SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-K/A
Amendment No. 1 to
Annual Report Pursuant to Section 13 or 15(d) of the
Securities Exchange Act of 1934
For the Fiscal Year Ended Commission File
December 31, 1999 No. 1-7361
AMERICAN FINANCIAL CORPORATION
Incorporated under IRS Employer I.D.
the Laws of Ohio No. 31-0624874
One East Fourth Street, Cincinnati, Ohio 45202
(513) 579-2121
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This Form 10-K/A is being filed to correct one number in the property and
casualty insurance loss development table on page 11. The re-estimated
liability for 1998 (in millions) has been changed to $3,203 (from $3,283 as
originally reported). Related amounts and percentages appearing on page 11,
which are derived from this number, have also been changed. This filing
includes Item 1 as amended and in its entirety.
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PART I
ITEM 1
Business
--------
Please refer to "Forward Looking Statements" following the Index in front of
this Form 10-K.
Introduction
American Financial Corporation ("AFC") is a holding company which, through
its subsidiaries, is engaged primarily in private passenger automobile and
specialty property and casualty insurance businesses and in the sale of
tax-deferred annuities and certain life and supplemental health insurance
products. AFC's property and casualty operations originated in the 1800's and
make up one of the twenty five largest property and casualty groups in the
United States based on statutory net premiums written. AFC was incorporated as
an Ohio corporation in 1955. Its address is One East Fourth Street, Cincinnati,
Ohio 45202; its phone number is (513) 579-2121. At December 31, 1999, all of the
outstanding Common Stock of AFC was owned by American Financial Group, Inc.
("AFG").
At the close of business on December 31, 1996, AFG contributed to AFC 81% of
the common stock of American Premier Underwriters, Inc. ("APU" or "American
Premier"). Because AFC and American Premier have been under the common control
of AFG since merger transactions completed in April 1995 (the "Mergers"), the
acquisition of American Premier has been recorded by AFC at AFG's historical
cost in a manner similar to a pooling of interests. Accordingly, the historical
consolidated financial statements of AFC for periods subsequent to the Mergers
have been restated to include the accounts of American Premier.
General
Generally, companies have been included in AFC's consolidated financial
statements when the ownership of voting securities has exceeded 50%; for
investments below that level but above 20%, AFC has accounted for the
investments as investees. (See Note E to AFC's financial statements.) The
following table shows AFC's percentage ownership of voting securities of its
significant affiliates over the past several years:
Voting Ownership at December 31,
--------------------------------
1999 1998 1997 1996 1995
---- ---- ---- ---- ----
American Premier Underwriters 81% 81% 81% 81% (a)
Great American Insurance Group 100% 100% 100% 100% 100%
American Annuity Group 83% 82% 81% 81% 81%
American Financial Enterprises 80% 80% 80% 83% 83%
Chiquita Brands International 36% 37% 39% 43% 44%
Citicasters - - - (b) 38%
(a) Exchanged for shares of American Financial Group in April 1995.
(b) Sold in September 1996.
The following summarizes the more significant changes in ownership
percentages shown in the above table.
American Premier Underwriters In April 1995, APU became a subsidiary of AFG
as a result of the Mergers.
1
Chiquita Brands International During the second half of 1997 and the first
half of 1998, Chiquita issued an aggregate of 4.6 million shares and 4.0 million
shares of its common stock, respectively, in connection with the purchase of new
businesses.
Citicasters In 1996, the investment in Citicasters was sold to an
unaffiliated company.
Property and Casualty Insurance Operations
Following the sale of substantially all of its Commercial lines division,
AFC's property and casualty group is engaged primarily in private passenger
automobile and specialty insurance businesses. Accordingly, AFC manages its
property and casualty group as two major business groups: Personal and
Specialty. Each group reports to an individual senior executive and is comprised
of multiple business units which operate autonomously but with certain strong
central controls and full accountability. Decentralized control allows each unit
the autonomy necessary to respond to local and specialty market conditions while
capitalizing on the efficiencies of centralized investment and administrative
support functions. AFC's property and casualty insurance operations employ
approximately 7,800 persons.
AFC sold the Commercial lines division to Ohio Casualty Corporation in
December 1998 for approximately $300 million plus warrants to purchase 6 million
(post split) shares of Ohio Casualty common stock. AFC may receive up to an
additional $40 million in the year 2000 based upon the retention and growth
through May 31, 2000 of the insurance businesses acquired by Ohio Casualty. The
commercial lines business sold generated net written premiums of approximately
$230 million in 1998 prior to the sale and $315 million in 1997.
In April 1999, AFC acquired Worldwide Insurance Company (formerly, Providian
Auto and Home Insurance Company), for $157 million in cash. The purchase price
reflects about $45 million in capital and surplus retained by Worldwide that had
been anticipated to be paid as a dividend by Worldwide after AFC's acquisition.
Worldwide is a provider of direct response private passenger automobile
insurance and is licensed in 45 states. The acquisition provides AFC with a
significant base for selling private passenger auto insurance business and a
variety of other insurance products directly to consumers, including over the
Internet. In 1999, Worldwide generated net written premiums of $94 million,
including $71 million after its acquisition.
AFC operates in a highly competitive industry that is affected by many
factors which can cause significant fluctuations in its results of operations.
The industry has historically been subject to pricing cycles characterized by
periods of intense competition and lower premium rates (a "downcycle") followed
by periods of reduced competition, reduced underwriting capacity due to lower
policyholders' surplus and higher premium rates (an "upcycle"). The property and
casualty insurance industry has been in an extended downcycle for over a decade,
although early indications of some price firming and increases are being seen in
certain specialty markets and in the private passenger automobile market.
The primary objective of AFC's property and casualty insurance operations is
to achieve underwriting profitability. Underwriting profitability is measured by
the combined ratio which is a sum of the ratios of underwriting losses, loss
adjustment expenses ("LAE"), underwriting expenses and policyholder dividends to
premiums. When the combined ratio is under 100%, underwriting results are
generally considered profitable; when the ratio is over 100%, underwriting
results are generally considered unprofitable. The combined ratio does not
reflect investment income, other income or federal income taxes.
2
Management's focus on underwriting performance has resulted in a statutory
combined ratio averaging 104.0% for the period 1995 to 1999, as compared to
105.4% for the property and casualty industry over the same period (Source:
"Best's Review/Preview - Property/Casualty" - January 2000 Edition). AFC
believes that its product line diversification and underwriting discipline have
contributed to the Company's ability to consistently outperform the industry's
underwriting results. Management's philosophy is to refrain from writing
business that is not expected to produce an underwriting profit even if it is
necessary to limit premium growth to do so.
Generally, while financial data is reported on a statutory basis for
insurance regulatory purposes, it is reported in accordance with generally
accepted accounting principles ("GAAP") for shareholder and other investment
purposes. In general, statutory accounting results in lower capital surplus and
net earnings than result from application of GAAP. Major differences include
charging policy acquisition costs to expense as incurred rather than spreading
the costs over the periods covered by the policies; recording bonds and
redeemable preferred stocks primarily at amortized cost; netting of reinsurance
recoverables and prepaid reinsurance premiums against the corresponding
liability; requiring additional loss reserves; and charging to surplus certain
assets, such as furniture and fixtures and agents' balances over 90 days old.
Unless indicated otherwise, the financial information presented for the
property and casualty insurance operations herein is presented based on GAAP and
includes for all periods (i) the insurance operations of AFC and American
Premier and (ii) the commercial lines businesses sold up to the sale date.
