American Financial Group, Inc. — Second-Quarter 2019 Form 10-Q
Reporting period: Three and six months ended June 30, 2019; comparisons are to the corresponding 2018 periods unless otherwise stated. AFG primarily operates in specialty property and casualty insurance and annuities.
Key financial results
| Metric | Q2 2019 | Q2 2018 | Six months 2019 | Six months 2018 |
|---|---|---|---|---|
| Total revenues | $1.960 billion | $1.833 billion | $3.984 billion | $3.452 billion |
| Earnings before income taxes | $259 million | $260 million | $672 million | $434 million |
| Net earnings attributable to shareholders | $210 million | $210 million | $539 million | $355 million |
| Diluted EPS | $2.31 | $2.31 | $5.94 | $3.92 |
| Core net operating earnings (non-GAAP) | $192 million | $185 million | $376 million | $404 million |
| Net cash from operating activities | Not separately stated | Not separately stated | $877 million | $823 million |
Six-month 2019 net earnings benefited substantially from $240 million of realized securities gains, compared with a $62 million loss in 2018. These gains were largely fair-value gains on equity securities, including gains on holdings still owned at period-end. Core earnings exclude realized securities gains and, beginning in Q2 2019, specified annuity market-value and assumption effects.
Business performance and material changes
- Property and casualty: Q2 net earned premiums increased 3% to $1.20 billion; pretax earnings declined 2% to $174 million. Underwriting profit fell 18% to $59 million, while net investment income rose 8% to $124 million. The aggregate combined ratio worsened to 95.1% from 93.7%, remaining below 100% and indicating an underwriting profit. For the first six months, earned premiums grew 5% to $2.37 billion, but pretax earnings fell 2% to $356 million and the combined ratio increased to 93.9% from 92.8%.
- Reserves and claims: P&C recorded $86 million of favorable prior-year reserve development in the first six months, versus $100 million in 2018. Current-year catastrophe losses were $24 million, compared with $29 million. Management cited unfavorable trends in some areas, including excess and surplus lines and Neon, offset by favorable experience in other businesses.
- Annuities: Q2 GAAP pretax earnings declined 28% to $71 million; first-half GAAP pretax earnings declined 28% to $161 million. First-half annuity core pretax earnings were $194 million, down 13%. Lower-than-anticipated interest rates materially affected fair values of FIA-related derivatives and annuity results. AFG reported $33 million of pretax annuity non-core losses in Q2 and $44 million for the first half under its revised presentation.
- Investment income and market-value effects: Consolidated net investment income rose 9% to $580 million in Q2 and 9% to $1.122 billion in the first half. AFG reported $762 million of after-tax other comprehensive income in the first half, principally reflecting unrealized investment gains; accumulated other comprehensive income rose to $809 million from $48 million at year-end 2018.
Balance sheet, cash flow and capital
- At June 30, 2019, total assets were $67.697 billion, total liabilities $61.607 billion and shareholders’ equity $6.090 billion. Cash and cash equivalents were $2.374 billion, up from $1.515 billion at year-end 2018.
- Long-term debt had a $1.423 billion carrying value and $1.443 billion principal amount, versus $1.302 billion and $1.318 billion, respectively, at year-end. The increase followed a March issuance of $125 million of 5.875% subordinated debentures due 2059. No amounts were drawn on AFG’s $500 million revolving credit facility; no scheduled principal payments were due through 2024.
- Debt to total capital was 21.5% including subordinated debt and 15.2% excluding it. The filing reports a 35% covenant ceiling for debt excluding subordinated debt and real-estate-secured debt.
- First-half cash flows were $877 million provided by operations, $1.052 billion used in investing and $1.034 billion provided by financing, producing an $859 million increase in cash. Annuity receipts exceeded surrenders, benefits and withdrawals by about $1.10 billion.
- AFG paid a $1.50-per-share special dividend in May 2019, totaling $135 million. It reported no common-share repurchases during the first six months.
Management outlook, risks and unusual items
- No specific consolidated earnings or revenue guidance is provided in the supplied filing text. Management expects delayed crop-insurance premiums, affected by excess moisture and late planting, to be reflected in Q3 2019 results.
- AFG said lower market interest rates prompted reductions in crediting rates on several annuity products and had begun slowing sales versus 2018. Management expects the annuity net interest spread to narrow as current products can support target profitability at lower spreads.
- AFG’s modeled sensitivity indicates an immediate 100-basis-point rise in interest rates would reduce after-tax AOCI by an estimated $961 million, after offsets. The filing also notes interest-rate, credit, equity-market, prepayment and reinvestment risks in its investment portfolio.
- Key uncertainties include the adequacy of P&C reserves, asbestos and environmental exposures, reinsurance recoverability, annuity embedded-derivative valuation, and investment impairments. Management scheduled an in-depth internal review of asbestos and environmental liabilities for completion in Q3 2019. No significant change to previously disclosed contingencies was reported.
- AFG adopted lease accounting in 2019, recognizing a $185 million operating lease liability at June 30; adoption was not material to results or liquidity. New credit-loss guidance was scheduled for adoption in 2020, and long-duration insurance accounting changes in 2021, subject to a proposed effective-date delay; AFG said the impacts could not yet be estimated.
- AFG stated that disclosure controls were effective and that there were no material changes in internal control over financial reporting during Q2.
Most important facts for investors to verify
- How much of first-half earnings growth is attributable to fair-value securities gains rather than recurring operating performance, and how comparable AFG’s revised core-earnings measure is to prior periods.
- Whether P&C underwriting trends, especially the higher combined ratio and lower favorable reserve development, persist; assess the quality and sensitivity of reserve estimates.
- How lower interest rates, option costs and FIA derivative accounting affect annuity spreads, sales, reserves and reported earnings; compare GAAP results with management’s non-GAAP core measures.
- The outcome of the scheduled asbestos and environmental reserve review, and developments in reinsurance recoverability and other disclosed contingencies.
- Investment portfolio credit quality and valuation uncertainty, including Level 3 assets, unrealized gains and the stated interest-rate sensitivity.
- Liquidity and funding at the insurance subsidiaries, including the $1.1 billion of FHLB advances due in 2020–2021 and available borrowing capacity.