AFG and its insurance subsidiaries lease the majority of their office and storage facilities in numerous cities throughout the United States and internationally, including the Company’s headquarters in Cincinnati, Ohio. Subsidiaries of AFG own several other buildings in downtown Cincinnati. AFG and its affiliates occupy approximately half of the aggregate 645,000 square feet of commercial and office space in these buildings. A property and casualty insurance subsidiary occupies approximately 90% of the 281,000 square feet of rentable office space on 17.5 acres of land that it owns in Richfield, Ohio. See Item 1 - Business - “Other Operations” for a discussion of AFG’s other commercial real estate operations.
The ratio of debt to total capital is a non-GAAP measure that management believes is useful for investors, analysts and ratings agencies to evaluate AFG’s financial strength and liquidity and to provide insight into how AFG finances its operations. In addition, maintaining a ratio of debt, excluding subordinated debt and debt secured by real estate (if any), to total capital of 35% or lower is a financial covenant in AFG’s bank credit facility. The ratio is calculated by dividing the principal amount of AFG’s long-term debt by its total capital, which includes long-term debt, noncontrolling interests and shareholders’ equity (excluding unrealized gains (losses) related to fixed maturity investments).
Net Cash Provided by Operating Activities AFG’s property and casualty insurance operations typically produce positive net operating cash flows as premiums collected and investment income exceed policy acquisition costs, claims payments and operating expenses. AFG’s net cash provided by operating activities is impacted by the level and timing of property and casualty premiums, claim and expense payments and recoveries from reinsurers. AFG’s annuity operations typically produce positive net operating cash flows as investment income exceeds acquisition costs and operating expenses. Interest credited on annuity policyholder funds is a non-cash increase in AFG’s annuity benefits accumulated liability and annuity premiums, benefits and withdrawals are considered financing activities due to the deposit-type nature of annuities. Cash flows provided by operating activities also include the activity of AFG’s managed investment entities (collateralized loan obligations) other than those activities included in investing or financing activities. The changes in the assets and liabilities of the managed investment entities included in operating activities increased cash flows from operating activities by $25 million in 2020, $23 million in 2019 and $148 million in 2018, accounting for a $2 million increase in cash flows from operating activities in 2020 compared to 2019 and a $125 million decrease in cash flows from operating activities in 2019 compared to 2018. As discussed in Note A - “Accounting Policies - Managed Investment Entities” to the financial statements, AFG has no right to use the CLO assets and no obligation to pay the CLO liabilities and such assets and liabilities are shown separately in AFG’s Balance Sheet. Excluding the impact of the managed investment entities, net cash provided by operating activities was $2.16 billion, $2.43 billion and $1.94 billion in 2020, 2019 and 2018, respectively.
The excess cash flow of AFG’s property and casualty group allows it to extend the duration of its investment portfolio somewhat beyond that of its claim reserves. Due to the anticipated slowdown in cash collections from the state mandated increases in grace periods for premium payments, AFG’s property and casualty insurance subsidiaries have maintained higher than typical cash balances since March 2020. AFG has not experienced a material increase in uncollectable premiums receivable as policyholders continue to make payments in accordance with the agreed upon terms.
Parent Net Cash Provided by (Used in) Investing Activities Parent holding company investing activities consist of capital contributions to and returns of capital from subsidiaries and, to a much lesser extent, parent company investment activity. Parent holding company net cash used in investing activities was $294 million in 2020 compared to
Municipal bonds represented approximately 13% of AFG’s fixed maturity portfolio at December 31, 2020. AFG’s municipal bond portfolio is high quality, with 99% of the securities rated investment grade at that date. The portfolio is well diversified across the states of issuance and individual issuers. At December 31, 2020, approximately 79% of the municipal bond portfolio was held in revenue bonds, with the remaining 21% held in general obligation bonds.
j)ability and intent to hold the investment for a period of time sufficient to allow for anticipated recovery in fair value.
AFG recorded adverse prior year reserve development of $99 million in 2020 and $143 million in 2019 related to its other liability - occurrence coverage due primarily to continued claim severity increases in excess and umbrella liability coverages. AFG recorded adverse prior year reserve development of $48 million in 2018 due to claim severity increases in excess and umbrella liability coverages as well as late emergence of excess workers’ compensation and Texas non-subscribers workers’ injury claims.
(b)Elimination of the change in fair value of AFG’s investments in the CLOs, including $10 million and $6 million in the fourth quarter of 2020 and 2019, respectively, in distributions recorded as interest expense by the CLOs.
