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 EndedSeptember 30, 2007
Commission File
AMERICAN FINANCIAL GROUP, INC.
Incorporated underthe Laws of Ohio
IRS Employer I.D.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) ofthe Securities Exchange Act of 1934 during the preceding 12 months, and (2) has been subject to such filing requirementsfor the past 90 days. Yes X No
Indicate by check mark whether the Registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer: Large Accelerated Filer X Accelerated Filer Non-Accelerated Filer
Indicate by check mark whether the Registrant is a shell company. Yes No X
As of November 1, 2007, there were 115,415,620 shares of the Registrant's Common Stock outstanding, excluding14.9 million shares owned by subsidiaries.
TABLE OF CONTENTS
Page
AMERICAN FINANCIAL GROUP, INC. 10-Q
PART I
ITEM I - FINANCIAL STATEMENTS
AMERICAN FINANCIAL GROUP, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEET (unaudited)
(Dollars In Millions)
September 30,
December 31,
2007
2006
Assets:
Cash and cash equivalents
$ 729.2
$ 1,329.0
Investments:
Fixed maturities:
Available for sale - at fair value
(amortized cost - $15,254.0 and $14,663.0)
15,114.7
14,624.3
Trading - at fair value
275.9
276.4
Equity securities - at fair value
(cost - $958.0 and $606.4)
1,031.2
729.4
Mortgage loans
346.5
264.5
Policy loans
269.9
267.1
Real estate and other investments
285.7
248.3
Total cash and investments
18,053.1
17,739.0
Recoverables from reinsurers and prepaid
reinsurance premiums
3,703.5
3,625.2
Agents' balances and premiums receivable
811.6
599.4
Deferred policy acquisition costs
1,382.9
1,266.9
Other receivables
463.3
425.0
Variable annuity assets (separate accounts)
717.1
700.5
Prepaid expenses and other assets
779.9
577.3
Goodwill
204.5
167.8
$26,115.9
$25,101.1
Liabilities and Capital:
Unpaid losses and loss adjustment expenses
$ 6,216.8
$ 6,027.7
Unearned premiums
1,892.0
1,653.9
Annuity benefits accumulated
9,978.5
9,456.7
Life, accident and health reserves
1,472.2
1,414.7
Payable to reinsurers
411.5
314.9
Long-term debt
897.2
921.0
Variable annuity liabilities (separate accounts)
Accounts payable, accrued expenses and other
liabilities
1,422.1
1,398.9
Total liabilities
23,007.4
21,888.3
Minority interest
95.6
283.9
Shareholders' Equity:
Common Stock, no par value
- 200,000,000 shares authorized
- 115,530,808 and 119,303,928 shares outstanding
115.5
119.3
Capital surplus
1,202.1
1,220.5
Retained earnings
1,695.4
1,533.6
Accumulated other comprehensive income (loss),
net of tax
(.1
55.5
Total shareholders' equity
3,012.9
2,928.9
2
CONSOLIDATED STATEMENT OF EARNINGS (unaudited)
(In Millions, Except Per Share Data)
Three months ended
Nine months ended
Income:
Property and casualty insurance premiums
$ 757.5
$ 730.9
$2,030.8
$1,925.0
Life, accident and health premiums
105.6
91.7
315.6
249.3
Investment income
252.7
233.1
747.5
698.5
Realized gains (losses) on securities
(7.1)
(2.4)
11.6
19.9
Other income
86.1
83.2
260.8
234.9
1,194.8
1,136.5
3,366.3
3,127.6
Costs and Expenses:
Property and casualty insurance:
Losses and loss adjustment expenses
436.0
424.8
1,117.7
1,135.3
Commissions and other underwriting
expenses
219.7
225.3
638.4
567.2
Annuity benefits
94.5
88.4
273.7
255.2
Life, accident and health benefits
87.1
69.1
258.0
203.3
Annuity and supplemental insurance
acquisition expenses
40.0
38.2
125.2
102.0
Interest charges on borrowed money
17.8
18.3
53.6
53.9
Other operating and general expenses
115.9
115.1
408.5
337.0
1,011.0
979.2
2,875.1
2,653.9
Operating earnings before income taxes
183.8
157.3
491.2
473.7
Provision for income taxes
62.9
56.5
172.0
157.8
Net operating earnings
120.9
100.8
319.2
315.9
Minority interest expense
(7.8)
(6.7)
(26.4)
(21.7)
Equity in net losses of investee,
(.4
(.6
(1.2
(1.6
Earnings from continuing operations
112.7
93.5
291.6
292.6
Discontinued operations, net of tax
-
1.7
25.3
Net Earnings
$ 112.7
$ 93.5
$ 293.3
$ 317.9
Basic earnings per Common Share:
Continuing operations
$ .96
$ .79
$2.46
$2.49
Discontinued operations
.01
.21
Net earnings available to Common Shares
$2.47
$2.70
Diluted earnings per Common Share:
$ .93
$ .77
$2.39
$2.43
$2.40
$2.64
Average number of Common Shares:
Basic
117.6
118.1
118.9
117.8
Diluted
119.8
120.6
121.6
120.1
Cash dividends per Common Share
$.10
$.092
$.30
$.275
3
CONSOLIDATED STATEMENT OF CHANGES IN SHAREHOLDERS' EQUITY (unaudited)
(Dollars in Millions)
Accumulated
Common Stock
Other
Common
and Capital
Retained
Comprehensive
Shares
Surplus
Earnings
Income (Loss)
Total
Balance at December 31, 2006
119,303,928
$1,339.8
$1,533.6
$ 55.5
$2,928.9
Cumulative effect of accounting change
(14.9)
Net earnings
293.3
Other comprehensive income, net of tax:
Change in unrealized gain (loss)
on securities
(71.1)
Change in foreign currency translation
20.6
Change in unrealized pension and other
postretirement benefits
2.9
Total comprehensive income
245.7
Dividends on Common Stock
(35.8)
Shares issued:
Exercise of stock options
641,460
14.9
Dividend reinvestment plan
126,523
4.0
Employee stock purchase plan
29,112
1.0
Deferred compensation distributions
31,863
1.1
Directors fees paid in stock
9,965
.4
Stock incentive plan
114,594
3.9
Other stock-based compensation expense
7.1
Shares acquired and retired
(4,700,139)
(53.2)
(80.2)
(133.4)
Shares tendered in option exercises
(26,498)
(.3)
(.6)
(.9)
Effect of minority interest repurchased
(8.0)
Capital transactions of subsidiaries
(1.1
Balance at September 30, 2007
115,530,808
$1,317.6
($ .1)
$3,012.9
Balance at December 31, 2005
117,101,271
$1,272.7
$1,134.1
$ 50.8
$2,457.6
317.9
Change in unrealized gain on securities
(30.7)
(30.7
287.2
(32.4)
1,541,427
35.8
145,243
3.8
27,206
.8
63,162
1.6
12,780
(217,953)
(3.8)
(6.2)
Stock-based compensation expense
5.1
1.9
4.6
Balance at September 30, 2006
118,673,136
$1,324.3
$1,415.8
$ 20.1
$2,760.2
4
CONSOLIDATED STATEMENT OF CASH FLOWS (UNAUDITED)
(In Millions)
Operating Activities:
Adjustments:
Equity in net losses of investee
1.2
26.7
27.5
Depreciation and amortization
139.7
120.7
Realized gains on investing activities
(26.9)
(82.8)
Net purchases/sales of trading securities
(34.8)
(10.8)
Deferred annuity and life policy acquisition costs
(154.6)
(114.6)
Increase in reinsurance and other receivables
(321.1)
(503.6)
Decrease (increase) in other assets
(177.9)
48.8
Increase in insurance claims and reserves
483.8
546.2
Increase in payable to reinsurers
96.6
181.0
Increase (decrease) in other liabilities
10.3
(6.8)
Other, net
11.0
17.4
Net cash provided by operating activities
621.0
797.7
Investing Activities
Purchases of and additional investments in:
