American Financial Group - 10-Q quarterly report FY

UNITED STATES SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q


Quarterly Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934



For the Quarterly Period Ended March 31, 2011		Commission File No. 1-13653

AMERICAN FINANCIAL GROUP, INC.



Incorporated under the 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) of the Securities Exchange Act of 1934 during the preceding 12 months, and (2) has been subject to such filing requirements for the past 90 days.Yes þ No o

Indicate by check mark whether the Registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the Registrant was required to submit and post such files). Yes þ No o

Indicate by check mark whether the Registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer or a smaller reporting company:


Large Accelerated Filer þ		Accelerated Filer o		Non-Accelerated Filer o		Smaller Reporting Company o

Indicate by check mark whether the Registrant is a shell company. Yes o No þ

As of May 1, 2011, there were 103,449,744 shares of the Registrant’s Common Stock outstanding, excluding 14.9 million shares owned by subsidiaries.

AMERICAN FINANCIAL GROUP, INC.

TABLE OF CONTENTS


	Page

Part I — Financial Information

Item 1 — Financial Statements:

Consolidated Balance Sheet		2

Consolidated Statement of Earnings		3

Consolidated Statement of Changes in Equity		4

Consolidated Statement of Cash Flows		5

Notes to Consolidated Financial Statements		6

Item 2 — Management’s Discussion and Analysis of Financial Condition and Results of Operations		31

Item 3 — Quantitative and Qualitative Disclosure of Market Risk		47

Item 4 — Controls and Procedures		47

Part II - Other Information

Item 1 — Legal Proceedings		47

Item 2 — Unregistered Sales of Equity Securities and Use of Proceeds		48

Item 6 — Exhibits		48

Signatures		48

Exhibit 12
Exhibit 31.A
Exhibit 31.B
Exhibit 31.C
Exhibit 32
EX-101 INSTANCE DOCUMENT
EX-101 SCHEMA DOCUMENT
EX-101 CALCULATION LINKBASE DOCUMENT
EX-101 LABELS LINKBASE DOCUMENT
EX-101 PRESENTATION LINKBASE DOCUMENT
EX-101 DEFINITION LINKBASE DOCUMENT

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)


	March 31,		December 31,
	2011		2010
Assets:
Cash and cash equivalents	$	1,499	$	1,099
Investments:
Fixed maturities, available for sale at fair value (amortized cost — $18,755 and $18,490)		19,630		19,328
Fixed maturities, trading at fair value		397		393
Equity securities, at fair value (cost — $498 and $458)		743		690
Mortgage loans		551		468
Policy loans		258		264
Real estate and other investments		459		428

Total cash and investments		23,537		22,670

Recoverables from reinsurers		2,852		2,964
Prepaid reinsurance premiums		395		422
Agents’ balances and premiums receivable		520		535
Deferred policy acquisition costs		1,228		1,244
Assets of managed investment entities		2,570		2,537
Other receivables		407		674
Variable annuity assets (separate accounts)		635		616
Other assets		618		606
Goodwill		186		186


Total assets	$	32,948	$	32,454


Liabilities and Equity:
Unpaid losses and loss adjustment expenses	$	6,279	$	6,413
Unearned premiums		1,448		1,534
Annuity benefits accumulated		13,405		12,905
Life, accident and health reserves		1,668		1,650
Payable to reinsurers		228		320
Liabilities of managed investment entities		2,388		2,323
Long-term debt		949		952
Variable annuity liabilities (separate accounts)		635		616
Other liabilities		1,336		1,121

Total liabilities		28,336		27,834

Shareholders’ equity:
Common Stock, no par value - 200,000,000 shares authorized - 103,483,152 and 105,168,366 shares outstanding		103		105
Capital surplus		1,159		1,166
Retained earnings:
Appropriated — managed investment entities		162		197
Unappropriated		2,536		2,523
Accumulated other comprehensive income, net of tax		503		479

Total shareholders’ equity		4,463		4,470

Noncontrolling interests		149		150

Total equity		4,612		4,620


Total liabilities and equity	$	32,948	$	32,454

2

AMERICAN FINANCIAL GROUP, INC. 10-Q

AMERICAN FINANCIAL GROUP, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENT OF EARNINGS(UNAUDITED)

(In Millions, Except Per Share Data)


	Three months ended
	March 31,
	2011			2010
Revenues:
Property and casualty insurance premiums	$	599		$	579
Life, accident and health premiums		110			115
Investment income		300			295
Realized gains (losses) on:
Securities (*)		—			4
Subsidiaries		(3	)		—
Income (loss) of managed investment entities:
Investment income		25			22
Loss on change in fair value of assets/liabilities		(33	)		(25	)
Other income		41			44

Total revenues		1,039			1,034

Costs and Expenses:
Property and casualty insurance:
Losses and loss adjustment expenses		341			304
Commissions and other underwriting expenses		212			204
Annuity benefits		116			108
Life, accident and health benefits		96			96
Annuity and supplemental insurance acquisition expenses		53			49
Interest charges on borrowed money		21			18
Expenses of managed investment entities		18			9
Other operating and general expenses		87			99

Total costs and expenses		944			887


Operating earnings before income taxes		95			147
Provision for income taxes		46			59


Net earnings, including noncontrolling interests		49			88
Less: Net earnings (loss) attributable to noncontrolling interests		(34	)		(18	)


Net Earnings Attributable to Shareholders	$	83		$	106


Earnings Attributable to Shareholders per Common Share:
Basic	$	.80		$	.94

Diluted	$	.79		$	.93


Average number of Common Shares:
Basic		104.6			112.0
Diluted		106.2			113.1

Cash dividends per Common Share	$	.1625		$	.1375

(*) Consists of the following:
Realized gains before impairments	$	10		$	25

Losses on securities with impairment		(7	)		(14	)
Non-credit portion recognized in other comprehensive income (loss)		(3	)		(7	)

Impairment charges recognized in earnings		(10	)		(21	)


Total realized gains (losses) on securities	$	—		$	4

3

AMERICAN FINANCIAL GROUP, INC. 10-Q

AMERICAN FINANCIAL GROUP, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENT OF CHANGES IN EQUITY(UNAUDITED)

(Dollars in Millions)


				Shareholders’ Equity
				Common Stock									Accum.						Noncon-
	Common			and Capital			Retained Earnings						Other Comp						trolling			Total
	Shares			Surplus			Appro.			Unappro.			Inc. (Loss)			Total			Interests			Equity
Balance at December 31, 2010		105,168,366		$	1,271		$	197		$	2,523		$	479		$	4,470		$	150		$	4,620

Net earnings		—			—			—			83			—			83			(34	)		49
Other comprehensive income (loss), net of tax:
Change in unrealized gain (loss) on securities		—			—			—			—			17			17			—			17
Change in foreign currency translation		—			—			—			—			7			7			—			7

Total comprehensive income (loss)																	107			(34	)		73

Allocation of losses of managed investment entities		—			—			(35	)		—			—			(35	)		35			—

Dividends on Common Stock		—			—			—			(16	)		—			(16	)		—			(16	)
Shares issued:
Exercise of stock options		436,127			11			—			—			—			11			—			11
Other benefit plans		332,337			7			—			—			—			7			—			7
Dividend reinvestment plan		4,043			—			—			—			—			—			—			—
Stock-based compensation expense		—			3			—			—			—			3			—			3
Shares acquired and retired		(2,457,721	)		(30	)		—			(54	)		—			(84	)		—			(84	)
Other		—			—			—			—			—			—			(2	)		(2	)


Balance at March 31, 2011		103,483,152		$	1,262		$	162		$	2,536		$	503		$	4,463		$	149		$	4,612



Balance at December 31, 2009		113,386,343		$	1,344		$	—		$	2,274		$	163		$	3,781		$	138		$	3,919

Cumulative effect of accounting change		—			—			261			4			(4	)		261			—			261
Net earnings		—			—			—			106			—			106			(18	)		88
Other comprehensive income (loss), net of tax:
Change in unrealized gain (loss) on securities		—			—			—			—			127			127			2			129
Change in foreign currency translation		—			—			—			—			4			4			1			5

Total comprehensive income (loss)																	237			(15	)		222

Allocation of losses of managed investment entities		—			—			(20	)		—			—			(20	)		20			—

Dividends on Common Stock		—			—			—			(16	)		—			(16	)		—			(16	)
Shares issued:
Exercise of stock options		312,661			6			—			—			—			6			—			6
Other benefit plans		337,993			4			—			—			—			4			—			4
Dividend reinvestment plan		4,753			—			—			—			—			—			—			—
Stock-based compensation expense		—			3			—			—			—			3			—			3
Shares acquired and retired		(2,911,834	)		(34	)		—			(41	)		—			(75	)		—			(75	)
Other		—			—			—			—			—			—			(1	)		(1	)


Balance at March 31, 2010		111,129,916		$	1,323		$	241		$	2,327		$	290		$	4,181		$	142		$	4,323

4

AMERICAN FINANCIAL GROUP, INC. 10-Q

AMERICAN FINANCIAL GROUP, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENT OF CASH FLOWS(UNAUDITED)

(In Millions)


	Three months ended
	March 31,
	2011			2010
Operating Activities:
Net earnings, including noncontrolling interests	$	49		$	88
Adjustments:
Depreciation and amortization		52			47
Annuity benefits		116			108
Realized (gains) losses on investing activities		3			(4	)
Net purchases of trading securities		(5	)		(15	)
Deferred annuity and life policy acquisition costs		(56	)		(45	)
Change in:
Reinsurance and other receivables		446			570
Other assets		23			9
Insurance claims and reserves		(202	)		(288	)
Payable to reinsurers		(92	)		(106	)
Other liabilities		57			43
Other operating activities, net		(2	)		(14	)

Net cash provided by operating activities		389			393


Investing Activities:
Purchases of:
Fixed maturities		(1,044	)		(1,312	)
Equity securities		(34	)		(6	)
Mortgage loans		(91	)		(36	)
Real estate, property and equipment		(20	)		(38	)
Proceeds from:
Maturities and redemptions of fixed maturities		590			508
Repayments of mortgage loans		10			5
Sales of fixed maturities		291			497
Sales of equity securities		6			1
Sales of real estate, property and equipment		—			1
Managed investment entities:
Purchases of investments		(352	)		(141	)
Proceeds from sales and redemptions of investments		400			210
Other investing activities, net		(13	)		8

Net cash used in investing activities		(257	)		(303	)


Financing Activities:
Annuity receipts		672			387
Annuity surrenders, benefits and withdrawals		(311	)		(311	)
Managed investment entities’ retirement of liabilities		(4	)		(28	)
Issuances of Common Stock		11			7
Repurchases of Common Stock		(84	)		(75	)
Cash dividends paid on Common Stock		(16	)		(15	)
Other financing activities, net		—			(5	)

Net cash provided by (used in) financing activities		268			(40	)


Net Change in Cash and Cash Equivalents		400			50

Cash and cash equivalents at beginning of period		1,099			1,120


Cash and cash equivalents at end of period	$	1,499		$	1,170

5

AMERICAN FINANCIAL GROUP, INC. 10-Q

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

INDEX TO NOTES

	A.		Accounting Policies

	B.		Acquisition

	C.		Segments of Operations

	D.		Fair Value Measurements

	E.		Investments

	F.		Derivatives

	G.		Deferred Policy Acquisition Costs

	H.		Managed Investment Entities

	I.		Goodwill and Other Intangibles

	J.		Long-Term Debt

	K.		Shareholders’ Equity

	L.		Income Taxes

	M.		Contingencies

	N.		Condensed Consolidating Information

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 U.S. generally accepted accounting principles.

Certain reclassifications have been made to prior periods to conform to the current year’s presentation. All significant intercompany balances and transactions have been eliminated. The results of operations of companies since their formation or acquisition are included in the consolidated financial statements. Events or transactions occurring subsequent to March 31, 2011, and prior to the filing date of this Form 10-Q, have been evaluated for potential recognition or disclosure herein.

The preparation of the financial statements requires management to make estimates and assumptions that affect the amounts reported in the financial statements and accompanying notes. Changes in circumstances could cause actual results to differ materially from those estimates.

Fair Value Measurements Accounting standards define fair value as the price that would be received to sell an asset or paid to transfer a liability (an exit price) in an orderly transaction between market participants on the measurement date. The standards establish a hierarchy of valuation techniques based on whether the assumptions that market participants would use in pricing the asset or liability (“inputs”) are observable or unobservable. Observable inputs reflect market data obtained from independent sources, while unobservable inputs reflect AFG’s assumptions about the assumptions market participants would use in pricing the asset or liability. In the first quarter of 2011, AFG did not have any significant nonrecurring fair value measurements of nonfinancial assets and liabilities.

