American Financial Group, Inc. — Q2 2011 Form 10-Q
Reporting period: Three and six months ended June 30, 2011. Unaudited consolidated results; dollar amounts are in millions except per-share data. AFG operates in property and casualty (P&C) insurance, annuity and supplemental insurance, and other activities.
Financial performance
| Metric | Q2 2011 | Q2 2010 | Six months 2011 | Six months 2010 |
|---|---|---|---|---|
| Total revenues | $1,093 | $1,052 | $2,132 | $2,086 |
| Operating earnings before tax | $69 | $158 | $164 | $305 |
| Net earnings attributable to shareholders | $55 | $108 | $138 | $214 |
| Diluted earnings per share | $0.52 | $0.97 | $1.31 | $1.90 |
| Core net operating earnings (non-GAAP) | $81 | $102 | $167 | $205 |
- Revenue increased 4% in Q2 and 2% for the first half, while shareholder net earnings declined 49% and 36%, respectively.
- Cash provided by operating activities was $534 for the first half, versus $461 in 2010. Investing activities used $741; financing activities provided $737. Cash and equivalents rose to $1,629 from $1,099 at year-end 2010. Annuity receipts and benefit payments are classified as financing cash flows.
- At June 30, cash and investments were $24,368; total assets were $34,053; total liabilities were $29,428; shareholders’ equity was $4,472. Long-term debt was $940, down from $952 at year-end. Debt-to-total-capital was 18.8% (17.7% excluding real-estate-secured debt). AFG reported no borrowings on its $500 revolving facility; National Interstate had $22 outstanding on its separate facility.
- Common dividends were $0.1625 per share in Q2, versus $0.1375 a year earlier. AFG repurchased 5.2 million shares for $178 in the first half.
Material changes and segment results
- P&C: P&C premiums earned rose to $609 in Q2 from $572; first-half premiums were $1,208 versus $1,151. P&C underwriting results fell to a loss of $11 in Q2 from income of $63, and to income of $35 for the first half from $134. Reported aggregate combined ratios were 101.8% and 97.1%, respectively, versus 89.1% and 88.4% in 2010. Specialty combined ratios were 93.6% for Q2 and 93.0% for the first half, compared with 88.1% and 87.5%.
- P&C premium growth reflected crop business and the Vanliner acquisition. Underwriting results weakened mainly because favorable prior-year reserve development was lower. Q2 catastrophe losses declined to $23 from $34; renewal rates were flat overall.
- Annuity and supplemental insurance: Pretax operating earnings rose 22% in Q2 to $56 and 20% in the first half to $108, driven mainly by fixed annuity and supplemental health results. Annuity sales increased to $906 in Q2 from $559 and to $1,578 for the first half from $945, reflecting indexed annuity and bank-channel growth.
- Investment income increased to $306 in Q2 from $294 and to $606 for the first half from $589, on higher average invested assets, partly offset by lower yields. P&C investment income was lower. Interest expense rose, partly reflecting the $132 of 7% senior notes issued in 2010.
Outlook, risks and unusual items
- AFG recorded a Q2 special charge of $50, net of reinsurance, to strengthen P&C asbestos reserves by $28 and environmental reserves by $22. It also recorded a $9 charge for asbestos and environmental liabilities tied to former railroad and manufacturing operations. The core-earnings reconciliation reflects a $38 after-tax special charge.
- At June 30, P&C asbestos and environmental reserves were $382 net of reinsurance recoverables. Separate liabilities for environmental and personal-injury claims from former railroad and manufacturing operations totaled $101. Management’s study cited increased expected cancer claims, defense costs and certain environmental-site costs; asbestos claim trends and legal outcomes remain difficult to predict.
- Management stated it believes insurance reserves are adequate and subsidiaries have sufficient liquidity and capital, while identifying reserve adequacy and former railroad/manufacturing contingencies as significant risks. Reinsurance collectability, catastrophe losses, investment values, interest rates, competitive pricing and regulatory or legal changes are also cited risks.
- About 91% of fixed maturities were investment grade. Management estimated an immediate 100-basis-point rise in rates would reduce fixed-maturity fair value by approximately $919, or 4.4%. Residential mortgage-backed securities and credit quality remain areas to monitor; Q2 filing data report $34 of first-half impairment charges on residential MBS.
- AFG said that if the low interest-rate environment persisted through year-end, fixed-annuity deferred acquisition costs might require a write-off, which management did not expect to materially affect full-year net earnings. No specific earnings or revenue guidance is provided.
- One managed CLO was expected to liquidate in August 2011, reducing reported managed-entity assets by about $498 and liabilities by about $480; the effect on shareholder net income was not expected to be material. AFG reported maximum ultimate CLO economic exposure of $19, its investment fair value, and stated it had no obligation or intention to provide additional support.
Important facts for investors to verify
- How asbestos and environmental reserve assumptions, reinsurance recoverables and future claim development compare with actual experience after the 2011 study.
- Whether P&C underwriting ratios and favorable prior-year reserve development stabilize, particularly across discontinued and run-off lines.
- Whether annuity sales growth produces sustainable margins amid low investment yields, and whether any deferred acquisition cost write-off becomes necessary.
- Investment portfolio credit quality, mortgage-backed security valuations and impairment charges; consider the reported interest-rate sensitivity.
- Capital deployment and liquidity after share repurchases, dividends, debt maturities and the expected CLO liquidation.