UNITED STATES SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549

FORM 10-Q

Quarterly Report Pursuant to Section 13 or 15(d) of the
Securities Exchange Act of 1934

For the Quarterly Period Ended June 30, 2018March 31, 2019
   
Commission File No. 1-13653 

afglogo.jpg


AMERICAN FINANCIAL GROUP, INC.
Incorporated under the Laws of Ohio IRS Employer I.D. No. 31-1544320
301 East Fourth Street, Cincinnati, Ohio 45202
(513) 579-2121
Indicate by check mark whether the Registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months, and (2) has been subject to such filing requirements for the past 90 days. Yes þ No ¨
Indicate by check mark whether the Registrant has submitted electronically, and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding 12 months. Yes þ No ¨
Indicate by check mark whether the Registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, a smaller reporting company or an emerging growth company. See definitions of “large accelerated filer,” “accelerated filer,” “smaller reporting company” and “emerging growth company” in Rule 12b-2 of the Exchange Act.
Large accelerated filer  þ                        Accelerated filer  ¨                        Non-accelerated filer  ¨
Smaller reporting company  ¨                        Emerging growth company  ¨
If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. ¨
Indicate by check mark whether the Registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes ¨ No þ
Securities Registered Pursuant to Section 12(b) of the Act:
Title of Each ClassTrading Symbol(s)Name of Each Exchange on Which Registered
Common StockAFGNew York Stock Exchange
6-1/4% Subordinated Debentures due September 30, 2054AFGENew York Stock Exchange
6% Subordinated Debentures due November 15, 2055AFGHNew York Stock Exchange
5.875% Subordinated Debentures due March 30, 2059AFGBNew York Stock Exchange
As of AugustMay 1, 20182019, there were 89,087,66389,687,455 shares of the Registrant’s Common Stock outstanding, excluding 14.9 million shares owned by subsidiaries.



Table of Contents
AMERICAN FINANCIAL GROUP, INC. 10-Q

TABLE OF CONTENTS
 
  
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Table of Contents
AMERICAN FINANCIAL GROUP, INC. 10-Q

PART I
ITEM I — FINANCIAL STATEMENTS
AMERICAN FINANCIAL GROUP, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEET (UNAUDITED)
(Dollars in Millions)
June 30,
2018
 December 31,
2017
March 31,
2019
 December 31,
2018
Assets:      
Cash and cash equivalents$1,810
 $2,338
$2,000
 $1,515
Investments:      
Fixed maturities, available for sale at fair value (amortized cost — $39,244 and $37,038)39,648
 38,379
Fixed maturities, available for sale at fair value (amortized cost — $42,418 and $41,837)43,431
 41,997
Fixed maturities, trading at fair value137
 348
107
 105
Equity securities, at fair value1,777
 1,662
1,930
 1,814
Investments accounted for using the equity method1,194
 999
1,440
 1,374
Mortgage loans1,147
 1,125
1,078
 1,068
Policy loans179
 184
172
 174
Equity index call options615
 701
620
 184
Real estate and other investments272
 312
262
 267
Total cash and investments46,779
 46,048
51,040
 48,498
Recoverables from reinsurers3,073
 3,369
3,258
 3,349
Prepaid reinsurance premiums645
 600
636
 610
Agents’ balances and premiums receivable1,266
 1,146
1,283
 1,234
Deferred policy acquisition costs1,582
 1,216
1,447
 1,682
Assets of managed investment entities5,032
 4,902
4,786
 4,700
Other receivables1,048
 1,030
1,011
 1,090
Variable annuity assets (separate accounts)636
 644
610
 557
Other assets1,574
 1,504
1,854
 1,529
Goodwill199
 199
207
 207
Total assets$61,834
 $60,658
$66,132
 $63,456
      
Liabilities and Equity:      
Unpaid losses and loss adjustment expenses$9,093
 $9,678
$9,623
 $9,741
Unearned premiums2,539
 2,410
2,605
 2,595
Annuity benefits accumulated34,886
 33,316
38,006
 36,616
Life, accident and health reserves647
 658
632
 635
Payable to reinsurers721
 743
730
 752
Liabilities of managed investment entities4,840
 4,687
4,593
 4,512
Long-term debt1,301
 1,301
1,423
 1,302
Variable annuity liabilities (separate accounts)636
 644
610
 557
Other liabilities2,087
 1,887
2,245
 1,774
Total liabilities56,750
 55,324
60,467
 58,484
      
Redeemable noncontrolling interests
 3

 
      
Shareholders’ equity:      
Common Stock, no par value
— 200,000,000 shares authorized
— 89,072,114 and 88,275,460 shares outstanding
89
 88
Common Stock, no par value
— 200,000,000 shares authorized
— 89,637,713 and 89,291,724 shares outstanding
90
 89
Capital surplus1,220
 1,181
1,256
 1,245
Retained earnings3,628
 3,248
3,875
 3,588
Accumulated other comprehensive income, net of tax147
 813
444
 48
Total shareholders’ equity5,084
 5,330
5,665
 4,970
Noncontrolling interests
 1

 2
Total equity5,084
 5,331
5,665
 4,972
Total liabilities and equity$61,834
 $60,658
$66,132
 $63,456

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AMERICAN FINANCIAL GROUP, INC. 10-Q

AMERICAN FINANCIAL GROUP, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENT OF EARNINGS (UNAUDITED)
(In Millions, Except Per Share Data)
Three months ended June 30, Six months ended June 30,Three months ended March 31,
2018 2017 2018 20172019 2018
Revenues:          
Property and casualty insurance net earned premiums$1,161
 $1,065
 $2,268
 $2,087
$1,173
 $1,107
Life, accident and health net earned premiums6
 5
 12
 11
6
 6
Net investment income530
 460
 1,025
 895
542
 495
Realized gains (losses) on securities (*)31
 8
 (62) 11
184
 (93)
Income (loss) of managed investment entities:          
Investment income64
 50
 122
 101
69
 58
Gain (loss) on change in fair value of assets/liabilities(2) 11
 (5) 11

 (3)
Other income43
 47
 92
 106
50
 49
Total revenues1,833
 1,646
 3,452
 3,222
2,024
 1,619
          
Costs and Expenses:          
Property and casualty insurance:          
Losses and loss adjustment expenses693
 635
 1,334
 1,244
692
 641
Commissions and other underwriting expenses400
 366
 781
 705
399
 381
Annuity benefits260
 224
 442
 420
311
 182
Life, accident and health benefits11
 6
 22
 15
9
 11
Annuity and supplemental insurance acquisition expenses50
 48
 132
 101
28
 82
Interest charges on borrowed money16
 23
 31
 44
16
 15
Expenses of managed investment entities54
 51
 102
 92
55
 48
Other expenses89
 88
 174
 173
101
 85
Total costs and expenses1,573
 1,441
 3,018
 2,794
1,611
 1,445
Earnings before income taxes260
 205
 434
 428
413
 174
Provision for income taxes52
 60
 85
 128
87
 33
Net earnings, including noncontrolling interests208
 145
 349
 300
326
 141
Less: Net earnings (losses) attributable to noncontrolling interests(2) 
 (6) 2
(3) (4)
Net Earnings Attributable to Shareholders$210
 $145
 $355
 $298
$329
 $145
          
Earnings Attributable to Shareholders per Common Share:          
Basic$2.36
 $1.64
 $3.99
 $3.40
$3.68
 $1.64
Diluted$2.31
 $1.61
 $3.92
 $3.32
$3.63
 $1.60
Average number of Common Shares:          
Basic89.0
 87.8
 88.8
 87.5
89.4
 88.6
Diluted90.7
 89.8
 90.5
 89.6
90.7
 90.4
       
Cash dividends per Common Share$1.85
 $1.8125
 $2.20
 $2.125
________________________________________          
(*) Consists of the following:          
Realized gains (losses) before impairments$31
 $17
 $(61) $26
$186
 $(92)
          
Losses on securities with impairment
 (10) (1) (16)(2) (1)
Non-credit portion recognized in other comprehensive income (loss)
 1
 
 1

 
Impairment charges recognized in earnings
 (9) (1) (15)(2) (1)
Total realized gains (losses) on securities$31
 $8
 $(62) $11
$184
 $(93)

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AMERICAN FINANCIAL GROUP, INC. 10-Q

AMERICAN FINANCIAL GROUP, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENT OF COMPREHENSIVE INCOME (UNAUDITED)
(In Millions)
 
Three months ended June 30, Six months ended June 30,Three months ended March 31,
2018 2017 2018 20172019 2018
Net earnings, including noncontrolling interests$208
 $145
 $349
 $300
$326
 $141
Other comprehensive income (loss), net of tax:          
Net unrealized gains (losses) on securities:          
Unrealized holding gains (losses) on securities arising during the period(148) 115
 (427) 240
384
 (279)
Reclassification adjustment for realized gains included in net earnings(3) (5) (1) (5)
Reclassification adjustment for realized (gains) losses included in net earnings(3) 2
Total net unrealized gains (losses) on securities(151) 110
 (428) 235
381
 (277)
Net unrealized gains (losses) on cash flow hedges(3) 2
 (14) 1
11
 (11)
Foreign currency translation adjustments(4) 4
 (3) 4
4
 1
Other comprehensive income (loss), net of tax(158) 116
 (445) 240
396
 (287)
Total comprehensive income (loss), net of tax50
 261
 (96) 540
722
 (146)
Less: Comprehensive income (loss) attributable to noncontrolling interests(2) 
 (6) 2
(3) (4)
Comprehensive income (loss) attributable to shareholders$52
 $261
 $(90) $538
$725
 $(142)


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AMERICAN FINANCIAL GROUP, INC. 10-Q

AMERICAN FINANCIAL GROUP, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENT OF CHANGES IN EQUITY (UNAUDITED)
(Dollars in Millions)
 
   Shareholders’ Equity     Redeemable   Shareholders’ Equity     Redeemable
Common
Shares
  
Common Stock
and Capital
Surplus
 
Retained
Earnings
 
Accumulated
Other Comp.
Income (Loss)
 Total 
Noncon-
trolling
Interests
 
Total
Equity
 Noncon-
trolling
Interests
Common
Shares
  
Common Stock
and Capital
Surplus
 
Retained
Earnings
 
Accumulated
Other Comp.
Income (Loss)
 Total 
Noncon-
trolling
Interests
 
Total
Equity
 Noncon-
trolling
Interests
Balance at December 31, 201788,275,460
  $1,269
 $3,248
 $813
 $5,330
 $1
 $5,331
 $3
Cumulative effect of accounting change
  
 225
 (221) 4
 
 4
 
Balance at December 31, 201889,291,724
  $1,334
 $3,588
 $48
 $4,970
 $2
 $4,972
 $
Net earnings (losses)
  
 355
 
 355
 (1) 354
 (5)
  
 329
 
 329
 
 329
 (3)
Other comprehensive loss
  
 
 (445) (445) 
 (445) 
Dividends on Common Stock
  
 (196) 
 (196) 
 (196) 
Other comprehensive income
  
 
 396
 396
 
 396
 
Dividends ($0.40 per share)
  
 (36) 
 (36) 
 (36) 
Shares issued:                                
Exercise of stock options531,726
  19
 
 
 19
 
 19
 
152,253
  6
 
 
 6
 
 6
 
Restricted stock awards200,625
  
 
 
 
 
 
 
232,565
  
 
 
 
 
 
 
Other benefit plans73,676
  8
 
 
 8
 
 8
 
11,062
  1
 
 
 1
 
 1
 
Dividend reinvestment plan18,006
  2
 
 
 2
 
 2
 
1,893
  
 
 
 
 
 
 
Stock-based compensation expense
  11
 
 
 11
 
 11
 

  6
 
 
 6
 
 6
 
Shares exchanged — benefit plans(24,310)  
 (2) 
 (2) 
 (2) 
(43,470)  (1) (3) 
 (4) 
 (4) 
Forfeitures of restricted stock(3,069)  
 
 
 
 
 
 
(8,314)  
 
 
 
 
 
 
Other
  
 (2) 
 (2) 
 (2) 2

  
 (3) 
 (3) (2) (5) 3
Balance at June 30, 201889,072,114
  $1,309
 $3,628
 $147
 $5,084
 $
 $5,084
 $
Balance at March 31, 201989,637,713
  $1,346
 $3,875
 $444
 $5,665
 $
 $5,665
 $
                                
Balance at December 31, 201686,924,399
  $1,198
 $3,343
 $375
 $4,916
 $3
 $4,919
 $
Net earnings
  
 298
 
 298
 2
 300
 
Other comprehensive income
  
 
 240
 240
 
 240
 
Dividends on Common Stock
  
 (187) 
 (187) 
 (187) 
Balance at December 31, 201788,275,460
  $1,269
 $3,248
 $813
 $5,330
 $1
 $5,331
 $3
Cumulative effect of accounting change
  
 225
 (221) 4
 
 4
 
Net earnings (losses)
  
 145
 
 145
 (1) 144
 (3)
Other comprehensive loss
  
 
 (287) (287) 
 (287) 
Dividends ($0.35 per share)
  
 (31) 
 (31) 
 (31) 
Shares issued:         
   
           
   
  
Exercise of stock options792,288
  26
 
 
 26
 
 26
 
374,314
  14
 
 
 14
 
 14
 
Restricted stock awards232,250
  
 
 
 
 
 
 
200,625
  
 
 
 
 
 
 
Other benefit plans75,381
  7
 
 
 7
 
 7
 
52,583
  6
 
 
 6
 
 6
 
Dividend reinvestment plan19,516
  2
 
 
 2
 
 2
 
2,779
  
 
 
 
 
 
 
Stock-based compensation expense
  13
 
 
 13
 
 13
 

  5
 
 
 5
 
 5
 
Shares exchanged — benefit plans(32,509)  
 (3) 
 (3) 
 (3) 
(23,882)  
 (3) 
 (3) 
 (3) 
Forfeitures of restricted stock(4,073)  
 
 
 
 
 
 
(666)  
 
 
 
 
 
 
Other
  
 
 
 
 (5) (5) 

  
 
 
 
 
 
 
Balance at June 30, 201788,007,252
  $1,246
 $3,451
 $615
 $5,312
 $
 $5,312
 $
Balance at March 31, 201888,881,213
  $1,294
 $3,584
 $305
 $5,183
 $
 $5,183
 $

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Table of Contents
AMERICAN FINANCIAL GROUP, INC. 10-Q

AMERICAN FINANCIAL GROUP, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENT OF CASH FLOWS (UNAUDITED)
(In Millions)
Six months ended June 30,Three months ended March 31,
2018 20172019 2018
Operating Activities:      
Net earnings, including noncontrolling interests$349
 $300
$326
 $141
Adjustments:      
Depreciation and amortization106
 69
34
 71
Annuity benefits442
 420
311
 182
Realized (gains) losses on investing activities64
 (28)(184) 93
Net sales of trading securities83
 31
1
 61
Deferred annuity and life policy acquisition costs(127) (133)(64) (57)
Change in:      
Reinsurance and other receivables72
 (291)128
 245
Other assets(16) (8)(271) 26
Insurance claims and reserves(268) 275
(112) (284)
Payable to reinsurers(22) 47
(22) (82)
Other liabilities55
 (32)304
 (16)
Managed investment entities’ assets/liabilities138
 (72)16
 31
Other operating activities, net(53) (4)(13) (20)
Net cash provided by operating activities823
 574
454
 391
      
Investing Activities:      
Purchases of:      
Fixed maturities(4,549) (5,387)(1,801) (2,464)
Equity securities(248) (44)(35) (212)
Mortgage loans(90) (146)(38) 
Equity index options and other investments(446) (360)(220) (195)
Real estate, property and equipment(44) (30)(10) (23)
Proceeds from:      
Maturities and redemptions of fixed maturities2,283
 3,285
1,032
 962
Repayments of mortgage loans68
 110
29
 43
Sales of fixed maturities203
 150
201
 105
Sales of equity securities106
 50
95
 32
Sales and settlements of equity index options and other investments446
 360
79
 208
Sales of real estate, property and equipment1
 53
1
 
Managed investment entities:      
Purchases of investments(1,261) (1,780)(391) (606)
Proceeds from sales and redemptions of investments1,035
 1,738
373
 478
Other investing activities, net11
 7
1
 16
Net cash used in investing activities(2,485) (1,994)(684) (1,656)
      
Financing Activities:      
Annuity receipts2,547
 2,556
1,395
 1,148
Annuity surrenders, benefits and withdrawals(1,372) (1,161)(782) (647)
Net transfers from variable annuity assets21
 30
13
 11
Additional long-term borrowings
 345
121
 
Reductions of long-term debt
 (230)
Issuances of managed investment entities’ liabilities1,572
 977

 775
Retirements of managed investment entities’ liabilities(1,461) (835)(3) (684)
Issuances of Common Stock21
 27
7
 14
Cash dividends paid on Common Stock(194) (185)(36) (31)
Other financing activities, net
 (4)
Net cash provided by financing activities1,134
 1,520
715
 586
Net Change in Cash and Cash Equivalents(528) 100
485
 (679)
Cash and cash equivalents at beginning of period2,338
 2,107
1,515
 2,338
Cash and cash equivalents at end of period$1,810
 $2,207
$2,000
 $1,659

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AMERICAN FINANCIAL GROUP, INC. 10-Q
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 


INDEX TO NOTES
      
A.Accounting Policies H.Goodwill and Other Intangibles 
B.Segments of Operations I.Long-Term Debt 
C.Fair Value Measurements J.Redeemable Noncontrolling InterestsLeases 
D.Investments K.Shareholders’ Equity 
E.Derivatives L.Income Taxes 
F.Deferred Policy Acquisition Costs M.Contingencies 
G.Managed Investment Entities N.Insurance 
      

A.     Accounting Policies

Basis of Presentation   The accompanying consolidated financial statements for American Financial Group, Inc. and its subsidiaries (“AFG”) are unaudited; however, management believes that all adjustments (consisting only of normal recurring accruals unless otherwise disclosed herein) necessary for fair presentation have been made. The results of operations for interim periods are not necessarily indicative of results to be expected for the year. The financial statements have been prepared in accordance with the instructions to Form 10-Q and, therefore, do not include all information and footnotes necessary to be in conformity with U.S. generally accepted accounting principles (“GAAP”).
 
Certain reclassifications have been made to prior periods to conform to the current year’s presentation. All significant intercompany balances and transactions have been eliminated. The results of operations of companies since their formation or acquisition are included in the consolidated financial statements. Events or transactions occurring subsequent to June 30, 2018March 31, 2019, and prior to the filing of this Form 10-Q, have been evaluated for potential recognition or disclosure herein.
 
The preparation of the financial statements requires management to make estimates and assumptions that affect the amounts reported in the financial statements and accompanying notes. Changes in circumstances could cause actual results to differ materially from those estimates.

Fair Value Measurements   Accounting standards define fair value as the price that would be received to sell an asset or paid to transfer a liability (an exit price) in an orderly transaction between market participants on the measurement date. The standards establish a hierarchy of valuation techniques based on whether the assumptions that market participants would use in pricing the asset or liability (“inputs”) are observable or unobservable. Observable inputs reflect market data obtained from independent sources, while unobservable inputs reflect AFG’s assumptions about the assumptions market participants would use in pricing the asset or liability. AFG did not have any significant nonrecurring fair value measurements in the first sixthree months of 20182019.

Investments On January 1, 2018, AFG adopted Accounting Standards Update (“ASU”) 2016-01, which requires all equity securities other than those accounted for under the equity method to be reported at fair value with holding gains and losses recognized in net earnings. At December 31, 2017, AFG had $1.60 billion in equity securities classified as “available for sale” under the prior guidance with holding gains and losses included in accumulated other comprehensive income (“AOCI”) instead of net earnings. At the date of adoption, the $221 million net unrealized gain on equity securities included in AOCI was reclassified to retained earnings as the cumulative effect of an accounting change. The cumulative effect of the accounting change also includes the net unrealized gain on AFG’s small number of limited partnerships and similar investments carried at cost under the prior guidance that are carried at fair value through net earnings under the new guidance ($4 million net of tax at the date of adoption).

Holding gains and losses on equity securities carried at fair value under ASU 2016-01 are generally recorded in realized gains (losses) on securities. However, prior to the adoption of the new guidance, AFG classified a small portion of its equity securities as “trading” and reported those investments at fair value with holding gains and losses recognized in net investment income. These investments consisted primarily of equity securities held to offset the impact of changes in the stock market on employee benefit plans that are impacted by stock market performance and totaled $62 million at December 31, 2017. Following the adoption of the new guidance, AFG continues to recordrecords holding gains and losses on these securities classified as well as“trading” under previous guidance, its small portfolio of limited partnerships and similar investments carried at fair value under the new guidance and certain other securities classified at purchase as “fair value through net investment income” in net investment income.





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AMERICAN FINANCIAL GROUP, INC. 10-Q
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — CONTINUED


Under the new guidance, AFG recorded holding losses of $57 million on equity securities in net earnings during the first six months of 2018 on securities that were still owned at June 30, 2018. Under the prior guidance, these holding losses would have been recorded in AOCI (with the exception of any impairment charge that may have been recorded). Because almost all of the equity securities impacted by the new guidance were carried at fair value through AOCI under the prior guidance, the adoption of the new guidance did not have a material impact on AFG’s financial position.

Fixed maturity securities classified as “available for sale” are reported at fair value with unrealized gains and losses included in AOCI in AFG’s Balance Sheet. Fixed maturity securities classified as “trading” are reported at fair value with changes in unrealized holding gains or losses during the period included in net investment income. Mortgage and policy loans are carried primarily at the aggregate unpaid balance.

Premiums and discounts on fixed maturity securities are amortized using the effective interest method. Mortgage-backed securities (“MBS”) are amortized over a period based on estimated future principal payments, including prepayments. Prepayment assumptions are reviewed periodically and adjusted to reflect actual prepayments and changes in expectations.

Limited partnerships and similar investments are generally accounted for using the equity method of accounting. Under the equity method, AFG records its share of the earnings or losses of the investee based on when they are reported by the investee in its financial statements rather than in the period in which the investee declares a dividend. AFG’s share of the earnings or losses from equity method investments is generally recorded on a quarter lag due to the timing of the receipt of the investee’s financial statements. AFG’s equity in the earnings (losses) of limited partnerships and similar investments is included in net investment income.

Gains or losses on fixed maturity 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 at the balance sheet date, a provision for impairment is charged to earnings (included in realized gains (losses) on securities) and the cost basis of that investment is reduced. If management can assert that it does not intend to sell an impaired fixed maturity security and it is not more likely than not that it will have to sell the security before recovery of its amortized cost basis, then the other-than-temporary impairment is separated into two components: (i) the amount related to credit losses (recorded in earnings) and (ii) the amount related to all other factors (recorded in other comprehensive income). The credit-related portion of an other-than-temporary impairment is measured by comparing a security’s amortized cost to the present value of its current expected cash flows discounted at its effective yield prior to the impairment charge. Both components are shown in the statement of earnings. If management intends to sell an impaired security, or it is more likely than not that it will be required to sell the security before recovery, an impairment charge to earnings is recorded to reduce the amortized cost of that security to fair value.

Derivatives   Derivatives included in AFG’s Balance Sheet are recorded at fair value. Changes in fair value of derivatives are included in earnings, unless the derivatives are designated and qualify as highly effective cash flow hedges. Derivatives that do not qualify for hedge accounting under GAAP consist primarily of (i) components of certain fixed maturity securities (primarily interest-only and principal-only MBS) and (ii) the equity-based component of certain annuity products (included in annuity benefits accumulated) and related equity index options designed to be consistent with the characteristics of the liabilities and used to mitigate the risk embedded in those annuity products.

To qualify for hedge accounting, at the inception of a derivative contract, AFG formally documents the relationship between the terms of the hedge and the hedged items and its risk management objective. This documentation includes defining how hedge effectiveness and ineffectiveness will be measured on a retrospective and prospective basis.

Changes in the fair value of derivatives that are designated and qualify as highly effective cash flow hedges are recorded in AOCI and are reclassified into earnings when the variability of the cash flows from the hedged items impacts earnings. Any hedge ineffectiveness is immediately recorded in current period earnings. When the change in the fair value of a qualifying cash flow hedge is included in earnings, it is included in the same line item in the statement of earnings as the cash flows from the hedged item. AFG uses interest rate swaps that are designated and qualify as highly effective cash flow hedges to mitigate interest rate risk related to certain floating-rate securities included in AFG’s portfolio of fixed maturity securities.

For derivatives that are designated and qualify as highly effective fair value hedges, changes in the fair value of the derivative, along with changes in the fair value of the hedged item attributable to the hedged risk, are recognized in current period earnings.


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Goodwill   Goodwill represents the excess of cost of subsidiaries over AFG’s equity in their underlying net assets. Goodwill is not amortized, but is subject to an impairment test at least annually. An entity is not required to complete the quantitative annual goodwill impairment test on a reporting unit if the entity elects to perform a qualitative analysis and determines that it is more likely than not that the reporting unit’s fair value exceeds its carrying amount.

Reinsurance Amounts recoverable from reinsurers are estimated in a manner consistent with the claim liability associated with the reinsured policies. AFG’s property and casualty insurance subsidiaries report as assets (i) the estimated reinsurance recoverable on paid and unpaid losses, including an estimate for losses incurred but not reported, and (ii) amounts paid or due to reinsurers applicable to the unexpired terms of policies in force. Payable to reinsurers includes ceded premiums due to reinsurers, as well as ceded premiums retained by AFG’s property and casualty insurance subsidiaries under contracts to fund

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ceded losses as they become due. AFG’s insurance subsidiaries also assume reinsurance from other companies. Earnings on reinsurance assumed is recognized based on information received from ceding companies.

An AFG subsidiary cedes life insurance policies to a third party on a funds withheld basis whereby the subsidiary retains the assets (securities) associated with the reinsurance contract. Interest is credited to the reinsurer based on the actual investment performance of the retained assets. This reinsurance contract is considered to contain an embedded derivative (that must be adjusted to fair value) because the yield on the payable is based on a specific block of the ceding company’s assets, rather than the overall creditworthiness of the ceding company. AFG determined that changes in the fair value of the underlying portfolio of fixed maturity securities is an appropriate measure of the value of the embedded derivative. The securities related to this contract are classified as “trading.” The adjustment to fair value on the embedded derivative offsets the investment income recorded on the adjustment to fair value of the related trading portfolio.
 
Deferred Policy Acquisition Costs (“DPAC”)   Policy acquisition costs (principally commissions, premium taxes and certain underwriting and policy issuance costs) directly related to the successful acquisition or renewal of an insurance contract are deferred. DPAC also includes capitalized costs associated with sales inducements offered to fixed annuity policyholders such as enhanced interest rates and premium and persistency bonuses.
 
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. A premium deficiency is recognized if the sum of expected claims costs, claims adjustment expenses and unamortized acquisition costs exceed the related unearned premiums. A premium deficiency is first recognized by charging any unamortized acquisition costs to expense to the extent required to eliminate the deficiency. If the premium deficiency is greater than unamortized acquisition costs, a liability is accrued for the excess deficiency and reported with unpaid losses and loss adjustment expenses.

DPAC related to annuities is deferred to the extent deemed recoverable and amortized, with interest, in relation to the present value of actual and expected gross profits on the policies. Expected gross profits consist principally of estimated future investment margin (estimated future net investment income less interest credited on policyholder funds) and surrender, mortality, and other life and annuity policy charges, less death, annuitization and guaranteed withdrawal benefits in excess of account balances and estimated future policy administration expenses. 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 (losses) on 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. See Life, Accident and Health Reserves below for details on the impact of loss recognition on the accounting for traditional life and health insurance contracts.

DPAC includes the present value of future profits on business in force of annuity and life, accident and health insurance companies acquired (“PVFP”). PVFP represents the portion of the costs to acquire companies that is allocated to the value of the right to receive future cash flows from insurance contracts existing at the date of acquisition. PVFP is amortized with interest in relation to expected gross profits of the acquired policies for annuities and universal life products and in relation to the premium paying period for traditional life and health insurance products.

DPAC and certain other balance sheet amounts related to annuity and life businesses are also adjusted, net of tax, for the change in expense that would have been recorded if the unrealized gains (losses) from securities had actually been realized. These adjustments are included in unrealized gains (losses) on marketable securities, a component of AOCI in AFG’s Balance Sheet.


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Managed Investment Entities   A company is considered the primary beneficiary of, and therefore must consolidate, a variable interest entity (“VIE”) based primarily on its ability to direct the activities of the VIE that most significantly impact that entity’s economic performance and the obligation to absorb losses of, or receive benefits from, the entity that could potentially be significant to the VIE.
 
AFG manages, and has investments in, collateralized loan obligations (“CLOs”) that are VIEs (see Note G — “Managed Investment Entities). AFG has determined that it is the primary beneficiary of the CLOs because (i) its role as asset manager gives it the power to direct the activities that most significantly impact the economic performance of the CLOs and (ii) through its investment in the CLO debt tranches, it has exposure to CLO losses (limited to the amount AFG invested) and the right to receive CLO benefits that could potentially be significant to the CLOs.

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Because AFG has no right to use the CLO assets and no obligation to pay the CLO liabilities, the assets and liabilities of the CLOs are shown separately in AFG’s Balance Sheet. AFG has elected the fair value option for reporting on the CLO assets and liabilities to improve the transparency of financial reporting related to the CLOs. The net gain or loss from accounting for the CLO assets and liabilities at fair value is presented separately in AFG’s Statement of Earnings.

The fair values of a CLO’s assets may differ from the separately measured fair values of its liabilities even though the CLO liabilities only have recourse to the CLO assets. AFG has set the carrying value of the CLO liabilities equal to the fair value of the CLO assets (which have more observable fair values) as an alternative to reporting those liabilities at a separately measured fair value. CLO earnings attributable to AFG’s shareholders are measured by the change in the fair value of AFG’s investments in the CLOs and management fees earned.

Unpaid Losses and Loss Adjustment Expenses   The net liabilities stated for unpaid claims and for expenses of investigation and adjustment of unpaid claims represent management’s best estimate and are based upon (i) the accumulation of case estimates for losses reported prior to the close of the accounting period on direct business written; (ii) estimates received from ceding reinsurers and insurance pools and associations; (iii) estimates of unreported losses (including possible development on known claims) based on past experience; (iv) estimates based on experience of expenses for investigating and adjusting claims; and (v) the current state of the law and coverage litigation. Establishing reserves for asbestos, environmental and other mass tort claims involves considerably more judgment than other types of claims 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.
 
Loss reserve 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 earnings in the period in which determined. Despite the variability inherent in such estimates, management believes that the liabilities for unpaid losses and loss adjustment expenses are adequate.
 
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 annuity benefits expense and decreases for annuity policy charges are recorded in other income. For traditional fixed annuities, the liability for annuity benefits accumulated represents the account value that had accrued to the benefit of the policyholder as of the balance sheet date. For fixed-indexed annuities, the liability for annuity benefits accumulated includes an embedded derivative that represents the estimated fair value of the index participation with the remaining component representing the discounted value of the guaranteed minimum contract benefits.
 
For certain products, annuity benefits accumulated also includes reserves for accrued persistency and premium bonuses, guaranteed withdrawals and excess benefits expected to be paid on future deaths and annuitizations (“EDAR”). The liabilities for EDAR and guaranteed withdrawals are accrued for and modified using assumptions consistent with those used in determining DPAC and DPAC amortization, except that amounts are determined in relation to the present value of total expected assessments. Total expected assessments consist principally of estimated future investment margin, surrender, mortality, and other life and annuity policy charges, and unearned revenues once they are recognized as income.
 
Annuity benefits accumulated also includes amounts advanced from the Federal Home Loan Bank of Cincinnati.
 
Unearned Revenue   Certain upfront policy charges on annuities are deferred as unearned revenue (included in other liabilities) and recognized in net earnings (included in other income) using the same assumptions and estimated gross profits used to amortize DPAC.

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 the original projections of investment yields, mortality, morbidity and surrenders and include provisions for unfavorable deviations unless a loss recognition event (premium

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deficiency) occurs. Claim reserves and liabilities established for accident and health claims are modified as necessary to reflect actual experience and developing trends.

For long-duration contracts (such as traditional life and long-term care policies), loss recognition occurs when, based on current expectations as of the measurement date, existing contract liabilities plus the present value of future premiums (including reasonably expected rate increases) are not expected to cover the present value of future claims payments and related settlement

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and maintenance costs (excluding overhead) as well as unamortized acquisition costs. If a block of business is determined to be in loss recognition, a charge is recorded in earnings in an amount equal to the excess of the present value of expected future claims costs and unamortized acquisition costs over existing reserves plus the present value of expected future premiums (with no provision for adverse deviation). The charge is recorded first to reduce unamortized acquisition costs and then as an additional reserve (if unamortized acquisition costs have been reduced to zero).

In addition, reserves for traditional life and long-term care policies are subject to adjustment for loss recognition charges 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, a component of AOCI in AFG’s Balance Sheet.

Debt Issuance Costs   Debt issuance costs related to AFG’s outstanding debt are presented in its Balance Sheet as a direct reduction in the carrying value of long-term debt and are amortized over the life of the related debt using the effective interest method as a component of interest expense. Debt issuance costs related to AFG’s revolving credit facilities are included in other assets in AFG’s Balance Sheet.

Variable Annuity Assets and Liabilities   Separate accounts related to variable annuities represent the fair value of deposits invested in underlying investment funds on which AFG earns a fee. Investment funds are selected and may be changed only by the policyholder, who retains all investment risk.

AFG’s variable annuity contracts contain a guaranteed minimum death benefit (“GMDB”) to be paid if the policyholder dies before the annuity payout period commences. In periods of declining equity markets, the GMDB may exceed the value of the policyholder’s account. A GMDB liability is established for future excess death benefits using assumptions together with a range of reasonably possible scenarios for investment fund performance that are consistent with DPAC capitalization and amortization assumptions.

Leases   On January 1, 2019, AFG adopted ASU 2016-02, which requires entities that lease assets for terms longer than one year to recognize assets and liabilities for the rights and obligations created by those leases on the balance sheet based on the present value of contractual cash flows. As permitted under the ASU, AFG adopted the guidance on a modified retrospective basis (comparative periods were not adjusted) and elected the following accounting policies and practical expedients:
exclude leases with a term of 12 months or less from the calculation of lease assets and liabilities,
not separate lease and non-lease components except for buildings (office space and storage facilities),
for contracts existing at the date of adoption – not reassess whether a contract is a lease or contains a lease, how initial direct costs were accounted for or whether the lease is an operating or finance lease, and
use hindsight to determine the lease term for leases existing at the date of adoption.

Adoption of the new guidance resulted in AFG recognizing a lease liability of $198 million (included in other liabilities) and a corresponding right-of-use asset of $174 million (which is presented net of $24 million in deferred rent and lease incentives) on January 1, 2019. Deferred rent and lease incentives were recognized as liabilities under the previous guidance and result from the straight-line expensing of operating leases. The adoption of the new guidance did not have a material effect on the AFG’s results of operations or liquidity. See Note J — “Leases for additional disclosures.

Noncontrolling Interests   For balance sheet purposes, noncontrolling interests represent the interests of shareholders other than AFG in consolidated entities. In the statement of earnings, net earnings and losses attributable to noncontrolling interests represents such shareholders’ interest in the earnings and losses of those entities. Noncontrolling interests that are redeemable at the option of the holder are presented separately in the mezzanine section of the balance sheet (between liabilities and equity).

Premium Recognition   Property and casualty premiums are earned generally 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 information 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.

Noncontrolling Interests   For balance sheet purposes, noncontrolling interests represent the interests of shareholders other than AFG in consolidated entities. In the statement of earnings, net earnings and losses attributable to noncontrolling interests represents such shareholders’ interest in the earnings and losses of those entities. Noncontrolling interests that are redeemable at the option of the holder are presented separately in the mezzanine section of the balance sheet (between liabilities and equity).

Income Taxes   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. A valuation allowance is established to reduce total deferred tax assets to an amount that will more likely than not be

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realized. The effect of a change in tax rates on deferred tax assets and liabilities is recorded in net earnings in the period that includes the enactment date.

AFG recognizes the tax benefits of uncertain tax positions only when the position is more likely than not to be sustained under examination by the appropriate taxing authority. Interest and penalties on AFG’s reserve for uncertain tax positions are recognized as a component of tax expense.

Stock-Based Compensation   All share-based grants are recognized as compensation expense on a straight-line basis over their vesting periods based on their calculated fair value at the date of grant. AFG uses the Black Scholes pricing model to measure the fair value of employee stock options. See Note K — “Shareholders’ Equity for further information.

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AFG records excess tax benefits or deficiencies for share-based payments through income tax expense in the statement of earnings. In addition, AFG accounts for forfeitures of awards when they occur.

Benefit Plans   AFG provides retirement benefits to qualified employees of participating companies through the AFG 401(k) Retirement and Savings Plan, a defined contribution plan. AFG makes all contributions to the retirement fund portion of the plan and matches a percentage of employee contributions to the savings fund. Company contributions are expensed 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 employees earn such benefits.

Earnings Per Share   Although basic earnings per share only considers shares of common stock outstanding during the period, the calculation of diluted earnings per share includes the following adjustments to weighted average common shares related to stock-based compensation plans: second quarterfirst three months of 2019 and 2018 and 2017 1.71.3 million and 2.0 million; first six months of 2018 and 2017 — 1.7 million and 2.11.8 million, respectively.
 
There were no anti-dilutive potential common shares infor the second quarter or first sixthree months of 20182019 or 2017.2018.
 
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.equipment and businesses. “Financing activities” include obtaining resources from owners and providing them with a return on their investments, borrowing money and repaying amounts borrowed. Annuity receipts, surrenders, 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.

Revenue Recognition Guidance Effective in 2018 On January 1, 2018, AFG adopted ASU 2014-09, which provides guidance on recognizing revenue when (or as) performance obligations under the contract are satisfied. The new guidance also updates the accounting for certain costs associated with obtaining and fulfilling contracts with customers and requires certain new disclosures. Because revenue recognition for insurance contracts and financial instruments (AFG’s primary sources of revenue) were excluded from the scope of the new guidance, the adoption of ASU 2014-09 did not have a material impact on AFG’s results of operations or financial position.

B.    Segments of Operations

AFG manages its business as three segments: (i) Property and casualty insurance, (ii) Annuity and (iii) Other, which includes holding company costs, revenues and costs of AFG’s limited insurance operations outside of property and casualty insurance and annuities, and operations attributable to the noncontrolling interests of the managed investment entities.

AFG reports its property and casualty insurance business in the following Specialty sub-segments: (i) Property and transportation, which includes physical damage and liability coverage for buses, trucks and recreational vehicles, inland and ocean marine, agricultural-related products and other commercial property coverages, (ii) Specialty casualty, which includes primarily excess and surplus, general liability, executive liability, professional liability, umbrella and excess liability, specialty coveragecoverages in targeted markets, customized programs for small to mid-sized businesses and workers’ compensation insurance, and (iii) Specialty financial, which includes risk management insurance programs for leasinglending and financingleasing institutions (including equipment leasing and collateral and lender-placed mortgage property insurance), surety and fidelity products and trade credit insurance. Premiums and underwriting profit included under Other specialty represent business assumed by AFG’s internal reinsurance program from the operations that make up AFG’s other Specialty sub-segments and amortization of deferred gains on retroactive reinsurance transactions related to the sales of businesses in prior years. AFG’s annuity business marketssells traditional fixed, fixed-indexed and variable-indexed annuities in the retail, financial institutions, broker-dealer and registered investment advisor and education markets. AFG’s reportable segments and their components were determined based primarily upon similar economic characteristics, products and services. Effective January 1, 2018, the results of AFG’s run-off long-term care and life businesses are included in the “Other” segment instead of as a separate reportable segment based on the immaterial size of the remaining operations. Prior period amounts were reclassified for consistent presentation.


