AMERICAN FINANCIAL GROUP INC quarterly report, Q3 FY2017

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Business Context and Reporting Period

American Financial Group, Inc. (AFG) filed this unaudited Form 10-Q for the quarter and nine months ended September 30, 2017. AFG primarily writes specialty property and casualty insurance and sells fixed and fixed-indexed annuities; it also reports run-off long-term care and life operations and holding-company activities.

Key Financial Metrics

Dollar amounts are in millions except per-share data.

  • Third-quarter revenue: $1,835, up 8% from $1,705 a year earlier. Net earnings attributable to shareholders were $11, or $0.13 diluted per share, versus $109, or $1.23 per share.
  • Nine-month revenue: $5,057, up 6% from $4,761. Net earnings attributable to shareholders were $309, or $3.44 diluted per share, versus $264, or $2.98 per share.
  • Core net operating earnings (non-GAAP): Third-quarter earnings were $95 ($1.06 diluted per share), down from $134 ($1.51). Nine-month earnings were $391 ($4.35), up from $358 ($4.04).
  • Cash flow, nine months: Operating cash flow was $993, compared with $746; investing cash outflow was $2,230, compared with $2,519; financing cash inflow was $1,479, compared with $2,192. Cash increased $242 to $2,349.
  • Balance sheet at September 30: Total assets were $60,163; total liabilities $54,784; shareholders’ equity $5,379. Cash and investments totaled $45,253.
  • Debt and liquidity: Long-term debt had a $1,284 carrying value and $1,303 principal amount. Debt-to-total-capital was 21.2% including subordinated debt (16.3% excluding it). AFG had no borrowings on its $500 revolving credit facility. Its annuity subsidiary had $935 of Federal Home Loan Bank advances.
  • Insurance and annuity measures: Third-quarter P&C aggregate combined ratio, including exited lines, was 106.4%; Specialty’s ratio was 99.3%. For nine months, the aggregate ratio was 97.9%. Fixed-annuity net spread earned was 1.31% in the quarter and 1.23% for nine months.
  • Dividends: Cash dividends were $0.3125 per common share in the third quarter. Nine-month dividends were $2.4375 per share, including a $1.50 special dividend.

Material Changes Versus the Prior Comparable Period

  • Third-quarter shareholder earnings fell sharply, primarily because of catastrophe losses, higher asbestos and environmental (A&E) charges, and securities impairment losses. Nine-month earnings increased, helped by higher annuity earnings and lower realized securities losses than in 2016, partly offset by higher A&E charges and lower P&C underwriting results.
  • Third-quarter catastrophe losses were $107, principally from Hurricanes Harvey, Irma and Maria and two Mexican earthquakes, versus $14 in 2016. The nine-month total was $132 versus $43.
  • AFG recorded $113 of third-quarter pretax A&E charges: $89 in P&C insurance reserves and $24 related to former railroad and manufacturing operations. The comparable 2016 charges totaled $41.
  • P&C net earned premiums rose 9% in the quarter and 5% for nine months. Nine-month P&C core underwriting gain declined to $158 from $227; the overall nine-month combined ratio rose to 97.9% from 96.0%.
  • Nine-month annuity pretax earnings increased 20% to $283. However, third-quarter annuity pretax earnings declined 5% to $102, and the fixed-annuity net interest spread narrowed to 2.69% from 2.85%.
  • AFG issued $350 of 4.50% senior notes due 2047 and redeemed $355 principal amount of older senior notes. The refinancing is expected to reduce annual pretax interest expense by $6; a $11 nine-month loss on debt retirement was recorded.

Outlook, Commentary, Risks and Unusual Items

  • AFG did not provide specific earnings guidance in the supplied filing text. Management said annuity net interest spreads are expected to narrow as reinvestment yields remain below yields on maturing investments.
  • Management attributed lower quarterly P&C results to catastrophe activity. It reported that renewal rates increased approximately 1% in the quarter and that pricing discipline contributed to lower third-quarter annuity sales.
  • AFG estimated that the Department of Labor Fiduciary Rule could cause some short-term disruption to annuity premiums, but management did not expect a material effect on results. Implementation timing and the rule’s final form remained uncertain.
  • As a subsequent event, October 2017 Northern California wildfires were expected to cause fourth-quarter pretax losses, net of reinsurance and associated offsets, of $20–$25; the midpoint was estimated to reduce EPS by about $0.18.
  • Key exposures include catastrophe severity, reserve adequacy—especially A&E and mass-tort claims—reinsurance recoverability, investment-market and interest-rate movements, annuity guarantees, and regulatory or tax changes. AFG said its P&C A&E reserves were $408 net of reinsurance at September 30.
  • A 100-basis-point immediate rise in interest rates was estimated to reduce after-tax AOCI by $753, after related balance-sheet offsets. About 5% of assets carried at fair value were Level 3; AFG noted limited transparency for many broker-quoted valuations.
  • The third-quarter effective tax rate was 62%, reflecting a valuation allowance against Neon catastrophe-loss tax benefits; excluding those catastrophe losses, the rate was 22%. Securities impairment charges contributed to third-quarter realized losses of $12.
  • Management concluded disclosure controls were effective and reported no material change in internal control over financial reporting during the quarter. AFG also cautioned that interim results are not necessarily indicative of full-year results.

Important Facts for Investors to Verify

  • Track subsequent catastrophe claims, reinsurance recoveries and the final cost of the October California wildfires.
  • Review future development of P&C reserves, particularly the A&E exposures and the reasons for the 2017 reserve strengthening.
  • Monitor P&C loss trends and combined ratios after the elevated catastrophe losses, alongside premium growth and renewal pricing.
  • Assess annuity investment yields, crediting rates, spread compression, sales trends and fair-value volatility in fixed-indexed annuity derivatives.
  • Confirm parent-company liquidity, debt maturities and compliance with credit-facility covenants; distinguish AFG debt from nonrecourse managed-entity liabilities and policyholder obligations.
  • Review the assumptions supporting investment valuations and potential credit impairments, including the sensitivity of AOCI to market and interest-rate changes.