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 September 30, 20172018
   
Commission File No. 1-13653 

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AMERICAN FINANCIAL GROUP, INC.
Incorporated under the Laws of Ohio IRS Employer I.D. No. 31-1544320
301 East Fourth Street, Cincinnati, Ohio 45202
(513) 579-2121
Indicate by check mark whether the Registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months, and (2) has been subject to such filing requirements for the past 90 days. Yes þ No ¨
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. Yes þ No ¨
Indicate by check mark whether the Registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, smaller reporting company or an emerging growth company. See definitions of “large accelerated filer,” “accelerated filer,” “smaller reporting company” and “emerging growth company” in Rule 12b-2 of the Exchange Act.
Large accelerated filer  þ                        Accelerated filer  ¨                        Non-accelerated filer  ¨
Smaller reporting company  ¨                        Emerging growth company  ¨
If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. ¨
Indicate by check mark whether the Registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes ¨ No þ
As of November 1, 20172018, there were 88,112,75389,253,183 shares of the Registrant’s Common Stock outstanding, excluding 14.9 million shares owned by subsidiaries.



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AMERICAN FINANCIAL GROUP, INC. 10-Q

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Table of Contents
AMERICAN FINANCIAL GROUP, INC. 10-Q

PART I
ITEM I — FINANCIAL STATEMENTS
AMERICAN FINANCIAL GROUP, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEET (UNAUDITED)
(Dollars in Millions)
September 30,
2017
 December 31,
2016
September 30,
2018
 December 31,
2017
Assets:      
Cash and cash equivalents$2,349
 $2,107
$2,009
 $2,338
Investments:      
Fixed maturities, available for sale at fair value (amortized cost — $36,412 and $33,735)37,818
 34,544
Fixed maturities, available for sale at fair value (amortized cost — $40,053 and $37,038)40,244
 38,379
Fixed maturities, trading at fair value350
 359
103
 348
Equity securities, available for sale at fair value (cost — $1,312 and $1,351)1,579
 1,502
Equity securities, trading at fair value60
 56
Equity securities, at fair value1,827
 1,662
Investments accounted for using the equity method1,289
 999
Mortgage loans1,043
 1,147
1,152
 1,125
Policy loans186
 192
176
 184
Equity index call options629
 492
759
 701
Real estate and other investments1,239
 1,034
282
 312
Total cash and investments45,253
 41,433
47,841
 46,048
Recoverables from reinsurers3,262
 2,737
3,352
 3,369
Prepaid reinsurance premiums691
 539
717
 600
Agents’ balances and premiums receivable1,173
 997
1,299
 1,146
Deferred policy acquisition costs1,119
 1,239
1,669
 1,216
Assets of managed investment entities4,767
 4,765
4,998
 4,902
Other receivables1,545
 908
1,633
 1,030
Variable annuity assets (separate accounts)628
 600
650
 644
Other assets1,526
 1,655
1,832
 1,504
Goodwill199
 199
199
 199
Total assets$60,163
 $55,072
$64,190
 $60,658
      
Liabilities and Equity:      
Unpaid losses and loss adjustment expenses$9,563
 $8,563
$9,670
 $9,678
Unearned premiums2,567
 2,171
2,740
 2,410
Annuity benefits accumulated32,671
 29,907
35,958
 33,316
Life, accident and health reserves667
 691
643
 658
Payable to reinsurers906
 634
932
 743
Liabilities of managed investment entities4,506
 4,549
4,807
 4,687
Long-term debt1,284
 1,283
1,302
 1,301
Variable annuity liabilities (separate accounts)628
 600
650
 644
Other liabilities1,992
 1,755
2,324
 1,887
Total liabilities54,784
 50,153
59,026
 55,324
   
Redeemable noncontrolling interests
 3
   
Shareholders’ equity:      
Common Stock, no par value
— 200,000,000 shares authorized
— 88,092,794 and 86,924,399 shares outstanding
88
 87
Common Stock, no par value
— 200,000,000 shares authorized
— 89,188,708 and 88,275,460 shares outstanding
89
 88
Capital surplus1,167
 1,111
1,231
 1,181
Retained earnings3,435
 3,343
3,800
 3,248
Accumulated other comprehensive income, net of tax689
 375
44
 813
Total shareholders’ equity5,379
 4,916
5,164
 5,330
Noncontrolling interests
 3

 1
Total equity5,379
 4,919
5,164
 5,331
Total liabilities and equity$60,163
 $55,072
$64,190
 $60,658

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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 September 30, Nine months ended September 30,Three months ended September 30, Nine months ended September 30,
2017 2016 2017 20162018 2017 2018 2017
Revenues:              
Property and casualty insurance net earned premiums$1,267
 $1,159
 $3,354
 $3,184
$1,327
 $1,267
 $3,595
 $3,354
Life, accident and health net earned premiums6
 6
 17
 18
6
 6
 18
 17
Net investment income471
 433
 1,366
 1,267
527
 471
 1,552
 1,366
Realized gains (losses) on:       
Securities (*)(12) 2
 (1) (32)
Subsidiaries
 
 
 2
Income of managed investment entities:       
Realized gains (losses) on securities (*)34
 (12) (28) (1)
Income (loss) of managed investment entities:       
Investment income54
 48
 155
 141
65
 54
 187
 155
Gain on change in fair value of assets/liabilities1
 11
 12
 9
Gain (loss) on change in fair value of assets/liabilities(5) 1
 (10) 12
Other income48
 46
 154
 172
54
 48
 146
 154
Total revenues1,835
 1,705
 5,057
 4,761
2,008
 1,835
 5,460
 5,057
              
Costs and Expenses:              
Property and casualty insurance:              
Losses and loss adjustment expenses995
 765
 2,239
 2,033
872
 995
 2,206
 2,239
Commissions and other underwriting expenses357
 356
 1,062
 1,038
424
 357
 1,205
 1,062
Annuity benefits215
 189
 635
 640
222
 215
 664
 635
Life, accident and health benefits6
 8
 21
 26
10
 6
 32
 21
Annuity and supplemental insurance acquisition expenses55
 54
 156
 131
71
 55
 203
 156
Interest charges on borrowed money21
 19
 65
 56
15
 21
 46
 65
Expenses of managed investment entities45
 38
 137
 109
52
 45
 154
 137
Other expenses112
 98
 285
 258
98
 112
 272
 285
Total costs and expenses1,806
 1,527
 4,600
 4,291
1,764
 1,806
 4,782
 4,600
Earnings before income taxes29
 178
 457
 470
244
 29
 678
 457
Provision for income taxes18
 65
 146
 190
41
 18
 126
 146
Net earnings, including noncontrolling interests11
 113
 311
 280
203
 11
 552
 311
Less: Net earnings attributable to noncontrolling interests
 4
 2
 16
Less: Net earnings (losses) attributable to noncontrolling interests(1) 
 (7) 2
Net Earnings Attributable to Shareholders$11
 $109
 $309
 $264
$204
 $11
 $559
 $309
              
Earnings Attributable to Shareholders per Common Share:              
Basic$0.13
 $1.25
 $3.52
 $3.04
$2.30
 $0.13
 $6.29
 $3.52
Diluted$0.13
 $1.23
 $3.44
 $2.98
$2.26
 $0.13
 $6.17
 $3.44
Average number of Common Shares:              
Basic88.1
 86.9
 87.7
 86.8
89.1
 88.1
 88.9
 87.7
Diluted90.0
 88.5
 89.7
 88.4
90.7
 90.0
 90.6
 89.7
              
Cash dividends per Common Share$0.3125
 $0.28
 $2.4375
 $0.84
$0.35
 $0.3125
 $2.55
 $2.4375
________________________________________              
(*) Consists of the following:              
Realized gains before impairments$26
 $18
 $52
 $75
Realized gains (losses) before impairments$36
 $26
 $(25) $52
              
Losses on securities with impairment(38) (16) (54) (106)(2) (38) (3) (54)
Non-credit portion recognized in other comprehensive income (loss)
 
 1
 (1)
 
 
 1
Impairment charges recognized in earnings(38) (16) (53) (107)(2) (38) (3) (53)
Total realized gains (losses) on securities$(12) $2
 $(1) $(32)$34
 $(12) $(28) $(1)

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AMERICAN FINANCIAL GROUP, INC. 10-Q

AMERICAN FINANCIAL GROUP, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENT OF COMPREHENSIVE INCOME (UNAUDITED)
(In Millions)
 
 Three months ended September 30, Nine months ended September 30,
 2017 2016 2017 2016
Net earnings, including noncontrolling interests$11
 $113
 $311
 $280
Other comprehensive income, net of tax:       
Net unrealized gains on securities:       
Unrealized holding gains on securities arising during the period59
 89
 299
 427
Reclassification adjustment for realized (gains) losses included in net earnings8
 (1) 3
 20
Total net unrealized gains on securities67
 88
 302
 447
Net unrealized gains on cash flow hedges
 
 1
 4
Foreign currency translation adjustments7
 (3) 11
 4
Pension and other postretirement plans adjustments
 
 
 1
Other comprehensive income, net of tax74
 85
 314
 456
Total comprehensive income, net of tax85
 198
 625
 736
Less: Comprehensive income attributable to noncontrolling interests
 5
 2
 23
Comprehensive income attributable to shareholders$85
 $193
 $623
 $713
 Three months ended September 30, Nine months ended September 30,
 2018 2017 2018 2017
Net earnings, including noncontrolling interests$203
 $11
 $552
 $311
Other comprehensive income (loss), net of tax:       
Net unrealized gains (losses) on securities:       
Unrealized holding gains (losses) on securities arising during the period(96) 59
 (523) 299
Reclassification adjustment for realized (gains) losses included in net earnings(2) 8
 (3) 3
Total net unrealized gains (losses) on securities(98) 67
 (526) 302
Net unrealized gains (losses) on cash flow hedges(5) 
 (19) 1
Foreign currency translation adjustments
 7
 (3) 11
Other comprehensive income (loss), net of tax(103) 74
 (548) 314
Total comprehensive income, net of tax100
 85
 4
 625
Less: Comprehensive income (loss) attributable to noncontrolling interests(1) 
 (7) 2
Comprehensive income attributable to shareholders$101
 $85
 $11
 $623


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AMERICAN FINANCIAL GROUP, INC. 10-Q

AMERICAN FINANCIAL GROUP, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENT OF CHANGES IN EQUITY (UNAUDITED)
(Dollars in Millions)
 
   Shareholders’ Equity       Shareholders’ Equity     Redeemable
Common
Shares
  
Common Stock
and Capital
Surplus
 
Retained
Earnings
 
Accumulated
Other Comp.
Income (Loss)
 Total 
Noncon-
trolling
Interests
 
Total
Equity
 Noncon-
trolling
Interests
Balance at December 31, 201788,275,460
  $1,269
 $3,248
 $813
 $5,330
 $1
 $5,331
 $3
Cumulative effect of accounting change
  
 225
 (221) 4
 
 4
 
Net earnings (losses)
  
 559
 
 559
 (1) 558
 (6)
Other comprehensive loss
  
 
 (548) (548) 
 (548) 
Dividends on Common Stock
  
 (227) 
 (227) 
 (227) 
Shares issued:                
Exercise of stock options635,364
  23
 
 
 23
 
 23
 
Restricted stock awards200,625
  
 
 
 
 
 
 
Other benefit plans86,229
  10
 
 
 10
 
 10
 
Dividend reinvestment plan21,072
  2
 
 
 2
 
 2
 
Stock-based compensation expense
  17
 
 
 17
 
 17
 
Shares exchanged — benefit plans(26,520)  (1) (2) 
 (3) 
 (3) 
Forfeitures of restricted stock(3,522)  
 
 
 
 
 
 
Other
  
 (3) 
 (3) 
 (3) 3
Balance at September 30, 201889,188,708
  $1,320
 $3,800
 $44
 $5,164
 $
 $5,164
 $
Common
Shares
  
Common
Stock and
Capital
Surplus
 
Retained
Earnings
 
Accumulated
Other
Comprehensive
Income
 Total 
Noncontrolling
Interests
 
Total
Equity
                
86,924,399
  $1,198
 $3,343
 $375
 $4,916
 $3
 $4,919
86,924,399
  $1,198
 $3,343
 $375
 $4,916
 $3
 $4,919
 $
Net earnings
  
 309
 
 309
 2
 311

  
 309
 
 309
 2
 311
 
Other comprehensive income
  
 
 314
 314
 
 314

  
 
 314
 314
 
 314
 
Dividends on Common Stock
  
 (214) 
 (214) 
 (214)
  
 (214) 
 (214) 
 (214) 
Shares issued:                       
   
  
Exercise of stock options870,022
  29
 
 
 29
 
 29
870,022
  29
 
 
 29
 
 29
 
Restricted stock awards232,250
  
 
 
 
 
 
232,250
  
 
 
 
 
 
 
Other benefit plans85,190
  8
 
 
 8
 
 8
85,190
  8
 
 
 8
 
 8
 
Dividend reinvestment plan22,243
  2
 
 
 2
 
 2
22,243
  2
 
 
 2
 
 2
 
Stock-based compensation expense
  18
 
 
 18
 
 18

  18
 
 
 18
 
 18
 
Shares exchanged — benefit plans(34,922)  
 (3) 
 (3) 
 (3)(34,922)  
 (3) 
 (3) 
 (3) 
Forfeitures of restricted stock(6,388)  
 
 
 
 
 
(6,388)  
 
 
 
 
 
 
Other
  
 
 
 
 (5) (5)
  
 
 
 
 (5) (5) 
Balance at September 30, 201788,092,794
  $1,255
 $3,435
 $689
 $5,379
 $
 $5,379
88,092,794
  $1,255
 $3,435
 $689
 $5,379
 $
 $5,379
 $
              
Balance at December 31, 201587,474,452
  $1,301
 $2,987
 $304
 $4,592
 $178
 $4,770
Net earnings
  
 264
 
 264
 16
 280
Other comprehensive income
  
 
 449
 449
 7
 456
Dividends on Common Stock
  
 (73) 
 (73) 
 (73)
Shares issued:         
   
Exercise of stock options753,095
  26
 
 
 26
 
 26
Restricted stock awards318,940
  
 
 
 
 
 
Other benefit plans82,087
  6
 
 
 6
 
 6
Dividend reinvestment plan10,930
  1
 
 
 1
 
 1
Stock-based compensation expense
  22
 
 
 22
 
 22
Shares acquired and retired(1,796,009)  (27) (97) 
 (124) 
 (124)
Shares exchanged — benefit plans(28,059)  
 (2) 
 (2) 
 (2)
Forfeitures of restricted stock(2,785)  
 
 
 
 
 
Other
  
 
 
 
 (4) (4)
Balance at September 30, 201686,812,651
  $1,329
 $3,079
 $753
 $5,161
 $197
 $5,358

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AMERICAN FINANCIAL GROUP, INC. 10-Q

AMERICAN FINANCIAL GROUP, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENT OF CASH FLOWS (UNAUDITED)
(In Millions)
Nine months ended September 30,Nine months ended September 30,
2017 20162018 2017
Operating Activities:      
Net earnings, including noncontrolling interests$311
 $280
$552
 $311
Adjustments:      
Depreciation and amortization105
 91
163
 105
Annuity benefits635
 640
664
 635
Realized gains on investing activities(18) (6)
Realized (gains) losses on investing activities28
 (18)
Net sales of trading securities5
 73
116
 5
Deferred annuity and life policy acquisition costs(177) (172)(192) (177)
Change in:      
Reinsurance and other receivables(1,467) (972)(868) (1,467)
Other assets(59) (193)(257) (59)
Insurance claims and reserves1,372
 796
507
 1,372
Payable to reinsurers272
 244
189
 272
Other liabilities
 230
346
 
Managed investment entities’ assets/liabilities14
 (235)104
 14
Other operating activities, net
 (30)(75) 
Net cash provided by operating activities993
 746
1,277
 993
      
Investing Activities:      
Purchases of:      
Fixed maturities(7,163) (5,604)(6,700) (7,163)
Equity securities(73) (143)(342) (73)
Mortgage loans(149) (310)(112) (149)
Equity index call options and other investments(594) (490)
Equity index options and other investments(695) (594)
Real estate, property and equipment(46) (37)(60) (46)
Proceeds from:      
Maturities and redemptions of fixed maturities4,690
 3,111
3,516
 4,690
Repayments of mortgage loans191
 197
87
 191
Sales of fixed maturities179
 496
275
 179
Sales of equity securities97
 193
150
 97
Sales and settlements of equity index call options and other investments565
 138
Sales and settlements of equity index options and other investments688
 565
Sales of real estate, property and equipment54
 45
3
 54
Managed investment entities:      
Purchases of investments(2,330) (1,405)(1,674) (2,330)
Proceeds from sales and redemptions of investments2,343
 1,381
1,485
 2,343
Other investing activities, net6
 (91)4
 6
Net cash used in investing activities(2,230) (2,519)(3,375) (2,230)
      
Financing Activities:      
Annuity receipts3,432
 3,474
3,925
 3,432
Annuity surrenders, benefits and withdrawals(1,725) (1,726)(2,101) (1,725)
Net transfers from variable annuity assets43
 29
35
 43
Additional long-term borrowings345
 302

 345
Reductions of long-term debt(355) 

 (355)
Issuances of managed investment entities’ liabilities1,926
 1,028
1,572
 1,926
Retirements of managed investment entities’ liabilities(1,998) (747)(1,463) (1,998)
Issuances of Common Stock30
 34
26
 30
Repurchases of Common Stock
 (124)
Cash dividends paid on Common Stock(212) (72)(225) (212)
Other financing activities, net(7) (6)
 (7)
Net cash provided by financing activities1,479
 2,192
1,769
 1,479
Net Change in Cash and Cash Equivalents242
 419
(329) 242
Cash and cash equivalents at beginning of period2,107
 1,220
2,338
 2,107
Cash and cash equivalents at end of period$2,349
 $1,639
$2,009
 $2,349

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AMERICAN FINANCIAL GROUP, INC. 10-Q
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 


INDEX TO NOTES
      
A.Accounting Policies I.H.Goodwill and Other Intangibles 
B.AcquisitionSegments of BusinessOperations J.I.Long-Term Debt 
C.Segments of OperationsFair Value MeasurementsJ.Redeemable Noncontrolling Interests
D.Investments K.Shareholders’ Equity 
D.E.Fair Value MeasurementsDerivatives L.Income Taxes 
E.F.InvestmentsDeferred Policy Acquisition Costs M.Contingencies 
F.DerivativesN.Insurance
G.Deferred Policy Acquisition CostsO.Subsequent Event
H.Managed Investment Entities N.Insurance 
      

A.     Accounting Policies

Basis of Presentation   The accompanying consolidated financial statements for American Financial Group, Inc. and its subsidiaries (“AFG”) are unaudited; however, management believes that all adjustments (consisting only of normal recurring accruals unless otherwise disclosed herein) necessary for fair presentation have been made. The results of operations for interim periods are not necessarily indicative of results to be expected for the year. The financial statements have been prepared in accordance with the instructions to Form 10-Q and, therefore, do not include all information and footnotes necessary to be in conformity with U.S. generally accepted accounting principles (“GAAP”).
 
Certain reclassifications have been made to prior periods to conform to the current year’s presentation. All significant intercompany balances and transactions have been eliminated. The results of operations of companies since their formation or acquisition are included in the consolidated financial statements. Events or transactions occurring subsequent to September 30, 20172018, and prior to the filing of this Form 10-Q, have been evaluated for potential recognition or disclosure herein.
 
The preparation of the financial statements requires management to make estimates and assumptions that affect the amounts reported in the financial statements and accompanying notes. Changes in circumstances could cause actual results to differ materially from those estimates.

Fair Value Measurements   Accounting standards define fair value as the price that would be received to sell an asset or paid to transfer a liability (an exit price) in an orderly transaction between market participants on the measurement date. The standards establish a hierarchy of valuation techniques based on whether the assumptions that market participants would use in pricing the asset or liability (“inputs”) are observable or unobservable. Observable inputs reflect market data obtained from independent sources, while unobservable inputs reflect AFG’s assumptions about the assumptions market participants would use in pricing the asset or liability. AFG did not have any significant nonrecurring fair value measurements in the first nine months of 20172018.

Investments On January 1, 2018, AFG adopted Accounting Standards Update (“ASU”) 2016-01, which requires all equity securities other than those accounted for under the equity method to be reported at fair value with holding gains and losses recognized in net earnings. At December 31, 2017, AFG had $1.60 billion in equity securities classified as “available for sale” under the prior guidance with holding gains and losses included in accumulated other comprehensive income (“AOCI”) instead of net earnings. At the date of adoption, the $221 million net unrealized gain on equity securities included in AOCI was reclassified to retained earnings as the cumulative effect of an accounting change. The cumulative effect of the accounting change also includes the net unrealized gain on AFG’s small number of limited partnerships and similar investments carried at cost under the prior guidance that are carried at fair value through net earnings under the new guidance ($4 million net of tax at the date of adoption).

Holding gains and losses on equity securities carried at fair value under ASU 2016-01 are generally recorded in realized gains (losses) on securities. However, prior to the adoption of the new guidance, AFG classified a small portion of its equity securities as “trading” and reported those investments at fair value with holding gains and losses recognized in net investment income. These investments consisted primarily of equity securities held to offset the impact of changes in the stock market on employee benefit plans that are impacted by stock market performance and totaled $62 million at December 31, 2017. Following the adoption of the new guidance, AFG continues to record holding gains and losses on these securities, as well as its small portfolio of limited partnerships and similar investments carried at fair value under the new guidance and certain other securities classified at purchase as “fair value through net investment income” in net investment income.


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Under the new guidance, AFG recorded holding losses of $35 million on equity securities in net earnings during the first nine months of 2018 on securities that were still owned at September 30, 2018. Under the prior guidance, these holding losses would have been recorded in AOCI (with the exception of any impairment charge that may have been recorded). Because almost all of the equity securities impacted by the new guidance were carried at fair value through AOCI under the prior guidance, the adoption of the new guidance did not have a material impact on AFG’s financial position.

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 (“AOCI”)AOCI 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 net investment income. Mortgage and policy loans are carried primarily at the aggregate unpaid balance.

In January 2016, the Financial Accounting Standards Board (“FASB”) issued Accounting Standards Update (“ASU”) 2016-01, which, among other things, will require all equity securities currently classified as “available for sale” to be reported at fair value, with holding gains and losses recognized in net income, instead of AOCI. AFG will be required to adopt this guidance effective January 1, 2018. At the date of adoption, the net unrealized gain on equity securities included in AOCI will be reclassified to retained earnings in the Balance Sheet as the cumulative effect of an accounting change.

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

Limited partnerships and similar investments are generally accounted for using the equity method of accounting. Under the equity method, AFG records its share of the earnings or losses of the investee based on when they are reported by the investee in its financial statements rather than in the period in which the investee declares a dividend. AFG’s share of the earnings or losses from equity method investments is generally recorded on a quarter lag due to the timing of the receipt of the investee’s financial statements. AFG’s equity in the earnings (losses) of limited partnerships and similar investments is included in net investment income.

Gains or losses on fixed maturity 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) on securities) and the cost basis of that investment is reduced. If management can assert that

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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 the other-than-temporary impairment is separated into two components: (i) the amount related to credit losses (recorded in earnings) and (ii) the amount related to all other factors (recorded in other comprehensive income). The credit-related portion 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 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 recorded to reduce the amortized cost of that security to fair value.

Derivatives Derivatives included in AFG’s Balance Sheet are recorded at fair value. Changes in fair value of derivatives are included in earnings, unless the derivatives are designated and qualify as highly effective cash flow hedges. Derivatives that do not qualify for hedge accounting under GAAP consist primarily of (i) components of certain fixed maturity securities (primarily interest-only MBS) and (ii) the equity-based component of certain annuity products (included in annuity benefits accumulated) and related equity index call options designed to be consistent with the characteristics of the liabilities and used to mitigate the risk embedded in those annuity products.

To qualify for hedge accounting, at the inception of a derivative contract, AFG formally documents the relationship between the terms of the hedge and the hedged items and its risk management objective. This documentation includes defining how hedge effectiveness and ineffectiveness will be measured on a retrospective and prospective basis.

Changes in the fair value of derivatives that are designated and qualify as highly effective cash flow hedges are recorded in AOCI and are reclassified into earnings when the variability of the cash flows from the hedged items impacts earnings. Any hedge ineffectiveness is immediately recorded in current period earnings. When the change in the fair value of a qualifying cash flow hedge is included in earnings, it is included in the same line item in the statement of earnings as the cash flows from the hedged item. AFG uses interest rate swaps that are designated and qualify as highly effective cash flow hedges to mitigate interest rate risk related to certain floating-rate securities included in AFG’s portfolio of fixed maturity securities.

For derivatives that are designated and qualify as highly effective fair value hedges, changes in the fair value of the derivative, along with changes in the fair value of the hedged item attributable to the hedged risk, are recognized in current period earnings. AFG has entered into an interest rate swap that qualifies as a highly effective fair value hedge to mitigate the interest rate risk associated with fixed-rate long-term debt by economically converting certain fixed-rate debt obligations to floating-rate obligations. Since the terms


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Table of the swap match the terms of the hedged debt, changes in the fair value of the swap are offset by changes in the fair value of the hedged debt attributable to changes in interest rates. Accordingly, the net impact on AFG’s current period earnings is that the interest expense associated with the hedged debt is effectively recorded at the floating rate.Contents
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Goodwill   Goodwill represents the excess of cost of subsidiaries over AFG’s equity in their underlying net assets. Goodwill is not amortized, but is subject to an impairment test at least annually. An entity is not required to complete the quantitative annual goodwill impairment test on a reporting unit if the entity elects to perform a qualitative analysis and determines that it is more likely than not that the reporting unit’s fair value exceeds its carrying amount.
 
Reinsurance   Amounts recoverable from reinsurers are estimated in a manner consistent with the claim liability associated with the reinsured policies. AFG’s property and casualty insurance subsidiaries report as assets (i) the estimated reinsurance recoverable on paid and unpaid losses, including an estimate for losses incurred but not reported, and (ii) amounts paid or due to reinsurers applicable to the unexpired terms of policies in force. Payable to reinsurers includes ceded premiums due to reinsurers, as well as ceded premiums retained by AFG’s property and casualty insurance subsidiaries under contracts to fund ceded losses as they become due. AFG’s insurance subsidiaries also assume reinsurance from other companies. Earnings on reinsurance assumed is recognized based on information received from ceding companies.
 
An AFG subsidiary cedes life insurance policies to a third party on a funds withheld basis whereby the subsidiary retains the assets (securities) associated with the reinsurance contract. Interest is credited to the reinsurer based on the actual investment performance of the retained assets. This reinsurance contract is considered to contain an embedded derivative (that must be adjusted to fair value) because the yield on the payable is based on a specific block of the ceding company’s assets, rather than the overall creditworthiness of the ceding company. AFG determined that changes in the fair value of the underlying portfolio of fixed maturity securities is an appropriate measure of the value of the embedded derivative. The securities related to this contract are classified as “trading.” The adjustment to fair value on the embedded derivative offsets the investment income recorded on the adjustment to fair value of the related trading portfolio.
 

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Deferred Policy Acquisition Costs (“DPAC”)   Policy acquisition costs (principally commissions, premium taxes and certain underwriting and policy issuance costs) directly related to the successful acquisition or renewal of an insurance contract are deferred. DPAC also includes capitalized costs associated with sales inducements offered to fixed annuity policyholders such as enhanced interest rates and premium and persistency bonuses.
 
For the property and casualty companies, DPAC is limited based upon recoverability without any consideration for anticipated investment income and is charged against income ratably over the terms of the related policies. A premium deficiency is recognized if the sum of expected claims costs, claims adjustment expenses and unamortized acquisition costs exceed the related unearned premiums. A premium deficiency is first recognized by charging any unamortized acquisition costs to expense to the extent required to eliminate the deficiency. If the premium deficiency is greater than unamortized acquisition costs, a liability is accrued for the excess deficiency and reported with unpaid losses and loss adjustment expenses.

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

DPAC related to traditional life and health insurance is amortized over the expected premium paying period of the related policies, in proportion to the ratio of annual premium revenues to total anticipated premium revenues. See Life, Accident and Health Reserves below for details on the impact of loss recognition on the accounting for traditional life and health insurance contracts.

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

DPAC and certain other balance sheet amounts related to annuity long-term care and life businesses are also adjusted, net of tax, for the change in expense that would have been recorded if the unrealized gains (losses) from securities had actually been realized. These adjustments are included in unrealized gains (losses) on marketable securities, a component of AOCI in AFG’s Balance Sheet.


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Managed Investment EntitiesA company is considered the primary beneficiary of, and therefore must consolidate, a variable interest entity (“VIE”) based primarily on its ability to direct the activities of the VIE that most significantly impact that entity’s economic performance and the obligation to absorb losses of, or receive benefits from, the entity that could potentially be significant to the VIE.
 
AFG manages, and has investments in, collateralized loan obligations (“CLOs”) that are VIEs (see Note HG — “Managed Investment Entities). 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) through its investment in the CLO debt tranches, it has exposure to CLO losses (limited to the amount AFG invested) and the right to receive CLO benefits that could potentially be significant to the CLOs.

Because AFG has no right to use the CLO assets and no obligation to pay the CLO liabilities, the assets and liabilities of the CLOs are shown separately in AFG’s Balance Sheet. AFG has elected the fair value option for reporting on the CLO assets and liabilities to improve the transparency of financial reporting related to the CLOs. The net gain or loss from accounting for the CLO assets and liabilities at fair value is presented separately in AFG’s Statement of Earnings.

The fair values of a CLO’s assets may differ from the separately measured fair values of its liabilities even though the CLO liabilities only have recourse to the CLO assets. AFG has set the carrying value of the CLO liabilities equal to the fair value of the CLO assets (which have more observable fair values) as an alternative to reporting those liabilities at a separately measured fair value. CLO earnings attributable to AFG’s shareholders are measured by the change in the fair value of AFG’s investments in the CLOs and management fees earned.

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At September 30, 2017, assets and liabilities of managed investment entities included $383 million in assets and $316 million in liabilities of a temporary warehousing entity that was established in connection with the formation of a new CLO that closed in October 2017. At closing, all warehoused assets were transferred to the new CLO and the liabilities were repaid.

Unpaid Losses and Loss Adjustment Expenses   The net liabilities stated for unpaid claims and for expenses of investigation and adjustment of unpaid claims represent management’s best estimate and are based upon (i) the accumulation of case estimates for losses reported prior to the close of the accounting period on direct business written; (ii) estimates received from ceding reinsurers and insurance pools and associations; (iii) estimates of unreported losses (including possible development on known claims) based on past experience; (iv) estimates based on experience of expenses for investigating and adjusting claims; and (v) the current state of the law and coverage litigation. Establishing reserves for asbestos, environmental and other mass tort claims involves considerably more judgment than other types of claims due to, among other things, inconsistent court decisions, an increase in bankruptcy filings as a result of asbestos-related liabilities, novel theories of coverage, and judicial interpretations that often expand theories of recovery and broaden the scope of coverage.
 
Loss reserve liabilities are subject to the impact of changes in claim amounts and frequency and other factors. Changes in estimates of the liabilities for losses and loss adjustment expenses are reflected in the statement of earnings in the period in which determined. Despite the variability inherent in such estimates, management believes that the liabilities for unpaid losses and loss adjustment expenses are adequate.
 
Annuity Benefits Accumulated   Annuity receipts and benefit payments are recorded as increases or decreases in annuity benefits accumulated rather than as revenue and expense. Increases in this liability for interest credited are charged to annuity benefits expense and decreases for annuity policy charges are creditedrecorded in other income. For traditional fixed annuities, the liability for annuity benefits accumulated represents the account value that has accrued to other income.the benefit of the policyholder as of the balance sheet date. For fixed-indexed annuities, the liability or annuity benefits accumulated includes an embedded derivative that represents the estimated fair value of the index participation with the remaining component representing the discounted value of the guaranteed minimum contract benefits.
 
For certain products, annuity benefits accumulated also includes reserves for accrued persistency and premium bonuses, guaranteed withdrawals and excess benefits expected to be paid on future deaths and annuitizations (“EDAR”). The liabilities for EDAR and guaranteed withdrawals are accrued for and modified using assumptions consistent with those used in determining DPAC and DPAC amortization, except that amounts are determined in relation to the present value of total expected assessments. Total expected assessments consist principally of estimated future investment margin, surrender, mortality, and other life and annuity policy charges, and unearned revenues once they are recognized as income.
 
Annuity benefits accumulated also includes amounts advanced from the Federal Home Loan Bank of Cincinnati.
 
Unearned Revenue   Certain upfront policy charges on annuities are deferred as unearned revenue (included in other liabilities) and recognized in net earnings (included in other income) using the same assumptions and estimated gross profits used to amortize DPAC.

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

For long-duration contracts (such as traditional life and long-term care policies), loss recognition occurs when, based on current expectations as of the measurement date, existing contract liabilities plus the present value of future premiums (including reasonably expected rate increases) are not expected to cover the present value of future claims payments and related settlement and maintenance costs (excluding overhead) as well as unamortized acquisition costs. If a block of business is determined to be in loss recognition, a charge is recorded in earnings in an amount equal to the excess of the present value of expected future claims costs and unamortized acquisition costs over existing reserves plus the present value of expected future premiums (with no provision for adverse deviation). The charge is recorded first to reduce unamortized acquisition costs and then as an additional reserve (if unamortized acquisition costs have been reduced to zero).

In addition, reserves for traditional life and long-term care policies are subject to adjustment for loss recognition charges that would have been recorded if the unrealized gains (losses) from securities had actually been realized. This adjustment is included in unrealized gains (losses) on marketable securities, a component of AOCI in AFG’s Balance Sheet.


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Debt Issuance Costs   Debt issuance costs related to AFG’s outstanding debt are presented in its Balance Sheet as a direct reduction in the carrying value of long-term debt and are amortized over the life of the related debt using the effective interest method as a component of interest expense. Debt issuance costs related to AFG’s revolving credit facilities are included in other assets in AFG’s Balance Sheet.

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

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

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 representsrepresent the interests of shareholders other than AFG in consolidated entities. In the statement of earnings, net earnings and losses attributable to noncontrolling interests represents such shareholders’ interest in the earnings and losses of those entities. Noncontrolling interests that are redeemable at the option of the holder are presented separately in the mezzanine section of the balance sheet (between liabilities and equity).

Income Taxes   Deferred income taxes are calculated using the liability method. Under this method, deferred income tax assets and liabilities are determined based on differences between financial reporting and tax bases and are measured using enacted tax rates. A valuation allowance is established to reduce total deferred tax assets to an amount that will more likely than not be realized. The effect of a change in tax rates on deferred tax assets and liabilities is recorded in net earnings in the period that includes the enactment date.

AFG recognizes the tax benefits of uncertain tax positions only when the position is more likely than not to be sustained under examination by the appropriate taxing authority. Interest and penalties on AFG’s reserve for uncertain tax positions are recognized as a component of tax expense.

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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.

In the fourth quarter of 2016, AFG adopted ASU 2016-09, which, among other things, requiresrecords excess tax benefits or deficiencies for share-based payments to be recorded through income tax expense in the statement of earnings instead of directly to capital surplus (as required under the previous guidance).earnings. In addition, under the new guidance, AFG elected to accountaccounts for forfeitures of awards when they occur rather than accruing expense based on an estimate of expected forfeitures (as required under the previous guidance). The resulting cumulative effect of accounting change of less than $1 million was recorded directly to retained earnings on January 1, 2016.occur.

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

Earnings Per Share   Although basic earnings per share only considers shares of common stock outstanding during the period, the calculation of diluted earnings per share includes the following adjustments to weighted average common shares related to

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stock-based compensation plans: third quarter of 2018 and 2017 and 2016 1.91.6 million and 1.61.9 million; first nine months of 2018 and 2017 — 1.7 million and 2016 — 2.0 million, and 1.6 million, respectively.
 
AFG’s weighted average diluted shares outstanding for the third quarter and first nine months of 2016 excludes 0.2 million and 0.6 million anti-dilutive potential common shares related to stock compensation plans, respectively. There were no anti-dilutive potential common shares in the third quarter or first nine months of 20172018. or 2017.
 
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, surrenders, benefits and withdrawals are also reflected as financing activities. All other activities are considered “operating.” Short-term investments having original maturities of three months or less when purchased are considered to be cash equivalents for purposes of the financial statements.

Effective October 1, 2016, AFG early adopted (on a retrospective basis) ASU 2016-15, which addresses the diversity in practice in how certain cash receipts and cash payments are presented in the statement of cash flows. Among other things, this guidance requires proceeds received from the settlement of corporate-owned life insurance policies to be classified as cash inflows from investing activities and allows premiums paid for policies to be reported as cash outflows either from investing activities or operating activities. AFG has elected to show all corporate-owned life insurance activity in investing activities. Prior to adoption of this guidance, AFG accounted for these transactions as operating activities. In addition, ASU 2016-15 clarifies when distributions received from investees accounted under the equity method should be accounted for as a cash inflow from operating activities or as a cash inflow from investing activities. AFG had previously accounted for all distributions from investments accounted for under the equity method as investing activities. The new guidance solely related to the presentation of certain transactions in the statement of cash flows. Accordingly, adoption of this guidance did not impact AFG’s results of operations or financial position.

Revenue Recognition Guidance Effective in 2018 In May 2014, the FASB issuedOn January 1, 2018, AFG adopted ASU 2014-09, which requires an entity to recognizeprovides guidance on recognizing revenue to depict the transfer of promised goods or services to customers in an amount that reflects the consideration to which the entity expects to be entitled in exchange for those goods or services. Revenue is recognized when (or as) the entity satisfies a performance obligationobligations under the contract.contract are satisfied. The new guidance also updates the accounting for certain costs associated with obtaining and fulfilling contracts with customers and requires disclosures regarding the nature, amount, timing and uncertainty ofcertain new disclosures. Because revenue and cash flows arising from contracts with customers. Revenue recognition for insurance contracts and financial instruments which are AFG’s(AFG’s primary sources of revenue, isrevenue) were excluded from the scope of the new guidance. AFG will adopt the new guidance, effective January 1, 2018. Because the new guidance does not apply to the vast majority of AFG’s business, management does not expect the adoption of this guidance toASU 2014-09 did not have a material impact on AFG’s results of operations or financial position. Based on implementation efforts to date, management believes that the new standard would only have applied to 2% of AFG’s 2016 consolidated revenues.

B.Acquisition of Business

Acquisition of Noncontrolling Interest in National Interstate Corporation   In November 2016, AFG acquired the 49% of National Interstate Corporation (“NATL”) not previously owned by AFG’s wholly-owned subsidiary, Great American Insurance Company, for $315 million ($32.00 per share) in a merger transaction. In addition, NATL paid a one-time special cash dividend of $0.50 per share to its shareholders immediately prior to the merger closing. Because NATL was already a consolidated subsidiary of AFG prior to the merger, the acquisition was accounted for as an equity transaction.


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C.    Segments of Operations

AFG manages its business as fourthree segments: (i) Property and casualty insurance, (ii) Annuity (iii) Run-off long-term care and life and (iv)(iii) Other, which includes holding company costs.costs, revenues and costs of AFG’s limited insurance operations outside of property and casualty insurance and annuities, and operations attributable to the noncontrolling interests of the managed investment entities.

AFG reports its property and casualty insurance business in the following Specialty sub-segments: (i) Property and transportation, which includes physical damage and liability coverage for buses, 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, professional liability, umbrella and excess liability, specialty coverage in targeted markets, customized programs for small to mid-sized businesses and workers’ compensation insurance, and (iii) Specialty financial, which includes risk management insurance programs for leasing and financing institutions (including equipment leasing and collateral and lender-placed mortgage property insurance), surety and fidelity products and trade credit insurance. Premiums and underwriting profit included under Other specialty represent business assumed by AFG’s internal reinsurance program from the operations that make up AFG’s other Specialty sub-segments and amortization of deferred gains on retroactive reinsurance transactions related to the sales of businesses in prior years. AFG’s annuity business markets traditional fixed, fixed-indexed and fixed-indexedvariable-indexed annuities in the retail, financial institutions, registered investment advisor and education markets. AFG’s reportable segments and their components were determined based primarily upon similar economic characteristics, products and services. Effective January 1, 2018, the results of AFG’s run-off long-term care and life

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businesses are included in the “Other” segment instead of as a separate reportable segment based on the immaterial size of the remaining operations. Prior period amounts were reclassified for consistent presentation.

The following tables (in millions) show AFG’s revenues and earnings before income taxes by segment and sub-segment.
Three months ended September 30, Nine months ended September 30,Three months ended September 30, Nine months ended September 30,
2017 2016 2017 20162018 2017 2018 2017
Revenues              
Property and casualty insurance:              
Premiums earned:              
Specialty              
Property and transportation$527
 $493
 $1,226
 $1,197
$526
 $527
 $1,250
 $1,226
Specialty casualty568
 497
 1,613
 1,496
616
 568
 1,790
 1,613
Specialty financial142
 145
 435
 416
149
 142
 457
 435
Other specialty30
 24
 80
 75
36
 30
 98
 80
Total premiums earned1,267
 1,159
 3,354
 3,184
1,327
 1,267
 3,595
 3,354
Net investment income94
 93
 276
 265
108
 94
 323
 276
Other income (a)1
 3
 21
 46
4
 1
 8
 21
Total property and casualty insurance1,362
 1,255
 3,651
 3,495
1,439
 1,362
 3,926
 3,651
Annuity:              
Net investment income375
 351
 1,082
 1,010
413
 375
 1,219
 1,082
Other income26
 26
 79
 76
27
 26
 80
 79
Total annuity401
 377
 1,161
 1,086
440
 401
 1,299
 1,161
Run-off long-term care and life12
 13
 35
 37
Other72
 58
 211
 173
95
 84
 263
 246
Total revenues before realized gains (losses)1,847
 1,703
 5,058
 4,791
1,974
 1,847
 5,488
 5,058
Realized gains (losses) on securities(12) 2
 (1) (32)34
 (12) (28) (1)
Realized gains on subsidiaries
 
 
 2
Total revenues$1,835
 $1,705
 $5,057
 $4,761
$2,008
 $1,835
 $5,460
 $5,057
Earnings Before Income Taxes              
Property and casualty insurance:              
Underwriting:              
Specialty              
Property and transportation$6
 $44
 $70
 $91
$
 $6
 $56
 $70
Specialty casualty2
 13
 46
 65
49
 2
 119
 46
Specialty financial(3) 19
 42
 64
9
 (3) 46
 42
Other specialty4
 2
 3
 7
(3) 4
 (1) 3
Other lines (b)(90) (36) (92) (101)(17) (90) (19) (92)
Total underwriting(81) 42
 69
 126
38
 (81) 201
 69
Investment and other income, net (a)87
 79
 271
 269
101
 87
 300
 271
Total property and casualty insurance6
 121
 340
 395
139
 6
 501
 340
Annuity102
 107
 283
 236
117
 102
 341
 283
Run-off long-term care and life2
 1
 4
 
Other (c)(69) (53) (169) (131)(46) (67) (136) (165)
Total earnings before realized gains (losses) and income taxes41
 176
 458
 500
210
 41
 706
 458
Realized gains (losses) on securities(12) 2
 (1) (32)34
 (12) (28) (1)
Realized gains on subsidiaries
 
 
 2
Total earnings before income taxes$29
 $178
 $457
 $470
$244
 $29
 $678
 $457
(a)Includes pretax income of $13 million (before noncontrolling interest) from the sale of a hotel in the first quarter of 2017 and pretax income of $32 million (before noncontrolling interest) from the sale of an apartment property in the second quarter of 2016.2017.
(b)Includes special charges of $89$18 million and $36$89 million in the third quarter of 20172018 and 2016,2017, respectively, to increase asbestos and environmental (“A&E”) reserves and a $65 million special charge related to the exit of certain lines of business with AFG’s Lloyd’s-based insurer, Neon, in the second quarter of 2016.reserves.
(c)Includes holding company interest and expenses, including losses on retirement of debt of $4 million in the third quarter of 2017 and $7 million in the second quarter of 2017, and special charges of $24$9 million and $5$24 million in the third quarter of 20172018 and 2016,2017, respectively, to increase A&E reserves related to AFG’s former railroad and manufacturing operations.

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AMERICAN FINANCIAL GROUP, INC. 10-Q
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — CONTINUED


D.C.    Fair Value Measurements

Accounting standards for measuring fair value are based on inputs used in estimating fair value. The three levels of the hierarchy are as follows:
 
Level 1 — Quoted prices for identical assets or liabilities in active markets (markets in which transactions occur with sufficient frequency and volume to provide pricing information on an ongoing basis). AFG’s Level 1 financial instruments consist primarily of publicly traded equity securities, highly liquid government bonds for which quoted market prices in active markets are available and short-term investments of managed investment entities.

