American Financial Group, Inc. — Q2 2013 Form 10-Q
Business context and period. This unaudited report covers the quarter and six months ended June 30, 2013, compared with the corresponding 2012 periods. AFG primarily operates in specialty property and casualty insurance and fixed and fixed-indexed annuities. Its Medicare supplement and critical illness businesses were sold in August 2012, affecting period-to-period comparisons.
Key financial results
Amounts are in millions of dollars except per-share data and ratios.
| Metric | Q2 2013 | Q2 2012 | Six months 2013 | Six months 2012 |
|---|---|---|---|---|
| Total revenue | $1,139 | $1,124 | $2,287 | $2,211 |
| Earnings before tax | $126 | $136 | $301 | $282 |
| Net earnings attributable to shareholders | $110 | $99 | $230 | $212 |
| Diluted earnings per share | $1.20 | $1.01 | $2.52 | $2.15 |
| Core net operating earnings (non-GAAP) | $87 | $90 | $171 | $175 |
| Cash provided by operating activities | — | $196 | $226 |
- Revenue and earnings: Q2 shareholder earnings rose 11% and diluted EPS rose 19%; six-month shareholder earnings increased 8%. Higher realized securities gains contributed materially: $41 million in Q2 and $98 million year to date, versus $16 million and $60 million, respectively, in 2012. Core earnings declined 3% in Q2 and 2% year to date.
- Property and casualty: Q2 net earned premiums grew 11% to $709 million, while pretax earnings fell 25% to $79 million. The aggregate combined ratio increased to 97.2% from 92.9% (below 100% indicates underwriting profit). For the first six months, earned premiums rose 12% to $1.396 billion, pretax earnings fell 14% to $178 million, and the combined ratio was 95.5% versus 92.5%.
- Annuity: Q2 pretax earnings increased 31% to $77 million; six-month pretax earnings increased 29% to $153 million. Growth and favorable effects from rising interest rates and investment results helped, partly offset by runoff of higher-yielding investments. Fixed-annuity net spread earned was 1.65% in Q2 and 1.61% for six months, excluding the ELNY assessment.
- Cash flow and capital: Six-month operating cash flow was $196 million, investing cash outflow was $1.192 billion, and financing cash inflow was $562 million. Cash and cash equivalents declined $434 million to $1.271 billion. AFG attributed the operating cash-flow decrease in part to a $124 million asbestos settlement payment accrued in prior years.
- Balance sheet and debt: At June 30, total assets were $39.414 billion, total liabilities $34.776 billion, and total equity $4.638 billion. Long-term debt was $949 million, down from $953 million at year-end. Debt to total capital was 18.6% (17.6% excluding real-estate-secured debt). AFG had no borrowings on its $500 million revolving credit facility; subsidiary National Interstate had $12 million outstanding on its $100 million facility.
- Other balance-sheet and market measures: Available-for-sale fixed maturities were $25.035 billion at fair value. Net unrealized gains on securities included in AOCI declined to $600 million from $823 million at year-end; shareholders’ equity was $4.473 billion, versus $4.578 billion at year-end. A 100-basis-point immediate increase in interest rates was estimated to reduce fixed-maturity fair value by $1.140 billion, or 4.5%.
Material changes, outlook, and risks
- AFG said higher annuity profits and securities gains were partly offset by lower P&C underwriting profit and investment income, and the absence of earnings from the sold Medicare supplement and critical illness businesses.
- P&C catastrophe losses were $19 million in Q2, compared with $6 million a year earlier; six-month losses were $29 million versus $9 million. Spring storms in the southeastern U.S. were a principal factor. Property and transportation reported a Q2 underwriting loss of $31 million and a six-month loss of $21 million, reflecting transportation results and catastrophe losses.
- Management said delayed crop acreage reporting reduced P&C premiums in the first half and expected delayed premiums to be included in Q3 results. Overall renewal rates increased about 5% in Q2; management said it would pursue rate increases and reduce transportation premium volume as needed to improve profitability.
- AFG expected annuity net interest spread to narrow as higher-yielding investments run off, and projected fixed-annuity net spread earned of approximately 1.30%–1.40% in the second half of 2013, compared with about 1.60% in Q2 and the first half. Management cited competition and new market entrants as factors affecting annuity sales.
- The run-off long-term-care and life segment recorded a pretax loss of $2 million in Q2 and $3 million for six months, versus profits of $5 million and $6 million in the prior-year periods. Management attributed higher long-term-care benefit costs primarily to increased new claims and warned of period-to-period claims volatility.
- AFG recorded a $5 million pretax ($3 million after-tax) charge for expected state guaranty-fund assessments related to Executive Life Insurance Company of New York. Management did not expect significant additional ELNY charges. The separate $124 million A.P. Green asbestos settlement was paid in Q2 and had been accrued in prior years.
- Key risks identified include insurance reserve adequacy, especially asbestos, environmental, mass-tort and run-off long-term-care claims; reinsurance collectability; catastrophe and severe-weather losses; investment valuation and interest-rate or credit-market movements; annuity persistency, spreads and competition; and legal, regulatory, economic and rating changes. AFG reported no significant change in its previously disclosed contingencies apart from the A.P. Green payment.
- The filing provides no broad full-year earnings guidance. Statements about Q3 crop premiums and second-half annuity spreads are management expectations, not guarantees. Management stated disclosure controls were effective and reported no material second-quarter change in internal control over financial reporting.
Important facts for investors to verify
- Whether P&C pricing, transportation underwriting and catastrophe experience improve, and whether delayed crop premiums materialize in Q3.
- Whether favorable annuity earnings persist as higher-yielding assets mature, and whether second-half net spread earned falls within management’s 1.30%–1.40% estimate.
- Long-term-care claim trends and adequacy of insurance reserves, including asbestos, environmental and other mass-tort exposures.
- Investment portfolio valuation, unrealized-loss recovery assumptions, rate sensitivity and exposure to non-agency mortgage-backed securities.
- Operating cash generation, liquidity at the parent and insurance subsidiaries, and the effect of debt obligations and share repurchases.
- The treatment of non-GAAP core earnings and one-time or market-sensitive items, including securities gains, ELNY assessments and managed investment entity results.