At December 31, 2015, AFG (parent) held approximately $252 million in cash and securities and had $500 million available under a bank line of credit expiring in December 2016.
Fourth quarter 2015 net earnings attributable to AFG’s shareholders were $129 million ($1.45 per share, diluted) compared to $127 million ($1.41 per share) in the fourth quarter of 2014, reflecting:
improved core net operating results in the run-off long-term care and life segment,
realized losses on securities in the fourth quarter of 2015 compared to realized gains in the fourth quarter of 2014.
higher core underwriting profit and net investment income in the property and casualty insurance segment,
the loss on the sale of substantially all of AFG’s run-off long-term care business, and
realized losses on securities in 2015 compared to realized gains in 2014.
See “Liquidity and Capital Resources - Uncertainties” for a discussion of insurance reserves, recoverables from reinsurers, and contingencies related to American Premier’s former operations and “Liquidity and Capital Resources - Investments” for a discussion of impairments on investments. DPAC and certain liabilities related to annuities and universal life insurance products are amortized in relation to the present value of expected gross profits on the policies. Assumptions considered in determining expected gross profits involve significant judgment and include management’s estimates of interest rates and investment spreads, surrenders, annuitizations, renewal premiums and mortality. Should actual experience require management to change its assumptions (commonly referred to as “unlocking”), a charge or credit would be recorded to adjust DPAC or annuity liabilities to the levels they would have been if the new assumptions had been used from the inception date of each policy.
The ratio of debt to total capital is a non-GAAP measure that management believes is useful for investors, analysts and independent ratings agencies to evaluate AFG’s financial strength and liquidity and to provide insight into how AFG finances 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, 2015, the capital ratios of all AFG insurance companies substantially exceeded the RBC requirements.
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. Net cash provided by operating activities was $1.36 billion, $1.22 billion and $760 million in 2015, 2014 and 2013, respectively.
Net cash used in investing activities was $3.62 billion in 2014 compared to $2.92 billion in 2013, an increase of $704 million. Net investment activity in the managed investment entities was a $275 million use of cash in 2014 compared to a $478 million source of cash in 2013, accounting for a $753 million increase in net cash used in investing activities in 2014 compared to 2013.
Net cash provided by financing activities was $2.10 billion in 2014 compared to $2.09 billion in 2013, an increase of $12 million. Annuity receipts exceeded annuity surrenders, benefits, withdrawals and transfers by $1.97 billion in 2014 compared to $2.68 billion in 2013, resulting in a $711 million decrease in net cash provided by financing activities. During 2014, AFG repurchased 3.3 million shares of its Common Stock for $191 million compared to 1.4 million shares repurchased in 2013 for $70 million, which accounted for a $121 million decrease in net cash provided by financing activities in 2014 compared to 2013. AFG issued $150 million of 6-1/4% Subordinated Debentures in 2014, the net proceeds of which contributed $145 million to net cash provided by financing activities. Issuances of managed investment entity liabilities exceeded retirements by $306 million in 2014 while retirements of managed investment entity liabilities exceeded issuances by $368 million in 2013, accounting for a $674 million increase in net cash provided by financing activities in 2014 compared to 2013.
In November 2015, AFG issued $150 million of 6% Subordinated Debentures due 2055. AFG intends to use the net proceeds from the offering for general corporate purposes, which may include repurchases of outstanding common stock. In September 2015, AFG redeemed its $132 million of 7% Senior Notes due 2050 at par using cash on hand at the parent company.
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 a substantial additional source of liquidity. These advances further the FHLB’s mission of improving access to housing by increasing liquidity in the residential mortgage-backed securities market. At December 31, 2015, GALIC had $785 million in outstanding advances from the FHLB (included in annuity benefits accumulated), bearing interest at rates ranging from 0.02% to 0.49% over LIBOR (average rate of 0.58% at December 31, 2015). While these advances must be repaid between 2016 and 2020, 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 for the purpose of earning a spread over the interest payments due to the FHLB. At December 31, 2015, GALIC estimated that it had additional borrowing capacity of approximately $750 million from the FHLB.
National Interstate Corporation (“NATL”), a 51%-owned property and casualty insurance subsidiary, can borrow up to $100 million under its unsecured credit agreement, which expires in November 2017. There was $12 million borrowed under this agreement at December 31, 2015, bearing interest at 1.40% (six-month LIBOR plus 0.875%). The maximum outstanding balance in 2015 was $12 million.
Parent Net Cash Provided by Operating Activities Parent holding company cash flows from operating activities consist primarily of dividends and tax payments received from AFG’s insurance subsidiaries, reduced by tax payments to the IRS and holding company interest and other expenses. Parent holding company net cash provided by operating activities was $162 million in 2015 compared to $372 million in 2014 and $428 million in 2013. Lower dividends from subsidiaries received in 2015 as compared to 2014 and 2014 as compared to 2013 were the primary driver of the $210 million decrease in net cash provided by operating activities in 2015 compared to 2014 and the $56 million decrease in net cash provided by operating activities in 2014 compared to 2013.
AFG’s investment portfolio at December 31, 2015, contained $32.28 billion in fixed maturity securities and $1.55 billion in equity securities classified as available for sale and carried at fair value with unrealized gains and losses included in a separate component of shareholders’ equity on an after-tax basis. In addition, $254 million in fixed maturities and $166 million in equity securities were classified as trading with changes in unrealized holding gains or losses included in net investment income.
Fixed income investment funds are generally invested in securities with intermediate-term maturities with an objective of optimizing total return while allowing flexibility to react to changes in market conditions. At December 31, 2015, the average life of AFG’s fixed maturities was about 6-1/2 years.
Approximately 89% of the fixed maturities held by AFG at December 31, 2015, were rated “investment grade” (credit rating of AAA to BBB) by nationally recognized rating agencies. Investment grade securities generally bear lower yields and lower degrees of risk than those that are unrated and non-investment grade. Management believes that the high quality investment portfolio should generate a stable and predictable investment return.
Summarized information for AFG’s MBS (including those classified as trading) at December 31, 2015, is shown in the table below (dollars in millions). Agency-backed securities are those issued by a U.S. government-backed agency; Alt-A mortgages are those with risk profiles between prime and subprime. The majority of the Alt-A securities and substantially all of the subprime securities are backed by fixed-rate mortgages. The average life of the residential and commercial MBS is approximately 4-1/2 years and 3 years, respectively.
Municipal bonds represented approximately 21% of AFG’s fixed maturity portfolio at December 31, 2015. AFG’s municipal bond portfolio is high quality, with 98% 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, 2015, approximately 75% of the municipal bond portfolio was held in revenue bonds, with the remaining 25% held in general obligation bonds. General obligation securities of California, Illinois, Michigan, New Jersey, New York and Puerto Rico collectively represented approximately 1% of this portfolio.
The table below (dollars in millions) summarizes the unrealized gains and losses on fixed maturity securities by dollar amount:
The following table (dollars in millions) summarizes the unrealized loss for all securities with unrealized losses by issuer quality and the length of time those securities have been in an unrealized loss position:
Supplementary statistical information is also reviewed to determine which methods are most appropriate to use or if adjustments are needed to particular methods. Such information includes:
Within each line, results of individual methods are reviewed, supplementary statistical information is analyzed, and data from underwriting, operating and claim management are considered in deriving management’s best estimate of the ultimate liability. This estimate may be the result of one method, a weighted average of several methods, or a judgmental selection as the management team determines is appropriate.
redundant (for six years) by as much as 13.3%. Excluding the effect of special charges for asbestos and environmental exposures, the original estimates of AFG’s liability for losses and loss adjustment expenses, net of reinsurance have developed through December 31, 2015 to be redundant (for ten years) by as much as 19.4%. This development illustrates the historical impact caused by variability in factors considered in estimating insurance reserves.
The judgments and uncertainties surrounding management’s reserve estimation process and the potential for reasonably possible variability in management’s most recent reserve estimates may also be viewed by looking at how recent historical estimates of reserves have developed. The following table shows (dollars in millions) what the impact on AFG’s net earnings would be on the more significant lines of business if the December 31, 2015, reserves (net of reinsurance) developed at the same rate as the average development of the most recent five years.
In April 2014, AFG acquired Summit Holding Southeast, Inc. and related companies, a leading provider of workers’ compensation solutions in the southeastern United States. The Summit acquisition significantly increased AFG’s volume of workers’ compensation business and improved its geographic diversity. Approximately 23% and 19% of AFG’s workers’ compensation reserves at December 31, 2015 relate to policies written in Florida and California, respectively. Over the past 12 years in both states, there have been numerous revisions to workers’ compensation regulations and operating environments, adding difficulty and uncertainty to the estimation of related liabilities.
AFG recorded favorable prior year reserve development of $7 million in 2015, $15 million in 2014 and $11 million in 2013 related to its other liability - occurrence coverage where both the frequency and severity of claims in excess and umbrella liability coverages were lower than previously projected.
AFG recorded adverse prior year reserve development of $20 million in 2015, $28 million in 2014 and $37 million in 2013 for this line of business as claim severity has been significantly higher than expected in accident years 2010 and subsequent.
A slow moving judicial system including varying approaches to medical malpractice claims among courts
Marketform recorded adverse prior year reserve development of $44 million in 2015, $14 million in 2014 and $1 million in 2013. The adverse development in 2015 and 2014 was attributable to reserve strengthening in several lines of business, primarily Dutch hospital medical malpractice, Australian and other general liability and personal accident insurance. In October of 2015, AFG announced the hiring of a new management team at Marketform with extensive underwriting experience in the Lloyd’s market. The new management is in the process of evaluating Marketform’s operational structure and lines of business with the goal of improving the profitability of these operations.
