Subsidiaries of AFG own several buildings in downtown Cincinnati. AFG and its affiliates occupy about three-fifths of the aggregate 600,000 square feet of commercial and office space.
AFG'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 70% of the 126,000 square feet and lease the remaining space to unaffiliated tenants.
As discussed in Note A to the financial statements, financial statements for periods prior to the Mergers are those of AFC. The operations of American Premier are included in AFG's financial statements from the date of acquisition.
Ratios From the date of the Mergers to the end of 1996, approximately $1.1 billion of AFC and American Premier debt was retired or replaced with lower cost debt, resulting in a net reduction of aggregate debt by approximately 75%. Consequently, AFG's debt to total capital ratio at the parent holding company level improved from nearly 60% at the date of the Mergers to approximately 15% at December 31, 1996. These debt reductions and replacements will also reduce AFG's interest expense by over $100 million annually.
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, 1996, the capital ratios of all AFG insurance companies substantially exceeded the RBC requirements.
In the past, funds have been borrowed under certain of these bank facilities and used for working capital, capital infusions into subsidiaries, and to retire other issues of short-term or high-rate debt. Also, AFG believes it may be prudent and advisable to borrow up to $200 million of bank debt in the normal course in order to retire public or privately held fixed rate obligations over the next year or two.
AFC and American Premier have each filed consolidated tax returns. 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. American Premier has tax allocation agreements with its U.S. insurance subsidiaries whereby such subsidiaries compute tax provisions based on taxable income in accordance with statutory accounting principles. In each case, the resulting provision (or credit) is currently payable to (or receivable from) AFC or American Premier. American Premier's federal income tax loss carryforward was available to offset taxable income and, as a result, American Premier's obligation to pay federal income tax for 1996 was substantially eliminated. Beginning with the 1997 federal tax return, American Premier will join AFC's consolidated return.
While the results of all such uncertainties cannot be predicted, based upon its knowledge of the facts, circumstances and applicable laws, management believes that sufficient reserves have been provided.
Investments Approximately 70% of AFG's consolidated assets are invested in marketable securities. A diverse portfolio of bonds and redeemable preferred stocks accounts for 95% of these securities. AFG attempts to optimize investment income while building the value of its portfolio, placing emphasis upon long-term performance. AFG's goal is to maximize return on an ongoing basis rather than focusing on short-term performance.
Approximately 93% of the bonds and redeemable preferred stocks held by AFG were rated "investment grade" (credit rating of AAA to BBB) by nationally recognized rating agencies at December 31, 1996. 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.
Because most income of the property and casualty insurance subsidiaries has been sheltered from income taxes through 1996, non-taxable municipal bonds represent only a small portion (approximately 1%) of the portfolio.
The realization of capital gains, primarily through sales of equity securities, was an integral part of AFG's investment program. Individual securities are sold creating gains or losses as market opportunities exist. Pretax capital gains recognized upon disposition of securities, including investees, during the past five years have been: 1996 - $166 million; 1995 - $84 million; 1994 - $50 million; 1993 - $165 million and 1992 - $104 million. At December 31, 1996, the net unrealized gain on AFG's bonds and redeemable preferred stocks was $169 million; the net unrealized gain on equity securities was $185 million.
General As previously noted, financial statements for periods prior to the April 1995 Mergers are those of AFC. The operations of American Premier are included in AFG's financial statements from the date of acquisition. AFC had accounted for American Premier as an investee from the second quarter of 1993 through the first quarter of 1995. Accordingly, current year income statement components are not comparable to prior years.
Pretax earnings before extraordinary items were $353 million in 1996, $247 million in 1995 and $44 million in 1994.
Combined Ratios (GAAP) NSA Group 99.9% 105.2% 100.0% Specialty Operations 84.1 94.8 97.2 Commercial and Personal Operations 110.6 99.1 98.9 Aggregate (including A&E and other lines) 102.9 101.2 99.4
Operating results for 1996 were adversely impacted by two unusual items: (i) higher than normal catastrophe losses including approximately $30 million in losses due to Hurricane Fran and (ii) the strengthening of A&E reserves (exposures for which AFG may be liable under general liability policies written years ago). AFG increased A&E reserves of its discontinued insurance lines by $120 million by recording a third quarter, non-cash pretax charge of $80 million and reallocating $40 million in reserves from its Specialty Operations. A&E reserves at December 31, 1996, were approximately $343 million, an amount equal to approximately 10.5 times the preceding three years' average claim payments.
In 1996, underwriting results of AFG's insurance operations significantly outperformed the industry average for the eleventh consecutive year. AFG's insurance operations have been able to exceed the industry's results by focusing on highly specialized niche products, supplemented by commercial lines coverages and personal automobile products.
The improvement in the combined ratio of the Specialty Lines for 1996 includes 4.1 percentage points attributable to a reallocation of loss reserves in connection with the strengthening of A&E reserves. Further improvement is attributable to (i) improved results in certain niche businesses, (ii) reductions in loss, loss adjustment expense and policyholder dividend reserves prompted by the fundamental changes in the California workers' compensation market and actuarial evaluations, and (iii) losses in 1995 from participation in the voluntary pool.
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 AFG withdrew.
Net written premiums 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. These profitable results were offset by unfavorable results in the personal lines operations from weather-related losses, start-up costs related to a direct-to- consumer operation and deteriorating automobile loss experience.
1995 compared to 1994 AFC's investment income increased $50 million (9%) from 1994 due to an increase in the average amount of investments held. For the period following the Mergers, investment income includes $117 million attributable to American Premier.
Investee Corporations Equity in net earnings of investee corporations (companies in which AFG owns a significant portion of the voting stock) represents AFG's proportionate share of the investees' earnings and losses.
1996 compared to 1995 Interest expense for 1996 was $76.1 million and interest expense for 1995, adjusted to reflect the effect of the Mergers retroactively to January 1, 1995, was $116.3 million. The $40 million (35%) decrease reflects significant debt retirements during both 1995 and 1996.
Other Operating and General Expenses Operating and general expenses included the following (in millions): 1996 1995 1994 Minority interest $48 $33 $ 9 Allowance for bad debts - - 18 Charge for California insurance reform measure - - 19
Consolidated Statement of Cash Flows: Years ended December 31, 1996, 1995 and 1994
"Selected Quarterly Financial Data" has been included in Note N to the Consolidated Financial Statements.