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 
or

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

afglogo.jpg



AMERICAN FINANCIAL GROUP, INC.
Incorporated under the Laws of Ohio                                                                                 IRS Employer I.D. No. 31-1544320
Incorporated under the Laws of OhioIRS 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 ClassTrading Symbol(s)Name of Each Exchange on Which Registered
Common StockAFGNew York Stock Exchange
6-1/4% Subordinated Debentures due September 30, 2054AFGENew York Stock Exchange
6% Subordinated Debentures due November 15, 2055AFGHNew York Stock Exchange
5.875% Subordinated Debentures due March 30, 2059AFGBNew York Stock Exchange
As of NovemberAugust 1, 20182019, there were 89,253,18389,941,874 shares of the Registrant’s Common Stock outstanding, excluding 14.9 million shares owned by subsidiaries.




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AMERICAN FINANCIAL GROUP, INC. 10-Q


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


PART I
ITEM I — FINANCIAL STATEMENTS
AMERICAN FINANCIAL GROUP, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEET (UNAUDITED)
(Dollars in Millions)
September 30,
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 value103
 348
106
 105
Equity securities, at fair value1,827
 1,662
1,985
 1,814
Investments accounted for using the equity method1,289
 999
1,506
 1,374
Mortgage loans1,152
 1,125
1,073
 1,068
Policy loans176
 184
170
 174
Equity index call options759
 701
712
 184
Real estate and other investments282
 312
271
 267
Total cash and investments47,841
 46,048
52,907
 48,498
Recoverables from reinsurers3,352
 3,369
3,150
 3,349
Prepaid reinsurance premiums717
 600
651
 610
Agents’ balances and premiums receivable1,299
 1,146
1,398
 1,234
Deferred policy acquisition costs1,669
 1,216
1,203
 1,682
Assets of managed investment entities4,998
 4,902
4,781
 4,700
Other receivables1,633
 1,030
999
 1,090
Variable annuity assets (separate accounts)650
 644
616
 557
Other assets1,832
 1,504
1,785
 1,529
Goodwill199
 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 premiums2,740
 2,410
2,683
 2,595
Annuity benefits accumulated35,958
 33,316
39,044
 36,616
Life, accident and health reserves643
 658
619
 635
Payable to reinsurers932
 743
755
 752
Liabilities of managed investment entities4,807
 4,687
4,590
 4,512
Long-term debt1,302
 1,301
1,423
 1,302
Variable annuity liabilities (separate accounts)650
 644
616
 557
Other liabilities2,324
 1,887
2,300
 1,774
Total liabilities59,026
 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 surplus1,231
 1,181
1,277
 1,245
Retained earnings3,800
 3,248
3,914
 3,588
Accumulated other comprehensive income, net of tax44
 813
809
 48
Total shareholders’ equity5,164
 5,330
6,090
 4,970
Noncontrolling interests
 1

 2
Total equity5,164
 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 20172019 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 premiums6
 6
 18
 17
5
 6
 11
 12
Net investment income527
 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 income65
 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 income54
 48
 146
 154
51
 43
 101
 92
Total revenues2,008
 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 expenses872
 995
 2,206
 2,239
723
 693
 1,415
 1,334
Commissions and other underwriting expenses424
 357
 1,205
 1,062
426
 400
 825
 781
Annuity benefits222
 215
 664
 635
339
 260
 650
 442
Life, accident and health benefits10
 6
 32
 21
8
 11
 17
 22
Annuity and supplemental insurance acquisition expenses71
 55
 203
 156
33
 50
 61
 132
Interest charges on borrowed money15
 21
 46
 65
17
 16
 33
 31
Expenses of managed investment entities52
 45
 154
 137
59
 54
 114
 102
Other expenses98
 112
 272
 285
96
 89
 197
 174
Total costs and expenses1,764
 1,806
 4,782
 4,600
1,701
 1,573
 3,312
 3,018
Earnings before income taxes244
 29
 678
 457
259
 260
 672
 434
Provision for income taxes41
 18
 126
 146
50
 52
 137
 85
Net earnings, including noncontrolling interests203
 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:              
Basic89.1
 88.1
 88.9
 87.7
89.7
 89.0
 89.6
 88.8
Diluted90.7
 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)


3

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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 20172019 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 tax100
 85
 4
 625
Total comprehensive income (loss), net of tax575
 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)




4

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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, 201788,275,460
  $1,269
 $3,248
 $813
 $5,330
 $1
 $5,331
 $3
Cumulative effect of accounting change
  
 225
 (221) 4
 
 4
 
Balance at March 31, 201989,637,713
  $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 options635,364
  23
 
 
 23
 
 23
 
247,753
  11
 
 
 11
 
 11
 
Restricted stock awards200,625
  
 
 
 
 
 
 

  
 
 
 
 
 
 
Other benefit plans86,229
  10
 
 
 10
 
 10
 
30,081
  3
 
 
 3
 
 3
 
Dividend reinvestment plan21,072
  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, 201889,188,708
  $1,320
 $3,800
 $44
 $5,164
 $
 $5,164
 $
Balance at June 30, 201989,917,601
  $1,367
 $3,914
 $809
 $6,090
 $
 $6,090
 $
                                
Balance at December 31, 201686,924,399
  $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, 201888,881,213
  $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 options870,022
  29
 
 
 29
 
 29
 
157,412
  5
 
 
 5
 
 5
 
Restricted stock awards232,250
  
 
 
 
 
 
 

  
 
 
 
 
 
 
Other benefit plans85,190
  8
 
 
 8
 
 8
 
21,093
  2
 
 
 2
 
 2
 
Dividend reinvestment plan22,243
  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, 201788,092,794
  $1,255
 $3,435
 $689
 $5,379
 $
 $5,379
 $
Balance at June 30, 201889,072,114
  $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, 201889,291,724
  $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 options400,006
  17
 
 
 17
 
 17
 
Restricted stock awards232,565
  
 
 
 
 
 
 
Other benefit plans41,143
  4
 
 
 4
 
 4
 
Dividend reinvestment plan9,489
  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, 201989,917,601
  $1,367
 $3,914
 $809
 $6,090
 $
 $6,090
 $
                 
Balance at December 31, 201788,275,460
  $1,269
 $3,248
 $813
 $5,330
 $1
 $5,331
 $3
Cumulative effect of accounting change
  
 225
 (221) 4
 
 4
 
Net earnings (losses)
  
 355
 
 355
 (1) 354
 (5)
Other comprehensive loss
  
 
 (445) (445) 
 (445) 
Dividends ($2.20 per share)
  
 (196) 
 (196) 
 (196) 
Shares issued:                
Exercise of stock options531,726
  19
 
 
 19
 
 19
 
Restricted stock awards200,625
  
 
 
 
 
 
 
Other benefit plans73,676
  8
 
 
 8
 
 8
 
Dividend reinvestment plan18,006
  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, 201889,072,114
  $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 20172019 2018
Operating Activities:      
Net earnings, including noncontrolling interests$552
 $311
$535
 $349
Adjustments:      
Depreciation and amortization163
 105
72
 106
Annuity benefits664
 635
650
 442
Realized (gains) losses on investing activities28
 (18)(241) 64
Net sales of trading securities116
 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 reserves507
 1,372
(92) (268)
Payable to reinsurers189
 272
3
 (22)
Other liabilities346
 
329
 55
Managed investment entities’ assets/liabilities104
 14
(3) 138
Other operating activities, net(75) 
(43) (53)
Net cash provided by operating activities1,277
 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 maturities3,516
 4,690
2,347
 2,283
Repayments of mortgage loans87
 191
38
 68
Sales of fixed maturities275
 179
459
 203
Sales of equity securities150
 97
139
 106
Sales and settlements of equity index options and other investments688
 565
329
 446
Sales of real estate, property and equipment3
 54
2
 1
Managed investment entities:      
Purchases of investments(1,674) (2,330)(697) (1,261)
Proceeds from sales and redemptions of investments1,485
 2,343
702
 1,035
Other investing activities, net4
 6

 11
Net cash used in investing activities(3,375) (2,230)(1,052) (2,485)
      
Financing Activities:      
Annuity receipts3,925
 3,432
2,744
 2,547
Annuity surrenders, benefits and withdrawals(2,101) (1,725)(1,668) (1,372)
Net transfers from variable annuity assets35
 43
28
 21
Additional long-term borrowings
 345
121
 
Reductions of long-term debt
 (355)
Issuances of managed investment entities’ liabilities1,572
 1,926

 1,572
Retirements of managed investment entities’ liabilities(1,463) (1,998)(5) (1,461)
Issuances of Common Stock26
 30
19
 21
Cash dividends paid on Common Stock(225) (212)(205) (194)
Other financing activities, net
 (7)
Net cash provided by financing activities1,769
 1,479
1,034
 1,134
Net Change in Cash and Cash Equivalents(329) 242
859
 (528)
Cash and cash equivalents at beginning of period2,338
 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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AMERICAN FINANCIAL GROUP, INC. 10-Q
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS




INDEX TO NOTES
      
A.Accounting Policies H.I.Goodwill and Other Intangibles 
B.SegmentsAcquisition of OperationsBusiness I.J.Long-Term Debt 
C.Segments of OperationsK.Leases
D.Fair Value Measurements J.Redeemable Noncontrolling Interests
D.InvestmentsK.L.Shareholders’ Equity 
E.DerivativesInvestments L.M.Income Taxes 
F.Deferred Policy Acquisition CostsDerivatives M.N.Contingencies 
G.Deferred Policy Acquisition CostsO.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 SeptemberJune 30, 20182019, 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 significantmaterial nonrecurring fair value measurements in the first ninesix months of 20182019.


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 thethese 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 hashad 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: thirdsecond quarter of2019 and 2018 and 2017 1.61.3 million and 1.91.7 million; first ninesix 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 thirdsecond quarter or first ninesix months of 20182019 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, generalexecutive and professional liability, executive liability, professionalgeneral liability, umbrella and excess liability, specialty coveragecoverages 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 leasinglending and financingleasing institutions (including equipment leasing and collateral and lender-placed mortgage property insurance), suretyfidelity and fidelitysurety 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 marketssells 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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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 casualty634
 595
 1,263
 1,174
Specialty financial151
 159
 297
 308
Other specialty36
 33
 73
 62
Total premiums earned1,200
 1,161
 2,373
 2,268
Net investment income124
 115
 228
 215
Other income2
 2
 5
 4
Total property and casualty insurance1,326
 1,278
 2,606
 2,487
Annuity:       
Net investment income451
 412
 886
 806
Other income27
 27
 54
 53
Total annuity478
 439
 940
 859
Other100
 85
 198
 168
Total revenues before realized gains (losses)1,904
 1,802
 3,744
 3,514
Realized gains (losses) on securities56
 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 casualty616
 568
 1,790
 1,613
Specialty financial149
 142
 457
 435
Other specialty36
 30
 98
 80
Total premiums earned1,327
 1,267
 3,595
 3,354
Net investment income108
 94
 323
 276
Other income (a)4
 1
 8
 21
Total property and casualty insurance1,439
 1,362
 3,926
 3,651
Annuity:       
Net investment income413
 375
 1,219
 1,082
Other income27
 26
 80
 79
Total annuity440
 401
 1,299
 1,161
Other95
 84
 263
 246
Total revenues before realized gains (losses)1,974
 1,847
 5,488
 5,058
Realized gains (losses) on securities34
 (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 casualty47
 29
 83
 70
Specialty financial21
 22
 34
 37
Other specialty(12) (1) (12) 2
Other lines(1) (1) (2) (2)
Total underwriting59
 72
 146
 163
Investment and other income, net115
 106
 210
 199
Total property and casualty insurance174
 178
 356
 362
Annuity71
 99
 161
 224
Other (*)(42) (48) (85) (90)
Total earnings before realized gains (losses) and income taxes203
 229
 432
 496
Realized gains (losses) on securities56
 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 casualty49
 2
 119
 46
Specialty financial9
 (3) 46
 42
Other specialty(3) 4
 (1) 3
Other lines (b)(17) (90) (19) (92)
Total underwriting38
 (81) 201
 69
Investment and other income, net (a)101
 87
 300
 271
Total property and casualty insurance139
 6
 501
 340
Annuity117
 102
 341
 283
Other (c)(46) (67) (136) (165)
Total earnings before realized gains (losses) and income taxes210
 41
 706
 458
Realized gains (losses) on securities34
 (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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AMERICAN FINANCIAL GROUP, INC. 10-Q
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — CONTINUED




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




Assets and liabilities measured and carried at fair value in the financial statements are summarized below (in millions):
Level 1 Level 2 Level 3 TotalLevel 1 Level 2 Level 3 Total
September 30, 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 other29
 18,482
 1,646
 20,157
29
 21,376
 2,014
 23,419
Total AFS fixed maturities171
 37,166
 2,907
 40,244
172
 41,828
 2,710
 44,710
Trading fixed maturities9
 94
 
 103
4
 102
 
 106
Equity securities1,462
 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 other30
 17,662
 1,044
 18,736
28
 19,184
 1,996
 21,208
Total AFS fixed maturities152
 36,125
 2,102
 38,379
169
 38,664
 3,164
 41,997
Trading fixed maturities44
 304
 
