Insurance

Securities owned by U.S.-based insurance subsidiaries having a carrying value of approximately $1.18 billion at December 31, 2014, were on deposit as required by regulatory authorities. At December 31, 2014, AFG and its subsidiaries had $223 million in undrawn letters of credit (none of which was collateralized) supporting the underwriting capacity of its U.K.-based Lloyd’s insurer.

Property and Casualty Insurance Reserves The liability for losses and LAE for long-term scheduled payments under certain workers’ compensation insurance has been discounted at 4.5% at both December 31, 2014 and 2013, which represents an approximation of long-term investment yields. As a result, the total liability for losses and loss adjustment expenses at December 31, 2014 and 2013, has been reduced by $19 million and $20 million.

The following table provides an analysis of changes in the liability for losses and loss adjustment expenses, net of reinsurance (and grossed up), over the past three years (in millions):



	2014			2013			2012
Balance at beginning of period	$	4,288		$	4,129		$	4,282
Provision for losses and LAE occurring in the current year	2,488			2,055			1,903
Net increase (decrease) in provision for claims of prior years	6			(15		)	(30		)
Total losses and LAE incurred	2,494			2,040			1,873
Payments for losses and LAE of:
Current year	(789		)	(739		)	(841		)
Prior years	(1,340		)	(1,131		)	(1,185		)
Total payments	(2,129		)	(1,870		)	(2,026		)
Reserves of businesses acquired (*)	1,028			—			—
Foreign currency translation and other	(36		)	(11		)	—
Balance at end of period	5,645			4,288			4,129
Add back reinsurance recoverables, net of allowance	2,227			2,122			2,716
Gross unpaid losses and LAE included in the Balance Sheet	$	7,872		$	6,410		$	6,845

(*) Reflects the acquisition of Summit in April 2014 (see Note B — “Acquisitions and Sales of Businesses”).

Net adverse development in 2014 reflects higher than expected severity in commercial auto liability losses written in the transportation businesses (within the Property and transportation sub-segment), higher than expected claims severity in contractor claims and in a run-off book of casualty business and adverse reserve development at Marketform (all within the Specialty casualty sub-segment), and the $24 million special charge to increase asbestos and environmental reserves. This adverse development was offset by (i) lower than expected claim severity in directors and officers liability insurance, lower than expected claim severity and frequency in excess liability insurance and lower than anticipated claim severity in specialty workers’ compensation business (all within the Specialty casualty sub-segment), and (ii) lower than expected claim severity in the surety and fidelity businesses and lower than expected claim frequency and severity in the foreign credit business and products for financial institutions (within the Specialty financial sub-segment).

Favorable development in 2013 was due primarily to lower than expected severity in directors and officers liability insurance and lower than expected claim severity and frequency in the excess liability business (both within the Specialty casualty sub-segment) lower than expected frequency and severity in the foreign credit and financial institutions businesses (within the Specialty financial sub-segment) and favorable reserve development associated with AFG’s internal reinsurance program, partially offset by the $54 million special charge to increase asbestos and environmental reserves.

Favorable development in 2012 was due primarily to lower than expected frequency and severity in the homebuilders’ general liability business (within the Specialty casualty sub-segment) and lower than expected frequency in the crop business (within the Property and transportation sub-segment), partially offset by higher frequency and severity in a block of program business (within the Specialty casualty sub-segment) and the $31 million special charge to increase asbestos and environmental reserves.

Closed Block of Long-Term Care Insurance AFG, as well as other companies that sell long-term care products, have accumulated relatively limited claims, lapse and mortality experience, making it difficult to predict future claims. Long-term care claims tend to be much higher in dollar amount and longer in duration than other health care products. In addition, long-term care claims are incurred much later in the life of a policy than most other health products. These factors made it difficult to appropriately price this product and were instrumental in AFG’s decision to stop writing new policies in January 2010. AFG’s outstanding long-term care policies have level premiums and are guaranteed renewable. Premium rates can potentially be increased in reaction to adverse experience; however, any rate increases would require regulatory approval.

In 2012, AFG recorded a $153 million pretax loss recognition charge to write off deferred policy acquisition costs and strengthen reserves on its closed block of long-term care insurance, due primarily to the impact of changes in assumptions related to future investment yields resulting from the continued low interest rate environment, as well as changes in claims, expenses and persistency assumptions. No additional loss recognition charges were recorded in 2014 or 2013. At December 31, 2014, AFG’s long-term care insurance reserves were $807 million, net of reinsurance recoverables and excluding the impact of unrealized gains on securities.

FHLB Funding Agreements Great American Life Insurance Company (“GALIC”), a wholly-owned annuity subsidiary, is a member of the Federal Home Loan Bank of Cincinnati (“FHLB”). The FHLB makes advances and provides other banking services to member institutions. Members are required to purchase stock in the FHLB in addition to maintaining collateral deposits that back any funds advanced. GALIC’s $34 million investment in FHLB capital stock at December 31, 2014, is included in other investments at cost. Membership in the FHLB provides the annuity operations with a substantial additional source of liquidity. These advances further the FHLB’s mission of improving access to housing by increasing liquidity in the residential mortgage-backed securities market. In the second quarter of 2013, the FHLB advanced GALIC $200 million, (included in annuity benefits accumulated) increasing the total amount advanced to $440 million at both December 31, 2013 and December 31, 2014. Interest rates under the various funding agreements on these advances range from 0.02% to 0.23% over LIBOR (average rate of 0.32% at December 31, 2014). While these advances must be repaid between 2016 and 2018, GALIC has the option to prepay all or a portion of the advances. The advances on these agreements are collateralized by mortgage-backed securities with a fair value of $544 million (included in available for sale fixed maturity securities) at December 31, 2014. Interest credited on the funding agreements, which is included in annuity benefits, was $1 million in 2014 and 2013 and less than $1 million in 2012.