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

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

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

AFG’s management is responsible for the valuation process and uses data from outside sources (including nationally recognized pricing services and broker/dealers) in establishing fair value. AFG’s internal investment professionals are a group of approximately 25 analysts whose primary responsibility is to manage AFG’s investment portfolio. These professionals monitor individual investments as well as overall industries and are active in the financial markets on a daily basis. The group is led by AFG’s chief investment officer, who reports directly to one of AFG’s Co-CEOs. Valuation techniques utilized by pricing services and prices obtained from external sources are reviewed by AFG’s internal investment professionals who are familiar with the securities being priced and the markets in which they trade to ensure the fair value determination is representative of an exit price. To validate the appropriateness of the prices obtained, these investment managers consider widely published indices (as benchmarks), recent trades, changes in interest rates, general economic conditions and the credit quality of the specific issuers. In addition, the Company communicates directly with the pricing services regarding the methods and assumptions used in pricing, including verifying, on a test basis, the inputs used by the service to value specific securities.

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AMERICAN FINANCIAL GROUP, INC. 10-Q
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — CONTINUED


Assets and liabilities measured and carried at fair value in the financial statements are summarized below (in millions): 
Level 1 Level 2 Level 3 TotalLevel 1 Level 2 Level 3 Total
September 30, 2017       
September 30, 2018       
Assets:              
Available for sale (“AFS”) fixed maturities:              
U.S. Government and government agencies$120
 $129
 $8
 $257
$142
 $84
 $8
 $234
States, municipalities and political subdivisions
 6,845
 152
 6,997

 6,715
 60
 6,775
Foreign government
 144
 
 144

 139
 
 139
Residential MBS
 3,252
 144
 3,396

 2,564
 145
 2,709
Commercial MBS
 974
 36
 1,010

 866
 57
 923
Asset-backed securities (“ABS”)
 6,860
 536
 7,396
Asset-backed securities
 8,316
 991
 9,307
Corporate and other30
 17,538
 1,050
 18,618
29
 18,482
 1,646
 20,157
Total AFS fixed maturities150
 35,742
 1,926
 37,818
171
 37,166
 2,907
 40,244
Trading fixed maturities48
 302
 
 350
9
 94
 
 103
Equity securities — AFS and trading1,397
 79
 163
 1,639
Equity securities1,462
 76
 289
 1,827
Equity index call options
 759
 
 759
Assets of managed investment entities (“MIE”)368
 4,378
 21
 4,767
258
 4,718
 22
 4,998
Variable annuity assets (separate accounts) (*)
 628
 
 628

 650
 
 650
Equity index call options
 629
 
 629
Other assets — derivatives
 1
 
 1
Total assets accounted for at fair value$1,963
 $41,759
 $2,110
 $45,832
$1,900
 $43,463
 $3,218
 $48,581
Liabilities:              
Liabilities of managed investment entities$348
 $4,138
 $20
 $4,506
$248
 $4,537
 $22
 $4,807
Derivatives in annuity benefits accumulated
 
 2,293
 2,293

 
 3,105
 3,105
Derivatives in long-term debt
 
 
 
Other liabilities — derivatives
 31
 
 31

 83
 
 83
Total liabilities accounted for at fair value$348
 $4,169
 $2,313
 $6,830
$248
 $4,620
 $3,127
 $7,995
              
December 31, 2016       
December 31, 2017       
Assets:              
Available for sale fixed maturities:              
U.S. Government and government agencies$133
 $174
 $8
 $315
$122
 $112
 $8
 $242
States, municipalities and political subdivisions
 6,641
 140
 6,781

 6,975
 148
 7,123
Foreign government
 136
 
 136

 127
 
 127
Residential MBS
 3,445
 190
 3,635

 3,105
 122
 3,227
Commercial MBS
 1,468
 25
 1,493

 926
 36
 962
Asset-backed securities
 5,475
 484
 5,959

 7,218
 744
 7,962
Corporate and other29
 15,484
 712
 16,225
30
 17,662
 1,044
 18,736
Total AFS fixed maturities162
 32,823
 1,559
 34,544
152
 36,125
 2,102
 38,379
Trading fixed maturities30
 329
 
 359
44
 304
 
 348
Equity securities — AFS and trading1,305
 79
 174
 1,558
Equity securities1,411
 86
 165
 1,662
Equity index call options
 701
 
 701
Assets of managed investment entities380
 4,356
 29
 4,765
307
 4,572
 23
 4,902
Variable annuity assets (separate accounts) (*)
 600
 
 600

 644
 
 644
Equity index call options
 492
 
 492
Other assets — derivatives
 1
 
 1
Total assets accounted for at fair value$1,877
 $38,680
 $1,762
 $42,319
$1,914
 $42,432
 $2,290
 $46,636
Liabilities:              
Liabilities of managed investment entities$363
 $4,158
 $28
 $4,549
$293
 $4,372
 $22
 $4,687
Derivatives in annuity benefits accumulated
 
 1,759
 1,759

 
 2,542
 2,542
Derivatives in long-term debt
 (1) 
 (1)
Other liabilities — derivatives
 30
 
 30

 35
 
 35
Total liabilities accounted for at fair value$363
 $4,187
 $1,787
 $6,337
$293
 $4,407
 $2,564
 $7,264
(*)Variable annuity liabilities equal the fair value of variable annuity assets.


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AMERICAN FINANCIAL GROUP, INC. 10-Q
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — CONTINUED



Transfers between Level 1 and Level 2 for all periods presented were a result of increases or decreases in observable trade activity.

During the third quarter there were no transfers between Level 1 and Level 2. During the first nine months of 2018, there were two preferred stocks with an aggregate fair value of $6 million that transferred from Level 1 to Level 2. During the third quarter of 2017, there was one perpetual preferred stock with an aggregate fair value of $1 million that transferred betweenfrom Level 2 andto Level 1. During the first nine months of 2017, there were three preferred stocks with an aggregate fair value of $17 million that transferred from Level 2 to Level 1. During the third quarter of 2016, there was one common stock with a fair value of less than $1 million that transferred from Level 1 to Level 2. During the first nine months of 2016, there were six perpetual preferred stocks with a fair value of $35 million that transferred from Level 2 to Level 1 and five perpetual preferred stocks and one common stock with aggregate fair values of $12 million and less than $1 million, respectively, that transferred from Level 1 to Level 2.

Approximately 5%7% of the total assets carried at fair value at September 30, 2017,2018, were Level 3 assets. Approximately 76%68% ($1.612.18 billion) of the Level 3 assets were priced using non-binding broker quotes, for which there is a lack of transparency as to the inputs used to determine fair value. Details as to the quantitative inputs are neither provided by the brokers nor otherwise reasonably obtainable by AFG. Since internally developed Level 3 asset fair values represent less than 10%approximately 18% of AFG’s Shareholders’ Equity, any justifiable changes in unobservable inputs used to determine internally developed fair values would not be expected to have a material impact on AFG’s financial position.

The only significant Level 3 assets or liabilities carried at fair value in the financial statements that were not measured using broker quotes are the derivatives embedded in AFG’s fixed-indexed and variable-indexed annuity liabilities, which are measured using a discounted cash flow approach and had a fair value of $2.293.11 billion at September 30, 20172018. The following table presents information about the unobservable inputs used by management in determining fair value of these embedded derivatives. See Note FE — “Derivatives.”

 Unobservable Input Range 
 Adjustment for insurance subsidiary’s credit risk 0.2%0.4%2.4%1.6% over the risk free rate 
 Risk margin for uncertainty in cash flows 0.68%0.70% reduction in the discount rate 
 Surrenders 3% – 23% of indexed account value 
 Partial surrenders 2% – 10%9% of indexed account value 
 Annuitizations 0.1% – 1% of indexed account value 
 Deaths 1.5%1.6% – 8.0% of indexed account value 
 Budgeted option costs 2.4% – 3.7%3.6% of indexed account value 

The range of adjustments for insurance subsidiary’s credit risk reflects credit spread variations across the yield curve. The range of projected surrender rates reflects the specific surrender charges and other features of AFG’s individual fixed-indexed and variable-indexed annuity products with an expected range of 6%7% to 10%11% in the majority of future calendar years (3% to 23% over all periods). Increasing the budgeted option cost or risk margin for uncertainty in cash flowsflow assumptions in the table above would increase the fair value of the fixed-indexed and variable-indexed annuity embedded derivatives, while increasing any of the other unobservable inputs in the table above would decrease the fair value of the embedded derivatives.


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AMERICAN FINANCIAL GROUP, INC. 10-Q
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — CONTINUED


Changes in balances of Level 3 financial assets and liabilities carried at fair value during the third quarter and first nine months of 20172018 and 20162017 are presented below (in millions). The transfers into and out of Level 3 were due to changes in the availability of market observable inputs.inputs and $29 million of equity securities transferred into Level 3 in the first quarter of 2018 related to a small number of limited partnerships and similar investments carried at cost under the prior guidance that are carried at fair value through net earnings under new guidance adopted on January 1, 2018, as discussed in Note A — Accounting Policies — Investments.” 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
            
Total realized/unrealized
gains (losses) included in
          
Balance at June 30, 2017 
Net
income
 
Other
comprehensive
income (loss)
 
Purchases
and
issuances
 
Sales and
settlements
 
Transfer
into
Level 3
 
Transfer
out of
Level 3
 Balance at September 30, 2017Balance at June 30, 2018 Net
earnings
 
Other
comprehensive
income (loss)
 
Purchases
and
issuances
 
Sales and
settlements
 
Transfer
into
Level 3
 
Transfer
out of
Level 3
 Balance at September 30, 2018
AFS fixed maturities:                              
U.S. government agency$8
 $
 $
 $
 $
 $
 $
 $8
$8
 $
 $
 $
 $
 $
 $
 $8
State and municipal143
 
 
 
 (1) 10
 
 152
61
 
 
 
 (1) 
 
 60
Residential MBS153
 2
 1
 
 (6) 15
 (21) 144
147
 (2) (2) 
 (6) 13
 (5) 145
Commercial MBS45
 1
 
 
 (10) 
 
 36
56
 2
 
 (1) 
 
 
 57
Asset-backed securities498
 (2) 1
 13
 (26) 163
 (111) 536
1,004
 
 (3) 13
 (23) 
 
 991
Corporate and other953
 (9) 
 172
 (59) 
 (7) 1,050
1,408
 
 (3) 312
 (59) 
 (12) 1,646
Total AFG fixed maturities1,800
 (8) 2
 185
 (102) 188
 (139) 1,926
Total AFS fixed maturities2,684
 
 (8) 324
 (89) 13
 (17) 2,907
Equity securities168
 (3) (4) 2
 
 
 
 163
230
 (5) 
 81
 
 
 (17) 289
Assets of MIE23
 (4) 
 2
 
 
 
 21
23
 (1) 
 
 
 
 
 22
Total Level 3 assets$1,991
 $(15) $(2) $189
 $(102) $188
 $(139) $2,110
$2,937
 $(6) $(8) $405
 $(89) $13
 $(34) $3,218
                              
Embedded derivatives$(2,129) $(127) $
 $(65) $28
 $
 $
 $(2,293)$(2,776) $(223) $
 $(151) $45
 $
 $
 $(3,105)
Total Level 3 liabilities (*)$(2,129) $(127) $
 $(65) $28
 $
 $
 $(2,293)$(2,776) $(223) $
 $(151) $45
 $
 $
 $(3,105)


  
Total realized/unrealized
gains (losses) included in
            
Total realized/unrealized
gains (losses) included in
          
Balance at June 30, 2016 
Net
income
 
Other
comprehensive
income (loss)
 
Purchases
and
issuances
 
Sales and
settlements
 
Transfer
into
Level 3
 
Transfer
out of
Level 3
 Balance at September 30, 2016Balance at June 30, 2017 Net
earnings
 
Other
comprehensive
income (loss)
 
Purchases
and
issuances
 
Sales and
settlements
 
Transfer
into
Level 3
 
Transfer
out of
Level 3
 Balance at September 30, 2017
AFS fixed maturities:                              
U.S. government agency$8
 $
 $
 $
 $
 $
 $
 $8
$8
 $
 $
 $
 $
 $
 $
 $8
State and municipal91
 
 1
 
 (1) 
 
 91
143
 
 
 
 (1) 10
 
 152
Residential MBS231
 (2) 
 
 (8) 
 (2) 219
153
 2
 1
 
 (6) 15
 (21) 144
Commercial MBS36
 
 
 
 (2) 
 
 34
45
 1
 
 
 (10) 
 
 36
Asset-backed securities478
 (1) 4
 
 (5) 
 (9) 467
498
 (2) 1
 13
 (26) 163
 (111) 536
Corporate and other689
 
 (3) 37
 (14) 
 
 709
953
 (9) 
 172
 (59) 
 (7) 1,050
Total AFS fixed maturities1,533
 (3) 2
 37
 (30) 
 (11) 1,528
1,800
 (8) 2
 185
 (102) 188
 (139) 1,926
Equity securities166
 5
 5
 10
 (21) 
 
 165
168
 (3) (4) 2
 
 
 
 163
Assets of MIE26
 (2) 
 
 
 
 
 24
23
 (4) 
 2
 
 
 
 21
Total Level 3 assets$1,725
 $
 $7
 $47
 $(51) $
 $(11) $1,717
$1,991
 $(15) $(2) $189
 $(102) $188
 $(139) $2,110
                              
Embedded derivatives$(1,557) $(109) $
 $(53) $31
 $
 $
 $(1,688)$(2,129) $(127) $
 $(65) $28
 $
 $
 $(2,293)
Total Level 3 liabilities (*)$(1,557) $(109) $
 $(53) $31
 $
 $
 $(1,688)$(2,129) $(127) $
 $(65) $28
 $
 $
 $(2,293)

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

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AMERICAN FINANCIAL GROUP, INC. 10-Q
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — CONTINUED



  
Total realized/unrealized
gains (losses) included in
            
Total realized/unrealized
gains (losses) included in
          
Balance at December 31, 2016 
Net
income
 
Other
comprehensive
income (loss)
 
Purchases
and
issuances
 
Sales and
settlements
 
Transfer
into
Level 3
 
Transfer
out of
Level 3
 Balance at September 30, 2017Balance at December 31, 2017 Net
earnings
 
Other
comprehensive
income (loss)
 
Purchases
and
issuances
 
Sales and
settlements
 
Transfer
into
Level 3
 
Transfer
out of
Level 3
 Balance at September 30, 2018
AFS fixed maturities:                              
U.S. government agency$8
 $
 $
 $
 $
 $
 $
 $8
$8
 $
 $
 $
 $
 $
 $
 $8
State and municipal140
 
 4
 
 (2) 10
 
 152
148
 
 (2) 
 (2) 
 (84) 60
Residential MBS190
 
 3
 1
 (37) 35
 (48) 144
122
 (9) (2) 
 (17) 70
 (19) 145
Commercial MBS25
 2
 
 15
 (10) 4
 
 36
36
 1
 
 20
 
 
 
 57
Asset-backed securities484
 (2) 3
 117
 (62) 199
 (203) 536
744
 (2) (6) 353
 (80) 
 (18) 991
Corporate and other712
 (4) 8
 460
 (124) 29
 (31) 1,050
1,044
 2
 (21) 784
 (138) 
 (25) 1,646
Total AFS fixed maturities1,559
 (4) 18
 593
 (235) 277
 (282) 1,926
2,102
 (8) (31) 1,157
 (237) 70
 (146) 2,907
Equity securities174
 (19) 9
 22
 (3) 
 (20) 163
165
 9
 
 106
 (4) 30
 (17) 289
Assets of MIE29
 (10) 
 6
 
 
 (4) 21
23
 (6) 
 5
 
 
 
 22
Total Level 3 assets$1,762
 $(33) $27
 $621
 $(238) $277
 $(306) $2,110
$2,290
 $(5) $(31) $1,268
 $(241) $100
 $(163) $3,218
                              
Embedded derivatives(a)$(1,759) $(386) $
 $(224) $76
 $
 $
 $(2,293)$(2,542) $(286) $
 $(395) $118
 $
 $
 $(3,105)
Total Level 3 liabilities (*)$(1,759) $(386) $
 $(224) $76
 $
 $
 $(2,293)
Total Level 3 liabilities (b)$(2,542) $(286) $
 $(395) $118
 $
 $
 $(3,105)


  
Total realized/unrealized
gains (losses) included in
            
Total realized/unrealized
gains (losses) included in
          
Balance at December 31, 2015 
Net
income
 
Other
comprehensive
income (loss)
 
Purchases
and
issuances
 
Sales and
settlements
 
Transfer
into
Level 3
 
Transfer
out of
Level 3
 Balance at September 30, 2016Balance at December 31, 2016 Net
earnings
 
Other
comprehensive
income (loss)
 
Purchases
and
issuances
 
Sales and
settlements
 
Transfer
into
Level 3
 
Transfer
out of
Level 3
 Balance at September 30, 2017
AFS fixed maturities:                              
U.S. government agency$15
 $(8) $1
 $
 $
 $
 $
 $8
$8
 $
 $
 $
 $
 $
 $
 $8
State and municipal89
 
 4
 
 (2) 
 
 91
140
 
 4
 
 (2) 10
 
 152
Residential MBS224
 
 1
 
 (21) 33
 (18) 219
190
 
 3
 1
 (37) 35
 (48) 144
Commercial MBS39
 (1) 
 
 (4) 
 
 34
25
 2
 
 15
 (10) 4
 
 36
Asset-backed securities470
 (1) 1
 15
 (24) 41
 (35) 467
484
 (2) 3
 117
 (62) 199
 (203) 536
Corporate and other633
 
 24
 131
 (89) 15
 (5) 709
712
 (4) 8
 460
 (124) 29
 (31) 1,050
Total AFS fixed maturities1,470
 (10) 31
 146
 (140) 89
 (58) 1,528
1,559
 (4) 18
 593
 (235) 277
 (282) 1,926
Equity securities140
 (12) 21
 22
 (21) 15
 
 165
174
 (19) 9
 22
 (3) 
 (20) 163
Assets of MIE26
 (6) 
 4
 
 
 
 24
29
 (10) 
 6
 
 
 (4) 21
Total Level 3 assets$1,636
 $(28) $52
 $172
 $(161) $104
 $(58) $1,717
$1,762
 $(33) $27
 $621
 $(238) $277
 $(306) $2,110
                              
Embedded derivatives$(1,369) $(188) $
 $(207) $76
 $
 $
 $(1,688)$(1,759) $(386) $
 $(224) $76
 $
 $
 $(2,293)
Total Level 3 liabilities (*)$(1,369) $(188) $
 $(207) $76
 $
 $
 $(1,688)
Total Level 3 liabilities (b)$(1,759) $(386) $
 $(224) $76
 $
 $
 $(2,293)
(*)(a)Total realized/unrealized gains (losses) included in net earnings for the embedded derivatives reflects losses related to the unlocking of actuarial assumptions of $44 million in the first nine months of 2018.
(b)As previously discussed, previously, these tables exclude the portion of MIE liabilities allocated to Level 3, which are derived from the fair value of the MIE assets.


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AMERICAN FINANCIAL GROUP, INC. 10-Q
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — CONTINUED


Fair Value of Financial Instruments   The carrying value and fair value of financial instruments that are not carried at fair value in the financial statements are summarized below (in millions): 
Carrying Fair ValueCarrying Fair Value
Value Total Level 1 Level 2 Level 3Value Total Level 1 Level 2 Level 3
September 30, 2017         
September 30, 2018         
Financial assets:                  
Cash and cash equivalents$2,349
 $2,349
 $2,349
 $
 $
$2,009
 $2,009
 $2,009
 $
 $
Mortgage loans1,043
 1,040
 
 
 1,040
1,152
 1,130
 
 
 1,130
Policy loans186
 186
 
 
 186
176
 176
 
 
 176
Total financial assets not accounted for at fair value$3,578
 $3,575
 $2,349
 $
 $1,226
$3,337
 $3,315
 $2,009
 $
 $1,306
Financial liabilities:                  
Annuity benefits accumulated (*)$32,464
 $31,857
 $
 $
 $31,857
$35,729
 $33,923
 $
 $
 $33,923
Long-term debt1,284
 1,380
 
 1,377
 3
1,302
 1,260
 
 1,257
 3
Total financial liabilities not accounted for at fair value$33,748
 $33,237
 $
 $1,377
 $31,860
$37,031
 $35,183
 $
 $1,257
 $33,926
                  
December 31, 2016         
December 31, 2017         
Financial assets:                  
Cash and cash equivalents$2,107
 $2,107
 $2,107
 $
 $
$2,338
 $2,338
 $2,338
 $
 $
Mortgage loans1,147
 1,146
 
 
 1,146
1,125
 1,119
 
 
 1,119
Policy loans192
 192
 
 
 192
184
 184
 
 
 184
Total financial assets not accounted for at fair value$3,446
 $3,445
 $2,107
 $
 $1,338
$3,647
 $3,641
 $2,338
 $
 $1,303
Financial liabilities:                  
Annuity benefits accumulated (*)$29,703
 $28,932
 $
 $
 $28,932
$33,110
 $32,461
 $
 $
 $32,461
Long-term debt1,284
 1,356
 
 1,353
 3
1,301
 1,354
 
 1,351
 3
Total financial liabilities not accounted for at fair value$30,987
 $30,288
 $
 $1,353
 $28,935
$34,411
 $33,815
 $
 $1,351
 $32,464

(*)Excludes $207$229 million and $204$206 million of life contingent annuities in the payout phase at September 30, 20172018 and December 31, 2016,2017, respectively.

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.


2019

Table of Contents
AMERICAN FINANCIAL GROUP, INC. 10-Q
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — CONTINUED


E.D.    Investments

Available for sale fixed maturities and equity securities at September 30, 20172018 and December 31, 20162017, consisted of the following (in millions):
September 30, 2017 December 31, 2016September 30, 2018 December 31, 2017
Amortized
Cost
 Gross Unrealized 
Net
Unrealized
 
Fair
Value
 
Amortized
Cost
 Gross Unrealized 
Net
Unrealized
 
Fair
Value
Amortized
Cost
 Gross Unrealized 
Net
Unrealized
 
Fair
Value
 
Amortized
Cost
 Gross Unrealized 
Net
Unrealized
 
Fair
Value
Gains Losses Gains LossesGains Losses Gains Losses
Fixed maturities:                                      
U.S. Government and government agencies$257
 $2
 $(2) $
 $257
 $315
 $3
 $(3) $
 $315
$238
 $
 $(4) $(4) $234
 $244
 $1
 $(3) $(2) $242
States, municipalities and political subdivisions6,761
 259
 (23) 236
 6,997
 6,650
 200
 (69) 131
 6,781
6,756
 117
 (98) 19
 6,775
 6,887
 254
 (18) 236
 7,123
Foreign government141
 3
 
 3
 144
 131
 5
 
 5
 136
137
 2
 
 2
 139
 124
 3
 
 3
 127
Residential MBS3,062
 341
 (7) 334
 3,396
 3,367
 281
 (13) 268
 3,635
2,408
 310
 (9) 301
 2,709
 2,884
 349
 (6) 343
 3,227
Commercial MBS967
 44
 (1) 43
 1,010
 1,446
 49
 (2) 47
 1,493
913
 14
 (4) 10
 923
 927
 36
 (1) 35
 962
Asset-backed securities7,268
 143
 (15) 128
 7,396
 5,962
 43
 (46) (3) 5,959
9,249
 122
 (64) 58
 9,307
 7,836
 142
 (16) 126
 7,962
Corporate and other17,956
 699
 (37) 662
 18,618
 15,864
 473
 (112) 361
 16,225
20,352
 169
 (364) (195) 20,157
 18,136
 638
 (38) 600
 18,736
Total fixed maturities$36,412
 $1,491
 $(85) $1,406
 $37,818
 $33,735
 $1,054
 $(245) $809
 $34,544
$40,053
 $734
 $(543) $191
 $40,244
 $37,038
 $1,423
 $(82) $1,341
 $38,379
                                      
Equity Securities:                   
Common stocks$830
 $251
 $(27) $224
 $1,054
 $879
 $160
 $(23) $137
 $1,016
Perpetual preferred stocks482
 44
 (1) 43
 525
 472
 21
 (7) 14
 486
Total equity securities$1,312
 $295
 $(28) $267
 $1,579
 $1,351
 $181
 $(30) $151
 $1,502

The non-credit related portion of other-than-temporary impairment charges is included in other comprehensive income. Cumulative non-credit charges taken for securities still owned at September 30, 20172018 and December 31, 20162017 were $165$144 million and $189$158 million, respectively. Gross unrealized gains on such securities at September 30, 20172018 and December 31, 20162017 were $141$130 million and $130$137 million, respectively. Gross unrealized losses on such securities at both September 30, 20172018 and December 31, 20162017 were $4 million and $3 million, respectively.million. These amounts represent the non-credit other-than-temporary impairment charges recorded in AOCI adjusted for subsequent changes in fair values and nearly all relate primarily to residential MBS.

As discussed in Note A — Accounting Policies — Investments,” beginning on January 1, 2018, AFG implemented new accounting guidance, which required all equity securities previously classified as “available for sale” to be reported at fair value, with holding gains and losses recognized in net earnings. Equity securities reported at fair value consisted of the following at September 30, 2018 (in millions):
21
     Fair Value in
 Actual Cost Fair Value excess of Cost
Common stocks$1,040
 $1,151
 $111
Perpetual preferred stocks683
 676
 (7)
Total equity securities carried at fair value$1,723
 $1,827
 $104


20

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AMERICAN FINANCIAL GROUP, INC. 10-Q
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — CONTINUED


The following tables show gross unrealized losses (dollars in millions) on available for sale fixed maturities and equity securities by investment category and length of time that individual securities have been in a continuous unrealized loss position at September 30, 2017 and December 31, 2016.the following balance sheet dates. 
Less Than Twelve Months Twelve Months or MoreLess Than Twelve Months Twelve Months or More
Unrealized
Loss
 
Fair
Value
 
Fair Value as
% of Cost
 
Unrealized
Loss
 
Fair
Value
 
Fair Value as
% of Cost
Unrealized
Loss
 
Fair
Value
 
Fair Value as
% of Cost
 
Unrealized
Loss
 
Fair
Value
 
Fair Value as
% of Cost
September 30, 2017           
September 30, 2018           
Fixed maturities:                      
U.S. Government and government agencies$
 $97
 100% $(2) $57
 97%$(1) $113
 99% $(3) $100
 97%
States, municipalities and political subdivisions(18) 1,099
 98% (5) 160
 97%(63) 2,729
 98% (35) 721
 95%
Foreign government
 105
 100% 
 
 %
Residential MBS(3) 200
 99% (6) 132
 96%
Commercial MBS(3) 178
 98% (1) 51
 98%
Asset-backed securities(47) 4,775
 99% (17) 353
 95%
Corporate and other(283) 10,984
 97% (81) 1,346
 94%
Total fixed maturities$(400) $19,084
 98% $(143) $2,703
 95%
           
December 31, 2017           
Fixed maturities:           
U.S. Government and government agencies$
 $55
 100% $(3) $123
 98%
States, municipalities and political subdivisions(8) 825
 99% (10) 431
 98%
Foreign government
 4
 100% 
 
 %
Residential MBS(2) 163
 99% (5) 189
 97%(1) 118
 99% (5) 118
 96%
Commercial MBS(1) 69
 99% 
 
 %(1) 67
 99% 
 
 %
Asset-backed securities(7) 828
 99% (8) 245
 97%(7) 1,195
 99% (9) 299
 97%
Corporate and other(24) 1,744
 99% (13) 310
 96%(20) 2,031
 99% (18) 603
 97%
Total fixed maturities$(52) $4,000
 99% $(33) $961
 97%$(37) $4,295
 99% $(45) $1,574
 97%
                      
Equity securities:                      
Common stocks$(27) $141
 84% $
 $
 %$(22) $117
 84% $
 $
 %
Perpetual preferred stocks
 23
 100% (1) 13
 93%
 41
 100% (1) 13
 93%
Total equity securities$(27) $164
 86% $(1) $13
 93%$(22) $158
 88% $(1) $13
 93%
           
December 31, 2016           
Fixed maturities:           
U.S. Government and government agencies$(1) $153
 99% $(2) $8
 80%
States, municipalities and political subdivisions(64) 2,289
 97% (5) 44
 90%
Residential MBS(7) 502
 99% (6) 162
 96%
Commercial MBS(2) 121
 98% 
 
 %
Asset-backed securities(29) 1,737
 98% (17) 634
 97%
Corporate and other(93) 3,849
 98% (19) 312
 94%
Total fixed maturities$(196) $8,651
 98% $(49) $1,160
 96%
           
Equity securities:           
Common stocks$(23) $215
 90% $
 $
 %
Perpetual preferred stocks(6) 135
 96% (1) 6
 86%
Total equity securities$(29) $350
 92% $(1) $6
 86%

At September 30, 20172018, the gross unrealized losses on fixed maturities of $85543 million relate to 7352,392 securities. Investment grade securities (as determined by nationally recognized rating agencies) represented approximately 73%95% of the gross unrealized loss and 88%96% of the fair value.

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. In the first nine months of 20172018, AFG recorded $1 million in other-than-temporary impairment charges related to its residential MBS.

In the first nine months of 2017,2018, AFG recorded $15$2 million in other-than-temporary impairment charges related to corporate bonds and other fixed maturities.

AFG recorded $42 million in other-than-temporary impairment charges on common stocks in the first nine months of 2017. At September 30, 2017, the gross unrealized losses on common stocks of $27 million relate to 19 securities, none of which has been in an unrealized loss position for more than 12 months.


22

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AMERICAN FINANCIAL GROUP, INC. 10-Q
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — CONTINUED


AFG recorded $7 million in other-than-temporary impairment charges on preferred stocks in the first nine months of 2017. At September 30, 2017, the gross unrealized losses on preferred stocks of $1 million relate to 5 securities, 3 of which have been in an unrealized loss position for 12 months or more and are rated investment grade.

Management believes AFG will recover its cost basis in the securities with unrealized losses and that AFG has the ability to hold the securities until they recover in value and had no intent to sell them at September 30, 20172018. As discussed in Note A — “Accounting PoliciesInvestments,” effective January 1, 2018, all equity securities previously classified as “available for sale” are required to be carried at fair value through net earnings instead of accumulated other comprehensive income and therefore are no longer evaluated for other-than-temporary impairment.


21

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AMERICAN FINANCIAL GROUP, INC. 10-Q
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — CONTINUED


A progression of 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 is shown below (in millions):

2017 20162018 2017
Balance at June 30$145
 $157
$144
 $145
Additional credit impairments on:      
Previously impaired securities
 

 
Securities without prior impairments3
 

 3
Reductions due to sales or redemptions(1) (2)(1) (1)
Balance at September 30$147
 $155
$143
 $147
      
Balance at January 1$153
 $160
$145
 $153
Additional credit impairments on:      
Previously impaired securities1
 2

 1
Securities without prior impairments3
 
1
 3
Reductions due to sales or redemptions(10) (7)(3) (10)
Balance at September 30$147
 $155
$143
 $147

The table below sets forth the scheduled maturities of available for sale fixed maturities as of September 30, 20172018 (dollars in millions). Securities with sinking funds are reported at average maturity. Actual maturities may differ from contractual maturities because certain securities may be called or prepaid by the issuers.
Amortized Fair ValueAmortized Fair Value
Cost Amount %Cost Amount %
Maturity          
One year or less$927
 $939
 2%$1,212
 $1,223
 3%
After one year through five years6,521
 6,787
 18%8,150
 8,184
 20%
After five years through ten years13,074
 13,527
 36%13,372
 13,211
 33%
After ten years4,593
 4,763
 13%4,749
 4,687
 12%
25,115
 26,016
 69%27,483
 27,305
 68%
ABS (average life of approximately 5 years)7,268
 7,396
 19%
ABS (average life of approximately 4-1/2 years)9,249
 9,307
 23%
MBS (average life of approximately 4-1/2 years)4,029
 4,406
 12%3,321
 3,632
 9%
Total$36,412
 $37,818
 100%$40,053
 $40,244
 100%

Certain risks are inherent in fixed maturity securities, including loss upon default, price volatility in reaction to changes in interest rates, and general market factors and risks associated with reinvestment of proceeds due to prepayments or redemptions in a period of declining interest rates.
There were no investments in individual issuers that exceeded 10% of shareholders’ equity at September 30, 20172018 or December 31, 20162017.


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AMERICAN FINANCIAL GROUP, INC. 10-Q
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — CONTINUED


Net Unrealized Gain on Marketable Securities   In addition to adjusting fixed maturity securities and equity securities classified as “available for sale” to fair value, GAAP requires that deferred policy acquisition costs and certain other balance sheet amounts related to annuity, long-term care and life businesses be adjusted to the extent that unrealized gains and losses from securities would result in adjustments to those balances had the unrealized gains or losses actually been realized. The following table shows (in millions) the components of the net unrealized gain on securities that is included in AOCI in AFG’s Balance Sheet.
Pretax Deferred Tax NetPretax Deferred Tax Net
September 30, 2017     
September 30, 2018     
Net unrealized gain on:          
Fixed maturities — annuity segment (*)$1,131
 $(396) $735
Fixed maturities — annuity segment (a)$143
 $(30) $113
Fixed maturities — all other275
 (96) 179
48
 (10) 38
Total fixed maturities1,406
 (492) 914
191
 (40) 151
Equity securities267
 (94) 173
Deferred policy acquisition costs — annuity segment(56) 12
 (44)
Annuity benefits accumulated(18) 3
 (15)
Unearned revenue1
 
 1
Total net unrealized gain on marketable securities$118
 $(25) $93
     
December 31, 2017     
Net unrealized gain on:     
Fixed maturities — annuity segment (a)$1,082
 $(227) $855
Fixed maturities — all other259
 (55) 204
Total fixed maturities1,341
 (282) 1,059
Equity securities (b)279
 (58) 221
Total investments1,673
 (586) 1,087
1,620
 (340) 1,280
Deferred policy acquisition costs — annuity segment(465) 163
 (302)(433) 91
 (342)
Annuity benefits accumulated(141) 49
 (92)(137) 29
 (108)
Unearned revenue20
 (7) 13
13
 (3) 10
Total net unrealized gain on marketable securities$1,087
 $(381) $706
$1,063
 $(223) $840
     
December 31, 2016     
Net unrealized gain on:     
Fixed maturities — annuity segment (*)$640
 $(224) $416
Fixed maturities — all other169
 (59) 110
Total fixed maturities809
 (283) 526
Equity securities151
 (53) 98
Total investments960
 (336) 624
Deferred policy acquisition costs — annuity segment(273) 96
 (177)
Annuity benefits accumulated(78) 27
 (51)
Unearned revenue13
 (5) 8
Total net unrealized gain on marketable securities$622
 $(218) $404

(*)(a)Net unrealized gains on fixed maturity investments supporting AFG’s annuity benefits accumulated.
(b)
As discussed in Note A — “Accounting PoliciesInvestments,” effective January 1, 2018, all equity securities other than those accounted for under the equity method are carried at fair value through net earnings.

Net Investment Income   The following table shows (in millions) investment income earned and investment expenses incurred.
Three months ended September 30, Nine months ended September 30,Three months ended September 30, Nine months ended September 30,
2017 2016 2017 20162018 2017 2018 2017
Investment income:              
Fixed maturities$405
 $378
 $1,191
 $1,126
$440
 $405
 $1,283
 $1,191
Equity securities17
 20
 57
 59
Equity securities:       
Dividends19
 17
 59
 53
Change in fair value (*)2
 
 16
 4
Equity in earnings of partnerships and similar investments20
 16
 51
 31
41
 20
 128
 51
Other33
 23
 80
 64
31
 33
 82
 80
Gross investment income475
 437
 1,379
 1,280
533
 475
 1,568
 1,379
Investment expenses(4) (4) (13) (13)(6) (4) (16) (13)
Net investment income$471
 $433
 $1,366
 $1,267
$527
 $471
 $1,552
 $1,366

(*)
As discussed in Note A — “Accounting PoliciesInvestments,” AFG adopted guidance in January 2018 that requires all equity securities other than those accounted for under the equity method to be reported at fair value with holding gains and losses recognized in net earnings. Although the change in the fair value of the majority of AFG’s equity securities is recorded in realized gains (losses) on securities, AFG records holding gains and losses in net investment income on equity

2423

AMERICAN FINANCIAL GROUP, INC. 10-Q
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — CONTINUED


securities classified as “trading” under the previous guidance and on a small portfolio of limited partnership and similar investments that do not qualify for the equity method of accounting.
Realized gains (losses) and changes in unrealized appreciation (depreciation) related to fixed maturity and equity security investments are summarized as follows (in millions): 
Three months ended September 30, 2017 Three months ended September 30, 2016Three months ended September 30, 2018 Three months ended September 30, 2017
Realized gains (losses)   Realized gains (losses)  Realized gains (losses)   Realized gains (losses)  
Before Impairments Impairments Total Change in Unrealized Before Impairments Impairments Total Change in UnrealizedBefore Impairments Impairments Total Change in Unrealized Before Impairments Impairments Total Change in Unrealized
Fixed maturities$9
 $(15) $(6) $133
 $5
 $(2) $3
 $52
$
 $(2) $(2) $(213) $9
 $(15) $(6) $133
Equity securities19
 (29) (10) 24
 14
 (16) (2) 89
33
 
 33
 
 19
 (29) (10) 24
Mortgage loans and other investments
 
 
 
 
 
 
 

 
 
 
 
 
 
 
Other (*)(2) 6
 4
 (53) (1) 2
 1
 (5)3
 
 3
 89
 (2) 6
 4
 (53)
Total pretax26

(38)
(12)
104

18

(16)
2

136
36

(2)
34

(124)
26

(38)
(12)
104
Tax effects(9) 13
 4
 (37) (7) 5
 (2) (48)(8) 1
 (7) 26
 (9) 13
 4
 (37)
Noncontrolling interests
 
 
 
 
 1
 1
 (1)
Net of tax and noncontrolling interests$17

$(25)
$(8)
$67

$11

$(10)
$1

$87
Net of tax$28

$(1)
$27

$(98)
$17

$(25)
$(8)
$67
               
                              
Nine months ended September 30, 2017 Nine months ended September 30, 2016Nine months ended September 30, 2018 Nine months ended September 30, 2017
Realized gains (losses)   Realized gains (losses)  Realized gains (losses)   Realized gains (losses)  
Before Impairments Impairments Total Change in Unrealized Before Impairments Impairments Total Change in UnrealizedBefore Impairments Impairments Total Change in Unrealized Before Impairments Impairments Total Change in Unrealized
Fixed maturities$25
 $(16) $9
 $597
 $36
 $(37) $(1) $1,089
$3
 $(3) $
 $(1,150) $25
 $(16) $9
 $597
Equity securities29
 (49) (20) 116
 46
 (83) (37) 77
(39) 
 (39) 
 29
 (49) (20) 116
Mortgage loans and other investments3
 
 3
 
 
 
 
 

 
 
 
 3
 
 3
 
Other (*)(5) 12
 7
 (248) (7) 13
 6
 (478)11
 
 11
 484
 (5) 12
 7
 (248)
Total pretax52
 (53) (1) 465
 75
 (107) (32) 688
(25) (3) (28) (666) 52
 (53) (1) 465
Tax effects(18) 18
 
 (163) (27) 38
 11
 (241)5
 1
 6
 140
 (18) 18
 
 (163)
Noncontrolling interests
 
 
 
 (1) 3
 2
 (7)
Net of tax and noncontrolling interests$34
 $(35) $(1) $302
 $47
 $(66) $(19) $440
Net of tax$(20) $(2) $(22) $(526) $34
 $(35) $(1) $302
(*)Primarily adjustments to deferred policy acquisition costs and reserves related to the annuity business.

As discussed in Note A — “Accounting PoliciesInvestments,” effective January 1, 2018, all equity securities other than those accounted for under the equity method are carried at fair value through net earnings. AFG recorded net holding gains (losses) on equity securities during the third quarter and first nine months of 2018 on securities that were still owned at September 30, 2018 as follows (in millions):
 Three months ended Nine months ended
 September 30, 2018 September 30, 2018
Included in realized gains (losses)$25
 $(51)
Included in net investment income2
 16
 $27
 $(35)

Gross realized gains and losses (excluding impairment write-downs and mark-to-market of derivatives) on available for sale fixed maturity and equity security investment transactions consisted of the following (in millions): 
Nine months ended September 30,Nine months ended September 30,
2017 20162018 2017
Fixed maturities:      
Gross gains$32
 $44
$19
 $32
Gross losses(4) (8)(8) (4)
Equity securities:   
Gross gains36
 49
Gross losses(6) (3)

In the first nine months of 2017, AFG recorded gross gains of $36 million and gross losses of $6 million on available for sale equity securities.

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — CONTINUED



F.E.    Derivatives

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

Derivatives That Do Not Qualify for Hedge Accounting   The following derivatives that do not qualify for hedge accounting under GAAP are included in AFG’s Balance Sheet at fair value (in millions):
   September 30, 2017 December 31, 2016   September 30, 2018 December 31, 2017
Derivative Balance Sheet Line Asset Liability Asset Liability Balance Sheet Line Asset Liability Asset Liability
MBS with embedded derivatives Fixed maturities $111
 $
 $107
 $
 Fixed maturities $110
 $
 $105
 $
Public company warrants Equity securities 3
 
 4
 
 Equity securities 3
 
 4
 
Fixed-indexed annuities (embedded derivative) Annuity benefits accumulated 
 2,293
 
 1,759
Fixed-indexed and variable-indexed annuities (embedded derivative) Annuity benefits accumulated 
 3,105
 
 2,542
Equity index call options Equity index call options 629
 
 492
 
 Equity index call options 759
 
 701
 
Equity index put options Other liabilities 
 
 
 
Reinsurance contracts (embedded derivative) Other liabilities 
 10
 
 8
 Other liabilities 
 2
 
 4
 $743
 $2,303
 $603
 $1,767
 $872
 $3,107
 $810
 $2,546

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

Warrants to purchase shares of publicly traded companies, which represent a small component of AFG’s overall investment portfolio, are considered to be derivatives that are required to be carried at fair value through earnings.

AFG’s fixed-indexed and variable-indexed annuities provide policyholders with a crediting rate tied, in part, to the performance of an existing stock market or other financial index. AFG attempts to mitigate the risk in the index-based component of these products through the purchase and sale of call and put options on the appropriate index. AFG receives collateral from itscertain counterparties to support its purchased call option assets.assets (net of collateral required under put option contracts with the same counterparties). This collateral ($374545 million at September 30, 20172018 and $380$389 million at December 31, 2016)2017) is included in other assets in AFG’s Balance Sheet with an offsetting liability to return the collateral, which is included in other liabilities. AFG’s strategy is designed so that the change in the fair value of the call option assetsand put options will generally offset the economic change in the liabilities from the index participation. Both the index-based component of the annuities and the related call and put options are considered derivatives. Fluctuations in interest rates and the stock market, among other factors, can cause volatility in the periodic measurement of fair value of the embedded derivative that management believes can be inconsistent with the long-term economics of these products.

As discussed under “Reinsurance” in Note A, certainAFG has a reinsurance contracts arecontract that is considered to contain an embedded derivatives.derivative.


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AMERICAN FINANCIAL GROUP, INC. 10-Q
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — CONTINUED


The following table summarizes the gain (loss)gains (losses) included in AFG’s Statement of Earnings for changes in the fair value of derivatives that do not qualify for hedge accounting for the third quarter and first nine months of 20172018 and 20162017 (in millions): 
 Three months ended September 30, Nine months ended September 30, Three months ended September 30, Nine months ended September 30,
Derivative Statement of Earnings Line 2017 2016 2017 2016 Statement of Earnings Line 2018 2017 2018 2017
MBS with embedded derivatives Realized gains on securities $
 $(4) $(3) $
 Realized gains (losses) on securities $(3) $
 $(8) $(3)
Public company warrants Realized gains on securities (1) 1
 (1) 
 Realized gains (losses) on securities 1
 (1) 
 (1)
Fixed-indexed annuities (embedded derivative) Annuity benefits (127) (109) (386) (188)
Fixed-indexed and variable-indexed annuities (embedded derivative) (*) Annuity benefits (223) (127) (286) (386)
Equity index call options Annuity benefits 116
 105
 338
 81
 Annuity benefits 219
 116
 271
 338
Reinsurance contracts (embedded derivative) Net investment income 
 
 (2) (6)
Equity index put options Annuity benefits 
 
 
 
Reinsurance contract (embedded derivative) Net investment income 
 
 2
 (2)
 $(12) $(7) $(54) $(113) $(6) $(12) $(21) $(54)

(*)The change in fair value of the embedded derivative for the nine months ended September 30, 2018 includes a $44 million charge in the second quarter of 2018 related to the unlocking of actuarial assumptions.

Derivatives Designated and Qualifying as Cash Flow Hedges   As of September 30, 2017,2018, AFG has entered into eightfourteen interest rate swaps that are designated and qualify as highly effective cash flow hedges to mitigate interest rate risk related to certain floating-rate securities included in AFG’s portfolio of fixed maturity securities. The purpose of each of these swaps is to effectively convert a portion of AFG’s floating-rate fixed maturity securities to fixed rates by offsetting the variability in cash flows attributable to changes in short-term LIBOR.

