AFG and its insurance subsidiaries lease the majority of their office and storage facilities in numerous cities throughout the United States, including the Company’s home offices in Cincinnati. National Interstate occupies approximately 87% of the 164,000 square feet of rentable office space on 17.5 acres of land that it owns in Richfield, Ohio. See Item 1 - Business - “Other Operations” for a discussion of AFG’s other commercial real estate operations.
the fourth quarter 2015 gain on the sale of an apartment property, and
Net Cash Provided by Operating Activities AFG’s property and casualty insurance operations typically produce positive net operating cash flows as premiums collected and investment income exceed policy acquisition costs, claims payments and operating expenses. AFG’s net cash provided by operating activities is impacted by the level and timing of property and casualty premiums, claim and expense payments and recoveries from reinsurers. AFG’s annuity operations typically produce positive net operating cash flows as investment income exceeds acquisition costs and operating expenses. Interest credited on annuity policyholder funds is a non-cash increase in AFG’s annuity benefits accumulated liability and annuity premiums, benefits and withdrawals are considered financing activities due to the deposit-type nature of annuities. Net cash provided by operating activities was $1.15 billion, $1.35 billion and $1.23 billion in 2016, 2015 and 2014, respectively.
AFG has no material contractual purchase obligations or other long-term liabilities at December 31, 2016.
While management applies the actuarial methods mentioned above, more judgment is involved in arriving at the final reserve to be held. For recent accident years, more weight is given to the Bornhuetter-Ferguson method.
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 $5 million in 2016, $12 million in 2015 and $6 million in 2014. For a discussion of the charges recorded for those operations, see “Holding Company, Other and Unallocated - Results of Operations.” Liabilities for claims and contingencies arising from these former railroad and manufacturing operations totaled $86 million at December 31, 2016. For a discussion of the uncertainties in determining the ultimate liability, see Note M - “Contingencies” to the financial statements.
Elimination of the change in fair value of AFG’s investments in the CLOs, including $23 million in distributions recorded as interest expense by the CLOs.
The increase in average invested assets in the property and casualty insurance segment for the fourth quarter of 2016 as compared to the fourth quarter of 2015 is due primarily to growth in the property and casualty insurance segment. The property and casualty insurance segment’s overall yield on investments (net investment income as a percentage of average invested assets) was 3.48% for the fourth quarter of 2016 compared to 3.25% for the fourth quarter of 2015, an increase of 0.23 percentage points, reflecting a $5 million increase in income from certain investments that are required to be carried at fair value through earnings and an $8 million increase in equity in the earnings of limited partnerships and similar investments, partially offset by slightly higher investment expenses and lower yields available in the financial markets. The 7% increase in average invested assets in the fourth quarter of 2016 compared to the fourth quarter of 2015 reflects a higher average balance in cash and cash equivalents.
GAAP other income and expenses, net for AFG’s property and casualty operations was a net expense of $13 million for the fourth quarter of 2016 compared to net income of $5 million for the fourth quarter of 2015, a decrease of $18 million (360%). Core other income and expenses, net for AFG’s property and casualty operations was a net expense of $13 million in the fourth quarter of 2016 compared to $10 million in the fourth quarter of 2015, an increase of $3 million (30%). The table below details the items included in GAAP and core other income and expenses, net for AFG’s property and casualty operations (in millions):
a percentage of average fixed annuity benefits accumulated, these expenses increased 0.03 percentage points to 0.35% from 0.32% for the fourth quarter of 2016 as compared to the fourth quarter of 2015.
Other income in the table above includes $5 million and $4 million in the fourth quarter of 2016 and 2015, respectively, 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 insurance operations of $3 million in the fourth quarter of 2016 and $2 million in the fourth quarter of 2015.
Underwriting profit for this group was $14 million in 2015 compared to $16 million in 2014, a decrease of $2 million (13%).
Aggregate Aggregate net prior accident years reserve development for AFG’s property and casualty insurance segment includes the A&E charges and Neon exited lines charge mentioned above and adverse reserve development of $3 million in 2015 and $1 million in 2014 related to business outside of the Specialty group that AFG no longer writes.
The increase in average invested assets and net investment income in the property and casualty insurance segment in 2015 compared to 2014 is due primarily to the investment of cash acquired in the Summit acquisition, which occurred over the two quarters following the April 2014 acquisition, as well as growth in the property and casualty insurance segment. The property and casualty insurance segment’s overall yield on investments was 3.56% in 2015 compared to 3.75% in 2014, a decline of 0.19 percentage points reflecting the impact of lower yields available in the financial markets and lower earnings from other investments.
