Fixed charges are computed on a “total enterprise” basis. For purposes of calculating the ratios, “earnings” have been computed by adding to pretax earnings the fixed charges and the noncontrolling interests in earnings of subsidiaries having fixed charges and the undistributed equity in earnings or losses of investees. Fixed charges include interest (including annuity benefits as indicated), amortization of debt premium/discount and expense, preferred dividend and distribution requirements of subsidiaries and a portion of rental expense deemed to be representative of the interest factor. The ratio of core earnings to fixed charges excluding annuity benefits and the ratio of earnings to fixed charges excluding and including annuity benefits are shown in the table below:
(b)Dollar amounts and time periods are estimates based on historical net payment patterns applied to the gross reserves and do not represent actual contractual obligations. Based on the same assumptions, AFG projects reinsurance recoveries related to these reserves totaling $3.12 billion as follows: Within 1 year - $848 million; 2-3 years - $829 million; 4-5 years - $352 million; and thereafter - $1.09 billion. Actual payments and their timing could differ significantly from these estimates.
In general, the fair value of AFG’s fixed maturity investments is inversely correlated to changes in interest rates. The following table demonstrates the sensitivity of such fair values to reasonably likely changes in interest rates by illustrating the estimated effect on AFG’s fixed maturity portfolio and accumulated other comprehensive income that an immediate increase of 100 basis points in the interest rate yield curve would have at December 31, 2020 (dollars in millions). Effects of increases or decreases from the 100 basis points illustrated would be approximately proportional.
h)the continuity of interest payments, maintenance of investment grade ratings and hybrid nature of certain investments,
•Health care costs and utilization of medical services by injured parties
Asbestos claims against manufacturers, distributors or installers of asbestos products were presented under the products liability section of their policies, which typically had aggregate limits that capped an insurer’s liability. In addition, asbestos claims are being presented as “non-products” claims, such as those by installers of asbestos products and by property owners or operators who allegedly had asbestos on their property, under the premises or operations section of their policies. Unlike products exposures, these non-products exposures typically had no aggregate limits, creating greater exposure for insurers. Further, in an effort to seek additional insurance coverage, some insureds with installation activities who have substantially eroded their products coverage are presenting new asbestos claims as non-products operations claims or attempting to reclassify previously settled products claims as non-products claims to restore a portion of previously exhausted products aggregate limits.
Indexed Annuity Embedded Derivatives As of December 31, 2020, annuity benefits accumulated in AFG’s Balance Sheet includes $3.93 billion for the fair value of the derivatives embedded in its fixed-indexed and variable-indexed annuities. As discussed in Note F - “Derivatives” to the financial statements, 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. Under GAAP, this index participation is considered an embedded derivative that is required to be carried at fair value in the financial statements. 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 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. The fair value of the embedded derivatives represents an estimate of the present value of projected policyholder benefits from the equity participation in excess of the projected minimum guaranteed contract values. As discussed in Note D - “Fair Value Measurements” to the financial statements, the fair value of the embedded derivatives is impacted by fluctuations in interest rates, the stock market (including the cost of options), policyholder behavior and 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. The indexed annuity embedded derivatives are part of the pending sale of annuity business, which is expected to close in the second quarter of 2021.
Specialty casualty Gross written premiums decreased $64 million (7%) in the fourth quarter of 2020 compared to the fourth quarter of 2019 due primarily to the run-off of Neon. Excluding the impact of $138 million in gross written premiums from the Neon exited lines in the fourth quarter of 2019, gross written premiums increased 9% in the fourth quarter of 2020 compared to the fourth quarter of 2019. This increase reflects significant renewal rate increases, and new business opportunities in the excess and surplus, excess liability and directors and officers businesses, partially offset by lower premiums in the workers’ compensation businesses due to reduced exposures as a result of the COVID-19 pandemic, coupled with renewal rate decreases. Average renewal rates for this group increased approximately 19% in the fourth quarter of 2020. Excluding rate decreases in the workers’ compensation business, renewal rates for this group increased approximately 29%, much higher than the renewal rate increases in the first three quarters of 2020. Reinsurance premiums ceded as a percentage of gross written premiums increased 7 percentage points for the fourth quarter of 2020 compared to the fourth quarter of 2019, reflecting growth in the excess and surplus businesses, which cede a larger percentage of premiums than the overall Specialty casualty sub-segment.
