Subsidiaries of AFG own several buildings in downtown Cincinnati. AFG and its affiliates occupy about three-fourths of the aggregate 675,000 square feet of commercial and office space.
Reflects the results of Transport Insurance Company which is expected to be sold in 2004.
AFG strengthened its capital and liquidity during 2003 with shareholders' equity growing by more than $350 million (20%) to $2.1 billion. Nearly half of this increase resulted from the elimination of a deferred tax liability following the merger of AFG and two subsidiary holding companies in November. In the merger, AFG issued 3.3 million common shares to retire all $72 million of voting preferred stock of the subsidiary holding company, American Financial Corporation, thereby reducing annual dividends by over $4 million.
AFG received $186 million on the February initial public offering of 61% of Infinity Property and Casualty, a former subsidiary engaged primarily in nonstandard automobile insurance.
In addition, AFG and its subsidiaries issued just over $200 million in debt during the first quarter of 2004 and used the proceeds primarily to retire higher coupon trust preferred securities.
referred to as a "hard market" or "upcycle." The 1990's were a soft market period; prices started to harden in 2000 and accelerated significantly following the terrorist attacks in 2001. Rates have continued to rise into 2004, although the increases have moderated somewhat during the latter part of 2003.
Net realized gains of $50.8 million on the sale of securities, subsidiaries and investees.
Charge of $28.5 million for an arbitration decision relating to a 1995 property insurance claim.
Impairment provision of $35.8 million (included in discontinued operations) related to the planned disposal of an inactive property and casualty subsidiary with approximately one-eighth of AFG's total asbestos and environmental liabilities.
AFG's debt to total capital ratio (at the parent holding company level) was approximately 21% at December 31, 2003, compared to 25% at December 31, 2002.
AFG's ratio of earnings to fixed charges, including annuity benefits as a fixed charge, was 1.69 for the year ended December 31, 2003. Excluding annuity benefits, this ratio was 3.71 for 2003. Although the ratio excluding interest on annuities is not required or encouraged to be disclosed under Securities and Exchange Commission rules, it is presented because interest credited to annuity policyholder accounts is not always considered a borrowing cost for an insurance company.
AFG is organized as a holding company with almost all of its operations being conducted by subsidiaries. AFG, however, has continuing cash needs for administrative expenses, the payment of principal and interest on borrowings, shareholder dividends, and taxes. Funds to meet these obligations come primarily from dividend and tax payments from its subsidiaries.
Management believes AFG has sufficient resources to meet its liquidity requirements. If funds generated from operations, including dividends and tax payments from subsidiaries, are insufficient to meet fixed charges in any period, AFG would be required to generate cash through borrowings, sales of securities or other assets, or similar transactions.
The AFG Convertible Debentures issued in 2003 are included in the above table at the first put date (2008). AFG's Balance Sheet at December 31, 2003, includes estimated liabilities for claims and benefits payable related to its insurance operations. AFG expects operating cash flows to be sufficient to meet these obligations and also have marketable investments available for sale should the operating cash flows prove to be inadequate.
AFG has no material contractual purchase obligations or other long-term liabilities at December 31, 2003.
Approximately two-thirds of AFG's consolidated assets are invested in marketable securities. AFG's investment portfolio at December 31, 2003, contained $12 billion in "Fixed maturities" classified as available-for-sale and $455 million in "Other stocks", all carried at market value with unrealized gains and losses reported as a separate component of shareholders' equity on an after-tax basis. At December 31, 2003, AFG had pretax net unrealized gains of $377.8 million on fixed maturities and $196.4 million on other stocks. AFG attempts to optimize investment income while building the value of its portfolio, placing emphasis upon long-term performance.
Approximately 93% of the fixed maturities held by AFG were rated "investment grade" (credit rating of AAA to BBB) by nationally recognized rating agencies at December 31, 2003. Investment grade securities generally bear lower yields and lower degrees of risk than those that are unrated or noninvestment grade. Management believes that the high quality investment portfolio should generate a stable and predictable investment return.
