Document
________________________________________________________________________________________________________________
UNITED STATES SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-K
Annual Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934
For the Fiscal Year Ended December 31, 2017
 
Commission File No. 1-13653 
https://cdn.kscope.io/f7250c4b16386b1d92371c5fa78d1a6a-afglogoa01.jpg
AMERICAN FINANCIAL GROUP, INC.
Incorporated under the Laws of Ohio
 
IRS Employer I.D. No. 31-1544320
301 East Fourth Street, Cincinnati, Ohio 45202
(513) 579-2121
Securities Registered Pursuant to Section 12(b) of the Act:
 
Title of Each Class
 
Name of Each Exchange on Which Registered
 
Common Stock
 
New York Stock Exchange
 
6-1/4% Subordinated Debentures due September 30, 2054
 
New York Stock Exchange
 
6% Subordinated Debentures due November 15, 2055
 
New York Stock Exchange
Securities Registered Pursuant to Section 12(g) of the Act: None
Indicate by check mark if the Registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act. Yes þ No ¨
Indicate by check mark if the Registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act. Yes ¨ No þ
Indicate by check mark whether the Registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months, and (2) has been subject to such filing requirements for the past 90 days. Yes þ No ¨
Indicate by check mark whether the Registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding 12 months. Yes þ No ¨
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of Registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. ¨
Indicate by check mark whether the Registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer or a smaller reporting company. See definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. 
Large accelerated filer  þ                        Accelerated filer  ¨                        Non-accelerated filer  ¨
Smaller reporting company  ¨                        Emerging growth company  ¨
If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. ¨
Indicate by check mark whether the Registrant is a shell company (as defined in Rule 12b-2 of the Act). Yes ¨ No þ
State the aggregate market value of the voting and non-voting common equity held by non-affiliates computed by reference to the price at which the common equity was last sold, or the average bid and asked price of such common equity, as of the last business day of the Registrant’s most recently completed second fiscal quarter: $7.64 billion.
Indicate the number of shares outstanding of each of the Registrant’s classes of common stock, as of the latest practicable date: 88,425,972 shares (excluding 14.9 million shares owned by subsidiaries) as of February 1, 2018.
________________________________
Documents Incorporated by Reference:
Proxy Statement for 2018 Annual Meeting of Stockholders (portions of which are incorporated by reference into Part III hereof).
________________________________________________________________________________________________________________


Table of Contents

AMERICAN FINANCIAL GROUP, INC.
INDEX TO ANNUAL REPORT ON FORM 10-K
 
  
 
 
Page
FORWARD-LOOKING STATEMENTS
 
 
 
 
Part I
 
 
 
Item 1
Business
Item 1A
Risk Factors
Item 1B
Unresolved Staff Comments
none
Item 2
Properties
Item 3
Legal Proceedings
Item 4
Mine Safety Disclosures
none
 
 
 
 
Part II
 
 
 
Item 5
Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities
Item 6
Selected Financial Data
Item 7
Management’s Discussion and Analysis of Financial Condition and Results of Operations
Item 7A
Quantitative and Qualitative Disclosure About Market Risk
Item 8
Financial Statements and Supplementary Data
Item 9
Changes in and Disagreements With Accountants on Accounting and Financial Disclosure
none
Item 9A
Controls and Procedures
Item 9B
Other Information
none
 
 
 
 
Part III
 
 
 
Item 10
Directors, Executive Officers and Corporate Governance
Item 11
Executive Compensation
Item 12
Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters
Item 13
Certain Relationships and Related Transactions, and Director Independence
Item 14
Principal Accounting Fees and Services
 
 
 
 
Part IV
 
 
 
Item 15
Exhibits, Financial Statement Schedules



Table of Contents

FORWARD-LOOKING STATEMENTS

The disclosures in this Form 10-K contain certain forward-looking statements that are subject to numerous assumptions, risks or uncertainties. 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 the following and those discussed in Item 1A — Risk Factors.
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;
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;
regulatory actions (including changes in statutory accounting rules);
changes in the legal environment affecting AFG or its customers;
tax law and accounting changes, including the impact of recent changes in U.S. corporate tax law;
levels of natural catastrophes and severe weather, terrorist activities (including any nuclear, biological, chemical or radiological events), incidents of war or losses resulting from civil unrest and other major losses;
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 (including those associated with the United Kingdom’s expected withdrawal from the European Union, or “Brexit”) 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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PART I
ITEM 1
Business

Introduction

American Financial Group, Inc. (“AFG” or the “Company”) is a holding company that, through the operations of Great American Insurance Group, is engaged primarily in property and casualty insurance, focusing on specialized commercial products for businesses, and in the sale of fixed and fixed-indexed annuities in the retail, financial institutions and education markets. Its address is 301 East Fourth Street, Cincinnati, Ohio 45202; its phone number is (513) 579-2121. SEC filings, news releases, AFG’s Code of Ethics applicable to directors, officers and employees and other information may be accessed free of charge through AFG’s Internet site at: www.AFGinc.com. (Information on AFG’s Internet site is not part of this Form 10-K.)

See Note C — “Segments of Operations to the financial statements for information on AFG’s assets, revenues and earnings before income taxes by segment.

Property and Casualty Insurance Segment

General

AFG’s property and casualty insurance operations provide a wide range of commercial coverages through over 30 niche insurance businesses that make up the Great American Insurance Group. AFG’s property and casualty insurance operations ultimately report to a single senior executive and operate under a business model that allows local decision-making for underwriting, claims and policy servicing in each of the niche operations. Each business is managed by experienced professionals in particular lines or customer groups and operates autonomously but with certain central controls and accountability. The decentralized approach allows each unit the autonomy necessary to respond to local and specialty market conditions while capitalizing on the efficiencies of centralized investment and administrative support functions. AFG’s property and casualty insurance operations employed approximately 6,700 people as of December 31, 2017. These operations are conducted through the subsidiaries listed in the following table, which includes independent financial strength ratings and 2017 gross written premiums (in millions) for each major subsidiary. These ratings are generally based on concerns for policyholders and agents and are not directed toward the protection of investors. AFG believes that maintaining a rating in the “A” category by A.M. Best is important to compete successfully in most lines of business.
 
Ratings
 
Gross
Written
 
AM Best
 
S&P
 
Premiums
Company
 
 
 
 
 
Great American Insurance
  A+
 
  A+
 
$
4,243

National Interstate
A
 
not rated
 
746

Summit (Bridgefield Casualty and Bridgefield Employers)
A
 
  A+
 
607

Republic Indemnity
A
 
  A+
 
245

Neon Lloyd’s Syndicate
A
 
  A+
 
295

American Empire Surplus Lines
  A+
 
  A+
 
133

Mid-Continent Casualty
  A+
 
  A+
 
131

Other
 
 
 
 
102

 
 
 
 
 
$
6,502


The primary objectives of AFG’s property and casualty insurance operations are to achieve solid underwriting profitability and provide excellent service to its policyholders and agents. Underwriting profitability is measured by the combined ratio, which is a sum of the ratios of losses, loss adjustment expenses (“LAE”), underwriting expenses and policyholder dividends to premiums. A combined ratio under 100% indicates an underwriting profit. The combined ratio does not reflect investment income, other income or federal income taxes.

While many costs included in underwriting are readily determined (commissions, administrative expenses and many of the losses on claims reported), the process of determining overall underwriting results is highly dependent upon the use of estimates in the case of losses incurred or expected but not yet reported or developed. Actuarial procedures and projections are

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used to obtain “point estimates” of ultimate losses. While the process is imprecise and develops amounts which are subject to change over time, management believes that the liabilities for unpaid losses and loss adjustment expenses are adequate.

Financial information is reported in accordance with U.S. generally accepted accounting principles (“GAAP”) for shareholder and other investor-related purposes and reported on a statutory basis for U.S. insurance regulatory purposes. Unless indicated otherwise, the financial information presented in the Form 10-K for AFG’s property and casualty insurance operations is presented based on GAAP. Statutory information is only prepared for AFG’s U.S.-based subsidiaries, which represented approximately 94% of AFG’s direct written premiums in 2017, and is provided for industry comparisons or where comparable GAAP information is not readily available.

Major differences for statutory accounting include charging policy acquisition costs to expense as incurred rather than spreading the costs over the periods covered by the policies; reporting investment grade bonds and redeemable preferred stocks at amortized cost rather than fair value; netting of reinsurance recoverables and prepaid reinsurance premiums against the corresponding liabilities rather than reporting such items separately; and charging to surplus certain GAAP assets, such as furniture and fixtures and agents’ balances over 90 days old.

AFG’s statutory combined ratio averaged 92.0% for the period 2015 to 2017 as compared to 101.4% for the property and casualty industry over the same period (Source: “A.M. Best’s Review & Preview Report” — February 2018 Edition). AFG believes that its specialty niche focus, product line diversification and underwriting discipline have contributed to the Company’s ability to consistently outperform the industry’s underwriting results. Management’s philosophy is to refrain from writing business that is not expected to produce an underwriting profit even if it is necessary to limit premium growth to do so.

Property and Casualty Results

Performance measures such as underwriting profit or loss and related combined ratios are often used by property and casualty insurers to help users of their financial statements better understand the company’s performance. See Note C — “Segments of Operations to the financial statements for the reconciliation of AFG’s earnings before income taxes by significant business segment to the statement of earnings.

The following table shows the performance of AFG’s property and casualty insurance operations (dollars in millions):
 
 
2017
 
2016
 
2015
Gross written premiums
 
$
6,502

 
$
5,981

 
$
5,832

Ceded reinsurance
 
(1,751
)
 
(1,595
)
 
(1,505
)
Net written premiums
 
$
4,751

 
$
4,386

 
$
4,327

 
 
 
 
 
 
 
Net earned premiums
 
$
4,579

 
$
4,328

 
$
4,224

Loss and LAE
 
2,884

 
2,669

 
2,628

Special asbestos and environmental (“A&E”) charges
 
89

 
36

 
67

Neon exited lines charge
 
(18
)
 
65

 

Underwriting expenses
 
1,382

 
1,322

 
1,304

Underwriting gain
 
$
242

 
$
236

 
$
225

 
 
 
 
 
 
 
GAAP ratios:
 
 
 
 
 
 
Loss and LAE ratio
 
64.5
%
 
63.8
%
 
63.8
%
Underwriting expense ratio
 
30.2
%
 
30.7
%
 
30.9
%
Combined ratio
 
94.7
%
 
94.5
%
 
94.7
%
 
 
 
 
 
 
 
Statutory ratios:
 
 
 
 
 
 
Loss and LAE ratio
 
63.0
%
 
58.8
%
 
60.9
%
Underwriting expense ratio
 
30.1
%
 
31.4
%
 
31.7
%
Combined ratio
 
93.1
%
 
90.2
%
 
92.6
%
 
 
 
 
 
 
 
Industry statutory combined ratio (a)
 
 
 
 
 
 
All lines
 
105.1
%
 
100.9
%
 
98.3
%
Commercial lines
 
103.5
%
 
99.6
%
 
97.5
%
(a)
The source of the industry ratios is “A.M. Best’s Review & Preview Report” (February 2018 Edition).


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As with other property and casualty insurers, AFG’s operating results can be adversely affected by unpredictable catastrophe losses. Certain natural disasters (hurricanes, severe storms, earthquakes, tornadoes, floods, etc.) and other incidents of major loss (explosions, civil disorder, terrorist events, fires, etc.) are classified as catastrophes by industry associations. Losses from these incidents are usually tracked separately from other business of insurers because of their sizable effects on overall operations. Total net losses to AFG’s insurance operations from current accident year catastrophes were $140 million in 2017, $55 million in 2016 and $35 million in 2015 and are included in the table above.

AFG generally seeks to reduce its exposure to catastrophes through individual risk selection, including minimizing coastal and known fault-line exposures, and the purchase of reinsurance. AFG’s net exposure to a catastrophic earthquake or windstorm that industry models indicate could occur once in every 500 years (a “500-year event”) is expected to be less than 4% of AFG’s Shareholders’ Equity.

Property and Casualty Insurance Products

AFG is focused on growth opportunities in what it believes to be more profitable specialty businesses where AFG personnel are experts in particular lines of business or customer groups. The following are examples of AFG’s specialty businesses:

Property and Transportation
 
Inland and Ocean Marine
Provides coverage primarily for builders’ risk, contractors’ equipment, property, motor truck cargo, marine cargo, boat dealers, marina operators/dealers and excursion vessels.
Agricultural-related
Provides federally reinsured multi-peril crop (allied lines) insurance covering most perils as well as crop-hail, equine mortality and other coverages for full-time operating farms/ranches and agribusiness operations on a nationwide basis.
Commercial Automobile
Provides coverage for vehicles (such as buses and trucks) in a broad range of businesses including the moving and storage and transportation industries, and a specialized physical damage product for the trucking industry.
 
 
Specialty Casualty
 
Executive and Professional Liability
Markets coverage for directors and officers of businesses and non-profit organizations; errors and omissions; cyber; and mergers and acquisitions.
Umbrella and Excess Liability
Provides liability coverage in excess of primary layers.
Excess and Surplus
Provides liability, umbrella and excess coverage for unique, volatile or hard to place risks, using rates and forms that generally do not have to be approved by state insurance regulators.
General Liability
Provides coverage for contractor-related businesses, energy development and production risks, and environmental liability risks.
Targeted Programs
Includes coverage (primarily liability and property) for social service agencies, leisure, entertainment and non-profit organizations, customized solutions for other targeted markets and alternative risk programs using agency captives.
Workers’ Compensation
Provides coverage for prescribed benefits payable to employees who are injured on the job.
 
 
Specialty Financial
 
Fidelity and Surety
Provides fidelity and crime coverage for government, mercantile and financial institutions and surety coverage for various types of contractors and public and private corporations.
Lease and Loan Services
Provides coverage for insurance risk management programs for lending and leasing institutions, including equipment leasing and collateral and lender-placed mortgage property insurance.

