-----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, AQ7n0NH+7XiwNN02hDNI/tW9GVhtuR1oO9zJ7pXSHCRONYUUNx5hscJTDQ1Nw/u8 Q5eLvOwbTPCDuTl0WIuS9A== 0000005016-99-000037.txt : 19991117 0000005016-99-000037.hdr.sgml : 19991117 ACCESSION NUMBER: 0000005016-99-000037 CONFORMED SUBMISSION TYPE: 10-Q PUBLIC DOCUMENT COUNT: 2 CONFORMED PERIOD OF REPORT: 19990930 FILED AS OF DATE: 19991115 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: 99751539 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, 1999 No. 1-7361 AMERICAN FINANCIAL CORPORATION Incorporated under IRS Employer I.D. the Laws of Ohio No. 31-1544320 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, 1999, there were 10,593,000 shares of the Registrant's Common Stock outstanding, all of which were owned 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, 1999 1998 Assets: Cash and short-term investments $ 311,061 $ 289,944 Investments: Fixed maturities - at market (amortized cost - $10,040,299 and $9,920,407) 9,952,899 10,323,407 Other stocks - at market (cost - $231,533 and $207,345) 427,733 430,345 Investment in investee corporation 191,179 192,138 Policy loans 217,205 220,496 Real estate and other investments 268,085 268,171 Total investments 11,057,101 11,434,557 Recoverables from reinsurers and prepaid reinsurance premiums 2,124,232 1,973,895 Agents' balances and premiums receivable 709,348 618,198 Deferred acquisition costs 563,537 464,047 Other receivables 214,727 318,154 Assets held in separate accounts 243,444 120,049 Prepaid expenses, deferred charges and other assets 420,003 343,554 Cost in excess of net assets acquired 332,594 285,469 $15,976,047 $15,847,867 Liabilities and Capital: Unpaid losses and loss adjustment expenses $ 4,876,564 $ 4,773,377 Unearned premiums 1,260,249 1,232,848 Annuity benefits accumulated 5,473,639 5,449,633 Life, accident and health reserves 369,370 341,595 Payable to American Financial Group, Inc. 407,768 270,500 Long-term debt: Holding companies 104,544 315,536 Subsidiaries 239,188 176,896 Liabilities related to separate accounts 243,444 120,049 Accounts payable, accrued expenses and other liabilities 1,109,753 1,112,442 Total liabilities 14,084,519 13,792,876 Minority interest 497,296 524,335 Shareholders' Equity: Preferred Stock (liquidation value $72,154) 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 956,621 943,359 Retained earnings 282,032 157,218 Unrealized gains on marketable securities, net 73,800 348,300 Total shareholders' equity 1,394,232 1,530,656 $15,976,047 $15,847,867
2 AMERICAN FINANCIAL CORPORATION 10-Q AMERICAN FINANCIAL CORPORATION AND SUBSIDIARIES CONSOLIDATED STATEMENT OF EARNINGS (In Thousands)
Three months ended Nine months ended September 30, September 30, 1999 1998 1999 1998 Income: Property and casualty insurance premiums $585,560 $ 696,537 $1,680,561 $2,080,003 Life, accident and health premiums 26,463 50,434 77,418 145,710 Investment income 215,872 223,322 632,048 672,760 Equity in net earnings (loss) of investee (14,797) (5,518) 2,639 26,396 Realized gains (losses) on sales of: Securities (5,744) 14,302 5,981 28,890 Investee and subsidiaries - 11,090 - 20,510 Other investments - - - 6,843 Other income 47,374 42,262 105,501 106,112 854,728 1,032,429 2,504,148 3,087,224 Costs and Expenses: Property and casualty insurance: Losses and loss adjustment expenses 423,402 513,537 1,188,050 1,577,440 Commissions and other underwriting expenses 171,824 201,777 506,646 586,409 Annuity benefits 66,516 64,514 194,977 204,735 Life, accident and health benefits 17,365 40,547 52,238 115,208 Interest charges on borrowed money 16,494 19,005 49,715 54,059 Minority interest expense 10,626 15,048 35,778 38,135 Other operating and general expenses 99,161 88,823 263,084 248,655 805,388 943,251 2,290,488 2,824,641 Earnings before income taxes, extraordinary items and cumulative effect of accounting change 49,340 89,178 213,660 262,583 Provision for income taxes 18,460 31,185 78,257 98,594 Earnings before extraordinary items and cumulative effect of accounting change 30,880 57,993 135,403 163,989 Extraordinary items - loss on prepayment of debt - (33) (3,849) (754) Cumulative effect of accounting change - - (3,854) - Net Earnings $ 30,880 $ 57,960 $ 127,700 $ 163,235
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 Stock Surplus Earnings Securities Total Balance at January 1, 1999 $72,154 $952,984 $157,218 $348,300 $1,530,656 Net earnings - - 127,700 - 127,700 Change in unrealized - - - (274,500) (274,500) Comprehensive income (loss) (146,800) Dividends on Preferred Stock - - (2,886) - (2,886) Capital contribution from parent - 9,200 - - 9,200 Other - 4,062 - - 4,062 Balance at September 30, 1999 $72,154 $966,246 $282,032 $ 73,800 $1,394,232 Balance at January 1, 1998 $72,154 $936,154 $ 34,350 $341,200 $1,383,858 Net earnings - - 163,235 - 163,235 Change in unrealized - - - 12,300 12,300 Comprehensive income (loss) 175,535 Dividends on Preferred Stock - - (2,886) - (2,886) Capital contribution from parent - 12,530 - - 12,530 Other - 56 - - 56 Balance at September 30, 1998 $72,154 $948,740 $194,699 $353,500 $1,569,093