The following table shows (in millions) certain information of AFC's property
and casualty insurance operations.
1999 1998 1997
---- ---- ----
Statutory Basis
---------------
Premiums Earned $ 2,197 $ 2,657 $2,802
Admitted Assets 6,332 6,463 6,983
Unearned Premiums 1,005 914 1,133
Loss and LAE Reserves 3,525 3,702 3,475
Capital and Surplus 1,664 1,840 1,916
GAAP Basis
----------
Premiums Earned $ 2,211 $ 2,699 $2,824
Total Assets 9,487 10,053 9,212
Unearned Premiums 1,326 1,233 1,329
Loss and LAE Reserves 4,795 4,773 4,225
Shareholder's Equity 3,158 3,174 3,019
The following table shows the segment, independent ratings, and size (in
millions) of AFC's major property and casualty insurance subsidiaries. AFC
continues to focus on growth opportunities in what it believes to be more
profitable specialty and private passenger auto businesses which represented the
bulk of 1999 net written premiums.
Net Written Premiums
--------------------
Company (Ratings - AM Best/S&P) Personal Specialty
--------------------------------------- -------- ---------
Great American Pool(*) A A+ $ 204 $ 811
Republic Indemnity A A+ - 135
Mid-Continent A A+ - 105
National Interstate A- - - 37
American Empire Surplus Lines A A+ - 15
Atlanta Casualty A- A+ 281 -
Infinity A A+ 308 -
Windsor A A+ 229 -
Leader A- A+ 125 -
Other 7 8
------ ------
$1,154 $1,111
====== ======
(*) The Great American Pool represents approximately 15 subsidiaries,
including Great American Insurance, American National Fire and Worldwide.
Duff & Phelps assigned the Great American Pool a rating of AA- (very
high).
3
The following table shows the performance of AFC's property and casualty
insurance operations (dollars in millions):
1999 1998 1997
---- ---- ----
Net written premiums $2,263 $2,609(a) $2,858
====== ====== ======
Net earned premiums $2,211 $2,699 $2,824
Loss and LAE 1,589 2,001 2,076
Special A&E charge - 214 -
Underwriting expenses 661 764 783
Policyholder dividends 4 9 7
------ ------ ------
Underwriting loss ($ 43) ($ 289) ($ 42)
====== ====== ======
GAAP ratios:
Loss and LAE ratio 71.9% 82.1% 73.5%
Underwriting expense ratio 29.9 28.3 27.7
Policyholder dividend ratio .2 .3 .2
----- ----- -----
Combined ratio (b) 102.0% 110.7% 101.4%
===== ===== =====
Statutory ratios:
Loss and LAE ratio 73.4% 82.7% 73.4%
Underwriting expense ratio 30.0 27.9 27.3
Policyholder dividend ratio .3 .5 .7
----- ----- -----
Combined ratio (b) 103.7% 111.1% 101.4%
===== ===== =====
Industry statutory combined ratio (c) 107.5% 105.6% 101.6%
(a) Includes $232 million generated by the Commercial lines sold.
(b) The 1998 combined ratios include effects of the strengthening of
insurance reserves relating to asbestos and other environmental matters
("A&E") of 7.9 percentage points (GAAP) and 8.0 percentage points
(statutory).
(c) Ratios are derived from "Best's Review/Preview - Property/Casualty"
(January 2000 Edition).
As with other property and casualty insurers, AFC's operating results can be
adversely affected by unpredictable catastrophe losses. Certain natural
disasters (hurricanes, tornadoes, floods, forest fires, etc.) and other
incidents of major loss (explosions, civil disorder, fires, etc.) are classified
as catastrophes by industry associations. Losses from these incidents are
usually tracked separately from other business of insurers because of their
sizable effects on overall operations. AFC generally seeks to reduce its
exposure to such events through individual risk selection and the purchase of
reinsurance. Major catastrophes in recent years included midwestern hailstorms
and tornadoes and Hurricanes Bonnie and Georges in 1998. Total net losses to
AFC's insurance operations from catastrophes were $24 million in 1999; $60
million in 1998; and $20 million in 1997. These amounts are included in the
tables herein.
4
Personal
General The Personal group writes primarily private passenger automobile
liability and physical damage insurance, and to a lesser extent, homeowners'
insurance.
The majority of AFC's auto premiums has been from sales in the nonstandard
market covering drivers unable to obtain insurance through standard market
carriers due to factors such as age, record of prior accidents, driving
violations, particular occupation or type of vehicle. Though the Personal group
will continue to write coverage in this market, it has launched an expanded
approach making personal automobile coverage available to drivers across a full
spectrum from preferred to nonstandard with emphasis on the preferred and
standard categories. AFC's approach to its auto business is to develop tailored
rates for its personal automobile customers based on a variety of factors,
including the driving record of the insureds, the number of and type of vehicles
covered, etc.
AFC's approach to homeowners business is to limit exposure in locations which
have significant catastrophic potential (such as windstorms, earthquakes and
hurricanes). Since the beginning of 1998, AFC has ceded 90% of its homeowners'
business through reinsurance agreements and will continue to do so at least
through the end of 2000.
The Personal group writes business in 49 states and holds licenses to write
policies in all states and the District of Columbia. The U.S. geographic
distribution of the Personal group's statutory direct written premiums in 1999
compared to 1995, was as follows:
1999 1995 1999 1995
---- ---- ---- ----
California 18.1% 5.8% Arizona 2.1% 3.3%
New York 9.7 * Tennessee * 3.1
Georgia 9.6 6.8 Oklahoma * 2.5
Connecticut 9.4 8.4 Indiana * 2.5
Florida 9.0 8.7 Washington * 2.2
Pennsylvania 5.1 7.2 Mississippi * 2.2
Texas 4.6 19.5 Alabama * 2.2
New Jersey 3.4 2.0 Ohio * 2.0
North Carolina 2.4 3.0 Other 26.6 18.6
----- -----
--------------- 100.0% 100.0%
(*) less than 2% ===== =====
Management believes that the Personal group's underwriting success has been
due, in part, to the refinement of various risk profiles, thereby dividing the
consumer market into more defined segments which can be underwritten or priced
properly. In addition, the Personal group has implemented cost control measures
both in the underwriting and claims handling areas.
5
The following table shows the performance of AFC's Personal group insurance
operations (dollars in millions):
1999 1998 1997
---- ---- ----
Net written premiums $1,154 $1,279 $1,345
====== ====== ======
Net earned premiums $1,163 $1,290 $1,357
Loss and LAE 881 958 1,019
Underwriting expenses 290 298 318
Policyholder dividends - - (1)
------ ------ ------
Underwriting profit (loss) ($ 8) $ 34 $ 21
====== ====== ======
GAAP ratios:
Loss and LAE ratio 75.7% 74.2% 75.1%
Underwriting expense ratio 25.0 23.1 23.5
Policyholder dividend ratio - - (.1)
----- ---- ----
Combined ratio 100.7% 97.3% 98.5%
===== ==== ====
Statutory ratios:
Loss and LAE ratio 75.6% 74.3% 75.2%
Underwriting expense ratio 25.4 22.4 22.9
----- ---- ----
Combined ratio 101.0% 96.7% 98.1%
===== ==== ====
Industry statutory combined ratio (a) 106.0% 104.3% 100.1%
(a) Represents the personal lines industry statutory combined ratio derived
from "Best's Review/Preview - Property/Casualty" (January 2000 Edition).
