- -------------------------------------------------------------------------------
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 Commission File
March 31, 2001 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
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 X No
As of May 1, 2001, there were 10,593,000 shares of the Registrant's Common
Stock outstanding, all of which were owned by American Financial Group, Inc.
Page 1 of 19
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AMERICAN FINANCIAL CORPORATION 10-Q
PART I
FINANCIAL INFORMATION
AMERICAN FINANCIAL CORPORATION AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEET
(Dollars In Thousands)
March 31, December 31,
2001 2000
------------ -----------
Assets:
Cash and short-term investments $ 210,562 $ 437,263
Investments:
Fixed maturities - at market
(amortized cost - $10,355,140 and $10,148,248) 10,526,540 10,164,648
Other stocks - at market
(cost - $175,708 and $174,959) 308,208 385,359
Investment in investee corporations 23,996 23,996
Policy loans 212,005 213,469
Real estate and other investments 249,485 270,250
----------- -----------
Total investments 11,320,234 11,057,722
Recoverables from reinsurers and prepaid
reinsurance premiums 1,940,462 1,845,171
Agents' balances and premiums receivable 706,746 700,215
Deferred acquisition costs 782,939 763,097
Other receivables 253,431 239,806
Variable annuity assets (separate accounts) 472,902 533,655
Prepaid expenses, deferred charges and other assets 484,025 508,163
Cost in excess of net assets acquired 328,033 322,380
----------- -----------
$16,499,334 $16,407,472
=========== ===========
Liabilities and Capital:
Unpaid losses and loss adjustment expenses $ 4,504,618 $ 4,515,561
Unearned premiums 1,482,400 1,414,492
Annuity benefits accumulated 5,549,650 5,543,683
Life, accident and health reserves 598,133 599,360
Payable to American Financial Group, Inc. 424,706 439,371
Long-term debt:
Holding companies 186,401 204,338
Subsidiaries 192,492 195,087
Variable annuity liabilities (separate accounts) 472,902 533,655
Accounts payable, accrued expenses and other
liabilities 1,057,422 998,104
----------- -----------
Total liabilities 14,468,724 14,443,651
Minority interest 522,191 509,705
Shareholders' Equity:
Preferred Stock - at liquidation value 72,154 72,154
Common Stock, no par value
- 20,000,000 shares authorized
- 10,593,000 shares outstanding 9,625 9,625
Capital surplus 977,659 974,766
Retained earnings 275,381 258,371
Unrealized gain on marketable securities, net 173,600 139,200
----------- -----------
Total shareholders' equity 1,508,419 1,454,116
----------- -----------
$16,499,334 $16,407,472
=========== ===========
2
AMERICAN FINANCIAL CORPORATION 10-Q
AMERICAN FINANCIAL CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENT OF EARNINGS
(In Thousands, Except Per Share Data)
Three months ended
March 31,
-----------------------
2001 2000
---- ----
Income:
Property and casualty insurance premiums $644,723 $572,137
Life, accident and health premiums 69,158 49,919
Investment income 209,790 209,015
Realized losses on sales of:
Securities (6,881) (1,433)
Subsidiaries (1,586) -
Other income 58,292 54,627
-------- --------
973,496 884,265
Costs and Expenses:
Property and casualty insurance:
Losses and loss adjustment expenses 496,216 417,651
Commissions and other underwriting expenses 184,974 178,432
Annuity benefits 69,264 66,161
Life, accident and health benefits 54,083 36,724
Interest charges on borrowed money 18,873 15,554
Other operating and general expenses 107,871 96,106
-------- --------
931,281 810,628
-------- --------
Operating earnings before income taxes 42,215 73,637
Provision for income taxes 14,952 24,255
-------- --------
Net operating earnings 27,263 49,382
Minority interest expense, net of tax (6,919) (8,207)
Equity in net earnings (losses) of investees,
net of tax (3,334) 7,175
-------- --------
Net Earnings $ 17,010 $ 48,350
======== ========
3
AMERICAN FINANCIAL CORPORATION 10-Q
AMERICAN FINANCIAL CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENT OF CHANGES IN SHAREHOLDERS' EQUITY
(Dollars in Thousands)
Common Stock Unrealized
Preferred and Capital Retained Gain (Loss)
Stock Surplus Earnings on Securities Total
--------- ------------ -------- ------------- ----------
Balance at January 1, 2001 $72,154 $984,391 $258,371 $139,200 $1,454,116
Net earnings - - 17,010 - 17,010
Change in unrealized - - - 34,400 34,400
----------
Comprehensive income 51,410
Capital contribution from parent - 3,067 - - 3,067
Other - (174) - - (174)
------- -------- -------- -------- ----------
Balance at March 31, 2001 $72,154 $987,284 $275,381 $173,600 $1,508,419
======= ======== ======== ======== ==========
Balance at January 1, 2000 $72,154 $970,407 $296,246 ($14,700) $1,324,107
Net earnings - - 48,350 - 48,350
Change in unrealized - - - (22,600) (22,600)
----------
Comprehensive income 25,750
Capital contribution from parent - 3,067 - - 3,067
Other - 47 - - 47
------- -------- -------- ------- ----------
Balance at March 31, 2000 $72,154 $973,521 $344,596 ($37,300) $1,352,971
