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 Commission File
September 30, 1998 No. 1-13653
AMERICAN FINANCIAL GROUP, INC.
Incorporated under IRS Employer I.D.
the Laws of Ohio No. 31-1544320
One 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 X No ___
As of November 1, 1998, there were 61,066,903 shares of the
Registrant's Common Stock outstanding, excluding 18,666,614 shares
owned by subsidiaries.
Page 1 of 21
AMERICAN FINANCIAL GROUP, INC. 10-Q
PART I
FINANCIAL INFORMATION
AMERICAN FINANCIAL GROUP, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEET
(Dollars In Thousands)
September 30, December 31,
1998 1997
Assets:
Cash and short-term investments $ 412,411 $ 257,117
Investments:
Fixed maturities:
Held to maturity - at amortized cost
(market - $2,912,300 and $3,419,000) 2,765,074 3,328,082
Available for sale - at market
(amortized cost - $7,462,670 and $7,225,736) 7,897,070 7,532,836
Other stocks - principally at market
(cost - $196,868 and $153,322) 393,468 446,222
Investment in investee corporation 232,933 200,714
Policy loans 221,208 240,955
Real estate and other investments 272,401 283,979
Total investments 11,782,154 12,032,788
Recoverables from reinsurers and prepaid
reinsurance premiums 1,161,686 998,743
Agents' balances and premiums receivable 754,855 691,005
Deferred acquisition costs 500,052 521,898
Other receivables 261,676 243,330
Assets held in separate accounts 84,890 300,491
Prepaid expenses, deferred charges and other assets 364,159 410,569
Cost in excess of net assets acquired 283,422 299,408
$15,605,305 $15,755,349
Liabilities and Capital:
Unpaid losses and loss adjustment expenses $ 4,528,175 $ 4,225,336
Unearned premiums 1,294,259 1,328,910
Annuity benefits accumulated 5,424,690 5,528,111
Life, accident and health reserves 339,558 709,899
Long-term debt:
Holding companies 432,589 386,661
Subsidiaries 207,306 194,084
Liabilities related to separate accounts 84,890 300,491
Accounts payable, accrued expenses and other
liabilities 979,677 906,151
Total liabilities 13,291,144 13,579,643
Minority interest 525,441 512,997
Shareholders' Equity:
Common Stock, no par value
- 200,000,000 shares authorized
- 61,046,072 and 61,048,904 shares outstanding 61,046 61,049
Capital surplus 781,780 775,689
Retained earnings 584,494 477,071
Net unrealized gain on marketable securities,
net of deferred income taxes 361,400 348,900
Total shareholders' equity 1,788,720 1,662,709
$15,605,305 $15,755,349
2
AMERICAN FINANCIAL GROUP, INC. 10-Q
AMERICAN FINANCIAL GROUP, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENT OF EARNINGS
(In Thousands, Except Per Share Data)
Three months ended Nine months ended
September 30, September 30,
1998 1997 1998 1997
Income:
Property and casualty insurance
premiums $ 696,537 $ 739,858 $2,080,003 $2,102,001
Life, accident and health premiums 50,434 32,149 145,710 84,845
Investment income 222,683 218,684 671,923 646,178
Equity in net earnings (loss) of investee (5,518) (13,914) 26,396 18,094
Realized gains on sales of:
Securities 14,302 29,682 28,890 35,693
Investee and subsidiaries 11,090 - 20,510 731
Other investments - - 6,843 -
Other income 42,276 28,347 106,153 80,633
1,031,804 1,034,806 3,086,428 2,968,175
Costs and Expenses:
Property and casualty insurance:
Losses and loss adjustment expenses 513,537 545,915 1,577,440 1,510,426
Commissions and other underwriting
expenses 201,777 208,975 586,409 586,580
Annuity benefits 64,514 72,868 204,735 212,305
Life, accident and health benefits 40,547 28,250 115,208 78,238
Interest charges on borrowed money 14,932 12,879 42,878 40,433
Minority interest expense 16,628 16,794 43,795 46,851
Other operating and general expenses 93,816 91,657 254,616 238,882
945,751 977,338 2,825,081 2,713,715
Earnings before income taxes and
extraordinary items 86,053 57,468 261,347 254,460
Provision for income taxes 29,622 23,801 97,464 96,396
Earnings before extraordinary items 56,431 33,667 163,883 158,064
Extraordinary items - loss on prepayment
of debt (36) (6,973) (763) (7,051)
Net Earnings $ 56,395 $ 26,694 $ 163,120 $ 151,013
Basic earnings (loss) per Common Share:
Before extraordinary items $.92 $.57 $2.67 $2.65
Loss on prepayment of debt - (.12) (.01) (.12)
Net earnings available to Common Shares $.92 $.45 $2.66 $2.53
Diluted earnings (loss) per Common Share:
Before extraordinary items $.91 $.56 $2.63 $2.60
Loss on prepayment of debt - (.12) (.01) (.12)
Net earnings available to Common Shares $.91 $.44 $2.62 $2.48
Average number of Common Shares:
Basic 61,374 58,939 61,278 59,747
Diluted 62,191 60,349 62,315 60,853
3
AMERICAN FINANCIAL GROUP, INC. 10-Q
AMERICAN FINANCIAL GROUP, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENT OF CHANGES IN SHAREHOLDERS' EQUITY
(Dollars in Thousands)
Common Stock Unrealized
Common and Capital Retained Gain on Comprehensive
Shares Surplus Earnings Securities Income
Balance at January 1, 1998 61,048,904 $836,738 $477,071 $348,900
Net earnings - - 163,120 - $163,120
Dividends on Common Stock - - (45,960) - -
Shares issued:
Exercise of stock options 296,416 8,288 - - -
Dividend reinvestment plan 7,094 294 - - -
Employee stock purchase plan 51,323 2,089 - - -
401-K plan company match 44,035 1,783 - - -
Portion of bonuses paid in stock 20,300 816 - - -
Directors fees paid in stock 1,622 68 - - -
Shares repurchased (423,622) (5,846) (9,737) - -
Capital transactions of subsidiaries - (1,470) - - -
Change in unrealized - - - 12,500 12,500
Other - 66 - - -
Balance at September 30, 1998 61,046,072 $842,826 $584,494 $361,400 $175,620