 348
9
 96
 
 105
Equity securities1,411
 86
 165
 1,662
1,410
 68
 336
 1,814
Equity index call options
 701
 
 701

 184
 
 184
Assets of managed investment entities307
 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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AMERICAN FINANCIAL GROUP, INC. 10-Q
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — CONTINUED




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


During the thirdsecond quarter and first six months of 2019, there were no transfers betweenwas one preferred stock with an aggregate fair value of $6 million that transferred from Level 1 andto Level 2. During the second quarter and first ninesix 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 SeptemberJune 30, 2018,2019, were Level 3 assets. Approximately 68%55% ($2.181.71 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 valuesvalue would not be expected to have resulted in a material impact onchange 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 $3.113.54 billion at SeptemberJune 30, 20182019. 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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AMERICAN FINANCIAL GROUP, INC. 10-Q
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — CONTINUED




Changes in balances of Level 3 financial assets and liabilities carried at fair value during the thirdsecond quarter and first ninesix months of 20182019 and 20172018 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, 2018Balance 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 municipal61
 
 
 
 (1) 
 
 60
63
 
 2
 
 (1) 18
 
 82
Residential MBS147
 (2) (2) 
 (6) 13
 (5) 145
169
 4
 
 
 (4) 2
 (32) 139
Commercial MBS56
 2
 
 (1) 
 
 
 57
55
 2
 
 
 (2) 
 (5) 50
Asset-backed securities1,004
 
 (3) 13
 (23) 
 
 991
Collateralized loan obligations37
 
 
 
 
 13
 
 50
Other asset-backed securities633
 
 3
 17
 (18) 
 (268) 367
Corporate and other1,408
 
 (3) 312
 (59) 
 (12) 1,646
2,346
 
 20
 229
 (161) 2
 (422) 2,014
Total AFS fixed maturities2,684
 
 (8) 324
 (89) 13
 (17) 2,907
3,311
 6
 25
 246
 (186) 35
 (727) 2,710
Equity securities230
 (5) 
 81
 
 
 (17) 289
354
 (1) 
 19
 (1) 6
 
 377
Assets of MIE23
 (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, 2017Balance 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 municipal143
 
 
 
 (1) 10
 
 152
62
 
 (1) 
 
 
 
 61
Residential MBS153
 2
 1
 
 (6) 15
 (21) 144
115
 (3) 
 
 (5) 50
 (10) 147
Commercial MBS45
 1
 
 
 (10) 
 
 36
47
 
 
 9
 
 
 
 56
Asset-backed securities498
 (2) 1
 13
 (26) 163
 (111) 536
Collateralized loan obligations181
 
 (4) 35
 
 
 
 212
Other asset-backed securities731
 
 (2) 101
 (20) 
 (18) 792
Corporate and other953
 (9) 
 172
 (59) 
 (7) 1,050
1,238
 1
 (4) 234
 (48) 
 (13) 1,408
Total AFS fixed maturities1,800
 (8) 2
 185
 (102) 188
 (139) 1,926
2,382
 (2) (11) 379
 (73) 50
 (41) 2,684
Equity securities168
 (3) (4) 2
 
 
 
 163
194
 19
 
 16
 
 1
 
 230
Assets of MIE23
 (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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AMERICAN FINANCIAL GROUP, INC. 10-Q
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — CONTINUED




  
Total realized/unrealized
gains (losses) included in
            
Total realized/unrealized
gains (losses) included in
          
Balance at December 31, 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, 2018Balance 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 municipal148
 
 (2) 
 (2) 
 (84) 60
59
 
 7
 
 (2) 18
 
 82
Residential MBS122
 (9) (2) 
 (17) 70
 (19) 145
197
 9
 (5) 
 (10) 2
 (54) 139
Commercial MBS36
 1
 
 20
 
 
 
 57
56
 2
 
 
 (3) 
 (5) 50
Asset-backed securities744
 (2) (6) 353
 (80) 
 (18) 991
Collateralized loan obligations116
 (3) 6
 
 
 13
 (82) 50
Other asset-backed securities731
 
 5
 92
 (132) 
 (329) 367
Corporate and other1,044
 2
 (21) 784
 (138) 
 (25) 1,646
1,996
 2
 51
 661
 (249) 2
 (449) 2,014
Total AFS fixed maturities2,102
 (8) (31) 1,157
 (237) 70
 (146) 2,907
3,164
 10
 64
 753
 (397) 35
 (919) 2,710
Equity securities165
 9
 
 106
 (4) 30
 (17) 289
336
 
 
 20
 (1) 22
 
 377
Assets of MIE23
 (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 municipal148
 
 (2) 
 (1) 
 (84) 61
Residential MBS122
 (7) 
 
 (11) 57
 (14) 147
Commercial MBS36
 (1) 
 21
 
 
 
 56
Collateralized loan obligations180
 (2) (1) 35
 
 
 
 212
Other asset-backed securities564
 
 (2) 305
 (57) 
 (18) 792
Corporate and other1,044
 2
 (18) 472
 (79) 
 (13) 1,408
Total AFS fixed maturities2,102

(8) (23) 833
 (148) 57
 (129) 2,684
Equity securities165
 14
 
 25
 (4) 30
 
 230
Assets of MIE23
 (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 municipal140
 
 4
 
 (2) 10
 
 152
Residential MBS190
 
 3
 1
 (37) 35
 (48) 144
Commercial MBS25
 2
 
 15
 (10) 4
 
 36
Asset-backed securities484
 (2) 3
 117
 (62) 199
 (203) 536
Corporate and other712
 (4) 8
 460
 (124) 29
 (31) 1,050
Total AFS fixed maturities1,559
 (4) 18
 593
 (235) 277
 (282) 1,926
Equity securities174
 (19) 9
 22
 (3) 
 (20) 163
Assets of MIE29
 (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 ninesix 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 ValueCarrying Fair Value
Value Total Level 1 Level 2 Level 3Value 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 loans1,152
 1,130
 
 
 1,130
1,073
 1,080
 
 
 1,080
Policy loans176
 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 debt1,302
 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 loans1,125
 1,119
 
 
 1,119
1,068
 1,056
 
 
 1,056
Policy loans184
 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 debt1,301
 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 SeptemberJune 30, 20182019 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.




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




D.    E.    Investments


Available for sale fixed maturities at SeptemberJune 30, 20182019 and December 31, 20172018, 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
Gains Losses Gains Losses
Fixed maturities:                   
U.S. Government and government agencies$226
 $4
 $(2) $2
 $228
 $235
 $1
 $(3) $(2) $233
States, municipalities and political subdivisions6,628
 374
 (6) 368
 6,996
 6,825
 169
 (55) 114
 6,939
Foreign government146
 3
 
 3
 149
 140
 2
 
 2
 142
Residential MBS2,368
 303
 (4) 299
 2,667
 2,476
 277
 (9) 268
 2,744
Commercial MBS938
 36
 
 36
 974
 905
 17
 (2) 15
 920
Collateralized loan obligations4,359
 10
 (36) (26) 4,333
 4,350
 1
 (73) (72) 4,278
Other asset-backed securities5,749
 205
 (10) 195
 5,944
 5,431
 129
 (27) 102
 5,533
Corporate and other22,494
 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 subdivisions6,756
 117
 (98) 19
 6,775
 6,887
 254
 (18) 236
 7,123
Foreign government137
 2
 
 2
 139
 124
 3
 
 3
 127
Residential MBS2,408
 310
 (9) 301
 2,709
 2,884
 349
 (6) 343
 3,227
Commercial MBS913
 14
 (4) 10
 923
 927
 36
 (1) 35
 962
Asset-backed securities9,249
 122
 (64) 58
 9,307
 7,836
 142
 (16) 126
 7,962
Corporate and other20,352
 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 SeptemberJune 30, 20182019 and December 31, 20172018 were $144$130 million and $158$140 million, respectively. Gross unrealized gains on such securities at SeptemberJune 30, 20182019 and December 31, 20172018 were $130$120 million and $137$119 million, respectively. Gross unrealized losses on such securities at both SeptemberJune 30, 20182019 and December 31, 20172018 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 beare reported at fair value with holding gains and losses recognized in net earnings. Equity securities reported at fair valueearnings, consisted of the following at SeptemberJune 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   
  Fair Value   Fair Value 
Common stocks$1,163
 $1,251
 $88
 $1,241
 $1,148
 $(93)
Perpetual preferred stocks731
 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 stocks683
 676
 (7)
Total equity securities carried at fair value$1,723
 $1,827
 $104




2021

Table of Contents
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 SeptemberJune 30, 20182019, the gross unrealized losses on fixed maturities of $54393 million relate to 2,392712 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 ninesix 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 ninesix 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 SeptemberJune 30, 20182019. As discussed in Note A — “Accounting PoliciesInvestments,” effective January 1, 2018, all equity securities previously classified as “available for sale” are required to be carried at fair value through net earnings instead of accumulated other comprehensive income and therefore are no longer evaluated for other-than-temporary impairment.




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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 impairments1
 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 SeptemberJune 30, 20182019 (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 years10,179
 10,523
 24%
After five years through ten years14,140
 14,861
 33%
After ten years3,595
 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 years8,150
 8,184
 20%
After five years through ten years13,372
 13,211
 33%
After ten years4,749
 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 SeptemberJune 30, 20182019 or December 31, 20172018.




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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 other341
 (71) 270
Total fixed maturities1,802
 (378) 1,424
Deferred policy acquisition costs — annuity segment(602) 126
 (476)
Annuity benefits accumulated(186) 39
 (147)
Unearned revenue14
 (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 other59
 (13) 46
Total fixed maturities160
 (34) 126
Deferred policy acquisition costs — annuity segment(42) 9
 (33)
Annuity benefits accumulated(14) 3
 (11)
Unearned revenue1
 
 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 other48
 (10) 38
Total fixed maturities191
 (40) 151
Deferred policy acquisition costs — annuity segment(56) 12
 (44)
Annuity benefits accumulated(18) 3
 (15)
Unearned revenue1
 
 1
Total net unrealized gain on marketable securities$118
 $(25) $93
      
December 31, 2017     
Net unrealized gain on:     
Fixed maturities — annuity segment (a)$1,082
 $(227) $855
Fixed maturities — all other259
 (55) 204
Total fixed maturities1,341
 (282) 1,059
Equity securities (b)279
 (58) 221
Total investments1,620
 (340) 1,280
Deferred policy acquisition costs — annuity segment(433) 91
 (342)
Annuity benefits accumulated(137) 29
 (108)
Unearned revenue13
 (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 PoliciesInvestments,” effective January 1, 2018, all equity securities other than those accounted for under the equity method are carried at fair value through net earnings.


Net Investment Income   The following table shows (in millions) investment income earned and investment expenses incurred.
 Three months ended June 30, Six months ended June 30,
 2019 2018 2019 2018
Investment income:       
Fixed maturities$478
 $431
 $947
 $843
Equity securities:       
Dividends22
 20
 44
 40
Change in fair value (*)7
 15
 18
 14
Equity in earnings of partnerships and similar investments45
 41
 66
 87
Other34
 28
 59
 51
Gross investment income586
 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:       
Dividends19
 17
 59
 53
Change in fair value (*)2
 
 16
 4
Equity in earnings of partnerships and similar investments41
 20
 128
 51
Other31
 33
 82
 80
Gross investment income533
 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 PoliciesInvestments,” AFG adopted guidance in January 2018 that requires all equity securities other than those accounted for under the equity method to be reported at fair value with holding gains and losses recognized in net earnings. Although the change in the fair value of the majority of AFG’s equity securities is recorded in realized gains (losses) on securities, AFG records holding gains and losses in net investment income on equity
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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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 securities44
 
 44
 
 23
 
 23
 
Mortgage loans and other investments3
 
 3
 
 
 
 
 
Other (*)
 1
 1
 (349) 4
 
 4
 147
Total pretax58

(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 securities226
 
 226
 
 (72) 
 (72) 
Mortgage loans and other investments3
 
 3
 
 
 
 
 
Other (*)1
 2
 3
 (719) 8
 
 8
 395
Total pretax244
 (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 securities33
 
 33
 
 19
 (29) (10) 24
Mortgage loans and other investments
 
 
 
 
 
 
 
Other (*)3
 
 3
 89
 (2) 6
 4
 (53)
Total pretax36

(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 effects5
 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 PoliciesInvestments,” effective January 1, 2018, allAll 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 ninesix months of 2019 and 2018 on securities that were still owned at SeptemberJune 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 income7
 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 income2
 16
 $27
 $(35)


Gross realized gains and losses (excluding impairment write-downs and mark-to-market of derivatives) on available for sale fixed maturity 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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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 ($545449 million at SeptemberJune 30, 20182019 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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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 thirdsecond quarter and first ninesix months of 20182019 and 20172018 (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 2018loss 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 SeptemberJune 30, 2018,2019, AFG has entered into fourteenfifteen 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 SeptemberJune 30, 20182019 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 SeptemberJune 30, 20182019 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 SeptemberJune 30, 20182019 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 duringfor the third quarter and first ninesix months of 2018 as compared to income of $1 millionboth 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 SeptemberJune 30, 20182019 and $70$135 million at December 31, 20172018 is included in other assets in AFG’s Balance Sheet.