AFG’s Specialty property and casualty insurance operations recorded net favorable reserve development related to prior accident years of $32 million in the fourth quarter of 2020 compared to $53 million in the fourth quarter of 2019, a decrease of $21 million (40%).
Other income and expenses, net for AFG’s property and casualty insurance operations was a net expense of $11 million for both the fourth quarter of 2020 and the fourth quarter of 2019. The table below details the items included in other income and expenses, net for AFG’s property and casualty insurance operations (in millions):
AFG’s property and casualty insurance operations contributed $607 million in GAAP pretax earnings in 2020 compared to $649 million in 2019, a decrease of $42 million (6%). Property and casualty core pretax earnings were $776 million in 2020 compared to $743 million in 2019, an increase of $33 million (4%). The decrease in GAAP pretax earnings reflects pretax non-core special A&E charges of $47 million in 2020 compared to $18 million in 2019 and higher non-core losses in the Neon exited lines, partially offset by higher core pretax earnings. The increase in core pretax earnings reflects higher core underwriting results, partially offset by lower net investment income in 2020 compared to 2019.
The following table details AFG’s GAAP and core earnings before income taxes from its property and casualty insurance operations for the years ended December 31, 2020, 2019 and 2018 (dollars in millions):
increases, new business opportunities and higher retentions on renewal business, partially offset by lower premiums in the workers’ compensation businesses due to reduced exposures as a result of the COVID-19 pandemic coupled with renewal rate decreases. Average renewal rates increased approximately 14% for this group in 2020. Excluding rate decreases in the workers’ compensation business, renewal rates for this group increased nearly 24% in 2020. Reinsurance premiums ceded as a percentage of gross written premiums increased 5 percentage points in 2020 compared to 2019, reflecting growth in the excess and surplus and public sector businesses, which cede a larger percentage of premiums than many of the businesses in the Specialty casualty sub-segment and higher cessions in the professional liability business.
Underwriting profit for this group was $79 million in 2019 compared to $120 million in 2018, a decrease of $41 million (34%). Record levels of prevented planting claims in the crop operations were the driver of the lower underwriting profit in 2019 compared to 2018, partially offset by higher underwriting profits in the transportation businesses. Catastrophe losses were $32 million (1.8 points on the combined ratio) in 2019 compared to $26 million (1.5 points) in 2018.
AFG’s overall loss and LAE ratio was 64.1%, 63.0% and 61.7% in 2020, 2019 and 2018, respectively. The components of AFG’s property and casualty losses and LAE amounts and ratio are detailed below (dollars in millions):
Specialty casualty The 0.3 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 ratios of the workers’ compensation, targeted markets, executive liability and excess and surplus businesses, partially offset by the impact of the Neon exited lines in 2019, which has a lower loss and LAE ratio than many of the other businesses in the Specialty casualty group. Excluding the impact of the Neon exited lines, the loss and LAE ratio for the current year, excluding COVID-19 related and catastrophe losses decreased 2.1 percentage points in 2020 compared to 2019.
Catastrophe losses of $103 million in 2018 resulted primarily from mudslides in California in the first quarter, storms and flooding in several regions of the United States in the second quarter, Hurricane Florence in the third quarter and Hurricane Michael and wildfires in California in the fourth quarter.
Specialty financial Commissions and other underwriting expenses as a percentage of net earned premiums decreased 1.2 percentage points in 2020 compared to 2019 reflecting the impact of higher premiums on the ratio in the fidelity and equipment leasing businesses and lower travel expenses.
(*)Adjusts the yield on equity securities and tax-exempt bonds to the fully taxable equivalent yield.
related to FIAs can be inversely impacted by the calculated FIA embedded derivative reserve as the value to policyholders of the guaranteed withdrawal benefits decreases when the benefit of stock market participation increases. As shown in the table above, the impact of reinsurance and changes in the stock market and interest rates on FIAs increased AFG’s guaranteed withdrawal benefit reserve by $56 million in 2020 compared to $14 million in 2019. This $42 million (300%) increase was the primary cause of the $39 million overall increase in other annuity benefits, net of guaranteed withdrawal fees in 2020 compared to 2019.
AFG’s fixed-indexed (including 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’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. For a list of other factors impacting the fair value of the embedded derivative component of AFG’s annuity benefits accumulated, see Note D - “Fair Value Measurements” to the financial statements. 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.
(b)Excludes pretax non-core special A&E charges of $21 million, $11 million and $9 million in 2020, 2019 and 2018, respectively, and a pretax non-core loss on retirement of debt of $5 million in both 2020 and 2019.