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

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

6

AMERICAN FINANCIAL GROUP, INC. 10-Q

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — CONTINUED

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 (losses)) and the cost basis of that investment is reduced.

In 2009, AFG adopted new accounting guidance relating to the recognition and presentation of other-than-temporary impairments. Under the guidance, if management can assert that it does not intend to sell an impaired fixed maturity security and it is not more likely than not that it will have to sell the security before recovery of its amortized cost basis, then an entity may separate other-than-temporary impairments into two components: 1) the amount related to credit losses (recorded in earnings) and 2) the amount related to all other factors (recorded in other comprehensive income (loss)). The credit-related portion of an other-than-temporary impairment is measured by comparing a security’s amortized cost to the present value of its current expected cash flows discounted at its effective yield prior to the impairment charge. Both components are required to be shown in the Statement of Earnings. If management intends to sell an impaired security, or it is more likely than not that it will be required to sell the security before recovery, an impairment charge to earnings is required to reduce the amortized cost of that security to fair value.

Derivatives Derivatives included in AFG’s Balance Sheet are recorded at fair value and consist primarily of (i) components of certain fixed maturity securities (primarily interest-only MBS) and (ii) the equity-based component of certain annuity products (included in annuity benefits accumulated) and related call options (included in other investments) designed to be consistent with the characteristics of the liabilities and used to mitigate the risk embedded in those annuity products. Changes in the fair value of derivatives are included in earnings.

Goodwill Goodwill represents the excess of cost of subsidiaries over AFG’s equity in their underlying net assets. Goodwill is not amortized, but is subject to an impairment test at least annually.

Reinsurance Amounts recoverable from reinsurers are estimated in a manner consistent with the claim liability associated with the reinsured policies. AFG’s property and casualty insurance subsidiaries report as assets (a) the estimated reinsurance recoverable on paid and 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. Payable to reinsurers includes ceded premiums due to reinsurers as well as ceded premiums retained by AFG’s property and casualty insurance subsidiaries under contracts to fund ceded losses as they become due. AFG’s insurance subsidiaries also assume reinsurance from other companies. Earnings on reinsurance assumed is recognized based on information received from ceding companies.

7

AMERICAN FINANCIAL GROUP, INC. 10-Q

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — CONTINUED

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.

Deferred Policy Acquisition Costs (“DPAC”) Policy acquisition costs (principally commissions, premium taxes and other marketing and underwriting expenses) related to the production of new business are deferred. DPAC also includes capitalized costs associated with sales inducements offered to fixed annuity policyholders such as enhanced interest rates and premium and persistency bonuses.

For the property and casualty companies, DPAC is limited based upon recoverability without any consideration for anticipated investment income and is charged against income ratably over the terms of the related policies. A premium deficiency is recognized if the sum of expected claims costs, claims adjustment expenses, unamortized acquisition costs and policy maintenance costs exceed the related unearned premiums. A premium deficiency is first recognized by charging any unamortized acquisition costs to expense to the extent required to eliminate the deficiency. If the premium deficiency is greater than unamortized acquisition costs, a liability is accrued for the excess deficiency and reported with unpaid losses and loss adjustment expenses.

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

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 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 in AFG’s Balance Sheet.

New accounting guidance issued in October 2010 specifies that a cost must be directly related to the successful acquisition of an insurance contract to qualify for deferral. The guidance is effective January 1, 2012, with retrospective application permitted, but not required. This guidance will result in fewer acquisition costs being capitalized by AFG. Management continues assessing the impact of adoption and expects that adoption will be reported retrospectively.

8

AMERICAN FINANCIAL GROUP, INC. 10-Q

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — CONTINUED

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

Managed Investment Entities In 2009, the Financial Accounting Standards Board issued a new standard changing how a company determines if it is the primary beneficiary of, and therefore must consolidate, a variable interest entity (“VIE”). This determination is based primarily on a company’s ability to direct the activities of the entity that most significantly impact the entity’s economic performance and the obligation to absorb losses of, or receive benefits from, the entity that could potentially be significant to the VIE.

AFG manages, and has minor investments in, six collateralized loan obligations (“CLOs”) that are VIEs (see Note H — “Managed Investment Entities”). Both the management fees (payment of which are subordinate to other obligations of the CLOs) and the investments in the CLOs are considered variable interests. Based on the new accounting guidance, AFG has determined that it is the primary beneficiary of the CLOs because (i) its role as asset manager gives it the power to direct the activities that most significantly impact the economic performance of the CLOs and (ii) it has exposure to CLO losses (through its investments in the CLO subordinated debt tranches) and the right to receive benefits (through its subordinated management fees and returns on its investments), both of which could potentially be significant to the CLOs. Accordingly, AFG began consolidating these entities on January 1, 2010.

Because AFG has no right to use the CLO assets and no obligation to pay the CLO liabilities, the assets and liabilities of the CLOs are shown separately in AFG’s Balance Sheet. As permitted under the new standard, the assets and liabilities of the CLOs have been recorded at fair value upon adoption of the new standard on January 1, 2010. At that date, the $261 million excess of fair value of the assets over the fair value of the liabilities was included in AFG’s Balance Sheet as appropriated retained earnings — managed investment entities, representing the cumulative effect of adopting the new standard that ultimately will inure to the benefit of the CLO debt holders.

AFG has elected the fair value option for reporting on the CLO assets and liabilities to improve the transparency of financial reporting related to the CLOs. The net gain or loss from accounting for the CLO assets and liabilities at fair value subsequent to January 1, 2010, is separately presented in AFG’s Statement of Earnings. CLO earnings attributable to AFG’s shareholders represent the change in fair value of AFG’s investments in the CLOs and management fees earned. All other CLO earnings (losses) are not attributable to AFG’s shareholders and will ultimately inure to the benefit of the other CLO debt holders. As a result, such CLO earnings (losses) are included in net earnings (loss) attributable to noncontrolling interests in AFG’s Statement of Earnings and in appropriated retained earnings — managed investment entities in the Balance Sheet. As the CLOs approach maturity (2016 to 2022), it is expected that losses attributable to noncontrolling interests will reduce appropriated retained earnings towards zero as the fair values of the assets and liabilities converge and the CLO assets are used to pay the CLO debt.

9

AMERICAN FINANCIAL GROUP, INC. 10-Q

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — CONTINUED

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 direct business written; (b) estimates received from ceding reinsurers and insurance pools and associations; (c) estimates of unreported losses (including possible development on known claims) 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. Establishing reserves for asbestos, environmental and other mass tort claims involves considerably more judgment than other types of claims due to, among other things, inconsistent court decisions, an increase in bankruptcy filings as a result of asbestos-related liabilities, novel theories of coverage, and judicial interpretations that often expand theories of recovery and broaden the scope of coverage.

Loss reserve liabilities are subject to the impact of changes in claim amounts and frequency and other factors. Changes in estimates of the liabilities for losses and loss adjustment expenses are reflected in the Statement of Earnings in the period in which determined. Despite the variability inherent in such estimates, management believes that the liabilities for unpaid losses and loss adjustment expenses are adequate.

Annuity Benefits Accumulated Annuity receipts and benefit payments are recorded as increases or decreases in annuity benefits accumulated rather than as revenue and expense. Increases in this liability for interest credited are charged to expense and decreases for surrender charges are credited to other income.

For certain products, annuity benefits accumulated also includes reserves for accrued persistency and premium bonuses and excess benefits expected to be paid on future deaths and annuitizations (“EDAR”). The liability for EDAR is accrued for and modified using assumptions consistent with those used in determining DPAC and DPAC amortization, except that amounts are determined in relation to the present value of total expected assessments. Total expected assessments consist principally of estimated future investment margin, surrender, mortality, and other life and variable annuity policy charges, and unearned revenues once they are recognized as income.

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

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

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

10

AMERICAN FINANCIAL GROUP, INC. 10-Q

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — CONTINUED

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

Noncontrolling Interests For Balance Sheet purposes, noncontrolling interests represents the interests of shareholders other than AFG in consolidated entities. In the Statement of Earnings, net earnings and losses attributable to noncontrolling interests represents such shareholders’ interest in the earnings and losses of those entities.

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. Related interest and penalties are recognized as a component of tax expense.

Stock-Based Compensation All share-based grants are recognized as compensation expense on a straight-line basis over their vesting periods based on their calculated “fair value” at the date of grant. AFG uses the Black-Scholes pricing model to measure the fair value of employee stock options. See Note K - “Shareholders’ Equity” for further information.

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

Earnings Per Share Basic earnings per share is calculated using the weighted average number of shares of common stock outstanding during the period. The calculation of diluted earnings per share includes adjustments to weighted average common shares of 1.6 million for the first quarter of 2011 and 1.1 million for the first quarter of 2010 related to stock-based compensation plans.

AFG’s weighted average diluted shares outstanding excludes the following anti-dilutive potential common shares related to stock compensation plans: first quarter 2011 and 2010 — 1.8 million and 5.0 million, respectively. Adjustments to net earnings attributable to shareholders in the calculation of diluted earnings per share were nominal in the 2011 and 2010 periods.

11

AMERICAN FINANCIAL GROUP, INC. 10-Q

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — CONTINUED

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.

B.

Acquisition

Vanliner Group, Inc. (“Vanliner”) In July 2010, National Interstate (“NATL”), a 52%-owned subsidiary of AFG, completed the acquisition of Vanliner, a market leader in providing insurance for the moving and storage industry, for $114 million (including post-closing adjustments). Vanliner’s moving and storage insurance premiums associated with policies in force as of December 31, 2010, totaled approximately $90 million, representing approximately 78% of its total business.

C.

Segments of Operations

AFG manages its business as three segments: (i) property and casualty insurance, (ii) annuity and supplemental insurance and (iii) other, which includes holding company costs and operations of the managed investment entities.

AFG reports its property and casualty insurance business in the following Specialty sub-segments: (i) Property and transportation, which includes physical damage and liability coverage for buses, 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 liability, umbrella and excess liability, customized programs for small to mid-sized businesses and California workers’ compensation, and (iii) Specialty financial, which includes risk management insurance programs for lending and leasing institutions (including collateral and mortgage protection insurance), surety and fidelity products and trade credit insurance. AFG’s annuity and supplemental insurance business markets traditional fixed and indexed annuities and a variety of supplemental insurance products such as Medicare supplement. AFG’s reportable segments and their components were determined based primarily upon similar economic characteristics, products and services.

12

AMERICAN FINANCIAL GROUP, INC. 10-Q

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — CONTINUED

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


	Three months ended
	March 31,
	2011			2010
Revenues
Property and casualty insurance:
Premiums earned:
Specialty
Property and transportation	$	255		$	216
Specialty casualty		216			218
Specialty financial		112			128
Other		16			17

Total premiums earned		599			579
Investment income		73			92
Realized gains (losses)		—			10
Other income		15			15

Total property and casualty insurance		687			696
Annuity and supplemental insurance:
Investment income		226			202
Life, accident and health premiums		110			115
Realized gains (losses)		(3	)		(6	)
Other income		23			25

Total annuity and supplemental insurance		356			336
Other		(4	)		2


Total revenues	$	1,039		$	1,034


Operating Earnings Before Income Taxes
Property and casualty insurance:
Underwriting income (loss):
Specialty
Property and transportation	$	33		$	32
Specialty casualty		2			18
Specialty financial		10			21
Other		1			6
Other lines		—			(6	)

Total underwriting		46			71
Investment and other income, net		68			81
Realized gains (losses)		—			10

		114			162
Annuity and supplemental insurance:
Operations		52			44
Realized gains (losses)		(3	)		(6	)

Total annuity and supplemental insurance		49			38
Other (*)		(68	)		(53	)


Total operating earnings before income taxes	$	95		$	147


(*)		Includes $9 million and $8 million in earnings from managed investment entities attributable to AFG shareholders and $35 million and $20 million in losses of managed investment entities attributable to noncontrolling interests for the three months ended March 31, 2011 and 2010, respectively.

13

AMERICAN FINANCIAL GROUP, INC. 10-Q

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — CONTINUED

D.

Fair Value Measurements

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

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

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

Level 3 — Valuations derived from market valuation techniques generally consistent with those used to estimate the fair values of Level 2 financial instruments in which one or more significant inputs are unobservable. The unobservable inputs may include management’s own assumptions about the assumptions market participants would use based on the best information available in the circumstances. AFG’s Level 3 is comprised of financial instruments, including liabilities of managed investment entities, whose fair value is estimated based on non-binding broker quotes or internally developed using significant inputs not based on, or corroborated by, observable market information.