Management believes specialization is the key element to the underwriting success of these business units. These specialty businesses are opportunistic and their premium volume will vary based on prevailing market conditions. AFG continually evaluates expansion in existing markets and opportunities in new specialty markets that meet its profitability objectives. Likewise, AFG will withdraw from markets that do not meet its profit objectives or business strategy.


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Premium Distribution

The following table shows the net written premiums by sub-segment for AFG’s property and casualty insurance operations for 2017, 2016 and 2015 (in millions):
 
2017
 
2016
 
2015
Property and transportation
$
1,765

 
$
1,672

 
$
1,636

Specialty casualty
2,280

 
2,036

 
2,052

Specialty financial
596

 
572

 
540

Other
110

 
106

 
99

 
$
4,751

 
$
4,386

 
$
4,327


The geographic distribution of statutory direct written premiums by AFG’s U.S.-based insurers for 2017, 2016 and 2015 is shown below. Approximately 6% of AFG’s direct written premiums in 2017 were derived from non U.S.-based insurers, primarily Neon, a United Kingdom-based Lloyd’s insurer.
 
 
2017
 
2016
 
2015
 
 
 
2017
 
2016
 
2015
California
 
13.2
%
 
14.3
%
 
14.2
%
 
New Jersey
 
2.6
%
 
2.5
%
 
2.3
%
Florida
 
10.0
%
 
9.6
%
 
9.0
%
 
Arizona
 
2.6
%
 
2.1
%
 
1.1
%
New York
 
6.6
%
 
6.7
%
 
6.7
%
 
Pennsylvania
 
2.4
%
 
2.5
%
 
2.6
%
Texas
 
6.2
%
 
6.1
%
 
6.1
%
 
Iowa
 
2.4
%
 
2.3
%
 
2.5
%
Illinois
 
5.6
%
 
5.3
%
 
5.7
%
 
Kansas
 
2.2
%
 
2.2
%
 
2.5
%
Georgia
 
3.2
%
 
2.9
%
 
2.8
%
 
North Carolina
 
2.1
%
 
2.4
%
 
2.7
%
Missouri
 
2.8
%
 
2.7
%
 
2.8
%
 
Other
 
38.1
%
 
38.4
%
 
39.0
%
 
 
 
 
 
 
 
 
 
 
100.0
%
 
100.0
%
 
100.0
%

Reinsurance

Consistent with standard practice of most insurance companies, AFG reinsures a portion of its property and casualty business with other insurance companies and assumes a relatively small amount of business from other insurers. AFG uses reinsurance for two primary purposes: (i) to provide higher limits of coverage than it would otherwise be willing to provide (i.e. large line capacity) and (ii) to protect its business by reducing the impact of catastrophes. The availability and cost of reinsurance are subject to prevailing market conditions, which may affect the volume and profitability of business that is written. AFG is subject to credit risk with respect to its reinsurers, as the ceding of risk to reinsurers does not relieve AFG of its liability to its insureds until claims are fully settled.

Reinsurance is provided on one of two bases, facultative or treaty. Facultative reinsurance is generally provided on a risk-by-risk basis. Individual risks are ceded and assumed based on an offer and acceptance of risk by each party to the transaction. AFG purchases facultative reinsurance, both pro rata and excess of loss, depending on the risk and available reinsurance markets. Treaty reinsurance provides for risks meeting prescribed criteria to be automatically ceded and assumed according to contract provisions.

Catastrophe Reinsurance AFG has taken steps to limit its exposure to wind and earthquake losses through individual risk selection, including minimizing coastal and known fault-line exposures, and purchasing catastrophe reinsurance. Catastrophe reinsurance is purchased separately for AFG’s U.S. property and casualty insurance group and for Neon, AFG’s Lloyd’s insurance business. In addition, AFG purchases catastrophe reinsurance for its workers’ compensation businesses. Although the cost of catastrophe reinsurance varies depending on exposure and the level of worldwide loss activity, AFG continues to obtain reinsurance coverage in adequate amounts at acceptable rates.

In June 2017, AFG’s property and casualty insurance subsidiaries entered into a reinsurance agreement to obtain supplemental catastrophe protection through a catastrophe bond structure with Riverfront Re Ltd. (“Riverfront”). The reinsurance agreement provides supplemental reinsurance coverage up to 95% of $200 million (fully collateralized) for catastrophe losses in excess of $100 million (per occurrence and annual aggregate) occurring between June 1, 2017 and December 31, 2020. In connection with the reinsurance agreement, Riverfront issued notes to unrelated investors for the full amount of coverage provided under the reinsurance agreement. Riverfront is a variable interest entity in which AFG does not have a variable interest because the variability in Riverfront’s results will be absorbed entirely by the investors in Riverfront. Accordingly, Riverfront is not

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consolidated in AFG’s financial statements and the reinsurance agreement is accounted for as ceded reinsurance. AFG’s cost for this coverage is approximately $11 million per year.

In January 2018, Neon launched NCM Re (UK PCC) Ltd. (“NCM Re”), the first insurance-linked securities (“ILS”) vehicle in the United Kingdom (“UK”). NCM Re utilizes recently approved UK regulations to provide Neon with the ability to further enhance its global reinsurance offering to clients. NCM Re plans to use a range of catastrophe modeling and pricing techniques to make use of Neon’s underwriting and risk selection skills to source business for third-party ILS investors in the capital markets. In early 2018, NCM Re completed its first ILS transaction, which provides $72 million in collateralized quota share reinsurance that will assume 20% of the Neon Lloyd’s syndicate’s property treaty reinsurance and direct and facultative portfolios. Losses are recovered from NCM Re before Neon’s catastrophe excess of loss reinsurance coverage applies. In addition to NCM Re, Neon also placed a 35% quota share reinsurance treaty covering its property insurance (but not assumed reinsurance) lines.

Also in January 2018, AFG’s property and casualty insurance subsidiaries renewed their catastrophe reinsurance coverages. For AFG’s U.S. based operations, the Company continued to place $85 million of coverage in excess of a $15 million per event primary retention in the traditional reinsurance markets but as part of the placement, eliminated its 5% participation from previous treaty years. Neon placed $200 million of coverage in excess of a $15 million per event primary retention (extending to $225 million for U.S. risks only) with a 7.5% participation. For the catastrophe excess of loss reinsurance coverage, recoveries from NCM Re and Neon’s property insurance quota share apply before calculating losses recoverable from the catastrophe excess of loss reinsurance treaty. In addition to Neon’s catastrophe excess of loss reinsurance coverage, Neon has placed a quota share treaty which covers 12.5% of Neon’s gross property losses with a $400 million event limit (maximum $50 million recoverable) which supplements its catastrophe excess of loss reinsurance coverage and property quota share coverages up to the event limit.

The commercial marketplace requires large policy limits ($25 million or more) in several of AFG’s lines of business, including certain executive and professional liability, umbrella and excess liability, and fidelity and surety coverages. Since these limits exceed management’s desired exposure to an individual risk, AFG generally enters into reinsurance agreements to reduce its net exposure under such policies to an acceptable level. Reinsurance continues to be available for this large line capacity exposure with satisfactory pricing and terms.

In addition to the catastrophe and large line capacity reinsurance programs discussed above, AFG purchases reinsurance on a product-by-product basis. AFG regularly reviews the financial strength of its current and potential reinsurers. These reviews include consideration of credit ratings, available capital, claims paying history and expertise. This process periodically results in the transfer of risks to more financially secure reinsurers. Substantially all reinsurance is ceded to companies with investment grade S&P ratings or is secured by “funds withheld” or other collateral. Under “funds withheld” arrangements, AFG retains ceded premiums to fund ceded losses as they become due from the reinsurer. Recoverables from the following companies were individually between 5% and 10% of AFG’s total property and casualty reinsurance recoverable (including prepaid reinsurance premiums and net of payables to reinsurers) at December 31, 2017: Hannover Rueck SE, Munich Reinsurance America, Inc. and Swiss Reinsurance America Corporation. In addition, AFG has a reinsurance recoverable from Ohio Casualty Insurance Company of $156 million related to that company’s purchase of AFG’s commercial lines business in 1998. No other reinsurers exceeded 5% of AFG’s property and casualty reinsurance recoverable.


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The following table presents (by type of coverage) the amount of each loss above the specified retention covered by treaty reinsurance programs in AFG’s U.S.-based property and casualty insurance operations (in millions) as of January 1, 2018:
 
 
 
 
Reinsurance Coverage
 
AFG
 
 
Primary
 
Coverage
 
AFG Participation (a)
 
Maximum
 
 
Retention
 
Amount
 
%
 
$
 
Loss (b)
U.S.-based operations:
 
 
 
 
 
 
 
 
 


California Workers’ Compensation
 
$
2

 
$
148

 
1
%
 
$
1

 
$
3

Other Workers’ Compensation
 
3

 
37

 
%
 

 
3

Commercial Umbrella
 
1

 
49

 
14
%
 
7

 
8

Property — General
 
5

 
45

 
%
 

 
5

Property — Catastrophe
 
15

 
85

 
%
 

 
15

Neon Lloyd’s Syndicate
 
 
 
 
 
 
 
 
 


Property — Catastrophe (c)
 
15

 
200

 
7.5
%
 

 
15

Riverfront Re Ltd. catastrophe bond (d)
 
100

 
200

 
5
%
 
10

 
N/A

 
(a)
Includes the participation of AFG’s internal reinsurance program.
(b)
Maximum loss per event for claims up to reinsurance coverage limit.
(c)
Coverage amount extends to $225 million for U.S. catastrophe events. The combination of Neon’s excess of loss catastrophe reinsurance and 12.5% gross property loss treaty (discussed above) limits the maximum retained loss per event to $15 million until such coverage is exhausted.
(d)
Includes aggregate coverage. See description above.

In addition to the coverage shown above, AFG reinsures a portion of its crop insurance business through the Federal Crop Insurance Corporation (“FCIC”). The FCIC offers both proportional (or “quota share”) and non-proportional coverages. The proportional coverage provides that a fixed percentage of risk is assumed by the FCIC. The non-proportional coverage allows AFG to select desired retention of risk on a state-by-state, county, crop or plan basis. AFG typically reinsures 15% to 25% of gross written premiums with the FCIC. AFG also purchases quota share reinsurance in the private market. This quota share provides for a ceding commission to AFG and a profit sharing provision. During both 2017 and 2016, AFG reinsured 52.5% of premiums not reinsured by the FCIC in the private market and purchased stop loss protection coverage for the remaining portion of the business. In 2018, AFG expects to reinsure 50% of the premiums not reinsured by the FCIC in the private market.

The balance sheet caption “recoverables from reinsurers” included approximately $100 million on paid losses and LAE and $2.96 billion on unpaid losses and LAE at December 31, 2017. These amounts are net of allowances of approximately $20 million for doubtful collection of reinsurance recoverables. The collectibility of a reinsurance balance is based upon the financial condition of a reinsurer as well as individual claim considerations.

Reinsurance premiums ceded and assumed are presented in the following table (in millions):
 
 
2017
 
2016
 
2015
Reinsurance ceded
 
$
1,751

 
$
1,595

 
$
1,505

Reinsurance ceded, excluding crop
 
1,076

 
985

 
899

Reinsurance assumed — including involuntary pools and associations
 
192

 
123

 
119


Loss and Loss Adjustment Expense Reserves

The consolidated financial statements include the estimated liability for unpaid losses and LAE of AFG’s insurance subsidiaries. This liability represents estimates of the ultimate net cost of all unpaid losses and LAE and is determined by using case-basis evaluations, actuarial projections and management’s judgment. These estimates are subject to the effects of changes in claim amounts and frequency and are periodically reviewed and adjusted as additional information becomes known. In accordance with industry practices, such adjustments are reflected in current year operations. Generally, reserves for reinsurance assumed and involuntary pools and associations are reflected in AFG’s results at the amounts reported by those entities. See Note O — “InsuranceProperty and Casualty Insurance Reserves to the financial statements for information on the development of AFG’s liability for unpaid losses and loss adjustment expenses by accident year as well as a progression of the liability on a GAAP basis over the past three years.


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The differences between the liability for losses and LAE reported in the annual statements filed with the state insurance departments in accordance with statutory accounting principles (“SAP”) and that reported in the accompanying consolidated financial statements in accordance with GAAP at December 31, 2017 are as follows (in millions):
Liability reported on a SAP basis, net of $152 million of retroactive reinsurance
$
5,931

Reinsurance recoverables, net of allowance
2,957

Other, including reserves of foreign insurers
790

Liability reported on a GAAP basis
$
9,678


Asbestos and Environmental (“A&E”) Reserves   AFG’s property and casualty group, like many others in the industry, has A&E claims arising in most cases from general liability policies written more than thirty years ago. The establishment of reserves for such A&E claims presents unique and difficult challenges and is subject to uncertainties significantly greater than those presented by other types of claims. For a discussion of these uncertainties, see Item 7 Management’s Discussion and Analysis Uncertainties — Asbestos and Environmental-related (“A&E”) Insurance Reservesand Note M Contingencies to the financial statements.