As a result of the comprehensive external study and in-depth internal reviews of A&E exposures discussed under “Uncertainties - Asbestos and Environmental-related (“A&E”) Insurance Reserves,” AFG’s holding companies and other operations outside of its property and casualty insurance and annuity segments recorded pretax non-core special charges of $21 million in 2020, $11 million in 2019 and $9 million in 2018 to increase liabilities related to the A&E exposures of AFG’s former railroad and manufacturing operations. The charges in 2020, 2019 and 2018 are due to relatively small movements across several sites that primarily reflect changes in the scope and costs of investigation and an increase in estimated ongoing operation and maintenance costs. AFG has also increased its reserve for asbestos and toxic substance exposures arising out of these operations. Total charges recorded to increase liabilities for A&E exposures of AFG’s former railroad and manufacturing operations (included in other expenses) were $28 million in 2020, $19 million in 2019 and $21 million in 2018.
Net losses attributable to noncontrolling interests in 2019 includes $18 million related to the $76 million non-core charge for costs associated with AFG’s plans to exit the Lloyd’s of London insurance market in 2020. See “Neon exited lines” under “Property and Casualty Insurance Segment - Results of Operations” for the quarters ended December 31, 2020 and 2019.
Sales of property and casualty insurance outside of the United States represented 5% of AFG’s revenues in 2020 and 7% of AFG’s revenues in 2019 and 2018. Approximately one-half and two-thirds of these 2020 and 2019 sales, respectively, were through the Neon Lloyd’s of London business.
AFG analyzes its MBS securities for expected credit losses (impairment) each quarter based upon expected future cash flows. Management estimates expected future cash flows based upon its knowledge of the MBS market, cash flow projections (which reflect loan to collateral values, subordination, vintage and geographic concentration) received from independent sources, implied cash flows inherent in security ratings and analysis of historical payment data.
AFG completed a comprehensive external study of its asbestos and environmental (“A&E”) exposures in the third quarter of 2020 with the aid of specialty actuarial, engineering and consulting firms and outside counsel. The study resulted in special A&E charges of $47 million for the property and casualty group and $21 million for the former railroad and manufacturing operations. AFG completed an in-depth internal review of its A&E exposures in the third quarter of 2019. The review resulted in special A&E charges of $18 million for the property and casualty group and $11 million for the former railroad and manufacturing operations. AFG also completed an in-depth internal review of its A&E exposures in the third quarter of 2018, which resulted in special A&E charges of $18 million for the property and casualty group and $9 million for the former railroad and manufacturing operations.
In December 2015, AFG completed the sale of substantially all of its run-off long-term care insurance business to HC2 Holdings, Inc. (“HC2”). In connection with obtaining regulatory approval for the transaction, AFG agreed to provide up to an aggregate of $35 million of capital support for the insurance companies, on an as-needed basis to maintain specified surplus levels, subject to immediate reimbursement by HC2 through a five-year capital maintenance agreement. AFG was released of any obligation to perform under this agreement in the first quarter of 2020.
(a)The amounts shown in Other specialty 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. Accordingly, the liability for incurred claims and allocated LAE represents additional reserves held on claims counted in the tables provided for the other sub-segments (above).
Annuity Business On January 27, 2021, AFG announced that it entered into a definitive agreement to sell its Annuity business to Massachusetts Mutual Life Insurance Company (“MassMutual”). Under the terms of the agreement, which is expected to close in the second quarter of 2021, MassMutual will acquire Great American Life Insurance Company (“GALIC”) and its two insurance subsidiaries, Annuity Investors Life Insurance Company and Manhattan National Life Insurance Company. In addition to AFG’s annuity operations, these subsidiaries include the run-off life and long-term care operations. Prior to the sale, AFG will acquire (based on December 31, 2020 values) $430 million in investments accounted for using the equity method and $97 million of directly owned real estate from GALIC. Beginning with the first quarter of 2021, AFG will report the results of the Annuity business as discontinued operations, in accordance with generally accepted accounting principles, which includes adjusting prior period results to reflect these operations as discontinued.
Amended and Restated Deferred Compensation Plan, filed as Exhibit 10(b) to AFG’s Form 10-K for 2008. (*)
Senior Executive Long Term Incentive Compensation Plan, filed as Appendix A to AFG’s Proxy Statement filed on April 1, 2016. (*)