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____________________________________________________________________________________________
UNITED STATES SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549

FORM 10-Q

Quarterly Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934
For the Quarterly Period Ended March 31, 2020
or
Transition Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934
For the transition period from ____ to ____

Commission File No. 1-13653

https://cdn.kscope.io/dba5f05496e73eed480634da5c120c75-afglogoa04.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
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  No 

Indicate by check mark whether the Registrant has submitted electronically, every Interactive Data File required to be submitted pursuant to Rule 405 of Regulation S-T during the preceding 12 months. Yes  No 

Indicate by check mark whether the Registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, a smaller reporting company or an emerging growth company. See definitions of “large accelerated filer,” “accelerated filer,” “smaller reporting company” and “emerging growth company” in Rule 12b-2 of the Exchange Act.
Large accelerated filer                          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 Exchange Act). Yes  No 
Securities Registered Pursuant to Section 12(b) of the Act:
 
Title of Each Class
 
Trading Symbol(s)
 
Name of Each Exchange on Which Registered
 
Common Stock
 
AFG
 
New York Stock Exchange
 
6% Subordinated Debentures due November 15, 2055
 
AFGH
 
New York Stock Exchange
 
5.875% Subordinated Debentures due March 30, 2059
 
AFGB
 
New York Stock Exchange
 
5.125% Subordinated Debentures due December 15, 2059
 
AFGC
 
New York Stock Exchange
As of May 1, 2020, there were 89,841,655 shares of the Registrant’s Common Stock outstanding, excluding 14.9 million shares owned by subsidiaries.
____________________________________________________________________________________________


AMERICAN FINANCIAL GROUP, INC. 10-Q

TABLE OF CONTENTS
 



AMERICAN FINANCIAL GROUP, INC. 10-Q

PART I
ITEM 1. — FINANCIAL STATEMENTS
AMERICAN FINANCIAL GROUP, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEET (UNAUDITED)
(Dollars in Millions)
 
March 31,
2020
 
December 31,
2019
Assets:
 
 
 
Cash and cash equivalents
$
1,673

 
$
2,314

Investments:
 
 
 
Fixed maturities, available for sale at fair value (amortized cost — $46,101 and $44,524; allowance for expected credit losses of $61 at March 31, 2020)
46,134

 
46,505

Fixed maturities, trading at fair value
96

 
113

Equity securities, at fair value
1,559

 
1,937

Investments accounted for using the equity method
1,763

 
1,688

Mortgage loans
1,346

 
1,329

Policy loans
161

 
164

Equity index call options
209

 
924

Real estate and other investments
280

 
278

Total cash and investments
53,221

 
55,252

Recoverables from reinsurers
3,387

 
3,415

Prepaid reinsurance premiums
708

 
678

Agents’ balances and premiums receivable
1,302

 
1,335

Deferred policy acquisition costs
1,573

 
1,037

Assets of managed investment entities
4,026

 
4,736

Other receivables
981

 
975

Variable annuity assets (separate accounts)
497

 
628

Other assets
1,741

 
1,867

Goodwill
207

 
207

Total assets
$
67,643

 
$
70,130

 
 
 
 
Liabilities and Equity:
 
 
 
Unpaid losses and loss adjustment expenses
$
10,106

 
$
10,232

Unearned premiums
2,808

 
2,830

Annuity benefits accumulated
40,463

 
40,406

Life, accident and health reserves
607

 
612

Payable to reinsurers
779

 
814

Liabilities of managed investment entities
3,865

 
4,571

Long-term debt
1,473

 
1,473

Variable annuity liabilities (separate accounts)
497

 
628

Other liabilities
1,998

 
2,295

Total liabilities
62,596

 
63,861

 
 
 
 
Redeemable noncontrolling interests

 

 
 
 
 
Shareholders’ equity:
 
 
 
Common Stock, no par value
       — 200,000,000 shares authorized
       — 89,827,336 and 90,303,686 shares outstanding
90

 
90

Capital surplus
1,309

 
1,307

Retained earnings
3,616

 
4,009

Accumulated other comprehensive income, net of tax
32

 
863

Total shareholders’ equity
5,047

 
6,269

Noncontrolling interests

 

Total equity
5,047

 
6,269

Total liabilities and equity
$
67,643

 
$
70,130


2

AMERICAN FINANCIAL GROUP, INC. 10-Q

AMERICAN FINANCIAL GROUP, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENT OF EARNINGS (UNAUDITED)
(In Millions, Except Per Share Data)
 
Three months ended March 31,
 
2020
 
2019
Revenues:
 
 
 
Property and casualty insurance net earned premiums
$
1,209

 
$
1,173

Net investment income
544

 
542

Realized gains (losses) on securities (*)
(551
)
 
184

Income (loss) of managed investment entities:
 
 
 
Investment income
59

 
69

Gain (loss) on change in fair value of assets/liabilities
(43
)
 

Other income
57

 
56

Total revenues
1,275

 
2,024

 
 
 
 
Costs and Expenses:
 
 
 
Property and casualty insurance:
 
 
 