Investments in mortgage backed securities ("MBSs") represented approximately one-fourth of AFG's fixed maturities at December 31, 2003. MBSs are subject to significant prepayment risk due to the fact that, 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. Due to the significant decline in the general level of interest rates in 2002 and 2003, AFG has experienced an increase in the level of prepayments on its MBSs; these prepayments have not been reinvested at interest rates comparable to the rates earned on the prepaid MBSs. Substantially all of AFG's MBSs are investment grade quality, with over 95% rated "AAA" at December 31, 2003.
AFG's investment in equity securities of Provident Financial Group, a Cincinnati-based commercial banking and financial services company, represents $159 million of the $197 million in unrealized gains on other stocks at December 31, 2003.
The following table summarizes (dollars in millions) the unrealized loss for all fixed maturity securities with unrealized losses by issuer quality and length of time those securities have been in an unrealized loss position.
Net realized gains (losses) on securities sold and charges for "other than temporary" impairment on securities held were as follows (in millions):
Does not include $16.9 million writedown of certain collateralized debt obligations which was recorded as the cumulative effect of an adoption of an accounting change at April 1, 2001.
While current factors and reasonably likely changes in variable factors are considered in estimating the liability for unpaid losses, there is no method or system which can eliminate the risk of actual ultimate results differing from such estimates. As shown in the reserve development table (loss triangle) on page 11, the original estimates of AFG's liability for losses and loss adjustment expenses, net of reinsurance, over the past 10 years have developed through December 31, 2003, to be deficient (for three years) by as much as 10.4% and redundant (for 7 years) by as much as 7.2% (excluding the effect of special charges for asbestos and environmental exposures). AFG believes this development illustrates the variability in factors considered in estimating its insurance reserves.
Quarterly reviews of unpaid loss and LAE reserves are prepared using standard actuarial techniques. These may include: Case Incurred Development Method; Paid Development Method; Bornhuetter-Ferguson Method; and Incremental Paid LAE to Paid Loss Methods. Generally, data is segmented by major product or coverage within product using countrywide data; however, in some situations data may be reviewed by state or region.
In February 2003, Great American Insurance Company entered into an agreement for the settlement of asbestos related coverage litigation under insurance polices issued during the 1970's and 1980's to Bigelow-Liptak Corporation and related companies, subsequently known as A.P. Green Industries, Inc. Management believes that this settlement will enhance financial certainty and provides resolution to litigation that represents AFG's largest known asbestos-related claim and the only such claim that management believes to be material.
The assumed reinsurance business includes exposures for the periods 1954 to 1983. The asbestos and environmental assumed claims are ceded by various insurance companies under reinsurance treaties. A majority of the individual assumed claims have exposures of less than $100,000 to AFG. Asbestos losses assumed include some of the industry known manufacturers, distributors and installers. Pollution losses include industry known insured names and sites.
Other mass tort losses include lead, silica and various chemical exposures.
Market risk represents the potential economic loss arising from adverse changes in the fair value of financial instruments. AFG's exposures to market risk relate primarily to its investment portfolio and annuity contracts which are exposed to interest rate risk and, to a lesser extent, equity price risk. To a much lesser extent, AFG's long-term debt is also exposed to interest rate risk.
Substantially all of GAFRI's fixed rate annuity contracts permit GAFRI to change crediting rates (subject to minimum interest rate guarantees of 3% to 4% per annum as determined by applicable law) enabling management to react to changes in market interest rates. Nonetheless, due to the drop in interest rates, GAFRI's spreads have narrowed and will likely continue to narrow through at least 2004. In the fourth quarter of 2003, GAFRI began to issue a portion of new business using a minimum interest guarantee of less than 3% in states where required approvals have been received. Actuarial assumptions used to estimate DPAC and annuity benefits, as well as GAFRI's ability to maintain spread, could be impacted if the current interest rate environment continues for an extended period and causes policyholder behavior to be altered.
Projected payments (in millions) in each of the subsequent five years and for all years thereafter on GAFRI's fixed annuity liabilities at December 31 were as follows.
The following table shows scheduled principal payments (in millions) on fixed-rate long-term debt of AFG and its subsidiaries and related weighted average interest rates for each of the subsequent five years and for all years thereafter.
