At December 31, 2020, AFG (parent) held approximately $215 million in cash and securities and had $500 million available under a bank line of credit, which expires in December 2025.
agreement, GALIC ceded approximately $5.96 billion of in force traditional fixed and indexed annuities, representing approximately 15% of its in force business, and transferred related investments to Commonwealth. The agreement requires Commonwealth to maintain collateral in a trust in excess of amounts owed to GALIC.
•lower net investment income in the property and casualty insurance segment,
The COVID-19 pandemic began to have a significant impact on global, social and economic activity during the first quarter of 2020. AFG has taken actions under its business continuity plan to minimize risk to the Company’s employees and to prevent any significant disruption to AFG’s business, agents or policyholders.
Management believes that AFG’s strong financial position and current liquidity and capital at its subsidiaries will give AFG the flexibility to continue to effectively address and respond to the ongoing uncertainties presented by the pandemic. Even with management’s expectation that the impacts of the pandemic will continue into 2021, AFG’s insurance subsidiaries have capital at or in excess of the levels required by ratings agencies in order to maintain their current ratings, and the parent company does not have any near-term debt maturities.
•the establishment of asbestos and environmental reserves of former railroad and manufacturing operations, and
AFG’s debt to total capital ratio on a consolidated basis is shown below (dollars in millions). Management intends to maintain the ratio of debt to capital at or below 25% and intends to maintain the capital of its significant insurance subsidiaries at or above levels currently indicated by rating agencies as appropriate for the current ratings.
Net Cash Used in Investing Activities AFG’s investing activities consist primarily of the investment of funds provided by its property and casualty and annuity businesses. Net cash used in investing activities was $1.56 billion in 2020 compared to $3.07 billion in 2019, a decrease of $1.51 billion. As discussed below (under net cash provided by financing activities), AFG’s annuity segment had net cash flows from annuity policyholders of $351 million in 2020 and $1.66 billion in 2019. Settlements of equity index call options exceeded purchases by $322 million in 2020 compared to $64 million in 2019, accounting for a $258 million decrease in cash used in investing activities. On December 31, 2020, AFG completed the sale of GAI Holding Bermuda and its subsidiaries, comprising the legal entities that own Neon. The assets sold included $425 million in cash and cash equivalents, resulting in an increase in cash used in investing activities in 2020. In addition to the investment of funds provided by the insurance operations, investing activities also include the purchase and disposal of managed investment entity investments, which are presented separately in AFG’s Balance Sheet. Net investment activity in the managed investment entities was a $281 million use of cash in 2020 compared to an $11 million source of cash in 2019, accounting for a $292 million increase in net cash used in investing activities in 2020 compared to 2019. See Note A - “Accounting Policies - Managed Investment Entities” and Note H - “Managed Investment Entities” to the financial statements.
Net cash used in investing activities was $3.07 billion in 2019 compared to $5.35 billion in 2018, a decrease of $2.28 billion. As discussed below (under net cash provided by financing activities), AFG’s annuity segment had net cash flows from annuity policyholders of $1.66 billion in 2019 and $2.76 billion in 2018. In addition, AFG’s cash on hand increased by $799 million during 2019 as AFG held more cash due to fewer investment opportunities in 2019 compared to 2018 when AFG invested a large portion of its cash on hand at the beginning of the year. Net investment activity in the managed investment entities was an $11 million source of cash in 2019 compared to a $169 million use of cash in 2018, accounting for a $180 million decrease in net cash used in investing activities in 2019 compared to 2018.
Net Cash Provided by (Used In) Financing Activities AFG’s financing activities consist primarily of transactions with annuity policyholders, issuances and retirements of long-term debt, issuances and repurchases of common stock, and dividend payments. Net cash used in financing activities was $123 million in 2020 compared to net cash provided by financing activities of $1.41 billion in 2019, a decrease in net cash provided by financing activities of $1.53 billion. Net annuity receipts exceeded annuity surrenders, benefits, withdrawals and transfers by $351 million in 2020 compared to $1.66 billion in 2019, resulting in a $1.31 billion decrease in net cash provided by financing activities in 2020 compared to 2019. In 2020, GALIC transferred $554 million of cash as part of its reinsurance agreement with Commonwealth to cede in force traditional fixed and indexed annuities. In 2020, AFG issued $300 million of 5.25% Senior Notes due in 2030, $150 million of 5.625% Subordinated Debentures due in 2060 and $200 million of 4.50% Subordinated Debentures due in 2060. The net proceeds of these offerings contributed $634 million to net cash provided by financing activities in 2020. The November 2020 redemption of AFG’s 6% Subordinated Debentures due in 2055 was a $150 million use of cash in 2020. In 2019, AFG issued $125 million of 5.875% Subordinated Debentures due in 2059 and $200 million of 5.125% Subordinated Debentures due in 2059, the net proceeds of which contributed $315 million to net cash provided by financing activities in 2019. The December 2019 redemption of AFG’s 6-1/4% Subordinated Debentures was a $150 million use of cash in 2019. During 2020, AFG repurchased $313 million of its Common Stock compared to no share repurchases in 2019. In addition to its regular quarterly cash dividends, AFG paid special cash dividends of $2.00 per share in 2020 and $3.30 per share in 2019, which resulted in total cash dividends of $334 million in 2020 compared to $444 million in 2019. Financing activities also include issuances and retirements of managed investment entity liabilities, which are nonrecourse to AFG and presented separately in AFG’s Balance Sheet. Issuances of managed investment entity liabilities exceeded retirements by $221 million in 2020 compared to retirements of managed investment entity liabilities exceeding issuances by $11 million in 2019, accounting for an $232 million increase in net cash provided by financing activities in 2020 compared to 2019. See Note A - “Accounting Policies - Managed Investment Entities” and Note H - “Managed Investment Entities” to the financial statements.
Net cash provided by financing activities was $1.41 billion in 2019 compared to $2.44 billion in 2018, a decrease of $1.03 billion. Annuity receipts exceeded annuity surrenders, benefits, withdrawals and transfers by $1.66 billion in 2019 compared to $2.76 billion in 2018, resulting in a $1.10 billion decrease in net cash provided by financing activities in 2019 compared to 2018. In 2019, AFG issued $125 million of 5.875% Subordinated Debentures due in 2059 and $200 million of 5.125% Subordinated Debentures due in 2059, the net proceeds of which contributed $315 million to net cash provided by financing activities in 2019. The December redemption of AFG’s 6-1/4% Subordinated Debentures was a $150 million use of cash in 2019. During 2018, AFG had no additional long-term debt borrowings or repayments. In addition to its regular quarterly cash dividends, AFG paid special cash dividends of $3.30 per share and $3.00 per share in 2019 and 2018, respectively, which resulted in total cash dividends of $444 million in 2019 compared to $394 million in 2018. Retirements of managed investment entity liabilities exceeded issuances by $11 million in 2019 compared to issuances of managed investment entity liabilities exceeding retirements by $48 million in 2018, accounting for a $59 million decrease in net cash provided by financing activities in 2019 compared to 2018.
In December 2020, AFG replaced its existing credit facility with a new five-year, $500 million revolving credit facility which expires in December 2025. 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. The credit facility also includes provisions relating to the replacement of LIBOR with different floating rates in the event of the discontinuance of LIBOR. There were no borrowings under this agreement, or under any other parent company short-term borrowing arrangements, during 2020.
In 2020, AFG issued $300 million of 5.25% Senior Notes due in April 2030, $150 million of 5.625% Subordinated Debentures due in June 2060 and $200 million of 4.50% Subordinated Debentures due in September 2060 to increase liquidity and provide flexibility at the parent holding company in its response to the uncertainties of the economic environment. The net proceeds from the offerings were used for general corporate purposes, which included repurchases of outstanding common shares and the November 2020 redemption of AFG’s $150 million outstanding principal amount of 6% Subordinated Debentures due in November 2055 at par value.
In March 2019, AFG issued $125 million of 5.875% Subordinated Debentures due in March 2059. The net proceeds of the offering were used for general corporate purposes.
Subsidiary Liquidity GALIC, which is expected to be sold in the second quarter of 2021, is a member of the Federal Home Loan Bank of Cincinnati (“FHLB”). The FHLB makes advances and provides other banking services to member institutions, which provides the annuity operations with an additional source of liquidity. At December 31, 2020, GALIC had $1.13 billion in outstanding advances from the FHLB (included in annuity benefits accumulated), bearing interest at rates ranging from 0.31% to 1.35% (average rate of 0.53% at December 31, 2020). While these advances must be repaid between 2021 and 2025 ($931 million in 2021 and $200 million in 2025), GALIC has the option to prepay all or a portion on the majority 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. At December 31, 2020, GALIC estimated that it had additional borrowing capacity of approximately $600 million from the FHLB.
As discussed above, in the fourth quarter of 2020, GALIC entered into a reinsurance agreement with Commonwealth. Under the terms of the agreement, GALIC ceded approximately $5.96 billion of traditional fixed and indexed annuities, representing approximately 15% of its in force business, and transferred a similar amount of investments to Commonwealth. The assets transferred were primarily available for sale fixed maturity securities, the disposal of which resulted in the recognition of approximately $292 million (net of DPAC and tax) in net realized gains on securities. Under reinsurance accounting guidance, the transaction will be accounted for using the deposit method and the loss on the transaction will be deferred and recognized over the expected life of the underlying annuity contracts (7-10 years). Under both the flow and the block reinsurance agreements, Commonwealth is required to maintain collateral in trusts in excess of amounts owed to GALIC.
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, 2020, AFG’s insurance companies owned publicly traded equity securities with a fair value of $1.59 billion and equity index call and put options with a net fair value of $820 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.
(c)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 $89 million are as follows: Within 1 year - $18 million; 2-3 years - $30 million; 4-5 years - $25 million; and thereafter - $16 million.
AFG has no material contractual purchase obligations or other long-term liabilities at December 31, 2020.
See Note Q - “Additional Information - Financial Instruments - Unfunded Commitments” to the financial statements.
AFG’s investment portfolio at December 31, 2020, contained $43.21 billion (79% in the annuity subsidiaries to be sold) in fixed maturity securities classified as available for sale and carried at fair value with unrealized gains and losses included in accumulated other comprehensive income and $66 million (64% in the annuity subsidiaries to be sold) in fixed maturities classified as trading with holding gains and losses included in net investment income. In addition, AFG’s investment portfolio includes $1.25 billion (46% in the annuity subsidiaries to be sold) in equity securities carried at fair value with holding gains and losses included in realized gains (losses) on securities and $413 million (50% in the annuity subsidiaries to be sold) in equity securities carried at fair value with holding gains and losses included in net investment income.
Fair values for AFG’s portfolio are determined by AFG’s internal investment professionals using data from nationally recognized pricing services as well as non-binding broker quotes. Fair values of equity securities are generally based on published closing prices. For AFG’s fixed maturity portfolio, approximately 87% was priced using pricing services at December 31, 2020 and the balance was priced primarily by using non-binding broker quotes. When prices obtained for the same security vary, AFG’s internal investment professionals select the price they believe is most indicative of an exit price.
At December 31, 2020 the fair value of the fixed maturity portfolio in AFG’s property and casualty group was $9.10 billion. The pretax impact on the fair value upon a 100 basis point increase in interest rates would have been a decline of approximately $273 million in fair value ($216 million after tax) at December 31, 2020.
