SEC Filing | American Financial Group, Inc.

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afg-20200630

____________________________________________________________________________________________

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 June 30, 2020

☐ 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/c8f3eb2b578a7572ddcfa6e421a1639f-afg-20200630_g1.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

5.625% Subordinated Debentures due June 1, 2060

AFGD

New York Stock Exchange

5.125% Subordinated Debentures due December 15, 2059

AFGC

New York Stock Exchange

As of August 1, 2020, there were 88,540,128 shares of the Registrant’s Common Stock outstanding, excluding 14.9 million shares owned by subsidiaries.

____________________________________________________________________________________________

Table of Contents

AMERICAN FINANCIAL GROUP, INC. 10-Q

TABLE OF CONTENTS



			Page
Part I — Financial Information
Item 1 — Financial Statements:
Consolidated Balance Sheet			2
Consolidated Statement of Earnings			3
Consolidated Statement of Comprehensive Income			4
Consolidated Statement of Changes in Equity			5
Consolidated Statement of Cash Flows			7
Notes to Consolidated Financial Statements			8
Item 2 — Management’s Discussion and Analysis of Financial Condition and Results of Operations			36
Item 3 — Quantitative and Qualitative Disclosure about Market Risk			98
Item 4 — Controls and Procedures			98

Part II — Other Information
Item 1A — Risk Factors			98
Item 2 — Unregistered Sales of Equity Securities and Use of Proceeds			99
Item 6 — Exhibits			100
Signature			100

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)


	June 30, 2020		December 31, 2019
Assets:
Cash and cash equivalents	$	2,698	$	2,314
Investments:
Fixed maturities, available for sale at fair value (amortized cost — $45,670 and $44,524; allowance for expected credit losses of $61 at June 30, 2020)	48,046		46,505
Fixed maturities, trading at fair value	97		113
Equity securities, at fair value	1,602		1,937
Investments accounted for using the equity method	1,781		1,688
Mortgage loans	1,475		1,329
Policy loans	158		164
Equity index call options	605		924
Real estate and other investments	279		278
Total cash and investments	56,741		55,252
Recoverables from reinsurers	3,476		3,415
Prepaid reinsurance premiums	733		678
Agents’ balances and premiums receivable	1,366		1,335
Deferred policy acquisition costs	818		1,037
Assets of managed investment entities	4,393		4,736
Other receivables	880		975
Variable annuity assets (separate accounts)	577		628
Other assets	1,676		1,867
Goodwill	207		207
Total assets	$	70,867	$	70,130

Liabilities and Equity:
Unpaid losses and loss adjustment expenses	$	10,321	$	10,232
Unearned premiums	2,778		2,830
Annuity benefits accumulated	41,392		40,406
Life, accident and health reserves	606		612
Payable to reinsurers	746		814
Liabilities of managed investment entities	4,236		4,571
Long-term debt	1,912		1,473
Variable annuity liabilities (separate accounts)	577		628
Other liabilities	2,173		2,295
Total liabilities	64,741		63,861

Redeemable noncontrolling interests	—		—

Shareholders’ equity:
Common Stock, no par value — 200,000,000 shares authorized — 88,659,407 and 90,303,686 shares outstanding	89		90
Capital surplus	1,299		1,307
Retained earnings	3,685		4,009
Accumulated other comprehensive income, net of tax	1,053		863
Total shareholders’ equity	6,126		6,269
Noncontrolling interests	—		—
Total equity	6,126		6,269
Total liabilities and equity	$	70,867	$	70,130

Table of Contents

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 June 30,						Six months ended June 30,
	2020		2019		2020		2019
Revenues:
Property and casualty insurance net earned premiums	$	1,184	$	1,200	$	2,393	$	2,373
Net investment income	468		580		1,012		1,122

Realized gains (losses) on securities	204		56		(347)		240

Income (loss) of managed investment entities:
Investment income	49		70		108		139
Loss on change in fair value of assets/liabilities	(5)		(2)		(48)		(2)
Other income	51		56		108		112
Total revenues	1,951		1,960		3,226		3,984

Costs and Expenses:
Property and casualty insurance:
Losses and loss adjustment expenses	771		723		1,478		1,415
Commissions and other underwriting expenses	409		426		829		825
Annuity benefits	426		339		702		650
Annuity and supplemental insurance acquisition expenses	(35)		33		78		61
Interest charges on borrowed money	23		17		40		33
Expenses of managed investment entities	38		59		86		114
Other expenses	101		104		183		214
Total costs and expenses	1,733		1,701		3,396		3,312
Earnings (loss) before income taxes	218		259		(170)		672
Provision (credit) for income taxes	51		50		(33)		137
Net earnings (loss), including noncontrolling interests	167		209		(137)		535
Less: Net earnings (loss) attributable to noncontrolling interests	(10)		(1)		(13)		(4)
Net Earnings (Loss) Attributable to Shareholders	$	177	$	210	$	(124)	$	539

Earnings (Loss) Attributable to Shareholders per Common Share:
Basic	$	1.98	$	2.34	$	(1.38)	$	6.02
Diluted	$	1.97	$	2.31	$	(1.38)	$	5.94
Average number of Common Shares:
Basic	89.7		89.7		90.0		89.6
Diluted	90.0		91.0		90.0		90.8

Table of Contents

AMERICAN FINANCIAL GROUP, INC. 10-Q

AMERICAN FINANCIAL GROUP, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENT OF COMPREHENSIVE INCOME (UNAUDITED)

(In Millions)


	Three months ended June 30,						Six months ended June 30,
	2020		2019		2020		2019
Net earnings (loss), including noncontrolling interests	$	167	$	209	$	(137)	$	535
Other comprehensive income (loss), net of tax:
Net unrealized gains (losses) on securities:
Unrealized holding gains on securities arising during the period	1,021		356		156		740
Reclassification adjustment for realized (gains) losses included in net earnings	(7)		(8)		12		(11)

Total net unrealized gains on securities	1,014		348		168		729
Net unrealized gains on cash flow hedges	3		18		30		29
Foreign currency translation adjustments	4		—		(6)		4

Other comprehensive income, net of tax	1,021		366		192		762
Total comprehensive income, net of tax	1,188		575		55		1,297
Less: Comprehensive income (loss) attributable to noncontrolling interests	(10)		—		(11)		(3)
Comprehensive income attributable to shareholders	$	1,198	$	575	$	66	$	1,300

Table of Contents

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 March 31, 2020	89,827,336		$	1,399		$	3,616		$	32		$	5,047		$	—		$	5,047		$	—
Net earnings (loss)	—		—			177			—			177			—			177			(10)
Other comprehensive income	—		—			—			1,021			1,021			—			1,021			—
Dividends ($0.45 per share)	—		—			(41)			—			(41)			—			(41)			—
Shares issued:
Exercise of stock options	5,250		—			—			—			—			—			—			—
Restricted stock awards	—		—			—			—			—			—			—			—
Other benefit plans	51,955		4			—			—			4			—			4			—
Dividend reinvestment plan	2,733		—			—			—			—			—			—			—
Stock-based compensation expense	—		4			—			—			4			—			4			—
Shares acquired and retired	(1,194,236)		(19)			(57)			—			(76)			—			(76)			—
Shares exchanged — benefit plans	(540)		—			—			—			—			—			—			—
Forfeitures of restricted stock	(33,091)		—			—			—			—			—			—			—
Other	—		—			(10)			—			(10)			—			(10)			10
Balance at June 30, 2020	88,659,407		$	1,388		$	3,685		$	1,053		$	6,126		$	—		$	6,126		$	—

Balance at March 31, 2019	89,637,713		$	1,346		$	3,875		$	444		$	5,665		$	—		$	5,665		$	—
Net earnings (loss)	—		—			210			—			210			—			210			(1)
Other comprehensive income	—		—			—			365			365			—			365			1
Dividends ($1.90 per share)	—		—			(170)			—			(170)			—			(170)			—
Shares issued:
Exercise of stock options	247,753		11			—			—			11			—			11			—
Restricted stock awards	—		—			—			—			—			—			—			—
Other benefit plans	30,081		3			—			—			3			—			3			—
Dividend reinvestment plan	7,596		1			—			—			1			—			1			—
Stock-based compensation expense	—		6			—			—			6			—			6			—

Shares exchanged — benefit plans	(3,519)		—			(1)			—			(1)			—			(1)			—
Forfeitures of restricted stock	(2,023)		—			—			—			—			—			—			—
Other	—		—			—			—			—			—			—			—
Balance at June 30, 2019	89,917,601		$	1,367		$	3,914		$	809		$	6,090		$	—		$	6,090		$	—

Table of Contents

AMERICAN FINANCIAL GROUP, INC. 10-Q

AMERICAN FINANCIAL GROUP, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENT OF CHANGES IN EQUITY (UNAUDITED) — CONTINUED

(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 loss	—		—			(124)			—			(124)			—			(124)			(13)
Other comprehensive income	—		—			—			190			190			—			190			2
Dividends ($0.90 per share)	—		—			(81)			—			(81)			—			(81)			—
Shares issued:
Exercise of stock options	209,343		9			—			—			9			—			9			—
Restricted stock awards	227,867		—			—			—			—			—			—			—
Other benefit plans	66,496		5			—			—			5			—			5			—
Dividend reinvestment plan	4,350		—			—			—			—			—			—			—
Stock-based compensation expense	—		10			—			—			10			—			10			—
Shares acquired and retired	(2,020,519)		(31)			(106)			—			(137)			—			(137)			—
Shares exchanged — benefit plans	(96,394)		(2)			(9)			—			(11)			—			(11)			—
Forfeitures of restricted stock	(35,422)		—			—			—			—			—			—			—
Other	—		—			(11)			—			(11)			—			(11)			11
Balance at June 30, 2020	88,659,407		$	1,388		$	3,685		$	1,053		$	6,126		$	—		$	6,126		$	—

Balance at December 31, 2018	89,291,724		$	1,334		$	3,588		$	48		$	4,970		$	2		$	4,972		$	—
Net earnings (loss)	—		—			539			—			539			—			539			(4)
Other comprehensive income	—		—			—			761			761			—			761			1
Dividends ($2.30 per share)	—		—			(206)			—			(206)			—			(206)			—
Shares issued:
Exercise of stock options	400,006		17			—			—			17			—			17			—
Restricted stock awards	232,565		—			—			—			—			—			—			—
Other benefit plans	41,143		4			—			—			4			—			4			—
Dividend reinvestment plan	9,489		1			—			—			1			—			1			—
Stock-based compensation expense	—		12			—			—			12			—			12			—

Shares exchanged — benefit plans	(46,989)		(1)			(4)			—			(5)			—			(5)			—
Forfeitures of restricted stock	(10,337)		—			—			—			—			—			—			—
Other	—		—			(3)			—			(3)			(2)			(5)			3
Balance at June 30, 2019	89,917,601		$	1,367		$	3,914		$	809		$	6,090		$	—		$	6,090		$	—

Table of Contents

AMERICAN FINANCIAL GROUP, INC. 10-Q

AMERICAN FINANCIAL GROUP, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENT OF CASH FLOWS (UNAUDITED)

(In Millions)


	Six months ended June 30,
	2020		2019
Operating Activities:
Net earnings (loss), including noncontrolling interests	$	(137)	$	535
Adjustments:
Depreciation and amortization	79		72
Annuity benefits	702		650
Realized (gains) losses on investing activities	346		(241)
Net sales of trading securities	11		—
Deferred annuity and life policy acquisition costs	(79)		(120)
Change in:
Reinsurance and other receivables	46		85
Other assets	211		(298)
Insurance claims and reserves	30		(92)
Payable to reinsurers	(68)		3
Other liabilities	(233)		329
Managed investment entities’ assets/liabilities	116		(3)
Other operating activities, net	63		(43)
Net cash provided by operating activities	1,087		877

Investing Activities:
Purchases of:
Fixed maturities	(6,121)		(3,761)
Equity securities	(324)		(80)
Mortgage loans	(152)		(43)
Equity index options and other investments	(501)		(467)
Real estate, property and equipment	(20)		(20)

Proceeds from:
Maturities and redemptions of fixed maturities	2,343		2,347
Repayments of mortgage loans	7		38
Sales of fixed maturities	2,777		459
Sales of equity securities	342		139
Sales and settlements of equity index options and other investments	404		329
Sales of real estate, property and equipment	4		2


Managed investment entities:
Purchases of investments	(603)		(697)
Proceeds from sales and redemptions of investments	540		702
Other investing activities, net	8		—
Net cash used in investing activities	(1,296)		(1,052)

Financing Activities:
Annuity receipts	2,097		2,744
Annuity surrenders, benefits and withdrawals	(1,641)		(1,668)
Ceded annuity receipts	(78)		—
Net transfers from variable annuity assets	28		28
Additional long-term borrowings	439		121


Retirements of managed investment entities’ liabilities	(46)		(5)
Issuances of Common Stock	12		19
Repurchases of Common Stock	(137)		—
Cash dividends paid on Common Stock	(81)		(205)

Net cash provided by financing activities	593		1,034
Net Change in Cash and Cash Equivalents	384		859
Cash and cash equivalents at beginning of period	2,314		1,515
Cash and cash equivalents at end of period	$	2,698	$	2,374

Table of Contents

AMERICAN FINANCIAL GROUP, INC. 10-Q

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

INDEX TO NOTES

Accounting Policies

Managed Investment Entities

Acquisition of Businesses

Goodwill and Other Intangibles

Segments of Operations

Long-Term Debt

Fair Value Measurements

Shareholders’ Equity

Investments

Income Taxes

Derivatives

Contingencies

Deferred Policy Acquisition Costs

Insurance

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 June 30, 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 six 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).

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

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AMERICAN FINANCIAL GROUP, INC. 10-Q

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — CONTINUED

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 loans (net of any allowance) 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. 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.

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

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AMERICAN FINANCIAL GROUP, INC. 10-Q

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — CONTINUED

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.

Certain reinsurance arrangements in AFG’s annuity operations do not transfer significant insurance risk and are therefore accounted for using the deposit method. This accounting treatment results in amounts paid by AFG to the reinsurer to be recorded as a deposit asset. The reinsurance deposit asset is adjusted as amounts are paid or received under the underlying contracts.

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.

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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.

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.

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Annuity benefits accumulated also includes amounts advanced from the Federal Home Loan Bank of Cincinnati.

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 June 30, 2020 AFG has a $184 million lease liability included in other liabilities and a lease right-of-use asset of $163 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

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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, 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: second quarter 2020 and 2019 — 0.3 million and 1.3 million; first six months of 2020 and 2019 — none and 1.2 million, respectively.

There were 0.6 million anti-dilutive potential common shares for the first six months of 2020 due to AFG’s net loss and no anti-dilutive potential common shares for the second quarter of 2020 or 2019 or the first six 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.

B. Acquisition of Businesses

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 following inception of the agreement. Under the terms of the agreement (as extended in 2020), AFH will act as an underwriting manager for National Interstate until at least August 2021 for fleets with seven or fewer vehicles and until November 2020 for accounts with eight or more vehicles, 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.

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On June 30, 2020, AFG acquired 100% of the indirect noncontrolling interest in Neon, its United Kingdom-based Lloyd’s insurer from certain former and current Neon executives for cash based on the nominal fair value of the interest acquired as determined by a third-party valuation firm.

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.

The following tables (in millions) show AFG’s revenues and earnings before income taxes by segment and sub-segment.


	Three months ended June 30,						Six months ended June 30,
	2020		2019		2020		2019
Revenues
Property and casualty insurance:
Premiums earned:
Specialty
Property and transportation	$	390	$	379	$	776	$	740
Specialty casualty	547		634		1,103		1,263
Specialty financial	144		151		300		297
Other specialty	42		36		82		73
Other lines (a)	61		—		132		—
Total premiums earned	1,184		1,200		2,393		2,373
Net investment income (b)	72		124		165		228
Other income	3		2		8		5
Total property and casualty insurance	1,259		1,326		2,566		2,606
Annuity:
Net investment income	384		451		806		886
Other income	30		30		65		58
Total annuity	414		481		871		944
Other	74		97		136		194
Total revenues before realized gains (losses)	1,747		1,904		3,573		3,744
Realized gains (losses) on securities	204		56		(347)		240

Total revenues	$	1,951	$	1,960	$	3,226	$	3,984

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(a)Represents premiums earned in the Neon exited lines during the second quarter and first six months of 2020. Neon’s $89 million and $177 million in earned premiums during the second quarter and first six months of 2019, respectively, are included in the Specialty casualty sub-segment.

(b)Includes income of less than $1 million for the second quarter of 2020 and a loss of $6 million in the Neon exited lines in the first six months of 2020 (primarily from the change in fair value of equity securities).


	Three months ended June 30,						Six months ended June 30,
	2020		2019		2020		2019
Earnings (Loss) Before Income Taxes
Property and casualty insurance:
Underwriting:
Specialty
Property and transportation	$	33	$	4	$	60	$	43
Specialty casualty	27		47		79		83
Specialty financial	—		21		17		34
Other specialty	(6)		(12)		(13)		(12)
Other lines (a)	(45)		(1)		(47)		(2)
Total underwriting	9		59		96		146
Investment and other income, net (b)	65		115		149		210
Total property and casualty insurance	74		174		245		356
Annuity	(17)		71		12		161
Other (c)	(43)		(42)		(80)		(85)
Total earnings before realized gains (losses) and income taxes	14		203		177		432
Realized gains (losses) on securities	204		56		(347)		240

Total earnings (loss) before income taxes	$	218	$	259	$	(170)	$	672

(a)Includes an underwriting loss of $43 million in the second quarter of 2020 and $44 million in the first six months of 2020 in the Neon exited lines. Neon’s $4 million and $14 million underwriting losses in the second quarter and first six months of 2019, respectively, are included in the Specialty casualty sub-segment.

(b)Includes $1 million and $10 million in the second quarter and first six months of 2020, respectively, in net expenses from the Neon exited lines, before noncontrolling interest.

(c)Includes holding company interest and expenses.

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D. Fair Value Measurements

Accounting standards for measuring fair value are based on inputs used in estimating fair value. The three levels of the hierarchy are as follows:

Level 1 — Quoted prices for identical assets or liabilities in active markets (markets in which transactions occur with sufficient frequency and volume to provide pricing information on an ongoing basis). AFG’s Level 1 financial instruments consist primarily of publicly traded equity securities, highly liquid government bonds for which quoted market prices in active markets are available and short-term investments of managed investment entities.

Level 2 — Quoted prices for similar instruments in active markets; quoted prices for identical or similar assets or liabilities in inactive markets (markets in which there are few transactions, the prices are not current, price quotations vary substantially over time or among market makers, or in which little information is released publicly); and valuations based on other significant inputs that are observable in active markets. AFG’s Level 2 financial instruments include separate account assets, corporate and municipal fixed maturity securities, asset-backed securities (“ABS”), mortgage-backed securities (“MBS”), certain non-affiliated common stocks, equity index options and investments of managed investment entities priced using observable inputs. Level 2 inputs include benchmark yields, reported trades, corroborated broker/dealer quotes, issuer spreads and benchmark securities. When non-binding broker quotes can be corroborated by comparison to similar securities priced using observable inputs, they are classified as Level 2.

Level 3 — Valuations derived from market valuation techniques generally consistent with those used to estimate the fair values of Level 2 financial instruments in which one or more significant inputs are unobservable or when the market for a security exhibits significantly less liquidity relative to markets supporting Level 2 fair value measurements. The unobservable inputs may include management’s own assumptions about the assumptions market participants would use based on the best information available at the valuation date. Financial instruments whose fair value is estimated based on non-binding broker quotes or internally developed using significant inputs not based on, or corroborated by, observable market information are classified as Level 3.

As discussed in Note A — “Accounting Policies — Managed Investment Entities,” AFG has set the carrying value of its 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 separately measured fair values. As a result, the CLO liabilities are categorized within the fair value hierarchy on the same basis (proportionally) as the related CLO assets. Since the portion of the CLO liabilities allocated to Level 3 is derived from the fair value of the CLO assets, these amounts are excluded from the progression of Level 3 financial instruments.

AFG’s management is responsible for the valuation process and uses data from outside sources (including nationally recognized pricing services and broker/dealers) in establishing fair value. AFG’s internal investment professionals are a group of approximately 20 analysts whose primary responsibility is to manage AFG’s investment portfolio. These professionals monitor individual investments as well as overall industries and are active in the financial markets on a daily basis. The group is led by AFG’s chief investment officer, who reports directly to one of AFG’s Co-CEOs. 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, the Company communicates directly with the pricing services regarding the methods and assumptions used in pricing, including verifying, on a test basis, the inputs used by the service to value specific securities.

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Assets and liabilities measured and carried at fair value in the financial statements are summarized below (in millions):


	Level 1		Level 2		Level 3		Total
June 30, 2020
Assets:
Available for sale (“AFS”) fixed maturities:
U.S. Government and government agencies	$	167	$	28	$	15	$	210
States, municipalities and political subdivisions	—		6,844		107		6,951
Foreign government	—		184		—		184
Residential MBS	—		3,066		156		3,222
Commercial MBS	—		856		33		889
Collateralized loan obligations	—		4,300		207		4,507
Other asset-backed securities	—		5,987		1,328		7,315
Corporate and other	28		23,215		1,525		24,768
Total AFS fixed maturities	195		44,480		3,371		48,046
Trading fixed maturities	1		96		—		97
Equity securities	1,075		75		452		1,602
Equity index call options	—		605		—		605
Assets of managed investment entities (“MIE”)	151		4,225		17		4,393
Variable annuity assets (separate accounts) (*)	—		577		—		577
Other assets — derivatives	—		124		—		124
Total assets accounted for at fair value	$	1,422	$	50,182	$	3,840	$	55,444
Liabilities:
Liabilities of managed investment entities	$	145	$	4,074	$	17	$	4,236
Derivatives in annuity benefits accumulated	—		—		3,675		3,675
Other liabilities — derivatives	—		10		—		10
Total liabilities accounted for at fair value	$	145	$	4,084	$	3,692	$	7,921

December 31, 2019
Assets:
Available for sale fixed maturities:
U.S. Government and government agencies	$	151	$	43	$	15	$	209
States, municipalities and political subdivisions	—		6,858		105		6,963
Foreign government	—		172		—		172
Residential MBS	—		2,987		173		3,160
Commercial MBS	—		892		35		927
Collateralized loan obligations	—		4,265		15		4,280
Other asset-backed securities	—		5,842		1,286		7,128
Corporate and other	29		21,879		1,758		23,666
Total AFS fixed maturities	180		42,938		3,387		46,505
Trading fixed maturities	2		111		—		113
Equity securities	1,433		67		437		1,937
Equity index call options	—		924		—		924
Assets of managed investment entities	213		4,506		17		4,736
Variable annuity assets (separate accounts) (*)	—		628		—		628
Other assets — derivatives	—		50		—		50
Total assets accounted for at fair value	$	1,828	$	49,224	$	3,841	$	54,893
Liabilities:
Liabilities of managed investment entities	$	206	$	4,349	$	16	$	4,571
Derivatives in annuity benefits accumulated	—		—		3,730		3,730
Other liabilities — derivatives	—		10		—		10
Total liabilities accounted for at fair value	$	206	$	4,359	$	3,746	$	8,311

(*)Variable annuity liabilities equal the fair value of variable annuity assets.

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Approximately 7% of the total assets carried at fair value at June 30, 2020, were Level 3 assets. Approximately 37% ($1.40 billion) of the Level 3 assets were priced using non-binding broker quotes, for which there is a lack of transparency as to the inputs used to determine fair value. Details as to the quantitative inputs are neither provided by the brokers nor otherwise reasonably obtainable by AFG.

Internally developed Level 3 asset fair values represent approximately $1.87 billion at June 30, 2020. Of this amount, approximately $736 million relates to fixed maturity securities that were priced using management’s best estimate of an appropriate credit spread over the treasury yield (of a similar duration) to discount future expected cash flows using a third-party model. The credit spread applied by management is the significant unobservable input. For this group of 41 securities, the average spread used was 389 basis points over the reference treasury yield and the spreads ranged from 53 basis points to 1,253 basis points (approximately 70% of the spreads were between 200 and 700 basis points). Had management used higher spreads, the fair value of this group of securities would have been lower. Conversely, if the spreads used were lower, the fair values would have been higher. For the remainder of the internally developed prices, any justifiable changes in unobservable inputs used to determine fair value would not have resulted in a material change in AFG’s financial position.

The derivatives embedded in AFG’s fixed-indexed and variable-indexed annuity liabilities are measured using a discounted cash flow approach and had a fair value of $3.68 billion at June 30, 2020. The following table presents information about the unobservable inputs used by management in determining fair value of these Level 3 liabilities. See Note F — “Derivatives.”

Unobservable Input

Range

Adjustment for insurance subsidiary’s credit risk

0.2% – 3.5% over the risk-free rate

Risk margin for uncertainty in cash flows

0.80% reduction in the discount rate

Surrenders

4% – 21% of indexed account value

Partial surrenders

2% – 9% of indexed account value

Annuitizations

0.1% – 1% of indexed account value

Deaths

1.9% – 10.7% of indexed account value

Budgeted option costs

2.5% – 3.3% of indexed account value

The range of adjustments for insurance subsidiary’s credit risk is based on the Moody’s corporate A2 bond index and reflects credit spread variations across the yield curve. The range of projected surrender rates reflects the specific surrender charges and other features of AFG’s individual fixed-indexed and variable-indexed annuity products with an expected range of 7% to 10% in the majority of future calendar years (4% to 21% over all periods). Increasing the budgeted option cost or risk margin for uncertainty in cash flow assumptions in the table above would increase the fair value of the fixed-indexed and variable-indexed annuity embedded derivatives, while increasing any of the other unobservable inputs in the table above would decrease the fair value of the embedded derivatives.

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AMERICAN FINANCIAL GROUP, INC. 10-Q

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — CONTINUED

Changes in balances of Level 3 financial assets and liabilities carried at fair value during the second quarter and first six months of 2020 and 2019 are presented below (in millions). The transfers into and out of Level 3 were due to changes in the availability of market observable inputs. All transfers are reflected in the table at fair value as of the end of the reporting period.


				Total realized/unrealized gains (losses) included in
			Balance at March 31, 2020			Net earnings (loss)			Other comprehensive income (loss)			Purchases and issuances			Sales and settlements			Transfer into Level 3			Transfer out of Level 3			Balance at June 30, 2020
AFS fixed maturities:
U.S. government agency	$	15		$	1		$	(1)		$	—		$	—		$	—		$	—		$	15
State and municipal	105			—			5			—			(1)			—			(2)			107
Residential MBS	163			—			4			—			(4)			—			(7)			156
Commercial MBS	32			1			—			—			—			—			—			33
Collateralized loan obligations	168			(3)			13			—			—			29			—			207
Other asset-backed securities	1,030			—			4			198			(25)			121			—			1,328
Corporate and other	1,548			1			47			48			(20)			4			(103)			1,525
Total AFS fixed maturities	3,061			—			72			246			(50)			154			(112)			3,371
Equity securities	436			(1)			—			17			—			—			—			452
Assets of MIE	16			(1)			—			—			—			2			—			17
Total Level 3 assets	$	3,513		$	(2)		$	72		$	263		$	(50)		$	156		$	(112)		$	3,840

Embedded derivatives	$	(3,099)		$	(601)		$	—		$	(46)		$	71		$	—		$	—		$	(3,675)
Total Level 3 liabilities (*)	$	(3,099)		$	(601)		$	—		$	(46)		$	71		$	—		$	—		$	(3,675)


				Total realized/unrealized gains (losses) included in
			Balance at March 31, 2019			Net earnings (loss)			Other comprehensive income (loss)			Purchases and issuances			Sales and settlements			Transfer into Level 3			Transfer out of Level 3			Balance at June 30, 2019
AFS fixed maturities:
U.S. government agency	$	8		$	—		$	—		$	—		$	—		$	—		$	—		$	8
State and municipal	63			—			2			—			(1)			18			—			82
Residential MBS	169			4			—			—			(4)			2			(32)			139
Commercial MBS	55			2			—			—			(2)			—			(5)			50
Collateralized loan obligations	37			—			—			—			—			13			—			50
Other asset-backed securities	633			—			3			17			(18)			—			(268)			367
Corporate and other	2,346			—			20			229			(161)			2			(422)			2,014
Total AFS fixed maturities	3,311			6			25			246			(186)			35			(727)			2,710
Equity securities	354			(1)			—			19			(1)			6			—			377
Assets of MIE	20			(1)			—			—			—			—			—			19
Total Level 3 assets	$	3,685		$	4		$	25		$	265		$	(187)		$	41		$	(727)		$	3,106

Embedded derivatives	$	(3,247)		$	(251)		$	—		$	(101)		$	58		$	—		$	—		$	(3,541)
Total Level 3 liabilities (*)	$	(3,247)		$	(251)		$	—		$	(101)		$	58		$	—		$	—		$	(3,541)

(*)As previously discussed, these tables exclude the portion of MIE liabilities allocated to Level 3, which are derived from the fair value of MIE assets.

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AMERICAN FINANCIAL GROUP, INC. 10-Q

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — CONTINUED


				Total realized/unrealized gains (losses) included in
			Balance at December 31, 2019			Net earnings (loss)			Other comprehensive income (loss)			Purchases and issuances			Sales and settlements			Transfer into Level 3			Transfer out of Level 3			Balance at June 30, 2020
AFS fixed maturities:
U.S. government agency	$	15		$	2		$	(2)		$	—		$	—		$	—		$	—		$	15
State and municipal	105			—			6			—			(2)			—			(2)			107
Residential MBS	173			5			(8)			—			(9)			2			(7)			156
Commercial MBS	35			1			—			—			(3)			—			—			33
Collateralized loan obligations	15			(10)			15			—			—			187			—			207
Other asset-backed securities	1,286			(14)			(7)			275			(203)			134			(143)			1,328
Corporate and other	1,758			(2)			20			167			(56)			9			(371)			1,525
Total AFS fixed maturities	3,387			(18)			24			442			(273)			332			(523)			3,371
Equity securities	437			(25)			—			23			—			17			—			452
Assets of MIE	17			(2)			—			—			—			2			—			17
Total Level 3 assets	$	3,841		$	(45)		$	24		$	465		$	(273)		$	351		$	(523)		$	3,840

Embedded derivatives	$	(3,730)		$	46		$	—		$	(124)		$	133		$	—		$	—		$	(3,675)
Total Level 3 liabilities (*)	$	(3,730)		$	46		$	—		$	(124)		$	133		$	—		$	—		$	(3,675)


				Total realized/unrealized gains (losses) included in
			Balance at December 31, 2018			Net earnings (loss)			Other comprehensive income (loss)			Purchases and issuances			Sales and settlements			Transfer into Level 3			Transfer out of Level 3			Balance at June 30, 2019
AFS fixed maturities:
U.S. government agency	$	9		$	—		$	—		$	—		$	(1)		$	—		$	—		$	8
State and municipal	59			—			7			—			(2)			18			—			82
Residential MBS	197			9			(5)			—			(10)			2			(54)			139
Commercial MBS	56			2			—			—			(3)			—			(5)			50
Collateralized loan obligations	116			(3)			6			—			—			13			(82)			50
Other asset-backed securities	731			—			5			92			(132)			—			(329)			367
Corporate and other	1,996			2			51			661			(249)			2			(449)			2,014
Total AFS fixed maturities	3,164			10			64			753			(397)			35			(919)			2,710
Equity securities	336			—			—			20			(1)			22			—			377
Assets of MIE	21			(2)			—			—			—			—			—			19
Total Level 3 assets	$	3,521		$	8		$	64		$	773		$	(398)		$	57		$	(919)		$	3,106

Embedded derivatives	$	(2,720)		$	(713)		$	—		$	(213)		$	105		$	—		$	—		$	(3,541)
Total Level 3 liabilities (*)	$	(2,720)		$	(713)		$	—		$	(213)		$	105		$	—		$	—		$	(3,541)

(*)As previously discussed, these tables exclude the portion of MIE liabilities allocated to Level 3, which are derived from the fair value of the MIE assets.

