AMERICAN FINANCIAL GROUP, INC.
INDEX TO MD&A
Page Page
Results of Operations - Third
Forward-Looking Statements 38 Quarter 54
Overview 39 Segmented Statement of Earnings 54
Critical Accounting Policies 40 Property and Casualty Insurance 56
Liquidity and Capital Resources 40 Annuity 68
Holding Company, Other and
Ratios 40 Unallocated 78
Results of Operations - First
Condensed Consolidated Cash Flows 41 Nine Months 82
Parent and Subsidiary Liquidity 42 Segmented Statement of Earnings 82
Investments 44 Property and Casualty Insurance 84
Uncertainties 47 Annuity 94
Holding Company, Other and
Managed Investment Entities 48 Unallocated 103
Recent and Pending Accounting
Results of Operations 52 Standards 106
General 52
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 U.S. and/or abroad;
•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
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AMERICAN FINANCIAL GROUP, INC. 10-Q
Management's Discussion and Analysis of Financial Condition and Results of
Operations - Continued•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. 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 net earnings attributable to shareholders of$164 million ($1.86 per share, diluted) for the third quarter of 2020 compared to$147 million ($1.62 per share, diluted) for the third quarter of 2019. AFG's results reflect: •net realized gains on securities in the third quarter of 2020 compared to net realized losses in the third quarter of 2019, •higher special A&E charges, •lower underwriting profit in the property and casualty insurance segment, •lower net investment income in the property and casualty insurance segment, •higher earnings in the annuity segment, and •higher interest charges on borrowed money. AFG reported net earnings attributable to shareholders of$40 million ($0.45 per share, diluted) for the first nine months of 2020 compared to$686 million ($7.55 per share, diluted) for the first nine months 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$3.72 billion of investments that are accounted for using the equity method or carried at fair value through net earnings. AFG's results reflect: •net realized losses on securities in the first nine months of 2020 compared to net realized gains in the first nine months of 2019, •higher special A&E charges, •lower underwriting profit in the property and casualty insurance segment, •lower net investment income in the property and casualty insurance segment, •lower earnings in the annuity segment, reflecting losses from investments accounted for using the equity method and AFG-managed CLOs, •higher interest charges on borrowed money, 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 quarter 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 into 2021, 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.
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AMERICAN FINANCIAL GROUP, INC. 10-Q
Management's Discussion and Analysis of Financial Condition and Results of
Operations - Continued
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 nine months of 2020. Management expects there to be
continued volatility in the financial markets for the remainder of 2020.
As a result of the contracted economy, exposures in many of AFG's property and
casualty businesses have changed due to workforce reduction, fewer miles driven
and reduced revenue. This has and may continue to lead to lower frequency in
certain lines while there has and may continue to be COVID-19 related increases
in claim frequency in other lines of business.
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
property for business interruption coverage to apply and the vast majority of
AFG's property policies also contain virus exclusions. 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 impairment
allowances.
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):
September 30, 2020 December 31,
Actual Adjusted (*) 2019 2018
Principal amount of long-term debt $ 2,143 $ 1,993 $ 1,493 $ 1,318
Total capital 7,230 7,080 6,883 6,218
Ratio of debt to total capital:
Including subordinated debt 29.6 % 28.1 % 21.7 % 21.2 %
Excluding subordinated debt 18.2 % 18.6 % 14.8 % 16.4 %
(*)Reflects the retirement of AFG's $150 million of 6% Subordinated Debentures
due in November 2055 , which have been called for redemption on November 15,
2020 .
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
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AMERICAN FINANCIAL GROUP, INC. 10-Q
Management's Discussion and Analysis of Financial Condition and Results of
Operations - Continued
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:
Nine months ended Year ended
September 30, 2020 December 31, 2019
Ratio of core earnings to fixed charges excluding
annuity benefits 9.62 12.78
Impact of non-core items (8.94) 1.83
Ratio of earnings to fixed charges excluding annuity benefits (*)
0.68 14.61
Impact of including interest on annuities as a fixed charge
0.30 (12.76)
Ratio of earnings to fixed charges including annuity
benefits (*) 0.98 1.85
(*)Earnings for the nine months ended
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): Nine months ended September 30, 2020 2019 Net cash provided by operating activities $ 1,696$ 1,691 Net cash used in investing activities (772) (1,778) Net cash provided by financing activities 509 1,265 Net change in cash and cash equivalents $ 1,433$ 1,178 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$99 million during the first nine months of 2020 and reduced cash flows from operating activities by$2 million in the first nine months of 2019, accounting for a$101 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$1.60 billion in the first nine months of 2020 compared to$1.69 billion in the first nine months of 2019, a decrease of$96 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$772 million for the first nine months of 2020 compared to$1.78 billion in the first nine months of 2019, a decrease of$1.01 billion . As discussed below (under net cash provided by financing activities), AFG's annuity segment had net cash flows from annuity 41
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AMERICAN FINANCIAL GROUP, INC. 10-Q
Management's Discussion and Analysis of Financial Condition and Results of
Operations - Continued
policyholders of $260 million in the first nine months of 2020 and $1.36 billion
in the first nine months of 2019. In addition to the investment of funds
provided by the insurance operations, investing activities also include the
