AFG’s net earnings per share (diluted), determined in accordance with GAAP, includes certain items that may not be indicative of its ongoing core operations. AFG believes that its core net operating earnings per share provides management, financial analysts, rating agencies and investors with an understanding of the results from the ongoing operations of the Company by excluding the impact of net realized gains and losses and other items that are not necessarily indicative of operating trends. AFG’s management uses core net operating earnings to evaluate financial performance against historical results because it believes this provides a more comparable measure of its continuing business. Core net operating earnings is also used by AFG’s management as a basis for strategic planning and forecasting. Core net operating earnings per share (diluted) is a non-GAAP financial measure. See
Through the operations of its subsidiaries, AFG is engaged primarily in property and casualty insurance, focusing on specialized commercial products for businesses, and in the sale of traditional fixed and indexed annuities in the retail, financial institutions, broker-dealer and registered investment advisor markets.
net realized gains on securities in the fourth quarter of 2019 compared to net realized losses on securities in the fourth quarter of 2018. Both the 2019 and 2018 periods reflect the change in the fair value of equity securities that are required to be carried at fair value through net earnings under accounting guidance adopted on January 1, 2018,
Full year 2019 net earnings attributable to AFG’s shareholders were $897 million ($9.85 per share, diluted) compared to $530 million ($5.85 per share, diluted) in 2018, reflecting:
See “Liquidity and Capital Resources - Uncertainties” for a discussion of insurance reserves, recoverables from reinsurers, indexed annuity embedded derivatives and contingencies related to American Premier’s former operations and “Liquidity and Capital Resources - Investments” for a discussion of impairments on investments. Deferred policy acquisition costs (“DPAC”) and certain liabilities related to annuities are amortized in relation to the present value of expected gross profits on the policies. Assumptions considered in determining expected gross profits involve significant judgment and include management’s estimates of interest rates and investment spreads, surrenders, annuitizations, renewal premiums and mortality. Should actual experience require management to change its assumptions (commonly referred to as “unlocking”), a charge or credit would be recorded to adjust DPAC or annuity liabilities to the levels they would have been if the new assumptions had been used from the inception date of each policy.
AFG’s ratio of earnings to fixed charges, including annuity benefits as a fixed charge, was 1.85 for the year ended December 31, 2019. Excluding annuity benefits, this ratio was 14.61. The ratio excluding annuity benefits is presented because interest credited to annuity policyholder accounts is not always considered a borrowing cost for an insurance company.
The NAIC’s model law for risk-based capital (“RBC”) applies to both life and property and casualty companies. RBC formulas determine the amount of capital that an insurance company needs so that it has an acceptable expectation of not becoming financially impaired. At December 31, 2019, the capital ratios of all AFG insurance companies exceeded the RBC requirements.
Net cash provided by financing activities was $2.44 billion in 2018 compared to $1.72 billion in 2017, an increase of $725 million. Annuity receipts exceeded annuity surrenders, benefits, withdrawals and transfers by $2.76 billion in 2018 compared to $1.99 billion in 2017, resulting in a $773 million increase in net cash provided by financing activities in 2018 compared to 2017. During 2018, AFG had no additional long-term borrowings or repayments compared to $712 million of additional long-term borrowings and $745 million of debt repayments in 2017. In addition to its regular quarterly cash dividends, AFG paid special cash dividends of $3.00 per share and $3.50 per share in 2018 and 2017, respectively, which resulted in total cash dividends of $394 million in 2018 compared to $417 million in 2017. Issuances of managed investment entity liabilities exceeded retirements by $48 million in 2018 compared to $146 million in 2017, accounting for a $98 million decrease in net cash provided by financing activities in 2018 compared to 2017.
AFG can borrow up to $500 million under its revolving credit facility which expires in June 2021. 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 2019.
In 2019, AFG paid special cash dividends of $3.30 per share of AFG Common Stock ($1.50 per share in May and $1.80 per share in November) totaling approximately $297 million.
In 2017, AFG paid special cash dividends of $3.50 per share of AFG Common Stock ($1.50 per share in May and $2.00 per share in November) totaling approximately $308 million.
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”). At December 31, 2019, AFG could reduce the average crediting rate on approximately $30 billion of traditional fixed, fixed-indexed and variable-indexed annuities without guaranteed withdrawal benefits by approximately 119 basis points (on a weighted average basis). Annuity policies are subject to 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 and put options used in the fixed-indexed and variable-indexed annuity business are generally carried at fair value. At December 31, 2019, AFG’s insurance companies owned publicly traded equity securities with a fair value of $1.87 billion and equity index call and put options with a net fair value of $923 million. 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.
AFG’s parent holding company only condensed cash flows from operating, investing and financing activities are shown below (in millions):
Parent Net Cash Provided by (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 $56 million in 2019 compared to net cash provided by investing activities of $10 million in 2018 and net cash used in investing activities of $63 million in 2017. The fluctuations in net cash provided by (used in) investing activities are due primarily to higher capital contributions to subsidiaries in 2019 and 2017 as compared to 2018.
Parent Net Cash Used in Financing Activities Parent company financing activities consist primarily of the issuance and retirement of long-term debt, dividends to shareholders, and, to a lesser extent, proceeds from employee stock option exercises and repurchases of AFG Common Stock. 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 $242 million in 2019 compared to $366 million in 2018 and $413 million in 2017. The $124 million decrease in net cash used in financing activities in 2019 as compared to 2018 reflects the net issuances of long-term debt in 2019, partially offset by increased dividends (due primarily to special dividends of $3.30 per share in 2019 compared to $3.00 per share in 2018). The $47 million decrease in net cash used in financing activities in 2018 as compared to 2017 reflects lower net redemptions of long-term debt in 2018 and decreased dividends (due primarily to special dividends of $3.00 per share in 2018 compared to $3.50 per share in 2017).
Amounts presented in the table represent lease component payments, including short-term lease payments, and exclude non-lease component payments of building leases (primarily common area maintenance and property tax payments). Estimated non-lease component payments totaling $92 million are as follows: Within 1 year - $17 million; 2-3 years - $30 million; 4-5 years - $24 million; and thereafter - $21 million.
AFG’s investment portfolio at December 31, 2019, contained $46.51 billion in fixed maturity securities classified as available for sale and carried at fair value with unrealized gains and losses included in a separate component of shareholders’ equity on an after-tax basis and $113 million in fixed maturities classified as trading with holding gains and losses included in net investment income. In addition, AFG’s investment portfolio includes $1.64 billion in equity securities carried at fair value with holding gains and losses included in realized gains (losses) on securities and $294 million in equity securities carried at fair value with holding gains and losses included in net investment income.
In general, the fair value of AFG’s fixed maturity investments is inversely correlated to changes in interest rates. The following table demonstrates the sensitivity of such fair values to reasonably likely changes in interest rates by illustrating the estimated effect on AFG’s fixed maturity portfolio and accumulated other comprehensive income that an immediate increase of 100 basis points in the interest rate yield curve would have at December 31, 2019 (dollars in millions). Effects of increases or decreases from the 100 basis points illustrated would be approximately proportional.
MBS are subject to significant prepayment risk because, in periods of declining interest rates, mortgages may be repaid more rapidly than scheduled as borrowers refinance higher rate mortgages to take advantage of lower rates.
Municipal bonds represented approximately 15% of AFG’s fixed maturity portfolio at December 31, 2019. AFG’s municipal bond portfolio is high quality, with 99% of the securities rated investment grade at that date. The portfolio is well diversified across the states of issuance and individual issuers. At December 31, 2019, approximately 79% of the municipal bond portfolio was held in revenue bonds, with the remaining 21% held in general obligation bonds.
Summarized information for the unrealized gains and losses recorded in AFG’s Balance Sheet at December 31, 2019, is shown in the following table (dollars in millions). Approximately $1.09 billion of available for sale fixed maturity securities had no unrealized gains or losses at December 31, 2019.
The table below sets forth the scheduled maturities of AFG’s available for sale fixed maturity securities at December 31, 2019, 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.
The following table shows (in millions) the breakdown of AFG’s property and casualty insurance reserves between case reserves, IBNR reserves and LAE reserves (estimated amounts required to adjust, record and settle claims, other than the claim payments themselves) at December 31, 2019 and gross written premiums for the year ended December 31, 2019.
The judgments and uncertainties surrounding management’s reserve estimation process and the potential for reasonably possible variability in management’s most recent reserve estimates may also be viewed by looking at how recent historical estimates of reserves have developed. The following table shows (dollars in millions) what the impact on AFG’s net earnings would be on the more significant lines of business if the December 31, 2019, reserves (net of reinsurance) developed at the same rate as the average development of the most recent five years.
This long-tail line of business consists of coverages protecting the insured against legal liability resulting from negligence, carelessness, or a failure to act causing property damage or personal injury to others. Some of the important variables affecting estimation of loss reserves for other liability - occurrence include:
AFG recorded adverse prior year reserve development of $143 million in 2019 related to its other liability - occurrence coverage due primarily to continued claim severity increases in excess and umbrella liability coverages. AFG recorded adverse prior year reserve development of $48 million in 2018 due to claim severity increases in excess and umbrella liability coverages as well as late emergence of excess workers’ compensation and Texas non-subscribers workers’ injury claims. AFG recorded adverse prior year reserve development of $37 million in 2017 due to increased severity of New York contractor claims, as well as increased claim severity across other excess and umbrella liability coverages and general liability coverages.
Approximately 27% and 23% of AFG’s workers’ compensation reserves at December 31, 2019 relate to policies written in Florida and California, respectively. The Castellanos v. Next Door Company decision in Florida and the implementation of Senate Bill 863 in California are two examples of recent changes that impacted the workers’ compensation operating environment and added difficulty and uncertainty to the estimation of related liabilities.
AFG recorded favorable prior year reserve development of $180 million in 2019 related to its workers’ compensation coverage due to lower than anticipated frequency of lost-time claims and medical severity. AFG recorded favorable prior year reserve development of $127 million in 2018 due to lower than anticipated claim severity in the southeastern United States and improving claim closure rates in California. AFG recorded favorable prior year reserve development of $79 million in 2017 due to lower than anticipated claim severity and improving claim closure rates, particularly in the southeastern United States and California.
This long-tail line of business consists mostly of directors’ and officers’ liability (“D&O”). Some of the important variables affecting estimation of loss reserves for other liability - claims made include:
AFG recorded favorable prior year reserve development of $15 million in 2019 for this line of business due primarily to lower than expected claim frequency and severity. AFG recorded favorable prior year reserve development of $26 million in 2018 due primarily to lower than expected claim severity. AFG recorded adverse prior year reserve development of $2 million in 2017 for this line of business.
Approximately $512 million of the $804 million in gross reserves of foreign operations relate to the operations of Neon Underwriting Limited, AFG’s wholly-owned United Kingdom-based Lloyd’s insurer. In December 2019, AFG initiated actions to exit the Lloyd’s of London insurance market, which included placing its Lloyd’s Managing Agency, Neon Underwriting Ltd., into run-off. Neon’s reserves will decline as the business is run-off. Historically, Neon wrote cargo, cyber, financial lines, marine and energy liability, marine hull and war, general casualty, personal accident and health, political and trade risk, professional indemnity, property insurance and reinsurance, and terrorism and political violence insurance. Significant variables in estimating Neon’s loss reserves include:
Neon recorded adverse prior year reserve development of $13 million in 2019, due primarily to lower than expected recoveries and higher than expected claim severity of assumed property catastrophe losses and reserve strengthening in its general casualty, ocean marine and non-catastrophe property lines of business.