AFG’s management is responsible for the valuation process and uses data from outside sources (including nationally recognized pricing services and broker/dealers) in establishing fair value. Valuation techniques utilized by pricing services and prices obtained from external sources are reviewed by AFG’s internal investment professionals who are familiar with the securities being priced and the markets in which they trade to ensure the fair value determination is representative of an exit price. To validate the appropriateness of the prices obtained, these investment managers consider widely published indices (as benchmarks), recent trades, changes in interest rates, general economic conditions and the credit quality of the specific issuers.

14

AMERICAN FINANCIAL GROUP, INC. 10-Q

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — CONTINUED

Assets and liabilities measured at fair value are summarized below (in millions):


	Level 1		Level 2		Level 3		Total
March 31, 2011
Assets:
Available for sale (“AFS”) fixed maturities:
U.S. Government and government agencies	$	236	$	192	$	—	$	428
States, municipalities and political subdivisions		—		3,058		21		3,079
Foreign government		—		280		—		280
Residential MBS		—		3,580		271		3,851
Commercial MBS		—		2,287		9		2,296
All other corporate		10		9,262		424		9,696

Total AFS fixed maturities		246		18,659		725		19,630

Trading fixed maturities		—		396		1		397
Equity securities		516		206		21		743
Assets of managed investment entities (“MIE”)		112		2,404		54		2,570
Variable annuity assets (separate accounts) (a)		—		635		—		635
Other investments		—		117		—		117

Total assets accounted for at fair value	$	874	$	22,417	$	801	$	24,092


Liabilities:
Liabilities of managed investment entities	$	72	$	—	$	2,316	$	2,388
Derivatives in annuity benefits accumulated		—		—		234		234

Total liabilities accounted for at fair value	$	72	$	—	$	2,550	$	2,622


December 31, 2010
Assets:
Available for sale (“AFS”) fixed maturities:
U.S. Government and government agencies	$	249	$	218	$	—	$	467
States, municipalities and political subdivisions		—		2,919		20		2,939
Foreign government		—		278		—		278
Residential MBS		—		3,563		312		3,875
Commercial MBS		—		2,117		6		2,123
All other corporate		9		9,201		436		9,646

Total AFS fixed maturities		258		18,296		774		19,328

Trading fixed maturities		—		390		3		393
Equity securities		461		208		21		690
Assets of managed investment entities (“MIE”)		96		2,393		48		2,537
Variable annuity assets (separate accounts) (a)		—		616		—		616
Other investments		—		98		—		98

Total assets accounted for at fair value	$	815	$	22,001	$	846	$	23,662


Liabilities:
Liabilities of managed investment entities	$	65	$	—	$	2,258	$	2,323
Derivatives in annuity benefits accumulated		—		—		190		190

Total liabilities accounted for at fair value	$	65	$	—	$	2,448	$	2,513


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

During the first quarter of 2011, there were no significant transfers between Level 1 and Level 2. Approximately 3% of the total assets measured at fair value on March 31, 2011, were Level 3 assets. Approximately 35% of these assets were MBS whose fair values were determined primarily using non-binding broker quotes; the balance was primarily private placement debt securities whose fair values were determined internally using significant unobservable inputs, including the evaluation of underlying collateral and issuer creditworthiness, as well as certain Level 2 inputs such as comparable yields and multiples on similar publicly traded issues. The fair values of the liabilities of managed investment entities were determined using non-binding broker quotes, which were reviewed by AFG’s investment professionals.

15

AMERICAN FINANCIAL GROUP, INC. 10-Q

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — CONTINUED

Changes in balances of Level 3 financial assets and liabilities during the first quarter of 2011 and 2010 are presented below (in millions). The transfers into and out of Level 3 were due to changes in the availability of market observable inputs. All transfers are reflected in the table at fair value as of the end of the reporting period.


				Total
				realized/unrealized
				gains (losses)
				included in
							Other
	Balance at						comp.		Purchases						Transfer		Transfer			Balance at
	Dec. 31,			Net			income		and			Sales and			into		out of			March 31,
	2010			income			(loss)		issuances			Settlements			Level 3		Level 3			2011
AFS fixed maturities:
State and municipal	$	20		$	—		$	1	$	—		$	—		$	—	$	—		$	21
Residential MBS		312			1			—		—			(13	)		7		(36	)		271
Commercial MBS		6			—			—		—			—			3		—			9
All other corporate		436			(2	)		—		45			(11	)		22		(66	)		424
Trading fixed maturities		3			—			—		—			—			—		(2	)		1
Equity securities		21			—			2		—			(2	)		—		—			21
Assets of MIE		48			(1	)		—		7			(4	)		6		(2	)		54
Liabilities of MIE (*)		(2,258	)		(62	)		—		—			4			—		—			(2,316	)
Embedded derivatives		(190	)		(19	)		—		(30	)		5			—		—			(234	)


(*)		Total realized/unrealized loss included in net income includes losses of $61 million related to liabilities outstanding as of March 31, 2011. See Note H — “Managed Investment Entities.”


							Total
							realized/unrealized
							gains (losses)
							included in
				Consolidate						Other			Purchases,
	Balance at			Managed						comp.			sales,			Transfer		Transfer			Balance at
	Dec. 31,			Inv.			Net			income			issuances and			into		out of			March 31,
	2009			Entities			income			(loss)			settlements			Level 3		Level 3			2010
AFS fixed maturities:
State and municipal	$	23		$	—		$	—		$	—		$	—		$	—	$	(17	)	$	6
Residential MBS		435			—			1			1			18			—		(83	)		372
Commercial MBS		—			—			—			—			6			—		—			6
All other corporate		311			(6	)		(1	)		(1	)		45			23		(15	)		356
Trading fixed maturities		1			—			—			—			4			—		(1	)		4
Equity securities		25			—			—			(1	)		—			—		—			24
Assets of MIE		—			90			4			—			6			—		—			100
Liabilities of MIE		—			(2,100	)		(106	)		—			28			—		—			(2,178	)
Embedded derivatives		(113	)		—			(12	)		—			(6	)		—		—			(131	)

Fair Value of Financial Instruments The following table presents (in millions) the carrying value and estimated fair value of AFG’s financial instruments at March 31, 2011 and December 31, 2010.


	March 31, 2011				December 31, 2010
	Carrying		Fair		Carrying		Fair
	Value		Value		Value		Value
Assets:
Cash and cash equivalents	$	1,499	$	1,499	$	1,099	$	1,099
Fixed maturities		20,027		20,027		19,721		19,721
Equity securities		743		743		690		690
Mortgage loans		551		552		468		469
Policy loans		258		258		264		264
Other investments — derivatives		117		117		98		98
Assets of managed investment entities		2,570		2,570		2,537		2,537
Variable annuity assets (separate accounts)		635		635		616		616

Liabilities:
Annuity benefits accumulated(*)	$	13,196	$	12,590	$	12,696	$	12,233
Long-term debt		949		1,033		952		1,023
Liabilities of managed investment entities		2,388		2,388		2,323		2,323
Variable annuity liabilities (separate accounts)		635		635		616		616
Other liabilities — derivatives		14		14		14		14


(*)		Excludes life contingent annuities in the payout phase.

16

AMERICAN FINANCIAL GROUP, INC. 10-Q

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — CONTINUED

The carrying amount of cash and cash equivalents approximates fair value. Fair values for mortgage loans are estimated by discounting the future contractual cash flows using the current rates at which similar loans would be made to borrowers with similar credit ratings. The fair value of policy loans is estimated to approximate carrying value; policy loans have no defined maturity dates and are inseparable from insurance contracts. The fair value of annuity benefits was estimated based on expected cash flows discounted using forward interest rates adjusted for the Company’s credit risk and includes the impact of maintenance expenses and capital costs. Fair values of long-term debt are based primarily on quoted market prices.

E.

Investments

Available for sale fixed maturities and equity securities at March 31, 2011, and December 31, 2010, consisted of the following (in millions):


	March 31, 2011									December 31, 2010
	Amortized		Fair		Gross Unrealized					Amortized		Fair		Gross Unrealized
	Cost		Value		Gains		Losses			Cost		Value		Gains		Losses

Fixed maturities:
U.S. Government and government agencies	$	417	$	428	$	12	$	(1	)	$	453	$	467	$	15	$	(1	)
States, municipalities and political subdivisions		3,076		3,079		49		(46	)		2,927		2,939		53		(41	)
Foreign government		273		280		7		—			269		278		9		—
Residential MBS		3,725		3,851		237		(111	)		3,781		3,875		222		(128	)
Commercial MBS		2,128		2,296		169		(1	)		1,972		2,123		153		(2	)
All other corporate		9,136		9,696		595		(35	)		9,088		9,646		602		(44	)


Total fixed maturities	$	18,755	$	19,630	$	1,069	$	(194	)	$	18,490	$	19,328	$	1,054	$	(216	)


Common stocks	$	348	$	587	$	240	$	(1	)	$	312	$	543	$	232	$	(1	)


Perpetual preferred stocks	$	150	$	156	$	10	$	(4	)	$	146	$	147	$	6	$	(5	)

The non-credit related portion of other-than-temporary impairment charges are included in other comprehensive income (loss). Such charges taken for securities still owned at March 31, 2011 and December 31, 2010, respectively were: residential MBS — $253 million and $258 million; commercial MBS — $1 million and $1 million; corporate bonds — $1 million and $1 million.

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AMERICAN FINANCIAL GROUP, INC. 10-Q

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — CONTINUED

The following tables show gross unrealized losses (in millions) on fixed maturities and equity securities by investment category and length of time that individual securities have been in a continuous unrealized loss position at March 31, 2011 and December 31, 2010.


	Less Than Twelve Months								Twelve Months or More
	Unrealized			Fair		Fair Value as			Unrealized			Fair		Fair Value as
	Loss			Value		% of Cost			Loss			Value		% of Cost
March 31, 2011
Fixed maturities:
U.S. Government and government agencies	$	(1	)	$	88		99	%	$	—		$	—		—	%
States, municipalities and political subdivisions		(43	)		1,296		97	%		(3	)		47		94	%
Foreign government		—			37		100	%		—			—		—	%
Residential MBS		(11	)		483		98	%		(100	)		489		83	%
Commercial MBS		(1	)		70		99	%		—			17		100	%
All other corporate		(25	)		1,010		98	%		(10	)		186		95	%


Total fixed maturities	$	(81	)	$	2,984		97	%	$	(113	)	$	739		87	%


Common Stocks	$	(1	)	$	22		96	%	$	—		$	—		—	%


Perpetual Preferred Stocks	$	—		$	6		100	%	$	(4	)	$	41		91	%


December 31, 2010
Fixed maturities:
U.S. Government and government agencies	$	(1	)	$	86		99	%	$	—		$	—		—	%
States, municipalities and political subdivisions		(38	)		1,180		97	%		(3	)		40		93	%
Foreign government		—			37		99	%		—			—		—	%
Residential MBS		(11	)		412		97	%		(117	)		551		82	%
Commercial MBS		(2	)		83		98	%		—			15		97	%
All other corporate		(24	)		1,020		98	%		(20	)		275		93	%


Total fixed maturities	$	(76	)	$	2,818		97	%	$	(140	)	$	881		86	%


Common Stocks	$	—		$	21		99	%	$	(1	)	$	4		88	%


Perpetual Preferred Stocks	$	—		$	22		98	%	$	(5	)	$	37		88	%

At March 31, 2011 the gross unrealized losses on fixed maturities of $194 million relate to approximately 1,150 securities. Investment grade securities (as determined by nationally recognized rating agencies) represented approximately 62% of the gross unrealized loss and 86% of the fair value.

Gross Unrealized Losses on MBS At March 31, 2011, gross unrealized losses on AFG’s residential MBS represented 57% of the total gross unrealized loss on fixed maturity securities (and 88% of the “twelve months or more”). Of the residential MBS that have been in an unrealized loss position (“impaired”) for 12 months or more (244 securities), approximately 37% of the unrealized losses and 49% of the fair value relate to investment grade rated securities. AFG analyzes its MBS securities for other-than-temporary impairment each quarter based upon expected future cash flows. Management estimates expected future cash flows based upon its knowledge of the MBS market, cash flow projections (which reflect loan to collateral values, subordination, vintage and geographic concentration) received from independent sources, implied cash flows inherent in security ratings and analysis of historical payment data. For the first three months of 2011, AFG recorded in earnings $8.1 million in other-than-temporary impairment charges related to its residential MBS.

