AMERICAN FINANCIAL GROUP, INC.
INDEX TO MD&A
Page Page
Forward-Looking Statements 32 Managed Investment Entities 41
Overview 33 Results of Operations 44
Critical Accounting
Policies 34 General 44
Liquidity and Capital Segmented Statement of
Resources 34 Earnings 47
Property and Casualty
Ratios 34 Insurance 48
Condensed Consolidated Cash
Flows 35 Annuity 58
Parent and Subsidiary Holding Company, Other and
Liquidity 36 Unallocated 67
Recent and Pending Accounting
Investments 37 Standards 69
Uncertainties 41
FORWARD-LOOKING STATEMENTS
The Private Securities Litigation Reform Act of 1995 provides a safe harbor for
forward-looking statements. Some of the forward-looking statements can be
identified by the use of words such as "anticipates", "believes", "expects",
"projects", "estimates", "intends", "plans", "seeks", "could", "may", "should",
"will" or the negative version of those words or other comparable terminology.
Such forward-looking statements include statements relating to: expectations
concerning market and other conditions and their effect on future premiums,
revenues, earnings, investment activities, and the amount and timing of share
repurchases; recoverability of asset values; expected losses and the adequacy of
reserves for asbestos, environmental pollution and mass tort claims; rate
changes; and improved loss experience.
Actual results and/or financial condition could differ materially from those
contained in or implied by such forward-looking statements for a variety of
reasons including but not limited to:
• changes in financial, political and economic conditions, including changes
in interest and inflation rates, currency fluctuations and extended
economic recessions or expansions in the
• performance of securities markets, including the cost of equity index options;
• new legislation or declines in credit quality or credit ratings that could
have a material impact on the valuation of securities in AFG's investment
portfolio;
• the availability of capital;
• changes in insurance law or regulation, including changes in statutory
accounting rules and changes in regulation of the Lloyd's market, including
modifications to capital requirements, changes in costs associated with the
exit from the Lloyd's market and the run-off of AFG's Lloyd's based
insurer, Neon;
• the effects of the COVID-19 outbreak, including the effects on the
international and national economy and credit markets, legislative or
regulatory developments affecting the insurance industry, quarantines or
other travel or health-related restrictions;
• changes in the legal environment affecting AFG or its customers;
• tax law and accounting changes;
• levels of natural catastrophes and severe weather, terrorist activities
(including any nuclear, biological, chemical or radiological events),
incidents of war or losses resulting from pandemics, civil unrest and other
major losses;
• disruption caused by cyber-attacks or other technology breaches or failures
by AFG or its business partners and service providers, which could
negatively impact AFG's business and/or expose AFG to litigation;
• development of insurance loss reserves and establishment of other reserves,
particularly with respect to amounts associated with asbestos and
environmental claims;
• availability of reinsurance and ability of reinsurers to pay their
obligations;
• trends in persistency and mortality;
• competitive pressures;
• the ability to obtain adequate rates and policy terms;
• changes in AFG's credit ratings or the financial strength ratings assigned
by major ratings agencies to AFG's operating subsidiaries; and
• the impact of the conditions in the international financial markets and the
global economy relating to AFG's international operations.
The forward-looking statements herein are made only as of the date of this report. The Company assumes no obligation to publicly update any forward-looking statements.
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AMERICAN FINANCIAL GROUP, INC. 10-Q Management's Discussion and Analysis of Financial Condition and Results of Operations - Continued OVERVIEW Financial Condition AFG is organized as a holding company with almost all of its operations being conducted by subsidiaries. AFG, however, has continuing cash needs for administrative expenses, the payment of principal and interest on borrowings, shareholder dividends, and taxes. Therefore, certain analyses are most meaningfully presented on a parent only basis while others are best done on a total enterprise basis. In addition, because most of its businesses are financial in nature, AFG does not prepare its consolidated financial statements using a current-noncurrent format. Consequently, certain traditional ratios and financial analysis tests are not meaningful. Results of Operations Through the operations of its subsidiaries, AFG is engaged primarily in property and casualty insurance, focusing on specialized commercial products for businesses, and in the sale of traditional fixed and indexed annuities in the retail, financial institutions, broker-dealer and registered investment advisor markets. AFG reported a net loss attributable to shareholders for the first three months of 2020 of$301 million ($3.34 per share, diluted), compared to net earnings attributable to shareholders of$329 million ($3.63 per share, diluted) reported in the same period of 2019. The COVID-19 pandemic has had widespread financial and economic impacts, including a significant decrease in both the equity and credit markets, which adversely impacted returns on AFG's$3.58 billion of investments that are required to be carried at fair value through net earnings. AFG's results reflect: • net realized losses on securities in the first three months of 2020
compared to net realized gains on securities in the first three months of
2019,
• lower earnings in the annuity segment reflecting negative adjustments to
investments that are marked to market through net investment income,
• lower net investment income in the property and casualty insurance segment
due primarily to negative adjustments to investments that are marked to
market through net investment income, and
• lower holding company expenses.