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — CONTINUED



Under the terms of the swaps, AFG receives fixed-rate interest payments in exchange for variable interest payments based on short-term LIBOR. The notional amounts of the interest rate swaps generally decline over each swap’s respective life (the swaps expire between August 2019 and June 2030) in anticipation of the expected decline in AFG’s portfolio of fixed maturity securities with floating interest rates based on short-term LIBOR. The total outstanding notional amount of AFG’s interest rate swaps was $1.35$2.17 billion at September 30, 20172018 compared to $1.08$1.58 billion at December 31, 2016,2017, reflecting afour new swapswaps with an aggregate notional amount at issuance of $400$697 million entered into in the third quarterfirst nine months of 2017,2018, partially offset by the scheduled amortization discussed above. The fair value of the effective portion of the interest rate swaps in an asset position and included in other assets was zero at September 30, 2018 and less than $1 million at both September 30, 2017 and December 31, 2016.2017. The fair value of the effective portion of the interest rate swaps in a liability position and included in other liabilities was $21$81 million at September 30, 20172018 and $22$31 million at December 31, 2016.2017. The net unrealized gain or loss on cash flow hedges is included in AOCI, net of DPAC and deferred taxes. Amounts reclassified from AOCI (before DPAC and taxes) to net investment income were losses of $1 million and $2 million induring the third quartersquarter and $4 million and $5 million in the first nine months of 20172018 as compared to income of $1 million and 2016,$4 million in the third quarter and first nine months of 2017, respectively. There was no ineffectiveness recorded in net earnings during these periods. A collateral receivable supporting these swaps of $60$126 million at both September 30, 20172018 and $70 million at December 31, 20162017 is included in other assets in AFG’s Balance Sheet.

Derivative Designated and Qualifying as a Fair Value Hedge   In June 2015, AFG entered into an interest rate swap to mitigate the interest rate risk associated with its fixed-rate 9-7/8% Senior Notes due June 2019 by effectively converting the interest rate on those notes to a floating rate of three-month LIBOR plus 8.099% (9.4190% at September 30, 2017). Since the terms of the interest rate swap match the terms of the hedged debt, changes in the fair value of the interest rate swap are offset by changes in the fair value of the hedged debt attributable to changes in interest rates. The fair value of the interest rate swap (a liability of less than $1 million at September 30, 2017 and an asset of $1 million at December 31, 2016) and the offsetting adjustment to the carrying value of the 9-7/8% Senior Notes are both included in long-term debt on AFG’s Balance Sheet. Accordingly, the net impact on AFG’s current period earnings is that the interest expense associated with the hedged debt is effectively recorded at the floating rate. The net reduction in interest expense from the swap was less than $1 million and $1 million in the third quarters and $1 million and $3 million in the first nine months of 2017 and 2016, respectively.


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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — CONTINUED


G.F.    Deferred Policy Acquisition Costs

A progression of deferred policy acquisition costs is presented below (in millions):
P&C  Annuity and Run-off Long-term Care and Life   P&C  Annuity and Other   
Deferred  Deferred Sales          ConsolidatedDeferred  Deferred Sales          Consolidated
Costs  Costs Inducements PVFP Subtotal Unrealized (*) Total  Total
Balance at June 30, 2018$298
  $1,243
 $94
 $45
 $1,382
 $(98) $1,284
  $1,582
Additions181
  65
 1
 
 66
 
 66
  247
Amortization:                 
Periodic amortization(171)  (58) (5) (2) (65) 
 (65)  (236)
Included in realized gains
  3
 
 
 3
 
 3
  3
Foreign currency translation
  
 
 
 
 
 
  
Change in unrealized
  
 
 
 
 73
 73
  73
Balance at September 30, 2018$308
  $1,253
 $90
 $43
 $1,386
 $(25) $1,361
  $1,669
Costs  Costs Inducements PVFP Subtotal Unrealized (*) Total  Total                 
Balance at June 30, 2017$258
  $1,167
 $103
 $42
 $1,312
 $(414) $898
  $1,156
$258
  $1,167
 $103
 $42
 $1,312
 $(414) $898
  $1,156
Additions149
  44
 1
 
 45
 
 45
  194
149
  44
 1
 
 45
 
 45
  194
Amortization:                              

   
Periodic amortization(142)  (44) (4) (2) (50) 
 (50)  (192)(142)  (44) (4) (2) (50) 
 (50)  (192)
Included in realized gains
  4
 
 
 4
 
 4
  4

  4
 
 
 4
 
 4
  4
Foreign currency translation1
  
 
 
 
 
 
  1
1
  
 
 
 
 
 
  1
Change in unrealized
  
 
 
 
 (44) (44)  (44)
  
 
 
 
 (44) (44)  (44)
Balance at September 30, 2017$266
  $1,171
 $100
 $40
 $1,311
 $(458) $853
  $1,119
$266
  $1,171
 $100
 $40
 $1,311
 $(458) $853
  $1,119
                                  
Balance at June 30, 2016$234
  $1,089
 $116
 $51
 $1,256
 $(609) $647
  $881
Balance at December 31, 2017$270
  $1,217
 $102
 $49
 $1,368
 $(422) $946
  $1,216
Additions132
  48
 1
 
 49
 
 49
  181
524
  192
 2
 
 194
 
 194
  718
Amortization:             

                    
Periodic amortization(134)  (42) (6) (3) (51) 
 (51)  (185)(485)  (193) (15) (6) (214) 
 (214)  (699)
Annuity unlocking
  28
 1
 
 29
 
 29
  29
Included in realized gains
  1
 
 
 1
 
 1
  1

  9
 
 
 9
 
 9
  9
Foreign currency translation(1)  
 
 
 
 
 
  (1)(1)  
 
 
 
 
 
  (1)
Change in unrealized
  
 
 
 
 (10) (10)  (10)
  
 
 
 
 397
 397
  397
Balance at September 30, 2016$231
  $1,096
 $111
 $48
 $1,255
 $(619) $636
  $867
Balance at September 30, 2018$308
  $1,253
 $90
 $43
 $1,386
 $(25) $1,361
  $1,669
                                  
Balance at December 31, 2016$238
  $1,110
 $110
 $46
 $1,266
 $(265) $1,001
  $1,239
$238
  $1,110
 $110
 $46
 $1,266
 $(265) $1,001
  $1,239
Additions439
  177
 3
 
 180
 
 180
  619
439
  177
 3
 
 180
 
 180
  619
Amortization:                                  
Periodic amortization(413)  (122) (14) (6) (142) 
 (142)  (555)(413)  (122) (14) (6) (142) 
 (142)  (555)
Included in realized gains
  6
 1
 
 7
 
 7
  7

  6
 1
 
 7
 
 7
  7
Foreign currency translation2
  
 
 
 
 
 
  2
2
  
 
 
 
 
 
  2
Change in unrealized
  
 
 
 
 (193) (193)  (193)
  
 
 
 
 (193) (193)  (193)
Balance at September 30, 2017$266
  $1,171
 $100
 $40
 $1,311
 $(458) $853
  $1,119
$266
  $1,171
 $100
 $40
 $1,311
 $(458) $853
  $1,119
                 
Balance at December 31, 2015$226
  $1,018
 $119
 $55
 $1,192
 $(234) $958
  $1,184
Additions403
  172
 8
 
 180
 
 180
  583
Amortization:                 
Periodic amortization(396)  (99) (17) (7) (123) 
 (123)  (519)
Included in realized gains
  5
 1
 
 6
 
 6
  6
Foreign currency translation(2)  
 
 
 
 
 
  (2)
Change in unrealized
  
 
 
 
 (385) (385)  (385)
Balance at September 30, 2016$231
  $1,096
 $111
 $48
 $1,255
 $(619) $636
  $867

(*)Unrealized adjustments to DPAC includes net unrealized gains/losses on securities and net unrealized gains/losses on cash flow hedges.

The present value of future profits (“PVFP”) amounts in the table above are net of $140147 million and $134141 million of accumulated amortization at September 30, 20172018 and December 31, 20162017, respectively.


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AMERICAN FINANCIAL GROUP, INC. 10-Q
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — CONTINUED


H.G.    Managed Investment Entities

AFG is the investment manager and its subsidiaries have investments ranging from 15.0% to 60.9% of the most subordinate debt tranche of fifteen collateralized loan obligation entities or “CLOs,” which are considered variable interest entities. AFG’s subsidiaries also own portions of the senior debt tranches of certain of these CLOs. Upon formation between 2004 and 2017,2018, these entities issued securities in various senior and subordinate classes and invested the proceeds primarily in secured bank loans, which serve as collateral for the debt securities issued by each particular CLO. None of the collateral was purchased from AFG. AFG’s investments in the subordinate debt tranches of these entities receive residual income from the CLOs only after the CLOs pay expenses (including management fees to AFG) and interest on and returns of capital to senior levels of debt securities. There are no contractual requirements for AFG to provide additional funding for these entities. AFG has not provided and does not intend to provide any financial support to these entities.

AFG’s maximum exposure to economic loss on its CLOs is limited to its investment in the CLOs, which had an aggregate fair value of $261191 million (including $197$133 million invested in the most subordinate tranches) at September 30, 20172018, and $216215 million at December 31, 20162017.

In March 2018 and March 2017, AFG formed a new CLO,CLOs, which issued $463 million and $408 million face amount of liabilities, respectively (including $31 million and $24 million face amount purchased by subsidiaries of AFG). During the first nine months of 2017, AFG subsidiaries also purchased $58 million face amount of senior debt and subordinate tranches of existing CLOs for $58 million. In May 2016, AFG formed a new CLO, which issued $406 million face amount of liabilities (including $36 million face amount purchased by subsidiaries of AFG). During the first nine months of 2016, AFG subsidiaries also purchased $19 million face amount of senior debt2018 and subordinate tranches of existing CLOs for $15 million. During the first nine months of 2017, and 2016, AFG subsidiaries received $86$45 million and $69$86 million, respectively, in sale and redemption proceeds from its CLO investments. During the first nine months of 2018 and 2017, one and two AFG CLOs, respectively, were substantially liquidated, as permitted by the CLO indenture.indentures.

The revenues and expenses of the CLOs are separately identified in AFG’s Statement of Earnings, after the elimination of management fees and earnings attributable to shareholders of AFG as measured by the change in the fair value of AFG’s investments in the CLOs. Selected financial information related to the CLOs is shown below (in millions): 
Three months ended September 30, Nine months ended September 30,Three months ended September 30, Nine months ended September 30,
2017 2016 2017 20162018 2017 2018 2017
Investment in CLO tranches at end of period$261
 $245
 $261
 $245
$191
 $261
 $191
 $261
Gains (losses) on change in fair value of assets/liabilities (a):              
Assets(8) 60
 (12) 107
20
 (8) 5
 (12)
Liabilities9
 (49) 24
 (98)(25) 9
 (15) 24
Management fees paid to AFG5
 4
 14
 12
4
 5
 12
 14
CLO earnings (losses) attributable to AFG shareholders (b)5
 17
 16
 29
4
 5
 11
 16

(a)Included in revenues in AFG’s Statement of Earnings.
(b)Included in earnings before income taxes in AFG’s Statement of Earnings.
The aggregate unpaid principal balance of the CLOs’ fixed maturity investments exceeded the fair value of the investments by $6645 million and $7555 million at September 30, 20172018 and December 31, 20162017, respectively. The aggregate unpaid principal balance of the CLOs’ debt exceeded its carrying value by $135160 million and $159$118 million at those dates. The CLO assets include loans with an aggregate fair value of $5 million at September 30, 2017 and $1 million at both September 30, 2018 and December 31, 2016,2017, for which the CLOs are not accruing interest because the loans are in default (aggregate unpaid principal balance of $198 million and $10 million at both those dates, respectively)dates).

I.H.    Goodwill and Other Intangibles

There were no changes in the goodwill balance of $199 million during the first nine months of 20172018. Included in other assets in AFG’s Balance Sheet is $2931 million at September 30, 20172018 and $3426 million at December 31, 20162017 in amortizable intangible assets related to property and casualty insurance acquisitions. These amounts are net of accumulated amortization of $28$37 million and $2530 million, respectively. Amortization of intangibles was $3 million and $2 million in both the third quartersquarter of 2018 and 2017, respectively, and 2016$7 million and $6 million in both the first nine months of 20172018 and 20162017.


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AMERICAN FINANCIAL GROUP, INC. 10-Q
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — CONTINUED


J.I.    Long-Term Debt

Long-term debt consisted of the following (in millions):
 September 30, 2017 December 31, 2016
 Principal Discount and Issue Costs Carrying Value Principal Discount and Issue Costs Carrying Value
Direct Senior Obligations of AFG:           
9-7/8% Senior Notes due June 2019$350
 $(1) $349
 $350
 $(1) $349
4.50% Senior Notes due June 2047350
 (5) 345
 
 
 
3.50% Senior Notes due August 2026300
 (3) 297
 300
 (3) 297
6-3/8% Senior Notes due June 2042
 
 
 230
 (7) 223
5-3/4% Senior Notes due August 2042
 
 
 125
 (4) 121
Other3
 
 3
 3
 
 3
 1,003
 (9) 994
 1,008
 (15) 993
            
Direct Subordinated Obligations of AFG:           
6-1/4% Subordinated Debentures due September 2054150
 (5) 145
 150
 (5) 145
6% Subordinated Debentures due November 2055150
 (5) 145
 150
 (5) 145
 300
 (10) 290
 300
 (10) 290
 $1,303
 $(19) $1,284
 $1,308
 $(25) $1,283

To achieve a desired balance between fixed and variable rate debt, AFG entered into an interest rate swap in June 2015, which effectively converts its 9-7/8% Senior Notes to a floating rate of three-month LIBOR plus 8.099% (9.4190% at September 30, 2017 and 9.0624% at December 31, 2016). The fair value of the interest rate swap (a liability of less than $1 million at September 30, 2017 and an asset of $1 million at December 31, 2016) and the offsetting adjustment to the carrying value of the notes are both included in the carrying value of the 9-7/8% Senior Notes in the table above.
 September 30, 2018 December 31, 2017
 Principal Discount and Issue Costs Carrying Value Principal Discount and Issue Costs Carrying Value
Direct Senior Obligations of AFG:           
4.50% Senior Notes due June 2047$590
 $(2) $588
 $590
 $(2) $588
3.50% Senior Notes due August 2026425
 (4) 421
 425
 (5) 420
Other3
 
 3
 3
 
 3
 1,018
 (6) 1,012
 1,018
 (7) 1,011
            
Direct Subordinated Obligations of AFG:           
6-1/4% Subordinated Debentures due September 2054150
 (5) 145
 150
 (5) 145
6% Subordinated Debentures due November 2055150
 (5) 145
 150
 (5) 145
 300
 (10) 290
 300
 (10) 290
 $1,318
 $(16) $1,302
 $1,318
 $(17) $1,301

ScheduledAFG has no scheduled principal payments on its long-term debt for the balance of 20172018, or in the subsequent five years and thereafter were as follows:
2017 — none; 2018 — none; 2019 — $350 million; 2020 — none; 2021 — none; 2022 — none and thereafter — $953 million.

In June 2017, AFG issued $350 million in 4.50% Senior Notes due in 2047 at a price of 99.46%. The net proceeds were used to redeem AFG’s $230 million outstanding principal amount of 6-3/8% Senior Notes due June 2042 at par value and to redeem AFG’s $125 million outstanding principal amount of 5-3/4% Senior Notes due August 2042 at par value in June 2017 and August 2017, respectively.years.

AFG can borrow up to $500 million under its revolving credit facility, which expires in June 2021. Amounts borrowed under this agreement bear interest at rates ranging from 1.00% to 1.875% (currently 1.375%) over LIBOR based on AFG’s credit rating. No amounts were borrowed under this facility at September 30, 20172018 or December 31, 20162017.

J.     Redeemable Noncontrolling Interests

Neon Lloyd’s Business   On December 29, 2017, AFG completed the sale of an indirect noncontrolling interest in Neon, its United Kingdom-based Lloyd’s insurer, to certain Neon executives for cash equal to the fair value of the interest sold as determined by a third-party valuation firm. This noncontrolling interest is redeemable at the option of the holder and is presented separately in the mezzanine section of the balance sheet, as discussed in Note A — Accounting Policies — Noncontrolling Interests.”

K.    Shareholders’ Equity

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

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


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AMERICAN FINANCIAL GROUP, INC. 10-Q
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — CONTINUED


The progression of the components of accumulated other comprehensive income follows (in millions): 
  Other Comprehensive Income    Other Comprehensive Income (Loss)    
AOCI
Beginning
Balance
 Pretax Tax 
Net
of
tax
 
Attributable to
noncontrolling
interests
 
Attributable to
shareholders
 Other (c) 
AOCI
Ending
Balance
Quarter ended September 30, 2018               
Net unrealized gains (losses) on securities:               
Unrealized holding losses on securities arising during the period  $(122) $26
 $(96) $
 $(96)   

Reclassification adjustment for realized (gains) losses included in net earnings (a)  (2) 
 (2) 
 (2)   

Total net unrealized gains (losses) on securities (b)$191
 (124) 26
 (98) 
 (98) $
 $93
Net unrealized losses on cash flow hedges(27) (6) 1
 (5) 
 (5) 
 (32)
Foreign currency translation adjustments(9) 
 
 
 
 
 
 (9)
Pension and other postretirement plans adjustments(8) 
 
 
 
 
 
 (8)
Total$147
 $(130) $27
 $(103) $
 $(103) $
 $44
AOCI
Beginning
Balance
 Pretax Tax 
Net
of
tax
 
Attributable to
noncontrolling
interests
 
Attributable to
shareholders
 
AOCI
Ending
Balance
               
Quarter ended September 30, 2017                            
Net unrealized gains on securities:                            
Unrealized holding gains on securities arising during the period  $92
 $(33) $59
 $
 $59
 

  $92
 $(33) $59
 $
 $59
    
Reclassification adjustment for realized (gains) losses included in net earnings (a)  12
 (4) 8
 
 8
 

  12
 (4) 8
 
 8
    
Total net unrealized gains on securities (b)$639
 104
 (37) 67
 
 67
 $706
Total net unrealized gains on securities$639
 104
 (37) 67
 
 67
 $
 $706
Net unrealized losses on cash flow hedges(6) (1) 1
 
 
 
 (6)(6) (1) 1
 
 
 
 
 (6)
Foreign currency translation adjustments(11) 5
 2
 7
 
 7
 (4)(11) 5
 2
 7
 
 7
 
 (4)
Pension and other postretirement plans adjustments(7) 
 
 
 
 
 (7)(7) 
 
 
 
 
 
 (7)
Total$615
 $108
 $(34) $74
 $
 $74
 $689
$615
 $108
 $(34) $74
 $
 $74
 $
 $689
                            
Quarter ended September 30, 2016             
Nine months ended September 30, 2018               
Net unrealized gains (losses) on securities:               
Unrealized holding losses on securities arising during the period  $(662) $139
 $(523) $
 $(523)   

Reclassification adjustment for realized (gains) losses included in net earnings (a)  (4) 1
 (3) 
 (3)   

Total net unrealized gains (losses) on securities (b)$840
 (666) 140
 (526) 
 (526) $(221) $93
Net unrealized losses on cash flow hedges(13) (24) 5
 (19) 
 (19) 
 (32)
Foreign currency translation adjustments(6) (2) (1) (3) 
 (3) 
 (9)
Pension and other postretirement plans adjustments(8) 
 
 
 
 
 
 (8)
Total$813
 $(692) $144
 $(548) $
 $(548) $(221) $44
               
Nine months ended September 30, 2017               
Net unrealized gains on securities:                            
Unrealized holding gains on securities arising during the period  $138
 $(49) $89
 $(1) $88
    $461
 $(162) $299
 $
 $299
    
Reclassification adjustment for realized (gains) losses included in net earnings (a)  (2) 1
 (1) 
 (1)    4
 (1) 3
 
 3
    
Total net unrealized gains on securities$685
 136
 (48) 88
 (1) 87
 $772
$404
 465
 (163) 302
 
 302
 $
 $706
Net unrealized gains (losses) on cash flow hedges5
 (1) 1
 
 
 
 5
(7) 1
 
 1
 
 1
 
 (6)
Foreign currency translation adjustments(15) (2) (1) (3) 
 (3) (18)(15) 8
 3
 11
 
 11
 
 (4)
Pension and other postretirement plans adjustments(6) 
 
 
 
 
 (6)(7) 
 
 
 
 
 
 (7)
Total$669
 $133
 $(48) $85
 $(1) $84
 $753
$375
 $474
 $(160) $314
 $
 $314
 $
 $689
             
Nine months ended September 30, 2017             
Net unrealized gains on securities:             
Unrealized holding gains on securities arising during the period  $461
 $(162) $299
 $
 $299
 

Reclassification adjustment for realized (gains) losses included in net earnings (a)  4
 (1) 3
 
 3
 

Total net unrealized gains on securities (b)$404
 465
 (163) 302
 
 302
 $706
Net unrealized gains (losses) on cash flow hedges(7) 1
 
 1
 
 1
 (6)
Foreign currency translation adjustments(15) 8
 3
 11
 
 11
 (4)
Pension and other postretirement plans adjustments(7) 
 
 
 
 
 (7)
Total$375
 $474
 $(160) $314
 $
 $314
 $689
             
Nine months ended September 30, 2016             
Net unrealized gains on securities:             
Unrealized holding gains on securities arising during the period  $656
 $(229) $427
 $(6) $421
  
Reclassification adjustment for realized (gains) losses included in net earnings (a)  32
 (12) 20
 (1) 19
  
Total net unrealized gains on securities$332
 688
 (241) 447
 (7) 440
 $772
Net unrealized gains on cash flow hedges1
 6
 (2) 4
 
 4
 5
Foreign currency translation adjustments(22) 2
 2
 4
 
 4
 (18)
Pension and other postretirement plans adjustments(7) 1
 
 1
 
 1
 (6)
Total$304
 $697
 $(241) $456
 $(7) $449
 $753


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AMERICAN FINANCIAL GROUP, INC. 10-Q
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — CONTINUED


(a)The reclassification adjustment out of net unrealized gains on securities affected the following lines in AFG’s Statement of Earnings:
(a)The reclassification adjustment out of net unrealized gains (losses) on securities affected the following lines in AFG’s Statement of Earnings:
 OCI component Affected line in the statement of earnings 
 Pretax Realized gains (losses) on securities 
 Tax Provision for income taxes 
Attributable to noncontrolling interestsNet earnings (loss) attributable to noncontrolling interests
(b)
Includes net unrealized gains of $58$64 million at September 30, 20172018 compared to $56$67 million at June 30, 20172018 and $52$68 million at December 31, 20162017 related to securities for which only the credit portion of an other-than-temporary impairment has been recorded in earnings.
(c)On January 1, 2018, AFG adopted new guidance that requires all equity securities other than those accounted for under the equity method to be reported at fair value with holding gains and losses recognized in net earnings. At the date of adoption, the $221 million net unrealized gain on equity securities classified as available for sale (with unrealized holding gains and losses reported in AOCI) under the prior guidance was reclassified from AOCI to retained earnings as the cumulative effect of an accounting change.

Stock Incentive Plans   Under AFG’s stock incentive plans, employees of AFG and its subsidiaries are eligible to receive equity awards in the form of stock options, stock appreciation rights, restricted stock awards, restricted stock units and stock awards. In the first nine months of 2017,2018, AFG issued 232,250200,625 shares of restricted Common Stock (fair value of $94.44$112.86 per share) under the Stock Incentive Plan. In addition, AFG issued 47,82645,804 shares of Common Stock (fair value of $96.13115.49 per share) in the first quarter of 20172018 under the Equity Bonus Plan. AFG did not grant any stock options in the first nine months of 2017.2018.

Total compensation expense related to stock incentive plans of AFG and its subsidiaries was $7$6 million and $7 million in the third quarters of 2018 and 2017 and 2016$17 million and $24 million and $21 million in the first nine months of 20172018 and 20162017, respectively.

L.    Income Taxes

The following is a reconciliation of income taxes at the statutory rate of(21% in 2018 and 35% in 2017) to the provision for income taxes as shown in AFG’s Statement of Earnings (dollars in millions):
Three months ended September 30, Nine months ended September 30,Three months ended September 30, Nine months ended September 30,
2017 2016 2017 20162018 2017 2018 2017
Amount % of EBT Amount % of EBT Amount % of EBT Amount % of EBTAmount % of EBT Amount % of EBT Amount % of EBT Amount % of EBT
Earnings before income taxes (“EBT”)$29
   $178
   $457
   $470
  $244
   $29
   $678
   $457
  
                              
Income taxes at statutory rate$10
 35% $63
 35% $160
 35% $165
 35%$51
 21% $10
 35% $142
 21% $160
 35%
Effect of:                              
Stock-based compensation(1) (3%) 
 % (14) (3%) 
 %
Adjustment to prior year taxes(9) (4%) (2) (7%) (9) (1%) (2) (1%)
Tax exempt interest(5) (17%) (5) (3%) (17) (4%) (18) (4%)(3) (1%) (5) (17%) (10) (1%) (17) (4%)
Dividends received deduction(2) (7%) (1) (1%) (6) (1%) (5) (1%)(1) % (2) (7%) (3) % (6) (1%)
Employee Stock Ownership Plan dividends paid deduction
 % 
 % (2) % (1) %(1) % 
 % (2) % (2) %
Stock-based compensation
 % (1) (3%) (7) (1%) (14) (3%)
Foreign operations
 % 1
 3% 3
 % 7
 2%
Nondeductible expenses1
 % 2
 7% 5
 1% 5
 1%
Change in valuation allowance16
 55% 7
 4% 16
 4% 40
 9%1
 % 16
 55% 3
 % 16
 4%
Subsidiaries not in AFG’s tax return
 % 2
 1% 
 % 4
 1%
Other
 (1%) (1) 1% 9
 1% 5
 %2
 1% (1) (4%) 4
 % (1) (1%)
Provision for income taxes as shown in the statement of earnings$18
 62% $65
 37% $146
 32% $190
 40%$41
 17% $18
 62% $126
 19% $146
 32%

AFG’s effective tax rate for the three months ended September 30, 2017 reflects the impact of catastrophe losses in the Neon Lloyd’s insurance business for which no tax benefit is recognized. AFG maintains a full valuation allowance against the deferred tax benefits associated with losses related to Neon. Excluding the $53 million in catastrophe losses at Neon, AFG’s effective tax rate for the three months ended September 30, 2017 was 22%, which reflects the impact of a typical level of tax-favored investment income on lower earnings before income taxes. Excluding the $65 million charge in the second quarter


31

Table of 2016 related to the exit of certain lines of business within Neon, AFG’s effective tax rate for the nine months ended September 30, 2016, was 36%. Contents
AMERICAN FINANCIAL GROUP, INC. 10-Q
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — CONTINUED


The favorable impact of stock-based compensation on AFG’s effective tax rate in the first nine months of 2018 and 2017 reflects the high volume of employee stock option exercises during that period and the increase in the market price of AFG Common Stock.

The Tax Cuts and Jobs Act of 2017 (“TCJA”), which was enacted on December 22, 2017, lowered the U.S corporate tax rate to 21% and made other widespread changes to the U.S. tax code effective in 2018. Because the TCJA was enacted in December 2017, AFG recorded the $83 million decrease in its net deferred tax asset resulting from the changes in the tax code (primarily the lower corporate tax rate applicable to 2018 and future years) in the fourth quarter of 2017.

The TCJA is subject to further clarification and interpretation by the U.S. Treasury Department and the Internal Revenue Service. For example, the TCJA changes the way that companies calculate their insurance claims and reserves for tax purposes, including revaluing those tax basis liabilities as of January 1, 2018, based on a methodology and discount factors that have not been published. The resulting transitional deferred tax liability (taxes payable over eight years under the TCJA) and offsetting increase in AFG’s insurance claims and reserves deferred tax assets, were recorded at December 31, 2017 using reasonable estimates based on available information and should be considered provisional in accordance with Securities and Exchange Commission Staff Accounting Bulletin No. 118 (“SAB 118”). Because the established transition liability was completely offset by an increase in related deferred tax assets, any adjustment to the provisional amount will not impact AFG’s effective tax rate. In accordance with SAB 118, the insurance claims and reserves transitional deferred tax liability (and offsetting adjustment to the related deferred tax assets) and any other changes in deferred taxes resulting from clarification and interpretation of the TCJA provided during 2018 will be recorded in the period in which the guidance is published (none through September 30, 2018).

Approximately $13$19 million of AFG’s net operating loss carryforwards (“NOL”) subject to separate return limitation year (“SRLY”) tax rules will expire unutilized at December 31, 2017.2018. Since AFG maintains a full valuation allowance against its SRLY NOLs, the expiration of these loss carryforwards will be offset by a corresponding reduction in the valuation allowance and will have no overall impact on AFG’s income tax expense or results of operations.

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AMERICAN FINANCIAL GROUP, INC. 10-Q
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — CONTINUED



During the first nine months of 2017, there were no material changes to AFG’s liability for uncertain tax positions.

M.     Contingencies

There have been no significant changes to the matters discussed and referred to in Note M — “Contingencies” of AFG’s 20162017 Form 10-K, which covers property and casualty insurance reserves for claims related to environmental exposures, asbestos and other mass tort claims and environmental and occupational injury and disease claims of former subsidiary railroad and manufacturing operations, as well as contingencies related to the sale of substantially all of AFG’s run-off long-term care insurance business.


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AMERICAN FINANCIAL GROUP, INC. 10-Q
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — CONTINUED


N.    Insurance

Property and Casualty Insurance Reserves The following table provides an analysis of changes in the liability for losses and loss adjustment expenses during the first nine months of 20172018 and 20162017 (in millions):
Nine months ended September 30,Nine months ended September 30,
2017 20162018 2017
Balance at beginning of year$8,563
 $8,127
$9,678
 $8,563
Less reinsurance recoverables, net of allowance2,302
 2,201
2,957
 2,302
Net liability at beginning of year6,261
 5,926
6,721
 6,261
Provision for losses and LAE occurring in the current period2,237
 2,011
2,337
 2,237
Net increase (decrease) in the provision for claims of prior years:      
Special A&E charges89
 36
18
 89
Neon exited lines charge
 57
Other(87) (71)(149) (87)
Total losses and LAE incurred2,239
 2,033
2,206
 2,239
Payments for losses and LAE of:      
Current year(530) (463)(569) (530)
Prior years(1,272) (1,206)(1,313) (1,272)
Total payments(1,802) (1,669)(1,882) (1,802)
Reserves of business disposed (*)(319) 
Foreign currency translation and other32
 (3)(4) 32
Net liability at end of period6,730
 6,287
6,722
 6,730
Add back reinsurance recoverables, net of allowance2,833
 2,374
2,948
 2,833
Gross unpaid losses and LAE included in the balance sheet at end of period$9,563
 $8,661
$9,670
 $9,563

(*)Reflects the reinsurance to close transaction at Neon discussed below.

The net decrease in the provision for claims of prior years during the first nine months of 2018 reflects (i) lower than expected losses in the crop business and lower than expected severity in claims at National Interstate (within the Property and transportation sub-segment), (ii) lower than anticipated claim severity in the workers’ compensation and executive liability businesses (within the Specialty casualty sub-segment), and (iii) lower than expected claim frequency and severity in the surety business and lower than expected claim severity in the fidelity business (within the Specialty financial sub-segment). This favorable development was partially offset by (i) the $18 million special charge to increase asbestos and environmental reserves and (ii) higher than expected claim severity in the Singapore branch and aviation operations (within the Property and transportation sub-segment).

The net increase in the provision for claims of prior years during the first nine months of 2017 reflects (i) the $89 million special charge to increase asbestos and environmental reserves, (ii) higher than expected claim severity in the ocean marine business (within the Property and transportation sub-segment), (iii) higher than anticipated claim severity in the targeted markets and general liability businesses (all within the Specialty casualty sub-segment) and (iv) an adjustment to the deferred gain on the retroactive reinsurance transaction entered into in connection with the sale of businesses in 1998 (included in Other specialty sub-segment). This adverse development was partially offset by (i) lower than expected losses in the crop and equine businesses and lower than expected claim severity in the property and inland marine and transportation businesses (all within the Property and transportation sub-segment), (ii) lower than anticipated claim severity in the workers’ compensation businesses and at Neon (all within the Specialty casualty sub-segment) and (iii) lower than anticipated claim severity in the fidelity business and lower than expected claim frequency and severity in the surety business (both within the Specialty financial sub-segment).

The net increase inIn December 2017, the provision for claims of prior years during the first nine months of 2016 reflects (i) the $36 million special charge to increase asbestos and environmental reserves, (ii) adverse reserve development at Neon higher than anticipated severity in New York contractor claims and higher than anticipated claim severity in the general liability insurance (all within the Specialty casualty sub-segment), (iii) the $57 million special charge to increase loss reserves related to Neon’s exit of its UK and international medical malpractice and general liability lines of business and (iv) higher than anticipated claim frequency in the financial institutions business (within the Specialty financial sub-segment). This adverse development was partially offset by (i) lower than expected losses in the crop business and lower than expected claim severity in the property and inland marine and trucking businesses (all within the Property and transportation sub-segment), (ii) lower than anticipated claim

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AMERICAN FINANCIAL GROUP, INC. 10-Q
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — CONTINUED


severity in workers’ compensation business and directors and officers liability insurance and lower than expected claim frequency and severity in excess liability business (all within the Specialty casualty sub-segment) and (iii) lower than anticipated claim severity in the fidelity business and lower than expected claim frequency and severity in the surety business (all within the Specialty financial sub-segment).

Reinsurance   Subsequent to Hurricane Irma, AFG’s property and casualty operations purchased replacement reinsurance coverage for those layers of the catastrophe reinsurance program expected to be affected by Hurricanes Harvey and Irma. The following table presents (by type of coverage) the amount of each loss above the specified retention covered by treaty reinsurance programs in AFG’s property and casualty insurance operations (in millions) as of October 1, 2017:
    Reinsurance Coverage AFG
  Primary Coverage AFG Participation (a) Maximum
  Retention Amount % $ Loss (b)
U.S.-based operations:          
California Workers’ Compensation $2
 $148
 1% $1
 $3
Other Workers’ Compensation 3
 37
 % 
 3
Commercial Umbrella 1
 49
 13% 6
 7
Property — General 5
 45
 % 
 5
Property — Catastrophe 15
 85
 5% 4
 19
Neon Lloyd’s Syndicate 15
 210
 % 
 15
Riverfront Re Ltd. catastrophe bond (c) 100
 200
 5% 10
 N/A
(a)Includes the participation of AFG’s internal reinsurance program.
(b)Maximum loss for claims up to reinsurance coverage limit.
(c)Includes aggregate coverage. See description below.

In June 2017, AFG’s property and casualty insurance subsidiariesLloyd’s syndicate entered into a reinsurance agreement to obtain supplemental catastrophe protection throughclose transaction for the 2015 and prior years of account with StarStone Underwriting Limited, a catastrophe bond structure with Riverfront Re Ltd. (“Riverfront”). The reinsurance agreement provides supplemental reinsurance coverage up to 95%subsidiary of $200 million (fully collateralized) for catastrophe losses in excessEnstar Group Limited, which was effective as of $100 million (per occurrence and annual aggregate) occurring between June 1, 2017 and December 31, 2020.2017 (the transaction settled in early 2018). In connection with the Lloyd’s market, a reinsurance agreement, Riverfront issued notes to unrelated investorsclose transaction transfers the responsibility for the full amount of coverage provided under the reinsurance agreement. Through September 30, 2017, AFG’s incurred catastrophe losses have not reached the level of attachment for the catastrophe bond structure. Riverfront is a variable interest entity in which AFG does not have a variable interest because the variability in Riverfront’s results will be absorbed entirely by the investors in Riverfront. Accordingly, Riverfront is not consolidated in AFG’s financial statements and the reinsurance agreement is accounted for as ceded reinsurance. AFG’s cost for this coverage is approximately $11 million per year.

O.    Subsequent Event

Wildfires struck northern California’s wine region in October 2017, which will result in fourth quarter 2017 catastrophe losses in AFG’s property and casualty insurance segment. Based on information available asdischarging all of the filingliabilities that attach to the transferred year of this Form 10-Q, management estimatesaccount plus the right to any income due to the closing year of account in return for a pretax loss from these events, net of reinsurance and inclusive of reinstatement premiums and other associated offsets, in the range of $20 million to $25 million. At the midpoint of that range, AFG’s earnings per share would be negatively impacted by approximately $0.18.premium. This transaction provided Neon with finality on its legacy business.


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AMERICAN FINANCIAL GROUP, INC. 10-Q
ITEM 2
Management’s Discussion and Analysis of Financial Condition and Results of Operations

INDEX TO MD&A
Page PagePage Page
  
  
  
  
  
  
  
  
  
  
  
  
  
 

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

Actual results and/or financial condition could differ materially from those contained in or implied by such forward-looking statements for a variety of reasons including but not limited to:
changes in financial, political and economic conditions, including changes in interest and inflation rates, currency fluctuations and extended economic recessions or expansions in the U.S. and/or abroad;
performance of securities markets;markets, including the cost of equity index options;
new legislation or declines in credit quality or credit ratings that could have a material impact on the valuation of securities in AFG’s investment portfolio;
the availability of capital;
regulatory actions (includingchanges in insurance law or regulation, including changes in statutory accounting rules);rules and changes in regulation of the Lloyd’s market, including modifications to the establishment of capital requirements for and approval of business plans for syndicate participation;
changes in the legal environment affecting AFG or its customers;
tax law and accounting changes;changes, including the impact of recent changes in U.S. corporate tax law;
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;
disruption caused by cyber-attacks or other technology breaches or failures by AFG or its business partners and service providers, which could negatively impact AFG’s business and/or expose AFG to litigation;
development of insurance loss reserves and establishment of other reserves, particularly with respect to amounts associated with asbestos and environmental claims;
availability of reinsurance and ability of reinsurers to pay their obligations;
trends in persistency and mortality;
competitive pressures, including as a result of the outcome of U.S. business tax reform efforts;pressures;
the ability to obtain adequate rates and policy terms;
changes in AFG’s credit ratings or the financial strength ratings assigned by major ratings agencies to AFG’s operating subsidiaries; and
the impact of the conditions in the international financial markets and the global economy (including those associated with the United Kingdom’s expected withdrawal from the European Union, or “Brexit”) relating to AFG’s international operations.
The forward-looking statements herein are made only as of the date of this report. The Company assumes no obligation to publicly update any forward-looking statements.


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AMERICAN FINANCIAL GROUP, INC. 10-Q
Management’s Discussion and Analysis of Financial Condition and Results of Operations — Continued


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

OVERVIEW

Financial Condition

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

Results of Operations

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

Net earnings attributable to AFG’s shareholders for the third quarter and first nine months of 20172018 were $204 million ($2.26 per share, diluted) and $559 million ($6.17 per share, diluted), respectively, compared to $11 million ($0.13 per share, diluted) and $309 million ($3.44 per share, diluted), respectively, compared to $109 million ($1.23 per share, diluted) and $264 million ($2.98 per share, diluted) reported in the same periods of 2016,2017, reflecting:
lowerhigher earnings in the annuity segment,
higher underwriting profit in the property and casualty insurance segment due primarily to higherlower catastrophe losses and higherlower special charges to increase asbestos and environmental reserves, partially offset by the impact of a second quarter 2016 charge related to the exit of certain lines of business within Neon Underwriting Ltd. (“Neon”), AFG’s Lloyd’s-based insurer,
higher net investment income in the property and casualty insurance segment,
lower interest charges on borrowed money,
a lower corporate income tax rate,
realized lossesgains on securities in the third quarter of 20172018 compared to realized gainslosses in the third quarter of 20162017 and lowerhigher realized losses on securities in the first nine months of 20172018 compared to the first nine months of 2016,
for2017. Both periods in 2018 reflect the nine month period, higher earningschange in the annuity segment, andfair value of equity securities that are required to be carried at fair value through net earnings under new accounting guidance adopted on January 1, 2018,
the impact of the gain onlower income from the sale of an apartment propertyreal estate in the secondfirst nine months of 2018 compared to the first nine months of 2017, and
a loss on the retirement of debt in the third quarter and first nine months of 2016.2017.

CRITICAL ACCOUNTING POLICIES

Significant accounting policies are summarized in Note A — “Accounting Policiesto the financial statements. The preparation of financial statements in conformity with U.S. generally accepted accounting principles (“GAAP”) requires management to make estimates and assumptions that can have a significant effect on amounts reported in the financial statements. As more information becomes known, these estimates and assumptions change and, thus, impact amounts reported in the future. The areas where management believes the degree of judgment required to determine amounts recorded in the financial statements is most significant are as follows:
the establishment of insurance reserves, especially asbestos and environmental-related reserves,
the recoverability of reinsurance,
the 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 20162017 Form 10-K.



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AMERICAN FINANCIAL GROUP, INC. 10-Q
Management’s Discussion and Analysis of Financial Condition and Results of Operations — Continued


LIQUIDITY AND CAPITAL RESOURCES

Ratios   AFG’s debt to total capital ratio on a consolidated basis is shown below (dollars in millions):
 September 30,
2017
 December 31, September 30,
2018
 December 31,
2016 20152017 2016
Principal amount of long-term debt $1,303
 $1,308
 $1,020
 $1,318
 $1,318
 $1,308
Total capital 6,149
 5,921
 5,512
 6,389
 6,033
 5,921
Ratio of debt to total capital:            
Including subordinated debt 21.2% 22.1% 18.5% 20.6% 21.8% 22.1%
Excluding subordinated debt 16.3% 17.0% 13.1% 15.9% 16.9% 17.0%

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. In addition, maintaining a ratio of debt, excluding subordinated debt and debt secured by real estate (if any), to total capital of 35% or lower is a financial covenant in AFG’s bank credit facility. The ratio is calculated by dividing the principal amount of AFG’s long-term debt by its total capital, which includes long-term debt, noncontrolling interests and shareholders’ equity (excluding unrealized gains (losses) on fixed maturity investments).

AFG’s ratio of earnings to fixed charges, including annuity benefits as a fixed charge, was 1.621.86 for the nine months ended September 30, 20172018 and 1.851.72 for the year ended December 31, 20162017. Excluding annuity benefits, this ratio was 6.4510.87 and 8.62,7.67, 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.

Condensed Consolidated Cash Flows   AFG’s principal sources of cash include insurance premiums, income from its investment portfolio and proceeds from the maturities, redemptions and sales of investments. Insurance premiums in excess of acquisition expenses and operating costs are invested until they are needed to meet policyholder obligations or made available to the parent company through dividends to cover debt obligations and corporate expenses, and to provide returns to shareholders through share repurchases and dividends. Cash flows from operating, investing and financing activities as detailed in AFG’s Consolidated Statement of Cash Flows are shown below (in millions):
Nine months ended September 30,Nine months ended September 30,
2017 20162018 2017
Net cash provided by operating activities$993
 $746
$1,277
 $993
Net cash used in investing activities(2,230) (2,519)(3,375) (2,230)
Net cash provided by financing activities1,479
 2,192
1,769
 1,479
Net change in cash and cash equivalents$242
 $419
$(329) $242

Net Cash Provided by Operating Activities   AFG’s property and casualty insurance operations typically produce positive net operating cash flows as premiums collected and investment income exceed policy acquisition costs, claims payments and operating expenses. AFG’s net cash provided by operating activities is impacted by the level and timing of property and casualty premiums, claim and expense payments and recoveries from reinsurers. AFG’s annuity operations typically produce positive net operating cash flows as investment income exceeds acquisition costs and operating expenses. Interest credited on annuity policyholder funds is a non-cash increase in AFG’s annuity benefits accumulated liability and annuity premiums, benefits and withdrawals are considered financing activities due to the deposit-type nature of annuities. Cash flows provided by operating activities also includesinclude the activity of AFG’s managed investment entities (collateralized loan obligations) other than those activities included in investing or financing activities. The changes in the assets and liabilities of the managed investment entities included in operating activities increased cash flows from operating activities by $14$104 million during the first nine months of 20172018 and reduced cash flows from operating activities by $235$14 million in the first nine months of 2016,2017, accounting for a $249$90 million increase in cash flows from operating activities in the 20172018 period compared to the 20162017 period. As discussed in Note A — “Accounting PoliciesManaged Investment Entities”Entities to the financial statements, AFG has no right to use the CLO assets and no obligation to pay the CLO liabilities and such assets and liabilities are shown separately in AFG’s Balance Sheet. Excluding the impact of the managed investment entities, net cash flows provided by operating activities werewas $1.17 billion in the first nine months of 2018 compared to $979 million in the first nine months of 2017, an increase of $194 million.


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AMERICAN FINANCIAL GROUP, INC. 10-Q
Management’s Discussion and Analysis of Financial Condition and Results of Operations — Continued


$979 million in the first nine months of 2017 compared to $981 million in the first nine months of 2016, a decrease of $2 million.

Net Cash Used in Investing Activities   AFG’s investing activities consist primarily of the investment of funds provided by its property and casualty and annuity products.businesses. Net cash used in investing activities was $2.233.38 billion for the first nine months of 20172018 compared to $2.522.23 billion in the first nine months of 2016, a decrease2017, an increase of $289 million1.15 billion reflecting the timing of investing available cash.. As discussed below (under net cash provided by financing activities), AFG’s annuity group had net cash flows from annuity policyholders of $1.86 billion in the first nine months of 2018 and $1.75 billion in the first nine months of 2017, and $1.78 billion in the first nine months of 2016, which is the primary source of AFG’s cash used in investing activities. Settlements of equity index call options exceeded purchases by $201 million inDuring the first nine months of 2017 compared to purchases exceeding settlements by $124 million in the first nine months2018, AFG also invested a portion of 2016, accounting for a $325 million decrease inits overall cash used in investing activities. In general, purchases of equity index call options have increased due to growth in the fixed-indexed annuity business while proceeds from settlements of equity options are impacted by the performance of the stock market during the term of the options.held at December 31, 2017. In addition to the investment of funds provided by the insurance operations, investing activities also include the purchase and disposal of managed investment entity investments, which are presented separately in AFG’s Balance Sheet. Net investment activity in the managed investment entities was a $13189 million sourceuse of cash in the first nine months of 20172018 compared to a $2413 million usesource of cash in the 20162017 period, accounting for a $37$202 million decreaseincrease in net cash used in investing activities in the first nine months of 20172018 compared to the same 20162017 period. See Note A — “Accounting PoliciesManaged Investment Entities and Note HG — “Managed Investment Entities to the financial statements.

