Includes special cash dividends of $1.00 per share paid in December 2015, 2014 and 2013 and $0.25 per share paid in December 2012.
Fixed charges are computed on a “total enterprise” basis. For purposes of calculating the ratios, “earnings” have been computed by adding to pretax earnings the fixed charges and the noncontrolling interests in earnings of subsidiaries having fixed charges and the undistributed equity in earnings or losses of investees. Fixed charges include interest (including annuity benefits as indicated), amortization of debt premium/discount and expense, preferred dividend and distribution requirements of subsidiaries and a portion of rental expense deemed to be representative of the interest factor. The ratio of earnings to fixed charges excluding annuity benefits was 6.58, 7.95, 8.86, 7.16 and 6.59 for 2015, 2014, 2013, 2012 and 2011, respectively. Although the ratio of earnings to fixed charges excluding annuity benefits is not required or encouraged to be disclosed under Securities and Exchange Commission rules, some investors and lenders may not consider interest credited to annuity policyholders’ accounts a borrowing cost for an insurance company, and accordingly, believe this ratio is meaningful.
Adjusted shareholders’ equity and adjusted book value per share exclude appropriated retained earnings and net unrealized gains related to fixed maturity securities. Management believes that investors find a measurement of shareholders’ equity excluding these items to be meaningful as (i) the unrealized gain on fixed maturities fluctuates with changes in interest rates in a way that is primarily only meaningful to AFG if it sells those investments and (ii) appropriated retained earnings represents amounts that will ultimately inure to the debt holders of the collateralized loan obligations managed by AFG (see Note A - “Accounting Policies - Managed Investment Entities” to the financial statements).
AFG is organized as a holding company with almost all of its operations being conducted by subsidiaries. AFG, however, has continuing cash needs for administrative expenses, the payment of principal and interest on borrowings, shareholder dividends, and taxes. Therefore, certain analyses are most meaningfully presented on a parent only basis while others are best done on a total enterprise basis. In addition, because most of its businesses are financial in nature, AFG does not prepare its consolidated financial statements using a current-noncurrent format. Consequently, certain traditional ratios and financial analysis tests are not meaningful.
the fourth quarter loss reported upon closing of the sale of the long-term care business, and
Full year 2015 net earnings attributable to AFG’s shareholders were $352 million ($3.94 per share, diluted) compared to $452 million ($4.97 per share) in 2014, reflecting:
improved core net operating earnings in the run-off long-term care and life segment,
the fourth quarter 2015 gain on the sale of an apartment property,
the second quarter 2015 gain on the sale of Le Pavillon Hotel,
AFG’s ratio of earnings to fixed charges, including annuity benefits as a fixed charge, was 1.66 for the year ended December 31, 2015. Excluding annuity benefits, this ratio was 6.58. Although the ratio excluding annuity benefits is not
required or encouraged to be disclosed under Securities and Exchange Commission rules, it is presented because interest credited to annuity policyholder accounts is not always considered a borrowing cost for an insurance company.
Condensed Consolidated Cash Flows AFG’s principal sources of cash include insurance premiums, income from its investment portfolio and proceeds from the maturities, redemptions and sales of investments. Insurance premiums in excess of acquisition expenses and operating costs are invested until they are needed to meet policyholder obligations or made available to the parent company through dividends to cover debt obligations and corporate expenses, and to provide returns to shareholders through share repurchases and dividends. AFG’s cash flows from operating, investing and financing activities as detailed in its Consolidated Statement of Cash Flows are shown below (in millions):
Net Cash Used in Investing Activities AFG’s investing activities consist primarily of the investment of funds provided by its property and casualty and annuity products. Net cash used in investing activities was $4.58 billion in 2015 compared to $3.62 billion in 2014, an increase of $958 million. The $537 million increase in net cash flows from annuity policyholders in 2015 as compared to 2014 (discussed below under net cash provided by financing activities) increased the amount of cash available for investment in 2015 compared to 2014. In addition to the investment of funds provided by the insurance operations, investing activities also include the purchase and disposal of managed investment entity investments (collateralized loan obligations), which are presented separately in AFG’s Balance Sheet. Net investment activity in the managed investment entities was a $675 million use of cash in 2015 compared to a $275 million use of cash in 2014, accounting for a $400 million increase in net cash used in investing activities in 2015 compared to 2014. See Note A - “Accounting Policies - Managed Investment Entities” and Note H - “Managed Investment Entities” to the financial statements.
Net Cash Provided by Financing Activities AFG’s financing activities consist primarily of transactions with annuity policyholders, issuances and retirements of long-term debt, repurchases of common stock and dividend payments. Net cash provided by financing activities was $3.10 billion in 2015 compared to $2.10 billion in 2014, an increase of $996 million. Annuity receipts exceeded annuity surrenders, benefits, withdrawals and transfers by $2.50 billion in 2015 compared to $1.97 billion in 2014, resulting in a $537 million increase in net cash provided by financing activities. Redemptions of long-term debt resulted in a $192 million use of cash in 2015. AFG issued $150 million of 6% Subordinated Debentures in 2015 and $150 million of 6-1/4% Subordinated Debentures in 2014, the net proceeds of each issuance contributed $145 million to net cash provided by financing activities in those years. During 2015, AFG repurchased 2.0 million shares of its Common Stock for $126 million compared to 3.3 million shares repurchased in 2014 for $191 million, which accounted for a $65 million increase in net cash provided by financing activities in 2015 compared to 2014. Financing activities also include issuances and
retirements of managed investment entity liabilities, which are nonrecourse to AFG and presented separately in AFG’s Balance Sheet. Issuances of managed investment entity liabilities exceeded retirements by $890 million in 2015 while issuances of managed investment entity liabilities exceeded retirements by $306 million in 2014, accounting for a $584 million increase in net cash provided by financing activities in 2015 compared to 2014. See Managed Investment Entities in Note A - “Accounting Policies” and Note H - “Managed Investment Entities” to the financial statements.
AFG can borrow up to $500 million under its revolving credit facility which expires in December 2016. Amounts borrowed under this agreement bear interest at rates ranging from 1.00% to 1.875% (currently 1.375%) over LIBOR based on AFG’s credit rating. There were no borrowings under this agreement, or under any other parent company short-term borrowing arrangements, during 2015.
In April 2014, AFG completed the purchase of Summit Holding Southeast, Inc. and its related companies (“Summit”) from Liberty Mutual Insurance for $259 million using cash on hand at the parent company. In addition, AFG made a capital contribution of approximately $140 million, bringing its capital investment in the Summit business to $399 million. Summit’s results of operations are included in AFG’s consolidated results beginning in April of 2014.
In the annuity business, where profitability is largely dependent on earning a spread between invested assets and annuity liabilities, the duration of investments is generally maintained close to that of liabilities. In a rising interest rate environment, significant protection from withdrawals exists in the form of temporary and permanent surrender charges on AFG’s annuity products. With declining rates, AFG receives some protection (from spread compression) due to the ability to lower crediting rates, subject to contractually guaranteed minimum interest rates (“GMIRs”). AFG began selling policies with GMIRs below 2% in 2003; almost all new business since late 2010 has been issued with a 1% GMIR. At December 31, 2015, AFG could reduce the average crediting rate on approximately $20 billion of traditional fixed and fixed-indexed deferred annuities without guaranteed withdrawal benefits by approximately 72 basis points (on a weighted average basis). Annuity policies are subject to Guaranteed Minimum Interest Rates (“GMIRs”) at policy issuance. The table below shows the breakdown of annuity reserves by GMIR. The current interest crediting rates on substantially all of AFG’s annuities with a GMIR of 3% or higher are at their minimum.
For statutory accounting purposes, equity securities of non-affiliates and equity call options used in the fixed-indexed annuity business are generally carried at fair value. At December 31, 2015, AFG’s insurance companies owned publicly traded equity securities with a fair value of $1.67 billion and equity call options with a fair value of $241 million. In addition, GAI’s investment in NATL common stock had a fair value of $272 million and a statutory carrying value of $217 million at December 31, 2015. Decreases in market prices could adversely affect the insurance group’s capital, potentially impacting the amount of dividends available or necessitating a capital contribution. Conversely, increases in market prices could have a favorable impact on the group’s dividend-paying capability.
Parent Net Cash Used in Investing Activities Parent holding company investing activities consist of capital contributions to and returns of capital from subsidiaries and, to a much lesser extent, parent company investment activity. Parent holding company net cash used in investing activities was $33 million in 2015 compared to $432 million in 2014 and $4 million in 2013. The $33 million in net cash used in investing activities in 2015 and the $4 million in 2013 are significantly lower than the $432 million in net cash used in investing activities in 2014 due primarily to capital contributions made to a subsidiary to fund the $399 million investment in Summit in 2014.
Parent Net Cash Used in Financing Activities Parent company financing activities consist primarily of repurchases of AFG Common Stock, dividends to shareholders, the issuance and retirement of long-term debt and, to a lesser extent, proceeds from employee stock option exercises. Significant long-term debt and common stock transactions are discussed above under “Parent Holding Company Liquidity.” Parent holding company net cash used in financing activities was $232 million in 2015 compared to $171 million in 2014 and $180 million in 2013. The $61 million increase in net cash used in financing activities in 2015 as compared to 2014 reflects the 2015 redemption of $132 million of 7% Senior Notes due 2050, partially offset by a $65 million decrease in common stock repurchases. The $9 million decrease in net cash used in financing activities in 2014 as compared to 2013 reflects net proceeds of $145 million received in 2014 from the issuance of 6-1/4% Subordinated Debentures due in 2054, partially offset by a $121 million increase in common stock repurchases.