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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          ConsolidatedDeferred  Deferred Sales          Consolidated
Costs  Costs Inducements PVFP Subtotal Unrealized (*) Total  TotalCosts  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
Additions181
  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
Additions181
  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
Additions149
  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 translation1
  
 
 
 
 
 
  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
Additions524
  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
Additions439
  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 translation2
  
 
 
 
 
 
  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 adjustmentsAdjustments to DPAC includesrelated 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 $147152 million and $141148 million of accumulated amortization at SeptemberJune 30, 20182019 and December 31, 20172018, respectively.




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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 fifteeneleven 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 20042012 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 itsthe CLOs that it manages is limited to its investment in thethose CLOs, which had an aggregate fair value of $191 million (including $133$128 million invested in the most subordinate tranches) at SeptemberJune 30, 20182019, and $215188 million at December 31, 20172018.


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 ninesix months of 2017, AFG subsidiaries also purchased $58 million face amount of senior debt2019 and subordinate tranches of existing CLOs for $58 million. During the first nine months of 2018, and 2017, AFG subsidiaries received $45less than $1 million and $86$45 million, respectively, in sale and redemption proceeds from its CLO investments. During the first ninesix months of 2018, and 2017, one and two AFG CLOs, respectively, wereCLO 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 20172019 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):              
Assets20
 (8) 5
 (12)
 (29) 87
 (15)
Liabilities(25) 9
 (15) 24
(2) 27
 (89) 10
Management fees paid to AFG4
 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 SeptemberJune 30, 20182019 and December 31, 20172018, respectively. The aggregate unpaid principal balance of the CLOs’ debt exceeded its carrying value by $160150 million and $118$241 million at those dates. The CLO assets include loans with an aggregate fair value of $1$7 million at both SeptemberJune 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 ninesix months of 20182019. Included in other assets in AFG’s Balance Sheet is $3148 million at SeptemberJune 30, 20182019 and $2654 million at December 31, 20172018 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 quartersecond quarters of 20182019 and 2017,2018, respectively, and $7$6 million and $6$4 million in the first ninesix months of 20182019 and 2017.2018, respectively.




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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, 2017June 30, 2019 December 31, 2018
Principal Discount and Issue Costs Carrying Value Principal Discount and Issue Costs Carrying ValuePrincipal 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 2026425
 (4) 421
 425
 (5) 420
425
 (4) 421
 425
 (4) 421
Other3
 
 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 2054150
 (5) 145
 150
 (5) 145
150
 (5) 145
 150
 (5) 145
6% Subordinated Debentures due November 2055150
 (5) 145
 150
 (5) 145
150
 (5) 145
 150
 (5) 145
5.875% Subordinated Debentures due March 2059125
 (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 20182019 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 SeptemberJune 30, 20182019 or December 31, 20172018.


J.     Redeemable Noncontrolling InterestsK.    Leases


Neon Lloyd’s Business   On December 29, 2017, AFG completedand 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 salelease 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 toexercising 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 separatelyimplicit discount rate in the mezzanine sectionlease. 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 discussedsix 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 leases1
 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
202043
202137
202229
202324
Thereafter52
Total lease payments209
Impact of discounting(24)
Operating lease liability$185



31

K.    
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, 20182019 compared to $61 million at March 31, 2019 and $68$58 million at December 31, 20172018 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 ninesix months of 2018,2019, AFG issued 200,625232,565 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 ninesix 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 thirdsecond quarters of 2019 and 2018 and 2017 and $17$12 million and $24$11 million in the first ninesix months of 20182019 and 20172018, 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 expenses2
 1% 2
 1% 4
 1% 4
 1%
Change in valuation allowance1
 % 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 expenses1
 % 2
 7% 5
 1% 5
 1%
Change in valuation allowance1
 % 16
 55% 3
 % 16
 4%
Other2
 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.


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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.



34

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 20172018 Form 10-K, which covers property and casualty insurance reserves for claims related to environmental exposures, asbestos and other mass tort claims and environmental and occupational injury and disease claims of former subsidiary railroad and manufacturing operations, as well as contingencies related to the sale of substantially all of AFG’s run-off long-term care insurance business.



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Table of ContentsO.    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 ninesix months of 20182019 and 20172018 (in millions):
 Six months ended June 30,
 2019 2018
Balance at beginning of year$9,741
 $9,678
Less reinsurance recoverables, net of allowance2,942
 2,957
Net liability at beginning of year6,799
 6,721
Provision for losses and LAE occurring in the current period1,501
 1,434
Net decrease in the provision for claims of prior years(86) (100)
Total losses and LAE incurred1,415
 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 other1
 (4)
Net liability at end of period6,845
 6,463
Add back reinsurance recoverables, net of allowance2,732
 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 allowance2,957
 2,302
Net liability at beginning of year6,721
 6,261
Provision for losses and LAE occurring in the current period2,337
 2,237
Net increase (decrease) in the provision for claims of prior years:   
Special A&E charges18
 89
Other(149) (87)
Total losses and LAE incurred2,206
 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 period6,722
 6,730
Add back reinsurance recoverables, net of allowance2,948
 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 ninesix 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 (withinthe 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 transactionand 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 PagePage Page
  
  
  
  
  
  
  
  
  
  
  
  
  


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


Actual results and/or financial condition could differ materially from those contained in or implied by such forward-looking statements for a variety of reasons including but not limited to:
changes in financial, political and economic conditions, including changes in interest and inflation rates, currency fluctuations and extended economic recessions or expansions in the U.S. and/or abroad;
performance of securities markets, 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.

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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


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


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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 thirdsecond quarter and first ninesix months of 20182019 were $204$210 million ($2.262.31 per share, diluted) and $559$539 million ($6.175.94 per share, diluted), respectively, compared to $11$210 million ($0.132.31 per share, diluted) and $309$355 million ($3.443.92 per share, diluted) reported in the same periods of 2017,2018, reflecting:
higherlower earnings in the annuity segment,
higherlower 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 thirdsecond quarter of 2019 compared to the second quarter of 2018 compared toand realized lossesgains on securities in the third quarterfirst six months of 2017 and higher2019 compared to realized losses on securities in the first ninesix 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 Policiesto the financial statements. The preparation of financial statements in conformity with U.S. generally accepted accounting principles (“GAAP”) requires management to make estimates and assumptions that can have a significant effect on amounts reported in the financial statements. As more information becomes known, these estimates and assumptions change and, thus, impact amounts reported in the future. The areas where management believes the degree of judgment required to determine amounts recorded in the financial statements is most significant are as follows:
the establishment of insurance reserves, especially asbestos and environmental-related reserves,
the recoverability of reinsurance,
the recoverability of deferred acquisition costs,
the 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 20172018 Form 10-K.




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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 20162018 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 1.861.95 for the ninesix months ended SeptemberJune 30, 20182019 and 1.721.54 for the year ended December 31, 20172018. Excluding annuity benefits, this ratio was 10.8715.60 and 7.67,7.86, respectively. Although theThe 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 20172019 2018
Net cash provided by operating activities$1,277
 $993
$877
 $823
Net cash used in investing activities(3,375) (2,230)(1,052) (2,485)
Net cash provided by financing activities1,769
 1,479
1,034
 1,134
Net change in cash and cash equivalents$(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 ninesix months of 2017,2018, accounting for a $90$141 million increasedecline in cash flows from operating activities in the 20182019 period compared to the 20172018 period. As discussed in Note A — “Accounting PoliciesManaged 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 ninesix 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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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 $3.381.05 billion for the first ninesix months of 2019 compared to $2.49 billion in the first six months of 2018, compared to $2.23 billion in the first nine monthsa 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 ninesix months of 20182019 and $1.75$1.20 billion in the first ninesix months of 2017,2018, which is the primary source of AFG’s cash used in investing activities. DuringIn addition, AFG’s cash on hand increased by $859 million during the first ninesix 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 heldon 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 $1895 millionusesource of cash in the first ninesix months of 20182019 compared to a $13226 million source use of cash in the 20172018 period, accounting for a $202$231 million increasedecrease in net cash used in investing activities in the first ninesix months of 20182019 compared to the same 20172018 period. See Note A — “Accounting PoliciesManaged 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 $1.771.03 billion for the first ninesix months of 2019 compared to $1.13 billion in the first six months of 2018, compared to $1.48 billion in the first nine monthsa decrease of 2017, an increase of $290100 million. Annuity receipts exceeded annuity surrenders, benefits, withdrawals and transfers by $1.86$1.10 billion in the first ninesix months of 20182019 compared to $1.75$1.20 billion in the first ninesix months of 2017,2018, accounting for a $109$92 million increasedecrease in net cash provided by financing activities in the 20182019 period compared to the 20172018 period. In June 2017,March 2019, AFG issued $350$125 million of 4.50% Senior Notes5.875% 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 ninesix 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. IssuancesRetirements of managed investment entity liabilities exceeded retirementsissuances by $1095 million in the first ninesix 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 $181116 millionincreasedecrease in net cash provided by financing activities in the 20182019 period compared to the 20172018 period. See Note A — “Accounting PoliciesManaged 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 20172018 or the first ninesix 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.


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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 SeptemberJune 30, 20182019, 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 SeptemberJune 30, 20182019). While these advances must be repaid

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


between 20182020 and 2021 ($40510 million in 2018, $345 million in 20192020 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 SeptemberJune 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 SeptemberJune 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 116120 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 SeptemberJune 30, 20182019, includes contained $40.2444.71 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 $103106 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.


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



Fair values for AFG’s portfolio are determined by AFG’s internal investment professionals using data from nationally recognized pricing services as well as non-binding broker quotes. Fair values of equity securities are generally based on published closing prices. For mortgage-backed securities (“MBS”), which comprise approximately 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% are91% 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 MBSmortgage-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 SeptemberJune 30, 20182019 (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)$(2,017)
Offsetting adjustments to deferred policy acquisition costs and other balance sheet amounts750
800
Estimated pretax impact on accumulated other comprehensive income(1,066)(1,217)
Deferred income tax224
256
Estimated after-tax impact on accumulated other comprehensive income$(842)$(961)


Approximately 90%91% of the fixed maturities held by AFG at SeptemberJune 30, 20182019, were rated “investment grade” (credit rating of AAA to BBB) by nationally recognized rating agencies. Investment grade securities generally bear lower yields and lower degrees of risk than those that are unrated and non-investment grade. Management believes that the high quality investment portfolio should generate a stable and predictable investment return.


MBS are subject to significant prepayment risk due to the fact that, in periods of declining interest rates, mortgages may be repaid more rapidly than scheduled as borrowers refinance higher rate mortgages to take advantage of lower rates. Although interest rates have been low in recent years, tighter lending standards have resulted in fewer buyers being able to refinance the mortgages underlying much of AFG’s non-agency residential MBS portfolio.



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


Summarized information for AFG’s MBS (including those classified as trading) at SeptemberJune 30, 20182019, 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 4-1/24.5 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 SeptemberJune 30, 20182019, 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 SeptemberJune 30, 20182019. 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 SeptemberJune 30, 20182019, 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 SeptemberJune 30, 2018,2019, is shown in the following table (dollars in millions). Approximately $563686 million of available for sale fixed maturity securities had no unrealized gains or losses at SeptemberJune 30, 20182019.
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 cost104% 98%105% 98%
Number of security positions2,876
 2,392
4,648
 712
Number individually exceeding $2 million gain or loss50
 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 securities122
 (64)
States and municipalities117
 (98)
Banks, savings and credit institutions32
 (100)219
 (3)
Manufacturing29
 (57)
Insurance companies15
 (47)
Other asset-backed securities205
 (10)
Healthcare60
 (6)
Energy – exploration and production35
 (5)
Collateralized loan obligations10
 (36)
Percentage rated investment grade84% 96%92% 91%



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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 sets forth the scheduled maturities of AFG’s available for sale fixed maturity securities at SeptemberJune 30, 20182019, 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 less5% 1%4% 1%
After one year through five years25% 17%25% 12%
After five years through ten years24% 41%36% 15%
After ten years9% 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%



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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) 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 20172018 Form 10-K under Management’s Discussion and Analysis — “Investments.”



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


Based on its analysis, management believes AFG will recover its cost basis in the fixed maturity securities with unrealized losses and that AFG has the ability to hold the securities until they recover in value and had no intent to sell them at SeptemberJune 30, 20182019. 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 20172018 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.