Marketing A goal of the Personal group is to be able to provide a full
spectrum of quality, competitively priced products to customers at any time and
in any manner desirable to the customer, whether through independent agents or
direct marketing channels, including over the Internet. The acquisition of
Worldwide Insurance Company was important to the Personal group's overall
marketing strategy as it enhances AFC's ability to sell products over the
Internet and through other direct marketing channels. By the end of the year
2000, AFC expects to have the capability to sell over the Internet in as many as
twelve states which together represent the majority of the U.S. auto market.
The Personal group had approximately 1.1 million policies in force at
December 31, 1999, just under 80% of which had policy limits of $50,000 or less
per occurrence.
Competition A large number of national, regional and local insurers write
private passenger automobile and homeowners' insurance coverage. Insurers in
this market generally compete on the basis of price (including differentiation
on liability limits, variety of coverages offered and deductibles), geographic
presence and ease of enrollment and, to a lesser extent, reputation for claims
handling, financial stability and customer service. Management believes that
sophisticated data analysis for refinement of risk profiles has helped the
Personal group to compete successfully. The Personal group attempts to provide
selected pricing for a wider spectrum of risks and with a greater variety of
payment options, deductibles and limits of liability than are offered by many of
its competitors.
6
Specialty
General The Specialty group emphasizes the writing of specialized insurance
coverage where AFC personnel are experts in particular lines of business or
customer groups. The following are examples of such specialty businesses:
Inland and Ocean Marine Provides coverage primarily for
marine cargo, boat dealers, marina operators/dealers,
excursion vessels, builder's risk, contractor's
equipment, excess property and motor truck cargo.
Workers' Compensation Writes coverage for prescribed benefits
payable to employees (principally in California) who
are injured on the job.
Agricultural-related Provides federally reinsured multi-peril crop
(allied lines) insurance covering most perils as well as crop
hail, equine mortality and other coverages for
full-time operating farms/ranches and agribusiness
operations on a nationwide basis.
Executive and Markets liability coverage for attorneys and for
Professional Liability directors and officers of businesses and not-
for-profit organizations.
Japanese Business Provides coverage primarily for workers'
compensation, commercial auto, umbrella, and general
liability of Japanese businesses operating in the
U.S.
Fidelity and Provides surety coverage for various
Surety Bonds types of contractors and public and private
corporations and fidelity and crime coverage for
government, mercantile and financial institutions.
Collateral Protection Provides coverage for insurance risk
management programs for lending and leasing
institutions.
Umbrella and Excess Consists primarily of large liability
coverage in excess of primary layers.
Specialization is the key element to the underwriting success of these
business units. Each unit has independent management with significant operating
autonomy to oversee the important operational functions of its business such as
underwriting, pricing, marketing, policy processing and claims service. These
specialty businesses are opportunistic and their premium volume will vary based
on current market conditions. AFC continually evaluates expansion in existing
markets and opportunities in new specialty markets.
7
The U.S. geographic distribution of the Specialty group statutory direct
written premiums in 1999 compared to 1995 is shown below.
1999 1995 1999 1995
---- ---- ---- ----
California 26.3% 25.7% Pennsylvania 2.3% 3.1%
Texas 7.8 6.6 Ohio 2.2 2.6
New York 5.7 8.4 North Dakota 2.1 *
Florida 4.4 3.1 Georgia 2.0 *
Illinois 4.0 3.5 North Carolina * 3.4
Massachusetts 3.7 4.1 Michigan * 3.2
Oklahoma 3.3 2.7 Connecticut * 2.6
New Jersey 2.5 4.3 Maryland * 2.0
Other 33.7 24.7
----- -----
--------------- 100.0% 100.0%
===== =====
(*) less than 2%
The following table sets forth a distribution of statutory net written
premiums for AFC's Specialty group by NAIC annual statement line for 1999
compared to 1995.
1999 1995
---- ----
Other liability 19.3% 18.6%
Workers' compensation 18.7 30.9
Inland marine 13.3 6.2
Commercial multi-peril 9.8 14.7
Auto liability 9.3 8.3
Allied lines 5.9 6.5
Fidelity and surety 4.9 2.5
Auto physical damage 4.5 2.7
Ocean marine 3.7 3.4
General aviation 2.8 *
Collateral protection 2.7 *
Other 5.1 6.2
----- -----
--------------- 100.0% 100.0%
===== =====
(*) less than 2%
The following table shows the performance of AFC's Specialty group insurance
operations (dollars in millions):
1999 1998 1997
---- ---- ----
Net written premiums $1,111 $1,312(a) $1,468
====== ====== ======
Net earned premiums $1,048 $1,372 $1,429
Loss and LAE 702 979 967
Underwriting expenses 370 451 454
Policyholder dividends 4 9 8
------ ------ ------
Underwriting profit (loss) ($ 28) ($ 67) $ -
====== ====== ======
GAAP ratios:
Loss and LAE ratio 67.0% 71.4% 67.6%
Underwriting expense ratio 35.3 32.9 31.8
Policyholder dividend ratio .4 .7 .6
----- ----- -----
Combined ratio 102.7% 105.0% 100.0%
===== ===== =====
Statutory ratios:
Loss and LAE ratio 70.2 72.1% 67.6%
Underwriting expense ratio 34.8 34.1 31.5
Policyholder dividend ratio .5 1.0 1.4
----- ----- -----
Combined ratio 105.5% 107.2% 100.5%
===== ===== =====
Industry statutory combined ratio (b) 109.0% 107.3% 103.7%
(a) Includes $232 million generated by the Commercial lines sold.
(b) Represents the commercial industry statutory combined ratio derived
from "Best's Review/Preview - Property/Casualty" (January 2000
Edition).
8
Marketing The Specialty group operations direct their sales efforts primarily
through independent property and casualty insurance agents and brokers, although
portions are written through employee agents. These businesses write insurance
through several thousand agents and brokers and have approximately 330,000
policies in force.
Competition These businesses compete with other individual insurers, state
funds and insurance groups of varying sizes, some of which are mutual insurance
companies possessing competitive advantages in that all their profits inure to
their policyholders. They also compete with self- insurance plans, captive
programs and risk retention groups. Because of the specialty nature of these
coverages, competition is based primarily on service to policyholders and
agents, specific characteristics of products offered and reputation for claims
handling. Price, commissions and profit sharing terms are also important
factors. Management believes that sophisticated data analysis for refinement of
risk profiles, extensive specialized knowledge and loss prevention service have
helped AFC's Specialty group compete successfully.
Reinsurance
Consistent with standard practice of most insurance companies, AFC reinsures
a portion of its business with other insurance companies and assumes a
relatively small amount of business from other insurers. Ceding reinsurance
permits diversification of risks and limits the maximum loss arising from large
or unusually hazardous risks or catastrophic events. The availability and cost
of reinsurance are subject to prevailing market conditions which may affect the
volume and profitability of business that is written. AFC is subject to credit
risk with respect to its reinsurers, as the ceding of risk to reinsurers
generally does not relieve AFC of its liability to its insureds.
Reinsurance is provided on one of two bases, facultative or treaty.
Facultative reinsurance is generally provided on a risk by risk basis.
