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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
September 30, 2001 No. 1-13653
AMERICAN FINANCIAL GROUP, INC.
Incorporated under IRS Employer I.D.
the Laws of Ohio No. 31-1544320
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 November 1, 2001, there were 68,305,711 shares of the Registrant's
Common Stock outstanding, excluding 18,666,614 shares owned by subsidiaries.
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Page 1 of 22
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AMERICAN FINANCIAL GROUP, INC. 10-Q
PART I
FINANCIAL INFORMATION
AMERICAN FINANCIAL GROUP, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEET
(Dollars In Thousands)
September 30, December 31,
2001 2000
------------ -----------
Assets:
Cash and short-term investments $ 489,584 $ 438,670
Investments:
Fixed maturities - at market
(amortized cost - $10,578,281 and $10,148,348) 10,914,781 10,164,648
Other stocks - at market
(cost - $185,890 and $174,959) 304,990 385,359
Investment in investee corporations - 23,996
Policy loans 214,797 213,469
Real estate and other investments 231,696 273,994
----------- -----------
Total investments 11,666,264 11,061,466
Recoverables from reinsurers and prepaid
reinsurance premiums 2,247,868 1,845,171
Agents' balances and premiums receivable 738,456 700,215
Deferred acquisition costs 802,290 763,097
Other receivables 297,287 240,731
Variable annuity assets (separate accounts) 453,780 533,655
Prepaid expenses, deferred charges and other assets 538,281 513,616
Cost in excess of net assets acquired 316,098 318,920
----------- -----------
$17,549,908 $16,415,541
=========== ===========
Liabilities and Capital:
Unpaid losses and loss adjustment expenses $ 4,887,388 $ 4,515,561
Unearned premiums 1,598,200 1,414,492
Annuity benefits accumulated 5,717,539 5,543,683
Life, accident and health reserves 614,708 599,360
Long-term debt:
Holding companies 612,204 584,869
Subsidiaries 252,110 195,087
Variable annuity liabilities (separate accounts) 453,780 533,655
Accounts payable, accrued expenses and other
liabilities 1,372,285 972,271
----------- -----------
Total liabilities 15,508,214 14,358,978
Minority interest 458,724 508,033
Shareholders' Equity:
Common Stock, no par value
- 200,000,000 shares authorized
- 68,215,312 and 67,410,091 shares outstanding 68,215 67,410
Capital surplus 910,387 898,244
Retained earnings 345,068 442,276
Unrealized gain on marketable securities, net 259,300 140,600
----------- -----------
Total shareholders' equity 1,582,970 1,548,530
----------- -----------
$17,549,908 $16,415,541
=========== ===========
2
AMERICAN FINANCIAL GROUP, INC. 10-Q
AMERICAN FINANCIAL GROUP, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENT OF OPERATIONS
(In Thousands, Except Per Share Data)
Three months ended Nine months ended
September 30, September 30,
------------------------ --------------------------
2001 2000 2001 2000
---- ---- ---- ----
Income:
Property and casualty insurance
premiums $ 664,381 $ 661,077 $1,988,667 $1,856,935
Life, accident and health premiums 69,116 66,523 208,807 166,146
Investment income 214,439 210,174 638,755 628,489
Realized gains (losses) on:
Securities (22) (15,223) (33,328) (20,563)
Subsidiaries 7,065 (5,962) 5,479 19,038
Other investments - 27,230 - 27,230
Other income 59,857 68,777 171,945 178,596
---------- ---------- ---------- ----------
1,014,836 1,012,596 2,980,325 2,855,871
Costs and Expenses:
Property and casualty insurance:
Losses and loss adjustment expenses 626,642 562,308 1,649,269 1,463,456
Commissions and other underwriting
expenses 189,327 195,267 567,203 556,272
Annuity benefits 74,016 72,139 213,996 218,027
Life, accident and health benefits 53,952 50,699 160,246 124,308
Interest charges on borrowed money 14,924 18,182 45,883 51,007
Other operating and general expenses 118,404 113,362 345,187 344,092
---------- ---------- ---------- ----------
1,077,265 1,011,957 2,981,784 2,757,162
---------- ---------- ---------- ----------
Operating earnings (loss) before
income taxes (62,429) 639 (1,459) 98,709
Provision (credit) for income taxes (22,152) (1,595) (4,547) 28,767
---------- ---------- ---------- ----------
Net operating earnings (loss) (40,277) 2,234 3,088 69,942
Minority interest expense, net of tax (9,028) (10,839) (27,346) (26,699)
Equity in net losses of investees,
net of tax (6,395) (13,570) (12,042) (4,368)
---------- ---------- ---------- -----------
Earnings (loss) before cumulative
effect of accounting change (55,700) (22,175) (36,300) 38,875
Cumulative effect of accounting change - - (10,040) -
---------- ---------- ---------- ----------
Net Earnings (Loss) ($ 55,700) ($ 22,175) ($ 46,340) $ 38,875
========== ========== ========== ==========
Earnings (Loss) per Common Share:
Basic ($.82) ($.38) ($.68) $.66
Diluted ($.81) ($.38) ($.67) $.66
