Fair Value Measurements

9 Months Ended

Sep. 30, 2011

Fair Value Measurements [Abstract]

Fair Value Measurements

D. Fair Value Measurements

Accounting standards for measuring fair value are based on inputs used in estimating fair value. The three levels of the hierarchy are as follows:

Level 1 — Quoted prices for identical assets or liabilities in active markets (markets in which transactions occur with sufficient frequency and volume to provide pricing information on an ongoing basis). AFG’s Level 1 financial instruments consist primarily of publicly traded equity securities and highly liquid government bonds for which quoted market prices in active markets are available and short-term investments of managed investment entities.

Level 2 — Quoted prices for similar instruments in active markets; quoted prices for identical or similar assets or liabilities in inactive markets (markets in which there are few transactions, the prices are not current, price quotations vary substantially over time or among market makers, or in which little information is released publicly); and valuations based on other significant inputs that are observable in active markets. AFG’s Level 2 financial instruments include separate account assets, corporate and municipal fixed maturity securities, mortgage-backed securities (“MBS”) and investments of managed investment entities priced using observable inputs. Level 2 inputs include benchmark yields, reported trades, corroborated broker/dealer quotes, issuer spreads and benchmark securities. When non-binding broker quotes can be corroborated by comparison to similar securities priced using observable inputs, they are classified as Level 2.

Level 3 — Valuations derived from market valuation techniques generally consistent with those used to estimate the fair values of Level 2 financial instruments in which one or more significant inputs are unobservable. The unobservable inputs may include management’s own assumptions about the assumptions market participants would use based on the best information available in the circumstances. AFG’s Level 3 is comprised of financial instruments, including liabilities of managed investment entities, whose fair value is estimated based on non-binding broker quotes or internally developed using significant inputs not based on, or corroborated by, observable market information.

AFG’s management is responsible for the valuation process and uses data from outside sources (including nationally recognized pricing services and broker/dealers) in establishing fair value. Valuation techniques utilized by pricing services and prices obtained from external sources are reviewed by AFG’s internal investment professionals who are familiar with the securities being priced and the markets in which they trade to ensure the fair value determination is representative of an exit price. To validate the appropriateness of the prices obtained, these investment managers consider widely published indices (as benchmarks), recent trades, changes in interest rates, general economic conditions and the credit quality of the specific issuers.

Assets and liabilities measured at fair value are summarized below (in millions):

	Level 1		Level 2		Level 3		Total
September 30, 2011
Assets:
Available for sale (“AFS”) fixed maturities:
U.S. Government and government agencies	$	234	$	188	$	—	$	422
States, municipalities and political subdivisions		—		3,697		72		3,769
Foreign government		—		267		—		267
Residential MBS		—		3,540		284		3,824
Commercial MBS		—		2,774		28		2,802
All other corporate		9		10,023		436		10,468
Total AFS fixed maturities		243		20,489		820		21,552
Trading fixed maturities		—		440		1		441
Equity securities		777		129		24		930
Assets of managed investment entities (“MIE”)		132		2,267		40		2,439
Variable annuity assets (separate accounts) (a)		—		515		—		515
Other investments		—		47		—		47
Total assets accounted for at fair value	$	1,152	$	23,887	$	885	$	25,924
Liabilities:
Liabilities of managed investment entities	$	47	$	—	$	2,182	$	2,229
Derivatives in annuity benefits accumulated		—		—		332		332
Total liabilities accounted for at fair value	$	47	$	—	$	2,514	$	2,561
December 31, 2010
Assets:
Available for sale (“AFS”) fixed maturities:
U.S. Government and government agencies	$	249	$	218	$	—	$	467
States, municipalities and political subdivisions		—		2,919		20		2,939
Foreign government		—		278		—		278
Residential MBS		—		3,563		312		3,875
Commercial MBS		—		2,117		6		2,123
All other corporate		9		9,201		436		9,646
Total AFS fixed maturities		258		18,296		774		19,328
Trading fixed maturities		—		390		3		393
Equity securities		461		208		21		690
Assets of managed investment entities (“MIE”)		96		2,393		48		2,537
Variable annuity assets (separate accounts) (a)		—		616		—		616
Other investments		—		98		—		98
Total assets accounted for at fair value	$	815	$	22,001	$	846	$	23,662
Liabilities:
Liabilities of managed investment entities	$	65	$	—	$	2,258	$	2,323
Derivatives in annuity benefits accumulated		—		—		190		190
Total liabilities accounted for at fair value	$	65	$	—	$	2,448	$	2,513

(a) Variable annuity liabilities equal the fair value of variable annuity assets.

During the third quarter of 2011, there were no significant transfers between Level 1 and Level 2. Approximately 3% of the total assets measured at fair value on September 30, 2011, were Level 3 assets. Approximately 95% of these assets were priced using non-binding broker quotes. The fair values of the liabilities of managed investment entities were determined using non-binding broker quotes, which were reviewed by AFG’s investment professionals.

Changes in balances of Level 3 financial assets and liabilities during the third quarter and first nine months of 2011 and 2010 are presented below (in millions). The transfers into and out of Level 3 were due to changes in the availability of market observable inputs. All transfers are reflected in the table at fair value as of the end of the reporting period.