Outlook
The COVID-19 pandemic began to have a significant impact on global, social and economic activity during the first three months of 2020. AFG has taken actions under its business continuity plan to minimize risk to the Company's employees and to prevent any significant disruption to AFG's business, agents or policyholders. Management believes that AFG's strong financial position coming into 2020 and current liquidity and capital at its subsidiaries will give AFG the flexibility to continue to effectively address and respond to the ongoing uncertainties presented by the pandemic. Even with management's expectation that the impacts of the pandemic will continue through 2020, AFG's insurance subsidiaries are projected to have capital at or in excess of the levels required by ratings agencies in order to maintain their current ratings, and the parent company does not have any near-term debt maturities. The widespread economic impacts of the pandemic, including a significant decrease in both equity and credit markets, adversely affected AFG's investment returns during the first quarter of 2020. Because the majority of AFG's investments in limited partnerships and similar investments accounted for using the equity method are reported on a quarter lag, second quarter 2020 returns from those investments will reflect the financial results and valuations as ofMarch 31, 2020 , including the impact of the downturn in financial markets during the first quarter and could be negative. Management expects there to be continued volatility in the financial markets for the remainder of 2020. While AFG's underwriting results for the first three months of 2020 were not significantly impacted by the COVID-19 pandemic, management anticipates that the pandemic and current recessionary economic conditions will have a negative impact on premiums and earnings for the remainder of 2020. As the economy continues to contract, exposures in many of AFG's property and casualty businesses will change due to workforce reduction, fewer miles driven and reduced revenue. This may lead to lower frequency and severity in certain lines while there may be COVID-19 related increases in claim frequency in other lines of business. As states mandate longer grace periods for premium payments, AFG's property and casualty subsidiaries are likely to see a slowdown in cash collections and higher premiums receivable balances throughout the remainder of 2020, which will require management to monitor the reinvestment of cash flows from the property and casualty subsidiaries' investment portfolios. There is also uncertainty as to potential government decree or legislation that could alter the coverage landscape such as the imposition of retroactive business interruption insurance. Like most of the insurance industry, AFG's business interruption coverages require direct physical damage to covered 33
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AMERICAN FINANCIAL GROUP, INC. 10-Q
Management's Discussion and Analysis of Financial Condition and Results of
Operations - Continued
property for business interruption coverage to apply and the vast majority of
AFG's property policies also contain virus exclusions. While AFG has not
experienced an increase in death claims or surrender activity in the annuity
business related to COVID-19, stay at home orders and other restrictions are
likely to continue to reduce annuity sales for the remainder of 2020. See Part
II, Item 1A - "Risk Factors."
CRITICAL ACCOUNTING POLICIES
Significant accounting policies are summarized in Note A - "Accounting Policies"
to the financial statements. The preparation of financial statements in
conformity with U.S. generally accepted accounting principles ("GAAP") requires
management to make estimates and assumptions that can have a significant effect
on amounts reported in the financial statements. As more information becomes
known, these estimates and assumptions change and, thus, impact amounts reported
in the future. The areas where management believes the degree of judgment
required to determine amounts recorded in the financial statements is most
significant are as follows:
• the establishment of insurance reserves, especially asbestos and
environmental-related reserves,
• the recoverability of reinsurance,
• the amortization of annuity deferred policy acquisition costs,
• the measurement of the derivatives embedded in indexed annuity liabilities,
• the establishment of asbestos and environmental reserves of former railroad
and manufacturing operations, and
• the valuation of investments, including the determination of
other-than-temporary impairments.
For a discussion of these policies, see Management's Discussion and Analysis - "Critical Accounting Policies" in AFG's 2019 Form 10-K.