Gross Unrealized Losses on All Other Corporates For the first three months of 2011, AFG recorded in earnings $2.3 million in other-than-temporary charges on “all other corporate” securities. Management concluded that no additional charges for other-than-temporary impairments were required based on many factors, including AFG’s ability and intent to hold the investments for a period of time sufficient to allow for anticipated recovery of its amortized cost, the length of time and the extent to which fair value has been below cost, analysis of historical and projected company-specific financial data, the outlook for industry sectors, and credit ratings.

18

AMERICAN FINANCIAL GROUP, INC. 10-Q

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — CONTINUED

The following tables progress the credit portion of other-than-temporary impairments on fixed maturity securities for which the non-credit portion of an impairment has been recognized in other comprehensive income (loss) (in millions).


	2011		2010
Balance at January 1	$	143	$	99
Additional credit impairments on:
Previously impaired securities		7		19
Securities without prior impairments		1		4
Reductions — disposals		—		—


Balance at March 31	$	151	$	122

The table below sets forth the scheduled maturities of available for sale fixed maturities as of March 31, 2011 (in millions). 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. MBS had an average life of approximately 4 years at March 31, 2011.


	Amortized		Fair Value
Maturity	Cost		Amount		%
One year or less	$	497	$	511		3	%
After one year through five years		4,957		5,221		27
After five years through ten years		5,632		5,921		30
After ten years		1,816		1,830		9

		12,902		13,483		69
MBS		5,853		6,147		31

Total	$	18,755	$	19,630		100	%

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

There were no investments in individual issuers that exceeded 10% of Shareholders’ Equity at March 31, 2011 or December 31, 2010.

19

AMERICAN FINANCIAL GROUP, INC. 10-Q

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — CONTINUED

Net Unrealized Gain on Marketable Securities In addition to adjusting equity securities and fixed maturity securities classified as “available for sale” to fair value, GAAP requires that deferred policy acquisition costs related to annuities and certain other balance sheet amounts be adjusted to the extent that unrealized gains and losses from securities would result in adjustments to those balances had the unrealized gains or losses actually been realized. The following table shows the components of the net unrealized gain on securities that is included in Accumulated Other Comprehensive Income in AFG’s Balance Sheet.


				Deferred Tax and
				Amounts Attributable
				to Noncontrolling
	Pre-tax			Interests			Net
March 31, 2011
Unrealized gain on:
Fixed maturity securities	$	875		$	(308	)	$	567
Equity securities		245			(87	)		158
Deferred policy acquisition costs		(364	)		127			(237	)
Annuity benefits and other liabilities		6			(2	)		4

	$	762		$	(270	)	$	492


December 31, 2010
Unrealized gain on:
Fixed maturity securities	$	838		$	(295	)	$	543
Equity securities		232			(82	)		150
Deferred policy acquisition costs		(340	)		118			(222	)
Annuity benefits and other liabilities		6			(2	)		4

	$	736		$	(261	)	$	475

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


																Noncon-
	Fixed			Equity			Other						Tax			trolling
	Maturities			Securities			Investments(b)			Other(a)			Effects			Interests			Total
Quarter ended March 31, 2011
Realized before impairments	$	13		$	1		$	(2	)	$	(2	)	$	(3	)	$	—		$	7
Realized — impairments		(11	)		—			(3	)		4			3			—			(7	)
Change in Unrealized		37			13			—			(24	)		(9	)		—			17

Quarter ended March 31, 2010
Realized before impairments	$	34		$	1		$	(7	)	$	(3	)	$	(8	)	$	—		$	17
Realized — impairments		(28	)		—			(2	)		9			7			—			(14	)
Change in Unrealized		350			(5	)		—			(147	)		(69	)		(2	)		127


(a)		Primarily adjustments to deferred policy acquisition costs related to annuities.

(b)		Includes mortgage loans and other investments.

20

AMERICAN FINANCIAL GROUP, INC. 10-Q

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — CONTINUED

Realized gains (losses) on securities includes net losses of $3 million in the first quarter of 2011 and net gains of $17 million in the first quarter of 2010 from the mark-to-market of certain MBS, primarily interest-only securities with interest rates that float inversely with short-term rates. Gross realized gains and losses (excluding impairment writedowns and mark-to-market of derivatives) on available for sale fixed maturity and equity security investment transactions included in the Statement of Cash Flows consisted of the following (in millions):


	Three months ended
	March 31,
	2011			2010
Fixed maturities:
Gross gains	$	17		$	22
Gross losses		(1	)		(5	)

Equity securities:
Gross gains		1			1
Gross losses		—			—

F.

Derivatives

As discussed under “Derivatives” in Note A, AFG uses derivatives in certain areas of its operations. AFG’s derivatives do not qualify for hedge accounting under GAAP; changes in the fair value of derivatives are included in earnings.

The following derivatives are included in AFG’s Balance Sheet at fair value (in millions):


		March 31, 2011				December 31, 2010
Derivative	Balance Sheet Line	Asset		Liability		Asset		Liability
MBS with embedded derivatives	Fixed maturities	$	95	$	—	$	101	$	—
Interest rate swaptions	Other investments		26		—		21		—
Indexed annuities (embedded derivative)	Annuity benefits accumulated		—		234		—		190
Equity index call options	Other investments		91		—		77		—
Reinsurance contracts (embedded derivative)	Other liabilities		—		14		—		14

		$	212	$	248	$	199	$	204

The MBS with embedded derivatives consist primarily of interest-only MBS with interest rates that float inversely with short-term rates. AFG has elected to measure these securities (in their entirety) at fair value in its financial statements. These investments are part of AFG’s overall investment strategy and represent a small component of AFG’s overall investment portfolio.

AFG has entered into $1 billion notional amount of pay-fixed interest rate swaptions (options to enter into pay-fixed/receive floating interest rate swaps at future dates expiring between 2012 and 2015) to mitigate interest rate risk in its annuity operations. AFG paid $29 million to purchase these swaptions, which represents its maximum potential economic loss over the life of the contracts.

AFG’s indexed annuities, which represented 28% of annuity benefits accumulated at March 31, 2011, provide policyholders with a crediting rate tied, in part, to the performance of an existing stock market index. AFG attempts to mitigate the risk in the index-based component of these products through the purchase of call options on the appropriate index. AFG’s strategy is designed so that an increase in the liabilities, due to an increase in the market index, will be generally offset by unrealized and realized gains on the call options purchased by AFG. Both the index-based component of the annuities and the related call options are considered derivatives.

21

AMERICAN FINANCIAL GROUP, INC. 10-Q

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — CONTINUED

As discussed under “Reinsurance” in Note A, certain reinsurance contracts in AFG’s annuity and supplemental insurance business are considered to contain embedded derivatives.

The following table summarizes the gain (loss) included in the Statement of Earnings for changes in the fair value of these derivatives for the first quarter of 2011 and 2010 (in millions):


Derivative	Statement of Earnings Line	2011			2010
MBS with embedded derivatives	Realized gains	$	(3	)	$	17
Interest rate swaptions	Realized gains		(2	)		(8	)
Indexed annuities (embedded derivative)	Annuity benefits		(19	)		(12	)
Equity index call options	Annuity benefits		18			11
Reinsurance contracts (embedded derivative)	Investment income		—			(5	)

		$	(6	)	$	3

G.

Deferred Policy Acquisition Costs

Deferred policy acquisition costs consisted of the following (in millions):


	March 31,			December 31,
	2011			2010
Property and casualty insurance	$	322		$	324
Annuity and supplemental insurance:
Policy acquisition costs		904			892
Policyholder sales inducements		208			204
Present value of future profits (“PVFP”)		158			164
Impact of unrealized gains and losses on securities		(364	)		(340	)

Total annuity and supplemental		906			920


	$	1,228		$	1,244

The PVFP amounts in the table above are net of $180 million and $174 million of accumulated amortization at March 31, 2011 and December 31, 2010, respectively. Amortization of the PVFP was $6 million in both the first three months of 2011 and 2010.

H.

Managed Investment Entities

AFG is the investment manager and has investments ranging from 7.5% to 24.4% of the most subordinate debt tranche of six collateralized loan obligation entities or “CLOs,” which are considered variable interest entities. Upon formation between 2004 and 2007, these entities issued securities in various senior and subordinate classes and invested the proceeds primarily in secured bank loans, which serve as collateral for the debt securities issued by each particular CLO. None of the collateral was purchased from AFG. AFG’s investments in these entities receive residual income from the CLOs only after the CLOs pay operating expenses (including management fees to AFG), interest on and returns of capital to senior levels of debt securities. There are no contractual requirements for AFG to provide additional funding for these entities. AFG has not provided and does not intend to provide any financial support to these entities.

AFG’s maximum ultimate exposure to economic loss on its CLOs is limited to its investment in the CLOs, which had an aggregate fair value of $20 million at March 31, 2011.

22

AMERICAN FINANCIAL GROUP, INC. 10-Q

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — CONTINUED

The revenues and expenses of the CLOs are separately identified in AFG’s Statement of Earnings after elimination of $3 million and $4 million in management fees and $6 million and $4 million in income attributable to shareholders of AFG as measured by the change in the fair value of AFG’s investments in the CLOs for the three months ended March 31, 2011 and 2010, respectively. AFG’s “Operating earnings before income taxes” for the first three months of 2011 and 2010 includes $35 million and $20 million, respectively, in CLO losses attributable to noncontrolling interests.

The net losses from changes in the fair value of assets and liabilities of managed investment entities included in the Statement of Earnings for the first quarter of 2011 and 2010 includes gains of $29 million and $81 million from changes in the fair value of CLO assets and losses of $62 million and $106 million from changes in the fair value of CLO liabilities. The aggregate unpaid principal balance of the CLOs’ fixed maturity investments exceeded the fair value of the investments by $45 million and $69 million at March 31, 2011 and December 31, 2010. The aggregate unpaid principal balance of the CLOs’ debt exceeded its fair value by $239 million and $301 million at those dates. The CLO assets include $6 million in loans at both March 31, 2011 and December 31, 2010, (aggregate unpaid principal balance of $16 million and $12 million, respectively) for which the CLOs are not accruing interest because the loans are in default.

I.

Goodwill and Other Intangibles

There were no changes in the goodwill balance of $186 million during the three months ended March 31, 2011. Included in other assets in AFG’s Balance Sheet is $46 million at March 31, 2011 and $49 million at December 31, 2010, in amortizable intangible assets related to property and casualty insurance acquisitions, primarily the 2008 acquisitions of Marketform and Strategic Comp. These amounts are net of accumulated amortization of $38 million and $35 million, respectively. Amortization of these intangibles was $3 million for each of the first three months of 2011 and 2010.

Other assets also include $8 million in non-amortizable intangible assets related to insurance licenses acquired in the acquisition of Vanliner in 2010.

23

AMERICAN FINANCIAL GROUP, INC. 10-Q

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — CONTINUED

J.

Long-Term Debt

The carrying value of long-term debt consisted of the following (in millions):


	March 31,		December 31,
	2011		2010
Direct obligations of AFG:
9-7/8% Senior Notes due June 2019	$	350	$	350
7% Senior Notes due September 2050		132		132
7-1/8% Senior Debentures due February 2034		115		115
Other		3		3

		600		600


Subsidiaries:
Obligations of AAG Holding (guaranteed by AFG):
7-1/2% Senior Debentures due November 2033		112		112
7-1/4% Senior Debentures due January 2034		86		86
Notes payable secured by real estate due 2011 through 2016		65		65
Secured borrowings ($17 and $18 guaranteed by AFG)		38		41
National Interstate bank credit facility		20		20
American Premier Underwriters 10-7/8% Subordinated Notes due May 2011		8		8

		329		332

Payable to Subsidiary Trusts:
AAG Holding Variable Rate Subordinated Debentures due May 2033		20		20


	$	949	$	952

Scheduled principal payments on debt for the balance of 2011 and the subsequent five years were as follows: 2011 — $17 million; 2012 — $32 million; 2013 — $20 million; 2014 — $2 million; 2015 — $14 million and 2016 — $45 million.

As shown below (in millions), the majority of AFG’s long-term debt is unsecured obligations of the holding company and its subsidiaries:


	March 31,		December 31,
	2011		2010
Unsecured obligations	$	846	$	846
Obligations secured by real estate		65		65
Other secured borrowings		38		41

	$	949	$	952

AFG can borrow up to $500 million under its revolving credit facility which expires in August 2013. Amounts borrowed under this agreement bear interest at rates ranging from 1.75% to 3.00% (currently 2%) over LIBOR based on AFG’s credit rating. No amounts were borrowed under this facility at March 31, 2011.

In September 2010, AFG issued $132 million of 7% Senior Notes due in 2050.

