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 June 30, 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 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 August 1, 1999, 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 22 AMERICAN FINANCIAL CORPORATION 10-Q PART I FINANCIAL INFORMATION AMERICAN FINANCIAL CORPORATION AND SUBSIDIARIES CONSOLIDATED BALANCE SHEET (Dollars In Thousands) June 30, December 31, 1999 1998 Assets: Cash and short-term investments $ 308,805 $ 289,944 Investments: Fixed maturities - at market (amortized cost - $10,134,734 and $9,920,407) 10,166,634 10,323,407 Other stocks - at market (cost - $238,857 and $207,345) 499,057 430,345 Investment in investee corporation 207,176 192,138 Policy loans 217,712 220,496 Real estate and other investments 251,669 268,171 Total investments 11,342,248 11,434,557 Recoverables from reinsurers and prepaid reinsurance premiums 2,049,570 1,973,895 Agents' balances and premiums receivable 595,402 618,198 Deferred acquisition costs 535,300 464,047 Other receivables 238,188 318,154 Assets held in separate accounts 215,946 120,049 Prepaid expenses, deferred charges and other assets 379,028 343,554 Cost in excess of net assets acquired 315,210 285,469 $15,979,697 $15,847,867 Liabilities and Capital: Unpaid losses and loss adjustment expenses $ 4,807,628 $ 4,773,377 Unearned premiums 1,234,112 1,232,848 Annuity benefits accumulated 5,469,517 5,449,633 Life, accident and health reserves 358,034 341,595 Payable to American Financial Group, Inc. 413,800 270,500 Long-term debt: Holding companies 133,590 315,536 Subsidiaries 223,959 176,896 Liabilities related to separate accounts 215,946 120,049 Accounts payable, accrued expenses and other liabilities 1,159,002 1,112,442 Total liabilities 14,015,588 13,792,876 Minority interest 503,025 524,335 Shareholders' Equity: Preferred Stock (liquidation value $72,154) 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 952,353 943,359 Retained earnings 251,152 157,218 Net unrealized gain on marketable securities, net of deferred income taxes 175,800 348,300 Total shareholders' equity 1,461,084 1,530,656 $15,979,697 $15,847,867 2 AMERICAN FINANCIAL CORPORATION 10-Q AMERICAN FINANCIAL CORPORATION AND SUBSIDIARIES CONSOLIDATED STATEMENT OF EARNINGS (In Thousands) Three months ended Six months ended June 30, June 30, 1999 1998 1999 1998 Income: Property and casualty insurance premiums $557,535 $ 707,294 $1,095,001 $1,383,466 Life, accident and health premiums 25,367 48,460 50,955 95,276 Investment income 210,716 229,207 416,176 449,438 Equity in net earnings of investee 1,119 17,996 17,436 31,914 Realized gains on sales of: Securities 7,276 7,142 11,725 14,588 Investee - 1,716 - 9,420 Other investments - - - 6,843 Other income 30,322 26,317 58,127 63,850 832,335 1,038,132 1,649,420 2,054,795 Costs and Expenses: Property and casualty insurance: Losses and loss adjustment expenses 398,819 564,078 764,648 1,063,903 Commissions and other underwriting expenses 166,601 191,027 334,822 384,632 Annuity benefits 63,520 69,111 128,461 140,221 Life, accident and health benefits 15,994 36,555 34,873 74,661 Interest charges on borrowed money 16,374 18,023 33,221 35,054 Minority interest expense 11,533 10,946 25,152 23,087 Other operating and general expenses 87,696 83,133 163,923 159,832 760,537 972,873 1,485,100 1,881,390 Earnings before income taxes, extraordinary items and cumulative effect of accounting change 71,798 65,259 164,320 173,405 Provision for income taxes 25,529 25,673 59,797 67,409 Earnings before extraordinary items and cumulative effect of accounting change 46,269 39,586 104,523 105,996 Extraordinary items - loss on prepayment of debt (3,849) (36) (3,849) (721) Cumulative effect of accounting change - - (3,854) - Net Earnings $ 42,420 $ 39,550 $ 96,820 $ 105,275 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 on Comprehensive Stock Surplus Earnings Securities Income (Loss) Balance at January 1, 1999 $72,154 $952,984 $157,218 $348,300 Net earnings - - 96,820 - $ 96,820 Dividends on Preferred Stock - - (2,886) - - Capital contribution from parent - 6,134 - - - Change in unrealized - - - (172,500) (172,500) Other - 2,860 - - - Balance at June 30, 1999 $72,154 $961,978 $251,152 $175,800 ($ 75,680) Balance at January 1, 1998 $72,154 $945,779 $ 34,350 $341,200 Net earnings - - 105,275 - $105,275 Dividends on Preferred Stock - - (2,886) - - Capital contribution from parent - 8,354 - - - Change in unrealized - - - (10,500) (10,500) Other - 220 - - - Balance at June 30, 1998 $72,154 $954,353 $136,739 $330,700 $ 94,775 4 AMERICAN FINANCIAL CORPORATION 10-Q AMERICAN FINANCIAL CORPORATION AND SUBSIDIARIES CONSOLIDATED STATEMENT OF CASH FLOWS (In Thousands) Six months ended June 30, 1999 1998 Operating Activities: Net earnings $ 96,820 $ 105,275 Adjustments: Extraordinary items 3,849 721 Cumulative