-----BEGIN PRIVACY-ENHANCED MESSAGE----- Proc-Type: 2001,MIC-CLEAR Originator-Name: webmaster@www.sec.gov Originator-Key-Asymmetric: MFgwCgYEVQgBAQICAf8DSgAwRwJAW2sNKK9AVtBzYZmr6aGjlWyK3XmZv3dTINen TWSM7vrzLADbmYQaionwg5sDW3P6oaM5D3tdezXMm7z1T+B+twIDAQAB MIC-Info: RSA-MD5,RSA, A4m59CLfh3/2GfoZviCBiLDP7i6KvDbH8ZeVsBZxAzYhehkMdGSJ8+TsvTaQ6rkN cZ10mm60+TssOnEoV308uw== 0000005016-98-000030.txt : 19981116 0000005016-98-000030.hdr.sgml : 19981116 ACCESSION NUMBER: 0000005016-98-000030 CONFORMED SUBMISSION TYPE: 10-Q PUBLIC DOCUMENT COUNT: 2 CONFORMED PERIOD OF REPORT: 19980930 FILED AS OF DATE: 19981113 FILER: COMPANY DATA: COMPANY CONFORMED NAME: AMERICAN FINANCIAL CORP CENTRAL INDEX KEY: 0000005016 STANDARD INDUSTRIAL CLASSIFICATION: FIRE, MARINE & CASUALTY INSURANCE [6331] IRS NUMBER: 310624874 STATE OF INCORPORATION: OH FISCAL YEAR END: 1231 FILING VALUES: FORM TYPE: 10-Q SEC ACT: SEC FILE NUMBER: 001-07361 FILM NUMBER: 98749291 BUSINESS ADDRESS: STREET 1: ONE E 4TH ST CITY: CINCINNATI STATE: OH ZIP: 45202 BUSINESS PHONE: 5135792121 10-Q 1 SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549 FORM 10-Q Quarterly Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934 For the Quarterly Period Ended Commission File September 30, 1998 No. 1-7361 AMERICAN FINANCIAL CORPORATION Incorporated under IRS Employer I.D. the Laws of Ohio No. 31-0624874 One East Fourth Street, Cincinnati, Ohio 45202 (513) 579-2121 Indicate by check mark whether the Registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months, and (2) has been subject to such filing requirements for the past 90 days. Yes X No ___ As of November 1, 1998, there were 10,593,000 shares of the Registrant's Common Stock outstanding, all of which were owned indirectly by American Financial Group, Inc. Page 1 of 21 AMERICAN FINANCIAL CORPORATION 10-Q PART I FINANCIAL INFORMATION AMERICAN FINANCIAL CORPORATION AND SUBSIDIARIES CONSOLIDATED BALANCE SHEET (Dollars In Thousands) September 30, December 31, 1998 1997 Assets: Cash and short-term investments $ 405,831 $ 231,227 Investments: Fixed maturities: Held to maturity - at amortized cost (market - $2,911,400 and $3,417,900) 2,764,137 3,326,996 Available for sale - at market (amortized cost - $7,462,670 and $7,225,736) 7,897,070 7,532,836 Other stocks - principally at market (cost - $196,868 and $153,322) 393,468 446,222 Investment in investee corporation 232,933 200,714 Policy loans 221,208 240,955 Real estate and other investments 268,657 280,235 Total investments 11,777,473 12,027,958 Recoverables from reinsurers and prepaid reinsurance premiums 1,161,686 998,743 Agents' balances and premiums receivable 754,855 691,005 Deferred acquisition costs 500,052 521,898 Other receivables 262,182 261,454 Assets held in separate accounts 84,890 300,491 Prepaid expenses, deferred charges and other assets 359,600 405,798 Cost in excess of net assets acquired 283,422 299,408 $15,589,991 $15,737,982 Liabilities and Capital: Unpaid losses and loss adjustment expenses $ 4,528,175 $ 4,225,336 Unearned premiums 1,294,259 1,328,910 Annuity benefits accumulated 5,424,690 5,528,111 Life, accident and health reserves 339,558 709,899 Payable to American Financial Group, Inc. 292,000 352,766 Other long-term debt: Holding companies 332,589 286,661 Subsidiaries 207,306 194,084 Liabilities related to separate accounts 84,890 300,491 Accounts payable, accrued expenses and other liabilities 980,005 908,622 Total liabilities 13,483,472 13,834,880 Minority interest 527,801 509,619 Shareholders' Equity: Preferred Stock - $72,154 liquidation value 72,154 72,154 Common Stock, no par value - 20,000,000 shares authorized - 10,593,000 shares outstanding 9,625 9,625 Capital surplus 948,740 936,154 Retained earnings 194,699 34,350 Net unrealized gain on marketable securities, net of deferred income taxes 353,500 341,200 Total shareholders' equity 1,578,718 1,393,483 $15,589,991 $15,737,982 2 AMERICAN FINANCIAL CORPORATION 10-Q AMERICAN FINANCIAL CORPORATION AND SUBSIDIARIES CONSOLIDATED STATEMENT OF EARNINGS (In Thousands, Except Per Share Data)
Three months ended Nine months ended September 30, September 30, 1998 1997 1998 1997 Income: Property and casualty insurance premiums $ 696,537 $ 739,858 $2,080,003 $2,102,001 Life, accident and health premiums 50,434 32,149 145,710 84,845 Investment income 223,322 218,626 672,760 645,961 Equity in net earnings (loss) of investee (5,518) (13,914) 26,396 18,094 Realized gains on sales of: Securities 14,302 29,682 28,890 35,693 Investee and subsidiaries 11,090 - 20,510 731 Other investments - - 6,843 - Other income 42,262 28,335 106,112 80,582 1,032,429 1,034,736 3,087,224 2,967,907 Costs and Expenses: Property and casualty insurance: Losses and loss adjustment expenses 513,537 545,915 1,577,440 1,510,426 Commissions and other underwriting expenses 201,777 208,975 586,409 586,580 Annuity benefits 64,514 72,868 204,735 212,305 Life, accident and health benefits 40,547 28,250 115,208 78,238 Interest charges on borrowed money 19,005 21,167 54,059 67,293 Minority interest expense 15,048 10,530 38,135 30,887 Other operating and general expenses 88,823 89,775 248,655 233,214 943,251 977,480 2,824,641 2,718,943 Earnings before income taxes and extraordinary items 89,178 57,256 262,583 248,964 Provision for income taxes 31,185 22,339 98,594 91,343 Earnings before extraordinary items 57,993 34,917 163,989 157,621 Extraordinary items - loss on prepayment of debt (33) (6,908) (754) (6,986) Net Earnings $ 57,960 $ 28,009 $ 163,235 $ 150,635
3 AMERICAN FINANCIAL CORPORATION 10-Q AMERICAN FINANCIAL CORPORATION AND SUBSIDIARIES CONSOLIDATED STATEMENT OF CHANGES IN SHAREHOLDERS' EQUITY (Dollars in Thousands)
Common Stock Unrealized Preferred and Capital Retained Gain on Comprehensive Stock Surplus Earnings Securities Income Balance at January 1, 1998 $72,154 $936,154 $ 34,350 $341,200 Net earnings - - 163,235 - $163,235 Dividends on Preferred Stock - - (2,886) - - Capital contribution from parent - 12,530 - - - Change in unrealized - - - 12,300 12,300 Other - 56 - - - Balance at September 30, 1998 $72,154 $948,740 $194,699 $353,500 $175,535 Balance at January 1, 1997 $162,760 $929,371 $ 1,364 $183,400 Net earnings - - 150,635 - $150,635 Dividends on Preferred Stock - - (12,773) - - Capital contribution from parent - 12,530 - - - Change in unrealized - - - 128,200 128,200 Other - (384) - - - Balance at September 30, 1997 $162,760 $941,517 $139,226 $311,600 $278,835
