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SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-K
ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE
SECURITIES EXCHANGE ACT OF 1934
FOR THE FISCAL YEAR ENDED COMMISSION FILE
DECEMBER 31, 2001 NO. 1-13653
AMERICAN FINANCIAL GROUP, INC.
INCORPORATED UNDER IRS EMPLOYER I.D.
THE LAWS OF OHIO NO. 31-1544320
ONE EAST FOURTH STREET, CINCINNATI, OHIO 45202
(513) 579-2121
SECURITIES REGISTERED PURSUANT TO SECTION 12(B) OF THE ACT:
Name of Each Exchange
Title of Each Class on which Registered
------------------- -----------------------
AMERICAN FINANCIAL GROUP, INC.:
Common Stock New York Stock Exchange
7-1/8% Senior Debentures due December 15, 2007 New York Stock Exchange
7-1/8% Senior Debentures due April 15, 2009 New York Stock Exchange
AMERICAN FINANCIAL CAPITAL TRUST I (GUARANTEED BY REGISTRANT):
9-1/8% Trust Originated Preferred Securities New York Stock Exchange
SECURITIES REGISTERED PURSUANT TO SECTION 12(G) OF THE ACT: None
OTHER SECURITIES FOR WHICH REPORTS ARE SUBMITTED PURSUANT TO SECTION 15(D)
OF THE ACT: None
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
Indicate by check mark if disclosure of delinquent filers pursuant to
Item 405 of Regulation S-K is not contained herein, and need not be contained,
to the best of registrant's knowledge, in definitive proxy or information
statements incorporated by reference in Part III of this Form 10-K or any
amendment to this Form 10-K. [X]
As of March 1, 2002, there were 68,559,656 shares of the Registrant's
Common Stock outstanding, excluding 18,666,614 shares owned by subsidiaries. The
aggregate market value of the Common Stock held by nonaffiliates at that date
was approximately $1.1 billion (based upon nonaffiliate holdings of 39,993,711
shares and a market price of $26.32 per share.)
-------------
DOCUMENTS INCORPORATED BY REFERENCE:
Proxy Statement for the 2002 Annual Meeting of Shareholders (portions of
which are incorporated by reference into Part III hereof).
--------------------------------------------------------------------------------
AMERICAN FINANCIAL GROUP, INC.
INDEX TO ANNUAL REPORT
ON FORM 10-K
PAGE
PART I ----
Item 1 - Business:
Introduction 1
Property and Casualty Insurance Operations 1
Annuity and Life Operations 13
Other Companies 16
Investment Portfolio 17
Foreign Operations 18
Regulation 18
Item 2 - Properties 19
Item 3 - Legal Proceedings 20
Item 4 - Submission of Matters to a Vote of Security Holders (a)
PART II
Item 5 - Market for Registrant's Common Equity and Related
Stockholder Matters 22
Item 6 - Selected Financial Data 23
Item 7 - Management's Discussion and Analysis of Financial
Condition and Results of Operations 24
Item 7A - Quantitative and Qualitative Disclosures About
Market Risk 36
Item 8 - Financial Statements and Supplementary Data 36
Item 9 - Changes in and Disagreements with Accountants on
Accounting and Financial Disclosure (a)
PART III
Item 10 - Directors and Executive Officers of the Registrant 36
Item 11 - Executive Compensation 36
Item 12 - Security Ownership of Certain Beneficial Owners
and Management 36
Item 13 - Certain Relationships and Related Transactions 36
PART IV
Item 14 - Exhibits, Financial Statement Schedules and
Reports on Form 8-K S-1
(a) The response to this Item is "none".
------------------------------------------------
AMERICAN FINANCIAL GROUP, INC.
FORWARD-LOOKING STATEMENTS
THIS FORM 10-K, CHIEFLY IN ITEMS 1, 3, 5, 7 AND 8, CONTAINS CERTAIN
FORWARD-LOOKING STATEMENTS THAT ARE SUBJECT TO NUMEROUS ASSUMPTIONS, RISKS OR
UNCERTAINTIES. THE PRIVATE SECURITIES LITIGATION REFORM ACT OF 1995 PROVIDES A
SAFE HARBOR FOR FORWARD-LOOKING STATEMENTS. SOME OF THE FORWARD-LOOKING
STATEMENTS CAN BE IDENTIFIED BY THE USE OF FORWARD-LOOKING WORDS SUCH AS
"BELIEVES", "EXPECTS", "MAY", "WILL", "SHOULD", "SEEKS", "INTENDS", "PLANS",
"ESTIMATES", "ANTICIPATES" OR THE NEGATIVE VERSION OF THOSE WORDS OR OTHER
COMPARABLE TERMINOLOGY. EXAMPLES OF SUCH FORWARD-LOOKING STATEMENTS INCLUDE
STATEMENTS RELATING TO: EXPECTATIONS CONCERNING MARKET AND OTHER CONDITIONS AND
THEIR EFFECT ON FUTURE PREMIUMS, REVENUES, EARNINGS AND INVESTMENT ACTIVITIES;
EXPECTED LOSSES AND THE ADEQUACY OF RESERVES FOR ASBESTOS, ENVIRONMENTAL
POLLUTION AND MASS TORT CLAIMS; RATE INCREASES, IMPROVED LOSS EXPERIENCE AND
EXPECTED EXPENSE SAVINGS RESULTING FROM RECENT INITIATIVES.
ACTUAL RESULTS COULD DIFFER MATERIALLY FROM THOSE CONTAINED IN OR IMPLIED BY
SUCH FORWARD-LOOKING STATEMENTS FOR A VARIETY OF FACTORS INCLUDING:
o CHANGES IN ECONOMIC CONDITIONS, INCLUDING INTEREST RATES,
PERFORMANCE OF SECURITIES MARKETS, AND THE AVAILABILITY OF CAPITAL;
o REGULATORY ACTIONS;
o CHANGES IN LEGAL ENVIRONMENT;
o TAX LAW CHANGES;
o LEVELS OF CATASTROPHES AND OTHER MAJOR LOSSES;
o THE ULTIMATE AMOUNT OF LIABILITIES ASSOCIATED WITH CERTAIN ASBESTOS
AND ENVIRONMENTAL-RELATED INSURANCE CLAIMS;
o ADEQUACY OF LOSS RESERVES;
o AVAILABILITY OF REINSURANCE AND ABILITY OF REINSURERS TO PAY THEIR
OBLIGATIONS; AND
o COMPETITIVE PRESSURES, INCLUDING THE ABILITY TO OBTAIN RATE INCREASES.
THE FORWARD-LOOKING STATEMENTS HEREIN ARE MADE ONLY AS OF THE DATE OF THIS
REPORT. THE COMPANY ASSUMES NO OBLIGATION TO PUBLICLY UPDATE ANY FORWARD-LOOKING
STATEMENTS.
PART I
ITEM 1
BUSINESS
PLEASE REFER TO "FORWARD-LOOKING STATEMENTS" FOLLOWING THE INDEX IN FRONT OF
THIS FORM 10-K.
INTRODUCTION
American Financial Group, Inc. ("AFG") is a holding company which, through
its subsidiaries, is engaged primarily in specialty and private passenger
automobile insurance businesses and in the sale of tax-deferred annuities and
certain life and supplemental health insurance products. AFG's property and
casualty operations originated in the 1800's and make up one of the twenty-five
largest property and casualty groups in the United States based on statutory net
premiums written. AFG was incorporated as an Ohio corporation in July 1997. Its
address is One East Fourth Street, Cincinnati, Ohio 45202; its phone number is
(513) 579-2121.
AFG's predecessor had been formed in 1994 for the purpose of acquiring
American Financial Corporation ("AFC") and American Premier Underwriters, Inc.
("American Premier" or "APU") in merger transactions completed in April 1995.
At December 31, 2001, Carl H. Lindner, members of his immediate family and
trusts for their benefit (collectively the "Lindner Family") beneficially owned
approximately 44% of AFG's outstanding voting common stock.
Over the years, AFG and its predecessors have owned, operated, and
invested in businesses in a variety of industries and geographic areas,
culminating in today's group of insurance companies. Generally, AFG's interests
have been in the following areas: insurance, savings and loan, leasing, banking,
real estate, communications/entertainment and food distribution. A small number
of opportunistic investments have been made in troubled and other undervalued
assets.
Generally, companies have been included in AFG's consolidated financial
statements when the ownership of voting securities has exceeded 50%; for
investments below that level but above 20%, AFG has accounted for the
investments as investees. (See Note E to AFG's financial statements.)
PROPERTY AND CASUALTY INSURANCE OPERATIONS
AFG's property and casualty group is engaged primarily in specialty and
private passenger automobile insurance businesses which are managed as two major
business groups: Specialty and Personal. Each group reports to an individual
senior executive and is comprised of multiple business units which operate
autonomously but with certain strong central controls and full accountability.
Decentralized control allows each unit the autonomy necessary to respond to
local and specialty market conditions while capitalizing on the efficiencies of
centralized investment and administrative support functions. AFG's property and
casualty insurance operations employ approximately 7,300 persons.
In March 2001, AFG's Great American Insurance Group sold its Japanese
property and casualty division to Mitsui Marine & Fire Insurance Company of
America for $22 million in cash. At the same time, a reinsurance agreement under
which Great American ceded a portion of its pool of insurance to Mitsui was
terminated. The Japanese division generated net written premiums of
approximately $60 million per year to Great American while Great American ceded
approximately $45 million per year to Mitsui.
In connection with the sale of the Japanese division, and as was done with
a similar sale of Great American's Commercial lines division to Ohio Casualty
Corporation in 1998, Great American continues to write certain business for, and
fully reinsures it to, the respective purchasers of those divisions. Such
business generally does not appear in the tables and discussion herein.
1
In September 2000, AFG sold Stonewall Insurance Company for approximately
$31 million. Stonewall was a non-operating property and casualty subsidiary
engaged primarily in the run-off of approximately $170 million in asbestos and
environmental liabilities associated with policies written through 1991.
AFG operates in a highly competitive industry that is affected by many
factors which can cause significant fluctuations in its results of operations.
The industry has historically been subject to pricing cycles characterized by
periods of intense competition and lower premium rates (a "downcycle") followed
by periods of reduced competition, reduced underwriting capacity due to lower
policyholders' surplus and higher premium rates (an "upcycle"). After being in
an extended downcycle for over a decade, the property and casualty insurance
industry is experiencing significant market firming and price increases in
certain specialty markets and in the private passenger automobile market.
The primary objective of AFG's property and casualty insurance operations
is to achieve underwriting profitability. Underwriting profitability is measured
by the combined ratio which is a sum of the ratios of underwriting losses, loss
adjustment expenses ("LAE"), 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.
While many costs included in underwriting are readily determinable
(commissions, administrative expenses, many of the losses on claims reported),
the process of determining overall underwriting results is also highly dependent
upon the use of estimates in the case of losses incurred or expected but not yet
reported or developed. Actuarial procedures and projections are used to obtain
"best estimates" which are then included in the overall results. While the
process is imprecise and develops amounts which are subject to change over time,
AFG's projections, excluding asbestos and environmental ("A&E") claims, have
been close to the developed ultimate results, as can be seen in the "loss
triangles" on page 11.
AFG's property and casualty group, like many others in the industry, has
A&E claims arising in most cases from general liability policies written in
years before 1987. The establishment of reserves for such A&E claims presents
unique and difficult challenges and is subject to uncertainties significantly
greater than those presented by other types of claims. For a discussion of
uncertainties, see MANAGEMENT'S DISCUSSION AND ANALYSIS - "SPECIAL A&E CHARGE."
Management's focus on underwriting performance has resulted in a statutory
combined ratio averaging 104.4% for the period 1997 to 2001 (excluding special
charges in 1998 and 2001 to increase reserves for asbestos and other
environmental matters), as compared to 108.7% for the property and casualty
industry over the same period (Source: "Best's Review/Preview -
Property/Casualty" - January 2002 Edition). AFG believes that its product line
diversification and underwriting discipline have contributed to the Company's
ability to consistently outperform the industry's underwriting results.
Management's philosophy is to refrain from writing business that is not expected
to produce an underwriting profit even if it is necessary to limit premium
growth to do so.
Generally, while financial data is reported on a statutory basis for
insurance regulatory purposes, it is reported in accordance with generally
accepted accounting principles ("GAAP") for shareholder and other investment
purposes. In general, statutory accounting results in lower capital and surplus
and lower net earnings than result from application of GAAP. Major differences
include charging policy acquisition costs to expense as incurred rather than
spreading the costs over the periods covered by the policies; reporting
investment-grade bonds and redeemable preferred stocks at amortized cost;
netting of reinsurance recoverables and prepaid reinsurance premiums against the
corresponding liability; requiring additional loss reserves; and charging to
surplus certain assets, such as furniture and fixtures and agents' balances over
90 days old.
2
Unless indicated otherwise, the financial information presented for the
property and casualty insurance operations herein is presented based on GAAP.
The following table shows (in millions) certain information of AFG's
property and casualty insurance operations.
2001 2000 1999
---- ---- ----
STATUTORY BASIS
Premiums Earned $ 2,566 $2,484 $2,197
Admitted Assets 6,736 6,472 6,332
Unearned Premiums 1,158 1,154 1,005
Loss and LAE Reserves (net) 3,539 3,445 3,525
Capital and Surplus 1,669 1,763 1,664
GAAP BASIS
Premiums Earned $ 2,594 $2,495 $2,211
Total Assets 10,007 9,458 9,487
Unearned Premiums 1,641 1,414 1,326
Loss and LAE Reserves (gross)(*) 4,778 4,516 4,795
Shareholder's Equity 3,288 3,360 3,158
(*) GAAP loss and LAE reserves net of reinsurance recoverable were $3.3
billion at December 31, 2001 and $3.2 billion at December 31, 2000
and 1999.
The following table shows the segment, independent ratings, and size (in
millions) of AFG's major property and casualty insurance subsidiaries. AFG
continues to focus on growth opportunities in what it believes to be more
profitable specialty and private passenger auto businesses which represented the
bulk of 2001 net written premiums.
Net Written Premiums
--------------------
Company (Ratings - Am Best/S&P) Personal Specialty
--------------------------------------------------- -------- ---------
Great American Pool(a) A A $ 287 $ 969(b)
Republic Indemnity A- A - 236
Mid-Continent A A - 183
National Interstate A- - - 73
American Empire Surplus Lines A A - 75
Atlanta Casualty A- A 224 -
Infinity A A 242 -
Windsor A A 182 -
Leader A- A 93 -
Other 12 6
------ ------
$1,040 $1,542
====== ======
(a) The Great American Pool represents approximately 15 subsidiaries,
including Great American Insurance.
(b) Before a reduction of $29.7 million for unearned premium transfer
related to the sale of the Japanese division.
3
The following table shows the performance of AFG's property and casualty
insurance operations (dollars in millions):
2001 2000 1999
---- ---- ----
Net written premiums $2,582(a) $2,638 $2,263
====== ====== ======
Net earned premiums $2,594 $2,495 $2,211
Loss and LAE 1,980 1,962 1,589
Special A&E charge 100 - -
Underwriting expenses 737 732 661
Policyholder dividends 5 3 4
------ ------ ------
Underwriting loss ($ 228) ($ 202) ($ 43)
====== ====== ======
GAAP ratios:
Loss and LAE ratio 80.2% 78.6% 71.9%
Underwriting expense ratio 28.4 29.3 29.9
Policyholder dividend ratio .2 .1 .2
------ ------ ------
Combined ratio (b) 108.8% 108.0% 102.0%
====== ====== ======
Statutory ratios:
Loss and LAE ratio 81.1% 80.1% 73.4%
Underwriting expense ratio 28.3 28.4 30.0
Policyholder dividend ratio .3 .3 .3
------ ------ ------
Combined ratio (b) 109.7% 108.8% 103.7%
====== ====== ======
Industry statutory combined ratio (c) 117.0% 110.1% 107.8%
(a) Before a reduction of $29.7 million for unearned premium transfer
related to the sale of the Japanese division.
(b) The 2001 combined ratios include 3.9 percentage points for the
third quarter strengthening of insurance reserves relating to
A&E matters and 1 percentage point attributable to the attack on the
World Trade Center. The 2000 combined ratios include 1.4 percentage
points for reserve strengthening in AFG's California workers'
compensation business.
(c) Ratios are derived from "Best's Review/Preview - Property/Casualty"
(January 2002 Edition).
As with other property and casualty insurers, AFG's operating results can
be adversely affected by unpredictable catastrophe losses. Certain natural
disasters (hurricanes, tornadoes, floods, forest fires, etc.) and other
incidents of major loss (explosions, civil disorder, fires, etc.) are classified
as catastrophes by industry associations. Losses from these incidents are
usually tracked separately from other business of insurers because of their
sizable effects on overall operations. AFG generally seeks to reduce its
exposure to such events through individual risk selection and the purchase of
reinsurance. The major catastrophe in 2001 was the terrorist attack on the World
Trade Center. Total net losses to AFG's insurance operations from catastrophes
were $42 million in 2001; $8 million in 2000 and $24 million in 1999. These
amounts are included in the tables herein.
The casualty industry is examining the ultimate liability for damages in
the event of any future terrorist events. Efforts to add terrorist exclusions on
policies written since September 11, 2001 have been mixed as a number of states
have declined to approve the use of such exclusions or have limited the use and
scope of such exclusions to certain types of policies. There are no terrorism
exclusions on workers compensation policies. As a result, the industry will
continue to face exposure to losses arising from terrorist events even as it
attempts to find ways to mitigate this exposure.
Reinsurance that has been placed on behalf of AFG's property and casualty
group since September 11, 2001 contains either a complete terrorism exclusion or
more limited terrorism coverage than in prior years. Management is reviewing the
business it insures with consideration of the potential changed net exposure.
4
SPECIALTY
GENERAL The Specialty group emphasizes the writing of specialized
insurance coverage where AFG personnel are experts in particular lines of
business or customer groups. The following are examples of such specialty
businesses:
INLAND AND OCEAN MARINE Provides coverage primarily for marine
cargo, boat dealers, marina
operators/dealers, excursion
vessels, builder's risk,
contractor's equipment, excess
property and motor truck cargo.
WORKERS' COMPENSATION Writes coverage for prescribed
benefits payable to employees
(principally in California) who
are injured on the job.
AGRICULTURAL-RELATED Provides federally reinsured
multi-peril crop (allied lines)
insurance covering most perils
as well as crop hail, equine
mortality and other coverages
for full-time operating
farms/ranches and agribusiness
operations on a nationwide
basis.
EXECUTIVE AND PROFESSIONAL Markets liability coverage for
LIABILITY attorneys and for directors and
officers of businesses and
not-for-profit organizations.
FIDELITY AND SURETY BONDS Provides surety coverage for various
types of contractors and public
and private corporations and
fidelity and crime coverage for
government, mercantile and
financial institutions.
COLLATERAL PROTECTION Provides coverage for insurance
risk management programs for lending
and leasing institutions.
UMBRELLA AND EXCESS Provides primarily large liability
coverage in excess of primary layers.
Specialization is the key element to the underwriting success of these
business units. Each unit has independent management with significant operating
autonomy to oversee the important operational functions of its business such as
underwriting, pricing, marketing, policy processing and claims service. These
specialty businesses are opportunistic and their premium volume will vary based
on prevailing market conditions. AFG continually evaluates expansion in existing
markets and opportunities in new specialty markets that meet its profitability
objectives.
The U.S. geographic distribution of the Specialty group's statutory direct
written premiums in 2001 compared to 1997 is shown below.
2001 1997 2001 1997
---- ---- ---- ----
California 24.4% 23.3% Michigan 2.5% 2.4%
Texas 8.8 6.6 Georgia 2.2 *
New York 5.9 7.1 Pennsylvania 2.1 2.6
Florida 5.3 4.2 Massachusetts * 4.7
Illinois 3.7 3.6 North Carolina * 3.2
Oklahoma 3.6 2.8 Connecticut * 2.4
New Jersey 2.6 4.1 Other 36.4 30.6
Ohio 2.5 2.4 ----- -----
100.0% 100.0%
===== =====
---------------
(*) less than 2%
5
The following table sets forth a distribution of statutory net written
premiums for AFG's Specialty group by NAIC annual statement line for 2001
compared to 1997.
2001 1997
---- ----
Other liability 22.5% 18.1%
Workers' compensation 18.1 27.9
Inland marine 11.2 7.3
Auto liability 8.2 8.7
Collateral protection 7.0 *
Commercial multi-peril 6.9 13.5
Allied lines 6.2 4.5
Auto physical damage 5.9 3.6
Fidelity and surety 5.0 3.1
Ocean marine 3.4 2.8
Aircraft * 5.4
Other 5.6 5.1
----- -----
_______________ 100.0% 100.0%
===== =====
(*) less than 2%
The following table shows the performance of AFG's Specialty group
insurance operations (dollars in millions):
2001 2000 1999
---- ---- ----
Net written premiums $1,542(a) $1,324 $1,111
====== ====== ======
Net earned premiums $1,409 $1,223 $1,048
Loss and LAE 997 902 702
Underwriting expenses 430 413 370
Policyholder dividends 5 3 4
------ ------ ------
Underwriting profit (loss) ($ 23) ($ 95) ($ 28)
====== ====== ======
GAAP ratios:
Loss and LAE ratio 70.7% 73.8% 67.0%
Underwriting expense ratio 30.6 33.8 35.3
Policyholder dividend ratio .4 .3 .4
------ ------ ------
Combined ratio (b) 101.7% 107.9% 102.7%
====== ====== ======
Statutory ratios:
Loss and LAE ratio 73.6% 76.5% 70.2%
Underwriting expense ratio 30.5 31.4 34.8
Policyholder dividend ratio .5 .5 .5
------ ------ -----
Combined ratio (b) 104.6% 108.4% 105.5%
====== ====== =====
Industry statutory combined ratio (c) 118.0% 108.2% 109.8%
(a) Before a reduction of $29.7 million for unearned premium transfer
related to the sale of the Japanese division.
(b) The 2001 combined ratios include 1.8 percentage points attributable to
the attack on the World Trade Center. The 2000 combined ratios include
2.9 percentage points for reserve strengthening in AFG's California
workers' compensation business.
(c) Represents the commercial industry statutory combined ratio derived
from "Best's Review/Preview - Property/Casualty" (January 2002
Edition).
MARKETING The Specialty group operations direct their sales efforts
primarily through independent property and casualty insurance agents and
brokers, although portions are written through employee agents. These businesses
write insurance through several thousand agents and brokers and have
approximately 400,000 policies in force.
6
COMPETITION These businesses compete with other individual insurers, state
funds and insurance groups of varying sizes, some of which are mutual insurance
companies possessing competitive advantages in that all their profits inure to
their policyholders. They also compete with self-insurance plans, captive
programs and risk retention groups. Because of the specialty nature of these
coverages, competition is based primarily on service to policyholders and
agents, specific characteristics of products offered and reputation for claims
handling. Price, commissions and profit sharing terms are also important
factors. Management believes that sophisticated data analysis for refinement of
risk profiles, extensive specialized knowledge and loss prevention service have
helped AFG's Specialty group compete successfully.