Net Cash Provided by Financing Activities   AFG’s financing activities consist primarily of transactions with annuity policyholders, issuances and retirements of long-term debt, repurchases of common stock and dividend payments. Net cash provided by financing activities was $1.481.77 billion for the first nine months of 20172018 compared to $2.191.48 billion in the first nine months of 2016, a decrease2017, an increase of $713290 million. Annuity receipts exceeded annuity surrenders, benefits, withdrawals and transfers by $1.86 billion in the first nine months of 2018 compared to $1.75 billion in the first nine months of 2017, compared to $1.78 billion in the first nine months of 2016 accounting for a $27$109 million decreaseincrease in net cash provided by financing activities in the 20172018 period compared to the 20162017 period. In June 2017, AFG issued $350 million of 4.50% Senior Notes due 2047, the net proceeds of which contributed $345 million to net cash provided by financing activities in the first nine months of 2017 compared to net proceeds from additional long-term borrowings of $302 million in the first nine months of 2016.2017. Redemptions of long-term debt were a $355 million use of cash in the first nine months of 2017 compared to no redemptions of long-term debt in 2016. There were no shares of AFG Common Stock repurchased during the first nine months of 2017 compared to $124 million repurchased in the first nine months of 2016, which accounted for a $124 million increase in net cash provided by financing activities in the 2017 period compared to the 2016 period. In May 2017, AFG paid a special cash dividend of $1.50 per share of American Financial Group Common Stock, which was in addition to its regular quarterly cash dividend. The aggregate amount of the special cash dividend was $132 million, which decreased net cash provided by financing activities.2017. Financing activities also include issuances and retirements of managed investment entity liabilities, which are nonrecourse to AFG and presented separately in AFG’s Balance Sheet. RetirementsIssuances of managed investment entity liabilities exceeded retirements by $109 million in the first nine months of 2018 compared to retirements of managed investment liabilities exceeding issuances by $72 million in the first nine months of 2017, compared to issuances exceeding retirements by $281 million in the first nine months of 2016, accounting for a $353181 million decreaseincrease in net cash provided by financing activities in the 20172018 period compared to the 20162017 period. See Note A — “Accounting PoliciesManaged Investment Entities and Note HG — “Managed Investment Entities to the financial statements.

Parent and Subsidiary Liquidity

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

In June 2016, AFG replacedcan borrow up to $500 million under its bankrevolving credit facility with a five-year, $500 million revolving credit line.which expires in June 2021. Amounts borrowed under this agreement bear interest at rates ranging from 1.00% to 1.875% (currently 1.375%) over LIBOR based on AFG’s credit rating. There were no borrowings under this agreement, or under any other parent company short-term borrowing arrangements, during 20162017 or the first nine months of 2017.2018.


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TableIn November 2018, AFG declared a special cash dividend of Contents
AMERICAN FINANCIAL GROUP, INC. 10-Q
Management’s Discussion$1.50 per share of AFG Common Stock. The dividend is payable on November 26, 2018 to shareholders of record on November 16, 2018. The aggregate amount of this special dividend will be approximately $134 million. In May 2018, AFG paid a special cash dividend of $1.50 per share of AFG Common Stock totaling $134 million. In 2017, AFG paid special cash dividends of $3.50 per share of AFG Common Stock ($1.50 per share in May and Analysis of Financial Condition and Results of Operations — Continued

$2.00 per share in November) totaling approximately $308 million.

In June 2017, AFG issued $350 million of 4.50% Senior Notes due June 2047. Net proceeds from the offering were used to redeem AFG’s $230 million outstanding principal amount of 6-3/8% Senior Notes due June 2042, at par value in June 2017 and AFG’s $125 million outstanding principal amount of 5-3/4% Senior Notes due August 2042 at par value in August 2017.

In MayNovember 2017, AFG paid a special cash dividendissued an additional $240 million of $1.50 per share of AFG Common Stock totaling $132 million.

In November 2016, AFG acquired the 49% of National Interstate Corporation (“NATL”) not previously owned by AFG’s wholly-owned subsidiary, Great American Insurance Company (“GAI”) for $315 million ($32.00 per share)4.50% Senior Notes due in cash in a merger transaction. In addition, NATL paid a one-time special cash dividend of $0.50 per share to its shareholders immediately prior to the merger closing ($5 million was paid to noncontrolling shareholders).

In August 2016, AFG issued $3002047 and $125 million of 3.50% Senior Notes due in 2026. AFG used theThe net proceeds fromof the offering were used to fundredeem AFG’s $350 million outstanding principal amount of 9-7/8% Senior Notes due in June 2019 for $388 million (including a portionmake-whole premium of the acquisition of NATL mentioned above.$38 million) in December 2017.

During 2016, AFG repurchased 1.9 million shares
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Table of its Common Stock for $133 million.Contents
AMERICAN FINANCIAL GROUP, INC. 10-Q
Management’s Discussion and Analysis of Financial Condition and Results of Operations — Continued


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

Subsidiary Liquidity   Great American Life Insurance Company (“GALIC”), a wholly-owned annuity subsidiary, is a member of the Federal Home Loan Bank of Cincinnati (“FHLB”). The FHLB makes advances and provides other banking services to member institutions, which provides the annuity operations with an additional source of liquidity. These advances further the FHLB’s mission of improving access to housing by increasing liquidity in the residential mortgage-backed securities market. At September 30, 20172018, GALIC had $935$871 million in outstanding advances from the FHLB (included in annuity benefits accumulated), bearing interest at rates ranging from 0.03% to 0.53%0.21% over LIBOR (average rate of 1.60%2.33% at September 30, 20172018). While these advances must be repaid between 2018 and 2021 ($28540 million in 2018, $500$345 million in 20202019 and $150$486 million in 2021), GALIC has the option to prepay all or a portion of the advances. GALIC has invested the proceeds from the advances in fixed maturity securities with similar expected lives as the advances for the purpose of earning a spread over the interest payments due to the FHLB. At September 30, 2017,2018, GALIC estimated that it had additional borrowing capacity of approximately $250$300 million from the FHLB.

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

The excess cash flow of AFG’s property and casualty group allows it to extend the duration of its investment portfolio somewhat beyond that of its claim reserves.

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AMERICAN FINANCIAL GROUP, INC. 10-Q
Management’s Discussion and Analysis of Financial Condition and Results of Operations — Continued


In the annuity business, where profitability is largely dependent on earning a spread between invested assets and annuity liabilities, the duration of investments is generally maintained close to that of liabilities. In a rising interest rate environment, significant protection from withdrawals exists in the form of temporary and permanent surrender charges on AFG’s annuity products. With declining rates, AFG receives some protection (from spread compression) due to the ability to lower crediting rates, subject to contractually guaranteed minimum interest rates (“GMIRs”). AFG began selling policies with GMIRs below 2% in 2003; almost all new business since late 2010 has been issued with a 1% GMIR. At September 30, 20172018, AFG could reduce the average crediting rate on approximately $24$27 billion of traditional fixed annuities and fixed-indexed and variable-indexed annuities without guaranteed withdrawal benefits by approximately 88116 basis points (on a weighted average basis). Annuity policies are subject to GMIRs at policy issuance. The table below shows the breakdown of annuity reserves by GMIR. The current interest crediting rates on substantially all of AFG’s annuities with a GMIR of 3% or higher are at their minimum.
     % of Reserves 
     September 30, December 31, 
 GMIR   2017 2016 2015 
 1 — 1.99%   75% 72% 67% 
 2 — 2.99%     5%   6%   7% 
 3 — 3.99%   10% 12% 14% 
 4.00% and above   10% 10% 12% 
           
 Annuity benefits accumulated (in millions) $32,671 $29,907 $26,622 
     % of Reserves 
     September 30, December 31, 
 GMIR   2018 2017 2016 
 1 — 1.99%   78% 76% 72% 
 2 — 2.99%     4%   5%   6% 
 3 — 3.99%     9% 10% 12% 
 4.00% and above     9%   9% 10% 
           
 Annuity benefits accumulated (in millions) $35,958 $33,316 $29,907 

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.

Investments   AFG’s investment portfolio at September 30, 20172018, containedincludes $37.8240.24 billion in fixed maturity securities and $1.58 billion in equity securities classified as available for sale and carried at fair value with unrealized gains and losses included in a separate component of shareholders’ equity on an after-tax basis. In addition,basis and $350103 million in fixed maturities and $60 million in equity securities were classified as trading with changes in unrealized holding gains or losses included in net investment income. In addition, AFG’s investment portfolio includes $1.65 billion in equity securities carried at fair value with holding gains and losses included in realized gains (losses) on securities and $176 million in equity securities carried at fair value with unrealized holding gains and losses included in net investment income.


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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 published closing prices. For mortgage-backed securities (“MBS”), which comprise approximately 12%9% 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 76%72% are priced using pricing services and the balance is priced primarily by using non-binding broker quotes. When prices obtained for the same security vary, AFG’s internal investment professionals select the price they believe is most indicative of an exit price.

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

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


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AMERICAN FINANCIAL GROUP, INC. 10-Q
Management’s Discussion and Analysis of Financial Condition and Results of Operations — Continued


In general, the fair value of AFG’s fixed maturity investments is inversely correlated to changes in interest rates. The following table demonstrates the sensitivity of such fair values to reasonably likely changes in interest rates by illustrating the estimated effect on AFG’s fixed maturity portfolio and accumulated other comprehensive income that an immediate increase of 100 basis points in the interest rate yield curve would have at September 30, 20172018 (dollars in millions). Effects of increases or decreases from the 100 basis points illustrated would be approximately proportional.

Fair value of fixed maturity portfolio$38,168
$40,347
Percentage impact on fair value of 100 bps increase in interest rates(5.0%)(4.5%)
Pretax impact on fair value of fixed maturity portfolio$(1,908)$(1,816)
Offsetting adjustments to deferred policy acquisition costs and other balance sheet amounts750
750
Estimated pretax impact on accumulated other comprehensive income(1,158)(1,066)
Deferred income tax405
224
Estimated after-tax impact on accumulated other comprehensive income$(753)$(842)

Approximately 90% of the fixed maturities held by AFG at September 30, 20172018, were rated “investment grade” (credit rating of AAA to BBB) by nationally recognized rating agencies. Investment grade securities generally bear lower yields and lower degrees of risk than those that are unrated and non-investment grade. Management believes that the high quality investment portfolio should generate a stable and predictable investment return.

MBS are subject to significant prepayment risk 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. Although interest rates have been low in recent years, tighter lending standards have resulted in fewer buyers being able to refinance the mortgages underlying much of AFG’s non-agency residential MBS portfolio.


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AMERICAN FINANCIAL GROUP, INC. 10-Q
Management’s Discussion and Analysis of Financial Condition and Results of Operations — Continued


Summarized information for AFG’s MBS (including those classified as trading) at September 30, 20172018, is shown in the table below (dollars in millions). Agency-backed securities are those issued by a U.S. government-backed agency; Alt-A mortgages are those with risk profiles between prime and subprime. The average life of the residential and commercial MBS is approximately 4-1/2 years and 5-1/25 years, respectively.
 
Amortized
Cost
 Fair Value 
Fair Value as
% of Cost
 
Unrealized
Gain (Loss)
 
% Rated
Investment
Grade
 
Amortized
Cost
 Fair Value 
Fair Value as
% of Cost
 
Unrealized
Gain (Loss)
 
% Rated
Investment
Grade
Collateral type                    
Residential:                    
Agency-backed $218
 $218
 100% $
 100% $177
 $173
 98% $(4) 100%
Non-agency prime 1,283
 1,452
 113% 169
 28% 1,009
 1,154
 114% 145
 27%
Alt-A 1,049
 1,167
 111% 118
 15% 837
 953
 114% 116
 15%
Subprime 515
 562
 109% 47
 22% 387
 431
 111% 44
 28%
Commercial 967
 1,010
 104% 43
 95% 913
 923
 101% 10
 94%
 $4,032
 $4,409
 109% $377
 43% $3,323
 $3,634
 109% $311
 44%

The National Association of Insurance Commissioners (“NAIC”) assigns creditworthiness designations on a scale of 1 to 6 with 1 being the highest quality and 6 being the lowest quality. The NAIC retains third-party investment management firms to assist in the determination of appropriate NAIC designations for MBS based not only on the probability of loss (which is the primary basis of ratings by the major ratings firms), but also on the severity of loss and statutory carrying value. At September 30, 20172018, 96%97% (based on statutory carrying value of $3.97$3.28 billion) of AFG’s MBS had an NAIC designation of 1.

Municipal bonds represented approximately 18%17% of AFG’s fixed maturity portfolio at September 30, 20172018. 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 September 30, 20172018, approximately 76%77% of the municipal bond portfolio was held in revenue bonds, with the remaining 24%23% held in general obligation bonds. General obligation securities of California, Illinois and Michigan collectively represented approximately 1% of this portfolio. AFG does not own general obligation bonds issued by New Jersey, New York or Puerto Rico.

Summarized information for the unrealized gains and losses recorded in AFG’s Balance Sheet at September 30, 2018, is shown in the following table (dollars in millions). Approximately $563 million of available for sale fixed maturity securities had no unrealized gains or losses at September 30, 2018.
 
Securities
With
Unrealized
Gains
 
Securities
With
Unrealized
Losses
Available for Sale Fixed Maturities   
Fair value of securities$17,894
 $21,787
Amortized cost of securities$17,160
 $22,330
Gross unrealized gain (loss)$734
 $(543)
Fair value as % of amortized cost104% 98%
Number of security positions2,876
 2,392
Number individually exceeding $2 million gain or loss50
 10
Concentration of gains (losses) by type or industry (exceeding 5% of unrealized):   
Mortgage-backed securities$324
 $(13)
Asset-backed securities122
 (64)
States and municipalities117
 (98)
Banks, savings and credit institutions32
 (100)
Manufacturing29
 (57)
Insurance companies15
 (47)
Percentage rated investment grade84% 96%


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AMERICAN FINANCIAL GROUP, INC. 10-Q
Management’s Discussion and Analysis of Financial Condition and Results of Operations — Continued


Summarized information for the unrealized gains and losses recorded in AFG’s Balance Sheet at September 30, 2017, is shown in the following table (dollars in millions). Approximately $674 million of available for sale fixed maturity securities and $84 million of available for sale equity securities had no unrealized gains or losses at September 30, 2017.
 
Securities
With
Unrealized
Gains
 
Securities
With
Unrealized
Losses
Available for Sale Fixed Maturities   
Fair value of securities$32,183
 $4,961
Amortized cost of securities$30,692
 $5,046
Gross unrealized gain (loss)$1,491
 $(85)
Fair value as % of amortized cost105% 98%
Number of security positions4,487
 735
Number individually exceeding $2 million gain or loss80
 
Concentration of gains (losses) by type or industry (exceeding 5% of unrealized):   
Mortgage-backed securities$385
 $(8)
States and municipalities259
 (23)
Banks, savings and credit institutions174
 (5)
Asset-backed securities143
 (15)
Manufacturing127
 (8)
Oil and gas extraction22
 (4)
Percentage rated investment grade91% 88%
    
Available for Sale Equity Securities   
Fair value of securities$1,318
 $177
Cost of securities$1,023
 $205
Gross unrealized gain (loss)$295
 $(28)
Fair value as % of cost129% 86%
Number of security positions176
 24
Number individually exceeding $2 million gain or loss34
 7

The table below sets forth the scheduled maturities of AFG’s available for sale fixed maturity securities at September 30, 20172018, based on their fair values. Securities with sinking funds are reported at average maturity. Actual maturities may differ from contractual maturities because certain securities may be called or prepaid by the issuers. 
 
Securities
With
Unrealized
Gains
 
Securities
With
Unrealized
Losses
Maturity   
One year or less2% 2%
After one year through five years19% 15%
After five years through ten years37% 34%
After ten years12% 18%
 70% 69%
Asset-backed securities (average life of approximately 5 years)18% 22%
Mortgage-backed securities (average life of approximately 4-1/2 years)12% 9%
 100% 100%


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AMERICAN FINANCIAL GROUP, INC. 10-Q
Management’s Discussion and Analysis of Financial Condition and Results of Operations — Continued

 
Securities
With
Unrealized
Gains
 
Securities
With
Unrealized
Losses
Maturity   
One year or less5% 1%
After one year through five years25% 17%
After five years through ten years24% 41%
After ten years9% 14%
 63% 73%
Asset-backed securities (average life of approximately 4-1/2 years)21% 24%
Mortgage-backed securities (average life of approximately 4-1/2 years)16% 3%
 100% 100%

The table below (dollars in millions) summarizes the unrealized gains and losses on fixed maturity securities by dollar amount:
  
Aggregate
Fair
Value
 
Aggregate
Unrealized
Gain (Loss)
 
Fair
Value as
% of Cost
Fixed Maturities at September 30, 2017      
Securities with unrealized gains:      
Exceeding $500,000 (887 securities) $12,972
 $970
 108%
$500,000 or less (3,600 securities) 19,211
 521
 103%
  $32,183
 $1,491
 105%
Securities with unrealized losses:      
Exceeding $500,000 (39 securities) $649
 $(34) 95%
$500,000 or less (696 securities) 4,312
 (51) 99%
  $4,961
 $(85) 98%
  
Aggregate
Fair
Value
 
Aggregate
Unrealized
Gain (Loss)
 
Fair
Value as
% of Cost
Fixed Maturities at September 30, 2018      
Securities with unrealized gains:      
Exceeding $500,000 (376 securities) $4,334
 $460
 112%
$500,000 or less (2,500 securities) 13,560
 274
 102%
  $17,894
 $734
 104%
Securities with unrealized losses:      
Exceeding $500,000 (307 securities) $6,001
 $(275) 96%
$500,000 or less (2,085 securities) 15,786
 (268) 98%
  $21,787
 $(543) 98%

The following table (dollars in millions) summarizes the unrealized losses for all securities with unrealized losses by issuer quality and the length of time those securities have been in an unrealized loss position: 
  
Aggregate
Fair
Value
 
Aggregate
Unrealized
Loss
 
Fair
Value as
% of Cost
Securities with Unrealized Losses at September 30, 2017      
Investment grade fixed maturities with losses for:      
Less than one year (498 securities) $3,682
 $(45) 99%
One year or longer (116 securities) 663
 (17) 98%
  $4,345
 $(62) 99%
Non-investment grade fixed maturities with losses for:      
Less than one year (71 securities) $318
 $(7) 98%
One year or longer (50 securities) 298
 (16) 95%
  $616
 $(23) 96%
Common stocks with losses for:      
Less than one year (19 securities) $141
 $(27) 84%
One year or longer (none) 
 
 %
  $141
 $(27) 84%
Perpetual preferred stocks with losses for:      
Less than one year (2 securities) $23
 $
 100%
One year or longer (3 securities) 13
 (1) 93%
  $36
 $(1) 97%
  
Aggregate
Fair
Value
 
Aggregate
Unrealized
Loss
 
Fair
Value as
% of Cost
Securities with Unrealized Losses at September 30, 2018      
Investment grade fixed maturities with losses for:      
Less than one year (1,865 securities) $18,458
 $(388) 98%
One year or longer (392 securities) 2,427
 (125) 95%
  $20,885
 $(513) 98%
Non-investment grade fixed maturities with losses for:      
Less than one year (81 securities) $626
 $(12) 98%
One year or longer (54 securities) 276
 (18) 94%
  $902
 $(30) 97%

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 20162017 Form 10-K under Management’s Discussion and Analysis — “Investments.”


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AMERICAN FINANCIAL GROUP, INC. 10-Q
Management’s Discussion and Analysis of Financial Condition and Results of Operations — Continued


Based on its analysis, management believes AFG will recover its cost basis in the fixed maturity securities with unrealized losses and that AFG has the ability to hold the securities until they recover in value and had no intent to sell them at September 30, 20172018. Although AFG has the ability to continue holding its fixed maturity investments with unrealized losses, its intent to hold them may change due to deterioration in the issuers’ creditworthiness, decisions to lessen exposure to a particular issuer or industry, asset/liability management decisions, market movements, changes in views about appropriate asset allocation or the desire to offset taxable realized gains. Should AFG’s ability or intent change 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. For information on AFG’s realized gains

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AMERICAN FINANCIAL GROUP, INC. 10-Q
Management’s Discussion and Analysis of Financial Condition and Results of Operations — Continued


(losses) on securities, including charges for other-than-temporary impairment, see “Results of Operations — Consolidated Realized Gains (Losses) on Securities.”

Uncertainties   Management believes that the areas posing the greatest risk of material loss are the adequacy of its insurance reserves and contingencies arising out of its former railroad and manufacturing operations. See “Special asbestos and environmental reserve charges”under “Results of Operations — Property and Casualty Insurance Segment — Net prior year reserve development”for the quarters ended September 30, 20172018 and 20162017 and Management’s Discussion and Analysis — “Uncertainties — Asbestos and Environmental-related (“A&E”) Insurance Reserves” in AFG’s 20162017 Form 10-K.

MANAGED INVESTMENT ENTITIES

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

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AMERICAN FINANCIAL GROUP, INC. 10-Q
Management’s Discussion and Analysis of Financial Condition and Results of Operations — Continued


CONDENSED CONSOLIDATING BALANCE SHEET
Before CLO
Consolidation
 
Managed
Investment
Entities
 
Consol.
Entries
 
Consolidated
As Reported
Before CLO
Consolidation
 
Managed
Investment
Entities
 
Consol.
Entries
 
Consolidated
As Reported
September 30, 2017       
September 30, 2018       
Assets:              
Cash and investments$45,514
 $
 $(261) (a) $45,253
$48,031
 $
 $(190) (a) $47,841
Assets of managed investment entities
 4,767
 
 4,767

 4,998
 
 4,998
Other assets10,143
 
 
 (a) 10,143
11,352
 
 (1) (a) 11,351
Total assets$55,657
 $4,767
 $(261) $60,163
$59,383
 $4,998
 $(191) $64,190
Liabilities:              
Unpaid losses and loss adjustment expenses and unearned premiums$12,130
 $
 $
 $12,130
$12,410
 $
 $
 $12,410
Annuity, life, accident and health benefits and reserves33,338
 
 
 33,338
36,601
 
 
 36,601
Liabilities of managed investment entities
 4,700
 (194) (a) 4,506

 4,998
 (191) (a) 4,807
Long-term debt and other liabilities4,810
 
 
 4,810
5,208
 
 
 5,208
Total liabilities50,278
 4,700
 (194) 54,784
54,219
 4,998
 (191) 59,026
       
Redeemable noncontrolling interests
 
 
 
       
Shareholders’ equity:              
Common Stock and Capital surplus1,255
 67
 (67) 1,255
1,320
 
 
 1,320
Retained earnings3,435
 
 
 3,435
3,800
 
 
 3,800
Accumulated other comprehensive income, net of tax689
 
 
 689
44
 
 
 44
Total shareholders’ equity5,379
 67
 (67) 5,379
5,164
 
 
 5,164
Noncontrolling interests
 
 
 

 
 
 
Total equity5,379
 67
 (67) 5,379
5,164
 
 
 5,164
Total liabilities and equity$55,657
 $4,767
 $(261) $60,163
$59,383
 $4,998
 $(191) $64,190
              
December 31, 2016       
December 31, 2017       
Assets:              
Cash and investments$41,649
 $
 $(216) (a) $41,433
$46,262
 $
 $(214) (a) $46,048
Assets of managed investment entities
 4,765
 
 4,765

 4,902
 
 4,902
Other assets8,874
 
 
 (a) 8,874
9,709
 
 (1) (a) 9,708
Total assets$50,523
 $4,765
 $(216) $55,072
$55,971
 $4,902
 $(215) $60,658
Liabilities:              
Unpaid losses and loss adjustment expenses and unearned premiums$10,734
 $
 $
 $10,734
$12,088
 $
 $
 $12,088
Annuity, life, accident and health benefits and reserves30,598
 
 
 30,598
33,974
 
 
 33,974
Liabilities of managed investment entities
 4,760
 (211) (a) 4,549

 4,902
 (215) (a) 4,687
Long-term debt and other liabilities4,272
 
 
 4,272
4,575
 
 
 4,575
Total liabilities45,604
 4,760
 (211) 50,153
50,637
 4,902
 (215) 55,324
       
Redeemable noncontrolling interests3
 
 
 3
       
Shareholders’ equity:              
Common Stock and Capital surplus1,198
 5
 (5) 1,198
1,269
 
 
 1,269
Retained earnings3,343
 
 
 3,343
3,248
 
 
 3,248
Accumulated other comprehensive income, net of tax375
 
 
 375
813
 
 
 813
Total shareholders’ equity4,916
 5
 (5) 4,916
5,330
 
 
 5,330
Noncontrolling interests3
 
 
 3
1
 
 
 1
Total equity4,919
 5
 (5) 4,919
5,331
 
 
 5,331
Total liabilities and equity$50,523
 $4,765
 $(216) $55,072
$55,971
 $4,902
 $(215) $60,658

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






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AMERICAN FINANCIAL GROUP, INC. 10-Q
Management’s Discussion and Analysis of Financial Condition and Results of Operations — Continued


CONDENSED CONSOLIDATING STATEMENT OF EARNINGS
Before CLO
Consolidation (a)
 
Managed
Investment
Entities
 
Consol.
Entries
 
Consolidated
As Reported
Before CLO
Consolidation (a)
 
Managed
Investment
Entities
 
Consol.
Entries
 
Consolidated
As Reported
Three months ended September 30, 2017       
Three months ended September 30, 2018       
Revenues:              
Insurance net earned premiums$1,273
 $
 $
 $1,273
$1,333
 $
 $
 $1,333
Net investment income476
 
 (5) (b) 471
531
 
 (4) (b) 527
Realized losses on securities(12) 
 
 (12)
Income of managed investment entities:       
Realized gains on securities34
 
 
 34
Income (loss) of managed investment entities:       
Investment income
 54
 
 54

 65
 
 65
Gain on change in fair value of assets/liabilities
 1
 
 (b) 1
Gain (loss) on change in fair value of assets/liabilities
 (5) 
 (b) (5)
Other income53
 
 (5) (c) 48
58
 
 (4) (c) 54
Total revenues1,790
 55
 (10) 1,835
1,956
 60
 (8) 2,008
Costs and Expenses:              
Insurance benefits and expenses1,628
 
 
 1,628
1,599
 
 
 1,599
Expenses of managed investment entities
 55
 (10) (b)(c)  45

 60
 (8) (b)(c)  52
Interest charges on borrowed money and other expenses133
 
 
 133
113
 
 
 113
Total costs and expenses1,761
 55
 (10) 1,806
1,712
 60
 (8) 1,764
Earnings before income taxes29
 
 
 29
244
 
 
 244
Provision for income taxes18
 
 
 18
41
 
 
 41
Net earnings, including noncontrolling interests11
 
 
 11
203
 
 
 203
Less: Net earnings attributable to noncontrolling interests
 
 
 
Less: Net earnings (loss) attributable to noncontrolling interests(1) 
 
 (1)
Net earnings attributable to shareholders$11
 $
 $
 $11
$204
 $
 $
 $204
              
Three months ended September 30, 2016       
Three months ended September 30, 2017       
Revenues:              
Insurance net earned premiums$1,165
 $
 $
 $1,165
$1,273
 $
 $
 $1,273
Net investment income450
 
 (17) (b) 433
476
 
 (5) (b) 471
Realized gains on securities2
 
 
 2
Income of managed investment entities:       
Realized losses on securities(12) 
 
 (12)
Income (loss) of managed investment entities:       
Investment income
 48
 
 48

 54
 
 54
Gain on change in fair value of assets/liabilities
 
 11
 (b) 11
Gain (loss) on change in fair value of assets/liabilities
 1
 
 (b) 1
Other income50
 
 (4) (c) 46
53
 
 (5) (c) 48
Total revenues1,667
 48
 (10) 1,705
1,790
 55
 (10) 1,835
Costs and Expenses:              
Insurance benefits and expenses1,372
 
 
 1,372
1,628
 
 
 1,628
Expenses of managed investment entities
 48
 (10) (b)(c)  38

 55
 (10) (b)(c)  45
Interest charges on borrowed money and other expenses117
 
 
 117
133
 
 
 133
Total costs and expenses1,489
 48
 (10) 1,527
1,761
 55
 (10) 1,806
Earnings before income taxes178
 
 
 178
29
 
 
 29
Provision for income taxes65
 
 
 65
18
 
 
 18
Net earnings, including noncontrolling interests113
 
 
 113
11
 
 
 11
Less: Net earnings attributable to noncontrolling interests4
 
 
 4
Less: Net earnings (loss) attributable to noncontrolling interests
 
 
 
Net earnings attributable to shareholders$109
 $
 $
 $109
$11
 $
 $
 $11

(a)Includes income of $5$4 million and $17$5 million in the third quarter of 20172018 and 2016,2017, respectively, representing the change in fair value of AFG’s CLO investments plus $5$4 million and $4$5 million in the third quarter of 20172018 and 2016,2017, respectively, in CLO management fees earned.
(b)Elimination of the change in fair value of AFG’s investments in the CLOs, including $5$4 million and $6$5 million in the third quarter of 20172018 and 2016,2017, respectively, in distributions recorded as interest expense by the CLOs.
(c)Elimination of management fees earned by AFG.




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AMERICAN FINANCIAL GROUP, INC. 10-Q
Management’s Discussion and Analysis of Financial Condition and Results of Operations — Continued


CONDENSED CONSOLIDATING STATEMENT OF EARNINGS
Before CLO
Consolidation (a)
 
Managed
Investment
Entities
 
Consol.
Entries
 
Consolidated
As Reported
Before CLO
Consolidation (a)
 
Managed
Investment
Entities
 
Consol.
Entries
 
Consolidated
As Reported
Nine months ended September 30, 2017       
Nine months ended September 30, 2018       
Revenues:              
Insurance net earned premiums$3,371
 $
 $
 $3,371
$3,613
 $
 $
 $3,613
Net investment income1,382
 
 (16) (b) 1,366
1,563
 
 (11) (b) 1,552
Realized losses on securities(1) 
 
 (1)(28) 
 
 (28)
Income of managed investment entities:       
Income (loss) of managed investment entities:       
Investment income
 155
 
 155

 187
 
 187
Gain on change in fair value of assets/liabilities
 22
 (10) (b) 12
Gain (loss) on change in fair value of assets/liabilities
 (6) (4) (b) (10)
Other income168
 
 (14) (c) 154
158
 
 (12) (c) 146
Total revenues4,920
 177
 (40) 5,057
5,306
 181
 (27) 5,460
Costs and Expenses:              
Insurance benefits and expenses4,113
 
 
 4,113
4,310
 
 
 4,310
Expenses of managed investment entities
 177
 (40) (b)(c)  137

 181
 (27) (b)(c) 154
Interest charges on borrowed money and other expenses350
 
 
 350
318
 
 
 318
Total costs and expenses4,463
 177
 (40) 4,600
4,628
 181
 (27) 4,782
Earnings before income taxes457
 
 
 457
678
 
 
 678
Provision for income taxes146
 
 
 146
126
 
 
 126
Net earnings, including noncontrolling interests311
 
 
 311
552
 
 
 552
Less: Net earnings attributable to noncontrolling interests2
 
 
 2
Less: Net earnings (loss) attributable to noncontrolling interests(7) 
 
 (7)
Net earnings attributable to shareholders$309
 $
 $
 $309
$559
 $
 $
 $559
              
Nine months ended September 30, 2016       
Nine months ended September 30, 2017       
Revenues:              
Insurance net earned premiums$3,202
 $
 $
 $3,202
$3,371
 $
 $
 $3,371
Net investment income1,296
 
 (29) (b) 1,267
1,382
 
 (16) (b) 1,366
Realized gains (losses) on:       
Securities(32) 
 
 (32)
Subsidiaries2
 
 
 2
Income of managed investment entities:       
Realized losses on securities(1) 
 
 (1)
Income (loss) of managed investment entities:       
Investment income
 141
 
 141

 155
 
 155
Gain on change in fair value of assets/liabilities
 2
 7
 (b) 9
Gain (loss) on change in fair value of assets/liabilities
 22
 (10) (b) 12
Other income184
 
 (12) (c) 172
168
 
 (14) (c) 154
Total revenues4,652
 143
 (34) 4,761
4,920
 177
 (40) 5,057
Costs and Expenses:              
Insurance benefits and expenses3,868
 
 
 3,868
4,113
 
 
 4,113
Expenses of managed investment entities
 142
 (33) (b)(c)  109

 177
 (40) (b)(c) 137
Interest charges on borrowed money and other expenses314
 
 
 314
350
 
 
 350
Total costs and expenses4,182
 142
 (33) 4,291
4,463
 177
 (40) 4,600
Earnings before income taxes470
 1
 (1) 470
457
 
 
 457
Provision for income taxes190
 
 
 190
146
 
 
 146
Net earnings, including noncontrolling interests280
 1
 (1) 280
311
 
 
 311
Less: Net earnings attributable to noncontrolling interests16
 
 
 16
Less: Net earnings (loss) attributable to noncontrolling interests2
 
 
 2
Net earnings attributable to shareholders$264
 $1
 $(1) $264
$309
 $
 $
 $309

(a)Includes income of $16$11 million and $29$16 million in the first nine months of 20172018 and 2016,2017, respectively, representing the change in fair value of AFG’s CLO investments plus $14$12 million and $12$14 million in the first nine months of 20172018 and 2016,2017, respectively, in CLO management fees earned.
(b)Elimination of the change in fair value of AFG’s investments in the CLOs, including $26$15 million and $21$26 million in the first nine months of 20172018 and 2016,2017, respectively, in distributions recorded as interest expense by the CLOs.
(c)Elimination of management fees earned by AFG.



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AMERICAN FINANCIAL GROUP, INC. 10-Q
Management’s Discussion and Analysis of Financial Condition and Results of Operations — Continued


RESULTS OF OPERATIONS

General   AFG’s net earnings attributable to shareholders, determined in accordance with GAAP, include certain items that may not be indicative of its ongoing core operations. For example, core net operating earnings excludes realized gains (losses) on securities because such gains and losses are influenced significantly by financial markets, interest rates and the timing of sales. Similarly, significant gains and losses from the sale of real estate are excluded from core earnings as they are influenced by the timing of sales and realized gains (losses) on subsidiaries are excluded because such gains and losses are largely the result of the changing business strategy and market opportunities. In addition, special charges related to coverage that AFG no longer writes such as the Neon exited lines charge in the second quarter of 2016 and for asbestos and environmental exposures are excluded from core earnings. The following table (in millions, except per share amounts) identifies non-core items and reconciles net earnings attributable to shareholders to core net operating earnings, a non-GAAP financial measure. AFG believes core net operating earnings is a useful tool for investors and analysts in analyzing ongoing operating trends and for management to evaluate financial performance against historical results because it believes this provides a more comparable measure of its continuing business.
Three months ended September 30, Nine months ended September 30,Three months ended September 30, Nine months ended September 30,
2017 2016 2017 20162018 2017 2018 2017
Components of net earnings attributable to shareholders:              
Core operating earnings before income taxes$158
 $217
 $582
 $574
$237
 $158
 $733
 $582
Pretax non-core items:              
Realized gains (losses) on securities(12) 2
 (1) (32)34
 (12) (28) (1)
Realized gain on subsidiaries
 
 
 2
Gain on sale of apartment property
 
 
 32
Special A&E charges(113) (41) (113) (41)(27) (113) (27) (113)
Neon exited lines charge
 
 
 (65)
Loss on retirement of debt(4) 
 (11) 

 (4) 
 (11)
Earnings before income taxes29
 178
 457
 470
244
 29
 678
 457
Provision (credit) for income taxes:              
Core operating earnings63
 79
 189
 202
40
 63
 138
 189
Non-core items(45) (14) (43) (12)1
 (45) (12) (43)
Total provision for income taxes18
 65
 146
 190
41
 18
 126
 146
Net earnings, including noncontrolling interests11
 113
 311
 280
203
 11
 552
 311
Less net earnings attributable to noncontrolling interests:       
Core operating earnings
 4
 2
 14
Less net earnings (losses) attributable to noncontrolling interests:       
Core operating earnings (losses)(1) 
 (7) 2
Non-core items
 
 
 2

 
 
 
Total net earnings attributable to noncontrolling interests
 4
 2
 16
Total net earnings (losses) attributable to noncontrolling interests(1) 
 (7) 2
Net earnings attributable to shareholders$11
 $109
 $309
 $264
$204
 $11
 $559
 $309
              
Net earnings:              
Core net operating earnings$95
 $134
 $391
 $358
$198
 $95
 $602
 $391
Non-core items(84) (25) (82) (94)6
 (84) (43) (82)
Net earnings attributable to shareholders$11
 $109
 $309
 $264
$204
 $11
 $559
 $309
              
Diluted per share amounts:              
Core net operating earnings$1.06
 $1.51
 $4.35
 $4.04
$2.19
 $1.06
 $6.65
 $4.35
Realized gains (losses) on securities(0.08) 0.02
 (0.01) (0.21)0.31
 (0.08) (0.24) (0.01)
Realized gain on subsidiaries
 
 
 0.01
Gain on sale of apartment property
 
 
 0.17
Special A&E charges(0.82) (0.30) (0.82) (0.30)(0.24) (0.82) (0.24) (0.82)
Neon exited lines charge
 
 
 (0.73)
Loss on retirement of debt(0.03) 
 (0.08) 

 (0.03) 
 (0.08)
Net earnings attributable to shareholders$0.13
 $1.23
 $3.44
 $2.98
$2.26
 $0.13
 $6.17
 $3.44

Net earnings attributable to shareholders decreased $98increased $193 million in the third quarter of 20172018 compared to the same period in 20162017 due primarily to lowerhigher core net operating earnings, higherlower special A&E charges recorded in the third quarter of 20172018 compared to the third quarter of 2016 and2017, net realized gains on securities in the 2018 period compared to the net realized losses on securities in the 2017 period and a loss on retirement of debt in the third quarter of 2017. Core net operating earnings increased $103 million in the third quarter of 2018 compared to the same period in 2017, reflecting higher earnings in the annuity segment, higher underwriting profit in the property and casualty segment due primarily to lower catastrophe losses, higher net realized gainsinvestment income in the property and casualty insurance segment, lower interest charges on borrowed money and a lower corporate

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AMERICAN FINANCIAL GROUP, INC. 10-Q
Management’s Discussion and Analysis of Financial Condition and Results of Operations — Continued


the 2016 period. Core net operating earnings decreased $39 millionincome tax rate. Realized gains on securities in the third quarter of 2018 includes the increase in fair value of equity securities that are required to be carried at fair value through net earnings under new accounting guidance adopted on January 1, 2018.2017

Net earnings attributable to shareholders increased $250 million in the first nine months of 2018 compared to the same period in 20162017 due primarily to higher core net operating earnings, lower special A&E charges in the 2018 period compared to the 2017 period and a loss on retirement of debt in the 2017 period, partially offset by higher net realized losses on securities in the 2018 period compared to the 2017 period. Core net operating earnings increased $211 million in the first nine months of 2018 compared to the same period in 2017, reflecting lowerhigher earnings in the annuity segment, higher underwriting profit in the property and casualty insurance segment due primarily to lower catastrophe losses from Hurricanes Harvey, Irma and Maria and two earthquakes in Mexico.

Net earnings attributable to shareholders increased $45 million in the first nine months of 2017 compared to the same period in 2016 due primarily to lower net realized losses on securities in the 2017 period compared to the 2016 period, a charge related to the exit of certain lines of business within Neon in the second quarter of 2016 and higher core net operating earnings. These results were partially offset by higher special A&E charges recorded in the 2017 period compared to the 2016 period, the impact of the gain on the sale of an apartment property in the second quarter of 2016 and losses on the retirement of debt in the 2017 period. Core net operating earnings increased $33 million in the first nine months of 2017 compared to the same period in 2016 reflecting higher earnings in the annuity segment andfavorable prior year reserve development, higher net investment income in the property and casualty insurance segment, partially offset by lower underwriting profitinterest charges on borrowed money, a lower corporate income tax rate and a loss on retirement of debt in the property and casualty insurance segment due primarily2017 period. Realized losses on securities in the first nine months of 2018 includes the decline in fair value of equity securities that are required to catastrophe losses from Hurricanes Harvey, Irma and Maria and two earthquakes in Mexico.be carried at fair value through net earnings under new accounting guidance adopted on January 1, 2018.


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AMERICAN FINANCIAL GROUP, INC. 10-Q
Management’s Discussion and Analysis of Financial Condition and Results of Operations — Continued


RESULTS OF OPERATIONS — QUARTERS ENDED SEPTEMBER 30, 20172018 AND 20162017

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

Effective January 1, 2018, the results of AFG’s run-off long-term care and life businesses are included in the “Other” segment instead of as a separate reportable segment based on the immaterial size of the remaining operations. Prior periods amounts were reclassified for consistent presentation.