======= ======== ======== ======= ==========
4
AMERICAN FINANCIAL CORPORATION 10-Q
AMERICAN FINANCIAL CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENT OF CASH FLOWS
(In Thousands)
Three months ended
March 31,
-----------------------
2001 2000
---- ----
Operating Activities:
Net earnings $ 17,010 $ 48,350
Adjustments:
Equity in net (earnings) losses of investees 3,334 (7,175)
Depreciation and amortization 36,485 30,498
Annuity benefits 69,264 66,161
Changes in reserves on assets 4,637 1,088
Realized gains on investing activities (6,840) (7,611)
Deferred annuity and life policy acquisition costs (35,551) (33,668)
Decrease in reinsurance and other receivables 90 124,640
Decrease (increase) in other assets (19,369) 13,710
Increase (decrease) in insurance claims and reserves 74,616 (50,957)
Increase in other liabilities 38,419 2,454
Increase (decrease) in minority interest 4,095 (285)
Other, net (434) (3,481)
-------- --------
185,756 183,724
-------- --------
Investing Activities:
Purchases of and additional investments in:
Fixed maturity investments (544,186) (601,115)
Equity securities (2,571) (14,786)
Real estate, property and equipment (13,278) (18,935)
Maturities and redemptions of fixed maturity
investments 131,547 154,704
Sales of:
Fixed maturity investments 194,182 227,797
Equity securities 4,679 19,265
Subsidiaries 22,000 -
Real estate, property and equipment 24,562 1,504
Cash and short-term investments of former
subsidiaries (132,858) -
Decrease (increase) in other investments (673) 5,486
-------- --------
(316,596) (226,080)
-------- --------
Financing Activities:
Fixed annuity receipts 126,223 126,416
Annuity surrenders, benefits and withdrawals (186,921) (192,820)
Net transfers from (to) variable annuity assets 2,929 (21,453)
Additional long-term borrowings 26,842 44,091
Reductions of long-term debt (47,601) (610)
Borrowings from AFG 1,000 -
Payments to AFG (23,000) (20,313)
Capital Contribution 4,667 4,667
Repurchases of trust preferred securities - (1,261)
-------- --------
(95,861) (61,283)
-------- --------
Net Decrease in Cash and Short-term Investments (226,701) (103,639)
Cash and short-term investments at beginning
of period 437,263 389,018
-------- --------
Cash and short-term investments at end of period $210,562 $285,379
======== ========
5
AMERICAN FINANCIAL CORPORATION 10-Q
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
A. ACCOUNTING POLICIES
BASIS OF PRESENTATION The accompanying consolidated financial statements
for American Financial Corporation ("AFC") and subsidiaries 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 generally accepted accounting
principles.
Certain reclassifications have been made to prior years to conform to the
current year's presentation. All significant intercompany balances and
transactions have been eliminated. All acquisitions have been treated as
purchases. The results of operations of companies since their formation or
acquisition are included in the consolidated financial statements.
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.
INVESTMENTS All fixed maturity securities are considered "available for
sale" and reported at fair value with unrealized gains and losses reported
as a separate component of shareholders' equity. Short-term investments are
carried at cost; loans receivable are carried primarily at the aggregate
unpaid balance. Premiums and discounts on mortgage-backed securities are
amortized over their expected average lives using the interest method.
Gains or losses on sales of securities are recognized at the time of
disposition with the amount of gain or loss determined on the specific
identification basis. 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 and the carrying value of that investment is reduced.
INVESTMENT IN INVESTEE CORPORATIONS Investments in securities of 20%- to
50%-owned companies are generally carried at cost, adjusted for AFC's
proportionate share of their undistributed earnings or losses.
Due to Chiquita's announced intention to pursue a plan to restructure its
public debt, AFC wrote down its investment in Chiquita common stock to
market value at December 31, 2000, and may suspend accounting for Chiquita
under the equity method pending resolution of the current uncertainty.
COST IN EXCESS OF NET ASSETS ACQUIRED The excess of cost of subsidiaries
and investees over AFC's equity in the underlying net assets ("goodwill")
is being amortized over periods of 20 to 40 years. In February 2001, the
Financial Accounting Standards Board issued a proposal to eliminate the
amortization of goodwill and require that goodwill be tested for
impairment.
INSURANCE As discussed under "Reinsurance" below, unpaid losses and loss
adjustment expenses and unearned premiums have not been reduced for
reinsurance recoverable. To the extent that unrealized gains (losses) from
securities classified as "available for sale" would result in adjustments
to deferred acquisition costs and policyholder liabilities had those gains
(losses) actually been realized, such balance sheet amounts are adjusted,
net of deferred taxes.