				Total
				realized/unrealized
				gains (losses)
				included in
							Other
	Balance at						comp.			Purchases						Transfer		Transfer			Balance at
	June 30,			Net			income			and			Sales and			into		out of			September 30,
	2011			income			(loss)			issuances			Settlements			Level 3		Level 3			2011
AFS fixed maturities:
State and municipal	$	84		$	—		$	4		$	—		$	(3	)	$	—	$	(13	)	$	72
Residential MBS		255			1			(4	)		25			(9	)		24		(8	)		284
Commercial MBS		10			—			—			9			—			9		—			28
All other corporate		382			2			11			32			(14	)		46		(23	)		436
Trading fixed maturities		1			—			—			—			—			—		—			1
Equity securities		21			—			(1	)		2			—			2		—			24
Assets of MIE		53			(6	)		—			5			(7	)		—		(5	)		40
Liabilities of MIE (*)		(2,322	)		89			—			—			51			—		—			(2,182	)
Embedded derivatives		(299	)		31			—			(71	)		7			—		—			(332	)

(*) Total realized/unrealized loss included in net income includes losses of $89 million related to liabilities outstanding as of September 30, 2011. See Note H — “Managed Investment Entities.”

				Total
				realized/unrealized
				gains (losses)
				included in
							Other		Purchases,
	Balance at						comp.		sales,			Transfer		Transfer			Balance at
	June 30,			Net			income		issuances and			into		out of			September 30,
	2010			income			(loss)		settlements			Level 3		Level 3			2010
AFS fixed maturities:
State and municipal	$	21		$	—		$	—	$	—		$	—	$	—		$	21
Residential MBS		326			4			11		5			7		(61	)		292
Commercial MBS		6			(1	)		—		—			—		—			5
All other corporate		426			—			7		14			27		(22	)		452
Trading fixed maturities		1			—			—		—			—		—			1
Equity securities		24			—			—		—			—		(3	)		21
Assets of MIE		46			—			—		(4	)		—		—			42
Liabilities of MIE		(2,152	)		(51	)		—		4			—		—			(2,199	)
Embedded derivatives		(128	)		(26	)		—		(16	)		—		—			(170	)

				Total
				realized/unrealized
				gains (losses)
				included in
							Other
	Balance at						comp.			Purchases						Transfer		Transfer			Balance at
	Dec. 31,			Net			income			and			Sales and			into		out of			September 30,
	2010			income			(loss)			issuances			Settlements			Level 3		Level 3			2011
AFS fixed maturities:
State and municipal	$	20		$	—		$	5		$	53		$	(3	)	$	10	$	(13	)	$	72
Residential MBS		312			2			(6	)		42			(29	)		31		(68	)		284
Commercial MBS		6			—			—			9			—			13		—			28
All other corporate		436			1			17			123			(51	)		70		(160	)		436
Trading fixed maturities		3			—			—			—			—			—		(2	)		1
Equity securities		21			—			1			2			(2	)		2		—			24
Assets of MIE		48			(7	)		—			21			(13	)		8		(17	)		40
Liabilities of MIE (*)		(2,258	)		17			—			—			59			—		—			(2,182	)
Embedded derivatives		(190	)		2			—			(161	)		17			—		—			(332	)

(*) Total realized/unrealized loss included in net income includes losses of $19 million related to liabilities outstanding as of September 30, 2011. See Note H — “Managed Investment Entities.”

							Total
							realized/unrealized
							gains (losses)
							included in
				Consolidate						Other			Purchases,
	Balance at			Managed						comp.			sales,			Transfer		Transfer			Balance at
	Dec. 31,			Inv.			Net			income			issuances and			into		out of			September 30,
	2009			Entities			income			(loss)			settlements			Level 3		Level 3			2010
AFS fixed maturities:
State and municipal	$	23		$	—		$	—		$	1		$	(3	)	$	17	$	(17	)	$	21
Residential MBS		435			—			6			22			11			9		(191	)		292
Commercial MBS		—			—			(1	)		—			6			—		—			5
All other corporate		311			(6	)		(12	)		15			101			96		(53	)		452
Trading fixed maturities		1			—			—			—			4			—		(4	)		1
Equity securities		25			—			—			(1	)		—			—		(3	)		21
Assets of MIE		—			90			5			—			(8	)		7		(52	)		42
Liabilities of MIE		—			(2,100	)		(141	)		—			42			—		—			(2,199	)
Embedded derivatives		(113	)		—			(25	)		—			(32	)		—		—			(170	)

Fair Value of Financial Instruments The following table presents (in millions) the carrying value and estimated fair value of AFG’s financial instruments at September 30, 2011 and December 31, 2010.

	September 30, 2011				December 31, 2010
	Carrying		Fair		Carrying		Fair
	Value		Value		Value		Value
Assets:
Cash and cash equivalents	$	991	$	991	$	1,099	$	1,099
Fixed maturities		21,993		21,993		19,721		19,721
Equity securities		930		930		690		690
Mortgage loans		384		387		468		469
Policy loans		253		253		264		264
Other investments — derivatives		47		47		98		98
Assets of managed investment entities		2,439		2,439		2,537		2,537
Variable annuity assets (separate accounts)		515		515		616		616
Liabilities:
Annuity benefits accumulated(*)	$	14,582	$	14,437	$	12,696	$	12,233
Long-term debt		937		1,023		952		1,023
Liabilities of managed investment entities		2,229		2,229		2,323		2,323
Variable annuity liabilities (separate accounts)		515		515		616		616
Other liabilities — derivatives		24		24		14		14

(*) Excludes life contingent annuities in the payout phase.

The carrying amount of cash and cash equivalents approximates fair value. Fair values for mortgage loans are estimated by discounting the future contractual cash flows using the current rates at which similar loans would be made to borrowers with similar credit ratings. The fair value of policy loans is estimated to approximate carrying value; policy loans have no defined maturity dates and are inseparable from insurance contracts. The fair value of annuity benefits was estimated based on expected cash flows discounted using forward interest rates adjusted for the Company’s credit risk and includes the impact of maintenance expenses and capital costs. Fair values of long-term debt are based primarily on quoted market prices.