Approximately 88% of the fixed maturities held by AFG at December 31, 2020, were rated “investment grade” (credit rating of AAA to BBB) by nationally recognized rating agencies. Investment grade securities generally bear lower yields and lower degrees of risk than those that are unrated and non-investment grade. Management believes that the high-quality investment portfolio should generate a stable and predictable investment return.
The National Association of Insurance Commissioners (“NAIC”) assigns creditworthiness designations on a scale of 1 to 6 with 1 being the highest quality and 6 being the lowest quality. The NAIC retains third-party investment management firms to assist in the determination of appropriate NAIC designations for MBS based not only on the probability of loss (which is the primary basis of ratings by the major ratings firms), but also on the severity of loss and statutory carrying value. At December 31, 2020, 96% (based on statutory carrying value of $3.52 billion) of AFG’s MBS had an NAIC designation of 1.
Summarized information for the unrealized gains and losses recorded in AFG’s Balance Sheet at December 31, 2020, is shown in the following table (dollars in millions). Approximately $2.47 billion of available for sale fixed maturity securities had no unrealized gains or losses at December 31, 2020.
The table below sets forth the scheduled maturities of AFG’s available for sale fixed maturity securities at December 31, 2020, 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.
b)the extent to which fair value is less than cost basis,
(iv) estimates (based on experience) of expense for investigating and adjusting claims; and (v) the current state of law and coverage litigation.
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. See Note P - “Insurance - Property and Casualty Insurance Reserves” to the financial statements for a discussion of the factors considered and actuarial methods used in determining management’s best estimate of the ultimate liability for unpaid losses and LAE.
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, 2020 and gross written premiums for the year ended December 31, 2020.
While current factors and reasonably likely changes in variable factors are considered in estimating the liability for unpaid losses and LAE, there is no method or system that can eliminate the risk of actual ultimate results differing from such estimates.
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, 2020, reserves (net of reinsurance) developed at the same rate as the average development of the most recent five years.
The following discussion describes key assumptions and important variables that affect the estimate of the reserve for loss and LAE of the more significant lines of business and explains what caused them to change from assumptions used in the preceding period.
Recoverables from Reinsurers and Availability of Reinsurance AFG is subject to credit risk with respect to its reinsurers, as reinsurance contracts do not relieve AFG of its liability to policyholders. To mitigate this risk, substantially all reinsurance is ceded to companies rated “A” or better by S&P or is secured by “funds withheld” or other collateral.
Approximately 42% of AFG’s net asbestos reserves relate to policies written directly by AFG subsidiaries. Claims from these policies generally are product-oriented claims with only a limited amount of non-products exposures and are dominated by small to mid-sized commercial entities that are mostly regional policyholders with few national target defendants. The remainder is assumed reinsurance business that includes exposures from 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.
Establishing reserves for A&E claims relating to policies and participations in reinsurance treaties and former operations is subject to uncertainties that are significantly greater than those presented by other types of claims. For this group of claims, traditional actuarial techniques that rely on historical loss development trends cannot be used and a range of reasonably possible losses cannot be estimated. Case reserves and expense reserves are established by the claims department as specific policies are identified. In addition to the case reserves established for known claims, management establishes additional reserves for claims not yet known or reported and for possible development on known claims. These additional reserves are management’s best estimate based on periodic comprehensive studies and internal
•The manner by which bankruptcy courts are addressing asbestos liabilities is in flux.
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, 2020, 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, 2019, and adjusted for several large portfolio transfers) as detailed in the following table:
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 its estimate of future, but as yet unreported, claims. 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.
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 $21 million in 2020, $11 million in 2019 and $9 million in 2018. 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 $101 million at December 31, 2020. For a discussion of the uncertainties in determining the ultimate liability, see Note N - “Contingencies” to the financial statements.
(a)Includes income of $19 million in the fourth quarter of 2020 and a loss of $7 million in the fourth quarter of 2019, representing the change in fair value of AFG’s CLO investments plus $4 million in both the fourth quarter of 2020 and 2019 in CLO management fees earned.
(a)Includes a loss of $2 million in 2020 and income of $4 million in 2019, representing the change in fair value of AFG’s CLO investments plus $15 million in both 2020 and 2019 in CLO management fees earned.
(b)Elimination of the change in fair value of AFG’s investments in the CLOs, including $26 million in both 2020 and 2019 in distributions recorded as interest expense by the CLOs.
(b)Elimination of the change in fair value of AFG’s investments in the CLOs, including $21 million in distributions recorded as interest expense by the CLOs.
AFG’s net earnings attributable to shareholders, determined in accordance with GAAP, include certain items that may not be indicative of its ongoing core operations. For example, core net operating earnings excludes realized gains (losses) on securities because such gains and losses are influenced significantly by financial markets, interest rates and the timing of sales. Similarly, significant gains and losses from the sale of real estate are excluded from core earnings as they are influenced by the timing of sales and realized gains (losses) and significant tax benefits (charges) related to subsidiaries are excluded because such gains and losses are largely the result of the changing business strategy and market opportunities. In addition, special charges related to coverage that AFG no longer writes, such as the Neon exited lines and for asbestos and environmental exposures, are excluded from core earnings.
In the fourth quarter of 2020, AFG entered into a reinsurance agreement (“annuity block reinsurance”) with Commonwealth. Under reinsurance accounting guidance, the transaction will be accounted for using the deposit method and the $180 million loss on the transaction will be deferred and recognized over the expected life of the underlying annuity contracts (7-10 years). Consistent with internal management reporting, the impact of reinsurance on earnings, which includes the amortization of the deferred loss and the impact of changes related to FIAs (discussed above) that are related to reinsured policies and other impacts of reinsurance are excluded from core operating earnings and reported as “annuity non-core earnings (losses)”.
AFG recorded $111 million in non-core losses related to the runoff of the Neon business in 2020, which included a $23 million gain on the sale of the business. In conjunction with the sale, AFG recognized a tax benefit of $72 million, resulting in a net non-core, after-tax loss of $39 million from the Neon exited lines in 2020.
The Neon exited lines impact is highlighted in the discussion following the reconciliation of net earnings attributable to shareholders to core net operating earnings.
The following table (in millions, except per share amounts) identifies non-core items and reconciles net earnings attributable to shareholders to core net operating earnings, a non-GAAP financial measure. AFG believes core net operating earnings is a useful tool for investors and analysts in analyzing ongoing operating trends and for management to evaluate financial performance against historical results because it believes this provides a more comparable measure of its continuing business.
(a)As discussed above, beginning 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 annuity non-core earnings
(b)As discussed above, beginning with the first quarter of 2020, the Neon run-off operations are considered property and casualty insurance non-core earnings (losses).
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 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.
AFG’s property and casualty insurance operations contributed $274 million in GAAP pretax earnings in the fourth quarter of 2020 compared to $121 million in the fourth quarter of 2019, an increase of $153 million (126%). Property and casualty core pretax earnings were $274 million in the fourth quarter of 2020 compared to $197 million in the fourth quarter of 2019, an increase of $77 million (39%). The increase in GAAP pretax earnings reflects higher core pretax earnings and the impact of losses in the Neon exited lines in the fourth quarter of 2019. The increase in core pretax earnings reflects higher core underwriting results in the fourth quarter of 2020 compared to the fourth quarter of 2019.
The following table details AFG’s GAAP and core earnings before income taxes from its property and casualty insurance operations for the three months ended December 31, 2020 and 2019 (dollars in millions):
Gross written premiums (“GWP”) for AFG’s property and casualty insurance segment were $1.72 billion for the fourth quarter of 2020 compared to $1.75 billion for the fourth quarter of 2019, a decrease of $28 million (2%). Detail of AFG’s property and casualty gross written premiums is shown below (dollars in millions):
Net written premiums (“NWP”) for AFG’s property and casualty insurance segment were $1.23 billion for the fourth quarter of 2020 compared to $1.31 billion for the fourth quarter of 2019, a decrease of $84 million (6%). 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 $1.33 billion for the fourth quarter of 2020 compared to $1.37 billion for the fourth quarter of 2019, a decrease of $45 million (3%). Detail of AFG’s property and casualty net earned premiums is shown below (dollars in millions):
The $28 million (2%) decrease in gross written premiums in the fourth quarter of 2020 compared to the fourth quarter of 2019 reflects a decrease in the Specialty casualty sub-segment, partially offset by an increase in the Specialty property and transportation and Specialty financial sub-segments. Overall average renewal rates increased approximately 13% in the fourth quarter of 2020. Excluding rate decreases in the workers’ compensation business, renewal pricing increased approximately 17%.
$20 million (1.5 points on the combined ratio) and related net reinstatement premium recoveries were $3 million in the fourth quarter of 2020 compared to catastrophe losses of $14 million (1.0 points) and related net reinstatement premiums of $1 million in the fourth quarter of 2019.
Property and transportation This group reported an underwriting profit of $74 million for the fourth quarter of 2020 compared to an underwriting loss of $2 million in the fourth quarter of 2019, an improvement of $76 million (3,800%). Improved year-over-year results in the crop operations following 2019 losses from prevented planting and, to a lesser extent, improved underwriting results in the aviation and transportation businesses were the drivers of the improved results. Catastrophe losses for this group were $6 million (1.2 points on the combined ratio) in the fourth quarter of 2020 compared to $7 million (1.4 points) in the fourth quarter of 2019.
Specialty financial Underwriting profit for this group was $20 million for the fourth quarter of 2020 compared to $32 million in the fourth quarter of 2019, a decrease of $12 million (38%). This decrease reflects lower underwriting profit in the surety and trade credit businesses, along with higher year-over-year catastrophe losses in the financial institutions business. Catastrophe losses were $7 million (4.5 points on the combined ratio) in the fourth quarter of 2020 compared to $2 million (1.1 points) in the fourth quarter of 2019.
Neon exited lines In December 2019, AFG initiated actions to exit the Lloyd’s of London insurance market, which included placing its Lloyd’s subsidiaries including its Lloyd’s Managing Agency, Neon Underwriting Ltd., into run-off and recording a non-core charge of $76 million for reserve strengthening and expenses related to exit costs incurred with the run-off of this business. The non-core charge includes $46 million to increase loss reserves (including $7 million of net adverse prior year reserve development) and $30 million of underwriting expenses representing contractual employee severance benefits and other incurred exit costs.
AFG’s overall loss and LAE ratio was 62.6% for the fourth quarter of 2020 compared to 66.6% for fourth quarter of 2019, a decrease of 4.0 percentage points. The components of AFG’s property and casualty losses and LAE amounts and ratio are detailed below (dollars in millions):
Property and transportation The 12.4 percentage points decrease in the loss and LAE ratio for the current year, excluding COVID-19 related and catastrophe losses reflects a decrease in the loss and LAE ratio in the crop operations due to a high level of prevented planting claims resulting from excess rain in the 2019 period and, to a lesser extent, lower loss and LAE ratios in the aviation and transportation businesses due primarily to rate increases and lower claim frequency in the fourth quarter of 2020 compared to the fourth quarter of 2019.
Specialty financial The 2.3 percentage points increase in the loss and LAE ratio for the current year, excluding COVID-19 related and catastrophe losses reflects an increase in the loss and LAE ratio of the fidelity business.
Property and transportation Net favorable reserve development of $29 million in the fourth quarter of 2020 reflects lower than anticipated claim frequency and severity in the aviation, transportation and agricultural businesses. 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.