24

AMERICAN FINANCIAL GROUP, INC. 10-Q

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — CONTINUED

K.

Shareholders’ Equity

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

Accumulated Other Comprehensive Income (Loss), Net of Tax Comprehensive income (loss) is defined as all changes in Shareholders’ Equity except those arising from transactions with shareholders. Comprehensive income (loss) includes net earnings and other comprehensive income (loss), which consists primarily of changes in net unrealized gains or losses on available for sale securities and foreign currency translation. The progression of the components of accumulated other comprehensive income (loss) follows (in millions):


	Pretax			Foreign											Accumulated
	Net Unrealized			Currency								Noncon-			Other
	Gains (Losses)			Translation					Tax			trolling			Comprehensive
	on Securities			Adjustment		Other (a)			Effects			Interests			Income (Loss)
Balance at December 31, 2010	$	736	(b)	$	9	$	(13	)	$	(253	)	$	—		$	479	(b)
Unrealized holding gains on securities arising during the period		26			—		—			(9	)		—			17
Realized losses included in net income		—			—		—			—			—			—
Foreign currency translation losses		—			7		—			—			—			7


Balance at March 31, 2011	$	762	(b)	$	16	$	(13	)	$	(262	)	$	—		$	503	(b)


Balance at December 31, 2009	$	258		$	1	$	(13	)	$	(86	)	$	3		$	163
Unrealized holding gains on securities arising during the period		202			—		—			(70	)		(2	)		130
Realized gains included in net income		(4	)		—		—			1			—			(3	)
Foreign currency translation gains		—			5		—			—			(1	)		4
Other		(6	)		—		1			1			—			(4	)


Balance at March 31, 2010	$	450		$	6	$	(12	)	$	(154	)	$	—		$	290


(a)		Net unrealized pension and other postretirement plan benefits.

(b)		Includes a net pretax unrealized gain of $2 million at March 31, 2011 ($1 million net of tax) compared to a net pretax unrealized loss of $17 million at December 31, 2010 ($11 million net of tax) related to securities for which only the credit portion of an other-than-temporary impairment has been recorded in earnings.

Stock Based Compensation Under AFG’s Stock Incentive Plan, employees of AFG and its subsidiaries are eligible to receive equity awards in the form of stock options, stock appreciation rights, restricted stock awards, restricted stock units and stock awards. In the first three months of 2011, AFG issued 131,955 shares of restricted Common Stock (fair value of $34.34 per share) and granted stock options for 1.1 million shares of Common Stock (at an average exercise price of $34.34) under the Stock Incentive Plan. In addition, AFG issued 188,302 shares of Common Stock (fair value of $33.99 per share) in the first quarter of 2011 under its Annual Co-CEO Equity Bonus Plan.

AFG uses the Black-Scholes option pricing model to calculate the “fair value” of its option grants. Expected volatility is based on historical volatility over a period equal to the expected term. The expected term was estimated based on historical exercise patterns and post vesting cancellations. The weighted average fair value of options granted during 2011 was $12.49 per share based on the following assumptions: expected dividend yield — 1.9%; expected volatility — 38%; expected term — 7.3 years; risk-free rate — 3.04%.

Total compensation expense related to stock incentive plans of AFG and its subsidiaries was $5 million for the first quarter of 2011 and 2010.

25

AMERICAN FINANCIAL GROUP, INC. 10-Q

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — CONTINUED

L.

Income Taxes

Operating earnings before income taxes includes $35 million and $20 million in non-deductible losses of managed investment entities attributable to noncontrolling interests for the three months ended March 31, 2011 and 2010, thereby increasing AFG’s effective tax rate.

There have been no material changes to AFG’s liability for uncertain tax positions, which is discussed in Note L - “Income Taxes,” to AFG’s 2010 Form 10-K.

M.

Contingencies

There have been no significant changes to the matters discussed and referred to in Note M - “Contingencies” of AFG’s 2010 Form 10-K covering property and casualty insurance reserves for claims related to environmental exposures, asbestos and other mass tort claims as well as environmental and occupational injury and disease claims of former subsidiary railroad and manufacturing operations.

26

AMERICAN FINANCIAL GROUP, INC. 10-Q

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — CONTINUED

N. Condensed Consolidating Information

N.

Condensed Consolidating InformationAFG has guaranteed all of the outstanding debt of Great American Financial Resources, Inc. (“GAFRI”) and GAFRI’s wholly-owned subsidiary, AAG Holding Company, Inc. In addition, GAFRI guarantees AAG Holding’s public debt. The AFG and GAFRI guarantees are full and unconditional and joint and several. Condensed consolidating financial statements for AFG are as follows:

CONDENSED CONSOLIDATING BALANCE SHEET
(In millions)


					AAG		All Other		Consol.
	AFG		GAFRI		Holding		Subs		Entries			Consolidated
MARCH 31, 2011

Assets:
Cash and investments	$	374	$	27	$	—	$	23,138	$	(2	)	$	23,537
Recoverables from reinsurers and prepaid reinsurance premiums		—		—		—		3,247		—			3,247
Agents’ balances and premiums receivable		—		—		—		520		—			520
Deferred policy acquisition costs		—		—		—		1,228		—			1,228
Assets of managed investment entities		—		—		—		2,570		—			2,570
Other assets		79		6		5		1,762		(6	)		1,846
Investment in subsidiaries and affiliates		4,863		1,955		2,051		669		(9,538	)		—


Total assets	$	5,316	$	1,988	$	2,056	$	33,134	$	(9,546	)	$	32,948


Liabilities and Equity:
Unpaid losses and loss adjustment expenses and unearned premiums	$	—	$	—	$	—	$	7,727	$	—		$	7,727
Annuity, life, accident and health benefits and reserves		—		—		—		15,074		(1	)		15,073
Liabilities of managed investment entities		—		—		—		2,388		—			2,388
Long-term debt		600		1		219		130		(1	)		949
Other liabilities		253		17		108		2,013		(192	)		2,199

Total liabilities		853		18		327		27,332		(194	)		28,336

Total shareholders’ equity		4,463		1,970		1,729		5,653		(9,352	)		4,463
Noncontrolling interests		—		—		—		149		—			149


Total liabilities and equity	$	5,316	$	1,988	$	2,056	$	33,134	$	(9,546	)	$	32,948


DECEMBER 31, 2010

Assets:
Cash and investments	$	412	$	33	$	—	$	22,228	$	(3	)	$	22,670
Recoverables from reinsurers and prepaid reinsurance premiums		—		—		—		3,386		—			3,386
Agents’ balances and premiums receivable		—		—		—		535		—			535
Deferred policy acquisition costs		—		—		—		1,244		—			1,244
Assets of managed investment entities		—		—		—		2,537		—			2,537
Other assets		36		6		5		2,050		(15	)		2,082
Investment in subsidiaries and affiliates		4,816		1,899		1,996		671		(9,382	)		—


Total assets	$	5,264	$	1,938	$	2,001	$	32,651	$	(9,400	)	$	32,454


Liabilities and Equity:
Unpaid losses and loss adjustment expenses and unearned premiums	$	—	$	—	$	—	$	7,947	$	—		$	7,947
Annuity, life, accident and health benefits and reserves		—		—		—		14,556		(1	)		14,555
Liabilities of managed investment entities		—		—		—		2,323		—			2,323
Long-term debt		600		1		219		133		(1	)		952
Other liabilities		194		19		110		1,888		(154	)		2,057

Total liabilities		794		20		329		26,847		(156	)		27,834

Total shareholders’ equity		4,470		1,918		1,672		5,654		(9,244	)		4,470
Noncontrolling interests		—		—		—		150		—			150


Total liabilities and equity	$	5,264	$	1,938	$	2,001	$	32,651	$	(9,400	)	$	32,454

27

AMERICAN FINANCIAL GROUP, INC. 10-Q

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — CONTINUED

CONDENSED CONSOLIDATING STATEMENT OF EARNINGS
(In millions)


FOR THE THREE MONTHS ENDED					AAG		All Other			Consol.
MARCH 31, 2011	AFG		GAFRI		Holding		Subs			Entries			Consolidated

Revenues:
Property and casualty insurance premiums	$	—	$	—	$	—	$	599		$	—		$	599
Life, accident and health premiums		—		—		—		110			—			110
Realized gains (losses)		—		—		—		(3	)		—			(3	)
Income (loss) of managed investment entities		—		—		—		(8	)		—			(8	)
Investment and other income		2		3		—		343			(7	)		341
Equity in earnings of subsidiaries		160		49		57		—			(266	)		—

Total revenues		162		52		57		1,041			(273	)		1,039

Costs and Expenses:
Insurance benefits and expenses		—		—		—		818			—			818
Interest charges on borrowed money		16		—		6		4			(5	)		21
Expenses of managed investment entities		—		—		—		18			—			18
Other operating and general expenses		17		3		1		67			(1	)		87

Total costs and expenses		33		3		7		907			(6	)		944


Operating earnings before income taxes		129		49		50		134			(267	)		95
Provision (credit) for income taxes		46		18		18		58			(94	)		46


Net earnings, including noncontrolling interests		83		31		32		76			(173	)		49
Less: Net earnings (loss) attributable to noncontrolling interests		—		—		—		(34	)		—			(34	)


Net Earnings Attributable to Shareholders	$	83	$	31	$	32	$	110		$	(173	)	$	83


FOR THE THREE MONTHS ENDED					AAG		All Other			Consol.
MARCH 31, 2010	AFG		GAFRI		Holding		Subs			Entries			Consolidated

Revenues:
Property and casualty insurance premiums	$	—	$	—	$	—	$	579		$	—		$	579
Life, accident and health premiums		—		—		—		115			—			115
Realized gains (losses)		—		—		—		4			—			4
Income (loss) of managed investment entities		—		—		—		(3	)		—			(3	)
Investment and other income		1		2		—		341			(5	)		339
Equity in earnings of subsidiaries		192		40		49		—			(281	)		—

Total Revenues		193		42		49		1,036			(286	)		1,034

Costs and Expenses:
Insurance benefits and expenses		—		—		—		761			—			761
Interest charges on borrowed money		14		—		6		3			(5	)		18
Expenses of managed investment entities		—		—		—		9			—			9
Other operating and general expenses		14		4		2		82			(3	)		99

Total costs and expenses		28		4		8		855			(8	)		887


Operating earnings before income taxes		165		38		41		181			(278	)		147
Provision (credit) for income taxes		59		13		14		72			(99	)		59


Net earnings, including noncontrolling interests		106		25		27		109			(179	)		88
Less: Net earnings (loss) attributable to noncontrolling interests		—		—		—		(18	)		—			(18	)


Net Earnings Attributable to Shareholders	$	106	$	25	$	27	$	127		$	(179	)	$	106

28

AMERICAN FINANCIAL GROUP, INC. 10-Q

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — CONTINUED

CONDENSED CONSOLIDATING STATEMENT OF CASH FLOWS
(In millions)


FOR THE THREE MONTHS ENDED							AAG			All Other			Consol.
MARCH 31, 2011	AFG			GAFRI			Holding			Subs			Entries			Consolidated

Operating Activities:
Net earnings, including noncontrolling interests	$	83		$	31		$	32		$	76		$	(173	)	$	49
Adjustments:
Equity in net earnings of subsidiaries		(105	)		(31	)		(37	)		—			173			—
Dividends from subsidiaries		105			—			—			—			(105	)		—
Other operating activities, net		(23	)		(2	)		(2	)		367			—			340

Net cash provided by (used in) operating activities		60			(2	)		(7	)		443			(105	)		389


Investing Activities:
Purchases of investments, property and equipment		(7	)		—			—			(1,182	)		—			(1,189	)
Capital contributions to subsidiaries		(5	)		(8	)		(1	)		—			14			—
Proceeds from maturities and redemptions of investments		2			2			—			596			—			600
Proceeds from sales of investments, property and equipment		—			—			—			297			—			297
Managed investment entities:
Purchases of investments		—			—			—			(352	)		—			(352	)
Proceeds from sales and redemptions of investments		—			—			—			400			—			400
Other investing activities, net		—			—			—			(13	)		—			(13	)

Net cash provided by (used in) investing activities		(10	)		(6	)		(1	)		(254	)		14			(257	)


Financing Activities:
Annuity receipts		—			—			—			672			—			672
Annuity surrenders, benefits and withdrawals		—			—			—			(311	)		—			(311	)
Managed investment entities’ retirement of liabilities		—			—			—			(4	)		—			(4	)
Issuances of Common Stock		10			—			—			1			—			11
Capital contributions from parent		—			4			8			2			(14	)		—
Repurchases of Common Stock		(84	)		—			—			—			—			(84	)
Cash dividends paid		(16	)		—			—			(105	)		105			(16	)

