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American Financial Group, Inc. Announces Record Second Quarter Results

August 1, 2018

CINCINNATI--(BUSINESS WIRE)--Aug 1, 2018--American Financial Group, Inc. (NYSE: AFG) today reported 2018 second quarter net earnings attributable to shareholders of $210 million ($2.31 per share) compared to $145 million ($1.61 per share) for the 2017 second quarter. The $2.31 per share is a record for AFG’s second quarter. Net earnings for the quarter include $25 million ($0.27 per share) in after-tax net realized gains on securities. By comparison, net earnings in the 2017 second quarter include $5 million ($0.05 per share) in after-tax net realized gains on securities and expenses of $5 million ($0.05 per share) related to the redemption of AFG’s 6.375% Senior Notes. The change in the federal corporate tax rate from 35% to 21%, enacted by the Tax Cuts and Jobs Act of 2017 and effective January 1, 2018, contributed to a lower effective tax rate in 2018 as compared to 2017. Details may be found in the table below. Book value per share was $57.08 per share at June 30, 2018. AFG paid cash dividends of $1.85 per share during the quarter, which included a $1.50 per share special dividend. Annualized return on equity was 17.1% and 12.3% for the second quarters of 2018 and 2017, respectively.

Core net operating earnings were $185 million ($2.04 per share) for the 2018 second quarter, compared to $145 million ($1.61 per share) in the 2017 second quarter. The $2.04 per share represents a 27% increase over the prior year period, and a record second quarter for AFG core earnings per share. The improved results were attributable to higher earnings in our Specialty Property and Casualty (“P&C”) Insurance operations and our Annuity Segment, as well as the benefit of the lower corporate income tax rate. Book value per share, excluding unrealized gains related to fixed maturities, was $55.24 per share at June 30, 2018. Core net operating earnings for the second quarters of 2018 and 2017 generated annualized returns on equity of 15.1% and 12.3%, respectively.

AFG’s net earnings attributable to shareholders, determined in accordance with U.S. generally accepted accounting principles (GAAP), include certain items that may not be indicative of its ongoing core operations. The table below identifies such items and reconciles net earnings attributable to shareholders to core net operating earnings, a non-GAAP financial measure. AFG believes that its core net operating earnings provides management, financial analysts, ratings agencies and investors with an understanding of the results from the ongoing operations of the Company by excluding the impact of net realized gains and losses and other special items that are not necessarily indicative of operating trends. AFG’s management uses core net operating earnings to evaluate financial performance against historical results because it believes this provides a more comparable measure of its continuing business. Core net operating earnings is also used by AFG’s management as a basis for strategic planning and forecasting.

Carl H. Lindner III and S. Craig Lindner, AFG’s Co-Chief Executive Officers, issued this statement: “We are pleased to report record second quarter earnings per share for AFG and an annualized core ROE that exceeded 15%. In addition to strong operating profitability and investment results in both our Specialty P&C and Annuity Segments, we achieved meaningful growth across our portfolio of businesses.

“AFG had approximately $720 million of excess capital (including parent company cash of approximately $260 million) at June 30, 2018 and following the payment of the special dividend. Where appropriate, our excess capital will be deployed into AFG’s core businesses as we identify potential for healthy, profitable organic growth, and opportunities to expand our specialty niche businesses through acquisitions and start-ups that meet our target return thresholds. In addition, returning capital to shareholders in the form of regular and special cash dividends and opportunistic share repurchases are also an important and effective component of our capital management strategy. We will evaluate our excess capital position again in the second half of 2018 and note that the special cash dividend paid in May does not preclude our consideration of additional actions with respect to our regular quarterly dividend, additional special dividends and opportunistic share repurchases.

“Based on results for the first six months of 2018, we now expect AFG’s core net operating earnings in 2018 to be in the range of $8.10 to $8.60 per share, up from our original estimate of $7.90 to $8.40 per share. Our core earnings per share guidance excludes non-core items such as realized gains and losses, as well as other significant items that are not able to be estimated with reasonable precision, or that may not be indicative of ongoing operations.”

Specialty Property and Casualty Insurance Operations

Core operating earnings before income taxes in AFG’s P&C Insurance Segment were $180 million in the second quarter of 2018, compared to $163 million in the prior year period, an increase of $17 million, or 10%. Underwriting profit in the second quarter of 2018 was in line with the strong results reported in the 2017 second quarter; higher P&C net investment income was the primary driver of the improved year-over-year results, primarily the result of higher earnings on certain investments (including limited partnerships and similar investments); these high returns should not necessarily be expected to repeat in future periods.

The Specialty P&C insurance operations generated an underwriting profit of $73 million in both the 2018 and 2017 second quarters. The second quarter 2018 combined ratio of 93.7% was 0.5 points higher than the prior year period. Results in the second quarter of 2018 include 3.9 points of favorable prior year reserve development, compared to 2.2 points in the 2017 second quarter. Catastrophe losses added 1.4 points to the second quarter 2018 results, compared to 1.7 points in the comparable prior year period.

Gross and net written premiums each grew 11% for the second quarter of 2018, when compared to the second quarter of 2017. Average renewal pricing across the entire P&C Group was up approximately 1.4% for the quarter. Excluding our workers’ compensation business, renewal pricing was up approximately 3.4%. Further details about AFG’s Specialty P&C operations may be found in the accompanying schedules.

