-----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, SYSUyh+r+Jx57U9/Q5IeFPagyS1lP1hroQlYDNp39x4ByJIDvMuFhQv8Ju8Yq5jt SW/+jC9mRGni8TvsIQigDg== 0000933537-97-000015.txt : 19970514 0000933537-97-000015.hdr.sgml : 19970514 ACCESSION NUMBER: 0000933537-97-000015 CONFORMED SUBMISSION TYPE: 10-Q PUBLIC DOCUMENT COUNT: 2 CONFORMED PERIOD OF REPORT: 19970331 FILED AS OF DATE: 19970513 SROS: NASD SROS: PSE 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: 1934 Act SEC FILE NUMBER: 001-07361 FILM NUMBER: 97602642 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 March 31, 1997 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 May 1, 1997, there were 45,000,000 shares of the Registrant's Common Stock outstanding, all of which were owned by American Financial Group, Inc. Page 1 of 16 AMERICAN FINANCIAL CORPORATION 10-Q PART I FINANCIAL INFORMATION AMERICAN FINANCIAL CORPORATION AND SUBSIDIARIES CONSOLIDATED BALANCE SHEET (Dollars In Thousands) March 31, December 31, 1997 1996 Assets Cash and short-term investments $ 404,801 $ 404,831 Investments: Bonds and redeemable preferred stocks: Held to maturity - at amortized cost (market - $3,412,300 and $3,528,100) 3,439,287 3,491,126 Available for sale - at market (amortized cost - $6,681,142 and $6,362,597) 6,674,942 6,494,597 Other stocks - principally at market (cost - $144,270 and $142,364) 340,670 327,664 Investment in investee corporation 213,234 199,651 Loans receivable 540,087 568,055 Real estate and other investments 207,335 205,021 Total investments 11,415,555 11,286,114 Recoverables from reinsurers and prepaid reinsurance premiums 932,704 942,450 Agents' balances and premiums receivable 638,718 609,403 Deferred acquisition costs 468,143 452,041 Other receivables 256,228 272,766 Deferred tax asset 154,429 137,284 Assets held in separate accounts 253,544 247,579 Prepaid expenses, deferred charges and other assets 373,953 368,114 Cost in excess of net assets acquired 274,971 278,581 $15,173,046 $14,999,163 Liabilities and Capital Unpaid losses and loss adjustment expenses $ 4,028,032 $ 4,123,701 Unearned premiums 1,311,851 1,247,806 Annuity benefits accumulated 5,423,164 5,365,612 Life, accident and health reserves 581,431 575,380 Payable to American Financial Group, Inc. 452,401 422,015 Other long-term debt: Holding Companies 338,214 339,504 Subsidiaries 184,848 178,415 Liabilities related to separate accounts 253,544 247,579 Accounts payable, accrued expenses and other liabilities 946,038 915,398 Total liabilities 13,519,523 13,415,410 Minority interest 378,151 306,858 Shareholders' Equity: Preferred Stock (liquidation value $258,638) 162,760 162,760 Common Stock without par value 9,625 9,625 Capital Surplus 923,519 919,746 Retained earnings 62,268 1,364 Net unrealized gain on marketable securities, net of deferred income taxes 117,200 183,400 Total shareholders' equity 1,275,372 1,276,895 $15,173,046 $14,999,163 2 AMERICAN FINANCIAL CORPORATION 10-Q AMERICAN FINANCIAL CORPORATION AND SUBSIDIARIES CONSOLIDATED STATEMENT OF EARNINGS (In Thousands) Three months ended March 31, 1997 1996 Income: Property and casualty insurance premiums $663,762 $ 713,389 Life, accident and health premiums 25,365 24,253 Investment income 212,752 202,460 Realized gains on sales of securities 1,813 18,718 Equity in net earnings of investee corporations 14,780 8,522 Gains on sales of subsidiaries 731 33,891 Other income 26,424 28,931 945,627 1,030,164 Costs and Expenses: Property and casualty insurance: Losses and loss adjustment expenses 469,324 509,157 Commissions and other underwriting expenses 184,301 200,679 Annuity benefits 68,830 68,015 Life, accident and health benefits 24,163 21,593 Interest charges on borrowed money 23,611 24,262 Other operating and general expenses 77,187 86,995 847,416 910,701 Earnings before income taxes and extraordinary items 98,211 119,463 Provision for income taxes 36,221 40,951 Earnings before extraordinary items 61,990 78,512 Extraordinary items - loss on prepayment of debt (55) (7,277) Net Earnings $ 61,935 $ 71,235 3 AMERICAN FINANCIAL CORPORATION 10-Q AMERICAN FINANCIAL CORPORATION AND SUBSIDIARIES CONSOLIDATED STATEMENT OF CASH FLOWS (In Thousands) Three months ended March 31, 1997 1996 Operating Activities: Net earnings $ 61,935 $ 71,235 Adjustments: Extraordinary items 55 7,277 Depreciation and amortization 17,979 15,414 Annuity benefits 68,830 