PERSONAL
GENERAL The Personal group writes primarily private passenger automobile
liability and physical damage insurance, and to a lesser extent, homeowners'
insurance.
Historically, the majority of AFG's auto premiums has been from sales in
the nonstandard market covering drivers unable to obtain insurance through
standard market carriers due to factors such as age, record of prior accidents,
driving violations, particular occupation or type of vehicle. Though the
Personal group will continue to write coverage in this market, it has expanded
its approach to make personal automobile coverage available to drivers across a
full spectrum from preferred to nonstandard risks. AFG's approach to its auto
business is to develop tailored rates for its personal automobile customers
based on a variety of factors, including the driving record of the insureds, the
number of and type of vehicles covered, credit history, and other factors.
AFG's approach to homeowners business is to limit exposure in locations
which have significant catastrophic potential (such as windstorms, earthquakes
and hurricanes). Since 1997, AFG has ceded the majority of its homeowners'
business through reinsurance agreements; in 2001, it ceded 80% of this business.
The Personal group holds licenses to write policies in all states and the
District of Columbia. The U.S. geographic distribution of the Personal group's
statutory direct written premiums in 2001 compared to 1997, was as follows:
2001 1997 2001 1997
---- ---- ---- ----
California 21.1% 13.2% North Carolina *% 2.8%
New York 10.5 4.3 Indiana * 2.8
Florida 10.0 9.7 Tennessee * 2.4
Connecticut 8.9 8.9 Missouri * 2.2
Georgia 6.8 8.7 Oklahoma * 2.2
Pennsylvania 6.7 8.1 Mississippi * 2.0
Texas 5.1 5.9 Arizona * 2.0
New Jersey 3.0 2.8 Ohio * 2.0
Kentucky 2.7 2.0 Other 22.6 18.0
South Carolina 2.6 * ----- -----
100.0% 100.0%
===== =====
---------------
(*) less than 2%
The Personal group's underwriting strategy includes (i) using highly
defined risk profiles to segment the consumer market for proper pricing and (ii)
a focus on controlling underwriting and claims costs. Significant rate increases
implemented during 2001 contributed to improved operating results in the latter
part of the year. Management expects these improvements to continue in 2002.
Since April 1, 2001, AFG has been ceding 90% of the automobile physical damage
business written by certain subsidiaries under reinsurance agreements expiring
in December 2002.
7
The following table shows the performance of AFG's Personal group
insurance operations (dollars in millions):
2001 2000 1999
---- ---- ----
Net written premiums $1,040 $1,311 $1,154
====== ====== ======
Net earned premiums $1,183 $1,270 $1,163
Loss and LAE 970 1,061 881
Underwriting expenses 306 317 290
------ ------ ------
Underwriting profit (loss) ($ 93) ($ 108) ($ 8)
====== ====== ======
GAAP ratios:
Loss and LAE ratio 82.1% 83.6% 75.7%
Underwriting expense ratio 25.8 25.0 25.0
------ ------ ------
Combined ratio 107.9% 108.6% 100.7%
====== ====== ======
Statutory ratios:
Loss and LAE ratio 82.3% 83.9% 75.6%
Underwriting expense ratio 25.0 25.2 25.4
------ ------ ------
Combined ratio 107.3% 109.1% 101.0%
====== ====== ======
Industry statutory combined ratio (a) 112.5% 110.3% 105.4%
(a) Represents the personal lines industry statutory combined ratio
derived from "Best's Review/Preview - Property/Casualty" (January
2002 Edition).
MARKETING The Personal group operations direct their sales efforts
primarily through several thousand independent agents. In addition, AFG sells
its products directly to customers, including over the Internet. AFG currently
has the ability to sell over the Internet in 13 states which together represent
the majority of the U.S. auto market.
The Personal group had approximately 940,000 auto policies in force at
December 31, 2001, nearly 75% of which had policy limits of $50,000 or less per
occurrence.
COMPETITION A large number of national, regional and local insurers write
private passenger automobile and homeowners' insurance coverage. Insurers in
this market generally compete on the basis of price (including differentiation
on liability limits, variety of coverages offered and deductibles), geographic
presence and ease of enrollment and, to a lesser extent, reputation for claims
handling, financial stability and customer service. Management believes that
sophisticated data analysis for refinement of risk profiles has helped the
Personal group to compete successfully. The Personal group attempts to provide
selected pricing for a wider spectrum of risks and with a greater variety of
payment options, deductibles and limits of liability than are offered by many of
its competitors.
REINSURANCE
Consistent with standard practice of most insurance companies, AFG
reinsures a portion of its business with other insurance companies and assumes a
relatively small amount of business from other insurers. Ceding reinsurance
permits diversification of risks and limits the maximum loss arising from large
or unusually hazardous risks or catastrophic events. The availability and cost
of reinsurance are subject to prevailing market conditions which may affect the
volume and profitability of business that is written. AFG is subject to credit
risk with respect to its reinsurers, as the ceding of risk to reinsurers
generally does not relieve AFG of its liability to its insureds until claims are
fully settled.
8
Reinsurance is provided on one of two bases, facultative or treaty.
Facultative reinsurance is generally provided on a risk by risk basis.
Individual risks are ceded and assumed based on an offer and acceptance of risk
by each party to the transaction. Treaty reinsurance provides for risks meeting
prescribed criteria to be automatically ceded and assumed according to contract
provisions. The following table presents (by type of coverage) the amount of
each loss above the specified retention maximum generally covered by treaty
reinsurance programs (in millions):
Retention Reinsurance
Coverage Maximum Coverage(a)
-------- --------- -----------
California Workers' Compensation $ .5 (b)
Other Workers' Compensation 1.0 $49.0
Commercial Umbrella 1.0 49.0
Other Casualty 5.0 25.0
Property - General 5.0(c) 25.0(d)
Property - Catastrophe 10.0 65.0
(a) Reinsurance covers substantial portions of losses in excess of
retention.
(b) All amounts in excess of $500,000.
(c) Reduced to $2 million in 2002.
(d) Since 1997, AFG has ceded at least 80% of its homeowners insurance
coverage through reinsurance agreements. Since April 1, 2001, AFG
has ceded 90% of the automobile physical damage business written by
certain subsidiaries through December 2002.
AFG also purchases facultative reinsurance providing coverage on a risk by
risk basis, both pro rata and excess of loss, depending on the risk and
available reinsurance markets.
Included in the balance sheet caption "recoverables from reinsurers and
prepaid reinsurance premiums" were approximately $156 million on paid losses and
LAE and $1.5 billion on unpaid losses and LAE at December 31, 2001. The
collectibility of a reinsurance balance is based upon the financial condition of
a reinsurer as well as individual claim considerations. At December 31, 2001,
AFG's insurance subsidiaries had allowances of approximately $31 million for
doubtful collection of reinsurance recoverables.
In connection with the sales of the Japanese division to Mitsui in 2001
and the Commercial lines division to Ohio Casualty in 1998, Great American
agreed to issue and renew policies related to the businesses transferred until
each purchaser received the required approvals and licensing to begin writing
business on their own behalf. Under these agreements, which last for a few
years, Great American cedes 100% of these premiums to the respective purchaser.
In 2001, 2000 and 1999, premiums of $160 million, $209 million and $337 million,
respectively, were ceded under these agreements.
AFG regularly monitors the financial strength of its reinsurers. This
process periodically results in the transfer of risks to more financially secure
reinsurers. Substantially all reinsurance is ceded to reinsurers having more
than $100 million in capital and A.M. Best ratings of "A-" or better. Excluding
business ceded to Mitsui and Ohio Casualty (discussed above), the following
companies assumed approximately half of AFG's 2001 ceded reinsurance: Inter
Ocean Reinsurance (Ireland), Ltd., General Reinsurance Corporation, Swiss
Reinsurance America Corporation, P.D.S. Reinsurance Company, Ltd., American
Re-Insurance Company, X.L. Reinsurance America, Inc., Transatlantic Reinsurance
Company, Zurich Reinsurance North America, Inc., Berkley Insurance Company,
Employers Reinsurance Corporation, PMA Capital Insurance Company and
Folksamerica Reinsurance Company. Premiums written for reinsurance ceded and
assumed are presented in the following table (in millions):
2001 2000 1999
---- ---- ----
Reinsurance ceded $1,101 $803 $898
Reinsurance assumed - including
involuntary pools and associations 94 76 48
9
LOSS AND LOSS ADJUSTMENT EXPENSE RESERVES
The consolidated financial statements include the estimated liability for
unpaid losses and LAE of AFG's insurance subsidiaries. This liability represents
estimates of the ultimate net cost of all unpaid losses and LAE and is
determined by using case-basis evaluations and actuarial projections. These
estimates are subject to the effects of changes in claim amounts and frequency
and are periodically reviewed and adjusted as additional information becomes
known. In accordance with industry practices, such adjustments are reflected in
current year operations.
AFG recognizes underwriting profit only when realization is reasonably
determinable and assured. In certain specialty businesses, where experience is
limited or where there is potential for volatile results, AFG holds reasonable
"incurred but not reported" reserves and does not recognize underwriting profit
until the experience matures.
Generally, reserves for reinsurance and involuntary pools and associations
are reflected in AFG's results at the amounts reported by those entities.
10
The following discussion of insurance reserves includes the reserves of
American Premier's subsidiaries for only those periods following its acquisition
in 1995. See Note N to the Financial Statements for an analysis of changes in
AFG's estimated liability for losses and LAE, net and gross of reinsurance, over
the past three years on a GAAP basis.
The following table presents the development of AFG's liability for losses
and LAE, net of reinsurance, on a GAAP basis for the last ten years, excluding
reserves of American Premier subsidiaries prior to 1995. The top line of the
table shows the estimated liability (in millions) for unpaid losses and LAE
recorded at the balance sheet date for the indicated years. The second line
shows the re-estimated liability as of December 31, 2001. The remainder of the
table presents development as percentages of the estimated liability. The
development results from additional information and experience in subsequent
years. The middle line shows a cumulative deficiency (redundancy) which
represents the aggregate percentage increase (decrease) in the liability
initially estimated. The lower portion of the table indicates the cumulative
amounts paid as of successive periods as a percentage of the original loss
reserve liability. For purposes of this table, reserves of businesses sold are
considered paid at the date of sale. For example, the percentage of the December
31, 1997 reserve liability paid in 1998 includes approximately 10 percentage
points for reserves ceded in connection with the sale of the Commercial lines
division.
1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001
---- ---- ---- ---- ---- ---- ---- ---- ---- ---- ----
LIABILITY FOR UNPAID LOSSES
AND LOSS ADJUSTMENT EXPENSES:
----------------------------
As originally estimated $2,129 $2,123 $2,113 $2,187 $3,393 $3,404 $3,489 $3,305 $3,224 $3,192 $3,253
As re-estimated at
December 31, 2001 2,592 2,527 2,440 2,521 3,622 3,638 3,677 3,219 3,227 3,353 N/A
LIABILITY RE-ESTIMATED:
----------------------
One year later 99.3% 99.9% 98.1% 95.9% 98.7% 100.9% 104.5% 97.8% 98.1% 105.1%
Two years later 98.7% 98.2% 94.1% 99.3% 98.5% 105.9% 104.6% 96.3% 100.1%
Three years later 98.0% 95.2% 97.4% 99.9% 103.9% 105.2% 102.9% 97.4%
Four years later 97.3% 100.3% 98.9% 109.4% 103.1% 103.6% 105.4%
Five years later 103.0% 102.6% 109.7% 109.0% 102.9% 106.9%
Six years later 105.6% 113.6% 108.8% 108.5% 106.8%
Seven years later 116.9% 112.3% 108.5% 115.3%
Eight years later 115.2% 112.2% 115.5%
Nine years later 115.2% 119.1%
Ten years later 121.7%
Cumulative deficiency
(redundancy):
Aggregate 21.7% 19.1% 15.5% 15.3% 6.8% 6.9% 5.4% (2.6%) 0.1% 5.1% N/A
===== ===== ===== ===== ==== ==== ==== ==== ==== ==== ===
Excluding A&E (*) (0.3%) (0.7%) (3.2%) (2.8%) (4.8%) (2.3%) (3.6%) (5.6%) (3.0%) 1.9% N/A
==== ==== ==== ==== ==== ==== ==== ==== ==== ==== ===
CUMULATIVE PAID AS OF:
---------------------
One year later 26.4% 26.7% 25.2% 26.8% 33.1% 33.8% 41.7% 28.3% 34.8% 38.3%
Two years later 43.0% 43.7% 40.6% 42.5% 51.6% 58.0% 56.6% 51.7% 52.7%
Three years later 55.4% 54.2% 50.9% 54.4% 67.2% 66.7% 70.8% 62.4%
Four years later 63.3% 60.8% 59.1% 66.3% 72.0% 77.3% 78.6%
Five years later 67.8% 67.0% 68.0% 69.8% 80.4% 82.8%
Six years later 72.7% 74.0% 70.8% 80.0% 84.7%
Seven years later 78.6% 76.3% 80.6% 84.9%
Eight years later 80.5% 85.9% 85.1%
Nine years later 89.9% 89.5%
Ten years later 93.1%
(*) Excludes special A&E charges and reallocations in 1994, 1996, 1998 and 2001
for prior years' losses.
The following is a reconciliation of the net liability to the gross
liability for unpaid losses and LAE.
1993 1994 1995 1996 1997 1998 1999 2000 2001
---- ---- ---- ---- ---- ---- ---- ---- ----
As originally estimated:
Net liability shown above $2,113 $2,187 $3,393 $3,404 $3,489 $3,305 $3,224 $3,192 $3,253
Add reinsurance recoverables 611 730 704 720 736 1,468 1,571 1,324 1,525
------ ------ ------ ------ ------ ------ ------ ------ ------
Gross liability $2,724 $2,917 $4,097 $4,124 $4,225 $4,773 $4,795 $4,516 $4,778
====== ====== ====== ====== ====== ====== ====== ====== ======
As re-estimated at December 31, 2001:
Net liability shown above $2,440 $2,521 $3,622 $3,638 $3,677 $3,219 $3,227 $3,353
Add reinsurance recoverables 819 762 1,015 1,043 1,099 1,753 1,773 1,413
------ ------ ------ ------ ------ ------ ------ ------
Gross liability $3,259 $3,283 $4,637 $4,681 $4,776 $4,972 $5,000 $4,766 N/A
====== ====== ====== ====== ====== ====== ====== ====== ===
Gross cumulative deficiency
(redundancy) 19.5% 12.6% 13.2% 13.5% 13.0% 4.2% 4.3% 5.5% N/A
==== ==== ==== ==== ==== === === === ===
These tables do not present accident or policy year development data.
Furthermore, in evaluating the re-estimated liability and cumulative deficiency
(redundancy), it should be noted that each percentage includes the effects of
changes in amounts for prior periods. For example, AFG's $100 million special
11
charge for A&E claims related to losses recorded in 2001, but incurred before
1991, is included in the re-estimated liability and cumulative deficiency
(redundancy) percentage for each of the previous years shown. Conditions and
trends that have affected development of the liability in the past may not
necessarily exist in the future. Accordingly, it may not be appropriate to
extrapolate future redundancies or deficiencies based on this table.
The adverse development in the tables is due primarily to A&E exposures
for which AFG has been held liable under general liability policies written
years ago where such coverage was not intended. Other factors affecting
development included higher than projected inflation on medical,
hospitalization, material, repair and replacement costs. Additionally, changes
in the legal environment have influenced the development patterns over the past
ten years. For example, changes in the California workers' compensation law in
1993 and subsequent court decisions, primarily in late 1996, greatly limited the
ability of insurers to challenge medical assessments and treatments. These
limitations, together with changes in work force characteristics and medical
delivery costs, are contributing to an increase in claims severity.
The differences between the liability for losses and LAE reported in the
annual statements filed with the state insurance departments in accordance with
statutory accounting principles ("SAP") and that reported in the accompanying
consolidated financial statements in accordance with GAAP at December 31, 2001
are as follows (in millions):
Liability reported on a SAP basis, net of $310 million
of retroactive reinsurance $3,229
Additional discounting of GAAP reserves in excess
of the statutory limitation for SAP reserves (12)
Reserves of foreign operations 5
Reinsurance recoverables, net of allowance 1,525
Reclassification of allowance for uncollectible
reinsurance 31
------
Liability reported on a GAAP basis $4,778
======
ASBESTOS AND ENVIRONMENTAL RESERVES ("A&E") In addressing asbestos and
environmental reserves, the insurance industry typically includes claims
relating to polluted waste sites and asbestos as well as other mass tort claims
such as those relating to breast implants, repetitive stress on keyboards, DES
(a drug used in pregnancies years ago alleged to cause cancer and birth defects)
and other latent injuries.
Establishing reserves for A&E claims is subject to uncertainties that are
significantly greater than those presented by other types of claims. For a
discussion of these uncertainties, see LEGAL PROCEEDINGS, MANAGEMENT'S
DISCUSSION AND ANALYSIS - "UNCERTAINTIES - PROPERTY AND CASUALTY INSURANCE
RESERVES", "UNCERTAINTIES - LITIGATION", AND "SPECIAL A&E CHARGE" AND NOTE L -
"COMMITMENTS AND CONTINGENCIES" TO THE FINANCIAL STATEMENTS.
The survival ratio, which is an industry measure of A&E claim reserves, is
derived by dividing reserves for A&E exposures by annual paid losses. At
December 31, 2001, AFG's three year survival ratio (after adjusting for the sale
of Stonewall) is approximately 12.2 times paid losses. In November 2001, A.M.
Best reported its estimate that the property and casualty insurance industry's
three year survival ratio was approximately 6.7 times paid losses at December
31, 2000.
12
The following table (in millions) is a progression of A&E reserves.
2001 2000 1999
---- ---- ----
Reserves at beginning of year $357.7 $576.7 $625.4
Incurred losses and LAE (a) 108.0 (1.9) .1
Paid losses and LAE (28.1) (48.7) (48.8)
Reserves not classified as A&E prior to 2001:
Reserves 1.4 - -
Allowance for uncollectible reinsurance
applicable to ceded A&E reserves 7.8 - -
Reserves transferred with sale of Stonewall - (168.4) -
------ ------ ------
Reserves at end of year, net of
reinsurance recoverable 446.8 357.7 576.7
Reinsurance recoverable, net of allowance 101.4 105.7 219.8
------ ------ ------
Gross reserves at end of year $548.2 $463.4 $796.5
====== ====== ======
(a) Includes a special charge of $100 million in 2001.
ANNUITY AND LIFE OPERATIONS
GENERAL
AFG's annuity and life operations are conducted through Great American
Financial Resources, Inc. ("GAFRI"), a holding company which markets retirement
products, primarily fixed and variable annuities, and various forms of life and
supplemental health insurance through the following subsidiaries which were
acquired in the years shown. GAFRI and its subsidiaries employ approximately
1,900 persons.
Great American Life Insurance Company ("GALIC") - 1992(*)
Annuity Investors Life Insurance Company ("AILIC") - 1994
Loyal American Life Insurance Company ("Loyal") - 1995
Great American Life Assurance Company of Puerto Rico ("GAPR") - 1997
United Teacher Associates Insurance Company ("UTA") - 1999
(*) Acquired from Great American Insurance.
Acquisitions in recent years have supplemented GAFRI's internal growth as
the assets of the holding company and its operating subsidiaries have increased
from $4.5 billion at the end of 1992 to $8.4 billion at the end of 2001.
Premiums over the last three years were as follows (in millions):
INSURANCE PRODUCT(*) 2001 2000 1999
----------------- ---- ---- ----
Annuities $ 751 $ 747 $588
Life and supplemental health 310 261 126
------ ------ ----
$1,061 $1,008 $714
====== ====== ====
----------------
(*) Table does not include premiums of subsidiaries or divisions
until their first full year following acquisition or formation.
ANNUITIES
GAFRI's principal retirement products are Flexible Premium Deferred
Annuities ("FPDAs") and Single Premium Deferred Annuities ("SPDAs"). Annuities
are long-term retirement saving instruments that benefit from income accruing on
a tax-deferred basis. The issuer of the annuity collects premiums, credits
interest or earnings on the policy and pays out a benefit upon death, surrender
or annuitization. FPDAs are characterized by premium payments that are flexible
in both amount and timing as determined by the policyholder. SPDAs are issued in
exchange for a one-time lump-sum premium payment.
13
The following table (in millions) presents combined financial information
of GAFRI's principal annuity operations.
2001 2000 1999
---- ---- ----
GAAP BASIS
Total Assets $7,456 $7,052 $6,657
Fixed Annuity Reserves 5,632 5,365 5,349
Variable Annuity Reserves 530 534 354
Stockholder's Equity 1,023 915 801
STATUTORY BASIS
Total Assets $6,896 $6,620 $6,493
Fixed Annuity Reserves 5,729 5,536 5,564
Variable Annuity Reserves 530 534 354
Capital and Surplus 388 363 404
Asset Valuation Reserve (a) 79 77 67
Interest Maintenance Reserve (a) 11 3 10
Annuity Receipts:
Flexible Premium:
First Year $ 67 $ 71 $ 55
Renewal 176 157 145
------ ------ ------
243 228 200
Single Premium 508 519 388
------ ------ ------
Total Annuity Receipts $ 751 $ 747 $ 588
====== ====== ======
----------------
(a) Allocation of surplus.
Sales of annuities are affected by many factors, including: (i)
competitive annuity products and rates; (ii) the general level of interest
rates; (iii) the favorable tax treatment of annuities; (iv) commissions paid to
agents; (v) services offered; (vi) ratings from independent insurance rating
agencies; (vii) other alternative investments; (viii) performance of the equity
markets and (ix) general economic conditions. At December 31, 2001, GAFRI had
over 290,000 annuity policies in force.
Annuity contracts are generally classified as either fixed rate (including
equity-indexed) or variable. The following table presents premiums by
classification:
PREMIUMS 2001 2000 1999
-------- ---- ---- ----
Traditional fixed 68% 50% 55%
Variable 27 43 35
Equity-indexed 5 7 10
--- --- ---
100% 100% 100%
=== === ===
With a traditional fixed rate annuity, the interest crediting rate is
initially set by the issuer and thereafter may be changed from time to time by
the issuer subject to any guaranteed minimum interest crediting rates or any
guaranteed term in the policy.
GAFRI seeks to maintain a desired spread between the yield on its
investment portfolio and the rate it credits to its fixed rate annuities. GAFRI
accomplishes this by: (i) offering crediting rates which it has the option to
change; (ii) designing annuity products that encourage persistency and (iii)
maintaining an appropriate matching of assets and liabilities. GAFRI designs its
products with certain provisions to encourage policyholders to maintain their
funds with GAFRI for at least five to ten years. Partly due to these features,
annuity surrenders have averaged nearly 11% of related statutory reserves over
the past five years.
All of GAFRI's traditional fixed rate annuities offer a minimum interest
rate guarantee of 3% or 4%; the majority permit GAFRI to change the crediting
rate at any time (subject to the minimum guaranteed interest rates). In
determining the frequency and extent of changes in the crediting rate, GAFRI
takes into account the economic environment and the relative competitive
position of its products.