4 AMERICAN FINANCIAL CORPORATION 10-Q AMERICAN FINANCIAL CORPORATION AND SUBSIDIARIES CONSOLIDATED STATEMENT OF CASH FLOWS (In Thousands) Nine months ended September 30, 1998 1997 Operating Activities: Net earnings $ 163,235 $ 150,635 Adjustments: Extraordinary items 754 6,986 Depreciation and amortization 71,589 51,173 Annuity benefits 204,735 212,144 Equity in net earnings of investee (26,396) (18,094) Changes in reserves on assets 761 (102) Realized gains on investing activities (80,357) (36,102) Increase in reinsurance and other receivables (229,730) (216,226) Decrease (increase) in other assets (125,352) 66,962 Increase in insurance claims and reserves 293,264 188,305 Increase (decrease) in other liabilities 111,765 (104,382) Increase in minority interest 14,743 24,944 Dividends from investee 3,600 3,600 Other, net (12,783) (19,044) 389,828 310,799 Investing Activities: Purchases of and additional investments in: Fixed maturity investments (1,682,077) (1,816,550) Equity securities (54,971) (22,783) Subsidiaries (30,325) (4,900) Real estate, property and equipment (49,425) (35,396) Maturities and redemptions of fixed maturity investments 1,017,004 535,178 Sales of: Fixed maturity investments 544,722 935,942 Equity securities 19,119 85,677 Subsidiaries 164,589 2,500 Real estate, property and equipment 48,634 2,792 Cash and short-term investments of acquired (former) subsidiaries (19,646) (70) Increase in other investments (9,363) (4,448) (51,739) (322,058) Financing Activities: Fixed annuity receipts 358,659 369,731 Annuity surrenders, benefits and withdrawals (538,912) (439,818) Additional long-term borrowings 217,537 63,090 Reductions of long-term debt (159,383) (110,494) Borrowings from AFG - 44,100 Payments to AFG (52,500) (118,500) Capital contribution 14,000 14,000 Issuances of trust preferred securities - 149,353 Cash dividends paid (2,886) (12,773) (163,485) (41,311) Net Increase (Decrease) in Cash and Short-term Investments 174,604 (52,570) Cash and short-term investments at beginning of period 231,227 404,831 Cash and short-term investments at end of period $ 405,831 $ 352,261 5 AMERICAN FINANCIAL CORPORATION, INC. 10-Q NOTES TO CONSOLIDATED FINANCIAL STATEMENTS A. Accounting Policies Basis of Presentation The accompanying consolidated financial statements for American Financial Corporation ("AFC") and subsidiaries are unaudited; however, management believes that all adjustments (consisting only of normal recurring accruals unless otherwise disclosed herein) necessary for fair presentation have been made. The results of operations for interim periods are not necessarily indicative of results to be expected for the year. The financial statements have been prepared in accordance with the instructions to Form 10-Q and therefore do not include all information and footnotes necessary to be in conformity with generally accepted accounting principles. Certain reclassifications have been made to prior years to conform to the current year's presentation. All significant intercompany balances and transactions have been eliminated. All acquisitions have been treated as purchases. The results of operations of companies since their formation or acquisition are included in the consolidated financial statements. The preparation of the financial statements requires management to make estimates and assumptions that affect the amounts reported in the financial statements and accompanying notes. Changes in circumstances could cause actual results to differ materially from those estimates. AFC's Common Stock is owned by AFC Holding Company, a wholly- owned subsidiary of American Financial Group, Inc. ("AFG"). AFC's ownership of subsidiaries and significant affiliates was as follows: September 30, December 31, 1998 1997 1996 American Annuity Group, Inc. ("AAG") 82% 81% 81% American Financial Enterprises, Inc. ("AFEI")(*) 80% 80% 83% American Premier Underwriters, Inc.(*) 81% 81% 81% Chiquita Brands International, Inc. 37% 39% 43% (*) AFG owned the remaining 20% of AFEI and 19% of American Premier at September 30, 1998 and December 31, 1997. Investments Debt securities are classified as "held to maturity" and reported at amortized cost if AFC has the positive intent and ability to hold them to maturity. Debt and equity securities are classified as "available for sale" and reported at fair value with unrealized gains and losses reported as a separate component of shareholders' equity if the securities are not classified as held to maturity or bought and held principally for selling in the near term. Only in certain limited circumstances, such as significant issuer credit deterioration or if required by insurance or other regulators, may a company change its intent to hold a certain security to maturity without calling into question its intent to hold other debt securities to maturity in the future. Short-term investments are carried at cost; loans receivable are carried primarily at the aggregate unpaid balance. Premiums and discounts on mortgage-backed securities are amortized over their expected average lives using the interest method. Gains or losses on sales of securities are recognized at the time of disposition with the amount of gain or loss determined on the specific identification basis. When a decline in the value of a specific investment is considered to be other than temporary, a provision for impairment is charged to earnings and the carrying value of that investment is reduced. 6 AMERICAN FINANCIAL CORPORATION 10-Q NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED Investment in Investee Corporation Investments in securities of 20%- to 50%-owned companies are generally carried at cost, adjusted for AFC's proportionate share of their undistributed earnings or losses. Cost in Excess of Net Assets Acquired The excess of cost of subsidiaries and investees over AFC's equity in the underlying net assets ("goodwill") is being amortized over 40 years. Insurance As discussed under "Reinsurance" below, unpaid losses and loss adjustment expenses and unearned premiums have not been reduced for reinsurance recoverable. Reinsurance In the normal course of business, AFC'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 the agreements covering reinsurance ceded, AFC's insurance subsidiaries would remain liable. Amounts recoverable from reinsurers are estimated in a manner consistent with the claim liability associated with the reinsurance policies. AFC's insurance subsidiaries report as assets (a) the estimated reinsurance recoverable on unpaid losses, including an estimate for losses incurred but not reported, and (b) amounts paid to reinsurers applicable to the unexpired terms of policies in force. AFC's insurance subsidiaries also assume reinsurance from other companies. Income on reinsurance assumed is recognized based on reports