American Financial Group, Inc. — Q1 2020 Form 10-Q
Reporting period: Three months ended March 31, 2020. AFG is an insurance holding company focused on specialty property and casualty insurance and fixed and indexed annuities.
Financial results and position
| Metric | Q1 2020 | Q1 2019 / comparison |
|---|---|---|
| Total revenue | $1.275 billion | $2.024 billion |
| Net earnings (loss) attributable to shareholders | $(301) million; diluted EPS $(3.34) | $329 million; diluted EPS $3.63 |
| Core net operating earnings, non-GAAP | $171 million; diluted EPS $1.88 | $184 million; diluted EPS $2.02 |
| Operating cash flow | $532 million | $454 million |
| Cash and cash equivalents, March 31 | $1.673 billion | $2.314 billion at December 31, 2019 |
| Total assets / shareholders’ equity | $67.643 billion / $5.047 billion | $70.130 billion / $6.269 billion at December 31, 2019 |
| Long-term debt, carrying value | $1.473 billion | Unchanged from December 31, 2019 |
- The $735 million year-over-year swing in realized securities results—from a $184 million gain to a $551 million loss—was the main driver of the GAAP net loss. The 2020 loss included a $535 million decline in equity-security fair values and $61 million of impairment charges, partly offset by related adjustments.
- Other comprehensive income was a loss of $829 million, principally reflecting market-driven unrealized investment losses. AOCI declined to $32 million from $863 million at year-end.
- Operating cash flow excludes the annuity deposit flows classified as financing. Investing activities used $1.653 billion; financing activities provided $480 million. Cash fell by $641 million, as AFG invested cash amid wider credit spreads.
- AFG reported $46.134 billion of available-for-sale fixed maturities at fair value, with $1.324 billion of gross unrealized losses. Management said it intended and had the ability to hold the securities until recovery; 91% of fixed maturities were investment grade.
Performance and changes versus prior year
- Property and casualty: Net earned premiums were $1.209 billion, up 3%; core pretax earnings were $181 million versus $182 million. Aggregate combined ratio was 92.8% versus 92.6%, with underwriting profit of $87 million in both periods. Prior-year reserve development was favorable by $42 million, compared with $45 million favorable in Q1 2019.
- Overall average renewal rates rose approximately 7% (about 11% excluding workers’ compensation rate decreases). Specialty casualty gross written premiums fell 7%, primarily because Neon’s Lloyd’s business was placed into run-off; excluding Neon, that sub-segment’s gross written premiums rose 13%.
- Annuity: GAAP pretax earnings were $29 million versus $90 million; core pretax earnings were $67 million versus $90 million. Net investment income declined 3% to $422 million. Net interest spread fell to 1.53% from 2.00%, while net spread earned on fixed annuities was 0.31% versus 0.96%.
- Annuity premiums were $1.210 billion, down 13%, reflecting lower market rates, reduced crediting rates and, increasingly, pandemic-related restrictions. The annuity result included $38 million of pretax non-core losses related to indexed-annuity market and interest-rate accounting; the 2019 core comparison was not adjusted consistently for these items.
- AFG’s non-GAAP core earnings exclude realized securities gains and losses and, beginning in 2020, Neon run-off results. Core earnings also exclude specified indexed-annuity market-related accounting effects. These definitions and period comparisons require care.
Outlook, risks and unusual items
- Management expected pandemic and recession effects to continue through 2020, with negative pressure on premiums and earnings, continued investment-market volatility and reduced annuity sales. No quantified earnings or revenue guidance was provided.
- Management said Q1 underwriting was not significantly affected by COVID-19, but expected changing exposures, slower premium collections and potentially higher receivables. Possible claims, mandated premium refunds or credits, extended payment grace periods, and legislative or judicial changes—including retroactive business-interruption coverage—were identified as risks. AFG stated that its business-interruption coverage generally requires direct physical damage and that most property policies contain virus exclusions.
- Because equity-method partnership results are reported on a quarter lag, AFG expected those investments to likely produce losses in Q2 reflecting Q1 market declines. CLO-related results were also exposed to market valuation changes.
- On April 2, 2020, after quarter-end, AFG issued $300 million of 5.25% senior notes due 2030 to increase parent-company liquidity. Including the issuance, management reported an adjusted debt-to-total-capital ratio of 26.4%, versus 23.0% before the issuance. The $500 million revolver had no borrowings at March 31 and expires in June 2021.
- Insurance-reserve adequacy, asbestos and environmental exposures, reinsurance recoverability, investment valuation and annuity embedded derivatives remain significant judgment areas. AFG reported no significant change in its previously disclosed contingencies; it was released from its former long-term-care capital-support obligation.
- AFG adopted the expected-credit-loss standard on January 1, 2020, recording a $7 million increase to opening retained earnings. At March 31, the allowance for credit losses on available-for-sale fixed maturities was $61 million.
Important facts for investors to verify
- Whether investment valuations, credit losses and subsequent equity-method investment results develop as anticipated, particularly given the quarter-lag reporting.
- COVID-19 effects on P&C exposures, claims, premium collection, policyholder refunds or credits, and annuity sales and surrenders.
- Changes in reserve development and the adequacy of insurance and legacy asbestos/environmental reserves.
- How annuity spreads, sales, indexed-option hedges and market-sensitive accounting affect reported and core earnings; review the non-GAAP reconciliations.
- Parent and subsidiary liquidity, capital and debt metrics after the April 2 notes issuance, including potential limits on subsidiary dividends.