In the fourth quarter of 2017, Neon entered into a reinsurance to close agreement for 2015 and prior years of account, which transfers the responsibility for all of the liabilities that attach to the transferred year of account (gross reserves of $385 million at December 31, 2017) as well as any income due to the closing year of account in return for a premium. The reinsurance to close agreement eliminates any remaining reserve volatility from years of account 2015 and prior, including all medical malpractice exposure. As a result of the reinsurance to close transaction, Neon recorded favorable reserve development of approximately $42 million, including $24 million related to its ongoing lines of business and $18 million that relates to exited lines of business. In addition to the prior year reserve development related to the reinsurance to close transaction, Neon recorded favorable prior year reserve development of $29 million in 2017 related to the retained loss reserves across all of Neon’s ongoing lines of business, particularly property lines.
Management believes that estimating the ultimate liability for asbestos claims presents a unique and difficult challenge to the insurance industry due to, among other things, inconsistent court decisions, an increase in bankruptcy filings as a result of asbestos-related liabilities, novel theories of coverage, and judicial interpretations that often expand theories of recovery and broaden the scope of coverage. Environmental claims likewise present challenges in prediction, due to uncertainty regarding the interpretation of insurance policies, complexities regarding multi-party involvements at sites, evolving cleanup standards and protracted time periods required to assess the level of cleanup required at contaminated sites.
There is interest at the state level to attempt to legislatively address asbestos liabilities and the manner in which asbestos claims are resolved. These developments are fluid and could result in piecemeal state-by-state solutions.
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 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 earnings by approximately $32 million.
Amounts paid (net of reinsurance recoveries) for asbestos and environmental claims, including LAE, were as follows (in millions):
The survival ratio is a measure often used by industry analysts to compare A&E reserves’ strength among companies. This ratio is typically calculated by dividing reserves for A&E exposures by the three-year average of paid losses, and therefore measures the number of years that it would take to pay off current reserves based on recent average payments. Because this ratio can be significantly impacted by a number of factors such as loss payout variability, caution should be exercised in attempting to determine reserve adequacy based simply on the survival ratio. At December 31, 2019, the property and casualty insurance segment’s three-year survival ratios compare favorably with industry survival ratios published by A.M. Best (as of December 31, 2018, and adjusted for several large portfolio transfers) as detailed in the following table:
As a result of the 2019 internal review, AFG’s property and casualty insurance segment recorded an $18 million pretax special charge to increase its asbestos reserves by $3 million (net of reinsurance) and its environmental reserves by $15 million (net of reinsurance). Over the past few years, the focus of AFG’s asbestos claims litigation has shifted to smaller companies and companies with ancillary exposures. AFG’s insureds with these exposures have been the driver of the property and casualty segment’s asbestos reserve increases in recent years. AFG is seeing modestly increasing estimates for indemnity and defense compared to prior studies on certain specific open claims.
investigation and remedial costs with respect to existing sites and newly identified sites. AFG has updated its view of legal
defense costs on open environmental claims as well as a number of claims and sites where the estimated investigation and remediation costs have increased. As in past years, there were no new or emerging broad industry trends that were identified in this review.
An in-depth internal review of AFG’s A&E reserves was also completed in the third quarter of 2018. As a result of the 2018 internal review, AFG’s property and casualty insurance segment recorded an $18 million pretax special charge to increase
its asbestos reserves by $6 million (net of reinsurance) and its environmental reserves by $12 million (net of reinsurance). The increase in property and casualty asbestos reserves relates to increased estimates for indemnity and defense costs. The increase in property and casualty environmental reserves was primarily associated with updated estimates of site investigation and remedial costs with respect to existing sites and newly identified sites.
Contingencies related to Subsidiaries’ Former Operations The A&E studies and reviews discussed above encompassed reserves 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 and certain manufacturing operations disposed of by American Premier and its subsidiaries and by Great American Financial Resources, Inc. Charges resulting from the A&E study and reviews were $11 million in 2019, $9 million in 2018 and $24 million in 2017. For a discussion of the charges recorded for those operations, see “Results of Operations - Holding Company, Other and Unallocated.” Liabilities for claims and contingencies arising from these former railroad and manufacturing operations totaled $91 million at December 31, 2019. For a discussion of the uncertainties in determining the ultimate liability, see Note N - “Contingencies” to the financial statements.
Indexed Annuity Embedded Derivatives As of December 31, 2019, annuity benefits accumulated in AFG’s Balance Sheet includes $3.73 billion for the fair value of the derivatives embedded in its fixed-indexed and variable-indexed annuities. As discussed in Note F - “Derivatives” to the financial statements, AFG’s fixed-indexed and variable-indexed annuities provide policyholders with a crediting rate tied, in part, to the performance of an existing stock market or other financial index. Under GAAP, this index participation is considered an embedded derivative that is required to be carried at fair value in the financial statements. AFG attempts to mitigate the risk in the index-based component of these products through the purchase and sale of call and put options on the appropriate index. AFG’s strategy is designed so that the net change in the fair value of the call option assets and put option liabilities will generally offset the economic change in the net liability from the index participation. The fair value of the embedded derivatives represents an estimate of the present value of projected policyholder benefits from the equity participation in excess of the projected minimum guaranteed contract values. As discussed in Note D - “Fair Value Measurements” to the financial statements, the fair value of the embedded derivatives is impacted by fluctuations in interest rates, the stock market (including the cost of options), policyholder behavior and other factors. Fluctuations in certain of these factors, such as changes in interest rates and the performance of the stock market, are not economic in nature for the current reporting period, but rather impact the timing of reported results.
Run-off Long-term Care Insurance In December 2015, AFG completed the sale of United Teacher Associates Insurance Company and Continental General Insurance Company, the legal entities containing substantially all of its run-off long-term care insurance business, to HC2 Holdings, Inc. (“HC2”) for approximately $13 million in net proceeds. AFG may also receive up to $13 million of additional proceeds from HC2 in 2020 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 expiring in 2020. With the completion of this sale, AFG divested substantially all of its long-term care business (96% as measured by net statutory reserves as of November 30, 2015) and retained only a small block of long-term care insurance (1,500 policies) with approximately $48 million of reserves at December 31, 2019. AFG will continue to accept renewal premiums on its remaining outstanding policies, which are guaranteed renewable.
Includes income of $4 million and $7 million in 2019 and 2018, respectively, representing the change in fair value of AFG’s CLO investments plus $15 million and $16 million in 2019 and 2018, respectively, in CLO management fees earned.
Elimination of the change in fair value of AFG’s investments in the CLOs, including $32 million in distributions recorded as interest expense by the CLOs.
Beginning prospectively with the second quarter of 2019, AFG’s core net operating earnings for its annuity segment excludes unlocking, the impact of changes in the fair value of derivatives related to fixed-indexed annuities (“FIAs”), and other impacts of changes in the stock market and interest rates on the accounting for FIAs over or under the cost of the equity index options purchased to mitigate the risk in the index-based component of those FIAs (“annuity non-core earnings (losses)”). Fluctuations in interest rates and the stock market, among other factors, can cause volatility in the periodic measurement of FIA liabilities that management believes can be inconsistent with the long-term economics of this growing portion of AFG’s annuity business. Management believes that separating these impacts as “non-core” will provide investors with a better view of the fundamental performance of the business, and a more comparable measure of the annuity segment’s business compared to the results identified as “core” by its peers. Core net operating earnings for the annuity segment for the first quarter of 2019 and prior periods were not adjusted, so results for periods following the change are not directly comparable to prior periods. The impact of the items now considered annuity non-core earnings on prior periods is highlighted in the discussion following the reconciliation of net earnings attributable to shareholders to core net operating earnings.
Net earnings attributable to shareholders increased $367 million for the full-year of 2019 compared to the same period in 2018 due primarily to after-tax net realized gains on securities of $227 million in 2019 compared to after-tax net realized losses of $210 million in 2018. In addition, net earnings attributable to shareholders includes an after-tax loss of $38 million for the full-year of 2019 (after tax losses of $9 million in the first quarter, $27 million in the second quarter and $21 million in the third quarter, and an after tax gain of $19 million in the fourth quarter) and an after-tax loss of $38 million for the full-year of 2018 from unlocking, the impact of changes in the fair value of derivatives related to FIAs, and other impacts of changes in the stock market and interest rates on the accounting for FIAs over or under the cost of the equity index options purchased to mitigate the risk in the index-based component of those FIAs. As discussed above, this impact on the accounting for FIAs is considered non-core earnings (losses) beginning prospectively with the second quarter of 2019. Excluding the $9 million after-tax negative impact of these items on results for the first quarter of 2019 and the $38 million after-tax negative impact of these items on results for the full-year of 2018, core net operating earnings decreased $6 million in 2019 compared to 2018 reflecting higher holding company expenses, partially offset by higher earnings in the property and casualty insurance segment. Realized gains (losses) on securities in 2019 and 2018 resulted primarily from the change in fair value of equity securities that were still held at the balance sheet date.
Net earnings attributable to shareholders increased $55 million for the full-year of 2018 compared to the same period in 2017 due primarily to higher core net operating earnings, lower special A&E charges recorded in 2018 compared to 2017, losses on the retirement of debt in 2017 and the 2017 tax expense related to the change in the U.S. corporate tax rate, partially offset by net realized losses on securities in 2018 compared to net realized gains on securities in 2017, the 2017 favorable development in the Neon exited lines in connection with a reinsurance to close transaction and the 2017 tax benefit from restructuring at Neon. Core net operating earnings increased $173 million in 2018 compared to 2017 reflecting higher net investment income in the property and casualty insurance segment, lower interest charges on borrowed money, lower holding company expenses and a lower corporate income tax rate, partially offset by lower earnings in the annuity segment and income from the sale of real estate in 2017. Realized losses on securities in 2018 includes the decline in fair value of equity securities that are required to be carried at fair value through net earnings under accounting guidance adopted on January 1, 2018. Included in the $210 million of non-core net realized losses on securities in 2018 were $214 million in net losses on equity securities that AFG continued to own at December 31, 2018.
RESULTS OF OPERATIONS - QUARTERS ENDED DECEMBER 31, 2019 AND 2018
AFG reports its business as three segments: (i) Property and casualty insurance (“P&C”), (ii) Annuity and (iii) Other, which includes run-off long-term care and life, holding company costs and income and expenses related to the managed investment entities (“MIEs”).
Excludes a pretax non-core charge of $46 million (3.3 points on the combined ratio) in the fourth quarter of 2019 associated with plans to exit the Lloyd’s of London insurance market in 2020.