Individual risks are ceded and assumed based on an offer and acceptance of risk
by each party to the transaction. Treaty reinsurance provides for risks meeting
prescribed criteria to be automatically ceded and assumed according to contract
provisions. The following table presents (by type of coverage) the amount of
each loss above the specified retention maximum generally covered by treaty
reinsurance programs (in millions):
Retention Reinsurance
Coverage Maximum Coverage(a)
-------- --------- -----------
California Workers' Compensation $ .5 $150.0(b)
Other Workers' Compensation 1.0 49.0
Commercial Umbrella 1.0 49.0
Other Casualty 5.0 15.0
Property - General 5.0 25.0(c)
Property - Catastrophe 10.0 65.0
(a) Reinsurance covers substantial portions of losses in excess of
retention.
(b) In 1999 and 1998, AFC ceded 30% of its California workers' compensation
business through a reinsurance agreement. This agreement was commuted in
2000.
(c) In 1999 and 1998, AFC ceded 90% (80% in 1997) of its homeowners insurance
coverage through a reinsurance agreement.
AFC also purchases facultative reinsurance providing coverage on a risk by
risk basis, both pro rata and excess of loss, depending on the risk and
available reinsurance markets. Due in part to the limited exposure on individual
policies, the nonstandard auto business is not materially involved in reinsuring
risks with third party insurance companies.
Included in the balance sheet caption "recoverables from reinsurers and
prepaid reinsurance premiums" were approximately $140 million on paid losses and
LAE and $1.6 billion on unpaid losses and LAE at December 31, 1999. The
collectibility of a reinsurance balance is based upon the financial condition of
a reinsurer as well as individual claim considerations. At December 31, 1999,
AFC's insurance subsidiaries had allowances of approximately $82 million for
doubtful collection of reinsurance recoverables, most of which related to unpaid
losses.
9
In 1998, AFC ceded $170 million in premiums to Ohio Casualty in connection
with the sale of the Commercial lines division. In addition, AFC agreed to
continue to issue and renew policies (in certain states) related to the business
transferred until Ohio Casualty receives the required approvals and licensing to
begin writing this business on its own behalf. Under the agreement, AFC cedes
100% of these premiums to Ohio Casualty. In 1999, AFC ceded approximately $337
million in premiums under the agreement.
In 1999 and 1998, AFC ceded approximately 30% of its California workers'
compensation business through a reinsurance agreement with Reliance Insurance
Company. Due to concerns over Reliance's participation in a reinsurance pool run
by Unicover Managers, Inc., AFC's reinsurance contracts with Reliance were
commuted in January 2000. Under the commutation, AFC received cash in exchange
for releasing Reliance from its obligations under the contracts. While amounts
have been reserved in connection with the original insurance policies and the
reinsurance agreement, no significant gain or loss was incurred from the
commutation itself.
AFC regularly monitors the financial strength of its reinsurers. This process
periodically results in the transfer of risks to more financially secure
reinsurers. Substantially all reinsurance is ceded to reinsurers having more
than $100 million in capital and A.M. Best ratings of "A-" or better. Excluding
business ceded to Ohio Casualty and Reliance (discussed above), the following
companies assumed nearly half of AFC's 1999 ceded reinsurance: Mitsui Marine and
Fire Insurance Company, American Re-Insurance Company, General Reinsurance
Corporation, Hartford Fire Insurance Company, NAC Reinsurance Corporation,
Transatlantic Reinsurance Company, Employers Reinsurance Corporation, Swiss
Reinsurance America Corporation, Zurich Reinsurance North America, Inc. and
Underwriters Reinsurance Company.
Premiums written for reinsurance ceded and assumed are presented in the
following table (in millions):
1999 1998 1997
---- ---- ----
Reinsurance ceded $898 $788 $614
Reinsurance assumed - including
involuntary pools and associations 48 38 89
Loss and Loss Adjustment Expense Reserves
The consolidated financial statements include the estimated liability for
unpaid losses and LAE of AFC's insurance subsidiaries. This liability represents
estimates of the ultimate net cost of all unpaid losses and LAE and is
determined by using case-basis evaluations and actuarial projections. These
estimates are subject to the effects of changes in claim amounts and frequency
and are periodically reviewed and adjusted as additional information becomes
known. In accordance with industry practices, such adjustments are reflected in
current year operations.
Future costs of claims are projected based on historical trends adjusted for
changes in underwriting standards, policy provisions, product mix and other
factors. Estimating the liability for unpaid losses and LAE is inherently
judgmental and is influenced by factors which are subject to significant
variation. Through the use of analytical reserve development techniques,
management monitors items such as the effect of inflation on medical,
hospitalization, material, repair and replacement costs, general economic trends
and the legal environment. Although management believes that the reserves
currently established reflect a reasonable provision for the ultimate cost of
all losses and claims, actual development may vary materially.
AFC recognizes underwriting profit only when realization is reasonably
determinable and assured. In certain specialty businesses, where experience is
limited or where there is potential for volatile results, AFC holds reasonable
"incurred but not reported" reserves and does not recognize underwriting profit
until the experience matures.
Generally, reserves for reinsurance and involuntary pools and associations
are reflected in AFC's results at the amounts reported by those entities.
10
Unless otherwise indicated, the following discussion of insurance reserves
includes the reserves of American Premier's subsidiaries for only those periods
following the Mergers. See Note O to the Financial Statements for an analysis of
changes in AFC's estimated liability for losses and LAE, net and gross of
reinsurance, over the past three years on a GAAP basis.
The following table presents the development of AFC's liability for losses
and LAE, net of reinsurance, on a GAAP basis for the last ten years, excluding
reserves of American Premier subsidiaries prior to the Mergers. The top line of
the table shows the estimated liability (in millions) for unpaid losses and LAE
recorded at the balance sheet date for the indicated years. The second line
shows the re-estimated liability as of December 31, 1999. The remainder of the
table presents development as percentages of the estimated liability. The
development results from additional information and experience in subsequent
years. The middle line shows a cumulative deficiency (redundancy) which
represents the aggregate percentage increase (decrease) in the liability
initially estimated. The lower portion of the table indicates the cumulative
amounts paid as of successive periods as a percentage of the original loss
reserve liability. The percentage of the December 31, 1997 reserve liability
paid in 1998 includes approximately 10 percentage points for reserves ceded in
connection with the sale of the Commercial lines division.
1989 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999
---- ---- ---- ---- ---- ---- ---- ---- ---- ---- ----
Liability for unpaid losses
and loss adjustment expenses:
- ----------------------------
As originally estimated $2,246 $2,137 $2,129 $2,123 $2,113 $2,187 $3,393 $3,404 $3,489 $3,305 $3,224
As re-estimated at
December 31, 1999 2,785 2,538 2,453 2,385 2,299 2,384 3,499 3,582 3,649 3,203 N/A
Liability re-estimated (*):
- --------------------------
One year later 100.4% 98.6% 99.3% 99.9% 98.1% 95.9% 98.7% 100.9% 104.5% 96.9%
Two years later 99.3% 97.7% 98.7% 98.2% 94.1% 99.3% 98.5% 105.9% 104.6%
Three years later 98.4% 97.4% 98.0% 95.2% 97.4% 99.9% 103.9% 105.2%
Four years later 98.2% 99.2% 97.3% 100.3% 98.9% 109.4% 103.1%
Five years later 101.1% 100.0% 103.0% 102.6% 109.7% 109.0%
Six years later 102.7% 106.3% 105.6% 113.6% 108.8%
Seven years later 109.2% 109.4% 116.9% 112.3%
Eight years later 112.2% 120.9% 115.2%
Nine years later 123.4% 118.8%
Ten years later 124.0%
Cumulative deficiency
(redundancy) 24.0% 18.8% 15.2% 12.3% 8.8% 9.0% 3.1% 5.2% 4.6% (3.1%) N/A
==== ==== ==== ==== === === === === === ==== ===
Cumulative paid as of:
- ---------------------
One year later 32.3% 26.1% 26.4% 26.7% 25.2% 26.8% 33.1% 33.8% 41.7% 29.8%
Two years later 48.2% 43.2% 43.0% 43.7% 40.6% 42.5% 51.6% 58.0% 56.6%
Three years later 59.2% 55.3% 55.4% 54.2% 50.9% 54.4% 67.2% 66.7%
Four years later 67.6% 64.8% 63.3% 60.8% 59.1% 66.3% 72.0%
Five years later 74.3% 71.1% 67.8% 67.0% 68.0% 69.8%
Six years later 78.8% 74.5% 72.7% 74.0% 70.8%
Seven years later 81.2% 78.6% 78.6% 76.3%
Eight years later 84.8% 83.9% 80.5%
Nine years later 89.0% 85.5%
Ten years later 93.2%
<FN>
(*) Reflects significant A&E charges and reallocations in 1994, 1996 and 1998
for prior years' losses. Excluding these items, the re-estimated liability
shown above would decrease ranging from approximately 17 percentage points
in 1989 to 6 percentage points in 1997.