Specialty financial Net favorable reserve development of $6 million in the fourth quarter of 2020 reflects lower than anticipated claim frequency and severity in the fidelity and surety businesses and lower than expected claim severity in the financial institutions business. Net favorable reserve development of $14 million in the fourth quarter of 2019 reflects lower than expected claim frequency and severity in the surety business and lower than anticipated claim severity in the foreign credit business.
Other specialty In addition to the development discussed above, total Specialty prior year reserve development includes net adverse reserve development of $9 million in the fourth quarter of 2020 and $4 million in the fourth quarter of 2019, reflecting adverse development associated with AFG’s internal reinsurance program, partially offset by the amortization of deferred gains on the retroactive reinsurance transactions entered into in connection with the sale of businesses in 1998 and 2001.
AFG generally seeks to reduce its exposure to catastrophes through individual risk selection, including minimizing coastal and known fault-line exposures, and the purchase of reinsurance. Based on data available at December 31, 2020, AFG’s exposure to a catastrophic earthquake or windstorm that industry models indicate should statistically occur once in every 100, 250 or 500 years as a percentage of AFG’s Shareholders’ Equity is shown below:
Property and transportation Commissions and other underwriting expenses as a percentage of net earned premiums decreased 0.1 percentage points in the fourth quarter of 2020 compared to the fourth quarter of 2019 reflecting higher profitability-based ceding commissions received from reinsurers in the crop business, partially offset by the impact of lower premiums on the ratio in the transportation businesses.
Specialty casualty Commissions and other underwriting expenses as a percentage of net earned premiums decreased 5.3 percentage points in the fourth quarter of 2020 compared to the fourth quarter of 2019 reflecting the runoff of Neon. Neon has a higher expense ratio than many of the other businesses in the Specialty casualty sub-segment. Excluding Neon exited lines, the underwriting expense ratio decreased 0.7 percentage points in the fourth quarter of 2020 compared to the fourth quarter of 2019 reflecting higher ceding commissions received from reinsurers as a result of growth in the excess liability business.
Aggregate Aggregate commissions and other underwriting expenses for AFG’s property and casualty insurance segment includes $27 million in the fourth quarter of 2020 and $30 million in the fourth quarter of 2019 related to the Neon exited lines. Commissions and other underwriting expenses related to the Neon exited lines in the fourth quarter of 2019
Excluding the Neon exited lines, net investment income in AFG’s property and casualty insurance operations was $122 million in the fourth quarter of 2020 compared to $120 million in the fourth quarter of 2019, an increase of $2 million (2%). 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):
In addition to the property and casualty segment’s other income and expenses, net from ongoing operations discussed above, the Neon exited lines incurred a net expense of less than $1 million in other income and expenses, net in the fourth quarter of 2020.
•Annuity benefits - unfavorable impact of $55 million in the fourth quarter of 2020 and favorable impact of $30 million in the fourth quarter of 2019.
•Acquisition expenses - favorable impact on the amortization of deferred policy acquisition costs of $13 million in the fourth quarter of 2020 and unfavorable impact of $6 million in the fourth quarter of 2019.
Annuity core earnings before income taxes were $129 million in the fourth quarter of 2020 compared to $104 million in the fourth quarter of 2019, an increase of $25 million (24%), reflecting higher income from partnerships and similar investments and AFG-managed CLOs, higher gains on equity index call options in excess of policyholder index credits, lower other expenses and a reduction in the cost of funds as a percentage of annuity benefits accumulated due to renewal actions taken by AFG. These favorable items were partially offset by the impact of lower short-term interest rates on investment income. The table below highlights the impact of reinsurance, 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):
Net investment income for the fourth quarter of 2020 was $429 million compared to $458 million for the fourth quarter of 2019, a decrease of $29 million (6%). This decrease reflects the impact of lower average fixed annuity investments due to the ceding of investments related to the annuity block reinsurance and the impact of the run-off of higher yielding investments and lower short-term interest rates, partially offset by higher earnings from partnerships and similar investments. 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), increased by 0.18 percentage points to 4.81% from 4.63% in the fourth quarter of 2020 compared to the fourth quarter of 2019. The increase in the net investment yield between periods reflects the impact of ceding lower yielding securities related to the annuity block reinsurance and the impact of the run-off of higher yielding investments and lower short-term interest rates, partially offset by the positive impact of higher earnings from partnerships and similar investments and AFG-managed CLOs. AFG’s annuity segment recorded $61 million in earnings from partnerships and similar investments and AFG-managed CLOs in the fourth quarter of 2020 compared to $23 million in the fourth quarter of 2019, an increase of $38 million (165%). The annualized yield earned on these partnerships and similar investments and AFG-managed CLOs was 17.4% in the fourth quarter of 2020 compared to 7.7% in the prior year period.
The following table provides details of AFG’s interest credited and other cost of funds (in millions):
Other annuity benefits, net of guaranteed withdrawal benefit fees excluding the impact of reinsurance and the stock market and interest rates, for the fourth quarter of 2020 were $16 million compared to $15 million for the fourth quarter of 2019, an increase of $1 million (7%). As a percentage of average fixed annuity benefits accumulated, these net expenses increased 0.03 percentage points to 0.18% from 0.15% in the fourth quarter of 2020 compared to the fourth quarter of 2019. 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):
The negative impact of reinsurance and significantly lower than anticipated interest rates in the fourth quarter of 2020 on the fair value of derivatives and other liabilities related to FIAs resulted in a partially offsetting deceleration of the amortization of DPAC. The positive impact of strong stock market performance during the fourth quarter of 2019 on the fair value of derivatives and other liabilities related to FIAs resulted in an acceleration of the amortization of DPAC.
Annuity other expenses were $26 million for the fourth quarter of 2020 compared to $34 million for the fourth quarter of 2019, a decrease of $8 million (24%) reflecting expense reimbursement related to reinsurance and lower expenses due to the COVID-19 pandemic. 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 0.28% from 0.33% for the fourth quarter of 2020 as compared to the fourth quarter of 2019.
Change in Fair Value of Derivatives Related to Fixed-Indexed (Including Variable-Indexed) Annuities and Other Impacts of Changes in the Stock Market and Interest Rates on FIAs
During the fourth quarter of 2020, the positive impact of strong stock market performance was more than offset by the impact of lower than anticipated interest rates and the amortization of the deferred loss on the annuity block reinsurance transaction entered into in the fourth quarter of 2020 and other reinsurance impacts, resulting in a decrease in earnings before income taxes for the annuity segment of $48 million. During the fourth quarter of 2019, the positive impact of the strong stock market performance increased the annuity segment’s earnings before income taxes by $24 million. As a percentage of average fixed annuity benefits accumulated, the impact of reinsurance and 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 of 0.54% in the fourth quarter of 2020 compared to a net expense reduction of 0.24% in the fourth quarter of 2019.
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 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 the amortization of DPAC (dollars in millions).
(*) The $47 million loss from the impact of reinsurance reflects the amortization of the deferred loss related to the annuity block reinsurance transaction entered into in the fourth quarter of 2020, impacts of changes in the stock market and interest rates on the accounting for FIAs and higher index credits paid to Commonwealth compared to the option cost reimbursements received from Commonwealth.
AFG’s net spread earned on fixed annuities excluding the impact of reinsurance and 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 increased 0.35 percentage points to 1.42% from 1.07% in the fourth quarter of 2020 compared to the same period in 2019 due primarily to the 0.34 percentage points increase in AFG’s net interest spread discussed above. AFG’s overall net spread earned on fixed annuities decreased 0.43 percentage points to 0.88% in the fourth quarter of 2020 from 1.31% in the fourth quarter of 2019 due to the negative impact of reinsurance in the fourth quarter of 2020, partially offset by the increase in AFG’s net interest spread, higher other income, lower other expenses and 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 and the impact of reinsurance discussed above.
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, 2020 and 2019 (in millions):
Annuity benefits accumulated includes a liability of $817 million at December 31, 2020 and $625 million at December 31, 2019 for guaranteed withdrawal benefits on annuities with features that allow the policyholder to take fixed periodic lifetime benefit payments that could exceed account value. As discussed above under “Other Annuity Benefits, Net of Guaranteed Withdrawal Benefit Fees” and “Annuity Acquisition Expenses,” the periodic accounting for DPAC and guaranteed withdrawal benefits related to FIAs is also impacted by changes in the stock market and interest rates.
AFG’s annuity operations generated gross statutory premiums of $1.32 billion in the fourth quarter of 2020 compared to $1.14 billion in the fourth quarter of 2019, an increase of $180 million (16%). The following table summarizes AFG’s annuity sales (dollars in millions):
The 16% increase in total gross annuity premiums in the fourth quarter of 2020 compared to the fourth quarter of 2019 reflects higher sales of traditional fixed annuities in the financial institutions channel and higher pension risk transfer premiums.
(*)Excludes a pretax non-core loss on retirement of debt of $5 million in both the fourth quarter of 2020 and 2019.
AFG recorded net investment income on investments held outside of its property and casualty insurance and annuity segments of $16 million in the fourth quarter of 2020 compared to $8 million in the fourth quarter of 2019, an increase of $8 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 $9 million in the fourth quarter of 2020 compared to $1 million in the fourth quarter of 2019.
As discussed under “Annuity Segment - Results of Operations,” AFG purchases and sells equity index options to mitigate the risk in the index-based component of its FIAs. In evaluating the performance of the annuity business, management views the cost of the equity options as a better measurement of the true expenses of the annuity segment as compared to the GAAP accounting for these options as derivatives because any proceeds at expiration from the options generally are passed to policyholders through index credits. On occasion, policyholders surrender their annuity prior to receiving the index credit, which results in any option exercise proceeds being retained by AFG. For internal management reporting, AFG views these “option gains” as miscellaneous (other) income rather than as a component of annuity benefits expense. Consistent with internal management reporting, these option gains are reclassified from annuity benefits to other income in AFG’s segmented results. In the fourth quarter of 2020 and 2019, AFG had $10 million and $4 million, respectively, in such option gains.
Other income in the table above includes $4 million in both the fourth quarter of 2020 and the fourth quarter of 2019, 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 other income outside of its property and casualty insurance and annuity segments of $4 million in both the fourth quarter of 2020 and the fourth quarter of 2019.
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 $50 million in the fourth quarter of 2020 compared to $42 million in the fourth quarter of 2019, an increase of $8 million (19%). 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 2020 compared to the fourth quarter of 2019.
AFG’s holding companies and other operations outside of its property and casualty insurance and annuity segments recorded interest expense of $24 million in the fourth quarter of 2020 compared to $18 million in the fourth quarter of 2019, an increase of $6 million (33%). This increase in interest expense primarily reflects higher average indebtedness. The following table details the principal amount of AFG’s long-term debt balances as of December 31, 2020 compared to December 31, 2019 (dollars in millions):
AFG’s consolidated realized gains (losses) on securities were net gains of $591 million in the fourth quarter of 2020 compared to $65 million in the fourth quarter of 2019, an increase of $526 million (809%). Realized gains (losses) on securities consisted of the following (in millions):
AFG’s consolidated provision for income taxes was $190 million for the fourth quarter of 2020 compared to $68 million in the fourth quarter of 2019, an increase of $122 million (179%). The following is a reconciliation of income taxes at the statutory rate to the provision for income taxes as shown in the segmented statement of earnings (dollars in millions):
AFG’s consolidated net earnings (loss) attributable to noncontrolling interests was net earnings of $2 million for the fourth quarter of 2020 compared to a net loss of $20 million for the fourth quarter of 2019, a change of $22 million (110%). The losses in the fourth quarter of 2019 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 exit of the Lloyd’s of London insurance market in 2020.