received from ceding reinsurers. Deferred Acquisition Costs Policy acquisition costs (principally commissions, premium taxes and other underwriting expenses) related to the production of new business are deferred ("DPAC"). For the property and casualty companies, the deferral of acquisition costs is limited based upon their recoverability without any consideration for anticipated investment income. DPAC is charged against income ratably over the terms of the related policies. For the annuity companies, DPAC is amortized, with interest, in relation to the present value of expected gross profits on the policies. Unpaid Losses and Loss Adjustment Expenses The net liabilities stated for unpaid claims and for expenses of investigation and adjustment of unpaid claims are based upon (a) the accumulation of case estimates for losses reported prior to the close of the accounting period on the direct business written; (b) estimates received from ceding reinsurers and insurance pools and associations; (c) estimates of unreported losses based on past experience; (d) estimates based on experience of expenses for investigating and adjusting claims and (e) the current state of the law and coverage litigation. These liabilities are subject to the impact of changes in claim amounts and frequency and other factors. In spite of the variability inherent in such estimates, management believes that the liabilities for unpaid losses and loss adjustment expenses are adequate. Changes in estimates of the liabilities for losses and loss adjustment expenses are reflected in the Statement of Earnings in the period in which determined. Annuity Benefits Accumulated Annuity receipts and benefit payments are recorded as increases or decreases in "annuity benefits accumulated" rather than as revenue and expense. Increases in this liability for interest credited are charged to expense and decreases for surrender charges are credited to other income. Life, Accident and Health Reserves Liabilities for future policy benefits under traditional life, accident and health policies are computed using a net level premium method. Computations are based on anticipated 7 AMERICAN FINANCIAL CORPORATION 10-Q NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED investment yield, mortality, morbidity and surrenders and include provisions for unfavorable deviations. Reserves are modified as necessary to reflect actual experience and developing trends. Assets Held In and Liabilities Related to Separate Accounts Separate account assets and related liabilities represent variable annuity deposits and, in 1997, include deposits maintained by several banks under a previously offered tax- deferred annuity program which was sold as part of the Funeral Services division (see Note B). Premium Recognition Property and casualty premiums are earned over the terms of the policies on a pro rata basis. Unearned premiums represent that portion of premiums written which is applicable to the unexpired terms of policies in force. On reinsurance assumed from other insurance companies or written through various underwriting organizations, unearned premiums are based on reports received from such companies and organizations. For traditional life, accident and health products, premiums are recognized as revenue when legally collectible from policyholders. For interest-sensitive life and universal life products, premiums are recorded in a policyholder account which is reflected as a liability. Revenue is recognized as amounts are assessed against the policyholder account for mortality coverage and contract expenses. Policyholder Dividends Dividends payable to policyholders are included in "Accounts payable, accrued expenses and other liabilities" and represent estimates of amounts payable on participating policies which share in favorable underwriting results. The estimate is accrued during the period in which the related premium is earned. Changes in estimates are included in income in the period determined. Policyholder dividends do not become legal liabilities unless and until declared by the boards of directors of the insurance companies. Minority Interest For balance sheet purposes, minority interest represents the interests of noncontrolling shareholders in AFC subsidiaries, including preferred securities issued by trust subsidiaries of AAG, and the AFG direct ownership interest in American Premier Underwriters, Inc. ("American Premier" or "APU") and AFEI. For income statement purposes, minority interest expense represents those shareholders' interest in the earnings of AFC subsidiaries as well as accrued distributions on the trust preferred securities. Issuances of Stock by Subsidiaries and Investees Changes in AFC's equity in a subsidiary or an investee caused by issuances of the subsidiary's or investee's stock are accounted for as gains or losses where such issuance is not part of a broader reorganization. Income Taxes AFC and American Premier have each filed consolidated federal income tax returns which include all 80%- owned U.S. subsidiaries, except for certain life insurance subsidiaries and their subsidiaries. At the close of business on December 31, 1996, AFG contributed 81% of the common stock of American Premier to AFC. Accordingly, AFC and American Premier filed a consolidated return for 1997. Deferred income taxes are calculated using the liability method. Under this method, deferred income tax assets and liabilities are determined based on differences between financial reporting and tax bases and are measured using enacted tax rates. Deferred tax assets are recognized if it is more likely than not that a benefit will be realized. 