Average number of Common Shares:
Basic 68,028 58,561 67,799 58,525
Diluted 68,494 58,797 68,312 58,731
Cash dividends per Common Share $.25 $.25 $.75 $.75
3
AMERICAN FINANCIAL GROUP, INC. 10-Q
AMERICAN FINANCIAL GROUP, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENT OF CHANGES IN SHAREHOLDERS' EQUITY
(Dollars in Thousands)
Common Stock Unrealized
Common and Capital Retained Gain (Loss)
Shares Surplus Earnings on Securities Total
---------- ------------ -------- ------------- ----------
Balance at January 1, 2001 67,410,091 $965,654 $442,276 $140,600 $1,548,530
Net earnings (loss) - - (46,340) - (46,340)
Change in unrealized - - - 118,700 118,700
----------
Comprehensive income 72,360
Dividends on Common Stock - - (50,819) - (50,819)
Shares issued:
Exercise of stock options 54,435 1,289 - - 1,289
Employee stock purchase plan 39,642 1,046 - - 1,046
Retirement plan contributions 711,477 17,007 - - 17,007
Directors fees paid in stock 2,874 72 - - 72
Shares acquired and retired (3,538) (51) (49) - (100)
Tax effect of intercompany dividends - (4,800) - - (4,800)
Capital transactions of subsidiaries - (375) - - (375)
Other 331 (1,240) - - (1,240)
---------- -------- -------- -------- ----------
Balance at September 30, 2001 68,215,312 $978,602 $345,068 $259,300 $1,582,970
========== ======== ======== ======== ==========
Balance at January 1, 2000 58,419,952 $800,640 $557,538 ($ 18,200) $1,339,978
Net earnings - - 38,875 - 38,875
Change in unrealized - - - 7,100 7,100
----------
Comprehensive income 45,975
Dividends on Common Stock - - (43,880) - (43,880)
Shares issued:
Exercise of stock options 39,319 831 - - 831
Dividend reinvestment plan 3,910 92 - - 92
Employee stock purchase plan 54,738 1,356 - - 1,356
Retirement plan contributions 274,716 6,242 - - 6,242
Directors fees paid in stock 2,820 72 - - 72
Shares acquired and retired (41,044) (562) (579) - (1,141)
Tax effect of intercompany dividends - (4,800) - - (4,800)
Capital transactions of subsidiaries - 178 - - 178
Other - 1,755 - - 1,755
---------- -------- -------- -------- ----------
Balance at September 30, 2000 58,754,411 $805,804 $551,954 ($ 11,100) $1,346,658
========== ======== ======== ======== ==========
4
AMERICAN FINANCIAL GROUP, INC. 10-Q
AMERICAN FINANCIAL GROUP, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENT OF CASH FLOWS
(In Thousands)
Nine months ended
September 30,
---------------------------
2001 2000
---- ----
Operating Activities:
Net earnings (loss) ($ 46,340) $ 38,875
Adjustments:
Cumulative effect of accounting change 10,040 -
Equity in net losses of investees 12,042 4,368
Depreciation and amortization 111,608 94,379
Annuity benefits 213,996 218,027
Realized (gains) losses on investing activities 1,106 (40,246)
Deferred annuity and life policy acquisition costs (111,377) (106,844)
Increase in reinsurance and other receivables (382,233) (57,172)
Increase in other assets (32,858) (63,973)
Increase in insurance claims and reserves 589,761 286,781
Increase (decrease) in other liabilities 176,933 (4,798)
Increase in minority interest 9,509 2,879
Other, net 16,173 13,330
---------- ----------
568,360 385,606
---------- ----------
Investing Activities:
Purchases of and additional investments in:
Fixed maturity investments (1,609,151) (1,237,409)
Equity securities (5,556) (22,547)
Real estate, property and equipment (43,660) (57,238)
Maturities and redemptions of fixed maturity
investments 579,916 465,637
Sales of:
Fixed maturity investments 666,593 651,578
Equity securities 11,978 67,473
Subsidiaries 40,395 35,000
Real estate, property and equipment 46,683 8,156
Cash and short-term investments of acquired
(former) subsidiaries (134,237) (131,880)
Decrease (increase) in other investments (4,711) 8,695
---------- ---------
(451,750) (212,535)
---------- ---------
Financing Activities:
Fixed annuity receipts 454,189 359,884
Annuity surrenders, benefits and withdrawals (482,997) (564,454)
Net transfers from (to) variable annuity assets 3,252 (44,305)
Additional long-term borrowings 185,668 131,341
Reductions of long-term debt (102,067) (133,343)
Issuances of Common Stock 2,078 1,890
Repurchases of trust preferred securities (75,000) (2,479)
Cash dividends paid (50,819) (43,788)
---------- ----------
(65,696) (295,254)
---------- ----------
Net Increase (Decrease) in Cash and Short-term Investments 50,914 (122,183)
Cash and short-term investments at beginning
of period 438,670 390,630
---------- ----------
Cash and short-term investments at end of period $ 489,584 $ 268,447
========== ==========
5
AMERICAN FINANCIAL GROUP, INC. 10-Q
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
A. ACCOUNTING POLICIES
BASIS OF PRESENTATION The accompanying consolidated financial statements
for American Financial Group, Inc. ("AFG") 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.