Balance at January 1, 1997 61,071,626 $806,721 $559,716 $188,000
Net earnings - - 151,013 - $151,013
Dividends on Common Stock - - (44,844) - -
Shares issued:
Exercise of stock options 131,994 2,849 - - -
Dividend reinvestment plan 6,651 257 - - -
Employee stock purchase plan 50,065 1,942 - - -
Portion of bonuses paid in stock 40,500 1,521 - - -
Directors fees paid in stock 1,164 45 - - -
Shares repurchased (2,327,943) (30,774) (53,452) - -
Capital transactions of subsidiaries - (1,470) - - -
Change in unrealized - - - 130,200 130,200
Other - (449) - - -
Balance at September 30, 1997 58,974,057 $780,642 $612,433 $318,200 $281,213
4
AMERICAN FINANCIAL GROUP, INC. 10-Q
AMERICAN FINANCIAL GROUP, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENT OF CASH FLOWS
(In Thousands)
Nine months ended
September 30,
1998 1997
Operating Activities:
Net earnings $ 163,120 $ 151,013
Adjustments:
Extraordinary items 763 7,051
Depreciation and amortization 71,589 51,202
Annuity benefits 204,735 212,144
Equity in net earnings of investee (26,396) (18,094)
Changes in reserves on assets 761 (102)
Realized gains on investing activities (80,357) (36,102)
Increase in reinsurance and other receivables (247,348) (216,610)
Decrease (increase) in other assets (125,140) 64,850
Increase in insurance claims and reserves 293,264 188,305
Increase (decrease) in other liabilities 121,631 (86,022)
Increase in minority interest 9,196 16,542
Dividends from investee 3,600 3,600
Other, net (9,792) (17,590)
379,626 320,187
Investing Activities:
Purchases of and additional investments in:
Fixed maturity investments (1,682,077) (1,816,909)
Equity securities (54,971) (22,783)
Subsidiaries (30,325) (4,900)
Real estate, property and equipment (49,425) (35,396)
Maturities and redemptions of fixed maturity
investments 1,017,153 535,178
Sales of:
Fixed maturity investments 544,722 935,942
Equity securities 19,119 85,677
Subsidiaries 164,589 2,500
Real estate, property and equipment 48,634 2,792
Cash and short-term investments of acquired
(former) subsidiaries (19,646) (70)
Increase in other investments (9,363) (4,448)
(51,590) (322,417)
Financing Activities:
Fixed annuity receipts 358,659 369,731
Annuity surrenders, benefits and withdrawals (538,912) (439,818)
Additional long-term borrowings 217,537 63,090
Reductions of long-term debt (159,383) (110,494)
Issuances of Common Stock 9,725 4,835
Repurchases of Common Stock (14,702) (84,226)
Issuances of trust preferred securities - 149,353
Cash dividends paid (45,666) (44,586)
(172,742) (92,115)
Net Increase (Decrease) in Cash and Short-term
Investments 155,294 (94,345)
Cash and short-term investments at beginning
of period 257,117 448,296
Cash and short-term investments at end of period $ 412,411 $ 353,951
5
AMERICAN FINANCIAL GROUP, INC. 10-Q
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
A. Accounting Policies
Basis of Presentation The accompanying consolidated financial
statements for American Financial Group, Inc. ("AFG") and
subsidiaries 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
generally accepted accounting principles.
Certain reclassifications have been made to prior years to conform
to the current year's presentation. All significant intercompany
balances and transactions have been eliminated. All acquisitions
have been treated as purchases. The results of operations of
companies since their formation or acquisition are included in the
consolidated financial statements.
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.
AFG's ownership of subsidiaries and significant investees with
publicly traded common shares was as follows:
September 30, December 31,
1998 1997 1996
American Annuity Group, Inc. ("AAG") 82% 81% 81%
American Financial Enterprises, Inc. ("AFEI") - (*) 83%
Chiquita Brands International, Inc. 37% 39% 43%
(*) Became a 100%-owned subsidiary in December 1997.
Investments Debt securities are classified as "held to maturity"
and reported at amortized cost if AFG has the positive intent and
ability to hold them to maturity. Debt and equity securities are
classified as "available for sale" and reported at fair value with
unrealized gains and losses reported as a separate component of
shareholders' equity if the securities are not classified as held
to maturity or bought and held principally for selling in the near
term. Only in certain limited circumstances, such as significant
issuer credit deterioration or if required by insurance or other
regulators, may a company change its intent to hold a certain
security to maturity without calling into question its intent to
hold other debt securities to maturity in the future.
Short-term investments are carried at cost; loans receivable are
carried primarily at the aggregate unpaid balance. Premiums and
discounts on mortgage-backed securities are amortized over their
expected average lives using the interest method.
Gains or losses on sales of securities are recognized at the time
of disposition with the amount of gain or loss determined on the
specific identification basis. When a decline in the value of a
specific investment is considered to be other than temporary, a
provision for impairment is charged to earnings and the carrying
value of that investment is reduced.
6
AMERICAN FINANCIAL GROUP, INC. 10-Q
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
Investment in Investee Corporation Investments in securities of
20%- to 50%-owned companies are generally carried at cost,
adjusted for AFG's proportionate share of their undistributed
earnings or losses.