</FN>
The following is a reconciliation of the net liability to the gross liability
for unpaid losses and LAE.
1993 1994 1995 1996 1997 1998 1999
---- ---- ---- ---- ---- ---- ----
As originally estimated:
Net liability shown above $2,113 $2,187 $3,393 $3,404 $3,489 $3,305 $3,224
Add reinsurance recoverables 611 730 704 720 736 1,468 1,571
------ ------ ------ ------ ------ ------ ------
Gross liability $2,724 $2,917 $4,097 $4,124 $4,225 $4,773 $4,795
====== ====== ====== ====== ====== ====== ======
As re-estimated at December 31, 1999:
Net liability shown above $2,299 $2,384 $3,499 $3,582 $3,649 $3,203
Add reinsurance recoverables 937 929 1,014 1,037 1,133 1,614
------ ------ ------ ------ ------ ------
Gross liability $3,236 $3,313 $4,513 $4,619 $4,782 $4,817 N/A
====== ====== ====== ====== ====== ====== ===
Gross cumulative deficiency
(redundancy) 18.8% 13.6% 10.2% 12.0% 13.2% 0.9% N/A
==== ==== ==== ==== ==== === ===
11
These tables do not present accident or policy year development data.
Furthermore, in evaluating the re-estimated liability and cumulative deficiency
(redundancy), it should be noted that each percentage includes the effects of
changes in amounts for prior periods. For example, AFC's $214 million special
charge for A&E claims related to losses recorded in 1998, but incurred before
1989, is included in the re-estimated liability and cumulative deficiency
(redundancy) percentage for each of the previous years shown. Conditions and
trends that have affected development of the liability in the past may not
necessarily exist in the future. Accordingly, it may not be appropriate to
extrapolate future redundancies or deficiencies based on this table.
The adverse development in the tables is due primarily to A&E exposures for
which AFC has been held liable under general liability policies written years
ago where environmental coverage was not intended. Other factors affecting
development included higher than projected inflation on medical,
hospitalization, material, repair and replacement costs. Additionally, changes
in the legal environment have influenced the development patterns over the past
ten years. For example, changes in the California workers' compensation law in
1993 and subsequent court decisions, primarily in late 1996, greatly limited the
ability of insurers to challenge medical assessments and treatments. These
limitations, together with changes in work force characteristics and medical
delivery costs, are contributing to an increase in claims severity.
The differences between the liability for losses and LAE reported in the
annual statements filed with the state insurance departments in accordance with
statutory accounting principles ("SAP") and that reported in the accompanying
consolidated financial statements in accordance with GAAP at December 31, 1999
are as follows (in millions):
Liability reported on a SAP basis, net of $377 million
of retroactive reinsurance $3,148
Additional discounting of GAAP reserves in excess
of the statutory limitation for SAP reserves (8)
Reserves of foreign operations 2
Reinsurance recoverables, net of allowance 1,571
Reclassification of allowance for uncollectible
reinsurance 82
------
Liability reported on a GAAP basis $4,795
======
12
Asbestos and Environmental Reserves ("A&E") In defining environmental
exposures, the insurance industry typically includes claims relating to polluted
waste sites and asbestos as well as other mass tort claims such as those
relating to breast implants, repetitive stress on keyboards, DES (a drug used in
pregnancies years ago alleged to cause cancer and birth defects) and other
latent injuries.
Establishing reserves for A&E claims is subject to uncertainties that are
greater than those presented by other types of claims. Factors contributing to
those uncertainties include a lack of sufficiently detailed historical data,
long reporting delays, uncertainty as to the number and identity of insureds
with potential exposure, unresolved legal issues regarding policy coverage, and
the extent and timing of any such contractual liability. Courts have reached
different and sometimes inconsistent conclusions as to when a loss is deemed to
have occurred, what policies provide coverage, what claims are covered, whether
there is an insured obligation to defend, how policy limits are determined and
other policy provisions. Management believes these issues are not likely to be
resolved in the near future.
Significant industrywide information concerning A&E reserves first became
broadly available in mid-1996 following the publication of new data relating to
that subject in the 1995 Annual Statements of insurance companies. During 1995
and 1996, a number of insurers recorded large reserve increases for A&E
exposures. During this time, the industry's survival ratio (reserves divided by
annual paid losses) was used as a benchmark for reserving such claims.
Industry actions and statistics in 1995 caused AFC to re-evaluate its
position in relation to its peers as part of the continuing process of obtaining
additional information and revising accounting estimates. This process led
management to conclude in 1996 that the A&E reserves should be increased
sufficiently to bring AFC's three-year survival ratio in line with those of the
top 50 companies. In the third quarter of 1996, AFC recorded a noncash, pretax
charge of $80 million and reallocated $40 million in reserves from its Specialty
group.
As part of the continuing process of monitoring appropriate reserve needs and
prompted by the retention of certain A&E exposures under the agreement covering
the sale of its Commercial lines division, AFC began a thorough study of its A&E
exposures in 1998. Based on this study and observations of industry trends in
this regard, AFC decided that the survival ratio may not be the best basis for
measuring ultimate A&E exposures. AFC's study was reviewed by independent
actuaries who used state of the art actuarial techniques that have wide
acceptance in the industry. AFC recorded a fourth quarter charge of $214 million
in 1998 to increase A&E reserves to its best estimate of the ultimate liability.
At December 31, 1999, AFC's three year survival ratio is approximately 15 times
paid losses.
13
The following table (in millions) is a progression of A&E reserves. The
significantly larger amount of payments made in 1999 reflects an acceleration of
the settlement process; individual claims were generally paid at projected
levels previously recorded as reserve liabilities. During the review of A&E
exposures in 1998, $13.8 million in reserves recorded prior to 1998 and not
identified as A&E were determined to be A&E reserves. In addition, the allowance
for uncollectible reinsurance applicable to ceded A&E reserves was not reflected
in the following table prior to 1998.