6
AMERICAN FINANCIAL CORPORATION 10-Q
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
REINSURANCE In the normal course of business, AFC's insurance
subsidiaries cede reinsurance to other companies to diversify risk and
limit maximum loss arising from large claims. To the extent that any
reinsuring companies are unable to meet obligations under the agreements
covering reinsurance ceded, AFC's insurance subsidiaries would remain
liable. Amounts recoverable from reinsurers are estimated in a manner
consistent with the claim liability associated with the reinsured policies.
AFC's insurance subsidiaries report as assets (a) the estimated reinsurance
recoverable on unpaid losses, including an estimate for losses incurred but
not reported, and (b) amounts paid to reinsurers applicable to the
unexpired terms of policies in force. AFC's insurance subsidiaries also
assume reinsurance from other companies. Income on reinsurance assumed is
recognized based on reports received from ceding reinsurers.
DEFERRED ACQUISITION COSTS Policy acquisition costs (principally
commissions, premium taxes and other underwriting expenses) related to the
production of new business are deferred ("DPAC"). 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. DPAC related to
annuities and universal life insurance products is amortized, with
interest, in relation to the present value of expected gross profits on the
policies. 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.
UNPAID LOSSES AND LOSS ADJUSTMENT EXPENSES The net liabilities stated
for unpaid claims and for expenses of investigation and adjustment of
unpaid claims are based upon (a) the accumulation of case estimates for
losses reported prior to the close of the accounting period on the direct
business written; (b) estimates received from ceding reinsurers and
insurance pools and associations; (c) estimates of unreported losses based
on past experience; (d) estimates based on experience of expenses for
investigating and adjusting claims and (e) the current state of the law and
coverage litigation. These liabilities are subject to the impact of changes
in claim amounts and frequency and other factors. In spite of the
variability inherent in such estimates, management believes that the
liabilities for unpaid losses and loss adjustment expenses are adequate.
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.
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 expense and decreases for surrender charges are
credited to other income.
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 anticipated
investment yield, mortality, morbidity and surrenders and include
provisions for unfavorable deviations. Reserves established for accident
and health claims are modified as necessary to reflect actual experience
and developing trends.
7
AMERICAN FINANCIAL CORPORATION 10-Q
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
VARIABLE ANNUITY ASSETS AND LIABILITIES Separate accounts related to
variable annuities represent deposits invested in underlying investment
funds on which Great American Financial Resources, Inc. ("GAFRI"), an
83%-owned subsidiary, earns a fee. The investment funds are selected and
may be changed only by the policyholder.
PREMIUM RECOGNITION Property and casualty premiums are earned 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 reports 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.
POLICYHOLDER DIVIDENDS Dividends payable to policyholders are included
in "Accounts payable, accrued expenses and other liabilities" and represent
estimates of amounts payable on participating policies which share in
favorable underwriting results. The estimate is accrued during the period
in which the related premium is earned. Changes in estimates are included
in income in the period determined. Policyholder dividends do not become
legal liabilities unless and until declared by the boards of directors of
the insurance companies.
MINORITY INTEREST For balance sheet purposes, minority interest represents
(i) the interests of noncontrolling shareholders in AFC subsidiaries,
including preferred securities issued by trust subsidiaries of GAFRI and
(ii) American Financial Group, Inc.'s ("AFG") direct ownership interest in
American Premier Underwriters, Inc. ("American Premier" or "APU") and
American Financial Enterprises, Inc. For income statement purposes,
minority interest expense represents those shareholders' interest in the
earnings of AFC subsidiaries as well as accrued distributions on the trust
preferred securities.
INCOME TAXES AFC files consolidated federal income tax returns which
include all 80%-owned U.S. subsidiaries, except for certain life insurance
subsidiaries and their subsidiaries. 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. Deferred
tax assets are recognized if it is more likely than not that a benefit will
be realized.
BENEFIT PLANS AFC provides retirement benefits to qualified employees of
participating companies through contributory and noncontributory defined
contribution plans contained in AFG's Retirement and Savings Plan. Under
the retirement portion of the plan, company contributions are invested
primarily in securities of AFG and affiliates. Under the savings portion of
the plan, AFC matches a specific portion of employee contributions.
Contributions to benefit plans are charged against earnings in the year for
which they are declared.
AFC and many of its subsidiaries provide health care and life insurance
benefits to eligible retirees. AFC 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 the employees earn
such benefits.
8
AMERICAN FINANCIAL CORPORATION 10-Q
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
DERIVATIVES Effective October 1, 2000, AFC implemented Statement of
Financial Accounting Standards ("SFAS") No. 133, "Accounting for Derivative
Instruments and Hedging Activities", which establishes accounting and
reporting standards for derivative instruments (including derivative
instruments that are embedded in other contracts) and for hedging
activities. Prior year financial statements were not restated. SFAS No. 133
generally requires that derivatives (both assets and liabilities) be
recognized in the balance sheet at fair value with changes in fair value
included in current earnings.