Emerging Issues Task Force Issue No. 99-20 established a new standard for
recognizing impairment of certain asset-backed investments. Impairment
losses on these investments must be recognized when (i) the fair value of
the security is less than its carrying value and (ii) there has been an
adverse change in the expected cash flows. The new standard became
effective on April 1, 2001. Impairment losses on initial application of
this rule were recognized as the cumulative effect of an accounting
change. Subsequent impairments are recognized as a component of net
realized gains and losses.
INVESTMENT IN INVESTEE CORPORATIONS Investments in securities of 20%- to
50%-owned companies are generally carried at cost, adjusted for AFG's
proportionate share of their undistributed earnings or losses.
Due to Chiquita's announced intention to pursue a plan to restructure its
public debt, AFG wrote down its investment in Chiquita common stock to
market value at December 31, 2000. In 2001, AFG suspended accounting for
the investment under the equity method due to the expected restructuring,
and reclassified the investment to "Other stocks."
COST IN EXCESS OF NET ASSETS ACQUIRED The excess of cost of subsidiaries
over AFG's equity in the underlying net assets ("goodwill") is being
amortized over periods of 20 to 40 years.
6
AMERICAN FINANCIAL GROUP, INC. 10-Q
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
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.
REINSURANCE In the normal course of business, AFG'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, AFG'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. AFG'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. AFG'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 Operations in the period in which
determined. In spite of the variability inherent in such estimates,
management believes that the liabilities for unpaid losses and loss
adjustment expenses are adequate.
ANNUITY BENEFITS ACCUMULATED Annuity receipts and benefit payments
are recorded as increases or decreases in "annuity benefits accumulated"
rather than as revenue and expense. Increases in this liability for
interest credited are charged to 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 GROUP, INC. 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
the interests of noncontrolling shareholders in AFG subsidiaries,
including American Financial Corporation ("AFC") preferred stock and
preferred securities issued by trust subsidiaries of AFG. For income
statement purposes, minority interest expense represents those
shareholders' interest in the earnings of AFG subsidiaries as well as AFC
preferred dividends and 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. Because holders of AFC Preferred
Stock hold in excess of 20% of AFC's voting rights, AFG (parent) and its
direct subsidiary, AFC Holding Company ("AFC Holding" or "AFCH"), are not
eligible to file consolidated returns with AFC, and therefore, file
separately.
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.
STOCK-BASED COMPENSATION As permitted under Statement of Financial
Accounting Standards ("SFAS") No. 123, "Accounting for Stock-Based
Compensation," AFG accounts for stock options and other stock-based
compensation plans using the intrinsic value based method prescribed by
Accounting Principles Board Opinion No. 25, "Accounting for Stock Issued
to Employees."
BENEFIT PLANS AFG 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
8
AMERICAN FINANCIAL GROUP, INC. 10-Q
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
securities of AFG and affiliates. Under the savings portion of the plan,
AFG matches a specific portion of employee contributions. Contributions to
benefit plans are charged against earnings in the year for which they are
declared.
AFG and many of its subsidiaries provide health care and life insurance
benefits to eligible retirees. AFG also provides postemployment benefits
to former or inactive employees (primarily those on disability) who were
not deemed retired under other company plans. The projected future cost of
providing these benefits is expensed over the period employees earn such
benefits.
DERIVATIVES Effective October 1, 2000, AFG implemented 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 AFG'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.
