Fair Value Measurements

6 Months Ended

Jun. 30, 2019

Fair Value Disclosures [Abstract]

Fair Value Measurements

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, 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, asset-backed securities (“ABS”), mortgage-backed securities (“MBS”), non-affiliated common stocks, equity index options 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 or when the market for a security exhibits significantly less liquidity relative to markets supporting Level 2 fair value measurements. The unobservable inputs may include management’s own assumptions about the assumptions market participants would use based on the best information available at the valuation date. AFG’s Level 3 is comprised of financial instruments 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.

As discussed in Note A — “Accounting Policies — Managed Investment Entities,” AFG has set the carrying value of its CLO liabilities equal to the fair value of the CLO assets (which have more observable fair values) as an alternative to reporting those liabilities at separately measured fair values. As a result, the CLO liabilities are categorized within the fair value hierarchy on the same basis (proportionally) as the related CLO assets. Since the portion of the CLO liabilities allocated to Level 3 is derived from the fair value of the CLO assets, these amounts are excluded from the progression of Level 3 financial instruments.

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. AFG’s internal investment professionals are a group of approximately 20 analysts whose primary responsibility is to manage AFG’s investment portfolio. These professionals monitor individual investments as well as overall industries and are active in the financial markets on a daily basis. The group is led by AFG’s chief investment officer, who reports directly to one of AFG’s Co-CEOs. 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. In addition, the Company communicates directly with the pricing services regarding the methods and assumptions used in pricing, including verifying, on a test basis, the inputs used by the service to value specific securities.

Assets and liabilities measured and carried at fair value in the financial statements are summarized below (in millions): 

	Level 1		Level 2		Level 3		Total
June 30, 2019
Assets:
Available for sale (“AFS”) fixed maturities:
U.S. Government and government agencies	$	143	$	77	$	8	$	228
States, municipalities and political subdivisions	—		6,914		82		6,996
Foreign government	—		149		—		149
Residential MBS	—		2,528		139		2,667
Commercial MBS	—		924		50		974
Collateralized loan obligations	—		4,283		50		4,333
Other asset-backed securities	—		5,577		367		5,944
Corporate and other	29		21,376		2,014		23,419
Total AFS fixed maturities	172		41,828		2,710		44,710
Trading fixed maturities	4		102		—		106
Equity securities	1,532		76		377		1,985
Equity index call options	—		712		—		712
Assets of managed investment entities (“MIE”)	225		4,537		19		4,781
Variable annuity assets (separate accounts) (*)	—		616		—		616
Other assets — derivatives	—		54		—		54
Total assets accounted for at fair value	$	1,933	$	47,925	$	3,106	$	52,964
Liabilities:
Liabilities of managed investment entities	$	216	$	4,356	$	18	$	4,590
Derivatives in annuity benefits accumulated	—		—		3,541		3,541
Other liabilities — derivatives	—		12		—		12
Total liabilities accounted for at fair value	$	216	$	4,368	$	3,559	$	8,143
December 31, 2018
Assets:
Available for sale fixed maturities:
U.S. Government and government agencies	$	141	$	83	$	9	$	233
States, municipalities and political subdivisions	—		6,880		59		6,939
Foreign government	—		142		—		142
Residential MBS	—		2,547		197		2,744
Commercial MBS	—		864		56		920
Collateralized loan obligations	—		4,162		116		4,278
Other asset-backed securities	—		4,802		731		5,533
Corporate and other	28		19,184		1,996		21,208
Total AFS fixed maturities	169		38,664		3,164		41,997
Trading fixed maturities	9		96		—		105
Equity securities	1,410		68		336		1,814
Equity index call options	—		184		—		184
Assets of managed investment entities	203		4,476		21		4,700
Variable annuity assets (separate accounts) (*)	—		557		—		557
Other assets — derivatives	—		16		—		16
Total assets accounted for at fair value	$	1,791	$	44,061	$	3,521	$	49,373
Liabilities:
Liabilities of managed investment entities	$	195	$	4,297	$	20	$	4,512
Derivatives in annuity benefits accumulated	—		—		2,720		2,720
Other liabilities — derivatives	—		49		—		49
Total liabilities accounted for at fair value	$	195	$	4,346	$	2,740	$	7,281

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

During the second quarter and first six months of 2019, there was one preferred stock with an aggregate fair value of $6 million that transferred from Level 1 to Level 2. During the second quarter and first six months of 2018, there were two preferred stocks with an aggregate fair value of $6 million that transferred from Level 1 to Level 2.