Cost in Excess of Net Assets Acquired The excess of cost of
subsidiaries and investees over AFG's equity in the underlying net
assets ("goodwill") is being amortized over 40 years.
Insurance As discussed under "Reinsurance" below, unpaid losses
and loss adjustment expenses and unearned premiums have not been
reduced for reinsurance recoverable.
Reinsurance In the normal course of business, AFG's insurance
subsidiaries cede reinsurance to other companies to diversify risk
and limit maximum loss arising from large claims. To the extent
that any reinsuring companies are unable to meet obligations under
the agreements covering reinsurance ceded, AFG's insurance
subsidiaries would remain liable. Amounts recoverable from
reinsurers are estimated in a manner consistent with the claim
liability associated with the reinsurance policies. AFG's
insurance subsidiaries report as assets (a) the estimated
reinsurance recoverable on unpaid losses, including an estimate
for losses incurred but not reported, and (b) amounts paid to
reinsurers applicable to the unexpired terms of policies in force.
AFG's insurance subsidiaries also assume reinsurance from other
companies. Income on reinsurance assumed is recognized based on
reports received from ceding reinsurers.
Deferred Acquisition Costs Policy acquisition costs
(principally commissions, premium taxes and other underwriting
expenses) related to the production of new business are deferred
("DPAC"). For the property and casualty companies, the deferral
of acquisition costs is limited based upon their recoverability
without any consideration for anticipated investment income. DPAC
is charged against income ratably over the terms of the related
policies. For the annuity companies, DPAC is amortized, with
interest, in relation to the present value of expected gross
profits on the policies.
Unpaid Losses and Loss Adjustment Expenses The net liabilities
stated for unpaid claims and for expenses of investigation and
adjustment of unpaid claims are based upon (a) the accumulation of
case estimates for losses reported prior to the close of the
accounting period on the direct business written; (b) estimates
received from ceding reinsurers and insurance pools and
associations; (c) estimates of unreported losses based on past
experience; (d) estimates based on experience of expenses for
investigating and adjusting claims and (e) the current state of
the law and coverage litigation. These liabilities are subject to
the impact of changes in claim amounts and frequency and other
factors. In spite of the variability inherent in such estimates,
management believes that the liabilities for unpaid losses and
loss adjustment expenses are adequate. 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.
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
expense and decreases for surrender charges are credited to other
income.
Life, Accident and Health Reserves Liabilities for future
policy benefits under traditional life, accident and health
policies are computed using a net level premium method.
Computations are based on anticipated investment yield, mortality,
morbidity and surrenders and include provisions for unfavorable
deviations. Reserves are modified as necessary to reflect actual
experience and developing trends.
7
AMERICAN FINANCIAL GROUP, INC. 10-Q
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
Assets Held In and Liabilities Related to Separate Accounts
Separate account assets and related liabilities represent variable
annuity deposits and, in 1997, include deposits maintained by
several banks under a previously offered tax-deferred annuity
program which was sold as part of the Funeral Services division
(see Note B).
Premium Recognition Property and casualty premiums are earned
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 reports received from such companies and organizations.
For traditional life, accident and health products, premiums are
recognized as revenue when legally collectible from policyholders.
For interest-sensitive life and universal life products, premiums
are recorded in a policyholder account which is reflected as a
liability. Revenue is recognized as amounts are assessed against
the policyholder account for mortality coverage and contract expenses.
Policyholder Dividends Dividends payable to policyholders are
included in "Accounts payable, accrued expenses and other
liabilities" and represent estimates of amounts payable on
participating policies which share in favorable underwriting
results. The estimate is accrued during the period in which the
related premium is earned. Changes in estimates are included in
income in the period determined. Policyholder dividends do not
become legal liabilities unless and until declared by the boards
of directors of the insurance companies.
Minority Interest For balance sheet purposes, minority interest
represents the interests of noncontrolling shareholders in AFG
subsidiaries, including American Financial Corporation ("AFC")
preferred stock and preferred securities issued by trust
subsidiaries of AFG. For income statement purposes, minority
interest expense represents those shareholders' interest in the
earnings of AFG subsidiaries as well as AFC preferred dividends
and accrued distributions on the trust preferred securities.
Issuances of Stock by Subsidiaries and Investees Changes in AFG's
equity in a subsidiary or an investee caused by issuances of the
subsidiary's or investee's stock are accounted for as gains or
losses where such issuance is not part of a broader reorganization.
Income Taxes AFC and American Premier Underwriters, Inc.
("American Premier" or "APU") have each filed consolidated federal
income tax returns which include all 80%-owned U.S. subsidiaries,
except for certain life insurance subsidiaries and their
subsidiaries. AFG (parent) was included in American Premier's
consolidated return for 1996. At the close of business on
December 31, 1996, AFG contributed 81% of the common stock of
American Premier to AFC. Accordingly, AFC and American Premier
filed a consolidated return for 1997. Because holders of AFC
Preferred Stock hold in excess of 20% of AFC's voting rights, AFG
(parent) and AFC Holding Company own less than 80% of AFC, and
therefore, filed separate returns.
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. Deferred tax
assets are recognized if it is more likely than not that a benefit
will be realized.
8
AMERICAN FINANCIAL GROUP, INC. 10-Q
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
Stock-Based Compensation As permitted under Statement of
Financial Accounting Standards ("SFAS") No. 123, "Accounting for
Stock-Based Compensation", AFG accounts for stock options and
other stock-based compensation plans using the intrinsic value
based method prescribed by Accounting Principles Board Opinion No. 25,
"Accounting for Stock Issued to Employees."
Benefit Plans AFG provides retirement benefits to qualified
employees of participating companies through contributory and
noncontributory defined contribution plans contained in AFG's
Retirement and Savings Plan. Under the retirement portion of the
plan, company contributions (approximately 6% of covered
compensation in 1997) are invested primarily in securities of AFG
and affiliates. Under the savings portion of the plan, AFG
matches a specific portion of employee contributions.