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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 AAccounting PoliciesManaged 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 assets11,352
 
 (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 reserves36,601
 
 
 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 liabilities5,208
 
 
 5,208
5,094
 
 
 5,094
Total liabilities54,219
 4,998
 (191) 59,026
57,017
 4,781
 (191) 61,607
              
Redeemable noncontrolling interests
 
 
 

 
 
 
              
Shareholders’ equity:              
Common Stock and Capital surplus1,320
 
 
 1,320
1,367
 
 
 1,367
Retained earnings3,800
 
 
 3,800
3,914
 
 
 3,914
Accumulated other comprehensive income, net of tax44
 
 
 44
809
 
 
 809
Total shareholders’ equity5,164
 
 
 5,164
6,090
 
 
 6,090
Noncontrolling interests
 
 
 

 
 
 
Total equity5,164
 
 
 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 assets9,709
 
 (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 reserves33,974
 
 
 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 liabilities4,575
 
 
 4,575
4,385
 
 
 4,385
Total liabilities50,637
 4,902
 (215) 55,324
53,972
 4,700
 (188) 58,484
              
Redeemable noncontrolling interests3
 
 
 3

 
 
 
              
Shareholders’ equity:              
Common Stock and Capital surplus1,269
 
 
 1,269
1,334
 
 
 1,334
Retained earnings3,248
 
 
 3,248
3,588
 
 
 3,588
Accumulated other comprehensive income, net of tax813
 
 
 813
48
 
 
 48
Total shareholders’ equity5,330
 
 
 5,330
4,970
 
 
 4,970
Noncontrolling interests1
 
 
 1
2
 
 
 2
Total equity5,331
 
 
 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 income531
 
 (4) (b) 527
585
 
 (5) (b) 580
Realized gains on securities34
 
 
 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 income58
 
 (4) (c) 54
55
 
 (4) (c) 51
Total revenues1,956
 60
 (8) 2,008
1,901
 69
 (10) 1,960
Costs and Expenses:              
Insurance benefits and expenses1,599
 
 
 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 expenses113
 
 
 113
113
 
 
 113
Total costs and expenses1,712
 60
 (8) 1,764
1,642
 69
 (10) 1,701
Earnings before income taxes244
 
 
 244
259
 
 
 259
Provision for income taxes41
 
 
 41
50
 
 
 50
Net earnings, including noncontrolling interests203
 
 
 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 income476
 
 (5) (b) 471
534
 
 (4) (b) 530
Realized losses on securities(12) 
 
 (12)
Realized gains on securities31
 
 
 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 income53
 
 (5) (c) 48
47
 
 (4) (c) 43
Total revenues1,790
 55
 (10) 1,835
1,779
 64
 (10) 1,833
Costs and Expenses:              
Insurance benefits and expenses1,628
 
 
 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 expenses133
 
 
 133
105
 
 
 105
Total costs and expenses1,761
 55
 (10) 1,806
1,519
 64
 (10) 1,573
Earnings before income taxes29
 
 
 29
260
 
 
 260
Provision for income taxes18
 
 
 18
52
 
 
 52
Net earnings, including noncontrolling interests11
 
 
 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 thirdsecond quarter of 20182019 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.


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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
Six months ended June 30, 2019         
Revenues:         
Insurance net earned premiums$2,384
 $
 $
   $2,384
Net investment income1,138
 
 (16) (b) 1,122
Realized gains on securities240
 
 
   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 income108
 
 (7) (c) 101
Total revenues3,870
 133
 (19)   3,984
Costs and Expenses:         
Insurance benefits and expenses2,968
 
 
   2,968
Expenses of managed investment entities
 133
 (19) (b)(c) 114
Interest charges on borrowed money and other expenses230
 
 
   230
Total costs and expenses3,198
 133
 (19)   3,312
Earnings before income taxes672
 
 
   672
Provision for income taxes137
 
 
   137
Net earnings, including noncontrolling interests535
 
 
   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 income1,032
 
 (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 income100
 
 (8) (c) 92
Total revenues3,350
 121
 (19)   3,452
Costs and Expenses:         
Insurance benefits and expenses2,711
 
 
   2,711
Expenses of managed investment entities
 121
 (19) (b)(c) 102
Interest charges on borrowed money and other expenses205
 
 
   205
Total costs and expenses2,916
 121
 (19)   3,018
Earnings before income taxes434
 
 
   434
Provision for income taxes85
 
 
   85
Net earnings, including noncontrolling interests349
 
 
   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 quarterfirst 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 quarterfirst six months of 20182019 and 2017,2018, respectively, in distributions recorded as interest expense by the CLOs.
(c)Elimination of management fees earned by AFG.





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




CONDENSED CONSOLIDATING STATEMENT OF EARNINGS
 
Before CLO
Consolidation (a)
 
Managed
Investment
Entities
 
Consol.
Entries
   
Consolidated
As Reported
Nine months ended September 30, 2018         
Revenues:         
Insurance net earned premiums$3,613
 $
 $
   $3,613
Net investment income1,563
 
 (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 income158
 
 (12) (c) 146
Total revenues5,306
 181
 (27)   5,460
Costs and Expenses:         
Insurance benefits and expenses4,310
 
 
   4,310
Expenses of managed investment entities
 181
 (27) (b)(c) 154
Interest charges on borrowed money and other expenses318
 
 
   318
Total costs and expenses4,628
 181
 (27)   4,782
Earnings before income taxes678
 
 
   678
Provision for income taxes126
 
 
   126
Net earnings, including noncontrolling interests552
 
 
   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 income1,382
 
 (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 income168
 
 (14) (c) 154
Total revenues4,920
 177
 (40)   5,057
Costs and Expenses:         
Insurance benefits and expenses4,113
 
 
   4,113
Expenses of managed investment entities
 177
 (40) (b)(c) 137
Interest charges on borrowed money and other expenses350
 
 
   350
Total costs and expenses4,463
 177
 (40)   4,600
Earnings before income taxes457
 
 
   457
Provision for income taxes146
 
 
   146
Net earnings, including noncontrolling interests311
 
 
   311
Less: Net earnings (loss) attributable to noncontrolling interests2
 
 
   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.



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


RESULTS OF OPERATIONS


General AFG’s net earnings attributable to shareholders, determined in accordance with GAAP, include certain items that may not be indicative of its ongoing core operations. For example, core net operating earnings excludes realized gains (losses) on securities because such gains and losses are influenced significantly by financial markets, interest rates and the timing of sales. Similarly, significant gains and losses from the sale of real estate are excluded from core earnings as they are influenced by the timing of sales and realized gains (losses) 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.


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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 (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 securities34
 (12) (28) (1)
Special A&E charges(27) (113) (27) (113)
Loss on retirement of debt
 (4) 
 (11)
Earnings before income taxes244
 29
 678
 457
Provision (credit) for income taxes:       
Core operating earnings40
 63
 138
 189
Non-core items1
 (45) (12) (43)
Total provision for income taxes41
 18
 126
 146
Net earnings, including noncontrolling interests203
 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 items6
 (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 securities0.31
 (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 securities56
 31
 240
 (62)
Annuity non-core earnings (losses)(33) 
 (33) 
Earnings before income taxes259
 260
 672
 434
Provision (credit) for income taxes:       
Core operating earnings45
 46
 93
 98
Non-core items:       
Realized gains (losses) on securities11
 6
 50
 (13)
Annuity non-core earnings (losses)(6) 
 (6) 
Total provision for income taxes50
 52
 137
 85
Net earnings, including noncontrolling interests209
 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 securities45
 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 securities0.48
 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

(*)
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 annuity non-core earnings (losses).

Net earnings attributable to shareholders increased $193was $210 million in both the thirdsecond quarter of 2018 compared to2019 and the same period in 2017 due to higher core net operating earnings, lower special A&E charges recorded in the thirdsecond quarter of 2018 compared to2018. Net earnings for the thirdsecond 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, periodrespectively, 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 thirdsecond quarter of 2018 compared to the same period in 2017, reflecting higherslightly 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 corporateannuity


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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 quartersecond quarters of 2019 and 2018 includesresulted primarily from the increasechange in fair value of equity securities that are required to be carriedwere 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 ninesix months of 20182019 compared to the same period in 20172018 due primarily to higherafter-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 infor the 2018 periodfirst 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 ninesix months of 2018 compared to the same period in 2017, reflecting higherlower 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 lossesgains (losses) on securities in the first ninesix months of 2019 and 2018 includesresulted primarily from the declinechange in fair value of equity securities that are required to be carriedwere 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 — QUARTERSTHREE MONTHS ENDED SEPTEMBERJUNE 30, 20182019 AND 20172018


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 SeptemberJune 30, 20182019 and 20172018 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 TotalP&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 income108
 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 income4
 27
 (4) 27
 54
 
 54
2
 27
 (4) 26
 51
 
 51
Total revenues1,439
 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 expenses854
 
 
 
 854
 18
 872
723
 
 
 
 723
 
 723
Commissions and other underwriting expenses417
 
 
 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 expenses11
 32
 
 46
 89
 9
 98
11
 35
 
 50
 96
 
 96
Total costs and expenses1,282
 323
 52
 80
 1,737
 27
 1,764
1,152
 374
 59
 83
 1,668
 33
 1,701
Earnings before income taxes157
 117
 
 (37) 237
 7
 244
174
 104
 
 (42) 236
 23
 259
Provision for income taxes26
 19
 
 (5) 40
 1
 41
35
 20
 
 (10) 45
 5
 50
Net earnings, including noncontrolling interests131
 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 Earnings132
 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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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 TotalP&C Annuity Consol. MIEs Holding Co., other and unallocated Total Non-core reclass GAAP Total
Three months ended September 30, 2017             
Three months ended 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 income94
 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 income1
 26
 (5) 26
 48
 
 48
2
 27
 (4) 18
 43
 
 43
Total revenues1,362
 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 expenses906
 
 
 
 906
 89
 995
693
 
 
 
 693
 
 693
Commissions and other underwriting expenses353
 
 
 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 expenses8
 30
 
 46
 84
 28
 112
11
 31
 
 47
 89
 
 89
Total costs and expenses1,267
 299
 45
 78
 1,689
 117
 1,806
1,100
 340
 54
 79
 1,573
 
 1,573
Earnings before income taxes95
 102
 
 (39) 158
 (129) 29
178
 99
 
 (48) 229
 31
 260
Provision for income taxes43
 34
 
 (14) 63
 (45) 18
37
 21
 
 (12) 46
 6
 52
Net earnings, including noncontrolling interests52
 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 Earnings52
 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 thirdsecond quarter of 2019 compared to $178 million in the second quarter of 2018, compared to $6a decrease of $4 million in the third quarter of 2017, an increase of $133 million (2,217%(2%). Property and casualty coreThe 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 chargesunderwriting profit in the thirdsecond 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 SeptemberJune 30, 20182019 and 20172018 (dollars in millions):
Three months ended September 30,  Three months ended June 30,  
2018 2017 % Change2019 2018 % Change
Gross written premiums$2,104
 $2,104
 %$1,664
 $1,665
 %
Reinsurance premiums ceded(648) (671) (3%)(400) (408) (2%)
Net written premiums1,456
 1,433
 2%1,264
 1,257
 1%
Change in unearned premiums(129) (166) (22%)(64) (96) (33%)
Net earned premiums1,327
 1,267
 5%1,200
 1,161
 3%
Loss and loss adjustment expenses (*)854
 906
 (6%)
Loss and loss adjustment expenses723
 693
 4%
Commissions and other underwriting expenses417
 353
 18%418
 396
 6%
Core underwriting gain56
 8
 600%
Underwriting gain59
 72
 (18%)
    

    

Net investment income108
 94
 15%124
 115
 8%
Other income and expenses, net(7) (7) %(9) (9) %
Core earnings before income taxes157
 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 ratio64.3% 71.4% (7.1%)60.2% 59.7% 0.5%
Underwriting expense ratio31.4% 27.9% 3.5%34.8% 34.0% 0.8%
Combined ratio95.7% 99.3% (3.6%)95.0% 93.7% 1.3%
          
Aggregate — including exited lines          
Loss and LAE ratio65.8% 78.5% (12.7%)60.3% 59.7% 0.6%
Underwriting expense ratio31.4% 27.9% 3.5%34.8% 34.0% 0.8%
Combined ratio97.2% 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):
50
 Three months ended June 30,  
 2019 2018  
 GWP % GWP % % Change
Property and transportation$579
 35% $615
 37% (6%)
Specialty casualty896
 54% 858
 52% 4%
Specialty financial189
 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 casualty956
 46% 850
 40% 12%
Specialty financial195
 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 thirdsecond quarter of 20182019 compared to 32%25% of gross written premiums for the thirdsecond 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 in2019 2018 Change in
Ceded % of GWP Ceded % of GWP % of GWPCeded % 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 specialty48
   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 $1.461.26 billion for the thirdsecond quarter of 20182019 compared to $1.431.26 billion for the thirdsecond quarter of 20172018, 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 % % ChangeNWP % NWP % % Change
Property and transportation$560
 38% $624
 44% (10%)$422
 33% $422
 33% %
Specialty casualty695
 48% 624
 44% 11%662
 52% 639
 51% 4%
Specialty financial153
 11% 150
 10% 2%149
 12% 159
 13% (6%)
Other specialty48
 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):
51
 Three months ended June 30,  
 2019 2018  
 NEP % NEP % % Change
Property and transportation$379
 32% $374
 32% 1%
Specialty casualty634
 53% 595
 51% 7%
Specialty financial151
 13% 159
 14% (5%)
Other specialty36
 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 earnedas a percentage of gross written premiums (“NEP”) for AFG’s property and casualty insurance segment were $1.33 billiondecreased 4 percentage points for the thirdsecond 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 casualty616
 46% 568
 45% 8%
Specialty financial149
 11% 142
 11% 5%
Other specialty36
 3% 30
 2% 20%
 $1,327
 100% $1,267
 100% 5%

Gross written premiums were flat for the third quarter of 20182019 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 thirdsecond quarter of 2018 compared to the third quarter of 2017. This decrease was largely the result ofreflecting a change in the timingmix of two large policy renewalsbusiness.

