holdings, including unrealized losses, Level 3 estimates, non-agency MBS exposure and sensitivity to interest-rate changes.
- Reconciliation of GAAP earnings to core earnings and the impact of prior-period disposal gains and tax benefits on comparisons; core earnings are a non-GAAP measure.