Approximately 6% of the total assets carried at fair value at June 30, 2019, were Level 3 assets. Approximately 55% ($1.71 billion) of the Level 3 assets were priced using non-binding broker quotes, for which there is a lack of transparency as to the inputs used to determine fair value. Details as to the quantitative inputs are neither provided by the brokers nor otherwise reasonably obtainable by AFG.

Internally developed Level 3 asset fair values represent approximately $1.19 billion at June 30, 2019. Of this amount, approximately $833 million relates to fixed maturity securities that were priced using management’s best estimate of an appropriate credit spread over the treasury yield (of a similar duration) to discount future expected cash flows using a third party model. The credit spread applied by management is the significant unobservable input. For this group of approximately 140 securities, the average spread used was 576 basis points over the reference treasury yield and the spreads ranged from 100 basis points to 2,966 basis points (approximately 80% of the spreads were between 400 and 700 basis points). Had management used higher spreads, the fair value of this group of securities would have been lower. Conversely, if the spreads used were lower, the fair values would have been higher. For the remainder of the internally developed prices, any justifiable changes in unobservable inputs used to determine fair value would not have resulted in a material change in AFG’s financial position.

The derivatives embedded in AFG’s fixed-indexed and variable-indexed annuity liabilities are measured using a discounted cash flow approach and had a fair value of $3.54 billion at June 30, 2019. The following table presents information about the unobservable inputs used by management in determining fair value of these Level 3 liabilities. See Note F — “Derivatives.”

Unobservable Input	Range
Adjustment for insurance subsidiary’s credit risk	less than 0.1% – 2.4% over the risk free rate
Risk margin for uncertainty in cash flows	0.73% reduction in the discount rate
Surrenders	4% – 23% of indexed account value
Partial surrenders	2% – 9% of indexed account value
Annuitizations	0.1% – 1% of indexed account value
Deaths	1.7% – 9.5% of indexed account value
Budgeted option costs	2.6% – 3.6% of indexed account value

The range of adjustments for insurance subsidiary’s credit risk is based on the Moody’s corporate A2 bond index and reflects credit spread variations across the yield curve. The range of projected surrender rates reflects the specific surrender charges and other features of AFG’s individual fixed-indexed and variable-indexed annuity products with an expected range of 7% to 11% in the majority of future calendar years (4% to 23% over all periods). Increasing the budgeted option cost or risk margin for uncertainty in cash flow assumptions in the table above would increase the fair value of the fixed-indexed and variable-indexed annuity embedded derivatives, while increasing any of the other unobservable inputs in the table above would decrease the fair value of the embedded derivatives.