Contributions to benefit plans are charged against earnings 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 the employees earn such
benefits.
Under AFG's stock option plan, options are granted to officers,
directors and key employees at exercise prices equal to the fair
value of the shares at the dates of grant. No compensation
expense is recognized for stock option grants.
Start-up Costs Certain costs associated with introducing new
products and distribution channels are deferred by AAG and are
amortized on a straight-line basis over 5 years. See Management's
Discussion and Analysis - "New Accounting Standard to be
Implemented."
Earnings Per Share In 1997, AFG implemented SFAS No. 128,
"Earnings Per Share". This standard requires the presentation of
basic and diluted earnings per share. Basic earnings per share
are calculated using the weighted average number of shares of
common stock outstanding during the period. Diluted earnings per
share include the effect of the assumed exercise of dilutive
common stock options. Per share amounts for prior periods have
been restated to conform to the current presentation.
Comprehensive Income Effective January 1, 1998, AFG implemented
SFAS No. 130, "Reporting Comprehensive Income." SFAS No. 130 uses
the term "comprehensive income" to describe the total of net
earnings plus other comprehensive income. For AFG, other
comprehensive income represents the change in net unrealized gain
on marketable securities net of deferred taxes and a
reclassification adjustment for gains and losses included in net
earnings. Implementation of this statement had no impact on net
earnings or shareholders' equity. Prior periods have been
restated to conform to the current presentation.
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 and property
and equipment. "Financing activities" include obtaining resources
from owners and providing them with a return on their investments,
borrowing money and repaying amounts borrowed. Annuity receipts,
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.
9
AMERICAN FINANCIAL GROUP, INC. 10-Q
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
B. Sale of Subsidiaries On September 30, 1998, AAG sold its Funeral
Services division for approximately $165 million in cash. AFG
realized a pretax gain of $21.6 million, before $2.7 million of
minority interest, on this sale.
In September 1998, AFG reached a definitive agreement to sell the
majority of its commercial lines division to Ohio Casualty Company
for $300 million in cash plus warrants to purchase 3 million
shares of Ohio Casualty common stock. The commercial lines being
sold generated net written premiums of approximately $215 million
and $235 million for the nine months ended September 30, 1998 and
1997, respectively, and $330 million for the year ended
December 31, 1997. AFG expects to record a pretax gain in excess
of $140 million on this transaction. Completion of the sale,
which is expected to occur in the fourth quarter of 1998, is
subject to certain conditions, including receipt of regulatory
approval.
C. Segments of Operations Following the sale of its Commercial lines
division, AFG's property and casualty group will be engaged
primarily in private passenger automobile and specialty insurance
businesses. AFG's annuity and life business primarily sells tax-
deferred annuities to employees of primary and secondary
educational institutions and hospitals. In addition, AFG has
owned significant portions of the voting equity securities of
certain companies (investee corporation - see Note D).
The Financial Accounting Standards Board issued SFAS No. 131,
"Disclosures about Segments of an Enterprise and Related
Information", which is required to be implemented by the end of
1998. The implementation of SFAS No. 131 will have no effect on
AFG's earnings or its financial position.
The following table (in thousands) shows AFG's revenues by
significant business segment. The Personal group consists of the
nonstandard auto group along with the preferred/standard private
passenger auto and other personal insurance business, formerly
included in the Commercial and Personal lines. The Specialty
group now includes a highly diversified group of specialty
business units (formerly, Specialty lines) plus the commercial
business previously included in the Commercial and Personal lines.
Nine months ended September 30,
1998 1997
Property and casualty insurance:
Premiums earned:
Personal $ 980,288 $1,017,976
Specialty 1,068,854 1,056,531
Other (a) 30,861 27,494
2,080,003 2,102,001
Investment and other income 376,684 340,608
2,456,687 2,442,609
Annuities and life (b) 584,834 466,046
Other 18,511 41,426
3,060,032 2,950,081
Equity in net earnings of investee 26,396 18,094
$3,086,428 $2,968,175
(a) Includes nonstandard auto group operations in the United Kingdom.
(b) Represents primarily investment income.
10
AMERICAN FINANCIAL GROUP, INC. 10-Q
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
D. Investment in Investee Corporation Investment in investee
corporation reflects AFG's ownership of 24 million shares of
Chiquita common stock. The market value of this investment was
$253 million and $391 million at September 30, 1998 and December
31, 1997, respectively. Chiquita is a leading international
marketer, producer and distributor of bananas and other quality
fresh and processed food products.
Summarized financial information for Chiquita follows (in millions):
Nine months ended September 30,
1998 1997
Net Sales $2,095 $1,834
Operating Income 157 134
Net Income 83 56
In November 1998, Chiquita reported that it had incurred significant
damage to its operations in Honduras as a result of widespread flooding
caused by Hurricane Mitch. Chiquita estimated that its asset write-offs
and charges relating to Honduras for its fourth quarter will be in the
$50 million range.