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AMERICAN FINANCIAL GROUP, INC. 10-Q

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — CONTINUED

Fair Value of Financial Instruments The carrying value and fair value of financial instruments that are not carried at fair value in the financial statements are summarized below (in millions):


	Carrying		Fair Value
	Value		Total		Level 1		Level 2		Level 3
June 30, 2020
Financial assets:
Cash and cash equivalents	$	2,698	$	2,698	$	2,698	$	—	$	—
Mortgage loans	1,475		1,492		—		—		1,492
Policy loans	158		158		—		—		158
Total financial assets not accounted for at fair value	$	4,331	$	4,348	$	2,698	$	—	$	1,650
Financial liabilities:
Annuity benefits accumulated (*)	$	41,137	$	42,462	$	—	$	—	$	42,462
Long-term debt	1,912		2,060		—		2,057		3
Total financial liabilities not accounted for at fair value	$	43,049	$	44,522	$	—	$	2,057	$	42,465

December 31, 2019
Financial assets:
Cash and cash equivalents	$	2,314	$	2,314	$	2,314	$	—	$	—
Mortgage loans	1,329		1,346		—		—		1,346
Policy loans	164		164		—		—		164
Total financial assets not accounted for at fair value	$	3,807	$	3,824	$	2,314	$	—	$	1,510
Financial liabilities:
Annuity benefits accumulated (*)	$	40,159	$	40,182	$	—	$	—	$	40,182
Long-term debt	1,473		1,622		—		1,619		3
Total financial liabilities not accounted for at fair value	$	41,632	$	41,804	$	—	$	1,619	$	40,185

(*)Excludes $255 million and $247 million of life contingent annuities in the payout phase at June 30, 2020 and December 31, 2019, respectively.

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AMERICAN FINANCIAL GROUP, INC. 10-Q

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — CONTINUED

E. Investments

Available for sale fixed maturities at June 30, 2020 and December 31, 2019, consisted of the following (in millions):


	Amortized Cost		Allowance for Expected Credit Losses		Gross Unrealized						Net Unrealized		Fair Value
														Gains	Losses
June 30, 2020
Fixed maturities:
U.S. Government and government agencies	$	196	$	—	$	14	$	—	$	14	$	210
States, municipalities and political subdivisions	6,373		—		581		(3)		578		6,951
Foreign government	176		—		8		—		8		184
Residential MBS	3,000		5		239		(12)		227		3,222
Commercial MBS	852		—		39		(2)		37		889
Collateralized loan obligations	4,625		20		16		(114)		(98)		4,507
Other asset-backed securities	7,400		14		118		(189)		(71)		7,315
Corporate and other	23,048		22		1,879		(137)		1,742		24,768
Total fixed maturities	$	45,670	$	61	$	2,894	$	(457)	$	2,437	$	48,046

December 31, 2019
Fixed maturities:
U.S. Government and government agencies	$	199	$	—	$	10	$	—	$	10	$	209
States, municipalities and political subdivisions	6,604		—		363		(4)		359		6,963
Foreign government	170		—		3		(1)		2		172
Residential MBS	2,900		—		265		(5)		260		3,160
Commercial MBS	896		—		31		—		31		927
Collateralized loan obligations	4,307		—		10		(37)		(27)		4,280
Other asset-backed securities	6,992		—		156		(20)		136		7,128
Corporate and other	22,456		—		1,231		(21)		1,210		23,666
Total fixed maturities	$	44,524	$	—	$	2,069	$	(88)	$	1,981	$	46,505

Equity securities, which are reported at fair value with holding gains and losses recognized in net earnings, consisted of the following at June 30, 2020 and December 31, 2019 (in millions):


	June 30, 2020												December 31, 2019
						Fair Value							Fair Value
	Actual Cost					over (under)			Actual Cost				over (under)
					Fair Value			Cost					Fair Value		Cost
Common stocks	$	1,178	$	885		$	(293)		$	1,164	$	1,283	$	119
Perpetual preferred stocks	730		717			(13)			640		654		14
Total equity securities carried at fair value	$	1,908	$	1,602		$	(306)		$	1,804	$	1,937	$	133

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AMERICAN FINANCIAL GROUP, INC. 10-Q

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — CONTINUED

The following tables show gross unrealized losses (dollars in millions) on available for sale fixed maturities by investment category and length of time that individual securities have been in a continuous unrealized loss position at the following balance sheet dates.


	Less Than Twelve Months															Twelve Months or More
			Unrealized Loss			Fair Value			Fair Value as % of Cost			Unrealized Loss			Fair Value			Fair Value as % of Cost
June 30, 2020
Fixed maturities:
U.S. Government and government agencies	$	—		$	4		100	%		$	—		$	—		—	%
States, municipalities and political subdivisions	(3)			112			97	%		—			18			100	%
Foreign government	—			2			100	%		—			—			—	%
Residential MBS	(10)			328			97	%		(2)			34			94	%
Commercial MBS	(2)			57			97	%		—			—			—	%
Collateralized loan obligations	(44)			1,732			98	%		(70)			1,510			96	%
Other asset-backed securities	(176)			2,918			94	%		(13)			133			91	%
Corporate and other	(121)			2,826			96	%		(16)			204			93	%
Total fixed maturities	$	(356)		$	7,979		96	%		$	(101)		$	1,899		95	%

December 31, 2019
Fixed maturities:
U.S. Government and government agencies	$	—		$	16		100	%		$	—		$	11		100	%
States, municipalities and political subdivisions	(3)			254			99	%		(1)			82			99	%
Foreign government	(1)			70			99	%		—			—			—	%
Residential MBS	(4)			509			99	%		(1)			69			99	%
Commercial MBS	—			17			100	%		—			—			—	%
Collateralized loan obligations	(11)			1,284			99	%		(26)			1,728			99	%
Other asset-backed securities	(12)			1,211			99	%		(8)			123			94	%
Corporate and other	(13)			1,100			99	%		(8)			211			96	%
Total fixed maturities	$	(44)		$	4,461		99	%		$	(44)		$	2,224		98	%

At June 30, 2020, the gross unrealized losses on fixed maturities of $457 million relate to 993 securities. Investment grade securities (as determined by nationally recognized rating agencies) represented approximately 83% of the gross unrealized loss and 86% of the fair value.

To evaluate fixed maturities for expected credit losses (impairment), management considers whether the unrealized loss is credit-driven or a result of changes in market interest rates, the extent to which fair value is less than cost basis, historical operating, balance sheet and cash flow data from the issuer, third party research and communications with industry specialists and discussions with issuer management.

AFG analyzes its MBS securities for expected credit losses (impairment) each quarter based upon expected future cash flows. Management estimates expected future cash flows based upon its knowledge of the MBS market, cash flow projections (which reflect loan to collateral values, subordination, vintage and geographic concentration) received from independent sources, implied cash flows inherent in security ratings and analysis of historical payment data.

Management believes AFG will recover its cost basis (net of any allowance) in the securities with unrealized losses and that AFG has the ability to hold the securities until they recover in value and had no intent to sell them at June 30, 2020.

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AMERICAN FINANCIAL GROUP, INC. 10-Q

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — CONTINUED

See Note A — “Accounting Policies — Credit Losses on Financial Instruments,” for a discussion of new guidance effective January 1, 2020, which impacts the accounting for expected credit losses (impairments) of fixed maturity securities. Under the new guidance, credit losses on available for sale fixed maturities continue to be measured based on the present value of expected future cash flows compared to amortized cost; however, impairment losses are now recognized through an allowance instead of a direct writedown of amortized cost. Under the new guidance, recoveries of previously impaired amounts are recorded as an immediate reversal of all or a portion of the allowance instead of accreted as investment income through a yield adjustment. In addition, the allowance on available for sale fixed maturities cannot cause the amortized cost net of the allowance to be below fair value. Accordingly, future changes in the fair value of an impaired security (when the allowance was limited by the fair value) due to reasons other than issuer credit (e.g. changes in market interest rates) result in increases or decreases in the allowance, which are recorded through realized gains (losses) on securities. A progression of the allowance for expected credit losses on fixed maturity securities is shown below (in millions):


	Structured Securities (*)		Corporate and Other		Total
Balance at March 31	$	37	$	24	$	61

Initial allowance for purchased securities with credit deterioration	1		—		1
Provision for expected credit losses on securities with no previous allowance	2		4		6
Additions (reductions) to previously recognized expected credit losses	(1)		(6)		(7)
Reductions due to sales or redemptions	—		—		—
Balance at June 30	$	39	$	22	$	61

Balance at January 1	$	—	$	—	$	—
Impact of adoption of new accounting policy	—		—		—
Initial allowance for purchased securities with credit deterioration	1		—		1
Provision for expected credit losses on securities with no previous allowance	39		28		67
Additions (reductions) to previously recognized expected credit losses	(1)		(6)		(7)
Reductions due to sales or redemptions	—		—		—
Balance at June 30	$	39	$	22	$	61

(*)Includes mortgage-backed securities, collateralized loan obligations and other asset-backed securities.

In the second quarter of 2020, AFG purchased two residential mortgage-backed securities with expected credit losses. In aggregate at the time of purchase, the par value was $8 million, the purchase price was $6 million and both the allowance for credit losses and the discount were $1 million.

The table below sets forth the scheduled maturities of available for sale fixed maturities as of June 30, 2020 (dollars in millions). 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.


	Amortized			Fair Value
			Cost, net (*)			Amount			%
Maturity
One year or less	$	1,851		$	1,874		4	%
After one year through five years	10,604			11,212			23	%
After five years through ten years	14,125			15,485			32	%
After ten years	3,191			3,542			7	%
	29,771			32,113			66	%
Collateralized loan obligations and other ABS (average life of approximately 4 years)	11,991			11,822			25	%
MBS (average life of approximately 3-1/2 years)	3,847			4,111			9	%
Total	$	45,609		$	48,046		100	%

(*)Amortized cost, net of allowance for expected credit losses.

Certain risks are inherent in fixed maturity securities, including loss upon default, price volatility in reaction to changes in interest rates, and general market factors and risks associated with reinvestment of proceeds due to prepayments or redemptions in a period of declining interest rates.

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AMERICAN FINANCIAL GROUP, INC. 10-Q

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — CONTINUED

There were no investments in individual issuers that exceeded 10% of shareholders’ equity at June 30, 2020 or December 31, 2019.

Net Unrealized Gain on Marketable Securities In addition to adjusting fixed maturity securities classified as “available for sale” to fair value, GAAP requires that deferred policy acquisition costs and certain other balance sheet amounts related to annuity, long-term care and life businesses be adjusted to the extent that unrealized gains and losses from securities would result in adjustments to those balances had the unrealized gains or losses actually been realized.

The following table shows (in millions) the components of the net unrealized gain on securities that is included in AOCI in AFG’s Balance Sheet.


	Pretax		Deferred Tax		Net
June 30, 2020
Net unrealized gain on:
Fixed maturities — annuity segment (*)	$	2,031	$	(427)	$	1,604
Fixed maturities — all other	406		(85)		321
Total fixed maturities	2,437		(512)		1,925
Deferred policy acquisition costs — annuity segment	(877)		184		(693)
Annuity benefits accumulated	(269)		57		(212)
Life, accident and health reserves	(1)		—		(1)
Unearned revenue	14		(3)		11
Total net unrealized gain on marketable securities	$	1,304	$	(274)	$	1,030

December 31, 2019
Net unrealized gain on:
Fixed maturities — annuity segment (*)	$	1,611	$	(338)	$	1,273
Fixed maturities — all other	370		(78)		292
Total fixed maturities	1,981		(416)		1,565
Deferred policy acquisition costs — annuity segment	(681)		143		(538)
Annuity benefits accumulated	(219)		46		(173)
Life, accident and health reserves	(1)		—		(1)
Unearned revenue	11		(2)		9
Total net unrealized gain on marketable securities	$	1,091	$	(229)	$	862

(*)Net unrealized gains on fixed maturity investments supporting AFG’s annuity benefits accumulated.

Net Investment Income The following table shows (in millions) investment income earned and investment expenses incurred.


	Three months ended June 30,						Six months ended June 30,
	2020		2019		2020		2019
Investment income:
Fixed maturities	$	485	$	478	$	976	$	947
Equity securities:
Dividends	16		22		33		44
Change in fair value (a) (b)	9		7		(3)		18
Equity in earnings of partnerships and similar investments	(54)		45		(29)		66
Other	18		34		46		59
Gross investment income	474		586		1,023		1,134
Investment expenses	(6)		(6)		(11)		(12)
Net investment income (b)	$	468	$	580	$	1,012	$	1,122

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AMERICAN FINANCIAL GROUP, INC. 10-Q

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — CONTINUED

(a)Although the change in the fair value of the majority of AFG’s equity securities is recorded in realized gains (losses) on securities, AFG records holding gains and losses in net investment income on equity securities classified as “trading” under previous guidance and on a small portfolio of limited partnership and similar investments that do not qualify for the equity method of accounting.

(b)Net investment income in the second quarter and first six months of 2020 includes income of less than $1 million and losses of $6 million, respectively, on investments held by the companies that comprise the Neon exited lines due primarily to the $7 million loss in first quarter of 2020 recorded on equity securities that are carried at fair value through net investment income.

Realized gains (losses) and changes in unrealized appreciation (depreciation) included in AOCI related to fixed maturity and equity security investments are summarized as follows (in millions):


	Three months ended June 30, 2020														Three months ended June 30, 2019
	Realized gains (losses)												Realized gains (losses)
	Before Impairments		Impairment Allowance		Total		Change in Unrealized		Before Impairments		Impairments		Total		Change in Unrealized
Fixed maturities	$	3	$	1	$	4	$	2,343	$	11	$	(3)	$	8	$	789
Equity securities	202		—		202		—		44		—		44		—
Mortgage loans and other investments	—		—		—		—		3		—		3		—
Other (*)	(2)		—		(2)		(1,059)		—		1		1		(349)
Total pretax	203		1		204		1,284		58		(2)		56		440
Tax effects	(43)		—		(43)		(270)		(12)		1		(11)		(92)

Net of tax	$	160	$	1	$	161	$	1,014	$	46	$	(1)	$	45	$	348

	Six months ended June 30, 2020														Six months ended June 30, 2019
	Realized gains (losses)												Realized gains (losses)
	Before Impairments		Impairment Allowance		Total		Change in Unrealized		Before Impairments		Impairments		Total		Change in Unrealized
Fixed maturities	$	32	$	(60)	$	(28)	$	456	$	14	$	(6)	$	8	$	1,642
Equity securities	(333)		—		(333)		—		226		—		226		—
Mortgage loans and other investments	4		—		4		—		3		—		3		—
Other (*)	(5)		15		10		(243)		1		2		3		(719)
Total pretax	(302)		(45)		(347)		213		244		(4)		240		923
Tax effects	63		10		73		(45)		(51)		1		(50)		(194)

Net of tax	$	(239)	$	(35)	$	(274)	$	168	$	193	$	(3)	$	190	$	729

(*)Primarily adjustments to deferred policy acquisition costs and reserves related to the annuity business.

All equity securities other than those accounted for under the equity method are carried at fair value through net earnings. AFG recorded net holding gains (losses) on equity securities during the second quarter and first six months of 2020 and 2019 on securities that were still owned at June 30, 2020 and June 30, 2019 as follows (in millions):


	Three months ended June 30,						Six months ended June 30,
	2020		2019		2020		2019
Included in realized gains (losses)	$	161	$	38	$	(340)	$	193
Included in net investment income	10		7		4		18
	$	171	$	45	$	(336)	$	211

Gross realized gains and losses (excluding impairment write-downs and mark-to-market of derivatives) on available for sale fixed maturity investment transactions consisted of the following (in millions):


	Six months ended June 30,
			2020			2019
Gross gains	$	56		$	11
Gross losses	(31)			(9)

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AMERICAN FINANCIAL GROUP, INC. 10-Q

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — CONTINUED

F. Derivatives

As discussed under “Derivatives” in Note A — “Accounting Policies,” AFG uses derivatives in certain areas of its operations.

Derivatives That Do Not Qualify for Hedge Accounting The following derivatives that do not qualify for hedge accounting under GAAP are included in AFG’s Balance Sheet at fair value (in millions):


		June 30, 2020						December 31, 2019
Derivative	Balance Sheet Line	Asset		Liability		Asset		Liability
MBS with embedded derivatives	Fixed maturities	$	171	$	—	$	102	$	—

Fixed-indexed and variable-indexed annuities (embedded derivative)	Annuity benefits accumulated	—		3,675		—		3,730
Equity index call options	Equity index call options	605		—		924		—
Equity index put options	Other liabilities	—		5		—		1
Reinsurance contracts (embedded derivative)	Other liabilities	—		5		—		4
		$	776	$	3,685	$	1,026	$	3,735

The MBS with embedded derivatives consist of primarily interest-only and principal-only MBS. AFG records the entire change in the fair value of these securities in earnings. These investments are part of AFG’s overall investment strategy and represent a small component of AFG’s overall investment portfolio.

AFG’s fixed-indexed and variable-indexed annuities 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 and sale of call and put options on the appropriate index. AFG receives collateral from certain counterparties to support its purchased call option assets (net of collateral required under put option contracts with the same counterparties). This collateral ($284 million at June 30, 2020 and $577 million at December 31, 2019) is included in other assets in AFG’s Balance Sheet with an offsetting liability to return the collateral, which is included in other liabilities. AFG’s strategy is designed so that the net change in the fair value of the call option assets and put option liabilities will generally offset the economic change in the net liability from the index participation. Both the index-based component of the annuities (an embedded derivative) and the related call and put options are considered derivatives that must be adjusted for changes in fair value through earnings each period. The fair values of these derivatives are impacted by actual and expected stock market performance and interest rates as well as other factors. Fluctuations in certain of these factors, such as changes in interest rates and the performance of the stock market, are not economic in nature for the current reporting period, but rather impact the timing of reported results.

As discussed under “Reinsurance” in Note A, AFG has a reinsurance contract that is considered to contain an embedded derivative.

The following table summarizes the gains (losses) included in AFG’s Statement of Earnings for changes in the fair value of derivatives that do not qualify for hedge accounting for the second quarter and first six months of 2020 and 2019 (in millions):


		Three months ended June 30,						Six months ended June 30,
Derivative	Statement of Earnings Line	2020		2019		2020		2019
MBS with embedded derivatives	Realized gains (losses) on securities	$	3	$	6	$	7	$	12

Fixed-indexed and variable-indexed annuities (embedded derivative)	Annuity benefits	(601)		(251)		46		(713)
Equity index call options	Annuity benefits	383		148		(245)		514
Equity index put options	Annuity benefits	5		—		(1)		1
Reinsurance contract (embedded derivative)	Net investment income	(3)		(1)		(1)		(2)
		$	(213)	$	(98)	$	(194)	$	(188)

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AMERICAN FINANCIAL GROUP, INC. 10-Q

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — CONTINUED

Derivatives Designated and Qualifying as Cash Flow Hedges As of June 30, 2020, AFG has nine active 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. The purpose of each of these swaps is to effectively convert a portion of AFG’s floating-rate fixed maturity securities to fixed rates by offsetting the variability in cash flows attributable to changes in short-term LIBOR.

Under the terms of the swaps, AFG receives fixed-rate interest payments in exchange for variable interest payments based on short-term LIBOR. The notional amounts of the interest rate swaps generally decline over each swap’s respective life (the swaps expire between December 2023 and June 2030) in anticipation of the expected decline in AFG’s portfolio of fixed maturity securities with floating interest rates based on short-term LIBOR. The total outstanding notional amount of AFG’s interest rate swaps was $1.68 billion at June 30, 2020 compared to $1.98 billion at December 31, 2019, reflecting the scheduled amortization discussed above, the termination of a swap with a total notional amount of $83 million in the first quarter of 2020, the termination of two swaps with a total notional amount of $166 million in the second quarter of 2020 and the expiration of a swap with a notional amount of $44 million in the second quarter of 2020. The fair value of the interest rate swaps in an asset position and included in other assets was $124 million at June 30, 2020 and $50 million at December 31, 2019. The fair value of the interest rate swaps in a liability position and included in other liabilities was zero at June 30, 2020 and $5 million at December 31, 2019. The net unrealized gain or loss on cash flow hedges is included in AOCI, net of DPAC and deferred taxes. Amounts reclassified from AOCI (before DPAC and taxes) to net investment income were income of $11 million in the second quarter of 2020 and $1 million in the second quarter of 2019 and income of $23 million and losses of $1 million for the first six months of 2020 and 2019, respectively. AFG had a $13 million liability to return collateral related to these swaps (included in other liabilities) at June 30, 2020 and a $20 million receivable for collateral posted related to these swaps (included in other assets) at December 31, 2019.

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AMERICAN FINANCIAL GROUP, INC. 10-Q

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — CONTINUED

G. Deferred Policy Acquisition Costs

A progression of deferred policy acquisition costs is presented below (in millions):


	P&C		Annuity and Other
	Deferred		Deferred		Sales										Consolidated
	Costs		Costs		Inducements		PVFP		Subtotal		Unrealized (*)		Total		Total
Balance at March 31, 2020	$	310	$	1,264	$	73	$	34	$	1,371	$	(108)	$	1,263	$	1,573
Additions	148		30		—		—		30		—		30		178
Amortization:
Periodic amortization	(160)		50		(1)		(1)		48		—		48		(112)

Included in realized gains	—		(2)		1		—		(1)		—		(1)		(1)
Foreign currency translation	(2)		—		—		—		—		—		—		(2)
Change in unrealized	—		—		—		—		—		(818)		(818)		(818)
Balance at June 30, 2020	$	296	$	1,342	$	73	$	33	$	1,448	$	(926)	$	522	$	818

Balance at March 31, 2019	$	312	$	1,336	$	84	$	40	$	1,460	$	(325)	$	1,135	$	1,447
Additions	194		56		—		—		56		—		56		250
Amortization:
Periodic amortization	(175)		(19)		(4)		(2)		(25)		—		(25)		(200)

Included in realized gains	—		—		1		—		1		—		1		1
Foreign currency translation	(1)		—		—		—		—		—		—		(1)
Change in unrealized	—		—		—		—		—		(294)		(294)		(294)
Balance at June 30, 2019	$	330	$	1,373	$	81	$	38	$	1,492	$	(619)	$	873	$	1,203

Balance at December 31, 2019	$	322	$	1,303	$	75	$	36	$	1,414	$	(699)	$	715	$	1,037
Additions	306		79		1		—		80		—		80		386
Amortization:
Periodic amortization	(330)		(48)		(4)		(3)		(55)		—		(55)		(385)

Included in realized gains	—		8		1		—		9		—		9		9
Foreign currency translation	(2)		—		—		—		—		—		—		(2)
Change in unrealized	—		—		—		—		—		(227)		(227)		(227)
Balance at June 30, 2020	$	296	$	1,342	$	73	$	33	$	1,448	$	(926)	$	522	$	818

Balance at December 31, 2018	$	299	$	1,285	$	86	$	42	$	1,413	$	(30)	$	1,383	$	1,682
Additions	381		120		1		—		121		—		121		502
Amortization:
Periodic amortization	(350)		(34)		(7)		(4)		(45)		—		(45)		(395)

Included in realized gains	—		2		1		—		3		—		3		3
Foreign currency translation	—		—		—		—		—		—		—		—
Change in unrealized	—		—		—		—		—		(589)		(589)		(589)
Balance at June 30, 2019	$	330	$	1,373	$	81	$	38	$	1,492	$	(619)	$	873	$	1,203

(*)Adjustments to DPAC related to net unrealized gains/losses on securities and cash flow hedges.

The present value of future profits (“PVFP”) amounts in the table above are net of $157 million and $154 million of accumulated amortization at June 30, 2020 and December 31, 2019, respectively.

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AMERICAN FINANCIAL GROUP, INC. 10-Q

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — CONTINUED

H. Managed Investment Entities

AFG is the investment manager and its subsidiaries have investments ranging from 15.0% to 100.0% of the most subordinate debt tranche of eleven active collateralized loan obligation entities (“CLOs”), which are considered variable interest entities. AFG’s subsidiaries also own portions of the senior debt tranches of certain of these CLOs. Upon formation between 2012 and 2018, these entities issued securities in various senior and subordinate classes and invested the proceeds primarily in secured bank loans, which serve as collateral for the debt securities issued by each CLO. None of the collateral was purchased from AFG. AFG’s investments in the subordinate debt tranches of these entities receive residual income from the CLOs only after the CLOs pay expenses (including management fees to AFG) and interest on and returns of capital to senior levels of debt securities. There are no contractual requirements for AFG to provide additional funding for these entities. AFG has not provided and does not intend to provide any financial support to these entities.

AFG’s maximum exposure to economic loss on the CLOs that it manages is limited to its investment in those CLOs, which had an aggregate fair value of $157 million (including $72 million invested in the most subordinate tranches) at June 30, 2020, and $165 million at December 31, 2019.

During the first six months of 2020, AFG subsidiaries purchased $57 million face amount of senior debt and subordinate tranches of existing CLOs for $39 million. During both the first six months of 2020 and 2019, AFG subsidiaries received less than $1 million in sale and redemption proceeds from its CLO investments.

The revenues and expenses of the CLOs are separately identified in AFG’s Statement of Earnings, after the elimination of management fees and earnings attributable to shareholders of AFG as measured by the change in the fair value of AFG’s investments in the CLOs. Selected financial information related to the CLOs is shown below (in millions):


	Three months ended June 30,									Six months ended June 30,
			2020			2019			2020			2019
Investment in CLO tranches at end of period	$	157		$	191		$	157		$	191
Gains (losses) on change in fair value of assets/liabilities (a):
Assets	363			—			(316)			87
Liabilities	(368)			(2)			268			(89)
Management fees paid to AFG	4			4			8			7
CLO earnings (losses) attributable to AFG shareholders (b)	2			5			(34)			16

(a)Included in revenues in AFG’s Statement of Earnings.

(b)Included in earnings before income taxes in AFG’s Statement of Earnings.

The aggregate unpaid principal balance of the CLOs’ fixed maturity investments exceeded the fair value of the investments by $439 million and $146 million at June 30, 2020 and December 31, 2019, respectively. The aggregate unpaid principal balance of the CLOs’ debt exceeded its carrying value by $379 million and $129 million at those dates. The CLO assets include loans with an aggregate fair value of $42 million at June 30, 2020 and $10 million at December 31, 2019, for which the CLOs are not accruing interest because the loans are in default (aggregate unpaid principal balance of $92 million at June 30, 2020 and $25 million at December 31, 2019).

In addition to the CLOs that it manages, AFG had investments in CLOs that are managed by third parties (therefore not consolidated), which are included in available for sale fixed maturity securities and had a fair value of $4.51 billion at June 30, 2020 and $4.28 billion at December 31, 2019.

I. Goodwill and Other Intangibles

There were no changes in the goodwill balance of $207 million during the first six months of 2020. Included in other assets in AFG’s Balance Sheet is $37 million at June 30, 2020 and $43 million at December 31, 2019 in amortizable intangible assets related to property and casualty insurance acquisitions. These amounts are net of accumulated amortization of $56 million and $50 million, respectively. Amortization of intangibles was $3 million in both the second quarters of 2020 and 2019, and $6 million in both the first six months of 2020 and 2019.

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J. Long-Term Debt

Long-term debt consisted of the following (in millions):


	June 30, 2020										December 31, 2019
	Principal		Discount and Issue Costs		Carrying Value		Principal		Discount and Issue Costs		Carrying Value
Direct Senior Obligations of AFG:
4.50% Senior Notes due June 2047	$	590	$	(2)	$	588	$	590	$	(2)	$	588
3.50% Senior Notes due August 2026	425		(3)		422		425		(3)		422
5.25% Senior Notes due April 2030	300		(7)		293		—		—		—
Other	3		—		3		3		—		3
	1,318		(12)		1,306		1,018		(5)		1,013

Direct Subordinated Obligations of AFG:
5.125% Subordinate Debentures due December 2059	200		(6)		194		200		(6)		194
6% Subordinated Debentures due November 2055	150		(5)		145		150		(5)		145
5.625% Subordinated Debentures due June 2060	150		(4)		146		—		—		—
5.875% Subordinated Debentures due March 2059	125		(4)		121		125		(4)		121
	625		(19)		606		475		(15)		460
	$	1,943	$	(31)	$	1,912	$	1,493	$	(20)	$	1,473

In April and May 2020, AFG issued $300 million in 5.25% Senior Notes due in 2030 and $150 million in 5.625% Subordinated Debentures due in June 2060, respectively. The net proceeds of these offerings will be used for general corporate purposes, which includes repurchases of outstanding common shares.

AFG has no scheduled principal payments on its long-term debt for the balance of 2020 or in the subsequent five years.

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. No amounts were borrowed under this facility at June 30, 2020 or December 31, 2019.

K. Shareholders’ Equity

AFG is authorized to issue 12.5 million shares of Voting Preferred Stock and 12.5 million shares of Nonvoting Preferred Stock, each without par value.

Accumulated Other Comprehensive Income, Net of Tax (“AOCI”) Comprehensive income is defined as all changes in shareholders’ equity except those arising from transactions with shareholders. Comprehensive income includes net earnings and other comprehensive income, which consists primarily of changes in net unrealized gains or losses on available for sale securities.

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AMERICAN FINANCIAL GROUP, INC. 10-Q

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — CONTINUED

The progression of the components of accumulated other comprehensive income follows (in millions):


			Other Comprehensive Income (Loss)
	AOCI Beginning Balance		Pretax		Tax		Net of tax		Attributable to noncontrolling interests		Attributable to shareholders		AOCI Ending Balance
Quarter ended June 30, 2020
Net unrealized gains on securities:
Unrealized holding gains on securities arising during the period			$	1,293	$	(272)	$	1,021	$	—	$	1,021
Reclassification adjustment for realized (gains) losses included in net earnings (*)			(9)		2		(7)		—		(7)
Total net unrealized gains (losses) on securities	$	16	1,284		(270)		1,014		—		1,014		$	1,030
Net unrealized gains on cash flow hedges	44		4		(1)		3		—		3		47
Foreign currency translation adjustments	(21)		4		—		4		—		4		(17)
Pension and other postretirement plans adjustments	(7)		—		—		—		—		—		(7)
Total	$	32	$	1,292	$	(271)	$	1,021	$	—	$	1,021	$	1,053

Quarter ended June 30, 2019
Net unrealized gains on securities:
Unrealized holding gains on securities arising during the period			$	450	$	(94)	$	356	$	—	$	356
Reclassification adjustment for realized (gains) losses included in net earnings (*)			(10)		2		(8)		—		(8)
Total net unrealized gains on securities	$	464	440		(92)		348		—		348		$	812
Net unrealized gains on cash flow hedges	—		23		(5)		18		—		18		18
Foreign currency translation adjustments	(12)		(1)		1		—		(1)		(1)		(13)
Pension and other postretirement plans adjustments	(8)		—		—		—		—		—		(8)
Total	$	444	$	462	$	(96)	$	366	$	(1)	$	365	$	809

Six months ended June 30, 2020
Net unrealized gains (losses) on securities:
Unrealized holding gains on securities arising during the period			$	198	$	(42)	$	156	$	—	$	156
Reclassification adjustment for realized (gains) losses included in net earnings (*)			15		(3)		12		—		12
Total net unrealized gains (losses) on securities	$	862	213		(45)		168		—		168		$	1,030
Net unrealized gains on cash flow hedges	17		38		(8)		30		—		30		47
Foreign currency translation adjustments	(9)		(6)		—		(6)		(2)		(8)		(17)
Pension and other postretirement plans adjustments	(7)		—		—		—		—		—		(7)
Total	$	863	$	245	$	(53)	$	192	$	(2)	$	190	$	1,053

Six months ended June 30, 2019
Net unrealized gains on securities:
Unrealized holding gains on securities arising during the period			$	937	$	(197)	$	740	$	—	$	740
Reclassification adjustment for realized (gains) losses included in net earnings (*)			(14)		3		(11)		—		(11)
Total net unrealized gains on securities	$	83	923		(194)		729		—		729		$	812
Net unrealized gains (losses) on cash flow hedges	(11)		37		(8)		29		—		29		18
Foreign currency translation adjustments	(16)		3		1		4		(1)		3		(13)
Pension and other postretirement plans adjustments	(8)		—		—		—		—		—		(8)
Total	$	48	$	963	$	(201)	$	762	$	(1)	$	761	$	809

(*)The reclassification adjustment out of net unrealized gains (losses) on securities affected the following lines in AFG’s Statement of Earnings:

OCI component

Affected line in the statement of earnings

Pretax

Realized gains (losses) on securities

Tax

Provision (credit) for income taxes

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AMERICAN FINANCIAL GROUP, INC. 10-Q

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Stock Incentive Plans Under AFG’s stock incentive plans, employees of AFG and its subsidiaries are eligible to receive equity awards in the form of stock options, stock appreciation rights, restricted stock awards, restricted stock units and stock awards. In the first six months of 2020, AFG issued 227,867 shares of restricted Common Stock (fair value of $104.15 per share) under the Stock Incentive Plan.

Total compensation expense related to stock incentive plans of AFG and its subsidiaries was $4 million and $6 million in the second quarters of 2020 and 2019, respectively, and $9 million and $12 million in the first six months of 2020 and 2019, respectively.