Gross written premiums (“GWP”) for AFG’s property and casualty insurance segment were $1.75 billion for the fourth quarter of 2019 compared to $1.61 billion for the fourth quarter of 2018, an increase of $136 million (8%). Detail of AFG’s property and casualty gross written premiums is shown below (dollars in millions):
Reinsurance premiums ceded (“Ceded”) for AFG’s property and casualty insurance segment were 25% of gross written premiums for both the fourth quarter of 2019 and the fourth quarter of 2018. 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 $1.31 billion for the fourth quarter of 2019 compared to $1.21 billion for the fourth quarter of 2018, an increase of $105 million (9%). Detail of AFG’s property and casualty net written premiums is shown below (dollars in millions):
Net earned premiums (“NEP”) for AFG’s property and casualty insurance segment were $1.37 billion for the fourth quarter of 2019 compared to $1.27 billion for the fourth quarter of 2018, an increase of $100 million (8%). Detail of AFG’s property and casualty net earned premiums is shown below (dollars in millions):
The $136 million (8%) increase in gross written premiums in the fourth quarter of 2019 compared to the fourth quarter of 2018 reflects growth in the Specialty casualty and Specialty financial sub-segments, partially offset by lower premiums in
Property and transportation Gross written premiums decreased $23 million (4%) in the fourth quarter of 2019 compared to the fourth quarter of 2018. Higher premiums in the property and inland marine and ocean marine businesses were more than offset by lower premiums in the transportation businesses (due primarily to the timing of the renewal of a large commercial auto account) and lower year-over-year premiums related to winter wheat and rainfall index products in the crop operations. Average renewal rates increased nearly 5% for this group in the fourth quarter of 2019. Reinsurance premiums ceded as a percentage of gross written premiums decreased 2 percentage points for the fourth quarter of 2019 compared to the fourth quarter of 2018, reflecting lower cessions in the crop insurance business.
Specialty casualty Gross written premiums increased $151 million (19%) in the fourth quarter of 2019 compared to the fourth quarter of 2018. Growth in the surplus lines and excess liability businesses, primarily the result of new business opportunities, rate increases and higher retentions on renewal business, were primary drivers of the higher premiums. Higher premiums reported by Neon, premium growth in the executive liability business and the addition of ABA Insurance Services also contributed to the increase in premiums. Average renewal rates for this group increased approximately 6% in the fourth quarter of 2019. Excluding rate decreases in the workers’ compensation business, renewal rates for this group increased approximately 11%. Reinsurance premiums ceded as a percentage of gross written premiums increased 3 percentage points for the fourth quarter of 2019 compared to the fourth quarter of 2018, reflecting growth in the surplus lines, excess liability and mergers and acquisitions businesses, which have a higher ceding percentage than the overall Specialty casualty sub-segment.
Specialty financial Gross written premiums increased $8 million (4%) in the fourth quarter of 2019 compared to the fourth quarter of 2018, due to modest growth across all businesses in the group. Average renewal rates for this group increased approximately 2% in the fourth quarter of 2019. Reinsurance premiums ceded as a percentage of gross written premiums decreased 4 percentage points for the fourth quarter of 2019 compared to the fourth quarter of 2018 reflecting lower cessions in the financial institutions business due to reduced gross written premiums in certain lines of business that are 100% reinsured.
Specialty financial Underwriting profit for this group was $32 million for the fourth quarter of 2019 compared to $20 million in the fourth quarter of 2018, an increase of $12 million (60%). Higher underwriting profits in the financial institutions, surety and trade credit businesses contributed to these results. Catastrophe losses were $2 million (1.1 points on the combined ratio) in the fourth quarter of 2019 compared to $10 million (7.1 points) in the fourth quarter of 2018.
Consistent with the treatment of other items that are not indicative of AFG’s ongoing operations (both favorable and unfavorable), the $76 million charge related to the Neon exited lines recorded in 2019 in connection with AFG’s plans to exit the Lloyd’s of London insurance market in 2020 and the $18 million of favorable development related to the Neon exited lines recorded in connection with the December 2017 reinsurance to close transaction were treated as non-core.
Aggregate Aggregate underwriting results for AFG’s property and casualty insurance segment for the fourth quarter of 2019 includes the Neon exited lines charge mentioned above.
AFG’s overall loss and LAE ratio was 66.6% for the fourth quarter of 2019 compared to 62.7% for fourth quarter of 2018, an increase of 3.9 percentage points. The components of AFG’s property and casualty losses and LAE amounts and ratio are detailed below (dollars in millions):
Specialty financial The 0.3 percentage points decrease in the loss and LAE ratio for the current year, excluding catastrophe losses reflects a decrease in the loss and LAE ratio of the financial institutions business, partially offset by an increase in the loss and LAE ratio of the fidelity business.
Property and transportation Net favorable reserve development of $18 million in the fourth quarter of 2019 reflects lower than expected claim frequency at National Interstate and lower than anticipated claim severity in the property and inland marine business. Net favorable reserve development of $7 million in the fourth quarter of 2018 reflects lower than expected claim frequency and severity at National Interstate and lower than expected losses in the crop business.
AFG’s property and casualty commissions and other underwriting expenses (“U/W Exp”) were $446 million in the fourth quarter of 2019 compared to $372 million for the fourth quarter of 2018, an increase of $74 million (20%). AFG’s underwriting expense ratio, calculated as commissions and other underwriting expenses divided by net premiums earned, was 32.5% for the fourth quarter of 2019 compared to 29.3% for the fourth quarter of 2018, an increase of 3.2 percentage points. Detail of AFG’s property and casualty commissions and other underwriting expenses and underwriting expense ratios is shown below (dollars in millions):
Specialty casualty Commissions and other underwriting expenses as a percentage of net earned premiums decreased 2.7 percentage points in the fourth quarter of 2019 compared to the fourth quarter of 2018 reflecting the impact of higher premiums on the ratio, particularly in the excess and surplus lines businesses.
Net investment income in AFG’s property and casualty insurance operations was $120 million in the fourth quarter of 2019 compared to $115 million in the fourth quarter of 2018, an increase of $5 million (4%). The average invested assets and overall yield earned on investments held by AFG’s property and casualty insurance operations are provided below (dollars in millions):
2019 compared to 4.32% for the fourth quarter of 2018, a decrease of 0.23 percentage points, reflecting a lower yield on partnerships and similar investments. AFG’s property and casualty insurance operations recorded $18 million in earnings from partnerships and similar investments and AFG-managed CLOs in the fourth quarter of 2019 compared to $22 million in the fourth quarter of 2018, a decrease of $4 million (18%). The annualized yield earned on these investments was 9.1% in the fourth quarter of 2019 compared to 13.8% in the prior year period.
Other income and expenses, net for AFG’s property and casualty insurance operations was a net expense of $11 million for the fourth quarter of 2019 compared to $8 million for the fourth quarter of 2018, an increase of $3 million (38%). The table below details the items included in other income and expenses, net for AFG’s property and casualty insurance operations (in millions):
AFG’s annuity operations contributed $128 million in GAAP pretax earnings in the fourth quarter of 2019 compared to $20 million in the fourth quarter of 2018, an increase of $108 million (540%). This increase in AFG’s GAAP annuity segment results for the fourth quarter of 2019 as compared to the fourth quarter of 2018 is due primarily to the favorable impact of the significant increase in stock market performance on annuities with guaranteed withdrawal benefits and on the fair value of derivatives related to FIAs in the fourth quarter of 2019 compared to the unfavorable impact of the significant decline in the stock market on these annuities in the fourth quarter of 2018. The increase in pretax earnings also reflects growth in the annuity business. AFG monitors the major actuarial assumptions underlying its annuity operations throughout the year and has historically conducted detailed reviews (“unlocking”) of its assumptions in the fourth quarter of each year. Beginning with the third quarter of 2019, AFG moved its annual unlocking to the third quarter and expects to continue to conduct the annual review in the third quarter of each year (consistent with many of its peers). The unlocking of the actuarial assumptions resulted in a net charge to earnings of $4 million in the fourth quarter of 2018. If changes in the economic environment or actual experience would cause material revisions to future estimates, these assumptions are updated (unlocked) in an interim quarter.
The following table details AFG’s GAAP and core earnings before income taxes from its annuity operations for the three months ended December 31, 2019 and 2018 (dollars in millions):
Annuity core earnings before income taxes were $104 million in the fourth quarter of 2019 compared to $20 million in the fourth quarter of 2018, an increase of $84 million (420%). As discussed under “Results of Operations - General,” beginning prospectively with the second quarter of 2019, unlocking, changes in the fair value of derivatives related to FIAs, and other impacts of changes in the stock market and interest rates on the accounting for FIAs over or under the cost of the equity index options purchased to mitigate the risk in the index-based component of those FIAs are considered non-core earnings (losses). For the fourth quarter of 2019, the annuity segment’s core earnings before income taxes excludes $24 million in pretax earnings related to these items. Since annuity core earnings for the first quarter of 2019 and prior periods were not adjusted, the annuity segment’s core earnings before income taxes for the fourth quarter of 2018 includes the $66 million negative impact from these items in that period. Excluding the $66 million negative impact of these items on results for the fourth quarter of 2018, annuity core earnings before income taxes were $18 million (21%) higher in the fourth quarter of 2019 compared to the fourth quarter of 2018, reflecting growth in the annuity business. The table below highlights the impact of unlocking, changes in the fair value of derivatives and other impacts of the changes in the stock market and interest rates on annuity segment results (dollars in millions):
See “Annuity Unlocking” below for a discussion of the impact that the unlocking of actuarial assumptions had on annuity benefits expense in the fourth quarter of 2018.
Excluding unlocking, the impact of changes in the fair value of derivatives related to FIAs, and other impacts of changes in the stock market and interest rates on annuity benefits and the related impact on the amortization of deferred policy acquisition costs.
Net investment income for the fourth quarter of 2019 was $458 million compared to $419 million for the fourth quarter of 2018, an increase of $39 million (9%). This increase reflects the growth in AFG’s annuity business and higher earnings on investments accounted for under the equity method. The overall yield earned on investments in AFG’s fixed annuity operations, calculated as net investment income divided by average investment balances (at amortized cost), decreased by 0.01 percentage points to 4.63% from 4.64% in the fourth quarter of 2019 compared to the fourth quarter of 2018. The impact of the reinvestment of proceeds from maturity and redemption of higher yielding investments at the lower yields available in the financial markets was substantially offset by very strong investment income in the 2019 quarter, including higher yields on investments accounted for under the equity method. For the period from October 1, 2018 through December 31, 2019, $6.4 billion in annuity segment investments with an average yield of approximately 5.0% were redeemed or sold with the proceeds reinvested at an approximately 0.8% lower yield.
Annuity policy charges and other miscellaneous income, which consist primarily of surrender charges, amortization of deferred upfront policy charges (unearned revenue) and income from sales of real estate were $9 million in the fourth quarter of 2019 compared to $10 million the fourth quarter of 2018, a decrease of $1 million (10%). Annuity policy charges and other miscellaneous income as a percentage of average fixed annuity benefits accumulated decreased 0.01 percentage points to 0.07% in the fourth quarter of 2019 from 0.08% in the fourth quarter of 2018.
See “Annuity Unlocking” below for a discussion of the impact that the unlocking of actuarial assumptions had on annuity and supplemental insurance acquisition expenses in the fourth quarter of 2018. Unanticipated spread compression, decreases in the stock market, adverse mortality experience, and higher than expected lapse rates could lead to future write-offs of DPAC or the present value of future profits on business in force of companies acquired (“PVFP”).
The positive impact of strong market performance during the fourth quarter of 2019 on the fair value of derivatives and other liabilities related to FIAs resulted in a partially offsetting acceleration of the amortization of DPAC. The unfavorable impact of the significant decline in stock market performance during the fourth quarter of 2018 on the fair value of derivatives and other liabilities related to FIAs resulted in a partially offsetting deceleration of the amortization of DPAC.