AFG’s net earnings attributable to shareholders, determined in accordance with GAAP, include certain items that may not be indicative of its ongoing core operations. The following tables for the three months ended September 30, 20172018 and 20162017 identify such items by segment and reconcile net earnings attributable to shareholders to core net operating earnings, a non-GAAP financial measure that AFG believes is a useful tool for investors and analysts in analyzing ongoing operating trends (in millions):
      Other          Other      
P&C Annuity Run-off long-term care and life Consol. MIEs Holding Co., other and unallocated Total Non-core reclass GAAP TotalP&C Annuity Consol. MIEs Holding Co., other and unallocated Total Non-core reclass GAAP Total
Three months ended September 30, 2017               
Three months ended September 30, 2018             
Revenues:                            
Property and casualty insurance net earned premiums$1,267
 $
 $
 $
 $
 $1,267
 $
 $1,267
$1,327
 $
 $
 $
 $1,327
 $
 $1,327
Life, accident and health net earned premiums
 
 6
 
 
 6
 
 6

 
 
 6
 6
 
 6
Net investment income94
 375
 6
 (5) 1
 471
 
 471
108
 413
 (4) 10
 527
 
 527
Realized losses on securities
 
 
 
 
 
 (12) (12)
Income of MIEs:               
Realized gains on securities
 
 
 
 
 34
 34
Income (loss) of MIEs:             
Investment income
 
 
 54
 
 54
 
 54

 
 65
 
 65
 
 65
Gain on change in fair value of assets/liabilities
 
 
 1
 
 1
 
 1
Gain (loss) on change in fair value of assets/liabilities
 
 (5) 
 (5) 
 (5)
Other income1
 26
 
 (5) 26
 48
 
 48
4
 27
 (4) 27
 54
 
 54
Total revenues1,362
 401
 12
 45
 27
 1,847
 (12) 1,835
1,439
 440
 52
 43
 1,974
 34
 2,008
                            
Costs and Expenses:                            
Property and casualty insurance:                            
Losses and loss adjustment expenses906
 
 
 
 
 906
 89
 995
854
 
 
 
 854
 18
 872
Commissions and other underwriting expenses353
 
 
 
 4
 357
 
 357
417
 
 
 7
 424
 
 424
Annuity benefits
 215
 
 
 
 215
 
 215

 222
 
 
 222
 
 222
Life, accident and health benefits
 
 6
 
 
 6
 
 6

 
 
 10
 10
 
 10
Annuity and supplemental insurance acquisition expenses
 54
 1
 
 
 55
 
 55

 69
 
 2
 71
 
 71
Interest charges on borrowed money
 
 
 
 21
 21
 
 21

 
 
 15
 15
 
 15
Expenses of MIEs
 
 
 45
 
 45
 
 45

 
 52
 
 52
 
 52
Other expenses8
 30
 3
 
 43
 84
 28
 112
11
 32
 
 46
 89
 9
 98
Total costs and expenses1,267
 299
 10
 45
 68
 1,689
 117
 1,806
1,282
 323
 52
 80
 1,737
 27
 1,764
Earnings before income taxes95
 102
 2
 
 (41) 158
 (129) 29
157
 117
 
 (37) 237
 7
 244
Provision for income taxes43
 34
 1
 
 (15) 63
 (45) 18
26
 19
 
 (5) 40
 1
 41
Net earnings, including noncontrolling interests52
 68
 1
 
 (26) 95
 (84) 11
131
 98
 
 (32) 197
 6
 203
Less: Net earnings attributable to noncontrolling interests
 
 
 
 
 
 
 
Less: Net loss attributable to noncontrolling interests(1) 
 
 
 (1) 
 (1)
Core Net Operating Earnings52
 68
 1
 
 (26) 95
    132
 98
 
 (32) 198
    
Non-core earnings attributable to shareholders (a):                            
Realized losses on securities, net of tax
 
 
 
 (8) (8) 8
 
Realized gains on securities, net of tax
 
 
 27
 27
 (27) 
Special A&E charges, net of tax

(58) 
 
 
 (16) (74) 74
 
(14) 
 
 (7) (21) 21
 
Loss on retirement of debt, net of tax
 
 
 
 (2) (2) 2
 
Net Earnings Attributable to Shareholders$(6) $68
 $1
 $
 $(52) $11
 $
 $11
$118
 $98
 $
 $(12) $204
 $
 $204

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AMERICAN FINANCIAL GROUP, INC. 10-Q
Management’s Discussion and Analysis of Financial Condition and Results of Operations — Continued


 Other       Other      
P&C Annuity Run-off long-term care and life Consol. MIEs Holding Co., other and unallocated Total Non-core reclass GAAP TotalP&C Annuity Consol. MIEs Holding Co., other and unallocated Total Non-core reclass GAAP Total
Three months ended September 30, 2016               
Three months ended September 30, 2017             
Revenues:                            
Property and casualty insurance net earned premiums$1,159
 $
 $
 $
 $
 $1,159
 $
 $1,159
$1,267
 $
 $
 $
 $1,267
 $
 $1,267
Life, accident and health net earned premiums
 
 6
 
 
 6
 
 6

 
 
 6
 6
 
 6
Net investment income93
 351
 5
 (17) 1
 433
 
 433
94
 375
 (5) 7
 471
 
 471
Realized gains on securities
 
 
 
 
 
 2
 2
Income of MIEs:               
Realized losses on securities
 
 
 
 
 (12) (12)
Income (loss) of MIEs:             
Investment income
 
 
 48
 
 48
 
 48

 
 54
 
 54
 
 54
Gain on change in fair value of assets/liabilities
 
 
 11
 
 11
 
 11
Gain (loss) on change in fair value of assets/liabilities
 
 1
 
 1
 
 1
Other income3
 26
 2
 (4) 19
 46
 
 46
1
 26
 (5) 26
 48
 
 48
Total revenues1,255
 377
 13
 38
 20
 1,703
 2
 1,705
1,362
 401
 45
 39
 1,847
 (12) 1,835
                            
Costs and Expenses:                            
Property and casualty insurance:                            
Losses and loss adjustment expenses729
 
 
 
 
 729
 36
 765
906
 
 
 
 906
 89
 995
Commissions and other underwriting expenses352
 
 
 
 4
 356
 
 356
353
 
 
 4
 357
 
 357
Annuity benefits
 189
 
 
 
 189
 
 189

 215
 
 
 215
 
 215
Life, accident and health benefits
 
 8
 
 
 8
 
 8

 
 
 6
 6
 
 6
Annuity and supplemental insurance acquisition expenses
 53
 1
 
 
 54
 
 54

 54
 
 1
 55
 
 55
Interest charges on borrowed money
 
 
 
 19
 19
 
 19

 
 
 21
 21
 
 21
Expenses of MIEs
 
 
 38
 
 38
 
 38

 
 45
 
 45
 
 45
Other expenses17
 28
 3
 
 45
 93
 5
 98
8
 30
 
 46
 84
 28
 112
Total costs and expenses1,098
 270
 12
 38
 68
 1,486
 41
 1,527
1,267
 299
 45
 78
 1,689
 117
 1,806
Earnings before income taxes157
 107
 1
 
 (48) 217
 (39) 178
95
 102
 
 (39) 158
 (129) 29
Provision for income taxes59
 38
 
 
 (18) 79
 (14) 65
43
 34
 
 (14) 63
 (45) 18
Net earnings, including noncontrolling interests98
 69
 1
 
 (30) 138
 (25) 113
52
 68
 
 (25) 95
 (84) 11
Less: Net earnings attributable to noncontrolling interests4
 
 
 
 
 4
 
 4

 
 
 
 
 
 
Core Net Operating Earnings94
 69
 1
 
 (30) 134
    52
 68
 
 (25) 95
    
Non-core earnings attributable to shareholders (a):                            
Realized gains on securities, net of tax and noncontrolling interests
 
 
 
 1
 1
 (1) 
Realized losses on securities, net of tax
 
 
 (8) (8) 8
 
Special A&E charges, net of tax(23) 
 
 
 (3) (26) 26
 
(58) 
 
 (16) (74) 74
 
Loss on retirement of debt, net of tax
 
 
 (2) (2) 2
 
Net Earnings Attributable to Shareholders$71
 $69
 $1
 $
 $(32) $109
 $
 $109
$(6) $68
 $
 $(51) $11
 $
 $11

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

Property and Casualty Insurance Segment — Results of Operations   Performance measures such as underwriting profit or loss and related combined ratios are often used by property and casualty insurers to help users of their financial statements better understand the company’s performance. Underwriting profitability is measured by the combined ratio, which is a sum of the ratios of losses and loss adjustment expenses, and commissions and other underwriting expenses to premiums. A combined ratio under 100% indicates an underwriting profit. The combined ratio does not reflect net investment income, other income, other expenses or federal income taxes.

AFG’s property and casualty insurance operations contributed $6$139 million in GAAP pretax earnings in the third quarter of 20172018 compared to $121$6 million in the third quarter of 2017, an increase of $133 million (2,217%). Property and casualty core pretax earnings were $157 million in the third quarter of 2016, a decrease of $115 million (95%). Property and casualty core pretax earnings were2018 compared to $95 million in the third quarter of 2017, compared to $157 million in the third quarter of 2016, a decreasean increase of $62 million (39%(65%). The decreaseincrease in GAAP and core pretax earnings reflects lowerhigher underwriting resultsprofit due primarily to higherlower catastrophe losses from Hurricanes Harvey, Irma and Maria and two earthquakes in Mexico inthe third quarter of 2018 compared to the third quarter of 2017. The2017 and higher net investment income

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AMERICAN FINANCIAL GROUP, INC. 10-Q
Management’s Discussion and Analysis of Financial Condition and Results of Operations — Continued


decreasereflecting higher earnings from limited partnerships and similar investments. The high returns from limited partnerships and similar investments should not necessarily be expected to repeat in future periods. The increase in GAAP pretax earnings also reflects higherlower special A&E charges in the third quarter of 20172018 compared to the third quarter of 2016.2017.

The following table details AFG’s earnings before income taxes from its property and casualty insurance operations for the three months ended September 30, 20172018 and 20162017 (dollars in millions):
Three months ended September 30,  Three months ended September 30,  
2017 2016 % Change2018 2017 % Change
Gross written premiums$2,104
 $1,899
 11%$2,104
 $2,104
 %
Reinsurance premiums ceded(671) (631) 6%(648) (671) (3%)
Net written premiums1,433
 1,268
 13%1,456
 1,433
 2%
Change in unearned premiums(166) (109) 52%(129) (166) (22%)
Net earned premiums1,267
 1,159
 9%1,327
 1,267
 5%
Loss and loss adjustment expenses (*)906
 729
 24%854
 906
 (6%)
Commissions and other underwriting expenses353
 352
 %417
 353
 18%
Core underwriting gain8
 78
 (90%)56
 8
 600%
    

    

Net investment income94
 93
 1%108
 94
 15%
Other income and expenses, net(7) (14) (50%)(7) (7) %
Core earnings before income taxes95
 157
 (39%)157
 95
 65%
Pretax non-core special A&E charges(89) (36) 147%(18) (89) (80%)
GAAP earnings before income taxes$6
 $121
 (95%)$139
 $6
 2,217%
          
(*) Excludes pretax non-core special A&E charges of $89 million and $36 million in the third quarter of 2017 and 2016, respectively.
(*) Excludes pretax non-core special A&E charges of $18 million and $89 million in the third quarter of 2018 and 2017, respectively.(*) Excludes pretax non-core special A&E charges of $18 million and $89 million in the third quarter of 2018 and 2017, respectively.
          
          
Combined Ratios:          
Specialty lines    Change    Change
Loss and LAE ratio71.4% 62.9% 8.5%64.3% 71.4% (7.1%)
Underwriting expense ratio27.9% 30.3% (2.4%)31.4% 27.9% 3.5%
Combined ratio99.3% 93.2% 6.1%95.7% 99.3% (3.6%)
          
Aggregate — including exited lines          
Loss and LAE ratio78.5% 66.0% 12.5%65.8% 78.5% (12.7%)
Underwriting expense ratio27.9% 30.3% (2.4%)31.4% 27.9% 3.5%
Combined ratio106.4% 96.3% 10.1%97.2% 106.4% (9.2%)

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

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


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AMERICAN FINANCIAL GROUP, INC. 10-Q
Management’s Discussion and Analysis of Financial Condition and Results of Operations — Continued


Gross Written Premiums
Gross written premiums (“GWP”) for AFG’s property and casualty insurance segment were $2.10 billion for both the third quarter of 2018 and the third quarter of 2017 compared to $1.90 billion for the third quarter of 2016, an increase of $205 million (11%). Detail of AFG’s property and casualty gross written premiums is shown below (dollars in millions):
Three months ended September 30,  Three months ended September 30,  
2017 2016  2018 2017  
GWP % GWP % % ChangeGWP % GWP % % Change
Property and transportation$1,073
 51% $991
 52% 8%$953
 45% $1,073
 51% (11%)
Specialty casualty850
 40% 722
 38% 18%956
 46% 850
 40% 12%
Specialty financial181
 9% 186
 10% (3%)195
 9% 181
 9% 8%
$2,104
 100% $1,899
 100% 11%$2,104
 100% $2,104
 100% %

Reinsurance Premiums Ceded
Reinsurance premiums ceded (“Ceded”) for AFG’s property and casualty insurance segment were 32%31% of gross written premiums for the third quarter of 20172018 compared to 33%32% of gross written premiums for the third quarter of 2016,2017, a decrease of 1 percentage point. Detail of AFG’s property and casualty reinsurance premiums ceded is shown below (dollars in millions):
Three months ended September 30,  Three months ended September 30,  
2017 2016 Change in2018 2017 Change in
Ceded % of GWP Ceded % of GWP % of GWPCeded % of GWP Ceded % of GWP % of GWP
Property and transportation$(449) 42% $(406) 41% 1%$(393) 41% $(449) 42% (1%)
Specialty casualty(226) 27% (218) 30% (3%)(261) 27% (226) 27% %
Specialty financial(31) 17% (37) 20% (3%)(42) 22% (31) 17% 5%
Other specialty35
   30
    48
   35
    
$(671) 32% $(631) 33% (1%)$(648) 31% $(671) 32% (1%)

Net Written Premiums
Net written premiums (“NWP”) for AFG’s property and casualty insurance segment were $1.46 billion for the third quarter of 2018 compared to $1.43 billion for the third quarter of 2017 compared to $1.27 billion for the third quarter of 2016, an increase of $16523 million (13%2%). Detail of AFG’s property and casualty net written premiums is shown below (dollars in millions):
Three months ended September 30,  Three months ended September 30,  
2017 2016  2018 2017  
NWP % NWP % % ChangeNWP % NWP % % Change
Property and transportation$624
 44% $585
 46% 7%$560
 38% $624
 44% (10%)
Specialty casualty624
 44% 504
 40% 24%695
 48% 624
 44% 11%
Specialty financial150
 10% 149
 12% 1%153
 11% 150
 10% 2%
Other specialty35
 2% 30
 2% 17%48
 3% 35
 2% 37%
$1,433
 100% $1,268
 100% 13%$1,456
 100% $1,433
 100% 2%


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


Net Earned Premiums
Net earned premiums (“NEP”) for AFG’s property and casualty insurance segment were $1.33 billion for the third quarter of 2018 compared to $1.27 billion for the third quarter of 2017 compared to $1.16 billion for the third quarter of 2016, an increase of $10860 million (9%5%). Detail of AFG’s property and casualty net earned premiums is shown below (dollars in millions):
Three months ended September 30,  Three months ended September 30,  
2017 2016  2018 2017  
NEP % NEP % % ChangeNEP % NEP % % Change
Property and transportation$527
 42% $493
 43% 7%$526
 40% $527
 42% %
Specialty casualty568
 45% 497
 43% 14%616
 46% 568
 45% 8%
Specialty financial142
 11% 145
 12% (2%)149
 11% 142
 11% 5%
Other specialty30
 2% 24
 2% 25%36
 3% 30
 2% 20%
$1,267
 100% $1,159
 100% 9%$1,327
 100% $1,267
 100% 5%

The $205 million (11%) increase in grossGross written premiums were flat for the third quarter of 20172018 compared to the third quarter of 2016 reflects2017 reflecting growth in the Specialty casualty and Specialty financial sub-segments, offset by lower gross written premiums in the Property and transportation and Specialty casualty sub-segments.sub-segment. Overall average renewal rates increased approximately 1%2% in the third quarter of 2017.2018. Excluding the workers’ compensation business, renewal pricing increased approximately 3%.

Property and transportation Gross written premiums increased $82decreased $120 million (8%(11%) in the third quarter of 20172018 compared to the third quarter of 2016.2017. This increasedecrease was largely the result of higher grossa change in the timing of two large policy renewals in one of the transportation businesses from the third quarter to the fourth quarter, as well as lower year-over-year premiums in the crop insurance business. Gross written premiums in the agricultural and transportation businesses. This growth was partially offsetother businesses in this group grew by lower premiums resulting from an exit from6% in the customs bond business, which was partthird quarter of 2018 compared to the ocean marine operations.third quarter of 2017. Average renewal rates increased approximately 2%3% for this group in the third quarter of 2017.2018. Reinsurance premiums ceded as a percentage of gross written premiums increaseddecreased 1 percentage point reflectingfor the impactthird quarter of reinstatement premiums resulting from reinsured hurricane losses.2018 compared to the third quarter of 2017.

Specialty casualty Gross written premiums increased $128106 million (18%12%) in the third quarter of 20172018 compared to the third quarter of 2016. New accounts written in the targeted markets businesses were the primary driver of the increase. Additionally, higher2017 due primarily to growth at Neon. Higher gross written premiums in the workers’ compensation businesses, primarily the result of rate increases in the state of Florida, and higher premiums in the executive liability and excess and surplus lines businesses and Neon,also contributed to the year-over-year growth. Average renewal rates increased approximately 1% for this group in the third quarter of 2017.2018. Excluding the workers’ compensation businesses, renewal rates for this group increased approximately 2%. Reinsurance premiums ceded as a percentage of gross written premiums decreased 3 percentage points forwere comparable in the third quarter of 20172018 compared to the third quarter of 2016,2017 reflecting higher cessions to AFG’s internal reinsurance program, which is included in Other specialty and higher cessions in the prior yearworkers’ compensation businesses, offset by lower reinstatement premiums resulting from reinsured hurricane losses in the 2018 period as a result ofcompared to the timing of reinsurance agreements at Neon.2017 period.

Specialty financial Gross written premiums decreasedincreased $514 million (3%8%) in the third quarter of 20172018 compared to the third quarter of 20162017 due primarily to lower gross writtenhigher premiums in the financial institutions business, partially offset by higher premiums in the surety business. Average renewal rates for this group decreasedincreased approximately 1%6% in the third quarter of 2017.2018. Reinsurance premiums ceded as a percentage of gross written premiums decreased 3increased 5 percentage points for the third quarter of 20172018 compared to the third quarter of 2016,2017, reflecting lower premiumshigher cessions in the financial institutions business, which were largely ceded, partially offset byand equipment leasing businesses and the impact of reinstatement premiums in the third quarter of 2018 resulting from a reinsured hurricane losses.loss in the fidelity business.

Other specialty The amounts shown as reinsurance premiums ceded represent business assumed by AFG’s internal reinsurance program from the operations that make up AFG’s other Specialty property and casualty insurance sub-segments. Reinsurance premiums assumed increased $13 million (37%) in the third quarter of 2018 compared to the third quarter of 2017, reflecting an increase in premiums retained, primarily from businesses in the Specialty casualty sub-segment.


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AMERICAN FINANCIAL GROUP, INC. 10-Q
Management’s Discussion and Analysis of Financial Condition and Results of Operations — Continued


Combined Ratio
The table below (dollars in millions) details the components of the combined ratio for AFG’s property and casualty segment:
Three months ended September 30,   Three months ended September 30,Three months ended September 30,   Three months ended September 30,
2017 2016 Change 2017 20162018 2017 Change 2018 2017
Property and transportation                  
Loss and LAE ratio77.3% 68.8% 8.5%    77.1% 77.3% (0.2%)    
Underwriting expense ratio21.6% 22.3% (0.7%)    22.9% 21.6% 1.3%    
Combined ratio98.9% 91.1% 7.8%    100.0% 98.9% 1.1%    
Underwriting profit      $6
 $44
Underwriting profit (loss)      $
 $6
                  
Specialty casualty                  
Loss and LAE ratio70.7% 66.5% 4.2%    59.2% 70.7% (11.5%)    
Underwriting expense ratio28.8% 30.9% (2.1%)    32.9% 28.8% 4.1%    
Combined ratio99.5% 97.4% 2.1%    92.1% 99.5% (7.4%)    
Underwriting profit      $2
 $13
      $49
 $2
                  
Specialty financial                  
Loss and LAE ratio56.0% 31.6% 24.4%    40.1% 56.0% (15.9%)    
Underwriting expense ratio46.2% 54.8% (8.6%)    54.3% 46.2% 8.1%    
Combined ratio102.2% 86.4% 15.8%    94.4% 102.2% (7.8%)    
Underwriting profit (loss)      $(3) $19
      $9
 $(3)
                  
Total Specialty                  
Loss and LAE ratio71.4% 62.9% 8.5%    64.3% 71.4% (7.1%)    
Underwriting expense ratio27.9% 30.3% (2.4%)    31.4% 27.9% 3.5%    
Combined ratio99.3% 93.2% 6.1%    95.7% 99.3% (3.6%)    
Underwriting profit      $9
 $78
      $55
 $9
                  
Aggregate — including exited lines                  
Loss and LAE ratio78.5% 66.0% 12.5%    65.8% 78.5% (12.7%)    
Underwriting expense ratio27.9% 30.3% (2.4%)    31.4% 27.9% 3.5%    
Combined ratio106.4% 96.3% 10.1%    97.2% 106.4% (9.2%)    
Underwriting profit (loss)      $(81) $42
      $38
 $(81)

The Specialty property and casualty insurance operations generated an underwriting profit of $955 million in the third quarter of 20172018 compared to $78$9 million in the third quarter of 2016, a decrease2017, an increase of $69$46 million (88% (511%). The lowerhigher underwriting profit in the third quarter of 20172018 reflects lowerhigher underwriting profitprofits in each of the Specialty propertycasualty and casualty insuranceSpecialty financial sub-segments due primarily to significantly higherlower catastrophe losses. Overall catastrophe losses were $107$35 million (8.4(2.6 points on the combined ratio) for the third quarter of 20172018 compared to $14$107 million (1.2(8.4 points) for the third quarter of 2016.2017. In connection with catastrophe losses incurred in the third quarter of 2018, AFG paid $3 million in net reinstatement premiums, resulting in a total pretax loss from catastrophes of $38 million for the quarter. In connection with catastrophe losses incurred in the third quarter of 2017, AFG reduced profit-based commissions payable to agents by $8 million in the Specialty financial sub-segment and paid $6 million in net reinstatement premiums, resulting in a total pretax loss from catastrophes of $105 million for the quarter.

Property and transportation Underwriting profit for thisThis group was $6reported an underwriting loss of less than $1 million for the third quarter of 20172018 compared to $44an underwriting profit of $6 million in the third quarter of 2016,2017, a decrease of $38$6 million (86%(100%). LowerImproved underwriting profitsresults in the crop, property and inland marine and ocean marine businessesoperations and higher underwriting profit at National Interstate were the primary drivers of theseoffset by lower results. The comparable 2016 quarter included strong profitability in the crop business.several other businesses in this group. Catastrophe losses were $23$12 million (4.4(2.3 points on the combined ratio) and related reinstatement premiums paid were $1 million for the third quarter of 2018 compared to catastrophe losses of $23 million (4.4 points) and related reinstatement premiums of $2 million for the third quarter of 2017 compared to catastrophe losses of $7 million (1.6 points) for the third quarter of 2016.2017.

Specialty casualty Underwriting profit for this group was $249 million for the third quarter of 20172018 compared to $13$2 million in for the third quarter of 2016, a decrease2017, an increase of $11$47 million (85% (2,350%). Improved underwriting results, reflecting lower catastrophe losses at Neon and higher profitability in the excess and surplus lines, targeted markets, workers’ compensation and professionalexecutive liability businesses were more than offset by lower underwriting profitability at Neon, due primarily to catastrophe losses.business. Catastrophe losses were $54$11 million (9.5(1.7 points on the combined ratio) and

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AMERICAN FINANCIAL GROUP, INC. 10-Q
Management’s Discussion and Analysis of Financial Condition and Results of Operations — Continued


ratio) and related net reinstatement premiums paid were $1 million for the third quarter of 2018 compared to catastrophe losses of $54 million (9.5 points) and related reinstatement premiums of $2 million for the third quarter of 2017 compared to catastrophe losses of $2 million (0.3 points) for the third quarter of 2016.2017.

Specialty financial This group reported an underwriting lossprofit of $39 million for the third quarter of 20172018 compared to an underwriting profitloss of $19$3 million in the third quarter of 2016, a decrease2017, an improvement of $22$12 million (116%(400%) due primarily to. Lower year-over-year catastrophe losses in the lender-placed mortgage property insurance business.book within the financial institutions business and higher underwriting profit in the surety business contributed to these improved results. Catastrophe losses were $29$12 million (20.4(8.0 points on the combined ratio) for the third quarter of 20172018 compared to $5$29 million (3.3(20.4 points) for the third quarter of 2016.2017. In connection with catastrophe losses incurred in the third quarter of 2017,2018, the Specialty financial sub-segment reducedpaid $1 million in reinstatement premiums compared to a reduction of profit-based commissions payable to agents byof $8 million (5.6 points favorable on the combined ratio) and paidreinstatement premiums of $2 million in reinstatement premiums.the third quarter of 2017.

Other specialty This group reported an underwriting loss of $3 million in the third quarter of 2018 compared to an underwriting profit of $4 million in the third quarter of 2017 compared. This decrease is due primarily to $2 millionlosses in the third quarter of 2016. This increase is due primarily to favorable prior year reserve development in the third quarter of 20172018 in the business assumed by AFG’s internal reinsurance program from the operations that make up AFG’s other Specialty sub-segments.sub-segments compared to earnings in the third quarter of 2017.

Aggregate As discussed below in more detail under Net prior year reserve development,” AFG recorded special charges to increase property and casualty A&E reserves by $18 million in the third quarter of 2018 and $89 million in the third quarter of 2017 and $36 million in the third quarter of 2016.2017.


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AMERICAN FINANCIAL GROUP, INC. 10-Q
Management’s Discussion and Analysis of Financial Condition and Results of Operations — Continued


Losses and Loss Adjustment Expenses
AFG’s overall loss and LAE ratio was 78.5%65.8% for the third quarter of 20172018 compared to 66.0%78.5% for the third quarter of 20162017, an increasea decrease of 12.512.7 percentage points. The components of AFG’s property and casualty losses and LAE amounts and ratio are detailed below (dollars in millions):
Three months ended September 30,  Three months ended September 30,  
Amount Ratio Change inAmount Ratio Change in
2017 2016 2017 2016 Ratio2018 2017 2018 2017 Ratio
Property and transportation                  
Current year, excluding catastrophe losses$392
 $337
 74.4% 68.4% 6.0%$398
 $392
 75.6% 74.4% 1.2%
Prior accident years development(8) (5) (1.5%) (1.2%) (0.3%)(4) (8) (0.8%) (1.5%) 0.7%
Current year catastrophe losses23
 7
 4.4% 1.6% 2.8%12
 23
 2.3% 4.4% (2.1%)
Property and transportation losses and LAE and ratio$407
 $339
 77.3% 68.8% 8.5%$406
 $407
 77.1% 77.3% (0.2%)
                  
Specialty casualty                  
Current year, excluding catastrophe losses$371
 $330
 65.2% 66.5% (1.3%)$390
 $371
 63.5% 65.2% (1.7%)
Prior accident years development(23) (2) (4.0%) (0.3%) (3.7%)(37) (23) (6.0%) (4.0%) (2.0%)
Current year catastrophe losses54
 2
 9.5% 0.3% 9.2%11
 54
 1.7% 9.5% (7.8%)
Specialty casualty losses and LAE and ratio$402
 $330
 70.7% 66.5% 4.2%$364
 $402
 59.2% 70.7% (11.5%)
                  
Specialty financial                  
Current year, excluding catastrophe losses$55
 $46
 38.7% 32.2% 6.5%$56
 $55
 37.2% 38.7% (1.5%)
Prior accident years development(5) (6) (3.1%) (3.9%) 0.8%(8) (5) (5.1%) (3.1%) (2.0%)
Current year catastrophe losses29
 5
 20.4% 3.3% 17.1%12
 29
 8.0% 20.4% (12.4%)
Specialty financial losses and LAE and ratio$79
 $45
 56.0% 31.6% 24.4%$60
 $79
 40.1% 56.0% (15.9%)
                  
Total Specialty                  
Current year, excluding catastrophe losses$836
 $729
 65.9% 62.8% 3.1%$869
 $836
 65.4% 65.9% (0.5%)
Prior accident years development(38) (14) (2.9%) (1.1%) (1.8%)(49) (38) (3.7%) (2.9%) (0.8%)
Current year catastrophe losses107
 14
 8.4% 1.2% 7.2%35
 107
 2.6% 8.4% (5.8%)
Total Specialty losses and LAE and ratio$905
 $729
 71.4% 62.9% 8.5%$855
 $905
 64.3% 71.4% (7.1%)
                  
Aggregate — including exited lines                  
Current year, excluding catastrophe losses$836
 $729
 65.9% 62.8% 3.1%$868
 $836
 65.4% 65.9% (0.5%)
Prior accident years development52
 22
 4.2% 2.0% 2.2%(31) 52
 (2.2%) 4.2% (6.4%)
Current year catastrophe losses107
 14
 8.4% 1.2% 7.2%35
 107
 2.6% 8.4% (5.8%)
Aggregate losses and LAE and ratio$995
 $765
 78.5% 66.0% 12.5%$872
 $995
 65.8% 78.5% (12.7%)

Current accident year losses and LAE, excluding catastrophe losses
The current accident year loss and LAE ratio, excluding catastrophe losses for AFG’s Specialty property and casualty insurance operations was 65.4% for the third quarter of 2018 compared to 65.9% for the third quarter of 2017 compared to 62.8% for the third quarter, a decrease of 2016, an increase of 3.10.5 percentage points.

Property and transportation   The 6.01.2 percentage point increase in the loss and LAE ratio for the current year, excluding catastrophe losses reflects an increase in the loss and LAE ratio in the crop business forequine and aviation businesses and the Singapore branch in the third quarter of 20172018 compared to the third quarter of 2016.2017.

Specialty casualty   The 1.31.7 percentage point decrease in the loss and LAE ratio for the current year, excluding catastrophe losses reflects a decrease in the loss and LAE ratio in the executive liability business and at Neon, partially offset by an increase in the loss and LAE ratio in the public sectortargeted markets business.


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AMERICAN FINANCIAL GROUP, INC. 10-Q
Management’s Discussion and Analysis of Financial Condition and Results of Operations — Continued


Specialty financial The 6.51.5 percentage point increasedecrease in the loss and LAE ratio for the current year, excluding catastrophe losses reflects an increasea decrease in the loss and LAE ratio of the financial institutions business.

Net prior year reserve development
AFG’s Specialty property and casualty insurance operations recorded net favorable reserve development related to prior accident years of $3849 million in the third quarter of 20172018 compared to $14$38 million in the third quarter of 2016,2017, an increase of $24$11 million (171%(29%).

Property and transportation Net favorable reserve development of $84 million in the third quarter of 20172018 reflects lower than expected claims severity at National Interstate, lower than expected losses in the crop business and lower than expected claim frequency and severity in the property and inland marine business, partially offset by higher than expected losses in the Singapore branch and aviation operations. Net favorable reserve development of $8 million in the third quarter of 2017 reflects lower than anticipated claim severity in the transportation businesses and lower than expected losses in the crop and equine businesses.

Specialty casualty Net favorable reserve development of $5$37 million in the third quarter of 20162018 reflects lower than anticipated claim severity in the workers’ compensation businesses, and to a lesser extent, lower than expected claim severity in the trucking business.

Specialty casualtytargeted markets and executive liability businesses. This was partially offset by higher than expected claim frequency and severity in the excess and surplus lines. Net favorable reserve development of $23 million in the third quarter of 2017 reflects lower than anticipated claim severity in the workers’ compensation businesses and at Neon, partially offset by higher than anticipated claim severity in the general liability business.

Specialty financial Net favorable reserve development of $2$8 million in the third quarter of 20162018 reflects lower than anticipatedexpected claim severityfrequency and frequencyseverity in the workers’ compensation businessessurety business and lower than anticipated claim severity in directors and officers liability insurance, partially offset by higher than anticipated severity in New York contractor claims, adverse reserve development at Neon and higher than anticipated claim severity in general liability insurance.

Specialty financial the fidelity business. Net favorable reserve development of $5 million in the third quarter of 2017 reflects lower than anticipated claim severity in the fidelity and trade credit businesses. Net favorable reserve development of $6 million in the third quarter of 2016 reflects lower than anticipated claim severity in the fidelity business and lower than expected claim frequency and severity in the surety business.

Other specialty In addition to the development discussed above, total Specialty prior year reserve development includes net favorable reserve development of $2 million in the third quarter of 2017 and $1 million in the third quarter of 2016,2018 and 2017, reflecting amortization of the deferred gaingains on the retroactive reinsurance transactiontransactions entered into in connection with the sale of businesses in 1998 and 2001 and2001. In addition, the third quarter of 2018 includes $2 million of adverse reserve development associated with AFG’s internal reinsurance program.

Special asbestos and environmental reserve charges During the third quarter of 2017,2018, AFG completed a comprehensive external studyan in-depth internal review of its asbestos and environmental exposures relating to the run-off operations of its property and casualty insurance segment and its exposures related to former railroad and manufacturing operations and sites. In addition to its ongoing internal monitoring of asbestos and environmental exposures, AFG has periodically conducted comprehensive external studies of its asbestos and environmental reserves with the aid of specialty actuarial, engineering and consulting firms and outside counsel, generally every two years in recent periods, with an in-depth internal review during the intervening years. AFG is currently evaluating the frequency of future external studies.
As a result of the 2017 external study,2018 internal review, AFG’s property and casualty insurance segment recorded an $89$18 million pretax special charge to increase its asbestos reserves by $53$6 million (net of reinsurance) and its environmental reserves by $36$12 million (net of reinsurance). Over the past few years, the focus of AFG’s asbestos claims litigation has shifted to smaller companies and companies with ancillary exposures. AFG’s insureds with these exposures have been the driver of the property and casualty segment’s asbestos reserve increases in recent years. AFG is seeing modestly increasing estimates for indemnity and defense compared to prior studies. Overall, the rate of new asbestos cases received is down modestly, however, increasing life expectancies in the U.S. have allowed more time for the impacts of asbestos exposure to emerge. AFG’s comprehensive external study incorporates, among other factors, the increase in projected industry ultimate losses attributable to asbestos exposures, as well as revised estimates for future claims emergence, which has resulted in an increase in AFG’s provision for future asbestosstudies on certain specific open claims.

The increase in property and casualty environmental reserves was primarily associated with updated estimates of site investigation and remedial costs with respect to existing sites and newly identified sites. AFG is seeing increasedhas updated its view of legal defense costs inon open environmental claims generally, as well as a number of claims and sites where the estimated investigation and remediation costs have increased. Certain individual claims are taking a longer time to settle than originally estimated, causing AFG to increase its reserves to reflect related increased costs. As in past years, there were no new or emerging broad industry trends that were identified in this study.review.


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


At September 30, 2017,2018, the property and casualty insurance segment’s insurance reserves include A&E reserves of $408$398 million, net of reinsurance recoverables. At September 30, 2017,2018, the property and casualty insurance segment’s three-year survival ratios compare favorably with industry survival ratios published by S&P Global Market Intelligence (as of December 31, 2016)2017) as detailed in the following table:
 Property and Casualty Insurance Reserves
 Three-Year Survival Ratio (% Times Paid Losses)
 Asbestos Environmental Total A&E
AFG (9/30/2017)17.5
 11.8
 14.6
Industry (12/31/2016)6.2
 7.1
 6.4
 Property and Casualty Insurance Reserves
 Three-Year Survival Ratio (% Times Paid Losses)
 Asbestos Environmental Total A&E
AFG (9/30/2018)19.0
 11.4
 15.0
Industry (12/31/2017)6.7
 6.7
 6.7

In addition, the 2017 external study2018 internal review encompassed reserves for asbestos and environmental exposures of AFG’s former railroad and manufacturing operations. For a discussion of the $24$9 million pretax special charge recorded for those operations, see “Results of Operations — Holding Company, Other and Unallocated, for the quarters ended September 30, 20172018 and 2016.2017.

A comprehensive external study of AFG’s A&E reserves was completed in the third quarter of 2017 with the aid of specialty actuarial, engineering and consulting firms and outside council. As a result of the 2016 internal review,study, AFG recorded a $41an $89 million (net of reinsurance) pretax special charge to increase its property and casualty insurance segment’s A&E reserves by $36and a $24 million andspecial charge to increase the reserves of its former railroad and manufacturing operations by $5 million.operations. See Management’s Discussion and Analysis — “Uncertainties — Asbestos and Environmental-related (“A&E”) Insurance Reserves” and Management’s Discussion and Analysis — “Results of Operations — Holding Company, Other and Unallocated” in AFG’s 20162017 Form 10-K.

Aggregate Aggregate net prior accident years reserve development for AFG’s property and casualty insurance segment includes the special A&E charges mentioned above and net adverse reserve development of $1 million in the third quarter of 2017 related to business outside of the Specialty insurance group that AFG no longer writes.

Catastrophe losses
AFG generally seeks to reduce its exposure to catastrophes through individual risk selection, including minimizing coastal and known fault-line exposures, and the purchase of reinsurance. Based on data available at December 31, 2016,2017, AFG’s exposure to a catastrophic earthquake or windstorm that industry models indicate should statistically occur once in every 100, 250 or 500 years as a percentage of AFG’s Shareholders’ Equity is shown below:

   Impact of modeled loss on AFG’s 
 Industry Model Shareholders’ Equity 
 100-year event Less than 1% 
 250-year event Less than 2% 
 500-year event Less than 4% 


Catastrophe losses of $107 million in the third quarter of 2017 resulted primarily from Hurricanes Harvey, Irma and Maria and two earthquakes in Mexico. AFG maintains comprehensive catastrophe reinsurance coverage, including a $15 million per occurrence net retention for its U.S.-based property and casualty insurance operations for losses up to $100 million and a separate $15 million per occurrence retention for Neon. SubsequentNeon for losses up to Hurricane Irma, AFG’s operating units purchased replacement reinsurance coverage$200 million ($225 million for those layers of theU.S. catastrophe reinsurance program affected by Hurricanes Harvey and Irma.events). AFG’s property and casualty insurance operations further maintain supplemental fully collateralized reinsurance coverage up to 95% of $200 million for catastrophe losses in excess of $100$104 million of traditional catastrophe reinsurance through a catastrophe bond.

Catastrophe losses of $14$35 million in the third quarter of 2018 resulted primarily from Hurricane Florence. Catastrophe losses of $107 million in the third quarter of 20162017 resulted primarily from floodingHurricanes Harvey, Irma and Maria and two earthquakes in Louisiana and multiple storms in the southern United States.Mexico.


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


Commissions and Other Underwriting Expenses
AFG’s property and casualty commissions and other underwriting expenses (“U/W Exp”) were $353$417 million in the third quarter of 20172018 compared to $352$353 million for the third quarter of 20162017, an increase of $164 million (18%). AFG’s underwriting expense ratio, calculated as commissions and other underwriting expenses divided by net premiums earned, was 31.4% for the third quarter of 2018 compared to 27.9% for the third quarter of 2017 compared to 30.3% for the third quarter of 2016, a decreasean increase of 2.43.5 percentage points. Detail of AFG’s property and casualty commissions and other underwriting expenses and underwriting expense ratios is shown below (dollars in millions):
 Three months ended September 30,  
 2017 2016 Change in
 U/W Exp % of NEP U/W Exp % of NEP % of NEP
Property and transportation$114
 21.6% $110
 22.3% (0.7%)
Specialty casualty164
 28.8% 154
 30.9% (2.1%)
Specialty financial66
 46.2% 81
 54.8% (8.6%)
Other specialty9
 32.5% 7
 36.3% (3.8%)
 $353
 27.9% $352
 30.3% (2.4%)

AFG’s overall expense ratio decreased 2.4 percentage points in the third quarter of 2017 as compared to the third quarter of 2016.
 Three months ended September 30,  
 2018 2017 Change in
 U/W Exp % of NEP U/W Exp % of NEP % of NEP
Property and transportation$120
 22.9% $114
 21.6% 1.3%
Specialty casualty203
 32.9% 164
 28.8% 4.1%
Specialty financial80
 54.3% 66
 46.2% 8.1%
Other specialty14
 37.5% 9
 32.5% 5.0%
 $417
 31.4% $353
 27.9% 3.5%

Property and transportation   Commissions and other underwriting expenses as a percentage of net earned premiums decreased 0.7increased 1.3 percentage points in the third quarter of 20172018 compared to the third quarter of 20162017, reflecting a changelower premiums in the mix of business.crop business, which has a lower expense ratio than AFG’s overall Property and transportation group and an increase in the expense ratio in the transportation businesses.

Specialty casualty   Commissions and other underwriting expenses as a percentage of net earned premiums decreased 2.1increased 4.1 percentage points in the third quarter of 20172018 compared to the third quarter of 20162017, reflecting growth at Neon, which has a higher expense ratio than AFG’s overall Specialty casualty group, higher dividends paid to policyholders in the impact ofworkers’ compensation businesses and higher premiums oncommissions in the ratio.targeted markets businesses.

Specialty financial   Commissions and other underwriting expenses as a percentage of net earned premiums decreasedincreased 8.68.1 percentage points in the third quarter of 20172018 compared to the third quarter of 20162017, reflecting lowerhigher ceding commissions and higher profitability-based commissions paid to agents in the financial institutions business includingcompared to the third quarter of 2017, which included an $8 million commission expense reduction due to hurricane losses.losses in the period.

Property and Casualty Net Investment Income
Net investment income in AFG’s property and casualty insurance operations was $94$108 million in the third quarter of 20172018 compared to $9394 million in the third quarter of 20162017, an increase of $114 million (1%15%). In recent years, yields available in the financial markets on fixed maturity securities have generally declined, placing downward pressure on AFG’s investment portfolio yield. The average invested assets and overall yield earned on investments held by AFG’s property and casualty insurance operations are provided below (dollars in millions):
Three months ended September 30,    Three months ended September 30,    
2017 2016 Change % Change2018 2017 Change % Change
Net investment income$94
 $93
 $1
 1%$108
 $94
 $14
 15%
    

      

  
Average invested assets (at amortized cost)$9,851
 $9,647
 $204
 2%$10,388
 $9,851
 $537
 5%
    

      

  
Yield (net investment income as a % of average invested assets)3.82% 3.86% (0.04%) 

4.16% 3.82% 0.34% 

              
Tax equivalent yield (*)4.26% 4.34% (0.08%)  4.34% 4.26% 0.08%  
(*)   Adjusts the yield on equity securities and tax-exempt bonds to the fully taxable equivalent yield.

The increase in average invested assets and net investment income in the property and casualty insurance segmentsegment’s increase in net investment income for the third quarter of 2018 compared to the third quarter of 2017 as compared to the third quarter of 2016 is due primarily toreflects growth in the property and casualty insurance segment.segment and very strong earnings from limited partnerships and similar investments. The property and casualty insurance segment’s overall yield on investments (net investment income as a percentage of average invested assets) was 3.82%4.16% for the third quarter of 20172018 compared to 3.86%3.82% for the third quarter of 2016, a decrease2017, an increase of 0.040.34 percentage points, reflectingdue primarily to the impact of lower yields availablehigher earnings from limited partnerships and similar investments. The high returns from limited partnerships and similar investments should not necessarily be expected to repeat in the financial markets and lower income from certain investments that are required to be carried at fair value through earnings, partially offset by the growth in average investments.future periods.


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



Property and Casualty Other Income and Expenses, Net
Other income and expenses, net for AFG’s property and casualty insurance operations was a net expense of $7 million for both the third quarter of 2017 compared to $14 million in2018 and the third quarter of 2016, a decrease of $7 million (50%).2017. The table below details the items included in other income and expenses, net for AFG’s property and casualty insurance operations (in millions):
Three months ended September 30,Three months ended September 30,
2017 20162018 2017
Other income$1
 $3
   
Income from the sale of real estate$
 $
Other4
 1
Total other income4
 1
Other expenses      
Amortization of intangibles2
 2
3
 2
NATL merger expenses
 2
Other6
 13
8
 6
Total other expenses8
 17
11
 8
Other income and expenses, net$(7) $(14)$(7) $(7)


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AMERICAN FINANCIAL GROUP, INC. 10-Q
Management’s Discussion and Analysis of Financial Condition and Results of Operations — Continued


Annuity Segment — Results of Operations
AFG’s annuity operations contributed $102$117 million in pretax earnings in the third quarter of 20172018 compared to $107$102 million in the third quarter of 2016, a decrease2017, an increase of $5$15 million (5%(15%). AFG’s annuity segment results for the third quarter of 20172018 as compared to the third quarter of 20162017 reflect an 11%a 10% increase in average annuity investments (at amortized cost), and higher earnings from limited partnerships and similar investments, partially offset by the impact of lower investment yields due to the run-off of higher yielding investments. The high returns on limited partnerships and similar investments should not necessarily be expected to repeat in future periods. While both periods reflect the positive impact of a higherstrong stock market performance and the negative impact of lower than anticipated interest rates on the fair value accounting forof derivatives related to fixed-indexed annuities (“FIAs”), strong stock market performance in the third quarter of 2018 had a significantly higher favorable impact than the stock market increase in the 2017 period and the decrease in interest rates in the third quarter of 2017 had a significantly larger unfavorable impact in the 2017 period compared to the lower than anticipated interest rates on the 2018 period. The favorable impact of interest rates between periods was partially offset by the negative impact of higher interest on the embedded derivative (from growth in the 2017 quarter had aFIA business and higher unfavorable impactinterest rates) in the 2018 period compared to the 2016 quarter.2017 period.

The following table details AFG’s earnings before income taxes from its annuity operations for the three months ended September 30, 20172018 and 20162017 (dollars in millions):
Three months ended September 30,  Three months ended September 30,  
2017 2016 % Change2018 2017 % Change
Revenues:          
Net investment income$375
 $351
 7%$413
 $375
 10%
Other income:          
Guaranteed withdrawal benefit fees15
 14
 7%16
 15
 7%
Policy charges and other miscellaneous income11
 12
 (8%)11
 11
 %
Total revenues401
 377
 6%440
 401
 10%
          
Costs and Expenses:          
Annuity benefits (*)215
 189
 14%222
 215
 3%
Acquisition expenses54
 53
 2%69
 54
 28%
Other expenses30
 28
 7%32
 30
 7%
Total costs and expenses299
 270
 11%323
 299
 8%
Earnings before income taxes$102
 $107
 (5%)$117
 $102
 15%
Detail of annuity earnings before income taxes (dollars in millions):
Three months ended September 30,  Three months ended September 30,  
2017 2016 % Change2018 2017 % Change
Earnings before income taxes — before the impact of derivatives related to FIAs$106
 $106
 %$119
 $106
 12%
Impact of derivatives related to FIAs(4) 1
 (500%)(2) (4) (50%)
Earnings before income taxes$102
 $107
 (5%)$117
 $102
 15%

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


(*)Annuity benefits consisted of the following (dollars in millions):
Three months ended September 30,  Three months ended September 30,  
2017 2016 % Change2018 2017 % Change
Interest credited — fixed$160
 $145
 10%$179
 $160
 12%
Interest credited — fixed component of variable annuities1
 1
 %1
 1
 %
Other annuity benefits:          
Change in expected death and annuitization reserve5
 5
 %5
 5
 %
Amortization of sales inducements4
 6
 (33%)5
 4
 25%
Change in guaranteed withdrawal benefit reserve18
 18
 %18
 18
 %
Change in other benefit reserves16
 10
 60%10
 16
 (38%)
Total other annuity benefits43
 39
 10%38
 43
 (12%)
Total before impact of derivatives related to FIAs204
 185
 10%218
 204
 7%
Derivatives related to fixed-indexed annuities:          
Embedded derivative mark-to-market127
 109
 17%223
 127
 76%
Equity option mark-to-market(116) (105) 10%(219) (116) 89%
Impact of derivatives related to FIAs11
 4
 175%4
 11
 (64%)
Total annuity benefits$215
 $189
 14%$222
 $215
 3%

The profitability of a fixed annuity business is largely dependent on the ability of a company to earn income on the assets supporting the business in excess of the amounts credited to policyholder accounts plus expenses incurred (earning a “spread”). Performance measures such as net interest spread and net spread earned are often presented by annuity businesses to help users of their financial statements better understand the company’s performance.