For certain lines of business and products where the credibility of the range of loss estimates is less certain (primarily many of the various specialty businesses listed above), management believes that it is prudent and appropriate to use conservative assumptions until such time as the data, experience and projections have more credibility, as evidenced by data volume, consistency and maturity of the data. While this practice mitigates the risk of adverse development on this business, it does not eliminate it.
AFG's combined ratio has been better than the industry average for seventeen of the last eighteen years and excluding AFG's special A&E charges, for all eighteen years. Management believes that AFG's insurance operations have performed better than the industry as a result of product line diversification and stringent underwriting discipline.
(b) Includes 2.3 points in 2003 for the effect of an arbitration decision
relating to a claim arising from a business in runoff, 1.2 points for
2002 relating to the A. P. Green asbestos litigation charge and 3.6 points
As shown in Note P under "Insurance Reserves," AFG's property and casualty operations recorded loss development of $167 million in 2003, $171 million in 2002 and $163 million in 2001 related to prior accident years. Major areas of adverse development were as follows (in millions):
The prior year development in Property and transportation related primarily to higher than anticipated frequency of claims in the 1993 through 2001 accident years for the homebuilders' liability business, which is in runoff.
During the third quarter of 2001, AFG recorded an A&E charge of $100 million after experiencing an increase in the number and severity of asbestos claims and observing the developments of adverse trends in the property and casualty insurance industry concerning asbestos losses. Of this charge, $31 million was recorded by Transport Insurance Company, which has been reclassified to discontinued operations. This charge, accompanied by a transfer of $36 million from excess reserves for other environmental claims, resulted in an increase of $136 million in asbestos reserves. For a discussion of uncertainties relative to asbestos and environmental claims, see "Uncertainties - Asbestos and Environmental-related Reserves".
The 2.3 point improvement in property and transportation's combined ratio reflects rate increases, partially offset by $13 million in additional prior year development in 2003 compared to 2002. Specialty Casualty's 8.4 point combined ratio improvement is primarily due to rate increases.
The Personal group results represent primarily Infinity's underwriting results through the public offering in mid-February 2003 and the direct-to-consumer auto business, which was sold in April 2003. AFG's remaining personal lines business generated about 3% of net written premiums in 2003 and 2002.
Realized gains (losses) on sales of securities include provisions for other than temporary impairment of securities still held of $58.4 million in 2003, $179.4 million in 2002 and $125.5 million in 2001. Impairment charges in 2003 reflect primarily the downturn in the airline industry and writedowns of certain asset-backed securities. Impairment charges in 2002 and 2001 reflect primarily the downturn in the communications and airline industries and writedowns of certain asset-backed securities.
Realized gains (losses) on securities include losses of $1.1 million in 2003 and $11.9 million in 2002, and gains of $5.2 million in 2001 to adjust the carrying value of AFG's investment in warrants to market value under SFAS No. 133.
Other income increased $37.3 million (17%) in 2002 due primarily to higher income from real estate operations (including the effect of property sales and a hotel acquired in May 2002), increased fees earned by the Specialty group's new warranty business and higher fee income in certain other specialty insurance operations.
Annuity benefits reflect amounts accrued on annuity policyholders' funds accumulated. On its deferred annuities (annuities in the accumulation phase), GAFRI generally credits interest to policyholders' accounts at their current stated interest rates. Furthermore, for "two-tier" deferred annuities (annuities under which a higher interest amount can be earned if a policy is annuitized rather than surrendered), GAFRI accrues an additional liability to provide for expected deaths and annuitizations. Changes in crediting rates, actual surrender, death and annuitization experience or modifications in actuarial assumptions can affect this accrual.
The majority of GAFRI's fixed annuity products permit GAFRI to change the crediting rate at any time subject to minimum interest rate guarantees (as determined by applicable law). Approximately half of the annuity benefits accumulated relate to policies that have a minimum guarantee of 3%; the majority of the balance has a guarantee of 4%. In states where required approvals have been received, GAFRI has begun issuing products with guaranteed minimum crediting rates of less than 3% beginning in the fourth quarter of 2003.