LIQUIDITY AND CAPITAL RESOURCES
Ratios
AFG's debt to total capital ratio on a consolidated basis is shown below
(dollars in millions):
March 31, 2020 December 31,
Actual Adjusted (*) 2019 2018
Principal amount of long-term debt
$ 1,318 Total capital 6,480 6,780 6,883
6,218
Ratio of debt to total capital: Including subordinated debt 23.0 % 26.4 % 21.7 % 21.2 % Excluding subordinated debt 15.7 % 19.4 % 14.8 % 16.4 %
(*) Reflects the impact of the
Senior Notes due in
The ratio of debt to total capital is a non-GAAP measure that management
believes is useful for investors, analysts and ratings agencies to evaluate
AFG's financial strength and liquidity and to provide insight into how AFG
finances its operations. In addition, maintaining a ratio of debt, excluding
subordinated debt and debt secured by real estate (if any), to total capital of
35% or lower is a financial covenant in AFG's bank credit facility. The ratio is
calculated by dividing the principal amount of AFG's long-term debt by its total
capital, which includes long-term debt, noncontrolling interests and
shareholders' equity (excluding unrealized gains (losses) related to fixed
maturity investments).
Fixed charges are computed on a "total enterprise" basis. For purposes of
calculating the ratios, "earnings (loss)" have been computed by adding to pretax
earnings (loss) 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
(loss) to fixed charges excluding and including annuity benefits are shown in
the table below:
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AMERICAN FINANCIAL GROUP, INC. 10-Q Management's Discussion and Analysis of Financial Condition and Results of Operations - Continued Three Months Ended Year EndedMarch 31, 2020 December 31, 2019 Ratio of core earnings to fixed charges excluding annuity benefits 11.15
12.78
Impact of non-core items (29.95 )
1.83
Ratio of earnings to fixed charges excluding annuity benefits *
14.61
Impact of including interest on annuities as a fixed charge (18.47 ) (12.76 ) Ratio of earnings to fixed charges including annuity benefits * 1.85
* Earnings for the three months ended
fixed charges by
Although the ratio of earnings to fixed charges excluding annuity benefits is not required or encouraged to be disclosed underSecurities and Exchange Commission rules, some investors and lenders may not consider interest credited to annuity policyholders' accounts a borrowing cost for an insurance company, and accordingly, believe this ratio is meaningful. Condensed Consolidated Cash Flows AFG's principal sources of cash include insurance premiums, income from its investment portfolio and proceeds from the maturities, redemptions and sales of investments. Insurance premiums in excess of acquisition expenses and operating costs are invested until they are needed to meet policyholder obligations or made available to the parent company through dividends to cover debt obligations and corporate expenses, and to provide returns to shareholders through share repurchases and dividends. Cash flows from operating, investing and financing activities as detailed in AFG's Consolidated Statement of Cash Flows are shown below (in millions): Three months endedMarch 31, 2020 2019
Net cash provided by operating activities $ 532
(1,653 ) (684 )
Net cash provided by financing activities 480 715
Net change in cash and cash equivalents $ (641 )
Net Cash Provided by Operating Activities AFG's property and casualty insurance operations typically produce positive net operating cash flows as premiums collected and investment income exceed policy acquisition costs, claims payments and operating expenses. AFG's net cash provided by operating activities is impacted by the level and timing of property and casualty premiums, claim and expense payments and recoveries from reinsurers. AFG's annuity operations typically produce positive net operating cash flows as investment income exceeds acquisition costs and operating expenses. Interest credited on annuity policyholder funds is a non-cash increase in AFG's annuity benefits accumulated liability and annuity premiums, benefits and withdrawals are considered financing activities due to the deposit-type nature of annuities. Cash flows provided by operating activities also include the activity of AFG's managed investment entities (collateralized loan obligations) other than those activities included in investing or financing activities. The changes in the assets and liabilities of the managed investment entities included in operating activities increased cash flows from operating activities by$89 million during the first three months of 2020 and$16 million in the first three months of 2019, accounting for a$73 million increase in cash flows from operating activities in the 2020 period compared to the 2019 period. As discussed in Note A - "Accounting Policies - Managed Investment Entities" to the financial statements, AFG has no right to use the CLO assets and no obligation to pay the CLO liabilities and such assets and liabilities are shown separately in AFG's Balance Sheet. Excluding the impact of the managed investment entities, net cash provided by operating activities was$443 million in the first three months of 2020 compared to$438 million in the first three months of 2019, an increase of$5 million .