AFG subsidiaries own transferable rights to develop approximately 1.4 million square foot of floor space in the Grand Central Terminal area in New York City. The development rights were derived from ownership of the land upon which the terminal is constructed.
IT INITIATIVE In 1999, AFG initiated an enterprise-wide study of its information technology ("IT") resources, needs and opportunities. The initiative entails extensive effort and costs and has led to substantial changes in the area, which should result in significant cost savings, efficiencies and effectiveness in the future. While the costs (most of which are being expensed) precede the expected savings, management expects benefits to greatly exceed the costs incurred, all of which have been and will be funded through available working capital.
AFG's ratio of earnings to fixed charges on a total enterprise basis was 1.63 for the year ended December 31, 2000 compared to 3.36 in 1999 and 3.22 in 1998.
SOURCES OF FUNDS AFG, AFC Holding, AFC and American Premier, are organized as holding companies with almost all of their operations being conducted by subsidiaries. These parent corporations, however, have continuing cash needs for administrative expenses, the payment of principal and interest on borrowings, shareholder dividends, and taxes. Funds to meet these obligations come primarily from dividend and tax payments from their subsidiaries.
The parent holding companies have a reciprocal Master Credit Agreement under which these companies make funds available to each other for general corporate purposes.
In December 2000, AFG issued 8.3 million shares of Common Stock, using the $155 million in net cash proceeds to make capital contributions to its property and casualty operations. In April 1999, AFG issued $350 million principal amount of 7-1/8% senior debentures due 2009, using the proceeds to retire outstanding holding company public debt and borrowings under AFC's credit line. All debentures issued by the parent holding companies and GAFRI are rated investment grade by three nationally recognized rating agencies. Under a currently effective shelf registration statement, AFG can issue up to an aggregate of approximately $340 million in additional common stock, debt or trust securities. The shelf registration provides AFG with greater flexibility to access the capital markets from time to time as market and other conditions permit.
Dividend payments from subsidiaries have been very important to the liquidity and cash flow of the individual holding companies during certain periods in the past. However, the reliance on such dividend payments has been lessened in recent years by the combination of (i) reductions in the amounts and cost of debt at the holding companies subsequent to the Mergers (and the related decrease in ongoing cash needs for interest and principal payments), (ii) AFG's ability to obtain financing in capital markets, as well as (iii) the sales of certain noncore investments.
EXPOSURE TO MARKET RISK Market risk represents the potential economic loss arising from adverse changes in the fair value of financial instruments. AFG's exposures to market risk relate primarily to its investment portfolio and annuity contracts which are exposed to interest rate risk and, to a lesser extent, equity price risk. AFG's long-term debt is also exposed to interest rate risk.
FIXED MATURITY PORTFOLIO The fair value of AFG's fixed maturity portfolio is directly impacted by changes in market interest rates. For example, as a result of increased market rates, AFG's fixed maturity portfolio declined in value by more than six percent in 1999. AFG's fixed maturity portfolio is comprised of substantially all fixed rate investments with primarily short-term and intermediate-term maturities. This practice allows flexibility in reacting to fluctuations of interest rates. The portfolios of AFG's property and casualty insurance and life and annuity operations are managed with an attempt to achieve an adequate risk-adjusted return while maintaining sufficient liquidity to meet policyholder obligations. AFG's life and annuity operations use various actuarial models in an attempt to align the duration of their invested assets to the projected cash flows of policyholder liabilities.
The following table provides information about AFG's fixed maturity investments at December 31, 2000 and 1999, that are sensitive to interest rate risk. The table shows principal cash flows (in millions) and related weighted average interest rates by expected maturity date for each of the five subsequent years and for all years thereafter. Callable bonds and notes are included based on call date or maturity date depending upon which date produces the most conservative yield. Mortgage-backed securities ("MBSs") and sinking fund issues are included based on maturity year adjusted for expected payment patterns. Actual cash flows may differ from those expected.