L. Income Taxes

The following is a reconciliation of income taxes at the statutory rate of 21% to the provision for income taxes as shown in AFG’s Statement of Earnings (dollars in millions):


	Three months ended June 30,														Six months ended June 30,
	2020						2019						2020				2019
	Amount		% of EBT		Amount		% of EBT		Amount		% of EBT		Amount		% of EBT
Earnings (loss) before income taxes (“EBT”)	$	218			$	259			$	(170)			$	672

Income taxes at statutory rate	$	45	21	%	$	54	21	%	$	(36)	21	%	$	141	21	%
Effect of:

Tax exempt interest	(3)		(1	%)	(3)		(1	%)	(6)		4	%	(7)		(1	%)
Stock-based compensation	—		—	%	(2)		(1	%)	(4)		2	%	(4)		(1	%)
Dividends received deduction	—		—	%	(1)		—	%	(1)		1	%	(2)		—	%
Employee Stock Ownership Plan dividends paid deduction	—		—	%	(1)		—	%	—		—	%	(1)		—	%
Change in valuation allowance	9		4	%	1		—	%	11		(6	%)	3		—	%
Nondeductible expenses	—		—	%	2		1	%	2		(1	%)	4		1	%

Foreign operations	—		—	%	—		—	%	1		(1	%)	—		—	%
Other	—		(1	%)	—		(1	%)	—		(1	%)	3		—	%
Provision (credit) for income taxes as shown in the statement of earnings	$	51	23	%	$	50	19	%	$	(33)	19	%	$	137	20	%

The changes in valuation allowance in the table above are primarily increases in the valuation allowance on tax benefits related to losses in the Neon Lloyd’s insurance business. Approximately $23 million of AFG’s net operating loss carryforwards (“NOL”) subject to separate return limitation year (“SRLY”) tax rules will expire unutilized at December 31, 2020. Since AFG maintains a full valuation allowance against its SRLY NOLs, the expiration of these loss carryforwards will be offset by a corresponding reduction in the valuation allowance and will have no overall impact on AFG’s income tax expense or results of operations.

M. Contingencies

In December 2015, AFG completed the sale of substantially all of its run-off long-term care insurance business to HC2 Holdings, Inc. (“HC2”). As part of the transaction, AFG agreed to provide up to an aggregate of $35 million of capital support for the insurance companies, on an as-needed basis to maintain specified surplus levels, subject to immediate reimbursement by HC2 through a five-year capital maintenance agreement. AFG was released of any obligation to perform under this agreement in the first quarter of 2020.

Other than the matter described above, there have been no significant changes to the matters discussed and referred to in Note N — “Contingencies” of AFG’s 2019 Form 10-K, which covers property and casualty insurance reserves for claims related to environmental exposures, asbestos and other mass tort claims and environmental and occupational injury and disease claims of former subsidiary railroad and manufacturing operations.

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AMERICAN FINANCIAL GROUP, INC. 10-Q

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N. Insurance

Property and Casualty Insurance Reserves The following table provides an analysis of changes in the liability for losses and loss adjustment expenses during the first six months of 2020 and 2019 (in millions):


	Six months ended June 30,
	2020		2019
Balance at beginning of year	$	10,232	$	9,741
Less reinsurance recoverables, net of allowance	3,024		2,942
Net liability at beginning of year	7,208		6,799
Provision for losses and LAE occurring in the current period	1,597		1,501
Net increase (decrease) in the provision for claims of prior years	(119)		(86)
Total losses and LAE incurred (*)	1,478		1,415
Payments for losses and LAE of:
Current year	(284)		(291)
Prior years	(1,068)		(1,079)
Total payments	(1,352)		(1,370)

Foreign currency translation and other	(20)		1
Net liability at end of period	7,314		6,845
Add back reinsurance recoverables, net of allowance	3,007		2,732
Gross unpaid losses and LAE included in the balance sheet at end of period	$	10,321	$	9,577

(*)Includes $106 million in losses and LAE incurred in the Neon exited lines in the first six months of 2020.

The net decrease in the provision for claims of prior years during the first six months of 2020 reflects (i) lower than expected claim frequency and severity in the agricultural businesses and lower than anticipated claim frequency and severity in the transportation businesses (within the Property and transportation sub-segment), (ii) lower than anticipated claim frequency and severity in the workers’ compensation businesses and lower than anticipated claim frequency in the executive liability business (within the Specialty casualty sub-segment) and (iii) lower than anticipated claim frequency in the trade credit and surety businesses (within the Specialty financial sub-segment). This favorable development was partially offset by higher than expected claim frequency and severity in the excess and surplus businesses (within the Specialty casualty sub-segment).

The net decrease in the provision for claims of prior years during the first six months of 2019 reflects (i) lower than expected losses in the crop business and lower than expected claim frequency and severity in the transportation businesses (all within the Property and transportation sub-segment), (ii) lower than anticipated claim severity in the workers’ compensation businesses (within the Specialty casualty sub-segment), and (iii) lower than expected claim frequency and severity in the surety and financial institutions businesses and lower than anticipated claim severity in the fidelity business (all within the Specialty financial sub-segment). This favorable development was partially offset by higher than expected claim severity in the in the excess and surplus lines businesses and higher than expected losses at Neon (all within the Specialty casualty sub-segment).

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AMERICAN FINANCIAL GROUP, INC. 10-Q

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — CONTINUED

Recoverables from Reinsurers and Premiums Receivable See Note A — “Accounting Policies — Credit Losses on Financial Instruments,” for a discussion of new guidance effective January 1, 2020, which impacts the accounting for expected credit losses of recoverables from reinsurers and premiums receivable. Progressions of the 2020 allowance for expected credit losses are shown below (in millions):


	Recoverables from Reinsurers		Premiums Receivable
Balance at March 31	$	13	$	9

Provision for expected credit losses	—		1
Write-offs charged against the allowance	—		—
Balance at June 30	$	13	$	10

Balance at January 1	$	18	$	13
Impact of adoption of new accounting policy	(6)		(3)
Provision (credit) for expected credit losses	1		—
Write-offs charged against the allowance	—		—
Balance at June 30	$	13	$	10

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AMERICAN FINANCIAL GROUP, INC. 10-Q

ITEM 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations


INDEX TO MD&A
	Page		Page
Forward-Looking Statements	36	Results of Operations — Second Quarte r	52
Overview	37	Segmented Statement of Earnings	52
Critical Accounting Policies	38	Property and Casualty Insurance	53
Liquidity and Capital Resources	38	Annuity	63
Ratios	38	Holding Company, Other and Unallocated	70
Condensed Consolidated Cash Flows	39	Results of Operations — F irst Six Months	74
Parent and Subsidiary Liquidity	40	Segmented Statement of Earnings	74
Investments	42	Property and Casualty Insurance	75
Uncertainties	45	Annuity	84
Managed Investment Entities	45	Holding Company, Other and Unallocated	94
Results of Operations	49	Recent and Pending Accounting Standards	96
General	49

FORWARD-LOOKING STATEMENTS

The Private Securities Litigation Reform Act of 1995 provides a safe harbor for forward-looking statements. Some of the forward-looking statements can be identified by the use of words such as “anticipates”, “believes”, “expects”, “projects”, “estimates”, “intends”, “plans”, “seeks”, “could”, “may”, “should”, “will” or the negative version of those words or other comparable terminology. Such forward-looking statements include statements relating to: expectations concerning market and other conditions and their effect on future premiums, revenues, earnings, investment activities, and the amount and timing of share repurchases; recoverability of asset values; expected losses and the adequacy of reserves for asbestos, environmental pollution and mass tort claims; rate changes; and improved loss experience.

Actual results and/or financial condition could differ materially from those contained in or implied by such forward-looking statements for a variety of reasons including but not limited to:

•changes in financial, political and economic conditions, including changes in interest and inflation rates, currency fluctuations and extended economic recessions or expansions in the U.S. and/or abroad;

•performance of securities markets, including the cost of equity index options;

•new legislation or declines in credit quality or credit ratings that could have a material impact on the valuation of securities in AFG’s investment portfolio;

•the availability of capital;

•changes in insurance law or regulation, including changes in statutory accounting rules and changes in regulation of the Lloyd’s market, including modifications to capital requirements, changes in costs associated with the exit from the Lloyd’s market and the run-off of AFG’s Lloyd’s based insurer, Neon;

•the effects of the COVID-19 outbreak, including the effects on the international and national economy and credit markets, legislative or regulatory developments affecting the insurance industry, quarantines or other travel or health-related restrictions;

•changes in the legal environment affecting AFG or its customers;

•tax law and accounting changes;

•levels of natural catastrophes and severe weather, terrorist activities (including any nuclear, biological, chemical or radiological events), incidents of war or losses resulting from pandemics, civil unrest and other major losses;

•disruption caused by cyber-attacks or other technology breaches or failures by AFG or its business partners and service providers, which could negatively impact AFG’s business and/or expose AFG to litigation;

•development of insurance loss reserves and establishment of other reserves, particularly with respect to amounts associated with asbestos and environmental claims;

•availability of reinsurance and ability of reinsurers to pay their obligations;

•trends in persistency and mortality;

•competitive pressures;

•the ability to obtain adequate rates and policy terms;

•changes in AFG’s credit ratings or the financial strength ratings assigned by major ratings agencies to AFG’s operating subsidiaries; and

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AMERICAN FINANCIAL GROUP, INC. 10-Q

Management’s Discussion and Analysis of Financial Condition and Results of Operations — Continued

•the impact of the conditions in the international financial markets and the global economy relating to AFG’s international operations.

The forward-looking statements herein are made only as of the date of this report. The Company assumes no obligation to publicly update any forward-looking statements.

OVERVIEW

Financial Condition

AFG is organized as a holding company with almost all of its operations being conducted by subsidiaries. AFG, however, has continuing cash needs for administrative expenses, the payment of principal and interest on borrowings, shareholder dividends, and taxes. Therefore, certain analyses are most meaningfully presented on a parent only basis while others are best done on a total enterprise basis. In addition, because most of its businesses are financial in nature, AFG does not prepare its consolidated financial statements using a current-noncurrent format. Consequently, certain traditional ratios and financial analysis tests are not meaningful.

Results of Operations

Through the operations of its subsidiaries, AFG is engaged primarily in property and casualty insurance, focusing on specialized commercial products for businesses, and in the sale of traditional fixed and indexed annuities in the retail, financial institutions, broker-dealer and registered investment advisor markets.

AFG reported net earnings attributable to shareholders of $177 million ($1.97 per share, diluted) for the second quarter of 2020 and a net loss of $124 million ($1.38 per share, diluted) for the first six months of 2020, compared to net earnings of $210 million ($2.31 per share, diluted) for the second quarter of 2019 and $539 million ($5.94 per share, diluted) for the first six months of 2019. The COVID-19 pandemic has had widespread financial and economic impacts, including a significant decrease in both the equity and credit markets, which adversely impacted returns on AFG’s $3.64 billion of investments that are accounted for using the equity method or carried at fair value through net earnings. AFG’s results reflect:

•higher net realized gains on securities in the second quarter of 2020 compared to the second quarter of 2019 and net realized losses on securities in the first six months of 2020 compared to net realized gains in the first six months of 2019,

•lower earnings in the annuity segment, including losses from investments accounted for using the equity method and lower earnings from AFG-managed CLOs,

•lower net investment income in the property and casualty insurance segment due primarily to losses from investments accounted for using the equity method and AFG-managed CLOs,

•lower underwriting profit in the property and casualty insurance segment,

•higher interest charges on borrowed money due to higher average indebtedness, and

•lower holding company expenses.

Outlook

The COVID-19 pandemic began to have a significant impact on global, social and economic activity during the first quarter of 2020. AFG has taken actions under its business continuity plan to minimize risk to the Company’s employees and to prevent any significant disruption to AFG’s business, agents or policyholders.

Management believes that AFG’s strong financial position coming into 2020 and current liquidity and capital at its subsidiaries will give AFG the flexibility to continue to effectively address and respond to the ongoing uncertainties presented by the pandemic. Even with management’s expectation that the impacts of the pandemic will continue through 2020, AFG’s insurance subsidiaries are projected to have capital at or in excess of the levels required by ratings agencies in order to maintain their current ratings, and the parent company does not have any near-term debt maturities.

The widespread economic impacts of the pandemic, including a significant decrease in both equity and credit markets, adversely affected AFG’s investment returns during the first six months of 2020. Because the majority of AFG’s investments in limited partnerships and similar investments accounted for using the equity method are reported on a quarter lag, second quarter 2020 returns from those investments reflect the financial results and valuations as of March 31, 2020, including the impact of the downturn in financial markets during the first quarter. Management expects there to be continued volatility in the financial markets for the remainder of 2020.

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AMERICAN FINANCIAL GROUP, INC. 10-Q

Management’s Discussion and Analysis of Financial Condition and Results of Operations — Continued

Management anticipates that the pandemic and current recessionary economic conditions will continue to impact premiums and earnings for the remainder of 2020. As a result of the contracted economy, exposures in many of AFG’s property and casualty businesses have changed due to workforce reduction, fewer miles driven and reduced revenue. This may lead to lower frequency in certain lines while there may be COVID-19 related increases in claim frequency in other lines of business. With longer state mandated grace periods for premium payments, AFG’s property and casualty subsidiaries could see a slowdown in cash collections and higher premiums receivable balances throughout the remainder of 2020, which will require management to monitor the reinvestment of cash flows from the property and casualty subsidiaries’ investment portfolios.

There is also uncertainty as to potential government decree or legislation that could alter the coverage landscape, such as the imposition of retroactive business interruption insurance. Like most of the insurance industry, AFG’s business interruption coverages require direct physical damage to covered property for business interruption coverage to apply and the vast majority of AFG’s property policies also contain virus exclusions.

While AFG has not experienced an increase in death claims or surrender activity in the annuity business related to COVID-19, stay at home orders and other restrictions are likely to continue to reduce annuity sales for the remainder of 2020. See Part II, Item 1A — “Risk Factors.”

CRITICAL ACCOUNTING POLICIES

Significant accounting policies are summarized in Note A — “Accounting Policies” to the financial statements. The preparation of financial statements in conformity with U.S. generally accepted accounting principles (“GAAP”) requires management to make estimates and assumptions that can have a significant effect on amounts reported in the financial statements. As more information becomes known, these estimates and assumptions change and, thus, impact amounts reported in the future. The areas where management believes the degree of judgment required to determine amounts recorded in the financial statements is most significant are as follows:

•the establishment of insurance reserves, especially asbestos and environmental-related reserves,

•the recoverability of reinsurance,

•the amortization of annuity deferred policy acquisition costs,

•the measurement of the derivatives embedded in indexed annuity liabilities,

•the establishment of asbestos and environmental reserves of former railroad and manufacturing operations, and

•the valuation of investments, including the determination of impairment allowances.

For a discussion of these policies, see Management’s Discussion and Analysis — “Critical Accounting Policies” in AFG’s 2019 Form 10-K.

LIQUIDITY AND CAPITAL RESOURCES

Ratios

AFG’s debt to total capital ratio on a consolidated basis is shown below (dollars in millions):


	June 30, 2020			December 31,
										2019	2018
Principal amount of long-term debt	$	1,943		$	1,493		$	1,318
Total capital	6,992			6,883			6,218
Ratio of debt to total capital:
Including subordinated debt	27.8		%	21.7		%	21.2		%
Excluding subordinated debt	18.9		%	14.8		%	16.4		%

The ratio of debt to total capital is a non-GAAP measure that management believes is useful for investors, analysts and ratings agencies to evaluate AFG’s financial strength and liquidity and to provide insight into how AFG finances its operations. In addition, maintaining a ratio of debt, excluding subordinated debt and debt secured by real estate (if any), to total capital of 35% or lower is a financial covenant in AFG’s bank credit facility. The ratio is calculated by dividing the principal amount of AFG’s long-term debt by its total capital, which includes long-term debt, noncontrolling interests and shareholders’ equity (excluding unrealized gains (losses) related to fixed maturity investments).

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AMERICAN FINANCIAL GROUP, INC. 10-Q

Management’s Discussion and Analysis of Financial Condition and Results of Operations — Continued

Fixed charges are computed on a “total enterprise” basis. For purposes of calculating the ratios, “earnings (loss)” have been computed by adding to pretax earnings (loss) the fixed charges and the noncontrolling interests in earnings of subsidiaries having fixed charges and the undistributed equity in earnings or losses of investees. Fixed charges include interest (including annuity benefits as indicated), amortization of debt premium/discount and expense, preferred dividend and distribution requirements of subsidiaries and a portion of rental expense deemed to be representative of the interest factor. The ratio of core earnings to fixed charges excluding annuity benefits and the ratio of earnings (loss) to fixed charges excluding and including annuity benefits are shown in the table below:


	Six months ended June 30, 2020	Year ended December 31, 2019
Ratio of core earnings to fixed charges excluding annuity benefits	9.56	12.78
Impact of non-core items	(11.03)	1.83
Ratio of earnings to fixed charges excluding annuity benefits	*	14.61
Impact of including interest on annuities as a fixed charge	(2.32)	(12.76)
Ratio of earnings to fixed charges including annuity benefits	*	1.85

*Earnings for the six months ended June 30, 2020 were insufficient to cover fixed charges by $111 million.

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.

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):


	Six months ended June 30,
	2020		2019
Net cash provided by operating activities	$	1,087	$	877
Net cash used in investing activities	(1,296)		(1,052)
Net cash provided by financing activities	593		1,034
Net change in cash and cash equivalents	$	384	$	859

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 $116 million during the first six months of 2020 and reduced cash flows from operating activities by $3 million in the first six months of 2019, accounting for a $119 million increase in cash flows from operating activities in the 2020 period compared to the 2019 period. As discussed in Note A — “Accounting Policies — Managed Investment Entities” to the financial statements, AFG has no right to use the CLO assets and no obligation to pay the CLO liabilities and such assets and liabilities are shown separately in AFG’s Balance Sheet. Excluding the impact of the managed investment entities, net cash provided by operating activities was $971 million in the first six months of 2020 compared to $880 million in the first six months of 2019, an increase of $91 million.

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AMERICAN FINANCIAL GROUP, INC. 10-Q

Management’s Discussion and Analysis of Financial Condition and Results of Operations — Continued

Net Cash Used in Investing Activities AFG’s investing activities consist primarily of the investment of funds provided by its property and casualty and annuity businesses. Net cash used in investing activities was $1.30 billion for the first six months of 2020 compared to $1.05 billion in the first six months of 2019, an increase of $244 million. As discussed below (under net cash provided by financing activities), AFG’s annuity segment had net cash flows from annuity policyholders of $406 million in the first six months of 2020 and $1.10 billion in the first six months of 2019. In addition to the investment of funds provided by the insurance operations, investing activities also include the purchase and disposal of managed investment entity investments, which are presented separately in AFG’s Balance Sheet. Net investment activity in the managed investment entities was a $63 million use of cash in the first six months of 2020 compared to a $5 million source of cash in the 2019 period, accounting for a $68 million increase in net cash used in investing activities in the first six months of 2020 compared to the same 2019 period. See Note A — “Accounting Policies — Managed Investment Entities” and Note H — “Managed Investment Entities” to the financial statements.

Net Cash Provided by Financing Activities AFG’s financing activities consist primarily of transactions with annuity policyholders, issuances and retirements of long-term debt, issuances and repurchases of common stock, and dividend payments. Net cash provided by financing activities was $593 million for the first six months of 2020 compared to $1.03 billion in the first six months of 2019, a decrease of $441 million. Net annuity receipts exceeded annuity surrenders, benefits, withdrawals and transfers by $406 million in the first six months of 2020 compared to $1.10 billion in the first six months of 2019, accounting for a $698 million decrease in net cash provided by financing activities in the 2020 period compared to the 2019 period. In May 2020, AFG issued $150 million of 5.625% Subordinated Debentures due in 2060 and in April 2020, AFG issued $300 million of 5.25% Senior Notes due in 2030. The net proceeds of these offerings contributed $439 million to net cash provided by financing activities in the first six month of 2020. In March 2019, AFG issued $125 million of 5.875% Subordinated Debentures due in 2059, the net proceeds of which contributed $121 million to net cash provided by financing activities in the first six months of 2019. During the first six months of 2020, AFG repurchased $137 million of its Common Stock compared to no share repurchases in the 2019 period. In addition to its regular quarterly cash dividends, AFG paid a special cash dividend of $1.50 per share in May 2019 totaling $135 million, which resulted in total cash dividends of $205 million in the first six months of 2019 compared to $81 million in the first six months of 2020. Financing activities also include issuances and retirements of managed investment entity liabilities, which are nonrecourse to AFG and presented separately in AFG’s Balance Sheet. Retirements of managed investment entity liabilities were $46 million in the first six months of 2020 compared to $5 million in the first six months of 2019, accounting for a $41 million decrease in net cash provided by financing activities in the 2020 period compared to the 2019 period. See Note A — “Accounting Policies — Managed Investment Entities” and Note H — “Managed Investment Entities” to the financial statements.

Parent and Subsidiary Liquidity

Parent Holding Company Liquidity Management believes AFG has sufficient resources to meet its liquidity requirements. If funds generated from operations, including dividends, tax payments and borrowings from subsidiaries, are insufficient to meet fixed charges in any period, AFG would be required to utilize parent company cash and marketable securities or to generate cash through borrowings, sales of other assets, or similar transactions.

AFG can borrow up to $500 million under its revolving credit facility which expires 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 2019 or the first six months of 2020.

In April and May 2020, AFG issued $300 million of 5.25% Senior Notes due in April 2030 and $150 million of 5.625% Subordinated Debentures due in June 2060 to increase liquidity and provide flexibility at the parent holding company in its response to the uncertainties of the current economic environment. The net proceeds of the offerings will be used for general corporate purposes.

During the first six months of 2020, AFG repurchased 2,020,519 shares of its Common Stock for $137 million.

In December 2019, AFG issued $200 million of 5.125% Subordinated Debentures due in December 2059. A portion of the net proceeds of the offering were used to redeem AFG’s $150 million outstanding principal amount of 6-1/4% Subordinated Debentures due in September 2054, at par value, with the remainder used for general corporate purposes.

In March 2019, AFG issued $125 million of 5.875% Subordinated Debentures due in March 2059. The net proceeds of the offering were used for general corporate purposes.

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AMERICAN FINANCIAL GROUP, INC. 10-Q

Management’s Discussion and Analysis of Financial Condition and Results of Operations — Continued

In 2019, AFG paid special cash dividends of $3.30 per share of AFG Common Stock ($1.50 per share in May and $1.80 per share in November) resulting in a total distribution of approximately $297 million.

Under a tax allocation agreement with AFG, its 80%-owned 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 June 30, 2020, GALIC had $1.26 billion in outstanding advances from the FHLB (included in annuity benefits accumulated), bearing interest at rates ranging from 0.36% to 1.35% (average rate of 0.54% at June 30, 2020). While these advances must be repaid between 2020 and 2025 ($125 million in 2020, $931 million in 2021 and $200 million in 2025), GALIC has the option to prepay all or a portion on the majority of the advances. GALIC has invested the proceeds from the advances in fixed maturity securities with similar expected lives as the advances for the purpose of earning a spread over the interest payments due to the FHLB. At June 30, 2020, GALIC estimated that it had additional borrowing capacity of approximately $740 million from the FHLB.

The liquidity requirements of AFG’s insurance subsidiaries relate primarily to the liabilities associated with their products as well as operating costs and expenses, payments of dividends and taxes to AFG and contributions of capital to their subsidiaries. Historically, cash flows from premiums and investment income have generally provided more than sufficient funds to meet these requirements. Funds received in excess of cash requirements are generally invested in additional marketable securities. In addition, the insurance subsidiaries generally hold a significant amount of highly liquid, short-term investments.

The excess cash flow of AFG’s property and casualty group allows it to extend the duration of its investment portfolio somewhat beyond that of its claim reserves. Due to the anticipated slowdown in cash collections from the state mandated increases in grace periods for premium payments, AFG’s property and casualty insurance subsidiaries have maintained higher than typical cash balances since March 2020. AFG has not experienced a material increase in uncollectable premiums receivable as policyholders continue to make payments in accordance with the agreed upon terms.

In the annuity business, where profitability is largely dependent on earning a spread between invested assets and annuity liabilities, the duration of investments is generally maintained close to that of liabilities. In a rising interest rate environment, significant protection from withdrawals exists in the form of temporary and permanent surrender charges on AFG’s annuity products. With declining rates, AFG receives some protection (from spread compression) due to the ability to lower crediting rates, subject to contractually guaranteed minimum interest rates (“GMIRs”). With interest rates at historic lows, AFG began to lower crediting rates on existing policies in the first six months of 2020, particularly on policies near or after the end of the surrender charge period. At June 30, 2020, AFG could reduce the average crediting rate on approximately $32 billion of traditional fixed, fixed-indexed and variable-indexed annuities without guaranteed withdrawal benefits by approximately 114 basis points (on a weighted average basis). The table below shows the breakdown of annuity reserves by GMIR. The current interest crediting rates on substantially all of AFG’s annuities with a GMIR of 3% or higher are at their minimum.


	% of Reserves
	June 30,	December 31,
GMIR	2020	2019	2018
1 — 1.99%	85%	84%	81%
2 — 2.99%	3%	3%	4%
3 — 3.99%	6%	7%	8%
4.00% and above	6%	6%	7%

Annuity benefits accumulated (in millions)		$41,392	$40,406	$36,616

AFG believes its insurance subsidiaries maintain sufficient liquidity to pay claims and benefits and operating expenses. In addition, these subsidiaries have sufficient capital to meet commitments in the event of unforeseen events such as reserve deficiencies, inadequate premium rates or reinsurer insolvencies. Even in the current uncertain COVID-19 environment, management believes that the capital levels in AFG’s insurance subsidiaries are adequate to maintain its businesses and rating agency ratings. Should the current adverse financial conditions continue through 2020, AFG’s insurance subsidiaries will reduce dividend payments to AFG parent as needed to maintain sufficient capital at the

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AMERICAN FINANCIAL GROUP, INC. 10-Q

Management’s Discussion and Analysis of Financial Condition and Results of Operations — Continued

insurance companies. Nonetheless, changes in statutory accounting rules, significant declines in the fair value of the insurance subsidiaries’ investment portfolios or significant ratings downgrades on these investments, could create a need for additional capital.

Investments

AFG’s investment portfolio at June 30, 2020, contained $48.05 billion in fixed maturity securities classified as available for sale and carried at fair value with unrealized gains and losses included in accumulated other comprehensive income and $97 million in fixed maturities classified as trading with holding gains and losses included in net investment income. In addition, AFG’s investment portfolio includes $1.27 billion in equity securities carried at fair value with holding gains and losses included in realized gains (losses) on securities and $330 million in equity securities carried at fair value with holding gains and losses included in net investment income.

Fair values for AFG’s portfolio are determined by AFG’s internal investment professionals using data from nationally recognized pricing services as well as non-binding broker quotes. Fair values of equity securities are generally based on published closing prices. For AFG’s fixed maturity portfolio, approximately 90% was priced using pricing services at June 30, 2020 and the balance was priced primarily by using non-binding broker quotes. When prices obtained for the same security vary, AFG’s internal investment professionals select the price they believe is most indicative of an exit price.

The pricing services use a variety of observable inputs to estimate fair value of fixed maturities that do not trade on a daily basis. Based upon information provided by the pricing services, these inputs include, but are not limited to, recent reported trades, benchmark yields, issuer spreads, bids or offers, reference data, and measures of volatility. Included in the pricing of mortgage-backed securities (“MBS”) are estimates of the rate of future prepayments and defaults of principal over the remaining life of the underlying collateral. Due to the lack of transparency in the process that brokers use to develop prices, valuations that are based on brokers’ prices are classified as Level 3 in the GAAP hierarchy unless the price can be corroborated, for example, by comparison to similar securities priced using observable inputs.

Valuation techniques utilized by pricing services and prices obtained from external sources are reviewed by AFG’s internal investment professionals who are familiar with the securities being priced and the markets in which they trade to ensure the fair value determination is representative of an exit price. To validate the appropriateness of the prices obtained, these investment managers consider widely published indices (as benchmarks), recent trades, changes in interest rates, general economic conditions and the credit quality of the specific issuers. In addition, AFG communicates directly with pricing services regarding the methods and assumptions used in pricing, including verifying, on a test basis, the inputs used by the services to value specific securities.

In general, the fair value of AFG’s fixed maturity investments is inversely correlated to changes in interest rates. The following table demonstrates the sensitivity of such fair values to reasonably likely changes in interest rates by illustrating the estimated effect on AFG’s fixed maturity portfolio and accumulated other comprehensive income that an immediate increase of 100 basis points in the interest rate yield curve would have at June 30, 2020 (dollars in millions). Effects of increases or decreases from the 100 basis points illustrated would be approximately proportional.


Fair value of fixed maturity portfolio	$	48,143
Percentage impact on fair value of 100 bps increase in interest rates	(4.0		%)
Pretax impact on fair value of fixed maturity portfolio	$	(1,926)
Offsetting adjustments to deferred policy acquisition costs and other balance sheet amounts	850
Estimated pretax impact on accumulated other comprehensive income	(1,076)
Deferred income tax	226
Estimated after-tax impact on accumulated other comprehensive income	$	(850)

Approximately 91% of the fixed maturities held by AFG at June 30, 2020, were rated “investment grade” (credit rating of AAA to BBB) by nationally recognized rating agencies. Investment grade securities generally bear lower yields and lower degrees of risk than those that are unrated and non-investment grade. Management believes that the high-quality investment portfolio should generate a stable and predictable investment return.

MBS are subject to significant prepayment risk because, in periods of declining interest rates, mortgages may be repaid more rapidly than scheduled as borrowers refinance higher rate mortgages to take advantage of lower rates.

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AMERICAN FINANCIAL GROUP, INC. 10-Q

Management’s Discussion and Analysis of Financial Condition and Results of Operations — Continued

Summarized information for AFG’s MBS (including those classified as trading) at June 30, 2020, is shown in the table below (dollars in millions). Agency-backed securities are those issued by a U.S. government-backed agency; Alt-A mortgages are those with risk profiles between prime and subprime. The average life of the residential and commercial MBS is approximately 4 years and 3 years, respectively.


	Amortized Cost, net (*)		Fair Value		Fair Value as % of Cost		Unrealized Gain (Loss)		% Rated Investment Grade
Collateral type
Residential:
Agency-backed	$	437	$	445	102	%	$	8	100	%
Non-agency prime	1,330		1,435		108	%	105		60	%
Alt-A	843		929		110	%	86		36	%
Subprime	386		414		107	%	28		36	%
Commercial	852		889		104	%	37		94	%
	$	3,848	$	4,112	107	%	$	264	64	%

(*)Amortized cost, net of allowance for expected credit losses.

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 June 30, 2020, 97% (based on statutory carrying value of $3.80 billion) of AFG’s MBS had an NAIC designation of 1.

Municipal bonds represented approximately 14% of AFG’s fixed maturity portfolio at June 30, 2020. AFG’s municipal bond portfolio is high quality, with 99% of the securities rated investment grade at that date. The portfolio is well diversified across the states of issuance and individual issuers. At June 30, 2020, approximately 78% of the municipal bond portfolio was held in revenue bonds, with the remaining 22% held in general obligation bonds.

Summarized information for the unrealized gains and losses recorded in AFG’s Balance Sheet at June 30, 2020, is shown in the following table (dollars in millions). Approximately $1.54 billion of available for sale fixed maturity securities had no unrealized gains or losses at June 30, 2020.


	Securities With Unrealized Gains			Securities With Unrealized Losses
Available for Sale Fixed Maturities
Fair value of securities	$	36,628		$	9,878
Amortized cost of securities, net of allowance for expected credit losses	$	33,734		$	10,335
Gross unrealized gain (loss)	$	2,894		$	(457)
Fair value as % of amortized cost	109		%	96		%
Number of security positions	4,322			993
Number individually exceeding $2 million gain or loss	331			43
Concentration of gains (losses) by type or industry (exceeding 5% of unrealized):
States and municipalities	$	581		$	(3)
Banks, savings and credit institutions	404			(15)
Mortgage-backed securities	278			(14)
Insurance	200			(3)
Technology	175			(2)
Other asset-backed securities	118			(189)
Collateralized loan obligations	16			(114)
Percentage rated investment grade	94		%	86		%

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AMERICAN FINANCIAL GROUP, INC. 10-Q

Management’s Discussion and Analysis of Financial Condition and Results of Operations — Continued

The table below sets forth the scheduled maturities of AFG’s available for sale fixed maturity securities at June 30, 2020, based on their fair values. Securities with sinking funds are reported at average maturity. Actual maturities may differ from contractual maturities because certain securities may be called or prepaid by the issuers.