Specialty casualty Gross written premiums increased$38 million (4%) in onethe second quarter of the transportation businesses from the third quarter2019 compared to the fourthsecond 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 otherworkers’ 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 thirdsecond 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 werewas comparable in the thirdsecond quarter of 2019 and the second quarter of 2018 compared to the third quarter of 2017 reflecting higherlower cessions to AFG’s internal reinsurance program, which is included in Other specialty, andoffset 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 periodsecond quarter of 2019 compared to the 2017 period.

Specialty financial Gross written premiums increased$14 million (8%) in the thirdsecond quarter of 2018 compared to the third quarter of 2017 due primarily to higherlower premiums in the financial institutions business. Average renewal rates for this group increased approximately 6%1% in the thirdsecond quarter of 2018.2019. Reinsurance premiums ceded as a percentage of gross written premiums increased 54 percentage points for the thirdsecond quarter of 20182019 compared to the thirdsecond 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 $13decreased $6 million (37%(16%) in the thirdsecond quarter of 2019 compared to the second quarter of 2018, compared to the third quarter of 2017, reflecting an increasea decrease in premiums retained, primarily from businesses in the Specialty casualty sub-segment.




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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 20172019 2018 Change 2019 2018
Property and transportation                  
Loss and LAE ratio77.1% 77.3% (0.2%)    68.4% 63.8% 4.6%    
Underwriting expense ratio22.9% 21.6% 1.3%    30.7% 30.1% 0.6%    
Combined ratio100.0% 98.9% 1.1%    99.1% 93.9% 5.2%    
Underwriting profit (loss)      $
 $6
Underwriting profit      $4
 $23
                  
Specialty casualty                  
Loss and LAE ratio59.2% 70.7% (11.5%)    60.0% 63.4% (3.4%)    
Underwriting expense ratio32.9% 28.8% 4.1%    32.5% 31.7% 0.8%    
Combined ratio92.1% 99.5% (7.4%)    92.5% 95.1% (2.6%) ��  
Underwriting profit      $49
 $2
      $47
 $29
                  
Specialty financial                  
Loss and LAE ratio40.1% 56.0% (15.9%)    32.3% 33.9% (1.6%)    
Underwriting expense ratio54.3% 46.2% 8.1%    53.3% 51.7% 1.6%    
Combined ratio94.4% 102.2% (7.8%)    85.6% 85.6% %    
Underwriting profit (loss)      $9
 $(3)
Underwriting profit      $21
 $22
                  
Total Specialty                  
Loss and LAE ratio64.3% 71.4% (7.1%)    60.2% 59.7% 0.5%    
Underwriting expense ratio31.4% 27.9% 3.5%    34.8% 34.0% 0.8%    
Combined ratio95.7% 99.3% (3.6%)    95.0% 93.7% 1.3%    
Underwriting profit      $55
 $9
      $60
 $73
                  
Aggregate — including exited lines                  
Loss and LAE ratio65.8% 78.5% (12.7%)    60.3% 59.7% 0.6%    
Underwriting expense ratio31.4% 27.9% 3.5%    34.8% 34.0% 0.8%    
Combined ratio97.2% 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 thirdsecond quarter of 2019 compared to $73 million in the second quarter of 2018, compared to $9a decrease of $13 million (18%). The lower underwriting profit in the thirdsecond quarter of 2017, an increase of $46 million (511%). The2019 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 casualtyUnderwriting profit for this group was $49$4 million for the thirdsecond 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 thirdsecond 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 liabilityworkers’ 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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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 thirdsecond quarter of 20182019 compared to an underwriting profit of $4$1 million in the thirdsecond quarter of 2017. This decrease is due primarily to2018, 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 thirdsecond 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.


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



Losses and Loss Adjustment Expenses
AFG’s overall loss and LAE ratio was 65.8%60.3% for the thirdsecond quarter of 20182019 compared to 78.5%59.7% for the thirdsecond quarter of 20172018, a decreasean increase of 12.70.6 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 inAmount Ratio Change in
2018 2017 2018 2017 Ratio2019 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 losses12
 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 losses11
 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 losses12
 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 losses35
 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 losses35
 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 thirdsecond quarter of 20182019 compared to 65.9%62.2% for the thirdsecond quarter of 20172018, a decreasean increase of 0.5 percentage points.


Property and transportation   The 1.21.3 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 andat the Singapore branch infor the thirdsecond quarter of 20182019 compared to the thirdsecond quarter of 2017.2018.



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


Specialty casualty   The 1.71.2 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 businessworkers’ compensation businesses and at Neon, partially offset by an increase in the loss and LAE ratio in the targeted markets business.Neon.



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


Specialty financial The 1.50.9 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 thirdsecond quarter of 20182019 compared to $38$45 million in the thirdsecond quarter of 2017, an increase2018, a decrease of $11$3 million (29%(7%).


Property and transportation Net favorable reserve development of $46 million in the thirdsecond quarter of 20182019 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 thirdsecond 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 20182019 reflects lower than anticipated claim severity in the workers’ compensation businesses, and to a lesser extent, lowerpartially offset by higher than expected claim severity in the targeted marketsexcess and executive liabilitysurplus lines businesses. This was partially offset by higherNet 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 excesssurety 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 thirdsecond quarter of 2018 reflects lower than expected claim frequency and severity in the surety business and lower than anticipated claim severity in the fidelityfinancial 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 thirdsecond 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 gainsgain on the retroactive reinsurance transactionsinsurance 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.


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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 thirdsecond quarter of 20172019 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 separatemillion. 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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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 thirdsecond quarter of 20182019 compared to $353$396 million for the thirdsecond quarter of 20172018, 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 thirdsecond quarter of 20182019 compared to 27.9%34.0% for the thirdsecond quarter of 20172018, an increase of 3.50.8 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 in2019 2018 Change in
U/W Exp % of NEP U/W Exp % of NEP % of NEPU/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 casualty203
 32.9% 164
 28.8% 4.1%207
 32.5% 188
 31.7% 0.8%
Specialty financial80
 54.3% 66
 46.2% 8.1%81
 53.3% 83
 51.7% 1.6%
Other specialty14
 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 1.30.6 percentage points in the thirdsecond quarter of 20182019 compared to the thirdsecond quarter of 2017,2018 reflecting higher underwriting expenses and lower premiumsancillary 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 4.10.8 percentage points in the thirdsecond quarter of 20182019 compared to the thirdsecond 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 policyholderslower ceding commissions received from reinsurers in the workers’ compensation businessesexcess and higher commissions in the targeted marketssurplus lines businesses.


Specialty financial   Commissions and other underwriting expenses as a percentage of net earned premiums increased8.11.6 percentage points in the thirdsecond quarter of 20182019 compared to the thirdsecond 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 thirdsecond quarter of 20182019 compared to $94115 million in the thirdsecond quarter of 20172018, 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 % Change2019 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 thirdsecond quarter of 20182019 compared to the thirdsecond quarter of 2017 reflects2018 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 thirdsecond quarter of 20182019 compared to 3.82%4.45% for the thirdsecond quarter of 2017, an increase2018, a decrease of 0.340.02 percentage points,points. The decrease is due primarily to the higher earnings from limited partnerships and similar investments. The high returns from limiteda 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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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 thirdsecond quarter of 20182019 and for the thirdsecond 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 20172019 2018
Other income   $2
 $2
Income from the sale of real estate$
 $
Other4
 1
Total other income4
 1
Other expenses      
Amortization of intangibles3
 2
3
 2
Other8
 6
8
 9
Total other expenses11
 8
11
 11
Other income and expenses, net$(7) $(7)$(9) $(9)




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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 thirdsecond quarter of 2019 compared to $99 million in the second quarter of 2018, compared to $102a 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 thirdsecond quarter of 20182019 as compared to the thirdsecond 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 by2018 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 performanceFIAs in the third quarter of 2018 had a significantly2019 period compared to higher favorable impact than the stock market increase in the 2017 period and the decrease inanticipated interest rates in the third quarter of 2017 had a significantly larger unfavorable impact in the 20172018 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 growthan unlocking charge in the FIA businesssecond 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 compareddue 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 SeptemberJune 30, 20182019 and 20172018 (dollars in millions):
Three months ended September 30,  Three months ended June 30,  
2018 2017 % Change2019 2018 % Change
Revenues:          
Net investment income$413
 $375
 10%$451
 $412
 9%
Other income:          
Guaranteed withdrawal benefit fees16
 15
 7%17
 16
 6%
Policy charges and other miscellaneous income11
 11
 %10
 11
 (9%)
Total revenues440
 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 expenses32
 30
 7%35
 31
 13%
Total costs and expenses323
 299
 8%374
 340
 10%
Earnings before income taxes$117
 $102
 15%
Core earnings before income taxes104
 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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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 annuities1
 1
 %
Other annuity benefits:     
Change in expected death and annuitization reserve5
 5
 %
Amortization of sales inducements5
 4
 25%
Change in guaranteed withdrawal benefit reserve18
 18
 %
Change in other benefit reserves10
 16
 (38%)
Total other annuity benefits38
 43
 (12%)
Total before impact of derivatives related to FIAs218
 204
 7%
Derivatives related to fixed-indexed annuities:     
Embedded derivative mark-to-market223
 127
 76%
Equity option mark-to-market(219) (116) 89%
Impact of derivatives related to FIAs4
 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 options146
 122
 20%
Related impact on the amortization of deferred policy acquisition costs34
 (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 options146
 122
Cost of funds244
 210
    
Interest credited — fixed component of variable annuities1
 2
Other annuity benefits, excluding the impact of interest rates and the stock market on FIAs27
 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 FIAs103
 (8)
Accretion of guaranteed minimum FIA benefits102
 85
Other annuity benefits — impact of the stock market and interest rates on FIAs8
 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 % Change2019 2018 % Change
Average fixed annuity investments (at amortized cost)$34,955
 $31,713
 10%$37,907
 $33,935
 12%
Average fixed annuity benefits accumulated35,226
 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 spread2.67% 2.69%  2.08% 2.28%  
          
Policy charges and other miscellaneous income0.09% 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 FIAs1.11% 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 annuities1.35% 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 FIAs1.37% 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 annuities1.35% 1.31%

(*)An estimateExcluding 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 ofimpact (acceleration/deceleration) on the amortization of deferred policy acquisition costs and deferred sales inducements.costs.


Annuity Net Investment Income
Net investment income for the thirdsecond 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 thirdsecond quarter of 2018 and2019 compared to the thirdsecond quarter of 2017.2018. The decrease in the net investment yield between periods reflects higher earningsthe lower yields on investments accounted for under the equity method and from limited partnerships and similar investments, offset byequity 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 JulyApril 1, 2017,2018, through SeptemberJune 30, 2018, $4.42019, $6.2 billion in annuity segment investments with an average yield of 5.01%approximately 5.0% were redeemed or sold whilewith the investments purchased during that period (with new premium dollarsproceeds 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 purchaseAnalysis of 4.26%.Financial Condition and Results of Operations — Continued



Annuity Interest Credited — FixedCost of Funds
Interest credited — fixedCost of funds for the thirdsecond 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 creditedcost of funds divided by average fixed annuity benefits accumulated, increased0.020.09 percentage points to 2.03%2.55% in the thirdsecond 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 annuities61
 58
Fixed component of fixed-indexed annuities23
 19
Immediate annuities6
 6
Pension risk transfer products1
 
Federal Home Loan Bank advances7
 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 thirdsecond quarter of 2017 due2019 compared to higher creditingthe 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 reserve20
 19
Change in other benefit reserves3
 (1)
Other annuity benefits27
 23
Offset guaranteed withdrawal benefit fees(17) (16)
Other annuity benefits excluding the impact of the stock market and interest rates, net10
 7
Other annuity benefits — impact of the stock market and interest rates8
 16
Other annuity benefits, net$18
 $23

As discussed under “Annuity Benefits Accumulated” in Note A — “Accounting Policiesto the financial statements, guaranteed withdrawal benefit reserves are accrued for and modified using assumptions similar to those used in establishing and amortizing deferred policy acquisition costs. 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 Unlockingbelow 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 decreased0.02 0.20 percentage points to 2.67%2.08% from 2.69%2.28% in the thirdsecond quarter of 20182019 compared to the same period in 20172018 due primarily to higher crediting rates on new businessrenewal 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 thirdsecond quarter of 2019 compared to $11 million for the second quarter of 2018, anda decrease of $1 million (9%). Excluding the thirdimpact of a $1 million unlocking charge related to unearned revenue in the second quarter of 2017. Annuity2018, 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 0.010.02 percentage points to 0.09%0.08% from 0.10% in the thirdsecond 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 toan increase of $7 million (12%), reflecting growth in the thirdannuity business.