Management has periodically conducted comprehensive external studies of its asbestos and environmental reserves with the aid of specialty actuarial, engineering and consulting firms and outside counsel, generally every two years, with an in-depth internal review during the intervening years. Charges resulting from these studies and reviews are included in “Incurred losses and LAE” in the table below. As a result of the 2017 comprehensive external study, AFG recorded an $89 million pretax special charge in the third quarter of 2017 to increase the property and casualty group’s asbestos reserves by $53 million (net of reinsurance) and its environmental reserves by $36 million (net of reinsurance). Over the past few years, the focus of AFG’s asbestos claims litigation has shifted to smaller companies and companies with ancillary exposures. AFG’s insureds with these exposures have been the driver of the property and casualty segment’s asbestos reserve increases in recent years. AFG is seeing modestly increasing estimates for indemnity and defense compared to prior studies. Overall, the rate of new asbestos cases received is down modestly however, increasing life expectancies in the U.S. have allowed more time for the impacts of asbestos exposure to emerge. AFG’s comprehensive external study incorporated, among other factors, the increase in projected industry ultimate losses attributable to asbestos exposures, as well as revised estimates for future claims emergence, which resulted in an increase in AFG’s provision for future asbestos claims. The increase in property and casualty environmental reserves in 2017 (as well as in 2016, discussed below) was primarily associated with updated estimates of site investigation costs with respect to existing sites and newly identified sites. AFG is seeing increased legal defense costs in environmental claims generally, as well as a number of claims and sites where the estimated investigation and remediation costs have increased. Certain individual claims are taking a longer time to settle than originally estimated, causing AFG to increase its reserves to reflect related increased costs. As in past years, there were no new or emerging broad industry trends that were identified in this study. As a result of the 2016 internal review, AFG recorded a $36 million pretax special charge in the third quarter of 2016 to increase the property and casualty group’s asbestos reserves by $5 million (net of reinsurance) and its environmental reserves by $31 million (net of reinsurance). As a result of the 2015 comprehensive external study, AFG recorded a $67 million pretax special charge in the third quarter of 2015 to increase the property and casualty group’s asbestos reserves by $25 million (net of reinsurance) and its environmental reserves by $42 million (net of reinsurance). The increase in property and casualty environmental reserves in 2015 was attributed primarily to AFG’s increased defense costs and a number of claims where the estimated costs of remediation have increased.

The following table (in millions) is a progression of the property and casualty group’s A&E reserves.
 
 
2017
 
2016
 
2015
Reserves at beginning of year
 
$
337

 
$
327

 
$
289

Incurred losses and LAE
 
89

 
36

 
67

Paid losses and LAE
 
(23
)
 
(26
)
 
(29
)
Reserves at end of year, net of reinsurance recoverable
 
403

 
337

 
327

Reinsurance recoverable, net of allowance
 
125

 
106

 
99

Gross reserves at end of year
 
$
528

 
$
443

 
$
426



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Marketing

The property and casualty insurance group directs its sales efforts primarily through independent insurance agents and brokers, although small portions are written through employee agents. Independent agents and brokers generally receive a commission on the sale of each policy. Some agents and brokers are eligible for a bonus commission based on the overall profitability of policies placed with AFG by the broker or agent in a particular year. The property and casualty insurance group writes insurance through several thousand agents and brokers.

Competition

AFG’s property and casualty insurance businesses compete with other individual insurers, state funds and insurance groups of varying sizes, some of which are mutual insurance companies possessing competitive advantages in that all their profits inure to their policyholders. See Item 1A Risk Factors. They also compete with self-insurance plans, captive programs and risk retention groups. Due to the specialty nature of these coverages, competition is based primarily on service to policyholders and agents, specific characteristics of products offered and reputation for claims handling. Financial strength ratings, price, commissions and profit sharing terms are also important factors. Management believes that sophisticated data analysis for refinement of risk profiles, extensive specialized knowledge and loss prevention service have helped AFG compete successfully.

Annuity Segment

General

AFG sells traditional fixed and fixed-indexed annuities in the retail, financial institutions and education markets through independent producers and through direct relationships with certain financial institutions. The annuity operations employed approximately 600 people at December 31, 2017. These operations are conducted primarily through the subsidiaries listed in the following table, which includes 2017 statutory annuity premiums (in millions), annuity policies in force and independent ratings.
 
 
 
 
Annuity
 
 
 
 
 
 
Annuity
 
Policies
 
Ratings
Company
 
Premiums
 
In Force
 
AM Best
 
S&P
Great American Life Insurance Company
 
$
4,130

 
402,000

 
A
 
A+
Annuity Investors Life Insurance Company
 
211

 
114,000

 
A
 
A+

AFG believes that the ratings assigned by independent insurance rating agencies are an important competitive factor because agents, potential policyholders and financial institutions often use a company’s rating as an initial screening device in considering annuity products. AFG believes that a rating in the “A” category by at least one rating agency is necessary to successfully compete in its primary annuity markets.

Statutory premiums of AFG’s annuity operations for the last three years were as follows (in millions):
 
 
Premiums
 
 
2017
 
2016
 
2015
Financial institutions single premium annuities — indexed
 
$
1,711

 
$
1,950

 
$
1,741

Financial institutions single premium annuities — fixed
 
622

 
468

 
229

Retail single premium annuities — indexed
 
1,723

 
1,714

 
1,864

Retail single premium annuities — fixed
 
83

 
82

 
70

Education market — fixed and indexed annuities
 
174

 
184

 
194

Total fixed annuity premiums
 
4,313

 
4,398

 
4,098

Variable annuities
 
28

 
37

 
42

Total annuity premiums
 
$
4,341

 
$
4,435

 
$
4,140


Annuities are long-term retirement saving instruments that benefit from income accruing on a tax-deferred basis. The issuer of the annuity collects premiums, credits interest or earnings on the policy and pays out a benefit upon death, surrender or annuitization. Single premium annuities are generally issued in exchange for a one-time lump-sum premium payment. Certain annuities, primarily in the education market, have premium payments that are flexible in both amount and timing as determined by the policyholder and are generally made through payroll deductions.


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Annuity contracts are generally classified as either fixed rate (including fixed-indexed) or variable. With a traditional fixed rate annuity, AFG seeks to maintain a desired spread between the yield on its investment portfolio and the rate it credits to policyholders. AFG accomplishes this by: (i) offering crediting rates that it has the option to change after any initial guarantee period (subject to minimum interest rate and other contractual guarantees); (ii) designing annuity products that encourage persistency; and (iii) maintaining an appropriate matching of assets and liabilities.

A fixed-indexed annuity provides policyholders with the opportunity to receive a crediting rate tied, in part, to the performance of an existing market index (generally the S&P 500) while protecting against the related downside risk through a guarantee of principal (excluding surrender charges, market value adjustments, and certain benefit charges). AFG purchases call options designed to substantially offset the effect of the index participation in the liabilities associated with fixed-indexed annuities.

As an accommodation in its education market, AFG offers a limited amount of variable annuities. With a variable annuity, the earnings credited to the policy vary based on the investment results of the underlying investment options chosen by the policyholder, generally without any guarantee of principal except in the case of death of the insured. Premiums directed to the underlying investment options maintained in separate accounts are invested in funds managed by various independent investment managers. AFG earns a fee on amounts deposited into separate accounts. Subject to contractual provisions, policyholders may also choose to direct all or a portion of their premiums to various fixed-rate options, in which case AFG earns a spread on amounts deposited.

The profitability of a fixed annuity business is largely dependent on the ability of a company to earn income on the assets supporting the business in excess of the amounts credited to policyholder accounts plus expenses incurred (earning a “spread”). Performance measures such as net spread earned are often presented by annuity businesses to help users of their financial statements better understand the company’s performance. The following table shows the earnings before income taxes, as well as the net spread earned on fixed annuities, for the annuity segment both before and after the impact of fair value accounting for derivatives related to fixed-indexed annuities (“FIAs”) (dollars in millions):
 
 
Year ended December 31,
 
 
2017
 
2016
 
2015
Annuity earnings before income taxes — before the impact of derivatives related to FIAs
 
$
413

 
$
395

 
$
354

Impact of derivatives related to FIAs (a)
 
(33
)
 
(27
)
 
(23
)
Annuity segment earnings before income taxes
 
$
380

 
$
368

 
$
331

 
 
 
 
 
 
 
Net spread earned on fixed annuities — before impact of derivatives related to FIAs
 
1.33
%
 
1.39
%
 
1.35
%
Impact of derivatives related to FIAs
 
(0.10
%)
 
(0.10
%)
 
(0.09
%)
Net spread earned on fixed annuities
 
1.23
%
 
1.29
%
 
1.26
%

(a)
FIAs provide policyholders with a crediting rate tied, in part, to the performance of an existing stock market or other financial index. AFG attempts to mitigate the risk in the index-based component of these products through the purchase of call options on the appropriate index. AFG’s strategy is designed so that the change in the fair value of the call option assets will generally offset the economic change in the liabilities from the index participation. Both the index-based component of the annuities (fair value of $2.54 billion at December 31, 2017) and the related call options (fair value of $701 million at December 31, 2017) are considered derivatives that must be marked-to-market through earnings each period. Fluctuations in interest rates and the stock market, among other factors, can cause volatility in the periodic measurement of fair value of the embedded derivative that management believes can be inconsistent with the long-term economics of these products.

Marketing

AFG sells its single premium annuities, excluding financial institution production (discussed below), primarily through a retail network of approximately 65 national marketing organizations (“NMOs”) and managing general agents (“MGAs”) who, in turn, direct nearly 1,100 actively producing agents.


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AFG also sells single premium annuities in financial institutions through direct relationships with certain financial institutions and through independent agents and brokers. The table below highlights the percentage of AFG’s total annuity premiums generated through its top five financial institution relationships (ranked based on 2017 statutory premiums):
 
2017
 
2016
The PNC Financial Services Group, Inc.
9.1
%
 
9.7
%
Wells Fargo & Company
8.1
%
 
14.2
%
Regions Financial Corporation
6.5
%
 
4.8
%
LPL Financial
5.5
%
 
4.8
%
BB&T Corporation
5.5
%
 
4.5
%

In the education market, schools may allow employees to save for retirement through contributions made on a before-tax basis. Federal income taxes are not payable on pretax contributions or earnings until amounts are withdrawn. AFG sells its education market annuities directly through writing agents rather than through NMOs and MGAs.

AFG is licensed to sell its fixed annuity products in all states except New York; it is licensed to sell its variable products in all states except New York and Vermont. At December 31, 2017, AFG had approximately 515,000 annuity policies in force. The states that accounted for 5% or more of AFG’s statutory annuity premiums in 2017 and the comparable preceding years are shown below:
 
 
2017
 
2016
 
2015
California
 
10.0
%
 
9.8
%
 
9.7
%
Florida
 
7.3
%
 
8.5
%
 
9.0
%
Pennsylvania
 
6.1
%
 
7.2
%
 
7.2
%
Ohio
 
5.4
%
 
5.2
%
 
5.7
%
Texas
 
5.1
%
 
4.6
%
 
4.3
%

Competition

AFG’s annuity businesses operate in highly competitive markets. They compete with other insurers and financial institutions based on many factors, including: (i) ratings; (ii) financial strength; (iii) reputation; (iv) service to policyholders and agents; (v) product design (including interest rates credited, bonus features and index participation); and (vi) commissions. Since most policies are marketed and distributed through independent agents, the insurance companies must also compete for agents.

No single insurer dominates the markets in which AFG’s annuity businesses compete. See Item 1A — Risk Factors. Competitors include (i) individual insurers and insurance groups, (ii) mutual funds and (iii) other financial institutions. In a broader sense, AFG’s annuity businesses compete for retirement savings with a variety of financial institutions offering a full range of financial services. In the financial institution annuity market, AFG’s annuities compete directly against competitors’ annuities, certificates of deposit and other investment alternatives at the point of sale. In addition, over the last few years, several offshore and/or hedge fund companies have made significant acquisitions of annuity businesses, resulting in annuity groups that are larger in size than AFG’s annuity business.

Sales of annuities, including renewal premiums, are affected by many factors, including: (i) competitive annuity products and rates; (ii) the general level and volatility of interest rates, including the slope of the yield curve; (iii) the favorable tax treatment of annuities; (iv) commissions paid to agents; (v) services offered; (vi) ratings from independent insurance rating agencies; (vii) other alternative investments; (viii) performance and volatility of the equity markets; (ix) media coverage of annuities; (x) regulatory developments regarding suitability and the sales process; and (xi) general economic conditions.

Run-off Long-term Care and Life Segment

AFG ceased new sales of long-term care insurance in January 2010 and sold substantially all of its run-off long-term care business in December 2015. See Note B — “Acquisitions and Sale of Businessesto the financial statements. Renewal premiums on the remaining policies covering approximately 1,600 lives will be accepted unless those policies lapse. At December 31, 2017, AFG’s long-term care insurance reserves were $39 million, net of reinsurance recoverables and excluding the impact of unrealized gains on securities.


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Although AFG no longer actively markets new life insurance products, it continues to service and receive renewal premiums on its in-force block of approximately 105,000 policies and $12.05 billion gross ($3.73 billion net of reinsurance) of life insurance in force at December 31, 2017. Renewal premiums, net of reinsurance, were $17 million in 2017, $18 million in 2016 and $28 million in 2015. At December 31, 2017, AFG’s life insurance reserves were $309 million, net of reinsurance recoverables.

Other Operations

Through subsidiaries, AFG is engaged in a variety of other operations, including commercial real estate operations in Cincinnati (office buildings), Whitefield, New Hampshire (Mountain View Grand Resort), Chesapeake Bay (Skipjack Cove Yachting Resort and Bay Bridge Marina), Charleston (Charleston Harbor Resort and Marina) and Palm Beach (Sailfish Marina and Resort). These operations employed approximately 300 full-time employees at December 31, 2017.

Investment Portfolio

General

A summary of AFG’s fixed maturities and equity securities is shown in Note E to the financial statements. For additional information on AFG’s investments, see Item 7 — Management’s Discussion and Analysis — Investments.” Portfolio yields are shown below:
 
 
2017
 
2016
 
2015
Yield on Fixed Maturities (a):
 
 
 
 
 
 
Excluding realized gains and losses
 
4.4
%
 
4.5
%
 
4.7
%
Including realized gains and losses
 
4.4
%
 
4.5
%
 
4.6
%
 
 
 
 
 
 
 
Yield on Equity Securities (includes perpetual preferred stocks) (a):
 
 
 
 
 
 
Excluding realized gains and losses
 
5.7
%
 
5.3
%
 
5.4
%
Including realized gains and losses
 
6.1
%
 
6.2
%
 
5.4
%
 
(a)
Based on amortized cost; excludes effects of changes in unrealized gains and losses. Realized losses include impairment charges.

The table below compares total returns, which include changes in fair value, on AFG’s fixed maturities and equity securities to comparable public indices. While there are no directly comparable indices to AFG’s portfolio, the two shown below are widely used benchmarks in the financial services industry.
 
