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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, 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 August 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.
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Page 1 of 21
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AMERICAN FINANCIAL CORPORATION 10-Q
PART I
FINANCIAL INFORMATION
AMERICAN FINANCIAL CORPORATION AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEET
(Dollars In Thousands)
June 30, December 31,
2001 2000
---------- -----------
Assets:
Cash and short-term investments $ 283,783 $ 437,263
Investments:
Fixed maturities - at market
(amortized cost - $10,424,166 and $10,148,248) 10,513,266 10,164,648
Other stocks - at market
(cost - $195,896 and $174,959) 365,696 385,359
Investment in investee corporations - 23,996
Policy loans 210,721 213,469
Real estate and other investments 245,548 270,250
----------- -----------
Total investments 11,335,231 11,057,722
Recoverables from reinsurers and prepaid
reinsurance premiums 1,971,791 1,845,171
Agents' balances and premiums receivable 743,162 700,215
Deferred acquisition costs 801,543 763,097
Other receivables 267,367 239,806
Variable annuity assets (separate accounts) 530,710 533,655
Prepaid expenses, deferred charges and other asset 484,019 508,163
Cost in excess of net assets acquired 324,414 322,380
----------- -----------
$16,742,020 $16,407,472
=========== ===========
Liabilities and Capital:
Unpaid losses and loss adjustment expenses $ 4,576,306 $ 4,515,561
Unearned premiums 1,501,957 1,414,492
Annuity benefits accumulated 5,603,648 5,543,683
Life, accident and health reserves 601,951 599,360
Payable to American Financial Group, Inc. 395,007 439,371
Long-term debt:
Holding companies 222,871 204,338
Subsidiaries 172,655 195,087
Variable annuity liabilities (separate accounts) 530,710 533,655
Accounts payable, accrued expenses and other
liabilities 1,116,394 998,104
----------- -----------
Total liabilities 14,721,499 14,443,651
Minority interest 517,866 509,705
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 980,891 974,766
Retained earnings 285,085 258,371
Unrealized gain on marketable securities, net 154,900 139,200
----------- -----------
Total shareholders' equity 1,502,655 1,454,116
----------- -----------
$16,742,020 $16,407,472
=========== ===========
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,
--------------------- ------------------------
2001 2000 2001 2000
---- ---- ---- ----
Income:
Property and casualty insurance
premiums $679,563 $623,721 $1,324,286 $1,195,858
Life, accident and health premiums 70,533 49,704 139,691 99,623
Investment income 217,451 209,952 427,241 418,967
Realized gains (losses) on:
Securities (26,425) (3,907) (33,306) (5,340)
Subsidiaries - 25,000 (1,586) 25,000
Other income 53,838 55,188 112,130 109,815
-------- -------- ---------- ----------
994,960 959,658 1,968,456 1,843,923
Costs and Expenses:
Property and casualty insurance:
Losses and loss adjustment expenses 526,411 483,497 1,022,627 901,148
Commissions and other underwriting
expenses 192,902 182,573 377,876 361,005
Annuity benefits 70,716 79,727 139,980 145,888
Life, accident and health benefits 52,211 36,885 106,294 73,609
Interest charges on borrowed money 14,777 16,544 33,650 32,098
Other operating and general expenses 114,505 129,756 222,376 225,862
-------- -------- ---------- ----------
971,522 928,982 1,902,803 1,739,610
-------- -------- ---------- ----------
Operating earnings before income taxes 23,438 30,676 65,653 104,313
Provision for income taxes 4,347 8,363 19,299 32,618
-------- -------- ---------- ----------
Net operating earnings 19,091 22,313 46,354 71,695
Minority interest expense, net of tax (4,188) (3,140) (11,107) (11,347)
Equity in net earnings (losses) of
investees, net of tax (2,313) 2,027 (5,647) 9,202
-------- -------- ---------- ----------
Net Earnings $ 12,590 $ 21,200 $ 29,600 $ 69,550
======== ======== ========== ==========
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 - - 29,600 - 29,600
Change in unrealized - - - 15,700 15,700
---------
Comprehensive income 45,300
Capital contribution from parent - 6,134 - - 6,134
Dividends on Preferred Stock - - (2,886) - (2,886)
Other - (9) - - (9)
------- -------- -------- -------- ----------
Balance at June 30, 2001 $72,154 $990,516 $285,085 $154,900 $1,502,655
======= ======== ======== ======== ==========
Balance at January 1, 2000 $72,154 $970,407 $296,246 ($ 14,700) $1,324,107
Net earnings - - 69,550 - 69,550
Change in unrealized - - - (92,100) (92,100)
----------