14
Sales of GAFRI's fixed rate annuities have increased over the past two
years, due to the weak stock market environment, as well as the development of
new fixed rate products with multi-year guarantee periods and certain features
designed to assist the elderly.
In addition to traditional fixed rate annuities, GAFRI offers variable and
equity-indexed annuities. Industry sales of such annuities have increased
substantially over the last ten years as investors have sought to obtain the
returns available in the equity markets while enjoying the tax-deferred status
of annuities. With the downturn in the stock market during the past two years,
industry-wide sales of variable and equity-indexed annuities, including GAFRI's
sales, have decreased substantially in 2001. With a variable annuity, the
earnings credited to the policy vary based on the investment results of the
underlying investment options chosen by the policyholder, generally without any
guarantee of principal except in the case of death of the insured annuitant.
Premiums directed to the variable options in policies issued by GAFRI are
invested in funds maintained in separate accounts managed by various independent
investment managers. GAFRI earns a fee on amounts deposited into variable
accounts. Policyholders may also choose to direct all or a portion of their
premiums to various fixed rate options, in which case GAFRI earns a spread on
amounts deposited.
An equity-indexed fixed annuity provides policyholders with a crediting
rate tied, in part, to the performance of an existing stock market index while
protecting them against the related downside risk through a guarantee of
principal. GAFRI purchases call options designed to offset substantially all of
the increase in the liabilities associated with equity-indexed annuities.
In 2001, 2000 and 1999, 17%, 24% and 25%, respectively, of GAFRI's
retirement annuity premiums came from California. In 2001, 13% of GAFRI's
retirement annuity premiums came from Ohio. No other state accounted for more
than 10% of premiums in those years.
GAFRI's FPDAs are sold primarily to employees of not-for-profit and
commercial organizations who are eligible to save for retirement through
contributions made on a before-tax or after-tax basis. Contributions are made at
the discretion of the participants through payroll deductions or through
tax-free "rollovers" of funds from other qualified investments. Federal income
taxes are not payable on pretax contributions or earnings until amounts are
withdrawn.
GAFRI distributes its fixed rate and equity-indexed products primarily
through a network of 150 managing general agents who, in turn, direct more than
750 actively producing independent agents. In addition, GAFRI offers all of its
annuity product lines through financial institutions. Sales of annuities through
financial institutions were approximately one-sixth of total annuity premiums in
2001.
GAFRI distributes its variable annuity products through nearly 700
actively producing registered representatives representing more than 200
broker/dealers. Approximately one-third of GAFRI's variable annuity sales in
2001 were made through a wholly-owned subsidiary, Great American Advisors, Inc.
("GAA"). GAA is a broker/dealer licensed in all 50 states to sell stocks, bonds,
options, mutual funds and variable insurance contracts through independent
representatives and financial institutions. GAA also acts as the principal
underwriter and distributor for GAFRI's variable annuity products.
LIFE AND SUPPLEMENTAL INSURANCE
GAFRI offers a variety of life and supplemental health products through
GALIC's life operations, Loyal, GAPR and UTA. This group produced $310 million
of statutory premiums in 2001. It also had in excess of 800,000 policies and $15
billion face amount of life insurance in force. GALIC offers traditional term,
universal and whole life insurance products through national marketing
organizations.
In October 1999, GAFRI acquired UTA, a provider of supplemental health
products and annuities through independent agents. UTA's principal product
offerings are annuities and coverage for Medicare supplement, cancer and
long-term care. UTA also purchases blocks of insurance policies from other
companies. In 2000, UTA acquired approximately 50,000 Medicare supplement and
cancer policies.
15
Loyal offers a variety of supplemental health and life products. The
principal products sold by Loyal include cancer, accidental injury, short-term
disability, hospital indemnity, universal life and traditional whole life. In
2001, Loyal reinsured a substantial portion of its life insurance business and
expects to reduce its marketing efforts in the future.
GAPR sells in-home service life and supplemental health products through a
network of company-employed agents. Ordinary life, cancer, credit and group life
products are sold through independent agents.
INDEPENDENT RATINGS
GAFRI's principal insurance subsidiaries are rated by Standard & Poor's and
A.M. Best. In addition, GALIC is rated A3 (good financial security) by Moody's.
Such ratings are generally based on items of concern to policyholders and agents
and are not directed toward the protection of investors.
Standard
& Poor's A.M. Best
--------- -------------
GALIC A (Strong) A (Excellent)
AILIC A (Strong) A (Excellent)
Loyal A (Strong) A (Excellent)
UTA Not rated A- (Excellent)
GAPR Not rated A (Excellent)
GAFRI believes that the ratings assigned by independent insurance rating
agencies are important because potential policyholders often use a company's
rating as an initial screening device in considering annuity products. GAFRI
believes that a rating in the "A" category by at least one rating agency is
necessary to successfully market tax-deferred annuities to public education
employees and other not-for-profit groups.
Although GAFRI believes that its insurance companies' ratings are stable,
those companies' operations could be materially and adversely affected by a
downgrade in ratings.
COMPETITION
GAFRI's insurance companies operate in highly competitive markets. They
compete with other insurers and financial institutions based on many factors,
including: (i) ratings; (ii) financial strength; (iii) reputation; (iv) service
to policyholders and agents; (v) product design (including interest rates
credited and premium rates charged); and (vi) commissions. Since policies are
marketed and distributed primarily through independent agents (except at GAPR),
the insurance companies must also compete for agents.
No single insurer dominates the markets in which GAFRI's insurance
companies compete. Competitors include (i) individual insurers and insurance
groups, (ii) mutual funds and (iii) other financial institutions. In a broader
sense, GAFRI's insurance companies compete for retirement savings with a variety
of financial institutions offering a full range of financial services. Financial
institutions have demonstrated a growing interest in marketing investment and
savings products other than traditional deposit accounts.
OTHER COMPANIES
Through subsidiaries, AFG is engaged in a variety of other businesses,
including The Golf Center at Kings Island (golf and tennis facility) in the
Greater Cincinnati area; commercial real estate operations in Cincinnati (office
buildings and The Cincinnatian Hotel), New Orleans (Le Pavillon Hotel), Cape Cod
(Chatham Bars Inn), Austin (Driskill Hotel), Chesapeake Bay (Skipjack Cove
Yachting Resort) and apartments in Louisville, Pittsburgh, St. Paul and Tampa
Bay. These operations employ approximately 600 full-time employees.
16
INVESTMENT PORTFOLIO
GENERAL
The following tables present the percentage distribution and yields of
AFG's investment portfolio (excluding investment in equity securities of
investee corporations) as reflected in its financial statements.
2001 2000 1999 1998 1997
---- ---- ---- ---- ----
Cash and Short-term Investments 4.5% 3.8% 3.5% 2.6% 2.1%
Fixed Maturities:
U.S. Government and Agencies 8.3 4.7 4.9 4.4 5.0
State and Municipal 3.4 3.6 2.7 1.2 1.3
Public Utilities 6.4 5.5 5.1 6.0 6.8
Mortgage-Backed Securities 21.8 22.7 22.0 20.8 21.4
Corporate and Other 47.3 51.4 55.3 53.0 52.3
Redeemable Preferred Stocks .5 .5 .6 .5 .6
----- ----- ----- ----- -----
87.7 88.4 90.6 85.9 87.4
Net Unrealized Gains (Losses) on
fixed maturities held
Available for Sale 1.3 .1 (2.1) 3.5 2.5
----- ----- ----- ----- -----
89.0 88.5 88.5 89.4 89.9
Other Stocks, Options and Warrants 2.6 3.4 3.7 3.7 3.7
Policy Loans 1.7 1.9 1.9 1.9 2.0
Real Estate and Other Investments 2.2 2.4 2.4 2.4 2.3
----- ----- ----- ----- -----
100.0% 100.0% 100.0% 100.0% 100.0%
===== ===== ===== ===== =====
Yield on Fixed Income Securities:
Excluding realized gains and losses 7.6% 7.7% 7.7% 7.8% 7.8%
Including realized gains and losses 7.5% 7.4% 7.6% 8.0% 7.9%
Yield on Stocks:
Excluding realized gains and losses 4.5% 5.0% 5.9% 5.4% 5.6%
Including realized gains and losses (.3%) 3.9% 20.7% (5.3%) 30.2%
Yield on Investments (*):
Excluding realized gains and losses 7.6% 7.6% 7.7% 7.8% 7.8%
Including realized gains and losses 7.4% 7.4% 7.9% 7.8% 8.2%
(*) Excludes "Real Estate and Other Investments".
FIXED MATURITY INVESTMENTS
AFG's bond portfolio is invested primarily in taxable bonds. The NAIC
assigns quality ratings which range from Class 1 (highest quality) to Class 6
(lowest quality). The following table shows AFG's bonds and redeemable preferred
stocks, by NAIC designation (and comparable Standard & Poor's Corporation
rating) as of December 31, 2001 (dollars in millions).
Market Value
NAIC Amortized -----------------
Rating Comparable S&P Rating Cost Amount %
------ --------------------- --------- --------- -----
1 AAA, AA, A $ 7,515 $ 7,718 72%
2 BBB 2,232 2,242 21
------- ------- ---
Total investment grade 9,747 9,960 93
------- ------- ---
3 BB 375 356 3
4 B 312 275 3
5 CCC, CC, C 144 143 1
6 D 15 15 *
------- ------- ---
Total noninvestment grade 846 789 7
------- ------- ---
Total $10,593 $10,749 100%
======= ======= ===
-------------------
(*) Less than 1%
Risks inherent in connection with fixed income securities include loss
upon default and market price volatility. Factors which can affect the market
price of securities include: creditworthiness, changes in interest rates, the
number of market makers and investors and defaults by major issuers of
securities.
17
AFG's primary investment objective for fixed maturities is to earn
interest and dividend income rather than to realize capital gains. AFG invests
in bonds and redeemable preferred stocks that have primarily short-term and
intermediate-term maturities. This practice allows flexibility in reacting to
fluctuations of interest rates.
EQUITY INVESTMENTS
AFG's equity investment practice permits concentration of attention on a
relatively limited number of companies. At December 31, 2001, AFG held $314
million in stocks and warrants; approximately 60% represents an investment in
Provident Financial Group, Inc., a Cincinnati-based commercial banking and
financial services company; another 20% consists of four investments of more
than $10 million each. Such equity investments, because of their size, may not
be as readily marketable as the typical small investment position.
Alternatively, a large equity position may be attractive to persons seeking to
control or influence the policies of a company and AFG's concentration in a
relatively small number of companies may permit it to identify investments with
above average potential to increase in value.
CHIQUITA At December 31, 2001, AFG owned 24 million shares of Chiquita
common stock (book value $16 million) representing 31% of its outstanding
shares. In March 2002, Chiquita completed a reorganization under Chapter 11 of
the U.S. Bankruptcy Code. In exchange for its "old" Chiquita shares, AFG
received approximately 171,000 "new" shares (less than one-half of 1%) in the
reorganized company plus warrants expiring in 2009 to purchase an additional 2.9
million shares at $19.23 per share.
FOREIGN OPERATIONS
AFG sells life and supplemental health products in Puerto Rico and
property and casualty products in Mexico, Canada, Puerto Rico, Europe and Asia.
In addition, GAFRI has an office in India where employees perform computer
programming and certain back office functions. Less than 3% of AFG's revenues
and costs and expenses are derived from foreign sources.
REGULATION
AFG's insurance company subsidiaries are subject to regulation in the
jurisdictions where they do business. In general, the insurance laws of the
various states establish regulatory agencies with broad administrative powers
governing, among other things, premium rates, solvency standards, licensing of
insurers, agents and brokers, trade practices, forms of policies, maintenance of
specified reserves and capital for the protection of policyholders, deposits of
securities for the benefit of policyholders, investment activities and
relationships between insurance subsidiaries and their parents and affiliates.
Material transactions between insurance subsidiaries and their parents and
affiliates generally must be disclosed and prior approval of the applicable
insurance regulatory authorities generally is required for any such transaction
which may be deemed to be material or extraordinary. In addition, while
differing from state to state, these regulations typically restrict the maximum
amount of dividends that may be paid by an insurer to its shareholders in any
twelve-month period without advance regulatory approval. Such limitations are
generally based on net earnings or statutory surplus. Under applicable
restrictions, the maximum amount of dividends available to AFG in 2002 from its
insurance subsidiaries without seeking regulatory clearance is approximately $92
million.
Changes in state insurance laws and regulations have the potential to
materially affect the revenues and expenses of the insurance operations. For
example, between July 1993 and January 1995, the California Commissioner ordered
reductions in workers' compensation insurance premium rates totaling more than
30% and subsequently replaced the workers' compensation insurance minimum rate
law with an "open rating" policy. The Company is unable to predict whether or
when other state insurance laws or regulations may be adopted or enacted or what
the impact of such developments would be on the future operations and revenues
of its insurance businesses.
18
Most states have created insurance guaranty associations to provide for
the payment of claims of insurance companies that become insolvent. Annual
assessments for AFG's insurance companies have not been material. In addition,
many states have created "assigned risk" plans or similar arrangements to
provide state mandated minimum levels of automobile liability coverage to
drivers whose driving records or other relevant characteristics make it
difficult for them to obtain insurance otherwise. Automobile insurers in those
states are required to provide such coverage to a proportionate number of those
drivers applying as assigned risks. Premium rates for assigned risk business are
established by the regulators of the particular state plan and are frequently
inadequate in relation to the risks insured, resulting in underwriting losses.
Assigned risks accounted for less than one percent of AFG's net written premiums
in 2001.
The NAIC is an organization which is comprised of the chief insurance
regulator for each of the 50 states and the District of Columbia. The NAIC model
law for Risk Based Capital applies to both life and property and casualty
companies. The risk-based capital formulas determine the amount of capital that
an insurance company needs to ensure that it has an acceptably low expectation
of becoming financially impaired. The model law provides for increasing levels
of regulatory intervention as the ratio of an insurer's total adjusted capital
and surplus decreases relative to its risk-based capital, culminating with
mandatory control of the operations of the insurer by the domiciliary insurance
department at the so-called "mandatory control level". At December 31, 2001, the
capital ratios of all AFG insurance companies substantially exceeded the
risk-based capital requirements.
----------------------------------------
ITEM 2
PROPERTIES
----------
Subsidiaries of AFG own several buildings in downtown Cincinnati. AFG and
its affiliates occupy about three-fourths of the aggregate 660,000 square feet
of commercial and office space.
AFG's insurance subsidiaries lease the majority of their office and
storage facilities in numerous cities throughout the United States, including
Great American's and GAFRI's home offices in Cincinnati. A GAFRI subsidiary owns
a 40,000 square foot office building in Austin, Texas, most of which is used by
the company for its operations.
AFG subsidiaries own transferable rights to develop approximately 1.3
million square feet of floor space in the Grand Central Terminal area in New
York City. The development rights were derived from ownership of the land upon
which the terminal is constructed.
19
ITEM 3
LEGAL PROCEEDINGS
PLEASE REFER TO "FORWARD-LOOKING STATEMENTS" FOLLOWING THE INDEX IN FRONT OF
THIS FORM 10-K.
AFG and its subsidiaries are involved in various litigation, most of which
arose in the ordinary course of business, including litigation alleging bad
faith in dealing with policyholders and challenging certain business practices
of insurance subsidiaries. Except for the following, management believes that
none of the litigation meets the threshold for disclosure under this Item.
AFG's insurance company subsidiaries and American Premier are parties to
litigation and receive claims asserting alleged injuries and damages from
asbestos, environmental and other substances and workplace hazards and have
established loss accruals for such potential liabilities. The ultimate loss for
these claims may vary materially from amounts currently recorded as the
conditions surrounding resolution of these claims continue to change.
American Premier is a party or named as a potentially responsible party in
a number of proceedings and claims by regulatory agencies and private parties
under various environmental protection laws, including the Comprehensive
Environmental Response, Compensation and Liability Act ("CERCLA"), seeking to
impose responsibility on American Premier for hazardous waste remediation costs
at certain railroad sites formerly owned by its predecessor, Penn Central
Transportation Company ("PCTC"), and at certain other sites where hazardous
waste allegedly generated by PCTC's railroad operations is present. It is
difficult to estimate American Premier's liability for remediation costs at
these sites for a number of reasons, including the number and financial
resources of other potentially responsible parties involved at a given site, the
varying availability of evidence by which to allocate responsibility among such
parties, the wide range of costs for possible remediation alternatives, changing
technology and the period of time over which these matters develop.
Nevertheless, American Premier believes that its accruals for potential
pre-reorganization environmental liabilities are adequate to cover the probable
amount of such liabilities, based on American Premier's estimates of remediation
costs and related expenses and its estimates of the portions of such costs that
will be borne by other parties. Such estimates are based on information
currently available to American Premier and are subject to future change as
additional information becomes available. American Premier seeks reimbursement
from certain insurers for portions of whatever remediation costs it incurs.
In terms of potential liability to American Premier, the company believes
that the most significant site is the railyard at Paoli, Pennsylvania ("Paoli
Yard") which PCTC transferred to Consolidated Rail Corporation ("Conrail") in
1976. A Record of Decision issued by the U.S. Environmental Protection Agency in
1992 presented a final selected remedial action for clean-up of polychlorinated
biphenyls ("PCB's") at Paoli Yard having an estimated cost of approximately $28
million. American Premier has accrued its portion of such estimated clean-up
costs in its financial statements (in addition to other expenses) but has not
accrued the entire amount because it believes it is probable that other parties,
including Conrail, will be responsible for substantial percentages of the
clean-up costs by virtue of their operation of electrified railroad cars at
Paoli Yard that discharged PCB's at higher levels than discharged by cars
operated by PCTC.
On February 14, 2002, A.P. Green Industries, Inc. and its subsidiary, A.P.
Green Services, Inc. (the "Policyholders") filed petitions for bankruptcy under
Chapter 11 of the Bankruptcy Code. Great American Insurance Company and certain
other insurers are parties to litigation with the Policyholders involving
liability coverage for a substantial number of asbestos related bodily injury
claims that have been asserted against the Policyholders. These claims (some of
which are direct actions against Great American) allege that the refractory
materials manufactured, sold or installed by the Policyholders contained
asbestos and resulted in bodily injury from exposure to asbestos. The
Policyholders seek to recover defense and indemnity expenses related to those
claims from a number of insurers, including Great American, and in an effort to
maximize coverage assert that Great American's policies on various grounds are
not subject to aggregate limits on liability, that each exposure alleged by a
claimant constitutes a separate occurrence, and that each insurer is required
20
to pay all sums the Policyholders become legally obliged to pay. Prior to the
bankruptcy filing, Great American sought to have these coverage issues decided
as part of a contribution and declaratory judgment action that it brought
several years earlier (GREAT AMERICAN INSURANCE COMPANY, ET AL. V. THE ROYAL
INSURANCE COMPANY, ET AL., United States District Court, Southern District of
Ohio, filed January 29, 1998)(the "District Court Action") and asked the court
to declare, among other things, that all asbestos bodily injury claims against
the Policyholders constitute not more than one occurrence, are subject to a
$1,000,000 aggregate limit under each of the four Great American policies at
issue in the action, and should be allocated among triggered policies and
implicated years on a pro rata basis. Great American believes that its coverage
defenses are substantial and intends to vigorously defend its position. The
bankruptcy filing, however, stays the District Court Action unless the
Bankruptcy Court for the Western District of Pennsylvania modifies the stay to
permit the District Court Action to proceed. On March 20, 2002, Great American
and certain other insurers filed a motion in the Bankruptcy Court to modify the
stay. On March 27, 2002, the Policyholders filed adversary proceedings in the
Bankruptcy Court to decide the coverage issues. If the stay is not modified or
the adversary proceedings are permitted to go forward in the Bankruptcy Court,
then the resolution of these disputes will be subject to the complexities and
uncertainties associated with a Chapter 11 proceeding.
For a discussion of the uncertainties relative to confronting asbestos and
environmental claims, see BUSINESS - "ASBESTOS AND ENVIRONMENTAL RESERVES
('A&E')", MANAGEMENT'S DISCUSSION AND ANALYSIS - "UNCERTAINTIES - PROPERTY AND
CASUALTY INSURANCE RESERVES", "UNCERTAINTIES - LITIGATION", AND "SPECIAL A&E
CHARGE" AND NOTE L - "COMMITMENTS AND CONTINGENCIES" TO THE FINANCIAL
STATEMENTS. As a consequence of these uncertainties, the outcome of the
litigation relating to asbestos and environmental matters may result in
liabilities exceeding current related reserves by an amount that could have a
material adverse effect on AFG's results of operations and financial condition.
In March 2000, a jury in Dallas, Texas, returned a verdict against GALIC
with total damages of $11.2 million in a lawsuit brought by two former agents of
GALIC (MARTIN V. GREAT AMERICAN LIFE INSURANCE COMPANY, 191st District Court of
Dallas County, Texas, Case No. 96-04843). The former agents had alleged that
their agency agreement with GALIC had been wrongfully terminated. GALIC believes
that the verdict was contrary to both the facts and the law and expects to
prevail on appeal. The Dallas County Court of Appeals heard oral arguments on
the appeal in November 2001, and a decision is expected in 2002. The ultimate
outcome of this case will not have a material adverse effect on GALIC's
financial condition.
UTA was named a defendant in a purported class action lawsuit. (PEGGY BERRY, ET
AL. V. UNITED TEACHER ASSOCIATES INSURANCE COMPANY, Travis County District
Court, Case No. GN100461, filed February 11, 2001). The complaint seeks
unspecified damages based on the alleged misleading disclosure of UTA's interest
crediting practices on its fixed rate annuities. GAFRI believes that UTA has
meritorious defenses but it is not possible to predict the ultimate outcome.
Nonetheless, the ultimate outcome of this case should not have a material
adverse impact on UTA's financial condition.
21
PART II
ITEM 5
MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
PLEASE REFER TO "FORWARD-LOOKING STATEMENTS" FOLLOWING THE INDEX IN FRONT OF
THIS FORM 10-K.
AFG Common Stock has been listed and traded on the New York Stock Exchange
under the symbol AFG. The information presented in the table below represents
the high and low sales prices per share reported on the NYSE Composite Tape.
2001 2000
---------------- ----------------
High Low High Low
---- --- ---- ---
First Quarter $29.00 $21.80 $29.00 $18.38
Second Quarter 30.30 23.30 29.00 24.38
Third Quarter 30.75 18.35 26.63 23.13
Fourth Quarter 25.33 20.20 27.19 18.69
There were approximately 13,500 shareholders of record of AFG Common Stock
at March 1, 2002. In 2001 and 2000, AFG declared and paid quarterly dividends of
$.25 per share. In November 2001, AFG announced its intention to reduce the
annual dividends on its Common Stock from $1.00 to $.50 per share beginning in
2002 in order to retain available capital to grow its profitable insurance
operations and build long-term value. The ability of AFG to pay dividends will
be dependent upon, among other things, the availability of dividends and
payments under intercompany tax allocation agreements from its insurance company
subsidiaries.
