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Maximilian Thompson

AFE AT A GLANCE

 

 

 

 

 

 

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.

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.

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References

1. ↑ AFE. Annual Report, 10-k, Property and Casualty Insurance Operations, p. 1.
2. ↑ AFE. Annual Report, 10-k, Segment Information.
3. ↑ AFG. Annual Report, 10-k, Property and Casualty Insurance Operations, p. 1.
4. ↑ [1]
5. ↑ AFE. Annual Report, 10-k, Property and Casualty Insurance Operations, p. 15.
6. ↑ Reuters, Towers Perrin Survey. 17-Jan-2008 BW20080117 Towers Perrin Commercial Insurance Pricing Study Reports Modest Price Decreases.
7. ↑ AFE. Annual Report, 10-k, Property and Casualty Insurance Operations, p. 15.
8. ↑ Friedman, Fliescher, Lowe, LLC. The Insurance Industry's Ability to Attract Capital Given Historically Low ROE.
9. ↑ ^{9.0 9.1 9.2} [2]
10. ↑ AFG. Annual Report, 10-k, Risk Factors, p. 17.
11. ↑ AFE. Annual Report, 10-k, Legal Proceedings, p. 20.
12. ↑ AFE. Annual Report, 10-k, Legal Proceedings, p. 37.
13. ↑ AFE. Annual Report, 10-k, Legal Proceedings, p. 19.
14. ↑ AFE. Annual Report, 10-k, Legal Proceedings, p. 19.
15. ↑ AFE. Annual Report, 10-k, Risk Factors, p. 13.
16. ↑ AFE. Annual Report, 10-k, Risk Factors, p. 13.
17. ↑ AFE. Annual Report, 10-k, Risk Factors, p. 13.
18. ↑ Company Website, "History"
19. ↑ Yahoo Finance
20. ↑ Boom Bust Blog
21. ↑ National Association of Insurance Commissioners. Annual Report 2008.