Starting in 1986, AFG’s statutory combined ratio has been better than the U.S. industry average for 33 of the 35 years. Management believes that AFG’s insurance operations have performed better than the industry as a result of its specialty niche focus, product line diversification, stringent underwriting discipline and alignment of compensation incentives.
AFG maintains comprehensive catastrophe reinsurance coverage for its property and casualty insurance operations, including a $15 million per occurrence net retention for losses up to $100 million in the vast majority of circumstances. In certain unlikely events, AFG’s ultimate loss under this coverage could be as high as $24 million. Effective July 1, 2020, AFG purchased an additional $50 million of reinsurance coverage for losses in excess of $100 million.
(a)As discussed under “Results of Operations - General,” unlocking, the impact of changes in the fair value of derivatives related to FIAs, and other impacts of changes in the stock market and interest rates on the accounting for FIAs over or under the cost of the equity index options purchased to mitigate the risk in the index-based component of those FIAs are considered non-core earnings (losses). In addition, the amortization of the deferred loss related to the annuity block reinsurance transaction entered into in the fourth quarter of 2020 and other reinsurance impacts are considered non-core earnings (losses). The impact of these items are shown aggregated as non-core annuity earnings (losses) and excluded from the income statement line items in the table above for the fourth quarter of 2020 and 2019, respectively:
AFG’s run-off long-term care and life insurance operations recorded net earned premiums of $4 million and related benefits and acquisition expenses of $11 million in the fourth quarter of 2020 compared to net earned premiums of $5 million and related benefits and acquisition expenses of $11 million in the fourth quarter of 2019.
Net earned premiums (“NEP”) for AFG’s property and casualty insurance segment were $5.10 billion in 2020 compared to $5.19 billion in 2019, a decrease of $86 million (2%). NEP increased $320 million (7%) in 2019 compared to 2018. Detail of AFG’s property and casualty net earned premiums is shown below (dollars in millions):
Reinsurance premiums assumed decreased $10 million (6%) in 2019 compared to 2018, reflecting lower premiums retained, primarily from businesses in the Specialty casualty sub-segment.
AFG’s property and casualty commissions and other underwriting expenses (“U/W Exp”) were $1.60 billion in 2020 compared to $1.70 billion in 2019, a decrease of $98 million (6%). AFG’s underwriting expense ratio was 31.4% in 2020 compared to 32.8% in 2019, a decrease of 1.4 percentage points.
Aggregate Aggregate commissions and other underwriting expenses for AFG’s property and casualty insurance segment includes $117 million of underwriting expenses in the Neon run-off operations in 2020 and $30 million related to the Neon exited lines charge in 2019 representing contractual employee severance benefits and other incurred exit costs. See “Neon exited lines” under “Property and Casualty Insurance Segment - Results of Operations” for the quarters ended December 31, 2020 and 2019.
(*)Excluding the impact of reinsurance, unlocking, the impact of changes in the fair value of derivatives related to FIAs, and other impacts of changes in the stock market and interest rates on annuity benefits and the related impact on the amortization of deferred policy acquisition costs.
Other annuity benefits, net of guaranteed withdrawal benefit fees excluding the impact of unlocking and the stock market and interest rates were $54 million in 2019 and $49 million in 2018, representing an increase of $5 million (10%) in 2019 compared to 2018. As a percentage of average fixed annuity benefits accumulated, these net expenses decreased 0.01 percentage points to 0.14% in 2019 from 0.15% in 2018.
As discussed above under “Other Annuity Benefits, Net of Guaranteed Withdrawal Benefit Fees” and “Annuity Acquisition Expenses,” the periodic accounting for DPAC and guaranteed withdrawal benefits related to FIAs is also impacted by changes in the stock market and interest rates. These impacts may be temporary in nature and not necessarily indicative of the long-term performance of the FIA business. The table below highlights the impact of reinsurance and changes in the fair value of derivatives related to FIAs and the other impacts of the stock market and interest rates (excluding the impact of unlocking) over or under the cost of the equity index options (discussed above) on earnings before income taxes for the annuity segment (dollars in millions):
AFG’s consolidated net earnings (loss) attributable to noncontrolling interests was a net loss of $11 million in 2020 compared to $28 million in 2019, a decrease of $17 million (61%). AFG’s consolidated net earnings (loss) attributable to noncontrolling interests was a net loss of $28 million in 2019 compared to $13 million in 2018, an increase of $15 million (115%). Each period reflects losses at Neon, AFG’s United-Kingdom-based Lloyd’s insurer, which was sold on December 31, 2020. See Note B - “Acquisitions and Sale of Businesses” to the financial statements.