See “Annuity Unlockingbelow 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, NetThe 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 inducements5
 4
Change in guaranteed withdrawal benefit reserve18
 18
Change in other benefit reserves10
 16
Other annuity benefits38
 43
Offset guaranteed withdrawal benefit fees(16) (15)
Other annuity benefits, net$22
 $28

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

Annuity Acquisition Expenses
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 amortizationfixed-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 DPAC0.79% 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 accumulated0.76% 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 rates0.68% 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 accumulated0.32% 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 thirdsecond 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 thirdsecond quarter of 2019 from 0.35% in the second quarter of 2018 anddue primarily to growth in the third quarter of 2017.business.

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



Change in Fair Value of Derivatives Related to Fixed-Indexed (Including Variable-Indexed) Annuities 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 Measurementsto 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 changetable 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 $10 million (125%). AFG expects both the sizeother impacts of the embedded derivativestock market and interest rates to rise, resulting in continued increases in interest on the embedded derivative. During the third quarter of 2018,(excluding the impact of higherthe 2018 unlocking charge) over or under the cost of the equity index options (discussed above) on earnings before income taxes for the annuity segment (dollars in millions):
 Three months ended June 30,  
 2019 2018 % Change
Change in the fair value of derivatives related to FIAs$(103) $8
 (1,388%)
Accretion of guaranteed minimum FIA benefits(102) (85) 20%
Other annuity benefits(8) (16) (50%)
Less cost of equity options146
 122
 20%
Related impact on the amortization of DPAC34
 (16) (313%)
Impact on annuity segment earnings before income taxes$(33) $13
 (354%)

During the second quarter of 2019, the negative impact of significantly lower than anticipated interest on the embedded derivative wasrates, 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’ssegments’ earnings before income taxes by $2$33 million incompared to the third quarter$13 million favorable impact of 2018the stock market and decreased theinterest rates (excluding unlocking) on annuity segment’s earnings before income taxes by $4 million infor the thirdsecond quarter of 2017.2018, a change of $46 million (354%). In the 2018 quarter, the



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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) $(4) 150%
Changes in interest rates higher (lower) than expected(2) (10) (80%)
Change in the stock market, including volatility12
 6
 100%
Renewal option costs lower (higher) than expected
 1
 (100%)
Other, including the impact of actual versus expected lapses(2) 3
 (167%)
Impact of derivatives related to FIAs$(2) $(4) (50%)
 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 0.04excluding 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 thirdsecond quarter of 2018 compared to2019 from 1.34% in the same period in 2017second 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 offsetother impacts of the stock market and interest rates on the accounting for FIAs discussed above partially offset byand 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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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 SeptemberJune 30, 20182019 and 20172018 (in millions):
Three months ended September 30,Three months ended June 30,
2018 20172019 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 credited179
 160
Cost of funds244
 210
Embedded derivative mark-to-market223
 127
251
 82
Change in other benefit reserves29
 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 gains8
 138
192
 32
Fixed component of variable annuities176
 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):
65
 Three months ended June 30,  
2019 2018 % Change
Financial institutions single premium annuities — indexed$429
 $448
 (4%)
Financial institutions single premium annuities — fixed313
 131
 139%
Retail single premium annuities — indexed274
 378
 (28%)
Retail single premium annuities — fixed36
 22
 64%
Broker dealer single premium annuities — indexed189
 355
 (47%)
Broker dealer single premium annuities — fixed8
 4
 100%
Pension risk transfer50
 1
 4,900%
Education market — fixed and indexed annuities44
 54
 (19%)
Total fixed annuity premiums1,343
 1,393
 (4%)
Variable annuities6
 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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Management’s Discussion and Analysis of Financial Condition and Results of Operations — Continued




Statutory Annuity PremiumsUnlocking
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 thirdsecond quarter of 2018 comparedresulted in a net charge related to $876its annuity business of $27 million, in the third quarter of 2017, an increase of $502 million (57%). The following table summarizeswhich impacted AFG’s annuity sales (dollars infinancial 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 — fixed114
 82
 39%
Retail single premium annuities — indexed354
 219
 62%
Retail single premium annuities — fixed17
 18
 (6%)
Broker dealer single premium annuities — indexed322
 148
 118%
Broker dealer single premium annuities — fixed3
 1
 200%
Pension risk transfer56
 
 %
Education market — fixed and indexed annuities46
 41
 12%
Total fixed annuity premiums1,372
 869
 58%
Variable annuities6
 7
 (14%)
Total annuity premiums$1,378
 $876
 57%
  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 inThe net charge from unlocking annuity premiumsassumptions in the thirdsecond quarter of 2018 comparedis due primarily to the third quarterunfavorable impact of 2017higher 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 retailhigher 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 SeptemberJune 30, 20182019 and 20172018 (in millions):
Three months ended September 30,Three months ended June 30,
2018 20172019 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 earnings1
 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 SeptemberJune 30, 20182019 and 20172018, 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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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 thirdsecond 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 SeptemberJune 30, 20182019 and 20172018 (dollars in millions):
Three months ended September 30,  Three months ended June 30,  
2018 2017 % Change2019 2018 % Change
Revenues:          
Life, accident and health net earned premiums$6
 $6
 %$5
 $6
 (17%)
Net investment income10
 7
 43%10
 7
 43%
Other income — P&C fees18
 17
 6%20
 15
 33%
Other income9
 9
 %6
 3
 100%
Total revenues43
 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 expenses7
 4
 75%8
 4
 100%
Life, accident and health benefits10
 6
 67%8
 11
 (27%)
Life, accident and health acquisition expenses2
 1
 100%
 1
 (100%)
Other expense — expenses associated with P&C fees11
 13
 (15%)12
 11
 9%
Other expenses (*)35
 33
 6%
Other expenses38
 36
 6%
Costs and expenses, excluding interest charges on borrowed money65
 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 money15
 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 thirdsecond quarter of 2018 compared to net earned premiums of $62018. The $3 million and related benefits and acquisition expenses of $7 million in the third quarter of 2017. The $4 million (67%(27%) increasedecrease in life, accident and health benefits reflects higherlower 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 thirdsecond quarter of 20182019 compared to $7 million in the thirdsecond 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 thirdsecond quarter of 20182019 compared to an increasea $1 million decrease in value of less than $1 million in the thirdsecond quarter 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 thirdsecond quarter of 2018,2019, AFG collected $18$20 million in fees for these services compared to $17$15 million in the thirdsecond quarter of 2017.2018. Management views this fee income, net of the $12 million in the second quarter of 2019 and $11 million in the thirdsecond quarter of 2018, and $13 million in the third quarter of

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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 thirdsecond quarter of 20182019 and $5 million in the thirdsecond 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 2026425
 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 2054150
 150
6% Subordinated Debentures due November 2055150
 150
Other3
 3
Total principal amount of Holding Company Debt$1,318
 $1,428
    
Weighted Average Interest Rate4.6% 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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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 2026425
 425
6-1/4% Subordinated Debentures due September 2054150
 150
6% Subordinated Debentures due November 2055150
 150
5.875% Subordinated Debentures due March 2059125
 
Other3
 3
Total principal amount of Holding Company Debt$1,443
 $1,318
    
Weighted Average Interest Rate4.7% 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 gaingains of $34$56 million in the thirdsecond quarter of 2019 compared to $31 million in the second quarter of 2018, compared to lossesan 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 20172019 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 items3
 (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 amountThe 2019 quarter includes a $25$38 million net gain on securities that were still held at SeptemberJune 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 NoteL — “Income Taxesto the financial statements for an analysis of items affecting AFG’s effective tax rate.

Consolidated Noncontrolling Interests   AFG’s consolidated net earnings (losses) attributable to noncontrolling interests was a net loss of $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 Taxesto the financial statements for an analysis of items affecting AFG’s effective tax rate.

Consolidated Noncontrolling Interests   AFG’s consolidated net earnings (losses) attributable to noncontrolling interests was a net loss of $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 — NINESIX MONTHS ENDED SEPTEMBER 30, 20182019 AND 20172018


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 ninesix months ended SeptemberJune 30, 20182019 and 20172018 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 TotalP&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 income323
 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 income8
 80
 (12) 70
 146
 
 146
5
 54
 (7) 49
 101
 
 101
Total revenues3,926
 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 expenses2,188
 
 
 
 2,188
 18
 2,206
1,415
 
 
 
 1,415
 
 1,415
Commissions and other underwriting expenses1,188
 
 
 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 expenses31
 95
 
 137
 263
 9
 272
23
 70
 
 104
 197
 
 197
Total costs and expenses3,407
 958
 154
 236
 4,755
 27
 4,782
2,250
 746
 114
 169
 3,279
 33
 3,312
Earnings before income taxes519
 341
 
 (127) 733
 (55) 678
356
 194
 
 (85) 465
 207
 672
Provision for income taxes100
 65
 
 (27) 138
 (12) 126
72
 39
 
 (18) 93
 44
 137
Net earnings, including noncontrolling interests419
 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 Earnings426
 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 TotalP&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 income276
 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 income21
 79
 (14) 68
 154
 
 154
4
 53
 (8) 43
 92
 
 92
Total revenues3,651
 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 expenses2,150
 
 
 
 2,150
 89
 2,239
1,334
 
 
 
 1,334
 
 1,334
Commissions and other underwriting expenses1,046
 
 
 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 expenses26
 90
 
 134
 250
 35
 285
20
 63
 
 91
 174
 
 174
Total costs and expenses3,222
 878
 137
 239
 4,476
 124
 4,600
2,125
 635
 102
 156
 3,018
 
 3,018
Earnings before income taxes429
 283
 
 (130) 582
 (125) 457
362
 224
 
 (90) 496
 (62) 434
Provision for income taxes150
 96
 
 (57) 189
 (43) 146
74
 46
 
 (22) 98
 (13) 85
Net earnings, including noncontrolling interests279
 187
 
 (73) 393
 (82) 311
288
 178
 
 (68) 398
 (49) 349
Less: Net earnings attributable to noncontrolling interests2
 
 
 
 2
 
 2
Less: Net earnings (losses) attributable to noncontrolling interests(6) 
 
 
 (6) 
 (6)
Core Net Operating Earnings277
 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)
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).


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 ninesix months of 20182019 compared to $340362 million in the first ninesix months of 20172018, an increasea decrease of $1616 million (47% (2%). Property and casualty coreThe decrease in pretax earnings were $519 millionreflects lower underwriting profit in the first ninesix 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 20182019 compared to the same period in 2017 due primarily to lower catastrophe losses and higher favorable prior year reserve development as well as2018, 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 ninesix months ended SeptemberJune 30, 20182019 and 20172018 (dollars in millions):


Nine months ended September 30,  Six months ended June 30,  
2018 2017 % Change2019 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 premiums3,815
 3,590
 6%2,411
 2,359
 2%
Change in unearned premiums(220) (236) (7%)(38) (91) (58%)
Net earned premiums3,595
 3,354
 7%2,373
 2,268
 5%
Loss and loss adjustment expenses (*)2,188
 2,150
 2%
Loss and loss adjustment expenses1,415
 1,334
 6%
Commissions and other underwriting expenses1,188
 1,046
 14%812
 771
 5%
Core underwriting gain219
 158
 39%
Underwriting gain146
 163
 (10%)
          
Net investment income323
 276
 17%228
 215
 6%
Other income and expenses, net(23) (5) 360%(18) (16) 13%
Core earnings before income taxes519
 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 ratio60.8% 64.0% (3.2%)59.6% 58.8% 0.8%
Underwriting expense ratio33.0% 31.2% 1.8%34.2% 34.0% 0.2%
Combined ratio93.8% 95.2% (1.4%)93.8%
92.8% 1.0%
          
Aggregate — including exited lines          
Loss and LAE ratio61.4% 66.7% (5.3%)59.7% 58.8% 0.9%
Underwriting expense ratio33.0% 31.2% 1.8%34.2% 34.0% 0.2%
Combined ratio94.4% 97.9% (3.5%)93.9% 92.8% 1.1%


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


Gross Written Premiums
Gross written premiums (“GWP”) for AFG’s property and casualty insurance segment were $5.233.20 billion for the first ninesix months of 20182019 compared to $4.933.12 billion for the first ninesix months of 20172018, an increase of $29676 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 % % ChangeGWP % GWP % % Change
Property and transportation$1,994
 38% $2,062
 42% (3%)$1,018
 32% $1,041
 33% (2%)
Specialty casualty2,667
 51% 2,350
 48% 13%1,808
 57% 1,711
 55% 6%
Specialty financial566
 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 ninesix months of 2018 and2019 compared to 24% of gross written premiums for the first ninesix 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 in2019 2018 Change in
Ceded % of GWP Ceded % of GWP % of GWPCeded % 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 specialty121
   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 ninesix months of 20182019 compared to $3.592.36 billion for the first ninesix months of 20172018, an increase of $22552 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 % % ChangeNWP % NWP % % Change
Property and transportation$1,306
 34% $1,341
 37% (3%)$766
 32% $746
 32% 3%
Specialty casualty1,928
 51% 1,725
 48% 12%1,288
 53% 1,233
 52% 4%
Specialty financial460
 12% 440
 12% 5%294
 12% 307
 13% (4%)
Other specialty121
 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 $3.602.37 billion for the first ninesix months of 20182019 compared to $3.35$2.27 billion for the first ninesix months of 20172018, an increase of $241105 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 % % ChangeNEP % NEP % % Change
Property and transportation$1,250
 35% $1,226
 37% 2%$740
 31% $724
 32% 2%
Specialty casualty1,790
 50% 1,613
 48% 11%1,263
 53% 1,174
 52% 8%
Specialty financial457
 12% 435
 13% 5%297
 13% 308
 13% (4%)
Other specialty98
 3% 80
 2% 23%73
 3% 62
 3% 18%
$3,595
 100% $3,354
 100% 7%$2,373
 100% $2,268
 100% 5%


The $29676 million (6% (2%) increase in gross written premiums for the first ninesix months of 20182019 compared to the first ninesix months of 20172018 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 ninesix months of 20182019. 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 ninesix months of 20182019 compared to the first ninesix months of 2017. This decrease was largely the2018, due primarily to delayed acreage reporting from insureds as a result of lower year-over-yearexcess moisture and late planting of corn and soybean crops. Management expects that the delayed crop premiums will be included in thethird 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. Grossgross written premiums in the other businesses infor this group for the first six months of 2019 grew by 6% in the first nine months of 20188% when compared to the first ninesix 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 ninesix months of 2018.2019. Reinsurance premiums ceded as a percentage of gross written premiums were comparabledecreased 3 percentage points in the first ninesix months of 2019 compared to the first six months of 2018, andreflecting lower cessions in the first nine months of 2017.crop insurance business.