AFG’s net earnings attributable to shareholders, determined in accordance with GAAP, include certain items that may not be indicative of its ongoing core operations. The following tables for the years ended December 31, 2020, 2019 and 2018 identify such items by segment and reconcile net earnings attributable to shareholders to core net operating earnings, a non-GAAP financial measure that AFG believes is a useful tool for investors and analysts in analyzing ongoing operating trends (in millions):
(a)See the reconciliation of core earnings to GAAP net earnings under “Results of Operations - General” for details on the tax and noncontrolling interest impacts of these reconciling items.
(b)As discussed under “Results of Operations - General,” beginning 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). In addition, the amortization of the deferred loss related to the annuity block reinsurance transaction entered into in the fourth quarter of 2020 and other reinsurance impacts are considered non-core earnings (losses).
The $212 million (3%) decrease in gross written premiums in 2020 compared to 2019 reflects a decrease in the Specialty casualty and Specialty financial sub-segments, partially offset by an increase in the Specialty property and transportation sub-segment. Overall average renewal rates increased approximately 11% in 2020. Excluding the workers’ compensation business, renewal pricing increased nearly 15%.
Property and transportation Gross written premiums increased $54 million (2%) in 2020 compared to 2019, due primarily to growth and new business opportunities in the property and inland marine and ocean marine businesses, partially offset by lower premiums in the transportation businesses, primarily from the return of premiums and reduced exposures as a result of the COVID-19 pandemic and premium reductions in two large national accounts. Average renewal rates increased nearly 6% for this group in 2020. Reinsurance premiums ceded as a percentage of gross written premiums increased 1 percentage point in 2020 compared to 2019, reflecting higher cessions in the transportation businesses.
Other specialty The amounts shown as reinsurance premiums ceded represent business assumed by AFG’s internal reinsurance program from the operations that make up AFG’s other Specialty property and casualty insurance sub-segments. Reinsurance premiums assumed increased $49 million (33%) in 2020 compared to 2019, reflecting an increase in premiums retained, primarily from businesses in the Specialty casualty sub-segment.
The table below (dollars in millions) details the components of the combined ratio for AFG’s property and casualty insurance segment for 2020, 2019 and 2018:
The Specialty property and casualty insurance operations generated an underwriting profit of $426 million in 2020 compared to $325 million in 2019, an increase of $101 million (31%). The higher underwriting profit in 2020 reflects higher underwriting profits in the Property and transportation and Specialty casualty sub-segments, partially offset by lower underwriting profit in the Specialty financial sub-segment. Underwriting results for the Specialty property and casualty insurance operations include $95 million in COVID-19 related losses (1.9 points on the combined ratio) in 2020. Overall catastrophe losses were $91 million (1.9 points on the combined ratio) and related net reinstatement premiums were $2 million for 2020 compared to catastrophe losses of $60 million (1.2 points) and related net reinstatement premiums of $1 million for 2019.
The Specialty property and casualty insurance operations generated an underwriting profit of $325 million in 2019 compared to $322 million in 2018, an increase of $3 million (1%). The higher underwriting profit in 2019 reflects higher underwriting profits in the Specialty casualty and Specialty financial sub-segments, partially offset by lower underwriting profit in the Property and transportation sub-segment. Overall catastrophe losses were $60 million (1.2 points on the combined ratio) and related net reinstatement premiums were $1 million for 2019 compared to catastrophe losses of $103 million (2.1 points) and related net reinstatement premiums of $2 million for 2018.
Property and transportation Underwriting profit for this group was $181 million in 2020 compared to $79 million in 2019, an increase of $102 million (129%). This increase reflects higher underwriting profitability in the crop operations following record levels of prevented planting claims in 2019 and, to a lesser extent, higher favorable prior year reserve development in the transportation businesses and improved underwriting results in the aviation business and the Singapore branch. COVID-19 related losses for this group were $7 million (0.4 points on the combined ratio) in 2020.
Catastrophe losses were $47 million (2.5 points on the combined ratio) in 2020 compared to $32 million (1.8 points) in 2019.
Specialty casualty Underwriting profit for this group was $223 million in 2020 compared to $175 million in 2019, an increase of $48 million (27%). This increase reflects higher year-over-year underwriting profitability in the excess surplus and excess liability businesses and the impact of $36 million of underwriting losses at Neon in 2019, partially offset by lower year-over-year underwriting profits in the targeted markets and workers’ compensation businesses. See “Neon exited lines” under “Property and Casualty Insurance Segment - Results of Operations” for the quarters ended December 31, 2020 and 2019 for information about AFG’s exit from the Lloyd’s of London insurance market in 2020. COVID-19 related losses were $60 million (2.7 points on the combined ratio) in 2020, primarily in the workers’ compensation and executive liability businesses. Catastrophe losses were $14 million (0.6 points on the combined ratio) and related net reinstatement premiums were $2 million in 2020 compared to catastrophe losses of $17 million (0.7 points) and related net reinstatement premiums of $1 million in 2019.
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. 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.
Other specialty This group reported an underwriting loss of $28 million in 2020 compared to $21 million in 2019, an increase of $7 million (33%). 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 2020 compared to 2019.
Specialty financial The 0.8 percentage points decrease in the loss and LAE ratio for the current year, excluding COVID-19 related and catastrophe losses in 2020 compared to 2019 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.
Net favorable reserve development of $50 million in 2018 reflects lower than expected losses in the crop business and lower than expected claim severity at National Interstate, partially offset by higher than expected claim frequency and severity in the Singapore branch and aviation operations.
Specialty casualty Net favorable reserve development of $97 million in 2020 reflects lower than anticipated claim severity in the workers’ compensation businesses and lower than anticipated claim frequency in the executive liability business, partially offset by higher than expected claim frequency and severity in general liability contractor claims and the excess and surplus and excess liability businesses and higher than anticipated claim severity in the targeted markets businesses.
Net favorable reserve development of $139 million in 2018 reflects lower than anticipated claim severity in the workers’ compensation businesses and lower than expected emergence in assumed 2017 property catastrophe losses at Neon, and to a lesser extent, lower than expected claim severity in the executive liability business.
Asbestos and environmental reserve charges As previously discussed under “Uncertainties” - “Asbestos and Environmental-related (“A&E”) Insurance Reserves,” AFG has established property and casualty reserves for claims related to environmental exposures and asbestos claims. Total charges recorded to increase reserves (net of reinsurance recoverable) for A&E exposures of AFG’s property and casualty group (included in loss and loss adjustment expenses) were $47 million in 2020 and $18 million in both 2019 and 2018.
Aggregate Aggregate net prior accident years reserve development for AFG’s property and casualty insurance segment includes the special A&E charges, reserve development related to the Neon exited lines mentioned above and net adverse reserve development of $20 million, $19 million and $2 million in 2020, 2019 and 2018, respectively, related to business outside the Specialty group that AFG no longer writes.
In addition, underwriting results for the Neon exited lines includes $20 million of COVID-19 related losses in 2020.
Catastrophe losses of $60 million in 2019 resulted primarily from winter storms in multiple regions of the United States in the first quarter; storms and tornadoes in multiple regions of the United States in the second quarter; Hurricane Dorian and Tropical Storm Imelda in the third quarter and Typhoons Faxai and Hagibis, storms and tornadoes in the south-central United States and the Kincade fire in California in the fourth quarter.
AFG’s property and casualty 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.
Commissions and other underwriting expenses as a percentage of net earned premiums increased 0.6 percentage points in 2019 compared to 2018 reflecting lower profitability-based ceding commissions received from reinsurers in the crop business.
Specialty casualty Commissions and other underwriting expenses as a percentage of net earned premiums decreased 4.7 percentage points in 2020 compared to 2019 due to the runoff of Neon. Neon has a higher expense ratio than many of the other businesses in the Specialty casualty sub-segment. Excluding Neon exited lines, the underwriting expense ratio decreased 1.5 percentage points in 2020 compared to 2019 reflecting higher ceding commissions received from reinsurers as a result of growth in the excess liability business.
Excluding the Neon exited lines, net investment income in AFG’s property and casualty insurance operations was $404 million in 2020 compared to $472 million in 2019, a decrease of $68 million (14%). Net investment income in AFG’s property and casualty operations was $472 million in 2019 compared to $438 million in 2018, an increase of $34 million (8%). 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):
The increase in average invested assets and net investment income in the property and casualty insurance segment in 2019 compared to 2018 reflects growth in the property and casualty insurance segment. The property and casualty insurance segment’s overall yield on investments was 4.16% in 2019 compared to 4.17% in 2018, a decrease of 0.01 percentage points reflecting lower earnings from alternative investments. The yield earned on alternative investments was 10.3% in 2019 compared to 13.9% in 2018.
AFG’s annuity operations contributed $362 million in GAAP pretax earnings in 2019 compared to $361 million in 2018, an increase of $1 million. This slight increase in AFG’s GAAP annuity segment results for 2019 compared 2018 is due primarily to the positive impact of strong market performance in the 2019 period, the unfavorable impact of the decline in the stock market in 2018 and higher unlocking charges in the 2018 period, offset by the unfavorable impact of significantly lower than anticipated interest rates on the fair value of derivatives related to FIAs in 2019 compared to the favorable impact of higher than anticipated interest rates in 2018. In addition to the fourth quarter detailed review in 2018, AFG unlocked its assumptions for option costs and interest rates in the second quarter of 2018 due to continued higher FIA option costs (resulting primarily from higher than expected risk-free rates). AFG’s unlocking of the actuarial assumptions underlying its annuity operations resulted in a net charge of $1 million in 2019 compared to $31 million in 2018.
The following table details AFG’s GAAP and core earnings before income taxes from its annuity operations for 2020, 2019 and 2018 (dollars in millions):
•Policy charges and other miscellaneous income - $5 million unfavorable impact in 2020 and $1 million favorable in 2019.
table below highlights the impact of reinsurance, 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):
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 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 reinsurance, unlocking and the stock market and interest rates were $51 million in 2020 and $54 million in 2019, representing a decrease of $3 million (6%) in 2020 compared to 2019. As a percentage of average fixed annuity benefits accumulated, these net expenses decreased 0.01 percentage points to 0.13% in 2020 from 0.14% in 2019.
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):
As discussed under “Annuity Benefits Accumulated” in Note A - “Accounting Policies” to the financial statements, guaranteed withdrawal benefit reserves are accrued for and modified using assumptions similar to those used in establishing and amortizing deferred policy acquisition costs. In addition, the guaranteed withdrawal benefit reserve
The change in the stock market and interest rates increased AFG’s guaranteed withdrawal benefit reserve by $14 million in 2019 compared to $83 million 2018. This $69 million (83%) decrease was the primary cause of the $64 million overall decrease in other annuity benefits, net of guaranteed withdrawal benefit fees in 2019 compared to 2018.
AFG’s net interest spread decreased 0.24 percentage points to 1.74% from 1.98% in 2020 compared to 2019 due primarily to the negative impact of lower earnings from partnerships and similar investments and AFG-managed CLOs in 2020 and lower investment yields. Features included in current annuity product offerings allow AFG to achieve its desired profitability at a lower net interest spread than historical product offerings. As a result, AFG expects its net interest spread to narrow in the future.
AFG’s net interest spread decreased 0.11 percentage points to 1.98% in 2019 from 2.09% in 2018 due primarily to higher renewal option costs and lower investment yields.