Changes in balances of Level 3 financial assets and liabilities carried at fair value during the second quarter and first six months of 2019 and 2018 are presented below (in millions). The transfers into and out of Level 3 were due to changes in the availability of market observable inputs and $29 million of equity securities transferred into Level 3 in the first quarter of 2018 related to a small number of limited partnerships and similar investments carried at cost under the prior guidance that are carried at fair value through net earnings under new guidance adopted on January 1, 2018, as discussed in Note A — “Accounting Policies — Investments.” 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
	Balance at March 31, 2019			Net earnings			Other comprehensive income (loss)		Purchases and issuances			Sales and settlements			Transfer into Level 3		Transfer out of Level 3			Balance at June 30, 2019
AFS fixed maturities:
U.S. government agency	$	8		$	—		$	—	$	—		$	—		$	—	$	—		$	8
State and municipal	63			—			2		—			(1		)	18		—			82
Residential MBS	169			4			—		—			(4		)	2		(32		)	139
Commercial MBS	55			2			—		—			(2		)	—		(5		)	50
Collateralized loan obligations	37			—			—		—			—			13		—			50
Other asset-backed securities	633			—			3		17			(18		)	—		(268		)	367
Corporate and other	2,346			—			20		229			(161		)	2		(422		)	2,014
Total AFS fixed maturities	3,311			6			25		246			(186		)	35		(727		)	2,710
Equity securities	354			(1		)	—		19			(1		)	6		—			377
Assets of MIE	20			(1		)	—		—			—			—		—			19
Total Level 3 assets	$	3,685		$	4		$	25	$	265		$	(187	)	$	41	$	(727	)	$	3,106
Embedded derivatives	$	(3,247	)	$	(251	)	$	—	$	(101	)	$	58		$	—	$	—		$	(3,541	)
Total Level 3 liabilities (b)	$	(3,247	)	$	(251	)	$	—	$	(101	)	$	58		$	—	$	—		$	(3,541	)

				Total realized/unrealized gains (losses) included in
	Balance at March 31, 2018			Net earnings			Other comprehensive income (loss)			Purchases and issuances			Sales and settlements			Transfer into Level 3		Transfer out of Level 3			Balance at June 30, 2018
AFS fixed maturities:
U.S. government agency	$	8		$	—		$	—		$	—		$	—		$	—	$	—		$	8
State and municipal	62			—			(1		)	—			—			—		—			61
Residential MBS	115			(3		)	—			—			(5		)	50		(10		)	147
Commercial MBS	47			—			—			9			—			—		—			56
Collateralized loan obligations	181			—			(4		)	35			—			—		—			212
Other asset-backed securities	731			—			(2		)	101			(20		)	—		(18		)	792
Corporate and other	1,238			1			(4		)	234			(48		)	—		(13		)	1,408
Total AFS fixed maturities	2,382			(2		)	(11		)	379			(73		)	50		(41		)	2,684
Equity securities	194			19			—			16			—			1		—			230
Assets of MIE	24			(3		)	—			2			—			—		—			23
Total Level 3 assets	$	2,600		$	14		$	(11	)	$	397		$	(73	)	$	51	$	(41	)	$	2,937
Embedded derivatives (a)	$	(2,549	)	$	(126	)	$	—		$	(141	)	$	40		$	—	$	—		$	(2,776	)
Total Level 3 liabilities (b)	$	(2,549	)	$	(126	)	$	—		$	(141	)	$	40		$	—	$	—		$	(2,776	)

(a) Total realized/unrealized gains (losses) included in net earnings for the embedded derivatives reflects losses related to the unlocking of actuarial assumptions of $44 million in the second quarter of 2018.

(b) As previously discussed, these tables exclude the portion of MIE liabilities allocated to Level 3, which are derived from the fair value of the MIE assets.

				Total realized/unrealized gains (losses) included in
	Balance at December 31, 2018			Net earnings			Other comprehensive income (loss)			Purchases and issuances			Sales and settlements			Transfer into Level 3		Transfer out of Level 3			Balance at June 30, 2019
AFS fixed maturities:
U.S. government agency	$	9		$	—		$	—		$	—		$	(1	)	$	—	$	—		$	8
State and municipal	59			—			7			—			(2		)	18		—			82
Residential MBS	197			9			(5		)	—			(10		)	2		(54		)	139
Commercial MBS	56			2			—			—			(3		)	—		(5		)	50
Collateralized loan obligations	116			(3		)	6			—			—			13		(82		)	50
Other asset-backed securities	731			—			5			92			(132		)	—		(329		)	367
Corporate and other	1,996			2			51			661			(249		)	2		(449		)	2,014
Total AFS fixed maturities	3,164			10			64			753			(397		)	35		(919		)	2,710
Equity securities	336			—			—			20			(1		)	22		—			377
Assets of MIE	21			(2		)	—			—			—			—		—			19
Total Level 3 assets	$	3,521		$	8		$	64		$	773		$	(398	)	$	57	$	(919	)	$	3,106
Embedded derivatives	$	(2,720	)	$	(713	)	$	—		$	(213	)	$	105		$	—	$	—		$	(3,541	)
Total Level 3 liabilities (b)	$	(2,720	)	$	(713	)	$	—		$	(213	)	$	105		$	—	$	—		$	(3,541	)