effect of accounting change 3,854 - Depreciation and amortization 44,065 51,233 Annuity benefits 128,461 140,221 Equity in net earnings of investee (17,436) (31,914) Realized gains on investing activities (16,503) (44,411) Deferred annuity and life policy acquisition costs (59,181) (48,936) Decrease (increase) in reinsurance and other receivables 15,977 (121,030) Decrease (increase) in other assets (51,376) 5,192 Increase in insurance claims and reserves 10,181 167,165 Increase in other liabilities 51,925 33,618 Increase in minority interest 11,655 11,462 Dividends from investee 2,400 2,400 Other, net (12,080) (10,707) 212,611 260,289 Investing Activities: Purchases of and additional investments in: Fixed maturity investments (1,141,911) (1,243,852) Equity securities (47,901) (33,137) Subsidiaries (183,886) (30,325) Real estate, property and equipment (38,594) (34,932) Maturities and redemptions of fixed maturity investments 619,073 772,496 Sales of: Fixed maturity investments 653,969 358,597 Equity securities 33,241 12,194 Real estate, property and equipment 9,201 30,989 Cash and short-term investments of acquired subsidiaries, net 19,413 20,841 Decrease (increase) in other investments 22,042 (4,843) (55,353) (151,972) Financing Activities: Fixed annuity receipts 219,250 238,198 Annuity surrenders, benefits and withdrawals (361,498) (354,790) Additional long-term borrowings 123,162 202,248 Reductions of long-term debt (263,550) (134,164) Borrowings from AFG 222,100 - Payments to AFG (78,800) (22,500) Capital contribution 9,334 9,334 Repurchases of trust preferred securities (5,509) - Cash dividends paid (2,886) (2,886) (138,397) (64,560) Net Increase in Cash and Short-term Investments 18,861 43,757 Cash and short-term investments at beginning of period 289,944 231,227 Cash and short-term investments at end of period $ 308,805 $ 274,984 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 "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 Corporation 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. 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 40 years. Insurance As discussed under "Reinsurance" below, unpaid losses and loss adjustment expenses and unearned premiums have not been reduced for reinsurance recoverable. 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. 6 AMERICAN FINANCIAL CORPORATION 10-Q NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED 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, the deferral of acquisition costs is limited based upon their recoverability without any consideration for anticipated investment income. DPAC is charged against income ratably over the terms of the related policies. For the annuity companies, DPAC is amortized, with interest, in relation to the present value of expected gross profits on the policies. 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 are modified as necessary to reflect actual experience and developing trends. Assets Held In and Liabilities Related to Separate Accounts Separate account assets and related liabilities represent variable annuity deposits. 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. 7 AMERICAN FINANCIAL CORPORATION 10-Q NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED 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 American Annuity Group ("AAG"), and (ii) the American Financial Group ("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. Issuances of Stock by Subsidiaries and Investees Changes in AFC's equity in a subsidiary or an investee caused by issuances of the subsidiary's or investee's stock are accounted for as gains or losses where such issuance is not a part of a broader reorganization. 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 AFC's Retirement and Savings Plan. Under the retirement portion of the plan, company contributions (approximately 6% of covered compensation in 1998) are invested primarily in securities of AFC 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. Start-up Costs Prior to 1999, AAG, an 83%-owned subsidiary, deferred certain costs associated with introducing new products and distribution channels and amortized them on a straight-line basis over 5 years. In 1999, AAG implemented Statement of Position ("SOP") 98-5, "Reporting on the Costs of Start-Up Activities." The SOP requires that (i) costs of start-up activities be expensed as incurred and (ii) unamortized balances of previously deferred costs be expensed and reported as the cumulative effect of a change in accounting principle. Accordingly, AFC expensed previously capitalized start-up costs of $3.8 million (net of minority interest and taxes), effective January 1, 1999. 