American Financial Group, Inc. — 2012 Form 10-K
Reporting period: Fiscal year ended December 31, 2012. This is an annual report, not a standalone fourth-quarter filing. AFG is an insurance holding company focused on specialty commercial property and casualty insurance and fixed and fixed-indexed annuities.
Financial results and position
| Metric | 2012 | 2011 |
|---|---|---|
| Total revenue | $5.062 billion | $4.750 billion |
| Operating earnings before tax | $537 million | $558 million |
| Net earnings attributable to shareholders | $488 million; diluted EPS $5.09 | $342 million; diluted EPS $3.32 |
| Core net operating earnings (non-GAAP) | $314 million; diluted EPS $3.27 | $363 million; diluted EPS $3.52 |
| Operating cash flow | $817 million | $667 million |
| Cash and cash equivalents at year-end | $1.705 billion | $1.324 billion |
| Total assets / shareholders’ equity | $39.171 billion / $4.578 billion | $35.838 billion / $4.411 billion |
| Long-term debt | $953 million | $934 million |
Property and casualty (P&C) net written premiums rose 6% to $2.949 billion. Net earned premiums were $2.847 billion and underwriting gain was $87 million, down from $180 million. The GAAP combined ratio deteriorated to 96.9% from 93.4% but remained below 100%, indicating an underwriting profit. Annuity premiums were $2.991 billion, down from $3.086 billion. Annuity operating earnings before tax, excluding realized gains and losses, increased to $256 million from $188 million.
Debt to total capital was 19.4%, within management’s stated aim to remain at or below 25%. AFG reported $323 million of parent-company cash and securities and a $500 million undrawn revolving credit facility expiring in December 2016. Insurance subsidiaries’ capital ratios substantially exceeded risk-based capital requirements. The filing does not provide a conventional current ratio or comparable liquidity measure.
Changes and notable items
- Shareholder net earnings rose, while core net operating earnings declined. The 2012 result included a $114 million after-tax gain on the sale of Medicare supplement and critical illness businesses, $128 million of other after-tax realized gains, and $67 million of tax benefits. These items were partly offset by a $99 million after-tax long-term-care charge.
- AFG sold its Medicare supplement and critical illness businesses to Cigna for $326 million in cash, recording a $170 million pretax gain. The business contributed $28 million of pretax operating earnings through the August sale date.
- P&C underwriting earnings weakened, principally because Midwest drought reduced crop profitability, catastrophe losses increased to $52 million from $46 million, and favorable prior-year reserve development fell to $74 million from $120 million. Average renewal rates increased about 3% overall.
- AFG recorded a $153 million pretax loss-recognition charge in its closed long-term-care block, including a write-off of deferred acquisition costs and higher reserves. AFG had stopped writing new long-term-care policies in 2010; year-end net reserves were $755 million.
- AFG issued $355 million of long-dated senior notes and used the proceeds to redeem higher-coupon debt. It repurchased 10.9 million shares for $415 million and paid a $0.25-per-share special dividend, in addition to regular dividends.
Outlook, risks and contingencies
Management reported that specialty P&C renewal pricing began to harden in late 2011 and continued during 2012. Annuity sales faced pressure from low interest rates and competitive conditions; AFG reduced credited rates and agent commissions. The filing provides no quantified earnings or revenue guidance for 2013.
- Insurance reserves: Reserve estimates are judgmental and may change. P&C net loss and LAE reserves were $6.845 billion; reinsurance recoverables were $2.716 billion on unpaid losses. AFG cited asbestos and environmental claims, long-tail liability, Italian medical-malpractice reserves, and changing legal and claim-cost trends as areas of uncertainty. It recorded a $31 million net P&C A&E charge in 2012.
- Long-term care: The closed block remains exposed to claim, persistency, investment-yield, and regulatory assumptions. Management’s sensitivity analysis indicates adverse assumption changes could prompt further charges; premium increases require regulatory approval.
- Investments and rates: Fixed maturities totaled $24.118 billion at fair value; 86% were investment grade. A 100-basis-point immediate increase in rates was estimated to reduce fixed-maturity fair value by $1.124 billion pretax. Low rates may compress annuity spreads and affect reserve and acquisition-cost assumptions.
- Catastrophe, crop and reinsurance risks: Severe weather, crop prices, reinsurance availability, and reinsurer collectibility could affect earnings. AFG remains liable to policyholders if reinsurers fail to pay.
- Other contingencies: Liabilities for former railroad and manufacturing operations totaled $102 million. AFG also disclosed the unresolved final approval process for the A.P. Green bankruptcy plan and related asbestos settlement. Outcomes may differ from recorded estimates.
Investor verification priorities
- Reconcile GAAP earnings growth with the decline in core net operating earnings, including sale gains, tax benefits, and reserve charges.
- Track long-term-care claim and persistency experience, approved rate increases, reinvestment assumptions, and any further loss-recognition charges.
- Review P&C reserve development, A&E exposures, crop results, catastrophe losses, and the sustainability of renewal-rate increases.
- Assess reinsurance recoverables and counterparty concentration, including the collectibility of the substantial unpaid-loss recoverable balance.
- Monitor investment credit quality, unrealized gains and losses, interest-rate sensitivity, and annuity spread and surrender trends.
- Check the progress and potential implications of the A.P. Green plan approval and other former-operations contingencies.