In November 2017, AFG issued an additional $240 million of 4.50% Senior Notes due in 2047 and $125 million of 3.50% Senior Notes due in 2026. The net proceeds of the offering were used to redeem AFG’s $350 million outstanding principal amount of 9-7/8% Senior Notes due in June 2019 for $388 million (including a make-whole premium of $38 million) in December 2017.
Subsidiary Liquidity Great American Life Insurance Company (“GALIC”), a wholly-owned annuity subsidiary, is a member of the Federal Home Loan Bank of Cincinnati (“FHLB”). The FHLB makes advances and provides other banking services to member institutions, which provides the annuity operations with an additional source of liquidity. At December 31, 2019, GALIC had $1.1 billion in outstanding advances from the FHLB (included in annuity benefits accumulated), bearing interest at rates ranging from 0.13% to 0.21% over LIBOR (average rate of 1.95% at December 31, 2019). While these advances must be repaid between 2020 and 2021 ($310 million in 2020 and $786 million in 2021), GALIC has the option to prepay all or a portion of the advances. GALIC has invested the proceeds from the advances in fixed maturity securities with similar expected lives as the advances for the purpose of earning a spread over the interest payments due to the FHLB. At December 31, 2019, GALIC estimated that it had additional borrowing capacity of approximately $800 million from the FHLB.
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 $3.02 billion as follows: Within 1 year - $838 million; 2-3 years - $813 million; 4-5 years - $342 million; and thereafter - $1.03 billion. Actual payments and their timing could differ significantly from these estimates.
Property and transportation This group reported an underwriting loss of $2 million for the fourth quarter of 2019 compared to an underwriting profit of $64 million in the fourth quarter of 2018, a change of $66 million (103%). Record levels of prevented planting claims in the crop operations were the driver of the lower underwriting results in the fourth quarter of 2019 compared to the fourth quarter of 2018. Catastrophe losses for this group were $7 million in the fourth quarter of 2019. By comparison, catastrophe losses had a favorable impact of $1 million in the 2018 fourth quarter, with catastrophe losses reported from the previous quarter developing favorably in the fourth quarter of 2018.
The current accident year loss and LAE ratio, excluding catastrophe losses for AFG’s Specialty property and casualty insurance operations was 66.0% for the fourth quarter of 2019 compared to 64.4% for the fourth quarter of 2018, an increase of 1.6 percentage points.
AFG’s Specialty property and casualty insurance operations recorded net favorable reserve development related to prior accident years of $53 million in the fourth quarter of 2019 compared to $61 million in the fourth quarter of 2018, a decrease of $8 million (13%).
The net charge from unlocking annuity assumptions in the fourth quarter of 2018 reflects the favorable impact of an increase in projected net interest spreads on in-force business (due primarily to higher actual yields than previously anticipated), more than offset by a slight increase in projected expenses and the unfavorable impact of changes in projected policyholder annuitization and lapse behavior. Reinvestment rate assumptions are based primarily on 7-year and 10-year corporate bond yields.
Gross written premiums increased $358 million (12%) in 2018 compared to 2017 due primarily to growth at Neon. Higher gross written premiums in the excess and surplus, targeted markets and executive liability businesses also contributed to the year-over-year growth. Average renewal rates decreased approximately 1% for this group in 2018. Excluding rate decreases in the workers’ compensation business, renewal rates for this group increased approximately 3% in 2018. Reinsurance premiums ceded as a percentage of gross written premiums increased 1 percentage point in 2018 compared to 2017, reflecting higher cessions to AFG’s internal reinsurance program, which is included in Other specialty and higher cessions in the workers’ compensation businesses.
Specialty casualty Net favorable reserve development of $88 million in 2019 reflects lower than anticipated claim frequency and severity in the workers’ compensation businesses, partially offset by higher than expected claim severity in the excess and surplus lines businesses and higher than expected claim frequency in product liability contractor claims.
