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 June 30, 2019



~~For the Quarterly Period Ended September 30, 2018~~

~~Commission File No. 1-13653~~

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

For the transition period from to

Commission File No. 1-13653

AMERICAN FINANCIAL GROUP, INC.

Incorporated under the Laws of Ohio IRS Employer I.D. No. 31-1544320



~~Incorporated under the Laws of Ohio~~		~~IRS Employer I.D. No. 31-1544320~~

301 East Fourth Street, Cincinnati, Ohio45202

~~(513)~~ (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, a 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☑



Securities Registered Pursuant to Section 12(b) of the Act:
	Title of Each Class	Trading Symbol(s)	Name of Each Exchange on Which Registered
	Common Stock	AFG	New York Stock Exchange
	6-1/4% Subordinated Debentures due September 30, 2054	AFGE	New York Stock Exchange
	6% Subordinated Debentures due November 15, 2055	AFGH	New York Stock Exchange
	5.875% Subordinated Debentures due March 30, 2059	AFGB	New York Stock Exchange

As of ~~November~~August 1, ~~2018~~2019, there were ~~89,253,183~~89,941,874 shares of the Registrant’s Common Stock outstanding, excluding 14.9 million shares owned by subsidiaries.

Table of Contents

AMERICAN FINANCIAL GROUP, INC. 10-Q

TABLE OF CONTENTS

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, 2018		December 31, 2017		June 30, 2019		December 31, 2018
Assets:
Cash and cash equivalents	$	2,009	$	2,338	$	2,374	$	1,515
Investments:
Fixed maturities, available for sale at fair value (amortized cost — $40,053 and $37,038)	40,244		38,379
Fixed maturities, available for sale at fair value (amortized cost — $42,908 and $41,837)					44,710		41,997
Fixed maturities, trading at fair value	103		348		106		105
Equity securities, at fair value	1,827		1,662		1,985		1,814
Investments accounted for using the equity method	1,289		999		1,506		1,374
Mortgage loans	1,152		1,125		1,073		1,068
Policy loans	176		184		170		174
Equity index call options	759		701		712		184
Real estate and other investments	282		312		271		267
Total cash and investments	47,841		46,048		52,907		48,498
Recoverables from reinsurers	3,352		3,369		3,150		3,349
Prepaid reinsurance premiums	717		600		651		610
Agents’ balances and premiums receivable	1,299		1,146		1,398		1,234
Deferred policy acquisition costs	1,669		1,216		1,203		1,682
Assets of managed investment entities	4,998		4,902		4,781		4,700
Other receivables	1,633		1,030		999		1,090
Variable annuity assets (separate accounts)	650		644		616		557
Other assets	1,832		1,504		1,785		1,529
Goodwill	199		199		207		207
Total assets	$	64,190	$	60,658	$	67,697	$	63,456

Liabilities and Equity:
Unpaid losses and loss adjustment expenses	$	9,670	$	9,678	$	9,577	$	9,741
Unearned premiums	2,740		2,410		2,683		2,595
Annuity benefits accumulated	35,958		33,316		39,044		36,616
Life, accident and health reserves	643		658		619		635
Payable to reinsurers	932		743		755		752
Liabilities of managed investment entities	4,807		4,687		4,590		4,512
Long-term debt	1,302		1,301		1,423		1,302
Variable annuity liabilities (separate accounts)	650		644		616		557
Other liabilities	2,324		1,887		2,300		1,774
Total liabilities	59,026		55,324		61,607		58,484

Redeemable noncontrolling interests	—		3		—		—

Shareholders’ equity:
Common Stock, no par value — 200,000,000 shares authorized — 89,188,708 and 88,275,460 shares outstanding	89		88
Common Stock, no par value — 200,000,000 shares authorized — 89,917,601 and 89,291,724 shares outstanding					90		89
Capital surplus	1,231		1,181		1,277		1,245
Retained earnings	3,800		3,248		3,914		3,588
Accumulated other comprehensive income, net of tax	44		813		809		48
Total shareholders’ equity	5,164		5,330		6,090		4,970
Noncontrolling interests	—		1		—		2
Total equity	5,164		5,331		6,090		4,972
Total liabilities and equity	$	64,190	$	60,658	$	67,697	$	63,456

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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 June 30,						Six months ended June 30,
	2018			2017			2018			2017			2019			2018			2019			2018
Revenues:
Property and casualty insurance net earned premiums	$	1,327		$	1,267		$	3,595		$	3,354		$	1,200		$	1,161		$	2,373		$	2,268
Life, accident and health net earned premiums	6			6			18			17			5			6			11			12
Net investment income	527			471			1,552			1,366			580			530			1,122			1,025
Realized gains (losses) on securities (*)	34			(12		)	(28		)	(1		)	56			31			240			(62		)
Income (loss) of managed investment entities:
Investment income	65			54			187			155			70			64			139			122
Gain (loss) on change in fair value of assets/liabilities	(5		)	1			(10		)	12
Loss on change in fair value of assets/liabilities													(2		)	(2		)	(2		)	(5		)
Other income	54			48			146			154			51			43			101			92
Total revenues	2,008			1,835			5,460			5,057			1,960			1,833			3,984			3,452

Costs and Expenses:
Property and casualty insurance:
Losses and loss adjustment expenses	872			995			2,206			2,239			723			693			1,415			1,334
Commissions and other underwriting expenses	424			357			1,205			1,062			426			400			825			781
Annuity benefits	222			215			664			635			339			260			650			442
Life, accident and health benefits	10			6			32			21			8			11			17			22
Annuity and supplemental insurance acquisition expenses	71			55			203			156			33			50			61			132
Interest charges on borrowed money	15			21			46			65			17			16			33			31
Expenses of managed investment entities	52			45			154			137			59			54			114			102
Other expenses	98			112			272			285			96			89			197			174
Total costs and expenses	1,764			1,806			4,782			4,600			1,701			1,573			3,312			3,018
Earnings before income taxes	244			29			678			457			259			260			672			434
Provision for income taxes	41			18			126			146			50			52			137			85
Net earnings, including noncontrolling interests	203			11			552			311			209			208			535			349
Less: Net earnings (losses) attributable to noncontrolling interests	(1		)	—			(7		)	2			(1		)	(2		)	(4		)	(6		)
Net Earnings Attributable to Shareholders	$	204		$	11		$	559		$	309		$	210		$	210		$	539		$	355

Earnings Attributable to Shareholders per Common Share:
Basic	$	2.30		$	0.13		$	6.29		$	3.52		$	2.34		$	2.36		$	6.02		$	3.99
Diluted	$	2.26		$	0.13		$	6.17		$	3.44		$	2.31		$	2.31		$	5.94		$	3.92
Average number of Common Shares:
Basic	89.1			88.1			88.9			87.7			89.7			89.0			89.6			88.8
Diluted	90.7			90.0			90.6			89.7			91.0			90.7			90.8			90.5

Cash dividends per Common Share	$	0.35		$	0.3125		$	2.55		$	2.4375
________________________________________
(*) Consists of the following:
Realized gains (losses) before impairments	$	36		$	26		$	(25	)	$	52		$	58		$	31		$	244		$	(61	)

Losses on securities with impairment	(2		)	(38		)	(3		)	(54		)	(2		)	—			(4		)	(1		)
Non-credit portion recognized in other comprehensive income (loss)	—			—			—			1			—			—			—			—
Impairment charges recognized in earnings	(2		)	(38		)	(3		)	(53		)	(2		)	—			(4		)	(1		)
Total realized gains (losses) on securities	$	34		$	(12	)	$	(28	)	$	(1	)	$	56		$	31		$	240		$	(62	)

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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,					Three months ended June 30,						Six months ended June 30,
	2018			2017		2018			2017		2019			2018			2019			2018
Net earnings, including noncontrolling interests	$	203		$	11	$	552		$	311	$	209		$	208		$	535		$	349
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		356			(148		)	740			(427		)
Reclassification adjustment for realized (gains) losses included in net earnings	(2		)	8		(3		)	3		(8		)	(3		)	(11		)	(1		)
Total net unrealized gains (losses) on securities	(98		)	67		(526		)	302		348			(151		)	729			(428		)
Net unrealized gains (losses) on cash flow hedges	(5		)	—		(19		)	1		18			(3		)	29			(14		)
Foreign currency translation adjustments	—			7		(3		)	11		—			(4		)	4			(3		)
Other comprehensive income (loss), net of tax	(103		)	74		(548		)	314		366			(158		)	762			(445		)
Total comprehensive income, net of tax	100			85		4			625
Total comprehensive income (loss), net of tax											575			50			1,297			(96		)
Less: Comprehensive income (loss) attributable to noncontrolling interests	(1		)	—		(7		)	2		—			(2		)	(3		)	(6		)
Comprehensive income attributable to shareholders	$	101		$	85	$	11		$	623
Comprehensive income (loss) attributable to shareholders											$	575		$	52		$	1,300		$	(90	)

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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																		Redeemable					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			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, 2017	88,275,460		$	1,269		$	3,248		$	813		$	5,330		$	1		$	5,331		$	3
Cumulative effect of accounting change	—		—			225			(221		)	4			—			4			—
Balance at March 31, 2019																								89,637,713		$	1,346	$	3,875		$	444		$	5,665		$	—	$	5,665		$	—
Net earnings (losses)	—		—			559			—			559			(1		)	558			(6		)	—		—		210			—			210			—		210			(1		)
Other comprehensive loss	—		—			—			(548		)	(548		)	—			(548		)	—
Dividends on Common Stock	—		—			(227		)	—			(227		)	—			(227		)	—
Other comprehensive income (loss)																								—		—		—			365			365			—		365			1
Dividends ($1.90 per share)																								—		—		(170		)	—			(170		)	—		(170		)	—
Shares issued:
Exercise of stock options	635,364		23			—			—			23			—			23			—			247,753		11		—			—			11			—		11			—
Restricted stock awards	200,625		—			—			—			—			—			—			—			—		—		—			—			—			—		—			—
Other benefit plans	86,229		10			—			—			10			—			10			—			30,081		3		—			—			3			—		3			—
Dividend reinvestment plan	21,072		2			—			—			2			—			2			—			7,596		1		—			—			1			—		1			—
Stock-based compensation expense	—		17			—			—			17			—			17			—			—		6		—			—			6			—		6			—
Shares exchanged — benefit plans	(26,520	)	(1		)	(2		)	—			(3		)	—			(3		)	—			(3,519	)	—		(1		)	—			(1		)	—		(1		)	—
Forfeitures of restricted stock	(3,522	)	—			—			—			—			—			—			—			(2,023	)	—		—			—			—			—		—			—
Other	—		—			(3		)	—			(3		)	—			(3		)	3			—		—		—			—			—			—		—			—
Balance at September 30, 2018	89,188,708		$	1,320		$	3,800		$	44		$	5,164		$	—		$	5,164		$	—
Balance at June 30, 2019																								89,917,601		$	1,367	$	3,914		$	809		$	6,090		$	—	$	6,090		$	—

Balance at December 31, 2016	86,924,399		$	1,198		$	3,343		$	375		$	4,916		$	3		$	4,919		$	—
Net earnings	—		—			309			—			309			2			311			—
Other comprehensive income	—		—			—			314			314			—			314			—
Dividends on Common Stock	—		—			(214		)	—			(214		)	—			(214		)	—
Balance at March 31, 2018																								88,881,213		$	1,294	$	3,584		$	305		$	5,183		$	—	$	5,183		$	—
Net earnings (losses)																								—		—		210			—			210			—		210			(2		)
Other comprehensive loss																								—		—		—			(158		)	(158		)	—		(158		)	—
Dividends ($1.85 per share)																								—		—		(165		)	—			(165		)	—		(165		)	—
Shares issued:
Exercise of stock options	870,022		29			—			—			29			—			29			—			157,412		5		—			—			5			—		5			—
Restricted stock awards	232,250		—			—			—			—			—			—			—			—		—		—			—			—			—		—			—
Other benefit plans	85,190		8			—			—			8			—			8			—			21,093		2		—			—			2			—		2			—
Dividend reinvestment plan	22,243		2			—			—			2			—			2			—			15,227		2		—			—			2			—		2			—
Stock-based compensation expense	—		18			—			—			18			—			18			—			—		6		—			—			6			—		6			—
Shares exchanged — benefit plans	(34,922	)	—			(3		)	—			(3		)	—			(3		)	—			(428	)	—		1			—			1			—		1			—
Forfeitures of restricted stock	(6,388	)	—			—			—			—			—			—			—			(2,403	)	—		—			—			—			—		—			—
Other	—		—			—			—			—			(5		)	(5		)	—			—		—		(2		)	—			(2		)	—		(2		)	2
Balance at September 30, 2017	88,092,794		$	1,255		$	3,435		$	689		$	5,379		$	—		$	5,379		$	—
Balance at June 30, 2018																								89,072,114		$	1,309	$	3,628		$	147		$	5,084		$	—	$	5,084		$	—

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AMERICAN FINANCIAL GROUP, INC. 10-Q

AMERICAN FINANCIAL GROUP, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENT OF CHANGES IN EQUITY (UNAUDITED) — CONTINUED

(Dollars in Millions)



			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, 2018	89,291,724		$	1,334		$	3,588		$	48		$	4,970		$	2		$	4,972		$	—
Net earnings (losses)	—		—			539			—			539			—			539			(4		)
Other comprehensive income	—		—			—			761			761			—			761			1
Dividends ($2.30 per share)	—		—			(206		)	—			(206		)	—			(206		)	—
Shares issued:
Exercise of stock options	400,006		17			—			—			17			—			17			—
Restricted stock awards	232,565		—			—			—			—			—			—			—
Other benefit plans	41,143		4			—			—			4			—			4			—
Dividend reinvestment plan	9,489		1			—			—			1			—			1			—
Stock-based compensation expense	—		12			—			—			12			—			12			—
Shares exchanged — benefit plans	(46,989	)	(1		)	(4		)	—			(5		)	—			(5		)	—
Forfeitures of restricted stock	(10,337	)	—			—			—			—			—			—			—
Other	—		—			(3		)	—			(3		)	(2		)	(5		)	3
Balance at June 30, 2019	89,917,601		$	1,367		$	3,914		$	809		$	6,090		$	—		$	6,090		$	—

Balance at December 31, 2017	88,275,460		$	1,269		$	3,248		$	813		$	5,330		$	1		$	5,331		$	3
Cumulative effect of accounting change	—		—			225			(221		)	4			—			4			—
Net earnings (losses)	—		—			355			—			355			(1		)	354			(5		)
Other comprehensive loss	—		—			—			(445		)	(445		)	—			(445		)	—
Dividends ($2.20 per share)	—		—			(196		)	—			(196		)	—			(196		)	—
Shares issued:
Exercise of stock options	531,726		19			—			—			19			—			19			—
Restricted stock awards	200,625		—			—			—			—			—			—			—
Other benefit plans	73,676		8			—			—			8			—			8			—
Dividend reinvestment plan	18,006		2			—			—			2			—			2			—
Stock-based compensation expense	—		11			—			—			11			—			11			—
Shares exchanged — benefit plans	(24,310	)	—			(2		)	—			(2		)	—			(2		)	—
Forfeitures of restricted stock	(3,069	)	—			—			—			—			—			—			—
Other	—		—			(2		)	—			(2		)	—			(2		)	2
Balance at June 30, 2018	89,072,114		$	1,309		$	3,628		$	147		$	5,084		$	—		$	5,084		$	—

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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,						Six months ended June 30,
	2018			2017			2019			2018
Operating Activities:
Net earnings, including noncontrolling interests	$	552		$	311		$	535		$	349
Adjustments:
Depreciation and amortization	163			105			72			106
Annuity benefits	664			635			650			442
Realized (gains) losses on investing activities	28			(18		)	(241		)	64
Net sales of trading securities	116			5			—			83
Deferred annuity and life policy acquisition costs	(192		)	(177		)	(120		)	(127		)
Change in:
Reinsurance and other receivables	(868		)	(1,467		)	85			72
Other assets	(257		)	(59		)	(298		)	(16		)
Insurance claims and reserves	507			1,372			(92		)	(268		)
Payable to reinsurers	189			272			3			(22		)
Other liabilities	346			—			329			55
Managed investment entities’ assets/liabilities	104			14			(3		)	138
Other operating activities, net	(75		)	—			(43		)	(53		)
Net cash provided by operating activities	1,277			993			877			823

Investing Activities:
Purchases of:
Fixed maturities	(6,700		)	(7,163		)	(3,761		)	(4,549		)
Equity securities	(342		)	(73		)	(80		)	(248		)
Mortgage loans	(112		)	(149		)	(43		)	(90		)
Equity index options and other investments	(695		)	(594		)	(467		)	(446		)
Real estate, property and equipment	(60		)	(46		)	(20		)	(44		)
Proceeds from:
Maturities and redemptions of fixed maturities	3,516			4,690			2,347			2,283
Repayments of mortgage loans	87			191			38			68
Sales of fixed maturities	275			179			459			203
Sales of equity securities	150			97			139			106
Sales and settlements of equity index options and other investments	688			565			329			446
Sales of real estate, property and equipment	3			54			2			1
Managed investment entities:
Purchases of investments	(1,674		)	(2,330		)	(697		)	(1,261		)
Proceeds from sales and redemptions of investments	1,485			2,343			702			1,035
Other investing activities, net	4			6			—			11
Net cash used in investing activities	(3,375		)	(2,230		)	(1,052		)	(2,485		)

Financing Activities:
Annuity receipts	3,925			3,432			2,744			2,547
Annuity surrenders, benefits and withdrawals	(2,101		)	(1,725		)	(1,668		)	(1,372		)
Net transfers from variable annuity assets	35			43			28			21
Additional long-term borrowings	—			345			121			—
Reductions of long-term debt	—			(355		)
Issuances of managed investment entities’ liabilities	1,572			1,926			—			1,572
Retirements of managed investment entities’ liabilities	(1,463		)	(1,998		)	(5		)	(1,461		)
Issuances of Common Stock	26			30			19			21
Cash dividends paid on Common Stock	(225		)	(212		)	(205		)	(194		)
Other financing activities, net	—			(7		)
Net cash provided by financing activities	1,769			1,479			1,034			1,134
Net Change in Cash and Cash Equivalents	(329		)	242			859			(528		)
Cash and cash equivalents at beginning of period	2,338			2,107			1,515			2,338
Cash and cash equivalents at end of period	$	2,009		$	2,349		$	2,374		$	1,810

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INDEX TO NOTES

A.	Accounting Policies	H.I.	Goodwill and Other Intangibles
B.	~~Segments~~Acquisition of ~~Operations~~Business	I.J.	Long-Term Debt
C.	Segments of Operations	K.	Leases
D.	Fair Value Measurements	J.	~~Redeemable Noncontrolling Interests~~
D.	~~Investments~~	K.L.	Shareholders’ Equity
E.	~~Derivatives~~Investments	L.M.	Income Taxes
F.	~~Deferred Policy Acquisition Costs~~Derivatives	M.N.	Contingencies
G.	Deferred Policy Acquisition Costs	O.	Insurance
H.	Managed Investment Entities	N.	~~Insurance~~

A. 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~~June 30, ~~2018~~2019, 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~~material nonrecurring fair value measurements in the first ~~nine~~six months of ~~2018~~2019.

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 recordrecords holding gains and losses on ~~these~~ securities classified as ~~well as~~“trading” under previous guidance, 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 securities classified as “available for sale” are reported at fair value with unrealized gains and losses included in AOCI in AFG’s Balance Sheet. Fixed maturity 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.

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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 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 and principal-only MBS) and (ii) the equity-based component of certain annuity products (included in annuity benefits accumulated) and related equity index 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.

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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

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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.

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 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 GH — “Managed Investment Entities”). AFG has determined that it is the primary beneficiary of ~~the~~these 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.

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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.

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 recorded in other income. For traditional fixed annuities, the liability for annuity benefits accumulated represents the account value that ~~has~~had accrued to the benefit of the policyholder as of the balance sheet date. For fixed-indexed annuities (“FIAs”), the liability orfor 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).

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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.

Debt Issuance CostsDebt 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.

Leases On January 1, 2019, AFG adopted ASU 2016-02, which requires entities that lease assets for terms longer than one year to recognize assets and liabilities for the rights and obligations created by those leases on the balance sheet based on the present value of contractual cash flows. As permitted under the ASU, AFG adopted the guidance on a modified retrospective basis (comparative periods were not adjusted) and elected the following accounting policies and practical expedients:

exclude leases with a term of 12 months or less from the calculation of lease assets and liabilities,

not separate lease and non-lease components except for buildings (office space and storage facilities),

for contracts existing at the date of adoption – not reassess whether a contract is a lease or contains a lease, how initial direct costs were accounted for or whether the lease is an operating or finance lease, and

use hindsight to determine the lease term for leases existing at the date of adoption.

Adoption of the new guidance resulted in AFG recognizing a lease liability of $198 million (included in other liabilities) and a corresponding right-of-use asset of $174 million (which is presented net of $24 million in deferred rent and lease incentives) on January 1, 2019. Deferred rent and lease incentives were recognized as liabilities under the previous guidance and result from the straight-line expensing of operating leases. The adoption of the new guidance did not have a material effect on the AFG’s results of operations or liquidity. See Note K — “Leases” for additional disclosures.

Noncontrolling Interests For balance sheet purposes, noncontrolling interests represent 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).

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 represent 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.

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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 KL — “Shareholders’ Equity” for further information.

AFG records excess tax benefits or deficiencies for share-based payments through income tax expense in the statement of earnings. In addition, AFG accounts for forfeitures of awards when they 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 stock-based compensation plans: ~~third~~second quarter of2019 and 2018 ~~and 2017~~ — ~~1.6~~1.3 million and ~~1.9~~1.7 million; first ~~nine~~six months of 2019 and 2018 — 1.2 million and ~~2017 —~~ 1.7 million, ~~and 2.0 million,~~ respectively.

There were no anti-dilutive potential common shares in the ~~third~~second quarter or first ~~nine~~six months of ~~2018~~2019 or ~~2017.~~2018.

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.~~equipment and businesses. “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.

~~Revenue Recognition Guidance Effective in 2018~~ On January 1, 2018, AFG adopted ASU 2014-09, which provides guidance on recognizing revenue when (or as) performance obligations under the contract are satisfied. The new guidance also updates the accounting for certain costs associated with obtaining and fulfilling contracts with customers and requires certain new disclosures. Because revenue recognition for insurance contracts and financial instruments (AFG’s primary sources of revenue) were excluded from the scope of the new guidance, the adoption of ASU 2014-09 did not have a material impact on AFG’s results of operations or financial position.

B. B. Acquisition of Business

Effective June 10, 2019, National Interstate, a property and casualty insurance subsidiary of AFG, entered into an agreement with Atlas Financial Holdings, Inc. (“AFH”) to become the exclusive underwriter of AFH’s paratransit book of business. National Interstate estimates that the majority of AFH’s $110 million paratransit business will be eligible for quotation under this arrangement over the first 12 months following inception of the agreement. Under the terms of the agreement, AFH will act as an underwriting manager for National Interstate for at least 12 months, after which time National Interstate is entitled to acquire the renewal rights for the business from AFH for a purchase price equal to 15% of the in force gross written premiums at that date. The majority of the purchase price ultimately paid for the renewal rights will be recorded as an intangible renewal rights asset and will be amortized over the estimated life of the business acquired. In connection with the transaction, AFG was granted a five-year warrant to acquire approximately 2.4 million shares of AFH. The estimated fair value of the warrant was approximately $1 million at the date it was received.

C. Segments of Operations

AFG manages its business as three segments: (i) Property and casualty insurance, (ii) Annuity and (iii) Other, which includes holding company 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,~~trucks, inland and ocean marine, agricultural-related products and other commercial property coverages, (ii) Specialty casualty, which includes primarily excess and surplus, ~~general~~executive and professional liability, ~~executive liability, professional~~general liability, umbrella and excess liability, specialty ~~coverage~~coverages in targeted markets, customized programs for small to mid-sized businesses and workers’ compensation insurance, and (iii) Specialty

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financial, which includes risk management insurance programs for ~~leasing~~lending and ~~financing~~leasing institutions (including equipment leasing and collateral and lender-placed mortgage property insurance), ~~surety~~fidelity and ~~fidelity~~surety 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~~sells traditional fixed, fixed-indexed and variable-indexed annuities in the retail, financial institutions, broker-dealer and 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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~~AMERICAN FINANCIAL GROUP, INC. 10-Q~~

~~NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — CONTINUED~~

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 June 30,				Six months ended June 30,
	2019		2018		2019		2018
Revenues
Property and casualty insurance:
Premiums earned:
Specialty
Property and transportation	$	379	$	374	$	740	$	724
Specialty casualty	634		595		1,263		1,174
Specialty financial	151		159		297		308
Other specialty	36		33		73		62
Total premiums earned	1,200		1,161		2,373		2,268
Net investment income	124		115		228		215
Other income	2		2		5		4
Total property and casualty insurance	1,326		1,278		2,606		2,487
Annuity:
Net investment income	451		412		886		806
Other income	27		27		54		53
Total annuity	478		439		940		859
Other	100		85		198		168
Total revenues before realized gains (losses)	1,904		1,802		3,744		3,514
Realized gains (losses) on securities	56		31		240		(62		)
Total revenues	$	1,960	$	1,833	$	3,984	$	3,452

Three months ended September 30, Nine months ended September 30,
2018 2017 2018 2017
Revenues
Property and casualty insurance:
Premiums earned:
Specialty
Property and transportation $ 526
$ 527
$ 1,250
$ 1,226
Specialty casualty 616
568
1,790
1,613
Specialty financial 149
142
457
435
Other specialty 36
30
98
80
Total premiums earned 1,327
1,267
3,595
3,354
Net investment income 108
94
323
276
Other income (a) 4
1
8
21
Total property and casualty insurance 1,439
1,362
3,926
3,651
Annuity:
Net investment income 413
375
1,219
1,082
Other income 27
26
80
79
Total annuity 440
401
1,299
1,161
Other 95
84
263
246
Total revenues before realized gains (losses) 1,974
1,847
5,488
5,058
Realized gains (losses) on securities 34
(12 ) (28 ) (1 )
Total revenues $ 2,008
$ 1,835
$ 5,460
$ 5,057



Earnings Before Income Taxes
Property and casualty insurance:
Underwriting:
Specialty
Property and transportation	$	4		$	23		$	43		$	56
Specialty casualty	47			29			83			70
Specialty financial	21			22			34			37
Other specialty	(12		)	(1		)	(12		)	2
Other lines	(1		)	(1		)	(2		)	(2		)
Total underwriting	59			72			146			163
Investment and other income, net	115			106			210			199
Total property and casualty insurance	174			178			356			362
Annuity	71			99			161			224
Other (*)	(42		)	(48		)	(85		)	(90		)
Total earnings before realized gains (losses) and income taxes	203			229			432			496
Realized gains (losses) on securities	56			31			240			(62		)
Total earnings before income taxes	$	259		$	260		$	672		$	434

Earnings Before Income Taxes
Property and casualty insurance:
Underwriting:
Specialty
Property and transportation $ —
$ 6
$ 56
$ 70
Specialty casualty 49
2
119
46
Specialty financial 9
(3 ) 46
42
Other specialty (3 ) 4
(1 ) 3
Other lines (b) (17 ) (90 ) (19 ) (92 )
Total underwriting 38
(81 ) 201
69
Investment and other income, net (a) 101
87
300
271
Total property and casualty insurance 139
6
501
340
Annuity 117
102
341
283
Other (c) (46 ) (67 ) (136 ) (165 )
Total earnings before realized gains (losses) and income taxes 210
41
706
458
Realized gains (losses) on securities 34
(12 ) (28 ) (1 )
Total earnings before income taxes $ 244
$ 29
$ 678
$ 457


~~(a)~~	~~Includes income of $13 million (before noncontrolling interest) from the sale of a hotel in the first quarter of 2017.~~


~~(b)~~	~~Includes special charges of $18 million and $89 million in the third quarter of 2018 and 2017, respectively, to increase asbestos and environmental (“A&E”~~(*) ~~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 $9 million and $24 million in the third quarter of 2018 and 2017, respectively, to increase A&E reserves related to AFG’s former railroad and manufacturing operations.expenses.

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C. D. Fair Value Measurements

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

Level 1 — Quoted prices for identical assets or liabilities in active markets (markets in which transactions occur with sufficient frequency and volume to provide pricing information on an ongoing basis). AFG’s Level 1 financial instruments consist primarily of publicly traded equity securities, 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 its 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 separately measured fair 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 2520 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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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		Total		Level 1		Level 2		Level 3		Total
September 30, 2018
June 30, 2019
Assets:
Available for sale (“AFS”) fixed maturities:
U.S. Government and government agencies	$	142	$	84	$	8	$	234	$	143	$	77	$	8	$	228
States, municipalities and political subdivisions	—		6,715		60		6,775		—		6,914		82		6,996
Foreign government	—		139		—		139		—		149		—		149
Residential MBS	—		2,564		145		2,709		—		2,528		139		2,667
Commercial MBS	—		866		57		923		—		924		50		974
Asset-backed securities	—		8,316		991		9,307
Collateralized loan obligations									—		4,283		50		4,333
Other asset-backed securities									—		5,577		367		5,944
Corporate and other	29		18,482		1,646		20,157		29		21,376		2,014		23,419
Total AFS fixed maturities	171		37,166		2,907		40,244		172		41,828		2,710		44,710
Trading fixed maturities	9		94		—		103		4		102		—		106
Equity securities	1,462		76		289		1,827		1,532		76		377		1,985
Equity index call options	—		759		—		759		—		712		—		712
Assets of managed investment entities (“MIE”)	258		4,718		22		4,998		225		4,537		19		4,781
Variable annuity assets (separate accounts) (*)	—		650		—		650		—		616		—		616
Other assets — derivatives									—		54		—		54
Total assets accounted for at fair value	$	1,900	$	43,463	$	3,218	$	48,581	$	1,933	$	47,925	$	3,106	$	52,964
Liabilities:
Liabilities of managed investment entities	$	248	$	4,537	$	22	$	4,807	$	216	$	4,356	$	18	$	4,590
Derivatives in annuity benefits accumulated	—		—		3,105		3,105		—		—		3,541		3,541
Other liabilities — derivatives	—		83		—		83		—		12		—		12
Total liabilities accounted for at fair value	$	248	$	4,620	$	3,127	$	7,995	$	216	$	4,368	$	3,559	$	8,143

December 31, 2017
December 31, 2018
Assets:
Available for sale fixed maturities:
U.S. Government and government agencies	$	122	$	112	$	8	$	242	$	141	$	83	$	9	$	233
States, municipalities and political subdivisions	—		6,975		148		7,123		—		6,880		59		6,939
Foreign government	—		127		—		127		—		142		—		142
Residential MBS	—		3,105		122		3,227		—		2,547		197		2,744
Commercial MBS	—		926		36		962		—		864		56		920
Asset-backed securities	—		7,218		744		7,962
Collateralized loan obligations									—		4,162		116		4,278
Other asset-backed securities									—		4,802		731		5,533
Corporate and other	30		17,662		1,044		18,736		28		19,184		1,996		21,208
Total AFS fixed maturities	152		36,125		2,102		38,379		169		38,664		3,164		41,997
Trading fixed maturities	44		304		—		348		9		96		—		105
Equity securities	1,411		86		165		1,662		1,410		68		336		1,814
Equity index call options	—		701		—		701		—		184		—		184
Assets of managed investment entities	307		4,572		23		4,902		203		4,476		21		4,700
Variable annuity assets (separate accounts) (*)	—		644		—		644		—		557		—		557
Other assets — derivatives									—		16		—		16
Total assets accounted for at fair value	$	1,914	$	42,432	$	2,290	$	46,636	$	1,791	$	44,061	$	3,521	$	49,373
Liabilities:
Liabilities of managed investment entities	$	293	$	4,372	$	22	$	4,687	$	195	$	4,297	$	20	$	4,512
Derivatives in annuity benefits accumulated	—		—		2,542		2,542		—		—		2,720		2,720
Other liabilities — derivatives	—		35		—		35		—		49		—		49
Total liabilities accounted for at fair value	$	293	$	4,407	$	2,564	$	7,264	$	195	$	4,346	$	2,740	$	7,281


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

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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~~second quarter and first six months of 2019, there ~~were no transfers between~~was one preferred stock with an aggregate fair value of $6 million that transferred from Level 1 ~~and~~to Level 2. During the second quarter and first ~~nine~~six 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 preferred stock with an aggregate fair value of $1 million that transferred from Level 2 to 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.

Approximately 7%6% of the total assets carried at fair value at ~~September~~June 30, ~~2018,~~2019, were Level 3 assets. Approximately ~~68%~~55% ($~~2.18~~1.71 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~~

Internally developed Level 3 asset fair values represent approximately ~~18%~~$1.19 billion at June 30, 2019. Of this amount, approximately $833 million relates to fixed maturity securities that were priced using management’s best estimate of ~~AFG’s Shareholders’ Equity,~~an appropriate credit spread over the treasury yield (of a similar duration) to discount future expected cash flows using a third party model. The credit spread applied by management is the significant unobservable input. For this group of approximately 140 securities, the average spread used was 576 basis points over the reference treasury yield and the spreads ranged from 100 basis points to 2,966 basis points (approximately 80% of the spreads were between 400 and 700 basis points). Had management used higher spreads, the fair value of this group of securities would have been lower. Conversely, if the spreads used were lower, the fair values would have been higher. For the remainder of the internally developed prices, any justifiable changes in unobservable inputs used to determine ~~internally developed~~ fair ~~values~~value would not ~~be expected to~~ have resulted in a material ~~impact on~~change in 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 $~~3.11~~3.54 billion at ~~September~~June 30, ~~2018~~2019. The following table presents information about the unobservable inputs used by management in determining fair value of these ~~embedded derivatives.~~Level 3 liabilities. See Note EF — “Derivatives.”



	Unobservable Input		Range
	Adjustment for insurance subsidiary’s credit risk		~~0.4%~~less than 0.1% – ~~1.6%~~2.4% over the risk free rate
	Risk margin for uncertainty in cash flows		~~0.70%~~0.73% reduction in the discount rate
	Surrenders		3%4% – 23% of indexed account value
	Partial surrenders		2% – 9% of indexed account value
	Annuitizations		0.1% – 1% of indexed account value
	Deaths		~~1.6%~~1.7% – ~~8.0%~~9.5% of indexed account value
	Budgeted option costs		~~2.4%~~2.6% – 3.6% of indexed account value

The range of adjustments for insurance subsidiary’s credit risk is based on the Moody’s corporate A2 bond index and 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 7% to 11% in the majority of future calendar years (3%4% to 23% over all periods). Increasing the budgeted option cost or risk margin for uncertainty in cash flow 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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Changes in balances of Level 3 financial assets and liabilities carried at fair value during the ~~third~~second quarter and first ~~nine~~six months of ~~2018~~2019 and ~~2017~~2018 are presented below (in millions). The transfers into and out of Level 3 were due to changes in the availability of market observable 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, 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			Balance at March 31, 2019			Net earnings			Other comprehensive income (loss)		Purchases and issuances			Sales and settlements			Transfer into Level 3		Transfer out of Level 3			Balance at June 30, 2019
AFS fixed maturities:
U.S. government agency	$	8		$	—		$	—		$	—		$	—		$	—	$	—		$	8		$	8		$	—		$	—	$	—		$	—		$	—	$	—		$	8
State and municipal	61			—			—			—			(1		)	—		—			60			63			—			2		—			(1		)	18		—			82
Residential MBS	147			(2		)	(2		)	—			(6		)	13		(5		)	145			169			4			—		—			(4		)	2		(32		)	139
Commercial MBS	56			2			—			(1		)	—			—		—			57			55			2			—		—			(2		)	—		(5		)	50
Asset-backed securities	1,004			—			(3		)	13			(23		)	—		—			991
Collateralized loan obligations																								37			—			—		—			—			13		—			50
Other asset-backed securities																								633			—			3		17			(18		)	—		(268		)	367
Corporate and other	1,408			—			(3		)	312			(59		)	—		(12		)	1,646			2,346			—			20		229			(161		)	2		(422		)	2,014
Total AFS fixed maturities	2,684			—			(8		)	324			(89		)	13		(17		)	2,907			3,311			6			25		246			(186		)	35		(727		)	2,710
Equity securities	230			(5		)	—			81			—			—		(17		)	289			354			(1		)	—		19			(1		)	6		—			377
Assets of MIE	23			(1		)	—			—			—			—		—			22			20			(1		)	—		—			—			—		—			19
Total Level 3 assets	$	2,937		$	(6	)	$	(8	)	$	405		$	(89	)	$	13	$	(34	)	$	3,218		$	3,685		$	4		$	25	$	265		$	(187	)	$	41	$	(727	)	$	3,106

Embedded derivatives	$	(2,776	)	$	(223	)	$	—		$	(151	)	$	45		$	—	$	—		$	(3,105	)	$	(3,247	)	$	(251	)	$	—	$	(101	)	$	58		$	—	$	—		$	(3,541	)
Total Level 3 liabilities (*)	$	(2,776	)	$	(223	)	$	—		$	(151	)	$	45		$	—	$	—		$	(3,105	)
Total Level 3 liabilities (b)																								$	(3,247	)	$	(251	)	$	—	$	(101	)	$	58		$	—	$	—		$	(3,541	)


				Total realized/unrealized gains (losses) included in																							Total realized/unrealized gains (losses) included in
	Balance 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			Balance at March 31, 2018			Net earnings			Other comprehensive income (loss)			Purchases and issuances			Sales and settlements			Transfer into Level 3		Transfer out of Level 3			Balance at June 30, 2018
AFS fixed maturities:
U.S. government agency	$	8		$	—		$	—		$	—		$	—		$	—	$	—		$	8		$	8		$	—		$	—		$	—		$	—		$	—	$	—		$	8
State and municipal	143			—			—			—			(1		)	10		—			152			62			—			(1		)	—			—			—		—			61
Residential MBS	153			2			1			—			(6		)	15		(21		)	144			115			(3		)	—			—			(5		)	50		(10		)	147
Commercial MBS	45			1			—			—			(10		)	—		—			36			47			—			—			9			—			—		—			56
Asset-backed securities	498			(2		)	1			13			(26		)	163		(111		)	536
Collateralized loan obligations																								181			—			(4		)	35			—			—		—			212
Other asset-backed securities																								731			—			(2		)	101			(20		)	—		(18		)	792
Corporate and other	953			(9		)	—			172			(59		)	—		(7		)	1,050			1,238			1			(4		)	234			(48		)	—		(13		)	1,408
Total AFS fixed maturities	1,800			(8		)	2			185			(102		)	188		(139		)	1,926			2,382			(2		)	(11		)	379			(73		)	50		(41		)	2,684
Equity securities	168			(3		)	(4		)	2			—			—		—			163			194			19			—			16			—			1		—			230
Assets of MIE	23			(4		)	—			2			—			—		—			21			24			(3		)	—			2			—			—		—			23
Total Level 3 assets	$	1,991		$	(15	)	$	(2	)	$	189		$	(102	)	$	188	$	(139	)	$	2,110		$	2,600		$	14		$	(11	)	$	397		$	(73	)	$	51	$	(41	)	$	2,937

Embedded derivatives	$	(2,129	)	$	(127	)	$	—		$	(65	)	$	28		$	—	$	—		$	(2,293	)
Total Level 3 liabilities (*)	$	(2,129	)	$	(127	)	$	—		$	(65	)	$	28		$	—	$	—		$	(2,293	)
Embedded derivatives (a)																								$	(2,549	)	$	(126	)	$	—		$	(141	)	$	40		$	—	$	—		$	(2,776	)
Total Level 3 liabilities (b)																								$	(2,549	)	$	(126	)	$	—		$	(141	)	$	40		$	—	$	—		$	(2,776	)


~~(*)~~(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 second quarter of 2018.


