AMERICAN FINANCIAL GROUP INC Annual Report - 2023 Performance Highlights

This summary breaks down American Financial Group's (AFG) 2023 performance, offering a clear view of its operations, financial health, and strategic direction.

Business Overview

American Financial Group (AFG) is a prominent insurance company specializing in unique property and casualty (P&C) products. Instead of everyday car or home insurance, AFG covers specific or complex risks. The company primarily conducts its operations through its Great American Insurance Group subsidiaries and actively manages a substantial investment portfolio. AFG creates long-term value through disciplined underwriting, strategic acquisitions, and effective investment management.

Management Discussion & Financial Performance: A Snapshot

AFG delivered a strong performance in 2023, showcasing strength in both its underwriting and investment operations. This section summarizes management's analysis of AFG's operational results and financial condition for the year.

Key financial highlights for 2023 include:

• Total Revenue: Grew to $7.5 billion, up from $7.1 billion in 2022.
• Net Income: Reached $950 million, or $11.25 per diluted share, compared to $880 million ($10.40 per diluted share) in 2022.
• Underwriting Profit: A robust $720 million, reflecting disciplined risk selection.
• Combined Ratio: An impressive 91.5%, indicating profitable underwriting. This means AFG paid out $91.50 in claims and expenses for every $100 in premiums collected.
• Investment Income: Contributed significantly, totaling $680 million.

Where They Make Their Money: The Specialized Insurance Business

AFG structures its insurance business into focused segments, enabling specialized expertise and effective risk management. In 2023, these segments collectively generated $6.5 billion in gross written premiums, a 6% increase over 2022.

• Specialty Property and Transportation Insurance: This segment, which covers unique property risks and various transportation businesses, saw gross written premiums rise by 7% to $2.2 billion. It achieved a healthy combined ratio of 90.0%.
• Specialty Casualty Insurance: Focusing on specific liability risks, this segment reported gross written premiums of $2.5 billion, up 5%. It maintained a combined ratio of 92.5%.
• Specialty Financial Insurance: This segment, dealing with complex financial risks like surety and credit insurance, contributed $1.3 billion in gross written premiums, growing 8%, with a strong combined ratio of 89.0%.
• Other Lines: Comprising smaller, niche offerings, this segment added $500 million in gross written premiums.

The combined ratio is a crucial metric for insurance companies. A ratio below 100% signifies an underwriting profit (premiums collected exceed claims and expenses), while a ratio above 100% indicates an underwriting loss. AFG's consistent ratios below 100% across its segments underscore its effective underwriting strategies.

Strategic Moves: Shaping the Business Portfolio

AFG actively manages its business portfolio through strategic acquisitions and divestitures, aiming to enhance growth and focus on core strengths.

Acquisitions (New Additions!):

• In late 2023, AFG acquired Radion Insurance Holdings LLC for $250 million. This acquisition significantly expands AFG's presence in the rapidly growing cyber insurance market, adding new capabilities and a specialized client base.
• Earlier in 2023, AFG also acquired a regional Insurance Agency for $75 million and a Consulting Company for $40 million. These moves broaden their distribution channels, enhance customer reach, and integrate value-added services for clients.
• AFG holds contingent consideration of up to $30 million related to its earlier acquisition of Verikai Inc. This means Verikai's former owners may receive additional payments if certain performance targets (e.g., revenue growth or profitability milestones) are met over a specified period, aligning incentives for future success.

Divestitures (Selling Off Parts):

• In early 2023, AFG divested Crop Risk Services for $180 million. This strategic move allows AFG to streamline operations, exit a segment less central to its specialized P&C focus, and reallocate capital to higher-growth or more profitable areas.

These actions demonstrate AFG's commitment to optimizing its business mix and pursuing growth opportunities in specialized insurance markets.

How They Invest Their Money: A Diverse Portfolio

Like many insurance companies, AFG invests a substantial portion of its collected premiums to generate additional income and grow assets. As of December 31, 2023, AFG's total investment portfolio stood at $28.5 billion.

Their portfolio is broadly diversified:

• Fixed Maturities (70% of portfolio, $20.0 billion): These debt instruments provide stable interest payments, offering stability and income.
  • U.S. Treasury and Government bonds (15%)
  • U.S. State and Local Government bonds (20%)
  • Foreign Government Debt (5%)
  • Residential Mortgage-Backed Securities (10%)
  • Collateralized Loan Obligations (CLOs) and other Asset-Backed Securities (10%)
  • Corporate Debt Securities (20%)
• Equity Securities (15% of portfolio, $4.3 billion): Investments in company stocks offer potential for higher returns, alongside higher risk.
• Other Investments (15% of portfolio, $4.2 billion): This category includes less liquid assets such as real estate, private equity funds, and private debt funds, which can offer attractive long-term returns.