Net cash provided by (used in) financing activities		(90	)		4			8			255			91			268


Net change in cash and cash equivalents		(40	)		(4	)		—			444			—			400
Cash and cash equivalents at beginning of period		370			20			—			709			—			1,099


Cash and cash equivalents at end of period	$	330		$	16		$	—		$	1,153		$	—		$	1,499

29

AMERICAN FINANCIAL GROUP, INC. 10-Q

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — CONTINUED

CONDENSED CONSOLIDATING STATEMENT OF CASH FLOWS
(In millions)


FOR THE THREE MONTHS ENDED							AAG			All Other			Consol.
MARCH 31, 2010	AFG			GAFRI			Holding			Subs			Entries			Consolidated

Operating Activities:
Net earnings, including noncontrolling interests	$	106		$	25		$	27		$	109		$	(179	)	$	88
Adjustments:
Equity in net earnings of subsidiaries		(124	)		(26	)		(33	)		—			183			—
Dividends from subsidiaries		105			—			—			—			(105	)		—
Other operating activities, net		(25	)		(3	)		(2	)		339			(4	)		305

Net cash provided by (used in) operating activities		62			(4	)		(8	)		448			(105	)		393


Investing Activities:
Purchases of investments, property and equipment		—			—			—			(1,392	)		—			(1,392	)
Capital contributions to subsidiaries		(4	)		(8	)		—			—			12			—
Proceeds from maturities and redemptions of investments		—			2			—			511			—			513
Proceeds from sales of investments, property and equipment		—			—			—			499			—			499
Managed investment entities:
Purchases of investments		—			—			—			(141	)		—			(141	)
Proceeds from sales and redemptions of investments		—			—			—			210			—			210
Other investing activities, net		—			—			—			8			—			8

Net cash provided by (used in) investing activities		(4	)		(6	)		—			(305	)		12			(303	)


Financing Activities:
Annuity receipts		—			—			—			387			—			387
Annuity surrenders, benefits and withdrawals		—			—			—			(311	)		—			(311	)
Managed investment entities’ retirement of liabilities		—			—			—			(28	)		—			(28	)
Issuances of Common Stock		6			—			—			1			—			7
Capital contributions from parent		—			4			8			—			(12	)		—
Repurchases of Common Stock		(75	)		—			—			—			—			(75	)
Cash dividends paid		(15	)		—			—			(105	)		105			(15	)
Other financing activities, net		—			—			—			(5	)		—			(5	)

Net cash provided by (used in) financing activities		(84	)		4			8			(61	)		93			(40	)


Net change in cash and cash equivalents		(26	)		(6	)		—			82			—			50
Cash and cash equivalents at beginning of period		197			12			—			911			—			1,120


Cash and cash equivalents at end of period	$	171		$	6		$	—		$	993		$	—		$	1,170

30

AMERICAN FINANCIAL GROUP, INC. 10-Q

ITEM 2

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

INDEX TO MD&A


	Page

Forward-Looking Statements		31

Overview		32

Critical Accounting Policies		32

Liquidity and Capital Resources		33

Ratios		33

Parent and Subsidiary Liquidity		33

Investments		34

Uncertainties		39

Managed Investment Entities		39

Results of Operations		41

General		41

Income Items		41

Expense Items		45

Recent Accounting Standards		46

FORWARD-LOOKING STATEMENTS

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

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

	•		changes in financial, political and economic conditions, including changes in interest and inflation rates, currency fluctuations and extended economic recessions or expansions;

	•		performance of securities markets;

	•		AFG’s ability to estimate accurately the likelihood, magnitude and timing of any losses in connection with investments in the non-agency residential mortgage market;

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

	•		the availability of capital;

	•		regulatory actions (including changes in statutory accounting rules);

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

	•		tax law and accounting changes;

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

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

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

	•		the unpredictability of possible future litigation if certain settlements of current litigation do not become effective;

	•		trends in persistency, mortality and morbidity;

	•		competitive pressures, including the ability to obtain adequate rates and policy terms; and

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

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.

31

AMERICAN FINANCIAL GROUP, INC. 10-Q

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

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 addition, because most of its businesses are financial in nature, AFG does not prepare its consolidated financial statements using a current-noncurrent format. Consequently, certain traditional ratios and financial analysis tests are not meaningful.

Results of Operations

Through the operations of its subsidiaries, AFG is engaged primarily in property and casualty insurance, focusing on specialized commercial products for businesses and in the sale of traditional fixed and indexed annuities and a variety of supplemental insurance products such as Medicare supplement.

Net earnings attributable to AFG’s shareholders for the first three months of 2011 were $83 million ($.79 per share, diluted) compared to $106 million ($.93 per share, diluted) reported in the same period of 2010. Improved operating results in the annuity and supplemental insurance group were more than offset by lower underwriting profit and lower investment income in the property and casualty insurance operations.

CRITICAL ACCOUNTING POLICIES

Significant accounting policies are summarized in Note A to the financial statements. The preparation of financial statements in conformity with U.S. generally accepted accounting principles 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:

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

	•		the recoverability of reinsurance,

	•		the recoverability of deferred acquisition costs,

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

	•		the valuation of investments, including the determination of “other-than-temporary” impairments.

For a discussion of these policies, see Management’s Discussion and Analysis — “Critical Accounting Policies” in AFG’s 2010 Form 10-K.

32

AMERICAN FINANCIAL GROUP, INC. 10-Q

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

LIQUIDITY AND CAPITAL RESOURCES

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


	March 31,			December 31,
	2011			2010			2009
Long-term debt	$	949		$	952		$	828
Total capital		5,065			5,050			4,698
Ratio of debt to total capital:
Including debt secured by real estate		18.7	%		18.9	%		17.6	%
Excluding debt secured by real estate		17.7	%		17.8	%		16.4	%

The ratio of debt to total capital is a non-GAAP measure that management believes is useful for investors, analysts and independent ratings agencies to evaluate AFG’s financial strength and liquidity and to provide insight into how AFG finances its operations. It is calculated by dividing AFG’s long-term debt by its total capital, which includes long-term debt, noncontrolling interests and shareholders’ equity (excluding unrealized gains (losses) related to fixed maturity investments and appropriated retained earnings related to managed investment entities).

AFG’s ratio of earnings to fixed charges, including annuity benefits as a fixed charge, was 1.92 for the three months ended March 31, 2011 and 2.41 for the entire year of 2010. Excluding annuity benefits, this ratio was 6.19 and 9.09, respectively. Although the ratio excluding annuity benefits is not required or encouraged to be disclosed under Securities and Exchange Commission rules, it is presented because interest credited to annuity policyholder accounts is not always considered a borrowing cost for an insurance company.

Parent and Subsidiary Liquidity

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

AFG can borrow up to $500 million under its revolving credit facility which expires in August 2013. There were no borrowings under this agreement, or any other parent company short-term borrowing arrangements, during 2011. In September 2010, AFG issued $132 million of 7% Senior Notes due 2050.

During the first three months of 2011, AFG repurchased 2.5 million shares of its Common Stock for $84 million. During 2010, AFG repurchased 10.3 million shares of its Common Stock for $292 million.

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

33

AMERICAN FINANCIAL GROUP, INC. 10-Q

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

Subsidiary Liquidity Great American Life Insurance Company (“GALIC”), a wholly-owned annuity and supplemental insurance subsidiary, became a member of the Federal Home Loan Bank of Cincinnati (“FHLB”) in 2009. The FHLB makes loans and provides other banking services to member institutions. Members are required to purchase stock in the FHLB in addition to maintaining collateral deposits that back any funds borrowed. GALIC’s $15 million investment in FHLB capital stock at March 31, 2011 is included in other investments at cost. Membership in the FHLB provides the annuity and supplemental insurance operations with a substantial additional source of liquidity. No funds have been borrowed from the FHLB.

National Interstate, a 52%-owned property and casualty insurance subsidiary, can borrow up to $75 million, subject to certain conditions, under an unsecured credit agreement expiring in December 2012. Amounts borrowed bear interest at rates ranging from .45% to .9% (currently ..65%) over LIBOR based on National Interstate’s credit rating. There was $20 million outstanding under this agreement at March 31, 2011.

The liquidity requirements of AFG’s insurance subsidiaries relate primarily to the liabilities associated with their products as well as operating costs and expenses, payments of dividends and taxes to AFG and contributions of capital to their subsidiaries. Historically, cash flows from premiums and investment income have generally provided more than sufficient funds to meet these requirements 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. In addition, these subsidiaries have sufficient capital to meet commitments in the event of unforeseen events such as reserve deficiencies, inadequate premium rates or reinsurer insolvencies. Nonetheless, changes in statutory accounting rules, significant declines in the fair value of the insurance subsidiaries’ investment portfolios or significant ratings downgrades on these investments, could create a need for additional capital.

InvestmentsAFG’s investment portfolio at March 31, 2011, contained $19.6 billion in “Fixed maturities” classified as available for sale and $743 million in “Equity securities,” all carried at fair value with unrealized gains and losses included in a separate component of shareholders’ equity on an after-tax basis. In addition, $397 million in fixed maturities were classified as trading with changes in unrealized holding gains or losses included in investment income.

34

AMERICAN FINANCIAL GROUP, INC. 10-Q

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

Fair values for AFG’s portfolio are determined by AFG’s internal investment professionals using data from nationally recognized pricing services as well as non-binding broker quotes. Fair values of equity securities are generally based on closing prices obtained from the pricing services. For mortgage-backed securities (“MBS”), which comprise approximately 30% of AFG’s fixed maturities, prices for each security are generally obtained from both pricing services and broker quotes. For the remainder of AFG’s fixed maturity portfolio, approximately 93% are priced using pricing services and the balance is priced internally or by using non-binding broker quotes. When prices obtained for the same security vary, AFG’s internal investment professionals select the price they believe is most indicative of an exit price.

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

Valuation techniques utilized by pricing services and prices obtained from external sources are reviewed by AFG’s internal investment professionals who are familiar with the securities being priced and the markets in which they trade to ensure the fair value determination is representative of an exit price. To validate the appropriateness of the prices obtained, these investment managers consider widely published indices (as benchmarks), recent trades, changes in interest rates, general economic conditions and the credit quality of the specific issuers. Prices obtained from a broker or pricing service are adjusted only in cases where they are deemed not to be representative of an appropriate exit price (fewer than 1% of the securities).

In general, the fair value of AFG’s fixed maturity investments is inversely correlated to changes in interest rates. The following table demonstrates the sensitivity of such fair values to reasonably likely changes in interest rates by illustrating the estimated effect on AFG’s fixed maturity portfolio that an immediate increase of 100 basis points in the interest rate yield curve would have at March 31, 2011 (dollars in millions). Increases or decreases from the 100 basis points illustrated would be approximately proportional.


Fair value of fixed maturity portfolio	$	20,027
Pretax impact on fair value of 100 bps increase in interest rates	$	(901	)
Pretax impact as % of total fixed maturity portfolio		(4.5	%)

Approximately 91% of the fixed maturities held by AFG at March 31, 2011, 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 the high quality investment portfolio should generate a stable and predictable investment return.

35

AMERICAN FINANCIAL GROUP, INC. 10-Q

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

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

Summarized information for AFG’s MBS (including those classified as trading) at March 31, 2011, is shown (in millions) in the table below. Agency-backed securities are those issued by a U.S. government-backed agency; Alt-A mortgages are those with risk profiles between prime and subprime. The majority of the Alt-A securities and substantially all of the subprime securities are backed by fixed-rate mortgages. The average life of the residential and commercial MBS is approximately 4 and 5 years, respectively.


											% Rated
	Amortized				Fair Value as			Unrealized			Investment
Collateral type	Cost		Fair Value		% of Cost			Gain (Loss)			Grade
Residential:
Agency-backed	$	433	$	448		103	%	$	15			100	%
Non-agency prime		2,117		2,227		105			110			78
Alt-A		736		729		99			(7	)		51
Subprime		454		458		101			4			41
Commercial		2,164		2,332		108			168			100
Other		25		29		116			4			52

	$	5,929	$	6,223		105	%	$	294			82	%

The National Association of Insurance Commissioners (“NAIC”) assigns creditworthiness designations on a scale of 1 to 6 with 1 being the highest quality and 6 being the lowest quality. The NAIC retained a third-party investment management firm to assist in the determination of appropriate NAIC designations for mortgage-backed securities based not only on the probability of loss (which is the primary basis of ratings by the major ratings firms), but also on the severity of loss and statutory carrying value. At March 31, 2011, 98% (based on statutory carrying value of $5.9 billion) of AFG’s MBS securities had an NAIC designation of 1 or 2.