E. Long-Term Debt The carrying value of long-term debt consisted of
the following (in thousands):
September 30, December 31,
1998 1997
Holding Companies:
AFG 7-1/8% Senior Debentures due December 2007 $100,000 $100,000
AFC notes payable to banks due December 2002 95,000 45,000
AFC 9-3/4% Debentures due April 2004 78,797 79,792
APU 9-3/4% Subordinated Notes due August 1999 89,738 92,127
APU 10-5/8% Subordinated Notes due April 2000 43,108 43,889
APU 10-7/8% Subordinated Notes due May 2011 17,544 17,586
Other 8,402 8,267
$432,589 $386,661
Subsidiaries:
AAG 6-7/8% Senior Notes due June 2008 $100,000 $ -
AAG notes payable to banks due in
installments to December 2003 57,000 107,000
AAG 11-1/8% Senior Subordinated Notes - 24,080
Notes payable secured by real estate 37,744 49,525
Other 12,562 13,479
$207,306 $194,084
At September 30, 1998, sinking fund and other scheduled principal
payments on debt for the balance of 1998 and the subsequent five
years were as follows (in thousands):
Holding
Companies Subsidiaries Total
1998 $ - $ 472 $ 472
1999 89,030 1,962 90,992
2000 42,042 8,666 50,708
2001 - 1,381 1,381
2002 100,502 1,266 101,768
2003 - 58,294 58,294
11
AMERICAN FINANCIAL GROUP, INC. 10-Q
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
Debentures purchased in excess of scheduled payments may be
applied to satisfy any sinking fund requirement. The scheduled
principal payments shown above assume that debentures previously
purchased are applied to the earliest scheduled retirements.
In February 1998, AFC entered into a new unsecured credit
agreement with a group of banks under which AFC can borrow up to
$300 million through December 2002. Borrowings bear interest at
floating rates based on prime or Eurodollar rates.
In January 1998, AAG replaced its existing bank lines with a new
$200 million unsecured credit agreement. Loans under the credit
agreement mature from 2000 to 2003 and bear interest at floating
rates based on prime or Eurodollar rates. In February 1998, AAG
borrowed $50 million under the line and retired its 11-1/8% Notes
(including $24.3 million principal amount held by AAG and its
subsidiaries). In June 1998, AAG sold $100 million principal
amount of 6-7/8% Senior Notes due 2008 to the public and used the
net proceeds to reduce outstanding indebtedness under the credit
agreement.
F. Minority Interest Minority interest in AFG's balance sheet is
comprised of the following (in thousands):
September 30, December 31,
1998 1997
Interest of noncontrolling shareholders
in subsidiaries' common stock $128,287 $115,843
Preferred securities issued by
subsidiary trusts 325,000 325,000
AFC preferred stock 72,154 72,154
$525,441 $512,997
Preferred Securities Wholly-owned subsidiary trusts of AFC
Holding ("AFCH") and AAG have issued $325 million of preferred
securities and, in turn, purchased $325 million of newly
authorized AFC Holding and AAG subordinated debt issues which
provide interest and principal payments to fund the respective
trusts' obligations. The preferred securities are mandatorily
redeemable upon maturity or redemption of the subordinated debt.
The preferred securities are summarized as follows:
Date of Optional
Issuance Issue (Maturity Date) Amount Redemption Dates
October 1996 AFCH 9-1/8% TOPrS (2026) $100,000,000 On or after 10/22/2001
November 1996 AAG 9-1/4% TOPrS (2026) 75,000,000 On or after 11/7/2001
March 1997 AAG 8-7/8% Pfd (2027) 75,000,000 On or after 3/1/2007
May 1997 AAG 7-1/4% ROPES (2041) 75,000,000 Prior to 9/28/2000 and
after 9/28/2001
AFC Holding and AAG effectively provide unconditional guarantees
of their respective trusts' obligations and AFG guarantees AFC
Holding's obligation.
AFC Preferred Stock AFC's Preferred Stock was voting, cumulative,
and consisted of the following:
Series J, no par value; $25.00 liquidating value per share;
annual dividends per share $2.00; redeemable at $25.75 per
share beginning December 2005 declining to $25.00 at
December 2007; 2,886,161 shares (stated value $72.2 million)
outstanding at September 30, 1998 and December 31, 1997.
12
AMERICAN FINANCIAL GROUP, INC. 10-Q
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
Minority Interest Expense Minority interest expense is comprised
of (in thousands):
Nine months ended
September 30,
1998 1997
Interest of noncontrolling shareholders
in earnings of subsidiaries $18,323 $11,680
Accrued distributions by subsidiaries
on preferred securities:
Trust issued securities 21,143 17,558
AFC preferred stock 4,329 17,613
$43,795 $46,851
G. Shareholders' Equity At September 30, 1998, there were 61,046,072
shares of AFG Common Stock outstanding, including 1,367,981 shares
held by American Premier for distribution to certain creditors and
other claimants pursuant to a plan of reorganization relating to
American Premier's predecessor. 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.
At September 30, 1998, there were 4.7 million shares of AFG Common
Stock reserved for issuance upon exercise of stock options. As of
that date, AFG had options for 3.8 million shares outstanding.
Options generally become exercisable at the rate of 20% per year
commencing one year after grant; those granted to non-employee
directors of AFG are fully exercisable upon grant. All options
expire ten years after the date of grant.
The change in net unrealized gain on marketable securities for the
nine months ended September 30 included the following (in millions):
Minority
Pretax Taxes Interest Net
1998
Unrealized holding gains (losses) on
securities arising during the period $ 67.2 ($22.0) ($ 7.0) $ 38.2
Less reclassification adjustment for
realized gains included in net income and
unrealized gains of subsidiaries sold (45.1) 15.8 3.6 (25.7)
Change in net unrealized gain on
marketable securities $ 22.1 ($ 6.2) ($ 3.4) $ 12.5
1997
Unrealized holding gains (losses) on
securities arising during the period $254.0 ($89.0) ($11.6) $153.4
Less reclassification adjustment for
realized gains included in net income (36.1) 12.6 .3 (23.2)
Change in net unrealized gain on
marketable securities $217.9 ($76.4) ($11.3) $130.2
13
AMERICAN FINANCIAL GROUP, INC. 10-Q
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
H. Extraordinary Items Extraordinary items represent AFG's
proportionate share of losses related to debt retirements by the
following companies. Amounts shown are net of minority interest
and income tax benefits (in thousands):
Nine months ended
September 30,
1998 1997
Holding Companies:
AFC (parent) ($ 51) ($5,357)
APU (parent) (63) (444)
Subsidiaries:
AAG (649) (1,250)
($763) ($7,051)
I. Cash Flows - Fixed Maturity Investments "Investing activities"
related to fixed maturity investments in AFG's Statement of Cash
Flows consisted of the following (in thousands):
Held to Available
Maturity For Sale Total
1998
Purchases $ 826 $1,681,251 $1,682,077
Maturities and redemptions 478,860 538,293 1,017,153
Sales 37,903 (*) 506,819 544,722
1997
Purchases $ 4,118 $1,812,791 $1,816,909
Maturities and redemptions 268,432 266,746 535,178
Sales - 935,942 935,942
(*) Sold (at a gain of $.7 million) due to significant
deterioration in the issuers' creditworthiness.