Fixed maturity investments
(2,894.6)
(1,872.0)
Equity securities
(416.4)
(264.7)
Subsidiaries
(239.7)
(207.0)
Real estate, property and equipment
(25.0)
(36.9)
Maturities and redemptions of fixed maturity investments
1,125.5
708.5
Sales of:
1,164.1
1,176.9
125.4
185.9
Subsidiary
37.5
24.0
36.2
Decrease (increase) in securities lending collateral
11.2
(159.2)
Cash and cash equivalents of businesses
acquired or sold, net
201.9
Increase in other investments
(108.5
(38.7
Net cash used in investing activities
(1,234.0
(231.6
Financing Activities
Annuity receipts
1,204.5
914.3
Annuity surrenders, benefits and withdrawals
(1,057.3)
(898.6)
Net transfers from variable annuity assets
51.3
Additional long-term borrowings
142.0
117.5
Reductions of long-term debt
(167.5)
Increase (decrease) in securities lending obligation
(11.2)
159.2
Issuances of Common Stock
14.5
27.9
Repurchases of Common Stock
Cash dividends paid on Common Stock
(31.7)
(28.6)
2.0
Net cash provided by financing activities
13.2
101.9
Net Increase (Decrease) in Cash and Cash Equivalents
(599.8)
668.0
Cash and cash equivalents at beginning of period
1,329.0
471.8
Cash and cash equivalents at end of period
$1,139.8
5
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
_________________________________________________________________________________
INDEX TO NOTES
A.
F.
B.
G.
H.
C.
I.
D.
J.
E.
________________________________________________________________________________
Basis of Presentation
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.
Stock Split
Investments
Gains or losses on securities are determined on the specific identification basis. When a decline in the value of a specific investment is considered to be other than temporary at the balance sheet date, a provision for impairment is charged to earnings (included in realized gains) and the cost basis of that investment is reduced.
Certain AFG subsidiaries loan fixed maturity and equity securities to other institutions for short periods of time. The borrower is required to provide collateral on which AFG earns investment income, net of a fee to the lending
6
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
agent. AFG records the collateral held (included in other assets) and the liability to return the collateral (included in other liabilities) in its Balance Sheet at fair value. The securities loaned remain a recorded asset on AFG's Balance Sheet. At September 30, 2007, the fair value of collateral held was approximately $147 million and the fair value of securities loaned plus accrued interest was approximately $145 million.
Derivatives
The terms of the interest rate swaps match those of the debt; therefore, the swaps are considered to be (and are accounted for as) 100% effective fair value hedges. Both the swaps and the hedged debt are adjusted for changes in fair value by offsetting amounts. Accordingly, since the swaps are included with long-term debt in the Balance Sheet, the only effect on AFG's financial statements is that the interest expense on the hedged debt is recorded based on the variable rate.
Reinsurance
Certain annuity and supplemental insurance subsidiaries cede life insurance policies to a third party on a funds withheld basis whereby the subsidiaries retain the assets (securities) associated with the reinsurance contracts. Interest is credited to the reinsurer based on the actual investment performance of the retained assets. These reinsurance contracts are considered to contain embedded derivatives (that must be adjusted to fair value) because the yield on the payables is based on specific blocks of the ceding companies' assets, rather than the overall creditworthiness of the ceding company. AFG determined that changes in the fair value of the underlying portfolios of fixed maturity securities is an appropriate measure of the value of the embedded derivative. The securities related to these transactions are classified as "trading." The adjustment to fair value on the embedded derivatives offsets the investment income recorded on the adjustment to fair value of the related trading portfolios.
7
Deferred Policy Acquisition Costs ("DPAC")
DPAC related to annuities and universal life insurance products 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. 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. DPAC related to annuities is also adjusted, net of tax, for the change in amortization that would have been recorded if the unrealized gains (losses) from securities had actually been realized. This adjustment is included in unrealized gains on marketable securities, a component of "Accumulated Other Comprehensive Income (Loss), net of tax" in the shareholders' equity section of the Balance Sheet.
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. DPAC includes the present value of future profits on business in force of insurance companies acquired by AFG's annuity and supplemental insurance business, which 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. The present value of future profits 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.
Unpaid Losses and Loss Adjustment Expenses
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
8
estimates, management believes that the liabilities for unpaid losses and loss adjustment expenses are adequate.
Annuity Benefits Accumulated
Life, Accident and Health Reserves
Variable Annuity Assets and Liabilities
Premium Recognition
Minority Interest
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. Deferred tax assets are recognized if it is more likely than not that a benefit will be realized.
AFG records a liability for the inherent uncertainty in quantifying its income tax provisions. Interest and penalties related to these unrecognized tax benefits are recognized as a component of tax expense.
AFG implemented FASB Interpretation No. 48, "Accounting for Uncertainty in Income Taxes (an interpretation of FASB Statement No. 109)" ("FIN 48") on January 1, 2007. FIN 48 sets forth criteria for recognition and measurement of tax positions taken or expected to be taken in a tax return. FIN 48 requires that companies recognize the impact of a tax position if that position is more likely than not of being sustained on audit, based on the technical merits of
9
the position. FIN 48 also provides guidance on derecognition, classification, interest, penalties, accounting in interim periods and disclosure. The cumulative effect of applying FIN 48 was recorded as a reduction to retained earnings at January 1, 2007 and is shown separately in the Statement of Changes in Shareholders' Equity. See Note G - "Income Taxes."