Derivatives included in AFC's Balance Sheet consist primarily of
investments in common stock warrants (included in other stocks), the
equity-based component of certain annuity products (included in annuity
benefits accumulated) and call options (included in other investments) used
to mitigate the risk embedded in the equity-indexed annuity products.
STATEMENT OF CASH FLOWS For cash flow purposes, "investing activities" are
defined as making and collecting loans and acquiring and disposing of debt
or equity instruments and property and equipment. "Financing activities"
include obtaining resources from owners and providing them with a return on
their investments, borrowing money and repaying amounts borrowed. Annuity
receipts, 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.
B. SALE OF SUBSIDIARIES
JAPANESE DIVISION In December 2000, AFC agreed to sell its Japanese
property and casualty division to Mitsui Marine & Fire Insurance Company of
America for approximately $22 million in cash and recorded a $10.7 million
pretax loss on the sale. Upon completion of the sale in March 2001, AFC
realized an additional pretax loss of $1.6 million and deferred a gain of
approximately $21 million on ceded insurance which is being recognized over
the estimated settlement period (weighted average of 4 years) of the ceded
claims. At the same time, a reinsurance agreement under which Great
American Insurance ceded a portion of its pool of insurance to Mitsui was
terminated. The Japanese division generated net written premiums of
approximately $60 million per year to Great American while Great American
ceded approximately $45 million per year to Mitsui.
C. SEGMENTS OF OPERATIONS AFC's property and casualty group is engaged
primarily in private passenger automobile and specialty insurance
businesses. The Personal group writes nonstandard and preferred/standard
private passenger auto and other personal insurance coverage. The Specialty
group includes a highly diversified group of specialty business units. Some
of the more significant areas are inland and ocean marine, California
workers' compensation, agricultural-related coverages, executive and
professional liability, fidelity and surety bonds, collateral protection,
and umbrella and excess coverages. AFC's annuity and life business markets
primarily retirement products as well as life and supplemental health
insurance. In addition, AFC owns a significant portion of the voting equity
securities of Chiquita Brands International, Inc. (an investee corporation
- see Note D).
9
AMERICAN FINANCIAL CORPORATION 10-Q
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
The following table (in thousands) shows AFC's revenues and operating
profit (loss) by significant business segment. Operating profit (loss)
represents total revenues less operating expenses.
Three months ended
March 31,
---------------------
2001 2000
---- ----
Revenues (a)
Property and casualty insurance:
Premiums earned:
Personal $327,632 $297,313
Specialty 316,307 274,823
Other lines - primarily discontinued 784 1
-------- --------
644,723 572,137
Investment and other income 107,335 121,167
-------- --------
752,058 693,304
Annuities and life (b) 217,030 187,337
Other 4,408 3,624
-------- --------
$973,496 $884,265
======== ========
Operating Profit (Loss)
Property and casualty insurance:
Underwriting:
Personal ($ 27,782) ($10,933)
Specialty (2,230) (10,498)
Other lines - primarily discontinued (6,455) (2,515)
-------- --------
(36,467) (23,946)
Investment and other income 75,202 84,525
-------- --------
38,735 60,579
Annuities and life 30,123 27,514
Other (c) (26,643) (14,456)
-------- --------
$ 42,215 $ 73,637
======== ========
(a) Revenues include sales of products and services as well as other
income earned by the respective segments.
(b) Represents primarily investment income.
(c) Includes holding company expenses.
D. Investee Corporations Investment in investee corporations reflects AFC's
ownership of 24 million shares (33%) of Chiquita common stock. The market
value of this investment was $31 million and $24 million at March 31, 2001
and December 31, 2000, respectively. Chiquita is a leading international
marketer, producer and distributor of quality fresh fruits and vegetables
and processed foods. Summarized financial information for Chiquita follows
(in millions):
Three months ended March 31,
----------------------------
2001 2000
---- ----
Net Sales $577 $658
Operating Income 38 68
Net Income 4 35
Net Income Attributed to Common Shares 0.4 31
In January 2001, Chiquita announced a restructuring initiative that
included discontinuing all interest and principal payments on its public
debt. If successful, the restructuring would result in the conversion of a
significant portion of Chiquita's $862 million in public debt into common
equity. Although the intended restructuring would not impact Chiquita's
day-to-day operations, it would adversely affect the holders of its stock,
including AFC.