4 AMERICAN FINANCIAL CORPORATION 10-Q AMERICAN FINANCIAL CORPORATION AND SUBSIDIARIES CONSOLIDATED STATEMENT OF CASH FLOWS (In Thousands) Nine months ended September 30, 1999 1998 Operating Activities: Net earnings $ 127,700 $ 163,235 Adjustments: Extraordinary items 3,849 754 Cumulative effect of accounting change 3,854 - Depreciation and amortization 68,548 71,589 Annuity benefits 194,977 204,735 Equity in net earnings of investee (2,639) (26,396) Realized gains on investing activities (20,733) (80,357) Deferred annuity and life policy acquisition costs (87,009) (87,459) Increase in reinsurance and other receivables (123,522) (229,730) Increase in other assets (58,870) (37,893) Increase in insurance claims and reserves 116,590 293,264 Increase in other liabilities 81,495 111,765 Increase in minority interest 17,026 14,743 Dividends from investee 3,600 3,600 Other, net (13,082) (12,022) 311,784 389,828 Investing Activities: Purchases of and additional investments in: Fixed maturity investments (1,547,160) (1,682,077) Equity securities (56,041) (54,971) Subsidiaries (204,942) (31,825) Real estate, property and equipment (63,496) (49,425) Maturities and redemptions of fixed maturity investments 801,833 1,017,004 Sales of: Fixed maturity investments 885,901 544,722 Equity securities 45,887 19,119 Subsidiaries - 164,589 Real estate, property and equipment 24,394 48,634 Cash and short-term investments of acquired (former) subsidiaries, net 19,454 (18,146) Decrease (increase) in other investments 12,734 (9,363) (81,436) (51,739) Financing Activities: Fixed annuity receipts 330,744 358,659 Annuity surrenders, benefits and withdrawals (524,148) (538,912) Additional long-term borrowings 212,232 217,537 Reductions of long-term debt (366,464) (159,383) Borrowings from AFG 254,100 - Payments to AFG (121,300) (52,500) Capital contribution 14,000 14,000 Repurchases of trust preferred securities (5,509) - Cash dividends paid (2,886) (2,886) (209,231) (163,485) Net Increase in Cash and Short-term Investments 21,117 174,604 Cash and short-term investments at beginning of period 289,944 231,227 Cash and short-term investments at end of period $ 311,061 $ 405,831 5 AMERICAN FINANCIAL CORPORATION 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. Investments All fixed maturity securities are "available for sale" and reported at fair value with unrealized gains and losses reported as a separate component of shareholders' equity. 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. 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. To the extent that unrealized gains (losses) from securities classified as "available for sale" would result in adjustments to deferred acquisition costs and policyholder liabilities had those gains (losses) actually been realized, such balance sheet amounts are adjusted, net of deferred taxes. 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 reinsured 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 6 AMERICAN FINANCIAL CORPORATION 10-Q NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED 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 the net level premium method. Computations are based on anticipated investment yield, mortality, morbidity and surrenders and include provisions for unfavorable deviations. Reserves established for accident and health claims 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. 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. 7 AMERICAN FINANCIAL CORPORATION 10-Q NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED Minority Interest For balance sheet purposes, minority interest represents (i) the interests of noncontrolling shareholders in AFC subsidiaries, including preferred securities issued by trust subsidiaries of American Annuity Group ("AAG"), and (ii) the American Financial Group ("AFG") direct ownership interest in American Premier Underwriters, Inc. ("American Premier" or "APU") and American Financial Enterprises, Inc. 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 a part of a broader reorganization. Income Taxes AFC files consolidated federal income tax returns which include all 80%-owned U.S. subsidiaries, except for certain life insurance subsidiaries and their subsidiaries. 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. 