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The following tables (in millions) show AFG’s revenues and earnings before income taxes by segment and sub-segment.
 Three months ended March 31,
 2019 2018
Revenues   
Property and casualty insurance:   
Premiums earned:   
Specialty   
Property and transportation$361
 $350
Specialty casualty629
 579
Specialty financial146
 149
Other specialty37
 29
Total premiums earned1,173
 1,107
Net investment income104
 100
Other income3
 2
Total property and casualty insurance1,280
 1,209
Annuity:   
Net investment income435
 394
Other income27
 26
Total annuity462
 420
Other98
 83
Total revenues before realized gains (losses)1,840
 1,712
Realized gains (losses) on securities184
 (93)
Total revenues$2,024
 $1,619
 Three months ended June 30, Six months ended June 30,
 2018 2017 2018 2017
Revenues       
Property and casualty insurance:       
Premiums earned:       
Specialty       
Property and transportation$374
 $357
 $724
 $699
Specialty casualty595
 537
 1,174
 1,045
Specialty financial159
 146
 308
 293
Other specialty33
 25
 62
 50
Total premiums earned1,161
 1,065
 2,268
 2,087
Net investment income115
 96
 215
 182
Other income (a)2
 4
 4
 20
Total property and casualty insurance1,278
 1,165
 2,487
 2,289
Annuity:       
Net investment income412
 360
 806
 707
Other income27
 26
 53
 53
Total annuity439
 386
 859
 760
Other85
 87
 168
 162
Total revenues before realized gains (losses)1,802
 1,638
 3,514
 3,211
Realized gains (losses) on securities31
 8
 (62) 11
Total revenues$1,833
 $1,646
 $3,452
 $3,222
Earnings Before Income Taxes   
Property and casualty insurance:   
Underwriting:   
Specialty   
Property and transportation$39
 $33
Specialty casualty36
 41
Specialty financial13
 15
Other specialty
 3
Other lines (*)(1) (1)
Total underwriting87
 91
Investment and other income, net95
 93
Total property and casualty insurance182
 184
Annuity90
 125
Other(43) (42)
Total earnings before realized gains (losses) and income taxes229
 267
Realized gains (losses) on securities184
 (93)
Total earnings before income taxes$413
 $174
Earnings Before Income Taxes       
Property and casualty insurance:       
Underwriting:       
Specialty       
Property and transportation$23
 $21
 $56
 $64
Specialty casualty29
 29
 70
 44
Specialty financial22
 23
 37
 45
Other specialty(1) 
 2
 (1)
Other lines(1) (1) (2) (2)
Total underwriting72
 72
 163
 150
Investment and other income, net (a)106
 91
 199
 184
Total property and casualty insurance178
 163
 362
 334
Annuity99
 85
 224
 181
Other (b)(48) (51) (90) (98)
Total earnings before realized gains (losses) and income taxes229
 197
 496
 417
Realized gains (losses) on securities31
 8
 (62) 11
Total earnings before income taxes$260
 $205
 $434
 $428
(a)Includes income of $13 million (before noncontrolling interest) from the sale of a hotel in the first quarter of 2017.
(b)(*)Includes holding company interest and expenses, including a $7 million loss on retirement of debt in the second quarter of 2017.expenses.

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C.    Fair Value Measurements

Accounting standards for measuring fair value are based on inputs used in estimating fair value. The three levels of the hierarchy are as follows:
 
Level 1 — Quoted prices for identical assets or liabilities in active markets (markets in which transactions occur with sufficient frequency and volume to provide pricing information on an ongoing basis). AFG’s Level 1 financial instruments consist primarily of publicly traded equity securities, highly liquid government bonds for which quoted market prices in active markets are available and short-term investments of managed investment entities.

Level 2 — Quoted prices for similar instruments in active markets; quoted prices for identical or similar assets or liabilities in inactive markets (markets in which there are few transactions, the prices are not current, price quotations vary substantially over time or among market makers, or in which little information is released publicly); and valuations based on other significant inputs that are observable in active markets. AFG’s Level 2 financial instruments include separate account assets, corporate and municipal fixed maturity securities, asset-backed securities (“ABS”), mortgage-backed securities (“MBS”), non-affiliated common stocks, equity index call options and investments of managed investment entities priced using observable inputs. Level 2 inputs include benchmark yields, reported trades, corroborated broker/dealer quotes, issuer spreads and benchmark securities. When non-binding broker quotes can be corroborated by comparison to similar securities priced using observable inputs, they are classified as Level 2.

Level 3 — Valuations derived from market valuation techniques generally consistent with those used to estimate the fair values of Level 2 financial instruments in which one or more significant inputs are unobservable or when the market for a security exhibits significantly less liquidity relative to markets supporting Level 2 fair value measurements. The unobservable inputs may include management’s own assumptions about the assumptions market participants would use based on the best information available at the valuation date. AFG’s Level 3 is comprised of financial instruments whose fair value is estimated based on non-binding broker quotes or internally developed using significant inputs not based on, or corroborated by, observable market information.

As discussed in Note A — Accounting Policies — Managed Investment Entities,” AFG has set the carrying value of its CLO liabilities equal to the fair value of the CLO assets (which have more observable fair values) as an alternative to reporting those liabilities at separately measured fair values. As a result, the CLO liabilities are categorized within the fair value hierarchy on the same basis (proportionally) as the related CLO assets. Since the portion of the CLO liabilities allocated to Level 3 is derived from the fair value of the CLO assets, these amounts are excluded from the progression of Level 3 financial instruments.

AFG’s management is responsible for the valuation process and uses data from outside sources (including nationally recognized pricing services and broker/dealers) in establishing fair value. AFG’s internal investment professionals are a group of approximately 25 analysts whose primary responsibility is to manage AFG’s investment portfolio. These professionals monitor individual investments as well as overall industries and are active in the financial markets on a daily basis. The group is led by AFG’s chief investment officer, who reports directly to one of AFG’s Co-CEOs. Valuation techniques utilized by pricing services and prices obtained from external sources are reviewed by AFG’s internal investment professionals who are familiar with the securities being priced and the markets in which they trade to ensure the fair value determination is representative of an exit price. To validate the appropriateness of the prices obtained, these investment managers consider widely published indices (as benchmarks), recent trades, changes in interest rates, general economic conditions and the credit quality of the specific issuers. In addition, the Company communicates directly with the pricing services regarding the methods and assumptions used in pricing, including verifying, on a test basis, the inputs used by the service to value specific securities.

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Assets and liabilities measured and carried at fair value in the financial statements are summarized below (in millions): 
Level 1 Level 2 Level 3 TotalLevel 1 Level 2 Level 3 Total
June 30, 2018       
March 31, 2019       
Assets:              
Available for sale (“AFS”) fixed maturities:              
U.S. Government and government agencies$140
 $92
 $8
 $240
$144
 $81
 $8
 $233
States, municipalities and political subdivisions
 6,852
 61
 6,913

 6,914
 63
 6,977
Foreign government
 129
 
 129

 148
 
 148
Residential MBS
 2,739
 147
 2,886

 2,587
 169
 2,756
Commercial MBS
 878
 56
 934

 869
 55
 924
Asset-backed securities
 7,931
 1,004
 8,935

 9,348
 670
 10,018
Corporate and other29
 18,174
 1,408
 19,611
29
 20,000
 2,346
 22,375
Total AFS fixed maturities169
 36,795
 2,684
 39,648
173
 39,947
 3,311
 43,431
Trading fixed maturities38
 99
 
 137
8
 99
 
 107
Equity securities1,471
 76
 230
 1,777
1,507
 69
 354
 1,930
Equity index call options
 615
 
 615

 620
 
 620
Assets of managed investment entities (“MIE”)229
 4,780
 23
 5,032
213
 4,553
 20
 4,786
Variable annuity assets (separate accounts) (*)
 636
 
 636

 610
 
 610
Other assets — derivatives
 25
 
 25
Total assets accounted for at fair value$1,907
 $43,001
 $2,937
 $47,845
$1,901
 $45,923
 $3,685
 $51,509
Liabilities:              
Liabilities of managed investment entities$220
 $4,598
 $22
 $4,840
$204
 $4,370
 $19
 $4,593
Derivatives in annuity benefits accumulated
 
 2,776
 2,776

 
 3,247
 3,247
Other liabilities — derivatives
 72
 
 72

 28
 
 28
Total liabilities accounted for at fair value$220
 $4,670
 $2,798
 $7,688
$204
 $4,398
 $3,266
 $7,868
              
December 31, 2017       
December 31, 2018       
Assets:              
Available for sale fixed maturities:              
U.S. Government and government agencies$122
 $112
 $8
 $242
$141
 $83
 $9
 $233
States, municipalities and political subdivisions
 6,975
 148
 7,123

 6,880
 59
 6,939
Foreign government
 127
 
 127

 142
 
 142
Residential MBS
 3,105
 122
 3,227

 2,547
 197
 2,744
Commercial MBS
 926
 36
 962

 864
 56
 920
Asset-backed securities
 7,218
 744
 7,962

 8,964
 847
 9,811
Corporate and other30
 17,662
 1,044
 18,736
28
 19,184
 1,996
 21,208
Total AFS fixed maturities152
 36,125
 2,102
 38,379
169
 38,664
 3,164
 41,997
Trading fixed maturities44
 304
 
 348
9
 96
 
 105
Equity securities1,411
 86
 165
 1,662
1,410
 68
 336
 1,814
Equity index call options
 701
 
 701

 184
 
 184
Assets of managed investment entities307
 4,572
 23
 4,902
203
 4,476
 21
 4,700
Variable annuity assets (separate accounts) (*)
 644
 
 644

 557
 
 557
Other assets — derivatives
 16
 
 16
Total assets accounted for at fair value$1,914
 $42,432
 $2,290
 $46,636
$1,791
 $44,061
 $3,521
 $49,373
Liabilities:              
Liabilities of managed investment entities$293
 $4,372
 $22
 $4,687
$195
 $4,297
 $20
 $4,512
Derivatives in annuity benefits accumulated
 
 2,542
 2,542

 
 2,720
 2,720
Other liabilities — derivatives
 35
 
 35

 49
 
 49
Total liabilities accounted for at fair value$293
 $4,407
 $2,564
 $7,264
$195
 $4,346
 $2,740
 $7,281
(*)Variable annuity liabilities equal the fair value of variable annuity assets.



15

Table of Contents
AMERICAN FINANCIAL GROUP, INC. 10-Q
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — CONTINUED


TransfersDuring the first three months of 2019 and 2018, there were no transfers between Level 1 and Level 2 for all periods presented were a result of increases or decreases in observable trade activity.

During the second quarter and first six months of 2018, there were two preferred stocks with an aggregate fair value of $6 million that transferred from Level 1 to Level 2. During the second quarter and first six months of 2017, there were two preferred stocks with an aggregate fair value of $16 million that transferred from Level 2 to Level 1.

Approximately 6%7% of the total assets carried at fair value at June 30, 2018,March 31, 2019, were Level 3 assets. Approximately 73%60% ($2.142.20 billion) of the Level 3 assets were priced using non-binding broker quotes, for which there is a lack of transparency as to the inputs used to determine fair value. Details as to the quantitative inputs are neither provided by the brokers nor otherwise reasonably obtainable by AFG. Since internally

Internally developed Level 3 asset fair values represent approximately 14%$1.23 billion at March 31, 2019. Of this amount, approximately $743 million relates to fixed maturity securities that were priced using management’s best estimate of AFG’s Shareholders’ Equity,an appropriate credit spread over the treasury yield (of a similar duration) to discount future expected cash flows using a third party model. The credit spread applied by management is the significant unobservable input. For this group of approximately 120 securities, the average spread used was 577 basis points over the reference treasury yield and the spreads ranged from 100 basis points to 2,966 basis points (approximately 80% of the spreads were between 400 and 700 basis points). Had management used higher spreads, the fair value of this group of securities would have been lower. Conversely, if the spreads used were lower, the fair values would have been higher. For the remainder of the internally developed prices, any justifiable changes in unobservable inputs used to determine internally developed fair valuesvalue would not have resulted in a material impact onchange in AFG’s financial position.

The only significant Level 3 assets or liabilities carried at fair value in the financial statements that were not measured using broker quotes are the derivatives embedded in AFG’s fixed-indexed and variable-indexed annuity liabilities which are measured using a discounted cash flow approach and had a fair value of $2.783.25 billion at June 30, 2018March 31, 2019. The following table presents information about the unobservable inputs used by management in determining fair value of these embedded derivatives.Level 3 liabilities. See Note E — “Derivatives.”

 Unobservable Input Range 
 Adjustment for insurance subsidiary’s credit risk 0.4%0.1%1.7%2.2% over the risk free rate 
 Risk margin for uncertainty in cash flows 0.70%0.73% reduction in the discount rate 
 Surrenders 3%4% – 23% of indexed account value 
 Partial surrenders 2% – 9% of indexed account value 
 Annuitizations 0.1% – 1% of indexed account value 
 Deaths 1.6%1.7%8.0%9.5% of indexed account value 
 Budgeted option costs 2.5%2.6%3.5%3.6% of indexed account value 

The range of adjustments for insurance subsidiary’s credit risk is based on the Moody’s corporate A2 bond index and reflects credit spread variations across the yield curve. The range of projected surrender rates reflects the specific surrender charges and other features of AFG’s individual fixed-indexed and variable-indexed annuity products with an expected range of 7% to 11% in the majority of future calendar years (3%4% to 23% over all periods). Increasing the budgeted option cost or risk margin for uncertainty in cash flow assumptions in the table above would increase the fair value of the fixed-indexed and variable-indexed annuity embedded derivatives, while increasing any of the other unobservable inputs in the table above would decrease the fair value of the embedded derivatives.


16

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AMERICAN FINANCIAL GROUP, INC. 10-Q
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — CONTINUED


Changes in balances of Level 3 financial assets and liabilities carried at fair value during the second quarter and first sixthree months of 20182019 and 20172018 are presented below (in millions). The transfers into and out of Level 3 were due to changes in the availability of market observable inputs and $29 million of equity securities transferred into Level 3 in the first quarter of 2018 related to a small number of limited partnerships and similar investments carried at cost under the prior guidance that are carried at fair value through net earnings under new guidance adopted on January 1, 2018, as discussed in Note A — Accounting Policies — Investments.” All transfers are reflected in the table at fair value as of the end of the reporting period.
  
Total realized/unrealized
gains (losses) included in
            
Total realized/unrealized
gains (losses) included in
          
Balance at March 31, 2018 Net
earnings
 
Other
comprehensive
income (loss)
 
Purchases
and
issuances
 
Sales and
settlements
 
Transfer
into
Level 3
 
Transfer
out of
Level 3
 Balance at June 30, 2018Balance at December 31, 2018 Net
earnings
 
Other
comprehensive
income (loss)
 
Purchases
and
issuances
 
Sales and
settlements
 
Transfer
into
Level 3
 
Transfer
out of
Level 3
 Balance at March 31, 2019
AFS fixed maturities:                              
U.S. government agency$8
 $
 $
 $
 $
 $
 $
 $8
$9
 $
 $
 $
 $(1) $
 $
 $8
State and municipal62
 
 (1) 
 
 
 
 61
59
 
 5
 
 (1) 
 
 63
Residential MBS115
 (3) 
 
 (5) 50
 (10) 147
197
 5
 (5) 
 (6) 
 (22) 169
Commercial MBS47
 
 
 9
 
 
 
 56
56
 
 
 
 (1) 
 
 55
Asset-backed securities912
 
 (6) 136
 (20) 
 (18) 1,004
847
 (3) 8
 75
 (114) 
 (143) 670
Corporate and other1,238
 1
 (4) 234
 (48) 
 (13) 1,408
1,996
 2
 31
 432
 (88) 
 (27) 2,346
Total AFS fixed maturities2,382
 (2) (11) 379
 (73) 50
 (41) 2,684
3,164
 4
 39
 507
 (211) 
 (192) 3,311
Equity securities194
 19
 
 16
 
 1
 
 230
336
 1
 
 1
 
 16
 
 354
Assets of MIE24
 (3) 
 2
 
 
 
 23
21
 (1) 
 
 
 
 
 20
Total Level 3 assets$2,600
 $14
 $(11) $397
 $(73) $51
 $(41) $2,937
$3,521
 $4
 $39
 $508
 $(211) $16
 $(192) $3,685
                              
Embedded derivatives (a)$(2,549) $(126) $
 $(141) $40
 $
 $
 $(2,776)$(2,720) $(462) $
 $(112) $47
 $
 $
 $(3,247)
Total Level 3 liabilities (b)$(2,549) $(126) $
 $(141) $40
 $
 $
 $(2,776)
Total Level 3 liabilities (*)$(2,720) $(462) $
 $(112) $47
 $
 $
 $(3,247)


  
Total realized/unrealized
gains (losses) included in
            
Total realized/unrealized
gains (losses) included in
          
Balance at March 31, 2017 Net
earnings
 
Other
comprehensive
income (loss)
 
Purchases
and
issuances
 
Sales and
settlements
 
Transfer
into
Level 3
 
Transfer
out of
Level 3
 Balance at June 30, 2017Balance at December 31, 2017 Net
earnings
 
Other
comprehensive
income (loss)
 
Purchases
and
issuances
 
Sales and
settlements
 
Transfer
into
Level 3
 
Transfer
out of
Level 3
 Balance at March 31, 2018
AFS fixed maturities:                              
U.S. government agency$8
 $
 $
 $
 $
 $
 $
 $8
$8
 $
 $
 $
 $
 $
 $
 $8
State and municipal143
 
 1
 
 (1) 
 
 143
148
 
 (1) 
 (1) 
 (84) 62
Residential MBS175
 (3) 2
 
 (23) 13
 (11) 153
122
 (4) 
 
 (6) 7
 (4) 115
Commercial MBS29
 1
 
 15
 
 
 
 45
36
 (1) 
 12
 
 
 
 47
Asset-backed securities594
 
 2
 
 (25) 19
 (92) 498
744
 (2) 3
 204
 (37) 
 
 912
Corporate and other828
 4
 4
 168
 (27) 
 (24) 953
1,044
 1
 (14) 238
 (31) 
 
 1,238
Total AFS fixed maturities1,777
 2
 9
 183
 (76) 32
 (127) 1,800
2,102
 (6) (12) 454
 (75) 7
 (88) 2,382
Equity securities173
 (10) 6
 8
 (3) 
 (6) 168
165
 (5) 
 9
 (4) 29
 
 194
Assets of MIE26
 (5) 
 2
 
 
 
 23
23
 (2) 
 3
 
 
 
 24
Total Level 3 assets$1,976
 $(13) $15
 $193
 $(79) $32
 $(133) $1,991
$2,290
 $(13) $(12) $466
 $(79) $36
 $(88) $2,600
                              
Embedded derivatives$(1,963) $(112) $
 $(80) $26
 $
 $
 $(2,129)$(2,542) $63
 $
 $(103) $33
 $
 $
 $(2,549)
Total Level 3 liabilities (b)$(1,963) $(112) $
 $(80) $26
 $
 $
 $(2,129)
Total Level 3 liabilities (*)$(2,542) $63
 $
 $(103) $33
 $
 $
 $(2,549)

(a)Total realized/unrealized gains (losses) included in net earnings for the embedded derivatives reflects losses related to the unlocking of actuarial assumptions of $44 million in the second quarter of 2018.
(b)As previously discussed, these tables exclude the portion of MIE liabilities allocated to Level 3, which are derived from the fair value of the MIE assets.

17

Table of Contents
AMERICAN FINANCIAL GROUP, INC. 10-Q
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — CONTINUED


   
Total realized/unrealized
gains (losses) included in
          
Balance at December 31, 2017 Net
earnings
 
Other
comprehensive
income (loss)
 
Purchases
and
issuances
 
Sales and
settlements
 
Transfer
into
Level 3
 
Transfer
out of
Level 3
 Balance at June 30, 2018
AFS fixed maturities:               
U.S. government agency$8
 $
 $
 $
 $
 $
 $
 $8
State and municipal148
 
 (2) 
 (1) 
 (84) 61
Residential MBS122
 (7) 
 
 (11) 57
 (14) 147
Commercial MBS36
 (1) 
 21
 
 
 
 56
Asset-backed securities744
 (2) (3) 340
 (57) 
 (18) 1,004
Corporate and other1,044
 2
 (18) 472
 (79) 
 (13) 1,408
Total AFS fixed maturities2,102
 (8) (23) 833
 (148) 57
 (129) 2,684
Equity securities165
 14
 
 25
 (4) 30
 
 230
Assets of MIE23
 (5) 
 5
 
 
 
 23
Total Level 3 assets$2,290
 $1
 $(23) $863
 $(152) $87
 $(129) $2,937
                
Embedded derivatives (a)$(2,542) $(63) $
 $(244) $73
 $
 $
 $(2,776)
Total Level 3 liabilities (b)$(2,542) $(63) $
 $(244) $73
 $
 $
 $(2,776)


   
Total realized/unrealized
gains (losses) included in
          
Balance at December 31, 2016 Net
earnings
 
Other
comprehensive
income (loss)
 
Purchases
and
issuances
 
Sales and
settlements
 
Transfer
into
Level 3
 
Transfer
out of
Level 3
 Balance at June 30, 2017
AFS fixed maturities:               
U.S. government agency$8
 $
 $
 $
 $
 $
 $
 $8
State and municipal140
 
 4
 
 (1) 
 
 143
Residential MBS190
 (2) 2
 1
 (31) 20
 (27) 153
Commercial MBS25
 1
 
 15
 
 4
 
 45
Asset-backed securities484
 
 2
 104
 (36) 36
 (92) 498
Corporate and other712
 5
 8
 288
 (65) 29
 (24) 953
Total AFS fixed maturities1,559
 4
 16
 408
 (133) 89
 (143) 1,800
Equity securities174
 (16) 13
 20
 (3) 
 (20) 168
Assets of MIE29
 (6) 
 4
 
 
 (4) 23
Total Level 3 assets$1,762
 $(18) $29
 $432
 $(136) $89
 $(167) $1,991
                
Embedded derivatives$(1,759) $(259) $
 $(159) $48
 $
 $
 $(2,129)
Total Level 3 liabilities (b)$(1,759) $(259) $
 $(159) $48
 $
 $
 $(2,129)
(a)Total realized/unrealized gains (losses) included in net earnings for the embedded derivatives reflects losses related to the unlocking of actuarial assumptions of $44 million in the first six months of 2018.
(b)(*)As previously discussed, these tables exclude the portion of MIE liabilities allocated to Level 3, which are derived from the fair value of the MIE assets.


1817

Table of Contents
AMERICAN FINANCIAL GROUP, INC. 10-Q
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — CONTINUED


Fair Value of Financial Instruments   The carrying value and fair value of financial instruments that are not carried at fair value in the financial statements are summarized below (in millions): 
Carrying Fair ValueCarrying Fair Value
Value Total Level 1 Level 2 Level 3Value Total Level 1 Level 2 Level 3
June 30, 2018         
March 31, 2019         
Financial assets:                  
Cash and cash equivalents$1,810
 $1,810
 $1,810
 $
 $
$2,000
 $2,000
 $2,000
 $
 $
Mortgage loans1,147
 1,136
 
 
 1,136
1,078
 1,071
 
 
 1,071
Policy loans179
 179
 
 
 179
172
 172
 
 
 172
Total financial assets not accounted for at fair value$3,136
 $3,125
 $1,810
 $
 $1,315
$3,250
 $3,243
 $2,000
 $
 $1,243
Financial liabilities:                  
Annuity benefits accumulated (*)$34,673
 $33,204
 $
 $
 $33,204
$37,768
 $36,881
 $
 $
 $36,881
Long-term debt1,301
 1,265
 
 1,262
 3
1,423
 1,406
 
 1,403
 3
Total financial liabilities not accounted for at fair value$35,974
 $34,469
 $
 $1,262
 $33,207
$39,191
 $38,287
 $
 $1,403
 $36,884
                  
December 31, 2017         
December 31, 2018         
Financial assets:                  
Cash and cash equivalents$2,338
 $2,338
 $2,338
 $
 $
$1,515
 $1,515
 $1,515
 $
 $
Mortgage loans1,125
 1,119
 
 
 1,119
1,068
 1,056
 
 
 1,056
Policy loans184
 184
 
 
 184
174
 174
 
 
 174
Total financial assets not accounted for at fair value$3,647
 $3,641
 $2,338
 $
 $1,303
$2,757
 $2,745
 $1,515
 $
 $1,230
Financial liabilities:                  
Annuity benefits accumulated (*)$33,110
 $32,461
 $
 $
 $32,461
$36,384
 $34,765
 $
 $
 $34,765
Long-term debt1,301
 1,354
 
 1,351
 3
1,302
 1,231
 
 1,228
 3
Total financial liabilities not accounted for at fair value$34,411
 $33,815
 $
 $1,351
 $32,464
$37,686
 $35,996
 $
 $1,228
 $34,768

(*)Excludes $213$238 million and $206$232 million of life contingent annuities in the payout phase at June 30, 2018March 31, 2019 and December 31, 2017,2018, respectively.

The carrying amount of cash and cash equivalents approximates fair value. Fair values for mortgage loans are estimated by discounting the future contractual cash flows using the current rates at which similar loans would be made to borrowers with similar credit ratings. The fair value of policy loans is estimated to approximate carrying value; policy loans have no defined maturity dates and are inseparable from insurance contracts. The fair value of annuity benefits was estimated based on expected cash flows discounted using forward interest rates adjusted for the Company’s credit risk and includes the impact of maintenance expenses and capital costs. Fair values of long-term debt are based primarily on quoted market prices.


1918

Table of Contents
AMERICAN FINANCIAL GROUP, INC. 10-Q
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — CONTINUED


D.    Investments

Available for sale fixed maturities at June 30, 2018March 31, 2019 and December 31, 20172018, consisted of the following (in millions):
June 30, 2018 December 31, 2017March 31, 2019 December 31, 2018
Amortized
Cost
 Gross Unrealized 
Net
Unrealized
 
Fair
Value
 
Amortized
Cost
 Gross Unrealized 
Net
Unrealized
 
Fair
Value
Amortized
Cost
 Gross Unrealized 
Net
Unrealized
 
Fair
Value
 
Amortized
Cost
 Gross Unrealized 
Net
Unrealized
 
Fair
Value
Gains Losses Gains LossesGains Losses Gains Losses
Fixed maturities:                                      
U.S. Government and government agencies$243
 $1
 $(4) $(3) $240
 $244
 $1
 $(3) $(2) $242
$233
 $2
 $(2) $
 $233
 $235
 $1
 $(3) $(2) $233
States, municipalities and political subdivisions6,804
 162
 (53) 109
 6,913
 6,887
 254
 (18) 236
 7,123
6,744
 253
 (20) 233
 6,977
 6,825
 169
 (55) 114
 6,939
Foreign government127
 2
 
 2
 129
 124
 3
 
 3
 127
146
 2
 
 2
 148
 140
 2
 
 2
 142
Residential MBS2,564
 329
 (7) 322
 2,886
 2,884
 349
 (6) 343
 3,227
2,477
 287
 (8) 279
 2,756
 2,476
 277
 (9) 268
 2,744
Commercial MBS920
 18
 (4) 14
 934
 927
 36
 (1) 35
 962
900
 24
 
 24
 924
 905
 17
 (2) 15
 920
Asset-backed securities8,849
 132
 (46) 86
 8,935
 7,836
 142
 (16) 126
 7,962
9,909
 163
 (54) 109
 10,018
 9,781
 130
 (100) 30
 9,811
Corporate and other19,737
 198
 (324) (126) 19,611
 18,136
 638
 (38) 600
 18,736
22,009
 471
 (105) 366
 22,375
 21,475
 167
 (434) (267) 21,208
Total fixed maturities$39,244
 $842
 $(438) $404
 $39,648
 $37,038
 $1,423
 $(82) $1,341
 $38,379
$42,418
 $1,202
 $(189) $1,013
 $43,431
 $41,837
 $763
 $(603) $160
 $41,997
                                      

The non-credit related portion of other-than-temporary impairment charges is included in other comprehensive income. Cumulative non-credit charges taken for securities still owned at June 30, 2018March 31, 2019 and December 31, 20172018 were $149$135 million and $158$140 million, respectively. Gross unrealized gains on such securities at June 30, 2018March 31, 2019 and December 31, 20172018 were $135$123 million and $137$119 million, respectively. Gross unrealized losses on such securities at both June 30, 2018March 31, 2019 and December 31, 20172018 were $4 million. These amounts represent the non-credit other-than-temporary impairment charges recorded in AOCI adjusted for subsequent changes in fair values and relate primarily to residential MBS.

As discussed in Note A — Accounting Policies — Investments,” beginning on January 1, 2018, AFG implemented new accounting guidance,Equity securities, which required all equity securities previously classified as “available for sale” to beare reported at fair value with holding gains and losses recognized in net earnings. Equity securities reported at fair valueearnings, consisted of the following at June 30,March 31, 2019 and December 31, 2018 (in millions):
March 31, 2019 December 31, 2018
    
Fair Value
 over (under)
Cost
     Fair Value
over (under)
Cost
    Fair Value inActual Cost   Actual Cost   
Actual Cost Fair Value excess of Cost Fair Value 
Fair Value
 over (under)
Cost
Fair Value 
Common stocks$1,066
 $1,180
 $114
$1,162
 $1,218
 $56
$1,241
1,148
 $(93)
Perpetual preferred stocks603
 597
 (6)719
 712
 (7)705
666
 (39)
Total equity securities carried at fair value$1,669
 $1,777
 $108
$1,881
 $1,930
 $49
 $1,946
 $1,814
 $(132)


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AMERICAN FINANCIAL GROUP, INC. 10-Q
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — CONTINUED


The following tables show gross unrealized losses (dollars in millions) on available for sale fixed maturities and equity securities by investment category and length of time that individual securities have been in a continuous unrealized loss position at the following balance sheet dates. 
Less Than Twelve Months Twelve Months or MoreLess Than Twelve Months Twelve Months or More
Unrealized
Loss
 
Fair
Value
 
Fair Value as
% of Cost
 
Unrealized
Loss
 
Fair
Value
 
Fair Value as
% of Cost
Unrealized
Loss
 
Fair
Value
 
Fair Value as
% of Cost
 
Unrealized
Loss
 
Fair
Value
 
Fair Value as
% of Cost
June 30, 2018           
March 31, 2019           
Fixed maturities:                      
U.S. Government and government agencies$(1) $102
 99% $(3) $99
 97%$
 $3
 100% $(2) $118
 98%
States, municipalities and political subdivisions(36) 1,957
 98% (17) 451
 96%(4) 240
 98% (16) 869
 98%
Foreign government
 26
 100% 
 
 %
 63
 100% 
 7
 100%
Residential MBS(2) 157
 99% (5) 110
 96%(4) 240
 98% (4) 136
 97%
Commercial MBS(4) 215
 98% 
 
 %
 12
 100% 
 10
 100%
Asset-backed securities(36) 3,738
 99% (10) 256
 96%(35) 3,370
 99% (19) 981
 98%
Corporate and other(281) 10,673
 97% (43) 651
 94%(13) 1,280
 99% (92) 3,949
 98%
Total fixed maturities$(360) $16,868
 98% $(78) $1,567
 95%$(56) $5,208
 99% $(133) $6,070
 98%
                      
December 31, 2017           
December 31, 2018           
Fixed maturities:                      
U.S. Government and government agencies$
 $55
 100% $(3) $123
 98%$
 $41
 100% $(3) $120
 98%
States, municipalities and political subdivisions(8) 825
 99% (10) 431
 98%(23) 1,497
 98% (32) 902
 97%
Foreign government
 4
 100% 
 
 %
 18
 100% 
 4
 100%
Residential MBS(1) 118
 99% (5) 118
 96%(4) 279
 99% (5) 139
 97%
Commercial MBS(1) 67
 99% 
 
 %(1) 147
 99% (1) 30
 97%
Asset-backed securities(7) 1,195
 99% (9) 299
 97%(77) 5,406
 99% (23) 629
 96%
Corporate and other(20) 2,031
 99% (18) 603
 97%(306) 10,378
 97% (128) 2,078
 94%
Total fixed maturities$(37) $4,295
 99% $(45) $1,574
 97%$(411) $17,766
 98% $(192) $3,902
 95%
           
Equity securities:           
Common stocks$(22) $117
 84% $
 $
 %
Perpetual preferred stocks
 41
 100% (1) 13
 93%
Total equity securities$(22) $158
 88% $(1) $13
 93%

At June 30, 2018March 31, 2019, the gross unrealized losses on fixed maturities of $438189 million relate to 2,0431,274 securities. Investment grade securities (as determined by nationally recognized rating agencies) represented approximately 93%85% of the gross unrealized loss and 96%93% of the fair value.

AFG analyzes its MBS securities for other-than-temporary impairment each quarter based upon expected future cash flows. Management estimates expected future cash flows based upon its knowledge of the MBS market, cash flow projections (which reflect loan to collateral values, subordination, vintage and geographic concentration) received from independent sources, implied cash flows inherent in security ratings and analysis of historical payment data. In the first sixthree months of both 20182019, and 2018, AFG recorded less than $1 million in other-than-temporary impairment charges related to its residential MBS.

In the first sixthree months of 2019 and 2018, AFG recorded less than$3 million and $1 million, respectively, in other-than-temporary impairment charges related to corporate bonds and other fixed maturities.

Management believes AFG will recover its cost basis in the securities with unrealized losses and that AFG has the ability to hold the securities until they recover in value and had no intent to sell them at June 30, 2018March 31, 2019. As discussed in Note A — “Accounting PoliciesInvestments,” effective January 1, 2018, all equity securities previously classified as “available for sale” are required to be carried at fair value through net earnings instead of accumulated other comprehensive income and therefore are no longer evaluated for other-than-temporary impairment.


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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — CONTINUED


A progression of the credit portion of other-than-temporary impairments on fixed maturity securities for which the non-credit portion of an impairment has been recognized in other comprehensive income is shown below (in millions):

2018 2017
Balance at March 31$144
 $146
Additional credit impairments on:   
Previously impaired securities
 1
Securities without prior impairments1
 
Reductions due to sales or redemptions(1) (2)
Balance at June 30$144
 $145
   2019 2018
Balance at January 1$145
 $153
$142
 $145
Additional credit impairments on:      
Previously impaired securities
 1

 
Securities without prior impairments1
 

 
Reductions due to sales or redemptions(2) (9)(1) (1)
Balance at June 30$144
 $145
Balance at March 31$141
 $144

The table below sets forth the scheduled maturities of available for sale fixed maturities as of June 30, 2018March 31, 2019 (dollars in millions). Securities with sinking funds are reported at average maturity. Actual maturities may differ from contractual maturities because certain securities may be called or prepaid by the issuers.
Amortized Fair ValueAmortized Fair Value
Cost Amount %Cost Amount %
Maturity          
One year or less$994
 $1,003
 3%$1,549
 $1,561
 4%
After one year through five years7,703
 7,764
 20%9,016
 9,177
 21%
After five years through ten years13,386
 13,285
 33%14,097
 14,384
 33%
After ten years4,828
 4,841
 12%4,470
 4,611
 11%
26,911
 26,893
 68%29,132
 29,733
 69%
ABS (average life of approximately 4-1/2 years)8,849
 8,935
 22%
MBS (average life of approximately 4-1/2 years)3,484
 3,820
 10%
ABS (average life of approximately 4.5 years)9,909
 10,018
 23%
MBS (average life of approximately 4.5 years)3,377
 3,680
 8%
Total$39,244
 $39,648
 100%$42,418
 $43,431
 100%

Certain risks are inherent in 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.
There were no investments in individual issuers that exceeded 10% of shareholders’ equity at June 30, 2018March 31, 2019 or December 31, 20172018.


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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — CONTINUED


Net Unrealized Gain on Marketable Securities   In addition to adjusting fixed maturity securities and equity securities classified as “available for sale” to fair value, GAAP requires that deferred policy acquisition costs and certain other balance sheet amounts related to annuity, long-term care and life businesses be adjusted to the extent that unrealized gains and losses from securities would result in adjustments to those balances had the unrealized gains or losses actually been realized. The following table shows (in millions) the components of the net unrealized gain on securities that is included in AOCI in AFG’s Balance Sheet.
Pretax Deferred Tax NetPretax Deferred Tax Net
June 30, 2018     
March 31, 2019     
Net unrealized gain on:          
Fixed maturities — annuity segment (a)$310
 $(65) $245
Fixed maturities — annuity segment (*)$792
 $(166) $626
Fixed maturities — all other94
 (20) 74
221
 (47) 174
Total fixed maturities404
 (85) 319
1,013
 (213) 800
Deferred policy acquisition costs — annuity segment(124) 26
 (98)(325) 68
 (257)
Annuity benefits accumulated(41) 9
 (32)(108) 23
 (85)
Unearned revenue3
 (1) 2
8
 (2) 6
Total net unrealized gain on marketable securities$242
 $(51) $191
$588
 $(124) $464
          
December 31, 2017     
December 31, 2018     
Net unrealized gain on:          
Fixed maturities — annuity segment (a)$1,082
 $(227) $855
Fixed maturities — annuity segment (*)$101
 $(21) $80
Fixed maturities — all other259
 (55) 204
59
 (13) 46
Total fixed maturities1,341
 (282) 1,059
160
 (34) 126
Equity securities (b)279
 (58) 221
Total investments1,620
 (340) 1,280
Deferred policy acquisition costs — annuity segment(433) 91
 (342)(42) 9
 (33)
Annuity benefits accumulated(137) 29
 (108)(14) 3
 (11)
Unearned revenue13
 (3) 10
1
 
 1
Total net unrealized gain on marketable securities$1,063
 $(223) $840
$105
 $(22) $83
(a)(*)Net unrealized gains on fixed maturity investments supporting AFG’s annuity benefits accumulated.
(b)
As discussed in Note A — “Accounting PoliciesInvestments,” effective January 1, 2018, all equity securities other than those accounted for under the equity method are carried at fair value through net earnings.

Net Investment Income   The following table shows (in millions) investment income earned and investment expenses incurred.
Three months ended June 30, Six months ended June 30,Three months ended March 31,
2018 2017 2018 20172019 2018
Investment income:          
Fixed maturities$431
 $397
 $843
 $786
$469
 $412
Equity securities:          
Dividends20
 17
 40
 36
22
 20
Change in fair value (*)15
 2
 14
 4
11
 (1)
Equity in earnings of partnerships and similar investments41
 21
 87
 31
21
 46
Other28
 27
 51
 47
25
 23
Gross investment income535
 464
 1,035
 904
548
 500
Investment expenses(5) (4) (10) (9)(6) (5)
Net investment income$530
 $460
 $1,025
 $895
$542
 $495
(*)
As discussed in Note A — “Accounting PoliciesInvestments,” AFG adopted guidance in January 2018 that requires all equity securities other than those accounted for under the equity method to be reported at fair value with holding gains and losses recognized in net earnings. Although the change in the fair value of the majority of AFG’s equity securities is recorded in realized gains (losses) on securities, AFG records holding gains and losses in net investment income on equity
securities classified as “trading” under previous guidance and on a small portfolio of limited partnership and similar investments that do not qualify for the equity method of accounting.