10
AMERICAN FINANCIAL CORPORATION 10-Q
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
START-UP MANUFACTURING BUSINESSES Since 1998, AFC subsidiaries have made
loans to two start-up manufacturing businesses which were previously owned
by unrelated third-parties. During 2000, the former owners chose to forfeit
their equity interests to AFC rather than invest additional capital. In the
fourth quarter of 2000, AFC sold the equity interests to a group of
employees for nominal cash consideration plus warrants to repurchase a
significant ownership interest. Due to the absence of significant financial
investment by the buyers relative to the amount of debt owed to AFC
subsidiaries, the sale was not recognized as a divestiture for accounting
purposes. Assets of the businesses transferred (approximately $55 million
at March 31, 2001 and December 31, 2000) are included in other assets;
liabilities of the businesses transferred (approximately $7 million at
March 31, 2001 and December 31, 2000, after elimination of loans from AFC
subsidiaries) are included in other liabilities. AFC's equity in the losses
of these two companies during the first quarter of 2001 of $3.3 million is
included in investee losses in the statement of earnings.
E. PAYABLE TO AMERICAN FINANCIAL GROUP AFC has a reciprocal Master Credit
Agreement with various AFG holding companies under which these companies
make funds available to each other for general corporate purposes.
F. LONG-TERM DEBT The carrying value of long-term debt consisted of the
following (in thousands):
March 31, December 31,
2001 2000
-------- -----------
Holding Companies:
AFC notes payable under bank line $160,000 $178,000
APU 10-7/8% Subordinated Notes due May 2011 11,597 11,611
Other 14,804 14,727
-------- --------
$186,401 $204,338
======== ========
Subsidiaries:
GAFRI 6-7/8% Senior Notes due June 2008 $100,000 $100,000
GAFRI notes payable under bank line 53,100 48,500
Notes payable secured by real estate 24,396 31,201
Other 14,996 15,386
-------- --------
$192,492 $195,087
======== ========
At March 31, 2001, sinking fund and other scheduled principal payments on
debt for the balance of 2001 and the subsequent five years were as follows
(in millions):
Holding
Companies Subsidiaries Total
--------- ------------ --------
2001 $ 1.4 $ 1.0 $ 2.4
2002 170.4 1.5 171.9
2003 - 1.5 1.5
2004 - 61.5 61.5
2005 - 10.0 10.0
2006 - .7 .7
Debentures purchased in excess of scheduled payments may be applied to
satisfy any sinking fund requirement. The scheduled principal payments
shown above assume that debentures previously purchased are applied to the
earliest scheduled retirements.
11
AMERICAN FINANCIAL CORPORATION 10-Q
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
AFC and GAFRI each have an unsecured credit agreement with a group of banks
under which they can borrow up to $300 million and $155 million,
respectively. Borrowings bear interest at floating rates based on prime or
Eurodollar rates. Loans mature in December 2002 under the AFC credit
agreement and in December 2004 under the GAFRI credit agreement.
G. MINORITY INTEREST Minority interest in AFC's balance sheet is comprised of
the following (in thousands):
March 31, December 31,
2001 2000
-------- -----------
Interest of AFG (parent) and noncontrolling
shareholders in subsidiaries' common stock $304,278 $291,792
Preferred securities issued by
subsidiary trusts 217,913 217,913
-------- --------
$522,191 $509,705
======== ========
TRUST ISSUED PREFERRED SECURITIES Wholly-owned subsidiary trusts of GAFRI
have issued preferred securities and, in turn, purchased a like amount of
subordinated debt which provides interest and principal payments to fund
the respective trusts' obligations. The preferred securities must be
redeemed upon maturity or redemption of the subordinated debt. GAFRI
effectively provides unconditional guarantees of its respective trusts'
obligations.
The preferred securities consisted of the following (in thousands):
Date of March 31, December 31, Optional
Issuance Issue (Maturity Date) 2001 2000 Redemption Dates
------------- ------------------------ -------- ----------- ---------------------
November 1996 GAFRI 9-1/4% TOPrS (2026) $72,913 $72,913 On or after 11/7/2001
March 1997 GAFRI 8-7/8% Pfd (2027) 70,000 70,000 On or after 3/1/2007
May 1997 GAFRI 7-1/4% ROPES (2041) 75,000 75,000 After 9/28/2001
MINORITY INTEREST EXPENSE Minority interest expense is comprised of (in
thousands):
Three months ended
March 31,
------------------
2001 2000
---- ----
Interest of AFG (parent) and noncontrolling
shareholders in earnings of subsidiaries $4,005 $5,192
Accrued distributions by subsidiaries
on trust issued preferred securities,
net of tax 2,914 3,015
------ ------
$6,919 $8,207
====== ======
12
AMERICAN FINANCIAL CORPORATION 10-Q
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
H. SHAREHOLDERS' EQUITY At March 31, 2001 and December 31, 2000, American
Financial Group beneficially owned all of the outstanding shares of AFC's
Common Stock.