The Property and Transportation Group reported an underwriting profit of $23 million in the second quarter of 2018, compared to $21 million in the second quarter of 2017. These results include higher year-over-year underwriting profits in our transportation businesses and improved results in our ocean marine operations and lower underwriting profitability in our property & inland marine and equine mortality businesses . Catastrophe losses were $10 million for this group during the second quarter of 2018, compared to $11 million in the comparable prior year period.

Gross and net written premiums for the second quarter of 2018 were both 7% higher than the comparable 2017 period. The growth is primarily attributable to new business opportunities in our property & inland marine business and higher premiums in our transportation businesses, which included a 5% renewal premium increase in National Interstate’s business. Overall renewal rates in this group increased 4% on average for the second quarter of 2018.

The Specialty Casualty Group reported an underwriting profit of $29 million in both the second quarters of 2018 and 2017. Higher profitability in our targeted markets businesses was offset by lower year-over-year profitability in our excess and surplus lines. Underwriting profitability in our workers compensation business continues to be very strong. Catastrophe losses for this group were $1 million and $2 million in the second quarters of 2018 and 2017, respectively.

Gross and net written premiums for the second quarter of 2018 increased 13% and 14%, respectively, when compared to the second quarter of 2017. Growth within Neon was the driver of the higher premiums. Our general liability, executive liability and excess and surplus lines businesses also reported higher year-over-year premiums. This growth was partially offset by lower premiums in our workers’ compensation businesses. Renewal pricing for this group was flat in the second quarter. Excluding rate decreases in our workers’ compensation businesses, renewal rates in this group were up approximately 3%.

The Specialty Financial Group reported underwriting profit of $22 million in the second quarter of 2018, compared to $23 million in the second quarter of 2017. Higher underwriting profitability in our financial institutions business was partially offset by lower underwriting profitability in our surety business. Catastrophe losses for this group were $3 million and $5 million in the second quarters of 2018 and 2017, respectively. All of the businesses in this group continued to achieve excellent underwriting margins.

Gross and net written premiums for the second quarter of 2018 were up 10% and 7%, respectively, when compared to the same 2017 period, primarily as a result of higher premiums in our financial institutions business. Renewal pricing in this group was up approximately 5% for the quarter.

Carl Lindner III stated: “I’m pleased with our Specialty P&C results during the second quarter. Each of our Specialty P&C Groups reported strong underwriting margins and we achieved double digit year-over-year growth in net written premiums. Second quarter renewal pricing for our Specialty P&C Group overall was at its highest level in 13 quarters. Based on results during the first six months of the year, we now expect growth in net written premium to be in the range of 4% to 8%, up from our original estimate of 3% to 7%, and we continue to expect an overall 2018 calendar year combined ratio in the range of 92% to 94%.”

Further details about AFG’s Specialty P&C operations may be found in the accompanying schedules and in our Quarterly Investor Supplement, which is posted on our website.

Annuity Segment

As shown in the following table, AFG’s Annuity Segment reported $99 million in pretax earnings in the second quarter of 2018, a 16% increase over the $85 million reported in the second quarter of 2017.

Annuity Earnings Before Fair Value Accounting for FIAs – Annuity earnings before fair value accounting for fixed-indexed annuities (FIAs) and unlocking were $123 million in the second quarter of 2018, a 22% increase over the $101 million reported in the second quarter of 2017. These earnings represent a quarterly record for the Annuity segment. As shown in AFG’s Quarterly Investor Supplement, these outstanding results were favorably impacted by growth in assets and by exceptionally high returns on certain investments (including very strong earnings from limited partnerships and similar investments); these high returns should not necessarily be expected to repeat in future periods. The benefit of these items was partially offset by the runoff of higher-yielding investments.

Impact of Fair Value Accounting for FIAs – Under GAAP, a portion of the reserves for FIAs ($2.8 billion and $2.1 billion at June 30, 2018 and 2017, respectively) is considered an embedded derivative and is recorded at fair value based on the estimated present value of certain expected future cash flows. Assumptions used in calculating this fair value include projected interest rates, option costs, surrenders, withdrawals and mortality. Variances from these assumptions, as well as changes in the stock market, will generally result in a change in fair value. Some of these adjustments are not economic in nature for the current reporting period, but rather impact the timing of reported results. The components of this impact were as follows (in millions):

The impact of fair value accounting for FIAs includes an ongoing expense for annuity interest accreted on the FIA embedded derivative reserve. The amount of interest accreted in any period is generally based on the size of the embedded derivative and current interest rates. We expect both the size of the embedded derivative and interest rates to rise, resulting in continued increases in interest on the embedded derivative liability.

In the second quarter of 2018, the stock market increased nearly 3% and interest rates rose 20 to 25 basis points; these increases exceeded our expectation of a 1% increase and a 5 basis point increase, respectively. The significant favorable impact from these two items more than offset continued higher FIA option costs.

For additional analysis of fair value accounting, see our Quarterly Investor Supplement, which is posted on AFG’s website.

Unlocking – AFG monitors the major actuarial assumptions underlying its annuity operations throughout the year and conducts detailed reviews (“unlocking”) of its assumptions in the fourth quarter of each year. If changes in the economic environment or actual experience would cause material revisions to future estimates, AFG will unlock assumptions in an interim quarter. Due to continued higher FIA option costs (resulting primarily from higher than expected risk-free interest rates), AFG unlocked its assumptions for option costs and interest rates in the second quarter of 2018, resulting in a net charge to earnings of $27 million, as shown in the table above. AFG will continue its practice of conducting detailed reviews of its assumptions (including option costs and interest rates) in the fourth quarter each year, including 2018.

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