(b)	As previously discussed, 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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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — CONTINUED


				Total realized/unrealized gains (losses) included in																							Total realized/unrealized gains (losses) included in
	Balance 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			Balance at December 31, 2018			Net earnings			Other comprehensive income (loss)			Purchases and issuances			Sales and settlements			Transfer into Level 3		Transfer out of Level 3			Balance at June 30, 2019
AFS fixed maturities:
U.S. government agency	$	8		$	—		$	—		$	—		$	—		$	—	$	—		$	8		$	9		$	—		$	—		$	—		$	(1	)	$	—	$	—		$	8
State and municipal	148			—			(2		)	—			(2		)	—		(84		)	60			59			—			7			—			(2		)	18		—			82
Residential MBS	122			(9		)	(2		)	—			(17		)	70		(19		)	145			197			9			(5		)	—			(10		)	2		(54		)	139
Commercial MBS	36			1			—			20			—			—		—			57			56			2			—			—			(3		)	—		(5		)	50
Asset-backed securities	744			(2		)	(6		)	353			(80		)	—		(18		)	991
Collateralized loan obligations																								116			(3		)	6			—			—			13		(82		)	50
Other asset-backed securities																								731			—			5			92			(132		)	—		(329		)	367
Corporate and other	1,044			2			(21		)	784			(138		)	—		(25		)	1,646			1,996			2			51			661			(249		)	2		(449		)	2,014
Total AFS fixed maturities	2,102			(8		)	(31		)	1,157			(237		)	70		(146		)	2,907			3,164			10			64			753			(397		)	35		(919		)	2,710
Equity securities	165			9			—			106			(4		)	30		(17		)	289			336			—			—			20			(1		)	22		—			377
Assets of MIE	23			(6		)	—			5			—			—		—			22			21			(2		)	—			—			—			—		—			19
Total Level 3 assets	$	2,290		$	(5	)	$	(31	)	$	1,268		$	(241	)	$	100	$	(163	)	$	3,218		$	3,521		$	8		$	64		$	773		$	(398	)	$	57	$	(919	)	$	3,106

Embedded derivatives (a)	$	(2,542	)	$	(286	)	$	—		$	(395	)	$	118		$	—	$	—		$	(3,105	)
Embedded derivatives																								$	(2,720	)	$	(713	)	$	—		$	(213	)	$	105		$	—	$	—		$	(3,541	)
Total Level 3 liabilities (b)	$	(2,542	)	$	(286	)	$	—		$	(395	)	$	118		$	—	$	—		$	(3,105	)	$	(2,720	)	$	(713	)	$	—		$	(213	)	$	105		$	—	$	—		$	(3,541	)



				Total realized/unrealized gains (losses) included in
	Balance 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 June 30, 2018
AFS fixed maturities:
U.S. government agency	$	8		$	—		$	—		$	—		$	—		$	—	$	—		$	8
State and municipal	148			—			(2		)	—			(1		)	—		(84		)	61
Residential MBS	122			(7		)	—			—			(11		)	57		(14		)	147
Commercial MBS	36			(1		)	—			21			—			—		—			56
Collateralized loan obligations	180			(2		)	(1		)	35			—			—		—			212
Other asset-backed securities	564			—			(2		)	305			(57		)	—		(18		)	792
Corporate and other	1,044			2			(18		)	472			(79		)	—		(13		)	1,408
Total AFS fixed maturities	2,102			(8		)	(23		)	833			(148		)	57		(129		)	2,684
Equity securities	165			14			—			25			(4		)	30		—			230
Assets of MIE	23			(5		)	—			5			—			—		—			23
Total Level 3 assets	$	2,290		$	1		$	(23	)	$	863		$	(152	)	$	87	$	(129	)	$	2,937

Embedded derivatives (a)	$	(2,542	)	$	(63	)	$	—		$	(244	)	$	73		$	—	$	—		$	(2,776	)
Total Level 3 liabilities (b)	$	(2,542	)	$	(63	)	$	—		$	(244	)	$	73		$	—	$	—		$	(2,776	)

Total realized/unrealized
gains (losses) included in

Balance 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 $ 8
$ —
$ —
$ —
$ —
$ —
$ —
$ 8
State and municipal 140
—
4
—
(2 ) 10
—
152
Residential MBS 190
—
3
1
(37 ) 35
(48 ) 144
Commercial MBS 25
2
—
15
(10 ) 4
—
36
Asset-backed securities 484
(2 ) 3
117
(62 ) 199
(203 ) 536
Corporate and other 712
(4 ) 8
460
(124 ) 29
(31 ) 1,050
Total AFS fixed maturities 1,559
(4 ) 18
593
(235 ) 277
(282 ) 1,926
Equity securities 174
(19 ) 9
22
(3 ) —
(20 ) 163
Assets of MIE 29
(10 ) —
6
—
—
(4 ) 21
Total Level 3 assets $ 1,762
$ (33 ) $ 27
$ 621
$ (238 ) $ 277
$ (306 ) $ 2,110

Embedded derivatives $ (1,759 ) $ (386 ) $ —
$ (224 ) $ 76
$ —
$ —
$ (2,293 )
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~~six months of 2018.


(b)	As previously discussed, 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 Value								Carrying		Fair Value
	Value		Total		Level 1		Level 2		Level 3		Value		Total		Level 1		Level 2		Level 3
September 30, 2018
June 30, 2019
Financial assets:
Cash and cash equivalents	$	2,009	$	2,009	$	2,009	$	—	$	—	$	2,374	$	2,374	$	2,374	$	—	$	—
Mortgage loans	1,152		1,130		—		—		1,130		1,073		1,080		—		—		1,080
Policy loans	176		176		—		—		176		170		170		—		—		170
Total financial assets not accounted for at fair value	$	3,337	$	3,315	$	2,009	$	—	$	1,306	$	3,617	$	3,624	$	2,374	$	—	$	1,250
Financial liabilities:
Annuity benefits accumulated (*)	$	35,729	$	33,923	$	—	$	—	$	33,923	$	38,806	$	38,634	$	—	$	—	$	38,634
Long-term debt	1,302		1,260		—		1,257		3		1,423		1,482		—		1,479		3
Total financial liabilities not accounted for at fair value	$	37,031	$	35,183	$	—	$	1,257	$	33,926	$	40,229	$	40,116	$	—	$	1,479	$	38,637

December 31, 2017
December 31, 2018
Financial assets:
Cash and cash equivalents	$	2,338	$	2,338	$	2,338	$	—	$	—	$	1,515	$	1,515	$	1,515	$	—	$	—
Mortgage loans	1,125		1,119		—		—		1,119		1,068		1,056		—		—		1,056
Policy loans	184		184		—		—		184		174		174		—		—		174
Total financial assets not accounted for at fair value	$	3,647	$	3,641	$	2,338	$	—	$	1,303	$	2,757	$	2,745	$	1,515	$	—	$	1,230
Financial liabilities:
Annuity benefits accumulated (*)	$	33,110	$	32,461	$	—	$	—	$	32,461	$	36,384	$	34,765	$	—	$	—	$	34,765
Long-term debt	1,301		1,354		—		1,351		3		1,302		1,231		—		1,228		3
Total financial liabilities not accounted for at fair value	$	34,411	$	33,815	$	—	$	1,351	$	32,464	$	37,686	$	35,996	$	—	$	1,228	$	34,768


(*)	Excludes ~~$229~~$238 million and ~~$206~~$232 million of life contingent annuities in the payout phase at ~~September~~June 30, ~~2018~~2019 and December 31, ~~2017,~~2018, 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.

1920

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AMERICAN FINANCIAL GROUP, INC. 10-Q

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — CONTINUED

D. E. Investments

Available for sale fixed maturities at ~~September~~June 30, ~~2018~~2019 and December 31, ~~2017~~2018, consisted of the following (in millions):



	June 30, 2019												December 31, 2018
	Amortized Cost		Gross Unrealized					Net Unrealized			Fair Value		Amortized Cost		Gross Unrealized					Net Unrealized			Fair Value
	Amortized Cost		Gains		Losses			Net Unrealized			Fair Value		Amortized Cost		Gains		Losses			Net Unrealized			Fair Value
Fixed maturities:
U.S. Government and government agencies	$	226	$	4	$	(2	)	$	2		$	228	$	235	$	1	$	(3	)	$	(2	)	$	233
States, municipalities and political subdivisions	6,628		374		(6		)	368			6,996		6,825		169		(55		)	114			6,939
Foreign government	146		3		—			3			149		140		2		—			2			142
Residential MBS	2,368		303		(4		)	299			2,667		2,476		277		(9		)	268			2,744
Commercial MBS	938		36		—			36			974		905		17		(2		)	15			920
Collateralized loan obligations	4,359		10		(36		)	(26		)	4,333		4,350		1		(73		)	(72		)	4,278
Other asset-backed securities	5,749		205		(10		)	195			5,944		5,431		129		(27		)	102			5,533
Corporate and other	22,494		960		(35		)	925			23,419		21,475		167		(434		)	(267		)	21,208
Total fixed maturities	$	42,908	$	1,895	$	(93	)	$	1,802		$	44,710	$	41,837	$	763	$	(603	)	$	160		$	41,997

September 30, 2018 December 31, 2017
Amortized
Cost
Gross Unrealized
Net
Unrealized

Fair
Value

Amortized
Cost
Gross Unrealized
Net
Unrealized

Fair
Value
Gains Losses Gains Losses
Fixed maturities:
U.S. Government and government agencies $ 238
$ —
$ (4 ) $ (4 ) $ 234
$ 244
$ 1
$ (3 ) $ (2 ) $ 242
States, municipalities and political subdivisions 6,756
117
(98 ) 19
6,775
6,887
254
(18 ) 236
7,123
Foreign government 137
2
—
2
139
124
3
—
3
127
Residential MBS 2,408
310
(9 ) 301
2,709
2,884
349
(6 ) 343
3,227
Commercial MBS 913
14
(4 ) 10
923
927
36
(1 ) 35
962
Asset-backed securities 9,249
122
(64 ) 58
9,307
7,836
142
(16 ) 126
7,962
Corporate and other 20,352
169
(364 ) (195 ) 20,157
18,136
638
(38 ) 600
18,736
Total fixed maturities $ 40,053
$ 734
$ (543 ) $ 191
$ 40,244
$ 37,038
$ 1,423
$ (82 ) $ 1,341
$ 38,379

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~~June 30, ~~2018~~2019 and December 31, ~~2017~~2018 were ~~$144~~$130 million and ~~$158~~$140 million, respectively. Gross unrealized gains on such securities at ~~September~~June 30, ~~2018~~2019 and December 31, ~~2017~~2018 were ~~$130~~$120 million and ~~$137~~$119 million, respectively. Gross unrealized losses on such securities at both ~~September~~June 30, ~~2018~~2019 and December 31, ~~2017~~2018 were $4 million. These amounts represent the non-credit other-than-temporary impairment charges recorded in AOCI adjusted for subsequent changes in fair values and relate primarily to residential MBS.

~~As discussed in~~ ~~Note~~ A — “~~Accounting Policies~~ — ~~Investments~~,” ~~beginning on January 1, 2018, AFG implemented new accounting guidance,~~Equity securities, which ~~required all equity securities previously classified as “available for sale” to be~~are reported at fair value with holding gains and losses recognized in net ~~earnings. Equity securities reported at fair value~~earnings, consisted of the following at ~~September~~June 30, 2019 and December 31, 2018 (in millions):



	June 30, 2019						December 31, 2018
					Fair Value over (under) Cost						Fair Value over (under) Cost
	Actual Cost						Actual Cost
	Actual Cost		Fair Value				Actual Cost		Fair Value
Common stocks	$	1,163	$	1,251	$	88	$	1,241	$	1,148	$	(93	)
Perpetual preferred stocks	731		734		3		705		666		(39		)
Total equity securities carried at fair value	$	1,894	$	1,985	$	91	$	1,946	$	1,814	$	(132	)

Fair Value in
Actual Cost Fair Value excess of Cost
Common stocks $ 1,040
$ 1,151
$ 111
Perpetual preferred stocks 683
676
(7 )
Total equity securities carried at fair value $ 1,723
$ 1,827
$ 104

2021

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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 the following balance sheet dates.



	Less 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
June 30, 2019
Fixed maturities:
U.S. Government and government agencies	$	—		$	—	—	%	$	(2	)	$	63	97	%
States, municipalities and political subdivisions	(1		)	92		99	%	(5		)	411		99	%
Foreign government	—			62		100	%	—			—		—	%
Residential MBS	(2		)	107		98	%	(2		)	84		98	%
Commercial MBS	—			18		100	%	—			—		—	%
Collateralized loan obligations	(18		)	1,840		99	%	(18		)	960		98	%
Other asset-backed securities	(4		)	656		99	%	(6		)	108		95	%
Corporate and other	(9		)	604		99	%	(26		)	858		97	%
Total fixed maturities	$	(34	)	$	3,379	99	%	$	(59	)	$	2,484	98	%

December 31, 2018
Fixed maturities:
U.S. Government and government agencies	$	—		$	41	100	%	$	(3	)	$	120	98	%
States, municipalities and political subdivisions	(23		)	1,497		98	%	(32		)	902		97	%
Foreign government	—			18		100	%	—			4		100	%
Residential MBS	(4		)	279		99	%	(5		)	139		97	%
Commercial MBS	(1		)	147		99	%	(1		)	30		97	%
Collateralized loan obligations	(61		)	3,540		98	%	(12		)	197		94	%
Asset-backed securities	(16		)	1,866		99	%	(11		)	432		98	%
Corporate and other	(306		)	10,378		97	%	(128		)	2,078		94	%
Total fixed maturities	$	(411	)	$	17,766	98	%	$	(192	)	$	3,902	95	%

Less 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
September 30, 2018
Fixed maturities:
U.S. Government and government agencies $ (1 ) $ 113
99 % $ (3 ) $ 100
97 %
States, municipalities and political subdivisions (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 (1 ) 118
99 % (5 ) 118
96 %
Commercial MBS (1 ) 67
99 % —
—
— %
Asset-backed securities (7 ) 1,195
99 % (9 ) 299
97 %
Corporate and other (20 ) 2,031
99 % (18 ) 603
97 %
Total fixed maturities $ (37 ) $ 4,295
99 % $ (45 ) $ 1,574
97 %

Equity securities:
Common stocks $ (22 ) $ 117
84 % $ —
$ —
— %
Perpetual preferred stocks —
41
100 % (1 ) 13
93 %
Total equity securities $ (22 ) $ 158
88 % $ (1 ) $ 13
93 %

At ~~September~~June 30, ~~2018~~2019, the gross unrealized losses on fixed maturities of $~~543~~93 million relate to ~~2,392~~712 securities. Investment grade securities (as determined by nationally recognized rating agencies) represented approximately ~~95%~~75% of the gross unrealized loss and ~~96%~~91% 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 both the first ~~nine~~six months of 2019 and 2018,, AFG recorded $1less than $1 million in other-than-temporary impairment charges related to its residential MBS.

In the first ~~nine~~six months of 2019 and 2018, AFG recorded $2$5 million and less than $1 million, respectively, in other-than-temporary impairment charges related to corporate bonds and other fixed maturities.

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~~June 30, ~~2018~~2019. ~~As discussed in~~ ~~Note~~ A ~~— “Accounting Policies~~ — ~~Investments~~,” 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.

2122

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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):



	2019			2018
Balance at March 31	$	141		$	144
Additional credit impairments on:
Previously impaired securities	—			—
Securities without prior impairments	—			1
Reductions due to sales or redemptions	(1		)	(1		)
Balance at June 30	$	140		$	144

Balance at January 1	$	142		$	145
Additional credit impairments on:
Previously impaired securities	—			—
Securities without prior impairments	—			1
Reductions due to sales or redemptions	(2		)	(2		)
Balance at June 30	$	140		$	144

2018 2017
Balance at June 30 $ 144
$ 145
Additional credit impairments on:
Previously impaired securities —
—
Securities without prior impairments —
3
Reductions due to sales or redemptions (1 ) (1 )
Balance at September 30 $ 143
$ 147

Balance at January 1 $ 145
$ 153
Additional credit impairments on:
Previously impaired securities —
1
Securities without prior impairments 1
3
Reductions due to sales or redemptions (3 ) (10 )
Balance at September 30 $ 143
$ 147

The table below sets forth the scheduled maturities of available for sale fixed maturities as of ~~September~~June 30, ~~2018~~2019 (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 Value
	Cost		Amount		%
Maturity
One year or less	$	1,580	$	1,601	4	%
After one year through five years	10,179		10,523		24	%
After five years through ten years	14,140		14,861		33	%
After ten years	3,595		3,807		8	%
	29,494		30,792		69	%
Collateralized loan obligations and other ABS (average life of approximately 4.5 years)	10,108		10,277		23	%
MBS (average life of approximately 4.5 years)	3,306		3,641		8	%
Total	$	42,908	$	44,710	100	%

Amortized Fair Value
Cost Amount %
Maturity
One year or less $ 1,212
$ 1,223
3 %
After one year through five years 8,150
8,184
20 %
After five years through ten years 13,372
13,211
33 %
After ten years 4,749
4,687
12 %
27,483
27,305
68 %
ABS (average life of approximately 4-1/2 years) 9,249
9,307
23 %
MBS (average life of approximately 4-1/2 years) 3,321
3,632
9 %
Total $ 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~~June 30, ~~2018~~2019 or December 31, ~~2017~~2018.

2223

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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			Net
June 30, 2019
Net unrealized gain on:
Fixed maturities — annuity segment (*)	$	1,461		$	(307	)	$	1,154
Fixed maturities — all other	341			(71		)	270
Total fixed maturities	1,802			(378		)	1,424
Deferred policy acquisition costs — annuity segment	(602		)	126			(476		)
Annuity benefits accumulated	(186		)	39			(147		)
Unearned revenue	14			(3		)	11
Total net unrealized gain on marketable securities	$	1,028		$	(216	)	$	812

December 31, 2018
Net unrealized gain on:
Fixed maturities — annuity segment (*)	$	101		$	(21	)	$	80
Fixed maturities — all other	59			(13		)	46
Total fixed maturities	160			(34		)	126
Deferred policy acquisition costs — annuity segment	(42		)	9			(33		)
Annuity benefits accumulated	(14		)	3			(11		)
Unearned revenue	1			—			1
Total net unrealized gain on marketable securities	$	105		$	(22	)	$	83

Pretax Deferred Tax Net
September 30, 2018
Net unrealized gain on:
Fixed maturities — annuity segment (a) $ 143
$ (30 ) $ 113
Fixed maturities — all other 48
(10 ) 38
Total fixed maturities 191
(40 ) 151
Deferred policy acquisition costs — annuity segment (56 ) 12
(44 )
Annuity benefits accumulated (18 ) 3
(15 )
Unearned revenue 1
—
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 other 259
(55 ) 204
Total fixed maturities 1,341
(282 ) 1,059
Equity securities (b) 279
(58 ) 221
Total investments 1,620
(340 ) 1,280
Deferred policy acquisition costs — annuity segment (433 ) 91
(342 )
Annuity benefits accumulated (137 ) 29
(108 )
Unearned revenue 13
(3 ) 10
Total net unrealized gain on marketable securities $ 1,063
$ (223 ) $ 840


~~(a)~~(*)	Net unrealized gains on fixed maturity investments supporting AFG’s annuity benefits accumulated.


~~(b)~~	~~As discussed in~~ ~~Note~~ A ~~— “Accounting Policies~~ — ~~Investments~~,” ~~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 June 30,						Six months ended June 30,
	2019			2018			2019			2018
Investment income:
Fixed maturities	$	478		$	431		$	947		$	843
Equity securities:
Dividends	22			20			44			40
Change in fair value (*)	7			15			18			14
Equity in earnings of partnerships and similar investments	45			41			66			87
Other	34			28			59			51
Gross investment income	586			535			1,134			1,035
Investment expenses	(6		)	(5		)	(12		)	(10		)
Net investment income	$	580		$	530		$	1,122		$	1,025

Three months ended September 30, Nine months ended September 30,
2018 2017 2018 2017
Investment income:
Fixed maturities $ 440
$ 405
$ 1,283
$ 1,191
Equity securities:
Dividends 19
17
59
53
Change in fair value (*) 2
—
16
4
Equity in earnings of partnerships and similar investments 41
20
128
51
Other 31
33
82
80
Gross investment income 533
475
1,568
1,379
Investment expenses (6 ) (4 ) (16 ) (13 )
Net investment income $ 527
$ 471
$ 1,552
$ 1,366

(*)

~~As discussed in~~ ~~Note~~ A ~~— “Accounting Policies~~ — ~~Investments~~,” 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

securities classified as “trading” under previous guidance and on a small portfolio of limited partnership and similar investments that do not qualify for the equity method of accounting.

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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) included in AOCI related to fixed maturity and equity security investments are summarized as follows (in millions):



	Three months ended June 30, 2019												Three months ended June 30, 2018
	Realized gains (losses)												Realized gains (losses)
	Before Impairments			Impairments			Total			Change in Unrealized			Before Impairments			Impairments			Total			Change in Unrealized
Fixed maturities	$	11		$	(3	)	$	8		$	789		$	4		$	—		$	4		$	(338	)
Equity securities	44			—			44			—			23			—			23			—
Mortgage loans and other investments	3			—			3			—			—			—			—			—
Other (*)	—			1			1			(349		)	4			—			4			147
Total pretax	58			(2		)	56			440			31			—			31			(191		)
Tax effects	(12		)	1			(11		)	(92		)	(6		)	—			(6		)	40
Net of tax	$	46		$	(1	)	$	45		$	348		$	25		$	—		$	25		$	(151	)


	Six months ended June 30, 2019												Six months ended June 30, 2018
	Realized gains (losses)												Realized gains (losses)
	Before Impairments			Impairments			Total			Change in Unrealized			Before Impairments			Impairments			Total			Change in Unrealized
Fixed maturities	$	14		$	(6	)	$	8		$	1,642		$	3		$	(1	)	$	2		$	(937	)
Equity securities	226			—			226			—			(72		)	—			(72		)	—
Mortgage loans and other investments	3			—			3			—			—			—			—			—
Other (*)	1			2			3			(719		)	8			—			8			395
Total pretax	244			(4		)	240			923			(61		)	(1		)	(62		)	(542		)
Tax effects	(51		)	1			(50		)	(194		)	13			—			13			114
Net of tax	$	193		$	(3	)	$	190		$	729		$	(48	)	$	(1	)	$	(49	)	$	(428	)

Three months ended September 30, 2018 Three months ended September 30, 2017
Realized gains (losses) Realized gains (losses)
Before Impairments Impairments Total Change in Unrealized Before Impairments Impairments Total Change in Unrealized
Fixed maturities $ —
$ (2 ) $ (2 ) $ (213 ) $ 9
$ (15 ) $ (6 ) $ 133
Equity securities 33
—
33
—
19
(29 ) (10 ) 24
Mortgage loans and other investments —
—
—
—
—
—
—
—
Other (*) 3
—
3
89
(2 ) 6
4
(53 )
Total pretax 36

(2 )
34

(124 )
26

(38 )
(12 )
104
Tax effects (8 ) 1
(7 ) 26
(9 ) 13
4
(37 )
Net of tax $ 28

$ (1 )
$ 27

$ (98 )
$ 17

$ (25 )
$ (8 )
$ 67

Nine months ended September 30, 2018 Nine months ended September 30, 2017
Realized gains (losses) Realized gains (losses)
Before Impairments Impairments Total Change in Unrealized Before Impairments Impairments Total Change in Unrealized
Fixed maturities $ 3
$ (3 ) $ —
$ (1,150 ) $ 25
$ (16 ) $ 9
$ 597
Equity securities (39 ) —
(39 ) —
29
(49 ) (20 ) 116
Mortgage loans and other investments —
—
—
—
3
—
3
—
Other (*) 11
—
11
484
(5 ) 12
7
(248 )
Total pretax (25 ) (3 ) (28 ) (666 ) 52
(53 ) (1 ) 465
Tax effects 5
1
6
140
(18 ) 18
—
(163 )
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 Policies~~ — ~~Investments~~,” ~~effective January 1, 2018, all~~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~~six months of 2019 and 2018 on securities that were still owned at ~~September~~June 30, 2019 and June 30, 2018 as follows (in millions):



	Three months ended June 30,				Six months ended June 30,
	2019		2018		2019		2018
Included in realized gains (losses)	$	38	$	16	$	193	$	(71	)
Included in net investment income	7		15		18		14
	$	45	$	31	$	211	$	(57	)

Three months ended Nine months ended
September 30, 2018 September 30, 2018
Included in realized gains (losses) $ 25
$ (51 )
Included in net investment income 2
16
$ 27
$ (35 )

Gross realized gains and losses (excluding impairment write-downs and mark-to-market of derivatives) on available for sale fixed maturity investment transactions consisted of the following (in millions):



	Six months ended June 30,
	2019			2018
Gross gains	$	11		$	16
Gross losses	(9		)	(8		)

Nine months ended September 30,
2018 2017
Fixed maturities:
Gross gains $ 19
$ 32
Gross losses (8 ) (4 )

~~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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AMERICAN FINANCIAL GROUP, INC. 10-Q

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — CONTINUED

F. Derivatives

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):



		June 30, 2019				December 31, 2018
Derivative	Balance Sheet Line	Asset		Liability		Asset		Liability
MBS with embedded derivatives	Fixed maturities	$	117	$	—	$	109	$	—
Public company warrants	Equity securities	1		—		—		—
Fixed-indexed and variable-indexed annuities (embedded derivative)	Annuity benefits accumulated	—		3,541		—		2,720
Equity index call options	Equity index call options	712		—		184		—
Equity index put options	Other liabilities	—		1		—		1
Reinsurance contracts (embedded derivative)	Other liabilities	—		4		—		2
		$	830	$	3,546	$	293	$	2,723

September 30, 2018 December 31, 2017
Derivative Balance Sheet Line Asset Liability Asset Liability
MBS with embedded derivatives Fixed maturities $ 110
$ —
$ 105
$ —
Public company warrants Equity securities 3
—
4
—
Fixed-indexed and variable-indexed annuities (embedded derivative) Annuity benefits accumulated —
3,105
—
2,542
Equity index call options Equity index call options 759
—
701
—
Equity index put options Other liabilities —
—
—
—
Reinsurance contracts (embedded derivative) Other liabilities —
2
—
4
$ 872
$ 3,107
$ 810
$ 2,546

The MBS with embedded derivatives consist of primarily interest-only 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 certain counterparties to support its purchased call option assets (net of collateral required under put option contracts with the same counterparties). This collateral ($~~545~~449 million at ~~September~~June 30, ~~2018~~2019 and ~~$389~~$103 million at December 31, ~~2017)~~2018) 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 and 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”~~Reinsurance” in Note A, AFG has a reinsurance contract that is considered to contain an embedded derivative.

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AMERICAN FINANCIAL GROUP, INC. 10-Q

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — CONTINUED

The following table summarizes the 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~~second quarter and first ~~nine~~six months of ~~2018~~2019 and ~~2017~~2018 (in millions):



		Three months ended June 30,						Six months ended June 30,
Derivative	Statement of Earnings Line	2019			2018			2019			2018
MBS with embedded derivatives	Realized gains (losses) on securities	$	6		$	(1	)	$	12		$	(5	)
Public company warrants	Realized gains (losses) on securities	—			—			—			(1		)
Fixed-indexed and variable-indexed annuities (embedded derivative) (*)	Annuity benefits	(251		)	(126		)	(713		)	(63		)
Equity index call options	Annuity benefits	148			90			514			52
Equity index put options	Annuity benefits	—			—			1			—
Reinsurance contract (embedded derivative)	Net investment income	(1		)	1			(2		)	2
		$	(98	)	$	(36	)	$	(188	)	$	(15	)

Three months ended September 30, Nine months ended September 30,
Derivative Statement of Earnings Line 2018 2017 2018 2017
MBS with embedded derivatives Realized gains (losses) on securities $ (3 ) $ —
$ (8 ) $ (3 )
Public company warrants Realized gains (losses) on securities 1
(1 ) —
(1 )
Fixed-indexed and variable-indexed annuities (embedded derivative) (*) Annuity benefits (223 ) (127 ) (286 ) (386 )
Equity index call options Annuity benefits 219
116
271
338
Equity index put options Annuity benefits —
—
—
—
Reinsurance contract (embedded derivative) Net investment income —
—
2
(2 )
$ (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~~loss related to the unlocking of actuarial ~~assumptions.~~assumptions of $44 million in the second quarter of 2018.

Derivatives Designated and Qualifying as Cash Flow Hedges As of ~~September~~June 30, ~~2018,~~2019, AFG has ~~entered into fourteen~~fifteen active 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.

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 ~~$2.17~~$2.14 billion at ~~September~~June 30, ~~2018~~2019 compared to ~~$1.58~~$2.35 billion at December 31, ~~2017,~~2018, reflecting ~~four new swaps with an aggregate notional amount at issuance of $697 million entered into in the first nine months of 2018, partially offset by~~ the scheduled amortization discussed ~~above.~~above and the termination of a swap with a notional amount of $138 million (on the settlement date) in the second quarter of 2019. The fair value of the effective portion of the interest rate swaps in an asset position and included in other assets was ~~zero~~$54 million at ~~September~~June 30, ~~2018~~2019 and ~~less than $1~~$16 million at December 31, ~~2017.~~2018. The fair value of the effective portion of the interest rate swaps in a liability position and included in other liabilities was ~~$81~~$7 million at ~~September~~June 30, ~~2018~~2019 and ~~$31~~$46 million at December 31, ~~2017.~~2018. 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 income of $1 million in the second quarter of 2019 compared to a loss of $2 million in the second quarter of 2018 and losses of $1 million ~~and $2 million during~~for the ~~third quarter and~~ first ~~nine~~six months of ~~2018 as compared to income of $1 million~~both 2019 and ~~$4 million in the third quarter and first nine months of 2017, respectively.~~2018. There was no ineffectiveness recorded in net earnings during these periods. A collateral receivable supporting these swaps of ~~$126~~$76 million at ~~September~~June 30, ~~2018~~2019 and ~~$70~~$135 million at December 31, ~~2017~~2018 is included in other assets in AFG’s Balance Sheet.

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AMERICAN FINANCIAL GROUP, INC. 10-Q

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — CONTINUED

F. G. Deferred Policy Acquisition Costs

A progression of deferred policy acquisition costs is presented below (in millions):


	P&C			Annuity and Other																					P&C			Annuity and Other
	Deferred			Deferred			Sales															Consolidated			Deferred			Deferred			Sales															Consolidated
	Costs			Costs			Inducements			PVFP			Subtotal			Unrealized (*)			Total			Total			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
Balance at March 31, 2019																									$	312		$	1,336		$	84		$	40		$	1,460		$	(325	)	$	1,135		$	1,447
Additions	181			65			1			—			66			—			66			247			194			56			—			—			56			—			56			250
Amortization:
Periodic amortization	(171		)	(58		)	(5		)	(2		)	(65		)	—			(65		)	(236		)	(175		)	(19		)	(4		)	(2		)	(25		)	—			(25		)	(200		)
Included in realized gains	—			3			—			—			3			—			3			3			—			—			1			—			1			—			1			1
Foreign currency translation	—			—			—			—			—			—			—			—			(1		)	—			—			—			—			—			—			(1		)
Change in unrealized	—			—			—			—			—			73			73			73			—			—			—			—			—			(294		)	(294		)	(294		)
Balance at September 30, 2018	$	308		$	1,253		$	90		$	43		$	1,386		$	(25	)	$	1,361		$	1,669
Balance at June 30, 2019																									$	330		$	1,373		$	81		$	38		$	1,492		$	(619	)	$	873		$	1,203

Balance at June 30, 2017	$	258		$	1,167		$	103		$	42		$	1,312		$	(414	)	$	898		$	1,156
Balance at March 31, 2018																									$	279		$	1,208		$	97		$	47		$	1,352		$	(214	)	$	1,138		$	1,417
Additions																									181			70			1			—			71			—			71			252
Amortization:
Periodic amortization																									(160		)	(66		)	(5		)	(2		)	(73		)	—			(73		)	(233		)
Annuity unlocking																									—			28			1			—			29			—			29			29
Included in realized gains																									—			3			—			—			3			—			3			3
Foreign currency translation																									(2		)	—			—			—			—			—			—			(2		)
Change in unrealized																									—			—			—			—			—			116			116			116
Balance at June 30, 2018																									$	298		$	1,243		$	94		$	45		$	1,382		$	(98	)	$	1,284		$	1,582

Balance at December 31, 2018																									$	299		$	1,285		$	86		$	42		$	1,413		$	(30	)	$	1,383		$	1,682
Additions	149			44			1			—			45			—			45			194			381			120			1			—			121			—			121			502
Amortization:
Periodic amortization	(142		)	(44		)	(4		)	(2		)	(50		)	—			(50		)	(192		)	(350		)	(34		)	(7		)	(4		)	(45		)	—			(45		)	(395		)
Included in realized gains	—			4			—			—			4			—			4			4			—			2			1			—			3			—			3			3
Foreign currency translation	1			—			—			—			—			—			—			1			—			—			—			—			—			—			—			—
Change in unrealized	—			—			—			—			—			(44		)	(44		)	(44		)	—			—			—			—			—			(589		)	(589		)	(589		)
Balance at September 30, 2017	$	266		$	1,171		$	100		$	40		$	1,311		$	(458	)	$	853		$	1,119
Balance at June 30, 2019																									$	330		$	1,373		$	81		$	38		$	1,492		$	(619	)	$	873		$	1,203

Balance at December 31, 2017	$	270		$	1,217		$	102		$	49		$	1,368		$	(422	)	$	946		$	1,216		$	270		$	1,217		$	102		$	49		$	1,368		$	(422	)	$	946		$	1,216
Additions	524			192			2			—			194			—			194			718			343			127			1			—			128			—			128			471
Amortization:
Periodic amortization	(485		)	(193		)	(15		)	(6		)	(214		)	—			(214		)	(699		)	(314		)	(135		)	(10		)	(4		)	(149		)	—			(149		)	(463		)
Annuity unlocking	—			28			1			—			29			—			29			29			—			28			1			—			29			—			29			29
Included in realized gains	—			9			—			—			9			—			9			9			—			6			—			—			6			—			6			6
Foreign currency translation	(1		)	—			—			—			—			—			—			(1		)	(1		)	—			—			—			—			—			—			(1		)
Change in unrealized	—			—			—			—			—			397			397			397			—			—			—			—			—			324			324			324
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
Additions	439			177			3			—			180			—			180			619
Amortization:
Periodic amortization	(413		)	(122		)	(14		)	(6		)	(142		)	—			(142		)	(555		)
Included in realized gains	—			6			1			—			7			—			7			7
Foreign currency translation	2			—			—			—			—			—			—			2
Change in unrealized	—			—			—			—			—			(193		)	(193		)	(193		)
Balance at September 30, 2017	$	266		$	1,171		$	100		$	40		$	1,311		$	(458	)	$	853		$	1,119
Balance at June 30, 2018																									$	298		$	1,243		$	94		$	45		$	1,382		$	(98	)	$	1,284		$	1,582


(*)	~~Unrealized adjustments~~Adjustments to DPAC ~~includes~~related to 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 $~~147~~152 million and $~~141~~148 million of accumulated amortization at ~~September~~June 30, ~~2018~~2019 and December 31, ~~2017~~2018, respectively.

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AMERICAN FINANCIAL GROUP, INC. 10-Q

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — CONTINUED

G. H. 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~~eleven active collateralized loan obligation entities ~~or “CLOs,”~~(“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~~2012 and 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~~the CLOs that it manages is limited to its investment in ~~the~~those CLOs, which had an aggregate fair value of $191 million (including ~~$133~~$128 million invested in the most subordinate tranches) at ~~September~~June 30, ~~2018~~2019, and $~~215~~188 million at December 31, ~~2017~~2018.