December 31, 2000 December 31, 1999 ----------------- -------------------- Principal Principal Cash Flows Rate Cash Flows Rate ---------- ---- ---------- ---- 2001 $ 494.2 8.46% 2000 $ 618.2 7.83% 2002 673.4 7.60 2001 622.6 8.69 2003 1,406.6 7.74 2002 848.4 8.14 2004 835.6 8.01 2003 1,267.6 7.65 2005 1,142.1 7.46 2004 999.2 7.73 Thereafter 5,737.0 7.41 Thereafter 5,871.0 7.50 --------- ---------
DEBT AND PREFERRED SECURITIES The following table shows scheduled principal payments (in millions) on fixed-rate long-term debt of AFG and its subsidiaries and related weighted average interest rates for each of the subsequent five years and for all years thereafter.
INVESTMENTS Approximately two-thirds of AFG's consolidated assets are invested in marketable securities. A diverse portfolio of primarily publicly traded bonds and notes accounts for over 95% of these securities. AFG attempts to optimize investment income while building the value of its portfolio, placing emphasis upon long-term performance. AFG's goal is to maximize return on an ongoing basis rather than focusing on short-term performance.
Fixed income investment funds are generally invested in securities with short-term and intermediate-term maturities with an objective of optimizing total return while allowing flexibility to react to changes in market conditions. At December 31, 2000, the average life of AFG's fixed maturities was about 6 years.
Individual portfolio securities are sold creating gains or losses as market opportunities exist. Pretax capital gains (losses) recognized upon disposition of securities, including investees, during the past five years have been: 2000 - ($27 million); 1999 - $20 million; 1998 - $16 million; 1997 - $57 million and 1996 - $166 million. At December 31, 2000, AFG had a net unrealized gain on fixed maturities of $16.3 million (before income taxes). The net unrealized gain on equity securities was $210.4 million (before income taxes) at that same date.
GENERAL Operating earnings before income taxes were $110 million in 2000, $302 million in 1999 and $274 million in 1998. Results for 1998 include a pretax charge of $214 million for reserve strengthening relating to asbestos and other environmental matters ("A&E") and $159 million of pretax gains on sales of subsidiaries.
Pretax operating earnings for 2000 were 64% lower than those of 1999 due primarily to a decline in property and casualty underwriting results (including a $35 million charge for reserve strengthening in the California workers' compensation business), special litigation charges and lower realized gains, partially offset by $23 million in income from the sale of certain lease rights.
Many investors and analysts focus on "core earnings" of companies, setting aside certain items included in net earnings. Such "core earnings" for AFG, consisting of net earnings (loss) adjusted to exclude: (i) realized gains (losses), (ii) equity in investee losses, (iii) extraordinary items, and (iv) accounting changes, were $42.3 million ($.71 per share, diluted) in 2000 compared to $150.4 million ($2.50 per share) in 1999 and $162 million ($2.60 per share) in 1998.
PROPERTY AND CASUALTY INSURANCE - UNDERWRITING AFG's property and casualty operations consist of two major business groups: Personal and Specialty.
Underwriting results of AFG's insurance operations outperformed the industry average for the fifteenth consecutive year (excluding the special $214 million A&E charge in 1998). AFG's insurance operations have been able to exceed the industry's results by focusing on growth opportunities in the more profitable areas of the specialty and nonstandard auto businesses.
SPECIAL 1998 A&E CHARGE Under the agreement covering the sale of its Commercial lines division in 1998, AFG retained liabilities for certain A&E exposures. Prompted by this retention and as part of the continuing process of monitoring reserves, AFG began a thorough study of its A&E exposures. AFG's study was reviewed by independent actuaries who used state of the art actuarial techniques that have wide acceptance in the industry. The methods used involved sampling and statistical modeling incorporating external databases that supplement the internal information. AFG recorded a fourth quarter charge of $214 million increasing A&E reserves at December 31, 1998, to approximately $866 million (before deducting reinsurance recoverables of $241 million).
In response to continuing losses in the California workers' compensation business, rate increases implemented for this business averaged 25% in 2000 and will likely be in excess of 40% on renewals in the first quarter of 2001. Rate increases implemented in the other specialty operations averaged 12% in 2000 and are expected to be around 15% in the first quarter of 2001.
Due primarily to adverse development in prior year losses, AFG recorded a $35 million pretax charge in the third quarter of 2000 to strengthen loss reserves in its California workers' compensation business. The combined ratio for 2000 reflects this reserve strengthening (a combined ratio effect of 2.9 points) and the effect of a highly competitive pricing environment on policies written during 1999.
