American Financial Group, Inc. — 2017 Form 10-K
Business and reporting period. AFG is an insurance holding company operating primarily through Great American Insurance Group. Its main businesses are specialty property and casualty insurance and fixed and fixed-indexed annuities. This summary covers the fiscal year ended December 31, 2017, with 2016 as the principal comparable period.
Financial results and position
| Metric | 2017 | 2016 | Change |
|---|---|---|---|
| Total revenues | $6.865 billion | $6.498 billion | Up 6% |
| Earnings before income taxes | $724 million | $787 million | Down 8% |
| Net earnings attributable to shareholders | $475 million | $649 million | Down 27% |
| Diluted GAAP EPS | $5.28 | $7.33 | Down 28% |
| Core net operating earnings (non-GAAP) | $588 million; $6.55 diluted EPS | $534 million; $6.03 diluted EPS | Up 10% and 9% |
| Net cash provided by operating activities | $1.804 billion | $1.150 billion | Up 57% |
| Total assets | $60.658 billion | $55.072 billion | Up 10% |
| Shareholders’ equity | $5.330 billion | $4.916 billion | Up 8% |
- Property and casualty: Net earned premiums grew 6% to $4.579 billion; underwriting gain was $242 million versus $236 million. The GAAP combined ratio was 94.7% versus 94.5% (below 100% indicates an underwriting profit). Catastrophe losses rose to $140 million from $55 million, while favorable prior-year reserve development was $64 million, compared with $32 million adverse development in 2016.
- Annuities: Segment pretax earnings increased 3% to $380 million. Fixed-annuity net spread earned declined to 1.23% from 1.29%. Statutory annuity premiums fell 2% to $4.341 billion, which management attributed to pricing discipline in a low and declining interest-rate environment.
- Investments: Net investment income increased to $1.831 billion from $1.696 billion. Available-for-sale fixed maturities had a fair value of $38.379 billion; 90% were investment grade. Management estimated that an immediate 100-basis-point rate increase would reduce after-tax accumulated other comprehensive income by about $937 million.
- Liquidity and debt: Cash and cash equivalents were $2.338 billion; cash and investments totaled $46.048 billion. Long-term debt was $1.301 billion carrying value, or $1.318 billion principal. Debt-to-capital was 21.8%, including subordinated debt, against management’s stated goal of 25% or lower. The parent had $369 million in cash and securities and $500 million available under its revolving credit facility; no parent borrowings were outstanding under that facility in 2017.
- Cash returns: AFG paid $4.7875 per common share in dividends, including $3.50 in special dividends, and repurchased no shares during 2017.
Material changes and unusual items
- Reported shareholder earnings fell despite higher revenue and core operating earnings. The comparison was materially affected by an $83 million tax expense from revaluing deferred taxes after U.S. corporate tax reform; $56 million of tax benefit from the Neon restructuring; a $51 million pretax debt-retirement loss; lower realized securities gains; and $89 million in special P&C asbestos and environmental reserve charges. In 2016, AFG recorded tax benefits related to the National Interstate merger and Neon restructuring.
- The 2017 P&C A&E charge increased net reserves by $89 million. Net A&E reserves were $403 million, with $125 million of reinsurance recoverables; gross reserves were $528 million. Management noted substantial estimation uncertainty.
- Neon entered into a reinsurance-to-close agreement for 2015 and prior years of account. It transferred associated legacy liabilities and produced $42 million favorable reserve development, including $18 million on exited lines.
- AFG issued new senior notes and redeemed higher-coupon debt, including $350 million of 9.875% notes at a $38 million make-whole premium. The reported debt weighted-average interest rate declined to 4.6% from 6.5%.
- U.S. tax reform lowered the federal corporate rate to 21%. Management expected an effective tax rate of approximately 20% in 2018, while noting that implementation guidance could affect estimates.
Outlook, commentary and risks
- Management emphasized disciplined specialty underwriting and said it may limit growth or exit markets that do not meet profitability objectives. Overall P&C renewal rates increased approximately 1% in 2017.
- Management expects annuity net interest spreads to narrow, reflecting lower reinvestment yields. In 2017, assets yielding 5.14% that matured or were sold were replaced with investments purchased at an average 3.94% yield.
- Key exposures include catastrophe severity and frequency, reserve adequacy (especially long-tail, asbestos and environmental claims), reinsurance availability and collectibility, interest-rate and credit-market movements, and annuity surrender and spread risks. AFG estimated that a 1% change in cost trends in certain major P&C lines could affect net earnings by $10 million to $75 million, depending on the line.
- Annuity distribution is concentrated: financial institutions generated 54% of annuity premiums, and two institutions represented 17% of total annuity sales. The DOL fiduciary rule remained subject to delay and change; management anticipated possible short-term sales disruption but did not expect a material effect on results.
- Other disclosed risks include regulatory and tax changes, competition, cyber and data-security events, Brexit-related uncertainty for UK operations, and limits on dividends from insurance subsidiaries. Up to $826 million could be distributed by insurance subsidiaries to AFG in 2018 without prior regulatory approval.
- Auditors issued an unqualified opinion on the financial statements and internal controls; management also concluded disclosure controls and internal control over financial reporting were effective at year-end.
Important facts for investors to verify
- Reconcile the $174 million decline in GAAP shareholder earnings with the 10% increase in non-GAAP core earnings, including tax, reserve, securities and debt-retirement items.
- Review P&C reserve development, catastrophe losses, the 2017 A&E study, and the assumptions and recoverability behind reinsurance balances.
- Assess whether annuity spreads can withstand lower reinvestment yields, and monitor the mix and concentration of annuity distribution.
- Confirm the effect of tax reform and subsequent implementation guidance on the 2018 effective tax rate and deferred tax balances.
- Evaluate debt refinancing, insurer dividend capacity, capital adequacy and the sensitivity of investment values and annuity liabilities to interest-rate changes.