 
2017
 
2016
 
2015
Total return on AFG’s fixed maturities
 
5.9
%
 
4.7
%
 
1.5
%
Barclays Capital U.S. Universal Bond Index
 
4.1
%
 
3.9
%
 
0.4
%
 
 
 
 
 
 
 
Total return on AFG’s equity securities (includes perpetual preferred stocks)
 
13.7
%
 
10.3
%
 
(3.4
%)
Standard & Poor’s 500 Index
 
21.8
%
 
12.0
%
 
1.4
%


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Fixed Maturity Investments

AFG’s bond portfolio is invested primarily in taxable bonds. The following table shows AFG’s available for sale fixed maturity investments by Standard & Poor’s Corporation or comparable rating as of December 31, 2017 (dollars in millions).
 
 
Amortized
 
Fair Value
 
 
Cost
 
Amount
 
%
S&P or comparable rating
 
 
 
 
 
 
AAA, AA, A
 
$
23,259

 
$
23,920

 
63
%
BBB
 
10,104

 
10,455

 
27
%
Total investment grade
 
33,363

 
34,375

 
90
%
BB
 
716

 
730

 
2
%
B
 
321

 
326

 
1
%
CCC, CC, C
 
797

 
935

 
2
%
D
 
458

 
521

 
1
%
Total non-investment grade
 
2,292

 
2,512

 
6
%
Not rated
 
1,383

 
1,492

 
4
%
Total
 
$
37,038

 
$
38,379

 
100
%

The National Association of Insurance Commissioners (“NAIC”) has retained third-party investment management firms to assist in the determination of appropriate NAIC designations for mortgage-backed securities (“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. Approximately 11% of AFG’s fixed maturity investments are MBS. At December 31, 2017, 98% (based on statutory carrying value of $37.01 billion) of AFG’s fixed maturity investments held by its insurance companies had a NAIC designation of 1 or 2 (the highest of the six designations).

Equity Investments

At December 31, 2017, AFG held common and perpetual preferred stocks classified as available for sale with a fair value of $1.60 billion.

Regulation

AFG’s insurance company subsidiaries are subject to regulation in the jurisdictions where they do business. In general, the insurance laws of the various states establish regulatory agencies with broad administrative powers governing, among other things, premium rates, solvency standards, licensing of insurers, agents and brokers, trade practices, forms of policies, maintenance of specified reserves and capital for the protection of policyholders, deposits of securities for the benefit of policyholders, investment activities and relationships between insurance subsidiaries and their parents and affiliates. Material transactions between insurance subsidiaries and their parents and affiliates generally must receive prior approval of the applicable insurance regulatory authorities and be disclosed. In addition, while differing from state to state, these regulations typically restrict the maximum amount of dividends that may be paid by an insurer to its shareholders in any twelve-month period without advance regulatory approval. Such limitations are generally based on net earnings or statutory surplus. Under applicable restrictions, the maximum amount of dividends available to AFG in 2018 from its insurance subsidiaries without seeking regulatory approval is approximately $826 million.

The Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010 (“Dodd-Frank Act”), among other things, established a Federal Insurance Office (“FIO”) within the U.S. Treasury. Under this law, regulations will need to be created for the FIO to carry out its mandate to focus on systemic risk oversight. Since its formation, the FIO has worked with the NAIC and other stakeholders to explore a hybrid approach to regulation of the insurance industry; however, the state-based system of regulation has largely been retained. AFG cannot predict the future role of the FIO and its role in regulation of the insurance industry and how that might ultimately affect AFG’s operations.

Neon, AFG’s UK-based Lloyd’s insurer, is subject to regulation by the European Union’s executive body, the European Commission. On January 1, 2016, Neon adopted new capital adequacy and risk management regulations known as Solvency II. Because Lloyd’s insurers were already operating under the proposed Solvency II guidelines, implementation was not material to AFG.

Most states have created insurance guaranty associations that assess solvent insurers to pay claims of insurance companies that become insolvent. Annual guaranty assessments for AFG’s insurance companies have not been material.

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Disclosure of Certain Activities Under Section 13(r) of the Securities Exchange Act of 1934

Section 13(r) of the Securities Exchange Act of 1934, as amended (“Section 13(r)”), requires a registrant to disclose in its annual or quarterly reports whether it or an affiliate knowingly engaged in certain activities, transactions or dealings related to Iran during the period covered by the report. Many of the activities, transactions and dealings that are required to be reported under Section 13(r) were previously subject to U.S. sanctions or prohibited by applicable local law. On January 16, 2016, the United States and the European Union eased sanctions against Iran pursuant to the Joint Comprehensive Plan of Action, and many of the reportable activities, transactions and dealings under Section 13(r) are no longer subject to U.S. sanctions and no longer prohibited by applicable local law.

Certain of the Company’s subsidiaries located outside the United States subscribe to insurance policies that provide insurance coverage to vessels owned by international shipping and marine entities with vessels that travel worldwide. As a result, the insurance policies may be called upon to respond to claims involving or that have exposure to Iranian petroleum resources, refined petroleum, and petrochemical industries. For example, certain of the Company’s non-U.S. subsidiaries participate in global marine hull and war policies that provide coverage for damage to vessels navigating into and out of ports worldwide, which could include Iran.

For the year ended December 31, 2017, the Company is not aware of any additional premium with respect to underwriting insurance or reinsurance activities reportable under Section 13(r). Should any such risks have entered into the stream of commerce covered by these insurance or reinsurance activities, the Company believes that the premiums associated with such business would be immaterial.

ITEM 1A
Risk Factors

In addition to the other information set forth in this report, particularly information under “Forward-Looking Statements” and “Management’s Discussion and Analysis of Financial Condition and Results of Operations,” the following factors could materially affect AFG’s business, financial condition, cash flows or future results. Any one of these factors could cause AFG’s actual results to vary materially from recent results or from anticipated future results. The risks described below are not the only risks facing AFG. Additional risks and uncertainties not currently known to management or that management currently deems to be immaterial also may materially adversely affect AFG’s business, financial condition and/or operating results.

Adverse developments in the financial markets and deterioration in global economic conditions could have a material adverse effect on AFG’s results of operations and financial condition.

Worldwide financial markets have, from time to time, experienced significant and unpredictable disruption. For example, during the financial crisis that started approximately ten years ago, the United States and many other economies experienced a prolonged economic downturn, resulting in heightened credit risk, reduced valuation of certain investments and decreased economic activity. Financial markets may again experience significant and prolonged disruption, including disruption from unanticipated events. In the years following the financial crisis, the federal government has taken steps to stabilize financial markets, but such steps may not be effective.

Changes in financial markets including fluctuations in interest rates, credit conditions, equity prices and many other factors that are unpredictable and beyond AFG’s control can adversely affect the value of investments and the realization of investment income.

A significant majority of AFG’s investment portfolio consists of fixed maturity investments, and changes in global economic conditions, including interest rates, could have a material adverse effect on AFG’s results of operations and financial condition.

As of December 31, 2017, approximately 84% of AFG’s investment portfolio holdings consisted of fixed maturity investments that are sensitive to changes in interest rates. A decline in interest rates may reduce the returns earned on new and floating-rate fixed maturity investments, thereby reducing AFG’s net investment income, while an increase in interest rates may reduce the value of AFG’s existing fixed maturity investments, which primarily have fixed interest rates. The value of AFG’s fixed maturity investments is also subject to risk that certain investments may default or become impaired due to deterioration in the financial condition of issuers of those investments. If a decline in the fair value of a specific investment (below its amortized cost) is considered to be other-than-temporary, a provision for impairment would be charged to earnings.

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Interest rates have remained at historical lows for an extended period. In addition, central banks in some countries have recently pursued largely unprecedented negative interest rate policies, the consequences of which are uncertain. The continuation of the current low interest rate environment or a deflationary environment with negative interest rates could affect business behavior in ways that are adverse to AFG and could constrict AFG’s net investment income.

As of December 31, 2017, mortgage-backed securities constituted approximately 11% of AFG’s fixed maturity portfolio. In addition to the risks applicable to the entire fixed maturity investment portfolio, changes in interest rates can expose AFG to prepayment risks on mortgage-backed securities. In periods of declining interest rates, mortgage prepayments generally increase and mortgage-backed securities are paid down more quickly, requiring AFG to reinvest the proceeds at the then current market rates, which may be lower than on the securities repaid.

Changes in interest rates could adversely affect the profitability of AFG’s annuity business.

The profitability of AFG’s annuity segment is largely dependent on the spread between what it earns on its investments and the crediting rate it pays on its annuity contracts plus expenses incurred.

Both rising and declining interest rates can negatively affect the Company’s annuity results. Most of AFG’s annuity products have guaranteed minimum crediting rates. Although AFG could reduce the average crediting rate on a substantial portion of its traditional fixed and fixed-indexed deferred annuities during periods of low or falling interest rates, AFG may not be able to fully offset the decline in investment earnings with lower crediting rates.

During periods of rising interest rates, the Company may experience competitive pressure to increase crediting rates to avoid a decline in sales or increased surrenders, thus resulting in lower spreads. In addition, an increase in surrenders could require the sale of investments at a time when the prices of those assets are lower due to the increase in market rates, which may result in realized investment losses.

Intense competition could adversely affect AFG’s results of operations.

The property and casualty insurance segment operates in a highly competitive industry that is affected by many factors that can cause significant fluctuations in its results of operations. The lines of business in this segment compete with other individual insurers, state funds and insurance groups of varying sizes, some of which are mutual insurance companies possessing competitive advantages in that all their profits inure to their policyholders. In addition, certain foreign insurers may be taxed at lower rates, which may result in a competitive advantage over AFG. The property and casualty insurance segment also competes with self-insurance plans, captive programs and risk retention groups. Competition is based on many factors, including service to policyholders and agents, product design, reputation for claims handling, price, commissions, ratings and financial strength. Peer companies and competitors in some or all of AFG’s specialty lines include the following companies and/or their subsidiaries: Alleghany Corp., American International Group Inc., American National Insurance Company, AmTrust Financial Services, Inc., Arch Capital Group Ltd., Baldwin & Lyons, Inc., Chubb Ltd., Cincinnati Financial Corp., CNA Financial Corp., Fairfax Financial Holdings Ltd. (Zenith National), The Hartford Financial Services Group, Inc., Lancer Insurance Company, Liberty Mutual, Markel Corp., Munich Re Group (American Modern Insurance), RLI Corp., The Travelers Companies, Inc., Tokio Marine Holdings, Inc. (HCC Insurance, Philadelphia Consolidated), W.R. Berkley Corp., XL Group Ltd. and Zurich Insurance Group Ltd.

AFG’s annuity segment competes with individual insurers and insurance groups, mutual funds and other financial institutions. In addition, in recent years, offshore and/or hedge fund companies have made significant acquisitions of annuity businesses. Competition is based on numerous factors including reputation, product design, interest crediting rates, performance, scope of distribution, price and perceived financial strength and credit ratings. Peer companies and competitors for AFG’s annuity segment include the following companies and/or their subsidiaries: Allianz Life Insurance Company of North America, American Equity Investment Life Holding Company (Eagle Life Insurance Company), American International Group Inc., Athene Holding Ltd, Global Atlantic Financial Group Ltd. (Forethought Life Insurance Company), Lincoln National Corp., MetLife, Inc., Nationwide Mutual Insurance Company, Pacific Life Insurance Company, Sumitomo Life Insurance Company (Symetra Financial Corp.) and Voya Financial, Inc.

Some of AFG’s competitors have more capital and greater resources than AFG, and may offer a broader range of products and lower prices than AFG offers. If competition limits AFG’s ability to write new or renewal business at adequate rates, its results of operations will be adversely affected.


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A significant percentage of AFG’s sales of annuity products through financial institutions is concentrated in a small number of institutions.

Annuity premiums generated through financial institutions represented 54% of AFG’s annuity premiums in 2017 and have been a key driver in the growth of AFG’s annuity business. In 2017, two large financial institutions accounted for 32% of AFG’s total sales through financial institutions and 17% of AFG’s overall annuity sales. In the financial institutions annuity market, AFG competes directly against competitors’ annuities, certificates of deposit and other investment alternatives at the point of sale. Loss of a substantial portion of this business coupled with a failure to replace these financial institutions if they significantly reduce sales of AFG annuities could reduce AFG’s future growth.

AFG’s revenues could be adversely affected if it is not able to attract and retain independent agents.

AFG’s reliance on the independent agency market makes it vulnerable to a reduction in the amount of business written by agents. Many of AFG’s competitors also rely significantly on the independent agency market. Accordingly, AFG must compete with other insurance carriers for independent agents’ business. Some of its competitors offer a wider variety of products, lower price for insurance coverage or higher commissions. A reduction in the number of independent agencies marketing AFG’s products, the failure of agencies to successfully market AFG’s products, changes in the strategy or operations of agencies (including agency consolidation) or the choice of agencies to reduce their writings of AFG products could adversely affect AFG’s revenues and profitability.

The inability to obtain reinsurance or to collect on ceded reinsurance could adversely affect AFG’s results of operations.

AFG purchases reinsurance to limit the amount of risk it retains. Market conditions determine the availability and cost of the reinsurance protection AFG purchases, which affects the level of AFG’s business and profitability, as well as the level and types of risk AFG retains. If AFG is unable to obtain sufficient reinsurance at a cost AFG deems acceptable, AFG may opt to reduce the volume of its underwriting. AFG is also subject to credit risk with respect to its reinsurers, as AFG will remain liable to its insureds regardless of whether a reinsurer is able to meet its obligations under agreements covering the reinsurance ceded. The collectability of recoverables from reinsurers is subject to uncertainty arising from a number of factors, including a reinsurers’ financial capacity and willingness to make payments under the terms of a reinsurance treaty or contract and changes in market conditions. As of December 31, 2017, recoverables from reinsurances reported on AFG’s Balance Sheet were approximately $3.37 billion.

AFG is subject to comprehensive regulation, and its ability to earn profits may be restricted by these regulations.

AFG is subject to comprehensive regulation by government agencies in the states and countries where its insurance company subsidiaries are domiciled and where these subsidiaries issue policies and handle claims. In addition, the Lloyd’s marketplace sets rules under which its members operate, including Neon (AFG’s Lloyd’s syndicate). Most insurance regulations are designed to protect the interests of AFG’s policyholders and third party claimants as opposed to its investors.