Losses and loss adjustment expenses
707

 
692

Commissions and other underwriting expenses
420

 
399

Annuity benefits
276

 
311

Annuity and supplemental insurance acquisition expenses
113

 
28

Interest charges on borrowed money
17

 
16

Expenses of managed investment entities
48

 
55

Other expenses
82

 
110

Total costs and expenses
1,663

 
1,611

Earnings (loss) before income taxes
(388
)
 
413

Provision (credit) for income taxes
(84
)
 
87

Net earnings (loss), including noncontrolling interests
(304
)
 
326

Less: Net earnings (loss) attributable to noncontrolling interests
(3
)
 
(3
)
Net Earnings (Loss) Attributable to Shareholders
$
(301
)
 
$
329

 
 
 
 
Earnings (Loss) Attributable to Shareholders per Common Share:
 
 
 
Basic
$
(3.34
)
 
$
3.68

Diluted
$
(3.34
)
 
$
3.63

Average number of Common Shares:
 
 
 
Basic
90.3

 
89.4

Diluted
90.3

 
90.7

________________________________________
 
 
 
(*) Consists of the following:
 
 
 
Realized gains (losses) before impairments
$
(505
)
 
$
186

 
 
 
 
Losses on securities with impairment
(69
)
 
(2
)
Non-credit portion recognized in other comprehensive income (loss)
23

 

Impairment charges recognized in earnings
(46
)
 
(2
)
Total realized gains (losses) on securities
$
(551
)
 
$
184


3

AMERICAN FINANCIAL GROUP, INC. 10-Q

AMERICAN FINANCIAL GROUP, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENT OF COMPREHENSIVE INCOME (UNAUDITED)
(In Millions)
 
 
Three months ended March 31,
 
2020
 
2019
Net earnings (loss), including noncontrolling interests
$
(304
)
 
$
326

Other comprehensive income (loss), net of tax:
 
 
 
Net unrealized gains (losses) on securities:
 
 
 
Unrealized holding gains (losses) on securities arising during the period
(865
)
 
384

Reclassification adjustment for realized (gains) losses included in net earnings
19

 
(3
)
Total net unrealized gains (losses) on securities
(846
)
 
381

Net unrealized gains on cash flow hedges
27

 
11

Foreign currency translation adjustments
(10
)
 
4

Other comprehensive income (loss), net of tax
(829
)
 
396

Total comprehensive income (loss), net of tax
(1,133
)
 
722

Less: Comprehensive income (loss) attributable to noncontrolling interests
(1
)
 
(3
)
Comprehensive income (loss) attributable to shareholders
$
(1,132
)
 
$
725



4

AMERICAN FINANCIAL GROUP, INC. 10-Q

AMERICAN FINANCIAL GROUP, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENT OF CHANGES IN EQUITY (UNAUDITED)
(Dollars in Millions)
 
 
 
 
 
Shareholders’ Equity
 
 
 
 
 
Redeemable
Common
 
 
Common Stock
and Capital
 
Retained
 
Accumulated
Other Comp.
 
 
 
Noncon-
trolling
 
Total
 
Noncon-
trolling
Shares
 
 
Surplus
 
Earnings
 
Inc. (Loss)
 
Total
 
Interests
 
Equity
 
Interests
Balance at December 31, 2019
90,303,686

 
 
$
1,397

 
$
4,009

 
$
863

 
$
6,269

 
$

 
$
6,269

 
$

Cumulative effect of accounting change

 
 

 
7

 

 
7

 

 
7

 

Net earnings (loss)

 
 

 
(301
)
 

 
(301
)
 

 
(301
)
 
(3
)
Other comprehensive income (loss)

 
 

 

 
(831
)
 
(831
)
 

 
(831
)
 
2

Dividends ($0.45 per share)

 
 

 
(40
)
 

 
(40
)
 

 
(40
)
 

Shares issued:
 
 
 
 
 
 
 
 
 

 
 
 

 
 
Exercise of stock options
204,093

 
 
9

 

 

 
9

 

 
9

 

Restricted stock awards
227,867

 
 

 

 

 

 

 

 

Other benefit plans
14,541

 
 
1

 

 

 
1

 

 
1

 

Dividend reinvestment plan
1,617

 
 

 

 

 

 

 

 

Stock-based compensation expense

 
 
6

 

 

 
6

 

 
6

 

Shares acquired and retired
(826,283
)
 
 
(12
)
 
(49
)
 

 
(61
)
 

 
(61
)
 

Shares exchanged — benefit plans
(95,854
)
 
 
(2
)
 
(9
)
 

 
(11
)
 

 
(11
)
 

Forfeitures of restricted stock
(2,331
)
 
 

 

 

 

 

 

 

Other

 
 

 
(1
)
 

 
(1
)
 

 
(1
)
 
1

Balance at March 31, 2020
89,827,336

 
 
$
1,399

 
$
3,616

 
$
32

 
$
5,047

 
$

 
$
5,047

 
$

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Balance at December 31, 2018
89,291,724

 
 
$
1,334

 
$
3,588

 
$
48

 
$
4,970

 
$
2

 
$
4,972

 
$

Net earnings (loss)

 
 

 
329

 

 
329

 

 
329

 
(3
)
Other comprehensive income

 
 

 

 
396

 
396

 

 
396

 

Dividends ($0.40 per share)

 
 

 
(36
)
 

 
(36
)
 