Comprehensive income (loss) (22,550)
Capital contribution from parent - 6,134 - - 6,134
Dividends on Preferred Stock - - (2,886) - (2,886)
Other - (98) 22 - (76)
------- -------- -------- -------- ----------
Balance at June 30, 2000 $72,154 $976,443 $362,932 ($106,800) $1,304,729
======= ======== ======== ======== ==========
4
AMERICAN FINANCIAL CORPORATION 10-Q
AMERICAN FINANCIAL CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENT OF CASH FLOWS
(In Thousands)
Six months ended
June 30,
-------------------
2001 2000
---- ----
Operating Activities:
Net earnings $29,600 $ 69,550
Adjustments:
Equity in net (earnings) losses of investees 5,647 (9,202)
Depreciation and amortization 71,503 63,863
Annuity benefits 139,980 145,888
Realized (gains) losses on investing activities 10,167 (33,330)
Deferred annuity and life policy acquisition costs (73,530) (70,617)
Increase in reinsurance and other receivables (77,612) (34,563)
Increase in other assets (26,742) (56,417)
Increase in insurance claims and reserves 169,679 170,303
Increase (decrease) in other liabilities 74,352 (19,302)
Increase (decrease) in minority interest 4,770 (347)
Other, net 1,521 (4,944)
-------- --------
329,335 220,882
-------- --------
Investing Activities:
Purchases of and additional investments in:
Fixed maturity investments (981,049) (942,929)
Equity securities (2,907) (20,126)
Real estate, property and equipment (31,090) (39,819)
Maturities and redemptions of fixed maturity
investments 337,280 348,447
Sales of:
Fixed maturity investments 368,003 380,062
Equity securities 9,148 30,678
Subsidiaries 22,000 -
Real estate, property and equipment 43,456 4,810
Cash and short-term investments of acquired
(former) subsidiaries (132,858) 259
Decrease (increase) in other investments (171) 2,337
-------- --------
(368,188) (236,281)
-------- --------
Financing Activities:
Fixed annuity receipts 271,827 251,100
Annuity surrenders, benefits and withdrawals (341,310) (387,667)
Net transfers to variable annuity assets (1,368) (34,150)
Additional long-term borrowings 78,868 110,172
Reductions of long-term debt (83,192) (26,981)
Borrowings from AFG 7,600 4,500
Payments to AFG (53,500) (52,313)
Capital contribution 9,334 9,334
Repurchases of trust preferred securities - (1,427)
Cash dividends paid (2,886) (2,886)
-------- --------
(114,627) (130,318)
-------- --------
Net Decrease in Cash and Short-term Investments (153,480) (145,717)
Cash and short-term investments at beginning
of period 437,263 389,018
-------- --------
Cash and short-term investments at end of period $283,783 $243,301
======== ========
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 a period based on estimated future principal
prepayments and adjusted to reflect actual prepayments.
Gains or losses on securities are determined on the specific
identification basis. When a decline in the value of a specific investment
is considered to be other than temporary, 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. In 2001, AFC suspended accounting for
the investment under the equity method due to the expected restructuring.
COST IN EXCESS OF NET ASSETS ACQUIRED The excess of cost of subsidiaries
over AFC's equity in the underlying net assets ("goodwill") is being
amortized over periods of 20 to 40 years.
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 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 companies.
DEFERRED ACQUISITION COSTS Policy acquisition costs (principally
commissions, premium taxes and other marketing and 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 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. 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.
In response to a recent increase in asbestos and other environmental
("A&E") claims, AFC has begun a current review of such exposures. Any
strengthening of reserves determined to be necessary will be recorded upon
completion of the review. With the exception of the A&E claims, management
believes that the liabilities for unpaid losses and loss adjustment
expenses are adequate.
ANNUITY BENEFITS ACCUMULATED Annuity receipts and benefit payments
are recorded as increases or decreases in "annuity benefits accumulated"
rather than as revenue and expense. Increases in this liability for
interest credited are charged to 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. 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. Estimates are accrued during the
period in which premiums are 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 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 $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.