The Dodd-Frank Act, enacted in June 2010, mandates changes to the regulation of the financial services industry. Implementation of the Dodd-Frank Act is ongoing. The potential impacts of the Act on the U.S. insurance industry are not clear, but may affect AFG’s operations and governance in ways that could adversely affect AFG’s financial condition and results of operations.

Changes in domestic or foreign tax laws or interpretations of such laws could increase AFG’s corporate taxes and reduce earnings. On December 22, 2017, the U.S. enacted The Tax Cuts and Jobs Act of 2017 (“TCJA”), which significantly reforms the U.S. tax code. AFG’s deferred tax assets and liabilities have been revalued as of December 31, 2017 to reflect the newly enacted corporate tax rate. The U.S. Treasury and the Internal Revenue Service are expected to issue implementation guidance for the TCJA in 2018. Clarifications and interpretations of the TCJA may adversely affect our expected effective tax rate and the realization of deferred taxes.

As a participant in the federal crop insurance program, AFG could also be impacted by regulatory and legislative changes affecting that program. For example, the reinsurance levels that the federal government provides to authorized carriers could be reduced by future legislation. AFG will continue to monitor new and changing federal regulations and their potential impact, if any, on its insurance company subsidiaries.

On April 6, 2016, the U.S. Department of Labor (“DOL”) released a final regulation that substantially expands the range of activities that will be considered fiduciary advice under the Employee Retirement Income Security Act of 1974 and the Internal Revenue Code of 1986. The regulation’s scheduled effective date was April 10, 2017. This regulation deems advisers, including

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insurance agents, who sell annuities to IRAs, IRA rollovers or 401(k) plans to be fiduciaries and prohibits them from receiving compensation unless they comply with a prohibited transaction exemption requiring, among other things, advisers to comply with impartial conduct standards of acting in the customer’s best interest, making no misleading statements and receiving reasonable compensation. On February 3, 2017, President Trump issued a presidential memorandum directing the DOL to examine the regulation, and on April 4, 2017, the DOL announced “the delay rule” that deferred the effective date of the regulation until June 9, 2017, as it continued its examination as mandated by the President’s executive order. The rule further delayed certain requirements associated with prohibited transaction exemptions, other than the impartial conduct standards, under the final regulation until January 1, 2018. On November 29, 2017, the DOL extended this transition period another 18 months. As a result, insurance agents can continue selling fixed-indexed annuities through July 1, 2019, provided the agent complies with the impartial conduct standards. Regardless, during this transition period, the increased regulatory burdens and compensation changes required of agents to comply with the prohibited transaction exemptions may negatively impact AFG’s business, results of operations or financial condition. If the final regulation is fully implemented on July 1, 2019, compliance with the prohibited transaction exemptions will likely result in additional regulatory burdens, changes to AFG’s product offerings and increased litigation risk, which could negatively impact AFG’s business, results of operations or financial condition. Management cannot currently predict the effect on AFG’s business if the DOL’s examination mandated by the President results in the proposal of significant changes to the final regulation (or a further delay of the July 1, 2019 implementation date).

Existing insurance-related laws and regulations may become more restrictive in the future or new restrictive laws may be enacted; it is not possible to predict the potential effects of these laws and regulations. The costs of compliance or the failure to comply with existing or future regulations could impose significant burdens on the Company.

A downgrade or potential downgrade in AFG’s financial strength and/or credit ratings by one or more rating agencies could adversely affect its business, financial condition, results of operations and/or cash flows.

Financial strength ratings are an important factor in establishing the competitive position of insurance companies and may have an effect on an insurance company’s sales. A downgrade out of the “A” category in AFG’s insurers’ claims-paying and financial strength ratings could significantly reduce AFG’s business volumes in certain lines of business, adversely impact AFG’s ability to access the capital markets and increase AFG’s borrowing costs.

In addition to the financial strength ratings of AFG’s principal insurance company subsidiaries, various rating agencies also publish credit ratings for AFG. Credit ratings are indicators of a debt issuer’s ability to meet the terms of debt obligations in a timely manner, are part of AFG’s overall financial profile and affect AFG’s ability to access certain types of capital. A downgrade in AFG’s credit ratings could have a material adverse effect on AFG’s financial condition and results of operations and cash flows in a number of ways, including adversely limiting access to capital markets, potentially increasing the cost of debt or increasing borrowing costs under AFG’s current revolving credit facility.

The continued threat of terrorism and ongoing military and other actions, as well as civil unrest, may adversely affect AFG’s results of operations.

The occurrence of one or more terrorist attacks could cause significant losses from insurance claims that could adversely affect AFG’s profitability. Private sector catastrophe reinsurance is limited and generally unavailable for terrorism losses caused by attacks with nuclear, biological, chemical or radiological weapons. Reinsurance coverage from the federal government under the Terrorism Risk Insurance Program Reauthorization Act of 2015 (“TRIPRA”) is also limited. Although TRIPRA provides benefits for certified acts of terrorism that exceed a certain threshold of industry losses ($140 million in 2017, increasing by $20 million annually to $200 million by 2020), those benefits are subject to a deductible and other limitations. In 2018, AFG would have to sustain losses from terrorism of over $670 million to be eligible for reinsurance under the program. In addition, because the interpretation of this law is untested, there is substantial uncertainty as to how it will be applied to specific circumstances. Finally, the program currently expires at the end of 2020, and the elimination or modification of the program, or a failure to extend the program, could adversely affect AFG’s property and casualty insurance business through increased exposure to a catastrophic level of terrorism losses.

AFG may experience difficulties with technology or data security, which could have an adverse effect on its business or reputation.

AFG uses computer systems and services to store, retrieve, evaluate and utilize company and customer data and information. Systems failures or outages could compromise AFG’s ability to perform business functions in a timely manner, which could harm its ability to conduct business and hurt its relationships with business partners and customers. In the event of a disaster such as a natural catastrophe, an industrial accident, a blackout, a computer virus, a terrorist attack or war, AFG’s systems may

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be inaccessible to employees, customers or business partners for an extended period of time. Even if AFG’s employees are able to report to work, they may be unable to perform their duties for an extended period of time if the Company’s data or systems are disabled or destroyed.

AFG’s computer systems are vulnerable to security breaches due to the sophistication of cyber-attacks, viruses, malware, hackers and other external hazards, as well as inadvertent errors, equipment and system failures, and employee misconduct. In addition, over time, and particularly recently, the sophistication of these threats continues to increase. AFG’s administrative and technical controls as well as other preventative actions used to reduce the risk of cyber incidents and protect AFG’s information may be insufficient to detect or prevent unauthorized access, other physical and electronic break-ins, cyber-attacks or other security breaches to AFG’s computer systems or those of third parties with whom AFG does business.

AFG has increasingly outsourced certain technology and business process functions to third parties and may continue to do so in the future. Outsourcing of certain technology and business process functions to third parties may expose AFG to increased risk related to data security or service disruptions. If AFG does not effectively develop, implement and monitor these relationships, third party providers do not perform as anticipated, technological or other problems are incurred with a transition, or outsourcing relationships relevant to AFG’s business process functions are terminated, AFG may not realize expected productivity improvements or cost efficiencies and may experience operational difficulties, increased costs and a loss of business.

The increased risks identified above could expose AFG to data loss, disruption of service, monetary and reputational damages, competitive disadvantage and significant increases in compliance costs and costs to improve the security and resiliency of AFG’s computer systems. The compromise of personal, confidential or proprietary information could also subject AFG to legal liability or regulatory action under evolving cyber-security, data protection and privacy laws and regulations enacted by the U.S. federal and state governments, Canada, the European Union (the “EU”) or other jurisdictions or by various regulatory organizations or exchanges. As a result, AFG’s ability to conduct business and its results of operations might be materially and adversely affected.

Any failure to protect the confidentiality of customer information could adversely affect AFG’s reputation and have a material adverse effect on AFG’s business, financial condition and results of operations.

AFG receives and is required to protect certain confidential information from customers, vendors and other third parties that may include financial information and, in connection with AFG’s property and casualty insurance operations, medical information. In addition, AFG and certain of its third-party vendors receive and store personal information in connection with AFG’s human resources operations and other aspects of AFG’s business. AFG is subject to numerous federal, state and international laws regarding the privacy and security of personal information, which laws vary significantly from jurisdiction to jurisdiction. If any disruption or security breach results in a loss or damage to AFG’s data, or inappropriate disclosure of AFG’s confidential information or that of others, it could damage AFG’s reputation, affect its relationships with customers and clients, lead to claims against AFG, result in regulatory action and harm AFG’s business. In addition, AFG may be required to incur significant costs to mitigate the damage caused by any security breach or to protect against future damage.

AFG’s property and casualty reserves may be inadequate, which could have a material adverse effect on AFG’s results of operations.

Liabilities for unpaid losses and loss adjustment expenses do not represent an exact calculation of liability but instead represent management estimates of what the ultimate settlement and administration of claims will cost, supported by actuarial expertise and projection techniques, at a given accounting date. The process of estimating unpaid losses and loss adjustment expense reserves involves a high degree of judgment and is subject to a number of variables. These variables can be affected by both internal and external events, such as: changes in claims handling procedures, adverse changes in loss cost trends (including inflationary pressures on medical costs), economic conditions (including general inflation), legal trends and legislative changes, and varying judgments and viewpoints of the individuals involved in the estimation process, among others. The impact of many of these items on ultimate costs for unpaid losses and loss adjustment expenses is difficult to estimate. Unpaid losses and loss adjustment expense reserve estimation difficulties also differ significantly by product line due to differences in claim complexity, the volume of claims, the potential severity of individual claims, the determination of an occurrence date for a claim and lags in the time between damage, loss or injury and when a claim is actually reported to the insurer. In addition, the historic development of AFG’s liability for unpaid losses and loss adjustment expenses may not necessarily reflect future trends in the development of these amounts. Accordingly, it is not appropriate to extrapolate future redundancies or deficiencies based on historical information. To the extent that reserves are inadequate and are strengthened, AFG’s profitability would be adversely affected because the amount of any such increase would be treated as a charge to earnings in the period in which the deficiency is recognized.

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AFG’s results of operations could be adversely impacted by severe weather conditions or other catastrophes, both natural and man-made.

Catastrophes can be caused by unpredictable natural events such as hurricanes, windstorms, severe storms, tornadoes, floods, hailstorms, severe winter weather, earthquakes, explosions and fire, and by man-made events, such as terrorist attacks. While not considered a catastrophe by insurance industry standards, droughts can have a significant adverse impact on AFG’s crop insurance results. In addition, extreme weather events that are linked to rising temperatures, changing global weather patterns and fluctuating rain, snow and sea levels could result in increased occurrence and severity of catastrophes. The extent of gross losses from a catastrophe event is a function of both the total amount of insured exposure in the area affected by the event and the severity of the event, potentially mitigated by any reinsurance coverage purchased by AFG’s insurance subsidiaries. In addition, certain catastrophes could result in both property and non-property claims from the same event. A severe catastrophe or a series of catastrophes could result in losses exceeding AFG’s reinsurance protection and may have a material adverse impact on its results of operations or financial condition.

Volatility in crop prices, as a result of weather conditions or otherwise, could adversely impact AFG’s results of operations.

Weather conditions, including too much moisture (flooding or excessive rain) or not enough moisture (droughts), and the level of crop prices in the commodities market heavily impact AFG’s crop insurance business. These factors are inherently unpredictable and could result in significant volatility in the results of the crop insurance business from one year to the next. AFG’s crop results could also be negatively impacted by pests and plant disease. A large decline in the commodity prices of one or more of the major crops that AFG insures could have a material adverse effect on AFG’s results of operations or financial condition.

AFG’s international operations exposes it to investment, political and economic risks, including foreign currency and credit risk.

AFG’s international operations expose AFG to a number of additional risks. These risks include restrictions such as price controls, capital controls, currency exchange limits, ownership limits and other restrictive or anti-competitive governmental actions or requirements, which could have an adverse effect on AFG’s business and reputation. AFG’s business activities outside the United States may also be subject to political and economic risks, including foreign currency and credit risk.

AFG’s business activities outside the United States subject AFG to additional domestic and foreign laws and regulations, including the Foreign Corrupt Practices Act, the UK Bribery Act and similar laws in other countries that prohibit the making of improper payments to foreign officials. Although AFG has policies and controls in place that are designed to ensure compliance with these laws, if those controls are ineffective and an employee or intermediary fails to comply with applicable laws and regulations, AFG could suffer civil and criminal penalties and AFG’s business and reputation could be adversely affected. Some countries have laws and regulations that lack clarity and, even with local expertise and effective controls, it can be difficult to determine the exact requirements of, and potential liability under, the local laws. Failure to comply with local laws in a particular market may result in substantial liability and could have a significant and negative effect not only on AFG’s business in that market but also on AFG’s reputation generally.

Exposure to asbestos or environmental claims could materially adversely affect AFG’s results of operations and financial condition.

AFG has asbestos and environmental (“A&E”) exposures arising from its insurance operations and former railroad and manufacturing operations. Uncertainties surrounding the final resolution of these asbestos and environmental liabilities continue, and it is difficult to estimate AFG’s ultimate exposure to such liabilities and related litigation. Establishing A&E liabilities is subject to uncertainties that are significantly greater than those presented by other types of liabilities. Uncertainties include the long delays between exposure and manifestation of any bodily injury or property damage, difficulty in identifying the source of the asbestos or environmental contamination, long reporting delays, the risks inherent in complex litigation and difficulty in properly allocating liability for the asbestos or environmental damage. As a result, A&E liabilities are subject to revision as new information becomes available and as claims are made and develop. Claimants continue to assert new and novel theories of recovery, and from time to time, there is proposed state and federal legislation regarding A&E liability, which would also affect AFG’s exposure. If AFG has not established adequate reserves to cover future claims, AFG’s results of operations and financial condition could be materially adversely affected.