Stock-Based Compensation
Benefit Plans
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
Adjustments to net earnings:
Dilution of majority-owned subsidiaries
($0.1)
($0.4)
($1.0)
($0.9)
Assumed issuance of shares under
deferred compensation plan
(0.6)
(0.8)
Adjustments to weighted average common shares:
Stock-based compensation plans
2.3
2.5
2.7
AFG's weighted average diluted shares outstanding excludes the following anti-dilutive potential common shares related to stock compensation plans: third quarter of 2007 and 2006 - 2.5 million and 1.8 million; nine months of 2007 and 2006 - 1.1 million and 1.6 million.
Statement of Cash Flows
10
Great American Financial Resources
Ceres Group, Inc.
Chatham Bars Inn
Old Standard Life Fixed Annuity Business
Great American Life Assurance Company of Puerto Rico
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, trucks and recreational vehicles, inland and ocean marine, agricultural-related products and other property coverages, (ii) Specialty casualty, which includes primarily excess and surplus, general liability, executive and professional liability and customized programs for small to mid-sized businesses, (iii) Specialty financial, which includes risk management insurance programs for lending and leasing institutions, surety and fidelity products and trade credit insurance, and (iv) California workers' compensation. AFG's annuity and supplemental insurance business markets traditional fixed, indexed and variable annuities and a variety of supplemental insurance products. AFG's reportable segments and their components were determined based primarily upon si milar economic characteristics, products and services.
11
The following tables (in millions) show AFG's revenues and operating earnings before income taxes by significant business segment and sub-segment.
Revenues
Premiums earned:
Specialty
Property and transportation
$ 350.1
$ 322.4
$ 817.5
$ 747.5
Specialty casualty
206.6
207.6
630.0
593.1
Specialty financial
125.1
110.6
351.9
304.2
California workers' compensation
57.1
69.6
178.6
222.8
18.4
20.3
52.3
55.9
Other lines
.2
.5
1.5
757.5
730.9
2,030.8
1,925.0
89.6
79.8
260.3
240.5
Realized gains (losses)
(4.6)
1.4
28.7
50.3
45.9
149.6
143.8
892.8
858.0
2,445.8
2,338.0
Annuity and supplemental insurance:
161.2
151.7
479.5
452.4
(2.8)
(7.9)
33.1
33.0
92.0
79.3
293.7
273.6
890.9
773.1
8.3
4.9
29.6
16.5
$1,194.8
$1,136.5
$3,366.3
$3,127.6
Operating Earnings Before Income Taxes
Underwriting:
$ 58.5
$ 40.4
$ 123.2
$ 113.6
39.0
44.0
165.3
87.0
8.2
(24.1)
22.5
(22.7)
12.8
37.9
54.1
Other (a)
(13.7)
(3.4)
(26.1)
(3.1)
Other lines (b)
(3.0
(1.4
(48.1
(6.4
101.8
80.8
274.7
222.5
Investment income, realized gains
and other
74.7
70.9
231.5
244.0
176.5
506.2
466.5
23.3
30.8
89.4
78.9
Other (c)
(16.0
(25.2
(104.4
(71.7
$ 183.8
$ 157.3
$ 491.2
$ 473.7
(a) Includes charges of $11.3 million in the third quarter of 2007 and $24.8 million
for the first nine months of 2007 to adjust a retroactive reinsurance gain.
(b) Includes a second quarter 2007 charge of $44.2 million to increase asbestos
and environmental reserves.
(c) Includes holding company expenses and a second quarter 2007 charge of
$41 million related to asbestos and environmental liabilities at former
railroad and manufacturing operations.
12
Included in deferred policy acquisition costs in AFG's Balance Sheet are $73.5 million and $95.0 million at September 30, 2007, and December 31, 2006, respectively, representing the present value of future profits ("PVFP") related to acquisitions by AFG's annuity and supplemental insurance business. In the second quarter of 2007, PVFP was reduced by $12.3 million due to a refinement of the purchase price allocation for the August 2006 Ceres acquisition. The PVFP amounts are net of $80.0 million and $70.5 million of accumulated amortization. Amortization of the PVFP was $1.9 million in the third quarter and $9.5 million during the first nine months of 2007 and $2.8 million in the third quarter and $6.1 million in the first nine months of 2006, respectively. The increase in amortization for the first nine months of 2007 compared to the 2006 period reflects the acquisition of Ceres.
Direct obligations of AFG:
7-1/8% Senior Debentures due April 2009
$173.1
$182.9
Senior Convertible Notes due June 2033
189.7
7-1/8% Senior Debentures due February 2034
115.0
7-1/8% Senior Debentures due December 2007
59.5
3.7
541.0
550.9
Obligations of AAG Holding (guaranteed by AFG):
7-1/2% Senior Debentures due November 2033
112.5
7-1/4% Senior Debentures due January 2034
86.3
6-7/8% Senior Notes due June 2008
28.5
31.5
Borrowings under bank credit facility
16.0
Notes payable secured by real estate
67.6
67.8
American Premier Underwriters 10-7/8% Subordinated
Notes due May 2011
8.0
8.1
6.9
321.2
313.1
Payable to Subsidiary Trusts:
AAG Holding 7.35% Subordinated Debentures due
May 2033
20.0
AAG Holding 8-7/8% Subordinated Debentures
22.0
National Interstate Variable Rate Subordinated
Debentures due May 2033
15.0
35.0
57.0
$897.2
$921.0
At September 30, 2007, scheduled principal payments on debt for the balance of 2007 and the subsequent five years were as follows: 2007 - $60.4 million; 2008 - $29.2 million; 2009 - $174.6 million; 2010 - $2.8 million; 2011 - $25.1 million; and 2012 - $1.4 million.
13
As shown below (in millions), the majority of AFG's long-term debt is unsecured obligations of the holding company and its subsidiaries:
Unsecured obligations
$829.6
$853.2
Obligations secured by real estate
On March 1, 2007, GAFRI's wholly-owned subsidiary, AAG Holding, used funds borrowed under the bank credit facility to redeem its $22 million in outstanding 8-7/8% Subordinated Debentures for $22.9 million.
In March 2006, AFG and AAG Holding replaced their existing credit agreements with a five-year revolving credit facility under which they can borrow a combined $500 million. Amounts borrowed bear interest at rates ranging from 0.5% to 1.25% over LIBOR based on AFG's credit rating. At September 30, 2007, AAG Holding had $16 million in borrowings outstanding under the credit facility (interest rate of 6.3% at September 30, 2007).