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 1998) are invested primarily in securities of AFC 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 Prior to 1999, AAG, an 83%-owned subsidiary, deferred certain costs associated with introducing new products and distribution channels and amortized them on a straight-line basis over 5 years. In 1999, AAG implemented Statement of Position ("SOP") 98-5, "Reporting on the Costs of Start-Up Activities." The SOP requires that (i) costs of start-up activities be expensed as incurred and (ii) unamortized balances of previously deferred costs be expensed and reported as the cumulative effect of a change in accounting principle. Accordingly, AFC expensed previously capitalized start-up costs of $3.8 million (net of minority interest and taxes), effective January 1, 1999. 8 AMERICAN FINANCIAL CORPORATION 10-Q NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED Derivatives The Financial Accounting Standards Board issued SFAS No. 133, "Accounting for Derivative Instruments and Hedging Activities," during the second quarter of 1998. AFC must implement SFAS No. 133 no later than January 1, 2001. SFAS No. 133 establishes accounting and reporting standards for derivative instruments, including derivative instruments that are embedded in other contracts, and for hedging activities. SFAS No. 133 requires the recognition of all derivatives (both assets and liabilities) in the balance sheet at fair value. Changes in fair value of derivative instruments are included in current income or as a component of comprehensive income (outside current income) depending on the type of derivative. Implementation of SFAS No. 133 is not expected to have a material effect on AFC's financial position or results of operations. 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. B. Acquisitions and Sales of Subsidiaries Worldwide Insurance Company In April 1999, AFC completed the purchase of Worldwide Insurance Company (formerly Providian Auto and Home Insurance Company) for $157 million in cash. Worldwide is a provider of direct response private passenger automobile insurance. Old Republic and Consolidated Financial In February 1999, AAG acquired Old Republic Life Insurance Company of New York for $27 million in cash. In July 1999, AAG acquired Consolidated Financial Corp., an insurance agency, for $21 million in cash. United Teacher Associates In October 1999, AAG acquired United Teacher Associates Insurance Company of Austin, Texas ("UTA") for $81 million in cash subject to post-closing adjustments. UTA provides supplemental health products and retirement annuities, and purchases blocks of insurance policies from other insurers. Commercial lines division In December 1998, AFC completed the sale of substantially all of its Commercial lines division to Ohio Casualty Corporation for $300 million plus warrants to purchase 6 million (post split) shares of Ohio Casualty common stock. AFC deferred a gain of $103 million on the insurance ceded to Ohio Casualty and recognized a pretax gain of $153 million on the sale of the other net assets. The deferred gain is being recognized over the estimated remaining settlement period (weighted average of 4.25 years) of the claims ceded. AFC may receive up to an additional $40 million in the year 2000 based upon the retention and growth of the insurance businesses acquired by Ohio Casualty. The commercial lines sold generated net written premiums of $210 million for the nine months ended September 30, 1998. 9 AMERICAN FINANCIAL CORPORATION 10-Q NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED Funeral Services division In September 1998, AAG sold its Funeral Services division for approximately $165 million in cash. The division held assets of approximately $1 billion at the sale date. AFG realized a pretax gain of $21.6 million, before $2.7 million of minority interest, on this sale. C. Segments of Operations Having sold substantially all of its Commercial lines division in December 1998, AFC's property and casualty group is engaged primarily in private passenger automobile and specialty insurance businesses. The Personal group consists of the nonstandard auto group along with the preferred/standard private passenger auto and other personal insurance business. The Specialty group includes a highly diversified group of specialty business units. AFC's annuity and life business markets primarily retirement products as well as life and supplemental health insurance. In addition, AFC owns a significant portion of the voting equity securities of Chiquita Brands International, Inc. (an investee corporation - see Note D). The following table (in thousands) shows AFC's revenues and operating profit (loss) by significant business segment. Operating profit (loss) represents total revenues less operating expenses.