68,015 Equity in net earnings of investee corporations (14,780) (8,522) Changes in reserves on assets 418 3,752 Realized gains on investing activities (2,544) (51,582) Decrease (increase) in reinsurance and other receivables (24,175) 15,500 Increase in other assets (49,036) (50,392) Decrease in insurance claims and reserves (25,573) (82,242) Increase (decrease) in other liabilities (26,180) 32,431 Increase in minority interest 6,293 6,788 Dividends from investees 1,200 1,200 Other, net (830) (2,622) 13,592 26,252 Investing Activities: Purchases of and additional investments in: Fixed maturity investments (616,655) (726,148) Equity securities (9,408) (8,573) Real estate, property and equipment (8,762) (7,898) Maturities and redemptions of fixed maturity investments 155,184 167,358 Sales of: Fixed maturity investments 332,008 242,365 Equity securities 7,943 20,845 Investees and subsidiaries 2,500 59,585 Real estate, property and equipment 396 1,206 Cash and short-term investments of former subsidiaries (70) (4,589) Increase in other investments (1,119) (390) (137,983) (256,239) Financing Activities: Annuity receipts 133,402 137,241 Annuity payments (134,699) (113,852) Additional long-term borrowings 7,053 111,200 Reductions of long-term debt (1,718) (197,918) Borrowings from AFG 42,000 103,800 Payments to AFG - (15,000) Capital contribution 4,667 4,667 Issuance of trust preferred securities 74,687 - Cash dividends paid (1,031) (191) 124,361 29,947 Net Decrease in Cash and Short-term Investments (30) (200,040) Cash and short-term investments at beginning of period 404,831 448,201 Cassh and short-term investments at end of period $404,801 $248,161 4 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. 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. At the close of business on December 31, 1996, American Financial Group ("AFG") contributed to AFC 81% of the common stock of American Premier. Since AFC and American Premier are under the common control of AFG, the acquisition of American Premier has been recorded by AFC at AFG's historical cost in a manner similar to a pooling of interests. Accordingly, the historical consolidated financial statements of AFC for periods subsequent to April 3, 1995 (date of common control) have been restated to include the accounts of American Premier. AFC's ownership of subsidiaries and significant affiliates with publicly traded common shares was as follows: March 31, December 31, 1997 1996 1995 American Annuity Group, Inc. ("AAG") 81% 81% 81% American Financial Enterprises, Inc. ("AFEI") 83% 83% 83% American Premier Underwriters, Inc. 81% 81% - Chiquita Brands International, Inc. 43% 43% 44% Citicasters Inc. (a) (a) 38% (a) Sold in September 1996. 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. 5 AMERICAN FINANCIAL CORPORATION 10-Q NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED 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. Short-term investments are carried at cost; loans receivable are stated primarily at the aggregate unpaid balance. Investment in Investee Corporation Investments in securities of 20%- to 50%-owned companies are carried at cost, adjusted for AFC's proportionate share of their undistributed earnings or losses. Investments in less than 20%-owned companies are accounted for by the equity method when, in the opinion of management, AFC can exercise significant influence over operating and financial policies of the investee. 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. The excess of AFC's equity in the net assets of other subsidiaries and investees over its cost of acquiring these companies ("negative goodwill") is allocated to AFC's basis in these companies' fixed assets, goodwill and other long-term assets and is amortized on a 10- to 40-year basis. 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 6 AMERICAN FINANCIAL CORPORATION 10-Q NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED 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 ordinary life, accident and health policies are computed using a net level premium method. Computations are based on anticipated investment yields, 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 Investment annuity deposits and related liabilities represent primarily deposits maintained by several banks under a previously offered tax-deferred annuity program. AAG receives an annual fee from each bank for sponsoring the program; if depositors elect to purchase an annuity from AAG, funds are transferred to AAG. 