Amounts presented in the table represent estimated cash payments under such contracts, based on significant assumptions related to mortality, morbidity, lapse, renewal, retirement and annuitization. These assumptions also include interest and index crediting consistent with assumptions used to amortize DPAC and assess loss recognition. All estimated cash payments are undiscounted for the time value of money. As a result, total outflows for all years exceed the corresponding liabilities of $26.62 billion for annuity benefits accumulated and $705 million for life, accident and health reserves included in AFG’s Balance Sheet as of December 31, 2015. Based on the same assumptions, AFG projects reinsurance recoveries related to life, accident and health reserves totaling $851 million as follows: Within 1 year - $86 million; 2-3 years - $146 million; 4-5 years - $121 million; and thereafter - $498 million. Actual payments and their timing could differ significantly from these estimates.
Dollar amounts and time periods are estimates based on historical net payment patterns applied to the gross reserves and do not represent actual contractual obligations. Based on the same assumptions, AFG projects reinsurance recoveries related to these reserves totaling $2.20 billion as follows: Within 1 year - $500 million; 2-3 years - $500 million; 4-5 years - $200 million; and thereafter - $1.00 billion. Actual payments and their timing could differ significantly from these estimates.
AFG has no material contractual purchase obligations or other long-term liabilities at December 31, 2015.
Investments AFG attempts to optimize investment income while building the value of its portfolio, placing emphasis upon total long-term performance.
Fair values for AFG’s portfolio are determined by AFG’s internal investment professionals using data from nationally recognized pricing services as well as non-binding broker quotes. Fair values of equity securities are generally based on published closing prices. For mortgage-backed securities (“MBS”), which comprise approximately 18% of AFG’s fixed maturities, prices for each security are generally obtained from both pricing services and broker quotes. For the remainder of AFG’s fixed maturity portfolio, approximately 80% are priced using pricing services and the balance is priced primarily by
The National Association of Insurance Commissioners (“NAIC”) assigns creditworthiness designations on a scale of 1 to 6 with 1 being the highest quality and 6 being the lowest quality. The NAIC retains third-party investment management firms to assist in the determination of appropriate NAIC designations for mortgage-backed securities based not only on the probability of loss (which is the primary basis of ratings by the major ratings firms), but also on the severity of loss and statutory carrying value. At December 31, 2015, 97% (based on statutory carrying value of $5.28 billion) of AFG’s MBS securities had an NAIC designation of 1.
Summarized information for the unrealized gains and losses recorded in AFG’s Balance Sheet at December 31, 2015, is shown in the following table (dollars in millions). Approximately $559 million of available for sale fixed maturity securities and $99 million of available for sale equity securities had no unrealized gains or losses at December 31, 2015.
The table below sets forth the scheduled maturities of AFG’s available for sale fixed maturity securities at December 31, 2015, based on their fair values. 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.
Based on its analysis of the factors listed above, management believes AFG will recover its cost basis in the securities with unrealized losses and that AFG has the ability to hold the securities until they recover in value and had no intent to sell them at December 31, 2015. Although AFG has the ability to continue holding its investments with unrealized losses, its intent to hold them may change due to deterioration in the issuers’ creditworthiness, decisions to lessen exposure to a particular issuer or industry, asset/liability management decisions, market movements, changes in views about appropriate asset allocation or the desire to offset taxable realized gains. Should AFG’s ability or intent change with regard to a particular security, a charge for impairment would likely be required. While it is not possible to accurately predict if or when a specific security will become impaired, charges for other-than-temporary impairment could be material to results of operations in future periods. Significant declines in the fair value of AFG’s investment portfolio could have a significant adverse effect on AFG’s liquidity. For information on AFG’s realized gains (losses) on securities, including charges for “other-than-temporary” impairment, see “Results of Operations - Consolidated Realized Gains (Losses) on Securities.”
Some of the standard actuarial methods employed for the quarterly reserve analysis may include (but may not be limited to):
The period of time from the occurrence of a loss through the settlement of the liability is referred to as the “tail”. Generally, the same actuarial methods are considered for both short-tail and long-tail lines of business because most of them work properly for both. The methods are designed to incorporate the effects of the differing length of time to settle particular claims. For short-tail lines, management tends to give more weight to the Case Incurred and Paid Development methods, although the various
methods tend to produce similar results. For long-tail lines, more judgment is involved, and more weight may be given to the Bornhuetter-Ferguson method. Liability claims for long-tail lines are more susceptible to litigation and can be significantly affected by changing contract interpretation and the legal environment. Therefore, the estimation of loss reserves for these classes is more complex and subject to a higher degree of variability.
While current factors and reasonably likely changes in variable factors are considered in estimating the liability for unpaid losses, there is no method or system that can eliminate the risk of actual ultimate results differing from such estimates. As shown in the reserve development table (loss triangle) on page 7, the original estimates of AFG’s liability for losses and loss adjustment expenses, net of reinsurance and including the effect of special charges for asbestos and environmental exposures, over the past 10 years have developed through December 31, 2015, to be deficient (for four years) by as much as 1.8% and
AFG recorded favorable prior year reserve development of $45 million in 2015 due to lower than anticipated claim severity across all regions of the country. AFG recorded favorable prior year reserve development of $7 million in both 2014 and 2013, as favorable reserve development in the business written in California was partially offset by adverse reserve development in other states.
This line of business is a mix of coverage protecting the insured against legal liability for property damage or personal injury to others arising from the operation of commercial motor vehicles. The property damage liability exposure is usually short-tail with relatively quick reporting and settlement of claims. The bodily injury and medical payments exposures are longer-tailed; although the claim reporting is relatively quick, the final settlement can take longer to achieve. Some of the important variables affecting estimation of loss reserves for commercial auto/truck liability/medical are similar to other liability - occurrence and include:
economic conditions led to higher frequency of claims, particularly in the D&O policies for small account and not-for-profit organizations. Since then, claim frequency has continually decreased from its peak in 2010, offsetting increased claim severity.
AFG recorded favorable prior year reserve development of $12 million in 2015, $18 million in 2014 and $41 million in 2013 on its D&O business as claim severity was less than expected across several prior accident years.
Reserves of foreign operations relate primarily to the operations of Marketform Group, Limited, AFG’s wholly-owned United Kingdom-based Lloyd’s insurer. Historically, the largest line of business written by Marketform has been non-U.S. medical malpractice, which provides coverage for injuries and damages caused by medical care providers, including but not limited to, hospitals and their physicians. Although Marketform offers this product in approximately 30 countries, the majority of the business has been written in the United Kingdom, Australia and Italy. In addition, Marketform writes general liability, marine, equine, professional indemnity and directors and officers liability insurance. Significant variables in estimating the loss reserves include:
Outside of its property and casualty operations, AFG also has reinsurance recoverables totaling $355 million, including$315 million related to the run-off life business. These recoverables include $184 million from Hannover Life Reassurance Company of America (rated A+ by A.M. Best).
While management believes that AFG’s reserves for A&E claims are a reasonable estimate of ultimate liability for such claims, actual results may vary materially from the amounts currently recorded due to the difficulty in predicting the number of future claims, the impact of recent bankruptcy filings, and unresolved issues such as whether coverage exists, whether policies are subject to aggregate limits on coverage, how claims are to be allocated among triggered policies and implicated years, and whether claimants who exhibit no signs of illness will be successful in pursuing their claims. A 1% variation in loss cost trends, caused by any of the factors previously described, would change net income by approximately $20 million.
As a result of the comprehensive external study completed in the third quarter of 2015, AFG’s property and casualty insurance segment recorded a $67 million pretax special charge to increase its asbestos reserves by $25 million (net of reinsurance) and its
An in-depth internal review of AFG’s A&E reserves was completed in the third quarter of 2014 by AFG’s internal A&E claims specialists and actuaries in consultation with specialty outside counsel and an outside consultant. As a result of the review, AFG’s property and casualty insurance segment recorded a $24 million pretax special charge to increase its asbestos reserves by $4 million (net of reinsurance) and its environmental reserves by $20 million (net of reinsurance). The increase in property and casualty environmental reserves was attributed primarily to AFG’s increased defense costs and a number of claims where the estimated costs of remediation have increased.
Includes losses of $11 million in the fourth quarter of 2015 and $2 million in the fourth quarter of 2014 representing the change in fair value of AFG’s CLO investments plus $4 million and $7 million in the fourth quarter of 2015 and 2014, respectively, in CLO management fees earned.
Elimination of the change in fair value of AFG’s investments in the CLOs, including $7 million and $5 million in the fourth quarter of 2015 and 2014, respectively, in distributions recorded as interest expense by the CLOs.
Elimination of the change in fair value of AFG’s investments in the CLOs, including $28 million and $23 million in 2015 and 2014, respectively, in distributions recorded as interest expense by the CLOs.
