Earnings from Continuing Operations before Income Taxes 332 113 41 190 84
Earnings (loss) from: Continuing Operations 250 67 1 243 51 Discontinued Operations - - (1) (11) 1 Extraordinary Items (12) (5) - - - Cumulative Effect of Accounting Change - - - - 253 Net Earnings 238 62 - 232 305
Unpaid Losses and Loss Adjustment Expenses, Unearned Premiums and Policyholder Dividends 1,452 1,684 1,674 1,426 1,069
Long-term Debt: Parent Company 161 321 500 516 650 Subsidiaries 8 9 10 10 10
In April 1995, APU became a wholly-owned subsidiary of American Premier Group, Inc., a new corporation formed by APU for the purpose of acquiring all of the common stock of APU and American Financial Corporation (the "Mergers"). In June 1995, American Premier Group changed its name to American Financial Group, Inc. ("AFG"). Under terms of the Mergers, each share of APU Common Stock then outstanding was converted into one share of AFG common stock and all shares of American Financial Corporation ("AFC") common stock were exchanged for 28.3 million shares of AFG common stock. As a result of the Mergers, all of the common stock of APU and AFC was owned by AFG and AFG became APU's successor as the issuer of publicly held common stock.
Sources of Funds APU is organized as a holding company with almost all of its operations being conducted by subsidiaries. The parent corporation, however, has continuing cash needs for administrative expenses, the payment of principal and interest on borrowings and dividends on Common Stock. Thus, APU relies primarily on dividends and tax payments from its subsidiaries for funds to meet its obligations.
Management believes APU has sufficient resources to meet its liquidity requirements through operations in the short- term and long-term future. If funds generated from operations, including dividends from subsidiaries, are insufficient to meet fixed charges in any period, APU would be required to generate cash through borrowings, sales of securities or other assets, or similar transactions.
Subsequent to the Mergers, APU entered into a credit agreement with AFG under which APU and AFG will make loans of up to $200 million available to each other. Principal amounts payable to AFG under the credit agreement totaled $175.5 million and $84.0 million at December 31, 1996 and 1995, respectively.
In September and October of 1996, three nationally recognized rating agencies issued or upgraded ratings on APU public debentures. All of the APU subordinated debentures are now rated investment grade by two of the agencies. Generally, the upgrades reflect the expectation that consolidated debt to total capital will remain conservative and that coverage ratios will benefit from higher subsidiary earnings.
Uncertainties APU and its subsidiaries are parties in a number of proceedings relating to former operations. See Note K of Notes to Financial Statements. 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 half of APU's consolidated assets are invested in marketable securities. A diverse portfolio of bonds and redeemable preferred stocks accounts for approximately 94% of these securities. APU attempts to optimize investment income while building the value of its portfolio, placing emphasis upon long-term performance. APU's goal is to maximize return on an ongoing basis rather than focusing on short-term performance.
At December 31, 1996, APU's mortgage-backed securities ("MBSs"), represented approximately 14% of APU's bonds and mandatory redeemable preferred stocks. APU invests primarily in MBSs which have a reduced risk of prepayment. The portfolio does not include any interest only (I/Os), principal only (P/Os) or other "high risk" MBSs. In addition, the majority of MBSs held by APU 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 MBS portfolio. More than 95% of APU'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, APU does not believe a material risk (relative to earnings or liquidity) is inherent in holding such investments.
Results for 1995 include a $76 million decrease in underwriting results of APU's insurance operations and an $8 million decrease in portfolio interest and dividend income. These items were partially offset by $45 million of interest income from loans to AFC, $24 million in realized gains on the sales of securities and an $8 million decrease in interest on borrowed money.
Property and Casualty Insurance - Underwriting APU manages and operates its property and casualty business as two major sectors. The NSA Group is a group of nonstandard automobile insurance companies which insure risks not typically accepted for standard automobile coverage because of the applicant's driving record, type of vehicle, age or other criteria. Republic Indemnity is engaged in the sale of workers' compensation insurance in California and, to a lesser extent, in Arizona. Workers' compensation policies provide coverage for prescribed benefits that employers are required to pay employees who are injured in the course of employment and for an employer's liability for losses suffered by its employees which are not included within the prescribed workers' compensation coverage.
Underwriting profitability is measured by the combined ratio which is a sum of the ratios of underwriting losses loss adjustment expenses, underwriting expenses and policyholder dividends to premiums. When the combined ratio is under 100%, underwriting results are generally considered profitable; when the ratio is over 100%, underwriting results are generally considered unprofitable. The combined ratio does not reflect investment income, other income or federal income taxes.
NSA Group The NSA Group has implemented premium rate increases in various states over the last three years. The higher rate levels along with competitive pressures in the nonstandard automobile insurance industry resulted in a 14% decline in net written premiums in 1996 and adversely impacted premium growth during 1995. These rate increases contributed to an improvement, however, in the combined ratio for 1996. The increase in the combined ratio for 1995 was due primarily to inadequate rate levels in certain markets and weather- related losses (principally from hailstorms in Texas) which more than offset a reduction in underwriting expenses due largely to cost control measures.
Republic Indemnity The decline in California workers' compensation premiums reflects the continuing impact of mandatory premium rate reductions phased in over the course of policy terms during 1994 and 1995, and the extremely competitive pricing environment in the California workers' compensation market resulting from the open rating system which began on January 1, 1995. Despite lower premium volume, the combined ratio improved in 1996 as compared to 1995 due primarily to significant reductions in loss, loss adjustment expense and policyholder dividend reserves prompted by fundamental changes in the California workers' compensation market and actuarial evaluations.
1996 compared to 1995 Excluding interest income of $81 million and $45 million earned in 1996 and 1995, respectively, on amounts due from affiliates, investment income decreased $22 million (14%) due to a decrease in average investments held.
Investee Corporations Equity in net earnings (losses) of investee corporations (companies in which APU owns a significant portion of the voting stock) in 1996 and 1995 represents APU's proportionate share of the losses of Chiquita Brands International, Inc. APU purchased 3.2 million shares of Chiquita common stock from AFC during the second quarter of 1995.
Other Income Other income includes revenues from coal, oil and gas properties and gains and losses from sales of real estate and other assets.
Sales of Other Products and Services Sales of other products and services represents APU's revenues from its non-insurance businesses, substantially all of which have been sold.
Interest on Borrowed Money Changes in interest expense result from fluctuations in money rates as well as changes in borrowings. APU has generally financed its borrowings on a long-term basis which has resulted in higher current costs.
1995 compared to 1994 Interest expense decreased by $8.3 million (16%) due primarily to APU's repurchase throughout 1995 of $180 million principal amount of its Subordinated notes.
Other Operating and General Expenses Operating and general expenses included $39.3 million in 1994, from divested, non- insurance subsidiaries.
The 1994 provision for income tax reflects less than full realization of the tax benefit attributable to the net realized capital loss recorded in that period.