EARNINGS PER SHARE Basic earnings per share is calculated using the
weighted average number of shares of common stock outstanding during the
period. The calculation of diluted earnings per share includes the
following dilutive effect of common stock options: third quarter of 2001
and 2000 - 466,000 shares and 236,000 shares; nine months of 2001 and 2000
- 513,000 shares and 206,000 shares, respectively.
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
SEVEN HILLS INSURANCE COMPANY In July 2001, AFG sold Seven Hills Insurance
Company for $18.4 million, realizing a pretax gain of $7.1 million. As a
part of the sale, AFG assumed all liability for Seven Hills' business
prior to the date of the sale.
JAPANESE DIVISION In December 2000, AFG 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, AFG 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
9
AMERICAN FINANCIAL GROUP, INC. 10-Q
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
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.
STONEWALL INSURANCE COMPANY In September 2000, AFG sold Stonewall
Insurance Company, realizing a pretax loss of $6 million. AFG recognized
an additional pretax loss of $4.3 million in the fourth quarter of 2000 as
a result of post-closing adjustments. Stonewall was a non-operating
property and casualty subsidiary with approximately $320 million in
assets, engaged primarily in the run-off of approximately $170 million in
asbestos and environmental liabilities associated with policies written
through 1991.
COMMERCIAL LINES DIVISION In 1998, AFG sold its Commercial lines division
to Ohio Casualty Corporation. In August 2000, AFG 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.
C. SEGMENTS OF OPERATIONS AFG'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. AFG's annuity, life and health
business markets primarily retirement products as well as life and
supplemental health insurance.
10
AMERICAN FINANCIAL GROUP, INC. 10-Q
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
The following table (in thousands) shows AFG's revenues and operating
profit (loss) by significant business segment. Operating profit (loss)
represents total revenues less operating expenses.
Three months ended Nine months ended
September 30, September 30,
---------------------------- -------------------------------
2001 2000 2001 2000
---- ---- ---- ----
Revenues (a)
Property and casualty insurance:
Premiums earned:
Specialty $ 390,254 $ 334,846 $1,062,749 $ 917,057
Personal 273,905 326,591 924,166 940,237
Other lines - primarily
discontinued 222 (360) 1,752 (359)
---------- ---------- ---------- ----------
664,381 661,077 1,988,667 1,856,935
Investment and other income 117,233 98,703 331,008 349,181
---------- ---------- ---------- ----------
781,614 759,780 2,319,675 2,206,116
Annuities, life and health (b) 228,044 235,862 647,636 619,144
Other 5,178 16,954 13,014 30,611
---------- ---------- ---------- ----------
$1,014,836 $1,012,596 $2,980,325 $2,855,871
========== ========== ========== ==========
Operating Profit (Loss)
Property and casualty insurance:
Underwriting:
Specialty ($ 32,119) ($ 56,580) ($ 38,958) ($ 81,758)
Personal (21,104) (34,704) (84,681) (72,029)
Other lines (c) (98,365) (5,214) (104,166) (9,006)
---------- ---------- ---------- ----------
(151,588) (96,498) (227,805) (162,793)
Investment and other income 73,115 57,450 217,464 235,457
---------- ---------- ---------- ----------
(78,473) (39,048) (10,341) 72,664
Annuities, life and health 36,959 50,501 84,417 75,806
Other (d) (20,915) (10,814) (75,535) (49,761)
---------- ---------- ---------- ----------
($ 62,429) $ 639 ($ 1,459) $ 98,709
========== ========== ========== ==========
(a) Revenues include sales of products and services as well as other
income earned by the respective segments.
(b) Represents primarily investment income.
(c) Represents primarily losses related to asbestos and other
environmental matters ("A&E")
(d) Includes holding company expenses.
D. INVESTEE CORPORATIONS Investment in investee corporations at December 31,
2000, reflects AFG'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 nine months
ended September 30, 2000, follows (in millions):
Net Sales $1,725
Operating Income 88
Net Loss (6)
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 AFG.
11
AMERICAN FINANCIAL GROUP, INC. 10-Q
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
START-UP MANUFACTURING BUSINESSES Since 1998, AFG 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 AFG rather than invest additional
capital. In the fourth quarter of 2000, AFG 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 AFG subsidiaries, the sale was not recognized as a
divestiture for accounting purposes. Assets of the businesses transferred
(approximately $55 million at September 30, 2001 and December 31, 2000)
are included in other assets; liabilities of the businesses transferred
(approximately $9 million at September 30, 2001 and $7 million at December
31, 2000, after elimination of loans from AFG subsidiaries) are included
in other liabilities. AFG's equity in the losses of these two companies
($6.4 million in the third quarter and $12.0 million in the first nine
months of 2001) is included in investee losses in the Statement of
Operations. One of the businesses is involved in litigation impacting its
operations; see "Investee Corporations" in Management's Discussion and
Analysis.