Net Spread on Fixed Annuities (excludes variable annuity earnings)
The table below (dollars in millions) details the components of these spreads for AFG’s fixed annuity operations (including fixed-indexed and variable-indexed annuities):
Three months ended September 30,  Three months ended September 30,  
2017 2016 % Change2018 2017 % Change
Average fixed annuity investments (at amortized cost)$31,713
 $28,548
 11%$34,955
 $31,713
 10%
Average fixed annuity benefits accumulated32,029
 28,538
 12%35,226
 32,029
 10%
          
As % of fixed annuity benefits accumulated (except as noted):

 

  

 

  
Net investment income (as % of fixed annuity investments)4.70% 4.88%  4.70% 4.70%  
Interest credited — fixed(2.01%) (2.03%)  (2.03%) (2.01%)  
Net interest spread2.69% 2.85%  2.67% 2.69%  
          
Policy charges and other miscellaneous income0.10% 0.14%  0.09% 0.10%  
Other annuity benefit expenses, net of guaranteed withdrawal benefit fees(0.33%) (0.36%)  (0.24%) (0.33%)  
Acquisition expenses(0.65%) (0.72%)  (0.76%) (0.65%)  
Other expenses(0.36%) (0.39%)  (0.36%) (0.36%)  
Change in fair value of derivatives related to fixed-indexed annuities(0.14%) (0.05%)  (0.05%) (0.14%)  
Net spread earned on fixed annuities1.31% 1.47%  1.35% 1.31%  


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AMERICAN FINANCIAL GROUP, INC. 10-Q
Management’s Discussion and Analysis of Financial Condition and Results of Operations — Continued


The table below illustrates the impact of fair value accounting for derivatives related to fixed-indexed annuities on the annuity segment’s net spread earned on fixed annuities:
Three months ended September 30,Three months ended September 30,
2017 20162018 2017
Net spread earned on fixed annuities — before impact of derivatives related to FIAs1.36% 1.46%
Net spread earned on fixed annuities — before the impact of derivatives related to FIAs1.37% 1.36%
Impact of derivatives related to fixed-indexed annuities:      
Change in fair value of derivatives(0.14%) (0.05%)(0.05%) (0.14%)
Related impact on amortization of deferred policy acquisition costs (*)0.09% 0.06%0.03% 0.09%
Related impact on amortization of deferred sales inducements (*)% %% %
Net spread earned on fixed annuities1.31% 1.47%1.35% 1.31%
(*)An estimate of the related acceleration/deceleration of the amortization of deferred policy acquisition costs and deferred sales inducements.

Annuity Net Investment Income
Net investment income for the third quarter of 20172018 was $375$413 million compared to $351$375 million for the third quarter of 2016,2017, an increase of $24$38 million (7%(10%). This increase reflects the growth in AFG’s annuity business and higher earnings from limited partnerships and similar investments, partially offset by the impact of lower investment yields and lower investment income from certain investments that are required to be carried at fair value through earnings.yields. The overall yield earned on investments in AFG’s fixed annuity operations, calculated as net investment income divided by average investment balances (at amortized cost), decreased by 0.18 percentage points towas 4.70% from 4.88% in both the third quarter of 2017 compared to2018 and the third quarter of 2016. This decline in2017. The net investment yield between periods reflects (i) the investment of new premium dollars at lower yields as compared to the existing investment portfoliohigher earnings from limited partnerships and (ii)similar investments, offset by the impact of the reinvestment of proceeds from maturity and redemption of higher yielding investments at the lower yields available in the financial markets. DuringThe high returns from limited partnerships and similar investments should not necessarily be expected to repeat in future periods. For the first nine months ofperiod from July 1, 2017, $3.6through September 30, 2018, $4.4 billion in annuity segment investments with an average yield of 5.24%5.01% were redeemed or sold while the investments purchased during 2017that period (with new premium dollars and the redemption/sale proceeds) had an average yield at purchase of 3.93%4.26%.

Annuity Interest Credited — Fixed
Interest credited — fixed for the third quarter of 20172018 was $160179 million compared to $145160 million for the third quarter of 2016,2017, an increase of $1519 million (10%12%). TheThis increase reflects the impact of growth in the annuity business was partially offset by lower interest crediting rates on new premiums as compared to the crediting rates on policyholder funds surrendered or withdrawn.business. The average interest rate credited to policyholders, calculated as interest credited divided by average fixed annuity benefits accumulated, decreasedincreased 0.02 percentage points to 2.03% in the third quarter of 2018 from 2.01% in the third quarter of 2017 from 2.03% in the third quarter of 2016.due to higher crediting rates on new business.

Annuity Net Interest Spread
AFG’s net interest spread decreased 0.160.02 percentage points to 2.69%2.67% from 2.85%2.69% in the third quarter of 20172018 compared to the same period in 20162017 due primarily to the impact ofhigher crediting rates on new business and lower investment yields, partially offset by lower crediting rates.higher earnings from limited partnerships and similar investments. Features included in current annuity product offerings allow AFG to achieve its desired profitability at a lower net interest spread than historical product offerings. As a result, AFG expects its net interest spread to narrow in the future.

Annuity Policy Charges and Other Miscellaneous Income
Annuity policy charges and other miscellaneous income, which consist primarily of surrender charges, amortization of deferred upfront policy charges (unearned revenue) and income from sales of real estate were $11 million for both the third quarter of 2017 compared to $12 million for2018 and the third quarter of 2016, a decrease of $1 million (8%). As2017. Annuity policy charges and other miscellaneous income as a percentage of average fixed annuity benefits accumulated, annuity policy charges and other miscellaneous income decreased 0.040.01 percentage points to 0.10%0.09% from 0.14%0.10% in the third quarter of 20172018 compared to the third quarter of 2016.2017.


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AMERICAN FINANCIAL GROUP, INC. 10-Q
Management’s Discussion and Analysis of Financial Condition and Results of Operations — Continued


Other Annuity Benefits, Net of Guaranteed Withdrawal Benefit Fees
Other annuity benefits, net of guaranteed withdrawal benefit fees, for the third quarter of 20172018 were $28$22 million compared to $25$28 million for the third quarter of 2016, an increase2017, a decrease of $3$6 million (12%(21%). As a percentage of average fixed annuity benefits accumulated, these net expenses decreased 0.030.09 percentage points to 0.33%0.24% from 0.36%0.33% in the third quarter of 20172018 compared to the third quarter of 2016.2017. In addition to interest credited to policyholders’ accounts and the change in fair value of derivatives related to fixed-indexed annuities, annuity benefits expense also includes the following expenses (in millions, net of guaranteed withdrawal benefit fees):
Three months ended September 30,Three months ended September 30,
2017 20162018 2017
Change in expected death and annuitization reserve$5
 $5
$5
 $5
Amortization of sales inducements4
 6
5
 4
Change in guaranteed withdrawal benefit reserve18
 18
18
 18
Change in other benefit reserves16
 10
10
 16
Other annuity benefits43
 39
38
 43
Offset guaranteed withdrawal benefit fees(15) (14)(16) (15)
Other annuity benefits, net$28
 $25
$22
 $28

As discussed under “Annuity Benefits Accumulated” in Note A — “Accounting Policiesto the financial statements, guaranteed withdrawal benefit reserves are accrued for and modified using assumptions similar to those used in establishing and amortizing deferred policy acquisition costs. The guaranteed withdrawal benefit reserve related to FIAs can be inversely impacted by the calculated FIA embedded derivative reserve as the value to policyholders of the guaranteed withdrawal benefits decreases when the benefit of stock market participation increases.

Annuity Acquisition Expenses
AFG’sAnnuity acquisition expenses for the third quarter of 2018 were $69 million compared to $54 million for the third quarter of 2017, an increase of $15 million (28%), reflecting growth in the business and the acceleration/deceleration of amortization of deferred policy acquisition costs (“DPAC”) as a result of changes in the fair value of derivatives related to FIAs. AFG’s amortization of DPAC and commission expenses as a percentage of average fixed annuity benefits accumulated was 0.65%0.76% for the third quarter of 20172018 compared to 0.72%0.65% for the third quarter of 20162017 and has generally ranged between 0.75% and 0.85%. Variances from the general range relate primarily to the impact of (i) material changes in interest rates or the stock market on AFG’s fixed-indexed annuity business, and (ii) differences in actual experience from actuarially projected estimates and assumptions. For example, the negativefavorable impact of lower than anticipated interest ratesstrong stock market performance during the third quarter of 20172018 on the fair value of derivatives related to fixed-indexed annuities (discussed below)FIAs resulted in a partially offsetting decelerationacceleration of the amortization of DPAC.

The table below illustrates the estimated impact of fair value accounting for derivatives related to fixed-indexed annuities on annuity acquisition expenses as a percentage of average fixed annuity benefits accumulated:accumulated (excluding the impact of unlocking):
Three months ended September 30,Three months ended September 30,
2017 20162018 2017
Before the impact of changes in the fair value of derivatives related to FIAs on the amortization of DPAC0.74% 0.78%0.79% 0.74%
Impact of changes in fair value of derivatives related to FIAs on amortization of DPAC (*)(0.09%) (0.06%)(0.03%) (0.09%)
Annuity acquisition expenses as a % of fixed annuity benefits accumulated0.65% 0.72%0.76% 0.65%
(*)An estimate of the acceleration/deceleration of the amortization of deferred policy acquisition costs resulting from fair value accounting for derivatives related to fixed-indexed annuities.

Annuity Other Expenses
Annuity other expenses were $32 million for the third quarter of 2018 compared to $30 million for the third quarter of 2017, compared to $28 million for the third quarter of 2016, an increase of $2 million (7%). Annuity other expenses represent primarily general and administrative expenses, as well as selling and issuance expenses that are not deferred. As a percentage of average fixed annuity benefits accumulated, these expenses were 0.36% for both the third quarter of 2017 compared to 0.39% for2018 and the third quarter of 2016.

Change in Fair Value of Derivatives Related to Fixed-Indexed Annuities
AFG’s fixed-indexed annuities 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 the change in the fair value of the call option assets will2017.

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AMERICAN FINANCIAL GROUP, INC. 10-Q
Management’s Discussion and Analysis of Financial Condition and Results of Operations — Continued


Change in Fair Value of Derivatives Related to Fixed-Indexed (Including Variable-Indexed) Annuities
AFG’s fixed-indexed (including variable-indexed) annuities provide policyholders with a crediting rate tied, in part, to the performance of an existing stock market or other financial index. AFG attempts to mitigate the risk in the index-based component of these products through the purchase and sale of call and put options on the appropriate index. AFG’s strategy is designed so that the net change in the fair value of the call option assets and put option liabilities will generally offset the economic change in the liabilitiesnet liability from the index participation. Both the index-based component of the annuities (an embedded derivative) and the related call and put options are considered derivatives that must be adjusted for changes in fair value through earnings each period. The change in the fair value of the embedded derivative includes an ongoing expense for interest accreted on the embedded derivative. The interest accreted in any period is generally based on the size of the embedded derivative and current interest rates. The fair values of these derivatives are impacted by actual and expected stock market performance and interest rates as well as other factors. For a list of other factors impacting the fair value of the index-basedembedded derivative component of AFG’s annuity benefits accumulated, see Note DC — “Fair Value Measurementsto the financial statements.

The net change in fair value of derivatives related to fixed-indexed annuities increased annuity benefits by $114 million in the third quarter of 2018 compared to $11 million in the third quarter of 2017. The change in the fair value of these derivatives includes $18 million in the third quarter of 2018 and $4$8 million in the third quarter of 2017 in interest accreted on the embedded derivative (before DPAC amortization), an increase of $10 million (125%). AFG expects both the size of the embedded derivative and 2016, respectively.interest rates to rise, resulting in continued increases in interest on the embedded derivative. During the third quarter of 2018, the impact of higher interest on the embedded derivative was offset by the positive impact of strong stock market performance on the fair value of the derivatives. During the third quarter of 2017, the negative impact of lower than anticipated interest rates on the fair value of these derivatives was partially offset by the positive impact of strong stock market performance. During the third quarter of 2016, slightly lower than anticipated interest rates had a negative impact on the fair value of these derivatives that was partially offset by a moderate increase in the stock market. As a percentage of average fixed annuity benefits accumulated, this net expense increaseddecreased 0.09 percentage points to 0.05% in the third quarter of 2018 from 0.14% in the third quarter of 2017 from 0.05% in the third quarter of 2016.2017.

Fluctuations in interest rates and the stock market, among other factors, can cause volatility in the periodic measurement of fair value of the embedded derivative that management believes can be inconsistent with the long-term economics of these products. The table below illustrates the impact of fair value accounting for derivatives related to fixed-indexed annuities on the annuity segment’s earnings before income taxes (dollars in millions):
Three months ended September 30,  Three months ended September 30,  
2017 2016 % Change2018 2017 % Change
Earnings before income taxes — before change in fair value of derivatives related to fixed-indexed annuities$106
 $106
 %
Change in fair value of derivatives related to fixed-indexed annuities(11) (4) 175%
Earnings before income taxes — before change in fair value of derivatives related to FIAs$119
 $106
 12%
Impact of derivatives related to fixed-indexed annuities:     
Change in fair value of derivatives related to FIAs(4) (11) (64%)
Related impact on amortization of DPAC (*)7
 5
 40%2
 7
 (71%)
Earnings before income taxes$102
 $107
 (5%)$117
 $102
 15%

(*)An estimate of the related acceleration/deceleration of the amortization of deferred sales inducements and deferred policy acquisition costs and deferred sales inducements.costs.

As illustrated in the table above, the change in fair value of derivatives related to fixed-indexed annuities, including the related impact on amortization of DPAC, decreased the annuity segment’s earnings before income taxes by $4$2 million in the third quarter of 20172018 and increaseddecreased the annuity segment’s earnings before income taxes by $1$4 million in the third quarter of 2016.2017.


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AMERICAN FINANCIAL GROUP, INC. 10-Q
Management’s Discussion and Analysis of Financial Condition and Results of Operations — Continued


The following table provides analysis of the primary factors impacting the change in the fair value of derivatives related to FIAs. Each factor is presented net of the estimated related impact on amortization of DPAC (dollars in millions).
 Three months ended September 30,  
 2018 2017 % Change
Interest on the embedded derivative liability$(10) $(4) 150%
Changes in interest rates higher (lower) than expected(2) (10) (80%)
Change in the stock market, including volatility12
 6
 100%
Renewal option costs lower (higher) than expected
 1
 (100%)
Other, including the impact of actual versus expected lapses(2) 3
 (167%)
Impact of derivatives related to FIAs$(2) $(4) (50%)

Annuity Net Spread Earned on Fixed Annuities
AFG’s net spread earned on fixed annuities decreased 0.16increased 0.04 percentage points to 1.31%1.35% from 1.47%1.31% in the third quarter of 20172018 compared to the same period in 20162017 due primarily to the net impact of changes in the fair value of derivatives and related DPAC amortization offset discussed above, andpartially offset by the 0.160.02 percentage points decrease in AFG’s net interest spread.

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


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AMERICAN FINANCIAL GROUP, INC. 10-Q
Management’s Discussion and Analysis of Financial Condition and Results of Operations — Continued


For certain products, annuity benefits accumulated also includes reserves for accrued persistency and premium bonuses, excess benefits expected to be paid on future deaths and annuitizations (“EDAR”) and guaranteed withdrawal benefits. Annuity benefits accumulated also includes amounts advanced from the Federal Home Loan Bank of Cincinnati. The following table is a progression of AFG’s annuity benefits accumulated liability for the three months ended September 30, 20172018 and 20162017 (in millions):
 Three months ended September 30,
 2017 2016
Beginning fixed annuity reserves$31,704
 $28,222
Fixed annuity premiums (receipts)869
 932
Surrenders, benefits and other withdrawals(540) (586)
Interest and other annuity benefit expenses:   
Interest credited160
 145
Embedded derivative mark-to-market127
 109
Change in other benefit reserves34
 31
Ending fixed annuity reserves$32,354
 $28,853
    
Reconciliation to annuity benefits accumulated per balance sheet:   
Ending fixed annuity reserves (from above)$32,354
 $28,853
Impact of unrealized investment related gains138
 180
Fixed component of variable annuities179
 189
Annuity benefits accumulated per balance sheet$32,671
 $29,222

Statutory Annuity Premiums
AFG’s annuity operations generated statutory premiums of $876 million in the third quarter of 2017 compared to $941 million in the third quarter of 2016, a decrease of $65 million (7%). The following table summarizes AFG’s annuity sales (dollars in millions):
 Three months ended September 30,  
2017 2016 % Change
Financial institutions single premium annuities — indexed$360
 $435
 (17%)
Financial institutions single premium annuities — fixed82
 97
 (15%)
Retail single premium annuities — indexed367
 340
 8%
Retail single premium annuities — fixed19
 18
 6%
Education market — fixed and indexed annuities41
 42
 (2%)
Total fixed annuity premiums869
 932
 (7%)
Variable annuities7
 9
 (22%)
Total annuity premiums$876
 $941
 (7%)

Management attributes the 7% decrease to AFG’s adherence to pricing discipline in a relatively low and decreasing interest rate environment during the year, as well as from aggressive pricing by certain of AFG’s competitors.

AFG continues to implement product and process changes needed to comply with the Department of Labor (“DOL”) Fiduciary Rule. Although the DOL Fiduciary Rule became effective on June 9, 2017, the DOL delayed certain requirements until January 1, 2018. As a result, insurance-only agents are able to continue selling fixed-indexed annuities through the end of 2017, provided the agent acts in the customer’s best interest, makes no misleading statements and receives only reasonable compensation. The DOL recently released a proposal to delay full implementation until July 1, 2019. There is uncertainty as to whether the rule will take effect in its current form on that date.

AFG believes the biggest impact of the rule will be on insurance-only licensed agents whose qualified sales represented approximately 10% of its third quarter 2017 annuity premiums. AFG’s management continues to believe that full implementation is likely to cause some short-term disruption in annuity premiums. Nonetheless, management does not believe the new rule will have a material impact on AFG’s results of operations.
 Three months ended September 30,
 2018 2017
Beginning fixed annuity reserves$34,678
 $31,704
Fixed annuity premiums (receipts)1,372
 869
Surrenders, benefits and other withdrawals(707) (540)
Interest and other annuity benefit expenses:   
Interest credited179
 160
Embedded derivative mark-to-market223
 127
Change in other benefit reserves29
 34
Ending fixed annuity reserves$35,774
 $32,354
    
Reconciliation to annuity benefits accumulated per balance sheet:   
Ending fixed annuity reserves (from above)$35,774
 $32,354
Impact of unrealized investment related gains8
 138
Fixed component of variable annuities176
 179
Annuity benefits accumulated per balance sheet$35,958
 $32,671


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AMERICAN FINANCIAL GROUP, INC. 10-Q
Management’s Discussion and Analysis of Financial Condition and Results of Operations — Continued


Statutory Annuity Premiums
AFG’s annuity operations generated statutory premiums of $1.38 billion in the third quarter of 2018 compared to $876 million in the third quarter of 2017, an increase of $502 million (57%). The following table summarizes AFG’s annuity sales (dollars in millions):
 Three months ended September 30,  
2018 2017 % Change
Financial institutions single premium annuities — indexed$460
 $360
 28%
Financial institutions single premium annuities — fixed114
 82
 39%
Retail single premium annuities — indexed354
 219
 62%
Retail single premium annuities — fixed17
 18
 (6%)
Broker dealer single premium annuities — indexed322
 148
 118%
Broker dealer single premium annuities — fixed3
 1
 200%
Pension risk transfer56
 
 %
Education market — fixed and indexed annuities46
 41
 12%
Total fixed annuity premiums1,372
 869
 58%
Variable annuities6
 7
 (14%)
Total annuity premiums$1,378
 $876
 57%

Management attributes the 57% increase in annuity premiums in the third quarter of 2018 compared to the third quarter of 2017 to the introduction of new products, efforts to expand in the retail and broker dealer markets and an improving interest rate environment during the first nine months of 2018.

Annuity Earnings before Income Taxes Reconciliation
The following table reconciles the net spread earned on AFG’s fixed annuities to overall annuity pretax earnings for the three months ended September 30, 20172018 and 20162017 (in millions):
Three months ended September 30,Three months ended September 30,
2017 20162018 2017
Earnings on fixed annuity benefits accumulated$105
 $105
$119
 $105
Earnings impact of investments in excess of fixed annuity benefits accumulated (*)(4) 
(3) (4)
Variable annuity earnings1
 2
1
 1
Earnings before income taxes$102
 $107
$117
 $102

(*)
Net investment income (as a % of investments) of 4.70% and 4.88%for both the three months ended September 30, 20172018 and 20162017, respectively, multiplied by the difference between average fixed annuity investments (at amortized cost) and average fixed annuity benefits accumulated in each period.

Run-off Long-Term Care and Life Segment — Results of OperationsThe following table details AFG’s earnings before income taxes from its run-off long-term care and life operations for the three months ended September 30, 2017 and 2016 (dollars in millions):
 Three months ended September 30,  
 2017 2016 % Change
Revenues:     
Net earned premiums:    

Long-term care$
 $
 %
Life operations6
 6
 %
Net investment income6
 5
 20%
Other income
 2
 (100%)
Total revenues12
 13
 (8%)
      
Costs and Expenses:     
Life, accident and health benefits:    

Long-term care1
 2
 (50%)
Life operations5
 6
 (17%)
Acquisition expenses1
 1
 %
Other expenses3
 3
 %
Total costs and expenses10
 12
 (17%)
Earnings before income taxes$2
 $1
 100%

The $1 million increase in earnings before income taxes reflects the impact of improved life claims experience in the third quarter of 2017 compared to the third quarter of 2016.



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AMERICAN FINANCIAL GROUP, INC. 10-Q
Management’s Discussion and Analysis of Financial Condition and Results of Operations — Continued


Holding Company, Other and Unallocated — Results of Operations   AFG’s net GAAP pretax loss outside of its property and casualty insurance and annuity operations (excluding realized gains and losses) totaled $69$46 million in the third quarter of 2018 compared to $67 million in the third quarter of 2017, compared to $53a decrease of $21 million in the third quarter of 2016, an increase of $16 million (30%(31%). AFG’s net core pretax loss outside of its property and casualty insurance and annuity operations (excluding realized gains and losses) totaled $41$37 million in the third quarter of 2018 compared to $39 million in the third quarter of 2017, compared to $48 million in the third quarter of 2016, a decrease of $7$2 million (15%(5%).

The following table details AFG’s GAAP and core loss before income taxes from operations outside of its property and casualty insurance and annuity operations for the three months ended September 30, 20172018 and 20162017 (dollars in millions):
Three months ended September 30,  Three months ended September 30,  
2017 2016 % Change2018 2017 % Change
Revenues:          
Life, accident and health net earned premiums$6
 $6
 %
Net investment income$1
 $1
 %10
 7
 43%
Other income — P&C fees17
 14
 21%18
 17
 6%
Other income9
 5
 80%9
 9
 %
Total revenues27
 20
 35%43
 39
 10%
          
Costs and Expenses:     
Costs and Expenses, excluding interest charges on borrowed money     
Property and casualty insurance — commissions and other underwriting expenses4
 4
 %7
 4
 75%
Interest charges on borrowed money21
 19
 11%
Life, accident and health benefits10
 6
 67%
Life, accident and health acquisition expenses2
 1
 100%
Other expense — expenses associated with P&C fees13
 10
 30%11
 13
 (15%)
Other expenses (*)30
 35
 (14%)35
 33
 6%
Total costs and expenses68
 68
 %
Costs and expenses, excluding interest charges on borrowed money65
 57
 14%
Core loss before income taxes, excluding realized gains and losses and interest charges on borrowed money(22) (18) 22%
Interest charges on borrowed money15
 21
 (29%)
Core loss before income taxes, excluding realized gains and losses(41) (48) (15%)(37) (39) (5%)
Pretax non-core special A&E charges(24) (5) 380%(9) (24) (63%)
Pretax non-core loss on retirement of debt(4) 
 %
 (4) (100%)
GAAP loss before income taxes, excluding realized gains and losses$(69) $(53) 30%$(46) $(67) (31%)

(*)
Excludes pretax non-core special A&E charges of $24$9 million and $5$24 million in the third quarter of 20172018 and 2016,2017, respectively, and a pretax non-core loss on retirement of debt of $4 million in the third quarter of 2017.

Holding Company and Other — Life, Accident and Health Premiums, Benefits and Acquisition Expenses
AFG’s run-off long-term care and life insurance operations recorded net earned premiums of $6 million and related benefits and acquisition expenses of $12 million in the third quarter of 2018 compared to net earned premiums of $6 million and related benefits and acquisition expenses of $7 million in the third quarter of 2017. The $4 million (67%) increase in life, accident and health benefits reflects higher claims in both the run-off long-term care and run-off life insurance businesses.

Holding Company and Other — Net Investment Income
AFG recorded net investment income on investments held outside of its property and casualty insurance and annuity operations of $1$10 million in boththe third quarter of 2018 compared to $7 million in the third quarter of 2017, andan increase of $3 million (43%). The parent company holds a small portfolio of securities that are carried at fair value through net investment income. These securities increased in value by $3 million in the third quarter of 2016.2018 compared to an increase in value of less than $1 million in the third quarter of 2017.

Holding Company and Other — P&C Fees and Related Expenses
Summit, a workers’ compensation insurance business,subsidiary, collects fees from a small group of unaffiliated insurers for providing underwriting, policy administration and claims services. In addition, certain of AFG’s property and casualty insurance businesses collect fees from customers for ancillary services such as workplace safety programs and premium financing. In the third quarter of 2017,2018, AFG collected $17$18 million in fees for these services compared to $14$17 million in the third quarter of 2016.2017. Management views this fee income, net of the $11 million in the third quarter of 2018 and $13 million in the third quarter of 2017

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AMERICAN FINANCIAL GROUP, INC. 10-Q
Management’s Discussion and $10 million in the third quarterAnalysis of 2016Financial Condition and Results of Operations — Continued


2017, in expenses incurred to generate such fees, as a reduction in the cost of underwriting its property and casualty insurance policies. Consistent with internal management reporting, these fees and the related expenses are netted and recorded as a reduction of commissions and other underwriting expenses in AFG’s segmented results.

Holding Company and Other — Other Income
Other income in the table above includes $5 million and $4 million in the third quarter of 20172018 and $5 million in the 2016third, respectively, quarter of 2017, in management fees paid to AFG by the AFG-managed CLOs (AFG’s consolidated managed investment entities). The management fees are eliminated in consolidation — see the other income line in the Consolidate MIEs column under “Results of Operations — Segmented Statement of Earnings.” Results forExcluding amounts eliminated in consolidation, AFG recorded other income outside of its property and casualty insurance and annuity operations of $5 million in the third quarter of 2018 compared to $4 million in the third quarter of 2017.

Holding Company and Other — Other Expenses
Excluding the non-core special A&E charges and the non-core loss on retirement of debt discussed below, AFG’s holding companies and other operations outside of its property and casualty insurance and annuity operations recorded other expenses of $35 million in the third quarter of 2018 compared to $33 million in the third quarter of 2017, includean increase of $2 million in income related to the sale of real estate.(6%).

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AMERICAN FINANCIAL GROUP, INC. 10-Q
Management’s Discussion and Analysis of Financial Condition and Results of Operations — Continued


Holding Company and Other — Interest Charges on Borrowed Money
AFG’s holding companies and other operations outside of its property and casualty insurance and annuity operations recorded interest expense of $2115 million in the third quarter of 20172018 compared to $19$21 million in the third quarter of 2016, an increase2017, a decrease of $2$6 million (11%(29%). This increase reflects higher average indebtedness, partially offset by due primarily to a lower weighted average interest rate on AFG’s outstanding debt. The following table details the principal amount of AFG’s long-term debt balances as of September 30, 2017July 1, 2018 compared to July 1, 20162017 (dollars in millions):
September 30,
2017
 July 1,
2016
July 1,
2018
 July 1,
2017
Direct obligations of AFG:      
4.50% Senior Notes due June 2047$590
 $350
3.50% Senior Notes due August 2026425
 300
9-7/8% Senior Notes due June 2019$350
 $350

 350
3.50% Senior Notes due August 2026300
 
6-3/8% Senior Notes due June 2042
 230
5-3/4% Senior Notes due August 2042
 125

 125
4.50% Senior Notes due June 2047350
 
6-1/4% Subordinated Debentures due September 2054150
 150
150
 150
6% Subordinated Debentures due November 2055150
 150
150
 150
Other3
 3
3
 3
Total principal amount of Holding Company Debt$1,303
 $1,008
$1,318
 $1,428
      
Weighted Average Interest Rate6.1% 7.4%4.6% 6.1%

The increasedecrease in the weighted average indebtednessinterest rate for the third quarter of 20172018 as compared to the third quarter of 20162017 reflects the following financing transactions completed by AFG between July 1, 20162017 and September 30,December 31, 2017:
Issued $300 million of 3.50% Senior Notes on August 22, 2016
Issued $350 million of 4.50% Senior Notes on June 2, 2017
Redeemed $230 million of 6-3/8% Senior Notes on June 26, 2017
Redeemed $125 million of 5-3/4% Senior Notes on August 25, 2017

The redemptionIssued an additional $125 million of the 6-3/8% and 5-3/4%3.50% Senior Notes and the issuanceon November 9, 2017
Issued an additional $240 million of the 4.50% Senior Notes inon November 9, 2017 will result in annual pretax interest savings to AFG
Redeemed $350 million of $6 million.9-7/8% Senior Notes on December 11, 2017

Holding Company and Other — Special A&E Charges
As a result of the 2018 in-depth internal review and the 2017 comprehensive external study and the 2016 internal review of A&E exposures discussed under Special asbestos and environmental reserve charges under “Results of Operations — Property and Casualty Insurance Segment — Net prior year reserve development,”AFG’s holding companies and other operations outside of its insurance operations recorded pretax special charges of $9 million in the third quarter of 2018 and $24 million in the third quarter of 2017 and $5 million in the third quarter of 2016 to increase liabilities related to the A&E exposures of AFG’s former railroad and manufacturing operations. The $24 million chargecharges in 2017 isboth periods were due primarily to relatively small movements across several sites that primarily reflect changes in the scope and costs of investigation. In addition, AFG has seen a small increase in claims arising from exposure to deleterious substances other than asbestos, which has caused it to increase its estimated future liability. The $5 million charge in 2016 is due primarily to relatively small movements across several sites related to changesliability in the scope and costs of investigation.2017 quarter.

Holding Company and Other — Loss on Retirement of Debt
AFG wrote off unamortized debt issuance costs of $4 million related to the redemption of its $125 million outstanding 5-3/4% Senior Notes due 2042 at par value onin August 25, 2017.

Holding Company and Other — Other Expenses
Excluding the non-core special A&E charges and the non-core loss on retirement of debt discussed above, AFG’s holding companies and other operations outside of its insurance operations recorded other expenses of $30 million in the third quarter of 2017 compared to $35 million in the third quarter of 2016, a decrease of $5 million (14%). This decrease reflects the impact of a $5 million donation to the University of Cincinnati College of Business in the third quarter of 2016.


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



Consolidated Realized Gains (Losses) on Securities   AFG’s consolidated realized gains (losses) on securities, which are not allocated to segments, were lossesa net gain of $12$34 million in the third quarter of 20172018 compared to gainslosses of $2$12 million in the third quarter of 2016, a decrease2017, an improvement of $14$46 million (700%(383%). Realized gains (losses) on securities consisted of the following (in millions):
Three months ended September 30,Three months ended September 30,
2017 20162018 2017
Realized gains (losses) before impairments:      
Disposals$29
 $22
$2
 $29
Change in the fair value of equity securities (*)33
 
Change in the fair value of derivatives(1) (3)(2) (1)
Adjustments to annuity deferred policy acquisition costs and related items(2) (1)3
 (2)
26
 18
36
 26
Impairment charges:      
Securities(44) (18)(2) (44)
Adjustments to annuity deferred policy acquisition costs and related items6
 2

 6
(38) (16)(2) (38)
Realized gains (losses) on securities$(12) $2
$34
 $(12)
(*)
As discussed in Note A — “Accounting PoliciesInvestments,” beginning in January 2018, all equity securities other than those accounted for under the equity method are carried at fair value through net earnings. This amount includes a $25 million net gain on securities that were still held at September 30, 2018.

The $33 million net realized gain from the change in the fair value of equity securities in the third quarter of 2018 includes gains of $11 million on investments in technology companies, $10 million from investments in communications companies and $8 million on health care-related investments. AFG’s $44 million in impairment charges on securities for the third quarter of 2017 consistconsisted of $29 million on equity securities and $15 million on fixed maturities compared to $16 million on equity securities and $2 million on fixed maturities in the third quarter of 2016.maturities. Approximately $14 million in impairment charges in the third quarter of 2017 relaterelated to investments in pharmaceutical companies, $10 million relatesrelated to an investment in a media company and the remainder relatesrelated primarily to investments in various industrial entities. Approximately $11 million of the impairment charges recorded in the third quarter of 2016 are related to financial institutions and $6 million relates to a company in the forest products industry.

Consolidated Income Taxes   AFG’s consolidated provision for income taxes was $41 million for the third quarter of 2018 compared to $18 million for the third quarter of 2017, compared to $65an increase of $23 million for the third quarter of 2016, a decrease of $47 million (72%(128%). See Note L — “Income Taxesto the financial statements for an analysis of items affecting AFG’s effective tax rate.

Consolidated Noncontrolling Interests   AFG’s consolidated net earnings (losses) attributable to noncontrolling interests was $4a net loss of $1 million for the third quarter of 2016. The following table details net earnings in consolidated subsidiaries attributable2018 related to holders other than AFG (dollars in millions):losses at Neon, AFG’s United Kingdom-based Lloyd’s insurer.
 Three months ended September 30,  
 2017 2016 % Change
National Interstate$
 $4
 (100%)
Earnings attributable to noncontrolling interests$
 $4
 (100%)



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AMERICAN FINANCIAL GROUP, INC. 10-Q
Management’s Discussion and Analysis of Financial Condition and Results of Operations — Continued


RESULTS OF OPERATIONS — NINE MONTHS ENDED SEPTEMBER 30, 20172018 AND 20162017

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

Effective January 1, 2018, the results of AFG’s run-off long-term care and life businesses are included in the “Other” segment instead of as a separate reportable segment based on the immaterial size of the remaining operations. Prior periods amounts were reclassified for consistent presentation.

AFG’s net earnings attributable to shareholders, determined in accordance with GAAP, include certain items that may not be indicative of its ongoing core operations. The following tables for the nine months ended September 30, 20172018 and 20162017 identify such items by segment and reconcile net earnings attributable to shareholders to core net operating earnings, a non-GAAP financial measure that AFG believes is a useful tool for investors and analysts in analyzing ongoing operating trends (in millions):
      Other          Other      
P&C Annuity Run-off long-term care and life Consol. MIEs Holding Co., other and unallocated Total Non-core reclass GAAP TotalP&C Annuity Consol. MIEs Holding Co., other and unallocated Total Non-core reclass GAAP Total
Nine months ended September 30, 2017               
Nine months ended September 30, 2018             
Revenues:                            
Property and casualty insurance net earned premiums$3,354
 $
 $
 $
 $
 $3,354
 $
 $3,354
$3,595
 $
 $
 $
 $3,595
 $
 $3,595
Life, accident and health net earned premiums
 
 17
 
 
 17
 
 17

 
 
 18
 18
 
 18
Net investment income276
 1,082
 16
 (16) 8
 1,366
 
 1,366
323
 1,219
 (11) 21
 1,552
 
 1,552
Realized losses on securities
 
 
 
 
 
 (1) (1)
 
 
 
 
 (28) (28)
Income of MIEs:               
Income (loss) of MIEs:             
Investment income
 
 
 155
 
 155
 
 155

 
 187
 
 187
 
 187
Gain on change in fair value of assets/liabilities
 
 
 12
 
 12
 
 12
Gain (loss) on change in fair value of assets/liabilities
 
 (10) 
 (10) 
 (10)
Other income21
 79
 2
 (14) 66
 154
 
 154
8
 80
 (12) 70
 146
 
 146
Total revenues3,651
 1,161
 35
 137
 74
 5,058
 (1) 5,057
3,926
 1,299
 154
 109
 5,488
 (28) 5,460
                            
Costs and Expenses:                            
Property and casualty insurance:                            
Losses and loss adjustment expenses2,150
 
 
 
 
 2,150
 89
 2,239
2,188
 
 
 
 2,188
 18
 2,206
Commissions and other underwriting expenses1,046
 
 
 
 16
 1,062
 
 1,062
1,188
 
 
 17
 1,205
 
 1,205
Annuity benefits
 635
 
 
 
 635
 
 635

 664
 
 
 664
 
 664
Life, accident and health benefits
 
 21
 
 
 21
 
 21

 
 
 32
 32
 
 32
Annuity and supplemental insurance acquisition expenses
 153
 3
 
 
 156
 
 156

 199
 
 4
 203
 
 203
Interest charges on borrowed money
 
 
 
 65
 65
 
 65

 
 
 46
 46
 
 46
Expenses of MIEs
 
 
 137
 
 137
 
 137

 
 154
 
 154
 
 154
Other expenses26
 90
 7
 
 127
 250
 35
 285
31
 95
 
 137
 263
 9
 272
Total costs and expenses3,222
 878
 31
 137
 208
 4,476
 124
 4,600
3,407
 958
 154
 236
 4,755
 27
 4,782
Earnings before income taxes429
 283
 4
 
 (134) 582
 (125) 457
519
 341
 
 (127) 733
 (55) 678
Provision for income taxes150
 96
 1
 
 (58) 189
 (43) 146
100
 65
 
 (27) 138
 (12) 126
Net earnings, including noncontrolling interests279
 187
 3
 
 (76) 393
 (82) 311
419
 276
 
 (100) 595
 (43) 552
Less: Net earnings attributable to noncontrolling interests2
 
 
 
 
 2
 
 2
Less: Net loss attributable to noncontrolling interests(7) 
 
 
 (7) 
 (7)
Core Net Operating Earnings277
 187
 3
 
 (76) 391
    426
 276
 
 (100) 602
    
Non-core earnings attributable to shareholders (a):                            
Realized losses on securities, net of tax
 
 
 
 (1) (1) 1
 

 
 
 (22) (22) 22
 
Special A&E charges, net of tax(58) 
 
 
 (16) (74) 74
 
(14) 
 
 (7) (21) 21
 
Loss on retirement of debt, net of tax
 
 
 
 (7) (7) 7
 
Net Earnings Attributable to Shareholders$219
 $187
 $3
 $
 $(100) $309
 $
 $309
$412
 $276
 $
 $(129) $559
 $
 $559

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


      Other          Other      
P&C Annuity Run-off long-term care and life Consol. MIEs Holding Co., other and unallocated Total Non-core reclass GAAP TotalP&C Annuity Consol. MIEs Holding Co., other and unallocated Total Non-core reclass GAAP Total
Nine months ended September 30, 2016               
Nine months ended September 30, 2017             
Revenues:                            
Property and casualty insurance net earned premiums$3,184
 $
 $
 $
 $
 $3,184
 $
 $3,184
$3,354
 $
 $
 $
 $3,354
 $
 $3,354
Life, accident and health net earned premiums
 
 18
 
 
 18
 
 18

 
 
 17
 17
 
 17
Net investment income265
 1,010
 15
 (29) 6
 1,267
 
 1,267
276
 1,082
 (16) 24
 1,366
 
 1,366
Realized gains (losses) on:               
Securities
 
 
 
 
 
 (32) (32)
Subsidiaries
 
 
 
 
 
 2
 2
Realized losses on securities
 
 
 
 
 (1) (1)
Income of MIEs:                            
Investment income
 
 
 141
 
 141
 
 141

 
 155
 
 155
 
 155
Gain on change in fair value of assets/liabilities
 
 
 9
 
 9
 
 9

 
 12
 
 12
 
 12
Other income14
 76
 4
 (12) 58
 140
 32
 172
21
 79
 (14) 68
 154
 
 154
Total revenues3,463
 1,086
 37
 109
 64
 4,759
 2
 4,761
3,651
 1,161
 137
 109
 5,058
 (1) 5,057
                            
Costs and Expenses:                            
Property and casualty insurance:                            
Losses and loss adjustment expenses1,940
 
 
 
 
 1,940
 93
 2,033
2,150
 
 
 
 2,150
 89
 2,239
Commissions and other underwriting expenses1,017
 
 
 
 13
 1,030
 8
 1,038
1,046
 
 
 16
 1,062
 
 1,062
Annuity benefits
 640
 
 
 
 640
 
 640

 635
 
 
 635
 
 635
Life, accident and health benefits
 
 26
 
 
 26
 
 26

 
 
 21
 21
 
 21
Annuity and supplemental insurance acquisition expenses
 127
 4
 
 
 131
 
 131

 153
 
 3
 156
 
 156
Interest charges on borrowed money
 
 
 
 56
 56
 
 56

 
 
 65
 65
 
 65
Expenses of MIEs
 
 
 109
 
 109
 
 109

 
 137
 
 137
 
 137
Other expenses42
 83
 7
 
 121
 253
 5
 258
26
 90
 
 134
 250
 35
 285
Total costs and expenses2,999
 850
 37
 109
 190
 4,185
 106
 4,291
3,222
 878
 137
 239
 4,476
 124
 4,600
Earnings before income taxes464
 236
 
 
 (126) 574
 (104) 470
429
 283
 
 (130) 582
 (125) 457
Provision for income taxes164
 83
 
 
 (45) 202
 (12) 190
150
 96
 
 (57) 189
 (43) 146
Net earnings, including noncontrolling interests300
 153
 
 
 (81) 372
 (92) 280
279
 187
 
 (73) 393
 (82) 311
Less: Net earnings attributable to noncontrolling interests14
 
 
 
 
 14
 2
 16
2
 
 
 
 2
 
 2
Core Net Operating Earnings286
 153
 
 
 (81) 358
    277
 187
 
 (73) 391
    
Non-core earnings attributable to shareholders (a):                            
Realized losses on securities, net of tax and noncontrolling interests
 
 
 
 (19) (19) 19
 
Realized gain on subsidiaries, net of tax
 
 1
 
 
 1
 (1) 
Gain on sale of apartment property, net of tax and noncontrolling interests15
 
 
 
 
 15
 (15) 
Realized losses on securities, net of tax
 
 
 (1) (1) 1
 
Special A&E charges, net of tax(23) 
 
 
 (3) (26) 26
 
(58) 
 
 (16) (74) 74
 
Neon exited lines charge(65) 
 
 
 
 (65) 65
 
Loss on retirement of debt, net of tax
 
 
 (7) (7) 7
 
Net Earnings Attributable to Shareholders$213
 $153
 $1
 $
 $(103) $264
 $
 $264
$219
 $187
 $
 $(97) $309
 $
 $309

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


Property and Casualty Insurance Segment — Results of Operations   AFG’s property and casualty insurance operations contributed $340$501 million in GAAP pretax earnings in the first nine months of 20172018 compared to $395340 million in the first nine months of 20162017, a decreasean increase of $55161 million (14%(47%). Property and casualty core pretax earnings were $519 million in the first nine months of 2018 compared to $429 million in the first nine months of 2017, compared to $464 an increase of $90 million (21%). The increase in GAAP and core operating earnings reflects higher underwriting profits in the first nine months of 2018 compared to the same period in 2017 due primarily to lower catastrophe losses and higher favorable prior year reserve development as well as higher net investment income, due primarily to higher earnings from limited partnerships and similar investments and growth in the business, partially offset by lower income from the sale of real estate in the first 2016nine, a decrease months of $35 million (8%).2018 compared to the first nine months of 2017. The decreasehigh returns on limited partnerships and similar investments should not necessarily be expected to repeat in future periods. The increase in GAAP pretax earnings also reflects lower special A&E charges of $89 million in the first nine months of 20172018 compared to $36 million inthe first nine months of 2017.


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


the comparable 2016 period, lower core pretax earnings and a $32 million pretax non-core gain on the sale of an apartment property in the second quarter of 2016, partially offset by a pretax non-core charge of $65 million in the second quarter of 2016 related to the exit of certain lines of business within Neon. The decrease in GAAP and core pretax earnings reflects lower underwriting results due primarily to catastrophe losses from Hurricanes Harvey, Irma and Maria and two earthquakes in Mexico.

The following table details AFG’s GAAP and core earnings before income taxes from its property and casualty insurance operations for the nine months ended September 30, 20172018 and 20162017 (dollars in millions):

Nine months ended September 30,  Nine months ended September 30,  
2017 2016 % Change2018 2017 % Change
Gross written premiums$4,931
 $4,540
 9%$5,227
 $4,931
 6%
Reinsurance premiums ceded(1,341) (1,237) 8%(1,412) (1,341) 5%
Net written premiums3,590
 3,303
 9%3,815
 3,590
 6%
Change in unearned premiums(236) (119) 98%(220) (236) (7%)
Net earned premiums3,354
 3,184
 5%3,595
 3,354
 7%
Loss and loss adjustment expenses (a)2,150
 1,940
 11%
Loss and loss adjustment expenses (*)2,188
 2,150
 2%
Commissions and other underwriting expenses (b)1,046
 1,017
 3%1,188
 1,046
 14%
Core underwriting gain158
 227
 (30%)219
 158
 39%
          
Net investment income276
 265
 4%323
 276
 17%
Other income and expenses, net (c)(5) (28) (82%)(23) (5) 360%
Core earnings before income taxes429
 464
 (8%)519
 429
 21%
Pretax non-core special A&E charges(89) (36) 147%(18) (89) (80%)
Pretax non-core Neon exited lines charge
 (65) (100%)
Pretax non-core gain on sale of apartment property
 32
 (100%)
GAAP earnings before income taxes$340
 $395
 (14%)$501
 $340
 47%
          
(a) Excludes pretax non-core special A&E charges of $89 million and $36 million in the third quarter of 2017 and 2016, respectively, and a non-core charge of $57 million related to the exit of certain lines of business within Neon in the second quarter of 2016.
(b) Excludes a non-core charge of $8 million related to the exit of certain lines of business within Neon in the second quarter of 2016.
(c) Excludes a pretax non-core gain of $32 million on the sale of an apartment property in the second quarter of 2016.
(*) Excludes pretax non-core special A&E charges of $18 million and $89 million in the third quarter of 2018 and 2017, respectively.(*) Excludes pretax non-core special A&E charges of $18 million and $89 million in the third quarter of 2018 and 2017, respectively.
          