8 AMERICAN FINANCIAL CORPORATION 10-Q NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED Benefit Plans AFC provides retirement benefits to qualified employees of participating companies through contributory and noncontributory defined contribution plans contained in AFC's Retirement and Savings Plan. Under the retirement portion of the plan, company contributions (approximately 6% of covered compensation in 1997) are invested primarily in securities of AFG and affiliates. Under the savings portion of the plan, AFC matches a specific portion of employee contributions. Contributions to benefit plans are charged against earnings in the year for which they are declared. AFC and many of its subsidiaries provide health care and life insurance benefits to eligible retirees. AFC also provides postemployment benefits to former or inactive employees (primarily those on disability) who were not deemed retired under other company plans. The projected future cost of providing these benefits is expensed over the period the employees earn such benefits. Start-up Costs Certain costs associated with introducing new products and distribution channels are deferred by AAG and are amortized on a straight-line basis over 5 years. See Management's Discussion and Analysis - "New Accounting Standards to be Implemented." Comprehensive Income Effective January 1, 1998, AFC implemented Statement of Financial Accounting Standards ("SFAS") No. 130, "Reporting Comprehensive Income." SFAS No. 130 uses the term "comprehensive income" to describe the total of net earnings plus other comprehensive income. For AFC, other comprehensive income represents the change in net unrealized gain on marketable securities net of deferred taxes and a reclassification adjustment for gains and losses included in net earnings. Implementation of this statement had no impact on net earnings or shareholders' equity. Prior periods have been restated to conform to the current presentation. Statement of Cash Flows For cash flow purposes, "investing activities" are defined as making and collecting loans and acquiring and disposing of debt or equity instruments and property and equipment. "Financing activities" include obtaining resources from owners and providing them with a return on their investments, borrowing money and repaying amounts borrowed. Annuity receipts, benefits and withdrawals are also reflected as financing activities. All other activities are considered "operating". Short-term investments having original maturities of three months or less when purchased are considered to be cash equivalents for purposes of the financial statements. 9 AMERICAN FINANCIAL CORPORATION 10-Q NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED B. Sale of Subsidiaries On September 30, 1998, AAG sold its Funeral Services division for approximately $165 million in cash. AFC realized a pretax gain of $21.6 million, before $2.7 million of minority interest, on this sale. In September 1998, AFC reached a definitive agreement to sell the majority of its Commercial lines division to Ohio Casualty Company for $300 million in cash plus warrants to purchase 3 million shares of Ohio Casualty common stock. The commercial lines being sold generated net written premiums of approximately $215 million and $235 million for the nine months ended September 30, 1998 and 1997, respectively, and $330 million for the year ended December 31, 1997. AFC expects to record a pretax gain in excess of $140 million on this transaction. Completion of the sale, which is expected to occur in the fourth quarter of 1998, is subject to certain conditions, including receipt of regulatory approval. C. Segments of Operations Following the sale of its Commercial lines division, AFC's property and casualty group will be engaged primarily in private passenger automobile and specialty insurance businesses. AFC's annuity and life business primarily sells tax-deferred annuities to employees of primary and secondary educational institutions and hospitals. In addition, AFC has owned significant portions of the voting equity securities of certain companies (investee corporation - see Note D). The Financial Accounting Standards Board issued SFAS No. 131, "Disclosures about Segments of an Enterprise and Related Information" which is required to be implemented by the end of 1998. The implementation of SFAS No. 131 will have no effect on AFC's earnings or its financial position. The following table (in thousands) shows AFC's revenues by significant business segment. The Personal group consists of the nonstandard auto group along with the preferred/standard private passenger auto and other personal insurance business, formerly included in the Commercial and Personal lines. The Specialty group now includes a highly diversified group of specialty business units (formerly, Specialty lines) plus the commercial business previously included in the Commercial and Personal lines. Nine months ended September 30, 1998 1997 Property and casualty insurance: Premiums earned: Personal $ 980,288 $1,017,976 Specialty 1,068,854 1,056,531 Other (a) 30,861 27,494 2,080,003 2,102,001 Investment and other income 376,684 340,608 2,456,687 2,442,609 Annuities and life (b) 584,834 466,046 Other 19,307 41,158 3,060,828 2,949,813 Equity in net earnings of investee 26,396 18,094 $3,087,224 $2,967,907 (a) Includes nonstandard auto group operations in the United Kingdom. (b) Represents primarily investment income. 10 AMERICAN FINANCIAL CORPORATION 10-Q NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED D. Investment in Investee Corporation Investment in investee corporation reflects AFC's ownership of 24 million shares of Chiquita common stock. The market value of this investment was $253 million and $391 million at September 30, 1998 and December 31, 1997, respectively. Chiquita is a leading international marketer, producer and distributor of bananas and other quality fresh and processed food products. Summarized financial information for Chiquita follows (in millions): Nine months ended September 30, 1998 1997 Net Sales $2,095 $1,834 Operating Income 157 134 Net Income 83 56 In November 1998, Chiquita reported that it had incurred significant damage to its operations in Honduras as a result of widespread flooding caused by Hurricane Mitch. Chiquita estimated that its asset write-offs and charges relating to Honduras for its fourth quarter will be in the $50 million range. E. Payable to American Financial Group In December 1997, AFC and APU entered into a ten-year reciprocal Master Credit Agreement with AFG and AFC's direct parent, AFC Holding Company, under which funds are made available to each other at one percent over LIBOR. At September 30, 1998 and December 31, 1997, AFC and APU had outstanding net borrowings due AFG and AFC Holding under the Master Credit Agreement of $292.0 million and $352.8 million (including accrued interest payable), respectively. F. Other Long-Term Debt The carrying value of long-term debt consisted of the following (in thousands): September 30, December 31, 1998 1997 Holding Companies: AFC notes payable to banks due December 2002 $ 95,000 $45,000 AFC 9-3/4% Debentures due April 2004 78,797 79,792 APU 9-3/4% Subordinated Notes due August 1999 89,738 92,127 APU 10-5/8% Subordinated Notes due April 2000 43,108 43,889 APU 10-7/8% Subordinated Notes due May 2011 17,544 17,586 Other 8,402 8,267 $332,589 $286,661 Subsidiaries: AAG 6-7/8% Senior Notes due June 2008 $100,000 $ - AAG notes payable to banks due in installments to December 2003 57,000 107,000 AAG 11-1/8% Senior Subordinated Notes - 24,080 Notes payable