The table below illustrates the impact of unlocking and the estimated impact of changes in the fair value of derivatives related to fixed-indexed annuities and other impacts of changes in the stock market and interest rates on FIAs on annuity acquisition expenses as a percentage of average fixed annuity benefits accumulated:
Annuity other expenses were $34 million for the fourth quarter of 2019 compared to $36 million for the fourth quarter of 2018, a decrease of $2 million (6%). 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 decreased 0.05 percentage points to 0.33% from 0.38% for the fourth quarter of 2019 as compared to the fourth quarter of 2018 due primarily to growth in the annuity business.
During the fourth quarter of 2019, the positive impact of strong stock market performance increased earnings before income taxes for the annuity segment by $24 million. During the fourth quarter of 2018, the negative impact of the significant decline in the stock market reduced the annuity segment’s earnings before income taxes by $62 million. As a percentage of average fixed annuity benefits accumulated, the impact of changes in the fair value of derivatives related to FIAs and other impacts of changes in the stock market and interest rates on the accounting for FIAs over or under the cost of the equity index options purchased to mitigate the risk in the indexed-based component of those FIAs was a net expense reduction of 0.24% in the fourth quarter of 2019 compared to a net expense of 0.69% in the fourth quarter of 2018.
See “Annuity Unlocking” below for a discussion of the impact that the unlocking of actuarial assumptions had on the change in the fair value of the embedded derivative and other annuity liabilities in the fourth quarter of 2018.
For certain products, annuity benefits accumulated also includes reserves for accrued persistency and premium bonuses, excess benefits expected to be paid on future deaths and annuitizations (“EDAR”) and guaranteed withdrawal benefits. Annuity benefits accumulated also includes amounts advanced from the Federal Home Loan Bank of Cincinnati. The following table is a progression of AFG’s annuity benefits accumulated liability for the three months ended December 31, 2019 and 2018 (in millions):
The detailed review of the major actuarial assumptions was conducted in the third quarter of 2019.
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, 2019 and 2018 (in millions):
Excludes a pretax non-core loss on retirement of debt of $5 million in the fourth quarter of 2019.
Holding Company and Other - Life, Accident and Health Premiums, Benefits and Acquisition Expenses
AFG’s run-off long-term care and life insurance operations recorded net earned premiums of $5 million and related benefits and acquisition expenses of $11 million in the fourth quarter of 2019 compared to net earned premiums of $6 million and related benefits and acquisition expenses of $10 million in the fourth quarter of 2018. The $2 million (25%) increase in life, accident and health benefits reflects higher claims in the run-off life insurance business.
AFG recorded net investment income on investments held outside of its property and casualty insurance and annuity segments of $8 million in the fourth quarter of 2019 compared to $4 million in the fourth quarter of 2018, an increase of $4 million (100%). The parent company holds a small portfolio of securities that are carried at fair value through net investment income. These securities increased in value by $1 million in the fourth quarter of 2019 compared to a decrease of $5 million in the fourth quarter of 2018.
Other income in the table above includes $4 million in both the fourth quarter of 2019 and 2018, in management fees paid to AFG by the AFG-managed CLOs (AFG’s consolidated managed investment entities). 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 $4 million in other income outside of its property and casualty insurance and annuity segments in the fourth quarter of 2019 compared to $5 million in the fourth quarter of 2018.
Excluding the non-core loss on retirement of debt discussed below, AFG’s holding companies and other operations outside of its property and casualty insurance and annuity segments recorded other expenses of $42 million in the fourth quarter of 2019 compared to $22 million in the fourth quarter of 2018, an increase of $20 million (91%). This increase is due primarily to the impact of higher holding company expenses related to employee benefit plans that are tied to stock market performance in the fourth quarter of 2019 compared to the fourth quarter of 2018.
The increase in interest expense for the fourth quarter of 2019 as compared to the fourth quarter of 2018 reflects the following financing transactions completed by AFG between October 1, 2018 and December 31, 2019:
AFG’s consolidated realized gains (losses) on securities, which are not allocated to segments, were net gains of $65 million in the fourth quarter of 2019 compared to net losses of $238 million in the fourth quarter of 2018, a change of $303 million (127%). Realized gains (losses) on securities consisted of the following (in millions):
The $67 million net realized gain from the change in the fair value of equity securities in the fourth quarter of 2019 includes gains of $17 million on investments in banks and financing companies, $16 million on investments in technology companies and $14 million on investments in media companies. The $223 million net realized loss from the change in the fair value of equity securities in the fourth quarter of 2018 includes losses of $65 million on banks and financing companies, $23 million on asset management companies, $22 million on energy exploration and production companies and $21 million on technology companies.
AFG’s consolidated provision (credit) for income taxes was an expense of $68 million for the fourth quarter of 2019 compared to a credit of $4 million in the fourth quarter of 2018. The following is a reconciliation of income taxes at the statutory rate to the provision (credit) for income taxes as shown in the segmented statement of earnings (dollars in millions):
AFG’s consolidated net earnings (losses) attributable to noncontrolling interests was a net loss of $20 million for the fourth quarter of 2019 compared to $6 million for the fourth quarter of 2018, an increase of $14 million (233%). The losses in both periods are related to losses at Neon, AFG’s United Kingdom-based Lloyd’s insurer. Net losses attributable to noncontrolling interests in the fourth quarter of 2019 includes $18 million related to the $76 million non-core charge for costs associated with AFG’s plans to exit the Lloyd’s of London insurance market in 2020. See “Neon exited lines charge” under “Property and Casualty Insurance Segment - Results of Operations” for the quarters ended December 31, 2019 and 2018.
unlocking, the impact of changes in the fair value of derivatives related to FIAs, and other impacts of changes in the stock market and interest rates on the accounting for FIAs over or under the cost of the equity index options purchased to mitigate the risk in the index-based component of those FIAs are considered non-core earnings (losses).
Excludes pretax non-core special A&E charges of $18 million in both 2019 and 2018 (0.3 and 0.4 points on the combined ratio, respectively) and $89 million (1.9 points) in 2017, a pretax non-core charge of $46 million (0.9 points) in 2019 associated with plans to exit the Lloyd’s of London insurance market in 2020 and income of $18 million (0.4 points) in 2017 representing favorable development related to the Neon exited lines in connection with a reinsurance to close transaction.
Excludes a pretax non-core charge of $30 million (0.6 points on the combined ratio) in 2019 associated with plans to exit the Lloyd’s of London insurance market in 2020.
Gross written premiums (“GWP”) for AFG’s property and casualty insurance segment were $7.30 billion in 2019 compared to $6.84 billion in 2018, an increase of $459 million (7%). GWP increased $338 million (5%) in 2018 compared to 2017. Detail of AFG’s property and casualty gross written premiums is shown below (dollars in millions):
Reinsurance premiums ceded (“Ceded”) for AFG’s property and casualty insurance segment were 27% of gross written premiums for each of the years ended December 31, 2019, 2018 and 2017. 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 $5.34 billion in 2019 compared to $5.02 billion in 2018, an increase of $319 million (6%). NWP increased $272 million (6%) in 2018 compared to 2017. Detail of AFG’s property and casualty net written premiums is shown below (dollars in millions):
Net earned premiums (“NEP”) for AFG’s property and casualty insurance segment were $5.19 billion in 2019 compared to $4.87 billion in 2018, an increase of $320 million (7%). NEP increased $286 million (6%) in 2018 compared to 2017. Detail of AFG’s property and casualty net earned premiums is shown below (dollars in millions):
The $338 million (5%) increase in gross written premiums in 2018 compared to 2017 reflects growth in the Specialty casualty and Specialty financial sub-segments. Overall average renewal rates increased approximately 1% in 2018. Excluding rate decreases in the workers’ compensation business, renewal pricing increased approximately 3%.
Gross written premiums decreased $43 million (2%) in 2018 compared to 2017. This decrease was largely the result of lower year-over-year premiums in the crop insurance business and underwriting actions on under-performing accounts in the Singapore branch. Average renewal rates increased approximately 3% for this group in 2018. Reinsurance premiums ceded as a percentage of gross written premiums were comparable in 2018 and 2017.
Specialty financial Gross written premiums increased $22 million (3%) in 2019 compared to 2018 due primarily to higher premiums in the fidelity, surety and equipment leasing businesses, partially offset by lower premiums in the financial institutions business. Average renewal rates for this group increased approximately 1% in 2019. Reinsurance premiums ceded as a percentage of gross written premiums were comparable in 2019 and 2018.
Reinsurance premiums assumed increased $48 million (44%) in 2018 compared to 2017, reflecting an increase in premiums retained, primarily from businesses in the Specialty casualty sub-segment.
The Specialty property and casualty insurance operations generated an underwriting profit of $322 million in 2018 compared to $317 million in 2017, an increase of $5 million (2%). Higher underwriting profits in the Specialty casualty and Specialty financial sub-segments were partially offset by lower underwriting profit in the Property and transportation sub-segment. Overall catastrophe losses were $103 million (2.1 points on the combined ratio) for 2018 compared to $140 million (3.0 points) for 2017. In connection with catastrophe losses incurred in 2018, AFG paid $2 million in net reinstatement premiums, resulting in a total pretax loss from catastrophes of $105 million. In connection with catastrophe losses incurred in 2017, AFG reduced profit-based commissions payable to agents by $8 million in the Specialty financial sub-segment and paid $10 million in net reinstatement premiums, resulting in a total pretax loss from catastrophes of $142 million in 2017.
Property and transportation Underwriting profit for this group was $79 million in 2019 compared to $120 million in 2018, a decrease of $41 million (34%). Record levels of prevented planting claims in the crop operations were the driver of the lower underwriting profit in 2019 compared to 2018, partially offset by higher underwriting profits in the transportation businesses. Catastrophe losses were $32 million (1.8 points on the combined ratio) in 2019 compared to catastrophe losses of $26 million (1.5 points) in 2018.
Underwriting profit for this group was $120 million in 2018 compared to $154 million in 2017, a decrease of $34 million (22%). Lower underwriting profits in the agricultural, property and inland marine and aviation businesses and the Singapore branch were partially offset by higher underwriting profit at National Interstate and improved results in the ocean marine operations. Catastrophe losses were $26 million (1.5 points on the combined ratio) in 2018 compared to catastrophe losses of $36 million (2.1 points) and related net reinstatement premiums of $2 million in 2017.
Specialty casualty Underwriting profit for this group was $175 million in 2019 compared to $141 million in 2018, an increase of $34 million (24%). Higher underwriting profits in the targeted markets and workers’ compensation businesses and a reduction in the underwriting loss at Neon (excluding the Neon exited lines charge), due primarily to lower year-over-year catastrophe losses, were partially offset by lower underwriting profits in the excess and surplus lines, executive liability and general liability businesses. See “Neon exited lines charge” under “Property and Casualty Insurance Segment - Results of Operations” for the quarters ended December 31, 2019 and 2018 for information about AFG’s plans to exit the Lloyd’s of London insurance market in 2020. Catastrophe losses were $17 million (0.7 points on the combined ratio) and related net reinstatement premiums were $1 million in 2019 compared to catastrophe losses of $45 million (1.9 points) and related net reinstatement premiums of $1 million in 2018.
Underwriting profit for this group was $141 million in 2018 compared to $104 million in 2017, an increase of $37 million (36%). These results reflect higher underwriting profits in the executive liability and targeted markets businesses and lower adverse prior year reserve development in run-off businesses. Catastrophe losses were $45 million (1.9 points on the combined ratio) and related net reinstatement premiums were $1 million in 2018 compared to catastrophe losses of $71 million (3.3 points) and related net reinstatement premiums of $6 million in 2017.