22
ITEM 6
SELECTED FINANCIAL DATA
The following table sets forth certain data for the periods indicated
(dollars in millions, except per share data).
2001 2000 1999 1998 1997
---- ---- ---- ---- ----
EARNINGS STATEMENT DATA:
-----------------------
Total Revenues $3,924 $3,817 $3,360 $4,082 $4,026
Operating Earnings Before Income Taxes 56 110 302 274 380
Earnings (Loss) Before Extraordinary Items
and Accounting Changes (5) (47) 147 125 199
Extraordinary Items - - (2) (1) (7)
Cumulative Effect of Accounting Changes (10) (9) (4) - -
Net Earnings (Loss) (15) (56) 141 124 192
Basic Earnings (Loss) Per Common Share (a):
Earnings (Loss) Before Extraordinary Items and
Accounting Changes ($.07) ($.80) $2.46 $2.04 $.77
Net Earnings (Loss) Available to Common Shares (.22) (.95) 2.37 2.03 .65
Diluted Earnings (Loss) Per Common Share (a):
Earnings (Loss) Before Extraordinary Items
and Accounting Changes ($.07) ($.80) $2.44 $2.01 $.76
Net Earnings (Loss) Available to Common Shares (.22) (.95) 2.35 2.00 .64
Cash Dividends Paid Per Share of
Common Stock $1.00 $1.00 $1.00 $1.00 $1.00
Ratio of Earnings to Fixed Charges (b) 1.21 1.63 3.36 3.22 3.98
BALANCE SHEET DATA:
------------------
Total Assets $17,402 $16,416 $16,054 $15,845 $15,755
Long-term Debt:
Holding Companies 609 585 493 415 387
Subsidiaries 271 195 240 177 194
Minority Interest 455 508 489 522 513
Shareholders' Equity 1,498 1,549 1,340 1,716 1,663
(a) Per share results for 1997 are calculated after deducting a premium over
stated value on redemption of a subsidiary's preferred stock of $153.3
million.
(b) Fixed charges are computed on a "total enterprise" basis. For purposes
of calculating the ratios, "earnings" have been computed by adding to
pretax earnings the fixed charges and the minority interest in earnings
of subsidiaries having fixed charges and the undistributed equity in
losses of investees. Fixed charges include interest (excluding interest
on annuity benefits), amortization of debt premium/discount and expense,
preferred dividend and distribution requirements of subsidiaries and a
portion of rental expense deemed to be representative of the interest
factor.
23
ITEM 7
MANAGEMENT'S DISCUSSION AND ANALYSIS
OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
PLEASE REFER TO "FORWARD-LOOKING STATEMENTS" FOLLOWING THE INDEX IN FRONT OF
THIS FORM 10-K.
GENERAL
Following is a discussion and analysis of the financial statements and
other statistical data that management believes will enhance the understanding
of AFG's financial condition and results of operations. This discussion should
be read in conjunction with the financial statements beginning on page F-1.
AFG was formed through the combination of AFC and American Premier in
merger transactions completed in April 1995.
IT INITIATIVE In 1999, AFG initiated an enterprise-wide study of its
information technology ("IT") resources, needs and opportunities. The
initiative, involving improvements in physical infrastructure and business
support systems, entails extensive effort and costs over a period of several
years. While the costs precede the expected savings, management believes the
benefits will exceed the costs incurred, all of which have been and will be
funded through available working capital.
LIQUIDITY AND CAPITAL RESOURCES
RATIOS AFG's debt to total capital ratio (at the parent holding company level)
was approximately 27% at December 31, 2001, compared to 25% at December 31,
2000.
AFG's ratio of earnings to fixed charges on a total enterprise basis was
1.21 for the year ended December 31, 2001, compared to 1.63 in 2000 and 3.36 in
1999.
The National Association of Insurance Commissioners' model law for risk
based capital ("RBC") applies to both life and property and casualty companies.
RBC formulas determine the amount of capital that an insurance company needs to
ensure that it has an acceptable expectation of not becoming financially
impaired. At December 31, 2001, the capital ratios of all AFG insurance
companies substantially exceeded the RBC requirements (the lowest capital ratio
of any AFG subsidiary was 2.1 times its authorized control level RBC; weighted
average of all AFG subsidiaries was 4.9 times).
SOURCES OF FUNDS AFG, 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. Funds to meet these obligations come primarily
from dividend and tax payments from their subsidiaries.
Management believes these parent holding companies have sufficient
resources to meet their liquidity requirements. 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.
The parent holding companies have a reciprocal Master Credit Agreement
under which these companies make funds available to each other for general
corporate purposes.
AFC has a revolving credit line with several banks under which it can
borrow up to $300 million until December 31, 2002. This credit line provides
ample liquidity and can be used to obtain funds for operating subsidiaries or,
if necessary, for the parent companies. At December 31, 2001, approximately
two-thirds of the credit line had been used. While management expects to
negotiate a replacement bank agreement later this year, market conditions
indicate the maximum amount may be smaller and interest costs will likely be
greater.
24
In December 2000, AFG issued 8.3 million shares of Common Stock, using the
$155 million in net cash proceeds to make capital contributions to its property
and casualty operations. In April 1999, AFG issued $350 million principal amount
of 7-1/8% senior debentures due 2009, using the proceeds to retire outstanding
holding company public debt and borrowings under AFC's credit line. All
debentures issued by the parent holding companies and GAFRI are rated investment
grade by three nationally recognized rating agencies. Under a currently
effective shelf registration statement, AFG can issue up to an aggregate of
approximately $340 million in additional Common Stock, debt or trust securities.
The shelf registration provides AFG with greater flexibility to access the
capital markets from time to time as market and other conditions permit.
For statutory accounting purposes, equity securities of non-affiliates are
generally carried at market value. At December 31, 2001, AFG's insurance
companies owned publicly traded equity securities with a market value of $310
million. In addition, Great American owns GAFRI common stock with a market value
of $657 million and a carrying value of $460 million. Since significant amounts
of these are concentrated in a relatively small number of companies, decreases
in the market prices could adversely affect the insurance group's capital,
potentially impacting the amount of dividends available or necessitating a
capital contribution. Conversely, increases in the market prices could have a
favorable impact on the group's dividend-paying capability.
Under tax allocation agreements with AFC, its 80%-owned U.S. subsidiaries
generally compute tax provisions as if filing separate returns based on book
taxable income computed in accordance with generally accepted accounting
principles. The resulting provision (or credit) is currently payable to (or
receivable from) AFC.
INVESTMENTS Approximately two-thirds of AFG's consolidated assets are
invested in marketable securities. A diverse portfolio of primarily publicly
traded bonds and notes accounts for over 97% of these securities. AFG attempts
to optimize investment income while building the value of its portfolio, placing
emphasis upon long-term performance. AFG's goal is to maximize return on an
ongoing basis rather than focusing on short-term performance.
Fixed income investment funds are generally invested in securities with
short-term and intermediate-term maturities with an objective of optimizing
total return while allowing flexibility to react to changes in market
conditions. At December 31, 2001, the average life of AFG's fixed maturities was
about 5-1/2 years.
Approximately 93% of the fixed maturities held by AFG were rated
"investment grade" (credit rating of AAA to BBB) by nationally recognized rating
agencies at December 31, 2001. Investment grade securities generally bear lower
yields and lower degrees of risk than those that are unrated or noninvestment
grade. Management believes that the high quality investment portfolio should
generate a stable and predictable investment return.
Investments in MBSs represented approximately one-fourth of AFG's fixed
maturities at December 31, 2001. MBSs are subject to significant prepayment risk
due to the fact that, in periods of declining interest rates, mortgages may be
repaid more rapidly than scheduled as borrowers refinance higher rate mortgages
to take advantage of the lower current rates. As a result, holders of MBSs may
receive prepayments on their securities, which cannot be reinvested at an
interest rate comparable to the rate on the prepaid MBSs. The majority of MBSs
held by AFG were purchased at a discount. Management believes that the
discounted nature of the MBSs will mitigate the effect of prepayments on
earnings over the anticipated life of the MBS portfolio. Over 90% of AFG's MBSs
are rated "AAA" with substantially all being of investment grade quality. The
market in which these securities trade is highly liquid. Aside from interest
rate risk, AFG does not believe a material risk (relative to earnings or
liquidity) is inherent in holding such investments.
25
At December 31, 2001, AFG had a net unrealized gain on fixed maturities of
$155.3 million (before income taxes) consisting of $306.2 million in gross
unrealized gains and $150.9 million in gross unrealized losses. At that same
date, AFG also had a net unrealized gain on equity securities of $125.9 million
consisting of $135.7 million in gross gains and $9.8 million in gross losses.
Individual portfolio securities are sold creating gains or losses as market
opportunities exist.
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
(accounted for as a realized loss) and the cost basis of that investment is
reduced. The determination of whether unrealized losses are "other than
temporary" requires judgment based on subjective as well as objective factors.
Factors considered and resources used by management include:
a) whether the unrealized loss is credit-driven or a result of changes
in market interest rates,
b) the extent to which market value is less than cost basis,
c) historical operating, balance sheet and cash flow data contained in
issuer SEC filings,
d) issuer news releases,
e) near-term prospects for improvement in the issuer and/or its industry,
f) industry research and communications with industry specialists,
g) third party research and credit rating reports,
h) internally generated financial models and forecasts,
i) discussions with issuer management, and
j) ability and intent to hold the investment for a period of time sufficient
to allow for any anticipated recovery in market value.
The $150.9 million in gross unrealized losses on fixed maturities at
December 31, 2001, represents unrealized losses on more than 450 positions. None
of the individual losses exceeds $8 million and only 12 have unrealized losses
exceeding $2 million. All of the securities with unrealized losses are current
in payment of principal and interest.
Based on its analysis of the factors enumerated above, management believes
(i) the issuers of these securities will continue to meet their obligations and
(ii) that AFG has the ability and intent to hold the securities until they
mature or recover in value. Should either of these beliefs change with regard to
a particular security, a charge for impairment would likely be required.
Net realized gains (losses) on securities sold and charges for "other than
temporary" impairment on securities held were as follows (in millions):
Net Realized
Gains (Losses) Charges for
On Sales Impairment Other(a) Total
-------------- ----------- ----- ------
2001 $89.8 ($125.5)(b) $11.6 ($24.1)
2000 (1.7) (27.5) 2.6 (26.6)
1999 31.1 (13.0) 2.1 20.2
1998 40.2 (32.2) (1.7) 6.3
1997 54.7 (6.7) (2.0) 46.0
(a) Includes adjustments to carry derivatives at market and to reflect
the impact of realized gains and losses on the amortization of
deferred policy acquisition costs.
(b) Does not include $16.9 million writedown of certain collateralized
debt obligations which was recorded as the cumulative effect of an
adoption of an accounting change at April 1, 2001.
Increased impairment charges in recent years reflect a rise in corporate
defaults in the marketplace resulting from the weakened economy.
UNCERTAINTIES Aside from risks common to most insurance operations, management
believes that the areas posing the greatest risk of material loss are Great
American's exposure to asbestos, environmental and other mass tort claims and
American Premier's exposure to asbestos, environmental and other contingencies
arising out of its former operations.
26
PROPERTY AND CASUALTY INSURANCE RESERVES Future costs of claims are
projected based on historical trends adjusted for changes in underwriting
standards, policy provisions, product mix and other factors. Estimating the
liability for unpaid losses and LAE is inherently judgmental and is influenced
by factors which are subject to significant variation. Through the use of
analytical reserve development techniques, management monitors items such as the
effect of inflation on medical, hospitalization, material, repair and
replacement costs, general economic trends and the legal environment.
Establishing reserves for A&E claims is subject to uncertainties that are
significantly greater than those presented by other types of claims. For a
discussion of uncertainties, see "LITIGATION" AND "SPECIAL A&E CHARGE" BELOW AND
NOTE L - "COMMITMENTS AND CONTINGENCIES" TO THE FINANCIAL STATEMENTS.
LITIGATION AFG's insurance subsidiaries and American Premier are parties
to litigation and receive claims alleging injuries and damages from asbestos,
environmental and other substances and workplace hazards. The outcome of
litigation relating to asbestos and environmental claims is uncertain due to
numerous factors and may result in liabilities materially exceeding amounts AFG
has currently recorded. For a discussion of uncertainties, see LEGAL
PROCEEDINGS.
EXPOSURE TO MARKET RISK Market risk represents the potential economic loss
arising from adverse changes in the fair value of financial instruments. AFG's
exposures to market risk relate primarily to its investment portfolio and
annuity contracts which are exposed to interest rate risk and, to a lesser
extent, equity price risk. To a much lesser extent, AFG's long-term debt is also
exposed to interest rate risk.
FIXED MATURITY PORTFOLIO The fair value of AFG's fixed maturity portfolio
is directly impacted by changes in market interest rates. AFG's fixed maturity
portfolio is comprised of substantially all fixed rate investments with
primarily short-term and intermediate-term maturities. This practice allows
flexibility in reacting to fluctuations of interest rates. The portfolios of
AFG's insurance operations are managed with an attempt to achieve an adequate
risk-adjusted return while maintaining sufficient liquidity to meet policyholder
obligations. AFG's life and annuity operations attempt to align the duration of
their invested assets to the projected cash flows of policyholder liabilities.
The following table provides information about AFG's fixed maturity
investments at December 31, 2001 and 2000, that are sensitive to interest rate
risk. The table shows principal cash flows (in millions) and related weighted
average interest rates by expected maturity date for each of the five subsequent
years and for all years thereafter. Callable bonds and notes are included based
on call date or maturity date depending upon which date produces the most
conservative yield. Mortgage-backed securities ("MBSs") and sinking fund issues
are included based on maturity year adjusted for expected payment patterns.
Actual cash flows may differ from those expected.
DECEMBER 31, 2001 DECEMBER 31, 2000
------------------- ------------------
Principal Principal
Cash Flows Rate Cash Flows Rate
---------- ---- ---------- ----
2002 $ 956.2 8.62% 2001 $ 494.2 8.46%
2003 1,407.3 7.84 2002 673.4 7.60
2004 860.1 8.56 2003 1,406.6 7.74
2005 1,081.6 7.50 2004 835.6 8.01
2006 1,109.7 6.89 2005 1,142.1 7.46
Thereafter 5,263.1 7.08 Thereafter 5,737.0 7.41
--------- ---------
Total $10,678.0 7.46% $10,288.9 7.57%
========= =========
Fair Value $10,748.6 $10,164.6
========= =========
EQUITY PRICE RISK Equity price risk is the potential economic loss from
adverse changes in equity security prices. Although AFG's investment in "Other
stocks" is less than 3% of total investments, it is concentrated in a relatively
limited number of positions; approximately four-fifths of the total is in five
investments. While
27
this approach allows management to more closely monitor the companies and
industries in which they operate, it does increase risk exposure to adverse
price declines in a major position.
Included in "Other stocks" at December 31, 2001 were warrants (valued at
$15.6 million) to purchase common stock of various companies. Under Statement of
Financial Accounting Standards ("SFAS") No. 133, which was adopted as of October
1, 2000, these warrants are generally considered derivatives and marked to
market through current earnings as realized gains and losses.
ANNUITY CONTRACTS Substantially all of GAFRI's fixed rate annuity
contracts permit GAFRI to change crediting rates (subject to minimum interest
rate guarantees of 3% to 4% per annum) enabling management to react to changes
in market interest rates and maintain an adequate spread. The spread could be at
risk, however, if yields available on newly invested funds fell significantly
from current yields and remained lower for a long period. Projected payments (in
millions) in each of the subsequent five years and for all years thereafter on
GAFRI's fixed annuity liabilities at December 31 were as follows.
Fair
First Second Third Fourth Fifth Thereafter Total Value
----- ------ ----- ------ ----- ---------- ------ ------
2001 $750 $680 $650 $630 $610 $2,512 $5,832 $5,659
2000 720 710 660 630 620 2,204 5,544 5,426
Nearly half of GAFRI's fixed annuity liabilities at December 31, 2001,
were two-tier in nature in that policyholders can receive a higher amount if
they annuitize rather than surrender their policy, even if the surrender charge
period has expired. Current stated crediting rates on GAFRI's principal fixed
annuity products average 5% and range from 3% on equity-indexed annuities
(before any equity participation) to 7% on certain new policies (including first
year bonus amounts). GAFRI estimates that its effective weighted-average
crediting rate over the next five years will approximate 5%. This rate reflects
actuarial assumptions as to (i) deaths, (ii) the number of policyholders who
annuitize and receive higher credited amounts and (iii) the number of
policyholders who surrender. Actual experience and changes in actuarial
assumptions may result in different effective crediting rates than those above.
GAFRI's equity-indexed fixed annuities provide policyholders with a
crediting rate tied, in part, to the performance of an existing stock market
index. GAFRI attempts to mitigate the risk in the equity-based component of
these products through the purchase of call options on the appropriate index.
GAFRI's strategy is designed so that an increase in the liabilities due to an
increase in the market index will be substantially offset by unrealized gains on
the call options. Under SFAS No. 133, both the equity-based component of the
annuities and the related call options are considered derivatives and marked to
market through current earnings as annuity benefits. Adjusting these derivatives
to market value had a net effect of less than $1 million on annuity benefits in
2001 and 2000.
DEBT AND PREFERRED SECURITIES The following table shows scheduled
principal payments (in millions) on fixed-rate long-term debt of AFG and its
subsidiaries and related weighted average interest rates for each of the
subsequent five years and for all years thereafter.
December 31, 2001 December 31, 2000
----------------- -----------------
Scheduled Scheduled
Principal Principal
Payments Rate Payments Rate
--------- ---- --------- ----
2002 $ 4.3 7.02% 2001 $ 2.9 6.74%
2003 * 2002 4.7 6.86
2004 * 2003 *
2005 10.1 9.07 2004 14.2 8.38
2006 18.7 6.73 2005 9.7 9.16
Thereafter 509.3 7.14 Thereafter 509.6 7.14
------ ------
Total $544.1 7.16% $542.2 7.20%
====== ======
Fair Value $514.7 $496.3
====== ======
(*) Less than $2 million.
28
At December 31, 2001 and 2000, respectively, AFG and its subsidiaries had
$337 million and $239 million in variable-rate debt maturing primarily in 2002
and 2004. The weighted average interest rate on AFG's variable-rate debt was
2.67% at December 31, 2001 compared to 7.10% at December 31, 2000. There were
$242 million and $317 million of subsidiary trust preferred securities
outstanding at December 31, 2001 and 2000, none of which is scheduled for
maturity or mandatory redemption during the next five years; the weighted
average interest rate on these securities was 9.09% at December 31, 2001 and
8.65% at December 31, 2000.
RESULTS OF OPERATIONS - THREE YEARS ENDED DECEMBER 31, 2001
GENERAL Results of operations as shown in the accompanying financial statements
are prepared in accordance with generally accepted accounting principles. Many
investors and analysts focus on "core earnings" of companies, setting aside
certain items included in net earnings.
The following table reconciles AFG's operating earnings before income
taxes as shown in the Statement of Operations to "core earnings" as generally
referred to in quarterly news releases and independent financial analysts'
reports (in millions, except per share amounts):
2001 2000 1999
---- ---- ----
Operating earnings before income taxes $ 55.9 $109.9 $302.1
Adjustments for normal items:
Eliminate net realized (gains) losses 24.0 (4.7) (20.2)
Include minority interest (46.1) (45.1) (50.1)
Adjustments for unusual items:
Add back special A&E charge 100.0 - -
Add back World Trade Center losses 25.0 - -
------ ------ ------
158.8 60.1 231.8
Provision for income taxes (53.1) (17.8) (81.4)
------ ------ ------
Core earnings from insurance businesses $105.7 $ 42.3 $150.4
====== ====== ======
Per Common Share (diluted) $1.55 $.71 $2.50
===== ==== =====
The increase in "core earnings" in 2001 is due primarily to improvement
in underwriting results (aside from the two unusual items shown above) partially
offset by a $15 million charge to increase reserves for environmental costs
related to certain former operations.
The decrease in "core earnings" in 2000 is due primarily to a
deterioration in underwriting results (including a $35 million strengthening of
California workers' compensation reserves), a $41 million charge for the
settlement of litigation and an offsetting gain of $23 million on the sale of
certain real estate lease rights.
PROPERTY AND CASUALTY INSURANCE - UNDERWRITING AFG's property and casualty
operations consist of two major business groups: Specialty and Personal.
The Specialty group includes a highly diversified group of business lines.
Some of the more significant areas are inland and ocean marine, California
workers' compensation, agricultural-related coverages, executive and
professional liability, fidelity and surety bonds, collateral protection, and
umbrella and excess coverages.
The Personal group sells nonstandard and preferred/standard private
passenger auto insurance and, to a lesser extent, homeowners' insurance.
Nonstandard automobile insurance covers risks not typically accepted for
standard automobile coverage because of the applicant's driving record, type of
vehicle, age or other criteria.
29
To understand the overall profitability of particular lines, the timing of
claims payments and the related impact of investment income must be considered.
Certain "short-tail" lines of business (primarily property coverages) have quick
loss payouts which reduce the time funds are held, thereby limiting investment
income earned thereon. On the other hand, "long-tail" lines of business
(primarily liability coverages and workers' compensation) have payouts that are
either structured over many years or take many years to settle, thereby
significantly increasing investment income earned on related premiums received.
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
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.
While AFG desires and seeks to earn an underwriting profit on all of its
business, it is not always possible to do so. As a result, AFG attempts to
expand in the most profitable areas and control growth or even reduce its
involvement in the least profitable ones.
Since mid-2000, AFG has been actively realigning its mix of business and
resetting its rate structure with a goal of achieving underwriting profits, even
if it entails sacrificing volume. Management expects the improvement experienced
in the latter part of 2001 to continue in 2002.
Underwriting results of AFG's insurance operations outperformed the
industry average for the sixteenth consecutive year (excluding special A&E
charges of $100 million in 2001 and $214 million in 1998). AFG's insurance
operations have been able to exceed the industry's results by focusing on growth
opportunities in the more profitable areas of the specialty and nonstandard auto
businesses.
Net written premiums and combined ratios for AFG's property and casualty
insurance subsidiaries were as follows (dollars in millions):
2001 2000 1999
---- ---- ----
NET WRITTEN PREMIUMS (GAAP)
Specialty $1,542 $1,324 $1,111
Personal 1,040 1,311 1,154
Other Lines - 3 (2)
------ ------ ------
$2,582 $2,638 $2,263
====== ====== ======
COMBINED RATIOS (GAAP)
Specialty 101.7% 107.9% 102.7%
Personal 107.9 108.6 100.7
Aggregate (including A&E and other lines) 108.8% 108.0% 102.0%
SPECIAL A&E CHARGE Estimating ultimate liability for asbestos claims
presents unique and difficult challenges to the insurance industry due to, among
other things, inconsistent court decisions, an increase in bankruptcy filings as
a result of asbestos-related liabilities, novel theories of coverage, and
judicial interpretations that often expand theories of recovery and broaden the
scope of coverage. The casualty insurance industry is engaged in extensive
litigation over these coverage and liability issues as the volume and severity
of claims against asbestos defendants continue to increase.
