American Financial Group, Inc. — Q2 2015 Form 10-Q
Business context and reporting period. AFG is an insurance holding company focused on specialty property and casualty insurance and fixed and fixed-indexed annuities. This unaudited report covers the quarter and six months ended June 30, 2015; amounts are in millions except per-share data.
Financial performance and position
| Metric | Q2 2015 | Q2 2014 | Six months 2015 | Six months 2014 |
|---|---|---|---|---|
| Total revenue | $1,541 | $1,392 | $2,835 | $2,603 |
| Earnings before income taxes | $226 | $130 | $256 | $291 |
| Net earnings attributable to shareholders | $141 | $106 | $160 | $209 |
| Diluted EPS | $1.57 | $1.15 | $1.79 | $2.28 |
| Core net operating earnings (non-GAAP) | $115 | $99 | $227 | $190 |
| Core diluted EPS (non-GAAP) | $1.28 | $1.07 | $2.54 | $2.07 |
Quarterly shareholder earnings improved, supported by higher core earnings and a $51 pretax gain on the Le Pavillon Hotel sale. First-half GAAP earnings declined because of the $162 pretax loss recorded on the pending long-term-care business sale; higher core earnings and the hotel gain partly offset it. AFG reports core earnings as a non-GAAP measure.
- Property and casualty: Q2 net earned premiums were $985, up 6%; underwriting profit was $50 versus $29. The combined ratio improved to 94.9% from 96.9% (below 100% indicates underwriting profit). For the first half, premiums rose 15% to $1,931, underwriting profit rose to $110 from $87, and the combined ratio improved to 94.2% from 94.8%.
- Annuity: Pretax earnings were $88 in Q2 and $163 for the first half, up 5% and 4%, respectively. First-half annuity premiums fell 11% to $1,712; management attributed the decline to disciplined pricing in a low-rate environment and increased competition. Fixed-annuity net spread earned was 1.30% for the first half versus 1.38% a year earlier.
- Cash flow: First-half operating cash flow was $576 versus $499; investing cash use was $2,114 versus $970; financing cash flow was $1,411 versus $948. Cash and cash equivalents ended June at $1,216, down $127 from year-end.
- Balance sheet and debt: Total assets were $49,424 at June 30, versus $47,535 at year-end; cash and investments were $37,644. Total equity was $4,984 versus $5,054. Long-term debt was $1,024, down from $1,061; debt-to-total-capital was 18.4% (18.4% including subordinated and real-estate-secured debt). AFG had no borrowings on its $500 revolving facility; the facility expires in December 2016.
- Investment and comprehensive income: Net investment income was $404 in Q2 and $792 for the first half, versus $379 and $740. First-half other comprehensive loss was $166, largely reflecting unrealized securities losses; AOCI declined to $563 from $727 at year-end.
Material changes and unusual items
- AFG agreed to sell its run-off long-term-care business to HC2 Holdings. The estimated sale proceeds recorded for accounting purposes were $14 net of estimated expenses, and the business was written down by $162 pretax in Q1. AFG estimated after-tax proceeds of $105–$115, excluding potential additional proceeds of up to $13 tied to release of statutory liabilities. Closing was expected in the second half of 2015, subject to customary conditions and regulatory approvals; the transaction had not closed by June 30.
- The sale of Le Pavillon Hotel generated a $51 pretax gain in Q2; AFG treated it as non-core. AFG recorded $34 of net securities impairment losses in the first half, including $25 on equity securities and $15 on corporate and other bonds before related adjustments.
- AFG adopted accounting guidance for collateralized loan obligations (CLOs) in 2015 that changed the presentation of CLO liabilities and noncontrolling interests, without changing shareholder net earnings. The filing says new consolidation guidance expected in 2016 was not expected to affect currently outstanding CLOs.
- Summit, acquired in April 2014, contributed to year-over-year P&C premium growth. First-half P&C gross written premiums rose 9%, but excluding Summit growth was 3%.
Outlook, commentary and risks
- Management said it expects annuity net interest spreads to narrow as higher-yielding investments run off and are replaced at lower yields. Low interest rates also pressure investment yields; AFG said it could lower crediting rates on about $19 billion of deferred annuities by an average 64 basis points, subject to policy guarantees.
- No specific consolidated earnings or revenue guidance was provided in the supplied filing text. Management stated it believed parent and insurance-subsidiary liquidity and capital were adequate.
- Key exposures include reserve adequacy—particularly long-term care, asbestos, environmental and mass-tort claims—reinsurance recoverability, catastrophe and severe-weather losses, investment credit and market risk, interest-rate and annuity policyholder behavior, and regulatory or rating changes. Management cautioned that investment impairments could be material and that significant portfolio-value declines could adversely affect liquidity.
- AFG’s fixed-maturity portfolio was sensitive to rates: management estimated an immediate 100-basis-point increase would reduce after-tax AOCI by about $590. Fixed-indexed annuity derivative fair values can also create earnings volatility that management says may not reflect the products’ long-term economics.
- Management reported effective disclosure controls and no material change in internal control over financial reporting during the quarter.
Important facts for investors to verify
- Whether the long-term-care sale closed, final sale proceeds and net assets transferred, tax benefits realized, and any statutory-liability release proceeds.
- Long-term-care and P&C reserve development, including the assumptions underlying claims reserves and reinsurance recoverables.
- Underlying P&C growth and profitability excluding Summit, and whether current accident-year loss trends and favorable reserve development persist.
- Evolution of annuity sales, renewal pricing, investment yields, credited rates, guaranteed-withdrawal reserves and net spread as rates and competition change.
- Investment portfolio valuation and impairment exposure, including broker-priced Level 3 assets, equity and energy-related impairments, and sensitivity to market or interest-rate movements.