Changes in interest expense result from fluctuations in market rates as well as changes in borrowings. AFG has generally financed its borrowings on a long-term basis which has resulted in higher current costs.
2002 compared to 2001 Interest expense was virtually unchanged in 2002 as lower average rates on AFG's variable rate debt were substantially offset by higher average indebtedness and higher average payable to reinsurers balances.
The 2003 provision for income taxes includes a benefit of $136 million related to the AFG/AFC merger for the effect of the elimination of deferred tax liabilities associated with AFC's holding of AFG stock and reflects $5.5 million in tax benefits related to AFG's basis in Infinity stock. The 2002 provision for income taxes includes $31 million in tax benefits for the reduction of previously accrued amounts due to the resolution of certain tax matters. See Note K to the Financial Statements for more information on the effects of the AFG/AFC merger and an analysis of items affecting AFG's effective tax rate.
Equity in earnings (losses) of investees also includes losses of two start-up manufacturing businesses that were formerly subsidiaries. Equity in net earnings (losses) of investees includes $3.1 million in 2003 compared to $3.6 million in 2002 and $2.9 million in 2001 in losses of one of these businesses. Investee losses in 2002 and 2001 include $5.4 million and $13.7 million (including litigation judgments of $4.7 million), respectively, in losses of the other manufacturing business, which sold substantially all of its assets in December 2002.
Effective January 1, 2002, AFG implemented Statement of Financial Accounting Standards ("SFAS") No. 142, "Goodwill and Other Intangible Assets", under which goodwill is no longer amortized, but is subject to an impairment test at least annually. The initial impairment testing resulted in a charge of $40.4 million (net of minority interest and taxes) for the cumulative effect of a change in accounting principle.
GAFRI will adopt the SOP effective January 1, 2004. Although interpretation of accounting for certain items covered by the SOP has not been finalized, the effect of initially adopting this SOP is expected to be less than 1% of AFG's equity and will be reported as a cumulative effect of a change in accounting principle in the 2004 results of operations. This effect results primarily from the change in accounting for persistency bonuses. GAFRI does not expect that the final amount will have a material adverse impact on the company.
We have audited the accompanying consolidated balance sheet of American Financial Group, Inc. and subsidiaries as of December 31, 2003 and 2002, and the related consolidated statements of operations, changes in shareholders' equity and cash flows for each of the three years in the period ended December 31, 2003. Our audits also included the financial statement schedules listed in the Index at Item 15(a). These financial statements and schedules are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements and schedules based on our audits.
In our opinion, the financial statements referred to above present fairly, in all material respects, the consolidated financial position of American Financial Group, Inc. and subsidiaries at December 31, 2003 and 2002, and the consolidated results of their operations and their cash flows for each of the three years in the period ended December 31, 2003, in conformity with accounting principles generally accepted in the United States. Also, in our opinion, the related financial statement schedules, when considered in relation to the basic financial statements taken as a whole, present fairly in all material respects the information set forth therein.
As discussed in Notes A and E to the consolidated financial statements, in 2002, the Company implemented Statement of Financial Accounting Standards No. 142, which required a change in the method of accounting for goodwill, and in 2003, the Company implemented FASB interpretation No. 46, which required a change in consolidation policy related to variable interest entities.
Early in 2003, AFG began an analysis of alternatives to simplify its corporate structure and promote easier oversight, analysis and operation of its subsidiaries. As a result, mergers and a recapitalization were consummated. Committees of independent directors conducted the analyses with the counsel of recognized outside experts and approved each of the transactions. AFG merged with two of its subsidiaries, American Financial Corporation ("AFC") and AFC Holding Company with AFC's Series J Preferred stock being acquired and retired in exchange for approximately 3.3 million shares of AFG Common Stock (aggregate value of $75 million). In addition, approximately $170 million in deferred tax liabilities associated with AFC's holding of AFG stock were eliminated. As of January 31, 2004, American Premier Underwriters, Inc. ("APU", a wholly-owned subsidiary) paid an extraordinary dividend consisting of approximately two-thirds of its assets, including insurance subsidiaries, to its immediate parent, APU Holding Company, and retained sufficient assets to enable it to meet its estimated liabilities.