30
During the third quarter of 2001, AFG recorded an A&E charge of $100
million after experiencing an increase in the number and severity of asbestos
claims and observing the developments of adverse trends in the property and
casualty insurance industry concerning asbestos losses. This charge, accompanied
by a transfer of $36 million from excess reserves for other environmental
claims, resulted in an increase of $136 million in asbestos reserves.
While management believes that the reserves, as strengthened, are a
reasonable estimate of ultimate liability for A&E claims, actual results may
vary materially from the amounts currently recorded due to outstanding issues
and uncertainties such as whether coverage exists, whether claims are to be
allocated among triggered policies and implicated years, whether claimants who
exhibit no signs of illness will be successful in pursuing their claims,
predicting the number of future claims, and the impact of recent bankruptcy
filings.
Further, certain policyholders assert that each bodily injury claim should
be treated as a separate occurrence under the policy, and that their claims are
not subject to aggregate limits on coverage because either their policies did
not contain aggregate limits with respect to products liability coverage or,
faced with exhaustion of products coverage limits, their asbestos claims fall
within non-products liability coverage which is not subject to any aggregate
limit. These claims are now being contested in insurance coverage litigation in
various jurisdictions. In rejecting the claims that are the basis of this
litigation, AFG believes its coverage defenses are substantial and intends to
continue to vigorously defend its position. Nonetheless, the outcome of this
litigation is uncertain and such claims may have a material adverse effect upon
AFG's future results of operations and financial condition. For a discussion of
asbestos and enviornmental litigation, see LEGAL PROCEEDINGS.
SPECIALTY The Specialty group's increase in net written premiums in 2001
reflects the impact of rate increases implemented in 2000 and 2001 and the
realization of growth opportunities in certain commercial markets, partially
offset by the decision to discontinue certain lines of business that were not
achieving adequate returns. Specialty rate increases averaged over 20% in 2001
and are expected to be at least 15% in 2002. The improvement in the combined
ratio compared to 2000 reflects the impact of rate increases and unusually
strong results in several businesses. Excluding the effect of the attack on the
World Trade Center, the Specialty group reported an underwriting profit with a
combined ratio of 99.9% for 2001.
The Specialty group's increase in net written premiums in 2000 reflects
the effect of (i) the January 2000 termination of reinsurance agreements
relating to the California workers' compensation business which were in effect
throughout 1999, (ii) rate increases in certain casualty markets (particularly
California workers' compensation) and (iii) the realization of growth
opportunities in certain commercial markets. Excluding the impact of the
terminated reinsurance agreements, net written premiums were up approximately
14% for 2000. In response to continued losses in the California workers'
compensation business, rate increases implemented for this business averaged 25%
in 2000. Rate increases implemented in the other specialty operations averaged
12% in 2000.
Due primarily to adverse development in prior year losses, AFG recorded a
$35 million pretax charge in the third quarter of 2000 to strengthen loss
reserves in its California workers' compensation business. The combined ratio
for 2000 reflects this reserve strengthening (a combined ratio effect of 2.9
points) and the effect of a highly competitive pricing environment on policies
written during 1999.
PERSONAL The Personal group's decline in net written premiums in 2001
reflects a reinsurance agreement, effective April 1, 2001, under which AFG cedes
90% of the automobile physical damage business written by certain of its
insurance subsidiaries. This agreement is enabling AFG to reallocate some of its
capital to the more profitable specialty operations. Excluding the effect of
this agreement, the Personal group's net written premiums declined about 4% in
2001 as lower business volume was partially offset by the impact of significant
rate increases in 2000 and 2001. The group implemented rate increases of about
14% in 2001 and expects to implement rate increases of at least 7% in 2002. As a
result of rate increases in 2001 and 2000, the combined ratio improved to 107.9%
for 2001.
31
The Personal group's increase in net written premiums for 2000 reflects
firming market prices in the nonstandard auto market and expanded writings in
certain private passenger automobile markets. These items were partially offset
by the expected decline in volume caused by rate increases implemented
throughout 2000. The combined ratio for 2000 increased due to (i) increased auto
claim frequency and severity (particularly in medical and health related costs),
(ii) the impact of a very competitive pricing environment on policies written
during 1999 and early 2000 and (iii) increased underwriting expenses associated
with the direct and Internet marketing initiatives. In an effort to alleviate
increasing losses, AFG implemented rate increases averaging approximately 13% in
2000.
LIFE, ACCIDENT AND HEALTH PREMIUMS AND BENEFITS Life, accident and health
premiums and benefits increased in 2001 and 2000 due primarily to the
acquisition of a block of supplemental health insurance business in November
2000 and the October 1999 acquisition of United Teacher Associates.
INVESTMENT INCOME Changes in investment income reflect fluctuations in market
rates and changes in average invested assets. Investment income increased in
2001 due primarily to higher average investment in fixed maturity securities,
partially offset by lower average interest rates on those investments.
GAIN ON SALE OF OTHER INVESTMENTS In September 2000, GAFRI realized a $27.2
million pretax gain on the sale of its minority ownership in a company engaged
in the production of ethanol. GAFRI's investment was repurchased by the ethanol
company which, following the purchase, became wholly-owned by AFG's Chairman.
GAINS (LOSSES) ON SECURITIES Realized gains (losses) on sales of securities
include provisions for other than temporary impairment of securities still held
of $125.5 million in 2001, $27.5 million in 2000 and $13 million in 1999. The
provision for 2001 includes $8 million for the writedown of AFG's investment in
Chiquita from $1.00 per share to $.67 per share.
Realized gains (losses) on securities includes gains of $5.2 million in
2001 and $1.5 million in the fourth quarter of 2000 to adjust the carrying value
of AFG's investment in warrants to market value under SFAS No. 133.
GAINS ON SALES OF SUBSIDIARIES In 2001, AFG recognized a $7.1 million pretax
gain on the sale of a small insurance subsidiary. In connection with the sale of
the Japanese division in 2001, AFG recognized a $6.9 million pretax loss and
deferred a gain of approximately $21 million on ceded insurance which is being
recognized over the estimated settlement period (weighted average of 4 years) of
the ceded claims.
In 2000, AFG recognized (i) a $25 million pretax gain representing an
earn-out related to the 1998 sale of its Commercial lines division, (ii) a $10.3
million pretax loss on the sale of Stonewall Insurance Company and (iii) a $10.7
million estimated pretax loss related to the agreement to sell its Japanese
division (completed in 2001).
REAL ESTATE OPERATIONS AFG's subsidiaries are engaged in a variety of real
estate operations including hotels, apartments, office buildings and
recreational facilities; they also own several parcels of land. Revenues and
expenses of these operations, including gains and losses on disposal, are
included in AFG's statement of operations as shown below (in millions).
2001 2000 1999
---- ---- ----
Other income $102.6 $95.9 $87.4
Other operating and general expenses 64.9 65.6 62.5
Interest charges on borrowed money 2.3 2.6 2.8
Minority interest expense, net 3.7 1.5 2.0
Other income includes net pretax gains on the sale of real estate assets
of $27.2 million in 2001, $12.4 million in 2000 and $15.2 million in 1999.
32
OTHER INCOME
2001 COMPARED TO 2000 Other income returned to more normal levels in 2001
due primarily to the absence of income from the sale of lease rights, lease
residuals and other operating assets.
2000 COMPARED TO 1999 Other income increased $78.4 million (45%) in 2000
due primarily to increased fee income generated by certain insurance operations,
income from the sale of lease rights and lease residuals and increased revenues
from real estate operations.
ANNUITY BENEFITS For GAAP financial reporting purposes, annuity receipts are
accounted for as interest-bearing deposits ("annuity benefits accumulated")
rather than as revenues. Under these contracts, policyholders' funds are
credited with interest on a tax-deferred basis until withdrawn by the
policyholder. Annuity benefits reflect amounts accrued on annuity policyholders'
funds accumulated. The rate at which GAFRI credits interest on most of its
annuity policyholders' funds is subject to change based on management's judgment
of market conditions. As a result, management has been able to react to changes
in market interest rates and maintain a desired interest rate spread. While
GAFRI believes the interest rate and stock market environment over the last
several years has contributed to an increase in annuitizations and surrenders,
the company's persistency rate remains approximately 90%. In 2000, annuity
benefits also includes a second quarter charge of $14.2 million related to the
settlement of a policyholder class action lawsuit.
INTEREST ON BORROWED MONEY Changes in interest expense result from fluctuations
in market rates as well as changes in borrowings. AFG has generally financed its
borrowings on a long-term basis which has resulted in higher current costs.
Interest expense decreased in 2001 as lower average interest rates on AFG's
variable rate debt and lower average subsidiary indebtedness more than offset
higher average borrowings under the AFC bank line. Interest expense increased in
2000 due to higher average indebtedness.
OTHER OPERATING AND GENERAL EXPENSES
2001 COMPARED TO 2000 Excluding the 2000 litigation charges discussed
below, other operating and general expenses increased $30.2 million (7%) due
primarily to a $14.8 million increase in environmental reserves related to
former operations and increased amortization of annuity and life deferred
acquisition costs resulting from increased sales of traditional life insurance
and changes in actuarial assumptions related to variable annuities.
2000 COMPARED TO 1999 Other operating and general expenses for 2000
include second quarter charges of $18.3 million related to an agreement to
settle a lawsuit against a GAFRI subsidiary and $8.8 million for an adverse
California Supreme Court ruling against an AFG property and casualty subsidiary.
Excluding these litigation charges, other operating and general expenses
increased $56.1 million (14%) due primarily to the inclusion of the operations
of UTA following its acquisition in October 1999 and increased expenses from
certain start-up operations.
During 1999, AFG expensed approximately $23 million to successfully ensure
that its systems would function properly in the year 2000 and beyond. Because a
significant portion of the Year 2000 Project was completed using internal staff,
these costs do not represent solely incremental costs.
INCOME TAXES See Note J to the Financial Statements for an analysis of items
affecting AFG's effective tax rate.
INVESTEE CORPORATIONS
CHIQUITA Equity in net losses of investee corporations for 2000 and 1999
includes AFG's proportionate share of the results of Chiquita Brands
International. Chiquita reported net losses attributable to common shareholders
of $112 million in 2000 and $75.5 million in 1999. In 2001, AFG suspended
accounting for Chiquita under the equity method due to Chiquita's pending
restructuring.
33
Equity in net losses of investees for 2000 includes a $95.7 million pretax
charge to writedown AFG's investment in Chiquita to a market value of
approximately $1 per share. Chiquita's results for 2000 include $20 million in
charges and writedowns of production and sourcing assets in its Fresh Produce
operations.
In late 1999, Chiquita underwent a workforce reduction program that
streamlined certain corporate and staff functions in the U.S., Central America
and Europe. Operating income for 1999 includes a $9 million charge for severance
and other costs associated with the program.
START-UP MANUFACTURING BUSINESSES AFG's pretax operating earnings for 2000
include losses of $6.7 million from two start-up manufacturing businesses
acquired in 2000 from their former owners. AFG sold the equity interests in
these businesses in the fourth quarter of 2000 for a nominal cash consideration
plus warrants to repurchase a significant ownership interest. Beginning in the
fourth quarter of 2000, AFG's equity in the results of operations of these
businesses is included in investee earnings. Loans outstanding to these
businesses totaled $86.1 million at December 31, 2001 and $61.5 million at
December 31, 2000. Because AFG retains the financial risk in these businesses,
it continues accounting for their operations under the equity method as
investees. Accordingly, AFG's carrying value of these businesses was
approximately $45 million at December 31, 2001 and 2000.
In 2001 and 2000, equity in net losses of investee corporations includes
$16.6 million and $4.1 million, respectively, in losses of these businesses.
Investee losses in 2001 include litigation judgments of $4.7 million against one
of the companies relating to the alleged misappropriation of a trade secret and
infringement of a patent. In November 2001, an injunction was issued which would
prohibit the company from using the equipment which was the subject of the trade
secret claim and effectively close the plant. The injunction was subsequently
modified, pending appeal, to permit operations to continue and require certain
escrow payments. If the investee is unsuccessful in its attempt to have the
injunction lifted or further modified, or if operating results fail to improve,
a substantial portion of AFG's investment ($31.8 million as of December 31,
2001), may be written off.
CUMULATIVE EFFECT OF ACCOUNTING CHANGES In 2001, the cumulative effect of
accounting change represents the implementation of a new accounting standard
(EITF 99-20) which resulted in a writedown of $16.9 million ($10.0 million or
$.15 per share after tax and minority interest) of the carrying value of certain
collateralized debt obligations as of April 1, 2001.
In October 2000, AFG implemented Statement of Financial Accounting
Standards No. 133, "Accounting for Derivative Instruments and Hedging
Activities", which requires all derivatives to be recognized in the balance
sheet at fair value and that the initial effect of recognizing derivatives at
fair value be reported as a cumulative effect of a change in accounting
principle. Accordingly, AFG recorded a charge of $9.1 million (net of minority
interest and taxes) to record its derivatives at fair value at the beginning of
the fourth quarter of 2000.
In 1999, GAFRI 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, AFG expensed previously capitalized start-up
costs of $3.8 million (net of minority interest and taxes) in the first quarter
of 1999.
34
RECENT ACCOUNTING STANDARDS The following accounting standards have been or will
be implemented by AFG. The implementation of these standards is discussed under
various subheadings of Note A to the Financial Statements; effects of each are
shown in the relevant Notes.
Accounting
Standard Subject of Standard (Year Implemented) Reference
---------- -------------------------------------- ---------
SOP 98-5 Start-up Costs (1999) "Start-up Costs"
SFAS #133 Derivatives (2000) "Derivatives"
EITF 99-20 Asset-backed Securities (2001) "Investments"
SFAS #141 Business Combinations (2001) "Business Combinations"
SFAS #142 Goodwill and Other Intangibles (2002) "Goodwill"
Other standards issued in recent years did not apply to AFG or had only
negligible effects on AFG.
In July 2001, the Financial Accounting Standards Board issued SFAS No.
141, "Business Combinations", and No. 142, "Goodwill and Other Intangible
Assets." Under SFAS No. 141, business combinations initiated after June 30, 2001
are required to be accounted for using the purchase method of accounting. Under
SFAS No. 142, goodwill will no longer be required to be amortized beginning
January 1, 2002, but will be subject to an impairment test at least annually. A
transitional test for impairment is required to be completed in 2002 with any
resulting writedown reported during the first quarter as a cumulative effect of
a change in accounting principle. Other operating and general expenses include
goodwill amortization of $14.4 million in 2001, $17.2 million in 2000 and $14.3
million in 1999. The carrying value of AFG's goodwill at December 31, 2001, was
$312.8 million. AFG has not yet determined what effect, if any, the transitional
test for impairment will have on its earnings or financial position.
35
ITEM 7A
QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
The information required by Item 7A is included in Management's Discussion
and Analysis of Financial Condition and Results of Operations.
ITEM 8
FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
PAGE
----
Report of Independent Auditors F-1
Consolidated Balance Sheet:
December 31, 2001 and 2000 F-2
Consolidated Statement of Operations:
Years ended December 31, 2001, 2000 and 1999 F-3
Consolidated Statement of Changes in Shareholders' Equity
Years ended December 31, 2001, 2000 and 1999 F-4
Consolidated Statement of Cash Flows:
Years ended December 31, 2001, 2000 and 1999 F-5
Notes to Consolidated Financial Statements F-6
"Selected Quarterly Financial Data" has been included in Note M to the
Consolidated Financial Statements.
PLEASE REFER TO "FORWARD-LOOKING STATEMENTS" FOLLOWING THE INDEX IN FRONT OF
THIS FORM 10-K.
---------------------------------------------
PART III
The information required by the following Items will be included in AFG's
definitive Proxy Statement for the 2002 Annual Meeting of Shareholders which
will be filed with the Securities and Exchange Commission within 120 days after
the end of Registrant's fiscal year and is incorporated herein by reference.
ITEM 10 DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
--------------------------------------------------
ITEM 11 EXECUTIVE COMPENSATION
----------------------
ITEM 12 SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
--------------------------------------------------------------
ITEM 13 CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
----------------------------------------------
36
REPORT OF INDEPENDENT AUDITORS
BOARD OF DIRECTORS
AMERICAN FINANCIAL GROUP, INC.
We have audited the accompanying consolidated balance sheet of American
Financial Group, Inc. and subsidiaries as of December 31, 2001 and 2000, and the
related consolidated statements of operations, changes in shareholders' equity
and cash flows for each of the three years in the period ended December 31,
2001. Our audits also included the financial statement schedules listed in the
Index at Item 14(a). These financial statements and schedules are the
responsibility of the Company's management. Our responsibility is to express an
opinion on these financial statements and schedules based on our audits.
We conducted our audits in accordance with auditing standards generally accepted
in the United States. Those standards require that we plan and perform the audit
to obtain reasonable assurance about whether the financial statements are free
of material misstatement. An audit includes examining, on a test basis, evidence
supporting the amounts and disclosures in the financial statements. An audit
also includes assessing the accounting principles used and significant estimates
made by management, as well as evaluating the overall financial statement
presentation. We believe that our audits provide a reasonable basis for our
opinion.
In our opinion, the financial statements referred to above present fairly, in
all material respects, the consolidated financial position of American Financial
Group, Inc. and subsidiaries at December 31, 2001 and 2000, and the consolidated
results of their operations and their cash flows for each of the three years in
the period ended December 31, 2001, in conformity with accounting principles
generally accepted in the United States. Also, in our opinion, the related
financial statement schedules, when considered in relation to the basic
financial statements taken as a whole, present fairly in all material respects
the information set forth therein.
ERNST & YOUNG LLP
Cincinnati, Ohio
March 8, 2002
F-1
AMERICAN FINANCIAL GROUP, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEET
(DOLLARS IN THOUSANDS)
December 31,
--------------------------
2001 2000
---- ----
ASSETS:
Cash and short-term investments $ 544,173 $ 438,670
Investments:
Fixed maturities - at market
(amortized cost - $10,593,305 and $10,148,348) 10,748,605 10,164,648
Other stocks - at market
(cost - $187,810 and $174,959) 313,710 385,359
Investment in investee corporations - 23,996
Policy loans 211,288 213,469
Real estate and other investments 266,545 273,994
----------- -----------
Total investments 11,540,148 11,061,466
Recoverables from reinsurers and prepaid
reinsurance premiums 2,286,509 1,845,171
Agents' balances and premiums receivable 666,171 700,215
Deferred acquisition costs 818,323 763,097
Other receivables 254,255 240,731
Variable annuity assets (separate accounts) 529,590 533,655
Prepaid expenses, deferred charges and other assets 449,693 513,616
Cost in excess of net assets acquired 312,819 318,920
----------- -----------
$17,401,681 $16,415,541
=========== ===========
LIABILITIES AND CAPITAL:
Unpaid losses and loss adjustment expenses $ 4,777,580 $ 4,515,561
Unearned premiums 1,640,955 1,414,492
Annuity benefits accumulated 5,832,120 5,543,683
Life, accident and health reserves 638,522 599,360
Long-term debt:
Holding companies 608,960 584,869
Subsidiaries 270,752 195,087
Variable annuity liabilities (separate accounts) 529,590 533,655
Accounts payable, accrued expenses and other
liabilities 1,150,093 972,271
----------- -----------
Total liabilities 15,448,572 14,358,978
Minority interest 454,730 508,033
Shareholders' Equity:
Common Stock, no par value
- 200,000,000 shares authorized
- 68,491,610 and 67,410,091 shares outstanding 68,492 67,410
Capital surplus 911,074 898,244
Retained earnings 359,513 442,276
Unrealized gain on marketable securities, net 159,300 140,600
----------- -----------
Total shareholders' equity 1,498,379 1,548,530
----------- -----------
$17,401,681 $16,415,541
=========== ===========
See notes to consolidated financial statements.
F-2
AMERICAN FINANCIAL GROUP, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENT OF OPERATIONS
(IN THOUSANDS, EXCEPT PER SHARE DATA)
Year Ended December 31,
----------------------------------------
2001 2000 1999
---- ---- ----
INCOME:
Property and casualty insurance premiums $2,593,938 $2,494,892 $2,210,819
Life, accident and health premiums 280,122 230,441 119,160
Investment income 853,673 834,288 835,375
Realized gains (losses) on:
Securities (24,140) (26,581) 20,152
Subsidiaries 170 4,032 -
Other investments - 27,230 -
Other income 219,869 253,025 174,601
---------- ---------- ----------
3,923,632 3,817,327 3,360,107
COSTS AND EXPENSES:
Property and casualty insurance:
Losses and loss adjustment expenses 2,080,057 1,961,538 1,588,651
Commissions and other underwriting expenses 741,396 735,241 665,109
Annuity benefits 294,654 293,171 262,632
Life, accident and health benefits 213,022 175,174 86,439
Interest charges on borrowed money 60,744 67,642 63,672
Other operating and general expenses 477,861 474,668 391,543
---------- ---------- ----------
3,867,734 3,707,434 3,058,046
---------- ---------- ----------
Operating earnings before income taxes 55,898 109,893 302,061
Provision for income taxes 10,078 29,041 98,198
---------- ---------- ----------
Net operating earnings 45,820 80,852 203,863
Minority interest expense, net of tax (34,070) (35,366) (39,085)
Equity in net losses of investees, net of tax (16,550) (92,449) (17,783)
---------- ---------- ----------
Earnings (loss) before extraordinary items
and accounting changes (4,800) (46,963) 146,995
Extraordinary items - loss on prepayment of debt - - (1,701)
Cumulative effect of accounting changes (10,040) (9,072) (3,854)
---------- ---------- ----------
NET EARNINGS (LOSS) ($ 14,840) ($ 56,035) $ 141,440
========== ========== ==========
BASIC EARNINGS (LOSS) PER COMMON SHARE:
Before extraordinary items and
accounting changes ($.07) ($.80) $2.46
Loss on prepayment of debt - - (.03)
Cumulative effect of accounting changes (.15) (.15) (.06)
---- ---- -----
Net earnings (loss) available to Common Shares ($.22) ($.95) $2.37
==== ==== =====
DILUTED EARNINGS (LOSS) PER COMMON SHARE:
Before extraordinary items and
accounting changes ($.07) ($.80) $2.44
Loss on prepayment of debt - - (.03)
Cumulative effect of accounting changes (.15) (.15) (.06)
---- ---- -----
Net earnings (loss) available to Common Shares ($.22) ($.95) $2.35
==== ==== =====
Average number of Common Shares:
Basic 67,928 58,905 59,732
Diluted 68,368 59,074 60,210
Cash dividends per Common Share $1.00 $1.00 $1.00
See notes to consolidated financial statements.