In addition, reconciling items are shown net of noncontrolling interests as follows (in millions):
Net earnings attributable to shareholders increased $2 million in the fourth quarter of 2015 compared to the same period of 2014 reflecting higher core net operating earnings and a gain on the sale of an apartment property, partially offset by realized losses on securities in the fourth quarter of 2015 compared to realized gains on securities in the fourth quarter of 2014 and a fourth quarter loss reported upon closing of the sale of substantially all of AFG’s run-off long-term care insurance business. Core net operating earnings increased $14 million in the fourth quarter of 2015 compared to the fourth quarter of 2014 due primarily to higher core underwriting profit in the property and casualty insurance segment, higher earnings in the annuity segment and improved core operating results in the run-off long-term care and life segment.
AFG’s net earnings attributable to shareholders, determined in accordance with GAAP, include certain items that may not be indicative of its ongoing core operations. The following tables for the quarters ended December 31, 2015 and 2014 identify such items by segment and reconcile net earnings attributable to shareholders to core net operating earnings, a non-GAAP financial measure that AFG believes is a useful tool for investors and analysts in analyzing ongoing operating trends (in millions):
The following table details AFG’s GAAP and core earnings before income taxes from its property and casualty insurance operations for the three months ended December 31, 2015 and 2014 (dollars in millions):
Gross written premiums (“GWP”) for AFG’s property and casualty insurance segment were $1.36 billion for the fourth quarter of 2015 compared to $1.30 billion for the fourth quarter of 2014, an increase of $53 million (4%). Detail of AFG’s property and casualty gross written premiums is shown below (dollars in millions):
The $53 million increase in gross written premiums in the fourth quarter of 2015 compared to the fourth quarter of 2014 reflects growth in each of the Specialty property and casualty insurance sub-segments. Overall average renewal rates were up less than 1% in the fourth quarter of 2015.
Property and transportation Gross written premiums increased $33 million (7%) in the fourth quarter of 2015 compared to the fourth quarter of 2014 reflecting higher gross written premiums in the transportation and 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 and ocean marine businesses. Average renewal rates for this group were up approximately 2% in the fourth quarter of 2015, including a 4% increase in National Interstate’s renewal rates. Reinsurance premiums ceded as a percentage of gross written premiums increased 4 percentage points in the fourth quarter of 2015 compared to the fourth quarter of 2014 reflecting higher cessions of crop insurance premiums.
Specialty financial Gross written premiums increased $19 million (12%) in the fourth quarter of 2015 compared to the fourth quarter of 2014, due primarily to growth in the financial institutions business. Average renewal rates for this group were up approximately 1% in the fourth quarter of 2015. Reinsurance premiums ceded as a percentage of gross written premiums decreased 3 percentage points, reflecting a decline in auto dealer business, which is heavily reinsured.
Performance measures such as the combined ratio are often used by property and casualty insurers to help users of their financial statements better understand the company’s performance. The combined ratio is the sum of the loss and loss adjustment expenses (“LAE”) and underwriting expense ratios. These ratios are calculated by dividing each of the respective expenses by net earned premiums. The table below (dollars in millions) details the components of the combined ratio for AFG’s property and casualty segment:
Specialty casualty Underwriting profit for this group was $50 million for the fourth quarter of 2015 compared to $36 million in the fourth quarter of 2014, an increase of $14 million (39%). This increase is due primarily to higher profitability in the workers’ compensation, targeted markets, executive liability and excess and surplus businesses, partially offset by underwriting losses at Marketform.
Property and transportation The 2.1 percentage point decrease in the loss and LAE ratio for the current year, excluding catastrophe losses is due primarily to higher profitability in the agricultural businesses and lower commercial auto claims in the transportation businesses, partially offset by higher current year losses in the ocean marine business.
AFG’s Specialty property and casualty insurance operations recorded net favorable reserve development related to prior accident years of $5 million in the fourth quarter of 2015 compared to net adverse reserve development related to prior accident years of $10 million in the fourth quarter of 2014, an improvement of $15 million.
Property and transportation Net adverse reserve development of $8 million in the fourth quarter of 2015 reflects higher than expected claim severity in commercial auto liability insurance at National Interstate and higher than expected claim frequency in the ocean marine business, partially offset by lower than expected claim severity in the property and inland marine business. Net adverse reserve development of $3 million in the fourth quarter of 2014 reflects higher than expected claim frequency in the ocean marine business and higher than anticipated claim severity in the trucking operations, partially offset by lower than expected claim severity in the property and inland marine 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. Based on data available at December 31, 2015, AFG’s exposure to a catastrophic earthquake or windstorm that industry models indicate could occur once in every 500 years (a “500-year event”) is expected to be less than 3.5% of AFG’s shareholders’ equity. The $5 million of catastrophe losses in the Specialty financial group in the fourth quarter of 2015 resulted primarily from flooding in the midwestern United States.
The overall increase of 0.6% in AFG’s expense ratio in the fourth quarter of 2015 as compared to the fourth quarter of 2014 reflects higher profitability-based commissions paid to agents and brokers.
Specialty financial Commissions and other underwriting expenses as a percentage of net earned premiums increased 4.8 percentage points in the fourth quarter of 2015 compared to the fourth quarter of 2014 due primarily to higher profitability-based commissions paid to agents and brokers.
Net investment income in AFG’s property and casualty operations was $74 million for the fourth quarter of 2015 compared to $75 million in the fourth quarter of 2014, a decrease of $1 million (1%). In recent years, yields available in the financial markets on fixed maturity securities have generally declined, placing downward pressure on AFG’s investment portfolio yield. The average invested assets and overall yield earned on investments held by AFG’s property and casualty operations are provided below (dollars in millions):
The increase in average invested assets in the property and casualty segment for the fourth quarter of 2015 as compared to the fourth quarter of 2014 is due primarily to growth in the property and casualty segment. The property and casualty segment’s overall yield on investments (net investment income as a percentage of average invested assets) was 3.25% for the fourth quarter of 2015 compared to 3.54% for the fourth quarter of 2014, a decline of 0.29 percentage points, reflecting lower income from equity in the earnings of limited partnerships and from other investments.
The lower amortization of intangibles in the fourth quarter of 2015 compared to the fourth quarter of 2014 reflects the impact of intangible assets related to three acquisitions that became fully amortized in 2014.
AFG’s annuity operations contributed $101 million in pretax earnings in the fourth quarter of 2015 compared to $85 million in the fourth quarter of 2014, an increase of $16 million (19%). While AFG’s average annuity investments (at amortized cost) were 13% higher for the fourth quarter of 2015 as compared to the fourth quarter of 2014, the benefit of this growth was partially offset by the impact of lower investment yields. In addition, strong stock market performance in the fourth quarter of 2015 had a positive impact on the fair value accounting for fixed-indexed annuities (“FIAs”). Conversely, in the fourth quarter of 2014, the favorable impact of the increase in the stock market was more than offset by a decrease in longer-term interest rates and resulted in a negative impact on the fair value accounting for FIAs. AFG’s periodic detailed review (“unlocking”) of the major actuarial assumptions underlying its annuity operations resulted in a net annuity expense reduction of $10 million in the fourth quarter of 2015 compared to $1 million in the fourth quarter of 2014.
Net investment income for the fourth quarter of 2015 was $309 million compared to $285 million for the fourth quarter of 2014, an increase of $24 million (8%). This increase reflects the growth in AFG’s annuity business, partially offset by the impact of lower investment yields. 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 the fourth quarter of 2015 compared to the fourth quarter of 2014. This decline in net investment yield reflects (i) lower income from other investments, (ii) the investment of new premium dollars at lower yields as compared to the existing investment portfolio and (iii) the impact of the reinvestment of proceeds from maturity and redemption of higher yielding investments at the lower yields available in the financial markets.
Interest credited - fixed for the fourth quarter of 2015 was $138 million compared to $127 million for the fourth quarter of 2014, an increase of $11 million (9%). 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
Other annuity benefits, net of guaranteed withdrawal benefit fees (excluding the impact of unlocking) for the fourth quarter of 2015 were $19 million compared to $13 million for the fourth quarter of 2014, an increase of $6 million (46%). 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 0.75% for the fourth quarter of 2015 and 0.65% for the fourth quarter of 2014 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 lower interest rates during the fourth quarter of 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. During the third quarter of 2015, the deceleration in the amortization of DPAC caused by the negative impact of poor stock market performance on the fair value accounting for derivatives related to fixed-indexed annuities was limited on certain recently issued products. This prior period limitation had a $5 million favorable impact on the amortization of DPAC related to the fair value accounting for those derivatives when the stock market rebounded during the fourth quarter of 2015. This favorable impact is reported in the impact on DPAC of derivatives related to FIAs.
As illustrated in the table above, the change in fair value of derivatives related to fixed-indexed annuities, including the related impact on amortization of DPAC increased the annuity segment’s earnings before income taxes by $5 million in the fourth quarter of 2015 and decreased the annuity segment’s earnings before income taxes by $8 million in the fourth quarter of 2014.
Management attributes the 14% increase in annuity premiums in the fourth quarter of 2015 as compared to the fourth quarter of 2014 to the significant rise of interest rates during the second quarter of 2015 from first quarter 2015 lows and strong investment performance, which allowed AFG to raise the crediting rates on its annuities and become more competitive in its markets.
In the fourth quarters of 2015 and 2014, AFG conducted a 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, which impacted AFG’s financial statements as follows (in millions):
The 2014 net expense reduction was due primarily to the impact of changes in assumptions to reflect a decrease in future expected call option costs related to the fixed-indexed annuity business and lower lapses, partially offset by lower future investment yield assumptions. For the 2014 unlocking, AFG assumed a net reinvestment rate (net of default and expense assumptions) of 3.57% in 2015, grading up ratably to an ultimate net reinvestment rate of 5.54% in 2022 and beyond.