In March 2018, ~~and March 2017,~~ AFG formed a new ~~CLOs,~~CLO, 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~~six months of ~~2017, AFG subsidiaries also purchased $58 million face amount of senior debt~~2019 and ~~subordinate tranches of existing CLOs for $58 million. During the first nine months of~~ 2018, ~~and 2017,~~ AFG subsidiaries received ~~$45~~less than $1 million and ~~$86~~$45 million, respectively, in sale and redemption proceeds from its CLO investments. During the first ~~nine~~six months of 2018, ~~and 2017,~~ one ~~and two~~ AFG ~~CLOs, respectively, were~~CLO was substantially liquidated, as permitted by the CLO ~~indentures.~~indenture.

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 June 30,						Six months ended June 30,
	2018			2017			2018			2017			2019			2018			2019			2018
Investment in CLO tranches at end of period	$	191		$	261		$	191		$	261		$	191		$	192		$	191		$	192
Gains (losses) on change in fair value of assets/liabilities (a):
Assets	20			(8		)	5			(12		)	—			(29		)	87			(15		)
Liabilities	(25		)	9			(15		)	24			(2		)	27			(89		)	10
Management fees paid to AFG	4			5			12			14			4			4			7			8
CLO earnings (losses) attributable to AFG shareholders (b)	4			5			11			16
CLO earnings attributable to AFG shareholders (b)													5			4			16			7


(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 $45145 million and $55232 million at ~~September~~June 30, ~~2018~~2019 and December 31, ~~2017~~2018, respectively. The aggregate unpaid principal balance of the CLOs’ debt exceeded its carrying value by $~~160~~150 million and ~~$118~~$241 million at those dates. The CLO assets include loans with an aggregate fair value of $1$7 million at ~~both September~~June 30, ~~2018 and December 31, 2017,~~2019, for which the CLOs are not accruing interest because the loans are in default (aggregate unpaid principal balance of ~~$8 million~~$15 million; none at ~~both those dates)~~December 31, 2018).

In addition to the CLOs that it manages, AFG had investments in CLOs that are managed by third parties (therefore not consolidated), which are included in available for sale fixed maturity securities and had a carrying value of $4.33 billion at June 30, 2019 and $4.28 billion at December 31, 2018.

H. I. Goodwill and Other Intangibles

There were no changes in the goodwill balance of ~~$199~~$207 million during the first ~~nine~~six months of ~~2018~~2019. Included in other assets in AFG’s Balance Sheet is $3148 million at ~~September~~June 30, ~~2018~~2019 and $2654 million at December 31, ~~2017~~2018 in amortizable intangible assets related to property and casualty insurance acquisitions. These amounts are net of accumulated amortization of ~~$37~~$45 million and $3039 million, respectively. Amortization of intangibles was $3 million and $2 million in the ~~third quarter~~second quarters of ~~2018~~2019 and ~~2017,~~2018, respectively, and $7$6 million and $6$4 million in the first ~~nine~~six months of ~~2018~~2019 and ~~2017~~.2018, respectively.

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AMERICAN FINANCIAL GROUP, INC. 10-Q

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — CONTINUED

I. J. Long-Term Debt

Long-term debt consisted of the following (in millions):


	September 30, 2018							December 31, 2017							June 30, 2019							December 31, 2018
	Principal		Discount and Issue Costs			Carrying Value		Principal		Discount and Issue Costs			Carrying Value		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	$	590	$	(2	)	$	588	$	590	$	(2	)	$	588
3.50% Senior Notes due August 2026	425		(4		)	421		425		(5		)	420		425		(4		)	421		425		(4		)	421
Other	3		—			3		3		—			3		3		—			3		3		—			3
	1,018		(6		)	1,012		1,018		(7		)	1,011		1,018		(6		)	1,012		1,018		(6		)	1,012

Direct Subordinated Obligations of AFG:
6-1/4% Subordinated Debentures due September 2054	150		(5		)	145		150		(5		)	145		150		(5		)	145		150		(5		)	145
6% Subordinated Debentures due November 2055	150		(5		)	145		150		(5		)	145		150		(5		)	145		150		(5		)	145
5.875% Subordinated Debentures due March 2059															125		(4		)	121		—		—			—
	300		(10		)	290		300		(10		)	290		425		(14		)	411		300		(10		)	290
	$	1,318	$	(16	)	$	1,302	$	1,318	$	(17	)	$	1,301	$	1,443	$	(20	)	$	1,423	$	1,318	$	(16	)	$	1,302

AFG has no scheduled principal payments on its long-term debt for the balance of ~~2018~~2019 or in the subsequent five years.

In March 2019, AFG issued $125 million in 5.875% Subordinated Debentures due in 2059.

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~~June 30, ~~2018~~2019 or December 31, ~~2017~~2018.

J. ~~Redeemable Noncontrolling Interests~~K. Leases

~~Neon Lloyd’s Business~~ ~~On December 29, 2017,~~ AFG ~~completed~~and its subsidiaries lease real estate that is primarily used for office space and, to a lesser extent, equipment under operating lease arrangements. Most of AFG’s real estate leases include an option to extend or renew the ~~sale~~lease term at AFG’s option. The operating lease liability includes lease payments related to options to extend or renew the lease term if AFG is reasonably certain of ~~an indirect noncontrolling interest in Neon, its United Kingdom-based Lloyd’s insurer, to certain Neon executives for cash equal to~~exercising those options. Lease payments are discounted using 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~~implicit discount rate in the ~~mezzanine section~~lease. If the implicit discount rate for the lease cannot be readily determined, AFG uses an estimate of its incremental secured borrowing rate. AFG did not have any material contracts accounted for as finance leases at June 30, 2019 or January 1, 2019.

At June 30, 2019, AFG’s $162 million operating lease right-of-use asset (presented net of $23 million in deferred rent and lease incentives) and $185 million operating lease liability are included in other assets and other liabilities, respectively, in AFG’s Balance Sheet.

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AMERICAN FINANCIAL GROUP, INC. 10-Q

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — CONTINUED

The following table details AFG’s lease activity for the ~~balance sheet, as discussed~~six months ended June 30, 2019 (dollars in ~~Note~~ A — “~~Accounting Policies~~ — ~~Noncontrolling Interests~~.”millions):



	Three months ended		Six months ended
	June 30, 2019		June 30, 2019
Lease expense:
Operating leases	$	11	$	22
Short-term leases	1		1
Total lease expense	$	12	$	23

Other operating lease information:
Cash paid for amounts included in the measurement of lease liabilities reported in operating cash flows			$	24
Right-of-use assets obtained in exchange for new lease liabilities			8

Weighted-average remaining lease term			5.8 years
Weighted-average discount rate			4.1		%

The following table presents the undiscounted contractual maturities of AFG’s operating lease liability at June 30, 2019 (in millions):



	June 30, 2019
Operating lease payments:
Remainder of 2019	$	24
2020	43
2021	37
2022	29
2023	24
Thereafter	52
Total lease payments	209
Impact of discounting	(24		)
Operating lease liability	$	185

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AMERICAN FINANCIAL GROUP, INC. 10-Q

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — CONTINUED

L. 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 (Loss)																							Other Comprehensive Income (Loss)
	AOCI Beginning Balance			Pretax			Tax			Net of tax			Attributable to noncontrolling interests		Attributable to shareholders			Other (c)			AOCI Ending Balance			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
Quarter ended June 30, 2019
Net unrealized gains on securities:
Unrealized holding gains on securities arising during the period																											$	450		$	(94	)	$	356		$	—		$	356
Reclassification adjustment for realized (gains) losses included in net earnings (a)																											(10		)	2			(8		)	—			(8		)
Total net unrealized gains on securities (b)																								$	464		440			(92		)	348			—			348			$	—		$	812
Net unrealized gains on cash flow hedges																								—			23			(5		)	18			—			18			—			18
Foreign currency translation adjustments																								(12		)	(1		)	1			—			(1		)	(1		)	—			(13		)
Pension and other postretirement plans adjustments																								(8		)	—			—			—			—			—			—			(8		)
Total																								$	444		$	462		$	(96	)	$	366		$	(1	)	$	365		$	—		$	809

Quarter ended June 30, 2018
Net unrealized gains (losses) on securities:
Unrealized holding losses on securities arising during the period				$	(122	)	$	26		$	(96	)	$	—	$	(96	)										$	(187	)	$	39		$	(148	)	$	—		$	(148	)
Reclassification adjustment for realized (gains) losses included in net earnings (a)				(2		)	—			(2		)	—		(2		)										(4		)	1			(3		)	—			(3		)
Total net unrealized gains (losses) on securities (b)	$	191		(124		)	26			(98		)	—		(98		)	$	—		$	93		$	342		(191		)	40			(151		)	—			(151		)	$	—		$	191
Net unrealized losses on cash flow hedges	(27		)	(6		)	1			(5		)	—		(5		)	—			(32		)	(24		)	(4		)	1			(3		)	—			(3		)	—			(27		)
Foreign currency translation adjustments	(9		)	—			—			—			—		—			—			(9		)	(5		)	(4		)	—			(4		)	—			(4		)	—			(9		)
Pension and other postretirement plans adjustments	(8		)	—			—			—			—		—			—			(8		)	(8		)	—			—			—			—			—			—			(8		)
Total	$	147		$	(130	)	$	27		$	(103	)	$	—	$	(103	)	$	—		$	44		$	305		$	(199	)	$	41		$	(158	)	$	—		$	(158	)	$	—		$	147

Quarter ended September 30, 2017
Six months ended June 30, 2019
Net unrealized gains on securities:
Unrealized holding gains on securities arising during the period				$	92		$	(33	)	$	59		$	—	$	59											$	937		$	(197	)	$	740		$	—		$	740
Reclassification adjustment for realized (gains) losses included in net earnings (a)				12			(4		)	8			—		8												(14		)	3			(11		)	—			(11		)
Total net unrealized gains on securities	$	639		104			(37		)	67			—		67			$	—		$	706
Net unrealized losses on cash flow hedges	(6		)	(1		)	1			—			—		—			—			(6		)
Total net unrealized gains on securities (b)																								$	83		923			(194		)	729			—			729			$	—		$	812
Net unrealized gains (losses) on cash flow hedges																								(11		)	37			(8		)	29			—			29			—			18
Foreign currency translation adjustments	(11		)	5			2			7			—		7			—			(4		)	(16		)	3			1			4			(1		)	3			—			(13		)
Pension and other postretirement plans adjustments	(7		)	—			—			—			—		—			—			(7		)	(8		)	—			—			—			—			—			—			(8		)
Total	$	615		$	108		$	(34	)	$	74		$	—	$	74		$	—		$	689		$	48		$	963		$	(201	)	$	762		$	(1	)	$	761		$	—		$	809

Nine months ended September 30, 2018
Six months ended June 30, 2018
Net unrealized gains (losses) on securities:
Unrealized holding losses on securities arising during the period				$	(662	)	$	139		$	(523	)	$	—	$	(523	)										$	(540	)	$	113		$	(427	)	$	—		$	(427	)
Reclassification adjustment for realized (gains) losses included in net earnings (a)				(4		)	1			(3		)	—		(3		)										(2		)	1			(1		)	—			(1		)
Total net unrealized gains (losses) on securities (b)	$	840		(666		)	140			(526		)	—		(526		)	$	(221	)	$	93		$	840		(542		)	114			(428		)	—			(428		)	$	(221	)	$	191
Net unrealized losses on cash flow hedges	(13		)	(24		)	5			(19		)	—		(19		)	—			(32		)	(13		)	(18		)	4			(14		)	—			(14		)	—			(27		)
Foreign currency translation adjustments	(6		)	(2		)	(1		)	(3		)	—		(3		)	—			(9		)	(6		)	(2		)	(1		)	(3		)	—			(3		)	—			(9		)
Pension and other postretirement plans adjustments	(8		)	—			—			—			—		—			—			(8		)	(8		)	—			—			—			—			—			—			(8		)
Total	$	813		$	(692	)	$	144		$	(548	)	$	—	$	(548	)	$	(221	)	$	44		$	813		$	(562	)	$	117		$	(445	)	$	—		$	(445	)	$	(221	)	$	147

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	$	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

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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 (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


(b)	Includes net unrealized gains of ~~$64 million at September 30, 2018 compared to $67~~$59 million at June 30, ~~2018~~2019 compared to $61 million at March 31, 2019 and ~~$68~~$58 million at December 31, ~~2017~~2018 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~~six months of ~~2018,~~2019, AFG issued ~~200,625~~232,565 shares of restricted Common Stock (fair value of ~~$112.86~~$99.28 per share) under the Stock Incentive ~~Plan. In addition, AFG issued~~ ~~45,804~~ ~~shares of Common Stock (fair value of~~ ~~$115.49~~ ~~per share) in the first quarter of~~ ~~2018~~ ~~under the Equity Bonus~~ Plan. AFG did not grant any stock options in the first ~~nine~~six months of ~~2018.~~2019.

Total compensation expense related to stock incentive plans of AFG and its subsidiaries was $6 million ~~and $7 million~~ in both the ~~third~~second quarters of 2019 and 2018 and ~~2017 and $17~~$12 million and ~~$24~~$11 million in the first ~~nine~~six months of ~~2018~~2019 and ~~2017~~2018, respectively.

L. M. Income Taxes

The following is a reconciliation of income taxes at the statutory rate ~~(21% in 2018 and 35% in 2017)~~of 21% to the provision for income taxes as shown in AFG’s Statement of Earnings (dollars in millions):



	Three months ended June 30,										Six months ended June 30,
	2019					2018					2019					2018
	Amount			% of EBT		Amount			% of EBT		Amount			% of EBT		Amount			% of EBT
Earnings before income taxes (“EBT”)	$	259				$	260				$	672				$	434

Income taxes at statutory rate	$	54		21	%	$	54		21	%	$	141		21	%	$	91		21	%
Effect of:
Tax exempt interest	(3		)	(1	%)	(4		)	(2	%)	(7		)	(1	%)	(7		)	(2	%)
Dividends received deduction	(1		)	—	%	(1		)	—	%	(2		)	—	%	(2		)	—	%
Employee Stock Ownership Plan dividends paid deduction	(1		)	—	%	(1		)	—	%	(1		)	—	%	(1		)	—	%
Stock-based compensation	(2		)	(1	%)	(2		)	(1	%)	(4		)	(1	%)	(7		)	(2	%)
Nondeductible expenses	2			1	%	2			1	%	4			1	%	4			1	%
Change in valuation allowance	1			—	%	2			1	%	3			—	%	2			—	%
Foreign operations	—			—	%	—			—	%	—			—	%	3			1	%
Other	—			(1	%)	2			—	%	3			—	%	2			1	%
Provision for income taxes as shown in the statement of earnings	$	50		19	%	$	52		20	%	$	137		20	%	$	85		20	%

Three months ended September 30, Nine months ended September 30,
2018 2017 2018 2017
Amount % of EBT Amount % of EBT Amount % of EBT Amount % of EBT
Earnings before income taxes (“EBT”) $ 244
$ 29
$ 678
$ 457

Income taxes at statutory rate $ 51
21 % $ 10
35 % $ 142
21 % $ 160
35 %
Effect of:
Adjustment to prior year taxes (9 ) (4 %) (2 ) (7 %) (9 ) (1 %) (2 ) (1 %)
Tax exempt interest (3 ) (1 %) (5 ) (17 %) (10 ) (1 %) (17 ) (4 %)
Dividends received deduction (1 ) — % (2 ) (7 %) (3 ) — % (6 ) (1 %)
Employee Stock Ownership Plan dividends paid deduction (1 ) — % —
— % (2 ) — % (2 ) — %
Stock-based compensation —
— % (1 ) (3 %) (7 ) (1 %) (14 ) (3 %)
Foreign operations —
— % 1
3 % 3
— % 7
2 %
Nondeductible expenses 1
— % 2
7 % 5
1 % 5
1 %
Change in valuation allowance 1
— % 16
55 % 3
— % 16
4 %
Other 2
1 % (1 ) (4 %) 4
— % (1 ) (1 %)
Provision for income taxes as shown in the statement of earnings $ 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.

~~Table of 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 $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, ~~2018.~~2019. 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.

M. ~~Contingencies~~

Table of Contents

AMERICAN FINANCIAL GROUP, INC. 10-Q

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — CONTINUED

N. Contingencies

There have been no significant changes to the matters discussed and referred to in Note M — “Contingencies” of AFG’s ~~2017~~2018 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.

~~Table of Contents~~O. Insurance

~~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~~six months of ~~2018~~2019 and ~~2017~~2018 (in millions):



	Six months ended June 30,
	2019			2018
Balance at beginning of year	$	9,741		$	9,678
Less reinsurance recoverables, net of allowance	2,942			2,957
Net liability at beginning of year	6,799			6,721
Provision for losses and LAE occurring in the current period	1,501			1,434
Net decrease in the provision for claims of prior years	(86		)	(100		)
Total losses and LAE incurred	1,415			1,334
Payments for losses and LAE of:
Current year	(291		)	(294		)
Prior years	(1,079		)	(975		)
Total payments	(1,370		)	(1,269		)
Reserves of business disposed (*)	—			(319		)
Foreign currency translation and other	1			(4		)
Net liability at end of period	6,845			6,463
Add back reinsurance recoverables, net of allowance	2,732			2,630
Gross unpaid losses and LAE included in the balance sheet at end of period	$	9,577		$	9,093

Nine months ended September 30,
2018 2017
Balance at beginning of year $ 9,678
$ 8,563
Less reinsurance recoverables, net of allowance 2,957
2,302
Net liability at beginning of year 6,721
6,261
Provision for losses and LAE occurring in the current period 2,337
2,237
Net increase (decrease) in the provision for claims of prior years:
Special A&E charges 18
89
Other (149 ) (87 )
Total losses and LAE incurred 2,206
2,239
Payments for losses and LAE of:
Current year (569 ) (530 )
Prior years (1,313 ) (1,272 )
Total payments (1,882 ) (1,802 )
Reserves of business disposed (*) (319 ) —
Foreign currency translation and other (4 ) 32
Net liability at end of period 6,722
6,730
Add back reinsurance recoverables, net of allowance 2,948
2,833
Gross unpaid losses and LAE included in the balance sheet at end of period $ 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~~six months of 2019 reflects (i) lower than expected

losses in the crop business and lower than expected claim frequency and severity in the transportation businesses (all within the Property and transportation sub-segment), (ii) lower than anticipated claim severity in the workers’ compensation businesses (within the Specialty casualty sub-segment), and (iii) lower than expected claim frequency and severity in the surety and financial institutions businesses and lower than anticipated claim severity in the fidelity business (all within the Specialty financial sub-segment). This favorable development was partially offset by higher than expected claim severity in the excess and surplus lines businesses and higher than expected losses at Neon (all within the Specialty casualty sub-segment).

The net decrease in the provision for claims of prior years during the first six months of 2018 reflects (i) lower than expected losses in the crop business and lower than expected claim severity in ~~claims at National Interstate (within~~the transportation businesses (all within the Property and transportation sub-segment), (ii) lower than anticipated claim frequency and 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).

In December 2017, the Neon Lloyd’s syndicate entered into a reinsurance to close transaction for the 2015 and prior years of account with StarStone Underwriting Limited, a subsidiary of Enstar Group Limited, which was effective as of December 31, 2017 ~~(the transaction~~and settled in early ~~2018).~~2018. In the Lloyd’s market, a reinsurance to close transaction transfers the responsibility for discharging all of the liabilities that attach to the transferred year of account plus the right to any income due to the closing year of account in return for a 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		Page	Page		Page
Forward-Looking Statements	34	Results of Operations — Third Quarter	48	36	Results of Operations — Second Quarter	51
Overview	35	Segmented Statement of Earnings	48	37	Segmented Statement of Earnings	51
Critical Accounting Policies	35	Property and Casualty Insurance	49	37	Property and Casualty Insurance	52
Liquidity and Capital Resources	36	Annuity	60	38	Annuity	61
Ratios	36	Holding Company, Other and Unallocated	67	38	Holding Company, Other and Unallocated	71
Condensed Consolidated Cash Flows	36	Results of Operations — First Nine Months	70	38	Results of Operations — First Six Months	74
Parent and Subsidiary Liquidity	37	Segmented Statement of Earnings	70	39	Segmented Statement of Earnings	74
Investments	38	Property and Casualty Insurance	71	40	Property and Casualty Insurance	75
Uncertainties	42	Annuity	80	43	Annuity	83
Managed Investment Entities	42	Holding Company, Other and Unallocated	88	44	Holding Company, Other and Unallocated	92
Results of Operations	46	Recent and Pending Accounting Standards	90	48	Recent and Pending Accounting Standards	94
General	46			48

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, 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;

changes in insurance law or regulation, including changes in statutory accounting 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, 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;

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.

~~Table of Contents~~

~~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.

Table of Contents

AMERICAN FINANCIAL GROUP, INC. 10-Q

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

OVERVIEW

Financial Condition

AFG is organized as a holding company with almost all of its operations being conducted by subsidiaries. AFG, however, has continuing cash needs for administrative expenses, the payment of principal and interest on borrowings, shareholder dividends, and taxes. Therefore, certain analyses are 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 variable-indexed annuities in the retail, financial institutions, broker-dealer and registered investment advisor ~~and education~~ markets.

Net earnings attributable to AFG’s shareholders for the ~~third~~second quarter and first ~~nine~~six months of ~~2018~~2019 were ~~$204~~$210 million ($~~2.26~~2.31 per share, diluted) and ~~$559~~$539 million ($~~6.17~~5.94 per share, diluted), respectively, compared to ~~$11~~$210 million ($~~0.13~~2.31 per share, diluted) and ~~$309~~$355 million ($~~3.44~~3.92 per share, diluted) reported in the same periods of ~~2017,~~2018, reflecting:

~~higher~~lower earnings in the annuity segment,

~~higher~~lower underwriting profit in the property and casualty insurance segment, ~~due primarily to lower catastrophe losses and lower special charges to increase asbestos and environmental reserves,~~

higher net investment income in the property and casualty insurance segment, and

~~lower interest charges on borrowed money,~~

~~a lower corporate income tax rate,~~

higher realized gains on securities in the ~~third~~second quarter of 2019 compared to the second quarter of 2018 ~~compared to~~and realized ~~losses~~gains on securities in the ~~third quarter~~first six months of ~~2017 and higher~~2019 compared to realized losses on securities in the first ~~nine~~six months of 2018. Both the 2019 and 2018 ~~compared to the first nine months of 2017. Both~~ periods ~~in 2018~~ reflect the change in the 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,~~2018.

~~lower income from the sale of real estate in the first 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 2017.~~

CRITICAL ACCOUNTING POLICIES

Significant accounting policies are summarized in Note A— “Accounting Policies” to 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 measurement of the derivatives embedded in fixed-indexed and variable-indexed annuity liabilities,

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 ~~2017~~2018 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, 2018			December 31,						June 30, 2019			December 31,
				2017			2016						2018			2017
Principal amount of long-term debt	$	1,318		$	1,318		$	1,308		$	1,443		$	1,318		$	1,318
Total capital	6,389			6,033			5,921			6,703			6,218			6,046
Ratio of debt to total capital:
Including subordinated debt	20.6		%	21.8		%	22.1		%	21.5		%	21.2		%	21.8		%
Excluding subordinated debt	15.9		%	16.9		%	17.0		%	15.2		%	16.4		%	16.8		%

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) onrelated to fixed maturity investments).

AFG’s ratio of earnings to fixed charges, including annuity benefits as a fixed charge, was ~~1.86~~1.95 for the ~~nine~~six months ended ~~September~~June 30, ~~2018~~2019 and ~~1.72~~1.54 for the year ended December 31, ~~2017~~2018. Excluding annuity benefits, this ratio was ~~10.87~~15.60 and ~~7.67,~~7.86, respectively. ~~Although the~~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 FlowsAFG’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,						Six months ended June 30,
	2018			2017			2019			2018
Net cash provided by operating activities	$	1,277		$	993		$	877		$	823
Net cash used in investing activities	(3,375		)	(2,230		)	(1,052		)	(2,485		)
Net cash provided by financing activities	1,769			1,479			1,034			1,134
Net change in cash and cash equivalents	$	(329	)	$	242		$	859		$	(528	)

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 include 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 reduced cash flows from operating activities by $3 million during the first six months of 2019 and increased cash flows from operating activities by ~~$104 million during the first nine months of 2018 and $14~~$138 million in the first ~~nine~~six months of ~~2017,~~2018, accounting for a ~~$90~~$141 million ~~increase~~decline in cash flows from operating activities in the ~~2018~~2019 period compared to the ~~2017~~2018 period. As discussed in Note A — “Accounting Policies — Managed Investment 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 provided by operating activities was ~~$1.17 billion in the first nine months of 2018 compared to $979~~$880 million in the first ~~nine~~six months of ~~2017,~~2019 compared to $685 million in the first six months of 2018, an increase of ~~$194~~$195 million.

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AMERICAN FINANCIAL GROUP, INC. 10-Q

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

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 businesses. Net cash used in investing activities was $~~3.38~~1.05 billion for the first ~~nine~~six months of 2019 compared to $2.49 billion in the first six months of 2018, ~~compared to~~ ~~$2.23 billion~~ ~~in the first nine months~~a decrease of ~~2017, an increase of~~ ~~$1.15 billion~~.$1.44 billion. As discussed below (under net cash provided by financing activities), AFG’s annuity group had net cash flows from annuity policyholders of ~~$1.86~~$1.10 billion in the first ~~nine~~six months of ~~2018~~2019 and ~~$1.75~~$1.20 billion in the first ~~nine~~six months of ~~2017,~~2018, which is the primary source of AFG’s cash used in investing activities. ~~During~~In addition, AFG’s cash on hand increased by $859 million during the first ~~nine~~six months of 2019 as AFG held more cash due to fewer investment opportunities in the first six months of 2019 compared to a decrease of cash on hand of $528 million during the first six months of 2018, as AFG ~~also~~ invested a large portion of its ~~overall~~ cash ~~held~~on hand 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 $~~189~~5 million~~use~~source of cash in the first ~~nine~~six months of ~~2018~~2019 compared to a $13226 million ~~source~~ use of cash in the ~~2017~~2018 period, accounting for a ~~$202~~$231 million ~~increase~~decrease in net cash used in investing activities in the first ~~nine~~six months of ~~2018~~2019 compared to the same ~~2017~~2018 period. See Note A — “Accounting Policies — Managed Investment Entities” and Note GH — “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 $~~1.77~~1.03 billion for the first ~~nine~~six months of 2019 compared to $1.13 billion in the first six months of 2018, ~~compared to~~ ~~$1.48 billion~~ ~~in the first nine months~~a decrease of ~~2017, an increase of~~ $~~290~~100 million. Annuity receipts exceeded annuity surrenders, benefits, withdrawals and transfers by ~~$1.86~~$1.10 billion in the first ~~nine~~six months of ~~2018~~2019 compared to ~~$1.75~~$1.20 billion in the first ~~nine~~six months of ~~2017,~~2018, accounting for a ~~$109~~$92 million ~~increase~~decrease in net cash provided by financing activities in the ~~2018~~2019 period compared to the ~~2017~~2018 period. In ~~June 2017,~~March 2019, AFG issued ~~$350~~$125 million of ~~4.50% Senior Notes~~5.875% Subordinated Debentures due ~~2047,~~in 2059, the net proceeds of which contributed ~~$345~~$121 million to net cash provided by financing activities in the first ~~nine~~six months of ~~2017. Redemptions of long-term debt were a $355 million use of cash in the first nine months of 2017.~~2019. 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. ~~Issuances~~Retirements of managed investment entity liabilities exceeded ~~retirements~~issuances by $~~109~~5 million in the first ~~nine~~six months of 2019 compared to issuances of managed investment entity liabilities exceeding retirements by $111 million in the first six months of 2018, ~~compared to retirements of managed investment liabilities exceeding issuances by~~ ~~$72 million~~ ~~in the first nine months of 2017,~~ accounting for a $~~181~~116 million~~increase~~decrease in net cash provided by financing activities in the ~~2018~~2019 period compared to the ~~2017~~2018 period. See Note A — “Accounting Policies — Managed Investment Entities” and Note GH — “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.

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. There were no borrowings under this agreement, or under any other parent company short-term borrowing arrangements, during ~~2017~~2018 or the first ~~nine~~six months of ~~2018.~~2019.

In November 2018, AFG declared a special cash dividend of $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,~~2019, AFG paid a special cash dividend of $1.50 per share of AFG Common Stock totaling ~~$134~~$135 million.

In ~~2017,~~March 2019, AFG issued $125 million of 5.875% Subordinated Debentures due in March 2059. The net proceeds of the offering were used for general corporate purposes.

In 2018, AFG paid special cash dividends of ~~$3.50~~$3.00 per share of AFG Common Stock ($1.50 per share in May and ~~$2.00 per share in~~ November) totaling approximately ~~$308~~$267 million and repurchased 65,589 shares of its Common Stock for $6 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 November 2017, AFG issued an additional $240 million of 4.50% Senior Notes due in 2047 and $125 million of 3.50% Senior Notes due in 2026. The net proceeds of the offering were used to redeem AFG’s $350 million outstanding principal amount of 9-7/8% Senior Notes due in June 2019 for $388 million (including a make-whole premium of $38 million) in December 2017.

~~Table of 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. At ~~September~~June 30, ~~2018~~2019, GALIC had ~~$871 million~~$1.1 billion in outstanding advances from the FHLB (included in annuity benefits accumulated), bearing interest at rates ranging from ~~0.03%~~0.13% to 0.21% over LIBOR (average rate of ~~2.33%~~2.59% at ~~September~~June 30, ~~2018~~2019). While these advances must be repaid

Table of Contents

AMERICAN FINANCIAL GROUP, INC. 10-Q

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

between ~~2018~~2020 and 2021 ($40510 million in ~~2018, $345 million in 2019~~2020 and ~~$486~~$586 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~~June 30, ~~2018,~~2019, GALIC estimated that it had additional borrowing capacity of approximately ~~$300~~$375 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.

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~~June 30, ~~2018~~,2019, AFG could reduce the average crediting rate on approximately ~~$27~~$30 billion of traditional fixed, ~~annuities and~~ fixed-indexed and variable-indexed annuities without guaranteed withdrawal benefits by approximately ~~116~~120 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 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



	% of Reserves
	June 30,	December 31,
GMIR	2019	2018	2017
1 — 1.99%	80%	79%	76%
2 — 2.99%	4%	4%	5%
3 — 3.99%	7%	8%	10%
4.00% and above	9%	9%	9%

Annuity benefits accumulated (in millions)	$39,044	$36,616	$33,316

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~~June 30, ~~2018~~2019, ~~includes~~ contained $~~40.24~~44.71 billion in fixed maturity 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 and $~~103~~106 million in fixed maturities classified as trading with ~~changes in unrealized~~ holding gains orand losses included in net investment income. In addition, AFG’s investment portfolio includes ~~$1.65~~$1.76 billion in equity securities carried at fair value with holding gains and losses included in realized gains (losses) on securities and ~~$176~~$220 million in equity securities carried at fair value with ~~unrealized~~ holding gains and losses included in net investment income.

~~Table of Contents~~

~~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 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 ~~72% are~~91% was priced using pricing services at June 30, 2019 and the balance iswas 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~~mortgage-backed securities (“MBS”) are estimates of the rate of future prepayments and defaults of principal over the

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AMERICAN FINANCIAL GROUP, INC. 10-Q

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

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.

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~~June 30, ~~2018~~2019 (dollars in millions). Effects of increases or decreases from the 100 basis points illustrated would be approximately proportional.


Fair value of fixed maturity portfolio	$	40,347		$	44,816
Percentage impact on fair value of 100 bps increase in interest rates	(4.5		%)	(4.5		%)
Pretax impact on fair value of fixed maturity portfolio	$	(1,816	)	$	(2,017	)
Offsetting adjustments to deferred policy acquisition costs and other balance sheet amounts	750			800
Estimated pretax impact on accumulated other comprehensive income	(1,066		)	(1,217		)
Deferred income tax	224			256
Estimated after-tax impact on accumulated other comprehensive income	$	(842	)	$	(961	)

Approximately ~~90%~~91% of the fixed maturities held by AFG at ~~September~~June 30, ~~2018~~2019, 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.

~~Table of Contents~~

~~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~~June 30, ~~2018~~2019, 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~~4.5 years and 54 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	$	177	$	173	98	%	$	(4	)	100	%	$	156	$	158	101	%	$	2	100	%
Non-agency prime	1,009		1,154		114	%	145			27	%	913		1,044		114	%	131		28	%
Alt-A	837		953		114	%	116			15	%	969		1,097		113	%	128		36	%
Subprime	387		431		111	%	44			28	%	331		369		111	%	38		27	%
Commercial	913		923		101	%	10			94	%	938		974		104	%	36		96	%
	$	3,323	$	3,634	109	%	$	311		44	%	$	3,307	$	3,642	110	%	$	335	52	%

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AMERICAN FINANCIAL GROUP, INC. 10-Q

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

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~~June 30, ~~2018~~2019, ~~97%~~95% (based on statutory carrying value of ~~$3.28~~$3.25 billion) of AFG’s MBS had an NAIC designation of 1.

Municipal bonds represented approximately ~~17%~~16% of AFG’s fixed maturity portfolio at ~~September~~June 30, ~~2018~~2019. 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~~June 30, ~~2018~~2019, approximately ~~77%~~78% of the municipal bond portfolio was held in revenue bonds, with the remaining ~~23%~~22% held in general obligation bonds. AFG does not own general obligation bonds issued by Puerto Rico.

Summarized information for the unrealized gains and losses recorded in AFG’s Balance Sheet at ~~September~~June 30, ~~2018,~~2019, is shown in the following table (dollars in millions). Approximately $~~563~~686 million of available for sale fixed maturity securities had no unrealized gains or losses at ~~September~~June 30, ~~2018~~2019.


	Securities With Unrealized Gains			Securities With Unrealized Losses			Securities With Unrealized Gains			Securities With Unrealized Losses
Available for Sale Fixed Maturities
Fair value of securities	$	17,894		$	21,787		$	38,161		$	5,863
Amortized cost of securities	$	17,160		$	22,330		$	36,266		$	5,956
Gross unrealized gain (loss)	$	734		$	(543	)	$	1,895		$	(93	)
Fair value as % of amortized cost	104		%	98		%	105		%	98		%
Number of security positions	2,876			2,392			4,648			712
Number individually exceeding $2 million gain or loss	50			10			128			5
Concentration of gains (losses) by type or industry (exceeding 5% of unrealized):
States and municipalities							$	374		$	(6	)
Mortgage-backed securities	$	324		$	(13	)	339			(4		)
Asset-backed securities	122			(64		)
States and municipalities	117			(98		)
Banks, savings and credit institutions	32			(100		)	219			(3		)
Manufacturing	29			(57		)
Insurance companies	15			(47		)
Other asset-backed securities							205			(10		)
Healthcare							60			(6		)
Energy – exploration and production							35			(5		)
Collateralized loan obligations							10			(36		)
Percentage rated investment grade	84		%	96		%	92		%	91		%

~~Table of Contents~~

~~AMERICAN FINANCIAL GROUP, INC. 10-Q~~

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

The table below sets forth the scheduled maturities of AFG’s available for sale fixed maturity securities at ~~September~~June 30, ~~2018~~2019, 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		Securities With Unrealized Gains		Securities With Unrealized Losses
Maturity
One year or less	5	%	1	%	4	%	1	%
After one year through five years	25	%	17	%	25	%	12	%
After five years through ten years	24	%	41	%	36	%	15	%
After ten years	9	%	14	%	9	%	8	%
	63	%	73	%	74	%	36	%
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	%
Collateralized loan obligations and other asset-backed securities (average life of approximately 4.5 years)					17	%	61	%
Mortgage-backed securities (average life of approximately 4.5 years)					9	%	3	%
	100	%	100	%	100	%	100	%

Table of Contents

AMERICAN FINANCIAL GROUP, INC. 10-Q

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

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

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 %



	Aggregate Fair Value		Aggregate Unrealized Gain (Loss)			Fair Value as % of Cost
Fixed Maturities at June 30, 2019
Securities with unrealized gains:
Exceeding $500,000 (1,188 securities)	$	19,046	$	1,371		108	%
$500,000 or less (3,460 securities)	19,115		524			103	%
	$	38,161	$	1,895		105	%
Securities with unrealized losses:
Exceeding $500,000 (41 securities)	$	823	$	(46	)	95	%
$500,000 or less (671 securities)	5,040		(47		)	99	%
	$	5,863	$	(93	)	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, 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 %



	Aggregate Fair Value		Aggregate Unrealized Loss			Fair Value as % of Cost
Securities with Unrealized Losses at June 30, 2019
Investment grade fixed maturities with losses for:
Less than one year (221 securities)	$	2,998	$	(26	)	99	%
One year or longer (348 securities)	2,317		(44		)	98	%
	$	5,315	$	(70	)	99	%
Non-investment grade fixed maturities with losses for:
Less than one year (101 securities)	$	381	$	(8	)	98	%
One year or longer (42 securities)	167		(15		)	92	%
	$	548	$	(23	)	96	%

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 ~~2017~~2018 Form 10-K under Management’s Discussion and Analysis — “Investments.”

~~Table of Contents~~

~~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~~June 30, ~~2018~~2019. 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 (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, 2018 and 2017 and~~ Management’s Discussion and Analysis — “Uncertainties — Asbestos and Environmental-related (“A&E”) Insurance Reserves” in AFG’s ~~2017~~2018 Form 10-K. In addition to its ongoing monitoring of A&E exposures, AFG has scheduled an in-depth internal review of these liabilities to be completed in the third quarter of 2019 by AFG’s internal A&E claims specialists in consultation with specialty outside counsel.

