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Financial Analysis of American Financial Group

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Netra Shetty
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netrashetty
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Financial Analysis of American Financial Group - February 9th, 2011

American Financial Group Incorporated (NYSE: AFG) is a holding company based in Cincinnati, Ohio whose primary business is insurance and investments. American Financial Group's purpose is to enable businesses and individuals to manage risk using insurance products and services tailored to meet their specific needs.
American Financial Group's major insurance division operates as the Great American Insurance Company, founded in 1872 and focuses on property and casualty insurance services. Other affiliates and subsidiaries include American Custom, Mid Continent, National Interstate, Republic Indemnity. Additional insurance specialties include (but are not limited to) equine, trucking, executive liability, fidelity and crime, and agri-business. Great American Financial Resources is a wholly owned subsidiary of American Financial Group and supplies a range of annuities, life insurance products and supplemental insurances to individuals and enterprises.
The parent company, AFG, is owned principally by financier Carl Lindner, Jr. and his family. Carl Lindner is Chairman of the Board of Directors of AFG. The senior Lindner's sons, Carl H. Lindner, III and S. Craig Lindner serve as Co-Chief Executive Officers.
American Financial Group was ranked 486th on the Fortune 500 list in 2004. Through the years American Financial Group has owned a number of subsidiaries, real estate properties, and companies, including The Mountain View Grand Resort & Spa in Whitefield, New Hampshire, The Cincinnatian in Cincinnati, Ohio, The Biltmore in Coral Gables, Florida, Le Pavillon in New Orleans, Louisiana, and the Charleston Harbor Resort & Marina in Charleston, South Carolina. Great American Insurance Group partnered with the first professional baseball team, the Cincinnati Reds, and Hamilton County to purchase naming rights for Great American Ball Park.
On December 6, 2006, American Financial sold assets acquired from successors to the dissolution of the Penn Central Railroad including the land under Grand Central Terminal and the 156 miles (251 km) of Metro North track leading to the New York City landmark to Argent Ventures. The company announced in December 2007 that they will combine their offices and move their headquarters to the brand new Great American Insurance Building at Queen City Square in 2011.
American Financial Group was one of the first publicly traded Fortune 500 companies to make political donations after corporations' freedom of speech rights were expanded to include donations as a result of the Citizens United v. Federal Election Commission decision. Carl Linder, Jr is a longtime top Republican donor, comfortably donating millions of his personal income to candidates and political action committees,[3]which sent ripples in campaign finance circles during the 2010 mid-term elections. American Financial, of which Linder has a non-majority 42% share, donated $400,000 to the Republican-allied PAC American Crossroads


American Financial Group (AFE) is an insurance holding company that sells property and casualty insurance to businesses and annuity, life, and supplemental health insurance to individuals. The company has had an average combined ratio of 91.6% from 2005 to 2007, which means it has outperformed the property & casualty insurance industry's average combined ratio of 96.4%.[1] The lower the combined ratio is below 100%, the higher the profit earned on previously written policies is.


[2]

Corporate Overview

The company employs 5,300 in its property and casualty insurance business. [3]

Financial Metrics


AFE's Total Revenue, Net Income, and Profit Margin [4]
Revenue Sources
Trends and Forces

Cyclicality in the Industry
AFE has averaged an ROE of 13.75% over the past five years, outperforming the industry average of 11.04%. However, rate increases for insurance started to decline during 2004 and have continued to decline, indicating the start of a "down cycle" coinciding with a recession economy.[5] An industy-wide survey indicated an average price decrease of approximately 5%, with large account and specialty insured lines experiencing the largest decrease of nearly 9%. [6]

The insurance industry is highly cyclical, with periods of lower premiums and firm profits followed by periods of higher premiums, less competition, and higher profits. [7] It is unlikely that AFE could outperform the industry's ROE in a downturn by more than the 3.71% that it has over the past 5 years.



P&C insurance ROE's are highly cyclical. [8]
Investment Portfolio
Investment income is an important contributor to AFE's profitability that volatility in the market and economy undermine. In 2007, AFE had considerable declines in the value of its fixed maturity and mortgage-backed security holdings.

Contents
1 Corporate Overview
1.1 Financial Metrics
1.2 Revenue Sources
2 Trends and Forces
2.1 Cyclicality in the Industry
2.2 Investment Portfolio
2.3 Tort Settlements
3 Competition
4 Market Share
5 References


AFE's Losses and Gains by Asset Class in 2007[9]
Although many of those losses are unrealized, the contribution of sales of portfolio holdings on a year to year basis has a substantial effect on profitability. AFE will realize losses upon their sale unless the holdings appreciate to there pre-decline level. In 2007, earned premium and other income was decreased by 15% due to realized portfolio losses.