Statutory Information AFG’s U.S.-based insurance subsidiaries are required to file financial statements with state insurance regulatory authorities prepared on an accounting basis prescribed or permitted by such authorities (statutory basis). Net earnings and capital and surplus on a statutory basis for the insurance subsidiaries were as follows (in millions):



	Net Earnings						Capital and Surplus
	2014		2013		2012		2014		2013
Property and casualty companies	$	318	$	332	$	221	$	2,286	$	1,896
Life insurance companies	349		294		171		1,714		1,619

The National Association of Insurance Commissioners’ (“NAIC”) model law for risk based capital (“RBC”) applies to both life and property and casualty insurance companies. RBC formulas determine the amount of capital that an insurance company needs so that it has an acceptable expectation of not becoming financially impaired. Companies below specific trigger points or ratios are subject to regulatory action. At December 31, 2014 and 2013, the capital ratios of all AFG insurance companies substantially exceeded the RBC requirements. AFG’s insurance companies did not use any prescribed or permitted statutory accounting practices that differed from the NAIC statutory accounting practices at December 31, 2014 or 2013.

Payments of dividends by AFG’s insurance companies are subject to various state laws that limit the amount of dividends that can be paid. Under applicable restrictions, the maximum amount of dividends available to AFG in 2015 from its insurance subsidiaries without seeking regulatory clearance is $673 million. Additional amounts of dividends require regulatory approval.

AFG paid common stock dividends to shareholders totaling $169 million, $161 million and $91 million in 2014, 2013 and 2012, respectively. Currently, there are no regulatory restrictions on AFG’s retained earnings or net income that materially impact its ability to pay dividends. Based on shareholders’ equity at December 31, 2014, AFG could pay dividends in excess of $1 billion without violating its most restrictive debt covenant. However, the payment of future dividends will be at the discretion of AFG’s Board of Directors and will be dependent on many factors including AFG’s financial condition and results of operations, the capital requirements of its insurance subsidiaries, and rating agency commitments.

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. The following table shows (in millions) (i) amounts deducted from property and casualty written and earned premiums in connection with reinsurance ceded, (ii) written and earned premiums included in income for reinsurance assumed and (iii) reinsurance recoveries, which represent ceded losses and loss adjustment expenses.



	2014			2013			2012
Direct premiums written	$	5,387		$	4,744		$	4,283
Reinsurance assumed	90			61			38
Reinsurance ceded	(1,457		)	(1,464		)	(1,372		)
Net written premiums	$	4,020		$	3,341		$	2,949

Direct premiums earned	$	5,195		$	4,684		$	4,120
Reinsurance assumed	75			45			36
Reinsurance ceded	(1,392		)	(1,525		)	(1,309		)
Net earned premiums	$	3,878		$	3,204		$	2,847

Reinsurance recoveries	$	895		$	1,255		$	1,743

In March 2014, AFG’s property and casualty insurance operations entered into a reinsurance agreement to obtain additional catastrophe protection through a catastrophe bond structure with Riverfront Re Ltd. (“Riverfront”). The reinsurance agreement provides supplemental reinsurance coverage up to $95 million (fully collateralized) for catastrophe losses in excess of $100 million occurring during the period from April 1, 2014 through December 31, 2016. In connection with the reinsurance agreement, Riverfront issued notes to unrelated investors for the full $95 million of coverage provided under the reinsurance agreement. At the time of the agreement, AFG concluded that Riverfront is a variable interest entity, but that it does not have a variable interest in the entity because the variability in Riverfront’s results is expected to be absorbed entirely by the investors in Riverfront. Accordingly, Riverfront is not consolidated in AFG’s financial statements and the reinsurance agreement is accounted for as ceded reinsurance. AFG’s cost for this coverage is approximately $5 million per year.

AFG has reinsured approximately $12.70 billion of its $16.71 billion in face amount of life insurance at December 31, 2014 compared to $13.43 billion of its $17.98 billion in face amount of life insurance at December 31, 2013. Life written premiums ceded were $41 million, $44 million and $42 million for 2014, 2013 and 2012, respectively.

Fixed Annuities For certain products, the liability for “annuity benefits accumulated” includes reserves for excess benefits expected to be paid on future deaths and annuitizations (“EDAR”), guaranteed withdrawal benefits and accrued persistency and premium bonuses. The liabilities included in AFG’s Balance Sheet for these benefits, excluding the impact of unrealized gains on securities, were as follows at December 31 (in millions):



	2014		2013
Excess death and annuitization	$	213	$	197
Guaranteed withdrawal benefits	151		71
Accrued persistency and premium bonuses	14		15

Variable Annuities At December 31, 2014, the aggregate guaranteed minimum death benefit value (assuming every variable annuity policyholder died on that date) on AFG’s variable annuity policies exceeded the fair value of the underlying variable annuities by $23 million, compared to $26 million at December 31, 2013. Death benefits paid in excess of the variable annuity account balances were less than $1 million in each of the last three years.