Underwriting profit for this group was $66 million in 2018 compared to $61 million in 2017, an increase of $5 million (8%) due primarily to favorable prior year reserve development in run-off businesses. Catastrophe losses were $28 million (4.7 points on the combined ratio) in 2018 compared to $30 million (5.2 points) in 2017. In connection with catastrophe losses incurred in 2018, the Specialty financial sub-segment paid $1 million in reinstatement premiums compared to a reduction of profit-based commissions payable to agents of $8 million (1.1 points on the combined ratio) and reinstatement premiums of $2 million in 2017.
Other specialty This group reported an underwriting loss of $21 million in 2019 compared to $5 million in 2018, an increase of $16 million (320%). This increase reflects higher losses in the business assumed by AFG’s internal reinsurance program from the operations that make up AFG’s other Specialty sub-segments in 2019 compared to 2018.
AFG’s overall loss and LAE ratio was 63.0%, 61.7% and 64.5% in 2019, 2018 and 2017, respectively. The components of AFG’s property and casualty losses and LAE amounts and ratio are detailed below (dollars in millions):
Property and transportation The 2.5 percentage points increase in the loss and LAE ratio for the current year, excluding catastrophe losses in 2019 compared to 2018 reflects an increase in the loss and LAE ratio of the crop operations due to a high level of prevented planting claims resulting from excess rain in 2019.
Specialty financial The 1.1 percentage points decrease in the loss and LAE ratio for the current year, excluding catastrophe losses in 2019 compared to 2018 reflects a decrease in the loss and LAE ratio of the financial institutions business.
Net favorable reserve development of $40 million in 2017 reflects lower than expected losses in the crop and equine businesses and lower than expected claim severity in the property and inland marine and transportation businesses, partially offset by higher than expected claim frequency and severity in the ocean marine business.
Net favorable reserve development of $26 million in 2018 reflects lower than expected claim frequency and severity in the surety business, lower than expected claim severity in the fidelity business and lower than expected claim frequency in run-off businesses.
Other specialty In addition to the reserve development discussed above, total Specialty prior year reserve development includes net adverse reserve development of $6 million, $3 million and $8 million in 2019, 2018, and 2017, respectively. The net adverse reserve development in 2019 reflects $12 million of adverse development associated with AFG’s internal reinsurance program, partially offset by the amortization of the deferred gains on the retroactive reinsurance transactions entered into in connection with the sale of businesses in 1998 and 2001.
The net adverse reserve development in 2018 reflects $10 million of adverse reserve development associated with AFG’s internal reinsurance program, partially offset by amortization of deferred gains on retroactive reinsurance.
AFG’s property and casualty commissions and other underwriting expenses (“U/W Exp”) were $1.70 billion in 2019 compared to $1.56 billion in 2018, an increase of $142 million (9%). AFG’s underwriting expense ratio was 32.8% in 2019 compared to 32.1% in 2018, an increase of 0.7 percentage points.
AFG’s property and casualty U/W Exp were $1.56 billion in 2018 compared to $1.38 billion in 2017, an increase of $178 million (13%). AFG’s underwriting expense ratio was 32.1% in 2018 compared to 30.2% in 2017, an increase of 1.9 percentage points.
Commissions and other underwriting expenses as a percentage of net earned premiums increased 1.6 percentage points in 2018 compared to 2017 reflecting lower premiums in the crop business, which has a lower expense ratio than many of the businesses in the Property and transportation sub-segment and an increase in the expense ratio in the transportation businesses.
Aggregate Aggregate commissions and other underwriting expenses for AFG’s property and casualty insurance segment includes $30 million of underwriting expenses related to the Neon exited lines charge in 2019 representing contractual employee severance benefits and other incurred exit costs. See “Neon exited lines charge” under “Property and Casualty Insurance Segment - Results of Operations” for the quarters ended December 31, 2019 and 2018.
The increase in average invested assets and net investment income in the property and casualty insurance segment in 2018 compared to 2017 reflects growth in the property and casualty insurance segment and very strong earnings from limited partnerships and similar investments. The property and casualty insurance segment’s overall yield on investments was 4.17% in 2018 compared to 3.64% in 2017, an increase of 0.53 percentage points due primarily to higher earnings from limited partnerships and similar investments. AFG’s property and casualty insurance operations recorded $80 million in earnings from partnerships and similar investments and AFG-managed CLOs in 2018 compared to $34 million in 2017, an increase of $46 million (135%). The yield earned on these investments was 13.9% in 2018 compared to 7.9% in 2017.
The following table details AFG’s GAAP and core earnings before income taxes from its annuity operations for 2019, 2018 and 2017 (dollars in millions):
As discussed under “Results of Operations - General,” beginning prospectively with the second quarter of 2019, unlocking, the impact of changes in the fair value of derivatives related to FIAs, and other impacts of changes in the stock market and interest rates on the accounting for FIAs over or under the cost of the equity index options purchased to mitigate the risk in the index-based component of those FIAs are considered non-core earnings (losses). For 2019, policy charges and other miscellaneous income excludes the $1 million favorable impact of these items and annuity benefits and acquisition expenses exclude the $11 million and $26 million, respectively, unfavorable impact of these items.
As discussed under “Results of Operations - General,” beginning prospectively with the second quarter of 2019, unlocking, changes in the fair value of derivatives related to FIAs, and other impacts of changes in the stock market and interest rates on the accounting for FIAs over or under the cost of the equity index options purchased to mitigate the risk in the index-based component of those FIAs are considered non-core earnings (losses). For 2019, annuity benefits expense includes the negative impact of $56 million related to these items (including $45 million in the first quarter). Since annuity core earnings for the first quarter of 2019 and prior periods were not adjusted, core annuity benefits expense for
The table below (dollars in millions) details the components of the spreads for AFG’s fixed annuity operations (including fixed-indexed and variable-indexed annuities):
Net investment income in 2019 was $1.79 billion compared to $1.64 billion in 2018, an increase of $154 million (9%). 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), decreased by 0.06 percentage points to 4.67% from 4.73% in 2019 compared to 2018. The decrease in the net investment yield between periods reflects lower yields on investments accounted for under the equity method.
Cost of funds for 2019 was $982 million compared to $863 million for 2018, an increase of $119 million (14%). This increase reflects growth in the annuity business and higher renewal option costs. The average cost of policyholder funds, calculated as cost of funds divided by average fixed annuity benefits accumulated, increased 0.06 percentage points to 2.55% from 2.49% in 2019 compared to 2018 reflecting higher renewal option costs.
Other annuity benefits, net of guaranteed withdrawal benefit fees excluding the impact of unlocking and the stock market and interest rates for 2019 were $42 million in 2019 and $31 million in both 2018 and 2017, representing an increase of $11 million (35%) in 2019 compared to 2018. As a percentage of average fixed annuity benefits accumulated, these net expenses increased 0.01 percentage points to 0.11% in 2019 from 0.10% in both 2018 and 2017. 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 $1 million favorable impact of unlocking in 2019 and the $1 million unlocking charge in 2018 related to unearned revenue, annuity policy charges and other miscellaneous income, which consist primarily of surrender charges, amortization of deferred upfront policy charges (unearned revenue) and income from sales of real estate, were $40 million in 2019 compared to $43 million in 2018, a decrease of $3 million (7%). Excluding the impact of unlocking charges related to unearned revenue, annuity policy charges and other miscellaneous income as a percentage of average fixed annuity benefits accumulated decreased 0.02 percentage points to 0.08% in 2019 from 0.10% in 2018.
Excluding the impact of unlocking charges of $1 million in 2018 and $3 million in 2017 related to unearned revenue, annuity policy charges and other miscellaneous income were $43 million in 2018 compared to $46 million in 2017, a decrease of $3 million (7%). Other miscellaneous income includes $1 million from the sale of real estate in 2017. Excluding the impact of unlocking charges related to unearned revenue, annuity policy charges and other miscellaneous income as a percentage of average fixed annuity benefits accumulated decreased 0.01 percentage points to 0.10% in 2018 from 0.11% in 2017.
See “Annuity Unlocking” below for a discussion of the impact that the unlocking of actuarial assumptions had on annuity policy charges and other miscellaneous income.
deferred policy acquisition costs (“DPAC”) resulting from changes in the fair value of derivatives related to FIAs and other
on the accounting for FIAs over or under option costs were $242 million for 2018 compared to $220 million for 2017, an increase of $22 million (10%), reflecting growth in the annuity business.
The negative impact of lower than anticipated interest rates during 2019 on the fair value of derivatives and other liabilities related to FIAs resulted in a partially offsetting deceleration of the amortization of DPAC. In contrast, the positive impact of higher than anticipated interest rates during 2018 on the fair value of derivatives and other liabilities related to FIAs resulted in a partially offsetting acceleration of the amortization of DPAC. In 2017, the negative impact of significantly lower than anticipated interest rates on the fair value of derivatives and other liabilities related to FIAs resulted in a partially offsetting deceleration of the amortization of DPAC.
Annuity other expenses were $139 million in 2019, $131 million in 2018 and $121 million in 2017, representing an increase of $8 million (6%) in 2019 compared to 2018 and an increase of $10 million (8%) in 2018 compared to 2017 reflecting growth in the annuity business. 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 decreased 0.02 percentage points to 0.35% in 2019 from 0.37% in both 2018 and 2017.
The following table provides analysis of the primary factors impacting the change in the fair value of derivatives related to FIAs and the other impacts of the stock market and interest rates (excluding the impact of unlocking) on the accounting for FIAs over or under the cost of the equity index options discussed above. Each factor is presented net of the estimated related impact on amortization of DPAC (dollars in millions).
AFG’s net spread earned on fixed annuities excluding the impact of unlocking, changes in the fair value of derivatives related to FIAs and other impacts of changes in the stock market and interest rates over or under option costs decreased 0.12 percentage points to 1.08% in 2019 from 1.20% in 2018 due primarily to the 0.13 percentage points decrease in AFG’s net interest spread discussed above. AFG’s overall net spread earned on fixed annuities decreased 0.11 percentage points to 0.96% in 2019 from 1.07% in 2018 due to the decrease in AFG’s net interest spread, the impact of changes in the fair value of derivatives and other impacts of the stock market and interest rates on the accounting for FIAs discussed above partially offset by the impact of unlocking discussed below under “Annuity Unlocking.”
AFG’s net spread earned on fixed annuities excluding the impact of unlocking, changes in the fair value of derivatives related to FIAs and other impacts of changes in the stock market and interest rates over or under option costs decreased 0.05 percentage points to 1.20% in 2018 from 1.25% in 2017 due primarily to the 0.05 percentage point decrease in AFG’s net interest spread discussed above. AFG’s overall net spread earned on fixed annuities decreased 0.16 percentage points to 1.07% in 2018 from 1.23% in 2017 due to the decrease in AFG’s net interest spread, the impact
of changes in the fair value of derivatives and other impacts of the stock market and interest rates on the accounting for FIAs discussed above and the impact of the unlocking of actuarial assumptions discussed below under “Annuity Unlocking.”
Management attributes the 8% decrease in annuity premiums in 2019 compared to 2018 to the lower market interest rate environment. In response to the continued drop in market interest rates during 2019, AFG lowered crediting rates on several products, which has slowed annuity sales compared to 2018 levels.