8 AMERICAN FINANCIAL CORPORATION 10-Q NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED Derivatives The Financial Accounting Standards Board issued SFAS No. 133, "Accounting for Derivative Instruments and Hedging Activities," during the second quarter of 1998. AFC must implement SFAS No. 133 no later than January 1, 2001. SFAS No. 133 establishes accounting and reporting standards for derivative instruments, including derivative instruments that are embedded in other contracts, and for hedging activities. SFAS No. 133 requires the recognition of all derivatives (both assets and liabilities) in the balance sheet at fair value. Changes in fair value of derivative instruments are included in current income or as a component of comprehensive income (outside current income) depending on the type of derivative. Implementation of SFAS No. 133 is not expected to have a material effect on AFC's financial position or results of operations. Comprehensive Income Comprehensive income represents the total of net earnings plus other comprehensive income. For AFC, other comprehensive income represents the change in net unrealized gain on marketable securities net of deferred taxes. 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. Acquisitions and Sales of Subsidiaries Worldwide Insurance Company In April 1999, AFC completed the purchase of Worldwide Insurance Company (formerly Providian Auto and Home Insurance Company) for $157 million in cash. Worldwide is a provider of direct response private passenger automobile insurance. Old Republic In February 1999, AAG acquired Old Republic Life Insurance Company of New York for approximately $27 million in cash. United Teacher Associates In July 1999, AAG reached a definitive agreement to acquire United Teacher Associates Insurance Company of Austin, Texas ("UTA"). UTA provides retired and active teachers with supplemental health products and retirement annuities. Completion of the acquisition, which is expected to occur in the third quarter of 1999, is subject to certain conditions, including receipt of approval from the Texas Department of Insurance. Commercial lines division In December 1998, AFC completed the sale of substantially all of its Commercial lines division to Ohio Casualty Corporation for $300 million plus warrants to purchase 6 million (post split) shares of Ohio Casualty common stock. AFC deferred a gain of $103 million on the insurance ceded to Ohio Casualty and recognized a pretax gain of $153 million on the sale of the other net assets. The deferred gain is being recognized over the estimated remaining settlement period (weighted average of 4.25 years) of the claims ceded. AFC may receive up to an additional $40 million in the year 2000 based upon the retention and growth of the insurance businesses acquired by Ohio Casualty. The commercial lines sold generated net written premiums of approximately $142 million for the six months ended June 30, 1998. 9 AMERICAN FINANCIAL CORPORATION 10-Q NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED Funeral Services division In September 1998, AAG sold its Funeral Services division for approximately $165 million in cash. The division held assets of approximately $1 billion at the sale date. AFC realized a pretax gain of $21.6 million, before $2.7 million of minority interest, on this sale. C. Segments of Operations Having sold substantially all of its Commercial lines division in December 1998, AFC's property and casualty group is engaged primarily in private passenger automobile and specialty insurance businesses. The Personal group consists of the nonstandard auto group along with the preferred/standard private passenger auto and other personal insurance business. The Specialty group includes a highly diversified group of specialty business units. 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). 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 Six months ended June 30, June 30, 1999 1998 1999 1998 Revenues (a) Property and casualty insurance: Premiums earned: Personal $300,765 $ 330,615 $ 586,582 $ 658,587 Specialty 258,115 366,275 508,703 703,184 Other lines - primarily discontinued (1,345) 10,404 (284) 21,695 557,535 707,294 1,095,001 1,383,466 Investment and other income 116,694 121,255 218,962 253,556 674,229 828,549 1,313,963 1,637,022 Annuities and life (b) 149,858 185,435 303,874 373,992 Other 7,129 6,152 14,147 11,867 831,216 1,020,136 1,631,984 2,022,881 Equity in net earnings of investee 1,119 17,996 17,436 31,914 $832,335 $1,038,132 $1,649,420 $2,054,795 Operating Profit (Loss) Property and casualty insurance: Underwriting: Personal ($ 2,434) $ 9,295 $ 2,046 $ 21,269 Specialty 972 (49,792) 1,321 (59,105) Other lines - primarily discontinued (6,423) (7,314) (7,836) (27,233) (7,885) (47,811) (4,469) (65,069) Investment and other income 73,094 91,536 137,622 194,046 65,209 43,725 133,153 128,977 Annuities and life 23,671 26,618 50,431 58,672 Other (c) (18,201) (23,080) (36,700) (46,158) 70,679 47,263 146,884 141,491 Equity in net earnings of investee 1,119 17,996 17,436 31,914 $ 71,798 $ 65,259 $ 164,320 $ 173,405 (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. 