Approximately 43% of AFG’s net asbestos reserves relate to policies written directly by AFG subsidiaries. Claims from these policies generally are product oriented claims with only a limited amount of non-products exposures, and are dominated by small to mid-sized commercial entities that are mostly regional policyholders with few national target defendants. The remainder is assumed reinsurance business that includes exposures for the periods 1954 to 1983. The asbestos and environmental assumed claims are ceded by various insurance companies under reinsurance treaties. A majority of the individual assumed claims have exposures of less than $100,000 to AFG. Asbestos losses assumed include some of the industry known manufacturers, distributors and installers. Pollution losses include industry known insured names and sites.
Establishing reserves for A&E claims relating to policies and participations in reinsurance treaties and former operations 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. Case reserves and expense reserves are established by the claims department as specific policies are identified. In addition to the case reserves established for known claims, management establishes additional reserves for claims not yet known or reported and for possible development on known claims. These additional reserves are management’s best estimate based on periodic comprehensive studies and internal reviews adjusted for payments and identifiable changes, supplemented by management’s review of industry information about such claims, with due consideration to individual claim situations.
Management believes that estimating the ultimate liability for asbestos claims presents a unique and difficult challenge to the insurance industry due to, among other things, inconsistent court decisions, an increase in bankruptcy filings as a result of asbestos-related liabilities, novel theories of coverage, and judicial interpretations that often expand theories of recovery and broaden the scope of coverage. The casualty insurance industry is engaged in extensive litigation over these coverage and liability issues as the volume and severity of claims against asbestos defendants continue to increase. Environmental claims likewise present challenges in prediction, due to uncertainty regarding the interpretation of insurance policies, complexities regarding multi-party involvements at sites, evolving cleanup standards and protracted time periods required to assess the level of cleanup required at contaminated sites.
Amounts paid (net of reinsurance recoveries) for asbestos and environmental claims, including loss adjustment expenses, were as follows (in millions):
environmental reserves by $42 million (net of reinsurance). As the overall industry exposure to asbestos has matured, the focus of litigation has shifted to smaller companies and companies with ancillary exposures. AFG’s insureds with these exposures have been the driver of the property and casualty segment’s asbestos reserve increases in recent years; AFG has seen increased estimates for indemnity and defense compared to prior studies. The increase in property and casualty environmental reserves was attributed primarily to increased defense costs and a number of claims where the estimated costs of remediation have increased. As in past years, there were no new or emerging broad industry trends that were identified in this study.
Run-off Long-term Care Insurance AFG, as well as other companies that sell long-term care products, have accumulated relatively limited claims, lapse and mortality experience, making it difficult to predict future claims. Long-term care claims tend to be much higher in dollar amount and longer in duration than other health care products. In addition, long-term care claims are incurred much later in the life of a policy than most other health products. These factors made it difficult to appropriately price this product and were instrumental in AFG’s decision to stop writing new policies in January 2010. In December 2015, AFG completed the sale of United Teacher Associates Insurance Company and Continental General Insurance Company, the legal entities containing substantially all of its run-off long-term care insurance business, to HC2 Holdings, Inc. (“HC2”) for approximately $13 million in net proceeds. AFG may also receive up to $13 million of additional proceeds from HC2 in the future contingent upon the release of certain statutory-basis liabilities of the legal entities sold by AFG. In connection with obtaining regulatory approval for the transaction, AFG agreed to provide up to an aggregate of $35 million of capital support for the insurance companies, on an as-needed basis to maintain specified surplus levels, subject to immediate reimbursement by HC2 through a five-year capital maintenance agreement. With the completion of this sale, AFG has divested substantially all of its long-term care business (96% as measured by net statutory reserves as of November 30, 2015) and will retain only a small block of long-term care insurance (1,700 policies) with approximately $34 million of reserves. AFG will continue to service and accept renewal premiums on its remaining outstanding policies, which are guaranteed renewable.
Includes $35 million in net investment income representing the change in fair value of AFG’s CLO investments plus $16 million in CLO management fees earned.
Elimination of the change in fair value of AFG’s investments in the CLOs, including $25 million in distributions recorded as interest expense by the CLOs.
Allocate losses of CLOs attributable to other debt holders to noncontrolling interests.
Net earnings attributable to shareholders decreased $100 million for the full-year of 2015 compared to the same period in 2014 due primarily to the loss on the sale of substantially all of AFG’s run-off long-term care insurance business, higher special A&E charges and realized losses on securities in 2015 compared to realized gains on securities in 2014, partially offset by the gain on the sale of Le Pavillon Hotel and an apartment property and higher core net operating earnings. Core net operating earnings
increased $47 million for the full-year of 2015 compared to the same period in 2014 due primarily to higher underwriting profit and higher net investment income in the property and casualty insurance segment and improved core operating results in the run-off long-term care and life segment.
Net earnings attributable to shareholders decreased $19 million for the full-year of 2014 compared to the same period of 2013 reflecting significantly lower realized gains on securities, partially offset by higher core net operating earnings and lower special A&E charges. Core net operating earnings increased $54 million in 2014 compared to 2013 due primarily to higher underwriting profit and higher net investment income in the property and casualty insurance segment and lower holding company expenses.
RESULTS OF OPERATIONS - QUARTERS ENDED DECEMBER 31, 2015 AND 2014
AFG’s property and casualty insurance operations contributed $179 million in GAAP pretax earnings in the fourth quarter of 2015 compared to $143 million in the fourth quarter of 2014, an increase of $36 million (25%). Property and casualty core pretax earnings were $164 million in the fourth quarter of 2015 compared to $143 million in the fourth quarter of 2014, an increase of $21 million (15%). The increase in GAAP and core pretax earnings reflects higher underwriting profit in the Property and transportation and Specialty casualty insurance sub-segments. The increase in GAAP earnings also includes a $15 million pretax gain on the sale of an apartment property in the fourth quarter of 2015.
AFG’s combined ratio has been better than the industry average for 28 of the last 30 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.
Reinsurance premiums ceded (“Ceded”) for AFG’s property and casualty insurance segment were 22% of gross written premiums for the fourth quarter of 2015 compared to 21% for the fourth quarter of 2014, an increase of 1 percentage point. Detail of AFG’s property and casualty reinsurance premiums ceded is shown below (dollars in millions):
Net written premiums (“NWP”) for AFG’s property and casualty insurance segment were $1.06 billion for the fourth quarter of 2015 compared to $1.03 billion for the fourth quarter of 2014, an increase of $31 million (3%). Detail of AFG’s property and casualty net written premiums is shown below (dollars in millions):
Net earned premiums (“NEP”) for AFG’s property and casualty insurance segment were $1.12 billion for the fourth quarter of 2015 compared to $1.06 billion for the fourth quarter of 2014, an increase of $59 million (6%). Detail of AFG’s property and casualty net earned premiums is shown below (dollars in millions):
Specialty casualty Gross written premiums increased $1 million in the fourth quarter of 2015 compared to the fourth quarter of 2014. The majority of businesses in this group reported modest growth, particularly the excess and surplus businesses. This growth was partially offset by lower gross written premiums in the general liability business, primarily the result of competitive market conditions, re-underwriting efforts within the Florida homebuilders market and the slowdown within the energy sector. Average renewal rates for this group were down approximately 2% in the fourth quarter of 2015 due primarily to lower pricing in the workers’ compensation business. Excluding the workers’ compensation business, average renewal rates in this group increased approximately 1% in the fourth quarter of 2015. Reinsurance premiums ceded as a percentage of gross written premiums declined 1 percentage point for the fourth quarter of 2015 compared to the fourth quarter of 2014.
Other specialty The amounts shown as reinsurance premiums ceded represent business assumed by AFG’s internal reinsurance program from the operations that make up AFG’s other Specialty property and casualty insurance sub-segments.
The Specialty property and casualty insurance operations generated an underwriting profit of $100 million for the fourth quarter of 2015 compared to $79 million in the fourth quarter of 2014, an increase of $21 million (27%). The higher underwriting profit in the 2015 fourth quarter reflects higher underwriting profit in the Property and transportation and Specialty casualty sub-segments.
Property and transportation Underwriting profit for this group was $34 million for the fourth quarter of 2015 compared to $22 million in the fourth quarter of 2014, an increase of $12 million (55%). This increase is due primarily to higher accident year profitability in the transportation and agricultural businesses, partially offset by adverse prior year reserve development at National Interstate, as well as lower profitability in the property and inland marine and ocean marine businesses.
Specialty financial Underwriting profit for this group was $15 million for the fourth quarter of 2015 compared to $18 million in the fourth quarter of 2014, a decrease of $3 million (17%). Catastrophe losses were $5 million in the fourth quarter of 2015 compared to negligible catastrophe losses in the fourth quarter of 2014.
AFG’s overall loss and LAE ratio was 61.8% for the fourth quarter of 2015 compared to 64.0% for fourth quarter of 2014, a decrease of 2.2 percentage points. The components of AFG’s property and casualty losses and LAE amounts and ratio are detailed below (dollars in millions):
The current accident year loss and LAE ratio, excluding catastrophe losses for AFG’s Specialty property and casualty insurance operations was 61.4% for the fourth quarter of 2015 compared to 62.8% for the fourth quarter of 2014, a decrease of 1.4%.
Specialty financial The 4.8 percentage point decrease in the loss and LAE ratio for the current year, excluding catastrophe losses reflects an improvement in the loss and LAE ratio of the financial institutions, fidelity, equipment leasing and surety businesses.