	Securities With Unrealized Gains		Securities With Unrealized Losses
Maturity
One year or less	4	%	4	%
After one year through five years	27	%	11	%
After five years through ten years	38	%	14	%
After ten years	9	%	3	%
	78	%	32	%
Collateralized loan obligations and other asset-backed securities (average life of approximately 4 years)	12	%	64	%
Mortgage-backed securities (average life of approximately 3-1/2 years)	10	%	4	%
	100	%	100	%

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 June 30, 2020
Securities with unrealized gains:
Exceeding $500,000 (1,617 securities)	$	24,210	$	2,467	111	%
$500,000 or less (2,705 securities)	12,418		427		104	%
	$	36,628	$	2,894	109	%
Securities with unrealized losses:
Exceeding $500,000 (288 securities)	$	5,397	$	(381)	93	%
$500,000 or less (705 securities)	4,481		(76)		98	%
	$	9,878	$	(457)	96	%

The following table (dollars in millions) summarizes the unrealized losses for all securities with unrealized losses by issuer quality and the length of time those securities have been in an unrealized loss position:


	Aggregate Fair Value		Aggregate Unrealized Loss		Fair Value as % of Cost
Securities with Unrealized Losses at June 30, 2020
Investment grade fixed maturities with losses for:
Less than one year (531 securities)	$	6,704	$	(292)	96	%
One year or longer (131 securities)	1,824		(88)		95	%
	$	8,528	$	(380)	96	%
Non-investment grade fixed maturities with losses for:
Less than one year (296 securities)	$	1,275	$	(64)	95	%
One year or longer (35 securities)	75		(13)		85	%
	$	1,350	$	(77)	95	%

When a decline in the value of a specific investment is considered to be other-than-temporary, an allowance for credit losses (impairment) is charged to earnings (accounted for as a realized loss). The determination of whether unrealized losses are other-than-temporary requires judgment based on subjective as well as objective factors as detailed in AFG’s 2019 Form 10-K under Management’s Discussion and Analysis — “Investments.”

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AMERICAN FINANCIAL GROUP, INC. 10-Q

Management’s Discussion and Analysis of Financial Condition and Results of Operations — Continued

Based on its analysis, management believes AFG will recover its cost basis (net of any allowance) in the fixed maturity securities with unrealized losses and that AFG has the ability to hold the securities until they recover in value and had no intent to sell them at June 30, 2020. Although AFG has the ability to continue holding its fixed maturity investments with unrealized losses, its intent to hold them may change due to deterioration in the issuers’ creditworthiness, decisions to lessen exposure to a particular issuer or industry, asset/liability management decisions, market movements, changes in views about appropriate asset allocation or the desire to offset taxable realized gains. Should AFG’s ability or intent change regarding a particular security, a charge for impairment would likely be required. While it is not possible to accurately predict if or when a specific security will become impaired, charges for other-than-temporary impairment could be material to results of operations in future periods. Significant declines in the fair value of AFG’s investment portfolio could have a significant adverse effect on AFG’s liquidity. For information on AFG’s realized gains (losses) on securities, including charges for other-than-temporary impairment, see “Results of Operations — Consolidated Realized Gains (Losses) on Securities.”

Uncertainties

Management believes that the areas posing the greatest risk of material loss are the adequacy of its insurance reserves and contingencies arising out of its former railroad and manufacturing operations. See Management’s Discussion and Analysis — “Uncertainties — Asbestos and Environmental-related (“A&E”) Insurance Reserves” in AFG’s 2019 Form 10-K. In the third quarter of 2020, AFG expects to complete a comprehensive external study of its asbestos and environmental exposures relating to the run-off operations of its property and casualty insurance segment and exposures related to its former railroad and manufacturing operations with the aid of specialty actuarial, engineering and consulting firms and outside counsel. AFG generally conducts an external study of these exposures every few years with an in-depth internal review during the intervening years.

MANAGED INVESTMENT ENTITIES

Accounting standards require AFG to consolidate its investments in collateralized loan obligation (“CLO”) entities that it manages and owns an interest in (in the form of debt). See Note A — “Accounting Policies — Managed Investment Entities” and Note H — “Managed Investment Entities” to the financial statements. The effect of consolidating these entities is shown in the tables below (in millions). The “Before CLO Consolidation” columns include AFG’s investment and earnings in the CLOs on an unconsolidated basis.

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AMERICAN FINANCIAL GROUP, INC. 10-Q

Management’s Discussion and Analysis of Financial Condition and Results of Operations — Continued

CONDENSED CONSOLIDATING BALANCE SHEET


	Before CLO Consolidation		Managed Investment Entities		Consol. Entries			Consolidated As Reported
June 30, 2020
Assets:
Cash and investments	$	56,898	$	—	$	(157)	(a)	$	56,741
Assets of managed investment entities	—		4,393		—			4,393
Other assets	9,733		—		—		(a)	9,733
Total assets	$	66,631	$	4,393	$	(157)		$	70,867
Liabilities:
Unpaid losses and loss adjustment expenses and unearned premiums	$	13,099	$	—	$	—		$	13,099
Annuity, life, accident and health benefits and reserves	41,998		—		—			41,998
Liabilities of managed investment entities	—		4,393		(157)		(a)	4,236
Long-term debt and other liabilities	5,408		—		—			5,408
Total liabilities	60,505		4,393		(157)			64,741

Redeemable noncontrolling interests	—		—		—			—

Shareholders’ equity:
Common Stock and Capital surplus	1,388		—		—			1,388
Retained earnings	3,685		—		—			3,685
Accumulated other comprehensive income, net of tax	1,053		—		—			1,053
Total shareholders’ equity	6,126		—		—			6,126
Noncontrolling interests	—		—		—			—
Total equity	6,126		—		—			6,126
Total liabilities and equity	$	66,631	$	4,393	$	(157)		$	70,867

December 31, 2019
Assets:
Cash and investments	$	55,416	$	—	$	(164)	(a)	$	55,252
Assets of managed investment entities	—		4,736		—			4,736
Other assets	10,143		—		(1)		(a)	10,142
Total assets	$	65,559	$	4,736	$	(165)		$	70,130
Liabilities:
Unpaid losses and loss adjustment expenses and unearned premiums	$	13,062	$	—	$	—		$	13,062
Annuity, life, accident and health benefits and reserves	41,018		—		—			41,018
Liabilities of managed investment entities	—		4,736		(165)		(a)	4,571
Long-term debt and other liabilities	5,210		—		—			5,210
Total liabilities	59,290		4,736		(165)			63,861

Redeemable noncontrolling interests	—		—		—			—

Shareholders’ equity:
Common Stock and Capital surplus	1,397		—		—			1,397
Retained earnings	4,009		—		—			4,009
Accumulated other comprehensive income, net of tax	863		—		—			863
Total shareholders’ equity	6,269		—		—			6,269
Noncontrolling interests	—		—		—			—
Total equity	6,269		—		—			6,269
Total liabilities and equity	$	65,559	$	4,736	$	(165)		$	70,130

(a)Elimination of the fair value of AFG’s investment in CLOs and related accrued interest.

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AMERICAN FINANCIAL GROUP, INC. 10-Q

Management’s Discussion and Analysis of Financial Condition and Results of Operations — Continued

CONDENSED CONSOLIDATING STATEMENT OF EARNINGS


	Before CLO Consolidation (a)		Managed Investment Entities		Consol. Entries			Consolidated As Reported
Three months ended June 30, 2020
Revenues:
Property and casualty insurance net earned premiums	$	1,184	$	—	$	—		$	1,184
Net investment income	470		—		(2)		(b)	468
Realized gains (losses) on securities	204		—		—			204
Income (loss) of managed investment entities:
Investment income	—		49		—			49
Gain (loss) on change in fair value of assets/liabilities	—		(2)		(3)		(b)	(5)
Other income	55		—		(4)		(c)	51
Total revenues	1,913		47		(9)			1,951
Costs and Expenses:
Insurance benefits and expenses	1,571		—		—			1,571
Expenses of managed investment entities	—		47		(9)		(b)(c)	38
Interest charges on borrowed money and other expenses	124		—		—			124
Total costs and expenses	1,695		47		(9)			1,733
Earnings (loss) before income taxes	218		—		—			218
Provision (credit) for income taxes	51		—		—			51
Net earnings (loss), including noncontrolling interests	167		—		—			167
Less: Net earnings (loss) attributable to noncontrolling interests	(10)		—		—			(10)
Net earnings (loss) attributable to shareholders	$	177	$	—	$	—		$	177

Three months ended June 30, 2019
Revenues:
Property and casualty insurance net earned premiums	$	1,200	$	—	$	—		$	1,200
Net investment income	585		—		(5)		(b)	580
Realized gains (losses) on securities	56		—		—			56
Income (loss) of managed investment entities:
Investment income	—		70		—			70
Gain (loss) on change in fair value of assets/liabilities	—		(1)		(1)		(b)	(2)
Other income	60		—		(4)		(c)	56
Total revenues	1,901		69		(10)			1,960
Costs and Expenses:
Insurance benefits and expenses	1,521		—		—			1,521
Expenses of managed investment entities	—		69		(10)		(b)(c)	59
Interest charges on borrowed money and other expenses	121		—		—			121
Total costs and expenses	1,642		69		(10)			1,701
Earnings (loss) before income taxes	259		—		—			259
Provision (credit) for income taxes	50		—		—			50
Net earnings (loss), including noncontrolling interests	209		—		—			209
Less: Net earnings (loss) attributable to noncontrolling interests	(1)		—		—			(1)
Net earnings (loss) attributable to shareholders	$	210	$	—	$	—		$	210

(a)Includes income of $2 million in the second quarter of 2020 and $5 million in the second quarter of 2019, representing the change in fair value of AFG’s CLO investments plus $4 million in both the second quarter of 2020 and 2019 in CLO management fees earned.

(b)Elimination of the change in fair value of AFG’s investments in the CLOs, including $5 million and $6 million in the second quarter of 2020 and 2019, respectively, in distributions recorded as interest expense by the CLOs.

(c)Elimination of management fees earned by AFG.

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AMERICAN FINANCIAL GROUP, INC. 10-Q

Management’s Discussion and Analysis of Financial Condition and Results of Operations — Continued

CONDENSED CONSOLIDATING STATEMENT OF EARNINGS


	Before CLO Consolidation (a)		Managed Investment Entities		Consol. Entries			Consolidated As Reported
Six months ended June 30, 2020
Revenues:
Property and casualty insurance net earned premiums	$	2,393	$	—	$	—		$	2,393
Net investment income	978		—		34		(b)	1,012
Realized gains (losses) on securities	(347)		—		—			(347)
Income (loss) of managed investment entities:
Investment income	—		108		—			108
Gain (loss) on change in fair value of assets/liabilities	—		(2)		(46)		(b)	(48)
Other income	116		—		(8)		(c)	108
Total revenues	3,140		106		(20)			3,226
Costs and Expenses:
Insurance benefits and expenses	3,087		—		—			3,087
Expenses of managed investment entities	—		106		(20)		(b)(c)	86
Interest charges on borrowed money and other expenses	223		—		—			223
Total costs and expenses	3,310		106		(20)			3,396
Earnings (loss) before income taxes	(170)		—		—			(170)
Provision (credit) for income taxes	(33)		—		—			(33)
Net earnings (loss), including noncontrolling interests	(137)		—		—			(137)
Less: Net earnings (loss) attributable to noncontrolling interests	(13)		—		—			(13)
Net earnings (loss) attributable to shareholders	$	(124)	$	—	$	—		$	(124)

Six months ended June 30, 2019
Revenues:
Property and casualty insurance net earned premiums	$	2,373	$	—	$	—		$	2,373
Net investment income	1,138		—		(16)		(b)	1,122
Realized gains (losses) on securities	240		—		—			240
Income (loss) of managed investment entities:
Investment income	—		139		—			139
Gain (loss) on change in fair value of assets/liabilities	—		(6)		4		(b)	(2)
Other income	119		—		(7)		(c)	112
Total revenues	3,870		133		(19)			3,984
Costs and Expenses:
Insurance benefits and expenses	2,951		—		—			2,951
Expenses of managed investment entities	—		133		(19)		(b)(c)	114
Interest charges on borrowed money and other expenses	247		—		—			247
Total costs and expenses	3,198		133		(19)			3,312
Earnings (loss) before income taxes	672		—		—			672
Provision (credit) for income taxes	137		—		—			137
Net earnings (loss), including noncontrolling interests	535		—		—			535
Less: Net earnings (loss) attributable to noncontrolling interests	(4)		—		—			(4)
Net earnings (loss) attributable to shareholders	$	539	$	—	$	—		$	539

(a)Includes a loss of $34 million in the first six months of 2020 and income of $16 million in the first six months of 2019, representing the change in fair value of AFG’s CLO investments plus $8 million and $7 million in the first six months of 2020 and 2019, respectively, in CLO management fees earned.

(b)Elimination of the change in fair value of AFG’s investments in the CLOs, including $12 million in both the first six months of 2020 and 2019, in distributions recorded as interest expense by the CLOs.

(c)Elimination of management fees earned by AFG.

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AMERICAN FINANCIAL GROUP, INC. 10-Q

Management’s Discussion and Analysis of Financial Condition and Results of Operations — Continued

RESULTS OF OPERATIONS

General

AFG’s net earnings (loss) attributable to shareholders, determined in accordance with GAAP, include certain items that may not be indicative of its ongoing core operations. For example, core net operating earnings excludes realized gains (losses) on securities because such gains and losses are influenced significantly by financial markets, interest rates and the timing of sales. Similarly, significant gains and losses from the sale of real estate are excluded from core earnings as they are influenced by the timing of sales and realized gains (losses) and significant tax benefits (charges) related to subsidiaries are excluded because such gains and losses are largely the result of the changing business strategy and market opportunities. In addition, special charges related to coverage that AFG no longer writes, such as the Neon exited lines discussed below and for asbestos and environmental exposures, are excluded from core earnings.

Beginning prospectively with the second quarter of 2019, AFG’s core net operating earnings for its annuity segment excludes unlocking, the impact of changes in the fair value of derivatives related to fixed-indexed annuities (“FIAs”), and other impacts of changes in the stock market and interest rates on the accounting for FIAs over or under the cost of the equity index options purchased to mitigate the risk in the index-based component of those FIAs (“annuity non-core earnings (losses)”). Fluctuations in interest rates and the stock market, among other factors, can cause volatility in the periodic measurement of FIA liabilities that management believes can be inconsistent with the long-term economics of this growing portion of AFG’s annuity business. Management believes that separating these impacts as “non-core” will provide investors with a better view of the fundamental performance of the business, and a more comparable measure of the annuity segment’s business compared to the results identified as “core” by its peers. Core net operating earnings for the annuity segment for the first quarter of 2019 and prior periods were not adjusted, so results for the six months ended June 30, 2020 are not directly comparable to the six months ended June 30, 2019. The impact of the items now considered annuity non-core earnings (losses) on prior periods is highlighted in the discussion following the reconciliation of net earnings (loss) attributable to shareholders to core net operating earnings.

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. Consistent with the treatment of other items that are not indicative of AFG’s ongoing operations (both favorable and unfavorable), beginning prospectively with the first quarter of 2020, AFG’s core net operating earnings for its property and casualty insurance segment excludes the run-off operations of Neon (“Neon exited lines”). The Neon exited lines impact is highlighted in the discussion following the reconciliation of net earnings (loss) attributable to shareholders to core net operating earnings.

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AMERICAN FINANCIAL GROUP, INC. 10-Q

Management’s Discussion and Analysis of Financial Condition and Results of Operations — Continued

The following table (in millions, except per share amounts) identifies non-core items and reconciles net earnings (loss) attributable to shareholders to core net operating earnings, a non-GAAP financial measure. AFG believes core net operating earnings is a useful tool for investors and analysts in analyzing ongoing operating trends and for management to evaluate financial performance against historical results because it believes this provides a more comparable measure of its continuing business.


	Three months ended June 30,									Six months ended June 30,
			2020			2019			2020			2019
Components of net earnings (loss) attributable to shareholders:
Core operating earnings before income taxes	$	115		$	236		$	326		$	465
Pretax non-core items:
Realized gains (losses) on securities	204			56			(347)			240
Annuity non-core earnings (losses) (a)	(59)			(33)			(97)			(33)
Neon exited lines (b)	(42)			—			(52)			—
Earnings (loss) before income taxes	218			259			(170)			672
Provision (credit) for income taxes:
Core operating earnings	20			45			60			93
Non-core items:
Realized gains (losses) on securities	43			11			(73)			50
Annuity non-core earnings (losses) (a)	(12)			(6)			(20)			(6)

Total provision for income taxes	51			50			(33)			137
Net earnings (loss), including noncontrolling interests	167			209			(137)			535
Less net earnings (loss) attributable to noncontrolling interests:
Core operating earnings (loss)	—			(1)			—			(4)
Neon exited lines (b)	(10)			—			(13)			—
Total net earnings (loss) attributable to noncontrolling interests	(10)			(1)			(13)			(4)
Net earnings (loss) attributable to shareholders	$	177		$	210		$	(124)		$	539

Net earnings (loss):
Core net operating earnings	$	95		$	192		$	266		$	376
Realized gains (losses) on securities	161			45			(274)			190
Annuity non-core earnings (losses) (a)	(47)			(27)			(77)			(27)
Neon exited lines (b)	(32)			—			(39)			—

Net earnings (loss) attributable to shareholders	$	177		$	210		$	(124)		$	539

Diluted per share amounts:
Core net operating earnings	$	1.05		$	2.12		$	2.94		$	4.14
Realized gains (losses) on securities	1.80			0.48			(3.03)			2.09
Annuity non-core earnings (losses) (a)	(0.52)			(0.29)			(0.86)			(0.29)
Neon exited lines (b)	(0.36)			—			(0.43)			—

Net earnings (loss) attributable to shareholders	$	1.97		$	2.31		$	(1.38)		$	5.94

(a)As discussed above, beginning prospectively with the second quarter of 2019, unlocking, the impact of changes in the fair value of derivatives related to FIAs, and other impacts of changes in the stock market and interest rates on the accounting for FIAs over or under the cost of the equity index options purchased to mitigate the risk in the index-based component of those FIAs are considered annuity non-core earnings (losses).

(b)As discussed above, beginning prospectively with the first quarter of 2020, the Neon run-off operations are considered property and casualty insurance non-core earnings (losses).

Because AFG’s limited partnerships and similar investments accounted for using the equity method are reported on a quarter lag, the second quarter returns reflect March 31, 2020 results provided by third party sources and incorporate the downturn in financial markets during the first quarter.

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AMERICAN FINANCIAL GROUP, INC. 10-Q

Management’s Discussion and Analysis of Financial Condition and Results of Operations — Continued

Net earnings attributable to shareholders was $177 million in the second quarter of 2020 compared to $210 million in the second quarter of 2019 reflecting lower core net operating earnings, higher losses from the impact of changes in the fair value of derivatives related to FIAs and other impacts of changes in the stock market and interest rates on the accounting for FIAs over or under the cost of the equity index options purchased to mitigate the risk in the index-based component of those FIAs, and non-core losses from the Neon exited lines, partially offset by higher net realized gains on securities. Core net operating earnings for the second quarter of 2020 decreased $97 million compared to the second quarter of 2019 reflecting the negative impact of the COVID-19 pandemic on partnerships and similar investments and AFG-managed CLOs in both the property and casualty insurance and annuity segments. Realized gains (losses) on securities in the second quarter of 2020 and 2019 resulted primarily from the change in fair value of equity securities that were still held at the balance sheet date.

Net earnings (loss) attributable to shareholders was a net loss of $124 million for the first six months of 2020 compared to net earnings of $539 million for the first six months of 2019 reflecting net realized losses on securities in the 2020 period compared to net realized gains in the 2019 period, lower core net operating earnings and non-core losses from the Neon exited lines. In addition, net earnings (loss) attributable to shareholders includes after-tax losses of $77 million in the first six months of 2020 and $36 million in the first six months of 2019 ($9 million in the first quarter and $27 million in the second quarter) from the impact of changes in the fair value of derivatives related to FIAs and other impacts of changes in the stock market and interest rates on the accounting for FIAs over or under the cost of the equity index options purchased to mitigate the risk in the index-based component of those FIAs. As discussed above, this impact on the accounting for FIAs is considered non-core earnings (losses) beginning prospectively with the second quarter of 2019. Excluding the $9 million after-tax negative impact of these items on results for the first quarter of 2019, core net operating earnings for the first six months of 2020 decreased $119 million compared to the first six months of 2019 reflecting the negative impact of the COVID-19 pandemic on partnerships and similar investments and AFG-managed CLOs in both the property and casualty insurance and annuity segments, partially offset by lower holding company expenses. Realized gains (losses) on securities in the first six months of 2020 and 2019 resulted primarily from the change in fair value of equity securities that were still held at the balance sheet date.

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AMERICAN FINANCIAL GROUP, INC. 10-Q

Management’s Discussion and Analysis of Financial Condition and Results of Operations — Continued

RESULTS OF OPERATIONS — THREE MONTHS ENDED JUNE 30, 2020 AND 2019

Segmented Statement of Earnings

AFG reports its business as three segments: (i) Property and casualty insurance (“P&C”), (ii) Annuity and (iii) Other, which includes run-off long-term care and life, holding company costs and income and expenses related to the managed investment entities (“MIEs”).

AFG’s net earnings (loss) attributable to shareholders, determined in accordance with GAAP, include certain items that may not be indicative of its ongoing core operations. The following tables for the three months ended June 30, 2020 and 2019 identify such items by segment and reconcile net earnings attributable to shareholders to core net operating earnings, a non-GAAP financial measure that AFG believes is a useful tool for investors and analysts in analyzing ongoing operating trends (in millions):


					Other
	P&C		Annuity		Consol. MIEs		Holding Co., other and unallocated		Total		Non-core reclass		Neon exited lines (c)		GAAP Total
Three months ended June 30, 2020
Revenues:
Property and casualty insurance net earned premiums	$	1,123	$	—	$	—	$	—	$	1,123	$	—	$	61	$	1,184
Net investment income	72		384		(2)		14		468		—		—		468
Realized gains (losses) on securities	—		—		—		—		—		204		—		204
Income (loss) of MIEs:
Investment income	—		—		49		—		49		—		—		49
Gain (loss) on change in fair value of assets/liabilities	—		—		(5)		—		(5)		—		—		(5)
Other income	3		30		(4)		22		51		—		—		51
Total revenues	1,198		414		38		36		1,686		204		61		1,951

Costs and Expenses:
Property and casualty insurance:
Losses and loss adjustment expenses	705		—		—		—		705		—		66		771
Commissions and other underwriting expenses	366		—		—		5		371		—		38		409
Annuity benefits	—		274		—		(5)		269		157		—		426
Annuity and supplemental insurance acquisition expenses	—		62		—		1		63		(98)		—		(35)
Interest charges on borrowed money	—		—		—		23		23		—		—		23
Expenses of MIEs	—		—		38		—		38		—		—		38
Other expenses	11		36		—		55		102		—		(1)		101
Total costs and expenses	1,082		372		38		79		1,571		59		103		1,733
Earnings (loss) before income taxes	116		42		—		(43)		115		145		(42)		218
Provision (credit) for income taxes	22		6		—		(8)		20		31		—		51
Net earnings (loss), including noncontrolling interests	94		36		—		(35)		95		114		(42)		167
Less: Net earnings (loss) attributable to noncontrolling interests	—		—		—		—		—		—		(10)		(10)
Core Net Operating Earnings (Loss)	94		36		—		(35)		95
Non-core earnings (loss) attributable to shareholders (a):
Realized gains (losses) on securities, net of tax	—		—		—		161		161		(161)		—		—
Annuity non-core earnings (losses), net of tax (b)	—		(47)		—		—		(47)		47		—		—
Neon exited lines (c)	(32)		—		—		—		(32)		—		32		—

Net Earnings (Loss) Attributable to Shareholders	$	62	$	(11)	$	—	$	126	$	177	$	—	$	—	$	177

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AMERICAN FINANCIAL GROUP, INC. 10-Q

Management’s Discussion and Analysis of Financial Condition and Results of Operations — Continued


									Other
	P&C		Annuity		Consol. MIEs		Holding Co., other and unallocated			Total		Non-core reclass		GAAP Total
Three months ended June 30, 2019
Revenues:
Property and casualty insurance net earned premiums	$	1,200	$	—	$	—	$	—		$	1,200	$	—	$	1,200
Net investment income	124		451		(5)		10			580		—		580
Realized gains (losses) on securities	—		—		—		—			—		56		56
Income (loss) of MIEs:
Investment income	—		—		70		—			70		—		70
Gain (loss) on change in fair value of assets/liabilities	—		—		(2)		—			(2)		—		(2)
Other income	2		30		(4)		28			56		—		56
Total revenues	1,326		481		59		38			1,904		56		1,960

Costs and Expenses:
Property and casualty insurance:
Losses and loss adjustment expenses	723		—		—		—			723		—		723
Commissions and other underwriting expenses	418		—		—		8			426		—		426
Annuity benefits	—		275		—		(3)			272		67		339
Annuity and supplemental insurance acquisition expenses	—		67		—		—			67		(34)		33
Interest charges on borrowed money	—		—		—		17			17		—		17
Expenses of MIEs	—		—		59		—			59		—		59
Other expenses	11		35		—		58			104		—		104
Total costs and expenses	1,152		377		59		80			1,668		33		1,701
Earnings (loss) before income taxes	174		104		—		(42)			236		23		259
Provision (credit) for income taxes	35		20		—		(10)			45		5		50
Net earnings (loss), including noncontrolling interests	139		84		—		(32)			191		18		209
Less: Net earnings (loss) attributable to noncontrolling interests	(1)		—		—		—			(1)		—		(1)
Core Net Operating Earnings (Loss)	140		84		—		(32)			192
Non-core earnings (loss) attributable to shareholders (a):
Realized gains (losses) on securities, net of tax	—		—		—		45			45		(45)		—

Annuity non-core earnings (losses), net of tax (b)	—		(27)		—		—			(27)		27		—
Net Earnings (Loss) Attributable to Shareholders	$	140	$	57	$	—	$	13		$	210	$	—	$	210

(a)See the reconciliation of core earnings to GAAP net earnings under “Results of Operations — General” for details on the tax and noncontrolling interest impacts of these reconciling items.

(b)As discussed under “Results of Operations — General,” beginning with the second quarter of 2019, unlocking, the impact of changes in the fair value of derivatives related to FIAs, and other impacts of changes in the stock market and interest rates on the accounting for FIAs over or under the cost of the equity index options purchased to mitigate the risk in the index-based component of those FIAs are considered annuity non-core earnings (losses).

(c)As discussed under “Results of Operations — General,” beginning with the first quarter of 2020, the Neon run-off operations are considered property and casualty insurance non-core earnings (losses).

Property and Casualty Insurance Segment — Results of Operations

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. Underwriting profitability is measured by the combined ratio, which is a sum of the ratios of losses and loss adjustment expenses, and commissions and other underwriting expenses to premiums. A combined ratio under 100% indicates an underwriting profit. The combined ratio does not reflect net investment income, other income, other expenses or federal income taxes.

AFG’s property and casualty insurance operations contributed $74 million in GAAP pretax earnings in the second quarter of 2020 compared to $174 million in the second quarter of 2019, a decrease of $100 million (57%). Property and casualty core pretax earnings were $116 million in the second quarter of 2020 compared to $174 million in the second quarter of 2019, a decrease of $58 million (33%). The decrease in both GAAP and core pretax earnings reflects lower net investment income in the second quarter of 2020 compared to the second quarter of 2019 due primarily to the impact of financial market disruption on earnings (losses) from partnerships and similar investments.

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AMERICAN FINANCIAL GROUP, INC. 10-Q

Management’s Discussion and Analysis of Financial Condition and Results of Operations — Continued

The following table details AFG’s GAAP and core earnings before income taxes from its property and casualty insurance operations for the three months ended June 30, 2020 and 2019 (dollars in millions):


	Three months ended June 30,
	2020			2019			% Change
Gross written premiums	$	1,539		$	1,664		(8		%)
Reinsurance premiums ceded	(416)			(400)			4		%
Net written premiums	1,123			1,264			(11		%)
Change in unearned premiums	—			(64)			(100		%)
Net earned premiums	1,123			1,200			(6		%)
Loss and loss adjustment expenses	705			723			(2		%)
Commissions and other underwriting expenses	366			418			(12		%)
Core underwriting gain	52			59			(12		%)

Net investment income	72			124			(42		%)
Other income and expenses, net	(8)			(9)			(11		%)
Core earnings before income taxes	116			174			(33		%)
Pretax non-core Neon exited lines (*)	(42)			—			—		%
GAAP earnings before income taxes	$	74		$	174		(57		%)


(*) 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. (“Neon”), into run-off. As discussed under “Results of Operations — General,” following the December 2019 decision to exit the Lloyd’s of London insurance market, the results from the Neon exited lines are being treated as non-core earnings (losses) prospectively beginning in 2020. Each line item in the table above has been adjusted to remove the impact from the Neon run-off operations in 2020. The following table details the impact of the Neon exited lines to each component of earnings (loss) before income taxes in the property and casualty insurance operations for the three months ended June 30, 2020 (in millions):

	Three months ended June 30, 2020
	Excluding Neon exited lines			Neon exited lines			Total
Gross written premiums	$	1,539		$	14		$	1,553
Reinsurance premiums ceded	(416)			(6)			(422)
Net written premiums	1,123			8			1,131
Change in unearned premiums	—			53			53
Net earned premiums	1,123			61			1,184
Loss and loss adjustment expenses	705			66			771
Commissions and other underwriting expenses	366			38			404
Underwriting gain (loss)	52			(43)			9

Net investment income	72			—			72
Other income and expenses, net	(8)			1			(7)
Earnings (loss) before income taxes and noncontrolling interests	$	116		$	(42)		$	74


	Three months ended June 30,
	2020			2019			Change
Combined Ratios:
Specialty lines
Loss and LAE ratio	62.6		%	60.2		%	2.4		%
Underwriting expense ratio	32.6		%	34.8		%	(2.2		%)
Combined ratio	95.2		%	95.0		%	0.2		%

Aggregate — including exited lines
Loss and LAE ratio	65.1		%	60.3		%	4.8		%
Underwriting expense ratio	34.1		%	34.8		%	(0.7		%)
Combined ratio	99.2		%	95.1		%	4.1		%

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AMERICAN FINANCIAL GROUP, INC. 10-Q

Management’s Discussion and Analysis of Financial Condition and Results of Operations — Continued

AFG reports the underwriting performance of its Specialty property and casualty insurance business in the following sub-segments: (i) Property and transportation, (ii) Specialty casualty and (iii) Specialty financial.

To understand the overall profitability of particular lines, the timing of claims payments and the related impact of investment income must be considered. Certain “short-tail” lines of business (primarily property coverages) generally have quick loss payouts, which reduce the time funds are held, thereby limiting investment income earned thereon. In contrast, “long-tail” lines of business (primarily liability coverages and workers’ compensation) generally have payouts that are either structured over many years or take many years to settle, thereby significantly increasing investment income earned on related premiums received.

Gross Written Premiums

Gross written premiums (“GWP”) for AFG’s property and casualty insurance segment were $1.55 billion for the second quarter of 2020 compared to $1.66 billion for the second quarter of 2019, a decrease of $111 million (7%). Detail of AFG’s property and casualty gross written premiums is shown below (dollars in millions):


	Three months ended June 30,
	2020						2019
	GWP		%		GWP		%		% Change
Property and transportation	$	611	39	%	$	579	35	%	6	%
Specialty casualty	752		49	%	896		54	%	(16	%)
Specialty financial	176		11	%	189		11	%	(7	%)
Total specialty	1,539		99	%	1,664		100	%	(8	%)
Neon exited lines	14		1	%	—		—	%	—	%
Aggregate	$	1,553	100	%	$	1,664	100	%	(7	%)

Reinsurance Premiums Ceded

Reinsurance premiums ceded (“Ceded”) for AFG’s property and casualty insurance segment were 27% of gross written premiums for the second quarter of 2020 compared to 24% of gross written premiums for the second quarter of 2019, an increase of 3 percentage points. Detail of AFG’s property and casualty reinsurance premiums ceded is shown below (dollars in millions):


	Three months ended June 30,
	2020						2019				Change in
	Ceded		% of GWP		Ceded		% of GWP		% of GWP
Property and transportation	$	(185)	30	%	$	(157)	27	%	3	%
Specialty casualty	(241)		32	%	(234)		26	%	6	%
Specialty financial	(37)		21	%	(40)		21	%	—	%
Other specialty	47				31
Total specialty	(416)		27	%	(400)		24	%	3	%
Neon exited lines	(6)		43	%	—		—	%	43	%
Aggregate	$	(422)	27	%	$	(400)	24	%	3	%

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AMERICAN FINANCIAL GROUP, INC. 10-Q

Management’s Discussion and Analysis of Financial Condition and Results of Operations — Continued

Net Written Premiums

Net written premiums (“NWP”) for AFG’s property and casualty insurance segment were $1.13 billion for the second quarter of 2020 compared to $1.26 billion for the second quarter of 2019, a decrease of $133 million (11%). Detail of AFG’s property and casualty net written premiums is shown below (dollars in millions):


	Three months ended June 30,
	2020						2019
	NWP		%		NWP		%		% Change
Property and transportation	$	426	38	%	$	422	33	%	1	%
Specialty casualty	511		45	%	662		52	%	(23	%)
Specialty financial	139		12	%	149		12	%	(7	%)
Other specialty	47		4	%	31		3	%	52	%
Total specialty	1,123		99	%	1,264		100	%	(11	%)
Neon exited lines	8		1	%	—		—	%	—	%
Aggregate	$	1,131	100	%	$	1,264	100	%	(11	%)

Net Earned Premiums

Net earned premiums (“NEP”) for AFG’s property and casualty insurance segment were $1.18 billion for the second quarter of 2020 compared to $1.20 billion for the second quarter of 2019, a decrease of $16 million (1%). Detail of AFG’s property and casualty net earned premiums is shown below (dollars in millions):


	Three months ended June 30,
	2020						2019
	NEP		%		NEP		%		% Change
Property and transportation	$	390	33	%	$	379	32	%	3	%
Specialty casualty	547		46	%	634		53	%	(14	%)
Specialty financial	144		12	%	151		13	%	(5	%)
Other specialty	42		4	%	36		2	%	17	%
Total specialty	1,123		95	%	1,200		100	%	(6	%)
Neon exited lines	61		5	%	—		—	%	—	%
Aggregate	$	1,184	100	%	$	1,200	100	%	(1	%)

Gross written premiums for the second quarter of 2020 decreased $111 million (7%) compared to the second quarter of 2019 reflecting a decrease in the Specialty casualty and Specialty financial sub-segments, partially offset by an increase in the Specialty property and transportation sub-segment. Overall average renewal rates increased approximately 9% in the second quarter of 2020. Excluding rate decreases in the workers’ compensation business, renewal pricing increased approximately 13%.