Gains or losses on securities are determined on the specific identification basis. When a decline in the value of a specific investment is considered to be other than temporary, a provision for impairment is charged to earnings (included in realized gains) and the cost basis of that investment is reduced.
The Financial Accounting Standards Board ("FASB") issued revised Interpretation ("FIN") No. 46, "Consolidation of Variable Interest Entities" ("VIEs") in December 2003. FIN 46 sets forth the requirements for consolidating entities that do not share economic risk and reward through typical equity ownership, but rather through contractual relationships that distribute economic risks and rewards among various parties. Once an entity is determined to be a VIE, it is generally required to be consolidated by the primary beneficiary (the party with a majority of either the expected losses or residual rewards or both). Under FIN 46, AFG is considered to be the primary beneficiary of a collateralized debt obligation ("CDO") in which it owns subordinated notes (considered equity) representing approximately two-thirds of the CDO's equity (but less than 50% of the voting power) and 5% of the total notes issued by the CDO. Accordingly, AFG implemented FIN 46 effective December 31, 2003; the cumulative difference between accounting for the CDO as an investment and as a consolidated subsidiary at that date is shown in the Statement of Operations as the cumulative effect of an accounting change. Since AFG has no right to use the CDO assets and the CDO liabilities can be extinguished only by using CDO assets, the assets and liabilities of the CDO are shown separate from AFG's other assets and liabilities in the Consolidated Balance Sheet.
GAFRI's subsidiaries cede life insurance policies to a third party on a funds withheld basis where GAFRI retains the assets (securities) associated with the reinsurance contracts. Interest is credited to the reinsurer based on the actual investment performance (including realized gains and losses) of the retained assets. Effective October 1, 2003, GAFRI implemented SFAS No. 133 Implementation Issue B36 ("B36"). Under B36, these reinsurance contracts are considered to contain embedded derivatives (that must be marked to market) because the yield on the payables is based on specific blocks of the ceding companies' assets, rather than the overall creditworthiness of the ceding company. GAFRI determined that changes in the fair value of the underlying portfolios of fixed maturity securities is an appropriate measure of the value of the embedded derivative. As permitted under B36, GAFRI reclassified the securities related to these transactions from "available for sale" to "trading". The $16.1 million cumulative effect of marking to market the derivatives embedded in the payables at October 1, 2003, was offset by the initial effect of transferring the related securities from available for sale to trading. Beginning in the fourth quarter of 2003, the mark to market on the embedded derivatives offsets the investment income recorded on the mark to market of the related trading portfolios.
DPAC related to annuities and universal life insurance products is deferred to the extent deemed recoverable and amortized, with interest, in relation to the present value of expected gross profits on the policies. To the extent that realized gains and losses result in adjustments to the amortization of DPAC related to annuities, such adjustments are reflected as components of realized gains. DPAC related to annuities is also adjusted, net of tax, for the change in amortization that would have been recorded if the unrealized gains (losses) from securities had actually been realized. This adjustment is included in "Unrealized gains (losses) on marketable securities, net" in the shareholders' equity section of the Balance Sheet.
Unpaid Losses and Loss Adjustment Expenses The net liabilities stated for unpaid claims and for expenses of investigation and adjustment of unpaid claims are based upon (a) the accumulation of case estimates for losses reported prior to the close of the accounting period on direct business written; (b) estimates received from ceding reinsurers and insurance pools and associations; (c) estimates of unreported losses based on past experience; (d) estimates based on experience of expenses for investigating and adjusting claims and (e) the current state of the law and coverage litigation. Establishing reserves for asbestos and environmental claims involves considerably more judgment than other types of claims 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.
Dividends payable to policyholders are included in "Accounts payable, accrued expenses and other liabilities" and represent estimates of amounts payable on participating policies which share in favorable underwriting results. Estimates are accrued during the period in which premiums are earned. Changes in estimates are included in income in the period determined. Policyholder dividends do not become legal liabilities unless and until declared by the boards of directors of the insurance companies.