Three months ended Nine months ended September 30, September 30, 1999 1998 1999 1998 Revenues (a) Property and casualty insurance: Premiums earned: Personal $288,454 $ 321,701 $ 875,036 $ 980,288 Specialty 296,254 365,670 804,957 1,068,854 Other lines - primarily discontinued 852 9,166 568 30,861 585,560 696,537 1,680,561 2,080,003 Investment and other income 110,923 123,128 329,885 376,684 696,483 819,665 2,010,446 2,456,687 Annuities and life (b) 161,474 210,842 465,348 584,834 Other 11,568 7,440 25,715 19,307 869,525 1,037,947 2,501,509 3,060,828 Equity in net earnings (loss) of investee (14,797) (5,518) 2,639 26,396 $854,728 $1,032,429 $2,504,148 $3,087,224 Operating Profit (Loss) Property and casualty insurance: Underwriting: Personal ($ 3,167) $ 8,860 ($ 1,121) $ 30,129 Specialty (9,246) (21,781) (7,925) (80,886) Other lines - primarily discontinued 2,747 (5,856) (5,089) (33,089) (9,666) (18,777) (14,135) (83,846) Investment and other income 68,452 88,193 206,074 282,239 58,786 69,416 191,939 198,393 Annuities and life 21,250 48,977 71,681 107,649 Other (c) (15,899) (23,697) (52,599) (69,855) 64,137 94,696 211,021 236,187 Equity in net earnings (loss) of investee (14,797) (5,518) 2,639 26,396 $ 49,340 $ 89,178 $ 213,660 $ 262,583
(a) Revenues include sales of products and services as well as other income earned by the respective segments. (b) Represents primarily investment income. (c) Includes holding company expenses. 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 (36%) of Chiquita common stock. The market value of this investment was $142 million and $229 million at September 30, 1999 and December 31, 1998, respectively. Chiquita is a leading international marketer, producer and distributor of quality fresh fruits and vegetables and processed foods. Summarized financial information for Chiquita follows (in millions): Nine months ended September 30, 1999 1998 Net Sales $1,937 $2,094 Operating Income 93 157 Net Income 19 83 E. Payable to American Financial Group In 1997, AFC entered into a ten- year reciprocal Master Credit Agreement among AFG and several of AFG's subsidiary holding companies, including APU and AFC's direct parent, AFC Holding Company, under which funds are made available to each other at one percent over LIBOR. F. Long-Term Debt The carrying value of long-term debt consisted of the following (in thousands): September 30, December 31, 1999 1998 Holding Companies: AFC notes payable under bank line $ 60,000 $ 80,000 AFC 9-3/4% Debentures due April 2004 - 78,560 American Premier Underwriters, Inc. ("APU") 9-3/4% Subordinated Notes due August 1999 - 89,467 APU 10-5/8% Subordinated Notes due April 2000 23,885 41,518 APU 10-7/8% Subordinated Notes due May 2011 11,673 17,473 Other 8,986 8,518 $104,544 $315,536 Subsidiaries: AAG 6-7/8% Senior Notes due June 2008 $100,000 $100,000 AAG notes payable under bank line 95,000 27,000 Notes payable secured by real estate 31,823 37,602 Other 12,365 12,294 $239,188 $176,896 In the second quarter of 1999, AFC used funds borrowed under its credit agreement with AFG to (i) repay $155 million borrowed under its bank line; (ii) redeem its 9-3/4% Debentures for $82.9 million and (iii) repurchase $22.2 million of APU Notes for $24.5 million. In August 1999, APU redeemed its 9-3/4% Notes at maturity and AFC borrowed $60 million under the bank line. At September 30, 1999, sinking fund and other scheduled principal payments on debt for the balance of 1999 and the subsequent five years were as follows (in thousands): Holding Companies Subsidiaries Total 1999 $ - $ 596 $ 596 2000 23,667 3,501 27,168 2001 - 1,512 1,512 2002 66,044 36,405 102,449 2003 - 61,438 61,438 2004 - 14,391 14,391 11 AMERICAN FINANCIAL CORPORATION 10-Q NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED 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. AFC and AAG each have an unsecured credit agreement with a group of banks under which they can borrow up to $300 million and $200 million, respectively. Borrowings bear interest at floating rates based on prime or Eurodollar rates. Loans mature December 2002 under the AFC credit agreement and from 2000 to 2003 under the AAG credit agreement. G. Minority