10 AMERICAN FINANCIAL CORPORATION 10-Q NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED D. Investment in Investee Corporation Investment in investee corporation reflects AFC's ownership of 24 million shares (36%) of Chiquita common stock. The market value of this investment was $216 million and $229 million at June 30, 1999 and December 31, 1998, 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): Six months ended June 30, 1999 1998 Net Sales $1,370 $1,461 Operating Income 113 144 Net Income 56 94 E. Payable to American Financial Group In 1997, AFC entered into a ten-year reciprocal Master Credit Agreement among AFG and several of AFG's subsidiary holding companies, including APU and AFC's direct parent, AFC Holding Company, under which funds are made available to each other at one percent over LIBOR. F. Long-Term Debt The carrying value of long-term debt consisted of the following (in thousands): June 30, December 31, 1999 1998 Holding Companies: AFC notes payable under bank line - $ 80,000 AFC 9-3/4% Debentures due April 2004 - 78,560 APU 9-3/4% Subordinated Notes due August 1999 $ 89,049 89,467 APU 10-5/8% Subordinated Notes due April 2000 23,985 41,518 APU 10-7/8% Subordinated Notes due May 2011 11,685 17,473 Other 8,871 8,518 $133,590 $315,536 Subsidiaries: AAG 6-7/8% Senior Notes due June 2008 $100,000 $100,000 AAG notes payable under bank line 75,000 27,000 Notes payable secured by real estate 37,328 37,602 Other 11,631 12,294 $223,959 $176,896 In the second quarter of 1999, AFC used funds borrowed under its credit agreement with AFG to (i) repay $155 million borrowed under its bank line; (ii) redeem its 9-3/4% Debentures for $82.9 million and (iii) repurchase $22.2 million of APU Notes for $24.5 million. In August 1999, APU redeemed its 9-3/4% Notes at maturity and AFC borrowed $40 million under the bank line. At June 30, 1999, sinking fund and other scheduled principal payments on debt for the balance of 1999 and the subsequent five years, adjusted to reflect the new bank borrowings and the payment of the APU 9-3/4% Notes, were as follows (in thousands): Holding Companies Subsidiaries Total 1999 $ - $ 1,041 $ 1,041 2000 23,667 8,685 32,352 2001 - 1,379 1,379 2002 45,939 1,266 47,205 2003 - 76,294 76,294 2004 - 14,241 14,241 11 AMERICAN FINANCIAL CORPORATION 10-Q NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED 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. AFC and AAG each have an unsecured credit agreement with a group of banks under which they can borrow up to $300 million and $200 million, respectively. Borrowings bear interest at floating rates based on prime or Eurodollar rates. Loans mature December 2002 under the AFC credit agreement and from 2000 to 2003 under the AAG credit agreement. G. Minority Interest Minority interest in AFC's balance sheet is comprised of the following (in thousands): June 30, December 31, 1999 1998 Interest of AFG (parent) and noncontrolling shareholders in subsidiaries' common stock $283,425 $299,335 Preferred securities issued by subsidiary trusts 219,600 225,000 $503,025 $524,335 Trust Issued Preferred Securities Wholly-owned subsidiary trusts of AAG have issued $225 million of preferred securities and, in turn, purchased a like amount of AAG 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. AAG effectively provides unconditional guarantees of its trusts' obligations. The trust issued preferred securities consisted of the following (in thousands): Date of June 30, December 31, Optional Issuance Issue (Maturity Date) 1999 1998 Redemption Dates November 1996 AAG 9-1/4% TOPrS (2026) $74,600 $75,000 On or after 11/7/2001 March 1997 AAG 8-7/8% Pfd (2027) 70,000 75,000 On or after 3/1/2007 May 1997 AAG 7-1/4% ROPES (2041) 75,000 75,000 Prior to 9/28/2000 and after 9/28/2001 In the first quarter of 1999, AAG repurchased $5.4 million of its preferred securities for $5.5 million in cash. 12 AMERICAN FINANCIAL CORPORATION 10-Q NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED Minority Interest Expense Minority interest expense is comprised of (in thousands): Six months ended June 30, 1999 1998 Interest of AFG (parent) and noncontrolling shareholders in earnings of subsidiaries $15,912 $13,571 Accrued distributions by subsidiaries on trust issued preferred securities 9,240 9,516 $25,152 $23,087 H. Shareholders' Equity 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. The outstanding voting shares of AFC's Preferred Stock consisted of the following: Series J, no par value; $25.00 liquidation value per share; annual dividends per share $2.00; redeemable at $25.75 per share beginning December 2005 declining to $25.00 at December 2007; 2,886,161 shares (stated value $72.2 million) outstanding at June 30, 1999 and December 