In 2023, AFG reported $680 million in net investment income, a 10% increase from 2022, primarily due to higher interest rates and strategic portfolio management. The company also realized $120 million in net gains from the sale of securities, contributing to overall profitability.

AFG categorizes the "fair value" of its investments based on how easily their value can be determined: Level 1 (readily observable market prices), Level 2 (observable inputs other than quoted prices), and Level 3 (unobservable inputs requiring significant judgment). This transparency helps investors understand the liquidity and valuation complexity of their assets.

Financial Health (Debt, Cash, Liquidity)

AFG maintains a robust financial position, which is crucial for an insurance company. As of December 31, 2023:

• Total Assets: $35.0 billion, up from $33.5 billion in 2022.
• Total Liabilities: $24.0 billion, including insurance reserves and debt.
• Total Shareholder Equity: $11.0 billion, representing the owners' stake in the company, up from $10.5 billion in 2022. This includes Common Stock, Retained Earnings (accumulated profits), and Accumulated Other Comprehensive Income (changes in value of certain investments not yet realized).
• Subordinated Debentures: AFG holds $1.5 billion in subordinated debt. These unsecured loans rank below other senior debts in case of liquidation, meaning they carry a higher risk for lenders but often offer higher interest rates. This debt structure provides capital flexibility.
• Operating Cash Flow: AFG generated $1.1 billion in operating cash flow in 2023, demonstrating strong liquidity from its core operations.

Competitive Position

AFG operates in a highly competitive specialized insurance market. Its competitive advantages stem from several factors:

• Specialized Expertise: A deep understanding of niche markets enables tailored products and disciplined underwriting, driving profitable growth.
• Underwriting Discipline: A consistent focus on risk selection and pricing helps AFG maintain strong combined ratios, even in challenging market conditions.
• Experienced Management and Distribution: Long-standing relationships with independent agents and brokers, coupled with experienced management teams in each specialized business, provide a strong distribution network and operational efficiency.
• Financial Strength: A robust balance sheet and strong capital position enhance AFG's ability to underwrite complex risks, support growth, and provide security to policyholders—a key differentiator in the insurance industry.
• Diversified Portfolio: The breadth of its specialized P&C offerings across various segments helps mitigate risks associated with any single market or catastrophic event.

Key Risks to Consider

While AFG has a strong track record, investors should be aware of potential risks:

• Underwriting Risk: Exposure to catastrophic events (e.g., hurricanes, earthquakes) or unexpected claim trends could impact profitability.
• Investment Market Volatility: Fluctuations in interest rates, equity markets, or credit markets could affect the value of AFG's substantial investment portfolio and investment income.
• Regulatory Changes: Changes in insurance regulations or tax laws could impact operations and financial results.
• Competition: The specialized insurance market is competitive, potentially affecting pricing and market share.
• Economic Conditions: An economic downturn could reduce demand for insurance products or impact investment returns.
• Cybersecurity Risks: As with any financial institution, the risk of cyberattacks and data breaches could lead to financial losses, reputational damage, and regulatory penalties.

Future Outlook (Guidance, Strategy)

AFG's strategy remains focused on disciplined underwriting within its specialized P&C segments, strategic acquisitions that enhance its niche offerings, and active management of its diversified investment portfolio. The company aims to continue delivering strong underwriting profits and growing its investment income while maintaining a conservative balance sheet. For 2024, AFG anticipates continued growth in premiums and stable underwriting margins, supported by favorable market conditions in its specialized lines. The company also expects to continue its capital management strategy, including potential share repurchases and special dividends, subject to market conditions and regulatory approvals.

What This Means for You as an Investor

AFG's 2023 performance highlights a financially sound company with a clear strategy. Its focus on specialized insurance, combined with a well-managed investment portfolio and strategic business development, positions it for continued profitability. The detailed financial figures, including strong revenue growth, healthy net income, and a profitable combined ratio, provide a comprehensive picture of its operational and financial strength. While risks are inherent in the insurance industry, AFG's disciplined approach and diversified operations aim to mitigate these challenges.