There are inherent limitations to the effectiveness of any system of internal controls and procedures, including the possibility of human error and the circumvention or overriding of the controls and procedures. Accordingly, even effective internal controls and procedures can only provide reasonable assurance of achieving their control objectives.
How We Addressed the Matter in Our Audit We obtained an understanding, evaluated the design, and tested the operating effectiveness of controls over management’s valuation process for the fixed-income and equity securities priced using unobservable inputs. This included, among others, testing controls over investment pricing and the development and review of significant inputs and assumptions used in determining the fair values.
Changes in the fair value of derivatives that are designated and qualify as highly effective cash flow hedges are recorded in AOCI and are reclassified into earnings when the variability of the cash flows from the hedged items impacts earnings. When the change in the fair value of a qualifying cash flow hedge is included in earnings, it is included in the same line
Earnings Per Share Although basic earnings per share only considers shares of common stock outstanding during the period, the calculation of diluted earnings per share includes the following adjustments to weighted average common shares related to stock-based compensation plans: 2020 - 0.5 million, 2019 - 1.1 million and 2018 - 1.6 million.
(a)Total realized/unrealized gains (losses) included in net earnings for the embedded derivatives reflects a favorable adjustment related to the unlocking of actuarial assumptions of $240 million in 2020.
All equity securities other than those accounted for under the equity method are carried at fair value through net earnings. AFG recorded net holding gains (losses) on equity securities during 2020, 2019 and 2018 on securities that were still owned at December 31 of each year presented as follows (in millions):
secured borrowing rate. AFG did not have any material contracts accounted for as finance leases at December 31, 2020 or December 31, 2019.
Establishing property and casualty insurance reserves for claims related to environmental exposures, asbestos and other mass tort claims is subject to uncertainties that are significantly greater than those presented by other types of claims. For this group of claims, traditional actuarial techniques that rely on historical loss development trends cannot be used and a range of reasonably possible losses cannot be estimated. In addition, accruals (included in other liabilities) have been recorded for various environmental and occupational injury and disease claims and other contingencies arising out of the railroad operations disposed of by American Premier’s predecessor, Penn Central Transportation Company (“PCTC”) and its subsidiaries, prior to its bankruptcy reorganization in 1978 and certain manufacturing operations disposed of by American Premier and Great American Financial Resources, Inc. (“GAFRI”).
The net decrease in the provision for claims of prior years in 2020 reflects (i) lower than expected claim frequency and severity in the aviation, transportation and agricultural businesses (within the Property and transportation sub-segment), (ii) lower than anticipated claim severity in the workers’ compensation businesses and lower than anticipated claim frequency in the executive liability business (within the Specialty casualty sub-segment) and (iii) lower than anticipated claim frequency in the trade credit business and lower than anticipated claim frequency and severity in the financial institutions, fidelity and surety businesses (within the Specialty financial sub-segment). This favorable development was partially offset by (i) the $47 million special charge to increase asbestos and environmental reserves and adverse reserve development of $19 million on Neon’s exited lines of business, (ii) higher than expected claim frequency and severity in general liability contractor claims and the excess and surplus and excess liability businesses and higher than anticipated claim severity in the targeted markets businesses (within the Specialty casualty sub-segment), and (iii) net adverse reserve development related to business outside the Specialty group that AFG no longer writes..
Recoverables from Reinsurers and Premiums Receivable See Note A - “Accounting Policies - Credit Losses on Financial Instruments,” for a discussion of new guidance effective January 1, 2020, which impacts the accounting for expected credit losses of recoverables from reinsurers and premiums receivable. AFG reviews the allowance quarterly and makes adjustments as necessary to reflect changes in expected credit losses. Progressions of the 2020 allowance for expected credit losses are shown below (in millions):
Variable Annuities At December 31, 2020, the aggregate guaranteed minimum death benefit value (assuming every variable annuity policyholder died on that date) on AFG’s variable annuity policies exceeded the fair value of the underlying variable annuities by $11 million, compared to $13 million at December 31, 2019. Death benefits paid in excess of the variable annuity account balances were less than $1 million in each of the last three years ended December 31, 2020, 2019 and 2018.