Net cash used in investing activities was $3.29 billion in 2017 compared to $2.98 billion in 2016, an increase of $311 million. Purchases of fixed maturities and equity securities exceeded maturities, redemptions and sales by $2.95 billion in 2017 compared to $2.04 billion in 2016, accounting for a $912 million increase in cash used in investing activities in 2017 compared to 2016. Settlements of equity index call options exceeded purchases by $285 million in 2017 compared to purchases exceeding settlements by $110 million in 2016, accounting for a $395 million decrease in cash used in investing activities. In general, purchases of equity index call options have increased due to growth in the fixed-indexed annuity business while proceeds from settlements of equity options are impacted by the performance of the stock market during the term of the options. Net investment activity in the managed investment entities was a $205 million use of cash in 2017 compared to a $364 million use of cash in 2016, accounting for a $159 million decrease in net cash used in investing activities in 2017 compared to 2016.
Net cash provided by financing activities was $1.72 billion in 2017 compared to $2.72 billion in 2016, a decrease of $999 million. Annuity receipts exceeded annuity surrenders, benefits, withdrawals and transfers by $1.99 billion in 2017 compared to $2.35 billion in 2016, resulting in a $362 million decrease in net cash provided by financing activities in 2017 compared to 2016. In 2017, AFG issued $590 million of 4.50% Senior Notes due in 2047 and $125 million of 3.50% Senior Notes due in 2026, the net proceeds of which contributed $712 million to net cash provided by financing activities in 2017 compared to net proceeds from additional long-term borrowings of $302 million in 2016, which accounted for a $410 million increase in cash provided by financing activities in 2017 compared to 2016. Redemptions of long-term debt were a $745 million use of cash in 2017 and an $18 million use of cash in 2016, which accounted for a $727 million decrease in net cash provided by financing activities in 2017 compared to 2016. There were no shares of AFG Common Stock repurchased in 2017 compared to $133 million repurchased in 2016. In addition to its regular quarterly cash dividends, AFG paid special cash dividends of $3.50 per share and $1.00 per share of American Financial Group Common Stock in 2017 and 2016, respectively, which resulted in total cash dividends of $417 million in 2017 compared to $185 million in 2016. Additionally, in 2016, $315 million was used to fund the acquisition of the noncontrolling interest in National Interstate Corporation. Issuances of managed investment entity liabilities exceeded retirements by $146 million in 2017 compared to $693 million in 2016, accounting for a $547 million decrease in net cash provided by financing activities in 2017 compared to 2016.
AFG can borrow up to $500 million under its revolving credit facility which expires in June 2021. Amounts borrowed under this agreement bear interest at rates ranging from 1.00% to 1.875% (currently 1.375%) over LIBOR based on AFG’s credit rating. There were no borrowings under this agreement, or under any other parent company short-term borrowing arrangements, during 2018.
Dollar amounts and time periods are estimates based on historical net payment patterns applied to the gross reserves and do not represent actual contractual obligations. Based on the same assumptions, AFG projects reinsurance recoveries related to these reserves totaling $2.94 billion as follows: Within 1 year - $800 million; 2-3 years - $800 million; 4-5 years - $300 million; and thereafter - $1.04 billion. Actual payments and their timing could differ significantly from these estimates.
Approximately $417 million of the $689 million in gross reserves of foreign operations relate to the operations of Neon Underwriting Limited, AFG’s wholly-owned United Kingdom-based Lloyd’s insurer. Neon writes cargo, cyber, financial lines, marine and energy liability, marine hull and war, personal accident and health, political and trade risk, professional indemnity, property reinsurance and terrorism and political violence insurance. Significant variables in estimating Neon’s loss reserves include:
Specialty financial Commissions and other underwriting expenses as a percentage of net earned premiums decreased 4.0 percentage points in the fourth quarter of 2018 compared to the fourth quarter of 2017 reflecting lower profitability-based commissions paid to agents in the financial institutions business and the impact of higher premiums on the ratio in the international operations.
