Approximately 25% and 22% of AFG’s workers’ compensation reserves at December 31, 2018 relate to policies written in Florida and California, respectively. The Castellanos v. Next Door Company decision in Florida and the implementation of Senate Bill 863 in California are two examples of recent changes that impacted the workers’ compensation operating environment and added difficulty and uncertainty to the estimation of related liabilities.
See Item 1 - Business - “Property and Casualty Insurance Segment - Reinsurance” for more information on AFG’s reinsurance programs. For additional information on the effect of reinsurance on AFG’s historical results of operations see Note O - “Insurance - Reinsurance” to the financial statements.
Approximately 43% 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 for the periods 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 investigation and remedial costs with respect to existing sites and newly identified sites. 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.
Reinsurance premiums ceded (“Ceded”) for AFG’s property and casualty insurance segment were 25% of gross written premiums for the fourth quarter of 2018 compared to 26% for the fourth quarter of 2017, a decrease of 1 percentage point. Detail of AFG’s property and casualty reinsurance premiums ceded is shown below (dollars in millions):
The Specialty property and casualty insurance operations generated an underwriting profit of $102 million for the fourth quarter of 2018 compared to $156 million in the fourth quarter of 2017, a decrease of $54 million (35%). Lower underwriting profitability in the Specialty casualty sub-segment, due primarily to higher catastrophe losses and lower favorable reserve development at Neon, and lower underwriting profit in the Property and transportation sub-segment, primarily the result of lower crop earnings, contributed to these results. Overall catastrophe losses were $39 million (3.0 points on the combined ratio) in the fourth quarter of 2018 compared to $8 million (0.6 points) in the fourth quarter of 2017. Net reinstatement premiums related to catastrophe losses were less than $1 million in the fourth quarter of 2018. In connection with catastrophe losses incurred in the fourth quarter of 2017, AFG paid $4 million in net reinstatement premiums, resulting in a total pretax loss from catastrophes of $12 million for the quarter. Losses related to third quarter 2018 catastrophes, primarily Hurricane Florence, developed favorably by $7 million, primarily in the Property and transportation and Specialty financial sub-segments. Losses related to third quarter 2017 catastrophes, specifically Hurricanes Harvey, Irma and Maria, and two earthquakes in Mexico, developed favorably by $25 million during the fourth quarter of 2017 across all property and casualty sub-segments.
Interest credited - fixed for the fourth quarter of 2018 was $186 million compared to $164 million for the fourth quarter of 2017, an increase of $22 million (13%). This increase reflects the impact of growth in the annuity business. The average interest rate credited to policyholders, calculated as interest credited divided by average fixed annuity benefits accumulated, increased 0.06 percentage points to 2.06% in the fourth quarter of 2018 from 2.00% in the fourth quarter of 2017 due to higher crediting rates on new business.
The change in the fair value of derivatives related to FIAs includes an ongoing expense for annuity interest accreted on the embedded derivative reserve. The amount of interest accreted in any period is generally based on the size of the embedded derivative and current interest rates. AFG expects both the size of the embedded derivative and interest rates to rise, resulting in continued increases in interest on the embedded derivative liability.
Gross written premiums (“GWP”) for AFG’s property and casualty insurance segment were $6.84 billion in 2018 compared to $6.50 billion in 2017, an increase of $338 million (5%). GWP increased $521 million (9%) in 2017 compared to 2016. Detail of AFG’s property and casualty gross written premiums is shown below (dollars in millions):
The 0.8 percentage points improvement in the loss and LAE ratio for the current year, excluding catastrophe losses in 2017 compared to 2016 reflects a decrease in the loss and LAE ratio at Neon.
Aggregate Aggregate net prior accident years reserve development for AFG’s property and casualty insurance segment includes the A&E charges, the Neon exited lines charge and the favorable development on the Neon exited lines mentioned above and adverse reserve development of $2 million in 2018 and $4 million in 2017 related to business outside the Specialty group that AFG no longer writes.