Specialty casualty Net favorable reserve development of $7 million in the fourth quarter of 2015 reflects lower than anticipated claim severity in workers’ compensation business, excess liability insurance and directors and officers liability insurance, partially offset by adverse reserve development at Marketform. Net adverse reserve development of $14 million in the fourth quarter of 2014 reflects adverse reserve development at Marketform and higher than expected claim severity in contractor claims and in a run-off book of casualty business, partially offset by lower than anticipated claim severity in specialty workers’ compensation business.
Specialty financial Net favorable reserve development of $5 million in the fourth quarter of 2015 reflects lower than anticipated claim severity in the fidelity business, lower than expected claim frequency and severity in the surety business and lower than expected claim severity on a run-off block of collateral value insurance, partially offset by higher than expected claim severity in products for financial institutions and in the trade credit business. Net favorable reserve development of $4 million in the fourth quarter of 2014 reflects lower than expected claim severity in the surety and fidelity businesses.
Other specialty In addition to the development discussed above, total Specialty prior year reserve development includes net favorable reserve development of $1 million in the fourth quarter of 2015 and $3 million in the fourth quarter of 2014, reflecting amortization of the deferred gain on the retroactive insurance transaction entered into in connection with the sale of businesses in 1998 and 2001 and reserve development associated with AFG’s internal reinsurance program.
AFG’s property and casualty commissions and other underwriting expenses (“U/W Exp”) were $327 million in the fourth quarter of 2015 compared to $303 million for the fourth quarter of 2014, an increase of $24 million (8%). AFG’s underwriting expense ratio, calculated as commissions and other underwriting expenses divided by net premiums earned, was 29.2% for the fourth quarter of 2015 compared to 28.6% for the fourth quarter of 2014, an increase of 0.6 percentage points. Detail of AFG’s property and casualty commissions and other underwriting expenses and underwriting expense ratios is shown below (dollars in millions):
Specialty casualty Commissions and other underwriting expenses as a percentage of net earned premiums increased 1.3 percentage points in the fourth quarter of 2015 compared to the fourth quarter of 2014 due primarily to higher expenses in the international businesses.
GAAP other income and expenses, net for AFG’s property and casualty operations was net income of $5 million for the fourth quarter of 2015 compared to a net expense of $11 million for the fourth quarter of 2014, an improvement of $16 million (145%). Core other income and expenses, net for AFG’s property and casualty operations was a net expense of $10 million in the fourth quarter of 2015 compared to $11 million in the fourth quarter of 2014, a decrease of $1 million (9%). The table below details the items included in GAAP and core other income and expenses, net for AFG’s property and casualty operations (in millions):
Excludes the $15 million pretax non-core gain on the sale of an apartment property in the fourth quarter of 2015.
Interest expense for AFG’s property and casualty operations includes interest charges on long-term debt within the property and casualty operations, primarily notes secured by real estate.
The following table details AFG’s earnings before income taxes from its annuity operations for the three months ended December 31, 2015 and 2014 (dollars in millions):
average interest rate credited to policyholders, calculated as interest credited divided by average fixed annuity benefits accumulated, decreased 0.09 percentage points in the fourth quarter of 2015 compared to the fourth quarter of 2014. During the fourth quarter of 2015, interest rates credited on new premiums generally ranged from 1.00% to 2.80%.
AFG’s net interest spread decreased 0.11 percentage points in the fourth quarter of 2015 compared to the same period in 2014 due primarily to the impact of lower investment yields. In addition, features included in current annuity product offerings allow AFG to achieve its desired profitability at a lower net interest spread than historical product offerings. As a result of these two items, AFG expects its net interest spread to narrow in the future.
Annuity policy charges and other miscellaneous income, which consist primarily of surrender charges and the amortization of deferred upfront policy charges (unearned revenue), were $11 million in the fourth quarter of 2015 compared to $24 million in the fourth quarter of 2014, a decrease of $13 million (54%). Excluding the impact of an unlocking charge of $2 million in the fourth quarter of 2015 and unlocking income of $10 million in the fourth quarter of 2014 related to unearned revenue, annuity policy charges and other miscellaneous income were $13 million in 2015 compared to $14 million in 2014, a decrease of $1 million (7%).
at a lower cost than previously estimated. Annuity other expenses represent primarily general and administrative expenses, as well as selling and issuance expenses that are not deferred. As a percentage of average fixed annuity benefits accumulated, these expenses increased 0.04 percentage points for the fourth quarter of 2015 as compared to the fourth quarter of 2014. In general, this percentage is expected to decrease as AFG’s annuity business grows and annuity other expenses remain relatively stable.
AFG’s fixed-indexed annuities, which represented approximately 60% of annuity benefits accumulated at December 31, 2015, provide policyholders with a crediting rate tied, in part, to the performance of an existing stock market index. AFG attempts to mitigate the risk in the index-based component of these products through the purchase of call options on the appropriate index. AFG’s strategy is designed so that the change in the fair value of the call option assets will generally offset the economic change in the liabilities from the index participation. Both the index-based component of the annuities and the related call options are considered derivatives that must be marked-to-market through earnings each period. The fair values of these derivatives are impacted by actual and expected stock market performance and interest rates as well as other factors. For a list of other factors impacting the fair value of the index-based component of AFG’s annuity benefits accumulated, see Note D - “Fair Value Measurements” to the financial statements. Excluding the impact of unlocking charges, the net change in fair value of derivatives related to fixed-indexed annuities had a nominal impact on annuity benefits in the fourth quarter of 2015 and increased annuity benefits by $18 million in the fourth quarter of 2014. The $18 million impact in the fourth quarter of 2014 reflects the negative impact of lower interest rates on the derivatives, partially offset by the favorable impact of strong stock market performance.
AFG’s net spread earned on fixed annuities decreased 0.01 percentage points in the fourth quarter of 2015 compared to the same period in 2014 due primarily to the 0.11 percentage points decrease in AFG’s net interest spread and the impact of growth in AFG’s annuity business on other expenses and other annuity benefits as a percent of fixed annuity benefits accumulated discussed above, partially offset by the net impact of changes in the fair value of derivatives and related DPAC amortization offset discussed above.
For certain products, annuity benefits accumulated also includes reserves for accrued persistency and premium bonuses, excess benefits expected to be paid on future deaths and annuitizations (“EDAR”) and guaranteed withdrawal benefits. Annuity benefits accumulated also includes amounts advanced from the Federal Home Loan Bank of Cincinnati. The following table is a progression of AFG’s annuity benefits accumulated liability for the three months ended December 31, 2015 and 2014 (in millions):
AFG’s annuity operations generated statutory premiums of $1.11 billion in the fourth quarter of 2015 compared to $971 million in the fourth quarter of 2014, an increase of $136 million (14%). The following table summarizes AFG’s annuity sales (dollars in millions):
The 2015 net expense reduction was due primarily to the impact of changes in assumptions to reflect higher than previously projected net interest spreads as well as the impact of higher assets under management and expense discipline. Reinvestment rates used to project future investment yields are based primarily on 7-year and 10-year corporate bond yields. For the 2015 unlocking, AFG assumed a net reinvestment rate (net of default and expense assumptions) of 3.87% in 2016, grading up ratably to an ultimate net reinvestment rate of 5.53% in 2022 and beyond.
Net investment income (as a % of investments) of 4.65% and 4.85% for the three months ended December 31, 2015 and 2014, respectively, multiplied by the difference between average fixed annuity investments (at amortized cost) and average fixed annuity benefits accumulated in each period.
The $11 million decrease in long-term care benefit expense in the fourth quarter of 2015 compared to the fourth quarter of 2014 is due primarily to a $5 million charge related to the commutation of a reinsurance agreement in 2014 and improved claims experience.
Holding Company, Other and Unallocated - Results of Operations AFG’s net pretax loss outside of its insurance operations (excluding realized gains and losses) totaled $45 million for the fourth quarter of 2015 compared to $35 million for the fourth quarter of 2014, an increase of $10 million (29%).
The following table details AFG’s loss before income taxes from operations outside of its insurance operations for three months ended December 31, 2015 and 2014 (dollars in millions):
AFG recorded net investment income on investments held outside of its insurance operations of $3 million in the fourth quarter of 2015 compared to $2 million in the fourth quarter of 2014.
Summit, the workers’ compensation insurance business that AFG acquired in April 2014, collects fees from a small group of unaffiliated insurers for providing underwriting, policy administration and claims services. In addition, certain of AFG’s property and casualty businesses collect fees from customers for ancillary services such as workplace safety programs and premium financing. In the fourth quarter of 2015, AFG collected $16 million in fees for these services. Management views this fee income, net of the $10 million in expenses incurred to generate such fees, as a reduction in the cost of underwriting its property and casualty insurance policies. Consistent with internal management reporting, these fees and the related expenses are netted and recorded as a reduction of commissions and other underwriting expenses in AFG’s segmented results. Beginning with the first quarter of 2015, these fees are shown in other income and the related expenses are shown in other expenses in AFG’s Statement of Earnings.
In June 2015, AFG entered into an interest rate swap to mitigate the interest rate risk associated with its fixed-rate 9-7/8% Senior Notes due June 2019 by effectively converting the interest rate on those notes to a floating rate of three-month LIBOR plus 8.099% (8.6110% at December 31, 2015).