F-3
AMERICAN FINANCIAL GROUP, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENT OF CHANGES IN SHAREHOLDERS' EQUITY
(DOLLARS IN THOUSANDS)
Common Stock Unrealized
Common and Capital Retained Gain (Loss)
Shares Surplus Earnings on Securities Total
---------- ------------ -------- ------------- ----------
BALANCE AT DECEMBER 31, 1998 60,928,322 $831,649 $527,028 $357,500 $1,716,177
Net earnings - - 141,440 - 141,440
Change in unrealized - - - (375,700) (375,700)
----------
Comprehensive income (loss) (234,260)
Dividends on Common Stock - - (59,754) - (59,754)
Shares issued:
Exercise of stock options 79,762 2,200 - - 2,200
Dividend reinvestment plan 6,099 222 - - 222
Employee stock purchase plan 63,794 2,136 - - 2,136
Retirement plan contributions 57,888 2,171 - - 2,171
Portion of bonuses paid in stock 38,640 1,439 - - 1,439
Directors fees paid in stock 2,683 90 - - 90
Shares acquired and retired (2,757,236) (37,726) (51,176) - (88,902)
Tax effect of intercompany dividends - (6,400) - - (6,400)
Other - 4,859 - - 4,859
---------- -------- -------- -------- ----------
BALANCE AT DECEMBER 31, 1999 58,419,952 $800,640 $557,538 ($ 18,200) $1,339,978
========== ======== ======== ======== ==========
Net earnings (loss) - $ - ($ 56,035) $ - ($ 56,035)
Change in unrealized - - - 158,800 158,800
----------
Comprehensive income 102,765
Dividends on Common Stock - - (58,571) - (58,571)
Shares issued:
Public offering 8,337,500 154,783 - - 154,783
Exercise of stock options 68,523 1,376 - - 1,376
Dividend reinvestment plan 285,694 5,731 - - 5,731
Employee stock purchase plan 70,621 1,694 - - 1,694
Retirement plan contributions 274,716 6,242 - - 6,242
Directors fees paid in stock 3,813 96 - - 96
Shares acquired and retired (50,728) (695) (656) - (1,351)
Tax effect of intercompany dividends - (6,400) - - (6,400)
Capital transactions of subsidiaries - 178 - - 178
Other - 2,009 - - 2,009
---------- -------- -------- -------- ----------
BALANCE AT DECEMBER 31, 2000 67,410,091 $965,654 $442,276 $140,600 $1,548,530
========== ======== ======== ======== ==========
Net earnings (loss) - $ - ($ 14,840) $ - ($ 14,840)
Change in unrealized - - - 18,700 18,700
----------
Comprehensive income 3,860
Dividends on Common Stock - - (67,874) - (67,874)
Shares issued:
Exercise of stock options 65,335 1,522 - - 1,522
Dividend reinvestment plan 85,105 1,806 - - 1,806
Employee stock purchase plan 53,370 1,365 - - 1,365
Retirement plan contributions 876,877 20,970 - - 20,970
Directors fees paid in stock 4,044 96 - - 96
Shares acquired and retired (3,543) (51) (49) - (100)
Tax effect of intercompany dividends - (6,400) - - (6,400)
Capital transactions of subsidiaries - (4,215) - - (4,215)
Other 331 (1,181) - - (1,181)
---------- -------- -------- -------- ----------
BALANCE AT DECEMBER 31, 2001 68,491,610 $979,566 $359,513 $159,300 $1,498,379
========== ======== ======== ======== ==========
See notes to consolidated financial statements.
F-4
AMERICAN FINANCIAL GROUP, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENT OF CASH FLOWS
(IN THOUSANDS)
Year Ended December 31,
-----------------------------------------
2001 2000 1999
---- ---- ----
OPERATING ACTIVITIES:
Net earnings (loss) ($ 14,840) ($ 56,035) $ 141,440
Adjustments:
Extraordinary items - - 1,701
Cumulative effect of accounting changes 10,040 9,072 3,854
Equity in net losses of investees 16,550 92,449 17,783
Depreciation and amortization 147,588 117,388 94,984
Annuity benefits 294,654 293,171 262,632
Changes in reserves on assets 10,505 3,795 (8,285)
Realized gains on investing activities (2,604) (25,173) (37,988)
Deferred annuity and life policy acquisition
costs (137,724) (146,686) (119,382)
Decrease (increase) in reinsurance and
other receivables (309,500) 70,433 (112,558)
Decrease (increase) in other assets (42,103) (87,501) 58,404
Increase in insurance claims and reserves 546,522 189,587 112,721
Increase (decrease) in other liabilities 158,942 (28,848) (50,590)
Increase in minority interest 15,156 4,957 11,112
Dividends from investees - - 4,799
Other, net 28,730 4,856 8,588
---------- ---------- ----------
721,916 441,465 389,215
---------- ---------- ----------
INVESTING ACTIVITIES:
Purchases of and additional investments in:
Fixed maturity investments (3,827,768) (1,635,578) (2,049,536)
Equity securities (9,071) (45,800) (80,624)
Subsidiaries - - (285,971)
Real estate, property and equipment (90,111) (88,371) (74,063)
Maturities and redemptions of fixed maturity
investments 902,820 689,691 1,047,169
Sales of:
Fixed maturity investments 2,468,492 810,942 1,226,111
Equity securities 15,814 84,147 100,076
Investees and subsidiaries 40,395 30,694 -
Real estate, property and equipment 71,002 30,150 31,354
Cash and short-term investments of acquired
(former) subsidiaries, net (134,237) (132,163) 54,331
Decrease (increase) in other investments (7,827) 5,637 21,439
---------- ---------- ----------
(570,491) (250,651) (9,714)
---------- ---------- ----------
FINANCING ACTIVITIES:
Fixed annuity receipts 616,628 496,742 446,430
Annuity surrenders, benefits and withdrawals (622,474) (731,856) (698,281)
Net transfers from fixed to variable annuities (363) (50,475) (19,543)
Additional long-term borrowings 242,613 182,462 614,638
Reductions of long-term debt (143,840) (141,577) (478,657)
Issuances of Common Stock 2,582 157,295 3,459
Repurchases of Common Stock - - (88,597)
Repurchases of trust preferred securities (75,000) (2,479) (5,509)
Cash dividends paid (66,068) (52,886) (59,532)
---------- ---------- ----------
(45,922) (142,774) (285,592)
---------- ---------- ----------
NET INCREASE IN CASH AND SHORT-TERM INVESTMENTS 105,503 48,040 93,909
Cash and short-term investments at beginning of
period 438,670 390,630 296,721
---------- ---------- ----------
Cash and short-term investments at end of period $ 544,173 $ 438,670 $ 390,630
========== ========== ==========
See notes to consolidated financial statements.
F-5
AMERICAN FINANCIAL GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
INDEX TO NOTES
A. ACCOUNTING POLICIES I. SHAREHOLDERS' EQUITY
B. ACQUISITIONS AND SALES OF SUBSIDIARIES J. INCOME TAXES
AND INVESTEES K. EXTRAORDINARY ITEMS
C. SEGMENTS OF OPERATIONS L. COMMITMENTS AND CONTINGENCIES
D. INVESTMENTS M. QUARTERLY OPERATING RESULTS
E. INVESTMENT IN INVESTEE CORPORATIONS N. INSURANCE
F. COST IN EXCESS OF NET ASSETS ACQUIRED O. ADDITIONAL INFORMATION
G. LONG-TERM DEBT P. SUBSEQUENT EVENT
H. MINORITY INTEREST
A. ACCOUNTING POLICIES
BASIS OF PRESENTATION The consolidated financial statements include the
accounts of American Financial Group, Inc. ("AFG") and its subsidiaries.
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 in conformity with generally
accepted accounting principles 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 considered "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 a period based on estimated future principal
prepayments and adjusted to reflect actual prepayments.
Gains or losses on securities are 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 cost basis of that investment is reduced.
Emerging Issues Task Force Issue No. 99-20 established a new standard for
recognition of impairment on certain asset-backed investments. Impairment
losses on these investments must be recognized when (i) the fair value of
the security is less than its cost basis and (ii) there has been an
adverse change in the expected cash flows. The new standard became
effective on April 1, 2001. Impairment losses at initial application of
this rule were recognized as the cumulative effect of an accounting
change. Subsequent impairments are recognized as a component of net
realized gains and losses.
INVESTMENT IN INVESTEE CORPORATIONS Investments in securities of 20%- to
50%-owned companies are generally carried at cost, adjusted for AFG's
proportionate share of their undistributed earnings or losses.
Due to Chiquita's announced intention to pursue a plan to restructure its
public debt, AFG wrote down its investment in Chiquita common stock to
market value at December 31, 2000. In 2001, AFG suspended accounting for
the investment under the equity method due to the expected restructuring,
and reclassified the investment to "Other stocks."
F-6
AMERICAN FINANCIAL GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
COST IN EXCESS OF NET ASSETS ACQUIRED Through December 31, 2001, the
excess of cost of subsidiaries over AFG's equity in the underlying net
assets ("goodwill") was being amortized over periods of 20 to 40 years.
Under Statement of Financial Accounting Standards ("SFAS") No. 142 (issued
in July 2001), goodwill will no longer be amortized but will be subject to
an impairment test at least annually. SFAS No. 142 is effective beginning
January 1, 2002, with the initial effect of the standard reported as a
first quarter 2002 cumulative effect of a change in accounting principle.
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, AFG'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 agreements
covering reinsurance ceded, AFG'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. AFG'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. AFG's insurance subsidiaries
also assume reinsurance from other companies. Income on reinsurance
assumed is recognized based on reports received from ceding companies.
DEFERRED POLICY ACQUISITION COSTS ("DPAC") Policy acquisition costs
(principally commissions, premium taxes and other marketing and
underwriting expenses) related to the production of new business are
deferred. For the property and casualty companies, DPAC is limited based
upon recoverability without any consideration for anticipated investment
income and is charged against income ratably over the terms of the related
policies.
DPAC related to annuities and universal life insurance products is
amortized, with interest, in relation to the present value of expected
gross profits on the policies. To the extent that realized gains and
losses result in adjustments to the amortization of DPAC related to
annuities, such adjustments are reflected as components of realized gains.
DPAC related to annuities is also adjusted, net of tax, for the change in
amortization that would have been recorded if the unrealized gains
(losses) from securities had actually been realized. This adjustment is
included in unrealized gains (losses) on marketable securities.
DPAC related to traditional life and health insurance is amortized
over the expected premium paying period of the related policies, in
proportion to the ratio of annual premium revenues to total anticipated
premium revenues.
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 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. Changes in
estimates of the liabilities for losses and loss adjustment expenses are
reflected in the Statement of Operations in the period in which
determined. In spite of the variability inherent in such estimates,
management believes that the liabilities for unpaid losses and loss
adjustment expenses are adequate.
F-7
AMERICAN FINANCIAL GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
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.
VARIABLE ANNUITY ASSETS AND LIABILITIES Separate accounts related to
variable annuities represent deposits invested in underlying investment
funds on which Great American Financial Resources, Inc. ("GAFRI"), an
83%-owned subsidiary, earns a fee. Investment funds are selected and may
be changed only by the policyholder, who retains all investment risk.
Accordingly, GAFRI's liability for these accounts equals the value of the
account assets.
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. Estimates are accrued during the
period in which premiums are 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 AFG subsidiaries,
including American Financial Corporation ("AFC") preferred stock and
preferred securities issued by trust subsidiaries of AFG. For income
statement purposes, minority interest expense represents those
shareholders' interest in the earnings of AFG subsidiaries as well as AFC
preferred dividends and accrued distributions on the trust preferred
securities.
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. Because holders of AFC Preferred
Stock hold in excess of 20% of AFC's voting rights, AFG (parent) and its
direct subsidiary, AFC Holding Company ("AFC Holding" or "AFCH"), are not
eligible to file consolidated returns with AFC, and therefore, file
separately.
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.
STOCK-BASED COMPENSATION As permitted under SFAS No. 123, "Accounting for
Stock-Based Compensation," AFG accounts for stock options and other
F-8
AMERICAN FINANCIAL GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
stock-based compensation plans using the intrinsic value based method
prescribed by Accounting Principles Board Opinion No. 25, "Accounting for
Stock Issued to Employees." Under AFG's stock option plan, options are
granted to officers, directors and key employees at exercise prices equal
to the fair value of the shares at the dates of grant. No compensation
expense is recognized for stock option grants.
BENEFIT PLANS AFG provides retirement benefits to qualified employees of
participating companies through contributory and noncontributory defined
contribution plans contained in AFG's Retirement and Savings Plan. Under
the retirement portion of the plan, company contributions are invested
primarily in securities of AFG and affiliates. Under the savings portion
of the plan, AFG matches a specific portion of employee contributions.
Contributions to benefit plans are charged against earnings in the year
for which they are declared.
AFG and many of its subsidiaries provide health care and life insurance
benefits to eligible retirees. AFG 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.
DERIVATIVES Effective October 1, 2000, AFG implemented SFAS No. 133,
"Accounting for Derivative Instruments and Hedging Activities", which
establishes accounting and reporting standards for derivative instruments
(including derivative instruments that are embedded in other contracts)
and for hedging activities. Prior year financial statements were not
restated. SFAS No. 133 generally requires that derivatives (both assets
and liabilities) be recognized in the balance sheet at fair value with
changes in fair value included in current earnings. The cumulative effect
of implementing SFAS No. 133, which resulted from the initial recognition
of AFG's derivatives at fair value, was a loss of $9.1 million (net of
minority interest and taxes) or $.15 per diluted share.
Derivatives included in AFG's Balance Sheet consist primarily of
investments in common stock warrants (included in other stocks), the
equity-based component of certain annuity products (included in annuity
benefits accumulated) and call options (included in other investments)
used to mitigate the risk embedded in the equity-indexed annuity products.
START-UP COSTS Prior to 1999, GAFRI deferred certain costs associated with
introducing new products and distribution channels and amortized them on a
straight-line basis over 5 years. In 1999, GAFRI 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, AFG expensed previously capitalized start-up costs
of $3.8 million (net of minority interest and taxes) or $.06 per diluted
share, effective January 1, 1999.
EARNINGS PER SHARE Basic earnings per share is calculated using the
weighted average number of shares of common stock outstanding during the
period. The calculation of diluted earnings per share includes the
following dilutive effects of common stock options: 2001 - 440,000 shares;
2000 - 169,000 shares and 1999 - 478,000 shares.
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.
F-9
AMERICAN FINANCIAL GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
B. ACQUISITIONS AND SALES OF SUBSIDIARIES AND INVESTEES
SEVEN HILLS INSURANCE COMPANY In July 2001, AFG sold Seven Hills Insurance
Company for $18.4 million, realizing a pretax gain of $7.1 million. AFG
retained all liability for Seven Hills' business related to the period AFG
owned the company.
JAPANESE DIVISION In December 2000, AFG agreed to sell its Japanese
property and casualty division to Mitsui Marine & Fire Insurance Company
of America for $22 million in cash and recorded an estimated $10.7 million
pretax loss. Upon completion of the sale in March 2001, AFG realized an
additional pretax loss of $6.9 million (including post closing
adjustments) and deferred a gain of approximately $21 million on ceded
insurance; the deferred gain is being recognized over the estimated
settlement period (weighted average of 4 years) of the ceded claims. At
the same time, a reinsurance agreement under which Great American
Insurance ceded a portion of its pool of insurance to Mitsui was
terminated. The Japanese division generated net written premiums of
approximately $60 million per year to Great American while Great American
ceded approximately $45 million per year to Mitsui.
STONEWALL INSURANCE COMPANY In September 2000, AFG sold Stonewall
Insurance Company for $31.2 million (net of post closing adjustments),
realizing a pretax loss of $10.3 million. Stonewall was a non-operating
property and casualty subsidiary with approximately $320 million in
assets, engaged primarily in the run-off of approximately $170 million in
asbestos and environmental liabilities associated with policies written
through 1991.
COMMERCIAL LINES DIVISION In 1998, AFG sold its Commercial lines division
to Ohio Casualty Corporation for $300 million cash plus warrants to
purchase shares of Ohio Casualty common stock. AFG received an additional
$25 million (included in gains on sales of subsidiaries) in August 2000
under a provision in the sale agreement related to the retention and
growth of the insurance businesses sold.
START-UP MANUFACTURING BUSINESSES Since 1998, AFG subsidiaries have made
loans to two start-up manufacturing businesses which were previously owned
by unrelated third-parties. During 2000, the former owners chose to
forfeit their equity interests to AFG rather than invest additional
capital. Total loans extended to these businesses prior to forfeiture
amounted to $49.7 million and the accumulated losses of the two businesses
were approximately $29.7 million.
During the fourth quarter of 2000, AFG sold the equity interests to a
group of employees for nominal cash consideration plus warrants to
repurchase a significant ownership interest. Due to the absence of
significant financial investment by the buyers relative to the amount of
loans ($61.5 million at December 31, 2000) owed to AFG subsidiaries, the
sale was not recognized as a divestiture for accounting purposes. Assets
of the businesses ($57.1 million at December 31, 2001 and $55.3 million at
December 31, 2000) are included in other assets; liabilities of the
businesses ($11.8 million at December 31, 2001 and $7.5 million at
December 31, 2000, after consolidation and elimination of loans from AFG
subsidiaries) are included in other liabilities. AFG's equity in the
losses of these two companies during 2001 and the fourth quarter of 2000
of $16.6 million and $4.1 million, respectively, is included in investee
losses in the Statement of Operations.
WORLDWIDE INSURANCE COMPANY In 1999, AFG acquired Worldwide Insurance
Company for $157 million in cash. Worldwide is a provider of direct
response private passenger automobile insurance.
UNITED TEACHER ASSOCIATES In 1999, GAFRI acquired United Teacher
Associates Insurance Company of Austin, Texas ("UTA") for $81 million in
cash. UTA provides supplemental health products and retirement annuities,
and purchases blocks of insurance policies from other insurers.
F-10
AMERICAN FINANCIAL GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
GREAT AMERICAN LIFE INSURANCE COMPANY OF NEW YORK AND CONSOLIDATED
FINANCIAL In 1999, GAFRI acquired Great American Life Insurance Company of
New York, formerly Old Republic Life Insurance Company of New York, for
$27 million and Consolidated Financial Corporation, an insurance agency,
for $21 million.
C. SEGMENTS OF OPERATIONS AFG's property and casualty group is engaged
primarily in specialty and private passenger automobile insurance
businesses. The Specialty group includes a highly diversified group of
specialty business units. Some of the more significant areas are inland
and ocean marine, California workers' compensation, agricultural-related
coverages, executive and professional liability, fidelity and surety
bonds, collateral protection, and umbrella and excess coverages. The
Personal group writes nonstandard and preferred/standard private passenger
auto and other personal insurance coverage. AFG's annuity and life
business markets primarily retirement products as well as life and
supplemental health insurance. AFG's businesses operate throughout the
United States. In 2001, 2000, and 1999, AFG derived less than 2% of its
revenues from the sale of life and supplemental health products in Puerto
Rico and less than 1% of its revenues from the sale of property and
casualty insurance in Mexico, Canada, Puerto Rico, Europe and Asia.
The following tables (in thousands) show AFG's assets, revenues and
operating profit (loss) by significant business segment. Operating profit
(loss) represents total revenues less operating expenses.
2001 2000 1999
---- ---- ----
ASSETS
Property and casualty insurance (a) $ 8,796,909 $ 8,200,683 $ 8,158,371
Annuities and life 8,370,904 7,934,851 7,523,570
Other 233,868 256,011 212,150
----------- ----------- -----------
17,401,681 16,391,545 15,894,091
Investment in investees - 23,996 159,984
----------- ----------- -----------
$17,401,681 $16,415,541 $16,054,075
=========== =========== ===========
REVENUES (b)
Property and casualty insurance:
Premiums earned:
Specialty $ 1,409,497 $ 1,223,435 $ 1,047,858
Personal 1,182,651 1,270,328 1,163,223
Other lines (c) 1,790 1,129 (262)
----------- ----------- -----------
2,593,938 2,494,892 2,210,819
Investment and other income 458,410 450,537 450,829
----------- ----------- -----------
3,052,348 2,945,429 2,661,648
Annuities and life (d) 855,733 823,586 665,661
Other 15,551 48,312 32,798
----------- ----------- -----------
$ 3,923,632 $ 3,817,327 $ 3,360,107
=========== =========== ===========
OPERATING PROFIT (LOSS)
Property and casualty insurance:
Underwriting:
Specialty ($ 23,274) ($ 94,857) ($ 28,015)
Personal (93,254) (108,372) (7,685)
Other lines (c)(e) (110,987) 1,342 (7,241)
----------- ----------- -----------
(227,515) (201,887) (42,941)
Investment and other income 296,725 289,549 282,440
----------- ----------- -----------
69,210 87,662 239,499
Annuities and life 100,864 96,211 110,750
Other (f) (114,176) (73,980) (48,188)
----------- ----------- -----------
$ 55,898 $ 109,893 $ 302,061
=========== =========== ===========
(a) Not allocable to segments.
(b) Revenues include sales of products and services as well as other
income earned by the respective segments.
(c) Represents lines in "run-off"; AFG has ceased underwriting
new business in these operations.
(d) Represents primarily investment income.
(e) Includes a charge of $100 million in 2001 related to asbestos and
other environmental matters ("A&E").
(f) Includes holding company expenses.
F-11
AMERICAN FINANCIAL GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
D. INVESTMENTS Fixed maturities and other stocks at December 31 consisted of
the following (in millions):
2001 2000
---------------------------------------- -----------------------------------------
Gross Unrealized Gross Unrealized
Amortized Market ----------------- Amortized Market -----------------
Cost Value Gains Losses Cost Value Gains Losses
--------- ------ ------ ------ --------- ------ ------ ------
Fixed maturities:
United States Government
and government agencies
and authorities $ 1,000.1 $ 1,017.8 $ 21.7 ($ 4.0) $ 537.9 $ 553.5 $ 16.9 ($ 1.3)
States, municipalities and
political subdivisions 405.6 414.9 16.2 (6.9) 416.6 426.9 12.2 (1.9)
Foreign government 105.5 108.8 3.5 (.2) 84.1 86.5 2.7 (.3)
Public utilities 772.0 778.8 14.4 (7.6) 634.7 637.3 11.5 (8.9)
Mortgage-backed securities 2,632.9 2,702.5 89.5 (19.9) 2,604.2 2,670.1 79.4 (13.5)
All other corporate 5,616.7 5,673.5 160.1 (103.3) 5,809.4 5,734.6 87.7 (162.5)
Redeemable preferred stocks 60.5 52.3 .8 (9.0) 61.4 55.7 .2 (5.9)
--------- --------- ------ ------ --------- --------- ------ ------
$10,593.3 $10,748.6 $306.2 (150.9) $10,148.3 $10,164.6 $210.6 ($194.3)
========= ========= ====== ====== ========= ========= ====== ======
Other stocks $ 187.8 $ 313.7 $135.7 ($ 9.8) $ 175.0 $ 385.4 $224.6 ($ 14.2)
========= ========= ====== ====== ========= ========= ====== ======
The table below sets forth the scheduled maturities of fixed maturities
based on market value as of December 31, 2001. Data based on amortized
cost is generally the same. Mortgage-backed securities had an average life
of approximately five years at December 31, 2001.