				Total realized/unrealized gains (losses) included in
	Balance at December 31, 2017			Net earnings			Other comprehensive income (loss)			Purchases and issuances			Sales and settlements			Transfer into Level 3		Transfer out of Level 3			Balance at June 30, 2018
AFS fixed maturities:
U.S. government agency	$	8		$	—		$	—		$	—		$	—		$	—	$	—		$	8
State and municipal	148			—			(2		)	—			(1		)	—		(84		)	61
Residential MBS	122			(7		)	—			—			(11		)	57		(14		)	147
Commercial MBS	36			(1		)	—			21			—			—		—			56
Collateralized loan obligations	180			(2		)	(1		)	35			—			—		—			212
Other asset-backed securities	564			—			(2		)	305			(57		)	—		(18		)	792
Corporate and other	1,044			2			(18		)	472			(79		)	—		(13		)	1,408
Total AFS fixed maturities	2,102			(8		)	(23		)	833			(148		)	57		(129		)	2,684
Equity securities	165			14			—			25			(4		)	30		—			230
Assets of MIE	23			(5		)	—			5			—			—		—			23
Total Level 3 assets	$	2,290		$	1		$	(23	)	$	863		$	(152	)	$	87	$	(129	)	$	2,937
Embedded derivatives (a)	$	(2,542	)	$	(63	)	$	—		$	(244	)	$	73		$	—	$	—		$	(2,776	)
Total Level 3 liabilities (b)	$	(2,542	)	$	(63	)	$	—		$	(244	)	$	73		$	—	$	—		$	(2,776	)

(a) Total realized/unrealized gains (losses) included in net earnings for the embedded derivatives reflects losses related to the unlocking of actuarial assumptions of $44 million in the first six months of 2018.

(b) As previously discussed, these tables exclude the portion of MIE liabilities allocated to Level 3, which are derived from the fair value of the MIE assets.

Fair Value of Financial Instruments   The carrying value and fair value of financial instruments that are not carried at fair value in the financial statements are summarized below (in millions): 

	Carrying		Fair Value
	Value		Total		Level 1		Level 2		Level 3
June 30, 2019
Financial assets:
Cash and cash equivalents	$	2,374	$	2,374	$	2,374	$	—	$	—
Mortgage loans	1,073		1,080		—		—		1,080
Policy loans	170		170		—		—		170
Total financial assets not accounted for at fair value	$	3,617	$	3,624	$	2,374	$	—	$	1,250
Financial liabilities:
Annuity benefits accumulated (*)	$	38,806	$	38,634	$	—	$	—	$	38,634
Long-term debt	1,423		1,482		—		1,479		3
Total financial liabilities not accounted for at fair value	$	40,229	$	40,116	$	—	$	1,479	$	38,637
December 31, 2018
Financial assets:
Cash and cash equivalents	$	1,515	$	1,515	$	1,515	$	—	$	—
Mortgage loans	1,068		1,056		—		—		1,056
Policy loans	174		174		—		—		174
Total financial assets not accounted for at fair value	$	2,757	$	2,745	$	1,515	$	—	$	1,230
Financial liabilities:
Annuity benefits accumulated (*)	$	36,384	$	34,765	$	—	$	—	$	34,765
Long-term debt	1,302		1,231		—		1,228		3
Total financial liabilities not accounted for at fair value	$	37,686	$	35,996	$	—	$	1,228	$	34,768

(*) Excludes $238 million and $232 million of life contingent annuities in the payout phase at June 30, 2019 and December 31, 2018, respectively.

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.