 
(36
)
 

Shares issued:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Exercise of stock options
152,253

 
 
6

 

 

 
6

 

 
6

 

Restricted stock awards
232,565

 
 

 

 

 

 

 

 

Other benefit plans
11,062

 
 
1

 

 

 
1

 

 
1

 

Dividend reinvestment plan
1,893

 
 

 

 

 

 

 

 

Stock-based compensation expense

 
 
6

 

 

 
6

 

 
6

 

Shares exchanged — benefit plans
(43,470
)
 
 
(1
)
 
(3
)
 

 
(4
)
 

 
(4
)
 

Forfeitures of restricted stock
(8,314
)
 
 

 

 

 

 

 

 

Other

 
 

 
(3
)
 

 
(3
)
 
(2
)
 
(5
)
 
3

Balance at March 31, 2019
89,637,713

 
 
$
1,346

 
$
3,875

 
$
444

 
$
5,665

 
$

 
$
5,665

 
$



5

AMERICAN FINANCIAL GROUP, INC. 10-Q

AMERICAN FINANCIAL GROUP, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENT OF CASH FLOWS (UNAUDITED)
(In Millions)
 
Three months ended March 31,
 
2020
 
2019
Operating Activities:
 
 
 
Net earnings (loss), including noncontrolling interests
$
(304
)
 
$
326

Adjustments:
 
 
 
Depreciation and amortization
113

 
34

Annuity benefits
276

 
311

Realized (gains) losses on investing activities
550

 
(184
)
Net sales of trading securities
8

 
1

Deferred annuity and life policy acquisition costs
(49
)
 
(64
)
Change in:
 
 
 
Reinsurance and other receivables
161

 
128

Other assets
410

 
(271
)
Insurance claims and reserves
(152
)
 
(112
)
Payable to reinsurers
(35
)
 
(22
)
Other liabilities
(543
)
 
304

Managed investment entities’ assets/liabilities
89

 
16

Other operating activities, net
8

 
(13
)
Net cash provided by operating activities
532

 
454

 
 
 
 
Investing Activities:
 
 
 
Purchases of:
 
 
 
Fixed maturities
(4,140
)
 
(1,801
)
Equity securities
(232
)
 
(35
)
Mortgage loans
(21
)
 
(38
)
Equity index options and other investments
(245
)
 
(220
)
Real estate, property and equipment
(9
)
 
(10
)
Proceeds from:
 
 
 
Maturities and redemptions of fixed maturities
1,220

 
1,032

Repayments of mortgage loans
4

 
29

Sales of fixed maturities
1,483

 
201

Sales of equity securities
80

 
95

Sales and settlements of equity index options and other investments
248

 
79

Sales of real estate, property and equipment
1

 
1

Managed investment entities:
 
 
 
Purchases of investments
(414
)
 
(391
)
Proceeds from sales and redemptions of investments
370

 
373

Other investing activities, net
2

 
1

Net cash used in investing activities
(1,653
)
 
(684
)
 
 
 
 
Financing Activities:
 
 
 
Annuity receipts
1,410

 
1,395

Annuity surrenders, benefits and withdrawals
(813
)
 
(782
)
Net transfers from variable annuity assets
15

 
13

Additional long-term borrowings

 
121

Retirements of managed investment entities’ liabilities
(41
)
 
(3
)
Issuances of Common Stock
10

 
7

Repurchases of Common Stock
(61
)
 

Cash dividends paid on Common Stock
(40
)
 
(36
)
Net cash provided by financing activities
480

 
715

Net Change in Cash and Cash Equivalents
(641
)
 
485

Cash and cash equivalents at beginning of period
2,314

 
1,515

Cash and cash equivalents at end of period
$
1,673

 
$
2,000


6

AMERICAN FINANCIAL GROUP, INC. 10-Q
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 

INDEX TO NOTES
 
 
 
 
 
 
A.
Accounting Policies
 
I.
Goodwill and Other Intangibles
 
B.
Acquisition of Business
 
J.
Long-Term Debt
 
C.
Segments of Operations
 
K.
Shareholders’ Equity
 
D.
Fair Value Measurements
 
L.
Income Taxes
 
E.
Investments
 
M.
Contingencies
 
F.
Derivatives
 
N.
Insurance
 
G.
Deferred Policy Acquisition Costs
 
O.
Subsequent Events
 
H.
Managed Investment Entities
 
 
 
 
 
 
 
 
 
 

A.     Accounting Policies

Basis of Presentation   The accompanying consolidated financial statements for American Financial Group, Inc. and its subsidiaries (“AFG”) are unaudited; however, management believes that all adjustments (consisting only of normal recurring accruals unless otherwise disclosed herein) necessary for fair presentation have been made. The results of operations for interim periods are not necessarily indicative of results to be expected for the year. The financial statements have been prepared in accordance with the instructions to Form 10-Q and, therefore, do not include all information and footnotes necessary to be in conformity with U.S. generally accepted accounting principles (“GAAP”).
 
Certain reclassifications have been made to prior periods to conform to the current year’s presentation. All significant intercompany balances and transactions have been eliminated. The results of operations of companies since their formation or acquisition are included in the consolidated financial statements. Events or transactions occurring subsequent to March 31, 2020, and prior to the filing of this Form 10-Q, have been evaluated for potential recognition or disclosure herein.
 
