American Financial Group, Inc. — Q1 2019 Form 10-Q
Reporting period: Three months ended March 31, 2019; unaudited. AFG operates primarily in specialty property and casualty insurance and fixed, fixed-indexed and variable-indexed annuities. Dollar amounts below are in millions unless stated otherwise.
Financial performance and condition
| Metric | Q1 2019 | Q1 2018 / prior date |
|---|---|---|
| Total revenues | $2,024 | $1,619 |
| Net earnings attributable to shareholders | $329; diluted EPS $3.63 | $145; diluted EPS $1.60 |
| Core net operating earnings (non-GAAP) | $184; diluted EPS $2.02 | $219; diluted EPS $2.42 |
| Net cash from operating activities | $454 | $391 |
| Cash and cash equivalents | $2,000 at March 31 | $1,515 at December 31, 2018 |
| Total assets / shareholders’ equity | $66,132 / $5,665 | $63,456 / $4,970 at December 31, 2018 |
| Long-term debt | $1,423 carrying value; $1,443 principal | $1,302 carrying value at December 31, 2018 |
- Revenue rose about 25%, but the increase in reported earnings primarily reflected a swing in securities results: $184 net realized gains versus $93 net realized losses a year earlier. Most of the 2019 gain reflected fair-value appreciation of equity securities.
- Core net operating earnings fell about 16%. Pretax annuity earnings declined to $90 from $125; P&C pretax earnings were $182 versus $184; and other operations recorded a $43 pretax loss versus $42.
- P&C net earned premiums grew 6% to $1,173. The aggregate combined ratio increased to 92.6% from 91.8% (below 100% indicates underwriting profit); underwriting profit was $87 versus $91. Prior-year reserve development remained favorable, at $45 versus $56.
- Annuity net investment income increased 10% to $435, but pretax earnings were pressured by the fair-value effects of derivatives tied to fixed-indexed annuities. The net interest spread narrowed to 2.59% from 2.75%; net spread earned on fixed annuities fell to 0.96% from 1.54%.
- Operating cash flow was $454; investing activities used $684 and financing activities provided $715. Cash increased by $485 during the quarter. Financing cash flow included $626 of net annuity policyholder inflows and $121 of net proceeds from new subordinated debt.
- Debt to total capital was 21.7% including subordinated debt and 15.3% excluding it. AFG had no borrowings under its $500 revolving credit facility. The annuity subsidiary also had $1.1 billion of FHLB advances recorded within annuity benefits accumulated.
- Other comprehensive income was $396, largely reflecting an increase in unrealized securities gains; accumulated other comprehensive income rose to $444 from $48 at year-end.
Changes, outlook, and risks
- Material year-over-year changes: Reported earnings benefited from the reversal in securities gains and losses, while core earnings weakened. P&C premium growth was partly offset by a higher loss ratio. Annuity earnings were affected by interest-rate-driven derivative valuations and related adjustments to acquisition-cost amortization.
- Management commentary: AFG said lower-than-anticipated interest rates adversely affected FIA derivative results, partly offset by strong stock-market performance. Management expects annuity net interest spreads to narrow over time and noted that lower market rates and reduced crediting rates had begun to slow annuity sales compared with Q4 2018. No specific consolidated earnings guidance is provided in the supplied filing text.
- Capital returns and debt: AFG issued $125 of 5.875% subordinated debentures due 2059 in March. After quarter-end, in May 2019, it declared a special cash dividend of $1.50 per share, approximately $135 in aggregate, payable May 28 to shareholders of record May 15. AFG repurchased no shares during Q1.
- Key risks and estimates: Results depend on insurance reserve adequacy, reinsurance recoverability, investment valuations and annuity derivative assumptions. Management identified reserves and contingencies related to asbestos, environmental and mass-tort claims, including former railroad and manufacturing operations, as significant areas of uncertainty. Market, interest-rate, equity, credit, catastrophe, legal, regulatory and reinsurer risks could materially affect results or liquidity.
- Investment and valuation exposure: Approximately 91% of fixed maturities were investment grade. AFG estimated that an immediate 100-basis-point rate increase would reduce fixed-maturity fair value by about $1,959 pretax and AOCI by about $916 after tax, after estimated offsets. About 7% of assets carried at fair value were Level 3; estimates for less observable securities and annuity embedded derivatives involve judgment.
- Other items: AFG adopted lease accounting in January 2019, recognizing a $198 lease liability and $174 right-of-use asset; management said adoption did not materially affect results or liquidity. A $3 charitable donation and higher stock-market-linked employee benefit costs contributed to higher other expenses.
Important facts for investors to verify
- How much of the reported earnings increase came from market-sensitive equity-security gains, and whether core earnings trends persist.
- FIA derivative valuation sensitivities, the effect of interest rates and equity markets, and the relationship between derivative liabilities, options and deferred acquisition costs.
- P&C reserve development by line, catastrophe exposure and the adequacy of reserves for long-tail, asbestos, environmental and mass-tort claims.
- Changes in annuity sales, surrender behavior, crediting rates, investment yields and FHLB advance maturities and repayment capacity.
- Potential effects of the expected adoption of credit-loss accounting in 2020 and long-duration insurance accounting in 2021; AFG said it could not yet estimate the impacts.