American Financial Group

Moat: 2/5

Understandability: 4/5

Balance Sheet Health: 4/5

American Financial Group is a diversified insurance holding company primarily engaged in property and casualty insurance, with a focus on specialized commercial insurance for businesses, and a small life and annuity business.

Investor Relations Previous Earnings Calls

The moat, understandability, and balance sheet health scores reflect a conservative evaluation to ensure a margin of safety in any assessment.

Business Overview: American Financial Group (AFG) operates as a diversified insurance holding company. Its main operations are in property and casualty insurance, with a focus on specialized commercial insurance lines. It also has a smaller business in life insurance and annuities. AFG conducts business through subsidiaries, all of which are run semi-autonomously.

  • Revenue Distribution:
    • AFG primarily generates revenue through premiums from its insurance business.
    • Its Specialty Financial segment includes premiums for coverage in specialty markets.
    • Property and Transportation includes insurance premiums from a variety of lines including commercial auto, ocean marine, and inland marine.
    • The company also earns revenue from investment income and other non-insurance businesses.
  • Industry Trends:
    • The insurance industry is subject to various market forces, including interest rate fluctuations, natural disasters, changes in regulatory requirements, and a constantly evolving competitive landscape.
    • In the property and casualty sector, premium rates and volume are subject to cyclical swings and economic pressures that may materially impact the insurance business.
    • There is increasing reliance on data analysis and technology to drive underwriting performance.
    • Insurance companies continue to face increased costs associated with higher inflation.
  • Margins:
    • AFG focuses on underwriting profitability, a key component of which is its combined ratio. A lower combined ratio indicates better profitability.
    • Recent economic shifts have impacted the expense ratios across some segments as well.
    • The company has reported positive underwriting gains in some businesses, including a significant contribution from their Specialty and P&C insurance operations.
    • Investment income also plays a significant role in overall profit.
  • Competitive Landscape:
    • The insurance industry is competitive, with numerous participants across all segments.
    • AFG’s competitive positioning is somewhat unique, given the focus on specialist markets.
    • Companies compete for market share via pricing, customer service, brand recognition and technology innovation.
  • What Makes AFG Different:
    • Management focuses on niche markets with higher returns rather than commoditized or low-margin businesses.
    • AFG emphasizes the stability and predictability of earnings.

Financials Overview (Based on recent reports and earnings calls): AFG’s recent financial performance reflects a few noteworthy trends:

  • The company achieved strong financial results in the third quarter of 2023, with increases in premiums and investment income. A key contributor was the Property and Casualty Insurance segment.
  • Despite increases in loss and LAE reserves, particularly in the Speciality Property and Casualty business, earnings remained healthy due to improved pricing.
  • Management has focused on returning cash to shareholders with dividends and buybacks.
  • Net earnings were $242 million in 3Q 2023, or $2.75 per share, compared to $218 million, or $2.36 per share in the same period 2022
  • Through the nine-month period, AGF recorded net earnings of $632 million, or $7.12 per share, which includes a decrease from $926 million, or $10.05 in the same period from 2022.
  • Despite higher cat losses, improved pricing in insurance business contributed to solid results.
  • A focus on share buybacks, to further enhance shareholder returns.
  • The specialty financial group had strong performance, partially offset by lower investment income outside of the specialty group.

Moat Analysis: AFG’s moat is assessed as narrow, with sources of competitive advantage.

  • Intangible Assets: AFG relies somewhat on brand recognition, especially in specialty niches such as American Financial Group, Great American and National Interstate, but this brand strength is limited due to insurance being based more on price and coverage.
  • Switching Costs: The nature of insurance coverage creates some friction to changing insurers, as customers build relationships, learn processes, and develop certain preferences for providers.
  • Cost Advantages: AFG has some advantage with their specialty business by using technology to streamline claims processes and underwrite business more effectively, but this is easily replicable, and they do not have the economies of scale a larger insurer might have.
  • Network Effects: AFG doesn’t benefit from network effects.

Moat Rating: 2/5

Risks That Can Harm the Moat:

  • Competition: Intense competition in the insurance industry could pressure premium pricing.
  • Technological Disruption: New insurtech models could erode switching costs that make companies less sticky.
  • Regulatory Changes: Evolving insurance regulations or government policy may pose a threat.
  • Catastrophic Events: More frequent and severe losses will negatively affect profitability.
  • Interest Rate Changes: An increase in interest rates can reduce the value of bonds held and could impact overall profitability.

Business Resilience:

  • The nature of insurance, with a broad mix of geographical areas and policies, offers a degree of stability. * Management has a strong track record and focuses on profitability over growth.
  • AFG’s focus on specialty insurance reduces the risk associated with commoditization of core products.

Understandability Rating: 4/5

The business is relatively straightforward to understand as it involves a wide variety of insurance products, however, with special focuses on different sectors of the economy. However, there are some unique elements in how they do business, such as the reliance on niche and specialty markets, that make the business somewhat difficult to fully comprehend.

Balance Sheet Health Rating: 4/5

AFG’s balance sheet shows overall stability and resilience.

  • Their debt-to-capital ratio hovers at ~23-24 percent which is within the parameters management aims for (at or below 30% and is also below sector averages) * The company generates strong operating cash flow, and the capital structure is stable.
  • It holds large amounts of unassigned and available capital, providing flexibility. *The credit ratings were also generally in the single A rating or above.

Recent Concerns/Controversies:

  • High cat losses in 2023 in their property and casualty insurance segment. Although, they say better underwriting should offset this in the long term.
  • They have a large fixed maturity portfolio that can be hurt by rapidly changing interest rates.
  • They need to improve their financial analysis in their specialty lines of business to have more granular data.
  • They have seen higher expenses in their core segments.

In conclusion, AFG is a profitable company that has a management team that focuses on building and maintaining their niche businesses while carefully allocating capital. They have stable financial performance and a decent track record of returning cash to shareholders, giving them a better overall rating of 2/5 for moat, 4/5 for understandability and 4/5 for balance sheet health.