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. 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. Because holders of AFC Series F and G Preferred Stock hold 21% of AFC's voting rights, the companies file separate consolidated returns. 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 will file a single consolidated return for 1997. 7 AMERICAN FINANCIAL CORPORATION 10-Q NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED 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. Contributions to benefit plans are charged against earnings in the year for which they are declared. Both AFC and American Premier had Employee Stock Ownership Retirement Plans ("ESORP"). In 1997, these ESORP plans were combined into a new plan. Like the ESORP plan, the new plan is a noncontributory, qualified plan invested in securities of AFG and affiliates for the benefit of employees. 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 qualify for such benefits. Minority Interest For balance sheet purposes, minority interest represents (i) the interests of noncontrolling shareholders in AFC subsidiaries including $150 million of preferred securities issued by trust subsidiaries of AAG and (ii) AFG's direct ownership interest in American Premier. For income statement purposes, minority interest expense (included in "Other operating and general expenses") represents those shareholders' interest in the earnings of AFC subsidiaries as well as accrued distributions on the trust preferred securities. 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. 8 AMERICAN FINANCIAL CORPORATION 10-Q NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED B. Segments of Operations AFC operates its property and casualty insurance business in three major segments: nonstandard automobile, specialty lines, and commercial and personal lines. 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 corporations - see Note C). The following table (in thousands) shows AFC's revenues by significant business segment. Three months ended March 31, Revenues 1997 1996 Property and casualty insurance: Premiums earned: Nonstandard automobile $288,659 $ 304,392 Specialty lines 232,590 229,292 Commercial and personal lines 142,485 179,547 Other lines 28 158 663,762 713,389 Investment and other income 110,150 121,364 773,912 834,753 Annuities and life (*) 148,706 139,414 Other 8,229 47,475 930,847 1,021,642 Equity in net earnings of investee corporations 14,780 8,522 $945,627 $1,030,164 (*) Represents primarily investment income. C. Investment in Investee Corporation AFC owned 24 million shares (43%) of Chiquita common stock at March 31, 1997 and December 31, 1996. The market value of AFC's investment in Chiquita was $372 million and $306 million at March 31, 1997 and December 31, 1996, 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): Three months ended March 31, 1997 1996 Net Sales $631 $625 Operating Income 71 58 Net Income 43 24 D. Payable to American Financial Group, Inc. At March 31, 1997, AFC had outstanding borrowings under a note with AFG (bearing interest at 11-5/8%) of $225 million, plus accrued interest of $6.4 million. American Premier has a credit agreement with AFG under which American Premier and AFG may make loans of up to $250 million available to each other. The balance outstanding under the credit line bears interest at a variable rate of one percent over LIBOR and is payable on December 31, 2010. At March 31, 1997, American Premier had outstanding borrowings under the credit agreement of $217.5 million, plus accrued interest of $3.5 million. 9 AMERICAN FINANCIAL CORPORATION 10-Q NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED E. Other Long-Term Debt The carrying value of other long-term debt consisted of the following (in thousands): March 31, December 31, 1997 1996 Holding Companies: 9-3/4% AFC Debentures due April 2004 $163,968 $164,368 9-3/4% APU Subordinated Notes due August 1999 93,101 93,604 10-5/8% APU Subordinated Notes due April 2000 54,193 54,595 10-7/8% APU Subordinated Notes due May 2011 18,381 18,496 Other 8,571 8,441 $338,214 $339,504 Subsidiaries: AAG notes payable to banks due September 1999 $ 51,700 $ 44,700 9-1/2% AAG Senior Notes due August 2001 40,845 40,845 11-1/8% AAG Senior