secured by real estate 37,744 49,525 Other 12,562 13,479 $207,306 $194,084 11 AMERICAN FINANCIAL CORPORATION 10-Q NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED At September 30, 1998, sinking fund and other scheduled principal payments on debt for the balance of 1998 and the subsequent five years were as follows (in thousands): Holding Companies Subsidiaries Total 1998 $ - $ 472 $ 472 1999 89,030 1,962 90,992 2000 42,042 8,666 50,708 2001 - 1,381 1,381 2002 100,502 1,266 101,768 2003 - 58,294 58,294 Debentures purchased in excess of scheduled payments may be applied to satisfy any sinking fund requirement. The scheduled principal payments shown above assume that debentures previously purchased are applied to the earliest scheduled retirements. In February 1998, AFC entered into a new unsecured credit agreement with a group of banks under which AFC can borrow up to $300 million through December 2002. Borrowings bear interest at floating rates based on prime or Eurodollar rates. In January 1998, AAG replaced its existing bank lines with a new $200 million unsecured credit agreement. Loans under the credit agreement mature from 2000 to 2003 and bear interest at floating rates based on prime or Eurodollar rates. In February 1998, AAG borrowed $50 million under the line and retired its 11-1/8% Notes (including $24.3 million principal amount held by AAG and its subsidiaries). In June 1998, AAG sold $100 million principal amount of 6-7/8% Senior Notes due 2008 to the public and used the net proceeds to reduce outstanding indebtedness under the credit agreement. G. Minority Interest Minority interest in AFC's balance sheet is comprised of the following (in thousands): September 30, December 31, 1998 1997 Interest of AFG (parent) and of noncontrolling shareholders in subsidiaries' common stock $302,801 $284,619 Preferred securities issued by subsidiary trusts 225,000 225,000 $527,801 $509,619 Trust Issued Preferred Securities Wholly-owned subsidiary trusts of AAG have issued $225 million of preferred securities and, in turn, purchased $225 million of newly authorized AAG subordinated debt issues which provide interest and principal payments to fund the respective trusts' obligations. The preferred securities are mandatorily redeemable upon maturity or redemption of the subordinated debt. The preferred securities are summarized as follows: Date of Optional Issuance Issuance (Maturity Date) Amount Redemption Dates November 1996 9-1/4% TOPrS (2026) $75,000,000 On or after 11/7/2001 March 1997 8-7/8% Pfd (2027) 75,000,000 On or after 3/1/2007 May 1997 7-1/4% ROPES (2041) 75,000,000 Prior to 9/28/2000 and after 9/28/2001 AAG effectively provides unconditional guarantees of its trusts' obligations. 12 AMERICAN FINANCIAL CORPORATION 10-Q NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED Minority Interest Expense Minority interest expense is comprised of (in thousands): Nine months ended September 30, 1998 1997 Interest of AFG (parent) and noncontrolling shareholders in earnings of subsidiaries $23,861 $20,417 Accrued distributions on trust issued preferred securities 14,274 10,470 $38,135 $30,887 H. Preferred Stock Under provisions of both the Nonvoting (4.0 million shares authorized) and Voting (4.0 million shares authorized) Cumulative Preferred Stock, the Board of Directors may divide the authorized stock into series and set specific terms and conditions of each series. AFC's Preferred Stock consisted of the following: Series J, no par value; $25.00 liquidating value per share; annual dividends per share $2.00; redeemable at $25.75 per share beginning December 2005 declining to $25.00 at December 2007; 2,886,161 shares (stated value $72.2 million) outstanding at September 30, 1998 and December 31, 1997. I. Unrealized Gain on Marketable Securities The change in net unrealized gain on marketable securities for the nine months ended September 30 included the following (in millions):
Minority Pretax Taxes Interest Net 1998 Unrealized holding gains (losses) on securities arising during the period $67.2 ($22.0) ($8.1) $37.1 Less reclassification adjustment for realized gains included in net income and unrealized gains of subsidiaries sold (45.1) 15.8 4.5 (24.8) Change in net unrealized gain on marketable securities $22.1 ($ 6.2) ($3.6) $12.3 1997 Unrealized holding gains (losses) on securities arising during the period $254.0 ($89.0) ($15.6) $149.4 Less reclassification adjustment for realized gains included in net income (36.1) 12.6 2.3 (21.2) Change in net unrealized gain on marketable securities $217.9 ($76.4) ($13.3) $128.2
J. Extraordinary Items Extraordinary items represent AFC's proportionate share of losses related to debt retirements by the following companies. Amounts shown are net of minority interest and income tax benefits (in thousands): Nine months ended September 30, 1998 1997 Holding Companies: AFC (parent) ($ 51) ($5,357) APU (parent) (54) (379) Subsidiaries: AAG (649) (1,250) ($ 754) ($6,986) 13 AMERICAN FINANCIAL CORPORATION 10-Q NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED K. Cash Flows - Fixed Maturity Investments "Investing activities" related to fixed maturity investments in AFC's Statement of Cash Flows consisted of the following (in thousands): Held to Available Maturity For Sale Total 1998 Purchases 826 1,681,251 1,682,077 Maturities and redemptions 478,711 538,293 1,017,004 Sales 37,903(*) 506,819 544,722 1997 Purchases $ 3,759 $1,812,791 $1,816,550 Maturities and redemptions 268,432 266,746 535,178 Sales - 935,942 935,942 (*) Sold (at a gain of $.7 million) due to significant deterioration in the issuers' creditworthiness. L. Commitments and Contingencies Other than as disclosed in "Legal Proceedings" in Part II of AFC's June 30, 1998 Form 10- Q, there have been no significant changes to the matters discussed and referred to in Note O "Commitments and Contingencies" in AFC's Annual Report on Form 10-K for 1997. 