Business context and reporting period
American Financial Group, Inc. (AFG) filed this Form 10-K for the fiscal year ended December 31, 2019. AFG operates through Great American Insurance Group, primarily in specialized commercial property and casualty insurance and fixed and indexed annuities. The filing also reports fourth-quarter 2019 results.
Financial performance and position
| Metric | 2019 | 2018 |
|---|---|---|
| Total revenue | $8.24 billion | $7.15 billion |
| Earnings before income taxes | $1.11 billion | $639 million |
| Net earnings attributable to shareholders | $897 million | $530 million |
| Diluted GAAP EPS | $9.85 | $5.85 |
| Core net operating earnings (non-GAAP) | $784 million; $8.62 diluted EPS | $761 million; $8.40 diluted EPS |
| Net cash from operating activities | $2.46 billion | $2.08 billion |
| Cash and investments at year-end | $55.25 billion | $48.50 billion |
| Total assets / shareholders’ equity | $70.13 billion / $6.27 billion | $63.46 billion / $4.97 billion |
| Long-term debt, principal amount | $1.49 billion | $1.32 billion |
- Property and casualty: Gross written premiums rose 7% to $7.30 billion; net earned premiums rose 7% to $5.19 billion. The GAAP combined ratio was 95.8%, versus 93.8%; underwriting gain declined to $212 million from $302 million. Current-year catastrophe losses were $60 million, down from $103 million.
- Annuities: Segment pretax earnings were $362 million, roughly level with $361 million. Statutory annuity premiums fell 8% to $4.96 billion. Net spread earned on fixed annuities was 0.96%, versus 1.07%; excluding specified market, derivative and unlocking effects, it was 1.08%, versus 1.20%.
- Investments: Net investment income increased 10% to $2.30 billion. Net realized securities gains were $287 million, compared with losses of $266 million in 2018; much of the swing reflected equity-security fair-value changes recognized in earnings.
- Cash and liquidity: Investing activities used $3.07 billion and financing activities provided $1.41 billion; cash and cash equivalents increased $799 million to $2.31 billion. AFG’s parent held approximately $243 million in cash and securities and had $500 million available under its revolving credit facility; no parent revolver borrowings were outstanding.
- Capital: Debt to total capital, including subordinated debt, was 21.7%, compared with 21.2%; management’s stated objective is to keep it at or below 25%. All insurance subsidiaries exceeded regulatory risk-based capital requirements.
Material changes and unusual items
- GAAP net earnings rose substantially, chiefly because 2019 had securities gains while 2018 had securities losses. Core net operating earnings increased modestly, from $761 million to $784 million.
- AFG recorded a $76 million pretax charge in the fourth quarter for Neon reserve strengthening and costs associated with its planned exit from the Lloyd’s of London market. Neon was placed into run-off; the filing anticipates additional run-off costs.
- AFG recorded $18 million of pretax P&C asbestos and environmental reserve charges in 2019, equal to the 2018 charge and below the $89 million recorded in 2017. Year-end gross P&C A&E reserves were $529 million ($383 million net of reinsurance).
- AFG issued $325 million of subordinated debentures in 2019 and redeemed $150 million of higher-coupon subordinated debt. It paid $446 million in common dividends, including special dividends; it made no public-market common-stock repurchases.
- Fourth-quarter net earnings attributable to shareholders were $211 million, compared with a $29 million loss in fourth-quarter 2018, reflecting securities results and higher annuity earnings, partly offset by lower P&C underwriting profit and the Neon charge.
Outlook, commentary and principal risks
- AFG announced a new Accident & Health division in 2019, focused on customized coverage for organizations and educational institutions. It also plans to exit the Lloyd’s market and reallocate capital to other opportunities.
- Management said lower interest rates led it to reduce crediting rates on some annuity products, contributing to slower sales. It expects annuity net interest spreads to narrow over time; it did not provide company-wide quantified earnings guidance in the provided filing text.
- Key exposures include low or changing interest rates, credit and market valuation risk, annuity spread compression and policyholder behavior, catastrophe and crop losses, and uncertainty in long-tail insurance reserves. A modeled 100-basis-point rate increase would reduce accumulated other comprehensive income by an estimated $802 million after tax.
- Reinsurance counterparty collectibility is a risk: P&C reinsurance recoverables were about $3.02 billion on unpaid losses, and AFG remains liable to policyholders if reinsurers do not pay. AFG also disclosed $897 million of commitments to fund credit facilities and contribute capital to investment entities.
- Reserve adequacy and A&E exposures remain uncertain; management states that actual outcomes may differ materially from recorded estimates. Other disclosed risks include regulatory and litigation changes, cyber and data-security incidents, and concentration in annuity distribution: two financial institutions accounted for 21% of total annuity sales in 2019.
Important facts for investors to verify
- How much of the 2019 earnings increase is attributable to volatile securities marks versus recurring operating results; review the company’s non-GAAP reconciliation and adjustment definitions.
- Whether P&C underwriting performance, particularly crop and property-and-transportation results, improves, and how prior-year reserve development evolves in long-tail liability lines.
- The ultimate cost, timing and reserve development of the Neon run-off, including whether additional exit expenses arise.
- Whether annuity investment yields and crediting costs sustain acceptable spreads as rates remain low, and whether annuity sales and financial-institution relationships remain resilient.
- Changes in P&C and A&E reserve estimates, reinsurance recoverables and counterparty credit quality; also review the sensitivity of earnings to claim-cost trends.
- The filing reports an unqualified audit opinion and effective internal control over financial reporting as of December 31, 2019.