AFG’s property and casualty commissions and other underwriting expenses (“U/W Exp”) were $1.56 billion in 2018 compared to $1.38 billion in 2017, an increase of $178 million (13%). AFG’s underwriting expense ratio was 32.1% in 2018 compared to 30.2% in 2017, an increase of 1.9 percentage points.
The increase in average invested assets and net investment income in the property and casualty insurance segment in 2017 as compared to 2016 is due primarily to growth in the property and casualty insurance segment. The property and casualty segment’s overall yield on investments was 3.64% in 2017 compared to 3.66% in 2016, a decrease of 0.02 percentage points reflecting the impact of lower yields available in the financial markets and lower income from certain investments that are required to be carried at fair value through earnings, partially offset by higher earnings from limited partnerships and similar investments.
Net investment income in 2017 was $1.46 billion compared to $1.36 billion in 2016, an increase of $102 million (8%). This increase reflects growth in AFG’s annuity business, partially offset by the impact of lower investment yields. The overall yield earned on investments in AFG’s annuity operations decreased by 0.14 percentage points to 4.63% from 4.77% in 2017 compared to 2016. This decline in net investment yield reflects (i) the investment of new premium dollars at lower yields as compared to the existing investment portfolio and (ii) the impact of the reinvestment of proceeds from maturity and redemption of higher yielding investments at the lower yields available in the financial markets. During 2017, $4.9 billion in annuity segment investments with an average yield of 5.14% were redeemed or sold while the investments purchased during 2017 (with new premium dollars and the redemption/sale proceeds) had an average yield at purchase of 3.94%.
As illustrated in the table above, the change in fair value of derivatives related to fixed-indexed annuities, including the related impact on amortization of DPAC decreased the annuity segment’s earnings before income taxes by $33 million in both 2018 and 2017 and $27 million in 2016.
For derivatives that are designated and qualify as highly effective fair value hedges, changes in the fair value of the derivative, along with changes in the fair value of the hedged item attributable to the hedged risk, are recognized in current period earnings.
The present value of future profits (“PVFP”) amounts in the table above are net of $148 million and $141 million of accumulated amortization at December 31, 2018 and 2017, respectively. During each of the next five years, the PVFP is expected to decrease at a rate of approximately one-eighth of the balance at the beginning of each respective year.
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 2017, AFG formed two new CLOs, which issued an aggregate of $865 million face amount of liabilities (including $48 million face amount purchased by subsidiaries of AFG). During 2017, AFG subsidiaries also purchased $71 million face amount of senior debt and subordinate tranches of existing CLOs for $71 million and received $103 million in sale and redemption proceeds from its CLO investments. In 2016, AFG formed two new CLOs, which issued an aggregate of $866 million face amount of liabilities (including $64 million face amount purchased by subsidiaries of AFG). During 2016, AFG subsidiaries also purchased $24 million face amount of senior debt and subordinate tranches of existing CLOs for $17 million and received $115 million in sale and redemption proceeds from its CLO investments. In 2018 and 2017, one and two AFG CLOs, respectively, were substantially liquidated, as permitted by the CLO indentures.
AFG’s net deferred tax asset at December 31, 2018 and 2017 is included in other assets in AFG’s Balance Sheet. The increase in AFG’s net deferred tax asset at December 31, 2018 compared to December 31, 2017 reflects significantly lower pretax unrealized gains on securities.
As discussed in Note A - “Accounting Policies - Investments” and Note E - “Investments,” effective January 1, 2018, all equity securities other than those accounted for under the equity method are carried at fair value through net earnings. Realized gains (losses) on securities for the fourth quarter and full-year 2018 includes net holding losses on equity securities that were
Benefit Plans AFG expensed approximately $37 million in 2018, $45 million in 2017 and $43 million in 2016 for its retirement and employee savings plans.