GAI, its subsidiaries, and American Premier's insurance subsidiaries lease the majority of their office and storage facilities in numerous cities throughout the United States, including GAI's and AAG's home offices in Cincinnati. Two of AAG's subsidiaries own home office buildings in Mobile, Alabama and Rapid City, South Dakota. These companies occupy approximately two-thirds of the 133,000 square feet and lease the remaining space to unaffiliated tenants.
As discussed in Note A to the financial statements, on April 3, 1995, AFC merged with a newly formed subsidiary of American Financial Group, Inc., another new company formed to own both AFC and American Premier.
Ratios The following ratios may be considered relevant indicators of AFC's liquidity and are typically presented by AFC in its prospectuses and similar documents. Management believes that balance sheet ratios (debt to total capital) are more meaningful on a parent only basis. On the other hand, earnings statement ratios (fixed charges) are more meaningful on a total enterprise basis since the parent only ratio is dependent, to a great degree, on the discretionary nature of dividend payments from subsidiaries.
AFC's ratio of debt to total capital at the holding company level (excluding amounts due to affiliates) was .31, .68 and .57 at December 31, 1995, 1994 and 1993, respectively. Including the note payable to American Premier, the ratio changes to .57. at December 31, 1995. Ratios of earnings to fixed charges, excluding and including preferred dividends, for the three years ended December 31, 1995, are shown below.
The National Association of Insurance Commissioners' 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 to ensure that it has an acceptable expectation of not becoming financially impaired. At December 31, 1995, the capital ratios of all AFC insurance companies substantially exceeded the RBC requirements.
In April 1995, AFC entered into a subordinated credit agreement with American Premier under which it can borrow up to $675 million. The credit line bears interest at 11-5/8% and converts to a four-year term loan in March 2005 with scheduled principal payments to begin in April 2005. During 1995, AFC borrowed $623 million under the agreement using the proceeds for debt retirements, capital contributions to subsidiaries and other corporate purposes. Borrowings, repayments and interest payments on the line are included in "net advances from (to) affiliates" in the following table.
Generally, over 90% of the dividends (including non-cash dividends) received from subsidiaries have been from GAI. Payments of dividends by GAI are subject to various laws and regulations which limit the amount of dividends that can be paid without regulatory approval. Under Ohio law, the maximum amount of dividends which may be paid without (i) prior approval or (ii) expiration of a 30 day waiting period without disapproval
Under tax allocation agreements with AFC, its 80%-owned U.S. subsidiaries generally compute tax provisions as if filing separate returns based on book taxable income computed in accordance with generally accepted accounting principles. The resulting provision (or credit) is currently payable to (or receivable from) AFC. Following the Mergers, AFC and American Premier will each continue to file separate consolidated tax returns.
In exchange for $5 million, AFC has agreed to indemnify a former subsidiary for up to $35 million in excess of a threshold amount of $25 million of the costs it may incur in the 12 years beginning April 1, 1993 to resolve environmental matters, bankruptcy claims and certain other matters. Additionally, another AFC subsidiary has accrued $10.3 million at December 31, 1995 for environmental costs associated with the sales of former manufacturing properties.
Investments Approximately two-thirds of AFC's consolidated assets are invested in marketable securities. A diverse portfolio of bonds and redeemable preferred stocks accounts for over 95% of these securities. AFC attempts to optimize investment income while building the value of its portfolio, placing emphasis upon long-term performance. AFC's goal is to maximize return on an ongoing basis rather than focusing on short-term performance.
Fixed income investment funds are generally invested in securities with short-term and intermediate-term maturities with an objective of optimizing total return while allowing flexibility to react to changes in market conditions. At December 31, 1995, the average life of AFC's bonds and redeemable preferred stocks was approximately 6 years.
Approximately 94% of the bonds and redeemable preferred stocks held by AFC were rated "investment grade" (credit rating of AAA to BBB) by nationally recognized rating agencies at December 31, 1995. 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.
Investments in mortgage-backed securities ("MBSs") represented approximately 30% of AFC's bonds and redeemable preferred stocks at December 31, 1995. AFC invests primarily in MBSs which have a reduced risk of prepayment. Interest only (I/Os), principal only (P/Os) and other "high risk" MBSs represented approximately two percent of AFC's total mortgage-backed securities portfolio. In addition, the majority of MBSs held by AFC were purchased at a discount. Management believes that the structure and discounted nature of the MBSs will minimize the effect of prepayments on earnings over the anticipated life of the MBSs portfolio. More than 90% of AFC's MBSs are rated "AAA" with substantially all being of investment grade quality. The majority are collateralized by GNMA, FNMA and FHLMC single- family residential pass-through certificates. The market in which these securities trade is highly liquid. Aside from interest rate risk, AFC does not believe a material risk (relative to earnings and liquidity) is inherent in holding such investments.
Because most income of the property and casualty insurance subsidiaries is currently sheltered from income taxes, non- taxable municipal bonds represent only a small portion (less than 1%) of the portfolio.
Pretax earnings were $183 million in 1995 compared to $44 million in 1994 and $262 million in 1993.