Property and transportation Gross written premiums increased $32 million (6%) in the second quarter of 2020 when compared to the second quarter of 2019, which was impacted by delayed acreage reporting from insureds as a result of excess moisture and late planting of corn and soybean crops. Excluding crop insurance, gross written premiums for the second quarter of 2020 decreased by 3% in this group when compared to the 2019 second quarter. Decreases in premiums due to return of premiums and reduced exposures as a result of the COVID-19 pandemic were partially offset by new business opportunities in the transportation, property and inland marine and ocean marine businesses. Average renewal rates increased approximately 7% for this group in the second quarter of 2020. Reinsurance premiums ceded as a percentage of gross written premiums increased 3 percentage points in the second quarter of 2020 compared to the second quarter of 2019 reflecting growth in crop and certain ocean marine business, which cede a larger percentage of premiums than the other businesses in the Specialty property and transportation sub-segment.

Specialty casualty Gross written premiums decreased $144 million (16%) in the second quarter of 2020 compared to the second quarter of 2019 due primarily to the run-off of Neon. Excluding the impact of $159 million in gross written premiums from the Neon exited lines in the second quarter of 2019, gross written premiums increased 2% in the second quarter of 2020 compared to the second quarter of 2019. This increase reflects significant renewal rate increases, coupled with new business opportunities in the excess and surplus and excess liability businesses, partially offset by lower premiums due to reduced exposures in the workers’ compensation businesses as a result of the COVID-19 pandemic.

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AMERICAN FINANCIAL GROUP, INC. 10-Q

Management’s Discussion and Analysis of Financial Condition and Results of Operations — Continued

Average renewal rates increased approximately 12% for this group in the second quarter of 2020. Excluding rate decreases in the workers’ compensation business, renewal rates for this group increased approximately 21%. Reinsurance premiums ceded as a percentage of gross written premiums increased 6 percentage points in the second quarter of 2020 compared to the second quarter of 2019 reflecting growth in the excess and surplus and excess liability businesses, which cede a larger percentage of premiums than the other businesses in the Specialty casualty sub-segment.

Specialty financial Gross written premiums decreased $13 million (7%) in the second quarter of 2020 compared to the second quarter of 2019 due primarily to lower premiums from the impact of various state regulations regarding policy cancellations and the placement of forced coverage in the financial institutions business. Average renewal rates increased approximately 6% for this group in the second quarter of 2020. Reinsurance premiums ceded as a percentage of gross written premiums were comparable for the second quarter of 2020 and the second quarter of 2019.

Other specialty The amounts shown as reinsurance premiums ceded represent business assumed by AFG’s internal reinsurance program from the operations that make up AFG’s other Specialty property and casualty insurance sub-segments. Reinsurance premiums assumed increased $16 million (52%) in the second quarter of 2020 compared to the second quarter of 2019, reflecting an increase in premiums retained, primarily from businesses in the Specialty casualty sub-segment.

Combined Ratio

The table below (dollars in millions) details the components of the combined ratio for AFG’s property and casualty insurance segment:


	Three months ended June 30,								Three months ended June 30,
	2020		2019		Change		2020		2019
Property and transportation
Loss and LAE ratio	61.3	%	68.4	%	(7.1	%)
Underwriting expense ratio	30.4	%	30.7	%	(0.3	%)
Combined ratio	91.7	%	99.1	%	(7.4	%)
Underwriting profit							$	33	$	4

Specialty casualty
Loss and LAE ratio	67.1	%	60.0	%	7.1	%
Underwriting expense ratio	27.8	%	32.5	%	(4.7	%)
Combined ratio	94.9	%	92.5	%	2.4	%
Underwriting profit							$	27	$	47

Specialty financial
Loss and LAE ratio	44.9	%	32.3	%	12.6	%
Underwriting expense ratio	55.5	%	53.3	%	2.2	%
Combined ratio	100.4	%	85.6	%	14.8	%
Underwriting profit (loss)							$	—	$	21

Total Specialty
Loss and LAE ratio	62.6	%	60.2	%	2.4	%
Underwriting expense ratio	32.6	%	34.8	%	(2.2	%)
Combined ratio	95.2	%	95.0	%	0.2	%
Underwriting profit							$	54	$	60

Aggregate — including exited lines
Loss and LAE ratio	65.1	%	60.3	%	4.8	%
Underwriting expense ratio	34.1	%	34.8	%	(0.7	%)
Combined ratio	99.2	%	95.1	%	4.1	%
Underwriting profit							$	9	$	59

The Specialty property and casualty insurance operations generated an underwriting profit of $54 million in the second quarter of 2020 compared to $60 million in the second quarter of 2019, a decrease of $6 million (10%). The lower

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AMERICAN FINANCIAL GROUP, INC. 10-Q

Management’s Discussion and Analysis of Financial Condition and Results of Operations — Continued

underwriting profit in the second quarter of 2020 reflects lower underwriting profits in the Specialty casualty and Specialty financial sub-segments, partially offset by higher underwriting profit in the Property and transportation sub-segment. Underwriting results for the Specialty property and casualty insurance operations includes $85 million in COVID-19 related losses (7.6 points on the combined ratio) in the second quarter of 2020.

Property and transportation Underwriting profit for this group was $33 million for the second quarter of 2020 compared to $4 million for the second quarter of 2019, an increase of $29 million (725%). This increase reflects higher favorable prior year reserve development of $22 million in the second quarter of 2020 compared to the second quarter of 2019, primarily in the transportation businesses. COVID-19 related losses for this group were $3 million (0.8 points on the combined ratio) in the second quarter of 2020. Catastrophe losses were $15 million (3.8 points) in the second quarter of 2020 compared to $8 million (2.0 points) in the second quarter of 2019.

Specialty casualty Underwriting profit for this group was $27 million for the second quarter of 2020 compared to $47 million for the second quarter of 2019, a decrease of $20 million (43%). COVID-19 related losses for this group were $52 million (9.5 points on the combined ratio) in the second quarter of 2020, primarily in the workers’ compensation and executive liability businesses. These losses, in addition to lower year-over-year underwriting profitability in the alternative markets and social services businesses were partially offset by higher favorable prior year reserve development of $20 million in the second quarter of 2020 compared to the second quarter of 2019, primarily in the workers’ compensation businesses, higher profitability in the excess and surplus and excess liability businesses, and the impact of $4 million of underwriting losses at Neon in the second quarter of 2019.

Specialty financial This group reported an underwriting loss of less than $1 million for the second quarter of 2020 compared to an underwriting profit of $21 million in the second quarter of 2019, a decrease of $21 million (100%). COVID-19 related losses for this group were $30 million (21.1 points on the combined ratio) in the second quarter of 2020, primarily related to trade credit insurance.

Other specialty This group reported an underwriting loss of $6 million in the second quarter of 2020 compared to $12 million in the second quarter of 2019, reflecting lower losses in the business assumed by AFG’s internal reinsurance program from the operations that make up AFG’s other Specialty sub-segments in the second quarter of 2020 compared to the second quarter of 2019.

Aggregate Aggregate underwriting results for AFG’s property and casualty insurance segment includes an underwriting loss of $43 million at Neon in the second quarter of 2020, due primarily to losses related to the COVID-19 pandemic. AFG also recorded adverse prior year reserve development of $2 million and $1 million in the second quarter of 2020 and 2019, respectively, related to business outside of the Specialty group that AFG no longer writes.

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AMERICAN FINANCIAL GROUP, INC. 10-Q

Management’s Discussion and Analysis of Financial Condition and Results of Operations — Continued

Losses and Loss Adjustment Expenses

AFG’s overall loss and LAE ratio was 65.1% for the second quarter of 2020 compared to 60.3% for the second quarter of 2019, an increase of 4.8 percentage points. The components of AFG’s property and casualty losses and LAE amounts and ratio are detailed below (dollars in millions):


	Three months ended June 30,
	Amount						Ratio				Change in
	2020		2019		2020		2019		Ratio
Property and transportation
Current year, excluding COVID-19 related and catastrophe losses	$	249	$	257	63.9	%	68.0	%	(4.1	%)
Prior accident years development	(28)		(6)		(7.2	%)	(1.6	%)	(5.6	%)
COVID-19 related losses	3		—		0.8	%	—	%	0.8	%
Current year catastrophe losses	15		8		3.8	%	2.0	%	1.8	%
Property and transportation losses and LAE and ratio	$	239	$	259	61.3	%	68.4	%	(7.1	%)

Specialty casualty
Current year, excluding COVID-19 related and catastrophe losses	$	360	$	410	66.0	%	64.6	%	1.4	%
Prior accident years development	(51)		(31)		(9.3	%)	(4.7	%)	(4.6	%)
COVID-19 related losses	52		—		9.5	%	—	%	9.5	%
Current year catastrophe losses	6		1		0.9	%	0.1	%	0.8	%
Specialty casualty losses and LAE and ratio	$	367	$	380	67.1	%	60.0	%	7.1	%

Specialty financial
Current year, excluding COVID-19 related and catastrophe losses	$	41	$	55	28.2	%	36.4	%	(8.2	%)
Prior accident years development	(11)		(9)		(8.0	%)	(5.9	%)	(2.1	%)
COVID-19 related losses	30		—		21.1	%	—	%	21.1	%
Current year catastrophe losses	5		3		3.6	%	1.8	%	1.8	%
Specialty financial losses and LAE and ratio	$	65	$	49	44.9	%	32.3	%	12.6	%

Total Specialty
Current year, excluding COVID-19 related and catastrophe losses	$	677	$	752	60.3	%	62.7	%	(2.4	%)
Prior accident years development	(85)		(42)		(7.6	%)	(3.4	%)	(4.2	%)
COVID-19 related losses	85		—		7.6	%	—	%	7.6	%
Current year catastrophe losses	26		12		2.3	%	0.9	%	1.4	%
Total Specialty losses and LAE and ratio	$	703	$	722	62.6	%	60.2	%	2.4	%

Aggregate — including exited lines
Current year, excluding COVID-19 related and catastrophe losses	$	717	$	752	60.7	%	62.7	%	(2.0	%)
Prior accident years development	(77)		(41)		(6.5	%)	(3.3	%)	(3.2	%)
COVID-19 related losses	105		—		8.8	%	—	%	8.8	%
Current year catastrophe losses	26		12		2.1	%	0.9	%	1.2	%
Aggregate losses and LAE and ratio	$	771	$	723	65.1	%	60.3	%	4.8	%

Current accident year losses and LAE, excluding COVID-19 related and catastrophe losses

The current accident year loss and LAE ratio, excluding COVID-19 related and catastrophe losses for AFG’s Specialty property and casualty insurance operations was 60.3% for the second quarter of 2020 compared to 62.7% for the second quarter of 2019, an improvement of 2.4 percentage points.

Property and transportation The 4.1 percentage point improvement in the loss and LAE ratio for the current year, excluding COVID-19 related and catastrophe losses reflects a decrease in the loss and LAE ratio at National Interstate,

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AMERICAN FINANCIAL GROUP, INC. 10-Q

Management’s Discussion and Analysis of Financial Condition and Results of Operations — Continued

due primarily to rate increases and lower claim frequency in the second quarter of 2020, and lower loss and LAE ratios in the Singapore branch and equine mortality business in the second quarter of 2020 compared to the second quarter of 2019.

Specialty casualty The 1.4 percentage point increase in the loss and LAE ratio for the current year, excluding COVID-19 related and catastrophe losses reflects the impact of the Neon exited lines in the second quarter of 2019, which have a lower loss and LAE ratio than many of the other businesses in the Specialty casualty group. Excluding the impact of the Neon exited lines, the loss and LAE ratio for the current year, excluding COVID-19 related and catastrophe losses increased 0.4 percentage points in the second quarter of 2020 compared to the second quarter of 2019.

Specialty financial The 8.2 percentage point improvement in the loss and LAE ratio for the current year, excluding COVID-19 related and catastrophe losses reflects a decrease in the loss and LAE ratio of the financial institutions business.

Net prior year reserve development

AFG’s Specialty property and casualty insurance operations recorded net favorable reserve development related to prior accident years of $85 million in the second quarter of 2020 compared to $42 million in the second quarter of 2019, an increase of $43 million (102%).

Property and transportation Net favorable reserve development of $28 million in the second quarter of 2020 reflects lower than anticipated claim frequency and severity in the transportation businesses and lower than expected claim frequency and severity in the agricultural businesses. Net favorable reserve development of $6 million in the second quarter of 2019 reflects lower than expected losses in the crop business.

Specialty casualty Net favorable reserve development of $51 million in the second quarter of 2020 reflects lower than anticipated claim frequency and severity in the workers’ compensation businesses. Net favorable reserve development of $31 million in the second quarter of 2019 reflects lower than anticipated claim severity in the workers’ compensation businesses, partially offset by higher than expected claim severity in the excess and surplus lines businesses.

Specialty financial Net favorable reserve development of $11 million in the second quarter of 2020 reflects lower than anticipated claim frequency in the trade credit and surety businesses. Net favorable reserve development of $9 million in the second quarter of 2019 reflects lower than expected claim frequency and severity in the surety and financial institutions businesses.

Other specialty In addition to the development discussed above, total Specialty prior year reserve development includes net adverse reserve development of $5 million in the second quarter of 2020 and $4 million in the second quarter of 2019, reflecting adverse development of $7 million and $6 million in the second quarter of 2020 and the second quarter of 2019, respectively, associated with AFG’s internal reinsurance program, partially offset by the amortization of the deferred gain on the retroactive reinsurance transactions entered into in connection with the sale of businesses in 1998 and 2001.

Aggregate Aggregate net prior accident years reserve development for AFG’s property and casualty insurance segment includes net adverse reserve development of $6 million in the second quarter of 2020 from the Neon exited lines and net adverse reserve development of $2 million and $1 million in the second quarter of 2020 and the second quarter of 2019, respectively, related to other business outside of the Specialty group that AFG no longer writes.

COVID-19 related losses

Underwriting results for AFG’s Specialty property and casualty insurance operations for the second quarter of 2020 included $85 million in COVID-19 related losses. Given the uncertainties surrounding the ultimate number or scope of claims relating to the pandemic, these charges, approximately 90% of which establish reserves for claims that have been incurred but not reported, represent the Company’s current best estimate of losses from the pandemic and related economic disruption incurred through June 30, 2020. Approximately 70% of AFG’s COVID-19 related losses were reported in the workers’ compensation, executive liability and trade credit businesses, with the remainder spread across numerous other businesses.

In addition, COVID related losses were the primary driver of the increased underwriting loss recorded in the Neon exited lines for the second quarter of 2020.

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AMERICAN FINANCIAL GROUP, INC. 10-Q

Management’s Discussion and Analysis of Financial Condition and Results of Operations — Continued

Catastrophe losses

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. Based on data available at December 31, 2019, AFG’s exposure to a catastrophic earthquake or windstorm that industry models indicate should statistically occur once in every 100, 250 or 500 years as a percentage of AFG’s Shareholders’ Equity is shown below:

Approximate impact of modeled loss

Industry Model

on AFG’s Shareholders’ Equity

100-year event

250-year event

500-year event

AFG maintains comprehensive catastrophe reinsurance coverage, including a $15 million per occurrence net retention for its U.S.-based property and casualty insurance operations for losses up to $109 million. Neon’s excess of loss catastrophe reinsurance limits the maximum retained loss per event to $15 million for losses up to $145 million on direct business and $15 million for losses up to $45 million on assumed business. AFG’s property and casualty insurance operations further maintain supplemental fully collateralized reinsurance coverage up to 95% of $200 million for catastrophe losses in excess of $109 million of traditional catastrophe reinsurance through a catastrophe bond. Effective July 1, 2020, AFG purchased an additional $50 million of reinsurance coverage for losses in excess of $100 million. Recoveries from the catastrophe bond apply before calculating losses recoverable from this catastrophe excess of loss reinsurance.

Catastrophe losses of $26 million in the second quarter of 2020 resulted primarily from storms and tornadoes in multiple regions of the United States and included $4 million related to civil unrest. Catastrophe losses of $12 million in the second quarter of 2019 resulted primarily from storms and tornadoes in multiple regions of the United States.

Commissions and Other Underwriting Expenses

AFG’s property and casualty commissions and other underwriting expenses (“U/W Exp”) were $404 million in the second quarter of 2020 compared to $418 million for the second quarter of 2019, a decrease of $14 million (3%). AFG’s underwriting expense ratio, calculated as commissions and other underwriting expenses divided by net premiums earned, was 34.1% for the second quarter of 2020 compared to 34.8% for the second quarter of 2019, a decrease of 0.7 percentage points. Detail of AFG’s property and casualty commissions and other underwriting expenses and underwriting expense ratios is shown below (dollars in millions):


	Three months ended June 30,
	2020						2019				Change in
	U/W Exp		% of NEP		U/W Exp		% of NEP		% of NEP
Property and transportation	$	118	30.4	%	$	116	30.7	%	(0.3	%)
Specialty casualty	153		27.8	%	207		32.5	%	(4.7	%)
Specialty financial	79		55.5	%	81		53.3	%	2.2	%
Other specialty	16		37.3	%	14		39.1	%	(1.8	%)
Total specialty	366		32.6	%	418		34.8	%	(2.2	%)
Neon exited lines	38				—
Aggregate	$	404	34.1	%	$	418	34.8	%	(0.7	%)

Property and transportation Commissions and other underwriting expenses as a percentage of net earned premiums decreased 0.3 percentage points in the second quarter of 2020 compared to the second quarter of 2019 reflecting the impact of higher premiums on the ratio in the property and inland marine business, partially offset by lower profitability-based ceding commissions received from reinsurers in the crop business in the second quarter of 2020 compared to the second quarter of 2019.

Specialty casualty Commissions and other underwriting expenses as a percentage of net earned premiums decreased 4.7 percentage points in the second quarter of 2020 compared to the second quarter of 2019 due to the runoff of Neon. Neon has a higher expense ratio than many of the other businesses in the Specialty casualty sub-segment. Excluding Neon exited lines, the underwriting expense ratio decreased 2.2 percentage points in the second quarter of

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AMERICAN FINANCIAL GROUP, INC. 10-Q

Management’s Discussion and Analysis of Financial Condition and Results of Operations — Continued

2020 compared to the second quarter of 2019 reflecting the impact of higher premiums on the ratio in the excess and surplus and excess liability businesses.

Specialty financial Commissions and other underwriting expenses as a percentage of net earned premiums increased 2.2 percentage points in the second quarter of 2020 compared to the second quarter of 2019 reflecting the impact of lower premiums on the ratio.

Property and Casualty Net Investment Income

Excluding the Neon exited lines, net investment income in AFG’s property and casualty insurance operations was $72 million in the second quarter of 2020 compared to $124 million in the second quarter of 2019, a decrease of $52 million (42%). The average invested assets and overall yield earned on investments held by AFG’s property and casualty insurance operations are provided below (dollars in millions):


	Three months ended June 30,
	2020			2019			Change			% Change
Net investment income	$	72		$	124		$	(52)		(42	%)

Average invested assets (at amortized cost)	$	11,454		$	11,193		$	261		2	%

Yield (net investment income as a % of average invested assets)	2.51		%	4.43		%	(1.92		%)

Tax equivalent yield (*)	2.64		%	4.60		%	(1.96		%)

(*)Adjusts the yield on equity securities and tax-exempt bonds to the fully taxable equivalent yield.

The property and casualty insurance segment’s decrease in net investment income for the second quarter of 2020 compared to the second quarter of 2019 reflects lower earnings from partnerships and similar investments in the second quarter of 2020, higher average cash balances and lower short-term interest rates, partially offset by the impact of growth in the property and casualty insurance segment. The property and casualty insurance segment’s overall yield on investments (net investment income as a percentage of average invested assets) was 2.51% for the second quarter of 2020 compared to 4.43% for the second quarter of 2019, a decrease of 1.92 percentage points. AFG’s property and casualty insurance operations recorded $13 million in losses from partnerships and similar investments and AFG-managed CLOs in the second quarter of 2020 compared to $23 million in earnings in the second quarter of 2019, a $36 million (157%) decrease in earnings. The annualized yield earned on these partnerships and similar investments and AFG-managed CLOs was a negative yield of 5.9% in the second quarter of 2020 compared to a positive yield of 13.3% in the prior year period. Because the property and casualty segment’s partnerships and similar investments accounted for using the equity method are reported on a quarter lag, the second quarter 2020 returns on those investments reflect the financial results and valuations for the quarter ended March 31, 2020, including the impact of the downturn in financial markets during the first quarter.

Property and Casualty Other Income and Expenses, Net

Other income and expenses, net for AFG’s property and casualty insurance operations was a net expense of $8 million for the second quarter of 2020 compared to $9 million for the second quarter of 2019, a decrease of $1 million (11%). The table below details the items included in other income and expenses, net for AFG’s property and casualty insurance operations (in millions):


	Three months ended June 30,
	2020		2019



Other income	$	3	$	2
Other expenses
Amortization of intangibles	3		3
Other	8		8
Total other expenses	11		11
Other income and expenses, net	$	(8)	$	(9)

In addition to the property and casualty segment’s other income and expenses, net from ongoing operations discussed above, the Neon exited lines incurred net income of $1 million in other income and expenses, net during the second quarter of 2020.

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AMERICAN FINANCIAL GROUP, INC. 10-Q

Management’s Discussion and Analysis of Financial Condition and Results of Operations — Continued

Annuity Segment — Results of Operations

AFG’s annuity operations incurred a GAAP pretax loss of $17 million in the second quarter of 2020 compared to pretax earnings of $71 million in the second quarter of 2019, a change of $88 million (124%) due primarily to the losses from partnerships and similar investments and the unfavorable impact of significantly lower than anticipated interest rates in the second quarter of 2020, partially offset by the positive impact of strong stock market performance in the 2020 quarter.

The following table details AFG’s GAAP and core earnings (loss) before income taxes from its annuity operations for the three months ended June 30, 2020 and 2019 (dollars in millions):


	Three months ended June 30,
	2020		2019		% Change
Revenues:
Net investment income	$	384	$	451	(15	%)
Other income:
Guaranteed withdrawal benefit fees	17		17		—	%
Policy charges and other miscellaneous income (a)	13		13		—	%
Total revenues	414		481		(14	%)

Costs and Expenses:
Annuity benefits (a)(b)	274		275		—	%
Acquisition expenses (a)	62		67		(7	%)
Other expenses	36		35		3	%
Total costs and expenses	372		377		(1	%)
Core earnings before income taxes	42		104		(60	%)
Pretax non-core earnings (losses) (a)	(59)		(33)		79	%
GAAP earnings (loss) before income taxes	$	(17)	$	71	(124	%)

(a)As discussed under “Results of Operations — General,” beginning prospectively with the second quarter of 2019, unlocking, the impact of changes in the fair value of derivatives related to FIAs, and other impacts of changes in the stock market and interest rates on the accounting for FIAs over or under the cost of the equity index options purchased to mitigate the risk in the index-based component of those FIAs are considered non-core earnings (losses). For the second quarter of 2020 and 2019, annuity benefits exclude the $157 million and $67 million unfavorable impact, respectively, of these items and acquisition expenses exclude the related $98 million and $34 million favorable impact, respectively, on the amortization of deferred policy acquisition costs.

(b)Details of the components of annuity benefits are provided below.

Annuity core earnings before income taxes were $42 million in the second quarter of 2020 compared to $104 million in the second quarter of 2019, a decrease of $62 million (60%), reflecting losses from partnerships and similar investments in the 2020 quarter and the impact of lower interest rates, partially offset by growth in the business, higher than expected persistency, lower than expected expenses related to guaranteed withdrawal benefits, strong stock market performance and a reduction in the cost of funds as a percentage of average annuity benefits accumulated. The table below highlights the impact of changes in the fair value of derivatives and other impacts of the changes in the stock market and interest rates on annuity segment results (dollars in millions):


	Three months ended June 30,
	2020		2019		% Change
Earnings before income taxes — before the impact of derivatives related to FIAs and other impacts of stock market performance and interest rates on FIAs	$	42	$	104	(60	%)

Impact of derivatives related to FIAs and other impacts of changes in the stock market and interest rates on FIAs over or under option costs:
Change in fair value of derivatives related to FIAs	(213)		(103)		107	%
Accretion of guaranteed minimum FIA benefits	(106)		(102)		4	%
Other annuity benefits	14		(8)		(275	%)
Less cost of equity options	148		146		1	%
Related impact on the amortization of deferred policy acquisition costs	98		34		188	%
Earnings (loss) before income taxes	$	(17)	$	71	(124	%)

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AMERICAN FINANCIAL GROUP, INC. 10-Q

Management’s Discussion and Analysis of Financial Condition and Results of Operations — Continued

Annuity benefits consisted of the following (dollars in millions):


	Three months ended June 30,
	2020										2019				Total
	Core		Non-core		Total		Core		Non-core		Total		% Change
Interest credited — fixed	$	103	$	—	$	103	$	98	$	—	$	98	5	%
Accretion of guaranteed minimum FIA benefits	—		106		106		—		102		102		4	%
Interest credited — fixed component of variable annuities	1		—		1		1		—		1		—	%
Cost of equity options	148		(148)		—		146		(146)		—		—	%
Other annuity benefits:
Amortization of sales inducements	2		(1)		1		4		—		4		(75	%)
Change in guaranteed withdrawal benefit reserve:
Impact of change in the stock market and interest rates	—		(24)		(24)		—		(4)		(4)		500	%
Accretion of benefits and other	17		—		17		20		—		20		(15	%)
Change in expected death and annuitization reserves and other	3		—		3		6		—		6		(50	%)
Change in other benefit reserves — impact of changes in interest rates and the stock market	—		11		11		—		12		12		(8	%)

Derivatives related to fixed-indexed annuities:
Embedded derivative mark-to-market	—		601		601		—		251		251		139	%
Equity option mark-to-market	—		(388)		(388)		—		(148)		(148)		162	%
Impact of derivatives related to FIAs	—		213		213		—		103		103		107	%

Total annuity benefits	$	274	$	157	$	431	$	275	$	67	$	342	26	%

Because fluctuations in interest rates and the stock market, among other factors, can cause volatility in annuity benefits expense related to FIAs that can be inconsistent with the long-term economics of the FIA business, management believes that including the actual cost of the equity options purchased in the FIA business and excluding unlocking, the impact of changes in the fair value of derivatives related to FIAs, and other impacts of changes in the stock market and interest rates on the accounting for FIAs provides investors with a better view of the true cost of funds in the business and a more comparable measure compared to the cost of funds reported by its peers. The cost of the equity options included in AFG’s cost of funds is the net purchase price of the option contracts amortized on a straight-line basis over the life of the contracts, which is generally one year. The following table reconciles AFG’s non-GAAP cost of funds measure to total annuity benefits expense (in millions):


	Three months ended June 30,
	2020		2019
Interest credited — fixed	$	103	$	98
Include cost of equity options	148		146
Cost of funds	251		244

Interest credited — fixed component of variable annuities	1		1
Other annuity benefits, excluding the impact of interest rates and the stock market on FIAs	22		30
	274		275
Changes in fair value of derivatives related to FIAs and other impacts of the stock market and interest rates over or under option costs:
Impact of derivatives related to FIAs	213		103
Accretion of guaranteed minimum FIA benefits	106		102
Other annuity benefits — impact of the stock market and interest rates on FIAs	(14)		8
Less cost of equity options (included in cost of funds)	(148)		(146)
Total annuity benefits expense	$	431	$	342

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AMERICAN FINANCIAL GROUP, INC. 10-Q

Management’s Discussion and Analysis of Financial Condition and Results of Operations — Continued

Net Spread on Fixed Annuities (excludes variable annuity earnings)

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 interest spread and net spread earned are often presented by annuity businesses to help users of their financial statements better understand the company’s performance.

The table below (dollars in millions) details the components of these spreads for AFG’s fixed annuity operations (including fixed-indexed and variable-indexed annuities):


	Three months ended June 30,
	2020			2019			% Change
Average fixed annuity investments (at amortized cost)	$	40,570		$	37,907		7	%
Average fixed annuity benefits accumulated	40,601			38,202			6	%

As % of fixed annuity benefits accumulated (except as noted):
Net investment income (as % of fixed annuity investments)	3.77		%	4.73		%
Cost of funds	(2.47		%)	(2.55		%)
Other annuity benefit expenses, net of guaranteed withdrawal benefit fees (*)	(0.06		%)	(0.13		%)
Net interest spread	1.24		%	2.05		%

Policy charges and other miscellaneous income (*)	0.11		%	0.11		%
Acquisition expenses (*)	(0.61		%)	(0.68		%)
Other expenses	(0.35		%)	(0.37		%)
Net spread earned on fixed annuities excluding the impact of changes in the fair value of derivatives related to FIAs and other impacts of changes in the stock market and interest rates on FIAs	0.39		%	1.11		%
Changes in fair value of derivatives related to FIAs and other impacts of the stock market and interest rates under (over) option costs	(0.58		%)	(0.35		%)

Net spread earned on fixed annuities	(0.19		%)	0.76		%

(*)Excluding the impact of changes in the fair value of derivatives related to FIAs and other impacts of changes in the stock market and interest rates on annuity benefits and the related impact on the amortization of deferred policy acquisition costs.

Annuity Net Investment Income

Net investment income for the second quarter of 2020 was $384 million compared to $451 million for the second quarter of 2019, a decrease of $67 million (15%), reflecting lower earnings from partnerships and similar investments, partially offset by growth in AFG’s annuity business. The overall yield earned on investments in AFG’s fixed annuity operations, calculated as net investment income divided by average investment balances (at amortized cost), decreased by 0.96 percentage points to 3.77% from 4.73% in the second quarter of 2020 compared to the second quarter of 2019. The decrease in the net investment yield between periods reflects the negative impact of lower earnings from partnerships and similar investments in the second quarter of 2020, lower short-term interest rates and the impact of the run-off of higher yielding investments. AFG’s annuity segment recorded $37 million in losses from partnerships and similar investments and AFG-managed CLOs in the second quarter of 2020 compared to $31 million in earnings in the second quarter of 2019, a change of $68 million (219%). The annualized yield earned on these partnerships and similar investments and AFG-managed CLOs was a negative yield of 11.3% in the second quarter of 2020 compared to a positive yield of 11.2% in the prior year period. Because the annuity segment’s partnerships and similar investments accounted for using the equity method are reported on a quarter lag, the second quarter 2020 returns from those investments reflect the financial results and valuations as of March 31, 2020, including the downturn in financial markets during the first quarter.

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AMERICAN FINANCIAL GROUP, INC. 10-Q

Management’s Discussion and Analysis of Financial Condition and Results of Operations — Continued

Annuity Cost of Funds

Cost of funds for the second quarter of 2020 was $251 million compared to $244 million for the second quarter of 2019, an increase of $7 million (3%). This increase reflects growth in the annuity business. The average cost of policyholder funds, calculated as cost of funds divided by average fixed annuity benefits accumulated, decreased 0.08 percentage points to 2.47% in the second quarter of 2020 from 2.55% in the second quarter of 2019 reflecting the impact of offering lower renewal crediting rates on option costs.