The preparation of the financial statements requires management to make estimates and assumptions that affect the amounts reported in the financial statements and accompanying notes. Changes in circumstances could cause actual results to differ materially from those estimates.

Fair Value Measurements   Accounting standards define fair value as the price that would be received to sell an asset or paid to transfer a liability (an exit price) in an orderly transaction between market participants on the measurement date. The standards establish a hierarchy of valuation techniques based on whether the assumptions that market participants would use in pricing the asset or liability (“inputs”) are observable or unobservable. Observable inputs reflect market data obtained from independent sources, while unobservable inputs reflect AFG’s assumptions about the assumptions market participants would use in pricing the asset or liability. AFG did not have any material nonrecurring fair value measurements in the first three months of 2020.

Credit Losses on Financial Instruments   On January 1, 2020, AFG adopted Accounting Standards Update (“ASU”) 2016-13, Financial Instruments – Credit Losses: Measurement of Credit Losses on Financial Instruments, which provides a new loss model for determining credit-related impairments for financial instruments measured at amortized cost (mortgage loans, premiums receivable and reinsurance recoverables) and requires an entity to estimate the credit losses expected over the life of an exposure or pool of exposures. The estimate of expected credit losses considers historical information, current information, as well as reasonable and supportable forecasts, including estimates of prepayments. Expected credit losses, and subsequent increases or decreases in such expected losses, are recorded immediately through net earnings as an allowance that is deducted from the amortized cost basis of the financial asset, with the net carrying value of the financial asset presented on the balance sheet at the amount expected to be collected. AFG’s portfolio of mortgage loans crosses a wide variety of commercial properties with very strong loan to value ratios and no credit losses in recent years. In addition, the reinsurance used in AFG’s insurance operations is purchased from financially strong (highly rated) reinsurers and the Company has a long history of collecting premiums receivable through various economic cycles. At the date of adoption, the impact of adjusting AFG’s existing allowances for uncollectable mortgage loans, premiums receivable and reinsurance recoverables to the allowances calculated under the new guidance resulted in a reduction in the net allowance, which was recorded as the cumulative effect of an accounting change ($7 million increase in retained earnings at January 1, 2020).


7

AMERICAN FINANCIAL GROUP, INC. 10-Q
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — CONTINUED


The updated guidance also amended the current other-than-temporary impairment model for available for sale debt securities by requiring the recognition of impairments relating to credit losses through an allowance and limits the amount of credit loss to the difference between a security’s amortized cost basis and its fair value. Subsequent increases or decreases in expected credit losses will be recorded immediately in net earnings through realized gains (losses).

Investments   Equity securities other than those accounted for under the equity method are reported at fair value with holding gains and losses generally recorded in realized gains (losses) on securities. However, AFG records holding gains and losses on securities classified as “trading” under previous guidance, its small portfolio of limited partnerships and similar investments carried at fair value and certain other securities classified at purchase as “fair value through net investment income” in net investment income.

Fixed maturity securities classified as “available for sale” are reported at fair value with unrealized gains and losses included in AOCI in AFG’s Balance Sheet. Fixed maturity securities classified as “trading” are reported at fair value with changes in unrealized holding gains or losses during the period included in net investment income. Mortgage and policy loans are carried primarily at the aggregate unpaid balance.

Premiums and discounts on fixed maturity securities are amortized using the effective interest method. Mortgage-backed securities (“MBS”) are amortized over a period based on estimated future principal payments, including prepayments. Prepayment assumptions are reviewed periodically and adjusted to reflect actual prepayments and changes in expectations.

Limited partnerships and similar investments are generally accounted for using the equity method of accounting. Under the equity method, AFG records its share of the earnings or losses of the investee based on when they are reported by the investee in its financial statements rather than in the period in which the investee declares a dividend. AFG’s share of the earnings or losses from equity method investments is generally recorded on a quarter lag due to the timing of the receipt of the investee’s financial statements. AFG’s equity in the earnings (losses) of limited partnerships and similar investments is included in net investment income.

Realized gains or losses on the disposal of fixed maturity securities are determined on the specific identification basis. When a decline in the value of an available for sale fixed maturity is considered to be other-than-temporary at the balance sheet date, an allowance for credit losses (impairment), including any write-off of accrued interest, is charged to earnings (included in realized gains (losses) on securities). If management can assert that it does not intend to sell the security and it is not more likely than not that it will have to sell it before recovery of its amortized cost basis (net of allowance), then the impairment allowance is separated into two components: (i) the amount related to credit losses (recorded in earnings) and (ii) the amount related to all other factors (recorded in other comprehensive income). The credit-related portion is measured by comparing a security’s amortized cost to the present value of its current expected cash flows discounted at its effective yield prior to the charge. Both components are shown in the statement of earnings. If management intends to sell an impaired security, or it is more likely than not that it will be required to sell the security before recovery, an impairment is recorded in earnings to reduce the amortized cost (net of allowance) of that security to fair value. See Credit Losses on Financial Instruments above for a discussion of new guidance adopted on January 1, 2020.

