American Financial Group, Inc. — Q2 2020 Form 10-Q
Reporting period: Quarter and six months ended June 30, 2020. AFG is an insurance holding company focused on specialty property and casualty insurance and fixed and indexed annuities. Amounts below are in millions of dollars except per-share data and ratios.
Financial performance and key metrics
| Metric | Q2 2020 | Q2 2019 | Six months 2020 | Six months 2019 |
|---|---|---|---|---|
| Total revenue | $1,951 | $1,960 | $3,226 | $3,984 |
| Net earnings (loss) attributable to shareholders | $177 | $210 | $(124) | $539 |
| Diluted earnings (loss) per share | $1.97 | $2.31 | $(1.38) | $5.94 |
| Core net operating earnings, non-GAAP | $95 | $192 | $266 | $376 |
| Net cash from operating activities | — | $1,087 | $877 |
- Q2 pretax earnings were $218, versus $259 a year earlier. Six-month pretax results were a loss of $170, compared with earnings of $672.
- Six-month reported results included $347 of realized investment losses, versus $240 of realized gains in 2019. The 2020 loss included a $333 net mark-to-market loss on equity securities and $60 of impairment allowance expense. Q2 realized gains were $204, largely from recovery in equity-security fair values.
- Net investment income declined to $468 in Q2 from $580 and to $1,012 for the first half from $1,122. AFG cited losses on equity-method partnerships and managed CLO investments, lower short-term rates, and higher cash balances.
- P&C net earned premiums were $1,184 in Q2, down 1%; first-half premiums were $2,393, up 1%. Q2 P&C combined ratio was 99.2%, including Neon run-off, versus 95.1%; the Specialty business combined ratio was 95.2%. First-half combined ratio was 96.0% versus 93.9%.
- AFG recorded $85 of COVID-19-related P&C losses in Q2 and $95 in the first half for Specialty operations; approximately 90% of the first-half charges established incurred-but-not-reported reserves. First-half favorable prior-year reserve development was $119 across P&C.
- Annuity pretax earnings were a $17 loss in Q2, versus $71 earnings, and $12 earnings for the first half, versus $161. Q2 annuity core pretax earnings fell to $42 from $104. Fixed-annuity net interest spread was 1.24% in Q2 versus 2.05%; net spread earned, including market-related FIA accounting effects, was negative 0.19% versus positive 0.76%.
Financial position, liquidity and capital
- At June 30, cash and cash equivalents were $2,698, total assets $70,867, shareholders’ equity $6,126, and total liabilities $64,741. Available-for-sale fixed maturities were $48,046 at fair value.
- Long-term debt was $1,912 carrying value ($1,943 principal), up from $1,473 carrying value at year-end 2019. AFG issued $300 of 5.25% senior notes due 2030 and $150 of 5.625% subordinated debentures due 2060. No borrowings were outstanding under its $500 revolving facility, which expires June 2021; no parent-company principal maturities are scheduled for the balance of 2020 or the subsequent five years.
- Debt to total capital, including subordinated debt, rose to 27.8% from 21.7% at year-end; excluding subordinated debt it was 18.9%. Six-month earnings were insufficient to cover fixed charges by $111.
- Six-month operating cash flow was $1,087; investing used $1,296 and financing provided $593. Cash increased $384 to $2,698. AFG repurchased $137 of common stock and paid $81 in dividends during the first half.
- Annuity benefits accumulated were $41,392, compared with $40,406 at year-end. The annuity subsidiary had $1.26 billion of Federal Home Loan Bank advances and estimated additional borrowing capacity of about $740.
- AFG reported $1,030 of after-tax net unrealized gains on marketable securities in AOCI, up from $862 at year-end. These unrealized amounts can fluctuate with markets and do not represent realized earnings.
Material changes, outlook and risks
- Management attributed weaker earnings to COVID-19 disruption, investment-market volatility, lower returns on partnerships and CLOs, lower P&C investment income, reduced underwriting profit, and FIA fair-value effects. First-half annuity sales fell 31% to $1.90 billion; Q2 sales fell 49% to $687. Management expects pandemic restrictions and low rates to continue weighing on annuity sales through 2020.
- AFG expects pandemic and recession impacts to affect premiums and earnings through the remainder of 2020. Management noted possible lower claim frequency in some lines from reduced activity, but COVID-related claims in others; premium grace periods could slow collections. Management reported no material increase in uncollectible premiums to date.
- Management said subsidiary capital and liquidity were adequate to support operations and ratings, but may reduce dividends to the parent if adverse conditions persist. AFG maintained higher-than-usual P&C cash balances. Management also cited continued financial-market volatility and expects it to persist during 2020. No formal earnings guidance was provided.
- AFG’s Lloyd’s insurer Neon is in run-off following the decision to exit the Lloyd’s market. Neon exited lines generated a $52 pretax loss for the first half, including a $44 underwriting loss; AFG acquired the remaining indirect noncontrolling interest in Neon on June 30.
- Potential risks include further COVID-19 claims or losses beyond reserves, investment losses and defaults, persistently low rates, premium payment delays, catastrophe losses, reserve uncertainty, reinsurer collectability, and legal or regulatory actions that could alter coverage or require refunds. Management planned an external asbestos and environmental exposure study in Q3 2020. The filing says there were no other significant changes to previously disclosed contingencies.
- AFG adopted the expected-credit-loss accounting standard in January 2020; adoption increased opening retained earnings by $7. Management could not yet estimate the effect of the forthcoming long-duration insurance accounting standard, then scheduled for 2022, with a proposed one-year delay under consideration.
Most important facts for investors to verify
- Whether COVID-19-related claims, especially IBNR estimates, develop beyond the $95 first-half Specialty loss estimate and how any subsequent estimates affect reserves and combined ratios.
- Whether investment valuations, credit-loss allowances, and returns from equity-method partnerships and CLOs recover or deteriorate further; note that some partnership results are reported on a quarter lag.
- How annuity spreads, crediting-rate reductions, sales volumes, surrenders, and FIA derivative accounting respond to low rates and market volatility.
- Neon’s run-off losses, costs, and remaining obligations, as well as the outcome of the planned asbestos and environmental reserve study.
- Parent and insurance-subsidiary capital, liquidity, ratings, debt levels, and capacity to sustain dividends and share repurchases if conditions worsen.