The following table provides details of AFG’s interest credited and other cost of funds (in millions):


	Three months ended June 30,
	2020		2019
Cost of equity options (FIAs)	$	148	$	146
Interest credited:
Traditional fixed annuities	64		61
Fixed component of fixed-indexed annuities	26		23
Immediate annuities	6		6
Pension risk transfer products	4		1
Federal Home Loan Bank advances	3		7
Total cost of funds	$	251	$	244

Other Annuity Benefits, Net of Guaranteed Withdrawal Benefit Fees

Other annuity benefits, net of guaranteed withdrawal benefit fees excluding the impact of the stock market and interest rates, for the second quarter of 2020 were $5 million compared to $13 million for the second quarter of 2019, a decrease of $8 million (62%). As a percentage of average fixed annuity benefits accumulated, these net expenses decreased 0.07% to 0.06% from 0.13% in the second quarter of 2020 compared to the second quarter of 2019. In addition to interest credited to policyholders’ accounts and the change in fair value of derivatives related to fixed-indexed annuities, annuity benefits expense also includes the following expenses (in millions, net of guaranteed withdrawal benefit fees):


	Three months ended June 30,
	2020		2019
Other annuity benefits, excluding the impact of the stock market and interest rates on FIAs:
Amortization of sales inducements	$	2	$	4
Change in guaranteed withdrawal benefit reserve	17		20
Change in other benefit reserves	3		6
Other annuity benefits	22		30
Offset guaranteed withdrawal benefit fees	(17)		(17)
Other annuity benefits excluding the impact of the stock market and interest rates, net	5		13
Other annuity benefits — impact of the stock market and interest rates	(14)		8
Other annuity benefits, net	$	(9)	$	21

As discussed under “Annuity Benefits Accumulated” in Note A — “Accounting Policies” to the financial statements, guaranteed withdrawal benefit reserves are accrued for and modified using assumptions similar to those used in establishing and amortizing deferred policy acquisition costs. In addition, the guaranteed withdrawal benefit reserve related to FIAs can be inversely impacted by the calculated FIA embedded derivative reserve as the value to policyholders of the guaranteed withdrawal benefits decreases when the benefit of stock market participation increases. As shown in the table above, changes in the stock market and interest rates decreased AFG’s guaranteed withdrawal benefit reserve by $14 million in the second quarter of 2020 compared to an increase of $8 million in the second quarter of 2019. This $22 million (275%) change was the primary driver of the $30 million overall change in other annuity benefits, net of guaranteed withdrawal fees in the second quarter of 2020 compared to the second quarter of 2019.

Annuity Net Interest Spread

AFG’s net interest spread decreased 0.81 percentage points to 1.24% from 2.05% in the second quarter of 2020 compared to the same period in 2019 due primarily to the lower earnings from partnerships and similar investments in the second quarter of 2020. Features included in current annuity product offerings allow AFG to achieve its desired profitability at a lower net interest spread than historical product offerings. As a result, AFG expects its net interest spread to narrow in the future.

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AMERICAN FINANCIAL GROUP, INC. 10-Q

Management’s Discussion and Analysis of Financial Condition and Results of Operations — Continued

Annuity Policy Charges and Other Miscellaneous Income

Annuity Acquisition Expenses

The following table illustrates the acceleration/deceleration of the amortization of deferred policy acquisition costs (“DPAC”) resulting from changes in the fair value of derivatives related to FIAs and other impacts of changes in the stock market and interest rates on the accounting for FIAs over or under option costs (in millions):


	Three months ended June 30,
	2020		2019
Annuity acquisition expenses before the impact of changes in the fair value of derivatives related to FIAs and other impacts of the stock market and interest rates	$	62	$	67

Impact of changes in the fair value of derivatives and other impacts of the stock market and interest rates	(98)		(34)
Annuity acquisition expenses	$	(36)	$	33

Annuity acquisitions expenses before the acceleration/deceleration of the amortization resulting from changes in the fair value of derivatives related to FIAs and other impacts of changes in the stock market and interest rates on the accounting for FIAs over or under option costs were $62 million for the second quarter of 2020 compared to $67 million for the second quarter of 2019, a decrease of $5 million (7%), reflecting higher than expected persistency and the positive impact of the significant increase in stock market performance on variable annuities in the second quarter of 2020.

The negative impact of significantly lower than anticipated interest rates in the second quarter of 2020 on the fair value of derivatives and other liabilities related to FIAs resulted in a partially offsetting deceleration of the amortization of DPAC. This deceleration of the amortization of DPAC in the second quarter of 2020 was partially offset by the positive impact of strong stock market performance in the 2020 period. The negative impact of lower than anticipated interest rates during the second quarter of 2019 on the fair value of derivatives and other liabilities related to FIAs resulted in a partially offsetting deceleration of the amortization of DPAC.

The table below illustrates the estimated impact of changes in the fair value of derivatives related to fixed-indexed annuities and other impacts of changes in the stock market and interest rates on FIAs on annuity acquisition expenses as a percentage of average fixed annuity benefits accumulated:


	Three months ended June 30,
	2020		2019
Before the impact of changes in the fair value of derivatives related to FIAs and other impacts of the stock market and interest rates	0.61	%	0.68	%

Impact of changes in fair value of derivatives and other impacts of the stock market and interest rates	(0.97	%)	(0.36	%)
Annuity acquisition expenses as a % of fixed annuity benefits accumulated	(0.36	%)	0.32	%

Annuity Other Expenses

Annuity other expenses were $36 million for the second quarter of 2020 compared to $35 million for the second quarter of 2019, an increase of $1 million (3%). Annuity other expenses represent primarily general and administrative expenses, as well as selling and issuance expenses that are not deferred. As a percentage of average fixed annuity benefits accumulated, these expenses decreased 0.02 percentage points to 0.35% for the second quarter of 2020 from 0.37% in the second quarter of 2019 due primarily to growth in the annuity business.

Change in Fair Value of Derivatives Related to Fixed-Indexed (Including Variable-Indexed) Annuities and Other Impacts of Changes in the Stock Market and Interest Rates on FIAs

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AMERICAN FINANCIAL GROUP, INC. 10-Q

Management’s Discussion and Analysis of Financial Condition and Results of Operations — Continued

strategy is designed so that the net change in the fair value of the call option assets and put option liabilities will generally offset the economic change in the net liability from the index participation. Both the index-based component of the annuities (an embedded derivative) and the related call and put options are considered derivatives that must be adjusted for changes in fair value through earnings each period. The fair values of these derivatives are impacted by actual and expected stock market performance and interest rates as well as other factors. For a list of other factors impacting the fair value of the embedded derivative component of AFG’s annuity benefits accumulated, see Note D — “Fair Value Measurements” to the financial statements. Fluctuations in certain of these factors, such as changes in interest rates and the performance of the stock market, are not economic in nature for the current reporting period, but rather impact the timing of reported results.

As discussed above under “Other Annuity Benefits, Net of Guaranteed Withdrawal Benefit Fees” and “Annuity Acquisition Expenses,” the periodic accounting for DPAC and guaranteed withdrawal benefits related to FIAs is also impacted by changes in the stock market and interest rates. These impacts may be temporary in nature and not necessarily indicative of the long-term performance of the FIA business. The table below highlights the impact of changes in the fair value of derivatives related to FIAs and the other impacts of the stock market and interest rates over or under the cost of the equity index options (discussed above) on earnings before income taxes for the annuity segment (dollars in millions):


	Three months ended June 30,
	2020		2019		% Change
Change in the fair value of derivatives related to FIAs	$	(213)	$	(103)	107	%
Accretion of guaranteed minimum FIA benefits	(106)		(102)		4	%
Other annuity benefits	14		(8)		(275	%)
Less cost of equity options	148		146		1	%
Related impact on the amortization of DPAC	98		34		188	%
Impact on annuity segment earnings before income taxes	$	(59)	$	(33)	79	%

During the second quarter of 2020, the negative impact of significantly lower than anticipated interest rates, partially offset by the positive impact of strong stock market performance, reduced earnings before income taxes for the annuity segment by $59 million compared to the $33 million impact of significantly lower than anticipated interest rates, partially offset by the favorable impact of positive stock market performance on annuity earnings before income taxes for the second quarter of 2019, an increase of $26 million (79%). As a percentage of average fixed annuity benefits accumulated, the impact of changes in the fair value of derivatives related to FIAs and other impacts of changes in the stock market and interest rates on the accounting for FIAs over or under the cost of the equity index options purchased to mitigate the risk in the indexed-based component of those FIAs was a net expense of 0.58% in the second quarter of 2020 compared to 0.35% in the second quarter of 2019.

The following table provides analysis of the primary factors impacting the change in the fair value of derivatives related to FIAs and the other impacts of the stock market and interest rates on the accounting for FIAs over or under the cost of the equity index options discussed above. Each factor is presented net of the estimated related impact on amortization of DPAC (dollars in millions).


	Three months ended June 30,
	2020		2019		% Change
Changes in the stock market, including volatility	$	38	$	7	443	%
Changes in interest rates higher (lower) than expected	(100)		(38)		163	%
Other	3		(2)		(250	%)
Impact on annuity segment earnings before income taxes	$	(59)	$	(33)	79	%

Annuity Net Spread Earned on Fixed Annuities

AFG’s net spread earned on fixed annuities excluding the impact of changes in the fair value of derivatives related to FIAs and other impacts of changes in the stock market and interest rates over or under option costs decreased 0.72 percentage points to 0.39% in the second quarter of 2020 from 1.11% in the second quarter of 2019 due primarily to the 0.81 percentage points decrease in AFG’s net interest spread discussed above. AFG’s overall net spread earned on fixed annuities changed 0.95 percentage points to a net loss of 0.19% in the second quarter of 2020 from net earnings of 0.76% in the second quarter of 2019 due to the decrease in AFG’s net interest spread, the impact of changes in the fair value of derivatives and other impacts of the stock market and interest rates on the accounting for FIAs discussed above.

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AMERICAN FINANCIAL GROUP, INC. 10-Q

Management’s Discussion and Analysis of Financial Condition and Results of Operations — Continued

Annuity Benefits Accumulated

Annuity premiums received 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 and other benefits are charged to expense and decreases for surrender and other policy charges are credited to other income.

For certain products, annuity benefits accumulated also includes reserves for accrued persistency and premium bonuses, excess benefits expected to be paid on future deaths and annuitizations (“EDAR”) and guaranteed withdrawal benefits. Annuity benefits accumulated also includes amounts advanced from the Federal Home Loan Bank of Cincinnati. The following table is a progression of AFG’s annuity benefits accumulated liability for the three months ended June 30, 2020 and 2019 (in millions):


	Three months ended June 30,
	2020		2019
Beginning fixed annuity reserves	$	40,260	$	37,724
Fixed annuity premiums (receipts)	682		1,343
Federal Home Loan Bank advances and repayments	(40)		—
Surrenders, benefits and other withdrawals	(768)		(862)
Interest and other annuity benefit expenses:
Cost of funds	251		244
Embedded derivative mark-to-market	601		251
Change in other benefit reserves	(44)		(20)

Ending fixed annuity reserves	$	40,942	$	38,680

Reconciliation to annuity benefits accumulated per balance sheet:
Ending fixed annuity reserves (from above)	$	40,942	$	38,680
Impact of unrealized investment related gains	285		192
Fixed component of variable annuities	165		172
Annuity benefits accumulated per balance sheet	$	41,392	$	39,044

Annuity benefits accumulated includes a liability of $680 million at June 30, 2020 and $491 million at June 30, 2019 for guaranteed withdrawal benefits on annuities with features that allow the policyholder to take fixed periodic lifetime benefit payments that could exceed account value. As discussed above under “Other Annuity Benefits, Net of Guaranteed Withdrawal Benefit Fees” and “Annuity Acquisition Expenses,” the periodic accounting for DPAC and guaranteed withdrawal benefits related to FIAs is also impacted by changes in the stock market and interest rates.

Statutory Annuity Premiums

AFG’s annuity operations generated gross statutory premiums of $687 million in the second quarter of 2020 compared to $1.35 billion in the second quarter of 2019, a decrease of $662 million (49%). The following table summarizes AFG’s annuity sales (dollars in millions):


	Three months ended June 30,
			2020			2019			% Change
Financial institutions single premium annuities — indexed	$	258		$	429		(40	%)
Financial institutions single premium annuities — fixed	98			313			(69	%)
Retail single premium annuities — indexed	138			274			(50	%)
Retail single premium annuities — fixed	31			36			(14	%)
Broker dealer single premium annuities — indexed	100			189			(47	%)
Broker dealer single premium annuities — fixed	2			8			(75	%)
Pension risk transfer	23			50			(54	%)
Education market — fixed and indexed annuities	32			44			(27	%)
Total fixed annuity premiums	682			1,343			(49	%)
Variable annuities	5			6			(17	%)
Total gross fixed annuity premiums	687			1,349			(49	%)
Ceded premiums	(78)			—			—	%
Total net annuity premiums	$	609		$	1,349		(55	%)

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AMERICAN FINANCIAL GROUP, INC. 10-Q

Management’s Discussion and Analysis of Financial Condition and Results of Operations — Continued

Management attributes the 49% decrease in total gross fixed annuity premiums in the second quarter of 2020 compared to the second quarter of 2019 to the lower market interest rate environment. In response to the continued drop in market interest rates during 2019 and 2020, AFG lowered crediting rates on several products, which has slowed annuity sales compared to 2019 levels. In addition, many of the restrictions from the COVID-19 pandemic impact the ability of agents to conduct business in the same manner as usual. As a result, management expects annuity premiums to be negatively impacted during the remainder of 2020.

Annuity Earnings before Income Taxes Reconciliation

The following table reconciles the net spread earned on AFG’s fixed annuities to overall annuity pretax earnings for the three months ended June 30, 2020 and 2019 (in millions):


	Three months ended June 30,
	2020		2019
Earnings (loss) on fixed annuity benefits accumulated	$	(19)	$	73
Earnings impact of investments in excess of fixed annuity benefits accumulated (*)	—		(3)
Variable annuity earnings	2		1
Earnings (loss) before income taxes	$	(17)	$	71

(*)Net investment income (as a % of investments) of 3.77% and 4.73% for the three months ended June 30, 2020 and 2019, respectively, multiplied by the difference between average fixed annuity investments (at amortized cost) and average fixed annuity benefits accumulated in each period.

Holding Company, Other and Unallocated — Results of Operations

AFG’s net pretax loss outside of its property and casualty insurance and annuity segments (excluding realized gains and losses) totaled $43 million in the second quarter of 2020 compared to $42 million in the second quarter of 2019, an increase of $1 million (2%).

The following table details AFG’s loss before income taxes from operations outside of its property and casualty insurance and annuity segments for the three months ended June 30, 2020 and 2019 (dollars in millions):


	Three months ended June 30,
	2020		2019		% Change
Revenues:
Life, accident and health net earned premiums	$	5	$	5	—	%
Net investment income	14		10		40	%
Other income — P&C fees	16		20		(20	%)
Reclassify annuity segment option gains	(5)		(3)		67	%
Other income	6		6		—	%
Total revenues	36		38		(5	%)

Costs and Expenses:
Property and casualty insurance — commissions and other underwriting expenses	5		8		(38	%)
Annuity — annuity benefits	(5)		(3)		67	%
Life, accident and health benefits	9		8		13	%
Life, accident and health acquisition expenses	1		—		—	%
Other expense — expenses associated with P&C fees	11		12		(8	%)
Other expenses	35		38		(8	%)
Costs and expenses, excluding interest charges on borrowed money	56		63		(11	%)
Loss before income taxes, excluding realized gains and losses and interest charges on borrowed money	(20)		(25)		(20	%)
Interest charges on borrowed money	23		17		35	%



Loss before income taxes, excluding realized gains and losses	$	(43)	$	(42)	2	%

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AMERICAN FINANCIAL GROUP, INC. 10-Q

Management’s Discussion and Analysis of Financial Condition and Results of Operations — Continued

Holding Company and Other — Life, Accident and Health Premiums, Benefits and Acquisition Expenses

AFG’s run-off long-term care and life insurance operations recorded net earned premiums of $5 million and related benefits and acquisition expenses of $10 million in the second quarter of 2020 compared to net earned premiums of $5 million and related benefits and acquisition expenses of $8 million in the second quarter of 2019. The $1 million (13%) increase in life, accident and health benefits reflects higher claims in the run-off life insurance business.

Holding Company and Other — Net Investment Income

AFG recorded net investment income on investments held outside of its property and casualty insurance and annuity segments of $14 million in the second quarter of 2020 compared to $10 million in the second quarter of 2019, an increase of $4 million (40%). The parent company holds a small portfolio of securities that are carried at fair value through net investment income. These securities increased in value by $7 million in the second quarter of 2020 compared to an increase in value of $3 million in the second quarter of 2019.

Holding Company and Other — P&C Fees and Related Expenses

Summit, a workers’ compensation insurance subsidiary, collects fees from a small group of unaffiliated insurers for providing underwriting, policy administration and claims services. In addition, certain of AFG’s property and casualty insurance businesses collect fees from customers for ancillary services such as workplace safety programs and premium financing. In the second quarter of 2020, AFG collected $16 million in fees for these services compared to $20 million in the second quarter of 2019. Management views this fee income, net of the $11 million in the second quarter of 2020 and $12 million the second quarter of 2019, in expenses incurred to generate such fees, as a reduction in the cost of underwriting its property and casualty insurance policies. Consistent with internal management reporting, these fees and the related expenses are netted and recorded as a reduction of commissions and other underwriting expenses in AFG’s segmented results.

Holding Company and Other — Annuity Segment Option Gains

As discussed under “Annuity Segment — Results of Operations,” AFG purchases and sells equity index options to mitigate the risk in the index-based component of its FIAs. In evaluating the performance of the annuity business, management views the cost of the equity options as a better measurement of the true expenses of the Annuity segment as compared to the GAAP accounting for these options as derivatives because any proceeds at expiration from the options generally are passed to policyholders through index credits. On occasion, policyholders surrender their annuity prior to receiving the index credit, which results in any option exercise proceeds being retained by AFG. For internal management reporting, AFG views these “option gains” as miscellaneous (other) income rather than as a component of annuity benefits expense. Consistent with internal management reporting, these option gains are reclassified from annuity benefits to other income in AFG’s segmented results. In the second quarter of 2020 and 2019, AFG had $5 million and $3 million, respectively, in such option gains.

Holding Company and Other — Other Income

Other income in the table above includes $4 million in both the second quarter of 2020 and the second quarter of 2019, in management fees paid to AFG by the AFG-managed CLOs (AFG’s consolidated managed investment entities). The management fees are eliminated in consolidation — see the other income line in the Consolidate MIEs column under “Results of Operations — Segmented Statement of Earnings.” Excluding amounts eliminated in consolidation, AFG recorded other income outside of its property and casualty insurance and annuity segments of $2 million in both the second quarter of 2020 and the second quarter of 2019.

Holding Company and Other — Other Expenses

AFG’s holding companies and other operations outside of its property and casualty insurance and annuity segments recorded other expenses of $35 million in the second quarter of 2020 compared to $38 million in the second quarter of 2019, a decrease of $3 million (8%). This decrease reflects lower expenses associated with certain incentive compensation plans.

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AMERICAN FINANCIAL GROUP, INC. 10-Q

Management’s Discussion and Analysis of Financial Condition and Results of Operations — Continued

Holding Company and Other — Interest Charges on Borrowed Money

AFG’s holding companies and other operations outside of its property and casualty insurance and annuity segments recorded interest expense of $23 million in the second quarter of 2020 compared to $17 million in the second quarter of 2019, an increase of $6 million (35%). The following table details the principal amount of AFG’s long-term debt balances as of June 30, 2020 compared to June 30, 2019 (dollars in millions):


	June 30, 2020			June 30, 2019
Direct obligations of AFG:
4.50% Senior Notes due June 2047	$	590		$	590
3.50% Senior Notes due August 2026	425			425
5.25% Senior Notes due April 2030	300			—
5.125% Subordinated Debentures due December 2059	200			—
6% Subordinated Debentures due November 2055	150			150
5.625% Subordinated Debentures due June 2060	150			—
5.875% Subordinated Debentures due March 2059	125			125
6-1/4% Subordinated Debentures due September 2054	—			150
Other	3			3
Total principal amount of Holding Company Debt	$	1,943		$	1,443

Weighted Average Interest Rate	4.8		%	4.7		%

The increase in interest expense for the second quarter of 2020 as compared to the second quarter of 2019 reflects the following financial transactions completed by AFG between March 31, 2019 and June 30, 2020:

•Issued $200 million of 5.125% Subordinated Debentures in December 2019

•Redeemed $150 million of 6-1/4% Subordinated Debentures in December 2019

•Issued $300 million of 5.25% Senior Notes in April 2020

•Issued $150 million of 5.625% Subordinated Debentures in May 2020

Consolidated Realized Gains on Securities

AFG’s consolidated realized gains on securities, which are not allocated to segments, were $204 million in the second quarter of 2020 compared to $56 million in the second quarter of 2019, an increase of $148 million (264%). Realized gains on securities consisted of the following (in millions):


	Three months ended June 30,
			2020			2019
Realized gains before impairments:
Disposals	$	—		$	8
Change in the fair value of equity securities	202			44
Change in the fair value of derivatives	3			6
Adjustments to annuity deferred policy acquisition costs and related items	(2)			—
	203			58
Change in allowance for impairments:
Securities	1			(3)
Adjustments to annuity deferred policy acquisition costs and related items	—			1
	1			(2)
Realized gains (losses) on securities	$	204		$	56

The $202 million net realized gain from the change in the fair value of equity securities in the second quarter of 2020 includes gains of $63 million on investments in banks and financing companies, $34 million on investments in media companies, $21 million on investments in natural gas companies, $10 million on investments in energy companies and $13 million on real estate investment trusts. The $44 million net realized gain from the change in the fair value of equity securities in the second quarter of 2019 includes gains of $18 million on investments in banks and financing companies, $13 million from investments in communications companies and $10 million on investments in asset management companies.

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AMERICAN FINANCIAL GROUP, INC. 10-Q

Management’s Discussion and Analysis of Financial Condition and Results of Operations — Continued

The $1 million reduction of previously recognized expected credit losses in the second quarter of 2020 includes $2 million in income related to corporate bonds and other fixed maturities and $1 million in expense related to structured securities.

Consolidated Income Taxes

AFG’s consolidated provision for income taxes was $51 million for the second quarter of 2020 compared to $50 million for the second quarter of 2019, an increase of $1 million (2%). See Note L — “Income Taxes” to the financial statements for an analysis of items affecting AFG’s effective tax rate.

Consolidated Noncontrolling Interests

AFG’s consolidated net earnings (loss) attributable to noncontrolling interests was a net loss of $10 million for the second quarter of 2020 compared to $1 million for the second quarter of 2019. Both periods reflect losses at Neon, AFG’s United Kingdom-based Lloyd’s insurer.

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AMERICAN FINANCIAL GROUP, INC. 10-Q

Management’s Discussion and Analysis of Financial Condition and Results of Operations — Continued

RESULTS OF OPERATIONS — SIX MONTHS ENDED JUNE 30, 2020 AND 2019

Segmented Statement of Earnings

AFG’s net earnings (loss) attributable to shareholders, determined in accordance with GAAP, include certain items that may not be indicative of its ongoing core operations. The following tables for the six months ended June 30, 2020 and 2019 identify such items by segment and reconcile net earnings attributable to shareholders to core net operating earnings, a non-GAAP financial measure that AFG believes is a useful tool for investors and analysts in analyzing ongoing operating trends (in millions):


					Other
	P&C		Annuity		Consol. MIEs		Holding Co., other and unallocated		Total		Non-core reclass		Neon exited lines (c)		GAAP Total
Six months ended June 30, 2020
Revenues:
Property and casualty insurance net earned premiums	$	2,261	$	—	$	—	$	—	$	2,261	$	—	$	132	$	2,393
Net investment income	171		806		34		7		1,018		—		(6)		1,012
Realized gains (losses) on securities	—		—		—		—		—		(347)		—		(347)
Income (loss) of MIEs:
Investment income	—		—		108		—		108		—		—		108
Gain (loss) on change in fair value of assets/liabilities	—		—		(48)		—		(48)		—		—		(48)
Other income	8		65		(8)		43		108		—		—		108
Total revenues	2,440		871		86		50		3,447		(347)		126		3,226

Costs and Expenses:
Property and casualty insurance:
Losses and loss adjustment expenses	1,372		—		—		—		1,372		—		106		1,478
Commissions and other underwriting expenses	749		—		—		10		759		—		70		829
Annuity benefits	—		561		—		(13)		548		154		—		702
Annuity and supplemental insurance acquisition expenses	—		133		—		2		135		(57)		—		78
Interest charges on borrowed money	—		—		—		40		40		—		—		40
Expenses of MIEs	—		—		86		—		86		—		—		86
Other expenses	22		68		—		91		181		—		2		183
Total costs and expenses	2,143		762		86		130		3,121		97		178		3,396
Earnings (loss) before income taxes	297		109		—		(80)		326		(444)		(52)		(170)
Provision (credit) for income taxes	60		20		—		(20)		60		(93)		—		(33)
Net earnings (loss), including noncontrolling interests	237		89		—		(60)		266		(351)		(52)		(137)
Less: Net earnings (loss) attributable to noncontrolling interests	—		—		—		—		—		—		(13)		(13)
Core Net Operating Earnings (Loss)	237		89		—		(60)		266
Non-core earnings (loss) attributable to shareholders (a):
Realized gains (losses) on securities, net of tax	—		—		—		(274)		(274)		274		—		—
Annuity non-core earnings (losses), net of tax (b)	—		(77)		—		—		(77)		77		—		—
Neon exited lines (c)	(39)		—		—		—		(39)		—		39		—

Net Earnings (Loss) Attributable to Shareholders	$	198	$	12	$	—	$	(334)	$	(124)	$	—	$	—	$	(124)

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AMERICAN FINANCIAL GROUP, INC. 10-Q

Management’s Discussion and Analysis of Financial Condition and Results of Operations — Continued


					Other
	P&C		Annuity		Consol. MIEs		Holding Co., other and unallocated		Total		Non-core reclass		GAAP Total
Six months ended June 30, 2019
Revenues:
Property and casualty insurance net earned premiums	$	2,373	$	—	$	—	$	—	$	2,373	$	—	$	2,373
Net investment income	228		886		(16)		24		1,122		—		1,122
Realized gains (losses) on securities	—		—		—		—		—		240		240
Income (loss) of MIEs:
Investment income	—		—		139		—		139		—		139
Gain (loss) on change in fair value of assets/liabilities	—		—		(2)		—		(2)		—		(2)
Other income	5		58		(7)		56		112		—		112
Total revenues	2,606		944		114		80		3,744		240		3,984

Costs and Expenses:
Property and casualty insurance:
Losses and loss adjustment expenses	1,415		—		—		—		1,415		—		1,415
Commissions and other underwriting expenses	812		—		—		13		825		—		825
Annuity benefits	—		587		—		(4)		583		67		650
Annuity and supplemental insurance acquisition expenses	—		93		—		2		95		(34)		61
Interest charges on borrowed money	—		—		—		33		33		—		33
Expenses of MIEs	—		—		114		—		114		—		114
Other expenses	23		70		—		121		214		—		214
Total costs and expenses	2,250		750		114		165		3,279		33		3,312
Earnings (loss) before income taxes	356		194		—		(85)		465		207		672
Provision (credit) for income taxes	72		39		—		(18)		93		44		137
Net earnings (loss), including noncontrolling interests	284		155		—		(67)		372		163		535
Less: Net earnings (loss) attributable to noncontrolling interests	(4)		—		—		—		(4)		—		(4)
Core Net Operating Earnings (Loss)	288		155		—		(67)		376
Non-core earnings (loss) attributable to shareholders (a):
Realized gains (losses) on securities, net of tax	—		—		—		190		190		(190)		—
Annuity non-core earnings (losses), net of tax (b)	—		(27)		—		—		(27)		27		—


Net Earnings (Loss) Attributable to Shareholders	$	288	$	128	$	—	$	123	$	539	$	—	$	539

(a)See the reconciliation of core earnings to GAAP net earnings under “Results of Operations — General” for details on the tax and noncontrolling interest impacts of these reconciling items.

(b)As discussed under “Results of Operations — General,” beginning prospectively with the second quarter of 2019, unlocking, the impact of changes in the fair value of derivatives related to FIAs, and other impacts of changes in the stock market and interest rates on the accounting for FIAs over or under the cost of the equity index options purchased to mitigate the risk in the index-based component of those FIAs are considered non-core earnings (losses).

Property and Casualty Insurance Segment — Results of Operations

AFG’s property and casualty insurance operations contributed $245 million in GAAP pretax earnings in the first six months of 2020 compared to $356 million in the first six months of 2019, a decrease of $111 million (31%). Property and casualty core pretax earnings were $297 million in the first six months of 2020 compared to $356 million in the first six months of 2019, a decrease of $59 million (17%). The decrease in GAAP and core pretax earnings reflects lower net investment income in the first six months of 2020 compared to the same period in 2019 due primarily to the impact of financial market disruption on earnings (losses) from partnerships and similar investments and AFG-managed CLOs.

The following table details AFG’s GAAP and core earnings before income taxes from its property and casualty insurance operations for the six months ended June 30, 2020 and 2019 (dollars in millions):

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AMERICAN FINANCIAL GROUP, INC. 10-Q

Management’s Discussion and Analysis of Financial Condition and Results of Operations — Continued


	Six months ended June 30,
	2020			2019			% Change
Gross written premiums	$	3,065		$	3,199		(4		%)
Reinsurance premiums ceded	(777)			(788)			(1		%)
Net written premiums	2,288			2,411			(5		%)
Change in unearned premiums	(27)			(38)			(29		%)
Net earned premiums	2,261			2,373			(5		%)
Loss and loss adjustment expenses	1,372			1,415			(3		%)
Commissions and other underwriting expenses	749			812			(8		%)
Core underwriting gain	140			146			(4		%)

Net investment income	171			228			(25		%)
Other income and expenses, net	(14)			(18)			(22		%)
Core earnings before income taxes	297			356			(17		%)
Pretax non-core Neon exited lines (*)	(52)			—			—		%

GAAP earnings before income taxes and noncontrolling interests	$	245		$	356		(31		%)

(*) 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. (“Neon”), into run-off. As discussed under “Results of Operations — General,” following the December 2019 decision to exit the Lloyd’s of London insurance market, the results from the Neon exited lines are being treated as non-core earnings (losses) prospectively beginning in 2020. Each line item in the table above has been adjusted to remove the impact from the Neon run-off operations in 2020. The following table details the impact of the Neon exited lines to each component of earnings (loss) before income taxes in the property and casualty insurance operations for the six months ended June 30, 2020 (in millions):

	Six months ended June 30, 2020
	Excluding Neon exited lines			Neon exited lines			Total
Gross written premiums	$	3,065		$	70		$	3,135
Reinsurance premiums ceded	(777)			(63)			(840)
Net written premiums	2,288			7			2,295
Change in unearned premiums	(27)			125			98
Net earned premiums	2,261			132			2,393
Loss and loss adjustment expenses	1,372			106			1,478
Commissions and other underwriting expenses	749			70			819
Underwriting gain (loss)	140			(44)			96

Net investment income	171			(6)			165
Other income and expenses, net	(14)			(2)			(16)
Earnings (loss) before income taxes	$	297		$	(52)		$	245


	Six months ended June 30,
	2020			2019			Change
Combined Ratios:
Specialty lines
Loss and LAE ratio	60.5		%	59.6		%	0.9		%
Underwriting expense ratio	33.2		%	34.2		%	(1.0		%)
Combined ratio	93.7		%	93.8		%	(0.1		%)

Aggregate — including exited lines
Loss and LAE ratio	61.8		%	59.7		%	2.1		%
Underwriting expense ratio	34.2		%	34.2		%	—		%
Combined ratio	96.0		%	93.9		%	2.1		%

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AMERICAN FINANCIAL GROUP, INC. 10-Q

Management’s Discussion and Analysis of Financial Condition and Results of Operations — Continued

Gross Written Premiums

Gross written premiums (“GWP”) for AFG’s property and casualty insurance segment were $3.14 billion for the first six months of 2020 compared to $3.20 billion for the first six months of 2019, a decrease of $64 million (2%). Detail of AFG’s property and casualty gross written premiums is shown below (dollars in millions):


	Six months ended June 30,
	2020						2019
	GWP		%		GWP		%		% Change
Property and transportation	$	1,105	35	%	$	1,018	32	%	9	%
Specialty casualty	1,601		51	%	1,808		57	%	(11	%)
Specialty financial	359		12	%	373		11	%	(4	%)
Total specialty	3,065		98	%	3,199		100	%	(4	%)
Neon exited lines	70		2	%	—		—	%	—	%
Aggregate	$	3,135	100	%	$	3,199	100	%	(2	%)

Reinsurance Premiums Ceded

Reinsurance premiums ceded (“Ceded”) for AFG’s property and casualty insurance segment were 27% of gross written premiums for the first six months of 2020 compared to 25% of gross written premiums for the first six months of 2019, an increase of 2 percentage points. Detail of AFG’s property and casualty reinsurance premiums ceded is shown below (dollars in millions):


	Six months ended June 30,
	2020						2019				Change in
	Ceded		% of GWP		Ceded		% of GWP		% of GWP
Property and transportation	$	(293)	27	%	$	(252)	25	%	2	%
Specialty casualty	(504)		31	%	(520)		29	%	2	%
Specialty financial	(71)		20	%	(79)		21	%	(1	%)
Other specialty	91				63
Total specialty	(777)		25	%	(788)		25	%	—	%
Neon exited lines	(63)		90	%	—		—	%	90	%
Aggregate	$	(840)	27	%	$	(788)	25	%	2	%

Net Written Premiums

Net written premiums (“NWP”) for AFG’s property and casualty insurance segment were $2.30 billion for the first six months of 2020 compared to $2.41 billion for the first six months of 2019, a decrease of $116 million (5%). Detail of AFG’s property and casualty net written premiums is shown below (dollars in millions):


	Six months ended June 30,
	2020						2019
	NWP		%		NWP		%		% Change
Property and transportation	$	812	35	%	$	766	32	%	6	%
Specialty casualty	1,097		48	%	1,288		53	%	(15	%)
Specialty financial	288		13	%	294		12	%	(2	%)
Other specialty	91		4	%	63		3	%	44	%
Total specialty	2,288		100	%	2,411		100	%	(5	%)
Neon exited lines	7		—	%	—		—	%	—	%
Aggregate	$	2,295	100	%	$	2,411	100	%	(5	%)

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AMERICAN FINANCIAL GROUP, INC. 10-Q

Management’s Discussion and Analysis of Financial Condition and Results of Operations — Continued

Net Earned Premiums

Net earned premiums (“NEP”) for AFG’s property and casualty insurance segment were $2.39 billion for the first six months of 2020 compared to $2.37 billion for the first six months of 2019, an increase of $20 million (1%). Detail of AFG’s property and casualty net earned premiums is shown below (dollars in millions):


	Six months ended June 30,
	2020						2019
	NEP		%		NEP		%		% Change
Property and transportation	$	776	32	%	$	740	31	%	5	%
Specialty casualty	1,103		46	%	1,263		53	%	(13	%)
Specialty financial	300		13	%	297		13	%	1	%
Other specialty	82		3	%	73		3	%	12	%
Total specialty	2,261		94	%	2,373		100	%	(5	%)
Neon exited lines	132		6	%	—		—	%	—	%
Aggregate	$	2,393	100	%	$	2,373	100	%	1	%

The $64 million (2%) decrease in gross written premiums for the first six months of 2020 compared to the first six months of 2019 reflects a decrease in the Specialty casualty and Specialty financial sub-segments, partially offset by an increase in the Specialty property and transportation sub-segment . Overall average renewal rates increased approximately 8% in the first six months of 2020. Excluding the workers’ compensation business, renewal pricing increased approximately 12%.