In addition to the impact of unlocking, the following table illustrates the acceleration/deceleration of the amortization of
See “Annuity Unlocking” below for a discussion of the impact that the unlocking of actuarial assumptions had on annuity and supplemental insurance acquisition expenses. Unanticipated spread compression, decreases in the stock market, adverse mortality experience, and higher than expected lapse rates could lead to future write-offs of DPAC or present value of future profits on business in force of companies acquired (“PVFP”).
The following table reconciles the net spread earned on AFG’s fixed annuities to overall annuity pretax earnings for 2019, 2018 and 2017 (in millions):
AFG’s run-off long-term care and life insurance operations recorded net earned premiums of $24 million and related benefits and acquisition expenses of $46 million in 2018 compared to net earned premiums of $22 million and related benefits and acquisition expenses of $31 million in 2017. The $14 million (54%) increase in life, accident and health benefits reflects higher claims in both the run-off life and run-off long-term care insurance businesses in 2018 compared to 2017.
AFG’s impairment charges on securities in 2017 consist of $63 million on equity securities, $21 million on fixed maturities and $4 million on other investments. Approximately $28 million of the impairment charges in 2017 relates to investments in pharmaceutical companies, $24 million relates to investments in various industrial entities, $14 million relates to investments in financial institutions and $12 million relates to investments in media companies.
AFG’s management is responsible for establishing and maintaining adequate internal control over financial reporting, as such term is defined in Securities Exchange Act Rules 13a-15(f). Under the supervision and with the participation of management, including AFG’s Co-Chief Executive Officers and Chief Financial Officer, AFG conducted an evaluation of the effectiveness of internal control over financial reporting as of December 31, 2019, based on the criteria set forth in “Internal Control - Integrated Framework” issued in 2013 by the Committee of Sponsoring Organizations of the Treadway Commission.
We obtained an understanding, evaluated the design and tested the operating effectiveness of controls over the process for estimating reserves. This included, among others, the review and approval processes that management has in place for the methods and assumptions used in estimating the reserves.
Available for sale fixed maturities at December 31 consisted of the following (in millions):
The determination of whether unrealized losses are other-than-temporary requires judgment based on subjective as well as objective factors. Factors considered and resources used by management include:
As discussed in Note A - “Accounting Policies - Investments,” effective January 1, 2018, 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 2019 and 2018 on securities that were still owned at December 31 as follows (in millions):
AFG’s maximum exposure to economic loss on the CLOs that it manages is limited to its investment in those CLOs, which had an aggregate fair value of $165 million (including $102 million invested in the most subordinate tranches) at December 31, 2019, and $188 million at December 31, 2018.
Accumulated Other Comprehensive Income, Net of Tax (“AOCI”) Comprehensive income is defined as all changes in shareholders’ equity except those arising from transactions with shareholders. Comprehensive income includes net earnings and other comprehensive income, which consists primarily of changes in net unrealized gains or losses on available for sale securities. The progression of the components of accumulated other comprehensive income follows (in millions):
The impact of unlocking, 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 were as follows, net of the related acceleration/deceleration of the amortization of deferred policy acquisition costs and deferred sales inducements (in millions):
In December 2017, the Neon Lloyd’s syndicate entered into a reinsurance to close transaction for the 2015 and prior years of account with StarStone Underwriting Limited, a subsidiary of Enstar Group Limited, which was effective as of December 31, 2017 and settled in early 2018. In the Lloyd’s market, a reinsurance to close transaction transfers the responsibility for discharging all of the liabilities that attach to the transferred year of account plus the right to any income due to the closing year of account in return for a premium. This transaction provided Neon with finality on its legacy business. As a result of the reinsurance to close agreement, Neon was able to better estimate its ultimate liability for the 2015 and prior years of account as of December 31, 2017, resulting in favorable development of $42 million, of which $24 million related to its ongoing lines of business (included in Specialty casualty) and $18 million related to its exited lines of business.
Benefit Plans AFG expensed approximately $39 million in 2019, $37 million in 2018 and $45 million in 2017 for its retirement and employee savings plans.
Certification of Chief Financial Officer pursuant to Section 302(a) of the Sarbanes-Oxley Act of 2002.