Excluding the $5 million unlocking charge in 2020 and the $1 million favorable impact of unlocking in 2019 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 equity index call option proceeds received at maturity that are not passed to policyholders through index credits due to surrenders, were $67 million in 2020 compared to $52 million in 2019, an increase of $15 million (29%), reflecting higher gains on equity index call options in excess of policyholder index credits. 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 increased 0.03 percentage points to 0.14% in 2020 from 0.11% in 2019.
Excluding the $1 million favorable impact of unlocking in 2019 and $1 million unlocking charge in 2018 related to unearned revenue, annuity policy charges and other miscellaneous income were $52 million in 2019 compared to $60 million in 2018, a decrease of $8 million (13%). 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 0.04 percentage points to 0.11% in 2019 from 0.15% in 2018.
Annuity acquisitions expenses excluding unlocking and the acceleration/deceleration of the amortization resulting from 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 option costs were $256 million for 2019 compared to $242 million for 2018, an increase of $14 million (6%), reflecting growth in the annuity business.
The negative impact of significantly lower than anticipated interest rates during both 2020 and 2019 on the fair value of derivatives and other liabilities related to FIAs and the negative impact of reinsurance in the fourth quarter of 2020 resulted in a 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.
During 2020, the negative impact of significantly lower than anticipated interest rates and the amortization of the deferred loss related to the annuity block reinsurance agreement entered into in the fourth quarter of 2020 and other reinsurance impacts reduced the annuity segment’s earnings before income taxes (excluding unlocking) by $142 million compared to the $46 million negative impact of the stock market and interest rates (excluding unlocking) on annuity earnings before income taxes for 2019, an increase of $96 million (209%). In 2019, the negative impact of significantly lower than anticipated interest rates was partially offset by the positive impact of strong stock market performance. In 2018, the positive impact of higher than expected interest rates was more than offset by higher interest on the embedded derivative, the negative impact of higher than expected option costs and significantly lower stock market performance. As a percentage of average fixed annuity benefits accumulated, the impact of reinsurance and 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 in 2020 was a net expense (excluding unlocking) of 0.36%, 0.12% and 0.04% in 2020, 2019 and 2018, respectively.
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 on a net of reinsurance basis. Each factor is presented net of the estimated related impact on amortization of DPAC (dollars in millions).
(*) The $47 million loss from the impact of reinsurance reflects the amortization of the deferred loss from the annuity block reinsurance transaction entered into in the fourth quarter of 2020, impacts of changes in the stock market and interest rates on the accounting for FIAs and higher index credits paid to Commonwealth compared to the option cost reimbursements received from Commonwealth.
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.
AFG’s net spread earned on fixed annuities excluding the impact of reinsurance, 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 0.17 percentage points to 0.91% in 2020 from 1.08% in 2019 due primarily to the 0.24 percentage points decrease in AFG’s net interest spread discussed above. AFG’s overall net spread earned on fixed annuities decreased 0.53 percentage points to 0.43% in 2020 from 0.96% in 2019 due to the decrease in AFG’s net interest spread, the impact of reinsurance and 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 unlocking discussed below under “Annuity Unlocking.”
AFG’s annuity operations generated gross statutory premiums of $4.09 billion in 2020, $4.96 billion in 2019 and $5.41 billion in 2018, a decrease of $873 million (18%) in 2020 compared to 2019 and a decrease of $447 million (8%) in 2019 compared to 2018. The following table summarizes AFG’s annuity sales (dollars in millions):
Management attributes the 18% decrease in gross annuity premiums in 2020 compared to 2019 to the lower market interest rate environment. In response to the continued drop in market interest rates during 2019 and 2020, AFG lowered crediting rates on several products, which has slowed annuity sales compared to 2019 and 2018 levels. In addition, many of the restrictions from the COVID-19 pandemic impact the ability of agents to conduct business in the same manner as usual.
The unlocking of the major actuarial assumptions underlying AFG’s annuity operations resulted in net charges related to its annuity business of $46 million, $1 million and $31 million in 2020, 2019 and 2018, respectively, which impacted AFG’s financial statements as follows (in millions):
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 following table reconciles the net spread earned on AFG’s fixed annuities to overall annuity pretax earnings for 2020, 2019 and 2018 (in millions):
(*)Net investment income (as a % of investments) of 4.31%, 4.67% and 4.73% in 2020, 2019 and 2018, 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 $219 million in 2020 compared to $190 million in 2019, an increase of $29 million (15%). AFG’s net core pretax loss outside of its property and casualty insurance and annuity segments (excluding realized gains and losses) totaled $189 million in 2020 compared to $174 million in 2019, an increase of $15 million (9%).
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 2020, 2019 and 2018 (dollars in millions):
(a)Excludes pretax non-core long-term care loss recognition charge of $4 million in 2020.
AFG recorded net investment income on investments held outside of its property and casualty insurance and annuity segments of $32 million, $43 million and $25 million in 2020, 2019 and 2018, respectively. The $11 million (26%) decrease in 2020 compared to 2019 and the $18 million (72%) increase in 2019 compared to 2018 is due primarily to the impact of the stock market performance on a small portfolio of securities that are carried at fair value through net investment
Excluding the non-core special A&E charges, the non-core loss on retirement of debt and the non-core run-off long-term care loss recognition charge discussed below, AFG’s holding companies and other operations outside of its property and casualty insurance and annuity segments recorded other expenses of $135 million in 2020 compared to $158 million in 2019, a decrease of $23 million (15%). This decrease reflects lower holding company expenses related to employee benefit plans that are tied to stock market performance and lower expenses associated with certain incentive compensation plans in 2020 compared to 2019.
AFG’s holding companies and other operations outside of its property and casualty insurance and annuity segments recorded interest expense of $88 million in 2020, $68 million in 2019 and $62 million in 2018. The $20 million (29%) increase in interest expense in 2020 compared to 2019 and the $6 million (10%) increase in interest expense in 2019
The increase in interest expense in 2020 compared to 2019 and in 2019 compared to 2018 reflect the following financing transactions completed by AFG between January 1, 2018 and December 31, 2020:
The $4 million pretax loss recognition charge in 2020 was due primarily to the unfavorable impact related to lower expected future investment income resulting from a decrease in the long-term interest rate assumptions.
The $475 million net realized gains from disposals in 2020 includes gains of $415 million on investments disposed of in AFG’s 2020 annuity block reinsurance transaction. See Note P - “Insurance” to the financial statements. The $96 million net realized loss from the change in the fair value of equity securities in 2020 includes losses of $57 million on investments in natural gas companies, $25 million on investments in energy companies, $19 million on investments in banks and financing companies, $18 million on real estate investment trusts and $17 million on investments in media companies. These losses were partially offset by gains of $17 million on investments in healthcare companies and $16 million on investments in technology companies. The $46 million of impairment allowance expense in 2020 includes $21 million in charges related to other structured securities, $13 million in charges related to third-party collateralized loan obligations and $12 million in charges related to corporate bonds and other fixed maturities.
In the third quarter of 2020, AFG reached a definitive agreement to sell GAI Holding Bermuda and its subsidiaries, comprising the legal entities that own Neon, to RiverStone Holdings Limited. The transaction closed in the fourth quarter of 2020. AFG recorded $111 million in non-core losses related to the runoff of the Neon business in 2020, which included a $23 million gain on the sale of the business. In conjunction with the sale, AFG recognized a tax benefit of $72 million, resulting in an overall net non-core, after-tax loss of $39 million from the Neon exited lines in 2020. See Note B - “Acquisitions and Sale of Businesses” to the financial statements.
AFG’s consolidated provision for income taxes was $127 million in 2020 compared to $239 million in 2019, a decrease of $112 million (47%). AFG’s consolidated provision for income taxes was $239 million in 2019 compared to $122 million in 2018, an increase of $117 million (96%). See Note M - “Income Taxes” to the financial statements for an analysis of items affecting AFG’s effective tax rate.
See Note A - “Accounting Policies - Credit Losses on Financial Instruments” to the financial statements for a discussion of accounting guidance adopted on January 1, 2020, which provides a new credit loss model for determining credit-related impairments for financial instruments measured at amortized cost (mortgage loans, premiums receivable and reinsurance recoverables) and requires an entity to estimate the credit losses expected over the life of an exposure or pool of exposures.
See Note A - “Accounting Policies - Leases” and Note K - “Leases” to the financial statements for a discussion of accounting guidance adopted on January 1, 2019, which requires entities that lease assets for terms longer than one year to recognize the assets and liabilities for the rights and obligations created by those leases on the balance sheet based on the present value of cash flows.
Consolidated Statement of Earnings for the years ended December 31, 2020, 2019 and 2018
Consolidated Statement of Changes in Equity for the years ended December 31, 2020, 2019 and 2018
Consolidated Statement of Cash Flows for the years ended December 31, 2020, 2019 and 2018
AFG’s management is responsible for establishing and maintaining adequate internal control over financial reporting, as such term is defined in Securities Exchange Act Rules 13a-15(f). Under the supervision and with the participation of management, including AFG’s Co-Chief Executive Officers and Chief Financial Officer, AFG conducted an evaluation of the effectiveness of internal control over financial reporting as of December 31, 2020, based on the criteria set forth in “Internal Control - Integrated Framework” issued in 2013 by the Committee of Sponsoring Organizations of the Treadway Commission.
Based on AFG’s evaluation, management concluded that internal control over financial reporting was effective as of December 31, 2020. The attestation report of AFG’s independent registered public accounting firm on AFG’s internal control over financial reporting as of December 31, 2020, is set forth on the next page.
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, 2020 and 2019, 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, 2020, and the related notes and financial statement schedules listed in the Index at Item 15(a)(2) and our report dated February 25, 2021 expressed an unqualified opinion thereon.
The Company’s management is responsible for maintaining effective internal control over financial reporting and for its assessment of the effectiveness of internal control over financial reporting included in the accompanying Management’s Report on Internal Control Over Financial Reporting. Our responsibility is to express an opinion on the Company’s internal control over financial reporting based on our audit. We are a public accounting firm registered with the PCAOB and are required to be independent with respect to the Company in accordance with the U.S. federal securities laws and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB.
Auditing the fair value of the fixed-income and equity securities that use unobservable inputs was complex and highly judgmental due to the judgment used by the Company in determining unobservable inputs and assumptions to estimate the securities’ fair value. Significant unobservable inputs and assumptions include non-binding broker quotes and credit spreads over the treasury yield.
To test the Company’s investment fair values, our audit procedures included, among others, comparing the fair values for a sample of securities to pricing service values or internally developed cash flow models. With the assistance of our valuation specialists, we evaluated the valuation methodologies used by the Company and compared the Company’s fair value estimate to an independently calculated range of fair value estimates for a sample of securities. We evaluated information that corroborated or contradicted the Company’s fair value estimates, including observable spreads, transaction data for similar securities, and historical collateral performance data.
Description of the Matter As of December 31, 2020, the Company’s unpaid losses and loss adjustment expenses reserve liabilities net of reinsurance recoverables, net of allowance, (“reserves”) totaled $7.28 billion as disclosed in Note P to the consolidated financial statements. This liability represents management’s best estimate of the ultimate net cost of all unpaid losses and loss adjustment expenses and is determined by using case-basis evaluations, actuarial projections, and management’s judgment. Estimating the reserves is inherently judgmental and is influenced by factors that are subject to significant variation, particularly for lines of business that develop or are paid over a long period of time or that contain exposures with high potential severities, such as workers’ compensation, other liability, and asbestos and environmental.