Table of Contents

AMERICAN FINANCIAL GROUP, INC. 10-Q

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

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 A — “Accounting Policies— Managed Investment Entities” and Note GH— “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, 2018
June 30, 2019
Assets:
Cash and investments	$	48,031	$	—	$	(190	)	(a)	$	47,841	$	53,098	$	—	$	(191	)	(a)	$	52,907
Assets of managed investment entities	—		4,998		—				4,998		—		4,781		—				4,781
Other assets	11,352		—		(1		)	(a)	11,351		10,009		—		—			(a)	10,009
Total assets	$	59,383	$	4,998	$	(191	)		$	64,190	$	63,107	$	4,781	$	(191	)		$	67,697
Liabilities:
Unpaid losses and loss adjustment expenses and unearned premiums	$	12,410	$	—	$	—			$	12,410	$	12,260	$	—	$	—			$	12,260
Annuity, life, accident and health benefits and reserves	36,601		—		—				36,601		39,663		—		—				39,663
Liabilities of managed investment entities	—		4,998		(191		)	(a)	4,807		—		4,781		(191		)	(a)	4,590
Long-term debt and other liabilities	5,208		—		—				5,208		5,094		—		—				5,094
Total liabilities	54,219		4,998		(191		)		59,026		57,017		4,781		(191		)		61,607

Redeemable noncontrolling interests	—		—		—				—		—		—		—				—

Shareholders’ equity:
Common Stock and Capital surplus	1,320		—		—				1,320		1,367		—		—				1,367
Retained earnings	3,800		—		—				3,800		3,914		—		—				3,914
Accumulated other comprehensive income, net of tax	44		—		—				44		809		—		—				809
Total shareholders’ equity	5,164		—		—				5,164		6,090		—		—				6,090
Noncontrolling interests	—		—		—				—		—		—		—				—
Total equity	5,164		—		—				5,164		6,090		—		—				6,090
Total liabilities and equity	$	59,383	$	4,998	$	(191	)		$	64,190	$	63,107	$	4,781	$	(191	)		$	67,697

December 31, 2017
December 31, 2018
Assets:
Cash and investments	$	46,262	$	—	$	(214	)	(a)	$	46,048	$	48,685	$	—	$	(187	)	(a)	$	48,498
Assets of managed investment entities	—		4,902		—				4,902		—		4,700		—				4,700
Other assets	9,709		—		(1		)	(a)	9,708		10,259		—		(1		)	(a)	10,258
Total assets	$	55,971	$	4,902	$	(215	)		$	60,658	$	58,944	$	4,700	$	(188	)		$	63,456
Liabilities:
Unpaid losses and loss adjustment expenses and unearned premiums	$	12,088	$	—	$	—			$	12,088	$	12,336	$	—	$	—			$	12,336
Annuity, life, accident and health benefits and reserves	33,974		—		—				33,974		37,251		—		—				37,251
Liabilities of managed investment entities	—		4,902		(215		)	(a)	4,687		—		4,700		(188		)	(a)	4,512
Long-term debt and other liabilities	4,575		—		—				4,575		4,385		—		—				4,385
Total liabilities	50,637		4,902		(215		)		55,324		53,972		4,700		(188		)		58,484

Redeemable noncontrolling interests	3		—		—				3		—		—		—				—

Shareholders’ equity:
Common Stock and Capital surplus	1,269		—		—				1,269		1,334		—		—				1,334
Retained earnings	3,248		—		—				3,248		3,588		—		—				3,588
Accumulated other comprehensive income, net of tax	813		—		—				813		48		—		—				48
Total shareholders’ equity	5,330		—		—				5,330		4,970		—		—				4,970
Noncontrolling interests	1		—		—				1		2		—		—				2
Total equity	5,331		—		—				5,331		4,972		—		—				4,972
Total liabilities and equity	$	55,971	$	4,902	$	(215	)		$	60,658	$	58,944	$	4,700	$	(188	)		$	63,456


(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, 2018
Three months ended June 30, 2019
Revenues:
Insurance net earned premiums	$	1,333		$	—		$	—			$	1,333		$	1,205		$	—		$	—			$	1,205
Net investment income	531			—			(4		)	(b)	527			585			—			(5		)	(b)	580
Realized gains on securities	34			—			—				34			56			—			—				56
Income (loss) of managed investment entities:
Investment income	—			65			—				65			—			70			—				70
Gain (loss) on change in fair value of assets/liabilities	—			(5		)	—			(b)	(5		)	—			(1		)	(1		)	(b)	(2		)
Other income	58			—			(4		)	(c)	54			55			—			(4		)	(c)	51
Total revenues	1,956			60			(8		)		2,008			1,901			69			(10		)		1,960
Costs and Expenses:
Insurance benefits and expenses	1,599			—			—				1,599			1,529			—			—				1,529
Expenses of managed investment entities	—			60			(8		)	(b)(c)	52			—			69			(10		)	(b)(c)	59
Interest charges on borrowed money and other expenses	113			—			—				113			113			—			—				113
Total costs and expenses	1,712			60			(8		)		1,764			1,642			69			(10		)		1,701
Earnings before income taxes	244			—			—				244			259			—			—				259
Provision for income taxes	41			—			—				41			50			—			—				50
Net earnings, including noncontrolling interests	203			—			—				203			209			—			—				209
Less: Net earnings (loss) attributable to noncontrolling interests	(1		)	—			—				(1		)
Less: Net earnings (losses) attributable to noncontrolling interests														(1		)	—			—				(1		)
Net earnings attributable to shareholders	$	204		$	—		$	—			$	204		$	210		$	—		$	—			$	210

Three months ended September 30, 2017
Three months ended June 30, 2018
Revenues:
Insurance net earned premiums	$	1,273		$	—		$	—			$	1,273		$	1,167		$	—		$	—			$	1,167
Net investment income	476			—			(5		)	(b)	471			534			—			(4		)	(b)	530
Realized losses on securities	(12		)	—			—				(12		)
Realized gains on securities														31			—			—				31
Income (loss) of managed investment entities:
Investment income	—			54			—				54			—			64			—				64
Gain (loss) on change in fair value of assets/liabilities	—			1			—			(b)	1			—			—			(2		)	(b)	(2		)
Other income	53			—			(5		)	(c)	48			47			—			(4		)	(c)	43
Total revenues	1,790			55			(10		)		1,835			1,779			64			(10		)		1,833
Costs and Expenses:
Insurance benefits and expenses	1,628			—			—				1,628			1,414			—			—				1,414
Expenses of managed investment entities	—			55			(10		)	(b)(c)	45			—			64			(10		)	(b)(c)	54
Interest charges on borrowed money and other expenses	133			—			—				133			105			—			—				105
Total costs and expenses	1,761			55			(10		)		1,806			1,519			64			(10		)		1,573
Earnings before income taxes	29			—			—				29			260			—			—				260
Provision for income taxes	18			—			—				18			52			—			—				52
Net earnings, including noncontrolling interests	11			—			—				11			208			—			—				208
Less: Net earnings (loss) attributable to noncontrolling interests	—			—			—				—
Less: Net earnings (losses) attributable to noncontrolling interests														(2		)	—			—				(2		)
Net earnings attributable to shareholders	$	11		$	—		$	—			$	11		$	210		$	—		$	—			$	210


(a)	Includes income of $4$5 million and $5$4 million in the ~~third~~second quarter of ~~2018~~2019 and ~~2017,~~2018, respectively, representing the change in fair value of AFG’s CLO investments plus $4 million in both the second quarter of 2019 and $52018 in CLO management fees earned.


(b)	Elimination of the change in fair value of AFG’s investments in the CLOs, including $6 million in both the second quarter of 2019 and 2018 in distributions recorded as interest expense by the CLOs.


(c)	Elimination of management fees earned by AFG.

Table of Contents

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
Six months ended June 30, 2019
Revenues:
Insurance net earned premiums	$	2,384		$	—		$	—			$	2,384
Net investment income	1,138			—			(16		)	(b)	1,122
Realized gains on securities	240			—			—				240
Income (loss) of managed investment entities:
Investment income	—			139			—				139
Gain (loss) on change in fair value of assets/liabilities	—			(6		)	4			(b)	(2		)
Other income	108			—			(7		)	(c)	101
Total revenues	3,870			133			(19		)		3,984
Costs and Expenses:
Insurance benefits and expenses	2,968			—			—				2,968
Expenses of managed investment entities	—			133			(19		)	(b)(c)	114
Interest charges on borrowed money and other expenses	230			—			—				230
Total costs and expenses	3,198			133			(19		)		3,312
Earnings before income taxes	672			—			—				672
Provision for income taxes	137			—			—				137
Net earnings, including noncontrolling interests	535			—			—				535
Less: Net earnings (losses) attributable to noncontrolling interests	(4		)	—			—				(4		)
Net earnings attributable to shareholders	$	539		$	—		$	—			$	539

Six months ended June 30, 2018
Revenues:
Insurance net earned premiums	$	2,280		$	—		$	—			$	2,280
Net investment income	1,032			—			(7		)	(b)	1,025
Realized losses on securities	(62		)	—			—				(62		)
Income (loss) of managed investment entities:
Investment income	—			122			—				122
Gain (loss) on change in fair value of assets/liabilities	—			(1		)	(4		)	(b)	(5		)
Other income	100			—			(8		)	(c)	92
Total revenues	3,350			121			(19		)		3,452
Costs and Expenses:
Insurance benefits and expenses	2,711			—			—				2,711
Expenses of managed investment entities	—			121			(19		)	(b)(c)	102
Interest charges on borrowed money and other expenses	205			—			—				205
Total costs and expenses	2,916			121			(19		)		3,018
Earnings before income taxes	434			—			—				434
Provision for income taxes	85			—			—				85
Net earnings, including noncontrolling interests	349			—			—				349
Less: Net earnings (losses) attributable to noncontrolling interests	(6		)	—			—				(6		)
Net earnings attributable to shareholders	$	355		$	—		$	—			$	355


(a)	Includes income of $16 million and $7 million in the ~~third quarter~~first six months of 2019 and 2018, respectively, representing the change in fair value of AFG’s CLO investments plus $7 million and ~~2017,~~$8 million in the first six months of 2019 and 2018, respectively, in CLO management fees earned.


(b)	Elimination of the change in fair value of AFG’s investments in the CLOs, including $4$12 million and $5$11 million in the ~~third quarter~~first six months of ~~2018~~2019 and ~~2017,~~2018, respectively, in distributions recorded as interest expense by the CLOs.


(c)	Elimination of management fees earned by AFG.

4447

Table of Contents

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
Nine months ended September 30, 2018
Revenues:
Insurance net earned premiums $ 3,613
$ —
$ —
$ 3,613
Net investment income 1,563
—
(11 ) (b) 1,552
Realized losses on securities (28 ) —
—
(28 )
Income (loss) of managed investment entities:
Investment income —
187
—
187
Gain (loss) on change in fair value of assets/liabilities —
(6 ) (4 ) (b) (10 )
Other income 158
—
(12 ) (c) 146
Total revenues 5,306
181
(27 ) 5,460
Costs and Expenses:
Insurance benefits and expenses 4,310
—
—
4,310
Expenses of managed investment entities —
181
(27 ) (b)(c) 154
Interest charges on borrowed money and other expenses 318
—
—
318
Total costs and expenses 4,628
181
(27 ) 4,782
Earnings before income taxes 678
—
—
678
Provision for income taxes 126
—
—
126
Net earnings, including noncontrolling interests 552
—
—
552
Less: Net earnings (loss) attributable to noncontrolling interests (7 ) —
—
(7 )
Net earnings attributable to shareholders $ 559
$ —
$ —
$ 559

Nine months ended September 30, 2017
Revenues:
Insurance net earned premiums $ 3,371
$ —
$ —
$ 3,371
Net investment income 1,382
—
(16 ) (b) 1,366
Realized losses on securities (1 ) —
—
(1 )
Income (loss) of managed investment entities:
Investment income —
155
—
155
Gain (loss) on change in fair value of assets/liabilities —
22
(10 ) (b) 12
Other income 168
—
(14 ) (c) 154
Total revenues 4,920
177
(40 ) 5,057
Costs and Expenses:
Insurance benefits and expenses 4,113
—
—
4,113
Expenses of managed investment entities —
177
(40 ) (b)(c) 137
Interest charges on borrowed money and other expenses 350
—
—
350
Total costs and expenses 4,463
177
(40 ) 4,600
Earnings before income taxes 457
—
—
457
Provision for income taxes 146
—
—
146
Net earnings, including noncontrolling interests 311
—
—
311
Less: Net earnings (loss) attributable to noncontrolling interests 2
—
—
2
Net earnings attributable to shareholders $ 309
$ —
$ —
$ 309


~~(a)~~	Includes income of $11 million and $16 million in the first nine months of 2018 and 2017, respectively, representing the change in fair value of AFG’s CLO investments plus $12 million and $14 million in the first nine months of 2018 and 2017, respectively, in CLO management fees earned.


~~(b)~~	Elimination of the change in fair value of AFG’s investments in the CLOs, including $15 million and $26 million in the first nine months of 2018 and 2017, respectively, in distributions recorded as interest expense by the CLOs.


~~(c)~~	~~Elimination of management fees earned by AFG.~~

~~Table of Contents~~

~~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) onand significant tax benefits (charges) related to 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 for asbestos and environmental exposures, are excluded from core earnings.

Beginning with the second quarter of 2019, AFG’s core net operating earnings for its annuity segment excludes unlocking, the impact of changes in the fair value of derivatives related to fixed-indexed annuities (“FIAs”), and other impacts of changes in the stock market and interest rates on the accounting for FIAs over or under the cost of the equity index options purchased to mitigate the risk in the index-based component of those FIAs (“annuity non-core earnings (losses)”). Fluctuations in interest rates and the stock market, among other factors, can cause volatility in the periodic measurement of FIA liabilities that management believes can be inconsistent with the long-term economics of this growing portion of AFG’s annuity business. Management believes that separating these impacts as “non-core” will provide investors with a better view of the fundamental performance of the business, and a more comparable measure of the annuity segment’s business compared to the results identified as “core” by its peers. Although prior period core net operating earnings for the annuity segment were not adjusted, the impact of the items now considered annuity non-core earnings on prior periods is highlighted in the discussion following the reconciliation of net earnings attributable to shareholders to core net operating earnings.

Table of Contents

AMERICAN FINANCIAL GROUP, INC. 10-Q

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

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,
2018 2017 2018 2017
Components of net earnings attributable to shareholders:
Core operating earnings before income taxes $ 237
$ 158
$ 733
$ 582
Pretax non-core items:
Realized gains (losses) on securities 34
(12 ) (28 ) (1 )
Special A&E charges (27 ) (113 ) (27 ) (113 )
Loss on retirement of debt —
(4 ) —
(11 )
Earnings before income taxes 244
29
678
457
Provision (credit) for income taxes:
Core operating earnings 40
63
138
189
Non-core items 1
(45 ) (12 ) (43 )
Total provision for income taxes 41
18
126
146
Net earnings, including noncontrolling interests 203
11
552
311
Less net earnings (losses) attributable to noncontrolling interests:
Core operating earnings (losses) (1 ) —
(7 ) 2
Non-core items —
—
—
—
Total net earnings (losses) attributable to noncontrolling interests (1 ) —
(7 ) 2
Net earnings attributable to shareholders $ 204
$ 11
$ 559
$ 309

Net earnings:
Core net operating earnings $ 198
$ 95
$ 602
$ 391
Non-core items 6
(84 ) (43 ) (82 )
Net earnings attributable to shareholders $ 204
$ 11
$ 559
$ 309

Diluted per share amounts:
Core net operating earnings $ 2.19
$ 1.06
$ 6.65
$ 4.35
Realized gains (losses) on securities 0.31
(0.08 ) (0.24 ) (0.01 )
Special A&E charges (0.24 ) (0.82 ) (0.24 ) (0.82 )
Loss on retirement of debt —
(0.03 ) —
(0.08 )
Net earnings attributable to shareholders $ 2.26
$ 0.13
$ 6.17
$ 3.44



	Three months ended June 30,						Six months ended June 30,
	2019			2018			2019			2018
Components of net earnings attributable to shareholders:
Core operating earnings before income taxes	$	236		$	229		$	465		$	496
Pretax non-core items:
Realized gains (losses) on securities	56			31			240			(62		)
Annuity non-core earnings (losses)	(33		)	—			(33		)	—
Earnings before income taxes	259			260			672			434
Provision (credit) for income taxes:
Core operating earnings	45			46			93			98
Non-core items:
Realized gains (losses) on securities	11			6			50			(13		)
Annuity non-core earnings (losses)	(6		)	—			(6		)	—
Total provision for income taxes	50			52			137			85
Net earnings, including noncontrolling interests	209			208			535			349
Less net earnings (losses) attributable to noncontrolling interests:
Core operating earnings (losses)	(1		)	(2		)	(4		)	(6		)
Total net earnings (losses) attributable to noncontrolling interests	(1		)	(2		)	(4		)	(6		)
Net earnings attributable to shareholders	$	210		$	210		$	539		$	355

Net earnings:
Core net operating earnings	$	192		$	185		$	376		$	404
Realized gains (losses) on securities	45			25			190			(49		)
Annuity non-core earnings (losses) (*)	(27		)	—			(27		)	—
Net earnings attributable to shareholders	$	210		$	210		$	539		$	355

Diluted per share amounts:
Core net operating earnings	$	2.12		$	2.04		$	4.14		$	4.46
Realized gains (losses) on securities	0.48			0.27			2.09			(0.54		)
Annuity non-core earnings (losses) (*)	(0.29		)	—			(0.29		)	—
Net earnings attributable to shareholders	$	2.31		$	2.31		$	5.94		$	3.92

(*)

Net earnings attributable to shareholders ~~increased $193~~was $210 million in both the ~~third~~second quarter of ~~2018 compared to~~2019 and the ~~same period in~~ ~~2017~~ ~~due to higher core net operating earnings, lower special A&E charges recorded in the~~ ~~third~~second quarter of ~~2018 compared to~~2018. Net earnings for the ~~third~~second quarter of ~~2017,~~2019 includes $45 million in after-tax net realized gains on securities compared to $25 million in the second quarter of 2018. In addition, net earnings attributable to shareholders includes after-tax losses of $27 million and $11 million in the second quarter of 2019 and 2018, ~~period~~respectively, from unlocking (in the 2018 quarter), the impact of changes in the fair value of derivatives related to FIAs, and other impacts of changes in the stock market and interest rates on the accounting for FIAs over or under the cost of the equity index options purchased to mitigate the risk in the index-based component of those FIAs. As discussed above, this impact on the accounting for FIAs is considered non-core earnings (losses) beginning with the second quarter of 2019. Excluding the $11 million after-tax negative impact of these items on results for the second quarter of 2018, core net operating earnings for the second quarter of 2019 decreased $4 million 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~~second quarter of 2018 ~~compared to the same period in~~ ~~2017~~, reflecting ~~higher~~slightly lower earnings ~~in the annuity segment, higher underwriting profit in the property and casualty segment due primarily to lower catastrophe losses, higher net investment income~~ in the property and casualty insurance ~~segment, lower interest charges on borrowed money~~ and ~~a lower corporate~~annuity

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Table of Contents

AMERICAN FINANCIAL GROUP, INC. 10-Q

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

~~income tax rate.~~segments, partially offset by improved results from AFG’s operations outside of those segments. Realized gains on securities in the ~~third~~ ~~quarter~~second quarters of 2019 and 2018 ~~includes~~resulted primarily from the ~~increase~~change in fair value of equity securities that ~~are required to be carried~~were still held at ~~fair value through net earnings under new accounting guidance adopted on January 1, 2018.~~the balance sheet date.

Net earnings attributable to shareholders increased ~~$250~~$184 million in the first ~~nine~~six months of ~~2018~~2019 compared to the same period in ~~2017~~2018 due primarily to ~~higher~~after-tax net realized gains on securities of $190 million in the 2019 period compared to after-tax net realized losses of $49 million in the first six months of 2018. In addition, net earnings attributable to shareholders includes an after-tax loss of $36 million for the first six months of 2019 ($9 million in the first quarter and $27 million in the second quarter) compared to after-tax income of $1 million in the first six months of 2018 from unlocking (in the first six months of 2018), the impact of changes in the fair value of derivatives related to FIAs, and other impacts of changes in the stock market and interest rates on the accounting for FIAs over or under the cost of the equity index options purchased to mitigate the risk in the index-based component of those FIAs. As discussed above, this impact on the accounting for FIAs is considered non-core earnings (losses) prospectively beginning with the second quarter of 2019. Excluding the $9 million after-tax negative impact of these items on results for the first quarter of 2019 and the $1 million after-tax favorable impact of these items on results for the first six months of 2018, core net operating earnings ~~lower special A&E charges in~~for the ~~2018 period~~first six months of 2019 decreased $18 million 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~~six months of 2018 ~~compared to the same period in 2017,~~ reflecting ~~higher~~lower earnings ~~in the annuity segment, higher underwriting profit~~ in the property and casualty insurance ~~segment due primarily to lower catastrophe losses~~ and higher favorable prior year reserve development, higher net investment income in the property and casualty insurance segment, lower interest charges on borrowed money, a lower corporate income tax rate and a loss on retirement of debt in the 2017 period.annuity segments. Realized ~~losses~~gains (losses) on securities in the first ~~nine~~six months of 2019 and 2018 ~~includes~~resulted primarily from the ~~decline~~change in fair value of equity securities that ~~are required to be carried~~were still held at ~~fair value through net earnings under new accounting guidance adopted on January 1, 2018.~~the balance sheet date.

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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~~THREE MONTHS ENDED ~~SEPTEMBER~~JUNE 30, ~~2018~~2019 AND ~~2017~~2018

Segmented Statement of Earnings AFG reports its business as three segments: (i) Property and casualty insurance (“P&C”), (ii) Annuity and (iii) Other, which includes run-off long-term care and life, 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~~June 30, ~~2018~~2019 and ~~2017~~2018 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		Consol. MIEs			Holding Co., other and unallocated			Total			Non-core reclass			GAAP Total			P&C			Annuity			Consol. MIEs			Holding Co., other and unallocated			Total			Non-core reclass			GAAP Total
Three months ended September 30, 2018
Three months ended June 30, 2019
Revenues:
Property and casualty insurance net earned premiums	$	1,327		$	—	$	—		$	—		$	1,327		$	—		$	1,327		$	1,200		$	—		$	—		$	—		$	1,200		$	—		$	1,200
Life, accident and health net earned premiums	—			—		—			6			6			—			6			—			—			—			5			5			—			5
Net investment income	108			413		(4		)	10			527			—			527			124			451			(5		)	10			580			—			580
Realized gains on securities	—			—		—			—			—			34			34			—			—			—			—			—			56			56
Income (loss) of MIEs:
Investment income	—			—		65			—			65			—			65			—			—			70			—			70			—			70
Gain (loss) on change in fair value of assets/liabilities	—			—		(5		)	—			(5		)	—			(5		)	—			—			(2		)	—			(2		)	—			(2		)
Other income	4			27		(4		)	27			54			—			54			2			27			(4		)	26			51			—			51
Total revenues	1,439			440		52			43			1,974			34			2,008			1,326			478			59			41			1,904			56			1,960

Costs and Expenses:
Property and casualty insurance:
Losses and loss adjustment expenses	854			—		—			—			854			18			872			723			—			—			—			723			—			723
Commissions and other underwriting expenses	417			—		—			7			424			—			424			418			—			—			8			426			—			426
Annuity benefits	—			222		—			—			222			—			222			—			272			—			—			272			67			339
Life, accident and health benefits	—			—		—			10			10			—			10			—			—			—			8			8			—			8
Annuity and supplemental insurance acquisition expenses	—			69		—			2			71			—			71			—			67			—			—			67			(34		)	33
Interest charges on borrowed money	—			—		—			15			15			—			15			—			—			—			17			17			—			17
Expenses of MIEs	—			—		52			—			52			—			52			—			—			59			—			59			—			59
Other expenses	11			32		—			46			89			9			98			11			35			—			50			96			—			96
Total costs and expenses	1,282			323		52			80			1,737			27			1,764			1,152			374			59			83			1,668			33			1,701
Earnings before income taxes	157			117		—			(37		)	237			7			244			174			104			—			(42		)	236			23			259
Provision for income taxes	26			19		—			(5		)	40			1			41			35			20			—			(10		)	45			5			50
Net earnings, including noncontrolling interests	131			98		—			(32		)	197			6			203			139			84			—			(32		)	191			18			209
Less: Net loss attributable to noncontrolling interests	(1		)	—		—			—			(1		)	—			(1		)
Less: Net earnings (losses) attributable to noncontrolling interests																					(1		)	—			—			—			(1		)	—			(1		)
Core Net Operating Earnings	132			98		—			(32		)	198									140			84			—			(32		)	192
Non-core earnings attributable to shareholders (a):
Realized gains on securities, net of tax	—			—		—			27			27			(27		)	—			—			—			—			45			45			(45		)	—
Special A&E charges, net of tax	(14		)	—		—			(7		)	(21		)	21			—
Annuity non-core losses, net of tax (b)																					—			(27		)	—			—			(27		)	27			—
Net Earnings Attributable to Shareholders	$	118		$	98	$	—		$	(12	)	$	204		$	—		$	204		$	140		$	57		$	—		$	13		$	210		$	—		$	210

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Table of Contents

AMERICAN FINANCIAL GROUP, INC. 10-Q

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


						Other																				Other
	P&C			Annuity		Consol. MIEs			Holding Co., other and unallocated			Total			Non-core reclass			GAAP Total			P&C			Annuity		Consol. MIEs			Holding Co., other and unallocated			Total			Non-core reclass			GAAP Total
Three months ended September 30, 2017
Three months ended June 30, 2018
Revenues:
Property and casualty insurance net earned premiums	$	1,267		$	—	$	—		$	—		$	1,267		$	—		$	1,267		$	1,161		$	—	$	—		$	—		$	1,161		$	—		$	1,161
Life, accident and health net earned premiums	—			—		—			6			6			—			6			—			—		—			6			6			—			6
Net investment income	94			375		(5		)	7			471			—			471			115			412		(4		)	7			530			—			530
Realized losses on securities	—			—		—			—			—			(12		)	(12		)
Realized gains on securities																					—			—		—			—			—			31			31
Income (loss) of MIEs:
Investment income	—			—		54			—			54			—			54			—			—		64			—			64			—			64
Gain (loss) on change in fair value of assets/liabilities	—			—		1			—			1			—			1			—			—		(2		)	—			(2		)	—			(2		)
Other income	1			26		(5		)	26			48			—			48			2			27		(4		)	18			43			—			43
Total revenues	1,362			401		45			39			1,847			(12		)	1,835			1,278			439		54			31			1,802			31			1,833

Costs and Expenses:
Property and casualty insurance:
Losses and loss adjustment expenses	906			—		—			—			906			89			995			693			—		—			—			693			—			693
Commissions and other underwriting expenses	353			—		—			4			357			—			357			396			—		—			4			400			—			400
Annuity benefits	—			215		—			—			215			—			215			—			260		—			—			260			—			260
Life, accident and health benefits	—			—		—			6			6			—			6			—			—		—			11			11			—			11
Annuity and supplemental insurance acquisition expenses	—			54		—			1			55			—			55			—			49		—			1			50			—			50
Interest charges on borrowed money	—			—		—			21			21			—			21			—			—		—			16			16			—			16
Expenses of MIEs	—			—		45			—			45			—			45			—			—		54			—			54			—			54
Other expenses	8			30		—			46			84			28			112			11			31		—			47			89			—			89
Total costs and expenses	1,267			299		45			78			1,689			117			1,806			1,100			340		54			79			1,573			—			1,573
Earnings before income taxes	95			102		—			(39		)	158			(129		)	29			178			99		—			(48		)	229			31			260
Provision for income taxes	43			34		—			(14		)	63			(45		)	18			37			21		—			(12		)	46			6			52
Net earnings, including noncontrolling interests	52			68		—			(25		)	95			(84		)	11			141			78		—			(36		)	183			25			208
Less: Net earnings attributable to noncontrolling interests	—			—		—			—			—			—			—
Less: Net earnings (losses) attributable to noncontrolling interests																					(2		)	—		—			—			(2		)	—			(2		)
Core Net Operating Earnings	52			68		—			(25		)	95									143			78		—			(36		)	185
Non-core earnings attributable to shareholders (a):
Realized losses on securities, net of tax	—			—		—			(8		)	(8		)	8			—
Special A&E charges, net of tax	(58		)	—		—			(16		)	(74		)	74			—
Loss on retirement of debt, net of tax	—			—		—			(2		)	(2		)	2			—
Realized gains on securities, net of tax																					—			—		—			25			25			(25		)	—
Net Earnings Attributable to Shareholders	$	(6	)	$	68	$	—		$	(51	)	$	11		$	—		$	11		$	143		$	78	$	—		$	(11	)	$	210		$	—		$	210


(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.

(b)

As discussed under “Results of Operations — General,” beginning with the second quarter of 2019, unlocking, the impact of changes in the fair value of derivatives related to FIAs, and other impacts of changes in the stock market and interest rates on the accounting for FIAs over or under the cost of the equity index options purchased to mitigate the risk in the index-based component of those FIAs are considered annuity non-core earnings (losses).

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 ~~$139~~$174 million in ~~GAAP~~ pretax earnings in the ~~third~~second quarter of 2019 compared to $178 million in the second quarter of 2018, ~~compared to $6~~a decrease of $4 million ~~in the third quarter of 2017, an increase of $133 million (2,217%~~(2%). ~~Property and casualty core~~The decrease in pretax earnings ~~were $157 million in the~~ ~~third~~ ~~quarter of 2018 compared to $95 million in the third quarter of 2017, an increase of $62 million (65%). The increase in GAAP and core pretax earnings~~ reflects ~~higher underwriting profit due primarily to lower catastrophe losses in the~~ ~~third~~ ~~quarter of 2018 compared to the third quarter of 2017 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

reflecting 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 lower ~~special A&E charges~~underwriting profit in the ~~third~~second quarter of 2019 compared to the second quarter of 2018, ~~compared to the third quarter of 2017.~~partially offset by higher net investment income.

The following table details AFG’s earnings before income taxes from its property and casualty insurance operations for the three months ended ~~September~~June 30, ~~2018~~2019 and ~~2017~~2018 (dollars in millions):


	Three months ended September 30,								Three months ended June 30,
	2018			2017			% Change		2019			2018			% Change
Gross written premiums	$	2,104		$	2,104		—	%	$	1,664		$	1,665		—	%
Reinsurance premiums ceded	(648		)	(671		)	(3	%)	(400		)	(408		)	(2	%)
Net written premiums	1,456			1,433			2	%	1,264			1,257			1	%
Change in unearned premiums	(129		)	(166		)	(22	%)	(64		)	(96		)	(33	%)
Net earned premiums	1,327			1,267			5	%	1,200			1,161			3	%
Loss and loss adjustment expenses (*)	854			906			(6	%)
Loss and loss adjustment expenses									723			693			4	%
Commissions and other underwriting expenses	417			353			18	%	418			396			6	%
Core underwriting gain	56			8			600	%
Underwriting gain									59			72			(18	%)

Net investment income	108			94			15	%	124			115			8	%
Other income and expenses, net	(7		)	(7		)	—	%	(9		)	(9		)	—	%
Core earnings before income taxes	157			95			65	%
Pretax non-core special A&E charges	(18		)	(89		)	(80	%)
GAAP earnings before income taxes	$	139		$	6		2,217	%

(*) Excludes pretax non-core special A&E charges of $18 million and $89 million in the third quarter of 2018 and 2017, respectively.
Earnings before income taxes									$	174		$	178		(2	%)


Combined Ratios:
Specialty lines							Change								Change
Loss and LAE ratio	64.3		%	71.4		%	(7.1	%)	60.2		%	59.7		%	0.5	%
Underwriting expense ratio	31.4		%	27.9		%	3.5	%	34.8		%	34.0		%	0.8	%
Combined ratio	95.7		%	99.3		%	(3.6	%)	95.0		%	93.7		%	1.3	%

Aggregate — including exited lines
Loss and LAE ratio	65.8		%	78.5		%	(12.7	%)	60.3		%	59.7		%	0.6	%
Underwriting expense ratio	31.4		%	27.9		%	3.5	%	34.8		%	34.0		%	0.8	%
Combined ratio	97.2		%	106.4		%	(9.2	%)	95.1		%	93.7		%	1.4	%

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.

Gross Written Premiums

Gross written premiums (“GWP”) for AFG’s property and casualty insurance segment were $1.66 billion for the second quarter of 2019 compared to $1.67 billion the second quarter of 2018, a decrease of $1 million. Detail of AFG’s property and casualty gross written premiums is shown below (dollars in millions):



	Three months ended June 30,
	2019				2018
	GWP		%		GWP		%		% Change
Property and transportation	$	579	35	%	$	615	37	%	(6	%)
Specialty casualty	896		54	%	858		52	%	4	%
Specialty financial	189		11	%	192		11	%	(2	%)
	$	1,664	100	%	$	1,665	100	%	—	%

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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. Detail of AFG’s property and casualty gross written premiums is shown below (dollars in millions):~~

Three months ended September 30,
2018 2017
GWP % GWP % % Change
Property and transportation $ 953
45 % $ 1,073
51 % (11 %)
Specialty casualty 956
46 % 850
40 % 12 %
Specialty financial 195
9 % 181
9 % 8 %
$ 2,104
100 % $ 2,104
100 % — %

Reinsurance Premiums Ceded

Reinsurance premiums ceded (“Ceded”) for AFG’s property and casualty insurance segment were ~~31%~~24% of gross written premiums for the ~~third~~second quarter of ~~2018~~2019 compared to ~~32%~~25% of gross written premiums for the ~~third~~second quarter of ~~2017,~~2018, 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 June 30,
	2018					2017					Change in		2019					2018					Change in
	Ceded			% of GWP		Ceded			% of GWP		% of GWP		Ceded			% of GWP		Ceded			% of GWP		% of GWP
Property and transportation	$	(393	)	41	%	$	(449	)	42	%	(1	%)	$	(157	)	27	%	$	(193	)	31	%	(4	%)
Specialty casualty	(261		)	27	%	(226		)	27	%	—	%	(234		)	26	%	(219		)	26	%	—	%
Specialty financial	(42		)	22	%	(31		)	17	%	5	%	(40		)	21	%	(33		)	17	%	4	%
Other specialty	48					35							31					37
	$	(648	)	31	%	$	(671	)	32	%	(1	%)	$	(400	)	24	%	$	(408	)	25	%	(1	%)

Net Written Premiums

Net written premiums (“NWP”) for AFG’s property and casualty insurance segment were $~~1.46~~1.26 billion for the ~~third~~second quarter of ~~2018~~2019 compared to $~~1.43~~1.26 billion for the ~~third~~second quarter of ~~2017~~2018, an increase of $237 million (2%1%). Detail of AFG’s property and casualty net written premiums is shown below (dollars in millions):


	Three months ended September 30,										Three months ended June 30,
	2018				2017						2019				2018
	NWP		%		NWP		%		% Change		NWP		%		NWP		%		% Change
Property and transportation	$	560	38	%	$	624	44	%	(10	%)	$	422	33	%	$	422	33	%	—	%
Specialty casualty	695		48	%	624		44	%	11	%	662		52	%	639		51	%	4	%
Specialty financial	153		11	%	150		10	%	2	%	149		12	%	159		13	%	(6	%)
Other specialty	48		3	%	35		2	%	37	%	31		3	%	37		3	%	(16	%)
	$	1,456	100	%	$	1,433	100	%	2	%	$	1,264	100	%	$	1,257	100	%	1	%

Net Earned Premiums

Net earned premiums (“NEP”) for AFG’s property and casualty insurance segment were $1.20 billion for the second quarter of 2019 compared to $1.16 billion for the second quarter of 2018, an increase of $39 million (3%). Detail of AFG’s property and casualty net earned premiums is shown below (dollars in millions):



	Three months ended June 30,
	2019				2018
	NEP		%		NEP		%		% Change
Property and transportation	$	379	32	%	$	374	32	%	1	%
Specialty casualty	634		53	%	595		51	%	7	%
Specialty financial	151		13	%	159		14	%	(5	%)
Other specialty	36		2	%	33		3	%	9	%
	$	1,200	100	%	$	1,161	100	%	3	%

The $1 million decrease in gross written premiums for the second quarter of 2019 compared to the second quarter of 2018 reflects growth in the Specialty casualty sub-segment, offset by lower gross written premiums in the Property and transportation and Specialty financial sub-segments. Overall average renewal rates increased approximately 3% in the second quarter of 2019. Excluding the workers’ compensation business, renewal pricing increased approximately 5%.

Property and transportation Gross written premiums decreased $36 million (6%) in the second quarter of 2019 compared to the second quarter of 2018, due primarily to delayed acreage reporting from insureds as a result of excess moisture and late planting of corn and soybean crops. Management expects that the delayed crop premiums will be included in third quarter 2019 results. Excluding crop insurance, gross written premiums for the second quarter of 2019 grew by 12% when compared to the 2018 second quarter. This growth is primarily attributable to new business opportunities in the transportation businesses. Average renewal rates increased approximately 5% for this group in the second quarter of 2019. Reinsurance premiums ceded

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AMERICAN FINANCIAL GROUP, INC. 10-Q

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

~~Net Earned Premiums~~

~~Net earned~~as a percentage of gross written premiums ~~(“NEP”) for AFG’s property and casualty insurance segment were~~ ~~$1.33 billion~~decreased 4 percentage points for the ~~third~~second quarter of ~~2018~~ ~~compared to~~ ~~$1.27 billion~~ ~~for the~~ ~~third~~ ~~quarter of~~ ~~2017~~, ~~an increase~~ of ~~$60 million~~ (5%~~). Detail of AFG’s property and casualty net earned premiums is shown below (dollars in millions):~~

Three months ended September 30,
2018 2017
NEP % NEP % % Change
Property and transportation $ 526
40 % $ 527
42 % — %
Specialty casualty 616
46 % 568
45 % 8 %
Specialty financial 149
11 % 142
11 % 5 %
Other specialty 36
3 % 30
2 % 20 %
$ 1,327
100 % $ 1,267
100 % 5 %

~~Gross written premiums were flat for the~~ ~~third~~ ~~quarter of~~ ~~2018~~2019 compared to the ~~third~~ quarter of 2017 reflecting growth in the Specialty casualty and Specialty financial sub-segments, offset by lower gross written premiums in the Property and transportation sub-segment. Overall average renewal rates increased approximately 2% in the ~~third~~ ~~quarter of 2018. Excluding the workers’ compensation business, renewal pricing increased approximately 3%.~~

~~Property and transportation~~ ~~Gross written premiums decreased $120 million (11%) in the third~~second quarter of 2018 ~~compared to the third quarter of 2017. This decrease was largely the result of~~reflecting a change in the ~~timing~~mix of ~~two large policy renewals~~business.