COMMERCIAL LINES DIVISION In 1998, AFC sold its Commercial lines division
to Ohio Casualty Corporation. In August 2000, AFC received an additional
payment of $25 million from Ohio Casualty based on retention and growth
through May 2000 of the businesses sold. This earn-out was recognized as
additional "gain on sale of subsidiary" in the second quarter of 2000.
9
AMERICAN FINANCIAL CORPORATION 10-Q
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
C. SEGMENTS OF OPERATIONS AFC's property and casualty group is engaged
primarily in private passenger automobile and specialty insurance
businesses. 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. The
Personal group writes nonstandard and preferred/standard private passenger
auto and other personal insurance coverage. AFC's annuity, life and health
business markets primarily retirement products as well as life and
supplemental health insurance.
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,
------------------- -----------------------
2001 2000 2001 2000
---- ---- ---- ----
Revenues (a)
Property and casualty insurance:
Premiums earned:
Specialty $356,188 $307,388 $ 672,495 $ 582,211
Personal 322,629 316,333 650,261 613,646
Other lines - primarily
discontinued 746 - 1,530 1
-------- -------- ---------- ----------
679,563 623,721 1,324,286 1,195,858
Investment and other income 106,440 129,311 213,775 250,478
-------- -------- --------- ----------
786,003 753,032 1,538,061 1,446,336
Annuities, life and health (b) 202,562 195,945 419,592 383,282
Other 6,395 10,681 10,803 14,305
-------- -------- ---------- ----------
$994,960 $959,658 $1,968,456 $1,843,923
======== ======== ========== ==========
Operating Profit (Loss)
Property and casualty insurance:
Underwriting:
Specialty ($ 4,609)($ 14,680) ($ 6,839) ($ 25,178)
Personal (35,795) (26,392) (63,577) (37,325)
Other lines - primarily
discontinued 654 (1,277) (5,801) (3,792)
-------- -------- ---------- ----------
(39,750) (42,349) (76,217) (66,295)
Investment and other income 69,147 93,482 144,349 178,007
-------- -------- ---------- ----------
29,397 51,133 68,132 111,712
Annuities, life and health 17,335 (2,209) 47,458 25,305
Other (c) (23,294) (18,248) (49,937) (32,704)
-------- -------- ---------- ----------
$ 23,438 $ 30,676 $ 65,653 $ 104,313
======== ======== ========== ==========
(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. 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 $24 million at December 31, 2000. Chiquita is
a leading international marketer, producer and distributor of quality
fresh fruits and vegetables and processed foods. Summarized financial
information for Chiquita for the six months ended June 30, 2000, follows
(in millions):
Net Sales $1,260
Operating Income 112
Income before Extraordinary Item 46
Extraordinary Gain on Debt Prepayment 2
Net Income 48
Net Income Attributed to Common Shares 39
In January 2001, Chiquita announced a restructuring initiative that
included discontinuing all interest and principal payments on its public
debt. A restructuring is expected to result in the conversion of a
significant portion of Chiquita's $862 million in public debt into common
equity. Although the expected restructuring would not impact Chiquita's
day-to-day operations, it would adversely affect the holders of its stock,
including AFC.
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 June 30, 2001 and December 31, 2000) are
included in other assets; liabilities of the businesses transferred
(approximately $7 million at June 30, 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 ($2.3
million in the second quarter and $5.6 million in the first six months of
2001) 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):
June 30, December 31,
2001 2000
-------- ---------
Holding Companies:
AFC notes payable under bank line $197,000 $178,000
APU 10-7/8% Subordinated Notes due May 2011 11,584 11,611
Other 14,287 14,727
-------- --------
$222,871 $204,338
======== ========
Subsidiaries:
GAFRI 6-7/8% Senior Notes due June 2008 $100,000 $100,000
GAFRI notes payable under bank line 41,300 48,500
Notes payable secured by real estate 16,569 31,201
Other 14,786 15,386
-------- --------
$172,655 $195,087
======== ========
11
AMERICAN FINANCIAL CORPORATION 10-Q
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
At June 30, 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 $ .9 $ .6 $ 1.5
2002 207.3 1.3 208.6
2003 - 1.3 1.3
2004 - 42.3 42.3
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.