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





Specialty casualty Gross written premiums increased$31797 million (13%6%) in the first ninesix months of 20182019 compared to the first ninesix months of 20172018 due primarily to growth at Neon. Higher gross writtenthe 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 toand 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 thanincreased approximately 1% for this group in the first ninesix 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 ninesix months of 20182019 compared to the first ninesix 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 ninesix months of 20182019 compared to the first ninesix months of 20172018 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 ninesix months of 2018.2019. Reinsurance premiums ceded as a percentage of gross written premiums increased 4 percentage points for the first ninesix months of 20182019 compared to the first ninesix 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 $37decreased $10 million (44%(14%) in the first ninesix months of 20182019 compared to the first ninesix months of 2017,2018, reflecting an increasea 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 20172019 2018 Change 2019 2018
Property and transportation                  
Loss and LAE ratio69.2% 69.1% 0.1%    65.4% 63.4% 2.0%    
Underwriting expense ratio26.3% 25.2% 1.1%    28.8% 28.8% %    
Combined ratio95.5% 94.3% 1.2%    94.2% 92.2% 2.0%    
Underwriting profit      $56
 $70
      $43
 $56
                  
Specialty casualty                  
Loss and LAE ratio60.7% 66.4% (5.7%)    60.8% 61.5% (0.7%)    
Underwriting expense ratio32.6% 30.7% 1.9%    32.6% 32.5% 0.1%    
Combined ratio93.3% 97.1% (3.8%)    93.4% 94.0% (0.6%)    
Underwriting profit      $119
 $46
      $83
 $70
                  
Specialty financial                  
Loss and LAE ratio38.0% 41.4% (3.4%)    35.3% 37.0% (1.7%)    
Underwriting expense ratio52.0% 49.0% 3.0%    53.3% 50.9% 2.4%    
Combined ratio90.0% 90.4% (0.4%)    88.6% 87.9% 0.7%    
Underwriting profit      $46
 $42
      $34
 $37
                  
Total Specialty                  
Loss and LAE ratio60.8% 64.0% (3.2%)    59.6% 58.8% 0.8%    
Underwriting expense ratio33.0% 31.2% 1.8%    34.2% 34.0% 0.2%    
Combined ratio93.8% 95.2% (1.4%)    93.8% 92.8% 1.0%    
Underwriting profit      $220
 $161
      $148
 $165
                  
Aggregate — including exited lines                  
Loss and LAE ratio61.4% 66.7% (5.3%)    59.7% 58.8% 0.9%    
Underwriting expense ratio33.0% 31.2% 1.8%    34.2% 34.0% 0.2%    
Combined ratio94.4% 97.9% (3.5%)    93.9% 92.8% 1.1%    
Underwriting profit      $201
 $69
      $146
 $163



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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 ninesix months of 20182019 compared to $161$165 million for the first ninesix months of 2017, an increase2018, a decrease of $59$17 million (37%(10%) with. The lower underwriting profit in the Specialty casualtyfirst six months of 2019 reflects lower underwriting profits in the Property and transportation and Specialty financial sub-segments, reportingpartially 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 ninesix months of 2018 compared to $70 million for the first nine months of 2017, a decrease of $1413 million (20% (23%). HigherLower 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 resultstransportation 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 operationstargeted markets and workers’ compensation businesses were more thanpartially offset by lower underwriting profits in the propertyexcess and inland marine, aviation, trucking and equinesurplus 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 casualtyfinancial Underwriting profit for this group was $11934 million for the first ninesix months of 20182019 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 ninesix 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 lossesunderwriting 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 ninesix months of 20182019 compared to an underwriting profit of $3$2 million in the first ninesix months of 2017,2018, a decreasechange of $4$14 million (133%(700%). This decrease is due primarily tochange 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 ninesix months of 20182019 compared to earnings in the first ninesix 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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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 ninesix months of 20182019 compared to 66.7%58.8% for the first ninesix months of 20172018, a decreasean increase of 5.30.9 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 inAmount Ratio Change in
2018 2017 2018 2017 Ratio2019 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 losses27
 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 losses17
 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 losses18
 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 losses64
 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 losses64
 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 ninesix months of 20182019 compared to 62.7%62.0% for the first ninesix months of 20172018, an increase of 0.60.3 percentage points.


Property and transportation   The 1.60.8 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 businessesSingapore branch in the first ninesix months of 20182019 compared to the first ninesix months of 2017.2018.


Specialty casualty   The 0.41.0 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 changeand in the mix of business, partially offset by an increase in the lossgeneral liability and LAE ratio in the targeted marketsprofessional 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 $15188 million in the first ninesix months of 20182019 compared to $90$102 million in the first ninesix months of 2017, an increase2018, a decrease of $61$14 million (68%(14%).


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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 ninesix 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 ninesix months of 20172019 reflects lower than expected losses in the crop and equine businesses and lower than expectedanticipated claim severity in the property and inland marine and transportationworkers’ compensation businesses, partially offset by higher than expected claim severity in the ocean marine business.

Specialty casualtyexcess and surplus lines businesses and higher than expected losses at Neon. Net favorable reserve development of $87$50 million in the first ninesix 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 severitybusinesses.

Specialty financial Net favorable reserve development of $15 million in the executive liability business. This was partially offset by higherfirst six months of 2019 reflects lower than expected claim frequency and severity in the excesssurety and surplus lines. Net favorable reserve development of $34 million in the first nine months of 2017 reflectsfinancial 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 ninesix 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 ninesix months of 2018 and2018. The adverse net adverse reserve development of $2 million in the first nine months of 2017. The favorable development in the first ninesix 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 ninesix 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 ninesix 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.


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



Commissions and Other Underwriting Expenses
AFG’s property and casualty commissions and other underwriting expenses (“U/W Exp”) were $1.19 billion$812 million in the first ninesix 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 ninesix 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 1.80.2 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 in2019 2018 Change in
U/W Exp % of NEP U/W Exp % of NEP % of NEPU/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 casualty584
 32.6% 495
 30.7% 1.9%412
 32.6% 381
 32.5% 0.1%
Specialty financial237
 52.0% 213
 49.0% 3.0%158
 53.3% 157
 50.9% 2.4%
Other specialty38
 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.

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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 1.10.1 percentage points in the first ninesix months of 20182019 compared to the first ninesix months of 2017,2018, reflecting lower premiumsceding commissions received from reinsurers in the cropexcess 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 Propertyat Neon and transportation group and an increase in the expense ratio in the transportation businesses.impact of higher net earned premiums at Neon.


Specialty casualtyfinancial   Commissions and other underwriting expenses as a percentage of net earned premiums increased 1.92.4 percentage points in the first ninesix months of 20182019 compared to the first ninesix months of 20172018, 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 commissionpartially offset by a lower underwriting expense reduction due to hurricane lossesratio in the period.fidelity business.


Property and Casualty Net Investment Income
Net investment income in AFG’s property and casualty insurance operations was $323228 million in the first ninesix months of 20182019 compared to $276215 million in the first ninesix months of 20172018, 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 % Change2019 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 ninesix months of 20182019 as compared to the first ninesix months of 20172018 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 ninesix months of 20182019 compared to 3.73%4.14% for the first ninesix months of 20172018, an increasea decrease of 0.410.03 percentage points due primarily to the higher earningslower income from limited partnerships and similar investments. The high returnsAFG’s property and casualty insurance operations recorded $23 million in earnings from limited partnerships and similar investments should not necessarily be expectedand 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.


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



Property and Casualty Other Income and Expenses, Net
Other income and expenses, net for AFG’s property and casualty insurance operations was a net expense of $23$18 million for the first ninesix months of 20182019 compared to $5$16 million for the first ninesix months of 20172018, 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 20172019 2018
Other income   $5
 $4
Income from the sale of real estate$
 $16
Other8
 5
Total other income8
 21
Other expenses      
Amortization of intangibles7
 6
6
 4
Other24
 20
17
 16
Total other expense31
 26
23
 20
Other income and expenses, net$(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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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 ninesix months of 20182019 compared to $283$224 million in the first ninesix months of 20172018, an increasea decrease of $58$63 million (20% (28%). This decrease in AFG’s GAAP annuity segment results for the first ninesix months of 20182019 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 ninesix months of 2018 andis due primarily to the unfavorable impact of significantly lower investment yields due tothan 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 byin 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 wasperiod, partially offset by the negative impact of higher interest on the embedded derivative (from growthstrong stock market performance in the FIA business2019 period and higher interest rates) and higher than expected option costsan 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 ninesix months ended SeptemberJune 30, 20182019 and 20172018 (dollars in millions).:
Nine months ended September 30,  Six months ended June 30,  
2018 2017 % Change2019 2018 % Change
Revenues:          
Net investment income$1,219
 $1,082
 13%$886
 $806
 10%
Other income:          
Guaranteed withdrawal benefit fees48
 43
 12%33
 32
 3%
Policy charges and other miscellaneous income32
 36
 (11%)21
 21
 %
Total revenues1,299
 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 expenses95
 90
 6%70
 63
 11%
Total costs and expenses958
 878
 9%746
 635
 17%
Earnings before income taxes$341
 $283
 20%
Core earnings before income taxes194
 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 FIAs14
 (22) (164%)
Earnings before income taxes$341
 $283
 20%

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




(*)Annuity benefits consisted of the following (dollars in millions):
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 annuities4
 4
 %
Other annuity benefits:     
Change in expected death and annuitization reserve13
 13
 %
Amortization of sales inducements15
 14
 7%
Change in guaranteed withdrawal benefit reserve60
 51
 18%
Change in other benefit reserves29
 36
 (19%)
Total other annuity benefits117
 114
 3%
Total before impact of derivatives related to FIAs and unlocking639
 587
 9%
Derivatives related to fixed-indexed annuities:     
Embedded derivative mark-to-market242
 386
 (37%)
Equity option mark-to-market(271) (338) (20%)
Impact of derivatives related to FIAs(29) 48
 (160%)
Unlocking54
 
 %
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 options287
 233
 23%
Related impact on the amortization of deferred policy acquisition costs68
 (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%


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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):
 Six months ended June 30,
 2019 2018
Interest credited — fixed$193
 $175
Include cost of equity options287
 233
Cost of funds480
 408
    
Interest credited — fixed component of variable annuities2
 3
Other annuity benefits, excluding the impact of interest rates and the stock market on FIAs56
 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 FIAs198
 (33)
Accretion of guaranteed minimum FIA benefits201
 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.



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


Net Spread on Fixed Annuities (excludes variable annuity earnings)
The table below (dollars in millions) details the components of the spreads for AFG’s fixed annuity operations (including fixed-indexed and variable-indexed annuities):
Nine months ended September 30,  Six months ended June 30,  
2018 2017 % Change2019 2018 % Change
Average fixed annuity investments (at amortized cost)$33,964
 $30,919
 10%$37,449
 $33,469
 12%
Average fixed annuity benefits accumulated34,240
 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 spread2.74% 2.63%  2.05% 2.30%  
          
Policy charges and other miscellaneous income0.10% 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 annuities0.11% (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 FIAs1.10% 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 annuities1.35% 1.23%  0.86% 1.36%  


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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:
 Nine months ended September 30,
 2018 2017
Net spread earned on fixed annuities — before the impact of unlocking and derivatives related to FIAs1.41% 1.32%
Unlocking(0.11%) %
Impact of derivatives related to fixed-indexed annuities:   
Change in fair value of derivatives0.11% (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 annuities1.35% 1.23%

(*)An estimateExcluding 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 ofimpact (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 ninesix months of 20182019 was $1.22 billion886 million compared to $1.08 billion806 million for the first ninesix months of 20172018, an increase of $13780 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), increaseddecreased by 0.120.08 percentage points to 4.76%4.71% from 4.64%4.79% for the first ninesix months of 20182019 compared to the first ninesix months of 2017. This increase2018. 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 JulyApril 1, 2017,2018, through SeptemberJune 30, 2018, $4.42019, $6.2 billion in annuity segment investments with an average yield of 5.01%5.0% were redeemed or sold whilewith the investments purchased during that period (with new premium dollars and the redemption/sale proceeds) hadproceeds reinvested at an average yield at purchase of 4.26%.approximately 0.4% lower yield.