Derivatives   Derivatives included in AFG’s Balance Sheet are recorded at fair value. Changes in fair value of derivatives are included in earnings unless the derivatives are designated and qualify as highly effective cash flow hedges. Derivatives that do not qualify for hedge accounting under GAAP consist primarily of (i) components of certain fixed maturity securities (primarily interest-only and principal-only MBS) and (ii) the equity-based component of certain annuity products (included in annuity benefits accumulated) and related equity index options designed to be consistent with the characteristics of the liabilities and used to mitigate the risk embedded in those annuity products.

To qualify for hedge accounting, at the inception of a derivative contract, AFG formally documents the relationship between the terms of the hedge and the hedged items and its risk management objective. This documentation includes defining how hedge effectiveness and ineffectiveness will be measured on a retrospective and prospective basis.

Changes in the fair value of derivatives that are designated and qualify as highly effective cash flow hedges are recorded in AOCI and are reclassified into earnings when the variability of the cash flows from the hedged items impacts earnings. When the change in the fair value of a qualifying cash flow hedge is included in earnings, it is included in the same line item in the statement of earnings as the cash flows from the hedged item. AFG uses interest rate swaps that are designated and qualify as highly effective cash flow hedges to mitigate interest rate risk related to certain floating-rate securities included in AFG’s portfolio of fixed maturity securities.


8

AMERICAN FINANCIAL GROUP, INC. 10-Q
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — CONTINUED


Goodwill   Goodwill represents the excess of cost of subsidiaries over AFG’s equity in their underlying net assets. Goodwill is not amortized, but is subject to an impairment test at least annually. An entity is not required to complete the quantitative annual goodwill impairment test on a reporting unit if the entity elects to perform a qualitative analysis and determines that it is more likely than not that the reporting unit’s fair value exceeds its carrying amount.

Reinsurance   Amounts recoverable from reinsurers are estimated in a manner consistent with the claim liability associated with the reinsured policies. AFG’s property and casualty insurance subsidiaries report as assets (i) the estimated reinsurance recoverable on paid and unpaid losses, including an estimate for losses incurred but not reported, and (ii) amounts paid or due to reinsurers applicable to the unexpired terms of policies in force. Payable to reinsurers includes ceded premiums due to reinsurers, as well as ceded premiums retained by AFG’s property and casualty insurance subsidiaries under contracts to fund ceded losses as they become due. AFG’s insurance subsidiaries also assume reinsurance from other companies. Earnings on reinsurance assumed is recognized based on information received from ceding companies.

An AFG subsidiary cedes life insurance policies to a third party on a funds withheld basis whereby the subsidiary retains the assets (securities) associated with the reinsurance contract. Interest is credited to the reinsurer based on the actual investment performance of the retained assets. This reinsurance contract is considered to contain an embedded derivative (that must be adjusted to fair value) because the yield on the payable is based on a specific block of the ceding company’s assets, rather than the overall creditworthiness of the ceding company. AFG determined that changes in the fair value of the underlying portfolio of fixed maturity securities is an appropriate measure of the value of the embedded derivative. The securities related to this contract are classified as “trading.” The adjustment to fair value on the embedded derivative offsets the investment income recorded on the adjustment to fair value of the related trading portfolio.
 
Deferred Policy Acquisition Costs (“DPAC”)   Policy acquisition costs (principally commissions, premium taxes and certain underwriting and policy issuance costs) directly related to the successful acquisition or renewal of an insurance contract are deferred. DPAC also includes capitalized costs associated with sales inducements offered to fixed annuity policyholders such as enhanced interest rates and premium and persistency bonuses.
 
For the property and casualty companies, DPAC is limited based upon recoverability without any consideration for anticipated investment income and is charged against income ratably over the terms of the related policies. A premium deficiency is recognized if the sum of expected claims costs, claims adjustment expenses and unamortized acquisition costs exceed the related unearned premiums. A premium deficiency is first recognized by charging any unamortized acquisition costs to expense to the extent required to eliminate the deficiency. If the premium deficiency is greater than unamortized acquisition costs, a liability is accrued for the excess deficiency and reported with unpaid losses and loss adjustment expenses.

DPAC related to annuities is deferred to the extent deemed recoverable and amortized, with interest, in relation to the present value of actual and expected gross profits on the policies. Expected gross profits consist principally of estimated future investment margin (estimated future net investment income less interest credited on policyholder funds) and surrender, mortality, and other life and annuity policy charges, less death, annuitization and guaranteed withdrawal benefits in excess of account balances and estimated future policy administration expenses. To the extent that realized gains and losses result in adjustments to the amortization of DPAC related to annuities, such adjustments are reflected as components of realized gains (losses) on securities.

DPAC related to traditional life and health insurance is amortized over the expected premium paying period of the related policies, in proportion to the ratio of annual premium revenues to total anticipated premium revenues. See Life, Accident and Health Reserves below for details on the impact of loss recognition on the accounting for traditional life and health insurance contracts.

DPAC includes the present value of future profits on business in force of annuity and life, accident and health insurance companies acquired (“PVFP”). PVFP represents the portion of the costs to acquire companies that is allocated to the value of the right to receive future cash flows from insurance contracts existing at the date of acquisition. PVFP is amortized with interest in relation to expected gross profits of the acquired policies for annuities and universal life products and in relation to the premium paying period for traditional life and health insurance products.