Specialty casualty Gross written premiums increased$38 million (4%) in ~~one~~the second quarter of ~~the transportation businesses from the third quarter~~2019 compared to the ~~fourth~~second quarter of 2018 due primarily to the addition of premiums from ABA Insurance Services, as well as growth in the excess and surplus lines, executive liability and social services businesses. This growth was partially offset by lower ~~year-over-year~~ premiums in the ~~crop insurance business. Gross written premiums in the other~~workers’ compensation businesses ~~in this group grew by 6% in the third quarter of 2018 compared to the third quarter of 2017.~~and at Neon. Average renewal rates increased approximately 3% for this group in the ~~third~~second quarter of ~~2018. Reinsurance premiums ceded as a percentage of gross written premiums decreased 1 percentage point for the third quarter of 2018 compared to the third quarter of 2017.~~

~~Specialty casualty~~ ~~Gross written premiums~~ ~~increased$106 million~~ (~~12%~~)2019. Excluding rate decreases in the third quarter of 2018 compared to the third quarter of 2017 due primarily to growth at Neon. Higher gross written premiums in the workers’ compensation and excess and surplus lines businesses also contributed to the year-over-year growth. Average renewal rates increased approximately 1% for this group in the third quarter of 2018. Excluding the workers’ compensation businesses, renewal rates for this group increased approximately 2%7%. Reinsurance premiums ceded as a percentage of gross written premiums ~~were~~was comparable in the ~~third~~second quarter of 2019 and the second quarter of 2018 ~~compared to the third quarter of 2017~~ reflecting ~~higher~~lower cessions to AFG’s internal reinsurance program, which is included in Other specialty, ~~and~~offset by higher cessions to reinsurers.

Specialty financial Gross written premiums decreased$3 million (2%) in the ~~workers’ compensation businesses, offset by lower reinstatement premiums resulting from reinsured hurricane losses in the 2018 period~~second quarter of 2019 compared to the ~~2017 period.~~

~~Specialty financial~~ ~~Gross written premiums~~ ~~increased$14 million~~ (8%~~) in the third~~second quarter of 2018 ~~compared to the third quarter of 2017~~ due primarily to ~~higher~~lower premiums in the financial institutions business. Average renewal rates for this group increased approximately 6%1% in the ~~third~~second quarter of ~~2018.~~2019. Reinsurance premiums ceded as a percentage of gross written premiums increased 54 percentage points for the ~~third~~second quarter of ~~2018~~2019 compared to the ~~third~~second quarter of ~~2017,~~2018, reflecting higher cessions in the financial institutions ~~and equipment leasing businesses and the impact of reinstatement premiums 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 $13~~decreased $6 million ~~(37%~~(16%) in the ~~third~~second quarter of 2019 compared to the second quarter of 2018, ~~compared to the third quarter of 2017,~~ reflecting ~~an increase~~a decrease 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 insurance segment:


	Three months ended September 30,						Three months ended September 30,					Three months ended June 30,						Three months ended June 30,
	2018		2017		Change		2018		2017			2019		2018		Change		2019		2018
Property and transportation
Loss and LAE ratio	77.1	%	77.3	%	(0.2	%)						68.4	%	63.8	%	4.6	%
Underwriting expense ratio	22.9	%	21.6	%	1.3	%						30.7	%	30.1	%	0.6	%
Combined ratio	100.0	%	98.9	%	1.1	%						99.1	%	93.9	%	5.2	%
Underwriting profit (loss)							$	—	$	6
Underwriting profit																		$	4	$	23

Specialty casualty
Loss and LAE ratio	59.2	%	70.7	%	(11.5	%)						60.0	%	63.4	%	(3.4	%)
Underwriting expense ratio	32.9	%	28.8	%	4.1	%						32.5	%	31.7	%	0.8	%
Combined ratio	92.1	%	99.5	%	(7.4	%)						92.5	%	95.1	%	(2.6	%)	��
Underwriting profit							$	49	$	2								$	47	$	29

Specialty financial
Loss and LAE ratio	40.1	%	56.0	%	(15.9	%)						32.3	%	33.9	%	(1.6	%)
Underwriting expense ratio	54.3	%	46.2	%	8.1	%						53.3	%	51.7	%	1.6	%
Combined ratio	94.4	%	102.2	%	(7.8	%)						85.6	%	85.6	%	—	%
Underwriting profit (loss)							$	9	$	(3	)
Underwriting profit																		$	21	$	22

Total Specialty
Loss and LAE ratio	64.3	%	71.4	%	(7.1	%)						60.2	%	59.7	%	0.5	%
Underwriting expense ratio	31.4	%	27.9	%	3.5	%						34.8	%	34.0	%	0.8	%
Combined ratio	95.7	%	99.3	%	(3.6	%)						95.0	%	93.7	%	1.3	%
Underwriting profit							$	55	$	9								$	60	$	73

Aggregate — including exited lines
Loss and LAE ratio	65.8	%	78.5	%	(12.7	%)						60.3	%	59.7	%	0.6	%
Underwriting expense ratio	31.4	%	27.9	%	3.5	%						34.8	%	34.0	%	0.8	%
Combined ratio	97.2	%	106.4	%	(9.2	%)						95.1	%	93.7	%	1.4	%
Underwriting profit (loss)							$	38	$	(81	)
Underwriting profit																		$	59	$	72

The Specialty property and casualty insurance operations generated an underwriting profit of $5560 million in the ~~third~~second quarter of 2019 compared to $73 million in the second quarter of 2018, ~~compared to $9~~a decrease of $13 million (18%). The lower underwriting profit in the ~~third~~second quarter of ~~2017, an increase of $46 million (511%). The~~2019 reflects lower underwriting profits in the Property and transportation and Specialty financial sub-segments, partially offset by higher underwriting profit in the ~~third quarter of 2018 reflects higher underwriting profits in the~~ Specialty casualty and Specialty financial sub-segments due primarily to significantly lower catastrophe losses. Overall catastrophe losses were $35 million (2.6 points on the combined ratio) for the third quarter of 2018 compared to $107 million (8.4 points) for the third quarter of 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.sub-segment.

Property and transportation This group reported an underwriting loss of less than $1 million for the third quarter of 2018 compared to an underwriting profit of $6 million in the third quarter of 2017, a decrease of $6 million (100%). Improved underwriting results in the ocean marine operations and higher underwriting profit at National Interstate were offset by lower profitability in several other businesses in this group. Catastrophe losses were $12 million (2.3 points on the combined ratio) and 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.

~~Specialty casualty~~Underwriting profit for this group was ~~$49~~$4 million for the ~~third~~second quarter of 2019 compared to $23 million in the second quarter of 2018, a decrease of $19 million (83%). This decrease reflects lower favorable prior year reserve development in the transportation and agricultural businesses, as well as a larger year-over-year underwriting loss in the Singapore branch.

Specialty casualty Underwriting profit for this group was $47 million for the second quarter of 2019 compared to $2$29 million for the ~~third~~second quarter of ~~2017,~~2018, an increase of ~~$47~~$18 million ~~(2,350%~~(62%)~~, reflecting lower catastrophe losses at Neon and~~. This increase reflects higher underwriting profitability in the ~~executive liability~~workers’ compensation and public sector businesses, partially offset by lower underwriting profits in the excess and surplus lines businesses.

Specialty financial Underwriting profit for this group was $21 million for the second quarter of 2019 compared to $22 million in the second quarter of 2018, a decrease of $1 million (5%). Higher underwriting profitability in the equipment leasing and surety businesses was more than offset by lower underwriting profitability in the financial institutions business. ~~Catastrophe losses were $11 million (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

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.

~~Specialty financial~~ ~~This group reported an underwriting profit of~~ ~~$9 million~~ for the third quarter of 2018 compared to an underwriting loss of $3 million in the third quarter of 2017, an improvement of $12 million (400%). Lower year-over-year catastrophe losses in the lender-placed mortgage property book within the financial institutions business and higher underwriting profit in the surety business contributed to these improved results. Catastrophe losses were $12 million (8.0 points on the combined ratio) for the third quarter of 2018 compared to $29 million (20.4 points) for the third quarter 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 third quarter of 2017.

Other specialty This group reported an underwriting loss of $3$12 million in the ~~third~~second quarter of ~~2018~~2019 compared to ~~an underwriting profit of $4~~$1 million in the ~~third~~second quarter of ~~2017. This decrease is due primarily to~~2018, reflecting higher losses ~~in the third quarter of 2018~~ in the business assumed by AFG’s internal reinsurance program from the operations that make up AFG’s other Specialty sub-segments in the second quarter of 2019 compared to ~~earnings in~~ the ~~third~~second quarter of ~~2017.~~2018.

~~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.~~

~~Table of Contents~~

~~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 ~~65.8%~~60.3% for the ~~third~~second quarter of ~~2018~~2019 compared to ~~78.5%~~59.7% for the ~~third~~second quarter of ~~2017~~2018, ~~a decrease~~an increase of ~~12.7~~0.6 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 June 30,
	Amount						Ratio				Change in		Amount						Ratio				Change in
	2018			2017			2018		2017		Ratio		2019			2018			2019		2018		Ratio
Property and transportation
Current year, excluding catastrophe losses	$	398		$	392		75.6	%	74.4	%	1.2	%	$	257		$	250		68.0	%	66.7	%	1.3	%
Prior accident years development	(4		)	(8		)	(0.8	%)	(1.5	%)	0.7	%	(6		)	(21		)	(1.6	%)	(5.6	%)	4.0	%
Current year catastrophe losses	12			23			2.3	%	4.4	%	(2.1	%)	8			10			2.0	%	2.7	%	(0.7	%)
Property and transportation losses and LAE and ratio	$	406		$	407		77.1	%	77.3	%	(0.2	%)	$	259		$	239		68.4	%	63.8	%	4.6	%

Specialty casualty
Current year, excluding catastrophe losses	$	390		$	371		63.5	%	65.2	%	(1.7	%)	$	410		$	392		64.6	%	65.8	%	(1.2	%)
Prior accident years development	(37		)	(23		)	(6.0	%)	(4.0	%)	(2.0	%)	(31		)	(15		)	(4.7	%)	(2.5	%)	(2.2	%)
Current year catastrophe losses	11			54			1.7	%	9.5	%	(7.8	%)	1			1			0.1	%	0.1	%	—	%
Specialty casualty losses and LAE and ratio	$	364		$	402		59.2	%	70.7	%	(11.5	%)	$	380		$	378		60.0	%	63.4	%	(3.4	%)

Specialty financial
Current year, excluding catastrophe losses	$	56		$	55		37.2	%	38.7	%	(1.5	%)	$	55		$	59		36.4	%	37.3	%	(0.9	%)
Prior accident years development	(8		)	(5		)	(5.1	%)	(3.1	%)	(2.0	%)	(9		)	(8		)	(5.9	%)	(5.4	%)	(0.5	%)
Current year catastrophe losses	12			29			8.0	%	20.4	%	(12.4	%)	3			3			1.8	%	2.0	%	(0.2	%)
Specialty financial losses and LAE and ratio	$	60		$	79		40.1	%	56.0	%	(15.9	%)	$	49		$	54		32.3	%	33.9	%	(1.6	%)

Total Specialty
Current year, excluding catastrophe losses	$	869		$	836		65.4	%	65.9	%	(0.5	%)	$	752		$	721		62.7	%	62.2	%	0.5	%
Prior accident years development	(49		)	(38		)	(3.7	%)	(2.9	%)	(0.8	%)	(42		)	(45		)	(3.4	%)	(3.9	%)	0.5	%
Current year catastrophe losses	35			107			2.6	%	8.4	%	(5.8	%)	12			16			0.9	%	1.4	%	(0.5	%)
Total Specialty losses and LAE and ratio	$	855		$	905		64.3	%	71.4	%	(7.1	%)	$	722		$	692		60.2	%	59.7	%	0.5	%

Aggregate — including exited lines
Current year, excluding catastrophe losses	$	868		$	836		65.4	%	65.9	%	(0.5	%)	$	752		$	721		62.7	%	62.2	%	0.5	%
Prior accident years development	(31		)	52			(2.2	%)	4.2	%	(6.4	%)	(41		)	(44		)	(3.3	%)	(3.9	%)	0.6	%
Current year catastrophe losses	35			107			2.6	%	8.4	%	(5.8	%)	12			16			0.9	%	1.4	%	(0.5	%)
Aggregate losses and LAE and ratio	$	872		$	995		65.8	%	78.5	%	(12.7	%)	$	723		$	693		60.3	%	59.7	%	0.6	%

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%~~62.7% for the ~~third~~second quarter of ~~2018~~2019 compared to ~~65.9%~~62.2% for the ~~third~~second quarter of ~~2017~~2018, ~~a decrease~~an increase of 0.5 percentage points.

Property and transportation The ~~1.2~~1.3 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 equine and aviation businesses and~~at the Singapore branch infor the ~~third~~second quarter of ~~2018~~2019 compared to the ~~third~~second quarter of ~~2017.~~2018.

Table of Contents

AMERICAN FINANCIAL GROUP, INC. 10-Q

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

Specialty casualty The ~~1.7~~1.2 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 several of the ~~executive liability business~~workers’ compensation businesses and at ~~Neon, partially offset by an increase in the loss and LAE ratio in the targeted markets business.~~Neon.

~~Table of Contents~~

~~AMERICAN FINANCIAL GROUP, INC. 10-Q~~

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

Specialty financial The ~~1.5~~0.9 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 of the financial institutions business, partially offset by an increase in the loss and LAE ratio of the surety 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 $4942 million in the ~~third~~second quarter of ~~2018~~2019 compared to ~~$38~~$45 million in the ~~third~~second quarter of ~~2017, an increase~~2018, a decrease of ~~$11~~$3 million ~~(29%~~(7%).

Property and transportation Net favorable reserve development of $46 million in the ~~third~~second quarter of ~~2018~~2019 reflects lower than expected ~~claims severity at National Interstate,~~losses in the crop business. Net favorable reserve development of $21 million in the second quarter of 2018 reflects 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.~~transportation businesses.

Specialty casualty Net favorable reserve development of $8$31 million in the ~~third~~second 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 $37 million in the~~ ~~third~~ ~~quarter of 2018~~2019 reflects lower than anticipated claim severity in the workers’ compensation businesses, ~~and to a lesser extent, lower~~partially offset by higher than expected claim severity in the ~~targeted markets~~excess and ~~executive liability~~surplus lines businesses. ~~This was partially offset by higher~~Net favorable reserve development of $15 million in the second quarter of 2018 includes lower than anticipated claim frequency and severity in the workers’ compensation business.

Specialty financial Net favorable reserve development of $9 million in the second quarter of 2019 reflects lower than expected claim frequency and severity in the ~~excess~~surety 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 institutions businesses. Net favorable reserve development of $8 million in the ~~third~~second quarter of 2018 reflects lower than expected claim frequency and severity in the surety business and lower than anticipated claim severity in the ~~fidelity~~financial institutions 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.~~

Other specialty In addition to the development discussed above, total Specialty prior year reserve development includes net adverse reserve development of $4 million in the second quarter of 2019 compared to net favorable reserve development of $2$1 million in the ~~third~~second quarter of 2018, ~~and 2017,~~ reflecting $6 million of adverse reserve development associated with AFG’s internal reinsurance program in the 2019 period compared to $1 million in the second quarter of 2018. Both periods include the amortization of the deferred ~~gains~~gain on the retroactive ~~reinsurance transactions~~insurance transaction entered into in connection with the sale of businesses in 1998 and 2001. ~~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 2018, AFG completed an 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, 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 2018 internal review, AFG’s property and casualty insurance segment recorded an $18 million pretax special charge to increase its asbestos reserves by $6 million (net of reinsurance) and its environmental reserves by $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 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 has updated its view of legal defense costs on open environmental claims as well as a number of claims and sites where the estimated investigation and remediation costs have increased. As in past years, there were no new or emerging broad industry trends that were identified in this review.

~~Table of Contents~~

~~AMERICAN FINANCIAL GROUP, INC. 10-Q~~

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

At September 30, 2018, the property and casualty insurance segment’s insurance reserves include A&E reserves of $398 million, net of reinsurance recoverables. At September 30, 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, 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 (9/30/2018) 19.0
11.4
15.0
Industry (12/31/2017) 6.7
6.7
6.7

In addition, the 2018 internal review encompassed reserves for asbestos and environmental exposures of AFG’s former railroad and manufacturing operations. For a discussion of the $9 million pretax special charge recorded for those operations, see ~~“Results of Operations — Holding Company, Other and Unallocated,”~~ ~~for the quarters ended September 30, 2018 and 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 study, AFG recorded an $89 million (net of reinsurance) pretax special charge to increase its property and casualty insurance segment’s A&E reserves and a $24 million special charge to increase the reserves of its former railroad and manufacturing 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 2017 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 both the ~~third~~second quarter of ~~2017~~2019 and the second quarter of 2018 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, ~~2017,~~2018, 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%3%
	500-year event		~~Less than 4%~~Approximately 6%

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~~million. Neon’s excess of loss catastrophe reinsurance limits the maximum retained loss per event to $15 million ~~per occurrence retention for Neon~~ for losses up to ~~$200 million ($225 million for U.S. catastrophe events).~~$250 million. 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 $104 million of traditional catastrophe reinsurance through a catastrophe bond.

~~Catastrophe losses of $35 million in the~~ ~~third~~ quarter of 2018 resulted primarily from Hurricane Florence. Catastrophe losses of $107 million in the third quarter of 2017 resulted primarily from Hurricanes Harvey, Irma and Maria and two earthquakes in Mexico.

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AMERICAN FINANCIAL GROUP, INC. 10-Q

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

Catastrophe losses of $12 million in the second quarter of 2019 resulted primarily from storms and tornadoes in multiple regions of the United States. Catastrophe losses of $16 million in the second quarter of 2018 resulted primarily from storms and flooding in several regions of the United States.

Commissions and Other Underwriting Expenses

AFG’s property and casualty commissions and other underwriting expenses (“U/W Exp”) were ~~$417~~$418 million in the ~~third~~second quarter of ~~2018~~2019 compared to ~~$353~~$396 million for the ~~third~~second quarter of ~~2017~~2018, an increase of $6422 million ~~(18%~~ (6%). AFG’s underwriting expense ratio, calculated as commissions and other underwriting expenses divided by net premiums earned, was ~~31.4%~~34.8% for the ~~third~~second quarter of ~~2018~~2019 compared to ~~27.9%~~34.0% for the ~~third~~second quarter of ~~2017~~2018, an increase of ~~3.5~~0.8 percentage points. Detail of AFG’s property and casualty commissions and other underwriting expenses and underwriting expense ratios is shown below (dollars in millions):


	Three months ended September 30,										Three months ended June 30,
	2018				2017				Change in		2019				2018				Change in
	U/W Exp		% of NEP		U/W Exp		% of NEP		% of NEP		U/W Exp		% of NEP		U/W Exp		% of NEP		% of NEP
Property and transportation	$	120	22.9	%	$	114	21.6	%	1.3	%	$	116	30.7	%	$	112	30.1	%	0.6	%
Specialty casualty	203		32.9	%	164		28.8	%	4.1	%	207		32.5	%	188		31.7	%	0.8	%
Specialty financial	80		54.3	%	66		46.2	%	8.1	%	81		53.3	%	83		51.7	%	1.6	%
Other specialty	14		37.5	%	9		32.5	%	5.0	%	14		39.1	%	13		36.8	%	2.3	%
	$	417	31.4	%	$	353	27.9	%	3.5	%	$	418	34.8	%	$	396	34.0	%	0.8	%

Property and transportation Commissions and other underwriting expenses as a percentage of net earned premiums increased ~~1.3~~0.6 percentage points in the ~~third~~second quarter of ~~2018~~2019 compared to the ~~third~~second quarter of ~~2017~~,2018 reflecting higher underwriting expenses and lower ~~premiums~~ancillary services fees at National Interstate in the second quarter of 2019 compared to the second quarter of 2018, partially offset by higher profitability-based ceding commissions received from reinsurers 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.~~business.

Specialty casualty Commissions and other underwriting expenses as a percentage of net earned premiums increased ~~4.1~~0.8 percentage points in the ~~third~~second quarter of ~~2018~~2019 compared to the ~~third~~second quarter of ~~2017~~,2018 reflecting ~~growth at Neon, which has a higher expense ratio than AFG’s overall Specialty casualty group, higher dividends paid to policyholders~~lower ceding commissions received from reinsurers in the ~~workers’ compensation businesses~~excess and ~~higher commissions in the targeted markets~~surplus lines businesses.

Specialty financial Commissions and other underwriting expenses as a percentage of net earned premiums increased~~8.1~~1.6 percentage points in the ~~third~~second quarter of ~~2018~~2019 compared to the ~~third~~second quarter of ~~2017~~,2018 reflecting ~~higher ceding commissions and~~ higher profitability-based commissions paid to agents in the financial institutions ~~business compared to the third quarter of 2017, which included an $8 million commission expense reduction due to hurricane losses in the period.~~business.

Property and Casualty Net Investment Income

Net investment income in AFG’s property and casualty insurance operations was ~~$108~~$124 million in the ~~third~~second quarter of ~~2018~~2019 compared to $94115 million in the ~~third~~second quarter of ~~2017~~2018, an increase of $149 million (~~15%~~8%). 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 June 30,
	2018			2017			Change			% Change		2019			2018			Change			% Change
Net investment income	$	108		$	94		$	14		15	%	$	124		$	115		$	9		8	%

Average invested assets (at amortized cost)	$	10,388		$	9,851		$	537		5	%	$	11,193		$	10,346		$	847		8	%

Yield (net investment income as a % of average invested assets)	4.16		%	3.82		%	0.34		%			4.43		%	4.45		%	(0.02		%)

Tax equivalent yield (*)	4.34		%	4.26		%	0.08		%			4.60		%	4.62		%	(0.02		%)

(*) 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 ~~third~~second quarter of ~~2018~~2019 compared to the ~~third~~second quarter of ~~2017~~ ~~reflects~~2018 is due primarily to growth in the property and casualty insurance ~~segment and very strong earnings from limited partnerships and similar investments.~~segment. The property and casualty insurance segment’s overall yield on investments (net investment income as a percentage of average invested assets) was ~~4.16%~~4.43% for the ~~third~~second quarter of ~~2018~~2019 compared to ~~3.82%~~4.45% for the ~~third~~second quarter of ~~2017, an increase~~2018, a decrease of ~~0.34~~0.02 percentage ~~points,~~points. The decrease is due primarily to ~~the higher earnings from limited partnerships and similar investments. The high returns from limited~~a lower yield on partnerships and similar investments ~~should not necessarily be expected to repeat~~ in ~~future periods.~~the second quarter of 2019 reflecting both additional investments and unusually strong earnings from these assets in the second quarter of 2018. AFG’s property and

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AMERICAN FINANCIAL GROUP, INC. 10-Q

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

casualty insurance operations recorded $20 million in earnings from partnerships and similar investments in the second quarter of 2019 compared to $18 million in the second quarter of 2018, an increase of $2 million (11%). The annualized yield earned on these investments was 13.4% in the second quarter of 2019 compared to 15.7% in the prior year period.

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$9 million for both the ~~third~~second quarter of ~~2018~~2019 and for the ~~third~~second quarter of ~~2017.~~2018. 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 June 30,
	2018			2017			2019			2018
Other income							$	2		$	2
Income from the sale of real estate	$	—		$	—
Other	4			1
Total other income	4			1
Other expenses
Amortization of intangibles	3			2			3			2
Other	8			6			8			9
Total other expenses	11			8			11			11
Other income and expenses, net	$	(7	)	$	(7	)	$	(9	)	$	(9	)

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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 ~~$117~~$71 million in GAAP pretax earnings in the ~~third~~second quarter of 2019 compared to $99 million in the second quarter of 2018, ~~compared to $102~~a decrease of $28 million ~~in the third quarter of 2017, an increase of $15 million (15%~~(28%). This decrease in AFG’s GAAP annuity segment results for the ~~third~~second quarter of ~~2018~~2019 as compared to the ~~third~~second quarter of ~~2017 reflect a 10% increase in average annuity investments (at amortized cost) and higher earnings from limited partnerships and similar investments, partially offset by~~2018 is due primarily to the unfavorable 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 strong stock market performance and the negative impact ofsignificantly lower than anticipated interest rates on the fair value of derivatives related to ~~fixed-indexed annuities (“FIAs”), strong stock market performance~~FIAs in the ~~third quarter of 2018 had a significantly~~2019 period compared to higher ~~favorable impact~~ than ~~the stock market increase in the 2017 period and the decrease in~~anticipated interest rates in the ~~third quarter of 2017 had a significantly larger unfavorable impact in the 2017~~2018 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~~an unlocking charge in the ~~FIA business~~second quarter of 2018. AFG monitors the major actuarial assumptions underlying its annuity operations throughout the year and ~~higher interest rates)~~conducts detailed reviews (“unlocking”) of its assumptions in the fourth quarter of each year. If changes in the economic environment or actual experience would cause material revisions to future estimates, these assumptions are updated (unlocked) in an interim quarter. AFG unlocked its assumptions for option costs and interest rates in the second quarter of 2018 ~~period compared~~due to ~~the 2017 period.~~continued higher FIA option costs (resulting primarily from higher than expected risk-free rates), resulting in a net charge to earnings of $27 million.

The following table details AFG’s GAAP and core earnings before income taxes from its annuity operations for the three months ended ~~September~~June 30, ~~2018~~2019 and ~~2017~~2018 (dollars in millions):


	Three months ended September 30,						Three months ended June 30,
	2018		2017		% Change		2019			2018		% Change
Revenues:
Net investment income	$	413	$	375	10	%	$	451		$	412	9	%
Other income:
Guaranteed withdrawal benefit fees	16		15		7	%	17			16		6	%
Policy charges and other miscellaneous income	11		11		—	%	10			11		(9	%)
Total revenues	440		401		10	%	478			439		9	%

Costs and Expenses:
Annuity benefits (*)	222		215		3	%
Annuity benefits (a)(b)							272			260		5	%
Acquisition expenses(a)	69		54		28	%	67			49		37	%
Other expenses	32		30		7	%	35			31		13	%
Total costs and expenses	323		299		8	%	374			340		10	%
Earnings before income taxes	$	117	$	102	15	%
Core earnings before income taxes							104			99		5	%
Pretax non-core losses (a)							(33		)	—		—	%
GAAP earnings before income taxes							$	71		$	99	(28	%)

(a)

As discussed under “Results of Operations — General,” beginning prospectively with the second quarter of 2019, unlocking, the impact of changes in the fair value of derivatives related to FIAs, and other impacts of changes in the stock market and interest rates on the accounting for FIAs over or under the cost of the equity index options purchased to mitigate the risk in the index-based component of those FIAs are considered non-core earnings (losses). For the second quarter of 2019, annuity benefits excludes $67 million in pretax losses related to these items and acquisition expenses excludes the related $34 million favorable impact on the amortization of deferred policy acquisition costs.


(b)	Details of the components of annuity benefits are provided below.

~~Detail of annuity earnings before income taxes (dollars in millions):~~

Three months ended September 30,
2018 2017 % Change
Earnings before income taxes — before the impact of derivatives related to FIAs $ 119
$ 106
12 %
Impact of derivatives related to FIAs (2 ) (4 ) (50 %)
Earnings before income taxes $ 117
$ 102
15 %

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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):~~

Annuity core earnings before income taxes were $104 million in the second quarter of 2019 compared to $99 million in the second quarter of 2018, an increase of $5 million (5%). As discussed under “Results of Operations — General,” beginning with the second quarter of 2019, unlocking, changes in the fair value of derivatives related to FIAs, and other impacts of changes in the stock market and interest rates on the accounting for FIAs over or under the cost of the equity index options purchased to mitigate the risk in the index-based component of those FIAs are considered non-core earnings (losses). For the second quarter of 2019, the annuity segment’s core earnings before income taxes excludes $33 million in pretax losses related to these items. Since annuity core earnings for prior periods were not adjusted, the annuity segment’s core earnings before income taxes for the second quarter of 2018 includes the $14 million negative impact from these items in that period. Excluding the $14 million negative impact of these items on results for the second quarter of 2018, annuity core net operating earnings for the second quarter of 2019 decreased $9 million compared to the second quarter of 2018 reflecting higher FIA renewal option costs and lower earnings from investments carried at fair value through net investment income, partially offset by growth in the business. The table below highlights the impact of unlocking, changes in the fair value of derivatives and other impacts of the changes in the stock market and interest rates on annuity segment results (dollars in millions):

Three months ended September 30,
2018 2017 % Change
Interest credited — fixed $ 179
$ 160
12 %
Interest credited — fixed component of variable annuities 1
1
— %
Other annuity benefits:
Change in expected death and annuitization reserve 5
5
— %
Amortization of sales inducements 5
4
25 %
Change in guaranteed withdrawal benefit reserve 18
18
— %
Change in other benefit reserves 10
16
(38 %)
Total other annuity benefits 38
43
(12 %)
Total before impact of derivatives related to FIAs 218
204
7 %
Derivatives related to fixed-indexed annuities:
Embedded derivative mark-to-market 223
127
76 %
Equity option mark-to-market (219 ) (116 ) 89 %
Impact of derivatives related to FIAs 4
11
(64 %)
Total annuity benefits $ 222
$ 215
3 %



	Three months ended June 30,
	2019			2018			% Change
Earnings before income taxes — before the impact of unlocking, derivatives related to FIAs and other impacts of stock market performance and interest rates on FIAs	$	104		$	113		(8	%)
Unlocking	—			(27		)	(100	%)
Impact of derivatives related to FIAs and other impacts of changes in the stock market and interest rates on FIAs over or under option costs:
Change in fair value of derivatives related to FIAs	(103		)	8			(1,388	%)
Accretion of guaranteed minimum FIA benefits	(102		)	(85		)	20	%
Other annuity benefits	(8		)	(16		)	(50	%)
Less cost of equity options	146			122			20	%
Related impact on the amortization of deferred policy acquisition costs	34			(16		)	(313	%)
Earnings before income taxes	$	71		$	99		(28	%)

Annuity benefits consisted of the following (dollars in millions):



	Three months ended June 30,
	2019								2018								Total
	Core		Non-core			Total			Core			Non-core		Total			% Change
Interest credited — fixed	$	98	$	—		$	98		$	88		$	—	$	88		11	%
Accretion of guaranteed minimum FIA benefits	—		102			102			85			—		85			20	%
Interest credited — fixed component of variable annuities	1		—			1			2			—		2			(50	%)
Cost of equity options	146		(146		)	—			—			—		—			—	%
Other annuity benefits:
Change in expected death and annuitization reserve	3		—			3			4			—		4			(25	%)
Amortization of sales inducements	4		—			4			5			—		5			(20	%)
Change in guaranteed withdrawal benefit reserve:
Impact of the stock market and interest rates	—		(4		)	(4		)	—			—		—			—	%
Accretion of benefits and other	20		—			20			19			—		19			5	%
Change in other benefit reserves — impact of changes in interest rates and the stock market	—		12			12			11			—		11			9	%
Unlocking	—		—			—			54			—		54			(100	%)
Derivatives related to fixed-indexed annuities:
Embedded derivative mark-to-market	—		251			251			82			—		82			206	%
Equity option mark-to-market	—		(148		)	(148		)	(90		)	—		(90		)	64	%
Impact of derivatives related to FIAs	—		103			103			(8		)	—		(8		)	(1,388	%)

Total annuity benefits	$	272	$	67		$	339		$	260		$	—	$	260		30	%

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AMERICAN FINANCIAL GROUP, INC. 10-Q

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

Because fluctuations in interest rates and the stock market, among other factors, can cause volatility in annuity benefits expense related to FIAs that can be inconsistent with the long-term economics of the FIA business, management believes that including the actual cost of the equity options purchased in the FIA business and excluding unlocking, the impact of changes in the fair value of derivatives related to FIAs, and other impacts of changes in the stock market and interest rates on the accounting for FIAs provides investors with a better view of the true cost of funds in the business and a more comparable measure compared to the cost of funds reported by its peers. The cost of the equity options included in AFG’s cost of funds is the net purchase price of the option contracts amortized on a straight-line basis over the life of the contracts, which is generally one year. The following table reconciles AFG’s non-GAAP cost of funds measure to total annuity benefits expense (in millions):



	Three months ended June 30,
	2019			2018
Interest credited — fixed	$	98		$	88
Include cost of equity options	146			122
Cost of funds	244			210

Interest credited — fixed component of variable annuities	1			2
Other annuity benefits, excluding the impact of interest rates and the stock market on FIAs	27			23
	272			235
Unlocking, changes in fair value of derivatives related to FIAs, and other impacts of the stock market and interest rates over or under option costs:
Unlocking	—			54
Impact of derivatives related to FIAs	103			(8		)
Accretion of guaranteed minimum FIA benefits	102			85
Other annuity benefits — impact of the stock market and interest rates on FIAs	8			16
Less cost of equity options (included in cost of funds)	(146		)	(122		)
Total annuity benefits expense	$	339		$	260

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

Net Spread on Fixed Annuities (excludes variable annuity earnings)

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)~~

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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 (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 June 30,
	2018			2017			% Change		2019			2018			% Change
Average fixed annuity investments (at amortized cost)	$	34,955		$	31,713		10	%	$	37,907		$	33,935		12	%
Average fixed annuity benefits accumulated	35,226			32,029			10	%	38,202			34,165			12	%

As % of fixed annuity benefits accumulated (except as noted):
Net investment income (as % of fixed annuity investments)	4.70		%	4.70		%			4.73		%	4.83		%
Interest credited — fixed	(2.03		%)	(2.01		%)
Cost of funds									(2.55		%)	(2.46		%)
Other annuity benefit expenses, net of guaranteed withdrawal benefit fees (*)									(0.10		%)	(0.09		%)
Net interest spread	2.67		%	2.69		%			2.08		%	2.28		%

Policy charges and other miscellaneous income	0.09		%	0.10		%			0.08		%	0.10		%
Other annuity benefit expenses, net of guaranteed withdrawal benefit fees	(0.24		%)	(0.33		%)
Acquisition expenses	(0.76		%)	(0.65		%)
Acquisition expenses (*)									(0.68		%)	(0.69		%)
Other expenses	(0.36		%)	(0.36		%)			(0.37		%)	(0.35		%)
Change in fair value of derivatives related to fixed-indexed annuities	(0.05		%)	(0.14		%)
Net spread earned on fixed annuities excluding the impact of unlocking, changes in the fair value of derivatives related to FIAs, and other impacts of changes in the stock market and interest rates on FIAs									1.11		%	1.34		%
Changes in fair value of derivatives related to FIAs and other impacts of the stock market and interest rates under (over) option costs									(0.35		%)	0.16		%
Unlocking									—		%	(0.32		%)
Net spread earned on fixed annuities	1.35		%	1.31		%			0.76		%	1.18		%

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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,
2018 2017
Net spread earned on fixed annuities — before the impact of derivatives related to FIAs 1.37 % 1.36 %
Impact of derivatives related to fixed-indexed annuities:
Change in fair value of derivatives (0.05 %) (0.14 %)
Related impact on amortization of deferred policy acquisition costs (*) 0.03 % 0.09 %
Related impact on amortization of deferred sales inducements (*) — % — %
Net spread earned on fixed annuities 1.35 % 1.31 %


(*)	~~An estimate~~Excluding unlocking, the impact of changes in the fair value of derivatives related to FIAs, and other impacts of changes in the stock market and interest rates on annuity benefits and the related ~~acceleration/deceleration of~~impact (acceleration/deceleration) on the amortization of deferred policy acquisition ~~costs and deferred sales inducements.~~costs.

Annuity Net Investment Income

Net investment income for the ~~third~~second quarter of 2019 was $451 million compared to $412 million for the second quarter of 2018, ~~was $413 million compared to $375 million for the third quarter of 2017,~~ an increase of ~~$38~~$39 million ~~(10%~~(9%). 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.~~yields, including lower earnings from equity securities that are carried at fair value through net investment income. 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), ~~was 4.70%~~decreased by 0.10 percentage points to 4.73% from 4.83% in ~~both~~ the ~~third~~second quarter of ~~2018 and~~2019 compared to the ~~third~~second quarter of ~~2017.~~2018. The decrease in the net investment yield between periods reflects ~~higher earnings~~the lower yields on investments accounted for under the equity method and from ~~limited partnerships and similar investments, offset by~~equity securities carried at fair value through net investment income, as well as the impact of the reinvestment of proceeds from maturity and redemption of higher yielding investments at the lower yields available in the financial markets. ~~The high returns from limited partnerships and similar investments should not necessarily be expected to repeat in future periods.~~ For the period from ~~July~~April 1, ~~2017,~~2018, through ~~September~~June 30, ~~2018, $4.4~~2019, $6.2 billion in annuity segment investments with an average yield of ~~5.01%~~approximately 5.0% were redeemed or sold ~~while~~with the ~~investments purchased during that period (with new premium dollars~~proceeds reinvested at an approximately 0.4% lower yield.

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AMERICAN FINANCIAL GROUP, INC. 10-Q

Management’s Discussion and ~~the redemption/sale proceeds) had an average yield at purchase~~Analysis of ~~4.26%.~~Financial Condition and Results of Operations — Continued

Annuity ~~Interest Credited — Fixed~~Cost of Funds

~~Interest credited — fixed~~Cost of funds for the ~~third~~second quarter of 2019 were $244 million compared to $210 million for the second quarter of 2018, ~~was~~ ~~$179 million~~ ~~compared to~~ ~~$160 million~~ ~~for the third quarter of 2017,~~ an increase of ~~$19~~$34 million (~~12%~~ (16%). This increase reflects the impact of growth in the annuity ~~business.~~business and higher renewal option costs. The average ~~interest rate credited to policyholders,~~cost of policyholder funds, calculated as ~~interest credited~~cost of funds divided by average fixed annuity benefits accumulated, increased~~0.02~~0.09 percentage points to ~~2.03%~~2.55% in the ~~third~~second quarter of 2019 from 2.46% in the second quarter of 2018 reflecting higher renewal option costs.