J. Commitments and Contingencies Other than as disclosed in "Legal
Proceedings" in Part II of AFG's June 30, 1998 Form 10-Q, there
have been no significant changes to the matters discussed and
referred to in Note N "Commitments and Contingencies" in AFG's
Annual Report on Form 10-K for 1997.
14
AMERICAN FINANCIAL GROUP, INC. 10-Q
ITEM 2
Management's Discussion and Analysis
of Financial Condition and Results of Operations
GENERAL
AFG and its subsidiaries, AFC Holding, AFC and American Premier,
are organized as holding companies with almost all of their
operations being conducted by subsidiaries. These parent
corporations, however, have continuing cash needs for
administrative expenses, the payment of principal and interest on
borrowings, shareholder dividends, and taxes. Therefore, certain
analyses are best done on a parent only basis while others are
best done on a total enterprise basis. In addition, since 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.
Year 2000 Status AFG's Year 2000 Project is a corporate-wide
program designed to ensure that its computer systems will function
properly in the year 2000. The Project also encompasses
communicating with agents, vendors, financial institutions and
others with which the companies conduct business to determine
their Year 2000 readiness and resulting effects on AFG. AFG's
Year 2000 Project is being coordinated by its Year 2000 Project
Office which monitors the work being performed by the various
business units and reports monthly to the Audit Committee of the
Board of Directors and more frequently to senior management.
To address the Year 2000 problem, AFG's operations have been
divided into separate systems groups. At September 30, 1998,
these groups were in the process of either (i) modifying their
software programs or (ii) replacing programs with new software
that is Year 2000 compliant. Nearly three-fourths of the groups
are "on target" to meet AFG's goal of having program modifications
and new software installations substantially completed by the end
of 1998, with testing continuing in and through 1999. About one-
fourth of the groups are being "closely watched" because there is
some risk that critical dates in the project schedule may be
missed with a potential for some disruption of normal business
operations. One group is considered "critical" at this time since
it has significantly missed internal project deadlines. This project
has recently been reorganized and staffing levels have been increased.
The project is being closely monitored and will be reviewed to
determine if it can be upgraded to the "closely watched" category
during the fourth quarter of 1998.
Contingency plans have been developed for certain systems deemed
most critical to operations. These plans provide a documented
order of actions necessary to keep the business functions
operating for these systems. Such plans typically include
procedures and workflow processes for developing contingent
databases. Contingency planning for other systems deemed critical
to operations and reasonably likely not to be modified on schedule
will begin in the fourth quarter of 1998 and be completed by mid-1999.
Many of the systems being replaced were planned replacements which
were merely accelerated due to the Year 2000 problem. In
addition, a significant portion of AFG's Year 2000 Project is
being completed using internal staff. Therefore, cost estimates
for the Year 2000 Project do not entirely represent incremental costs.
From inception in the early 1990s through September 30, 1998, AFG
has incurred approximately $32 million in Year 2000 costs,
including capitalized costs of $7 million for new systems. During
the first nine months of 1998, $17 million in Year 2000 costs have
been expensed. AFG estimates that it will incur an additional $30
million of such costs in completing the Project.
15
AMERICAN FINANCIAL GROUP, INC. 10-Q
Management's Discussion and Analysis
of Financial Condition and Results of Operations - Continued
Projected Year 2000 costs and completion dates are based on
management's best estimates. However, there can be no assurance
that these estimates will be achieved. Should software
modifications and new software installations not be completed on a
timely basis, the resulting disruptions could have a material
adverse affect on operations.
AFG's operations could also be affected by the inability of third
parties such as agents and vendors to become Year 2000 compliant.
In addition, AFG's property and casualty insurance subsidiaries
are reviewing the potential impact of the Year 2000 issue on
insureds as part of their underwriting process. They are also
reviewing policy forms, issuing clarifying endorsements where
appropriate and examining coverage issues for Year 2000 exposures.
While it is possible that Year 2000 claims may emerge in future
periods, it is not possible to estimate any such amounts.
A&E Reserves Under the agreement to sell a majority of its
Commercial lines division, AFG will retain liabilities for certain
asbestos and environmental exposures ("A&E") relating to claims
under policies written prior to the mid-1980's. AFG's insurance
subsidiaries are in the process of reviewing their A&E reserves
and expect this review to be completed before the end of this
year. While its A&E reserves at September 30, 1998, were about
$350 million, approximately 10 times the preceding three years'
average claim payments, AFG expects that the review could indicate
estimated ultimate aggregate losses as much as two-thirds greater
than that amount. Any additional A&E reserves estimated to be
required will be recorded as a special charge upon completion of
the review.
Forward-Looking Statements The Private Securities Litigation
Reform Act of 1995 encourages corporations to provide investors
with information about the company's anticipated performance and
provides protection from liability if future results are not the
same as management's expectations. This document contains certain
forward-looking statements that are based on assumptions which
management believes are reasonable, but by their nature,
inherently uncertain. Future results could differ materially from
those projected. Factors that could cause such differences
include, but are not limited to: changes in economic conditions,
regulatory actions, level of catastrophe losses, the Year 2000
issue, and competitive pressures. AFG undertakes no obligation to
update any forward-looking statements.