DPAC and certain other balance sheet amounts related to annuity and life businesses are also adjusted, net of tax, for the change in expense that would have been recorded if the unrealized gains (losses) from securities had actually been realized. These adjustments are included in unrealized gains (losses) on marketable securities, a component of AOCI in AFG’s Balance Sheet.

9

AMERICAN FINANCIAL GROUP, INC. 10-Q
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — CONTINUED



Managed Investment Entities   A company is considered the primary beneficiary of, and therefore must consolidate, a variable interest entity (“VIE”) based primarily on its ability to direct the activities of the VIE that most significantly impact that entity’s economic performance and the obligation to absorb losses of, or receive benefits from, the entity that could potentially be significant to the VIE.
 
AFG manages, and has investments in, collateralized loan obligations (“CLOs”) that are VIEs (see Note H — “Managed Investment Entities). AFG has determined that it is the primary beneficiary of these CLOs because (i) its role as asset manager gives it the power to direct the activities that most significantly impact the economic performance of the CLOs and (ii) through its investment in the CLO debt tranches, it has exposure to CLO losses (limited to the amount AFG invested) and the right to receive CLO benefits that could potentially be significant to the CLOs.

Because AFG has no right to use the CLO assets and no obligation to pay the CLO liabilities, the assets and liabilities of the CLOs are shown separately in AFG’s Balance Sheet. AFG has elected the fair value option for reporting on the CLO assets and liabilities to improve the transparency of financial reporting related to the CLOs. The net gain or loss from accounting for the CLO assets and liabilities at fair value is presented separately in AFG’s Statement of Earnings.

The fair values of a CLO’s assets may differ from the separately measured fair values of its liabilities even though the CLO liabilities only have recourse to the CLO assets. AFG has set the carrying value of the CLO liabilities equal to the fair value of the CLO assets (which have more observable fair values) as an alternative to reporting those liabilities at a separately measured fair value. CLO earnings attributable to AFG’s shareholders are measured by the change in the fair value of AFG’s investments in the CLOs and management fees earned.

Unpaid Losses and Loss Adjustment Expenses   The net liabilities stated for unpaid claims and for expenses of investigation and adjustment of unpaid claims represent management’s best estimate and are based upon (i) the accumulation of case estimates for losses reported prior to the close of the accounting period on direct business written; (ii) estimates received from ceding reinsurers and insurance pools and associations; (iii) estimates of unreported losses (including possible development on known claims) based on past experience; (iv) estimates based on experience of expenses for investigating and adjusting claims; and (v) the current state of the law and coverage litigation. Establishing reserves for asbestos, environmental and other mass tort claims involves considerably more judgment than other types of claims due to, among other things, inconsistent court decisions, an increase in bankruptcy filings as a result of asbestos-related liabilities, novel theories of coverage, and judicial interpretations that often expand theories of recovery and broaden the scope of coverage.
 
Loss reserve liabilities are subject to the impact of changes in claim amounts and frequency and other factors. Changes in estimates of the liabilities for losses and loss adjustment expenses are reflected in the statement of earnings in the period in which determined. Despite the variability inherent in such estimates, management believes that the liabilities for unpaid losses and loss adjustment expenses are adequate.
 
Annuity Benefits Accumulated   Annuity receipts and benefit payments are recorded as increases or decreases in annuity benefits accumulated rather than as revenue and expense. Increases in this liability for interest credited are charged to annuity benefits expense and decreases for annuity policy charges are recorded in other income. For traditional fixed annuities, the liability for annuity benefits accumulated represents the account value that had accrued to the benefit of the policyholder as of the balance sheet date. For fixed-indexed annuities (“FIAs”), the liability for annuity benefits accumulated includes an embedded derivative that represents the estimated fair value of the index participation with the remaining component representing the discounted value of the guaranteed minimum contract benefits.
 
For certain products, annuity benefits accumulated also includes reserves for accrued persistency and premium bonuses, guaranteed withdrawals and excess benefits expected to be paid on future deaths and annuitizations (“EDAR”). The liabilities for EDAR and guaranteed withdrawals are accrued for and modified using assumptions consistent with those used in determining DPAC and DPAC amortization, except that amounts are determined in relation to the present value of total expected assessments. Total expected assessments consist principally of estimated future investment margin, surrender, mortality, and other life and annuity policy charges, and unearned revenues once they are recognized as income.
 
Annuity benefits accumulated also includes amounts advanced from the Federal Home Loan Bank of Cincinnati.
 

10

AMERICAN FINANCIAL GROUP, INC. 10-Q
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — CONTINUED


Unearned Revenue   Certain upfront policy charges on annuities are deferred as unearned revenue (included in other liabilities) and recognized in net earnings (included in other income) using the same assumptions and estimated gross profits used to amortize DPAC.

Life, Accident and Health Reserves   Liabilities for future policy benefits under traditional life, accident and health policies are computed using the net level premium method. Computations are based on the original projections of investment yields, mortality, morbidity and surrenders and include provisions for unfavorable deviations unless a loss recognition event (premium deficiency) occurs. Claim reserves and liabilities established for accident and health claims are modified as necessary to reflect actual experience and developing trends.