START-UP MANUFACTURING BUSINESSES AFG's pretax operating earnings for 2000 include losses of $6.7 million from two start-up manufacturing businesses acquired in 2000 from their former owners. AFG sold the equity interests in these businesses in the fourth quarter of 2000 for a nominal cash consideration plus warrants to repurchase a significant ownership interest. Beginning in the fourth quarter of 2000, AFG's equity in the results of operations of these businesses is included in investee earnings. Loans outstanding to these businesses totaled $61.5 million at December 31, 2000. Because AFG retains the financial risk in these businesses, it will continue accounting for their operations on the equity method. The businesses are expected to reach "break-even" by the latter part of 2001.
INVESTMENT INCOME Changes in investment income reflect fluctuations in market rates and changes in average invested assets. Investment income decreased 4% in 1999 compared to 1998 due primarily to the transfer of investment assets in connection with the sales of the Commercial lines division and Funeral Services division in 1998, partially offset by the effect of the purchases of Worldwide and United Teacher Associates in 1999.
GAINS ON SALES OF SUBSIDIARIES In 2000, AFG recognized (i) a $25 million pretax gain representing an earn-out related to the 1998 sale of its Commercial lines division, (ii) a $10.3 million pretax loss (including post closing adjustments) on the sale of Stonewall Insurance Company and (iii) a $10.7 million pretax loss related to the pending sale of its Japanese division. In connection with the sale of the Japanese division, a gain of approximately $21 million on ceded insurance will be deferred and subsequently recognized over the estimated settlement period (weighted average of 4 years) of the claims ceded.
The gains on sales of subsidiaries in 1998 include (i) a pretax gain of $152.6 million on the sale of the Commercial lines division, (ii) a pretax gain of $21.6 million on GAFRI's sale of its Funeral Services division and (iii) a charge of $15.5 million relating to the disposal of other operations.
CUMULATIVE EFFECT OF ACCOUNTING CHANGE In October 2000, AFG implemented Statement of Financial Accounting Standards No. 133, "Accounting for Derivative Instruments and Hedging Activities", which requires all derivatives to be recognized in the balance sheet at fair value and that the initial effect of recognizing derivatives at fair value be reported as a cumulative effect of a change in accounting principle. Accordingly, AFG recorded a charge of $9.1 million (net of minority interest and taxes) to record its derivatives at fair value at the beginning of the fourth quarter of 2000.
In the first quarter of 1999, GAFRI implemented Statement of Position 98-5, "Reporting on the Costs of Start-Up Activities". The SOP requires that costs of start-up activities be expensed as incurred and that unamortized balances of previously deferred costs be expensed and reported as the cumulative effect of a change in accounting principle. Accordingly, AFG expensed previously capitalized start-up costs of $3.8 million (net of minority interest and taxes) in the first quarter of 1999.
Other standards issued in recent years did not apply to AFG or had only negligible effects on AFG.
Consolidated Statement of Changes in Shareholders' Equity Years ended December 31, 2000, 1999 and 1998
Consolidated Statement of Cash Flows: Years ended December 31, 2000, 1999 and 1998
The information required by the following Items will be included in AFG's definitive Proxy Statement for the 2001 Annual Meeting of Shareholders which will be filed with the Securities and Exchange Commission within 120 days after the end of Registrant's fiscal year and is incorporated herein by reference.
Due to Chiquita's announced intention to pursue a plan to restructure its public debt, AFG wrote down its investment in Chiquita common stock to market value at December 31, 2000, and may suspend accounting for Chiquita under the equity method pending resolution of the current uncertainty.
COST IN EXCESS OF NET ASSETS ACQUIRED The excess of cost of subsidiaries and investees over AFG's equity in the underlying net assets ("goodwill") is being amortized over periods of 20 to 40 years. In February 2001, the Financial Accounting Standards Board issued a proposal to eliminate the amortization of goodwill and require that goodwill be tested for impairment.
INSURANCE As discussed under "Reinsurance" below, unpaid losses and loss adjustment expenses and unearned premiums have not been reduced for reinsurance recoverable. To the extent that unrealized gains (losses) from securities classified as "available for sale" would result in adjustments to deferred acquisition costs and policyholder liabilities had those gains (losses) actually been realized, such balance sheet amounts are adjusted, net of deferred taxes.