1999 1998 1997
---- ---- ----
Reserves at beginning of year $625.4 $347.9 $343.4
Incurred losses and LAE (a) .1 247.5 43.2
Paid losses and LAE (48.8) (26.1) (38.7)
Reserves transferred with sale of
Commercial lines - (11.4) -
Reserves not classified as A&E prior to 1998:
Reserves - 13.8 -
Allowance for uncollectable reinsurance
applicable to ceded A&E reserves - 53.7 -
------ ------ ------
Reserves at end of year, net of
reinsurance recoverable 576.7 625.4 347.9
Reinsurance recoverable, net of
allowance in 1999 and 1998 219.8 240.7 173.2
------ ------ ------
Gross reserves at end of year $796.5 $866.1 $521.1
====== ====== ======
<FN>
(a) Includes a special charge of $214 million in 1998.
</FN>
Since the mid-1980's, AFC has also written certain environmental coverages
(asbestos abatement and underground storage tank liability) in which the premium
charged is intended to provide coverage for the specific environmental exposures
inherent in these policies. To date, approximately $200 million of premiums has
been written; losses and LAE incurred (paid and reserved) through December 31,
1999 are estimated at less than 50% of premiums. This business is not included
in the discussion or table above.
14
Annuity and Life Operations
General
AFC's annuity and life operations are conducted through American Annuity
Group, Inc. ("AAG"), a holding company which markets primarily retirement
annuity products as well as life and supplemental health insurance through the
following major entities which were acquired or formed in the years shown. AAG
and its subsidiaries employ approximately 1,900 persons.
Great American Life Insurance Company ("GALIC") - 1992(*)
Annuity Investors Life Insurance Company ("AILIC") - 1994
Loyal American Life Insurance Company ("Loyal") - 1995
Great American Life Assurance Company of Puerto Rico, Inc. ("GAPR") - 1997
GALIC's Life Division - 1997
United Teacher Associates Insurance Company ("UTA") - 1999
(*) Acquired from Great American.
Acquisitions in recent years have supplemented AAG's internal growth as the
assets of the holding company and its operating subsidiaries have increased from
$4.5 billion at the end of 1992 to approximately $7.5 billion at the end of
1999. Premiums over the last three years were as follows (in millions):
Insurance Product(*) 1999 1998 1997
-------------------- ---- ---- ----
Annuities $588 $521 $489
Life and health 126 104 42
---- ---- ----
$714 $625 $531
-------------------- ==== ==== ====
(*) Table does not include premiums of subsidiaries or divisions until their
first full year following acquisition or formation. All periods exclude
premiums of subsidiaries sold.
In October 1999, AAG acquired United Teacher Associates. UTA provides retired
and active teachers with supplemental health products and retirement annuities,
and purchases blocks of insurance policies from other insurance companies. In
July 1999, AAG acquired Consolidated Financial Corporation, an insurance agency.
Consolidated Financial historically has been one of the top 10 sellers of AAG's
annuity products. In February 1999, AAG acquired Great American Life Insurance
Company of New York (formerly known as Old Republic Life Insurance Company of
New York) to facilitate AAG's entry into the New York market.
In September 1998, AAG sold its Funeral Services division. This division had
assets of approximately $1 billion and 1997 premiums of $111 million.
Retirement Products
AAG's principal retirement products are Flexible Premium Deferred Annuities
("FPDAs") and Single Premium Deferred Annuities ("SPDAs"). Annuities are
long-term retirement saving instruments that benefit from income accruing on a
tax-deferred basis. The issuer of the annuity collects premiums, credits
interest on the policy and pays out a benefit upon death, surrender or
annuitization. FPDAs are characterized by premium payments that are flexible in
both amount and timing as determined by the policyholder. SPDAs are issued in
exchange for a one-time lump-sum premium payment.
15
The following table (in millions) presents combined financial information
concerning AAG's principal annuity subsidiaries.
1999 1998 1997
---- ---- ----
GAAP Basis
----------
Total Assets $6,657 $6,549 $6,289
Fixed Annuity Reserves 5,349 5,396 5,355
Variable Annuity Reserves 354 120 37
Stockholder's Equity 801 862 770
Statutory Basis
---------------
Total Assets $6,493 $6,159 $5,977
Fixed Annuity Reserves 5,564 5,538 5,469
Variable Annuity Reserves 354 120 37
Capital and Surplus 404 350 317
Asset Valuation Reserve (a) 67 63 65
Interest Maintenance Reserve (a) 10 21 24
Annuity Receipts:
Flexible Premium:
First Year $ 55 $ 45 $ 38
Renewal 145 149 160
------ ------ ------
200 194 198
Single Premium 388 327 291
------ ------ ------
Total Annuity Receipts $ 588 $ 521 $ 489
====== ====== ======
----------------
(a) Allocation of surplus.
Sales of annuities are affected by many factors, including: (i) competitive
annuity products and rates; (ii) the general level of interest rates; (iii) the
favorable tax treatment of annuities; (iv) commissions paid to agents; (v)
services offered; (vi) ratings from independent insurance rating agencies; (vii)
other alternative investments and (viii) general economic conditions. At
December 31, 1999, AAG had approximately 280,000 annuity policies in force.
Annuity contracts are generally classified as either fixed rate (including
equity-indexed) or variable. The following table presents premiums by
classification:
Premiums 1999 1998 1997
-------- ---- ---- ----
Traditional fixed 55% 72% 83%
Variable 35 17 9
Equity-indexed 10 11 8
--- --- ---
100% 100% 100%
=== === ===
With a traditional fixed rate annuity, the interest crediting rate is
initially set by the issuer and thereafter may be changed from time to time by
the issuer subject to any guaranteed minimum interest crediting rates in the
policy.
AAG seeks to maintain a desired spread between the yield on its investment
portfolio and the rate it credits to its fixed rate annuities. AAG accomplishes
this by: (i) offering crediting rates which it has the option to change; (ii)
designing annuity products that encourage persistency and (iii) maintaining an
appropriate matching of assets and liabilities. AAG designs its products with
certain provisions to encourage policyholders to maintain their funds with AAG
for at least five to ten years. Partly due to these features, annuity surrenders
have averaged less than 10% of statutory reserves over the past five years.
16
All of AAG's traditional fixed rate annuities offer a minimum interest rate
guarantee of 3% or 4%; the majority permit AAG to change the crediting rate at
any time (subject to the minimum guaranteed interest rates). In determining the
frequency and extent of changes in the crediting rate, AAG takes into account
the economic environment and the relative competitive position of its products.
Over the last few years, traditional fixed rate annuities have met
substantial competition from mutual funds and other equity-based investments. In
response, AAG began offering variable annuities and equity-indexed annuities.
Industry sales of variable annuities have increased substantially over the last
ten years as investors have sought to obtain the returns available in the equity
markets while enjoying the tax-deferred status of annuities. With a variable
annuity, the earnings credited to the policy vary based on the investment
results of the underlying investment options chosen by the policyholder.
Premiums directed to the variable options in policies issued by AAG are invested
in funds managed by various independent investment managers. AAG earns a fee on
amounts deposited into variable accounts. Policyholders may also choose to
direct all or a portion of their premiums to various fixed rate options, in
which case AAG earns a spread on amounts deposited.
An equity-indexed fixed annuity provides policyholders with a crediting rate
tied, in part, to the performance of an existing stock market index while
protecting them against the related downside risk through a guarantee of
principal. AAG hedges the equity-based risk component of this product through
the purchase of call options on the appropriate index. These options are
designed to offset substantially all of the increases in the liabilities
associated with equity-indexed annuities.
The following table reflects the geographical distribution of AAG's annuity
premiums in 1999 compared to 1995.
