Fair Value Measurements

9 Months Ended

Sep. 30, 2020

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”), certain 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. 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 are classified as Level 3.

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 investment professionals 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
September 30, 2020
Assets:
Available for sale (“AFS”) fixed maturities:
U.S. Government and government agencies	$	182	$	27	$	15	$	224
States, municipalities and political subdivisions	—		6,616		106		6,722
Foreign government	—		195		—		195
Residential MBS	—		2,959		178		3,137
Commercial MBS	—		846		10		856
Collateralized loan obligations	—		4,395		212		4,607
Other asset-backed securities	—		6,075		1,344		7,419
Corporate and other	24		23,528		1,481		25,033
Total AFS fixed maturities	206		44,641		3,346		48,193
Trading fixed maturities	—		92		—		92
Equity securities	1,090		72		444		1,606
Equity index call options	—		697		—		697
Assets of managed investment entities (“MIE”)	148		4,554		15		4,717
Variable annuity assets (separate accounts) (*)	—		603		—		603
Other assets — derivatives	—		114		—		114
Total assets accounted for at fair value	$	1,444	$	50,773	$	3,805	$	56,022
Liabilities:
Liabilities of managed investment entities	$	142	$	4,384	$	15	$	4,541
Derivatives in annuity benefits accumulated	—		—		3,657		3,657
Other liabilities — derivatives	—		9		—		9
Total liabilities accounted for at fair value	$	142	$	4,393	$	3,672	$	8,207

December 31, 2019
Assets:
Available for sale fixed maturities:
U.S. Government and government agencies	$	151	$	43	$	15	$	209
States, municipalities and political subdivisions	—		6,858		105		6,963
Foreign government	—		172		—		172
Residential MBS	—		2,987		173		3,160
Commercial MBS	—		892		35		927
Collateralized loan obligations	—		4,265		15		4,280
Other asset-backed securities	—		5,842		1,286		7,128
Corporate and other	29		21,879		1,758		23,666
Total AFS fixed maturities	180		42,938		3,387		46,505
Trading fixed maturities	2		111		—		113
Equity securities	1,433		67		437		1,937
Equity index call options	—		924		—		924
Assets of managed investment entities	213		4,506		17		4,736
Variable annuity assets (separate accounts) (*)	—		628		—		628
Other assets — derivatives	—		50		—		50
Total assets accounted for at fair value	$	1,828	$	49,224	$	3,841	$	54,893
Liabilities:
Liabilities of managed investment entities	$	206	$	4,349	$	16	$	4,571
Derivatives in annuity benefits accumulated	—		—		3,730		3,730
Other liabilities — derivatives	—		10		—		10
Total liabilities accounted for at fair value	$	206	$	4,359	$	3,746	$	8,311

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

Approximately 7% of the total assets carried at fair value at September 30, 2020, were Level 3 assets. Approximately 38% ($1.46 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 $1.74 billion at September 30, 2020. Of this amount, approximately $730 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 43 securities, the average spread used was 397 basis points over the reference treasury yield and the spreads ranged from 100 basis points to 1,253 basis points (approximately 80% of the spreads were between 200 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. Management believes that any justifiable changes in unobservable inputs used to determine internally developed fair values 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 $3.66 billion at September 30, 2020. 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

0.2% – 2.9% over the risk-free rate

Risk margin for uncertainty in cash flows

0.99% reduction in the discount rate

Surrenders

4% – 23% of indexed account value

Partial surrenders

2% – 11% of indexed account value

Annuitizations

0.1% – 1% of indexed account value

Deaths

1.8% – 13.2% of indexed account value

Budgeted option costs

2.2% – 2.8% 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 8% 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 third quarter and first nine months of 2020 and 2019 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
	Balance at June 30, 2020		Net earnings (loss)		Other comprehensive income (loss)		Purchases and issuances		Sales and settlements		Transfer into Level 3		Transfer out of Level 3		Balance at September 30, 2020
AFS fixed maturities:
U.S. government agency	$	15	$	1	$	(1)	$	—	$	—	$	—	$	—	$	15
State and municipal	107		—		—		—		(1)		—		—		106
Residential MBS	156		(4)		1		—		(6)		49		(18)		178
Commercial MBS	33		(1)		—		—		—		—		(22)		10
Collateralized loan obligations	207		(1)		6		—		—		—		—		212
Other asset-backed securities	1,328		(2)		13		39		(75)		77		(36)		1,344
Corporate and other	1,525		6		4		53		(77)		121		(151)		1,481
Total AFS fixed maturities	3,371		(1)		23		92		(159)		247		(227)		3,346
Equity securities	452		(10)		—		12		—		—		(10)		444
Assets of MIE	17		(2)		—		—		—		—		—		15
Total Level 3 assets	$	3,840	$	(13)	$	23	$	104	$	(159)	$	247	$	(237)	$	3,805