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — CONTINUED


securities classified as “trading” under the previous guidance and on a small portfolio of limited partnership and similar investments that do not qualify for the equity method of accounting.
Realized gains (losses) and changes in unrealized appreciation (depreciation) included in AOCI related to fixed maturity and equity security investments are summarized as follows (in millions): 
Three months ended June 30, 2018 Three months ended June 30, 2017Three months ended March 31, 2019 Three months ended March 31, 2018
Realized gains (losses)   Realized gains (losses)  Realized gains (losses)   Realized gains (losses)  
Before Impairments Impairments Total Change in Unrealized Before Impairments Impairments Total Change in UnrealizedBefore Impairments Impairments Total Change in Unrealized Before Impairments Impairments Total Change in Unrealized
Fixed maturities$4
 $
 $4
 $(338) $11
 $(1) $10
 $262
$3
 $(3) $
 $853
 $(1) $(1) $(2) $(599)
Equity securities23
 
 23
 
 8
 (11) (3) 20
182
 
 182
 
 (95) 
 (95) 
Mortgage loans and other investments
 
 
 
 
 
 
 
Other (*)4
 
 4
 147
 (2) 3
 1
 (112)1
 1
 2
 (370) 4
 
 4
 248
Total pretax31



31

(191)
17

(9)
8

170
186
 (2) 184
 483
 (92) (1) (93) (351)
Tax effects(6) 
 (6) 40
 (6) 3
 (3) (60)(39) 
 (39) (102) 20
 
 20
 74
Net of tax$25

$

$25

$(151)
$11

$(6)
$5

$110
$147
 $(2) $145
 $381
 $(72) $(1) $(73) $(277)
               
               
Six months ended June 30, 2018 Six months ended June 30, 2017
Realized gains (losses)   Realized gains (losses)  
Before Impairments Impairments Total Change in Unrealized Before Impairments Impairments Total Change in Unrealized
Fixed maturities$3
 $(1) $2
 $(937) $16
 $(1) $15
 $464
Equity securities(72) 
 (72) 
 10
 (20) (10) 92
Mortgage loans and other investments
 
 
 
 3
 
 3
 
Other (*)8
 
 8
 395
 (3) 6
 3
 (195)
Total pretax(61) (1) (62) (542) 26
 (15) 11
 361
Tax effects13
 
 13
 114
 (9) 5
 (4) (126)
Net of tax$(48) $(1) $(49) $(428) $17
 $(10) $7
 $235
(*)Primarily adjustments to deferred policy acquisition costs and reserves related to the annuity business.

As discussed in Note A — “Accounting PoliciesInvestments,” effective January 1, 2018, allAll equity securities other than those accounted for under the equity method are carried at fair value through net earnings. AFG recorded net holding gains (losses) on equity securities during the second quarter and first sixthree months of 2019 and 2018 on securities that were still owned at June 30,March 31, 2019 and March 31, 2018 as follows (in millions):
Three months ended Six months endedThree months ended March 31,
June 30, 2018 June 30, 20182019 2018
Included in realized gains (losses)$16
 $(71)$163
 $(94)
Included in net investment income15
 14
11
 (1)
$31
 $(57)$174
 $(95)

Gross realized gains and losses (excluding impairment write-downs and mark-to-market of derivatives) on available for sale fixed maturity investment transactions consisted of the following (in millions): 
  
Six months ended June 30,
2018 2017
Fixed maturities:   
Gross gains$16
 $21
Gross losses(8) (2)

In the first six months of 2017, AFG recorded gross gains of $15 million and gross losses of $5 million on available for sale equity securities.

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AMERICAN FINANCIAL GROUP, INC. 10-Q
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — CONTINUED


  
Three months ended March 31,
2019 2018
Gross gains$6
 $6
Gross losses(9) (3)

E.    Derivatives

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

Derivatives That Do Not Qualify for Hedge Accounting   The following derivatives that do not qualify for hedge accounting under GAAP are included in AFG’s Balance Sheet at fair value (in millions):
   June 30, 2018 December 31, 2017   March 31, 2019 December 31, 2018
Derivative Balance Sheet Line Asset Liability Asset Liability Balance Sheet Line Asset Liability Asset Liability
MBS with embedded derivatives Fixed maturities $115
 $
 $105
 $
 Fixed maturities $113
 $
 $109
 $
Public company warrants Equity securities 3
 
 4
 
 Equity securities 
 
 
 
Fixed-indexed and variable-indexed annuities (embedded derivative) Annuity benefits accumulated 
 2,776
 
 2,542
 Annuity benefits accumulated 
 3,247
 
 2,720
Equity index call options Equity index call options 615
 
 701
 
 Equity index call options 620
 
 184
 
Equity index put options Other liabilities 
 
 
 
 Other liabilities 
 
 
 1
Reinsurance contracts (embedded derivative) Other liabilities 
 2
 
 4
 Other liabilities 
 3
 
 2
 $733
 $2,778
 $810
 $2,546
 $733
 $3,250
 $293
 $2,723




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AMERICAN FINANCIAL GROUP, INC. 10-Q
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — CONTINUED


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

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

AFG’s fixed-indexed and variable-indexed annuities provide policyholders with a crediting rate tied, in part, to the performance of an existing stock market or other financial index. AFG attempts to mitigate the risk in the index-based component of these products through the purchase and sale of call and put options on the appropriate index. AFG receives collateral from certain counterparties to support its purchased call option assets (net of collateral required under put option contracts with the same counterparties). This collateral ($353406 million at June 30, 2018March 31, 2019 and $389$103 million at December 31, 2017)2018) is included in other assets in AFG’s Balance Sheet with an offsetting liability to return the collateral, which is included in other liabilities. AFG’s strategy is designed so that the change in the fair value of the call and put options will generally offset the economic change in the liabilities from the index participation. Both the index-based component of the annuities and the related call and put options are considered derivatives. Fluctuations in interest rates and the stock market, among other factors, can cause volatility in the periodic measurement of fair value of the embedded derivative that management believes can be inconsistent with the long-term economics of these products.

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


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AMERICAN FINANCIAL GROUP, INC. 10-Q
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — CONTINUED


The following table summarizes the gains (losses) included in AFG’s Statement of Earnings for changes in the fair value of derivatives that do not qualify for hedge accounting for the second quarter and first sixthree months of 20182019 and 20172018 (in millions): 
 Three months ended June 30, Six months ended June 30, Three months ended March 31,
Derivative Statement of Earnings Line 2018 2017 2018 2017 Statement of Earnings Line 2019 2018
MBS with embedded derivatives Realized gains (losses) on securities $(1) $(3) $(5) $(3) Realized gains (losses) on securities $6
 $(4)
Public company warrants Realized gains (losses) on securities 
 
 (1) 
 Realized gains (losses) on securities 
 (1)
Fixed-indexed and variable-indexed annuities (embedded derivative) (*) Annuity benefits (126) (112) (63) (259)
Fixed-indexed and variable-indexed annuities (embedded derivative) Annuity benefits (462) 63
Equity index call options Annuity benefits 90
 81
 52
 222
 Annuity benefits 366
 (38)
Equity index put options Annuity benefits 
 
 
 
 Annuity benefits 1
 
Reinsurance contract (embedded derivative) Net investment income 1
 (1) 2
 (2) Net investment income (1) 1
 $(36) $(35) $(15) $(42) $(90) $21

(*)The change in fair value of the embedded derivative includes losses related to unlocking of actuarial assumptions of $44 million in both the second quarter and first six months of 2018.

Derivatives Designated and Qualifying as Cash Flow Hedges   As of June 30, 2018,March 31, 2019, AFG has entered into elevensixteen interest rate swaps that are designated and qualify as highly effective cash flow hedges to mitigate interest rate risk related to certain floating-rate securities included in AFG’s portfolio of fixed maturity securities. The purpose of each of these swaps is to effectively convert a portion of AFG’s floating-rate fixed maturity securities to fixed rates by offsetting the variability in cash flows attributable to changes in short-term LIBOR.

Under the terms of the swaps, AFG receives fixed-rate interest payments in exchange for variable interest payments based on short-term LIBOR. The notional amounts of the interest rate swaps generally decline over each swap’s respective life (the swaps expire between August 2019 and June 2030) in anticipation of the expected decline in AFG’s portfolio of fixed maturity securities with floating interest rates based on short-term LIBOR. The total outstanding notional amount of AFG’s interest rate swaps was $1.64$2.31 billion at June 30, 2018March 31, 2019 compared to $1.58$2.35 billion at December 31, 2017,2018, reflecting a new swap with an aggregate notional amount at issuance of $130 million entered into in the first quarter of 2018, partially offset by the scheduled amortization discussed above. The fair value of the effective portion of the interest rate swaps in an asset position and included in other assets was zero$25 million at June 30, 2018March 31, 2019 and less than $1$16 million at December 31, 2017.2018. The fair value of the effective portion of the interest rate swaps in a liability position and included in other liabilities was $70$25 million at June 30, 2018March 31, 2019 and $31$46 million at December 31, 2017.2018. The net unrealized gain or loss on cash flow hedges is included in AOCI, net of DPAC and deferred taxes. Amounts reclassified from AOCI (before DPAC and taxes) to net investment income were losses of $2 million and $1 million duringin the second quarter and first sixthree months of 2018 as2019 compared to income of $1 million and $3 million in the second quarter and first sixthree months of 2017, respectively.2018. There was no ineffectiveness recorded in net earnings during these periods. A collateral receivable supporting these swaps of $116$134 million at June 30, 2018March 31, 2019 and $70$135 million at December 31, 20172018 is included in other assets in AFG’s Balance Sheet.


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AMERICAN FINANCIAL GROUP, INC. 10-Q
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — CONTINUED



F.    Deferred Policy Acquisition Costs

A progression of deferred policy acquisition costs is presented below (in millions):
P&C  Annuity and Other   P&C  Annuity and Other   
Deferred  Deferred Sales          ConsolidatedDeferred  Deferred Sales          Consolidated
Costs  Costs Inducements PVFP Subtotal Unrealized (*) Total  TotalCosts  Costs Inducements PVFP Subtotal Unrealized (*) Total  Total
Balance at March 31, 2018$279
  $1,208
 $97
 $47
 $1,352
 $(214) $1,138
  $1,417
Additions181
  70
 1
 
 71
 
 71
  252
Amortization:                 
Periodic amortization(160)  (66) (5) (2) (73) 
 (73)  (233)
Annuity unlocking
  28
 1
 
 29
 
 29
  29
Included in realized gains
  3
 
 
 3
 
 3
  3
Foreign currency translation(2)  
 
 
 
 
 
  (2)
Change in unrealized
  
 
 
 
 116
 116
  116
Balance at June 30, 2018$298
  $1,243
 $94
 $45
 $1,382
 $(98) $1,284
  $1,582
                 
Balance at March 31, 2017$243
  $1,137
 $105
 $44
 $1,286
 $(324) $962
  $1,205
Balance at December 31, 2018$299
  $1,285
 $86
 $42
 $1,413
 $(30) $1,383
  $1,682
Additions151
  66
 1
 
 67
 
 67
  218
187
  64
 1
 
 65
 
 65
  252
Amortization:             

                    
Periodic amortization(136)  (36) (4) (2) (42) 
 (42)  (178)(175)  (15) (3) (2) (20) 
 (20)  (195)
Included in realized gains
  
 1
 
 1
 
 1
  1

  2
 
 
 2
 
 2
  2
Foreign currency translation
  
 
 
 
 
 
  
1
  
 
 
 
 
 
  1
Change in unrealized
  
 
 
 
 (90) (90)  (90)
  
 
 
 
 (295) (295)  (295)
Balance at June 30, 2017$258
  $1,167
 $103
 $42
 $1,312
 $(414) $898
  $1,156
Balance at March 31, 2019$312
  $1,336
 $84
 $40
 $1,460
 $(325) $1,135
  $1,447
                                  
Balance at December 31, 2017$270
  $1,217
 $102
 $49
 $1,368
 $(422) $946
  $1,216
$270
  $1,217
 $102
 $49
 $1,368
 $(422) $946
  $1,216
Additions343
  127
 1
 
 128
 
 128
  471
Amortization:                 
Periodic amortization(314)  (135) (10) (4) (149) 
 (149)  (463)
Annuity unlocking
  28
 1
 
 29
 
 29
  29
Included in realized gains
  6
 
 
 6
 
 6
  6
Foreign currency translation(1)  
 
 
 
 
 
  (1)
Change in unrealized
  
 
 
 
 324
 324
  324
Balance at June 30, 2018$298
  $1,243
 $94
 $45
 $1,382
 $(98) $1,284
  $1,582
                 
Balance at December 31, 2016$238
  $1,110
 $110
 $46
 $1,266
 $(265) $1,001
  $1,239
Additions290
  133
 2
 
 135
 
 135
  425
162
  57
 
 
 57
 
 57
  219
Amortization:                                  
Periodic amortization(271)  (78) (10) (4) (92) 
 (92)  (363)(154)  (69) (5) (2) (76) 
 (76)  (230)
Included in realized gains
  2
 1
 
 3
 
 3
  3

  3
 
 
 3
 
 3
  3
Foreign currency translation1
  
 
 
 
 
 
  1
1
  
 
 
 
 
 
  1
Change in unrealized
  
 
 
 
 (149) (149)  (149)
  
 
 
 
 208
 208
  208
Balance at June 30, 2017$258
  $1,167
 $103
 $42
 $1,312
 $(414) $898
  $1,156
Balance at March 31, 2018$279
  $1,208
 $97
 $47
 $1,352
 $(214) $1,138
  $1,417

(*)Unrealized adjustmentsAdjustments to DPAC includesrelated to net unrealized gains/losses on securities and net unrealized gains/losses on cash flow hedges.

The present value of future profits (“PVFP”) amounts in the table above are net of $145150 million and $141148 million of accumulated amortization at June 30, 2018March 31, 2019 and December 31, 20172018, respectively.


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AMERICAN FINANCIAL GROUP, INC. 10-Q
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — CONTINUED


G.    Managed Investment Entities

AFG is the investment manager and its subsidiaries have investments ranging from 15.0% to 60.9% of the most subordinate debt tranche of sixteeneleven active collateralized loan obligation entities or “CLOs,��CLOs,” which are considered variable interest entities. AFG’s subsidiaries also own portions of the senior debt tranches of certain of these CLOs. Upon formation between 20042012 and 2018, these entities issued securities in various senior and subordinate classes and invested the proceeds primarily in secured bank loans, which serve as collateral for the debt securities issued by each particular CLO. None of the collateral was purchased from AFG. AFG’s investments in the subordinate debt tranches of these entities receive residual income from the CLOs only after the CLOs pay expenses (including management fees to AFG) and interest on and returns of capital to senior levels of debt securities. There are no contractual requirements for AFG to provide additional funding for these entities. AFG has not provided and does not intend to provide any financial support to these entities.

AFG’s maximum exposure to economic loss on its CLOs is limited to its investment in the CLOs, which had an aggregate fair value of $192193 million (including $134$130 million invested in the most subordinate tranches) at June 30, 2018March 31, 2019, and $215188 million at December 31, 20172018.

In March 2018, and March 2017, AFG formed a new CLOs,CLO, which issued $463 million and $408 million face amount of liabilities respectively (including $31 million and $24 million face amount purchased by subsidiaries of AFG). During the first sixthree months of 2017, AFG subsidiaries also purchased $29 million face amount of senior debt2019 and subordinate tranches of existing CLOs for $29 million. During the first six months of 2018, and 2017, AFG subsidiaries received $45less than $1 million and $64$17 million, respectively, in sale and redemption proceeds from its CLO investments. During both the first sixthree months of 2018, and 2017, one AFG CLO was substantially liquidated, as permitted by the CLO indentures.indenture.


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AMERICAN FINANCIAL GROUP, INC. 10-Q
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — CONTINUED


The revenues and expenses of the CLOs are separately identified in AFG’s Statement of Earnings, after the elimination of management fees and earnings attributable to shareholders of AFG as measured by the change in the fair value of AFG’s investments in the CLOs. Selected financial information related to the CLOs is shown below (in millions): 
Three months ended June 30, Six months ended June 30,Three months ended March 31,
2018 2017 2018 20172019 2018
Investment in CLO tranches at end of period$192
 $188
 $192
 $188
$193
 $221
Gains (losses) on change in fair value of assets/liabilities (a):          
Assets(29) (9) (15) (4)87
 14
Liabilities27
 20
 10
 15
(87) (17)
Management fees paid to AFG4
 5
 8
 9
3
 4
CLO earnings (losses) attributable to AFG shareholders (b)4
 5
 7
 11
CLO earnings attributable to AFG shareholders (b)11
 3

(a)Included in revenues in AFG’s Statement of Earnings.
(b)Included in earnings before income taxes in AFG’s Statement of Earnings.
The aggregate unpaid principal balance of the CLOs’ fixed maturity investments exceeded the fair value of the investments by $62144 million and $55232 million at June 30, 2018March 31, 2019 and December 31, 20172018, respectively. The aggregate unpaid principal balance of the CLOs’ debt exceeded its carrying value by $167145 million and $118$241 million at those dates. The CLO assets include loans with an aggregate fair value of $1 million at both June 30, 2018At March 31, 2019 and December 31, 2017, for which2018, the CLOsCLO assets do not have any loans that are not accruing interest because the loans are in default (aggregate unpaid principal balance of $8 million at both those dates).default.

H.    Goodwill and Other Intangibles

There were no changes in the goodwill balance of $199$207 million during the first sixthree months of 20182019. Included in other assets in AFG’s Balance Sheet is $3451 million at June 30, 2018March 31, 2019 and $2654 million at December 31, 20172018 in amortizable intangible assets related to property and casualty insurance acquisitions. These amounts are net of accumulated amortization of $34$42 million and $3039 million, respectively. Amortization of intangibles was $3 million and $2 million in both the second quarters of 2018 and 2017 and $4 million in both the first sixthree months of 20182019 and 20172018., respectively.


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AMERICAN FINANCIAL GROUP, INC. 10-Q
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — CONTINUED


I.    Long-Term Debt

Long-term debt consisted of the following (in millions):
June 30, 2018 December 31, 2017March 31, 2019 December 31, 2018
Principal Discount and Issue Costs Carrying Value Principal Discount and Issue Costs Carrying ValuePrincipal Discount and Issue Costs Carrying Value Principal Discount and Issue Costs Carrying Value
Direct Senior Obligations of AFG:                      
4.50% Senior Notes due June 2047$590
 $(2) $588
 $590
 $(2) $588
$590
 $(2) $588
 $590
 $(2) $588
3.50% Senior Notes due August 2026425
 (5) 420
 425
 (5) 420
425
 (4) 421
 425
 (4) 421
Other3
 
 3
 3
 
 3
3
 
 3
 3
 
 3
1,018
 (7) 1,011
 1,018
 (7) 1,011
1,018
 (6) 1,012
 1,018
 (6) 1,012
                      
Direct Subordinated Obligations of AFG:                      
6-1/4% Subordinated Debentures due September 2054150
 (5) 145
 150
 (5) 145
150
 (5) 145
 150
 (5) 145
6% Subordinated Debentures due November 2055150
 (5) 145
 150
 (5) 145
150
 (5) 145
 150
 (5) 145
5.875% Subordinated Debentures due March 2059125
 (4) 121
 
 
 
300
 (10) 290
 300
 (10) 290
425
 (14) 411
 300
 (10) 290
$1,318
 $(17) $1,301
 $1,318
 $(17) $1,301
$1,443
 $(20) $1,423
 $1,318
 $(16) $1,302

AFG has no scheduled principal payments on its long-term debt for the balance of 20182019 or in the subsequent five years.

In March 2019, AFG issued $125 million in 5.875% Subordinated Debentures due in 2059.

AFG can borrow up to $500 million under its revolving credit facility, which expires in June 2021. Amounts borrowed under this agreement bear interest at rates ranging from 1.00% to 1.875% (currently 1.375%) over LIBOR based on AFG’s credit rating. No amounts were borrowed under this facility at June 30, 2018March 31, 2019 or December 31, 20172018.

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AMERICAN FINANCIAL GROUP, INC. 10-Q
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — CONTINUED



J.    Redeemable Noncontrolling InterestsLeases

Neon Lloyd’s Business   On December 29, 2017, AFG completedand its subsidiaries lease real estate that is primarily used for office space and, to a lesser extent, equipment under operating lease arrangements. Most of AFG’s real estate leases include an option to extend or renew the salelease term at AFG’s option. The operating lease liability includes lease payments related to options to extend or renew the lease term if AFG is reasonably certain of an indirect noncontrolling interest in Neon, its United Kingdom-based Lloyd’s insurer, to certain Neon executives for cash equal toexercising those options. Lease payments are discounted using the fair value of the interest sold as determined by a third-party valuation firm. This noncontrolling interest is redeemable at the option of the holder and is presented separatelyimplicit discount rate in the mezzanine sectionlease. If the implicit discount rate for the lease cannot be readily determined, AFG uses an estimate of the balance sheet,its incremental secured borrowing rate. AFG did not have any material contracts accounted for as discussed in Note A — Accounting Policies — Noncontrolling Interests.”finance leases at March 31, 2019 or January 1, 2019.

At March 31, 2019, AFG’s $167 million operating lease right-of-use asset (presented net of $23 million in deferred rent and lease incentives) and $190 million operating lease liability are included in other assets and other liabilities, respectively, in AFG’s Balance Sheet.

The following table details AFG’s lease activity for the three months ended March 31, 2019 (dollars in millions):
 Three months ended
 March 31, 2019
Lease expense: 
Operating leases$11
Short-term leases
Total lease expense$11
  
Other operating lease information: 
Cash paid for amounts included in the measurement of lease liabilities reported in operating cash flows$12
Right-of-use assets obtained in exchange for new lease liabilities3
  
Weighted-average remaining lease term5.9 years
Weighted-average discount rate4.1%

The following table presents the undiscounted contractual maturities of AFG’s operating lease liability at March 31, 2019 (dollars in millions):
 March 31, 2019
Operating lease payments: 
Remainder of 2019$35
202042
202136
202228
202323
Thereafter51
Total lease payments215
Impact of discounting(25)
Operating lease liability$190



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AMERICAN FINANCIAL GROUP, INC. 10-Q
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — CONTINUED


K.    Shareholders’ Equity

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.

Accumulated Other Comprehensive Income, Net of Tax (“AOCI”)   Comprehensive income is defined as all changes in shareholders’ equity except those arising from transactions with shareholders. Comprehensive income includes net earnings and other comprehensive income, which consists primarily of changes in net unrealized gains or losses on available for sale securities.


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AMERICAN FINANCIAL GROUP, INC. 10-Q
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — CONTINUED


The progression of the components of accumulated other comprehensive income follows (in millions): 
   Other Comprehensive Income (Loss)    
 
AOCI
Beginning
Balance
 Pretax Tax 
Net
of
tax
 
Attributable to
noncontrolling
interests
 
Attributable to
shareholders
 Other (c) 
AOCI
Ending
Balance
Quarter ended June 30, 2018               
Net unrealized gains (losses) on securities:               
Unrealized holding losses on securities arising during the period  $(187) $39
 $(148) $
 $(148)   

Reclassification adjustment for realized (gains) losses included in net earnings (a)  (4) 1
 (3) 
 (3)   

Total net unrealized gains (losses) on securities (b)$342
 (191) 40
 (151) 
 (151) $
 $191
Net unrealized losses on cash flow hedges(24) (4) 1
 (3) 
 (3) 
 (27)
Foreign currency translation adjustments(5) (4) 
 (4) 
 (4) 
 (9)
Pension and other postretirement plans adjustments(8) 
 
 
 
 
 
 (8)
Total$305
 $(199) $41
 $(158) $
 $(158) $
 $147
                
Quarter ended June 30, 2017               
Net unrealized gains on securities:               
Unrealized holding gains on securities arising during the period  $178
 $(63) $115
 $
 $115
    
Reclassification adjustment for realized (gains) losses included in net earnings (a)  (8) 3
 (5) 
 (5)    
Total net unrealized gains on securities$529
 170
 (60) 110
 
 110
 $
 $639
Net unrealized gains (losses) on cash flow hedges(8) 4
 (2) 2
 
 2
 
 (6)
Foreign currency translation adjustments(15) 3
 1
 4
 
 4
 
 (11)
Pension and other postretirement plans adjustments(7) 
 
 
 
 
 
 (7)
Total$499
 $177
 $(61) $116
 $
 $116
 $
 $615
                
Six months ended June 30, 2018               
Net unrealized gains (losses) on securities:               
Unrealized holding losses on securities arising during the period  $(540) $113
 $(427) $
 $(427)   

Reclassification adjustment for realized (gains) losses included in net earnings (a)  (2) 1
 (1) 
 (1)   

Total net unrealized gains (losses) on securities (b)$840
 (542) 114
 (428) 
 (428) $(221) $191
Net unrealized losses on cash flow hedges(13) (18) 4
 (14) 
 (14) 
 (27)
Foreign currency translation adjustments(6) (2) (1) (3) 
 (3) 
 (9)
Pension and other postretirement plans adjustments(8) 
 
 
 
 
 
 (8)
Total$813
 $(562) $117
 $(445) $
 $(445) $(221) $147
                
Six months ended June 30, 2017               
Net unrealized gains on securities:               
Unrealized holding gains on securities arising during the period  $369
 $(129) $240
 $
 $240
    
Reclassification adjustment for realized (gains) losses included in net earnings (a)  (8) 3
 (5) 
 (5)    
Total net unrealized gains on securities$404
 361
 (126) 235
 
 235
 $
 $639
Net unrealized gains (losses) on cash flow hedges(7) 2
 (1) 1
 
 1
 
 (6)
Foreign currency translation adjustments(15) 3
 1
 4
 
 4
 
 (11)
Pension and other postretirement plans adjustments(7) 
 
 
 
 
 
 (7)
Total$375
 $366
 $(126) $240
 $
 $240
 $
 $615


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AMERICAN FINANCIAL GROUP, INC. 10-Q
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — CONTINUED


   Other Comprehensive Income (Loss)    
 
AOCI
Beginning
Balance
 Pretax Tax 
Net
of
tax
 
Attributable to
noncontrolling
interests
 
Attributable to
shareholders
 Other (c) 
AOCI
Ending
Balance
Three months ended March 31, 2019               
Net unrealized gains on securities:               
Unrealized holding gains on securities arising during the period  $487
 $(103) $384
 $
 $384
   

Reclassification adjustment for realized (gains) losses included in net earnings (a)  (4) 1
 (3) 
 (3)   

Total net unrealized gains on securities$83
 483
 (102) 381
 
 381
 $
 $464
Net unrealized gains (losses) on cash flow hedges(11) 14
 (3) 11
 
 11
 
 
Foreign currency translation adjustments(16) 4
 
 4
 
 4
 
 (12)
Pension and other postretirement plans adjustments(8) 
 
 
 
 
 
 (8)
Total$48
 $501
 $(105) $396
 $
 $396
 $
 $444
                
Three months ended March 31, 2018               
Net unrealized gains (losses) on securities:               
Unrealized holding losses on securities arising during the period  $(353) $74
 $(279) $
 $(279)    
Reclassification adjustment for realized (gains) losses included in net earnings (a)  2
 
 2
 
 2
    
Total net unrealized gains (losses) on securities (b)$840
 (351) 74
 (277) 
 (277) $(221) $342
Net unrealized losses on cash flow hedges(13) (14) 3
 (11) 
 (11) 
 (24)
Foreign currency translation adjustments(6) 2
 (1) 1
 
 1
 
 (5)
Pension and other postretirement plans adjustments(8) 
 
 
 
 
 
 (8)
Total$813
 $(363) $76
 $(287) $
 $(287) $(221) $305
(a)The reclassification adjustment out of net unrealized gains (losses) on securities affected the following lines in AFG’s Statement of Earnings:
 OCI component Affected line in the statement of earnings 
 Pretax Realized gains (losses) on securities 
 Tax Provision for income taxes 
(b)Includes net unrealized gains of $67$61 million at June 30, 2018 and $68March 31, 2019 compared to $58 million at both MarchDecember 31, 2018 and December 31, 2017 related to securities for which only the credit portion of an other-than-temporary impairment has been recorded in earnings.
(c)On January 1, 2018, AFG adopted new guidance that requires all equity securities other than those accounted for under the equity method to be reported at fair value with holding gains and losses recognized in net earnings. At the date of adoption, the $221 million net unrealized gain on equity securities classified as available for sale (with unrealized holding gains and losses reported in AOCI) under the prior guidance was reclassified from AOCI to retained earnings as the cumulative effect of an accounting change.

Stock Incentive Plans   Under AFG’s stock incentive plans, employees of AFG and its subsidiaries are eligible to receive equity awards in the form of stock options, stock appreciation rights, restricted stock awards, restricted stock units and stock awards. In the first sixthree months of 2018,2019, AFG issued 200,625232,565 shares of restricted Common Stock (fair value of $112.86$99.28 per share) under the Stock Incentive Plan. In addition, AFG issued 45,804 shares of Common Stock (fair value of $115.49 per share) in the first quarter of 2018 under the Equity Bonus Plan. AFG did not grant any stock options in the first sixthree months of 2018.2019.


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AMERICAN FINANCIAL GROUP, INC. 10-Q
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — CONTINUED


Total compensation expense related to stock incentive plans of AFG and its subsidiaries was $6 million in both the second quarters of 2018 and 2017 and $11 million and $17$5 million in the first sixthree months of 20182019 and 20172018, respectively.

L.    Income Taxes

The following is a reconciliation of income taxes at the statutory rate (21% in 2018 and 35% in 2017)of 21% to the provision for income taxes as shown in AFG’s Statement of Earnings (dollars in millions):
 Three months ended June 30, Six months ended June 30,
 2018 2017 2018 2017
 Amount % of EBT Amount % of EBT Amount % of EBT Amount % of EBT
Earnings before income taxes (“EBT”)$260
   $205
   $434
   $428
  
                
Income taxes at statutory rate$54
 21% $72
 35% $91
 21% $150
 35%
Effect of:               
Stock-based compensation(2) (1%) (7) (3%) (7) (2%) (13) (3%)
Tax exempt interest(4) (2%) (6) (3%) (7) (2%) (12) (3%)
Dividends received deduction(1) % (2) (1%) (2) % (4) (1%)
Employee Stock Ownership Plan dividends paid deduction(1) % (2) (1%) (1) % (2) %
Foreign operations
 % 
 % 3
 1% 6
 1%
Nondeductible expenses2
 1% 1
 % 4
 1% 3
 1%
Change in valuation allowance2
 1% 2
 1% 2
 % 
 %
Other2
 % 2
 1% 2
 1% 
 %
Provision for income taxes as shown in the statement of earnings$52
 20% $60
 29% $85
 20% $128
 30%
The Tax Cuts and Jobs Act of 2017 (“TCJA”), which was enacted on December 22, 2017, lowered the U.S corporate tax rate to 21% and made other widespread changes to the U.S. tax code effective in 2018. Because the TCJA was enacted in December 2017, AFG recorded the $83 million decrease in its net deferred tax asset resulting from the changes in the tax code (primarily the lower corporate tax rate applicable to 2018 and future years) in the fourth quarter of 2017.

The TCJA is subject to further clarification and interpretation by the U.S. Treasury Department and the Internal Revenue Service. For example, the TCJA changes the way that companies calculate their insurance claims and reserves for tax purposes,

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AMERICAN FINANCIAL GROUP, INC. 10-Q
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — CONTINUED


including revaluing those tax basis liabilities as of January 1, 2018, based on a methodology and discount factors that have not been published. The resulting transitional deferred tax liability (taxes payable over eight years under the TCJA) and offsetting increase in AFG’s insurance claims and reserves deferred tax assets, were recorded at December 31, 2017 using reasonable estimates based on available information and should be considered provisional in accordance with Securities and Exchange Commission Staff Accounting Bulletin No. 118 (“SAB 118”). Because the established transition liability was completely offset by an increase in related deferred tax assets, any adjustment to the provisional amount will not impact AFG’s effective tax rate. In accordance with SAB 118, the insurance claims and reserves transitional deferred tax liability (and offsetting adjustment to the related deferred tax assets) and any other changes in deferred taxes resulting from clarification and interpretation of the TCJA provided during 2018 (none through June 30, 2018) will be recorded in the period in which the guidance is published.
The favorable impact of stock-based compensation on AFG’s effective tax rate in the second quarters and first six months of 2018 and 2017 reflects the high volume of employee stock option exercises during that period and the increase in the market price of AFG Common Stock.
 Three months ended March 31,
 2019 2018
 Amount % of EBT Amount % of EBT
Earnings before income taxes (“EBT”)$413
   $174
  
        
Income taxes at statutory rate$87
 21% $37
 21%
Effect of:       
Tax exempt interest(4) (1%) (3) (2%)
Dividends received deduction(1) % (1) %
Stock-based compensation(2) % (5) (3%)
Nondeductible expenses2
 % 2
 1%
Change in valuation allowance2
 % 
 %
Foreign operations
 % 3
 2%
Other3
 1% 
 %
Provision for income taxes as shown in the statement of earnings$87
 21% $33
 19%

Approximately $19 million of AFG’s net operating loss carryforwards (“NOL”) subject to separate return limitation year (“SRLY”) tax rules will expire unutilized at December 31, 2018.2019. Since AFG maintains a full valuation allowance against its SRLY NOLs, the expiration of these loss carryforwards will be offset by a corresponding reduction in the valuation allowance and will have no overall impact on AFG’s income tax expense or results of operations.

M.     Contingencies

There have been no significant changes to the matters discussed and referred to in Note M — “Contingencies” of AFG’s 20172018 Form 10-K, which covers property and casualty insurance reserves for claims related to environmental exposures, asbestos and other mass tort claims and environmental and occupational injury and disease claims of former subsidiary railroad and manufacturing operations, as well as contingencies related to the sale of substantially all of AFG’s run-off long-term care insurance business.


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AMERICAN FINANCIAL GROUP, INC. 10-Q
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — CONTINUED


N.    Insurance

Property and Casualty Insurance Reserves The following table provides an analysis of changes in the liability for losses and loss adjustment expenses during the first sixthree months of 20182019 and 20172018 (in millions):
Six months ended June 30,Three months ended March 31,
2018 20172019 2018
Balance at beginning of year$9,678
 $8,563
$9,741
 $9,678
Less reinsurance recoverables, net of allowance2,957
 2,302
2,942
 2,957
Net liability at beginning of year6,721
 6,261
6,799
 6,721
Provision for losses and LAE occurring in the current period1,434
 1,294
737
 697
Net increase (decrease) in the provision for claims of prior years(100) (50)
Net decrease in the provision for claims of prior years(45) (56)
Total losses and LAE incurred1,334
 1,244
692
 641
Payments for losses and LAE of:      
Current year(294) (253)(89) (86)
Prior years(975) (953)(615) (554)
Total payments(1,269) (1,206)(704) (640)
Reserves of business disposed (*)(319) 

 (319)
Foreign currency translation and other(4) 24
1
 2
Net liability at end of period6,463
 6,323
6,788
 6,405
Add back reinsurance recoverables, net of allowance2,630
 2,407
2,835
 2,788
Gross unpaid losses and LAE included in the balance sheet at end of period$9,093
 $8,730
$9,623
 $9,193
(*)Reflects the reinsurance to close transaction at Neon discussed below.

The net decrease in the provision for claims of prior years during the first sixthree months of 20182019 reflects (i) lower than expected
losses in the crop business and lower than expected claim severity in the transportation businessesfrequency at National Interstate (all within the Property and transportation sub-segment), (ii) lower than anticipated claim frequency and severity in the workers’ compensation businesses

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AMERICAN FINANCIAL GROUP, INC. 10-Q
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — CONTINUED


(withinbusiness (within the Specialty casualty sub-segment), and (iii) lower than expected claim frequency and severity in the surety business and lower than expectedanticipated claim severity in the fidelity business (all within the Specialty financial sub-segment). This favorable development was partially offset by higher than expected claim severity in the targeted markets businesses and higher than expected losses at Neon (all within the Specialty casualty sub-segment).

The net decrease in the provision for claims of prior years during the first sixthree months of 20172018 reflects (i) lower than expected losses in the crop and equine operations and lower than expected claim severity in the property and inland marine business (all within(within the Property and transportation sub-segment), (ii) lower than anticipated claim frequency and severity in workers’ compensation business and lower than expected claim severity in the workers’ compensation businesses and at Neonexecutive liability business (all within the Specialty casualty sub-segment), and (iii) lower than anticipated claim severity in the fidelity business and lower than expected claim frequency and severity in the surety business (all within(within the Specialty financial sub-segment). This favorable development was partially offset by (i) higher than expected claim severity in the ocean marine business (within the Property and transportation sub-segment), (ii) higher than anticipated claim severityfrequency in the targeted markets and general liability business (all withinbusinesses (within the Specialty casualty sub-segment) and (iii) an adjustment to the deferred gain on the retroactive reinsurance transaction entered into in connection with the sale of businesses in 1998 (included in Other specialty sub-segment).

In December 2017, the Neon Lloyd’s syndicate entered into a reinsurance to close transaction for the 2015 and prior years of account with StarStone Underwriting Limited, a subsidiary of Enstar Group Limited, which was effective as of December 31, 2017 (the transactionand settled in early 2018).2018. In the Lloyd’s market, a reinsurance to close transaction transfers the responsibility for discharging all of the liabilities that attach to the transferred year of account plus the right to any income due to the closing year of account in return for a premium. This transaction provided Neon with finality on its legacy business.


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AMERICAN FINANCIAL GROUP, INC. 10-Q
ITEM 2
Management’s Discussion and Analysis of Financial Condition and Results of Operations

INDEX TO MD&A
Page PagePage Page
  
  
  
  
  
  
  
  
  
 
 
 
  

FORWARD-LOOKING STATEMENTS
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 words such as “anticipates”, “believes”, “expects”, “projects”, “estimates”, “intends”, “plans”, “seeks”, “could”, “may”, “should”, “will” or the negative version of those words or other comparable terminology. Such forward-looking statements include statements relating to: expectations concerning market and other conditions and their effect on future premiums, revenues, earnings, investment activities, and the amount and timing of share repurchases; recoverability of asset values; expected losses and the adequacy of reserves for asbestos, environmental pollution and mass tort claims; rate changes; and improved loss experience.

Actual results and/or financial condition could differ materially from those contained in or implied by such forward-looking statements for a variety of reasons including but not limited to:
changes in financial, political and economic conditions, including changes in interest and inflation rates, currency fluctuations and extended economic recessions or expansions in the U.S. and/or abroad;
performance of securities markets, including the cost of equity index call options used in the fixed-indexed and variable-indexed annuity business;options;
new legislation or declines in credit quality or credit ratings that could have a material impact on the valuation of securities in AFG’s investment portfolio;
the availability of capital;
regulatory actions (includingchanges in insurance law or regulation, including changes in statutory accounting rules);rules and changes in regulation of the Lloyd’s market, including modifications to the establishment of capital requirements for and approval of business plans for syndicate participation;
changes in the legal environment affecting AFG or its customers;
tax law and accounting changes, including the impact of recent changes in U.S. corporate tax law;
levels of natural catastrophes and severe weather, terrorist activities (including any nuclear, biological, chemical or radiological events), incidents of war or losses resulting from civil unrest and other major losses;
disruption caused by cyber-attacks or other technology breaches or failures by AFG or its business partners and service providers, which could negatively impact AFG’s business and/or expose AFG to litigation;
development of insurance loss reserves and establishment of other reserves, particularly with respect to amounts associated with asbestos and environmental claims;
availability of reinsurance and ability of reinsurers to pay their obligations;
trends in persistency and mortality;
competitive pressures;
the ability to obtain adequate rates and policy terms;
changes in AFG’s credit ratings or the financial strength ratings assigned by major ratings agencies to AFG’s operating subsidiaries; and
the impact of the conditions in the international financial markets and the global economy (including those associated with the United Kingdom’s expected withdrawal from the European Union, or “Brexit”) relating to AFG’s international operations.
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.