AFG redeemed its $132 million of outstanding 7% Senior Notes due September 2050 at par value in September 2015. AFG issued $150 million of 6% Subordinated Debentures in November 2015 and $150 million of 6-1/4% Subordinated Debentures in late September 2014. The impact of lower average indebtedness during the fourth quarter of 2015 as compared to the fourth quarter of 2014 and the favorable impact of the interest rate swap on the 9-7/8% Senior Notes due June 2019 that was entered into in June 2015 resulted in a $3 million decrease in interest expense for AFG’s holding companies in the fourth quarter of 2015 compared to the fourth quarter of 2014.
AFG’s impairment charges on securities for the fourth quarter of 2015 consist of $46 million on equity securities, $11 million on fixed maturities and $3 million on other investments. Approximately $26 million of the charges are on real estate and mortgage related investments, $12 million are on investments in asset managers and $8 million are on energy related investments.
Consolidated Realized Gains (Losses) on Subsidiaries The $4 million pretax realized loss on subsidiaries in the fourth quarter of 2015 represents an adjustment to the previously recognized $162 million estimated pretax loss on the sale of substantially all of AFG’s run-off long-term care insurance business that was recorded in the first quarter of 2015.
Consolidated Income Taxes AFG’s consolidated provision for income taxes was $80 million for the fourth quarter of 2015 compared to $65 million in the fourth quarter of 2014, an increase of $15 million (23%). See Note L - “Income Taxes” to the financial statements. The following is a reconciliation of income taxes at the statutory rate of 35% to the provision for income taxes as shown in the Segmented Statement of Earnings (dollars in millions):
Consolidated Noncontrolling Interests AFG’s consolidated net earnings (loss) attributable to noncontrolling interests was earnings of $1 million for the fourth quarter of 2015 compared to a loss of $2 million for the fourth quarter of 2014. The following table details net earnings (loss) in consolidated subsidiaries attributable to holders other than AFG (dollars in millions):
RESULTS OF OPERATIONS - YEARS ENDED DECEMBER 31, 2015, 2014 AND 2013
Gross written premiums (“GWP”) for AFG’s property and casualty insurance segment were $5.83 billion in 2015 compared to $5.48 billion in 2014, an increase of $355 million (6%). GWP increased $672 million (14%) in 2014 compared to 2013. Detail of AFG’s property and casualty gross written premiums is shown below (dollars in millions):
Net earned premiums (“NEP”) for AFG’s property and casualty insurance segment were $4.22 billion in 2015 compared to $3.88 billion in 2014, an increase of $346 million (9%). NEP increased $674 million (21%) in 2014 compared to 2013. Detail of AFG’s property and casualty net earned premiums is shown below (dollars in millions):
within the Specialty casualty and Property and transportation groups. Overall average renewal rates increased approximately 1% in 2015.
The $672 million (14%) increase in gross written premiums in 2014 compared to 2013 reflects $414 million in premiums from Summit (acquired in April 2014) as well as significant growth in other businesses within the Specialty casualty group. Excluding premiums from Summit, gross written premiums increased by 5% in 2014 compared to 2013. Overall average renewal rates increased approximately 3% in 2014.
Property and transportation Gross written premiums increased $113 million (5%) in 2015 compared to 2014. This increase is the result of higher gross written premiums in the transportation businesses due primarily to new accounts, higher gross written premiums in the agricultural businesses and new gross written premiums from the Singapore branch, which opened for business in June 2015, partially offset by lower gross written premiums in the property and inland marine businesses. Average renewal rates were up approximately 4% for this group in 2015, including a 5% increase in National Interstate’s renewal rates. Reinsurance premiums ceded as a percentage of gross written premiums were comparable in 2015 and 2014.
Gross written premiums decreased $50 million (2%) in 2014 compared to 2013 reflecting the impact of lower 2014 commodity prices on the crop operations, partially offset by growth in the transportation businesses resulting from rate increases. Excluding the crop insurance business, gross written premiums increased by 6% for this group in 2014 compared to 2013. Average renewal rates were up approximately 5% for this group in 2014, including a 7% increase in National Interstate’s renewal rates. Reinsurance premiums ceded as a percentage of gross written premiums declined 2 percentage points in 2014 compared to 2013 as lower cessions in the crop business were partially offset by higher cessions in the excess property business and certain captive programs in the transportation business and the impact of a change in the mix of business.
Gross written premiums increased $739 million (41%) in 2014 compared to 2013 reflecting $414 million in premiums from Summit, which was acquired in April 2014. Excluding premiums from Summit, gross written premiums increased 18% in 2014 compared to 2013 as a result of increased premiums in nearly all businesses in this group, particularly in the workers’ compensation, excess and surplus lines and targeted markets operations. New business opportunities and increased exposures from higher payroll on existing accounts contributed to the increase in premiums in the workers’ compensation businesses. Strong premium growth in the excess and surplus lines and targeted markets operations was the result of broadening opportunities to write business coupled with the benefit from rate increases over multiple quarters. Average renewal rates were up approximately 2% for this group in 2014. Reinsurance premiums ceded as a percentage of gross written premiums declined 6 percentage points in 2014 compared to 2013 reflecting the impact of the acquisition of Summit, which cedes only about 1% of its premiums.
Specialty financial Gross written premiums increased $32 million (5%) in 2015 compared to 2014 due primarily to higher gross written premiums in the surety, financial institutions and equipment leasing businesses. Average renewal rates for this group were flat in 2015. Reinsurance premiums ceded as a percentage of gross written premiums decreased 4 percentage points in 2015 compared to 2014, reflecting a decline in auto dealer business, which is heavily reinsured.
Gross written premiums decreased $17 million (3%) in 2014 compared to 2013. The impact of the October 2013 sale of a service contract business, which ceded all of its premiums under reinsurance contracts, more than offset growth in gross written premiums across most businesses in this group. Average renewal rates for this group decreased about 1% in 2014. Reinsurance premiums ceded as a percentage of gross written premiums declined 3 percentage points in 2014 compared to 2013 reflecting the sale of the service contract business, partially offset by higher cessions in the financial institutions business.
Other specialty The amounts shown as reinsurance premiums ceded represent business assumed by AFG’s internal reinsurance program from the operations that make up AFG’s other Specialty sub-segments.
Specialty casualty Underwriting profit for this group was $146 million in 2015 compared to $136 million in 2014, an increase of $10 million (7%). This increase is due primarily to higher profitability in the workers’ compensation and targeted markets businesses, partially offset by higher adverse prior year reserve development at Marketform and in the general liability and excess and surplus businesses and lower favorable prior year reserve development in the executive liability business.
Underwriting profit for this group was $136 million in 2014 compared to $102 million in 2013, an increase of $34 million (33%). Higher underwriting profit in the workers’ compensation businesses, including the impact of the Summit business acquired in April 2014, was partially offset by lower underwriting results in the general liability lines of business, adverse prior year reserve development in the international operations and lower favorable prior year reserve development in the executive liability business.
Specialty financial Underwriting profit for this group was $87 million in 2015 compared to $64 million in 2014, an increase of $23 million (36%). This increase was driven by higher favorable prior year reserve development across the group and higher current year underwriting profitability in the fidelity and financial institutions businesses, partially offset by an increase of $6 million in catastrophe losses in 2015 compared to 2014.
Underwriting profit for this group was $16 million in 2014 compared to $25 million in 2013, a decrease of $9 million (36%). The decrease is due primarily to lower favorable prior year loss development in the business assumed by AFG’s internal reinsurance program from the operations that make up AFG’s other Specialty sub-segments.
The current accident year loss and LAE ratio, excluding catastrophe losses for AFG’s Specialty property and casualty insurance operations was 62.2% in 2015, 63.5% in 2014 and 63.1% in 2013.
Property and transportation The 2.4 percentage point decrease in the loss and LAE ratio for the current year, excluding catastrophe losses in 2015 compared to 2014 reflects higher profitability in the agricultural businesses.
The 0.8% percentage point decrease in the loss and LAE ratio for the 2014 current year, excluding catastrophe losses compared to 2013 reflects higher profitability in the property and inland marine business.
Specialty casualty The 0.3 percentage point increase in the loss and LAE ratio for the current year, excluding catastrophe losses reflects the inclusion of Summit following its acquisition in April 2014, which has a higher loss and LAE ratio than AFG’s overall Specialty casualty group.
The 1.9 percentage point increase in the loss and LAE ratio for the 2014 current year, excluding catastrophe losses compared to 2013 reflects the inclusion of Summit following its acquisition in April 2014, which has a higher loss and LAE ratio than AFG’s overall Specialty casualty group, partially offset by higher profitability in the California workers’ compensation business.
Specialty financial The 3.2 percentage point decrease in the loss and LAE ratio for the current year, excluding catastrophe losses in 2015 compared to 2014 reflects an improvement in the loss and LAE ratio of the financial institutions, fidelity and equipment leasing businesses.
AFG’s Specialty property and casualty insurance operations recorded net favorable reserve development related to prior accident years of $37 million in 2015 compared to $19 million in 2014 and $75 million in 2012, an increase of $18 million and a decrease of $56 million, respectively.
Property and transportation Net adverse reserve development of $15 million in 2015 reflects higher than expected claim severity at National Interstate and higher than anticipated claim frequency in the ocean marine business, partially offset by lower than expected claim severity in the property and inland marine business, agricultural operations and a run-off book of homebuilders business.
Specialty casualty Net favorable reserve development of $11 million in 2015 includes lower than anticipated claim severity in workers’ compensation business, lower than anticipated claim severity and frequency in excess liability insurance and lower than expected claim severity in directors and officers liability insurance, partially offset by adverse reserve development at Marketform.
Net favorable reserve development of $40 million in 2013 reflects lower than expected claim severity in directors and officers liability insurance and lower than expected claim severity and frequency in excess liability business, partially offset by adverse development from higher than expected claim frequency and severity in products liability claims and higher than expected claim severity in contractor claims.