VARIABLE ANNUITY ASSETS AND LIABILITIES Separate accounts related to variable annuities represent deposits invested in underlying investment funds on which Great American Financial Resources, Inc. ("GAFRI", formerly American Annuity Group, Inc.), an 83%-owned subsidiary, earns a fee. The investment funds are selected and may be changed only by the policyholder.
ISSUANCES OF STOCK BY SUBSIDIARIES AND INVESTEES Changes in AFG's equity in a subsidiary or an investee caused by issuances of the subsidiary's or investee's stock are accounted for as gains or losses where such issuance is not a part of a broader reorganization.
INCOME TAXES AFC files consolidated federal income tax returns which include all 80%-owned U.S. subsidiaries, except for certain life insurance subsidiaries and their subsidiaries. Because holders of AFC Preferred Stock hold in excess of 20% of AFC's voting rights, AFG (parent) and its direct subsidiary, AFC Holding Company ("AFC Holding" or "AFCH") own less than 80% of AFC, and therefore, file separate returns.
STOCK-BASED COMPENSATION As permitted under Statement of Financial Accounting Standards ("SFAS") No. 123, "Accounting for Stock-Based Compensation," AFG accounts for stock options and other stock-based compensation plans using the intrinsic value based method prescribed by Accounting Principles Board Opinion No. 25, "Accounting for Stock Issued to Employees."
BENEFIT PLANS AFG provides retirement benefits to qualified employees of participating companies through contributory and noncontributory defined contribution plans contained in AFG's Retirement and Savings Plan. Under the retirement portion of the plan, company contributions are invested primarily in securities of AFG and affiliates. Under the savings portion of the plan, AFG matches a specific portion of employee contributions. Contributions to benefit plans are charged against earnings in the year for which they are declared.
START-UP COSTS Prior to 1999, GAFRI deferred certain costs associated with introducing new products and distribution channels and amortized them on a straight-line basis over 5 years. In 1999, GAFRI implemented Statement of Position ("SOP") 98-5, "Reporting on the Costs of Start-Up Activities." The SOP requires that (i) costs of start-up activities be expensed as incurred and (ii) unamortized balances of previously deferred costs be expensed and reported as the cumulative effect of a change in accounting principle. Accordingly, AFG expensed previously capitalized start-up costs of $3.8 million (net of minority interest and taxes) or $.06 per diluted share, effective January 1, 1999.
JAPANESE DIVISION In December 2000, AFG agreed to sell its Japanese property and casualty division to Mitsui Marine & Fire Insurance Company of America for approximately $22 million in cash and recorded a $10.7 million pretax loss on the sale. Upon completion of the sale, a gain of approximately $21 million on ceded insurance will be deferred and subsequently recognized over the estimated settlement period (weighted average of 4 years) of the ceded claims. The sale is expected to be completed at the end of March 2001. At the same time, a reinsurance agreement under which Great American Insurance ceded a portion of its pool of insurance to Mitsui will terminate. The Japanese division generated net written premiums of approximately $60 million per year to Great American while Great American ceded approximately $45 million per year to Mitsui.
During the fourth quarter of 2000, AFG sold the equity interests to a group of employees for nominal cash consideration plus warrants to repurchase a significant ownership interest. Due to the absence of significant financial investment by the buyers relative to the amount of debt ($61.5 million at December 31, 2000) owed to AFG subsidiaries, the sale was not recognized as a divestiture for accounting purposes. Assets of the businesses transferred ($55.3 million at December 31, 2000) are included in other assets; liabilities of the businesses transferred ($7.5 million at December 31, 2000, after elimination of loans from AFG subsidiaries) are included in other liabilities. AFG's equity in the losses of these two companies during the fourth quarter of 2000 of $4.1 million is included in investee losses in the statement of operations.
FUNERAL SERVICES DIVISION In September 1998, GAFRI sold its Funeral Services division for approximately $165 million in cash. The division held assets of approximately $1 billion at the sale date. AFG realized a pretax gain of $21.6 million, before $2.7 million of minority interest, on this sale.
CHIQUITA During 1998, Chiquita issued shares of its common stock in acquisitions of operating businesses. AFG recorded pretax gains of $9.4 million in 1998 representing the excess of AFG's equity in Chiquita following the issuances of its common stock over AFG's previously recorded carrying value.