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AMERICAN FINANCIAL GROUP, INC. 10-Q
Management’s Discussion and Analysis of Financial Condition and Results of Operations — Continued


OVERVIEW

Financial Condition

AFG is organized as a holding company with almost all of its operations being conducted by subsidiaries. AFG, however, has continuing cash needs for administrative expenses, the payment of principal and interest on borrowings, shareholder dividends, and taxes. Therefore, certain analyses are most meaningfully presented on a parent only basis while others are best done on a total enterprise basis. In addition, because most of its businesses are financial in nature, AFG does not prepare its consolidated financial statements using a current-noncurrent format. Consequently, certain traditional ratios and financial analysis tests are not meaningful.

Results of Operations

Through the operations of its subsidiaries, AFG is engaged primarily in property and casualty insurance, focusing on specialized commercial products for businesses, and in the sale of traditional fixed, fixed-indexed and variable-indexed annuities in the retail, financial institutions, broker-dealer and registered investment advisor and education markets.

Net earnings attributable to AFG’s shareholders for the second quarter and first sixthree months of 20182019 were $210$329 million ($2.313.63 per share, diluted) and $355 million ($3.92 per share, diluted), respectively, compared to $145 million ($1.61 per share, diluted) and $298 million ($3.321.60 per share, diluted) reported in the same periodsperiod of 2017,2018, reflecting:
higherlower earnings in the annuity segment,
lower underwriting profit in the property and casualty insurance segment,
higher net investment income in the property and casualty insurance segment, and
higher underwriting profit in the property and casualty insurance segmentrealized gains on securities in the first sixthree months of 20182019 compared to the first six months of 2017,
lower interest charges on borrowed money,
a lower corporate income tax rate,
realized losses on securities in the first sixthree months of 2018. Both the 2019 and 2018 compared to realized gains in the first six months of 2017 and higher realized gains on securities in the second quarter of 2018 compared to the second quarter of 2017. Both periods in 2018 reflect the change in the fair value of equity securities that are required to be carried at fair value through net earnings under new accounting guidance adopted on January 1, 2018, and
lower income from the sale of real estate in the first six months of 2018 compared to the first six months of 2017.2018.

CRITICAL ACCOUNTING POLICIES

Significant accounting policies are summarized in Note A — “Accounting Policiesto the financial statements. The preparation of financial statements in conformity with U.S. generally accepted accounting principles (“GAAP”) requires management to make estimates and assumptions that can have a significant effect on amounts reported in the financial statements. As more information becomes known, these estimates and assumptions change and, thus, impact amounts reported in the future. The areas where management believes the degree of judgment required to determine amounts recorded in the financial statements is most significant are as follows:
the establishment of insurance reserves, especially asbestos and environmental-related reserves,
the recoverability of reinsurance,
the recoverability of deferred acquisition costs,
the measurement of the derivatives embedded in fixed-indexed and variable-indexed annuity liabilities,
the establishment of asbestos and environmental reserves of former railroad and manufacturing operations, and
the valuation of investments, including the determination of other-than-temporary impairments.

For a discussion of these policies, see Management’s Discussion and Analysis — “Critical Accounting Policies” in AFG’s 20172018 Form 10-K.


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AMERICAN FINANCIAL GROUP, INC. 10-Q
Management’s Discussion and Analysis of Financial Condition and Results of Operations — Continued


LIQUIDITY AND CAPITAL RESOURCES

Ratios   AFG’s debt to total capital ratio on a consolidated basis is shown below (dollars in millions):
 June 30,
2018
 December 31, March 31,
2019
 December 31,
2017 20162018 2017
Principal amount of long-term debt $1,318
 $1,318
 $1,308
 $1,443
 $1,318
 $1,318
Total capital 6,211
 6,033
 5,921
 6,644
 6,218
 6,046
Ratio of debt to total capital:            
Including subordinated debt 21.2% 21.8% 22.1% 21.7% 21.2% 21.8%
Excluding subordinated debt 16.4% 16.9% 17.0% 15.3% 16.4% 16.8%


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AMERICAN FINANCIAL GROUP, INC. 10-Q
Management’s Discussion and Analysis of Financial Condition and Results of Operations — Continued


The ratio of debt to total capital is a non-GAAP measure that management believes is useful for investors, analysts and independent ratings agencies to evaluate AFG’s financial strength and liquidity and to provide insight into how AFG finances its operations. In addition, maintaining a ratio of debt, excluding subordinated debt and debt secured by real estate (if any), to total capital of 35% or lower is a financial covenant in AFG’s bank credit facility. The ratio is calculated by dividing the principal amount of AFG’s long-term debt by its total capital, which includes long-term debt, noncontrolling interests and shareholders’ equity (excluding unrealized gains (losses) onrelated to fixed maturity investments).

AFG’s ratio of earnings to fixed charges, including annuity benefits as a fixed charge, was 1.822.26 for the sixthree months ended June 30, 2018March 31, 2019 and 1.721.54 for the year ended December 31, 20172018. Excluding annuity benefits, this ratio was 10.4020.00 and 7.67,7.86, respectively. Although theThe ratio excluding annuity benefits is not required or encouraged to be disclosed under Securities and Exchange Commission rules, it is presented because interest credited to annuity policyholder accounts is not always considered a borrowing cost for an insurance company.

Condensed Consolidated Cash Flows   AFG’s principal sources of cash include insurance premiums, income from its investment portfolio and proceeds from the maturities, redemptions and sales of investments. Insurance premiums in excess of acquisition expenses and operating costs are invested until they are needed to meet policyholder obligations or made available to the parent company through dividends to cover debt obligations and corporate expenses, and to provide returns to shareholders through share repurchases and dividends. Cash flows from operating, investing and financing activities as detailed in AFG’s Consolidated Statement of Cash Flows are shown below (in millions):
Six months ended June 30,Three months ended March 31,
2018 20172019 2018
Net cash provided by operating activities$823
 $574
$454
 $391
Net cash used in investing activities(2,485) (1,994)(684) (1,656)
Net cash provided by financing activities1,134
 1,520
715
 586
Net change in cash and cash equivalents$(528) $100
$485
 $(679)

Net Cash Provided by Operating Activities   AFG’s property and casualty insurance operations typically produce positive net operating cash flows as premiums collected and investment income exceed policy acquisition costs, claims payments and operating expenses. AFG’s net cash provided by operating activities is impacted by the level and timing of property and casualty premiums, claim and expense payments and recoveries from reinsurers. AFG’s annuity operations typically produce positive net operating cash flows as investment income exceeds acquisition costs and operating expenses. Interest credited on annuity policyholder funds is a non-cash increase in AFG’s annuity benefits accumulated liability and annuity premiums, benefits and withdrawals are considered financing activities due to the deposit-type nature of annuities. Cash flows provided by operating activities also include the activity of AFG’s managed investment entities (collateralized loan obligations) other than those activities included in investing or financing activities. The changes in the assets and liabilities of the managed investment entities included in operating activities increased cash flows from operating activities by $138$16 million during the first sixthree months of 20182019 and reduced cash flows from operating activities by $72$31 million in the first sixthree months of 2017,2018, accounting for a $210$15 million increasedecline in cash flows from operating activities in the 20182019 period compared to the 20172018 period. As discussed in Note A — “Accounting PoliciesManaged Investment Entities to the financial statements, AFG has no right to use the CLO assets and no obligation to pay the CLO liabilities and such assets and liabilities are shown separately in AFG’s Balance Sheet. Excluding the impact of the managed investment entities, net cash provided by operating activities was $685$438 million in the first sixthree months of 20182019 compared to $646$360 million in the first sixthree months of 2017,2018, an increase of $39$78 million.


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AMERICAN FINANCIAL GROUP, INC. 10-Q
Management’s Discussion and Analysis of Financial Condition and Results of Operations — Continued


Net Cash Used in Investing Activities   AFG’s investing activities consist primarily of the investment of funds provided by its property and casualty and annuity businesses. Net cash used in investing activities was $2.49 billion684 million for the first sixthree months of 20182019 compared to $1.991.66 billion in the first sixthree months of 2017, an increase2018, a decrease of $491972 million. While the $229 million decrease inAs discussed below (under net cash provided by financing activities), AFG’s annuity group had net cash flows from annuity policyholders of $626 million in the first sixthree months of 2019 and $512 million in the first three months of 2018, which is the primary source of AFG’s cash used in investing activities. In addition, AFG’s cash on hand increased by $485 million during the first three months of 2019 as AFG held more cash due to fewer investment opportunities in the first quarter of 2019 compared to a decrease of cash on hand of $679 million during the first three months of 2018, as compared to the 2017 period (discussed below under netAFG invested a large portion of its cash provided by financing activities) reduced the amount of cash available for investment in the first six months of 2018 compared to the same 2017 period, this reduction was more than offset by the investment of AFG’s overall cash heldon hand at December 31, 2017 during the first six months of 2018. In addition to the investment of funds provided by the insurance operations, investing activities also include the purchase and disposal of managed investment entity investments, which are presented separately in AFG’s Balance Sheet.2017. Net investment activity in the managed investment entities was a $22618 million use of cash in the first sixthree months of 20182019 compared to a $42128 million use of cash in the 20172018 period, accounting for a $184$110 million increasedecrease in net cash used in investing activities in the first sixthree months of 20182019 compared to the same 20172018 period. See Note A — “Accounting PoliciesManaged Investment Entities and Note G — “Managed Investment Entities to the financial statements.


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AMERICAN FINANCIAL GROUP, INC. 10-Q
Management’s Discussion and Analysis of Financial Condition and Results of Operations — Continued


Net Cash Provided by Financing Activities   AFG’s financing activities consist primarily of transactions with annuity policyholders, issuances and retirements of long-term debt, repurchases of common stock and dividend payments. Net cash provided by financing activities was $1.13 billion715 million for the first sixthree months of 20182019 compared to $1.52 billion586 million in the first sixthree months of 2017, a decrease2018, an increase of $386129 million. Annuity receipts exceeded annuity surrenders, benefits, withdrawals and transfers by $1.20 billion$626 million in the first sixthree months of 2019 compared to $512 million in the first three months of 2018, compared to $1.43 billion in the first six months of 2017, accounting for a $229$114 million decreaseincrease in net cash provided by financing activities in the 20182019 period compared to the 20172018 period. In June 2017, AFG issued $350 million of 4.50% Senior Notes due 2047, the net proceeds of which contributed $345 million to net cash provided by financing activities in the first six months of 2017. Redemptions of long-term debt were a $230 million use of cash in the first six months of 2017. Financing activities also include issuances and retirements of managed investment entity liabilities, which are nonrecourse to AFG and presented separately in AFG’s Balance Sheet. IssuancesIn March 2019, AFG issued $125 million of 5.875% Subordinated Debentures due in 2059, the net proceeds of which contributed $121 million to net cash provided by financing activities in the first three months of 2019. Retirements of managed investment entity liabilities exceeded retirementsissuances by $1113 million in the first sixthree months of 20182019 compared to issuances of managed investment entity liabilities exceeding retirements by $14291 million in the first sixthree months of 2017,2018, accounting for a $3194 million decrease in net cash provided by financing activities in the 20182019 period compared to the 20172018 period. See Note A — “Accounting PoliciesManaged Investment Entities and Note G — “Managed Investment Entities to the financial statements.

Parent and Subsidiary Liquidity

Parent Holding Company Liquidity   Management believes AFG has sufficient resources to meet its liquidity requirements. If funds generated from operations, including dividends, tax payments and borrowings from subsidiaries, are insufficient to meet fixed charges in any period, AFG would be required to utilize parent company cash and marketable securities or to generate cash through borrowings, sales of other assets, or similar transactions.

AFG can borrow up to $500 million under its revolving credit facility which expires in June 2021. Amounts borrowed under this agreement bear interest at rates ranging from 1.00% to 1.875% (currently 1.375%) over LIBOR based on AFG’s credit rating. There were no borrowings under this agreement, or under any other parent company short-term borrowing arrangements, during 20172018 or the first sixthree months of 2018.2019.

In May 2018,2019, AFG paiddeclared a special cash dividend of $1.50 per share of AFG Common Stock totaling $134Stock. The dividend is payable on May 28, 2019 to shareholders of record on May 15, 2019. The aggregate amount of this special dividend will be approximately $135 million.

In 2017,March 2019, AFG issued $125 million of 5.875% Subordinated Debentures due in March 2059. The net proceeds of the offering will be used for general corporate purposes.

In 2018, AFG paid special cash dividends of $3.50$3.00 per share of AFG Common Stock ($1.50 per share in May and $2.00 per share in November) totaling approximately $308$267 million and repurchased 65,589 shares of its Common Stock for $6 million.

In June 2017, AFG issued $350 million of 4.50% Senior Notes due June 2047. Net proceeds from the offering were used to redeem AFG’s $230 million outstanding principal amount of 6-3/8% Senior Notes due June 2042, at par value in June 2017 and AFG’s $125 million outstanding principal amount of 5-3/4% Senior Notes due August 2042 at par value in August 2017.

In November 2017, AFG issued an additional $240 million of 4.50% Senior Notes due in 2047 and $125 million of 3.50% Senior Notes due in 2026. The net proceeds of the offering were used to redeem AFG’s $350 million outstanding principal amount of 9-7/8% Senior Notes due in June 2019 for $388 million (including a make-whole premium of $38 million) in December 2017.

Under a tax allocation agreement with AFG, its 80%-owned U.S. subsidiaries generally pay taxes to (or recover taxes from) AFG based on each subsidiary’s contribution to amounts due under AFG’s consolidated tax return.

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AMERICAN FINANCIAL GROUP, INC. 10-Q
Management’s Discussion and Analysis of Financial Condition and Results of Operations — Continued



Subsidiary Liquidity   Great American Life Insurance Company (“GALIC”), a wholly-owned annuity subsidiary, is a member of the Federal Home Loan Bank of Cincinnati (“FHLB”). The FHLB makes advances and provides other banking services to member institutions, which provides the annuity operations with an additional source of liquidity. At June 30, 2018March 31, 2019, GALIC had $871 million$1.1 billion in outstanding advances from the FHLB (included in annuity benefits accumulated), bearing interest at rates ranging from 0.03%0.15% to 0.22% over LIBOR (average rate of 2.25%2.67% at June 30, 2018March 31, 2019). While these advances must be repaid between 20182019 and 2021 ($40 million in 2018, $345345 million in 2019, $150$225 million in 2020 and $336$526 million in 2021), GALIC has the option to prepay all or a portion of the advances. GALIC has invested the proceeds from the advances in fixed maturity securities with similar expected lives as the advances for the purpose of earning a spread over the interest payments due to the FHLB. At June 30, 2018,March 31, 2019, GALIC estimated that it had additional borrowing capacity of approximately $300 million from the FHLB.

The liquidity requirements of AFG’s insurance subsidiaries relate primarily to the liabilities associated with their products as well as operating costs and expenses, payments of dividends and taxes to AFG and contributions of capital to their subsidiaries. Historically, cash flows from premiums and investment income have generally provided more than sufficient funds to meet these requirements. Funds received in excess of cash requirements are generally invested in additional marketable securities. In addition, the insurance subsidiaries generally hold a significant amount of highly liquid, short-term investments.


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AMERICAN FINANCIAL GROUP, INC. 10-Q
Management’s Discussion and Analysis of Financial Condition and Results of Operations — Continued


The excess cash flow of AFG’s property and casualty group allows it to extend the duration of its investment portfolio somewhat beyond that of its claim reserves.

In the annuity business, where profitability is largely dependent on earning a spread between invested assets and annuity liabilities, the duration of investments is generally maintained close to that of liabilities. In a rising interest rate environment, significant protection from withdrawals exists in the form of temporary and permanent surrender charges on AFG’s annuity products. With declining rates, AFG receives some protection (from spread compression) due to the ability to lower crediting rates, subject to contractually guaranteed minimum interest rates (“GMIRs”). AFG began selling policies with GMIRs below 2% in 2003; almost all new business since late 2010 has been issued with a 1% GMIR. At June 30, 2018,March 31, 2019, AFG could reduce the average crediting rate on approximately $27$29 billion of traditional fixed, annuities and fixed-indexed and variable-indexed annuities without guaranteed withdrawal benefits by approximately 109120 basis points (on a weighted average basis). Annuity policies are subject to GMIRs at policy issuance. The table below shows the breakdown of annuity reserves by GMIR. The current interest crediting rates on substantially all of AFG’s annuities with a GMIR of 3% or higher are at their minimum.
     % of Reserves 
     June 30, December 31, 
 GMIR   2018 2017 2016 
 1 — 1.99%   78% 76% 72% 
 2 — 2.99%   4%   5%   6% 
 3 — 3.99%   9% 10% 12% 
 4.00% and above   9%   9% 10% 
           
 Annuity benefits accumulated (in millions) $34,886 $33,316 $29,907 
     % of Reserves 
     March 31, December 31, 
 GMIR   2019 2018 2017 
 1 — 1.99%   79% 79% 76% 
 2 — 2.99%   4% 4% 5% 
 3 — 3.99%   8% 8% 10% 
 4.00% and above   9% 9% 9% 
           
 Annuity benefits accumulated (in millions) $38,006 $36,616 $33,316 

AFG believes its insurance subsidiaries maintain sufficient liquidity to pay claims and benefits and operating expenses. In addition, these subsidiaries have sufficient capital to meet commitments in the event of unforeseen events such as reserve deficiencies, inadequate premium rates or reinsurer insolvencies. Nonetheless, changes in statutory accounting rules, significant declines in the fair value of the insurance subsidiaries’ investment portfolios or significant ratings downgrades on these investments, could create a need for additional capital.

Investments   AFG’s investment portfolio at June 30, 2018March 31, 2019, includescontained $39.6543.43 billion in fixed maturity securities classified as available for sale and carried at fair value with unrealized gains and losses included in a separate component of shareholders’ equity on an after-tax basis and $137107 million in fixed maturities classified as trading with changes in unrealized holding gains orand losses included in net investment income. In addition, AFG’s investment portfolio includes $1.62$1.73 billion in equity securities carried at fair value with holding gains and losses included in realized gains (losses) on securities and $160$198 million in equity securities carried at fair value with unrealized holding gains and losses included in net investment income.

Fair values for AFG’s portfolio are determined by AFG’s internal investment professionals using data from nationally recognized pricing services as well as non-binding broker quotes. Fair values of equity securities are generally based on

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AMERICAN FINANCIAL GROUP, INC. 10-Q
Management’s Discussion and Analysis of Financial Condition and Results of Operations — Continued


published closing prices. For mortgage-backed securities (“MBS”), which comprise approximately 10% of AFG’s fixed maturities, prices for each security are generally obtained from both pricing services and broker quotes. For the remainder of AFG’s fixed maturity portfolio, approximately 73% are92% was priced using pricing services at March 31, 2019 and the balance iswas priced primarily by using non-binding broker quotes. When prices obtained for the same security vary, AFG’s internal investment professionals select the price they believe is most indicative of an exit price.

The pricing services use a variety of observable inputs to estimate fair value of fixed maturities that do not trade on a daily basis. Based upon information provided by the pricing services, these inputs include, but are not limited to, recent reported trades, benchmark yields, issuer spreads, bids or offers, reference data, and measures of volatility. Included in the pricing of MBS are estimates of the rate of future prepayments and defaults of principal over the remaining life of the underlying collateral. Due to the lack of transparency in the process that brokers use to develop prices, valuations that are based on brokers’ prices are classified as Level 3 in the GAAP hierarchy unless the price can be corroborated, for example, by comparison to similar securities priced using observable inputs.

Valuation techniques utilized by pricing services and prices obtained from external sources are reviewed by AFG’s internal investment professionals who are familiar with the securities being priced and the markets in which they trade to ensure the fair value determination is representative of an exit price. To validate the appropriateness of the prices obtained, these investment managers consider widely published indices (as benchmarks), recent trades, changes in interest rates, general economic conditions and the credit quality of the specific issuers. In addition, AFG communicates directly with pricing services regarding the methods and assumptions used in pricing, including verifying, on a test basis, the inputs used by the services to value specific securities.

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AMERICAN FINANCIAL GROUP, INC. 10-Q
Management’s Discussion and Analysis of Financial Condition and Results of Operations — Continued



In general, the fair value of AFG’s fixed maturity investments is inversely correlated to changes in interest rates. The following table demonstrates the sensitivity of such fair values to reasonably likely changes in interest rates by illustrating the estimated effect on AFG’s fixed maturity portfolio and accumulated other comprehensive income that an immediate increase of 100 basis points in the interest rate yield curve would have at June 30, 2018March 31, 2019 (dollars in millions). Effects of increases or decreases from the 100 basis points illustrated would be approximately proportional.

Fair value of fixed maturity portfolio$39,785
$43,538
Percentage impact on fair value of 100 bps increase in interest rates(4.5%)(4.5%)
Pretax impact on fair value of fixed maturity portfolio$(1,790)$(1,959)
Offsetting adjustments to deferred policy acquisition costs and other balance sheet amounts750
800
Estimated pretax impact on accumulated other comprehensive income(1,040)(1,159)
Deferred income tax218
243
Estimated after-tax impact on accumulated other comprehensive income$(822)$(916)

Approximately 90%91% of the fixed maturities held by AFG at June 30, 2018March 31, 2019, were rated “investment grade” (credit rating of AAA to BBB) by nationally recognized rating agencies. Investment grade securities generally bear lower yields and lower degrees of risk than those that are unrated and non-investment grade. Management believes that the high quality investment portfolio should generate a stable and predictable investment return.

MBS 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 lower rates. Although interest rates have been low in recent years, tighter lending standards have resulted in fewer buyers being able to refinance the mortgages underlying much of AFG’s non-agency residential MBS portfolio.


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AMERICAN FINANCIAL GROUP, INC. 10-Q
Management’s Discussion and Analysis of Financial Condition and Results of Operations — Continued


Summarized information for AFG’s MBS (including those classified as trading) at June 30, 2018March 31, 2019, is shown in the table below (dollars in millions). Agency-backed securities are those issued by a U.S. government-backed agency; Alt-A mortgages are those with risk profiles between prime and subprime. The average life of the residential and commercial MBS is approximately 4-1/24.5 years and 54 years, respectively.
 
Amortized
Cost
 Fair Value 
Fair Value as
% of Cost
 
Unrealized
Gain (Loss)
 
% Rated
Investment
Grade
 
Amortized
Cost
 Fair Value 
Fair Value as
% of Cost
 
Unrealized
Gain (Loss)
 
% Rated
Investment
Grade
Collateral type                    
Residential:                    
Agency-backed $189
 $185
 98% $(4) 100% $163
 $163
 100% $
 100%
Non-agency prime 1,076
 1,231
 114% 155
 28% 960
 1,089
 113% 129
 27%
Alt-A 891
 1,015
 114% 124
 14% 1,005
 1,118
 111% 113
 35%
Subprime 410
 457
 111% 47
 28% 351
 388
 111% 37
 27%
Commercial 920
 934
 102% 14
 94% 900
 924
 103% 24
 95%
 $3,486
 $3,822
 110% $336
 44% $3,379
 $3,682
 109% $303
 50%

The National Association of Insurance Commissioners (“NAIC”) assigns creditworthiness designations on a scale of 1 to 6 with 1 being the highest quality and 6 being the lowest quality. The NAIC retains third-party investment management firms to assist in the determination of appropriate NAIC designations for MBS based not only on the probability of loss (which is the primary basis of ratings by the major ratings firms), but also on the severity of loss and statutory carrying value. At June 30, 2018March 31, 2019, 97%96% (based on statutory carrying value of $3.44$3.32 billion) of AFG’s MBS had an NAIC designation of 1.

Municipal bonds represented approximately 17%16% of AFG’s fixed maturity portfolio at June 30, 2018March 31, 2019. AFG’s municipal bond portfolio is high quality, with 99% of the securities rated investment grade at that date. The portfolio is well diversified across the states of issuance and individual issuers. At June 30, 2018March 31, 2019, approximately 77%78% of the municipal bond portfolio was held in revenue bonds, with the remaining 23%22% held in general obligation bonds. AFG does not own general obligation bonds issued by Puerto Rico.

Summarized information for the unrealized gains and losses recorded in AFG’s Balance Sheet at June 30, 2018, is shown in the following table (dollars in millions). Approximately $607 million of available for sale fixed maturity securities had no unrealized gains or losses at June 30, 2018.
 
Securities
With
Unrealized
Gains
 
Securities
With
Unrealized
Losses
Available for Sale Fixed Maturities   
Fair value of securities$20,606
 $18,435
Amortized cost of securities$19,764
 $18,873
Gross unrealized gain (loss)$842
 $(438)
Fair value as % of amortized cost104% 98%
Number of security positions3,212
 2,043
Number individually exceeding $2 million gain or loss53
 6
Concentration of gains (losses) by type or industry (exceeding 5% of unrealized):   
Mortgage-backed securities$347
 $(11)
States and municipalities162
 (53)
Asset-backed securities132
 (46)
Banks, savings and credit institutions43
 (87)
Manufacturing32
 (53)
Insurance companies20
 (40)
Percentage rated investment grade86% 96%


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AMERICAN FINANCIAL GROUP, INC. 10-Q
Management’s Discussion and Analysis of Financial Condition and Results of Operations — Continued


Summarized information for the unrealized gains and losses recorded in AFG’s Balance Sheet at March 31, 2019, is shown in the following table (dollars in millions). Approximately $624 million of available for sale fixed maturity securities had no unrealized gains or losses at March 31, 2019.
 
Securities
With
Unrealized
Gains
 
Securities
With
Unrealized
Losses
Available for Sale Fixed Maturities   
Fair value of securities$31,529
 $11,278
Amortized cost of securities$30,327
 $11,467
Gross unrealized gain (loss)$1,202
 $(189)
Fair value as % of amortized cost104% 98%
Number of security positions4,075
 1,274
Number individually exceeding $2 million gain or loss64
 6
Concentration of gains (losses) by type or industry (exceeding 5% of unrealized):   
Mortgage-backed securities$311
 $(8)
States and municipalities253
 (20)
Asset-backed securities163
 (54)
Banks, savings and credit institutions98
 (22)
Manufacturing89
 (21)
Insurance companies51
 (11)
Percentage rated investment grade91% 93%

The table below sets forth the scheduled maturities of AFG’s available for sale fixed maturity securities at June 30, 2018March 31, 2019, based on their fair values. Securities with sinking funds are reported at average maturity. Actual maturities may differ from contractual maturities because certain securities may be called or prepaid by the issuers. 
Securities
With
Unrealized
Gains
 
Securities
With
Unrealized
Losses
Securities
With
Unrealized
Gains
 
Securities
With
Unrealized
Losses
Maturity      
One year or less4% 1%4% 3%
After one year through five years22% 17%22% 17%
After five years through ten years24% 45%35% 30%
After ten years12% 13%12% 7%
62% 76%73% 57%
Asset-backed securities (average life of approximately 4-1/2 years)22% 22%
Mortgage-backed securities (average life of approximately 4-1/2 years)16% 2%
Asset-backed securities (average life of approximately 4.5 years)17% 39%
Mortgage-backed securities (average life of approximately 4.5 years)10% 4%
100% 100%100% 100%


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AMERICAN FINANCIAL GROUP, INC. 10-Q
Management’s Discussion and Analysis of Financial Condition and Results of Operations — Continued


The table below (dollars in millions) summarizes the unrealized gains and losses on fixed maturity securities by dollar amount:
  
Aggregate
Fair
Value
 
Aggregate
Unrealized
Gain (Loss)
 
Fair
Value as
% of Cost
Fixed Maturities at June 30, 2018      
Securities with unrealized gains:      
Exceeding $500,000 (457 securities) $5,797
 $534
 110%
$500,000 or less (2,755 securities) 14,809
 308
 102%
  $20,606
 $842
 104%
Securities with unrealized losses:      
Exceeding $500,000 (235 securities) $4,529
 $(213) 96%
$500,000 or less (1,808 securities) 13,906
 (225) 98%
  $18,435
 $(438) 98%
  
Aggregate
Fair
Value
 
Aggregate
Unrealized
Gain (Loss)
 
Fair
Value as
% of Cost
Fixed Maturities at March 31, 2019      
Securities with unrealized gains:      
Exceeding $500,000 (685 securities) $10,978
 $749
 107%
$500,000 or less (3,390 securities) 20,551
 453
 102%
  $31,529
 $1,202
 104%
Securities with unrealized losses:      
Exceeding $500,000 (75 securities) $1,435
 $(80) 95%
$500,000 or less (1,199 securities) 9,843
 (109) 99%
  $11,278
 $(189) 98%

The following table (dollars in millions) summarizes the unrealized losses for all securities with unrealized losses by issuer quality and the length of time those securities have been in an unrealized loss position: 
  
Aggregate
Fair
Value
 
Aggregate
Unrealized
Loss
 
Fair
Value as
% of Cost
Securities with Unrealized Losses at June 30, 2018      
Investment grade fixed maturities with losses for:      
Less than one year (1,649 securities) $16,260
 $(344) 98%
One year or longer (249 securities) 1,353
 (63) 96%
  $17,613
 $(407) 98%
Non-investment grade fixed maturities with losses for:      
Less than one year (95 securities) $608
 $(16) 97%
One year or longer (50 securities) 214
 (15) 93%
  $822
 $(31) 96%
  
Aggregate
Fair
Value
 
Aggregate
Unrealized
Loss
 
Fair
Value as
% of Cost
Securities with Unrealized Losses at March 31, 2019      
Investment grade fixed maturities with losses for:      
Less than one year (388 securities) $4,758
 $(49) 99%
One year or longer (740 securities) 5,711
 (113) 98%
  $10,469
 $(162) 98%
Non-investment grade fixed maturities with losses for:      
Less than one year (85 securities) $450
 $(7) 98%
One year or longer (61 securities) 359
 (20) 95%
  $809
 $(27) 97%

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 by the amount of the charge. The determination of whether unrealized losses are other-than-temporary requires judgment based on subjective as well as objective factors as detailed in AFG’s 20172018 Form 10-K under Management’s Discussion and Analysis — “Investments.”


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Table of Contents
AMERICAN FINANCIAL GROUP, INC. 10-Q
Management’s Discussion and Analysis of Financial Condition and Results of Operations — Continued


Based on its analysis, management believes AFG will recover its cost basis in the fixed maturity securities with unrealized losses and that AFG has the ability to hold the securities until they recover in value and had no intent to sell them at June 30, 2018March 31, 2019. Although AFG has the ability to continue holding its fixed maturity investments with unrealized losses, its intent to hold them may change due to deterioration in the issuers’ creditworthiness, decisions to lessen exposure to a particular issuer or industry, asset/liability management decisions, market movements, changes in views about appropriate asset allocation or the desire to offset taxable realized gains. Should AFG’s ability or intent change with regard to a particular security, a charge for impairment would likely be required. While it is not possible to accurately predict if or when a specific security will become impaired, charges for other-than-temporary impairment could be material to results of operations in future periods. Significant declines in the fair value of AFG’s investment portfolio could have a significant adverse effect on AFG’s liquidity. For information on AFG’s realized gains (losses) on securities, including charges for other-than-temporary impairment, see “Results of Operations — Consolidated Realized Gains (Losses) on Securities.”

Uncertainties   Management believes that the areas posing the greatest risk of material loss are the adequacy of its insurance reserves and contingencies arising out of its former railroad and manufacturing operations. See Management’s Discussion and Analysis — “Uncertainties — Asbestos and Environmental-related (“A&E”) Insurance Reserves” in AFG’s 20172018 Form 10-K. In addition to its ongoing internal monitoring of asbestos and environmental exposures, AFG has periodically conducted comprehensive external studies of its asbestos and environmental reserves relating to the run-off operations of its property and casualty insurance segment and exposures related to its former railroad and manufacturing operations with the aid of specialty actuarial, engineering and consulting firms and outside counsel, generally every two years, with an in-depth internal review during the intervening years. AFG has scheduled its 2018 internal review of these liabilities to be completed in the third quarter of 2018.


38

Table of Contents
AMERICAN FINANCIAL GROUP, INC. 10-Q
Management’s Discussion and Analysis of Financial Condition and Results of Operations — Continued


MANAGED INVESTMENT ENTITIES

Accounting standards require AFG to consolidate its investments in collateralized loan obligation (“CLO”) entities that it manages and owns an interest in (in the form of debt). See Note AAccounting Policies Managed Investment Entities and Note G — “Managed Investment Entities to the financial statements. The effect of consolidating these entities is shown in the tables below (in millions). The “Before CLO Consolidation” columns include AFG’s investment and earnings in the CLOs on an unconsolidated basis.

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AMERICAN FINANCIAL GROUP, INC. 10-Q
Management’s Discussion and Analysis of Financial Condition and Results of Operations — Continued


CONDENSED CONSOLIDATING BALANCE SHEET
Before CLO
Consolidation
 
Managed
Investment
Entities
 
Consol.
Entries
 
Consolidated
As Reported
Before CLO
Consolidation
 
Managed
Investment
Entities
 
Consol.
Entries
 
Consolidated
As Reported
June 30, 2018       
March 31, 2019       
Assets:              
Cash and investments$46,970
 $
 $(191) (a) $46,779
$51,232
 $
 $(192) (a) $51,040
Assets of managed investment entities
 5,032
 
 5,032

 4,786
 
 4,786
Other assets10,024
 
 (1) (a) 10,023
10,307
 
 (1) (a) 10,306
Total assets$56,994
 $5,032
 $(192) $61,834
$61,539
 $4,786
 $(193) $66,132
Liabilities:              
Unpaid losses and loss adjustment expenses and unearned premiums$11,632
 $
 $
 $11,632
$12,228
 $
 $
 $12,228
Annuity, life, accident and health benefits and reserves35,533
 
 
 35,533
38,638
 
 
 38,638
Liabilities of managed investment entities
 5,032
 (192) (a) 4,840

 4,786
 (193) (a) 4,593
Long-term debt and other liabilities4,745
 
 
 4,745
5,008
 
 
 5,008
Total liabilities51,910
 5,032
 (192) 56,750
55,874
 4,786
 (193) 60,467
              
Redeemable noncontrolling interests
 
 
 

 
 
 
              
Shareholders’ equity:              
Common Stock and Capital surplus1,309
 
 
 1,309
1,346
 
 
 1,346
Retained earnings3,628
 
 
 3,628
3,875
 
 
 3,875
Accumulated other comprehensive income, net of tax147
 
 
 147
444
 
 
 444
Total shareholders’ equity5,084
 
 
 5,084
5,665
 
 
 5,665
Noncontrolling interests
 
 
 

 
 
 
Total equity5,084
 
 
 5,084
5,665
 
 
 5,665
Total liabilities and equity$56,994
 $5,032
 $(192) $61,834
$61,539
 $4,786
 $(193) $66,132
              
December 31, 2017       
December 31, 2018       
Assets:              
Cash and investments$46,262
 $
 $(214) (a) $46,048
$48,685
 $
 $(187) (a) $48,498
Assets of managed investment entities
 4,902
 
 4,902

 4,700
 
 4,700
Other assets9,709
 
 (1) (a) 9,708
10,259
 
 (1) (a) 10,258
Total assets$55,971
 $4,902
 $(215) $60,658
$58,944
 $4,700
 $(188) $63,456
Liabilities:              
Unpaid losses and loss adjustment expenses and unearned premiums$12,088
 $
 $
 $12,088
$12,336
 $
 $
 $12,336
Annuity, life, accident and health benefits and reserves33,974
 
 
 33,974
37,251
 
 
 37,251
Liabilities of managed investment entities
 4,902
 (215) (a) 4,687

 4,700
 (188) (a) 4,512
Long-term debt and other liabilities4,575
 
 
 4,575
4,385
 
 
 4,385
Total liabilities50,637
 4,902
 (215) 55,324
53,972
 4,700
 (188) 58,484
              
Redeemable noncontrolling interests3
 
 
 3

 
 
 
              
Shareholders’ equity:              
Common Stock and Capital surplus1,269
 
 
 1,269
1,334
 
 
 1,334
Retained earnings3,248
 
 
 3,248
3,588
 
 
 3,588
Accumulated other comprehensive income, net of tax813
 
 
 813
48
 
 
 48
Total shareholders’ equity5,330
 
 
 5,330
4,970
 
 
 4,970
Noncontrolling interests1
 
 
 1
2
 
 
 2
Total equity5,331
 
 
 5,331
4,972
 
 
 4,972
Total liabilities and equity$55,971
 $4,902
 $(215) $60,658
$58,944
 $4,700
 $(188) $63,456

(a)Elimination of the fair value of AFG’s investment in CLOs and related accrued interest.

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AMERICAN FINANCIAL GROUP, INC. 10-Q
Management’s Discussion and Analysis of Financial Condition and Results of Operations — Continued


CONDENSED CONSOLIDATING STATEMENT OF EARNINGS
Before CLO
Consolidation (a)
 
Managed
Investment
Entities
 
Consol.
Entries
 
Consolidated
As Reported
Before CLO
Consolidation (a)
 
Managed
Investment
Entities
 
Consol.
Entries
 
Consolidated
As Reported
Three months ended June 30, 2018       
Three months ended March 31, 2019       
Revenues:              
Insurance net earned premiums$1,167
 $
 $
 $1,167
$1,179
 $
 $
 $1,179
Net investment income534
 
 (4) (b) 530
553
 
 (11) (b) 542
Realized gains on securities31
 
 
 31
184
 
 
 184
Income (loss) of managed investment entities:              
Investment income
 64
 
 64

 69
 
 69
Gain (loss) on change in fair value of assets/liabilities
 
 (2) (b) (2)
 (5) 5
 (b) 
Other income47
 
 (4) (c) 43
53
 
 (3) (c) 50
Total revenues1,779
 64
 (10) 1,833
1,969
 64
 (9) 2,024
Costs and Expenses:              
Insurance benefits and expenses1,414
 
 
 1,414
1,439
 
 
 1,439
Expenses of managed investment entities
 64
 (10) (b)(c)  54

 64
 (9) (b)(c) 55
Interest charges on borrowed money and other expenses105
 
 
 105
117
 
 
 117
Total costs and expenses1,519
 64
 (10) 1,573
1,556
 64
 (9) 1,611
Earnings before income taxes260
 
 
 260
413
 
 
 413
Provision for income taxes52
 
 
 52
87
 
 
 87
Net earnings, including noncontrolling interests208
 
 
 208
326
 
 
 326
Less: Net earnings (loss) attributable to noncontrolling interests(2) 
 
 (2)
Less: Net earnings (losses) attributable to noncontrolling interests(3) 
 
 (3)
Net earnings attributable to shareholders$210
 $
 $
 $210
$329
 $
 $
 $329
              
Three months ended June 30, 2017       
Three months ended March 31, 2018       
Revenues:              
Insurance net earned premiums$1,070
 $
 $
 $1,070
$1,113
 $
 $
 $1,113
Net investment income465
 
 (5) (b) 460
498
 
 (3) (b) 495
Realized gains on securities8
 
 
 8
Realized losses on securities(93) 
 
 (93)
Income (loss) of managed investment entities:              
Investment income
 50
 
 50

 58
 
 58
Gain (loss) on change in fair value of assets/liabilities
 21
 (10) (b) 11

 (1) (2) (b) (3)
Other income52
 
 (5) (c) 47
53
 
 (4) (c) 49
Total revenues1,595
 71
 (20) 1,646
1,571
 57
 (9) 1,619
Costs and Expenses:              
Insurance benefits and expenses1,279
 
 
 1,279
1,297
 
 
 1,297
Expenses of managed investment entities
 71
 (20) (b)(c)  51

 57
 (9) (b)(c) 48
Interest charges on borrowed money and other expenses111
 
 
 111
100
 
 
 100
Total costs and expenses1,390
 71
 (20) 1,441
1,397
 57
 (9) 1,445
Earnings before income taxes205
 
 
 205
174
 
 
 174
Provision for income taxes60
 
 
 60
33
 
 
 33
Net earnings, including noncontrolling interests145
 
 
 145
141
 
 
 141
Less: Net earnings (loss) attributable to noncontrolling interests
 
 
 
Less: Net earnings (losses) attributable to noncontrolling interests(4) 
 
 (4)
Net earnings attributable to shareholders$145
 $
 $
 $145
$145
 $
 $
 $145

(a)Includes income of $4$11 million and $5$3 million in the second quarterfirst three months of 20182019 and 2017,2018, respectively, representing the change in fair value of AFG’s CLO investments plus $4$3 million and $5$4 million in the second quarterfirst three months of 20182019 and 2017,2018, respectively, in CLO management fees earned.
(b)Elimination of the change in fair value of AFG’s investments in the CLOs, including $6 million and $15 million in the second quarter of 2018 and 2017, respectively, in distributions recorded as interest expense by the CLOs.
(c)Elimination of management fees earned by AFG.