Other specialty In addition to the development discussed above, total Specialty prior year reserve development includes net favorable reserve development of $11 million in both 2015 and 2014 and $20 million in 2013, reflecting amortization of the deferred gain on the retroactive insurance transaction entered into in connection with the sale of businesses in 1998 and 2001 and reserve development associated with AFG’s internal reinsurance program.
Aggregate Aggregate net prior accident years reserve development for AFG’s property and casualty segment includes the A&E charges mentioned above and adverse reserve development of $3 million in 2015, $1 million in 2014 and $1 million in 2013 related to run-off assumed insurance business.
AFG generally seeks to reduce its exposure to catastrophes through individual risk selection, including minimizing coastal and known fault-line exposures, and the purchase of reinsurance. The $21 million of catastrophe losses in the Property and transportation group in 2015 resulted primarily from winter storms in the first quarter and multiple storms in the midwestern and central United States in the second and third quarters. The $9 million of catastrophe losses in the Specialty financial group in 2015 resulted primarily from flooding in the midwestern United States. The $20 million of catastrophe losses in the Property and transportation group in 2014 were primarily from winter storms in the month of January and multiple storms in the midwestern and central United States in the second quarter. The $27 million of catastrophe losses in the Property and transportation group in 2013 resulted primarily from spring storms in the southeastern United States.
Property and transportation Commissions and other underwriting expenses as a percentage of net earned premiums increased 0.7 percentage points in 2015 compared to 2014 reflecting higher profitability-based commissions paid to agents and brokers, partially offset by the impact of higher premiums on the ratio.
Commissions and other underwriting expenses as a percentage of net earned premiums decreased 0.3 percentage points in 2014 compared to 2013 reflecting lower profitability-based commissions paid to agents and brokers, an increase in ceding commissions received from reinsurers and a change in the mix of business.
Commissions and other underwriting expenses as a percentage of net earned premiums increased 0.5 percentage points in 2014 compared to 2013 due primarily to the impact of $5 million in reinsurance reinstatement premiums paid in 2014 on the ratio.
The increase in average invested assets and net investment income in the property and casualty segment in 2014 compared to 2013 is due primarily to the investment of cash acquired in the Summit acquisition in April 2014 and organic growth in the property and casualty segment. The property and casualty segment’s overall yield on investments was 3.75% in 2014 compared to 3.83% in 2013, a decline of 0.08 percentage points. The impact of equity in the earnings of limited partnerships and similar investments and strong investment results in the first nine months of 2014 was more than offset by the impact of lower yields available in the financial markets.
GAAP other income and expenses, net for AFG’s property and casualty operations was net income of $32 million in 2015 and a net expense of $50 million and $33 million in 2014 and 2013, respectively. Core other income and expenses, net for AFG’s property and casualty operations was a net expense of $34 million, $50 million and $33 million in 2015, 2014 and 2013, respectively. The table below details the items included in GAAP and core other income and expenses, net for AFG’s property and casualty operations (in millions):
The lower amortization of intangibles in 2015 compared to 2014 reflects the impact of intangible assets related to three acquisitions that became fully amortized in 2014. Amortization of intangibles includes $7 million in 2015 and $5 million in 2014 related to the Summit acquisition.
AFG’s annuity operations contributed $328 million in GAAP pretax earnings in 2014 compared to $323 million in 2013, an increase of $5 million (2%). AFG’s annuity operations contributed $328 million in core pretax earnings in both 2014 and 2013. While AFG’s average annuity investments (at amortized cost) were 17% higher in 2014 as compared to 2013, the benefit of this growth was offset by the run-off of higher yielding investments, and the impact that fluctuations in interest rates in 2014 and 2013 had on the fair value accounting for FIAs. Operating earnings also include a net unlocking expense reduction of $1 million in 2014 compared to a $2 million charge in 2013.
The following table details AFG’s GAAP and core earnings before income taxes from its annuity operations for 2015, 2014 and 2013 (dollars in millions):
The table below (dollars in millions) details the components of the spreads for AFG’s fixed annuity operations (including fixed-indexed annuities):
The table below illustrates the impact of fair value accounting for derivatives related to fixed-indexed annuities on the annuity segment’s net spread earned on fixed annuities, excluding the impact of the non-core charge for ELNY guaranty fund assessments:
Net investment income in 2015 was $1.22 billion compared to $1.14 billion in 2014, an increase of $88 million (8%). This increase reflects primarily the growth in AFG’s annuity business, partially offset by the run-off of higher yielding investments. The overall yield earned on investments in AFG’s annuity operations, calculated as net investment income divided by average investment balances (at amortized cost), declined by 0.20 percentage points in 2015 compared to 2014. This decline in net investment yield reflects (i) the investment of new premium dollars at lower yields as compared to the existing investment portfolio and (ii) the impact of the reinvestment of proceeds from maturity and redemption of higher yielding investments at the lower yields available in the financial markets.
Net investment income in 2014 was $1.14 billion compared to $1.03 billion in 2013, an increase of $102 million (10%). This increase primarily reflects the growth in AFG’s annuity business, partially offset by the run-off of higher yielding investments. The overall yield earned on investments in AFG’s annuity operations declined by 0.32 percentage points in 2014 compared to 2013. This decline in net investment yield reflects the investment of new premium dollars at lower yields as compared to the
Interest credited - fixed in 2015 was $532 million compared to $497 million in 2014, an increase of $35 million (7%). The impact of growth in the annuity business was partially offset by lower interest crediting rates on new premiums as compared to the crediting rates on policyholder funds surrendered or withdrawn. The average interest rate credited to policyholders, calculated as interest credited divided by average fixed annuity benefits accumulated, decreased 0.11 percentage points in 2015 compared to 2014. During 2015, interest rates credited on new premiums generally ranged from 1.00% to 2.80%.
AFG’s net interest spread decreased 0.16 percentage points in 2014 compared to 2013 due primarily to the run-off of higher yielding investments, partially offset by lower crediting rates.
Annuity policy charges and other miscellaneous income, which consist primarily of surrender charges and the amortization of deferred upfront policy charges (unearned revenue), were $55 million in 2015 compared to $63 million in 2014, a decrease of $8 million (13%). Excluding the impact of unlocking charges of $2 million in 2015 and unlocking income of $10 million in 2014 related to unearned revenue, annuity policy charges and other miscellaneous income were $57 million in 2015 and $53 million in 2014, an increase of $4 million (8%). This increase reflects the impact of $6 million in income from the sale of real estate recorded in 2015.
Other annuity benefits, net of guaranteed withdrawal benefit fees (excluding the impact of unlocking) were $87 million in 2015, $63 million in 2014 and $69 million in 2013, representing an increase of $24 million (38%) in 2015 compared to 2014 and a decrease of $6 million (9%) in 2014 compared to 2013. In addition to interest credited to policyholders’ accounts and the change in fair value of derivatives related to fixed-indexed annuities, annuity benefits expense also includes the following expenses (in millions, net of guaranteed withdrawal benefit fees):
Excluding the impact of unlocking charges (expense reductions), AFG’s amortization of DPAC and commission expenses as a percentage of average fixed annuity benefits accumulated was 0.74% in 2015 compared to 0.67% in 2014 and 0.85% in 2013 and has generally ranged between 0.70% and 0.80%. Variances from the general range relate primarily to the impact of (i) material changes in interest rates or the stock market on AFG’s fixed-indexed annuity business, and (ii) differences in actual experience from actuarially projected estimates and assumptions. For example, the negative impact of the stock market decrease in 2015 and lower than anticipated interest rates during 2015 and 2014 on the fair value of derivatives related to fixed-indexed annuities (discussed below) resulted in a partially offsetting deceleration in the amortization of DPAC; conversely, higher interest rates in 2013 had a positive impact on the fair value of the derivatives, resulting in a partially offsetting acceleration in the amortization of DPAC.
Fluctuations in interest rates and the stock market, among other factors, can cause volatility in the periodic measurement of fair value of the embedded derivative that management believes can be inconsistent with the long-term economics of these products. The table below illustrates the impact of fair value accounting for derivatives related to fixed-indexed annuities on the annuity segment’s GAAP and core earnings before income taxes (dollars in millions):
AFG’s net spread earned on fixed annuities decreased 0.19 percentage points in 2014 compared to 2013 due primarily to the 0.16 percentage points decrease in AFG’s net interest spread and the net impact of changes in the fair value of derivatives and related DPAC amortization offset discussed above. These items were partially offset by the impact of growth in AFG’s annuity business on other expenses and other annuity benefits as a percent of fixed annuity benefits accumulated discussed above.
For certain products, annuity benefits accumulated also includes reserves for accrued persistency and premium bonuses, excess benefits expected to be paid on future deaths and annuitizations (“EDAR”) and guaranteed withdrawal benefits. Annuity benefits accumulated also includes amounts advanced from the Federal Home Loan Bank of Cincinnati. The following table is a progression of AFG’s annuity benefits accumulated liability for 2015, 2014 and 2013 (in millions):
AFG’s annuity operations generated statutory premiums of $4.14 billion in 2015, $3.70 billion in 2014 and $4.03 billion in 2013, an increase of $444 million (12%) in 2015 compared to 2014 and a decrease of $337 million (8%) in 2014 compared to 2013. The following table summarizes AFG’s annuity sales (dollars in millions):
Management attributes the 12% increase in annuity premiums in 2015 compared to 2014 to the significant rise of interest rates during the second quarter of 2015 from first quarter 2015 lows, allowing AFG to raise the crediting rates on its annuities and become more competitive in its markets.