To achieve a desired balance between fixed and variable rate debt, AAG Holding has entered into interest rate swaps that effectively convert its 6-7/8% fixed rate Senior Notes to a floating rate of 3-month LIBOR plus 2.9%.
AFG's Senior Convertible Notes were issued at a price of 37.153% of the principal amount due at maturity. Interest is payable semiannually at a rate of 4% of issue price per year through June 2008, after which interest at 4% annually will be accrued and added to the carrying value of the Notes. The Notes are redeemable at AFG's option at any time on or after June 2, 2008, at accreted value ranging from $371.53 per Note to $1,000 per Note at maturity. Generally, holders may convert each Note into 17.2524 shares of AFG Common Stock (at $21.53 per share currently) (i) if the average market price of AFG Common Stock to be received upon conversion exceeds 120% of the accreted value ($25.84 per share currently) for a specified period, (ii) if the credit rating of the Notes is significantly lowered, or, (iii) if AFG calls the notes for redemption. Based on the market price of AFG's Common Stock during the quarter ended September 30, 2007, t he Notes are currently convertible through December 31, 2007. AFG has delivered cash in lieu of Common Stock upon conversion of the Notes and intends to continue to do so. Accordingly, shares issuable upon conversion of the Notes are not included in AFG's calculation of diluted earnings per share.
During the first nine months of 2007, AFG repurchased 4.7 million shares of its Common Stock for approximately $133 million.
Accumulated Other Comprehensive Income (Loss), Net of Tax
Net unrealized gain (loss) on securities
($29.1)
$50.7
Foreign currency translation adjustment
24.9
4.3
Unrealized pension and other postretirement benefits
4.1
Total accumulated other comprehensive income (loss)
$55.5
14
Stock Incentive Plans
AFG uses the Black-Scholes option pricing model to calculate the "fair value" of its option grants. Expected volatility is based on historical volatility (after consideration of other factors). The weighted average fair value of options granted during 2007 was $9.73 per share based on the following assumptions: expected dividend yield - 1.3%; expected volatility - 22%; expected term - 6 1/2 years; risk-free rate - 4.6%.
Total compensation expense related to stock incentive plans of AFG and its subsidiaries was as follows: third quarter of 2007 and 2006 - $2.5 million and $2.6 million; nine months of 2007 and 2006 - $13.2 million and $7.4 million, respectively. Stock-based compensation expense for the first nine months of 2007 includes $3.9 million in first quarter non-deductible stock awards.
As of January 1, 2007, AFG's 2004, 2005 and 2006 tax years remain subject to examination by the IRS. In addition, AFG has several tax years for which there are ongoing disputes. AFG has subsidiaries in various states, cities and provinces that are currently under audit for years ranging from 1995 through 2004. In April 2007, AFG signed a settlement agreement with a municipality. As a result of this settlement, AFG reduced its liability for unrecognized income tax benefits by $5.7 million ($3.7 million net of federal tax effect) in the second quarter of 2007.
15
CONDENSED CONSOLIDATING BALANCE SHEET
(In millions)
AAG
All Other
Cons
September 30, 2007
AFG
GAFRI
Holding
Subs
Entries
Consolidated
Cash and investments
$ 51.4
$ 23.0
$ .4
$17,980.1
($ 1.8)
$18,053.1
Recoverables from reinsurers and
prepaid reinsurance premiums
Other assets
12.6
21.9
6.7
2,108.1
15.5
2,164.8
Investment in subsidiaries and
affiliates
3,696.4
1,108.0
1,235.4
1,868.8
(7,908.6
$3,760.4
$1,152.9
$1,242.5
$27,855.0
($7,894.9)
Unpaid losses, loss adjustment expenses
and unearned premiums
$ -
$ 8,108.8
Annuity, life, accident and health
benefits and reserves
11,456.1
(5.4)
11,450.7
335.4
91.9
(71.9)
Other liabilities
206.5
316.3
110.8
2,284.2
(271.5
2,646.3
317.1
446.2
21,941.0
(348.8)
23,103.0
835.8
796.3
5,914.0
(7,546.1
December 31, 2006
$ 223.6
$ 16.9
$17,501.8
($ 3.3)
$17,739.0
12.7
24.7
5.8
1,777.1
1,870.6
3,412.0
1,113.3
1,256.8
1,824.4
(7,606.5
$3,648.3
$1,154.9
$1,262.6
$26,594.8
($7,559.5)
$ 7,681.6
10,876.5
(5.1)
10,871.4
396.8
96.8
(124.3)
168.5
80.1
112.8
2,115.6
221.2
2,698.2
719.4
80.9
509.6
20,770.5
91.8
22,172.2
1,074.0
753.0
5,824.3
(7,651.3
16
CONDENSED CONSOLIDATING INCOME STATEMENT
FOR THE THREE MONTHS ENDED
SEPTEMBER 30, 2007
Income
(.2)
(11.8)
Investment and other income
1.8
349.2
(16.1)
338.8
Equity in earnings of subsidiaries
194.9
26.2
10.0
(253.0
200.4
25.6
1,210.5
(267.9)
Insurance benefits and expenses
877.3
19.2
8.8
(14.5)
Other expenses
2.8
124.3
25.0
3.0
9.9
994.1
(12.6
1,019.4
Earnings before income taxes
175.4
22.6
16.3
216.4
(255.3)
62.7
6.1
66.3
(74.2
$112.7
$16.5
$ 14.5
$ 150.1
($181.1)
FOR THE NINE MONTHS ENDED
2.6
5.4
7.2
14.0
1,034.3
(43.8)
1,008.3
540.0
83.0
106.9
36.8
(766.7
549.8
96.7
103.5
3,422.9
(806.6)
2,413.0
56.9
.3
27.6
12.0
(43.2)
30.0
9.4
385.5
9.0
436.8
86.9
9.7
30.5
2,810.5
(34.2
2,903.4
462.9
73.0
612.4
(772.4)
171.3
21.1
196.7
(245.4
Income from continuing operations
59.4
51.9
415.7
(527.0)
(3.8
$293.3
$61.3
$ 51.9
$ 417.6
($530.8)
17
SEPTEMBER 30, 2006
.1
(2.3)
.7
(0.1)
318.0
(11.1)
174.9
34.5
15.4
(249.8
175.5
34.4
1,153.7
(260.2)
845.8
13.6
0.1
10.2
(9.7)
12.3
2.4
102.3
3.3
122.8
25.9
952.2
986.9
21.8
201.5
(253.8)
56.1
10.7
7.6
68.6
(86.9
$19.8
$ 14.2
$ 132.9
($166.9)
(1.4)
22.4
5.0
(2.2)
950.9
(42.9)
933.4
535.4
64.8
148.1
65.1
(813.4
539.5
86.0
145.9
3,212.7
(856.5)
2,263.0
56.0
30.7
34.0
7.5
300.6
12.2
361.2
90.0
37.6
2,573.6
2,678.1
449.5
78.4
108.3
639.1
(825.8)
156.9
27.4
38.0
205.7
(271.1
51.0
70.3
433.4
(554.7)
31.0
(62.0
$317.9
$82.0
$ 70.3
$ 464.4
($616.7)
18
CONDENSED CONSOLIDATING STATEMENT OF CASH FLOWS