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Table of Contents
AMERICAN FINANCIAL GROUP, INC. 10-Q
Management’s Discussion and Analysis of Financial Condition and Results of Operations — Continued


CONDENSED CONSOLIDATING STATEMENT OF EARNINGS
 
Before CLO
Consolidation (a)
 
Managed
Investment
Entities
 
Consol.
Entries
   
Consolidated
As Reported
Six months ended June 30, 2018         
Revenues:         
Insurance net earned premiums$2,280
 $
 $
   $2,280
Net investment income1,032
 
 (7) (b) 1,025
Realized losses on securities(62) 
 
   (62)
Income (loss) of managed investment entities:         
Investment income
 122
 
   122
Gain (loss) on change in fair value of assets/liabilities
 (1) (4) (b) (5)
Other income100
 
 (8) (c) 92
Total revenues3,350
 121
 (19)   3,452
Costs and Expenses:         
Insurance benefits and expenses2,711
 
 
   2,711
Expenses of managed investment entities
 121
 (19) (b)(c) 102
Interest charges on borrowed money and other expenses205
 
 
   205
Total costs and expenses2,916
 121
 (19)   3,018
Earnings before income taxes434
 
 
   434
Provision for income taxes85
 
 
   85
Net earnings, including noncontrolling interests349
 
 
   349
Less: Net earnings (loss) attributable to noncontrolling interests(6) 
 
   (6)
Net earnings attributable to shareholders$355
 $
 $
   $355
          
Six months ended June 30, 2017         
Revenues:         
Insurance net earned premiums$2,098
 $
 $
   $2,098
Net investment income906
 
 (11) (b) 895
Realized gains on securities11
 
 
   11
Income (loss) of managed investment entities:         
Investment income
 101
 
   101
Gain (loss) on change in fair value of assets/liabilities
 21
 (10) (b) 11
Other income115
 
 (9) (c) 106
Total revenues3,130
 122
 (30)   3,222
Costs and Expenses:         
Insurance benefits and expenses2,485
 
 
   2,485
Expenses of managed investment entities
 122
 (30) (b)(c) 92
Interest charges on borrowed money and other expenses217
 
 
   217
Total costs and expenses2,702
 122
 (30)   2,794
Earnings before income taxes428
 
 
   428
Provision for income taxes128
 
 
   128
Net earnings, including noncontrolling interests300
 
 
   300
Less: Net earnings (loss) attributable to noncontrolling interests2
 
 
   2
Net earnings attributable to shareholders$298
 $
 $
   $298

(a)Includes income of $7 million and $11$5 million in the first sixthree months of 20182019 and 2017, respectively, representing the change in fair value of AFG’s CLO investments plus $8 million and $9 million in the first six months of 2018, and 2017, respectively, in CLO management fees earned.
(b)Elimination of the change in fair value of AFG’s investments in the CLOs, including $11 million and $21 million in the first six months of 2018 and 2017, respectively, in distributions recorded as interest expense by the CLOs.
(c)Elimination of management fees earned by AFG.



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AMERICAN FINANCIAL GROUP, INC. 10-Q
Management’s Discussion and Analysis of Financial Condition and Results of Operations — Continued


RESULTS OF OPERATIONS

General   AFG’s net earnings attributable to shareholders, determined in accordance with GAAP, include certain items that may not be indicative of its ongoing core operations. For example, core net operating earnings excludes realized gains (losses) on securities because such gains and losses are influenced significantly by financial markets, interest rates and the timing of sales. Similarly, significant gains and losses from the sale of real estate are excluded from core earnings as they are influenced by the timing of sales and realized gains (losses) onand significant tax benefits (charges) related to subsidiaries are excluded because such gains and losses are largely the result of the changing business strategy and market opportunities. In addition, special charges related to coverage that AFG no longer writes, such as for asbestos and environmental exposures are excluded from core earnings. The following table (in millions, except per share amounts) identifies non-core items and reconciles net earnings attributable to shareholders to core net operating earnings, a non-GAAP financial measure. AFG believes core net operating earnings is a useful tool for investors and analysts in analyzing ongoing operating trends and for management to evaluate financial performance against historical results because it believes this provides a more comparable measure of its continuing business.
 Three months ended June 30, Six months ended June 30,
2018 2017 2018 2017
Components of net earnings attributable to shareholders:       
Core operating earnings before income taxes$229
 $204
 $496
 $424
Pretax non-core items:       
Realized gains (losses) on securities31
 8
 (62) 11
Loss on retirement of debt
 (7) 
 (7)
Earnings before income taxes260
 205
 434
 428
Provision (credit) for income taxes:       
Core operating earnings46
 59
 98
 126
Non-core items6
 1
 (13) 2
Total provision for income taxes52
 60
 85
 128
Net earnings, including noncontrolling interests208
 145
 349
 300
Less net earnings (losses) attributable to noncontrolling interests:       
Core operating earnings (losses)(2) 
 (6) 2
Non-core items
 
 
 
Total net earnings (losses) attributable to noncontrolling interests(2) 
 (6) 2
Net earnings attributable to shareholders$210
 $145
 $355
 $298
        
Net earnings:       
Core net operating earnings$185
 $145
 $404
 $296
Non-core items25
 
 (49) 2
Net earnings attributable to shareholders$210
 $145
 $355
 $298
        
Diluted per share amounts:       
Core net operating earnings$2.04
 $1.61
 $4.46
 $3.29
Realized gains (losses) on securities0.27
 0.05
 (0.54) 0.08
Loss on retirement of debt
 (0.05) 
 (0.05)
Net earnings attributable to shareholders$2.31
 $1.61
 $3.92
 $3.32

Net earnings attributable to shareholders increased $65 million in the second quarter of 2018 compared to the same period in 2017 due to higher core net operating earnings, higher net realized gains on securities in the 2018 period compared to the 2017 period and a loss on retirement of debt in the second quarter of 2017. Core net operating earnings increased $40 million in the second quarter of 2018 compared to the same period in 2017, reflecting higher earnings in the annuity segment, higher net investment income in the property and casualty segment, lower interest charges on borrowed money and a lower corporate income tax rate. Realized gains on securities in the second quarter of 2018 includes the increase in fair value of equity securities that are required to be carried at fair value through net earnings under new accounting guidance adopted on January 1, 2018.


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AMERICAN FINANCIAL GROUP, INC. 10-Q
Management’s Discussion and Analysis of Financial Condition and Results of Operations — Continued

 Three months ended March 31,
2019 2018
Components of net earnings attributable to shareholders:   
Core operating earnings before income taxes$229
 $267
Pretax non-core item:   
Realized gains (losses) on securities184
 (93)
Earnings before income taxes413
 174
Provision (credit) for income taxes:   
Core operating earnings48
 52
Non-core item:   
Realized gains (losses) on securities39
 (19)
Total provision for income taxes87
 33
Net earnings, including noncontrolling interests326
 141
Less net earnings (losses) attributable to noncontrolling interests:   
Core operating earnings(3) (4)
Total net earnings (losses) attributable to noncontrolling interests(3) (4)
Net earnings attributable to shareholders$329
 $145
    
Net earnings:   
Core net operating earnings$184
 $219
Realized gains (losses) on securities145
 (74)
Net earnings attributable to shareholders$329
 $145
    
Diluted per share amounts:   
Core net operating earnings$2.02
 $2.42
Realized gains (losses) on securities1.61
 (0.82)
Net earnings attributable to shareholders$3.63
 $1.60

Net earnings attributable to shareholders increased $57$184 million in the first sixthree months of 20182019 compared to the same period in 20172018 due primarily to higher core net operating earnings in the 2018 period and a loss on retirement of debt in the 2017 period, partially offset by net realized losses on securities in the 2018 period compared to net realized gains on securities in the 2017 period.2019 period compared to net realized losses in the 2018 period, partially offset by lower core net operating earnings. Core net operating earnings increased $108decreased $35 million in the first sixthree months of 20182019 compared to the same period in 2017,2018, reflecting higherlower earnings in the annuity segment, higher underwriting profit and net investment income indue primarily to the property and casualty insurance segment,unfavorable impact of significantly lower than anticipated interest chargesrates on borrowed money and a lower corporate income tax rate.the fair value of derivatives related to fixed-indexed annuities. Realized lossesgains (losses) on securities in the first sixthree months of 2019 and 2018 includesresulted primarily from the declinechange in fair value of equity securities that are required to be carriedwere still held at fair value through net earnings under new accounting guidance adopted on January 1, 2018.the balance sheet date.


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AMERICAN FINANCIAL GROUP, INC. 10-Q
Management’s Discussion and Analysis of Financial Condition and Results of Operations — Continued


RESULTS OF OPERATIONS — QUARTERSTHREE MONTHS ENDED JUNE 30,MARCH 31, 2019 AND 2018 AND 2017

Segmented Statement of Earnings   AFG reports its business as three segments: (i) Property and casualty insurance (“P&C”), (ii) Annuity and (iii) Other, which includes run-off long-term care and life, holding company costs and income and expenses related to the managed investment entities (“MIEs”).

Effective January 1, 2018, the results of AFG’s run-off long-term care and life businesses are included in the “Other” segment instead of as a separate reportable segment based on the immaterial size of the remaining operations. Prior periods amounts were reclassified for consistent presentation.

AFG’s net earnings attributable to shareholders, determined in accordance with GAAP, include certain items that may not be indicative of its ongoing core operations. The following tables for the three months ended June 30, 2018March 31, 2019 and 20172018 identify such items by segment and reconcile net earnings attributable to shareholders to core net operating earnings, a non-GAAP financial measure that AFG believes is a useful tool for investors and analysts in analyzing ongoing operating trends (in millions):
    Other          Other      
P&C Annuity Consol. MIEs Holding Co., other and unallocated Total Non-core reclass GAAP TotalP&C Annuity Consol. MIEs Holding Co., other and unallocated Total Non-core reclass GAAP Total
Three months ended June 30, 2018             
Three months ended March 31, 2019             
Revenues:                          
Property and casualty insurance net earned premiums$1,161
 $
 $
 $
 $1,161
 $
 $1,161
$1,173
 $
 $
 $
 $1,173
 $
 $1,173
Life, accident and health net earned premiums
 
 
 6
 6
 
 6

 
 
 6
 6
 
 6
Net investment income115
 412
 (4) 7
 530
 
 530
104
 435
 (11) 14
 542
 
 542
Realized gains on securities
 
 
 
 
 31
 31

 
 
 
 
 184
 184
Income (loss) of MIEs:                          
Investment income
 
 64
 
 64
 
 64

 
 69
 
 69
 
 69
Gain (loss) on change in fair value of assets/liabilities
 
 (2) 
 (2) 
 (2)
 
 
 
 
 
 
Other income2
 27
 (4) 18
 43
 
 43
3
 27
 (3) 23
 50
 
 50
Total revenues1,278
 439
 54
 31
 1,802
 31
 1,833
1,280
 462
 55
 43
 1,840
 184
 2,024
                          
Costs and Expenses:                          
Property and casualty insurance:                          
Losses and loss adjustment expenses693
 
 
 
 693
 
 693
692
 
 
 
 692
 
 692
Commissions and other underwriting expenses396
 
 
 4
 400
 
 400
394
 
 
 5
 399
 
 399
Annuity benefits
 260
 
 
 260
 
 260

 311
 
 
 311
 
 311
Life, accident and health benefits
 
 
 11
 11
 
 11

 
 
 9
 9
 
 9
Annuity and supplemental insurance acquisition expenses
 49
 
 1
 50
 
 50

 26
 
 2
 28
 
 28
Interest charges on borrowed money
 
 
 16
 16
 
 16

 
 
 16
 16
 
 16
Expenses of MIEs
 
 54
 
 54
 
 54

 
 55
 
 55
 
 55
Other expenses11
 31
 
 47
 89
 
 89
12
 35
 
 54
 101
 
 101
Total costs and expenses1,100
 340
 54
 79
 1,573
 
 1,573
1,098
 372
 55
 86
 1,611
 
 1,611
Earnings before income taxes178
 99
 
 (48) 229
 31
 260
182
 90
 
 (43) 229
 184
 413
Provision for income taxes37
 21
 
 (12) 46
 6
 52
37
 19
 
 (8) 48
 39
 87
Net earnings, including noncontrolling interests141
 78
 
 (36) 183
 25
 208
145
 71
 
 (35) 181
 145
 326
Less: Net earnings (loss) attributable to noncontrolling interests(2) 
 
 
 (2) 
 (2)
Less: Net earnings (losses) attributable to noncontrolling interests(3) 
 
 
 (3) 
 (3)
Core Net Operating Earnings143
 78
 
 (36) 185
    148
 71
 
 (35) 184
    
Non-core earnings attributable to shareholders (a):                          
Realized gains on securities, net of tax
 
 
 25
 25
 (25) 

 
 
 145
 145
 (145) 
Net Earnings Attributable to Shareholders$143
 $78
 $
 $(11) $210
 $
 $210
$148
 $71
 $
 $110
 $329
 $
 $329

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AMERICAN FINANCIAL GROUP, INC. 10-Q
Management’s Discussion and Analysis of Financial Condition and Results of Operations — Continued


 Other       Other      
P&C Annuity Consol. MIEs Holding Co., other and unallocated Total Non-core reclass GAAP TotalP&C Annuity Consol. MIEs Holding Co., other and unallocated Total Non-core reclass GAAP Total
Three months ended June 30, 2017             
Three months ended March 31, 2018             
Revenues:                          
Property and casualty insurance net earned premiums$1,065
 $
 $
 $
 $1,065
 $
 $1,065
$1,107
 $
 $
 $
 $1,107
 $
 $1,107
Life, accident and health net earned premiums
 
 
 5
 5
 
 5

 
 
 6
 6
 
 6
Net investment income96
 360
 (5) 9
 460
 
 460
100
 394
 (3) 4
 495
 
 495
Realized gains on securities
 
 
 
 
 8
 8
Realized losses on securities
 
 
 
 
 (93) (93)
Income (loss) of MIEs:                          
Investment income
 
 50
 
 50
 
 50

 
 58
 
 58
 
 58
Gain (loss) on change in fair value of assets/liabilities
 
 11
 
 11
 
 11

 
 (3) 
 (3) 
 (3)
Other income4
 26
 (5) 22
 47
 
 47
2
 26
 (4) 25
 49
 
 49
Total revenues1,165
 386
 51
 36
 1,638
 8
 1,646
1,209
 420
 48
 35
 1,712
 (93) 1,619
                          
Costs and Expenses:                          
Property and casualty insurance:                          
Losses and loss adjustment expenses635
 
 
 
 635
 
 635
641
 
 
 
 641
 
 641
Commissions and other underwriting expenses358
 
 
 8
 366
 
 366
375
 
 
 6
 381
 
 381
Annuity benefits
 224
 
 
 224
 
 224

 182
 
 
 182
 
 182
Life, accident and health benefits
 
 
 6
 6
 
 6

 
 
 11
 11
 
 11
Annuity and supplemental insurance acquisition expenses
 47
 
 1
 48
 
 48

 81
 
 1
 82
 
 82
Interest charges on borrowed money
 
 
 23
 23
 
 23

 
 
 15
 15
 
 15
Expenses of MIEs
 
 51
 
 51
 
 51

 
 48
 
 48
 
 48
Other expenses9
 30
 
 42
 81
 7
 88
9
 32
 
 44
 85
 
 85
Total costs and expenses1,002
 301
 51
 80
 1,434
 7
 1,441
1,025
 295
 48
 77
 1,445
 
 1,445
Earnings before income taxes163
 85
 
 (44) 204
 1
 205
184
 125
 
 (42) 267
 (93) 174
Provision for income taxes52
 30
 
 (23) 59
 1
 60
37
 25
 
 (10) 52
 (19) 33
Net earnings, including noncontrolling interests111
 55
 
 (21) 145
 
 145
147
 100
 
 (32) 215
 (74) 141
Less: Net earnings attributable to noncontrolling interests
 
 
 
 
 
 
Less: Net earnings (losses) attributable to noncontrolling interests(4) 
 
 
 (4) 
 (4)
Core Net Operating Earnings111
 55
 
 (21) 145
    151
 100
 
 (32) 219
    
Non-core earnings attributable to shareholders (a):                          
Realized gains on securities, net of tax
 
 
 5
 5
 (5) 
Loss on retirement of debt, net of tax
 
 
 (5) (5) 5
 
Realized losses on securities, net of tax
 
 
 (74) (74) 74
 
Net Earnings Attributable to Shareholders$111
 $55
 $
 $(21) $145
 $
 $145
$151
 $100
 $
 $(106) $145
 $
 $145

(a)
See the reconciliation of core earnings to GAAP net earnings under “Results of Operations — General” for details on the tax and noncontrolling interest impacts of these reconciling items.

Property and Casualty Insurance Segment — Results of Operations   Performance measures such as underwriting profit or loss and related combined ratios are often used by property and casualty insurers to help users of their financial statements better understand the company’s performance. Underwriting profitability is measured by the combined ratio, which is a sum of the ratios of losses and loss adjustment expenses, and commissions and other underwriting expenses to premiums. A combined ratio under 100% indicates an underwriting profit. The combined ratio does not reflect net investment income, other income, other expenses or federal income taxes.

AFG’s property and casualty insurance operations contributed $178$182 million in pretax earnings in the secondfirst quarterthree months of 20182019 compared to $163$184 million in the second quarterfirst three months of 2017, an increase2018, a decrease of $15$2 million (9%(1%). The increasedecrease in pretax earnings reflects lower underwriting profit in the first three months of 2019 compared to the first three months of 2018, offset by higher net investment income due primarily to higher earnings from limited partnerships and similar investments. These high returns should not necessarily be expected to repeat in future periods.income.


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AMERICAN FINANCIAL GROUP, INC. 10-Q
Management’s Discussion and Analysis of Financial Condition and Results of Operations — Continued


The following table details AFG’s earnings before income taxes from its property and casualty insurance operations for the three months ended June 30, 2018March 31, 2019 and 20172018 (dollars in millions):
Three months ended June 30,  Three months ended March 31,  
2018 2017 % Change2019 2018 % Change
Gross written premiums$1,665
 $1,503
 11%$1,535
 $1,458
 5%
Reinsurance premiums ceded(408) (373) 9%(388) (356) 9%
Net written premiums1,257
 1,130
 11%1,147
 1,102
 4%
Change in unearned premiums(96) (65) 48%26
 5
 420%
Net earned premiums1,161
 1,065
 9%1,173
 1,107
 6%
Loss and loss adjustment expenses693
 635
 9%692
 641
 8%
Commissions and other underwriting expenses396
 358
 11%394
 375
 5%
Underwriting gain72
 72
 %87
 91
 (4%)
    

    

Net investment income115
 96
 20%104
 100
 4%
Other income and expenses, net(9) (5) 80%(9) (7) 29%
Earnings before income taxes$178
 $163
 9%$182
 $184
 (1%)
          
     
Combined Ratios:          
Specialty lines    Change    Change
Loss and LAE ratio59.7% 59.5% 0.2%58.9% 57.8% 1.1%
Underwriting expense ratio34.0% 33.7% 0.3%33.6% 33.9% (0.3%)
Combined ratio93.7% 93.2% 0.5%92.5% 91.7% 0.8%
          
Aggregate — including exited lines          
Loss and LAE ratio59.7% 59.7% %59.0% 57.9% 1.1%
Underwriting expense ratio34.0% 33.7% 0.3%33.6% 33.9% (0.3%)
Combined ratio93.7% 93.4% 0.3%92.6% 91.8% 0.8%

AFG reports the underwriting performance of its Specialty property and casualty insurance business in the following sub-segments: (i) Property and transportation, (ii) Specialty casualty and (iii) Specialty financial.

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) generally have quick loss payouts, which reduce the time funds are held, thereby limiting investment income earned thereon. In contrast, “long-tail” lines of business (primarily liability coverages and workers’ compensation) generally 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.

Gross Written Premiums
Gross written premiums (“GWP”) for AFG’s property and casualty insurance segment were $1.671.54 billion for the secondfirst quarterthree months of 2019 compared to $1.46 billion the first three months of 2018 compared to $1.50 billion for the second quarter, an increase of 2017, an increase of $162$77 million (11% (5%). Detail of AFG’s property and casualty gross written premiums is shown below (dollars in millions):
Three months ended June 30,  Three months ended March 31,  
2018 2017  2019 2018  
GWP % GWP % % ChangeGWP % GWP % % Change
Property and transportation$615
 37% $573
 38% 7%$439
 29% $426
 29% 3%
Specialty casualty858
 52% 756
 50% 13%912
 59% 853
 59% 7%
Specialty financial192
 11% 174
 12% 10%184
 12% 179
 12% 3%
$1,665
 100% $1,503
 100% 11%$1,535
 100% $1,458
 100% 5%


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AMERICAN FINANCIAL GROUP, INC. 10-Q
Management’s Discussion and Analysis of Financial Condition and Results of Operations — Continued


Reinsurance Premiums Ceded
Reinsurance premiums ceded (“Ceded”) for AFG’s property and casualty insurance segment were 25% of gross written premiums for both the secondfirst quarterthree months of 20182019 andcompared to 24% of gross written premiums for the secondfirst quarterthree months of 2017.2018, an increase of 1 percentage point. Detail of AFG’s property and casualty reinsurance premiums ceded is shown below (dollars in millions):
Three months ended June 30,  Three months ended March 31,  
2018 2017 Change in2019 2018 Change in
Ceded % of GWP Ceded % of GWP % of GWPCeded % of GWP Ceded % of GWP % of GWP
Property and transportation$(193) 31% $(180) 31% %$(95) 22% $(102) 24% (2%)
Specialty casualty(219) 26% (195) 26% %(286) 31% (259) 30% 1%
Specialty financial(33) 17% (25) 14% 3%(39) 21% (31) 17% 4%
Other specialty37
   27
    32
   36
    
$(408) 25% $(373) 25% %$(388) 25% $(356) 24% 1%

Net Written Premiums
Net written premiums (“NWP”) for AFG’s property and casualty insurance segment were $1.261.15 billion for the secondfirst quarterthree months of 20182019 compared to $1.131.10 billion for the secondfirst quarterthree months of 20172018, an increase of $12745 million (11%4%). Detail of AFG’s property and casualty net written premiums is shown below (dollars in millions):
Three months ended June 30,  Three months ended March 31,  
2018 2017  2019 2018  
NWP % NWP % % ChangeNWP % NWP % % Change
Property and transportation$422
 33% $393
 35% 7%$344
 30% $324
 29% 6%
Specialty casualty639
 51% 561
 50% 14%626
 55% 594
 54% 5%
Specialty financial159
 13% 149
 13% 7%145
 13% 148
 14% (2%)
Other specialty37
 3% 27
 2% 37%32
 2% 36
 3% (11%)
$1,257
 100% $1,130
 100% 11%$1,147
 100% $1,102
 100% 4%

Net Earned Premiums
Net earned premiums (“NEP”) for AFG’s property and casualty insurance segment were $1.161.17 billion for the secondfirst quarterthree months of 20182019 compared to $1.071.11 billion for the secondfirst quarterthree months of 20172018, an increase of $9666 million (9%6%). Detail of AFG’s property and casualty net earned premiums is shown below (dollars in millions):
Three months ended June 30,  Three months ended March 31,  
2018 2017  2019 2018  
NEP % NEP % % ChangeNEP % NEP % % Change
Property and transportation$374
 32% $357
 34% 5%$361
 31% $350
 32% 3%
Specialty casualty595
 51% 537
 50% 11%629
 54% 579
 52% 9%
Specialty financial159
 14% 146
 14% 9%146
 12% 149
 13% (2%)
Other specialty33
 3% 25
 2% 32%37
 3% 29
 3% 28%
$1,161
 100% $1,065
 100% 9%$1,173
 100% $1,107
 100% 6%

The $162$77 million (11% (5%) increase in gross written premiums for the secondfirst quarterthree months of 20182019 compared to the secondfirst quarterthree months of 20172018 reflects growth in each of the Specialty property and casualty insurance sub-segments. Overall average renewal rates increased approximately 1% in the secondfirst quarterthree months of 2018.2019. Excluding the workers’ compensation business, renewal pricing increased approximately 3%4%.

Property and transportation Gross written premiums increased $42$13 million (7%(3%) in the second quarterfirst three months of 20182019 compared to the second quarterfirst three months of 2017.2018. This increase was primarily the result of new business opportunities in the property and inland marine business and higher premiums in the transportation businesses, which included a 5% average renewal rate increase in National Interstate’s business.businesses. Average renewal rates increased approximately 4% for this group in the second quarterfirst three months of 2018.2019. Reinsurance premiums ceded as a percentage of gross written premiums are comparable between periods.decreased 2 percentage points for the first three months of 2019 compared to the first three months of 2018 reflecting lower cessions in the crop insurance business.


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AMERICAN FINANCIAL GROUP, INC. 10-Q
Management’s Discussion and Analysis of Financial Condition and Results of Operations — Continued


Specialty casualty Gross written premiums increased $10259 million (13%7%) in the second quarterfirst three months of 20182019 compared to the second quarterfirst three months of 20172018 due primarily to higher premiums within Neon, resulting from the growth at Neon. Higher gross writtenof its portfolio in targeted classes of business, the addition of premiums from ABA Insurance Services, and improved pricing in the general liability, executive liability and excess and surplus lines businesses also contributed to the year-over-yearbusinesses. This growth was partially offset by lower gross written premiums in the workers’ compensation businesses.business. Average renewal rates were flatdecreased approximately 1% for this group in the second quarterfirst three months of 2018.2019. Excluding rate decreases in the workers’ compensation businesses, renewal rates for this group increased approximately 3%5%. Reinsurance premiums ceded as a percentage of gross written premiums reflectincreased 1 percentage point in the first three months of 2019 compared to the first three months of 2018 reflecting higher cessions at Neon, partially offset by lower cessions to AFG’s internal reinsurance program, which is included in Other specialty, offset by lower cessions at Neon.specialty.

Specialty financial Gross written premiums increased $185 million (10%3%) in the second quarterfirst three months of 20182019 compared to the second quarterfirst three months of 20172018 due primarily to higher premiums in the fidelity business, partially offset by lower premiums in the surety, financial institutions business.and equipment leasing businesses. Average renewal rates for this group increased approximately 5%3% in the second quarterfirst three months of 2018.2019. Reinsurance premiums ceded as a percentage of gross written premiums increased 34 percentage points for the second quarterfirst three months of 20182019 compared to the second quarterfirst three months of 2017,2018, reflecting higher cessions in the financial institutions business and changes in the mix of business in the fidelity and equipment leasing businesses.

Other specialty The amounts shown as reinsurance premiums ceded represent business assumed by AFG’s internal reinsurance program from the operations that make up AFG’s other Specialty property and casualty insurance sub-segments. Reinsurance premiums assumed increased $10decreased $4 million (37%(11%) in the second quarterfirst three months of 20182019 compared to the second quarterfirst three months of 2017,2018, reflecting an increasea decrease in premiums retained, primarily from businesses in the Specialty casualty sub-segment.


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Table of Contents
AMERICAN FINANCIAL GROUP, INC. 10-Q
Management’s Discussion and Analysis of Financial Condition and Results of Operations — Continued


Combined Ratio
The table below (dollars in millions) details the components of the combined ratio for AFG’s property and casualty insurance segment:
Three months ended June 30,   Three months ended June 30,Three months ended March 31,   Three months ended March 31,
2018 2017 Change 2018 20172019 2018 Change 2019 2018
Property and transportation                  
Loss and LAE ratio63.8% 64.9% (1.1%)    62.2% 63.0% (0.8%)    
Underwriting expense ratio30.1% 29.3% 0.8%    26.8% 27.4% (0.6%)    
Combined ratio93.9% 94.2% (0.3%)    89.0% 90.4% (1.4%)    
Underwriting profit      $23
 $21
      $39
 $33
                  
Specialty casualty                  
Loss and LAE ratio63.4% 63.1% 0.3%    61.6% 59.5% 2.1%    
Underwriting expense ratio31.7% 31.6% 0.1%    32.6% 33.4% (0.8%)    
Combined ratio95.1% 94.7% 0.4%    94.2% 92.9% 1.3%    
Underwriting profit      $29
 $29
      $36
 $41
                  
Specialty financial                  
Loss and LAE ratio33.9% 33.1% 0.8%    38.2% 40.2% (2.0%)    
Underwriting expense ratio51.7% 51.3% 0.4%    53.2% 50.0% 3.2%    
Combined ratio85.6% 84.4% 1.2%    91.4% 90.2% 1.2%    
Underwriting profit      $22
 $23
      $13
 $15
                  
Total Specialty                  
Loss and LAE ratio59.7% 59.5% 0.2%    58.9% 57.8% 1.1%    
Underwriting expense ratio34.0% 33.7% 0.3%    33.6% 33.9% (0.3%)    
Combined ratio93.7% 93.2% 0.5%    92.5% 91.7% 0.8%    
Underwriting profit      $73
 $73
      $88
 $92
                  
Aggregate — including exited lines                  
Loss and LAE ratio59.7% 59.7% %    59.0% 57.9% 1.1%    
Underwriting expense ratio34.0% 33.7% 0.3%    33.6% 33.9% (0.3%)    
Combined ratio93.7% 93.4% 0.3%    92.6% 91.8% 0.8%    
Underwriting profit      $72
 $72
      $87
 $91

The Specialty property and casualty insurance operations generated an underwriting profit of $88 million in the first three months of 2019 compared to $92 million in the first three months of 2018, a decrease of $4 million (4%). The lower underwriting profit in the first three months of 2019 reflects lower underwriting profits in the Specialty casualty and Specialty financial sub-segments, partially offset by higher underwriting profit in the Property and transportation sub-segment.

Property and transportation Underwriting profit for this group was $39 million for the first three months of 2019 compared to $33 million in the first three months of 2018, an increase of $6 million (18%). Higher underwriting profit in the transportation businesses was partially offset by lower underwriting profits in the agricultural, property and inland marine and ocean marine businesses, as well as the Singapore branch.

Specialty casualty Underwriting profit for this group was $36 million for the first three months of 2019 compared to $41 million for the first three months of 2018, a decrease of $5 million (12%). Improved underwriting results in the targeted markets businesses were more than offset by lower underwriting profits in the excess and surplus lines and workers’ compensation businesses.

Specialty financial Underwriting profit for this group was $13 million for the first three months of 2019 compared to $15 million in the first three months of 2018, a decrease of $2 million (13%) due primarily to lower underwriting profitability in the financial institutions business.


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Management’s Discussion and Analysis of Financial Condition and Results of Operations — Continued


The Specialty property and casualty insurance operations generated an underwriting profit of $73 million in both the second quarter of 2018 and the second quarter of 2017, reflecting strong results in both periods. Higher underwriting profit in the Property and transportation sub-segment was offset by lower underwriting profits in the Specialty financial sub-segment.

Property and transportation Underwriting profit for this group was $23 million for the second quarter of 2018 compared to $21 million in the second quarter of 2017, an increase of $2 million (10%). These results include higher year-over-year underwriting profits in the transportation businesses and improved results in the ocean marine operations and lower underwriting profitability in the property and inland marine and equine businesses.

Specialty casualty Underwriting profit for this group was $29 million for both the second quarter of 2018 and the second quarter of 2017. Higher underwriting profitability in the targeted markets businesses was offset by lower profitability in the excess and surplus lines businesses.

Specialty financial Underwriting profit for this group was $22 million for the second quarter of 2018 compared to $23 million in the second quarter of 2017, a decrease of $1 million (4%). Lower underwriting profits in the fidelity and surety businesses were offset by higher underwriting profits in the financial institutions business.

Other specialty This group reported an underwriting loss of $1 million in the second quarter of 2018 compared to an underwriting profit of less than $1 million in the second quarterfirst three months of 2019 compared to $3 million in the first three months of 20172018.


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Table This decrease reflects adverse prior year reserve development in the business assumed by AFG’s internal reinsurance program from the operations that make up AFG’s other Specialty sub-segments in the first three months of Contents
AMERICAN FINANCIAL GROUP, INC. 10-Q
Management’s Discussion and Analysis2019 compared to favorable prior year reserve development in the first three months of Financial Condition and Results of Operations — Continued

2018.

Losses and Loss Adjustment Expenses
AFG’s overall loss and LAE ratio was 59.7%59.0% for both the secondfirst quarterthree months of 2019 compared to 57.9% for the first three months of 2018 and the second quarter, an increase of 2017.1.1 percentage points. The components of AFG’s property and casualty losses and LAE amounts and ratio are detailed below (dollars in millions):
Three months ended June 30,  Three months ended March 31,  
Amount Ratio Change inAmount Ratio Change in
2018 2017 2018 2017 Ratio2019 2018 2019 2018 Ratio
Property and transportation                  
Current year, excluding catastrophe losses$250
 $232
 66.7% 65.0% 1.7%$242
 $233
 66.8% 66.7% 0.1%
Prior accident years development(21) (11) (5.6%) (3.1%) (2.5%)(26) (18) (7.2%) (5.1%) (2.1%)
Current year catastrophe losses10
 11
 2.7% 3.0% (0.3%)9
 5
 2.6% 1.4% 1.2%
Property and transportation losses and LAE and ratio$239
 $232
 63.8% 64.9% (1.1%)$225
 $220
 62.2% 63.0% (0.8%)
                  
Specialty casualty                  
Current year, excluding catastrophe losses$392
 $342
 65.8% 63.6% 2.2%$400
 $375
 63.7% 64.5% (0.8%)
Prior accident years development(15) (5) (2.5%) (0.9%) (1.6%)(13) (35) (2.2%) (6.0%) 3.8%
Current year catastrophe losses1
 2
 0.1% 0.4% (0.3%)1
 5
 0.1% 1.0% (0.9%)
Specialty casualty losses and LAE and ratio$378
 $339
 63.4% 63.1% 0.3%$388
 $345
 61.6% 59.5% 2.1%
                  
Specialty financial                  
Current year, excluding catastrophe losses$59
 $52
 37.3% 35.2% 2.1%$60
 $60
 41.1% 40.2% 0.9%
Prior accident years development(8) (8) (5.4%) (5.4%) %(6) (3) (4.3%) (1.8%) (2.5%)
Current year catastrophe losses3
 5
 2.0% 3.3% (1.3%)2
 3
 1.4% 1.8% (0.4%)
Specialty financial losses and LAE and ratio$54
 $49
 33.9% 33.1% 0.8%$56
 $60
 38.2% 40.2% (2.0%)
                  
Total Specialty                  
Current year, excluding catastrophe losses$721
 $639
 62.2% 60.0% 2.2%$725
 $684
 61.8% 61.7% 0.1%
Prior accident years development(45) (23) (3.9%) (2.2%) (1.7%)(46) (57) (4.0%) (5.1%) 1.1%
Current year catastrophe losses16
 18
 1.4% 1.7% (0.3%)12
 13
 1.1% 1.2% (0.1%)
Total Specialty losses and LAE and ratio$692
 $634
 59.7% 59.5% 0.2%$691
 $640
 58.9% 57.8% 1.1%
                  
Aggregate — including exited lines                  
Current year, excluding catastrophe losses$721
 $639
 62.2% 60.0% 2.2%$725
 $684
 61.8% 61.7% 0.1%
Prior accident years development(44) (22) (3.9%) (2.0%) (1.9%)(45) (56) (3.9%) (5.0%) 1.1%
Current year catastrophe losses16
 18
 1.4% 1.7% (0.3%)12
 13
 1.1% 1.2% (0.1%)
Aggregate losses and LAE and ratio$693
 $635
 59.7% 59.7% %$692
 $641
 59.0% 57.9% 1.1%

Current accident year losses and LAE, excluding catastrophe losses
The current accident year loss and LAE ratio, excluding catastrophe losses for AFG’s Specialty property and casualty insurance operations was 62.2%61.8% for the secondfirst quarterthree months of 20182019 compared to 60.0%61.7% for the secondfirst quarterthree months of 20172018, an increase of 2.20.1 percentage points.

Property and transportation   The 1.7 percentage point increase in the loss and LAE ratio for the current year, excluding catastrophe losses reflects an increaseis comparable in the lossfirst three months of 2019 and LAE ratio in the property and inland marine and equine businesses for the second quarterfirst three months of 2018 compared to the second quarter of 2017.

Specialty casualty   The 2.2 percentage point increase in the loss and LAE ratio for the current year, excluding catastrophe losses reflects an increase in the loss and LAE ratio in the excess and surplus, workers’ compensation and targeted markets businesses.2018.


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Management’s Discussion and Analysis of Financial Condition and Results of Operations — Continued


Specialty casualty   The 0.8 percentage point decrease in the loss and LAE ratio for the current year, excluding catastrophe losses reflects a decrease in the loss and LAE ratio in the public sector, general liability and professional liability businesses.

Specialty financial The 2.10.9 percentage point increase in the loss and LAE ratio for the current year, excluding catastrophe losses reflects an increase in the loss and LAE ratio of the financial institutions business, partially offset by a decrease in the loss and trade credit businesses.LAE ratio of the fidelity business.

Net prior year reserve development
AFG’s Specialty property and casualty insurance operations recorded net favorable reserve development related to prior accident years of $4546 million in the secondfirst quarterthree months of 20182019 compared to $23$57 million in the secondfirst quarterthree months of 2017, an increase2018, a decrease of $22$11 million (96%(19%).

Property and transportation Net favorable reserve development of $2126 million in the secondfirst quarterthree months of 20182019 reflects lower than expected losses in the crop business and lower than expected claim frequency and severity in the transportation businesses. Net favorable reserve development of $11$18 million in the secondfirst quarterthree months of 20172018 reflects lower than expected losses in the crop and equine businesses and lower than expected claim severity in the property and inland marine businesses, partially offset by higher than expected claim severity in the ocean marine business.

Specialty casualty Net favorable reserve development of $15$13 million in the secondfirst quarterthree months of 2019 reflects lower than anticipated claim severity in the workers’ compensation business, partially offset by higher than expected claim severity in the targeted markets businesses and higher than expected losses at Neon. Net favorable reserve development of $35 million in the first three months of 2018 includes lower than anticipated claim frequency and severity in the workers’ compensation business. Net favorable reserve development of $5 million in the second quarter of 2017 reflectsbusiness and lower than anticipatedexpected claim severity in the workers’ compensation businesses and at Neon,executive liability business, partially offset by higher than anticipatedexpected claim severity and frequency in the targeted markets and general liability businesses.

Specialty financial Net favorable reserve development of $8$6 million in the secondfirst quarterthree months of 20182019 reflects lower than expected claim frequency and severity in the surety business and lower than anticipated claim severity in the financial institutionsfidelity business. Net favorable reserve development of $8$3 million in the secondfirst quarterthree months of 20172018 reflects lower than anticipated claim severity in the fidelity business and lower than expected claim frequency and severity in the surety business.