31, 1998. Unrealized Gain on Marketable Securities The change in net unrealized gain on marketable securities for the six months ended June 30 included the following (in millions): Minority Pretax Taxes Interest Net 1999 Unrealized holding gains (losses) on securities arising during the period ($292.3) $100.8 $25.1 ($166.4) Reclassification adjustment for realized gains included in net income (11.7) 4.1 1.5 (6.1) Change in net unrealized gain on marketable securities ($304.0) $104.9 $26.6 ($172.5) 1998 Unrealized holding gains (losses) on securities arising during the period ($ 6.8) $ 2.5 ($ .2) ($ 4.5) Reclassification adjustment for realized gains included in net income (10.1) 3.5 .6 (6.0) Change in net unrealized gain on marketable securities ($ 16.9) $ 6.0 $ .4 ($ 10.5) I. Extraordinary Items Extraordinary items represent AFC's proportionate share of gains (losses) related to debt retirements by the following companies. Amounts shown are net of minority interest and income tax benefits (in thousands): Six months ended June 30, 1999 1998 Holding Companies: AFC (parent) ($2,993) ($ 35) APU (parent) (856) (37) Subsidiaries: AAG - (649) ($3,849) ($721) 13 AMERICAN FINANCIAL CORPORATION 10-Q NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED J. Cash Flows - Fixed Maturity Investments "Investing activities" related to fixed maturity investments in AFC's Statement of Cash Flows consisted of the following (in thousands): Available Held to For Sale Maturity (a) Total 1999 Purchases $1,141,911 $ - $1,141,911 Maturities and redemptions 619,073 - 619,073 Sales 653,969 - 653,969 1998 Purchases $1,243,026 $ 826 $1,243,852 Maturities and redemptions 397,871 374,625 772,496 Sales 326,657 31,940 (b) 358,597 (a) At December 31, 1998, AFC reclassified all of its "held to maturity" fixed maturity securities to "available for sale." (b) Sold (at a gain of $.2 million) due to significant deterioration in the issuers' creditworthiness. K. Commitments and Contingencies Other than as disclosed in "Legal Proceedings" in Part II of this report, there have been no significant changes to the matters discussed and referred to in Note M "Commitments and Contingencies" in AFC's Annual Report on Form 10-K for 1998. 14 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. Year 2000 Status AFC's Year 2000 Project is a corporate-wide program designed to ensure that its computer systems and other equipment using date-sensitive computer chips will function properly in the year 2000. The Project also encompasses communicating with agents, vendors, financial institutions and others with which the companies conduct business to determine their Year 2000 readiness and resulting effects on AFC. AFC's Year 2000 Project Office monitors and coordinates the work being performed by the various business units and reports monthly to the Audit Committee of the Board of Directors and more frequently to senior management. To address the Year 2000 issue, AFC's operations have been divided into separate systems groups. A majority of the groups have met AFC's goal of having program modifications and new software installations substantially completed by the end of 1998, with testing continuing in and through 1999. About two-thirds of the groups are expected to have completed Year 2000 testing by the end of the third quarter of 1999. The remainder are now expected to be completed during the fourth quarter. Contingency plans are being developed for certain business processes and systems deemed most critical to operations. These plans provide a documented order of actions necessary to keep the business functions operating. Such plans typically include procedures and workflow processes for developing and operating contingent databases. Contingency planning for other business processes and systems deemed critical to operations and reasonably likely not to be modified on schedule is expected to be substantially completed by the end of the third quarter. Many of the systems being replaced were planned replacements which were accelerated due to the Year 2000 considerations. In addition, a significant portion of AFC's Year 2000 Project is being completed using internal staff. Therefore, cost estimates for the Year 2000 Project do not represent solely incremental costs. From the inception of the Year 2000 Project in the early 1990s through June 30, 1999, AFC estimates that it has incurred approximately $61 million in costs related to the Project, including capitalized costs of $15 million for new systems. During the first six months of 1999, $11 million in such costs have been expensed. AFC estimates that it will incur an additional $13 million of such costs in completing the Project, about two-thirds of which is projected to be expensed. 