Embedded derivatives (a)	$	(3,675)	$	(5)	$	—	$	(56)	$	79	$	—	$	—	$	(3,657)
Total Level 3 liabilities (b)	$	(3,675)	$	(5)	$	—	$	(56)	$	79	$	—	$	—	$	(3,657)


			Total realized/unrealized gains (losses) included in
	Balance at June 30, 2019		Net earnings (loss)		Other comprehensive income (loss)		Purchases and issuances		Sales and settlements		Transfer into Level 3		Transfer out of Level 3		Balance at September 30, 2019
AFS fixed maturities:
U.S. government agency	$	8	$	—	$	—	$	—	$	—	$	—	$	—	$	8
State and municipal	82		—		2		—		—		18		—		102
Residential MBS	139		1		(1)		—		(4)		22		(1)		156
Commercial MBS	50		1		—		—		—		4		—		55
Collateralized loan obligations	50		(2)		1		8		—		—		—		57
Other asset-backed securities	367		—		1		49		(3)		—		—		414
Corporate and other	2,014		—		20		324		(81)		10		(1)		2,286
Total AFS fixed maturities	2,710		—		23		381		(88)		54		(2)		3,078
Equity securities	377		(7)		—		18		(2)		34		—		420
Assets of MIE	19		(1)		—		—		—		—		—		18
Total Level 3 assets	$	3,106	$	(8)	$	23	$	399	$	(90)	$	88	$	(2)	$	3,516

Embedded derivatives (a)	$	(3,541)	$	70	$	—	$	(63)	$	65	$	—	$	—	$	(3,469)
Total Level 3 liabilities (b)	$	(3,541)	$	70	$	—	$	(63)	$	65	$	—	$	—	$	(3,469)

(a)Total realized/unrealized gains (losses) included in net earnings for the embedded derivatives reflects a favorable adjustment related to the unlocking of actuarial assumptions of $240 million in the third quarter of 2020 compared to $181 million in the third quarter of 2019.

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


			Total realized/unrealized gains (losses) included in
	Balance at December 31, 2019		Net earnings (loss)		Other comprehensive income (loss)		Purchases and issuances		Sales and settlements		Transfer into Level 3		Transfer out of Level 3		Balance at September 30, 2020
AFS fixed maturities:
U.S. government agency	$	15	$	3	$	(3)	$	—	$	—	$	—	$	—	$	15
State and municipal	105		—		6		—		(3)		—		(2)		106
Residential MBS	173		1		(7)		—		(15)		51		(25)		178
Commercial MBS	35		—		—		—		(3)		—		(22)		10
Collateralized loan obligations	15		(11)		21		—		—		187		—		212
Other asset-backed securities	1,286		(16)		6		314		(278)		211		(179)		1,344
Corporate and other	1,758		4		24		220		(133)		130		(522)		1,481
Total AFS fixed maturities	3,387		(19)		47		534		(432)		579		(750)		3,346
Equity securities	437		(35)		—		35		—		17		(10)		444
Assets of MIE	17		(4)		—		—		—		2		—		15
Total Level 3 assets	$	3,841	$	(58)	$	47	$	569	$	(432)	$	598	$	(760)	$	3,805

Embedded derivatives (a)	$	(3,730)	$	41	$	—	$	(180)	$	212	$	—	$	—	$	(3,657)
Total Level 3 liabilities (b)	$	(3,730)	$	41	$	—	$	(180)	$	212	$	—	$	—	$	(3,657)