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 estimated inflation. These assumptions have a significant effect on the valuation of reserves.
Description of the Matter At December 31, 2020, deferred policy acquisition costs totaled $546 million, of which $287 million related to annuity contracts. As described in Notes A and G to the consolidated financial statements, the carrying amount of the annuity deferred policy acquisition costs is the total of costs deferred less amortization that is calculated in relation to the present value of estimated gross profits of the underlying annuity policies. There is a significant amount of uncertainty inherent in calculating estimated gross profits as the calculation is sensitive to management’s best estimate of assumptions, such as future investment yields and lapse rates. Management’s assumptions are adjusted, also known as unlocking, over time for emerging experience and expected trends. The unlocking results in amortization being recalculated, using the new assumptions for estimated gross profits, that results either in additional or less cumulative amortization expense.
How We Addressed the Matter in Our Audit 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.
Description of the Matter At December 31, 2020, the liability for annuity benefits accumulated included $3.93 billion for the embedded derivatives related to the equity participation feature of the Company’s fixed-indexed annuity products. As described in Note F to the consolidated financial statements, there is a significant amount of estimation uncertainty inherent in measuring the fair value of the embedded derivatives as it includes management’s assumptions of various factors, such as future interest rates, expected stock market performance, budgeted option costs, lapses, and annuitizations. Management’s assumptions are adjusted for emerging experience and expected trends, resulting in changes to the estimated fair value of the embedded derivatives.
How We Addressed the Matter in Our Audit We obtained an understanding, evaluated the design, and tested the operating effectiveness of controls over the process for estimating the embedded derivatives. This included, among others, the review and approval processes that management has in place for the methods and assumptions used in the valuation process of the embedded derivatives.
Fair Value Measurements Accounting standards define fair value as the price that would be received to sell an asset or paid to transfer a liability (an exit price) in an orderly transaction between market participants on the measurement date. The standards establish a hierarchy of valuation techniques based on whether the assumptions that market participants would use in pricing the asset or liability (“inputs”) are observable or unobservable. Observable inputs reflect market data obtained from independent sources, while unobservable inputs reflect AFG’s assumptions about the assumptions market participants would use in pricing the asset or liability. Other than recording an estimated loss at September 30 on the sale of Neon, its United Kingdom-based Lloyd’s insurer (see Note B - “Acquisitions and Sale of Businesses”), AFG did not have any material nonrecurring fair value measurements in 2020 or 2019.
Investments On January 1, 2018, AFG adopted ASU 2016-01, which requires all equity securities other than those accounted for under the equity method to be reported at fair value with holding gains and losses recognized in net earnings. At December 31, 2017, AFG had $1.60 billion in equity securities classified as “available for sale” under the prior guidance with holding gains and losses included in accumulated other comprehensive income (“AOCI”) instead of net earnings. At the date of adoption, the $221 million net unrealized gain on equity securities included in AOCI was reclassified to retained earnings as the cumulative effect of an accounting change. The cumulative effect of the accounting change also includes the net unrealized gain on AFG’s 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 the new guidance ($4 million net of tax at the date of adoption).
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.
Fixed maturity securities classified as “available for sale” are reported at fair value with unrealized gains and losses included in AOCI in AFG’s Balance Sheet. Fixed maturity securities classified as “trading” are reported at fair value with changes in unrealized holding gains or losses during the period included in net investment income. Mortgage loans (net of any allowance) and policy loans are carried primarily at the aggregate unpaid balance.
Limited partnerships and similar investments are generally accounted for using the equity method of accounting. Under the equity method, AFG records its share of the earnings or losses of the investee based on when they are reported by the investee in its financial statements rather than in the period in which the investee declares a dividend. AFG’s share of the earnings or losses from equity method investments is generally recorded on a quarter lag due to the timing of the receipt of the investee’s financial statements. AFG’s equity in the earnings (losses) of limited partnerships and similar investments is included in net investment income.
Realized gains or losses on the disposal of fixed maturity securities are determined on the specific identification basis. When a decline in the value of an available for sale fixed maturity is considered to be other-than-temporary at the balance sheet date, an allowance for credit losses (impairment), including any write-off of accrued interest, is charged to earnings (included in realized gains (losses) on securities). If management can assert that it does not intend to sell the security and it is not more likely than not that it will have to sell it before recovery of its amortized cost basis (net of allowance), then the impairment allowance 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 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 charge. 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 is recorded in earnings to reduce the amortized cost (net of allowance) of that security to fair value. See “Credit Losses on Financial Instruments” above for a discussion of new guidance adopted on January 1, 2020.
Derivatives Derivatives included in AFG’s Balance Sheet are recorded at fair value. Changes in fair value of derivatives are included in earnings unless the derivatives are designated and qualify as highly effective cash flow hedges. Derivatives that do not qualify for hedge accounting under GAAP consist primarily of (i) components of certain fixed maturity securities (primarily interest-only and principal-only MBS) and (ii) the equity-based component of certain annuity products (included in annuity benefits accumulated) and related equity index options designed to be consistent with the characteristics of the liabilities and used to mitigate the risk embedded in those annuity products.
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.
Certain reinsurance arrangements in AFG’s fixed and indexed annuity operations do not transfer significant insurance risk and are therefore accounted for using the deposit method. This accounting treatment results in amounts paid by AFG to the reinsurer to be recorded as a deposit asset. The reinsurance deposit asset (reinsurance recoverable) is adjusted as amounts are paid or received under the underlying contracts. AFG’s reinsurance partner posts collateral in excess of amounts due to AFG under these contracts. Under reinsurance accounting guidance on transactions involving annuities, the gain or loss is deferred and recognized over the expected life of the underlying annuity contracts (using methods similar to those used to amortize DPAC).
DPAC related to traditional life and health insurance is amortized over the expected premium paying period of the related policies, in proportion to the ratio of annual premium revenues to total anticipated premium revenues. See “Life, Accident
and Health Reserves” below for details on the impact of loss recognition on the accounting for traditional life and health insurance contracts.
AFG manages, and has investments in, collateralized loan obligations (“CLOs”) that are VIEs (see Note H - “Managed Investment Entities”). AFG has determined that it is the primary beneficiary of these CLOs because (i) its role as asset manager gives it the power to direct the activities that most significantly impact the economic performance of the CLOs and (ii) through its investment in the CLO debt tranches, it has exposure to CLO losses (limited to the amount AFG invested) and the right to receive CLO benefits that could potentially be significant to the CLOs.
Unpaid Losses and Loss Adjustment Expenses The net liabilities stated for unpaid claims and for expenses of investigation and adjustment of unpaid claims represent management’s best estimate and are based upon (i) the accumulation of case estimates for losses reported prior to the close of the accounting period on direct business written; (ii) estimates received from ceding reinsurers and insurance pools and associations; (iii) estimates of unreported losses (including possible development on known claims) based on past experience; (iv) estimates based on experience of expenses for investigating and adjusting claims; and (v) the current state of the law and coverage litigation. Establishing reserves for asbestos, environmental and other mass tort 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.
Life, Accident and Health Reserves Liabilities for future policy benefits under traditional life, accident and health policies are computed using the net level premium method. Computations are based on the original projections of investment yields, mortality, morbidity and surrenders and include provisions for unfavorable deviations unless a loss recognition event (premium deficiency) occurs. Claim reserves and liabilities established for accident and health claims are modified as necessary to reflect actual experience and developing trends.
Debt Issuance Costs Debt issuance costs related to AFG’s outstanding debt are presented in its Balance Sheet as a direct reduction in the carrying value of long-term debt and are amortized over the life of the related debt using the effective interest method as a component of interest expense. Debt issuance costs related to AFG’s revolving credit facilities are included in other assets in AFG’s Balance Sheet.
Leases On January 1, 2019, AFG adopted ASU 2016-02, which requires entities that lease assets for terms longer than one year to recognize assets and liabilities for the rights and obligations created by those leases on the balance sheet based on the present value of contractual cash flows. As permitted under the ASU, AFG adopted the guidance on a modified retrospective basis (comparative periods were not adjusted) and elected the following accounting policies and practical expedients:
•exclude leases with a term of 12 months or less from the calculation of lease assets and liabilities,
•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
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 AFG’s results of operations or liquidity. See Note K - “Leases” for additional disclosures.
AFG recognizes the tax benefits of uncertain tax positions only when the position is more likely than not to be sustained under examination by the appropriate taxing authority. Interest and penalties on AFG’s reserve for uncertain tax positions are recognized as a component of tax expense.
Stock-Based Compensation All share-based grants are recognized as compensation expense on a straight-line basis over their vesting periods based on their calculated fair value at the date of grant.
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, 2020, 2019 or 2018.
activities. All other activities are considered “operating.” Short-term investments having original maturities of three months or less when purchased are considered to be cash equivalents for purposes of the financial statements.
On June 30, 2020, AFG acquired 100% of the indirect noncontrolling interest in Neon from certain former and current Neon executives for cash based on the nominal fair value of the interest acquired as determined by a third-party valuation firm.
Under GAAP accounting guidance, only disposals of components of an entity that represent a strategic shift and that have a major effect on a reporting entity’s operations and financial results are reported as discontinued operations. Because AFG’s primary business continues to be commercial property and casualty insurance, as well as the immaterial expected impact on AFG’s ongoing results of operations, the sale of Neon has not been reported as a discontinued operation.
The impact of Neon exited lines on AFG’s net earnings for the year ended December 31, 2020 is shown below (in millions):
Paratransit Book of Business Effective in June 2019, National Interstate, a property and casualty insurance subsidiary of AFG, entered into an agreement with Atlas Financial Holdings, Inc. (“AFH”) to become the exclusive underwriter of AFH’s paratransit book of business. National Interstate estimated that the majority of AFH’s $110 million paratransit business was eligible for quotation under this arrangement following inception of the agreement. Under the terms of the agreement (as extended in 2020), AFH acts as an underwriting manager for National Interstate until at least August 2021 for fleets with seven or fewer vehicles, after which time National Interstate is entitled to acquire the renewal rights for the business from AFH for a purchase price equal to 15% of the in force gross written premiums at that date. In November 2020, National Interstate acquired the renewal rights for fleets with eight or more vehicles from AFH for approximately $3 million. The majority of the purchase price ultimately paid for the renewal rights will be recorded as an intangible renewal rights asset and will be amortized over the estimated life of the business acquired. In connection with the transaction, AFG was granted a five-year warrant to acquire approximately 2.4 million shares of AFH (19.9% at the acquisition date). The estimated fair value of the warrant was approximately $1 million at the date it was received.
AFG manages its business as three segments: (i) Property and casualty insurance, (ii) Annuity and (iii) Other, which includes holding company assets and costs, revenues and costs of AFG’s limited insurance operations outside of property and casualty insurance and annuity segments, and operations attributable to the noncontrolling interests of the managed investment entities.