For long-duration contracts (such as traditional life and long-term care policies), loss recognition occurs when, based on current expectations as of the measurement date, existing contract liabilities plus the present value of future premiums (including reasonably expected rate increases) are not expected to cover the present value of future claims payments and related settlement and maintenance costs (excluding overhead) as well as unamortized acquisition costs. If a block of business is determined to be in loss recognition, a charge is recorded in earnings in an amount equal to the excess of the present value of expected future claims costs and unamortized acquisition costs over existing reserves plus the present value of expected future premiums (with no provision for adverse deviation). The charge is recorded first to reduce unamortized acquisition costs and then as an additional reserve (if unamortized acquisition costs have been reduced to zero).

In addition, reserves for traditional life and long-term care policies are subject to adjustment for loss recognition charges that would have been recorded if the unrealized gains (losses) from securities had actually been realized. This adjustment is included in unrealized gains (losses) on marketable securities, a component of AOCI in AFG’s Balance Sheet.

Debt Issuance Costs   Debt issuance costs related to AFG’s outstanding debt are presented in its Balance Sheet as a direct reduction in the carrying value of long-term debt and are amortized over the life of the related debt using the effective interest method as a component of interest expense. Debt issuance costs related to AFG’s revolving credit facilities are included in other assets in AFG’s Balance Sheet.

Variable Annuity Assets and Liabilities   Separate accounts related to variable annuities represent the fair value of deposits invested in underlying investment funds on which AFG earns a fee. Investment funds are selected and may be changed only by the policyholder, who retains all investment risk.

AFG’s variable annuity contracts contain a guaranteed minimum death benefit (“GMDB”) to be paid if the policyholder dies before the annuity payout period commences. In periods of declining equity markets, the GMDB may exceed the value of the policyholder’s account. A GMDB liability is established for future excess death benefits using assumptions together with a range of reasonably possible scenarios for investment fund performance that are consistent with DPAC capitalization and amortization assumptions.

Leases   On January 1, 2019, AFG adopted ASU 2016-02, which requires entities that lease assets for terms longer than one year to recognize assets and liabilities for the rights and obligations created by those leases on the balance sheet based on the present value of contractual cash flows. The adoption of the new guidance did not have a material effect on AFG’s results of operations or liquidity.

At March 31, 2020 AFG has a $182 million lease liability included in other liabilities and a lease right-of-use asset of $162 million included in other assets compared to $180 million and $158 million, respectively, at December 31, 2019.

Noncontrolling Interests   For balance sheet purposes, noncontrolling interests represent the interests of shareholders other than AFG in consolidated entities. In the statement of earnings, net earnings and losses attributable to noncontrolling interests represents such shareholders’ interest in the earnings and losses of those entities. Noncontrolling interests that are redeemable at the option of the holder are presented separately in the mezzanine section of the balance sheet (between liabilities and equity).

Premium Recognition   Property and casualty premiums are earned generally over the terms of the policies on a pro rata basis. Unearned premiums represent that portion of premiums written, which is applicable to the unexpired terms of policies in force. On reinsurance assumed from other insurance companies or written through various underwriting organizations, unearned premiums are based on information received from such companies and organizations. For traditional life, accident and health products, premiums are recognized as revenue when legally collectible from policyholders. For interest-sensitive life and universal life products, premiums are recorded in a policyholder account,

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AMERICAN FINANCIAL GROUP, INC. 10-Q
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which is reflected as a liability. Revenue is recognized as amounts are assessed against the policyholder account for mortality coverage and contract expenses.

Income Taxes   Deferred income taxes are calculated using the liability method. Under this method, deferred income tax assets and liabilities are determined based on differences between financial reporting and tax bases and are measured using enacted tax rates. A valuation allowance is established to reduce total deferred tax assets to an amount that will more likely than not be realized. The effect of a change in tax rates on deferred tax assets and liabilities is recorded in net earnings in the period that includes the enactment date.

AFG recognizes the tax benefits of uncertain tax positions only when the position is more likely than not to be sustained under examination by the appropriate taxing authority. Interest and penalties on AFG’s reserve for uncertain tax positions are recognized as a component of tax expense.

Stock-Based Compensation   All share-based grants are recognized as compensation expense on a straight-line basis over their vesting periods based on their calculated fair value at the date of grant. AFG uses the Black Scholes pricing model to measure the fair value of employee stock options.

AFG records excess tax benefits or deficiencies for share-based payments through income tax expense in the statement of earnings. In addition, AFG accounts for forfeitures of awards when they occur.

Benefit Plans   AFG provides retirement benefits to qualified employees of participating companies through the AFG 401(k) Retirement and Savings Plan, a defined contribution plan. AFG makes all contributions to the retirement fund portion of the plan and matches a percentage of employee contributions to the savings fund. Company contributions are expensed in the year for which they are declared. AFG and many of its subsidiaries provide health care and life insurance benefits to eligible retirees. AFG also provides postemployment benefits to former or inactive employees (primarily those on disability) who were not deemed retired under other company plans. The projected future cost of providing these benefits is expensed over the period employees earn such benefits.

Earnings Per Share   Although basic earnings per share only considers shares of common stock outstanding during the period, the calculation of diluted earnings per share includes the following adjustments to weighted average common shares related to stock-based compensation plans: first three months of 2020 and 2019none and 1.3 million, respectively.
 