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$1.65 billion for the first three months of 2020 compared to$684 million in the first three months of 2019, an increase of$969 million . As discussed below (under net cash provided by financing activities), AFG's annuity segment had net cash flows from annuity policyholders of$612 million in the first three months of 2020 and$626 million in the first three months of 2019. In addition, AFG's cash on hand decreased by$641 million in the first three months of 2020 as AFG opportunistically invested a large portion of its cash on hand when credit spreads widened in March of 2020 compared to an increase of$485 million in the first three months of 2019 when AFG held more cash due to fewer attractive investment opportunities. In addition to the investment of funds provided by the insurance operations, investing activities also include the purchase 35
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AMERICAN FINANCIAL GROUP, INC. 10-Q
Management's Discussion and Analysis of Financial Condition and Results of
Operations - Continued
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 $44 million use of cash in the first three months of
2020 compared to an $18 million use of cash in the 2019 period, accounting for
an $26 million increase in net cash used in investing activities in the first
three months of 2020 compared to the same 2019 period. See Note A - "Accounting
Policies - Managed Investment Entities" and Note H - "Managed Investment
Entities" to the financial statements.
Net Cash Provided by Financing Activities AFG's financing activities consist
primarily of transactions with annuity policyholders, issuances and retirements
of long-term debt, issuances and repurchases of common stock, and dividend
payments. Net cash provided by financing activities was $480 million for the
first three months of 2020 compared to $715 million in the first three months of
2019, a decrease of $235 million . Annuity receipts exceeded annuity surrenders,
benefits, withdrawals and transfers by $612 million in the first three months of
2020 compared to $626 million in the first three months of 2019, accounting for
a $14 million decrease in net cash provided by financing activities in the 2020
period compared to the 2019 period. In March 2019 , AFG issued $125 million of
5.875% Subordinated Debentures due in 2059, the net proceeds of which
contributed $121 million to net cash provided by financing activities in the
first three months of 2019. During the first three months of 2020, AFG
repurchased $61 million of its Common Stock compared to no share repurchases in
the 2019 period. Financing activities also include issuances and retirements of
managed investment entity liabilities, which are nonrecourse to AFG and
presented separately in AFG's Balance Sheet. Retirements of managed investment
entity liabilities were $41 million in the first three months of 2020 compared
to $3 million in the first three months of 2019, accounting for a $38 million
decrease in net cash provided by financing activities in the 2020 period
compared to the 2019 period. See Note A - "Accounting Policies - Managed
Investment Entities" and Note H - "Managed Investment Entities" to the financial
statements.
Parent and Subsidiary Liquidity
Parent Holding Company Liquidity Management believes AFG has sufficient resources to meet its liquidity requirements. If funds generated from operations, including dividends, tax payments and borrowings from subsidiaries, are insufficient to meet fixed charges in any period, AFG would be required to utilize parent company cash and marketable securities or to generate cash through borrowings, sales of other assets, or similar transactions. AFG can borrow up to$500 million under its revolving credit facility which expires inJune 2021 . 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 2019 or the first three months of 2020. OnApril 2, 2020 , AFG issued$300 million of 5.25% Senior Notes due inApril 2030 to increase liquidity and provide flexibility at the parent holding company. The net proceeds of the offering will be used for general corporate purposes.
During the first three months of 2020, AFG repurchased 826,283 shares of its
Common Stock for
InDecember 2019 , AFG issued$200 million of 5.125% Subordinated Debentures due inDecember 2059 . A portion of the net proceeds of the offering were used to redeem AFG's$150 million outstanding principal amount of 6-1/4% Subordinated Debentures due inSeptember 2054 , at par value, with the remainder used for general corporate purposes. InMarch 2019 , AFG issued$125 million of 5.875% Subordinated Debentures due inMarch 2059 . The net proceeds of the offering were used for general corporate purposes. In 2019, AFG paid special cash dividends of$3.30 per share of AFG Common Stock ($1.50 per share in May and$1.80 per share in November) totaling approximately$297 million .