15 AMERICAN FINANCIAL CORPORATION 10-Q Management's Discussion and Analysis of Financial Condition and Results of Operations - Continued Projected Year 2000 costs and completion dates are based on management's best estimates. However, there can be no assurances that these estimates will be achieved. Should software modifications and new software installations not be completed on a timely basis, the resulting disruptions could have a material adverse affect on operations. AFC's operations could also be affected by the inability of third parties such as agents and vendors to become Year 2000 compliant. Assessments of property and casualty agents have been completed and those of the life and annuity agents are expected to be completed in the third quarter. Efforts to evaluate third party vendors have been intensified and will extend into the fourth quarter. In addition, AFC's property and casualty insurance subsidiaries are reviewing the potential impact of the Year 2000 issue on insureds as part of their underwriting process. They are also reviewing policy forms, issuing clarifying endorsements where appropriate and examining coverage issues for Year 2000 exposures. While it is possible that Year 2000 claims may emerge in future periods, it is not possible to estimate any such amounts. Forward-Looking Statements The Private Securities Litigation Reform Act of 1995 encourages corporations to provide investors with information about the company's anticipated performance and provides protection from liability if future results are not the same as management's expectations. This document contains certain forward- looking statements that are based on assumptions which management believes are reasonable, but by their nature, inherently uncertain. Future results could differ materially from those projected. Factors that could cause such differences include, but are not limited to: changes in economic conditions especially with regard to availability of and returns on capital, regulatory actions, changes in legal environment, levels of catastrophe and other major losses, availability of reinsurance, the Year 2000 issue, and competitive pressures. AFC undertakes no obligation to update any forward-looking statements. LIQUIDITY AND CAPITAL RESOURCES Ratios AFC's debt to total capital ratio at the parent holding company level (excluding amounts due AFG) was approximately 8% at June 30, 1999 and 17% at December 31, 1998. Including amounts due AFG, the ratio was 27% at June 30, 1999 and 28% at December 31, 1998. AFC's ratio of earnings to fixed charges, excluding and including preferred dividends, (on a total enterprise basis) was 4.12 and 3.77 for the first six months of 1999 and 3.44 and 3.15 for the entire year of 1998. Sources of Funds Management believes the parent holding companies have sufficient resources to meet their liquidity requirements through operations in the short-term and long-term future. If funds generated from operations, including dividends and tax payments from subsidiaries, are insufficient to meet fixed charges in any period, these 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. The credit line provides ample liquidity and can be used to obtain funds for operating subsidiaries or, if necessary, for the parent companies. While there were no borrowings outstanding under the credit line at June 30, 1999, $40 million had been borrowed at August 6. In April 1999, AFG issued $350 million principal amount of 7-1/8% senior debentures due 2009; the proceeds were used primarily to retire outstanding holding company public debt and borrowings under AFC's credit line. 16 AMERICAN FINANCIAL CORPORATION 10-Q Management's Discussion and Analysis of Financial Condition and Results of Operations - Continued Dividend payments from subsidiaries have been very important to the liquidity and cash flow of the individual holding companies in the past. However, the reliance on such dividend payments has been lessened by the combination of (i) strong capital at AFC's insurance subsidiaries (and the related decreased likelihood of a need for investment in those companies), (ii) the reduction of debt at the holding companies from historical levels (and the related decrease in ongoing cash needs for interest and principal payments), (iii) AFC's ability to obtain financing in capital markets, as well as (iv) the sales of noncore investments. Investments Approximately 91% of the fixed maturities held by AFC were rated "investment grade" (credit rating of AAA to BBB) by nationally recognized rating agencies at June 30, 1999. 