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Variations from the actuarial assumptions used to establish certain assets and liabilities in AFG’s annuity business could adversely affect AFG’s results of operations.

The earnings on AFG’s annuity products depend significantly upon the extent to which actual experience is consistent with the assumptions used in setting reserves and establishing and amortizing deferred policy acquisition costs (“DPAC”). These assumptions relate to investment yields (and spreads over fixed annuity crediting rates), benefit utilization rates, equity market performance, the cost of call options used in the fixed-indexed annuity business, mortality, surrenders, annuitizations and other withdrawals. Developing such assumptions is complex and involves information obtained from company-specific and industry-wide data, as well as general economic information. These assumptions, and therefore AFG’s results of operations, could be negatively impacted by changes in any of the factors listed above.

Changes to existing accounting standards could adversely impact AFG’s reported results of operations.

As a U.S.-based SEC registrant, AFG prepares its financial statements in accordance with GAAP, as promulgated by the Financial Accounting Standards Board, subject to the accounting-related rules and interpretations of the SEC. Changes in accounting standards, particularly those that specifically apply to insurance company operations, may impact AFG’s reported financial results and could cause increased volatility in reported earnings, resulting in other adverse impacts on AFG’s ratings and cost of capital, and decrease the understandability of AFG’s financial results as well as the comparability of AFG’s reported results with other insurers.

As a holding company, AFG is dependent on the operations of its insurance company subsidiaries to meet its obligations and pay future dividends.

AFG is a holding company and a legal entity separate and distinct from its insurance company subsidiaries. As a holding company without significant operations of its own, AFG’s principal sources of funds are dividends and other distributions from its insurance company subsidiaries. State insurance laws differ from state to state but, absent advance regulatory approval, restrict the maximum amount of dividends that may be paid by an insurer to its shareholders in any twelve-month period. AFG’s rights to participate in any distribution of assets of its insurance company subsidiaries are subject to prior claims of policyholders and creditors (except to the extent that its rights, if any, as a creditor are recognized). Consequently, AFG’s ability to pay its debts, expenses and dividends to its shareholders may be limited.

Adverse developments in the financial markets may limit AFG’s access to capital.

Financial markets in the U.S. and elsewhere can experience extreme volatility, which exerts downward pressure on stock prices and limits access to the equity and debt markets for certain issuers, including AFG. AFG can borrow up to $500 million under its revolving credit facility, which expires in June 2021. In addition, AFG’s access to funds through this facility is dependent on the ability of its banks to meet their funding commitments. There were no borrowings outstanding under AFG’s bank credit line or any other parent company short-term borrowing arrangements during 2017. If AFG cannot obtain adequate capital or sources of credit on favorable terms, or at all, its business, operating results and financial condition would be adversely affected.

AFG may suffer losses from litigation, which could materially and adversely affect AFG’s financial condition and business operations.

AFG, primarily in its property and casualty insurance operations and historical operations, is involved in litigation. Litigation by nature is unpredictable, and the outcome of any case is uncertain and could result in liabilities that vary from the amounts AFG has currently recorded. Pervasive or significant changes in the judicial environment relating to matters such as trends in the size of jury awards, developments in the law relating to the liability of insurers or tort defendants, and rulings concerning the availability or amount of certain types of damages could cause AFG’s ultimate liabilities to change from current expectations. Changes in federal or state tort litigation laws or other applicable law could have a similar effect. It is not possible to predict changes in the judicial and legislative environment, including in connection with asbestos and environmental claims. AFG’s business, financial condition, results of operations and liquidity could also be adversely affected if judicial or legislative developments cause AFG’s ultimate liabilities to increase from current expectations.


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Recent developments relating to the United Kingdom’s referendum vote in favor of leaving the EU could adversely affect AFG’s London-based property and casualty insurance operations.

The United Kingdom (“UK”) held a referendum on June 23, 2016 in which a majority of voters voted for the UK’s withdrawal from the European Union (“Brexit”). Because of this vote, the terms of the UK’s withdrawal from the EU and the relationship between the UK and EU going forward will have to be negotiated, including the terms of trade between the UK and the EU. The ultimate impact of Brexit is uncertain and will depend on any agreements that the UK makes to retain access to EU markets. Brexit could also lead to legal uncertainty and potentially divergent national laws and regulations as the UK determines which EU laws to replace or replicate. These or other adverse consequences from Brexit could adversely affect the operations and business opportunities of AFG’s Ireland-based property and casualty subsidiary and Neon, AFG’s London-based Lloyd’s syndicate.

Certain shareholders exercise substantial control over AFG’s affairs, which may impede a change of control transaction.

Carl H. Lindner III and S. Craig Lindner are each Co-Chief Executive Officers and Directors of AFG. Together, Carl H. Lindner III and S. Craig Lindner beneficially own 12.1% of AFG’s outstanding Common Stock as of February 1, 2018. Other members of the Lindner family own, directly or through trusts, a significant number of additional shares of AFG Common Stock. As a result, the Lindner family has the ability to exercise significant influence over AFG’s management, including over matters requiring shareholder approval. Such concentrated ownership could prevent an acquisition of AFG at a price which other shareholders may find attractive.

The price of AFG Common Stock may fluctuate significantly, which may make it difficult for holders to resell common stock when they want or at a price they find attractive.

The price of AFG’s Common Stock, which is listed on the NYSE, constantly changes. During 2017, AFG’s Common Stock traded at prices ranging between $85.57 and $109.41. AFG’s Common Stock price can fluctuate as a result of a variety of factors, many of which are beyond its control. These factors include but are not limited to:
actual or anticipated variations in quarterly operating results;
actual or anticipated changes in the dividends paid on AFG Common Stock;
rating agency actions;
recommendations by securities analysts;
significant acquisitions or business combinations, strategic partnerships, joint ventures or capital commitments by or involving AFG or its competitors;
operating and stock price performance of other companies that investors deem comparable to AFG;
news reports relating to trends, concerns and other issues in AFG’s lines of business;
general economic conditions, including volatility in the financial markets; and
geopolitical conditions such as acts or threats of terrorism or military conflicts.

ITEM 2

Properties

AFG and its insurance subsidiaries lease the majority of their office and storage facilities in numerous cities throughout the United States and internationally, including the Company’s headquarters in Cincinnati, Ohio. Subsidiaries of AFG own several other buildings in downtown Cincinnati. AFG and its affiliates occupy approximately half of the aggregate 670,000 square feet of commercial and office space in these buildings. A property and casualty insurance subsidiary occupies approximately 87% of the 164,000 square feet of rentable office space on 17.5 acres of land that it owns in Richfield, Ohio. See Item 1 — Business — “Other Operations for a discussion of AFG’s other commercial real estate operations.

ITEM 3

Legal Proceedings

AFG and its subsidiaries are involved in litigation from time to time, generally arising in the ordinary course of business. This litigation may include, but is not limited to, general commercial disputes, lawsuits brought by policyholders, employment matters, reinsurance collection matters and actions challenging certain business practices of insurance subsidiaries. Except for the following, management believes that none of the litigation meets the threshold for disclosure under this Item.


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AFG’s insurance company subsidiaries and its 100%-owned subsidiary, American Premier Underwriters (including its subsidiaries, “American Premier”), are parties to litigation and receive claims alleging injuries and damages from asbestos, environmental and other substances and workplace hazards and have established loss accruals for such potential liabilities. None of such litigation or claims is individually material to AFG; however, the ultimate loss for these claims may vary materially from amounts currently recorded as the conditions surrounding resolution of these claims continue to change.

American Premier is a party or named as a potentially responsible party in a number of proceedings and claims by regulatory agencies and private parties under various environmental protection laws, including the Comprehensive Environmental Response, Compensation and Liability Act, seeking to impose responsibility on American Premier for hazardous waste or discharge remediation costs at certain railroad sites formerly owned by its predecessor, Penn Central Transportation Company (“PCTC”), and at certain other sites where hazardous waste or discharge allegedly generated by PCTC’s railroad operations and American Premier’s former manufacturing operations is present. It is difficult to estimate American Premier’s liability for remediation costs at these sites for a number of reasons, including the number and financial resources of other potentially responsible parties involved at a given site, the varying availability of evidence by which to allocate responsibility among such parties, the wide range of costs for possible remediation alternatives, changing technology and the period of time over which these matters develop. Nevertheless, American Premier believes that its accruals for potential environmental liabilities are adequate to cover the probable amount of such liabilities, based on American Premier’s estimates of remediation costs and related expenses and its estimates of the portions of such costs that will be borne by other parties. Such estimates are based on information currently available to American Premier and are subject to future change as additional information becomes available.


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PART II
ITEM 5
Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities
AFG Common Stock is listed and traded on the New York Stock Exchange under the symbol AFG. The information presented in the table below represents the high and low sales prices per share reported on the NYSE Composite Tape.
 
 
2017
 
2016
 
 
High
 
Low
 
High
 
Low
First Quarter
 
$
97.00

 
$
85.57

 
$
71.66

 
$
64.87

Second Quarter
 
103.19

 
93.25

 
73.95

 
66.78

Third Quarter
 
105.58

 
95.19

 
76.03

 
70.82

Fourth Quarter
 
109.41

 
101.02

 
88.54

 
73.38


There were approximately 5,200 shareholders of record of AFG Common Stock at February 1, 2018. AFG declared and paid regular quarterly dividends of $0.3125 per share in January, April and July 2017. In August 2017, AFG increased its quarterly dividend to $0.35 per share and declared and paid its first dividend at that rate in October 2017. In 2016, AFG declared and paid regular quarterly dividends of $0.28 per share in January, April and July and $0.3125 per share in October. In May and November 2017 and November 2016, AFG declared additional special cash dividends of $1.50, $2.00 and $1.00 per share of AFG Common Stock, which were paid in May and November 2017 and December 2016, respectively. The ability of AFG to pay dividends will be dependent upon, among other things, the availability of dividends and payments under intercompany tax allocation agreements from its insurance company subsidiaries.

Issuer Purchases of Equity Securities   AFG did not repurchase any shares of its Common Stock during the year ended December 31, 2017. There are 4,132,838 remaining shares that may be repurchased under the Plans authorized by AFG’s Board of Directors in December 2014 and February 2016.

AFG acquired 34,922 shares of its Common Stock (at an average of $94.07 per share) in the first nine months of 2017, 41 shares (at $103.80 per share) in October 2017 and 2,755 shares (at an average of $108.20 per share) in December 2017 in connection with its stock incentive plans.


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ITEM 6

Selected Financial Data

The following table sets forth certain data for the periods indicated (dollars in millions, except per share data).
 
 
2017
 
2016
 
2015
 
2014
 
2013
Earnings Statement Data:
 
 
 
 
 
 
 
 
 
 
Total revenues
 
$
6,865

 
$
6,498

 
$
6,145

 
$
5,733

 
$
5,103

Earnings before income taxes
 
724

 
787

 
565

 
626

 
689

Net earnings, including noncontrolling interests
 
477

 
668

 
370

 
406

 
453

Less: Net earnings (loss) attributable to noncontrolling interests
 
2

 
19

 
18

 
(46
)
 
(18
)
Net earnings attributable to shareholders
 
475

 
649

 
352

 
452

 
471

 
 
 
 
 
 
 
 
 
 
 
Earnings attributable to shareholders per Common Share:
 
 
 
 
 
 
 
 
 
 
Basic — GAAP
 
$
5.40

 
$
7.47

 
$
4.02

 
$
5.07

 
$
5.27

Diluted — GAAP
 
5.28

 
7.33

 
3.94

 
4.97

 
5.16

Core net operating earnings per share (diluted) (a)
 
6.55

 
6.03

 
5.44

 
4.82

 
4.22

 
 
 
 
 
 
 
 
 
 
 
Cash dividends paid per share of Common Stock (b)
 
$
4.7875

 
$
2.1525

 
$
2.03

 
$
1.91

 
$
1.805

Ratio of earnings to fixed charges including annuity benefits (c)
 
1.72

 
1.85

 
1.66

 
1.90

 
2.15

 
 
 
 
 
 
 
 
 
 
 
Balance Sheet Data:
 
 
 
 
 
 
 
 
 
 
Cash and investments
 
$
46,048

 
$
41,433

 
$
37,736

 
$
36,210

 
$
31,313

Total assets
 
60,658

 
55,072

 
49,837

 
47,513

 
42,070

Property and casualty insurance reserves:
 
 
 
 
 
 
 
 
 
 
Unpaid losses and loss adjustment expenses
 
9,678

 
8,563

 
8,127

 
7,872

 
6,410

Unearned premiums
 
2,410

 
2,171

 
2,060

 
1,956

 
1,757

Annuity benefits accumulated
 
33,316

 
29,907

 
26,622

 
23,764

 
20,944

Life, accident and health reserves
 
658

 
691

 
705

 
2,175

 
2,008

Long-term debt
 
1,301

 
1,283

 
998

 
1,039

 
896

Shareholders’ equity
 
5,330

 
4,916

 
4,592

 
4,879

 
4,599

Less:
 
 
 
 
 
 
 
 
 
 
Net unrealized gains related to fixed maturities (d)
 
606

 
299

 
279

 
604

 
441

Appropriated retained earnings
 

 

 

 
(2
)
 
49

Adjusted shareholders’ equity (e)
 
4,724

 
4,617

 
4,313

 
4,277

 
4,109

 
 
 
 
 
 
 
 
 
 
 
Book value per share
 
$
60.38

 
$
56.55

 
$
52.50

 
$
55.62

 
$
51.38

Adjusted book value per share (e)
 
53.51

 
53.11

 
49.32

 
48.76

 
45.90

 
(a)
AFG’s net earnings per share (diluted), determined in accordance with GAAP, includes certain items that may not be indicative of its ongoing core operations. AFG believes that its core net operating earnings per share provides management, financial analysts, rating agencies and investors with an understanding of the results from the ongoing operations of the Company by excluding the impact of net realized investment gains and losses and other items that are not necessarily indicative of operating trends. AFG’s management uses core net operating earnings to evaluate financial performance against historical results because it believes this provides a more comparable measure of its continuing business. Core net operating earnings is also used by AFG’s management as a basis for strategic planning and forecasting. Core net operating earnings per share (diluted) is a non-GAAP financial measure. See Item 7 — Management’s Discussion and Analysis — “Results of Operations — General” for additional details, including a reconciliation of core net operating earnings per share (diluted) to net earnings available to shareholders (diluted) computed in accordance with GAAP.
(b)
Includes special cash dividends of $3.50 paid in 2017 and $1.00 per share paid in 2016, 2015, 2014 and 2013.
(c)
Fixed charges are computed on a “total enterprise” basis. For purposes of calculating the ratios, “earnings” have been computed by adding to pretax earnings the fixed charges and the noncontrolling interests in earnings of subsidiaries having fixed charges and the undistributed equity in earnings or losses of investees. Fixed charges include interest (including annuity benefits as indicated), amortization of debt premium/discount and expense, preferred dividend and distribution requirements of subsidiaries and a portion of rental expense deemed to be representative of the interest factor. The ratio of earnings to fixed charges excluding annuity benefits was 7.67, 8.62, 6.58, 7.95 and 8.86 for 2017, 2016, 2015, 2014 and 2013, respectively. Although the ratio of earnings to fixed charges excluding annuity benefits is not required or encouraged to be disclosed under Securities 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.