14 AMERICAN FINANCIAL CORPORATION 10-Q ITEM 2 Management's Discussion and Analysis of Financial Condition and Results of Operations GENERAL AFC and American Premier are organized as holding companies with almost all of their operations being conducted by subsidiaries. These parent corporations, however, have continuing cash needs for administrative expenses, the payment of principal and interest on borrowings and shareholder dividends. Therefore, certain analyses are best done on a parent only basis while others are best done on a total enterprise basis. In addition, since most of its businesses are financial in nature, AFC does not prepare its consolidated financial statements using a current-noncurrent format. Consequently, certain traditional ratios and financial analysis tests are not meaningful. Year 2000 Status AFC's Year 2000 Project is a corporate-wide program designed to ensure that its computer systems will function properly in the year 2000. The Project also encompasses communicating with agents, vendors, financial institutions and others with which the companies conduct business to determine their Year 2000 readiness and resulting effects on AFC. AFC's Year 2000 Project is being coordinated by its Year 2000 Project Office which monitors the work being performed by the various business units and reports monthly to the Audit Committee of the Board of Directors and more frequently to senior management. To address the Year 2000 problem, AFC's operations have been divided into separate systems groups. At September 30, 1998, these groups were in the process of either (i) modifying their software programs or (ii) replacing programs with new software that is Year 2000 compliant. Nearly three-fourths of the groups are "on target" to meet AFC's goal of having program modifications and new software installations substantially completed by the end of 1998, with testing continuing in and through 1999. About one-fourth of the groups are being "closely watched" because there is some risk that critical dates in the project schedule may be missed with a potential for some disruption of normal business operations. One group is considered "critical" at this time since it has significantly missed internal project deadlines. This project has recently been reorganized and staffing levels have been increased. The project is being closely monitored and will be reviewed to determine if it can be upgraded to the "closely watched" category during the fourth quarter of 1998. Contingency plans have been developed for certain systems deemed most critical to operations. These plans provide a documented order of actions necessary to keep the business functions operating for these systems. Such plans typically include procedures and workflow processes for developing contingent databases. Contingency planning for other systems deemed critical to operations and reasonably likely not to be modified on schedule will begin in the fourth quarter of 1998 and be completed by mid- 1999. Many of the systems being replaced were planned replacements which were merely accelerated due to the Year 2000 problem. In addition, a significant portion of AFC's Year 2000 Project is being completed using internal staff. Therefore, cost estimates for the Year 2000 Project do not entirely represent incremental costs. From inception in the early 1990s through September 30, 1998, AFC has incurred approximately $32 million in Year 2000 costs, including capitalized costs of $7 million for new systems. During the first nine months of 1998, $17 million in Year 2000 costs have been expensed. AFC estimates that it will incur an additional $30 million of such costs in completing the Project. 15 AMERICAN FINANCIAL CORPORATION 10-Q Management's Discussion and Analysis of Financial Condition and Results of Operations - Continued Projected Year 2000 costs and completion dates are based on management's best estimates. However, there can be no assurance that these estimates will be achieved. Should software modifications and new software installations not be completed on a timely basis, the resulting disruptions could have a material adverse affect on operations. AFC's operations could also be affected by the inability of third parties such as agents and vendors to become Year 2000 compliant. In addition, AFC's property and casualty insurance subsidiaries are reviewing the potential impact of the Year 2000 issue on insureds as part of their underwriting process. They are also reviewing policy forms, issuing clarifying endorsements where appropriate and examining coverage issues for Year 2000 exposures. While it is possible that Year 2000 claims may emerge in future periods, it is not possible to estimate any such amounts. A&E Reserves Under the agreement to sell a majority of its Commercial lines division, AFC will retain liabilities for certain asbestos and environmental exposures ("A&E") relating to claims under policies written prior to the mid-1980's. AFC's insurance subsidiaries are in the process of reviewing their A&E reserves and expect this review to be completed before the end of this year. While its A&E reserves at September 30, 1998, were about $350 million, approximately 10 times the preceding three years' average claim payments, AFC expects that the review could indicate estimated ultimate aggregate losses as much as two-thirds greater than that amount. Any additional A&E reserves estimated to be required will be recorded as a special charge upon completion of the review. Forward-Looking Statements The Private Securities Litigation Reform Act of 1995 encourages corporations to provide investors with information about the company's anticipated performance and provides protection from liability if future results are not the same as management's expectations. This document contains certain forward-looking statements that are based on assumptions which management believes are reasonable, but by their nature, inherently uncertain. Future results could differ materially from those projected. Factors that could cause such differences include, but are not limited to: changes in economic conditions, regulatory actions, level of catastrophe losses, the Year 2000 issue and competitive pressures. AFC undertakes no obligation to update any forward-looking statements. LIQUIDITY AND CAPITAL RESOURCES Ratios AFC's debt to total capital ratio (at the parent holding company level and excluding amounts due AFG) was approximately 17% at September 30, 1998 and December 31, 1997. Including amounts due AFG, the ratio was 28% at September 30, 1998 and 31% at December 31, 1997. AFC's ratio of earnings to fixed charges, excluding and including preferred dividends, on a total enterprise basis are shown below. Nine months Year Ended Ended September 30, December 31, 1998 1997 Earnings to fixed charges 4.43 4.20 Earnings to fixed charges plus preferred dividends 4.06 3.52 16 AMERICAN FINANCIAL CORPORATION 10-Q Management's Discussion and Analysis of Financial Condition and Results of Operations - Continued Sources of Funds Management believes the parent holding companies have sufficient resources to meet their liquidity requirements through operations in the short-term and long-term future. If funds generated from operations, including dividends and tax payments from subsidiaries, are insufficient to meet fixed charges