AFG's ratio of earnings to fixed charges on a total enterprise basis was 3.22 for the year ended December 31, 1998 compared to 2.07 in 1994 (pro forma for the Mergers and related transactions).
Many of the systems being replaced were planned replacements which were accelerated due to the Year 2000 considerations. In addition, a significant portion of AFG's Year 2000 Project is being completed using internal staff. Therefore, cost estimates for the Year 2000 Project do not represent solely incremental costs.
Fixed Maturity Portfolio The fair value of AFG's fixed maturity portfolio ($10.3 billion at December 31, 1998) is directly impacted by changes in market interest rates. AFG's fixed maturity portfolio is comprised of substantially all fixed rate investments with primarily short-term and intermediate-term maturities. This practice allows flexibility in reacting to fluctuations of interest rates. The portfolios of AFG's property and casualty insurance and life and annuity operations are managed with an attempt to achieve an adequate risk-adjusted return while maintaining sufficient liquidity to meet policyholder obligations. AFG's life and annuity operations use various actuarial models in an attempt to align the duration of their invested assets to the projected cash flows of policyholder liabilities.
The following table provides information about AFG's fixed maturity investments at December 31, 1998, that are sensitive to interest rate risk. The table shows principal cash flows (in millions) and related weighted-average interest rates by expected maturity dates. Callable bonds and notes are included based on call date or maturity date depending upon which date produces the most conservative yield. Mortgage-backed securities ("MBSs") and sinking fund issues are included based on maturity year adjusted for expected payment patterns. Actual cash flows may differ from those expected.
The Specialty group includes a highly diversified group of business lines (formerly, Specialty lines) plus the commercial business previously included in the Commercial and Personal lines. Some of the more significant areas are executive liability, inland and ocean marine, U.S.-based operations of Japanese companies, agricultural-related coverages, California workers' compensation, nonprofit liability, general aviation coverages, fidelity and surety bonds, and umbrella and excess coverages. Commercial lines businesses sold included certain coverages in workers' compensation, commercial multi-peril, commercial automobile, and umbrella.
Net written premiums increased $101.8 million (7%) in 1997 due primarily to premiums recorded by a newly acquired aviation division and the return of premiums in 1996 related to the withdrawal from a voluntary pool. The Specialty group had a combined ratio of 100% in 1997 despite a significant decline in the results of AFG's California workers' compensation business relating to (i) deteriorating underwriting margins on business written in 1996 and 1997, (ii) reserve reductions in 1996 primarily for business written prior to 1995 in response to a fundamental change in the California workers' compensation market and actuarial evaluations and (iii) several current year commercial casualty losses as well as adverse development in certain prior year claims. The Specialty group's combined ratio was unusually low in 1996 due primarily to the reallocation of $40 million in reserves to A&E reserves (a combined ratio impact of 3.0 percentage points) and the 1996 reductions in California workers' compensation reserves mentioned above.
Life, Accident and Health Premiums and Benefits The increase in life, accident and health premiums and benefits in 1998 reflects primarily AAG's acquisition of Great American Life Assurance Company of Puerto Rico, Inc. in December 1997. Life, accident and health premiums and benefits increased in 1997 due primarily to an increase in pre-need life insurance sales by AAG's Funeral Services division which was sold in 1998.
1998 compared to 1997 Interest expense increased $5.4 million (10%) from 1997 due primarily to an increase in outstanding indebtedness.
In January 1998, AAG replaced its existing bank lines with a $200 million unsecured credit agreement. Loans under the credit agreement mature from 2000 to 2003 and bear interest at floating rates based on prime or Eurodollar rates. At December 31, 1998 and 1997, the weighted average interest rate on amounts borrowed under AAG's bank credit line was 6.09% and 6.80%, respectively. In
No compensation cost has been recognized for stock option grants. Had compensation cost been determined for stock option awards based on the fair values at grant dates consistent with the method prescribed by Statement of Financial Accounting Standards No. 123, AFG's net income and earnings per share would not have been materially different from amounts reported. For SFAS No. 123 purposes, calculations were determined using the Black-Scholes option pricing model and the following assumptions: dividend yield of 2%; expected volatility of 21% for 1998 and 1997 and 20% for 1996; risk-free interest rate of 4.8% for 1998, 5.8% for 1997 and 6.2% for 1996; and expected life of 7.3 years for 1998, 6.7 years for 1997 and 7.5 years for 1996.
In the second quarter of 1998, AFG recorded approximately $41 million of losses due to severe storms in the midwestern part of the country. In the fourth quarter of 1998, AFG increased A&E reserves by recording a noncash, pretax charge of $214 million. In the fourth quarter of 1997, AFG increased California workers' compensation reserves by approximately $25 million due to increased claims severity related to business written in 1996 and 1997.
Reinsurance ceded $788 $614 $518 Reinsurance assumed - including involuntary pools and associations 37 89 58 Reinsurance recoveries 651 296 306
Other operating and general expenses included charges for possible losses on agents' balances, reinsurance recoverables, other receivables and other assets in the following amounts: 1998 - $14.0 million; 1997 - $7.6 million; and 1996 - $0. The aggregate allowance for such losses amounted to approximately $149 million and $131 million at December 31, 1998 and 1997, respectively.