C. SEGMENTS OF OPERATIONS AFG's property and casualty group is engaged primarily in private passenger automobile and specialty insurance businesses. The Personal group writes nonstandard and preferred/standard private passenger auto and other personal insurance coverage. The Specialty group includes a highly diversified group of specialty business units. Some of the more significant areas are inland and ocean marine, California workers' compensation, agricultural-related coverages, executive and professional liability, fidelity and surety bonds, collateral protection, and umbrella and excess coverages. AFG's annuity and life business markets primarily retirement products as well as life and supplemental health insurance. AFG's businesses operate throughout the United States. In 2000, 1999 and 1998, AFG derived less than 2% of its revenues from the sale of life and supplemental health products in Puerto Rico and less than 1% of its revenues from the sale of property and casualty insurance in Canada, Mexico, Europe and Asia. In addition, AFG owns a significant portion of the voting equity securities of Chiquita Brands International, Inc. (an investee corporation - see Note E).
[FN] (*) Includes $6.8 million in realized gains on fixed maturities transferred to Ohio Casualty in connection with the sale of the Commercial lines division.
Transactions in fixed maturity investments included in the Statement of Cash Flows consisted of the following (in millions):
[FN] (*) Prior to reclassification to available for sale at December 31, 1998.
E. INVESTMENT IN INVESTEE CORPORATIONS Investment in investee corporations reflects AFG's ownership of 24 million shares (36%) of Chiquita common stock. The market value of this investment was $24 million and $114 million at December 31, 2000 and 1999, respectively. Chiquita is a leading international marketer, producer and distributor of quality fresh fruits and vegetables and processed foods.
Current Assets $ 845 $ 903 Noncurrent Assets 1,570 1,693 Current Liabilities 611 488 Noncurrent Liabilities 1,221 1,403 Shareholders' Equity 583 705
Chiquita's results for 2000 include $20 million in charges and writedowns of production and sourcing assets; 1999 results include a $9 million charge resulting from a workforce reduction program. Operating results for 1998 include $74 million of fourth quarter write-offs and costs resulting from widespread flooding in Honduras and Guatemala caused by Hurricane Mitch.
AFC and GAFRI each have an unsecured credit agreement with a group of banks under which they can borrow up to $300 million and $155 million, respectively. Borrowings bear interest at floating rates based on prime or Eurodollar rates. Loans mature in December 2002 under the AFC credit agreement and in December 2004 under the GAFRI credit agreement. At December 31, 2000, the weighted average interest rates on amounts borrowed under the AFC and GAFRI bank credit lines were 6.86% and 7.31%, respectively.
In 2000, AFG and GAFRI repurchased $1.3 million and $1.7 million of their preferred securities for $1.1 million and $1.4 million in cash, respectively. In 1999, GAFRI repurchased $5.4 million of its preferred securities for $5.5 million in cash.
I. SHAREHOLDERS' EQUITY At December 31, 2000, there were 67,410,091 shares of AFG Common Stock outstanding, including 1,364,099 shares held by American Premier for possible distribution to certain creditors and other claimants upon proper claim presentation and settlement pursuant to the 1978 plan of reorganization of American Premier's predecessor, The Penn Central Corporation. Shares being held for distribution are not eligible to vote but otherwise are accounted for as issued and outstanding. In December 2000, AFG issued 8.3 million Common Shares at $19.625 per share in a public offering. AFG is authorized to issue 12.5 million shares of Voting Preferred Stock and 12.5 million shares of Nonvoting Preferred Stock, each without par value.
STOCK OPTIONS At December 31, 2000, there were 6.8 million shares of AFG Common Stock reserved for issuance under AFG's Stock Option Plan. Options are granted with an exercise price equal to the market price of AFG Common Stock at the date of grant. Options generally become exercisable at the rate of 20% per year commencing one year after grant; those granted to nonemployee directors of AFG are fully exercisable upon grant. All options expire ten years after the date of grant. Data for AFG's Stock Option Plan is presented below:
J. INCOME TAXES The following is a reconciliation of income taxes at the statutory rate of 35% and income taxes as shown in the Statement of Operations (in thousands):
2000 1999 1998 ---- ---- ---- Current taxes: Federal $13,880 ($ 5,434) $63,368 Foreign 1,106 32 94 State 459 511 652 Deferred taxes: Federal (50,070) 81,419 14,553 Foreign (520) (1,031) 422 ------- ------- ------- ($35,145) $75,497 $79,089 ======= ======= =======
Cash payments for income taxes, net of refunds, were $24.7 million, $9.2 million and $45.9 million for 2000, 1999 and 1998, respectively.