Payable to Subsidiary Trusts (Issuers of Preferred Securities) Under FIN 46, AFG is required to deconsolidate three wholly-owned subsidiary trusts because they are "variable interest entities" in which AFG is not considered to be the primary beneficiary. These subsidiary trusts were formed to issue preferred securities and, in turn, purchase a like amount of subordinated debt from their parent company which provides interest and principal payments to fund the respective trust obligations. Accordingly, the subordinated debt due to the trusts is shown as a liability in the Balance Sheet beginning December 31, 2003, and the related interest expense will be shown in the Statement of Operations as "interest on subsidiary trust obligations" beginning in the first quarter of 2004. Prior to these dates, these items were included in the Balance Sheet as minority interest and in the Statement of Operations as minority interest expense. Implementation of FIN 46 with respect to the preferred securities had no effect on earnings.
For balance sheet purposes, minority interest represents the interests of noncontrolling shareholders in AFG subsidiaries. For income statement purposes, minority interest expense represents those shareholders' interest in the earnings of AFG subsidiaries. See "Payable to Subsidiary Trusts" above.
The following table illustrates the effect on net earnings (in thousands) and earnings per share had compensation cost been recognized and determined based on the "fair values" at grant dates consistent with the method prescribed by SFAS No. 123. See Note J "Shareholders' Equity" for further information on stock options.
Basic earnings per share is calculated using the weighted average number of shares of common stock outstanding during the period. The calculation of diluted earnings per share includes the following dilutive effect of common stock options: 2003 - 335,000 shares; 2002 - 403,000 shares; and 2001 - 440,000 shares.
For cash flow purposes, "investing activities" are defined as making and collecting loans and acquiring and disposing of debt or equity instruments and property and equipment. "Financing activities" include obtaining resources from owners and providing them with a return on their investments, borrowing money and repaying amounts borrowed. Annuity receipts,
In September 2002, an AFG subsidiary entered into an agreement under which two unrelated entities assumed the subsidiary's obligations to renew its private passenger automobile insurance business written in New Jersey. AFG recognized a $10.8 million pretax loss on the transaction. As of September 9, 2002, AFG no longer accepts any new private passenger automobile insurance in that state.
In July 2001, AFG sold Seven Hills Insurance Company for $18.4 million, realizing a pretax gain of $7.1 million. AFG retained all liability for Seven Hills' business related to the period AFG owned the company.
In December 2000, AFG agreed to sell its Japanese property and casualty division to Mitsui Marine & Fire Insurance Company of America for $22 million in cash and recorded an estimated $10.7 million pretax loss. Upon completion of the sale in March 2001, AFG realized an additional pretax loss of $6.9 million (including post closing adjustments) and deferred a gain of approximately $21 million on ceded insurance; the deferred gain is being recognized over the estimated settlement period (weighted average of 4 years) of the ceded claims.
AFG manages its business as three segments: (i) property and casualty insurance, (ii) annuity, life and supplemental health insurance and (iii) other, which includes holding company assets and costs, and beginning December 31, 2003, the assets and operations of the CDO that AFG manages.
AFG's annuity, life and health business markets primarily retirement products as well as life and supplemental health insurance. AFG's businesses operate throughout the United States. In 2003, 2002, and 2001, AFG derived just over 2% of its revenues from the sale of life and supplemental health products in Puerto Rico and just over 1% of its revenues from the sale of property and casualty insurance in Mexico, Canada and Europe.
from a discontinued business; AFG has ceased underwriting new business in these
A.P. Green settlement and $69 million in 2001 related to asbestos and other
(e) Includes a 2003 pretax charge of $35.5 million related to the settlement of
Realized gains (losses) and changes in unrealized appreciation (depreciation) on fixed maturity and equity security investments are summarized as follows (in thousands):
AFG has an investment in, and acts as investment manager for, a CDO of which AFG has been determined to be the "primary beneficiary." Under FIN 46, AFG is required to consolidate the CDO beginning December 31, 2003. The cumulative effect of this change in accounting was an increase in income of $6.3 million.