Property and transportation Gross written premiums increased $87 million (9%) in the first six months of 2020 when compared to the first six months of 2019, which was impacted by delayed acreage reporting from insureds as a result of excess moisture and late planting of corn and soybean crops. Excluding crop insurance, gross written premiums for the first six months of 2020 increased by 5% in this group when compared to the first six months of 2019. Decreases in premiums due to return of premiums and reduced exposures as a result of the COVID-19 pandemic were more than offset by new business opportunities in the transportation, property and inland marine and ocean marine businesses. Average renewal rates increased approximately 7% for this group in the first six months of 2020. Reinsurance premiums ceded as a percentage of gross written premiums increased 2 percentage points in the first six months of 2020 compared to the first six months of 2019, reflecting growth in crop and certain ocean marine business, which cede a larger percentage of premiums than the other businesses in the Specialty property and transportation sub-segment.

Specialty casualty Gross written premiums decreased $207 million (11%) in the first six months of 2020 compared to the first six months of 2019 due primarily to the run-off of Neon. Excluding the $318 million in gross written premiums from the Neon exited lines in the first six months of 2019, gross written premiums increased 7% in the first six months of 2020 compared to the first six months of 2019. This increase reflects growth in the excess and surplus and excess liability businesses, primarily the result of significant renewal rate increases, new business opportunities and higher retentions on renewal business. This growth was partially offset by lower premiums due to reduced exposures in the workers’ compensation businesses as a result of the COVID-19 pandemic. Average renewal rates increased approximately 10% for this group in the first six months of 2020. Excluding rate decreases in the workers’ compensation businesses, renewal rates for this group increased approximately 19%. Reinsurance premiums ceded as a percentage of gross written premiums increased 2 percentage points in the first six months of 2020 compared to the first six months of 2019, reflecting growth in the excess and surplus and excess liability businesses, which cede a larger percentage of premiums than the other businesses in the Specialty casualty sub-segment, partially offset by the impact of the Neon exited lines.

Specialty financial Gross written premiums decreased $14 million (4%) in the first six months of 2020 compared to the first six months of 2019 due primarily to lower premiums from the impact of various state regulations regarding policy cancellations and the placement of forced coverage in the financial institutions business, partially offset by higher premiums in the fidelity business. Average renewal rates for this group increased approximately 6% in the first six months of 2020. Reinsurance premiums ceded as a percentage of gross written premiums decreased 1 percentage point for the first six months of 2020 compared to the first six months of 2019, reflecting lower cessions in the financial institutions business.

Other specialty The amounts shown as reinsurance premiums ceded represent business assumed by AFG’s internal reinsurance program from the operations that make up AFG’s other Specialty property and casualty insurance sub-segments. Reinsurance premiums assumed increased $28 million (44%) in the first six months of 2020 compared to the

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AMERICAN FINANCIAL GROUP, INC. 10-Q

Management’s Discussion and Analysis of Financial Condition and Results of Operations — Continued

first six months of 2019, reflecting an increase in premiums retained, primarily from businesses in the Specialty casualty sub-segment.

Combined Ratio

The table below (dollars in millions) details the components of the combined ratio for AFG’s property and casualty insurance segment:


	Six months ended June 30,								Six months ended June 30,
	2020		2019		Change		2020		2019
Property and transportation
Loss and LAE ratio	61.4	%	65.4	%	(4.0	%)
Underwriting expense ratio	30.9	%	28.8	%	2.1	%
Combined ratio	92.3	%	94.2	%	(1.9	%)
Underwriting profit							$	60	$	43

Specialty casualty
Loss and LAE ratio	64.1	%	60.8	%	3.3	%
Underwriting expense ratio	28.7	%	32.6	%	(3.9	%)
Combined ratio	92.8	%	93.4	%	(0.6	%)
Underwriting profit							$	79	$	83

Specialty financial
Loss and LAE ratio	41.2	%	35.3	%	5.9	%
Underwriting expense ratio	53.2	%	53.3	%	(0.1	%)
Combined ratio	94.4	%	88.6	%	5.8	%
Underwriting profit							$	17	$	34

Total Specialty
Loss and LAE ratio	60.5	%	59.6	%	0.9	%
Underwriting expense ratio	33.2	%	34.2	%	(1.0	%)
Combined ratio	93.7	%	93.8	%	(0.1	%)
Underwriting profit							$	143	$	148

Aggregate — including exited lines
Loss and LAE ratio	61.8	%	59.7	%	2.1	%
Underwriting expense ratio	34.2	%	34.2	%	—	%
Combined ratio	96.0	%	93.9	%	2.1	%
Underwriting profit							$	96	$	146

The Specialty property and casualty insurance operations generated an underwriting profit of $143 million for the first six months of 2020 compared to $148 million for the first six months of 2019, a decrease of $5 million (3%). The lower underwriting profit in the first six months of 2020 reflects lower underwriting profits in the Specialty casualty and Specialty financial sub-segments, partially offset by higher underwriting profit in the Property and transportation sub-segment. Underwriting results for the Specialty property and casualty insurance operations include $95 million in COVID-19 related losses (4.2 points on the combined ratio) in the first six months of 2020.

Property and transportation Underwriting profit for this group was $60 million for the first six months of 2020 compared to $43 million for the first six months of 2019, an increase of $17 million (40%), This increase reflects higher favorable prior year reserve development in the transportation businesses and higher underwriting profits at the Singapore branch, partially offset by lower underwriting profit in the crop business. COVID-19 related losses for this group were $6 million (0.7 points on the combined ratio) in the first six months of 2020. Catastrophe losses were $23 million (3.0 points on the combined ratio) in the first six months of 2020 compared to $17 million (2.3 points) in the first six months of 2019.

Specialty casualty Underwriting profit for this group was $79 million for the first six months of 2020 compared to $83 million for the first six months of 2019, a decrease of $4 million (5%). COVID-19 related losses were $59 million (5.3 points on the combined ratio) in the first six months of 2020, primarily in the workers’ compensation and executive liability businesses. These losses, in addition to lower year-over-year underwriting profitability in the alternative markets and public sector businesses were partially offset by higher favorable prior year reserve development of $31 million in the first

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AMERICAN FINANCIAL GROUP, INC. 10-Q

Management’s Discussion and Analysis of Financial Condition and Results of Operations — Continued

six months of 2020 compared to the first six months of 2019, primarily in the workers’ compensation and executive liability businesses, higher profitability in the excess and surplus and excess liability businesses, and the impact of $14 million of underwriting losses at Neon in the first six months of 2019.

Specialty financial Underwriting profit for this group was $17 million for the first six months of 2020 compared to $34 million for the first six months of 2019, a decrease of $17 million (50%). COVID-19 related losses were $30 million (10.2 points on the combined ratio) in the first six months of 2020 primarily related to trade credit insurance. Lower underwriting profitability in the trade credit, surety and fidelity businesses was partially offset by higher underwriting profit in the financial institutions business.

Other specialty This group reported an underwriting loss of $13 million for the first six months of 2020 compared to $12 million in the first six months of 2019, an increase of $1 million (8%). This increase reflects higher losses in the business assumed by AFG’s internal reinsurance program from the operations that make up AFG’s other Specialty sub-segments in the first six months of 2020 compared to the first six months of 2019.

Aggregate Aggregate underwriting results for AFG’s property and casualty insurance segment includes an underwriting loss of $44 million at Neon in the second quarter of 2020, due primarily to losses related to the COVID-19 pandemic. AFG also recorded adverse prior year reserve development of $3 million and $2 million in the second quarter of 2020 and 2019, respectively, related to business outside of the Specialty group that AFG no longer writes.

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AMERICAN FINANCIAL GROUP, INC. 10-Q

Management’s Discussion and Analysis of Financial Condition and Results of Operations — Continued

Losses and Loss Adjustment Expenses

AFG’s overall loss and LAE ratio was 61.8% for the first six months of 2020 compared to 59.7% for the first six months of 2019, an increase of 2.1 percentage points. The components of AFG’s property and casualty losses and LAE amounts and ratio are detailed below (dollars in millions):


	Six months ended June 30,
	Amount						Ratio				Change in
	2020		2019		2020		2019		Ratio
Property and transportation
Current year, excluding COVID-19 related and catastrophe losses	$	499	$	499	64.4	%	67.5	%	(3.1	%)
Prior accident years development	(52)		(32)		(6.7	%)	(4.4	%)	(2.3	%)
COVID-19 related losses	6		—		0.7	%	—	%	0.7	%
Current year catastrophe losses	23		17		3.0	%	2.3	%	0.7	%
Property and transportation losses and LAE and ratio	$	476	$	484	61.4	%	65.4	%	(4.0	%)

Specialty casualty
Current year, excluding COVID-19 related and catastrophe losses	$	717	$	810	65.0	%	64.2	%	0.8	%
Prior accident years development	(75)		(44)		(6.7	%)	(3.5	%)	(3.2	%)
COVID-19 related losses	59		—		5.3	%	—	%	5.3	%
Current year catastrophe losses	6		2		0.5	%	0.1	%	0.4	%
Specialty casualty losses and LAE and ratio	$	707	$	768	64.1	%	60.8	%	3.3	%

Specialty financial
Current year, excluding COVID-19 related and catastrophe losses	$	101	$	115	33.5	%	38.8	%	(5.3	%)
Prior accident years development	(13)		(15)		(4.5	%)	(5.1	%)	0.6	%
COVID-19 related losses	30		—		10.2	%	—	%	10.2	%
Current year catastrophe losses	6		5		2.0	%	1.6	%	0.4	%
Specialty financial losses and LAE and ratio	$	124	$	105	41.2	%	35.3	%	5.9	%

Total Specialty
Current year, excluding COVID-19 related and catastrophe losses	$	1,372	$	1,477	60.6	%	62.3	%	(1.7	%)
Prior accident years development	(133)		(88)		(5.8	%)	(3.7	%)	(2.1	%)
COVID-19 related losses	95		—		4.2	%	—	%	4.2	%
Current year catastrophe losses	35		24		1.5	%	1.0	%	0.5	%
Total Specialty losses and LAE and ratio	$	1,369	$	1,413	60.5	%	59.6	%	0.9	%

Aggregate — including exited lines
Current year, excluding COVID-19 related and catastrophe losses	$	1,447	$	1,477	60.5	%	62.3	%	(1.8	%)
Prior accident years development	(119)		(86)		(5.0	%)	(3.6	%)	(1.4	%)
COVID-19 related losses	115		—		4.8	%	—	%	4.8	%
Current year catastrophe losses	35		24		1.5	%	1.0	%	0.5	%
Aggregate losses and LAE and ratio	$	1,478	$	1,415	61.8	%	59.7	%	2.1	%

Current accident year losses and LAE, excluding COVID-19 and catastrophe losses

The current accident year loss and LAE ratio, excluding COVID-19 and catastrophe losses for AFG’s Specialty property and casualty insurance operations was 60.6% for the first six months of 2020 compared to 62.3% for the first six months of 2019, an improvement of 1.7 percentage points.

Property and transportation The 3.1 percentage point improvement in the loss and LAE ratio for the current year, excluding COVID-19 and catastrophe losses reflects a decrease in the loss and LAE ratio at National Interstate, due primarily to rate increases and lower claim frequency in the first six months of 2020, and lower loss and LAE ratios in the Singapore branch and equine mortality business in the first six months of 2020 compared to the first six months of 2019, partially offset by an increase in the loss and LAE ratio of the aviation business in the first six months of 2020 compared to the first six months of 2019.

Specialty casualty The 0.8 percentage point increase in the loss and LAE ratio for the current year, excluding COVID-19 and catastrophe losses reflects the impact of the Neon exited lines in the first six months of 2019, which have a

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AMERICAN FINANCIAL GROUP, INC. 10-Q

Management’s Discussion and Analysis of Financial Condition and Results of Operations — Continued

lower loss and LAE ratio than many of the other businesses in the Specialty casualty group. Excluding the impact of the Neon exited lines, the loss and LAE ratio for the current year, excluding catastrophe losses decreased 0.4 percentage points in the first six months of 2020 compared to the first six months of 2019.

Specialty financial The 5.3 percentage point improvement in the loss and LAE ratio for the current year, excluding catastrophe losses reflects a decrease in the loss and LAE ratio of the financial institutions business in the first six months of 2020 compared to the first six months of 2019.

Net prior year reserve development

AFG’s Specialty property and casualty insurance operations recorded net favorable reserve development related to prior accident years of $133 million in the first six months of 2020 compared to $88 million in the first six months of 2019, an increase of $45 million (51%).

Property and transportation Net favorable reserve development of $52 million in the first six months of 2020 reflects lower than expected claim frequency and severity in the agricultural businesses and lower than anticipated claim frequency and severity in the transportation businesses. Net favorable reserve development of $32 million in the first six months of 2019 reflects lower than expected losses in the crop business and lower than expected claim frequency and severity in the transportation businesses.

Specialty casualty Net favorable reserve development of $75 million in the first six months of 2020 reflects lower than anticipated claim frequency and severity in the workers’ compensation businesses and lower than anticipated claim frequency in the executive liability business, partially offset by higher than expected claim frequency and severity in the excess and surplus businesses. Net favorable reserve development of $44 million in the first six months of 2019 reflects lower than anticipated claim severity in the workers’ compensation businesses, partially offset by higher than expected claim severity in the excess and surplus lines businesses and higher than expected losses at Neon.

Specialty financial Net favorable reserve development of $13 million in the first six months of 2020 reflects lower than anticipated claim frequency in the trade credit and surety businesses. Net favorable reserve development of $15 million in the first six months of 2019 reflects lower than expected claim frequency and severity in the surety business and lower than expected claim severity in the fidelity business.

Other specialty In addition to the development discussed above, total Specialty prior year reserve development includes net adverse reserve development of $7 million in the first six months of 2020 compared to $3 million in the first six months of 2019. The net adverse reserve development reflects adverse development of $10 million and $6 million in the first six months of 2020 and the first six months of 2019, respectively, associated with AFG’s internal reinsurance program. Both periods include the amortization of the deferred gain on the retroactive reinsurance transactions entered into in connection with the sale of businesses in 1998 and 2001.

Aggregate Aggregate net prior accident years reserve development for AFG’s property and casualty insurance segment includes net adverse reserve development of $11 million from the Neon exited lines in the first six months of 2020 and net adverse reserve development of $3 million and $2 million in the first six months of 2020 and the first six months of 2019, respectively, related to business outside the Specialty group that AFG no longer writes.

Covid-19 related losses

Underwriting results for AFG’s Specialty property and casualty insurance operations for the first six months of 2020 included $95 million in COVID-19 related losses. Given the uncertainties surrounding the ultimate number or scope of claims relating to the pandemic, these charges, approximately 90% of which establish reserves for claims that have been incurred but not reported, represent the Company’s current best estimate of losses from the pandemic and related economic disruption incurred through June 30, 2020. Approximately 70% of AFG’s COVID-19 related losses were reported in the workers’ compensation, executive liability and trade credit businesses, with the remainder spread across numerous other businesses.

In addition, COVID-19 related losses were the primary driver of the underwriting loss recorded in the Neon exited lines for the first six months of 2020.

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AMERICAN FINANCIAL GROUP, INC. 10-Q

Management’s Discussion and Analysis of Financial Condition and Results of Operations — Continued

Catastrophe losses

Catastrophe losses of $35 million in the first six months of 2020 resulted primarily from storms and tornadoes in multiple regions of the United States and included $4 million related to civil unrest. Catastrophe losses of $24 million in the first six months of 2019 resulted primarily from storms and tornadoes in multiple regions of the United States.

Commissions and Other Underwriting Expenses

AFG’s property and casualty commissions and other underwriting expenses (“U/W Exp”) were $819 million in the first six months of 2020 compared to $812 million for the first six months of 2019, an increase of $7 million (1%). AFG’s underwriting expense ratio was 34.2% for both the first six months of 2020 and the first six months of 2019. Detail of AFG’s property and casualty commissions and other underwriting expenses and underwriting expense ratios is shown below (dollars in millions):


	Six months ended June 30,
	2020						2019				Change in
	U/W Exp		% of NEP		U/W Exp		% of NEP		% of NEP
Property and transportation	$	240	30.9	%	$	213	28.8	%	2.1	%
Specialty casualty	317		28.7	%	412		32.6	%	(3.9	%)
Specialty financial	159		53.2	%	158		53.3	%	(0.1	%)
Other specialty	33		40.4	%	29		39.1	%	1.3	%
Total Specialty	749		33.2	%	812		34.2	%	(1.0	%)
Neon exited lines	70				—
Aggregate	$	819	34.2	%	$	812	34.2	%	—	%

Property and transportation Commissions and other underwriting expenses as a percentage of net earned premiums increased 2.1 percentage points in the first six months of 2020 compared to the first six months of 2019, reflecting lower profitability-based ceding commissions received from reinsurers in the crop business in the first six months of 2020 compared to the first six months of 2019, partially offset by the impact of higher premiums on the ratio in the property and inland marine business.

Specialty casualty Commissions and other underwriting expenses as a percentage of net earned premiums decreased 3.9 percentage points in the first six months of 2020 compared to the first six months of 2019, due to the run-off of Neon. Neon has a higher expense ratio than many of the other businesses in the Specialty casualty sub-segment. Excluding the Neon exited lines, the underwriting expense ratio decreased 1.3 percentage points in the first six months of 2020 compared to the first six months of 2019 reflecting the impact of higher premiums on the ratio in the excess and surplus business.

Specialty financial Commissions and other underwriting expenses as a percentage of net earned premiums is comparable in the first six months of 2020 and the first six months of 2019.

Property and Casualty Net Investment Income

Excluding the Neon exited lines, net investment income in AFG’s property and casualty insurance operations was $171 million in the first six months of 2020 compared to $228 million in the first six months of 2019, a decrease of $57 million (25%). The average invested assets and overall yield earned on investments held by AFG’s property and casualty insurance operations are provided below (dollars in millions):


	Six months ended June 30,
	2020			2019			Change			% Change
Net investment income	$	171		$	228		$	(57)		(25	%)

Average invested assets (at amortized cost)	$	11,509		$	11,084		$	425		4	%

Yield (net investment income as a % of average invested assets)	2.97		%	4.11		%	(1.14		%)

Tax equivalent yield (*)	3.10		%	4.29		%	(1.19		%)

(*)Adjusts the yield on equity securities and tax-exempt bonds to the fully taxable equivalent yield.

The property and casualty insurance segment’s decrease in net investment income for the first six months of 2020 compared to the first six months of 2019 reflects losses from partnerships and similar investments and AFG-managed

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AMERICAN FINANCIAL GROUP, INC. 10-Q

Management’s Discussion and Analysis of Financial Condition and Results of Operations — Continued

CLOs in the first six months of 2020 as a result of the negative impact of the COVID-19 pandemic on financial markets, partially offset by the impact of growth in the property and casualty insurance segment. The property and casualty insurance segment’s overall yield on investments (net investment income as a percentage of average invested assets) was 2.97% for the first six months of 2020 compared to 4.11% for the first six months of 2019, a decrease of 1.14 percentage points. AFG’s property and casualty insurance operations recorded $10 million in losses from partnerships and similar investments and AFG-managed CLOs in the first six months of 2020 compared to $31 million in earnings in the first six months of 2019, a $41 million (132%) decrease in earnings. The annualized yield earned on these partnerships and similar investments and AFG-managed CLOs was a negative yield of 2.3% in the first six months of 2020 compared to a positive yield of 9.1% in the prior year period.

In addition to the property and casualty segment’s net investment income from ongoing operations discussed above, the Neon exited lines reported a $6 million loss in the first six months of 2020 in net investment income, primarily from changes in the fair value of equity securities.

Property and Casualty Other Income and Expenses, Net

Other income and expenses, net for AFG’s property and casualty insurance operations was a net expense of $14 million for the first six months of 2020 compared to $18 million for the first six months of 2019, a decrease of $4 million (22%). The table below details the items included in other income and expenses, net for AFG’s property and casualty insurance operations (in millions):


	Six months ended June 30,
	2020		2019



Other income	$	8	$	5
Other expenses
Amortization of intangibles	6		6
Other	16		17
Total other expense	22		23
Other income and expenses, net	$	(14)	$	(18)

In addition to the property and casualty segment’s other income and expenses, net from ongoing operations discussed above, the Neon exited lines incurred $2 million in other expenses during the first six months of 2020.

Annuity Segment — Results of Operations

AFG’s annuity operations contributed $12 million in GAAP pretax earnings in the first six months of 2020 compared to $161 million in the first six months of 2019, a decrease of $149 million (93%) due primarily to losses from partnerships and similar investments and AFG-managed CLOs. The decrease in the financial markets during the first six months of 2020 had a negative impact on liabilities for annuities with guaranteed withdrawal benefits and on the fair value of derivatives related to FIAs in the first six months of 2020 compared to the favorable impact of strong stock market performance in the 2019 period.

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AMERICAN FINANCIAL GROUP, INC. 10-Q

Management’s Discussion and Analysis of Financial Condition and Results of Operations — Continued

The following table details AFG’s GAAP and core earnings before income taxes from its annuity operations for the six months ended June 30, 2020 and 2019 (dollars in millions):


	Six months ended June 30,
	2020		2019		% Change
Revenues:
Net investment income	$	806	$	886	(9	%)
Other income:
Guaranteed withdrawal benefit fees	34		33		3	%
Policy charges and other miscellaneous income (a)	31		25		24	%
Total revenues	871		944		(8	%)

Costs and Expenses:
Annuity benefits (a)(b)	561		587		(4	%)
Acquisition expenses (a)	133		93		43	%
Other expenses	68		70		(3	%)
Total costs and expenses	762		750		2	%
Core earnings before income taxes	109		194		(44	%)
Pretax non-core losses (a)	(97)		(33)		194	%
GAAP earnings before income taxes	$	12	$	161	(93	%)

(a)As discussed under “Results of Operations — General,” beginning prospectively with the second quarter of 2019, unlocking, the impact of changes in the fair value of derivatives related to FIAs, and other impacts of changes in the stock market and interest rates on the accounting for FIAs over or under the cost of the equity index options purchased to mitigate the risk in the index-based component of those FIAs are considered non-core earnings (losses). For the first six months of 2020 and 2019, annuity benefits exclude the $154 million and $67 million unfavorable impact, respectively, of these items and acquisition expenses exclude the $57 million and $34 million favorable impact, respectively, on the amortization of deferred policy acquisition costs.

(b)Details of the components of annuity benefits are provided below.

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AMERICAN FINANCIAL GROUP, INC. 10-Q

Management’s Discussion and Analysis of Financial Condition and Results of Operations — Continued

Annuity core earnings before income taxes were $109 million in the first six months of 2020 compared to $194 million in the first six months of 2019, a decrease of $85 million (44%). As discussed under “Results of Operations — General,” beginning with the second quarter of 2019, unlocking, changes in the fair value of derivatives related to FIAs, and other impacts of changes in the stock market and interest rates on the accounting for FIAs over or under the cost of the equity index options purchased to mitigate the risk in the index-based component of those FIAs are considered non-core earnings (losses). For the first six months of 2020, the annuity segment’s core earnings before income taxes includes $97 million in pretax losses related to these items. Since annuity core earnings for the first quarter of 2019 and prior periods were not adjusted, the annuity segment’s core earnings before income taxes for the first six months of 2019 includes the $11 million negative impact from these items in first quarter of 2019. Excluding the $11 million unfavorable impact in the first quarter of 2019, annuity core net operating earnings for the first six months of 2020 decreased $96 million compared to the first six months of 2019 reflecting the losses from partnerships and similar investments and AFG-managed CLOs and the impact of lower short-term interest rates in the first six months of 2020, partially offset by growth in the business, higher than expected persistency and a reduction in the cost of funds as a percentage of average annuity benefits accumulated. The table below highlights the impact of changes in the fair value of derivatives and other impacts of the changes in the stock market and interest rates on annuity segment results (dollars in millions):


	Six months ended June 30,
	2020		2019		% Change
Earnings before income taxes — before the impact of derivatives related to FIAs and other impacts of stock market performance and interest rates on FIAs	$	109	$	205	(47	%)

Impact of derivatives related to FIAs and other impacts of changes in the stock market and interest rates on FIAs over or under option costs:
Change in fair value of derivatives related to FIAs	(200)		(198)		1	%
Accretion of guaranteed minimum FIA benefits	(211)		(201)		5	%
Other annuity benefits	(41)		—		—	%
Less cost of equity options	298		287		4	%
Related impact on the amortization of deferred policy acquisition costs	57		68		(16	%)
Earnings before income taxes	$	12	$	161	(93	%)

Annuity benefits consisted of the following (dollars in millions):


	Six months ended June 30,
	2020										2019				Total
	Core		Non-core		Total		Core		Non-core		Total		% Change
Interest credited — fixed	$	206	$	—	$	206	$	193	$	—	$	193	7	%
Accretion of guaranteed minimum FIA benefits	—		211		211		99		102		201		5	%
Interest credited — fixed component of variable annuities	2		—		2		2		—		2		—	%
Cost of equity options	298		(298)		—		146		(146)		—		—	%
Other annuity benefits:
Amortization of sales inducements	4		—		4		8		—		8		(50	%)
Change in guaranteed withdrawal benefit reserve:
Impact of change in the stock market and interest rates	—		20		20		(1)		(4)		(5)		(500	%)
Accretion of benefits and other	42		—		42		39		—		39		8	%
Change in expected death and annuitization reserves and other	9		—		9		13		—		13		(31	%)
Change in other benefit reserves — impact of changes in interest rates and the stock market	—		21		21		(7)		12		5		320	%

Derivatives related to fixed-indexed annuities:
Embedded derivative mark-to-market	—		(46)		(46)		462		251		713		(106	%)
Equity option mark-to-market	—		246		246		(367)		(148)		(515)		(148	%)
Impact of derivatives related to FIAs	—		200		200		95		103		198		1	%

Total annuity benefits	$	561	$	154	$	715	$	587	$	67	$	654	9	%

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AMERICAN FINANCIAL GROUP, INC. 10-Q

Management’s Discussion and Analysis of Financial Condition and Results of Operations — Continued


	Six months ended June 30,
	2020		2019
Interest credited — fixed	$	206	$	193
Include cost of equity options	298		287
Cost of funds	504		480

Interest credited — fixed component of variable annuities	2		2
Other annuity benefits, excluding the impact of interest rates and the stock market on FIAs	55		60
	561		542
Changes in fair value of derivatives related to FIAs, and other impacts of the stock market and interest rates over or under option costs:

Impact of derivatives related to FIAs	200		198
Accretion of guaranteed minimum FIA benefits	211		201
Other annuity benefits — impact of the stock market and interest rates on FIAs	41		—
Less cost of equity options (included in cost of funds)	(298)		(287)
Total annuity benefits expense	$	715	$	654

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AMERICAN FINANCIAL GROUP, INC. 10-Q

Management’s Discussion and Analysis of Financial Condition and Results of Operations — Continued

Net Spread on Fixed Annuities (excludes variable annuity earnings)

The table below (dollars in millions) details the components of the spreads for AFG’s fixed annuity operations (including fixed-indexed and variable-indexed annuities):


	Six months ended June 30,
	2020			2019			% Change
Average fixed annuity investments (at amortized cost)	$	40,322		$	37,449		8	%
Average fixed annuity benefits accumulated	40,370			37,640			7	%

As % of fixed annuity benefits accumulated (except as noted):
Net investment income (as % of fixed annuity investments)	3.98		%	4.71		%
Cost of funds	(2.50		%)	(2.55		%)
Other annuity benefit expenses, net of guaranteed withdrawal benefit fees (*)	(0.10		%)	(0.13		%)
Net interest spread	1.38		%	2.03		%

Policy charges and other miscellaneous income (*)	0.13		%	0.10		%
Acquisition expenses (*)	(0.64		%)	(0.66		%)
Other expenses	(0.33		%)	(0.37		%)
Net spread earned on fixed annuities excluding the impact of changes in the fair value of derivatives related to FIAs, and other impacts of changes in the stock market and interest rates on FIAs	0.54		%	1.10		%
Changes in fair value of derivatives related to FIAs and other impacts of the stock market and interest rates under (over) option costs:
Included in core	—		%	(0.06		%)
Annuity non-core earnings (losses)	(0.48		%)	(0.18		%)

Net spread earned on fixed annuities	0.06		%	0.86		%

Annuity Net Investment Income

Net investment income for the first six months of 2020 was $806 million compared to $886 million for the first six months of 2019, a decrease of $80 million (9%). This decrease reflects losses from partnerships and similar investments and AFG-managed CLOs, partially offset by growth in AFG’s annuity business. The overall yield earned on investments in AFG’s fixed annuity operations, calculated as net investment income divided by average investment balances (at amortized cost), decreased by 0.73 percentage points to 3.98% from 4.71% for the first six months of 2020 compared to the first six months of 2019. The decrease in the net investment yield between periods reflects the negative impact of lower earnings from partnerships and similar investments and AFG-managed CLOs in the first six months of 2020, along with the impact of the run-off of higher yielding investments and lower short-term interest rates. AFG’s annuity segment recorded $43 million in losses from partnerships and similar investments and AFG-managed CLOs in the first six months of 2020 compared to $60 million in earnings in the first six months of 2019, a change of $103 million (172%). The annualized yield earned on these partnerships and similar investments and AFG-managed CLOs was a negative yield of 6.7% in the first six months of 2020 compared to a positive yield of 11.1% in the prior year period.

Annuity Cost of Funds

Cost of funds for the first six months of 2020 was $504 million compared to $480 million for the first six months of 2019, an increase of $24 million (5%). This increase reflects growth in the annuity business. The average cost of policyholder funds, calculated as cost of funds divided by average fixed annuity benefits accumulated, decreased 0.05 percentage points to 2.50% from 2.55% in the first six months of 2020 compared to the first six months of 2019 reflecting the impact of offering lower renewal crediting rates on option costs.

