AFG can borrow up to $500 million under its revolving credit facility which expires in December 2016. 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 2014. In September 2014, AFG issued $150 million of 6-1/4% Subordinated Debentures due 2054. AFG intends to use the net proceeds from the offering for general corporate purposes, which may include repurchases of outstanding common stock and/or the redemption of all or a portion of the outstanding 7% Senior Notes due 2050, which become redeemable, at par, at AFG’s option beginning in September 2015.
contribution of approximately $140 million, bringing its capital investment in the Summit business to $399 million. Summit’s results of operations are included in AFG’s consolidated results beginning in April of 2014.
While management believes that AFG’s reserves for A&E claims are a reasonable estimate of ultimate liability for such claims, actual results may vary materially from the amounts currently recorded due to the difficulty in predicting the number of future claims, the impact of recent bankruptcy filings, and unresolved issues such as whether coverage exists, whether policies are subject to aggregate limits on coverage, how claims are to be allocated among triggered policies and implicated years, and whether claimants who exhibit no signs of illness will be successful in pursuing their claims. A 1% variation in loss cost trends, caused by any of the factors previously described, would change net income by approximately $13 million.
Reserves for future policy benefits under long-term care policies are established (and related acquisition costs are amortized) over the life of the policies based on policy benefit assumptions as of the date of issuance, including investment yields, mortality, morbidity, persistency and expenses. Once these assumptions are established for a given policy or group of policies, they are not changed over the life of the policy unless a loss recognition event (premium deficiency) occurs. Loss recognition occurs when, based on current expectations as of the measurement date, the existing contract liabilities plus the present value of future premiums (including reasonably expected rate increases), are not expected to cover the present value of future claims payments, related settlement and maintenance costs, and unamortized acquisition costs. In performing loss recognition testing on the closed block of long-term care business, AFG estimates future claims, persistency, expenses, investment performance, and reinvestment rates, among other assumptions.
The following table (in millions) illustrates the impact of changes in key assumptions on AFG’s loss recognition margin as of December 31, 2014. Assumption changes could have either a favorable or an unfavorable impact on the margin depending on the nature of the change. Once the loss recognition margin (approximately $11 million at December 31, 2014) is reduced to zero, the impact of adverse changes in assumptions, unless offset by other favorable assumption changes, would be recorded as an increase in long-term care reserves through a charge to earnings. Each item reflects a change to a single assumption without changes to other assumptions. For example, assuming a change in claim payments did not change the assumption on future rate increases and persistency, nor did it change projected investment yields resulting from cash flow differences. These amounts are valid for a point in time, and will change in future periods as the in-force block ages, and as actual performance deviates from the assumptions used at December 31, 2014.
The following table details AFG’s earnings before income taxes from its property and casualty insurance operations for the three months ended December 31, 2014 and 2013 (dollars in millions):
The $232 million increase in gross written premiums for the fourth quarter of 2014 compared to the fourth quarter of 2013 reflects $144 million in premiums from Summit (acquired in April 2014) as well as significant growth in other businesses within the Specialty casualty group and Property and transportation group. Excluding premiums from Summit, gross written premiums increased by 8% compared to the fourth quarter of 2013. Overall average renewal rates increased approximately 2% in the fourth quarter of 2014.
Property and transportation Net adverse reserve development of $3 million in the fourth quarter of 2014 reflects higher than expected claim frequency in the ocean marine business and higher than anticipated claim severity in the trucking operations, partially offset by lower than expected claim severity in the property and inland marine business. Net adverse reserve development of $3 million in the fourth quarter of 2013 reflects higher than expected claim severity in commercial auto liability business written in the transportation businesses, partially offset by lower than expected claim severity in the ocean marine business.
As discussed in Note A - “Accounting Policies,” and Note H - “Managed Investment Entities” to the financial statements, the earnings (losses) of Managed Investment Entities represent CLO earnings (losses) that ultimately inure to holders of the CLO debt.
The Specialty property and casualty insurance operations generated an underwriting profit of $237 million in 2014 compared to $206 million in 2013, an increase of $31 million (15%). The higher underwriting profit in 2014 reflects significantly higher underwriting profits in the Specialty casualty and Property and transportation groups. Overall catastrophe losses were $28 million (0.7 points on the combined ratio) in 2014 compared to $31 million (1.0 points), in 2013.
Property and transportation Underwriting profit for this group was $21 million in 2014 compared to $12 million in 2013, an increase of $9 million (75%). Higher underwriting profit in the property and inland marine operations, including lower catastrophe losses, was partially offset by lower underwriting profit in the agricultural operations. Catastrophe losses were $20 million (1.3 points) for this group in 2014 compared to $27 million (1.8 points) in 2013.
During the third quarter of 2012, AFG acquired the remaining 28% of Marketform that it did not already own. As discussed in Note A - “Accounting Policies” and Note H - “Managed Investment Entities” to the financial statements, the losses of Managed Investment Entities in 2014, 2013 and 2012 represent CLO losses that ultimately inure to holders of CLO debt other than AFG.
Consolidated Statement of Comprehensive Income for the years ended December 31, 2014, 2013 and 2012
Expenses related to the acquisition were less than $1 million and were expensed as incurred. The purchase price was allocated to the acquired assets and liabilities of Summit based on management’s best estimate of fair value as of the acquisition date. The allocation of the purchase price is shown in the table below (in millions):
AFG manages its business as five segments: (i) Property and casualty insurance, (ii) Annuity, (iii) Run-off long-term care and life, (iv) Medicare supplement and critical illness (sold in August 2012) and (v) Other, which includes holding company assets and costs, and the assets and operations attributable to the noncontrolling interests of the managed investment entities.
AFG has $200 million notional amount of pay-fixed interest rate swaptions (options to enter into pay-fixed/receive floating interest rate swaps at future dates expiring in 2015) outstanding at December 31, 2014, which are used to mitigate interest rate risk in its annuity operations. AFG paid $4 million to purchase these swaptions, which represents its maximum potential economic loss over the life of the contracts.
AFG’s provision for income taxes included a benefit of $1 million in 2014, an expense of $1 million in 2013 and a benefit of $14 million in 2012 of interest (net of federal benefit or expense). AFG’s liability for interest related to unrecognized tax benefits was $1 million at December 31, 2013 (net of federal benefit); no penalties were accrued at that date.
Adverse prior year development for the third quarter of 2013 includes pretax special charges of $54 million to strengthen property and casualty insurance A&E reserves.