Interest Minority interest in AFC's balance sheet is comprised of the following (in thousands): September 30, December 31, 1999 1998 Interest of AFG (parent) and noncontrolling shareholders in subsidiaries' common stock $277,696 $299,335 Preferred securities issued by subsidiary trusts 219,600 225,000 $497,296 $524,335 Trust Issued Preferred Securities Wholly-owned subsidiary trusts of AAG have issued $225 million of preferred securities and, in turn, purchased a like amount of AAG subordinated debt which provides interest and principal payments to fund the respective trusts' obligations. The preferred securities must be redeemed upon maturity or redemption of the subordinated debt. AAG effectively provides unconditional guarantees of its trusts' obligations. The preferred securities consisted of the following (in thousands):
Date of September 30, December 31, Optional Issuance Issue (Maturity Date) 1999 1998 Redemption Dates November 1996 AAG 9-1/4% TOPrS (2026) 74,600 75,000 On or after 11/7/2001 March 1997 AAG 8-7/8% Pfd (2027) 70,000 75,000 On or after 3/1/2007 May 1997 AAG 7-1/4% ROPES (2041) 75,000 75,000 Prior to 9/28/2000 and after 9/28/2001
In the first quarter of 1999, AAG repurchased $5.4 million of its preferred securities for $5.5 million in cash. Minority Interest Expense Minority interest expense is comprised of (in thousands): Nine months ended September 30, 1999 1998 Interest of AFG (parent) and noncontrolling shareholders in earnings of subsidiaries $21,842 $23,861 Accrued distributions by subsidiaries on trust issued preferred securities 13,936 14,274 $35,778 $38,135 12 AMERICAN FINANCIAL CORPORATION 10-Q NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED H. Shareholders' Equity 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. The outstanding voting shares of AFC's Preferred Stock consisted of the following: Series J, no par value; $25.00 liquidation value per share; annual dividends per share $2.00; redeemable at AFC's option at $25.75 per share beginning December 2005 declining to $25.00 at December 2007 and thereafter; 2,886,161 shares (stated value $72.2 million) outstanding at September 30, 1999 and December 31, 1998. Unrealized Gain on Marketable Securities The change in unrealized gains on marketable securities for the nine months ended September 30 included the following (in millions):
Minority Pretax Taxes Interest Net 1999 Unrealized holding gains (losses) on securities arising during the period ($471.7) $163.4 $36.9 ($271.4) Reclassification adjustment for realized gains included in net income (6.0) 2.1 .8 (3.1) Change in unrealized gains on marketable securities, net ($477.7) $165.5 $37.7 ($274.5) 1998 Unrealized holding gains (losses) on securities arising during the period $ 67.2 ($ 22.0) ($ 8.1) $ 37.1 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 unrealized gains on marketable securities, net $ 22.1 ($ 6.2) ($ 3.6) $ 12.3
I. 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 taxes (in thousands): Nine months ended September 30, 1999 1998 Holding Companies: AFC (parent) ($2,993) ($ 51) APU (parent) (856) (54) Subsidiaries: AAG - (649) ($3,849) ($754) 13 AMERICAN FINANCIAL CORPORATION 10-Q NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED J. 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): Available Held to For Sale Maturity(a) Total 1999 Purchases $1,547,160 $ - $1,547,160 Maturities and redemptions 801,833 - 801,833 Sales 885,901 - 885,901 1998 Purchases $1,681,251 $ 826 $1,682,077 Maturities and redemptions 538,293 478,711 1,017,004 Sales 506,819 37,903(b) 544,722 (a) At December 31, 1998, AFC reclassified all of its "held to maturity" fixed maturity securities to "available for sale." (b) Sold (at a gain of $.7 million) due to significant deterioration in the issuers' creditworthiness. K. Commitments and Contingencies There have been no significant changes to the matters discussed and referred to in Part II of AFC's June 30, 1999 Form 10-Q and Note L "Commitments and Contingencies" in AFC's Annual Report on Form 10-K for 1998. 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, shareholder dividends, and taxes. 