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AMERICAN FINANCIAL GROUP, INC. 10-Q

Management’s Discussion and Analysis of Financial Condition and Results of Operations — Continued

The following table provides details of AFG’s interest credited and other cost of funds (in millions):


	Six months ended June 30,
	2020		2019
Cost of equity options (FIAs)	$	298	$	287
Interest credited:
Traditional fixed annuities	127		120
Fixed component of fixed-indexed annuities	51		45
Immediate annuities	12		12
Pension risk transfer products	8		2
Federal Home Loan Bank advances	8		14
Total cost of funds	$	504	$	480

Other Annuity Benefits, Net of Guaranteed Withdrawal Benefit Fees

Other annuity benefits, net of guaranteed withdrawal benefit fees excluding the impact of the stock market and interest rates for the first six months of 2020 were $21 million compared to $27 million for the first six months of 2019, a decrease of $6 million (22%). As a percentage of average fixed annuity benefits accumulated, these net expenses decreased 0.03 percentage points to 0.10% from 0.13% in the first six months of 2020 compared to the first six months of 2019. In addition to interest credited to policyholders’ accounts and the change in fair value of derivatives related to fixed-indexed annuities, annuity benefits expense also includes the following expenses (in millions, net of guaranteed withdrawal benefit fees):


	Six months ended June 30,
	2020		2019
Other annuity benefits, excluding the impact of the stock market and interest rates on FIAs:
Amortization of sales inducements	$	4	$	8
Change in guaranteed withdrawal benefit reserve	42		39
Change in other benefit reserves	9		13
Other annuity benefits	55		60
Offset guaranteed withdrawal benefit fees	(34)		(33)
Other annuity benefits excluding the impact of the stock market and interest rates, net	21		27
Other annuity benefits — impact of the stock market and interest rates	41		—
Other annuity benefits, net	$	62	$	27

As discussed under “Annuity Benefits Accumulated” in Note A — “Accounting Policies” to the financial statements, guaranteed withdrawal benefit reserves are accrued for and modified using assumptions similar to those used in establishing and amortizing deferred policy acquisition costs. In addition, the guaranteed withdrawal benefit reserve related to FIAs can be inversely impacted by the calculated FIA embedded derivative reserve as the value to policyholders of the guaranteed withdrawal benefits decreases when the benefit of stock market participation increases. As shown in the table above, changes in the stock market and interest rates increased AFG’s guaranteed withdrawal benefit reserve by $41 million in the first six months of 2020. This $41 million increase compared to the 2019 period was the primary driver of the $35 million (130%) overall increase in other annuity benefits, net of guaranteed withdrawal fees in the first six months of 2020 compared to the first six months of 2019.

Annuity Net Interest Spread

AFG’s net interest spread decreased 0.65 percentage points to 1.38% from 2.03% in the first six months of 2020 compared to the same period in 2019 due primarily to the negative impact of losses from partnerships and similar investments and AFG-managed CLOs in the first six months of 2020. Features included in current annuity product offerings allow AFG to achieve its desired profitability at a lower net interest spread than historical product offerings. As a result, AFG expects its net interest spread to narrow in the future.

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AMERICAN FINANCIAL GROUP, INC. 10-Q

Management’s Discussion and Analysis of Financial Condition and Results of Operations — Continued

Annuity Policy Charges and Other Miscellaneous Income

Annuity policy charges and other miscellaneous income, which consist primarily of surrender charges, amortization of deferred upfront policy charges (unearned revenue) and equity index call option proceeds received at maturity that are not passed to policyholders through index credits due to surrenders, were $31 million in the first six months of 2020 compared to $25 million in the first six months of 2019, an increase of $6 million (24%), reflecting higher gains on equity index options in excess of policyholder index credits in the first six months of 2020 compared to the first six months of 2019. Annuity policy charges and other miscellaneous income as a percentage of average fixed annuity benefits accumulated increased 0.03 percentage points to 0.13% from 0.10% in the first six months of 2020 compared to the first six months of 2019, reflecting the higher gains on equity index call options.

Annuity Acquisition Expenses


	Six months ended June 30,
	2020		2019
Annuity acquisition expenses before the impact of changes in the fair value of derivatives related to FIAs and other impacts of the stock market and interest rates	$	133	$	127

Impact of changes in the fair value of derivatives and other impacts of the stock market and interest rates:
Included in core	—		(34)
Annuity non-core earnings (losses)	(57)		(34)
Annuity acquisition expenses	$	76	$	59

Annuity acquisitions expenses before the acceleration/deceleration of the amortization resulting from changes in the fair value of derivatives related to FIAs and other impacts of changes in the stock market and interest rates on the accounting for FIAs over or under option costs were $133 million for the first six months of 2020 compared to $127 million for the first six months of 2019, an increase of $6 million (5%).

The negative impact of significantly lower than anticipated interest rates in both the first six months of 2020 and the first six months of 2019 on the fair value of derivatives and other liabilities related to FIAs resulted in a partially offsetting deceleration of the amortization of DPAC. The offsetting deceleration of the amortization of DPAC in the 2019 period was partially offset by the positive impact of strong stock market performance on the fair value of derivatives and other liabilities related to FIAs.

The table below illustrates the impact of changes in the fair value of derivatives related to fixed-indexed annuities and other impacts of changes in the stock market and interest rates on FIAs on annuity acquisition expenses as a percentage of average fixed annuity benefits accumulated:


	Six months ended June 30,
	2020		2019
Before the impact of changes in the fair value of derivatives related to FIAs and other impacts of the stock market and interest rates	0.64	%	0.66	%

Impact of changes in fair value of derivatives and other impacts of the stock market and interest rates	(0.28	%)	(0.36	%)
Annuity acquisition expenses as a % of fixed annuity benefits accumulated	0.36	%	0.30	%

Annuity Other Expenses

Annuity other expenses were $68 million for the first six months of 2020 compared to $70 million for the first six months of 2019, a decrease of $2 million (3%). Annuity other expenses represent primarily general and administrative expenses, as well as selling and issuance expenses that are not deferred. As a percentage of average fixed annuity benefits accumulated, these expenses decreased 0.04 percentage points to 0.33% from 0.37% for the first six months of 2020 compared to the first six months of 2019 due primarily to growth in the annuity business.

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AMERICAN FINANCIAL GROUP, INC. 10-Q

Management’s Discussion and Analysis of Financial Condition and Results of Operations — Continued

Change in Fair Value of Derivatives Related to Fixed-Indexed (Including Variable-Indexed) Annuities and Other Impacts of Changes in the Stock Market and Interest Rates on FIAs

AFG’s fixed-indexed (including variable-indexed) annuities 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 and sale of call and put options on the appropriate index. AFG’s strategy is designed so that the net change in the fair value of the call option assets and put option liabilities will generally offset the economic change in the net liability from the index participation. Both the index-based component of the annuities (an embedded derivative) and the related call and put options are considered derivatives that must be adjusted for changes in fair value through earnings each period. The fair values of these derivatives are impacted by actual and expected stock market performance and interest rates as well as other factors. For a list of other factors impacting the fair value of the embedded derivative component of AFG’s annuity benefits accumulated, see Note D — “Fair Value Measurements” to the financial statements. Fluctuations in certain of these factors, such as changes in interest rates and the performance of the stock market, are not economic in nature for the current reporting period, but rather impact the timing of reported results.


	Six months ended June 30,
	2020		2019		% Change
Change in the fair value of derivatives related to FIAs	$	(200)	$	(198)	1	%
Accretion of guaranteed minimum FIA benefits	(211)		(201)		5	%
Other annuity benefits	(41)		—		—	%
Less cost of equity options	298		287		4	%
Related impact on the amortization of DPAC	57		68		(16	%)
Impact on annuity segment earnings before income taxes	$	(97)	$	(44)	120	%

During the first six months of 2020, the negative impact of significantly lower than anticipated interest rates and the decrease in stock market performance reduced the annuity segments’ earnings before income taxes by $97 million compared to the $44 million negative impact of interest rates and the stock market on annuity earnings before income taxes for the first six months of 2019, an increase of $53 million (120%). In the first six months of 2019, the negative impact of significantly lower than anticipated interest rates was partially offset by the positive impact of strong stock market performance. As a percentage of average fixed annuity benefits accumulated, the impact of changes in the fair value of derivatives related to FIAs and other impacts of changes in the stock market and interest rates on the accounting for FIAs over or under the cost of the equity index options purchased to mitigate the risk in the indexed-based component of those FIAs was a net expense of 0.48% in the first six months of 2020 compared to 0.24% in the first six months of 2019.


	Six months ended June 30,
	2020		2019		% Change
Change in the stock market, including volatility	$	(26)	$	40	(165	%)
Changes in interest rates higher (lower) than expected	(71)		(83)		(14	%)
Other	—		(1)		(100	%)
Impact on annuity segment earnings before income taxes	$	(97)	$	(44)	120	%

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AMERICAN FINANCIAL GROUP, INC. 10-Q

Management’s Discussion and Analysis of Financial Condition and Results of Operations — Continued

Annuity Net Spread Earned on Fixed Annuities

AFG’s net spread earned on fixed annuities excluding the impact of changes in the fair value of derivatives related to FIAs and other impacts of changes in the stock market and interest rates over or under option costs decreased 0.56 percentage points to 0.54% in the first six months of 2020 from 1.10% in the first six months of 2019 due primarily to the 0.65 percentage point decrease in AFG’s net interest spread discussed above. AFG’s overall net spread earned on fixed annuities decreased 0.80 percentage points to 0.06% in the first six months of 2020 from 0.86% in the first six months of 2019 due to the decrease in AFG’s net interest spread, the impact of changes in the fair value of derivatives and other impacts of the stock market and interest rates on the accounting for FIAs discussed above.

Annuity Benefits Accumulated

For certain products, annuity benefits accumulated also includes reserves for accrued persistency and premium bonuses, excess benefits expected to be paid on future deaths and annuitizations (“EDAR”) and guaranteed withdrawal benefits. Annuity benefits accumulated also includes amounts advanced from the Federal Home Loan Bank of Cincinnati. The following table is a progression of AFG’s annuity benefits accumulated liability for the six months ended June 30, 2020 and 2019 (in millions):


	Six months ended June 30,
	2020		2019
Beginning fixed annuity reserves	$	40,018	$	36,431
Fixed annuity premiums (receipts)	1,887		2,733
Federal Home Loan Bank advances, net	160		—
Surrenders, benefits and other withdrawals	(1,562)		(1,623)
Interest and other annuity benefit expenses:
Cost of funds	504		480
Embedded derivative mark-to-market	(46)		713
Change in other benefit reserves	(19)		(54)

Ending fixed annuity reserves	$	40,942	$	38,680

Reconciliation to annuity benefits accumulated per balance sheet:
Ending fixed annuity reserves (from above)	$	40,942	$	38,680
Impact of unrealized investment gains	285		192
Fixed component of variable annuities	165		172
Annuity benefits accumulated per balance sheet	$	41,392	$	39,044

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AMERICAN FINANCIAL GROUP, INC. 10-Q

Management’s Discussion and Analysis of Financial Condition and Results of Operations — Continued

Statutory Annuity Premiums

AFG’s annuity operations generated gross statutory premiums of $1.90 billion in the first six months of 2020 compared to $2.74 billion in the first six months of 2019, a decrease of $847 million (31%). The following table summarizes AFG’s annuity sales (dollars in millions):


	Six months ended June 30,
			2020			2019			% Change
Financial institutions single premium annuities — indexed	$	682		$	853		(20	%)
Financial institutions single premium annuities — fixed	385			657			(41	%)
Retail single premium annuities — indexed	310			575			(46	%)
Retail single premium annuities — fixed	56			65			(14	%)
Broker dealer single premium annuities — indexed	238			416			(43	%)
Broker dealer single premium annuities — fixed	19			14			36	%
Pension risk transfer	126			60			110	%
Education market — fixed and indexed annuities	71			93			(24	%)
Total fixed annuity premiums	1,887			2,733			(31	%)
Variable annuities	10			11			(9	%)
Total gross fixed annuity premiums	1,897			2,744			(31	%)
Ceded premiums	(78)			—			—	%
Total net annuity premiums	$	1,819		$	2,744		(34	%)

Management attributes the 31% decrease in gross fixed annuity premiums in the first six months of 2020 compared to the first six months of 2019 to the lower market interest rate environment. In response to the continued drop in market interest rates during 2019 and 2020, AFG lowered crediting rates on several products, which has slowed annuity sales compared to 2019 levels. In addition, many of the restrictions from the COVID-19 pandemic impact the ability of agents to conduct business in the same manner as usual. As a result, management expects annuity premiums to be negatively impacted during the remainder of 2020.

Annuity Earnings before Income Taxes Reconciliation

The following table reconciles the net spread earned on AFG’s fixed annuities to overall annuity pretax earnings for the six months ended June 30, 2020 and 2019 (in millions):


	Six months ended June 30,
	2020		2019
Earnings on fixed annuity benefits accumulated	$	12	$	162
Earnings impact of investments in excess of fixed annuity benefits accumulated (*)	(1)		(4)
Variable annuity earnings	1		3
Earnings before income taxes	$	12	$	161

(*)Net investment income (as a % of investments) of 3.98% and 4.71% for the six months ended June 30, 2020 and 2019, respectively, multiplied by the difference between average fixed annuity investments (at amortized cost) and average fixed annuity benefits accumulated in each period.

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AMERICAN FINANCIAL GROUP, INC. 10-Q

Management’s Discussion and Analysis of Financial Condition and Results of Operations — Continued

Holding Company, Other and Unallocated — Results of Operations

AFG’s net pretax loss outside of its property and casualty insurance and annuity segments (excluding realized gains and losses) totaled $80 million in the first six months of 2020 compared to $85 million in the first six months of 2019, a decrease of $5 million (6%).

The following table details AFG’s loss before income taxes from operations outside of its property and casualty insurance and annuity segments for the six months ended June 30, 2020 and 2019 (dollars in millions):


	Six months ended June 30,
	2020		2019		% Change
Revenues:
Life, accident and health net earned premiums	$	10	$	11	(9	%)
Net investment income	7		24		(71	%)
Other income — P&C fees	33		35		(6	%)
Reclassify annuity segment option gains	(13)		(4)		225	%
Other income	13		14		(7	%)
Total revenues	50		80		(38	%)

Costs and Expenses:
Property and casualty insurance — commissions and other underwriting expenses	10		13		(23	%)
Annuity - annuity benefits	(13)		(4)		225	%
Life, accident and health benefits	19		17		12	%
Life, accident and health acquisition expenses	2		2		—	%
Other expense — expenses associated with P&C fees	23		22		5	%
Other expenses	49		82		(40	%)
Costs and expenses, excluding interest charges on borrowed money	90		132		(32	%)
Loss before income taxes, excluding realized gains and losses and interest charges on borrowed money	(40)		(52)		(23	%)
Interest charges on borrowed money	40		33		21	%



Loss before income taxes, excluding realized gains and losses	$	(80)	$	(85)	(6	%)

Holding Company and Other — Life, Accident and Health Premiums, Benefits and Acquisition Expenses

AFG’s run-off long-term care and life insurance operations recorded net earned premiums of $10 million and related benefits and acquisition expenses of $21 million in the first six months of 2020 compared to net earned premiums of $11 million and related benefits and acquisition expenses of $19 million in the first six months of 2019. The $2 million (12%) increase in life, accident and health benefits reflects higher claims in the run-off life insurance business.

Holding Company and Other — Net Investment Income

AFG recorded net investment income on investments held outside of its property and casualty insurance and annuity segments of $7 million in the first six months of 2020 compared to $24 million in the first six months of 2019, a decrease of $17 million (71%). The parent company holds a small portfolio of securities that are carried at fair value through net investment income. These securities decreased in value by $6 million in the first six months of 2020 compared to an increase in value of $9 million in the first six months of 2019.

Holding Company and Other — P&C Fees and Related Expenses

Summit, a workers’ compensation insurance subsidiary, collects fees from a small group of unaffiliated insurers for providing underwriting, policy administration and claims services. In addition, certain of AFG’s property and casualty insurance businesses collect fees from customers for ancillary services such as workplace safety programs and premium financing. In the first six months of 2020, AFG collected $33 million in fees for these services compared to $35 million in the first six months of 2019. Management views this fee income, net of the $23 million in the first six months of 2020 and $22 million the first six months of 2019, in expenses incurred to generate such fees, as a reduction in the cost of underwriting its property and casualty insurance policies. Consistent with internal management reporting, these fees and the related expenses are netted and recorded as a reduction of commissions and other underwriting expenses in AFG’s segmented results.

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AMERICAN FINANCIAL GROUP, INC. 10-Q

Management’s Discussion and Analysis of Financial Condition and Results of Operations — Continued

Holding Company and Other — Annuity Segment Option Gains

As discussed under “Annuity Segment — Results of Operations,” AFG purchases and sells equity index options to mitigate the risk in the index-based component of its FIAs. In evaluating the performance of the annuity business, management views the cost of the equity options as a better measurement of the true expenses of the Annuity segment as compared to the GAAP accounting for these options as derivatives because any proceeds at expiration from the options generally are passed to policyholders through index credits. On occasion, policyholders surrender their annuity prior to receiving the index credit, which results in any option exercise proceeds being retained by AFG. For internal management reporting, AFG views these “option gains” as miscellaneous (other) income rather than as a component of annuity benefits expense. Consistent with internal management reporting, these option gains are reclassified from annuity benefits to other income in AFG’s segmented results. In the first six months of 2020 and 2019, AFG had $13 million and $4 million, respectively, in such option gains.

Holding Company and Other — Other Income

Other income in the table above includes $8 million and $7 million in the first six months of 2020 and 2019, respectively, in management fees paid to AFG by the AFG-managed CLOs (AFG’s consolidated managed investment entities). The management fees are eliminated in consolidation — see the other income line in the Consolidate MIEs column under “Results of Operations — Segmented Statement of Earnings.” Excluding amounts eliminated in consolidation, AFG recorded other income outside of its property and casualty insurance and annuity operations of $5 million in the first six months of 2020 compared to $7 million the first six months of 2019.

Holding Company and Other — Other Expenses

AFG’s holding companies and other operations outside of its property and casualty insurance and annuity segments recorded other expenses of $49 million in the first six months of 2020 compared to $82 million the first six months of 2019, a decrease of $33 million (40%). This decrease reflects lower holding company expenses related to employee benefit plans that are tied to stock market performance and lower expenses associated with certain incentive compensation plans in the first six months of 2020 compared to the first six months of 2019 and a $3 million charitable donation in the first six months of 2019.

Holding Company and Other — Interest Charges on Borrowed Money

AFG’s holding companies and other operations outside of its property and casualty insurance and annuity segments recorded interest expense of $40 million in the first six months of 2020 compared to $33 million in the first six months of 2019, an increase of $7 million (21%).

The increase in interest expense for the first six months of 2020 as compared to the first six months of 2019 reflects the following financial transactions completed by AFG between January 1, 2019 and June 30, 2020:

•Issued $125 million of 5.875% Subordinated Debentures in March 2019

•Issued $200 million of 5.125% Subordinated Debentures in December 2019

•Redeemed $150 million of 6-1/4% Subordinated Debentures in December 2019

•Issued $300 million of 5.25% Senior Notes in April 2020

•Issued $150 million of 5.625% Subordinated Debentures in May 2020

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AMERICAN FINANCIAL GROUP, INC. 10-Q

Management’s Discussion and Analysis of Financial Condition and Results of Operations — Continued

Consolidated Realized Gains (Losses) on Securities

AFG’s consolidated realized gains (losses) on securities, which are not allocated to segments, were net losses of $347 million in the first six months of 2020 compared to net gains of $240 million in the first six months of 2019, a change of $587 million (245%). Realized gains (losses) on securities consisted of the following (in millions):


	Six months ended June 30,
			2020			2019
Realized gains (losses) before impairments:
Disposals	$	29		$	5
Change in the fair value of equity securities	(333)			226
Change in the fair value of derivatives	7			12
Adjustments to annuity deferred policy acquisition costs and related items	(5)			1
	(302)			244
Change in allowance for impairments:
Securities	(60)			(6)
Adjustments to annuity deferred policy acquisition costs and related items	15			2
	(45)			(4)
Realized gains (losses) on securities	$	(347)		$	240

The $333 million net realized loss from the change in the fair value of equity securities in the first six months of 2020 includes losses of $76 million on investments in banks and financing companies, $76 million on investments in media companies, $62 million on investments in natural gas companies, $36 million on investments in energy companies and $29 million on real estate investment trusts. The $226 million net realized gain from the change in the fair value of equity securities in the first six months of 2019 includes gains of $70 million on investments in banks and financing companies, $35 million from investments in media companies, $23 million on investments in asset management companies and $17 million on insurance companies.

The $60 million of impairment allowance expense in the first six months of 2020 include $38 million in charges related to structured securities and $22 million in charges related to corporate bonds and other fixed maturities.

Consolidated Income Taxes

AFG’s consolidated provision (credit) for income taxes was a credit of $33 million for the first six months of 2020 compared to a provision of $137 million for the first six months of 2019, a change of $170 million (124%). See Note L — “Income Taxes” to the financial statements for an analysis of items affecting AFG’s effective tax rate.

Consolidated Noncontrolling Interests

AFG’s consolidated net earnings (loss) attributable to noncontrolling interests was a net loss of $13 million for the first six months of 2020 compared to $4 million for the first six months of 2019, an increase of $9 million (225%). Both periods reflect losses at Neon, AFG’s United Kingdom-based Lloyd’s insurer.

RECENTLY ADOPTED ACCOUNTING STANDARDS

See Note A — “Accounting Policies — Credit Losses on Financial Instruments” to the financial statements for a discussion of accounting guidance adopted on January 1, 2020, which provides a new credit 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.

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AMERICAN FINANCIAL GROUP, INC. 10-Q

Management’s Discussion and Analysis of Financial Condition and Results of Operations — Continued

ACCOUNTING STANDARDS TO BE ADOPTED

In August 2018, the FASB issued ASU 2018-12, Financial Services – Insurance: Targeted Improvements to the Accounting for Long-Duration Contracts, which changes the assumptions used to measure the liability for future policy benefits for traditional and limited pay contracts (e.g. life, accident and health benefits) from being locked in at inception to being updated at least annually and standardizes the liability discount rate to be used and updated each reporting period, requires the measurement of market risk benefits associated with deposit contracts (e.g. annuities) to be recorded at fair value, simplifies the amortization of deferred policy acquisition costs to a constant level basis over the expected life of the related contracts and requires enhanced disclosures. AFG will be required to adopt this guidance effective January 1, 2022. In July 2020, the Financial Accounting Standards Board voted to expose a proposal to delay the effective date for public companies by one year. AFG cannot estimate the impact that the updated guidance will have on its results of operations, financial position or liquidity until the updated guidance is closer to adoption.

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AMERICAN FINANCIAL GROUP, INC. 10-Q

ITEM 3. Quantitative and Qualitative Disclosure about Market Risk

As of June 30, 2020, there were no material changes to the information provided in Item 7A — Quantitative and Qualitative Disclosures about Market Risk of AFG’s 2019 Form 10-K.

ITEM 4. Controls and Procedures

AFG’s management, with participation of its Co-Chief Executive Officers and its Interim Principal Financial Officer, has evaluated AFG’s disclosure controls and procedures (as defined in Exchange Act Rule 13a-15) as of the end of the period covered by this report. Based on that evaluation, AFG’s Co-CEOs and interim principal financial and accounting officer concluded that the controls and procedures are effective. There have been no changes in AFG’s internal control over financial reporting during the second fiscal quarter of 2020 that materially affected, or are reasonably likely to materially affect, AFG’s internal control over financial reporting.

In the ordinary course of business, AFG and its subsidiaries routinely enhance their information systems by either upgrading current systems or implementing new systems. There has been no change in AFG’s business processes and procedures during the second fiscal quarter of 2020 that has materially affected, or is reasonably likely to materially affect, AFG’s internal control over financial reporting.

PART II

OTHER INFORMATION

ITEM 1A. Risk Factors

For a discussion of AFG’s potential risks or uncertainties, please see “Part I — Item 1A — Risk Factors” and “Part II — Item 7 — Management’s Discussion and Analysis of Financial Condition and Results of Operations” in AFG’s 2019 Annual Report on Form 10-K filed with the SEC, and “Part I — Item 2 — Management’s Discussion and Analysis of Financial Condition and Results of Operations” in this Quarterly Report on Form 10-Q, in each case as updated by AFG’s periodic filings with the SEC. Other than as described below, there have been no material changes to the risk factors disclosed in Part I — Item 1A of the Company’s 2019 Annual Report on Form 10-K.

The impact of COVID-19 and related risks could materially affect AFG’s results of operations, financial position and liquidity.

The global COVID-19 pandemic has resulted in, and is expected to continue to result in, significant disruptions in economic activity and financial markets. COVID-19 has directly and indirectly adversely affected AFG and will likely continue to do so for an uncertain period of time. The cumulative effects of COVID-19 on AFG cannot be predicted at this time, but could include (or continue to include), without limitation:

•Continued volatility and further disruption in financial markets which could result in additional significant declines in the fair value of AFG’s investments and could lead to investment losses due to creditor defaults and bankruptcies;

•Continued low or declining interest rates which could reduce future investment results;

•Continued negative impact on premium volumes and annuity sales due to the impact of COVID-19 on general economic activity;

•Negative impact on the global economy or the economies of particular countries or regions, including travel, trade, tourism, the health system, food supply, consumption and overall economic output;

•Reduced cash flows from policyholders delaying premium payments and increased surrenders and annuitizations of in-force annuities;

•Increased claims, including annuity and life insurance death claims, losses, litigation and related expenses;

•Legislative, regulatory, and judicial actions in response to COVID-19, including, but not limited to: actions prohibiting AFG from canceling insurance policies in accordance with policy terms; requiring AFG to cover losses when its policies specifically excluded coverage or did not provide coverage; ordering AFG to provide premium refunds; granting extended grace periods for payment of premiums; and providing for extended periods of time to pay past due premiums; and

•Policyholder losses from COVID-19-related claims could be greater than AFG’s reserves for those losses.

Table of Contents

AMERICAN FINANCIAL GROUP, INC. 10-Q

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

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 other events, such as terrorist attacks, as well as pandemics and other similar outbreaks in many parts of the world, including the recent outbreak of COVID-19. These events may have a material adverse effect on AFG’s workforce and business operations as well as the workforce and operations of AFG’s customers and independent agents. Some of the assets in AFG’s investment portfolio may be adversely affected by declines in the financial markets, changes in interest rates, reduced liquidity and economic activity caused by large-scale catastrophes, pandemics, terrorist attacks or similar events which could have a material adverse effect on AFG’s revenue, liquidity and operating results.

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 (climate change) could result in increased occurrence and severity of catastrophes. The extent of gross losses for AFG’s insurance operations 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.

ITEM 2. Unregistered Sales of Equity Securities and Use of Proceeds

Issuer Purchases of Equity Securities AFG repurchased shares of its Common Stock during 2020 as follows:


	Total Number of Shares Purchased	Average Price Paid Per Share		Total Number of Shares Purchased as Part of Publicly Announced Plans or Programs	Maximum Number of Shares that May Yet be Purchased Under the Plans or Programs (*)
First quarter	826,283	$	74.28	826,283	4,173,717
Second quarter:
April	—	—		—	4,173,717
May	85,000	$	62.77	85,000	4,088,717
June	1,109,236	63.78		1,109,236	2,979,481
Total	2,020,519	$	68.04	2,020,519

(*)Represents the remaining shares that may be repurchased under the Plans authorized by AFG’s Board of Directors in February 2016 and February 2019.

In addition, AFG acquired 95,854 shares of its Common Stock (at an average of $110.80 per share) in the first quarter of 2020, 421 shares (at an average of $62.22 per share) in May 2020 and 119 shares (at $62.38 per share) in June 2020 in connection with its stock incentive plans.

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AMERICAN FINANCIAL GROUP, INC. 10-Q

ITEM 6. Exhibits


Number						Exhibit Description
31(a)						Certification of Co-Chief Executive Officer pursuant to section 302(a) of the Sarbanes-Oxley Act of 2002.
31(b)						Certification of Co-Chief Executive Officer pursuant to section 302(a) of the Sarbanes-Oxley Act of 2002.
31(c)						Certification o f i nter im p rincipal f inancial and accounting o fficer pursuant to section 302(a) of the Sarbanes-Oxley Act of 2002.
32						Certification of Co-Chief Executive Officers a nd i nterim p rincipal f inancial and accoun ting o ffic er pursuant to section 906 of the Sarbanes-Oxley Act of 2002.
101.INS						XBRL Instance Document - the instance document does not appear in the Interactive Data File because its XBRL tags are embedded within the Inline XBRL document.
101.SCH						Inline XBRL Taxonomy Extension Schema Document.
101.CAL						Inline XBRL Taxonomy Extension Calculation Linkbase Document.
101.DEF						Inline XBRL Taxonomy Extension Definition Linkbase Document.
101.LAB						Inline XBRL Taxonomy Extension Label Linkbase Document.
101.PRE						Inline XBRL Taxonomy Extension Presentation Linkbase Document.
104						Cover Page Interactive Data File (formatted as Inline XBRL and contained in Exhibit 101).

Signature

Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.

American Financial Group, Inc.

August 6, 2020

By:

/s/ Brian Hertzman

Brian Hertzman

Vice President and Controller

(interim principal financial and accounting officer)

100

Document

Exhibit 31(a)

AMERICAN FINANCIAL GROUP, INC. 10-Q

SARBANES-OXLEY SECTION 302(a) CERTIFICATIONS

I, Carl H. Lindner III, certify that:

1.I have reviewed this quarterly report on Form 10-Q of American Financial Group, Inc.;

2.Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this report;

3.Based on my knowledge, the financial statements, and other financial information included in this report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this report;

4.The registrant’s other certifying officers and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) and internal control over financial reporting (as defined in Exchange Act Rules 13a-15(f) and 15d-15(f)) for the registrant and have:

a)Designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this report is being prepared;

b)Designed such internal control over financial reporting, or caused such internal control over financial reporting to be designed under our supervision, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles;

c)Evaluated the effectiveness of the registrant’s disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and

d)Disclosed in this report any change in the registrant’s internal control over financial reporting that occurred during the registrant’s most recent fiscal quarter that has materially affected, or is reasonably likely to materially affect, the registrant’s internal control over financial reporting; and

5.The registrant’s other certifying officers and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the registrant’s auditors and the audit committee of registrant’s board of directors (or persons performing the equivalent functions):

a)All significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the registrant’s ability to record, process, summarize and report financial information; and

b)Any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant’s internal control over financial reporting.

August 6, 2020

By:

/s/ Carl H. Lindner III

Carl H. Lindner III

Co-Chief Executive Officer

E-1

Document

Exhibit 31(b)

AMERICAN FINANCIAL GROUP, INC. 10-Q

SARBANES-OXLEY SECTION 302(a) CERTIFICATIONS

I, S. Craig Lindner, certify that:

1.I have reviewed this quarterly report on Form 10-Q of American Financial Group, Inc.;

b)Any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant’s internal control over financial reporting.

August 6, 2020

By:

/s/ S. Craig Lindner

S. Craig Lindner

Co-Chief Executive Officer

E-2

Document

Exhibit 31(c)

AMERICAN FINANCIAL GROUP, INC. 10-Q

SARBANES-OXLEY SECTION 302(a) CERTIFICATIONS

I, Brian Hertzman, certify that:

1.I have reviewed this quarterly report on Form 10-Q of American Financial Group, Inc.;

b)Any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant’s internal control over financial reporting.

August 6, 2020

By:

/s/ Brian Hertzman

Brian Hertzman

Vice President and Controller

(interim principal financial and accounting officer)

E-3

Document

Exhibit 32

AMERICAN FINANCIAL GROUP, INC. 10-Q

CERTIFICATION OF CHIEF EXECUTIVE OFFICERS AND INTERIM PRINCIPAL FINANCIAL AND ACCOUNTING OFFICER

PURSUANT TO SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002

In connection with the filing with the Securities and Exchange Commission of the Quarterly Report of American Financial Group, Inc. (the “Company”) on Form 10-Q for the period ended June 30, 2020 (the “Report”), the undersigned officers of the Company, certify, pursuant to section 906 of the Sarbanes-Oxley Act of 2002, that to the best of their knowledge:

(1)The Report fully complies with the requirements of section 13(a) or 15(d) of the Securities Act of 1934; and

(2)The information contained in the Report fairly presents, in all material respects, the financial condition and results of operations of the Company.

August 6, 2020

By:

/s/ S. Craig Lindner

Date

S. Craig Lindner

Co-Chief Executive Officer

August 6, 2020

By:

/s/ Carl H. Lindner III

Date

Carl H. Lindner III

Co-Chief Executive Officer

August 6, 2020

By:

/s/ Brian Hertzman

Date

Brian Hertzman

Vice President and Controller

(interim principal financial and accounting officer)

A signed original of this written statement will be retained by the Registrant and

furnished to the Securities and Exchange Commission or its staff upon request.

E-4