purchase 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 $60 million use of cash in the first nine
months of 2020 compared to a $19 million source of cash in the 2019 period,
accounting for a $79 million increase in net cash used in investing activities
in the first nine 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 $509 million for the
first nine months of 2020 compared to $1.27 billion in the first nine months of
2019, a decrease of $756 million . Net annuity receipts exceeded annuity
surrenders, benefits, withdrawals and transfers by $260 million in the first
nine months of 2020 compared to $1.36 billion in the first nine months of 2019,
accounting for a $1.10 billion decrease in net cash provided by financing
activities in the 2020 period compared to the 2019 period. In the first nine
months of 2020, AFG issued $150 million of 5.625% Subordinated Debentures due in
2060, $300 million of 5.25% Senior Notes due in 2030 and $200 million 4.50%
Subordinated Debentures due in 2060. The net proceeds of these offerings
contributed $635 million to net cash provided by financing activities in the
first nine months of 2020. 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 nine
months of 2019. During the first nine months of 2020, AFG repurchased
$233 million of its Common Stock compared to no share repurchases in the 2019
period. In addition to its regular quarterly cash dividends, AFG paid a special
cash dividend of $1.50 per share in May 2019 totaling $135 million , which
resulted in total cash dividends of $241 million in the first nine months of
2019 compared to $119 million in the first nine months of 2020. 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 exceeded
issuances by $49 million in the first nine months of 2020 compared to $8 million
in the first nine months of 2019, accounting for a $41 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 nine months of 2020.
In
During the first nine months of 2020, AFG issued$300 million of 5.25% Senior Notes due inApril 2030 ,$150 million of 5.625% Subordinated Debentures due inJune 2060 and$200 million of 4.50% Subordinated Debentures due inSeptember 2060 to increase liquidity and provide flexibility at the parent holding company in its response to the uncertainties of the current economic environment. The net proceeds of the offerings will be used for general corporate purposes, which includes repurchases of outstanding common shares and the redemption of$150 million of 6% Subordinated Debentures due inNovember 2055 .
During the first nine months of 2020, AFG repurchased 3,468,107 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. 42
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AMERICAN FINANCIAL GROUP, INC. 10-Q
Management's Discussion and Analysis of Financial Condition and Results of
Operations - Continued
In March 2019 , AFG issued $125 million of 5.875% Subordinated Debentures due in
March 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) resulting in a total
distribution of 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. AtSeptember 30, 2020 , GALIC had$1.26 billion in outstanding advances from the FHLB (included in annuity benefits accumulated), bearing interest at rates ranging from 0.32% to 1.35% (average rate of 0.50% atSeptember 30, 2020 ). While these advances must be repaid between 2020 and 2025 ($325 million in 2020,$731 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. AtSeptember 30, 2020 , GALIC estimated that it had additional borrowing capacity of approximately$650 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. Due to the anticipated slowdown in cash collections from the state mandated increases in grace periods for premium payments, AFG's property and casualty insurance subsidiaries have maintained higher than typical cash balances sinceMarch 2020 . AFG has not experienced a material increase in uncollectable premiums receivable as policyholders continue to make payments in accordance with the agreed upon terms. 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"). With interest rates at historic lows, AFG began to lower crediting rates on existing policies in the first six months of 2020, particularly on policies near or after the end of the surrender charge period. AtSeptember 30, 2020 , AFG could reduce the average crediting rate on approximately$26 billion of traditional fixed, fixed-indexed and variable-indexed annuities without guaranteed withdrawal benefits (excludes reserves ceded to Commonwealth inOctober 2020 , see Note O - "Subsequent Events" to the financial statements) by approximately 108 basis points (on a weighted average basis). 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 September 30, December 31, GMIR 2020 (*) 2019 2018 1 - 1.99% 85% 84% 81% 2 - 2.99% 3% 3% 4% 3 - 3.99% 7% 7% 8% 4.00% and above 5% 6% 7% Annuity benefits accumulated (in millions)$41,932 $40,406 $36,616
(*)The breakdown of annuity reserves by GMIR excludes reserves ceded to
Commonwealth in
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AMERICAN FINANCIAL GROUP, INC. 10-Q
Management's Discussion and Analysis of Financial Condition and Results of
Operations - Continued
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 atSeptember 30, 2020 , contained$48.19 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$92 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$358 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 published closing prices. For AFG's fixed maturity portfolio, approximately 89% was priced using pricing services atSeptember 30, 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 atSeptember 30, 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$ 48,285 Percentage impact on fair value of 100 bps increase in interest rates (4.0 %) Pretax impact on fair value of fixed maturity portfolio$ (1,931) Offsetting adjustments to deferred policy acquisition costs and other balance sheet amounts
900
Estimated pretax impact on accumulated other comprehensive income
(1,031)
Deferred income tax
217
Estimated after-tax impact on accumulated other comprehensive income
$ (814) 44
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AMERICAN FINANCIAL GROUP, INC. 10-Q
Management's Discussion and Analysis of Financial Condition and Results of
Operations - Continued
Approximately 90% of the fixed maturities held by AFG at September 30, 2020 ,
were rated "investment grade" (credit rating of AAA 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.