Under a tax allocation agreement with AFG, its 80%-owned
Subsidiary LiquidityGreat American Life Insurance Company ("GALIC"), a wholly-owned annuity subsidiary, is a member of theFederal Home Loan Bank of Cincinnati ("FHLB"). The FHLB makes advances and provides other banking services to member institutions, which provides the annuity operations with an additional source of liquidity. AtMarch 31, 2020 , GALIC had$1.30 billion in outstanding advances from the FHLB (included in annuity benefits accumulated), bearing interest at rates ranging from 0.69% to 1.35% (average rate of 1.12% atMarch 31, 2020 ). While these advances 36
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AMERICAN FINANCIAL GROUP, INC. 10-Q
Management's Discussion and Analysis of Financial Condition and Results of
Operations - Continued
must be repaid between 2020 and 2025 ($165 million in 2020, $931 million in 2021
and $200 million in 2025), GALIC has the option to prepay all or a portion on
the majority of the advances. GALIC has invested the proceeds from the advances
in fixed maturity securities with similar expected lives as the advances for the
purpose of earning a spread over the interest payments due to the FHLB. At
March 31, 2020 , GALIC estimated that it had additional borrowing capacity of
approximately $550 million from the FHLB.
The liquidity requirements of AFG's insurance subsidiaries relate primarily to
the liabilities associated with their products as well as operating costs and
expenses, payments of dividends and taxes to AFG and contributions of capital to
their subsidiaries. Historically, cash flows from premiums and investment income
have generally provided more than sufficient funds to meet these requirements.
Funds received in excess of cash requirements are generally invested in
additional marketable securities. In addition, the insurance subsidiaries
generally hold a significant amount of highly liquid, short-term investments.
The excess cash flow of AFG's property and casualty group allows it to extend the duration of its investment portfolio somewhat beyond that of its claim reserves.
In the annuity business, where profitability is largely dependent on earning a
spread between invested assets and annuity liabilities, the duration of
investments is generally maintained close to that of liabilities. In a rising
interest rate environment, significant protection from withdrawals exists in the
form of temporary and permanent surrender charges on AFG's annuity products.
With declining rates, AFG receives some protection (from spread compression) due
to the ability to lower crediting rates, subject to contractually guaranteed
minimum interest rates ("GMIRs"). At March 31, 2020 , AFG could reduce the
average crediting rate on approximately $31 billion of traditional fixed,
fixed-indexed and variable-indexed annuities without guaranteed withdrawal
benefits by approximately 118 basis points (on a weighted average basis).
Annuity policies are subject to GMIRs at policy issuance. AFG has taken action
to lower crediting rates on annuity policies near or after the end of the
surrender charge period. The table below shows the breakdown of annuity reserves
by GMIR. The current interest crediting rates on substantially all of AFG's
annuities with a GMIR of 3% or higher are at their minimum.
% of Reserves
March 31, December 31,
GMIR 2020 2019 2018
1 - 1.99% 83% 83% 80%
2 - 2.99% 3% 3% 4%
3 - 3.99% 7% 7% 8%
4.00% and above 7% 7% 8%
Annuity benefits accumulated (in millions)
AFG believes its insurance subsidiaries maintain sufficient liquidity to pay claims and benefits and operating expenses. In addition, these subsidiaries have sufficient capital to meet commitments in the event of unforeseen events such as reserve deficiencies, inadequate premium rates or reinsurer insolvencies. Even in the current uncertain COVID-19 environment, management believes that the capital levels in AFG's insurance subsidiaries are adequate to maintain its businesses and rating agency ratings. Should the current adverse financial conditions continue through 2020, AFG's insurance subsidiaries will reduce dividend payments to AFG parent as needed to maintain sufficient capital at the insurance companies. Nonetheless, changes in statutory accounting rules, significant declines in the fair value of the insurance subsidiaries' investment portfolios or significant ratings downgrades on these investments, could create a need for additional capital.