The following table reconciles the net spread earned on AFG’s fixed annuities to overall annuity pretax earnings for the three months ended December 31, 2015 and 2014 (in millions):
Other income in the table above includes $4 million and $7 million in the fourth quarter of 2015 and 2014, respectively, in management fees paid to AFG by the AFG-managed CLOs (AFG’s consolidated managed investment entities). The $7 million in management fees in the fourth quarter of 2014 includes a $4 million incentive management fee earned in connection with the liquidation of a CLO. The management fees are eliminated in consolidation - see the other income line in the Consolidate 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 $2 million in the fourth quarter of 2015 and $4 million in the fourth quarter of 2014. Results for the fourth quarter of 2014 include $3 million in income related to the sale of real estate.
AFG’s holding companies and other operations outside of its insurance operations recorded interest expense of $16 million in the fourth quarter of 2015 compared to $19 million in the fourth quarter of 2014, a decrease of $3 million (16%). The following table details AFG’s long-term debt balances as of October 1, 2015 compared to October 1, 2014 (dollars in millions):
AFG’s holding companies and other operations outside of its insurance operations recorded other expenses of $38 million in the fourth quarter of 2015 compared to $29 million in the fourth quarter of 2014, an increase of $9 million (31%). The $9 million increase reflects a $2 million charge related to AFG’s former railroad and manufacturing operations and higher other holding company expenses.
Consolidated Realized Gains (Losses) on Securities AFG’s consolidated realized gains (losses) on securities, which are not allocated to segments, were losses of $21 million in the fourth quarter of 2015 compared to gains of $8 million in the fourth quarter of 2014, a decrease of $29 million (363%). Realized gains (losses) on securities consisted of the following (in millions):
The changes in valuation allowance in the table above are primarily increases in the valuation allowance on tax benefits related to losses in the Marketform Lloyd’s insurance business. Due to the uncertainty concerning the realization of the deferred tax benefits associated with these losses, AFG maintains a full valuation allowance against these deferred tax assets.
The losses of Managed Investment Entities for the fourth quarter of 2014 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.
Segmented Statement of Earnings AFG reports its business as four segments: (i) Property and casualty insurance (“P&C”), (ii) Annuity, (iii) Run-off long-term care and life and (iv) Other, which includes holding company costs and operations attributable to noncontrolling interests of the managed investment entities (“MIEs”).
AFG’s net earnings attributable to shareholders, determined in accordance with GAAP, include certain items that may not be indicative of its ongoing core operations. The following tables for the years ended December 31, 2015, 2014 and 2013 identify such items by segment and reconcile net earnings attributable to shareholders to core net operating earnings, a non-GAAP financial measure that AFG believes is a useful tool for investors and analysts in analyzing ongoing operating trends (in millions):
See the reconciliation of core earnings to GAAP net earnings under “Results of Operations - General” for details on the tax and noncontrolling interest impacts of these reconciling items.
Property and Casualty Insurance Segment - Results of Operations AFG’s property and casualty insurance operations contributed $576 million in GAAP pretax earnings in 2015 compared to $456 million in 2014, an increase of $120 million (26%). Property and casualty core pretax earnings were $577 million in 2015 compared to $480 million in 2014, an increase of $97 million (20%). The increase in GAAP and core pretax earnings reflects higher underwriting profit across each of AFG’s property and casualty insurance sub-segments, higher net investment income (due primarily to the investment of cash acquired in the Summit acquisition on April 1, 2014) and lower net expenses. The increase in GAAP pretax earnings in 2015 also reflects pretax non-core gains of $51 million on the sale of Le Pavillon Hotel and $15 million on the sale of an apartment property, partially offset by higher non-core special A&E charges in 2015 as compared to 2014.
AFG’s property and casualty insurance operations contributed $456 million in GAAP pretax earnings in 2014 compared to $375 million in 2013, an increase of $81 million (22%). Property and casualty core pretax earnings were $480 million in 2014 compared to $429 million in 2013, an increase of $51 million (12%). The increase in GAAP and core pretax earnings reflects higher underwriting profit in the Specialty casualty group and Property and transportation group and higher net investment income (due primarily to the investment of cash acquired in the April 2014 Summit acquisition), partially offset by higher other net expenses. The increase in GAAP pretax earnings also reflects lower non-core special A&E charges in 2014 as compared to 2013.
The following table details AFG’s GAAP and core earnings before income taxes from its property and casualty operations for the years ended December 31, 2015, 2014 and 2013 (dollars in millions):
Reinsurance premiums ceded (“Ceded”) for AFG’s property and casualty insurance segment were 26%, 27% and 30% of gross written premiums for the years ended December 31, 2015, 2014 and 2013, respectively. 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 $4.33 billion in 2015 compared to $4.02 billion in 2014, an increase of $307 million (8%). NWP increased $679 million (20%) in 2014 compared to 2013. Detail of AFG’s property and casualty net written premiums is shown below (dollars in millions):
The $355 million (6%) increase in gross written premiums in 2015 compared to 2014 reflects $535 million in premiums from Summit (acquired in April 2014) in 2015 compared to $414 million in 2014 as well as significant growth in other businesses
Specialty casualty Gross written premiums increased $210 million (8%) in 2015 compared to 2014 reflecting $535 million in gross written premiums from Summit (acquired in April 2014) in 2015 compared to $414 million in 2014. Excluding premiums from Summit, gross written premiums increased 4% in 2015 compared to 2014. While most of the businesses in this group reported growth, the workers’ compensation, excess and surplus lines and targeted markets businesses were primary drivers of the higher premiums, partially offset by lower 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 1% in 2015 due primarily to lower pricing in the workers’ compensation businesses. Excluding the workers’ compensation business, average renewal rates in this group increased 1% during 2015. Reinsurance premiums ceded as a percentage of gross written premiums declined 1 percentage point in 2015 compared to 2014 reflecting the impact of the acquisition of Summit, which cedes only about 1% of its premiums.
The table below details the components of the combined ratio for AFG’s property and casualty segment for 2015, 2014 and 2013 (dollars in millions):
The Specialty property and casualty insurance operations generated an underwriting profit of $295 million in 2015 compared to $237 million in 2014, an increase of $58 million (24%). The higher underwriting profit in 2015 reflects higher underwriting profit across each of AFG’s property and casualty insurance sub-segments. Overall catastrophe losses were $35 million (0.8 points on the combined ratio) in 2015 compared to $28 million (0.7 points on the combined ratio) in 2014.
Property and transportation Underwriting profit for this group was $48 million in 2015 compared to $21 million in 2014, an increase of $27 million (129%). Higher profits in the agricultural operations and improved year-over-year underwriting results at National Interstate, due primarily to lower adverse prior year reserve development, were partially offset by lower profitability in the property and inland marine, ocean marine and other transportation businesses.
Underwriting profit for this group was $21 million in 2014 compared to $12 million in 2013, an increase of $9 million (75%). Higher underwriting profit in the property and inland marine operations, including lower catastrophe losses, was partially offset by lower underwriting profit in the agricultural operations. Catastrophe losses were $20 million (1.3 points) for this group in 2014 compared to $27 million (1.8 points) in 2013.
Underwriting profit for this group was $64 million in 2014 compared to $67 million in 2013, a decrease of $3 million (4%). Lower profitability in the trade credit and financial institutions businesses was partially offset by higher profitability in the surety business.
Other specialty Underwriting profit for this group was $14 million in 2015 compared to $16 million in 2014, a decrease of $2 million (13%).
AFG’s overall loss and LAE ratio was 63.8%, 64.3% and 63.7% in 2015, 2014 and 2013, respectively. The components of AFG’s property and casualty losses and LAE amounts and ratio are detailed below (dollars in millions):
The 1.0% percentage point increase in the loss and LAE ratio for the 2014 current year, excluding catastrophe losses compared to 2013 reflects an increase in the loss and LAE ratio of the financial institutions business.
Net favorable reserve development of $7 million in 2014 reflects lower than expected claim severity in directors and officers liability insurance, lower than expected claim severity and frequency in excess liability insurance and lower than anticipated claim severity in specialty workers’ compensation business, partially offset by higher than expected severity in contractor claims and in a run-off book of casualty business and adverse reserve development at Marketform.
Specialty financial Net favorable reserve development of $30 million in 2015 reflects lower than anticipated claim frequency and severity in the surety business and products for financial institutions and lower than expected claim severity in the fidelity business and run-off collateral value insurance.
Net favorable reserve development of $14 million in 2013 is due to lower than expected claim frequency and severity in the trade credit and financial institutions businesses as economic conditions did not affect these lines as adversely as had been anticipated.
Asbestos and Environmental Reserve Charges As previously discussed under “Uncertainties” - “Asbestos and Environmental-related (“A&E”) Insurance Reserves,” AFG has established property and casualty reserves for claims related to environmental exposures and asbestos claims. Total charges recorded to increase reserves (net of reinsurance recoverable) for A&E exposures of AFG’s property and casualty group (included in loss and loss adjustment expenses) were $67 million in 2015, $24 million in 2014 and $59 million in 2013.