Annuity Interest Credited — FixedCost of Funds
Interest credited — fixedCost of funds for the first ninesix months of 2018 was $5182019 were $480 million compared to $469$408 million for the first ninesix 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 creditedcost 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 ninesix months of 20182019 compared to the first ninesix months of 2017 due2018 reflecting higher renewal option costs.


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


The following table provides 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 annuities120
 117
Fixed component of fixed-indexed annuities45
 37
Immediate annuities12
 12
Pension risk transfer products2
 
Federal Home Loan Bank advances14
 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 reserve39
 33
Change in other benefit reserves9
 1
Other annuity benefits56
 44
Offset guaranteed withdrawal benefit fees(33) (32)
Other annuity benefits excluding the impact of the stock market and interest rates, net23

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 0.11decreased 0.25 percentage points to 2.74%2.05% from 2.63%2.30% in the first ninesix months of 20182019 compared to the same period in 20172018 due primarily to higher earnings from limited partnershipsrenewal 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.



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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 ninesix 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 ninesix months of 20182019 compared to the first ninesix months of 2017.2018.



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


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

Other Annuity Benefits, Net of Guaranteed Withdrawal Benefit Fees
Other annuity benefits, net of guaranteed withdrawal benefit fees (excluding the impact of unlocking), for the first nine months of 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 inducements15
 14
Change in guaranteed withdrawal benefit reserve60
 51
Change in other benefit reserves29
 36
Other annuity benefits117
 114
Offset guaranteed withdrawal benefit fees(48) (43)
Other annuity benefits, net$69
 $71

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

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


Annuity Acquisition Expenses
Annuity acquisition expenses for the first nine months of 2018 were $199 million compared to $153 million for the first nine months of 2017, an increase of $46 million (30%). Excluding the $28 million favorable impact on amortization of DPAC from the unlocking recorded in the second quarter of 2018, annuity acquisition expenses were $227 million for the first nine months of 2018, an increase of $74 million (48%) comparedIn addition to the first nine monthsimpact of 2017, reflecting growth inunlocking, the business andfollowing table illustrates the acceleration (in 2018) and acceleration/deceleration (in 2017) of DPACthe amortization related toof
deferred policy acquisition costs (“DPAC”) resulting from changes in the fair value of derivatives related to FIAs. Excluding the impactFIAs 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 duringon the first nine monthsaccounting 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) resultedand other impacts on changes in a partially offsetting acceleration of the amortization of DPAC. In contrast, the negative impact of lower than anticipatedstock market and interest rates duringon the
accounting for FIAs over or under option costs were $127 million for the first ninesix months of 2017 on2019 compared to $118 million for the fair valuefirst six months of derivatives related to FIAs resulted2018, an increase of $9 million (8%), reflecting growth in a partially offsetting deceleration of the amortization of DPAC.annuity business.



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


The table below illustrates the estimated impact of fair value accounting for derivatives related to fixed-indexed annuities on annuity acquisition expenses as a percentage of average fixed annuity benefits accumulated (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 DPAC0.80% 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 accumulated0.86% 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 PVFPpresent 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 rates0.66% 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 accumulated0.30% 0.75%


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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 ninesix months of 20182019 compared to $9063 million for the first ninesix months of 20172018, 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 decreasedincreased 0.01 percentage points to 0.37% from 0.38%0.36% for the first ninesix months of 20182019 compared to the first ninesix months of 2017. The decrease in annuity other expenses as a percentage of average fixed annuity benefits accumulated is2018 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
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.


ExcludingAs 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 changecost 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 $29 million inmillions):
 Six months ended June 30,  
 2019 2018 % Change
Change in the fair value of derivatives related to FIAs$(198) $33
 (700%)
Accretion of guaranteed minimum FIA benefits(201) (164) 23%
Other annuity benefits
 (35) (100%)
Less cost of equity options287
 233
 23%
Related impact on the amortization of DPAC68
 (39) (274%)
Impact on annuity segment earnings before income taxes$(44) $28
 (257%)

During the first ninesix 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 $48a 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 ninesix 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, thisthe 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 pointsof 0.24% in the first six months of 2019 compared to a net expense reduction of 0.11%0.17% in the first ninesix 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 aunlocking 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).



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



Fluctuations in interest rates and the stock market, among other factors, can cause volatility in the periodic measurement of fair value of the embedded derivative that management believes can be inconsistent with the long-term economics of these products. The table below illustrates the impact of fair value accounting for derivatives related to fixed-indexed annuities on the annuity segment’s earnings before income taxes (dollars in millions):
 Nine months ended September 30,  
 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 annuities29
 (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 expected37
 (38) (197%)
Change in the stock market, including volatility16
 20
 (20%)
Renewal option costs lower (higher) than expected(7) 4
 (275%)
Other, including the impact of actual versus expected lapses(7) 3
 (333%)
Impact of derivatives related to FIAs$14
 $(22) (164%)

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


Annuity Net Spread Earned on Fixed Annuities
AFG’s net spread earned on fixed annuities increased 0.12excluding 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 ninesix months of 2018 compared to2019 from 1.35% in the same period in 2017first 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 offsetother 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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Management’s Discussion and Analysis of Financial Condition and Results of Operations — Continued



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


For certain products, annuity benefits accumulated also includes reserves for accrued persistency and premium bonuses, excess benefits expected to be paid on future deaths and annuitizations (“EDAR”) and guaranteed withdrawal benefits. Annuity benefits accumulated also includes amounts advanced from the Federal Home Loan Bank of Cincinnati. The following table is a progression of AFG’s annuity benefits accumulated liability for the ninesix months ended SeptemberJune 30, 20182019 and 20172018 (in millions):
Nine months ended September 30,Six months ended June 30,
2018 20172019 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 credited518
 469
Cost of funds480
 408
Embedded derivative mark-to-market242
 386
713
 19
Change in other benefit reserves88
 92
(54) (10)
Unlocking55
 

 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 gains8
 138
192
 32
Fixed component of variable annuities176
 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 — fixed350
 559
 (37%)
Retail single premium annuities — indexed1,026
 751
 37%
Retail single premium annuities — fixed60
 55
 9%
Broker dealer single premium annuities — indexed936
 559
 67%
Broker dealer single premium annuities — fixed10
 6
 67%
Pension risk transfer57
 
 %
Education market — fixed and indexed annuities146
 133
 10%
Total fixed annuity premiums3,906
 3,410
 15%
Variable annuities19
 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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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 — fixed657
 236
 178%
Retail single premium annuities — indexed575
 672
 (14%)
Retail single premium annuities — fixed65
 43
 51%
Broker dealer single premium annuities — indexed416
 614
 (32%)
Broker dealer single premium annuities — fixed14
 7
 100%
Pension risk transfer60
 1
 5,900%
Education market — fixed and indexed annuities93
 100
 (7%)
Total fixed annuity premiums2,733
 2,534
 8%
Variable annuities11
 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 netSee “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 annuityof 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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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 ninesix months ended SeptemberJune 30, 20182019 and 20172018 (in millions):
Nine months ended September 30,Six months ended June 30,
2018 20172019 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 earnings3
 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 ninesix months ended SeptemberJune 30, 20182019 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 ninesix months of 20182019 compared to $165$90 million in the first ninesix 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 ninesix months ended SeptemberJune 30, 20182019 and 20172018 (dollars in millions):
Nine months ended September 30,  Six months ended June 30,  
2018 2017 % Change2019 2018 % Change
Revenues:          
Life, accident and health net earned premiums$18
 $17
 6%$11
 $12
 (8%)
Net investment income21
 24
 (13%)24
 11
 118%
Other income — P&C fees50
 46
 9%35
 32
 9%
Other income20
 22
 (9%)14
 11
 27%
Total revenues109
 109
 %84
 66
 27%
          
Costs and Expenses, excluding interest charges on borrowed money:     
Costs and Expenses:     
Property and casualty insurance — commissions and other underwriting expenses17
 16
 6%13
 10
 30%
Life, accident and health benefits32
 21
 52%17
 22
 (23%)
Life, accident and health acquisition expenses4
 3
 33%2
 2
 %
Other expense — expenses associated with P&C fees33
 30
 10%22
 22
 %
Other expenses (*)104
 104
 %
Other expenses82
 69
 19%
Costs and expenses, excluding interest charges on borrowed money190
 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 money46
 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.


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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 ninesix months of 20182019 compared to net earned premiums of $17$12 million and related benefits and acquisition expenses of $24 million in the first ninesix months of 2017.2018. The $11$5 million (52%(23%) increasedecrease in life, accident and health benefits reflects higherlower claims in both the run-off long-term care and run-off life insurance businesses.business.



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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 ninesix months of 20182019 compared to $2411 million in the first ninesix months of 20172018, a decreasean 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 ninesix months of 20182019 compared to an increasea decrease in value by $4$2 million in the first ninesix 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 ninesix months of 2018,2019, AFG collected $50$35 million in fees for these services compared to $46$32 million in the first ninesix months of 2017.2018. Management views this fee income, net of the $33$22 million in both the first ninesix 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 ninesix months of 20182019 and 20172018, 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 ninesix months of 2018 and2019 compared to $3 million the first ninesix 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 ninesix months of 2019 compared to $69 million the first six months of 2018, andan increase of $13 million (19%). This increase reflects a $3 million charitable donation in the first ninesix months of 2017. The impact of lower2019 and higher holding company expenses related to employee benefit plans that are tied to stock market performance in the first ninesix months of 20182019 compared to the first ninesix months of 2017 was2018, 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 quarterfirst 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 ninesix months of 20182019 compared to $6531 million in the first ninesix months of 20172018, a decreasean 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 rateexpense for the first ninesix months of 20182019 as compared to the first ninesix months of 20172018 reflects the following financing transactions completed by AFG between April 1, 2017 and December 31, 2017:
Issued $350 millionissuance 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 Notes5.875% Subordinated Debentures on August 25, 2017March 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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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 lossesgains of $28240 million in the first ninesix months of 20182019 compared to a net loss of $162 million in the first ninesix months of 20172018, an increasea 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 20172019 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 items11
 (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 PoliciesInvestments,” beginning in January 2018, all equity securities other than those accounted for under the equity method are carried at fair value through net earnings. This amount includesThese 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 SeptemberJune 30, 2018.


The $39$226 million net realized lossgain from the change in the fair value of equity securities in the first ninesix 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 toon 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 ninesix months of 20182019 compared to $146$85 million for the first ninesix months of 2017, a decrease2018, an increase of $20$52 million (14%(61%). See NoteLM — “Income Taxesto the financial statements for an analysis of items affecting AFG’s effective tax rate.


Consolidated Noncontrolling Interests   AFG’s consolidated net earnings (losses) attributable to noncontrolling interests was a net loss of $7$4 million for the first ninesix months of 20182019 compared to net earnings of $2$6 million for the first ninesix months of 20172018. Losses attributable to noncontrolling interests for the first nine months of 2018 are related toBoth 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 PoliciesInvestmentsto 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 thatearnings.

See Note A — “Accounting PoliciesLeasesand Note K — “Leasesto the needfinancial statements for a

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


valuation allowanceaccounting 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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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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ITEM 3
Quantitative and Qualitative Disclosure about Market Risk


As of SeptemberJune 30, 20182019, there were no material changes to the information provided in Item 7A — Quantitative and Qualitative Disclosures about Market Risk of AFG’s 20172018 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 thirdsecond fiscal quarter of 20182019 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 thirdsecond fiscal quarter of 20182019 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 ninesix months of 20182019. As of SeptemberJune 30, 2018,2019, there were 4,132,8385,000,000 remaining shares that may be repurchased under the Plans authorized by AFG’s Board of Directors in December 2014February 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 2,21043,470 shares of its Common Stock (at an average of $111.31$99.11 per share) in August 2018 and an additional 24,310the 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 monthsMay 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

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


ITEM 6
Exhibits
 
Number Exhibit Description  
 
  
   
   
   
101101.INS The following financial information from American Financial Group’s Form 10-Q forXBRL Instance Document - the quarter ended September 30, 2018, formattedinstance 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 SheetInline XBRL Taxonomy Extension Schema Document.  
101.CAL       (ii) Consolidated Statement of EarningsInline XBRL Taxonomy Extension Calculation Linkbase Document  
101.DEF      (iii) Consolidated Statement of Comprehensive IncomeInline XBRL Taxonomy Extension Definition Linkbase Document  
101.LAB      (iv) Consolidated Statement of Changes in EquityInline 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.  
 

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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.
    
NovemberAugust 8, 20182019By: /s/ Joseph E. (Jeff) Consolino
   Joseph E. (Jeff) Consolino
   Executive Vice President and Chief Financial Officer


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