American Financial Group, Inc. — 2015 Form 10-K
Business context and reporting period. AFG is an insurance holding company focused on specialty property and casualty insurance and fixed and fixed-indexed annuities, with additional run-off life and long-term-care operations and other businesses. This filing covers the fiscal year ended December 31, 2015; comparisons are primarily with 2014. Filed February 26, 2016.
Key financial results
| Metric | 2015 | 2014 | Change / context |
|---|---|---|---|
| Total revenue | $6.145 billion | $5.733 billion | Up 7% |
| Earnings before tax | $565 million | $626 million | Down 10% |
| Net earnings attributable to shareholders | $352 million | $452 million | Down 22%; diluted EPS $3.94 vs. $4.97 |
| Core net operating earnings (non-GAAP) | $486 million | $439 million | Up 11%; diluted per-share amount $5.44 vs. $4.82 |
| Operating cash flow | $1.357 billion | $1.222 billion | Up 11%; investing cash use was $4.577 billion and financing cash provided was $3.097 billion |
| Cash and investments | $37.736 billion | $36.210 billion | At December 31 |
| Total assets / shareholders’ equity | $49.859 billion / $4.592 billion | $47.535 billion / $4.879 billion | Equity declined, including from lower unrealized investment gains |
| Long-term debt | $1.020 billion | $1.061 billion | Debt-to-capital ratio 18.5%, down from 19.2% |
Insurance and investment performance
- Property and casualty: Gross written premiums rose 6% to $5.832 billion and net earned premiums rose 9% to $4.224 billion. Underwriting gain increased to $225 million from $212 million. The GAAP combined ratio was 94.7% versus 94.5% (below 100% indicates underwriting profit); the statutory ratio improved to 92.5% from 93.6%. Core pretax earnings rose 20% to $577 million.
- Annuities: Annuity segment pretax earnings were $331 million, up slightly from $328 million. Statutory annuity premiums increased 12% to $4.140 billion. Fixed-annuity net spread earned narrowed to 1.26% from 1.41%, reflecting lower investment yields and other factors.
- Investments: Net investment income increased to $1.633 billion from $1.501 billion. Realized securities results shifted to a $19 million loss from a $52 million gain; 2015 included $125 million of net impairment charges. AFG reported a $719 million net unrealized gain on fixed maturities at year-end, while shareholders’ equity’s net unrealized investment gain component fell to $278 million from $604 million.
- Liquidity and capital: Parent AFG held approximately $252 million in cash and securities and had an undrawn $500 million revolving facility expiring in December 2016. Insurance subsidiaries’ capital ratios substantially exceeded regulatory risk-based capital requirements. Up to approximately $809 million of subsidiary dividends was available to the parent in 2016 without regulatory clearance.
Material changes versus 2014
- Reported shareholder earnings declined mainly because AFG recorded a $166 million pretax loss on the sale of substantially all of its run-off long-term-care business, higher asbestos and environmental (A&E) reserve charges, and realized securities losses rather than gains. These effects were partly offset by stronger core operating earnings and gains on hotel and apartment property sales.
- Core P&C underwriting profit and investment income increased; the combined ratio nevertheless edged up as the underwriting expense ratio rose.
- Annuity sales recovered, but fixed-annuity spreads continued to compress. The company said it expects net interest spread to narrow in the future.
- AFG sold the long-term-care businesses in December 2015. It received approximately $18 million in cash and securities at closing, may receive up to $13 million in additional proceeds subject to conditions, and agreed to provide up to $35 million of capital support, subject to reimbursement under a five-year HC2 capital-maintenance agreement. AFG also reported expected tax benefits of $97 million related to the transaction.
- AFG repurchased approximately 2.0 million shares for $126 million and paid a $1.00-per-share special dividend in December, in addition to regular dividends. The quarterly regular dividend was increased to $0.28 per share during 2015.
Outlook, commentary, risks and unusual items
- Management emphasizes specialty-market growth subject to underwriting profitability, and stated that it will avoid business not expected to earn an underwriting profit. No specific consolidated earnings or revenue guidance is provided in the supplied filing text.
- AFG hired a new Marketform management team in October 2015 to review operations and improve profitability; Marketform had adverse prior-year reserve development of $44 million in 2015.
- Reserve estimates are a major uncertainty. The 2015 external A&E review led to a $67 million pretax P&C charge—$25 million for asbestos and $42 million for environmental claims, net of reinsurance. A separate $12 million charge related to former railroad and manufacturing operations. Management cautions actual liabilities could differ materially; it says a 1% variation in A&E loss-cost trends could change net income by about $20 million.
- Other key exposures include catastrophe and severe-weather losses, workers’ compensation and commercial-auto reserve development, reinsurance collectability, low interest rates and annuity spread compression, market and credit risk in the investment portfolio, and competition. A 100-basis-point increase in rates was estimated to reduce fixed-maturity fair value by approximately $1.627 billion and after-tax AOCI by approximately $589 million, after offsets.
- AFG’s annuity results are exposed to market movements and actuarial assumptions; fixed-indexed annuities represented about 60% of accumulated annuity benefits. Fair-value accounting for embedded derivatives can create earnings volatility that management says may not reflect the products’ long-term economics.
- Other notable items include $66 million pretax gains on hotel and apartment property sales, the $166 million long-term-care sale loss, and the change in CLO accounting presentation adopted in 2015, which management said did not affect net earnings attributable to shareholders.
Most important facts for investors to verify
- Whether P&C premium growth and underwriting profitability persist, and how renewal pricing and catastrophe losses develop.
- Subsequent reserve development, especially A&E, Marketform, commercial auto and workers’ compensation; also review the assumptions behind the $8.127 billion gross P&C loss and LAE reserve.
- Actual long-term-care sale proceeds, realization of the stated tax benefits, and any capital-support payments or reimbursements under the HC2 agreement.
- Whether annuity investment yields and crediting costs sustain adequate spreads, and the sensitivity of earnings to interest rates, equity markets, surrenders and benefit assumptions.
- Investment impairment and reinsurance risks, including recoverables, portfolio credit quality and the effect of market-value changes on capital and liquidity.
- Renewal of the parent’s $500 million revolving credit facility before its December 2016 expiry, and the capacity of regulated insurance subsidiaries to continue supporting parent dividends and capital returns.