AFG’s property and casualty commissions and other underwriting expenses (“U/W Exp”) were $1.30 billion in 2015 compared to $1.17 billion in 2014, an increase of $132 million (11%). AFG’s underwriting expense ratio was 30.9% in 2015 compared to 30.2% in 2014, an increase of 0.7 percentage points.
The $132 million increase in commissions and other underwriting expenses reflects the acquisition of Summit in April 2014. The overall increase of 0.7% in AFG’s expense ratio in 2015 as compared to 2014 reflects higher profitability-based commissions paid to agents and brokers, partially offset by the impact of higher premiums on the ratio.
Specialty casualty Commissions and other underwriting expenses as a percentage of net earned premiums increased 0.2 percentage points in 2015 compared to 2014 due primarily to a charge of $6 million in the second quarter of 2015 to write off certain previously capitalized project costs, partially offset by the impact of higher premiums on the ratio.
Commissions and other underwriting expenses as a percentage of net earned premiums decreased 3.8 percentage points in 2014 compared to 2013 due primarily to the inclusion of Summit following its acquisition in April 2014, which has a lower expense ratio than AFG’s overall Specialty casualty group, and the impact of higher premiums across the Specialty casualty group on the ratio.
Specialty financial Commissions and other underwriting expenses as a percentage of net earned premiums increased 0.8 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.
Net investment income in AFG’s property and casualty operations was $319 million in 2015 compared to $294 million in 2014, an increase of $25 million (9%). Net investment income in AFG’s property and casualty operations was $294 million in 2014 compared to $263 million in 2013, an increase of $31 million (12%). Net investment income in AFG’s property and casualty operations includes $11 million in 2015 and $8 million in 2014, from recording equity in the earnings of limited partnerships and similar investments. Equity in the earnings of these investments had not been material and was included in realized gains (losses) on securities prior to 2014. In recent years, yields available in the financial markets on fixed maturity securities have generally declined, placing downward pressure on AFG’s investment portfolio yield. The average invested assets and overall yield earned on investments held by AFG’s property and casualty operations are provided below (dollars in millions):
Excludes the $51 million pretax non-core gain on the sale of Le Pavillon Hotel in the second quarter of 2015 and the $15 million pretax non-core gain on the sale of an apartment property in the fourth quarter of 2015.
AFG and its consolidated subsidiaries incurred $3 million in transaction expenses related to the February 2014 tender offer by Great American Insurance Company (“GAI”) to acquire all of the National Interstate Corporation common stock that GAI did not already own. These expenses consisted primarily of financial advisory and legal services. The tender offer was terminated in March 2014.
AFG’s annuity operations contributed $331 million in GAAP pretax earnings in 2015 compared to $328 million in 2014, an increase of $3 million (1%). While AFG’s average annuity investments (at amortized cost) were 12% higher in 2015 as compared to 2014, the benefit of this growth and the impact that fluctuations in interest rates had on the fair value accounting for fixed-indexed annuities (“FIAs”) was offset by the negative impact that the stock market decrease had on certain annuity reserves in 2015 compared to a stock market increase in 2014, the run-off of higher yielding investments and higher general and administrative expenses in 2015 compared to 2014. AFG’s periodic detailed review (“unlocking”) of the major actuarial assumptions underlying its annuity operations resulted in a net annuity expense reduction of $10 million in 2015 compared to $1 million in 2014.
In the second quarter of 2013, AFG recorded a pretax charge of $5 million in its annuity operations to cover expected assessments from state guaranty funds related to the insolvency and liquidation of Executive Life Insurance Company of New York (“ELNY”), an unaffiliated life insurance company. ELNY was placed into rehabilitation by the New York Insurance Department in 1991. In April 2012, ELNY was declared insolvent and ordered into liquidation. AFG’s life insurance
Other expenses exclude the $5 million pretax non-core charge for ELNY guaranty fund assessments in 2013.
existing investment portfolio and the impact of the reinvestment of proceeds from maturity and redemption of higher yielding investments at the lower yields available in the financial markets.
AFG’s net interest spread decreased 0.09 percentage points in 2015 compared to 2014 due primarily to the run-off of higher yielding investments, partially offset by lower crediting rates. 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.
The $24 million increase in other annuity benefits, net of guaranteed withdrawal benefit fees in 2015 compared to 2014 reflects higher expenses related to products with guaranteed withdrawal benefit features. The guaranteed withdrawal benefit reserve related to FIAs is inversely impacted by the calculated FIA embedded derivative reserve as the value to policyholders of the guaranteed withdrawal benefits increases when the benefit of stock market participation decreases.
See “Annuity Unlocking” below for a discussion of the impact that the periodic review of actuarial assumptions had on annuity and supplemental insurance acquisition expenses. Unanticipated spread compression, decreases in the stock market, adverse mortality experience, and higher than expected lapse rates could lead to write-offs of DPAC or PVFP in the future.
Excluding the non-core ELNY guaranty fund assessments charge in 2013, annuity other expenses were $96 million in 2015, $82 million in 2014 and $93 million in 2013, representing an increase of $14 million (17%) in 2015 compared to 2014 and a decrease of $11 million (12%) in 2014 compared to 2013. 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 0.02 percentage points in 2015 compared to 2014 due primarily to higher expenses related to professional services and employee compensation plans. Annuity other expenses for 2014 includes the favorable impact of settling certain accrued expenses at a lower cost than previously estimated, while annuity other expenses for 2013 includes a $7 million charge to write off certain previously capitalized project costs. In general this percentage is expected to decrease as AFG’s annuity business grows and annuity other expenses remain relatively stable.
As illustrated in the table above, the change in fair value of derivatives related to fixed-indexed annuities, net of the related impact on amortization of DPAC decreased the annuity segment’s earnings before income taxes by $23 million and $34 million in 2015 and 2014, respectively, and increased the annuity segment’s earnings before income taxes by $15 million in 2013.
AFG’s net spread earned on fixed annuities decreased 0.15 percentage points in 2015 compared to 2014 due primarily to the 0.09 percentage points decrease in AFG’s net interest spread, the impact of the decline in the stock market on guaranteed withdrawal benefit reserves, and higher general and administrative expenses, partially offset by income from the sale of real estate recorded primarily in the first quarter of 2015.
Run-off Long-Term Care and Life Segment - Results of Operations AFG’s run-off long-term care and life segment incurred GAAP pretax losses of $152 million in 2015, which includes a $166 million pretax non-core realized loss on the sale of the subsidiaries containing substantially all of AFG’s run-off long-term care insurance business. See Note B - “Acquisitions and Sale of Businesses” to the financial statements. The following table details AFG’s GAAP and core earnings (loss) before income taxes from its run-off long-term care and life operations in 2015, 2014 and 2013 (dollars in millions):
Higher long-term care and life core earnings before income taxes in 2015 as compared to 2014 reflects improved claims experience, rate increases, lower persistency and a $5 million loss in 2014 on the commutation of a reinsurance agreement.
Holding Company, Other and Unallocated - Results of Operations AFG’s net GAAP pretax loss outside of its insurance operations (excluding realized gains and losses) totaled $176 million in 2015 compared to $149 million in 2014, an increase of $27 million (18%). AFG’s net core pretax loss outside of its insurance operations (excluding realized gains and losses) totaled $160 million in 2015 compared to $143 million in 2014, an increase of $17 million (12%).
AFG’s net GAAP pretax loss outside of its insurance operations (excluding realized gains) totaled $149 million in 2014 compared to $190 million in 2013, a decrease of $41 million (22%). AFG’s net core pretax loss outside of its insurance operations (excluding realized gains) totaled $143 million in 2014 compared to $168 million in 2013, a decrease of $25 million (15%).
AFG’s holding companies and other operations outside of its insurance operations recorded interest expense of $72 million in 2015 compared to $69 million in 2014, an increase of $3 million (4%). This increase reflects the September 2014 issuance of $150 million of 6-1/4% Subordinated Debentures due 2054 and the November 2015 issuance of $150 million of 6% Subordinated Debentures due 2055, partially offset by the favorable impact of the interest rate swap entered into in June 2015 and the September 2015 redemption of $132 million of 7% Senior Notes due 2050.
As a result of the comprehensive external studies and internal review of A&E exposures discussed under “Uncertainties - Asbestos and Environmental-related (“A&E”) Insurance Reserves,” AFG’s holding companies and other operations outside of its insurance operations recorded non-core special charges of $12 million in 2015, $6 million in 2014 and $22 million in 2013 to increase liabilities related to the A&E exposures of AFG’s former railroad and manufacturing operations. These charges related to slightly higher estimated costs at sites where remediation is underway, coupled with higher estimated cleanup costs at a limited number of sites. Total charges recorded to increase liabilities for A&E exposures of AFG’s former railroad and manufacturing operations (included in other expenses) were $22 million in 2015, $13 million in 2014 and $29 million in 2013.
Holding Company and Other - Loss on Early Retirement of Debt
Excluding the non-core special A&E charges and the non-core loss on early retirement of debt, AFG’s holding companies and other operations outside of its insurance operations recorded other expenses of $116 million, $115 million and $135 million in 2015, 2014 and 2013, respectively. The $20 million (15%) decrease in 2014 compared to 2013 reflects the impact of higher holding company expenses in 2013, primarily related to employee benefit plans that are tied to stock market performance and certain share-based incentive plans.