AFG monitors the major actuarial assumptions underlying its annuity operations throughout the year and conducts detailed reviews (“unlocking”) of its assumptions annually. Beginning with the third quarter of 2019, AFG moved its unlocking from the fourth quarter to the third quarter and expects to continue to conduct the annual review in the third quarter of each year (consistent with many of its peers). If changes in the economic environment or actual experience would cause material revisions to future estimates, these assumptions are updated (unlocked) in an interim period.
The unlocking of the major actuarial assumptions underlying AFG’s annuity operations resulted in net charges related to its annuity business of $1 million, $31 million and $3 million in 2019, 2018 and 2017, respectively, which impacted AFG’s financial statements as follows (in millions):
See “Annuity Unlocking” under “Annuity Segment - Results of Operations” for the quarters ended December 31, 2019 and 2018 for a discussion of the overall net expense reduction from the periodic review of actuarial assumptions in the fourth quarter of 2018.
In addition to the $4 million net charge from the periodic review of annuity assumptions in the fourth quarter of 2018, AFG recorded a $27 million net unlocking charge in the second quarter of 2018 due primarily to the unfavorable impact of higher projected option costs, partially offset by the favorable impact of an increase in projected net interest spreads on in-force business (due primarily to higher than previously anticipated reinvestment rates).
The 2017 net charge reflects the unfavorable impacts of a decrease in projected net interest spreads on in-force business (due primarily to lower than previously anticipated reinvestment rates), a slight increase in projected expenses (due primarily to an increase in projected trailer commissions) and slightly higher projected option costs in the near term, substantially offset by the favorable impact of changes in projected policyholder annuitization and lapse behavior.
Net investment income (as a % of investments) of 4.67%, 4.73% and 4.63% in 2019, 2018 and 2017, respectively, multiplied by the difference between average fixed annuity investments (at amortized cost) and average fixed annuity benefits accumulated in each period.
AFG’s net GAAP pretax loss outside of its property and casualty insurance and annuity segments (excluding realized gains and losses) totaled $165 million in 2018 compared to $252 million in 2017, a decrease of $87 million (35%). AFG’s net core pretax loss outside of its property and casualty insurance and annuity segments (excluding realized gains and losses) totaled $156 million in 2018 compared to $177 million in 2017, a decrease of $21 million (12%).
The following table details AFG’s GAAP and core loss before income taxes from operations outside of its property and casualty insurance and annuity segments in 2019, 2018 and 2017 (dollars in millions):
AFG recorded net investment income on investments held outside of its property and casualty insurance and annuity segments of $43 million, $25 million and $34 million in 2019, 2018 and 2017, respectively. The $18 million (72%) increase in 2019 compared to 2018 and the $9 million (26%) decrease in 2018 compared to 2017 is due primarily to the impact of the market performance on a small portfolio of securities that are carried at fair value through net investment income. These securities increased in value by $13 million in 2019, decreased in value by $4 million in 2018 and increased in value by $6 million in 2017.
Summit, a workers’ compensation insurance subsidiary, collects fees from a small group of unaffiliated insurers for providing underwriting, policy administration and claims services. In addition, certain of AFG’s property and casualty insurance businesses collect fees from customers for ancillary services such as workplace safety programs and premium financing. In both 2019 and 2018, AFG collected $69 million in fees for these services compared to $66 million in 2017. Management views this fee income, net of the $46 million in both 2019 and 2018 and $41 million in 2017, in expenses incurred to generate such fees, as a reduction in the cost of underwriting its property and casualty insurance policies. Consistent with internal management reporting, these fees and the related expenses are netted and recorded as a reduction of commissions and other underwriting expenses in AFG’s segmented results.
The increase in interest expense in 2019 compared to 2018 and the decrease in interest expense in 2018 compared to 2017 reflect the following financing transactions completed by AFG between January 1, 2017 and December 31, 2019:
Issued an additional $240 million of 4.50% Senior Notes in November 2017
AFG’s consolidated realized gains (losses) on securities, which are not allocated to segments, were net gains of $287 million in 2019 compared to net losses of $266 million in 2018, a change of $553 million (208%). AFG’s consolidated realized gains (losses) on securities were net losses of $266 million in 2018 compared to net gains of $5 million in 2017, a change of $271 million (5,420%). Realized gains (losses) on securities consisted of the following (in millions):
amounts include a $169 million net gain and a $279 million net loss on securities that were still held at December 31, 2019 and 2018, respectively.
AFG’s consolidated provision for income taxes was $239 million in 2019 compared to $122 million in 2018, an increase of $117 million (96%). AFG’s consolidated provision for income taxes was $122 million in 2018 compared to $247 million in 2017, a decrease of $125 million (51%). See Note M - “Income Taxes” to the financial statements for an analysis of items affecting AFG’s effective tax rate.
In August 2018, the FASB issued ASU 2018-12, Financial Services - Insurance: Targeted Improvements to the Accounting for Long-Duration Contracts, which changes the assumptions used to measure the liability for future policy benefits for traditional and limited pay contracts (e.g. life, accident and health benefits) from being locked in at inception to being updated at least annually and standardizes the liability discount rate to be used and updated each reporting period, requires the measurement of market risk benefits associated with deposit contracts (e.g. annuities) to be recorded at fair value, simplifies the amortization of deferred policy acquisition costs to a constant level basis over the expected life of the related contracts and requires enhanced disclosures. AFG will be required to adopt this guidance effective January 1, 2022. AFG cannot estimate the impact that the updated guidance will have on its results of operations, financial position or liquidity until the updated guidance is closer to adoption.
Consolidated Statement of Comprehensive Income for the years ended December 31, 2019, 2018 and 2017
Consolidated Statement of Changes in Equity for the years ended December 31, 2019, 2018 and 2017
Consolidated Statement of Cash Flows for the years ended December 31, 2019, 2018 and 2017
Selected Quarterly Financial Data has been included in Note O to the Consolidated Financial Statements.
We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States) (“PCAOB”), the consolidated balance sheets of the Company as of December 31, 2019 and 2018, 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, 2019, and the related notes and financial statement schedules listed in the Index at Item 15(a)(2) and our report dated February 25, 2020 expressed an unqualified opinion thereon.
We obtained an understanding, evaluated the design, and tested the operating effectiveness of controls over management’s valuation process for the fixed-income and equity securities priced using unobservable inputs. This included, among others, testing controls over investment pricing and the development and review of significant inputs and assumptions used in determining the fair values.
Auditing management’s best estimate of reserves was complex because it required the involvement of our actuarial specialists due to the highly judgmental nature of the assumptions used in the evaluation process. The significant judgment was primarily due to the sensitivity of management’s best estimate to the selection and weighting of actuarial methods, loss development factors, expected loss ratios, and inflation. These assumptions have a significant effect on the valuation of reserves.
We obtained an understanding, evaluated the design, and tested the operating effectiveness of controls over the process for estimating amortization of annuity deferred policy acquisition costs. This included, among others, controls over the review and approval processes that management has in place for the assumptions used in measuring estimated gross profits.
To test the amortization of deferred policy acquisition costs related to annuity contracts, our audit procedures included, among others, testing the completeness and accuracy of the data used to calculate the estimated gross profits through testing the reconciliation of the underlying data recorded in the source systems to the actuarial valuation models. With the assistance of our actuarial specialists, we evaluated the assumptions used by management in determining estimated gross profits with those used in prior periods. Also, with the assistance of our actuarial specialists, we compared significant assumptions, including expected investment yields and lapse rates, to prior actual experience and observable market data, and we evaluated management’s estimates of prospective changes in these assumptions. In addition, we performed an independent calculation of estimated and actual gross profits for a sample of product cohorts for comparison with the actuarial model used by management.
To test the embedded derivatives related to fixed-indexed annuity products, our procedures included, among others, testing the completeness and accuracy of data used in the valuation process through testing the reconciliation of the underlying data recorded in the source systems to the actuarial valuation models. With the assistance of our actuarial specialists, we evaluated the methods and assumptions used by management in determining the estimated fair value of the embedded derivatives. We compared the significant assumptions, including expected budget option costs and lapses, to prior actual experience and management’s estimates of prospective changes in these assumptions. In addition, we performed an independent calculation of the embedded derivatives for a sample of policies for comparison with the fair value calculated by the actuarial model used by management.
Basis of Presentation The consolidated financial statements include the accounts of American Financial Group, Inc. and its subsidiaries (“AFG”). Certain reclassifications have been made to prior years to conform to the current year’s presentation. All significant intercompany balances and transactions have been eliminated. The results of operations of companies since their formation or acquisition are included in the consolidated financial statements. Events or transactions occurring subsequent to December 31, 2019, and prior to the filing of this Form 10-K, have been evaluated for potential recognition or disclosure herein.
Following the adoption of ASU 2016-01, holding gains and losses on equity securities carried at fair value are generally recorded in realized gains (losses) on securities. However, AFG records holding gains and losses on securities classified as “trading” under previous guidance, its small portfolio of limited partnerships and similar investments carried at fair value and certain other securities classified at purchase as “fair value through net investment income” in net investment income.
Under the new guidance, AFG recorded holding gains of $207 million on equity securities in net earnings during 2019 on securities still held at December 31, 2019 and holding losses of $257 million on equity securities in net earnings during 2018 on securities that were still owned at December 31, 2018. Under the prior guidance, these holding losses would have been recorded in AOCI until the securities were disposed (with exception of any impairment charge that may have been recorded). Because almost all of the equity securities impacted by the new guidance were carried at fair value through AOCI under the prior guidance, the adoption of the new guidance did not have a material impact on AFG’s financial position.
Gains or losses on fixed maturity securities classified as “available for sale” 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 comprehensive income). The credit-related portion of an other-than-temporary impairment is measured by comparing a security’s amortized cost to the present value of its current expected cash flows discounted at its effective yield prior to the impairment charge. Both components are shown in the statement of earnings. If management intends to sell an impaired security, or it is more likely than not that it will be required to sell the security before recovery, an impairment charge to earnings is recorded to reduce the amortized cost of that security to fair value.
Changes in the fair value of derivatives that are designated and qualify as highly effective cash flow hedges are recorded in AOCI and are reclassified into earnings when the variability of the cash flows from the hedged items impacts earnings. When the change in the fair value of a qualifying cash flow hedge is included in earnings, it is included in the same line item in the statement of earnings as the cash flows from the hedged item. AFG uses interest rate swaps that are designated and qualify as highly effective cash flow hedges to mitigate interest rate risk related to certain floating-rate securities included in AFG’s portfolio of fixed maturity securities.
not separate lease and non-lease components except for buildings (office space and storage facilities),
for contracts existing at the date of adoption - not reassess whether a contract is a lease or contains a lease, how initial direct costs were accounted for or whether the lease is an operating or finance lease, and
use hindsight to determine the lease term for leases existing at the date of adoption.
Adoption of the new guidance resulted in AFG recognizing a lease liability of $198 million (included in other liabilities) and a corresponding right-of-use asset of $174 million (included in other assets and presented net of $24 million in deferred rent and lease incentives) on January 1, 2019. Deferred rent and lease incentives were recognized as liabilities under the previous guidance and result from the straight-line expensing of operating leases. The adoption of the new guidance did not have a material effect on the AFG’s results of operations or liquidity. See Note K - “Leases” for additional disclosures.