Subordinated Notes due February 2003 24,080 24,080 Other 68,223 68,790 $184,848 $178,415 At March 31, 1997, sinking fund and other scheduled principal payments on debt for the balance of 1997 and the subsequent five years were as follows (in thousands): Holding Companies Subsidiaries Total 1997 $ 5,735 $ 1,933 $ 7,668 1998 - 2,846 2,846 1999 91,361 54,137 145,498 2000 51,744 8,752 60,496 2001 - 42,304 42,304 2002 - 1,411 1,411 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 purchased are applied to the earliest scheduled retirements. F. Preferred Stock Under provisions of both the Nonvoting (21.1 million shares authorized) and Voting (17.0 million shares authorized, 13.9 million shares outstanding) 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 shares of preferred stock consisted of the following (see Note K - "Subsequent Event"): Series F, $1 par value; $20.00 liquidating value per share; annual dividends per share $1.80; nonredeemable; 11,900,725 shares (stated value $145.4 million) outstanding at March 31, 1997 and December 31, 1996. Series G, $1 par value; annual dividends per share $1.05; redeemable at $10.50 per share; 1,964,158 shares (stated value $17.4 million) outstanding at March 31, 1997 and December 31, 1996. G. Common Stock At March 31, 1997, American Financial Group owned all of the outstanding shares of AFC's Common Stock. 10 AMERICAN FINANCIAL CORPORATION 10-Q NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED H. 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): Three months ended March 31, 1997 1996 AFC (parent) ($17) ($4,198) APU (parent) (38) (901) AAG - (2,178) ($55) ($7,277) I. 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 1997 Maturity For Sale Total Purchases $ 987 $615,668 $616,655 Maturities and redemptions 81,185 73,999 155,184 Sales - 332,008 332,008 1996 Purchases $86,697 $639,451 $726,148 Maturities and redemptions 72,669 94,689 167,358 Sales - 242,365 242,365 J. Commitments and Contingencies There have been no significant changes to the matters discussed and referred to in Note N "Commitments and Contingencies" in AFC's Annual Report on Form 10-K for 1996. K. Subsequent Event In April 1997, AFG announced two transactions intended to reduce its corporate expenses and simplify the public company structure of certain subsidiaries. AFG has proposed a merger transaction in which AFC's Series F and Series G preferred stock would be retired for $21.50 and $10.50 per share in cash, respectively. Under the proposal, holders of Series F and G preferred stock will have as an option the right to receive shares of a new issue of AFC preferred stock. The new preferred will be redeemable at AFC's option after the eighth anniversary of its issuance, have a liquidation value of $21.50 per share and an annual dividend of $1.8275 per share, paid semi-annually. AFG has also proposed that AFEI engage in a merger transaction whereby all publicly held shares of AFEI would be exchanged, at the option of AFEI shareholders, for shares of AFG common stock on a one-for-one basis, or $37.00 per share in cash. There are approximately 2.3 million shares of AFEI common stock outstanding which are not beneficially owned by AFG. The transactions would be subject to the negotiation of final documentation, the approval of the Board of Directors of each of AFG, AFC, and AFEI, and the receipt of all required shareholder, stock exchange listing and regulatory approvals. 11 AMERICAN FINANCIAL CORPORATION 10-Q ITEM 2 Management's Discussion and Analysis of Financial Condition and Results of Operations GENERAL AFC is organized as a holding company with almost all of its operations being conducted by subsidiaries and affiliates. The parent corporation, however, has continuing cash needs for administrative expenses, the payment of principal and interest on borrowings, dividends on AFC Preferred Stock, 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. LIQUIDITY AND CAPITAL RESOURCES Ratios AFC's debt to total capital ratio at the parent holding company level was just over 20% at March 31, 1997 and December 31, 1996. AFC's ratio of earnings to fixed charges on a total enterprise basis was 4.27 for the first three months of 1997 compared to 4.99 for the entire year of 1996; ratios of earnings to fixed charges and preferred dividends were 3.21 and 3.96 for the same periods. Sources of Funds Management