AFG reports its property and casualty insurance business in the following Specialty sub-segments: (i) Property and transportation, which includes physical damage and liability coverage for buses and trucks, inland and ocean marine, agricultural-related products and other commercial property coverages, (ii) Specialty casualty, which includes primarily excess and surplus, executive and professional liability, general liability, umbrella and excess liability, specialty coverages in targeted markets, customized programs for small to mid-sized businesses and workers’ compensation insurance, and (iii) Specialty financial, which includes risk management insurance programs for lending and leasing institutions (including equipment leasing and collateral and lender-placed mortgage property insurance), fidelity and surety products and trade credit insurance. Premiums and underwriting profit included under Other specialty represent business assumed by AFG’s internal reinsurance program from the operations that make up AFG’s other Specialty sub-segments and amortization of deferred gains on retroactive reinsurance transactions related to the sales of businesses in prior years. AFG’s annuity business sells traditional fixed and indexed annuities in the retail, financial institutions, broker-dealer and registered investment advisor markets. AFG’s reportable segments and their components were determined based primarily upon similar economic characteristics, products and services.
As discussed in Note B - “Acquisitions and Sale of Businesses,” AFG initiated actions to exit the Lloyd’s of London insurance market, which included placing its Lloyd’s subsidiaries including its Lloyd’s Managing Agency, Neon Underwriting Ltd., into run-off in December 2019. Beginning with the first quarter of 2020, the results for AFG’s Specialty casualty sub-segment exclude the run-off operations of Neon (“Neon exited lines”). AFG completed the sale of Neon in December 2020.
(b)Represents premiums earned in the Neon exited lines during 2020. Neon’s $384 million and $306 million in earned premiums during 2019 and 2018, respectively, are included in the Specialty casualty sub-segment.
(a)Includes an underwriting loss of $135 million in 2020 in the Neon exited lines. Neon’s $36 million and $63 million underwriting losses in 2019 and 2018, respectively, are included in the Specialty casualty sub-segment. Also includes special charges to increase asbestos and environmental (“A&E”) reserves of $47 million in 2020 and $18 million in both 2019 and 2018, and a $76 million charge in 2019 related to the Neon exited lines.
(b)Includes $10 million in 2020 in net expenses from the Neon exited lines, before noncontrolling interest.
Level 1 - Quoted prices for identical assets or liabilities in active markets (markets in which transactions occur with sufficient frequency and volume to provide pricing information on an ongoing basis). AFG’s Level 1 financial instruments consist primarily of publicly traded equity securities, highly liquid government bonds for which quoted market prices in active markets are available and short-term investments of managed investment entities.
Level 3 - Valuations derived from market valuation techniques generally consistent with those used to estimate the fair values of Level 2 financial instruments in which one or more significant inputs are unobservable or when the market for a security exhibits significantly less liquidity relative to markets supporting Level 2 fair value measurements. The unobservable inputs may include management’s own assumptions about the assumptions market participants would use based on the best information available at the valuation date. Financial instruments whose fair value is estimated based on non-binding broker quotes or internally developed using significant inputs not based on, or corroborated by, observable market information are classified as Level 3.
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 investment professionals 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.
(*)Variable annuity liabilities equal the fair value of variable annuity assets.
Approximately 7% of the total assets carried at fair value on December 31, 2020, were Level 3 assets. Approximately 40% ($1.50 billion) of the Level 3 assets were priced using non-binding broker quotes, for which there is a lack of transparency as to the inputs used to determine fair value. Details as to the quantitative inputs are neither provided by the brokers nor otherwise reasonably obtainable by AFG. Approximately $530 million (14%) of the Level 3 assets were priced by pricing services where either a single price was not corroborated, prices varied enough among the providers, or other market factors led management to determine these securities should be classified as Level 3 assets.
The derivatives embedded in AFG’s fixed-indexed and variable-indexed annuity liabilities are measured using a discounted cash flow approach and had a fair value of $3.93 billion at December 31, 2020. The following table presents information about the unobservable inputs used by management in determining fair value of these Level 3 liabilities. See Note F - “Derivatives.”
Changes in balances of Level 3 financial assets and liabilities carried at fair value during 2020, 2019 and 2018 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 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.
Equity securities, which are reported at fair value with holding gains and losses recognized in net earnings, consisted of the following at December 31 (in millions):
At December 31, 2020, the gross unrealized losses on fixed maturities of $118 million relate to 620 securities. Investment grade securities (as determined by nationally recognized rating agencies) represented approximately 76% of the gross unrealized loss and 88% of the fair value.
Management believes AFG will recover its cost basis (net of any allowance) 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, 2020.
See Note A - “Accounting Policies - Credit Losses on Financial Instruments,” for a discussion of new guidance effective January 1, 2020, which impacts the accounting for expected credit losses (impairments) of fixed maturity securities. Under the new guidance, credit losses on available for sale fixed maturities continue to be measured based on the present value of expected future cash flows compared to amortized cost; however, impairment losses are now recognized through an allowance instead of directly writing down the amortized cost. Under the new guidance, recoveries of previously impaired amounts are recorded as an immediate reversal of all or a portion of the allowance instead of accreted as investment income through a yield adjustment. In addition, the allowance on available for sale fixed maturities cannot cause the amortized cost net of the allowance to be below fair value. Accordingly, future changes in the fair value of an impaired security (when the allowance was limited by the fair value) due to reasons other than issuer credit (e.g. changes in market interest rates) result in increases or decreases in the allowance, which are recorded through realized gains (losses) on securities. A progression of the allowance for expected credit losses on fixed maturity securities is shown below (in millions):
The table below sets forth the scheduled maturities of available for sale fixed maturities as of December 31, 2020 (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.
Certain risks are inherent in fixed maturity securities, including loss upon default, price volatility in reaction to changes in interest rates, and general market factors and risks associated with reinvestment of proceeds due to prepayments or redemptions in a period of declining interest rates.
There were no investments in individual issuers that exceeded 10% of shareholders’ equity at December 31, 2020 or 2019.
Net Unrealized Gain on Marketable Securities In addition to adjusting fixed maturity securities classified as “available for sale” to fair value, GAAP requires that deferred policy acquisition costs and certain other balance sheet amounts related to annuity, long-term care and life businesses be adjusted to the extent that unrealized gains and losses from securities would result in adjustments to those balances had the unrealized gains or losses actually been realized.
The following table shows (in millions) the components of the net unrealized gain on securities that is included in AOCI in AFG’s Balance Sheet.
Net Investment Income The following table shows (in millions) investment income earned and investment expenses incurred.
(b)Net investment income in 2020 includes losses of $5 million on investments held by the companies that comprise the Neon exited lines due primarily to the $7 million loss recorded in first quarter of 2020 on equity securities that are carried at fair value through net investment income.
Realized gains (losses) and changes in unrealized appreciation (depreciation) included in AOCI related to fixed maturity securities are summarized as follows (in millions):
(a)Includes realized gains of $415 million on investments disposed of in AFG’s 2020 annuity block reinsurance transaction. See Note P - Insurance.
(b)Primarily adjustments to deferred policy acquisition costs and reserves related to the annuity business.
Gross realized gains and losses (excluding impairment charges and mark-to-market of derivatives) on available for sale fixed maturity investment transactions consisted of the following (in millions):
The MBS with embedded derivatives consist of primarily interest-only and principal-only MBS. AFG records the entire change in the fair value of these securities in earnings. These investments are part of AFG’s overall investment strategy and represent a small component of AFG’s overall investment portfolio.
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 ($351 million at December 31, 2020 and $577 million at December 31, 2019) 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 option assets and put option liabilities 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, GALIC 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 December 2023 and June 2030) in anticipation of the expected decline in GALIC’s portfolio of fixed maturity securities with floating interest rates based on short-term LIBOR. The total outstanding notional amount of GALIC’s interest rate swaps was $1.63 billion at December 31, 2020 compared to $1.98 billion at December 31, 2019, reflecting the scheduled amortization discussed above, the termination of a swap with a total notional amount of $83 million in the first quarter of 2020, the termination of two swaps with a total notional amount of $166 million in the second quarter 2020 and the expiration of a swap with a notional amount of $44 million in the second quarter 2020. The fair value of the interest rate swaps in an asset position and included in other assets was $102 million at December 31, 2020 and $50 million at December 31, 2019. The fair value of the interest rate swaps in a liability position and included in other liabilities was zero at December 31, 2020 and $5 million at December 31, 2019. 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 $40 million in 2020, $3 million in 2019 and losses of $3 million in 2018. A collateral receivable supporting these swaps of $2 million at December 31, 2020 and $20 million at December 31, 2019 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 $160 million and $154 million of accumulated amortization at December 31, 2020 and 2019, respectively. During each of the next five years, the PVFP is expected to decrease at a rate of approximately one-seventh of the balance at the beginning of each respective year.
In 2020, AFG formed a new CLO, which issued $303 million face amount of liabilities (including $31 million face amount purchased by subsidiaries of AFG). During 2020, AFG subsidiaries purchased $57 million face amount of senior and subordinate tranches of existing CLOs for $39 million and received $2 million in sale and redemption proceeds from its CLO investments. During 2019, AFG subsidiaries received less than $1 million in redemption proceeds from their CLO investments. In 2018, AFG formed a new CLO, which issued $463 million face amount of liabilities (including $31 million face amount purchased by subsidiaries of AFG). During 2018, AFG subsidiaries also purchased $7 million face amount of a senior debt tranche of an existing CLO for $7 million and received $45 million in sale and redemption proceeds from its CLO investments. In 2018, two AFG CLOs were substantially liquidated, as permitted by the CLO indentures.
(b)Included in earnings before income taxes in AFG’s Statement of Earnings.
Changes in the carrying value of goodwill during 2018, 2019 and 2020, by reporting segment, are presented in the following table (in millions):
Included in other assets in AFG’s Balance Sheet is $34 million at December 31, 2020 and $43 million at December 31, 2019 of amortizable intangible assets related to property and casualty insurance acquisitions. These amounts are net of accumulated amortization of $62 million and $50 million, respectively. Amortization of intangibles was $12 million in 2020,
$11 million in 2019 and $9 million in 2018. Future amortization of intangibles (weighted average amortization period of 3 years) is estimated to be $6 million in 2021, $4 million per year in 2022, 2023, 2024 and 2025 and $12 million thereafter.
In September 2020, AFG issued $200 million in 4.50% Subordinated Debentures due in September 2060. The net proceeds of this offering were used, in part, to redeem AFG’s $150 million in 6% Subordinated Debentures due in November 2055 at par value on November 15, 2020.
In April and May 2020, AFG issued $300 million in 5.25% Senior Notes due in April 2030 and $150 million in 5.625% Subordinated Debentures due in June 2060, respectively. The net proceeds of these offerings were used for general corporate purposes, which included repurchases of outstanding common shares.
In December 2019, AFG issued $200 million in 5.125% Subordinated Debentures due in December 2059. The net proceeds of the offering were used, in part, to redeem AFG’s $150 million of 6-1/4% Subordinated Debentures due in September 2054 at par value in December 2019.
AFG’s operating lease right-of-use asset (net of deferred rent and lease incentives) and operating lease liability are included in other assets and other liabilities, respectively, in AFG’s Balance Sheet at December 31 and are presented in the following table (in millions):
(*)Net of deferred rent and lease incentives of $20 million at December 31, 2020 and $22 million at December 31, 2019.
Other operating lease information for the years ended December 31, 2020 and December 31, 2019 (in millions):
Stock Incentive Plans Under AFG’s stock incentive plans, employees of AFG and its subsidiaries are eligible to receive equity awards in the form of stock options, stock appreciation rights, restricted stock awards, restricted stock units and stock awards. At December 31, 2020, there were 3.9 million shares of AFG Common Stock reserved for issuance under AFG’s stock incentive plans.