1999 1995 1999 1995
---- ---- ---- ----
California 28.5% 19.1% New Jersey 3.6 3.8
Ohio 7.2 6.1 North Carolina 3.2 5.8
Washington 6.7 5.6 Indiana 2.8 *
Massachusetts 4.7 6.2 Connecticut 2.5 3.3
Florida 4.6 7.4 Pennsylvania 2.1 *
Michigan 4.4 5.8 Illinois * 3.2
Texas 4.1 4.6 Iowa * 2.1
Minnesota 4.0 4.2 Other 21.6 22.8
----- -----
--------------- 100.0% 100.0%
(*) less than 2% ===== =====
AAG's FPDAs are sold primarily to employees of qualified not-for- profit
organizations. Employees of these organizations are eligible to save for
retirement through contributions made on a before-tax basis. Contributions are
made at the discretion of the participants through payroll deductions or through
tax-free "rollovers" of funds from other qualified investments. Federal income
taxes are not payable on contributions or earnings until amounts are withdrawn.
Historically, AAG's principal marketing focus had been on sales to employees
of educational institutions in the kindergarten through high school segment.
However, sales of non-qualified annuities have begun to represent an increasing
percentage of premiums (30% in 1999 compared to 15% in 1995) as AAG has
developed products and distribution channels targeted to the non-qualified
markets.
AAG distributes its annuity products through more than 100 managing general
agents ("MGAs") who, in turn, direct approximately 1,000 actively producing
independent agents. To extend the distribution of its annuities to a broader
customer base, AAG developed a personal producing general agent ("PPGA")
distribution system. More than 100 PPGAs are contracted to sell annuities in
those territories not served by an MGA.
17
Life, Accident and Health Products
AAG offers a variety of life, accident and health products through Loyal,
GAPR and GALIC's life division. This group produced over $120 million of
statutory premiums in 1999. It also had more than 740,000 policies and $11.9
billion of life insurance in force.
Loyal offers a variety of life and supplemental health insurance products
through payroll deduction plans and credit unions. The principal products sold
by Loyal include cancer, universal life, traditional whole life, hospital
indemnity, and short-term disability insurance. Loyal's products are marketed
with the endorsement or consent of the employer or the credit union management.
GAPR sells in-home service life and supplemental health products through a
network of company-employed agents. Ordinary life, cancer, credit and group life
products are sold through independent agents.
In December 1997, GALIC's life division began offering term, universal and
whole life insurance products through national marketing organizations.
In October 1999, AAG acquired UTA, a provider of supplemental health products
and annuities to retired and active teachers.
In late 1999, AAG began offering long-term care products.
Sale of Funeral Services Division
In September 1998, AAG sold its Funeral Services division for approximately
$165 million in cash. The Funeral Services division provided life insurance and
annuities to fund pre-arranged funerals, as well as administrative services for
pre-arranged funeral trusts. This division included American Memorial Life
Insurance Company (acquired in 1995) and Arkansas National Life Insurance
Company (acquired in 1998).
Independent Ratings
AAG's principal insurance subsidiaries are rated by Standard & Poor's, A.M.
Best and Duff & Phelps. In addition, GALIC is rated A3 (good financial security)
by Moody's. Such ratings are generally based on items of concern to
policyholders and agents and are not directed toward the protection of
investors.
Standard
& Poor's A.M. Best Duff & Phelps
----------- ------------- ---------------
GALIC A+ (Strong) A (Excellent) AA- (Very high)
AILIC A+ (Strong) A (Excellent) AA- (Very high)
Loyal A+ (Strong) A (Excellent) AA- (Very high)
GAPR Not rated A (Excellent) Not rated
UTA Not rated A- (Excellent) Not rated
AAG believes that the ratings assigned by independent insurance rating
agencies are important because potential policyholders often use a company's
rating as an initial screening device in considering annuity products. AAG
believes that a rating in the "A" category by at least one rating agency is
necessary to successfully market tax-deferred annuities to public education
employees and other not-for-profit groups.
Although AAG believes that its insurance companies' ratings are very stable,
those companies' operations could be materially adversely affected by a
downgrade in ratings.
18
Competition
AAG's insurance companies operate in highly competitive markets. They compete
with other insurers and financial institutions based on many factors, including:
(i) ratings; (ii) financial strength; (iii) reputation; (iv) service to
policyholders and agents; (v) product design (including interest rates credited
and premium rates charged); and (vi) commissions. Since policies are marketed
and distributed primarily through independent agents (except at GAPR), the
insurance companies must also compete for agents.
No single insurer dominates the markets in which AAG's insurance companies
compete. Competitors include (i) individual insurers and insurance groups, (ii)
mutual funds and (iii) other financial institutions. In a broader sense, AAG's
insurance companies compete for retirement savings with a variety of financial
institutions offering a full range of financial services. Financial institutions
have demonstrated a growing interest in marketing investment and savings
products other than traditional deposit accounts.
Other Companies
Through subsidiaries, AFC is engaged in a variety of other businesses,
including The Golf Center at Kings Island (golf and tennis facility) in the
Greater Cincinnati area; commercial real estate operations in Cincinnati (office
buildings and The Cincinnatian Hotel), New Orleans (Le Pavillon Hotel), Cape Cod
(Chatham Bars Inn), Austin (Driskill Hotel), Chesapeake Bay (Skipjack Cove
Yachting Resort) and apartments in Lafayette (Louisiana), Louisville,
Pittsburgh, St. Paul and Tampa Bay. These operations employ approximately 700
full-time employees.
Investment Portfolio
General
A summary of AFC's December 31, 1999, investment portfolio by business
segment follows (excluding investment in equity securities of investee
corporations) (in millions).
Carrying Value Total
---------------------------------- Market
P&C Annuity Other Total Value
--- ------- ----- ----- ------
Cash and short-term investments $ 260 $ 120 $ 9 $ 389 $ 389
Fixed maturities 3,903 5,947 12 9,862 9,862
Other stocks, options and
warrants 339 70 1 410 410
Policy loans - 217 - 217 217 (a)
Real estate and other investments 130 114 21 265 265 (a)
------ ------ --- ------- -------
$4,632 $6,468 $43 $11,143 $11,143
====== ====== === ======= =======
<FN>
(a) Carrying value used since market values are not readily available.
</FN>
19
The following tables present the percentage distribution and yields of AFC's
investment portfolio (excluding investment in equity securities of investee
corporations) as reflected in its financial statements.
1999 1998 1997 1996 1995
---- ---- ---- ---- ----
Cash and Short-term Investments 3.5% 2.5% 1.9% 3.5% 4.0%
Fixed Maturities:
U.S. Government and Agencies 4.9 4.4 5.0 4.1 3.7
State and Municipal 2.7 1.2 1.3 1.0 .7
Public Utilities 5.1 6.0 6.8 8.2 9.8
Mortgage-Backed Securities 22.0 20.8 21.4 22.3 20.9
Corporate and Other 55.3 53.2 52.5 51.7 50.0
Redeemable Preferred Stocks .6 .5 .6 .5 1.0
----- ----- ----- ----- -----
90.6 86.1 87.6 87.8 86.1
Net Unrealized Gains (Losses) on
fixed maturities held
Available for Sale (2.1) 3.5 2.5 1.1 2.7
----- ----- ----- ----- -----
88.5 89.6 90.1 88.9 88.8
Other Stocks, Options and Warrants 3.7 3.7 3.7 2.9 2.3
Policy Loans 1.9 1.9 2.0 2.1 2.2
Real Estate and Other Investments 2.4 2.3 2.3 2.6 2.7
----- ----- ----- ----- -----
100.0% 100.0% 100.0% 100.0% 100.0%
===== ===== ===== ===== =====
Yield on Fixed Income Securities:
Excluding realized gains and losses 7.7% 7.8% 7.8% 7.9% 7.9%
Including realized gains and losses 7.6% 8.0% 7.9% 7.7% 8.8%
Yield on Stocks:
Excluding realized gains and losses 5.9% 5.4% 5.6% 5.8% 3.9%
Including realized gains and losses 20.7% (5.3%) 30.2% 15.1% 8.4%
Yield on Investments (*):
Excluding realized gains and losses 7.7% 7.8% 7.8% 7.8% 7.9%
Including realized gains and losses 7.9% 7.8% 8.2% 7.8% 8.8%
<FN>
(*) Excludes "Real Estate and Other Investments".