          
Combined Ratios:          
Specialty lines    Change    Change
Loss and LAE ratio64.0% 61.0% 3.0%60.8% 64.0% (3.2%)
Underwriting expense ratio31.2% 31.9% (0.7%)33.0% 31.2% 1.8%
Combined ratio95.2% 92.9% 2.3%93.8% 95.2% (1.4%)
          
Aggregate — including exited lines          
Loss and LAE ratio66.7% 63.8% 2.9%61.4% 66.7% (5.3%)
Underwriting expense ratio31.2% 32.2% (1.0%)33.0% 31.2% 1.8%
Combined ratio97.9% 96.0% 1.9%94.4% 97.9% (3.5%)

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

Gross Written Premiums
Gross written premiums (“GWP”) for AFG’s property and casualty insurance segment were $5.23 billion for the first nine months of 2018 compared to $4.93 billion for the first nine months of 2017, an increase of $296 million (6%). Detail of AFG’s property and casualty gross written premiums is shown below (dollars in millions):
 Nine months ended September 30,  
 2018 2017  
 GWP % GWP % % Change
Property and transportation$1,994
 38% $2,062
 42% (3%)
Specialty casualty2,667
 51% 2,350
 48% 13%
Specialty financial566
 11% 519
 10% 9%
 $5,227
 100% $4,931
 100% 6%


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


Gross Written Premiums
Gross written premiums (“GWP”) for AFG’s property and casualty insurance segment were $4.93 billion for the first nine months of 2017 compared to $4.54 billion for the first nine months of 2016, an increase of $391 million (9%). Detail of AFG’s property and casualty gross written premiums is shown below (dollars in millions):
 Nine months ended September 30,  
 2017 2016  
 GWP % GWP % % Change
Property and transportation$2,062
 42% $1,927
 43% 7%
Specialty casualty2,350
 48% 2,108
 46% 11%
Specialty financial519
 10% 505
 11% 3%
 $4,931
 100% $4,540
 100% 9%

Reinsurance Premiums Ceded
Reinsurance premiums ceded (“Ceded”) for AFG’s property and casualty insurance segment were 27% of gross written premiums for both the first nine months of 20172018 and the first nine months of 20162017. Detail of AFG’s property and casualty reinsurance premiums ceded is shown below (dollars in millions):
Nine months ended September 30,  Nine months ended September 30,  
2017 2016 Change in2018 2017 Change in
Ceded % of GWP Ceded % of GWP % of GWPCeded % of GWP Ceded % of GWP % of GWP
Property and transportation$(721) 35% $(649) 34% 1%$(688) 35% $(721) 35% %
Specialty casualty(625) 27% (582) 28% (1%)(739) 28% (625) 27% 1%
Specialty financial(79) 15% (87) 17% (2%)(106) 19% (79) 15% 4%
Other specialty84
   81
    121
   84
    
$(1,341) 27% $(1,237) 27% %$(1,412) 27% $(1,341) 27% %

Net Written Premiums
Net written premiums (“NWP”) for AFG’s property and casualty insurance segment were $3.59$3.82 billion for the first nine months of 20172018 compared to $3.303.59 billion for the first nine months of 20162017, an increase of $287225 million (9%6%). Detail of AFG’s property and casualty net written premiums is shown below (dollars in millions):
Nine months ended September 30,  Nine months ended September 30,  
2017 2016  2018 2017  
NWP % NWP % % ChangeNWP % NWP % % Change
Property and transportation$1,341
 37% $1,278
 39% 5%$1,306
 34% $1,341
 37% (3%)
Specialty casualty1,725
 48% 1,526
 46% 13%1,928
 51% 1,725
 48% 12%
Specialty financial440
 12% 418
 13% 5%460
 12% 440
 12% 5%
Other specialty84
 3% 81
 2% 4%121
 3% 84
 3% 44%
$3,590
 100% $3,303
 100% 9%$3,815
 100% $3,590
 100% 6%

Net Earned Premiums
Net earned premiums (“NEP”) for AFG’s property and casualty insurance segment were $3.353.60 billion for the first nine months of 20172018 compared to $3.18$3.35 billion for the first nine months of 20162017, an increase of $170241 million (5%7%). Detail of AFG’s property and casualty net earned premiums is shown below (dollars in millions):
Nine months ended September 30,  Nine months ended September 30,  
2017 2016  2018 2017  
NEP % NEP % % ChangeNEP % NEP % % Change
Property and transportation$1,226
 37% $1,197
 38% 2%$1,250
 35% $1,226
 37% 2%
Specialty casualty1,613
 48% 1,496
 47% 8%1,790
 50% 1,613
 48% 11%
Specialty financial435
 13% 416
 13% 5%457
 12% 435
 13% 5%
Other specialty80
 2% 75
 2% 7%98
 3% 80
 2% 23%
$3,354
 100% $3,184
 100% 5%$3,595
 100% $3,354
 100% 7%

The $296 million (6%) increase in gross written premiums for the first nine months of 2018 compared to the first nine months of 2017 reflects growth in the Specialty casualty and Specialty financial sub-segments, partially offset by lower gross written premiums in the Property and transportation sub-segment. Overall average renewal rates increased approximately 1% in the first nine months of 2018. Excluding the workers’ compensation business, renewal pricing increased approximately 3%.

Property and transportation Gross written premiums decreased$68 million (3%) in the first nine months of 2018 compared to the first nine months of 2017. This decrease was largely the result of lower year-over-year premiums in the crop insurance business, as well as a change in the timing of two large policy renewals in one of the transportation businesses from the third quarter to the fourth quarter. Gross written premiums in the other businesses in this group grew by 6% in the first nine months of 2018 compared to the first nine months of 2017. Average renewal rates increased approximately 4% for this group in the first nine months of 2018. Reinsurance premiums ceded as a percentage of gross written premiums were comparable in the first nine months of 2018 and the first nine months of 2017.


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


TheSpecialty casualty Gross written premiums increased$391317 million (9%(13%) increasein gross written premiums for the first nine months of 20172018 compared to the first nine months of 20162017 reflectsdue primarily to growth in each of the Specialty property and casualty insurance sub-segments. Overall average renewal rates increased 1% in the first nine months of 2017.

Property and transportation Gross written premiums increased$135 million (7%) in the first nine months of 2017 compared to the first nine months of 2016. This increase was the result of higherat Neon. Higher gross written premiums in the agriculturalgeneral liability, executive liability and transportationexcess and surplus lines businesses andalso contributed to the Singapore branch. This growth was partially offset by lower premiums resulting from an exit from the customs bond business, which was part of the ocean marine operations.year-over-year growth. Average renewal rates increased approximately 3%decreased less than 1% for this group in the first nine months of 2017.2018. Excluding the workers’ compensation businesses, renewal rates for this group increased approximately 2%. Reinsurance premiums ceded as a percentage of gross written premiums increased 1 percentage point for the first nine months of 20172018 compared to the first nine months of 2016,2017, reflecting a changehigher cessions to AFG’s internal reinsurance program, which is included in the mix of businessOther specialty and the impact of reinstatement premiums resulting from reinsured hurricane losses.

Specialty casualty Gross written premiums increased$242 million (11%) in the first nine months of 2017 compared to the first nine months of 2016. New accounts written in the targeted markets businesses were the primary driver of the increase. Additionally, higher gross written premiumscessions in the workers’ compensation businesses, primarily the result of rate increases in the state of Florida, coupled with growth in the executive liability businesses and Neon, contributed to the growth in gross written premiums in 2017. Average renewal rates increased approximately 1% for this group in the first nine months of 2017. Reinsurance premiums ceded as a percentage of gross written premiums decreased 1 percentage point for the first nine months of 2017 compared to the first nine months of 2016, reflecting a change in the mix of business.businesses.

Specialty financial Gross written premiums increased $14$47 million (3%(9%) in the first nine months of 20172018 compared to the first nine months of 20162017 due primarily to growth in the fidelity and surety businesses, partially offset by lowerhigher premiums in the financial institutions business. Average renewal rates for this group decreasedincreased approximately 2%5% in the first nine months of 2017.2018. Reinsurance premiums ceded as a percentage of gross written premiums decreased 2increased 4 percentage points for the first nine months of 20172018 compared to the first nine months of 2016,2017, reflecting lower premiumshigher cessions in the financial institutions business, which were largely ceded.and equipment leasing businesses and the impact of a reinstatement premium in the third quarter of 2018 resulting from a reinsured loss in the fidelity business.

Other specialty The amounts shown as reinsurance premiums ceded represent business assumed by AFG’s internal reinsurance program from the operations that make up AFG’s other Specialty property and casualty insurance sub-segments. Reinsurance premiums assumed increased $37 million (44%) in the first nine months of 2018 compared to the first nine months of 2017, reflecting an increase in premiums retained, primarily from businesses in the Specialty casualty sub-segment.

Combined Ratio
The table below (dollars in millions) details the components of the combined ratio for AFG’s property and casualty insurance segment:
 Nine months ended September 30,   Nine months ended September 30,
 2018 2017 Change 2018 2017
Property and transportation         
Loss and LAE ratio69.2% 69.1% 0.1%    
Underwriting expense ratio26.3% 25.2% 1.1%    
Combined ratio95.5% 94.3% 1.2%    
Underwriting profit      $56
 $70
          
Specialty casualty         
Loss and LAE ratio60.7% 66.4% (5.7%)    
Underwriting expense ratio32.6% 30.7% 1.9%    
Combined ratio93.3% 97.1% (3.8%)    
Underwriting profit      $119
 $46
          
Specialty financial         
Loss and LAE ratio38.0% 41.4% (3.4%)    
Underwriting expense ratio52.0% 49.0% 3.0%    
Combined ratio90.0% 90.4% (0.4%)    
Underwriting profit      $46
 $42
          
Total Specialty         
Loss and LAE ratio60.8% 64.0% (3.2%)    
Underwriting expense ratio33.0% 31.2% 1.8%    
Combined ratio93.8% 95.2% (1.4%)    
Underwriting profit      $220
 $161
          
Aggregate — including exited lines         
Loss and LAE ratio61.4% 66.7% (5.3%)    
Underwriting expense ratio33.0% 31.2% 1.8%    
Combined ratio94.4% 97.9% (3.5%)    
Underwriting profit      $201
 $69


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AMERICAN FINANCIAL GROUP, INC. 10-Q
Management’s Discussion and Analysis of Financial Condition and Results of Operations — Continued


Combined Ratio
The table below (dollars in millions) details the components of the combined ratio for AFG’s property and casualty segment:
 Nine months ended September 30,   Nine months ended September 30,
 2017 2016 Change 2017 2016
Property and transportation         
Loss and LAE ratio69.1% 66.4% 2.7%    
Underwriting expense ratio25.2% 26.0% (0.8%)    
Combined ratio94.3% 92.4% 1.9%    
Underwriting profit      $70
 $91
          
Specialty casualty         
Loss and LAE ratio66.4% 65.0% 1.4%    
Underwriting expense ratio30.7% 30.7% %    
Combined ratio97.1% 95.7% 1.4%    
Underwriting profit      $46
 $65
          
Specialty financial         
Loss and LAE ratio41.4% 31.8% 9.6%    
Underwriting expense ratio49.0% 52.7% (3.7%)    
Combined ratio90.4% 84.5% 5.9%    
Underwriting profit      $42
 $64
          
Total Specialty         
Loss and LAE ratio64.0% 61.0% 3.0%    
Underwriting expense ratio31.2% 31.9% (0.7%)    
Combined ratio95.2% 92.9% 2.3%    
Underwriting profit      $161
 $227
          
Aggregate — including exited lines         
Loss and LAE ratio66.7% 63.8% 2.9%    
Underwriting expense ratio31.2% 32.2% (1.0%)    
Combined ratio97.9% 96.0% 1.9%    
Underwriting profit      $69
 $126
The Specialty property and casualty insurance operations generated an underwriting profit of $161$220 million for the first nine months of 20172018 compared to $227$161 million for the first nine months of 2016, a decrease2017, an increase of $66$59 million (29% (37%) with each of the Specialty propertycasualty and casualty insuranceSpecialty financial sub-segments reporting lowerhigher year-over-year underwriting profit, due primarily to significantly lower catastrophe losses and higher catastrophe losses.favorable prior year reserve development in the Specialty casualty sub-segment. Overall catastrophe losses were $132$64 million (3.9(1.8 points on the combined ratio) for the first nine months of 20172018 compared to $43$132 million (1.3(3.9 points) for the first nine months of 2016.2017. In connection with catastrophe losses incurred in the third quarterfirst nine months of 2018, AFG paid $3 million in net reinstatement premiums, resulting in a total pretax loss from catastrophes of $67 million. In connection with catastrophe losses incurred in the first nine months of 2017, AFG reduced profit-based commissions payable to agents by $8 million in the Specialty financial sub-segment and paid $6 million in net reinstatement premiums, resulting in a total pretax loss from catastrophes of $130 million for the nine months ended September 30, 2017.million.

Property and transportation Underwriting profit for this group was $56 million for the first nine months of 2018 compared to $70 million for the first nine months of 2017, a decrease of $7014 million (20%). Higher underwriting profit in the crop business and at National Interstate, and improved results in the ocean marine operations were more than offset by lower underwriting profits in the property and inland marine, aviation, trucking and equine businesses. Catastrophe losses were $27 million (2.2 points on the combined ratio) and reinstatement premiums paid were $1 million for the first nine months of 2018 compared to catastrophe losses of $39 million (3.2 points) and related reinstatement premiums of $2 million for the first nine months of 2017.

Specialty casualty Underwriting profit for this group was $119 million for the first nine months of 2018 compared to $46 million for the first nine months of 2017 compared, an increase of $73 million (159%). These results reflect lower catastrophe losses at Neon, higher underwriting profits in the workers’ compensation businesses, due primarily to $91higher favorable prior year reserve development, and improved results in the executive liability business. Catastrophe losses were $17 million (0.9 points on the combined ratio) and reinstatement premiums paid were $1 million for the first nine months of 2016, a decrease2018 compared to catastrophe losses of $21$57 million (23%). Lower underwriting profits in the crop and ocean marine businesses were the primary drivers of these lower results. The comparable 2016 period included strong profitability in the crop business. Catastrophe losses were $39 million (3.2 points on the combined ratio) (3.5 points) and related reinstatement premiums wereof $2 million for the first nine months of 2017 compared to catastrophe losses of $25 million (2.1 points) for the first nine months of 2016.2017.

Specialty casualtyfinancial Underwriting profit for this group was $46 million for the first nine months of 20172018 compared to $42 million for the first $65nine months of 2017, an increase of $4 million (10%) due primarily to lower catastrophe losses in the lender-placed mortgage property book within the financial institutions business. Catastrophe losses were $18 million (3.9 points on the combined ratio) for the first nine months of 2018 compared to $35 million (8.0 points) for the first nine months of 2017. In connection with catastrophe losses incurred in the third quarter of 2018, the Specialty financial sub-segment paid $1 million in reinstatement premiums compared to a reduction of profit-based commissions payable to agents of $8 million and reinstatement premiums of $2 million in the first nine months of 2017.

Other specialty This group reported an underwriting loss of $1 million for the first nine months of 2018 compared to an underwriting profit of $3 million in the first nine months of 2017, a decrease of $4 million (133%). This decrease is due primarily to losses in the business assumed by AFG’s internal reinsurance program from the operations that make up AFG’s other Specialty sub-segments in the first nine months of 2018 compared to earnings in the first nine months of 2017, partially offset by the impact of a $6 million charge recorded in 2017 to adjust the deferred gain on the retroactive reinsurance transaction entered into in connection with the sale of businesses in 1998.

Aggregate See Special asbestos and environmental reserve charges under “Results of Operations — Property and Casualty Insurance Segment — Net prior year reserve development” for the quarters ended September 30, 2018 and 2017 for a discussion of the $18 million and $89 million pretax non-core special A&E charges recorded in the third quarter of 2018 and 2017, respectively.

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


Losses and Loss Adjustment Expenses
AFG’s overall loss and LAE ratio was 61.4% for the first nine months of 20162018 compared to 66.7% for the first nine months of 2017, a decrease of $19 million5.3 (29%). Higher underwriting profitabilitypercentage points. The components of AFG’s property and casualty losses and LAE amounts and ratio are detailed below (dollars in the excessmillions):
 Nine months ended September 30,  
 Amount Ratio Change in
 2018 2017 2018 2017 Ratio
Property and transportation         
Current year, excluding catastrophe losses$881
 $844
 70.5% 68.9% 1.6%
Prior accident years development(43) (36) (3.5%) (3.0%) (0.5%)
Current year catastrophe losses27
 39
 2.2% 3.2% (1.0%)
Property and transportation losses and LAE and ratio$865
 $847
 69.2% 69.1% 0.1%
          
Specialty casualty         
Current year, excluding catastrophe losses$1,157
 $1,049
 64.6% 65.0% (0.4%)
Prior accident years development(87) (34) (4.8%) (2.1%) (2.7%)
Current year catastrophe losses17
 57
 0.9% 3.5% (2.6%)
Specialty casualty losses and LAE and ratio$1,087
 $1,072
 60.7% 66.4% (5.7%)
          
Specialty financial         
Current year, excluding catastrophe losses$175
 $167
 38.2% 38.4% (0.2%)
Prior accident years development(19) (22) (4.1%) (5.0%) 0.9%
Current year catastrophe losses18
 35
 3.9% 8.0% (4.1%)
Specialty financial losses and LAE and ratio$174
 $180
 38.0% 41.4% (3.4%)
          
Total Specialty         
Current year, excluding catastrophe losses$2,274
 $2,105
 63.3% 62.7% 0.6%
Prior accident years development(151) (90) (4.3%) (2.6%) (1.7%)
Current year catastrophe losses64
 132
 1.8% 3.9% (2.1%)
Total Specialty losses and LAE and ratio$2,187
 $2,147
 60.8% 64.0% (3.2%)
          
Aggregate — including exited lines         
Current year, excluding catastrophe losses$2,273
 $2,105
 63.3% 62.7% 0.6%
Prior accident years development(131) 2
 (3.7%) 0.1% (3.8%)
Current year catastrophe losses64
 132
 1.8% 3.9% (2.1%)
Aggregate losses and LAE and ratio$2,206
 $2,239
 61.4% 66.7% (5.3%)
Current accident year losses and surplus lines businessesLAE, excluding catastrophe losses
The current accident year loss and LAE ratio, excluding catastrophe losses for AFG’s Specialty property and casualty insurance operations was more than offset by lower underwriting profitability in the executive liability, workers’ compensation and general liability businesses, due primarily to lower favorable prior year reserve development. Catastrophe losses were $57 million (3.5 points on the combined ratio) and related net reinstatement premiums were $2 million63.3% for the first nine months of 20172018 compared to catastrophe losses of $6 million (0.4 points)62.7% for the first nine months of 2016.2017, an increase of 0.6 percentage points.

Property and transportation   The 1.6 percentage point increase in the loss and LAE ratio for the current year, excluding catastrophe losses reflects an increase in the loss and LAE ratio of the aviation, property and inland marine and equine businesses in the first nine months of 2018 compared to the first nine months of 2017.

Specialty casualty   The 0.4 percentage point decrease in the loss and LAE ratio for the current year, excluding catastrophe losses reflects a decrease in the loss and LAE ratio at Neon, due primarily to a change in the mix of business, partially offset by an increase in the loss and LAE ratio in the targeted markets businesses.

Specialty financial   The loss and LAE ratio for the current year, excluding catastrophe losses is comparable between periods.

Net prior year reserve development
AFG’s Specialty property and casualty insurance operations recorded net favorable reserve development related to prior accident years of $151 million in the first nine months of 2018 compared to $90 million in the first nine months of 2017, an increase of $61 million (68%).

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


Specialty financial Underwriting profit for this group was $42 million for the first nine months of 2017 compared to $64 million for the first nine months of 2016, a decrease of $22 million (34%). Higher underwriting profitability in the surety business was more than offset by lower underwriting profitability in the financial institutions business due primarily to higher catastrophe losses. Catastrophe losses were $35 million (8.0 points on the combined ratio) for the first nine months of 2017 compared to $9 million (2.2 points) for the first nine months of 2016. In connection with catastrophe losses incurred in the third quarter of 2017, the Specialty financial sub-segment reduced profit-based commissions payable to agents by $8 million (1.8 points on the combined ratio) and paid $2 million in reinstatement premiums.

Other specialty This group reported an underwriting profit of $3 million for the first nine months of 2017 compared to $7 million in the first nine months of 2016, a decrease of $4 million (57%). The decrease is due primarily to a $6 million charge to adjust the deferred gain on the retroactive reinsurance transaction entered into in connection with the sale of businesses in 1998.

Aggregate See “Special asbestos and environmental reserve charges” under “Results of Operations — Property and Casualty Insurance Segment — Net prior year reserve development” for the quarters ended September 30, 2017 and 2016 for a discussion of the $89 million and $36 million pretax non-core special A&E charges recorded in the third quarter of 2017 and 2016, respectively. As discussed below in more detail under “Net prior year reserve development,” AFG recorded a $65 million non-core charge in the second quarter of 2016 related to the exit of certain lines of business within Neon, AFG’s Lloyd’s-based insurer.

Losses and Loss Adjustment Expenses
AFG’s overall loss and LAE ratio was 66.7% for the first nine months of 2017 compared to 63.8% for the first nine months of 2016, an increase of 2.9 percentage points. The components of AFG’s property and casualty losses and LAE amounts and ratio are detailed below (dollars in millions):
 Nine months ended September 30,  
 Amount Ratio Change in
 2017 2016 2017 2016 Ratio
Property and transportation         
Current year, excluding catastrophe losses$844
 $804
 68.9% 67.1% 1.8%
Prior accident years development(36) (34) (3.0%) (2.8%) (0.2%)
Current year catastrophe losses39
 25
 3.2% 2.1% 1.1%
Property and transportation losses and LAE and ratio$847
 $795
 69.1% 66.4% 2.7%
          
Specialty casualty         
Current year, excluding catastrophe losses$1,049
 $982
 65.0% 65.7% (0.7%)
Prior accident years development(34) (16) (2.1%) (1.1%) (1.0%)
Current year catastrophe losses57
 6
 3.5% 0.4% 3.1%
Specialty casualty losses and LAE and ratio$1,072
 $972
 66.4% 65.0% 1.4%
          
Specialty financial         
Current year, excluding catastrophe losses$167
 $140
 38.4% 33.6% 4.8%
Prior accident years development(22) (17) (5.0%) (4.0%) (1.0%)
Current year catastrophe losses35
 9
 8.0% 2.2% 5.8%
Specialty financial losses and LAE and ratio$180
 $132
 41.4% 31.8% 9.6%
          
Total Specialty         
Current year, excluding catastrophe losses$2,105
 $1,968
 62.7% 61.8% 0.9%
Prior accident years development(90) (71) (2.6%) (2.1%) (0.5%)
Current year catastrophe losses132
 43
 3.9% 1.3% 2.6%
Total Specialty losses and LAE and ratio$2,147
 $1,940
 64.0% 61.0% 3.0%
          
Aggregate — including exited lines         
Current year, excluding catastrophe losses$2,105
 $1,968
 62.7% 61.8% 0.9%
Prior accident years development2
 22
 0.1% 0.7% (0.6%)
Current year catastrophe losses132
 43
 3.9% 1.3% 2.6%
Aggregate losses and LAE and ratio$2,239
 $2,033
 66.7% 63.8% 2.9%

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AMERICAN FINANCIAL GROUP, INC. 10-Q
Management’s Discussion and Analysis of Financial Condition and Results of Operations — Continued


Current accident year losses and LAE, excluding catastrophe losses
The current accident year loss and LAE ratio, excluding catastrophe losses for AFG’s Specialty property and casualty insurance operations was 62.7% for the first nine months of 2017 compared to 61.8% for the first nine months of 2016, an increase of 0.9 percentage points.

Property and transportation   The 1.8 percentage point increase in the loss and LAE ratio for the current year, excluding catastrophe losses reflects an increase in the loss and LAE ratio of the crop business in the first nine months of 2017 compared to the first nine months of 2016.

Specialty casualty   The 0.7 percentage point decrease in the loss and LAE ratio for the current year, excluding catastrophe losses reflects a decrease in the loss and LAE ratio at Neon, partially offset by an increase in the loss and LAE ratio in the public sector business.

Specialty financial   The 4.8 percentage point increase in the loss and LAE ratio for the current year, excluding catastrophe losses reflects an increase in the loss and LAE ratio of the financial institutions business.

Net prior year reserve development
AFG’s Specialty property and casualty insurance operations recorded net favorable reserve development related to prior accident years of $90 million in the first nine months of 2017 compared to $71 million in the first nine months of 2016, an increase of $19 million (27%).

Property and transportation Net favorable reserve development of $3643 million in the first nine months of 20172018 reflects lower than expected losses in the crop business and lower than expected claim severity at National Interstate, partially offset by higher than expected claim severity in the Singapore branch and aviation operations. Net favorable reserve development of $36 million in the first nine months of 2017 reflects lower than expected losses in the crop and equine businesses and lower than expected claim severity in the property and inland marine and transportation businesses, partially offset by higher than expected claim severity in the ocean marine business.

Specialty casualty Net favorable reserve development of $34$87 million in the first nine months of 20162018 reflects lower than expected lossesanticipated claim severity in the crop operationsworkers’ compensation businesses, and to a lesser extent, lower than expected claim severity in the propertyexecutive liability business. This was partially offset by higher than expected claim frequency and inland marineseverity in the excess and trucking businesses.

Specialty casualtysurplus lines. Net favorable reserve development of $34 million in the first nine months of 2017 reflects lower than anticipated claim severity in the workers’ compensation businesses and at Neon, partially offset by higher than anticipated claim severity in the targeted markets and general liability businesses.

Specialty financial Net favorable reserve development of $16$19 million in the first nine months of 20162018 reflects lower than anticipated claim severity in workers’ compensation business and directors and officers liability insurance and lower than expected claim frequency and severity in excess liabilitythe surety business partially offset by adverse reserve development at Neon, higherand lower than anticipated severity in New York contractor claims and higher than anticipatedexpected claim severity in general liability insurance.

Specialty financial the fidelity business. Net favorable reserve development of $22 million in the first nine months of 2017 reflects lower than anticipated claim severity in the fidelity business and lower than expected claim frequency and severity in the surety business. Net favorable reserve development of $17 million in the first nine months of 2016 reflects lower than anticipated claim severity in the fidelity business and lower than expected claim frequency and severity in the surety business, partially offset by higher than anticipated claim frequency in the financial institutions business.

Other specialty In addition to the development discussed above, total Specialty prior year reserve development includes net favorable reserve development of $2 million in the first nine months of 2018 and net adverse reserve development of $2 million in the first nine months of 2017 and2017. The favorable reserve development of $4 million in the first nine months of 2016.2018 reflects amortization of the deferred gains on the retroactive reinsurance transactions entered into in connection with the sale of businesses in 1998 and 2001, partially offset by adverse reserve development associated with AFG’s internal reinsurance program. The adverse reserve development in the first nine months of 2017 reflects a $6 million charge to adjust the deferred gain on the retroactive reinsurance transaction entered into in connection with the sale of businesses in 1998, partially offset by the amortization of deferred gains on retroactive reinsurance and favorable reserve development associated with AFG’s internal reinsurance program. Favorable reserve development in the first nine months of 2016 reflects amortization of deferred gains on retroactive reinsurance.

Special asbestos and environmental reserve charges See Special asbestos and environmental reserve charges”charges under “Results of Operations — Property and Casualty Insurance Segment — Net prior year reserve developmentdevelopment” for the quarters ended September 30, 20172018 and 20162017 for a discussion of the $89$18 million and $36$89 million special A&E charges recorded in the third quarter of 20172018 and 2016,2017, respectively.

Neon exited lines chargeAggregate DuringAggregate net prior accident years reserve development for AFG’s property and casualty insurance segment includes the second quarterspecial A&E charges mentioned above and net adverse reserve development of 2016, $2 million in the first nine months of 2018 and $3 million in the first nine months of 2017 related to business outside the Specialty group that AFG no longer writes.

Catastrophe losses
Catastrophe losses of $64 million in the first nine months of 2018 resulted primarily from Hurricane Florence, storms and flooding in several regions of the United States and mudslides in California. Catastrophe losses of $132 million in the first nine months of 2017 resulted primarily from Hurricanes Harvey, Irma and Maria, two earthquakes in Mexico and storms and tornadoes in several regions of the United States.


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AMERICAN FINANCIAL GROUP, INC. 10-Q
Management’s Discussion and Analysis of Financial Condition and Results of Operations — Continued


Commissions and Other Underwriting Expenses
AFG’s specialist Lloyd’s market insurer completed a strategic reviewproperty and casualty commissions and other underwriting expenses (“U/W Exp”) were $1.19 billion in the first nine months of its business under a new leadership team and re-launched as Neon Underwriting Ltd. (“Neon”2018 compared to $1.05 billion for the first nine months of 2017, an increase of $142 million (14%). As partAFG’s underwriting expense ratio was 33.0% for the first nine months of its strategic2018 compared to 31.2% for the first nine months of 2017, an increase of 1.8 percentage points. Detail of AFG’s property and casualty commissions and other underwriting expenses and underwriting expense ratios is shown below (dollars in millions):
 Nine months ended September 30,  
 2018 2017 Change in
 U/W Exp % of NEP U/W Exp % of NEP % of NEP
Property and transportation$329
 26.3% $309
 25.2% 1.1%
Specialty casualty584
 32.6% 495
 30.7% 1.9%
Specialty financial237
 52.0% 213
 49.0% 3.0%
Other specialty38
 37.8% 29
 35.4% 2.4%
Total Specialty$1,188
 33.0% $1,046
 31.2% 1.8%

Property and transportation   Commissions and other underwriting expenses as a percentage of net earned premiums increased 1.1 percentage points in the first nine months of 2018 compared to the first nine months of 2017, reflecting lower premiums in the crop business, which has a lower expense ratio than AFG’s overall Property and transportation group and an increase in the expense ratio in the transportation businesses.

Specialty casualty   Commissions and other underwriting expenses as a percentage of net earned premiums increased 1.9 percentage points in the first nine months of 2018 compared to the first nine months of 2017, reflecting growth at Neon, which has a higher expense ratio than AFG’s overall Specialty casualty group and higher dividends paid to policyholders in the workers’ compensation businesses.

Specialty financial   Commissions and other underwriting expenses as a percentage of net earned premiums increased 3.0 percentage points in the first nine months of 2018 compared to the first nine months of 2017, reflecting higher ceding commissions and higher profitability-based commissions paid to agents in the financial institutions business compared to the first nine months of 2017, which included an $8 million commission expense reduction due to hurricane losses in the period.

Property and Casualty Net Investment Income
Net investment income in AFG’s property and casualty insurance operations was $323 million in the first nine months of 2018 compared to $276 million in the first nine months of 2017, an increase of $47 million (17%). The average invested assets and overall yield earned on investments held by AFG’s property and casualty insurance operations are provided below (dollars in millions):
 Nine months ended September 30,    
 2018 2017 Change % Change
Net investment income$323
 $276
 $47
 17%
        
Average invested assets (at amortized cost)$10,405
 $9,853
 $552
 6%
        
Yield (net investment income as a % of average invested assets)4.14% 3.73% 0.41% 

        
Tax equivalent yield (*)4.32% 4.20% 0.12% 


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

The property and casualty insurance segment’s increase in net investment income for the first nine months of 2018 as compared to the first nine months of 2017 reflects growth in the property and casualty insurance segment and very strong earnings from limited partnerships and similar investments. The property and casualty insurance segment’s overall yield on investments (net investment income as a percentage of average invested assets) was 4.14% for the first nine months of 2018 compared to 3.73% for the first nine months of 2017, an increase of 0.41 percentage points due primarily to the higher earnings from limited partnerships and similar investments. The high returns from limited partnerships and similar investments should not necessarily be expected to repeat in future periods.


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AMERICAN FINANCIAL GROUP, INC. 10-Q
Management’s Discussion and Analysis of Financial Condition and Results of Operations — Continued


review, Neon sold and/or exited certain historical lines of business including its UK and international medical malpractice and general liability classes. As a result of Neon’s claims review of its exited lines of business, AFG recorded a charge of approximately $65 million including $57 million to increase loss reserves primarily related to its medical malpractice and general liability lines. Consistent with the treatment of other items that are not indicative of AFG’s ongoing operations (both favorable and unfavorable), this charge was treated as non-core because it resulted from a special strategic review of lines of business that Neon no longer writes.

Aggregate Aggregate net prior accident years reserve development for AFG’s property and casualty insurance segment includes the special A&E charges and Neon exited lines charge mentioned above and adverse reserve development of $3 million in the first nine months of 2017 related to business outside the Specialty group that AFG no longer writes.

Catastrophe losses
AFG generally seeks to reduce its exposure to catastrophes through individual risk selection, including minimizing coastal and known fault-line exposures, and the purchase of reinsurance. Catastrophe losses of $132 million in the first nine months of 2017 resulted primarily from Hurricanes Harvey, Irma and Maria, two earthquakes in Mexico and storms and tornadoes in several regions of the United States. Catastrophe losses of $43 million in the first nine months of 2016 resulted primarily from winter storms in the first quarter of 2016, April storms in Texas in the second quarter of 2016 and flooding in Louisiana and multiple storms in the southern United States in the third quarter of 2016.

Commissions and Other Underwriting Expenses
AFG’s property and casualty commissions and other underwriting expenses (“U/W Exp”) were $1.05 billion in the first nine months of 2017 compared to $1.03 billion for the first nine months of 2016, an increase of $21 million (2%). AFG’s underwriting expense ratio was 31.2% for the first nine months of 2017 compared to 32.2% for the first nine months of 2016, a decrease of 1.0 percentage point. Detail of AFG’s property and casualty commissions and other underwriting expenses and underwriting expense ratios is shown below (dollars in millions):
 Nine months ended September 30,  
 2017 2016 Change in
 U/W Exp % of NEP U/W Exp % of NEP % of NEP
Property and transportation$309
 25.2% $311
 26.0% (0.8%)
Specialty casualty495
 30.7% 459
 30.7% %
Specialty financial213
 49.0% 220
 52.7% (3.7%)
Other specialty29
 35.4% 27
 36.9% (1.5%)
Total Specialty1,046
 31.2% 1,017
 31.9% (0.7%)
Neon exited lines charge
   8
   

Total Aggregate$1,046
 31.2% $1,025
 32.2% (1.0%)

AFG’s overall expense ratio decreased 1.0 percentage points in the first nine months of 2017 as compared to the first nine months of 2016.

Property and transportation   Commissions and other underwriting expenses as a percentage of net earned premiums decreased 0.8 percentage points in the first nine months of 2017 compared to the first nine months of 2016 reflecting an increase in ceding commissions received from reinsurers in the crop business.

Specialty casualty   Commissions and other underwriting expenses as a percentage of net earned premiums were flat in the first nine months of 2017 compared to the first nine months of 2016.

Specialty financial   Commissions and other underwriting expenses as a percentage of net earned premiums decreased 3.7 percentage points in the first nine months of 2017 compared to the first nine months of 2016 reflecting lower profitability-based commissions paid to agents in the financial institutions business, including an $8 million commission expense reduction due to hurricane losses.

Aggregate   Aggregate commissions and other underwriting expenses for AFG’s property and casualty insurance segment includes $8 million of restructuring charges recorded as part of the $65 million non-core charge related to the exit of certain lines of business within Neon, AFG’s Lloyd’s-based insurer, recorded in the second quarter of 2016. See “Neon exited lines

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AMERICAN FINANCIAL GROUP, INC. 10-Q
Management’s Discussion and Analysis of Financial Condition and Results of Operations — Continued


charge” under “Results of Operations — Property and Casualty Insurance Segment — Net prior year reserve development” for the nine months ended September 30, 2017 and 2016.

Property and Casualty Net Investment Income
Net investment income in AFG’s property and casualty insurance operations was $276 million in the first nine months of 2017 compared to $265 million in the first nine months of 2016, an increase of $11 million (4%). In recent years, yields available in the financial markets on fixed maturity securities have generally declined, placing downward pressure on AFG’s investment portfolio yield. The average invested assets and overall yield earned on investments held by AFG’s property and casualty insurance operations are provided below (dollars in millions):
 Nine months ended September 30,    
 2017 2016 Change % Change
Net investment income$276
 $265
 $11
 4%
        
Average invested assets (at amortized cost)$9,853
 $9,507
 $346
 4%
        
Yield (net investment income as a % of average invested assets)3.73% 3.72% 0.01% 

        
Tax equivalent yield (*)4.20% 4.22% (0.02%) 


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

The increase in average invested assets and net investment income in the property and casualty insurance segment for the first nine months of 2017 as compared to the first nine months of 2016 is due primarily to growth in the property and casualty insurance segment. The property and casualty insurance segment’s overall yield on investments (net investment income as a percentage of average invested assets) was 3.73% for the first nine months of 2017 compared to 3.72% for the first nine months of 2016, an increase of 0.01 percentage points reflecting an increase in equity in the earnings of limited partnerships and similar investments, partially offset by the impact of lower yields available in the financial markets and lower income from certain investments that are required to be carried at fair value through earnings.

Property and Casualty Other Income and Expenses, Net
GAAP otherOther income and expenses, net for AFG’s property and casualty insurance operations was a net expense of $23 million for the first nine months of 2018 compared to $5 million for the first nine months of 2017 compared to net income, an increase of $4$18 million for the first nine months of 2016, a decrease of $9 million (225%). Core other income and expenses, net for AFG’s property and casualty insurance operations was a net expense of $5 million for the first nine months of 2017 compared to $28 million for the first nine months of 2016, an improvement of $23 million (82%(360%). The table below details the items included in GAAP and core other income and expenses, net for AFG’s property and casualty insurance operations (in millions):
 Nine months ended September 30,
 2017 2016
Other income   
Income from the sale of real estate (*)$16
 $
Other5
 14
Total other income21
 14
Other expenses   
Amortization of intangibles6
 6
NATL merger expenses
 5
Other20
 31
Total other expense26
 42
Core other income and expenses, net(5) (28)
Pretax non-core gain on sale of apartment property
 32
GAAP other income and expenses, net$(5) $4
(*)Excludes a pretax non-core gain of $32 million on the sale of an apartment property in the second quarter of 2016.

 Nine months ended September 30,
 2018 2017
Other income   
Income from the sale of real estate$
 $16
Other8
 5
Total other income8
 21
Other expenses   
Amortization of intangibles7
 6
Other24
 20
Total other expense31
 26
Other income and expenses, net$(23) $(5)
Other income for AFG’sIncome from the sale of real estate includes $13 million related to the sale of a hotel property and casualty insurance operations includes a $4 million death benefit on a life insurance policy received in the second quarter of 2016.2017.


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AMERICAN FINANCIAL GROUP, INC. 10-Q
Management’s Discussion and Analysis of Financial Condition and Results of Operations — Continued


Annuity Segment — Results of Operations
AFG’s annuity operations contributed $283341 million in pretax earnings in the first nine months of 20172018 compared to $236283 million in the first nine months of 20162017, an increase of $4758 million (20%). AFG’s annuity segment results for the first nine months of 20172018 compared to the first nine months of 20162017 reflect an 11%a 10% increase in average annuity investments (at amortized cost), higher equity in the earnings offrom limited partnerships and similar investments and the unfavorablefavorable impact of significantly lower than anticipated interest rates on the fair value accounting for derivatives related to fixed-indexed annuities in the 2016 period,(“FIAs”), partially offset by an unlocking charge in the first nine months of 2018 and the impact of lower investment yields due to the run-off of higher yielding investments. While both periods reflect the positive impact of a higher stock marketThe high returns on limited partnerships and the negative impact of lower than anticipated interest rates on thesimilar investments should not necessarily be expected to repeat in future periods.

The fair value accounting for fixed-indexed annuities, the decrease inof derivatives related to FIAs was favorably impacted by higher than anticipated interest rates in the first nine months of 2016 had a significantly higher unfavorable impact2018 compared to the 2017negative impact of lower than anticipated interest rates in the first nine months of 2017. The favorable impact of interest rates between periods was partially offset by the negative impact of higher interest on the embedded derivative (from growth in the FIA business and higher interest rates) and higher than expected option costs in the 2018 period. 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 of actual experience would cause material revisions to future estimates, these assumptions are updated (unlocked) in an interim quarter. Due to continued higher FIA option costs (resulting primarily from higher than expected risk-free 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.

The following table details AFG’s earnings before income taxes from its annuity operations for the nine months ended September 30, 20172018 and 20162017 (dollars in millions).
Nine months ended September 30,  Nine months ended September 30,  
2017 2016 % Change2018 2017 % Change
Revenues:          
Net investment income$1,082
 $1,010
 7%$1,219
 $1,082
 13%
Other income:          
Guaranteed withdrawal benefit fees43
 39
 10%48
 43
 12%
Policy charges and other miscellaneous income36
 37
 (3%)32
 36
 (11%)
Total revenues1,161
 1,086
 7%1,299
 1,161
 12%
          
Costs and Expenses:          
Annuity benefits (*)635
 640
 (1%)664
 635
 5%
Acquisition expenses153
 127
 20%199
 153
 30%
Other expenses90
 83
 8%95
 90
 6%
Total costs and expenses878
 850
 3%958
 878
 9%
Earnings before income taxes$283
 $236
 20%$341
 $283
 20%
Detail of annuity earnings before income taxes (dollars in millions):
Nine months ended September 30,  Nine months ended September 30,  
2017 2016 % Change2018 2017 % Change
Earnings before income taxes — before the impact of derivatives related to FIAs$305
 $292
 4%
Earnings before income taxes — before the impact of unlocking and derivatives related to FIAs$354
 $305
 16%
Unlocking(27) 
 %
Impact of derivatives related to FIAs(22) (56) (61%)14
 (22) (164%)
Earnings before income taxes$283
 $236
 20%$341
 $283
 20%

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AMERICAN FINANCIAL GROUP, INC. 10-Q
Management’s Discussion and Analysis of Financial Condition and Results of Operations — Continued


(*)Annuity benefits consisted of the following (dollars in millions):
Nine months ended September 30,  Nine months ended September 30,  
2017 2016 % Change2018 2017 % Change
Interest credited — fixed$469
 $426
 10%$518
 $469
 10%
Interest credited — fixed component of variable annuities4
 4
 %4
 4
 %
Other annuity benefits:          
Change in expected death and annuitization reserve13
 14
 (7%)13
 13
 %
Amortization of sales inducements14
 17
 (18%)15
 14
 7%
Change in guaranteed withdrawal benefit reserve51
 49
 4%60
 51
 18%
Change in other benefit reserves36
 23
 57%29
 36
 (19%)
Total other annuity benefits114
 103
 11%117
 114
 3%
Total before impact of derivatives related to FIAs587
 533
 10%
Total before impact of derivatives related to FIAs and unlocking639
 587
 9%
Derivatives related to fixed-indexed annuities:          
Embedded derivative mark-to-market386
 188
 105%242
 386
 (37%)
Equity option mark-to-market(338) (81) 317%(271) (338) (20%)
Impact of derivatives related to FIAs48
 107
 (55%)(29) 48
 (160%)
Unlocking54
 
 %
Total annuity benefits$635
 $640
 (1%)$664
 $635
 5%

See Annuity Unlocking below for a discussion of the impact that the unlocking of actuarial assumptions had on annuity benefit expense in 2018.

