AFG’s insurance subsidiaries lease the majority of their office and storage facilities in numerous cities throughout the United States, including Great American’s and GAFRI’s home offices in Cincinnati and UTA’s home office in Austin. In December 2007, AFG signed a 15-year lease (commencing in 2011) for space in a new office tower in downtown Cincinnati. The new building will enable AFG to consolidate operations from several leased locations. A property and casualty insurance subsidiary owns approximately 177,000 square feet of office space on 17.5 acres of land in Richfield, Ohio, approximately 90% of which it occupies; the remaining space is leased to unaffiliated tenants. See Item 1 - “Business” - “Other Operations” for a discussion of AFG’s other commercial real estate operations.
Municipal bonds represented approximately 15% of AFG’s fixed maturity portfolio at December 31, 2010. 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, 2010, approximately 70% of the municipal bond portfolio was held in revenue bonds, with the remaining 30% held in general obligation bonds. State general obligation securities of California, Illinois, New Jersey and New York represented only 2% of this portfolio.
Traditional actuarial techniques are not applicable to the Italian public hospital medical malpractice business due to the significant changes in this account over time. Accordingly, more detailed methods are used, including claim count development times average severity, and uplifting case reserves to historical severity levels.
Beginning January 1, 2010, new accounting standards require AFG to consolidate its investments in six collateralized loan obligation (“CLO”) entities that it manages and owns an interest in (in the form of debt). See Note A - “Accounting Policies - Managed Investment Entities” and Note H - “Managed Investment Entities.” The effect of consolidating these entities is shown in the tables below (in millions). The “Before CLO Consolidation” columns include AFG’s investment and earnings in the CLOs on an unconsolidated basis, which would be comparable to periods prior to adopting the new standards.
Gross and net written premiums decreased in 2009 due primarily to lower general liability coverages resulting from the softening in the homebuilders market and strong competition in the excess and surplus lines, partially offset by premium growth from Marketform, the start-up environmental operations and the executive liability business. This group reported an underwriting profit of $63 million in 2009, $181 million lower than in 2008. The combined ratio increased 17.3 points from the 2008 period to 93.2%. These results were considerably lower than 2008 due primarily to $56 million of adverse reserve development in Marketform’s run-off Italian public hospital medical malpractice business related to 2008 and prior years, and a $45 million decrease in the Califonia workers’ compensation underwriting results due primarily to a competitive pricing environment and rising average cost of claims. Also contributing to the Specialty casualty results were higher losses in a book of targeted program business, lower underwriting profits in the general liability and excess and surplus lines resulting from a depressed economy, particularly in the homebuilders’ market, and competitive market conditions. Other businesses in this group produced excellent underwriting profit margins, but at lower levels than 2008.
The increase in annuity premiums in 2010 compared to 2009 is attributable to higher sales of single premium annuities through the bank distribution channels and increased sales of indexed annuities in the non-403(b) single premium market.
Basis of Presentation The consolidated financial statements include the accounts of American Financial Group, Inc. (“AFG”) and its subsidiaries. Certain reclassifications have been made to prior years to conform to the current year’s presentation. All significant intercompany balances and transactions have been eliminated. The results of operations of companies since their formation or acquisition are included in the consolidated financial statements. Events or transactions occurring subsequent to December 31, 2010, and prior to the filing of this Form 10-K, have been evaluated for potential recognition or disclosure herein.
New accounting guidance issued in October 2010 specifies that a cost must be directly related to the successful acquisition of an insurance contract to qualify for deferral. The guidance is effective for periods ending after December 31, 2011, with retrospective application permitted, but not required. AFG expects that this guidance will result in fewer acquisition costs being capitalized and is currently assessing the method and impact of adoption.
In 2010, 2009, and 2008, less than 5% of AFG’s revenues were derived from the sale of property and casualty insurance outside of the United States.
AFG’s management is responsible for the valuation process and uses data from outside sources (including nationally recognized pricing services and broker/dealers) in establishing fair value. Valuation techniques utilized by pricing services and prices obtained from external sources are reviewed by AFG’s internal investment professionals who are familiar with the securities being priced and the markets in which they trade to ensure the fair value determination is representative of an exit price. To validate the appropriateness of the prices obtained, these investment managers consider widely published indices (as benchmarks), recent trades, changes in interest rates, general economic conditions and the credit quality of the specific issuers.
The MBS with embedded derivatives consist primarily of interest-only MBS with interest rates that float inversely with short-term rates. AFG has elected to measure these securities (in their entirety) at fair value in its financial statements. These investments are part of AFG’s overall investment strategy and represent a small component of AFG’s overall investment portfolio.
As discussed under “Reinsurance” in Note A, certain reinsurance contracts in AFG’s annuity and supplemental insurance business are considered to contain embedded derivatives.
In August 2010, AFG replaced its credit facility with a three-year, $500 million revolving credit line. Amounts borrowed under this agreement bear interest at rates ranging from 1.75% to 3.00% (currently 2%) over LIBOR based on AFG’s credit rating. No amounts were borrowed under this facility at December 31, 2010.
Includes $17 million at December 31, 2010 and $98 million at December 31, 2009 in net pretax unrealized losses ($11 million and $63 million, respectively, net of tax) related to securities for which only the credit portion of an other-than-temporary impairment has been recorded in earnings.
Net Investment Income The following table shows (in millions) investment income earned and investment expenses incurred by AFG’s insurance group.
The information required by the following Items will be included in AFG’s definitive Proxy Statement for the 2011 Annual Meeting of Shareholders which will be filed with the Securities and Exchange Commission within 120 days after the end of the Registrant’s fiscal year and is incorporated herein by reference.