PREFERRED STOCK Under provisions of both the Nonvoting (4.0 million shares
authorized) and Voting (4.0 million shares authorized) Cumulative Preferred
Stock, the Board of Directors may divide the authorized stock into series
and set specific terms and conditions of each series. At March 31, 2001 and
December 31, 2000, the outstanding voting shares of AFC's Preferred Stock
consisted of the following:
SERIES J, no par value; $25.00 liquidating value per share; annual
dividends per share $2.00; redeemable at AFC's option at $25.75 per
share beginning December 2005 declining to $25.00 at December 2007
and thereafter; 2,886,161 shares (stated value $72.2 million)
outstanding at March 31, 2001 and December 31, 2000.
The change in unrealized gain (loss) on marketable securities for the three
months ended March 31 included the following (in millions):
Minority
Pretax Taxes Interest Net
------ ----- -------- -----
2001
------------------------------------------
Unrealized holding gains on securities
arising during the period $59.0 ($20.6) ($8.2) $30.2
Reclassification adjustment for
realized losses included in net income 6.9 (2.4) (.3) 4.2
----- ----- ---- -----
Change in unrealized gain on
marketable securities, net $65.9 ($23.0) ($8.5) $34.4
===== ===== ==== =====
2000
------------------------------------------
Unrealized holding losses on securities
arising during the period ($40.3) $14.5 $2.4 ($23.4)
Reclassification adjustment for
realized losses included in net income 1.4 (.5) (.1) .8
----- ----- ---- -----
Change in unrealized gain (loss) on
marketable securities, net ($38.9) $14.0 $2.3 ($22.6)
===== ===== ==== =====
I. COMMITMENTS AND CONTINGENCIES There have been no significant changes to the
matters discussed and referred to in Note M "Commitments and Contingencies"
of AFC's Annual Report on Form 10-K for 2000.
13
AMERICAN FINANCIAL CORPORATION 10-Q
ITEM 2
Management's Discussion and Analysis
of Financial Condition and Results of Operations
------------------------------------------------
GENERAL
AFC and American Premier are organized as holding companies with almost all
of their operations being conducted by subsidiaries. These parent
corporations, however, have continuing cash needs for administrative
expenses, the payment of principal and interest on borrowings, shareholder
dividends, and taxes. Therefore, certain analyses are best done on a parent
only basis while others are best done on a total enterprise basis. In
addition, since most of its businesses are financial in nature, AFC does
not prepare its consolidated financial statements using a
current-noncurrent format. Consequently, certain traditional ratios and
financial analysis tests are not meaningful.
IT Initiative In 1999, AFC initiated an enterprise-wide study of its
information technology ("IT") resources, needs and opportunities. The
initiative entails extensive effort and costs. While the costs precede the
expected savings, management believes the benefits in efficiencies and
effectiveness will exceed the costs incurred, all of which have been and
will be funded through available working capital.
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 forward-looking
words such as "believes", "expects", "may", "will", "should", "seeks",
"intends", "plans", "estimates", "anticipates" or the negative version of
those words or other comparable terminology. Actual results could differ
materially from those contained in or implied by such forward-looking
statements for a variety of factors including:
o changes in economic conditions, including interest rates, performance
of securities markets, and the availability of capital;
o regulatory actions;
o changes in legal environment;
o tax law changes;
o levels of catastrophes and other major losses;
o adequacy of loss reserves;
o availability of reinsurance; and
o competitive pressures, including the ability to obtain rate
increases.
Forward-looking statements speak only as of the date made. AFC undertakes
no obligations to update any forward-looking statements to reflect events
or circumstances arising after the date on which they are made.
LIQUIDITY AND CAPITAL RESOURCES
RATIOS AFC's debt to total capital ratio at the parent holding company
level (excluding amounts due AFG) was approximately 11% at March 31, 2001
and 12% at December 31, 2000. Including amounts due AFG, the ratio was 29%
at March 31, 2001 and 31% at December 31, 2000.
AFC's ratio of earnings to fixed charges, excluding and including preferred
dividends, (on a total enterprise basis) was 2.39 and 2.20 for the first
three months of 2001 and 2.02 and 1.87 for the entire year of 2000.
14
AMERICAN FINANCIAL CORPORATION 10-Q
Management's Discussion and Analysis
of Financial Condition and Results of Operations - Continued
------------------------------------------------------------
Sources of Funds Management believes the parent holding companies have
sufficient resources to meet their liquidity requirements, primarily
through funds generated by their subsidiaries' operations. If funds
provided by subsidiaries through dividends and tax payments are
insufficient to meet fixed charges in any period, the holding companies
would be required to generate cash through borrowings, sales of securities
or other assets, or similar transactions.
AFC has a revolving credit agreement with several banks under which it can
borrow up to $300 million. This credit line provides ample liquidity and
can be used to obtain funds for operating subsidiaries or, if necessary,
for the parent companies. There was $160 million borrowed under the line at
March 31, 2001 and $212 million at May 1, 2001.