Municipal bonds represented approximately 16% of AFG’s fixed maturity portfolio at March 31, 2011. AFG’s municipal bond portfolio is high quality, with 99% of the securities rated investment grade at that date. The portfolio is well diversified across the states of issuance and individual issuers. At March 31, 2011, approximately 75% of the municipal bond portfolio was held in revenue bonds, with the remaining 25% held in general obligation bonds. State general obligation securities of California, Illinois, New Jersey and New York collectively represented only 2% of this portfolio.

36

AMERICAN FINANCIAL GROUP, INC. 10-Q

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

Summarized information for the unrealized gains and losses recorded in AFG’s Balance Sheet at March 31, 2011, is shown in the following table (dollars in millions). Approximately $263 million of available for sale “Fixed maturities” and $36 million of “Equity securities” had no unrealized gains or losses at March 31, 2011.


	Securities			Securities
	With			With
	Unrealized			Unrealized
	Gains			Losses
Available for Sale Fixed Maturities
Fair value of securities	$	15,644		$	3,723
Amortized cost of securities	$	14,575		$	3,917
Gross unrealized gain (loss)	$	1,069		$	(194	)
Fair value as % of amortized cost		107	%		95	%
Number of security positions		3,162			1,155
Number individually exceeding $2 million gain or loss		79			2
Concentration of gains (losses) by type or industry (exceeding 5% of unrealized):
Mortgage-backed securities	$	406		$	(112	)
States and municipalities		49			(46	)
Banks, savings and credit institutions		90			(8	)
Gas and electric services		112			(4	)
Percentage rated investment grade		92	%		86	%

Equity Securities
Fair value of securities	$	638		$	69
Cost of securities	$	388		$	74
Gross unrealized gain (loss)	$	250	(*)	$	(5	)
Fair value as % of cost		164	%		93	%
Number of security positions		111			33
Number individually exceeding $2 million gain or loss		11			—


(*)		Includes $159 million on AFG’s investment in Verisk Analytics, Inc.

The table below sets forth the scheduled maturities of AFG’s available for sale fixed maturity securities at March 31, 2011, 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.


	Securities			Securities
	With			With
	Unrealized			Unrealized
	Gains			Losses
Maturity
One year or less		3	%		—	%
After one year through five years		30			15
After five years through ten years		30			31
After ten years		6			25

		69			71

Mortgage-backed securities (average life of approximately four years)		31			29

		100	%		100	%

37

AMERICAN FINANCIAL GROUP, INC. 10-Q

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

The table below (dollars in millions) summarizes the unrealized gains and losses on fixed maturity securities by dollar amount.


						Fair
	Aggregate		Aggregate			Value as
	Fair		Unrealized			% of Cost
	Value		Gain (Loss)			Basis
Fixed Maturities at March 31, 2011

Securities with unrealized gains:
Exceeding $500,000 (644 issues)	$	8,101	$	768			110	%
$500,000 or less (2,518 issues)		7,543		301			104

	$	15,644	$	1,069			107	%


Securities with unrealized losses:
Exceeding $500,000 (100 issues)	$	562	$	(93	)		86	%
$500,000 or less (1,055 issues)		3,161		(101	)		97

	$	3,723	$	(194	)		95	%

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


						Fair
	Aggregate		Aggregate			Value as
	Fair		Unrealized			% of Cost
	Value		Loss			Basis
Securities with Unrealized Losses at March 31, 2011

Investment grade fixed maturities with losses for:
Less than one year (772 issues)	$	2,821	$	(76	)		97	%
One year or longer (153 issues)		386		(44	)		90

	$	3,207	$	(120	)		96	%


Non-investment grade fixed maturities with losses for:
Less than one year (62 issues)	$	162	$	(5	)		97	%
One year or longer (168 issues)		354		(69	)		84

	$	516	$	(74	)		87	%


Common equity securities with losses for:
Less than one year (14 issues)	$	22	$	(1	)		96	%
One year or longer (5 issues)		—		—			—

	$	22	$	(1	)		96	%


Perpetual preferred equity securities with losses for:
Less than one year (3 issues)	$	6	$	—			100	%
One year or longer (11 issues)		41		(4	)		91

	$	47	$	(4	)		92	%

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 by the amount of the charge. The determination of whether unrealized losses are “other-than-temporary” requires judgment based on subjective as well as objective factors as detailed in AFG’s 2010 Form 10-K underManagement’s Discussion and Analysis — “Investments.”

38

AMERICAN FINANCIAL GROUP, INC. 10-Q

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

Based on its analysis, management believes (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 recover in value and, at March 31, 2011, had no intent to sell them. 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 results of operations in future periods. Significant declines in the fair value of AFG’s investment portfolio could have a significant adverse effect on AFG’s liquidity.

Uncertainties Management believes that the areas posing the greatest risk of material loss are the adequacy of its insurance reserves and contingencies arising out of its former railroad and manufacturing operations. AFG has conducted comprehensive studies of its asbestos and environmental reserves with the aid of outside actuarial and engineering firms and specialty outside counsel every two years with an in-depth internal review during the intervening years. The 2011 study with the assistance of outside firms has commenced and is expected to be completed by the end of the second quarter. See Management’s Discussion and Analysis — “Uncertainties” in AFG’s 2010 Form 10-K.

MANAGED INVESTMENT ENTITIES

Beginning January 1, 2010, new accounting standards require AFG to consolidate its investments in six collateralized loan obligation (“CLO”) entities that it manages and owns an interest in (in the form of debt). See Note A - “Accounting Policies - Managed Investment Entities” andNote H - “Managed Investment Entities.” The effect of consolidating these entities is shown in the tables below (in millions). The “Before CLO Consolidation” columns include AFG’s investment and earnings in the CLOs on an unconsolidated basis.

CONDENSED CONSOLIDATING BALANCE SHEET


			Managed
	Before CLO		Investment		Consol.			Consolidated
March 31, 2011	Consolidation		Entities		Entries			As Reported
Assets:
Cash and other investments	$	23,557	$	—	$	(20	)(a)	$	23,537
Assets of managed investment entities		—		2,570		—			2,570
Other assets		6,841		—		—			6,841

	$	30,398	$	2,570	$	(20	)	$	32,948


Liabilities:
Unpaid losses, loss adjustment expenses and unearned premiums	$	7,727	$	—	$	—		$	7,727
Annuity, life, accident and health benefits and reserves		15,073		—		—			15,073
Liabilities of managed investment entities		—		2,408		(20	)(a)		2,388
Long-term debt and other liabilities		3,148		—		—			3,148

		25,948		2,408		(20	)		28,336

Shareholders’ Equity:
Common Stock and Capital surplus		1,262		—		—			1,262
Retained earnings:
Appropriated — managed investment entities		—		162		—			162
Unappropriated		2,536		—		—			2,536
Accumulated other comprehensive income		503		—		—			503

		4,301		162		—			4,463
Noncontrolling interests		149		—		—			149

		4,450		162		—			4,612

	$	30,398	$	2,570	$	(20	)	$	32,948


(a)		Elimination of the fair value of AFG’s investment in CLOs.

39

AMERICAN FINANCIAL GROUP, INC. 10-Q

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

CONDENSED CONSOLIDATING BALANCE SHEET


			Managed
	Before CLO		Investment		Consol.			Consolidated
December 31, 2010	Consolidation		Entities		Entries			As Reported
Assets:
Cash and other investments	$	22,687	$	—	$	(17	)(a)	$	22,670
Assets of managed investment entities		—		2,537		—			2,537
Other assets		7,247		—		—			7,247

	$	29,934	$	2,537	$	(17	)	$	32,454


Liabilities:
Unpaid losses, loss adjustment expenses and unearned premiums	$	7,947	$	—	$	—		$	7,947
Annuity, life, accident and health benefits and reserves		14,555		—		—			14,555
Liabilities of managed investment entities		—		2,340		(17	)(a)		2,323
Long-term debt and other liabilities		3,009		—		—			3,009

		25,511		2,340		(17	)		27,834

Shareholders’ equity:
Common Stock and Capital surplus		1,271		—		—			1,271
Retained earnings:
Appropriated — managed investment entities		—		197		—			197
Unappropriated		2,523		—		—			2,523
Accumulated other comprehensive income		479		—		—			479

		4,273		197		—			4,470
Noncontrolling interests		150		—		—			150

		4,423		197		—			4,620

	$	29,934	$	2,537	$	(17	)	$	32,454


(a)		Elimination of the fair value of AFG’s investment in CLOs.

CONDENSED CONSOLIDATING STATEMENT OF EARNINGS


				Managed
	Before CLO			Investment			Consol.			Consolidated
Three months ended March 31, 2011	Consolidation(a)			Entities			Entries			As Reported
Revenues:
Insurance premiums	$	709		$	—		$	—		$	709
Investment income		300			—			—			300
Realized gains (losses) on securities		6			—			(6	)(b)		—
Realized gains (loss) on subsidiaries		(3	)		—			—			(3	)
Income (loss) of managed investment entities:
Investment income		—			25			—			25
Loss on change in fair value of assets/liabilities		—			(36	)		3	(b)		(33	)
Other income		44			—			(3	)(c)		41

		1,056			(11	)		(6	)		1,039

Costs and Expenses:
Insurance benefits and expenses		818			—			—			818
Expenses of managed investment entities		—			24			(6	)(b)(c)		18
Interest on borrowed money and other expenses		108			—			—			108

		926			24			(6	)		944

Operating earnings before income taxes		130			(35	)		—			95
Provision for income taxes		46			—			—			46

Net earnings, including noncontrolling interests		84			(35	)		—			49
Less: Net earnings (loss) attributable to noncontrolling interests		1			—			(35	)(d)		(34	)

Net Earnings Attributable to Shareholders	$	83		$	(35	)	$	35		$	83


(a)		Includes $6 million in realized gains representing the change in fair value of AFG’s CLO investments plus $3 million in CLO management fees earned.

(b)		Elimination of the change in fair value of AFG’s investments in the CLOs, including $3 million in distributions recorded as interest expense by the CLOs.

(c)		Elimination of management fees earned by AFG.

(d)		Allocate losses of CLOs attributable to other debt holders to noncontrolling interests.

40

AMERICAN FINANCIAL GROUP, INC. 10-Q

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

CONDENSED CONSOLIDATING STATEMENT OF EARNINGS


			Managed
	Before CLO		Investment			Consol.			Consolidated
Three months ended March 31, 2010	Consolidation(a)		Entities			Entries			As Reported
Revenues:
Insurance premiums	$	694	$	—		$	—		$	694
Investment income		295		—			—			295
Realized gains (losses) on securities		8		—			(4	)(b)		4
Income (loss) of managed investment entities:
Investment income		—		22			—			22
Loss on change in fair value of assets/liabilities		—		(29	)		4	(b)		(25	)
Other income		48		—			(4	)(c)		44

		1,045		(7	)		(4	)		1,034
Costs and Expenses:
Insurance benefits and expenses		761		—			—			761
Expenses of managed investment entities		—		13			(4	)(c)		9
Interest on borrowed money and other expenses		117		—			—			117

		878		13			(4	)		887

Operating earnings before income taxes		167		(20	)		—			147
Provision for income taxes		59		—			—			59

Net earnings, including noncontrolling interests		108		(20	)		—			88
Less: Net earnings (loss) attributable to noncontrolling interests		2		—			(20	)(d)		(18	)

Net Earnings Attributable to Shareholders	$	106	$	(20	)	$	20		$	106


(a)		Includes $4 million in realized gains representing the change in fair value of AFG’s CLO investments plus $4 million in CLO management fees earned.

(b)		Elimination of the change in fair value of AFG’s investments in the CLOs.

(c)		Elimination of management fees earned by AFG.

(d)		Allocate losses of CLOs attributable to other debt holders to noncontrolling interests.

RESULTS OF OPERATIONS

General Results of operations as shown in the accompanying financial statements are prepared in accordance with U.S. generally accepted accounting principles (“GAAP”).

AFG reported operating earnings before income taxes of $95 million for the first quarter of 2011 compared to $147 million for the 2010 first quarter. Results for the first quarter of 2011 include (i) a $25 million decline in property and casualty insurance underwriting results, (ii) a $19 million decline in property and casualty investment income, (iii) a $15 million increase in losses of managed investment entities attributable to noncontrolling interests, and (iv) an $8 million improvement in the annuity and supplemental insurance results.