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):
June 30, December 31,
2001 2000
-------- -----------
Interest of AFG (parent) and noncontrolling
shareholders in subsidiaries' common stock $299,953 $291,792
Preferred securities issued by
subsidiary trusts 217,913 217,913
-------- --------
$517,866 $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 June 30, 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
Until September 28, 2001, GAFRI's ROPES are senior unsecured obligations
of GAFRI. On that date, the distribution rate on the ROPES will be reset
to current market rates (not to exceed 8.8%) and the ROPES will become
subordinate to GAFRI's senior indebtedness. Given the current interest
rate environment for these types of securities, GAFRI expects to redeem
its ROPES in September 2001 using borrowings under its bank line.
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,
------------------
2001 2000
---- ----
Interest of AFG (parent) and noncontrolling
shareholders in earnings of subsidiaries $ 5,128 $ 5,367
Accrued distributions by subsidiaries on trust
issued preferred securities, net of tax 5,979 5,980
------- -------
$11,107 $11,347
======= =======
H. SHAREHOLDERS' EQUITY At June 30, 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 June
30 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 $72.2 million)
outstanding at June 30, 2001 and December 31, 2000.
The change in unrealized gain (loss) on marketable securities for the six
months ended June 30 included the following (in millions):
Minority
Pretax Taxes Interest Net
------ ----- -------- -----
2001
---------------------------------------
Unrealized holding losses on securities
arising during the period ($ 3.4) $ 1.0 ($0.8) ($ 3.2)
Realized losses included in net income 33.3 (11.7) (2.7) 18.9
----- ----- ---- -----
Change in unrealized gain on
marketable securities, net $29.9 ($10.7) ($3.5) $15.7
===== ===== ==== =====
2000
---------------------------------------
Unrealized holding losses on securities
arising during the period ($157.3) $55.4 $6.7 ($95.2)
Realized losses included in net income 5.3 (1.9) (.3) 3.1
------ ----- ---- -----
Change in unrealized gain (loss) on
marketable securities, net ($152.0) $53.5 $6.4 ($92.1)
====== ===== ==== =====
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.
ASBESTOS AND ENVIRONMENTAL RESERVES STUDY Throughout the property and
casualty insurance industry, estimating ultimate liability for asbestos
claims has become increasingly uncertain due to inconsistent court
decisions, recent bankruptcy filings, novel theories of coverage, and
judicial interpretations that often expand theories of recovery and
broaden the scope of coverage. The casualty insurance industry as a whole
is engaged in extensive litigation over these coverage and liability
issues as the volume and severity of claims against asbestos defendants
continue to increase. During the second quarter of 2001, AFC experienced
an increase in the number and severity of these claims, which claims carry
with them a likelihood for higher than previously established reserves for
expected claim payments and settlement costs. While management presently
does not have sufficient information to accurately quantify the level or
range of any additional exposure, the additional costs of adjudicating or
settling pending and future claims may materially exceed amounts currently
established and may be material to the period in which they are recorded.
Accordingly, AFC is undertaking a current review for asbestos and
environmental exposures. Any resulting strengthening will be recorded upon
completion of the review which is expected to take several months. At June
30, 2001, AFC had recorded $430 million (before reinsurance recoverables
of $83 million) for various liability coverages related to these
environmental, asbestos and other mass tort claims.
IT INITIATIVE In 1999, AFC initiated an enterprise-wide project to study
its information technology ("IT") resources, needs and opportunities. The
initiative, involving improvements in physical infrastructure and business
support systems, entails extensive effort and costs over a period of
several years. 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;
14
AMERICAN FINANCIAL CORPORATION 10-Q
Management's Discussion and Analysis
of Financial Condition and Results of Operations - Continued
o judicial decisions and rulings;
o tax law changes;
o levels of catastrophes and other major losses;
o the actual amount of liabilities associated with certain environmental
and asbestos-related insurance claims;
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 13% at June 30, 2001
and 12% at December 31, 2000. Including amounts due AFG, the ratio was 29%
at June 30, 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 2.12 and 1.96 for
the first six months of 2001 and 2.02 and 1.87 for the entire year of
2000.
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 liquidity and can be
used to obtain funds for operating subsidiaries or, if necessary, for the
parent companies. At June 30, 2001, there was $197 million borrowed under
the line.
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 June 30, 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.