Dividend payments from subsidiaries have been very important to the
liquidity and cash flow of the individual holding companies during certain
periods in the past. However, the reliance on such dividend payments has
been lessened in recent years by the combination of (i) reductions in the
amounts and cost of debt at the holding companies from historical levels
(and the related decrease in ongoing cash needs for interest and principal
payments), (ii) the ability to obtain financing in capital markets, as well
as (iii) the sales of certain noncore investments.
INVESTMENTS Approximately 92% of the fixed maturities held by AFC were
rated "investment grade" (credit rating of AAA to BBB) by nationally
recognized rating agencies at March 31, 2001. Investment grade securities
generally bear lower yields and lower degrees of risk than those that are
unrated and noninvestment grade. Management believes that the high quality
investment portfolio should generate a stable and predictable investment
return.
AFC's equity securities are concentrated in a relatively limited number of
major positions. This approach allows management to more closely monitor
the companies and the industries in which they operate.
RESULTS OF OPERATIONS
GENERAL Pretax operating earnings for the first quarter of 2001 were $42.2
million compared to $13.7 million for the fourth quarter of 2000 and $73.6
million for the first quarter of 2000. Pretax operating earnings improved
compared to the fourth quarter of 2000 due primarily to decreased realized
losses and improved underwriting results. The decrease in pretax operating
earnings compared to the first quarter of 2000 reflects a decline in the
Personal group's underwriting results and increased realized losses.
PROPERTY AND CASUALTY INSURANCE - UNDERWRITING AFC's property and casualty
group consists of two major business groups: Personal and Specialty.
The Personal group sells nonstandard and preferred/standard private
passenger auto insurance and, to a lesser extent, homeowners' insurance.
Nonstandard automobile insurance covers risk not typically accepted for
standard automobile coverage because of the applicant's driving record,
type of vehicle, age or other criteria.
The Specialty group includes a highly diversified group of business lines.
Some of the more significant areas are inland and ocean marine, California
workers' compensation, agricultural-related coverages, executive and
professional liability, fidelity and surety bonds, collateral protection,
and umbrella and excess coverages.
15
AMERICAN FINANCIAL CORPORATION 10-Q
Management's Discussion and Analysis
of Financial Condition and Results of Operations - Continued
------------------------------------------------------------
Underwriting profitability is measured by the combined ratio which is a sum
of the ratios of underwriting losses, loss adjustment expenses,
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.
For certain lines of business and products where the credibility of the
range of loss projections is less certain (primarily the various specialty
businesses listed above), management believes that it is prudent and
appropriate to use conservative assumptions until such time as the data,
experience and projections have more credibility, as evidenced by data
volume, consistency and maturity of the data. While this practice mitigates
the risk of adverse development on this business, it does not eliminate it.
Net written premiums and combined ratios for AFC's property and casualty
insurance subsidiaries were as follows (dollars in millions):
Three months ended
March 31,
-------------------
2001 2000
---- ----
Net Written Premiums (GAAP)
---------------------------
Personal $370.5 $349.8
Specialty 356.6(a) 297.7
Other lines - -
------ ------
$727.1 $647.5
====== ======
Combined Ratios (GAAP)(b)
----------------------
Personal 108.5% 103.7%
Specialty 100.6 103.8
Aggregate (including discontinued lines) 105.6 104.2
(a) Before a reduction of $29.7 million for unearned premium transfer
related to the sale of the Japanese division.
(b) Combined ratios for the fourth quarter of 2000 were: Personal -
111.0%, Specialty - 104.3%, Aggregate - 106.1%. Combined ratios
for the entire year of 2000 were: Personal - 108.6%, Specialty -
107.9%, Aggregate - 108.0%.
PERSONAL The Personal group's increase in net written premiums reflects the
impact of significant rate increases implemented primarily in the second
half of 2000, partially offset by lower business volume. The combined ratio
improved compared to the 2000 fourth quarter due primarily to the impact of
these rate increases. The increase in the combined ratio compared to the
first quarter of 2000 reflects the impact of inadequate rates on policies
written during the first part of 2000. To further improve underwriting
results, AFC implemented rate increases averaging 5% in the first quarter
of 2001 and expects rate increases to be in excess of 10% by the end of
2001.
SPECIALTY The Specialty group's increase in net written premiums reflects
the impact of rate increases implemented in 2000 and 2001 and the
realization of growth opportunities in certain commercial markets. In its
California workers' compensation business, AFC implemented rate increases
averaging 40% on renewals in the first quarter 2001 and expects rate
increases of at least 30% on renewals in this business during the second
quarter. Rate increases implemented in the
16
AMERICAN FINANCIAL CORPORATION 10-Q
Management's Discussion and Analysis
of Financial Condition and Results of Operations - Continued
------------------------------------------------------------
other specialty operations averaged 17% for the first quarter of 2001. The
improvement in the combined ratio compared to both the fourth and first
quarters of 2000 reflects the impact of these rate increases. Excluding the
California workers' compensation business, the Specialty group's combined
ratio for the first quarter of 2001 was 98.0%.