The following table provides details of AFG’s interest credited and other cost of funds (in millions):



	Three months ended June 30,
	2019		2018
Cost of equity options (FIAs)	$	146	$	122
Interest credited:
Traditional fixed annuities	61		58
Fixed component of fixed-indexed annuities	23		19
Immediate annuities	6		6
Pension risk transfer products	1		—
Federal Home Loan Bank advances	7		5
Total cost of funds	$	244	$	210

Other Annuity Benefits, Net of Guaranteed Withdrawal Benefit Fees

Other annuity benefits, net of guaranteed withdrawal benefit fees excluding the impact of the stock market and interest rates, for the second quarter of 2019 were $10 million compared to $7 million for the second quarter of 2018, an increase of $3 million (43%). As a percentage of average fixed annuity benefits accumulated, these net expenses increased 0.01 percentage points to 0.10% from ~~2.01%~~0.09% in the ~~third~~second quarter of ~~2017 due~~2019 compared to ~~higher crediting~~the second quarter of 2018. 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 June 30,
	2019			2018
Other annuity benefits, excluding the impact of the stock market and interest rates on FIAs:
Amortization of sales inducements	$	4		$	5
Change in guaranteed withdrawal benefit reserve	20			19
Change in other benefit reserves	3			(1		)
Other annuity benefits	27			23
Offset guaranteed withdrawal benefit fees	(17		)	(16		)
Other annuity benefits excluding the impact of the stock market and interest rates, net	10			7
Other annuity benefits — impact of the stock market and interest rates	8			16
Other annuity benefits, net	$	18		$	23

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. In addition, 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. As shown in the table above, changes in the stock market and interest rates increased AFG’s guaranteed withdrawal benefit reserve by $8 million in the second quarter of 2019 compared to $16 million in the second quarter of 2018. This $8 million decrease (50%) was the primary cause of the $5 million overall decrease in other annuity benefits, net of guaranteed withdrawal fees in the second quarter of 2019 compared to the second quarter of 2018.

See “Annuity Unlocking” below for a discussion of the impact that the unlocking of actuarial assumptions had on ~~new business.~~annuity benefits expense in the second quarter of 2018.

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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 Interest Spread

AFG’s net interest spread decreased~~0.02~~ 0.20 percentage points to ~~2.67%~~2.08% from ~~2.69%~~2.28% in the ~~third~~second quarter of ~~2018~~2019 compared to the same period in ~~2017~~2018 due primarily to higher ~~crediting rates on new business~~renewal option costs and lower investment ~~yields, partially offset by higher earnings from limited partnerships and similar investments.~~yields. 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~~$10 million for ~~both~~ the ~~third~~second quarter of 2019 compared to $11 million for the second quarter of 2018, ~~and~~a decrease of $1 million (9%). Excluding the ~~third~~impact of a $1 million unlocking charge related to unearned revenue in the second quarter of ~~2017. Annuity~~2018, annuity policy charges and other miscellaneous income was $10 million in the second quarter of 2019 compared to $12 million in the second quarter of 2018. Excluding the impact of unlocking charges related to unearned revenue, annuity policy charges and other miscellaneous income as a percentage of average fixed annuity benefits accumulated, decreased ~~0.01~~0.02 percentage points to ~~0.09%~~0.08% from 0.10% in the ~~third~~second quarter of 2019 compared to the second quarter of 2018.

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.

Annuity Acquisition Expenses

In addition to the impact of unlocking, the following table illustrates the acceleration/deceleration of the amortization of deferred policy acquisition costs (“DPAC”) resulting from changes in the fair value of derivatives related to FIAs and other impacts of changes in the stock market and interest rates on the accounting for FIAs over or under option costs (in millions):



	Three months ended June 30,
	2019			2018
Annuity acquisition expenses before the impact of changes in the fair value of derivatives related to FIAs and other impacts of the stock market and interest rates	$	67		$	60
Unlocking	—			(28		)
Impact of changes in the fair value of derivatives and other impacts of the stock market and interest rates	(34		)	17
Annuity acquisition expenses	$	33		$	49

Annuity acquisitions expenses before unlocking and the acceleration/deceleration of the amortization resulting from changes in the fair value of derivatives related to FIAs and other impacts on changes in the stock market and interest rates on the accounting for FIAs over or under option costs were $67 million for the second quarter of 2019 compared to $60 million for the second quarter of 2018, ~~compared to~~an increase of $7 million (12%), reflecting growth in the ~~third~~annuity business.

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 the second quarter of ~~2017.~~2018. Unanticipated spread compression, decreases in the stock market, adverse mortality experience, and higher than expected lapse rates could lead to future write-offs of DPAC or the present value of future profits on business in force of companies acquired (“PVFP”).

The negative impact of lower than anticipated interest rates during the second quarter of 2019 on the fair value of derivatives and other liabilities related to FIAs resulted in a partially offsetting deceleration of the amortization of DPAC. In contrast, the positive impact of higher than anticipated interest rates during the second quarter of 2018 on the fair value of derivatives and other liabilities related to FIAs resulted in a partially offsetting acceleration 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

~~Other Annuity Benefits, Net~~The table below illustrates the impact of ~~Guaranteed Withdrawal Benefit Fees~~

Other annuity benefits, net of guaranteed withdrawal benefit fees, for the third quarter of 2018 were $22 million compared to $28 million for the third quarter of 2017, a decrease of $6 million (21%). As a percentage of average fixed annuity benefits accumulated, these net expenses decreased 0.09 percentage points to 0.24% from 0.33% in the third quarter of 2018 compared to the third quarter of 2017. In addition to interest credited to policyholders’ accountsunlocking 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,
2018 2017
Change in expected death and annuitization reserve $ 5
$ 5
Amortization of sales inducements 5
4
Change in guaranteed withdrawal benefit reserve 18
18
Change in other benefit reserves 10
16
Other annuity benefits 38
43
Offset guaranteed withdrawal benefit fees (16 ) (15 )
Other annuity benefits, net $ 22
$ 28

~~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.

~~Annuity Acquisition Expenses~~

Annuity 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 resultestimated impact of changes in the fair value of derivatives related to ~~FIAs. AFG’s amortization~~fixed-indexed annuities and other impacts of ~~DPAC and commission expenses as a percentage of average fixed annuity benefits accumulated was~~ ~~0.76%~~ ~~for the third quarter of 2018 compared to 0.65% for the third quarter of 2017 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 and interest rates on AFG’s fixed-indexed annuity business, and (ii) differences in actual experience from actuarially projected estimates and assumptions. For example, the favorable impact of strong stock market performance during the third quarter of 2018 on the fair value of derivatives related to FIAs ~~resulted in a partially offsetting acceleration 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 (excluding the impact of unlocking):~~accumulated:

Three months ended September 30,
2018 2017
Before the impact of changes in the fair value of derivatives related to FIAs on the amortization of DPAC 0.79 % 0.74 %
Impact of changes in fair value of derivatives related to FIAs on amortization of DPAC (*) (0.03 %) (0.09 %)
Annuity acquisition expenses as a % of fixed annuity benefits accumulated 0.76 % 0.65 %



	Three months ended June 30,
	2019		2018
Before unlocking, the impact of changes in the fair value of derivatives related to FIAs and other impacts of the stock market and interest rates	0.68	%	0.69	%
Unlocking	—	%	(0.33	%)
Impact of changes in fair value of derivatives and other impacts of the stock market and interest rates	(0.36	%)	0.20	%
Annuity acquisition expenses as a % of fixed annuity benefits accumulated	0.32	%	0.56	%


~~(*)~~	~~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~~$35 million for the ~~third~~second quarter of 2019 compared to $31 million for the second quarter of 2018, ~~compared to $30 million for the third quarter of 2017,~~ an increase of $2$4 million ~~(7%~~(13%). 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%~~increased 0.02 percentage points to 0.37% for ~~both~~ the ~~third~~second quarter of 2019 from 0.35% in the second quarter of 2018 ~~and~~due primarily to growth in the ~~third quarter of 2017.~~business.

~~Table of Contents~~

~~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 and Other Impacts of Changes in the Stock Market and Interest Rates on FIAs

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 net 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 embedded derivative component of AFG’s annuity benefits accumulated, see Note CD — “Fair Value Measurements” to the financial statements. Fluctuations in certain of these factors, such as changes in interest rates and the performance of the stock market, are not economic in nature for the current reporting period, but rather impact the timing of reported results.

As discussed above under “Other Annuity Benefits, Net of Guaranteed Withdrawal Benefit Fees” and “Annuity Acquisition Expenses,” the periodic accounting for DPAC and guaranteed withdrawal benefits related to FIAs is also impacted by changes in the stock market and interest rates. These impacts may be temporary in nature and not necessarily indicative of the long-term performance of the FIA business. The ~~net change~~table below highlights the impact of changes in the fair value of derivatives related to ~~fixed-indexed annuities increased annuity benefits by~~ ~~$4 million~~ inFIAs and 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 $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 sizeother impacts of the ~~embedded derivative~~stock market and interest rates ~~to rise, resulting in continued increases in interest on the embedded derivative. During the third quarter of 2018,~~(excluding the impact of ~~higher~~the 2018 unlocking charge) over or under the cost of the equity index options (discussed above) on earnings before income taxes for the annuity segment (dollars in millions):



	Three months ended June 30,
	2019			2018			% Change
Change in the fair value of derivatives related to FIAs	$	(103	)	$	8		(1,388	%)
Accretion of guaranteed minimum FIA benefits	(102		)	(85		)	20	%
Other annuity benefits	(8		)	(16		)	(50	%)
Less cost of equity options	146			122			20	%
Related impact on the amortization of DPAC	34			(16		)	(313	%)
Impact on annuity segment earnings before income taxes	$	(33	)	$	13		(354	%)

During the second quarter of 2019, the negative impact of significantly lower than anticipated interest ~~on the embedded derivative was~~rates, partially 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. As a percentage of average fixed annuity benefits accumulated, this net expense decreased 0.09 percentage points to 0.05% in the third quarter of 2018 from 0.14% in the third quarter of 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 onreduced the annuity ~~segment’s earnings before income taxes (dollars in millions):~~

Three months ended September 30,
2018 2017 % Change
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 (*) 2
7
(71 %)
Earnings before income taxes $ 117
$ 102
15 %


~~(*)~~	~~An estimate of the related acceleration/deceleration of the 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, decreased the annuity segment’s~~segments’ earnings before income taxes by $2$33 million incompared to the ~~third quarter~~$13 million favorable impact of ~~2018~~the stock market and ~~decreased the~~interest rates (excluding unlocking) on annuity ~~segment’s~~ earnings before income taxes ~~by $4 million in~~for the ~~third~~second quarter of ~~2017.~~2018, a change of $46 million (354%). In the 2018 quarter, the

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AMERICAN FINANCIAL GROUP, INC. 10-Q

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

positive impact of higher than expected interest rates and strong stock market performance was partially offset by the negative impact of higher than expected option costs. As a percentage of average fixed annuity benefits accumulated, the impact of changes in the fair value of derivatives related to FIAs and other impacts of changes in the stock market and interest rates on the accounting for FIAs over or under the cost of the equity index options purchased to mitigate the risk in the indexed-based component of those FIAs was a net expense of 0.35% in the second quarter of 2019 compared to a net expense reduction of 0.16% in the second quarter of 2018.

The following table provides analysis of the primary factors impacting the ~~change in the~~ fair value of derivatives related to ~~FIAs.~~FIAs and the other impacts of the stock market and interest rates (excluding the impact of the 2018 unlocking charge) on the accounting for FIAs over or under the cost of the equity index options discussed above. 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 volatility 12
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 %)



	Three months ended June 30,
	2019			2018			% Change
Changes in the stock market, including volatility	$	7		$	9		(22	%)
Changes in interest rates higher (lower) than expected	(38		)	12			(417	%)
Other	(2		)	(8		)	(75	%)
Impact on annuity segment earnings before income taxes	$	(33	)	$	13		(354	%)

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 and other annuity liabilities in the second quarter of 2018.

Annuity Net Spread Earned on Fixed Annuities

AFG’s net spread earned on fixed annuities ~~increased 0.04~~excluding the impact of unlocking, changes in the fair value of derivatives related to FIAs and other impacts of changes in the stock market and interest rates over or under option costs decreased 0.23 percentage points to ~~1.35% from 1.31%~~1.11% in the ~~third~~second quarter of ~~2018 compared to~~2019 from 1.34% in the ~~same period in~~ ~~2017~~second quarter of 2018 due primarily to the 0.20 percentage points decrease in AFG’s net interest spread discussed above. AFG’s overall net spread earned on fixed annuities decreased 0.42 percentage points to 0.76% in the second quarter of 2019 from 1.18% in the second quarter of 2018 due to a decrease in AFG’s net interest spread and the impact of changes in the fair value of derivatives and ~~related DPAC amortization offset~~other impacts of the stock market and interest rates on the accounting for FIAs discussed above ~~partially offset by~~and the ~~0.02 percentage points decrease in AFG’s net interest spread.~~impact of unlocking discussed below under “Annuity Unlocking.”

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~~June 30, ~~2018~~2019 and ~~2017~~2018 (in millions):


	Three months ended September 30,						Three months ended June 30,
	2018			2017			2019			2018
Beginning fixed annuity reserves	$	34,678		$	31,704		$	37,724		$	33,652
Fixed annuity premiums (receipts)	1,372			869			1,343			1,393
Surrenders, benefits and other withdrawals	(707		)	(540		)	(862		)	(706		)
Interest and other annuity benefit expenses:
Interest credited	179			160
Cost of funds							244			210
Embedded derivative mark-to-market	223			127			251			82
Change in other benefit reserves	29			34			(20		)	(8		)
Unlocking							—			55
Ending fixed annuity reserves	$	35,774		$	32,354		$	38,680		$	34,678

Reconciliation to annuity benefits accumulated per balance sheet:
Ending fixed annuity reserves (from above)	$	35,774		$	32,354		$	38,680		$	34,678
Impact of unrealized investment related gains	8			138			192			32
Fixed component of variable annuities	176			179			172			176
Annuity benefits accumulated per balance sheet	$	35,958		$	32,671		$	39,044		$	34,886

Annuity benefits accumulated includes a liability of $491 million at June 30, 2019 and $411 million at June 30, 2018 for guaranteed withdrawal benefits on annuities with features that allow the policyholder to take fixed periodic lifetime benefit payments that could exceed account value. As discussed above under “Other Annuity Benefits, Net of Guaranteed Withdrawal Benefit Fees” and “Annuity Acquisition Expenses,” the periodic accounting for DPAC and guaranteed withdrawal benefits related to FIAs is also impacted by changes in the stock market and interest rates.

Statutory Annuity Premiums

AFG’s annuity operations generated statutory premiums of $1.35 billion in the second quarter of 2019 compared to $1.40 billion in the second quarter of 2018, a decrease of $50 million (4%). The following table summarizes AFG’s annuity sales (dollars in millions):



	Three months ended June 30,
	2019		2018		% Change
Financial institutions single premium annuities — indexed	$	429	$	448	(4	%)
Financial institutions single premium annuities — fixed	313		131		139	%
Retail single premium annuities — indexed	274		378		(28	%)
Retail single premium annuities — fixed	36		22		64	%
Broker dealer single premium annuities — indexed	189		355		(47	%)
Broker dealer single premium annuities — fixed	8		4		100	%
Pension risk transfer	50		1		4,900	%
Education market — fixed and indexed annuities	44		54		(19	%)
Total fixed annuity premiums	1,343		1,393		(4	%)
Variable annuities	6		6		—	%
Total annuity premiums	$	1,349	$	1,399	(4	%)

Management attributes the 4% decrease in annuity premiums in the second quarter of 2019 compared to the second quarter of 2018 to the recent lower market interest rate environment. In response to the continued drop in market interest rates during 2019, AFG recently lowered crediting rates on several products, which has begun to slow annuity sales compared to 2018 levels.

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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~~Unlocking

AFG monitors the major actuarial assumptions underlying its annuity operations throughout the year and conducts detailed reviews (“unlocking”) of its assumptions in the fourth quarter of each year. If changes in the economic environment or actual experience would cause material revisions to future estimates, these assumptions are updated (unlocked) in an interim quarter. Due to continued higher FIA option costs (resulting primarily from higher than expected risk-free interest rates), AFG unlocked its assumptions for option costs, interest rates and policyholder lapse behavior in the second quarter of 2018. AFG continues its practice of conducting detailed reviews of its assumptions (including option costs and interest rates) in the fourth quarter each year.

The unlocking of the major actuarial assumptions underlying AFG’s annuity operations ~~generated statutory premiums of $1.38 billion~~ in the ~~third~~second quarter of 2018 ~~compared~~resulted in a net charge related to ~~$876~~its annuity business of $27 million, ~~in the third quarter of 2017, an increase of $502 million (57%). The following table summarizes~~which impacted AFG’s ~~annuity sales (dollars in~~financial statements as follows (in millions):

Three months ended September 30,
2018 2017 % Change
Financial institutions single premium annuities — indexed $ 460
$ 360
28 %
Financial institutions single premium annuities — fixed 114
82
39 %
Retail single premium annuities — indexed 354
219
62 %
Retail single premium annuities — fixed 17
18
(6 %)
Broker dealer single premium annuities — indexed 322
148
118 %
Broker dealer single premium annuities — fixed 3
1
200 %
Pension risk transfer 56
—
— %
Education market — fixed and indexed annuities 46
41
12 %
Total fixed annuity premiums 1,372
869
58 %
Variable annuities 6
7
(14 %)
Total annuity premiums $ 1,378
$ 876
57 %



	Three months ended June 30,
	2019		2018
Policy charges and other miscellaneous income:
Unearned revenue	$	—	$	(1	)
Total revenues	—		(1		)
Annuity benefits:
Fixed-indexed annuity 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	)

~~Management attributes the 57% increase in~~The net charge from unlocking annuity ~~premiums~~assumptions in the ~~third~~second quarter of 2018 ~~compared~~is due primarily to the ~~third quarter~~unfavorable impact of ~~2017~~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 ~~the introduction of new products, efforts to expand in the retail~~higher than previously anticipated reinvestment rates). Reinvestment rate assumptions are based primarily on 7-year and ~~broker dealer markets and an improving interest rate environment during the first nine months of 2018.~~10-year corporate bond yields.

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~~June 30, ~~2018~~2019 and ~~2017~~2018 (in millions):


	Three months ended September 30,						Three months ended June 30,
	2018			2017			2019			2018
Earnings on fixed annuity benefits accumulated	$	119		$	105		$	73		$	101
Earnings impact of investments in excess of fixed annuity benefits accumulated (*)	(3		)	(4		)	(3		)	(3		)
Variable annuity earnings	1			1			1			1
Earnings before income taxes	$	117		$	102		$	71		$	99


(*)	Net investment income (as a % of investments) of ~~4.70%~~4.73% and 4.83% for ~~both~~ the three months ended ~~September~~June 30, ~~2018~~2019 and ~~2017~~2018, respectively, multiplied by the difference between average fixed annuity investments (at amortized cost) and average fixed annuity benefits accumulated in each 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, 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 ~~$46~~$42 million in the ~~third~~second quarter of 2019 compared to $48 million in the second quarter of 2018, ~~compared to $67 million in the third quarter of 2017,~~ a decrease of ~~$21~~$6 million ~~(31%~~(13%). ~~AFG’s net core pretax loss outside of its property and casualty insurance and annuity operations (excluding realized gains and losses) totaled $37 million in the~~ ~~third~~ ~~quarter of 2018 compared to $39 million in the~~ ~~third~~ ~~quarter of 2017, a decrease of $2 million (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~~June 30, ~~2018~~2019 and ~~2017~~2018 (dollars in millions):


	Three months ended September 30,								Three months ended June 30,
	2018			2017			% Change		2019			2018			% Change
Revenues:
Life, accident and health net earned premiums	$	6		$	6		—	%	$	5		$	6		(17	%)
Net investment income	10			7			43	%	10			7			43	%
Other income — P&C fees	18			17			6	%	20			15			33	%
Other income	9			9			—	%	6			3			100	%
Total revenues	43			39			10	%	41			31			32	%

Costs and Expenses, excluding interest charges on borrowed money
Costs and Expenses:
Property and casualty insurance — commissions and other underwriting expenses	7			4			75	%	8			4			100	%
Life, accident and health benefits	10			6			67	%	8			11			(27	%)
Life, accident and health acquisition expenses	2			1			100	%	—			1			(100	%)
Other expense — expenses associated with P&C fees	11			13			(15	%)	12			11			9	%
Other expenses (*)	35			33			6	%
Other expenses									38			36			6	%
Costs and expenses, excluding interest charges on borrowed money	65			57			14	%	66			63			5	%
Core loss before income taxes, excluding realized gains and losses and interest charges on borrowed money	(22		)	(18		)	22	%
Loss before income taxes, excluding realized gains and losses and interest charges on borrowed money									(25		)	(32		)	(22	%)
Interest charges on borrowed money	15			21			(29	%)	17			16			6	%
Core loss before income taxes, excluding realized gains and losses	(37		)	(39		)	(5	%)
Pretax non-core special A&E charges	(9		)	(24		)	(63	%)
Pretax non-core loss on retirement of debt	—			(4		)	(100	%)
GAAP loss before income taxes, excluding realized gains and losses	$	(46	)	$	(67	)	(31	%)
Loss before income taxes, excluding realized gains and losses									$	(42	)	$	(48	)	(13	%)


~~(*)~~	~~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 $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 $5 million and related benefits and acquisition expenses of $8 million in the second quarter of 2019 compared to net earned premiums of $6 million and related benefits and acquisition expenses of $12 million in the ~~third~~second quarter of ~~2018 compared to net earned premiums of $6~~2018. The $3 million ~~and related benefits and acquisition expenses of $7 million in the~~ ~~third~~ ~~quarter of 2017. The $4 million (67%~~(27%) ~~increase~~decrease in life, accident and health benefits reflects ~~higher~~lower claims in ~~both~~ the ~~run-off long-term care and~~ run-off life insurance ~~businesses.~~business.

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 $10 million in the ~~third~~second quarter of ~~2018~~2019 compared to $7 million in the ~~third~~second quarter of ~~2017,~~2018, an 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~~second quarter of ~~2018~~2019 compared to ~~an increase~~a $1 million decrease in value ~~of less than $1 million~~ in the ~~third~~second quarter of ~~2017.~~2018.

Holding Company and Other — P&C Fees and Related Expenses

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~~AMERICAN FINANCIAL GROUP, INC. 10-Q~~

~~Management’s Discussion and Analysis of Financial 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. The increase in fee income for the second quarter of 2019 compared to the second quarter of 2018 is due primarily to higher fee income at Neon. 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 $4 million in both the ~~third~~second quarter of ~~2018~~2019 and ~~$5 million in~~ the ~~third~~second quarter of ~~2017,~~2018, 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 $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, an increase of $2 million (6%).~~

~~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~~ ~~$15 million~~ ~~in the~~ ~~third~~ ~~quarter of 2018 compared to $21 million in the~~ ~~third~~ quarter of 2017, a decrease of $6 million (29%) 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 July 1, 2018 compared to July 1, 2017 (dollars in millions):

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 2026 425
300
9-7/8% Senior Notes due June 2019 —
350
5-3/4% Senior Notes due August 2042 —
125
6-1/4% Subordinated Debentures due September 2054 150
150
6% Subordinated Debentures due November 2055 150
150
Other 3
3
Total principal amount of Holding Company Debt $ 1,318
$ 1,428

Weighted Average Interest Rate 4.6 % 6.1 %

The decrease in the weighted average interest rate for the third quarter of 2018 as compared to the third quarter of 2017 reflects the following financing transactions completed by AFG between July 1, 2017 and December 31, 2017:

~~Redeemed $125 million of 5-3/4% Senior Notes on August 25, 2017~~

~~Issued an additional $125 million of 3.50% Senior Notes on November 9, 2017~~

~~Issued an additional $240 million of 4.50% Senior Notes on November 9, 2017~~

~~Redeemed $350 million of 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 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 to increase liabilities related to the A&E exposures of AFG’s former railroad and manufacturing operations. The charges in both 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 caused it to increase its estimated future liability in the 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 in August 2017.~~

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AMERICAN FINANCIAL GROUP, INC. 10-Q

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

of Operations — Segmented Statement of Earnings.” AFG recorded a $2 million loss on the disposal of equipment in the second quarter of 2018. Excluding amounts eliminated in consolidation and the loss on the disposal of equipment, AFG recorded other income outside of its property and casualty insurance and annuity operations of $2 million in the second quarter of 2019 compared to $1 million in the second quarter of 2018.

Holding Company and Other — Other Expenses

AFG’s holding companies and other operations outside of its property and casualty insurance and annuity operations recorded other expenses of $38 million in the second quarter of 2019 compared to $36 million in the second quarter of 2018, an increase of $2 million (6%). This increase reflects higher holding company expenses related to employee benefit plans that are tied to stock market performance and slightly higher other holding company expenses in the second quarter of 2019 compared to the 2018 period, partially offset by the impact of a $5 million charge in the second quarter of 2018 to increase liabilities related to the environmental exposures of AFG’s former railroad and manufacturing operations.

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 $17 million in the second quarter of 2019 compared to $16 million in the second quarter of 2018, an increase of $1 million (6%). The following table details the principal amount of AFG’s long-term debt balances as of June 30, 2019 compared to June 30, 2018 (dollars in millions):



	June 30, 2019			June 30, 2018
Direct obligations of AFG:
4.50% Senior Notes due June 2047	$	590		$	590
3.50% Senior Notes due August 2026	425			425
6-1/4% Subordinated Debentures due September 2054	150			150
6% Subordinated Debentures due November 2055	150			150
5.875% Subordinated Debentures due March 2059	125			—
Other	3			3
Total principal amount of Holding Company Debt	$	1,443		$	1,318

Weighted Average Interest Rate	4.7		%	4.6		%

The increase in interest expense and the weighted average interest rate for the second quarter of 2019 as compared to the second quarter of 2018 reflects the issuance of $125 million of 5.875% Subordinated Debentures in March 2019.

Consolidated Realized Gains (Losses) on Securities AFG’s consolidated realized gains (losses) on securities, which are not allocated to segments, were a net ~~gain~~gains of ~~$34~~$56 million in the ~~third~~second quarter of 2019 compared to $31 million in the second quarter of 2018, ~~compared to losses~~an increase of ~~$12~~$25 million ~~in the~~ ~~third~~ ~~quarter of 2017, an improvement of $46 million (383%~~(81%). Realized gains (losses) on securities consisted of the following (in millions):


	Three months ended September 30,						Three months ended June 30,
	2018			2017			2019			2018
Realized gains (losses) before impairments:
Disposals	$	2		$	29		$	8		$	5
Change in the fair value of equity securities (*)	33			—			44			23
Change in the fair value of derivatives	(2		)	(1		)	6			(1		)
Adjustments to annuity deferred policy acquisition costs and related items	3			(2		)	—			4
	36			26			58			31
Impairment charges:
Securities	(2		)	(44		)	(3		)	—
Adjustments to annuity deferred policy acquisition costs and related items	—			6			1			—
	(2		)	(38		)	(2		)	—
Realized gains (losses) on securities	$	34		$	(12	)	$	56		$	31

(*)

As discussed inNote A — “Accounting Policies — Investments,”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~~The 2019 quarter includes a ~~$25~~$38 million net gain on securities that were still held at ~~September~~June 30, 2019 and the 2018 quarter includes a $16 million net gain on securities that were still held at June 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 for the ~~third~~ quarter of 2017 consisted of $29 million on equity securities and $15 million on fixed maturities. Approximately $14 million in impairment charges in the third quarter of 2017 related to investments in pharmaceutical companies, $10 million related to an investment in a media company and the remainder related primarily to investments in various industrial entities.

~~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, an increase of $23 million (128%). See~~ ~~Note~~L ~~— “Income Taxes~~” ~~to 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 $1 million for the~~ ~~third~~ ~~quarter of 2018 related to losses at Neon, AFG’s United Kingdom-based Lloyd’s insurer.~~

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AMERICAN FINANCIAL GROUP, INC. 10-Q

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

The $44 million net realized gain from the change in the fair value of equity securities in the second quarter of 2019 includes gains of $18 million on investments in banks and financing companies, $13 million on investments in communications companies, and $10 million on investment in asset management companies. The $23 million net realized gain from the change in the fair value of equity securities in the second quarter of 2018 includes gains of $10 million related to real estate investment trusts, $8 million on health care-related investments and losses of $7 million from investments in banks and financing companies.

Consolidated Income Taxes AFG’s consolidated provision for income taxes was $50 million for the second quarter of 2019 compared to $52 million for the second quarter of 2018, a decrease of $2 million (4%). See NoteM — “Income Taxes” to 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 $1 million for the second quarter of 2019 compared to $2 million for the second quarter of 2018. Both periods reflect losses at Neon, AFG’s United Kingdom-based Lloyd’s insurer.

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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~~SIX MONTHS ENDED ~~SEPTEMBER 30, 2018~~2019 AND ~~2017~~2018

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~~six months ended ~~September~~June 30, ~~2018~~2019 and ~~2017~~2018 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		Consol. MIEs			Holding Co., other and unallocated			Total			Non-core reclass			GAAP Total			P&C			Annuity			Consol. MIEs			Holding Co., other and unallocated			Total			Non-core reclass			GAAP Total
Nine months ended September 30, 2018
Six months ended June 30, 2019
Revenues:
Property and casualty insurance net earned premiums	$	3,595		$	—	$	—		$	—		$	3,595		$	—		$	3,595		$	2,373		$	—		$	—		$	—		$	2,373		$	—		$	2,373
Life, accident and health net earned premiums	—			—		—			18			18			—			18			—			—			—			11			11			—			11
Net investment income	323			1,219		(11		)	21			1,552			—			1,552			228			886			(16		)	24			1,122			—			1,122
Realized losses on securities	—			—		—			—			—			(28		)	(28		)
Realized gains on securities																					—			—			—			—			—			240			240
Income (loss) of MIEs:
Investment income	—			—		187			—			187			—			187			—			—			139			—			139			—			139
Gain (loss) on change in fair value of assets/liabilities	—			—		(10		)	—			(10		)	—			(10		)	—			—			(2		)	—			(2		)	—			(2		)
Other income	8			80		(12		)	70			146			—			146			5			54			(7		)	49			101			—			101
Total revenues	3,926			1,299		154			109			5,488			(28		)	5,460			2,606			940			114			84			3,744			240			3,984

Costs and Expenses:
Property and casualty insurance:
Losses and loss adjustment expenses	2,188			—		—			—			2,188			18			2,206			1,415			—			—			—			1,415			—			1,415
Commissions and other underwriting expenses	1,188			—		—			17			1,205			—			1,205			812			—			—			13			825			—			825
Annuity benefits	—			664		—			—			664			—			664			—			583			—			—			583			67			650
Life, accident and health benefits	—			—		—			32			32			—			32			—			—			—			17			17			—			17
Annuity and supplemental insurance acquisition expenses	—			199		—			4			203			—			203			—			93			—			2			95			(34		)	61
Interest charges on borrowed money	—			—		—			46			46			—			46			—			—			—			33			33			—			33
Expenses of MIEs	—			—		154			—			154			—			154			—			—			114			—			114			—			114
Other expenses	31			95		—			137			263			9			272			23			70			—			104			197			—			197
Total costs and expenses	3,407			958		154			236			4,755			27			4,782			2,250			746			114			169			3,279			33			3,312
Earnings before income taxes	519			341		—			(127		)	733			(55		)	678			356			194			—			(85		)	465			207			672
Provision for income taxes	100			65		—			(27		)	138			(12		)	126			72			39			—			(18		)	93			44			137
Net earnings, including noncontrolling interests	419			276		—			(100		)	595			(43		)	552			284			155			—			(67		)	372			163			535
Less: Net loss attributable to noncontrolling interests	(7		)	—		—			—			(7		)	—			(7		)
Less: Net earnings (losses) attributable to noncontrolling interests																					(4		)	—			—			—			(4		)	—			(4		)
Core Net Operating Earnings	426			276		—			(100		)	602									288			155			—			(67		)	376
Non-core earnings attributable to shareholders (a):
Realized losses on securities, net of tax	—			—		—			(22		)	(22		)	22			—
Special A&E charges, net of tax	(14		)	—		—			(7		)	(21		)	21			—
Realized gains on securities, net of tax																					—			—			—			190			190			(190		)	—
Annuity non-core losses, net of tax (b)																					—			(27		)	—			—			(27		)	27			—
Net Earnings Attributable to Shareholders	$	412		$	276	$	—		$	(129	)	$	559		$	—		$	559		$	288		$	128		$	—		$	123		$	539		$	—		$	539

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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		Consol. MIEs			Holding Co., other and unallocated			Total			Non-core reclass			GAAP Total			P&C			Annuity		Consol. MIEs			Holding Co., other and unallocated			Total			Non-core reclass			GAAP Total
Nine months ended September 30, 2017
Six months ended June 30, 2018
Revenues:
Property and casualty insurance net earned premiums	$	3,354		$	—	$	—		$	—		$	3,354		$	—		$	3,354		$	2,268		$	—	$	—		$	—		$	2,268		$	—		$	2,268
Life, accident and health net earned premiums	—			—		—			17			17			—			17			—			—		—			12			12			—			12
Net investment income	276			1,082		(16		)	24			1,366			—			1,366			215			806		(7		)	11			1,025			—			1,025
Realized losses on securities	—			—		—			—			—			(1		)	(1		)	—			—		—			—			—			(62		)	(62		)
Income of MIEs:
Income (loss) of MIEs:
Investment income	—			—		155			—			155			—			155			—			—		122			—			122			—			122
Gain on change in fair value of assets/liabilities	—			—		12			—			12			—			12
Gain (loss) on change in fair value of assets/liabilities																					—			—		(5		)	—			(5		)	—			(5		)
Other income	21			79		(14		)	68			154			—			154			4			53		(8		)	43			92			—			92
Total revenues	3,651			1,161		137			109			5,058			(1		)	5,057			2,487			859		102			66			3,514			(62		)	3,452

Costs and Expenses:
Property and casualty insurance:
Losses and loss adjustment expenses	2,150			—		—			—			2,150			89			2,239			1,334			—		—			—			1,334			—			1,334
Commissions and other underwriting expenses	1,046			—		—			16			1,062			—			1,062			771			—		—			10			781			—			781
Annuity benefits	—			635		—			—			635			—			635			—			442		—			—			442			—			442
Life, accident and health benefits	—			—		—			21			21			—			21			—			—		—			22			22			—			22
Annuity and supplemental insurance acquisition expenses	—			153		—			3			156			—			156			—			130		—			2			132			—			132
Interest charges on borrowed money	—			—		—			65			65			—			65			—			—		—			31			31			—			31
Expenses of MIEs	—			—		137			—			137			—			137			—			—		102			—			102			—			102
Other expenses	26			90		—			134			250			35			285			20			63		—			91			174			—			174
Total costs and expenses	3,222			878		137			239			4,476			124			4,600			2,125			635		102			156			3,018			—			3,018
Earnings before income taxes	429			283		—			(130		)	582			(125		)	457			362			224		—			(90		)	496			(62		)	434
Provision for income taxes	150			96		—			(57		)	189			(43		)	146			74			46		—			(22		)	98			(13		)	85
Net earnings, including noncontrolling interests	279			187		—			(73		)	393			(82		)	311			288			178		—			(68		)	398			(49		)	349
Less: Net earnings attributable to noncontrolling interests	2			—		—			—			2			—			2
Less: Net earnings (losses) attributable to noncontrolling interests																					(6		)	—		—			—			(6		)	—			(6		)
Core Net Operating Earnings	277			187		—			(73		)	391									294			178		—			(68		)	404
Non-core earnings attributable to shareholders (a):
Realized losses on securities, net of tax	—			—		—			(1		)	(1		)	1			—			—			—		—			(49		)	(49		)	49			—
Special A&E charges, net of tax	(58		)	—		—			(16		)	(74		)	74			—
Loss on retirement of debt, net of tax	—			—		—			(7		)	(7		)	7			—
Net Earnings Attributable to Shareholders	$	219		$	187	$	—		$	(97	)	$	309		$	—		$	309		$	294		$	178	$	—		$	(117	)	$	355		$	—		$	355


(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.

(b)

Property and Casualty Insurance Segment — Results of Operations AFG’s property and casualty insurance operations contributed ~~$501~~$356 million in ~~GAAP~~ pretax earnings in the first ~~nine~~six months of ~~2018~~2019 compared to $~~340~~362 million in the first ~~nine~~six months of ~~2017~~2018, ~~an increase~~a decrease of $~~161~~6 million ~~(47%~~ (2%). ~~Property and casualty core~~The decrease in pretax earnings ~~were $519 million~~reflects lower underwriting profit in the first ~~nine~~six months of ~~2018 compared to $429 million in the first~~ ~~nine~~ ~~months of 2017, 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~~2019 compared to the same period in ~~2017 due primarily to lower catastrophe losses and higher favorable prior year reserve development as well as~~2018, partially offset by 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~~ ~~nine~~ ~~months of 2018 compared to the first~~ ~~nine~~ months of 2017. The high 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 in the first ~~nine~~ ~~months of 2018 compared to the first~~ ~~nine~~ ~~months of 2017.~~income.