MATURITY
------------------------------
One year or less 4%
After one year through five years 25
After five years through ten years 30
After ten years 16
---
75
Mortgage-backed securities 25
---
100%
===
Certain risks are inherent in connection with fixed maturity securities,
including loss upon default, price volatility in reaction to changes in
interest rates, and general market factors and risks associated with
reinvestment of proceeds due to prepayments or redemptions in a period of
declining interest rates.
The only investment which exceeds 10% of Shareholders' Equity is an equity
investment in Provident Financial Group, Inc., having a market value of
$191 million and $272 million at December 31, 2001 and 2000, respectively.
Realized gains (losses) and changes in unrealized appreciation
(depreciation) on fixed maturity and equity security investments are
summarized as follows (in thousands):
Fixed Equity Tax
Maturities Securities Effects Total
---------- ---------- ------- ---------
2001
----
Realized ($ 15,315) ($ 8,825) $ 8,451 ($ 15,689)
Change in Unrealized 139,000 (84,500) (19,200) 35,300
2000
----
Realized (24,186) (2,395) 9,303 (17,278)
Change in Unrealized 255,200 29,900 (98,200) 186,900
1999
----
Realized (13,092) 33,244 (7,053) 13,099
Change in Unrealized (641,900) (42,500) 237,500 (446,900)
F-12
AMERICAN FINANCIAL GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
Gross gains and losses on fixed maturity investment transactions included
in the Statement of Cash Flows consisted of the following (in millions):
2001 2000 1999
---- ---- ----
Gross Gains $108.9 $15.9 $29.2
Gross Losses ($124.2) ($40.1) ($42.3)
E. INVESTMENT IN INVESTEE CORPORATIONS Investment in investee corporations at
December 31, 2000, reflects AFG's ownership of 24 million shares (36%) of
Chiquita common stock. The market value of this investment was $24 million
at December 31, 2000. Chiquita is a leading international marketer,
producer and distributor of quality fresh fruits and vegetables and
processed foods.
Summarized financial information for Chiquita at December 31 is shown
below (in millions).
2000 1999
---- ----
Current Assets $ 847
Noncurrent Assets 1,570
Current Liabilities 613
Noncurrent Liabilities 1,221
Shareholders' Equity 583
Net Sales $2,254 $2,556
Operating Income 27 42
Net Loss (95) (58)
Net Loss Attributable to Common Shares (112) (75)
Chiquita's results for 2000 include $20 million in charges and writedowns
of production and sourcing assets; 1999 results include a $9 million
charge resulting from a workforce reduction program.
In January 2001, Chiquita announced a restructuring initiative that
included discontinuing all interest and principal payments on its public
debt. Due to the expected restructuring, AFG recorded a fourth quarter
2000 pretax charge of $95.7 million to write down its investment in
Chiquita to quoted market value at December 31, 2000. In 2001, AFG
suspended accounting for the investment under the equity method and
reclassified the investment to "Other stocks". In the third quarter of
2001, AFG wrote down its investment in Chiquita by an additional $8
million (to $.67 per share). On March 8, 2002, the court approved
Chiquita's plan of reorganization under Chapter 11 of the U.S. Bankruptcy
Code. The plan calls for the conversion of over $700 million in principal
and accrued interest related to Chiquita's public debt into common equity.
As a result, AFG will receive approximately 171,000 "new" shares (less
than one-half of 1%) in the reorganized company plus warrants expiring in
2009 to purchase an additional 2.9 million shares at $19.23 per share.
F. COST IN EXCESS OF NET ASSETS ACQUIRED Amortization expense for the excess
of cost over net assets of purchased subsidiaries was $14.4 million in
2001, $17.2 million in 2000 and $14.3 million in 1999. At December 31,
2001 and 2000, accumulated amortization amounted to approximately $182
million and $168 million, respectively.
F-13
AMERICAN FINANCIAL GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
G. LONG-TERM DEBT Long-term debt consisted of the following at December 31,
(in thousands):
2001 2000
---- ----
HOLDING COMPANIES:
AFG 7-1/8% Senior Debentures due April 2009,
less discount of $1,742 and $1,919
(imputed rate - 7.2%) $301,108 $300,931
AFG 7-1/8% Senior Debentures due December 2007 79,600 79,600
AFC notes payable under bank line 203,000 178,000
American Premier Underwriters, Inc. ("APU")
10-7/8% Subordinated Notes due May 2011,
including premium of $836 and $890
(imputed rate - 9.6%) 11,557 11,611
Other 13,695 14,727
-------- --------
$608,960 $584,869
======== ========
SUBSIDIARIES:
GAFRI 6-7/8% Senior Notes due June 2008 $100,000 $100,000
GAFRI notes payable under bank line 121,100 48,500
Notes payable secured by real estate 36,253 31,201
Other 13,399 15,386
-------- --------
$270,752 $195,087
======== ========
At December 31, 2001, sinking fund and other scheduled principal payments
on debt for the subsequent five years were as follows (in millions):
Holding
Companies Subsidiaries Total
--------- ------------ ------
2002 $213.7 $1.2 $214.9
2003 - 1.2 1.2
2004 - 122.4 122.4
2005 - 10.4 10.4
2006 - 19.1 19.1
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 GAFRI each have an unsecured credit agreement with a group of
banks under which they can borrow up to $300 million and $155 million,
respectively. Borrowings bear interest at floating rates based on prime or
Eurodollar rates. Loans mature in December 2002 under the AFC credit
agreement and in December 2004 under the GAFRI credit agreement. At
December 31, 2001, the weighted average interest rates on amounts borrowed
under the AFC and GAFRI bank credit lines were 2.38% and 2.88%,
respectively.
Cash interest payments of $51 million, $56 million and $55 million were
made on long-term debt in 2001, 2000 and 1999, respectively.
F-14
AMERICAN FINANCIAL GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
H. MINORITY INTEREST Minority interest in AFG's balance sheet is comprised
of the following (in thousands):
2001 2000
---- ----
Interest of noncontrolling shareholders
in subsidiaries' common stock $140,913 $119,216
Preferred securities issued by
subsidiary trusts 241,663 316,663
AFC preferred stock 72,154 72,154
-------- --------
$454,730 $508,033
======== ========
PREFERRED SECURITIES Wholly-owned subsidiary trusts of AFG and GAFRI have
issued preferred securities and, in turn, purchased a like amount of
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. AFG and
GAFRI effectively provide unconditional guarantees of their respective
trusts' obligations.
The preferred securities consisted of the following (in thousands):
Date of Optional
Issuance Issue (Maturity Date) 2001 2000 Redemption Dates
------------- ------------------------- ---- ---- --------------------
October 1996 AFCH 9-1/8% TOPrS (2026) $98,750 $98,750 Currently redeemable
November 1996 GAFRI 9-1/4% TOPrS (2026) 72,913 72,913 Currently redeemable
March 1997 GAFRI 8-7/8% Pfd (2027) 70,000 70,000 On or after 3/1/2007
May 1997 GAFRI 7-1/4% ROPES (2041) - 75,000
In September 2001, GAFRI redeemed its ROPES for $75 million in cash. In
2000, AFG and GAFRI repurchased $1.3 million and $1.7 million of their
preferred securities for $1.1 million and $1.4 million in cash,
respectively.
AFC PREFERRED STOCK AFC's Preferred Stock is voting, cumulative, and
consists of the following:
SERIES J, no par value; $25.00 liquidating 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 December 31, 2001 and 2000.
MINORITY INTEREST EXPENSE Minority interest expense is comprised of
(in thousands):
2001 2000 1999
---- ---- ----
Interest of noncontrolling shareholders
in earnings of subsidiaries $11,366 $11,775 $15,308
Accrued distributions by subsidiaries
on preferred securities:
Trust issued securities, net of tax 16,932 17,819 18,005
AFC preferred stock 5,772 5,772 5,772
------- ------- -------
$34,070 $35,366 $39,085
======= ======= =======
F-15
AMERICAN FINANCIAL GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
I. SHAREHOLDERS' EQUITY At December 31, 2001, there were 68,491,610 shares of
AFG Common Stock outstanding, including 1,362,784 shares held by American
Premier for possible distribution to certain creditors and other claimants
upon proper claim presentation and settlement pursuant to the 1978 plan of
reorganization of American Premier's predecessor, The Penn Central
Corporation. Shares being held for distribution are not eligible to vote
but otherwise are accounted for as issued and outstanding. In December
2000, AFG issued 8.3 million Common Shares at $19.625 per share in a
public offering. AFG is authorized to issue 12.5 million shares of Voting
Preferred Stock and 12.5 million shares of Nonvoting Preferred Stock, each
without par value.
STOCK OPTIONS At December 31, 2001, there were 9.7 million shares of AFG
Common Stock reserved for issuance under AFG's Stock Option Plan. Options
are granted with an exercise price equal to the market price of AFG Common
Stock at the date of grant. Options generally become exercisable at the
rate of 20% per year commencing one year after grant; those granted to
nonemployee directors of AFG are fully exercisable upon grant. Options
generally expire ten years after the date of grant. Data for AFG's Stock
Option Plan is presented below:
2001 2000 1999
----------------------- ----------------------- -----------------------
Average Average Average
Exercise Exercise Exercise
Shares Price Shares Price Shares Price
--------- -------- --------- -------- --------- --------
Outstanding at beginning of year 6,452,496 $27.86 4,664,108 $31.28 3,808,369 $30.25
Granted 20,500 $26.22 1,997,000 $19.81 948,001 $34.92
Exercised (65,335) $21.39 (68,523) $18.22 (79,762) $24.42
Forfeited (318,530) $28.16 (140,089) $31.65 (12,500) $37.62
--------- --------- ---------
Outstanding at end of year 6,089,131 $27.91 6,452,496 $27.86 4,664,108 $31.28
========= ========= =========
Options exercisable at year-end 3,818,305 $29.23 3,226,294 $29.38 2,616,170 $28.19
The following table summarizes information about stock options outstanding
at December 31, 2001:
Options Outstanding Options Exercisable
------------------------------- -------------------
Average Average Average
Range of Exercise Remaining Exercise
Exercise Prices Shares Price Life Shares Price
--------------- --------- -------- --------- --------- --------
$18.56 - $20.00 1,836,073 $19.79 8.6 years 360,273 $19.78
$20.01 - $25.00 1,181,362 $23.97 3.3 " 1,181,362 $23.97
$25.01 - $30.00 333,270 $26.98 3.6 " 287,470 $27.02
$30.01 - $35.00 957,250 $30.42 4.1 " 943,350 $30.37
$35.01 - $40.00 1,493,676 $36.81 6.3 " 868,650 $37.12
$40.01 - $45.19 287,500 $42.41 6.2 " 177,200 $42.45
No compensation cost has been recognized for stock option grants. Had
compensation cost been determined for stock option awards based on the
fair values at grant dates consistent with the method prescribed by SFAS
No. 123, AFG's net income would have decreased by $3.7 million ($.05 per
share, diluted) in 2001, $4.9 million ($.08 per share) in 2000, and $5.0
million ($.08 per share) in 1999. The weighted-average fair value per
option granted was $8.18, $5.38 and $8.32 in 2001, 2000 and 1999,
respectively. For SFAS No. 123 purposes, calculations were determined
using the Black-Scholes option pricing model and the following
weighted-average assumptions: dividend yield of 2% for 2001 and 3% for
2000 and 1999; expected volatility of 27% for 2001, 24% for 2000 and 22%
for 1999; weighted average risk-free interest rate of 5.3% for 2001, 6%
for 2000 and 5.4% for 1999; and expected life of 7.4 years for 2001 and
2000 and 7.3 years for 1999.
F-16
AMERICAN FINANCIAL GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
UNREALIZED GAIN (LOSS) ON MARKETABLE SECURITIES, NET The change in
unrealized gain (loss) on marketable securities included the following (in
millions):
Tax Minority
Pretax Effects Interest Net
------ ------- -------- -----
2001
------------------------------------------
Unrealized holding gains (losses) on
securities arising during the period $ 0.8 ($ 0.3) ($ 4.1) ($ 3.6)
Adoption of EITF 99-20 16.9 (6.0) (0.9) 10.0
Realized losses included in net income and
unrealized gains of subsidiary sold 23.6 (8.3) (3.0) 12.3
------ ------ ----- ------
Change in unrealized gain on
marketable securities, net $ 41.3 ($ 14.6) ($ 8.0) $ 18.7
====== ====== ===== ======
2000
------------------------------------------
Unrealized holding gains on
securities arising during the period $221.1 ($ 75.8) ($14.5) $130.8
Adoption of SFAS No. 133 15.0 (5.3) - 9.7
Realized gains included in net income and
unrealized losses of subsidiary sold 31.3 (10.9) (2.1) 18.3
------ ------ ----- ------
Change in unrealized gain (loss) on
marketable securities, net $267.4 ($ 92.0) ($16.6) $158.8
====== ====== ===== ======
1999
------------------------------------------
Unrealized holding losses on
securities arising during the period ($612.1) $212.1 $38.4 ($361.6)
Realized gains included in net income (20.2) 7.1 (1.0) (14.1)
------ ------ ----- ------
Change in unrealized gain (loss) on
marketable securities, net ($632.3) $219.2 $37.4 ($375.7)
====== ====== ===== ======
J. INCOME TAXES The following is a reconciliation of income taxes at the
statutory rate of 35% and income taxes as shown in the Statement of
Operations (in thousands):
2001 2000 1999
---- ---- ----
Earnings (loss) before income taxes:
Operating $55,898 $109,893 $302,061
Minority interest expense (43,187) (44,961) (48,780)
Equity in net losses of investees (25,462) (142,230) (27,357)
Extraordinary items - - (2,617)
Accounting changes (15,948) (13,882) (6,370)
------- -------- --------
Total ($28,699) ($ 91,180) $216,937
======= ======== ========
Income taxes at statutory rate ($10,045) ($ 31,913) $ 75,928
Effect of:
Adjustment to prior year taxes (6,317) - -
Minority interest 5,672 6,187 7,093
Amortization of intangibles 4,526 5,495 4,686
Effect of foreign operations (3,421) 951 (550)
Dividends received deduction (2,317) (2,378) (2,783)
Nondeductible meals, etc. 1,381 1,300 776
Losses utilized (1,245) (7,000) (5,250)
Tax credits (1,243) (5,757) (1,900)
Tax exempt interest (1,233) (1,571) (1,721)
State income taxes 781 298 332
Other (398) (757) (1,114)
------- -------- --------
Total Provision (Credit) (13,859) (35,145) 75,497
Amounts applicable to:
Minority interest expense 9,117 9,595 9,695
Equity in net losses of investees 8,912 49,781 9,574
Extraordinary items - - 916
Accounting changes 5,908 4,810 2,516
------- -------- --------
Provision for income taxes as shown
on the Statement of Operations $10,078 $ 29,041 $ 98,198
======= ======== ========
F-17
AMERICAN FINANCIAL GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
Total earnings before income taxes include income subject to tax in
foreign jurisdictions of $8.3 million in 2001, $10.6 million in 2000 and
$8.1 million in 1999.
The total income tax provision (credit) consists of (in thousands):
2001 2000 1999
---- ---- ----
Current taxes:
Federal $44,715 $13,880 ($ 5,434)
Foreign - 1,106 32
State 1,201 459 511
Deferred taxes:
Federal (59,042) (50,070) 81,419
Foreign (733) (520) (1,031)
------- ------- -------
($13,859) ($35,145) $75,497
======= ======= =======
For income tax purposes, certain members of the AFC consolidated tax group
had the following carryforwards available at December 31, 2001 (in
millions):
Expiring Amount
----------- ------
{ 2002 - 2006 $ 83
Operating Loss { 2007 - 2016 -
{ 2017 - 2021 112
Other - Tax Credits 12
Deferred income tax assets and liabilities reflect temporary differences
between the carrying amounts of assets and liabilities recognized for
financial reporting purposes and the amounts recognized for tax purposes.
The significant components of deferred tax assets and liabilities included
in the Balance Sheet at December 31, were as follows (in millions):
2001 2000
---- ----
Deferred tax assets:
Net operating loss carryforwards $ 68.3 $ 78.8
Insurance claims and reserves 268.2 244.3
Other, net 106.5 90.0
------ ------
443.0 413.1
Valuation allowance for deferred
tax assets (40.9) (39.6)
------ ------
402.1 373.5
Deferred tax liabilities:
Deferred acquisition costs (231.5) (205.8)
Investment securities (101.1) (121.1)
------ ------
(332.6) (326.9)
------ ------
Net deferred tax asset $ 69.5 $ 46.6
====== ======
The gross deferred tax asset has been reduced by a valuation allowance
based on an analysis of the likelihood of realization. Factors considered
in assessing the need for a valuation allowance include: (i) recent tax
returns, which show neither a history of large amounts of taxable income
nor cumulative losses in recent years, (ii) opportunities to generate
taxable income from sales of appreciated assets, and (iii) the likelihood
of generating larger amounts of taxable income in the future. The
likelihood of realizing this asset will be reviewed periodically; any
adjustments required to the valuation allowance will be made in the period
in which the developments on which they are based become known.
Cash payments for income taxes, net of refunds, were $6.6 million, $27.8
million and $9.7 million for 2001, 2000 and 1999, respectively.
F-18
AMERICAN FINANCIAL GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
K. EXTRAORDINARY ITEMS Extraordinary items represent AFG's proportionate
share of gains and losses related to debt retirements by the following
companies. Amounts shown are net of minority interest and income taxes
(in thousands):
1999
----
AFG (parent) $2,295
AFC (parent) (2,993)
APU (parent) (1,003)
------
($1,701)
======
L. COMMITMENTS AND CONTINGENCIES Loss accruals (included in other
liabilities) have been recorded for various environmental and occupational
injury and disease claims and other contingencies arising out of the
railroad operations disposed of by American Premier's predecessor, Penn
Central Transportation Company ("PCTC"), prior to its bankruptcy
reorganization in 1978 and certain manufacturing operations disposed of by
American Premier.
At December 31, 2001, American Premier had liabilities for environmental
and personal injury claims aggregating $82.2 million. The environmental
claims consist of a number of proceedings and claims seeking to impose
responsibility for hazardous waste remediation costs related to certain
sites formerly owned or operated by the railroad and manufacturing
operations. Remediation costs are difficult to estimate for a number of
reasons, including the number and financial resources of other potentially
responsible parties, the range of costs for remediation alternatives,
changing technology and the time period over which these matters develop.
The personal injury claims include pending and expected claims, primarily
by former employees of PCTC, for injury or disease allegedly caused by
exposure to excessive noise, asbestos or other substances in the
workplace. In December 2001, American Premier recorded a $12.1 million
charge to increase its environmental reserves due to an increase in
expected ultimate claim costs. At December 31, 2001, American Premier had
$57 million of offsetting recovery assets (included in other assets) for
such environmental and personal injury claims based upon estimates of
probable recoveries from insurance carriers.
AFG has accrued approximately $13.4 million at December 31, 2001, for
environmental costs and certain other matters associated with the sales of
former operations.
AFG's insurance subsidiaries continue to receive claims related to
environmental exposures, asbestos and other mass tort claims. Establishing
reserves for these claims is subject to uncertainties that are
significantly greater than those presented by other types of claims. The
liability for asbestos and environmental reserves at December 31, 2001 and
2000, respectively, was $548 million and $463 million; related
recoverables from reinsurers (net of allowances for doubtful accounts) at
those dates were $101 million and $105 million, respectively.
While management believes AFG has recorded adequate reserves for the items
discussed in this note, the outcome is uncertain and could result in
liabilities exceeding amounts AFG has currently recorded. Additional
amounts could have a material adverse effect on AFG's future results of
operations and financial condition. For a discussion of the uncertainties
inherent in asbestos and environmental claims, see MANAGEMENT'S DISCUSSION
AND ANALYSIS - "UNCERTAINTIES - PROPERTY AND CASUALTY INSURANCE RESERVES",
"UNCERTAINTIES - LITIGATION", AND "SPECIAL A&E CHARGE".
M. QUARTERLY OPERATING RESULTS (UNAUDITED) The operations of certain of AFG's
business segments are seasonal in nature. While insurance premiums are
recognized on a relatively level basis, claim losses related to adverse
weather (snow, hail, hurricanes, tornadoes, etc.) may be seasonal.
Quarterly results necessarily rely heavily on estimates. These estimates
and certain other factors, such as the nature of investees' operations and
discretionary sales of assets, cause the quarterly results not to be
necessarily indicative of results for longer periods of time.
F-19
AMERICAN FINANCIAL GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
The following are quarterly results of consolidated operations for the two
years ended December 31, 2001 (in millions, except per share amounts).
1st 2nd 3rd 4th Total
Quarter Quarter Quarter Quarter Year
------- ------- ------- ------- -----
2001
------------------------------------------------
Revenues $972.3 $993.2 $1,014.8 $943.3 $3,923.6
Earnings (loss) before accounting change 13.1 6.3 (55.7) 31.5 (4.8)
Cumulative effect of accounting change - (10.0) - - (10.0)
Net earnings (loss) 13.1 (3.7) (55.7) 31.5 (14.8)
Basic earnings (loss) per common share:
Before accounting change $.19 $.09 ($.82) $ .46 ($.07)
Cumulative effect of accounting change - (.15) - - (.15)
Net earnings (loss) available to Common Shares .19 (.06) (.82) .46 (.22)
Diluted earnings (loss) per common share:
Before accounting change $.19 $.09 ($.81) $ .46 ($.07)
Cumulative effect of accounting change - (.15) - - (.15)
Net earnings (loss) available to Common Shares .19 (.06) (.81) .46 (.22)
Average number of Common Shares:
Basic 67.5 67.9 68.0 68.3 67.9
Diluted 67.9 68.5 68.5 68.6 68.4
2000
-----------------------------------------------
Revenues $884.1 $959.2 $1,012.6 $961.4 $3,817.3
Earnings (loss) before accounting change 44.7 16.3 (22.2) (85.7) (46.9)
Cumulative effect of accounting change - - - (9.1) (9.1)
Net earnings (loss) 44.7 16.3 (22.2) (94.8) (56.0)
Basic earnings (loss) per common share:
Before accounting change $.76 $.28 ($.38) ($1.43) ($.80)
Cumulative effect of accounting change - - - (.15) (.15)
Net earnings (loss) available to Common Shares .76 .28 (.38) (1.58) (.95)
Diluted earnings (loss) per common share:
Before accounting change $.76 $.28 ($.38) ($1.43) ($.80)
Cumulative effect of accounting change - - - (.15) (.15)
Net earnings (loss) available to Common Shares .76 .28 (.38) (1.58) (.95)
Average number of Common Shares:
Basic 58.5 58.5 58.6 60.0 58.9
Diluted 58.5 58.9 58.8 60.1 59.1
Quarterly earnings per share do not add to year-to-date amounts due to
changes in shares outstanding.
The 2001 third quarter results include a $100 million pretax charge to
strengthen asbestos and environmental insurance reserves and pretax losses
of $25 million resulting from the World Trade Center terrorist attack.