Other income for AFG’s property and casualty operations includes a $4 million death benefit on a life insurance policy received in the second quarter of 2016.
Prior to the adoption of ASU 2014-13, measuring both the CLO assets and CLO liabilities at separately determined fair values resulted in a difference between the carrying value of the CLO assets and the carrying value of the CLO liabilities that was not attributable to AFG’s ownership interest in the CLOs and CLO earnings (losses) that were not attributable to AFG’s shareholders. This difference was recorded as “appropriated retained earnings - managed investment entities” in AFG’s Balance Sheet and the earnings (losses) that were not attributable to AFG’s shareholders were included in net earnings (loss) attributable to noncontrolling interests in AFG’s Statement of Earnings. In accordance with the guidance adopted in 2015, the amount reported as “appropriated retained earnings - managed investment entities” at December 31, 2014 was reclassified to “liabilities of managed investment entities” on January 1, 2015 as the cumulative effect of an accounting change.
Because NATL was already a consolidated subsidiary of AFG prior to the merger, the acquisition was accounted for as an equity transaction. As a result, the excess of the consideration paid over the carrying value of the noncontrolling interest acquired was recorded as a $137 million reduction in AFG’s Capital Surplus. In addition, the merger allowed NATL and its subsidiaries to become members of the AFG consolidated tax group, which resulted in a tax benefit of $66 million in the fourth quarter of 2016.
Based on the status of ongoing negotiations at the end of the first quarter of 2015, management determined that the potential sale of the run-off long-term care insurance business met the GAAP “held for sale” criteria as of March 31, 2015. Accordingly, AFG recorded a $162 million pretax loss ($105 million loss after tax) in the first quarter of 2015 to establish a liability equal to the excess of the net carrying value of the assets and liabilities to be disposed over the estimated net sale proceeds. At the closing date, the loss was adjusted to $166 million ($108 million loss after tax) based on the actual proceeds received and the final carrying value of the net assets disposed. In the second quarter of 2016, AFG received additional proceeds based on the final closing balance sheet and adjusted certain accrued expense estimates associated with the sale, resulting in a $2 million pretax gain. At March 31, 2015 and at the sale date, the carrying value of the assets and liabilities disposed represented approximately 4% of both AFG’s assets and liabilities.
Sales of property and casualty insurance outside of the United States represented 4% of AFG’s revenues in 2016 and 2015 and 5% of AFG’s revenues in 2014.
The impact of implementing new guidance adopted in 2015, as discussed above and in Note A - “Accounting Policies - Managed Investment Entities.”
The changes in valuation allowance in the table above are primarily increases in the valuation allowance on tax benefits related to losses in the Neon Lloyd’s insurance business. AFG maintains a full valuation allowance against the deferred tax benefits associated with losses related to Neon.
In January 2008, AFG paid $75 million in cash to acquire approximately 67% of Neon Underwriting Limited (“Neon”, formerly known as Marketform Group Limited), a United Kingdom-based Lloyd’s insurer. During 2012, AFG acquired the then-remaining shares of Neon that it did not already own for $17 million. Neon has recorded underwriting losses in each period from the date of AFG’s initial investment, including adverse prior year reserve development related to Italian public hospital medical malpractice business which Neon ceased writing in 2008, as well as other lines of business. AFG’s investment in Neon includes the cost of acquiring the company as well as additional capital provided to Neon since the date of acquisition.
In July 2014, AFG finalized a settlement with the IRS related to tax years 2008 and 2009. As a result, AFG’s uncertain tax positions were effectively settled, allowing AFG to reduce its liability for previously uncertain tax positions by $19 million in the third quarter of 2014. Although AFG agreed to pay $11 million to the IRS, the majority of the reduction in this liability resulted in offsetting adjustments to AFG’s deferred tax liability and did not impact AFG’s effective tax rate. The portion of the reduction in this liability that favorably impacted the effective tax rate was approximately $4 million including interest. The reduction of the liability for previously uncertain tax positions includes $17 million related to the timing of recognition of investment income on certain debt securities and $2 million related to the deductibility of certain financing expenses.
Closed Block of Long-Term Care Insurance Following the completion of the sale of substantially all of its run-off long-term care insurance business in December 2015, AFG’s remaining long-term care insurance reserves were $37 million at December 31, 2016 and $34 million at December 31, 2015, net of reinsurance recoverables and excluding the impact of unrealized gains on securities. AFG’s remaining outstanding long-term care policies have level premiums and are guaranteed renewable. Premium rates can potentially be increased in reaction to adverse experience; however, any rate increases would require regulatory approval.