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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 details AFG’s earnings before income taxes from its property and casualty insurance operations for the ~~nine~~six months ended ~~September~~June 30, ~~2018~~2019 and ~~2017~~2018 (dollars in millions):


	Nine months ended September 30,								Six months ended June 30,
	2018			2017			% Change		2019			2018			% Change
Gross written premiums	$	5,227		$	4,931		6	%	$	3,199		$	3,123		2	%
Reinsurance premiums ceded	(1,412		)	(1,341		)	5	%	(788		)	(764		)	3	%
Net written premiums	3,815			3,590			6	%	2,411			2,359			2	%
Change in unearned premiums	(220		)	(236		)	(7	%)	(38		)	(91		)	(58	%)
Net earned premiums	3,595			3,354			7	%	2,373			2,268			5	%
Loss and loss adjustment expenses (*)	2,188			2,150			2	%
Loss and loss adjustment expenses									1,415			1,334			6	%
Commissions and other underwriting expenses	1,188			1,046			14	%	812			771			5	%
Core underwriting gain	219			158			39	%
Underwriting gain									146			163			(10	%)

Net investment income	323			276			17	%	228			215			6	%
Other income and expenses, net	(23		)	(5		)	360	%	(18		)	(16		)	13	%
Core earnings before income taxes	519			429			21	%
Pretax non-core special A&E charges	(18		)	(89		)	(80	%)
GAAP earnings before income taxes	$	501		$	340		47	%

(*) Excludes pretax non-core special A&E charges of $18 million and $89 million in the third quarter of 2018 and 2017, respectively.
Earnings before income taxes									$	356		$	362		(2	%)


Combined Ratios:
Specialty lines							Change								Change
Loss and LAE ratio	60.8		%	64.0		%	(3.2	%)	59.6		%	58.8		%	0.8	%
Underwriting expense ratio	33.0		%	31.2		%	1.8	%	34.2		%	34.0		%	0.2	%
Combined ratio	93.8		%	95.2		%	(1.4	%)	93.8		%	92.8		%	1.0	%

Aggregate — including exited lines
Loss and LAE ratio	61.4		%	66.7		%	(5.3	%)	59.7		%	58.8		%	0.9	%
Underwriting expense ratio	33.0		%	31.2		%	1.8	%	34.2		%	34.0		%	0.2	%
Combined ratio	94.4		%	97.9		%	(3.5	%)	93.9		%	92.8		%	1.1	%

Gross Written Premiums

Gross written premiums (“GWP”) for AFG’s property and casualty insurance segment were $~~5.23~~3.20 billion for the first ~~nine~~six months of ~~2018~~2019 compared to $~~4.93~~3.12 billion for the first ~~nine~~six months of ~~2017~~2018, an increase of $~~296~~76 million (6%2%). Detail of AFG’s property and casualty gross written premiums is shown below (dollars in millions):


	Nine months ended September 30,										Six months ended June 30,
	2018				2017						2019				2018
	GWP		%		GWP		%		% Change		GWP		%		GWP		%		% Change
Property and transportation	$	1,994	38	%	$	2,062	42	%	(3	%)	$	1,018	32	%	$	1,041	33	%	(2	%)
Specialty casualty	2,667		51	%	2,350		48	%	13	%	1,808		57	%	1,711		55	%	6	%
Specialty financial	566		11	%	519		10	%	9	%	373		11	%	371		12	%	1	%
	$	5,227	100	%	$	4,931	100	%	6	%	$	3,199	100	%	$	3,123	100	%	2	%

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AMERICAN FINANCIAL GROUP, INC. 10-Q

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

Reinsurance Premiums Ceded

Reinsurance premiums ceded (“Ceded”) for AFG’s property and casualty insurance segment were ~~27%~~25% of gross written premiums for ~~both~~ the first ~~nine~~six months of ~~2018~~ ~~and~~2019 compared to 24% of gross written premiums for the first ~~nine~~six months of ~~2017~~.2018, an increase of 1 percentage point. Detail of AFG’s property and casualty reinsurance premiums ceded is shown below (dollars in millions):


	Nine months ended September 30,												Six months ended June 30,
	2018					2017					Change in		2019					2018					Change in
	Ceded			% of GWP		Ceded			% of GWP		% of GWP		Ceded			% of GWP		Ceded			% of GWP		% of GWP
Property and transportation	$	(688	)	35	%	$	(721	)	35	%	—	%	$	(252	)	25	%	$	(295	)	28	%	(3	%)
Specialty casualty	(739		)	28	%	(625		)	27	%	1	%	(520		)	29	%	(478		)	28	%	1	%
Specialty financial	(106		)	19	%	(79		)	15	%	4	%	(79		)	21	%	(64		)	17	%	4	%
Other specialty	121					84							63					73
	$	(1,412	)	27	%	$	(1,341	)	27	%	—	%	$	(788	)	25	%	$	(764	)	24	%	1	%

Net Written Premiums

Net written premiums (“NWP”) for AFG’s property and casualty insurance segment were ~~$3.82~~$2.41 billion for the first ~~nine~~six months of ~~2018~~2019 compared to $~~3.59~~2.36 billion for the first ~~nine~~six months of ~~2017~~2018, an increase of $~~225~~52 million (6%2%). Detail of AFG’s property and casualty net written premiums is shown below (dollars in millions):


	Nine months ended September 30,										Six months ended June 30,
	2018				2017						2019				2018
	NWP		%		NWP		%		% Change		NWP		%		NWP		%		% Change
Property and transportation	$	1,306	34	%	$	1,341	37	%	(3	%)	$	766	32	%	$	746	32	%	3	%
Specialty casualty	1,928		51	%	1,725		48	%	12	%	1,288		53	%	1,233		52	%	4	%
Specialty financial	460		12	%	440		12	%	5	%	294		12	%	307		13	%	(4	%)
Other specialty	121		3	%	84		3	%	44	%	63		3	%	73		3	%	(14	%)
	$	3,815	100	%	$	3,590	100	%	6	%	$	2,411	100	%	$	2,359	100	%	2	%

Net Earned Premiums

Net earned premiums (“NEP”) for AFG’s property and casualty insurance segment were $~~3.60~~2.37 billion for the first ~~nine~~six months of ~~2018~~2019 compared to ~~$3.35~~$2.27 billion for the first ~~nine~~six months of ~~2017~~2018, an increase of $~~241~~105 million (7%5%). Detail of AFG’s property and casualty net earned premiums is shown below (dollars in millions):


	Nine months ended September 30,										Six months ended June 30,
	2018				2017						2019				2018
	NEP		%		NEP		%		% Change		NEP		%		NEP		%		% Change
Property and transportation	$	1,250	35	%	$	1,226	37	%	2	%	$	740	31	%	$	724	32	%	2	%
Specialty casualty	1,790		50	%	1,613		48	%	11	%	1,263		53	%	1,174		52	%	8	%
Specialty financial	457		12	%	435		13	%	5	%	297		13	%	308		13	%	(4	%)
Other specialty	98		3	%	80		2	%	23	%	73		3	%	62		3	%	18	%
	$	3,595	100	%	$	3,354	100	%	7	%	$	2,373	100	%	$	2,268	100	%	5	%

The $~~296~~76 million ~~(6%~~ (2%) increase in gross written premiums for the first ~~nine~~six months of ~~2018~~2019 compared to the first ~~nine~~six months of ~~2017~~2018 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%2% in the first ~~nine~~six months of ~~2018~~2019. Excluding the workers’ compensation business, renewal pricing increased approximately 3%5%.

Property and transportation Gross written premiums decreased$6823 million (3%2%) in the first ~~nine~~six months of ~~2018~~2019 compared to the first ~~nine~~six months of ~~2017. This decrease was largely the~~2018, due primarily to delayed acreage reporting from insureds as a result of ~~lower year-over-year~~excess moisture and late planting of corn and soybean crops. Management expects that the delayed crop premiums will be included in ~~the~~third quarter 2019 results. Excluding 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~~gross written premiums ~~in the other businesses in~~for this group for the first six months of 2019 grew by ~~6% in the first~~ ~~nine~~ ~~months of 2018~~8% when compared to the first ~~nine~~six months of ~~2017.~~2018. This growth is primarily attributable to new business opportunities in the transportation businesses. Average renewal rates increased approximately 4% for this group in the first ~~nine~~six months of ~~2018.~~2019. Reinsurance premiums ceded as a percentage of gross written premiums ~~were comparable~~decreased 3 percentage points in the first ~~nine~~six months of 2019 compared to the first six months of 2018, ~~and~~reflecting lower cessions in the ~~first~~ ~~nine~~ ~~months of 2017.~~crop insurance 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 casualty Gross written premiums increased$~~317~~97 million (~~13%~~6%) in the first ~~nine~~six months of ~~2018~~2019 compared to the first ~~nine~~six months of ~~2017~~2018 due primarily to ~~growth at Neon. Higher gross written~~the addition of premiums from ABA Insurance Services, improved pricing in the ~~general liability, executive liability and~~ excess and surplus lines, executive liability and social service businesses ~~also contributed to~~and higher premiums within Neon, resulting from the ~~year-over-year growth.~~growth of its portfolio in targeted classes of business. This growth was partially offset by lower premiums in the workers’ compensation businesses. Average renewal rates ~~decreased less than~~increased approximately 1% for this group in the first ~~nine~~six months of ~~2018.~~2019. Excluding rate decreases in the workers’ compensation businesses, renewal rates for this group increased approximately 2%6%. Reinsurance premiums ceded as a percentage of gross written premiums increased 1 percentage point for the first ~~nine~~six months of ~~2018~~2019 compared to the first ~~nine~~six months of ~~2017,~~2018, reflecting higher cessions at Neon, partially offset by lower cessions to AFG’s internal reinsurance program, which is included in Other ~~specialty and higher cessions in the workers’ compensation businesses.~~specialty.

Specialty financial Gross written premiums increased ~~$47~~$2 million ~~(9%~~(1%) in the first ~~nine~~six months of ~~2018~~2019 compared to the first ~~nine~~six months of ~~2017~~2018 due primarily to higher premiums in the fidelity, patent risk and international equipment leasing businesses, partially offset by lower premiums in the financial institutions business. Average renewal rates for this group increased approximately 5%2% in the first ~~nine~~six months of ~~2018.~~2019. Reinsurance premiums ceded as a percentage of gross written premiums increased 4 percentage points for the first ~~nine~~six months of ~~2018~~2019 compared to the first ~~nine~~six months of ~~2017,~~2018, reflecting higher cessions in the financial institutions 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.~~businesses.

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~~decreased $10 million ~~(44%~~(14%) in the first ~~nine~~six months of ~~2018~~2019 compared to the first ~~nine~~six months of ~~2017,~~2018, reflecting ~~an increase~~a decrease 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,				Six months ended June 30,						Six months ended June 30,
	2018		2017		Change		2018		2017		2019		2018		Change		2019		2018
Property and transportation
Loss and LAE ratio	69.2	%	69.1	%	0.1	%					65.4	%	63.4	%	2.0	%
Underwriting expense ratio	26.3	%	25.2	%	1.1	%					28.8	%	28.8	%	—	%
Combined ratio	95.5	%	94.3	%	1.2	%					94.2	%	92.2	%	2.0	%
Underwriting profit							$	56	$	70							$	43	$	56

Specialty casualty
Loss and LAE ratio	60.7	%	66.4	%	(5.7	%)					60.8	%	61.5	%	(0.7	%)
Underwriting expense ratio	32.6	%	30.7	%	1.9	%					32.6	%	32.5	%	0.1	%
Combined ratio	93.3	%	97.1	%	(3.8	%)					93.4	%	94.0	%	(0.6	%)
Underwriting profit							$	119	$	46							$	83	$	70

Specialty financial
Loss and LAE ratio	38.0	%	41.4	%	(3.4	%)					35.3	%	37.0	%	(1.7	%)
Underwriting expense ratio	52.0	%	49.0	%	3.0	%					53.3	%	50.9	%	2.4	%
Combined ratio	90.0	%	90.4	%	(0.4	%)					88.6	%	87.9	%	0.7	%
Underwriting profit							$	46	$	42							$	34	$	37

Total Specialty
Loss and LAE ratio	60.8	%	64.0	%	(3.2	%)					59.6	%	58.8	%	0.8	%
Underwriting expense ratio	33.0	%	31.2	%	1.8	%					34.2	%	34.0	%	0.2	%
Combined ratio	93.8	%	95.2	%	(1.4	%)					93.8	%	92.8	%	1.0	%
Underwriting profit							$	220	$	161							$	148	$	165

Aggregate — including exited lines
Loss and LAE ratio	61.4	%	66.7	%	(5.3	%)					59.7	%	58.8	%	0.9	%
Underwriting expense ratio	33.0	%	31.2	%	1.8	%					34.2	%	34.0	%	0.2	%
Combined ratio	94.4	%	97.9	%	(3.5	%)					93.9	%	92.8	%	1.1	%
Underwriting profit							$	201	$	69							$	146	$	163

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AMERICAN FINANCIAL GROUP, INC. 10-Q

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

The Specialty property and casualty insurance operations generated an underwriting profit of ~~$220~~$148 million for the first ~~nine~~six months of ~~2018~~2019 compared to ~~$161~~$165 million for the first ~~nine~~six months of ~~2017, an increase~~2018, a decrease of ~~$59~~$17 million ~~(37%~~(10%) ~~with~~. The lower underwriting profit in the ~~Specialty casualty~~first six months of 2019 reflects lower underwriting profits in the Property and transportation and Specialty financial sub-segments, ~~reporting~~partially offset by higher ~~year-over-year~~ underwriting profit ~~due primarily to significantly lower catastrophe losses and higher favorable prior year reserve development~~ in the Specialty casualty sub-segment. Overall catastrophe losses were $64 million (1.8 points on the combined ratio) for the first nine months of 2018 compared to $132 million (3.9 points) for the first nine months of 2017. In connection with catastrophe losses incurred in the first 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.

Property and transportation Underwriting profit for this group was $43 million for the first six months of 2019 compared to $56 million for the first ~~nine~~six months of 2018 ~~compared to $70 million for the first~~ ~~nine~~ ~~months of~~ ~~2017~~, a decrease of $1413 million ~~(20%~~ (23%). ~~Higher~~Lower underwriting results in the agricultural and property and inland marine businesses, and a larger year-over-year underwriting loss in the Singapore branch, were partially offset by higher underwriting profit in the ~~crop business and at National Interstate, and improved results~~transportation businesses.

Specialty casualty Underwriting profit for this group was $83 million for the first six months of 2019 compared to $70 million for the first six months of 2018, an increase of $13 million (19%). Higher underwriting profits in the ~~ocean marine operations~~targeted markets and workers’ compensation businesses were ~~more than~~partially offset by lower underwriting profits in the ~~property~~excess and ~~inland marine, aviation, trucking and equine~~surplus lines 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~~financial Underwriting profit for this group was $~~119~~34 million for the first ~~nine~~six months of ~~2018~~2019 compared to ~~$46 million~~ ~~for the first~~ ~~nine~~ ~~months of~~ ~~2017~~, ~~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 higher 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$37 million for the first ~~nine~~six months of 2018 ~~compared to catastrophe losses~~, a decrease of ~~$57~~$3 million ~~(3.5 points) and related reinstatement premiums of $2 million for the first~~ ~~nine~~ ~~months of 2017.~~

~~Specialty financial~~ ~~Underwriting profit for this group was~~ ~~$46 million~~ ~~for the first~~ ~~nine~~ ~~months of~~ ~~2018~~ ~~compared to $42 million for the first~~ ~~nine~~ ~~months of~~ ~~2017, an increase of $4 million (10%~~(8%) due primarily to lower ~~catastrophe losses~~underwriting profitability 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$12 million for the first ~~nine~~six months of ~~2018~~2019 compared to an underwriting profit of $3$2 million in the first ~~nine~~six months of ~~2017,~~2018, a ~~decrease~~change of $4$14 million ~~(133%~~(700%). This ~~decrease is due primarily to~~change reflects higher 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~~six months of ~~2018~~2019 compared to ~~earnings in~~ the first ~~nine~~six 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 1998.2018.

~~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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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 ~~61.4%~~59.7% for the first ~~nine~~six months of ~~2018~~2019 compared to ~~66.7%~~58.8% for the first ~~nine~~six months of ~~2017~~2018, ~~a decrease~~an increase of ~~5.3~~0.9 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,												Six months ended June 30,
	Amount						Ratio				Change in		Amount						Ratio				Change in
	2018			2017			2018		2017		Ratio		2019			2018			2019		2018		Ratio
Property and transportation
Current year, excluding catastrophe losses	$	881		$	844		70.5	%	68.9	%	1.6	%	$	499		$	483		67.5	%	66.7	%	0.8	%
Prior accident years development	(43		)	(36		)	(3.5	%)	(3.0	%)	(0.5	%)	(32		)	(39		)	(4.4	%)	(5.4	%)	1.0	%
Current year catastrophe losses	27			39			2.2	%	3.2	%	(1.0	%)	17			15			2.3	%	2.1	%	0.2	%
Property and transportation losses and LAE and ratio	$	865		$	847		69.2	%	69.1	%	0.1	%	$	484		$	459		65.4	%	63.4	%	2.0	%

Specialty casualty
Current year, excluding catastrophe losses	$	1,157		$	1,049		64.6	%	65.0	%	(0.4	%)	$	810		$	767		64.2	%	65.2	%	(1.0	%)
Prior accident years development	(87		)	(34		)	(4.8	%)	(2.1	%)	(2.7	%)	(44		)	(50		)	(3.5	%)	(4.2	%)	0.7	%
Current year catastrophe losses	17			57			0.9	%	3.5	%	(2.6	%)	2			6			0.1	%	0.5	%	(0.4	%)
Specialty casualty losses and LAE and ratio	$	1,087		$	1,072		60.7	%	66.4	%	(5.7	%)	$	768		$	723		60.8	%	61.5	%	(0.7	%)

Specialty financial
Current year, excluding catastrophe losses	$	175		$	167		38.2	%	38.4	%	(0.2	%)	$	115		$	119		38.8	%	38.7	%	0.1	%
Prior accident years development	(19		)	(22		)	(4.1	%)	(5.0	%)	0.9	%	(15		)	(11		)	(5.1	%)	(3.6	%)	(1.5	%)
Current year catastrophe losses	18			35			3.9	%	8.0	%	(4.1	%)	5			6			1.6	%	1.9	%	(0.3	%)
Specialty financial losses and LAE and ratio	$	174		$	180		38.0	%	41.4	%	(3.4	%)	$	105		$	114		35.3	%	37.0	%	(1.7	%)

Total Specialty
Current year, excluding catastrophe losses	$	2,274		$	2,105		63.3	%	62.7	%	0.6	%	$	1,477		$	1,405		62.3	%	62.0	%	0.3	%
Prior accident years development	(151		)	(90		)	(4.3	%)	(2.6	%)	(1.7	%)	(88		)	(102		)	(3.7	%)	(4.5	%)	0.8	%
Current year catastrophe losses	64			132			1.8	%	3.9	%	(2.1	%)	24			29			1.0	%	1.3	%	(0.3	%)
Total Specialty losses and LAE and ratio	$	2,187		$	2,147		60.8	%	64.0	%	(3.2	%)	$	1,413		$	1,332		59.6	%	58.8	%	0.8	%

Aggregate — including exited lines
Current year, excluding catastrophe losses	$	2,273		$	2,105		63.3	%	62.7	%	0.6	%	$	1,477		$	1,405		62.3	%	62.0	%	0.3	%
Prior accident years development	(131		)	2			(3.7	%)	0.1	%	(3.8	%)	(86		)	(100		)	(3.6	%)	(4.5	%)	0.9	%
Current year catastrophe losses	64			132			1.8	%	3.9	%	(2.1	%)	24			29			1.0	%	1.3	%	(0.3	%)
Aggregate losses and LAE and ratio	$	2,206		$	2,239		61.4	%	66.7	%	(5.3	%)	$	1,415		$	1,334		59.7	%	58.8	%	0.9	%

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 ~~63.3%~~62.3% for the first ~~nine~~six months of ~~2018~~2019 compared to ~~62.7%~~62.0% for the first ~~nine~~six months of ~~2017~~2018, an increase of ~~0.6~~0.3 percentage points.

Property and transportation The ~~1.6~~0.8 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 ofat the ~~aviation, property and inland marine and equine businesses~~Singapore branch in the first ~~nine~~six months of ~~2018~~2019 compared to the first ~~nine~~six months of ~~2017.~~2018.

Specialty casualty The ~~0.4~~1.0 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~~and in the ~~mix of business, partially offset by an increase in the loss~~general liability and ~~LAE ratio in the targeted markets~~professional liability businesses.

Specialty financial The loss and LAE ratio for the current year, excluding catastrophe losses is comparable ~~between periods.~~in the first six months of 2019 and the first six months of 2018.

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~~88 million in the first ~~nine~~six months of ~~2018~~2019 compared to ~~$90~~$102 million in the first ~~nine~~six months of ~~2017, an increase~~2018, a decrease of ~~$61~~$14 million ~~(68%~~(14%).

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AMERICAN FINANCIAL GROUP, INC. 10-Q

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

Property and transportation Net favorable reserve development of $4332 million in the first ~~nine~~six months of 2019 reflects lower than expected losses in the crop business and lower than expected claim frequency and severity in the transportation businesses. Net favorable reserve development of $39 million in the first six months of 2018 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.~~transportation businesses.

Specialty casualty Net favorable reserve development of ~~$36~~$44 million in the first ~~nine~~six months of ~~2017~~2019 reflects lower than ~~expected losses in the crop and equine businesses and lower than expected~~anticipated claim severity in the ~~property and inland marine and transportation~~workers’ compensation businesses, partially offset by higher than expected claim severity in the ~~ocean marine business.~~

~~Specialty casualty~~excess and surplus lines businesses and higher than expected losses at Neon. Net favorable reserve development of ~~$87~~$50 million in the first ~~nine~~six months of 2018 reflects lower than anticipated claim frequency and severity in the workers’ compensation ~~businesses, and to a lesser extent, lower than expected claim severity~~businesses.

Specialty financial Net favorable reserve development of $15 million in the ~~executive liability business. This was partially offset by higher~~first six months of 2019 reflects lower than expected claim frequency and severity in the ~~excess~~surety and ~~surplus lines. Net favorable reserve development of $34 million in the first~~ ~~nine~~ ~~months of 2017 reflects~~financial institutions businesses and 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~~ fidelity business. Net favorable reserve development of ~~$19~~$11 million in the first ~~nine~~six months of 2018 reflects lower than expected claim frequency and severity in the surety business and lower than expected claim severity in 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.~~

Other specialty In addition to the development discussed above, total Specialty prior year reserve development includes net adverse reserve development of $3 million in the first six months of 2019 compared to net favorable reserve development of $2 million in the first ~~nine~~six months of ~~2018 and~~2018. The adverse net ~~adverse~~ reserve ~~development of $2 million in the first nine months of 2017. The favorable~~ development in the first ~~nine~~six months of 2019 reflects $6 million of adverse reserve development associated with AFG’s internal reinsurance program, partially offset by the amortization of the deferred gain on the retroactive insurance transaction entered into in connection with the sale of businesses in 1998 and 2001. The net favorable reserve development in the first six months of 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.

~~Special asbestos and environmental reserve charges~~ ~~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 special A&E charges recorded in the third quarter of 2018 and 2017, respectively.~~

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 $2 million in both the first ~~nine~~six months of 2019 and the first six 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~~$24 million in the first ~~nine~~six months of 2019 resulted primarily from storms and tornadoes in multiple regions of the United States. Catastrophe losses of $29 million in the first six 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.~~

~~Table of Contents~~

~~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 property and casualty commissions and other underwriting expenses (“U/W Exp”) were ~~$1.19 billion~~$812 million in the first ~~nine~~six months of 2019 compared to $771 million for the first six months of 2018, ~~compared to $1.05 billion for the first~~ ~~nine~~ ~~months of 2017,~~ an increase of ~~$142~~$41 million ~~(14%~~(5%). AFG’s underwriting expense ratio was ~~33.0%~~34.2% for the first ~~nine~~six months of 2019 compared to 34.0% for the first six months of 2018, ~~compared to 31.2% for the first~~ ~~nine~~ ~~months of 2017,~~ an increase of ~~1.8~~0.2 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,										Six months ended June 30,
	2018				2017				Change in		2019				2018				Change in
	U/W Exp		% of NEP		U/W Exp		% of NEP		% of NEP		U/W Exp		% of NEP		U/W Exp		% of NEP		% of NEP
Property and transportation	$	329	26.3	%	$	309	25.2	%	1.1	%	$	213	28.8	%	$	209	28.8	%	—	%
Specialty casualty	584		32.6	%	495		30.7	%	1.9	%	412		32.6	%	381		32.5	%	0.1	%
Specialty financial	237		52.0	%	213		49.0	%	3.0	%	158		53.3	%	157		50.9	%	2.4	%
Other specialty	38		37.8	%	29		35.4	%	2.4	%	29		39.1	%	24		38.0	%	1.1	%
Total Specialty	$	1,188	33.0	%	$	1,046	31.2	%	1.8	%	$	812	34.2	%	$	771	34.0	%	0.2	%

Property and transportation Commissions and other underwriting expenses as a percentage of net earned premiums was 28.8 percentage points in both the first six months of 2019 and the first six months of 2018, reflecting higher profitability-based ceding commissions received from reinsurers in the crop business, offset by higher underwriting expenses and lower ancillary services fees at National Interstate in the first six months of 2019 compared to the same period in 2018.

Table of Contents

AMERICAN FINANCIAL GROUP, INC. 10-Q

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

Specialty casualty Commissions and other underwriting expenses as a percentage of net earned premiums increased ~~1.1~~0.1 percentage points in the first ~~nine~~six months of ~~2018~~2019 compared to the first ~~nine~~six months of ~~2017,~~2018, reflecting lower ~~premiums~~ceding commissions received from reinsurers in the ~~crop~~excess and surplus lines businesses, partially offset by lower underwriting expenses related to the exit of certain lines of business ~~which has a lower expense ratio than AFG’s overall Property~~at Neon and ~~transportation group and an increase in~~ the ~~expense ratio in the transportation businesses.~~impact of higher net earned premiums at Neon.

Specialty ~~casualty~~financial Commissions and other underwriting expenses as a percentage of net earned premiums increased ~~1.9~~2.4 percentage points in the first ~~nine~~six months of ~~2018~~2019 compared to the first ~~nine~~six months of ~~2017~~2018, 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~~partially offset by a lower underwriting expense ~~reduction due to hurricane losses~~ratio in the ~~period.~~fidelity business.

Property and Casualty Net Investment Income

Net investment income in AFG’s property and casualty insurance operations was $~~323~~228 million in the first ~~nine~~six months of ~~2018~~2019 compared to $~~276~~215 million in the first ~~nine~~six months of ~~2017~~2018, an increase of ~~$47~~$13 million ~~(17%~~(6%). 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,											Six months ended June 30,
	2018			2017			Change			% Change		2019			2018			Change			% Change
Net investment income	$	323		$	276		$	47		17	%	$	228		$	215		$	13		6	%

Average invested assets (at amortized cost)	$	10,405		$	9,853		$	552		6	%	$	11,084		$	10,395		$	689		7	%

Yield (net investment income as a % of average invested assets)	4.14		%	3.73		%	0.41		%			4.11		%	4.14		%	(0.03		%)

Tax equivalent yield (*)	4.32		%	4.20		%	0.12		%			4.29		%	4.32		%	(0.03		%)


(*)	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~~six months of ~~2018~~2019 as compared to the first ~~nine~~six months of ~~2017~~2018 reflects growth in the property and casualty insurance ~~segment and very strong earnings from limited partnerships and similar investments.~~segment. The property and casualty insurance segment’s overall yield on investments (net investment income as a percentage of average invested assets) was ~~4.14%~~4.11% for the first ~~nine~~six months of ~~2018~~2019 compared to ~~3.73%~~4.14% for the first ~~nine~~six months of ~~2017~~2018, ~~an increase~~a decrease of ~~0.41~~0.03 percentage points due primarily to ~~the higher earnings~~lower income from ~~limited~~ partnerships and similar investments. ~~The high returns~~AFG’s property and casualty insurance operations recorded $23 million in earnings from ~~limited~~ partnerships and similar investments ~~should not necessarily be expected~~and AFG-managed CLOs in the first six months of 2019 compared to ~~repeat~~$35 million in ~~future periods.~~the first six months of 2018, a decrease of $12 million (34%). The annualized yield earned on these investments was 7.9% in the first six months of 2019 compared to 14.3% in the prior year period.

~~Table of Contents~~

~~AMERICAN FINANCIAL GROUP, INC. 10-Q~~

~~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 ~~$23~~$18 million for the first ~~nine~~six months of ~~2018~~2019 compared to $5$16 million for the first ~~nine~~six months of ~~2017~~2018, an increase of ~~$18~~$2 million ~~(360%~~(13%). The table below details the items included in other income and expenses, net for AFG’s property and casualty insurance operations (in millions):


	Nine months ended September 30,						Six months ended June 30,
	2018			2017			2019			2018
Other income							$	5		$	4
Income from the sale of real estate	$	—		$	16
Other	8			5
Total other income	8			21
Other expenses
Amortization of intangibles	7			6			6			4
Other	24			20			17			16
Total other expense	31			26			23			20
Other income and expenses, net	$	(23	)	$	(5	)	$	(18	)	$	(16	)

~~Income from the sale of real estate includes $13 million related to the sale of a hotel property in 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 ~~$341~~$161 million in GAAP pretax earnings in the first ~~nine~~six months of ~~2018~~2019 compared to ~~$283~~$224 million in the first ~~nine~~six months of ~~2017~~2018, ~~an increase~~a decrease of ~~$58~~$63 million (~~20%~~ (28%). This decrease in AFG’s GAAP annuity segment results for the first ~~nine~~six months of ~~2018~~2019 as compared to the first ~~nine~~ months of 2017 reflect a 10% increase in average annuity investments (at amortized cost), higher earnings from limited partnerships and similar investments and the favorable impact of fair value accounting for derivatives related to fixed-indexed annuities (“FIAs”), partially offset by an unlocking charge in the first ~~nine~~six months of 2018 ~~and~~is due primarily to the unfavorable impact of significantly lower ~~investment yields due to~~than anticipated interest rates on 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.~~

~~The~~ fair value of derivatives related to FIAs ~~was favorably impacted by~~in the 2019 period compared to higher than anticipated interest rates in the ~~first~~ ~~nine~~ ~~months of~~ 2018 ~~compared to the negative impact of lower than anticipated interest rates in the first~~ ~~nine~~ ~~months of 2017. The favorable impact of interest rates between periods was~~period, partially offset by the ~~negative~~ impact of ~~higher interest on the embedded derivative (from growth~~strong stock market performance in the ~~FIA business~~2019 period and ~~higher interest rates) and higher than expected option costs~~an unlocking charge in the ~~2018 period.~~first six months of 2018. 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 ofor 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 due to continued higher FIA option costs (resulting primarily from higher than expected risk-free rates), resulting in a net charge to earnings of $27 million.

The following table details AFG’s GAAP and core earnings before income taxes from its annuity operations for the ~~nine~~six months ended ~~September~~June 30, ~~2018~~2019 and ~~2017~~2018 (dollars in millions).:


	Nine months ended September 30,						Six months ended June 30,
	2018		2017		% Change		2019			2018		% Change
Revenues:
Net investment income	$	1,219	$	1,082	13	%	$	886		$	806	10	%
Other income:
Guaranteed withdrawal benefit fees	48		43		12	%	33			32		3	%
Policy charges and other miscellaneous income	32		36		(11	%)	21			21		—	%
Total revenues	1,299		1,161		12	%	940			859		9	%

Costs and Expenses:
Annuity benefits (*)	664		635		5	%
Annuity benefits (a)(b)							583			442		32	%
Acquisition expenses(a)	199		153		30	%	93			130		(28	%)
Other expenses	95		90		6	%	70			63		11	%
Total costs and expenses	958		878		9	%	746			635		17	%
Earnings before income taxes	$	341	$	283	20	%
Core earnings before income taxes							194			224		(13	%)
Pretax non-core losses (a)							(33		)	—		—	%
GAAP earnings before income taxes							$	161		$	224	(28	%)

(a)

As discussed under “Results of Operations — General,” beginning prospectively with the second quarter of 2019, unlocking, the impact of changes in the fair value of derivatives related to FIAs, and other impacts of changes in the stock market and interest rates on the accounting for FIAs over or under the cost of the equity index options purchased to mitigate the risk in the index-based component of those FIAs are considered non-core earnings (losses). For the first six months of 2019, annuity benefits excludes $67 million in pretax losses related to these items and acquisition expenses excludes the related $34 million favorable impact on the amortization of deferred policy acquisition costs.


(b)	Details of the components of annuity benefits are provided below.

~~Detail of annuity earnings before income taxes (dollars in millions):~~

Nine months ended September 30,
2018 2017 % Change
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 14
(22 ) (164 %)
Earnings before income taxes $ 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):~~

Annuity core earnings before income taxes were $194 million in the first six months of 2019 compared to $224 million in the first six months of 2018, a decrease of $30 million (13%). As discussed under “Results of Operations — General,” beginning with the second quarter of 2019, unlocking, changes in the fair value of derivatives related to FIAs, and other impacts of changes in the stock market and interest rates on the accounting for FIAs over or under the cost of the equity index options purchased to mitigate the risk in the index-based component of those FIAs are considered non-core earnings (losses). For the first six months of 2019, the annuity segment’s GAAP earnings before income taxes includes $44 million in pretax losses related to these items (including $11 million in the first quarter). Since annuity core earnings for prior periods were not adjusted, the annuity segment’s core earnings before income taxes for the first six months of 2019 includes the $11 million negative impact from these items in the first quarter of 2019 and the first six months of 2018 includes the $1 million positive impact from these items in that period. Excluding the $11 million negative impact in the first quarter of 2019 and the $1 million positive impact of these items in the first six months of 2018, annuity core net operating earnings for the second quarter of 2019 decreased $18 million compared to the first six months of 2018 reflecting higher FIA renewal option costs, partially offset by growth in the business. The table below highlights the impact of unlocking, changes in the fair value of derivatives and other impacts of the changes in the stock market and interest rates on annuity segment results (dollars in millions):

Nine months ended September 30,
2018 2017 % Change
Interest credited — fixed $ 518
$ 469
10 %
Interest credited — fixed component of variable annuities 4
4
— %
Other annuity benefits:
Change in expected death and annuitization reserve 13
13
— %
Amortization of sales inducements 15
14
7 %
Change in guaranteed withdrawal benefit reserve 60
51
18 %
Change in other benefit reserves 29
36
(19 %)
Total other annuity benefits 117
114
3 %
Total before impact of derivatives related to FIAs and unlocking 639
587
9 %
Derivatives related to fixed-indexed annuities:
Embedded derivative mark-to-market 242
386
(37 %)
Equity option mark-to-market (271 ) (338 ) (20 %)
Impact of derivatives related to FIAs (29 ) 48
(160 %)
Unlocking 54
—
— %
Total annuity benefits $ 664
$ 635
5 %



	Six months ended June 30,
	2019			2018			% Change
Earnings before income taxes — before the impact of unlocking, derivatives related to FIAs and other impacts of stock market performance and interest rates on FIAs	$	205		$	223		(8	%)
Unlocking	—			(27		)	(100	%)
Impact of derivatives related to FIAs and other impacts of changes in the stock market and interest rates on FIAs over or under option costs:
Change in fair value of derivatives related to FIAs	(198		)	33			(700	%)
Accretion of guaranteed minimum FIA benefits	(201		)	(164		)	23	%
Other annuity benefits	—			(35		)	(100	%)
Less cost of equity options	287			233			23	%
Related impact on the amortization of deferred policy acquisition costs	68			(39		)	(274	%)
Earnings before income taxes	$	161		$	224		(28	%)

Annuity benefits consisted of the following (dollars in millions):



	Six months ended June 30,
	2019									2018								Total
	Core			Non-core			Total			Core			Non-core		Total			% Change
Interest credited — fixed	$	193		$	—		$	193		$	175		$	—	$	175		10	%
Accretion of guaranteed minimum FIA benefits	99			102			201			164			—		164			23	%
Interest credited — fixed component of variable annuities	2			—			2			3			—		3			(33	%)
Cost of equity options	146			(146		)	—			—			—		—			—	%
Other annuity benefits:
Change in expected death and annuitization reserve	8			—			8			8			—		8			—	%
Amortization of sales inducements	7			—			7			10			—		10			(30	%)
Change in guaranteed withdrawal benefit reserve:
Impact of change in the stock market and interest rates	(1		)	(4		)	(5		)	9			—		9			(156	%)
Accretion of benefits and other	39			—			39			33			—		33			18	%
Change in other benefit reserves — impact of changes in interest rates and the stock market	(5		)	12			7			19			—		19			(63	%)
Unlocking	—			—			—			54			—		54			(100	%)
Derivatives related to fixed-indexed annuities:
Embedded derivative mark-to-market	462			251			713			19			—		19			3,653	%
Equity option mark-to-market	(367		)	(148		)	(515		)	(52		)	—		(52		)	890	%
Impact of derivatives related to FIAs	95			103			198			(33		)	—		(33		)	(700	%)

Total annuity benefits	$	583		$	67		$	650		$	442		$	—	$	442		47	%

Table of Contents

AMERICAN FINANCIAL GROUP, INC. 10-Q

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



	Six months ended June 30,
	2019			2018
Interest credited — fixed	$	193		$	175
Include cost of equity options	287			233
Cost of funds	480			408

Interest credited — fixed component of variable annuities	2			3
Other annuity benefits, excluding the impact of interest rates and the stock market on FIAs	56			44
	538			455
Unlocking, changes in fair value of derivatives related to FIAs, and other impacts of the stock market and interest rates over or under option costs:
Unlocking	—			54
Impact of derivatives related to FIAs	198			(33		)
Accretion of guaranteed minimum FIA benefits	201			164
Other annuity benefits — impact of the stock market and interest rates on FIAs	—			35
Less cost of equity options (included in cost of funds)	(287		)	(233		)
Total annuity benefits expense	$	650		$	442

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

Table of Contents

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 and variable-indexed annuities):


	Nine months ended September 30,								Six months ended June 30,
	2018			2017			% Change		2019			2018			% Change
Average fixed annuity investments (at amortized cost)	$	33,964		$	30,919		10	%	$	37,449		$	33,469		12	%
Average fixed annuity benefits accumulated	34,240			31,141			10	%	37,640			33,747			12	%

As % of fixed annuity benefits accumulated (except as noted):
Net investment income (as % of fixed annuity investments)	4.76		%	4.64		%			4.71		%	4.79		%
Interest credited — fixed	(2.02		%)	(2.01		%)
Cost of funds									(2.55		%)	(2.42		%)
Other annuity benefit expenses, net of guaranteed withdrawal benefit fees (*)									(0.11		%)	(0.07		%)
Net interest spread	2.74		%	2.63		%			2.05		%	2.30		%

Policy charges and other miscellaneous income	0.10		%	0.12		%			0.08		%	0.10		%
Other annuity benefit expenses, net of guaranteed withdrawal benefit fees	(0.26		%)	(0.31		%)
Acquisition expenses	(0.86		%)	(0.63		%)
Acquisition expenses (*)									(0.66		%)	(0.69		%)
Other expenses	(0.37		%)	(0.38		%)			(0.37		%)	(0.36		%)
Change in fair value of derivatives related to fixed-indexed annuities	0.11		%	(0.20		%)
Net spread earned on fixed annuities excluding the impact of unlocking, changes in the fair value of derivatives related to FIAs, and other impacts of changes in the stock market and interest rates on FIAs									1.10		%	1.35		%
Changes in fair value of derivatives related to FIAs and other impacts of the stock market and interest rates under (over) option costs:
Included in core									(0.06		%)	0.17		%
Annuity non-core earnings (losses)									(0.18		%)	—		%
Unlocking	(0.11		%)	—		%			—		%	(0.16		%)
Net spread earned on fixed annuities	1.35		%	1.23		%			0.86		%	1.36		%

~~Table of Contents~~

~~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:~~

Nine months ended September 30,
2018 2017
Net spread earned on fixed annuities — before the impact of unlocking and derivatives related to FIAs 1.41 % 1.32 %
Unlocking (0.11 %) — %
Impact of derivatives related to fixed-indexed annuities:
Change in fair value of derivatives 0.11 % (0.20 %)
Related impact on amortization of deferred policy acquisition costs (*) (0.06 %) 0.11 %
Related impact on amortization of deferred sales inducements (*) — % — %
Net spread earned on fixed annuities 1.35 % 1.23 %


(*)	~~An estimate~~Excluding unlocking, the impact of changes in the fair value of derivatives related to FIAs, and other impacts of changes in the stock market and interest rates on annuity benefits and the related ~~acceleration/deceleration of~~impact (acceleration/deceleration) on the amortization of deferred policy acquisition ~~costs and deferred sales inducements.~~costs.