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 and other equipment using date-sensitive computer chips 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 Office monitors and coordinates 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 issue, AFC's operations were divided into separate systems groups. All groups have completed Year 2000 program modifications and software installations, about 98% of the tests to be performed, and are engaged in test documentation activities. Contingency plans are being developed for certain business processes and systems deemed most critical to operations. These plans provide a documented order of actions necessary to keep the business functions operating. Such plans typically include procedures and workflow processes for operating in a failed environment. Contingency planning is expected to be substantially completed by November 30, 1999. Many of the systems being replaced were planned replacements which were accelerated due to the Year 2000 considerations. 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 represent solely incremental costs. During the first nine months of 1999, AFC incurred $23 million for Year 2000 costs, of which $6 million was capitalized and $17 million was expensed. From the inception of the Year 2000 Project in the early 1990s, AFC estimates that it has incurred approximately $70 million of such costs, including capitalized costs of $16 million. AFC expects that an additional $7 million will be incurred, of which about half will be capitalized. Projected Year 2000 costs and completion dates are based on management's best estimates. However, there can be no assurances 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. Assessments of property and casualty agents and life and annuity agents have been completed. Efforts to evaluate third party vendors have been intensified and will continue to be 15 AMERICAN FINANCIAL CORPORATION 10-Q Management's Discussion and Analysis of Financial Condition and Results of Operations - Continued updated through the fourth quarter. 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. IT Initiative In the third quarter of 1999, AFC's newly hired Chief Information Officer initiated an enterprise-wide study of its information technology ("IT") resources, needs and opportunities. AFC expects that the initiative will entail extensive effort and costs and may lead to substantial changes in the area, which should result in significant cost savings, efficiencies and effectiveness in the future. While the costs (most of which will be expensed) will precede any savings to be realized, management expects benefits to greatly exceed the costs incurred, all of which will be funded through available working capital. 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 especially with regard to availability of and returns on capital, regulatory actions, changes in legal environment, levels of catastrophe and other major losses, availability of reinsurance, the Year 2000 issue, and competitive pressures. AFC undertakes no obligation to update any forward-looking statements. LIQUIDITY AND CAPITAL RESOURCES Ratios AFG's debt to total capital ratio at the parent holding company level (excluding amounts due AFG) was approximately 7% at September 30, 1999 and 17% at December 31, 1998. Including amounts due AFG, the ratio was 27% at September 30, 1999 and 28% at December 31, 1998. AFG's ratio of earnings to fixed charges, excluding and including preferred dividends, (on a total enterprise basis) was 4.06 and 3.71 for the first nine months of 1999 and 3.44 and 3.15 for the entire year of 1998. 