K. EXTRAORDINARY ITEMS Extraordinary items represent AFG's proportionate share of gains and losses related to debt retirements by the following companies. Amounts shown are net of minority interest and income taxes (in thousands):
L. COMMITMENTS AND CONTINGENCIES Loss accruals (included in other liabilities) have been recorded for various environmental and occupational injury and disease claims and other contingencies arising out of the railroad operations disposed of by American Premier's predecessor, Penn Central Transportation Company ("PCTC"), prior to its bankruptcy reorganization in 1978 and certain manufacturing operations disposed of by American Premier. Under purchase accounting in connection with the Mergers, any such excess liability will be charged to earnings in AFG's financial statements.
AFG has accrued approximately $9.8 million at December 31, 2000, for environmental costs and certain other matters associated with the sales of former operations.
The following are quarterly results of consolidated operations for the two years ended December 31, 2000 (in millions, except per share amounts).
FAIR VALUE OF FINANCIAL INSTRUMENTS The following table presents (in millions) the carrying value and estimated fair value of AFG's financial instruments at December 31.
UNREALIZED GAIN (LOSS) ON MARKETABLE SECURITIES, NET In addition to adjusting equity securities and fixed maturity securities classified as "available for sale" to fair value, SFAS 115 requires that certain other balance sheet amounts be adjusted to the extent that unrealized gains and losses from securities would result in adjustments had those gains or losses actually been realized. The components of the Consolidated Balance Sheet caption "Unrealized gain (loss) on marketable securities, net" in shareholders' equity are summarized as follows (in millions):
BENEFIT PLANS AFG expensed approximately $22 million in 2000, $13 million in 1999 and $22 million in 1998 for its retirement and employee savings plans.
TRANSACTIONS WITH AFFILIATES AFG owns a $3.7 million minority interest in a residential homebuilding company. Brothers of AFG's Chairman own the remaining interests. GAFRI has extended a line of credit to this company under which the homebuilder may borrow up to $8 million at 13%. At December 31, 2000 and 1999, $8 million was due under the credit line.
B. Schedules filed herewith for 2000, 1999 and 1998: Page I - Condensed Financial Information of Registrant S-2
November 14, 2000 Third quarter 2000 Earnings Release and additional material presented at an insurance industry investor conference on November 15, 2000.
AMERICAN FINANCIAL GROUP, INC. - PARENT ONLY (*) SCHEDULE I - CONDENSED FINANCIAL INFORMATION OF REGISTRANT (In Thousands)
$2,038,051 $1,830,418 ========== ========== Liabilities and Shareholders' Equity: Accounts payable, accrued expenses and other liabilities $ 5,185 $ 4,995 Payables to affiliates 103,805 105,079 Long-term debt 380,531 380,366 Shareholders' equity 1,548,530 1,339,978 ---------- ----------
AMERICAN FINANCIAL GROUP, INC. AND SUBSIDIARIES SCHEDULE V - SUPPLEMENTAL INFORMATION CONCERNING PROPERTY-CASUALTY INSURANCE OPERATIONS THREE YEARS ENDED DECEMBER 31, 2000 (IN MILLIONS)
--------------------------------------------------------------------------- COLUMN A COLUMN B COLUMN C COLUMN D COLUMN E --------------------------------------------------------------------------- (a) RESERVES FOR DEFERRED UNPAID CLAIMS (b) AFFILIATION POLICY AND CLAIMS DISCOUNT (c) WITH ACQUISITION ADJUSTMENT DEDUCTED IN UNEARNED REGISTRANT COSTS EXPENSES COLUMN C PREMIUMS --------------------------------------------------------------------------- CONSOLIDATED PROPERTY-CASUALTY ENTITIES
(a) Grossed up for reinsurance recoverables of $1,324 and $1,571 at December 31, 2000 and 1999, respectively. (b) Discounted at approximately 8%. (c) Grossed up for prepaid reinsurance premiums of $267 and $320 at December 31, 2000 and 1999, respectively.