E. LONG-TERM DEBT The carrying value of long-term debt consisted of the
following (in thousands):
September 30, December 31,
2001 2000
------------ -----------
Holding Companies:
AFG 7-1/8% Senior Debentures due April 2009 $301,064 $300,931
AFG 7-1/8% Senior Debentures due December 2007 79,600 79,600
AFC notes payable under bank line 206,000 178,000
APU 10-7/8% Subordinated Notes due May 2011 11,570 11,611
Other 13,970 14,727
-------- --------
$612,204 $584,869
======== ========
Subsidiaries:
GAFRI 6-7/8% Senior Notes due June 2008 $100,000 $100,000
GAFRI notes payable under bank line 121,100 48,500
Notes payable secured by real estate 16,500 31,201
Other 14,510 15,386
-------- --------
$252,110 $195,087
======== ========
At September 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 $ .5 $ .3 $ .8
2002 216.5 1.3 217.8
2003 - 1.3 1.3
2004 - 122.1 122.1
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.
12
AMERICAN FINANCIAL GROUP, INC. 10-Q
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
AFC and GAFRI each have an unsecured credit agreement with a group of
banks under which they can borrow up to $300 million and $155 million,
respectively. Borrowings bear interest at floating rates based on prime or
Eurodollar rates. Loans mature in December 2002 under the AFC credit
agreement and in December 2004 under the GAFRI credit agreement.
F. MINORITY INTEREST Minority interest in AFG's balance sheet is comprised
of the following (in thousands):
September 30, December 31,
2001 2000
------------ -----------
Interest of noncontrolling shareholders
in subsidiaries' common stock $144,907 $119,216
Preferred securities issued by
subsidiary trusts 241,663 316,663
AFC preferred stock 72,154 72,154
-------- --------
$458,724 $508,033
======== ========
PREFERRED SECURITIES Wholly-owned subsidiary trusts of AFG and 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. AFG and
GAFRI effectively provide unconditional guarantees of their respective
trusts' obligations.
The preferred securities consisted of the following (in thousands):
Date of September 30, December 31, Optional
Issuance Issue (Maturity Date) 2001 2000 Redemption Dates
------------- ------------------------ ------------ ----------- ---------------------------
October 1996 AFCH 9-1/8% TOPrS (2026) $98,750 $98,750 On or after 10/22/2001
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
On September 28, 2001, GAFRI redeemed its ROPES for $75 million in cash.
AFC PREFERRED STOCK AFC's Preferred Stock is voting, cumulative, and
consists 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.
MINORITY INTEREST EXPENSE Minority interest expense is comprised of (in
thousands):
Nine months ended
September 30,
---------------------
2001 2000
---- ----
Interest of noncontrolling shareholders
in earnings of subsidiaries $ 9,656 $ 9,011
Accrued distributions by subsidiaries
on preferred securities:
Trust issued securities, net of tax 13,361 13,359
AFC preferred stock 4,329 4,329
------- -------
$27,346 $26,699
======= =======
13
AMERICAN FINANCIAL GROUP, INC. 10-Q
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
G. SHAREHOLDERS' EQUITY At September 30, 2001, there were 68,215,312 shares
of AFG Common Stock outstanding, including 1,362,935 shares held by
American Premier for possible distribution to certain creditors and other
claimants upon proper claim presentation and settlement pursuant to the
1978 plan of reorganization of American Premier's predecessor, The Penn
Central Corporation. Shares being held for distribution are not eligible
to vote but otherwise are accounted for as issued and outstanding. AFG is
authorized to issue 12.5 million shares of Voting Preferred Stock and 12.5
million shares of Nonvoting Preferred Stock, each without par value.
At September 30, 2001, there were 9.7 million shares of AFG Common Stock
reserved for issuance upon exercise of stock options. As of that date,
options for 6.2 million shares were outstanding. Options generally become
exercisable at the rate of 20% per year commencing one year after grant;
those granted to non-employee directors of AFG are fully exercisable upon
grant. All options expire ten years after the date of grant.