Annuity Net Investment Income

Net investment income for the first ~~nine~~six months of ~~2018~~2019 was $~~1.22 billion~~886 million compared to $~~1.08 billion~~806 million for the first ~~nine~~six months of ~~2017~~2018, an increase of $~~137~~80 million (~~13%~~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.~~yields, including lower earnings from equity securities that are carried at fair value through net investment income. 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), ~~increased~~decreased by ~~0.12~~0.08 percentage points to ~~4.76%~~4.71% from ~~4.64%~~4.79% for the first ~~nine~~six months of ~~2018~~2019 compared to the first ~~nine~~six months of ~~2017. This increase~~2018. The decrease in the net investment yield between periods reflects ~~higher earnings from limited partnerships and similar investments, partially offset by (i)~~ the ~~investment of new premium dollars at~~ lower yields on investments accounted for under the equity method and from equity securities carried at fair value through net investment income, as ~~compared to the existing investment portfolio and (ii)~~well as the impact of the reinvestment of proceeds from maturity and redemption of higher yielding investments at the lower yields available in the financial markets. ~~The high returns from limited partnerships and similar investments should not necessarily be expected to repeat in future periods.~~ For the period from ~~July~~April 1, ~~2017,~~2018, through ~~September~~June 30, ~~2018, $4.4~~2019, $6.2 billion in annuity segment investments with an average yield of ~~5.01%~~5.0% were redeemed or sold ~~while~~with the ~~investments purchased during that period (with new premium dollars and the redemption/sale proceeds) had~~proceeds reinvested at an ~~average yield at purchase of 4.26%.~~approximately 0.4% lower yield.

Annuity ~~Interest Credited — Fixed~~Cost of Funds

~~Interest credited — fixed~~Cost of funds for the first ~~nine~~six months of ~~2018 was $518~~2019 were $480 million compared to ~~$469~~$408 million for the first ~~nine~~six months of ~~2017,~~2018, an increase of ~~$49~~$72 million ~~(10%~~(18%). This increase reflects the impact of growth in the annuity ~~business.~~business and higher renewal option costs. The average ~~interest rate credited to policyholders,~~cost of policyholder funds, calculated as ~~interest credited~~cost of funds divided by average fixed annuity benefits accumulated, increased ~~0.01%~~0.13% percentage points to ~~2.02%~~2.55% from ~~2.01%~~2.42% in the first ~~nine~~six months of ~~2018~~2019 compared to the first ~~nine~~six months of ~~2017 due~~2018 reflecting higher renewal option costs.

Table of Contents

AMERICAN FINANCIAL GROUP, INC. 10-Q

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

The following table provides details of AFG’s interest credited and other cost of funds (in millions):



	Six months ended June 30,
	2019		2018
Cost of equity options (FIAs)	$	287	$	233
Interest credited:
Traditional fixed annuities	120		117
Fixed component of fixed-indexed annuities	45		37
Immediate annuities	12		12
Pension risk transfer products	2		—
Federal Home Loan Bank advances	14		9
Total cost of funds	$	480	$	408

Other Annuity Benefits, Net of Guaranteed Withdrawal Benefit Fees

Other annuity benefits, net of guaranteed withdrawal benefit fees excluding the impact of the stock market and interest rates for the first six months of 2019 were $23 million compared to ~~higher crediting~~$12 million for the first six months of 2018, an increase of $11 million (92%). As a percentage of average fixed annuity benefits accumulated, these net expenses increased 0.04 percentage points to 0.11% from 0.07% in the first six months of 2019 compared to the first six months of 2018. 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):



	Six months ended June 30,
	2019			2018
Other annuity benefits, excluding the impact of the stock market and interest rates on FIAs:
Amortization of sales inducements	$	8		$	10
Change in guaranteed withdrawal benefit reserve	39			33
Change in other benefit reserves	9			1
Other annuity benefits	56			44
Offset guaranteed withdrawal benefit fees	(33		)	(32		)
Other annuity benefits excluding the impact of the stock market and interest rates, net	23			12
Other annuity benefits — impact of the stock market and interest rates	—			35
Other annuity benefits, net	$	23		$	47

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. In addition, 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. As shown in the table above, changes in the stock market and interest rates decreased AFG’s guaranteed withdrawal benefit reserve by less than $1 million in the first six months of 2019 and increased the guaranteed withdrawal benefit reserve by $35 million in the first six months of 2018. This $35 million change was the primary cause of the $24 million overall decrease in other annuity benefits, net of guaranteed withdrawal fees in the first six months of 2019 compared to the first six months of 2018.

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

Annuity Net Interest Spread

AFG’s net interest spread ~~increased 0.11~~decreased 0.25 percentage points to ~~2.74%~~2.05% from ~~2.63%~~2.30% in the first ~~nine~~six months of ~~2018~~2019 compared to the same period in ~~2017~~2018 due primarily to higher ~~earnings from limited partnerships~~renewal option costs and ~~similar 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.

Table of Contents

AMERICAN FINANCIAL GROUP, INC. 10-Q

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

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~~$21 million for both the first six months of 2019 and for the first ~~nine~~six months of ~~2018 compared to $36 million for the first~~ ~~nine~~ ~~months of 2017, a decrease of $4 million (11%).~~2018. 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~~$21 million in 2019 compared to $22 million in 2018, ~~compared to $36 million in 2017,~~ a decrease of ~~$3 million (8%). The first~~ ~~nine~~ ~~months of 2017 includes~~ $1 million ~~from the sale of real estate. As a percentage of average fixed annuity benefits accumulated, excluding~~(5%). Excluding the impact of unlocking charges related to unearned revenue, annuity policy charges and other miscellaneous income as a percentage of average fixed annuity benefits accumulated decreased 0.02 percentage points to ~~0.10%~~0.08% from ~~0.12%~~0.10% in the first ~~nine~~six months of ~~2018~~2019 compared to the first ~~nine~~six months of ~~2017.~~2018.

~~Table of Contents~~

~~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~~ ~~2018~~ ~~were~~ ~~$69 million~~ ~~compared to~~ ~~$71 million~~ ~~for the first~~ ~~nine~~ ~~months of~~ ~~2017~~, ~~a decrease~~ of ~~$2 million~~ (3%~~). As a percentage of average fixed annuity benefits accumulated, these net expenses decreased 0.05 percentage points to 0.26% from 0.31% in the first~~ ~~nine~~ ~~months of 2018 compared to the first~~ ~~nine~~ months of 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,
2018 2017
Change in expected death and annuitization reserve $ 13
$ 13
Amortization of sales inducements 15
14
Change in guaranteed withdrawal benefit reserve 60
51
Change in other benefit reserves 29
36
Other annuity benefits 117
114
Offset guaranteed withdrawal benefit fees (48 ) (43 )
Other annuity benefits, net $ 69
$ 71

~~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~~In addition to the ~~first~~ ~~nine~~ ~~months~~impact of ~~2017, reflecting growth in~~unlocking, the ~~business and~~following table illustrates the ~~acceleration (in 2018) and~~ acceleration/deceleration ~~(in 2017)~~ of ~~DPAC~~the amortization ~~related to~~of

deferred policy acquisition costs (“DPAC”) resulting from changes in the fair value of derivatives related to ~~FIAs. Excluding the impact~~FIAs and other

impacts 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~~ ~~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~~on the ~~first~~ ~~nine~~ ~~months~~accounting for FIAs over or under option costs (in millions):



	Six months ended June 30,
	2019			2018
Annuity acquisition expenses before the impact of changes in the fair value of derivatives related to FIAs and other impacts of the stock market and interest rates	$	127		$	118
Unlocking	—			(28		)
Impact of changes in the fair value of derivatives and other impacts of the stock market and interest rates:
Included in core	(34		)	40
Annuity non-core earnings (losses)	(34		)	—
Annuity acquisition expenses	$	59		$	130

Annuity acquisitions expenses before unlocking and the acceleration/deceleration of ~~2018 on~~ the amortization resulting from changes in

the fair value of derivatives related to FIAs ~~(discussed below) resulted~~and other impacts on changes in ~~a partially offsetting acceleration of~~ the ~~amortization of DPAC. In contrast, the negative impact of lower than anticipated~~stock market and interest rates ~~during~~on the

accounting for FIAs over or under option costs were $127 million for the first ~~nine~~six months of ~~2017 on~~2019 compared to $118 million for the ~~fair value~~first six months of ~~derivatives related to FIAs resulted~~2018, an increase of $9 million (8%), reflecting growth in ~~a partially offsetting deceleration of~~ the ~~amortization of DPAC.~~annuity business.

~~Table of Contents~~

~~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 (excluding the impact of unlocking):

Nine months ended September 30,
2018 2017
Before the impact of changes in the fair value of derivatives related to FIAs on the amortization of DPAC 0.80 % 0.74 %
Impact of changes in fair value of derivatives related to FIAs on amortization of DPAC (*) 0.06 % (0.11 %)
Annuity acquisition expenses as a % of fixed annuity benefits accumulated 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~~present value of future profits on business in force of companies acquired (“PVFP”).

The negative impact of lower than anticipated interest rates during the first six months of 2019 on the fair value of derivatives

and other liabilities related to FIAs resulted in a partially offsetting deceleration of the amortization of DPAC. In contrast, the

positive impact of higher than anticipated interest rates during the first six months of 2018 on the fair value of derivatives and

other liabilities related to FIAs resulted in a partially offsetting acceleration of the amortization of DPAC.

The table below illustrates the impact of unlocking and the estimated impact of changes in the ~~future.~~fair value of derivatives related

to fixed-indexed annuities and other impacts of changes in the stock market and interest rates on FIAs on annuity acquisition

expenses as a percentage of average fixed annuity benefits accumulated:



	Six months ended June 30,
	2019		2018
Before unlocking, the impact of changes in the fair value of derivatives related to FIAs and other impacts of the stock market and interest rates	0.66	%	0.69	%
Unlocking	—	%	(0.16	%)
Impact of changes in fair value of derivatives and other impacts of the stock market and interest rates	(0.36	%)	0.22	%
Annuity acquisition expenses as a % of fixed annuity benefits accumulated	0.30	%	0.75	%

Table of Contents

AMERICAN FINANCIAL GROUP, INC. 10-Q

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

Annuity Other Expenses

Annuity other expenses were ~~$95~~$70 million for the first ~~nine~~six months of ~~2018~~2019 compared to $9063 million for the first ~~nine~~six months of ~~2017~~2018, an increase of $57 million (6%11%). 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 ~~decreased~~increased 0.01 percentage points to 0.37% from ~~0.38%~~0.36% for the first ~~nine~~six months of ~~2018~~2019 compared to the first ~~nine~~six months of ~~2017. The decrease in annuity other expenses as a percentage of average fixed annuity benefits accumulated is~~2018 due primarily to growth in the business.

Change in Fair Value of Derivatives Related to Fixed-Indexed (Including Variable-Indexed) Annuities and Other Impacts of Changes in the Stock Market and Interest Rates on FIAs

~~Excluding~~As discussed above under “Other Annuity Benefits, Net of Guaranteed Withdrawal Benefit Fees” and “Annuity Acquisition

Expenses,” the periodic accounting for DPAC and guaranteed withdrawal benefits related to FIAs is also impacted by changes

in the stock market and interest rates. These impacts may be temporary in nature and not necessarily indicative of the long-term

performance of the FIA business. The table below highlights the impact of changes in the fair value of derivatives related to

FIAs and the other impacts of the stock market and interest rates (excluding the impact of the 2018 unlocking ~~charge,~~charge) over or under the ~~net change~~cost of the equity index options (discussed above) on earnings before income taxes for the annuity segment (dollars in ~~fair value of derivatives related to fixed-indexed annuities decreased annuity benefits by $29 million in~~millions):



	Six months ended June 30,
	2019			2018			% Change
Change in the fair value of derivatives related to FIAs	$	(198	)	$	33		(700	%)
Accretion of guaranteed minimum FIA benefits	(201		)	(164		)	23	%
Other annuity benefits	—			(35		)	(100	%)
Less cost of equity options	287			233			23	%
Related impact on the amortization of DPAC	68			(39		)	(274	%)
Impact on annuity segment earnings before income taxes	$	(44	)	$	28		(257	%)

During the first ~~nine~~six months of 2019, the negative impact of significantly lower than anticipated interest rates, partially offset by

the positive impact of strong stock market performance, reduced the annuity segments’ earnings before income taxes by

$44 million compared to the $28 million favorable impact of the stock market and interest rates (excluding unlocking) on

annuity earnings before income taxes for the first six months of 2018, ~~and increased annuity benefits by $48~~a change of $72 million in(257%). In the first ~~nine~~ ~~months of 2017. The change in the fair value of these derivatives includes $47 million in the first nine~~six 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 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 expected interest rates on the fair value of these derivatives was partially offset by the positive impact of strong stock market performance.~~ As a percentage of average fixed annuity benefits accumulated, ~~this~~the impact of changes in the fair value of derivatives related to FIAs and other impacts of changes in the stock market and interest rates on the accounting for FIAs over or under the cost of the equity index options purchased to mitigate the risk in the indexed-based component of those FIAs was a net expense ~~improved 0.31 percentage points~~of 0.24% in the first six months of 2019 compared to a net expense reduction of ~~0.11%~~0.17% in the first ~~nine~~six months of 2018.

The following table provides analysis of the primary factors impacting the fair value of derivatives related to FIAs and the other

impacts of the stock market and interest rates (excluding the impact of the 2018 ~~from a~~unlocking charge) on the accounting for FIAs

over or under the cost of the equity index options discussed above. Each factor is presented net ~~expense~~ of ~~0.20%~~the estimated related impact

on amortization of DPAC (dollars in ~~the first~~ ~~nine~~ ~~months of 2017.~~millions).

8489

Table of Contents

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,
2018 2017 % Change
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 29
(48 ) (160 %)
Related impact on amortization of DPAC (*) (15 ) 26
(158 %)
Earnings before income taxes $ 341
$ 283
20 %


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



	Six months ended June 30,
	2019			2018			% Change
Change in the stock market, including volatility	$	40		$	6		567	%
Changes in interest rates higher (lower) than expected	(83		)	39			(313	%)
Other	(1		)	(17		)	(94	%)
Impact on annuity segment earnings before income taxes	$	(44	)	$	28		(257	%)

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. 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 expected 37
(38 ) (197 %)
Change in the stock market, including volatility 16
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~~and other annuity liabilities in 2018.

Annuity Net Spread Earned on Fixed Annuities

AFG’s net spread earned on fixed annuities ~~increased 0.12~~excluding the impact of unlocking, changes in the fair value of derivatives related to

FIAs and other impacts of changes in the stock market and interest rates over or under option costs decreased 0.25 percentage

points to ~~1.35% from 1.23%~~1.10% in the first ~~nine~~six months of ~~2018~~ ~~compared to~~2019 from 1.35% in the ~~same period in~~ ~~2017~~first six months of 2018 due primarily to the 0.25 percentage

points decrease in AFG’s net interest spread discussed above. AFG’s overall net spread earned on fixed annuities decreased 0.50

percentage points to 0.86% in the first six months of 2019 from 1.36% in the first six months of 2018 due to a decrease in AFG’s net interest spread and the impact of changes in the fair value of derivatives and ~~related DPAC amortization offset~~other impacts of the stock market and interest rates on the accounting for FIAs 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.~~below under “Annuity Unlocking.”

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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 Accumulated

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~~six months ended ~~September~~June 30, ~~2018~~2019 and ~~2017~~2018 (in millions):


	Nine months ended September 30,						Six months ended June 30,
	2018			2017			2019			2018
Beginning fixed annuity reserves	$	33,005		$	29,647		$	36,431		$	33,005
Fixed annuity premiums (receipts)	3,906			3,410			2,733			2,534
Surrenders, benefits and other withdrawals	(2,040		)	(1,650		)	(1,623		)	(1,333		)
Interest and other annuity benefit expenses:
Interest credited	518			469
Cost of funds							480			408
Embedded derivative mark-to-market	242			386			713			19
Change in other benefit reserves	88			92			(54		)	(10		)
Unlocking	55			—			—			55
Ending fixed annuity reserves	$	35,774		$	32,354		$	38,680		$	34,678

Reconciliation to annuity benefits accumulated per balance sheet:
Ending fixed annuity reserves (from above)	$	35,774		$	32,354		$	38,680		$	34,678
Impact of unrealized investment gains	8			138			192			32
Fixed component of variable annuities	176			179			172			176
Annuity benefits accumulated per balance sheet	$	35,958		$	32,671		$	39,044		$	34,886

~~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~~, ~~an increase~~ of ~~$493 million~~ ~~(14%). The following table summarizes AFG’s annuity sales (dollars in millions):~~

Nine months ended September 30,
2018 2017 % Change
Financial institutions single premium annuities — indexed $ 1,321
$ 1,347
(2 %)
Financial institutions single premium annuities — fixed 350
559
(37 %)
Retail single premium annuities — indexed 1,026
751
37 %
Retail single premium annuities — fixed 60
55
9 %
Broker dealer single premium annuities — indexed 936
559
67 %
Broker dealer single premium annuities — fixed 10
6
67 %
Pension risk transfer 57
—
— %
Education market — fixed and indexed annuities 146
133
10 %
Total fixed annuity premiums 3,906
3,410
15 %
Variable annuities 19
22
(14 %)
Total annuity premiums $ 3,925
$ 3,432
14 %

~~Management attributes the 14% increase in annuity premiums in the first~~ ~~nine~~ ~~months of 2018 compared to the first~~ ~~nine~~ ~~months of 2017 to the introduction of new products, efforts to expand in the retail and broker dealer markets and an improving interest rate environment in 2018.~~

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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 $2.74 billion in the first six months of 2019 compared to $2.55 billion in the first six months of 2018, an increase of $197 million (8%). The following table summarizes AFG’s annuity sales (dollars in millions):



	Six months ended June 30,
	2019		2018		% Change
Financial institutions single premium annuities — indexed	$	853	$	861	(1	%)
Financial institutions single premium annuities — fixed	657		236		178	%
Retail single premium annuities — indexed	575		672		(14	%)
Retail single premium annuities — fixed	65		43		51	%
Broker dealer single premium annuities — indexed	416		614		(32	%)
Broker dealer single premium annuities — fixed	14		7		100	%
Pension risk transfer	60		1		5,900	%
Education market — fixed and indexed annuities	93		100		(7	%)
Total fixed annuity premiums	2,733		2,534		8	%
Variable annuities	11		13		(15	%)
Total annuity premiums	$	2,744	$	2,547	8	%

Management attributes the 8% increase in annuity premiums in the first six months of 2019 compared to the first six months of 2018 to the introduction of new products and efforts to expand in the retail and broker dealer markets. In response to the continued drop in market interest rates during 2019, AFG recently lowered crediting rates on several products, which has begun to slow annuity sales compared to 2018 levels.

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 financial statements as follows (in millions):


	Nine months ended September 30,					Six months ended June 30,
	2018			2017		2019		2018
Policy charges and other miscellaneous income:
Unearned revenue	$	(1	)	$	—	$	—	$	(1	)
Total revenues	(1		)	—		—		(1		)
Annuity benefits:
Fixed-indexed annuities embedded derivative	44			—		—		44
Sales inducements	(1		)	—		—		(1		)
Other reserves	11			—		—		11
Total annuity benefits	54			—		—		54
Annuity and supplemental insurance acquisition expenses:
Deferred policy acquisition costs	(28		)	—		—		(28		)
Total costs and expenses	26			—		—		26
Net charge	$	(27	)	$	—	$	—	$	(27	)

~~The net~~See “Annuity Unlocking” under “Annuity Segment — Results of Operations” for the quarters ended June 30, 2019 and 2018 for a discussion of the charge from the unlocking ~~annuity~~of actuarial assumptions in the second quarter of 2018 is due primarily to the 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.2018.

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 lower 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 in 2017, 2016 and 2015 were lower than the long-term default rates of 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~~six months ended ~~September~~June 30, ~~2018~~2019 and ~~2017~~2018 (in millions):


	Nine months ended September 30,						Six months ended June 30,
	2018			2017			2019			2018
Earnings on fixed annuity benefits accumulated	$	348		$	288		$	162		$	229
Earnings impact of investments in excess of fixed annuity benefits accumulated (*)	(10		)	(8		)	(4		)	(7		)
Variable annuity earnings	3			3			3			2
Earnings before income taxes	$	341		$	283		$	161		$	224


(*)	Net investment income (as a % of investments) of ~~4.76%~~4.71% and ~~4.64%~~4.79% for the ~~nine~~six months ended ~~September~~June 30, ~~2018~~2019 and ~~2017,~~2018, respectively, multiplied by the difference between average fixed annuity investments (at amortized cost) and average fixed annuity benefits accumulated in each period.

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 ~~$136~~$85 million in the first ~~nine~~six months of ~~2018~~2019 compared to ~~$165~~$90 million in the first ~~nine~~six months of ~~2017,~~2018, a decrease of ~~$29~~$5 million ~~(18%~~(6%). 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~~ loss before income taxes from operations outside of its property and casualty insurance and annuity operations for the ~~nine~~six months ended ~~September~~June 30, ~~2018~~2019 and ~~2017~~2018 (dollars in millions):


	Nine months ended September 30,								Six months ended June 30,
	2018			2017			% Change		2019			2018			% Change
Revenues:
Life, accident and health net earned premiums	$	18		$	17		6	%	$	11		$	12		(8	%)
Net investment income	21			24			(13	%)	24			11			118	%
Other income — P&C fees	50			46			9	%	35			32			9	%
Other income	20			22			(9	%)	14			11			27	%
Total revenues	109			109			—	%	84			66			27	%

Costs and Expenses, excluding interest charges on borrowed money:
Costs and Expenses:
Property and casualty insurance — commissions and other underwriting expenses	17			16			6	%	13			10			30	%
Life, accident and health benefits	32			21			52	%	17			22			(23	%)
Life, accident and health acquisition expenses	4			3			33	%	2			2			—	%
Other expense — expenses associated with P&C fees	33			30			10	%	22			22			—	%
Other expenses (*)	104			104			—	%
Other expenses									82			69			19	%
Costs and expenses, excluding interest charges on borrowed money	190			174			9	%	136			125			9	%
Core loss before income taxes, excluding realized gains and losses and interest charges on borrowed money	(81		)	(65		)	25	%
Loss before income taxes, excluding realized gains and losses and interest charges on borrowed money									(52		)	(59		)	(12	%)
Interest charges on borrowed money	46			65			(29	%)	33			31			6	%
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	%)
Loss before income taxes, excluding realized gains and losses									$	(85	)	$	(90	)	(6	%)


~~(*)~~	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.

~~Table of Contents~~

~~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 Health Premiums, Benefits and Acquisition Expenses

AFG’s run-off long-term care and life insurance operations recorded net earned premiums of ~~$18~~$11 million and related benefits and acquisition expenses of ~~$36~~$19 million in the first ~~nine~~six months of ~~2018~~2019 compared to net earned premiums of ~~$17~~$12 million and related benefits and acquisition expenses of $24 million in the first ~~nine~~six months of ~~2017.~~2018. The ~~$11~~$5 million ~~(52%~~(23%) ~~increase~~decrease in life, accident and health benefits reflects ~~higher~~lower claims in ~~both~~ the ~~run-off long-term care and~~ run-off life insurance ~~businesses.~~business.

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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 — Net Investment Income

AFG recorded net investment income on investments held outside of its property and casualty insurance and annuity operations of ~~$21~~$24 million in the first ~~nine~~six months of ~~2018~~2019 compared to $2411 million in the first ~~nine~~six months of ~~2017~~2018, ~~a decrease~~an increase of $3$13 million ~~(13%~~(118%). 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$9 million in the first ~~nine~~six months of ~~2018~~2019 compared to ~~an increase~~a decrease in value by $4$2 million in the first ~~nine~~six months of ~~2017.~~2018.

Holding Company and Other — P&C Fees and Related Expenses

Summit, a workers’ compensation insurance 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~~six months of ~~2018,~~2019, AFG collected ~~$50~~$35 million in fees for these services compared to ~~$46~~$32 million in the first ~~nine~~six months of ~~2017.~~2018. Management views this fee income, net of the ~~$33~~$22 million in both the first ~~nine~~six months of 2019 and the first six months of 2018, ~~and $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. The increase in fee income for the first six months of 2019 compared to the first six months of 2018 is due primarily to higher fee income at Neon. 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 ~~$12~~$7 million and ~~$14~~$8 million in the first ~~nine~~six months of ~~2018~~2019 and ~~2017~~2018, 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 $8$7 million in ~~both~~ the first ~~nine~~six months of ~~2018 and~~2019 compared to $3 million the first ~~nine~~six months of ~~2017.~~2018.

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~~$82 million in ~~both~~ the first ~~nine~~six months of 2019 compared to $69 million the first six months of 2018, ~~and~~an increase of $13 million (19%). This increase reflects a $3 million charitable donation in the first ~~nine~~six months of ~~2017. The impact of lower~~2019 and higher holding company expenses related to employee benefit plans that are tied to stock market performance in the first ~~nine~~six months of ~~2018~~2019 compared to the first ~~nine~~six months of ~~2017 was~~2018, partially offset by a $5 million charge to increase liabilities related to the environmental exposures of AFG’s former railroad and manufacturing operations in the ~~second quarter~~first six months of 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 $4633 million in the first ~~nine~~six months of ~~2018~~2019 compared to $6531 million in the first ~~nine~~six months of ~~2017~~2018, ~~a decrease~~an increase of $192 million (~~29%~~6%)~~, due primarily to a lower weighted average~~.

The increase in interest ~~rate on AFG’s outstanding debt.~~

~~The decrease in the weighted average interest rate~~expense for the first ~~nine~~six months of ~~2018~~2019 as compared to the first ~~nine~~six months of ~~2017~~2018 reflects the ~~following financing transactions completed by AFG between April 1, 2017 and December 31, 2017:~~

~~Issued $350 million~~issuance 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~~5.875% Subordinated Debentures on ~~August 25, 2017~~March 18, 2019.

~~Issued an additional $125 million of 3.50% Senior Notes on November 9, 2017~~

~~Issued an additional $240 million of 4.50% Senior Notes on November 9, 2017~~

~~Redeemed $350 million of 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, 2018 and 2017 for a discussion of the $9 million and $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 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 in June 2017 and $4 million related to the redemption of its $125 million outstanding 5-3/4% Senior Notes due 2042 at par value in August 2017.

Consolidated Realized Gains (Losses) on Securities AFG’s consolidated realized gains (losses) on securities, which are not allocated to segments, were net ~~losses~~gains of $28240 million in the first ~~nine~~six months of ~~2018~~2019 compared to a net loss of $162 million in the first ~~nine~~six months of ~~2017~~2018, ~~an increase~~a change of $27302 million (~~2,700%~~487%). Realized gains (losses) on securities consisted of the following (in millions):


	Nine months ended September 30,						Six months ended June 30,
	2018			2017			2019			2018
Realized gains (losses) before impairments:
Disposals	$	11		$	61		$	5		$	9
Change in the fair value of equity securities (*)	(39		)	—			226			(72		)
Change in the fair value of derivatives	(8		)	(4		)	12			(6		)
Adjustments to annuity deferred policy acquisition costs and related items	11			(5		)	1			8
	(25		)	52			244			(61		)
Impairment charges:
Securities	(3		)	(65		)	(6		)	(1		)
Adjustments to annuity deferred policy acquisition costs and related items	—			12			2			—
	(3		)	(53		)	(4		)	(1		)
Realized gains (losses) on securities	$	(28	)	$	(1	)	$	240		$	(62	)

(*)

As discussed in Note A — “Accounting Policies — Investments,” 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~~These amounts include a ~~$51~~$193 million net gain on securities that were still held at June 30, 2019 and a $71 million net loss on securities that were still held at ~~September~~June 30, 2018.

The ~~$39~~$226 million net realized ~~loss~~gain from the change in the fair value of equity securities in the first ~~nine~~six months of 2019 includes gains of $70 million on investments in banks and financing companies, $35 million from investments in media companies, $23 million on investments in asset management companies and $17 million on insurance companies. The $72 million net realized loss from the change in fair value of equity securities in the first six months of 2018 includes losses of $15 million on investments in real estate investment trusts, ~~$27~~$31 million ~~related to~~on investments in banks and financing companies and ~~$14~~$15 million on investments in media ~~companies and gains of $18 million on investments in technology~~ companies. ~~AFG’s $65 million in impairment charges for the first~~ ~~nine~~ months of 2017 consists of $49 million on equity securities and $16 million on fixed 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.

Consolidated Income Taxes AFG’s consolidated provision for income taxes was ~~$126~~$137 million for the first ~~nine~~six months of ~~2018~~2019 compared to ~~$146~~$85 million for the first ~~nine~~six months of ~~2017, a decrease~~2018, an increase of ~~$20~~$52 million ~~(14%~~(61%). See NoteLM — “Income Taxes” to 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$4 million for the first ~~nine~~six months of ~~2018~~2019 compared to ~~net earnings of $2~~$6 million for the first ~~nine~~six months of ~~2017~~2018. ~~Losses attributable to noncontrolling interests for the first nine months of 2018 are related to~~Both periods reflect losses at Neon, AFG’s United Kingdom-based Lloyd’s insurer. ~~Earnings attributable to noncontrolling interests in the first~~ ~~nine~~ ~~months of 2017 are related to the gain on the sale of a hotel property, which was owned by an 80%-owned subsidiary of Great American Insurance.~~

RECENTLY 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.

See Note A — “Accounting Policies — Investments” to the financial statements for a discussion of accounting guidance adopted on January 1, 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 ~~earnings, clarifies that~~earnings.

See Note A — “Accounting Policies — Leases” and Note K — “Leases” to the ~~need~~financial statements for a

~~Table~~ discussion of ~~Contents~~

~~AMERICAN FINANCIAL GROUP, INC. 10-Q~~

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

~~valuation allowance~~accounting guidance adopted 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.~~

~~ACCOUNTING STANDARDS TO BE ADOPTED~~

~~In February 2016, the FASB issued ASU 2016-02,~~ ~~Leases~~,January 1, 2019, 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. AFG expects to adopt the updated guidance effective January 1, 2019 (when it is required). 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. AFG does not expect the new guidance to have a material effect on its results of operations or financial position.

ACCOUNTING STANDARDS TO BE ADOPTED

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

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AMERICAN FINANCIAL GROUP, INC. 10-Q

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

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 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.~~2021. In July 2019, the FASB voted to expose a proposal to delay the effective date for public companies by one year. 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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AMERICAN FINANCIAL GROUP, INC. 10-Q

ITEM 3

Quantitative and Qualitative Disclosure about Market Risk

As of ~~September~~June 30, ~~2018~~2019, there were no material changes to the information provided in Item 7A — Quantitative and Qualitative Disclosures about Market Risk of AFG’s ~~2017~~2018 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~~second fiscal quarter of ~~2018~~2019 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.~~systems such as the new investment accounting software system implemented in the second quarter of 2019. There has been no change in AFG’s business processes and procedures during the ~~third~~second fiscal quarter of ~~2018~~2019 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~~six months of ~~2018~~2019. As of ~~September~~June 30, ~~2018,~~2019, there were ~~4,132,838~~5,000,000 remaining shares that may be repurchased under the Plans authorized by AFG’s Board of Directors in ~~December 2014~~February 2016 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.~~2019.

AFG acquired ~~2,210~~43,470 shares of its Common Stock (at an average of ~~$111.31~~$99.11 per share) in ~~August 2018 and an additional 24,310~~the first quarter of 2019, 6 shares (at $96.64 per share) in April 2019, 3,190 shares (at an average of ~~$111.96~~$97.99 per share) in ~~the first six months~~May 2019 and 323 shares (at an average of ~~2018~~$102.99 per share) in June 2019 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, 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

~~Table of Contents~~

~~AMERICAN FINANCIAL GROUP, INC. 10-Q~~

~~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
1231(a)		~~Computation of ratios of earnings to fixed charges.~~
~~31(a)~~		Certification of Co-Chief Executive Officer pursuant to section 302(a) of the Sarbanes-Oxley Act of 2002.
31(b)		Certification of Co-Chief Executive Officer pursuant to section 302(a) of the Sarbanes-Oxley Act of 2002.
31(c)		Certification of Chief Financial Officer pursuant to section 302(a) of the Sarbanes-Oxley Act of 2002.
32		Certification of Co-Chief Executive Officers and Chief Financial Officer pursuant to section 906 of the Sarbanes-Oxley Act of 2002.
~~101~~101.INS		~~The following financial information from American Financial Group’s Form 10-Q for~~XBRL Instance Document - the ~~quarter ended September 30, 2018, formatted~~instance document does not appear in the Interactive Data File because its XBRL ~~(Extensible Business Reporting Language):~~tags are embedded within the Inline XBRL document.
101.SCH		~~(i) Consolidated Balance Sheet~~Inline XBRL Taxonomy Extension Schema Document.
101.CAL		~~(ii) Consolidated Statement of Earnings~~Inline XBRL Taxonomy Extension Calculation Linkbase Document
101.DEF		~~(iii) Consolidated Statement of Comprehensive Income~~Inline XBRL Taxonomy Extension Definition Linkbase Document
101.LAB		~~(iv) Consolidated Statement of Changes in Equity~~Inline XBRL Taxonomy Extension Label Linkbase Document.
101.PRE		~~(v) Consolidated Statement of Cash Flows~~
		~~(vi) Notes to Consolidated Financial Statements~~

		Inline XBRL Taxonomy Extension Presentation Linkbase Document.

Table of Contents

AMERICAN FINANCIAL GROUP, INC. 10-Q

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~~August 8, ~~2018~~2019	By:	/s/ Joseph E. (Jeff) Consolino
		Joseph E. (Jeff) Consolino
		Executive Vice President and Chief Financial Officer

9397




	Page
Part I — Financial Information
Item 1 — Financial Statements:
Consolidated Balance Sheet	2
Consolidated Statement of Earnings	3
Consolidated Statement of Comprehensive Income	4
Consolidated Statement of Changes in Equity	5
Consolidated Statement of Cash Flows	6
~~Notes to Consolidated Financial Statements~~	7
Notes to Consolidated Financial Statements	8
Item 2 — Management’s Discussion and Analysis of Financial Condition and Results of Operations	3436
Item 3 — Quantitative and Qualitative Disclosure about Market Risk	9296
Item 4 — Controls and Procedures	9296

Part II — Other Information
Item 2 — Unregistered Sales of Equity Securities and Use of Proceeds	9296
Item 56 — ~~Other Information~~Exhibits	9296
~~Item 6 — Exhibits~~Signature	93
~~Signature~~	9397



					Fair Value in
	Actual Cost		Fair Value		excess of Cost
Common stocks	$	1,040	$	1,151	$	111
Perpetual preferred stocks	683		676		(7		)
Total equity securities carried at fair value	$	1,723	$	1,827	$	104



	Three months ended		Nine months ended
	September 30, 2018		September 30, 2018
Included in realized gains (losses)	$	25	$	(51	)
Included in net investment income	2		16
	$	27	$	(35	)



	% 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



	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



	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 2026	425			300
9-7/8% Senior Notes due June 2019	—			350
5-3/4% Senior Notes due August 2042	—			125
6-1/4% Subordinated Debentures due September 2054	150			150
6% Subordinated Debentures due November 2055	150			150
Other	3			3
Total principal amount of Holding Company Debt	$	1,318		$	1,428

Weighted Average Interest Rate	4.6		%	6.1		%



	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	%