in any period, these companies would be required to generate cash through borrowings, sales of securities or other assets, or similar transactions. AFC participates in a reciprocal Master Credit Agreement among the various AFG holding companies under which funds are made available to each other for general corporate purposes. Amounts due AFG under the Master Credit Agreement were $292 million at September 30, 1998 and $345 million at December 31, 1997. A new five-year, $300 million bank credit line was established by AFC in February 1998, replacing two subsidiary holding company lines. The new credit line provides ample liquidity and can be used to obtain funds for operating subsidiaries or, if necessary, for the parent companies. At September 30, 1998, there was $95 million borrowed under the credit line. Dividend payments from subsidiaries have been very important to the liquidity and cash flow of the individual holding companies in the past. However, the reliance on such dividend payments has been lessened by the combination of (i) strong capital at AFC's insurance subsidiaries (and the related decreased likelihood of a need for investment in those companies), (ii) the reduction of debt at the holding companies from historical levels (and the related decrease in ongoing cash needs for interest and principal payments), (iii) AFC's ability to obtain financing in capital markets, as well as (iv) the sales of non-core investments. Investments Approximately 91% of fixed maturities held by AFC were rated "investment grade" (credit rating of AAA to BBB) by nationally recognized rating agencies at September 30, 1998. Investment grade securities generally bear lower yields and lower degrees of risk than those that are unrated and non-investment grade. Management believes that the high quality investment portfolio should generate a stable and predictable investment return. AFC's equity securities are concentrated in a relatively limited number of major positions. This approach allows management to more closely monitor the companies and the industries in which they operate. RESULTS OF OPERATIONS General Pretax earnings before extraordinary items for the three months ended September 30, 1998 were $89.2 million compared to $57.3 million for the third quarter of 1997. The earnings improvement for the 1998 quarter reflects an increase in investment income and income from the sale of lease residuals and real estate properties, a decrease in investee losses and the absence of certain costs and expenses included in the 1997 period. Pretax earnings before extraordinary items for the nine months ended September 30, 1998 were $262.6 million compared to $249.0 million for the first nine months of 1997. The earnings reflect higher realized gains in addition to those items mentioned above related to the third quarter, partially offset by a deterioration in underwriting results in the property and casualty operations due primarily to severe storms in the midwestern part of the country during the 1998 second quarter and a continuation of the adverse claims environment in the California workers' compensation business. 17 AMERICAN FINANCIAL CORPORATION 10-Q Management's Discussion and Analysis of Financial Condition and Results of Operations - Continued Property and Casualty Insurance - Underwriting Following the sale of its Commercial lines division as described in Note B, which is expected to be completed in the fourth quarter of 1998, AFC's property and casualty group will be engaged primarily in private passenger automobile and specialty insurance businesses. Accordingly, AFC has realigned its property and casualty group into two major business groups: Personal and Specialty. The Personal group consists of the nonstandard auto group along with the preferred/standard private passenger auto and other personal insurance business, formerly included in the Commercial and Personal lines. The nonstandard automobile insurance companies insure risks not typically accepted for standard automobile coverage because of the applicant's driving record, type of vehicle, age or other criteria. The Specialty group includes a highly diversified group of business lines (formerly, Specialty lines) plus the commercial business previously included in the Commercial and Personal lines. Some of the more significant areas are executive liability, inland and ocean marine, U.S.-based operations of Japanese companies, agricultural-related coverages, California workers' compensation, non-profit liability, general aviation coverages, fidelity and surety bonds, and umbrella and excess coverages. Commercial lines businesses to be sold include certain coverages in workers' compensation, commercial multi-peril, umbrella, and commercial automobile. Underwriting profitability is measured by the combined ratio which is a sum of the ratios of underwriting losses, loss adjustment expenses, underwriting expenses and policyholder dividends to premiums. When the combined ratio is under 100%, underwriting results are generally considered profitable; when the ratio is over 100%, underwriting results are generally considered unprofitable. The combined ratio does not reflect investment income, other income or federal income taxes. For certain lines of business and products where the credibility of the range of loss projections is less certain (primarily the various specialty lines listed above), management believes that it is prudent and appropriate to use conservative assumptions until such time as the data, experience and projections have more credibility, as evidenced by data volume, consistency and maturity of the data. While this practice mitigates the risk of adverse development on this business, it does not eliminate it. Net written premiums and combined ratios for AFC's property and casualty insurance subsidiaries were as follows (dollars in millions): Three months ended Nine months ended September 30, September 30, 1998 1997 1998 1997 Net Written Premiums (GAAP) Personal $314.3 $329.0 $ 998.0 $1,030.6 Specialty 357.9 397.7 1,039.6 1,090.8 Other 2.1 13.6 17.7 29.4 $674.3 $740.3 $2,055.3 $2,150.8 Combined Ratios (GAAP) Personal 97.3% 98.5% 96.9% 99.1% Specialty 106.0 103.9 107.5 96.5 Aggregate (including other) 102.8 102.0 104.1 99.8 Personal The Personal group's net written premiums decreased 4% in the third quarter and 3% in the first nine months of the year compared to the same 1997 periods. The decline is due primarily to stronger price competition in the personal automobile market. 