$ 61.3
($ 530.8)
Equity in net earnings of subsidiaries
(350.6)
(58.4)
(74.8)
(36.8)
520.6
Capital contribution from parent
(to subsidiary)
(4.0)
(198.8)
198.8
Dividends from subsidiaries (to parent)
(112.8)
(279.3)
Other adjustments, net
(224.4
239.3
303.0
327.7
Net cash provided by (used in)
operating activities
(41.7
191.5
Investing Activities:
Purchase of investments, property and
equipment
(4.8)
(3,348.5)
17.3
(3,336.0)
Purchase of subsidiaries
(237.8)
(1.7)
Maturities and redemptions of fixed
maturity investments
32.2
1,143.7
(55.4)
Sale of investments, property and
71.8
1,241.7
(17.3)
1,313.5
(97.3
investing activities
(188.3
(1,062.1
(55.4
Financing Activities:
Annuity surrenders, benefits and
withdrawals
50.0
(60.5)
(.1)
(154.3)
55.4
13.5
(31.7
3.2
(12.4
(40.9
financing activities
(162.1
3.1
(62.3
179.1
Net increase (decrease) in cash and
cash equivalents
(132.0)
6.3
(474.5)
Cash and cash equivalents at beginning
of period
146.0
1,180.2
$ 14.0
$ 9.1
$ 705.7
19
$ 82.0
$70.3
(365.2)
(73.5)
(96.3)
(65.1)
600.1
(2.5)
(92.6)
92.6
271.7
(63.7)
(210.5)
40.5
12.5
(1.3
16.6
479.8
(6.8
200.1
602.8
(.4)
(2,173.2)
(2,173.6)
(204.4)
(2.6)
Proceeds received from sale of subsidiary
19.4
687.9
Cash and short-term investments of
businesses acquired, net
45.3
37.0
1,316.7
1,399.0
(197.9
64.3
(128.7
(167.2
65.0
52.5
(45.8)
(68.9)
(66.9)
(25.4)
(28.5
155.4
130.0
(46.4
(65.8
(1.9
216.0
11.1
5.6
(0.3)
651.6
20.9
7.9
0.3
442.7
$ 32.0
$ 13.5
$1,094.3
20
ITEM 2
Management's Discussion and Analysis
of Financial Condition and Results of Operations
INDEX TO MD&A
Forward-Looking Statements
21
Results of Operations
27
Overview
General
Critical Accounting Policies
22
Income Items
Liquidity and Capital Resources
23
Expense Items
31
Sources of Funds
Recent Accounting Standards
32
24
Proposed Accounting Standards
33
Uncertainties
_____________________________________________________________________________________________________
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", "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 and investment activities; recoverability of asset values; expected losses and the adequacy of reserves for asbestos, environmental pollution and mass tort claims; rate increases; and improved loss experience.
Actual results could differ materially from those contained in or implied by such forward-looking statements for a variety of factors including:
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 best done on a parent only basis while others are best done on a total enterprise basis. In
of Financial Condition and Results of Operations - Continued
addition, because most of its businesses are financial in nature, AFG does not prepare its consolidated financial statements using a current-noncurrent format. Consequently, certain traditional ratios and financial analysis tests are not meaningful.
At September 30, 2007, AFG (parent) had approximately $49 million in cash and securities and no amounts borrowed under the bank line of credit. AAG Holding had $16 million borrowed under this line at September 30, 2007.
Through the operations of its subsidiaries, AFG is engaged primarily in property and casualty insurance, and in the sale of traditional fixed, indexed and variable annuities and a variety of supplemental insurance products.
AFG's net earnings for the third quarter and first nine months of 2007 were $112.7 million ($.93 per share, diluted) and $293.3 million ($2.40 per share, diluted), respectively, compared to $93.5 million ($.77 per share, diluted) and $317.9 million ($2.64 per share) reported in the same periods of 2006. The improvement for the third quarter reflects higher earnings from the property and casualty insurance operations.
For the nine months, higher earnings from the ongoing property and casualty operations were more than offset by lower gains from sales of real estate, and the effect of charges to strengthen reserves for asbestos and other environmental exposures ("A&E") within the property and casualty insurance run-off operations and A&E reserves related to former railroad and manufacturing operations.
CRITICAL ACCOUNTING POLICIES
Significant accounting policies are summarized in Note A to the financial statements. The preparation of financial statements 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 make accounting policies critical are as follows:
For a discussion of these policies, see Management's Discussion and Analysis - "Critical Accounting Policies" in AFG's 2006 Form 10-K.
LIQUIDITY AND CAPITAL RESOURCES
Ratios
2005
$ 897
$ 921
$1,000
Total capital (*)
4,083
4,160
3,703
Ratio of debt to total capital:
Including debt secured by real estate
22.0%
22.1%
27.0%
Excluding debt secured by real estate
20.7%
20.9%
26.3%
(*) Includes long-term debt, minority interest and
shareholders' equity (excluding unrealized gains (losses)
related to fixed maturity investments).
AFG's ratio of earnings to fixed charges, including annuity benefits as a fixed charge, was 2.46 for the nine months ended September 30, 2007 and 2.62 for the entire year of 2006. Excluding annuity benefits, this ratio was 8.73 and 9.15, respectively. Although the ratio excluding interest on annuities is not required or encouraged to be disclosed under Securities and Exchange Commission rules, it is presented because interest credited to annuity policyholder accounts is not always considered a borrowing cost for an insurance company.
Parent Holding Company Liquidity
In March 2006, AFG and AAG Holding replaced their existing credit agreements with a five-year revolving credit facility under which they can borrow a combined $500 million. AAG Holding had $16 million in borrowings outstanding under this agreement at September 30, 2007, bearing interest at a rate of 6.3% at September 30, 2007.