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: 2019 - 1.1 million, 2018 - 1.6 million and 2017 - 2.0 million.
There were no anti-dilutive potential common shares related to stock compensation plans or adjustments to net earnings attributable to shareholders in the calculation of diluted earnings per share for the years ended December 31, 2019, 2018 or 2017.
Sales of property and casualty insurance outside of the United States represented 7% of AFG’s revenues in 2019 and in 2018 and 5% of AFG’s revenues in 2017. Approximately two-thirds of these 2019 sales were through the Neon Lloyd’s of London business, which AFG is exiting and will no longer write property and casualty business (beginning in early 2020).
Primarily holding company interest and expenses, including losses on retirement of debt of $5 million in 2019 and $51 million in 2017 and special charges to increase A&E reserves related to AFG’s former railroad and manufacturing operations ($11 million in 2019, $9 million in 2018 and $24 million in 2017).
Accounting standards for measuring fair value are based on inputs used in estimating fair value. The three levels of the hierarchy are as follows:
AFG’s management is responsible for the valuation process and uses data from outside sources (including nationally recognized pricing services and broker/dealers) in establishing fair value. AFG’s internal investment professionals are a group of approximately 20 analysts whose primary responsibility is to manage AFG’s investment portfolio. These professionals monitor individual investments as well as overall industries and are active in the financial markets on a daily basis. The group is led by AFG’s chief investment officer, who reports directly to one of AFG’s Co-CEOs. Valuation techniques utilized by pricing services and prices obtained from external sources are reviewed by AFG’s internal investment professionals who are familiar with the securities being priced and the markets in which they trade to ensure the fair value determination is representative of an exit price. To validate the appropriateness of the prices obtained, these investment managers consider widely published indices (as benchmarks), recent trades, changes in interest rates, general economic conditions and the credit quality of the specific issuers. In addition, the Company communicates directly with the pricing services regarding the methods and assumptions used in pricing, including verifying, on a test basis, the inputs used by the service to value specific securities.
The transfers between Level 1 and Level 2 for the years ended December 31, 2019, 2018 and 2017 are reflected in the table below at fair value as of the end of the reporting period (dollars in millions):
Internally developed Level 3 asset fair values represent approximately $1.36 billion at December 31, 2019. Of this amount, approximately $716 million relates to fixed maturity securities that were priced using management’s best estimate of an appropriate credit spread over the treasury yield (of a similar duration) to discount future expected cash flows using a third-party model. The credit spread applied by management is the significant unobservable input. For this group of approximately 35 securities, the average spread used was 396 basis points over the reference treasury yield and the spreads ranged from 100 basis points to 1,253 basis points (approximately 70% of the spreads were between 200 and 700 basis points). Had management used higher spreads, the fair value of this group of securities would have been lower. Conversely, if the spreads used were lower, the fair values would have been higher. For the remainder of the internally developed prices, any justifiable changes in unobservable inputs used to determine fair value would not have resulted in a material change in AFG’s financial position.
The range of adjustments for insurance subsidiary’s credit risk is based on the Moody’s corporate A2 bond index and reflects credit spread variations across the yield curve. The range of projected surrender rates reflects the specific surrender charges and other features of AFG’s individual fixed-indexed and variable-indexed annuity products with an expected range of 7% to 10% in the majority of future calendar years (3% to 22% over all periods). Increasing the budgeted option cost or risk margin for uncertainty in cash flow assumptions in the table above would increase the fair value of the fixed-indexed and variable-indexed annuity embedded derivatives, while increasing any of the other unobservable inputs in the table above would decrease the fair value of the embedded derivatives.
Changes in balances of Level 3 financial assets and liabilities carried at fair value during 2019, 2018 and 2017 are presented below (in millions). The transfers into and out of Level 3 were due to changes in the availability of market observable inputs and $29 million of equity securities transferred into Level 3 in the first quarter of 2018 related to a small number of limited partnerships and similar investments carried at cost under the prior guidance that are carried at fair value through net earnings under new guidance adopted on January 1, 2018, as discussed in Note A - “Accounting Policies - Investments.” All transfers are reflected in the table at fair value as of the end of the reporting period.
Total realized/unrealized gains (losses) included in net earnings for the embedded derivatives includes losses related to the unlocking of actuarial assumptions of $25 million in 2017.
The non-credit related portion of other-than-temporary impairment charges is included in other comprehensive income. Cumulative non-credit charges taken for securities still owned at December 31, 2019 and December 31, 2018 were $118 million and $140 million, respectively. Gross unrealized gains on such securities at December 31, 2019 and December 31, 2018 were $114 million and $119 million, respectively. Gross unrealized losses on such securities at December 31, 2019 and December 31, 2018 were $1 million and $4 million, respectively. These amounts represent the non-credit other-than-temporary impairment charges recorded in AOCI adjusted for subsequent changes in fair values and relate primarily to residential MBS.
The following tables show gross unrealized losses (dollars in millions) on available for sale fixed maturities by investment category and length of time that individual securities have been in a continuous unrealized loss position at the following balance sheet dates.
At December 31, 2019, the gross unrealized losses on fixed maturities of $88 million relate to 649 securities. Investment grade securities (as determined by nationally recognized rating agencies) represented approximately 74% of the gross unrealized loss and 93% of the fair value.
whether the unrealized loss is credit-driven or a result of changes in market interest rates,
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, 2019.
As discussed in Note A - “Accounting Policies - Investments,” effective January 1, 2018, all equity securities previously classified as “available for sale” are required to be carried at fair value through net earnings instead of accumulated other comprehensive income and therefore are no longer evaluated for other-than-temporary impairment. In 2017, AFG recorded other-than-temporary impairment charges on equity securities classified as available for sale of $64 million.
The table below sets forth the scheduled maturities of available for sale fixed maturities as of December 31, 2019 (dollars in millions). 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.
Realized gains (losses) and changes in unrealized appreciation (depreciation) included in AOCI related to fixed maturity and equity security investments are summarized as follows (in millions):
Gross realized gains and losses (excluding impairment write-downs and mark-to-market of derivatives) on available for sale fixed maturity investment transactions consisted of the following (in millions):
During 2017, AFG recorded gross gains of $87 million and gross losses of $17 million on available for sale equity securities.
As discussed under “Derivatives” in Note A - “Accounting Policies,” AFG uses derivatives in certain areas of its operations.
AFG’s fixed-indexed and variable-indexed annuities provide policyholders with a crediting rate tied, in part, to the performance of an existing stock market or other financial index. AFG attempts to mitigate the risk in the index-based component of these products through the purchase and sale of call and put options on the appropriate index. AFG receives collateral from certain counterparties to support its purchased call option assets (net of collateral required under put option contracts with the same counterparties). This collateral ($577 million at December 31, 2019 and $103 million at December 31, 2018) is included in other assets in AFG’s Balance Sheet with an offsetting liability to return the collateral, which is included in other liabilities. AFG’s strategy is designed so that the net change in the fair value of the call and put options will generally offset the economic change in the net liability from the index participation. Both the index-based component of the annuities (an embedded derivative) and the related call and put options are considered derivatives that must be adjusted for changes in fair value through earnings each period. The fair values of these derivatives are impacted by actual and expected stock market performance and interest rates as well as other factors. Fluctuations in certain of these factors, such as changes in interest rates and the performance of the stock market, are not economic in nature for the current reporting period, but rather impact the timing of reported results.
Under the terms of the swaps, AFG receives fixed-rate interest payments in exchange for variable interest payments based on short-term LIBOR. The notional amounts of the interest rate swaps generally decline over each swap’s respective life (the swaps expire between April 2020 and June 2030) in anticipation of the expected decline in AFG’s portfolio of fixed maturity securities with floating interest rates based on short-term LIBOR. The total outstanding notional amount of AFG’s interest rate swaps was $1.98 billion at December 31, 2019 compared to $2.35 billion at December 31, 2018, reflecting the scheduled amortization discussed above, the termination of two swaps with notional amounts of $138 million and $100 million (on the settlement dates) in the second quarter and fourth quarter of 2019, respectively, and the expiration of a swap with a notional amount of $78 million (on the expiration date) in the third quarter of 2019. The fair value of the interest rate swaps in an asset position and included in other assets was $50 million at December 31, 2019 and $16 million at December 31, 2018. The fair value of the interest rate swaps in a liability position and included in other liabilities was $5 million at December 31, 2019 and $46 million at December 31, 2018. The net unrealized gain or loss on cash flow hedges is included in AOCI, net of DPAC and deferred taxes. Amounts reclassified from AOCI (before DPAC and taxes) to net investment income were income of $3 million in 2019, losses of $3 million in 2018 and income of $6 million in 2017. A collateral receivable supporting these swaps of $20 million at December 31, 2019 and $135 million at December 31, 2018 is included in other assets in AFG’s Balance Sheet.
Adjustments to DPAC related to net unrealized gains/losses on securities and cash flow hedges.
The present value of future profits (“PVFP”) amounts in the table above are net of $154 million and $148 million of accumulated amortization at December 31, 2019 and 2018, respectively. During each of the next five years, the PVFP is expected to decrease at a rate of approximately one-eighth of the balance at the beginning of each respective year.
AFG is the investment manager and its subsidiaries have investments ranging from 15.0% to 60.9% of the most subordinate debt tranche of eleven active collateralized loan obligation entities (“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 2012 and 2018, 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 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.
In addition to the CLOs that it manages, AFG had investments in CLOs that are managed by third parties (therefore not consolidated), which are included in available for sale fixed maturity securities and had a carrying value of $4.28 billion at both December 31, 2019 and December 31, 2018.
Changes in the carrying value of goodwill during 2017, 2018 and 2019, by reporting segment, are presented in the following table (in millions):
AFG has no scheduled principal payments on its long-term debt in the next five years.
In March 2019, AFG issued $125 million in 5.875% Subordinated Debentures due in 2059.
AFG can borrow up to $500 million under its revolving credit facility, which expires in June 2021. 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, 2019 or December 31, 2018.
AFG and its subsidiaries lease real estate that is primarily used for office space and, to a lesser extent, equipment under operating lease arrangements. Most of AFG’s real estate leases include an option to extend or renew the lease term at AFG’s option. The operating lease liability includes lease payments related to options to extend or renew the lease term if AFG is reasonably certain of exercising those options. Lease payments are discounted using the implicit discount rate in the lease. If the implicit discount rate for the lease cannot be readily determined, AFG uses an estimate of its incremental secured borrowing rate. AFG did not have any material contracts accounted for as finance leases at December 31, 2019 or January 1, 2019.
At December 31, 2019, AFG’s $158 million operating lease right-of-use asset (presented net of $22 million in deferred rent and lease incentives) and $180 million operating lease liability are included in other assets and other liabilities, respectively, in AFG’s Balance Sheet.
The following table presents the undiscounted contractual maturities of AFG’s operating lease liability at December 31, 2019 (in millions):
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.
AFG issued 45,804 shares (fair value of $115.49 per share) in the first quarter of 2018 under its Equity Bonus Plan.
Total compensation expense related to stock incentive plans of AFG and its subsidiaries was $23 million for 2019 and 2018 and $30 million for 2017. AFG’s provision for income tax includes tax benefits of $13 million in 2019 and 2018 and $27 million in 2017 related to AFG’s stock incentive plans. At December 31, 2019, there was $36 million of unrecognized compensation expense related to restricted stock awards, which is expected to be recognized over a weighted average of 2.4 years. At December 31, 2019, there was less than $1 million of unrecognized compensation expense related to unvested stock options, which will be recognized in the first quarter of 2020.