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 has a revolving credit agreement with several banks under which it can borrow up to $300 million. The 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, 1999, there was $60 million borrowed under the credit line. In April 1999, AFG issued $350 million principal amount of 7-1/8% senior debentures due 2009; the proceeds were used primarily to retire outstanding holding company public debt and borrowings under AFC's credit line. 16 AMERICAN FINANCIAL CORPORATION 10-Q Management's Discussion and Analysis of Financial Condition and Results of Operations - Continued 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 noncore investments. Investments Approximately 90% of the fixed maturities held by AFC were rated "investment grade" (credit rating of AAA to BBB) by nationally recognized rating agencies at September 30, 1999. Investment grade securities generally bear lower yields and lower degrees of risk than those that are unrated and noninvestment 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 and cumulative effect of accounting change for the three months and nine months ended September 30, 1999 were $49.3 million and $214 million, respectively, compared to $89.2 million and $262.6 million in the comparable 1998 periods. Improved underwriting results for both the three and nine month periods were more than offset by decreases in realized gains, investment income and investee earnings. Property and Casualty Insurance - Underwriting AFC's property and casualty group consists of 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. 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. 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, nonprofit liability, general aviation coverages, fidelity and surety bonds, and umbrella and excess coverages. Commercial lines businesses sold included certain coverages in workers' compensation, commercial multi-peril, commercial automobile, and umbrella. 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. 17 AMERICAN FINANCIAL CORPORATION 10-Q Management's Discussion and Analysis of Financial Condition and Results of Operations - Continued For certain lines of business and products where the credibility of the range of loss projections is less certain (primarily the various specialty businesses 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, 1999 1998 1999 1998 Net Written Premiums (GAAP) Personal $287.3 $314.3 $ 839.2 $ 998.0 Specialty 323.7 357.9 850.4 1,039.6 Other lines .7 2.1 (.8) 17.7 $611.7 $674.3 $1,688.8 $2,055.3 Combined Ratios (GAAP) Personal 101.1% 97.3% 100.2% 96.9% Specialty 103.2 106.0 101.0 107.5 Aggregate (including discontinued lines) 101.7 102.8 100.8 104.1 Personal The Personal group's net written premiums for the third quarter and first nine months of 1999 includes $22.1 million and $42.9 million, respectively, in net premiums written by Worldwide since its acquisition in April. The decrease in written premiums reflects continuing strong price competition in the private passenger automobile market. The combined ratios for 1999 increased as loss and underwriting expenses declined at a slower rate than premiums. Specialty The Specialty Group's net written premiums for the third quarter and first nine months of 1999 increased slightly compared to the 1998 periods, excluding premiums of the commercial lines division sold in December 1998 and the effect of ceding approximately 30% of California workers' compensation premiums under a reinsurance agreement implemented during the third quarter of 1998. A deferred gain of $103 million on the Commercial lines business ceded to Ohio Casualty in December 1998 is being recognized over the estimated settlement period (weighted average 4.25 years) of the claims ceded. The Specialty group's underwriting results for the third quarter and first nine months of 1999 include $6.7 million and $20.1 million, respectively, in earnings recognized on the ceded business. In addition, the improvement in the combined ratios for the 1999 periods reflects (i) a decrease in losses from severe weather for the nine-month period (ii) improved underwriting margins in California workers' compensation business largely due to favorable reinsurance agreements and (iii) the absence of losses included in the 1998 periods attributable to the commercial lines sold. 18 AMERICAN FINANCIAL CORPORATION 10-Q Management's Discussion and Analysis of Financial Condition and Results of Operations - Continued Life, Accident and Health Premiums and Benefits The decrease in life, accident and health premiums and benefits reflects primarily the sale of AAG's Funeral Services division in September 1998. Investment Income Investment income decreased approximately $7.5 million (3%) in the third quarter