believes AFC has sufficient resources to meet its liquidity requirements through operations in the short-term and long-term future. If funds generated from operations, including dividends 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. In December 1996, American Premier paid a dividend to AFG in the form of a $675 million note receivable from AFC plus $18.7 million of related accrued interest. AFG then contributed $450 million of the note (without accrued interest) to the capital of AFC. At March 31, 1997, the remaining $225 million is included in payable to AFG on AFC's balance sheet. American Premier has a credit agreement with AFG under which American Premier and AFG will make loans of up to $250 million available to each other. Principal amounts payable to AFG under the credit agreement totaled $217.5 million and $175.5 million at March 31, 1997 and December 31, 1996, respectively. Bank credit lines at several subsidiary holding companies provide ample liquidity and can be used to obtain funds for the operating subsidiaries or, if necessary, for the parent company. Agreements with the banks generally run for three to seven years and are renewed before maturity. While it is highly unlikely that all such amounts would ever be borrowed at one time, a maximum of $510 million is available under these bank facilities, $52 million of which was borrowed at March 31, 1997. In the past, funds have been borrowed under certain of these bank facilities and used for working capital, capital infusions into subsidiaries, and to retire other issues of short-term or high-rate debt. Also, AFC believes it may be prudent and advisable to borrow up to $200 million of bank debt in the normal course in order to retire public or privately held fixed rate obligations over the next year or two. The cash to be utilized if the proposed transactions discussed in Note K are completed is expected to come from internally generated funds and existing credit lines. 12 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 reductions of debt at the holding companies (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-insurance investments. Investments Approximately 93% of the bonds and redeemable preferred stocks held by AFC were rated "investment grade" (credit rating of AAA to BBB) by nationally recognized rating agencies at March 31, 1997. 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 were $98.2 million for the first quarter of 1997 and $119.5 million for the first quarter of 1996. While results included (i) an increase of $6.6 million in underwriting profit in the property and casualty operations, (ii) an increase of $10.3 million in investment income primarily in the annuity, life and health operations and (iii) an increase of $6.3 million in investee earnings, these improvements were more than offset by reductions of $50.1 million in realized gains. Property and Casualty Insurance - Underwriting AFC manages and operates its property and casualty business as three major sectors. The nonstandard automobile insurance companies (the "NSA Group") 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 lines are a diversified group of over twenty-five business lines that offer a wide variety of specialty insurance products. Some of the more significant areas are California workers' compensation, executive liability, inland and ocean marine, U.S.-based operations of Japanese companies, agricultural-related coverages, excess and surplus lines, aviation coverages and fidelity and surety bonds. The commercial and personal lines provide coverages in commercial multi-peril, workers' compensation, umbrella and commercial automobile, standard private passenger automobile and homeowners insurance. 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. 