In 2015, 2014 and 2013, AFG conducted its detailed review (“unlocking”) of the major actuarial assumptions underlying its annuity operations. As a result of these reviews, AFG recorded net expense reductions related to its annuity business of $10 million in 2015 and $1 million in 2014 and a net annuity unlocking charge of $2 million in 2013, which impacted AFG’s financial statements as follows (in millions):
See “Results of Operations - Quarters ended December 31, 2015 and 2014 - Annuity Segment - Results of Operations - Annuity Unlocking” for a discussion of the overall net expense reduction and charge from the periodic review of actuarial assumptions in 2015 and 2014.
Net investment income (as a % of investments) of 4.83% and 5.03% and 5.35% in 2015, 2014 and 2013, respectively, multiplied by the difference between average fixed annuity investments (at amortized cost) and average fixed annuity benefits accumulated in each period.
The $6 million increase in long-term care benefit expense in 2014 as compared to 2013 is due primarily to a $5 million loss on the commutation of a reinsurance agreement.
The following table details AFG’s GAAP and core loss before income taxes from operations outside of its insurance operations in 2015, 2014 and 2013 (dollars in millions):
Excludes pretax non-core special A&E charges of $12 million, $6 million and $22 million in 2015, 2014 and 2013, respectively, and a pretax non-core loss on early retirement of debt of $4 million in 2015.
Summit, the workers’ compensation insurance business that AFG acquired in April 2014, collects fees from a small group of unaffiliated insurers for providing underwriting, policy administration and claims services. In addition, certain of AFG’s property and casualty businesses collect fees from customers for ancillary services such as workplace safety programs and premium financing. In 2015, AFG collected $54 million in fees for these services. Management views this fee income, net of the $38 million in expenses incurred to generate such fees, as a reduction in the cost of underwriting its property and casualty insurance policies. Consistent with internal management reporting, these fees and the related expenses are netted and recorded as a reduction of commissions and other underwriting expenses in AFG’s segmented results. Beginning with the first quarter of 2015, these fees are shown in other income and the related expenses are shown in other expenses in AFG’s Statement of Earnings.
Other income in the table above includes $15 million, $25 million and $16 million in 2015, 2014 and 2013, respectively of management fees paid to AFG by the AFG-managed CLOs (AFG’s consolidated managed investment entities). The $25 million of management fees in 2014 includes $13 million of incentive management fees earned in connection with the liquidation of three CLOs. The management fees are eliminated in consolidation - see the other income line in the Consolidated MIEs column under “Results of Operations - Segmented Statement of Earnings.” Excluding amounts eliminated in consolidation, AFG recorded other income outside of its insurance operations of $9 million in 2015 and $11 million in both 2014 and 2013.
Realized gains on disposals include gains on sales of shares of Verisk Analytics, Inc. of $49 million in 2013.
realized gain in the third quarter of 2015 representing an adjustment to the previously recognized loss on a small property and casualty subsidiary sold several years ago.
Consolidated Noncontrolling Interests AFG’s consolidated net earnings (loss) attributable to noncontrolling interests was earnings of $18 million in 2015 compared to a net loss of $46 million in 2014, an improvement of $64 million (139%). AFG’s consolidated net loss attributable to noncontrolling interests was $46 million in 2014 compared to $18 million in 2013, an increase of $28 million (156%). The following table details net earnings (loss) in consolidated subsidiaries attributable to holders other than AFG (dollars in millions):
The losses of Managed Investment Entities in 2014 and 2013 represent CLO losses that ultimately inure to holders of the CLO debt. See Note A - “Accounting Policies - Managed Investment Entities” to the financial statements for a discussion of accounting guidance adopted in 2015 that affects the measurement of the fair value of CLO liabilities. Under the new guidance, there are no longer any CLO earnings or losses to be attributed to noncontrolling interests in AFG’s Statement of Earnings.
See Note A - “Accounting Policies - Managed Investment Entities” to the financial statements for a discussion of accounting guidance adopted on January 1, 2015 that affects the measurement of the fair value of CLO liabilities.
In May 2015, the FASB issued ASU 2015-09, Financial Services-Insurance: Disclosures About Short-Duration Contracts, which requires additional disclosures about the liability for unpaid losses and loss adjustment expenses (including accident year information). AFG will be required to adopt the updated guidance for annual reporting beginning in 2016 and interim reporting beginning with the first quarter of 2017. Because the new guidance does not affect the existing recognition or measurement guidance, the adoption will have no effect on AFG’s financial condition or results of operations.
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, 2015, 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 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, 2015 and 2014, 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, 2015, and our report dated February 26, 2016, expressed an unqualified opinion thereon.
Basis of Presentation The consolidated financial statements include the accounts of American Financial Group, Inc. and its subsidiaries (“AFG”). 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, 2015, and prior to the filing of this Form 10-K, have been evaluated for potential recognition or disclosure herein.
In January 2016, the Financial Accounting Standards Board (“FASB”) issued Accounting Standards Update (“ASU”) 2016-01, which, among other things, will require all equity securities currently classified as “available for sale” to be reported at fair value, with holding gains and losses recognized in net income instead of AOCI. AFG will be required to adopt this guidance effective January 1, 2018.
comprehensive income). The credit-related portion of an other-than-temporary impairment is measured by comparing a security’s amortized cost to the present value of its current expected cash flows discounted at its effective yield prior to the impairment charge. Both components are shown in the Statement of Earnings. If management intends to sell an impaired security, or it is more likely than not that it will be required to sell the security before recovery, an impairment charge to earnings is recorded to reduce the amortized cost of that security to fair value.
Derivatives Derivatives included in AFG’s Balance Sheet are recorded at fair value. Changes in fair value of derivatives are included in earnings, unless the derivatives are designated and qualify as highly effective cash flow hedges. Derivatives that do not qualify for hedge accounting under GAAP consist primarily of (i) components of certain fixed maturity securities (primarily interest-only MBS) and (ii) the equity-based component of certain annuity products (included in annuity benefits accumulated) and related call options (included in other investments) designed to be consistent with the characteristics of the liabilities and used to mitigate the risk embedded in those annuity products.
For derivatives that are designated and qualify as highly effective fair value hedges, changes in the fair value of the derivative, along with changes in the fair value of the hedged item attributable to the hedged risk, are recognized in current period earnings. AFG has entered into an interest rate swap that qualifies as a highly effective fair value hedge to mitigate the interest rate risk associated with fixed-rate long-term debt by economically converting certain fixed-rate debt obligations to floating-rate obligations. Since the terms of the swap match the terms of the hedged debt, changes in the fair value of the swap are offset by changes in the fair value of the hedged debt attributable to changes in interest rates. Accordingly, the net impact on AFG’s current period earnings is that the interest expense associated with the hedged debt is effectively recorded at the floating rate.
Goodwill Goodwill represents the excess of cost of subsidiaries over AFG’s equity in their underlying net assets. Goodwill is not amortized, but is subject to an impairment test at least annually. An entity is not required to complete the quantitative annual goodwill impairment test on a reporting unit if the entity elects to perform a qualitative analysis and determines that it is more likely than not that the reporting unit’s fair value exceeds its carrying amount.
Because AFG has no right to use the CLO assets and no obligation to pay the CLO liabilities, the assets and liabilities of the CLOs are shown separately in AFG’s Balance Sheet. AFG has elected the fair value option for reporting on the CLO assets and
Prior to the adoption of ASU 2014-13, measuring both the CLO assets and CLO liabilities at separately determined fair values resulted in a difference between the carrying value of the CLO assets and the carrying value of the CLO liabilities that was not attributable to AFG’s ownership interest in the CLOs and CLO earnings (losses) that were not attributable to AFG’s shareholders. Accordingly, in periods prior to 2015, the difference between the fair value of the CLO assets and the fair value of the CLO liabilities was recorded as “appropriated retained earnings - managed investment entities” in AFG’s Balance Sheet and the earnings (losses) that were not attributable to AFG’s shareholders were included in net earnings (loss) attributable to noncontrolling interests in AFG’s Statement of Earnings.
Under the guidance adopted in 2015, there is no longer any excess carrying value of CLO assets over the carrying value of CLO liabilities to be reported as “appropriated retained earnings - managed investment entities” in AFG’s Balance Sheet or any CLO earnings to be attributed to noncontrolling interests in AFG’s Statement of Earnings. In accordance with the guidance, the amount reported as “appropriated retained earnings - managed investment entities” at December 31, 2014 was reclassified to “liabilities of managed investment entities” on January 1, 2015 as the cumulative effect of an accounting change. While the new guidance impacted the presentation of individual CLO-related line items in AFG’s Statement of Earnings, it had no overall impact on AFG’s net earnings attributable to shareholders.
For certain products, annuity benefits accumulated also includes reserves for accrued persistency and premium bonuses, guaranteed withdrawals and excess benefits expected to be paid on future deaths and annuitizations (“EDAR”). The liabilities for EDAR and guaranteed withdrawals are accrued for and modified using assumptions consistent with those used in determining DPAC and DPAC amortization, except that amounts are determined in relation to the present value of total
expected assessments. Total expected assessments consist principally of estimated future investment margin, surrender, mortality, and other life and annuity policy charges, and unearned revenues once they are recognized as income.
In addition, reserves for traditional life and long-term care policies are subject to adjustment for loss recognition charges that would have been recorded if the unrealized gains from securities had actually been realized. This adjustment is included in unrealized gains (losses) on marketable securities, a component of AOCI in AFG’s Balance Sheet.