Other specialty In addition to the development discussed above, total Specialty prior year reserve development includes net favorable reserve development of $1 million in both the secondfirst quarterthree months of 20182019 and net adverse reserve developmentthe first three months of $1 million in the second quarter of 2017,2018, reflecting amortization of the deferred gainsgain on the retroactive reinsurance transactionsinsurance transaction entered into in connection with the sale of businesses in 1998 and 2001 and reserve development associated with AFG’s internal reinsurance program.

Aggregate Aggregate net prior accident years reserve development for AFG’s property and casualty insurance segment includes net adverse reserve development of $1 million in both the second quartersfirst three months of 20182019 and 2017the first three months of 2018 related to business outside of the Specialty insurance group that AFG no longer writes.

Catastrophe losses
AFG generally seeks to reduce its exposure to catastrophes through individual risk selection, including minimizing coastal and known fault-line exposures, and the purchase of reinsurance. Based on data available at December 31, 2017,2018, AFG’s exposure to a catastrophic earthquake or windstorm that industry models indicate should statistically occur once in every 100, 250 or 500 years as a percentage of AFG’s Shareholders’ Equity is shown below:
   Impact of modeled loss on AFG’s 
 Industry Model Shareholders’ Equity 
 100-year event Less than 1% 
 250-year event Less than 2%3% 
 500-year event Less than 4%Approximately 6% 

AFG maintains comprehensive catastrophe reinsurance coverage, including a $15 million per occurrence net retention for its U.S.-based property and casualty insurance operations for losses up to $100 million. Neon’s excess of loss catastrophe reinsurance limits the maximum retained loss per event to $25 million andfor a separateU.S. catastrophe and $15 million per occurrence retention for Neona non-U.S. catastrophe for losses up to $200 million ($225 million for U.S. catastrophe events).$250 million. AFG’s property and casualty insurance operations further maintain supplemental fully collateralized reinsurance coverage up to 95% of $200 million for catastrophe losses in excess of $100$104 million of traditional catastrophe reinsurance through a catastrophe bond.

Catastrophe losses of $16 million in the second quarter of 2018 resulted primarily from storms and flooding in several regions of the United States. Catastrophe losses of $18 million in the second quarter of 2017 resulted primarily from storms and tornadoes in several regions of the United States.


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Management’s Discussion and Analysis of Financial Condition and Results of Operations — Continued



Catastrophe losses of $12 million in the first three months of 2019 resulted primarily from winter storms in multiple regions of the United States. Catastrophe losses of $13 million in the first three months of 2018 resulted primarily from winter storms in the eastern portion of the United States and mudslides in California.

Commissions and Other Underwriting Expenses
AFG’s property and casualty commissions and other underwriting expenses (“U/W Exp”) were $396$394 million in the secondfirst quarterthree months of 20182019 compared to $358$375 million for the secondfirst quarterthree months of 20172018, an increase of $3819 million (11%(5%). AFG’s underwriting expense ratio, calculated as commissions and other underwriting expenses divided by net premiums earned, was 34.0%33.6% for the secondfirst quarterthree months of 2019 compared to 33.9% for the first three months of 2018 compared to 33.7% for the second quarter of 2017, an increasea decrease of 0.3 percentage points. Detail of AFG’s property and casualty commissions and other underwriting expenses and underwriting expense ratios is shown below (dollars in millions):
Three months ended June 30,  Three months ended March 31,  
2018 2017 Change in2019 2018 Change in
U/W Exp % of NEP U/W Exp % of NEP % of NEPU/W Exp % of NEP U/W Exp % of NEP % of NEP
Property and transportation$112
 30.1% $104
 29.3% 0.8%$97
 26.8% $97
 27.4% (0.6%)
Specialty casualty188
 31.7% 169
 31.6% 0.1%205
 32.6% 193
 33.4% (0.8%)
Specialty financial83
 51.7% 74
 51.3% 0.4%77
 53.2% 74
 50.0% 3.2%
Other specialty13
 36.8% 11
 36.3% 0.5%15
 39.2% 11
 39.4% (0.2%)
$396
 34.0% $358
 33.7% 0.3%$394
 33.6% $375
 33.9% (0.3%)

Property and transportation   Commissions and other underwriting expenses as a percentage of net earned premiums increased 0.8decreased 0.6 percentage points in the secondfirst quarterthree months of 20182019 compared to the secondfirst quarterthree months of 20172018, reflecting a changehigher profitability-based ceding commissions received from reinsurers in the mix of business.crop business, partially offset by an increase in the expense ratio in the transportation businesses.

Specialty casualty   Commissions and other underwriting expenses as a percentage of net earned premiums increased 0.1decreased 0.8 percentage points in the secondfirst quarterthree months of 20182019 compared to the secondfirst quarterthree months of 20172018, reflecting growthlower underwriting expenses related to the exit of certain lines of business at Neon which has aand the impact of higher expense ratio than AFG’s overall Specialty casualty group.net earned premiums at Neon.

Specialty financial   Commissions and other underwriting expenses as a percentage of net earned premiums increased 0.43.2 percentage points in the secondfirst quarterthree months of 20182019 compared to the secondfirst quarterthree months of 20172018, reflecting higher profitability-based commissions paid to agents in the financial institutions business.

Property and Casualty Net Investment Income
Net investment income in AFG’s property and casualty insurance operations was $115$104 million in the secondfirst quarterthree months of 20182019 compared to $96100 million in the secondfirst quarterthree months of 20172018, an increase of $194 million (20%4%). The average invested assets and overall yield earned on investments held by AFG’s property and casualty insurance operations are provided below (dollars in millions):
Three months ended June 30,    Three months ended March 31,    
2018 2017 Change % Change2019 2018 Change % Change
Net investment income$115
 $96
 $19
 20%$104
 $100
 $4
 4%
    

      

  
Average invested assets (at amortized cost)$10,346
 $9,947
 $399
 4%$10,997
 $10,422
 $575
 6%
    

      

  
Yield (net investment income as a % of average invested assets)4.45% 3.86% 0.59% 

3.78% 3.84% (0.06%) 

              
Tax equivalent yield (*)4.62% 4.32% 0.30%  3.96% 4.02% (0.06%)  
(*)   Adjusts the yield on equity securities and tax-exempt bonds to the fully taxable equivalent yield.

The property and casualty insurance segment’s increase in net investment income for the secondfirst quarterthree months of 20182019 as compared to the secondfirst quarterthree months of 20172018 reflects growth in the property and casualty insurance segment and very strong earnings from limited partnerships and similar investments.segment. The property and casualty insurance segment’s overall yield on investments (net investment income as a percentage of average invested assets) was 4.45%3.78% for the secondfirst quarterthree months of 20182019 compared to 3.86%3.84% for the secondfirst quarterthree months of 2017, an increase2018, a decrease of 0.590.06 percentage points, due primarily to the higher earnings from limited partnerships and similar investments.


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Management’s Discussion and Analysis of Financial Condition and Results of Operations — Continued


due primarily to lower income from partnerships and similar investments. AFG’s property and casualty insurance operations recorded $8 million in earnings from partnerships and similar investments and AFG-managed CLOs in the first three months of 2019 compared to $18 million in the first three months of 2018, a decrease of $10 million (56%). The annualized yield earned on these investments was 4.7% in the first three months of 2019 compared to 14.0% in the prior year period.

Property and Casualty Other Income and Expenses, Net
Other income and expenses, net for AFG’s property and casualty insurance operations was a net expense of $9 million for the second quarterfirst three months of 20182019 compared to $5a net expense of $7 million infor the second quarterfirst three months of 2017, an increase of $4 million (80%).2018. The table below details the items included in other income and expenses, net for AFG’s property and casualty insurance operations (in millions):
Three months ended June 30,Three months ended March 31,
2018 20172019 2018
Other income   $3
 $2
Income from the sale of real estate$
 $3
Other2
 1
Total other income2
 4
Other expenses      
Amortization of intangibles2
 2
3
 2
Other9
 7
9
 7
Total other expenses11
 9
12
 9
Other income and expenses, net$(9) $(5)$(9) $(7)


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AMERICAN FINANCIAL GROUP, INC. 10-Q
Management’s Discussion and Analysis of Financial Condition and Results of Operations — Continued


Annuity Segment — Results of Operations
AFG’s annuity operations contributed $99$90 million in pretax earnings in the second quarterfirst three months of 20182019 compared to $85$125 million in the second quarterfirst three months of 2017, an increase2018, a decrease of $14$35 million (16%(28%). This decrease in AFG’s annuity segment results for the second quarterfirst three months of 20182019 as compared to the second quarterfirst three months of 2017 reflect a 10% increase in average investments (at amortized cost), higher earnings from limited partnerships and similar investments and2018 is due primarily to the favorableunfavorable impact of significantly lower than anticipated interest rates on the fair value accounting forof derivatives related to fixed-indexed annuities (“FIAs”), partially offset by an unlocking charge in the second quarter of 2018 and the impact of lower investment yields due to the run-off of higher yielding investments. The high returns on limited partnerships and similar investments should not necessarily be expected to repeat in future periods. The fair value of derivatives related to FIAs was favorably impacted by higher than anticipated interest ratesstrong stock market performance in the second quarter of 2018 compared to the negative impact of lower than anticipated interest rates in the second quarter of 2017, partially offset in the 2018 period by the negative impacts of higher interest on the embedded derivative (from growth in the FIA business and higher interest rates) and higher than expected option costs. AFG monitors the major actuarial assumptions underlying its annuity operations throughout the year and conducts detailed reviews (“unlocking”) of its assumptions in the fourth quarter of each year. If changes in the economic environment of actual experience would cause material revisions to future estimates, these assumptions are updated (unlocked) in an interim quarter. Due to continued higher FIA option costs (resulting primarily from higher than expected risk-free rates), AFG unlocked its assumptions for option costs and interest rates in the second quarter of 2018, resulting in a net charge to earnings of $27 million.2019 period.

The following table details AFG’s earnings before income taxes from its annuity operations for the three months ended June 30, 2018March 31, 2019 and 20172018 (dollars in millions):
Three months ended June 30,  Three months ended March 31,  
2018 2017 % Change2019 2018 % Change
Revenues:          
Net investment income$412
 $360
 14%$435
 $394
 10%
Other income:          
Guaranteed withdrawal benefit fees16
 14
 14%16
 16
 %
Policy charges and other miscellaneous income11
 12
 (8%)11
 10
 10%
Total revenues439
 386
 14%462
 420
 10%
          
Costs and Expenses:          
Annuity benefits (*)260
 224
 16%311
 182
 71%
Acquisition expenses49
 47
 4%26
 81
 (68%)
Other expenses31
 30
 3%35
 32
 9%
Total costs and expenses340
 301
 13%372
 295
 26%
Earnings before income taxes$99
 $85
 16%$90
 $125
 (28%)
(*)Details of the components of annuity benefits provided below.
DetailThe following tables provide an analysis of AFG’s annuity earnings before income taxes (dollars in millions):
Three months ended June 30,  Three months ended March 31,  
2018 2017 % Change2019 2018 % Change
Earnings before income taxes — before the impact of unlocking and derivatives related to FIAs$123
 $101
 22%
Unlocking(27) 
 %
Earnings before income taxes — before the impact of derivatives related to FIAs$134
 $112
 20%
Impact of derivatives related to FIAs3
 (16) (119%)(44) 13
 (438%)
Earnings before income taxes$99
 $85
 16%$90
 $125
 (28%)


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Management’s Discussion and Analysis of Financial Condition and Results of Operations — Continued


(*)Annuity benefits consisted of the following (dollars in millions):
The vast majority of AFG’s FIAs are indexed to the S&P 500, which increased 13% in the first three months of 2019. As highlighted in the table below, this positive stock market performance favorably impacted AFG’s earnings before income taxes from its annuity operations beyond the impact on derivatives related to FIAs by $19 million, particularly related to FIAs with guaranteed withdrawal benefits. This $19 million favorable impact on AFG’s earnings before income taxes in the first quarter of 2019 is effectively a reversal of a significant portion of the unfavorable impact of the 14% decrease in the S&P 500 in the fourth quarter of 2018. If the stock market reverts back to AFG’s long-term expectations of performance and volatility, management expects the impact of the stock market on annuity earnings before the impact of derivatives related to FIAs to be less significant in future periods.
 Three months ended June 30,  
 2018 2017 % Change
Interest credited — fixed$173
 $157
 10%
Interest credited — fixed component of variable annuities2
 2
 %
Other annuity benefits:     
Change in expected death and annuitization reserve4
 4
 %
Amortization of sales inducements5
 4
 25%
Change in guaranteed withdrawal benefit reserve19
 17
 12%
Change in other benefit reserves11
 9
 22%
Total other annuity benefits39
 34
 15%
Total before impact of derivatives related to FIAs and unlocking214
 193
 11%
Derivatives related to fixed-indexed annuities:     
Embedded derivative mark-to-market82
 112
 (27%)
Equity option mark-to-market(90) (81) 11%
Impact of derivatives related to FIAs(8) 31
 (126%)
Unlocking54
 
 %
Total annuity benefits$260
 $224
 16%
 Three months ended March 31,  
 2019 2018 % Change
Earnings before income taxes — before the impact of derivatives related to FIAs and other impacts of stock market performance on FIAs$115
 $113
 2%
Other impacts of stock market performance on FIAs:     
FIAs with guaranteed withdrawal benefits14
 (1) (1,500%)
DPAC associated with FIAs5
 
 %
Earnings before income taxes — before the impact of derivatives related to FIAs$134
 $112
 20%
Annuity benefits consisted of the following (dollars in millions):
 Three months ended March 31,  
 2019 2018 % Change
Interest credited — fixed$194
 $166
 17%
Interest credited — fixed component of variable annuities1
 1
 %
Other annuity benefits:     
Change in expected death and annuitization reserve4
 4
 %
Amortization of sales inducements3
 5
 (40%)
Change in guaranteed withdrawal benefit reserve:     
Impact of change in the stock market(14) 1
 (1,500%)
Accretion of benefits and other21
 22
 (5%)
Change in other benefit reserves7
 8
 (13%)
Total other annuity benefits21
 40
 (48%)
Total before impact of derivatives related to FIAs216
 207
 4%
Derivatives related to fixed-indexed annuities:     
Embedded derivative mark-to-market462
 (63) (833%)
Equity option mark-to-market(367) 38
 (1,066%)
Impact of derivatives related to FIAs95
 (25) (480%)
Total annuity benefits$311
 $182
 71%

See Annuity Unlocking below for a discussion of the impact that the unlocking of actuarial assumptions hadNet Spread on Fixed Annuities (excludes variable annuity benefit expense in the second quarter of 2018.

earnings)
The profitability of a fixed annuity business is largely dependent on the ability of a company to earn income on the assets supporting the business in excess of the amounts credited to policyholder accounts plus expenses incurred (earning a “spread”). Performance measures such as net interest spread and net spread earned are often presented by annuity businesses to help users of their financial statements better understand the company’s performance.

Net Spread on Fixed Annuities (excludes variable annuity earnings)
The table below (dollars in millions) details the components of these spreads for AFG’s fixed annuity operations (including fixed-indexed and variable-indexed annuities):
 Three months ended June 30,  
 2018 2017 % Change
Average fixed annuity investments (at amortized cost)$33,935
 $30,988
 10%
Average fixed annuity benefits accumulated34,165
 31,212
 9%
      
As % of fixed annuity benefits accumulated (except as noted):

 

  
Net investment income (as % of fixed annuity investments)4.83% 4.62%  
Interest credited — fixed(2.02%) (2.01%)  
Net interest spread2.81% 2.61%  
      
Policy charges and other miscellaneous income0.10% 0.12%  
Other annuity benefit expenses, net of guaranteed withdrawal benefit fees(0.27%) (0.27%)  
Acquisition expenses(0.89%) (0.58%)  
Other expenses(0.35%) (0.38%)  
Change in fair value of derivatives related to fixed-indexed annuities0.10% (0.39%)  
Unlocking(0.32%) %  
Net spread earned on fixed annuities1.18% 1.11%  


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Management’s Discussion and Analysis of Financial Condition and Results of Operations — Continued


The table below (dollars in millions) details the components of these spreads for AFG’s fixed annuity operations (including fixed-indexed and variable-indexed annuities):
 Three months ended March 31,  
 2019 2018 % Change
Average fixed annuity investments (at amortized cost)$36,991
 $33,002
 12%
Average fixed annuity benefits accumulated37,078
 33,329
 11%
      
As % of fixed annuity benefits accumulated (except as noted):

 

  
Net investment income (as % of fixed annuity investments)4.68% 4.74%  
Interest credited — fixed(2.09%) (1.99%)  
Net interest spread2.59% 2.75%  
      
Policy charges and other miscellaneous income0.08% 0.10%  
Other annuity benefit expenses, net of guaranteed withdrawal benefit fees(0.04%) (0.29%)  
Acquisition expenses(0.28%) (0.94%)  
Other expenses(0.36%) (0.38%)  
Change in fair value of derivatives related to fixed-indexed annuities(1.03%) 0.30%  
Net spread earned on fixed annuities0.96% 1.54%  

The table below illustrates the impact of fair value accounting for derivatives related to fixed-indexed annuities on the annuity segment’s net spread earned on fixed annuities:
 Three months ended June 30,
 2018 2017
Net spread earned on fixed annuities — before the impact of unlocking and derivatives related to FIAs1.46% 1.32%
Unlocking(0.32%) %
Impact of derivatives related to fixed-indexed annuities:   
Change in fair value of derivatives0.10% (0.39%)
Related impact on amortization of deferred policy acquisition costs (*)(0.06%) 0.18%
Related impact on amortization of deferred sales inducements (*)% %
Net spread earned on fixed annuities1.18% 1.11%
 Three months ended March 31,
 2019 2018
Net spread earned on fixed annuities — before the impact of derivatives related to FIAs1.43% 1.38%
Impact of derivatives related to fixed-indexed annuities:   
Change in fair value of derivatives(1.03%) 0.30%
Related impact on:   
Accretion of guaranteed withdrawal benefits (a)0.06% %
Amortization of deferred policy acquisition costs (b)0.49% (0.14%)
Amortization of deferred sales inducements (b)0.01% %
Net spread earned on fixed annuities0.96% 1.54%

(*)(a)An estimate of the related acceleration/deceleration of the accretion of guaranteed withdrawal benefits.
(b)An estimate of the related acceleration/deceleration of the amortization of deferred policy acquisition costs and deferred sales inducements.

The net spread earned on fixed annuities before the impact of derivatives related to FIAs increased 0.05 percentage points to 1.43% for the first three months of 2019 from 1.38% for the first three months of 2018 due primarily to the impact of unusually strong stock market performance on annuities with guaranteed withdrawal benefits. As previously noted, if the stock market reverts back to AFG’s long-term expectations of performance and volatility, management expects the impact of the stock market on annuity earnings before the impact of derivatives related to FIAs to be less significant in future periods.

Annuity Net Investment Income
Net investment income for the second quarterfirst three months of 20182019 was $412$435 million compared to $360$394 million for the second quarterfirst three months of 2017,2018, an increase of $52$41 million (14%(10%). This increase reflects the growth in AFG’s annuity business, and higher earnings from limited partnerships and similar investments, partially offset by the impact of lower investment yields. The overall yield earned on investments in AFG’s fixed annuity operations, calculated as net investment income divided by average investment balances (at amortized cost), increaseddecreased by 0.210.06 percentage points to 4.83%4.68% from 4.62%4.74% in the second quarterfirst three months of 20182019 compared to the second quarterfirst three months of 2017. This increase in2018. The net investment yield between periods reflects higher earnings from limited partnerships and similar investments, partially offset by (i) the investment of new premium dollars at lower yields as compared to the existing investment portfolio and (ii) the impact of the reinvestment of proceeds from maturity and redemption of higher yielding investments at the lower yields available in the financial markets. During 2017, $4.9For the period from January 1, 2018, through March 31, 2019, $5.8 billion in annuity segment investments with an average yield of 5.14%approximately 5.0% were redeemed or sold whilewith the investments purchased during 2017 (with new premium dollarsproceeds reinvested at an approximately 0.4% lower yield.


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Management’s Discussion and the redemption/sale proceeds) had an average yield at purchaseAnalysis of 3.94%.Financial Condition and Results of Operations — Continued


Annuity Interest Credited — Fixed
Interest credited — fixed for the second quarterfirst three months of 20182019 was $173194 million compared to $157166 million for the second quarterfirst three months of 2017,2018, an increase of $1628 million (10%17%). This increase reflects the impact of growth in the annuity business. The average interest rate credited to policyholders, calculated as interest credited divided by average fixed annuity benefits accumulated, increased 0.010.10 percentage points to 2.02%2.09% in the second quarterfirst three months of 2019 from 1.99% in the first three months of 2018 from 2.01% indue to higher crediting rates on new business (reflecting the second quarterimpact of 2017.rising interest rates during 2018).

Annuity Net Interest Spread
AFG’s net interest spread increaseddecreased 0.200.16 percentage points to 2.81%2.59% from 2.61%2.75% in the second quarterfirst three months of 20182019 compared to the same period in 20172018 due primarily to higher earnings from limited partnershipscrediting rates on new business and similar investments, partially offset by lower fixed maturity investment yields. Features included in current annuity product offerings allow AFG to achieve its desired profitability at a lower net interest spread than historical product offerings. As a result, AFG expects its net interest spread to narrow in the future.

Annuity Policy Charges and Other Miscellaneous Income
Annuity policy charges and other miscellaneous income, which consist primarily of surrender charges, amortization of deferred upfront policy charges (unearned revenue) and income from sales of real estate were $11 million for the second quarterfirst three months of 20182019 compared to $12$10 million for the second quarterfirst three months of 2017, a decrease2018, an increase of $1 million (8%(10%). Excluding the impact of a $1 million unlocking charge related to unearned revenue in the second quarter of 2018, annuity policy charges and other miscellaneous income were $12 million for both the second quarter of 2018 and the second quarter of 2017. Excluding the impact of unlocking charges related to unearned revenue, annuityAnnuity policy charges and other miscellaneous income as a percentage of average fixed annuity benefits accumulated, decreased 0.02 percentage points to 0.10%0.08% from 0.12%0.10% in the second quarterfirst three months of 20182019 compared to the second quarterfirst three months of 2017.2018.

See Annuity Unlocking below for a discussion of the impact that the unlocking of actuarial assumptions had on annuity policy charges and other miscellaneous income.

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AMERICAN FINANCIAL GROUP, INC. 10-Q
Management’s Discussion and Analysis of Financial Condition and Results of Operations — Continued


Other Annuity Benefits, Net of Guaranteed Withdrawal Benefit Fees
Other annuity benefits, net of guaranteed withdrawal benefit fees, (excluding the impact of unlocking), for the second quarterfirst three months of 20182019 were $23$5 million compared to $20$24 million for the second quarterfirst three months of 2017, an increase2018, a decrease of $3$19 million (15%(79%). As a percentage of average fixed annuity benefits accumulated, these net expenses were 0.27%decreased 0.25 percentage points to 0.04% from 0.29% in both the second quarterfirst three months of 2018 and2019 compared to the second quarterfirst three months of 2017.2018. In addition to interest credited to policyholders’ accounts and the change in fair value of derivatives related to fixed-indexed annuities, annuity benefits expense also includes the following expenses (in millions, net of guaranteed withdrawal benefit fees):
Three months ended June 30,Three months ended March 31,
2018 20172019 2018
Change in expected death and annuitization reserve$4
 $4
$4
 $4
Amortization of sales inducements5
 4
3
 5
Change in guaranteed withdrawal benefit reserve19
 17
Change in guaranteed withdrawal benefit reserve:   
Impact of change in the stock market(14) 1
Accretion of benefits and other21
 22
Change in other benefit reserves11
 9
7
 8
Other annuity benefits39
 34
21
 40
Offset guaranteed withdrawal benefit fees(16) (14)(16) (16)
Other annuity benefits, net$23
 $20
$5
 $24

As discussed under “Annuity Benefits Accumulated” in Note A — “Accounting Policiesto the financial statements, guaranteed withdrawal benefit reserves are accrued for and modified using assumptions similar to those used in establishing and amortizing deferred policy acquisition costs. The guaranteed withdrawal benefit reserve related to FIAs can be inversely impacted by the calculated FIA embedded derivative reserve as the value to policyholders of the guaranteed withdrawal benefits decreases when the benefit of stock market participation increases.

See Annuity Unlocking below for a discussion As shown in the table above, the change in the stock market decreased AFG’s guaranteed withdrawal benefit reserve by $14 million in the first three months of 2019 compared to an increase in AFG’s guaranteed benefit reserve by $1 million in the first three months of 2018. This $15 million change (1,500%) was the primary cause of the impact that the unlocking of actuarial assumptions had on$19 million overall decrease in other annuity benefits, expensenet of guaranteed withdrawal fees in the second quarterfirst three months of 2019 compared to the first three months of 2018.

Annuity Acquisition Expenses
Annuity acquisition expenses for the second quarterfirst three months of 20182019 were $49$26 million compared to $47$81 million for the second quarter of 2017, an increase of $2 million (4%). Excluding the $28 million favorable impact on amortization of DPAC from the unlocking recorded in the second quarterfirst three months of 2018, annuity acquisition expenses were $77a decrease of $55 million for the second quarter of 2018, an increase of $30 million (64%(68%) compared to the second quarter of 2017,, reflecting the acceleration/deceleration of DPAC amortization related toof deferred policy acquisition costs (“DPAC”) as a result of changes in the fair value of derivatives related to FIAs and growth in the business. Excluding the impact of the 2018 unlocking charge,FIAs. AFG’s amortization of deferred policy acquisition costs (“DPAC”)DPAC and commission expenses as a percentage of average fixed annuity benefits accumulated was 0.89%0.28% for the second quarterfirst three months

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Management’s Discussion and Analysis of Financial Condition and Results of Operations — Continued


of 2019 compared to 0.58%0.94% for the second quarterfirst three months of 20172018 and has generally ranged between 0.75% and 0.85%. Variances from the general range relate primarily to the impact of (i) material changes in interest rates or the stock market on AFG’s fixed-indexed annuityFIA business, and (ii) differences in actual experience from actuarially projected estimates and assumptions. For example, the positive impact of higher than anticipated interest rates during the second quarter of 2018 on the fair value of derivatives related to FIAs (discussed below) resulted in a partially offsetting acceleration of the amortization of DPAC. In contrast, the negative impact of lower than anticipated interest rates during the second quarterfirst three months of 20172019 on the fair value of derivatives related to FIAs resulted in a partially offsetting deceleration of the amortization of DPAC. In contrast, the positive impact of higher than anticipated interest rates during the first three months of 2018 on the fair value of derivatives related to FIAs resulted in a partially offsetting acceleration of the amortization of DPAC.

The table below illustrates the estimated impact of fair value accounting for derivatives related to fixed-indexed annuities on annuity acquisition expenses as a percentage of average fixed annuity benefits accumulated (excluding the impact of unlocking):accumulated:
Three months ended June 30,Three months ended March 31,
2018 20172019 2018
Before the impact of changes in the fair value of derivatives related to FIAs on the amortization of DPAC0.83% 0.76%0.77% 0.80%
Impact of changes in fair value of derivatives related to FIAs on amortization of DPAC (*)0.06% (0.18%)(0.49%) 0.14%
Annuity acquisition expenses as a % of fixed annuity benefits accumulated0.89% 0.58%0.28% 0.94%
(*)An estimate of the acceleration/deceleration of the amortization of deferred policy acquisition costs resulting from fair value accounting for derivatives related to fixed-indexed annuities.

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Management’s Discussion and Analysis of Financial Condition and Results of Operations — Continued



See Annuity Unlocking below for a discussion of the impact that the unlocking of actuarial assumptions had on annuity and supplemental insurance acquisition expenses in the second quarter of 2018. Unanticipated spread compression, decreases in the stock market, adverse mortality experience, and higher than expected lapse rates could lead to future write-offs of DPAC or the present value of future profits on business in force of companies acquired (“PVFP”).

Annuity Other Expenses
Annuity other expenses were $31$35 million for the second quarterfirst three months of 20182019 compared to $30$32 million for the second quarterfirst three months of 2017,2018, an increase of $1$3 million (3%(9%). Annuity other expenses represent primarily general and administrative expenses, as well as selling and issuance expenses that are not deferred. As a percentage of average fixed annuity benefits accumulated, these expenses were 0.35%decreased 0.02 percentage points to 0.36% for the second quarterfirst three months of 2018 and2019 from 0.38% forin the second quarterfirst three months of 2017. This decrease in annuity other expenses as a percentage of average fixed annuity benefits accumulated is2018 due primarily to growth in the business.

Change in Fair Value of Derivatives Related to Fixed-Indexed (Including Variable-Indexed) Annuities
AFG’s fixed-indexed (including variable-indexed) annuities provide policyholders with a crediting rate tied, in part, to the performance of an existing stock market or other financial index. AFG attempts to mitigate the risk in the index-based component of these products through the purchase and sale of call and put options on the appropriate index. AFG’s strategy is designed so that the net change in the fair value of the call option assets and put option liabilities will generally offset the economic change in the net liability from the index participation. Both the index-based component of the annuities (an embedded derivative) and the related call and put options are considered derivatives that must be adjusted for changes in fair value through earnings each period. The fair values of these derivatives are impacted by actual and expected stock market performance and interest rates as well as other factors. For a list of other factors impacting the fair value of the index-basedembedded derivative component (embedded derivative) of AFG’s annuity benefits accumulated, see Note C — “Fair Value Measurementsto the financial statements. Fluctuations in certain of these factors, such as changes in interest rates and the performance of the stock market, are not economic in nature for the current reporting period, but rather impact the timing of reported results.

Excluding the impact of the 2018 unlocking charge, theThe net change in fair value of derivatives related to fixed-indexed annuities decreasedincreased annuity benefits by $895 million in the second quarterfirst three months of 2018 and increased annuity benefits by $312019 compared to a decrease of $25 million in the second quarterfirst three months of 2017.2018. The change in the fair value of these derivatives includes $10 million in the first three months of 2019 and $7 million in the first three months of 2018 in interest accreted on the embedded derivative (before DPAC amortization), an increase of $3 million (43%). AFG expects both the size of the embedded derivative and interest rates to rise, resulting in continued increases in interest on the embedded derivative. During the second quarterfirst three months of 2019, the negative impact of significantly lower than anticipated interest rates on the fair value of the embedded derivative was partially offset by the positive impact of very strong stock market performance. During the first three months of 2018, the positive impact of higher than expected interest rates and strong market performance on the fair value of these derivatives was partially offset by the negative impact of higher than expected option costs. During the second quarter of 2017, the positive impact of strongcosts and poor stock market performance on the fair value of these derivatives was more than offset by the negative impact of lower than expected interest rates.performance. As a percentage of average fixed annuity benefits accumulated, thisthe change in fair value of derivatives related to fixed-indexed annuities was a net expense improved 0.49 percentage pointsof 1.03% in the first three months of 2019 compared to a net expense reduction of 0.10%0.30% in the second quarterfirst three months of 2018 from a net expense2018.


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AMERICAN FINANCIAL GROUP, INC. 10-Q
Management’s Discussion and Analysis of 2017.Financial Condition and Results of Operations — Continued


Fluctuations in interest rates and the stock market, among other factors, can cause volatility in the periodic measurement of fair value of the embedded derivative that management believes can be inconsistent with the long-term economics of these products. The table below illustrates the impact of fair value accounting for derivatives related to fixed-indexed annuities on the annuity segment’s earnings before income taxes (dollars in millions):
Three months ended June 30,  Three months ended March 31,  
2018 2017 % Change2019 2018 % Change
Earnings before income taxes — before unlocking and change in fair value of derivatives related to FIAs$123
 $101
 22%
Unlocking(27) 
 %
Earnings before income taxes — before change in fair value of derivatives related to FIAs$134
 $112
 20%
Impact of derivatives related to fixed-indexed annuities:          
Change in fair value of derivatives related to FIAs8
 (31) (126%)(95) 25
 (480%)
Related impact on amortization of DPAC (*)(5) 15
 (133%)
Related impact on amortization of DPAC and accretion of guaranteed withdrawal benefits (*)51
 (12) (525%)
Earnings before income taxes$99
 $85
 16%$90
 $125
 (28%)

(*)An estimate of the related acceleration/deceleration of the amortization of deferred sales inducements and deferred policy acquisition costs.costs and accretion of guaranteed withdrawal benefits.

As illustrated in the table above, the change in fair value of derivatives related to fixed-indexed annuities, including the related impact on amortization of DPAC, decreased the annuity segment’s earnings before income taxes by $44 million in the first three months of 2019 and increased the annuity segment’s earnings before income taxes by $3$13 million in the second quarterfirst three months of 2018 and decreased the annuity segment’s earnings before income taxes by $16 million in the second quarter of 2017.


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Management’s Discussion and Analysis of Financial Condition and Results of Operations — Continued

2018.

The following table provides analysis of the primary factors impacting the change in the fair value of derivatives related to FIAs. Each factor is presented net of the estimated related impact on amortization of DPAC (dollars in millions).
Three months ended June 30,  Three months ended March 31,  
2018 2017 % Change2019 2018 % Change
Interest on the embedded derivative liability$(8) $(4) 100%$(10) $(7) 43%
Changes in interest rates higher (lower) than expected12
 (17) (171%)(45) 27
 (267%)
Change in the stock market, including volatility6
 5
 20%15
 (2) (850%)
Renewal option costs lower (higher) than expected(3) 1
 (400%)
Other, including the impact of actual versus expected lapses(4) (1) 300%
Other(4) (5) (20%)
Impact of derivatives related to FIAs$3
 $(16) (119%)$(44) $13
 (438%)

See Annuity Unlocking below for a discussion of the impact that the unlocking of actuarial assumptions had on theThe change in the fair value of derivatives related to FIAs includes an ongoing expense for annuity interest accreted on the
embedded derivative reserve. The amount of interest accreted in any period is generally based on the size of the embedded
derivative and current interest rates. AFG expects both the size of the embedded derivative liabilityand interest rates to rise, resulting in
continued increases in interest on the second quarter of 2018.embedded derivative liability.

Annuity Net Spread Earned on Fixed Annuities
AFG’s net spread earned on fixed annuities increased 0.07decreased 0.58 percentage points to 1.18%0.96% from 1.11%1.54% in the second quarterfirst three months of 20182019 compared to the same period in 20172018 due primarily to the net impact of changes in the fair value of derivatives and related DPAC amortization offset discussed above and the 0.200.16 percentage points increasedecrease in AFG’s net interest spread, partially offset by the unlocking of actuarial assumptions discussed below.spread.

Annuity Benefits Accumulated
Annuity premiums received 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 and other benefits are charged to expense and decreases for surrender and other policy charges are credited to other income.


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Management’s Discussion and Analysis of Financial Condition and Results of Operations — Continued


For certain products, annuity benefits accumulated also includes reserves for accrued persistency and premium bonuses, excess benefits expected to be paid on future deaths and annuitizations (“EDAR”) and guaranteed withdrawal benefits. Annuity benefits accumulated also includes amounts advanced from the Federal Home Loan Bank of Cincinnati. The following table is a progression of AFG’s annuity benefits accumulated liability for the three months ended June 30, 2018March 31, 2019 and 20172018 (in millions):
Three months ended June 30,Three months ended March 31,
2018 20172019 2018
Beginning fixed annuity reserves$33,652
 $30,719
$36,431
 $33,005
Fixed annuity premiums (receipts)1,393
 1,258
1,390
 1,141
Surrenders, benefits and other withdrawals(706) (571)(761) (627)
Interest and other annuity benefit expenses:      
Interest credited173
 157
194
 166
Embedded derivative mark-to-market82
 112
462
 (63)
Change in other benefit reserves29
 29
8
 30
Unlocking55
 
Ending fixed annuity reserves$34,678
 $31,704
$37,724
 $33,652
      
Reconciliation to annuity benefits accumulated per balance sheet:      
Ending fixed annuity reserves (from above)$34,678
 $31,704
$37,724
 $33,652
Impact of unrealized investment related gains32
 128
108
 71
Fixed component of variable annuities176
 182
174
 178
Annuity benefits accumulated per balance sheet$34,886
 $32,014
$38,006
 $33,901

Annuity benefits accumulated includes a liability of $478 million at March 31, 2019 and $381 million at March 31, 2018 for guaranteed withdrawal benefits on annuities with features that allow the policyholder to take fixed periodic lifetime benefit payments that could exceed account value. As discussed in Note A — Accounting Policies — Annuity Benefits Accumulated,” these reserves are accrued for (accreted) and modified using assumptions consistent with those used to amortize deferred policy acquisition costs. Accordingly, changes in the fair value of derivatives associated with FIAs impact the accretion of the guaranteed withdrawal benefit reserve.

Statutory Annuity Premiums
AFG’s annuity operations generated statutory premiums of $1.40 billion in the first three months of 2019 compared to $1.15 billion in the first three months of 2018, an increase of $247 million (22%). The following table summarizes AFG’s annuity sales (dollars in millions):
 Three months ended March 31,  
2019 2018 % Change
Financial institutions single premium annuities — indexed$424
 $413
 3%
Financial institutions single premium annuities — fixed344
 105
 228%
Retail single premium annuities — indexed301
 294
 2%
Retail single premium annuities — fixed29
 21
 38%
Broker dealer single premium annuities — indexed227
 259
 (12%)
Broker dealer single premium annuities — fixed6
 3
 100%
Pension risk transfer10
 
 %
Education market — fixed and indexed annuities49
 46
 7%
Total fixed annuity premiums1,390
 1,141
 22%
Variable annuities5
 7
 (29%)
Total annuity premiums$1,395
 $1,148
 22%

Management attributes the 22% increase in annuity premiums in the first three months of 2019 compared to the first three months of 2018 to the introduction of new products and efforts to expand in the retail and broker dealer markets. As a result of lower market interest rates during the past several months, AFG recently lowered crediting rates on several products, which has begun to slow annuity sales compared to the fourth quarter of 2018.


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Management’s Discussion and Analysis of Financial Condition and Results of Operations — Continued


Statutory Annuity Premiums
AFG’s annuity operations generated statutory premiums of $1.40 billion in the second quarter of 2018 compared to $1.27 billion in the second quarter of 2017, an increase of $133 million (11%). The following table summarizes AFG’s annuity sales (dollars in millions):
 Three months ended June 30,  
2018 2017 % Change
Financial institutions single premium annuities — indexed$448
 $500
 (10%)
Financial institutions single premium annuities — fixed131
 215
 (39%)
Retail single premium annuities — indexed378
 265
 43%
Retail single premium annuities — fixed23
 19
 21%
Broker dealer single premium annuities — indexed355
 209
 70%
Broker dealer single premium annuities — fixed4
 3
 33%
Education market — fixed and indexed annuities54
 47
 15%
Total fixed annuity premiums1,393
 1,258
 11%
Variable annuities6
 8
 (25%)
Total annuity premiums$1,399
 $1,266
 11%

Management attributes the 11% increase in annuity premiums in the second quarter of 2018 compared to the second quarter of 2017 to the introduction of new products and an improving interest rate environment in the first half of 2018.

On June 21, 2018, the United States Fifth Circuit Court of Appeals (“Fifth Circuit”) issued a mandate of its decision vacating the Department of Labor (“DOL”) Fiduciary Rule in its entirety. The Fifth Circuit’s order to vacate the DOL Fiduciary Rule applies nationwide. The law regarding fiduciary status is once again the law in effect prior to the DOL Fiduciary Rule.