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 earnings before extraordinary items and cumulative effect of accounting change for the three months and six months ended June 30, 1999 were $71.8 million and $164.3 million, respectively, compared to $65.3 million and $173.4 million in the comparable 1998 periods. An improvement in underwriting results in the second quarter of 1999 more than offset reductions in investment income and investee earnings and a one-time expense of $5 million for integration and software related costs associated with the April acquisition of Worldwide Insurance Company. For the six months, reductions in investment income, investee earnings and income from the sale of real estate properties more than offset an improvement in underwriting results. The improvement in 1999's underwriting results reflects primarily the impact of severe storm losses in the second quarter of 1998. Property and Casualty Insurance - Underwriting AFC's property and casualty group consists of two major business groups: Personal and Specialty. The Personal group consists of the nonstandard auto group along with the preferred/standard private passenger auto and other personal insurance business. The nonstandard automobile insurance companies insure risks 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 executive liability, inland and ocean marine, U.S.-based operations of Japanese companies, agricultural-related coverages, California workers' compensation, nonprofit liability, general aviation coverages, fidelity and surety bonds, and umbrella and excess coverages. Commercial lines businesses sold included certain coverages in workers' compensation, commercial multi-peril, commercial automobile, and umbrella. 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. 17 AMERICAN FINANCIAL CORPORATION 10-Q Management's Discussion and Analysis of Financial Condition and Results of Operations - Continued 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 Six months ended June 30, June 30, 1999 1998 1999 1998 Net Written Premiums (GAAP) Personal $275.4 $325.5 $ 551.9 $ 683.6 Specialty 278.5 352.7 526.7 681.8 Other lines (1.6) 7.9 (1.5) 15.6 $552.3 $686.1 $1,077.1 $1,381.0 Combined Ratios (GAAP) Personal 100.7% 97.2% 99.7% 96.7% Specialty 99.7 113.6 99.8 108.5 Aggregate (including discontinued lines) 101.4 106.8 100.4 104.7 Personal The Personal group's net written premiums for the second quarter and first six months of 1999 includes $20.9 million in net premiums written by Worldwide since its acquisition in April. The decrease in written premiums reflects continuing strong price competition in the private passenger automobile market. The combined ratios for 1999 increased as loss and underwriting expenses did not decline at the same rate as premiums. Specialty The Specialty Group's net written premiums for the second quarter and first six months of 1999 increased slightly compared to the 1998 periods, excluding premiums of the commercial lines division sold in December 1998 and the effect of ceding approximately 30% of California workers' compensation premiums under a reinsurance agreement implemented during the third quarter of 1998. A deferred gain of $103 million on the Commercial lines business ceded to Ohio Casualty in December 1998 is being recognized over the estimated settlement period (weighted average 4.25 years) of the claims ceded. The Specialty group's underwriting results for the second quarter and first half of 1999 include $6.7 million and $13.4 million, respectively, in earnings recognized on the ceded business. In addition, the improvement in the combined ratios for the 1999 periods reflects (i) the absence of losses included in the 1998 periods attributable to midwestern storms which increased the second quarter and six-month ratios by 8.7 and 5.5 percentage points, respectively, (ii) improved underwriting margins in California workers' compensation business largely due to favorable reinsurance agreements and (iii) the absence of losses included in the 1998 periods attributable to the commercial lines sold. 18 AMERICAN FINANCIAL CORPORATION 10-Q Management's Discussion and Analysis of Financial Condition and Results of Operations - Continued Life, Accident and Health Premiums and Benefits The decrease in life, accident and health premiums and benefits reflects primarily the sale of AAG's Funeral Services division in September 1998. Investment Income Investment income decreased approximately $18.5 million (8%) in the second quarter of 1999 and $33.3 million (7%) in the first six months of 1999 compared to 1998 due primarily to the transfer of investment assets in connection with the sales of the Commercial lines division and Funeral Services division in 1998. Investee Corporation Equity in net earnings of investee corporation represents AFC's proportionate share of Chiquita's earnings. Chiquita reported net income for the second quarter and first six months of 1999 of $7.3 million and $56 million, respectively, compared to $52.8 million and $93.9 million for the same periods in 1998. 