Investments
AFG's investment portfolio atMarch 31, 2020 , contained$46.13 billion in fixed maturity securities classified as available for sale and carried at fair value with unrealized gains and losses included in accumulated other comprehensive income and$96 million in fixed maturities classified as trading with holding gains and losses included in net investment income. In addition, AFG's investment portfolio includes$1.25 billion in equity securities carried at fair value with holding gains and losses included in realized gains (losses) on securities and$306 million in equity securities carried at fair value with holding gains and losses included in net investment income. Fair values for AFG's portfolio are determined by AFG's internal investment professionals using data from nationally recognized pricing services as well as non-binding broker quotes. Fair values of equity securities are generally based on 37
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AMERICAN FINANCIAL GROUP, INC. 10-Q
Management's Discussion and Analysis of Financial Condition and Results of
Operations - Continued
published closing prices. For AFG's fixed maturity portfolio, approximately 89%
was priced using pricing services at March 31, 2020 and the balance was priced
primarily by using non-binding broker quotes. When prices obtained for the same
security vary, AFG's internal investment professionals select the price they
believe is most indicative of an exit price.
The pricing services use a variety of observable inputs to estimate fair value
of fixed maturities that do not trade on a daily basis. Based upon information
provided by the pricing services, these inputs include, but are not limited to,
recent reported trades, benchmark yields, issuer spreads, bids or offers,
reference data, and measures of volatility. Included in the pricing of
mortgage-backed securities ("MBS") are estimates of the rate of future
prepayments and defaults of principal over the remaining life of the underlying
collateral. Due to the lack of transparency in the process that brokers use to
develop prices, valuations that are based on brokers' prices are classified as
Level 3 in the GAAP hierarchy unless the price can be corroborated, for example,
by comparison to similar securities priced using observable inputs.
Valuation techniques utilized by pricing services and prices obtained from
external sources are reviewed by AFG's internal investment professionals who are
familiar with the securities being priced and the markets in which they trade to
ensure the fair value determination is representative of an exit price. To
validate the appropriateness of the prices obtained, these investment managers
consider widely published indices (as benchmarks), recent trades, changes in
interest rates, general economic conditions and the credit quality of the
specific issuers. In addition, AFG communicates directly with pricing services
regarding the methods and assumptions used in pricing, including verifying, on a
test basis, the inputs used by the services to value specific securities.
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 March 31, 2020 (dollars in
millions). Effects of increases or decreases from the 100 basis points
illustrated would be approximately proportional.
Fair value of fixed maturity portfolio $ 46,230
Percentage impact on fair value of 100 bps increase in interest rates
(4.0 %) Pretax impact on fair value of fixed maturity portfolio $
(1,849 ) Offsetting adjustments to deferred policy acquisition costs and other balance sheet amounts
850
Estimated pretax impact on accumulated other comprehensive income
(999 ) Deferred income tax
210
Estimated after-tax impact on accumulated other comprehensive income $
(789 )
Approximately 91% of the fixed maturities held by AFG atMarch 31, 2020 , were rated "investment grade" (credit rating ofAAA to BBB) by nationally recognized rating agencies. Investment grade securities generally bear lower yields and lower degrees of risk than those that are unrated and non-investment grade. Management believes that the high-quality investment portfolio should generate a stable and predictable investment return. MBS are subject to significant prepayment risk because, 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. 38
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AMERICAN FINANCIAL GROUP, INC. 10-Q
Management's Discussion and Analysis of Financial Condition and Results of
Operations - Continued
Summarized information for AFG's MBS (including those classified as trading) at
March 31, 2020 , is shown in the table below (dollars in millions). Agency-backed
securities are those issued by a U.S. government-backed agency; Alt-A mortgages
are those with risk profiles between prime and subprime. The average life of the
residential and commercial MBS is approximately 4 years and 3 years,
respectively.
% Rated
Amortized Fair Value as Unrealized Investment
Cost, net (*) Fair Value % of Cost Gain (Loss) Grade
Collateral type
Residential:
Agency-backed $ 494 $ 506 102 % $ 12 100 %
Non-agency prime 1,359 1,383 102 % 24 61 %
Alt-A 904 918 102 % 14 40 %
Subprime 316 325 103 % 9 28 %
Commercial 892 907 102 % 15 96 %
$ 3,965 $ 4,039 102 % $ 74 66 %
(*) Amortized cost, net of allowance for expected credit losses.