During the first nine months of 2007, AFG repurchased 4.7 million shares of its common stock for approximately $133 million. AFG continued repurchasing its shares in the fourth quarter using cash on hand and borrowings under its bank line. Through November 7, AFG has repurchased an additional 1.2 million shares for approximately $36 million.
Under a currently effective shelf registration statement, AFG can offer additional equity or debt securities. The shelf registration provides AFG with greater flexibility to access the capital markets from time to time as market and other conditions permit.
Subsidiary Liquidity
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 provided more than sufficient funds to meet these requirements without requiring a sale of investments or contributions from AFG. 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.
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. With declining rates, AFG receives some protection (from spread compression) due to the ability to lower crediting rates, subject to guaranteed minimums. 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.
AFG believes its insurance subsidiaries maintain sufficient liquidity to pay claims and benefits and operating expenses, as well as meet commitments in the event of unforeseen events such as reserve deficiencies, inadequate premium rates or reinsurer insolvencies.
Approximately 94% of the fixed maturities held by AFG at September 30, 2007, 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 noninvestment grade. Management believes that a high quality investment portfolio should generate a stable and predictable investment return.
Since fixed maturities and stocks are carried at fair value in the balance sheet, there is virtually no effect on financial condition upon the sale and ultimate realization of unrealized gains and losses.
Summarized information for the unrealized gains and losses recorded in AFG's Balance Sheet at September 30, 2007, is shown in the following table (dollars in millions). Approximately $175 million of available for sale "Fixed maturities" had no unrealized gains or losses at September 30, 2007.
Securities
With
Unrealized
Gains
Losses
Available for Sale Fixed Maturities
Fair value of securities
$4,483
$10,457
Amortized cost of securities
$4,375
$10,704
Gross unrealized gain (loss)
$ 108
($ 247)
Fair value as % of amortized cost
102%
98%
Number of security positions
1,320
1,550
Number individually exceeding
$2 million gain or loss
1
Concentration of gains (losses) by type or
industry (exceeding 5% of unrealized):
Mortgage-backed securities
$24.5
($94.8)
Banks, savings and credit institutions
(48.6)
Insurance companies
5.7
(15.0)
Gas and electric services
(13.5)
Percentage rated investment grade
93%
95%
Approximately 99% of AFG's mortgage-backed securities are rated "AAA." At September 30, 2007, AFG owned $498 million (representing 3% of AFG's total fixed maturity portfolio) of mortgage-backed securities in which the underlying collateral is sub-prime mortgages. At that date, the net unrealized loss on these securities was approximately $11.3 million. The securities are collateralized by fixed-rate mortgages and have an overall average life of approximately 3 years. None of the securities have been subject to downgrades or "watch listing" by rating agencies. At September 30, 2007, AFG had no collateralized debt obligations secured by residential mortgages.
The table below sets forth the scheduled maturities of AFG's available for sale fixed maturity securities at September 30, 2007, based on their fair values. Asset-backed securities and other 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.
Maturity
One year or less
3%
After one year through five years
39
After five years through ten years
29
35
After ten years
80
63
37
100
25
The table below (dollars in millions) summarizes the unrealized gains and losses on fixed maturity securities by dollar amount.
Fair
Aggregate
Value as
% of Cost
Value
Gain (Loss)
Basis
Fixed Maturities at September 30, 2007
Securities with unrealized gains:
Exceeding $500,000 (32 issues)
$ 269
$ 27
111%
Less than $500,000 (1,288 issues)
4,214
81
102
$ 4,483
$108
Securities with unrealized losses:
Exceeding $500,000 (121 issues)
$ 2,264
($105)
96%
Less than $500,000 (1,429 issues)
8,193
( 142)
98
($247)
The following table summarizes (dollars in millions) the unrealized loss for all fixed maturity securities with unrealized losses by issuer quality and length of time those securities have been in an unrealized loss position.
Loss
Fixed Maturities with Unrealized
Losses at September 30, 2007
Investment grade with losses for:
One year or less (428 issues)
$ 3,443
($ 61)
Greater than one year (983 issues)
6,456
( 165)
$ 9,899
($226)
Non-investment grade with losses for:
One year or less (102 issues)
$ 371
($ 14)
Greater than one year (37 issues)
187
( 7)
96
$ 558
($ 21)
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 (accounted for as a realized loss) and the cost basis of that investment is reduced. The determination of whether unrealized losses are "other than temporary" requires judgment based on subjective as well as objective factors. A listing of factors considered and resources used is contained in the discussion of "Investments" under Management's Discussion and Analysis in AFG's 2006 Form 10-K.
Based on its analysis, management believes (i) AFG will recover its cost basis in the securities with unrealized losses and (ii) that AFG has the ability and intent to hold the securities until they mature or recover in value. Although AFG has the ability to continue holding its 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 with regard to 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
26
results of operations in a future period. Management believes it is not likely that future impairment charges will have a significant effect on AFG's liquidity.
RESULTS OF OPERATIONS
Operating earnings before income taxes for the third quarter of 2007 improved by $26.5 million (17%) compared to the 2006 quarter reflecting a $22.5 million improvement in Specialty property and casualty underwriting results.
Nine month pretax operating earnings improved by $17.5 million (4%) compared to the 2006 period. A $93.9 million improvement in Specialty property and casualty underwriting results was offset by second quarter 2007 charges of $44.2 million to strengthen reserves for A&E exposure within the property and casualty insurance run-off operations and $43.0 million to increase A&E reserves related to former railroad and manufacturing operations. Results for the nine months of 2007 also include $11.6 million in net realized gains on securities compared to $19.9 million in the 2006 period.
Property and Casualty Insurance - Underwriting
Performance measures such as underwriting profit or loss and related combined ratios are often used by property and casualty insurers to help users of their financial statements better understand the company's performance. See Note C - "Segments of Operations" for the detail of AFG's operating profit by significant business segment.
Underwriting profitability is measured by the combined ratio, which is a sum of the ratios of losses, loss adjustment expenses, underwriting expenses and policyholder dividends to premiums. A combined ratio under 100% is indicative of an underwriting profit. The combined ratio does not reflect investment income, other income or federal income taxes.