The assets (substantially all cash and investments carried at market as "trading securities") of this managed investment entity are separately disclosed in the Consolidated Balance Sheet because they are not available for use to satisfy AFG obligations. Likewise, the CDO liabilities (substantially all debt) are separately disclosed because they represent claims against only the CDO's assets and not against AFG's other assets. Accordingly, AFG's exposure to loss on this investment is limited to its investment (approximately $11.5 million at December 31, 2003).
AFG is the investment manager and has an investment of $6.3 million in another CDO (included in fixed maturities) at December 31, 2003, which is not required to be consolidated. This CDO was formed in 2000 and had approximately $475 million in investments at December 31, 2003.
Changes in the carrying value of goodwill during 2002 and 2003, by reporting segment, are presented in the following table (in thousands):
In June 2003, AFG issued Senior Convertible Notes due in 2033 at an issue price of 37.153% of the principal amount due at maturity. AFG received $189.9 million before issue costs of $4.5 million. Interest is payable semiannually at a rate of 4% of issue price per year through June 2008, after which, interest at 4% annually will be accrued and added to the carrying value of the Notes. In addition, contingent cash interest will be paid if the average market price of a Note for an applicable five-day trading period equals 120% or more of the accreted value. The Notes are redeemable at AFG's option at any time on or after June 2, 2008, at prices ranging from $371.53 per Note to $1,000 per Note at maturity. Holders may require AFG to purchase all or a portion of their Notes on five year anniversaries beginning in 2008, at the accreted value. Generally, holders may convert each Note into 11.5016 shares of AFG Common Stock (i) if the average market price of AFG Common Stock to be received upon conversion exceeds 120% of the accreted value, (ii) if the credit rating of the Notes is significantly lowered, or (iii) if AFG calls the notes for redemption.
Cash interest payments of $48 million, $47 million and $51 million were made on long-term debt in 2003, 2002 and 2001, respectively. Interest expense in the Statement of Operations includes interest credited on funds held by AFG's insurance subsidiaries under reinsurance contracts and other similar agreements as follows: 2003 - $7.8 million; 2002 - $11.7 million; and 2001 - $7.1 million.
Wholly-owned subsidiary trusts of AFG and GAFRI have issued preferred securities and, in turn, purchased from their parent company a like amount of subordinated debt which provides interest and principal payments to fund the respective trusts' obligations. The preferred securities must be redeemed upon maturity or redemption of the subordinated debt. AFG and GAFRI effectively provide unconditional guarantees of their respective trusts' obligations.
The AFG 9-1/8% trust preferred securities and the GAFRI 9-1/4% trust preferred securities were redeemed at face value in the first quarter of 2004.
Minority interest in AFG's balance sheet is comprised of the following (in thousands):
(b) Exchanged for 3.3 million shares of AFG Common Stock in
In conjunction with the AFG/AFC merger, AFG issued 3.3 million shares of Common Stock in exchange for all of the outstanding shares of AFC Series J preferred stock in November 2003.
The Senior Convertible Notes issued in June 2003 could be converted under certain conditions into 5.9 million shares of AFG Common Stock.
No compensation cost has been recognized for stock option grants. For information about the SFAS #123 "fair value" of options granted, see Note A - "Accounting Policies - Stock-based Compensation."
The following is a reconciliation of income taxes at the statutory rate of 35% and income taxes as shown in the Statement of Operations (in thousands):
Total earnings before income taxes include income subject to tax in foreign jurisdictions of $21.7 million in 2003, $17.8 million in 2002 and $8.3 million in 2001.
environmental reserves due to an increase in expected ultimate claim costs. At December 31, 2003, American Premier had $8.8 million of offsetting recovery assets (included in other assets) for such environmental and personal injury claims based upon estimates of probable recoveries from insurance carriers.
AFG has accrued approximately $6.2 million at December 31, 2003, for environmental costs and certain other matters associated with the sales of former operations.
The following are quarterly results of consolidated operations for the two years ended December 31, 2003 (in millions, except per share amounts).
elimination of deferred taxes in connection with the AFG/AFC merger, and (vi) a fourth quarter $55 million charge related to the planned sale of Transport Insurance Company (included in discontinued operations).