The 2000 second quarter results include pretax charges of $32.5 million
related to an agreement to settle a lawsuit against a GAFRI subsidiary and
$8.8 million for an adverse California Supreme Court ruling against an AFG
property and casualty subsidiary. The 2000 third quarter results include a
$35 million pretax charge for reserve strengthening in the California
workers' compensation business, partially offset by $11.2 million in
income from the sale of certain lease rights. Fourth quarter 2000 results
include a $95.7 million pretax writedown of AFG's Chiquita investment,
partially offset by $11.8 million in income from the sale of certain lease
rights.
AFG has realized gains (losses) on sales of subsidiaries in recent years
(see Note B). Realized gains (losses) on securities, affiliates and other
investments amounted to (in millions):
1st 2nd 3rd 4th Total
Quarter Quarter Quarter Quarter Year
------- ------- ------- ------- ------
2001 ($8.5) ($26.4) $7.0 $3.9 ($24.0)
2000 (1.4) 21.1 6.0 (21.0) 4.7
F-20
AMERICAN FINANCIAL GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
N. INSURANCE Securities owned by insurance subsidiaries having a carrying
value of about $940 million at December 31, 2001, were on deposit as
required by regulatory authorities.
INSURANCE RESERVES The liability for losses and loss adjustment expenses
for certain long-term scheduled payments under workers' compensation, auto
liability and other liability insurance has been discounted at about 8%,
an approximation of long-term investment yields. As a result, the total
liability for losses and loss adjustment expenses at December 31, 2001,
has been reduced by $24 million.
The following table provides an analysis of changes in the liability for
losses and loss adjustment expenses, net of reinsurance (and grossed up),
over the past three years on a GAAP basis (in millions):
2001 2000 1999
---- ---- ----
Balance at beginning of period $3,192 $3,224 $3,305
Provision for losses and LAE occurring
in the current year 1,950 2,056 1,691
Net increase (decrease) in provision for
claims of prior years 163 (60) (74)
------ ------ ------
Total losses and LAE incurred (*) 2,113 1,996 1,617
Payments for losses and LAE of:
Current year (831) (905) (780)
Prior years (1,036) (936) (986)
------ ------ ------
Total payments (1,867) (1,841) (1,766)
Reserves of businesses acquired or sold, net (120) (187) 57
Reclass to unearned premiums (65) - -
Reclassification of allowance for
uncollectible reinsurance - - 11
------ ------ ------
Balance at end of period $3,253 $3,192 $3,224
====== ====== ======
Add back reinsurance recoverables, net
of allowance 1,525 1,324 1,571
------ ------ ------
Gross unpaid losses and LAE included
in the Balance Sheet $4,778 $4,516 $4,795
====== ====== ======
(*) Before amortization of deferred gains on retroactive reinsurance of
$33 million in 2001, $34 million in 2000 and $28 million in 1999.
NET INVESTMENT INCOME The following table shows (in millions) investment
income earned and investment expenses incurred by AFG's insurance
companies.
2001 2000 1999
---- ---- ----
Insurance group investment income:
Fixed maturities $841.0 $815.5 $806.1
Equity securities 8.1 10.4 12.2
Other 1.1 4.3 .9
------ ------ ------
850.2 830.2 819.2
Insurance group investment expenses (*) (36.8) (41.4) (39.6)
------ ------ ------
$813.4 $788.8 $779.6
====== ====== ======
(*) Included primarily in "Other operating and general expenses" in the
Statement of Operations.
F-21
AMERICAN FINANCIAL GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
STATUTORY INFORMATION AFG's insurance subsidiaries are required to file
financial statements with state insurance regulatory authorities prepared
on an accounting basis prescribed or permitted by such authorities
(statutory basis). Net earnings and policyholders' surplus on a statutory
basis for the insurance subsidiaries were as follows (in millions):
Policyholders'
Net Earnings Surplus
------------------ ---------------
2001 2000 1999 2001 2000
---- ---- ---- ---- ----
Property and casualty companies $34 $10 $170 $1,669 $1,763
Life insurance companies (25) 40 37 414 384
In January 2001, AFG's insurance companies adopted the Codification of
Statutory Accounting Principles. The cumulative effect of these changes at
adoption increased the surplus of the property and casualty companies by
$44 million; the effect on surplus of the life insurance companies was not
material.
REINSURANCE In the normal course of business, AFG's insurance subsidiaries
assume and cede reinsurance with other insurance companies. The following
table shows (in millions) (i) amounts deducted from property and casualty
written and earned premiums in connection with reinsurance ceded, (ii)
written and earned premiums included in income for reinsurance assumed and
(iii) reinsurance recoveries deducted from losses and loss adjustment
expenses.
2001 2000 1999
---- ---- ----
Direct premiums written $3,560 $3,365 $3,113
Reinsurance assumed 94 76 48
Reinsurance ceded (1,101) (803) (898)
------ ------ ------
Net written premiums $2,553(*) $2,638 $2,263
====== ====== ======
Direct premiums earned $3,393 $3,306 $3,056
Reinsurance assumed 92 45 45
Reinsurance ceded (891) (856) (890)
------ ------ ------
Net earned premiums $2,594 $2,495 $2,211
====== ====== ======
Reinsurance recoveries $ 773 $ 567 $ 811
====== ====== ======
(*) Net of $29.7 million unearned premium transfer related to
the sale of the Japanese division.
O. ADDITIONAL INFORMATION Total rental expense for various leases of office
space and equipment was $53 million, $44 million and $39 million for 2001,
2000 and 1999, respectively. Sublease rental income related to these
leases totaled $2.4 million in 2001, $2.5 million in 2000 and $2.6 million
in 1999.
Future minimum rentals, related principally to office space, required
under operating leases having initial or remaining noncancelable lease
terms in excess of one year at December 31, 2001, were as follows: 2002 -
$55 million; 2003 - $47 million; 2004 - $35 million; 2005 - $21 million;
2006 - $15 million; and $36 million thereafter.
Other operating and general expenses included charges for possible losses
on agents' balances, other receivables and other assets in the following
amounts: 2001 - $14.6 million; 2000 - $9.7 million; and 1999 - $5.1
million. Losses and loss adjustment expenses included charges for possible
losses on reinsurance recoverables of $11 million in 2001 and $.4 million
in 1999. The aggregate allowance for all such losses amounted to
approximately $68 million and $74 million at December 31, 2001 and 2000,
respectively.
F-22
AMERICAN FINANCIAL GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
UNREALIZED GAIN (LOSS) ON MARKETABLE SECURITIES, NET In addition to
adjusting equity securities and fixed maturity securities classified as
"available for sale" to fair value, SFAS 115 requires that certain other
balance sheet amounts be adjusted to the extent that unrealized gains and
losses from securities would result in adjustments had those gains or
losses actually been realized. The components of the Consolidated Balance
Sheet caption "Unrealized gain on marketable securities, net" in
shareholders' equity are summarized as follows (in millions):
Unadjusted Adjusted
Asset Effect of Asset
Liability) Sfas 115 (Liability)
---------- --------- -----------
2001
----
Fixed maturities $10,593.3 $155.3 $10,748.6
Other stocks 187.8 125.9 313.7
Deferred acquisition costs 827.3 (9.0) 818.3
Annuity benefits accumulated (5,827.9) (4.2) (5,832.1)
------
Pretax unrealized 268.0
Deferred taxes 162.7 (93.2) 69.5
Minority interest (439.2) (15.5) (454.7)
------
Unrealized gain $159.3
======
2000
----
Fixed maturities $10,148.3 $ 16.3 $10,164.6
Other stocks 175.0 210.4 385.4
Deferred acquisition costs 763.1 - 763.1
Annuity benefits accumulated (5,543.7) - (5,543.7)
------
Pretax unrealized 226.7
Deferred taxes 125.2 (78.6) 46.6
Minority interest (500.5) (7.5) (508.0)
------
Unrealized gain $140.6
======
FAIR VALUE OF FINANCIAL INSTRUMENTS The following table presents (in
millions) the carrying value and estimated fair value of AFG's
financial instruments at December 31.
2001 2000
------------------ -------------------
Carrying Fair Carrying Fair
Value Value Value Value
-------- -------- -------- --------
ASSETS:
Fixed maturities $10,749 $10,749 $10,165 $10,165
Other stocks 314 314 385 385
LIABILITIES:
Annuity benefits
accumulated $ 5,832 $ 5,659 $ 5,544 $ 5,426
Long-term debt:
Holding companies 609 587 585 548
Subsidiaries 271 264 195 187
MINORITY INTEREST:
Trust preferred securities $ 242 $ 242 $ 317 $ 304
AFC preferred stock 72 61 72 58
SHAREHOLDERS' EQUITY $ 1,498 $ 1,681 $ 1,549 $ 1,791
When available, fair values are based on prices quoted in the most active
market for each security. If quoted prices are not available, fair value
is estimated based on present values, discounted cash flows, fair value of
comparable securities, or similar methods. The fair value of the liability
for annuities in the payout phase is assumed to be the present value of
the anticipated cash
F-23
AMERICAN FINANCIAL GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
flows, discounted at current interest rates. Fair value of annuities in
the accumulation phase is assumed to be the policyholders' cash surrender
amount. Fair value of shareholders' equity is based on the quoted market
price of AFG's Common Stock.
FINANCIAL INSTRUMENTS WITH OFF-BALANCE-SHEET RISK On occasion, AFG and its
subsidiaries have entered into financial instrument transactions which may
present off-balance-sheet risks of both a credit and market risk nature.
These transactions include commitments to fund loans, loan guarantees and
commitments to purchase and sell securities or loans. At December 31,
2001, AFG and its subsidiaries had commitments to fund credit facilities
and contribute limited partnership capital totaling up to $21 million.
RESTRICTIONS ON TRANSFER OF FUNDS AND ASSETS OF SUBSIDIARIES Payments of
dividends, loans and advances by AFG's subsidiaries are subject to various
state laws, federal regulations and debt covenants which limit the amount
of dividends, loans and advances that can be paid. Under applicable
restrictions, the maximum amount of dividends available to AFG in 2002
from its insurance subsidiaries without seeking regulatory clearance is
approximately $92 million. Total "restrictions" on intercompany transfers
from AFG's subsidiaries cannot be quantified due to the discretionary
nature of the restrictions.
BENEFIT PLANS AFG expensed approximately $19 million in 2001, $22 million
in 2000 and $13 million in 1999 for its retirement and employee savings
plans.
TRANSACTIONS WITH AFFILIATES AFG purchased a $3.7 million minority
interest in a residential homebuilding company from an unrelated party in
1995. At that same time, a brother of AFG's chairman purchased a minority
interest in the company for $825,000. In 2000, that brother and another
brother of AFG's chairman acquired the remaining shares from the third
parties. GAFRI has extended a line of credit to this company under which
the homebuilder may borrow up to $8 million at 13%. At December 31, 2001
and 2000, $6.4 million and $8 million, respectively, was due under the
credit line.
In 2001, an AFG subsidiary purchased a 29% interest in an aircraft for
$1.6 million (fair value as determined by an independent third party) from
a company owned by a brother of AFG's chairman. The remaining interests in
the aircraft are owned by AFG's chairman and his two brothers. Costs of
operating the aircraft are being borne proportionately.
In September 2000, GAFRI's minority ownership in a company engaged in the
production of ethanol was repurchased by that company for $7.5 million in
cash and $21.9 million liquidation value of non-voting redeemable
preferred stock. Following the repurchase, AFG's Chairman beneficially
owns 100% of the ethanol company. In December 2000, the ethanol company
retired $3 million of the preferred stock at liquidation value plus
accrued dividends and issued an $18.9 million subordinated note in
exchange for the remaining preferred stock. The subordinated note bears
interest at 12-1/4% with scheduled repayments through 2005. During 2001,
$6 million of this note was repaid. The ethanol company also owes GAFRI
$4.0 million under a subordinated note bearing interest at 14%. In
addition, Great American has extended a $10 million line of credit to this
company; no amounts have been borrowed under the credit line.
P. SUBSEQUENT EVENT (UNAUDITED) On March 14, 2002, GAFRI reached an agreement
to acquire Manhattan National Life Insurance company ("MNL") from Conseco,
Inc. for $48.5 million in cash. GAFRI expects to close on this transaction
in the second quarter of 2002 and to fund this acquisition with cash on
hand and through reinsurance of up to 90% of the business in force. While
MNL is not currently writing new policies, the company reported over $43
million of statutory renewal premiums in 2001. MNL has approximately
90,000 policies in force (primarily term life) representing over $12
billion in face amount of insurance, statutory assets of $297.8 million
and statutory capital and surplus of $23.1 million.
F-24
PART IV
ITEM 14
EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K
(a) Documents filed as part of this Report:
1. Financial Statements are included in Part II, Item 8.
2. Financial Statement Schedules:
A. Selected Quarterly Financial Data is included in Note M
to the Consolidated Financial Statements.
B. Schedules filed herewith for 2001, 2000 and 1999:
Page
----
I - Condensed Financial Information of Registrant S-2
V - Supplemental Information Concerning
Property-Casualty Insurance Operations S-4
All other schedules for which provisions are made in
the applicable regulation of the Securities and
Exchange Commission have been omitted as they are not
applicable, not required, or the information required
thereby is set forth in the Financial Statements or the
notes thereto.
3. Exhibits - see Exhibit Index on page E-1.
(b) Reports on Form 8-K: none.
S-1
AMERICAN FINANCIAL GROUP, INC. - PARENT ONLY (*)
SCHEDULE I - CONDENSED FINANCIAL INFORMATION OF REGISTRANT
(IN THOUSANDS)
CONDENSED BALANCE SHEET
December 31,
--------------------------
2001 2000
---- ----
ASSETS:
Cash and short-term investments $ 529 $ 1,407
Receivables from affiliates 359,582 438,807
Investment in subsidiaries 1,562,550 1,534,280
Other assets 65,214 63,557
---------- ----------
$1,987,875 $2,038,051
========== ==========
LIABILITIES AND SHAREHOLDERS' EQUITY:
Accounts payable, accrued expenses and other
liabilities $ 4,983 $ 5,185
Payables to affiliates 103,805 103,805
Long-term debt 380,708 380,531
Shareholders' equity 1,498,379 1,548,530
---------- ----------
$1,987,875 $2,038,051
========== ==========
CONDENSED STATEMENT OF OPERATIONS
Year Ended December 31,
------------------------------
2001 2000 1999
---- ---- ----
INCOME:
Dividends from subsidiaries $ 282 $ 282 $ 282
Equity in undistributed earnings (losses)
of subsidiaries 10,863 (57,796) 242,850
Investment and other income 27,650 27,563 27,436
------- ------- --------
38,795 (29,951) 270,568
COSTS AND EXPENSES:
Interest charges on borrowed money 42,958 39,912 34,707
Other operating and general expenses 8,588 7,435 9,937
------- ------- --------
51,546 47,347 44,644
------- ------- --------
Earnings (loss) before income taxes,
extraordinary items and accounting changes (12,751) (77,298) 225,924
Provision (credit) for income taxes (7,951) (30,335) 78,929
------- ------- --------
Earnings (loss) before extraordinary items
and accounting changes (4,800) (46,963) 146,995
Extraordinary items - loss on prepayment
of debt - - (1,701)
Cumulative effect of accounting changes (10,040) (9,072) (3,854)
------- ------- --------
NET EARNINGS (LOSS) ($14,840) ($56,035) $141,440
======= ======= ========
(*) The Parent Only Financial Statements include the accounts of AFG and its
predecessor, AFC Holding Company, a wholly-owned subsidiary.
S-2
AMERICAN FINANCIAL GROUP, INC. - PARENT ONLY (*)
SCHEDULE I - CONDENSED FINANCIAL INFORMATION OF REGISTRANT - CONTINUED
(IN THOUSANDS)
CONDENSED STATEMENT OF CASH FLOWS
Year Ended December 31,
-----------------------------
2001 2000 1999
---- ---- ----
OPERATING ACTIVITIES:
Net earnings (loss) ($14,840) ($ 56,035) $141,440
Adjustments:
Extraordinary items - - 1,701
Cumulative effect of accounting changes 10,040 9,072 3,854
Equity in losses (earnings) of subsidiaries (10,613) 34,225 (158,067)
Change in balances with affiliates 83,189 (64,511) (110,243)
Increase in other assets (4,126) (10,987) (8,844)
Increase (decrease) in payables (202) 190 3,336
Dividends from subsidiaries 282 282 282
Other 458 602 15
------- -------- --------
64,188 (87,162) (126,526)
------- -------- --------
INVESTING ACTIVITIES:
Purchases of investments - - (14,894)
Sales of investments - - 13,903
------- -------- --------
- - (991)
------- -------- --------
FINANCING ACTIVITIES:
Additional long-term borrowings - - 344,938
Reductions of long-term debt - - (63,179)
Issuances of common stock 19,669 159,562 7,389
Repurchases of common stock - - (88,597)
Repurchases of trust preferred securities - (1,052) -
Cash dividends paid (84,735) (71,553) (78,199)
------- -------- --------
(65,066) 86,957 122,352
------- -------- --------
NET DECREASE IN CASH AND SHORT-TERM INVESTMENTS (878) (205) (5,165)
Cash and short-term investments at beginning
of period 1,407 1,612 6,777
------- -------- --------
Cash and short-term investments at end
of period $ 529 $ 1,407 $ 1,612
======= ======== ========
(*) The Parent Only Financial Statements include the accounts of AFG and its
predecessor, AFC Holding Company, a wholly-owned subsidiary.
S-3
AMERICAN FINANCIAL GROUP, INC. AND SUBSIDIARIES
SCHEDULE V - SUPPLEMENTAL INFORMATION CONCERNING
PROPERTY-CASUALTY INSURANCE OPERATIONS
THREE YEARS ENDED DECEMBER 31, 2001
(IN MILLIONS)
---------------------------------------------------------------------------
COLUMN A COLUMN B COLUMN C COLUMN D COLUMN E
---------------------------------------------------------------------------
(a)
RESERVES FOR
DEFERRED UNPAID CLAIMS (b)
AFFILIATION POLICY AND CLAIMS DISCOUNT (c)
WITH ACQUISITION ADJUSTMENT DEDUCTED IN UNEARNED
REGISTRANT COSTS EXPENSES COLUMN C PREMIUMS
---------------------------------------------------------------------------
CONSOLIDATED PROPERTY-CASUALTY ENTITIES
---------------------------------------
2001 $262 $4,778 $24 $1,641
==== ====== === ======
2000 $275 $4,516 $33 $1,414
==== ====== === ======
----------------------------------------------------------------------------------------------------------------------
COLUMN F COLUMN G COLUMN H COLUMN I COLUMN J COLUMN K
----------------------------------------------------------------------------------------------------------------------
CLAIMS AND CLAIM
ADJUSTMENT EXPENSES AMORTIZATION PAID
INCURRED RELATED TO OF DEFERRED CLAIMS
NET POLICY AND CLAIM
EARNED INVESTMENT CURRENT PRIOR ACQUISITION ADJUSTMENT PREMIUMS
PREMIUMS INCOME YEARS YEARS COSTS EXPENSES WRITTEN
----------------------------------------------------------------------------------------------------------------------
2001 $2,594 $308 $1,950 $163 $556 $1,867 $2,553
====== ==== ====== ==== ==== ====== ======
2000 $2,495 $298 $2,056 ($ 60) $560 $1,841 $2,638
====== ==== ====== ==== ==== ====== ======
1999 $2,211 $292 $1,691 ($ 74) $498 $1,766 $2,263
====== ==== ====== ==== ==== ====== ======
(a) Grossed up for reinsurance recoverables of $1,525 and $1,324 at
December 31, 2001 and 2000, respectively.
(b) Discounted at approximately 8%.
(c) Grossed up for prepaid reinsurance premiums of $477 and $267 at
December 31, 2001 and 2000, respectively.
S-4
SIGNATURES
Pursuant to the requirements of Section 13 of the Securities Exchange
Act of 1934, American Financial Group, Inc. has duly caused this Report to be
signed on its behalf by the undersigned, duly authorized.
American Financial Group, Inc.
Signed: March 27, 2002 BY:S/CARL H. LINDNER
----------------------------------
Carl H. Lindner
Chairman of the Board and
Chief Executive Officer
----------------------------------
Pursuant to the requirements of the Securities Exchange Act of 1934,
this Report has been signed below by the following persons on behalf of the
Registrant and in the capacities and on the dates indicated:
SIGNATURE CAPACITY DATE
S/CARL H. LINDNER Chairman of the Board March 27, 2002
----------------------- of Directors
Carl H. Lindner
S/THEODORE H. EMMERICH Director* March 27, 2002
-----------------------
Theodore H. Emmerich
S/JAMES E. EVANS Director March 27, 2002
-----------------------
James E. Evans
S/THOMAS M. HUNT Director* March 27, 2002
-----------------------
Thomas M. Hunt
S/CARL H. LINDNER III Director March 27, 2002
-----------------------
Carl H. Lindner III
S/KEITH E. LINDNER Director March 27, 2002
-----------------------
Keith E. Lindner
S/S. CRAIG LINDNER Director March 27, 2002
-----------------------
S. Craig Lindner
S/WILLIAM R. MARTIN Director* March 27, 2002
-----------------------
William R. Martin
S/FRED J. RUNK Senior Vice President and March 27, 2002
----------------------- Treasurer (principal
Fred J. Runk financial and accounting
officer)
* Member of the Audit Committee
INDEX TO EXHIBITS
AMERICAN FINANCIAL GROUP, INC.
Number Exhibit Description
------ ------------------------------------
3(a) Amended and Restated Articles of
Incorporation, filed as Exhibit 3(a)
to AFG's Form 10-K for 1997. (*)
3(b) Code of Regulations, filed as
Exhibit 3(b) to AFG's Form 10-K
for 1997. (*)
4 Instruments defining the rights of Registrant has no
security holders. outstanding debt issues
exceeding 10% of the
assets of Registrant and
consolidated subsidiaries.
Management Contracts:
10(a) Stock Option Plan, filed as Exhibit 10(a)
to AFG's Form 10-K for 1998. (*)
10(b) Form of stock option agreements, filed as
Exhibit 10(b) to AFG's Form 10-K for 1998. (*)
10(c) 2001 Annual Bonus Plan, filed as Exhibit 10 (*)
to AFG's June 30, 2001 Form 10-Q.
10(d) Nonqualified Auxiliary RASP, filed as
Exhibit 10(d) to AFG's Form 10-K for 1998. (*)
10(e) Retirement program for outside directors,
filed as Exhibit 10(e) to AFG's Form 10-K
for 1995. (*)
10(f) Directors' Compensation Plan,
filed as Exhibit 10(f) tO AFG's Form 10-K
for 1995. (*)
10(g) Deferred Compensation Plan, filed as
Exhibit 10 to AFG's Registration Statement
on Form S-8 on December 2, 1999. (*)
12 Computation of ratios of earnings
to fixed charges. _____
21 Subsidiaries of the Registrant. _____
23 Consent of independent auditors. _____
(*) Incorporated herein by reference.
E-1