TheNational 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 MBS 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. AtMarch 31, 2020 , 96% (based on statutory carrying value of$3.92 billion ) of AFG's MBS had an NAIC designation of 1. Municipal bonds represented approximately 15% of AFG's fixed maturity portfolio atMarch 31, 2020 . AFG's municipal bond portfolio is high quality, with 99% of the securities rated investment grade at that date. The portfolio is well diversified across the states of issuance and individual issuers. AtMarch 31, 2020 , approximately 79% of the municipal bond portfolio was held in revenue bonds, with the remaining 21% held in general obligation bonds. Summarized information for the unrealized gains and losses recorded in AFG's Balance Sheet atMarch 31, 2020 , is shown in the following table (dollars in millions). Approximately$1.17 billion of available for sale fixed maturity securities had no unrealized gains or losses atMarch 31, 2020 . Securities Securities With With Unrealized Unrealized Gains Losses Available for Sale Fixed Maturities Fair value of securities$ 26,535
$ 25,117 $ 19,751 Gross unrealized gain (loss)$ 1,418 $ (1,324 ) Fair value as % of amortized cost 106 % 93 % Number of security positions 3,520
1,871
Number individually exceeding$2 million gain or loss 117
183
Concentration of gains (losses) by type or industry (exceeding 5% of unrealized): States and municipalities
$ 388 $ (8 ) Banks, savings and credit institutions 165 (33 ) Mortgage-backed securities 153 (79 ) Insurance 113 (29 ) Other financials 97 (131 ) Other asset-backed securities 65 (362 ) Energy 19 (205 ) Collateralized loan obligations 5 (306 ) Percentage rated investment grade 95 % 89 % 39
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AMERICAN FINANCIAL GROUP, INC. 10-Q
Management's Discussion and Analysis of Financial Condition and Results of
Operations - Continued
The table below sets forth the scheduled maturities of AFG's available for sale
fixed maturity securities at March 31, 2020 , based on their fair values.
Securities with sinking funds are reported at average maturity. Actual
maturities may differ from contractual maturities because certain securities may
be called or prepaid by the issuers.
Securities Securities
With With
Unrealized Unrealized
Gains Losses
Maturity
One year or less 4 % 4 %
After one year through five years 31 % 12 %
After five years through ten years 39 % 24 %
After ten years 12 % 4 %
86 % 44 % Collateralized loan obligations and other asset-backed securities (average life of approximately 4-1/2 years)
6 % 47 %
Mortgage-backed securities (average life of approximately
3-1/2 years) 8 % 9 %
100 % 100 %
The table below (dollars in millions) summarizes the unrealized gains and losses on fixed maturity securities by dollar amount:
Aggregate Aggregate Fair
Fair Unrealized Value as
Value Gain (Loss) % of Cost
Fixed Maturities at March 31, 2020
Securities with unrealized gains:
Exceeding $500,000 (830 securities) $ 13,559 $ 1,036 108 %
$500,000 or less (2,690 securities) 12,976 382 103 %
$ 26,535 $ 1,418 106 % Securities with unrealized losses: Exceeding$500,000 (709 securities)$ 11,374 $ (1,172 ) 91 %$500,000 or less (1,162 securities) 7,053 (152 ) 98 %$ 18,427 $ (1,324 ) 93 % The following table (dollars in millions) summarizes the unrealized losses for all securities with unrealized losses by issuer quality and the length of time those securities have been in an unrealized loss position: Aggregate Aggregate Fair Fair Unrealized Value as Value
Loss % of
$ 14,456 $ (921 ) 94 % One year or longer (151 securities) 1,865
(179 ) 91 %
$ 16,321 $
(1,100 ) 94 % Non-investment grade fixed maturities with losses for: Less than one year (454 securities)
$ 2,030 $ (209 ) 91 % One year or longer (35 securities) 76 (15 ) 84 %$ 2,106 $ (224 ) 90 % When a decline in the value of a specific investment is considered to be other-than-temporary, an allowance for credit losses (impairment) is charged to earnings (accounted for as a realized loss). The determination of whether unrealized losses are other-than-temporary requires judgment based on subjective as well as objective factors as detailed in AFG's 2019 Form 10-K under Management's Discussion and Analysis - "Investments." 40
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AMERICAN FINANCIAL GROUP, INC. 10-Q
Management's Discussion and Analysis of Financial Condition and Results of
Operations - Continued
Based on its analysis, management believes AFG will recover its cost basis (net
of any allowance) in the fixed maturity securities with unrealized losses and
that AFG has the ability to hold the securities until they recover in value and
had no intent to sell them at March 31, 2020 . Although AFG has the ability to
continue holding its fixed maturity investments with unrealized losses, its
intent to hold them may change due to deterioration in the issuers'
creditworthiness, decisions to lessen exposure to a particular issuer or
industry, asset/liability management decisions, market movements, changes in
views about appropriate asset allocation or the desire to offset taxable
realized gains. Should AFG's ability or intent change regarding a particular
security, a charge for impairment would likely be required. While it is not
possible to accurately predict if or when a specific security will become
impaired, charges for other-than-temporary impairment could be material to
results of operations in future periods. Significant declines in the fair value
of AFG's investment portfolio could have a significant adverse effect on AFG's
liquidity. For information on AFG's realized gains (losses) on securities,
including charges for other-than-temporary impairment, see "Results of
Operations - Consolidated Realized Gains (Losses) on Securities."