AFG’s weighted average diluted shares outstanding excludes the following anti-dilutive potential common shares related to stock compensation plans: 2015 - 1.1 million, 2014 - 1.0 million and 2013 - 1.1 million. Adjustments to net earnings attributable to shareholders in the calculation of diluted earnings per share were nominal in the 2015, 2014 and 2013 periods.
AFG’s net deferred tax assets are included in Other assets in AFG’s Balance Sheet at December 31, 2015.
The intangible assets acquired include $1 million in indefinite lived intangible assets related to state insurance licenses and $46 million in finite lived intangibles, primarily related to agency relationships. The finite lived intangibles are being amortized over an average expected life of 7 years. The fair value of the acquired liability for unpaid losses and loss adjustment expenses and related recoverables from reinsurers was estimated by discounting actuarial projected future net cash flows using the U.S. Treasury yield curve (with an adjustment for the illiquidity of insurance reserves) and then adding a risk adjustment to reflect the net present value of the profit that a market participant would require in return for the assumption of the risk associated with the reserves. The fair value of Summit’s agency relationship was estimated using a multi-period excess earnings method, which is a form of the income approach. The acquisition resulted in the recognition of $16 million in goodwill based on the excess of the purchase price over the fair value of the net assets acquired. The goodwill represents the fair value of acquired intangible assets that do not qualify for separate recognition, including the value of Summit’s assembled workforce.
In addition to the $18 million in cash and securities received at closing and the $13 million of potential additional proceeds in the future from the release of statutory liabilities, AFG expects to receive $97 million in tax benefits (approximately $65 million through reduced estimated tax payments and $32 million from the carryback of the tax-basis capital loss) related to the sale in the first half of 2016. The receivables for these tax benefits are reflected in AFG’s financial statements at December 31, 2015.
Includes the fair value of the potential additional consideration and capital maintenance agreement and is shown net of estimated expenses.
Includes special charges to increase asbestos and environmental (“A&E”) reserves of $67 million, $24 million and $54 million in 2015, 2014 and 2013, respectively.
Includes pretax income of $51 million (before noncontrolling interest) from the sale of the Le Pavillon Hotel in the second quarter of 2015 and $15 million from the sale of an apartment property in the fourth quarter of 2015.
Primarily holding company expenses, including a $4 million loss on retirement of debt in the third quarter of 2015 and special charges to increase A&E reserves related to AFG’s former railroad and manufacturing operations ($12 million in 2015, $6 million in 2014 and $22 million in 2013) and losses of managed investment entities attributable to noncontrolling interests ($51 million in 2014 and $26 million in 2013). Following the adoption of new guidance in the first quarter of 2015, there are no longer earnings (losses) of managed investment entities that are attributable to noncontrolling interests. See Note A - “Accounting Policies - Managed Investment Entities.”
Level 2 - Quoted prices for similar instruments in active markets; quoted prices for identical or similar assets or liabilities in inactive markets (markets in which there are few transactions, the prices are not current, price quotations vary substantially over time or among market makers, or in which little information is released publicly); and valuations based on other significant inputs that are observable in active markets. AFG’s Level 2 financial instruments include separate account assets, corporate and municipal fixed maturity securities, mortgage-backed securities (“MBS”) and investments of managed investment entities priced using observable inputs. Level 2 inputs include benchmark yields, reported trades, corroborated broker/dealer quotes, issuer spreads and benchmark securities. When non-binding broker quotes can be corroborated by comparison to similar securities priced using observable inputs, they are classified as Level 2.
Under new guidance adopted in the first quarter of 2015, discussed in Note A - “Accounting Policies - Managed Investment Entities,” AFG has elected to set the carrying value of the CLO liabilities equal to the fair value of the CLO assets (which have more observable fair values) as an alternative to reporting those liabilities at separately measured fair values. Following the adoption of the new guidance, the CLO liabilities are categorized within the fair value hierarchy on the same basis (proportionally) as the related CLO assets. Since the portion of the CLO liabilities allocated to Level 3 is derived from the fair value of the CLO assets, beginning with the first quarter of 2015, these amounts are excluded from the progression of Level 3 financial instruments.
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. AFG’s internal investment professionals are a group of approximately 25 analysts whose primary responsibility is to manage AFG’s investment portfolio. These professionals monitor individual investments as well as overall industries and are active in the financial markets on a daily basis. The group is led by AFG’s chief investment officer, who reports directly to one of AFG’s Co-CEOs. 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. In addition, the Company communicates directly with the pricing service regarding the methods and assumptions used in pricing, including verifying, on a test basis, the inputs used by the service to value specific securities.
On December 24, 2015, AFG completed the sale of substantially all of its run-off long-term care insurance business. As discussed in Note B - “Acquisitions and Sale of Businesses,” AFG recorded a loss in the first quarter of 2015 to write down the net carrying value of the assets and liabilities to be disposed to the estimated net sale proceeds (estimated fair value less costs to sell). The estimate of fair value used to determine that loss was derived using significant unobservable inputs (Level 3). At the closing date, approximately $11 million (excluding cash) of the net proceeds was measured at fair value. These fair value measurements are categorized in the fair value hierarchy as follows: Level 1 - $5 million; Level 2 - $2 million and Level 3 - $4 million.
Assets and liabilities measured and carried at fair value in the financial statements on a recurring basis are summarized below (in millions):
(*) Variable annuity liabilities equal the fair value of variable annuity assets.
The transfers between Level 1 and Level 2 for the years ended December 31, 2015, 2014 and 2013 are reflected in the table below at fair value as of the end of the reporting period (dollars in millions):
The only significant Level 3 assets or liabilities carried at fair value in the financial statements that were not measured using broker quotes are the derivatives embedded in AFG’s fixed-indexed annuity liabilities, which are measured using a discounted cash flow approach and had a fair value of $1.37 billion at December 31, 2015. The following table presents information about the unobservable inputs used by management in determining fair value of these embedded derivatives. See Note F - “Derivatives.”
The range of adjustments for insurance subsidiary’s credit risk reflects credit spread variations across the yield curve. The range of projected surrender rates reflects the specific surrender charges and other features of AFG’s individual fixed-indexed annuity products with an expected range of 5% to 10% in the majority of future calendar years (3% to 18% over all periods). Increasing the budgeted option cost or risk margin for uncertainty in cash flows assumptions in the table above would increase the fair value of the fixed-indexed annuity embedded derivatives, while increasing any of the other unobservable inputs in the table above would decrease the fair value of the embedded derivatives.
Changes in balances of Level 3 financial assets and liabilities carried at fair value during 2015, 2014 and 2013 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.
Total realized/unrealized gains (losses) included in net income for the embedded derivatives reflects losses related to the unlocking of actuarial assumptions of $28 million in 2015.
Total realized/unrealized gains (losses) included in net income includes gains of $7 million related to liabilities outstanding as of December 31, 2013. See Note H - “Managed Investment Entities.”
AFG analyzes its MBS securities for other-than-temporary impairment each quarter based upon expected future cash flows. Management estimates expected future cash flows based upon its knowledge of the MBS market, cash flow projections (which reflect loan to collateral values, subordination, vintage and geographic concentration) received from independent sources, implied cash flows inherent in security ratings and analysis of historical payment data. During 2015, AFG recorded $7 million in other-than-temporary impairment charges related to its residential MBS.
In 2015, AFG recorded approximately $31 million and $4 million in other-than-temporary impairment charges related to corporate bonds and municipal bonds, respectively.
AFG recorded $94 million in other-than-temporary impairment charges on common stocks in 2015. At December 31, 2015, the gross unrealized losses on common stocks of $79 million relate to 63 securities, none of which has been in an unrealized loss position for more than 12 months.
The table below sets forth the scheduled maturities of available for sale fixed maturities as of December 31, 2015 (dollars in millions). Securities with sinking funds are reported at average maturity. Actual maturities may differ from contractual maturities because certain securities may be called or prepaid by the issuers.
AFG’s fixed-indexed annuities, which represented approximately 60% of annuity benefits accumulated at December 31, 2015, provide policyholders with a crediting rate tied, in part, to the performance of an existing stock market index. AFG attempts to mitigate the risk in the index-based component of these products through the purchase of call options on the appropriate index. AFG receives collateral from its counterparties to support its purchased call option assets. This collateral ($211 million at December 31, 2015 and $285 million at December 31, 2014) is included in other assets in AFG’s Balance Sheet with an offsetting liability to return the collateral, which is included in other liabilities. AFG’s strategy is designed so that the change in the fair value of the call option assets will generally offset the economic change in the liabilities from the index participation. Both the index-based component of the annuities and the related call options are considered derivatives. Fluctuations in interest rates and the stock market, among other factors, can cause volatility in the periodic measurement of fair value of the embedded derivative that management believes can be inconsistent with the long-term economics of these products.
As discussed under “Reinsurance” in Note A to the financial statements, certain reinsurance contracts are considered to contain embedded derivatives.
The following table summarizes the gain (loss) included in the Statement of Earnings for changes in the fair value of derivatives that do not qualify for hedge accounting for 2015, 2014 and 2013 (in millions):
Derivative Designated and Qualifying as a Fair Value Hedge In June 2015, AFG entered into an interest rate swap to mitigate the interest rate risk associated with its fixed-rate 9-7/8% Senior Notes due June 2019 by effectively converting the interest rate on those notes to a floating rate of three-month LIBOR plus 8.099% (8.6110% at December 31, 2015). Since the terms of the interest rate swap match the terms of the hedged debt, changes in the fair value of the interest rate swap are offset by changes in the fair value of the hedged debt attributable to changes in interest rates. The fair value of the interest rate swap (an asset of $2 million at December 31, 2015) and the offsetting adjustment to the carrying value of the 9-7/8% Senior Notes are both included in long-term debt on AFG’s Balance Sheet. Accordingly, the net impact on AFG’s current period earnings is that the interest expense associated with the hedged debt is effectively recorded at the floating rate. The net reduction in interest expense from the swap for 2015 was $2 million.