Consolidated Realized Gains (Losses) on Securities AFG’s consolidated realized gains (losses) on securities, which are not allocated to segments, were losses of $19 million in 2015 compared to gains of $52 million in 2014, a decrease of $71 million (137%). AFG’s consolidated realized gains on securities were $52 million in 2014 compared to $221 million in 2013, a decrease of $169 million (76%). Realized gains (losses) on securities consisted of the following (in millions):
Consolidated Realized Gains (Losses) on Subsidiaries In addition to the $166 million pretax realized loss on the sale of substantially all of AFG’s run-off long-term care insurance business recorded in 2015, AFG recorded a $5 million pretax
Consolidated Income Taxes AFG’s consolidated provision for income taxes was $195 million in 2015 compared to $220 million in 2014, a decrease of $25 million (11%). AFG’s consolidated provision for income taxes was $220 million in 2014 compared to $236 million in 2013, a decrease of $16 million (7%). See Note L - “Income Taxes” to the financial statements for an analysis of items affecting AFG’s effective tax rate.
Other noncontrolling interests includes $6 million related to the gain on the sale of Le Pavillon Hotel in the second quarter of 2015, which was owned by an 80%-owned subsidiary of Great American Insurance Company.
See Note B - “Acquisitions and Sale of Businesses” to the financial statements for a discussion of accounting guidance adopted on January 1, 2015 that impacts the determination of when a component of an entity qualifies for presentation as a discontinued operation.
See Note A - “Accounting Policies - Managed Investment Entities” to the financial statements for a discussion of accounting guidance that AFG will be required to adopt effective January 1, 2016, which could impact the consolidation of collateralized financing entities such as CLOs, as well as limited partnerships and similar investments.
In April 2015, the Financial Accounting Standards Board (“FASB”) issued Accounting Standards Update (“ASU”) 2015-03, which will require debt issuance costs to be presented in the balance sheet as a direct reduction in the carrying value of long-term debt (consistent with the treatment of debt discounts) with the periodic amortization of such costs included in interest expense. AFG currently carries debt issuance costs as a deferred charge ($23 million at December 31, 2015 and included in other assets in AFG’s Balance Sheet) with the periodic amortization ($1 million in 2015) included in other expenses in AFG’s Statement of Earnings. The updated guidance, which AFG will be required to adopt effective January 1, 2016, does not affect the overall recognition and measurement guidance for debt issuance costs. Accordingly, the guidance will have no overall impact on AFG’s Shareholders’ Equity or results of operations.
Consolidated Statement of Comprehensive Income for the years ended December 31, 2015, 2014 and 2013
Consolidated Statement of Changes in Equity for the years ended December 31, 2015, 2014 and 2013
In our opinion, American Financial Group, Inc. and subsidiaries maintained, in all material respects, effective internal control over financial reporting as of December 31, 2015, based on the COSO criteria.
We have audited the accompanying consolidated balance sheets of American Financial Group, Inc. and subsidiaries (the Company) 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. Our audits also included the financial statement schedules listed in the Index at Item 15(a)(2). These financial statements and schedules are the responsibility of the Company’s management. Our responsibility is to express an opinion on these financial statements and schedules based on our audits.
In our opinion, the financial statements referred to above present fairly, in all material respects, the consolidated financial position of American Financial Group, Inc. and subsidiaries at December 31, 2015 and 2014 and the consolidated results of their operations and their cash flows for each of the three years in the period ended December 31, 2015, in conformity with U.S. generally accepted accounting principles. Also, in our opinion, the related financial statement schedules, when considered in relation to the basic financial statements taken as a whole, present fairly in all material respects the information set forth therein.
We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), American Financial Group, Inc. and subsidiaries’ internal control over financial reporting as of December 31, 2015, based on criteria established in Internal Control - Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (2013 framework) and our report dated February 26, 2016 expressed an unqualified opinion thereon.
Fair Value Measurements Accounting standards define fair value as the price that would be received to sell an asset or paid to transfer a liability (an exit price) in an orderly transaction between market participants on the measurement date. The standards establish a hierarchy of valuation techniques based on whether the assumptions that market participants would use in pricing the asset or liability (“inputs”) are observable or unobservable. Observable inputs reflect market data obtained from independent sources, while unobservable inputs reflect AFG’s assumptions about the assumptions market participants would use in pricing the asset or liability. Other than the fair value measurements used in recording the loss on the sale of substantially all of its long-term care business in 2015 and the acquisition of Summit Holding Southeast, Inc. and its related companies in 2014 (see Note B - “Acquisitions and Sale of Businesses”), AFG did not have any significant nonrecurring fair value measurements of nonfinancial assets and liabilities in 2015 or 2014.
Investments Fixed maturity and equity securities classified as “available for sale” are reported at fair value with unrealized gains and losses included in accumulated other comprehensive income (“AOCI”) in AFG’s Balance Sheet. Fixed maturity and equity securities classified as “trading” are reported at fair value with changes in unrealized holding gains or losses during the period included in net investment income. Mortgage and policy loans are carried primarily at the aggregate unpaid balance.
Gains or losses on securities are determined on the specific identification basis. When a decline in the value of a specific investment is considered to be other-than-temporary at the balance sheet date, a provision for impairment is charged to earnings (included in realized gains (losses) on securities) and the cost basis of that investment is reduced. If management can assert that it does not intend to sell an impaired fixed maturity security and it is not more likely than not that it will have to sell the security before recovery of its amortized cost basis, then the other-than-temporary impairment is separated into two components: (i) the amount related to credit losses (recorded in earnings) and (ii) the amount related to all other factors (recorded in other
Deferred Policy Acquisition Costs (“DPAC”) Policy acquisition costs (principally commissions, premium taxes and certain underwriting and policy issuance costs) directly related to the successful acquisition or renewal of an insurance contract are
deferred. DPAC also includes capitalized costs associated with sales inducements offered to fixed annuity policyholders such as enhanced interest rates and premium and persistency bonuses.
In February 2015, the FASB issued ASU 2015-02, which amends certain consolidation accounting guidance, including the VIE guidance that applies to collateralized financing entities such as CLOs. The new guidance, which AFG intends to adopt effective January 1, 2016, will affect how fee arrangements with CLO asset managers impact the determination of the primary beneficiary of these entities. Due to the significance of AFG’s investments in the CLOs that it manages, management does not expect the new guidance to impact the consolidation of its currently outstanding CLOs. The new guidance also impacts the consolidation analysis that applies to limited partnerships and similar entities. Management does not expect this guidance to impact the accounting for AFG’s existing investments in those entities.
Effective January 1, 2015, AFG adopted (on a modified retrospective basis) ASU 2014-13, which addresses the diversity in practice regarding the accounting for assets and liabilities of a consolidated collateralized financing entity (such as a CLO) when an election has been made to account for that entity’s assets and liabilities at fair value. The fair values of a CLO’s assets may differ from the separately measured fair values of its liabilities even though the CLO liabilities only have recourse to the CLO assets. Under the new guidance, 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 a separately measured fair value. CLO earnings attributable to AFG’s shareholders continue to be measured by the change in the fair value of AFG’s investments in the CLOs and management fees earned.
At December 31, 2015, assets and liabilities of managed investment entities included $100 million in assets and $80 million in liabilities of a temporary warehousing entity that was established in connection with the formation of a new CLO that is expected to close in the second quarter of 2016. Upon closing, all warehoused assets are expected to be transferred to the new CLO and the liabilities will be repaid.
AFG’s variable annuity contracts contain a guaranteed minimum death benefit (“GMDB”) to be paid if the policyholder dies before the annuity payout period commences. In periods of declining equity markets, the GMDB may exceed the value of the policyholder’s account. A GMDB liability is established for future excess death benefits using assumptions together with a range of reasonably possible scenarios for investment fund performance that are consistent with DPAC capitalization and amortization assumptions.
Noncontrolling Interests For balance sheet purposes, noncontrolling interests represents the interests of shareholders other than AFG in consolidated entities. In the Statement of Earnings, net earnings and losses attributable to noncontrolling interests represents such shareholders’ interest in the earnings and losses of those entities.
Earnings Per Share Although basic earnings per share only considers shares of common stock outstanding during the period, the calculation of diluted earnings per share includes the following adjustments to weighted average common shares related to stock-based compensation plans: 2015 - 1.8 million, 2014 - 2.0 million and 2013 - 1.9 million.
Statement of Cash Flows For cash flow purposes, “investing activities” are defined as making and collecting loans and acquiring and disposing of debt or equity instruments and property and equipment. “Financing activities” include obtaining resources from owners and providing them with a return on their investments, borrowing money and repaying amounts borrowed. Annuity receipts, surrenders, benefits and withdrawals are also reflected as financing activities. All other activities are considered “operating.” Short-term investments having original maturities of three months or less when purchased are considered to be cash equivalents for purposes of the financial statements.
Acquisition of Summit Holding Southeast, Inc. In April 2014, AFG acquired Summit Holding Southeast, Inc. and its related companies (“Summit”), from Liberty Mutual Insurance for $259 million using cash on hand at the parent company. Immediately following the acquisition, AFG made a capital contribution of $140 million, bringing its total capital investment in the Summit business to $399 million. Summit is based in Lakeland, Florida and is a leading provider of specialty workers’ compensation solutions in the southeastern United States. Summit continues to operate under the Summit brand as a member of AFG’s Great American Insurance Group. Summit is included in the Specialty casualty sub-segment and generated $529 million in net earned premiums in 2015 and $410 million in net earned premiums during the nine months subsequent to AFG’s acquisition in 2014.