Uncertainties
Management believes that the areas posing the greatest risk of material loss are
the adequacy of its insurance reserves and contingencies arising out of its
former railroad and manufacturing operations. See Management's Discussion and
Analysis - "Uncertainties - Asbestos and Environmental-related ("A&E") Insurance
Reserves" in AFG's 2019 Form 10K.
MANAGED INVESTMENT ENTITIES
Accounting standards require AFG to consolidate its investments in
collateralized loan obligation ("CLO") entities that it manages and owns an
interest in (in the form of debt). See Note A - "Accounting Policies - Managed
Investment Entities" and Note H - "Managed Investment Entities" to the financial
statements. The effect of consolidating these entities is shown in the tables
below (in millions). The "Before CLO Consolidation" columns include AFG's
investment and earnings in the CLOs on an unconsolidated basis.
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AMERICAN FINANCIAL GROUP, INC. 10-Q
Management's Discussion and Analysis of Financial Condition and Results of
Operations - Continued
CONDENSED CONSOLIDATING BALANCE SHEET
Managed
Before CLO Investment Consol. Consolidated
Consolidation Entities Entries As Reported
March 31, 2020
Assets:
Cash and investments $ 53,381 $ - $ (160 ) (a) $ 53,221
Assets of managed investment entities - 4,026 - 4,026
Other assets 10,397 - (1 ) (a) 10,396
Total assets $ 63,778 $ 4,026 $ (161 ) $ 67,643
Liabilities:
Unpaid losses and loss adjustment expenses and
unearned premiums $ 12,914 $ - $ - $ 12,914
Annuity, life, accident and health benefits and
reserves 41,070 - - 41,070
Liabilities of managed investment entities - 4,026 (161 ) (a) 3,865
Long-term debt and other liabilities 4,747 - - 4,747
Total liabilities 58,731 4,026 (161 ) 62,596
Redeemable noncontrolling interests - - - -
Shareholders' equity:
Common Stock and Capital surplus 1,399 - - 1,399
Retained earnings 3,616 - - 3,616
Accumulated other comprehensive income, net of
tax 32 - - 32
Total shareholders' equity 5,047 - - 5,047
Noncontrolling interests - - - -
Total equity 5,047 - - 5,047
Total liabilities and equity $ 63,778 $ 4,026 $ (161 ) $ 67,643
December 31, 2019
Assets:
Cash and investments $ 55,416 $ - $ (164 ) (a) $ 55,252
Assets of managed investment entities - 4,736 - 4,736
Other assets 10,143 - (1 ) (a) 10,142
Total assets $ 65,559 $ 4,736 $ (165 ) $ 70,130
Liabilities:
Unpaid losses and loss adjustment expenses and
unearned premiums $ 13,062 $ - $ - $ 13,062
Annuity, life, accident and health benefits and
reserves 41,018 - - 41,018
Liabilities of managed investment entities - 4,736 (165 ) (a) 4,571
Long-term debt and other liabilities 5,210 - - 5,210
Total liabilities 59,290 4,736 (165 ) 63,861
Redeemable noncontrolling interests - - - -
Shareholders' equity:
Common Stock and Capital surplus 1,397 - - 1,397
Retained earnings 4,009 - - 4,009
Accumulated other comprehensive income, net of
tax 863 - - 863
Total shareholders' equity 6,269 - - 6,269
Noncontrolling interests - - - -
Total equity 6,269 - - 6,269
Total liabilities and equity $ 65,559 $ 4,736 $ (165 ) $ 70,130 (a) Elimination of the fair value of AFG's investment in CLOs and related accrued
interest.
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