15
AMERICAN FINANCIAL CORPORATION 10-Q
Management's Discussion and Analysis
of Financial Condition and Results of Operations - Continued
RESULTS OF OPERATIONS
GENERAL Pretax operating earnings for the three months and six months
ended June 30, 2001 were $23.4 million and $65.7 million, respectively,
compared to $30.7 million and $104.3 million in the comparable 2000
periods. Results for the second quarter of 2000 include special litigation
charges of $41.3 million, partially offset by a $25 million gain on the
sale of a subsidiary. Excluding these items, pretax operating earnings
declined as increased realized losses on securities and a decline in the
Personal group's underwriting results more than offset improved Specialty
group underwriting results.
PROPERTY AND CASUALTY INSURANCE - UNDERWRITING AFC's property and casualty
group consists of two major business groups: Specialty and Personal.
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.
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 an applicant's driving record,
type of vehicle, age or other criteria.
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.
16
AMERICAN FINANCIAL CORPORATION 10-Q
Management's Discussion and Analysis
of Financial Condition and Results of Operations - Continued
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,
------------------- --------------------
2001 2000 2001 2000
---- ---- ---- ----
Net Written Premiums (GAAP)
---------------------------
Specialty $393.8 $335.5 $ 750.4(a) $ 633.2
Personal 252.0 348.1 622.5 697.9
------ ------ -------- --------
$645.8 $683.6 $1,372.9 $1,331.1
====== ====== ======== ========
Combined Ratios (GAAP) (b)
----------------------
Specialty 101.3% 104.7% 101.0% 104.2%
Personal 111.1 108.4 109.8 106.0
Aggregate (including
discontinued lines) 105.9 106.8 105.7 105.5
(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 entire year of 2000 were:
Specialty - 107.9%, Personal - 108.6%, Aggregate - 108.0%.
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
in excess of 35% on renewals in the first half 2001. Rate increases
implemented in the other specialty operations averaged 15% for the first
six months of 2001. AFC expects these levels of rate increases to continue
for the remainder of 2001. The improvement in the combined ratio compared
to the 2000 periods reflects the impact of these rate increases. Excluding
the California workers' compensation business, the Specialty group's
combined ratio was 99.7% for the second quarter and 98.8% for the first
six months of 2001.
PERSONAL The Personal group's decline in net written premiums reflects a
reinsurance agreement, effective April 1, 2001, under which AFC cedes 80%
of the automobile physical damage business written by three of its
insurance subsidiaries. This agreement enabled AFC to reallocate some of
its capital to the more profitable specialty operations. Excluding the
effect of this agreement, the Personal group's net written premiums
declined approximately 11% for the second quarter and 3% for the six
months as lower business volume more than offset the impact of significant
rate increases. The increase in the combined ratio compared to the 2000
periods reflects unexpected loss development due to inadequate rates on
policies written during 2000 and $4.1 million in second quarter 2001 storm
losses, principally from Hurricane Allison and Midwest hailstorms. To
further improve underwriting results, AFC implemented rate increases
averaging 9% in the first six months of 2001 and expects rate increases to
be at least 15% by the end of 2001.
LIFE, ACCIDENT AND HEALTH PREMIUMS AND BENEFITS The increase in life,
accident and health premiums and benefits is due primarily to the
acquisition of blocks of supplemental health insurance business.
17
AMERICAN FINANCIAL CORPORATION 10-Q
Management's Discussion and Analysis
of Financial Condition and Results of Operations - Continued
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 Six months ended
June 30, June 30,
------------------ ----------------
2001 2000 2001 2000
---- ---- ---- ----
Other income $29.4 $26.5 $61.4 $44.4
Other operating and general expenses 16.6 17.0 31.6 31.3
Interest charges on borrowed money .6 .6 1.3 1.3
Minority interest expense, net 1.4 .5 3.3 .7
Other income includes net pretax gains on the sale of real estate assets
of $9.3 million in the second quarter and $24.6 million in the first six
months of 2001 compared to $4.6 million and $6.7 million for the 2000
periods.
OTHER INCOME Excluding gains on the sale of real estate assets (discussed
above), other income decreased $15.6 million (15%) in the first six months
of 2001 due primarily to 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.
Realized losses on securities includes the following provisions for other
than temporary impairment: second quarter of 2001 and 2000 - $29.2 million
and $2.5 million; six months of 2001 and 2000 - $37.2 million and $3.3
million, respectively.