Includes net unrealized gains of $55 million at December 31, 2019 compared to $58 million and $68 million at December 31, 2018 and 2017, related to securities for which only the credit portion of an other-than-temporary impairment has been recorded in earnings.
The following is a reconciliation of income taxes at the statutory rate (21% in 2019 and 2018 and 35% in 2017) to the provision for income taxes as shown in AFG’s Statement of Earnings (dollars in millions):
In 2011, cumulative losses at Neon across multiple lines of business resulted in uncertainty concerning the realization of the deferred tax benefits associated with the losses. Consequently, AFG began maintaining a full valuation allowance against the deferred tax assets related to the Lloyd’s insurance business in 2011.
The sale of the noncontrolling interest in Neon in the fourth quarter of 2017 resulted in the recognition of a tax benefit of $56 million, including the recognition of a deferred loss from the 2016 restructuring of Neon. Approximately $20 million of the $56 million tax benefit recorded in 2017 reduced current taxes payable for 2017. The majority of the remaining 2017
Excluding the tax benefit related to the Neon restructuring and the impact of the change in the U.S. corporate tax rate, AFG’s effective tax rate for the year ended December 31, 2017 was 31%.
AFG’s 2013 - 2019 tax years remain subject to examination by the IRS.
AFG’s net deferred tax asset at December 31, 2019 and 2018 is included in other assets in AFG’s Balance Sheet. The decrease in AFG’s net deferred tax asset at December 31, 2019 compared to December 31, 2018 reflects significantly higher pretax unrealized gains on securities.
“Foreign underwriting losses” in the table above is primarily the net operating loss carryforward and other deferred tax assets related to the Neon Lloyd’s insurance business. Due to uncertainty concerning the realization of the deferred tax benefits associated with these losses, AFG maintains a full valuation allowance of $118 million against these deferred tax assets at December 31, 2019. In addition to the valuation allowance related to the Neon Lloyd’s insurance business, the gross deferred tax asset has also been reduced by a $19 million valuation allowance related to AFG’s net operating loss carryforwards (“NOL”) subject to the separate return limitation year (“SRLY”) tax rules. A SRLY NOL can be used only by the entity that created it and only in years that both it and the consolidated group have taxable income. Approximately $19 million of AFG’s SRLY NOLs expired unutilized at December 31, 2019. Since AFG maintains a full valuation allowance against its SRLY NOLs, the expiration of these loss carryforwards was offset by corresponding reduction in the valuation allowance and had no overall impact on AFG’s income tax expense or results of operations.
At December 31, 2019, there are no unrecognized tax benefits and related interest and penalties that, if recognized, would impact the effective tax rate. The total unrecognized tax benefits and related interest and penalties that, if recognized, would impact the effective tax rate was less than $1 million at December 31, 2018. There is no interest expense related to unrecognized tax benefits included in AFG’s provision for income taxes in 2019; AFG’s provision for income taxes in 2018 and 2017 included interest expense related to unrecognized tax benefits of less than $1 million in each year (net of federal benefit or expense). There is no liability for interest related to unrecognized tax benefits at December 31, 2019 or December 31, 2018. AFG’s provision for income taxes in 2019, 2018 and 2017 included penalties of less than $1 million in each year. There is no liability for penalties related to unrecognized tax benefits at December 31, 2019; AFG’s liability for penalties related to unrecognized tax benefits was less than $1 million at December 31, 2018.
Cash payments for income taxes, net of refunds, were $278 million, $156 million and $194 million for 2019, 2018 and 2017, respectively.
The following are quarterly results of consolidated operations for the two years ended December 31, 2019 (in millions, except per share amounts). Quarterly earnings per share do not add to year-to-date amounts due to changes in shares outstanding.
FIAs provide policyholders with a crediting rate tied, in part, to the performance of an existing stock market or other financial index. AFG attempts to mitigate the risk in the index-based component of these products through the purchase and sale of call and put options on the appropriate index. AFG’s strategy is designed so that the change in the fair value of the call and put options will generally offset the economic change in the liabilities from the index participation. Both the index-based component of the annuities and the related call and put options are considered derivatives that must be
marked-to-market through earnings each period. Fluctuations in interest rates and the stock market, among other factors, can cause volatility in the periodic measurement of these derivatives and other FIA liabilities over or under the cost of the equity index options purchased to mitigate the risk in the index-based component of those FIAs.
Favorable prior year development of AFG’s liability for property and casualty losses and loss adjustment expenses (”LAE”) was as follows (in millions):
Prior year development in both the third quarters of 2019 and 2018 includes pretax special charges of $18 million to strengthen property and casualty insurance A&E reserves.
Results for the third quarter of 2019 and 2018 include pretax special charges of $11 million and $9 million, respectively, to strengthen reserves for A&E exposures related to AFG’s former railroad and manufacturing operations.
Holding company expenses were $20 million higher in the fourth quarter of 2019 compared to the fourth quarter of 2018 due primarily to higher expenses related to employee benefit plans that are tied to stock market performance.
The process used to determine the total reserve for liabilities involves estimating the ultimate incurred losses and LAE, adjusted for amounts already paid on the claims. The IBNR reserve is derived by first estimating the ultimate unpaid reserve liability and subtracting case reserves for loss and LAE.
The net decrease in the provision for claims of prior years in 2019 reflects (i) lower than expected claim frequency and severity at National Interstate and lower than expected losses in the crop business (all within the Property and transportation sub-segment), (ii) lower than anticipated claim frequency and severity in the workers’ compensation businesses (within the Specialty casualty sub-segment), and (iii) lower than expected claim frequency and severity in the surety and financial institutions businesses and lower than anticipated claim severity in the foreign credit business (all within the Specialty financial sub-segment). This favorable development was partially offset by (i) the $18 million special charge to increase asbestos and environmental reserves and adverse reserve development of $7 million on Neon’s exited lines of business, (ii) higher than expected claim severity in the excess and surplus lines businesses and higher than expected claim frequency in product liability contractor claims (all within the Specialty casualty sub-segment), and (iii) net adverse reserve development related to business outside the Specialty group that AFG no longer writes.
The net decrease in the provision for claims of prior years in 2017 reflects (i) lower than expected losses in the crop and equine businesses and lower than expected claim severity in the property and inland marine and transportation businesses (all within the Property and transportation sub-segment), (ii) favorable reserve development of $18 million on Neon’s exited lines, as well as additional favorable development on ongoing lines of business within Neon, recorded in connection with the reinsurance to close agreement entered into in December 2017 for the 2015 and prior years of account, lower than anticipated claim severity in the workers’ compensation businesses and lower than expected losses in the executive liability business (all within the Specialty casualty sub-segment) and (iii) lower than anticipated claim severity in the fidelity business and lower than expected claim frequency and severity in the surety business (both within the Specialty financial sub-segment). This favorable development was partially offset by (i) the $89 million special charge
to increase asbestos and environmental reserves, (ii) higher than expected claim frequency and severity in the ocean marine business (within the Property and transportation sub-segment), (iii) higher than anticipated claim severity in the targeted markets and general liability businesses and higher than anticipated severity in New York contractor claims (all within the Specialty casualty sub-segment) and (iv) a charge to adjust to the deferred gain on the retroactive reinsurance transaction entered into in connection with the sale of businesses in 1998 (included in Other specialty sub-segment).
Represents the cumulative percentage paid of incurred claims and allocated LAE (net of reinsurance, as estimated at December 31, 2019).
In 2019, GALIC refinanced the terms on advances totaling $610 million. In the fourth quarter of 2018, GALIC refinanced the terms on a $40 million advance and the FHLB advanced GALIC $225 million. At both December 31, 2019 and December 31, 2018, GALIC had $1.10 billion in outstanding advances from the FHLB (included in annuity benefits accumulated), bearing interest at rates ranging from 0.13% to 0.21% over LIBOR (average rate of 1.95% at December 31, 2019). While these advances must be repaid between 2020 and 2021 ($310 million in 2020 and $786 million in 2021), GALIC has the option to prepay all or a portion of the advances. GALIC has invested the proceeds from the advances in fixed maturity securities with similar expected lives as the advances for the purpose of earning a spread over the interest payments due to the FHLB. The advances on these agreements are collateralized by fixed maturity investments, which have a total fair value of $1.27 billion (included in available for sale fixed maturity securities) at December 31, 2019. Interest credited on the funding agreements, which is included in annuity benefits, was $27 million in 2019, $20 million in 2018 and $14 million in 2017.
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, 2019 and 2018, 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, 2019 or 2018.
Payments of dividends by AFG’s insurance companies are subject to various state laws that limit the amount of dividends that can be paid. Under applicable restrictions, the maximum amount of dividends available to AFG in 2020 from its insurance subsidiaries without seeking regulatory approval is $852 million. Additional amounts of dividends require regulatory approval.
Holding Company Dividends AFG declared and paid common stock dividends to shareholders totaling $446 million, $397 million and $421 million in 2019, 2018 and 2017, respectively. Currently, there are no regulatory restrictions on AFG’s retained earnings or net earnings that materially impact its ability to pay dividends. Based on shareholders’ equity at December 31, 2019, AFG could pay dividends in excess of $2.5 billion without violating its most restrictive debt covenant. However, the payment of future dividends will be at the discretion of AFG’s Board of Directors and will be dependent on many factors including AFG’s financial condition and results of operations, the capital requirements of its insurance subsidiaries, and rating agency commitments.
Allowance for Uncollectible Reinsurance AFG’s aggregate allowance for uncollectible reinsurance recoverables was $18 million at both December 31, 2019 and December 31, 2018. AFG reviews the allowance quarterly and adjusts it as necessary to reflect changes in estimates of uncollectible balances. AFG recorded net expense reductions against the allowance of less than $1 million in 2019, $2 million in 2018 and less than $1 million in 2017. In 2017, the allowance was reduced by reinsurance recoverable write-offs of $2 million.
See Note A - “Accounting Policies - Credit Impairment Guidance Effective in 2020” for a discussion of accounting guidance adopted on January 1, 2020, which provides a new credit loss model for determining credit-related impairments for reinsurance recoverables and requires an entity to estimate the credit losses expected over the life of an exposure or pool of exposures. The new guidance is not expected to have a material impact on AFG’s results of operations or financial position.
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, 2019, AFG and its subsidiaries had commitments to fund credit facilities and contribute capital to limited partnerships and limited liability corporations of approximately $897 million.
The information required by the following Items will be included in AFG’s definitive Proxy Statement for the 2020 Annual Meeting of Shareholders, which will be filed with the Securities and Exchange Commission within 120 days after the end of the Registrant’s fiscal year and is incorporated herein by reference.
Amended and Restated Non-Employee Directors Compensation Plan, filed as Exhibit 10 to the Form S-8 Registration Statement (File No. 333-184913) filed by AFG on November 13, 2012.
Certification of Co-Chief Executive Officer pursuant to Section 302(a) of the Sarbanes-Oxley Act of 2002.
XBRL Instance Document - the instance document does not appear in the Interactive Data File because its XBRL tags are embedded within the Inline XBRL document.
Cover Page Interactive Data File (formatted as Inline XBRL and contained in Exhibit 101).