Premiums and combined ratios for AFG's property and casualty insurance operations were as follows (dollars in millions):
Gross Written Premiums (GAAP)
$ 775
$ 638
$1,519
$1,356
319
371
1,030
1,113
163
142
440
396
61
70
190
230
$1,319
$1,222
$3,180
$3,096
Net Written Premiums (GAAP)
$ 393
$ 332
$ 915
$ 831
195
238
620
646
131
116
367
313
56
66
178
217
55
58
$ 798
$ 770
$2,135
$2,065
Combined Ratios (GAAP)
83.3%
87.4%
85.0%
84.7%
81.1
78.7
73.7
85.3
93.4
121.8
93.6
107.5
77.5
63.6
75.7
Total Specialty
86.2
88.7
84.1
88.1
Aggregate (including discontinued
lines)
86.6%
88.9%
86.5%
88.4%
Net written premiums for the Specialty insurance operations increased 4% for the third quarter and 3% for the first nine months compared to the same periods in 2006. Premium growth has been impacted by significant rate declines in the California workers' compensation business and stronger competition in certain of the Specialty casualty group operations. Excluding California workers' compensation, the net written premiums of the other specialty groups grew 5% for the quarter and 6% for the nine months compared to the 2006 periods. Apart from rate decreases in the California workers' compensation business, average rate levels in AFG's other specialty operations were down about 2% through the first nine months of the year.
The Specialty insurance operations generated an underwriting profit of $104.8 million in the 2007 third quarter, $22.5 million higher than the same quarter a year earlier. This improvement was largely due to increased crop earnings due to favorable crop prices and yields. The results for the 2007 quarter include $25.8 million (3.4 points) of favorable reserve development compared to $27.6 million (3.8 points) of favorable development in the 2006 third quarter. Underwriting profit of the Specialty insurance operations was $322.8 million for the first nine months of 2007, 41% above the 2006 period, reflecting the positive impact of favorable reserve development within the Specialty casualty group and lower catastrophe losses. The results for the nine months of 2007 include $124.8 million (6.2 points) of favorable reserve development compared to $51.1 million (2.7 points) of favorable development in the 2006 period.
28
Property and transportation gross written premiums for the 2007 three and nine month periods were 22% and 12% higher than in the respective 2006 periods due primarily to growth in the crop operations. Net written premiums were 18% and 10% higher than the respective 2006 periods. These businesses reported an underwriting profit of $58.5 million in the 2007 third quarter, $18.1 million higher than the 2006 third quarter. The combined ratio for the quarter of 83.3% improved 4.1 points over the 2006 quarter due primarily to higher underwriting profits in the agricultural operations. These results were partially offset by higher underwriting losses in a run-off homebuilders' operation. Even though the combined ratio for the 2007 nine-month period is up slightly from the 2006 period, underwriting profit increased 8% due primarily to premium growth. The nine-month results include $33.6 million (4.1 points) of favorable reserve development compared to $31.9 million (4.3 points) in the 2006 peri od.
Specialty casualty gross written premiums for the 2007 three and nine month periods were down 14% and 8% compared to the respective 2006 periods due primarily to stronger competition in the excess and surplus lines and less activity in the construction market which affect the general liability coverages. Net written premiums were down 18% and 4% compared to the respective 2006 periods. This group reported a combined ratio of 81.1% for the 2007 third quarter, an increase of 2.4 points over the 2006 third quarter. The 2007 results include $16.0 million (7.7 points) of favorable reserve development compared to $10.0 million (4.8 points) in the same quarter a year earlier. Through the first nine months of 2007, this group's combined ratio improved 11.6 points compared with the same prior year period, primarily due to favorable reserve development in the general liability and excess and surplus lines. These operations have continued to generate excellent accident year underwriting results in 2007.
Specialty financial gross written premiums for the 2007 three and nine month periods were 14% and 11% higher than in the respective 2006 periods due primarily to growth in the financial institutions, lease and loan and surety operations, which was partially offset by lower premiums resulting from the run-off of the residual value insurance ("RVI") business. Net written premiums were 14% and 17% higher than the respective 2006 periods. The higher net premium growth rate for the nine months resulted from greater premium retention in the group's lease and loan operations. The 28.4 point improvement for the quarter and 13.9 point improvement for the nine months in the combined ratio compared to the 2006 periods reflect lower losses in the run-off RVI business and continued strong performance by the other businesses in this group. Excluding the effect of RVI, the group's combined ratio would have been 88.6% for the first nine months of 2007 compared to 93.7% for the comparable 2006 period. The adverse financial impact of RVI is expected to be substantially complete by the end of 2007.
California workers' compensation gross written premiums for the 2007 three and nine month periods were down 12% and 17% compared to the respective 2006 periods due to lower premium rates. These rate reductions averaged about 23% through the first nine months of the year, demonstrating the positive impact of reform in lowering workers' compensation costs in California. Net written premiums were down 14% and 18% compared to the respective 2006 periods. This business continues to report excellent profitability. The third quarter of 2007 includes 10.2 points of favorable prior year development while the 2006 third quarter includes 22.3 points of favorable development. Through the first nine months of 2007, the combined ratio increased 3.0 points compared to the 2006 period.
Year-to-date 2007 results include 8.8 points of favorable development compared to 7.5 points in the 2006 period. The improved claims environment resulting from the California workers' compensation reform legislation has continued to benefit this group's results as well as those of the industry. Due to the long-tail nature of this business, we have continued to be conservative in recognizing the benefits from the reform legislation until a higher percentage of claims are paid and the ultimate impact of reforms can be determined.
Asbestos and Environmental Reserve Charge
As a result of the study, AFG recorded a $44.2 million charge (net of reinsurance) in the second quarter of 2007 to increase the property and casualty group's asbestos reserves by $30.8 million and its environmental reserves by $13.4 million. At September 30, 2007, the property and casualty group's A&E reserves were $446.0 million, net of reinsurance recoverables. At that date, AFG's three year survival ratio was 17.0 times paid losses for the asbestos reserves and 11.1 times paid losses for the total A&E reserves. These ratios compare favorably with A.M. Best's most recent report on A&E survival ratios (March 2007) which were 9.0 for asbestos and 8.0 for total industry A&E reserves. Excluding amounts associated with the settlements of asbestos related coverage litigation for A.P. Green Industries (see "Legal Proceedings" in AFG's 2006 Form 10-K) and another large claim, AFG's three year survival ratio was 10.2 and 7.6 times paid losses for the asbestos reserves and total A&E reserves, respectively.
The primary causes of the increase
In addition to the property and casualty group, the study encompassed reserves for asbestos and environmental exposures of our former railroad and manufacturing operations. As a result of the study, AFG recorded a second quarter 2007 charge of $43.0 million (included in other expenses) to increase the A&E reserves related to these former operations. The $19.0 million increase in asbestos reserves was the result of increasing estimates of the cost of mesothelioma claims partially offset by lower estimated overall claim counts. The $24.0 million increase in environmental reserves was due primarily to increased clean up estimates at certain former railroad and manufacturing sites.