AFE's Portfolio Gains and Losses in relation to Earned Premiums and Other Income[9]
Currently, 85% of AFG's investment portfolio is in fixed maturity securities and 5% in equities. Mortgage-Backed Securities (MBS) account for 3% of the portfolio, or $483 million. [10]

Tort Settlements
Major court settlements against insurance companies, including AFE, decrease profitability on policies and business units, affecting the whole company. Previous settlements have increased AFE's combined ratio from an average (2005-2007) of 88.6% to 91.6%, indicating a 26% decrease in profit due to unpredictable legal expense. [11] A 1% variation in loss cost trends, such as a court determining that AFE should adopt more extensive claim acceptance criteria, would change net income by $20 million.[12]

The following graph shows the size of tort settlements in the past three years relative to net income.



AFE's Net Income Relative to Settlements [9]
Specifically, asbestos and environmental cases present the greatest threat to profitability, and continue to present a liability for AFE. [13] There are two substantial court cases pending: [14]

Commonwealth of Massachusetts v. Great American Insurance Group (AFE subsidiary) Regarding: Improper issuance of quotation
Various Asbestos Claimants vs. American Premier Underwriters (AFE subsidiary) Regarding: Hazardous waste and discharge clean up due to policies issued in the 1970's and 1980's
Competition

The industry AFE competes in is highly competitive due to price competition and low barriers to entry. [15] There are two segments of insurers that have competitive advantage on cost: mutual insurance companies that distribute profits back to policy holders and foreign insurers that can write insurance in America with tax advantages. [16] Competition is based on many factors, including service and reputation as well as price.

Competitors include: [17]


Ace (ACE) was founded by 34 Fortune 500 companies in order to fill a need for insuring low-frequency, high-severity risks for institutional customers.[18]
American International Group (AIG) is one of the largest companies in the world by assets and employee size, and has the largest US insurance market share.[19]
Arch Capital Group (ACGL) specializes in excess and surplus insurance products through its international subsidiaries. It also provides reinsurance.
Cincinnati Financial (CINF) is a diversified insurance provider, that sells both commercial and personal products.
Philadelphia Consolidated Holding (PHLY) is a national insurer with less than 1% market share in the P&C insurance industry. Its managers own over 20% of the company shares.
Markel (MKL) specializes in insuring unusal risks, from amusement parks to thoroughbred horses and summer camps. It also provides insurance for one-time events, such as golf tournaments and auto races.
Hartford Financial Services Group (HIG) operates in two broad segments: Life and Property-Casualty (P&C) insurance. It has a very concentration of financial company securities in its investment portfolio, which has caused it to take both realize and unrealized losses.[20]
HCC Insurance Holdings (HCC) sells specialized P&C insurance, specifically to the aviation, marine, and offshore energy industries.
W.R. Berkley (WRB) provides commercial property & casualty insurance, focusing on small to midsized business customers and state and local governments.
XL Capital Limited (XL) provides corporate insurance through risk management products (global property and casualty programs for large multi-national corporations) and specialty lines products.
Market Share

AFE has captured 1.83% of domestic property and casualty insurance premiums, ranking as the 12th largest insurance company by market share.

Rank Group / Company Name Direct Premiums Written Market Share Loss Ratio
1 American International Group 11602235547 19.78 54.34
2 Zurich Insurance 4092466422 6.98 63.4
3 Travellers Group 3518222808 6 51.17
4 Chubb (CB) 3038610138 5.18 47.75
5 Ace (ACE) 2867705017 4.89 55.37
6 CNA 2551252759 4.35 49.28
7 Liberty Mutual 2081932554 3.55 60.93
8 XL CAPITAL LIMITED (XL) 1731426250 2.95 45.66
9 Nationwide Financial Services (NFS) 1458985846 2.49 38.94
10 Hartford Financial Services Group (HIG) 1241158592 2.12 22.06
11 W.R. Berkley (BER) 1230880130 2.1 39.82
12 American Financial Group (AFE) 1072363295 1.83 44.97
13 Allianz Insurance Group 1032882063 1.76 37.2
14 Alleghany (Y) 797416400 1.36 47.1
15 Arch Capital Group 777243994 1.32 46.7
16 Berkshire Hathaway (BRK) 752121011 1.28 19.78
17 Markel 736873092 1.26 39.41
18 State Farm Insurance 693917860 1.18 76.94
19 Axis Capital Holdings (AXS) 611440191 1.04 63.26
20 Cincinnati Financial (CINF) 592847793 1.01 40.97
Total 42,481,981,762 72.43
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Last edited by netrashetty; February 9th, 2011 at 02:50 PM..
   
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