Total compensation expense related to stock incentive plans of AFG and its subsidiaries was $20 million for 2020 and $23 million for 2019 and 2018. AFG’s provision for income tax includes tax benefits of $9 million in 2020 and $13 million in 2019 and 2018 related to AFG’s stock incentive plans. At December 31, 2020, there was $35 million of unrecognized compensation expense related to restricted stock awards, which is expected to be recognized over a weighted average of 2.5 years. At December 31, 2020, there was no unrecognized compensation expense related to unvested stock options.
(b)On January 1, 2018, AFG adopted new guidance that requires all equity securities other than those accounted for under the equity method to be reported at fair value with holding gains and losses recognized in net earnings. At the date of adoption, the $221 million net unrealized gain on equity securities classified as available for sale (with unrealized holding gains and losses reported in AOCI) under the prior guidance was reclassified from AOCI to retained earnings as the cumulative effect of an accounting change.
The following is a reconciliation of income taxes at the statutory rate of 21% to the provision for income taxes as shown in AFG’s Statement of Earnings (dollars in millions):
On December 31, 2020, AFG completed the sale of the legal entities that own Neon Underwriting Limited (“Neon”, formerly known as Marketform Group Limited), a United Kingdom-based Lloyd’s insurer (see Note B - “Acquisitions and Sale of Businesses”), which resulted in a taxable loss for U.S. tax purposes. AFG recorded a $72 million tax benefit associated with this loss in 2020. Approximately $65 million of the $72 million tax benefit reduced current taxes payable while the remaining tax benefit will be received from the carry-back of the tax-basis capital loss to offset capital gains in prior tax years.
Since almost all of AFG’s earnings are taxable based on U.S. tax rates, the Global Intangible Low-taxed Income (“GILTI”) provision is not expected to be material to AFG’s results of operations and will be recorded in the period that any tax arises.
AFG’s net deferred tax asset at December 31, 2020 and 2019 is included in other assets in AFG’s Balance Sheet. The decrease in AFG’s net deferred tax asset at December 31, 2020 compared to December 31, 2019 reflects higher pretax unrealized gains on securities.
The gross deferred tax asset has been reduced by a $15 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 $23 million of AFG’s SRLY NOLs expired unutilized at December 31, 2020. 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. “Foreign underwriting losses” in 2019 in the table above is primarily the net operating loss carryforward and other deferred tax assets related to the Neon Lloyd’s insurance business, which was sold in December 2020. Due to uncertainty concerning the realization of the deferred tax benefits associated with these losses, AFG maintained a full valuation allowance of $118 million against these deferred tax assets at December 31, 2019.
Cash payments for income taxes, net of refunds, were $179 million, $278 million and $156 million for 2020, 2019 and 2018, respectively.
The property and casualty group’s liability for A&E reserves was $572 million at December 31, 2020; related recoverables from reinsurers (net of allowances for doubtful accounts) at that date were $150 million.
The following are quarterly results of consolidated operations for the two years ended December 31, 2020 (in millions, except per share amounts). Quarterly earnings per share do not add to year-to-date amounts due to changes in shares outstanding.
Pretax realized gains (losses) on securities were as follows (in millions):
Other realized gains in the fourth quarter of 2020 includes realized gains of $369 million (net of DPAC) on investments disposed of in AFG’s annuity block reinsurance transaction.
Net investment income, which includes mark-to-market income/(losses) on alternative investments (partnerships and similar investments), was as follows (in millions):
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.
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 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, and beginning with the fourth quarter of 2020, the impact of the block reinsurance transaction entered into in October 2020 were as follows, net of the related acceleration/deceleration of the amortization of deferred policy acquisition costs and deferred sales inducements (in millions):
Prior year development in the third quarters of 2020 and 2019 includes pretax special charges of $47 million and $18 million, respectively, to strengthen property and casualty insurance A&E reserves.
Catastrophe losses include $37 million and $13 million in 2020 and 2019, respectively, at Neon.
AFG’s property and casualty operations recorded $10 million and $105 million in COVID-19 related losses in the first and second quarters of 2020, respectively, which includes $20 million at Neon.
AFG recorded pretax losses on the retirement of debt of $5 million in both the fourth quarter 2020 and 2019, respectively.
Cash and securities owned by U.S.-based insurance subsidiaries, having a carrying value of approximately $1.12 billion at December 31, 2020, were on deposit as required by regulatory authorities. AFG and its subsidiaries had $308 million in undrawn letters of credit (none of which was collateralized) and similar agreements supporting Neon’s underwriting capacity, which were terminated in connection with the December 2020 sale of Neon.
Each method has particular strengths and weaknesses and no single estimation method is most accurate in all situations. When applied to a particular group of claims, the relative strengths and weaknesses of each method can change over time based on the facts and circumstances. Ultimately, the estimation methods chosen are those which the actuary believes produce the most reliable indication for the particular liabilities under review.
The liability for losses and LAE for a very limited number of claims with long-term scheduled payments under certain workers’ compensation policies has been discounted at 3.5% at December 31, 2020 and 4.5% at December 31, 2019, which represents an approximation of long-term investment yields. Because of the limited amount of claims involved, the net impact of discounting did not materially impact AFG’s total liability for unpaid losses and loss adjustment expenses (net reductions from discounting of $9 million and $12 million at December 31, 2020 and 2019, respectively).
The net decrease in the provision for claims of prior years in 2018 reflects (i) lower than expected losses in the crop business and lower than expected claim severity at National Interstate (within the Property and transportation sub-segment), (ii) lower than anticipated claim severity in the workers’ compensation businesses, lower than expected emergence in assumed 2017 property catastrophe losses at Neon and lower than expected claim severity in the executive liability business (within the Specialty casualty sub-segment) and (iii) 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 (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 (ii) higher than expected claim frequency and severity in the Singapore branch and aviation operations (within the Property and transportation sub-segment).
(a)Represents the cumulative percentage paid of incurred claims and allocated LAE (net of reinsurance, as estimated at December 31, 2020).
(b)Represents the cumulative percentage paid of incurred claims and allocated LAE (net of reinsurance, as estimated at December 31, 2020).
FHLB Funding Agreements GALIC is a member of the Federal Home Loan Bank of Cincinnati (“FHLB”). The FHLB makes advances and provides other banking services to member institutions. Members are required to purchase stock in the FHLB in addition to maintaining collateral deposits that back any funds advanced. GALIC’s $56 million
In 2020, the FHLB advanced GALIC $200 million and GALIC repaid $165 million to the FHLB. In 2019, GALIC refinanced the terms on advances totaling $610 million. At December 31, 2020 and December 31, 2019, GALIC had $1.13 billion and $1.10 billion, respectively, in outstanding advances from the FHLB (included in annuity benefits accumulated), bearing interest at rates ranging from 0.31% to 1.35% (average rate of 0.53% at December 31, 2020). While these advances must be repaid between 2021 and 2025 ($931 million in 2021 and $200 million in 2025), GALIC has the option to prepay all or a portion on the majority 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 $1.37 billion (included in available for sale fixed maturity securities) at December 31, 2020. Interest credited on the funding agreements, which is included in annuity benefits, was $11 million in 2020, $27 million in 2019 and $20 million in 2018.
In the fourth quarter of 2018, GALIC, AFG’s primary annuity subsidiary, entered into a reinsurance treaty with Hannover Life Reassurance Company of America that transfers the risk of certain surrender activity in GALIC’s fixed-indexed annuity business. This treaty meets the statutory risk transfer rules and resulted in increases in statutory surplus (through an after-tax reserve credit) of $139 million at December 31, 2020 and $124 million at December 31, 2019, which is reflected in the life insurance companies capital and surplus in the table above. Under GAAP, this transaction does not meet the GAAP insurance risk transfer criteria and did not have a material impact on AFG’s financial statements.
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 2021 from its insurance subsidiaries without seeking regulatory approval is $705 million. Additional amounts of dividends require regulatory approval.
In June 2017, AFG’s property and casualty insurance subsidiaries entered into a reinsurance agreement to obtain supplemental catastrophe protection through a catastrophe bond structure with Riverfront Re Ltd. (“Riverfront”). The reinsurance agreement provided supplemental reinsurance coverage up to 95% of $200 million (fully collateralized) for catastrophe losses in excess of $109 million of traditional catastrophe reinsurance (per occurrence and annual aggregate) occurring until January 15, 2021. In connection with the reinsurance agreement, Riverfront issued notes to unrelated investors for the full amount of coverage provided under the reinsurance agreement. Through December 31, 2020, AFG’s incurred catastrophe losses have not reached the level of attachment for the catastrophe bond structure. Riverfront is a variable interest entity in which AFG does not have a variable interest because the variability in Riverfront’s results will be absorbed entirely by the investors in Riverfront. Accordingly, Riverfront is not consolidated in AFG’s financial statements and the reinsurance agreement is accounted for as ceded reinsurance. AFG’s cost for this coverage is approximately $11 million per year. In July 2020, AFG purchased an additional $50 million of reinsurance coverage for losses in excess of $100 million. Recoveries from the catastrophe bond apply before calculating losses recoverable from this catastrophe excess of loss reinsurance.
Under both the flow and block reinsurance agreements, Commonwealth is required to maintain collateral in trusts in excess of amounts owed to GALIC. Under these agreements, $492 million of gross annuity receipts were ceded and there were $206 million of ceded annuity surrenders, benefits and withdrawals. GALIC received $39 million of commission and expense allowances in 2020 and annuity benefits expense was reduced by $46 million.
AFG has reinsured approximately $5.42 billion of its $8.33 billion in face amount of life insurance at December 31, 2020 compared to $6.23 billion of its $9.53 billion in face amount of life insurance at December 31, 2019. Life written premiums ceded were $19 million, $20 million and $22 million for 2020, 2019 and 2018, respectively. Reinsurance recoveries on ceded life policies were $28 million, $32 million and $38 million for 2020, 2019 and 2018, respectively.
Prior to the new guidance, AFG recorded net expense reductions against the allowance for uncollectible reinsurance recoverables of less than $1 million in 2019 and $2 million in 2018.
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, 2020, AFG and its subsidiaries had commitments to fund credit facilities and contribute capital to limited partnerships and limited liability corporations of approximately $993 million. Approximately 50% of the unfunded commitments are related to GALIC, which is expected to be sold in the second quarter of 2021.
The Annuity subsidiaries to be sold impacted AFG’s Balance Sheet at December 31, 2020 as follows (in millions):
The fair value of the available for sale fixed maturities owned by the Annuity subsidiaries to be sold at December 31, 2020 is detailed below.
Results for the Annuity subsidiaries to be sold were (in millions):
Net investment income excludes $49 million in 2020 and $37 million in both 2019 and 2018, respectively, related to the real estate-related investments that AFG will acquire from GALIC prior to the completion of the sale.
A. Selected Quarterly Financial Data is included in Note O to the Consolidated Financial Statements.
Amended and Restated Code of Regulations, filed as Exhibit 3.1 to the Form 8-K filed on April 1, 2020. (*)
4 Instruments defining the rights of security holders. Registrant has no outstanding debt issues exceeding 10% of the assets of Registrant and consolidated subsidiaries.
Annual Senior Executive Bonus Plan, filed as Exhibit 10(d) to AFG’s 10-K for 2017. (*)
Credit Agreement dated December 14, 2020, among American Financial Group, Inc., Bank of America, N.A., as Administrative Agent, and several lenders, filed as Exhibit 10.1 to AFG’s Form 8-K filed on December 15, 2020. (*)