</FN>
Fixed Maturity Investments
Unlike many insurance groups which have portfolios that are invested heavily
in tax-exempt bonds, AFC's bond portfolio is invested primarily in taxable
bonds. The NAIC assigns quality ratings which range from Class 1 (highest
quality) to Class 6 (lowest quality). The following table shows AFC's bonds and
redeemable preferred stocks, by NAIC designation (and comparable Standard &
Poor's Corporation rating) as of December 31, 1999 (dollars in millions).
NAIC Amortized Market Value
Rating Comparable S&P Rating Cost Amount %
- ------ --------------------- --------- ------- ---
1 AAA, AA, A $ 7,041 $6,886 70%
2 BBB 2,085 2,025 20
------- ------ ---
Total investment grade 9,126 8,911 90
------- ------ ---
3 BB 448 434 5
4 B 420 410 4
5 CCC, CC, C 99 97 1
6 D 8 10 *
------- ------ ---
Total noninvestment grade 975 951 10
------- ------ ---
Total $10,101 $9,862 100%
======= ====== ===
- ---------------
(*) Less than 1%
20
Risks inherent in connection with fixed income securities include loss upon
default and market price volatility. Factors which can affect the market price
of securities include: creditworthiness, changes in interest rates, the number
of market makers and investors and defaults by major issuers of securities.
AFC's primary investment objective for fixed maturities is to earn interest
and dividend income rather than to realize capital gains. AFC invests in bonds
and redeemable preferred stocks that have primarily short- term and
intermediate-term maturities. This practice allows flexibility in reacting to
fluctuations of interest rates.
Equity Investments
AFC's equity investment practice permits concentration of attention on a
relatively limited number of companies. Some of the equity investments, because
of their size, may not be as readily marketable as the typical small investment
position. Alternatively, a large equity position may be attractive to persons
seeking to control or influence the policies of a company and AFC's
concentration in a relatively small number of companies may permit it to
identify investments with above average potential to increase in value.
Chiquita At December 31, 1999, AFC owned 24 million shares of Chiquita common
stock representing 36% of its outstanding shares. The carrying value and market
value of AFC's investment in Chiquita were approximately $160 million and $114
million, respectively, at December 31, 1999. Chiquita is a leading international
marketer, producer and distributor of quality fresh fruits and vegetables and
processed foods. In addition to bananas, these products include a wide variety
of other fresh fruits and vegetables; fruit and vegetable juices and beverages;
processed bananas and other processed fruits and vegetables; private-label and
branded canned vegetables; fresh cut and ready-to-eat salads; and edible
oil-based consumer products.
Other Stocks AFC's $231 million investment in Provident Financial Group,
Inc., a Cincinnati-based commercial banking and financial services company,
comprised approximately three-fifths of the equity investments included in
"Other stocks" in AFC's Balance Sheet at December 31, 1999.
Foreign Operations
AFC sells life and supplemental health products in Puerto Rico and property
and casualty products in Canada, Mexico, Europe and Asia. In addition, AAG has
an office in India where employees perform computer programming and certain back
office functions. Less than 3% of AFC's revenues and costs and expenses are
derived from foreign sources.
Regulation
AFC's insurance company subsidiaries are subject to regulation in the
jurisdictions where they do business. In general, the insurance laws of the
various states establish regulatory agencies with broad administrative powers
governing, among other things, premium rates, solvency standards, licensing of
insurers, agents and brokers, trade practices, forms of policies, maintenance of
specified reserves and capital for the protection of policyholders, deposits of
securities for the benefit of policyholders, investment activities and
relationships between insurance subsidiaries and their parents and affiliates.
Material transactions between insurance subsidiaries and their parents and
affiliates generally must be disclosed and prior approval of the applicable
insurance regulatory authorities generally is required for any such transaction
which may be deemed to be material or extraordinary. In addition, while
differing from state to state, these regulations typically restrict the maximum
amount of dividends that may be paid by an insurer to its shareholders in any
twelve-month period without advance regulatory approval. Such limitations are
generally based on net earnings or statutory surplus. Under applicable
restrictions, the maximum amount of dividends available to AFC in 2000 from its
insurance subsidiaries without seeking regulatory clearance is approximately
$186 million.
21
Changes in state insurance laws and regulations have the potential to
materially affect the revenues and expenses of the insurance operations. For
example, between July 1993 and January 1995, the California Commissioner ordered
reductions in workers' compensation insurance premium rates totaling more than
30% and subsequently replaced the workers' compensation insurance minimum rate
law with an "open rating" policy. The Company is unable to predict whether or
when other state insurance laws or regulations may be adopted or enacted or what
the impact of such developments would be on the future operations and revenues
of its insurance businesses.
Most states have created insurance guaranty associations to provide for the
payment of claims of insurance companies that become insolvent. Annual
assessments for AFC's insurance companies have not been material. In addition,
many states have created "assigned risk" plans or similar arrangements to
provide state mandated minimum levels of automobile liability coverage to
drivers whose driving records or other relevant characteristics make it
difficult for them to obtain insurance otherwise. Automobile insurers in those
states are required to provide such coverage to a proportionate number of those
drivers applying as assigned risks. Premium rates for assigned risk business are
established by the regulators of the particular state plan and are frequently
inadequate in relation to the risks insured, resulting in underwriting losses.
Assigned risks accounted for approximately one percent of AFC's net written
premiums in 1999.
The NAIC is an organization which is comprised of the chief insurance
regulator for each of the 50 states and the District of Columbia. The NAIC model
law for Risk Based Capital applies to both life and property and casualty
companies. The risk-based capital formulas determine the amount of capital that
an insurance company needs to ensure that it has an acceptably low expectation
of becoming financially impaired. The model law provides for increasing levels
of regulatory intervention as the ratio of an insurer's total adjusted capital
and surplus decreases relative to its risk-based capital, culminating with
mandatory control of the operations of the insurer by the domiciliary insurance
department at the so-called "mandatory control level". At December 31, 1999, the
capital ratios of all AFC insurance companies substantially exceeded the risk-
based capital requirements.
Legislation adopted in 1999 substantially eliminated restrictions on
affiliations among insurance companies, banks and securities firms. It is too
early to predict what impact this legislation will have in the markets in which
the insurance companies compete.
22
Pursuant to the requirements of the Securities Exchange Act of 1934,
the Registrant has duly caused this Amendment to be signed on its behalf
by the undersigned, duly authorized.
American Financial Corporation
BY: Fred J. Runk
-----------------------------------
Fred J. Runk
Senior Vice President and Treasurer
Signed: May 26, 2000