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(d)
Net unrealized gains related to fixed maturities, which includes net unrealized gains (losses) on cash flow hedges, is part of accumulated other comprehensive income and is shown net of related adjustments to deferred policy acquisition costs and certain liabilities in the annuity, long-term care and life businesses.
(e)
Adjusted shareholders’ equity and adjusted book value per share exclude appropriated retained earnings and net unrealized gains related to fixed maturity securities. Management believes that investors find a measurement of shareholders’ equity excluding these items to be meaningful as (i) the unrealized gains related to fixed maturities fluctuates with changes in interest rates in a way that is primarily only meaningful to AFG if it sells those investments and (ii) appropriated retained earnings represents amounts that will ultimately inure to the debt holders of the collateralized loan obligations managed by AFG (see Note A — “Accounting PoliciesManaged Investment Entities to the financial statements).

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ITEM 7
Management’s Discussion and Analysis of Financial Condition and Results of Operations
INDEX TO MD&A
 
Page
 
 
Page
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 

GENERAL

Following is a discussion and analysis of the financial statements and other statistical data that management believes will enhance the understanding of AFG’s financial condition and results of operations. This discussion should be read in conjunction with the financial statements beginning on page F-1.

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.

At December 31, 2017, AFG (parent) held approximately $369 million in cash and securities and had $500 million available under a bank line of credit, which expires in June 2021.

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 fixed and fixed-indexed annuities in the retail, financial institutions and education markets.

Fourth quarter 2017 net earnings attributable to AFG’s shareholders were $166 million ($1.84 per share, diluted) compared to $385 million ($4.33 per share, diluted) in the fourth quarter of 2016, reflecting:
higher underwriting profit in the property and casualty insurance segment,
lower earnings in the annuity segment, resulting from the fair value accounting for fixed-indexed annuities,
lower net realized gains on securities in the fourth quarter of 2017 compared to the fourth quarter of 2016,
the fourth quarter 2017 loss on retirement of debt,
the fourth quarter 2017 tax benefit related to the Neon Underwriting Ltd. (“Neon”) restructuring,
the fourth quarter 2017 tax expense related to the change in the U.S. corporate tax rate and
the fourth quarter 2016 tax benefits from the National Interstate merger and Neon restructuring.

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Full year 2017 net earnings attributable to AFG’s shareholders were $475 million ($5.28 per share, diluted) compared to $649 million ($7.33 per share, diluted) in 2016, reflecting:
higher underwriting profit in the property and casualty insurance segment due primarily to higher favorable prior year reserve development,
higher earnings in the annuity segment,
higher profitability in the run-off long-term care and life segment,
lower realized gains on securities in 2017 compared to 2016,
the 2017 loss on retirement of debt,
the fourth quarter 2017 tax benefit related to the Neon restructuring,
the fourth quarter 2017 tax expense related to the change in the U.S. corporate tax rate,
the second quarter 2016 gain on the sale of an apartment property, and
the fourth quarter 2016 tax benefits related to the National Interstate merger and Neon restructuring.

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 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 recoverability of deferred acquisition costs,
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.

See “Liquidity and Capital Resources — Uncertainties for a discussion of insurance reserves, recoverables from reinsurers, and contingencies related to American Premier’s former operations and “Liquidity and Capital Resources — Investments for a discussion of impairments on investments. Deferred policy acquisition costs (“DPAC”) and certain liabilities related to annuities are amortized in relation to the present value of expected gross profits on the policies. Assumptions considered in determining expected gross profits involve significant judgment and include management’s estimates of interest rates and investment spreads, surrenders, annuitizations, renewal premiums and mortality. Should actual experience require management to change its assumptions (commonly referred to as “unlocking”), a charge or credit would be recorded to adjust DPAC or annuity liabilities to the levels they would have been if the new assumptions had been used from the inception date of each policy.

LIQUIDITY AND CAPITAL RESOURCES

Ratios   AFG’s debt to total capital ratio on a consolidated basis is shown below (dollars in millions). Management intends to maintain the ratio of debt to capital at or below 25% and intends to maintain the capital of its significant insurance subsidiaries at or above levels currently indicated by rating agencies as appropriate for the current ratings.
  
 
December 31,
2017
 
2016
Principal amount of long-term debt
 
$
1,318

 
$
1,308

Total capital
 
6,033

 
5,921

Ratio of debt to total capital:
 
 
 
 
Including subordinated debt
 
21.8
%
 
22.1
%
Excluding subordinated debt
 
16.9
%
 
17.0
%
 
The ratio of debt to total capital is a non-GAAP measure that management believes is useful for investors, analysts and independent 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) on fixed maturity investments).


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AFG’s ratio of earnings to fixed charges, including annuity benefits as a fixed charge, was 1.72 for the year ended December 31, 2017. Excluding annuity benefits, this ratio was 7.67. Although the ratio excluding annuity benefits is not required or encouraged to be disclosed under Securities and Exchange Commission rules, it is presented because interest credited to annuity policyholder accounts is not always considered a borrowing cost for an insurance company.

The NAIC’s model law for risk based capital (“RBC”) applies to both life and property and casualty companies. RBC formulas determine the amount of capital that an insurance company needs so that it has an acceptable expectation of not becoming financially impaired. At December 31, 2017, the capital ratios of all AFG insurance companies substantially exceeded the RBC requirements.

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):
 
Year ended December 31,
 
2017
 
2016
 
2015
Net cash provided by operating activities
$
1,804

 
$
1,150

 
$
1,353

Net cash used in investing activities
(3,292
)
 
(2,981
)
 
(4,573
)
Net cash provided by financing activities
1,719

 
2,718

 
3,097

Net change in cash and cash equivalents
$
231

 
$
887

 
$
(123
)

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 $60 million in 2017 and reduced cash flows from operating activities by $279 million in 2016 and $190 million in 2015, accounting for a $339 million increase in cash flows from operating activities in 2017 compared to 2016 and an $89 million decrease in cash flows from operating activities in 2016 compared to 2015. As discussed in Note A — “Accounting PoliciesManaged 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 $1.74 billion, $1.43 billion and $1.54 billion in 2017, 2016 and 2015, respectively.

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 products. Net cash used in investing activities was $3.29 billion in 2017 compared to $2.98 billion in 2016, an increase of $311 million. As discussed below (under net cash provided by financing activities), AFG’s annuity group had net cash flows from annuity policyholders of $1.99 billion in 2017 and $2.35 billion in 2016, which is the primary source of AFG’s cash used in investing activities. Settlements of equity index call options exceeded purchases by $285 million in 2017 compared to purchases exceeding settlements by $110 million in 2016, accounting for a $395 million decrease in cash used in investing activities. In general, purchases of equity index call options have increased due to growth in the fixed-indexed annuity business while proceeds from settlements of equity options are impacted by the performance of the stock market during the term of the options. 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 $205 million use of cash in 2017 compared to a $364 million use of cash in 2016, accounting for a $159 million decrease in net cash used in investing activities in 2017 compared to 2016. See Note A — “Accounting PoliciesManaged Investment Entities and Note H — “Managed Investment Entities to the financial statements.


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Net cash used in investing activities was $2.98 billion in 2016 compared to $4.57 billion in 2015, a decrease of $1.59 billion. The $151 million decrease in net cash flows from annuity policyholders in 2016 as compared to 2015 decreased the amount of cash available for investment in 2016 compared to 2015. In addition, AFG’s cash on hand increased by $887 million during 2016, primarily in the property and casualty and annuity segments reflecting the timing of investing available cash in those segments. Net investment activity in the managed investment entities was a $364 million use of cash in 2016 compared to a $675 million use of cash in 2015, accounting for a $311 million decrease in net cash used in investing activities in 2016 compared to 2015.

Net Cash Provided by Financing Activities   AFG’s financing activities consist primarily of transactions with annuity policyholders, issuances and retirements of long-term debt, repurchases of common stock and dividend payments. Net cash provided by financing activities was $1.72 billion in 2017 compared to $2.72 billion in 2016, a decrease of $999 million. Annuity receipts exceeded annuity surrenders, benefits, withdrawals and transfers by $1.99 billion in 2017 compared to $2.35 billion in 2016, resulting in a $362 million decrease in net cash provided by financing activities in 2017 compared to 2016. In 2017, AFG issued $590 million of 4.50% Senior Notes due in 2047 and $125 million of 3.50% Senior Notes due in 2026, the net proceeds of which contributed $712 million to net cash provided by financing activities in 2017 compared to net proceeds from additional long-term borrowings of $302 million in 2016, which accounted for a $410 million increase in cash provided by financing activities in 2017 compared to 2016. Redemptions of long-term debt were a $745 million use of cash in 2017 and an $18 million use of cash in 2016, which accounted for a $727 million decrease in net cash provided by financing activities in 2017 compared to 2016. There were no shares of AFG Common Stock repurchased in 2017 compared to $133 million repurchased in 2016. In addition to its regular quarterly cash dividends, AFG paid special cash dividends of $3.50 per share and $1.00 per share of American Financial Group Common Stock in 2017 and 2016, respectively, which resulted in total cash dividends of $417 million in 2017 compared to $185 million in 2016. Additionally, in 2016, $315 million was used to fund the acquisition of the noncontrolling interest in National Interstate Corporation. 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. Issuances of managed investment entity liabilities exceeded retirements by $146 million in 2017 compared to $693 million in 2016, accounting for a $547 million decrease in net cash provided by financing activities in 2017 compared to 2016. See Note A — “Accounting PoliciesManaged Investment Entitiesand Note H — “Managed Investment Entities to the financial statements.

Net cash provided by financing activities was $2.72 billion in 2016 compared to $3.10 billion in 2015, a decrease of $379 million. Annuity receipts exceeded annuity surrenders, benefits, withdrawals and transfers by $2.35 billion in 2016 compared to $2.50 billion in 2015, resulting in a $151 million decrease in net cash provided by financing activities in 2016 compared to 2015. AFG issued $300 million of 3.50% Senior Notes in 2016 and $150 million of 6% Subordinated Debentures in 2015, the net proceeds of which contributed $296 million in 2016 and $145 million in 2015 to net cash provided by financing activities. Redemptions of long-term debt was an $18 million use of cash in 2016 and a $192 million use of cash in 2015. During 2016, AFG repurchased $133 million of its Common Stock compared to $126 million repurchased in 2015, which accounted for a $7 million decrease in net cash provided by financing activities in 2016 compared to 2015. Additionally, during the fourth quarter of 2016, $315 million was used to fund the acquisition of the noncontrolling interest in National Interstate Corporation. Issuances of managed investment entity liabilities exceeded retirements by $693 million in 2016 compared to $890 million in 2015, accounting for a $197 million decrease in net cash provided by financing activities in 2016 compared to 2015.

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 in June 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 2017.

In June 2017, AFG issued $350 million of 4.50% Senior Notes due in June 2047. Net proceeds from the offering were used to redeem AFG’s $230 million outstanding principal amount of 6-3/8% Senior Notes due in June 2042, at par value in June 2017 and AFG’s $125 million outstanding principal amount of 5-3/4% Senior Notes due in August 2042 at par value in August 2017.


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In November 2017, AFG issued an additional $240 million of 4.50% Senior Notes due in 2047 and $125 million of 3.50% Senior Notes due in 2026. The net proceeds of the offering were used to redeem AFG’s $350 million outstanding principal amount of 9-7/8% Senior Notes due in June 2019 for $388 million (including a make-whole premium of $38 million) in December 2017.

In 2017, AFG paid special cash dividends of $3.50 per share of AFG Common Stock ($1.50 per share in May and $2.00 per share in November) totaling approximately $308 million.

In November 2016, AFG acquired the 49% of National Interstate Corporation (“NATL”) not previously owned by AFG’s wholly-owned subsidiary, Great American Insurance Company (“GAI”) for $315 million ($32.00 per share) in cash in a merger transaction. In addition, NATL paid a one-time special cash dividend of $0.50 per share to its shareholders immediately prior to the merger closing ($5 million was paid to noncontrolling shareholders). See Note B — “Acquisitions and Sale of Businesses to the financial statements.

In August 2016, AFG issued $300 million of 3.50% Senior Notes due 2026. AFG used the net proceeds from the offering to fund a portion of the acquisition of NATL mentioned above.

During 2016, AFG repurchased 1.9 million shares of its Common Stock for $133 million. In December 2016, AFG paid a special cash dividend of $1.00 per share of AFG Common Stock totaling approximately $87 million.

In November 2015, AFG issued $150 million of 6% Subordinated Debentures due 2055. In September 2015, AFG redeemed its $132 million of 7% Senior Notes due 2050 at par using cash on hand at the parent company.

During 2015, AFG repurchased 2.0 million shares of its Common Stock for $126 million. In December 2015, AFG paid a special cash dividend of $1.00 per share of AFG Common Stock totaling approximately $88 million.

