Through the operations of its subsidiaries, AFG is engaged primarily in property and casualty insurance, focusing on specialized commercial products for businesses and in the sale of traditional fixed and fixed-indexed annuities in the individual, bank and education markets.
its operations. The ratio is calculated by dividing 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 and appropriated retained earnings related to managed investment entities).
The NAIC’s model law for risk based capital (“RBC”) applies to both life and property and casualty companies. RBC formulas determine the amount of capital that an insurance company needs so that it has an acceptable expectation of not becoming financially impaired. At December 31, 2012, the capital ratios of all AFG insurance companies substantially exceeded the RBC requirements.
Several methods (including development methods and those based on claim count and severity) are weighted together to produce indications of reserve need. Management continues to review the frequency, severity and loss and LAE ratios implied by the indications from the standard tests and considers the uncertainties of future costs in determining the appropriate reserve level.
AFG recorded adverse prior year reserve development of $1 million in 2012 for this line of business as claim severity was slightly higher than expected. AFG recorded favorable prior year loss development of $8 million in 2011 and $26 million in 2010 as claim severity was lower than in prior assumptions.
In the third quarter of 2010, AFG recorded an impairment charge of $22 million resulting from management’s decision to de-emphasize the sale of supplemental health insurance products through career agents, including the sale of a marketing subsidiary. Partially offsetting this loss was National Interstate’s $7 million gain on the acquisition of Vanliner in 2010. See Note I -“Goodwill and Other Intangibles” and Note B - “Acquisitions and Sales of Subsidiaries.”
We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the consolidated balance sheets of American Financial Group, Inc. and subsidiaries as of December 31, 2012 and 2011, and the related consolidated statements of earnings, comprehensive income, changes in equity and cash flows for each of the three years in the period ended December 31, 2012, and our report dated February 28, 2013, expressed an unqualified opinion thereon.
The impact of adoption on amounts previously reported is shown in the table below (in millions, except per share data):
Investments Fixed maturity and equity securities classified as “available for sale” are reported at fair value with unrealized gains and losses included in accumulated other comprehensive income in AFG’s Balance Sheet. Fixed maturity and equity securities classified as “trading” are reported at fair value with changes in unrealized holding gains or losses during the period included in investment income. Mortgage and policy loans are carried primarily at the aggregate unpaid balance.
Unearned Revenue Policy charges that represent fees for future services are deferred as unearned revenue (included in other liabilities) and recognized in net earnings using the same assumptions and estimated gross profits used to amortize DPAC.
AFG’s weighted average diluted shares outstanding excludes the following anti-dilutive potential common shares related to stock compensation plans: 2012 - 1.8 million, 2011 - 2.3 million and 2010 - 3.5 million. Adjustments to net earnings attributable to shareholders in the calculation of diluted earnings per share were nominal in the 2012, 2011 and 2010 periods.
At March 31, 2012, six preferred stocks with an aggregate fair value of $35 million and at December 31, 2012, one preferred stock with a fair value of $6 million, were transferred from Level 1 to Level 2 due to decreases in trade frequency, resulting in lack of available trade data sufficient to warrant classification in Level 1. At December 31, 2012, two perpetual preferred stocks with fair values aggregating $16 million and one redeemable preferred stock (included in Corporate and other fixed maturities) with a fair value of $2 million were transferred from Level 2 to Level 1 reflecting the frequency of trade activity. During 2011, there were no significant transfers between Level 1 and Level 2. Approximately 4% of the total assets carried at fair value on December 31, 2012, were Level 3 assets. Approximately 90% ($920 million) of the Level 3 assets were priced using non-binding broker quotes, for which there is a lack of transparency as to the inputs used to determine fair value. Details as to the quantitative inputs are neither provided by the brokers nor otherwise reasonably obtainable by AFG. Since internally developed Level 3 asset fair values represent less than one-half of 1% of the total assets measured at fair value and less than 3% of AFG’s shareholders’ equity, changes in unobservable inputs used to determine internally developed fair values would not have a material impact on AFG’s financial position.
Changes in balances of Level 3 financial assets and liabilities carried at fair value during 2012, 2011 and 2010 are presented below (in millions). The transfers into and out of Level 3 were due to changes in the availability of market observable inputs. All transfers are reflected in the table at fair value as of the end of the reporting period.
AFG’s 2008 - 2012 tax years remain subject to examination by the IRS.
Restrictions on Transfer of Funds and Assets of Subsidiaries Payments of dividends, loans and advances by AFG’s subsidiaries are subject to various state laws, federal regulations and debt covenants that limit the amount of dividends, loans and advances that can be paid. Under applicable restrictions, the maximum amount of dividends available to AFG in 2013 from its insurance subsidiaries without seeking regulatory clearance is $395 million. Additional amounts of dividends, loans and advances require regulatory approval.
Amended and Restated Articles of Incorporation, filed as Exhibit 3(a) to AFG’s Form 10-K for 1997.