18 AMERICAN FINANCIAL CORPORATION 10-Q Management's Discussion and Analysis of Financial Condition and Results of Operations - Continued Specialty The Specialty group's net written premiums decreased $39.8 million (10%) during the third quarter from the comparable 1997 period due primarily to the initial impact of a reinsurance agreement whereby approximately 30% of AFC's California workers' compensation premiums are being ceded. Also, the Specialty group's writings continue to be affected by intense price competition in the commercial casualty markets. Underwriting results for the third quarter of 1998 continue to be affected by the adverse claims environment in the California workers' compensation business and weak results in the general aviation business. Net written premiums for the first nine months of 1998 decreased $51.2 million (5%) from 1997 due to the workers' compensation reinsurance agreement mentioned above and a decline in commercial multi-peril due to price competition. Underwriting results for the first nine months of 1998 worsened from the comparable periods in 1997 due to (i) losses from the midwestern storms in the second quarter of 1998, (ii) the continuation of the adverse claims environment in the California workers' compensation business, (iii) weak results in the general aviation business and (iv) unusually good results in 1997 in certain other lines. Life, Accident and Health Premiums and Benefits The increase in life, accident and health premiums and benefits reflects primarily AAG's acquisition of GA Life Assurance Company in December 1997 and increased sales of pre-need life insurance. Investment Income Investment income increased $4.7 million (2%) for the third quarter of 1998 and $26.8 million (4%) for the first nine months of 1998 compared to 1997 due primarily to an increase in the average amount of investments held partially offset by decreasing market interest rates. Investee Corporations Equity in net earnings of investee corporations represents AFC's proportionate share of Chiquita's earnings. Chiquita reported net income (losses) for the third quarter and first nine months of 1998 of ($11 million) and $83 million, respectively, compared to ($28 million) and $56 million for the same periods in 1997. Realized Gains Realized capital gains have been an important part of the return on investments in marketable securities. Individual securities are sold creating gains and losses as market opportunities exist. Gain on Sale of Investee and Subsidiaries Investee Chiquita's public issuance of shares of its common stock in the first and second quarters of 1998 resulted in pretax gains to AFC of $7.7 million and $1.7 million in those periods. Subsidiaries In the third quarter of 1998, AFC recorded a pretax gain of $21.6 million on AAG's sale of its Funeral Services Division and a charge of $10.5 million relating to operations expected to be sold or otherwise disposed of. Other Income Other income increased $13.9 million (49%) during the third quarter and $25.5 million (32%) in the first nine months of 1998 due primarily to income from the sale of operating real estate assets and lease residuals. 19 AMERICAN FINANCIAL CORPORATION 10-Q Management's Discussion and Analysis of Financial Condition and Results of Operations - Continued Annuity Benefits Annuity benefits reflect interest credited to annuity policyholders' funds accumulated. The majority of AAG's fixed rate annuity products permit AAG to change the crediting rate at any time (subject to minimum interest rate guarantees of 3% or 4% per annum). As a result, management has been able to react to changes in market interest rates and maintain a desired interest rate spread. While management believes the recent interest rate environment has contributed to an increase in annuitizations and surrenders, AAG's persistency rate remains over 87%. A continuation of the current interest rate environment could adversely affect this rate. Interest on Borrowed Money Interest expense decreased $2.2 million (10%) during the third quarter and $13.2 million (20%) during the first nine months of 1998. The decrease reflects a decrease in average amounts borrowed and a decrease in average rates. Minority Interest Expense Minority interest expense increased $4.5 million (43%) during the third quarter and $7.2 million (23%) during the first nine months of 1998. Dividends paid by subsidiaries on their trust issued preferred securities have varied as the securities were issued over the past few years. New Accounting Standard to be Implemented Statement of Position 98- 5, "Reporting on the Costs of Start-Up Activities," was issued during the second quarter of 1998. The SOP is effective for fiscal years beginning after December 15, 1998, and requires that costs of start-up activities be expensed as incurred. The SOP requires that unamortized balances of previously deferred costs be expensed no later than the first quarter of 1999 and reported as the cumulative effect of a change in accounting principle. AAG had approximately $8 million in capitalized start-up costs at September 30, 1998. In June 1998, the Financial Accounting Standards Board issued SFAS No. 133, "Accounting for Derivative Instruments and Hedging Activities," which is required to be implemented for fiscal years beginning after June 15, 1999. Management does not anticipate that implementation of the new statement will have a significant effect on AFC's earnings or its financial position. 20 AMERICAN FINANCIAL CORPORATION 10-Q PART II OTHER INFORMATION Item 6 Exhibits and Reports on Form 8-K (a) Exhibit 27 - Financial Data Schedule as of September 30, 1998. For submission in electronic filing only. (b) Reports on Form 8-K: Date of Report Item Reported September 21, 1998 Agreement to sell Commercial Lines Division Signature Pursuant to the requirements of the Securities Exchange Act of 1934, American Financial Corporation has duly caused this Report to be signed on its behalf by the undersigned duly authorized. American Financial Corporation November 12, 1998 BY:Fred J. Runk Fred J. Runk Senior Vice President and Treasurer 21 EX-27 2
5 This schedule conatins summary financial information extracted from the American Financial Corporation 10-Q for the nine months ended Sepbember 30, 1998 and is qualified in its entirety by reference to such financial statements. 9-MOS DEC-31-1998 SEP-30-1998 $405,831 11,287,608 754,855 0 0 0 0 0 15,589,991 0 539,895 0 72,154 9,625 1,569,093 15,589,991 0 3,087,224 0 0 248,655 0 54,059 262,583 98,594 163,989 0 (754) 0 $163,235 0 0 Included an investment in investee of $233 million. Not applicable since all common shares are owned by American Financial Group, Inc.
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