Property and Casualty Insurance — Underwriting AFG reports its Specialty insurance business in the following sub-segments: (i) Property and transportation, (ii) Specialty casualty and (iii) Specialty financial.

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.

41

AMERICAN FINANCIAL GROUP, INC. 10-Q

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

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% indicates an underwriting profit. The combined ratio does not reflect investment income, other income or federal income taxes.

Premiums, combined ratios and prior year development for AFG’s property and casualty insurance operations were as follows (dollars in millions):


	Three months ended
	March 31,
	2011			2010
Gross Written Premiums
Property and transportation	$	318		$	277
Specialty casualty		319			347
Specialty financial		116			122
Other		—			(2	)

	$	753		$	744


Net Written Premiums
Property and transportation	$	254		$	216
Specialty casualty		214			238
Specialty financial		98			98
Other		18			14

	$	584		$	566


Combined Ratios
Property and transportation		87.0	%		85.2	%
Specialty casualty		99.2			91.5
Specialty financial		91.2			83.4
Total Specialty		92.3			86.6
Aggregate (including discontinued lines)		92.3	%		87.6	%

Favorable (Unfavorable) Prior Year Development
Property and transportation	$	22		$	9
Specialty casualty		—			19
Specialty financial		(4	)		10
Other specialty		3			7

		21			45
Other (primarily asbestos and environmental charges)		—			(6	)

	$	21		$	39

The overall increases in gross and net written premiums for the first quarter of 2011 compared to the same quarter of 2010 were the result of increased premiums in the transportation businesses, including additional premiums from National Interstate’s third quarter 2010 acquisition of Vanliner. These increases were partially offset by lower premium volume in the targeted markets operations and the decision to exit the excess workers’ compensation business. Overall average renewal rates for the first quarter of 2011 were flat when compared with the same 2010 period.

The Specialty insurance operations generated underwriting profits of $46 million in the first quarter of 2011, compared to $77 million in the first quarter of 2010. The reduced profit in 2011 is primarily the result of a $24 million decrease in favorable reserve development. Catastrophe losses were $8 million for the first quarter of 2011 compared to $9 million in the first quarter of 2010.

42

AMERICAN FINANCIAL GROUP, INC. 10-Q

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

Property and transportation gross and net written premiums increased during the first quarter of 2011 compared to 2010 as a result of additional premiums from the Vanliner acquisition and higher winter wheat commodity prices. Increased retention in the transportation businesses contributed to higher net written premiums for the 2011 first quarter. This group reported an underwriting profit of $33 million in the first quarter of 2011, compared to $32 million in the first quarter of 2010. Improved results in the agricultural operations were offset by lower underwriting profits in the transportation businesses. Catastrophe losses for this group were $5 million in 2011 compared to $8 million in the 2010 first quarter.

Specialty casualty gross and net written premiums decreased for the first quarter of 2011 compared to the same period of 2010 due primarily to a decision to exit the excess workers’ compensation business, the non-renewal of two major programs that did not meet return thresholds and a soft pricing environment in the excess and surplus markets. These declines were partially offset by growth in the executive liability operations. This group reported an underwriting profit of $2 million in the first quarter of 2011, compared to $18 million in the first quarter of 2010. The reduced profits are primarily the result of a $19 million decrease in favorable reserve development. Lower underwriting profits in a block of program business were partially offset by improved results in the general liability operations, (primarily those that serve the homebuilders industry), and the executive liability and excess and surplus lines businesses. Many businesses in this group produced solid underwriting profit margins but at lower levels than the 2010 first quarter.

Specialty financial gross written premiums decreased from the 2010 first quarter due primarily to the exit from certain automotive-related lines of business in 2009 that AFG continued to front through the first half of 2010. This group reported underwriting profits of $10 million in the first quarter of 2011 compared to $21 million in the first quarter of 2010. Lower favorable development resulting from a reserve increase in a run-off book of collateral mortgage protection insurance and the absence of favorable development related to the run-off automobile residual value insurance operations more than offset higher underwriting profits in the financial institutions business.

Annuity and Supplemental Insurance Operations Operating earnings before income taxes of the annuity and supplemental insurance segment increased $8 million (18%) from the comparable 2010 first quarter due primarily to higher earnings in the fixed annuity operations, especially the bank distribution channels, as well as the impact of expense savings.

43

AMERICAN FINANCIAL GROUP, INC. 10-Q

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

Statutory Annuity Premiums The following table summarizes AFG’s annuity sales (in millions):


	Three months ended
	March 31,
	2011		2010
403(b) Fixed and Indexed Annuities:
First Year	$	6	$	11
Renewal		42		42
Single Sum		17		25

Subtotal		65		78

Non-403(b) Indexed Annuities		257		132
Non-403(b) Fixed Annuities		60		102
Bank Annuities — Direct		100		54
Bank Annuities — Indirect		171		—
Variable Annuities		19		20

Total Annuity Premiums	$	672	$	386

“Bank Annuities — Direct” represent premiums generated by financial institutions appointed and serviced directly by AFG. “Bank Annuities — Indirect” represent premiums generated through banks by independent agents or brokers.

The increase in annuity premiums for the first three months of 2011 compared to the 2010 period is attributable to higher sales through the bank distribution channels and increased sales of indexed annuities in the non-403(b) single premium market. Higher sales in the bank channels reflect primarily “indirect” bank sales by one agent through Regions Bank; this relationship did not exist in the first quarter of 2010. In addition, AFG’s presence in PNC Bank (its primary “direct” bank distribution channel), and the corresponding “direct” sales of annuities through PNC, was minimal in the first two months of 2010. Increased sales of indexed annuities reflects the industry trend towards indexed annuities and away from traditional fixed annuities, as well as AFG’s introduction of new indexed products and features.

Life, Accident and Health Premiums and Benefits The following table summarizes AFG’s life, accident and health premiums and benefits as shown in the Consolidated Statement of Earnings (in millions):


	Three months ended
	March 31,
	2011		2010
Premiums
Supplemental insurance operations
First year	$	11	$	21
Renewal		92		87
Life operations (in run-off)		7		7

	$	110	$	115

Benefits
Supplemental insurance operations	$	85	$	86
Life operations (in run-off)		11		10

	$	96	$	96

Investment Income The $5 million increase in investment income for the first quarter of 2011 compared to the same period in 2010 reflects higher average invested assets, primarily related to growth in the annuity business, partially offset by lower yields on fixed maturity investments. Investment income includes $8 million in 2011 and $26 million in 2010 of interest income earned on interest-only and similar MBS, primarily non-agency interest-only securities with interest rates that float inversely with short-term rates.

44

AMERICAN FINANCIAL GROUP, INC. 10-Q

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

Over the past couple of years, yields available in the financial markets on fixed maturity securities have generally declined, placing downward pressure on AFG’s investment portfolio yield.

Realized Gains (Losses) on Securities Net realized gains (losses) on securities consisted of the following (in millions):


	Three months ended
	March 31,
	2011			2010
Realized gains (losses) before impairments:
Disposals	$	17		$	19
Change in the fair value of derivatives		(5	)		9
Adjustments to annuity deferred policy acquisition costs and related items		(2	)		(3	)

		10			25

Impairment charges:
Securities		(14	)		(30	)
Adjustments to annuity deferred policy acquisition costs and related items		4			9

		(10	)		(21	)


	$	—		$	4

The change in fair value of derivatives includes net losses of $3 million in the 2011 quarter and net gains of $17 million in the 2010 quarter from the mark-to-market of MBS, primarily interest-only securities with interest rates that float inversely with short-term rates. SeeNote F — “Derivatives.”

Annuity Benefits Annuity benefits reflect amounts accrued on annuity policyholders’ funds accumulated. On deferred annuities (annuities in the accumulation phase), interest is generally credited to policyholders’ accounts at their current stated interest rates. Furthermore, for “two-tier” deferred annuities (annuities under which a higher interest amount can be earned if a policy is annuitized rather 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 investment yields, crediting rates, actual surrender, death and annuitization experience or modifications in actuarial assumptions can affect these additional reserves and could result in charges (or credits) to earnings in the period the projections are modified.

The $8 million increase in annuity benefits in the first quarter of 2011 compared to the first quarter of 2010 reflects growth in the annuity business.

Annuity and Supplemental Insurance Acquisition Expenses Annuity and supplemental insurance acquisition expenses include amortization of annuity, supplemental insurance and life business deferred policy acquisition costs (“DPAC”) as well as a portion of commissions on sales of insurance products. Annuity and supplemental insurance acquisition expenses also include amortization of the present value of future profits of businesses acquired (“PVFP”).

45

AMERICAN FINANCIAL GROUP, INC. 10-Q

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

The $4 million increase in annuity and supplemental insurance acquisition expenses in the first quarter of 2011 compared to the first quarter of 2010 reflects growth in the annuity business.

The vast majority of the annuity and supplemental insurance group’s DPAC asset relates to its 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.

Interest Charges on Borrowed Money Interest expense increased $3 million (17%) for the first quarter of 2011 compared to the first quarter of 2010 reflecting AFG’s issuance of $132 million of 7% Senior Notes in September 2010.

Other Operating and General Expenses The $12 million (12%) decrease in other operating and general expenses for the first quarter of 2011 compared to the first quarter of 2010 reflects the impact of a $10 million recovery on a prior property and casualty extracontractual obligation claim and lower expenses in the annuity and supplemental insurance operations.

RECENT ACCOUNTING STANDARDS

In October 2010, the FASB issued Accounting Standards Update 2010-26 to address diversity in practice regarding which costs related to issuing or renewing insurance contracts qualify for deferral. To qualify for deferral, the guidance specifies that a cost must be directly related to the successful acquisition of an insurance contract. The guidance is effective January 1, 2012, with retrospective application permitted, but not required. Management continues assessing the impact of adoption and expects that adoption will be reported retrospectively.

46

AMERICAN FINANCIAL GROUP, INC. 10-Q

ITEM 3

Quantitative and Qualitative Disclosure of Market Risk

As of March 31, 2011, there were no material changes to the information provided in Item 7A - “Quantitative and Qualitative Disclosure of Market Risk” of AFG’s 2010 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 first fiscal quarter of 2011 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 first fiscal quarter of 2011 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 2010 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 of $123.5 million (Great American has the option to pay in cash or over time with 5.25% interest) has been fully accrued and 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.

On May 3, 2011, in connection with the appeal of the 2007 bankruptcy court confirmation, the Third Circuit Court of Appeals issued an opinion holding that two non-settling insurers had standing to challenge the trust established to administer silica claims which had been approved as part of the plan of bankruptcy along with the trust established to administer asbestos claims. The court also vacated the order confirming the Plan of Reorganization and remanded the Plan to the bankruptcy court for further proceedings on this limited issue. While the bankruptcy court had previously concluded that the trust to administer silica claims was a valid and legitimate trust, the Third Circuit held that a fuller evidentiary hearing is required on remand. Management believes that resolution of this issue ultimately will not impact the Great American settlement.

47

AMERICAN FINANCIAL GROUP, INC. 10-Q

PART II
OTHER INFORMATION

ITEM 2

Unregistered Sales of Equity Securities and Use of Proceeds

Issuer Purchases of Equity Securities AFG repurchased shares of its common stock during the first quarter of 2011 as follows:


					Total Number		Maximum Number
					of Shares		of Shares
	Total				Purchased as		that May
	Number		Average		Part of Publicly		Yet be Purchased
	of Shares		Price Paid		Announced Plans		Under the Plans
	Purchased		Per Share		or Programs		or Programs (a)

January		250,000	$	32.73		250,000		2,458,427

February		800,641	$	34.22		800,641		11,657,786

March		1,407,080	$	34.17		1,407,080		10,250,706


(a)		Represents the remaining shares that may be repurchased under the Plans authorized by AFG’s Board of Directors in August 2010 and February 2011. In February 2011, AFG’s Board of Directors authorized the repurchase of ten million additional shares.

ITEM 6

Exhibits


Number			Exhibit Description

	12		Computation of ratios of earnings to fixed charges.

	31	(a)	Certification of the Co-Chief Executive Officer pursuant to section 302(a) of the Sarbanes-Oxley Act of 2002.

	31	(b)	Certification of the Co-Chief Executive Officer pursuant to section 302(a) of the Sarbanes-Oxley Act of 2002.

	31	(c)	Certification of the Chief Financial Officer pursuant to section 302(a) of the Sarbanes-Oxley Act of 2002.

	32		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.
May 9, 2011	BY:	/s/ Keith A. Jensen
		Keith A. Jensen
		Senior Vice President (principal financial and accounting officer)

48

American Financial Group - 10-Q quarterly report FY

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