On April 18, 2018, the U.S. Securities and Exchange Commission released a package of regulatory proposals to enhance standards of conduct, including a proposal to enhance the standard of conduct owed by broker-dealers to their clients known as Regulation Best Interest. If adopted as proposed, the Regulation Best Interest would heighten the standard that registered representatives need to meet when making a recommendation by requiring them to act in the best interest of the retail customer at the time of the recommendation. Regulation Best Interest further proposes that satisfying this duty would require (i) disclosing to the customer the key facts about the relationship, (ii) exercising reasonable diligence, care, skill and prudence in recommending a product that is in the client’s best interest, and (iii) disclosing, mitigating or eliminating conflicts of interests arising from financial incentives and disclosing other conflicts.

Although approximately 70-75% of AFG’s premiums come through registered representatives associated with broker-dealers, neither traditional fixed annuities nor fixed-indexed annuities are securities. Based on AFG’s initial assessment, if the proposals are adopted as is, the new requirements would not be expected to have a material impact on AFG’s premiums.


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Management’s Discussion and Analysis of Financial Condition and Results of Operations — Continued


Annuity Unlocking
AFG monitors the major actuarial assumptions underlying its annuity operations throughout the year and conducts detailed reviews (“unlocking”) of its assumptions in the fourth quarter of each year. If changes in the economic environment or actual experience would cause material revisions to future estimates, these assumptions are updated (unlocked) in an interim quarter. Due to continued higher FIA option costs (resulting primarily from higher than expected risk-free interest rates), AFG unlocked its assumptions for option costs, interest rates and policyholder lapse behavior in the second quarter of 2018. AFG will continue its practice of conducting detailed reviews of its assumptions (including option costs and interest rates) in the fourth quarter each year, including 2018.

The unlocking of the major actuarial assumptions underlying AFG’s annuity operations in the second quarter of 2018 resulted in a net charge related to its annuity business of $27 million, which impacted AFG’s financial statements as follows (in millions):
  Three months ended June 30,
  2018 2017
Policy charges and other miscellaneous income:    
Unearned revenue $(1) $
Total revenues (1) 
Annuity benefits:    
Fixed-indexed annuity embedded derivative 44
 
Sales inducements (1) 
Other reserves 11
 
Total annuity benefits 54
 
Annuity and supplemental insurance acquisition expenses:    
Deferred policy acquisition costs (28) 
Total costs and expenses 26
 
Net charge $(27) $

The net charge from unlocking annuity assumptions in the second quarter of 2018 is due primarily to the unfavorable impact of higher projected option costs, partially offset by the favorable impact of an increase in projected net interest spreads on in-force business (due primarily to higher than previously anticipated reinvestment rates). Reinvestment rate assumptions are based primarily on 7-year and 10-year corporate bond yields. For the 2018 unlocking, AFG assumed a net reinvestment rate (net of default and expense assumptions) of 4.44% in the second half of 2018, grading up ratably to an ultimate net reinvestment rate of 5.55% in 2022 and beyond.

The table below compares the reinvestment rate assumed on assets purchased to directly support “fixed annuity benefits accumulated” in AFG’s fourth quarter unlockings for the next calendar year to the actual reinvestment rate achieved in that period (both net of investment expenses):
  First    
Unlocking Investment Reinvestment Rate
Year Period Assumed (a) Achieved
2014 2015 3.75% 4.27%
2015 2016 4.05% 4.27%
2016 2017 4.42% 3.95%
2017      2018 (b) 4.17% 4.43%
2018 July 2018 4.62% n/a
(a)Assumed reinvestment rates exclude default rates of 0.18% in each period.
(b)Reinvestment rate achieved is for the six months ended June 30, 2018.

Management believes that these results over the last several years demonstrate that AFG’s investment rate assumptions are reasonable and prudent. During 2017, long-term interest rates were lower than anticipated and credit spreads narrowed, resulting in a lower achieved reinvestment rate than assumed in the 2016 unlocking. In addition to the reinvestment rates above, actual default rates in the first six months of 2018 and in 2017, 2016 and 2015 were lower than the long-term default rates of 0.18% assumed in the unlocking in each of the periods above.

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Management’s Discussion and Analysis of Financial Condition and Results of Operations — Continued



Annuity Earnings before Income Taxes Reconciliation
The following table reconciles the net spread earned on AFG’s fixed annuities to overall annuity pretax earnings for the three months ended June 30, 2018March 31, 2019 and 20172018 (in millions):
Three months ended June 30,Three months ended March 31,
2018 20172019 2018
Earnings on fixed annuity benefits accumulated$101
 $87
$89
 $128
Earnings impact of investments in excess of fixed annuity benefits accumulated (*)(3) (3)(1) (4)
Variable annuity earnings1
 1
2
 1
Earnings before income taxes$99
 $85
$90
 $125

(*)
Net investment income (as a % of investments) of 4.83%4.68% and 4.62%4.74% for the three months ended June 30, 2018March 31, 2019 and 20172018, respectively, multiplied by the difference between average fixed annuity investments (at amortized cost) and average fixed annuity benefits accumulated in each period.

Holding Company, Other and Unallocated — Results of Operations   AFG’s net GAAP pretax loss outside of its property and casualty insurance and annuity operations (excluding realized gains and losses) totaled $48 million in the second quarter of 2018 compared to $51 million in the second quarter of 2017, a decrease of $3 million (6%). AFG’s net core pretax loss outside of its property and casualty insurance and annuity operations (excluding realized gains and losses) totaled $48$43 million in the secondfirst quarterthree months of 20182019 compared to $44$42 million in the secondfirst quarterthree months of 2017,2018, an increase of $4$1 million (9%(2%).

The following table details AFG’s GAAP and core loss before income taxes from operations outside of its property and casualty insurance and annuity operations for the three months ended June 30, 2018March 31, 2019 and 20172018 (dollars in millions):
Three months ended June 30,  Three months ended March 31,  
2018 2017 % Change2019 2018 % Change
Revenues:          
Life, accident and health net earned premiums$6
 $5
 20%$6
 $6
 %
Net investment income7
 9
 (22%)14
 4
 250%
Other income — P&C fees15
 15
 %15
 17
 (12%)
Other income3
 7
 (57%)8
 8
 %
Total revenues31
 36
 (14%)43
 35
 23%
          
Costs and Expenses, excluding interest charges on borrowed money     
Costs and Expenses:     
Property and casualty insurance — commissions and other underwriting expenses4
 8
 (50%)5
 6
 (17%)
Life, accident and health benefits11
 6
 83%9
 11
 (18%)
Life, accident and health acquisition expenses1
 1
 %2
 1
 100%
Other expense — expenses associated with P&C fees11
 7
 57%10
 11
 (9%)
Other expenses (*)36
 35
 3%
Other expenses44
 33
 33%
Costs and expenses, excluding interest charges on borrowed money63
 57
 11%70
 62
 13%
Core loss before income taxes, excluding realized gains and losses and interest charges on borrowed money(32) (21) 52%
Loss before income taxes, excluding realized gains and losses and interest charges on borrowed money(27) (27) %
Interest charges on borrowed money16
 23
 (30%)16
 15
 7%
Core loss before income taxes, excluding realized gains and losses(48) (44) 9%
Pretax non-core loss on retirement of debt
 (7) (100%)
GAAP loss before income taxes, excluding realized gains and losses$(48) $(51) (6%)
Loss before income taxes, excluding realized gains and losses$(43) $(42) 2%

(*)Excludes a pretax non-core loss on retirement of debt of $7 million in the second quarter of 2017.

Holding Company and Other — Life, Accident and Health Premiums, Benefits and Acquisition Expenses
AFG’s run-off long-term care and life insurance operations recorded net earned premiums of $6 million and related benefits and acquisition expenses of $12$11 million in the secondfirst quarterthree months of 20182019 compared to net earned premiums of $5$6 million and related benefits and acquisition expenses of $7$12 million in the secondfirst quarterthree months of 2017.2018. The $5$2 million (83%(18%) increasedecrease in life, accident and health benefits reflects higherlower claims in the run-off life insurance business.

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AMERICAN FINANCIAL GROUP, INC. 10-Q
Management’s Discussion and Analysis of Financial Condition and Results of Operations — Continued


Holding Company and Other — Net Investment Income
AFG recorded net investment income on investments held outside of its property and casualty insurance and annuity operations of $7$14 million in the secondfirst quarterthree months of 20182019 compared to $9$4 million in the secondfirst quarterthree months of 2017, a decrease2018, an increase of $2$10 million (22%(250%). The parent company holds a small portfolio of securities that are carried at fair value through net investment income. These securities decreasedincreased in value by $1$6 million in the secondfirst quarterthree months of 20182019 compared to an increasea $1 million decrease in value by $1 million in the secondfirst quarterthree months of 2017.2018.

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AMERICAN FINANCIAL GROUP, INC. 10-Q
Management’s Discussion and Analysis of Financial Condition and Results of Operations — Continued



Holding Company and Other — P&C Fees and Related Expenses
Summit, a workers’ compensation insurance subsidiary, collects fees from a small group of unaffiliated insurers for providing underwriting, policy administration and claims services. In addition, certain of AFG’s property and casualty insurance businesses collect fees from customers for ancillary services such as workplace safety programs and premium financing. In both the secondfirst quarterthree months of 2018 and 2017,2019, AFG collected $15 million in fees for these services.services compared to $17 million in the first three months of 2018. Management views this fee income, net of the $10 million in the first three months of 2019 and $11 million in the secondfirst quarterthree months of 2018, and $7 million in the second quarter of 2017, in expenses incurred to generate such fees, as a reduction in the cost of underwriting its property and casualty insurance policies. Consistent with internal management reporting, these fees and the related expenses are netted and recorded as a reduction of commissions and other underwriting expenses in AFG’s segmented results.

Holding Company and Other — Other Income
Other income in the table above includes $3 million in the first three months of 2019 and $4 million in the secondfirst quarterthree months of 2018, and $5 million in the second quarter of 2017, in management fees paid to AFG by the AFG-managed CLOs (AFG’s consolidated managed investment entities). The management fees are eliminated in consolidation — see the other income line in the Consolidate MIEs column under “Results of Operations — Segmented Statement of Earnings.” AFG recorded a $2 million loss on the disposal of equipment in the second quarter of 2018. Excluding amounts eliminated in consolidation, and the loss on the disposal of equipment, AFG recorded other income outside of its property and casualty insurance and annuity operations of $1$5 million in the secondfirst quarterthree months of 20182019 compared to $2$4 million in the secondfirst quarterthree months of 2017.2018.

Holding Company and Other — Other Expenses
Excluding the non-core loss on retirement of debt discussed below, AFG’s holding companies and other operations outside of its property and casualty insurance and annuity operations recorded other expenses of $36$44 million in the secondfirst quarterthree months of 20182019 compared to $35$33 million in the secondfirst quarterthree months of 2017,2018, an increase of $1$11 million (3%(33%). The secondThis increase reflects a $3 million charitable donation in the first quarter of 2018 reflects lower2019 and higher holding company expenses related to employee benefit plans that are tied to stock market performance offset by a $5 million charge to increase liabilities relatedin the first three months of 2019 compared to the environmental exposures of AFG’s former railroad and manufacturing operations.2018 period.

Holding Company and Other — Interest Charges on Borrowed Money
AFG’s holding companies and other operations outside of its property and casualty insurance and annuity operations recorded interest expense of $16 million in the secondfirst quarterthree months of 20182019 compared to $23$15 million in the secondfirst quarterthree months of 2017, a decrease2018, an increase of $7$1 million (30%(7%) due primarily to a lower weighted average interest rate on AFG’s outstanding debt.. The following table details the principal amount of AFG’s long-term debt balances as of April 1, 2018March 31, 2019 compared to April 1, 2017March 31, 2018 (dollars in millions):
 April 1,
2018
 April 1,
2017
Direct obligations of AFG:   
4.50% Senior Notes due June 2047$590
 $
3.50% Senior Notes due August 2026425
 300
9-7/8% Senior Notes due June 2019
 350
6-3/8% Senior Notes due June 2042
 230
5-3/4% Senior Notes due August 2042
 125
6-1/4% Subordinated Debentures due September 2054150
 150
6% Subordinated Debentures due November 2055150
 150
Other3
 3
Total principal amount of Holding Company Debt$1,318
 $1,308
    
Weighted Average Interest Rate4.6% 6.5%


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AMERICAN FINANCIAL GROUP, INC. 10-Q
Management’s Discussion and Analysis of Financial Condition and Results of Operations — Continued

 March 31,
2019
 March 31,
2018
Direct obligations of AFG:   
4.50% Senior Notes due June 2047$590
 $590
3.50% Senior Notes due August 2026425
 425
6-1/4% Subordinated Debentures due September 2054150
 150
6% Subordinated Debentures due November 2055150
 150
5.875% Subordinated Debentures due March 2059125
 
Other3
 3
Total principal amount of Holding Company Debt$1,443
 $1,318
    
Weighted Average Interest Rate4.7% 4.6%

The decrease in the weighted average interest rate for the second quarter of 2018 as compared to the second quarter of 2017 reflects the following financing transactions completed by AFG between April 1, 2017 and December 31, 2017:
Issued $350 million of 4.50% Senior Notes on June 2, 2017
Redeemed $230 million of 6-3/8% Senior Notes on June 26, 2017
Redeemed $125 million of 5-3/4% Senior Notes on August 25, 2017
Issued an additional $125 million of 3.50% Senior Notes on November 9, 2017
Issued an additional $240 million of 4.50% Senior Notes on November 9, 2017
Redeemed $350 million of 9-7/8% Senior Notes on December 11, 2017

Holding Company and Other — Loss on Retirement of Debt
AFG wrote off unamortized debt issuance costs of $7 million related to the redemption of its $230 million outstanding 6-3/8% Senior Notes due 2042 at par value in June 2017.

Consolidated Realized Gains (Losses) on Securities AFG’s consolidated realized gains (losses) on securities, which are not allocated to segments, were a net gain of $31 million in the second quarter of 2018 compared to $8 million in the second quarter of 2017, an increase of $23 million (288%). Realized gains (losses) on securities consisted of the following (in millions):
 Three months ended June 30,
2018 2017
Realized gains (losses) before impairments:   
Disposals$5
 $22
Change in the fair value of equity securities (*)23
 
Change in the fair value of derivatives(1) (3)
Adjustments to annuity deferred policy acquisition costs and related items4
 (2)
 31
 17
Impairment charges:   
Securities
 (12)
Adjustments to annuity deferred policy acquisition costs and related items
 3
 
 (9)
Realized gains on securities$31
 $8

(*)
As discussed in Note A — “Accounting PoliciesInvestments,” beginning in January 2018, all equity securities other than those accounted for under the equity method are carried at fair value through net earnings. This amount includes a $16 million net gain on securities that were still held at June 30, 2018.

The $23 million net realized gain from the change in the fair value of equity securities in the second quarter of 2018 includes gains of $10 million on real estate investment trusts, $8 million on health care-related investments and losses of $7 million from investments in banks and financing companies. AFG’s $12 million in impairment charges for the second quarter of 2017 related primarily to equity security investments in a pharmaceutical company and an energy-related business.

Consolidated Income Taxes   AFG’s consolidated provision for income taxes was $52 million for the second quarter of 2018 compared to $60 million for the second quarter of 2017, a decrease of $8 million (13%). See NoteL — “Income Taxesto the financial statements for an analysis of items affecting AFG’s effective tax rate.

Consolidated Noncontrolling Interests   AFG’s consolidated net earnings (losses) attributable to noncontrolling interests was a net loss of $2 million for the second quarter of 2018 related to losses at Neon, AFG’s United Kingdom-based Lloyd’s insurer.


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AMERICAN FINANCIAL GROUP, INC. 10-Q
Management’s Discussion and Analysis of Financial Condition and Results of Operations — Continued


RESULTS OF OPERATIONS — SIX MONTHS ENDED JUNE 30, 2018 AND 2017

Segmented Statement of Earnings   AFG reports its business as three segments: (i) Property and casualty insurance (“P&C”), (ii) Annuity and (iii) Other, which includes run-off long-term care and life, holding company costs and income and expenses related to the managed investment entities (“MIEs”).

Effective January 1, 2018, the results of AFG’s run-off long-term care and life businesses are included in the “Other” segment instead of as a separate reportable segment based on the immaterial size of the remaining operations. Prior periods amounts were reclassified for consistent presentation.

AFG’s net earnings attributable to shareholders, determined in accordance with GAAP, include certain items that may not be indicative of its ongoing core operations. The following tables for the six months ended June 30, 2018 and 2017 identify such items by segment and reconcile net earnings attributable to shareholders to core net operating earnings, a non-GAAP financial measure that AFG believes is a useful tool for investors and analysts in analyzing ongoing operating trends (in millions):
     Other      
 P&C Annuity Consol. MIEs Holding Co., other and unallocated Total Non-core reclass GAAP Total
Six months ended June 30, 2018             
Revenues:             
Property and casualty insurance net earned premiums$2,268
 $
 $
 $
 $2,268
 $
 $2,268
Life, accident and health net earned premiums
 
 
 12
 12
 
 12
Net investment income215
 806
 (7) 11
 1,025
 
 1,025
Realized losses on securities
 
 
 
 
 (62) (62)
Income (loss) of MIEs:             
Investment income
 
 122
 
 122
 
 122
Gain (loss) on change in fair value of assets/liabilities
 
 (5) 
 (5) 
 (5)
Other income4
 53
 (8) 43
 92
 
 92
Total revenues2,487
 859
 102
 66
 3,514
 (62) 3,452
              
Costs and Expenses:             
Property and casualty insurance:             
Losses and loss adjustment expenses1,334
 
 
 
 1,334
 
 1,334
Commissions and other underwriting expenses771
 
 
 10
 781
 
 781
Annuity benefits
 442
 
 
 442
 
 442
Life, accident and health benefits
 
 
 22
 22
 
 22
Annuity and supplemental insurance acquisition expenses
 130
 
 2
 132
 
 132
Interest charges on borrowed money
 
 
 31
 31
 
 31
Expenses of MIEs
 
 102
 
 102
 
 102
Other expenses20
 63
 
 91
 174
 
 174
Total costs and expenses2,125
 635
 102
 156
 3,018
 
 3,018
Earnings before income taxes362
 224
 
 (90) 496
 (62) 434
Provision for income taxes74
 46
 
 (22) 98
 (13) 85
Net earnings, including noncontrolling interests288
 178
 
 (68) 398
 (49) 349
Less: Net earnings (loss) attributable to noncontrolling interests(6) 
 
 
 (6) 
 (6)
Core Net Operating Earnings294
 178
 
 (68) 404
    
Non-core earnings attributable to shareholders (a):             
Realized losses on securities, net of tax
 
 
 (49) (49) 49
 
Net Earnings Attributable to Shareholders$294
 $178
 $
 $(117) $355
 $
 $355

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AMERICAN FINANCIAL GROUP, INC. 10-Q
Management’s Discussion and Analysis of Financial Condition and Results of Operations — Continued


     Other      
 P&C Annuity Consol. MIEs Holding Co., other and unallocated Total Non-core reclass GAAP Total
Six months ended June 30, 2017             
Revenues:             
Property and casualty insurance net earned premiums$2,087
 $
 $
 $
 $2,087
 $
 $2,087
Life, accident and health net earned premiums
 
 
 11
 11
 
 11
Net investment income182
 707
 (11) 17
 895
 
 895
Realized gains on securities
 
 
 
 
 11
 11
Income of MIEs:             
Investment income
 
 101
 
 101
 
 101
Gain on change in fair value of assets/liabilities
 
 11
 
 11
 
 11
Other income20
 53
 (9) 42
 106
 
 106
Total revenues2,289
 760
 92
 70
 3,211
 11
 3,222
              
Costs and Expenses:             
Property and casualty insurance:             
Losses and loss adjustment expenses1,244
 
 
 
 1,244
 
 1,244
Commissions and other underwriting expenses693
 
 
 12
 705
 
 705
Annuity benefits
 420
 
 
 420
 
 420
Life, accident and health benefits
 
 
 15
 15
 
 15
Annuity and supplemental insurance acquisition expenses
 99
 
 2
 101
 
 101
Interest charges on borrowed money
 
 
 44
 44
 
 44
Expenses of MIEs
 
 92
 
 92
 
 92
Other expenses18
 60
 
 88
 166
 7
 173
Total costs and expenses1,955
 579
 92
 161
 2,787
 7
 2,794
Earnings before income taxes334
 181
 
 (91) 424
 4
 428
Provision for income taxes107
 62
 
 (43) 126
 2
 128
Net earnings, including noncontrolling interests227
 119
 
 (48) 298
 2
 300
Less: Net earnings attributable to noncontrolling interests2
 
 
 
 2
 
 2
Core Net Operating Earnings225
 119
 
 (48) 296
    
Non-core earnings attributable to shareholders (a):             
Realized gains on securities, net of tax
 
 
 7
 7
 (7) 
Loss on retirement of debt, net of tax
 
 
 (5) (5) 5
 
Net Earnings Attributable to Shareholders$225
 $119
 $
 $(46) $298
 $
 $298

(a)
See the reconciliation of core earnings to GAAP net earnings under “Results of Operations — General” for details on the tax and noncontrolling interest impacts of these reconciling items.

Property and Casualty Insurance Segment — Results of Operations   AFG’s property and casualty insurance operations contributed $362 million in pretax earnings in the first six months of 2018 compared to $334 million in the first six months of 2017, an increase of $28 million (8%). The increase in pretax earnings reflects higher underwriting profit in the Specialty casualty insurance sub-segment and higher net investment income, due primarily to higher earnings from limited partnerships and similar investments, partially offset by lower underwriting profits in the Property and transportation and Specialty financial insurance sub-segments and lower income from the sale of real estate in the first six months of 2018 compared to the first six months of 2017. The high returns on limited partnerships and similar investments should not necessarily be expected to repeat in future periods.


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AMERICAN FINANCIAL GROUP, INC. 10-Q
Management’s Discussion and Analysis of Financial Condition and Results of Operations — Continued


The following table details AFG’s earnings before income taxes from its property and casualty insurance operations for the six months ended June 30, 2018 and 2017 (dollars in millions):

 Six months ended June 30,  
 2018 2017 % Change
Gross written premiums$3,123
 $2,827
 10%
Reinsurance premiums ceded(764) (670) 14%
Net written premiums2,359
 2,157
 9%
Change in unearned premiums(91) (70) 30%
Net earned premiums2,268
 2,087
 9%
Loss and loss adjustment expenses1,334
 1,244
 7%
Commissions and other underwriting expenses771
 693
 11%
Underwriting gain163
 150
 9%
      
Net investment income215
 182
 18%
Other income and expenses, net(16) 2
 (900%)
Earnings before income taxes$362
 $334
 8%
      
Combined Ratios:     
Specialty lines    Change
Loss and LAE ratio58.8% 59.5% (0.7%)
Underwriting expense ratio34.0% 33.2% 0.8%
Combined ratio92.8% 92.7% 0.1%
      
Aggregate — including exited lines     
Loss and LAE ratio58.8% 59.6% (0.8%)
Underwriting expense ratio34.0% 33.2% 0.8%
Combined ratio92.8% 92.8% %

AFG reports the underwriting performance of its Specialty property and casualty insurance business in the following sub-segments: (i) Property and transportation, (ii) Specialty casualty and (iii) Specialty financial.

Gross Written Premiums
Gross written premiums (“GWP”) for AFG’s property and casualty insurance segment were $3.12 billion for the first six months of 2018 compared to $2.83 billion for the first six months of 2017, an increase of $296 million (10%). Detail of AFG’s property and casualty gross written premiums is shown below (dollars in millions):
 Six months ended June 30,  
 2018 2017  
 GWP % GWP % % Change
Property and transportation$1,041
 33% $989
 35% 5%
Specialty casualty1,711
 55% 1,500
 53% 14%
Specialty financial371
 12% 338
 12% 10%
 $3,123
 100% $2,827
 100% 10%


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AMERICAN FINANCIAL GROUP, INC. 10-Q
Management’s Discussion and Analysis of Financial Condition and Results of Operations — Continued


Reinsurance Premiums Ceded
Reinsurance premiums ceded (“Ceded”) for AFG’s property and casualty insurance segment were 24% of gross written premiums for both the first six months of 2018 and the first six months of 2017. Detail of AFG’s property and casualty reinsurance premiums ceded is shown below (dollars in millions):
 Six months ended June 30,  
 2018 2017 Change in
 Ceded % of GWP Ceded % of GWP % of GWP
Property and transportation$(295) 28% $(272) 28% %
Specialty casualty(478) 28% (399) 27% 1%
Specialty financial(64) 17% (48) 14% 3%
Other specialty73
   49
    
 $(764) 24% $(670) 24% %

Net Written Premiums
Net written premiums (“NWP”) for AFG’s property and casualty insurance segment were $2.36 billion for the first six months of 2018 compared to $2.16 billion for the first six months of 2017, an increase of $202 million (9%). Detail of AFG’s property and casualty net written premiums is shown below (dollars in millions):
 Six months ended June 30,  
 2018 2017  
 NWP % NWP % % Change
Property and transportation$746
 32% $717
 33% 4%
Specialty casualty1,233
 52% 1,101
 51% 12%
Specialty financial307
 13% 290
 13% 6%
Other specialty73
 3% 49
 3% 49%
 $2,359
 100% $2,157
 100% 9%

Net Earned Premiums
Net earned premiums (“NEP”) for AFG’s property and casualty insurance segment were $2.27 billion for the first six months of 2018 compared to $2.09 billion for the first six months of 2017, an increase of $181 million (9%). Detail of AFG’s property and casualty net earned premiums is shown below (dollars in millions):
 Six months ended June 30,  
 2018 2017  
 NEP % NEP % % Change
Property and transportation$724
 32% $699
 33% 4%
Specialty casualty1,174
 52% 1,045
 50% 12%
Specialty financial308
 13% 293
 14% 5%
Other specialty62
 3% 50
 3% 24%
 $2,268
 100% $2,087
 100% 9%

The $296 million (10%) increase in gross written premiums for the first six months of 2018 compared to the first six months of 2017 reflects growth in each of the Specialty property and casualty insurance sub-segments. Overall average renewal rates increased approximately 1% in the first six months of 2018. Excluding the workers’ compensation business, renewal pricing increased approximately 3%.

Property and transportation Gross written premiums increased$52 million (5%) in the first six months of 2018 compared to the first six months of 2017. This increase was the result of new business opportunities in the property and inland marine businesses and higher premiums in the transportation businesses, which included a 5% average renewal rate increase in National Interstate’s business. Average renewal rates increased approximately 4% for this group in the first six months of 2018. Reinsurance premiums ceded as a percentage of gross written premiums are comparable between periods.

Specialty casualty Gross written premiums increased$211 million (14%) in the first six months of 2018 compared to the first six months of 2017 due primarily to growth at Neon. Higher gross written premiums in the general liability, executive liability and excess and surplus lines businesses also contributed to the year-over-year growth. Average renewal rates decreased

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AMERICAN FINANCIAL GROUP, INC. 10-Q
Management’s Discussion and Analysis of Financial Condition and Results of Operations — Continued


approximately 1% for this group in the first six months of 2018. Excluding rate decreases in the workers’ compensation businesses, renewal rates for this group increased approximately 2%. Reinsurance premiums ceded as a percentage of gross written premiums increased 1 percentage point for the first six months of 2018 compared to the first six months of 2017, reflecting higher cessions to AFG’s internal reinsurance program, which is included in Other specialty.

Specialty financial Gross written premiums increased $33 million (10%) in the first six months of 2018 compared to the first six months of 2017 due primarily to higher premiums in the financial institutions and equipment leasing businesses. Average renewal rates for this group increased approximately 4% in the first six months of 2018. Reinsurance premiums ceded as a percentage of gross written premiums increased 3 percentage points for the first six months of 2018 compared to the first six months of 2017, reflecting higher cessions in the financial institutions and equipment leasing businesses.

Other specialty The amounts shown as reinsurance premiums ceded represent business assumed by AFG’s internal reinsurance program from the operations that make up AFG’s other Specialty property and casualty insurance sub-segments. Reinsurance premiums assumed increased $24 million (49%) in the first six months of 2018 compared to the first six months of 2017, reflecting an increase in premiums retained, primarily from businesses in the Specialty casualty sub-segment.

Combined Ratio
The table below (dollars in millions) details the components of the combined ratio for AFG’s property and casualty segment:
 Six months ended June 30,   Six months ended June 30,
 2018 2017 Change 2018 2017
Property and transportation         
Loss and LAE ratio63.4% 62.8% 0.6%    
Underwriting expense ratio28.8% 27.9% 0.9%    
Combined ratio92.2% 90.7% 1.5%    
Underwriting profit      $56
 $64
          
Specialty casualty         
Loss and LAE ratio61.5% 64.1% (2.6%)    
Underwriting expense ratio32.5% 31.7% 0.8%    
Combined ratio94.0% 95.8% (1.8%)    
Underwriting profit      $70
 $44
          
Specialty financial         
Loss and LAE ratio37.0% 34.4% 2.6%    
Underwriting expense ratio50.9% 50.4% 0.5%    
Combined ratio87.9% 84.8% 3.1%    
Underwriting profit      $37
 $45
          
Total Specialty         
Loss and LAE ratio58.8% 59.5% (0.7%)    
Underwriting expense ratio34.0% 33.2% 0.8%    
Combined ratio92.8% 92.7% 0.1%    
Underwriting profit      $165
 $152
          
Aggregate — including exited lines         
Loss and LAE ratio58.8% 59.6% (0.8%)    
Underwriting expense ratio34.0% 33.2% 0.8%    
Combined ratio92.8% 92.8% %    
Underwriting profit      $163
 $150

The Specialty property and casualty insurance operations generated an underwriting profit of $165 million for the first six months of 2018 compared to $152 million for the first six months of 2017, an increase of $13 million (9%). Higher underwriting profit in the Specialty casualty insurance sub-segment was partially offset by lower underwriting profits in the Property and transportation and Specialty financial insurance sub-segments.

Property and transportation Underwriting profit for this group was $56 million for the first six months of 2018 compared to $64 million for the first six months of 2017, a decrease of $8 million (13%). Higher underwriting profit in the crop business and

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AMERICAN FINANCIAL GROUP, INC. 10-Q
Management’s Discussion and Analysis of Financial Condition and Results of Operations — Continued


improved results in the ocean marine operations were more than offset by lower underwriting profits in the property and inland marine and equine businesses.

Specialty casualty Underwriting profit for this group was $70 million for the first six months of 2018 compared to $44 million for the first six months of 2017, an increase of $26 million (59%). Higher underwriting profits in the workers’ compensation businesses due primarily to higher favorable prior year reserve development and improved results in the targeted markets businesses were partially offset by higher underwriting losses at Neon.

Specialty financial Underwriting profit for this group was $37 million for the first six months of 2018 compared to $45 million for the first six months of 2017, a decrease of $8 million (18%) due primarily to lower underwriting profitability in the fidelity and surety businesses.

Other specialty This group reported an underwriting profit of $2 million for the first six months of 2018 compared to an underwriting loss of $1 million in the first six months of 2017, a change of $3 million (300%). This improvement is due primarily to a $6 million charge recorded in 2017 to adjust the deferred gain on the retroactive reinsurance transaction entered into in connection with the sale of businesses in 1998, partially offset by adverse prior year reserve development in the business assumed by AFG’s internal reinsurance program from the operations that make up AFG’s other Specialty sub-segments in the first six months of 2018 compared to favorable reserve development in the first six months of 2017.

Losses and Loss Adjustment Expenses
AFG’s overall loss and LAE ratio was 58.8% for the first six months of 2018 compared to 59.6% for the first six months of 2017, a decrease of 0.8 percentage points. The components of AFG’s property and casualty losses and LAE amounts and ratio are detailed below (dollars in millions):
 Six months ended June 30,  
 Amount Ratio Change in
 2018 2017 2018 2017 Ratio
Property and transportation         
Current year, excluding catastrophe losses$483
 $452
 66.7% 64.6% 2.1%
Prior accident years development(39) (28) (5.4%) (4.0%) (1.4%)
Current year catastrophe losses15
 16
 2.1% 2.2% (0.1%)
Property and transportation losses and LAE and ratio$459
 $440
 63.4% 62.8% 0.6%
          
Specialty casualty         
Current year, excluding catastrophe losses$767
 $678
 65.2% 64.8% 0.4%
Prior accident years development(50) (11) (4.2%) (1.0%) (3.2%)
Current year catastrophe losses6
 3
 0.5% 0.3% 0.2%
Specialty casualty losses and LAE and ratio$723
 $670
 61.5% 64.1% (2.6%)
          
Specialty financial         
Current year, excluding catastrophe losses$119
 $112
 38.7% 38.2% 0.5%
Prior accident years development(11) (17) (3.6%) (5.8%) 2.2%
Current year catastrophe losses6
 6
 1.9% 2.0% (0.1%)
Specialty financial losses and LAE and ratio$114
 $101
 37.0% 34.4% 2.6%
          
Total Specialty         
Current year, excluding catastrophe losses$1,405
 $1,269
 62.0% 60.8% 1.2%
Prior accident years development(102) (52) (4.5%) (2.5%) (2.0%)
Current year catastrophe losses29
 25
 1.3% 1.2% 0.1%
Total Specialty losses and LAE and ratio$1,332
 $1,242
 58.8% 59.5% (0.7%)
          
Aggregate — including exited lines         
Current year, excluding catastrophe losses$1,405
 $1,269
 62.0% 60.8% 1.2%
Prior accident years development(100) (50) (4.5%) (2.4%) (2.1%)
Current year catastrophe losses29
 25
 1.3% 1.2% 0.1%
Aggregate losses and LAE and ratio$1,334
 $1,244
 58.8% 59.6% (0.8%)

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AMERICAN FINANCIAL GROUP, INC. 10-Q
Management’s Discussion and Analysis of Financial Condition and Results of Operations — Continued


Current accident year losses and LAE, excluding catastrophe losses
The current accident year loss and LAE ratio, excluding catastrophe losses for AFG’s Specialty property and casualty insurance operations was 62.0% for the first six months of 2018 compared to 60.8% for the first six months of 2017, an increase of 1.2 percentage points.

Property and transportation   The 2.1 percentage point increase in the loss and LAE ratio for the current year, excluding catastrophe losses reflects an increase in the loss and LAE ratio of the property and inland marine and equine businesses in the first six months of 2018 compared to the first six months of 2017.

Specialty casualty   The 0.4 percentage point increase in the loss and LAE ratio for the current year, excluding catastrophe losses reflects an increase in the loss and LAE ratio of the targeted markets businesses.

Specialty financial   The 0.5 percentage point increase in the loss and LAE ratio for the current year, excluding catastrophe losses reflects an increase in the loss and LAE ratio of the trade credit business.

Net prior year reserve development
AFG’s Specialty property and casualty insurance operations recorded net favorable reserve development related to prior accident years of $102 million in the first six months of 2018 compared to $52 million in the first six months of 2017, an increase of $50 million (96%).

Property and transportation Net favorable reserve development of $39 million in the first six months of 2018 reflects lower than expected losses in the crop business and lower than expected claim severity in the transportation businesses. Net favorable reserve development of $28 million in the first six months of 2017 reflects lower than expected losses in the crop and equine businesses and lower than expected claim severity in the property and inland marine business, partially offset by higher than expected claim severity in the ocean marine business.

Specialty casualty Net favorable reserve development of $50 million in the first six months of 2018 reflects lower than anticipated claim frequency and severity in the workers’ compensation businesses. Net favorable reserve development of $11 million in the first six months of 2017 reflects lower than expected claim severity in the workers’ compensation businesses and at Neon, partially offset by higher than expected claim severity in the targeted markets and general liability businesses.

Specialty financial Net favorable reserve development of $11 million in the first six months of 2018 reflects lower than expected claim frequency and severity in the surety business and lower than expected claim severity in the fidelity business. Net favorable reserve development of $17 million in the first six months of 2017 reflects lower than anticipated claim severity in the fidelity business and lower than expected claim frequency and severity in the surety business.

Other specialty In addition to the development discussed above, total Specialty prior year reserve development includes net favorable reserve development of $2 million in the first six months of 2018 and net adverse reserve development of $4 million in the first six months of 2017. The favorable development in the first six months of 2018 reflects amortization of the deferred gains on the retroactive reinsurance transactions entered into in connection with the sale of businesses in 1998 and 2001, partially offset by adverse reserve development associated with AFG’s internal reinsurance program. The adverse reserve development in the first six months of 2017 reflects a $6 million charge to adjust the deferred gain on the retroactive reinsurance transaction entered into in connection with the sale of businesses in 1998, partially offset by the amortization of deferred gains on retroactive reinsurance and favorable reserve development associated with AFG’s internal reinsurance program.

Aggregate Aggregate net prior accident years reserve development for AFG’s property and casualty insurance segment includes net adverse reserve development of $2 million in both the first six months of 2018 and the first six months of 2017 related to business outside the Specialty group that AFG no longer writes.

Catastrophe losses
Catastrophe losses of $29 million in the first six months of 2018 resulted primarily from storms and flooding in several regions of the United States and mudslides in California. Catastrophe losses of $25 million in the first six months of 2017 resulted primarily from storms and tornadoes in several regions of the United States.


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AMERICAN FINANCIAL GROUP, INC. 10-Q
Management’s Discussion and Analysis of Financial Condition and Results of Operations — Continued


Commissions and Other Underwriting Expenses
AFG’s property and casualty commissions and other underwriting expenses (“U/W Exp”) were $771 million in the first six months of 2018 compared to $693 million for the first six months of 2017, an increase of $78 million (11%). AFG’s underwriting expense ratio was 34.0% for the first six months of 2018 compared to 33.2% for the first six months of 2017, an increase of 0.8 percentage points. Detail of AFG’s property and casualty commissions and other underwriting expenses and underwriting expense ratios is shown below (dollars in millions):
 Six months ended June 30,  
 2018 2017 Change in
 U/W Exp % of NEP U/W Exp % of NEP % of NEP
Property and transportation$209
 28.8% $195
 27.9% 0.9%
Specialty casualty381
 32.5% 331
 31.7% 0.8%
Specialty financial157
 50.9% 147
 50.4% 0.5%
Other specialty24
 38.0% 20
 37.1% 0.9%
Total Specialty$771
 34.0% $693
 33.2% 0.8%

Property and transportation   Commissions and other underwriting expenses as a percentage of net earned premiums increased 0.9 percentage points in the first six months of 2018 compared to the first six months of 2017, reflecting a change in the mix of business, partially offset by higher profitability-based commissions received from reinsurers in the crop business.

Specialty casualty   Commissions and other underwriting expenses as a percentage of net earned premiums increased 0.8 percentage points in the first six months of 2018 compared to the first six months of 2017, reflecting growth at Neon, which has a higher expense ratio than AFG’s overall Specialty casualty group.

Specialty financial   Commissions and other underwriting expenses as a percentage of net earned premiums increased 0.5 percentage points in the first six months of 2018 compared to the first six months of 2017, reflecting higher profitability-based commissions paid to agents in the financial institutions business.

Property and Casualty Net Investment Income
Net investment income in AFG’s property and casualty insurance operations was $215 million in the first six months of 2018 compared to $182 million in the first six months of 2017, an increase of $33 million (18%). The average invested assets and overall yield earned on investments held by AFG’s property and casualty insurance operations are provided below (dollars in millions):
 Six months ended June 30,    
 2018 2017 Change % Change
Net investment income$215
 $182
 $33
 18%
        
Average invested assets (at amortized cost)$10,395
 $9,872
 $523
 5%
        
Yield (net investment income as a % of average invested assets)4.14% 3.69% 0.45% 

        
Tax equivalent yield (*)4.32% 4.16% 0.16% 


(*)
Adjusts the yield on equity securities and tax-exempt bonds to the fully taxable equivalent yield.