The change in unrealized gain (loss) on marketable securities for the nine
months ended September 30 included the following (in millions):
Minority
Pretax Taxes Interest Net
------ ----- -------- -----
2001
- -----------------------------------------------------
Unrealized holding gains on securities
arising during the period $175.4 ($60.9) ($15.7) $ 98.8
Realized losses included in net income and
unrealized gains of subsidiary sold 33.1 (11.6) (1.6) 19.9
------ ----- ----- ------
Change in unrealized gain on
marketable securities, net $208.5 ($72.5) ($17.3) $118.7
====== ===== ===== ======
2000
- -----------------------------------------------------
Unrealized holding losses on securities
arising during the period ($ 9.9) $ 4.3 ($2.3) ($ 7.9)
Realized losses included in net income and
unrealized losses of subsidiary sold 25.2 (8.8) (1.4) 15.0
----- ----- ---- -----
Change in unrealized gain (loss) on
marketable securities, net $15.3 ($ 4.5) ($3.7) $ 7.1
===== ===== ==== =====
H. COMMITMENTS AND CONTINGENCIES There have been no significant changes to
the matters discussed and referred to in Note L "Commitments and
Contingencies" of AFG's Annual Report on Form 10-K for 2000.
14
AMERICAN FINANCIAL GROUP, INC. 10-Q
ITEM 2
Management's Discussion and Analysis
of Financial Condition and Results of Operations
GENERAL
AFG and its subsidiaries, AFC Holding, 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, AFG does not prepare its
consolidated financial statements using a current-noncurrent format.
Consequently, certain traditional ratios and financial analysis tests are
not meaningful.
IT INITIATIVE In 1999, AFG 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;
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. AFG 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 AFG's debt to total capital ratio (at the parent holding company
level) was approximately 26% at September 30, 2001 and 25% at December 31,
2000. AFG's ratio of earnings to fixed charges (on a total enterprise
basis) was .68 for the first nine months of 2001 and 1.63 for the entire
year of 2000. Due primarily
15
AMERICAN FINANCIAL GROUP, INC. 10-Q
Management's Discussion and Analysis
of Financial Condition and Results of Operations - Continued
to the $100 million strengthening of asbestos and environmental reserves
in the third quarter, fixed charges exceeded earnings by $26 million
during the first nine months of 2001.
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 September 30, 2001, there was $206 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) AFG's ability to obtain financing in capital markets, as
well as (iii) the sales of certain noncore investments.
INVESTMENTS Approximately 93% of the fixed maturities held by AFG were
rated "investment grade" (credit rating of AAA to BBB) by nationally
recognized rating agencies at September 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.
AFG's equity securities are concentrated in a relatively limited number of
major positions. This approach allows management to more closely monitor
the companies and the industries in which they operate.
RESULTS OF OPERATIONS
GENERAL Pretax operating losses for the three months and nine months ended
September 30, 2001 were $62.4 million and $1.5 million, respectively,
compared to earnings of $639,000 and $98.7 million in the comparable 2000
periods. Results for the third quarter of 2001 include a $100 million
asbestos and environmental charge and losses of $25 million resulting from
the World Trade Center terrorist attack. Results for 2000 include a third
quarter charge of $35 million for reserve strengthening in the California
workers' compensation business and special litigation charges of $41
million recorded in the second quarter. Results for the first nine months
of 2001 include realized losses of $27.8 million compared to gains of
$25.7 million in the comparable 2000 period.
Many investors and analysts focus on "core earnings" of companies, setting
aside certain items included in net earnings. Such "core earnings" for
AFG, consisting of net earnings adjusted to exclude (i) realized gains
(losses), (ii) equity in investee losses, and (iii) the unusual items
discussed in the preceding paragraph, were $27.9 million ($.41 per share,
diluted) and $73.6 million ($1.08 per share) in the third quarter and nine
months of 2001 compared to $12 million ($.21 per share) and $74 million
($1.27 per share) in the third quarter and nine months of 2000.
16
AMERICAN FINANCIAL GROUP, INC. 10-Q
Management's Discussion and Analysis
of Financial Condition and Results of Operations - Continued
PROPERTY AND CASUALTY INSURANCE - UNDERWRITING AFG'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.
Net written premiums and combined ratios for AFG's property and casualty
insurance subsidiaries were as follows (dollars in millions):
Three months ended Nine months ended
September 30, September 30,
--------------------- ----------------------
2001 2000 2001 2000
---- ---- ---- ----
Net Written Premiums (GAAP)
Specialty $417.3 $341.7 $1,167.7(a) $ 974.9
Personal 190.6 299.4 813.1 997.3
Other lines - (.3) - (.3)
------ ------ -------- --------
$607.9 $640.8 $1,980.8 $1,971.9
====== ====== ======== ========
Combined Ratios (GAAP) (b)
----------------------
Specialty (c) 108.3% 116.8% 103.7% 108.9%
Personal 107.7 110.6 109.2 107.6
Aggregate (including
discontinued lines) (d) 122.8 114.7 111.4 108.8
(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%.
(c) Includes 6.5% and 2.3% for the three and nine month periods
of 2001 relating to the attack on the World Trade Center.