Results for 1994 include AFC's share ($28 million) of American Premier's loss on the sale of General Cable securities, GAI's $19 million charge relating to a rate rollback liability in California and a $35 million charge related to payments under AFC's Book Value Incentive Plan. These items were partially offset by a $42 million decrease in interest expense.
Property and Casualty Insurance - Underwriting Great American (GAI and its property and casualty insurance subsidiaries) manages and operates its property and casualty business as two major sectors. The specialty lines are a diversified group of over twenty-five business lines that offer a wide variety of specialty insurance products. Some of the more significant areas are executive liability, inland and ocean marine, U.S.- based operations of Japanese companies, agricultural-related coverages, excess and surplus lines and fidelity and surety bonds. The commercial and personal lines provide coverages in commercial multi-peril, workers' compensation, umbrella and commercial automobile, standard private passenger automobile and homeowners insurance.
To understand the overall profitability of particular lines, timing of claims payments and the related impact of investment income must be considered. Certain "short-tail" lines of business (primarily property coverages) have quick loss payouts which reduce the time funds are held, thereby limiting investment income earned thereon. On the other hand, "long- tail" lines of business (primarily liability coverages and workers' compensation) have payouts that are either structured over many years or take many years to settle, thereby significantly increasing investment income earned on related premiums received.
Results for Great American's property and casualty insurance subsidiaries are as follows (dollars in millions):
Specialty Operations Net written premiums for the specialty operations increased 10% during 1995 over 1994 due to increases in specialty niche lines (primarily crop hail, excess and surplus and executive liability). The combined ratio of the specialty operations in 1995 reflects improved results experienced in the crop hail and farm lines as well as coverages of U.S. operations of Japanese companies. The 1995 combined ratio also includes losses resulting from participation in a voluntary pool from which Great American withdrew in 1995.
Commercial and Personal Operations Net written premiums for the commercial and personal operations increased 5% in 1995 due primarily to increased writing of workers' compensation and commercial umbrella insurance. The profitability of both of these lines improved in 1995. Workers' compensation improved due to favorable rate action by rating bureaus, health care cost containment programs, marketing emphasis on profitable states and implementation of a Drug-Free Workplace program. Commercial umbrella results improved due to a focus on low hazard risks and more favorable pricing in the higher umbrella layers. In addition, cost control measures reduced the underwriting expense ratio. These improved results were offset by an increase in the combined ratio of the personal lines operations due primarily to weather-related losses, start-up costs from its direct-to- consumer operation and deteriorating automobile loss experience for accident years 1994 and 1995.
1995 compared to 1994 Investment income increased $50 million (9%) in 1995 due to an increase in average investments held.
1994 compared to 1993 Excluding American Premier, which was included as a subsidiary for the first three months of 1993, investment income increased $20 million (4%) due to an increase in average investments held.
1994 compared to 1993 AFC's equity in net earnings (losses) of investee corporations in 1994 includes its share ($28 million) of American Premier's loss on the sale of securities of General Cable and its share ($52 million) of American Premier's tax benefit in 1993. Chiquita's loss before extraordinary items was comparable in 1994 and 1993 as improvements in Meat Division operations and banana pricing were offset by charges and losses relating to farm closings and banana cultivation write-downs in Honduras and a substantial reduction of Chiquita's Japanese banana trading operations.
The gains on sales of investees in 1993 include (i) a pretax gain of $52 million on the sale of Spelling Entertainment and (ii) a pretax gain of $28 million on the public sale by AFEI of 4.5 million shares of American Premier common stock.
Gains on Sales of Subsidiaries The gains on sales of subsidiaries in 1993 include pretax gains of (i) $44 million from the sale of American Business Insurance, Inc. and (ii) $31 million representing an adjustment on AFC's 1990 sale of the nonstandard automobile insurance group to American Premier.
Sales of Other Products and Services Sales of other products and services represent American Premier's revenues from systems and software engineering services and the manufacture and supply of industrial products and services during the first quarter of 1993.
Annuity receipts totaled approximately $460 million in 1995, $440 million in 1994 and $400 million in 1993. Annuity receipts have increased in 1995, 1994 and 1993 due primarily to sales of newly introduced single premium products and, in 1995, the development of new single premium distribution channels. Annuity surrender payments have averaged approximately 8% of statutory reserves over the past three years.
Interest expense included in AFC's consolidated Statement of Earnings was comprised of (in millions):
1995 1994 1993 AFC Parent $ 86.7 $ 56.9 $ 71.1 Great American Holding 20.2 24.7 23.4 American Annuity 17.3 20.9 21.2 Great American Insurance 13.0 11.9 14.0 American Premier - - 17.2 Other Companies 1.0 .8 10.3 $138.2 $115.2 $157.2
1995 1994 1993 Minority interest $15 $ 9 $35 Proposition 103 - 19 - Allowance for bad debts - 18 10 Writeoff of debt discount and issue costs - - 24 Relocation expenses - - 8
Consolidated Statement of Earnings: Years ended December 31, 1995, 1994 and 1993