LIQUIDITY AND CAPITAL RESOURCES
Ratios AFG's debt to total capital ratio (at the parent holding
company level) was approximately 18% at September 30, 1998 and 17%
at December 31, 1997. AFG's ratio of earnings to fixed charges
(on a total enterprise basis) was 4.20 for the first nine months
of 1998 and 3.98 for the entire year of 1997.
Sources of Funds Management believes the parent holding companies
have sufficient resources to meet their liquidity requirements
through operations in the short-term and long-term future. If
funds generated from operations, including dividends and tax
payments from subsidiaries, are insufficient to meet fixed charges
in any period, these companies would be required to generate cash
through borrowings, sales of securities or other assets, or
similar transactions.
A new five-year, $300 million bank credit line was established by
AFC in February 1998, replacing two subsidiary holding company
lines. The new credit line provides ample liquidity and can be
used to obtain funds for operating subsidiaries or, if necessary,
for the parent companies. At September 30, 1998, there was
$95 million borrowed under the credit line.
16
AMERICAN FINANCIAL GROUP, INC. 10-Q
Management's Discussion and Analysis
of Financial Condition and Results of Operations - Continued
Dividend payments from subsidiaries have been very important to
the liquidity and cash flow of the individual holding companies in
the past. However, the reliance on such dividend payments has
been lessened by the combination of (i) strong capital at AFG's
insurance subsidiaries (and the related decreased likelihood of a
need for investment in those companies), (ii) the reduction of
debt at the holding companies from historical levels (and the
related decrease in ongoing cash needs for interest and principal
payments), (iii) AFG's ability to obtain financing in capital
markets, as well as (iv) the sales of non-core investments.
Investments Approximately 91% of fixed maturities held by AFG
were rated "investment grade" (credit rating of AAA to BBB) by
nationally recognized rating agencies at September 30, 1998.
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.
AFG's equity securities are concentrated in a relatively limited
number of major positions. This approach allows management to more
closely monitor the companies and the industries in which they operate.
RESULTS OF OPERATIONS
General Pretax earnings before extraordinary items for the three
months ended September 30, 1998 were $86.1 million compared to
$57.5 million for the third quarter of 1997. The earnings
improvement for the 1998 quarter reflects an increase in
investment income and income from the sale of lease residuals and
real estate properties, a decrease in investee losses, a reduction
in dividend requirements on a subsidiary's preferred stock and the
absence of certain costs and expenses included in the 1997 period.
Pretax earnings before extraordinary items for the nine months
ended September 30, 1998 were $261.3 million compared to $254.5
million for the first nine months of 1997. The earnings reflect
higher realized gains in addition to those items mentioned above
related to the third quarter, partially offset by a deterioration
in underwriting results in the property and casualty operations
due primarily to severe storms in the midwestern part of the
country during the 1998 second quarter and a continuation of the
adverse claims environment in the California workers' compensation
business.
Property and Casualty Insurance - Underwriting Following the sale
of its Commercial Lines division as described in Note B, which is
expected to be completed in the fourth quarter of 1998, AFG's
property and casualty group will be engaged primarily in private
passenger automobile and specialty insurance businesses.
Accordingly, AFG has realigned its property and casualty group
into two major business groups: Personal and Specialty.
The Personal group consists of the nonstandard auto group along
with the preferred/standard private passenger auto and other
personal insurance business, formerly included in the Commercial
and Personal lines. The nonstandard automobile insurance
companies insure risks not typically accepted for standard
automobile coverage because of the applicant's driving record,
type of vehicle, age or other criteria.
17
AMERICAN FINANCIAL GROUP, INC. 10-Q
Management's Discussion and Analysis
of Financial Condition and Results of Operations - Continued
The Specialty group includes a highly diversified group of
business lines (formerly, Specialty lines) plus the commercial
business previously included in the Commercial and Personal lines.
Some of the more significant areas are executive liability, inland
and ocean marine, U.S.-based operations of Japanese companies,
agricultural-related coverages, California workers' compensation,
non-profit liability, general aviation coverages, fidelity and
surety bonds, and umbrella and excess coverages. Commercial lines
businesses to be sold include certain coverages in workers'
compensation, commercial multi-peril, umbrella, and commercial
automobile.
Underwriting profitability is measured by the combined ratio which
is a sum of the ratios of underwriting losses, loss adjustment
expenses, underwriting expenses and policyholder dividends to
premiums. When the combined ratio is under 100%, underwriting
results are generally considered profitable; when the ratio is
over 100%, underwriting results are generally considered
unprofitable. The combined ratio does not reflect investment
income, other income or federal income taxes.
For certain lines of business and products where the credibility
of the range of loss projections is less certain (primarily the
various specialty lines listed above), management believes that it
is prudent and appropriate to use conservative assumptions until
such time as the data, experience and projections have more
credibility, as evidenced by data volume, consistency and maturity
of the data. While this practice mitigates the risk of adverse
development on this business, it does not eliminate it.
Net written premiums and combined ratios for AFG's property and
casualty insurance subsidiaries were as follows (dollars in millions):
Three months ended Nine months ended
September 30, September 30,
1998 1997 1998 1997
Net Written Premiums (GAAP)
Personal $314.3 $329.0 $ 998.0 $1,030.6
Specialty 357.9 397.7 1,039.6 1,090.8
Other 2.1 13.6 17.7 29.4
$674.3 $740.3 $2,055.3 $2,150.8
Combined Ratios (GAAP)
Personal 97.3% 98.5% 96.9% 99.1%
Specialty 106.0 103.9 107.5 96.5
Aggregate (including
other) 102.8 102.0 104.1 99.8
Personal The Personal group's net written premiums decreased 4%
in the third quarter and 3% in the first nine months of the year
compared to the same 1997 periods. The decline is due primarily
to stronger price competition in the personal automobile market.