(d) Includes an aggregate of 18.8% and 6.2% for the three and
nine month periods of 2001 relating to the A&E charge and the
attack on the World Trade Center.
17
AMERICAN FINANCIAL GROUP, INC. 10-Q
Management's Discussion and Analysis
of Financial Condition and Results of Operations - Continued
ASBESTOS AND ENVIRONMENTAL RESERVES CHARGE 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.
In October 2001, AFG completed a comprehensive study of its A&E reserves.
This study was initiated after experiencing an increase in the number and
severity of asbestos claims during the second quarter of 2001 and
observing the developments of adverse trends in the property and casualty
insurance industry concerning asbestos losses. As a result, AFG recorded a
third quarter charge of $100 million. This charge, accompanied by a
transfer of $36 million from excess reserves for other environmental
claims, resulted in an increase of $136 million in asbestos reserves. At
September 30, 2001, A&E reserves were $554 million (before deducting
reinsurance recoverables of $119 million).
While management believes that the reserves, as strengthened, are a
reasonable estimate of ultimate liability for A&E claims, actual results
may vary materially from the amount currently recorded due to
uncertainties such as insureds seeking bankruptcy protection, predicting
the number of future claims, the ability of claimants who exhibit no signs
of illness to successfully pursue claims, and the potential for allocation
of liability among insurers.
Further, certain policyholders assert that their claims are not subject to
aggregate limits on coverage because either their policies failed to
contain aggregate limits with respect to products liability coverage or,
faced with exhaustion of products coverage limits, their asbestos claims
fall within non-products liability coverage which is not subject to any
aggregate limit. These claims are now being contested in insurance
coverage litigation in various jurisdictions. In rejecting the claims that
are the basis of this litigation, AFG believes its coverage defenses are
substantial and intends to continue to vigorously defend its position.
Nonetheless, such claims may have a material adverse effect upon AFG if
resolved unfavorably.
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. Through
the first nine months of this year, rate increases in the California
worker's compensation business have been in excess of 35% and have
averaged over 17% in the other specialty operations. AFG 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 effect of the attack on
the World Trade Center, the Specialty group's combined ratio improved to
101.8% for the third quarter and 101.4% for the first nine months of 2001.
PERSONAL The Personal group's decline in net written premiums reflects a
reinsurance agreement, effective April 1, 2001, under which AFG cedes 90%
of the automobile physical damage business written by certain of its
insurance subsidiaries. This agreement is enabling AFG 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 slightly for the third quarter and nine months as lower business
volume was partially offset by the impact of significant rate increases.
Through the first nine months of 2001, the group has implemented rate
increases of 12%. As a result, the combined ratio improved to 107.7% for
the third quarter of 2001.
18
AMERICAN FINANCIAL GROUP, INC. 10-Q
Management's Discussion and Analysis
of Financial Condition and Results of Operations - Continued
LIFE, ACCIDENT AND HEALTH PREMIUMS AND BENEFITS The increase in life,
accident and health premiums and benefits for the nine months is due
primarily to the acquisition of a block of supplemental health insurance
business in 2000.
REAL ESTATE OPERATIONS AFG'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 AFG's statement of earnings as shown below (in millions).
Three months ended Nine months ended
September 30, September 30,
------------------- ------------------
2001 2000 2001 2000
---- ---- ---- ----
Other income $24.3 $26.8 $85.7 $71.2
Other operating and general expenses 17.9 18.5 49.5 49.8
Interest charges on borrowed money .3 .6 1.6 1.9
Minority interest expense, net .2 .7 3.5 1.4
Other income includes net pretax gains on the sale of real estate assets
of $2.0 million in the third quarter and $26.6 million in the first nine
months of 2001 compared to $.8 million and $7.5 million for the 2000
periods.
OTHER INCOME Excluding gains on the sale of real estate assets (discussed
above), other income decreased $25.8 million (15%) in the first nine
months of 2001 due primarily to income of $11.2 million from the sale of
certain lease rights in the third quarter of 2000 and 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. Individual assets are sold creating gains and
losses as market opportunities exist.
GAINS (LOSSES) ON SECURITIES In addition to gains (losses) on sales of
securities, provisions for other than temporary impairment of securities
still held are included as follows: third quarter of 2001 and 2000 - $22.9
million and $6.6 million; nine months of 2001 and 2000 - $60.1 million and
$9.9 million, respectively. The provisions for the 2001 periods include $8
million for the writedown of AFG's investment in Chiquita from $1.00 per
share to $.67 per share.
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 $60,000 in the third quarter and $2.4 million in the first nine
months to adjust the carrying value of AFG's investment in warrants to
market value.