Acquisition of Renewal Rights In March 2014, AFG completed a renewal rights agreement with Selective Insurance Company of America to acquire Selective’s pooled public entity book of business for $8 million. At the acquisition date, this book of business had approximately $38 million in in-force gross written premiums. The acquired business generated $34 million of gross written premiums and $16 million of net written premiums in 2015.
Sale of Long-term Care Business On December 24, 2015, AFG completed the sale of substantially all of its run-off long-term care insurance business (which was included in the run-off long-term care and life segment) to HC2 Holdings, Inc. (“HC2”) for an initial payment of $7 million in cash and HC2 securities with a fair value of $11 million (subject to post-closing adjustments). 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. The net sale proceeds include the fair value of the warrants to purchase two million shares of HC2 stock that AFG received in exchange for this agreement. The legal entities involved in the transaction, United Teacher Associates Insurance Company (“UTA”) and Continental General Insurance Company (“CGIC”), contain substantially all of AFG’s long-term care insurance reserves (96% as measured by net statutory reserves as of November 30, 2015), as well as smaller blocks of annuity and life insurance business. Following the sale of these subsidiaries, AFG has only a small block of long-term care insurance (1,700 policies) with approximately $34 million of reserves. AFG had ceased new sales of long-term care insurance in January 2010, but continued to service and accept renewal premiums on its outstanding policies, which are guaranteed renewable.
Based on the status of ongoing negotiations at the end of the first quarter, management determined that the potential sale of the run-off long-term care business met the GAAP “held for sale” criteria as of March 31, 2015. Accordingly, AFG recorded a $162 million pretax loss ($105 million loss after tax) in the first quarter of 2015 to establish a liability equal to the excess of the net carrying value of the assets and liabilities to be disposed over the estimated net sale proceeds. At the closing date, the loss was adjusted to $166 million based on the actual proceeds received and the final carrying value of the net assets disposed. On the sale date, the carrying value of the assets and liabilities disposed represented approximately 4% of both AFG’s assets and liabilities and are detailed in the table below.
Under accounting guidance effective on January 1, 2015, only disposals of components of an entity that represent a strategic shift and that have a major effect on a reporting entity’s operations and financial results are reported as discontinued operations. Due to the run-off nature of the business and the immaterial expected impact on AFG’s results of operations, the sale of AFG’s long-term care insurance business has not been reported as a discontinued operation.
Sales of property and casualty insurance outside of the United States represented 4% of AFG’s revenues in 2015 and 5% of AFG’s revenues in 2014 and 2013.
The following tables (in millions) show AFG’s assets, revenues and earnings before income taxes by segment and sub-segment.
Approximately 4% of the total assets carried at fair value on December 31, 2015, were Level 3 assets. Approximately 76% ($1.24 billion) of the Level 3 assets were priced using non-binding broker quotes, for which there is a lack of transparency as to the inputs used to determine fair value. Details as to the quantitative inputs are neither provided by the brokers nor otherwise reasonably obtainable by AFG. Since internally developed Level 3 asset fair values represent less than 10% of AFG’s shareholders’ equity, any justifiable changes in unobservable inputs used to determine internally developed fair values would not have a material impact on AFG’s financial position.
Total realized/unrealized gains (losses) included in net income includes gains of $50 million related to liabilities outstanding as of December 31, 2014. See Note H - “Managed Investment Entities.”
Excludes $200 million and $203 million of life contingent annuities in the payout phase at December 31, 2015 and 2014, respectively.
The following tables show gross unrealized losses (dollars in millions) on fixed maturities and equity securities by investment category and length of time that individual securities have been in a continuous unrealized loss position at December 31, 2015 and 2014.
At December 31, 2015, the gross unrealized losses on fixed maturities of $374 million relate to approximately 1,285 securities. Investment grade securities (as determined by nationally recognized rating agencies) represented approximately 77% of the gross unrealized loss and 91% of the fair value.
At December 31, 2015, the gross unrealized losses on preferred stocks of $6 million relate to 19 securities. All of the preferred stocks that have been in an unrealized loss position for 12 months or more (3 securities) have investment grade ratings.
There were no investments in individual issuers that exceeded 10% of Shareholders’ Equity at December 31, 2015 or 2014.
Net Unrealized Gain on Marketable Securities In addition to adjusting equity securities and fixed maturity securities classified as “available for sale” to fair value, GAAP requires that deferred policy acquisition costs and certain other balance sheet amounts related to annuity, long-term care and life businesses be adjusted to the extent that unrealized gains and losses from securities would result in adjustments to those balances had the unrealized gains or losses actually been realized. The following table shows (in millions) the components of the net unrealized gain on securities that is included in AOCI in AFG’s Balance Sheet.
(*) Unrealized gains on fixed maturity investments supporting AFG’s annuity benefits accumulated.
Prior to 2014, equity in the earnings of partnerships was not material and was included in realized gains (losses) on securities.
Gross realized gains and losses (excluding impairment write-downs and mark-to-market of derivatives) on available for sale fixed maturity and equity security investment transactions included in the Statement of Cash Flows consisted of the following (in millions):
The change in fair value of the embedded derivative includes losses related to unlocking of actuarial assumptions of $28 million in 2015 compared to gains related to unlocking of actuarial assumptions of $58 million in 2014 and $2 million in 2013.
Derivatives Designated and Qualifying as Cash Flow Hedges In the second quarter of 2015, AFG entered into two interest rate swaps (a five-year, $195 million notional amount swap and a fifteen-year, $132 million notional amount swap) under which AFG receives fixed-rate interest payments in exchange for variable interest payments based on three-month LIBOR. In the third quarter of 2014, AFG entered into a five-year $431 million notional amount interest rate swap under which AFG receives fixed-rate interest payments in exchange for variable interest payments based on one-month LIBOR. The purpose of each of these swaps is to effectively convert a portion of AFG’s floating rate fixed maturity securities to fixed rates by offsetting the variability in cash flows attributable to changes in LIBOR.
The notional amounts amortize down over each swap’s respective life in anticipation of an expected decline in AFG’s portfolio of fixed maturity securities with floating interest rates based on LIBOR ($614 million and $401 million total notional amounts at December 31, 2015 and December 31, 2014, respectively). The fair value of the effective portion of the interest rate swaps in an asset position and included in other assets was $2 million at December 31, 2015 and less than $1 million at December 31, 2014. The fair value of the effective portion of interest rate swaps in a liability position and included in other liabilities was less than $1 million at December 31, 2015 and zero at December 31, 2014. The net unrealized gain or loss on cash flow hedges is included in AOCI, net of DPAC and tax. During 2015 and 2014, $6 million and $2 million was reclassified from AOCI to net investment income. There was no ineffectiveness recorded in Net Earnings during these periods.
AFG is the investment manager and its subsidiaries have investments ranging from 15.0% to 100% of the most subordinate debt tranche of thirteen collateralized loan obligation entities or “CLOs,” which are considered variable interest entities. AFG’s subsidiaries also own portions of the senior debt tranches of certain of these CLOs. Upon formation between 2004 and 2015, these entities issued securities in various senior and subordinate classes and invested the proceeds primarily in secured bank loans, which serve as collateral for the debt securities issued by each particular CLO. None of the collateral was purchased from AFG. AFG’s investments in the subordinate debt tranches of these entities receive residual income from the CLOs only after the CLOs pay expenses (including management fees to AFG), and interest on and returns of capital to senior levels of debt securities. There are no contractual requirements for AFG to provide additional funding for these entities. AFG has not provided and does not intend to provide any financial support to these entities.
AFG’s maximum exposure to economic loss on its CLOs is limited to its investment in the CLOs, which had an aggregate fair value of $266 million (including $115 million invested in the most subordinate tranches) at December 31, 2015, and $289 million at December 31, 2014.
In 2015, AFG formed two new CLOs, which issued an aggregate of $869 million face amount of liabilities (including $81 million face amount purchased by subsidiaries of AFG). During 2015, AFG subsidiaries received $77 million in sale and redemption proceeds from its CLO investments. In 2014, AFG formed two new CLOs, which issued an aggregate of $917 million face amount of liabilities (including $94 million face amount purchased by subsidiaries of AFG). During 2014, AFG subsidiaries also purchased $13 million face amount of senior debt tranches of existing CLOs for $13 million and received $81 million in redemption proceeds from its CLO investments. In 2013, AFG formed two new CLOs, which issued an aggregate of $829 million face amount of liabilities (including $85 million face amount purchased by subsidiaries of AFG). During 2013, AFG subsidiaries also purchased $94 million face amount of senior debt tranches of existing CLOs for $89 million and received $142 million in redemption proceeds from its CLO investments. In 2014 and 2013, four and two AFG CLOs were substantially liquidated as permitted by the CLO indentures, respectively.
The revenues and expenses of the CLOs are separately identified in AFG’s Statement of Earnings, after the elimination of management fees and earnings attributable to shareholders of AFG as measured by the change in the fair value of AFG’s investments in the CLOs. See Note A - “Accounting Policies - Managed Investment Entities,” for a discussion of accounting guidance adopted on January 1, 2015 that impacts the measurement of the fair value of CLO liabilities. Selected financial information related to the CLOs is shown below (in millions):
The aggregate unpaid principal balance of the CLOs’ fixed maturity investments exceeded the fair value of the investments by $214 million and $83 million at December 31, 2015 and 2014. The aggregate unpaid principal balance of the CLOs’ debt exceeded its carrying value by $205 million and $131 million at those dates. The CLO assets include $1 million at December 31, 2015 and $2 million at December 31, 2014 in loans, for which the CLOs are not accruing interest because the loans are in default (aggregate unpaid principal balance of $10 million and $6 million at both of those dates, respectively).
