American Financial Group, Inc. — Q1 2014 Form 10-Q
Reporting period: Three months ended March 31, 2014; comparisons are with Q1 2013 unless otherwise noted. AFG primarily operates in specialty property and casualty insurance and fixed and fixed-indexed annuities.
Financial performance and position
| Metric | Q1 2014 | Q1 2013 / prior date |
|---|---|---|
| Total revenue | $1.211 billion | $1.148 billion |
| Earnings before income taxes | $161 million | $175 million |
| Net earnings attributable to shareholders | $103 million; diluted EPS $1.13 | $120 million; diluted EPS $1.32 |
| Core net operating earnings, non-GAAP | $91 million; diluted $1.00 per share | $84 million; diluted $0.92 per share |
| Net investment income | $361 million | $326 million |
| Realized gains on securities | $19 million | $57 million |
| Operating cash flow | $204 million | $59 million |
| Cash and cash equivalents | $1.876 billion at March 31 | $1.639 billion at December 31, 2013 |
| Total assets / total equity | $42.770 billion / $4.973 billion | $42.087 billion / $4.769 billion at December 31, 2013 |
| Long-term debt | $913 million | $913 million at December 31, 2013 |
Revenue grew about 5.5%, while shareholder net earnings fell about 14%. Higher P&C underwriting results and investment income were outweighed by lower realized securities gains and slightly lower annuity earnings. Core earnings increased about 8%. Operating cash flow rose mainly because of the timing of P&C claims payments and reinsurance recoveries; investing used $426 million and financing provided $459 million. The quarterly common dividend was $0.22 per share, versus $0.195 a year earlier.
Business results and material changes
- Property and casualty: Pretax earnings increased to $112 million from $99 million. Net earned premiums rose 10% to $754 million; gross written premiums increased 11% to $1.024 billion, led by 18% growth in Specialty casualty. The aggregate combined ratio improved to 92.2% from 93.8%; underwriting profit was $58 million versus $43 million. Results included $32 million of favorable prior-year reserve development and $12 million of catastrophe losses.
- Annuities: Pretax earnings declined to $73 million from $76 million. Annuity premiums increased 55% to $967 million, primarily from fixed-indexed sales through financial institutions. The fixed-annuity net interest spread narrowed to 2.81% from 2.99%; net spread earned was 1.30% versus 1.58%.
- Run-off long-term care and life: Pretax loss was $2 million versus $1 million. Long-term-care benefit expense increased, primarily due to more new claims.
- Investments and comprehensive income: Net unrealized gains on securities increased; other comprehensive income was $120 million, contributing to shareholder comprehensive income of $220 million. Available-for-sale fixed maturities were $27.390 billion at fair value; approximately 86% of fixed maturities were investment grade.
- Debt and liquidity: Debt to total capital was 17.3%, compared with 17.6% at year-end 2013. AFG had no borrowings on its $500 million parent revolving facility; National Interstate had $12 million outstanding on its $100 million facility. Management said it believes parent and insurance subsidiaries have sufficient liquidity.
Outlook, commentary, and risks
- Management expects annuity net interest spread to continue narrowing as higher-yielding investments run off. It expects full-year 2014 net spread earned on fixed annuities of approximately 1.35%–1.40%, compared with 1.30% in Q1 and 1.60% for full-year 2013.
- On April 1, 2014, after quarter-end, AFG acquired Summit Holding Southeast for approximately $260 million at closing and contributed approximately $140 million of additional capital, for an indicated total investment of about $400 million, subject to post-closing adjustments. Summit reported over $500 million in 2013 net written premiums; its results are to be included from Q2 2014.
- AFG entered a catastrophe reinsurance agreement providing up to $95 million of fully collateralized coverage for qualifying losses above $100 million from April 2014 through December 2016; stated annual cost is approximately $5 million.
- Key exposures include insurance-reserve estimation, particularly long-term care, asbestos, environmental and mass-tort claims; reinsurer collectability; investment valuation and impairment; interest-rate and market movements; catastrophe losses; and annuity persistency, mortality and morbidity. AFG estimated that an immediate 100-basis-point rate increase would reduce fixed-maturity fair value by approximately $1.246 billion pretax.
- AFG reported no significant changes to previously disclosed contingencies. Management concluded disclosure controls were effective and reported no material first-quarter change in internal control over financial reporting.
Important facts for investors to verify
- Whether favorable P&C prior-year reserve development and the improved combined ratio persist, and how catastrophe losses evolve.
- Reserve adequacy and claim trends in long-term care, asbestos, environmental and other mass-tort exposures.
- Investment portfolio credit quality, fair-value assumptions, unrealized losses and sensitivity to interest rates, including Level 3 valuations.
- Whether annuity spread pressure continues and whether the stated 2014 spread outlook is achieved.
- Summit’s final acquisition cost, integration, capital needs and contribution to results beginning in Q2.
- Cash generation and the timing of claims recoveries, as well as the collectability of reinsurance recoverables.