American Financial Group, Inc. — Q3 2020 Form 10-Q
Reporting period: Quarter and nine months ended September 30, 2020. AFG principally operates in specialty property and casualty insurance and fixed and indexed annuities. Amounts below are in U.S. dollars; financial statement figures are in millions unless noted.
Financial performance and condition
| Metric | Q3 2020 | Q3 2019 | Nine months 2020 | Nine months 2019 |
|---|---|---|---|---|
| Total revenue | $2,060 | $2,123 | $5,286 | $6,107 |
| Net investment income | $572 | $588 | $1,584 | $1,710 |
| Earnings (loss) before tax | $134 | $177 | $(36) | $849 |
| Net earnings attributable to shareholders | $164 | $147 | $40 | $686 |
| Diluted EPS | $1.86 | $1.62 | $0.45 | $7.55 |
| Core net operating earnings (non-GAAP) | $217 | $205 | $483 | $581 |
| Core diluted EPS (non-GAAP) | $2.45 | $2.25 | $5.37 | $6.39 |
- The nine-month GAAP result includes a $63 tax credit, including a $73 tax benefit associated with the planned Neon sale. The reported $40 net earnings therefore do not reflect positive pretax earnings; pretax results were a $36 loss.
- Nine-month realized losses on securities were $302, compared with $222 of realized gains in 2019, primarily reflecting fair-value losses on equity securities and impairment charges. In Q3, realized gains were $45 versus losses of $18 a year earlier.
- AFG’s specialty P&C combined ratio was 92.1% in Q3 and 93.2% for nine months, indicating underwriting profit before investment income and other items. Including exited Neon lines, aggregate ratios were 98.8% and 97.0%, respectively; the comparable 2019 figures were 96.3% and 94.7%.
- P&C net earned premiums were $1,381 in Q3, down 4%, and $3,774 for nine months, down 1%. Nine-month gross written premiums fell 3%; management cited Neon runoff and reduced exposures, partly offset by rate increases and growth in certain specialty lines.
- Annuity pretax earnings were $78 in Q3 versus $73, but $90 for nine months versus $234. Nine-month core annuity pretax earnings fell 22% to $230. The fixed-annuity net spread was 0.30% for nine months versus 0.83% in 2019; Q3 spread was 0.78% in both years.
- Operating cash flow was $1,696 for nine months, broadly unchanged from $1,691. Investing activities used $772 and financing activities provided $509. Cash and cash equivalents rose to $3,747 from $2,314 at year-end 2019. These cash flows include insurance and annuity-related activity; annuity receipts and withdrawals are classified as financing.
- Total assets were $73,110 and shareholders’ equity $6,340 at September 30. Long-term debt had a $2,108 carrying value ($2,143 principal), up from $1,473 at year-end. Debt to total capital was 29.6% including subordinated debt; management reported 28.1% adjusted for the announced $150 redemption. The $500 revolving facility was undrawn and expires in June 2021.
- AFG reported $1.26 billion of FHLB advances at its annuity subsidiary, with approximately $650 million of additional estimated borrowing capacity. Unpaid losses and LAE were $10,754, versus $10,232 at year-end.
Material changes and unusual items
- AFG agreed to sell Neon, its Lloyd’s-related business, for estimated net proceeds of about $4 million. It recorded a $30 pretax loss on the sale and $70 total pretax losses from Neon exited lines in Q3; the $73 tax benefit made Neon’s reported after-tax contribution a net gain of $3. The transaction remained subject to regulatory approval and other closing conditions.
- A third-quarter external review led to $68 of pretax asbestos and environmental reserve charges: $47 in P&C and $21 relating to former railroad and manufacturing operations. AFG also recorded a $4 long-term-care loss-recognition charge. P&C reserves had $181 of favorable prior-year development for nine months, before these and other adverse items.
- AFG estimated $95 of COVID-19-related losses in specialty P&C for the first nine months, about 80% of which established incurred-but-not-reported reserves, plus $19 in Neon exited lines. Nine-month catastrophe losses were $87. Management said there were no additional COVID-19 reserve charges in Q3 in the ongoing Specialty P&C operations.
- AFG adopted the credit-loss standard (CECL) on January 1, 2020; the adoption increased retained earnings by $7. At September 30, the allowance for expected credit losses on available-for-sale fixed maturities was $54.
- After quarter-end, AFG entered into a reinsurance agreement effective October 1, ceding approximately $6 billion of in-force annuities and transferring a similar amount of investments. AFG said the transfer would bring $275–$300 of net unrealized gains from AOCI into net income, while the transaction loss would be deferred and recognized over an expected 7–10 years. It also called its $150 of 6% subordinated debentures for redemption on November 15.
Outlook, management commentary and risks
- Management expected pandemic impacts to continue into 2021 and financial-market volatility to continue through the remainder of 2020. It said subsidiary capital was projected to remain at or above levels required to maintain current ratings, while noting dividends to the parent could be reduced if needed to preserve subsidiary capital.
- Management expected annuity premiums to remain pressured for the rest of 2020 because of low interest rates, lower crediting rates and COVID-related limits on agents’ ability to conduct business. It also expects the annuity net interest spread to narrow over time.
- COVID-19 may affect investment values and returns, premiums and annuity sales, claims, policyholder payments and surrenders. Management noted uncertainty about possible legislative or judicial changes to coverage; most AFG property policies contain virus exclusions and generally require direct physical damage for business-interruption coverage.
- Other highlighted risks include reserve-estimation uncertainty, especially asbestos and environmental claims; catastrophe losses; investment-credit and interest-rate risks; reinsurer collectability; and possible future DPAC write-offs if spreads, markets, mortality or policy lapses differ adversely from assumptions.
- The filing gives no numerical earnings or premium guidance. Management stated that insurance operations and parent liquidity were sufficient for expected needs, but nine-month earnings were insufficient to cover fixed charges excluding annuity benefits by $23.
Important facts for investors to verify
- Whether the Neon sale closed as expected, final proceeds and net assets disposed, and any adjustment to the recorded sale loss or tax benefit.
- Actual COVID-19 claim development versus the $95 specialty P&C estimate and the adequacy of reserves, including asbestos and environmental exposures.
- Performance of equity-method and fair-value investments, realized-loss allowances, and the effect of ongoing market and interest-rate changes on investment income and AOCI.
- Terms and fourth-quarter accounting for the Commonwealth annuity reinsurance transaction, including the AOCI gain recognition and deferred loss amortization.
- Announced debt redemption, leverage and refinancing plans, subsidiary capital and liquidity, and the trend in annuity sales and fixed-annuity spreads.
- Comparisons of core earnings should account for AFG’s non-GAAP exclusions, including realized investment results, annuity market/assumption effects, Neon runoff and special A&E charges.