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 $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. 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 $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. See Note A - “Accounting Policies - Managed Investment Entities” and Note H - “Managed Investment Entities” to the financial statements.
AFG has no material contractual purchase obligations or other long-term liabilities at December 31, 2019.
Fixed income investment funds are generally invested in securities with intermediate-term maturities with an objective of optimizing total return while allowing flexibility to react to changes in market conditions. At December 31, 2019, the average life of AFG’s fixed maturities was about 5-1/2 years.
Neon recorded favorable prior year reserve development of $26 million in 2018, due primarily to lower than expected emergence in assumed 2017 property catastrophe losses.
Outside of its property and casualty operations, AFG also has reinsurance recoverables totaling $282 million, including $228 million related to the run-off life business. These recoverables include $195 million directly or indirectly from Hannover Life Reassurance Company of America (rated AA- by S&P).
Asbestos and Environmental-related (“A&E”) Insurance Reserves Asbestos and environmental reserves of the property and casualty group consisted of the following (in millions):
Approximately 41% 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.
The increase in property and casualty environmental reserves was primarily associated with updated estimates of site
As a result of the comprehensive external study completed in the third quarter of 2017, AFG’s property and casualty insurance segment recorded an $89 million pretax special charge to increase its asbestos reserves by $53 million (net of reinsurance) and its environmental reserves by $36 million (net of reinsurance). The increase in property and casualty asbestos reserves reflects increasing life expectancies in the U.S., which have allowed more time for the impacts of asbestos exposure to emerge. AFG’s comprehensive external study incorporates, among other factors, the increase in projected industry ultimate losses attributable to asbestos exposures, as well as revised estimates for future claims emergence. The increase in property and casualty environmental reserves was attributed primarily to increased legal defense costs and a number of claims and sites where the estimated investigation and remediation costs have increased.
Includes losses of $7 million and $4 million in the fourth quarter of 2019 and 2018, respectively, representing the change in fair value of AFG’s CLO investments plus $4 million in both the fourth quarter of 2019 and 2018 in CLO management fees earned.
Includes income of $23 million representing the change in fair value of AFG’s CLO investments plus $18 million in CLO management fees earned.
Performance measures such as underwriting profit or loss and related combined ratios are often used by property and casualty insurers to help users of their financial statements better understand the company’s performance. Underwriting profitability is measured by the combined ratio, which is a sum of the ratios of losses and LAE, and commissions and other underwriting expenses to premiums. A combined ratio under 100% indicates an underwriting profit. The combined ratio does not reflect net investment income, other income, other expenses or federal income taxes.
AFG’s property and casualty insurance operations contributed $121 million in GAAP pretax earnings in the fourth quarter of 2019 compared to $208 million in the fourth quarter of 2018, a decrease of $87 million (42%). Property and casualty core pretax earnings were $197 million in the fourth quarter of 2019 compared to $208 million in the fourth quarter of 2018, a decrease of $11 million (5%). The decrease in GAAP and core pretax earnings reflects lower underwriting profit, partially offset by higher net investment income in the fourth quarter of 2019 compared to the fourth quarter of 2018.
Performance measures such as the combined ratio are often used by property and casualty insurers to help users of their financial statements better understand the company’s performance. The combined ratio is the sum of the loss and loss adjustment expenses (“LAE”) and underwriting expense ratios. These ratios are calculated by dividing each of the respective expenses by net earned premiums. The table below (dollars in millions) details the components of the combined ratio for AFG’s property and casualty insurance segment:
Specialty financial 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. Net favorable reserve development of $7 million in the fourth quarter of 2018 reflects lower than expected claim frequency and severity in the surety business and lower than anticipated claim frequency in run-off businesses.
Other specialty In addition to the development discussed above, total Specialty prior year reserve development includes net adverse reserve development of $4 million in the fourth quarter of 2019 and $5 million in the fourth quarter of 2018, reflecting adverse development associated with AFGs 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, 2019, 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:
Catastrophe losses of $14 million in the fourth quarter of 2019 resulted primarily from Typhoons Faxai and Hagibis, storms and tornadoes in the south-central United States and the Kincade fire in California. Catastrophe losses of $39 million in the fourth quarter of 2018 resulted primarily from Hurricane Michael and wildfires in California.
AFG’s impairment charges for the fourth quarter of 2019 consist of $7 million on corporate bonds and $2 million on third-party collateralized loan obligations compared to $17 million on corporate bonds and $6 million on residential MBS in the fourth quarter of 2018.
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, 2019, 2018 and 2017 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):
This group reported an underwriting loss of $5 million in 2018 compared to $2 million in 2017, an increase of $3 million (150%). The lower underwriting results are due primarily to losses in the business assumed by AFG’s internal reinsurance program from the operations that make up AFG’s other Specialty sub-segments in 2018, partially offset by the impact of a $14 million charge recorded in 2017 to adjust the deferred gain on the retroactive reinsurance transaction entered into in connection with the sale of businesses in 1998.
AFG’s annuity operations generated statutory premiums of $4.96 billion in 2019, $5.41 billion in 2018 and $4.34 billion in 2017, a decrease of $447 million (8%) in 2019 compared to 2018 and an increase of $1.07 billion (25%) in 2018 compared to 2017. The following table summarizes AFG’s annuity sales (dollars in millions):
Management attributes the 25% increase in annuity premiums in 2018 compared to 2017 to the introduction of new products, efforts to expand in the retail and broker dealer markets and an improving interest rate environment in 2018.
Issued an additional $125 million of 3.50% Senior Notes in November 2017
Other noncontrolling interests includes $2 million related to the gain on the sale of a hotel property in the first quarter of 2017. The property was owned by an 80%-owned subsidiary of GAI.
AFG’s management, with participation of its Co-Chief Executive Officers and its Chief Financial Officer, has evaluated AFG’s disclosure controls and procedures (as defined in Exchange Act Rule 13a-15) as of the end of the period covered by this report. Based on that evaluation, AFG’s Co-CEOs and CFO concluded that the controls and procedures are effective. There have been no changes in AFG’s internal control over financial reporting during the fourth fiscal quarter of 2019 that materially affected, or are reasonably likely to materially affect, AFG’s internal control over financial reporting.
Noncontrolling Interests For balance sheet purposes, noncontrolling interests represent the interests of shareholders other than AFG in consolidated entities. In the statement of earnings, net earnings and losses attributable to noncontrolling interests represents such shareholders’ interest in the earnings and losses of those entities. Noncontrolling
Cash interest payments on long-term debt were $65 million in 2019, $59 million in 2018 and $85 million in 2017.
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 4.5% at both December 31, 2019 and 2018, which represents an approximation of long-term investment yields. Because of the limited amount of claims involved, the net impact of
Closed Block of Long-Term Care Insurance Reserves for AFG’s closed block of long-term care insurance were $46 million at December 31, 2019 and $45 million at December 31, 2018, 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.
2005 Stock Incentive Plan Exhibit 10 to the Form S-8 Registration Statement (File No. 333-184914) filed by AFG on November 13, 2012.