GAIN (LOSS) ON SUBSIDIARIES Gain (loss) on sales of subsidiaries in 2001
includes a third quarter pretax gain of $7.1 on the sale of Seven Hills
Insurance Company and a first quarter pretax loss of $1.6 million
representing an adjustment to the fourth quarter 2000 loss recorded on the
sale of the Japanese division. In 2000, AFG recognized a $25 million gain
in the second quarter representing an earn-out related to the 1998 sale of
its Commercial lines division and a $6 million loss in the third quarter
on the sale of Stonewall Insurance Company.
GAIN ON OTHER INVESTMENTS In September 2000, GAFRI realized a $27.2
million pretax gain on the sale of its minority ownership in a company
engaged in the production of ethanol.
19
AMERICAN FINANCIAL GROUP, INC. 10-Q
Management's Discussion and Analysis
of Financial Condition and Results of Operations - Continued
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 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 a net
effect of less than $1 million on annuity benefits during the third
quarter or the first nine months of 2001.
INTEREST EXPENSE Interest expense for the third quarter and nine months of
2001 decreased compared to 2000 as lower average interest rates on AFG's
variable rate debt and lower average subsidiary indebtedness more than
offset higher average borrowings under the AFC bank line.
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 AFG property and casualty subsidiary. Excluding these
litigation charges, other operating and general expenses increased $28
million (9%) for the first nine months of 2001 compared to 2000 due
primarily to increased expenses associated with the IT initiative and
slightly higher holding company expenses.
INVESTEE CORPORATIONS Equity in losses of investee corporations in 2001
represents losses of two start-up manufacturing businesses (see Note D).
Investee losses in 2001 include a third quarter judgement of $2.7 million
against one of the companies for the misappropriation of a trade secret
and the infringement of a patent. In November 2001, an injunction was
issued which would prohibit the company from using the equipment which was
the subject of the trade secret claim and effectively close the plant. The
injunction was subsequently modified, pending appeal, to permit operations
to continue and require certain escrow payments. If the investee is
unsuccessful in its attempt to have the injunction lifted or further
modified, a substantial portion of AFG's investment ($35 million as of
November 1, 2001), may be written off.
Equity in net losses of investees in 2000 represents AFG's proportionate
share of Chiquita's earnings. Due to Chiquita's restructuring plans, AFG
suspended its use of equity accounting in 2001.
CUMULATIVE EFFECT OF ACCOUNTING CHANGE The cumulative effect of accounting
change represents the implementation of a new accounting standard (EITF
99-20) which resulted in a write down of $16.9 million ($10.0 million or
$.15 per share after tax and minority interest) of the carrying value of
certain collateralized debt obligations as of April 1, 2001.
20
AMERICAN FINANCIAL GROUP, INC. 10-Q
Management's Discussion and Analysis
of Financial Condition and Results of Operations - Continued
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 current levels of goodwill,
amortization is approximately $3.5 million per quarter.
-------------------------------------------------------------------------
Item 3
QUANTITATIVE AND QUALITATIVE DISCLOSURE OF MARKET RISK
As of September 30, 2001, there were no material changes to the
information provided in AFG'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.
21
AMERICAN FINANCIAL GROUP, INC. 10-Q
PART II
OTHER INFORMATION - CONTINUED
Item 5
OTHER INFORMATION
The following is an excerpt from AFG's third quarter earnings release dated
November 2, 2001.
COMMON STOCK DIVIDEND REDUCTION
According to [AFG's Chairman and Chief Executive Officer], "The
opportunity presented by significant price firming in the marketplace leads us
to believe that the best interests of the company and its shareholders are
served by retaining available capital to grow our profitable insurance
operations and build long-term value."
In that light, the company...expects to reduce its annual dividend
on its Common Stock from $1.00 to $.50 per share, representing a yield of about
2-1/4% on the current market price of the stock. This will retain more than $30
million of capital in the business. [The Chairman and CEO] said, "We believe
this method of providing capital to our growing businesses is prudent in the
circumstances and that the dividend yield is more in line with our industry
peers. In addition, it seems to be appropriate in relation to our expectation of
2002 operating earnings of between $2.20 and $2.40 per share."
Item 6
EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibits: none
(b) Reports on Form 8-K:
Date of Report Item Reported
-------------- ------------------------------------
August 2, 2001 Second quarter 2001 Earnings Release
-----------------------------------------------------------------------------
Signature
Pursuant to the requirements of the Securities Exchange Act of 1934, American
Financial Group, Inc. has duly caused this Report to be signed on its behalf by
the undersigned duly authorized.
American Financial Group, Inc.
November 14, 2001 BY: Fred J. Runk
----------------------------------
Fred J. Runk
Senior Vice President and Treasurer
22