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%. The lower the combined ratio is below 100%, the higher the profit earned on previously written policies is.
The company employs 5,300 in its property and casualty insurance business. 
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. 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%. 
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.  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.
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.
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.
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.  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.
The following graph shows the size of tort settlements in the past three years relative to net income.
The industry AFE competes in is highly competitive due to price competition and low barriers to entry.  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.  Competition is based on many factors, including service and reputation as well as price.
Competitors include: 
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|
|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|
|15||Arch Capital Group||777243994||1.32||46.7|
|16||Berkshire Hathaway (BRK)||752121011||1.28||19.78|
|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|