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. Gain on Sale of Investee Chiquita's public issuance of shares of its common stock in the first and second quarters of 1998 resulted in pretax gains to AFC of $7.7 million and $1.7 million in those periods. Other Income Other income decreased $5.7 million (9%) in the first six months of 1999 compared to 1998 due primarily to a reduction in income from the sale of operating real estate assets. Annuity Benefits Annuity benefits reflect amounts accrued on annuity policyholders' funds accumulated. The majority of AAG's fixed rate annuity products permit AAG 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. Annuity benefits decreased $5.6 million (8%) during the second quarter and $11.8 million (8%) in the first six months of 1999 compared to the same periods in 1998 due primarily to (i) decreases in crediting rates, (ii) changes in actuarial assumptions, (iii) the sale of the Funeral Services division and (iv) decreased sales and persistency of fixed annuities. Cumulative Effect of Accounting Change In the first quarter of 1999, AAG implemented Statement of Position 98-5, "Reporting on the Costs of Start-Up Activities." The SOP requires that costs of start-up activities be expensed as incurred and that unamortized balances of previously deferred costs be expensed and reported as the cumulative effect of a change in accounting principle. Accordingly, AFC expensed previously capitalized start-up costs of $3.8 million (net of minority interest and taxes) in the first quarter of 1999. 19 AMERICAN FINANCIAL CORPORATION 10-Q Item 3 Quantitative and Qualitative Disclosure of Market Risk The tables below show scheduled principal payments (in millions) on fixed-rate and variable-rate long-term debt of AFC and its subsidiaries and related average interest rates as of June 30, 1999 and December 31, 1998. June 30, 1999 Fixed-Rate Debt Variable-Rate Debt Weighted Weighted Scheduled Average Scheduled Average Principal Interest Principal Interest Payments Rate Payments Rate 1999 (remainder) $ 89.9 9.72% $ .1 7.81% 2000 32.2 9.44 .2 7.78 2001 1.2 7.11 .1 7.75 2002 1.1 6.80 6.1 9.95 2003 1.1 6.68 75.2 5.48 2004 14.1 8.43 .2 7.75 Thereafter 134.9 7.26 .1 7.75 Total $274.5 8.38% $ 82.0 5.84% Market Value $273.3 $ 82.0 December 31, 1998 Fixed-Rate Debt Variable-Rate Debt Weighted Weighted Scheduled Average Scheduled Average Principal Interest Principal Interest Payments Rate Payments Rate 1999 $ 90.7 9.69% $ .3 5.86% 2000 49.1 9.85 .2 5.80 2001 1.2 7.13 .1 5.58 2002 1.1 6.81 85.7 5.95 2003 1.1 6.68 27.2 6.09 Thereafter 233.3 8.26 .2 5.58 Total $376.5 8.80% $113.7 5.98% Market Value $388.9 $113.7 As of June 30, 1999, there were no material changes to the other information provided in AFC's Form 10-K for 1998 under the caption "Exposure to Market Risk" in Management's Discussion and Analysis of Financial Condition and Results of Operations. 20 AMERICAN FINANCIAL CORPORATION 10-Q PART II OTHER INFORMATION Item 1 Legal Proceedings Great American Life Insurance Company ("GALIC") was named a defendant in purported class action lawsuits (Woodward v. Great American Life Insurance Company, Hamilton County Court of Common Pleas, Case No. A9900587, filed February 2, 1999 and Marshak v. Great American Life Insurance Company, Harris County, Texas filed June 18, 1999). The complaints seek unspecified money damages (the Texas complaint also seeks declaratory relief) based on alleged (i) failure of GALIC to allow the tax-free transfer of the annuity value of certain annuities to other product providers, and (ii) misleading and fraudulent disclosures concerning GALIC's interest crediting practices. The Texas complaint also alleges that the sale of annuities to tax qualified plans was inappropriate. GALIC has not completed its review of the complaints but believes it has meritorious defenses. However, it is too early to predict the ultimate outcome of these actions and their impact on the Company. Item 4 Submission of Matters to a Vote of Security Holders AFC's Annual Meeting of Shareholders was held on May 19, 1999; the only matter voted upon was the election of a Board of Directors. Outstanding shares of AFC's Common Stock and Preferred Stock have voting rights. The votes cast for and those withheld are set forth below: Name For Against Withheld Abstain Theodore H. Emmerich 12,987,255 N/A 34,471 N/A James E. Evans 12,987,255 N/A 34,471 N/A Thomas M. Hunt 12,987,255 N/A 34,471 N/A Carl H. Lindner 12,987,752 N/A 33,974 N/A Carl H. Lindner III 12,987,253 N/A 34,473 N/A Keith E. Lindner 12,987,599 N/A 34,127 N/A S. Craig Lindner 12,987,352 N/A 34,374 N/A William R. Martin 12,987,889 N/A 33,837 N/A ____________________ N/A - Not Applicable 21 AMERICAN FINANCIAL CORPORATION 10-Q PART II OTHER INFORMATION Item 6 Exhibits and Reports on Form 8-K (a) Exhibit 27.1 - Financial Data Schedule as of June 30, 1999. For submission in electronic filing only. (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 August 9, 1999 BY: Fred J. Runk Fred J. Runk Senior Vice President and Treasurer 22