13 AMERICAN FINANCIAL CORPORATION 10-Q Management's Discussion and Analysis of Financial Condition and Results of Operations - Continued Net written premiums and combined ratios for AFC's property and casualty insurance subsidiaries were as follows (dollars in millions): Three months ended March 31, 1997 1996 Net Written Premiums (GAAP) NSA Group $329.7 $295.5 Specialty Operations 264.4 217.7 Commercial and Personal Operations 94.8 165.3 Other Lines - .1 $688.9 $678.6 Combined Ratios (GAAP) NSA Group 97.1% 101.9% Specialty Operations 92.7 90.0 Commercial and Personal Operations 102.9 103.7 Aggregate (including other lines) 98.5 99.6 NSA Group For the first three months of 1997, net written premiums of the NSA Group increased 12% from the comparable 1996 period due primarily to volume increases in California resulting from enactment of legislation which requires drivers to provide proof of insurance in order to obtain a valid permit. The improvement in the combined ratio reflects rate increases in various states over the last couple of years. Specialty Operations Net written premiums for the specialty operations increased 21% during the first three months of 1997 from the comparable 1996 period due to the impact of $30 million of premiums assumed on general aviation policies under a reinsurance agreement with American Eagle Insurance Company and the return of premiums related to the withdrawal from a voluntary pool in 1996. The combined ratio for the first three months of 1997 increased from the comparable 1996 period due in part to a reduction in underwriting profit in the California workers' compensation business. Underwriting results for the 1996 first quarter included reserve reductions prompted by fundamental changes in the California workers' compensation market and actuarial evaluations. Excluding the effects of such reserve reductions, first quarter 1997 underwriting results improved moderately as compared to 1996. Commercial and Personal Operations The 43% decrease in net written premiums for the commercial and personal operations from the comparable 1996 period was due primarily to a reinsurance agreement, effective January 1, 1997, under which 80% of all AFG's homeowners' business will be reinsured, and reduced writings of personal automobile coverages in certain states. Excluding the impact of the reinsurance agreement, premiums decreased 13%. Investment Income Investment income increased $10.3 million (5%) for the first quarter of 1997 compared to 1996 due primarily to an increase in the average amount of investments held. 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. Investee Corporations Equity in net earnings of investee corporations in 1997 represents AFC's proportionate share of Chiquita's earnings. Chiquita reported first quarter net income of $43.3 million for 1997 and $24.2 million for 1996. Chiquita's results for 1996 include $12 million of charges for damages resulting 14 AMERICAN FINANCIAL CORPORATION 10-Q Management's Discussion and Analysis of Financial Condition and Results of Operations - Continued from industry-wide flooding in Costa Rica. Included in earnings from investees in 1996 were losses of $330,000 attributable to AFC's investment in Citicasters which was sold in September 1996. Gains on Sales of Subsidiaries Gains on sales of subsidiaries represent pretax gains on the sales of a travel agency in 1997 and Buckeye Management Company in 1996. Annuity Benefits Annuity benefits expense increased slightly in the first three months of 1997 due to an increase in average funds accumulated. The rate at which interest is credited on annuity policyholders' funds is subject to change based on management's judgment of market conditions. Other Operating and General Expenses Included in other operating and general expenses are charges for minority interest of $9.5 million for the first quarter of 1997 compared to $11.4 million for the same period in 1996. ____________________________________________________________ 15 AMERICAN FINANCIAL CORPORATION 10-Q PART II OTHER INFORMATION Item 6 Exhibits and Reports on Form 8-K (a) Exhibit 27 - Financial Data Schedule - Included in Report filed electronically with the Securities and Exchange Commission. (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 May 12, 1997 BY:Fred J. Runk Fred J. Runk Senior Vice President and Treasurer 16 EX-27 2
5 This schedule contains summary financial information extracted from American Financial Corporation 10-Q for the three months ended March 31, 1997 and is qualified in its entirety by reference to such financial statements. 1,000 3-MOS DEC-31-1997 MAR-31-1997 $404,801 10,668,133 638,718 0 0 0 0 0 15,173,046 0 523,062 9,625 0 162,760 1,275,372 15,173,046 0 945,627 0 0 77,187 0 23,611 98,211 36,221 61,990 0 (55) 0 $61,935 0 0 Includes an investment in investees of $213 million. Not applicable since all common shares are owned by American Financial Group.
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