The property and casualty insurance segment’s increase in net investment income for the first six months of 2018 as compared to the first six months of 2017 reflects growth in the property and casualty insurance segment and very strong earnings from limited partnerships and similar investments. The property and casualty insurance segment’s overall yield on investments (net investment income as a percentage of average invested assets) was 4.14% for the first six months of 2018 compared to 3.69% for the first six months of 2017, an increase of 0.45 percentage points due primarily to the higher earnings from limited partnerships and similar investments.


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AMERICAN FINANCIAL GROUP, INC. 10-Q
Management’s Discussion and Analysis of Financial Condition and Results of Operations — Continued


Property and Casualty Other Income and Expenses, Net
Other income and expenses, net for AFG’s property and casualty insurance operations was a net expense of $16 million for the first six months of 2018 compared to net earnings of $2 million for the first six months of 2017, a change of $18 million (900%). The table below details the items included in other income and expenses, net for AFG’s property and casualty insurance operations (in millions):
 Six months ended June 30,
 2018 2017
Other income   
Income from the sale of real estate$
 $16
Other4
 4
Total other income4
 20
Other expenses   
Amortization of intangibles4
 4
Other16
 14
Total other expense20
 18
Other income and expenses, net$(16) $2
Income from the sale of real estate includes $13 million related to the sale of a hotel property in 2017.


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AMERICAN FINANCIAL GROUP, INC. 10-Q
Management’s Discussion and Analysis of Financial Condition and Results of Operations — Continued


Annuity Segment — Results of Operations
AFG’s annuity operations contributed $224 million in pretax earnings in the first six months of 2018 compared to $181 million in the first six months of 2017, an increase of $43 million (24%). AFG’s annuity segment results for the first six months of 2018 compared to the first six months of 2017 reflect a 10% increase in average annuity investments (at amortized cost), higher earnings from limited partnerships and similar investments and the favorable impact of fair value accounting for derivatives related to fixed-indexed annuities (“FIAs”), partially offset by an unlocking charge in the first six months of 2018 and the impact of lower investment yields due to the run-off of higher yielding investments. The high returns on limited partnerships and similar investments should not necessarily be expected to repeat in future periods. The fair value of derivatives related to FIAs was favorably impacted by higher than anticipated interest rates in the first six months of 2018 compared to the negative impact of lower than anticipated interest rates in the first six months of 2017, partially offset in the 2018 period by the negative impacts of higher interest on the embedded derivative (from growth in the FIA business and higher interest rates) and higher than expected option costs. AFG monitors the major actuarial assumptions underlying its annuity operations throughout the year and conducts detailed reviews (“unlocking”) of its assumptions in the fourth quarter of each year. If changes in the economic environment of actual experience would cause material revisions to future estimates, these assumptions are updated (unlocked) in an interim quarter. Due to continued higher FIA option costs (resulting primarily from higher than expected risk-free rates), AFG unlocked its assumptions for option costs and interest rates in the second quarter of 2018, resulting in a net charge to earnings of $27 million.

The following table details AFG’s earnings before income taxes from its annuity operations for the six months ended June 30, 2018 and 2017 (dollars in millions).
 Six months ended June 30,  
 2018 2017 % Change
Revenues:     
Net investment income$806
 $707
 14%
Other income:     
Guaranteed withdrawal benefit fees32
 28
 14%
Policy charges and other miscellaneous income21
 25
 (16%)
Total revenues859
 760
 13%
      
Costs and Expenses:     
Annuity benefits (*)442
 420
 5%
Acquisition expenses130
 99
 31%
Other expenses63
 60
 5%
Total costs and expenses635
 579
 10%
Earnings before income taxes$224
 $181
 24%
Detail of annuity earnings before income taxes (dollars in millions):
 Six months ended June 30,  
 2018 2017 % Change
Earnings before income taxes — before the impact of unlocking and derivatives related to FIAs$235
 $199
 18%
Unlocking(27) 
 %
Impact of derivatives related to FIAs16
 (18) (189%)
Earnings before income taxes$224
 $181
 24%

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AMERICAN FINANCIAL GROUP, INC. 10-Q
Management’s Discussion and Analysis of Financial Condition and Results of Operations — Continued


(*)Annuity benefits consisted of the following (dollars in millions):
 Six months ended June 30,  
 2018 2017 % Change
Interest credited — fixed$339
 $309
 10%
Interest credited — fixed component of variable annuities3
 3
 %
Other annuity benefits:     
Change in expected death and annuitization reserve8
 8
 %
Amortization of sales inducements10
 10
 %
Change in guaranteed withdrawal benefit reserve42
 33
 27%
Change in other benefit reserves19
 20
 (5%)
Total other annuity benefits79
 71
 11%
Total before impact of derivatives related to FIAs and unlocking421
 383
 10%
Derivatives related to fixed-indexed annuities:     
Embedded derivative mark-to-market19
 259
 (93%)
Equity option mark-to-market(52) (222) (77%)
Impact of derivatives related to FIAs(33) 37
 (189%)
Unlocking54
 
 %
Total annuity benefits$442
 $420
 5%

See Annuity Unlocking below for a discussion of the impact that the unlocking of actuarial assumptions had on annuity benefit expense in 2018.

Net Spread on Fixed Annuities (excludes variable annuity earnings)
The table below (dollars in millions) details the components of the spreads for AFG’s fixed annuity operations (including fixed-indexed and variable-indexed annuities):
 Six months ended June 30,  
 2018 2017 % Change
Average fixed annuity investments (at amortized cost)$33,469
 $30,522
 10%
Average fixed annuity benefits accumulated33,747
 30,698
 10%
      
As % of fixed annuity benefits accumulated (except as noted):     
Net investment income (as % of fixed annuity investments)4.79% 4.60%  
Interest credited — fixed(2.01%) (2.01%)  
Net interest spread2.78% 2.59%  
      
Policy charges and other miscellaneous income0.10% 0.13%  
Other annuity benefit expenses, net of guaranteed withdrawal benefit fees(0.28%) (0.29%)  
Acquisition expenses(0.91%) (0.62%)  
Other expenses(0.36%) (0.38%)  
Change in fair value of derivatives related to fixed-indexed annuities0.19% (0.24%)  
Unlocking(0.16%) %  
Net spread earned on fixed annuities1.36% 1.19%  


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AMERICAN FINANCIAL GROUP, INC. 10-Q
Management’s Discussion and Analysis of Financial Condition and Results of Operations — Continued


The table below illustrates the impact of fair value accounting for derivatives related to fixed-indexed annuities on the annuity segment’s net spread earned on fixed annuities:
 Six months ended June 30,
 2018 2017
Net spread earned on fixed annuities — before the impact of unlocking and derivatives related to FIAs1.43% 1.31%
Unlocking(0.16%) %
Impact of derivatives related to fixed-indexed annuities:   
Change in fair value of derivatives0.19% (0.24%)
Related impact on amortization of deferred policy acquisition costs (*)(0.10%) 0.12%
Related impact on amortization of deferred sales inducements (*)% %
Net spread earned on fixed annuities1.36% 1.19%
(*)An estimate of the related acceleration/deceleration of the amortization of deferred policy acquisition costs and deferred sales inducements.

Annuity Net Investment Income
Net investment income for the first six months of 2018 was $806 million compared to $707 million for the first six months of 2017, an increase of $99 million (14%). This increase reflects the growth in AFG’s annuity business and higher earnings from limited partnerships and similar investments, partially offset by the impact of lower investment yields. The overall yield earned on investments in AFG’s fixed annuity operations, calculated as net investment income divided by average investment balances (at amortized cost), increased by 0.19 percentage points to 4.79% from 4.60% for the first six months of 2018 compared to the first six months of 2017. This increase in net investment yield reflects higher earnings from limited partnerships and similar investments, partially offset by (i) the investment of new premium dollars at lower yields as compared to the existing investment portfolio and (ii) the impact of the reinvestment of proceeds from maturity and redemption of higher yielding investments at the lower yields available in the financial markets. During 2017, $4.9 billion in annuity segment investments with an average yield of 5.14% were redeemed or sold while the investments purchased during 2017 (with new premium dollars and the redemption/sale proceeds) had an average yield at purchase of 3.94%.

Annuity Interest Credited — Fixed
Interest credited — fixed for the first six months of 2018 was $339 million compared to $309 million for the first six months of 2017, an increase of $30 million (10%). This increase reflects the impact of growth in the annuity business. The average interest rate credited to policyholders, calculated as interest credited divided by average fixed annuity benefits accumulated, was 2.01% in both the first six months of 2018 and the first six months of 2017.

Annuity Net Interest Spread
AFG’s net interest spread increased 0.19 percentage points to 2.78% from 2.59% in the first six months of 2018 compared to the same period in 2017 due primarily to higher earnings from limited partnerships and similar investments, partially offset by lower investment yields. Features included in current annuity offerings allow AFG to achieve its desired profitability at a lower net interest spread than historical product offerings. As a result, AFG expects its net interest spread to narrow in the future.

Annuity Policy Charges and Other Miscellaneous Income
Annuity policy charges and other miscellaneous income, which consist primarily of surrender charges, amortization of deferred upfront policy charges (unearned revenue) and income from sales of real estate, were $21 million for the first six months of 2018 compared to $25 million for the first six months of 2017, a decrease of $4 million (16%). Excluding the impact of a $1 million unlocking charge related to unearned revenue in the second quarter of 2018, annuity policy charges and other miscellaneous income were $22 million in 2018 compared to $25 million in 2017, a decrease of $3 million (12%). The first six months of 2017 includes $1 million from the sale of real estate. As a percentage of average fixed annuity benefits accumulated, excluding the impact of unlocking charges related to unearned revenue, annuity policy charges and other miscellaneous income decreased 0.03 percentage points to 0.10% from 0.13% in the first six months of 2018 compared to the first six months of 2017.

See Annuity Unlocking below for a discussion of the impact that the unlocking of actuarial assumptions had on annuity policy charges and other miscellaneous income in 2018.


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AMERICAN FINANCIAL GROUP, INC. 10-Q
Management’s Discussion and Analysis of Financial Condition and Results of Operations — Continued


Other Annuity Benefits, Net of Guaranteed Withdrawal Benefit Fees
Other annuity benefits, net of guaranteed withdrawal benefit fees (excluding the impact of unlocking), for the first six months of 2018 were $47 million compared to $43 million for the first six months of 2017, an increase of $4 million (9%). As a percentage of average fixed annuity benefits accumulated, these net expenses decreased 0.01 percentage points to 0.28% from 0.29% in the first six months of 2018 compared to the first six months of 2017. In addition to interest credited to policyholders’ accounts and the change in fair value of derivatives related to fixed-indexed annuities, annuity benefits expense also includes the following expenses (in millions, net of guaranteed withdrawal benefit fees):
 Six months ended June 30,
 2018 2017
Change in expected death and annuitization reserve$8
 $8
Amortization of sales inducements10
 10
Change in guaranteed withdrawal benefit reserve42
 33
Change in other benefit reserves19
 20
Other annuity benefits79
 71
Offset guaranteed withdrawal benefit fees(32) (28)
Other annuity benefits, net$47
 $43

As discussed under “Annuity Benefits Accumulated” in Note A — “Accounting Policies to the financial statements, guaranteed withdrawal benefit reserves are accrued for and modified using assumptions similar to those used in establishing and amortizing deferred policy acquisition costs. The guaranteed withdrawal benefit reserve related to FIAs can be inversely impacted by the calculated FIA embedded derivative reserve as the value to policyholders of the guaranteed withdrawal benefits decreases when the benefit of stock market participation increases.

See Annuity Unlocking below for a discussion of the impact that the unlocking of actuarial assumptions had on annuity benefit expense in 2018.

Annuity Acquisition Expenses
Annuity acquisition expenses for the first six months of 2018 were $130 million compared to $99 million for the first six months of 2017, an increase of $31 million (31%). Excluding the $28 million favorable impact on amortization of DPAC from the unlocking recorded in the second quarter of 2018, annuity acquisition expenses were $158 million for the first six months of 2018, an increase of $59 million (60%) compared to the first six months of 2017, reflecting the acceleration/deceleration of DPAC amortization related to changes in the fair value of derivatives related to FIAs and growth in the business. Excluding the impact of the 2018 unlocking charge, AFG’s amortization of DPAC and commission expenses as a percentage of average fixed annuity benefits accumulated was 0.91% for the first six months of 2018 compared to 0.62% for the first six months of 2017 and has generally ranged between 0.75% and 0.85%. Variances from the general range relate primarily to the impact of (i) material changes in interest rates or the stock market on AFG’s fixed-indexed annuity business, and (ii) differences in actual experience from actuarially projected estimates and assumptions. For example, the positive impact of higher than anticipated interest rates during the first six months of 2018 on the fair value of derivatives related to FIAs (discussed below) resulted in a partially offsetting acceleration of the amortization of DPAC. In contrast, the negative impact of lower than anticipated interest rates during the first six months of 2017 on the fair value of derivatives related to FIAs resulted in a partially offsetting deceleration of the amortization of DPAC.

The table below illustrates the estimated impact of fair value accounting for derivatives related to fixed-indexed annuities on annuity acquisition expenses as a percentage of average fixed annuity benefits accumulated (excluding the impact of unlocking):
 Six months ended June 30,
 2018 2017
Before the impact of changes in the fair value of derivatives related to FIAs on the amortization of DPAC0.81% 0.74%
Impact of changes in fair value of derivatives related to FIAs on amortization of DPAC (*)0.10% (0.12%)
Annuity acquisition expenses as a % of fixed annuity benefits accumulated0.91% 0.62%
(*)An estimate of the acceleration/deceleration of the amortization of deferred policy acquisition costs resulting from fair value accounting for derivatives related to fixed-indexed annuities.


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AMERICAN FINANCIAL GROUP, INC. 10-Q
Management’s Discussion and Analysis of Financial Condition and Results of Operations — Continued


See Annuity Unlocking below for a discussion of the impact that the unlocking of actuarial assumptions had on annuity and supplemental insurance acquisition expenses in 2018. Unanticipated spread compression, decreases in the stock market, adverse mortality experience, and higher than expected lapse rates could lead to write-offs of DPAC or PVFP in the future.

Annuity Other Expenses
Annuity other expenses were $63 million for the first six months of 2018 compared to $60 million for the first six months of 2017, an increase of $3 million (5%). Annuity other expenses represent primarily general and administrative expenses, as well as selling and issuance expenses that are not deferred. As a percentage of average fixed annuity benefits accumulated, these expenses were 0.36% for the first six months of 2018 and 0.38% for the first six months of 2017. This decrease in annuity other expenses as a percentage of average fixed annuity benefits accumulated is due primarily to growth in the business.

Change in Fair Value of Derivatives Related to Fixed-Indexed (Including Variable-Indexed) Annuities
AFG’s fixed-indexed (including variable indexed) annuities provide policyholders with a crediting rate tied, in part, to the performance of an existing stock market or other financial index. AFG attempts to mitigate the risk in the index-based component of these products through the purchase and sale of call and put options on the appropriate index. AFG’s strategy is designed so that the net change in the fair value of the call option assets and put option liabilities will generally offset the economic change in the net liability from the index participation. Both the index-based component of the annuities (an embedded derivative) and the related call and put options are considered derivatives that must be adjusted for changes in fair value through earnings each period. The fair values of these derivatives are impacted by actual and expected stock market performance and interest rates as well as other factors. For a list of other factors impacting the fair value of the index-based component (embedded derivative) of AFG’s annuity benefits accumulated, see Note C — “Fair Value Measurements to the financial statements.

Excluding the impact of the 2018 unlocking charge, the net change in fair value of derivatives related to fixed-indexed annuities decreased annuity benefits by $33 million in the first six months of 2018 and increased annuity benefits by $37 million in the first six months of 2017. During the first six months of 2018, the positive impact of higher than expected interest rates on the fair value of these derivatives was partially offset by the negative impact of higher than expected option costs. During the first six months of 2017, the positive impact of strong market performance on the fair value of these derivatives was more than offset by the negative impact of lower than anticipated interest rates. As a percentage of average fixed annuity benefits accumulated, this net expense improved 0.43 percentage points to a net expense reduction of 0.19% in the first six months of 2018 from a net expense of 0.24% in the first six months of 2017.

Fluctuations in interest rates and the stock market, among other factors, can cause volatility in the periodic measurement of fair value of the embedded derivative that management believes can be inconsistent with the long-term economics of these products. The table below illustrates the impact of fair value accounting for derivatives related to fixed-indexed annuities on the annuity segment’s earnings before income taxes (dollars in millions):
 Six months ended June 30,  
 2018 2017 % Change
Earnings before income taxes — before unlocking and change in fair value of derivatives related to fixed-indexed annuities$235
 $199
 18%
Unlocking(27) 
 %
Impact of derivatives related to fixed-indexed annuities:     
Change in fair value of derivatives related to fixed-indexed annuities33
 (37) (189%)
Related impact on amortization of DPAC (*)(17) 19
 (189%)
Earnings before income taxes$224
 $181
 24%
(*)An estimate of the related acceleration/deceleration of amortization of deferred sales inducements and deferred policy acquisition costs.


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AMERICAN FINANCIAL GROUP, INC. 10-Q
Management’s Discussion and Analysis of Financial Condition and Results of Operations — Continued


As illustrated in the table above, the change in fair value of derivatives related to fixed-indexed annuities, including the related impact on amortization of DPAC increased the annuity segment’s earnings before income taxes by $16 million in the first six months of 2018 and decreased the annuity segment’s earnings before income taxes by $18 million in the first six months of 2017. The following table provides analysis of the primary factors impacting the change in the fair value of derivatives related to FIAs. Each factor is presented net of the estimated related impact on amortization of DPAC (dollars in millions).
 Six months ended June 30,  
 2018 2017 % Change
Interest on the embedded derivative liability$(15) $(7) 114%
Changes in interest rates higher (lower) than expected39
 (28) (239%)
Change in the stock market, including volatility4
 14
 (71%)
Renewal option costs lower (higher) than expected(7) 3
 (333%)
Other, including the impact of actual versus expected lapses(5) 
 %
Impact of derivatives related to FIAs$16
 $(18) (189%)

See Annuity Unlocking below for a discussion of the impact that the unlocking of actuarial assumptions had on the change in the fair value of the embedded derivative liability in 2018.

Annuity Net Spread Earned on Fixed Annuities
AFG’s net spread earned on fixed annuities increased 0.17 percentage points to 1.36% from 1.19% in the first six months of 2018 compared to the same period in 2017 due primarily to the net impact of changes in the fair value of derivatives and related DPAC amortization offset discussed above and the 0.19 percentage points increase in AFG’s net interest spread, partially offset by the impact of the unlocking of actuarial assumptions discussed below.

Annuity Benefits Accumulated
Annuity premiums received 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 and other benefits are charged to expense and decreases for surrender and other policy charges are credited to other income.

For certain products, annuity benefits accumulated also includes reserves for accrued persistency and premium bonuses, excess benefits expected to be paid on future deaths and annuitizations (“EDAR”) and guaranteed withdrawal benefits. Annuity benefits accumulated also includes amounts advanced from the Federal Home Loan Bank of Cincinnati. The following table is a progression of AFG’s annuity benefits accumulated liability for the six months ended June 30, 2018 and 2017 (in millions):
 Six months ended June 30,
 2018 2017
Beginning fixed annuity reserves$33,005
 $29,647
Fixed annuity premiums (receipts)2,534
 2,541
Surrenders, benefits and other withdrawals(1,333) (1,110)
Interest and other annuity benefit expenses:   
Interest credited339
 309
Embedded derivative mark-to-market19
 259
Change in other benefit reserves59
 58
Unlocking55
 
Ending fixed annuity reserves$34,678
 $31,704
    
Reconciliation to annuity benefits accumulated per balance sheet: �� 
Ending fixed annuity reserves (from above)$34,678
 $31,704
Impact of unrealized investment gains32
 128
Fixed component of variable annuities176
 182
Annuity benefits accumulated per balance sheet$34,886
 $32,014


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Management’s Discussion and Analysis of Financial Condition and Results of Operations — Continued


Statutory Annuity Premiums
AFG’s annuity operations generated statutory premiums of $2.55 billion in the first six months of 2018 compared to $2.56 billion in the first six months of 2017, a decrease of $9 million. The following table summarizes AFG’s annuity sales (dollars in millions):
 Six months ended June 30,  
2018 2017 % Change
Financial institutions single premium annuities — indexed$861
 $987
 (13%)
Financial institutions single premium annuities — fixed236
 477
 (51%)
Retail single premium annuities — indexed672
 532
 26%
Retail single premium annuities — fixed44
 37
 19%
Broker dealer single premium annuities — indexed614
 411
 49%
Broker dealer single premium annuities — fixed7
 5
 40%
Education market — fixed and indexed annuities100
 92
 9%
Total fixed annuity premiums2,534
 2,541
 %
Variable annuities13
 15
 (13%)
Total annuity premiums$2,547
 $2,556
 %

While annuity premiums were comparable in the first six months of 2018 and the first six months of 2017, annuity premiums in the second quarter of 2018 represent an increase of 22% compared to the first quarter of 2018, reflecting growth in all fixed annuity product lines and channels.

Annuity Unlocking
In the second quarter of 2018, AFG recorded a $27 million net charge related to its annuity business as a result of unlocking certain actuarial assumptions underlying its annuity operations, which impacted AFG’s financial statements as follows (in millions):
  Six months ended June 30,
  2018 2017
Policy charges and other miscellaneous income:    
Unearned revenue $(1) $
Total revenues (1) 
Annuity benefits:    
Fixed-indexed annuities embedded derivative 44
 
Sales inducements (1) 
Other reserves 11
 
Total annuity benefits 54
 
Annuity and supplemental insurance acquisition expenses:    
Deferred policy acquisition costs (28) 
Total costs and expenses 26
 
Net charge $(27) $

See Annuity Unlocking under “Annuity Segment — Results of Operations” for the quarters ended June 30, 2018 and 2017 for a discussion of the charge from the unlocking of actuarial assumptions in the second quarter of 2018.


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AMERICAN FINANCIAL GROUP, INC. 10-Q
Management’s Discussion and Analysis of Financial Condition and Results of Operations — Continued


Annuity Earnings before Income Taxes Reconciliation
The following table reconciles the net spread earned on AFG’s fixed annuities to overall annuity pretax earnings for the six months ended June 30, 2018 and 2017 (in millions):
 Six months ended June 30,
 2018 2017
Earnings on fixed annuity benefits accumulated$229
 $183
Earnings impact of investments in excess of fixed annuity benefits accumulated (*)(7) (4)
Variable annuity earnings2
 2
Earnings before income taxes$224
 $181

(*)
Net investment income (as a % of investments) of 4.79% and 4.60% for the six months ended June 30, 2018 and 2017, respectively, multiplied by the difference between average fixed annuity investments (at amortized cost) and average fixed annuity benefits accumulated in each period.

Holding Company, Other and Unallocated — Results of Operations AFG’s net GAAP pretax loss outside of its property and casualty insurance and annuity operations (excluding realized gains and losses) totaled $90 million in the first six months of 2018 compared to $98 million in the first six months of 2017, a decrease of $8 million (8%). AFG’s net core pretax loss outside of its property and casualty insurance and annuity operations (excluding realized gain and losses) totaled $90 million in the first six months of 2018 compared to $91 million in the first six months of 2017, a decrease of $1 million (1%).

The following table details AFG’s GAAP and core loss before income taxes from operations outside of its property and casualty insurance and annuity operations for the six months ended June 30, 2018 and 2017 (dollars in millions):
 Six months ended June 30,  
 2018 2017 % Change
Revenues:     
Life, accident and health net earned premiums$12
 $11
 9%
Net investment income11
 17
 (35%)
Other income — P&C fees32
 29
 10%
Other income11
 13
 (15%)
Total revenues66
 70
 (6%)
      
Costs and Expenses, excluding interest charges on borrowed money:     
Property and casualty insurance — commissions and other underwriting expenses10
 12
 (17%)
Life, accident and health benefits22
 15
 47%
Life, accident and health acquisition expenses2
 2
 %
Other expense — expenses associated with P&C fees22
 17
 29%
Other expenses (*)69
 71
 (3%)
Costs and expenses, excluding interest charges on borrowed money125
 117
 7%
Core loss before income taxes, excluding realized gains and losses and interest charges on borrowed money(59) (47) 26%
Interest charges on borrowed money31
 44
 (30%)
Core loss before income taxes, excluding realized gains and losses(90) (91) (1%)
Pretax non-core loss on retirement of debt
 (7) (100%)
GAAP loss before income taxes, excluding realized gains and losses$(90) $(98) (8%)

(*)Excludes a pretax non-core loss on retirement of debt of $7 million in the second quarter of 2017.

Holding Company and Other — Life, Accident and Health Premiums, Benefits and Acquisition Expenses
AFG’s run-off long-term care and life insurance operations recorded net earned premiums of $12 million and related benefits and acquisition expenses of $24 million in the first six months of 2018 compared to net earned premiums of $11 million and related benefits and acquisition expenses of $17 million in the first six months of 2017. The $7 million (47%) increase in life, accident and health benefits reflects higher claims in the run-off life business.


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AMERICAN FINANCIAL GROUP, INC. 10-Q
Management’s Discussion and Analysis of Financial Condition and Results of Operations — Continued


Holding Company and Other — Net Investment Income
AFG recorded net investment income on investments held outside of its property and casualty insurance and annuity operations of $11 million in the first six months of 2018 compared to $17 million in the first six months of 2017, a decrease of $6 million (35%). The parent company holds a small portfolio of securities that are carried at fair value through net investment income. These securities decreased in value by $2 million in the first six months of 2018 compared to an increase in value by $3 million in the first six months of 2017.

Holding Company and Other — P&C Fees and Related Expenses
Summit, a workers’ compensation insurance subsidiary, collects fees from a small group of unaffiliated insurers for providing underwriting, policy administration and claims services. In addition, certain of AFG’s property and casualty insurance businesses collect fees from customers for ancillary services such as workplace safety programs and premium financing. In the first six months of 2018, AFG collected $32 million in fees for these services compared to $29 million in the first six months of 2017. Management views this fee income, net of the $22 million in the first six months of 2018 and $17 million in the first six months of 2017, in expenses incurred to generate such fees, as a reduction in the cost of underwriting its property and casualty insurance policies. Consistent with internal management reporting, these fees and the related expenses are netted and recorded as a reduction of commissions and other underwriting expenses in AFG’s segmented results.

Holding Company and Other — Other Income
Other income in the table above includes $8 million and $9 million in the first six months of 2018 and 2017, respectively, in management fees paid to AFG by the AFG-managed CLOs (AFG’s consolidated managed investment entities). The management fees are eliminated in consolidation — see the other income line in the Consolidate MIEs column under “Results of Operations — Segmented Statement of Earnings.” Excluding amounts eliminated in consolidation, AFG recorded other income outside of its property and casualty insurance and annuity operations of $3 million in the first six months of 2018 and $4 million the first six months of 2017.

Holding Company and Other — Other Expenses
Excluding the non-core loss on retirement of debt discussed below, AFG’s holding companies and other operations outside of its property and casualty insurance and annuity operations recorded other expenses of $69 million in the first six months of 2018 compared to $71 million in the first six months of 2017, a decrease of $2 million (3%). This decrease reflects the impact of lower holding company expenses related to certain incentive compensation plans and employee benefit plans that are tied to stock market performance in the first six months of 2018 compared to the first six months of 2017, partially offset by a $5 million charge to increase liabilities related to the environmental exposures of AFG’s former railroad and manufacturing operations in the first six months of 2018.

Holding Company and Other — Interest Charges on Borrowed Money
AFG’s holding companies and other operations outside of its property and casualty insurance and annuity operations recorded interest expense of $31 million in the first six months of 2018 compared to $44 million in the first six months of 2017, a decrease of $13 million (30%), due primarily to a lower weighted average interest rate on AFG’s outstanding debt.

The decrease in the weighted average interest rate for the first sixthree months of 20182019 as compared to the first sixthree months of 20172018 reflects the following financing transactions completed by AFG between April 1, 2017 and December 31, 2017:
Issued $350 millionissuance of 4.50% Senior Notes on June 2, 2017
Redeemed $230 million of 6-3/8% Senior Notes on June 26, 2017
Redeemed $125 million of 5-3/4% Senior Notes5.875% Subordinated Debentures on August 25, 2017
Issued an additional $125 million of 3.50% Senior Notes on November 9, 2017
Issued an additional $240 million of 4.50% Senior Notes on November 9, 2017
Redeemed $350 million of 9-7/8% Senior Notes on December 11, 2017

Holding Company and Other — Loss on Retirement of Debt
AFG wrote off unamortized debt issuance costs of $7 million related to the redemption of its $230 million outstanding 6-3/8% Senior Notes due 2042 at par value in June 2017.March 18, 2019.


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Management’s Discussion and Analysis of Financial Condition and Results of Operations — Continued


Consolidated Realized Gains (Losses) on Securities   AFG’s consolidated realized gains (losses) on securities, which are not allocated to segments, were a net lossgains of $62$184 million in the first sixthree months of 20182019 compared to a net gainlosses of $11$93 million in the first sixfirst three months of 2017, a decrease2018, an improvement of $73$277 million (664% (298%). Realized gains (losses) on securities consisted of the following (in millions):
Six months ended June 30,Three months ended March 31,
2018 20172019 2018
Realized gains (losses) before impairments:      
Disposals$9
 $32
$(3) $4
Change in the fair value of equity securities (*)(72) 
182
 (95)
Change in the fair value of derivatives(6) (3)6
 (5)
Adjustments to annuity deferred policy acquisition costs and related items8
 (3)1
 4
(61) 26
186
 (92)
Impairment charges:      
Securities(1) (21)(3) (1)
Adjustments to annuity deferred policy acquisition costs and related items
 6
1
 
(1) (15)(2) (1)
Realized gains (losses) on securities$(62) $11
$184
 $(93)

(*)
As discussed inNote A — Accounting Policies — Investments,”beginning in January 2018, all equity securities other than those accounted for under the equity method are carried at fair value through net earnings. This amount includesThese amounts include a $71$163 million net gain on securities that were still held at March 31, 2019 and a $94 million net loss on securities that were still held at June 30,March 31, 2018.

The $72$182 million net realized gain from the change in the fair value of equity securities in the first three months of 2019 includes gains of $52 million on investments in banks and financing companies, $29 million from investments in media companies and $17 million on energy-related investments. The $95 million net realized loss from the change in the fair value of equity securities in the first sixfirst three months of 2018 includes losses of $15approximately $25 million on investments inrelated to real estate investment trusts, $31$24 million related to banks and financing companies and $15 million on investments inrelated to media companies. AFG’s $21 million in impairment charges for the first six months of 2017 consist of $20 million on equity securities and $1 million on fixed maturities. Approximately $10 million in impairment charges in the first six months of 2017 are related to pharmaceutical companies and $5 million are on energy-related investments.

Consolidated Income Taxes   AFG’s consolidated provision for income taxes was $85$87 million for the first six three months of 2019 compared to $33 million for the first three months of 2018, compared to $128an increase of $54 million for the first six months of 2017, a decrease of $43 million (34%(164%). See Note L — “Income Taxesto the financial statements for an analysis of items affecting AFG’s effective tax rate.

Consolidated Noncontrolling Interests   AFG’s consolidated net earnings (losses) attributable to noncontrolling interests was a net loss of $6$3 million for the first sixfirst three months of 20182019 compared to net earnings of $2$4 million for the first sixfirst three months of 2017. Losses attributable to noncontrolling interests for the first six months of 2018 are related to2018. Both periods reflect losses at Neon, AFG’s United Kingdom-based Lloyd’s insurer. Earnings attributable to noncontrolling interests in the first six months of 2017 are related to the gain on the sale of a hotel property, which was owned by an 80%-owned subsidiary of Great American Insurance.

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Management’s Discussion and Analysis of Financial Condition and Results of Operations — Continued


RECENTLY ADOPTED ACCOUNTING STANDARDS

Effective December 31, 2017, AFG adopted ASU 2018-02, which allowed the reclassification of amounts stranded in accumulated other comprehensive income from accounting for the Tax Cuts and Jobs Act of 2017 to retained earnings.

See Note A — “Accounting PoliciesInvestmentsto the financial statements for a discussion of accounting guidance adopted on January 1, 2018, which, among other things, requires equity investments that are not accounted for under the equity method of accounting to be measured at fair value with changes in fair value recognized in net earnings, clarifies that the need for a valuation allowance on a deferred tax asset related to available for sale securities should be evaluated with other deferred tax assets and modifies disclosure requirements for financial instruments.earnings.

ACCOUNTING STANDARDS TO BE ADOPTED

In February 2016, the FASB issued ASU 2016-02,See Note A — “Accounting Policies Leases,and Note J — “Leasesto the financial statements for a discussion of accounting guidance adopted on January 1, 2019, which requires entities that lease assets for terms longer than one year to recognize the assets and liabilities for the rights and obligations created by those leases on the balance sheet based on the present value of cash flows. Qualitative and quantitative disclosures of the amount, timing and uncertainty of cash flows arising from leases will also be required. Although the guidance allows for early adoption, AFG expects to adopt the updated

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Management’s Discussion and Analysis of Financial Condition and Results of Operations — Continued


guidance effective January 1, 2019 (when it is required). Although the guidance will result in higher assets and higher liabilities from the recognition of assets and liabilities related to operating leases, it does not change the manner in which lease expense is recognized in the statement of earnings. Although management is currently evaluating the impact of this guidance, AFG does not expect it to have a material effect on its results of operations or financial position.ACCOUNTING STANDARDS TO BE ADOPTED

In June 2016, the FASB issued ASU 2016-13, Financial Instruments – Credit Losses: Measurement of Credit Losses on Financial Instruments, which provides a new credit loss model for determining credit-related impairments for financial instruments measured at amortized cost (e.g. mortgage loans or reinsurance recoverables) and requires an entity to estimate the credit losses expected over the life of an exposure or pool of exposures. The estimate of expected credit losses considers historical information, current information, as well as reasonable and supportable forecasts, including estimates of prepayments. The expected credit losses, and subsequent increases or decreases in such losses, will be recorded immediately through realized gains (losses) as an allowance that is deducted from the amortized cost basis of the financial asset, with the net carrying value of the financial asset presented on the balance sheet at the amount expected to be collected. The updated guidance also amends the current other-than-temporary impairment model for available for sale debt securities by requiring the recognition of impairments relating to credit losses through an allowance account and limits the amount of credit loss to the difference between a security’s amortized cost basis and its fair value. Subsequent increases or decreases in expected credit losses will be recorded immediately in the income statement through realized gains (losses). AFG will be required to adopt this guidance effective January 1, 2020. AFG cannot estimate the impact that the updated guidance will have on its results of operations, financial position or liquidity until the updated guidance is adopted.

In August 2018, the FASB issued ASU 2018-12, Financial Services – Insurance: Targeted Improvements to the Accounting for Long-Duration Contracts, which changes the assumptions used to measure the liability for future policy benefits for traditional and limited pay contracts (e.g. life, accident and health benefits) from being locked in at inception to being updated at least annually and standardizes the liability discount rate to be used and updated each reporting period, requires the measurement of market risk benefits associated with deposit contracts (e.g. annuities) to be recorded at fair value, simplifies the amortization of deferred policy acquisition costs to a constant level basis over the expected life of the related contracts and requires enhanced disclosures. AFG will be required to adopt this guidance effective January 1, 2021. AFG cannot estimate the impact that the updated guidance will have on its results of operations, financial position or liquidity until the updated guidance is adopted.


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ITEM 3
Quantitative and Qualitative Disclosure about Market Risk

As of June 30, 2018March 31, 2019, there were no material changes to the information provided in Item 7A — Quantitative and Qualitative Disclosures about Market Risk of AFG’s 20172018 Form 10-K.

ITEM 4
Controls and Procedures

AFG’s management, with participation of its Co-Chief Executive Officers and its Chief Financial Officer, has evaluated AFG’s disclosure controls and procedures (as defined in Exchange Act Rule 13a-15) as of the end of the period covered by this report. Based on that evaluation, AFG’s Co-CEOs and CFO concluded that the controls and procedures are effective. There have been no changes in AFG’s internal control over financial reporting during the secondfirst fiscal quarter of 20182019 that materially affected, or are reasonably likely to materially affect, AFG’s internal control over financial reporting.

In the ordinary course of business, AFG and its subsidiaries routinely enhance their information systems by either upgrading current systems or implementing new systems. There has been no change in AFG’s business processes and procedures during the secondfirst fiscal quarter of 20182019 that has materially affected, or is reasonably likely to materially affect, AFG’s internal control over financial reporting.

PART II
OTHER INFORMATION
ITEM 2
Unregistered Sales of Equity Securities and Use of Proceeds

Issuer Purchases of Equity Securities   AFG did not repurchase any shares of its Common Stock during the first sixthree months of 20182019. There are 4,132,838As of March 31, 2019, there were 5,000,000 remaining shares that may be repurchased under the Plans authorized by AFG’s Board of Directors in December 2014February 2016 and February 2016.2019.

AFG acquired 23,8821,001 shares of its Common Stock (at an average of $112.04$89.94 per share) in the first quarter of 2018, 32January 2019, 42,316 shares (at $111.83an average of $99.33 per share) in May 2018February 2019 and 396153 shares (at $107.23$98.19 per share) in June 2018March 2019 in connection with its stock incentive plans.
ITEM 5
Other Information

Disclosure of Certain Activities Under Section 13(r) of the Securities Exchange Act of 1934   Section 13(r) of the Securities Exchange Act of 1934, as amended (“Section 13(r)”), requires a registrant to disclose in its annual or quarterly reports whether it or an affiliate knowingly engaged in certain activities, transactions or dealings related to Iran during the period covered by the report. Many of the activities, transactions and dealings that are required to be reported under Section 13(r) were previously subject to U.S. sanctions or prohibited by applicable local law. On January 16, 2016, the United States and the European Union eased sanctions against Iran pursuant to the Joint Comprehensive Plan of Action, and many of the reportable activities, transactions and dealings under Section 13(r) are no longer subject to U.S. sanctions and no longer prohibited by applicable local law.

Certain of the Company’s subsidiaries located outside the United States subscribe to insurance policies that provide insurance coverage to vessels owned by international shipping and marine entities with vessels that travel worldwide. As a result, the insurance policies may be called upon to respond to claims involving or that have exposure to Iranian petroleum resources, refined petroleum, and petrochemical industries. For example, certain of the Company’s non-U.S. subsidiaries participate in global marine hull and war policies that provide coverage for damage to vessels navigating into and out of ports worldwide, which could include Iran.

For the sixthree months ended June 30, 2018,March 31, 2019, the Company is not aware of any additional premium with respect to underwriting insurance or reinsurance activities reportable under Section 13(r). Should any such risks have entered into the stream of

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commerce covered by these insurance or reinsurance activities, the Company believes that the premiums associated with such business would be immaterial.


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ITEM 6
Exhibits
 
Number Exhibit Description
  
   
   
   
   
101 The following financial information from American Financial Group’s Form 10-Q for the quarter ended June 30, 2018,March 31, 2019, formatted in XBRL (Extensible Business Reporting Language):  
         (i) Consolidated Balance Sheet  
        (ii) Consolidated Statement of Earnings  
       (iii) Consolidated Statement of Comprehensive Income  
       (iv) Consolidated Statement of Changes in Equity  
        (v) Consolidated Statement of Cash Flows  
       (vi) Notes to Consolidated Financial Statements  
     
     
 


Signature
Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.

 American Financial Group, Inc.
    
AugustMay 3, 20182019By: /s/ Joseph E. (Jeff) Consolino
   Joseph E. (Jeff) Consolino
   Executive Vice President and Chief Financial Officer

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