A progression of deferred policy acquisition costs is presented below (in millions):
The present value of future profits (“PVFP”) amounts in the table above are net of $220 million and $209 million of accumulated amortization at December 31, 2015 and 2014, respectively. During each of the next five years, the PVFP is expected to decrease at a rate of approximately one-sixth of the balance at the beginning of each respective year.
Changes in the carrying value of goodwill during 2013, 2014 and 2015, by reporting segment, are presented in the following table (in millions):
In September 2015, AFG used cash on hand to redeem the $132 million in outstanding AFG 7% Senior Notes due September 2050 at par value. In November 2015, AFG issued $150 million in 6% Subordinated Debentures due in 2055. The net proceeds of the offering will be used for general corporate purposes, which may include repurchases of AFG’s outstanding Common Stock. During 2015, subsidiaries of AFG repaid all of the outstanding notes secured by real estate.
In 2013, AFG subsidiaries redeemed Variable Rate Subordinated Debentures at par value and paid off a secured borrowing balance at maturity.
Cash interest payments on long-term debt were $75 million in 2015, $72 million in 2014 and $71 million in 2013. In 2015, AFG received $2 million in interest under the interest rate swap discussed above.
At December 31, 2015, there were 10.7 million shares of AFG Common Stock reserved for issuance under AFG’s stock incentive plans. Options are granted with an exercise price equal to the market price of AFG Common Stock at the date of grant. Options generally become exercisable at the rate of 20% per year commencing one year after grant and expire ten years after the date of grant.
The total intrinsic value of options exercised during 2015, 2014 and 2013 was $52 million, $38 million and $35 million, respectively. During 2015, 2014 and 2013, AFG received $47 million, $35 million and $44 million, respectively, in cash from the exercise of stock options. The total tax benefit related to the exercises was $16 million, $12 million and $11 million(including $12 million, $9 million and $7 million credited directly to capital surplus) during those years, respectively.
AFG issued 54,732 shares of Common Stock (fair value of $62.55 per share) in the first quarter of 2015 and 84,036 shares (fair value of $57.16 per share) in the first quarter of 2014 under its Equity Bonus Plan.
Total compensation expense related to stock incentive plans of AFG and its subsidiaries for 2015, 2014 and 2013 was $27 million, $25 million and $36 million, respectively. Related tax benefits totaled $8 million in 2015 and 2014 and $12 million in 2013. At December 31, 2015, there was $27 million and $13 million of unrecognized compensation expense related to nonvested stock options and restricted stock awards, respectively. These amounts are expected to be recognized over a weighted average of 3.0 and 2.6 years, respectively.
The following is a reconciliation of income taxes at the statutory rate of 35% to the provision for income taxes as shown in the Statement of Earnings (dollars in millions):
Total earnings before income taxes include losses subject to tax in foreign jurisdictions of $66 million in 2015 compared to losses of $4 million in 2014 and income of $4 million in 2013.
AFG’s net deferred tax asset at December 31, 2015, is included in other assets in AFG’s Balance Sheet; its net deferred tax liability at December 31, 2014, is included in other liabilities.
“Foreign underwriting losses” in the table above include the net operating loss carryforward and other deferred tax assets related to the Marketform Lloyd’s insurance business. Due to uncertainty concerning the realization of the deferred tax benefits associated with these losses, AFG maintains a full valuation allowance of $77 million against these deferred tax assets at December 31, 2015. In addition to the valuation allowance related to the Marketform Lloyd’s insurance business, the gross deferred tax asset has also been reduced by a $50 million valuation allowance related to a portion of AFG’s net operating loss carryforwards (“NOL”) subject to the separate return limitation year (“SRLY”) tax rules. A SRLY NOL can be used only by the entity that created it and only in years that both it and the consolidated group have taxable income.
Cash payments for income taxes, net of refunds, were $234 million, $347 million and $204 million for 2015, 2014 and 2013, respectively.
At December 31, 2015, GAFRI had a liability of approximately $11 million for environmental costs and certain other matters associated with the sales of its former manufacturing operations.
See Note B - “Acquisitions and Sale of Businesses” for a discussion of the five-year capital maintenance agreement that AFG entered into in connection with obtaining regulatory approval for the sale of substantially all of its run-off long-term care business.
The following are quarterly results of consolidated operations for the two years ended December 31, 2015 (in millions, except per share amounts). Quarterly earnings per share do not add to year-to-date amounts due to changes in shares outstanding.
Realized losses on subsidiaries in 2015 include a $166 million realized loss (consisting of an initial loss estimate of $162 million recorded in the first quarter and a $4 million loss adjustment in the fourth quarter) related to the impact of the sale of two subsidiaries, which contained substantially all of AFG’s long-term care insurance business. See Note B - “Acquisitions and Sale of Businesses.”
Property and Casualty Insurance Reserves The liability for losses and LAE for long-term scheduled payments under certain workers’ compensation insurance has been discounted at 4.5% at both December 31, 2015 and 2014, which represents an approximation of long-term investment yields. As a result, the total liability for losses and loss adjustment expenses at December 31, 2015 and 2014, has been reduced by $18 million and $19 million.
Net favorable reserve development in 2013 was due primarily to lower than expected severity in directors and officers liability insurance and lower than expected claim severity and frequency in the excess liability business (both within the Specialty casualty sub-segment), lower than expected frequency and severity in the foreign credit and financial institutions businesses (within the Specialty financial sub-segment) and favorable reserve development associated with AFG’s internal reinsurance program, partially offset by the $54 million special charge to increase asbestos and environmental reserves.
FHLB Funding Agreements 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. Members are required to purchase stock in the FHLB in addition to maintaining collateral deposits that back any funds advanced. GALIC’s $41 million investment in FHLB capital stock at December 31, 2015, is included in other investments at cost. Membership in the FHLB provides the annuity operations with a substantial additional source of liquidity. These advances further the FHLB’s mission of improving access to housing by increasing liquidity in the residential mortgage-backed securities market. In 2015, the FHLB advanced GALIC $345 million (included in annuity benefits accumulated), increasing the total amount advanced to $785 million at December 31, 2015. Interest rates under the various funding agreements on these advances range from 0.02% to 0.49% over LIBOR (average rate of 0.58% at December 31, 2015). While these advances must be repaid between 2016 and 2020, GALIC has the option to prepay all or a portion of the advances. The advances on these agreements are collateralized by mortgage-backed securities with a fair value of $912 million (included in available for sale fixed maturity securities) at December 31, 2015. Interest credited on the funding agreements, which is included in annuity benefits, was $3 million in 2015 and $1 million in 2014 and 2013.
Payments of dividends by AFG’s insurance companies are subject to various state laws that limit the amount of dividends that can be paid. Under applicable restrictions, the maximum amount of dividends available to AFG in 2016 from its insurance subsidiaries without seeking regulatory clearance is $809 million. Additional amounts of dividends require regulatory approval.
AFG paid common stock dividends to shareholders totaling $178 million, $169 million and $161 million in 2015, 2014 and 2013, respectively. Currently, there are no regulatory restrictions on AFG’s retained earnings or net income that materially impact its ability to pay dividends. Based on shareholders’ equity at December 31, 2015, AFG could pay dividends in excess of $1 billion without violating its most restrictive debt covenant. However, the payment of future dividends will be at the discretion of AFG’s Board of Directors and will be dependent on many factors including AFG’s financial condition and results of operations, the capital requirements of its insurance subsidiaries, and rating agency commitments.
In March 2014, AFG’s property and casualty insurance operations entered into a reinsurance agreement to obtain additional catastrophe protection through a catastrophe bond structure with Riverfront Re Ltd. (“Riverfront”). The reinsurance agreement provides supplemental reinsurance coverage up to $95 million (fully collateralized) for catastrophe losses in excess of $119 million occurring during the period from April 1, 2014 through December 31, 2016. In connection with the reinsurance agreement, Riverfront issued notes to unrelated investors for the full $95 million of coverage provided under the reinsurance agreement. At the time of the agreement, AFG concluded that Riverfront is a variable interest entity, but that it does not have a variable interest in the entity because the variability in Riverfront’s results is expected to be absorbed entirely by the investors
AFG has reinsured approximately $11.19 billion of its $14.67 billion in face amount of life insurance at December 31, 2015 compared to $12.70 billion of its $16.71 billion in face amount of life insurance at December 31, 2014. Life written premiums ceded were $40 million, $41 million and $44 million for 2015, 2014 and 2013, respectively. Reinsurance recoveries on ceded life policies were $50 million, $59 million and $58 million for 2015, 2014 and 2013, respectively.
Benefit Plans AFG expensed approximately $34 million in 2015, $30 million in 2014 and $32 million in 2013 for its retirement and employee savings plans.
The information required by the following Items will be included in AFG’s definitive Proxy Statement for the 2016 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.
Credit Agreement dated December 5, 2012, among American Financial Group, Inc., Bank of America, N.A., as Administrative Agent, and several lenders, filed as Exhibit 10 to AFG’s Form 8-K filed on December 7, 2012.
The following financial information from American Financial Group’s Form 10-K for the year ended December 31, 2015, formatted in XBRL (Extensible Business Reporting Language):