All debentures and notes issued by AFG are rated investment grade by two nationally recognized rating agencies. Under a currently effective shelf registration statement, AFG can offer additional equity or debt securities. The shelf registration provides AFG with flexibility to access the capital markets from time to time as market and other conditions permit.

Under a tax allocation agreement with AFG, its 80%-owned U.S. subsidiaries generally pay taxes to (or recover taxes from) AFG based on each subsidiary’s contribution to amounts due under AFG’s consolidated tax return.

Subsidiary Liquidity   Great American Life Insurance Company (“GALIC”), a wholly-owned annuity subsidiary, is a member of the Federal 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. At December 31, 2017, GALIC had $871 million in outstanding advances from the FHLB (included in annuity benefits accumulated), bearing interest at rates ranging from 0.03% to 0.35% over LIBOR (average rate of 1.75% at December 31, 2017). While these advances must be repaid between 2018 and 2020 ($285 million in 2018 and $586 million in 2020), GALIC has the option to prepay all or a portion 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 December 31, 2017, GALIC estimated that it had additional borrowing capacity of approximately $300 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.


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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”). AFG began selling policies with GMIRs below 2% in 2003; almost all new business since late 2010 has been issued with a 1% GMIR. At December 31, 2017, AFG could reduce the average crediting rate on approximately $25 billion of traditional fixed and fixed-indexed annuities without guaranteed withdrawal benefits by approximately 92 basis points (on a weighted average basis). Annuity policies are subject to GMIRs at policy issuance. 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
 
 
 
 
 
 
at December 31,
 
 
GMIR
 
 
 
2017
 
2016
 
2015
 
 
1 — 1.99%
 
 
 
76%
 
72%
 
67%
 
 
2 — 2.99%
 
 
 
  5%
 
  6%
 
  7%
 
 
3 — 3.99%
 
 
 
10%
 
12%
 
14%
 
 
4.00% and above
 
 
 
  9%
 
10%
 
12%
 
 
 
 
 
 
 
 
 
 
 
 
 
Annuity benefits accumulated (in millions)
 
$33,316
 
$29,907
 
$26,662
 

For statutory accounting purposes, equity securities of non-affiliates and equity call options used in the fixed-indexed annuity business are generally carried at fair value. At December 31, 2017, AFG’s insurance companies owned publicly traded equity securities with a fair value of $1.61 billion and equity call options with a fair value of $701 million. Decreases in market prices could adversely affect the insurance group’s capital, potentially impacting the amount of dividends available or necessitating a capital contribution. Conversely, increases in market prices could have a favorable impact on the group’s dividend-paying capability.

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. 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.

Condensed Parent Only Cash Flows   AFG’s parent holding company only condensed cash flows from operating, investing and financing activities are shown below (in millions):
 
Year ended December 31,
 
2017
 
2016
 
2015
Net cash provided by operating activities
$
578

 
$
555

 
$
162

Net cash used in investing activities
(63
)
 
(560
)
 
(33
)
Net cash provided by (used in) financing activities
(413
)
 
13

 
(232
)
Net change in cash and cash equivalents
$
102

 
$
8

 
$
(103
)

Parent Net Cash Provided by Operating Activities   Parent holding company cash flows from operating activities consist primarily of dividends and tax payments received from AFG’s insurance subsidiaries, reduced by tax payments to the IRS and holding company interest and other expenses. Parent holding company net cash provided by operating activities was $578 million in 2017 compared to $555 million in 2016 and $162 million in 2015. The $23 million increase in net cash provided by operating activities in 2017 as compared to 2016 was due to lower taxes paid, partially offset by lower dividends received from subsidiaries for those comparable periods. Higher dividends received from subsidiaries in 2016 as compared to 2015 were the primary driver of the $393 million increase in net cash provided by operating activities.

Parent Net Cash Used in Investing Activities   Parent holding company investing activities consist of capital contributions to and returns of capital from subsidiaries and, to a much lesser extent, parent company investment activity. Parent holding company net cash used in investing activities was $63 million in 2017 compared to $560 million in 2016 and $33 million in 2015. The $63 million in net cash used in investing activities in 2017 and $33 million in 2015 are significantly lower than the $560 million in net cash used in investing activities in 2016 due primarily to capital contributions to a subsidiary to fund the acquisition of the noncontrolling interest in National Interstate Corporation.

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Parent Net Cash Provided by (Used in) Financing Activities   Parent company financing activities consist primarily of repurchases of AFG Common Stock, dividends to shareholders, the issuance and retirement of long-term debt and, to a lesser extent, proceeds from employee stock option exercises. Significant long-term debt and common stock transactions are discussed above under Parent Holding Company Liquidity.” Parent holding company net cash used in financing activities was $413 million in 2017 compared to net cash provided by financing activities of $13 million in 2016 and net cash used in financing activities of $232 million in 2015. The $426 million increase in cash used in financing activities in 2017 as compared to 2016 reflects higher net redemptions of long-term debt in 2017 and increased dividends (due primarily to special dividends of $3.50 per share in 2017 compared to $1.00 per share in 2016), partially offset by the absence of American Financial Group, Inc. Common Stock repurchases in 2017. The $245 million increase in net cash provided by financing activities in 2016 as compared to 2015 primarily reflects proceeds from additional long-term borrowings.

Contractual Obligations   The following table shows an estimate (based on historical patterns and expected trends) of payments to be made for insurance reserve liabilities, as well as scheduled payments for major contractual obligations (in millions).
 
 
Total
 
Within
One Year
 
2-3 Years
 
4-5 Years
 
More than
5 Years
Annuities (a)
 
$
38,653

 
$
2,655

 
$
6,552

 
$
8,464

 
$
20,982

Life, accident and health liabilities (a)
 
1,449

 
123

 
209

 
197

 
920

Property and casualty unpaid losses and loss adjustment expenses (b)
 
9,678

 
2,600

 
2,500

 
1,100

 
3,478

Long-term debt, including interest
 
2,922

 
60

 
120

 
120

 
2,622

Operating leases
 
346

 
63

 
107

 
76

 
100

Total
 
$
53,048

 
$
5,501

 
$
9,488

 
$
9,957

 
$
28,102


(a)
Amounts presented in the table represent estimated cash payments under such contracts, based on significant assumptions related to mortality, morbidity, lapse, renewal, retirement and annuitization. These assumptions also include interest and index crediting consistent with assumptions used to amortize DPAC and assess loss recognition. All estimated cash payments are undiscounted for the time value of money. As a result, total outflows for all years exceed the corresponding liabilities of $33.32 billion for annuity benefits accumulated and $658 million for life, accident and health reserves included in AFG’s Balance Sheet as of December 31, 2017. Based on the same assumptions, AFG projects reinsurance recoveries related to life, accident and health reserves totaling $708 million as follows: Within 1 year — $68 million; 2-3 years — $124 million; 4-5 years — $96 million; and thereafter — $420 million. Actual payments and their timing could differ significantly from these estimates.
(b)
Dollar amounts and time periods are estimates based on historical net payment patterns applied to the gross reserves and do not represent actual contractual obligations. Based on the same assumptions, AFG projects reinsurance recoveries related to these reserves totaling $2.96 billion as follows: Within 1 year — $800 million; 2-3 years — $800 million; 4-5 years — $300 million; and thereafter — $1.06 billion. Actual payments and their timing could differ significantly from these estimates.

AFG has no material contractual purchase obligations or other long-term liabilities at December 31, 2017.

Off-Balance Sheet Arrangements   See Note P — “Additional Information Financial Instruments — Unfunded Commitments to the financial statements.

Investments   AFG attempts to optimize investment income while building the value of its portfolio, placing emphasis upon total long-term performance.

AFG’s investment portfolio at December 31, 2017, contained $38.38 billion in fixed maturity securities and $1.60 billion in equity securities classified as available for sale and carried at fair value with unrealized gains and losses included in a separate component of shareholders’ equity on an after-tax basis. In addition, $348 million in fixed maturities and $62 million in equity securities were classified as trading with changes in unrealized holding gains or losses included in net investment income.

As detailed in Note E — “InvestmentsNet Unrealized Gain on Marketable Securities to the financial statements, unrealized gains and losses on AFG’s fixed maturity and equity securities are included in shareholders’ equity after adjustments for related changes in DPAC and certain liabilities related to annuity, long-term care and life businesses, noncontrolling interests and deferred income taxes. DPAC and certain other balance sheet amounts applicable to annuity, long-term care and life businesses are adjusted for the impact of unrealized gains or losses on investments as if these gains or losses had been realized, with

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corresponding increases or decreases (net of tax) included in accumulated other comprehensive income in AFG’s Balance Sheet.

Fixed income investment funds are generally invested in securities with intermediate-term maturities with an objective of optimizing total return while allowing flexibility to react to changes in market conditions. At December 31, 2017, the average life of AFG’s fixed maturities was about 6-1/2 years.
 
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 mortgage-backed securities (“MBS”), which comprise approximately 11% of AFG’s fixed maturities, prices for each security are generally obtained from both pricing services and broker quotes. For the remainder of AFG’s fixed maturity portfolio, approximately 76% are priced using pricing services and the balance is 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 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 December 31, 2017 (dollars in millions). Effects of increases or decreases from the 100 basis points illustrated would be approximately proportional.

Fair value of fixed maturity portfolio
$
38,727

Percentage impact on fair value of 100 bps increase in interest rates
(5.0
%)
Pretax impact on fair value of fixed maturity portfolio
$
(1,936
)
Offsetting adjustments to deferred policy acquisition costs and other balance sheet amounts
750

Estimated pretax impact on accumulated other comprehensive income
(1,186
)
Deferred income tax
249

Estimated after-tax impact on accumulated other comprehensive income
$
(937
)
 
Approximately 90% of the fixed maturities held by AFG at December 31, 2017, 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 due to the fact that, 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. Although interest rates have been low in recent years, tighter lending standards have resulted in fewer buyers being able to refinance the mortgages underlying much of AFG’s non-agency residential MBS portfolio.


33

Table of Contents

Summarized information for AFG’s MBS (including those classified as trading) at December 31, 2017, 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 4-1/2 years and 5-1/2 years, respectively.
 
 
Amortized
Cost
 
Fair Value
 
Fair Value as
% of Cost
 
Unrealized
Gain (Loss)
 
% Rated
Investment
Grade
Collateral type
 
 
 
 
 
 
 
 
 
 
Residential:
 
 
 
 
 
 
 
 
 
 
Agency-backed
 
$
207

 
$
205

 
99
%
 
$
(2
)
 
100
%
Non-agency prime
 
1,218

 
1,386

 
114
%
 
168

 
27
%
Alt-A
 
994

 
1,122

 
113
%
 
128

 
15
%
Subprime
 
468

 
517

 
110
%
 
49

 
19
%
Commercial
 
928

 
963

 
104
%
 
35

 
95
%
 
 
$
3,815

 
$
4,193

 
110
%
 
$
378

 
42
%

The National 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. At December 31, 2017, 97% (based on statutory carrying value of $3.75 billion) of AFG’s MBS had an NAIC designation of 1.

Municipal bonds represented approximately 18% of AFG’s fixed maturity portfolio at December 31, 2017. 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. At December 31, 2017, approximately 77% of the municipal bond portfolio was held in revenue bonds, with the remaining 23% held in general obligation bonds. AFG does not own general obligation bonds issued by Puerto Rico.


34

Table of Contents

Summarized information for the unrealized gains and losses recorded in AFG’s Balance Sheet at December 31, 2017, is shown in the following table (dollars in millions). Approximately $767 million of available for sale fixed maturity securities and $79 million of available for sale equity securities had no unrealized gains or losses at December 31, 2017.
 
Securities
With
Unrealized
Gains
 
Securities
With
Unrealized
Losses
Available for Sale Fixed Maturities
 
 
 
Fair value of securities
$
31,743

 
$
5,869

Amortized cost of securities
$
30,320

 
$
5,951

Gross unrealized gain (loss)
$
1,423

 
$
(82
)
Fair value as % of amortized cost
105
%
 
99
%
Number of security positions
4,354

 
841

Number individually exceeding $2 million gain or loss
82

 
1

Concentration of gains (losses) by type or industry (exceeding 5% of unrealized):
 
 
 
Mortgage-backed securities
$
385

 
$
(7
)
States and municipalities
254

 
(18
)
Banks, savings and credit institutions
167

 
(5
)
Asset-backed securities
142

 
(16
)
Manufacturing
107

 
(9
)
Insurance companies
76

 
(3
)
Percentage rated investment grade
90
%
 
90
%
 
 
 
 
Available for Sale Equity Securities
 
 
 
Fair value of securities
$
1,350

 
$
171

Cost of securities
$
1,048

 
$
194

Gross unrealized gain (loss)
$
302

 
$
(23
)
Fair value as % of cost
129
%
 
88
%
Number of security positions
172

 
23

Number individually exceeding $2 million gain or loss
36

 
4


The table below sets forth the scheduled maturities of AFG’s available for sale fixed maturity securities at December 31, 2017, 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
With
Unrealized
Gains
 
Securities
With
Unrealized
Losses
Maturity
 
 
 
 
One year or less
 
2
%
 
2
%
After one year through five years
 
18
%
 
20
%
After five years through ten years
 
37
%
 
31
%
After ten years
 
12
%
 
16
%
 
 
69
%
 
69
%
Asset-backed securities (average life of approximately 5 years)
 
19
%
 
26
%
Mortgage-backed securities (average life of approximately 4-1/2 years)
 
12
%
 
5
%
 
 
100
%
 
100
%


35

Table of Contents

The table below (dollars in millions) summarizes the unrealized gains and losses on fixed maturity securities by dollar amount:
 
 
Aggregate
Fair
Value
 
Aggregate
Unrealized
Gain (Loss)
 
Fair
Value as
% of Cost
Fixed Maturities at December 31, 2017
 
 
 
 
 
 
Securities with unrealized gains:
 
 
 
 
 
 
Exceeding $500,000 (829 securities)
 
$
12,450

 
$
923

 
108
%
$500,000 or less (3,525 securities)
 
19,293

 
500

 
103
%
 
 
$
31,743

 
$
1,423