Derivatives

9 Months Ended

Sep. 30, 2020

Derivative Instruments and Hedging Activities Disclosure [Abstract]

As discussed under “Derivatives” in Note A — “Accounting Policies,” AFG uses derivatives in certain areas of its operations.

Derivatives That Do Not Qualify for Hedge Accounting The following derivatives that do not qualify for hedge accounting under GAAP are included in AFG’s Balance Sheet at fair value (in millions):


		September 30, 2020				December 31, 2019
Derivative	Balance Sheet Line	Asset		Liability		Asset		Liability
MBS with embedded derivatives	Fixed maturities	$	172	$	—	$	102	$	—
Public company warrants	Equity securities	—		—		—		—
Fixed-indexed and variable-indexed annuities (embedded derivative)	Annuity benefits accumulated	—		3,657		—		3,730
Equity index call options	Equity index call options	697		—		924		—
Equity index put options	Other liabilities	—		4		—		1
Reinsurance contracts (embedded derivative)	Other liabilities	—		4		—		4
		$	869	$	3,665	$	1,026	$	3,735

The MBS with embedded derivatives consist of primarily interest-only and principal-only MBS. AFG records the entire change in the fair value of these securities in earnings. These investments are part of AFG’s overall investment strategy and represent a small component of AFG’s overall investment portfolio.

Warrants to purchase shares of publicly traded companies, which represent a small component of AFG’s overall investment portfolio, are considered to be derivatives that are required to be carried at fair value through earnings.

AFG’s fixed-indexed and variable-indexed annuities provide policyholders with a crediting rate tied, in part, to the performance of an existing stock market or other financial index. AFG attempts to mitigate the risk in the index-based component of these products through the purchase and sale of call and put options on the appropriate index. AFG receives collateral from certain counterparties to support its purchased call option assets (net of collateral required under put option contracts with the same counterparties). This collateral ($342 million at September 30, 2020 and $577 million at December 31, 2019) is included in other assets in AFG’s Balance Sheet with an offsetting liability to return the collateral, which is included in other liabilities. AFG’s strategy is designed so that the net change in the fair value of the call option assets and put option liabilities will generally offset the economic change in the net liability from the index participation. Both the index-based component of the annuities (an embedded derivative) and the related call and put options are considered derivatives that must be adjusted for changes in fair value through earnings each period. The fair values of these derivatives are impacted by actual and expected stock market performance and interest rates as well as other factors. Fluctuations in certain of these factors, such as changes in interest rates and the performance of the stock market, are not economic in nature for the current reporting period, but rather impact the timing of reported results.

As discussed under “Reinsurance” in Note A, AFG has a reinsurance contract that is considered to contain an embedded derivative.

The following table summarizes the gains (losses) included in AFG’s Statement of Earnings for changes in the fair value of derivatives that do not qualify for hedge accounting for the third quarter and first nine months of 2020 and 2019 (in millions):


		Three months ended September 30,				Nine months ended September 30,
Derivative	Statement of Earnings Line	2020		2019		2020		2019
MBS with embedded derivatives	Realized gains (losses) on securities	$	(5)	$	3	$	2	$	15
Public company warrants	Realized gains (losses) on securities	—		(1)		—		(1)
Fixed-indexed and variable-indexed annuities (embedded derivative) (*)	Annuity benefits	(5)		70		41		(643)
Equity index call options	Annuity benefits	203		30		(42)		544
Equity index put options	Annuity benefits	2		—		1		1
Reinsurance contract (embedded derivative)	Net investment income	1		—		—		(2)
		$	196	$	102	$	2	$	(86)

(*)The change in fair value of the embedded derivative includes a favorable adjustment related to the unlocking of actuarial assumptions of $240 million in the third quarter of 2020 and $181 million in the third quarter of 2019.

Derivatives Designated and Qualifying as Cash Flow Hedges As of September 30, 2020, AFG has nine active interest rate swaps that are designated and qualify as highly effective cash flow hedges to mitigate interest rate risk related to certain floating-rate securities included in AFG’s portfolio of fixed maturity securities. The purpose of each of these swaps is to effectively convert a portion of AFG’s floating-rate fixed maturity securities to fixed rates by offsetting the variability in cash flows attributable to changes in short-term LIBOR.

Under the terms of the swaps, AFG receives fixed-rate interest payments in exchange for variable interest payments based on short-term LIBOR. The notional amounts of the interest rate swaps generally decline over each swap’s respective life (the swaps expire between December 2023 and June 2030) in anticipation of the expected decline in AFG’s portfolio of fixed maturity securities with floating interest rates based on short-term LIBOR. The total outstanding notional amount of AFG’s interest rate swaps was $1.65 billion at September 30, 2020 compared to $1.98 billion at December 31, 2019, reflecting the scheduled amortization discussed above, the termination of a swap with a total notional amount of $83 million in the first quarter of 2020, the termination of two swaps with a total notional amount of $166 million in the second quarter of 2020 and the expiration of a swap with a notional amount of $44 million in the second quarter of 2020. The fair value of the interest rate swaps in an asset position and included in other assets was $114 million at September 30, 2020 and $50 million at December 31, 2019. The fair value of the interest rate swaps in a liability position and included in other liabilities was zero at September 30, 2020 and $5 million at December 31, 2019. The net unrealized gain or loss on cash flow hedges is included in AOCI, net of DPAC and deferred taxes. Amounts reclassified from AOCI (before DPAC and taxes) to net investment income were income of $8 million in the third quarter of 2020 and losses of less than $1 million in the third quarter of 2019 and income of $31 million and losses of $1 million for the first nine months of 2020 and 2019, respectively. AFG had a $7 million liability to return collateral related to these swaps (included in other liabilities) at September 30, 2020 and a $20 million receivable for collateral posted related to these swaps (included in other assets) at December 31, 2019.