The following table provides an analysis of changes in the liability for losses and loss adjustment expenses, net of reinsurance (and grossed up), over the past three years on a GAAP basis (in millions). Adverse development recorded in 2003, 2002 and 2001 in prior year reserves related primarily to charges for asbestos and certain Specialty lines in run-off.
$15 million in 2003, $20 million in 2002 and $33 million in 2001.
to discontinued operations: 2003 - $2 million; 2002 - $2 million; and
Total rental expense for various leases of office space and equipment was $38 million, $52 million and $53 million for 2003, 2002 and 2001, respectively. Sublease rental income related to these leases totaled $612,000 in 2002 and $2.4 million in 2001.
Future minimum rentals, related principally to office space, required under operating leases having initial or remaining noncancelable lease terms in excess of one year at December 31, 2003, were as follows: 2004 - $36 million; 2005 - $25 million; 2006 - $22 million; 2007 - $13 million; 2008 - $8 million and $13 million thereafter. In addition, AFG has 99-year land leases (approximately 93 years remaining) at one of its real estate properties. Minimum lease payments under these leases are expected to total approximately $180,000 in 2004 and are adjusted annually for inflation.
Other operating and general expenses included charges for possible losses on agents' balances, other receivables and other assets in the following amounts: 2003 - $1.3 million; 2002 - $2.7 million; and 2001 - $3.5 million. Losses and loss adjustment expenses included charges for possible losses on reinsurance recoverables of $4.7 million in 2003 and $6.6 million in 2002. The aggregate allowance for all such losses amounted to approximately $84 million and $89 million at December 31, 2003 and 2002, respectively.
In addition to adjusting equity securities and fixed maturity securities classified as "available for sale" to fair value, SFAS 115 requires that certain other balance sheet amounts be adjusted to the extent that unrealized gains and losses from securities would result in adjustments had those gains or losses actually been realized. The components of the Consolidated Balance Sheet caption "Unrealized gain on marketable securities, net" in shareholders' equity are summarized as follows (in millions):
When available, fair values are based on prices quoted in the most active market for each security. If quoted prices are not available, fair value is estimated based on present values, discounted cash flows, fair value of comparable securities, or similar methods. The fair value of the liability for annuities in the payout phase is assumed to be the present value of the anticipated cash flows, discounted at current interest rates. Fair value of annuities in the accumulation phase is assumed to be the policyholders' cash surrender amount. Fair value of shareholders' equity is based on the quoted market price of AFG's Common Stock.
On occasion, AFG and its subsidiaries have entered into financial instrument transactions which 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, 2003, AFG and its subsidiaries had commitments to fund credit facilities and contribute limited partnership capital totaling up to $15 million.
In 2001, an AFG subsidiary purchased a 29% interest in an aircraft for
In 2000, GAFRI received an $18.9 million subordinated note in connection with the sale of its minority ownership interest in an ethanol company back to that company. Following the sale, AFG's Chairman beneficially owns 100% of the ethanol company. The note bore interest at 12-1/4% and was repaid as follows: $6 million in 2001, $1 million in 2002 and the remaining $11.9 million in 2003. In December 2003, the ethanol company repaid a GAFRI subsidiary $4.0 million under a subordinated note that bore interest at 14%. As of the end of 2003, AFG's only remaining interest in the ethanol company is Great American's $10 million line of credit, under which no amounts have been borrowed.
In February 2004, Provident announced that it was being acquired by National City Corporation, one of the nation's largest banks. If this transaction is completed, AFG will receive 8.1 million shares (approximately $290 million market value at March 1, 2004) of National City in exchange for its investment in Provident. Based on the March 1 price for National City, AFG would recognize an after-tax gain of approximately $140 million on the sale.
Financial Statements include the accounts of AFG, AFC and AFC Holding Company.
(a) Grossed up for reinsurance recoverables of $2,059 and $1,804 at December 31, 2003 and 2002, respectively.
(c) Grossed up for prepaid reinsurance premiums of $620 and $679 at December 31, 2003 and 2002, respectively.