LIFE, ACCIDENT AND HEALTH PREMIUMS AND BENEFITS The increase in life,
accident and health premiums and benefits is due primarily to increased
sales of supplemental health insurance products.
REAL ESTATE OPERATIONS AFC's subsidiaries are engaged in a variety of real
estate operations including hotels, apartments, office buildings and
recreational facilities; they also own several parcels of land. Revenues
and expenses of these operations, including gains and losses on disposal,
are included in AFC's statement of earnings as shown below (in millions).
Three months ended
March 31,
------------------
2001 2000
---- ----
Other income $32.0 $17.9
Other operating and general expenses 15.0 14.3
Interest charges on borrowed money .7 .7
Minority interest expense, net 1.9 .2
Other income includes net pretax gains on the sale of real estate assets of
$15.3 million in the first quarter of 2001 and $2.1 million in the first
quarter of 2000.
OTHER INCOME Other income increased $3.7 million (7%) in the first quarter
of 2001 compared to 2000 due primarily to increased income from the sale of
real estate which exceeded income from the sale of operating assets and
lease residuals in the first quarter of 2000.
REALIZED GAINS Realized capital gains have been an important part of the
return on investments in marketable securities. Individual securities are
sold creating gains and losses as market opportunities exist.
Under Statement of Financial Accounting Standards ("SFAS") No. 133, which
was adopted as of October 1, 2000, warrants to purchase common stock of
publicly traded companies are generally considered derivatives and marked
to market through current earnings as realized gains and losses. Realized
losses on sales of securities includes $.8 million in losses recognized
during the first quarter of 2001 to adjust the carrying value of AFC's
investment in warrants to market value at March 31, 2001.
LOSS ON SALE OF SUBSIDIARIES In 2001, AFC recognized a $1.6 million pretax
loss representing an adjustment to the fourth quarter 2000 loss recorded on
the sale of its Japanese division.
ANNUITY BENEFITS Annuity benefits reflect amounts accrued on annuity
policyholders' funds accumulated. The majority of GAFRI's fixed rate
annuity products permit GAFRI to change the crediting rate at any time
(subject to minimum interest rate guarantees of 3% or 4% per annum). As a
result, management has been able to react to changes in market interest
rates and maintain a desired interest rate spread.
17
AMERICAN FINANCIAL CORPORATION 10-Q
Management's Discussion and Analysis
of Financial Condition and Results of Operations - Continued
------------------------------------------------------------
GAFRI's equity-indexed fixed annuities provide policyholders with a
crediting rate tied, in part, to the performance of an existing stock
market index. GAFRI attempts to mitigate the risk in the equity-based
component of these products through the purchase of call options on the
appropriate index. GAFRI's strategy is designed so that an increase in the
liabilities due to an increase in the market index will be substantially
offset by unrealized gains on the call options. Under SFAS No. 133, both
the equity-based component of the annuities and the related call options
are considered derivatives and marked to market through current earnings as
annuity benefits. Adjusting these derivatives to market value had virtually
no net effect on annuity benefits during the first quarter of 2001.
INTEREST ON BORROWED MONEY Interest expense increased $3.3 million (21%) in
the first quarter of 2001 compared to the first quarter of 2000 due to
higher average indebtedness to AFG under the Master Credit Agreement.
OTHER OPERATING AND GENERAL EXPENSES Other operating and general expenses
increased $11.8 million (12%) in the first quarter of 2001 compared to the
first quarter of 2000 due primarily to increased expenses associated with
the IT initiative and slightly higher holding company expenses.
INVESTEE CORPORATIONS For 2001, equity in earnings (losses) of investee
corporations represents losses of two start-up manufacturing businesses.
Equity in net earnings (losses) of investees in 2000 represents AFC's
proportionate share of Chiquita's earnings. Chiquita reported net income of
$.01 per share for the first quarter of 2001 and $.46 per share for the
first quarter of 2000.
----------------------------------------------------------------
Item 3
Quantitative and Qualitative Disclosure of Market Risk
------------------------------------------------------
As of March 31, 2001, there were no material changes to the information
provided in AFC's Form 10-K for 2000 under the caption "Exposure to Market
Risk" in Management's Discussion and Analysis of Financial Condition and
Results of Operations.
18
AMERICAN FINANCIAL CORPORATION 10-Q
PART II
OTHER INFORMATION
Item 6
Exhibits and Reports on Form 8-K
--------------------------------
(a) Exhibits: none
(b) Reports on Form 8-K: none
----------------------------------------------------------------
Signature
---------
Pursuant to the requirements of the Securities Exchange Act of 1934, American
Financial Corporation has duly caused this Report to be signed on its behalf by
the undersigned duly authorized.
American Financial Corporation
May 11, 2001 BY: Fred J. Runk
-----------------------------------
Fred J. Runk
Senior Vice President and Treasurer
19