Specialty The Specialty group's net written premiums decreased
$39.8 million (10%) during the third quarter from the comparable
1997 period due primarily to the initial impact of a reinsurance
agreement whereby approximately 30% of AFG's California workers'
compensation premiums are being ceded. Also, the Specialty
group's writings continue to be affected by intense price
competition in the commercial casualty markets. Underwriting
results for the third quarter of 1998 continue to be affected by
the adverse claims environment in the California workers'
compensation business and weak results in the general aviation
business.
18
AMERICAN FINANCIAL GROUP, INC. 10-Q
Management's Discussion and Analysis
of Financial Condition and Results of Operations - Continued
Net written premiums for the first nine months of 1998 decreased
$51.2 million (5%) from 1997 due to the workers' compensation
reinsurance agreement mentioned above and a decline in commercial
multi-peril due to price competition. Underwriting results for
the first nine months of 1998 worsened from the comparable periods
in 1997 due to (i) losses from the midwestern storms in the second
quarter of 1998, (ii) the continuation of the adverse claims
environment in the California workers' compensation business,
(iii) weak results in the general aviation business and (iv)
unusually good results in 1997 in certain other lines.
Life, Accident and Health Premiums and Benefits The increase in
life, accident and health premiums and benefits reflects primarily
AAG's acquisition of GA Life Assurance Company in December 1997
and increased sales of pre-need life insurance.
Investment Income Investment income increased approximately
$4 million (2%) for the third quarter of 1998 and $25.7 million
(4%) in the first nine months of 1998 compared to 1997 due
primarily to an increase in the average amount of investments held
partially offset by decreasing market interest rates.
Investee Corporations Equity in net earnings of investee
corporations represents AFG's proportionate share of Chiquita's
earnings. Chiquita reported net income (losses) for the third
quarter and first nine months of 1998 of ($11 million) and
$83 million, respectively, compared to ($28 million) and
$56 million for the same periods in 1997.
Realized Gains Realized capital gains have been an important part
of the return on investments in marketable securities. Individual
securities are sold creating gains and losses as market
opportunities exist.
Gains on Sales of Investee and Subsidiaries
Investee Chiquita's public issuance of shares of its common
stock in the first and second quarters of 1998 resulted in pretax
gains to AFG of $7.7 million and $1.7 million in those periods.
Subsidiaries In the third quarter of 1998, AFG recorded a
pretax gain of $21.6 million on AAG's sale of its Funeral Services
Division and a charge of $10.5 million relating to operations
expected to be sold or otherwise disposed of.
Other Income Other income increased $13.9 million (49%) during
the third quarter and $25.5 million (32%) in the first nine months
of 1998 compared to 1997 due primarily to income from the sale of
operating real estate assets and lease residuals.
Annuity Benefits Annuity benefits reflect interest credited to
annuity policyholders' funds accumulated. The majority of AAG's
fixed rate annuity products permit AAG to change the crediting
rate at any time (subject to minimum interest rate guarantees of
3% or 4% per annum). As a result, management has been able to
react to changes in market interest rates and maintain a desired
interest rate spread. While management believes the recent
interest rate environment has contributed to an increase in
annuitizations and surrenders, AAG's persistency rate remains over
87%. A continuation of the current interest rate environment
could adversely affect this rate.
Interest on Borrowed Money Interest expense increased
$2.1 million (16%) during the third quarter and $2.4 million (6%)
during the first nine months of 1998 from the comparable 1997
periods due primarily to an increase in outstanding indebtedness.
19
AMERICAN FINANCIAL GROUP, INC. 10-Q
Management's Discussion and Analysis
of Financial Condition and Results of Operations - Continued
New Accounting Standard to be Implemented Statement of Position
98-5, "Reporting on the Costs of Start-Up Activities," was issued
during the second quarter of 1998. The SOP is effective for
fiscal years beginning after December 15, 1998, and requires that
costs of start-up activities be expensed as incurred. The SOP
requires that unamortized balances of previously deferred costs be
expensed no later than the first quarter of 1999 and reported as
the cumulative effect of a change in accounting principle. AAG
had approximately $8 million in capitalized start-up costs at
September 30, 1998.
In June 1998, the Financial Accounting Standards Board issued SFAS
No. 133, "Accounting for Derivative Instruments and Hedging
Activities," which is required to be implemented for fiscal years
beginning after June 15, 1999. Management does not anticipate
that implementation of the new statement will have a significant
effect on AFG's earnings or its financial position.
20
AMERICAN FINANCIAL GROUP, INC. 10-Q
PART II
OTHER INFORMATION
Item 6
Exhibits and Reports on Form 8-K
(a) Exhibit 27.1 - Financial Data Schedule as of September 30, 1998.
For submission in electronic filing only.
(b) Reports on Form 8-K:
Date of Report Item Reported
September 21, 1998 Agreement to sell Commercial Lines Division
Signature
Pursuant to the requirements of the Securities Exchange Act of
1934, American Financial Group, Inc. has duly caused this Report
to be signed on its behalf by the undersigned duly authorized.
American Financial Group, Inc.
November 12, 1998 BY: Fred J. Runk
Fred J. Runk
Senior Vice President and Treasurer
21
5
1,000
9-MOS
DEC-31-1998
SEP-30-1998
$412,411
11,288,545
754,855
0
0
0
0
0
15,605,305
0
639,895
0
0
61,046
1,727,674
15,605,305
0
3,086,428
0
0
254,616
0
42,878
261,347
97,464
163,883
0
(763)
0
$163,120
2.66
2.62
Includes an investment in investee corporation of $233 million.