of 1999 and $40.7 million (6%) in the first nine months of 1999 compared to 1998 due primarily to the transfer of investment assets in connection with the sales of the Commercial lines division and Funeral Services division in 1998, partially offset by the effect of the purchase of Worldwide in April 1999. Investee Corporation Equity in net earnings of investee corporation represents AFC's proportionate share of Chiquita's earnings. Chiquita reported net losses for the third quarter of 1999 and 1998 of $37 million and $11 million, respectively. For the first nine months of 1999 and 1998, Chiquita reported net income of $19 million and $83 million, respectively. 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 The gains on sales of investees and subsidiaries in 1998 include (i) pretax gains of $7.7 million and $1.7 million in the first and second quarters as a result of Chiquita's public issuance of shares of its common stock, (ii) a pretax gain of $21.6 million on AAG's sale of its Funeral Services division in September and (iii) a third quarter charge of $10.5 million relating to operations expected to be sold or otherwise disposed of. Annuity Benefits Annuity benefits reflect amounts accrued on 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. Cumulative Effect of Accounting Change In the first quarter of 1999, AAG implemented Statement of Position 98-5, "Reporting on the Costs of Start-Up Activities." The SOP requires that costs of start-up activities be expensed as incurred and that unamortized balances of previously deferred costs be expensed and reported as the cumulative effect of a change in accounting principle. Accordingly, AFC expensed previously capitalized start-up costs of $3.8 million (net of minority interest and taxes) in the first quarter of 1999. 19 AMERICAN FINANCIAL CORPORATION 10-Q Item 3 Quantitative and Qualitative Disclosure of Market Risk The tables below show scheduled principal payments (in millions) on fixed-rate and variable-rate long-term debt of AFC and its subsidiaries and related average interest rates as of September 30, 1999 and December 31, 1998. September 30, 1999 Fixed-Rate Debt Variable-Rate Debt Weighted Weighted Scheduled Average Scheduled Average Principal Interest Principal Interest Payments Rate Payments Rate 1999 (remainder) $ .4 6.78% $ .1 7.26% 2000 27.0 9.96 .2 7.13 2001 1.4 6.81 .1 7.00 2002 1.3 6.50 101.2 6.08 2003 1.3 6.38 60.2 5.89 2004 14.2 8.38 .2 7.00 Thereafter 135.2 7.25 .1 7.00 Total $180.8 7.74% $162.1 6.01% Market Value $175.7 $162.1 December 31, 1998 Fixed-Rate Debt Variable-Rate Debt Weighted Weighted Scheduled Average Scheduled Average Principal Interest Principal Interest Payments Rate Payments Rate 1999 $ 90.7 9.69% $ .3 5.86% 2000 49.1 9.85 .2 5.80 2001 1.2 7.13 .1 5.58 2002 1.1 6.81 85.7 5.95 2003 1.1 6.68 27.2 6.09 Thereafter 233.3 8.26 .2 5.58 Total $376.5 8.80% $113.7 5.98% Market Value $388.9 $113.7 As of September 30, 1999, there were no material changes to the other information provided in AFC's Form 10-K for 1998 under the caption "Exposure to Market Risk" in Management's Discussion and Analysis of Financial Condition and Results of Operations. 20 AMERICAN FINANCIAL CORPORATION 10-Q PART II OTHER INFORMATION Item 6 Exhibits and Reports on Form 8-K (a) Exhibit 27.1 - Financial Data Schedule as of September 30, 1999. For submission in electronic filing only. (b) Reports on Form 8-K: none 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, 1999 BY: Fred J. Runk Fred J. Runk Senior Vice President and Treasurer 21 EX-27 2
5 This schedule contains summary financial information extracted from the American Financial Corporation 10-Q for the nine months ended September 30, 1999 and is qualified in its entirety by reference to such financial statements. 1,000 9-MOS DEC-31-1999 SEP-30-1999 $311,061 10,571,811 709,348 0 0 0 0 0 15,976,047 0 343,732 0 72,154 9,625 1,312,453 15,976,047 0 2,504,148 0 0 263,084 0 49,715 213,660 78,257 135,403 0 (3,849) (3,854) 127,700 0 0 Includes an investment in investee of $191 million. Not applicable since all common shares are owned by American Financial Group, Inc.
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