The study relied on a ground-up exposure analysis. With respect to asbestos, it considered products and non-products exposures, paid claims history, the pattern of new claims, settlements and projected development. The asbestos legal climate remains very difficult to predict. While some progress has been made in state asbestos tort reform and judicial rulings, that progress has been somewhat offset by increased claims costs, increased defense costs, the assertion of non-products theories and an expanding pool of plaintiffs and defendants.
30
Life, Accident and Health Premiums and Benefits
Investment Income
Realized Gains
Realized gains on securities include provisions for other than temporary impairment of securities as follows: third quarter of 2007 and 2006 - $18.2 million and $7.1 million; nine months of 2007 and 2006 - $29.5 million and $12.9 million, respectively.
Real Estate Operations
$17.3
$20.7
$64.8
$65.8
17.2
18.7
48.9
50.2
.9
Income from real estate operations includes net pretax gains on the sale of real estate assets of $12.7 million in the first nine months of 2007 compared to $14.2 million for the 2006 period.
Real Estate Operations - Discontinued
Other Income
Annuity Benefits
than surrendered), additional reserves are accrued for (i) persistency and premium bonuses and (ii) excess benefits expected to be paid for future deaths and annuitizations. Changes in crediting rates, actual surrender, death and annuitization experience or modifications in actuarial assumptions can affect these additional reserves. Significant changes in projected investment yields could result in charges (or credits) to earnings in the period the projections are modified.
Annuity benefits increased $6.1 million for the third quarter and $18.5 million the first nine months of 2007 compared to the 2006 periods, reflecting higher sales of fixed-indexed annuities.
Annuity and Supplemental Insurance Acquisition Expenses
The vast majority of the annuity and supplemental insurance group's DPAC asset relates to its fixed annuity, variable annuity and life insurance lines of business. Unanticipated spread compression, decreases in the stock market, adverse mortality experience and higher than expected lapse rates could lead to write-offs of DPAC or PVFP in the future.
Other Operating and General Expenses
In 2006, the FASB issued SFAS No. 157, "Fair Value Measurements," which defines and establishes a framework for measuring fair value and expands disclosures about fair value measurements. SFAS No. 157 is effective January 1, 2008, for calendar year companies; implementation is not expected to have a material effect on AFG's balance sheet or earnings.
In February 2007, the FASB issued SFAS No. 159, "The Fair Value Option for Financial Assets and Financial Liabilities," which permits entities to
irrevocably elect to report certain financial assets and liabilities (including most insurance contracts) at fair value and recognize the unrealized gains and losses on such items in earnings. SFAS No. 159 is effective January 1, 2008, for calendar year companies. AFG is currently evaluating whether it will elect the fair value option for any of its eligible assets or liabilities.
Convertible Notes
The FASB has proposed an amendment to SFAS No. 128, "Earnings per Share." Currently, SFAS No. 128 allows companies issuing securities that can be settled in cash or stock (such as AFG's convertible notes) to exclude the issuable shares from the calculation of diluted earnings per share when there is a stated intent and ability to deliver cash in lieu of stock upon settlement or conversion. The proposed statement would require companies to assume settlement in stock (despite the ability and intent to settle in cash) and include those shares in the calculation of diluted earnings per share.
_______________________________________________
ITEM 3
Quantitative and Qualitative Disclosure of Market Risk
As of September 30, 2007, there were no material changes to the information provided in Item 7A - "Quantitative and Qualitative Disclosure of Market Risk" of AFG's 2006 Form 10-K.
ITEM 4
Controls and Procedures
AFG's management, with participation of its Co-Chief Executive Officers and its 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 principal financial officer concluded that the controls and procedures are effective. There have been no changes in AFG's internal control over financial reporting during the third fiscal quarter of 2007 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 third fiscal quarter of 2007 that has materially affected, or is reasonably likely to materially affect, AFG's internal controls over financial reporting.
PART II
OTHER INFORMATION
ITEM 1
Legal Proceedings
As previously reported under "Legal Proceedings" in AFG's 2006 Form 10-K, Great American Insurance Company entered into an agreement in 2003, which was approved by the bankruptcy court, for the settlement of coverage litigation related to A.P. Green asbestos claims. The settlement is for $123.5 million (Great American has the option to pay in cash or over time with 5.25% interest). The agreement allows up to 10% of the settlement to be paid in AFG Common Stock. The settlement agreement is conditioned upon confirmation of a plan of reorganization that includes an injunction prohibiting the assertion against Great American of any present or future asbestos personal injury claims under policies issued to A.P. Green and related companies.
During the third quarter of 2007, the Bankruptcy Court confirmed the A.P. Green Plan of Reorganization which includes the injunction required by Great American's settlement agreement. Counsel for the Debtor notified Great American that it is likely that such confirmation will be appealed; Great American is not required to fund the settlement agreement until confirmation is final and non-appealable.
Unregistered Sales of Equity Securities and Use of Proceeds
Issuer Purchases of Equity Securities
Total Number
Maximum Number
of Shares
Purchased as
that May
Number
Average
Part of Publicly
Yet be Purchased
Price Paid
Announced Plans
Under the Plans
Period
Purchased
Per Share
or Programs
Or Programs (a)
3rd Quarter 2007
July
August
3,115,100
$27.08
6,039,500
September
729,100
$27.97
5,310,400
(a)
Represents the remaining shares that may be repurchased under the Plans authorized by AFG's Board of Directors in 2004 and 2007.
34
OTHER INFORMATION - CONTINUED
ITEM 6
Exhibits
Exhibit Description
First Supplemental Indenture among American Financial Group, Inc., AAG Holding Company, Inc., and U.S. Bank National Association, as trustee, with respect to the 7.35% Subordinated Debentures due 2033.
Third Supplement Indenture among American Financial Group, Inc., AAG Holding Company, Inc., and U.S. Bank National Association, (formerly known as Star Bank, N.A.) as trustee, with respect to the 6-7/8% Senior Notes due December 1, 2008, 7-1/2% Senior Note due November 5, 2033 and 7-1/4% Senior Notes due January 23, 2034.
Computation of ratios of earnings to fixed charges.
Certification of the Co-Chief Executive Officer pursuant
to section 302(a) of the Sarbanes-Oxley Act of 2002.
Certification of the Chief Financial Officer pursuant to
section 302(a) of the Sarbanes-Oxley Act of 2002.
Certification of the Co-Chief Executive Officers and Chief
Financial Officer pursuant to section 906 of the Sarbanes-
Oxley Act of 2002.
_____________________________________________________________
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 8, 2007
BY: s/Keith A. Jensen
Keith A. Jensen
Senior Vice President
(principal financial and
accounting officer)