Net Spread on Fixed Annuities (excludes variable annuity earnings)
The table below (dollars in millions) details the components of the spreads for AFG’s fixed annuity operations (including fixed-indexed and variable-indexed annuities):
 Nine months ended September 30,  
 2018 2017 % Change
Average fixed annuity investments (at amortized cost)$33,964
 $30,919
 10%
Average fixed annuity benefits accumulated34,240
 31,141
 10%
      
As % of fixed annuity benefits accumulated (except as noted):     
Net investment income (as % of fixed annuity investments)4.76% 4.64%  
Interest credited — fixed(2.02%) (2.01%)  
Net interest spread2.74% 2.63%  
      
Policy charges and other miscellaneous income0.10% 0.12%  
Other annuity benefit expenses, net of guaranteed withdrawal benefit fees(0.26%) (0.31%)  
Acquisition expenses(0.86%) (0.63%)  
Other expenses(0.37%) (0.38%)  
Change in fair value of derivatives related to fixed-indexed annuities0.11% (0.20%)  
Unlocking(0.11%) %  
Net spread earned on fixed annuities1.35% 1.23%  


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AMERICAN FINANCIAL GROUP, INC. 10-Q
Management’s Discussion and Analysis of Financial Condition and Results of Operations — Continued


Net Spread on Fixed Annuities (excludes variable annuity earnings)
The table below (dollars in millions) details the components of the spreads for AFG’s fixed annuity operations (including fixed-indexed annuities):
 Nine months ended September 30,  
 2017 2016 % Change
Average fixed annuity investments (at amortized cost)$30,919
 $27,899
 11%
Average fixed annuity benefits accumulated31,141
 27,778
 12%
      
As % of fixed annuity benefits accumulated (except as noted):     
Net investment income (as % of fixed annuity investments)4.64% 4.79%  
Interest credited — fixed(2.01%) (2.04%)  
Net interest spread2.63% 2.75%  
      
Policy charges and other miscellaneous income0.12% 0.14%  
Other annuity benefit expenses, net of guaranteed withdrawal benefit fees(0.31%) (0.31%)  
Acquisition expenses(0.63%) (0.58%)  
Other expenses(0.38%) (0.39%)  
Change in fair value of derivatives related to fixed-indexed annuities(0.20%) (0.51%)  
Net spread earned on fixed annuities1.23% 1.10%  

The table below illustrates the impact of fair value accounting for derivatives related to fixed-indexed annuities on the annuity segment’s net spread earned on fixed annuities:
Nine months ended September 30,Nine months ended September 30,
2017 20162018 2017
Net spread earned on fixed annuities — before impact of derivatives related to FIAs1.32% 1.37%
Net spread earned on fixed annuities — before the impact of unlocking and derivatives related to FIAs1.41% 1.32%
Unlocking(0.11%) %
Impact of derivatives related to fixed-indexed annuities:      
Change in fair value of derivatives(0.20%) (0.51%)0.11% (0.20%)
Related impact on amortization of deferred policy acquisition costs (*)0.11% 0.23%(0.06%) 0.11%
Related impact on amortization of deferred sales inducements (*)% 0.01%% %
Net spread earned on fixed annuities1.23% 1.10%1.35% 1.23%
(*)An estimate of the related acceleration/deceleration of the amortization of deferred policy acquisition costs and deferred sales inducements.

Annuity Net Investment Income
Net investment income for the first nine months of 20172018 was $1.081.22 billion compared to $1.011.08 billion for the first nine months of 20162017, an increase of $72137 million (7%13%). This increase reflects the growth in AFG’s annuity business and higher equity in the earnings offrom limited partnerships and similar investments, partially offset by the impact of lower investment yields. The overall yield earned on investments in AFG’s fixed annuity operations, calculated as net investment income divided by average investment balances (at amortized cost), declinedincreased by 0.150.12 percentage points to 4.64%4.76% from 4.79%4.64% for the first nine months of 20172018 compared to the first nine months of 2016.2017. This declineincrease in net investment yield reflects higher earnings from limited partnerships and similar investments, partially offset by (i) the investment of new premium dollars at lower yields as compared to the existing investment portfolio and (ii) the impact of the reinvestment of proceeds from maturity and redemption of higher yielding investments at the lower yields available in the financial markets, partially offset by higher equity in the earnings ofmarkets. The high returns from limited partnerships and similar investments. Duringinvestments should not necessarily be expected to repeat in future periods. For the first nine months ofperiod from July 1, 2017, $3.6through September 30, 2018, $4.4 billion in annuity segment investments with an average yield of 5.24%5.01% were redeemed or sold while the investments purchased during 2017that period (with new premium dollars and the redemption/sale proceeds) had an average yield at purchase of 3.93%4.26%.

Annuity Interest Credited — Fixed
Interest credited — fixed for the first nine months of 20172018 was $469$518 million compared to $426$469 million for the first nine months of 2016,2017, an increase of $43$49 million (10%). TheThis increase reflects the impact of growth in the annuity business was partially offset by lower interest crediting rates on new premiums as compared to the crediting rates on policyholder funds surrendered or withdrawn.business. The average interest rate credited to policyholders, calculated as interest credited divided by average fixed annuity benefits

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AMERICAN FINANCIAL GROUP, INC. 10-Q
Management’s Discussion and Analysis of Financial Condition and Results of Operations — Continued


accumulated, decreased0.03increased 0.01% percentage points to 2.01%2.02% from 2.04%2.01% in the first nine months of 20172018 compared to the first nine months of 2016.2017 due to higher crediting rates on new business.

Annuity Net Interest Spread
AFG’s net interest spread decreased 0.12increased 0.11 percentage points to 2.63%2.74% from 2.75%2.63% in the first nine months of 20172018 compared to the same period in 20162017 due primarily to lower fixed maturity investment yields, partially offset by the impact of lower crediting rates and higher equity in the earnings offrom limited partnerships and similar investments.investments, partially offset by lower investment yields. Features included in current annuity offerings allow AFG to achieve its desired profitability at a lower net interest spread than historical product offerings. As a result, AFG expects its net interest spread to narrow in the future.

Annuity Policy Charges and Other Miscellaneous Income
Annuity policy charges and other miscellaneous income, which consist primarily of surrender charges, amortization of deferred upfront policy charges (unearned revenue) and income from sales of real estate, were $32 million for the first nine months of 2018 compared to $36 million for the first nine months of 2017, a decrease of $4 million (11%). Excluding the impact of a $1 million unlocking charge related to unearned revenue in the second quarter of 2018, annuity policy charges and other miscellaneous income were $33 million in 2018 compared to $37$36 million for thein 2017, a decrease of $3 million (8%). The first nine months of 2016, a decrease of2017 includes $1 million (3%).from the sale of real estate. As a percentage of average fixed annuity benefits accumulated, excluding the impact of unlocking charges related to unearned revenue, annuity policy charges and other miscellaneous income decreased 0.02 percentage points to 0.12%0.10% from 0.14%0.12% in the first nine months of 20172018 compared to the first nine months of 2016.2017.


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AMERICAN FINANCIAL GROUP, INC. 10-Q
Management’s Discussion and Analysis of Financial Condition and Results of Operations — Continued


See Annuity Unlocking below for a discussion of the impact that the unlocking of actuarial assumptions had on annuity policy charges and other miscellaneous income in 2018.

Other Annuity Benefits, Net of Guaranteed Withdrawal Benefit Fees
Other annuity benefits, net of guaranteed withdrawal benefit fees (excluding the impact of unlocking), for the first nine months of 20172018 were $7169 million compared to $6471 million for the first nine months of 20162017, an increasea decrease of $72 million (11%3%). As a percentage of average fixed annuity benefits accumulated, these net expenses weredecreased 0.05 percentage points to 0.26% from 0.31% in both the first nine months of 2017 and2018 compared to the first nine months of 2016.2017. In addition to interest credited to policyholders’ accounts and the change in fair value of derivatives related to fixed-indexed annuities, annuity benefits expense also includes the following expenses (in millions, net of guaranteed withdrawal benefit fees):
Nine months ended September 30,Nine months ended September 30,
2017 20162018 2017
Change in expected death and annuitization reserve$13
 $14
$13
 $13
Amortization of sales inducements14
 17
15
 14
Change in guaranteed withdrawal benefit reserve51
 49
60
 51
Change in other benefit reserves36
 23
29
 36
Other annuity benefits114
 103
117
 114
Offset guaranteed withdrawal benefit fees(43) (39)(48) (43)
Other annuity benefits, net$71
 $64
$69
 $71

As discussed under “Annuity Benefits Accumulated” in Note A — “Accounting Policies to the financial statements, guaranteed withdrawal benefit reserves are accrued for and modified using assumptions similar to those used in establishing and amortizing deferred policy acquisition costs. The guaranteed withdrawal benefit reserve related to FIAs can be inversely impacted by the calculated FIA embedded derivative reserve as the value to policyholders of the guaranteed withdrawal benefits decreases when the benefit of stock market participation increases.

See Annuity Unlocking below for a discussion of the impact that the unlocking of actuarial assumptions had on annuity benefit expense in 2018.

Annuity Acquisition Expenses
Annuity acquisition expenses for the first nine months of 2018 were $199 million compared to $153 million for the first nine months of 2017, an increase of $46 million (30%). Excluding the $28 million favorable impact on amortization of DPAC from the unlocking recorded in the second quarter of 2018, annuity acquisition expenses were $227 million for the first nine months of 2018, an increase of $74 million (48%) compared to the first nine months of 2017, reflecting growth in the business and the acceleration (in 2018) and deceleration (in 2017) of DPAC amortization related to changes in the fair value of derivatives related to FIAs. Excluding the impact of the 2018 unlocking charge, AFG’s amortization of DPAC and commission expenses as a percentage of average fixed annuity benefits accumulated was 0.86% for the first nine months of 2018 compared to 0.63% for the first nine months of 2017 compared to 0.58% for the first nine months of 2016 and has generally ranged between 0.75% and 0.85%. Variances from the general range relate primarily to the impact of (i) material changes in interest rates or the stock market on AFG’s fixed-indexed annuity business, and (ii) differences in actual experience from actuarially projected estimates and assumptions. For example, the positive impact of higher than anticipated interest rates during the first nine months of 2018 on the fair value of derivatives related to FIAs (discussed below) resulted in a partially offsetting acceleration of the amortization of DPAC. In contrast, the negative impact of lower than anticipated interest rates during the first nine months of 2017 and the impact of significantly lower than anticipated interest rates during the first nine months of 2016 on the fair value of derivatives related to fixed-indexed annuities (discussed below)FIAs resulted in a partially offsetting deceleration of the amortization of DPAC.


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AMERICAN FINANCIAL GROUP, INC. 10-Q
Management’s Discussion and Analysis of Financial Condition and Results of Operations — Continued


The table below illustrates the estimated impact of fair value accounting for derivatives related to fixed-indexed annuities on annuity acquisition expenses as a percentage of average fixed annuity benefits accumulated:accumulated (excluding the impact of unlocking):
Nine months ended September 30,Nine months ended September 30,
2017 20162018 2017
Before the impact of changes in the fair value of derivatives related to FIAs on the amortization of DPAC0.74% 0.81%0.80% 0.74%
Impact of changes in fair value of derivatives related to FIAs on amortization of DPAC (*)(0.11%) (0.23%)0.06% (0.11%)
Annuity acquisition expenses as a % of fixed annuity benefits accumulated0.63% 0.58%0.86% 0.63%
(*)An estimate of the acceleration/deceleration of the amortization of deferred policy acquisition costs resulting from fair value accounting for derivatives related to fixed-indexed annuities.

See Annuity Unlocking below for a discussion of the impact that the unlocking of actuarial assumptions had on annuity and supplemental insurance acquisition expenses in 2018. 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.

Annuity Other Expenses
Annuity other expenses were $90$95 million for the first nine months of 20172018 compared to $8390 million for the first nine months of 20162017, an increase of $75 million (8%6%). Annuity other expenses represent primarily general and administrative expenses, as well as selling and issuance expenses that are not deferred. The increase in annuity other expenses reflects primarily growth in the business and an increase in the number of sales personnel focused on new initiatives and increased market share within existing financial institutions and retail marketing organizations in the first nine months of 2017 compared to the first nine months of 2016. As a percentage of average fixed annuity benefits accumulated, these expenses weredecreased 0.01 percentage points to 0.37% from 0.38% for the first nine months of 20172018 and 0.39% forcompared to the first nine months of 20162017. The decrease in annuity other expenses as a percentage of average fixed annuity benefits accumulated is due primarily to growth in the business.

Change in Fair Value of Derivatives Related to Fixed-Indexed (Including Variable-Indexed) Annuities
AFG’s fixed-indexed (including variable-indexed) annuities provide policyholders with a crediting rate tied, in part, to the performance of an existing stock market or other financial index. AFG attempts to mitigate the risk in the index-based component of these products through the purchase and sale of call and put options on the appropriate index. AFG’s strategy is designed so that the net change in the fair value of the call option assets and put option liabilities will generally offset the economic change in the liabilitiesnet liability from the index participation. Both the index-based component of the annuities (an embedded derivative) and the related call and put options are considered derivatives that must be adjusted for changes in fair value through earnings each period. The change in the fair value of the embedded derivative includes an ongoing expense for interest accreted on the embedded derivative. The interest accreted in any period is generally based on the size of the embedded derivative and current interest rates. The fair values of these derivatives are impacted by actual and expected stock market performance and interest rates as well as other factors. For a list of other factors impacting the fair value of the index-basedembedded derivative component of AFG’s annuity benefits accumulated, see Note DC — “Fair Value Measurements to the financial statements. The

Excluding the impact of the 2018 unlocking charge, the net change in fair value of derivatives related to fixed-indexed annuities decreased annuity benefits by $29 million in the first nine months of 2018 and increased annuity benefits by $48 million in the first nine months of 2017 compared to $1072017. The change in the fair value of these derivatives includes $47 million in the first nine months of 2018 and $19 million in the first nine months of 2017 in interest accreted on the embedded derivative (before DPAC amortization), an increase of $28 million (147%). AFG expects both the size of the embedded derivative and interest rates to rise, resulting in continued increases in interest on the embedded derivative. During the first nine months of 2016.2018, the positive impact of higher than expected interest rates and strong stock market performance on the fair value of these derivatives was partially offset by the higher interest on the embedded derivative and the negative impact of higher than expected option costs. During the first nine months of 2017, the negative impact of lower than anticipatedexpected interest rates on the fair value of these derivatives was partially offset by the positive impact of strong stock market performance. During the first nine months of 2016, significantly lower than anticipated interest rates had an unfavorable impact on the fair value of these derivatives that was partially offset by the impact of an increase in the stock market. As a percentage of average fixed annuity benefits accumulated, this net expense decreasedimproved 0.31 percentage points to 0.20% from 0.51% fora net expense reduction of 0.11% in the first nine months of 2017 compared to2018 from a net expense of 0.20% in the first nine months of 2016.2017.


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AMERICAN FINANCIAL GROUP, INC. 10-Q
Management’s Discussion and Analysis of Financial Condition and Results of Operations — Continued


Fluctuations in interest rates and the stock market, among other factors, can cause volatility in the periodic measurement of fair value of the embedded derivative that management believes can be inconsistent with the long-term economics of these products. The table below illustrates the impact of fair value accounting for derivatives related to fixed-indexed annuities on the annuity segment’s earnings before income taxes (dollars in millions):
Nine months ended September 30,  Nine months ended September 30,  
2017 2016 % Change2018 2017 % Change
Earnings before income taxes — before change in fair value of derivatives related to fixed-indexed annuities$305
 $292
 4%
Earnings before income taxes — before unlocking and change in fair value of derivatives related to fixed-indexed annuities$354
 $305
 16%
Unlocking(27) 
 %
Impact of derivatives related to fixed-indexed annuities:     
Change in fair value of derivatives related to fixed-indexed annuities(48) (107) (55%)29
 (48) (160%)
Related impact on amortization of DPAC (*)26
 51
 (49%)(15) 26
 (158%)
Earnings before income taxes$283
 $236
 20%$341
 $283
 20%
(*)An estimate of the related acceleration/deceleration of amortization of deferred sales inducements and deferred policy acquisition costs.

As illustrated in the table above, the change in fair value of derivatives related to fixed-indexed annuities, including the related impact on amortization of DPAC increased the annuity segment’s earnings before income taxes by $14 million in the first nine months of 2018 and decreased the annuity segment’s earnings before income taxes by $22 million in the first nine months of 2017 and $56 million2017. The following table provides analysis of the primary factors impacting the change in the fair value of derivatives related to FIAs. Each factor is presented net of the estimated related impact on amortization of DPAC (dollars in millions).
 Nine months ended September 30,  
 2018 2017 % Change
Interest on the embedded derivative liability$(25) $(11) 127%
Changes in interest rates higher (lower) than expected37
 (38) (197%)
Change in the stock market, including volatility16
 20
 (20%)
Renewal option costs lower (higher) than expected(7) 4
 (275%)
Other, including the impact of actual versus expected lapses(7) 3
 (333%)
Impact of derivatives related to FIAs$14
 $(22) (164%)

See Annuity Unlocking below for a discussion of the impact that the unlocking of actuarial assumptions had on the change in the fair value of the embedded derivative liability in 2018.

Annuity Net Spread Earned on Fixed Annuities
AFG’s net spread earned on fixed annuities increased 0.12 percentage points to 1.35% from 1.23% in the first nine months of 2016.2018 compared to the same period in 2017 due primarily to the net impact of changes in the fair value of derivatives and related DPAC amortization offset discussed above and the 0.11 percentage points increase in AFG’s net interest spread, partially offset by the impact of the unlocking of actuarial assumptions discussed below.


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AMERICAN FINANCIAL GROUP, INC. 10-Q
Management’s Discussion and Analysis of Financial Condition and Results of Operations — Continued



Annuity Net Spread Earned on Fixed Annuities
AFG’s net spread earned on fixed annuities increased 0.13 percentage points to 1.23% from 1.10% in the first nine months of 2017 compared to the same period in 2016 due primarily to the net impact of changes in the fair value of derivatives and related DPAC amortization offset discussed above, partially offset by the 0.12 percentage decrease in AFG’s net interest spread.

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

For certain products, annuity benefits accumulated also includes reserves for accrued persistency and premium bonuses, excess benefits expected to be paid on future deaths and annuitizations (“EDAR”) and guaranteed withdrawal benefits. Annuity benefits accumulated also includes amounts advanced from the Federal Home Loan Bank of Cincinnati. The following table is a progression of AFG’s annuity benefits accumulated liability for the nine months ended September 30, 20172018 and 20162017 (in millions):
Nine months ended September 30,Nine months ended September 30,
2017 20162018 2017
Beginning fixed annuity reserves$29,647
 $26,371
$33,005
 $29,647
Fixed annuity premiums (receipts)3,410
 3,295
3,906
 3,410
Federal Home Loan Bank advances
 150
Surrenders, benefits and other withdrawals(1,650) (1,665)(2,040) (1,650)
Interest and other annuity benefit expenses:      
Interest credited469
 426
518
 469
Embedded derivative mark-to-market386
 188
242
 386
Change in other benefit reserves92
 88
88
 92
Unlocking55
 
Ending fixed annuity reserves$32,354
 $28,853
$35,774
 $32,354
      
Reconciliation to annuity benefits accumulated per balance sheet:      
Ending fixed annuity reserves (from above)$32,354
 $28,853
$35,774
 $32,354
Impact of unrealized investment gains138
 180
8
 138
Fixed component of variable annuities179
 189
176
 179
Annuity benefits accumulated per balance sheet$32,671
 $29,222
$35,958
 $32,671

Statutory Annuity Premiums
AFG’s annuity operations generated statutory premiums of $3.93 billion in the first nine months of 2018 compared to $3.43 billion in the first nine months of 2017 compared to $3.32 billion in the first nine months of 2016, an increase of $108493 million (3%(14%). The following table summarizes AFG’s annuity sales (dollars in millions):
Nine months ended September 30,  Nine months ended September 30,  
2017 2016 % Change2018 2017 % Change
Financial institutions single premium annuities — indexed$1,347
 $1,476
 (9%)$1,321
 $1,347
 (2%)
Financial institutions single premium annuities — fixed559
 316
 77%350
 559
 (37%)
Retail single premium annuities — indexed1,310
 1,299
 1%1,026
 751
 37%
Retail single premium annuities — fixed61
 60
 2%60
 55
 9%
Broker dealer single premium annuities — indexed936
 559
 67%
Broker dealer single premium annuities — fixed10
 6
 67%
Pension risk transfer57
 
 %
Education market — fixed and indexed annuities133
 144
 (8%)146
 133
 10%
Total fixed annuity premiums3,410
 3,295
 3%3,906
 3,410
 15%
Variable annuities22
 29
 (24%)19
 22
 (14%)
Total annuity premiums$3,432
 $3,324
 3%$3,925
 $3,432
 14%

Management believesattributes the 3%14% increase in annuity premiums in the first nine months of 20172018 compared to the first nine months of 2016 is consistent with overall growth2017 to the introduction of new products, efforts to expand in the annuity industry, as sales of traditional fixedretail and fixed-indexed annuities have increased while sales of variable annuities have decreased. In addition, the increase reflects new products, additional staffing,broker dealer markets and increased market share within existing financial institutions. Annuity sales slowedan improving interest rate environment in the third quarter of 2017 as a result of2018.


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AMERICAN FINANCIAL GROUP, INC. 10-Q
Management’s Discussion and Analysis of Financial Condition and Results of Operations — Continued


Annuity Unlocking
In the second quarter of 2018, AFG recorded a $27 million net charge related to its annuity business as a result of unlocking certain actuarial assumptions underlying its annuity operations, which impacted AFG’s adherencefinancial statements as follows (in millions):
  Nine months ended September 30,
  2018 2017
Policy charges and other miscellaneous income:    
Unearned revenue $(1) $
Total revenues (1) 
Annuity benefits:    
Fixed-indexed annuities embedded derivative 44
 
Sales inducements (1) 
Other reserves 11
 
Total annuity benefits 54
 
Annuity and supplemental insurance acquisition expenses:    
Deferred policy acquisition costs (28) 
Total costs and expenses 26
 
Net charge $(27) $

The net charge from unlocking annuity assumptions in the second quarter of 2018 is due primarily to pricing disciplinethe unfavorable impact of higher projected option costs, partially offset by the favorable impact of an increase in projected net interest spreads on in-force business (due primarily to higher than previously anticipated reinvestment rates). Reinvestment rate assumptions are based primarily on 7-year and 10-year corporate bond yields. For the 2018 unlocking, AFG assumed a net reinvestment rate (net of default and expense assumptions) of 4.44% in the second half of 2018, grading up ratably to an ultimate net reinvestment rate of 5.55% in 2022 and beyond.

The table below compares the reinvestment rate assumed on assets purchased to directly support “fixed annuity benefits accumulated” in AFG’s fourth quarter unlockings for the next calendar year to the actual reinvestment rate achieved in that period (both net of investment expenses):
  First    
Unlocking Investment Reinvestment Rate
Year Period Assumed (a) Achieved
2014 2015 3.75% 4.27%
2015 2016 4.05% 4.27%
2016 2017 4.42% 3.95%
2017      2018 (b) 4.17% 4.48%
2018 July 2018 (c) 4.62% 4.57%
(a)Assumed reinvestment rates exclude default rates of 0.18% in each period.
(b)Reinvestment rate achieved is for the nine months ended September 30, 2018.
(c)Reinvestment rate achieved is for the three months ended September 30, 2018.

Management believes that these results over the last several years demonstrate that AFG’s investment rate assumptions are reasonable and prudent. During 2017, long-term interest rates were lower than anticipated and credit spreads narrowed, resulting in a relatively lowlower achieved reinvestment rate than assumed in the 2016 unlocking. In addition to the reinvestment rates above, actual default rates in the first six months of 2018 and decreasing interest rate environment duringin 2017, 2016 and 2015 were lower than the year, as well as from aggressive pricing by certainlong-term default rates of AFG’s competitors.0.18% assumed in the unlocking in each of the periods above.


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AMERICAN FINANCIAL GROUP, INC. 10-Q
Management’s Discussion and Analysis of Financial Condition and Results of Operations — Continued


Annuity Earnings before Income Taxes Reconciliation
The following table reconciles the net spread earned on AFG’s fixed annuities to overall annuity pretax earnings for the nine months ended September 30, 20172018 and 20162017 (in millions):
Nine months ended September 30,Nine months ended September 30,
2017 20162018 2017
Earnings on fixed annuity benefits accumulated$288
 $230
$348
 $288
Earnings impact of investments in excess of fixed annuity benefits accumulated (*)(8) 4
(10) (8)
Variable annuity earnings3
 2
3
 3
Earnings before income taxes$283
 $236
$341
 $283

(*)
Net investment income (as a % of investments) of 4.64%4.76% and 4.79%4.64% for the nine months ended September 30, 20172018 and 2016,2017, respectively, multiplied by the difference between average fixed annuity investments (at amortized cost) and average fixed annuity benefits accumulated in each period.

Run-off Long-Term CareHolding Company, Other and Life SegmentUnallocated — Results of Operations   AFG’s net GAAP pretax loss outside of its property and casualty insurance and annuity operations (excluding realized gains and losses) totaled $136 million in the first nine months of 2018 compared to $165 million in the first nine months of 2017, a decrease of $29 million (18%). AFG’s net core pretax loss outside of its property and casualty insurance and annuity operations (excluding realized gain and losses) totaled $127 million in the first nine months of 2018 compared to $130 million in the first nine months of 2017, a decrease of $3 million (2%).

The following table details AFG’s GAAP and core earningsloss before income taxes from operations outside of its run-off long-term careproperty and lifecasualty insurance and annuity operations for the nine months ended September 30, 20172018 and 20162017 (dollars in millions):
 Nine months ended September 30,  
 2017 2016 % Change
Revenues:     
Net earned premiums:     
Long-term care$2
 $2
 %
Life operations15
 16
 (6%)
Net investment income16
 15
 7%
Other income2
 4
 (50%)
Total revenues35
 37
 (5%)
      
Costs and Expenses:     
Life, accident and health benefits:     
Long-term care4
 5
 (20%)
Life operations17
 21
 (19%)
Acquisition expenses3
 4
 (25%)
Other expenses7
 7
 %
Total costs and expenses31
 37
 (16%)
Core earnings before income taxes4
 
 %
Pretax non-core realized gain on subsidiaries
 2
 (100%)
GAAP earnings before income taxes$4
 $2
 100%
 Nine months ended September 30,  
 2018 2017 % Change
Revenues:     
Life, accident and health net earned premiums$18
 $17
 6%
Net investment income21
 24
 (13%)
Other income — P&C fees50
 46
 9%
Other income20
 22
 (9%)
Total revenues109
 109
 %
      
Costs and Expenses, excluding interest charges on borrowed money:     
Property and casualty insurance — commissions and other underwriting expenses17
 16
 6%
Life, accident and health benefits32
 21
 52%
Life, accident and health acquisition expenses4
 3
 33%
Other expense — expenses associated with P&C fees33
 30
 10%
Other expenses (*)104
 104
 %
Costs and expenses, excluding interest charges on borrowed money190
 174
 9%
Core loss before income taxes, excluding realized gains and losses and interest charges on borrowed money(81) (65) 25%
Interest charges on borrowed money46
 65
 (29%)
Core loss before income taxes, excluding realized gains and losses(127) (130) (2%)
Pretax non-core special A&E charges(9) (24) (63%)
Pretax non-core loss on retirement of debt
 (11) (100%)
GAAP loss before income taxes, excluding realized gains and losses$(136) $(165) (18%)

The $4 million increase in core earnings before income taxes reflects the impact of improved life claims experience in the first nine months of 2017 compared to the first nine months of 2016.
(*)Excludes pretax non-core special A&E charges of $9 million and $24 million in the third quarter of 2018 and 2017, respectively, and a pretax non-core loss on retirement of debt of $11 million in the 2017 period.


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AMERICAN FINANCIAL GROUP, INC. 10-Q
Management’s Discussion and Analysis of Financial Condition and Results of Operations — Continued


Holding Company and Other — Life, Accident and Unallocated — Results of OperationsHealth Premiums, Benefits and Acquisition Expenses
AFG’s net GAAP pretax loss outside of itsrun-off long-term care and life insurance operations (excluding realized gainsrecorded net earned premiums of $18 million and losses) totaled $169related benefits and acquisition expenses of $36 million in the first nine months of 20172018 compared to $131net earned premiums of $17 million and related benefits and acquisition expenses of $24 million in the first nine months of 2016, an2017. The $11 million (52%) increase of $38 million (29%). AFG’s net core pretax loss outside of itsin life, accident and health benefits reflects higher claims in both the run-off long-term care and run-off life insurance operations (excluding realized gain and losses) totaled $134 million in the first nine months of 2017 compared to $126 million in the first nine months of 2016, an increase of $8 million (6%).businesses.

The following table details AFG’s GAAP and core loss before income taxes from operations outside of its insurance operations for the nine months ended September 30, 2017 and 2016 (dollars in millions):
 Nine months ended September 30,  
 2017 2016 % Change
Revenues:     
Net investment income$8
 $6
 33%
Other income — P&C fees46
 43
 7%
Other income20
 15
 33%
Total revenues74
 64
 16%
      
Costs and Expenses:     
Property and casualty insurance — commissions and other underwriting expenses16
 13
 23%
Interest charges on borrowed money65
 56
 16%
Other expense — expenses associated with P&C fees30
 30
 %
Other expenses (*)97
 91
 7%
Total costs and expenses208
 190
 9%
Core loss before income taxes, excluding realized gains and losses(134) (126) 6%
Pretax non-core special A&E charges(24) (5) 380%
Pretax non-core loss on retirement of debt(11) 
 %
GAAP loss before income taxes, excluding realized gains and losses$(169) $(131) 29%

(*)Excludes pretax non-core special A&E charges of $24 million and $5 million in the third quarter of 2017 and 2016, respectively, and a pretax non-core loss on retirement of debt of $11 million in the 2017 period.

Holding Company and Other — Net Investment Income
AFG recorded net investment income on investments held outside of its property and casualty insurance and annuity operations of $8$21 million in the first nine months of 20172018 compared to $624 million in the first nine months of 20162017, a decrease of $3 million (13%). The parent company holds a small portfolio of securities that are carried at fair value through net investment income. These securities increased in value by $1 million in the first nine months of 2018 compared to an increase in value by $4 million in the first nine months of 2017.

Holding Company and Other — P&C Fees and Related Expenses
Summit, a workers’ compensation insurance business,subsidiary, collects fees from a small group of unaffiliated insurers for providing underwriting, policy administration and claims services. In addition, certain of AFG’s property and casualty insurance businesses collect fees from customers for ancillary services such as workplace safety programs and premium financing. In the first nine months of 2017,2018, AFG collected $46$50 million in fees for these services compared to $43$46 million in the first nine months of 2016.2017. Management views this fee income, net of the $30$33 million in both the first nine months of 20172018 and 2016,$30 million in the first nine months of 2017, in expenses incurred to generate such fees, as a reduction in the cost of underwriting its property and casualty insurance policies. Consistent with internal management reporting, these fees and the related expenses are netted and recorded as a reduction of commissions and other underwriting expenses in AFG’s segmented results.

Holding Company and Other — Other Income
Other income in the table above includes $14$12 million and $12$14 million in the first nine months of 20172018 and 20162017, respectively, in management fees paid to AFG by the AFG-managed CLOs (AFG’s consolidated managed investment entities). The management fees are eliminated in consolidation — see the other income line in the Consolidate MIEs column under “Results of Operations — Segmented Statement of Earnings.” Excluding amounts eliminated in consolidation, AFG recorded other income outside of its property and casualty insurance and annuity operations of $6$8 million in both the first nine months of 2018 and the first nine months of 2017.

Holding Company and Other — Other Expenses
Excluding the non-core special A&E charges and the non-core loss on retirement of debt discussed below, AFG’s holding companies and other operations outside of its property and casualty insurance and annuity operations recorded other expenses of $104 million in both the first nine months of 2018 and the first nine months of 2017. The impact of lower holding company expenses related to employee benefit plans that are tied to stock market performance in the first nine months of 2017 and $3 million the first nine months of 2016. Results for2018 compared to the first nine months of 2017 include $2was offset by a $5 million in incomecharge to increase liabilities related to the saleenvironmental exposures of real estate.


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AMERICAN FINANCIAL GROUP, INC. 10-Q
Management’s Discussion and Analysis of Financial Condition and Results of Operations — Continued

2018.

Holding Company and Other — Interest Charges on Borrowed Money
AFG’s holding companies and other operations outside of its property and casualty insurance and annuity operations recorded interest expense of$46 million in the first nine months of 2018 compared to $65 million in the first nine months of 2017 compared to $56 million in the first nine months of 2016, an increasea decrease of $919 million (16%29%). This increase reflects higher average indebtedness, partially offset by, due primarily to a lower weighted average interest rate on AFG’s outstanding debt.

The increasedecrease in the weighted average indebtednessinterest rate for the first nine months of 20172018 as compared to the first nine months of 20162017 reflects the following financing transactions completed by AFG between JanuaryApril 1, 20162017 and September 30,December 31, 2017:
Issued $300 million of 3.50% Senior Notes on August 22, 2016
Issued $350 million of 4.50% Senior Notes on June 2, 2017
Redeemed $230 million of 6-3/8% Senior Notes on June 26, 2017
Redeemed $125 million of 5-3/4% Senior Notes on August 25, 2017

The redemptionIssued an additional $125 million of the 6-3/8% and 5-3/4%3.50% Senior Notes and the issuanceon November 9, 2017
Issued an additional $240 million of the 4.50% Senior Notes inon November 9, 2017 will result in annual pretax interest savings to AFG
Redeemed $350 million of $6 million.9-7/8% Senior Notes on December 11, 2017

Holding Company and Other — Special A&E Charges
See Holding Company and Other — Special A&E Charges under “Results of Operations — Holding Company, Other and Unallocated”for the quarters ended September 30, 20172018 and 20162017 for a discussion of the $24$9 million and $5$24 million in non-core special A&E charges recorded in the third quarter of 2018 and 2017, respectively.

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AMERICAN FINANCIAL GROUP, INC. 10-Q
Management’s Discussion and 2016, respectively.Analysis of Financial Condition and Results of Operations — Continued



Holding Company and Other — Loss on Retirement of Debt
AFG wrote off unamortized debt issuance costs of $7 million related to the redemption of its $230 million outstanding 6-3/8% Senior Notes due 2042 at par value onin June 26, 2017 and $4 million related to the redemption of its $125 million outstanding 5-3/4% Senior Notes due 2042 at par value onin August 25, 2017.

Holding Company and Other — Other Expenses
Excluding the non-core special A&E charges and the non-core loss on retirement of debt discussed above, AFG’s holding companies and other operations outside of its insurance operations recorded other expenses of $97 million in the first nine months of 2017 compared to $91 million in the first nine months of 2016, an increase of $6 million (7%). This increase reflects the impact of higher holding company expenses related to employee benefit plans that are tied to stock market performance for the first nine months of 2017 compared to the first nine months of 2016, partially offset by a $5 million donation to the University of Cincinnati College of Business in the third quarter of 2016.

Consolidated Realized Gains (Losses) on Securities   AFG’s consolidated realized gains (losses) on securities, which are not allocated to segments, were net losses of$28 million in the first nine months of 2018 compared to $1 million in the first nine months of 2017 compared to $32 million in the first nine months of 2016, a decreasean increase of $3127 million (97%2,700%). Realized gains (losses) on securities consisted of the following (in millions):
Nine months ended September 30,Nine months ended September 30,
2017 20162018 2017
Realized gains (losses) before impairments:      
Disposals$61
 $82
$11
 $61
Change in the fair value of equity securities (*)(39) 
Change in the fair value of derivatives(4) 
(8) (4)
Adjustments to annuity deferred policy acquisition costs and related items(5) (7)11
 (5)
52
 75
(25) 52
Impairment charges:      
Securities(65) (120)(3) (65)
Adjustments to annuity deferred policy acquisition costs and related items12
 13

 12
(53) (107)(3) (53)
Realized gains (losses) on securities$(1) $(32)$(28) $(1)
(*)
As discussed in Note A — “Accounting PoliciesInvestments,” beginning in January 2018, all equity securities other than those accounted for under the equity method are carried at fair value through net earnings. This amount includes a $51 million net loss on securities that were still held at September 30, 2018.

The $39 million net realized loss from the change in the fair value of equity securities in the first nine months of 2018 includes losses of $15 million on investments in real estate investment trusts, $27 million related to banks and financing companies and $14 million on investments in media companies and gains of $18 million on investments in technology companies. AFG’s $65 million in impairment charges on securities for the first nine months of 2017 consistconsists of $49 million on equity securities and $16 million on fixed maturities compared to $83 million on equity securities and $37 million on fixed maturities in the first nine months of 2016.maturities. Approximately $24 million in impairment charges in the first nine months of 2017 relate to investments in pharmaceutical companies, $10 million relates to an investment in a media company and the remainder relates primarily to investments in various industrial entities. Approximately $68 million of the impairment charges recorded in the first nine months of 2016 are related to financial institutions and $19 million are on energy-related investments.


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AMERICAN FINANCIAL GROUP, INC. 10-Q
Management’s Discussion and Analysis of Financial Condition and Results of Operations — Continued


Consolidated Realized Gain on Subsidiaries   The $2 million pretax realized gain on subsidiaries in the first nine months of 2016 represents an adjustment to the pretax realized loss on the sale of substantially all of AFG’s run-off long-term care insurance business that was recorded in 2015.

Consolidated Income Taxes   AFG’s consolidated provision for income taxes was $126 million for the first nine months of 2018 compared to $146 million for the first nine months of 2017, compared to $190 million for the first nine months of 2016, a decrease of $44$20 million (23%(14%). See Note L — “Income Taxesto the financial statements for an analysis of items affecting AFG’s effective tax rate.

Consolidated Noncontrolling Interests   AFG’s consolidated net earnings (losses) attributable to noncontrolling interests was a net loss of $7 million for the first nine months of 2018 compared to net earnings of $2 million for the first nine months of 2017 compared. Losses attributable to $16 millionnoncontrolling interests for the first nine months of 2018 are related to losses at Neon, AFG’s United Kingdom-based Lloyd’s insurer. Earnings attributable to noncontrolling interests in the first nine months of 2016. The following table details net earnings in consolidated subsidiaries attributable to holders other than AFG (dollars in millions):
 Nine months ended September 30,  
 2017 2016 % Change
National Interstate$
 $12
 (100%)
Other2
 4
 (50%)
Earnings attributable to noncontrolling interests$2
 $16
 (88%)

Other noncontrolling interests includes $2 million2017 are related to the gain on the sale of a hotel property, in the first quarter of 2017 and $4 million related to the gain on the sale of an apartment property in the second quarter of 2016. Both properties werewhich was owned by an 80%-owned subsidiary of GAI.Great American Insurance.

RECENTRECENTLY ADOPTED ACCOUNTING STANDARDS

Effective December 31, 2017, AFG adopted ASU 2018-02, which allowed the reclassification of amounts stranded in accumulated other comprehensive income from accounting for the Tax Cuts and Jobs Act of 2017 to retained earnings.

InSee Note A — “Accounting PoliciesInvestmentsto the financial statements for a discussion of accounting guidance adopted on January 2016, the FASB issued ASU 2016-01, Financial Instruments – Overall: Recognition and Measurement of Financial Assets and Financial Liabilities1, 2018, which, among other things, requires equity investments that are not accounted for under the equity method of accounting to be measured at fair value with changes in fair value recognized in net income,earnings, clarifies that the need for a

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


valuation allowance on a deferred tax asset related to available for sale securities should be evaluated with other deferred tax assets and modifies disclosure requirements for financial instruments. AFG will be required to adopt the updated guidance effective January 1, 2018 (early adoption is not permitted). Although recording changes in the fair value of investments in equity securities in net income will result in more volatility in AFG’s Statement of Earnings, it is not expected to have a material effect on the carrying value of AFG’s investments or on overall shareholders’ equity as AFG’s investments in equity securities are currently carried at fair value through accumulated other comprehensive income. At the date of adoption, the net unrealized gain on equity securities included in AOCI will be reclassified to retained earnings in the Balance Sheet as the cumulative effect of an accounting change.

ACCOUNTING STANDARDS TO BE ADOPTED

In February 2016, the FASB issued ASU 2016-02, Leases, which requires entities that lease assets for terms longer than one year to recognize the assets and liabilities for the rights and obligations created by those leases on the balance sheet based on the present value of cash flows. Qualitative and quantitative disclosures of the amount, timing and uncertainty of cash flows arising from leases will also be required. Although the guidance allows for early adoption, AFG expects to adopt the updated guidance effective January 1, 2019 (when it is required). The guidance will require the earliest comparative period presented to include the measurement and recognition of existing leases with an adjustment to shareholders’ equity as if the updated guidance had always been applied. Although the guidance will result in higher assets and higher liabilities from the recognition of assets and liabilities related to operating leases, it does not change the manner in which lease expense is recognized in the statement of earnings. Although management is currently evaluating the impact of this guidance, AFG does not expect itthe new guidance to have a material effect on its results of operations or financial position.

In June 2016, the FASB issued ASU 2016-13, Financial Instruments – Credit Losses: Measurement of Credit Losses on Financial Instruments, which provides a new credit loss model for determining credit-related impairments for financial instruments measured at amortized cost (e.g. mortgage loans or reinsurance recoverables) and requires an entity to estimate the credit losses expected over the life of an exposure or pool of exposures. The estimate of expected credit losses considers historical information, current information, as well as reasonable and supportable forecasts, including estimates of prepayments. The expected credit losses, and subsequent increases or decreases in such losses, will be recorded immediately through realized gains (losses) as an allowance that is deducted from the amortized cost basis of the financial asset, with the net carrying value of the financial asset presented on the balance sheet at the amount expected to be collected. The updated guidance also amends the current other-than-temporary impairment model for available for sale debt securities by requiring the recognition of impairments relating to credit losses through an allowance account and limits the amount of credit loss to the difference

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


between a security’s amortized cost basis and its fair value. Subsequent increases or decreases in expected credit losses will be recorded immediately in the income statement through realized gains (losses). AFG will be required to adopt this guidance effective January 1, 2020. AFG cannot estimate the impact that the updated guidance will have on its results of operations, financial position or liquidity until the updated guidance is adopted.

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


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ITEM 3
Quantitative and Qualitative Disclosure about Market Risk

As of September 30, 20172018, there were no material changes to the information provided in Item 7A — Quantitative and Qualitative Disclosures about Market Risk of AFG’s 20162017 Form 10-K.

ITEM 4
Controls and Procedures

AFG’s management, with participation of its Co-Chief Executive Officers and its Chief 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 CFO concluded that the controls and procedures are effective. There have been no changes in AFG’s internal control over financial reporting during the third fiscal quarter of 20172018 that materially affected, or are reasonably likely to materially affect, AFG’s internal control over financial reporting.

In the ordinary course of business, AFG and its subsidiaries routinely enhance their information systems by either upgrading current systems or implementing new systems. There has been no change in AFG’s business processes and procedures during the third fiscal quarter of 20172018 that has materially affected, or is reasonably likely to materially affect, AFG’s internal control over financial reporting.

PART II
OTHER INFORMATION
ITEM 2
Unregistered Sales of Equity Securities and Use of Proceeds

Issuer Purchases of Equity Securities   AFG did not repurchase any shares of its Common Stock during the first nine months of 20172018. There areAs of September 30, 2018, there were 4,132,838 remaining shares that may be repurchased under the Plans authorized by AFG’s Board of Directors in December 2014 and February 2016. Between October 1, 2018 and November 6, 2018, AFG repurchased 12,500 shares of its Common Stock at an average price of $99.48 per share.

AFG acquired 32,5092,210 shares of its Common Stock (at an average of $93.35$111.31 per share) in August 2018 and an additional 24,310 shares (at an average of $111.96 per share) in the first six months of 2017, 2,175 shares (at an average of $103.97 per share) in August 2017 and 238 shares (at $102.57 per share) in September 20172018 in connection with its stock incentive plans.
ITEM 5
Other Information

Disclosure of Certain Activities Under Section 13(r) of the Securities Exchange Act of 1934   Section 13(r) of the Securities Exchange Act of 1934, as amended (“Section 13(r)”), requires a registrant to disclose in its annual or quarterly reports whether it or an affiliate knowingly engaged in certain activities, transactions or dealings related to Iran during the period covered by the report. Many of the activities, transactions and dealings that are required to be reported under Section 13(r) were previously subject to U.S. sanctions or prohibited by applicable local law. On January 16, 2016, the United States and the European Union eased sanctions against Iran pursuant to the Joint Comprehensive Plan of Action, and many of the reportable activities, transactions and dealings under Section 13(r) are no longer subject to U.S. sanctions and no longer prohibited by applicable local law.

Certain of the Company’s subsidiaries located outside the United States subscribe to insurance policies that provide insurance coverage to vessels owned by international shipping and marine entities with vessels that travel worldwide. As a result, the insurance policies may be called upon to respond to claims involving or that have exposure to Iranian petroleum resources, refined petroleum, and petrochemical industries. For example, certain of the Company’s non-U.S. subsidiaries participate in global marine hull and war policies that provide coverage for damage to vessels navigating into and out of ports worldwide, which could include Iran.

For the nine months ended September 30, 2017,2018, the Company is not aware of any additional premium with respect to underwriting insurance or reinsurance activities reportable under Section 13(r). Should any such risks have entered into the

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stream of commerce covered by these insurance or reinsurance activities, the Company believes that the premiums associated with such business would be immaterial.

ITEM 6
Exhibits
 
Number Exhibit Description  
   
   
   
   
   
101 The following financial information from American Financial Group’s Form 10-Q for the quarter ended September 30, 2017,2018, formatted in XBRL (Extensible Business Reporting Language):  
         (i) Consolidated Balance Sheet  
        (ii) Consolidated Statement of Earnings  
       (iii) Consolidated Statement of Comprehensive Income  
       (iv) Consolidated Statement of Changes in Equity  
        (v) Consolidated Statement of Cash Flows  
       (vi) Notes to Consolidated Financial Statements  
     
     
 


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

 American Financial Group, Inc.
    
November 3, 20178, 2018By: /s/ Joseph E. (Jeff) Consolino
   Joseph E. (Jeff) Consolino
   Executive Vice President and Chief Financial Officer

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