Under 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 securities in 2001 includes
gains of $3.2 million in the second quarter and $2.3 million in the first
six months to adjust the carrying value of AFC's investment in warrants to
market value.
GAIN (LOSS) ON SALES OF SUBSIDIARIES In the first quarter of 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. In
the second quarter of 2000, AFC recognized a $25 million gain representing
an earn-out related to the 1998 sale of its Commercial lines 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. In 2000, annuity
benefits also includes a second quarter charge of $14.2 million related to
the settlement of a policyholder class action lawsuit.
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
18
AMERICAN FINANCIAL CORPORATION 10-Q
Management's Discussion and Analysis
of Financial Condition and Results of Operations - Continued
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 second quarter or the first six
months of 2001.
INTEREST EXPENSE Interest expense decreased $1.8 million (11%) in the
second quarter of 2001 as lower average interest rates on AFC's variable
rate debt and lower average subsidiary indebtedness more than offset
higher average borrowings under the AFC bank line and the AFG Master
Credit Agreement. The increase in interest expense for the six months
reflects higher average indebtedness (including borrowings from AFG),
partially offset by lower average interest rates on AFC's variable rate
debt.
OTHER OPERATING AND GENERAL EXPENSES Other operating and general expenses
for 2000 include second quarter charges of $18.3 million related to the
settlement of the policyholder class action lawsuit against a GAFRI
subsidiary and $8.8 million for an adverse California Supreme Court ruling
against an AFC property and casualty subsidiary. Excluding these
litigation charges, other operating and general expenses increased $11.8
million (11%) in the second quarter and $23.6 million (12%) for the first
six months of 2001 compared to 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. Due to Chiquita's
restructuring plans, AFG suspended its use of equity accounting and
reclassified its $24 million investment to "Other stocks" in the balance
sheet at June 30, 2001.
RECENT ACCOUNTING STANDARDS In July 2001, the Financial Accounting
Standards Board issued SFAS No. 141, "Business Combinations", and No. 142,
"Goodwill and Other Intangible Assets." Under SFAS No. 141, business
combinations initiated after June 30, 2001 are required to be accounted
for using the purchase method of accounting. Under SFAS No. 142, goodwill
will no longer be required to be amortized beginning January 1, 2002, but
will be subject to an impairment test at least annually. A transitional
test for impairment is required to be completed in 2002 with any resulting
writedown reported during the first quarter as a cumulative effect of a
change in accounting principle. Based on goodwill recorded at June 30,
2001, management expects that goodwill amortization in 2002 would have
been approximately $15 million.
------------------------------------------------------------------------
Item 3
Quantitative and Qualitative Disclosure of Market Risk
------------------------------------------------------
As of June 30, 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.
19
AMERICAN FINANCIAL CORPORATION 10-Q
PART II
OTHER INFORMATION
Item 1
Legal Proceedings
Reference is made to MD&A - Asbestos and Environmental Reserves Study.
Item 4
Submission of Matters to a Vote of Security Holders
AFC's Annual Meeting of Shareholders was held on May 24, 2001; the only issue
voted upon was the election of a Board of Directors. Approximately 95% of the
total voting shares (Common and Preferred) were represented at the meeting. The
votes cast for and those withheld are set forth below:
Name For Against Withheld Abstain
---- --- ------- -------- -------
Theodore H. Emmerich 12,778,484 N/A 10,775 N/A
James E. Evans 12,778,484 N/A 10,775 N/A
Thomas M. Hunt 12,778,349 N/A 10,910 N/A
Carl H. Lindner 12,777,707 N/A 11,552 N/A
Carl H. Lindner III 12,778,166 N/A 11,093 N/A
Keith E. Lindner 12,770,568 N/A 18,691 N/A
S. Craig Lindner 12,770,568 N/A 18,691 N/A
William R. Martin 12,778,484 N/A 10,775 N/A
- --------------------
N/A - Not Applicable
20
AMERICAN FINANCIAL CORPORATION 10-Q
PART II
OTHER INFORMATION - CONTINUED
Item 6
Exhibits and Reports on Form 8-K
(a) Exhibit 10 - 2001 Annual Bonus Plan.
(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 13, 2001 BY: Fred J. Runk
-----------------------------------
Fred J. Runk
Senior Vice President and Treasurer
21