To achieve a desired balance between fixed and variable rate debt, AFG entered into an interest rate swap in June 2015, which effectively converts its 9-7/8% Senior Notes to a floating rate of three-month LIBOR plus 8.099% (8.6110% at December 31, 2015). 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 notes are both included in the carrying value of the 9-7/8% Senior Notes in the table above.
At December 31, 2015, scheduled principal payments on debt for the subsequent five years and thereafter were as follows: 2016 - none; 2017 - $12 million; 2018 - none; 2019 - $350 million; 2020 - none and thereafter - $658 million.
AFG can borrow up to $500 million under its revolving credit facility which expires in December 2016. Amounts borrowed under this agreement bear interest at rates ranging from 1.00% to 1.875% (currently 1.375%) over LIBOR based on AFG’s credit rating. No amounts were borrowed under this facility at December 31, 2015 or December 31, 2014.
National Interstate can borrow up to $100 million under its unsecured credit agreement, which expires in November 2017. At December 31, 2015, there was $12 million outstanding under this agreement, bearing interest at 1.399% (six-month LIBOR plus 0.875%).
Stock Incentive Plans Under AFG’s stock incentive plans, employees of AFG and its subsidiaries are eligible to receive equity awards in the form of stock options, stock appreciation rights, restricted stock awards, restricted stock units and stock awards.
Includes net unrealized gains of $51 million at December 31, 2015 compared to net unrealized gains of $58 million and $54 million at December 31, 2014 and 2013, related to securities for which only the credit portion of an other-than-temporary impairment has been recorded in earnings.
AFG’s 2012 - 2015 tax years remain subject to examination by the IRS.
For income tax purposes, AFG and its subsidiaries had the following carryforwards available at December 31, 2015 (in millions):
Deferred income tax assets and liabilities reflect temporary differences between the carrying amounts of assets and liabilities recognized for financial reporting purposes and the amounts recognized for tax purposes. The significant components of deferred tax assets and liabilities included in AFG’s Balance Sheet at December 31 were as follows (in millions):
AFG increased its liability for uncertain tax positions by $1 million in 2013, exclusive of interest, for the uncertainty as to the timing of tax return inclusion of income related to certain securities.
AFG completed a comprehensive external study of its asbestos and environmental (“A&E”) exposures in the third quarter of 2015 with the aid of specialty actuarial, engineering and consulting firms and outside counsel. The study resulted in A&E charges of $67 million for the property and casualty group and $12 million for the former railroad and manufacturing operations. AFG completed an in-depth internal review of its A&E exposures in the third quarter of 2014, which resulted in A&E charges of $24 million for the property and casualty group and $6 million for the former railroad and manufacturing operations. In the third quarter of 2013, AFG completed a comprehensive external study of its A&E exposures with the aid of specialty actuarial, engineering and consulting firms and outside counsel, which resulted in A&E charges of $54 million for the property and casualty group and $22 million for the former railroad and manufacturing operations.
The property and casualty group’s liability for asbestos and environmental reserves was $426 million at December 31, 2015; related recoverables from reinsurers (net of allowances for doubtful accounts) at that date were $99 million.
At December 31, 2015, American Premier and its subsidiaries had liabilities for environmental and personal injury claims and other contingencies aggregating $77 million. The environmental claims consist of a number of proceedings and claims seeking to impose responsibility for hazardous waste remediation costs related to certain sites formerly owned or operated by the railroad and manufacturing operations. Remediation costs are difficult to estimate for a number of reasons, including the number and financial resources of other potentially responsible parties, the range of costs for remediation alternatives, changing technology and the time period over which these matters develop. The personal injury claims and other contingencies include pending and expected claims, primarily by former employees of PCTC, for injury or disease allegedly caused by exposure to excessive noise, asbestos or other substances in the workplace and other labor disputes.
Adverse prior year development for the third quarter of 2015 includes pretax special charges of $67 million to strengthen property and casualty insurance A&E reserves. Adverse prior year development for the second quarter of 2014 includes $22 million of adverse reserve development in the property and transportation sub-segment, which resulted from an increase in claim severity in the commercial auto liability business, partially offset by lower than expected claim severity in the agricultural and property and inland marine businesses. Adverse prior year development for the third quarter of 2014 includes pretax special charges of $24 million to strengthen property and casualty insurance A&E reserves. Adverse prior year development in the fourth quarter of 2014 was due primarily to adverse reserve development at Marketform and higher than expected claim severity in contractor claims and in a run-off book of casualty business.
In addition to realized gains (losses) on securities and subsidiaries, results for 2015 include pretax gains (included in other income) of $51 million from the sale of Le Pavillon Hotel in the second quarter and $15 million from the sale of an apartment property in the fourth quarter.
Cash and securities owned by U.S.-based insurance subsidiaries having a carrying value of approximately $1.00 billion at December 31, 2015, were on deposit as required by regulatory authorities. In addition, $203 million was on deposit in support of AFG’s underwriting activities at Lloyd’s. At December 31, 2015, AFG and its subsidiaries had $307 million in undrawn letters of credit (none of which was collateralized) supporting the underwriting capacity of its U.K.-based Lloyd’s insurer.
The net increase in the provision for claims of prior years in 2015 reflects (i) higher than expected claim severity at National Interstate and higher than anticipated claim frequency in the ocean marine business (all within the Property and transportation sub-segment), (ii) adverse reserve development at Marketform (within the Specialty casualty sub-segment), and (iii) the $67 million special charge to increase asbestos and environmental reserves. This adverse development was partially offset by (i) lower than expected claim severity in the property and inland marine business, agricultural operations and a run-off book of homebuilders business (all within the Property and transportation sub-segment), (ii) 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 (all within the Specialty casualty sub-segment), and (iii) lower than anticipated claim frequency and severity in the surety business and products for financial institutions and lower than expected claim severity in the fidelity business and run-off collateral value insurance (all within the Specialty financial sub-segment).
Net adverse reserve development in 2014 reflects higher than expected severity in commercial auto liability losses written in the transportation businesses (within the Property and transportation sub-segment), higher than expected claims severity in contractor claims and in a run-off book of casualty business and adverse reserve development at Marketform (all within the Specialty casualty sub-segment), and the $24 million special charge to increase asbestos and environmental reserves. This adverse reserve development was offset by (i) lower than expected claim severity in directors and officers liability insurance, lower than expected claim severity and frequency in excess liability insurance and lower than anticipated claim severity in specialty workers’ compensation business (all within the Specialty casualty sub-segment), and (ii) lower than expected claim severity in the surety and fidelity businesses and lower than expected claim frequency and severity in the foreign credit business and products for financial institutions (all within the Specialty financial sub-segment).
The National Association of Insurance Commissioners’ (“NAIC”) model law for risk based capital (“RBC”) applies to both life and property and casualty insurance 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. Companies below specific trigger points or ratios are subject to regulatory action. At December 31, 2015 and 2014, the capital ratios of all AFG insurance companies substantially exceeded the RBC requirements. AFG’s insurance companies did not use any prescribed or permitted statutory accounting practices that differed from the NAIC statutory accounting practices at December 31, 2015 or 2014.
Variable Annuities At December 31, 2015, the aggregate guaranteed minimum death benefit value (assuming every variable annuity policyholder died on that date) on AFG’s variable annuity policies exceeded the fair value of the underlying variable annuities by $27 million, compared to $23 million at December 31, 2014. Death benefits paid in excess of the variable annuity account balances were less than $1 million in each of the last three years.
AFG’s aggregate allowance for uncollectible reinsurance recoverables was $22 million and $25 million at December 31, 2015 and 2014, respectively. AFG reviews the allowance quarterly and adjusts it as necessary to reflect changes in estimates of uncollectible balances. In 2015, AFG recorded a net expense reduction of $3 million against the allowance. In 2014 and 2013, AFG recorded charges of $4 million and $1 million against the allowance, respectively (included in losses and loss adjustment expenses). In 2014, the allowance was reduced by reinsurance recoverable write-offs of $6 million.
Operating Leases Total rental expense for various leases of office space and equipment was $70 million in 2015, $65 million in 2014 and $57 million in 2013. Future minimum rentals, related principally to office space, required under operating leases having initial or remaining noncancelable lease terms in excess of one year at December 31, 2015, were as follows: 2016 - $64 million; 2017 - $60 million; 2018 - $51 million; 2019 - $43 million; 2020 - $36 million; and $148 million thereafter.
Financial Instruments - Unfunded Commitments On occasion, AFG and its subsidiaries have entered into financial instrument transactions that may present off-balance-sheet risks of both a credit and market risk nature. These transactions include commitments to fund loans, loan guarantees and commitments to purchase and sell securities or loans. At December 31, 2015, AFG and its subsidiaries had commitments to fund credit facilities and contribute capital to limited partnerships and limited liability corporations of approximately $410 million.
Amended and Restated Code of Regulations, filed as Exhibit 3 to AFG’s Form 8-K filed on August 16, 2012.