In December 2012, AFG replaced its bank credit facility with a four-year, $500 million revolving credit line. Amounts borrowed under this agreement bear interest at rates ranging from 1.00% to 1.875% (currently 1.375%) over LIBOR based on AFG’s credit rating. There were no borrowings under this agreement, or under any other parent company short-term borrowing arrangements, during 2013.
MBS are subject to significant prepayment risk due to the fact that, in periods of declining interest rates, mortgages may be repaid more rapidly than scheduled as borrowers refinance higher rate mortgages to take advantage of lower rates. Although interest rates have been low for the last few years, tighter lending standards have resulted in fewer buyers being able to refinance the mortgages underlying much of AFG’s non-agency residential MBS portfolio.
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 mortgage-backed securities 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, 2013, 98% (based on statutory carrying value of $6.42 billion) of AFG’s MBS securities had a NAIC designation of 1 or 2.
AFG’s subsidiary that writes workers’ compensation business in California recorded favorable reserve development of $7 million in 2013 compared to less than $1 million in 2012 and $5 million in 2011.
(a) The tax effects of reconciling items are shown below (in millions):
Net written premiums ("NWP") for AFG's property and casualty insurance segment were $821 million for the fourth quarter of 2013 compared to $702 million for the fourth quarter of 2012, an increase of $119 million (17%). Detail of AFG's property and casualty net written premiums is shown below (dollars in millions):
Specialty financial Gross written premiums increased $13 million (9%) for the fourth quarter of 2013 compared to the fourth quarter of 2012. This increase was due primarily to premium growth related to real estate owned and collateral products for financial institutions and growth in the surety operations. Gross written premiums for the fourth quarter of 2013 include $5 million in risk fees from AFG’s warranty operations. Prior to 2013, fees in the warranty operations were included in other income. Average renewal rates for this group were flat in the fourth quarter of 2013. Reinsurance premiums ceded as a percentage of gross written premiums declined 8 percentage points due to the sale of the service contract business, which was 100% reinsured, and lower reinsurance reinstatement premiums reflecting the impact of large reinsured losses in the fourth quarter of 2012 in the surety business.
The property and casualty segment’s overall yield on investments (net investment income as a percentage of average invested assets) was 3.94% for the fourth quarter of 2013 compared to 4.08% for the fourth quarter of 2012, a decline of 0.14 percentage points, reflecting the impact of lower yields available in the financial markets.
The profitability of a fixed annuity business is largely dependent on the ability of a company to earn income on the assets supporting the business in excess of the amounts credited to policyholder accounts plus expenses incurred (earning a “spread”). Performance measures such as net interest spread and net spread earned are often presented by annuity businesses to help users of their financial statements better understand the company's performance.
AFG expects revenues and expenses related to the long-term care business to generally increase over time as this closed block of business ages. Due to the age and relatively small size of its long-term care business, AFG expects claims volatility from period to period. Management continues to monitor its claims experience and update its loss recognition assumptions as needed.
AFG's property and casualty U/W Exp were $887 million in 2012 compared to $835 million in 2011, an increase of $52 million (6%). AFG's underwriting expense ratio was 31.1% in 2012 compared to 30.2% in 2011, an increase of 0.9 percentage points.
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 2013, 2012 and 2011 (in millions):
See “Results of Operations - Quarters ended December 31, 2013 and 2012 - Annuity Segment - Results of Operations - Annuity Unlocking” for a discussion of the overall net charge from the periodic review of actuarial assumptions in 2013 and 2012.
Other income in the table above includes management fees paid to AFG by the AFG-managed CLOs (AFG's consolidated managed investment entities) of $16 million, $18 million and $19 million in 2013, 2012 and 2011, respectively. These fees are eliminated in consolidation - see the other income line in the Consolidated 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 $11 million in 2013 compared to $4 million in 2012 and $6 million in 2011. Results for 2012 include a loss related to the sale of fixed assets of $7 million.
Excluding the non-core charges, AFG's holding companies and other operations outside of its insurance operations recorded other expenses of $135 million in 2013, $116 million in 2012 and $107 million in 2011. The $19 million (16%) increase in 2013 compared to 2012 and the $9 million (8%) increase in 2012 compared to 2011 reflect the impact of higher holding company expenses, primarily related to employee benefit plans that are tied to stock market performance and certain share-based incentive plans.
Realized gains on disposals include gains on sales of shares of Verisk Analytics, Inc. of $49 million, $93 million and $76 million in 2013, 2012 and 2011, respectively.
Consolidated Statement of Comprehensive Income for the years ended December 31, 2013, 2012 and 2011
DPAC includes the present value of future profits on business in force of annuity and life, accident and health insurance companies acquired (“PVFP”). PVFP represents the portion of the costs to acquire companies that is allocated to the value of the right to receive future cash flows from insurance contracts existing at the date of acquisition. PVFP is amortized with interest in relation to expected gross profits of the acquired policies for annuities and universal life products and in relation to the premium paying period for traditional life and health insurance products.
In the third quarter of 2012, goodwill decreased $1 million due to the sale of a small annuity subsidiary.
The following are quarterly results of consolidated operations for the two years ended December 31, 2013 (in millions, except per share amounts). Quarterly earnings per share do not add to year-to-date amounts due to changes in shares outstanding.
Property and Casualty Insurance Reserves The liability for losses and LAE for long-term scheduled payments under certain workers’ compensation insurance has been discounted at 4.5% at both December 31, 2013 and 2012, which represents an approximation of long-term investment yields. As a result, the total liability for losses and loss adjustment expenses at December 31, 2013 and 2012, has been reduced by $20 million and $22 million.
In 2012, AFG recorded a $153 million pretax loss recognition charge to write off deferred policy acquisition costs and strengthen reserves on its closed block of long-term care insurance, due primarily to the impact of changes in assumptions related to future investment yields resulting from the continued low interest rate environment, as well as changes in claims, expenses and persistency assumptions. No additional loss recognition charges were recorded in 2013. At December 31, 2013, AFG’s long-term care insurance reserves were $726 million, net of reinsurance recoverables.