Summarized information for AFG's MBS (including those classified as trading) at
September 30, 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 $ 485 $ 492 101 % $ 7 100 %
Non-agency prime 1,301 1,412 109 % 111 61 %
Alt-A 811 920 113 % 109 37 %
Subprime 283 314 111 % 31 18 %
Commercial 814 856 105 % 42 93 %
$ 3,694 $ 3,994 108 % $ 300 64 %
(*)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. AtSeptember 30, 2020 , 97% (based on statutory carrying value of$3.65 billion ) of AFG's MBS had an NAIC designation of 1. Municipal bonds represented approximately 14% of AFG's fixed maturity portfolio atSeptember 30, 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. AtSeptember 30, 2020 , approximately 78% of the municipal bond portfolio was held in revenue bonds, with the remaining 22% held in general obligation bonds. 45
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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 the unrealized gains and losses recorded in AFG's
Balance Sheet at September 30, 2020 , is shown in the following table (dollars in
millions). Approximately $1.77 billion of available for sale fixed maturity
securities had no unrealized gains or losses at September 30, 2020 .
Securities Securities
With With
Unrealized Unrealized
Gains Losses
Available for Sale Fixed Maturities
Fair value of securities $
39,000
$ 35,796 $ 7,676 Gross unrealized gain (loss)$ 3,204 $ (254) Fair value as % of amortized cost 109 % 97 % Number of security positions 4,429 759 Number individually exceeding$2 million gain or loss 387 22
Concentration of gains (losses) by type or industry (exceeding 5% of unrealized): States and municipalities
$ 575 $ (3) Banks, savings and credit institutions 438 (9) Mortgage-backed securities 308 (8) Insurance 241 - Technology 188 (1) Other asset-backed securities 154 (124) Energy 120 (17) Collateralized loan obligations 25 (41) Aviation 2 (16) Percentage rated investment grade 94 % 84 % The table below sets forth the scheduled maturities of AFG's available for sale fixed maturity securities atSeptember 30, 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 29 % 11 % After five years through ten years 34 % 9 % After ten years 8 % 5 % 75 % 29 %
Collateralized loan obligations and other asset-backed securities (average life of approximately 4 years)
16 % 68 %
Mortgage-backed securities (average life of approximately 3-1/2 years)
9 % 3 %
100 % 100 %
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AMERICAN FINANCIAL GROUP, INC. 10-Q
Management's Discussion and Analysis of Financial Condition and Results of
Operations - ContinuedThe 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 September 30, 2020
Securities with unrealized gains:
Exceeding $500,000 (1,764 securities) $ 26,329 $ 2,786 112 %
$500,000 or less (2,665 securities) 12,671 418 103 %
$ 39,000 $ 3,204 109 % Securities with unrealized losses: Exceeding$500,000 (145 securities)$ 2,436 $ (187) 93 %$500,000 or less (614 securities) 4,986 (67) 99 %$ 7,422 $ (254) 97 % 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 Cost
Securities with Unrealized Losses at
$ 4,545 $ (148) 97 % One year or longer (127 securities) 1,718 (49) 97 %$ 6,263 $ (197) 97 %
Non-investment grade fixed maturities with losses for: Less than one year (246 securities)
$ 993 $ (46) 96 % One year or longer (39 securities) 166 (11) 94 %$ 1,159 $ (57) 95 % 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." 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 atSeptember 30, 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, increases in the allowance for credit losses 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, 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 "Special asbestos and
environmental reserve charges" under "Results of Operations - Property and
Casualty Insurance Segment - Net prior year reserve development" for the
quarters ended
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AMERICAN FINANCIAL GROUP, INC. 10-Q
Management's Discussion and Analysis of Financial Condition and Results of
Operations - ContinuedAnalysis - "Uncertainties - Asbestos and Environmental-related ("A&E") Insurance Reserves" in AFG's 2019 Form 10-K.
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
September 30, 2020
Assets:
Cash and investments $ 58,262 $ - $ (175) (a) $ 58,087
Assets of managed investment entities - 4,717 - 4,717
Other assets 10,307 - (1) (a) 10,306
Total assets $ 68,569 $ 4,717 $ (176) $ 73,110
Liabilities:
Unpaid losses and loss adjustment expenses and unearned premiums $ 13,769 $ - $ - $ 13,769
Annuity, life, accident and health benefits and reserves 42,541 - - 42,541
Liabilities of managed investment entities - 4,707 (166) (a) 4,541
Long-term debt and other liabilities 5,919 - - 5,919
Total liabilities 62,229 4,707 (166) 66,770
Redeemable noncontrolling interests - - - -
Shareholders' equity:
Common Stock and Capital surplus 1,370 10 (10) 1,370
Retained earnings 3,737 - - 3,737
Accumulated other comprehensive income, net of tax 1,233 - - 1,233
Total shareholders' equity 6,340 10 (10) 6,340
Noncontrolling interests - - - -
Total equity 6,340 10 (10) 6,340
Total liabilities and equity $ 68,569 $ 4,717 $ (176) $ 73,110
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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