The net spread on fixed annuities before the impact of unlocking and derivatives related to FIAs decreased 0.59 percentage points to 0.81% for the fourth quarter of 2018 from 1.40% for the fourth quarter of 2017 due primarily to the impact of poor stock market performance on annuities with guaranteed withdrawal benefits. As previously noted, if the stock market performance reverts back to AFG’s long-term expectation over the life of these policies, a substantial portion of this unfavorable impact would be expected to reverse.
In the fourth quarter of 2018, the 14% decline in the S&P 500 Index had a $27 million unfavorable impact on the derivatives related to FIAs compared to a $9 million favorable impact of strong stock market performance on these derivatives in the fourth quarter of 2017. The derivatives related to FIAs were unfavorably impacted by lower than expected interest rates in the fourth quarter of both 2018 and 2017. Management believes that the majority of this impact is non-economic and is expected to reverse over time, even in the absence of a stock market recovery.
Segmented Statement of Earnings AFG reports its business as three segments: (i) Property and casualty insurance (“P&C”), (ii) Annuity and (iii) Other, which includes run-off long-term care and life, holding company costs and income and expenses related to the managed investment entities (“MIEs”).
Underwriting profit for this group was $104 million in 2017 compared to $78 million in 2016, an increase of $26 million (33%), reflecting favorable reserve development within Neon, including the portion of the 2015 and prior years reinsurance to close transaction attributed to ongoing lines of business, and higher underwriting profits in the excess and surplus lines and workers’ compensation businesses. These improved results were partially offset by lower underwriting profit in the executive liability business, due primarily to lower favorable prior year reserve development, adverse prior year reserve development in the targeted markets operations and higher catastrophe losses. Catastrophe losses were $71 million (3.3 points on the combined ratio) and related net reinstatement premiums were $6 million in 2017 compared to catastrophe losses of $10 million (0.5 points) in 2016.
The current accident year loss and LAE ratio, excluding catastrophe losses for AFG’s Specialty property and casualty insurance operations was 63.6% in 2018, 62.9% in 2017 and 61.8% in 2016.
Specialty financial The loss and LAE ratio for the current year, excluding catastrophe losses is comparable in 2018 and 2017.
AFG generally seeks to reduce its exposure to catastrophes through individual risk selection, including minimizing coastal and known fault-line exposures, and the purchase of reinsurance. AFG recorded net catastrophe losses of $103 million in 2018 primarily from mudslides in California in the first quarter, storms and flooding in several regions of the United States in the second quarter, Hurricane Florence in the third quarter and Hurricane Michael and wildfires in California in the fourth quarter. Catastrophe losses of $140 million in 2017 resulted primarily from storms and tornadoes in several regions of the United States in the first and second quarters, Hurricanes Harvey, Irma and Maria and earthquakes in Mexico in the third quarter and wildfires in California in the fourth quarter. Catastrophe losses of $55 million in 2016 resulted primarily from winter storms in the first quarter, storms in Texas in the second quarter, flooding in Louisiana and multiple storms in the southern United States in the third quarter and Hurricane Matthew in the fourth quarter.
As discussed under “Annuity Benefits Accumulated” in Note A - “Accounting Policies” to the financial statements, guaranteed withdrawal benefit reserves are accrued for and modified using assumptions similar to those used in establishing and amortizing deferred policy acquisition costs. The guaranteed withdrawal benefit reserve related to FIAs can be inversely impacted by the calculated FIA embedded derivative reserve as the value to policyholders of the guaranteed withdrawal benefits increases when the benefit of stock market participation decreases. As shown in the table above, the change in the stock market increased AFG’s guaranteed withdrawal benefit reserve by $14 million in 2018 compared to a favorable impact of $14 million in 2017. This $28 million increase (200%) was the primary cause of the $25 million overall increase in other annuity benefits, net of guaranteed withdrawal fees in 2018 compared to 2017.
