Insurance

Cash and securities owned by U.S.-based insurance subsidiaries having a carrying value of approximately $1.00 billion at December 31, 2015, were on deposit as required by regulatory authorities. In addition, $203 million was on deposit in support of AFG’s underwriting activities at Lloyd’s. At December 31, 2015, AFG and its subsidiaries had $307 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, 2015 and 2014, which represents an approximation of long-term investment yields. As a result, the total liability for losses and loss adjustment expenses at December 31, 2015 and 2014, has been reduced by $18 million and $19 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):



	2015			2014			2013
Balance at beginning of period	$	5,645		$	4,288		$	4,129
Provision for losses and LAE occurring in the current year	2,662			2,488			2,055
Net increase (decrease) in the provision for claims of prior years:
Special A&E charges	67			24			54
Other	(34		)	(18		)	(69		)
Total losses and LAE incurred	2,695			2,494			2,040
Payments for losses and LAE of:
Current year	(828		)	(789		)	(739		)
Prior years	(1,575		)	(1,340		)	(1,131		)
Total payments	(2,403		)	(2,129		)	(1,870		)
Reserves of businesses acquired (*)	—			1,028			—
Foreign currency translation and other	(11		)	(36		)	(11		)
Balance at end of period	5,926			5,645			4,288
Add back reinsurance recoverables, net of allowance	2,201			2,227			2,122
Gross unpaid losses and LAE included in the balance sheet	$	8,127		$	7,872		$	6,410

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

The net increase in the provision for claims of prior years in 2015 reflects (i) higher than expected claim severity at National Interstate and higher than anticipated claim frequency in the ocean marine business (all within the Property and transportation sub-segment), (ii) adverse reserve development at Marketform (within the Specialty casualty sub-segment), and (iii) the $67 million special charge to increase asbestos and environmental reserves. This adverse development was partially offset by (i) lower than expected claim severity in the property and inland marine business, agricultural operations and a run-off book of homebuilders business (all within the Property and transportation sub-segment), (ii) lower than anticipated claim severity in workers’ compensation business, lower than anticipated claim severity and frequency in excess liability insurance and lower than expected claim severity in directors and officers liability insurance (all within the Specialty casualty sub-segment), and (iii) lower than anticipated claim frequency and severity in the surety business and products for financial institutions and lower than expected claim severity in the fidelity business and run-off collateral value insurance (all within the Specialty financial sub-segment).

Net adverse reserve 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 reserve 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 (all within the Specialty financial sub-segment).

Net favorable reserve 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.

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 decisions to stop writing new policies in January 2010 and to sell substantially all of its run-off long-term care insurance business in December 2015 (see Note B —“Acquisitions and Sale of Businesses”). Following the completion of this sale, AFG’s remaining long-term care insurance reserves were $34 million at December 31, 2015, net of reinsurance recoverables and excluding the impact of unrealized gains on securities. AFG’s remaining 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.

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 $41 million investment in FHLB capital stock at December 31, 2015, 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 2015, the FHLB advanced GALIC $345 million (included in annuity benefits accumulated), increasing the total amount advanced to $785 million at December 31, 2015. Interest rates under the various funding agreements on these advances range from 0.02% to 0.49% over LIBOR (average rate of 0.58% at December 31, 2015). While these advances must be repaid between 2016 and 2020, 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 $912 million (included in available for sale fixed maturity securities) at December 31, 2015. Interest credited on the funding agreements, which is included in annuity benefits, was $3 million in 2015 and $1 million in 2014 and 2013.

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
	2015		2014		2013		2015		2014
Property and casualty companies	$	408	$	318	$	332	$	2,488	$	2,286
Life insurance companies	399		349		294		1,721		1,714

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, 2015 and 2014, 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, 2015 or 2014.

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 2016 from its insurance subsidiaries without seeking regulatory clearance is $809 million. Additional amounts of dividends require regulatory approval.

AFG paid common stock dividends to shareholders totaling $178 million, $169 million and $161 million in 2015, 2014 and 2013, 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, 2015, 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.



	2015			2014			2013
Direct premiums written	$	5,713		$	5,387		$	4,744
Reinsurance assumed	119			90			61
Reinsurance ceded	(1,505		)	(1,457		)	(1,464		)
Net written premiums	$	4,327		$	4,020		$	3,341

Direct premiums earned	$	5,613		$	5,195		$	4,684
Reinsurance assumed	105			75			45
Reinsurance ceded	(1,494		)	(1,392		)	(1,525		)
Net earned premiums	$	4,224		$	3,878		$	3,204

Reinsurance recoveries	$	936		$	895		$	1,255

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 $119 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 $11.19 billion of its $14.67 billion in face amount of life insurance at December 31, 2015 compared to $12.70 billion of its $16.71 billion in face amount of life insurance at December 31, 2014. Life written premiums ceded were $40 million, $41 million and $44 million for 2015, 2014 and 2013, respectively. Reinsurance recoveries on ceded life policies were $50 million, $59 million and $58 million for 2015, 2014 and 2013, 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):



	2015		2014
Expected death and annuitization	$	214	$	213
Guaranteed withdrawal benefits	203		151
Accrued persistency and premium bonuses	11		14

Variable Annuities At December 31, 2015, 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 $27 million, compared to $23 million at December 31, 2014. Death benefits paid in excess of the variable annuity account balances were less than $1 million in each of the last three years.