There were 0.8 million anti-dilutive potential common shares for the first three months of 2020 due to AFG’s net loss and no anti-dilutive potential common shares for the first three months of 2019.
 
Statement of Cash Flows   For cash flow purposes, “investing activities” are defined as making and collecting loans and acquiring and disposing of debt or equity instruments, property and equipment and businesses. “Financing activities” include obtaining resources from owners and providing them with a return on their investments, borrowing money and repaying amounts borrowed. Annuity receipts, surrenders, benefits and withdrawals are also reflected as financing activities. All other activities are considered “operating.” Short-term investments having original maturities of three months or less when purchased are considered to be cash equivalents for purposes of the financial statements


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B.     Acquisition of Business

Effective in June 2019, National Interstate, a property and casualty insurance subsidiary of AFG, entered into an agreement with Atlas Financial Holdings, Inc. (“AFH”) to become the exclusive underwriter of AFH’s paratransit book of business. National Interstate estimates that the majority of AFH’s $110 million paratransit business will be eligible for quotation under this arrangement over the first 12 months following inception of the agreement. Under the terms of the agreement, AFH will act as an underwriting manager for National Interstate for at least 12 months, after which time National Interstate is entitled to acquire the renewal rights for the business from AFH for a purchase price equal to 15% of the in force gross written premiums at that date. The majority of the purchase price ultimately paid for the renewal rights will be recorded as an intangible renewal rights asset and will be amortized over the estimated life of the business acquired. In connection with the transaction, AFG was granted a five-year warrant to acquire approximately 2.4 million shares of AFH (19.9% at the acquisition date). The estimated fair value of the warrant was approximately $1 million at the date it was received.

C.    Segments of Operations

AFG manages its business as three segments: (i) Property and casualty insurance, (ii) Annuity and (iii) Other, which includes holding company costs, revenues and costs of AFG’s limited insurance operations outside of property and casualty insurance and annuity segments, and operations attributable to the noncontrolling interests of the managed investment entities.

AFG reports its property and casualty insurance business in the following Specialty sub-segments: (i) Property and transportation, which includes physical damage and liability coverage for buses and trucks, inland and ocean marine, agricultural-related products and other commercial property coverages, (ii) Specialty casualty, which includes primarily excess and surplus, executive and professional liability, general liability, umbrella and excess liability, specialty coverages in targeted markets, customized programs for small to mid-sized businesses and workers’ compensation insurance, and (iii) Specialty financial, which includes risk management insurance programs for lending and leasing institutions (including equipment leasing and collateral and lender-placed mortgage property insurance), fidelity and surety products and trade credit insurance. Premiums and underwriting profit included under Other specialty represent business assumed by AFG’s internal reinsurance program from the operations that make up AFG’s other Specialty sub-segments and amortization of deferred gains on retroactive reinsurance transactions related to the sales of businesses in prior years. AFG’s annuity business sells traditional fixed and indexed annuities in the retail, financial institutions, broker-dealer and registered investment advisor markets. AFG’s reportable segments and their components were determined based primarily upon similar economic characteristics, products and services.

In December 2019, AFG initiated actions to exit the Lloyd’s of London insurance market, which included placing its Lloyd’s subsidiaries including its Lloyd’s Managing Agency, Neon Underwriting Ltd., into run-off. Neon and its predecessor, Marketform, have failed to achieve AFG’s profitability objectives since AFG’s purchase of Marketform in 2008. Beginning prospectively with the first quarter of 2020, the results for AFG’s Specialty casualty sub-segment exclude the run-off operations of Neon (“Neon exited lines”).

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AMERICAN FINANCIAL GROUP, INC. 10-Q
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The following tables (in millions) show AFG’s revenues and earnings before income taxes by segment and sub-segment.
 
Three months ended March 31,
 
2020
 
2019
Revenues
 
 
 
Property and casualty insurance:
 
 
 
Premiums earned:
 
 
 
Specialty
 
 
 
Property and transportation
$
386

 
$
361

Specialty casualty
556

 
629

Specialty financial
156

 
146

Other specialty
40

 
37

Other lines (a)
71

 

Total premiums earned
1,209

 
1,173

Net investment income (b)
93

 
104

Other income
5

 
3

Total property and casualty insurance
1,307

 
1,280

Annuity:
 
 
 
Net investment income
422

 
435

Other income
35

 
28

Total annuity
457

 
463

Other
62

 
97

Total revenues before realized gains (losses)
1,826

 
1,840

Realized gains (losses) on securities
(551
)
 
184

Total revenues
$
1,275

 
$
2,024


(a)
Represents premiums earned in the Neon exited lines during the first three months of 2020. Neon’s $88 million in earned premiums during the first three months of 2019 are included in the Specialty casualty sub-segment.
(b)
Includes a net loss of $6 million in the Neon exited lines, primarily from the change in fair value of equity securities.

 
Three months ended March 31,
 
2020
 
2019
Earnings (Loss) Before Income Taxes
 
 
 
Property and casualty insurance:
 
 
 
Underwriting:
 
 
 
Specialty
 
 
 
Property and transportation
$
27