			Total realized/unrealized gains (losses) included in
	Balance at December 31, 2018		Net earnings (loss)		Other comprehensive income (loss)		Purchases and issuances		Sales and settlements		Transfer into Level 3		Transfer out of Level 3		Balance at September 30, 2019
AFS fixed maturities:
U.S. government agency	$	9	$	—	$	—	$	—	$	(1)	$	—	$	—	$	8
State and municipal	59		—		9		—		(2)		36		—		102
Residential MBS	197		10		(6)		—		(14)		24		(55)		156
Commercial MBS	56		3		—		—		(3)		4		(5)		55
Collateralized loan obligations	116		(5)		7		8		—		13		(82)		57
Other asset-backed securities	731		—		6		141		(135)		—		(329)		414
Corporate and other	1,996		2		71		985		(330)		12		(450)		2,286
Total AFS fixed maturities	3,164		10		87		1,134		(485)		89		(921)		3,078
Equity securities	336		(7)		—		38		(3)		56		—		420
Assets of MIE	21		(3)		—		—		—		—		—		18
Total Level 3 assets	$	3,521	$	—	$	87	$	1,172	$	(488)	$	145	$	(921)	$	3,516

Embedded derivatives (a)	$	(2,720)	$	(643)	$	—	$	(276)	$	170	$	—	$	—	$	(3,469)
Total Level 3 liabilities (b)	$	(2,720)	$	(643)	$	—	$	(276)	$	170	$	—	$	—	$	(3,469)

(a)Total realized/unrealized gains (losses) included in net earnings for the embedded derivatives reflects a favorable adjustment related to the unlocking of actuarial assumptions of $240 million in the first nine months of 2020 compared to $181 million in the first nine months of 2019.

(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
September 30, 2020
Financial assets:
Cash and cash equivalents	$	3,747	$	3,747	$	3,747	$	—	$	—
Mortgage loans	1,482		1,507		—		—		1,507
Policy loans	154		154		—		—		154
Total financial assets not accounted for at fair value	$	5,383	$	5,408	$	3,747	$	—	$	1,661
Financial liabilities:
Annuity benefits accumulated (*)	$	41,082	$	42,938	$	—	$	—	$	42,938
Long-term debt	2,108		2,397		—		2,394		3
Total financial liabilities not accounted for at fair value	$	43,190	$	45,335	$	—	$	2,394	$	42,941

December 31, 2019
Financial assets:
Cash and cash equivalents	$	2,314	$	2,314	$	2,314	$	—	$	—
Mortgage loans	1,329		1,346		—		—		1,346
Policy loans	164		164		—		—		164
Total financial assets not accounted for at fair value	$	3,807	$	3,824	$	2,314	$	—	$	1,510
Financial liabilities:
Annuity benefits accumulated (*)	$	40,159	$	40,182	$	—	$	—	$	40,182
Long-term debt	1,473		1,622		—		1,619		3
Total financial liabilities not accounted for at fair value	$	41,632	$	41,804	$	—	$	1,619	$	40,185

(*)Excludes $850 million and $247 million of life contingent annuities in the payout phase at September 30, 2020 and December 31, 2019, respectively.

- Definition

The entire disclosure for the fair value of financial instruments (as defined), including financial assets and financial liabilities (collectively, as defined), and the measurements of those instruments as well as disclosures related to the fair value of non-financial assets and liabilities. Such disclosures about the financial instruments, assets, and liabilities would include: (1) the fair value of the required items together with their carrying amounts (as appropriate); (2) for items for which it is not practicable to estimate fair value, disclosure would include: (a) information pertinent to estimating fair value (including, carrying amount, effective interest rate, and maturity, and (b) the reasons why it is not practicable to estimate fair value; (3) significant concentrations of credit risk including: (a) information about the activity, region, or economic characteristics identifying a concentration, (b) the maximum amount of loss the entity is exposed to based on the gross fair value of the related item, (c) policy for requiring collateral or other security and information as to accessing such collateral or security, and (d) the nature and brief description of such collateral or security; (4) quantitative information about market risks and how such risks are managed; (5) for items measured on both a recurring and nonrecurring basis information regarding the inputs used to develop the fair value measurement; and (6) for items presented in the financial statement for which fair value measurement is elected: (a) information necessary to understand the reasons for the election, (b) discussion of the effect of fair value changes on earnings, (c) a description of [similar groups] items for which the election is made and the relation thereof to the balance sheet, the aggregate carrying value of items included in the balance sheet that are not eligible for the election; (7) all other required (as defined) and desired information.

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