American Financial Group, Inc. — Q3 2018 Form 10-Q
Reporting period: Quarter and nine months ended September 30, 2018. AFG primarily operates in specialty property and casualty insurance and annuities. Amounts below are in millions of dollars except per-share data and ratios.
Financial results and position
| Metric | Q3 2018 | Q3 2017 | Nine months 2018 | Nine months 2017 |
|---|---|---|---|---|
| Total revenues | $2,008 | $1,835 | $5,460 | $5,057 |
| Earnings before income taxes | $244 | $29 | $678 | $457 |
| Net earnings attributable to shareholders | $204 | $11 | $559 | $309 |
| Diluted earnings per share | $2.26 | $0.13 | $6.17 | $3.44 |
| Core net operating earnings, non-GAAP | $198 | $95 | $602 | $391 |
| Diluted core earnings per share, non-GAAP | $2.19 | $1.06 | $6.65 | $4.35 |
- Premiums and investment income: P&C net earned premiums were $1,327 in Q3, up 5%, and $3,595 for nine months, up 7%. Net investment income was $527 in Q3, up 12%, and $1,552 for nine months, up 14%.
- P&C underwriting: Aggregate combined ratio, including exited lines, improved to 97.2% in Q3 from 106.4%, and to 94.4% for nine months from 97.9%. A ratio below 100% indicates underwriting profit. Catastrophe losses were $35 in Q3 versus $107, and $64 for nine months versus $132. Favorable prior-year reserve development also contributed to results.
- Annuities: Pretax earnings were $117 in Q3, up 15%, and $341 for nine months, up 20%. Fixed-annuity net spread earned was 1.35% in both Q3 and year-to-date 2018; corresponding 2017 figures were 1.31% and 1.23%.
- Cash flow: For nine months, operating cash flow was $1,277 versus $993; investing activities used $3,375 versus $2,230; financing activities provided $1,769 versus $1,479. Cash and cash equivalents ended the period at $2,009, down $329 from year-end 2017.
- Balance sheet and debt: Total assets were $64,190 and shareholders’ equity $5,164, compared with $60,658 and $5,330 at year-end 2017. Long-term debt carrying value was $1,302; principal was $1,318. Debt to total capital was 20.6% including subordinated debt and 15.9% excluding it. The $4,807 of managed-investment-entity liabilities is associated with consolidated CLOs and is described as nonrecourse to AFG.
- Investment marks: AOCI fell to $44 from $813 at year-end, reflecting primarily a $548 after-tax other comprehensive loss, including unrealized securities losses. Available-for-sale fixed maturities had a $543 gross unrealized loss at quarter-end.
Material changes and drivers
- GAAP shareholder earnings rose sharply year over year, reflecting higher core earnings, lower catastrophe losses and lower A&E reserve charges, as well as the lower federal corporate tax rate. Q3 also included $34 of realized securities gains versus $12 of losses in Q3 2017; nine-month realized losses were $28 versus $1.
- Core earnings growth came from improved P&C underwriting and annuity results, higher P&C investment income and lower interest expense. The nine-month comparison also benefited from more favorable prior-year reserve development.
- Renewal pricing in P&C increased approximately 2% in Q3 and 1% in the first nine months overall; excluding workers’ compensation, increases were approximately 3%. Q3 gross written premiums were flat, with growth in specialty casualty and financial offset by lower property and transportation premiums.
- Annuity statutory premiums increased 57% in Q3 and 14% for nine months. Management attributed growth to new products, expansion in retail and broker-dealer markets, and an improving interest-rate environment.
- New accounting guidance adopted in 2018 requires most equity securities to be carried at fair value through earnings. AFG recorded $35 of holding losses on equity securities still owned at September 30 in the first nine months. Adoption also reclassified a $221 net unrealized gain from AOCI to retained earnings; this was an accounting presentation change.
Outlook, commentary, and risks
- No formal numerical earnings or revenue guidance is provided in the supplied filing text. Management says high returns from limited partnerships and similar investments should not necessarily repeat, and expects annuity net interest spreads to narrow over time.
- In Q2, AFG recorded a $27 net charge from updating annuity actuarial assumptions, primarily due to higher projected option costs, partly offset by higher assumed reinvestment rates. Interest-rate and equity-market movements can make annuity derivative marks volatile; management expects interest accretion on embedded annuity derivatives to continue increasing.
- AFG recorded Q3 special pretax A&E charges of $18 in P&C and $9 for former railroad and manufacturing exposures, versus $89 and $24, respectively, in Q3 2017. P&C A&E reserves were $398 net of reinsurance at September 30. Management identifies reserve adequacy and legacy railroad/manufacturing contingencies as important areas of potential loss.
- Management says it believes investment losses are recoverable and it has no intent to sell affected fixed maturities, but a change in ability or intent to hold could require impairment charges. AFG estimated that a 100-basis-point rate increase would reduce fixed-maturity fair value by 4.5% and after-tax AOCI by approximately $842.
- Other disclosed risks include catastrophe losses, reinsurance availability and collectability, interest rates and credit quality, annuity persistency and mortality, regulatory and tax changes, competition, and cyber or technology disruptions. The filing reports no significant change to previously disclosed contingencies.
- Liquidity: management states it believes resources are sufficient. AFG had no borrowings under its $500 revolving credit facility, which expires in June 2021. Annuity subsidiary GALIC had $871 of FHLB advances and estimated approximately $300 of additional borrowing capacity.
- After quarter-end, AFG declared a $1.50-per-share special cash dividend, payable November 26, 2018, totaling approximately $134. AFG paid another $1.50-per-share special dividend in May 2018. It made no open-market share repurchases in the first nine months; it repurchased 12,500 shares between October 1 and November 6.
Most important facts for investors to verify
- How much of earnings growth is sustainable after accounting for lower catastrophe losses, favorable reserve development, tax changes, and volatile investment returns and marks.
- Whether P&C reserve development remains favorable and whether A&E, former railroad and manufacturing, and other long-tail liabilities are adequately reserved.
- Whether annuity investment spreads can withstand reinvestment at lower yields, rising crediting costs, option costs, and market-related derivative volatility.
- The quality and liquidity of the investment portfolio, including unrealized losses, Level 3 valuations, credit exposure, and potential impairment risk.
- The parent company’s capacity to fund dividends and other obligations, and the effect of the post-quarter special dividend on capital and liquidity.