Annuity acquisition expenses were $255 million in 2018 compared to $168 million in 2017, an increase of $87 million (52%). Excluding the $29 million and $35 million favorable impact on amortization of DPAC from the unlocking recorded in 2018 and 2017, respectively, annuity acquisition expenses were $284 million in 2018 compared to $203 million in 2017, an increase of $81 million (40%), reflecting growth in the business and the acceleration (in 2018) and deceleration (in 2017) of DPAC amortization related to changes in the fair value of derivatives related to FIAs. Excluding the impact of unlocking charges (expense reductions) discussed under “Annuity Unlocking” below, AFG’s amortization of DPAC and commission expenses as a percentage of average fixed annuity benefits accumulated was 0.79% in 2018 compared to 0.62% in 2017 and 0.70% in 2016 and has generally ranged between 0.75% and 0.85%. Variances from the general range relate primarily to the impact of (i) material changes in interest rates or the stock market on AFG’s fixed-indexed annuity business, and (ii) differences in actual experience from actuarially projected estimates and assumptions. For example, the positive impact of higher than anticipated interest rates during 2018 on the fair value of derivatives related to FIAs (discussed below) resulted in a partially offsetting acceleration in the amortization of DPAC. In contrast, the negative impact of significantly lower than anticipated interest rates during 2017 and 2016 on the fair value of derivatives related to FIAs resulted in a partially offsetting deceleration of the amortization of DPAC.
AFG’s run-off long-term care and life insurance operations recorded net earned premiums of $22 million and related benefits and acquisition expenses of $31 million in 2017 compared to net earned premiums of $24 million and related benefits and acquisition expenses of $38 million in 2016. The $7 million (21%) decrease in life, accident and health benefits reflects the impact of improved life claims experience in 2017 compared to 2016.
In June 2016, the FASB issued ASU 2016-13, Financial Instruments - Credit Losses: Measurement of Credit Losses on Financial Instruments, which provides a new credit loss model for determining credit-related impairments for financial instruments measured at amortized cost (e.g. mortgage loans or reinsurance recoverables) and requires an entity to estimate the credit losses expected over the life of an exposure or pool of exposures. The estimate of expected credit losses considers historical information, current information, as well as reasonable and supportable forecasts, including estimates of prepayments. The expected credit losses, and subsequent increases or decreases in such losses, will be recorded immediately through realized gains (losses) as an allowance that is deducted from the amortized cost basis of the financial asset, with the net carrying value of the financial asset presented on the balance sheet at the amount expected to be collected. The updated guidance also amends the current other-than-temporary impairment model for available for sale debt securities by requiring the recognition of impairments relating to credit losses through an allowance account and limits the amount of credit loss to the difference between a security’s amortized cost basis and its fair value. Subsequent increases or decreases in expected credit losses will be recorded immediately in the income statement through realized gains (losses). AFG will be required to adopt this guidance effective January 1, 2020. AFG cannot estimate the impact that the updated guidance will have on its results of operations, financial position or liquidity until the updated guidance is adopted.
Includes special charges to increase asbestos and environmental (“A&E”) reserves of $18 million, $89 million and $36 million in 2018, 2017 and 2016, respectively. Also includes $18 million in favorable development related to the Neon exited lines recorded in connection with a reinsurance to close transaction in 2017 and a charge of $65 million related to Neon exited lines in 2016.
Primarily holding company interest and expenses, including losses on retirement of debt of $51 million in 2017 and special charges to increase A&E reserves related to AFG’s former railroad and manufacturing operations ($9 million in 2018, $24 million in 2017 and $5 million in 2016).
the continuity of interest payments, maintenance of investment grade ratings and hybrid nature of certain investments,
Amended and Restated Articles of Incorporation, filed as Exhibit 3(a) to AFG’s 10-K for 2017.